Risky Business

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Risky Business

Risky Business: How Insurance Companies are Chasing Profits over Policyholder Security

By Lucy Komisar

Major U.S. life and annuity insurance companies are endangering their policyholders’ benefits

with risky investments that trade client security for bigger payouts for executives and shareholders, according to an examination of financial filings, annual reports, and experts on insurance finance.

These strategies are part of a broader industry shift as insurance mutuals become publicly-traded companies. Private equity firms, too, have entered the insurance business and assumed greater control over corporate pension funds. 

Their actions have prompted Federal Reserve economists and trade unions to issue warnings about investment strategies that, they say, heighten risk for millions of insurance policyholders. These concerns are amplified by the significant role that insurance companies and private equity are playing in credit markets since the 2008 global financial crisis, with little federal oversight. 

The companies involved include giants of the insurance industry: Athene Life & Annuity Company, owned by Apollo Global Management Inc., one of the world’s largest asset management and private equity companies; Metropolitan Life Insurance Company (MetLife), the country’s largest life insurance concern; and Accordia, purchased last year by KKR & Co. Inc, also known as Kohlberg Kravis Roberts, the multi-billion-dollar investment and private equity firm. Together, these companies account for roughly one in six life insurance policies and annuities written in the United States.

The three, not alone in the industry, are diverting insurance liabilities into offshore entities, where oversight is scant. They use funds from policyholders to create credit products and buy other types of investments that are far less liquid than traditional investments and carry more risk. These include:

  • Collateralized loan obligations (CLOs), which bundle loans made to highly leveraged businesses into asset-backed securities. CLOs were a major factor in the 2007-2009 global financial crash. By the end of 2020, life insurance companies held a quarter of all collateralized loan obligations. And banking regulators are warning that their growing weight on insurance companies’ books and uncertainty about the value of the underlying assets make insurers far more vulnerable to downturns in the credit cycle.
  • Funding agreements, in which loans, sometimes issued through secretive special purpose vehicles (SPVs), are listed as assets but are in fact debt that must be repaid on demand. Financial experts describe this practice as an accounting sleight of hand, one that transforms a debt into an asset for accounting purposes, making the insurer’s balance sheet look far healthier than it really is.
  • Investments in affiliated companies owned by the insurance company. Essentially, the insurer is investing in itself, which concentrates risk. Often the affiliates are listed in secrecy jurisdictions such as Bermuda and the Cayman Islands that keep very limited public books or in U.S. states with lax regulations, making it very difficult for regulators or financial analysts to assess the true value of the affiliated investments. 

Driven by the growing involvement of private equity, giants of the industry are seeking quick returns, said Daniel Schwarcz, a law professor at the University of Minnesota and an expert on insurance regulation. And in the aftermath of the 2008 financial bailout and rescue of the insurance giant AIG, a number of insurance companies have increasingly abandoned traditional investment strategies that had a long-term horizon in the belief that the government will step in if things go bad, he said. 

There’s more of a willingness to push the envelope, to game the rules, to seek out the most profitable short-term strategy. There's some understanding that in a scenario like 2008, there's going to be bailouts. That changed the calculus.

Daniel Schwarcz
Law professor at the University of Minnesota

Insurance providers began as not-for-profit policyholder cooperatives, known as mutuals or fraternals. Meeting their obligations to policyholders was their top priority. Their managers bought U.S. Treasuries and corporate bonds that were largely safe and easy to sell on any exchange, matching maturities to the predictable, long-term payout schedule of benefits.

Some mutuals, such as MetLife in 2000, later converted to for-profit companies. Maximizing returns to shareholders became the new mantra, with managers incentivized to raise corporate profits. In the past decade, private equity (PE) companies began to buy up insurance companies and take over corporate pensions.

They, too, used the steady inflow of cash from policyholder premiums (insurance liabilities) to fund more speculative ventures, said David “Birny” Birnbaum, a member of the Treasury Department’s Federal Advisory Committee on Insurance (FACI), executive director of the Center for Economic Justice and a former member of the Federal Reserve’s insurance advisory board.  Insurance companies also created asset management firms owned by their parent to manage these more volatile portfolios, Birnbaum said, further increasing the parent company’s revenue through high management fees.

They’ve increased the risk of investments significantly. They put more money into CLOs and real estate, as well as more exotic types of investments.

David “Birny” Birnbaum

“Life insurance historically invested in bonds. You buy a term life policy, 20 or 30 years, the company buys a bond for 30 years that matches the liability to that asset. And they are liquid, you can sell bonds,” Birnbaum said. But that has changed under new Wall Street owners.   

“The business model is based on fees for managing assets. They’ve increased the risk of investments significantly,” he added, pouring more money into collateralized loan obligations and “more exotic types of investments.” These investments are less liquid and more volatile, he said. 

The trade union Unite Here has warned of a growing risk to the pensions of its members, citing the growing reliance on less liquid asset-backed securities and alternative investments to drive higher returns, the use of investment management agreements with their own affiliates, and the reinsuring of liabilities offshore. Unite Here has flagged the risk of systemic financial collapse.

“We believe that it will ultimately require state, federal and international regulators working together to protect the public from the risks of large life insurer insolvencies and/or contagion to the larger financial system to which they are interconnected,” Unite Here said in a June comment to the National Association of Insurance Commissioners (NAIC), which sets guidance for state regulators overseeing the industry.

In a September 2021 report, the NAIC Financial Stability Task Force noted that when insurance firms invest in affiliated companies, the firms may increase risk to their own solvency. The same report also pointed out that insurance firms often fail to accurately disclose investments in affiliated companies.

This report, the second in a series on how Wall Street is cashing in on the insurance industry, examines three types of risky investments each company uses to boost its profits, drawing from the annual reports filed with the Securities and Exchange Commission and state insurance departments, as well as collateral forms. Thomas Gober, a certified fraud investigator and former Mississippi Insurance Department examiner who has advised the U.S. Department of Justice on insurance fraud, analyzed the relevant documents for 100Reporters.

Bundles of Risk

Among structured securities, collateralized loan obligations, or CLOs, are considered the most complex, least liquid and highest risk asset category. The CLOs usually are pools of corporate loans with low credit ratings, or loans taken out by private equity firms to conduct leveraged buyouts. The loans are bundled together to create a high-yield debt instrument structured into tranches, based on the cash flow and on the riskiness of the underlying loans, with higher ratings for tranches claimed to be the most secure. Nobody except the seller knows exactly what’s in them. What is known: None of them are as safe as government bonds.

The rapid growth in the trade of such structured securities recalls developments in the U.S. sub-prime mortgage market in the run-up to the 2007-2009 global financial crisis, the Bank for International Settlements (BIS) said in its 2019 quarterly review.  Like CLOs today, sub-prime mortgages in the 2000s were cut into tranches with varying levels of risk, and they were rated by credit agencies.

As the world discovered in 2008, many of those ratings were misleading, which contributed to investors acquiring bundles of low-rated loans with a high risk of failure. BIS said the opacity of CLOs, their high concentration in financial institutions and uncertainty about the resilience of underlying loans are causes for concern. 

Federal Reserve Board economists have noted the heavy use of CLOs by insurance companies, including  Apollo’s Athene Life and Annuity and MetLife, and pointed to their dangers during a market downturn. In an exhaustive 2021 analysis, the economists detailed how the largest U.S. life insurers use their affiliates to establish shadow banking systems, reshaping the risk profile of the financial system.

By extending credit to these risky projects the insurers earn a sizable (interest rate) spread over the cost of their annuity liabilities. By holding the CLO deal risk of their affiliates and the rapidly growing portfolio of commercial real estate loans, life insurers are vulnerable to a downturn in the credit cycle.

Federal Reserve Report, 2021

But there is a danger. “By holding the CLO deal risk of their affiliates and the rapidly growing portfolio of commercial real estate loans, life insurers are vulnerable to a downturn in the credit cycle,” they warned. For example, a widespread decline in the value of the loans backing the CLOs would directly wipe out equity held by the affiliated subsidiaries of life insurers, they said.

“As we learned from the 2007-09 financial crisis, even a relatively small exposure would create a vulnerability for life insurers who pledged their excess capital to the deal risk,” the 2021 analysis found. As equity declines in value, institutional investors could withdraw wholesale funding, further pressuring life insurers and creating a severe liquidity crisis for the industry, they wrote. 

Athene Dives In

Despite these warnings, a sizable part of Athene’s investment strategy includes buying loan exposure through CLOs. They accounted for 10 percent of Athene’s portfolio in 2022, while other types of asset-backed securities made up 11 percent, according to Athene’s report to investors. Add residential and commercial mortgage-backed securities of 6 percent, that makes 27 percent — or nearly $50 billion, over a quarter of its investments — in riskier assets that are known to face declines in periods of economic stress. Even a slight market downturn could overwhelm Athene’s $1.27 billion surplus, said Gober. (Surplus is the amount of assets over liabilities the company must hold below which regulators can rule it insolvent.)

Athene invests more in high-risk collateralized loans and asset-backed securities

Source: Athene report to investors 2022

Athene’s exposure is 21 percent for asset-backed securities (ABS) and CLOs, over three times higher than its peers, which had 6 percent.

The NAIC Financial Stability Task Force in its September 2021 report expressed concern about the concentration of asset-backed securities in the holdings of private-equity owned insurance companies. “[P]rivate equity]-owned companies focus far more on investing in asset-backed securities (ABS) than the industry as a whole: 25 percent vs. 10 percent of total bonds in 2020,” the task force said.

The Fed economists in their 2021 report cited Athene, among others, in noting that “these life insurance companies hold some of the riskiest portions of the CLOs issued by their own affiliate asset managers.” It added that “a widespread default or downgrade of risky corporate debt could force life insurers to assume balance sheet losses of their CLO-issuing affiliates, wiping out their equity.”

Apollo's much-touted success in fashioning Athene as a ‘permanent capital vehicle’ for fee-generating asset management has spawned a bevy of private equity-affiliated imitators, transforming what we and others once viewed as a potential retirement security concern affecting a few thousand annuity owners into a much broader macroprudential challenge

Unite Here

Unite Here has voiced similar concerns. “Apollo’s much-touted success in fashioning Athene as a ‘permanent capital vehicle’ for fee-generating asset management has spawned a bevy of private equity-affiliated imitators, transforming what we and others once viewed as a potential retirement security concern affecting a few thousand annuity owners into a much broader macroprudential challenge,” it said in June comments to the NAIC.

Asked to comment, Athene spokesperson Danielle Collins said, “Policyholder protection is our top priority, and we do not engage in any practices that endanger our policyholders’ benefits. Insurance is regulated at the individual state level, and we work proactively with regulators to ensure that we operate our business in a manner that follows the respective state’s regulations. In addition, we transparently disclose our financial information quarterly, including for our Bermuda entity. Athene remains one of the best-capitalized insurance companies in the industry.” 

100Reporters also contacted Carl McCall, the former New York State comptroller, once charged with oversight of the state’s insurance companies. McCall joined Athene’s Board of Directors in 2016. Asked about Athene’s risky investment strategies and use of captive reinsurance companies in secrecy jurisdictions, McCall declined to comment.   

MetLife Exposure

MetLife has a similar high exposure to risky investments. Its 2021 annual financial report shows $16 billion listed under “Other loan-backed and structured securities.” Gober, the insurance investigator, said these include CLOs and student and credit-card loans bundled into asset-backed securities known for their higher default rates. In addition, MetLife reported its residential and commercial mortgage-backed securities were more than $27 billion, bringing riskier investments to $43 billion. MetLife’s surplus, at $11.8 billion, is just under 3 percent of total assets, or half of the national average for insurance companies.

These investments have caught the attention of Fed economists, who said in their 2021 paper: “U.S. insurers returned to RMBS (residential mortgage-backed securities) issuance in 2017, though issuance levels remain low relative to CLOs. The two main players in this relatively niche market are AIG and MetLife.”

John Patrick Hunt, professor at the University of California, Davis and a former regulatory lawyer and litigator who specializes in the financial regulation of insurance companies, told 100Reporters, “MetLife seems to be taking on the riskiest pieces of complex products called CLOs, as well as using Bermuda captive reinsurers, to reduce the equity U.S. regulators would otherwise require the companies to hold to cover losses.” He said such moves increase the risk that investment losses could make the insurance conglomerate insolvent, and ultimately unable to honor its commitments.

MetLife seems to be taking on the riskiest pieces of complex products called CLOs, as well as using Bermuda captive reinsurers, to reduce the equity U.S. regulators would otherwise require the companies to hold to cover losses.

John Patrick Hunt
University of California

Books in Bermuda are largely secret, so the public doesn’t know the details of what investments those companies hold. Scholars and regulators have identified ways in which the financial distress of a large insurer like MetLife could ripple through the entire financial system. “Large insurance conglomerates historically have had obligations to other systematically important financial firms such as major banks,” Hunt said. “If the insurer fails and can’t honor such contracts, that could contribute to the failure of the other party to the contract in a falling-dominoes effect similar to what we saw in the global financial crisis,” Hunt said.

