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22–186 PDF








JUNE 28, 2005

Serial No. 109–145

Printed for the use of the Committee on the Judiciary
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Available via the World Wide Web: http://judiciary.house.gov


F. JAMES SENSENBRENNER, Jr., Wisconsin, Chairman
HENRY J. HYDE, Illinois
HOWARD COBLE, North Carolina
BOB INGLIS, South Carolina
MARK GREEN, Wisconsin
DARRELL ISSA, California
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JOHN CONYERS, Jr., Michigan
HOWARD L. BERMAN, California
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ADAM B. SCHIFF, California
LINDA T. SÁNCHEZ, California

PHILIP G. KIKO, Chief of Staff-General Counsel
PERRY H. APELBAUM, Minority Chief Counsel

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Subcommittee on Commercial and Administrative Law

CHRIS CANNON, Utah Chairman

HOWARD COBLE, North Carolina
MARK GREEN, Wisconsin

MELVIN L. WATT, North Carolina
WILLIAM D. DELAHUNT, Massachusetts

JAMES DALEY, Full Committee Counsel
STEPHANIE MOORE, Minority Counsel


JUNE 28, 2005
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    The Honorable Chris Cannon, a Representative in Congress from the State of Utah, and Chairman, Subcommittee on Commercial and Administrative Law

    The Honorable Melvin L. Watt, a Representative in Congress from the State of North Carolina, and Ranking Member, Subcommittee on Commercial and Administrative Law

    The Honorable William D. Delahunt, a Representative in Congress from the State of Massachusetts, and Member, Subcommittee on the Judiciary

    The Honorable Louie Gohmert, a Representative in Congress from the State of Texas, and Member, Subcommittee on the Judiciary


Mr. Thomas Smegal, Chairman of the Board, Friends of the Legal Services Corporation
Oral Testimony
Prepared Statement

Mr. Frank B. Strickland, Chairman of the Board of Directors, Legal Services Corporation
Oral Testimony
Prepared Statement

Mr. R. Kirt West, Inspector General, Legal Services Corporation
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Oral Testimony
Prepared Statement


Material Submitted for the Hearing Record

    Letter from Thomas F. Smegal, Jr., Chairman, Friends of Legal Services Corporation, dated December 9, 2004, to Laurie Tarantowicz, Office of the Inspector General, Legal Services Corporation

    Letter from Laurie Tarantowicz, Assistant IG and Legal Counsel, Legal Services Corporation, Office of Inspector General, dated December 13, 2004, to Thomas F. Smegal, Jr., Chairman, Friends of the Legal Services Corporation

    Letter from Thomas Smegal, Chairman,, Friends of Legal Services Corporation, dated February 3, 2005, to Kirt West, Office of the Inspector General, Legal Services Corporation

    Letter from Kirt West, Inspector General, Legal Services Corporation, Office of Inspector General, dated February 23, 2005, to Thomas F. Smegal, Jr., Chairman, Friends of the Legal Services Corporation

    Letter from Thomas F. Smegal, Jr., Chair, Friends of Legal Services Corporation, dated March 2, 2005, to Kirt West, Inspector General, Office of the Inspector General, Legal Services Corporation
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    Letter from Laurie Tarantowicz, Assistant IG and Legal Counsel, Legal Services Corporation, Office of Inspector General, dated March 7, 2005, to Thomas F. Smegal, Jr., Chairman, Friends of the Legal Services Corporation

    Response to Post-Hearing Questions from Thomas Smegal, Chairman of the Board, Friends of the Legal Services Corporation

    Response to Post-Hearing Questions from Frank B. Strickland, Chairman of the Board of Directors, Legal Services Corporation

    Response to Post-Hearing Questions from R. Kirt West, Inspector General, Legal Services Corporation

    Letter from Thomas Smegal, Chairman of the Board, Friends of the Legal Services Corporation, dated October 13, 2005, to the Honorable Melvin L. Watt, Subcommittee on Commercial and Administrative Law, Committee on the Judiciary


TUESDAY, JUNE 28, 2005

House of Representatives,
Subcommittee on Commercial
and Administrative Law,
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Committee on the Judiciary,
Washington, DC.

    The Subcommittee met, pursuant to notice, at 12:41 p.m., in Room 2141, Rayburn House Office Building, the Honorable Chris Cannon (Chair of the Subcommittee) presiding.

    Mr. CANNON. Good morning, ladies and gentlemen. This hearing of the Subcommittee on Commercial and Administrative Law will now come to order.

    I will keep my opening remarks brief, as I believe that the testimony and the opportunity to ask questions of our witnesses will prove to be more valuable, and I want to leave as much time as possible for the Members of the Subcommittee to utilize this opportunity.

    We consider today the ''Legal Services Corporation: Leasing Choices and Landlord Relations.'' This hearing comes as a result of the findings in the report of the Office of the Inspector General for LSC, a report which raised several issues of serious concern and which was unanimously rejected by the LSC board of directors.

    It is important to stress the reason why we are here. Congress wanted an independent review of the Executive Branch and independent agencies to determine if there is waste, fraud, or abuse occurring in Government generally.

    Is this microphone working?

    In order to aid Congress and the agencies for whom they work in this endeavor, the Inspector General was created. The success that the IGs have had across the spectrum is unquestioned. Upon receiving this report, I'm glad to see the IG at LSC is trying hard to continue in this tradition.
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    The posture which the board and LSC management has adopted in this matter is troublesome. Some of the LSC management questioned the utility of this hearing, despite the conclusions of the IG's report. In view of their reluctance, I'm glad that Mr. Strickland, the board chairman, is here today to answer questions raised by that report.

    At issue today is how federally appropriated dollars are being utilized; whether there is efficient use of those dollars; and whether they are being used appropriately. These issues become all the more important when we're discussing the budget of an organization that is in existence to assure the provision of civil representation to those who could otherwise not afford it, and whose every inefficiency equates to the loss of representation to a potential client in need. These are serious questions which I can assure you this Committee and I will always have time for.

    I would like to thank each of our witnesses for taking the time to inform the Subcommittee of the facts involving this arrangement between LSC and Friends of LSC.

    At this time, I'd like to recognize my good friend and distinguished Ranking Member, Mr. Watt. I understand there are some issues he would like to address at this time. With the permission of Mr. Watt and the Subcommittee, I would also like to comment on the issues which he presents. I believe them to be of great concern to our body and our ability to conduct hearings which are conductive and can accomplish that which Congress needs to do as this Government's legislative arm. Thank you, Mr. Watt.

    Mr. WATT. Thank you, Mr. Chairman. And I want to start by thanking the Chairman for convening this oversight hearing of the Legal Services Corporation which, in my estimation, is an extremely vital part of our legal system.
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    Last year, the Legal Services Corporation celebrated its 30th anniversary. It was created by Congress in 1974 to ensure that Americans have access to our justice system regardless of their economic means. The Legal Services Corporation has for three decades lived up to the high purpose for which it was created, providing legal assistance in civil matters to tens of millions of low-income Americans who would have otherwise gone without counsel.

    Today, we are here to exercise our oversight responsibilities with respect to the Legal Services Corporation. The briefing materials issued by the Chairman in preparation for this hearing identify the purpose of the hearing to be, ''to examine the fiscal soundness of a lease entered into by Legal Services Corporation, the potentially false representations made by Friends of the Legal Services Corporation, the relationship key agents played in the interactions occurring between the Legal Services Corporation and Friends of the Legal Services Corporation, and the overall relationship between the Legal Services Corporation and Friends of the Legal Services Corporation.'' That's the purpose for which this hearing is here.

    Now, today we have three witnesses before us, and we have an empty chair in front of which I've taken the liberty of putting the name of the fourth witness who we've been trying to get to be here. The empty chair was to be occupied by John McKay, who is currently the U.S. Attorney for the Western District of Washington State. For the second consecutive year, the U.S. Department of Justice has thumbed its nose at a legitimate request from Congress, and refused to allow Mr. McKay to testify about the matters about which he has personal, historical, and professional knowledge.

    Before I continue, Mr. Chairman, I do want to acknowledge the support and assistance you have provided in attempting to secure Mr. McKay's presence. I believe you agree that the Department of Justice is undermining the ability of this Subcommittee to faithfully execute its oversight function.
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    The position of the Justice Department lacks credibility. Last year we were told, ''DOJ officials testify on DOJ matters, not on matters relating to other entities.'' Similarly, this year we were told that, ''Department of Justice witnesses testify about Department of Justice issues.''

    Notwithstanding this curious position, on Mr. McKay's DOJ website, his bio proudly proclaims, ''Between 1997 and 2001, Mr. McKay served as the president of the Legal Services Corporation in Washington, D.C. Mr. McKay's tenure at the Legal Services Corporation was characterized by a bipartisan approach to working with Congress, driven by a deeply-held commitment to the principle of equal justice.'' Apparently, that approach has not been adopted by Mr. McKay's superiors, who have again treated this Subcommittee with disdain.

    Mr. Chairman, I have specifically requested from the Department an official copy or reference to the policy that prohibits DOJ employees from responding to invitations from Congress to testify about issues relevant to their prior Government service—all to no avail. Can it be that the DOJ requires all of its employees to check their past lives at the door, even when the past life was with other entities of, or connected to, the Federal Government?

    I have not asked for Mr. McKay's cooperation because I think he would make an entertaining witness. The focus of this hearing is on the leasing arrangement between the Legal Services Corporation and the Friends of the Legal Services Corporation, Inc. Mr. McKay is integral to that leasing arrangement, which is both complicated in detail and lacks some key documentation.

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    Mr. McKay's role in the formation of Friends is undisputed. Let me quote from some of the submitted testimony. Mr. Smegal, Chair of Friends, states this concept of Friends—and I'm quoting, ''The concept of a Friends-owned building, leased to LSC for its administrative headquarters at a flat, fixed rate, was the motivation for the efforts of those including John McKay and Congressman John Erlenborn during their terms as president of LSC.''

    Mr. Strickland, the Chair of the LSC Board, states, ''This transaction was conceived by John McKay, who President Bush appointed as, and is now U.S. Attorney for the Western District of Washington.'' Even the Inspector General acknowledges Mr. McKay's role by reference to the dates of his presidency of LSC.

    As one of, if not the principal architect of the lease arrangement that we now review, Mr. McKay's presence is vital to a complete understanding of LSC's intent in entering into this arrangement with the Friends of LSC.

    While it is true that Congressman Erlenborn made many of the subsequent decisions necessary to implement the concept, he is, unfortunately, ill, and therefore unavailable to testify.

    The present president, Ms. Barnett, has only been over—been at Legal Services for a little over a year.

