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Gov. and friend Austin, Dallas News of the stock fraud scandal turned Gov. Preston Smith’s inaugural festivities into a wake. The Securities and Exchange Commission filed suit the day before Smith was sworn in for a second term. Photos of Smith leading the grand march of the inaugural ball and reviewing the inauguration parade were placed in the state’s dailies next to drear headlines about the mind-bending scandal. Depositions gathered by the SEC revealed that Smith and his business partner, Elmer Baum, made a $125,000 profit in three weeks on the sale of National Bankers Life Insurance stock to the Jesuit Fathers of Houston. The stock was purchased with an unsecured loan from Sharpstown State Bank of Houston. The SEC also alleges that Frank Sharp, former Atty. Gen. Waggoner Carr, John Osorio and other defendants used NBL stock and the Sharpstown Bank to get a banking bill passed in 1969. Smith opened a special legislative session to allow the Legislature to consider the bill, and, then, after it passed, he vetoed it. “When I vetoed that bill,” he told the Observer, “I had no idea that Frank Sharp was for it.” Why, then, did he open up the session to it? You have to know how the governor’s office operates, Smith explained. He said Galloway Calhoun, who, at that time, was his chief legal adviser, recommended that he let the special session take it up and so he did. “Here was the reason, and it made pretty good sense,” the governor said. “A lot of people are retiring and going to small towns with these small banks in them, and they won’t put their money in them above $15,000 because it’s not insured. They [his legal staff] said that this would provide insurance for deposits for over $15,000 and would insure them up to $100,000. That’s the only portion [of the bill] that was explained to me,” he told the Observer. Smith said he vetoed the bill because Banking Commissioner J. M. Falkner told him the bill would not do what it was supposed to do. \(See article on passage and “My position is one of complete innocence,” the governor said. Smith insists there was no conflict of interest in using an unsecured loan to buy 10,000 shares of stock during a period when the banker lending the money was supporting a deposit insurance bill in the Legislature. He is quoted in a Houston Chronicle story as saying he saw nothing unusual about getting an unsecured loan for $275,000. “I could get loans before I got to be governor.” “Unsecured, for that large an amount?” asked a reporter. “I would say I could, but that would be pushing it a little,” the governor answered. In unsworn testimony, Smith explained his involvement to SEC examiners. \(The governor was the only person questioned by the SEC who refused to testify under $275,000 loan. Baum, in addition to being the governor’s business partner and his Photo by Peter Kellogg Preston Smith, Governor of Texas doctor, is State Democratic Committee chairman and a member of the State Banking Board. “I went to him for treatment,” Smith told the SEC. “[Baum] said [the stock] sounded like a good idea, and handed me a [bank] note and I signed it.” Baum, it turns out, is a neighbor of John Osorio, former president of National Banker’s Life. Osorio and Carr are law partners. One of their partners, Eugene Palmer, wrote the now infamous H.B. 72-73. SEC examiners asked Baum why Sharpstown State Bank was willing to loan him and the governor money to buy the stock. “I don’t have the least idea. I just told John Osorio that I didn’t have that much money. He thought he could arrange financing,” Baum said. Q. Why was Osorio willing to arrange the financing for you? Baum Well, I don’t know. We had been good friends and neighbors but for no particular reason that I could see. Q. Did he discuss with you any pending or proposed legislation that was either already introduced in the Texas Legislature or that would be introduced during 1969? Baum You see, the Legislature was in session in . . . You know, they had this bill in there that would guarantee deposits up to $25,000 or whatever it was.. . . Yes, he discussed that with me. Baum was asked if he had any discussion with Osorio “concerning his desire that should this bill pass the Legislature, the governor should sign the bill?” Baum John [Osorio] was . . . He was for the bill, and he told me he was for the bill. Baum was asked if Osorio said Frank Sharp was for the bill. Baum Yes, yes. He said Sharp was interested in the bill. Q. Did he tell you Sharp and he were hopeful that the governor would sign the bill. Baum Yes. He was for the bill . . . and naturally he would like him to sign it, I guess. Baum also was asked if anyone had accused Smith of a “doublecross” for vetoing the bill. Baum said, “No.” Joseph P. Novotny, who was, at one time, Sharp’s right-hand man, was questioned by federal investigators as to why Smith and Baum received their profits almost a month after sale of the stock. Q. Do you recall any discussion with Mr. Sharp as to the effect that you were not going to credit Dr. Baum’s account, or the governor’s account, with any monies over and above the payment of the loan until the act was signed by the governor? NovotnyNo, sir. Q. Are you absolutely certain? NovotnyI am as positive as I can be I never discussed this. Q. Well, can you explain why everybody’s account except his was credited on Sept. 12 and his was not credited until Oct. 7? NovotnyI just don’t know. Q. Let me point out that the proclamation vetoing this bill was dated Sept. 29, 1969, and that your letter to Dr. Baum was dated Oct. 2 and in that letter you apologized for the delay. Novotny I am sorry. I just don’t know. The SEC also heard allegations that efforts were made to have the records of Smith’s loan from Sharpstown destroyed. Novotny said the request to do away with the records came from Osorio. Novotny I received a call from Osorio at which time he told me he would like to have those records destroyed. [He said it was after the loan was made and “probably” after the two profitable stock sales by Smith and Baum.] Q. Did [Osorio] give any reasons for .. . his request? February 12, 1971 5