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In March 2017, we released a research report explaining our opinion why Citizens Inc.'s (CIA) business model is analogous to a Ponzi Scheme. The company uses a network of brokers to prey on unsophisticated foreign families and retirees with false promises of illusory “guaranteed returns” from insurance policies purportedly secured by U.S. Treasury bonds. But the money from policyholders is funneled into continuous open market purchases of CIA shares, artificially inflating the company’s own stock price.
Over the past two years, Citizen’s financial condition has deteriorated while executive resignations and a multitude of red flags have combined to suggest that the company’s scheme is increasingly moving towards the verge of collapse.
Just weeks ago, Ernst & Young suddenly resigned as Citizens auditor.
Now, three former senior executives have emerged as witnesses in a recently filed lawsuit that exposes the depth of the alleged fraud at Citizens (CIA_Amended_Complaint.pdf) Juan Gamboa vs Citizens, Inc., U.S.D.C., W.D. Tex., Case No.: 1:17-cv-00241-RP amended on July 31, 2017).
It is extremely likely that one of the witnesses is Randall H. Riley, the son of the founder and controlling shareholder, Harold Riley.
The detailed new allegations described in the complaint include how:
- Citizen’s former CFO discovered fraud and was fired after reporting it and refusing to certify the financials.
- Citizen’s former Chief Actuary was fired after reporting actuarial issues to management.
- Citizen’s reserve for tax non-compliance liabilities is deficient by at least $80 million, an amount that imperils the company’s solvency.
- In an attempt to save the company, management concocted the “Irish Solution” which involved rushing to set up a secret new subsidiary in Ireland before the IRS could audit Citizens. Even though Citizens has failed to disclose having an Irish subsidiary, records we obtained from the Irish Government’s corporate registry prove its existence.
- Citizens is now subject to ongoing IRS and SEC investigations.
- Citizen’s former CEO, Rick Riley, created an undisclosed and illegal insurance policy that paid himself a six percent guaranteed return. After it was discovered by the audit committee, Citizens “lied and covered up” the self-dealing.
- Accounting irregularities include mortgages and certain receivables not paid since 2011 that weren’t even tested for impairment.
- Prior to Ernst & Young’s recent resignation, KPMG had resigned as Citizens auditor due to undisclosed disagreements with the company.
The three main witnesses supporting the complaint are seasoned former Citizens executives with the following backgrounds:
We encourage investors to read the complaint in its entirety because it both confirms and adds significant detail to the primary aspects of our initial report. Not only do these new allegations point to pervasive corruption within Citizens, but they also highlight the company’s precarious financial position and management’s deceitful efforts to keep the scheme alive.
Three elements we found particularly illuminating include:
Citizen’s Former CFO and Former Chief Actuary Report Being Fired After Uncovering Fraud and Lies
The complaint describes how the CFO refused to certify Citizens financials after discovering a multitude of accounting, internal control, financial reporting, and tax problems. He also discovered that Citizens was continuing “misleading and fraudulent” marketing practices. After voicing his concerns that “this is fraud”, the complaint says was fired without the audit committee even addressing the issues he raised.
Similarly, the account of Citizens former Chief Actuary discusses Citizen’s ongoing efforts to deceive policyholders and investors. For example, he discovered that: “the sales team was permitted to input any stock projection information they wanted into marketing documents and spreadsheets provided to their clients” (page 12). After raising a multitude of concerns, including the legality of funneling money from policyholders into Citizens stock, the complaint says he was fired.
Citizens Creates a Secret Irish Subsidiary to Dodge Tax and Avoid Insolvency (“The Irish Solution”)
In March 2015 Citizens indefinitely disbanded its quarterly conference calls after disclosing that most of its policies were not compliant with U.S. tax law (known as 7702 noncompliance). According to the complaint, Citizens was aware that this put its “entire business operations in doubt” because “current and future policyholders suddenly found themselves on the hook for tax payments which were and continue to be sold by brokers as tax-exempt”.
During his 25 day tenure, the complaint explains how the now-former CFO quickly discovered that Citizens reserve for its tax liabilities was “deficient by at least $80 million”. To put this in perspective, our initial report calculated that Citizen’s tangible equity was only $59 million with statutory equity (a regulatory capital calculation) of approximately $90 million. Thus, Citizens clearly can’t afford to reserve this amount of money without risking insolvency.
But before the IRS could audit Citizens, management concocted what was internally dubbed the “Irish Solution” of quickly forming a subsidiary in Ireland in an effort to “avoid any U.S. tax liabilities and regulations”.
The CFO voiced concerns that Citizens “could not simply avoid the IRS by moving CICA to Ireland”, but the complaint states that a Citizens executive declared that “if we don’t get the Irish solution, we’re going to have to shut the doors”. Unsurprisingly, the complaint elsewhere confirms that Citizens is now under an IRS investigation.
Citizens has not disclosed the “Irish Solution” to investors and the 10-K specifically omits any reference to having an Irish Subsidiary. However, we were able to corroborate the complaint’s assertions with records (below) obtained from the Irish Government’s corporate registry. The records prove the existence of a CICA Life entity in Ireland (CICA is the name of Citizen’s primary operating business).
Self-Dealing and Accounting Irregularities
Other major new allegations in the complaint include how the company “lied and covered up” Rick Riley’s creation of an undisclosed insurance policy that paid himself a six percent guaranteed return.
The complaint also highlights the CFO’s discovery that “certain receivables had not been paid since 2011” and yet had not even been tested for impairments (page 17). We find this revelation especially relevant because Citizen’s balance sheet carries $67 million in receivables related to policy loans. These balances reflect a feature whereby the company is automatically paying premiums for policyholders by making loans against the value of their accounts.
Because Citizen’s policy loan receivables have surged by 80% over the past five years to now exceed tangible equity, we have theorized that they are being used by management as an accounting gimmick to artificially suppress policy surrender rates and juice the financials. If the loans inside this portfolio are subject to undisclosed impairments, then Citizens financial position might be even worse than we initially believed.
The complaint states that Citizens is “currently under investigation by the Securities and Exchange Commission” and that “eventually, even the company’s auditors had seen enough and resigned”. Prior to E&Y’s recent resignation, the complaint reveals that KPMG had resigned “due to a disagreement with some of Citizens executives” (even though Citizen’s 8-k claimed it had dismissed KPMG and failed to disclose any disagreements).
Disclosure: I am/we are short CIA.