A 10-Minute Overview of 30 Years of Fraud at Lloyd's
LLOYD'S AND THE ASBESTOS CATASTROPHE:
For nearly three hundred years, Lloyd's of London insurance policies were backed by wealthy British investors, who came to be known as "Names" because, in the early days, their signatures were written on the face of each Lloyd's policy. The Names participated in one-year venture syndicates, to insure risks, chiefly in maritime insurance. Each Name pledged his entire personal wealth to back up his share in the syndicate's policies. The syndicates accepted business for one year, then allowed two more years for claims to come in and be settled. Each syndicate closed its "year of account" and wound up its affairs after the end of the third year. The Names received their share of the profits, or paid their share of the losses, and their liability ended. If, however, all claims could not be settled by the end of the third year, the syndicate had to remain "open" and the profits or losses could not be shared among the Names until all claims were finally settled. This system was efficient and profitable in maritime business; the outcome of any given voyage was almost always known within the year of account, and settled within three.
As both commerce and insurance grew more complex, and especially as Lloyd's expanded into non-maritime business, syndicates found they could no longer close their affairs after only three years. Staying open longer, however, and thus delaying the distribution of profits, would threaten their financial base: Names might well look elsewhere for more reliable investments with more rapid returns. Lloyd's solution was to have each closing syndicate reinsure its remaining risks with a syndicate from the next year of account. For a premium paid, a still-open syndicate, during its third year, would assume any remaining Incurred But Not yet Reported ("IBNR") liabilities of the closing syndicate from the prior year by issuing it a specialized policy of Re-Insurance To Close ("RITC"). Lloyd's syndicates could thus continue distributing profits after three years, instead of having to radically alter their long-established and familiar business procedure.
When this RITC developed, there were only a few thousand members of Lloyd's, of whom perhaps a thousand, known as "working Names", actually conducted the business of Lloyd's insurance market. The rest ("external" Names) relied on their syndicate managing agents to protect their interests, by carefully evaluating each risk accepted, and by calculating the RITC in such a way that neither excessive profit nor loss was realized by the Names on the old syndicate or the new syndicate. It was extremely important that RITC be calculated fairly, because the individual Names who made up those syndicates were not necessarily the same people.
In order to carve out a share of the U.S. insurance market while a "buy-American" attitude prevailed in the 1930's, 1940's and 1950's, syndicates at Lloyd's issued many broadly worded policies, without monetary limits, insuring and reinsuring risks in the United States. The loose language of these policies gave Lloyd's a temporary competitive advantage over many U.S, carriers; however, these overly generous policies eventually came back to haunt them. By the 1960's and 1970's it was clear to a handful of the highly placed working Names that claims due to asbestosis, pollution and other health hazards (so-called "APH" losses) were ripening into lawsuits in which unanticipatedly large damages were being awarded by American courts. American companies turned to their insurers, and their insurers turned to their reinsurers, who in very many cases were syndicates at Lloyd's.
An avalanche of claims was thus working its way through the courts and down the chain of reinsurance obligations, toward the Lloyd's syndicates that held the RITC policies issued to the syndicates who, in prior years, had written the original, broadly worded policies. The avalanche was moreover apparently going to continue well past the year 2000. Since the original policies were written without monetary limits, the Names backing the syndicates that had assumed liability for these policies through the annual RITC process were facing financial ruin, and Lloyd's ability to "pay all claims" was in jeopardy. The Names would soon be personally liable for coming claims far in excess of their original investments in Lloyd's syndicates, and apparently in excess of their combined wealth besides. If word got out about the magnitude of the undisclosed liabilities latent within numerous syndicates at Lloyd's, incoming investment would cease, and Lloyd's would go the way of the "do-do" bird.
In the early 1970's the ruling Committee of Lloyd's lowered the minimum net worth requirement for Names to $150,000 in assets, and opened membership at Lloyd's to the British upper-middle class, and foreigners, especially American, Canadian, Australian, and South African citizens, in which countries Lloyd's had an excellent reputation. Lloyd's began recruiting large numbers of new Names, and in 1973 even allowed women to join. Lloyd's also placed a new layer of bureaucracy, known as "members' agents", between the external Names and the syndicate managing agents. By their Agreement with Lloyd's, the external Names were strictly passive investors who delegated all authority to conduct insurance business to their member's and managing agents, who placed the Names on syndicates and otherwise handled all their business at Lloyd's.
