Monday, August 10, 2015

No. 112: Shadow Insurance—Confidential Documents Dated 2003 Are Now in the Public Domain

Readers of this blog know I have been trying without success to obtain documents associated with shadow insurance transactions between insurance companies and their wholly owned reinsurance subsidiaries. In the Ross case discussed in No. 111 (posted August 3, 2015), certain 2003 documents are now available in court filings. Despite their age, the documents shed light on the subject. (See Ross v. AXA Equitable Life, U.S. District Court, Southern District of New York, Case No. 1:14-cv-2904.)

The Exhibits
The exhibits mentioned here were filed in the Ross case on April 27, 2015. Exhibit 8 is an automatic level term reinsurance agreement between The Equitable Life Assurance Society of the United States (Equitable), which later became AXA Equitable Life, and AXA Financial (Bermuda) Ltd., a wholly owned reinsurance subsidiary of Equitable. The agreement was signed by the parties on December 22 and 29, 2003.

Exhibit 9 is an automatic lapse protection rider reinsurance agreement between the same parties. The agreement was signed by the parties on December 22 and 29, 2003.

Exhibit 10 consists of two standby letters of credit. The first, for $60 million, was issued by National Australia Bank (New York, NY) to AXA Financial (Bermuda) Ltd., was dated December 22, 2003, and expired December 21, 2004. Equitable was the beneficiary. The second, for $40 million, was issued by ABN Amro Bank N.V. (Chicago, IL) to AXA Financial (Bermuda) Ltd., was dated December 30, 2003, and expired December 21, 2004. Equitable was the beneficiary.

Exhibit 11 consists of a letter dated November 7, 2003 to the New York Department of Insurance (Department) from Equitable, and two proposed inter-company service agreements between Equitable and Athena Reinsurance, Ltd. (Bermuda). At the time Athena was being formed as a wholly owned reinsurance subsidiary of AXA Financial, Inc.

Exhibit 14 is a letter dated December 19, 2003 to Equitable from the Department. The Department expressed "no objection" to the agreements submitted with Equitable's November 7, 2003 letter.

The Freedom of Information Law
I have experience with New York State's Freedom of Information Law (FOIL). Equitable's November 7, 2003 letter to the Department referred to the FOIL exemption for trade secrets. The company requested confidential treatment for the letter and the agreements, and said the information was "provided with the express understanding that the confidentiality of such information will be safeguarded pursuant to all applicable provisions of the law . . . ."

Here is my understanding of what the above request means. If the Department had received a FOIL request for the material, the Department would have notified the company and asked the company to justify confidential treatment, with the burden of proof on the company.

If the company had submitted justification, and if the Department had agreed with the company, the Department would have denied the FOIL request. The requester could then have submitted to the Department an administrative appeal of the denial. If the Department had denied the appeal, the requester could have sought court review of the denial. If the Department had granted the appeal, the company could have sought a court order preventing the Department from releasing the material.

On the other hand, if the Department had disagreed with the company's justification, the company could have submitted to the Department an administrative appeal of the determination. If the Department had denied the appeal, the company could have sought court review of the determination. If the Department had granted the appeal, the requester could have sought court review of the determination.

The above is an oversimplified and incomplete description of the procedures associated with a FOIL request. Suffice it to say that going through the exercise can consume months or years. I was involved in such an exercise a few years ago when I sought documents filed with the Department by Phoenix Companies, Inc. relating to its cost-of-insurance increases on universal life policies used in stranger-originated life insurance transactions. The struggle went on for more than a year and was never fully resolved. However, I was able to announce in No. 26 (posted January 29, 2014) a judge's unsealing of several documents that had been filed initially under seal in lawsuits against Phoenix.

Available Material
I am offering a complimentary 88-page PDF consisting of the 19-page Exhibit 8, the 20-page Exhibit 9, the seven-page Exhibit 10, the 40-page Exhibit 11, and the two-page Exhibit 14. E-mail jmbelth@gmail.com and ask for the five exhibits in the case of Ross v. AXA Equitable Life.

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Monday, August 3, 2015

No. 111: Shadow Insurance—A Legal Setback in the Struggle against the Life Insurance Shell Game

On July 21, 2015, U.S. District Judge Jesse M. Furman issued an Opinion and Order dismissing for lack of jurisdiction a class action lawsuit relating to the use of shadow insurance. He ruled the plaintiffs had failed to show they suffered a "concrete injury-in-fact," as required to establish standing under the U.S. Constitution. He dismissed the complaint, and he denied the plaintiffs' motion for class certification as moot. (See Ross v. AXA Equitable Life, U.S. District Court, Southern District of New York, Case No. 1:14-cv-2904.)

