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 At the time I vaguely recalled a similar lawsuit filed earlier and withdrawn without explanation the next day.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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Monday, June 22, 2015

No. 104R: Guardian Life Rectifies an Unsuitable Rollover (revised)

[Note: In this revision, Scott Witt is correctly identified as a fee-only insurance advisor. In the original version, I identified him as a fee-only financial advisor. I regret the error.]

In August 2013, Beatrice (not her real name), a 78-year-old resident of New York State, rolled over her retirement accumulation at College Retirement Equities Fund (CREF) into an individual retirement account (IRA) containing a variable annuity issued by Guardian Insurance & Annuity Company, a subsidiary of Guardian Life Insurance Company of America. The rollover was unsuitable. Guardian eventually rectified the situation to Beatrice's satisfaction.

Edgar Montenegro
Edgar Montenegro (CRD# 4768006) is a registered representative of Park Avenue Securities, a Guardian subsidiary. He sold Beatrice on the idea of using her CREF accumulation to buy the Guardian annuity.

Scott Witt
Scott Witt is a Fellow of the Society of Actuaries, a Member of the American Academy of Actuaries, a fee-only insurance advisor, and a Financial Services Affiliate of the National Association of Personal Financial Advisors. His website is at www.wittactuarialservices.com.

Several months after the rollover, Beatrice sought Witt's advice. In March 2015, Witt posted an article about the case on his website. The article, written before the case was resolved, was entitled "An Embarrassing Variable Annuity Sale—and Refusal to Make Amends." Witt did not identify Beatrice, Montenegro, or the companies.

The CREF Accumulation
CREF and its affiliate, Teachers Insurance and Annuity Association of America (TIAA), cater mainly to members of the academic community. Beatrice's retirement accumulation with CREF was $325,000. According to Witt, CREF's annual expense charges were 41 basis points. Because a basis point is one hundredth of a percentage point, the expense charges were less than one half of 1 percent.

Problems with the Rollover
In his article, Witt cited five problems with the rollover. First, a benefit of a variable annuity is that investment earnings are deferred for income tax purposes. However, Beatrice already had that benefit with her CREF accumulation. Witt considers it unnecessary and inappropriate to place a tax deferral vehicle inside an IRA, which is a tax deferral vehicle.

Second, according to Witt, the Guardian annuity imposed 110 basis points of annual mortality and expense charges, 75 basis points of annual investment expense charges, and 20 basis points of annual administrative expense charges. The sum of 205 basis points far exceeded the 41 basis points for the CREF accumulation.

Third, the Guardian annuity included a death benefit at an annual cost of 50 basis points. According to Witt, Beatrice did not need the death benefit.

Fourth, the Guardian annuity included a rider guaranteeing that the eventual lifetime income from the annuity would be enhanced significantly if Beatrice avoided making withdrawals for ten years. The annual cost of the enhanced lifetime income guarantee was 115 basis points.

Fifth, Witt cited "a mistake in the purchase paperwork." Beatrice applied to have $200,000 of her $325,000 CREF accumulation rolled into the Guardian annuity. However, when the annuity was issued, the entire $325,000 was rolled into the annuity. Witt said "it's unclear which financial institution was responsible but it clearly was not Beatrice's mistake." Witt told me CREF informed Beatrice that there were some unauthorized telephone calls regarding her account around the time of the rollover. The "mistake" caused Beatrice to forfeit the enhanced lifetime income guarantee because she had to take required minimum distributions from the Guardian annuity to avoid draconian income tax penalties.

Complaint and Rejection
On July 26, 2014, Beatrice, aided by Witt, registered a complaint with Guardian. She explained why the rollover was unsuitable and asked for a full refund without the surrender charge of about $31,000.

On September 10, 2014, Judy Cummins, a complaint analyst at Park Avenue Securities, rejected the complaint in a four-page letter. She mentioned such things as the information in the prospectus, Beatrice's statement that she had read the prospectus, her agreement to the contract terms, her failure to ask for a full refund during the ten-day free look, and her statement that she would not need access to the funds. According to Cummins, Montenegro said he spoke with Beatrice after the $325,000 rollover (instead of the originally requested $200,000 rollover) and Beatrice agreed to it. Cummins said Park Avenue Securities "found no evidence of impropriety on the part of your Representative" and "We therefore respectfully reject your request for remuneration."

My Letter to Guardian
I knew about Beatrice before Witt posted his article, because he had told me about the case. I felt that Guardian would not have rejected the complaint if the company had conducted a thorough investigation.

On April 24, 2015, I sent a two-page letter by regular mail to Deanna Mulligan, president and chief executive officer of Guardian. I said I was going to post an article about the case on my blog. I said I would not identify Beatrice, but would indicate her age and say she is a resident of New York State. I asked Guardian for a statement, suitable for inclusion in the article, explaining how Guardian will restore Beatrice to her original financial position, or, alternatively, why Guardian will not restore her to her original financial position. I sent copies of the letter to Beatrice, Montenegro, Cummins, Witt, and Roger Ferguson, chief executive officer of TIAA-CREF. I requested the statement by May 11.

Guardian's Response
Jeanette Volpi is head of external communications at Guardian. On May 8, I received this statement from her by e-mail:
Guardian is legally constrained by federal privacy laws, as well as the Company's privacy policy, from providing client information publicly, but can confirm we are working directly with the client identified to address her concerns.
Guardian conducted an investigation and resolved the matter to Beatrice's satisfaction. The settlement terms are confidential.

General Observations
It is unfortunate that the rollover ever took place, and that Guardian initially rejected Beatrice's complaint. However, the company is to be commended for eventually doing the right thing.

