In a Washington Business story about a stockholder-management dispute at the State Bank of Prince William County, a large-type, featured quotation was edited incorrectly. As made clear in the text of the story, the quotation, "Stockholder Floyd Bagley, a delegate to the Virginia House, recalled, 'I woke up at 2 a.m. and found my wife reading the report. After she finished I read it until 4 a.m.' " refers to an annual report approved by the Federal Deposit Insurance Corp. and sent by State Bank to its stockholders.

On Dec. 17, 1981, a federal grand jury in Alexandria indicted Wayne Shiflett, 21, on 10 counts of embezzlement and misapplication of bank funds. It charged that Shiflett had absconded with at least $60,000 from the State Bank of Prince William County, with headquarters in Dumfries.

When this case goes to trial Jan. 25, stockholders, customers and neighbors of this small-town bank will be watching intently. It's not so much the news about a bank executive's indictment, nor the amount of money that could be involved, that has stirred intense interest.

Some stockholders are indignant that they were not kept abreast of recent developments. And although there have been encouraging signs, unraveling events surrounding the embezzlement charges and the inside troubles of the bank in the past couple of years provides a rare look at the complexities of a management-shareholder dispute disturbing this otherwise quiet country town.

Despite his youth, Wayne Shiflett was assistant vice president of State Bank, having worked his way up from runner in 18 months. His father, Cecil Shiflett, was president of the bank. Wayne's mother, sister and wife were also on the payroll about that time, but no longer are. As president, Cecil Shiflett received free country club membership and the use of a car.

The indictment charges that Wayne Shiflett unlawfully took money on six different occasions between March and July 1980 by making out cashier's checks to third parties and then cashing them. A shortfall was discovered on a Friday in early July by a teller and reported to the president, Cecil Shiflett, by a vice president who went to Shiflett's house the next day. Wayne Shiflett has pleaded not guilty to the charges.

The Federal Deposit Insurance Corp., the government agency that insures banks, says it did not know of the shortfall and other financial difficulties until January 1981. Wayne was kept on the payroll until Aug. 30. After he left, he went to work on a horse farm, then left the area until he turned himself in to the FBI last month after being indicted.

More than alleged embezzlement has troubled State Bank, however. A 10-page report, made by an FDIC examiner and signed by the regional director of the FDIC, dated Jan. 19, 1981, and marked "strictly confidential," found "the bank's general ledger records plus its statement of assets and liabilities have been and continue to be inaccurate and wholly unreliable." The report states that as of the date of examination, the correspondent balance with the Dominion National Bank of Northern Virginia was $48,828, but it showed up on State Bank's books as $1.6 million.

The report noted, "These extreme out-of-balance conditions are primarily attributable to the inability of the bank's computer to correctly post transactions . . . and the failure of operating personnel, hampered by high turnover and inadequate employe training, to effect prompt resolution."

According to an independent audit, the bank incurred a before-tax loss of $200,000 in 1980. Last year the bank wrote off $128,500, the remaining value of State's data-processing equipment lease with a large national computer company. State Bank blames its losses on the leased equipment, and bank stockholders have authorized State's directors to sue the computer company.

When contacted by The Washington Post, a spokesman for the computer firm blamed the problems on misoperation of equipment by bank personnel, management disregard of installation recommendations on grounding and power supplies and a consistent lack of trained personnel. He said the computer firm spent twice as long as usual training bank personnel because eight systems operators left the bank within two months.

The FDIC report continued, "The near collapse of the bank's internal operations from June to August 1980 represented a mortal threat to its very survival."

The examiner, Richard E. Thorpe, based on his investigation concluded that "the directors and senior management have not acted in a prudent and responsible manner in supervising the bank's affairs . . . Despite the fact that the bank's books were out of balance over $500,000 in some instances, the directors and senior management failed to implement any remedial measures until the near total collapse of the system occurred in late July and early August 1980."

Moreover, Thorpe said, "The board of directors and the senior management made absolutely no effort to inform the FDIC . . . which had no knowledge of the cited problems" until the following January. "In addition," he continued, "call reports of condition were submitted with the knowledge of the directors and senior management that they incorporated errors and unacceptable accounting practices which failed to disclose the extent of the bank's problems and at the same time represented incorrect data.

"The apparent reluctance to disclose the bank's difficulties plus the submission of known incorrect information can only be considered as an unfavorable reflection on the integrity of the directors and the senior management and their collective fitness to supervise and administer the affairs of this institution."

In its report, the FDIC concluded, "While it is unknown at this time whether or not there will be any loss as a result of fraud, the possibility that some degree of dishonesty may be revealed by a comprehensive audit cannot be disregarded."

It added that the directors gave "firm assurance that the cited criticisms would be eliminated or extensive efforts would be instituted to effect a merger of this bank with another institution."