The Ross (Yale) Lawsuit
The initial complaint was filed in April 2014. At that time, the lead plaintiff was Andrew Yale. On February 24, 2015, the judge granted Yale's unopposed motion to substitute—"due to family medical issues"—Jonathan Ross and David Levin as lead plaintiffs. Two days later they filed an amended complaint. On March 24 they filed a second amended complaint. On April 1 they filed a motion to certify the class. On April 14 AXA filed a motion to dismiss the complaint. On May 5 the plaintiffs filed an opposition to the motion to dismiss. On May 12 the defendant replied to the plaintiffs' opposition. Here, with citations omitted, are the two concluding paragraphs of Judge Furman's July 21 Opinion and Order (NYDFS is the New York Department of Financial Services):
For the reasons stated above, the Court concludes that Plaintiffs fail to demonstrate an injury sufficient to "satisfy the strictures of constitutional standing," and that the Complaint must therefore be dismissed for lack of subject-matter jurisdiction. In light of that conclusion, the Court need not and will not address Defendant's other grounds for dismissal. Further, Plaintiffs' motion for class certification must be and is denied as moot.
The Court does not arrive at its conclusion lightly. The pervasiveness of shadow insurance in New York—and AXA's alleged failure to disclose details of those transactions—may well pose a threat to the stability and reliability of the state's insurance system, as NYDFS suggested. Nevertheless, the Court cannot address the legality or propriety of AXA's conduct without the constitutional authority to do so. The absence of "a substantial controversy ... of sufficient immediacy and reality to justify judicial resolution" does not, of course, mean that Plaintiffs—or life insurance policyholders more generally—are without recourse. To the contrary, one of the purposes of the injury-in-fact requirement is to ensure that generalized claims of this nature are "committed ... ultimately to the political process." Notably, it appears that that process has at least partially served its purpose in this case: As plaintiffs themselves concede, the NYDFS promulgated a new regulation after its investigation "explicitly requiring disclosure of additional information regarding shadow insurance transactions." Ultimately, having to establish an injury-in-fact worthy of federal judicial intervention, it is those political channels (or, perhaps, state court) through (or in) which plaintiffs must seek to resolve their grievances.
Other Shadow Insurance Lawsuits
Several shadow insurance lawsuits have been filed in federal courts. Aside from the cases discussed in Nos. 107 (June 30, 2015) and 110 (July 17, 2015), and in addition to Ross, other cases have been consolidated under Senior District Judge Denise L. Cote in the same court as the Ross case. Among those other cases are two lawsuits against Metropolitan Life Insurance Company. (See Robainas v. Metropolitan Life and Intoccia v. Metropolitan Life, U.S. District Court, Southern District of New York, Case Nos. 1:15-cv-3061 and 1:14-cv-9926.)

On July 22, the day after Judge Furman issued his ruling, an attorney for Metropolitan Life sent a letter to Judge Cote about Judge Furman's "well reasoned" decision in the "nearly identical" Ross case. The attorney "wanted to be sure the Court had the benefit of Judge Furman's thinking as it considers [Metropolitan Life's] motion to dismiss" the Robainas complaint, and he attached Judge Furman's decision "for the Court's convenience."

On July 23 an attorney for Ross sent a courtesy letter to Judge Furman and attached a copy of a letter sent to Judge Cote in response to the above mentioned July 22 letter. In the letter to Judge Cote the attorney for Ross said: "Plaintiffs intend to appeal Judge Furman's decision and respectfully submit that it would be error for this Court to adopt the reasoning of that opinion in the MetLife cases." He described the analysis in Judge Furman's ruling as "flawed for several independent reasons," and he identified those reasons. Presumably the appeal will be filed in the U.S. Court of Appeals for the Second Circuit.

My Open Records Law Request in Iowa
In No. 109 (July 13, 2015) I discussed the May 2015 independent auditor reports filed by the eight "limited purpose subsidiaries" (LPSs) domiciled in Iowa. I mentioned dubious assets carried by the LPSs in their financial statements as of the end of 2014. Six of the LPSs carry as assets items that are not allowed under generally accepted accounting principles (GAAP) and are not allowed under statutory accounting practices. The other two LPSs carry as assets items that are not allowed under GAAP.

On July 24, pursuant to the Iowa Open Records Law, I requested copies of the documents associated with each of those dubious assets, including documents reflecting the Iowa Insurance Division's approval of those assets. The Division denied my request. I now plan to appeal the denial to Nick Gerhart, the Iowa insurance commissioner.

Available Material
I am offering a complimentary 28-page PDF consisting of three items: the 23-page July 21 Opinion and Order by Judge Furman, the two-page July 22 letter to Judge Cote from an attorney for Metropolitan Life, and the three-page July 23 letter to Judge Cote from an attorney for Ross. Email jmbelth@gmail.com and ask for the package relating to the case of Ross v. AXA Equitable Life.

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Friday, July 17, 2015

No. 110: Aviva, Guggenheim, Allegations of Phony Reinsurance, and a Strange Coincidence

In No. 107 posted June 30, 2015, I wrote about a federal class action lawsuit filed on June 12 against Aviva, Athene, and Apollo alleging phony reinsurance and violations of the Racketeer Influenced and Corrupt Organizations Act (RICO). At the time I vaguely recalled a similar lawsuit filed earlier and withdrawn without explanation the next day. I located the earlier lawsuit and found a strange coincidence. The earlier case was against Guggenheim and others. There were differences from the Aviva case; however, the earlier case involved the same plaintiffs' law firms, many of the same plaintiffs' attorneys, similar allegations of phony reinsurance, and similar RICO allegations. Here I update the Aviva case and describe the earlier Guggenheim case.