MetLife’s head of communications Dave Franecki emailed, “We appreciate you reaching out and walking through some of the themes.” But he declined to comment further: “MetLife is not going to provide an interview or comment for your story or the related series of stories being published by 100Reporters,” Franecki said.

Accordia is a small company compared to Athene and MetLife. Last year, the private equity firm KKR purchased a majority stake in Accordia’s parent company, Global Atlantic, from Goldman Sachs. Global Atlantic is based  in the Cayman Islands, where books are largely closed to the public and profits shielded from US taxes.

In its 2021 Schedule D bonds filing, which is part of its annual financial report, Accordia lists $2.5 billion under “Other Loan-Backed and Structured Securities”, which includes CLOs.

Lightly Regulated

Traditionally, insurance companies take in premiums and invest in relatively safe, high-grade corporate and government bonds. They create profits by generating higher returns on their investments than the amounts they have to pay out in claims. The NAIC sets overall guidelines on how to run a safe and secure insurance company, including following standard accounting, or what are called Statutory Accounting Principles (see Key Terms).

But the NAIC has no enforcement power, it can only threaten to withhold accreditation. Regulatory authority now resides with states, after the industry lobbied to get a federal law passed denying Washington that authority. Insurance companies increasingly are exploiting this patchwork regulatory regime to burnish their accounts, financial and legal experts say.

Funding Agreements, or Handy Tricks for Turning a Liability into an Asset

Funding agreements are short-term investor loans, which can appear on the insurance company’s balance sheet as an asset when in fact they are debt obligations. They generally are issued through a shell company known as a Special Purpose Vehicle (SPV) or Special Purpose Entity (SPE), which issues a note on behalf of the insurance firm. Investors buy the note from the SPV or SPE, which passes the money on to the insurance firm.

Spared from public disclosure requirements, SPVs played a major role in the 2008 financial crisis. “The SPV is off-balance sheet and under-regulated,” Gober said. “The SPV is a shell that impedes regulatory oversight and improves the insurer’s financial appearance.”

The SPV is off-balance sheet and under-regulated. The SPV is a shell that impedes regulatory oversight and improves the insurer’s financial appearance.

Thomas Gober
Certified fraud investigator and former Mississippi Insurance Department examiner

Why does the insurance company run this deal through an SPV? Doing so allows insurance companies to report such debts as “insurance products,” lowering the reserves they must hold against their eventual payment. On the balance sheet of the insurance company the influx of funds appears as an asset when the money is invested in securities. In reality, however, it is also a liability, because the money has to be paid back.

By lowering the reserve requirements, the insurance company frees up more cash to invest, said a senior government policy advisor on insurance, who spoke on background because he lacked authorization to speak to a journalist. But these loans are short-term and can be readily recalled, making the insurance companies less resilient to volatility in the marketplace.

Financial experts say a similar set of financial conditions prevailed during the banking crisis of 2008. At that time, plunging loan markets caused lenders to request their money back on short notice, forcing companies to liquidate their assets, which triggered a cascade of selling. SPVs were especially hard hit. Aggravating the damage, investors and regulators had little visibility into their risk, especially for SPVs held in offshore subsidiaries where financial disclosure is scant.

Funding agreements heighten risk for policyholders in another way. In the event of bankruptcy, insurance policyholders usually are the first in line to get paid. But under the terms of these funding agreements, the loan investors are deemed of equal standing with policyholders.

These funding activities render the insurer vulnerable to runs. During the financial crisis, runs on insurers forced them to scramble for liquidity from other sources, including FHLBs [Federal Home Loan Bank]. In some cases, insurers required substantial government assistance to prevent spillovers to households and to the rest of the financial system.

Federal Reserve Report, 2021

If the insurance company becomes insolvent, policyholders must compete with investors for the leftovers. And because of secret side agreements that give private equity companies wide discretion for favoring friends, relatives, and some select investors over others, policyholders and pensioners will have less standing as they compete for the remaining crumbs.

The Fed economists in their 2021 paper raised a red flag about these types of loans in particular. “These funding activities render the insurer vulnerable to runs,” the Fed economists wrote. “During the financial crisis, runs on insurers forced them to scramble for liquidity from other sources, including FHLBs [Federal Home Loan Bank]. In some cases, insurers required substantial government assistance to prevent spillovers to households and to the rest of the financial system.”

Despite the 2008 crisis which led to the taxpayer bailout of AIG, insurance companies have managed to remain outside federal regulation of the industry, leaving oversight to a patchwork of states, some of which have become havens known for lax oversight.

The latest filing by Athene says that none of its funding agreements allow discretionary, or on demand, withdrawals, which could cause a run during a steep market decline. MetLife says a small number allow them. However, the senior government insurance policy advisor asked, “What does discretionary mean? Is the term a long term? It’s feasible that fixed means a month. Or let’s say they are fixed for a year but they are staggered. At any point some are coming due.” The companies’ filings report their funding agreements but don’t answer those questions on their maturity dates.

Gober analyzed how funding agreements are reported as income, rather than debt, by Athene and MetLife.

In the section for reporting liabilities on its 2021 annual statement, Athene listed nothing on line 22 under “Borrowed Money”. It is blank, showing zero debt. 

But in another part of the annual statement for 2020, called Schedule T for reporting on premiums and annuity, there’s a hidden debt of $1.8 billion called “deposit-type contracts,” which are funding agreements – or loans issued through SPVs. 

This is not income but a form of debt, though Athene doesn’t report it as such. By 2021, funding agreements, shown in column 7, had increased 47-fold to $11.1 billion, up from $310 million in 2015, dwarfing Athene’s $1.2 billion surplus. Athene announced it was the largest issuer of funding agreements across six different currencies.

ATHENE'S FUNDING AGREEMENTS

INCREASED 47-FOLD

According to Athene’s filings, nearly all of the $11.1 billion raised through funding agreements and listed as insurance products is sent to reinsurance, much of it to lightly regulated affiliates or offshore, where secrecy reigns; it is unknown how much is invested in illiquid assets, of the kind the Fed warned of in its report. A sudden demand for the cash could be dangerous, Gober cautioned. In the face of massive losses, Athene’s nearly one million policyholders seeking claims would be standing in a very long line for payouts, absent significant government intervention.

Government economists long have expressed concern about MetLife’s heavy reliance on funding agreements, going back to the creation of  the Financial Stability Oversight Council (FSOC) in the U.S. Treasury, in the aftermath of the 2008 global financial crisis. The FSOC was charged with detecting conditions that could threaten the country’s financial system and was given authority to audit and assess not only banks but other large financial companies, including insurance companies. If FSOC considered a firm vital to the safe functioning of global markets, it was assigned a red flag and labeled “systemically important financial institutions” (SIFIs).

Along with AIG and Prudential, MetLife was a focus of the financial stability council’s’s investigation and was designated a SIFI, on the grounds that the collapse of any one of these companies could devastate the financial system. The financial stability council noted in a 2014 report that MetLife’s funding agreements made it vulnerable, since it issued 75 percent of the $50 billion market for funding agreements (FA) and FA-backed securities issued by U.S. life insurers in the first six months of 2013. In a financial downturn, creditors could immediately call that money back, forcing MetLife to liquidate assets at fire-sale prices, which would affect the wider markets, the Financial Stability Oversight Council said in its 2014 report.

Despite this warning, MetLife reported $30 billion in funding agreements in 2018, and its latest financial filing shows the insurer had increased that to $72 billion in 2021, listing them as  “deposit-type contracts.” Its website shows that it is actively promoting these instruments as a retirement solution for clients. 

Instead of calling this borrowed money, MetLife lists funding agreements on its financial statement alongside premiums. It describes these contracts as “holding the Deposit for the benefit of the Beneficial Owner.” Gober pointed out this is a convoluted way of describing a loan, since the beneficial owner is the creditor, not MetLife. He noted that by 2021, funding agreements dwarfed by three-fold MetLife’s worldwide business of $24.3 billion in premiums, shown on column 6 of its Schedule T. According to its filings, Gober noted, MetLife is borrowing three times as much money as it takes in as premiums.

If MetLife were forced to liquidate assets but had invested the money raised through SPVs in risky securities, it would be in trouble.

Thomas Gober
Certified fraud investigator and former Mississippi Insurance Department examiner

MetLife's Fight Against Federal Oversight

MetLife fought back against the financial stability council’s too-big-to-fail designation. It hired lawyer Eugene Scalia, then a partner at the law firm Gibson, Dunn and Crutcher and son of Supreme Court Justice Antonin Scalia. (The younger Scalia would go on to become Labor Secretary under Donald Trump.)

In a suit against the Treasury Department, MetLife argued that the FSOC used a flawed argument to determine that its collapse could devastate the financial system. It insisted that captives funded in part by letters of credit did transfer risk. And it argued that as it already operated under a strict state regulatory system, that non-bank SIFI regulation put it at a disadvantage against its competitors. MetLife maintained that the financial stability council should address the risk posed by specific systemic activities rather than by the size of companies. The case was brought during the Obama administration.

In 2016, U.S. District Judge Rosemary Collyer, a President George W. Bush appointee, overturned the designation, rejecting that MetLife was systemically important to the U.S. financial system and “too big to fail,” and determining the council’s decision  was “arbitrary and capricious.” The judge accepted MetLife’s argument, and ruled the Financial Stability Oversight  Council: “never established a basis for a finding that MetLife’s material financial distress would ‘materially impair’ MetLife counterparties….FSOC never projected what the losses would be, which financial institutions would have to actively manage their balance sheets, or how the market would destabilize as a result….FSOC was content to evaluate interconnectedness and to refrain from calculating actual loss, i.e., to stop short of projecting what could actually happen if MetLife were to suffer material financial distress.”

FSOC, by then chaired by President Donald Trump’s Treasury Secretary Steve Mnuchin, a former Goldman Sachs banker, didn’t appeal. Mnuchin also removed the SIFI designations from the insurance giants AIG – which had contributed to the 2008 financial crisis — and Prudential. In December 2019, Mnuchin issued new guidelines changing the SIFI criteria: instead of identifying institutions that pose systemic risk to the financial system, the government would identify certain types of investment activities that merit special monitoring. Today there are no financial institutions outside the banking sector designated as SIFIs, despite a major expansion of their credit intermediary role in the financial system. After the decision, FSOC regulatory oversight of the insurance industry was constrained and left to the states.

A senior Biden administration official, who worked on the FSOC designation process and requested anonymity because the official was not authorized to speak publicly, told 100Reporters that insurance oversight has not changed under the current administration. “We have not gone back and been aggressive,” the official said, adding there is a lack of “courage and backbone” to take on the insurance industry. This has caused mounting frustration among some Democrats on Capitol Hill.

MetLife has continued the practices that raised red flags over a decade ago.

The smaller Accordia does not have the financial size to borrow billions of dollars through funding agreements.

Shuffling Funds to Shells

Companies normally buy stocks and bonds in the open market, where prices are transparent and based on perceived risk. But there is a second strategy some insurance companies are using. It works like this: the insurance company sends $1 billion in cash to a related company which doesn’t have audits, isn’t publicly traded, and is, in fact, a shell. In return, the insurance company receives an internal IOU, which it calls a bond but which is not a marketable security. No one outside can see the paper trail. Essentially, the insurance company is buying a piece of itself and counting that as an investment. Gober said this lack of transparency is especially concerning for insurance companies that have subsidiaries in US states with lax regulations and offshore where they dump billions of dollars of investments that cannot be overseen because their books are largely shielded from public scrutiny. Outsiders cannot assess the level of risk, he said.

The Federal Insurance Office, an agency in the U.S. Treasury tasked with monitoring the industry under the Dodd-Frank law, has warned against the practice. “Due to the generally illiquid nature of affiliated holdings – i.e.: a market does not exist for such types of investments making it difficult to ascertain their value – significant growth in affiliated investments can erode the strength of an entity’s capital base,” it said in its 2019 annual report.

Two years later, the NAIC Financial Stability Task Force warned in its September 2021 report that state regulators may be failing to adequately assess the risk from this practice. “Affiliated transactions are considered by regulators, but it is not clear if all appropriate PE (private equity) transactions are captured,” it said.

Hidden Gamble

Apollo Capital Management has used its affiliated companies in questionable ways for at least a decade. Athene’s annual statement for 2014, for example, shows that in 2013 it made an investment in an Apollo affiliate to disguise a bailout of Caesar’s and Harrah’s casinos, which subsequently went bankrupt. 

Under a Nevada law passed to keep out organized crime, changes in casino ownership must be approved. In July 2013 the Nevada State Gaming Control Board heard a proposal to transfer an interest in Caesar’s Entertainment to Apollo. A lawyer for Caesar’s said, “This is essentially an investment by Athene indirectly in Caesar’s.” Five months later, Athene bought AAA Investments (Co-Invest VI). Nobody reading Athene’s financial statement would know that AAA Investments was a vehicle for funneling money to two risky Nevada casinos.