The formerly close and trusting relationship between Names and their managing agents disappeared. Many of the aristocrats who had been Names on the threatened syndicates before 1970 also quietly "disappeared" as soon as RITC had been contracted for them, either resigning from Lloyd's altogether or moving to "safe" syndicates. None of the new Names were told of the billions in losses sliding inexorably down the chain of reinsurances toward them. The members' agents for the new external Names (and some unwitting old Names) placed them on the endangered syndicates' next year(s) of account by the hundreds. The managing agents passed the old syndicates' massive and undisclosed liabilities to select syndicates populated by "new" Names via inadequate RITC, distributed money that was deemed to be "profits" to the Names on the closing syndicates, and paid themselves handsomely for their handiwork besides.
In August 1980, a formal study group of insiders, called the "Asbestos Working Party," was established at Lloyd's to formulate a strategy to deal with the ever-growing and ever-more-difficult to conceal problem of asbestos claims. In October 1980, the United States Court of Appeals for the Sixth circuit announced its decision in INA v. Forty-Eight Insulations, Inc. holding that every exposure to asbestos fibers was a separate harm, and that every insurer along the way during the entire period of exposure, which might be twenty years or more, had a duty to defend and indemnify.
In response, Lloyd's inner circle continued to conceal their knowledge of the massive impending losses, and intensified the aggressive recruitment of more and more external Names, which was being conducted at their direction by members' and managing agents, in what became known as the "recruit to dilute" campaign. [There were about 6,000 Names in 1970. In 1990, although nearly 31,000 new Names had been recruited, the total number had only risen to about 33,000. Two thirds (over four thousand) of the "old" Names had quietly got out of harm's way.] Syndicates continued to under-reserve and/or inadequately reinsure for incurred but not reported losses, thus hiding the coming losses and maintaining an illusion of profitability.
In 1982, Lloyd's persuaded Parliament to pass a Private Act, the Lloyd's Act of 1982, granting Lloyd's immunity from most lawsuits (much like government agencies have). The Lloyd's Act of 1982 also gave the Council of Lloyd's the power to unilaterally and even retroactively change Lloyd's by-laws, which formerly could only be done by majority vote of the Names at a General Meeting. The extent and implications of Lloyd's (effectively complete) legal immunity, and the Council's by-law-changing powers were kept secret from the Names for another nine years, until 1991 (the year that losses for the 1988 year of account first became public knowledge). In late 1986, for the upcoming 1987 year of account, Lloyd's required all Names to sign a new General Undertaking, that included "choice of forum" and "choice of law" clauses in which the Names unwittingly agreed that any legal disputes with Lloyd's would be brought in English courts under English law. Lloyd's explained the new Undertaking as a procedural technicality, and did not tell the Names that Lloyd's was by fiat of Parliament effectively immune from suit in England.
In 1986, Lloyd's also required that all Names sign a new Members Agency Agreement. In stark contrast to the minimal disclosures Lloyd's made concerning the General Undertaking, extensive, detailed explanations of the implications of the new agency agreement were given to Names prior to the deadline to sign it.
Lloyd's premium capacity increased dramatically as a result of the exponential growth in the number of Names, but Lloyd's brokers and managing agents were not generating that much new business. To keep all the Names' capital "in play", and thus keep the 30% deposits required for underwriting in place, the syndicate managers cleverly absorbed the excess capacity in a "reinsurance spiral" (properly, "retrocessional spiral"): syndicates reinsured other syndicates, then sought reinsurance on that reinsurance from other syndicates, who then did the same with still others, taking fees and commissions "off the top" each step of the way, in what became known as the "LMX" spiral. (Although "LMX" is an acronym for "London excess of loss market", it has in hindsight been euphemistically referred to as the "London excess of capacity market.)
The limited information in the Names' financial statements made it appear that their investments were doing very well. In actuality, since each Name's risk was spread across multiple syndicates, the "turns" of the spiral tended to re-focus their risk back on themselves. The members' agents and managing agents on the various syndicates had in fact put many of the Names in the position of repeatedly reinsuring themselves. The illusion of Lloyd's as a sound investment could thus be, and was, maintained for several years. Lloyd's syndicates wrote their usual "book" of business, capable of maintaining the appearance of stability as long as all was calm; but when (not "if") major catastrophic losses occurred, those affected syndicates and their Names were doomed. The commissions taken "off the top" by all the brokers in the spiral had eaten away the premium reserves. The reserves that remained were dangerously low - as low as 35% of premium in many instances. That is why "typical" disasters such as hurricanes and oil rig fires resulted in "atypical" and exponential losses in the late 1980's and early 1990's.
