Flegle Deary Simon
Following the class action lawsuit brought against Arthur J Gallagher & Co and Artex in December, we talk to the attorney for the plaintiffs, David Deary
Last December, a group of plaintiffs filed a class action lawsuit against a group of defendants, including Arthur J Gallagher & Co and its subsidiary Artex Risk Solutions, accusing them of being part of a ‘massive captive insurance conspiracy’.
The suit, filed in the US District Court for the District of Arizona, alleged that the defendants conspired to design, promote, sell, implement, and manage illegal tax-advantaged captive insurance strategies.
Additionally, it claimed the defendants entered into undisclosed business arrangements with each other and formed a nationwide referral network to funnel clients business to them.
Gallagher and Artex have said the case against them has “no merit” and will be dealt with accordingly.
We spoke to David Deary, attorney for the plaintiffs and partner at Loewinsohn Flegle Deary Simon, about the case and why it should serve as a warning to the industry.
Can you give me some background on your firm and the case?
Loewinsohn Flegle Deary Simon is a mid-sized law firm in Dallas, Texas, that specialises in litigation. We have represented over 500 clients since approximately 2003 against accounting, investment and law firms that designed, marketed, sold, and implemented all different types of reported tax-advantaged investment strategies that were ultimately disallowed by the Internal Revenue Service (IRS) and/or tax courts as illegal and abusive tax shelters.
We began looking at various micro captives under audit during 2018. Based on our analysis and input from consulting experts, we concluded that the various micro captives currently under audit and/or tax court scrutiny would more than likely be disallowed as illegal and abusive tax shelters and that micro captive clients would be assessed back-taxes, penalties and interest.
During the latter part of 2018 we began to receive phone calls from individuals under audit for participating in a micro captive insurance company. We now represent a large number of clients who have suffered substantial damages as a result of their participation in the micro captive insurance programme. In fact, we have clients with claims against virtually every major promoter. We anticipate we will be filing additional lawsuits against these other major promoters in the near future.
When did you first begin working on this case?
We began working on the Internal Revenue Code section 831(b) micro captives in 2018. Around that time, clients began contacting us as a result of our long and successful track record in this area of litigation. Our clients want to be made whole. They have been assessed and paid back-taxes, substantial penalties, and interest on penalties and taxes. They paid large annual fees and expenses as part of the captive insurance programme. They have incurred substantial legal fees and expenses defending the IRS audits and/or tax court proceedings. Our clients want to recover their full-measure of damages.
Are you alleging that in this case the defendants knowingly mislead your clients?
Yes, and the class action complaint that our clients recently filed goes into extensive detail as to how Artex knowingly misled its clients. Artex told its micro captive clients before it sold them micro captive services that it had the expertise to design, implement, and manage micro captives in a manner that complied with all applicable tax and insurance laws. Artex’s clients relied on these representations in retaining Artex and then later relied on Artex to design, implement, and manage the micro captives as it represented it would.
It is clear now to Artex’s clients that the company told these clients several misrepresentations. For instance, the actuarial studies Artex obtained in connection with managing the micro captives were not actuarially sound.
Instead, Artex selected actuaries who would provide assessments designed to justify policy premiums that would hit a predetermined value. Further, the pricing of the policies that Artex caused the micro captives to issue were inflated. Artex also advised its clients to obtain policies for risks that were unlikely to have a material impact on its clients’ operations.
Artex’s methods for distributing risks also did not meet tax law and insurance industry standards. Artex structured the micro captives so that 100 percent of the premiums paid went to an agent for a reinsurance pool. The agent would retain 2.5 percent of the premiums and then direct 51 percent of the net proceeds to the reinsurer while the micro captive received 49 percent of the net premiums. In exchange for these premiums, the micro captive would retain a primary layer of risk amounting to the first 25 percent of the policy limits.
The reinsurance pool would retain the remaining 75 percent of the risk for covered claims in an excess layer. Artex dictated to our clients which risks the micro captives would cover. Although Artex represented that these risks were material, this representation was false. In fact, covered losses almost never hit the excess layer pool because the micro captive’s primary layer of 25 percent sufficed to cover the claims. Because losses almost never hit the reinsurance pool, there was never proper risk distribution under tax law and insurance industry standards.
Artex touted their expertise and credibility and emphasised how sophisticated and complicated the micro captives are to design, implement, and manage. Artex claimed its micro captive insurance programme complied with section 831(b) of the Internal Revenue Code and actually discussed how the tax code specifically allows these micro captives.
Artex represented that it had the special expertise and experience to design, implement and operate a micro captive insurance company in a way that complies with the tax code, including section 831(b). In fact, Artex assured our clients that if the captive is managed and operated within the tax code rules and section 831(b) specifically, the IRS will allow it. Artex also told its micro captive clients that some of Artex’s other micro captive clients were audited for the use of captive services exactly like those Artex was promoting to them and that the IRS upheld these micro captives as legal. Artex touted the fact that it has tax lawyers, accountants and insurance experts at Artex that will make sure the captive is designed, implemented, managed and operated in compliance with the tax code. These representations gave our clients great comfort.
Artex understood that captive insurance was well beyond our client’s expertise and that our clients retained Artex to supply micro captive expertise.
Artex therefore understood that our clients relied upon and were at the mercy of Artex to design, implement, and manage the micro captives consistent with applicable tax law and insurance standards. In light of Artex’s micro captive expertise, our clients’ lack of micro captive expertise, and our client’s reliance on Artex, the conclusion is inescapable that Artex’s misrepresentations to our clients were knowing.
Unfortunately, Artex failed to design, implement, manage, and operate the micro captive insurance companies in accordance with the applicable rules and regulations, including section 831(b). Unfortunately, the clients relied upon Artex to their detriment.
What is the timeline moving forward?
We just filed the class action complaint a few weeks ago, and the defendants have not even answered yet. We expect in the coming months that there will be motion practice followed by discovery.
Does this lawsuit serve as a warning to other captive managers?
It serves as a warning to captive managers that if they are going to promote and sell micro captive services, the micro captives must be designed, implemented, and managed to comply with all applicable tax and insurance laws.
I assume that there will be more cases against Artex and others involved in the captive insurance industry.