The 2015 Complaint against Aviva
In No. 107 about the Aviva case, I identified the plaintiffs' attorneys. The defendants' attorneys are Bruce Roger Braun, Hille von Rosenvinge Sheppard, Joel Steven Feldman, Peter K. Huston, and Sarah Alison Hemmendinger of Sidley Austin LLP; and Reginald David Steer and Steven M. Pesner of Akin Gump Strauss Hauer & Feld LLP. The parties have consented to proceed before a magistrate judge, and have agreed that the defendants will answer, move, or otherwise respond to the complaint by August 24. (See Silva v. Aviva, U.S. District Court, Northern District of California, Case No. 5:15-cv-2665.)

The 2014 Complaint against Guggenheim
On February 11, 2014, the plaintiffs' attorneys filed a federal class action lawsuit against Guggenheim and others. The 105-page complaint alleged phony reinsurance transactions with affiliates and participation in a RICO enterprise. The lead plaintiffs were Clarice Whitmore, an Arkansas resident who bought an annuity in 2012 from Security Benefit Life Insurance Company; and Helga Maria Schulzki, a California resident who bought an annuity in 2013 from EquiTrust Life Insurance Company.

The plaintiffs' attorneys in the 2014 case (italics indicate those involved in the Guggenheim case but not involved in the Aviva case) were Steve W. Berman, Sean R. Matt, Elizabeth A. Fegan, and Robert B. Carey of Hagens Berman Sobol Shapiro LLP; Andrew S. Friedman and Francis J. Balint Jr. of Bonnett Fairbourn Friedman & Balint PC; Erin Dickinson and Chuck Crueger of Hansen Reynolds Dickinson Crueger LLC; and Ingrid M. Evans and Elliot Wong of Evans Law Firm Inc.

The defendants in the 2014 case were Guggenheim Partners LLC, Guggenheim Life and Annuity Company, Security Benefit Life, and EquiTrust Life. Other participants in the alleged RICO enterprise were Mark Walter, chief executive officer of Guggenheim Partners and chairman and controlling owner of the Los Angeles Dodgers; Todd Boehly, president of Guggenheim Partners; Robert Patton Jr., client and associate of Walter and Boehly; Paragon Life Insurance Company; and Heritage Life Insurance Company. The docket does not identify the defendants' attorneys because the case ended almost immediately after it was filed. (See Whitmore v. Guggenheim, U.S. District Court, Northern District of Illinois, Case No. 1:14-cv-948.)

