No. 172: Herbalife, the Federal Trade Commission, and a Wake-up Call for Primerica

Herbalife International of America, Inc. and its affiliates sell nutrition supplements and other products through a "multilevel marketing organization" of the type that is sometimes referred to as a "pyramid scheme." Herbalife's multilevel marketing organization is similar in many respects to the multilevel marketing organization that Primerica, Inc. uses to sell life insurance policies and other financial products. The Federal Trade Commission (FTC) recently completed a major investigation of Herbalife's multilevel marketing organization. I think the results of the investigation are a wake-up call for Primerica.

The FTC Complaint
On July 15, 2016, in federal court in Los Angeles, the FTC filed a "Complaint for Permanent Injunction and Other Equitable Relief" against Herbalife. The complaint alleges that Herbalife has been using deceptive acts and practices in violation of Section 5(a) of the FTC Act, which prohibits "unfair or deceptive acts or practices in or affecting commerce." (See FTC v. Herbalife, U.S. District Court, Central District of California, Case No. 2:16-cv-5217.)

The complaint has four counts: "unfair practices" (relating primarily to the compensation structure), "income misrepresentations" (primarily the advertising of substantial income opportunities), "false or unsubstantiated claims of income from retail sales," and "means and instrumentalities" (false and misleading representations). Here is the five-paragraph concluding section of the complaint:

145. In sum, Defendants' compensation structure incentivizes Distributors to purchase thousands of dollars of product to receive recruiting-based rewards and to recruit new participants who will do the same.

146. This results in the over-recruitment of participants and the oversupply of Defendants' products and exacerbates participants' difficulty in selling Herbalife products for a profit.

147. Participants in a business opportunity should have some reasonable prospect of earning profits from reselling products to consumers. However, most Herbalife participants earn little or no profit, or even lose money, from retailing Herbalife products.

148. In the absence of a viable retail-based opportunity, recruiting, rather than sales, is the natural focus of successful participants in Defendants' business opportunity.

149. Thus, participants' wholesale purchases from Herbalife are primarily a payment to participate in a business opportunity that rewards recruiting at the expense of retail sales.

The Proposed Settlement
Also on July 15 the FTC filed a "Stipulation to Entry of Order for Permanent Injunction and Monetary Judgment" containing a proposed settlement that is subject to court approval. It is common practice for an agency to file a complaint and a proposed settlement simultaneously.

The proposed settlement provides for numerous and significant changes in the operations of Herbalife. It also provides for Herbalife to pay a $200 million monetary penalty to the FTC.

The case was assigned to U.S. District Judge Christina A. Snyder, who was nominated in 1997 by President Bill Clinton and confirmed by the Senate that year. The FTC is represented by three of its attorneys in Washington, DC, one in Seattle, and one in Los Angeles. Herbalife is represented by two attorneys associated with Sidley Austin LLP.

On the same day the FTC issued a statement and a press release about the case. The press release is entitled "Herbalife Will Restructure Its Multilevel Marketing Operations and Pay $200 Million for Consumer Redress to Settle FTC Charges." The press release is subtitled "Company Must Tie Distributor Rewards to Verifiable Retail Product Sales and Stop Misleading Consumers about Potential Earnings." Also on the same day Herbalife filed with the Securities and Exchange Commission an 8-K (significant event) report. Major media outlets reported the settlement online the same day and in print the next day.

The Ackman/Icahn Struggle
Bill Ackman is a prominent short seller. He has long described Herbalife as a pyramid scheme that is headed for collapse. Carl Icahn is a prominent investor who has a large holding of Herbalife shares, and several of his associates are on Herbalife's board of directors.

For years Ackman and Icahn have been engaged in a public dispute about Herbalife. When the proposed settlement was announced, Icahn declared victory and Herbalife shares rose sharply. Those reactions probably stemmed from the fact that the FTC decided to enter into a proposed settlement rather than try to shut down the company.

I think the question of whether the proposed settlement is a victory for Herbalife and Icahn is yet to be determined. The settlement provides for complex and extensive revisions in Herbalife's business model. I think it is too early to tell whether Herbalife would be able to maintain its current level of profitability if the settlement is approved and if Herbalife makes the major revisions that are required in the settlement.

The Primerica Angle
Primerica, Inc., the successor to the A. L. Williams organization (ALW), sells life insurance policies and other financial products through a multilevel marketing organization that ALW developed in the late 1970s. Primerica's multilevel marketing organization resembles that of Herbalife in many respects and differs in some respects.

I think the biggest difference between Herbalife and Primerica is that the FTC has been barred by statute for more than three decades from doing anything about insurance companies. Indeed, the FTC is barred by statute from even investigating insurance companies without a formal request from a Congressional committee. Here is the current language of the statute:

The Commission may exercise such authority [to conduct studies and prepare reports relating to the business of insurance] only upon receiving a request which is agreed to by a majority of the members of the Committee on Commerce, Science, and Transportation of the Senate or the Committee on Energy and Commerce of the House of Representatives. The authority to conduct any such study shall expire at the end of the Congress during which the request for such study was made. [15 U.S. Code, Section 46—Additional powers of Commission.]

