EQUITABLE LIFE MEMBERS

EQUITABLE LIFE:  PENROSE AND BEYOND

- ANATOMY OF A FRAUD 

A paper by Dr. Michael Nassim

Last Updated: Friday, February 11, 2005 10:02 AM

The official Opposition view of regulatory failure:

1. The extract below is from pages 2 and 3 of Andrew Tyrie’s letter to Parliamentary Ombudsman Ann Abraham:  “Lord Penrose’s Report identified regulatory failure both of the system of regulation and of its operation over a sustained period, and particularly throughout the 1990’s.  These are documented in detail in, among others, Chapters 15 to 18.  No doubt you will already be examining Lord Penrose’s findings of regulatory failure in the short period covered by your first report, from 1^st January 1999 to 8^th December 2000.  The scale of the regulatory failure identified by Lord Penrose prior to that period, and the accompanying detail he provides, also require investigation.  Of the whole period Lord Penrose states: “There was a general failure on the part of the regulators and the GAD” (P chap 19.40).  He writes of 1998, that “GAD’s approach over this period seems to me to have been persistently naïve” (P chap 15.78).  In his conclusions, he describes the Department for Trade and Industry and the Treasury ( who were between them responsible for prudential regulation from the early 1980’s until 1^st January 1999) as “ill-equipped” (P chap 19.158) and the GAD as “complacent” (P chap 19.160).  Lord Penrose notes “short term objectives related to the support of solvency should have alerted regulators to the Society’s weakening position” (P chap 19.187).  He says that “information was not used to form a realistic appraisal of the society’s financial position” (P chap 19.209) and that “unsatisfactory answers were accepted without follow up” (P chap 19.228).

The events described by Lord Penrose which led to these and other conclusions of regulatory failure are very extensive.  Among those which would benefit from investigation for maladministration are that public bodies:

• allowed the Society to accumulate huge contingent liabilities by selling unguaranteed policies without ring-fencing the funding of Guaranteed Annuity Rate (GAR) policies and without declaring that those prior guaranteed policies existed;

• failed to discover that the Society was not reserving for the guarantees expressly contained in the GAR policies;

• endorsed the Society’s attempt to redress the balance by paying differential bonuses, later ruled illegal;

• permitted the publication of inadequate accounts and the submission of inadequate regulatory returns which obscured the financial weaknesses of the Society;

• failed to recognise the inadequacy of the reinsurance policy negotiated to cover reversionary bonuses for GARs in late 1998 and early 1999;

• allowed the Society to “over-bonus” for many years;

• allowed the Society to trade with totally inadequate reserves and to claim throughout that they were selling a low-risk product, coupled with prudent management and the benefits of mutuality

The GAD was the subject of particular criticism by Lord Penrose.  In your first report you took the view that the GAD was outside your jurisdiction and gave your reasons.  I strongly urge you to reconsider that view.  etc.”

At this point we may profitably revisit the axiom that: “no regulatory apparatus can function any better than the milieu in which it operates.”  Attitude and milieu would seem to be closely allied.  If so, attitude as well as its milieu may be reflected generally, such that individual personnel may not be wholly or even largely accountable for a collective stance.  Even so, stance and attitude must be expected to exert a major influence on operational characteristics independently of the organisational environment.  Hence, although Lord Penrose did not single out individual regulators for criticism, that should not be taken as proof that there was no operational deficiency.  Not surprisingly this position, when advanced by Treasury Minister Ruth Kelly in the Equitable March 24^th 2004 Commons debate, was effectively demolished by various opposition MP’s, who made a strong case for operational failure, let alone any systemic deficiencies.  For further analysis of regulatory failure please see the Level 2 narrative account.

Expansion and inflation.

2. Though it does not often say so directly, the PR implies that the Equitable did not fully appreciate the increased volatility of its equity portfolio, or the fundamentally inverse relationship between inflation and interest rates.  And in fact the PR account would itself be much strengthened were it adjusted for monetary inflation and the explosive growth in sales and of the membership.  This would make the underlying financial weakness and the failure of reserves to increase pro rata more insightful.