    Mr. McKay is the only prior LSC official with knowledge of the contemporaneous events and circumstances surrounding the lease arrangement that we are now asked to scrutinize so closely. Mr. McKay, at least last term, was willing to testify. This year, after 20 days of negotiating with the Department of Justice commencing on June 8, we were advised only yesterday, and I quote from a DOJ e-mail, ''Even if we agree that U.S. Attorney McKay should participate in this hearing—which we don't—he could not do it anyway, because we were told last week that he was away on vacation.''
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    It strikes me that that response is arrogant and insulting. Either the DOJ is totally inept, or completely contemptuous of this Congress.

    This matter was left unresolved last term, Mr. Chairman. But given Mr. Erlenborn's condition, it will certainly arise again if this Subcommittee is serious about getting to the facts about this lease arrangement.

    I will listen to the witnesses who are here today; but without Mr. McKay present before us, actively engaged in the dynamics of a hearing about his brainchild, the Friends of the LSC, and about a period he proudly and clearly—without the Department of Justice's objection—boasts on his website about, I certainly can't consider this record complete.

    Mr. Chairman, I hope that you will actively join with me to pursue this to an appropriate conclusion. I believe that the time is now for us to consider issuing a subpoena to either Mr. McKay or the appropriate Department of Justice official or officials who continue to disregard and disrespect this Committee's jurisdiction. And I yield back the balance of my time, if I have any.

    Mr. CANNON. Thank you. Let me just add to your comments that being on vacation is not an appropriate reason to not be here, especially when one wonders whether the vacation was planned in advanced, or a matter of convenience.

    The request that we made of Mr. McKay was as you said, a legitimate request. And it is not possible for us to faithfully fulfill—again, quoting you, Mr. Watt—our oversight obligations, if we don't have the ability to bring witnesses before us.
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    You mentioned that the Department of Justice is contemptuous. There may be people there who are contemptuous, who need to learn a lesson. And may I just suggest for the gentleman that I am willing to consider leaving this hearing open at the end of the hearing—recessing, rather than adjourning, so that we retain our options as they relate to Mr. McKay and the Department of Justice.

    Mr. WATT. If the gentleman would yield on that point?

    Mr. CANNON. Certainly.

    Mr. WATT. I've been told though, that the Chairman of our full Committee will not allow that to happen, so I suspect——

    Mr. CANNON. But actually, I'll run it by the Chairman of the full Committee just—I think we actually have authority here in our Committee to do what we want to do; but he was gracious enough to suggest that if we wanted to keep it open, he would be fine with that.

    Mr. WATT. Hallelujah.

    Mr. CANNON. The heavens open. I'm only going to introduce our board Members and submit their background for the record for purposes of conserving time here. I want to just say that we're very grateful to have the people who are here, who are outstanding individuals with terrific histories.
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    We'll begin with Mr. Thomas Smegal, who is the Chairman of the Board of Friends of Legal Services Corporation; and then go to Mr. Frank Strickland, who is the Chairman of the Board of Directors of the Legal Services Corporation; and then finally, we'll go to Mr. Kirt West, who is the Inspector General for Legal Services Corporation.

    And if you gentlemen will excuse me for not giving your whole bios here, I would appreciate that. And let us begin, Mr. Smegal——

    Mr. DELAHUNT. Mr. Chairman, I would like to make a statement.

    Mr. CANNON. Oh, the gentleman from Massachusetts. Or would anyone else like to make an opening statement at this point?

    [No response.]

    Mr. DELAHUNT. I'd just like to make an observation.

    Mr. CANNON. The gentleman is recognized for 5 minutes.

    Mr. DELAHUNT. I'm conflicted about this hearing. First, let me say that I think it's important that we conduct aggressive oversight. And I want to compliment the Chair of the Subcommittee, the Chair of the full Committee, for their work with Members on this side, in terms of doing that oversight in a way that is in camera, if you will.

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    And I see Mr. Daley here. Let me also acknowledge his role in terms of conducting oversight into the FBI.

    And I think we need to be much more aggressive in public. Yet at the same time, here we are with the LSC again. A year or two ago, we were talking about a lease where there was a disagreement over—I don't know—$1,000 a month. I'm looking at the facts as put—as memorialized in a memorandum.

    And again, I'll just presume that these facts, in arguendo, are accurate. Over the life of the lease, they will overpay 1.2 to 1.9 million. This is according to the Inspector General. And I should add that there appears to be a disagreement between the board of directors and the IG, and I'm sure that's what we'll hear about today.

    It's submitted that there could be saved 680,000, plus a 440,000 early termination fee, by staying at original location. And yet, here we are in Congress, Mr. Chairman, where it was just this past week that there was a congressional hearing on the development fund for Iraq—the first occasion for an oversight hearing—where there are allegations of fraud, waste, and abuse of some 9 billion. I guess I'm talking about proportionality here. I think it's time that we take on some issues that have more significance than the one we are today.

    Having said that, I think we need a sense of proportion. And I would like to discuss with you and Mr. Watt and other Members, as well as the Chair of the full Committee, some areas. And I think we should communicate in letter, requesting oversight hearings into areas that I think have vastly more significance, with all due respect to Legal Services, because Legal Services is an easy target. And again, I think we should have a conversation, and then a letter.
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    But—my final observation—to think that the Department of Justice—and I've met Mr. McKay, and I found him to be an individual of integrity, and I think he attempted to do well by Legal Services. I'm sure that this disagreement most likely will be a matter of opinion, but will establish that people were motivated by an effort to do better by Legal Services Corporation.

    But at the same time, to think that the Department of Justice won't provide Mr. McKay for testimony, that is contemptuous. And I would remind the Chair that I served with—on an ad hoc basis with the Government Reform Committee, and we ran into the same resistance there. And Chairman Burton had to threaten the White House with a contempt citation before there was cooperation. And again, I would suggest that it wasn't a full measure of cooperation; not what should be expected to a congressional Committee.

    And I would add that Chairman Burton had bipartisan, full support of every single Member of that Committee to issue a subpoena. So I would just mention that to you, and suggest that that's something to consider.

    One further final thought. When we talk about the sunset provision in the hearings that the Crime Subcommittee has had—and I know the Chairman of the Crime Subcommittee is here, Mr. Coble; and I see my friend from Texas, Mr. Gohmert—if this isn't an example of what myself and others have been saying about the need for a sunset provision to ensure that there is cooperation and collaboration by the Department of Justice, I can't think of a better case.

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    With that, I'll yield back.

    Mr. CANNON. If the gentleman would yield just for a moment, let me just say that no one has been more careful of the prerogatives of Congress than I have, regardless of the Administration, Republican or Democrat. And so I agree with the gentleman.

    And putting in perspective this hearing—and I think Mr. McKay is relevant to that fact—if he were here, that would help us solve the problem at one time and move on to what I agree with the gentleman are much more important problems. That said, I believe that our role here is, when we have a problem as has presented itself before us today, that we need to look at it. And it will be interesting to hear our witnesses present their information and be questioned.

    There is no question but what there's a problem. The problem is not in the nature of the 1.2 million or the 1.9 million dollars for rent. The question is in the nature of the relationship between the two organizations, a relationship that was created in the context of a rule by OMB that would have disallowed Legal Services Corporation from owning its own home because of its scoring rules.

    And so I think this is an appropriate time to look carefully and intimately into this problem, and then move on. But I agree with the gentleman, we have many things that we ought to look to. And we in particular ought to be enormously concerned about the prerogatives of this body, as opposed to those of what every Administration is going to presume, as opposed to what is appropriate. So I pledge to the gentleman that we'll work together both on our oversight process and as to this witness who is not with us today, in particular.
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    Are there other Members who would like to make an opening statement? Mr. Gohmert? The gentleman is recognized for 5 minutes.

    Mr. GOHMERT. I thank you, Mr. Chairman. And I would like to applaud you for calling the hearing. And even though some might feel like 1.2 to 1.9 million dollars overpayment over a 10-year period is not all that significant, as the old adage goes, you know, ''A million here, and a million there, and before long you're talking about—''

    Mr. DELAHUNT. ''A billion.''

    Mr. GOHMERT. Well, we're dealing with a million here, so before long you're talking real money.

    But it is important. And where we have an institution that's supposed to be providing legal advice and helping others with legal rights, my goodness, they certainly ought to be able to help themselves appropriately, ethically. And I think it's certainly worthy of review and oversight, and I applaud the Chairman, regardless of what Administration is in the White House. And I think it speaks volumes for the Chairman that we'd have a hearing of this nature with Republicans in the White House. It just shows, if there's some problem, we're not going to mask it. Let's get it out there where we can look at it.

    Now, I would like to also hear from Mr. McKay. I couldn't agree with my friend from Massachusetts more on that, and with Mr. Watt, as well. I think from what I was hearing there's a multiple problem, a multi-faceted problem in that he's on vacation, as well. But I get the impression that we're going to get a chance to hear from Mr. McKay, if enough of us want to hear from him, and that's what it sounds like.
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    So I'm very interested in getting to the bottom of this, especially where we have officers of the bar who are supposed to be providing help to other people and yet, if you do what my old professor in law school said and apply the smell test, there's an odor here that is not good, and we need to get to the bottom of it. So I appreciate the chance.

    Mr. WATT. Would the gentleman yield just briefly?

    Mr. GOHMERT. Surely.

    Mr. WATT. Just he hasn't been around quite as long as we have. But I've been working on getting Mr. McKay here for 2 years, and I haven't seen him yet. So my patience is running a little thin.

    Mr. GOHMERT. Well, there is——

    Mr. CANNON. If the gentleman would yield, I've been here for the last 2 years, and my patience is—''thin'' is a gentle way to say it.

    Mr. GOHMERT. Well, I'm newer here, and I have that hope that springs eternal in the human breast, I guess. And I believe we're going to get him here at an appropriate time, so I would encourage the Chairman. And I expect to see that happen, or there will be consequences.

    But I appreciate the effort, and I applaud the Chairman's effort, and thank you for allowing me to be a part of it.
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    Mr. CANNON. The gentleman yields back. Without further opening statements, let's turn to the panelists. Mr. Smegal, would you please take 5 minutes and explain. I assure you, we'll have time after.

    There's a light in front of you illuminating all panelists. It stays green for 4 minutes; turns yellow for a minute; and then turns red. You don't have to stop in the middle of a sentence, but if you could begin to wrap up at that point, we'd appreciate it. Thank you.


    Mr. SMEGAL. Thank you, Chairman Cannon, Ranking Member Watt, and the outpouring of others at this Committee. I appreciate the opportunity to address you. My name is Thomas Smegal, and I am Chairman of this Board of the Friends of the Legal Services Corporation, which is a District of Columbia non-profit Corporation recognized by the Internal Revenue Service as a public charity under section 501(c)(3) of the Internal Revenue Code.