In addition, the Consumer Financial Protection Bureau, which was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, is barred from doing anything about insurance companies. See my post No. 137 dated January 4, 2016.

On the other hand, another section of the Dodd-Frank Act established the Financial Stability Oversight Council (FSOC). That section does not bar the FSOC from investigating insurance companies. Indeed, it provides for the FSOC to investigate "nonbank insurance companies." The FSOC has designated three major U.S. insurance organizations—American International Group, MetLife, and Prudential Financial—as "nonbank systemically important financial institutions." MetLife filed a lawsuit against the FSOC, a federal judge rescinded the designation, and the FSOC's appeal is ongoing. See my post No. 170 dated July 15, 2016.

Thus it appears that state insurance regulators are the only source of protection for insurance consumers against potential wrongdoing through multilevel marketing organizations in the insurance business. It remains to be seen whether the recent developments involving the FTC and Herbalife will have any influence on state insurance regulators. As far as the past is concerned, with a few minor exceptions, I am not aware of state insurance regulators showing significant concern about the potential anti-consumer aspects of the multilevel marketing organization that Primerica and its predecessor have used for many years.

Available Material
I am offering a complimentary 77-page PDF consisting of the 42-page FTC complaint against Herbalife, the 31-page settlement between the FTC and Herbalife, the three-page FTC press release about the case, and the one-page FTC statement about the case. Email jmbelth@gmail.com and ask for the FTC/Herbalife July 2016 package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 171: Cost-of-Insurance Increases—Additional Secret Information from AXA Equitable Life Becomes Public

In No. 143 (February 15, 2016) and No. 169 (June 28, 2016), I discussed a cost-of-insurance (COI) class action lawsuit that Brach Family Foundation filed against AXA Equitable Life Insurance Company on February 1, 2016. The complaint alleged breach of contract when AXA singled out certain policyholders for substantial COI increases. The case was assigned to U.S. District Judge Jesse M. Furman. (See Brach Family Foundation v. AXA Equitable Life, U.S. District Court, Southern District of New York, Case No. 1:16-cv-740.)

The Amended Complaint
On May 2, as described in No. 169, a Brach attorney filed an amended complaint with secret information redacted (blacked out). On May 16, as mentioned, Judge Furman ordered the Brach attorney to refile the amended complaint without the redactions. In this follow-up I discuss additional secret information from AXA that has become public.

Opposition to the Motion to Dismiss
On May 27, as indicated in No. 169, an AXA attorney filed a motion to dismiss the amended complaint, together with supporting documents. On June 23, a Brach attorney filed an opposition to the motion to dismiss consisting of a memorandum of law and a declaration by the attorney. Both documents contained redactions. As he did earlier with the amended complaint, the Brach attorney asked Judge Furman for permission to file the documents under seal. The judge allowed the documents to be filed under seal temporarily and said this (citations omitted):

If Defendant believes that the unredacted memorandum, declaration, and exhibits should remain under seal, it shall file a letter no later than June 29, 2016, explaining why the redactions are consistent with the presumption in favor of public access to judicial documents. The Court notes again that "the mere fact that information is subject to a confidentiality agreement between litigants is not a valid basis to overcome the presumption in favor of public access to judicial documents." If Defendant does not file a letter by June 29, 2016, Plaintiff shall file the unredacted memorandum, declaration, and exhibits by June 30, 2016.

On June 30, after obtaining a one-day extension, an AXA attorney submitted a letter to Judge Furman saying: "Defendant does not request continued sealing of the unredacted documents...." On July 1, in view of the AXA attorney's letter, the judge ordered Brach to file the unredacted documents in the public court file. The Brach attorney did so that day.

The Memorandum of Law
The redactions in the memorandum of law were in one paragraph near the end of the 31-page document. Here is that paragraph, in which I show the redactions in boldface type, with italics that are in the original, with brackets that are my insertions, and with some citations omitted:

In the alternative, if for any reason the Court were to adopt AXA's proposed construction (which it should not), pursuant to FRCP 15, leave to amend should be granted. On May 13, 2016, after Plaintiff filed its [amended complaint], AXA produced a document it submitted to the NYDFS [New York Department of Financial Services] entitled "NGE Policy and Implementation Process" which provides that "The following documents AXA's policy on assessing the need for actions with respect to Non-Guaranteed Elements (NGE) for [life insurance] policies and the implementation process for such actions." The COI rate is one such NGE. This document is therefore also part of the "procedures and standards on file" with an insurance regulator that AXA's COI increase violated, even under AXA's proposed construction of that term. AXA's procedures and standards state "[w]e will not make any NGE actions to recoup past losses" and then lists certain documents by which it is clear that "recoup past losses" means that AXA's profit objective must be fixed at issuance and cannot be changed during the lifetime of the product. See NGE Policy [on page] 2 ("we will not make any changes to NGEs for any policies based upon changes in profit objectives"). The [amended complaint] already alleges that AXA has used the [COI] increase to increase its profit objectives on some policies, see, e.g., [amended complaint] ¶¶ 50-52, 74-76, and to the extent those allegations do not already suffice for Rule 8 purposes, leave to amend should be granted so that specific reference to this AXA procedure and standard document just produced by AXA, and breach thereof, should be granted.