The Allegations against Guggenheim
The introduction to the 2014 complaint against Guggenheim contained 30 paragraphs summarizing the allegations. Here were ten of them:
7. This case is about the fraud that Guggenheim and others working in association with it committed to sell Guggenheim Insurers' annuity products to unwitting annuity purchasers, many of whom are elderly, while concealing the adverse effects of their depletion of the funds needed to satisfy the Guggenheim Insurers' long-term obligations to these annuity purchasers.
8. Guggenheim's plan was pernicious: acquire insurance companies weakened by the recession and use them to sell seemingly safe and secure annuity products (particularly annuities with large, upfront premiums) while funneling cash out to Guggenheim and its affiliates, friends and associates rather than holding or reserving it to satisfy their long-term obligations to the annuity holders.
11. In addition to saddling the Guggenheim Insurers with the highly illiquid affiliated promissory notes and billions of dollars of highly illiquid mortgage and other risky asset-backed securities, Guggenheim Chief Executive Officer Mark R. Walter, Guggenheim President Todd L. Boehly, and Guggenheim business associate Robert "Bobby" Patton Jr. used the Guggenheim Insurers as a cash machine to buy the most expensive sports franchise in world history, the Los Angeles Dodgers, with over a billion dollars in policyholders' funds.
13. To accomplish their illicit goals Defendants took a page out of the Enron playbook, creating a fraudulent scheme through complicated accounting machinations that gave the false appearance of financial strength and stability to Security Benefit Life, Guggenheim Life and EquiTrust Life by: (1) moving liabilities off their books to affiliated and secretly affiliated entities (primarily through non-economic "reinsurance" transactions with affiliated entities), (2) inflating their assets by counting already encumbered assets as though they were available to make annuity holder payments, (3) executing billions of dollars of what appear to be essentially uncollateralized loans to affiliated entities or associates and portraying the related-party unsecured paper as assets, and (4) hiding their non-performing assets.
14. At the center of this scheme was a shell game that Defendants hoped no one could follow, where money and liabilities were continuously shifted between companies with whom the Guggenheim Insurers acknowledged an affiliation (Security Benefit Life, Guggenheim Life, EquiTrust Life and Paragon Life Insurance Company of Indiana) and with a separate, secretly affiliated company that Defendants acquired and corrupted to facilitate the fraudulent scheme, Heritage Life Insurance Company (AZ).
18. At the same time Defendants were hiding the Guggenheim Insurers' liabilities, Defendants were also inflating their assets by additional fraudulent accounting machinations.
19. For example, collectively the three Guggenheim Insurers improperly counted as "admitted assets" over $2.59 billion of collateral that was already pledged to repay loans to the Federal Home Loan Banks.
23. In sum, after their acquisition by Guggenheim each of the Guggenheim Insurers was in short order rendered statutorily impaired, each having an essentially negative surplus (which means annuity holder funds were consequently impaired).
25. Flush with their annuity holders' cash, for example, Security Benefit Life and EquiTrust Life paid over $445 million in dividends to their respective Guggenheim parents, over $217 million in management fees to Guggenheim affiliates, and over $55 million in investment fees to Guggenheim affiliates. Additionally, beyond the $5.1 billion the Guggenheim Insurers paid to various affiliates within the Guggenheim family of companies in what appears to be largely unsecured promissory notes, they loaned almost $1 billion to Guggenheim business associates. Perhaps the most perverse aspect of Defendants' fraudulent scheme, however, is the acquisition of the Dodgers by Guggenheim, Walter, Boehly and Patton for $2.15 billion—$1.2 billion of which was financed by policyholder and annuity holder money from the Guggenheim Insurers.
30. Defendants' fraudulent scheme constitutes a violation of the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §§ 1962(c) and (d). Plaintiffs and the Class have been damaged by Defendants' pattern of racketeering activity because they were misled into purchasing annuities based on material misrepresentations of the financial strength of the issuing companies, annuity products that no reasonable person would purchase if not deceived. This suit is necessary to remedy the injury caused by Defendants' racketeering activity.
The Withdrawal of the 2014 Complaint
The 2014 complaint against Guggenheim was assigned immediately to District Judge Samuel Der-Yeghiayan. (In 2003 President George W. Bush nominated him and the Senate confirmed him.) On February 12, 2014, the day after the complaint was filed, one of the plaintiffs' attorneys filed a notice of voluntary dismissal. The notice contained no explanation. On February 13, the case was dismissed without prejudice.

General Observations
The preparation of the elaborate 2014 complaint against Guggenheim undoubtedly required a major expenditure of resources. I asked one of the plaintiffs' attorneys to explain why the complaint was withdrawn the day after it was filed, but he did not respond. Thus the reason for the abrupt withdrawal of the complaint is a mystery.

Available Material
I am offering a complimentary 172-page PDF consisting of the 105-page complaint against Guggenheim and 67 pages of exhibits. E-mail jmbelth@gmail.com and ask for the Whitmore/Guggenheim complaint.

At the outset I mentioned No. 107 (6/30/15). I wrote about related matters in Nos. 44 (4/22/14), 66 (8/21/14), 71 (11/6/14), 72 (11/12/14), 73 (11/19/14), 93 (4/17/15), 94 (4/20/15), 99 (5/6/15), 100 (5/11/15), and 109 (7/13/15).

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Monday, July 13, 2015

No. 109: Iowa's Frightening Accounting Rules—An Update

In Nos. 71, 72, and 73 posted November 6, 12, and 19, 2014, I discussed Iowa's frightening accounting rules. Iowa statutes allow for limited purpose subsidiaries (LPSs), which are reinsurance entities created by Iowa-domiciled insurance companies. Iowa allows the LPSs to treat as assets items that are not treated as assets under generally accepted accounting principles (GAAP) and under statutory accounting practices (SAP) adopted by the National Association of Insurance Commissioners. This update is based on May 2015 independent auditor reports on the Iowa LPSs as of December 31, 2014. The reports are filed only in Iowa, and I obtained them in accordance with Iowa's Open Records Law.

The LPSs and Their Auditors
The eight Iowa LPSs are Cape Verity I Inc. (CV I), Cape Verity II Inc. (CV II), Cape Verity III Inc. (CV III), MNL Reinsurance Company (MNL Re), Solberg Reinsurance Company (Solberg Re), Symetra Reinsurance Corporation (Symetra Re), TLIC Oakbrook Reinsurance Inc. (Oakbrook), and TLIC Riverwood Reinsurance Inc. (Riverwood). CV I, CV II, and CV III are subsidiaries of Accordia Life and Annuity Company. MNL Re and Solberg Re are subsidiaries of Midland National Life Insurance Company. Oakbrook and Riverwood are subsidiaries of Transamerica Life Insurance Company. Symetra Re is a subsidiary of Symetra Life Insurance Company. (See No. 44 posted April 22, 2014 for a discussion of Symetra's redomestication from Washington State to Iowa.)

The reports for seven of the Iowa LPSs were prepared in the Des Moines office of PricewaterhouseCoopers LLP (PwC). The other, for Symetra Re, was prepared in the Seattle office of Ernst & Young LLP.