Since then, the practice of affiliated investments has ballooned. In a four-year timespan, Athene’s purchase of affiliated stocks and bonds increased 700 percent to $10.4 billion by 2021 from $1.5 billion in 2017, according to its annual statements. Athene declined requests for comment.

ATHENE'S AFFILIATED INVESTMENTS

INCREASED

MetLife, too, engages in internal money transfers. For 2021, its annual report shows affiliated investments of $10.7 billion and similar amounts for the prior three years, down from $15 billion in 2017. In the event of financial stress within an insurance group, opaque affiliated paper is typically first to plummet in value, Gober said.

The $10.7 billion of investments in affiliated businesses, combined with MetLife’s $44 billion in loan-backed and structured securities, indicate that more than one third of MetLife’s $155 billion in total investments is high-risk, Gober said.

While MetLife reported an $11.8 billion surplus in 2021, or $9.8 billion above the required minimum of $2 billion, the nature of its investments renders the company vulnerable, the Fed and other experts said.

A major correction of the kind currently roiling financial markets adds to the concerns. “The $55 billion worth of assets are the highest risk categories,” Gober said. “These asset categories are especially sensitive to economic stress.” A drop in portfolio value of 18 percent, or $9.9 billion, — which is in major market correction territory– would wipe out MetLife’s $9.8 billion surplus. Regulators would then have to work with the company, requiring it to find sufficient cash to restore the surplus; if they failed to do so, regulators could declare the company insolvent and take control.

Accordia’s affiliated investments for 2021 are $758 million, or 6 percent of assets, substantially higher than in past years. While its total assets ($12.739 billion) and liabilities ($12.709 billion) have grown from 2020 to 2021, its surplus has shrunk relative to liabilities, which it has to cover.

ACCORDIA'S AFFILIATED INVESTMENTS

INCREASED

Companies in an agreement reached with the NAIC are allowed to determine the level of risk-based capital they hold as a buffer to ensure they can meet their liabilities. The figure Accordia set in its 2021 financial statement was $141.8 million. It is the bare minimum that must be covered by the surplus.

Accordia’s affiliated investments for 2021, a 65 percent increase over the year before, represent 80 percent of surplus. Were a substantial number of affiliated investments to decline sharply in value, Accordia could be ruled insolvent, though its owner has the option of providing the missing cash. Combined with its structured loan portfolio, Accordia’s high-risk investments total $3.8 billion, leaving Accordia’s buffer vulnerable to an economic downturn, Gober said. Accordia declined requests to comment.

Rich Returns

Executives and shareholders of for-profit life insurance companies and their private equity owners can benefit generously from investment strategies that pour cash into higher risk assets.

As a mutual, policyholders were owners and they received dividends from MetLife, for example. When executives proposed it demutualize, or transform itself into a for-profit company, they won policyholder approval in part by promising that they would continue to receive dividends. They did, but their value went down to virtually nothing.

MetLife’s stock price has tripled to $71.47 over the last decade outpacing the overall gains in the broad stock market, and annual dividends to stockholders have risen from 60 cents a share in 2013 to $1.96 today. These gains have enriched its Chief Executive Officer Michael Khalaf: he enjoyed a 25 percent increase in his base salary to $1.35 million between 2019 and 2021, plus a 28 percent increase in stock and stock options awarded, bringing his total compensation last year to $16.62 million. Three of his top executives have received similarly rich rewards. 

In contrast, MetLife’s policyholder dividends fell to $23 million in 2020 down from $133 million the year before and $1.36 billion in 2012, even as executive compensation rose. Dividends continued to plummet to negative $1.9 million in 2021, while executive payouts grew still more. The increased payouts for executives are typical of mutuals that privatize.

They plummeted from $23 million in 2020 to negative $2 million in 2021, while the company was earning still more.

Athene found an extra way to reward its Chief Executive Officer James Belardi. In addition to his compensation package from Athene, Belardi owned a 5 percent stake in the investment management company set up by Apollo to handle Athene’s assets, which meant he benefited directly from the fees paid by his own company. Moreover, the Financial Times reported in 2018 that an internal investigation showed Athene was paying its investment management firm twice as much as an independent manager would charge for similar services – 0.3 percent of assets under management compared with 0.15-0.25 percent for an unaffiliated manager. Athene, which declined to comment for this article, has elsewhere defended the high fees, telling the Financial Times, “Apollo has sourced investment opportunities for Athene that other managers simply can’t provide, including some of our most successful investments to date.

What’s at stake

The investment practices described here represent dangers to policyholders on several levels should an insurance company grow insolvent, said Birnbaum, the veteran advisor on insurance to the Fed and Treasury. Even though state guarantee funds exist to cover policyholder losses, most states have caps of $250,000-$350,000. People who have paid higher premiums for more insurance or anticipate retirement annuities may lose much of their investment.

There’s a reason we have federal bank regulation. With these types of institutions, you want to limit how much risk they take, because when things get really bad, things will be felt by a lot of people. There are guard rails at the federal level. It’s not the same with insurance

Birnbaum
Veteran advisor on insurance to the Fed and Treasury

Additionally, guarantee funds are based on the premise that the failure of one company is absorbed by others. States recoup the cost through a surcharges, which then get passed onto policyholders through a surcharge. But state regulators may be under-estimating the risk.                   

“Abusive and deceptive sales — the domain of market regulation, not solvency regulation — can lead to solvency issues,” Birnbaum said. “That’s exactly what happened during the financial crisis with bond and mortgage insurers.

“The competition for these insurers to get the business of bond issuers and mortgage originators led to abandonment of risk management by the insurers that solvency regulators missed,” Birnbaum said.

“There’s a great danger because the financial regulators look at solvency solely from the perspective of a company going insolvent – Do they have adequate reserves? Do we have adequate oversight? That limited vision was exposed during the (2008) financial crisis,” he said.

There is also a risk that other parties to a transaction will not be able to fulfill their obligations. “It’s not just one company. If they’re all doing it, it’s all connected. If there are numerous significant failures, the guarantee fund system won’t be able to handle that,” Birnbaum said. Nor would the financial system.

Schwarcz, who was the lead author of the legal brief filed by insurance regulation scholars in support of the government’s move to oversee MetLife, said risk is compounded because insurance companies today are deeply interwoven with global credit markets. When a counterparty demands its money back on short notice, can the insurer liquidate assets quickly enough to repay?

“Unfortunately, it’s rather opaque,” Schwarcz said. In the past, financial companies that engaged in high-risk strategies have dipped into taxpayers’ pockets. Insurance conglomerate AIG survived the 2008 crash only with an $85 billion bailout by Federal Reserve Bank of New York..

Birnbaum fears a repeat. “As the products become more complex and riskier, there’s greater likelihood the [state] regulators don’t fully understand the risk and can’t stay on top of it. We’re talking about trillions of dollars of assets held by life insurers.” 

This article was produced with financial support from the Fund for Investigative Journalism and legal guidance from the Reporters Committee for Freedom of the Press.

Story design by Jessica Skorich.

Photography Credits

Feature
Photo by Harry Gillen on Unsplash 

CLOs
Photo by Kevin Matos on Unsplash 

Athene’s CLOs
Photo by Sean Pollock on Unsplash 

MetLife CLOs
Photo by Rodrigo Sümmer on Unsplash 

Accordia’s CLOs
Photo by Annie Spratt on Unsplash

MetLife Too Big
Photo by Finn on Unsplash 

Investments
Photo by Stephen Dawson on Unsplash

Athene’s Affiliates
Photo by Sid Suratia on Unsplash 

MetLife’s Affiliates
Photo by Izaac Crayton on Unsplash 

Accordia’s affiliates
Photo by Christian Wiediger on Unsplash 

Rich Returns
Photo by Claudio Schwarz on Unsplash

What’s at Stake
Photo by Lianhao Qu on Unsplash

Part 1: Captives of Industry

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Captives of Industry

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Captives of Industry

Captives of Industry: How Wall Street is Cashing in on Your Insurance

By Lucy Komisar

Some of Wall Street’s biggest firms are using accounting gimmicks in life insurance companies

to bolster their profits by overvaluing their assets and holding risky investments on books in secrecy jurisdictions, according to government, trade union and financial regulatory experts. They say the actions threaten the financial health of these firms and the pensions of millions of workers and retirees.

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The companies include giants in the financial industry: Apollo Global Management, the third largest asset management company in the world run by private equity billionaires; Metropolitan Life Insurance Company, the biggest U.S. life insurer; and the investment banking giant Goldman Sachs and Company have all employed these practices.

A review of their annual statements and state filings shows the three have set up a complex web of lightly regulated affiliates in secrecy jurisdictions offshore or in five lenient U.S. states, overstated assets in those affiliates that would be valued at zero under standard U.S. accounting practices and diverted the ready cash from insurance premiums into riskier, more speculative investments. The examination shows that if conventional accounting practices were used on their affiliates instead of those state ones, some of the affiliates owned by big names on Wall Street would be considered insolvent.

Some of these practices bear striking similarities to those that led to the unraveling of the global financial system in 2008 and the bailout of the insurance giant AIG, as well as the collapse of energy titan Enron Corp. in 2001, government and financial analysts said. Federal Reserve economists for years have been warning of their mounting concern over the way that private equity owners in the shadow insurance industry take advantage of lax jurisdictions to pour cash into higher risk investments, which are less easy to sell in a market downturn. Trade unions are sounding the alarm about the potential danger to pensions of their members.

With financial markets today under severe stress as interest rates rise and economies slow, regulators are watching closely. The Federal Reserve Board in its latest Financial Stability Report released in May flagged the growing risk, albeit in the dry language of finance. “Over the past decade the liquidity of insurers’ assets declined and liquidity of their liabilities increased, potentially making it more difficult for them to meet a sudden rise in withdrawals and other claims.”

The moves have prompted concern on Capitol Hill. In a hearing Thursday, Sen. Sherrod Brown (D-Ohio), chair of the Senate Banking Committee, said, “We know that workers end up worse off when Wall Street private equity firms get involved. We’ve seen it over and over.”  

"Over the past decade the liquidity of insurer’s’ assets declined and liquidity of their liabilities increased, potentially making it more difficult for them to meet a sudden rise in withdrawals and other claims."

Private equity companies have been buying up life insurance companies over the past decade and changing the way they do business. Global management consultants McKinsey and Company called tapping into the steady cash flow from life insurance and annuity premiums a “once in a generation opportunity” for investors who are willing to take higher risk to generate higher returns. Blackstone Inc., a leading global investment firm, and The Carlyle Group, private equity specialists, are getting into the game. The Federal Insurance Office at the U.S. Treasury reported that private equity controlled 11 percent of the life insurance industry’s cash and assets by the end of 2020, or more than $471 billion, up from almost nothing 10 years ago. 

Not only are private equity firms buying insurance companies, they also are taking over corporate pension plans and converting them into annuities. The aluminum company Alcoa Corp. and defense contractor Lockheed Martin Corp., for example, last year sent their workers’ pension funds with assets totaling $5.9 billion to Athene Holding, Apollo’s insurance arm.  But unlike company-run pension funds backed by federal ERISA guarantees, or bank deposits which are insured up to $250,000, there is no federal backstop for annuity contracts that replace pension plans. If an insurance company fails, retirees would stand in line with other creditors to pick up any scraps. 

This report focuses on three insurance companies dominant in the industry: Apollo’s Athene, MetLife and Goldman Sachs’ Accordia, which this year was acquired by global investment firm and takeover experts Kohlberg Kravis Roberts (KKR). The three have taken advantage of lax regulations and permissive accounting in offshore locations such as Bermuda and the Cayman Islands, and in five U.S. states that function as domestic secrecy jurisdictions by shielding their books from public view:  Delaware, Vermont, Iowa, South Carolina and Arizona.

The financial mechanisms detailed in this report are drawn from the annual reports filed with the state insurance departments and collateral forms filed with U.S. states under a 2015 policy adopted by the National Association of Insurance Commissioners (NAIC), which sets regulatory standards for the industry. These collateral forms part the curtain on the types of assets held on the books of subsidiaries registered in those states.

A spokesman for Athene denied the company engaged in practices that put clients at risk, and said that it met regulatory requirements in the states where it is based, calling the company one of the “best capitalized insurance companies in the industry.” Apollo did not respond to requests for interviews or comment. Accordia and MetLife declined requests for interviews.

How it works

Traditionally, insurance companies take in premiums and invest in relatively safe, high-grade corporate and government bonds. They create profits by generating higher returns on their investments than the amounts they have to pay out in claims. The NAIC sets overall guidelines on how to run a safe and secure insurance company, including following standard accounting, or what are called Statutory Accounting Principles (see Key Terms).