The Declaration
The redactions in the declaration as originally filed by the Brach attorney were in four of the six paragraphs of the four-page text of the declaration. Exhibits A and B, which are attached to the declaration, originally were redacted in their entirety.

General Observations
AXA probably decided to allow public court filing of the additional secret material discussed here in order to avoid another defeat on the issue. In other words, AXA probably concluded that Judge Furman likely would order the public court filing of the unredacted material irrespective of what AXA might have said in an effort to keep the material secret.

The latest released material is extremely interesting, especially Exhibit A to the Brach attorney's declaration. The exhibit describes in detail "AXA's policy on assessing the need for actions with respect to Non-Guaranteed Elements [NGE] for [life insurance] policies and the implementation process for such actions." Each page of the exhibit is marked "Trade Secret" and "Highly Confidential." It is significant that such a document is now in the public court file.

Available Material
I am offering a complimentary 53-page PDF consisting of the two pages of the memorandum of law containing redactions, the 31-page unredacted memorandum of law, the two pages of the text of the declaration containing redactions, the four-page unredacted text of the declaration, the 11-page unredacted Exhibit A to the declaration, and the three-page unredacted Exhibit B to the declaration. Email jmbelth@gmail.com and ask for the July 2016 Brach/AXA package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 170: MetLife and the Financial Stability Oversight Council—The Dispute over the Company's Designation as a Nonbank Systemically Important Financial Institution

On December 18, 2014, the Financial Stability Oversight Council (FSOC) designated MetLife, Inc. a nonbank systemically important financial institution (SIFI). FSOC, a unit of the U.S. Department of the Treasury, was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The MetLife Lawsuit
On January 13, 2015, MetLife filed a lawsuit against FSOC challenging the designation of the company as a nonbank SIFI. The case was assigned to U.S. District Judge Rosemary M. Collyer. (President George W. Bush nominated her in August 2002, the Senate confirmed her in November 2002, and she assumed senior status in May 2016.)

On March 30, 2016, Judge Collyer ruled that FSOC's nonbank SIFI designation of MetLife was "arbitrary and capricious," and she rescinded the designation. The ruling raised questions about FSOC's ability to carry out its duties under the Dodd-Frank Act. (See MetLife v. FSOC, U.S. District Court for the District of Columbia, Case No. 1:15-cv-45.)

The Appellate Case
On June 16 FSOC appealed the ruling by filing an appellate brief. MetLife's reply brief is due August 15, and FSOC's answer to the reply brief is due September 9. The makeup of the panel that will hear the appeal is not yet known. (See MetLife v. FSOC, U.S. Court of Appeals for the District of Columbia Circuit, Case No. 16-5086.)

The Amicus Briefs
In the district court, several amicus briefs were filed on behalf of the parties. Among those filing amicus briefs on behalf of MetLife were the National Association of Insurance Commissioners (NAIC), the American Council of Life Insurers, and the U.S. Chamber of Commerce. Among those filing amicus briefs on behalf of FSOC were a group of professors of economics, a group of professors of administrative law, and a group of professors who specialize in insurance and financial regulation.

In the appellate court, among those filing amicus briefs on behalf of FSOC were Ben S. Bernanke and Paul A. Volcker, a group of professors of administrative law, and a group of professors who specialize in insurance and financial regulation. I am not aware of any amicus briefs filed in the appellate court on behalf of MetLife.

The NAIC Amicus Brief
On September 28, 2015, the NAIC filed its amicus brief in the district court on behalf of MetLife. Here are the NAIC's three arguments:

A. FSOC failed to adequately consider the full range of regulatory tools available to state regulators at the individual entity and group level.

B. FSOC failed to assess the risk of asset liquidation against existing regulatory authority to actively prevent a "run on the bank" scenario, including early warning through risk-based capital requirements and stays on surrender activity.

C. FSOC failed to assess the risk of MetLife's ultimate failure against the deliberate, incremental process that applies to troubled companies supervised by state insurance commissioners.

In its conclusion, the NAIC said that "FSOC acted in an arbitrary and capricious manner." The NAIC also said that FSOC "misunderstood, misconstrued, and dismissed the state regulatory system."

The Bernanke/Volcker Amicus Brief
Bernanke is Distinguished Fellow in Residence with the Economic Studies Program at the Brookings Institution. Prior to his government service, Bernanke held academic positions at Princeton University, Stanford Graduate School of Business, Massachusetts Institute of Technology, and New York University. He served as a member of the Federal Reserve Board of Governors from 2002 to 2005, Chairman of the Council of Economic Advisors in 2005, and Chairman of the Federal Reserve Board of Governors from 2006 to 2014. He is a renowned expert on the Great Depression. He played a key role in dealing with the 2007-2009 financial crisis, and described the experience in The Courage to Act, A Memoir of a Crisis and Its Aftermath (2015).