    Congressman Watt, in my past life—you mentioned John McKay's past life—in my past life, I was first honored to be nominated by President Reagan in 1984 to serve on the Legal Services Corporation Board. In 1993, I was again honored by President Clinton to serve on this board, and I served over the course—each of those nominations, by the way, were confirmed unanimously by the United States Senate—and I served for approximately 18 years.

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    Now, I've made an attempt to balance a Federal budget while I've been on the board—while I was on the board. There's an attendance fee that members of the board get. Chairman Strickland tells me it's now $318. I didn't take that $318 a day for the 20 years I was on that board. I worked on my own nickel. I represent friends pro bono. The only compensation I have ever gotten—and I haven't gotten it yet—is that I understand from Mr. Daley that I may be reimbursed for my plane fare and hotel room last night, in coming to attend this hearing.

    Friends was established in 2001, during my then most recent term on the Board of the Legal Services Corporation. Until a month ago, when we replaced a pro bono staff person from the Corporation, there was no one who was paid to be part of Friends of the Legal Services Corporation. Friends has always been staffed by non-paid volunteers. Its sole mission has been to act in the best interests of the Legal Services Corporation. Upon dissolution of Friends, any asset that has accumulated, including the building that is the subject of this hearing, will revert—must revert—to the Legal Services Corporation.

    The way this process started was when John McKay was president—Congressman Watt pointed out that he was president of this—the staff president of the Legal Services Corporation, as Helaine Barnett is now, from 1997 to, I recall, about June of 2001, when he was then being nominated by President Bush to be the U.S. Attorney for the Western District of Washington. But prior to his departure, in 1999 he and others went to the Office of Management and Budget with the idea that had been created by some of us who were sitting on the board, had been subjected to two leases, payment of two leases, when we became board members in 1992—one at 750 Northeast First Street, and the other on Virginia Avenue. Our prior board had determined to move, expecting property in D.C. in 1991 to be rentable on a sublease, and we paid—we paid double rent for 2 years.
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    Anyway, the concept here was: Is there some way we can cap the rent of the Legal Services Corporation in the District of Columbia? We have to be in the District of Columbia. We have to have space here. And the concept was: If we owned our own building, if the Corporation owned its own building, then maybe we'd have some control over what the rent would be.

    In addition, it occurred to us—and at that time, I spent a lot of time before various Committees of the House and the Senate, defending the Corporation and defending its budget. And we got a lot of—there was a lot of concern upon the Hill here for the Legal Services Corporation. The other concept was: If we had a permanent home, we weren't just wandering around town renting, that maybe that would be helpful with you Members of Congress to demonstrate that we were a vital component of the United States delivery system of legal services.

    So John McKay and others went to OMB and said, ''Here's what we want to do. We want to buy a building.'' And OMB said, ''Well, you can do that, but if you do that, we're going to score it. We're going to take whatever that building costs off the top of your appropriation in whatever year you do it.'' And John McKay and others said, ''Geez, that doesn't sound like something that we want to do, then. Is there any alternative?'' And OMB said, ''Yes, there is an alternative. You can set up a 501(c)(3) corporation which will own the building, and you can rent from that corporation.''

    And there happens to be—and I think Mr. Strickland will share with you several examples of that, that existed before. The Navy has a setup like that; Friends of the Zoo here has a similar situation; and there are a couple of others that Mr. Strickland will get to.
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    In any event, that was the first conversation. There was no Friends of the Legal Services Corporation at that point. The next meeting—and I was part of that meeting, and went to the White House. And we talked to Counsel to the President, Charles Ruff, and we explained to him what we had hoped to do, if we could accomplish this. And the Clinton White House, through Charles Ruff, said, ''This is a great idea.''

    The process kept going. And incidentally, I'm not here to defend the Justice Department. I'm not here to defend John McKay. But let me at least give you a little insight into what was going on. If you want someone who was there all the time and can answer all the questions, I'm here.

    The original Gates offer of $4 million to buy a building occurred in the year 2001—19—no, 2001, when John McKay was, in fact, staff president. The problem with that original grant was that it would expire on December 31, 2001. The problem was at that point we had an opportunity. We hoped to buy a vacant lot up here, which fell through, and December 31 came and went.

    Now, John McKay had left the Corporation in June of 2001. He hadn't been there for 6 months. So when the contact is again made with Bill Gates, Sr., I make the contact. I call Bill Gates, Sr. I say, ''We couldn't make the deal by the end of December 31, 2001. Can you extend the term in which we could have this grant?'' And Bill Gates, Sr., said, ''Well, I'll check with my son. I'll call you back.'' A few months later, I got a call from Bill Gates, Sr., saying, ''I'm going to make your day, Tom. My son says we'll give you the money. You can have additional time in which to find a building for the Legal Services Corporation.''
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    Now, we're now in 2002, and we've got a building in sight. And the significance of the building—which, by the way, has to be a Class ''B'' building, because you can't be a Class ''A'' building unless you have 100,000 square feet of space. The building has 65,000 square feet. As the Inspector General's appraiser points out, it's 46 percent empty. It's the old adage of, ''Is the glass half-full or half-empty?'' To us, that's the good news; because we're looking for space to put the Legal Services Corporation in, in June of 2003, when they can get out of the lease at 750 Northeast First Street.

    We come to Congress; we come to this Committee; we come to the Judiciary Committee on April 23, 2002. There's no lease. There is no deal. We've got a hold on the building. We're trying to get it. We come up here. And John Erlenborn, Vic Fortuno, Lynn Bulan, Mauricio Vivero, and the person who's trying to put this deal together for us, a financial person, Don Carpenter—the five of them come up here. They meet with Patty DeMarco and J. Keith Ausbrook, who I understand then to have been the chief counsels for oversight investigation for this Committee. That was April 23, 2002, at 2 p.m.

    Now, this Committee signed off on the deal, and it was structured at that point. We understood what we were going to do. And then, we went to the only bank that would give us any money. We've got $4 million of Gates' money, maybe, and we have nothing else.

    Mr. CANNON. Mr. Smegal, I apologize for cutting you off, but we have—I can assure you that under questioning time you'll have the opportunity to finish——

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    Mr. SMEGAL. Well——

    Mr. WATT. Can I just yield him my 5 minutes, so we can get a clear picture of how this occurred?

    Mr. CANNON. Yes. Absolutely.

    Mr. SMEGAL. Thank you.

    Mr. CANNON. The gentleman is recognized for an additional 5 minutes.

    Mr. SMEGAL. Well, BankAmerica is very skeptical about this whole deal, and they say, ''Well, geez, we're going to have to give you $15.5 million. We want a million and a half of the Gates money set in a separate account as a reserve, in case you lose your tenant. We want a tenant in that building that will yield $1.7 million a year, so that we know you can service the debt, the 15-point-million-dollar debt that you're going to incur. And as long as you can guarantee us that, then we're willing to give you the opportunity to have this money and go and try and make your deal with the bank.''

    They had an appraiser. The appraiser is in here. You've got the appraiser's report that the BankAmerica—someone they trust; someone they went to; someone they go to a lot. And they said, ''What's this building worth?'' This individual said, ''This building is worth $60.2 million, once they put some tenant improvements in there.'' And the concept was up to $2 million in tenant improvements in this 54 percent of this vacant building that the Corporation is going to occupy in June of 2003.
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    The bank says, ''We'll make the deal. You get $38 a square foot, flat, because that's what we need—'' They didn't say that. ''That's what we need to carry the debt. That's what you're going to need to carry the debt in addition to the million and a half we've asked you to set aside.''

    So we go to the Corporation. John McKay is a year away from what's going on here now. He left in June of 2001. This is now June of 2002. The bank gets their appraisal. The banks says, ''Okay, we've got a deal.'' And I, as part of the Legal Services Corporation—I'm serving on the board—and the rest of us who are involved in this—there's nobody else here. It's just us. There's no conflict of interest. There's nobody. It's the Legal Services Corporation, trying to save the Government some money; trying to create a permanent home.

    So we create a lease. And the lease is for $38 a square foot, flat, forever. No pass-throughs; no increases; nothing. So what else did we do? There's parking spaces in the building. They're going for $175 to $200 a month in 2002. We say, ''A hundred bucks a month, forever.'' What else? No pass-throughs, no tax increases; $38.

    We have a meeting of the board on February 6, 2002. You have the minutes. Bill McAlpin, one of my fellow board members—appointed to the Legal Services Corporation twice—says to me, ''Tom, you know, when we came in the office in 1993, we were saddled with two leases, only one of which we could occupy. And you know, that was troublesome.'' And that was in response to the question he had asked me, ''How long is the lease going to be, Tom?'' And I said, ''Bill, how long do you want the lease to be?''

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    The tax-free Government bonds that I persuaded the District of Columbia to provide to us, in lieu of the $15.5 million in loan from the Bank of America, is a 25-year bond issue. Twenty-five years sounds like an appropriate term.

    The only reason for having the rent level at $38 a square foot, the million-seven, is to service the debt. We have other tenants in the building from which we obtain sufficient funding to accomplish the rest of the management of the building.

    And incidentally, there was some question raised somewhere along the way as to, ''Gee, the other tenants are paying much less. And how come the Corporation is having to pay this incredible amount?'' The other tenant on the fourth floor, Penzance, renewed their lease. We inherited a lot of leases in 2002, in the part of the 46 percent of the building that was occupied.

    Penzance recently executed a lease at $31 a square foot. They pay $175 a month for eight parking places; and they have pass-throughs and bumps every year; and their lease is going to end in 2009. The Corporation's current lease is going to end in 2013.

    Frank Strickland and his board asked for an additional lease extension—we're now past the owning two buildings, or renting two buildings—a number of months ago. And we started to prepare that. And the Inspector General decided that there was something wrong with a lease extension, so we have put that aside. But certainly, at some point we're going to pick that up.

    And incidentally, the other thing that seems to get overlooked in this process, the rest of our tenants are now paying for the space on what is called a BOMA measurement standard. The Corporation is paying on the D.C. standard process. And when you measure with the D.C. standard process, you now get 45,000 feet. If you measure with BOMA, you'd get 48,000-something. The rest of our tenants are paying more rent, based upon the way you measure the building. BOMA is the way you measure buildings in this city presently. The Corporation has the old standard; much less space they're paying for.
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    Your Honor, I appreciate—or Congressman, I appreciate this opportunity. And I expect to hear some questions.

    Mr. CANNON. I thought you were talking to Mr. Watt there for a moment. [Laughter.]

    Who is certainly honorable.

    Mr. SMEGAL. I'm sorry, I do have one other point that I want to make right now. Somebody referred—I think it may have been you, Congressman Gohmert—to this 1.3 to 1.8 million of overpayment over a 10-year period. And it was Adlai Stevenson said, ''A million here and a million there and sometimes—sooner or later, you have a lot of money.''

    The cover letter that the appraiser for Mr. West provided to him in his January 25 report contains the following statement, ''While the lease was—'' And he's evaluating this in 2001–2002. ''While this lease was under negotiation as of our retrospective value date, it had not been signed. And at your request, our evaluation does not include the terms of this lease. Our valuation is based on the terms of the seven existing leases that Friends inherited, encumbering 46 percent of the building, with 54 percent vacant; with the balance of the space being vacant on a current basis.'' Thank you.

    [The prepared statement of Mr. Smegal follows:]

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    Chairman Cannon, Ranking Member Watt and Members of the Subcommittee:

    Thank you for inviting me to speak at this hearing. My name is Thomas Smegal and I am the Chairman of the Board of Friends of the Legal Services Corporation (''Friends''), a District of Columbia non-profit corporation recognized by the Internal Revenue Service as a public charity under Section 501(c)(3) of the Internal Revenue Code.

    In 1984 I was nominated to the Board of the Legal Services Corporation (''Board'') by President Reagan. In 1993 I was again nominated to the Board by President Clinton. Both nominations received unanimous confirmation by the United States Senate and resulted in my serving on the Board for parts of 18 years until 2003.

    Friends was established in 2001 during my most recent term on the Board and at the direction of the Board. Until a month ago when Friends hired a part-time executive director, Friends has always been staffed by non-paid volunteers, including myself. Its sole mission has been to act in the best interests of the Legal Services Corporation (''LSC''). Upon dissolution of Friends, any assets it has accumulated, including the Building that is the subject of this hearing, must revert to the LSC.

    At the outset, let me suggest that, as the Inspector General (''IG'') himself has acknowledged, the discussions we are having today are premature. The IG has stated that his evaluation of the 3333 K Street Lease is not complete. In effect, what we are discussing is an interim report by the IG that says ''LSC is paying more for this car than the price of other cars available at the car dealer.'' What this statement omits is any discussion about whether the car being bought is a used Saturn with 100,000 miles on it or a brand new Buick.
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    In its simplest terms, the IG is saying ''LSC is paying $38 per square foot in rent, and that seems too high to me.'' What that comment ignores—by the IG's own admission—is the rest of the terms of both the Lease itself and the relationship between Friends and LSC. Thus, I would rather that the Subcommittee had the benefit of the full analysis—which the IG has suggested he is undertaking—as that full analysis will show this transaction to have been extremely favorable to both LSC and the Federal Government. However, as we are here today, let me point out the main features of the Lease that the IG has yet to consider and which, I am confident, will obligate him to render a favorable final report when it is written.

    First, the Lease at a fixed $38 per square foot is a long-term lease. All other leases in the building are for 5 years or less, as opposed to the 10-year lease Friends has with LSC. It is customary in the District of Columbia (''DC'') for long-term leases to have different terms than short-term leases. This long-term fixed rate Lease, with the resulting security of tenancy, was one of the primary goals the Board was seeking in looking for new space to occupy when the existing LSC lease on Capitol Hill expired in 2003.

    Second, this long-term Lease does not include any rent increases. A typical long-term lease would include both ''bumps'' every 5 years and CPI increases in each year. As the IG's appraisers acknowledge, even if there were a slightly higher initial rental rate fixed for 10 years, versus a slightly lower initial rental rate that rose over the term of a lease, the actual result would be a net savings to LSC. Further, the IG has yet to consider the added value throughout the Lease term of providing 52 below-market parking privileges to LSC.
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    Third, the Lease is a ''full service'' lease, which transfers the risk of rising real estate taxes, utilities and other operating expenses to the landlord. With oil prices spiraling, you can easily see that the structure of this Lease is highly favorable to LSC.

    Finally, and perhaps more importantly, the IG has not evaluated the unique relationship between Friends and LSC. As I noted in the beginning of this statement, Friends was created by LSC and its sole mission is to support LSC. Once the mortgage on the Building is paid, Friends has several options. Friends can either dissolve and turn the Building over to LSC, rent the Building to third parties and turn over the profits to LSC, or relet the Building to LSC at terms even more favorable to LSC than those provided by the present ten-year Lease.

    The concept of a Friends' owned building, leased to LSC for its administrative headquarters at a flat, fixed rate—to cap the LSC annual rent appropriation requested from Congress—was the motivation for the efforts of those including John McKay and Congressman John Erlenborn during their terms as President of LSC.

    As the attached chart shows, in 1992, the per square foot price of LSC's space was $28 per square foot (DC standard). By 2001, the year Friends was incorporated, that price had risen to $36 per square foot. One of the IG's appraisers projected that LSC's cost was going to rise to nearly $49 per square foot by 2012, and the Board actually saw it going higher than that. By contrast, LSC's current cost per square foot, fixed at $38 gross through 2013, is actually less than $37 net and declining annually when the increasing value of the parking subsidy is thrown in. Thus, as the attached chart clearly illustrates, bringing an end to soaring occupancy costs had already been one of the significant results of the Lease.
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    As the Board informed the IG in its ''Response'' of April 20, 2005, the creation of Friends and acquisition of 3333 K Street were vetted with and approved by his predecessor, OMB and both the Senate and House Appropriations Committees. The structure of Friends as a 501(c)(3) corporation was designed by the Board, based on advice of counsel, to satisfy OMB and CBO budgeting rules, and provide LSC with a mechanism to fix, and then to reduce, and finally to eliminate the occupancy cost component of its budget. Through the acquisition of 3333 K Street by Friends, LSC will be able to devote more of its precious resources—the taxpayers' dollars—to its vital mission of delivering legal services to indigents.

    We are proud of the creativity that went into developing Friends as an opportunity to save taxpayers' dollars, made possible by the generous contribution of the Melinda and Bill Gates Foundation in supporting the LSC mission through the vehicle of Friends.

    Thank you for your time. I'll be happy to respond to any questions.

    Mr. CANNON. Thank you, Mr. Smegal.

    Mr. Strickland, you're recognized for 5 minutes.

    Pardon me. Let me point out, staff has just pointed out that we did not swear witnesses in as we typically do. That's fine. Let me just say that if you swear in, then you're subject to perjury. If you just talk to Congress and say something that would otherwise be perjury, it is telling—it's not being truthful with Congress; which has exactly the same penalties.
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    So I just want to inform you that, in my view, a swearing in is redundant. And given the lawyers we're dealing with, I think you understand the implications of that. And I apologize for that diversion.

    Mr. Strickland, we're looking forward to hearing from you for 5 minutes.


    Mr. STRICKLAND. Thank you. Chairman Cannon and Mr. Watt, and other Members of the Committee, thank you for inviting me to be here today. I'm Frank Strickland, and this is my third year as Chairman of the Board of Directors of the Legal Services Corporation.

    I will add, also, that when our board members were nominated and confirmed in 2003, it was by unanimous vote of the Senate.

    You already have my prepared remarks, which I understand will be entered into the record, so let me just make a few brief comments.

    The transaction we're talking about today is at 3333 K Street. It was conceived by our predecessor board, not the current board. We have simply inherited what was delivered to us. So the question would be: Was it a good deal?

    We think it was. And we've said so in our replies to the Inspector General's report. The evidence to us is clear that what the prior board did was a far better alternative than the continued reliance on the Washington, D.C., commercial real estate market. And the market today, as we understand it, is that non-profit organizations are leaving the District, because they can't afford to pay the rent. LSC doesn't have that option. We're required by law to be located in D.C.
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    Now, another question might be whether everything that was done in connection with the lease transaction was done perfectly. I can't say that it was. But we do believe that our predecessors had a good idea, and that they implemented it successfully.

    Was the transaction transparent? We think it was. You've just heard Mr. Smegal explain all the bases he touched, and others in LSC touched, when the transaction was being contemplated.

    As far as we can tell, Congressman Erlenborn, who was then the president of LSC, and the LSC staff, briefed all appropriate parties, including this Committee and the Office of Inspector General.

    We've been told that because the Inspector General's report did not contain any recommendations, that our board actually did not have to respond. But when we got the report and reviewed it, we concluded that we had to reply to it. We disagreed with the methodology in the report, the conclusions reached in the report, and the characterization of the transaction.

    From the perspective of our board, dealing with a report that's critical of our organization, even though we didn't do the lease transaction, that's very distracting to our board and to our management from doing what we should be doing; and that's trying to run an efficient and effective nationwide program to provide legal assistance to the poor.

    That's our mission, and we shouldn't forget it. We know that in the past there have been disagreements between LSC and the Congress on exactly how our mission should be undertaken. Since I've been the Chairman, our instructions to the staff have been clear. We're going to run an efficient, high-quality legal services program exactly in the manner that Congress intends that we run it.
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    Our predecessors, we believe, were correct in trying to get LSC out of the D.C. office market. They were looking for a way to cap occupancy costs. They were creative, and they put together a deal that was far better than the status quo at the time.

    And as Mr. Smegal said, in doing so, they persuaded the Gates Foundation to donate $4 million, specifically for the purpose of this building. They cleared it with both the Clinton and Bush administrations and briefed the House and the Senate Appropriations Committees, as well as this Committee.

    Mr. Chairman, that concludes my short opening statement.

    [The prepared statement of Mr. Strickland follows:]


    Mr. Chairman, Mr. Watt, and Members of the Subcommittee, thank you for the opportunity today to testify with regard to the current leasing arrangement the Legal Services Corporation has for its headquarters at 3333 K Street, Northwest.

    When I and seven of my fellow members of the LSC Board of Directors had the honor of being nominated by President Bush and unanimously confirmed by the Senate in 2003, our plan was to oversee the delivery of high quality and efficient legal services to the poor throughout America, and to faithfully enforce the intent of Congress as expressed by the various laws governing both LSC and our local legal services programs. I believe we are doing that.
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    One of our first tasks was to fill the two positions at LSC that report directly to the Board. The President, former Congressman John Erlenborn, a distinguished member of this body for twenty years, clearly indicated his desire to retire and we had an acting Inspector General. The Board brought on Helaine Barnett as President in January 2004 and Kirt West as Inspector General last September.

    In February, the Inspector General delivered a draft report prepared by his Office regarding the lease of 3333 K Street. Because that report made no recommendations and did not question the conduct of either the current Board or President, the Board had no legal or substantive obligation to respond, a fact the Inspector General pointed out to us.

    However, because the report stated that LSC was overpaying rent by as much as $1.9 million over 10 years compared to fair market value, and paying more than if it had remained in its previous offices, we decided to examine the report carefully. Moreover, because of vague allusions to conflict of interest and breaches of fiduciary duty, our President in consultation with me decided to appoint a new senior staff person, who had not been present during the transaction, to help the Board review the matter.

    The Board concluded its review in the third week of March. We voted unanimously that, based on the information provided to us by the OIG, we could not conclude that the lease transaction was ''inappropriate or fiscally unsound.'' In short, we rejected the draft OIG report. The final OIG report, basically unmodified from the draft, and the Board response were transmitted to Congress on April 22.