But the NAIC has no enforcement power, it can only threaten to withhold accreditation. Regulatory authority now resides with states, after the industry lobbied to get a federal law passed denying Washington that authority. Insurance companies increasingly are exploiting this patchwork regulatory regime to burnish their accounts, financial and legal experts say.

How are Insurance Companies Regulated?

(Sources:  NAIC, FIO, FSOC websites)

Regulated at the state level.
The National Association of Insurance Commissioners (NAIC) sets standards for the 50 states and the District of Columbia and provides guidance on best practices. But each state has discretion on how to regulate the companies registered in its jurisdiction.

Monitored at the federal level. The Financial Stability Oversight Council (FSOC), an inter-governmental body of financial regulators, monitors overall financial conditions, identifies risks and responds to emerging threats to financial stability. Established after the 2008 global financial crisis, it is headed by the Treasury Secretary and reports to Congress. The Federal Reserve chairman and one insurance expert are among its 10 voting members. The Federal Insurance Office (FIO), a Treasury agency, monitors the insurance industry and is a non-voting advisory member of FSOC.

There are four key practices all the companies in this report employ

Set up reinsurance companies offshore or in one of the five U.S. states that waive standard U.S. accounting principles. Offshore, limited public financial reporting is required and often taxes are low. Reinsurance allows companies to lower their need for surplus funds by transferring liabilities (future claims) to another company. The parent and affiliate companies agree on terms for sharing the risk and the premiums paid by policyholders. Financial experts estimate nearly $800 billion of the insurance industry’s $7.5 trillion total cash and investments are associated with these “captive” reinsurance affiliates, some offshore, some in industry-friendly states, meaning they are opaque and at best poorly regulated.

Take risk off the books. Records show that Apollo, Accordia and MetLife – the companies examined here – are offloading as much as 80-90 percent of their assets and liabilities, mostly through reinsurance affiliates they own, shifting many billions of dollars into lightly regulated venues. Reinsurance is standard practice in the industry but usually only about 20 percent is sent to independent companies: Such “authorized” reinsurers are regulated and audited the same way insurers are regulated. Not so when they are subsidiaries or affiliates of the parent company located in lax jurisdictions with opaque books. These reinsurers are known as captives and labeled “unauthorized” on financial statements, because they are not subject to the usual requirements on the types of collateral needed to back their financial obligations. In some instances, companies use traditional reinsurance companies for an initial transfer but then further move the deal to affiliated captives, steps that serve to muddy the audit trail.

Overvalue the assets in the affiliated reinsurance companies. Once assets are booked in offshore venues such as Bermuda, insurance captives are not required to file detailed financial reports, making their value hard to track. In the U.S., insurance commissioners in industry-friendly states allow the captives to list as assets certain types of collateral that would be valued at zero under Statutory Accounting Principles. By inflating the value of their assets, the captives can more easily meet reserve requirements set by states, leaving them extra cash to invest elsewhere. For the companies examined here, the assets their affiliates hold that are not recognized under standard accounting reach up to 40 percent of total assets; and one type they all rely upon significantly is Letters of Credit (LOCs) issued by banks, which are contingent loans or promises to pay claims if the affiliate cannot. Other unorthodox practices regarding assets include contingent notes and parental guarantees. 

Invest in riskier financial instruments. Traditionally, insurance companies buy mostly ultra-safe U.S. Treasuries and high-grade corporate bonds. Insurance companies examined here are putting larger shares of their investments into riskier asset-backed securities, which are more vulnerable during a market downturn. They also buy illiquid stocks and bonds issued by their own subsidiaries – essentially investing in themselves or moving cash from one pocket to another. The Federal Insurance Office in its 2021 annual report warned this presents a growing danger in a market downturn because companies may not be able to sell the assets quickly to meet capital ratios. “Due to the more illiquid nature of affiliated holdings, significant growth in affiliated investments has the potential to adversely affect an entity’s capital base.” The practice had reached $213.7 billion by the end of 2020 and had grown by 7 percent a year for the past decade, the office reported.

The level of risk in the insurance business is drawing increased scrutiny at the Federal Reserve, U.S. Treasury, and the Senate Banking Committee. Unite Here, a union group representing pension holders, and the not-for-profit insurance company Northwestern Mutual also have raised concerns to the NAIC about the practices of private-equity owned insurance companies.

 

This story focuses on the first three practices: how insurance companies use affiliates to take risk off their books and overvalue assets by exploiting lax state and offshore regulations.  Thomas Gober, a certified fraud investigator and former Mississippi Insurance Department examiner who has advised the U.S. Department of Justice on insurance fraud, analyzed the relevant documents and regulatory filings for 100Reporters.

 

Asset or Liability?

A key technique used by all three companies that 100Reporters examined is booking LOCs as assets, using affiliates offshore or in compliant states. David “Birny” Birnbaum, a member of Treasury’s Federal Advisory Committee on Insurance and Director of the Center for Economic Justice, said life insurers started setting up captive affiliates and using LOCs after state regulators in 2000 increased the amount of money companies must hold in reserve to meet immediate claims. The companies argued that the reserve requirements were too high and tied up too much idle capital, which could be put to better use. “Life insurers said we don’t think we need them (extra reserves), so we’re going to create captive insurers, not regulated the same as admitted insurers.” They began to buy LOCs, which lax states allow them to book as assets, making it easier to meet reserve requirements.

The problem with LOCs is that they bear all the features of a contingent loan, said Douglas Baker, an insurance analyst for Fitch Ratings. The bank requires collateral, charges a fee, and any credit extended must be repaid with interest – all features common to a loan, and loans are liabilities that have to be repaid. Some states might allow them, but not Fitch when it rates the safety of a company. “When we do capital calculations, we don’t include the LOCs,” Baker said in an interview. “We only use hard assets. When we look at captives, we black out the reserve credit, charge the full amount of liabilities.” 

“They are fake assets,” said Gober, the insurance fraud investigator.

The 100Reporters investigation found that without booking LOCs as assets, some of the insurance company affiliates face solvency issues and would not meet capital requirements. A federal government analyst, who requested anonymity because he was not authorized by his agency to speak, said the practice is very concerning. “The insurance industry is now writing more coverage, assuming more risk with the same or less capital. It’s less prudent. It’s the same as if a bank holds less capital for loans it is making. More risk with less capital could cause a company to fail. Policyholders would not be covered.”

“There’s also a knock-on effect,” the analyst said. “If the bank pays the LOC and the insurance company is broke, the bank is not paid back and faces a loss. LOC contracts link the insurance and banking industries.

“Recall insurance giant AIG selling credit default swaps that linked insurance and banks and required an $85-billion Federal Reserve bailout. Significant losses could reverberate through the financial system.”

Letters of Credit

What are Letters of Credit?

Letters of Credit (LOCs) are loan agreements that companies arrange with banks. The agreements are contingent, and represent the promise of a loan if some event happens.  Insurance companies pay fees to purchase an LOC, typically a percentage of the maximum loan. The fee is like buying an option: you buy the opportunity to get a loan when you ask for it. Companies must also pay interest on the amount borrowed. Under standard accounting practices, LOCs are treated as contingent loans, meaning they are liabilities. However, insurance is regulated at the state level, and in some U.S. states and offshore jurisdictions, regulators allow companies to book the LOCs as assets.

How are LOCs used?

Let’s say a company wants to write more insurance but is stretched thin on capital (assets),or wishes to invest capital. It sets up a reinsurance subsidiary, called a captive, in an industry-friendly state. The parent company takes risk off its books by sending liabilities (what it owes new policyholders) to the subsidiary. The company books a reserve credit for the amount reinsured, which reduces its liabilities and frees up more capital to grow its business. Meanwhile, the captive needs assets/premiums to match its liabilities.  So, the company buys LOCs from a bank, sends them to the captive in lieu of real assets, and tells the regulator it guarantees that all policyholders’ claims will be paid in the event the captive is short of money. The regulator allows the LOCs to be booked as an asset at full potential value, even though any loan would have to be paid back to the bank. The insurance industry is now writing more coverage, assuming more risk with the same or less capital than before. There’s also a knock-on effect: LOC contracts link risk in the insurance industry to the banking system.

Apollo Global Management

Apollo Global Management is one of the world’s largest private equity funds with assets of $455 billion. Founded by Leon Black –  the right-hand man of convicted “junk bond king” Michael Milken – Marc Rowan and Josh Harris, it was one of the first private equity firms to get into the insurance business. Rowan and James Belardi, a veteran of AIG, which collapsed during the global financial crisis, set up Athene Holding (Bermuda) to buy distressed assets from insurers. Apollo first took a small piece of Athene and acquired the rest earlier this year. Today, Athene has a complex interlocking structure of at least 12 affiliated companies. Its financial records show widespread use of reinsurance and letters of credit by directly owned affiliates, or captives, based in lenient locations.

Case in point: Vermont and Bermuda. Athene Annuity and Life Co.’s 2021 financial filings in the U.S. states where it does business show that it transferred $50.6 billion in liabilities to its reinsurance affiliate Athene Annuity Re in tax haven Bermuda, listing it as modified coinsurance, which is another form of reinsurance. It also transferred $1.37 billion to its captive reinsurance subsidiary, Athene Re USA IV (Vermont), taking a reserve credit for removing those liabilities from its books. Both these actions reduce the level of risk-based capital which determines the surplus the parent must hold, on the grounds that Athene has reinsured risk and has assets readily at hand. Financial filings in offshore Bermuda do not show details of holdings, so there is no way to know exactly the value of the assets, if any, and whether they fully match liabilities transferred there. “We love Bermuda,” Athene CEO Belardi told an investors conference call in 2020. “I think we have a fantastic relationship with the regulators.” 

The reinsurance transfers are all marked as “unauthorized” on their U.S. financial statements, because they are internal transfers, made with affiliated subsidiaries owned by Athene in actions not recognized under standard U.S. accounting principles. Since Athene says that some other company is now responsible for the insurance claims, it subtracts them from its liabilities.

Unite Here, a trade union representing 300,000 service industry workers in the U.S. and Canada, in a letter this year to the NAIC criticized these practices, warning that they leave policyholders more vulnerable. By transferring risk to its Iowa affiliate, Athene lowers its required capitalization and frees up capital to invest elsewhere; in doing so it weakens the buffer against potential losses, which may limit its ability to pay on insurance policies should an affiliate default, the union said.   

"It’s a shell game; you're not actually offloading the risk. You're moving it to the other pocket,"

Daniel Schwarcz, University of Minnesota law professor

Daniel Schwarcz, a University of Minnesota law professor who specializes in insurance and has frequently testified before congressional committees, says this is not real reinsurance: it’s shifting money to lenient jurisdictions. “It’s a shell game; you’re not actually offloading the risk. You’re moving it to the other pocket,” Schwarcz said.

The magnitude of reliance on LOCs was hidden in state and offshore records until 2015, when the NAIC instructed companies to file a new form listing what assets are being sent to cover claims in reinsurance transactions with their U.S. affiliates. While short on details, these new collateral reports begin to reveal the scale of reliance on assets not recognized under standard accounting. (They still do not have to file for their offshore affiliates where reinsurance is massive.) For Athene’s Vermont affiliate, reliance on LOCs made the difference between solvency and a capital shortfall in 2018 through 2021, records show.

PriceWaterhouseCoopers (PwC) in its 2020 audit said that Athene Re IV, with explicit permission from the Vermont insurance commissioner, had booked as an asset an LOC worth $133.7 million that year. When the LOCs were deducted, it wiped out Athene Re IV’s surplus for three years and revealed a capital shortfall: the affiliate ran deficits of $102.9 million in 2020, $106.2 million in 2019 and $102.2 million in 2018, PwC wrote.

“If Athene Re IV had not been permitted to include the letters of credit in surplus, its risk-based capital would have been below Mandatory Control Levels,” PwC said in the financial note. In other words, the Vermont affiliate was insolvent using NAIC Statutory Accounting Principles. Normally, unless the company put real assets on its books, it would be ruled insolvent, taken over by regulators and the parent could not book as a credit its reinsurance business in that state, Gober said.  But Vermont regulators gave Athene Re IV a pass. Asked about its findings, PwC spokesman Paul Bergman said PwC declined to discuss the audit.

The practice continued in 2021. Athene Re USA IV booked $117 million of LOCs as assets against reinsurance liabilities that year; without those assets, the Vermont affiliate would face a deficit  and fail to meet its risk-based capital requirements, according to Athene’s latest 10K filing and PwC’s 2021 financial audit.

PWC audit reveals how Vermont affiliate keeps Athene afloat

A reconciliation of Athene Re IV’s surplus between practices prescribed and permitted by the State of Vermont and NAIC SAP is shown below:

The amounts reported for 2019 in the table above have been updated to reflect the amounts reported in the audited financials of Athene Re IV.

If Athene Re IV had not been permitted to include the letter of credit in surplus, its risk-based capital would have been below Mandatory Control Level.