An accompanying letter to the board, sent with the examiner's report on March 26, 1981, and signed by John R. Curtis, regional director of FDIC, stated, "Gentlemen, we feel the overall situation at your bank is intolerable." It ordered the bank to take corrective measures, "including providing the bank with effective daily management."

A thorough audit, costing the bank $226,000, was ordered by the FDIC. It was dated March 31, 1981, by Peat, Marwick & Mitchell and required over 7,000 employe hours, "an inordinate amount of time on a bank this size," in the words of auditor Ernie Brita. The firm found that it was cheaper to write off some of the relatively small computer errors in individuals' accounts than to locate and correct them. The audit did not address any questions of possible fraud.

The officers or directors who were connected with the bank at the time covered by the FDIC report would not comment by telephone on the report or could not be reached.

However, director Dare Clifton did offer the following explanation to a stockholders meeting last October for the apparent lapse of time between discovery in July 1980 of the discrepancies and notification of the authorities:

Shiflett "contacted the state and the FDIC and told them we had a problem that we thought we could handle . . . They didn't really respond. When they sent their people on their twice yearly periodic audit they found they hadn't responded as quickly as they could have." He added that, as for the FDIC's comments on bank officials' integrity, "the justification was zero."

The proxy statement for the annual meeting indicates that directors, officers and their interests had $837,000 in outstanding loans in 1980. Total loans outstanding at the bank, according to the annual report, were $7.7 million. Of the $837,000, 40 percent, or $518,832, of State Bank's total equity capital was in the form of loans to George T. Curtis III (no relation to John R. Curtis of the FDIC), his family and business interests, the FDIC report noted. Curtis, the largest stockholder of State Bank, runs Curtis Properties Inc. in Washington. The report shows the Curtis family had about $300,000 on deposit at the bank when the report was prepared.

Jim Coffey, nephew of Clarinda Coffey, the second largest stockholder, expressed indignation during the annual meeting about the extent of the loans to Curtis and said he was concerned about the bank's potential for growth.

Curtis then replied that the examiner had not found him in violation of regulations and that so long as the bank was charging him more to borrow than it was paying on his deposits, the bank was making money off him.

State Bank's annual meeting was originally scheduled to take place on March 17, 1981. On Feb. 25, John Curtis wrote Cecil Shiflett saying that the FDIC had reviewed what management proposed to include in its stockholders report about the situation and found its "disclosures inadequate and materially misleading."

For example, "flat earnings," the letter said, "does not appear to be an accurate description of the 1980 income results, nor would it appear to be accurate for 1981." It added, "There is no mention made that your bank's CPA has stated that he finds the bank's books to be unauditable. The shareholders should be informed of this material development." The bank was told to try again to write a report the FDIC would approve.

Meanwhile, documents show the following events later took place:

The FDIC notified the bank on March 26 that it was being put on the problem list.

Four days later, in a memorandum to all employes of the bank, Cecil Shiflett wrote that his son had "granted to himself an unauthorized loan" in July 1980, and that a comprehensive audit was under way to clear up the mess left by computer problems.

He also relinquished his duties as president and chief executive officer. In his resignation letter to the board, Cecil Shiflett maintained, "I did nothing wrong personally." Contacted at his home, Shiflett refused on the advice of his attorney to comment.

Ralph Hitchcock, a retired FDIC examiner, was named executive vice president and CEO temporarily until things could be cleared up. A month later, on April 23, the FDIC sent State Bank and its directors a consent order to cease and desist under which the bank was to refrain from engaging in "unsafe or unsound banking practices," without making any admission of improper conduct. The bank signed the consent order.

As for Cecil Shiflett, some members of the board, including Chairman Arthur T. Kelly, who had originally hired him, wanted to retain him in some capacity.

Draft minutes of a board meeting dated June 23 discuss the possibility of bringing Cecil Shiflett back as a loan officer after acknowledging the impossibility of reappointing him president due to FDIC opposition. An unidentified board member says, "We could make a case on his value to the bank as a loan officer. They the FDIC can't attack him on everything. It is not documented in writing." Shiflett, who no longer works for the bank, continued to draw his annual salary of $47,500 until the end of 1981, according to bank officials.

At this same board meeting, chaired by Kelly, there was a discussion of the cease-and-desist order. The draft minutes read: "Enter stipulation that the bank does not admit or deny anything. Whatever they think they can prove, let them prove it. The stipulations, findings and conclusions will all be closed and not available to anybody to look at."

The draft contains these words: "Those rules of confidentiality are falling. Cannot count on it very long. Freedom of Information Act. So far FDIC proceedings have not been opened up."

It continues: "A shareholder is the likely one to get there first. If he had a suit and served a demand to come in and review the records of the bank, we probably could not stop him. A stranger--no. Shareholder would be quite different."

The discussion ends thus: "Can keep it somewhat confidential. This bank was committing unsafe and unsound practices; fact is that this bank had a lot of things wrong. They have plenty to sustain a case."

