Source: http://www.adkissonconsulting.com/category/blog/page/3
Timestamp: 2019-04-23 11:57:53+00:00

Document:
I have been trying to learn about some of the homeopathic and medicinal qualities of some fairly typical garden plants, and flowers, to try to learn more about how to live healthy, and improve my quality of life. I am going to try to learn as much as I can, but I am starting with learning about flowers that are in my garden. So I am reading about Borage uses right now, because that is one of the first things on my list to learn about.
I was never any good at sports back in school. If you have ever seen a TV show where they show’s writers joke around by making a character on the show be the last one to be picked for a team sport, I was that kid in real life. It was pretty upsetting when I was just a little guy, but I soon learned that just because I am no good at sports does not mean I need to actually play them. I love watching them and observing. I ended up buying Madden 16 and a gaming console to play it on. I had never done this before and wondered if I would like it.
1. Merrill Scott is engaged in an ongoing scheme in which it has obtained investments of an unknown amount, but which exceeds $25 million, from clients to whom it provides offshore tax planning and asset protection advice and services. Merrill Scott provides its services in the form of a “Master Financial Plan” it sells to clients and implements on their behalf. The implementation of the plan involves the establishment of offshore entities and the execution of transactions through which its clients invest funds, securities and other assets. Merrill Scott promises its clients that, through the implementation of the Master Financial Plan, the clients will reduce their taxes by significant percentages, have their investments grow offshore in a tax free environment, and will be able to protect their assets from unwanted liabilities and encumbrances. Merrill Scott sells securities to its clients as part of its Master Financial Plan.
2. In fact, since in or about 1998, Merrill Scott has misappropriated investor funds and securities for uses contrary to representations made to investors. Investor funds have been used to pay for Brody’s personal expenses and extravagant lifestyle. Investor funds have been used for the obligations and expenses of Merrill Scott and to invest in start-up companies unaffiliated with Merrill Scott. This misappropriation of investor funds is ongoing. Recently, new funds coming to Merrill Scott from new clients and from the sale of securities have been used to pay Merrill Scott’s obligations to old clients and for obligations of other clients’ plans, rather than in accordance with the plans of the clients who invested the funds. In other words, Merrill Scott is currently operating a Ponzi scheme. In addition, Brody intends to misappropriate approximately $1.4 million of client money deposited in accounts controlled by Merrill Scott to purchase the stock of a start-up company unrelated to Merrill Scott or the plans of the clients.
3. The defendants, directly or indirectly, singly or in concert, have engaged, are continuing to engage, and are about to engage in, transactions, acts, practices, and courses of business that constitute, and would constitute, violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77q(a); Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. §§ 78j(b) and 78o(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, and Sections 206(1) and (2) of the Investment Advisers Act of 1940 (“Advisers Act”), 15 U.S.C. §§ 80b-6 (1) and (2), and they are likely to repeat such violations in the future unless the Court enjoins them from doing so. Accordingly, the Commission seeks relief in the form of a temporary restraining order, injunctions, disgorgement, civil penalties and other appropriate remedies.
4. The Commission brings this action pursuant to the authority conferred upon it by Section 22(a) of the Securities Act, 15 U.S.C. § 77u(a), Section 21(d) of the Exchange Act, 15 U.S.C. § 78u(d), and Sections 209(d) and (e) of the Advisers Act, 15 U.S.C. §§ 80b-9(d) and (e), to restrain and enjoin, temporarily, preliminarily and permanently, MSA, MSAI, Phoenix, Gibraltar, Brody, Ross and Licopantis from future violations of the federal securities laws. The Commission also seeks disgorgement by MSA, MSAI, Phoenix, Gibraltar and Brody of their ill-gotten gains plus prejudgment interest, and such other equitable relief as may be deemed appropriate. In addition, the Commission seeks civil penalties from each of the Defendants pursuant to Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d), Section 21(d) of the Exchange Act, 15 U.S.C. § 78u(d), and Section 209 (e) of the Advisers Act, 15 U.S.C. §80b-9(e). The Commission also seeks specific ancillary relief as detailed in its Prayer for Relief.
5. This Court has jurisdiction over this action, and venue is proper, pursuant to Section 22(a), 15 U.S.C. § 77u(a),of the Securities Act and Sections 21(d) and 27 of the Exchange Act, [15 U.S.C. §§ 78u(d) and 78aa, and Section 214 of the Advisers Act, 15 U.S.C. § 80b-14.
6. The Commission, pursuant to authority conferred upon it by Sections 10(b) and 23(a) of the Exchange Act, 15 U.S.C. §§ 78j(b), and 78w(a), has promulgated Rule 10b-5, 17 C.F.R. § 240.10b-5. Rule 10b-5 was in effect at the time of the transactions and events alleged in this Complaint and remains in effect.
7. The Defendants, directly or indirectly, singly or in concert, made use of the means or instruments of transportation and communication in, and the means or instrumentalities of, interstate commerce, or of the mails, in connection with the transactions, acts, practices and courses of business alleged herein. Certain of the transactions, acts, practices and courses of business alleged herein took place in the District of Utah, including, the offer, purchase and sale of securities, and acts and transactions involved in the misappropriation of investor funds and securities. Therefore, venue properly lies in this district pursuant to Section 22(a) of the Securities Act, 15 U.S.C. § 77v(a); Section 27 of the Exchange Act, 15 U.S.C. § 78aa, and Section 214 of the Advisers Act, 15 U.S.C. § 80b-14.
8. Merrill Scott & Associates, Ltd. is a Bahamian company. It used to maintain an office in Nassau, Bahamas, but it is has allegedly established an office in Hong Kong. Merrill Scott claims to be a leading firm in the business of providing tax reduction and asset protection through the establishment of offshore entities and accounts.
9. Merrill Scott & Associates, Inc., is a Utah corporation, incorporated in 1993. MSAI’s function is to provide the office space and the staff who provide services to Merrill Scott’s organization and its investors, and serves as the office through which investors are solicited. MSAI and MSA also regularly induce clients to purchase securities, including those issued by Gibraltar and Phoenix. MSAI is located in Salt Lake City, Utah.
10. Phoenix Overseas Advisors, Ltd., is a Bahamian entity that acts as an investment adviser and a “mutual fund company” for Merrill Scott investors. Phoenix manages “mutual funds” that have been sold to Merrill Scott investors. It also maintains accounts with brokerage firms into which investor securities are placed.
11. Gibraltar Permanente Assurance, Ltd., is an entity organized under the laws of Dominca, a Caribbean island. Gibraltar ostensibly acts as an issuer of many of the investment products sold to Merrill Scott investors. Gibraltar also controls the funds of Merrill Scott investors that are to be repatriated to those individuals from accounts located in the Bahamas.
12. Patrick M. Brody, age 37, is founder and control person of Merrill Scott. He is the sole signatory on all the accounts maintained by clients of Merrill Scott and its affiliated entities, including Phoenix and Gibraltar. Brody purportedly has exclusive control of Merrill Scott and its affiliated entities. Brody uses a Bahamian entity, Alex Jones & Associates, Ltd. and Alex Jones & Associates, Inc. as an alter ego.
13. David E. Ross II, has been associated with Merrill Scott since approximately 1998. Ross is an attorney licensed to practice in Utah, Kansas and Illinois, with experience in tax and insurance matters. Ross has functioned as General Counsel of MSA, and has been the Managing Director of Estate Planning Institute, a Bahamian law firm, and Gibraltar.
14. Michael Licopantis was associated with Merrill Scott functioning as the General Manager of Phoenix and Gibraltar from in or about 1998 until approximately June 2001. Licopantis had authority over the assets maintained or managed by Phoenix and Gibraltar. Licopantis purportedly has extensive experience managing investments for firms in the U.S.
15. Merrill Scott claims to have been in the business of advising and servicing clients in tax reduction and asset protection through offshore planning since at least 1993. The Merrill Scott organization offers services to clients in the United States that are designed to reduce taxes and protect assets through the creation and use of “offshore” legal entities.
Headquartered in the Bahamas, Merrill Scott & Associates is organized as a parent company, charged with coordinating the actions of its subsidiaries, as well as our affiliated law firm. Merrill Scott & Associates consists of a mergers and acquisitions company, a domestic insurance agency, an offshore insurance carrier, an accounting firm, a mutual fund company, a mortgage company and a headquarters services company.
17. Wealthy individuals solicited by Merrill Scott are told that they can utilize loopholes in the Internal Revenue Code and other laws and regulations to minimize tax obligations and protect assets against litigation or other unwanted encumbrances. Merrill Scott offers a product known as a “Master Financial Plan” (“MFP”). One of the functions of the MFP is to provide a means by which the investor can invest cash and securities offshore, usually in the Bahamas or another Caribbean nation, and receive tax-free gains from the investment activity.
Once money is invested offshore, there are several ways to repatriate part or all of it. These include such non-taxable methods as with secured credit cards, personal or corporate loans, mortgages, personal withdrawals or through insurance policies. Capital can also be repatriated through taxable means such as through salaries or annuities.
19. Merrill Scott advertises its services in publications such as The Robb Report, Celebrity Living, Tycoon, Departures, Boatshowing and The Wall Street Journal. Merrill Scott also retains financial advisers who solicit investors either through personal contacts or by referral from Merrill Scott and are there to sell the MFP. Merrill Scott solicits investors through its publications and through a website it maintains on the Internet. Most of Merrill Scott’s investors appear to have invested since 1998.
20. MSAI advertises the Merrill Scott organization’s services and employs the staff who solicit clients and design the investment plans. Merrill Scott’s other affiliated entities, including Phoenix and Gibraltar, are involved in structuring the individual details of a investor’s plan, issuing and selling the products recommended in the plan, and management of the investor’s assets offshore.
21. Merrill Scott retains professionals to provide “expert” advice on the clients’ financial plans. Those professionals include attorneys, accountants, financial planners, asset managers and persons with banking expertise.
22. The MFP essentially establishes the framework through which the Merrill Scott investor invests and protects cash and assets, avoids payment of taxes and repatriates his or her funds. The basic structure of the plan involves the transfer of an investor’s income and/or assets into offshore entities established on behalf of the investor. These funds and assets are then used to purchase investment and other products offered by MSA and its affiliates.
23. The primary source of revenue to Merrill Scott are the fees associated with the initial development of the MFP and the sale of various investment products, fees for the creation of offshore entities, and transactional and maintenance fees associated with the implementation of the plan.
24. In order to implement its MFP, Merrill Scott investors establish offshore entities in which they place assets and effect transactions. The main types of entities employed by Merrill Scott for its clients include International Business Corporations (IBCs) and Support Organizations (SOs).
25. Merrill Scott sales literature describes IBCs as corporations formed in a tax haven but not authorized to do business within that country. They are intended to be used as an investment or asset protection vehicle. The Merrill Scott investor transfers personal assets or an investment portfolio to the IBC.