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Friday, June 19, 2015

No. 105: Phoenix Changes Its Independent Auditor

On June 11, 2015, Phoenix Companies, Inc. filed an 8-K (material event) report disclosing that it changed its independent registered public accounting firm. Phoenix dismissed PricewaterhouseCoopers LLP (PwC) and appointed KPMG LLP, effective June 11. Normally an auditor change at a large public company is major news, but in this case the change appears to have slipped under the media radar.

10-K Report for 2014
On March 31, 2015, Phoenix filed its 10-K report for 2014. Included was PwC's independent auditor report dated March 30. PwC expressed the opinion that the financial statements present fairly the financial position of the company in conformity with generally accepted accounting principles. PwC also expressed the opinion that the company did not maintain effective control over financial reporting in several areas.

Proxy Statement
On April 2, 2015, Phoenix filed its proxy statement announcing the annual shareholder meeting scheduled for May 14. The board recommended that the shareholders ratify the appointment of PwC as the independent registered public accounting firm for fiscal year 2015.

Audit Committee Report
The proxy statement included the report of the audit committee of the Phoenix board of directors. The audit committee report said:
Notwithstanding the Audit Committee's appointment of PwC for fiscal 2015 and the outcome of the shareholder vote on this proposal, the Audit Committee has authorized and directed management to engage in a request for proposal process to identify an independent registered public accounting firm for potential appointment to audit and report on our consolidated financial statements for fiscal year 2015... PwC has indicated to management its intention to participate in this request for proposal process. As a result of the request for proposal process, PwC may remain our independent registered public accounting firm for 2015 or another independent registered public accounting firm may be selected. The determination by the Audit Committee to retain PwC or appoint another independent registered public accounting firm is expected to be made subsequent to the 2015 Annual Meeting.
The audit committee said audit costs in 2014 and 2013 were $52.3 million and $58.3 million, respectively. Those amounts included audit fees of $33.8 million and $24.7 million, respectively, and additional fees associated with the restatement of financial statements for the periods included in the 10-K report for 2012.

Shareholder Meeting
On May 15, Phoenix filed an 8-K report about the shareholder meeting. The company said 3,408,701 shareholders voted for ratification of the appointment of PwC, 793,015 voted against, and 8,673 abstained.

8-K Report Filed June 11
Phoenix said in the 8-K report filed June 11 that there were no "disagreements" or "reportable events," as those terms are defined in the regulations. In a news release attached to the 8-K as an exhibit, the company said: "The change was not the result of any disagreement between the company and PwC on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure." Also. as indicated in the audit committee report, PwC participated in the request for proposal process.

General Observations
It seems clear that PwC did not resign and was not fired. I believe that the audit committee's request for proposal process and subsequent auditor change grew out of cost concerns.

Available Material
I am offering a complimentary 15-page PDF consisting of three items: the 3-page independent auditor's report by PwC dated March 30; the 4-page audit committee report included in the April 2 proxy statement; and the 8-page 8-K report dated June 11, including its two exhibits. E-mail jmbelth@gmail.com and ask for the Phoenix auditor change package.

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Monday, June 15, 2015

No. 103: Phoenix Moves to Settle Two Cost-of-Insurance Lawsuits

On May 1, 2015, Phoenix Companies, Inc. filed an 8-K (material event) report with the Securities and Exchange Commission disclosing that the company is moving to settle two of several long-standing class action lawsuits. The complaints were filed because of cost-of-insurance (COI) increases on variable universal life policies of the type used in stranger-originated life insurance (STOLI). Phoenix made the move when the cases were about to go to trial. (See Fleisher v. Phoenix Life Ins. Co. and SPRR v. PHL Variable Ins. Co., U.S. District Court, Southern District of New York, Case Nos. 11-cv-8405 and 14-cv-8714.)

The description of the settlement in the 8-K filed May 1 was very brief.  For that reason, I postponed writing about the settlement until I could see it.  Phoenix filed it in court on May 29, and as an exhibit to another 8-K on June 3.

 Background of the Dispute
Phoenix first imposed COI increases on the STOLI policies in 2010. The company rescinded the 2010 increases, but only for New York policyholders, when the New York Department of Insurance ordered the company to do so. The company then imposed COI increases in 2011 on New York policyholders without objection from the Department.

California and Wisconsin regulators ordered Phoenix to rescind the 2010 increases, but the company refused. California did not pursue the matter. Wisconsin began administrative proceedings and prevailed, but Phoenix appealed and the matter is in litigation.

Several class action lawsuits were filed against Phoenix by angry policyholders. I wrote about some of the cases in the October 2012, December 2012, and November 2013 issues of The Insurance Forum, and in blog post No. 9 (November 13, 2013).

Purposes of the Agreement
U.S. District Court Judge Colleen McMahon has been handling the two cases. In the recent filing, the parties sought her preliminary approval of the settlement, certification of a class solely for the purposes of the settlement, approval of the notice to class members giving them an opportunity to object to or opt out of the settlement, and approval of the plan for a fairness hearing. Judge McMahon promptly issued an order preliminarily approving the above items and appointing an administrator.

