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Monthly Archives: August 2010

Scrutiny Over Retained Asset Accounts Rages On

Retained asset accounts (RAA) are in the regulatory hot seat, with critics of the vehicles calling on life insurance companies to improve disclosure policies and beef up transparency of the products to clients.

RAAs are interest-bearing accounts used by life insurers to hold death benefits of beneficiaries. Instead of providing a lump-sum payment, beneficiaries are paid via a “checkbook” supplied by the insurer. The checks themselves are draft-account checks, however, and cannot be used as easily as standard bank-account checks.

Bloomberg first reported on the issue of retained asset accounts earlier this summer, bringing to light the fact that RAAs allow insurers to earn high returns – 4.8% – on the proceeds of a life insurance policy. Meanwhile, beneficiaries get peanuts with interest rates as low as 0.5%.

On top of that, retained asset accounts are not insured by the Federal Deposit Insurance Corp. (FDIC).

Advocates of retained asset accounts say the products give beneficiaries additional time to decide what to do with their money.

Recently, retained asset accounts were the focus of subpoenas issued by New York Attorney General Andrew Cuomo to Prudential Financial and MetLife. Now, Cuomo’s office reportedly has expanded the investigation to include other insurers. According to an Aug. 31 article by the Indianapolis Star, one of those insurers is Carmel-based CNO Financial Group, formerly known as Conseco.

Currently, only six states have regulations pertaining to retained asset accounts. However, the regulations don’t mandate that insurers reveal how much interest income they make on the money held for the beneficiary.

In August, the National Association of Insurance Commissioners issued a consumer alert about retained asset accounts.

Retained Asset Accounts: Buyer Beware?

Retained asset accounts are facing growing scrutiny, with regulators calling into question the disclosure policies of insurance companies that market and sell the products to clients. In July, New York Attorney General Andrew Cuomo opened a fraud investigation into retained asset accounts, with subsequent probes announced by Georgia and New York insurance departments.

Earlier this month, the U.S. Department of Veterans Affairs also announced plans to review its own insurance program, followed by the U.S. House Oversight and Reform Committee saying it would investigate insurance benefits for 6 million U.S. soldiers.

Insurers like MetLife and Prudential Financial use retained asset accounts as a way to keep cash when beneficiaries of the policies do not elect a lump-sum payout of death benefits. Beneficiaries are instead issued a “checkbook” to access their funds. Meanwhile, the insurance companies earn interest from the money in the accounts.

Retained asset accounts are not backed by the Federal Deposit Insurance Corporation, however – a crucial fact that creates uncertainty and added risks. Take the case of Jasmine Williams.

After her mother passed away in 2002, Williams was assured by MetLife that her $101,819 in life insurance benefits were safe. She was then sent a guaranteed money market “checkbook.”

The next year, Williams, who was 19 at the time, told MetLife that a cousin had taken nearly $50,000 by forging her name on 12 checks. Williams sought reimbursement. The insurance company and Pittsburgh-based PNC Bank NA, which processed the MetLife checks, refused to make good on Williams’s losses, however. Each company denied responsibility, according to the Bloomberg, which first reported the story.

If Williams’s money had been in a bank, instead of an account managed by an insurer, federal and state laws would have required the bank to verify signatures on checks and cover losses.

“It’s high risk for the beneficiary to have money in these insurance accounts,” said Robert Hunter, director of insurance for the Consumer Federation of America in Washington, in the Bloomberg article. “I’ve been telling people to get their money out. You have what I consider a little black hole.”

Montana Sues Securities America Over Medical Capital Investments

Securities America has once again caught the attention of securities regulators over risky sales in Medical Capital Holdings. This time, Montana’s State Securities Commission is suing Securities America.

In January, Massachusetts Secretary of State William Galvin filed the first lawsuit against Securities America, accusing the broker/dealer of failing to reveal key information about failed private placements in Medical Capital.

According to the Montana lawsuit, Securities America and several of its top executives, including new chief executive James Nagengast, allegedly “withheld material information regarding heightened risks” from its representatives and their clients regarding notes issued by Medical Capital Holdings.

Securities America brokers sold $698 million worth of the notes from 2003 to 2008 and “concealed these risks” from its brokers and their clients, the Montana lawsuit contends.

In total, Medical Capital sold $2.2 billion of notes through dozens of independent broker-dealers, a number of which have failed or shut down. Securities America is the broker/dealer that sold the largest amount of Medical Capital notes.

Securities America is facing a number of lawsuits and arbitration claims from disgruntled investors who lost hundreds of thousands of dollars in their Medical Capital investments.

If you have a story to tell involving Securities America and/or Medical Capital Notes, please contact a member of the securities fraud team at Maddox, Hargett & Caruso.

Judge Not Ready To Sign Off On Citigroup/SEC Settlement

When Citigroup eked a $75 million settlement deal in July with the Securities and Exchange Commission (SEC) over claims it misled investors by failing to disclose $40 billion in risky mortgage-related holdings, many people thought Citigroup got off far too easy. Now, it appears a federal judge feels the same way.