Volcker is Chairman of Volcker Alliance, Inc., a nonprofit charitable corporation launched in 2012. Its mission is to address the challenge of effective execution of public policies and to rebuild public trust in government. He served as Undersecretary of the Treasury from 1969 to 1974, President of the Federal Reserve Bank of New York from 1975 to 1979, Chairman of the Federal Reserve Board of Governors from 1979 to 1987, and Chairman of the President's Economic Recovery Advisory Board from 2009 to 2011.

On June 23, 2016, Bernanke and Volcker filed their amicus brief in the appellate court on behalf of FSOC. They laid out the situation succinctly in this paragraph:

The District Court's decision rests on three grounds. First, the court held that FSOC was required to assess the likelihood of MetLife's distress before determining whether its distress could threaten financial stability. Second, the court held that FSOC was obligated to project estimated losses of counterparties and other market participants in the event of MetLife's distress. Third, the court held that FSOC was required to conduct a cost-benefit analysis, taking into account the costs of enhanced prudential standards on MetLife. Strikingly, not a single one of these purported requirements is enshrined in the Dodd-Frank Act, or anywhere else in statute; each is inconsistent with FSOC's interpretations of its own rules and guidance; and each defies the compelling logic behind the designation process contemplated by Congress when it established FSOC.

Bernanke and Volcker then discuss each of those three points in some detail. Here is their conclusion:

Amici respectfully submit the foregoing analysis and argument for the consideration of the Court. To accept the limitation on its authority inherent in the District Court rescission decision would in practice undermine both the letter of the relevant authorizing documents and the intent of the designation process embodied in the law.

General Observations
If the appellate court affirms the district court ruling, it would be frightening to contemplate the future of our financial system. I think it is imperative that the appellate court reverse the district court ruling.

Available Material
I am offering a complimentary 46-page PDF consisting of the 19-page Bernanke/Volcker amicus brief filed in the appellate court on behalf of FSOC, and the 27-page NAIC amicus brief filed in the district court on behalf of MetLife. Email jmbelth@gmail.com and ask for the July 2016 package relating to the MetLife/FSOC case.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 169: Cost-of-Insurance Increases—A Federal Judge Denies AXA Equitable Life's Outrageous Request for Secrecy

In No. 143 (posted February 15, 2016) I discussed a cost-of-insurance (COI) class action lawsuit filed February 1, 2016 against AXA Equitable Life Insurance Company. The original complaint, which I offered to my readers in No. 143, alleged breach of contract relating to AXA's singling out of certain policyholders for substantial COI increases. The case was assigned to U.S. District Judge Jesse M. Furman. In this follow-up I discuss important subsequent developments in the case. (See Brach Family Foundation v. AXA Equitable Life, U.S. District Court, Southern District of New York, Case No. 1:16-cv-740.)

The Amended Complaint
On May 2 the attorneys for Plaintiff Brach filed an amended complaint containing redacted (blacked out) sentences or parts of sentences in 12 of the 80 paragraphs. The same day a Brach attorney sent a letter to Judge Furman explaining that, pending the entry of a protective order, the parties had agreed to comply with a protective order AXA had drafted. A provision of the draft protective order required that all material designated as confidential discovery material be redacted. However, the Brach attorney said Brach's compliance with the draft protective order is not a stipulation to the terms of the draft protective order, and Brach believes that nothing in the amended complaint warrants redaction.

On May 3 Judge Furman issued an order temporarily allowing the unredacted version of the amended complaint to be filed under seal. He also ordered AXA to submit a letter by May 10 explaining why the proposed redactions are consistent with the presumption in favor of public access to judicial documents. He said he was inclined to allow some but not all the information to remain redacted. He also ordered the parties to appear for a May 16 telephone conference to address the issues.

On May 10 an AXA attorney submitted a letter to Judge Furman and attached a version of the amended complaint with fewer redactions. (That version of the amended complaint has not been made public, and I have not seen it.) The AXA attorney said the remaining redactions are "highly confidential business information, the public disclosure of which would place AXA at a competitive disadvantage."

On May 13 a Brach attorney submitted a letter to Judge Furman in advance of the May 16 telephone conference. The Brach attorney said "the Court should let putative class members and the interested public view and evaluate the Amended Complaint in its entirety."

On May 16, after the conference, Judge Furman issued an order denying altogether AXA's effort to seal the unredacted version of the amended complaint. He ordered Brach's attorney to place an unredacted version of the amended complaint in the public court file. He also attached to the order, thus placing in the public court file, the May 10 letter from the AXA attorney (but not the version of the amended complaint with fewer redactions) and the May 13 letter from the Brach attorney.

Later Developments
On May 27 AXA filed a motion to dismiss the amended complaint, together with documents in support of the motion. Presumably Brach will file a response to the motion, and AXA will file an answer to the response. Further developments, such as Judge Furman's ruling on the motion to dismiss, and perhaps rulings on class certification, remain to be seen.

The Redactions
By comparing the redacted and unredacted versions of the amended complaint, it is possible to see exactly what AXA wanted to keep secret. Here are four of the paragraphs that contained redactions. I show in boldface type the sentences and parts of sentences that AXA wanted to keep secret. My insertions are in brackets.

Paragraph 4: The size of the COI increase is extraordinary. AXA projects that the rate hike will increase its projected profits by approximately $500 million. The AXA COI increases range from approximately 25% to 70% as compared to prior COI charges. In its most recent SEC filing, AXA states that the COI increase will be larger than the increase it previously had anticipated, resulting in a $46 million increase to its net earnings—a figure that is in addition to the profits that management had initially assumed for the COI increase. [The "recent SEC filing" referred to is the 2015 10-K report filed March 18, 2016. The statement referred to is on page 39 of the report.]

Paragraph 26: First, there is no actuarially acceptable justification for increasing the COI rates on the selected group of policies—those with issue ages 70 and above and current face value amount of $1 million and above. Prior to the COI increase, AXA's mortality rate assumptions for any given insured were equal for a $900,000 and a $1 million face value policy. The COI increase, however, was not graded (i.e., gradually imposed across face-amount ranges) but applied in a step (i.e., those with [a] $1 million policy got a full increase, and those with a $900,000 policy got no increase), and thus the COI increase results in a $1 million policy becoming significantly more profitable to AXA (and more expensive to the COI rate hike victim) than a $900,000 policy, resulting in inequitable treatment of all policyholders of a given class.

Paragraph 50: AXA also claims that the increase was based on a change to its expectations of future "investment experience." The truth, however, is that the sensitivity of profits from investment income of the cash flows to AXA generated by these policies hit with the COI rate increase is trivial compared to the scale of the COI increases, such that alleged changes in mortality rates are clearly the dominant factor in the COI increase, and changes in investment income, if any, are a minor factor which on their own, would not justify the size and scale of the COI increase.

Paragraph 74: Prior to the COI increase, AXA alleges that it had a $500 million shortfall in future best estimate cash flows. AXA, however, claims that it repriced the program five times between 2004 and 2013, updating their internal mortality assumptions, with the first reset in 2007, without ever disclosing any shortfall to policy owners in the annual illustrations or to regulators. An alleged $500 million shortfall does not appear overnight. AXA has regularly updated its mortality assumptions and AXA knew about this alleged profitability shortfall for years, but unlawfully continued to use the original pricing through March 2016, and continued to provide illustrations and annual statements that were materially misleading and unlawfully more favorable than AXA's best estimate of pricing. [Italics in original.]

General Observations
It is outrageous for AXA to have tried to redact the amended complaint. With such redactions of sentences and parts of sentences it would have been impossible for a reader to understand what is being alleged in the amended complaint. Fortunately Judge Furman reached the correct conclusion by disallowing all AXA's proposed redactions.

Because of the significance of the developments in this case, I am offering readers the redacted version of the amended complaint and the unredacted version filed later. Only by comparing the two versions is it possible for readers to understand what AXA tried to keep secret and the significance of the redactions.

AXA has not yet filed a protective order for possible approval by Judge Furman. It remains to be seen whether AXA will make such a filing.

Those interested in the developments reported here might wish to look at No. 26 (posted January 29, 2014). There I described the unsealing of numerous documents in lawsuits against Phoenix Companies, Inc. The lawsuits involved COI increases, and a judge in the same court as the current case issued the order unsealing the documents.

Available Material
I am offering a complimentary 70-page PDF consisting of the 29-page redacted version of the amended complaint filed May 2, the 29-page unredacted version of the amended complaint filed May 16, the two-page letter submitted to Judge Furman by one of Brach's attorneys on May 2, the one-page order issued by the judge on May 3, and the nine-page order issued by the judge on May 16. The May 16 order includes the May 10 letter from an AXA attorney (but not the version of the amended complaint with fewer redactions) and the May 13 letter from a Brach attorney. Email jmbelth@gmail.com and ask for the June 2016 Brach/AXA package.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 168: Byron K. Smith—A Memorial Tribute

Byron K. Smith

Byron K. Smith, a native and lifelong resident of Bloomington, Indiana, died May 29, 2016, at age 71. The obituary in our local newspaper included this sentence: "It was important to Byron that his total blindness be only a minor issue for his family and friends." He is survived by his beloved wife Patsy, three stepchildren, an adopted son, and seven grandchildren.

Byron attended the Indiana School for the Blind. He also attended local elementary schools, and junior and senior high schools. He earned a Bachelor of Arts degree from Indiana University, where he majored in radio and television. He worked for many years at Indiana University as a writer, radio reporter, tape editor, program producer, and radio host. He was also active with the student-run radio station on the Indiana University campus. I will forever cherish the memory of the time he interviewed me on tape for his radio show.

According to the obituary, Byron listened faithfully to radio broadcasts of Indianapolis Colts football games and Indiana University men's basketball games. My wife and I attended those basketball games for about 50 years, and we often saw Byron sitting several rows behind us. When I walked by his row on the way to our seats, I would say, "Hello Byron." He would instantly respond, "Hi Joe." His ability to identify people by their voices was always a source of amazement.

Byron worked hard to improve accessibility in Bloomington for people with handicaps. He was a founding member of the Council for Community Accessibility. He was a member, deacon, and elder of the First Presbyterian Church. After his retirement from the University, he served with Volunteers in Medicine and Southern Care Hospice. His favorite charities were the Indiana School for the Blind, the National Braille Press, and the First Presbyterian Church.

Byron was an extraordinary human being. He was a source of inspiration to me and to everyone who had the good fortune to know him. 

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 167: STOLI Fraud and Daniel Carpenter—A Federal Judge Hands Down a Verdict of Guilty on 57 Criminal Counts

On June 6, 2016, after a bench trial, U.S. District Judge Robert N. Chatigny found Daniel E. Carpenter guilty on all 57 counts of an indictment charging him with criminal activity in connection with stranger-originated life insurance (STOLI). The judge scheduled sentencing for August 26, 2016. (See U.S.A. v. Carpenter, U.S. District Court, District of Connecticut, Case No. 3:13-cr-226.)

The STOLI Case
In December 2013 the U.S. Attorney in Connecticut filed a 33-count grand jury indictment charging Carpenter and his brother-in-law, Wayne Bursey, with conspiracy, mail fraud, wire fraud, illegal monetary transactions, and money laundering in connection with STOLI transactions. The defendants pleaded not guilty on all counts. Carpenter was already in prison as the result of another case, which I discuss below, and he remained in custody. Bursey was released on bail.

In May 2014 the U.S. Attorney filed a 57-count superseding indictment. The defendants pleaded not guilty on all counts. In May 2015 the charges against Bursey were dismissed following his death.

Carpenter waived his right to a jury trial. On February 16, 2016, the trial began. On March 21, after 19 trial days, the trial ended. On June 6 Judge Chatigny handed down a 91-page "Verdicts and Special Findings." Here is the introduction, with footnotes and citations omitted:

This criminal case is before the Court for decision following a bench trial. Defendant Daniel Carpenter is charged with devising and executing a scheme to defraud life insurance companies by using misrepresentations to induce them to issue high-value universal life insurance policies to straw insureds, which the companies would not have issued had they known the policies constituted "stranger-originated life insurance" ("STOLI") policies. This document sets forth the Court's verdicts and special findings in accordance with Federal Rule of Criminal Procedure 23(c).

A STOLI policy differs from a regular policy in that it is obtained not for estate planning purposes but for transfer to an investor with no insurable interest in the life of the insured. "[E]ssentially, it is a bet on a stranger's life." Life insurance providers are opposed to STOLI business and have taken steps to ensure that STOLI policies will not be issued. But STOLI policies can be obtained through misrepresentations concerning the insured's intent to resell the policy, the existence of third-party funding of premiums, and other matters, which are characteristic of "stealth STOLI" or "STOLI in disguise."

Schemes to defraud life insurance providers by causing them to issue STOLI policies based on misrepresentations have recently been the subject of federal prosecutions. In this case, the 57-count superseding indictment charges Mr. Carpenter with mail and wire fraud, conspiracy to commit mail and wire fraud, illegal monetary transactions, money laundering, conspiracy to commit money laundering and aiding and abetting the foregoing substantive offenses. The indictment alleges that the fraudulent scheme involved several steps. Insurance agents recruited older persons to act as straw insureds, often with the promise of free insurance for two years and a share of the profits from the sale of the policy. The agents then completed life insurance applications that contained misrepresentations concerning the insured's motivation for procuring the policy, along with false denials concerning the possibility of a policy sale, third-party funding of premiums and the performance of life expectancy reports. The indictment alleges that the applications were submitted and caused to be submitted to the life insurance providers by Mr. Carpenter and others.

At the trial, Mr. Carpenter testified that he was aware of the "evils of STOLI" when the applications underlying the indictment were submitted to providers. He did not dispute that the applications contained STOLI-related misrepresentations. He testified, rather, that he was deceived concerning the nature of the policies by people he trusted.

The evidence establishes beyond a reasonable doubt that from the outset of the conspiracy charged in the indictment, Mr. Carpenter knew the policies were being procured for resale to investors after the two-year contestability period expired. It also establishes that at his direction and on his behalf, misrepresentations were made in applications in order to thwart the providers' attempts to ensure that STOLI policies would not be issued. For these and other reasons explained below, I conclude that the government has sustained its burden of proving Mr. Carpenter's guilt beyond a reasonable doubt as to each count in the indictment.

Other Cases Involving Carpenter
Carpenter has been involved in several other criminal cases relating to his activities. In No. 54 (posted June 23, 2014) I wrote about the STOLI case and three other Carpenter-related cases. Here I provide an update on those other cases.