Thrust of the Dispute
The agreement, reached with the help of a mediator, includes brief descriptions of the parties' views. Here is the language:
The [Plaintiffs] alleged, in part, that Defendants' decision to raise cost of insurance rates on certain policies in April 2010 and on other policies beginning in November 2011 was unlawful and in violation of the terms of the Policies. These complaints further alleged that Defendants' rate increases did not apply uniformly to a class of insureds, discriminated unfairly between insureds of the same class, and were designed to recoup past losses.
Defendants deny any and all allegations of wrongdoing and do not admit or concede any actual or potential fault, wrongdoing, liability, or damage of any kind to Named Plaintiffs and the putative settlement class in connection with any facts or claims that have been or could have been alleged against them in the Actions. Defendants deny that they acted improperly or wrongfully in any way, believe that the Actions have no merit and contend that Named Plaintiffs' claims are improper as a matter of law. Defendants further contend that their decisions to implement the cost of insurance increases were, at all times, in accordance with the Policies' terms and accepted actuarial standards.
Structure of the Agreement
The basic document is a stipulation of settlement. Phoenix agrees to create a $42.5 million settlement fund and agrees not to object to a request for plaintiffs' attorney fees of one-third of the settlement fund (about $14.2 million). Phoenix agrees to pay plaintiffs' attorney expenses and the settlement expenses out of the settlement fund, leaving a net settlement fund of around $27 million. Phoenix agrees to pay an additional $6 million in plaintiffs' attorney fees outside the settlement fund, so that the total plaintiffs' attorney fees are about $20.2 million. No funds will revert to Phoenix, and the settlement includes broad releases. The parties entered into a separate, confidential agreement allowing Phoenix to terminate the agreement in the event too many class members opt out.

The system for allocating the net settlement fund among the class members is the responsibility of the plaintiffs' attorneys. Phoenix states that it is not insolvent, and that the payments required under the settlement will not render Phoenix insolvent. Phoenix agrees not to impose further COI increases on the class members until after the end of 2020.

There are three exhibits attached to the stipulation of agreement. Exhibit A is the notice to be sent to class members informing them of the settlement, offering them an opportunity to object to or opt out of the settlement, and inviting them to attend the fairness hearing.

Exhibit B is the proposed order for Judge McMahon to issue. She crossed out the word "proposed" and issued the order on June 3. She preliminarily approved the settlement as "fair, reasonable and adequate to the class," conditionally certified the class for purposes of the settlement, appointed Susman Godfrey LLP as class counsel for purposes of the settlement, appointed Rust Consulting as the settlement administrator. and scheduled a hearing for September 9, 2015.

Exhibit C shows proposed letters providing required notices to certain interested parties about the proposed agreement. Among those parties are the U.S. Attorney General, the coordinator of the federal Class Action Fairness Act, and state insurance regulators.

The Brief Initial Description
As mentioned earlier, the description of the settlement in the 8-K filed May 1 was very brief. Phoenix said it "will establish a Settlement fund," "will pay a class counsel fee if the Settlement is approved," "agreed to pay a total of $48.5 million," and "expects to incur a $48.5 million charge in the first quarter of 2015."

The brief description implied that Phoenix is proposing to create a $48.5 settlement fund. As explained above, the gross settlement fund is $42.5 million, and the other $6 million is an extra payment to the plaintiffs' attorneys.

General Observations
I am not sufficiently familiar with the cases to express an opinion about the fairness of the proposed settlement, or about whether the $20.2 million in fees for the plaintiffs' attorneys are reasonable. I also do not know whether the system the plaintiffs' attorneys will use to allocate the net settlement fund of around $27 million will be fair.

I am puzzled about the provision under which Phoenix promises not to impose further COI increases until after 2020. All the insureds were at least 68 years old when the policies were issued about a decade ago, and by 2021 the surviving insureds will be in their 80s and 90s.

It is impossible to know what will happen in the other COI lawsuits in which Phoenix is involved. However, the proposed settlement provides a template for settlements of those cases.

Available Material
I am offering, as a complimentary 77-page PDF, the version of the settlement filed in court on May 29. E-mail jmbelth@gmail.com and ask for the Phoenix COI settlement.

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Tuesday, May 26, 2015

No. 102: Life Partners—The Chapter 11 Trustee Lowers the Boom

On May 20, 2015, H. Thomas Moran II, the Chapter 11 Trustee in the bankruptcy case of Life Partners Holdings, Inc. and its subsidiaries (collectively, "Life Partners"), filed numerous documents. The key document is the "Declaration of H. Thomas Moran II in Support of Voluntary Petitions, First Day Motions and Designation as Complex Chapter 11 Case." The 39-page sworn declaration describes the background of the case and reports the results to date of the Trustee's investigation into the activities of Life Partners.

The Finding of Fraud
A major section of the declaration is the "Initial Findings of Trustee's Investigation." The Trustee said: "As a result of my investigation to date, I have concluded that Life Partners devised and executed a wide-ranging scheme to defraud its Investors." The Trustee also said the fraud "took place over the course of a number of years" and "occurred in a number of ways, including, but not limited to" these fourteen activities:

  • Use of artificially shortened life expectancies in the sale of its so-called "fractional investments";
  • Material misrepresentation of the returns Investors could expect;
  • Misrepresentations regarding whether policies had lapsed and resale of lapsed interests;
  • Use of so-called "escrow companies," including one with the word "trust" in its name, as instrumentalities of, and cover for, the fraudulent scheme;
  • Charging massive, undisclosed fees and commissions, the total of which, in many cases, exceeded the purchase price of the policies themselves;
  • Repeated misrepresentation of Life Partners' business practices in order to maneuver around securities regulatory regimes;
  • Egregious and continuous self dealing by insiders;
  • Failure to disclose CSV [cash surrender values];
  • Forcing Investors to abandon Contract Provisions, many of which were then resold for personal gain;
  • Systematic financial mismanagement, including improper payment of dividends;
  • Faulty and inconsistent record keeping, including with respect to the purported "escrow" companies and "trusts";
  • Commingling and unauthorized use of investor monies;
  • The offer and sale of unregistered securities; and
  • Implying the investment structure was a permissible investment for an IRA [individual retirement account], and failing to disclose the risks if it was not.
A major portion of the Trustee's declaration is devoted to detailed descriptions of the above elements of the "wide-ranging" fraud. The findings go far beyond the allegations by the Securities and Exchange Commission that led to what I referred to in No. 75 (posted December 10, 2014) as the "death sentence" imposed on Life Partners by Senior U.S. District Court Judge James R. Nowlin. The findings make clear why Life Partners and its senior officers fought so hard to continue operating the company during the bankruptcy proceedings and to oppose the appointment of an independent trustee who would have total access to the company's records of its activities.