The unwitting new Names, who believed they were investing in one of the world's oldest and safest institutions, were left to bear the losses when they hit, and hit they did, with a vengeance. In 1991, Lloyd's announced losses of 500 million pounds ($800 million), at the time, this was the largest single-year loss in its history (by 1995 the cumulative loss had grown to $15 billion even by Lloyd's unaudited accounting figures). Lloyd's paid out premium reserves at first, and then began making cash calls on the Names on the affected syndicates, not only to cover the outstanding claims, but to amass reserves to pay the IBNR claims that would come due against syndicates in the future. It was generally agreed that any Names on a syndicate insuring or reinsuring APH risks was financially ruined the day they were placed on it by their agents. The premium reserves of hundreds of syndicates were exhausted by the end of the traditional three-year accounting cycle. The syndicates could not close, and the Names bore unlimited personal responsibility for all the future (and still unquantifiable) claims. APH claims are expected to continue to flow into Lloyd's until the year 2030 and possibly beyond. Since 1991, thousands of Names have been bankrupted, and more than 30 have committed suicide. Lloyd's has continued to make cash calls, and English courts have continued to issue rulings in Lloyd's favor, making it easier for Lloyd's to collect more and more money from the remaining Names and/or their estates.
II. BASICS OF FRAUD:In legal terms, there are five elements to a fraud:
English Justices, even at the appeals level, have acknowledged on the record that there was ongoing fraud at Lloyd's, but they nonetheless have thus far decided every case and every point of law in Lloyd's favor. The U.K. courts have even gone so far as to rule that Names cannot use fraudulent non-disclosure and/or fraudulent misrepresentation as a defense or counter-claim to offset Lloyd's collection efforts.
III. SITUATION OVERVIEW:
Had Lloyd's been honest about their financial situation in 1970, no reasonable person would have invested in Lloyd's syndicates thereafter, and Lloyd's and its then-Names would have gone bankrupt. It is ultimately that simple.
Ian Hay Davison, appointed by the Bank of England to clean up Lloyd's, acted as the first non-insider chief executive officer of Lloyd's from 1983 to 1985. During his tenure, Davison took prima facie evidence of fraud at Lloyd's to the England's Serious Fraud Office. Then Prime Minister Margaret Thatcher made it British government policy not to prosecute any executives at Lloyd's, and the Serious Fraud Office therefore refused to bring charges against anyone involved. In the late 1980's, the U.S. Securities and Exchange Commission began an investigation into Lloyd's fraudulent recruitment of U.S. investors. Thatcher's successor John Major came to the U.S. in 1992 to meet with George Bush. After their meeting, the active SEC investigation was quietly dropped.
Summary judgments totaling approximately $90 million have recently been issued, as of June 1998, by an English court against approximately 300 American Names who invested in Lloyd's of London just before it experienced a five-year string of losses totaling more than $20 billion. These particular U.S. investors have been targeted by Lloyd's because they refused to sign onto a quasi-settlement scheme Lloyd's put forth in 1996. Lloyd's has sued these Names to pay for insurance-to-close premiums purportedly paid on their behalf to reinsure pre-1993 open syndicates into a new entity called Equitas. The English courts have consistently ruled in Lloyd's favor, even though:
These American investors, known as "Names," have found themselves defendants in an English court because American courts have closed their doors to them. Starting in 1992, seven United States Courts of Appeal have ruled that the investors' claims that they were defrauded by Lloyd's must be heard in English courts under English law. The U.S. Courts ruled that clauses in the investors' Lloyd's subscription documents from 1987 onward required this, notwithstanding that the investors were not told:
In sending the investors to English courts, the American courts assumed and stated that English law would provide adequate remedies if the investors were defrauded. This was assumed; the U.S. courts did not examine the history of cases against Lloyd's in the English courts, which clearly shows this assumption to be false.