26. Merrill Scott describes SOs as charitable organizations established for the benefit of an individual client. Among the stated benefits of an investor establishing an SO over using a domestic charitable organization is that investment funds transferred to the investor’s personal SO can grow tax free. These investment gains are available to the donor/investor through access to the offshore corporations that manage the investments of the SO.
27. Merrill Scott tells clients the offshore entities are not owned or controlled by the clients for tax purposes. Rather, nominee officers or directors act on behalf of the clients to control the entities and effect transactions. In fact, Merrill Scott personnel have authority to effect the transactions, with Brody retaining sole signatory authority over all accounts. Typically, in order to effect a transfer of funds, senior personnel at Gibraltar or Phoenix, such as Ross or Lipocantis, must authorize the transfer, which is then executed by Brody, using his signatory powers.
28. The types of investment products sold by Merrill Scott include Loss of Income Policies (“LOI”), Equity Management Mortgages (“EMM”), Foreign Variable Annuities (“FVA”) and mutual funds managed by Phoenix.
An LOI policy is usually purchased for coverage until the earlier of a specified term, such as 1 year, or the date of death of the insured . . . . The insurance company typically holds the net premium . . . in a separate account, along with the net premiums of other LOI insurance policies. Creditors cannot access policy reserves. The insurance company guarantees a fixed return on such premiums. . . . Most LOI policies provide that your premiums, plus a guaranteed return, will be paid back to the policy holder at the end of a specified period (usually 10 years).
30. The sales manual also states that investment decisions are made by the insurance company. The funds received by Gibraltar for the sale of LOIs are pooled in an account at Barclays Bank maintained by Gibraltar in the Bahamas.
31. In reality, LOIs are not purchased as insurance, but as a vehicle to make offshore and tax-free investments of funds which can be repatriated as desired by the investor. No Merrill Scott investor has ever filed a claim against an LOI for a loss of income. What, in fact, occurs is that the investor purchases the LOI from Gibraltar and then borrows back a percentage of the premium through a note or investment contract, usually in the form of a “mortgage,” called an Equity Management Mortgage or EMM.
32. The EMM is obtained through two affiliated entities of Merrill Scott, Fidelity Funding and Legacy Capital, which act as the mortgagee. The investor’s proceeds from the EMM are then placed in an IBC and invested offshore through Phoenix, or repatriated by the investor. The net effect of the LOI/EMM transaction is that the investor is able to deduct the premium paid for the LOI, encumber his property through a mortgage to himself and deduct the interest payments to himself on the mortgage. The investor can then invest the proceeds from the mortgage offshore through an IBC, with Phoenix managing the investment. The remainder of the premium left with Gibraltar is then invested to provide the investor with a fixed rate of return over the ten-year life of the policy.
33. Contributions by investors to SOs are treated in a similar way. Under Merrill Scott’s interpretation of the tax code, a certain percentage of the income derived from the funds contributed to the SO must be donated to charity, and the remainder may be loaned back to the investor through an EMM. The proceeds from the EMM are then invested in the same way as described in paragraph 32.
You could purchase a Foreign Variable Annuity Contract between you and a Foreign Insurer. During the accumulation period of the Annuity Contract you could set aside money and have it grow on a tax-deferred basis [pending] withdrawal. At retirement, or another time selected by you, the payout period begins whereby the insurance company promises to pay a steady stream of income for a fixed period of time or for life.
35. Another investment opportunity offered to Merrill Scott investors are mutual funds managed by Phoenix. Formerly, Phoenix offered three separate funds to Merrill Scott investors. Of those three, however, the most popular was a fixed-income fund. The fixed income fund still exists but no purchases or sales into or out of the fund are currently taking place. The current value of that fund is purported to be $1.5 million.
An IBC may open a mutual fund account with Phoenix Overseas Advisors. Phoenix provides a margin line of credit at 9.5% interest rate. The IBC may simply borrow against its position in the funds up to 50% of the value of the fund. Access to the funds can be through the secured credit card. Finds can also be wired against the line of credit or proceeds forwarded to a Nevada Corporation. This transaction is not reportable and not taxable.
37. Phoenix acts as an investment adviser, and is retained by the offshore entities established by the Merrill Scott investors to operate as such for their offshore assets. Phoenix receives the securities contributed by the investors to their offshore entities and places them in brokerage accounts controlled by Phoenix, usually with TD Evergreen, a Canadian broker dealer. 38 Phoenix is charged with managing the investor accounts and executing transactions on instructions provided by the Merrill Scott investors. Phoenix’s fee for these services is approximately 1.5% of the funds it manages.
39. The Defendants are engaged in an ongoing fraud, the heart of which is the solicitation of investor funds through misrepresentations of material fact or omissions of material facts.
a. The funds of MSA investors will be held in segregated accounts and will be held in trust on behalf of the investor.
b. That payments made to MSA investors are the proceeds of their own investment funds.
c. That the fees disclosed to MSA investors are the only funds used by the Defendants for their own purposes.
d. That even though the investor has, on paper, surrendered control of his assets to MSA, MSA investors will be able to direct the funds being held on their behalf offshore.
41. The Merrill Scott organization has used newly invested client funds to pay principal and returns promised to earlier investors. Merrill Scott has not been able to honor its investors’ demands for funds for repatriation or other from the assets contributed by investors because those funds no longer exist. As a result, Brody and others have used funds provided by new clients or from the sale of additional investments to existing clients to pay obligations to clients demanding promised returns.
42. The Merrill Scott organization has obtained funds to pay earlier investors by margining brokerage accounts in which clients’ securities had been deposited and by simply liquidating funds maintained in accounts established by Gibraltar in connection with client purchases of LOIs and FVAs.
[Y]ou are proposing somewhat of a Peter/Paul scheme that funds one client from another’s funds. I am not comfortable with that system until we all have a conversation about the ramifications of that type of payment. It is my understanding that up to $1 Million is coming in before the end of the month. It would seem to me that the funding should come from that source, not client payments against notes ultimately due SO Organizations.
44. Internal Merrill Scott emails also make reference to threatened lawsuits against Merrill Scott by its clients because of Merrill Scott’s inability to meet its financial obligations due its clients.
45. Since at least 1999, Brody has misappropriated approximately $9.5 million of client funds for his personal use, utilizing his alter ego, Alex Jones. Ross and Licopantis, who control the funds maintained by Gibraltar and Phoenix, have assisted Brody in the conversion of investor funds for Brody’s personal expenses.
46. Brody uses investor funds to pay for his extravagant lifestyle. Brody has boasted to a Merrill Scott associate that “I own nothing but live like a king.” As evidence of that maxim, Brody writes checks on corporate accounts to “cash” and uses the funds for personal expenses.
47. To pay his personal expenses, Brody has simply taken the funds, after having been authorized by Ross or Licopantis in many cases, from accounts maintained on behalf of clients over which he had signature authority.
48. Brody has used these funds to furnish a home, purchase art and on extravagant travel. Brody has also used client funds to lease expensive cars for Brody and his wife.
49. In response to objections to this conduct from associates at Merrill Scott concerning his appropriation of client funds, Brody stated Merrill Scott was his company, the funds coming to Merrill Scott were his, and that Brody could do whatever he wanted with the funds.
50. Brody has also used investor funds to purchase speculative securities, often to purchase stock in small, start-up companies.
51. Investors have not authorized the purchase of these speculative securities, and, in fact, have sometimes not been denominated as the owner of the securities once they are purchased.
52. Brody recently stated that he planned to use new funds recently obtained by Merrill Scott to purchase stock in a pre-IPO company because he believed the investment would result in significant returns when the company conducts its IPO.
53. Client funds have also been used to cover MSAI’s operating expenses. MSAI has operated at a loss for several years, and Brody and others have used funds in client accounts to cover operating expenses.
54. According to MSAI’s financial statements for the year ended December 31, 1999, MSAI’s income for the year was $2.24 million while its expenses totaled $4.77 million.
55. In order to help fund MSAI’s operational losses, POA loaned MSAI $1.5 million and GPA loaned $125,000.
56. For the years 2000 and 2001, MSAI’s books reflect as paid-in-capital from Alex Jones, funds taken from Gibraltar and Phoenix to cover MSAI’s losses. Brody has caused various persons with authority over client funds, including Ross and Licopantis, to authorize the withdrawal of funds from accounts maintained on behalf of clients and loan the funds to the Merrill Scott organization to cover operating expenses.
57. In recent months, in order for MSA to meet its payroll and other obligations, Brody, Ross and others margined securities maintained on behalf of Merrill Scott clients in accounts with a brokerage firm. The funds obtained from the margin transactions were then used to pay the obligations.
58. In addition, funds deposited in accounts maintained by Gibraltar on behalf of Merrill Scott clients were simply withdrawn from those accounts to meet similar obligations. Under those clients’ MFPs, the funds were to be used for the benefit of the clients pursuant to the plans’ instructions, not to pay Merrill Scott’s obligations.
59. Brody and Ross have told employees that the client funds were merely being borrowed by Merrill Scott to pay expenses and would be repaid to its clients.
60. The Commission realleges and incorporates by reference the allegations contained in Paragraphs 1 through 59 above.
61. From in or about 1998 through the present, the defendants, directly or indirectly, singly or in concert, by use of the means or instruments of transportation or communication in, or the means or instrumentalities of, interstate commerce, or of the mails, in connection with the purchase or sale of securities, knowingly or recklessly, have: (1) employed, and are about to employ, devices, schemes and artifices to defraud; (2) made, and are about to make, untrue statements of material fact, or have omitted, and are about to omit, to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; and (3) engaged, and are about to engage, in acts, transactions, practices and courses of business which have operated as a fraud or deceit upon purchasers of the securities and other persons.
62. By reason of the foregoing, the Defendants, have, directly or indirectly, singly or in concert, violated, and unless temporarily, preliminarily and permanently restrained and enjoined, will again violate Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5.
63. The Commission realleges and incorporates by reference the allegations contained in Paragraphs 1 through 59 above.
64. Defendants, with scienter, in the offer or sale of securities, by the use of means or instruments of transportation or communication in interstate commerce, or by the use of the mails, directly or indirectly employed, and are employing, devices, schemes or artifices to defraud in violation of Section 17(a)(1) of the Securities Act [15 U.S.C. § 77q(a)].
65. By reason of the foregoing, Defendants have, directly or indirectly, singly or in concert, violated, and unless temporarily, preliminarily and permanently restrained and enjoined, will again violate Section 17(a)(1) of the Securities Act and unless restrained and enjoined will continue to do so.
66. The Commission realleges and incorporates by reference the allegations contained in Paragraphs 1 through 59 above.
67. Defendants, in the offer or sale of securities, by the use of means or instruments of transportation or communication in interstate commerce, or by the use of the mails, directly or indirectly (a) obtained and are obtaining money or property by means of untrue statements of material facts or omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (b) engaged and are engaging in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon purchasers of securities in violation of Section 17(a)(2) and (3) of the Securities Act [15 U.S.C. § 77q(a)(2) and (3)].
68. By reason of the foregoing, Defendants have, directly or indirectly, singly or in concert, violated, and unless temporarily, preliminarily and permanently restrained and enjoined, will again violate Section 17(a)(2) and (3) of the Securities Act and unless restrained and enjoined will continue to do so.
69. The Commission realleges and incorporates by reference the allegations contained in Paragraphs 1 through 59 above.
70. MSAI, Phoenix and Brody from at least 1998 engaged, for compensation, in the business of advising others as to the value of certain securities, or as to the adviseability of investing in, purchasing or selling certain securities. Consequently, MSA, MSAI and Brody were investment advisers.
71. As described in paragraphs 1 through 59, MSAI, Phoenix and Brody, directly or indirectly: (1) employed devices, schemes, or artifices to defraud clients or prospective clients; and (2) engaged in transactions, practices or courses of business which operated as a fraud or deceit upon clients or prospective clients.
72. Consequently, MSAI, Phoenix and Brody violated, and unless temporarily, preliminarily and permanently restrained and enjoined, will again violate Sections 206(1) and (2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and (2), and unless restrained and enjoined will continue to do so.
73. The Commission realleges and incorporates by reference the allegations contained in Paragraphs 1 through 59 above.
74. As described above in paragraphs 1 through 59, Ross and Licopantis were aware that investors were told that securities would be purchased for them. Licopantis managed the assets of Phoenix and authorized Brody to transfer client funds, knowing that he would misappropriate the funds or use them in a manner other than represented to investors. Similarly, Ross authorized Brody to transfer investor assets from Phoenix to Brody knowing that Brody would misappropriate those funds or use them in a manner other than represented to investors.
75. Ross and Licopantis aided and abetted conduct by MSAI, Phoenix and Brody which, directly or indirectly: (1) employed devices, schemes, or artifices to defraud clients or prospective clients; and (2) engaged in transactions, practices or courses of business which operated as a fraud or deceit upon clients or prospective clients.
77. The Commission realleges and incorporates by reference the allegations contained in Paragraphs 1 through 59 above.
78. As part of their regular course of business, MSA, MSAI and Brody solicited investors to purchase securities, were involved in negotiations between issuers and investors, and received compensation related to the purchase of securities. Therefore, MSA, MSAI and Brody were acting as brokers.
79. Neither MSA nor MSAI has been registered with the Commission as a broker. Brody has not been associated with a broker or dealer registered with the Commission.
80. The activities of MSA, MSAI and Brody violated the registration provisions of Section 15(a)(1) of the Exchange Act, which requires that all brokers register with the Commission.
Enter an Order temporarily restraining and preliminarily enjoining: (A) MSA, MSAI, Phoenix, Gibraltar, Brody, and Ross, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), and Section 10(b) of the Exchange Act, 15 U.S.C. §§ 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, (B) MSA, MSAI and Brody, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Section 15(a) of the Exchange Act, 15 U.S.C. § 78o(a), and (C) MSAI, Phoenix and Brody, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 206(1) and (2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and (2), and (D) Ross, his agents, servants, employees, attorneys, and all persons in active concert or participation with him who receive actual notice of the injunction by personal service or otherwise, and each of them, from aiding and abetting future violations of Sections 206(1) and (2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and (2).
Grant a Final Judgment permanently enjoining: (A) MSA, MSAI, Phoenix, Gibraltar, Brody, Ross and Licopantis, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a), and Section 10(b) of the Exchange Act, 15 U.S.C. §§ 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, (B) MSA, MSAI and Brody, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Section 15(a) of the Exchange Act, 15 U.S.C. § 78o(a), and (C) MSAI, Phoenix and Brody, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from future violations of Sections 206(1) and (2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and (2), and (D)Ross and Licopantis, their agents, servants, employees, attorneys, and all persons in active concert or participation with them who receive actual notice of the injunction by personal service or otherwise, and each of them, from aiding and abetting future violations of Sections 206(1) and (2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) and (2).
Grant a Final Judgment requiring Defendants MSA, MSAI, Phoenix, Gibraltar, and Brody to disgorge an amount equal to the funds and securities they obtained illegally as a result of the violations alleged herein, plus prejudgment interest on that amount.
Grant a Final Judgment assessing penalties against the Defendants pursuant to Section 20(d) of the Securities Act, 15 U.S.C. § 77t(d), Section 21(d) of the Exchange Act, 15 U.S.C. § 78u(d), and Section 209 (e) of the Advisers Act, 15 U.S.C. §80b-9(e).
Issue an order directing MSA, MSAI, Phoenix, Gibraltar and Brody, jointly and severally, to prepare and present to the Court and the Commission, within thirty (30) days from the entry of said order, a sworn accounting of all of the proceeds collected by the defendants from the activities described in the Commission’s Complaint.
B. transferring, assigning, selling, hypothecating, or otherwise disposing of any assets of as of the date of the Order.
(c) information identifying all business and residence addresses, postal box numbers, telephone numbers and facsimile numbers.
Issue in a form consistent with Rule 65(e) of the Federal Rules of Civil Procedure, orders preliminarily and permanently enjoining the defendants, and their officers, agents, servants, employees and attorneys, and those persons in active concert or participation with any of them, who receive actual notice of the orders by personal service or otherwise, and each of them, from destroying, mutilating, concealing, transferring, altering, or otherwise disposing of, in any manner, any books, records, computer programs, computer files, computer printouts, correspondence, memoranda, brochures, or any other documents of any kind, pertaining in any manner to the business of the defendants, including, without limitation, the sale of securities.
Grant such other and further relief as this Court may determine to be just, equitable and necessary, including, but not limited to, (i) a freeze of assets, (ii) the acceleration of discovery including the forthwith production of books and records, (iii) the appointment of a receiver, (iv) an order requiring repatriation of assets, and (v) an order requiring the execution of consent directives.
Retain jurisdiction over this action in order to implement and carry out the terms of all orders and decrees that may hereby be entered, or to entertain any suitable application or motion by the Commission for additional relief within the jurisdiction of this Court.
Grant such other and further relief as the Court may deem just and equitable.
This page covers the MISUSE and ABUSE of living trusts — it does not knock Living Trusts as a legitimate planning tool. Living Trusts are great things to have, and in most instances it is hard to see how you could be harmed by a Living Trust. The problem is that there are quite a few promoters who hawk Living Trusts as an estate planning cure-all, when they are not.
What is a Living Trust? Well, the term “Living Trust” sounds pretty complicated, but these entities are really quite simple. The are nothing more than a revocable trust; that is, you convey property to a trustee for your benefit during your lifetime, and you retain the ability to cancel, or revoke, the trust at any time and get your property back. You can structure the trust in such a fashion that when you die, the trust changes so that the beneficiaries are your heirs, and the trust property passes to them outside of any probate proceeding.
This is plainly false. Because the trust is for your benefit and you have the right to revoke the trust at any time, Living Trusts are treated for tax purposes as nullities; that is, all the income earned by the trust is attributed to you and you pay taxes on it just as if the trust didn’t exist in the first place. For this reason, you should not seek to get a seperate federal tax ID number for your living trust, as that will just cause you headaches trying to explain why both you and the trust should not pay tax on the same income.
This is equally false, as the trust property is considered part of your estate. You can structure Living Trusts to have some tax savings the same way you structure wills for this purpose, but not on the basis that you didn’t own the property at your death, as with an irrevocable trust.
Wrong, most of the time. The difference is that with a Living Trust you also have to pay to convey assets to the Trust, whereas with a will you simply state to whom you want the assets to go. Moreover, assuming you have enough wealth to qualify for federal estate taxes, when you die it will take about the same effort to file the federal estate tax return as with a will.
This is the most common claim, and it is also false. Your Living Trust will only cover what property you have conveyed into the Living Trust — you will still need a will for all other property, such as what you acquire after you form the Living Trust. No estate practitioner worth his salt would form a Living Trust without a “pour over” will, which is a will that transfers everything that you have when you die which is outside the trust, into the trust.
Yes and no, but mostly no. First, as shown in the immediately preceding paragraph, you will need a pour-over will anyhow, and that will will certainly be subject to challenge. Second, in almost every states, trusts are challengeable for undue influence or lack or capacity on the very same grounds that wills are challengeable, so what’s the difference?
You’ve worked hard for your money, and made every attempt to be a conscientious saver. So it’s only natural that you want some control over what happens to your assets in the event of your death. At the very least, you probably want to minimize or avoid potential hassles and headaches for your loved ones.
Misinformation and misunderstanding about estate taxes and the length or complexity of probate provide the perfect cover for scam artists who have created an industry out of older people’s fears that their estates could be eaten up by costs or that the distribution of their assets could be delayed for years. Some unscrupulous businesses are advertising seminars on living trusts or sending postcards inviting consumers to call for in-home appointments to learn whether a living trust is right for them. In these cases, it’s not uncommon for the salesperson to exaggerate the benefits or the appropriateness of the living trust and claim — falsely — that locally-licensed lawyers will prepare the documents.
Other businesses are advertising living trust “kits”: consumers send money for these do-it-yourself products, but receive nothing in return. Stillother businesses are using estate planning services to gain access to consumers’ financial information and to sell them other financial products, suchas insurance annuities.
What’s a consumer to do? It’s true that for some people, a living trust can be a useful and practical tool. But for others, it can be a waste of money and time. What is a living trust, anyway, and how does it differ from a will? Who should you trust when it comes to estate planning? And how can you tell which tools and strategies will work best for your particular circumstances?
Probate is a legal process that usually involves filing a deceased person’s will with the local probate court, taking an inventory and getting appraisals of the deceased’s property, paying all legal debts, and eventually distributing the remaining assets and property. This process can be costly and time-consuming. Many states have simplified probate for estates below a certain amount, but that amount varies among states. If an estate meets the state’s requirements for “expedited” or “unsupervised” probate, the process is faster and less costly.
A trust is a legal arrangement where one person (the “grantor”) gives control of his property to a trust, which is administered by a “trustee” for the “beneficiary’s” benefit. The grantor, trustee and beneficiary may be the same person. The grantor names a successor trustee in the event of incapacitation or death, as well as successor beneficiaries.
A living trust, created while you’re alive, lets you control the distribution of your estate. You transfer ownership of your property and your assets into the trust. You can serve as the trustee or you can select a person or an institution to be the trustee. If you’re the trustee, you will have to name a successor trustee to distribute the assets at your death.
A will is a legal document that dictates how to distribute your property after your death. If you don’t have a will, you die intestate, and the law of your state determines what happens to your estate and your minor children. The probate court governs this process.
A living trust is different from a living will. A living will expresses your wishes about being kept alive if you’re terminally ill or seriously injured.
If you opt for a living trust, make sure it’s properly funded — that is, that the property has been transferred from your name to the trust. If the transfers aren’t done properly, the trust will be invalid and the state will determine who inherits your property and serves as guardian for your minor children.