The Trustee's Plans
At the same time, the Trustee filed eleven emergency motions. They include such items as joint administration of the Life Partners companies, payment of employee wages, payment of property and liability insurance premiums, payment for utilities, and payment of taxes. There is also a motion for authority to change the beneficiary designations on the policies that make up the fractional interests in the life settlements sold by Life Partners so as to eliminate the escrow companies and the expenses associated with the escrow companies. There is also a motion to approve a plan for paying premiums on those policies so as to make sure that those policies remain in force.

My Question
In earlier postings I expressed the opinion that the Trustee and the bankruptcy court judge would do everything possible to protect the owners of fractional interests in the life settlements sold by Life Partners. I am asking the Trustee a question about his plans for those policies, and I will report his answer.

Availability of the Declaration
Meanwhile, I am offering a complimentary 39-page PDF containing the Trustee's declaration. E-mail jmbelth@gmail.com and ask for the Trustee's May 20 declaration in the Life Partners bankruptcy case.

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Wednesday, May 13, 2015

No. 101: Life Partners and the Texas Supreme Court

On May 8, 2015, in a landmark opinion delivered by Justice Jeffrey S. Boyd, the Texas Supreme Court ruled that the life settlement agreements sold by Life Partners, Inc. (Waco, TX), an operating subsidiary of Life Partners Holdings, Inc. (LPHI), "are investment contracts, and thus securities, under the Texas Securities Act." No dissent was filed.

The opinion is the culmination of a 20-year struggle by the now bankrupt company and Brian D. Pardo, former chief executive officer and majority shareholder of LPHI, to avoid having to comply with securities laws. The impact of the opinion on the bankruptcy case is not known, but the ruling clears the air on the status of life settlement agreements.

The Opinion
The Texas Supreme Court opinion grew out of rulings by two Texas appellate courts. The trial courts had found in favor of Life Partners, and both appellate courts had reversed the trial court decisions. The Texas Supreme Court affirmed the rulings of the two appellate courts. (See Life Partners v. Arnold, Court of Appeals for the Fifth District of Texas, No. 14-0122, and LPHI v. State of Texas, Court of Appeals for the Third District of Texas, No. 14-0226.)

The elaborate 40-page opinion not only says Life Partners' life settlement agreements are securities under the Texas Securities Act, but also declines to give the ruling only prospective application. Life Partners had requested only prospective application in the event of an adverse decision on the underlying issue. This is important because it means that the ruling applies retroactively to all of Life Partners' past activities. Here is the first paragraph of the opinion:
The primary issue in these two separate cases is whether a "life settlement agreement" or "viatical settlement agreement" is an "investment contract" under the Texas Securities Act. We hold that the agreements at issue are investment contracts because they constitute transactions through which a person pays money to participate in a common enterprise with the expectation of receiving profits, under circumstances in which the failure or success of the enterprise and the person's realization of the expected profits is at least predominately due to the entrepreneurial or managerial efforts of others. We decline to give today's holding only prospective application, and we decline to consider the merits of the "relief defendants'" evidentiary arguments. In short, we affirm the courts of appeals' judgments in both cases.
The Trustee's Reaction
I contacted H. Thomas Moran II, the Chapter 11 Trustee in the Life Partners bankruptcy case. In response to my invitation to comment on the opinion, he said:
I respect the ruling by the Texas Supreme Court. The ruling brings clarity to the bankruptcy and ultimately will benefit those affected most by the Life Partners business model.
The 1996 Federal Appellate Ruling
I wrote many articles in The Insurance Forum over the years and posted many blog items about Life Partners. My first mention of the company was in the March 1999 issue of the Forum, which was devoted in its entirety to a 12-page article entitled "Viatical Transactions and the Growth of the Frightening Secondary Market for Life Insurance Policies." The article included a section subtitled "The Life Partners Case." Here is a shortened version of that section:
In 1995 the Securities and Exchange Commission (SEC) alleged that Life Partners had violated federal securities laws by selling unregistered securities. A federal district court ruled in favor of the SEC. Life Partners appealed. On July 5, 1996, a panel of the U.S. Court of Appeals for the District of Columbia Circuit reversed the decision in a 2 to 1 ruling. The majority said a viatical transaction satisfied two of the three necessary elements in the definition of a security, but did not satisfy the third element. The dissenting judge said a viatical transaction satisfied all three elements. The SEC petitioned for a rehearing; the panel denied the petition in a 2 to 1 ruling.
The 1996 Dissent
The 1996 dissent was written by Patricia M. Wald, a distinguished jurist. She served on the D.C. Circuit from 1979 to 1999, and was its chief judge from 1986 to 1991. She also has had an outstanding career before and after her tenure on the D.C. Circuit. She served as an assistant attorney general in the administration of President Jimmy Carter before he appointed her to the D.C. Circuit. Later she served as a judge on the International Criminal Tribunal for the Former Yugoslavia and currently serves as a member of the Privacy and Civil Liberties Oversight Board.

Many who cite the 1996 appellate ruling, including Life Partners, rarely if ever mention that it was a split opinion. Judge Boyd, in the ruling last week, included an exhaustive discussion of the judicial history of the issue and quoted extensively from Judge Wald's superb dissenting opinion. It is a classic example of a dissenting opinion that was later adopted by a majority of the judges who have studied the issue.