PriceWaterhouseCoopers, financial note to audit

A Treasury Department report had warned as early as 2014 about Athene’s reliance on LOCs in its Vermont affiliate. Lead author Jill Cetina, now Federal Reserve Bank of Dallas vice president for supervisory risk and surveillance, cautioned that captives can “cloud regulatory reporting of an insurer’s financial position and create ‘blind spots’ in the monitoring of threats to financial stability.”

Athene and its Vermont affiliate are not an isolated case, yet states are ignoring the risks of allowing LOCs in shadow insurance transactions with affiliates, Schwarcz said. “State regulators say, ‘We wouldn’t let them take credit if we had any concern.’ That is lipstick on the proverbial pig; it’s still a pig,” he said.

Vermont Deputy Insurance Commissioner Dave Provost told 100Reporters that his state allows LOCs to be used as captives’ assets, because “the liabilities are overly conservative, and the (state) regulators have agreed that they are.” So, Vermont agrees with the company that its risk profile is lower than NAIC’s Statutory Accounting Principles would require and allows companies to use what he called “alternative” assets to support their reserves. He said it works like this: the parent company sends what he called “excess reserves” to a captive subsidiary, and Vermont allows LOCs to be booked as an asset because under their terms, the LOCs would pay out in the “very remote” chance the company’s assets fell to a minimum surplus level.  

Provost is saying in effect that insurance companies are required to hold more assets than they think they need, so they have figured out how to finesse the system using LOCs as assets, even though standard accounting would treat them as a loan that has to be paid back, hence a liability. And Vermont, as an insurance industry-friendly state, has agreed to abandon standard accounting. The advantage for Vermont: 400 people directly employed by the captive insurance system, including managers, attorneys, actuaries and accountants, by Provost’s count. 

“It was not a common practice 15-20 years ago,” said Don Bratcher, an insurance examiner for 30 years, mostly in Arkansas and Delaware. But today, when state insurance commissioners are competing for business, they appear ready to give a favorable look at what some consider dubious practices, Bratcher said. “The states are pretty much given a free hand to regulate the way they want to now,” he said. “The states are the ones that make up the NAIC, and people stay out of your business. The NAIC is not going to butt in unless it’s something very egregious.”

The NAIC declined requests for an interview.

"Industry and regulatory credibility could be questioned if a transaction involving a block of business could meaningfully reduce the total reserve and capital requirements, while the risks associated with that business remain substantively the same"

Andrew Vedder, Northwestern Vice President

Northwestern Mutual, a Milwaukee-based non-profit insurance company owned by its policyholders, complained in a letter to the NAIC in June about its lack of progress in addressing the mounting risks fed by regulatory arbitrage, where companies shift insurance offshore or into lenient states. Offshore reinsurance can result in “lower total reserves and capital, reduced state regulatory oversight and diminished stakeholder transparency from what would be required by the statutory accounting and risk-based capital requirements the NAIC has established to protect policyholders in the United States,” Northwestern Vice President Andrew Vedder wrote.

“Industry and regulatory credibility could be questioned if a transaction involving a block of business could meaningfully reduce the total reserve and capital requirements, while the risks associated with that business remain substantively the same,” he wrote.

Athene and its Vermont captive are not alone. Gober analyzed Athene’s publicly filed financial statements to reconstruct how Athene transferred money via reinsurance around a network of its affiliates – a figure it does not aggregate in its public filings. He calculated that Athene Annuity Re Ltd of Bermuda ended up with $87 billion on its books in 2020. The next year, a massive $115.7 billion was involved in circular transactions among its offshore captives and U.S. affiliates, he said.

Apollo reinsures most of its new liabilities with Bermuda affiliates, thereby freeing up “excess capital” though it retains the same amount of overall risk. The trade union group Unite Here raised concerns in its June letter to the NAIC about this, saying that “these inter-company reinsurance transactions do not actually transfer risk. But they allow Athene to lower its overall level of capital and reserves without corresponding declines in its state-regulated affiliates’ reported risk-based capital (RBC) ratios.”

Indeed, Athene reported razor-thin surpluses of $1.3 billion in 2020 and 2021. If only a fraction of the $115.7 billion reinsurance transferred to those affiliate companies in 2021 was backed by LOCs, and the LOCs were evaluated based on NAIC statutory accounting principles and disallowed, Athene would face a funding shortfall. Moreover, because the insurance companies of Athene Holding represent 40 percent of the value of Apollo Global Management, according to its financial statements, it would raise questions about the health of the financial behemoth itself, Gober said.

Layers upon Layers

How money moves via reinsurance offshore and to captives

Source: All data from 12/31/2021 annual statements, reinsurance Schedule S-Parts 1 and 3.
Graphic by Thomas Gober.  

Apollo spokesperson Joanna Rose did not respond to phone and email requests for interviews or comment.

Asked to comment, Athene spokesperson Danielle Collins said, “Policyholder protection is our top priority, and we do not engage in any practices that endanger our policyholders’ benefits. Insurance is regulated at the individual state level, and we work proactively with regulators to ensure that we operate our business in a manner that follows the respective state’s regulations. In addition, we transparently disclose our financial information quarterly, including for our Bermuda entity. Athene remains one of the best capitalized insurance companies in the industry.”

In 2018 and 2021 research papers, Fed economists cited Athene’s and MetLife’s complex structures, reinsurance practices and increasingly risky investments in collateralized loan obligations as cause for concern. “As we learned from the 2007-09 financial crisis, even such relatively small exposures may create a vulnerability for life insurers,” the most recent paper said.

MetLife

Metropolitan Life Insurance Company is the largest life insurer in the United States. It has 4.3 million life and annuity policies and is responsible for $4.5 trillion in lifetime payouts. The holding company MetLife Inc. has hundreds of legal entities throughout the world, including dozens of U.S. insurance companies.  Like Athene and Accordia, the insurance company sets up captive reinsurance companies in lenient jurisdictions and sends them assets that are not accepted under standard U.S. accounting. Gober examined MetLife Inc.’s most recent 10K annual financial statement filed with the Securities and Exchange Commission and found that questionable assets had an important effect upon MetLife’s balance sheet.

In obtuse language loaded with acronyms, MetLife acknowledged that its Vermont affiliate, MetLife Reinsurance Co of Vermont (MRV), would be insolvent were it not for booking LOCs as assets. Its supplemental filing for Vermont shows $396 million in LOCs booked as assets.

The 10K states that the Vermont commissioner of insurance gave it “explicit permission” to value LOCs as collateral for reinsurance. This resulted “in a higher statutory capital and surplus of $2 billion in 2020 and 2021,” MetLife wrote. But if standard accounting principles were used, MetLife acknowledged the affiliate would face a capital shortfall and regulators would have to step in. “MRV’s RBC (risk-based capital) would have triggered a regulatory event without the use of the state-prescribed practice,” it said in the 10K filing. MetLife added that it has committed to “take necessary action” to maintain the level of capital required under Vermont state law. However, Gober pointed out this is whitewash, since MetLife’s captive already complies with Vermont law, which allowed the dubious practice in the first place.

MetLife affiliate insolvent, but for lenient rules in Vermont

MRV, with the explicit permission of the Commissioner of Insurance of the State of Vermont, has included, as admitted assets, the value of letters of credit serving as collateral for reinsurance credit…[Its balance sheet] would have triggered a regulatory event without the use of the state prescribed practice.

Source: MetLife 10K [7]

While MetLife also conducts reinsurance with affiliates in South Carolina and Bermuda, its 2021 10K filing reported a “regulatory event” only in Vermont.

MetLife had an $11.8 billion surplus in 2021, enough to absorb the loss from its Vermont affiliate. But there may well be more. Gober said that MetLife’s financial statements show it posted a total of more than $40 billion in modified coinsurance, which is another type of reinsurance, and reserve credit from liabilities sent to its U.S. captives and offshore affiliates in 2021. If all of these had LOCs or used other non-standard accounting in the same proportion as Vermont, namely 35 percent, more than $14 billion would be disallowed under statutory accounting principles — enough to wipe out MetLife’s $11.8 billion surplus, he said.

“Transparency is everything. In fact, the NAIC and the 50 states require that any material transactions between insurers and affiliates must clearly disclose their true nature and details. But with secret books, it is impossible to know the true financial health of MetLife,” Gober said. While the new NAIC guidance on disclosing collateral in reinsurance does provide some insight, still hidden is the detail required to assess the true value of these assets in the affiliates, he said.

Regulatory concerns about the health of MetLife’s insurance balance sheet are not new. The U.S. Treasury was sufficiently worried in 2014 about its size and complex financial arrangements that the Treasury Department’s Financial Stability Oversight Council (FSOC) named MetLife a systemically important financial institution (SIFI), meaning that it should be subject to supervision by the Federal Reserve and perhaps to heightened prudential standards, similar to those applicable to large U.S. bank holding companies after the 2008 global financial crisis.

In a 2015 legal filing, FSOC specifically pointed out that MetLife’s practice of reinsuring with captives posed dangers. This was not really reinsurance, rather the company in a circular fashion was using LOCs, collateral financing and notes to reinsure its own reinsurers. FSOC warned that if something went wrong, losses could spiral and spill over into the broader financial system.   

“In the event of material financial distress at MetLife, losses for MetLife’s customers and counterparties through the exposure transmission channel could be exacerbated due to its use of captives. In addition, the potential for off-balance sheet affiliated captive exposures converting to funded exposures could contribute to asset liquidation risk,” FSOC said in the filing.

MetLife successfully sued to stop federal oversight through a SIFI designation. The Trump administration later removed two other large insurers, AIG and Prudential, from federal oversight and changed the rules to review activities rather than entities. So, there is no federal regulation of companies, only the monitoring of insurance activities, even though the companies play an increasingly large and important role in the global financial system.

MetLife declined a request for an interview or comment for this story.

John Patrick Hunt, a financial regulatory expert at the University of California, Davis, who joined a group of law professors supporting the government’s attempt in the MetLife case to bring big insurance companies under federal purview, said MetLife’s reliance on unorthodox practices remains troubling.  

“MetLife seems to be taking on the riskiest pieces of complex products called CLOs (collateralized loan obligations), as well as using Bermuda captive reinsurers to reduce the equity U.S. regulators would otherwise require the companies to hold to cover losses,” he said. “Both would increase the risk that investment losses could make the insurance conglomerate insolvent, that is, unable to honor its commitments.” 

If a company the size of MetLife became distressed and had to sell its holdings quickly, the damage could spread throughout the economy. “If the insurer fails and can’t honor such contracts, that could contribute to the failure of the other party to the contract in a falling-dominoes effect, similar to what we saw in the global financial crisis,” Hunt said. 

Accordia

Accordia initially was owned by Goldman Sachs through its Global Atlantic Financial Group, which it sold to private equity investment fund KKR this year. Like the much larger Athene and MetLife, Accordia uses offshore locations and affiliates in lenient U.S. states to reinsure policies and book LOCs as assets.

Its 2021 annual financial statements show that Accordia removed from its books $6.5 billion in liabilities through reinsurance with U.S. captives, of which $4.46 billion went to its Iowa-based affiliate Cape Verity III. On the asset side of the balance sheet, the Iowa affiliate reported $3.3 billion in primary securities, which usually are stocks and bonds that the NAIC accepts, plus $1.26 billion in other securities. The latter are listed as LOCs and LOC-like assets, which are not recognized under standard accounting. So, one-third of the claimed assets of more than $4 billion are of questionable value, said Thomas Gober,  the insurance investigator.

Repeated requests to the Iowa insurance commissioner for comment went unanswered.

The collateral reports for other Accordia affiliates tell the same story: Cape Verity I (Iowa) has $571 million dollars in LOC-like assets out of $1.4 billion in total assets; of Gotham Re’s total assets of $467 million, some $159 million lie in LOC-like assets. Add together all the LOC-like assets in affiliates that are not permitted under statutory accounting and they total $1.99 billion–more than double Accordia’s total surplus of $952.6 million that year. Rejecting those assets would wipe out Accordia’s surplus, raising serious questions about its financial health, according to extensive analysis by Gober.

Asked to comment about Accordia’s use of captives, the company’s spokesperson Brian Ruby said, “No comment.”

Regulating an Octopus

For financial and insurance regulatory experts, the nub of the problem lies in state regulation. Insurance companies run by global asset management firms that are huge and deeply interconnected with the global financial system and seek to maximize short-term profits are no match for state insurance commissioners with limited tools and expertise. Expecting them to review the books of a captive affiliate and look broadly at risk embedded in the complex, octopus-like structure of a huge financial company that might stretch across all 50 states, Bermuda and the Cayman Islands is unrealistic, experts said.

“Do we really trust the states to be looking out for the integrity of the broader financial system?” said Schwarcz, the insurance regulation scholar. “Will you leave it to New Jersey or Iowa to make decisions that help save our entire financial system, when they don’t have the resources or the incentives to do that?” 

And if something goes wrong, there is an implicit assumption after the bailout of AIG in 2008 that the federal government would rescue the insurance industry once again, which drives further risk-taking by their new owners – the big asset managers and private equity firms on Wall Street, Schwarcz said. “There is more of a likelihood to push the envelope at times, essentially to game the rules to seek out the most profitable strategy in the short term.”