Remember the Cooling Off Rule. If you buy a living trust in your home or somewhere other than the seller’s permanent place of business (say, at a hotel seminar), the seller must give you a written statement of your right to cancel the deal within three business days.
The Cooling Off Rule provides that during the sales transaction, the salesperson must give you two copies of a cancellation form (one for you to keep and one to return to the company) and a copy of your contract or receipt. The contract or receipt must be dated, show the name and address of the seller, and explain your right to cancel. You can write a letter and exercise your right to cancel within three days, even if you don’t receive a cancellation form. You do not have to give a reason for canceling. Stopping payment on your check if you do cancel in these circumstances is a good idea. If you pay by credit card and the seller does not credit your account after you cancel, you can dispute the charge with the credit card issuer.
AARP: 1-800-424-3410; www.aarp.org. Ask for a copy of Product Report: Wills & Living Trusts. AARP does not sell or endorse living trust products.
Mr. Chairman, I am Elaine Kolish, Associate Director of the Bureau of Consumer Protection’s Division of Enforcement at the Federal Trade Commission. I am pleased to be here today to testify about scams involving living trusts. It is important to note at the outset that living trusts can be legitimate and valuable estate planning tools. However, scams involving living trusts raise serious and growing concerns. These scams often prey on older Americans’ concerns that their estates will be subject to long and costly probate, and involve misrepresentations about the costs and benefits of trusts versus wills and that local attorneys will create the trust documents.
I want to thank the Committee for holding this hearing and drawing public attention to this issue. To help alert older Americans and others about these scams, we are today issuing a new Consumer Alert. We hope that with the Committee’s assistance and that of our many partners such as AARP, state Attorneys General, and the Council of Better Business Bureaus, we can together raise consumer awareness about living trust scams.
The FTC is the federal government’s primary consumer protection agency. Congress has directed the FTC, under the FTC Act,(2) to take action against “unfair or deceptive acts or practices” in almost all sectors of the economy and to promote vigorous competition in the marketplace. The FTC Act authorizes the Commission to halt unfair or deceptive conduct through administrative proceedings, and to bring civil actions in federal district court for injunctive relief to halt the targeted illegal activity and for redress for victims.(3) Where redress is impracticable, the Commission obtains disgorgement to the U.S. Treasury of defendants’ ill-gotten gains or, in certain situations, uses the money to conduct educational campaigns to prevent further fraud.
Misinformation and misunderstanding about probate and estate taxes provide a ripe environment for scam artists to prey on older consumers’ fears that their estates will be eaten up by costs, and that distribution of their assets to loved ones will be long delayed. Some unscrupulous businesses advertise seminars on living trusts or send postcards inviting consumers to call for in-home appointments, ostensibly to learn whether a living trust is right for them. A common practice is to greatly exaggerate the benefits of living trusts and falsely claim that locally-licensed attorneys will prepare the documents.(7) In some instances, consumers send money for living trust kits but receive nothing. In others, the offer of estate planning services is merely a ruse to gain access to consumers’ financial information and to sell them other financial products, such as insurance annuities.(8) These practices may violate federal securities laws, as well as other laws.
Unlike state authorities, the Commission has had limited experience with prosecuting living trust scams. Historically, the Commission has received few consumer complaints about living trusts. Nonetheless, the Commission sued two companies selling living trusts after AARP brought their practices to our attention.
In 1997, the Commission charged that The Administrative Company (TAC), and its president, Michael McIntyre, and Pre-Paid Legal Services, Inc. (Pre-Paid) together violated the FTC Act by engaging in deceptive practices in selling living trusts. The Commission’s staff worked with a 21-state coalition in developing the cases.
The Commission’s complaint alleged that TAC, McIntyre and Pre-Paid misrepresented that a living trust avoids all probate and administrative costs; the use of a living trust allows assets to be distributed immediately or almost immediately; a living trust cannot be challenged; living trusts are prepared by local attorneys; a living trust protects against catastrophic medical costs; a living trust is the appropriate estate planning device for every consumer; and there are no disadvantages to a living trust. The administrative consent orders obtained by the Commission require the respondents to stop making these misrepresentations and to disclose clearly and conspicuously that living trusts may be challenged on similar grounds as wills; living trusts may not be appropriate in all instances; and all estate planning options should be examined before determining which estate plan best suits a particular individual’s needs and wishes.
Given differences in state laws, the orders also require the respondents to disclose, where true, that: (1) the availability of informal probate under a state’s law allows minimal or no contact with the courts and reduces the time required to probate a will; and (2) creditors have a longer period of time to file a claim against a living trust than against a probated estate. The order against Pre-Paid also required redress to consumers who had not previously received refunds or did not reside in states in which Pre-Paid already had settled with state authorities. Under the FTC order, 480 consumers received a total of more than $78,000.
The Commission’s Consumer Sentinel database does not identify living trusts as one of the most frequently complained about consumer protection problems.(12) Consumer Sentinel is an online complaint database and investigatory tool available to more than 240 law enforcement agencies in the U.S. and Canada. Initially focusing on telemarketing fraud when it was first created in the late 1990s, it has expanded to include complaints about all types of consumer fraud. The Consumer Sentinel database contains more than 250,000 consumer fraud complaints that have been filed directly with the FTC through a toll-free telephone number (1-877-FTC-HELP), an online complaint form, or the mail, or added by Sentinel partners. These include other federal, state and local law enforcement agencies, such as the U.S. Postal Inspection Service, Canada’s Project Phone Busters and private organizations, such as more than 100 BBBs, and the National Consumer League’s National Fraud Information Center and Internet Fraud Watch projects.
Consumer Sentinel shows few complaints about living trusts in both absolute numbers and in relative ranking to complaints on other topics. Thus far this year Consumer Sentinel has recorded 14 complaints on living trusts, ranking it the 144th category out of 200 that are recorded; in 1999, there were 17 living trust complaints, with a ranking of 163. By way of contrast, there are more than 1000 complaints for each of the top 30 complaint topics, involving many credit topics (e.g., credit bureaus, debt collection, credit cards, credit information providers, mortgage lenders, credit repair, advance fee loans), travel scams, Internet auctions, telephone pay-per-call services, autos, computers, Internet access providers, mail order sales, and business opportunities, subjects that are frequent targets of FTC actions.
Although Consumer Sentinel is a powerful tool for finding new or emerging frauds, the Commission also looks to other sources of information that may suggest budding problems. On the topic of living trust scams, for example, AARP and Michigan Attorney General Jennifer Granholm recently reported new data showing a 125% increase over the last decade in the number of people aged 50 and older, with incomes of $25,000 or less, who own living trusts, a growth that far outpaces the living trust ownership growth rate of seniors with moderate and higher incomes.(14) This is a cause for concern because generally consumers of modest means are the least likely to benefit from sophisticated estate planning services. At a press conference, General Granholm also warned that older people living in Michigan were being targeted by unscrupulous sellers of costly, “cookie-cutter” trusts.
The FTC shares AARP and General Granholm’s concern that the increase in living trust ownership among lower-income consumers may indicate a corresponding increase in living trust scams. We hope that this hearing and increased education about the dangers of one-size-fits-all trusts will raise awareness about this problem, preventing additional seniors from falling prey to these scams. To that end, the Commission today is issuing a new Consumer Alert (attached) about how to spot and avoid living trust scams.
The new Consumer Alert warns consumers about living trust scams, and how unscrupulous businesses may use marketing for estate planning services as a ruse to gain entrance to consumers’ homes and their financial data for the purpose of selling them other investments. It also notes that often living trust scam artists claim affiliation or endorsement with legitimate nonprofit organizations such as AARP or claim that they got the consumer’s name from AARP. Such claims are a red flag because AARP does not sell or endorse any living trust product, and does not partner with any company that promotes or sells such documents. AARP also never sells its members’ names or sells its services door to door. The Alert also advises consumers to check with their local BBB for a reliability report before making any major purchases of goods or services.
Consumers who are concerned about probate and other estate issues should consult a reputable local attorney experienced in wills and trusts or a trusted financial advisor. Although a living trust may be useful for some, it is not for everyone. And, unless the trust is properly drafted and the assets properly transferred to the trust, it will not achieve its purpose. Consumers should beware of individuals or companies who portray living trusts as a panacea for all estate planning issues and probate as a necessarily protracted, hugely expensive process.
Credit card issuers generally provide information on the back of credit card statements on how to dispute charges.
The Alert also advises consumers who have purchased a living trust or other financial planning services and who believe that they may be the victim of a scam to file complaints with the FTC in writing, online or by calling the FTC’s new toll-free number, 1-877-FTC-HELP.
The Commission will distribute the Consumer Alert through its extensive network of contacts, including organizations for the aging, legal aid societies, community service organizations, extension home economic services, state and local consumer protection agencies and thousands of media. We also are seeking new partnerships with other organizations that have frequent contact with older Americans. We hope that this outreach effort will prevent additional consumers from being victimized and lead others to report complaints to the FTC or other authorities.
The Commission greatly appreciates the Committee’s effort to investigate the problems associated with abuses in the marketing of living trusts and to assess the potential scope of living trust scams. Putting the spotlight on this problem will help alert consumers to the dangers they may face by buying living trusts or other estate planning products from strangers who play on their fears that their loved ones will not get the benefit of their estates in a timely fashion because of probate costs and delays. Thank you for providing the Commission the opportunity to participate in this hearing.
1. This written statement represent the views of the Federal Trade Commission. My oral presentation and response to questions are my own, and do not necessarily represent the views of the Commission or any individual Commissioner.
2. 15 U.S.C. §§ 41 et seq. The Commission also has responsibilities under more than 40 additional statutes.
3. 15 U.S.C. §§ 45(a) and 53(b).
4. See FTC Press Release, “Cross-Border Lottery-Bond Scheme Alleged to Violate U.S. Laws,” dated Jan. 21, 2000. Consumers complaining to the FTC about telemarketing activity often indicate that they are older citizens. Similarly, older Americans account for 60 percent of the fraud victims who call the National Consumer League’s National Fraud Information Center.
5. See, e.g., FTC Press Release, “Operation Cure.All Nets Shark Cartilage Promoters: Two Companies Charged With Making False and Unsubstantiated Claims for Their Shark Cartilage and Skin Cream as Cancer Treatments,” dated June 29, 2000 (Operation Cure.All is an ongoing federal and state law enforcement and education campaign launched in June 1999 targeting bogus health claims on the Internet); and FTC Press Release, “Marketers of ‘Vitamin O’ Settle FTC Charges of Making False Health Claims,” dated May 1, 2000.