LPHI's Pre-Bankruptcy Views
Prior to its January 2015 bankruptcy filing, LPHI, in filings with the SEC, often discussed the litigation that led to the Texas Supreme Court opinion. For example, the appellate court handed down its decision in the Arnold case on August 13, 2013. LPHI disclosed it in an 8-K (material event) report filed a full month later, despite the fact that an 8-K is supposed to be filed within four business days after the event. LPHI disagreed with the ruling and cited, among other things, the 1996 D.C. Circuit opinion without mentioning that it was a split opinion. LPHI said:
Should the decision ever become final, it would result in a material adverse effect on our operations and require substantial changes in our business model.
Availability of the Opinion
I am offering a complimentary 40-page PDF containing the recent opinion by the Texas Supreme Court. E-mail jmbelth@gmail.com and ask for the May 8 Texas Supreme Court opinion in the Life Partners cases.

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Monday, May 11, 2015

No. 100: Shadow Insurance—A Chronology of What May Become the Worst Financial Scandal in the History of the Life Insurance Business

"Shadow insurance" usually refers to reinsurance used to weaken (reduce) life insurance reserves, which are liabilities that measure a company's obligations to policyholders. Shadow insurance also involves questionable financial instruments such as parental guarantees, letters of credit, and contingent notes. The details of such instruments are shrouded in secrecy, and the reasons for the secrecy have not been explained.

Shadow insurance may become the worst financial scandal in the history of the life insurance business. The chronology presented here may be useful for those interested in the welfare of the life insurance business, including those who depend on life insurance protection.

1858
Elizur Wright, later called "The Father of Life Insurance," is appointed insurance commissioner of Massachusetts, thereby becoming the first insurance regulator in the U.S., and begins his campaign to require life insurance companies to establish adequate reserves.

1863
August Zillmer, a German actuary, publishes article explaining a method (used in the U.S. beginning about 40 years later) by which to weaken life insurance reserves.

1932
State insurance regulators allow life insurance companies to use, in financial statements for the end of 1932, asset values as of June 30, 1931.

1979
Universal life insurance is introduced.

April 1993
Prudential Insurance Company of America, to save $100 million in federal income taxes, issues $300 million of surplus notes through a confidential private offering to qualified investors.

1994
National Association of Insurance Commissioners (NAIC) begins to require "Triple-X" reserves designed to offset efforts by companies to weaken reserves through clever policy designs.

February 1994
Article entitled "The Recent Flurry of Controversial Surplus Notes" appears in The Insurance Forum.

March 2004
Article entitled "Secondary Guarantees, Marketers, Actuaries, Regulators, and a Potential Financial Disaster for the Life Insurance Business" appears in The Insurance Forum.

2009
NAIC adopts model law that includes reference to so-called principles based reserves designed to allow actuaries to use judgment in establishing reserves rather than using formulas in insurance statutes.

February 2009
Article entitled "Capital Infusions into Life Insurance Companies by Weakening Statutory Accounting Rules" appears in The Insurance Forum.

March 2011
Frederick Andersen, a New York Department of Financial Services (NYDFS) actuary, sends a letter to NAIC concerning what NYDFS perceives as inadequate reserves for universal life policies with secondary guarantees.

February 2012
Article entitled "The Controversy over Reserves for Universal Life Policies with Secondary Guarantees" appears in The Insurance Forum.

July 2012
NYDFS begins investigation of shadow insurance.

March 2013
Article entitled "A Review of More Than a Century of Efforts to Weaken Life Insurance Reserves" appears in The Insurance Forum.

April 18, 2013
NYDFS Superintendent Benjamin Lawsky, in a speech, discloses the existence of NYDFS investigation of shadow insurance.

June 11, 2013
Article by Mary Williams Walsh entitled "Insurers Inflating Books, New York Regulator Says" appears in The New York Times.

June 12, 2013
NYDFS issues report entitled "Shining a Light on Shadow Insurance: A Little Known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk."

August 2013
Moody's Investors Service issues report entitled "The Captive Triangle: Where Life Insurers' Reserves and Capital Requirements Disappear."

September 30, 2013
Article by Alistair Gray entitled "Shadow Insurance Schemes Multiply to $360 Billion" appears in Financial Times.

February 2014
Rector & Associates, consulting firm retained by NAIC, submits report to NAIC concerning shadow insurance.

April 1, 2014
Paper by Ralph Koijen and Motohiro Yogo entitled "Shadow Insurance" is published by Federal Reserve Bank of Minneapolis.

April 22, 2014
Joseph M. Belth blog post No. 44 discusses certain notes to 2013 statutory financial statement filed by Iowa-domiciled Transamerica Life Insurance Company concerning a massive increase in surplus resulting from use of accounting practices permitted in Iowa.

April 23, 2014
Class action lawsuit is filed against AXA Equitable Life Insurance Company following NYDFS report on shadow insurance. (See Yale v. AXA Equitable, U.S. District Court, Southern District of New York, No. 1:14-cv-2904.)

June 2014
Rector submits to NAIC a modified report which, according to Superintendent Lawsky, "essentially defanged" the February 2014 report.

August 12, 2014
Superintendent Lawsky sends letter to his fellow insurance commissioners deploring weak response of NAIC to problems of shadow insurance and improper use of captive reinsurance companies.

August 17, 2014
NAIC Executive Committee issues recommendations based on modified report submitted by Rector.

November 6, 12, 19, 2014
Belth blog post Nos. 71, 72, and 73 discuss frightening accounting rules promulgated in Iowa.