This article was produced with financial support from the Fund for Investigative Journalism and legal guidance from the Reporters Committee for Freedom of the Press.

Story design by Jessica Skorich.

Part 2: Risky Business​

Read Now

The Man Behind the Magnitsky Act

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The Man Behind the Magnitsky Act

At the meeting, Donald Trump Jr. and other Trump confederates, lured by a promise of compromising information on Trump’s rival, instead stumbled upon a quagmire: a fraud that bilked the Russian treasury of $230 million; a trans-Atlantic dispute over offshore accounts and tax evasion, and a U.S.-born investor, William Browder, who once ran the largest foreign investment fund in Russia, and who plays the eminence grise in this drama.

Browder is perhaps best known as an investor in Russia turned an anti-corruption activist, and the driving force behind the Magnitsky Act, the battery of economic sanctions aimed at Russian officials. However, an examination of Browder’s record in Russia and his testimony in court cases reveals contradictions with his statements to the public and Congress, and raises questions about his motives in attacking corruption in the Kremlin.

Browder has insisted that his departure from Russia resulted from his anti-corruption activities. However, Russian authorities revoked his visa in November 2005,  two years after a provincial court convicted Browder of  evading some $40 million in taxes. The Russian federal government next took up the case.  Magnitsky was interrogated in 2006 about the tax evasion and detained over it in 2008.

Nevertheless, by 2012 Browder had convinced key U.S. politicians that Magnitsky was his lawyer, hired to investigate the theft of three of Browder’s companies and jailed by corrupt Russian authorities, who engineered his death in prison. The Magnitsky Act banned visas and business ties for a number of Russians allegedly linked to Magnitsky’s death. The impact of that legislation has spread, with US and European human rights advocates pressing for a global Magnitsky Act against public officials and corporate officers everywhere accused of corruption or rights violations.

That human rights effort, named after a man Russian investigators say was part of a tax evasion scheme, has helped sour US-Russian relations.

Back in the spotlight this summer, Browder used Magnitsky’s death to again rail against shady Russian government officials and their cronies in Congressional testimony and in the press.

It is the theft of the three companies that ties Browder to the controversial Trump, Jr. meeting. In 2007, shell companies that had once been owned by Browder were used to claim a $230 million tax refund based on trumped-up financial loses. Browder has said the companies were stolen from him, and indeed in a murky operation organized by a convicted fraudster, they were re-registered in the names of others.  

About five years later,  Browder went after a company he said had gotten money laundered in the tax refund fraud. He persuaded the Justice Department to bring charges in 2013 in New York against Prevezon, a Russian real estate investment firm, and others. Browder accused Prevezon of receiving $1.9 million from the tax refund fraud. It used the money to buy New York real estate, he said.

Veselnitskaya says the Prevezon suit was a distraction Browder used to cover up his own tax evasion and–she claims–collusion in the tax refund fraud.  She bases her accusation in part on the role of Magnitsky.  She has lobbied against the Magnitsky Act, deriding it as Browder’s way of protecting himself from Russian legal trouble.

Browder declined repeated requests for an interview about the Russian charges, his time as an investor in Russia, and his campaigns for the Magnitsky Act. Browder went so far as to have the author of this article banned from a public talk he gave at the Institute for Advanced Studies in Princeton, New Jersey, in December 2016.

But this summer, in sworn testimony before the US Senate’s Judiciary Committee, Browder made statements that appear to contradict his testimony in the Prevezon case. Statements by Browder in this article come from the printed record of his Senate testimony, and his various public appearances and writings.

A Nested Russian Tale

“While working in Moscow I learned that Russian oligarchs stole from shareholders, which included the fund I advised,” Browder told the Senators during the Washington, DC hearing this summer.

There is, however, a record that suggests Browder knew well more about suspicious transactions involving the companies he controlled. That record questions the prevalent depiction of Browder as an entrepreneur wronged by a rough-and-tumble Russian business community.

A 100Reporters investigation, published in 2014, illustrated how Russian titanium company, Avisma, in which Browder was an investor, used an Isle of Man shell company to “buy” titanium at fake low prices and sell it abroad at higher market prices, cheating both minority share-holders and Russian tax authorities. A lawsuit showed Browder knew that was the business plan.

According to corporate documents, Browder’s holding company, Hermitage Capital Management, was built on corporate registrations authored by the Mossack Fonseca law firm. That firm is the source of more than one million documents made public by the International Consortium of Investigative Journalists in its Panama Papers investigation, involving assets hidden through the use of shell companies and secret offshore accounts. Its disclosures have led to resignations by government officials worldwide, criminal investigations and charges of corruption against bureaucrats and business leaders.

Mossack Fonseca set up two companies in the British Virgin Islands, Berkeley Advisors and Starcliff, to hold shares in Hermitage. The Browder family home in Princeton, New Jersey, is registered by a Mossack Fonseca shell, Pepperdine Holdings Ltd. Browder’s $11-million vacation home in Aspen is also “owned” by a shell registered in an agent’s name. The US taxes offshore earnings. In 1998, Browder traded his US citizenship for one in the UK, which does not.

How Hermitage Got Started

In Browder’s time in Russia, a key figure was accountant Konstantin Ponomarev, who in 1995 founded Firestone Duncan with American lawyer Jamison Firestone as a minority partner. Ponomarev hired Magnitsky, with whom he had studied at the Russian Economics Academy. He named Magnitsky deputy head of the new firm’s audit department and assigned him to Hermitage. According to Ponomarev, the firm – and Magnitsky — set up an offshore structure that Russian investigators would later say was used for tax evasion and illegal share purchases by Hermitage.

In a series of emails to the author, Ponomarev said that Firestone Duncan set up a number of Hermitage shell companies in the Russian republic of Kalmykia. They held stocks in some Russian companies that Browder had purchased for himself and clients. Ponomarev said the structure helped Browder execute tax-evasion and illegal share purchase schemes.   He said the holdings were layered to conceal ownership: The companies were “owned” by Cyprus shells Glendora and Kone, which, in turn, were “owned” by an HSBC Private Bank Guernsey Ltd trust. Ponomarev said the real owner was Browder’s Hermitage Fund. He said the structure allowed money to move through Cyprus to Guernsey with little or no taxes paid along the way. Profits could get cashed out in Guernsey by investors of the Hermitage Fund and HSBC.

Russian authorities contend that Magnitsky was a participant in a tax fraud led by Browder.

Ponomarev said Hermitage wanted to obtain shares of Gazprom, the giant Russian energy conglomerate. Company policy and then Russian law prohibited direct purchases of Gazprom shares by foreigners, including foreign companies and investment funds. Foreigners could buy shares only through ADRs (American Depository Receipts) sold in London, but they could not buy them in such numbers – or at the same prices – as Russians could. Ponomarev said that in 1996, the firm developed for Browder “a strategy of how to buy Gazprom shares in the local market, which was restricted for foreign investors.”

It did the same for the Ziff brothers, then owners of Ziff Davis Media, whose investments Hermitage managed. Ziff Brothers Investments did not return repeated requests for comments.

Tax Breaks and Disabled Employees
A central charge by Russian tax fraud investigators is that Hermitage’s shell companies falsely claimed they employed disabled workers and invested in the local economy. Ponomarev said the two claims would cut a company’s taxes by 40%.

He said, “After we successfully passed our own tax audit, we started to offer this to our clients, including Bill.”

In 2001, Hermitage shell companies Dalnaya Steppe and Saturn Invest declared on tax returns that a majority of their Kalmykian employees were disabled, complying with a law aimed at social rehabilitation of the disabled. But they hadn’t hired anyone, since they were just stock holding companies.

Russian tax authorities investigated the claim that disabled workers were “analysts” for the two companies. A legal judgement found that the employees were working at other locations as physical laborers. It said of the workers: “Bukayev has no education or qualifications. Badykov is a worker. Byatkiyev is a machine engineer. They had nothing to do with Saturn and were only used by the Claimant to get the income tax relief.”

The tax authority demanded overdue taxes plus a fine and interest. Russian court decisions show that Browder failed to pay, then later put the companies into bankruptcy. Back taxes could not be collected.

In a deposition he gave in the Prevezon case in 2015, Browder was asked, “Who came up with the idea that you could use this tax regime?”

“[W]e were advised by Arthur Andersen, Firestone Duncan, Ernst & Young and various other firms that this was a proper way of organizing our affairs,” Browder replied.

An important point, Ponomarev said, was that other companies had lowered taxes this way, but had actually hired disabled workers.

The alleged tax frauds came to $40 million, Russian tax authorities charged. Allegedly illegal purchases of shares in Gazprom through the use of offshore shell companies were reportedly valued at another $30 million, bringing the total figure to $70 million.

In his Prevezon deposition, Browder said that in 2004 he “transferred (Dalnaya Steppe) to be liquidated” by Visao Risk Management Group (VRMG), a Moscow security firm run by Jakir Sha‘ashoua, whom Browder has identified a former agent of the Mossad.

The Raid

On June 2, 2007, Russian tax investigators raided the offices of Hermitage and Firestone Duncan. They seized Hermitage company documents, computers and corporate stamps and seals.

In a statement to US senators, Browder said that interior ministry officials “seized all the corporate documents connected to the investment holding companies of the funds that I advised. I didn’t know the purpose of these raids so I hired the smartest Russian lawyer I knew, a 35-year-old named Sergei Magnitsky. I asked Sergei to investigate the purpose of the raids and try to stop whatever illegal plans these officials had.”

Magnitsky, however, had been Browder’s Firestone Duncan accountant for a decade.

In questioning by Russian investigators in 2006, Magnitsky said he was an auditor on contract with Firestone Duncan. Though Browder continued to say Magnitsky was his lawyer in this summer’s testimony before the Senate Judiciary Committee, two years ago, in his testimony in the US government’s Prevezon case, Browder told a different story.

He was asked if Magnitsky had a law degree in Russia.
“I'm not aware that he did,” Browder said.
Did he know if Magnitsky “went to law school?”
“No,” Browder answered.

Creative Tax Refunds

All this leads to a second Russian investigation involving three Browder shell companies.

Browder told the Senate committee that Magnitsky “went out, investigated, and came back with an astounding conclusion. . . that the purpose of stealing our companies was to try to steal our assets, which they didn’t succeed in doing. However, they did succeed in stealing $230 million in taxes that we paid to the Russian government from the Russian government.”

The companies were re-registered in the names of straw men and used in fake lawsuits that demanded damages for alleged contract violations. Once the damages were paid, the companies filed for tax refunds that came to $230 million. Browder says that the companies’ documents taken when his firm and Firestone Duncan were raided were to enable the re-registration. He said that he received none of the funds.

Moscow lawyer Andrey Pavlov in an interview in New York, told 100Reporters that he assisted in obtaining court orders based on the fake lawsuits claiming liabilities for the Hermitage companies that resulted in the $230 million tax refund fraud.

However, Pavlov contends that Browder knew the purpose of the raids on his company and on Firestone Duncan: authorities were looking for evidence to support Russian charges of tax evasion and illegal purchase of shares of Gazprom by his and the Ziffs’ companies. He disputes Browder’s contention that the tax investigators who did the raid were responsible for the Treasury scam.

Pavlov said the tax refund fraud he participated in was common in Russia at the time: firms agreed to settle claims from fake shell companies about bogus contract violations. The companies would then file amended tax returns to deduct the settlements, recouping money as tax refunds.

Pavlov said he was approached by Viktor Markelov, a convicted felon, who wanted to hire him. Markelov wanted Pavlov to obtain a court order based on an invented liability for the Hermitage companies, which would then lead to a claim for a tax refund. Pavlov said the refund application would require detailed information from the companies’ books for the year, which he said pointed to inside involvement. However, Pavlov said he was never told the identity of the client who would benefit from the refund scheme.

Pavlov was questioned by Russian authorities, and Markelov was convicted and sentenced to five years for the scam. At his trial, Markelov testified that one of the people he worked with to secure the fraudulent tax refund was Sergei Leonidovich. Magnitsky’s full name was Sergei Leonidovich Magnitsky.

“In October [2007] the whole Browder team knew about these claims and didn’t appeal the decision [allowing the take-over of his companies] which had been granted,” Pavlov said. “They did nothing till the money was paid out of the budget [the Russian Treasury].”  This corresponds with Browder’s book, which states that he and Magnitsky found out about the theft of the companies in October 2007. Just the same, Browder didn’t immediately go to court to challenge the re-registration of the companies and the court’s decision.

However, it would appear that Browder knew, or should have known, about the theft months before.  Financial documents for 2007-08 for HSBC Private Bank, which owned about 10 percent of Hermitage, state that as of July 27, 2007 Hermitage had set aside $7 million to cover legal expenses related to getting back Russian companies Hermitage owned. The document said others had taken control of the Hermitage companies to create fraudulent liabilities – and facilitate the fake lawsuit payouts. Deposed in the Prevezon case, Albert Dabbah, chief financial controller for HSBC, confirmed the document’s authenticity.