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    Let me quickly highlight the key findings of the Board. First, we had serious problems with the methodology employed by the two appraisers hired by the OIG as well as the manner in which the OIG analyzed those appraisals. The appraisers, on the apparent instructions of the OIG, used a static, retrospective analysis based solely on the state of the commercial real estate market in July 2002. It seems obvious, in reviewing the judgment of the prior Board and Congressman Erlenborn, the evaluation should be based on expectations of the commercial market from June 2003 through May 2013 (the life of the lease) and should take into account events that have transpired since mid-2002. In this regard, one of the OIG's appraisers noted that the retrospective analysis they employed is normally used for estate valuations, tax assessments, and condemnations. That kind of analysis is irrelevant to evaluating the merits of LSC's current lease.

    Second, in comparing LSC's costs to those at its prior offices, the OIG ignored the fact that the prior Board and management had concluded that LSC needed additional space, and in fact acquired 5,000 additional square feet and 27 additional parking spaces as a result of the move. The OIG did not take into account what it would have cost LSC to get 5,000 additional square feet in its previous office building on First Street, even if such space was available. The OIG also ignored the fact that LSC's lease was expiring in 2007 and that LSC had would have had to renegotiate with its then-existing landlord or find new space in what is clearly now a very hot D.C. commercial real estate market. In fact, as of this moment, LSC is paying less, when taking into account the additional space and parking spots, than it would have been paying had it not moved, a point one of the OIG's appraisers acknowledged.

    Third, with respect to the allegation that LSC is overpaying compared to fair market value, the Board concluded that the analysis employed by the OIG failed to take into account several key factors. I will not repeat all of them here; they are in our response. The key one is that LSC received tenant improvements of up to $2 million—well over what a typical market transaction would have provided for. Just like a car buyer gets a different price depending on whether he puts up cash or insists the dealer provide him with a no interest loan, when a tenant receives above market concessions from the landlord, they have to be paid for and that will reflect itself in the lease cost. The difference between tenant concessions assumed by one of the OIG's appraisers in estimating fair market rent and what LSC actually received is $1.6 million—$1.3 million in tenant improvements and at least $300,000 in parking concessions—over 80 percent of the alleged $1.9 million over-payment that the OIG calculated using that appraiser's assumptions. Even accepting some questionable assumptions on the part of the OIG and its appraisers, we are left with an alleged overpayment over ten years of $300,000 when the tenant concessions are accurately counted. That amounts to 1.7 percent of the total lease payments to be made under the contract.
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    A week after the OIG report was submitted to Congress, I was provided a copy of the contemporary appraisal commissioned by the Bank of America in 2002 before it agreed to finance the transaction. That appraisal concluded, taking into account the value of the above market build-out, that the proposed LSC rent was within the range of fair market value. The Board was not made aware of the appraisal during its consideration of the OIG draft report, although the OIG had the appraisal, and the Board subsequently voted unanimously that we should have had it and that it confirmed our conclusion. Accordingly, we believe the OIG failed to make his case and we consider this matter closed.

    Finally, I would like to make a few observations. First, I will not try to assert that everything done by LSC from 2001 to 2003 was perfect. However, the OIG's suggestion that LSC overpaid by $1.9 million over ten years or somehow failed to adequately serve as a reasonable, fiscally prudent steward of public funds is incorrect. I would note that the then-Inspector General was at the time represented at virtually every meeting at which the lease transaction was discussed and was fully aware of all the details of the transaction, even requesting and receiving a private briefing. It is my understanding that no objections were raised with the previous Board or management by the previous Inspector General or the OIG.

    Second, it is indisputable that this transaction will ultimately save LSC money. The only question is how much and beginning when. The OIG pegged the beginning of savings to be in the last couple of years of LSC's ten year lease with total savings only to be realized if there is an extension. Based on the evidence provided to the Board, it appears more likely that LSC is beginning to see savings now and will show significant savings during the current lease term. There is no question that, during a second ten year term and beyond, savings will be substantial compared to the alternative of continuing to rent commercial office space.
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    Third, there has been no evaluation by the OIG of the substantial benefits to LSC from the transaction. These include efficiencies from LSC's possession of space built to its needs and specifications; stabilizing LSC's cost of space and removing its dependence on the D.C. commercial office market; and the long-term advantage of having a nonprofit landlord which was specifically created for, and whose charter provides as its purpose, to benefit LSC and support its mission of delivering legal services to the poor. No other landlord fits this description.

    This transaction was conceived by John McKay, who President Bush appointed as and is now U.S. Attorney for the Western District of Washington. The K Street building was found, the details negotiated, and the contracts executed under the direction of former Congressman Erlenborn, with every key decision approved by my predecessors on the Board. I cannot say everything was done perfectly; I was not here at the time. I am confident, however, that the prior LSC Board acted honorably and properly every step of the way and that, if any mistakes were made, they were miniscule compared to the overall long-term gains that are and will be realized by LSC. The current Board has reviewed the reports of the Inspector General suggesting that our predecessors, previous management and the former Inspector General all erred in approving this transaction and we unanimously rejected that finding.

    Mr. SMEGAL. Would you mind referring to the graph, please?

    Mr. STRICKLAND. I would want to refer—you mean to the graph?

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    Mr. SMEGAL. Yes, I'm sorry, Your Honor——

    Mr. STRICKLAND. I'm sorry. Mr. Smegal reminded me, I want to refer to the graph that's over here on the chart. And I hope that we've provided—we're now providing copies of the graphs so that you can read it up close.

    Mr. CANNON. Without objection, the graph will be made part of the hearing record.

    [The information referred to follows:]

[Note: Image(s) not available in this format. See PDF version of this file for complete hearing record.]

    Mr. STRICKLAND. I'd be glad to discuss that, or Mr. Smegal can discuss that graph at the appropriate time, whether that's now or later, Mr. Chairman. But except for the presentation of the graph, that would conclude my brief opening. And I'll be glad to answer questions at the appropriate time.

    Mr. CANNON. Thank you, Mr. Strickland.

    Mr. West, you're recognized for 5 minutes.

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    Mr. WEST. Good afternoon, Mr. Chairman, Mr. Watt, and Members of the Subcommittee. My name is Kirt West. I've been the Inspector General of the Legal Services Corporation since September 1, 2004.

    For nearly 20 years, I've served in various legal and executive capacities in the inspector general community. I appreciate this, my first opportunity to discuss the work of the LSC OIG with the Subcommittee. A more exhaustive review will be included in my written statement.

    Before discussing the leasing arrangement, I would like to begin briefly by discussing my role as IG. Like all IGs, my mission is to prevent and detect waste, fraud, and abuse, and to promote efficiency and effectiveness. IG quality standards require me to adhere to the highest ethical principles, and to conduct my work with integrity.

    Ultimately, my job is to write independent and objective information to the LSC board, the Congress, and the public, as to whether federally-appropriated tax dollars are being spent wisely and prudently in carrying out the LSC mission.

    This past October, in response to inquiries from the Subcommittee, I decided to look into LSC's 2003 move from Capitol Hill to Georgetown. Staff from OIG and LSC management had also told me in confidence that they believed that LSC was overpaying for its Georgetown location. At that time, I was also aware that LSC was negotiating a lease extension, so I wanted to provide prompt, independent, and objective information about rent to assist the board in its negotiations.
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    Because we are not commercial real estate experts, I hired two experienced commercial real estate appraisal firms to determine whether LSC was paying fair-market rent when it signed a lease in July of 2002, as well as in November in 2004, in case there had been significant changes in the Georgetown market.

    The appraisers followed their professional standards and used their independent judgment. No one from my office directed the appraisers' work or suggested any particular outcome. Both appraisers independently concluded that LSC is paying higher than market rent for its Georgetown space. This was the case in July 2002, and is still the case.

    Based on these reports, the OIG calculated LSC would overpay the landlord between 1.23 million and 1.89 million over the life of the 10-year lease. This overpayment occurs in the first 7 years of the lease. For example, over the next 12 months, LSC will overpay at least $300,000.

    In addition to these appraisals, Mr. Chairman, the OIG has overwhelming objective evidence that LSC is overpaying rent. For instance, all other tenants in the building are paying below market rent. Even the landlord's own rental agent states that LSC's first-floor space would only rent for 24 to 26 dollars per square foot; far below what LSC is paying.

    The OIG also calculated that LSC could have saved at least $1.1 million by remaining at its Class ''A'' location on Capitol Hill, next to Union Station, instead of moving to its Class ''B'' building in Georgetown.

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    Finally, LSC may be due a rent credit of more than $100,000. LSC was charged for 2,000 square feet of space that it did not occupy for 18 months.

    I'd like to mention a few of the many other observations that have come from this review. Although this building is commonly referred to as LSC's permanent home—or, as Mr. Smegal suggested, forever—LSC has a 10-year lease, and the OIG is not aware of any legally binding agreement allowing LSC to stay permanently or to take ownership from Friends.

    LSC management has not provided the OIG with any documents that support the need for LSC to have a 45,000-square-foot headquarters out of a 65,000-square-foot building—which I think is more like two-thirds than 54 percent.

    LSC did not have records tracking how much of its $2 million tenant improvement allowance was spent.

    Although LSC officials created the Friends of Legal Services Corporation, LSC no longer controls Friends.

    Friends recently made an unrestricted contribution to the National Legal Aid and Defenders Association, that LSC itself could not make directly.

    Thank you, Mr. Chairman, for this opportunity to testify before the Subcommittee. I am proud of the work being done by the staff of the LSC OIG. We look forward to continuing to conduct independent and objective reviews, so that the LSC Board of Directors, the Congress, and ultimately the American taxpayers can be assured that federally-appropriated tax dollars are being spent wisely and prudently to provide legal services to those in need.
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    [The prepared statement of Mr. West follows:]


[Note: Image(s) not available in this format. See PDF version of this file for complete hearing record.]

    Mr. CANNON. You obviously practiced your time. That was within the 5 minutes. Thank you. Elegantly done.

    The Chair recognizes himself for 5 minutes. That's something I don't normally do. I usually go last on the questioning, but the situation really begs for my discussion early, I think.

    I was surprised, Mr. Strickland, on seeing this chart on the board when I walked in, because we talked about this chart last night in my office. And I thought I made some compelling points on that chart. Do you recall those points?

    Mr. STRICKLAND. As I recall our discussion, the chart demonstrates the cost of continuing at 750 First Street, versus the flat rate at 3333 K Street. Mr. Smegal wanted to make use of the chart, to make some of his points, and that's the reason why we brought it today.