December 18, 2014
Article by Mary Williams Walsh entitled "Regulators Deem MetLife 'Too Big to Fail' Institution" appears in The New York Times and discusses MetLife's designation as "systemically important financial institution" by Financial Stability Oversight Council.

April 12, 2015
Article by Mary Williams Walsh entitled "Risky Moves in the Game of Life Insurance" appears in The New York Times.

May 6, 2015
Belth blog post No. 99 discusses report released by American Academy of Actuaries on April 27, 2015 entitled "Key Ethical Concerns Facing the Actuarial Profession," in which by far the most serious ethical concern expressed by Academy members in 2012 survey was "responding to pressure from principals and/or management to select inappropriate assumptions used in pricing or reserving."

Available Material
Complimentary packages offered in Belth blog posts remain available. E-mail jmbelth@gmail.com and specify package(s) desired. All issues of The Insurance Forum are available in hard copy. E-mail belth@theinsuranceforum.com for ordering information.

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Wednesday, May 6, 2015

No. 99: Actuarial Ethics—The American Academy of Actuaries Releases a Significant and Timely Report

On April 27, 2015, the American Academy of Actuaries announced release of a 31-page report entitled "Key Ethical Concerns Facing the Actuarial Profession" and subtitled "Perceptions of Members of the American Academy of Actuaries." The report is based on a 2012 survey of Academy members by the Academy's Council on Professionalism (COP). Among the 18 potential ethical issues identified in the report, by far the most significant issue perceived by Academy members is "responding to pressure from principals and/or management to select inappropriate assumptions used in pricing or reserving."

The 2012 Survey
The 2012 survey was prepared by members of the COP, Professors Rahul Parsa and Garry L. Frank of Drake University, and the Academy. The cover letter on the survey was from Karen Fulton Terry, MAAA, FCAS, who at the time of the survey was vice president of the Academy and chairperson of the COP. She is listed in the current directory of the Society of Actuaries as assistant vice president and actuary in the home office of State Farm Mutual Automobile Insurance Company.

The key finding about pressure from principals and/or management with regard to assumptions used in pricing or reserving is timely in view of the ongoing controversy over reserve adequacy, shadow insurance, accounting practices permitted by individual states, and so-called principles based reserves. The other four of the top five ethical concerns are: (2) "false or misleading representation of products or services in marketing, advertising, or sales efforts," (3) "failure to take appropriate action when another actuary misrepresents information," (4) "conflicts of interest between opportunities for personal financial gain (or other personal benefits) and proper performance of one's responsibilities," and (5) "misrepresenting or concealing limitations in one's abilities to provide services."

More than 3,300 Academy members responded to the survey. The members were asked to rate each of 18 potential ethical concerns on a scale of 1 to 5, where 1 means it is not an ethical concern and 5 means it is a major ethical concern.

Availability of the Report
The Academy announced release of the report in a news item dated April 27, 2015, and provided a link to a PDF containing the full report. The following notice is at the bottom of every page except the cover page: "©2015 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission."

I immediately sent an e-mail request to the Academy for permission to offer a complimentary PDF of the full report to my readers. In my request, I mentioned the need for an immediate response.

Mary E. Downs, executive director of the Academy, responded promptly. She denied my request, but she also said:
We have, as you know, made the full report freely available on the Academy website, and you can refer your readers to our website for the complete report. We will also be having a webinar on the topic, and will be discussing it thoroughly in that venue on May 22. We will be continuing to have discussions about the report in Academy meetings and events.
A link to the report is on the home page of the Academy's website at www.actuary.org. I urge interested readers to read the report, and would welcome comments from those who read it.

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Tuesday, May 5, 2015

No. 98: Life Partners and the Improvement of the Bankruptcy Trustee's Website

In No. 95 posted April 27, I discussed the inadequacy of the website established by H. Thomas Moran II, the Chapter 11 Trustee in the bankruptcy case of Life Partners Holdings, Inc. (LPHI) to keep affected parties informed about the case. Three developments occurred the next day: (1) the Trustee sent a letter to those with interests in the life settlements sold by Life Partners, Inc. (LPI), the primary operating subsidiary of LPHI; (2) the Trustee significantly improved his website; and (3) LPHI filed an 8-K (material event) report with the Securities and Exchange Commission (SEC).

The Trustee's April 28 Letter
The April 28 letter was addressed to "LPI position holders," provided background, said there are well over 20,000 "parties in interest" in the bankruptcy proceeding, expressed the Trustee's understanding of how distressing the situation is for interested parties, and described the Trustee's undertakings since his appointment. The letter stated in part:
It is my goal to preserve your interests, reduce financial obligations and to provide you with information on an ongoing basis. However, please remember, this will not be a simple process and will take some time.
The Trustee said in the letter that he has reduced the ministerial service fees. He described the reduction and enclosed a bill covering the six-month period from September 2014 through February 2015.

The Improved Trustee's Website
The Trustee's significantly improved website (www.lphitrustee.com) includes extensive background on the bankruptcy proceedings and provides links to all recent LPHI filings with the SEC. The website also provides links to all major filings in the bankruptcy court case.

The April 28 8-K Report
On April 28 LPHI filed an 8-K report with the SEC. Attached to the report was an exhibit showing 19 frequently asked questions and the answers to them, as well as an exhibit showing the April 28 Trustee's letter to LPI position holders.

General Observations
The Trustee is to be commended in general for improving his communication with parties affected by the LPHI bankruptcy, and in particular for the improvement in his website. I think his actions are good news for the holders of fractional interests in LPI's life settlements.