Once Lloyd's had the benefit of the American courts' rulings, it unilaterally, without investors' consent, adopted in September 1996 a by-law requiring that all investors be reinsured into a new company, at a premium of some $22 billion, with each investor's share of the premium to be determined by Lloyd's. The Council of Lloyd's unilaterally appointed a so-called agent, that the Names neither knew nor approved, to sign this reinsurance contract on behalf of each U.S. Name. Two of the clauses in this illegally signed reinsurance agreement provide that investors who refuse to pay and are sued by Lloyd's have no right, even assuming Lloyd's fraud, to either: (a) defend on the basis of Lloyd's fraud; or (b) challenge Lloyd's unaudited calculation of the amount Lloyd's claims to be owed.
This unbelievable chain of events was spelled out in English court, in defenses raised by Names in the collection proceedings Lloyd's had filed against them. In a series of rulings in 1997 and 1998, concluding with summary judgments in June of this year, the English court upheld the onerous clauses which deprived Lloyd's investors of their defense of fraud, and denied them even the right to have Lloyd's claims against them independently audited.
In short, the U.S. citizens who were sent to England by American courts not only find no adequate remedy there; they find no remedy at all.
Justice requires granting these defrauded investors an opportunity to present evidence of fraud as a defense against the collection actions of Lloyd's, as guaranteed by the 5th and 14th amendments of the U.S. Constitution. U.S. Names are furthermore entitled to enjoy proper protection under U.S. securities laws, not only for themselves but also for the safety of future U.S. investors. Otherwise, any foreigner or foreign enterprise that fraudulently solicits American investors on American soil, in violation of U.S. securities laws, will also be able to escape with impunity, just as Lloyd's has thus far done. Foreign issuers of securities could deny U.S. investors due process under U.S. law simply by following the same fraudulent procedures as Lloyd's - and then hiding behind the legal precedent the U.S. courts have set in the cases involving Lloyd's.
1. In What Ways Did Lloyd's Defraud 32,000 Of Its Investors, Known As "Names"?
Metaphorically speaking, Lloyd's was like an exclusive country club which for 300 years had denied membership to anyone but the most elite members of the British society. By analogy, this mythical club, like Lloyd's, suddenly and without explanation, significantly lowered its membership requirements, allowing thousands of interested parties to become members. While the new recruits flooded in, the old members quietly resigned. After a few years, the club management announced that a long-term note was coming due on all the land and buildings "owned" by the club and all current members were bound by contract to pay a pro-rata share of the balloon payment. The primary difference between this fictional analogy and the reality facing Lloyd's Names is that instead of a mortgage note coming due, asbestos and pollution clean-up claims totaling more than $20 billion, deriving from broadly-worded policies Lloyd's issued in the 1930's, 40's and 50's, have recently surfaced for Names to pay.
2. How and When Did Lloyd's Recruit New "External" Names?
An unprecedented Names recruitment campaign was initiated in 1971. This recruitment effort began soon after Lloyd's of London received disturbing reports concerning asbestos claim histories and projections from their U.S. attorneys. Lloyd's membership drive was also motivated by a critical analysis of Lloyd's operating practices, known as the Cromer Commission Report, which was issued in 1969 and kept secret until the late 1980's. From 1972 to 1990, approximately 3,400 American citizens were solicited on U.S. soil and through the U.S. mail by unregistered sales agents to invest in unregistered securities contracts issued by syndicates at Lloyd's. To accelerate the influx of new investors, the standards for becoming a Name at Lloyd's were drastically changed in the early 1970's. These changes included a significantly lower minimum net worth requirement of $150,000 and a provision that allowed the British upper middle-class subjects, as well as citizens from other countries to become Names. Women were also allowed to join the ranks of Lloyd's investors beginning in 1973. On a worldwide basis, between 1972 and 1990, 32,000 new Names joined Lloyd's. During the same period, the majority of the 6,000 aristocratic British Names who were investing in Lloyd's as of 1970 quietly resigned. Internally at Lloyd's, the solicitation of new Names was euphemistically referred to as the "recruit to dilute" program.