The Dubious Assets
All eight reports include an adverse opinion with regard to GAAP, and most of them also identify differences between SAP and practices permitted by Iowa. The reports on MNL Re and Solberg Re do not state whether the LLC note guarantee and the irrevocable standby letters of credit are treated as assets under SAP.

The differences among GAAP, SAP, and Iowa relate to items that are not treated as assets under GAAP or SAP but are treated as assets by Iowa. Here is a list of the dubious assets as of December 31, 2014 (the parenthetical figures are to the nearest million):
CV I: Contingent note ($459) is not an asset under GAAP or SAP, but is treated as an asset by Iowa.
CV II: Parental guarantee ($688) by Global Atlantic Financial Group Ltd. is not an asset under GAAP or SAP, but is treated as an asset by Iowa.
CV III: Contingent note ($223) is not an asset under GAAP or SAP, but is treated as an asset by Iowa.
MNL Re: LLC note guarantee ($705) is not an asset under GAAP, but is treated as an asset by Iowa.
Solberg Re: Irrevocable standby letters of credit ($514) are not assets under GAAP but are treated as assets by Iowa.
Symetra Re: Variable funding note ($71) is not an asset under GAAP or SAP but is treated as an asset by Iowa.
Oakbrook: Credit linked note ($884) is not an asset under GAAP or SAP, but is treated as an asset by Iowa.
Riverwood: Parental guarantee ($1,930) by Aegon USA is not an asset under GAAP or SAP but is treated as an asset by Iowa.
General Observations
Several reports mention a high risk-based capital (RBC) ratio if the item in question is treated as an asset, but say the LPS would be below the RBC mandatory control level if the item is not treated as an asset. The fact is that the LPS would be insolvent if the item is not treated as an asset.

In some of the reports the dubious assets are described briefly, and in some they are not described. Also, documents associated with those assets are not available under Iowa's Open Records Law. The Iowa Insurance Division says each item in question is part of the LPS's "plan of operation," which is confidential under the Iowa LPS law and regulations. The secrecy associated with those assets is one reason why I describe the LPSs as part of a shell game that eventually will collapse, with dire consequences for policyholders and the life insurance business.

Available Material
As an example of the reports, I am offering a complimentary 48-page PDF of the PwC report on Riverwood. It refers to the $1.93 billion parental guarantee by Aegon USA. See especially PDF page numbers 3, 4, 5, 9, 12, 14, 16, 17, and 35. E-mail jmbelth@gmail.com and ask for the PwC report on Riverwood dated May 29, 2015.

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Monday, July 6, 2015

No. 108: Guardian Life's Rectification of an Unsuitable Rollover—An Update

In No. 104R posted June 22, 2015, I discussed an unsuitable rollover of a client's retirement accumulation at College Retirement Equities Fund (CREF) into an individual retirement account containing a variable annuity issued by a subsidiary of Guardian Life Insurance Company of America. Guardian initially rejected the client's complaint, but later resolved the complaint to the client's satisfaction. This is an update on the case.

Background
The client was Beatrice (not her real name). She was aged 78 at the time of the rollover. Edgar Montenegro (CRD# 4768006), a registered representative of Park Avenue Securities, a Guardian subsidiary, sold Beatrice on the idea of using $200,000 of her $325,000 CREF accumulation to buy the annuity from Guardian Insurance & Annuity Company, another Guardian subsidiary. However, through what has been referred to as "a mistake in the purchase paperwork," the entire $325,000 accumulation was rolled into the annuity. Consequently Beatrice had to take withdrawals from the annuity to meet required minimum distributions, thereby forfeiting an enhanced lifetime guarantee. The guarantee was an annuity benefit for which she had paid.

The Financial Industry Regulatory Authority (FINRA) shows "BrokerCheck Reports" on its website (www.finra.org). The BrokerCheck report on Montenegro originally said the complaint was denied. Although reports do not identify cases by the names of clients, in this instance the case was identifiable from the facts shown in the report.

The Updated BrokerCheck Report
I saw the updated BrokerCheck report on June 30. It shows a "status" of "settled," a "status date" of June 10, 2015, a "settlement amount" of $342,902.18, and an "individual contribution amount" [presumably the amount contributed to the settlement by Montenegro] of zero. The "broker statement" in the updated report reads:
A firm affiliate [presumably Guardian Insurance & Annuity Company] entered into a confidential settlement with the customer without the firm [presumably Park Avenue Securities] or the firm affiliate admitting liability.
The "employment history" section of the updated BrokerCheck report says Montenegro is employed by Park Avenue Securities from June 2011 to "Present." However, the report contains this note:
Please note that the broker is required to provide this information only while registered with FINRA or a national securities exchange and the information is not updated via Form U4 after the broker ceases to be registered. Therefore, an employment end date of "Present" may not reflect the broker's current employment status.
I asked Jeanette Volpi, a Guardian spokeswoman, whether Montenegro is currently employed by Park Avenue Securities. In her prompt response, she said Montenegro is currently employed by Park Avenue Securities.