I am offering a complimentary 11-page PDF containing the April 28 8-K report, which includes an exhibit showing the frequently asked questions and the answers to them, and an exhibit showing the Trustee's April 28 letter to LPI position holders. Send an e-mail to jmbelth@gmail.com and ask for LPHI's April 28 8-K report.

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Monday, May 4, 2015

No. 97: Senator Elizabeth Warren Investigates Annuity Sales Incentives

On April 28, 2015, U.S. Senator Elizabeth Warren (D-MA) sent a five-page letter to the chief executive officer of each of 15 major issuers of annuities seeking "information on rewards and incentives offered by your company to brokers and dealers who sell annuities to families and small investors." The response date is May 11. Senator Warren identifies herself in the letter as the Ranking Member of the Subcommittee on Economic Policy of the Committee on Banking, Housing, and Urban Affairs. Her office released copies of the 15 letters, a press release, and several examples of the incentives.

The Companies Contacted
Senator Warren sent her letter to the companies referred to in her press release as "15 of the largest annuity providers today." The companies, using the names shown in the letters, are AIG Companies, Allianz Life Insurance Company of North America, American Equity Investment Life, AVIVA, AXA Equitable, Jackson National Life Insurance Company, Lincoln Financial Group, MetLife, Nationwide Financial, New York Life, Pacific Life, Prudential Annuities, RiverSource Life Insurance, TIAA-CREF, and Transamerica.

The Information Requested
The second paragraph of Senator Warren's letter lays the foundation for her request. The paragraph reads:
A preliminary review by my staff reveals that annuity providers offer a vast range of perks—from cruises to international travel to iPads to diamond-encrusted "NFL Super Bowl Style" rings to cash and stock options—to entice sales of their products. I am concerned that these incentives present a conflict of interest for agents and financial advisers that could result in these agents providing inadequate advice about annuities to investors and selling products that may not meet the retirement investment needs of their buyers.
Senator Warren's specific request for information is near the end of her letter. The four components of her request are:
  1. A list of all incentives—including cash awards, cruises or other vacations, electronics, jewelry, and any other items of value—that are awarded by your company to agents, brokers, FMOs [field marketing organizations], or other sellers or middlemen involved in sales of your annuity products.
  2. Documents and information provided to agents, brokers, FMOs, or other sellers or middlemen involved in sales of your annuity products describing the incentives and the qualifications for earning those incentives.
  3. Information on the number of each of these incentives awarded to agents, brokers, FMOs, or other sellers or middlemen involved in sales of your annuity products, and the total value of each of those incentives.
  4. A copy of your company policies for disclosing and describing sales incentives and conflicts of interests to annuity purchasers. 
The ACLI Comment
Senator Warren's letter prompted the American Council of Life Insurers (ACLI) to issue a comment entitled "Comprehensive Regulations Protect Consumers' Interests In Annuity Sales." The ACLI comment describes "Product Content and Marketing Rules," "Sales Practices Requirements" including references to four model regulations promulgated by the National Association of Insurance Commissioners (NAIC), and "Federal Laws and Regulations." The ACLI comment does not mention the incentives that are at the heart of Senator Warren's investigation.

The NAIC Comment
When I saw Senator Warren's material and the ACLI comment on it, I asked the NAIC for a comment. In response, I obtained a short comment from Monica Lindeen. She is the president of the NAIC and the Montana commissioner of securities and insurance. The NAIC comment, like the ACLI comment, mentions various model laws, model regulations, and other materials, but does not mention the incentives that are at the heart of Senator Warren's investigation.

The DOL Proposed Rule
On February 23, 2015, President Barack Obama asked the U.S. Department of Labor (DOL) "to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests." On April 14, DOL issued a press release announcing a request for public comment on "a proposed rule that will protect 401(k) and IRA investors by mitigating the effect of conflicts of interest in the retirement investment marketplace." DOL also issued a "Fact Sheet" and other materials about the proposed rule. On April 20, DOL published the proposed rule in the Federal Register.

General Observations
The investigation launched by Senator Warren is long overdue. I agree with her that the widespread use of sales incentives is a serious problem. It is surprising that the insurance and securities regulators have not explored this area. It is disappointing, but understandable given the circumstances, that the vacuous comments by the ACLI and the NAIC merely call attention to existing rules and regulations without making any direct reference to the subject of Senator Warren's investigation. The comments therefore imply—incorrectly in my view—that there is no cause for concern because annuity sales activities are regulated. 

I am offering a complimentary 19-page PDF consisting of one of the five-page letters, the four pages of examples, the one-page press release, the three-page ACLI comment, the one-page NAIC comment, and the five-page "Fact Sheet" concerning the DOL proposed rule. Send an e-mail to jmbelth@gmail.com and ask for the Warren annuity incentives package.

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Wednesday, April 29, 2015

No. 96: STOLI and the Bazemore Criminal Case

On April 21, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit handed down a unanimous ruling in a criminal case against Vincent Bazemore. I did not write about the case previously, but the appellate ruling prompted me to do so at this time.

The Criminal Charges
On October 3, 2012, a federal grand jury indicted Bazemore on four counts of mail fraud in a scheme to obtain commissions by inducing insurance companies to issue stranger-originated life insurance (STOLI) policies to unqualified applicants. The counts relate to three policies issued by Principal Life Insurance Company and one issued by Transamerica Occidental Life Insurance Company. Other companies mentioned in the indictment are ING Annuity and Life Insurance Company, John Hancock Life Insurance Company, Sun Life Assurance Company of Canada, and Metropolitan Life Insurance Company. (See U.S.A. v. Bazemore, U.S. District Court, Northern District of Texas, No. 3:12-cr-319.)

