Blackstone’s Lombard Could Face Legal Issue with $1B-Plus of Unsigned Policies

For nearly a decade, Lombard International sat on a secret. It began to unravel in May 2016 when a wealthy German walked into a Luxembourg bank.

The man wanted a loan. For collateral, he offered a future payout from a Lombard policy that insured the life of his daughter. Looking over the paperwork, his bankers at VP Bank AG saw a potential problem: The daughter hadn’t signed the policy.

The episode set off alarms inside the German operation of Lombard, a global wealth manager and insurer that’s controlled by Blackstone Group Inc. It wasn’t a one-off. There were missing signatures on thousands of other policies, collectively valued at more than $1 billion.

What’s more, managers at Lombard had been aware of these unsigned policies a decade earlier. Although outside lawyers had advised Lombard back then that the policies weren’t valid and that premiums and fees should be returned to clients, Lombard had continued servicing the unsigned policies until the issue re-emerged in 2016.

Lombard’s effort to keep the unsigned policies secret, and the alarms set off by the German customer’s attempted loan, were described by people familiar with the matter and laid out in internal documents, email messages and outside legal opinions reviewed by Bloomberg News.

The problem with unsigned policies should be clear to anyone who has read a murder mystery: The people whose death could trigger payouts may not know that others stand to benefit from their demise. That’s why in the U.S. and other jurisdictions, insurers are required to get consent from the person whose life is insured.

But for Lombard and its clients, these unsigned policies posed another threat. Some clients had taken money out of them while the insured parties were still alive, taking advantage of a now-defunct German law that allowed tax-free distributions from policies after 12 years. If the policies weren’t valid, then withdrawals should have been taxed like any unsheltered investment — and the investors might owe back payments and penalties.

The sale of the unsigned policies, and Lombard’s subsequent attempts to mitigate the problem, “could be deemed tax fraud,” according to an internal 2007 report by a Lombard official advising management to keep the problem quiet.

Lombard, in a written statement, said it had notified policyholders about the issue and addressed it in accordance with all applicable laws and regulations. It said that its leadership team was appointed in 2015 and that it learned about the signature issue in 2016. It also said it couldn’t speak to actions of earlier management.

At least two executives now in senior management roles in compliance and sales have worked at Lombard since before 2007, according to company documents and online profiles. Lombard, through a spokesman, said those individuals were in more junior roles at the time and that “key decision makers within the business prior to 2015 no longer work for Lombard International.”

Blackstone Funds

By the time the wealthy German client walked into VP Bank in mid-2016, the company had a new owner, a group of Blackstone funds whose investments are overseen by top executives including chairman Stephen Schwarzman, according to regulatory filings. Known as tactical opportunities funds, or “tac opps,” they scour the globe for underpriced businesses.

Reviewing the matter anew after the VP Bank incident, Lombard enlisted a new team of attorneys. They determined that the unsigned policies were a problem that could possibly be remedied.

There are no indications that Lombard officials told Blackstone about the signature problem. It’s also unclear what, if anything, Blackstone’s due diligence uncovered before its 2014 Lombard acquisition.

Blackstone referred questions to Lombard.

Lombard said, “The company promptly reached out to affected policyholders to discuss an option available under German law which enables policyholders to preserve the benefits of their policies.” Most policyholders have addressed this issue, and there has been no adverse impact to Lombard or its clients, it said.

The episode illustrates how difficult it can be in the world of finance to figure out who’s responsible if corners are cut. In Lombard’s case, few parties would have had an incentive to air the issue. That includes the wealthy clients reaping tax benefits, the sales reps at Lombard and affiliated European banks making commissions, and even Blackstone’s funds, which took on Lombard’s liabilities.

“What you’ve got here is your basic Russian doll,” says Nell Minow, vice chair of ValueEdge Advisors and a corporate governance expert. “It shows how putting so many layers between owners and managers creates many opportunities for obfuscation.”

Tax Shelter

The affected Lombard policies weren’t marketed merely as death payouts. Instead, they were pitched from 2001 to 2004 as a tax-advantaged investment for the wealthy that allowed clients to extract cash, tax-free, after holding onto the policies for as little as a dozen years.

These products let clients bundle hedge funds and other alternative investments inside a life insurance policy. They’re sometimes known as Private Placement Life Insurance, or PPLI, in the U.S., where Lombard is the largest seller, said Aaron Hodari, who follows the PPLI market at Schechter, a wealth manager.

