Thursday, January 11, 2018

No. 248: Shadow Insurance—An Update Involving Two Surprises

In No. 107 (posted June 30, 2015) I wrote about a federal class action lawsuit filed in June 2015 on behalf of Rachel Silva and Don Hudson, who had purchased Aviva annuities in 2010. The elaborate complaint alleged that Aviva, Athene, and Apollo—together with other companies and individuals—participated in an unlawful Racketeer Influenced and Corrupt Organizations Act (RICO) enterprise involving phony reinsurance with affiliates. (See Silva v. Aviva, U.S. District Court, Northern District of California, Case No. 5:15-cv-2665.)

Since 2015 I had not followed the case. Recently a reader asked what happened to the case, so I decided to write an update. In the process of preparing the update, two developments came as surprises to me.

The Transfer to Iowa
The plaintiffs in the Silva case originally filed their lawsuit in California. The case was assigned to U.S. Magistrate Judge Paul Singh Grewal. In August 2015 the defendants filed motions to dismiss the complaint and transfer the case to Iowa, where most of them were based. In March 2016 Judge Grewal issued an order denying without prejudice the motions to dismiss and granting the motions to transfer the case to Iowa.

The Iowa Case
In Iowa the case was assigned to U.S. District Judge Stephanie M. Rose and U.S. Magistrate Judge Helen C. Adams. In April 2016 the defendants filed a motion to reinstate their motions to dismiss. In May 2016 Judge Adams denied the defendants' motion. Shortly thereafter Hudson filed an amended complaint against Athene and Apollo. Silva was no longer a plaintiff, and Aviva, whose U.S. business had been acquired by Athene, was no longer a defendant. In June 2016 the defendants filed a motion to dismiss the amended complaint.

In November 2016 Judge Rose issued an order staying the defendants' motion to dismiss the amended complaint. In her order, she mentioned a pending decision in a similar case in the U.S. Court of Appeals for the Eighth Circuit, which covers Iowa, Missouri, and five other midwestern states.

In May 2017 Judge Rose lifted the stay and granted the defendants' motion to dismiss the amended complaint. In the order she relied on the Eighth Circuit ruling. (See Hudson v. Athene, U.S. District Court, Southern District of Iowa, Case No. 4:16-cv-89.)

The Ludwick Case
The Eighth Circuit case to which Judge Rose referred was indeed similar to the Hudson case. The appellate ruling grew out of a district court case in Missouri. (See Ludwick v. Harbinger, U.S. District Court, Western District of Missouri, Case No. 4:15-cv-11.)

In April 2015, two months before Silva filed her RICO complaint in California, Dale Ludwick filed a class action RICO complaint against Harbinger Group, Inc., Fidelity and Guaranty Insurance Company, Raven Reinsurance Company, and Front Street Re (Cayman), Ltd. The case was assigned to U.S. Chief District Judge David Gregory Kays. In February 2016 Judge Kays dismissed the complaint. Here, without citations, are the fifth paragraph and the concluding paragraph of his order:
Plaintiff alleges that F&G [Life Insurance Company], Harbinger, and Harbinger's chairman and CEO, Philip A. Falcone, created a fraudulent accounting scheme to hide F&G's liabilities and artificially inflate F&G's reported assets. This scheme ignored the Statutory Accounting Principles promulgated by the National Association of Insurance Commissioners designed to protect annuity holders and certify that F&G had assets sufficient to meet current and future annuity holder obligations. Harbinger and Falcone orchestrated a series of transactions using wholly-owned captive subsidiaries and a reinsurance company named Wilton Re to transfer F&G's liabilities from its financial statements. Throughout 2011, 2012, and 2013, F&G created a false appearance of capital adequacy by transferring F&G liabilities to and among entities Raven Re, Front Street Cayman, and Wilton Re. F&G also used these transactions to report its holdings of non-agency mortgage-backed securities in its admitted asset base at cost, rather than at their true market value. Plaintiff contends that, absent these financial maneuvers, F&G would have had to report a negative statutory surplus after its acquisition by Harbinger....
Because the McCarran-Ferguson Act preempts RICO claims, the Court need not address whether Plaintiff has plausibly pled these claims. Plaintiff's complaint fails to state a claim upon which relief can be granted and Defendants' Motion to Dismiss is GRANTED.
The Eighth Circuit Ruling
Ludwick appealed the ruling to the Eighth Circuit. In November 2016 the case was assigned to a three-judge appellate panel consisting of Chief Judge William J. Riley and Circuit Judges Roger L. Wollman and Jane Kelly. (See Ludwick v. Harbinger, U.S. Court of Appeals, Eighth Circuit, Case No. 16-1561.)

In April 2017 the appellate panel, in a unanimous ruling written by Chief Judge Riley, affirmed the district court's dismissal of Ludwick's complaint. Here are the introductory and concluding paragraphs of the appellate ruling:
  • The question in this case is whether letting Dale Ludwick pursue her federal racketeering claims against an insurance company and its affiliates would impair state regulation of the insurance business in Iowa, Maryland, or Missouri. We agree with the district court that it would, and the McCarran-Ferguson Act forbids that result. See 15 U.S.C. § 1012(b). We affirm the dismissal of Ludwick's claims....
  • Litigating Ludwick's RICO claims would interfere with state regulation of the insurance business, and the claims are barred by the McCarran-Ferguson Act. The district court was right to dismiss. We affirm.
General Observations
I was surprised by Judge Kays' ruling and the Eighth Circuit's affirmation for two reasons. First, I was surprised by the involvement of Philip Falcone, about whom I wrote in Nos. 242 (posted November 20, 2017) and 244 (December 11, 2017). The Ludwick lawsuit was filed less than two years after Falcone's August 2013 settlement with the Securities and Exchange Commission. In that settlement he and his company paid civil penalties of more than $18 million, he was barred from the securities industry for at least five years, and he admitted wrongdoing.

Second, I had not heard of cases where the McCarran-Ferguson Act was used to dismiss federal RICO lawsuits. However, based on a review of documents in the Ludwick case, it appears that there have been other such cases. It is sobering to consider the implications for insurance consumers when some state insurance regulators are allowed by other state insurance regulators to deviate significantly from statutory accounting principles adopted by all state insurance regulators.

Available Material
In No. 107 I offered a complimentary PDF containing the Silva RICO complaint. The package is still available. Email and ask for the June 2015 package containing the Silva RICO complaint.

Now I am offering a complimentary 48-page PDF consisting of Judge Grewal's order granting the motion to transfer the Silva case to Iowa (13 pages), Judge Rose's order staying the defendants' motion to dismiss the amended complaint in the Hudson case (2 pages), Judge Rose's order dismissing the amended complaint in the Hudson case (7 pages), Judge Kays' order dismissing the complaint in the Ludwick case (13 pages), and the Eighth Circuit panel's ruling in the Ludwick case (13 pages). E-mail and ask for the January 2018 package relating to shadow insurance and the RICO complaints.