3. Who Orchestrated Lloyd's Fraud and How Was It Accomplished?
Lloyd's ruling Committee, from the late 1960's onward, saw that the survival of Lloyd's was in jeopardy unless significant numbers of new Names could be unwittingly enticed to pledge their entire net worth to "back" Lloyd's syndicates. The Committee of Lloyd's, comprised of Directors, CEO's and administrative heads of Lloyd's 12 largest syndicate management and brokerage agencies, controlled more than 80% of the insurance underwriting capacity at Lloyd's. The Committee members knew that for many years they could collectively suppress the incurred but not reported asbestos and pollution claims by not reserving for the losses that would eventually result from these claims. However, the time came in the early 1980's when these latent claims needed to be deliberately and fraudulently hidden to buy more time to continue the process of recruiting new Names.
In order to insulate members of the Committee of Lloyd's from liability, and keep the hands of British bureaucrats and regulators "clean", Lloyd's petitioned for passage of a Private Act of Parliament. This Private Act, which became known as the Lloyd's Act of 1982, granted Lloyd's Committee/Council the right to regulate itself, be immune from most lawsuits, and modify by-laws unilaterally and retroactively. Prior to the Lloyd's Act, changes in by-laws could only be made after a vote of the Names at a General Meeting.
In 1981 when lobbying for the passage of the Lloyd's Act, Lloyd's specifically promised Parliament that Lloyd's would improve the quality of communication provided to current and prospective Names within two years of the Act becoming law. This promise was not kept until 1987, a fact noted in a parliamentary inquiry, and for which Lloyd's specifically and publicly apologized to Parliament. IT WAS PRECISELY DURING THE YEARS THIS PROMISE WAS NOT KEPT THAT MOST AMERICANS JOINED LLOYD'S.
To ensure Lloyd's survival, the Committee of Lloyd's (and, after 1982, the Council of Lloyd's), initiated and perpetuated a complex Ponzi pyramid scheme that would protect old investors by paying asbestos and pollution insurance claims with the capital of newly recruited investors. The following list shows some of the ways in which the Committee/Council of Lloyd's went about achieving their objective:
(1971) Names' net worth requirement was lowered to $150,000.
(1971) A new type of agency was established at Lloyd's, known as Members' Agents. Members' Agents became the primary contact with Names, eliminating any direct relationship between Names and syndicate managers and brokers.
(1972) Investors worldwide (not just British subjects) could become Names.
(1972) Names could pledge as little as $150,000 of equity in their homes to back their Lloyd's investments.
(1982) By PRIVATE ACT, the British Parliament gave Lloyd's Committee/Council the right to regulate the Lloyd's enterprise independent of any British government agency and independent of Lloyd's Names.
(1982) By PRIVATE ACT, the British Parliament extended to Lloyd's (the Corporation of Lloyd's, its directors and officers) immunity from most lawsuits.
(1982) For the first time in 300 years, Members Agents, Managing Agents and brokers were permitted to become limited liability companies. Most of these companies subsequently went public, allowing Lloyd's insiders to divest themselves from these enterprises and insulate themselves from litigation prior to the huge, multi-billion dollar losses being publicly announced in the early 1990's.
(1982) Lloyd's syndicates were no longer required to have independent auditors determine syndicate reserve levels.
(1982) The Council of Lloyd's granted itself the authority to modify by-laws unilaterally and retroactively. This gave Lloyd's Ruling Council the power to amend terms of Agreements with Names, whether or not Names agreed with the amendments.
(1986) Lloyd's failed to explain to Names the immunities from lawsuits the Corporation of Lloyd's and its key executives and directors enjoyed under British law.
(1986) Lloyd's fraudulently, and without explanation, included a clause in the Names' General Undertaking Agreement which specified English jurisdiction and law for resolution of disputes between a Name and Lloyd's.
4. Why Didn't All U.S. Names Accept Lloyd's Settlement Offer in September 1996?
Names already financially ruined had no incentive to accept Lloyd's Settlement Offer, commonly referred to as "Reconstruction & Renewal" ("R&R"). Other U.S. Names were unwilling to submit to yet another of Lloyd's one-sided, ambiguous, misleading agreements. All-in-all, non-accepting Names had confidence that the U.S. justice system would hold Lloyd's accountable for its gross violations of the 1933-34 Securities Acts, the Racketeer Influenced Corrupt Organizations (RICO) Act and the 5th and 14th Amendments of the U.S. Constitution.
Of the 3,400 American investors in Lloyd's, approximately 400 did not agree to accept Lloyd's global settlement offer because the offer: