Circuit court upholds brokers' convictions for mail and wire fraud in sale of STOLI policies

Notably, every relevant state's law provides that, after a life insurance policy has been issued, an insured may resell that policy to an investor, who would become the policy's beneficiary and assume payment of the premiums. Thus, with respect to transferability, the difference between non-STOLI and STOLI policies is simply one of timing and certainty. A non-STOLI policy might someday be resold to an investor. A STOLI policy is intended for resale before its issuance. Altqhough life insurers are required by law to permit resale of policies originally obtained for estate-planning purposes, they are not obligated to issue policies intended for resale from the outset.

STOLI policies became a popular investment in the mid-2000s for hedge funds and others eager to bet that the value of a policy's death benefits would exceed the value of the required premium payments. Insurance brokers, such as the defendants, who received commissions from insurers for new policies that they brokered had a financial incentive to place STOLI policies by disguising them to the insurer as non-STOLI policies. By matching a potential insured with a STOLI investor, a broker could generate a commission on a policy that would not have been issued had the insurer known the policy's true purpose.

In 2006, defendant Michael Binday assembled a network of independent brokers to assist his company, Advocate Brokerage Inc., in placing STOLI policies through such deceit. Straw buyers were enticed to participate by promises of six-figure payments once the policies were sold to third-party investors — promises that defendants in some cases honored and in others did not. Binday explained to the field agents that he sought straw buyers who were "between 69 and 85 years' old," and "in good enough health to get preferred health or standard health [premium] rates," but who would not live "too long, to the point where the investors … would be paying the premium too long."

Along with falsifying the straw insured's financial information, the defendants lied in response to the insurers' questions aimed at detecting STOLI policies, including the purpose of the policy, how the premiums would be paid, and whether the applicant had discussed selling the policy. The defendants also lied to the insurers by providing required certifications that, to their knowledge, the policies were not STOLI.

The defendants sought policies that were worth between $3 million and $4 million — large enough to yield a lucrative commission, but small enough to "stay under the radar." Over the course of the scheme, the defendants submitted at least 92 fraudulent applications, resulting in the issuance of 74 policies with a total face value of more than $100 million. The policies generated a total of approximately $11.7 million in commissions, which ranged from 50% to 100% of the first year's premium payments and typically surpassed $100,000 on any given policy.

The indictment alleged that the defendants defrauded insurers by causing them to issue STOLI policies through misrepresentations regarding:

• The applicants' financial information
• The purpose of procuring the policy and the intent to resell the policy
• The fact that the premiums would be financed by third parties
• The existence of other policies or applications for the same applicant.

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Trial and sentencing

At trial, the government proved its case through documentary evidence and testimony from cooperating witnesses and other employees of Advocate Brokerage Inc. The defendants did not dispute that they had submitted applications with misrepresentations in order to generate commissions by inducing the insurers to issue STOLI policies. Instead, they argued that their conduct was not fraudulent because the insurers in fact "happily" issued STOLI policies, while paying lip service to weeding out STOLI policies for public relations reasons.

The defendants also argued that they did not intend to inflict, and that the insurers had not in fact suffered, any harm that is cognizable under the mail and wire fraud statutes. Under those statutes, the deceit must affect "the nature of the bargain itself" such as by creating a "discrepancy between benefits reasonably anticipated because of the misleading representations and the actual benefits which the defendant delivered or intended to deliver."

According to the defendants, there was no discrepancy between the benefits reasonably anticipated by the insurers and what they actually received because there was no meaningful difference between STOLI and non-STOLI policies. Specifically, the defendants said, because non-STOLI policies are freely transferable once they've been issued, insurers have no reasonable expectation that a policy won't be sold to a third-party investor at the time it's issued. Any difference in lapse rates, the defendants maintained, was a "windfall" and not a right bargained for in the insurance contract.

The jury returned a guilty verdict on all charges for all defendants in less than one day.

The Appeal: No mail or wire fraud

The defendants appealed their case to the U.S. Court of Appeals for the Second Circuit. The crux of defendants' argument on appeal is that the government failed to prove that they contemplated harm to the insurers that is cognizable under the mail fraud and wire fraud statutes.

The appellate court explained that the essential elements of both offenses are (1) a scheme to defraud, (2) money or property as the object of the scheme, and (3) use of the mails or wires to further the scheme. There is no requirement that the victims of the scheme in fact suffered harm, but the government must, at a minimum, prove that defendants contemplated some actual harm or injury to their victims.

The requisite harm is shown when defendants' misrepresentations pertained to the quality of services bargained for, the court said.

Defendants argue that the evidence was insufficient to show that they exposed the insurers to an unexpected risk of economic harm, because the evidence did not establish that STOLI policies were in fact any different economically than non-STOLI policies. There was direct testimony from several insurers that they believed the STOLI policies differed economically from the non-STOLI policies, and thus that the defendants misrepresentations deprived the insurers of potentially valuable economic information.

The Second Circuit recognized that the value of insurance transactions inherently depends on the ability of insurance companies to make refined, discretionary judgments on the basis of full information. "Insurance is based on managing probabilities," the court said. The fraud in this case deprived the insurers defrauded of managing the probabilities of loss to the lives they insured.

The brokers' fees received for services that were not performed in the manner agreed upon, the court pointed out. Thus, whether payment of commissions would constitute a standalone harm absent a showing of economic difference between STOLI and non-STOLI policies was of no consequence for this case. Because the jury reasonably found that the defendants deprived the insurers of economically valuable information, the appeals court said, the payment of commissions that were not legitimately earned merely represented an additional economic harm.

The STOLI fraud that Binday organized was a successful criminal enterprise judging by the amount of the restitution. The parties agreed to reduce the amount to $37,433,914.17, which means that the amount they obtained by fraud was probably a great deal more. To use elderly people to act as straw buyers for only six figures when the commissions obtained at the payment of the first premium exceeded the payment by large multiples and made the fraud perpetrators rich was despicable.

Barry Zalma, Esq., CFE, is a California attorney, insurance consultant and expert witness specializing in insurance coverage, claims handling, bad faith and fraud. Contact him at zalma@zalma.com.

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