6. In March 2000, the FTC, the Department of Justice and the Department of Housing and Urban Development announced a settlement with Delta Funding Corporation, a national subprime lender, that resolved allegations that Delta engaged in asset-based lending, in violation of the Home Owners Equity Protection Act (HOEPA) (i.e., extending loans based on the borrower’s collateral rather than considering the borrower’s current and expected income obligations, etc.) In July 1999, as part of “Operation Home Inequity,” the Commission obtained settlements with seven subprime mortgage lenders for violating HOEPA, the Truth in Lending Act and the FTC Act. See FTC Press Release, “FTC Testifies on Enforcement and Education Initiatives to Combat Predatory Lending Practices,” May 24, 2000.
7. Other problems include misrepresenting affiliation with or endorsement by a legitimate nonprofit organization such as AARP, and using a “cookie-cutter” approach to trust documents, which should be customized to the individual’s circumstances. See “Scams in the Marketing and Sale of Living Trusts: A New Fraud for the 1990s,” by Lori A. Stiegel, Lee Norrgard and Robin Talbert, Clearinghouse Review, Oct. 1992.
8. In 1998, for example, Florida Attorney General Bob Butterworth and AARP charged Senior Estate Services Inc., a Texas-based firm with offices in Florida, and Remington Estate Services of Florida Inc., an affiliated firm, which purported to sell living trusts, with using the sales presentation to persuade consumers to liquidate their assets and purchase insurance annuities, even if the annuities paid a lower rate of return than consumers already earned. See Florida Attorney General News Release, “Firm Charged With Deceiving Seniors Into Buying Trusts, Annuities,” dated June 10, 1998.
9. At least nineteen states have issued ethics opinions specifically addressing the marketing of living trusts, concluding that the determination about whether a living trust is an appropriate estate planning device should be made by an attorney and that the trust documents should be prepared by an attorney.
10. See “Fraudulent Notarios, Document Preparers, and Other Nonattorney Service Providers: Legal Remedies for a Growing Problem,” by Deanne Loonin, Kathleen Michon, and David Kinnecome, Clearinghouse Review at pp. 329, 335-36 and nn. 61-62, 70-71 (Nov.-Dec. 1997). The sale of self-help kits also may violate some state Unauthorized Practice of Law statutes. Id; see also The Florida Bar Re Advisory Opinion-Nonlawyer Preparations of Living Trusts, 613 So.2d 426 (Fla.1992).
11. See SEC Press Release, “SEC Halts Fraudulent Investment Scheme Targeting Senior Citizens,” dated Sept. 1, 1999. The release also notes that in 1996 a state court had enjoined some of the defendants from offering trust and estate planning services because they were engaged in the unauthorized practice of law. The SEC obtained a temporary restraining order and was seeking a permanent injunction forbidding further violations of the antifraud provisions of the federal securities laws, disgorgement of wrongfully obtained profits and penalties. The four individual defendants also were indicted on October 20, 1999 and as of June 7, 2000, three had been sentenced to terms ranging from 52 months to 20 years. SEC Press Release, “United States v. Gary Davenport, et al.,” dated June 7, 2000.
12. This may be because representations made in the promotion of living trusts often concern probate, a state and local issue, or because issues of validity and interpretation of living trusts are governed by state law. Thus, consumers may not direct complaints to the FTC.
13. In addition, Sentinel features include fraud trend analysis, an index of fraudulent telemarketing sales pitches available from the National Tape Library, a compilation of companies already sued for fraud and a catalog of companies currently under investigation. It also offers a contact list as well as how-to information to help agencies coordinate joint actions.
14. See AARP Press Release, “AARP, Granholm Take Aim at Generic ‘Living Trust’ Products,” dated June 14, 2000.
15. Rule Concerning Cooling-Off Period for Sales Made at Homes or at Certain Other Locations, 16 C.F.R. Part 429. The purchase price must be at least $25 for the rule to apply. See “FTC’s Facts for Consumers on the Cooling Off Rule: When and How to Cancel,” at <www.ftc.gov>.
16. Some state actions against living trust sellers have included charges that they failed to comply with applicable Cooling-Off rules.
17. 15 U.S.C. §§ 1666-1666j. See FTC’s “Facts for Consumers, The Fair Credit Billing Act,” at <www.ftc.gov>.
Living Trusts are good things to have, but you must understand how they should be properly formed, with a pour-over will in place, and then you should understand their limitations. If you are going to have estate tax headaches, the Living Trust is not aspirin.
“I’ll use bearer shares which nobody owns to own my corporation.” — The use of bearer shares by a U.S. citizen to obfuscate corporate ownership, where the corporation is receiving income, making investments, etc., is tax evasion, and anyone who tells you differently is probably lying. We see this varietal A LOT. Unfortunately, the IRS has been wise to this technique for about the last 30 years, and if they catch you using bearer shares (whether you hold them or not) to hide a corporation which is keeping assets or taking in income you will spend some serious Club Fed time.
But, you say, how will the IRS ever find out? There are a bunch of ways the IRS finds out, from spouses who were once trusted but now are mad, to disgruntled secretaries and staff, to folks who are just too dumb than to know better than to use their home or business telephone to call overseas, or to receive offshore bank statements at their home, or who are using someone offshore who is inept or can be bribed, or who fail to realize that all ATM machines use time-dated videocameras to . . . well you get the picture. There are a zillion possible ways for the IRS to find out about your offshore corporation, and they only need one. So just don’t use them, period.
We regularly deal with the very best licensed planners in the U.S., and they will all tell you that the use of bearer shares is a very, very bad idea. If someone suggests the use of bearer shares to you RUN-FAST-!-!-!- for they really don’t have the first clue about what they are doing, and are suggesting an act so amateurish as to belie even a hint of real competence on their part.
Notably, many of the offshore trust companies and offshore company formations company will advocate the use of bearer shares (so much so that even when we form a fully-disclosed offshore corporation and have specified the shareholders, that they will sometimes send us bearer shares simply because they are in the habit of sending bearer shares to their other clients). Keep in mind that these offshore “professionals” have no real knowledge of U.S. tax law, any more than a plumber understands a nuclear reactor because it has a lot of pipes. That they tell you bearer shares will protect you, will not keep you from going to the Big House.
Needless to say, we — and every other knowledgeable and experienced U.S. planner we know — avoids the use of bearer shares.
Bearer shares are corporation stock certificates which are owned simply by the person who holds them, the “Bearer”.
When corporations first came into existence, most shares were bearer shares. If you wanted to protect your interest in the corporation, you had to protect your bearer share certificates. To protect against theft and fraud, corporations starting keeping a register of the owners of the bearer shares which were issued, and notice had to be sent to the secretary of the corporation to record the change in ownership. Eventually, the corporation’s stock ledger determined ownership, and shares only facilitated the transfer of ownership (and, indeed, today few people ever see the stock shares they own). Eventually, most U.S. states even dropped the provisions allowing bearer shares.
But recently they have made a comeback, spurred on by the so-called asset protection sector and those seeking privacy. Nevada, for instance, has built a healthy incorporation industry because Nevada corporation law allows bearer shares.
And the offshore jurisdictions have always allowed bearer shares; indeed, almost all the offshore corporation providers presume that offshore corporations will be issued with bearer shares only (and often send our clients corporations with bearer shares even when we specifically request otherwise).
But does the fact that you can get a corporation with bearer shares both in the U.S. and in the offshore jurisdictions mean that you should use bearer shares? No — except in very specific circumstances you should avoid them like the plague.
For bearer shares suffer from a couple of very serious defects.
Of course, most structures utilizing bearer shares are for tax avoidance/evasion (or as Denver attorney Barry Engel says, “avoision”) purposes, and asset protection only plays a secondary role (if at all). However, sometimes bearer shares are utilized primarily for asset protection purposes.
In either case, this is discouraged. Our real-world experience both in attacking and defending bearer share structures is that judges eventually gravitate towards the position that if they can’t figure out who owns the corporation, they will presume that the defendant owns the corporation — then the bearer shares become counterproductive because the burden is on the defendant to prove that someone else owns the corporation.
The Upshot: You are much better off having some identifiable person own the corporation (even if only in a nominee capacity) than you are to have nobody own the corporation.
The first horrible tax trap for bearer shares is the IRS’s ability to make a jeopardy assessment that the entire value of a bearer instrument is income, if the IRS catches you in possession of the instrument and you have denied ownership.
For instance, let’s assume that you make $10 million on a stock deal, and like a good taxpayer pay your capital gains tax in that year. But then — because you fear divorce — you take your $10 million and you put it into a Bahamas IBC which is owned by bearer shares. The $10 million grow to $20 million in a couple of years. Unfortunately, your wife gets into your safe deposit box, and the IRS finds out about the bearer shares. Under IRC 6867, the IRS simply taxes the entire amount (not just the growth) at 39.6% plus penalties. And you will probably spend the remaining amount for criminal defense attorneys to fight the subsequent charges of tax evasion.
The second horrible tax trap is this: Every time bearer shares are handed over to and from a U.S. person — except for a bona fide sale for value — gift taxes must be paid! And, of course, if there is a sale then capital gains taxes must be paid.
For example, let’s say you have $10 million in the Bahamas IBC as set forth above. You think you are about to get divorced, so you give the shares to your brother to hold for awhile. In the divorce proceedings, you answer “no” when asked if you own any foreign stock interests. After the divorce proceedings are over, your brother gives the shares back to you. Easy enough, eh?
First, when you gave the bearer shares to your brother, you triggered a 55% gift tax, meaning that you now owe $5.5 million to Uncle Sam.
Second, when your brother gave the bearer shares back, he triggered a 55% gift tax (again on the $10 million value), meaning that he now owes $5.5 million to Uncle Sam.
Thus, your simple little transfer to your brother and back triggered a total of $11 million in federal gift tax liability to you and your brother — meaning that you and your brother are now $1 million in the hole! Needless to say, you would have done much better to split the $10 million with your ex-spouse in the divorce proceedings.
And if you don’t report and pay the taxes generated by handing these shares back-and-forth it is big-time tax evasion. So, if you hear someone talk about bearer shares, ask them whether giving the shares to someone triggers federal gift taxes. If they say either “no” or that they don’t know, then they have sufficiently displayed their ignorance in this area such that you should be quickly running away from them.
Additionally, the unreported transfer of bearer shares across the U.S. border can be argued to violate the Treasury Department requirements for transactions in excess of $10,000, i.e., if you hold bearer shares for a corporation having more than $10,000 in value, you must report the shares when you bring them into or take them out of the country, or else face steep fines and possible criminal penalties.
Notwithstanding the foregoing, bearer shares are a tool and in certain circumstances can serve their purposes. But they should be avoided most planning purposes, and when they are utilized the downside should be carefully discerned in advance.
The corporation sole is an entity recognized in some states and is an entity designed basically to allow religious groups to operate without the strict formalities of the typical business corporation. However, scam artists are now touting it as a vehicle that provides asset protection and tax freedom to ordinary citizens. In the words of Colonel Potter, “Horsehockey”.
(1) Corporations sole provide NO (i.e., zero, zip, nada) asset protection over and above what a typical corporation provides, which isn’t much.
