How Insurance Spat Further Frayed U.S.- French Ties

By John Carreyrou and Glenn R. Simpson | 16 April 2004 | The Wall Street Journal


When Executive Life collapsed in the early 1990s, the big California insurer became an emblem of the excesses of the junk-bond era. Today, it has morphed into a symbol of something else: the tattered Franco-American relationship.

In a highly humiliating move, the French government was recently forced to plead guilty in U.S. District Court in California to fraud in connection with French bank Credit Lyonnais's 12-year-old acquisition of the U.S. insurer. It was a costly admission: The plea negotiated with American prosecutors came with a $770 million fine -- the biggest criminal settlement in U.S. history.

Credit Lyonnais admitted it had circumvented laws barring it from owning a U.S. insurer by using a consortium of French investors to buy Executive Life and its ailing bond portfolio. When the bonds rebounded, the bank and French billionaire Francois Pinault reaped a $2.54 billion profit. France itself also was tarnished because a French government agency admitted it had helped cover up the fraud.

The case has tracked the steep decline in French-American relations during the Bush administration. Initially seen as an obscure affair, the dispute became so charged that it aggravated the rift between Paris and Washington opened by last year's diplomatic clash over Iraq. At one point, a congressman accused French investors of feasting on "wine and brie" with their gains from the Executive Life deal.

Now, the Executive Life scandal is entering a second stage in which the financial stakes are even larger. In a civil lawsuit that goes to trial next February, California's insurance regulator is seeking up to $5 billion from France, Credit Lyonnais and Mr. Pinault, the majority owner of Gucci. The French vow to fight the civil suit, but their guilty pleas in the criminal proceeding and the exclusion from the settlement of key individuals may leave them vulnerable to a big verdict from a U.S. jury.

The stakes for Mr. Pinault are huge. The California Department of Insurance is seeking around $2 billion from him. An unfavorable verdict could force him to liquidate chunks of his empire, which also includes auction house Christie's and French retailer Pinault-Printemps-Redoute SA.

The criminal case "was a shadow-box," says George J. Terwilliger III, an American lawyer representing the French government. "It's all about the civil case." He believes the plea agreement minimizes French liability in the civil case because it didn't contain an admission of defrauding the state of California.

Mr. Pinault's lawyers play down the likelihood of the tycoon losing the civil case and having to sell any of his assets. They say he will prove that the California Department of Insurance knew what Credit Lyonnais was doing and chose to turn a blind eye to it so that Executive Life could be saved.

The twisted tale has highlighted the very different legal cultures of the U.S., which strives to keep the courts free of political interference, and France, whose leaders often intervene in sensitive cases despite a nominal separation of powers. Paris repeatedly tried to get the case solved at a political rather than a judicial level, and insisted that any settlement involve Mr. Pinault, a close friend of French President Jacques Chirac.

The French refuse "to understand what they are up against," says Gary Fontana, a private lawyer for the California regulator who is handling the civil suit on a contingency basis. "They have been in clinical denial and still are." The French camp dismisses Mr. Fontana as a greedy trial lawyer and his client's lawsuit as an extortion attempt.

The criminal phase of the case battered the already strained friendship between France and the U.S. French government officials say they grew convinced that the Bush administration was using the case to punish France for opposing the war in Iraq. For Paris, the sting is especially sharp because a big chunk of the settlement is being paid by French taxpayers, who already financed Credit Lyonnais's huge state bailout in the mid-1990s.

The affair began in 1991 when high-flying Executive Life collapsed under the stewardship of Frederick Carr, an associate of fallen junk-bond king Michael Milken. Mr. Carr invested the premiums of Executive Life policyholders in junk bonds, whose value plunged when the U.S. economy tanked.

The insurer's troubles caught the eye of Credit Lyonnais, then owned by the French state. One of the world's largest banks at the time, Credit Lyonnais thought the bonds would rebound and result in a windfall. So when the California Department of Insurance, which oversees the state's insurance industry, auctioned off Executive Life and its bond portfolio to salvage the insurer, Credit Lyonnais wanted to buy them.

But several U.S. laws forbade the French bank from doing so. At the time, the Glass-Steagall Act barred banks from owning nonbank entities such as insurance companies. California law also made it illegal for a bank controlled by a foreign government to own an insurance company in the state. Knowingly violating those laws would amount to criminal fraud, carrying heavy fines and even jail sentences, and could get Credit Lyonnais expelled from the U.S.

To get around these restrictions, Credit Lyonnais arranged for a consortium of other French investors to do the deal. But, under secret agreements allegedly hidden from U.S. regulators, Credit Lyonnais was the true buyer, according to court documents. Later, it resold the insurance company and part of the bonds to Mr. Pinault, the documents show.