The Section 1031 Case
Carpenter owned and operated Benistar, Ltd. and its subsidiaries. One Benistar function was to act as an intermediary in Section 1031 property exchanges. That section of the Internal Revenue Code allows the owner of investment property to defer capital gains taxes on the sale of the property by rolling the proceeds of the sale into the purchase of replacement property. However, the tax deferral is lost if the owner ("exchangor") takes possession of the sale proceeds. Therefore, companies such as Benistar offer to act as an intermediary by holding the proceeds in escrow until the exchangor is ready to close on the replacement property.

Carpenter promoted the services of Benistar by offering to hold the funds safely, pay a small amount of interest, and provide the funds when needed. However, without the knowledge or consent of the exchangors, Carpenter embarked on a speculative program of options trading in the hope of generating large gains for himself.

Initially his plan worked well, but early in 2000 he began suffering large trading losses. In February 2004 a federal grand jury in Massachusetts returned a 19-count indictment charging Carpenter with mail fraud and wire fraud, and identifying seven exchangors who had lost a total of about $9 million. Carpenter pleaded not guilty on all counts. In September 2004 the grand jury returned a 19-count superseding indictment. Carpenter pleaded not guilty on all counts.

In July 2005 the jury trial ended with Carpenter's conviction on all counts. He filed a motion for a new trial, and the district court granted his motion. The government appealed the ruling to the U.S. Court of Appeals for the First Circuit, which, in a split decision, affirmed the district court ruling. The government appealed to the U.S. Supreme Court, which declined to review the case.

In June 2008 the new jury trial ended with Carpenter's conviction on all counts. He again filed a motion for a new trial. After a long delay, the district court again granted his motion. This time, however, after the government appealed the district court ruling, the First Circuit reversed the district court ruling, reinstated the conviction, and sent the case back to the district court for immediate sentencing. Carpenter appealed to the Supreme Court, which declined to review the case.

In February 2014 the judge sentenced Carpenter to 36 months in federal prison on each count, with the terms to run concurrently, followed by 36 months of supervised release. The judge also ordered Carpenter to pay restitution of about $310,000, and fined him $100,000. In May 2014 the judge denied Carpenter's motion for a stay of imprisonment pending appeal. Carpenter's appeals went nowhere. In June 2014 Carpenter began serving his prison term. (See U.S.A. v. Carpenter, U.S. District Court, District of Massachusetts, Case No. 1:04-cr-10029.)

The Section 419 Case
Carpenter marketed multi-employer welfare benefit plans. For many years the Internal Revenue Service (IRS) has been investigating such plans, through which participants may qualify for favorable federal income tax treatment under Section 419 of the Internal Revenue Code. Contributions to Section 419 plans may be deductible for federal income tax purposes. The IRS considers some of the plans to be abusive tax shelters.

Since 2004 the IRS has been trying to obtain from Carpenter detailed information about his Section 419 plans. He provided some documents, but has fought hard against releasing all the requested documents. In 2008 the IRS filed a lawsuit in an effort to obtain the documents. The case was assigned to Judge Chatigny.

On March 18, 2016, the government filed a stipulation of dismissal without prejudice (subject to possible reprosecution). On March 21 the judge approved the dismissal. (See U.S.A. v. Carpenter, U.S. District Court, District of Connecticut, Case No. 3:08-mc-111.)

The Waesche Case
Joseph Edward Waesche IV was an insurance agent who worked with Carpenter. In December 2013 the U.S. Attorney in Connecticut filed an "Information" charging Waesche with one count of conspiracy and describing the false answers Waesche and others gave in five applications submitted to life insurance companies. Waesche pleaded guilty. After a hearing, a magistrate judge ruled the guilty plea should be accepted. Waesche has not yet been sentenced. In response to my inquiry, a spokesman for the U.S. Attorney said Waesche will be sentenced after Carpenter is sentenced in the STOLI case. (See U.S.A. v. Waesche, U.S. District Court, District of Connecticut, Case No. 3:13-cr-224.)

General Observations
The decision by Judge Chatigny in the STOLI case is interesting in at least two ways. First, the judge seems to have a thorough understanding of STOLI transactions and the tactics employed by participants in those transactions. In other words, I think he "gets it." Consequently, I believe that his decision is strong.

Second, the judge does not use initials to represent the "straw insureds" and other individuals mentioned in the decision. Instead he identifies everyone involved in the case.

My only reservation stems from my belief that, during the STOLI heyday from 2004 to 2007, senior officials at some major life insurance companies encouraged the massive growth of STOLI through lax underwriting. In other words, I think the companies knew what was happening and therefore were responsible for the STOLI disaster.

Available Material
I am offering a complimentary 91-page PDF containing Judge Chatigny's decision in the STOLI criminal case against Carpenter. Email jmbelth@gmail.com and ask for Judge Chatigny's June 6, 2016 decision in the Carpenter STOLI case.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com

No. 166: STOLI—A Five-Year Federal Criminal Investigation of Imperial Holdings Ends with No Prison Time for the Defendants

On September 27, 2011, federal agents raided the headquarters of Imperial Holdings, Inc. (Boca Raton, FL), a company engaged in premium financing of stranger-originated life insurance (STOLI) transactions. On April 30, 2012, Imperial and the U.S. Attorney in New Hampshire entered into a non-prosecution agreement under which the company terminated its life insurance premium financing business, terminated its employees involved in that business, admitted to and accepted responsibility for improper conduct, and paid an $8 million fine. Also, Jonathan Neuman, the company's president and chief operating officer, resigned.