(2) Corporations sole provide NO asset protection to the owners of the corporation sole other than possibility containing the liability of the church — and mind you it is difficult to see how a church could have liability — within the entity.
(3) Corporations provide NO asset protection to the non-church of the owners, i.e., tort liability, debt liability, whatever.
(4) The Crown of England is NOT a corporation sole. I don’t know who came up with this lie, but it is a whopper.
(5) The Governor of Tennessee is also NOT a corporation sole. Another whopper.
(6) The corporation sole does NOT save taxes. The IRS does NOT recognize a corporation sole differently from any other entity. To obtain non-profit status, it MUST qualify under 501(c)(3) like every similar entity.
(7) The corporation sole does NOT help its owners save taxes. Claims to the contrary are totally bogus.
(8) A corporation sole MUST report the movement of funds just like any other taxpayer; the failure to report foreign accounts or transfers will in most cases subject those affiliated with the corporation sole to felony criminal penalties.
(9) Any money that the corporation sole pays out to you personally must be reported to the IRS by you personally, and taxes paid on those money. The claim below basically solicits tax evasion, and is wrong.
The below e-mail seems to be the typical claims of the scam artists who sell these things. You’ll find that none of the promoters of the corporation sole have any legal or accounting experience or education, or otherwise be qualified to know even 1% of what they are talking about. Usually, they are just repeating the fraudulent statements of some other seller of this scam that they have met.
Very little written materials are in print and available about Corporation Soles and yet they are one of the oldest and safest creations in the world for asset protection, individual privacy, and legal tax avoidance.
Americans are discovering they are not in control of their own assets and lives. Over time, both our property and us have become property of the world bankers and leaders that are pushing us into the one- world government and socialism. I’d like to introduce you to the best product money can buy today for asset protection and freedom from government control. Corporation Soles are by far the best protection for you and your properties against taxation, or seizures. The Crown of England is a Corporation Sole. Can you imagine the Queen/King of England being subject to any rules or regulations over their personal business or property? The Governor of Tennessee is considered a Corporation Sole.
Corporation Soles are superior to any other offshore and or on-shore structures in every way imaginable when it comes to privacy and asset protection. The IRS is on a rampage to destroy onshore and offshore Trusts, IBCs, UBOs, etc., no matter where they are. If you’ve set up a trust anywhere in the world they want to know what you’re hiding, you are automatically suspect of tax evasion. I have been down this path, and I recommend dispensing with these entities in lieu of one or more Corporation Soles over which the IRS has no jurisdiction. The rich and powerful say, “Own nothing and manage everything.” This is exactly what you do with a Corporation Sole. They’ve stood the tests of time for centuries. If you expect to earn funds off-shore – bring them into the US to a corporation sole bank account and there will be no reporting or tax liability. Corporation soles pay for themselves over and over in a very short time.
WASHINGTON, D.C. – The Department of Justice today filed suits in federal courts in California, Colorado, Oklahoma, Missouri, and North Carolina to stop a nationwide abusive tax scheme in which customers are advised to create, and claim church status for, a company known as a corporation sole.
“As con artists continue to press their tax scam promotions on the public, the Department of Justice continues to work with the IRS to shut them down.” said Eileen J. O’Connor, Assistant Attorney General for the Justice Department’s Tax Division.
Frank D. Perkinson of Garner, North Carolina.
According to papers filed in the cases, it is alleged that Saladino and the other defendants advise and assist customers to establish and claim church status for a corporation sole, to which the customers transfer assets and income that they continue to control. The government alleges the corporations sole are used merely to fund a person’s lifestyle, and not for church purposes. The complaint alleges that Saladino and his sales organization falsely state that customers who use corporations sole do not need to file tax returns or pay taxes.
It is further alleged that in another part of the scheme, the defendants help their customers file false returns seeking refunds from the government for past taxes paid, based on the bogus argument that compensation for personal labor is nontaxable. Defendants call this the “claim of right” doctrine.
The Justice Department has asked the courts to order Saladino and the other defendants–and anyone working with them–to stop promoting these schemes and to provide the government with their customer lists. More than 700 customers, located in nearly every state and several foreign countries, are alleged to be in the program.
According to court papers filed by the Justice Department, Saladino and his cronies market their scheme on the Internet, in conference calls and at seminars. In its court papers, the Justice Department alleges that customers are charged from $200 to $2,295 to participate in the schemes.
Corporation sole and claim of right promotions are named in the IRS’s annual consumer alert of the “Dirty Dozen” as tax scams taxpayers are urged to avoid. A complete list of the “Dirty Dozen” can be found http://www.irs.gov/newsroom/ article/0,,id=120803,00.html.
WASHINGTON – The Internal Revenue Service today issued a consumer alert advising taxpayers to be wary of promoters offering a tax evasion scheme that misuses “Corporation Sole” laws. Promoters of the scheme misrepresent state and federal laws intended only for bona-fide churches, religious institutions and church leaders.
Scheme promoters typically exploit legitimate laws to establish sham one-person, nonprofit religious corporations. Participants in the scam apply for incorporation under the pretext of being a “bishop” or “overseer” of the phony religious organization or society. The idea promoted is that the arrangement entitles the individual to exemption from federal income taxes as an organization described in Section 501(c)(3) laws.
The scheme is currently being marketed through seminars with fees of up to $1,000 or more per person. Would-be participants purportedly are told that Corporation Sole laws provide a “legal” way to escape paying federal income taxes, child support and other personal debts by hiding assets in a tax exempt entity.
While fraudulent Corporation Sole filings have happened sporadically for many years, the IRS has recently seen signs the scam could be starting to spread with multiple cases seen recently in states such as Utah and Washington. The IRS is concerned about this increase and is taking steps to pursue Corporation Sole promoters and participants.
Is the arrangement designed to hide income or assets?
Is the arrangement designed to evade income taxes?
Answering “yes,” or even “maybe,” to either of these questions should raise red flags for taxpayers.
Additional information on Corporate Sole and the rest of the “Dirty Dozen” tax scams and schemes is available on IRS.gov.
Tax guidelines for churches and religious institutions can be found in Publication 1828, “Tax Guide for Churches and Religious Organizations”.
Taxpayers with specific questions on a tax scheme or who wish to report a possible scheme can call (866) 775-7474 or send an e-mail to irs.tax.shelter.hotline@irs.gov.
“Scheme promoters are telling people that by filing a corporation sole they are creating a church or a religious organization. This information is false. A religious organization must already exist before the authority for the organization files the articles of incorporation for the corporation sole. Any legitimate religious organization filing a corporation sole would have no fear of IRS scrutiny or any regulatory filing associated with the corporation sole.
During the last three years, the Utah Division of Corporations/UCC has seen an unprecedented growth in corporation sole filings. It appears that many of the filings are mass-produced, as there are only a few variations in the document content and verbiage. These recent filings are an abuse of the legislative intent of the Corporation Sole Act.
This web page directly addresses the seedy side of the asset protection industry, including those people who run scams in the guise of providing asset protection structures, or who mislead people about their organization or qualifications, or who themselves are unqualified and/or misguided to assist clients with asset protection issues.
While the scam artists who push these have a lot of neat-sounding reasons why they should defeat creditors, the truth is that Pure Trusts are easily blown up by creditors under a bunch of theories, including that they are “self-settled spendthrift trusts” (expressly disallowed by all but a couple of states), that they have an illegal purpose (tax evasion), that they are a sham, that transfers to the trusts are fraudulent conveyances, and a bunch of other reasons.
Pure Trusts are often part of a three-tier trust structure, which purport to hide the existence of the trust (and also make the structure tax free). In reality, it doesn’t do anything except make it seem like the structure is worth the cost (it isn’t).
On top of everything else, the IRS goes after Pure Trusts like the proverbial heat-seeking missle, because the IRS has never lost a case against the Pure Trust and knows that it can easily grab the assets to satisfy the taxes, interests, and usually heavy penalties which are awarded by the court (using a Pure Trust really is like waiving a red blanket at a mad bull – while your feet are stuck in concrete; something very bad is bound to happen and usually does).
A new scam being marketed is the “Asset Protection Consultant”. Basically, you pay thousands of dollars for some rudimentary information worth maybe $12 which talks about the benefits of Nevada corporations. You then launch yourself as the “Advisor to the Stars”, never mind that your lack of a law license will both subject you to criminal penalties for the Unlicensed Practice of Law (UPL) as well blow the attorney-client privilege for whatever your client says to you or whatever information they give you.
Then, you charge your clients thousands of dollars to set up Nevada corporations that could be set up for a couple of hundred bucks, tops. You tell your clients that these are “foolproof” structures, and that creditors will be thwarted by the “Bearer Shares”, even though ownership can be imputed even when the bearer shares can’t be found, and Nevada law probably doesn’t even apply when the person and their assets are in another state.
Then, you have to hire your own lawyer when: (1) the tax bill for the entity comes due, and you didn’t know how to advise your client about how to correctly structure and fund these entities; or (2) your client actually gets sued by a creditor, who adds you as a co-defendant on a civil conspiracy claim, or, worse, your client gets sued by the U.S. government who then files money laundering charges against you.
And you get all this for just a few thousand bucks? Shrewd, shrewd. But, hey, even when you blow up you can be comforted in the knowledge that you paid for all of this stuff in advance, and whoever sold you this stuff is gone, long gone.
Lot’s of good planners give “asset protection” seminars – we hold “The Summit” once per year, and various other respected asset protection planners give seminars.
Unfortunately, we are in the minority. You see, the planners doing the best work are actually working for their clients, and don’t have time to be out on the seminar circuit. I’ve pretty much limited my appearances to a half-dozen or less times per year (frankly, I’d rather be out on the boat or up in the mountains), and most of the best planners try to limit themselves to a dozen or so appearances per year.
So mostly who you see giving the asset protection seminars are the dregs of the sector, being people who make their money either giving expensive seminars ($1,500 or more per person – real value $300), or giving ultra-cheap seminars ($15 per person) where they sell nearly worthless books and other materials, partnership forms and trust forms, etc., for many thousands of dollars (like $2,500 for a “do it yourself asset protection kit”).
If you go to one of the cheapie seminars, when they announce that they are selling materials at the back of the room, you’ll see about 20 people jump up out of their seats and rush back there, checkbook in hand. Don’t be fooled; most of these people are “shills” who are paid by the seminar promoters to run to the back to make it look like there is a great interest in the worthless materials being sold (your invitation to “join the herd” – Las Vegas casinos are notorious for using shills to encourage people to bet and to make bigger bets than they should be making). Just remember that if 20 people run to the back of the room to purchase a set of materials for $1,800 yours might be the only check actually cashed.
There are no “Institutes” where learned scholars sit around daily discussing asset protection issues. What you have instead are a bunch of marketers who put together the “Institute” to give this impression, but is really just the marketer trying to create a herd mentality for you to send them clients.
Is this practice illegal? No. Is it misleading? Can be, and often is.