Credit Lyonnais's subterfuge became known in late 1998 when a French whistleblower tipped off the Department of Insurance, according to lawyers involved in the case. The Federal Reserve Bank of New York and the U.S. Attorney's office in Los Angeles launched investigations. The Los Angeles probe was spearheaded by a dogged assistant U.S. attorney named Jeffrey Isaacs.

The whistleblower, whose identity remains secret, agreed to be a witness in the separate civil lawsuit filed by the Department of Insurance. The department's hulking 6-foot 6-inch attorney, Mr. Fontana, became the French camp's biggest nemesis. He argued relentlessly that Credit Lyonnais and Mr. Pinault earned their huge profits at the expense of Executive Life policyholders.

By 2001, Mr. Isaacs, the assistant U.S. attorney, had developed a criminal case against Credit Lyonnais and a French government agency called Consortium de Realisation, or CDR, set up in 1995 to assume Credit Lyonnais's liabilities. CDR, in Mr. Isaacs's view, had covered up the fraud after finding out about it. But Paris shrugged off the case. It couldn't understand why U.S. prosecutors would get worked up about what it saw as a minor transgression, say lawyers for the French government and for Credit Lyonnais.

France argued that the defendants shouldn't be penalized for lightly bending U.S. laws, especially since one of them, the Glass-Steagall Act, was later repealed. It also contended that Credit Lyonnais's acquisition of Executive Life spared California a much greater calamity -- the insurer's bankruptcy. But those arguments didn't persuade U.S. prosecutors, who considered the act of lying to regulators and later covering it up as grave crimes.

As Mr. Isaacs got the case into high gear in 2002, U.S. Reps. Doug Ose and Jerry Lewis, both California Republicans, took a keen interest. Some of their constituents were Executive Life policyholders.

"French billionaires pocketed roughly $2 billion at the expense of American policyholders and are now dining on wine and brie, cruising the French Riviera in their fancy yachts and living in big mansions while the American victims of this case are selling their homes and finding it hard to pay the bills," Rep. Ose declared at a congressional hearing in October 2002.

The congressional committee invited several disabled Executive Life policyholders to the hearing. They told heart-rending tales of poverty. In reality, the disabled represented 1.5% of Executive Life's 330,000 policyholders, lawyers for both sides say. The rest were mostly affluent Californians. Moreover, most of the policyholders recouped much of their losses from an insurance-industry protection fund.

By early 2003, Presidents Bush and Chirac were on a collision course over whether to go to war in Iraq. Around that time, Mr. Isaacs's boss, Los Angeles U.S. Attorney Debra Yang, informed France of her plans to indict Credit Lyonnais and CDR.

Jean-David Levitte, the French ambassador to the U.S., tried to convey back home the need to solve the case before it escalated, one lawyer who worked with him says. But Paris continued to downplay it. France "couldn't accept that there was not a political solution," this lawyer says. A spokeswoman for the French embassy in Washington declined to comment.

In July 2003, Mr. Isaacs obtained secret indictments on charges of fraud against Credit Lyonnais, CDR and several French bankers and businessmen from a grand jury. If the indictments were unsealed, the New York Fed would likely strip Credit Lyonnais of its U.S. banking license, crippling its business just as it was being acquired by domestic rival Credit Agricole to form one of Europe's biggest banks. CDR's indictment also meant the French state would be a defendant in a U.S. criminal trial.

The French went to the bargaining table. After weeks of talks, Credit Lyonnais and CDR agreed in early September 2003 to guilty pleas on some charges, plus $575 million in penalties. The criminal case appeared over.

But Mr. Pinault, the French tycoon, had been left out of the settlement and remained exposed to prosecution. Furious, he publicly called on France's parliament to investigate in an opinion piece in a French newspaper.

(MORE)

Mr. Fontana, the lawyer handling the civil case for the Department of Insurance, had his own reason to dislike the deal: It included former Credit Lyonnais Chairman Jean Peyrelevade. Without a major defendant from inside the bank such as Mr. Peyrelevade going to trial, evidence developed by prosecutors showing the bank covered up the fraud wouldn't enter the public record. Mr. Fontana needed that evidence for his civil suit. So, he says in an interview, he sent Mr. Isaacs a memo obtained in his research. The document, initialed by Mr. Peyrelevade, allegedly proved that Mr. Peyrelevade knew of the fraud as early as 1994.

As Mr. Fontana hoped, the memo's disclosure prompted Mr. Isaacs to exclude Mr. Peyrelevade from the settlement. Mr. Pinault seized on that to lobby Paris to kill the deal. No settlement would be airtight, the tycoon argued, unless it included everyone on the French side, according to people familiar with the matter.