3. Given the Society’s commitment to expansion, it might be expected that the large new sales tail would wag the dog in various ways, e.g. development of a sales-orientated culture, higher fixed costs, and an inevitable drive to maintain and increase sales (e.g. by over-bonusing) which could become an end in itself and steadily erode financial strength.  The PR shows that effectively this is what happened.  Despite the Society’s published claims for high administrative efficiency and low expense ratio, Lord Penrose states:  “The contractual expression of expenses, as 4½ % of contributions, did not reflect accurately the acquisition cost of new business. The actual cost was considerably higher (for actual yearly management expense ratio figures see P tables C2-4). The Society developed the mechanism of an internal “new business loan” to capitalise the excess un-recouped acquisition costs with a view to recovering them over the anticipated life of the contract”(P6.15). Was this over and above the inappropriate quasi-Zillmer adjustment used for a similar purpose? 

4. With regard to these points, there is a need to investigate the influence of the sales and marketing function on the Equitable’s business policy, and any active contribution it may have made to actuarial policy as defined in the “With Profits Without Mystery” approach at executive or Board level. 

5. With marketing objectives in mind, it is not unreasonable to assume that “deliberate cross-generational subsidy” of mature GAR policyholders was aimed more at getting and holding onto inward transfers under corporate and group schemes than at individual private clients.  The wooing and winning of influential and powerful group scheme friends (whose administrators and Trustees could themselves have been of suitable age to benefit from Equitable flexibility) might also be expected to confer incidental benefits on the Society, its officers and directors.  And given that the FSSU (Federated Superannuation Scheme for Universities) business needed retaining or replacing, this was more than usually important.  Under these circumstances, there would have been a bias against less mature and private policyholders. One such example of this bias is the extension of GAR privileges for group scheme clients from 1988 to 1993 (P2.43-4).

6. Remarkably, the PR makes no reference to the With Profits Fund degenerating into a Ponzi scheme, or the similarities between the Equitable Bubble and the Lloyd’s “recruit to dilute” campaign.  This is despite the writer having submitted the prima facie evidence for fraudulent mis-selling contained in an earlier paper entitled:  “THE EQUITABLE LIFE DISASTER; DOES IT COMPARE TO THE LLOYD’S ASBESTOSIS SCANDAL OF THE 1980’S?” to the Penrose Enquiry, receipt of which was specifically acknowledged on Feb 11^th 2002. This paper, based on an earlier letter to the Society and which was developed with the assistance and advice of Michael Josephs, became at his further instigation the starting point for EARW Section 6.  The Lloyd’s “recruit to dilute” campaign has aptly been described as a Ponzi scheme; the Society’s version of a Ponzi scheme has been earlier described in the Level 2 narrative section of this paper.

Sophistry, mythology, propaganda, misrepresentation and mis-selling.

7. The PR’s main description of the WPWM manifesto is given in P4.1-11 and 25-6.   It does not examine the manifesto in relation to the Society’s history prior to 1970 in much detail, and does not reveal that it is a set of interdependent sophistries of plan and practice which are antithetical denials of lessons previously learned. Nor does it stress the coherence, consistency, duration and “totality” of the wrongs that resulted.  As previously shown, these sophistries do not withstand searching examination (EARW sections 3 & 4 and main points summary above). The PR does, however, repeatedly allude to a complementary Equitable mythology, e.g. “Policyholders were encouraged to take the view that the Society’s practice was to allocate all available surpluses as they arose, subject to a degree of smoothing, in contrast to other offices that withheld benefits that should have been available from current surplus.  This approach, and the absence of a free estate, was presented as being a continuation of an approach that dated back to the establishment of the Society in the 18^th century, although this was part of a mythology that was build (sic) up over the period covered by this inquiry” (P19.8 & 4.4-5).  This was a carefully disingenuous misrepresentation which has further implications for PRE, issues of duty and good faith, and mis-selling generally.  With regard to the post hoc nature of the WPWM paradigm, Lord Penrose says:  “By 1990 the weakness of its (i.e. the Society’s) balance sheet was well advertised:  With Profits Without Mystery adopted the inevitable outcome of this approach as policy” (P6.98).