Wanna know about offshore trusts and so-called “Foreign Asset Protection Trusts”? You’re in luck, as there are a lot of books readily available for your casual perusal. Yessir, books (and even do-it-yourself kits) on offshore trusts are all the rage. Seems like everybody and their dog has written one book or another extolling the virtues of offshore trusts.
Unfortunately, as I chronicle elsewhere, offshore trusts are a bottom-tier asset protection solution, falling into the Dissociation Methodology (“It’s Not Mine Because I Gave It Away”). And they have been blown up in a major sort of way in several federal court opinions. Unless you are interested in the (nominal) federal gift and estate tax benefits of offshore trusts, there’s a good chance that forming one of these entities could put you into a worse situation than if you hadn’t done anything at all.
The problem is that books sales mean dinero, and even though the law has changed, nobody is rushing to pull their books from the shelves to talk about how the main focus of their books is now walking the legal plank into the Abyss of Failed Strategies.
You might be interested to know that many of these books are “ghostwritten” by somebody else — I know because I have had other planners ask me to ghostwrite their books for them, and though I refused, I didn’t fail to notice that their books were still later published (and basically were a re-hash of somebody else’s book; you’ll find that there is a real shortage of original ideas out there, especially amongst the offshore trust crowd).
A recent phenomenon is the entry of accountants into the asset protection planning sector. They are not only totally unqualified to engage in this sort of planning, but for reasons I will discuss their planning will often put you into much worse shape than if you had done nothing at all.
Fundamentally, if you really think about it, asset protection is “Pre-Litigation Planning,” i.e., doing things in anticipation of going to court and standing in front of a hostile judge with determined creditor’s counsel making arguments about how to get at assets. This requires knowledge and experience in the areas of debtor-creditor law, commercial law, civil procedure, conflicts of law, judgments & remedies, bankruptcy, etc.
Note that “tax” isn’t included in the foregoing. The only time that tax law is implicated in asset protection planning is in figuring out the tax treatment of certain transactions – but basically tax has nothing to do with asset protection planning, except that you don’t want to make a tax error while you are doing the planning.
Another way to say this is that you don’t let the anesthesiologist do the cutting.
What happens is that accountants have this terrible tendency to assume that because something is X for purposes of the Internal Revenue Code, that it must be X for purposes of civil law also – but this simply isn’t the case. With regard to asset protection issues, there is often inconsistent treatment of situations between civil law and tax law, and this is where accountants most often get into trouble.
Unfortunately, accountants are also unaware of criminal laws, and assume that if something is permissible in the Internal Revenue Code, that it must be legal. Thus, in two of the landmark asset protection disasters, Lawrence and Brennan, the plans in each case were put together by the client’s accountant, who got the clients indicted for bankruptcy fraud and money laundering, and the accountants themselves were also indicted on a variety of theories. Ugly.
Unless an attorney is directly involved and retains the accountant, communications between a client and an accountant are not subject to attorney-client privilege. This means that anything the client and the accountant discuss will be known to creditors, creating evidence of actual intent to defraud creditors.
Finally, by law attorneys are privileged to assist clients with certain types of transactions, but accountants are not – meaning that if the transaction goes south, the accountant and the client may have created the additional liability of civil conspiracy, thus making the client potentially worse off than if he had not engaged in the planning at all.
I have personally found that in collection cases where an accountant did the planning, the first thing to do is to add the accountant as a co-defendant under a civil conspiracy theory. Since the accountants Errors & Omissions insurance doesn’t cover intentional torts like civil conspiracy, it creates a tremendous amount of leverage on them to assist in unraveling the debtor’s asset protection plan, in addition of course to creating another (usually easy) source of funds to collect.
Most Estate Planners, to the extent they are attorneys, are usually competent to create some very basic asset protection for the Client, such as maximizing homestead exemptions, structuring limited partnerships, etc.
Unfortunately, too many Estate Planners will go to a couple of “asset protection” seminars, and suddenly decide that ten hours of legal training can substitute for a litigator’s years of actually fighting creditors. They go hog-wild, and start setting up entities and offshore trusts with abandon, and throwing lots of language into documents to “intimidate” a creditor, and thus deter any lawsuits.
The asset protection plans created by Estate Planners seem to almost always have two major defects: First, they involve a lot of “gifting” transactions, which may be good from a federal gift or estate tax perspective, but are usually easy to set aside as Fraudulent Transfers; and, Second, their planning is usually too overt, meaning it is easy for a creditor’s attorney to go to the judge and show that there was actual intent to subvert the interests of creditors.
Some (attorney) Estate Planners are very good asset protection planners, but most aren’t – the key seems to be whether they do much business planning also.
So To Whom Do You Turn?
First, you want to engage a Licensed Attorney — this is the ONLY way that attorney-client privilege can attach to your communications, or that Work Product Immunity has a chance of applying to the documents that you produce to him, and that he drafts for you.
Second, you’ll want to find someone who is a real-world asset protection planner, and not just a member of some Institute (which only means that they part of somebody else’s referral network). Probably the best way to do this is to talk with one of the attorneys on the American Bar Association’s Asset Protection Planning Committee. While membership in the Committee is no guarantee of special competence — since any attorney who pays dues to the ABA can join — generally the “best and brightest” of the asset protection planners are on this Committee. See http://www.abanet.org/rppt/committees/pt/j3/home.html or contact us by e-mail to falc@falc.com and we’ll put you in touch with a member in your area.
Risk-distribution-allowing the insurer to reduce the possibility that a single costly claim will exceed the amount taken in as premiums and set aside for the payment of such a claim.
The sharing and distribution of the insurance risk by all the parties insured is essential to the concept of true insurance. The “economic family theory” argues that where insurance risk has not been shifted or distributed outside the “economic family” there cannot be valid or bona-fide insurance contracts. Valid and bona-fide insurance contracts are essential in obtaining deductions for premiums paid to a related party insurer.
As an alternative to the “economic family theory,” the courts have historically employed a balance sheet test to determine if bona-fide insurance exists. Thus, where the risk of loss has been removed from the insured’s balance sheet, shift of risk has occurred.
Notice 2002-70, issued November 4, 2002: This notice deals with a type of entity known as a producer owned reinsurance company or “PORC.” The transaction outlined within the notice has been labeled a “listed transaction” by the IRS. Listed transactions require additional reporting and recordkeeping requirements and may involve significant penalties if the rules are not followed.
The transaction in the notice involves a taxpayer that offers its customers the opportunity to purchase an insurance contract through the taxpayer in connection with the products or services being sold. The insurance provides coverage for repair or replacement costs if the product breaks down or is lost, stolen, or damaged, or coverage for the customer’s payment obligations in case the customer dies, or becomes disabled or unemployed. The taxpayer offers the insurance to its customers by acting as an insurance agent for an unrelated insurance company. Taxpayer typically receives a commission on the sale of the insurance policy. Taxpayer then forms a company in a foreign jurisdiction and reinsures the policies it sold for the unrelated insurance company. The foreign company elects to be treated as a domestic United States taxpayer and claims the tax benefits associated with small closely held insurance companies pursuant to Internal Revenue Code Section 501(c)(15) or 831(b). In this manner the premiums are sheltered from U.S income tax.
The IRS has indicated that it will attack arrangements of this nature or similar arrangements by arguing that the company in question is not in the business of insurance. The Service has indicated that it will not respect warranty type arrangements similar to the transaction outlined in Notice 2002-70 as bona-fide insurance contracts. The IRS has also indicated that it may assert its income allocation powers under the provisions of Section 482 to tax the income in these arrangements (i.e. buy increasing the amount of the taxable commission) or by arguing that the transaction is a sham.
Arrangements such as the type described in Notice 2002-70 must be avoided at all costs to avoid possible civil and potentially criminal penalties associated with the use of closely-held insurance companies to shelter income.
Revenue Ruling 2002-89, issued December 11, 2002: This ruling discusses two scenarios involving the payment of premiums by a parent to its two wholly-owned captive subsidiaries.
The companies transacted their insurance business in a manner consistent with the standards applicable to an insurance arrangement between unrelated parties.
The IRS again focused on the concepts of adequate risk shift and risk distribution and concluded that the arrangement in scenario 1 did not provide sufficient risk shift or distribution while the facts in scenario 2 did. Thus, where 50% of the subsidiaries risk is with unrelated third parties, the IRS has concluded that sufficient shift and distribution of risk has passed to the subsidiary to constitute a valid and bona-fide insurance arrangement for the parent.
Although Revenue Ruling 2002-89 appears to definitively state that 50% of an insurance company’s business must be with unrelated parties in order for the related party insurance arrangement to constitute bona-fide insurance, judicial precedent exists in the 9th Circuit’s Harper Group decision that this third party element may be as little as 29% to constitute a valid and bona-fide arrangement between related parties.
The premiums of the operating subsidiaries were determined at arms-length.
The premiums were pooled such that a loss by one operating subsidiary is borne, in substantial part, by the premiums paid by others.
If separate financial reporting was maintained on behalf of the insurance company.
Whether the captive’s business operations and assets are kept separate from the business operations and assets of its shareholders.
Revenue Procedure 2002-75, issued December 11, 2002: This revenue procedure discusses certain insurance transactions whereby the IRS will now contemplate issuing private letter rulings regarding whether a valid and bona-fide insurance arrangement exists between related parties. The IRS has indicated that taxpayer’s seeking a ruling should contact the appropriate department at the IRS to determine whether the facts in each case will be considered by the IRS for a ruling before preparing the ruling request.
Internal Revenue Bulletin 2002-44, issued October 15, 2002: This bulletin addresses a specific transaction involving a taxpayer (typically a service provider, automobile dealer, lender or retailer) that offers its customers the opportunity to purchase an insurance contract through the taxpayer in connection with the products or services being sold. The taxpayer offers insurance to its customers by acting as an insurance agent for an unrelated insurance company. The taxpayer then reinsures the policies sold by the taxpayer on behalf of the third party insurer utilizing its wholly owned insurance corporation. The IRS has indicated that this type of transaction qualifies as a “listed transaction.” Listed transactions must be disclosed within the body of the income tax return containing the transaction and with a special department of the IRS. Significant civil penalties exist for taxpayers that do not comply with the listed transaction rules.
Notice 2003-34, issued June 9, 2003: Notice 2003-34 involves the use of offshore insurance companies organized for the purpose of sheltering passive investment income over the life of the company. The shareholder of the offshore insurance company then disposes of the stock in a transaction that qualifies for capital gain treatment. The insurance written by these companies frequently contains unrealistic policy limitations and the investment income generally far exceeds the amount of premiums received from insurance contracts. The IRS in this notice has indicated that it intends to attack these types of transactions in one of three ways.
Option1 – Definition of Insurance: In this method of challenging these transactions, the Service will argue that the insurance written by the insurance company does not meet the judicial established definition of insurance. This is the traditional attack based on the premise that bona-fide insurance contracts must shift and distribute risk from the insured to the insurer and that the insurer must distribute the risk amongst potential claimants.