But Magnitsky’s testimony in October 2008 does not mention any corrupt officials.

In his Senate testimony this summer, Browder said “they put [Magnitsky] in cells with 14 inmates and eight beds and left lights on 24 hours a day to impose sleep deprivation.  They put him in cells with no heat and no window panes in December in Moscow so he nearly froze to death. They put him in cells with no toilet, just a hole on the floor where the sewage would bubble up. They moved him from cell to cell to cell in the middle of the night.”

A report by the Russian Public Oversight Commission for Human Rights Observance, which Browder links to on his website, does not echo all Browder’s charges, but confirms that prison conditions were bad for everyone, not Magnitsky alone.  The group reported that one cell lacked a cold-water tap, and another hot water. On occasion, raw sewage spewed up from the in-ground toilet, covering the floor of Magnitsky’s cell. It took 35 hours for authorities to move Magnitsky and two cellmates. In important ways, Magnitsky did appear to suffer especially from harsh—and ultimately fatal—mistreatment. For six days, for example, Magnitsky had no access to boiled water, which worsened his already fragile health, the commission wrote. Despite documented need for ongoing medical attention, he was transferred to a prison where none was available.

In his written statement, Browder said Magnitsky wrote over 400 complaints detailing instances of mistreatment. “He was able to pass his hand-written complaints to his lawyers, who dutifully filed them with the Russian authorities. Although his complaints were either ignored or rejected, copies of them were retained. As a result, we have the most well-documented case of human rights abuse coming out of Russia in the last 35 years,” Browder wrote. The complaints were never made public.

In prison, Magnitsky turned to a fellow inmate, Oleg Lurie, for help in filing complaints about conditions. Lurie is a well-known Russian journalist who was accused of attempting to blackmail a member of the Duma, and later exonerated. Inmates often sought Lurie out for jailhouse advice. Deposed in the Prevezon case, Lurie described Magnitsky as initially “confident” that his employers were working to get him out.

But in a subsequent meeting, Lurie said, Magnitsky’s demeanor had changed. He was distraught, Lurie recalled, and said his employers were now selling him out and wanted him to sign documents that had nothing to do with his charges. On October 13, 2009, Magnitsky filed a complaint accusing police of “possible participation” in the theft of the Hermitage companies.

Magnitsky died on November 16, 2009.  Browder testified in the Senate that “eight riot guards with rubber batons beat him until he died.” He said elsewhere that the assault lasted eight hours. On a website devoted to Magnitsky, Browder posted the hospital death certificate, highlighting the notation, “closed craniocerebral injury?” But the report put a question mark after the finding, which wasn’t explained, and provided no evidence to indicate Magnitsky was beaten to death.

A 2011 analysis by the Physicians for Human Rights International Forensics Program of  documents provided by Browder found no evidence he was beaten to death. However the analysis also described the conditions of Magnitsky’s imprisonment as  “torturous,” and said that his lack of medical treatment was “calculated, deliberate and inhumane.” Conflicting and absent medical records undermined their confidence in the official determination of Magnitsky’s cause of death.

Meanwhile, in 2013, a Russian court, relying on investigations that included the testimony of Konstantin Ponomarev, convicted Browder of tax evasion. Browder was in London.

Though Browder claims Magnitsky was convicted, a Russian legal document shows the case against him was dropped because he had died.

Two weeks ago, Kirill Nogotkov, a Russian bankruptcy receiver on the trail of assets that Browder transferred out of Dalnaya Steppe, won a case in Russia against HSBC bank, the Hermitage trustee. The bank paid $30 million of evaded taxes.

Russian Sanctions Highlight Role of Western Enablers

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Russian Sanctions Highlight Role of Western Enablers

Russia’s President Vladimir Putin signs a law on ratification of a treaty making Crimea part of Russia, during a ceremony in the Kremlin in Moscow in March. SERGEI CHIRIKOV/AFP/Getty Images

As United States and European governments impose sanctions on bankers, businessmen and officials close to Vladimir Putin to pressure him over Crimea, the asset freezes will lead investigators not to the Kremlin alone, but to the western-built offshore system that has helped the Russian leader and his friends loot their country and consolidate their power.

Bank Rossiya, listed prominently on the U.S. Treasury as Putin’s favorite bank, applied to buy Russia’s fourth-largest mobile operator via companies in the offshore British Virgin Islands in October.

Nobody (except the bank) knows who those firms’ secret owners are.

Gennady Timchenko, also now banned, headed Gunvor International B.V., based in Cyprus and reportedly owned by BVI and Liechtenstein companies. After the banning notice, he quickly sold his shares in Gunvor, but the owners of the company’s offshore affiliates remain unknown. Gunvor controls international energy companies.

It is usually impossible to see how offshore corruption works. But there is a case whose details are not public that provides a fly-on-the-wall study of how westerners – lawyers, accountants, bankers and investors—may have used the offshore system to facilitate and benefit from Russian corruption.

It involves a self-described anti-corruption fighter, well-known in Washington for winning passage of the 2012 “Magnitsky Act,” which presaged the current law by blocking visas and freezing assets of named Russians accused of human rights violations and corruption.

The man, William Browder, campaigned for the law after his auditor, Sergei Magnitsky, charged extensive official corruption, including the illegal government takeover of three Browder companies. Magnitsky was arrested and refused medical care. He died in a Russian prison.

Privatization Boom

Browder had gone to Moscow in 1996 to take advantage of the privatization of state companies by Russian President Boris Yeltsin. He founded Hermitage Capital Management, a Moscow investment firm registered in offshore Guernsey in the Channel Islands, and its subsidiary Hermitage Fund, with Republic National Bank of New York as major shareholder. For a time, it was the largest foreign investor in Russian securities. In 1997, Browder traded his American citizenship for a British passport, avoiding U.S. taxes on his investment gains. (The U.K. doesn’t tax offshore profits.)

Speaking at Columbia University in November, Browder said, “I started out as an investor in Russia, and when I was investing, I discovered that a lot of the companies I was investing in were having money stolen – large amounts of money stolen by the management – so I became the first shareholder activist in Russia.”

William Browder at the Cinema for Peace Gala, Berlin International Film Festival, 2012.
William Browder at the Cinema for Peace Gala, Berlin International Film Festival, 2012.

However, documents in a little-known case suggest that Browder did what he decried at Columbia — stole profits. Letters, affidavits and other court documents show that Browder and his fellow investors obtained funds that were diverted via an Isle of Man shell from a Russian enterprise in which they had purchased a controlling interest.

The company, AVISMA (Aviation Special Materials), produced titanium sponge for a product used by Boeing airplanes. With partners Kenneth Dart, American billionaire and Dart cup heir, and Francis Baker, C.E.O. of the Andersen Group, a publicly-traded New York manufacturing and investment firm, Browder bought into AVISMA.

At the time of the American investors’ purchase, a large portion of AVISMA’s profits were being siphoned-off to the controlling stockholders through a “transfer pricing” scheme, documents in a subsequent court case show. A shell company sold raw material to AVISMA at inflated costs and purchased the finished product at below-market prices. The shell company then resold the products on the world market, collecting the difference for the majority stockholders. Browder and the other investors knew about the scheme; their lawyer in an affidavit later said it was what made the AVISMA transaction profitable.

The use of such illicit transfer pricing schemes is growing, “given the growth of the global economy and the ease of conducting cross-border transactions in the new electronic world, often with private bankers and financial service providers developing the structures and attorneys approving them,” said Daniel Reeves, who formerly led investigations of global tax evasion and money laundering for the U.S. Internal Revenue Service.

Browder did not respond to calls or emails. He was sent the documents cited in this story, but did not challenge their authenticity. Dart’s Grand Cayman spokesperson Kathy Jackson also did not respond to calls and emailed questions. In an interview, Baker acknowledged that profit-skimming had been part of the investors’ business plan.

A lawsuit filed in the Isle of Man by the partners, not reported before, provides insights into how Western professionals facilitated Russian corruption and how Western investors claimed the spoils.

Buying In

The story started when Russian oligarch Mikhail Khodorkovsky’s Bank Menatep and its industry group, Rosprom, purchased AVISMA at a knock-down price via one of the “loans for shares” scams in the mid-1990s, in which former Russian President Boris Yeltsin’s government took loans it would never repay. Menatep also bought into an Isle of Man shell company operator, Valmet.

In the late 1990s, Khodorkovsky decided to sell AVISMA. It had a quarter of the world market for titanium sponge– it now claims a third — with $100 million a year in sales and profits of $15 million. But those profits were reduced by transfer-pricing. According to AVISMA records, its cost for ilmenite, the raw material used to make titanium sponge, went from $95 a ton ($10 above market price) in 1996 to $130 a ton ($55 above market) in 1997.

Investors Browder, Dart and Baker obtained Menatep/Rosprom’s 60 percent of AVISMA in 1997. They paid more than $85 million for the shares, with Dart subscribing to the largest part. Browder agreed to buy up to $20 million and Baker $7 million.

AVISMA was about to be absorbed by another Russian company, VSMPO, Verknaya Salda Metallurgical Production Company, with the merged firm dominating the market for titanium. The Moscow office of the Austrian Creditanstalt Investment Bank (CAIB) suggested Browder acquire AVISMA, Baker recalled during a phone call. Browder, he said, sought to trade AVISMA shares for a seat on the board of VSMPO.

A later lawsuit by AVISMA alleged it was “a turnkey proposition,” continuing the skimming that defrauded the nearly 40-percent shareholder minority and evaded Russian taxes on profits.

The American investors were told that, “a significant part of the profits which AVISMA was able to earn on the sale of its product were taken offshore through TMC,” Titanium Metals Co., said Anthony Wollenberg, a former attorney for the American investors. Entitlement to the profits “was central to the entire transaction,” he said in an affidavit. “Without the right to those profits, investment in AVISMA was not an attractive proposition.” Wollenberg declined to comment for this article.

Though there are conflicting indications about whether the American investors planned to continue the mispricing scheme, it is clear that the investors wanted to retain the funds already skimmed.

In a December 1998 letter to CreditAnstalt, the investors’ law firm, Rakisons, noted that, “CAIB agreed that as soon as the Investor Group obtained control of AVISMA, CAIB would terminate the transfer pricing operations.”

But the letter also said that, “CAIB represented that any profits which accrued during the dismantling of the TMC transfer pricing operation would be the property of the Investor Group,” not AVISMA.

TMC Continues Skimming

The sale of AVISMA shares to the investors was signed December 6, 1997 and management transferred December 31st. There ensued an acrimonious dispute with Peter Bond, who ran TMC, over who would get nearly $2.7 million in profits skimmed in the intervening weeks and millions more taken in 1998. The investors believed Bond kept the money.

Browder attempted to negotiate with Bond in a September 24, 1998 phone call that Browder recorded. Bond was indignant, complaining that, “there was a perception that we are some screwed little offshore company used for nothing other than asset stripping.” He insisted, “We played an important part in AVISMA’s business.”

At a meeting weeks later, Baker summarized the investors’ frustration against TMC which, he said, continued siphoning “a huge percentage of the profits.” “And we are sort of relying on the good will of the manager [Bond] there to say, ‘You guys raise your right hand, I will send you a packet of money,’” Baker said.

The investors discussed whether to continue the TMC arrangement. Browder suggested the investors engage Bond “just as long as it takes to get the money out, and we decide very clearly on an arms-length basis whether there is any reason to use him or anyone else.” The money already skimmed, he said, “goes pro rata to the investors.”

In January 1999, Baker wrote AVISMA’s lawyer Robert Rakison at the London office of the Chicago law firm McDermott, Will & Emery, “As Tony [Wollenberg] may have told you, we appear to have run into an immense Russian bank money-laundering scheme in the Isle of Man — clearly a criminal matter. However, not being social reformers, our objective is to get the money due us, clear the AVISMA accounts and proceed to other matters.” AVISMA later alleged that it hired McDermott on the advice of Baker, who didn’t mention that McDermott was on retainer to his own company.

Baker told 100Reporters, “I do believe the money was being skimmed. I don’t know where it was being skimmed to. It didn’t come to me.”

Investors Sue

In February 1999, unable to get Bond to provide an accounting of AVISMA revenues, Browder, Dart, and Baker sued TMC for siphoning off $30 million from the company. The Browder group settled out of court in May for a TMC payment of $8 million, some of which the investors used to buy more shares of VSMPO and install three people on its board.

But VSMPO, which has since absorbed AVISMA, grew concerned that the investors wanted to take over the company. It hired Bruce Marks, a lawyer with offices in Philadelphia and Moscow who specializes in corporate corruption. Marks met with Rakison. To Marks’s astonishment, the lawyer opened his AVISMA case file. “I don’t think he realized what was in the file,” Marks said.