Criminal Charges

On October 31, 2012, the U.S. Attorney charged Robert Wertheim with criminal activity. He was one of two co-founders of a premium finance company in New York. On February 26, 2013, Wertheim pleaded guilty and entered into a plea agreement with the U.S. Attorney. Wertheim said that he worked with Imperial, and that he recruited Abraham Kirschenbaum and Maurice Kirschenbaum—brothers who were tax advisers in New York—to identify prospects for the STOLI scheme. Wertheim also said that life insurance applications he and the Kirschenbaums submitted contained false information.

On February 20, 2013, the U.S. Attorney charged the Kirschenbaums with criminal activity. On March 7, 2013, they pleaded guilty and entered into plea agreements with the U.S. Attorney. They described how prospective insureds had been coached to answer questions falsely in the event of calls from insurance companies checking on statements made in policy applications. Sentencing of Wertheim and the Kirschenbaums was postponed repeatedly. (See U.S.A. v. Wertheim, U.S. District Court, District of New Hampshire, Case No. 1:12-cr-136.)

Deferred Prosecution of Maurice Kirschenbaum

On May 22, 2015, the U.S. Attorney filed a motion to dismiss the charges against Maurice Kirschenbaum, who was seriously ill. Attached to the motion was a deferred prosecution agreement under which the U.S. Attorney reserved the right to refile the charges within five years. The judge granted the motion.

Sentencing of Wertheim and Abraham Kirschenbaum

The U.S. Attorney sought probation rather than prison time for Wertheim and Abraham Kirschenbaum in part because of their remorse, and in part because of their past and anticipated future cooperation in the ongoing criminal investigation of Neuman and others at Imperial. On May 27, 2015, the judge deviated downward from the sentencing guidelines and sentenced Wertheim and Abraham Kirschenbaum to serve 18 months in a minimum-security federal prison, followed by two years of supervised release. They were each fined $7,500, and Abraham Kirschenbaum forfeited $1 million to the government. However, the judge delayed for one year—until May 27, 2016—the date for them to report to prison. The judge left open the possibility that prison time might be avoided.

Forfeiture by Former Imperial Employees

As for the ongoing investigation of former Imperial employees, the U.S. Attorney, instead of filing criminal charges, sought forfeiture to the government of a total of $6.5 million—$5 million from Neuman and $750,000 each from Jonathan Moulton and James Purdy. Forfeiture is akin to restitution, and technically is not a fine. 

On January 8, 2016, the judge issued final forfeiture orders against Neuman and Purdy. On March 8, 2016, the judge issued a final forfeiture order against Moulton. The three individuals did not admit wrongdoing. [See U.S.A. v. $5,000,000 (Neuman), U.S.A. v. $750,000 (Moulton), and U.S.A. v. $750,000 (Purdy), U.S. District Court, District of New Hampshire, Case Nos. 1:15-cv-526, 527, and 528.]

Moulton is now president and managing member of Edison Risk (Delray Beach, FL), a brokerage consulting company. Biographical information on the company's website (edisonrisk.com) mentions his relationships with American United, Safeco, Transamerica, ING, and Gerber Life, but does not mention his relationship with Imperial.

Probation for Wertheim and Abraham Kirschenbaum

On May 16, 2016, the judge filed perfunctory amended judgments relating to Wertheim and Abraham Kirschenbaum. I have not found in the court filings any motions, any mention of hearings, or any rulings by the judge to explain the reasoning behind the amended judgments. The judge imposed three years of probation instead of the previously imposed 18 months of imprisonment. Thus ended a five-year investigation of STOLI-related activity by Imperial and those associated with the company.

General Observations

The Imperial case is not the only STOLI criminal case that resulted in no one serving prison time. For example, in No. 162 (May 16, 2016) I discussed the unexplained dismissal without prejudice (subject to possible reprosecution) of another lengthy STOLI criminal case. It is hard to believe that the brazen nature of the alleged criminal activity in such cases does not warrant prison time for the defendants.

I wrote about the investigation of Imperial in the May 2012, July 2012, and October 2013 issues of The Insurance Forum. An interesting item in the October 2013 article is a lengthy excerpt from Abraham Kirschenbaum's plea agreement with the U.S. Attorney. I also wrote about the Imperial investigation on my blog in No. 132 (December 11, 2015) and No. 142 (February 8, 2016).

Available Material

I am offering a complimentary 24-page PDF containing the three articles in The Insurance Forum about the Imperial investigation, the forfeiture orders directed at Neuman, Moulton, and Purdy, and the amended judgments relating to Wertheim and Abraham Kirschenbaum. Send an email to jmbelth@gmail.com and ask for the June 2016 package about the Imperial and Wertheim cases.

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Email: jmbelth@gmail.com

Blog: www.josephmbelth.com