General Observations
Guardian's settlement with Beatrice could have been for the rollover amount of $325,000 without a surrender charge. However, the settlement amount shown in the updated BrokerCheck report suggests that the settlement was for the full current value of Beatrice's account without a surrender charge. Although it is regrettable that Guardian initially rejected Beatrice's complaint, I am favorably impressed by, and commend the company for, the manner in which the company handled the complaint in the end.

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Tuesday, June 30, 2015

No. 107: Aviva, Athene, and Apollo Are Defendants in a RICO Lawsuit about Alleged Phony Reinsurance

On June 12, 2015, eight plaintiffs' attorneys filed a federal class action lawsuit on behalf of two individuals who purchased Aviva annuities in 2010. The elaborate 131-page complaint alleges violations of the Racketeer Influenced and Corrupt Organizations Act (RICO). The complaint further alleges that the defendant companies—Aviva, Athene, and Apollo—together with other companies and certain individuals, participated in an unlawful RICO enterprise involving phony reinsurance with affiliates. No specific amount of damages is mentioned in the complaint. (See Silva v. Aviva, U.S. District Court, Northern District of California, Case No. 5:15-cv-2665.)

Plaintiffs and Their Attorneys
The plaintiffs are Rachel Silva (a resident of California) and Don Hudson (a resident of Oklahoma). They are represented by Steve W. Berman, Jeff D. Friedman, and Sean R. Matt of Hagens Berman Sobol Shapiro LLP (Seattle); Francis J. Balint Jr. and Andrew S. Friedman of Bonnett Fairbourn Friedman & Balint PC (Phoenix); Chuck Crueger and Erin Dickinson of Hansen Reynolds Dickinson Crueger LLC (Milwaukee); and Ingrid M. Evans of Evans Law Firm Inc. (San Francisco).

Defendants and Other Participants
The defendants are Aviva plc (London, England), Athene Annuity and Life Co. (Iowa), Athene USA Corp. (Iowa), Athene Holding Ltd. (Bermuda), Athene Life Re Ltd. (Bermuda), Athene Asset Management LP (California), and Apollo Global Management LLC (Delaware).

The company participants—in addition to the defendants—identified in the complaint are Cure Life Ltd. (Bermuda), Global Atlantic Financial Group Ltd. (Bermuda), Accordia Life and Annuity Co. (Iowa), Tapioca View LLC (Delaware), Vermont special purpose financial captives Aviva Re USA Inc., Aviva Re USA II Inc., Aviva Re USA III Inc., Aviva Re USA IV Inc., Aviva Re USA V Inc., Aviva Re USA VI Inc., Iowa limited purpose subsidiaries Aviva Re Iowa Inc., Aviva Re Iowa II Inc., Cape Verity I Inc., Cape Verity II Inc., and Cape Verity III Inc.

The individual participants identified in the complaint are Leon Black, Mark Rowan, Joshua Harris, Mark Hammond, Christopher Littlefield, Thomas Godlasky, Michael Miller, Brenda Cushing, Richard Cohan, Guy Hudson Smith III, Erik Askelson, David Attaway, James Belardi, John Fowler, and Maureen Closson.

Allegations
Paragraphs 537-540 on pages 110-111 of the complaint provide a summary of the allegations. Those paragraphs read:
537. To pull off the reinsurance shell game and purport to move liabilities off Aviva's balance sheet and otherwise give it the appearance of financial strength, Defendants had to create and operate [the Aviva Captives] as well as [the Aviva Affiliates]. Additionally, Defendants had to create and utilize the "unaffiliated" Accordia as well as [the Accordia Captives].
538. The special purpose financial captives, including the Aviva Captives, the Aviva Affiliates, and the Accordia Captives formed the heart of the scheme because their finances are not publicly disclosed under state law, and these entities enabled the RICO Enterprise's unlawful activity to violate statutory accounting requirements, hide liabilities, artificially inflate surplus and RBC [risk-based capital], and improperly pay dividends and fees while fraudulently misrepresenting the financial strength of Aviva in order to sell annuities at inflated prices.
539. Defendants' use of the Aviva Captives, the Aviva Affiliates, and the Accordia Captives made it easier to commit and conceal the RICO Enterprise's fraudulent activities and purpose, because it allowed the generation of phony reserve credits and RBC boosts through circular, non-economic reinsurance and modified coinsurance transactions between entities.
540. The decision to use these entities to misrepresent the true financial condition of Aviva not only facilitated but enabled the RICO Enterprise's unlawful activity; in particular, Aviva used the separately incorporated nature of these entities to perpetrate the fraudulent scheme and the acts of mail and wire fraud that were at the center of the scheme.
General Observations
The lawsuit is in its early stages. Although the names of the attorneys representing the defendants are not yet shown on the docket sheet, a case management conference is tentatively scheduled for September 15. Normally I do not discuss a case until a later stage. However, I mention the case now because it is important, it should be brought to public attention immediately, the plaintiffs' attorneys did not issue a press release about the case, and they have not yet responded to my efforts to speak with them.