8. Here recall that Roy Ranson had been similarly disingenuous in front of an actuarial audience when closing the Edinburgh discussion of the WPWM paper in 1990:  “Regarding the estate, of course we do not have objections to its existence and of course if it exists it is of value to existing policyholders, but I will keep asking the questions: - who created it, which generation, and why was it created?  Those points need to be taken up and answered.  What contribution is required towards it from the current generation?  When are the holders of estates going to tell the public what it is all about?  How did they have this flash of inspiration to create it and who paid for it?  Who is going to go on paying for it?  As a matter of interest I did not inherit one so perhaps that influenced my views” (my italics).  As we have seen, he could say this because Sherlock and he had already distributed the Society’s estate. And in point of fact the estate concept had originated at the Equitable itself no later than 1775 (EARW Section 3 p8-9).

9. Overall, it is thus not surprising that Lord Penrose should at a later time say that the Society (presumably as a whole) was a victim of its own propaganda. But this does not explain the origins of propaganda, or why it was formulated by an influential minority with crucial knowledge- who are likely to be the same set of instrumental members on the “senior management team” referred to in 14 above.  As to its effect on policyholders, he says:  “It would be inappropriate to summarise the whole correspondence received.  These examples (pertaining to non-GAR issues- MN) illustrate a wide-ranging problem associated with policyholder discontent focused on the Society’s products, marketing and sales processes, and the management of its distribution policies (this can only be construed as a polite euphemism for general mis-selling- MN).  The attitudes towards the Society that the correspondence displays are in no small part a reaction to discovery that the myths the Equitable spread about its unique and highly superior ethos were not soundly based on fact” (P chap 8.61). What the Society’s former ethos had been, and how it was traduced during the last 30 years of its existence, is indicated by the postscript to this article. 

10. We also need to know why the important details of the WPWM approach, and particularly those referred to under the PRE heading above, did not come through in sales literature, product particulars and contracts, and why (as is emergent common knowledge) branch offices and representatives remained in ignorance of them.  Moreover, although Society literature stressed the absence of commission, presumably external, internal incentives were paid to sales staff:  “Sherlock recruited Ken Wills as marketing manager.  Wills introduced a “commission” based remuneration scheme for sales staff, superseding a limited incentive scheme that had been introduced in 1970 by Ogborn.  On 25^th September 1974, a new performance-related bonus system for the sales force was recommended” P chap 3.18) So, what percentage of the value of sales was this at different times?  “Incentivised ignorance” of sales staff thus remains an outstanding issue (EARW Section 8 p 16).  Sadly the PR has not addressed “incentivised ignorance” in any way.

11. In his postscript (chap 20.79 & 80) Lord Penrose says:  “…Any court or other adjudicator resolving issues of duty, or professional conduct, will require to make an independent assessment of the facts, in default of agreement, and that may agree or disagree with the views I have expressed.  Policyholders, in particular, must not base their expectations on the report beyond what it offers: my best assessment of the evidence I have recovered …” and:  “…A hard lesson for many has been that it is the nature of a mutual with-profits office that the members have little recourse to anyone other than the other members for recovery of their losses.  I am in no position to make any general finding as to the manner in which this aspect of their investment might or might not have been drawn to their attention; that depends upon what they were told individually and what they understood at the time, and it is clear that individual cases differ…”  But this does not entirely gainsay Lord Penrose’s authority and official standing, or what unites all cases, i.e. the general nature of the disinformation and misrepresentation as exemplified in the Society’s and director’s public statements, literature, and sales training platform.  Individuals’ corroboration of this is therefore merely a concluding formality.  Sufficient evidence has long been available for the burden of proof to have passed to the Society and the FSA, who should demonstrate that its statements, literature and sales pitch were a true representation of a normally functioning with-profits fund, that the fund did not lose its essential with-profits characteristics by 1982/3 following a selective dispersal of its estate, that it was not thereafter trading on a false basis because it was relying on unrepeatably boosted performance figures and did not cross over into a with-liabilities fund by 1987 at the very latest, and that at no time did it degenerate into an expanding and liability-diluting Ponzi operation implemented by an ignorant sales force.  Much trouble would have been saved if the FSA and the Society had made an appropriate demonstration earlier on, and so one can only conclude that this was, and remains, impossible.  And all this begs the question as to why Lord Penrose did not consider that he should make further use of his considerable learning and authority.