The Allegations
According to the indictment, the applications Bazemore submitted contained materially false and fraudulent representations. They include but are not limited to these seven areas: (1) false and grossly inflated statements of the applicant's net worth and income, (2) forged and fraudulent letters from Certified Public Accountants verifying the false financial information in the applications and related financial documents, (3) forged signatures of the applicant, (4) false statements that the purpose of the insurance policy was for estate planning, (5) false statements that the policy was not to be transferred to third parties, (6) false statements denying third parties had promised to pay premiums in return for an assignment of the policy, and (7) false statements that the applicant was not borrowing money to pay the premiums.

Subsequent Developments
Bazemore was arrested shortly after the indictment was filed, and he has been in custody ever since. In July 2013, after a three-day trial, the jury found him guilty on all four counts in the indictment.

In March 2014 the district court judge sentenced Bazemore to 240 months in prison on each of the four counts, to run partially concurrently and partially consecutively for an aggregate sentence of 292 months, followed by three years of supervised release. The judge ordered Bazemore to pay restitution of slightly more than $4 million and a special assessment of $400. The judge did not order a fine because Bazemore does not have the resources or future earning capacity to pay a fine.

Bazemore appealed the verdict, the sentence, and the restitution. The appellate panel affirmed the verdict, vacated the sentence and the restitution, and sent the case back to the district court for proceedings consistent with the appellate opinion. The appellate panel ruled that the district court judge had erred in the calculation of the length of the sentence and the amount of restitution. The appellate opinion explains the panel's reasoning. (See U.S.A. v. Bazemore, U.S. Court of Appeals for the Fifth Circuit, No. 14-10381.)

General Observations
Bazemore's actions that led to the indictment and the guilty verdicts are outrageous. However, my impression, based on my review of actions taken by the defendants in many other STOLI cases, most of which were civil rather than criminal cases, is that Bazemore's actions are typical of actions taken by STOLI defendants.

I am offering a complimentary 32-page PDF consisting of the 15-page indictment, the one-page jury verdict, and the 16-page appellate opinion. Send an e-mail to jmbelth@gmail.com and ask for the Bazemore package.

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Monday, April 27, 2015

No. 95: Life Partners and the Inadequacy of the Bankruptcy Trustee's Website

As I reported in recent weeks, the bankruptcy court judge in the Life Partners Holdings, Inc. (LPHI) case approved the appointment of H. Thomas Moran II as the Chapter 11 Trustee to operate the company in bankruptcy, and the Trustee established a website (www.lphitrustee.com) to keep affected parties informed of developments. In this follow-up I discuss the inadequacy of the Trustee's website.

The April 17 8-K Report
On April 17 LPHI filed an 8-K (material event) report with the Securities and Exchange Commission (SEC). The report contains four disclosures, which are paraphrased below. The expression "LP Market" refers to "a password-protected, limited access, web-based platform where investors in life settlement policies could place their positions for sale to a third party." Here are the disclosures:
  1. On April 9 the Trustee suspended all company activities related to the resale of positions, including suspension of the LP Market.
  2. The Trustee is investigating the business and will determine whether to reopen the LP Market. Should he decide to do so, he will make an announcement.
  3. LPHI updated its website (www.lphi.com) to include a link to the Trustee's website. The LPHI website continues to provide access to all LPHI filings with the SEC.
  4. On April 17 the Trustee released a list of 19 frequently asked questions. They and the answers to them are in an exhibit attached to the 8-K. There are ten questions about life settlement policies, eight questions about the bankruptcy, and one question about the Official Unsecured Creditors Committee.
    5.
As of the end of the day on April 24, the Trustee's website had not disclosed the existence of the April 17 8-K, let alone its content. This is surprising, not only because the frequently asked questions and the answers to them are important, but also because the 8-K exhibit showing the questions and answers is entitled "LPHI Trustee Website FAQ."

Other Recent 8-K Reports
The April 17 8-K report was the fourth 8-K filed subsequent to the appointment of the Trustee. The first was filed March 31. It disclosed the suspension of trading in LPHI shares as of the opening of business on March 30, and also disclosed the March 25 resignations of Frederick J. Dewald and Harold E. Refuse as LPHI directors. The Trustee's website mentions the existence of the March 31 8-K and says "The filing can be viewed on the SEC's Edgar system." The reader who clicks "Read More" is given a link to the 8-K.

The second 8-K subsequent to the appointment of the Trustee was filed April 6. It disclosed the March 31 resignation of Tad Ballantyne as an LPHI director and the termination of the employment of R. Scott Peden as LPHI general counsel. The existence of the April 6 8-K is not mentioned on the Trustee's website.

The third 8-K subsequent to the appointment of the Trustee was filed April 9. It disclosed that the bankruptcy court judge held a hearing on April 6 on the Trustee's motion to amend company documents to appoint the Trustee as the sole director of LPHI's two operating subsidiaries and, if the Trustee so chooses, to place the subsidiaries in bankruptcy. It also disclosed that the judge granted the motion and that the Trustee is moving to place the subsidiaries in bankruptcy. The existence of the April 9 8-K is not mentioned on the Trustee's website, although elsewhere on the Trustee's website the reader is given access to the bankruptcy court documents relating to the Trustee's motion, the hearing on the motion, and the bankruptcy court judge's granting of the Trustee's motion.

General Observations
I still think the Trustee and the bankruptcy court judge will make their decisions in the best interests of all parties affected by the LPHI bankruptcy. However, I am disappointed by the inadequacy of the Trustee's website in keeping affected parties informed of developments.

In view of the importance of the frequently asked questions and the answers to them, I am offering a complimentary six-page PDF containing the April 17 8-K report and the exhibit showing the questions and answers. Send an e-mail to jmbelth@gmail.com and ask for LPHI's April 17 8-K.

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