The defendants' attorneys may respond initially with procedural matters. However, they may argue that everything done by the defendants and the other participants in the alleged RICO enterprise was in accordance with state laws drafted by the participants and enacted by friendly legislators, in accordance with state regulations drafted by the participants and adopted by friendly regulators, approved by friendly regulators, and signed off on by friendly accountants, actuaries, attorneys, auditors, consultants, company executives, and company directors.

The lawsuit has been referred to Magistrate Judge Paul Singh Grewal. On June 26, a plaintiffs' attorney consented to magistrate judge jurisdiction for all proceedings including trial and entry of final judgment rather than requesting reassignment to a district judge. A federal district judge is appointed for life by the President and confirmed by the Senate. A magistrate judge is appointed—usually for eight years—by district judges to assist district judges. It is puzzling that a case such as this one is to be handled exclusively by a magistrate judge.

Available Material
I am offering a complimentary 149-page PDF consisting of the 131-page complaint and 18 pages of exhibits. E-mail jmbelth@gmail.com and ask for the Silva/Aviva RICO complaint.

Also, I wrote about these matters in blog post nos. 44 (4/22/14), 66 (8/21/14), 71 (11/6/14), 72 (11/12/14), 73 (11/19/14), 93 (4/17/15), 94 (4/20/15), 99 (5/6/15), and 100 (5/11/15).

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Wednesday, June 24, 2015

No. 106: Hank Greenberg's Pyrrhic Victory over the U.S. Government

On June 15, 2015, Judge Thomas C. Wheeler of the U.S. Court of Federal Claims handed down an Opinion and Order ("Opinion") in a lawsuit related to the federal government's bailout of American International Group, Inc. (AIG) in September 2008. The lawsuit was filed by Starr International Co., Inc., a large AIG shareholder. Starr is headed by Maurice R. ("Hank") Greenberg, who was AIG's chief executive officer from 1968 until his retirement in March 2005 during an investigation by then New York Attorney General Eliot Spitzer and then New York Superintendent of Insurance Howard D. Mills, III. The Opinion is a Pyrrhic victory for Greenberg because, although Judge Wheeler ruled in Starr's favor on the "illegal exaction" claim, he ruled that AIG shareholders are entitled to zero damages.

Background
On November 21, 2011, Starr filed two lawsuits against the federal government. One was the claims court lawsuit mentioned above. The other was a district court lawsuit against the Federal Reserve Bank of New York (FRBNY). The latter case was assigned to Judge Paul A. Engelmayer. The government filed motions to dismiss both lawsuits. Judge Wheeler granted the motion in part but denied it in significant part. Judge Engelmayer granted the motion in its entirety. (See Starr v. U.S., U.S. Court of Federal Claims, Case No. 1-11-cv-799, and Starr v. FRBNY, U.S. District Court, Southern District of New York, Case No. 1:11-cv-8422.)

Excerpts from the Opinion
Judge Wheeler's Opinion consists of 75 single-spaced pages. Here are six excerpts from the ten-page introductory section, with the page number indicated at the beginning of each excerpt:
Page 2: On the weekend of September 13-14, 2008, known in the financial world as "Lehman Weekend" because of the impending failure of Lehman Brothers, U.S. Government officials feared that the nation's and the world's economies were on the brink of a monumental collapse even larger than the Great Depression of the 1930s. While the Government frantically kept abreast of economic indicators on all fronts, the leaders at the Federal Reserve Board, the Federal Reserve Bank of New York, and the U.S. Treasury Department began focusing in particular on AIG's quickly deteriorating liquidity condition. AIG had grown to become a gigantic world insurance conglomerate, and its Financial Products Division was tied through transactions with most of the leading global financial institutions. The prognosis on Lehman Weekend was that AIG, without an immediate and massive cash infusion, would face bankruptcy by the following Tuesday, September 16, 2008. AIG's failure likely would have caused a rapid and catastrophic domino effect on a worldwide scale.
Page 2: On that following Tuesday [September 16, 2008], after AIG and the Government had explored other possible avenues of assistance, the Federal Reserve Board of Governors formally approved a "term sheet" that would provide an $85 billion loan facility to AIG. This sizable loan would keep AIG afloat and avoid bankruptcy, but the punitive terms of the loan were unprecedented and triggered this lawsuit. Operating as a monopolistic lender of last resort, the Board of Governors imposed a 12 percent interest rate on AIG, much higher than the 3.25 to 3.5 percent interest rates offered to other troubled financial institutions such as Citibank and Morgan Stanley. Moreover, the Board of Governors imposed a draconian requirement to take 79.9 percent equity ownership in AIG as a condition of the loan. Although it is common in corporate lending for a borrower to post its assets as collateral for a loan, here, the 79.9 percent equity taking of AIG ownership was much different. More than just collateral, the Government would retain its ownership interest in AIG even after AIG had repaid the loan.
Page 3: The main issues in the case are: (1) whether the Federal Reserve Bank of New York possessed the legal authority to acquire a borrower's equity when making a loan under Section 13(3) of the Federal Reserve Act...; and (2) whether there could legally be a taking without just compensation of AIG's equity under the Fifth Amendment where AIG's Board of Directors voted on September 16, 2008 to accept the Government's proposed terms. If Starr prevails on either or both of these questions of liability, the Court must also determine what damages should be awarded to the plaintiff shareholders...
Page 7: Having considered the entire record, the Court finds in Starr's favor on the illegal exaction claim. With the approval of the Board of Governors, the Federal Reserve Bank of New York had the authority to serve as a lender of last resort under Section 13(3) of the Federal Reserve Act in a time of "unusual and exigent circumstances,"... However, Section 13(3) did not authorize the Federal Reserve Bank to acquire a borrower's equity as consideration for the loan...
Page 8: A ruling in Starr's favor on the illegal exaction claim, finding that the Government's takeover of AIG was unauthorized, means that Starr's Fifth Amendment taking claim necessarily must fail. If the Government's actions were not authorized, there can be no Fifth Amendment taking claim...
Page 10: ...The end point for this case is that, however harshly or improperly the Government acted in nationalizing AIG, it saved AIG from bankruptcy. Therefore, application of the economic loss doctrine results in damages to the shareholders of zero.
Outline of the Opinion
After the introductory section, the remainder of the Opinion consists of seven sections and an "Appendix of Relevant Entities and Persons." Here are the titles of the sections and subsections:

  Findings of Fact 
The September 2008 Financial Crisis 
AIG's Financial Condition in 2008
September 13-14, 2008—"Lehman Weekend" 
September 16, 2008 Loan and Term Sheet 
Development of the September 22, 2008 Credit Agreement 
The Government's Control of AIG
The Creation of a Trust
The Restructuring of AIG's Loan in November 2008
The Walker Lawsuit
Maiden Lane II and III
Reverse Stock Split
The Government's Common Stock
Treatment of [five] Other Distressed Financial Entities 
Expert Testimony [four for each party]
AIG Epilogue
History of Proceedings
Jurisdiction—Section 13(3) of the Federal Reserve Act
Legal Analysis
The Illegal Exaction Claim
The Fifth Amendment Taking Claim
Damages
Summary of Starr's Damages Claim
Economic Loss Analysis
Defendant's Procedural Defense of Waiver
Conclusion

Parties' Statements
Starr issued a statement saying in part it was "pleased that the trial court found that the Federal Reserve acted illegally, discriminatorily, and for improper political purposes in requiring AIG, and AIG alone, to surrender 80% of their equity as compensation for a Federal Reserve loan." Starr also said it "will appeal the ruling that there is no remedy for the Government's illegal conduct, and ask the court of appeals to confirm that the Government is not entitled to keep billions of dollars of citizens' money in its pocket."

The Federal Reserve issued a statement saying in part it "strongly believes that its actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective." The Federal Reserve did not indicate whether it will appeal the illegal exaction ruling.

Press Coverage
The Opinion was the subject of page-one articles the next day in The New York Times, The Wall Street Journal, and other media outlets. The rush to report about such a complex ruling can produce errors. For example, a Bestwire article in the late afternoon of the day the Opinion was filed contained a significant error. The fourth sentence of the article said Judge Wheeler "ruled the takeover constituted an illegal taking without just compensation that violated the Fifth Amendment of the U.S. Constitution." He did not make such a ruling. The excerpt from page 8 of the Opinion, as quoted above, shows he ruled that "Starr's Fifth Amendment taking claim necessarily must fail." Subsequent Bestwire articles repeated the error by citing the original incorrect statement.

General Observations
I wrote about the two Starr lawsuits against the federal government in the April 2013 issue of The Insurance Forum. There I expressed agreement with observers who characterized the lawsuits as an attempt to rewrite the terms of the AIG rescue package. I still hold that view.

Several points should be kept in mind. First, during those fateful days in September 2008, those who devised the AIG rescue package had only a few hours to work with, and many other matters were demanding their attention at that hectic time.

Second, Judge Wheeler had nearly four years to study the matter (November 2011 to June 2015). That period consisted of nearly three years of pre-trial filings, a 37-day bench trial spanning two months, a transcript of nearly 9,000 pages, more than 1,600 exhibits, testimony of 36 witnesses (the most prominent were Ben Bernanke, Timothy Geithner, and Henry Paulson), and almost a year of post-trial filings and the writing of the Opinion.

Third, there was no time to seek shareholder approval of the rescue package. Even if there had been time, it is frightening to contemplate what might have happened if the shareholders, led by Greenberg, had voted it down.

Available Material
I am offering a complimentary 81-page PDF consisting of Judge Wheeler's 75-page Opinion, Starr's one-page statement, the Federal Reserve's one-page statement, and the four-page article from the April 2013 issue of The Insurance Forum. E-mail jmbelth@gmail.com and ask for the Wheeler/Starr/US package.

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