Documents showed that Barclays Bank had opened accounts for Bond shell companies in offshore secrecy jurisdictions — the Isle of Man, Cyprus and Ireland, Marks said. He found that TMC had funneled the skimmed funds to the offshore accounts and from there to Barclays accounts in the United States.

In August 1999, he filed a RICO anti-racketeering suit against Browder, Dart and Baker in New Jersey federal court, citing the Isle of Man documents and demanding $200 million in restitution and triple penalties.

The suit claimed that through the settlement of the case against TMC, the investors had illegally taken AVISMA’s revenues, which TMC had siphoned from the company using offshore companies and accounts at Barclays and the Bank of New York. It also accused the investors of reneging on promises to turn the settlement funds over to AVISMA, and claimed that AVISMA’S lawyer, compromised by conflict of interest, had failed to advise the company that it could pursue claims against the investors. (McDermott did not respond to a request for comment.)

Baker’s Andersen Group denied the allegations in required S.E.C. filings.

However, Baker knew more than he said. He told 100Reporters that about that time he had received a “gigantic block diagram” from an unidentified source. The diagram “showed how monies put in one end of the machine came out totally clean at the other end of the machine,” he said, adding, “It was not a piddling amount.”

“When it got to our shores, there was the old Bank of New York,” he said. “They moved it through about 20 entities. The bank was very complicit with that.”

VSMPO, AVISMA’s parent company, and the investors reached a confidential settlement in February 2000, which included a requirement that the investors sell their VSMPO shares.

Bond declined to comment on the mispricing. “The cast of characters are not on my Christmas card list. It was a long time ago and I am happy to leave it there. Frankly, why would I want to revisit any of this?”

NY Ethics: It Takes a Fed

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NY Ethics: It Takes a Fed
New York Governor Andrew Cuomo announcing new ethics legislation for public officials, June 2011. / OFFICIAL PHOTO

One could be forgiven for thinking that the New York State Legislature was a criminal enterprise. It had its mafioso style assemblyman, Democrat Tony Seminerio, telling a prospective “client” that he would “bury” him unless he paid off.

It had entrepreneurs like Democratic Senator Pedro Espada Jr., who set up a community health operation and, prosecutors say, looted it for millions.

It even had a comical nickel-and-dime guy, Democratic Assemblyman Brian McLaughlin, who sent one of his staffers driving on the New York Thruway with his E-ZPass so that McLaughlin could fake time in Albany and collect per diem payments.

New York State has rules against some of those practices, but rarely were they enforced against legislators who were collecting huge sums of cash from companies that wanted laws passed or state contracts awarded.

Why should they be, when Joseph Bruno, the Republican Senate Majority Leader and No. 3  power in the state, was a master of the trade, convicted of pocketing more than $3 million for peddling influence?

New York law prohibits public officials from accepting payments or having financial ties or other conflicts of interest in connection with their official duties, and bars them from using their positions to extort illegal payments. No gifts over $75 can be accepted, and lawmakers may not tap campaign contributions for personal use. It is a felony for a public servant to defraud the state government.

Legislators must also make annual disclosures to the Legislative Ethics Committee of  any outside income of more than $1,000, including “consultant fees.”

But loopholes have abounded. Therare no disclosure requirements to the legislature’s committee on the source of income to consulting shell companies that some legislators have established.  Nor have these minimal disclosure records been made readily available to the public.

Even so, 17 legislators have departed because of ethical misconduct or criminal charges since 1999, among them some of the state’s most powerful politicians. Most of these cases were brought by federal  – not state – authorities. In New York, the attorney general does not have authority over the state legislature and state agencies have chosen not to get involved.

The state’s disinterest in enforcing the law compared to federal authorities was so apparent that Ken Ridett, the state Senate counsel responsible for financial disclosure, once advised Bruno, “Hand deliver your financial disclosure report so you don’t violate the [federal] mail fraud statute,” recalled David Grandeau, the no-nonsense former executive director of the New York State Lobbying Commission.

New ethics legislation was recently enacted under pressure from Governor Andrew Cuomo, after a parade of legislative crooks filled the headlines. The measure, signed into law last August, sets up a Joint Commission on Public Ethics appointed by the governor and legislative leaders (see sidebar).

In New York state, legislators are paid $79,500 a year and are deemed part-time officials. The designation allows them to hold outside jobs – ones that often prove very lucrative.

The cast of New York’s most egregious recent cases highlights the serial failure of state authorities to enforce ethics laws, prompting federal prosecutors to step in.

New York state's former Senate Majority Leader Joseph Bruno at the Capitol building in Albany in 2008. /REUTERS

At the top is Republican Joseph L. Bruno, once among New York’s most powerful legislators. For more than 30 years, Bruno represented a district that included Saratoga, with its famous racetrack, and bordered Albany. His 14 years as Senate Majority Leader gave him power and influence over the state budget, which, a federal indictment suggests, he turned into a cash cow.

Bruno’s political world began to unravel when a 2005 investigation by Grandeau found that Jared Abbruzzese, an Albany businessman who was seeking control of the New York Racing Authority, was giving Bruno free plane rides. Federal investigators got interested.

A source close to the federal inquiry told 100Reporters, “You would see Abbruzzese was getting stuff from the state. It piques your interest. It’s a short hop, skip and jump to bank records. You see large amounts of money. [Bruno] was getting $20,000 a month [for ten months] from Abbruzzese.”

In exchange, Bruno funneled hundreds of thousands of dollars in state grants to consulting companies run by Abbruzzese. He collected $1.3 million from Wright Investors’ Services for getting trade unions to hire Wright as a pension advisor, and another $632,000 from McGinn, Smith & Co., Inc, a brokerage firm also seeking pension business.  A billing management company, Asentinel, provided him with $360,000 in commissions for meetings he arranged  with state officials.

To handle this cash, Bruno set up a shell company, manned by state employees, that enabled him to evade the Legislative Ethics Committee.

How did Bruno get away with it for so long? Barbara Bartoletti, legislative director for the New York State branch of the League of Women Voters, said some people had suspicions. “He was using his public staff to do his private business,” said Bartoletti. “Right out of his public office. But it was literally discarded as, ‘That’s the way business is done here.'”

Dick Dadey, executive director of the Citizens Union, a nonprofit civic organization, said state ethics rules were of little help.

“The rules were so loosely written that sufficient disclosure was never required of outside business interests,” said Dadey. “Elected officials like Bruno were able to not fully report.”

Bruno’s 2009 conviction for corruption was overturned last year based on a 2010 ruling by the U.S. Supreme Court that altered a part of the law used in his prosecution.  However, federal prosecutors seeking a second indictment on charges of embezzlement and conspiracy are presenting evidence to a grand jury.

On the other side of the aisle, Democratic Assemblyman Brian McLaughlin of Queens took kickbacks and stole from the state through fictitious staff and phony expense accounts. His activities were exposed by an anonymous tip to news agencies in 2004. A federal investigation ensued. Among the revelations in the federal indictment of McLaughlin:

Brian McLaughlin at booking.
  • He claimed non-existent positions on his legislative staff and then collected a portion of the salary;
  • He diverted about $55,500 from campaign committees for personal use, and also set up a shell company to hide payments;
  • Companies in the traffic signal industry paid him hundreds of thousands of dollars in cash and free work, including $80,000 worth of work on a house in Nissequogue, a beautiful beach town on the north shore of Long Island;
  • Another $24,000 went for a country club membership;
  • He pocketed state money earmarked for a Little League team.

Perhaps McLaughlin’s pettiest scam was to get the $139 daily payments legislators received for expenses while in Albany, even when he wasn’t there. To accomplish this, he had someone else drive to Albany using his E-ZPass to record its movements.

Federal prosecutors say that McLaughlin stole about $2 million from the state and also from a division of Local 3 of the International Brotherhood of Electrical Workers where he was business representative, the highest-ranking official, from 1990 to 2006.  He pleaded guilty and is serving ten years in prison.

But before he was locked up, McLaughlin wore a wire for investigators looking into corruption by Democrat Anthony Seminerio, Assemblyman for three decades representing a district in Queens, New York City. Seminerio specialized in taking pay-offs from health care companies doing business with the state – his total take was $1 million, according to the federal indictment.

Federal wiretaps recorded more than 15,000 phone conversations, some of which showed that Seminerio could be heavy-handed.

Former state assemblyman Tony Seminerio. / OFFICIAL PHOTO

In 1999, he approached the founder of a consulting firm working with health care companies and demanded 50% of the gross receipts. When the man refused, Seminerio contacted his clients to pressure them to cancel contracts. The company went out of business.

That year Seminerio also contacted Robert Richards, president of the Jamaica Chamber of Commerce, to say he would “bury” him unless he became a client. When Richards refused, Seminerio said if he didn’t hire him, he would “kill” any bill the chamber wanted and that he would pursue any legislator working with Richards and ruin that relationship. Besides, he wouldn’t be a “gavone” about the fee.  (Gavone is “Sopranos”-style slang for ill-mannered and trashy.) Richards ultimately paid about $17,000 over two years.

In 2008, an F.B.I. undercover agent, posing as a prospective client, told Seminerio he wanted to retain him as a consultant. The job: introduce him to legislators so he could argue for privatizing parts of New York’s probation services. Seminerio arranged a lunch with the chair of the committee that would handle such legislation. He even took the agent onto the Assembly floor and introduced him to the Speaker Pro Tempore as someone “with probation.” The F.B.I. made five $5,000 payments to Marc Consultants.

Seminerio pleaded guilty. Sentenced to six years, he died in prison last year.

Also using a shell company was Nicholas Spano, Republican of Westchester, who served in the Assembly and then the Senate for more than 25 years. He was senior assistant majority leader and chaired the Senate Investigations Committee.

His favorite money-maker was kickbacks from state contracts. Professional Risk Managers, an insurance company with state business, started paying him $1,500 biweekly in 1993 for his efforts to get the company a state insurance contract,, according to the federal indictment. Thanks to his efforts, the Office of General Services gave Professional Risk  the plum designation “broker of record,” entitling it to a two-percent commission on all insurance policies written on New York State properties and facilities that the office managed. Spano’s fee increased to $5,000 a month, and as the contract was extended, to $6,000 a month.  By 2002, he was taking in $100,000 a year in bribes from the company.

This scheme was uncovered when an IRS audit that compared Spano’s tax returns to his senate financial disclosure didn’t add up. Spano pleaded guilty to tax fraud in February and is expected to be sentenced in June to 12 to 18 months in prison.

One issue to be resolved is whether Spano will be allowed to act as a registered lobbyist – he has a firm called Empire Strategic Plannng – after he leaves prison. Nothing in the state law bars that for someone convicted of a felony.

Former New York State Senator Efrain Gonzalez. / OFFICIAL PHOTO

Another popular ploy by dirty legislators is to use nonprofit organizations as a conduit for cash.

Democrat Efrain Gonzalez, a Bronx Senator, favored a nonprofit named Pathways for Youth, Inc., which had received $423,000 from the state and another $4 million from the U.S. Department of Housing and Urban Development.

Pathways made $462,500 in payments to the West Bronx Neighborhood Association, Inc., Inc. , a shell company that paid rent on a luxury apartment Gonzalez kept in the Dominican Republic. West Bronx also paid for a house on the island for his mother-in-law, and membership fees in the DR Coral Vacation Club. There were also payments for logos for his cigar-making company and rent for a home in Monroe, New York, which is not in his district.

Gonzalez pleaded guilty to the federal indictment in 2009 and was sentenced to seven years in prison.

Democratic Senator Pedro Espada Jr. had in 1978, years before his election, set up a network of not-for-profit health care clinics, the Soundview Healthcare Network. State and federal complaints say he looted it of millions of dollars – including $14 million in excessive compensation and unwarranted benefits from 2005-2009.

In this case, the New York State Attorney General, which has authority over charities, initiated the investigation and turned over its findings to the Justice Department, which indicted Espada in 2010.  The state suit was put on hold pending the criminal case.

According to the complaint, Espada rolled up $450,000 in fake personal expenses, including $100,000 for meals and over $1,000 for flowers. Purloined cash allegedly went to pay $5,000 to a ghostwriter for a book and to make a $49,000 down-payment for $125,000 Bentley.

What is perhaps striking about Espada is his boldness. He didn’t even live in the poor district that elected him – and where the Soundview nonprofit was located. Instead, he lived in a mansion in Westchester County.

In September, 2010, Espada lost the Democratic primary. The federal criminal indictment came a few months later, and the trial began in New York City last week. In her opening statement March 14, 2012, Assistant U.S. Attorney Carolyn Pokorny said of Espada and his son, Pedro G. Espada, “They have lied, they have cheated, they have stolen and they have betrayed the public’s trust.”

It’s a comment prosecutors might make about each of the legislators described above.

 

This story is part of a joint project on state integrity with the Center for Public Integrity, Global Integrity and Public Radio International. For more stories in the series, visit www.stateintegrity.org. 

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