Wealthy purchasers often name themselves as the insured parties, aiming to leave a tax-sheltered windfall to their heirs. But until the tax rules changed in Germany in 2005, roughly half the policies taken out by Lombard clients — more than 3,000 — were written on the lives of the clients’ children, grandchildren or someone else, internal documents and a person familiar with the matter indicate. That could help a family maximize the lifespan of a policy and shift assets from one generation to another, the person said.

But Lombard had doubts about the validity of policies unsigned by the insured party. So in 2007, after some sales reps questioned the need to remedy the problem, it hired two insurance attorneys from PWC Legal in Frankfurt to assess the legal requirements and issue an opinion.

The PWC lawyers came back with bad news for Lombard: The unsigned policies were invalid under German law, according to their written opinion in 2007.

Lombard had previously come up with a workaround for gaining the signatures, by sending clients a health questionnaire for the insured parties to sign.

Such fixes weren’t adequate, the PWC attorneys warned. “These insurance contracts are null and void,” they wrote. “It is not possible to render the contracts effective by retroactively re-wording the declaration of consent or belatedly obtaining the insured person’s signature.”

Legal Liability

PWC also saw problems in another Lombard effort — to get the purchasers of the policies to sign disclaimers stating that they, and not Lombard, were legally responsible for the missing signatures. Using them could imply “that both the policyholder and Lombard know that the policy does not entitle the policyholder to the tax benefits he is claiming and this could be deemed tax fraud, in which Lombard is complicit,” an internal memo on PWC’s findings warned.

A spokesman for PWC Legal said the firm couldn’t comment on its work for clients.

PWC’s findings put Lombard in a precarious position. Not requiring signatures on these policies had become standard practice among sales representatives who said that asking for them had become “a point of resistance” with prospective clients, the unidentified official wrote. In some cases that was because clients didn’t want to reveal details of their succession plans to their heirs, the official wrote.

If these policy documents were amended by adding a signature, that would restart the clock to qualify for the tax benefit, according to the official. The good news for Lombard, the official wrote, was that policyholders and their heirs had little incentive to sue the company, because doing so would draw attention to any tax benefits they received or undeclared assets they invested.

The author concluded: “It might be unwise to alert policyholders.”

Lombard’s executive board was told of the matter. It went along with the memo’s recommendations that the company keep quiet about the unsigned policies and stop writing new policies without the necessary signatures, according to a 2007 email and people familiar with the matter.

New Lawyers

Nine years passed.

After the episode at VP Bank, it became clear inside Lombard how big the problem was. Bundled inside the thousands of policies written over seven years were assets valued at $1.8 billion. That was a significant chunk for Lombard, which now administers $50 billion in client assets.

Executives there assigned a new group to look into the matter, which discovered the 25-page PWC opinion. Lombard sought a fresh one.

The new attorneys, from CMS International, echoed the lawyers at PWC: Insurers are obligated to get signatures from insured parties in advance, they said.

Then they suggested that Lombard might benefit from an untested legal theory. They recommended alerting clients to the oversight and obtaining signatures to confirm the contracts — citing a German civil rule that allows parties to treat voided contracts as binding.

German courts haven’t decided whether that rule can be applied to unsigned life insurance policies. But CMS said the legal arguments suggest that this “seems permissible.”

CMS declined to comment, citing client confidentiality.

In 2016, many of the insurance policies were nearing expiration. Lombard wanted to keep servicing the policies, so they would continue to generate fees. It wrote to policyholders, saying it had examined its policies with outside legal experts.

“A review wouldn’t be a real review if there weren’t also at times something to correct, which earlier may have been absolutely acceptable, but today maybe has to be assessed in a different light,” it wrote.

An attached agreement explained that “doubts” existed over whether the original policies had been completed in a legally valid way. Lombard said its “unproblematic” solution was to request a fresh batch of signatures.

The company didn’t mention CMS’ warning that if clients didn’t sign the new documents, or if the insured parties had already died, then their policies were invalid and beyond legal repair. There was also a risk that heirs who felt shortchanged by the policies might sue.

“It’s an interesting window on the business that they identified risks and stayed quiet,” says Lawrence Cunningham, a professor at George Washington University Law School. “It’s a mess if they were charging premiums for invalid policies.”