U.S. Judge Ellen Huvelle said earlier this week that she wouldn’t approve the $75 million settlement and wants more information from the bank.

Citigroup first stated in 2007 that it had significantly reduced its exposure to mortgage securities by 45%, to $13 billion. That wasn’t the case, of course. In reality, Citigroup made a $40 billion understatement of its mortgage-related exposure.

The SEC then accused Citigroup of committing negligent – not intentional – fraud. No fraud allegations were filed against any executives at Citigroup, however. Instead, the SEC cited two men, former Citigroup Chief Financial Officer Gary Crittenden and former investor-relations head Arthur Tildesley, of engaging in “disclosure violations.”

Crittenden paid a $100,000 fine and Tildesley $80,000.

Like many people, Judge Huvelle has some questions for Citigroup, not the least of which is how the SEC settled upon the $75 million fine in the first place. Why didn’t federal regulators accuse Citigroup of intentional fraud? And, more important, why were only two individuals cited by the SEC? Surely there were others behind the obvious misdeeds.

Citigroup has until the end of September to get back to the judge with its answers.

Meanwhile, Citigroup shareholders are paying the price for Citigroup’s actions. Citigroup stock is down more than 90%.

Former ING Broker Rhonda Breard Sentenced

Former ING Financial broker Rhonda Breard is trading her swanky professional suits for prison garb. After pilfering clients out of $12 million, a federal judge has sentenced Breard to six years and eight months in prison.

The former chief executive officer of Breard and Associates Wealth Management in Kirkland was initially charged on March 10 to one count of mail fraud in connection to an investment scheme that defrauded clients out of millions. Breard later admitted she concealed the scheme by giving her clients fake account statements that showed investments in a variety of phony financial and insurance products.

The Financial Industry Regulatory Authority (FINRA) barred Breard from the securities industry in March.

After stealing from her clients, Breard allegedly used the money to purchase extravagant homes, jewelry and more than two dozen vehicles. In February, Breard tried to commit suicide, presumably because authorities were onto her fraud following a surprise audit by ING.

During Breard’s sentencing, several of the victims she defrauded were present. One of the victims was Shelly Heath, who had invested with Breard for 25 years. Gone from her account were her retirement savings and money for her children’s college education fund.

Another of Breard’s victims was an autistic man who lost his entire savings while working as a janitor and other small jobs.

As for Breard, she blamed her actions on greed and the need to appear wealthy.

N.J. SEC Fraud Case: More States To Follow?

In its first securities fraud case against a state, the Securities and Exchange Commission (SEC) has accused the state of New Jersey of misleading investors by hiding the underfunding of its two biggest pension plans. The situation in New Jersey is far from isolated, and many legal analysts believe similar lawsuits against other states will soon be forthcoming.

New Jersey settled the SEC’s claims without admitting or denying any wrongdoing.

As reported Aug. 18 by Bloomberg, New Jersey is the third-most-indebted state in the country, behind California and New York, with $37.7 billion in gross tax-supported debt outstanding. Its $66.9 billion pension system includes seven funds, which were underfunded by $46 billion as of June 30, 2009.

Nationwide, state pension systems were underfunded by at least $500 billion in 2008, according to a report by the Pew Center on the States. The report, The Trillion Dollar Gap, says that in 2000, slightly more than half of the states had fully funded pension systems. By 2006, that number had shrunk to six states. By 2008, only four—Florida, New York, Washington and Wisconsin—could make that claim.

The consequences of severely underfunded public sector retirement benefit systems translate into lower bond ratings, higher taxes and less money available for essential public services.

The one upside to the underfunding issue is the attention being generated for new reforms. Many states are now taking action to change how retirement benefits are set, how they are funded and how costs are managed.

State Insurance Regulators Issue Alert On Retained-Asset Accounts

Retained-asset accounts – a product that allows insurers to profit from beneficiary death benefits by placing the funds in interest-bearing accounts – have become the new tainted investment of the day.

Just days after the Federal Deposit Insurance Corporation announced that life insurers should disclose more information about retained-asset accounts to their customers, the National Association of Insurance Commissioners issued a consumer alert on the products.

Last month, New York Attorney General Andrew Cuomo subpoenaed Prudential Financial, MetLife and several other insurers as part of an investigation into possible fraud in the life insurance industry.

The focus of Cuomo’s investigation concerns whether consumers thoroughly understand the payout options associated with retained-asset accounts.

A retained-asset is considered a temporary repository of funds. Instead of paying out a lump-sum upon the death of a policyholder, insurers keep the money in their own general fund. By keeping the money, insurers are able to earn a higher return on the funds than they pay out in interest.