    Mr. SMEGAL. Congressman, yes, it's part of my presentation. But I ran out of even Congressman Watt's time, so I went on.
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    Mr. CANNON. Thank you. We'll come back to it. But let me just tell you why I think the chart is a problem here. The pink dots represent a possible future scenario that you can't know until you get to the signature on a new lease. And while that—even if it were true and not a fantasy, not a future projection, it totally misses the underlying point; which is looking backwards to the time when Friends of Legal Services was created.

    Friends of Legal Services was created to do something that Legal Services itself could not do directly; that is, get around the OMB A-11 regulation that dealt with capitalized loans. And so we have this. What is really deeply concerning me here about this discussion is that there is—and the presentation so far—is that you all are acting as lawyers and advocates; instead of acting as board members and considering the policy implications of what's going on.

    And as a result of that, the advocacy that you're presenting just begs for challenge. And in fact, if you will look at the issues, there are many points that can be challenged. And what's not happening here is you're not saying, ''We've got a problem. We've got a building. We have got a conflict of interest. We have two groups.''

    And I've read Mr. West's report very carefully. And Mr. Strickland, I think you were a little bit upset yesterday in my office about the statement in Mr. West's report that referred to if there were the Federal Government standards and ethics applicable to this agency there may be even a crime. That was outrageous, given the stature of the board members—which I agree is a pretty remarkable set of people.
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    The point is not that a crime was committed. The point is that there is an inherent context of conflict which you're not dealing with, and which leaves your opening statements subject to, I think, some serious questioning that puts your integrity on the line; instead of the problem with the decision.

    And the decision—I don't want to go back and say, ''Oh, you guys did it wrong, looking backwards.'' But you as a board—representing two boards, President of Legal Services, and LSC—ought to be looking back and saying, ''Hey, wait a minute. What did we do?''

    So for instance, you have said, Mr. Smegal, in your opening statement that the issue was vetted—not a legal term, but it is in fact a term of art. And that's important, because you said it's vetted with OMB and both the Senate and the House Appropriations Committees. And then you said here a moment ago that it was run by—the agreement was run by counsel to this Committee. Now, when you say ''vetted,'' what do you mean, Mr. Smegal?

    Mr. SMEGAL. Well, I'm sorry, Congressman, if I used a term that is too legal. But what I mean by that is that this Committee, April 23, 2002, 2 p.m. in the afternoon, its staff asked to be briefed on what it was the Corporation was intending to do. John Erlenborn, 20 years one of the members of your body——

    Mr. CANNON. Did you present to the staff the details of the lease?

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    Mr. SMEGAL. That was the purpose of the meeting, ''Here's what we're going to do.'' Don Carpenter had it all laid out. That was there for that purpose. They were there for that purpose. The Committee members—Patty DeMarco and J. Keith Ausbrook—were there for the purpose of asking those questions.

    Mr. CANNON. And did they agree with your proposed——

    Mr. SMEGAL. They agreed that the Corporation, through the vehicle of Friends, could proceed with the purpose of a building, if we could find one. We had one in sight. As I've told you, we had this——

    Mr. CANNON. Let me read Mr. Ausbrook's recollection of that meeting.

    Mr. SMEGAL. Okay.

    Mr. CANNON. Thank heaven for modern technology—or curse it; whatever you will. ''On the latter point, we did meet with them on their building. We expressed some concerns about the expense and the appearance of luxury digs in Georgetown. No further action was taken. The previous Chairman of the Subcommittee was aware of the purchase at the time. Are you now looking at this, almost 3 years later?''

    Well, the answer is, yes, we're looking at it. And I suspect that if Mr. Ausbrook was sitting here as a witness, he would disagree with you that there was an agreement.

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    Mr. SMEGAL. Oh, I don't know. I wasn't there——

    Mr. CANNON. Certainly, not as to details.

    Mr. SMEGAL. There are staff people who were here then. They were there for the meeting. I was not present. I didn't come to every meeting. I couldn't afford that, Your Honor. I live in San Francisco.

    Mr. CANNON. My——

    Mr. SMEGAL. But I do understand. My understanding of what happened at that meeting is this Committee was told April 2002, before any of this happened. We didn't make any deals. We didn't have the Gates money. Bill Gates says to me, ''When you have a building, call me up, and we'll see how we get you the money.''

    There was no building in April. We were there to the Committee to tell them what we had in mind; as we'd gone to OMB; as we'd gone to the Office of the Counsel to the President.

    Mr. CANNON. My time has expired. I think we'll probably do a second round on this issue.

    Mr. SMEGAL. I hope so, Your Honor.

    Mr. CANNON. And, well, normally, I would. If there were only three of us, we could probably share time. But we have so many Members that I think that we'll go, and I probably in an hour—Bill, would you like to take some time? The gentleman from Massachusetts is recognized for 5 minutes.
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    Mr. DELAHUNT. You know what I'm concerned about, Mr. Chairman, is that I see these two gentlemen here. It's clear that they were well intentioned; felt that they had a good deal. I concur. I happen to think that you did the right thing.

    Now, I don't know the details. But the last thing that we want to find ourselves in the position of doing is discouraging the likes of Mr. Strickland and Mr. Smegal from serving on the board of directors of the Legal Services Corporation, which is a non-profit charity. I mean, they're not getting a lot, other than just a sense of public service and reward, from their effort.

    Mr. CANNON. Would the gentleman yield?

    Mr. DELAHUNT. Yes.

    Mr. CANNON. I agree with the gentleman. And that's why this is such a matter of concern. The issue here is not to attack people of great integrity. The issue is to have the perspective of the current board on a problem that I think is a significant problem, and resolve the problem.

    Mr. SMEGAL. Congressman——

    Mr. CANNON. Not flail people here. That's not my objective at all.

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    Mr. SMEGAL. Congressman, the only reason there is an alleged problem is because the OIG has suggested there was one. I've seen no legal brief on a conflict of interest. I don't have a conflict of interest.

    Friends was created by the Legal Services Corporation. They were one entity. What OMB told us, we had to have a separate entity in order to avoid, as the Navy has done, as the Smithsonian Institute has done, as—what's the other one; there's a third one—has done, we had to set up a separate 501(c)(3). We did what we were told.

    Mr. CANNON. Mr. Smegal, look, I understand what you're saying and——

    Mr. STRICKLAND. It's the National Academy of Science.

    Mr. SMEGAL. National Academy of Science, Congressman.

    Mr. CANNON. I understand. The problem is that you now have an entity that has, as you pointed out, a lease figure that was set by the lender; not by two parties at an arm's length. And the owner of the building does not—is not—the same as the institution for which it was set up. That's an inherent conflict. And I just would—I'm on the gentleman's time, and I apologize for going on. I don't mean to lecture.

    Mr. DELAHUNT. That's all right.

    Mr. CANNON. But what I see is defensiveness about an issue, instead of resolution. And that is remarkable. This is not Mr. West who's bad; it's Mr. West who's doing his job and who should be not argued against, but considered and have the underlying problem resolved so we can get the little sliver out and go on with life.
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    Mr. SMEGAL. Well, Your Honor——

    Mr. CANNON. I yield back to the gentleman.

    Mr. SMEGAL. Congressman, I disagree with you on your characterization of Mr. West. But nevertheless, if you go to a bank and try to buy property, they're going to ask you for a financial statement. Friends did not have a financial statement. So the lender said to us, the prospective lender said, ''We want a certain amount of income to service this debt you're asking us to take on, $15.5 million.''

    Mr. CANNON. If the gentleman would yield again?

    Mr. DELAHUNT. Sure.

    Mr. CANNON. Our arguments are not joining here. I understand your argument. Just take my word for it. I understand your argument. And I'm suggesting that the animosity that you've just expressed toward Mr. West is highly misplaced. And everybody is better served if the animosity disappears and you deal with the underlying problem.

    You were talking about billions of dollars maybe that we ought to be overseeing at other places. Let me just reiterate, this is a problem in a context that is not infinite. But the problem which I am deeply concerned about is the reaction of both boards to Mr. West and his presentation of an issue which, on its face—and I've read his report very carefully—is valid. And your incensed reaction to it doesn't make it less valid.
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    And if you step back and look at it, nobody is being called criminal. The issue of a conflict between two entities is there and clear. But it's, again, not infinite. It has narrow scope. It has a clear definition. And what I'm not hearing is—I'm hearing more animosity toward Mr. West than I am about solving an underlying problem—which, by the way, can't be solved with a simple dissolution of Friends of Legal Services and with the building being turned over to LSC, because I think you'd still probably have the underlying problem with OMB.

    So instead of arguing back and forth, it would be a matter of great appreciation from my perspective if you said, ''Look, we have a problem. How do we solve it? We can't just dissolve. Let's talk to OMB and see what the path is.'' And if you did that, we'd say, ''Thanks.''

    Mr. SMEGAL. Congressman, I disagree. There is no problem. In fact, the statement of the Inspector General is internally inconsistent; contrary to what you've just said. He says on the one hand, the problem is that the Legal Services Corporation no longer controls Friends; and then on the other hand, he says the problem is that the Corporation is independent. You can't have it both ways. He's working both sides of the street in his statement. He's worked both sides of the street in everything he's filed.

    Mr. CANNON. That's consistent. He says that Legal Services doesn't control Friends.

    Mr. SMEGAL. That's right.

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    Mr. CANNON. And he says that Friends is independent.

    Mr. SMEGAL. That's right.

    Mr. CANNON. Those are highly consistent.

    Mr. SMEGAL. But he criticizes both of those.

    Mr. CANNON. Well, because when you have two independent organizations that overlap, then there is obviously criticism from both points of view. But it's actually really the same point of view.

    Mr. SMEGAL. No, no, he's saying—Congressman, he's saying that——

    Mr. DELAHUNT. Mr. Chairman, I ask unanimous consent that I receive an additional 2 minutes. [Laughter.]

    That I'll yield to the Chairman.

    Mr. CANNON. Without objection.

    Mr. GOHMERT. Mr. Chairman, I have no objection to 5 minutes. You really didn't get started.

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    Mr. DELAHUNT. I withdraw my unanimous consent, and concur with the gentleman from Texas and ask unanimous consent for an additional 5 minutes that I'll yield to the Chairman.

    Mr. CANNON. Thank you. And without objection, so ordered.

    Now, let me just say, Mr. Smegal, this is not a debate. And I actually don't want to pursue it any more, and I'd like to leave this part aside. Although let me just admonish the two of you that I have read this very carefully, and Mr. West's report does not go beyond the bounds of what an appropriate IG should be doing. And in the environment of advising the board—and the board that he advises is just LSC, and it gets to the friends of LSC, I think appropriately—I don't think in that report there is anything that is amiss.

    And the problem here is that the retrenching around that issue has created a problem where one probably doesn't need to be. There is a problem. The problem is, what do you do with OMB and this building long-term? I think we need to—you need to deal with that.

    But I don't want this just to be a back-and-forth debate where you assert something, and I'm just telling you something entirely different. I hope you'll recognize the difference.