The billionaire's friendship with President Chirac gave weight to his lobbying, according to a French government official. The two have been close ever since Mr. Pinault rescued a bankrupt sawmill in Mr. Chirac's parliamentary district in 1981.

Mr. Pinault's efforts to scuttle the deal got a boost in early October. The French justice ministry received a request from U.S. prosecutors to arrest and extradite four French nationals indicted in the case. The move infuriated Paris. "The U.S. attorney in California is treating the French state like the Cali [drug] cartel," fumed a high-ranking French finance ministry official.

Paris pulled out of the criminal settlement. By then, French politicians and commentators were accusing the U.S. of bullying and trying to extort France. "We'd like to speak with responsible people," bristled French Finance Minister Francis Mer, according to a press account of a public statement.

In what was widely interpreted by the French press as a reprisal, word leaked that French prosecutors had opened a probe into allegations that a consortium involving Halliburton Co. paid bribes in connection with a Nigerian gas contract when U.S. Vice President Dick Cheney ran the company. Halliburton has denied wrongdoing.

France also launched a campaign to get the case solved politically. Justice Minister Dominique Perben paid a visit to U.S. Attorney General John Ashcroft. Mr. Mer, the finance minister, who has since left office, buttonholed U.S. Treasury Secretary John Snow three times on the subject, including once at a secret meeting in a Paris hotel, according to U.S. and French officials. Each time, word came back that the matter was in the hands of Ms. Yang, the U.S. attorney -- and Washington wouldn't interfere.

Francois Perol, a deputy to Mr. Mer, led a last-ditch French delegation to Los Angeles to negotiate directly with Ms. Yang. Mr. Perol joked to Ms. Yang that she had become a celebrity in France because her picture had appeared in all the papers, and he offered to send her a book of her press clippings, says a person familiar with the matter.

The ice was broken, but the talks faltered over Mr. Pinault. Ms. Yang had agreed to let the billionaire avoid a guilty plea. But she wanted him to pay a big fine as punishment for allegedly knowing about Credit Lyonnais's deception and never reporting it. Mr. Pinault balked, and the French went home empty-handed.

On Dec. 10, 2003, Mr. Pinault finally came around to Ms. Yang's terms -- a $185 million fine -- hours before she was due to unseal the July indictments. The next day, Paris announced it had obtained a settlement that protected all French parties -- except Mr. Peyrelevade, the former Credit Lyonnais chairman.

Opposition leaders accused Mr. Chirac of playing favorites with his friend Mr. Pinault. And Mr. Peyrelevade, who maintains his innocence, says in an interview, "I was abandoned at the last minute by the French government, namely by the finance minister."

Mr. Chirac has said publicly that France acted with only one goal in mind: to protect the state and taxpayers. In a radio interview, Francois-Henri Pinault, Mr. Pinault's son and CEO of their family investment company, called the suggestion that Paris favored his father "shocking and insulting to the president." He added: "We're not living in a banana republic."

The mistrust between Paris and the U.S. attorney's office in California was so thick that when it came time to ratify the Dec. 10 settlement in court early this year, Mr. Isaacs and Ms. Yang vowed to hold up the deal until the last penny owed by the French state was in the bank. The French government refused to pay until it was sure a U.S. judge approved the deal.

The deadlock was broken on Jan. 21, when the Bank of France opened in the middle of the night to wire $375 million to the U.S. Treasury. Across the world in a Los Angeles courthouse, U.S. prosecutors and regulators and the French camp's lawyers frantically worked their cellphones to check that the money had arrived. Word finally came around 3:30 a.m. Paris time.

With Mr. Peyrelevade now facing a criminal trial, the Department of Insurance is poised to get more evidence for its civil suit. France, Credit Lyonnais and Mr. Pinault say the civil suit is without merit and promise to fight it vigorously. But CDR's and Credit Lyonnais's guilty pleas to several counts of fraud in the criminal case, and the evidence that may emerge from Mr. Peyrelevade's trial, could undermine much of their defense. A loss in the civil case would mean another major hit to the French taxpayer.

Mr. Fontana, meanwhile, the private lawyer representing the Department of Insurance in the civil suit, stands to make a fortune. He says the French state and Credit Lyonnais have never made any offers to settle the civil case. Mr. Pinault's camp says there have been talks about settling his part of the case, but Mr. Fontana says he laughed off the offers as too low. The civil trial is set for Feb. 15, 2005.

---


A Costly Deal

Breakdown of the $770 million fine paid by the French to settle the
Executive Life criminal case, in millions of dollars

French government ............. $375
Credit Lyonnais ............... $200
Francois Pinault .............. $185
MAAF* ......................... $10

*French insurer that Credit Lyonnais allegedly used to hide its ownership
of Executive Life and its junk bonds.

Source: U.S. Attorney for the Central District of California