Investigation Launched Into Prudential Over Death Benefit Allocations

Accusations over how life insurers allocate death benefits have resulted in a formal investigation by Rep. Edolphus Towns into Prudential Financial. Towns opened the investigation following allegations that Prudential didn’t automatically deliver a lump-sum check to families of deceased soldiers, but instead deposited that money into its own general fund.

The investigation comes on the heels of a similar life insurer fraud investigation launched in late July by New York Attorney General Andrew Cuomo. As part of that probe, Cuomo issued subpoenas to Prudential, MetLife Inc. and six other insurers for information concerning payouts to policy beneficiaries.

Towns, who is chairman of the House Oversight and Government Reform Committee, says his panel will investigate the insurance benefits for U.S. soldiers provided by Prudential Financial and the Department of Veterans Affairs.

Both the Towns and Cuomo investigations are focusing on how some life insurance companies place clients’ death benefits in an interest-bearing account, with the bulk of the interest benefiting the insurer, not the policy holders. The practice has been in existence since the 1990s.

Bloomberg Markets magazine reported on July 28 that Prudential holds payments owed to the families of fallen soldiers in its general corporate account and sends survivors “checkbooks” that aren’t insured by the Federal Deposit Insurance Corp. Meanwhile, Prudential earns a profit on the money held and pays the beneficiaries minimal interest.

As reported Aug. 11 by the Wall Street Journal, Prudential is the sole provider of life insurance for active duty members and veterans of the U.S. armed forces, under the Servicemembers Group Life Insurance Program and the Veterans’ Group Life Insurance program.

Risky Interest-Rate Swaps Spell Trouble For Denver Schools

Under the advice of JPMorgan Chase, high-risk interest-rate swaps have produced a mountain of debt for the Denver Public School system. The intent of the deal was for Denver schools to raise $750 million to refinance old debt and fully fund its pension system. That didn’t happen.

As reported back in March 2010 by The Cherry Creek News, it was former Denver Public School Superintendent Michael Bennet who first convinced the Denver school board to buy into the deal with JP Morgan. The strategy involved using variable-rate debt with interest rates of about 5%. The bank then attached an interest-rate swap to the arrangement, which essentially bet taxpayer money that interest rates would remain high.

When interest rates fell to historic lows, the deal earned the banks millions of dollars in fees, while Denver schools lost big.

Denver now wants to get out of the deal. But it will pay a hefty price to do so. The schools would have to pay the banks $81 million in termination fees, or about 19% of the system’s $420 million payroll.

As for the former superintendent at the center of the debacle, Bennet is now Democratic Senator Bennet – and desperately trying to stave off the bad press surrounding his role in the Denver school deal. On Tuesday night, Bennet beat out Andrew Romanoff – 54.2% to 45.7% – in Colorado’s Senate primary.

Interest-Rate Swaps Dig Municipalities Deeper Into Debt

Interest-rate swaps have become synonymous with toxic investments for a growing number of states, cities and towns across America. States and local governments initially turned to the exotic financial instruments as a way to boost their budgets. Instead, many have found themselves pushed to the brink financially and forced to cut basic services like public transportation and sanitation.

An interest-rate swap is a contract between a bond issuer such as a school district or a state or city government and an investment bank. Both parties involved in an interest-rate swap transaction essentially “bet” on the movement of interest rates. Whichever party guesses wrong ends up paying. How much is paid or lost depends on several factors, including the size of the debt and current economic conditions.

When the housing industry started to crumble in 2007, followed by the downturn in the financial markets, interest-rate swap deals quickly began to sour for many state and local governments. Case in point: the Denver school system.

Denver schools turned to interest-rate swaps in 2008 on the advice of JPMorgan Chase and the Royal Bank of Canada. The deal was supposed to eliminate a $400 million pension fund gap for the school system. Instead, it caused a financial drain on Denver’s already-strapped budget. So far, Denver schools have paid $115 million in interest and other fees – an amount that’s at least $25 million more than what was initially envisioned.

Escaping an interest-rate swap is not easy or cheap. As reported Aug. 6 by the New York Times, Denver schools must pay the banks $81 million in termination fees, or about 19% of the system’s $420 million payroll.

Wisconsin is in a similar boat. Several years ago, s group of five school districts invested in derivatives as a way to boost returns to a joint pension fund. They now face losses of nearly $200 million, with the retirement system close to bankruptcy. A lawsuit has since been filed against the financial institutions behind the deal, Stifel Nicolaus & Co. and the Royal Bank of Canada (RBC).

Perhaps the most publicized case involving interest-rate swaps is that of Jefferson County, Alabama. As in the Denver school system, JP Morgan was the bank that arranged the Jefferson County deal, which entailed refinancing the Jefferson County sewer system in 2002 and 2003 with $5 billion in interest-rate swaps. Far from the money-saving investment proposed by the bankers, the deal nearly bankrupted Jefferson County.

If you have a story to tell involving interest-rate swaps, please contact a member of the securities fraud team at Maddox, Hargett & Caruso.


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