    Mr. SMEGAL. Yes, Congressman. In fact, I'm particularly pleased that you've given me this opportunity to be a participant in this debate, because the OIG wouldn't do that. In his letter of February 23, 2005, in response to my request for his report, he says the following: I won't give it to you, ''However, we will consider your letter a request for a copy of the final report under the Freedom of Information Act. And once the final report is issued, we will release it to Friends, as appropriate, in accordance with FOIA.''
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    I haven't been part of this debate. I didn't have a chance to file anything with this Committee, Your Honor, other than my statement.

    Mr. CANNON. But you are not the agency that Mr. West represents. He couldn't give that to you directly. You're a lawyer. I don't understand why you've just made that statement. He couldn't do that.

    Mr. SMEGAL. That's incorrect, Congressman.

    Mr. CANNON. Well——

    Mr. SMEGAL. He could give it to me.

    Mr. CANNON. Why?

    Mr. SMEGAL. There is no basis for him taking this position with respect to this——

    Mr. CANNON. Well, because his client—he is the IG for LSC. The appropriate request would be from you to Mr. Strickland.

    Mr. SMEGAL. No, that's not correct. The appropriate request is from him. He labeled Friends as a contractor, a Government contractor. And under the provisions of the OIG Act, I get that report. I get the report from him. He never gave it to me. I'm here today for the first time in a position to respond to his various statements that he's filed with this body.
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    Mr. CANNON. And gave to LSC. And I assume that you got it from LSC at some early point, which would be perfectly appropriate.

    Mr. SMEGAL. I did, yes.

    Mr. CANNON. Let me just ask——

    Mr. SMEGAL. Not at an early point; at a later point.

    Mr. CANNON. Mr. West, Mr. Smegal has just said that he had a legal right, because you characterized him as a contractor, to get your report. Does he have that right, in your view? And did you appropriately withhold it?

    Mr. WEST. I'm unaware of ever calling him a contractor. In the financial statement that was prepared for the Legal Services Corporation, Friends of Legal Services is listed as a component.

    When I have dealt with contractors in previous instances, if we did an audit of the contractor, they of course get the draft audit report. But this was a report to the board that was for them to negotiate the lease extension with Friends. I had—and that's all that was, was information to the board.

    Mr. CANNON. Mr. Smegal, do you agree with that analysis?

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    Mr. SMEGAL. I wasn't listening. I'm looking at a letter I wrote to the Inspector General. Incidentally, I'd like, if it's possible, to keep the record open. I have an exchange of correspondence that I had with the Inspector General starting on December——

    Mr. CANNON. I can assure you that——

    Mr. SMEGAL. —December 9; none of which is in his report. But starting on December 9.

    Mr. CANNON. Well, without objection, that will be made part of the record.

    Mr. SMEGAL. Thank you, Your Honor.

    [The information referred to is available in the Appendix.]

    Mr. SMEGAL. In that, one of these communications from him, he did—he or one of his assistants referred to Friends as a Government contractor.

    Mr. CANNON. I think he dealt with that issue in his response.

    Mr. SMEGAL. Well, I'm not sure. I don't have a legal brief on it, so I don't know.

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    Mr. DELAHUNT. Mr. Chairman, reclaiming my time?

    Mr. CANNON. Oh, yes, it is your time. The gentleman—I yield.

    Mr. DELAHUNT. You know, I can see that this dispute has become, you know, a question of, I think, both—particularly Mr. Smegal feels that the role, as he understands it and has lived it, of the LSC and its clear, to me, good intentions have been impugned by the report. Now, I understand there are rules and guidelines, etcetera. But I would hope that, you know, an exchange that was appropriate and civil and courteous would always exist between any office of inspector general and those individuals that are participating or are being—whose actions and transactions are being reviewed.

    I mean, this is—well, let me ask you a question, Mr. West. Is there anything that you have discovered where any individual has accrued any particular financial benefit from this transaction?

    Mr. WEST. With respect to anybody on the LSC board?

    Mr. DELAHUNT. Right.

    Mr. WEST. Anybody on the Friends of LSC? No.

    Mr. DELAHUNT. Okay. I mean, which confirms, I think, what you and I have both been saying, Mr. Chairman; is that these are people of integrity.
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    I think, as I'm hearing the exchanges going on, you alluded to the OMB and the rule that requires this pass-through public charity corporation being created; not just in the case of the LSC but, I understand, the Smithsonian, the Navy, and others. You know, I would like to understand the rationale for that particular rule. It appears to me to be somewhat archaic.

    You know, maybe there is good reason. But I daresay we wouldn't be having this hearing today if the LSC as a board could have acquired the property directly; rather than the need to create another vehicle. It just doesn't seem to make any sense to me; particularly when, for protection of the taxpayer, we have an Office of Inspector General as part of the LSC board.

    So maybe Mr. Chairman, you should request the representative of the Office of Management and Budget to come and sit down. We don't need a public hearing. If the public wants to sit and listen to the conversation, I don't have any problems with that. But to explain to us the rationale for the rule. And then, among ourselves we ought to consider whether the rule has—no longer serves its original purpose—we don't know what that original purpose is—and do whatever has to be done to put the rule into the dustbin of oblivion, if you will.

    So that we don't find ourselves enmeshed in this kind of—you know, I'm sure they're great appraisers but, you know, that Bank of America appraiser, I bet he went to school for appraisers, and has his benefits, and has a master's degree in appraising buildings in Georgetown. I mean, that's the micro level that we're getting ourselves into, a dispute among professionals.

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    I mean, it's like in my former life, it was always fascinating to me that when a criminal defendant pled insanity in a criminal trial—I yield to my——

    Mr. GOHMERT. I take exception to saying ''insanity'' and pointing to me.

    Mr. DELAHUNT. No, I did it like this, Charlie. [Laughter.]

    It was up in the air. I didn't mean——

    Mr. CANNON. That was the Almighty.

    Mr. DELAHUNT. Okay? And somehow, psychiatrists—you could disagree as to whether there was legal responsibility on the behalf of the defendant. And we are, as a Subcommittee, monitoring, you know, which appraiser is right. I yield back.

    Mr. CANNON. The gentleman yields back. Let me point out, there are actually three appraisals. Two agreed, and the other appraisal was by the lender, which is in a different context. But I agree with most of what you said, Mr. Delahunt.

    Now the Chair recognizes the gentleman from Texas, Mr. Gohmert, for 5 minutes.

    Mr. GOHMERT. Okay, thank you, Mr. Chairman. And I do want to say, I am grateful that people of high esteem are willing to serve in these thankless jobs. I'm grateful that we have someone who would be able to solicit or obtain a $4 million contribution to an entity like this, because that's not something easy to do. So I'm grateful for that.
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    I think probably all of us up here agree that there are aspects of OMB scoring that we don't like. We don't think that they use good business judgment. And I will readily acknowledge right up front that all three of you are a lot more financially smart than I am, because you've never run for judge and you've certainly not—smart enough to avoid running for Congress. So I'll give you right up front, you're smarter than me.

    But just to go back on some of the testimony, Mr. Smegal, that you've given us. You gave us a good overview of the whole scenario, how this came about. Have you been with LSC board from the beginning? How long were you with it?

    Mr. SMEGAL. Congressman, you may have missed my opening remarks. I was nominated——

    Mr. GOHMERT. Oh, I was here for all of your remarks.

    Mr. SMEGAL. Well, I've been on the Legal Services Corporation Board at the nomination of two Presidents and the unanimous confirmation of the United States Senate for 18 years.

    Mr. GOHMERT. I guess what I was trying to get to was——

    Mr. SMEGAL. I was there—excuse me.

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    Mr. GOHMERT. What I was getting to was, you were testifying about conversations, some of which you said, ''And I was there at that one.'' And I take that to mean that you may have been testifying about conversations where you weren't there. And so I'm just trying to——

    Mr. SMEGAL. Yes.

    Mr. GOHMERT. So obviously, you're giving us an overview which includes some hearsay of what you've heard from other people; which if we want to get to the bottom of it, it's always best to hear it straight from the people that were there personally.

    But I am concerned, as the Chairman has indicated, as smart as you obviously are just—and I mean, I know I look stupid, but I did not miss some of the snubs like when you were talking about vetting and you comment, ''Well, sorry I used a term that was too legal,'' like, ''You wouldn't understand.''

    But you say you don't see a conflict. And I mean, it's very, very basic. If I'm a judge, and I'm dealing with a landlord and a tenant, and they may be friends, and one's got an attorney, I'm going to appoint an ad litem attorney to represent the other side; because there is a clear conflict between a landlord and a tenant.

    There is a clear conflict between someone who is a borrower on a note, and someone who is not a party to that note. There is a conflict between someone who's trying to get enough rent to service a note, as opposed to somebody that's trying to get the cheapest rent they possibly can, and therefore get the biggest bang for their buck. There is a conflict. And I'm shocked that, as brilliant as you are, that you cannot come in here and say that you actually see that.
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    So let me ask you this. Is there a legitimate basis for agreeing to $38 a foot for the LSC?

    Mr. SMEGAL. Is there a legitimate basis?

    Mr. GOHMERT. That's right.

    Mr. SMEGAL. Absolutely, Congressman. And in fact, the chart that I—that was supposed to be attached to my remarks, which is over there displayed, and you have, demonstrates that the reality of what the Corporation now has by way of its space is represented at 2003 by the line that continues.

    Now, $38 a square foot continues on that line and goes down because of the advantages of the $100-a-month parking spaces. So it's actually going down, as we go out to the right. Whereas the Corporation would have continued in—and the numbers there out through 2007 are real numbers. Congressman Cannon suggested maybe they weren't. They are the lease that the Corporation had through 2007. So you're up there at 42 or 43 dollars a square foot.

    The rest of that would be the anticipated—there was no additional renewal at 750 First Street, Northeast, Congressman. So those red numbers are what is anticipated might have happened after that time.

    Mr. GOHMERT. And we take it as just that: something that might have happened. But we're looking at a $38-a-foot lease for this whole—you indicated in your testimony in your opening statement—which I did hear—that by law any property of the Friends would revert or go to the LSC. The OIG says he knows of no contract or anything that would cause that to revert to the LSC. Do you know what law that is that would cause it to automatically revert to the LSC, if Friends is dissolved?
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    Mr. SMEGAL. Yes, the bylaws by which the LSC was created. It's a document that had to be filed with the District of Columbia when the 501(c) incorporation was obtained. It clearly spells out exactly what happens to Friends, should it be abolished. All—whatever assets Friends has is automatically transferred to the Legal Services Corporation.

    Mr. GOHMERT. Okay, so bylaws——

    Mr. SMEGAL. Incidentally——

    Mr. GOHMERT. —and I will conclude. My time is running out. But you mentioned bylaws. Bylaws, as you know, can be unilaterally changed by the Corporation that set up those bylaws; isn't that correct?