12. With this in mind, note that in connection with Headdon’s maxwellisation submission Lord Penrose concludes in chap 19.133:  “…Nor do I accept his contention that the selection of a bonus policy was a separate issue from how it was published.  That there are different processes is clear, but in a mutual society there should be no difference between the substance of a policy and what is communicated to policyholders about it” (my italics).  In effect this is succinctly because in a mutual society:  “…the persons with whom business is done are the persons for whom business is done” (P9.7).  Moreover the law of equity here has particular application to the Society over and above its mutual status.  In any commercial transaction there must be “good faith”, and in the case of an insurance society there must be the “utmost good faith”. The Society is open to the charge that it committed the tort of deceit of the policyholders by withholding information which, under the doctrine of uberrimae fidei, i.e. utmost faith, it should have supplied.

13. Re. 54 above, one may take a similarly sceptical view of the Financial Services Authority’s recent announcement that it has conducted its own investigation and concluded that there had been no general mis-selling by the Equitable.  That natural scepticism is increased by a refusal to publish the findings on which their conclusion is based.   Besides, such an investigation was most urgently required prior to the Compromise Scheme.  (The writer had therefore urged first the FSA, and failing their reply Sir Howard Davies in person to determine whether or not general mis-selling had occurred by quickly inexpensive yet adequate criteria in a letter dated Nov 28^th 2001.)  One must therefore ask what purpose is now being served by giving the public a wrong answer, and far too late in the day.  

Corporate governance and management culture.

14. The Equitable originated in London in the year 1762.  Its long association with the central establishment there is reflected in the names and locations of its London Offices. In 1993, besides its Registered Office at 4 Coleman Street EC2R (later re-located to City Place House, 55 Basinghall Street EC2V 5DR) it boasted no less than 6 London branch offices:

1. “Bank” at Birchin Court, Birchin Lane EC3V 9DJ

2. “Central” at 13 Hanover Square, W1R 9HD

3. “Law Courts” at Crown House, 51 Aldwych, WC2B 4AX

4.  “Minster Court” at 1 Minster Court, Mincing Lane, EC3R 7AA

5. “West” at First Floor, Ryder Court, 14 Ryder Street, SW1Y 6QA

6. “Westminster” at Southside, 105 Victoria Street, Sw1E 6QQ.

There were 20 regional offices in the rest of England:  Birmingham North, Birmingham South, Brighton, Bristol, Cambridge, Chelmsford, Epsom, Exeter, Guildford, Leeds, Liverpool, Maidstone, Manchester, Milton Keynes, Newcastle, Nottingham, Sheffield, Southampton, St Albans, and Windsor.  Outside England there were offices in Belfast, Edinburgh, Glasgow and Cardiff (“South Wales”).  From this it appears that, besides the capital, there was a preponderance of offices in the South East.

15. If the bridge of the Good Ship Equitable was Coleman Street or Basinghall Street, and most closely associated with the 6 London branch offices, the engine room was (and is) the Chief Administrative Office at Walton Street, Aylesbury, Bucks HP21 7QW.  This was the powerhouse and headquarters of the executive function. 