The final version of the minutes of this meeting are shorter than the draft and contains none of the above. The minutes say only that the bank's counsel was authorized to negotiate a settlement if possible, and if not, to oppose the order.

After this meeting management and directors met several times with stockholders impatient to know why the annual meeting was being postponed so long. A small group of dissident stockholders, representing about 30 percent of the outstanding stock, tried unsuccessfully to get three additional representatives onto the board of directors, according to one of the shareholders.

It was not until shortly before Oct. 15, when the FDIC-approved proxy material was sent out in anticipation of the annual meeting--now seven months late--that some of the stockholders learned what had been going on at State Bank.

Stockholder Floyd Bagley, a delegate to the Virginia House, recalled, "I woke up at 2 a.m. and found my wife reading the report. After she finished I read it until 4 a.m."

What Bagley and the other shareholders found, in addition to news of the alleged embezzlement and the losses, was a proposal from the bank's directors and management to lower the par value of the stock from $8 to $6. In this way they could make up their deficit, increasing the bank's surplus by $211,000 to cover the minus figure of $225,000 in the undistributed profits column. The result, according to major stockholder George Curtis, would be to give the bank "a little cushion of capital to work with."

According to those present, the October 1981 annual meeting was at times acrimonious. But in the end, a majority of the shareholders elected to go along with the reduction in the stock's par value as an alternative to the possibility of having federal or state authorities force them to make changes.

When the stock was originally issued in 1972, it had a par value of $40 and sold for $50. It split 5 for 1 that year, and dividends were paid until December 1980. Consequently, for an original investor the cost per share, adjusted for splits and dividends, is $7.77, according to a bank official. The current market value is $9 to $10 per share.

Moreover, through the use of proxy votes, management passed a floor resolution which in effect indemnifies all the officers and directors of any personal financial liability for any bank problems between March 18, 1980 (10 days before the first alleged embezzlement) and Oct. 15, 1981, date of the delayed annual meeting.

For the first nine months of 1981 the bank had a loss of $184,000. A call report shows the bank had total equity capital and liabilities (deposits) of $8.8 million at the end of October 1981, compared with total capital and liabilities of $12.4 million at the end of September 1980, or down nearly a third in a year.

State Bank acquired a new president and CEO in late July. P. Richard Malloy, 52, a veteran of 25 years in banking, had most recently worked for the banking commissioner of West Virginia. He was approved by the FDIC. In an interview, Malloy was optimistic about State Bank's future.

The staff has been trimmed and deposits, which had been declining since September 1979, have edged back up to $8.2 million from $7.7 million in October 1981. The bank, which has branches in Woodbridge and Manassas, has $9.3 million in assets. It now has $838,000 in capital as a result of the realignment voted upon.

"The road to recovery will begin in 1982," Malloy said, noting its loan portfolio and bond accounts were "in excellent shape." The FDIC once again permits it to accept uninsured deposits over $100,000. State Bank remains on the FDIC's problem list, however. The consent order to cease and desist will be lifted when an acceptable internal audit program is developed and the bank passes examination, he added. Virginia state commissioner of financial institutions, Sidney Bailey, who had warned State Bank against unsafe and unsound practices in March 1981, said recently he was satisfied the bank's difficulties have been cleared up.

The board of directors had voted back in April to seek a merger. Malloy last week declined to comment on possible merger activity. Among those who are said to be interested in taking over State Bank are Stuart, Robert, David and other members of the Bindeman family of Bethesda.

Stuart is an attorney and David is a real estate developer. Together the Bindemans own more than 7,000 shares--some recently acquired--out of about 105,000 outstanding shares of the bank stock. This makes them the third largest of the bank's 400 stockholders, after George Curtis and Clarinda Coffey, widow of founder Francis Coffey. Stockholder Mamie Evans said Robert Bindeman told her at the annual meeting, "Line up the people here, and I'll buy all their stock." Bindeman had no comment.

Another name mentioned was that of former senator Vance Hartke, representing a group of investors. At the annual meeting, a director acknowledged the bank had been contacted by Hartke and added, "They are very interested in the bank." Hartke referred all questions to Malloy.

He responded, "Nothing was presented to us that was a bona fide offer under the law." Then he added, "We're looking to be an independent bank. There is room for an independent bank such as State Bank in Prince William County." With a smile he appended this comment, "I'd like to buy their shares myself."

As for stockholder complaints about not being told what is going on, Malloy observed, "The auditors report didn't come back until July. In retrospect, I suppose we should have sent out a letter in August explaining the situation." He added, "I believe in communicating with stockholders. They have good questions; I know we've answered them factually."

Yet some stockholders remain unconvinced. One of the largest shareholders, who asked not to be named, said, "I don't know what's going on."

She said she believed "the bank is not telling stockholders what's going on. They're playing a waiting game."