Option 2 – Status as Insurance Company: This method of challenge relies upon the premise that a taxpayer taxed as an insurance company must use its capital and efforts primarily in earning income from the issuance of insurance contracts. The income tax regulations provide that a company will qualify as an insurance company only if more than half of its business is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. Thus, the IRS in asserting this challenge will look to all of the relevant facts and circumstances for making the determination of whether an entity qualifies as an insurance company. Items taken into consideration in this assessment may include the size and activities of the insurance company’s staff, whether it engages in other trades or businesses, and its sources of income.
Option 3 – Possible Tax Treatment of Stakeholder’s Interest in Foreign Corporation: In this method of challenge the Service will look for ways to categorize the income earned by the foreign corporation as passive investment income subject to U.S. income tax. This method depends upon the Service’s ability to show that the foreign corporation is not involved in the active conduct of an insurance business.
Notice 2003-35, issued June 9, 2003: Notice 2003-35 deals specifically with insurance companies that are availing themselves of the tax-exempt provisions contained in IRC Section 501(c)(15). The notice serves to remind taxpayers that in order to qualify for tax-exempt treatment, the corporation must first qualify as an insurance company. Notice 2003-34 is cited as containing guidelines regarding what constitutes an insurance company.
In summary, the multitude of rulings, procedures, notices, bulletins and notices makes it very clear that the IRS is concerned about the potential abuse of insurance entities to shelter income from U.S. tax. Clearly, the IRS is attempting to establish conservative parameters regarding what does and does not constitute the business of insurance. Although the publications do provide some cause for concern with respect to ongoing IRS scrutiny of taxpayers conducting legitimate insurance businesses, the rulings and notices also provide taxpayers and their tax advisors with a better idea of what the Service considers “the business of insurance.” Although the IRS publications provide some guidance regarding the IRS’s opinion as to what constitutes bona-fide insurance, it is important to note that revenue rulings, procedures, bulletins and notices are not tax law, but merely the IRS’s opinion and interpretation of tax law. Thus, they should be given high priority when considering a closely-held insurance business, however their content should not necessarily govern the treatment of insurance transactions.
The purpose of this notice is to remind taxpayers that an entity must be an insurance company for federal income tax purposes in order to qualify as exempt from federal income tax as an organization described in § 501(c)(15) of the Internal Revenue Code.
Section 501(a) provides that an organization described in § 501(c) shall be exempt from federal income tax. Section 501(c)(15) provides that an insurance company (other than a life insurance company) is tax-exempt if its net written premiums (or, if greater, direct written premiums) for the taxable year do not exceed $350,000. For purposes of this annual test, the company is treated as receiving during the taxable year premiums received during the same year by all other companies within the same controlled group, as defined in § 831(b)(2)(B)(ii).
For an entity to qualify as an insurance company, it must issue insurance contracts or reinsure risks underwritten by insurance companies as its primary and predominant business activity during the taxable year. For a discussion of the analysis applicable to evaluating whether an entity qualifies as an insurance company, see Notice 2003-34, 2003-23 I.R.B. ___ (June 9, 2003) and Notice 2002-70, 2002-44 I.R.B. 765 (November 4, 2002).
The Service is scrutinizing the tax-exempt status of entities claiming to be described in § 501(c)(15) and will challenge the exemption of any entity that does not qualify as an insurance company. The Service will challenge the exemption of the entity, regardless of whether the exemption is claimed pursuant to an existing determination letter or on a return filed with the Service.
Taxpayers claiming exemption pursuant to § 501(c)(15) should also consider whether they are engaged in arrangements described in Notice 2002-70 or substantially similar thereto.
The principal author of this notice is Lee T. Phaup. TE/GE Division, Exempt Organizations. For further information concerning this notice contact Ms. Phaup at (202) 283-8935 (not a toll-free call).
Why take our word for it when you can read what the Internal Revenue Service’s Exempt Organizations Technical Division says about these types of companies?
Have you decided to form a captive? This webpage clarifies certain issues regarding the business plan, purpose, and operation of your insurance company.
It is necessary for your insurance company to be operated as a bona fide insurance company for profit, to be deemed to be primarily in the business of insurance for purposes of the Internal Revenue Code. Your insurance company cannot be a “mere shell” for you to conduct non-insurance company activities, yet claim the favorable tax treatment for insurance companies under the Internal Revenue Code. We cannot, and will not, accept clients whose motivation is to form and hold insurance companies as a “mere shell” to place other businesses into a tax-favored environment.
If your insurance company is not operated as a bona fide insurance company for profit, i.e., if its predominant business activity is not insurance and the purpose and operation of your insurance company does not make good economic sense, you risk the company being deemed not in the business of insurance, in which case you could not take advantage of the certain favorable provisions for insurance companies under the Internal Revenue Code. In such event, your company could possibly be subject to federal income tax on all of its income (with the possibility of “double taxation” as a “C” corporation – or, worse, some type of foreign entity). Therefore, it is critical that your insurance company at all times be operated as a bona fide insurance company for profit, and that insurance activities constitute the primary business of the company.
Please note that if your insurance company is attempting to qualify as an IRC § 501(c)(15) company (which we do not suggest, based on anticipated changes to the tax laws), and your insurance company earns more in investment income that in premiums, it risks being deemed an “investment company” as opposed to an “insurance company”, with the loss of any tax benefits given to insurance companies by Congress. For more information on this topic, please see IRS Notice 2003-35.
One aspect of a bona fide insurance company is that your insurance company will charge a commercially reasonable or “arm’s length’s” rates for premiums on all insurance policies. Charging commercially unreasonable rates for premiums, or premiums that have rates well in excess of those available in the insurance marketplace, could endanger the classification of your company as an insurance company for a variety of purposes, including U.S. tax purposes.
The fact that you will arrange for insurance management and related services, such as actuarial and underwriting services, etc., does not negate the fact that the insurance company must be operated as a bona fide insurance company for profit. It is ultimately your responsibility to maintain your company as a legitimate insurance company whose primary business is that of insurance.
Accounting and audit services, performed by accountants who are approved in the jurisdiction of domicile of your insurance company.
However, the mere retaining of professionals to act on behalf of your insurance company does not ipso facto place it in the business of insurance. Rather, your insurance company enters the business of insurance by a relatively long and detailed process, which is further described below.
Most U.S. states have relatively high license fees, surplus and capital requirements. While these may be necessary to provide for the fiscal needs of the state, and to protect third party insureds, respectively, these requirements can economically strangle a new insurance company which is attempting to feel its way into the insurance business and has not yet established a book of high profit/low risk business. Therefore, it is often necessary for budding insurance companies to avail themselves of jurisdictions outside the U.S., to the so-called “offshore” jurisdictions that are characterized by minimal licensing fees and relatively low capital and surplus requirements.
Please keep in mind, however, that even though the “offshore” jurisdiction where you will initially domicile your insurance company will have relatively low fees, surplus and capital requirements, this does not mean that your insurance company will not be regulated. To the contrary, the Insurance Commission (or equivalent) of the jurisdiction wherein your domicile your insurance company is apt to have a number of technical requirements relating to minimum surplus and capital, types of policies which can be written, etc., that your company will be required to comply with. While a technical misstep in complying with these rules should not necessary invalidate the characterization of your company as an insurance company under current U.S. tax law, a wholesale failure by your insurance company to attempt to comply with these regulations could indicate that it is not seriously interested in being in the business of insurance, which could jeopardize its status as an insurance company for U.S. tax purposes. Although the local insurance regulators might require a relatively low capitalization for their purposes, the company must maintain adequate surplus to satisfy various aspects of U.S. tax law, especially in regard to “risk shifting” analysis, which might in some circumstances be substantially higher than what the local insurance regulators may require.
Economic Viability – Your insurance company and its plan of operation must be designed so that company is profitable. For budding insurance companies, such as yours, this will include identification of certain “niche” insurance markets, which are characterized by a level of profitability that is favorably high in relation to a low level of risk being assumed. At the same time, it is important that your insurance company not commit itself to a large amount of risk before it has built up its pool of business and reserves so that the risks can be spread and premiums earned in accordance with conservative underwriting considerations.
The outstanding risks and liabilities of the insurance company (the lower the level of outstanding risk and liabilities, the higher the rating your insurance company will likely receive).
Please note that the ratings your insurance company may receive from Standard & Poor’s, Moody’s and Best’s may create substantial additional value in your insurance company, as highly-rated insurance companies command a much higher sale value. This should motivate you to operate your company in a conservative fashion, as described above, so as to obtain these ratings.
Underwriting Activities –It is important that your new insurance company does not overextend itself, by accepting risks which are outside the company’s experience level. New insurance companies should usually attempt to limit themselves to underwriting the otherwise uninsured risks of related-party businesses (i.e., providing insurance for other businesses which you own or control, and for which you understand the risks and are currently self-insuring). You may also investigate participating in reinsurance pools as well as underwriting in the securities and financial markets in which you have expertise.
Investigation of “Niche” Insurance Opportunities – You should be prepared to locate and analyze certain opportunities to offer insurance in currently untapped or noncompetitive markets. Indeed, your desire to enter the insurance market in such niches should be one of your primary motivations in forming a new insurance company.The creation of the business plan for your insurance company is merely the first step towards qualifying your company as an insurance company. After licensing, your primary business must be that of insurance. Your insurance company must be operated in accordance with the business plan, and as a bona fide insurance company for profit, actuaries, underwriters, insurance managers, and accountants, etc.
IRS Guidelines and Requirements — The IRS is continually modifying the definition of what qualifies as an “insurance company”. In order to qualify as an insurance company, at a minimum your company will have to insure at least twelve brother-sister corporations, or underwriter at least 29% third-party risk (at least 50% is preferable). These merely represent two of a multitude of tests that your company must meet to qualify as an insurance company for Internal Revenue Service purposes.
Comprehensive information about captive insurance companies (captives) and arrangements, including risk retention groups. While our focus is on the uses of these structures for U.S. companies and business owners, many of these concepts may be useful to others.
Captive Insurance Companies Cases — A selection of Landmark Cases regarding the use of captive insurance arrangements is included.
Risk Retention Groups — Explains these pseudo-insurance company arrangements that are uniquely formed pursuant to federal law, and their use as fronting companies.
Captive Jurisdictions — Overview of the major captive jurisdictions, foreign and domestic, including the insurance company statutes of those jurisdictions.
Slang for an insurance company used predominantly to underwrite the business risk of other subsidiaries of the parent company or owner. The term “captive” is not used in any insurance statutes or in the Internal Revenue Code, but is rather a practice term used to describe an insurance company fulfilling the described role.
A privately-held insurance company that is typically owned either by the owner’s children or an irrevocable trust formed for the owner’s children, to provide additional tax and succession benefits in addition to those of the captive arrangement.
A person or entity that has obtained a license from the local insurance commissioner to manage insurance companies in that jurisdiction.

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