16.  Back now to Lord Penrose, who relates that:  “Until 1967 the Board of Equitable Life excluded current executives of the Society, including “the Actuary and Manager”, from appointment as director.  When Henry Tappenden retired from office as Actuary and Manager he was appointed executive director, and retained some executive duties.  This marked the first departure from established practice.  In the following year Tappenden retired from all executive duties, but executive representation on the board was firmly established with the appointment of Maurice Ogborn, Tappenden’s successor as Actuary, to the Board in 1969.  From that time, executives came increasingly to take part in the direction of the Society.  But it was to be some time before that was reflected in any fundamental change in attitude.  Peter Martin, an experienced solicitor who was to become vice-president in time, told the inquiry that when he joined the Board at the beginning of 1984 it was his impression that the Society was governed very much by an old-fashioned “gentlemen and players” culture in the form that it had been since it was constituted in 1762 (the period was somewhat exaggerated).  The Board consisted of City professionals with no specific life assurance expertise (mainly bankers and stockbrokers) who invested the premiums.  There was little connection culturally between them and those executives who were based at Aylesbury.  I accept his statement as reliable.  The role of the executive was wide, and included management of the sales force, product design and administration, and the actuarial valuation of the liabilities and provisions that quantified the long-term fund and, by comparison with the assets of the Society, the surplus available for distribution” (P9.20, 21).

17. At this stage, therefore, there were limits to an ambitious executive’s rise within the echelons of the Society.  But thereafter things changed, and throughout the late 1970’s and early 1980’s there were generally three executive directors in a board of ten or eleven.  Marketing manager Ken Wills joined in 1976, as did non-executive Professor Roland Smith.  Ranson, who entered the Equitable in 1951, had to wait until 1985 before he became an executive director.  During Smith’s presidency there were as many as five executive directors, and “….it was Martin’s impression that the character of the Board had changed.  There was a movement towards creating a modern Board that operated as a single cohesive body.  The “gentleman and players” culture was breaking down.  Non-executive directors were drawn from a wider background, and there were efforts to bridge the cultural divide……” (P9.25).

18. The writer maintains that these changes may have come at a price.  Provided that they satisfied the expectations of their non-executive colleagues and the interests they represented, executive directors might now look to form advantageous links outside the Society, and assist one another in this aim.  Influential outside interests would also have dealings with the more important branch offices, and most notably the London ones.

19.  It is a matter of concern that one of the creators of WPWM, who may have owed feudal allegiance to Ranson, ran the Systems and Controls Review Group (SCRG) (P chap 9.52) the purpose of which was to manage risk and counter fraud, and that Ranson maintained that SCRG’s responsibilities were executive, and not a Board matter.  Julian Hirst, the Society’s chief accountant at the time, told the Inquiry that: “The remit (of SCRG) was different to that of an internal audit function- its remit was to ensure compliance with office principles and policies and to assist management” (P chap 9.52; also ¶ 49, 50,129).  This smacks of control and censorship of information flows.

20. It is also a matter of concern that besides risk management and SCRG, product design and the entire WPWM concept were executive matters into which the Board of Directors had no real input.  Lack of relevant expertise in the non-executive directors was a material contributory factor (P19.90).

21. Lord Penrose has also commented on the disjointed and fragmentary nature of information given to the Board by the executive.  “...As a result of this practice…even if directors had all the relevant pieces of the jigsaw, they were most unlikely to have been able to piece them together and form a picture of the totality” (P19.85).  This we should set against the following statement by Roy Ranson in closing the Edinburgh discussion of the Ranson & Headdon paper:  “The Paper covers practically the whole range of activities associated with the operation of a predominantly with-profits office. The kind of points made through the paper are discussed with the Board and senior colleagues very much in the way we put them in the Paper (the wording is a bit different on occasions) and to the extent that we can, with policyholders.  That of course is a difficult exercise but we are making efforts. (EARW Section 3 p8) ”  Of course this statement is also relevant to PRE.