    Mr. SMEGAL. I apologize. I misspoke. ''Vetted'' was a bad term, and I apologize for that, too. But it's the articles of incorporation; not the bylaws.

    Mr. GOHMERT. All right. The articles of incorporation.

    Mr. SMEGAL. Of Friends.

    Mr. GOHMERT. Of Friends.

    Mr. SMEGAL. Yes, sir.
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    Mr. GOHMERT. And are you familiar with how—or the manner in which articles of incorporation could be changed?

    Mr. SMEGAL. I'm sure there's a provision in there that would permit changing under some circumstances, yes, sir.

    Mr. GOHMERT. And that LSC would not necessarily be a part.

    Mr. SMEGAL. Well, I don't know. I can't speculate.

    Mr. GOHMERT. Well——

    Mr. SMEGAL. Incidentally, I am advised that the red numbers that you and I were referring to a minute ago actually are the OIG's numbers, right off his materials that he's provided to you in one or more of his presentations.

    Incidentally, Congressman Delahunt, you said—or maybe it wasn't you, and I apologize if I'm——

    Mr. GOHMERT. All right, obviously, my time is up, and so it's up to the Chairman at this point to determine who's going to talk after this.

    Mr. CANNON. Are you yielding back, Mr. Gohmert?

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    Mr. GOHMERT. My time has expired.

    Mr. CANNON. I thank the gentleman.

    Let me just thank the members of the panel. I appreciate your being here through a relatively tense period. And it's been actually a pleasant exchange, let me just say, from my point of view. It's like a bunch of lawyers going back and forth at each other. Mr. Smegal, you wanted to say something?

    Mr. SMEGAL. I do. I have one other comment, and I apologize. Mr. West, in response to a question, I think it was of Congressman Delahunt, indicated that he had accused no one of doing anything, and he mentioned specifically the Friends and the Board of the Legal Services Corporation. But I would direct your attention to—his pages are unnumbered, but if you go to what I've numbered page 14, he's got a bullet. And the bullet is the following: ''Friends made a $50,000 unrestricted contribution to an organization to which LSC is restricted from making the same kind of contribution.''

    Now, three things. He doesn't identify the organization there, but he did in his opening statement. It's the National Legal Aid and Defender Association.

    Mr. CANNON. I think he identifies it earlier in his report.

    Mr. SMEGAL. I don't think it's in here, Your Honor. But in any event, there's two things wrong with what he says, two significant errors. One, it was not an unrestricted contribution. He has my letter of February 9, 2005, which will be in the packet that I'm providing, which includes the nine-page grant to the NLADA—very restricted in its use of the $50,000.
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    The other point that I would make is that NLADA is not an organization described as he states. Legal Services Corporation—and they can speak for themselves—have given grants to the NLADA for years for various things. There's nothing wrong with the National Legal Aid and Defender Association and, in particular, this $50,000 grant.

    The innuendo here by this Inspector General is that Bill Gates would give us $4 million so somehow we could give $50,000 to some organization that's going to violate congressional restrictions on LSC activities? That's nonsense.

    Mr. WATT. Mr. Chairman?

    Mr. CANNON. Certainly, Mr. Watt.

    Mr. WATT. Could I ask unanimous consent just to ask one question? And I know I gave my time away.

    Mr. CANNON. Before you do that, may I just say, Mr. West, I think you understood the two statements, or the two accusations made by Mr. Smegal. Are you comfortable responding to those in writing? Not now, because we're——

    Mr. WEST. Yes, I'll respond to them in writing.

    Mr. CANNON. Thank you. The Chair recognizes Mr. Watt for 5 minutes.
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    Mr. WATT. And I'm not sure exactly what implications this has, but Mr. West, do you have any idea what the value of this building is now?

    Mr. WEST. I have no idea. I have not seen an appraisal of the building. My report was restricted to what would have been the fair-market rent if the Legal Services Corporation entered into an at-arm's-length transaction in July 2002. That's what we wanted our appraisers to tell us: If they were going out in the marketplace, what would have been a fair-market rent?

    Mr. WATT. But the appraisers did the appraisal on an income approach?

    Mr. WEST. They did an income, and they also did a sales approach. Income—I don't have it in front of me. I could get the specific information for you. But the appraisals, I believe, are going to be in the record.

    Mr. WATT. Okay. Mr. Strickland or Mr. Smegal, either of you have any idea of what the value of this building is now?

    Mr. SMEGAL. Yes, and I haven't got this in writing, Congressman, but the tenant on the fourth floor along with us, who's working its way up and about to pass through $38 a square foot, I am advised by our realtor, is prepared to offer us $20 million for the building.

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    Mr. WATT. So the bottom line is this building was acquired for—what?—$15 million, $16 million?

    Mr. SMEGAL. No, Congressman, actually what happened was this building was sold for $16 million, and the deal fell through; which is the reason we got an opportunity to buy it. We bid 14.2. There were two other bidders at 14.2. The prior owner understood who we were and what we were going to do with the building, and said, ''You get it.''

    So we bought it for 14.2. We put $2 million, roughly, of tenant improvements in—a million-eight, eight-fifty—into it. And the bank then appraised it; understanding that to happen at 17.1. And my understanding from the realtor that's leased space for us in the building is that the other tenant on four is prepared to offer us $20 million.

    Mr. WATT. And of that $16.2 million that you all have in it, Bill Gates gave you 4 million of it?

    Mr. SMEGAL. Yes, Congressman, that's correct.

    Mr. WATT. So the net amount that Legal Services has in this building is approximately $12.2 million, and you have an asset that's worth $20 million in today's market.

    Mr. SMEGAL. Yes, Your Honor. Actually, we've been paying off the bonds over the last couple of years, so—and our financial statements show that our liabilities are even less than that.
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    Mr. DELAHUNT. Would the gentleman yield?

    Mr. WATT. Yes, I'm happy to yield.

    Mr. DELAHUNT. Mr. Chairman, there's a certain irony here because—and I'm not being critical of the work done by the Inspector General—but because of the lack of flexibility that's inherent in Government bureaucracy, big Government, we find ourselves not allowing a certain entrepreneurial initiative which I think is inherent in the free market.

    When you see something that's a good deal, if you can get 4 million out of Bill Gates and negotiate favorable terms and look down the future 20 years when the bonds are paid off, we have a quasi-public corporation not paying, you know, any rent; probably generating some revenue from this asset which would reduce the cost to the taxpayers, or maybe provide services for more individuals who need them. Because my recollection is Legal Services is incapable, because of lack of resources, to provide individuals—in terms of the number—the pie that ought to be receiving services, only 20 percent are in fact receiving the services that are necessary for them, thereabouts. I'm sure my figures are not exact. But again, with all due respect to Mr. West, you're building equity up.

    Mr. WATT. Let me reclaim my time, though. Because I want to be clear that just because the value of the building may exceed the investment, the end doesn't always justify the means. And I think what the Chair's concern is that a means was used that might have been an end around.
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    But the bottom line is that the Friends of Legal Services and, if they ever dissolve, Legal Services, would be the beneficiary of a much, much more valuable asset. So we need to figure out a way to resolve this in a way that it will cut off our nose despite our face or whatever the——

    Mr. DELAHUNT. Well, Mr. Watt, I just—I'm sure that, you know, the panel, and maybe those that are here, are somewhat confused. This is the Democratic side of the panel—— [Laughter.]

    —those, you know, who ascribe to the ''big Government'' theory——

    Mr. CANNON. If the gentleman would yield——

    Mr. DELAHUNT. And they're the Republicans over there, the ''free marketeers.''

    Mr. CANNON. If the gentleman would yield——

    Mr. WATT. No, I'm not going to yield. I'm not going to yield to either one of you—— [Laughter.]

    Mr. CANNON. The gentleman's time has expired. He yields back.

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    Mr. WATT. I'm not going to yield to either one of you. I'm just going to try to walk right down the middle here—— [Laughter.]

    —and remind you all that this is the result of an entrepreneurial ownership spirit. But it's a good thing, and we shouldn't be discouraging it for non-profits and valuable organizations like Legal Services any more than we discourage it—now, that doesn't mean that the end justifies the means.

    So we've got to figure out a way to step back from this. Now that we've got it all out on the table now, let's just figure out a way to resolve this in a way that doesn't disadvantage the clients of Legal Services.

    Mr. STRICKLAND. If I may address that, Mr. Watt's point, Mr. Chairman, certainl, it is the case with the current board having inherited this transaction, that it is our intent, if there's a problem that needs to be resolved, we will work diligently to resolve it. And I think the reason that we disagreed with the Inspector General is that as I said in my opening, we had questions about his methodology and his conclusions. And we don't necessarily think his office is infallible, so we disagreed with it. But having said that, I'll emphasize again that if there is a problem, we will do our best to resolve it.

    Mr. CANNON. Thank you. The gentleman yields back.

    A couple of points. First of all, let me ask—well, let me get to that, I guess, in order. First of all, as to the relevant rule at OMB, this is a rule that's been around for a very long time under both Administrations. In the fiction of Government, it's very difficult to deal with. And so the point I don't think is to change OMB, but to adapt to the circumstances.
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    And I suspect that both Friends and Legal Services Corporation—and what I take it that you've just suggested, Mr. Strickland, is that you're going to be working on this rule with Friends and with OMB to see how the underlying problem can be resolved.

    Because currently, all the equity that you referred to, Mr. Delahunt, is in Friends. In other words, it doesn't accrue yet to LSC. And so I suspect that we will see some discussion there.

    I ask unanimous consent that the record be kept open and that questions may be directed to the witnesses. Without objection, so ordered.

    One of those first questions, Mr. Smegal, is going to be in relationship to the grant that Friends has given, which you referred to as restricted. And staff tells me they've been through it; they don't see any restrictions. We'd like to understand what you view those restrictions as being. We'll get that to you by way of a written request.

    I'd also like to ask unanimous consent that we recess this hearing at this point, subject to the call of the Chair. Without objection, so ordered, and we'll finish.

    [Whereupon, at 2:15 p.m., the Subcommittee was recessed, subject to the call of the Chair.]


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    [The following is excerpted from the transcript of the legislative hearing on H.R. 6101, the ''Legal Services Corporation Improvement Act,'' held on Tuesday, September 26, 2006 by the Subcommittee on Commercial and Administrative Law, Committee on the Judiciary:]

  Mr. CANNON. If we could just take one more moment, Mr. Watt, I'd like to make the following motion: The unfinished business before the Subcommittee is the adjournment of the Subcommittee's June 28, 2005 hearing, which was recessed subject to the call of the Chair. Without objection, the aforementioned hearing is so adjourned. Without objection, so ordered. We left it open.


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