22. The PR has specifically examined only the executive roles of Ranson, Headdon and Nash, but feudatory allegiances and management culture in the actuarial, sales and marketing functions may deserve further general consideration. So do officers’ and directors’ mutually beneficial relationships with influential external connections. In this regard and with benefit of hindsight Sherlock’s appointment as inaugural head of LAUTRO (Life Assurance and Unit Trusts Regulatory Organisation) looks inappropriate.  Lord Penrose has also refrained from commenting on the role and significance of WPWM’s joint creator, who was assistant general manager and SCRG head David Driscoll, or how Ranson’s own feudatory allegiances progressed, e.g. in his relationships to Sherlock, Wills and Smith, or to Maurice Ogborn before them.  The most straightforward current interpretation of Nash and Headdon’s predicament is that they were feudatories (i.e. vassals) of Ranson, who were left exposed by his retirement in 1997.  The consequences of these relationships for the Society may have been accentuated because Ogborn, Sherlock, Ranson, and Headdon successively combined the responsibilities of Actuary and Managing Director.  For a general discussion of the feudal nature and external relationships of organisations see EARW section 5 p 12.

23. The Institute of Actuaries has taken a less lenient view than the PR, and as related on page 10 of  “The Actuary” for August 2004 has instituted disciplinary proceedings against Sherlock, Ranson, Headdon and Nash. Suffice it to say that the charges generally reflect much of the evidence presented here, but that in addition:

1. Of Headdon:  “the signing, in April 1999, of a side letter to the Society’s reinsurance agreement with ERC Frankona, which was relevant to the value attributed to such agreement in the regulatory returns, without disclosing such side letter to the regulator;”

2. Of Nash:  “authorising and signing a letter to policyholders dated 1 February 2000, upon which policyholders were likely to rely, that allegedly misrepresented the Society’s position in the event of its appeal to the House of Lords failing;”   (For further discussion of this misrepresentation and its effects see P chap 8.18, or EARW section 7 and 10 ¶ 3 for an explanation of its essentially fraudulent nature).   

24. Management culture may be relevant to why actuary Andrew Soundy made no headway with Headdon and Ranson when protesting the unfairness of the GAR Differential Terminal Bonus policy in 1993-4 ( P. Chap 1.9).  Conversely, it may also explain why Soundy could take over risk management and report to Julian Hirst in 2000 (P9.179) after SCRG was disbanded in 1999 (Ranson having retired in 1997).  In ¶ 180 Lord Penrose continues:  “The domestic solution developed by the Society in 2000 with the assistance of Ernst & Young was ample.  Subject to reflecting generally accepted contemporary views, there appears to be no reason why the Society could not have developed and comprehensive audit committee function and associated internal audit at any time during the 1990’s had there been the will to do so.  It appears that the lack of progress towards that end can only be attributed to the intransigent resistance of the executive to what was regarded as an attempt by the Board, or particular members of it, to encroach on what had come to be regarded as management’s exclusive area of interest (my italics).  Having regard to the articles of association, the notion that delegation to the executive could ever be exclusive of the continuing supervision of the Board, and to recall should that course seem appropriate, was at all times wholly without foundation.”  

Loss and harm suffered by policyholders:

25. Lord Penrose’s remit has not permitted him to say much about the harm done to policyholders, either collectively or individually. He estimates that the Society was short of 4.4 billion pounds in 2000/1.  This estimate does not include restoration of estate or reserves. Equally importantly, it does not include liabilities for residual inequities of guarantee, and most notably the GIR issue*. Nor does it address the continuing harm and difficulties resulting from the New Board being obliged to run the remnants of the with-profits fund on the discredited WPWM paradigm in order to maintain technical solvency.  For a more detailed explanation of these issues than what has initially been summarised, and more minute categories of loss and damage, please refer to the itemised listing in EARW section 11.  Some of the more important points are also placed in Level 2 narrative context in the section entitled: Compromised.  The current version of this article does not expand on the consequences of regulatory failure given there.