A lawsuit causes scrutiny of insurance, trust and disclosure practices.

Estate planning professionals are closely watching a lawsuit against a renowned attorney to see just how far it might go in setting a legal precedent regarding an estate planning attorney's duties when putting together a plan for a client.

A group of wealthy families, angry over what appears to be an advanced estate planning technique gone sour, are suing estate planning attorney Jonathon Blattmachr for fraud and conflict of interest relating to the insurance, trust and disclosure practices involved in the plan.

Blattmachr, a New York City-based attorney with Milbank, Tweed, Hadley & McCloy LLP, rose to estate planning prominence and spent much of the past seven years by putting together family reverse split-dollar plans for wealthy clients. The arrangements, which allow policyholders to sidestep much of the gift tax they would otherwise pay on insurance premiums paid into a policy for beneficiaries, were tentatively greenlighted by the Internal Revenue Service in a 1996 ruling obtained by Blattmachr and insurance broker Michael Brown.

Ironically the suit, which names Blattmachr, Brown and others, does not cite the reverse split-dollar arrangements, but rather a host of insurance, trust and conflict-of-interest issues. While the plaintiffs' attorneys at Anderson Kill & Olick in Philadelphia told Financial Advisor magazine that they reserve the right to include the arrangement in the suit in the future, the plan itself has not been audited by the IRS, making it difficult to show related damages.

The lawsuit raises a number of issues critical to estate planning professionals. For instance, is it an estate attorney's responsibility to ensure that insurance policies, especially multi-million dollar policies, are competitive in terms and price? Is it his responsibility to see that lower insurance premiums are negotiated or that private placement quotes are obtained? What should happen if the attorney represents the insurance brokers who are shopping for the policy, but then decides to excuse himself from all responsibility for the recommended policy, its costs and its suitability?

These and other issues could be decided in a suit being brought by New York real estate magnate Charles B. Benenson and his wife, Jane. At one time, Benenson made the Forbes 400 for his lucrative real estate investments. Blattmachr was the Benensons' attorney for several years before offering them the arrangement in early 2000 as a way to reduce gift and estate taxes.

After a scathing July 29, 2002, report in The New York Times describing how Blattmachr and his mega-wealthy clients were using the arrangements to shelter assets from taxes, the IRS waited just 18 days to issue Notice 2002-59 on August 16. The notice says that under reverse split-dollar arrangements, "one party holding a right to current life insurance protection uses inappropriately high current term insurance rates, prepayment of premiums or other techniques to confer policy benefits other than current life insurance protection on another party. The use of such techniques by any party to understate the value of these other policy benefits distorts the income, employment or gift tax consequences of the arrangement and does not conform to, and is not permitted by, any published guidance."

In effect, the notice closed the loophole that estate-planning attorneys such as Blattmachr had been using to encourage America's wealthiest families to buy super-sized insurance policies for the benefit of heirs. The basic reverse split-dollar technique allowed clients to use government tables or insurers' own published premium tables to reduce to minimum levels the premiums they had to report for purposes of paying gift taxes. In some cases, however, the actual premiums the families were "gifting" were tenfold or more than what they were reporting.

Alarmed by the report and alleging that Blattmachr and the other parties in the deal weren't returning phone calls, the Benensons retained counsel. The suit against Blattmachr and related parties was filed in Los Angeles Superior Court on June 5, 2003.

Also named in the suit, which alleges breach of contract, fraud and conflict of interest, are: Blattmachr's law firm, Milbank, Tweed; the insurance companies that sold the policy, Massachusetts Mutual Financial Group and its subsidiary, CM Life Insurance; insurance brokerage firms Spectrum Financial Network Insurance and Investments LLC and Executive Compensation Group; and insurance agents Louis and Amie Kreisberg of Executive and Michael Brown of Spectrum. Except for Blattmachr and the firm of Millbank, Tweed, none returned calls seeking comment.

The lawsuit alleges that Blattmachr and his firm failed to disclose a host of conflicts of interest and to act in the clients' best interest in doing due diligence on the insurance the Benensons purchased. Also at issue is the nearly $5.5 million in fees and commissions the Benensons paid, and the fact that the policy is now underfunded by $1.5 million. An expert insurance agent the Benensons and their attorneys hired says private placement of the $60 million insurance policy that is at the heart of the lawsuit would have cost the Benensons $600,000 in commissions, rather than the $4.4 million they paid. Blattmachr and his firm were paid an additional $970,000 to render a tax opinion on the arrangement.

"It's fair to say that the clients feel they've been had," says their attorney, Eugene Anderson, of Anderson Kill, a national law firm that specializes in representing insurance policyholders (and which once employed former New York mayor Rudolph Giuliani). "The New York Times article was probably the nail in the coffin for them," Anderson says.

Blattmachr referred a request for comment to Steve Blauner, an attorney at his firm. "The lawsuit against Jonathon Blattmachr and Milbank Tweed is patently absurd," Blauner says. "It will of course be vigorously defended, and we are completely confident that we will prevail in court. The Benensons' complaint falsely characterizes Mr. Blattmachr as having played the role of an insurance salesman, and then complains about the insurance product that the Benensons acquired. Neither Milbank nor Mr. Blattmachr had anything to do with the Benensons' choice of insurance product. The allegations in the complaint as to Mr. Blattmachr and Milbank are totally false."

Blauner declined to comment when asked if the firm's attorneys regularly recommend insurance providers and agents, or perform due diligence on policies, when they put insurance-based estate plans in place.

Eugene Anderson, one of the Benensons' attorneys, says Blauner's take on the situation "simply does not fit the facts. The family was sold a package that was put together and sold by packagers including Mr. Blattmachr."

"This case is about the marketing and sale of the policy and the disclosures not made," adds the Benensons' co-attorney, Virginia Miller, also of Anderson Kill.

The Benensons approved the purchase of a $60 million life insurance policy on Jane Benenson, age 81, in August 2000. The lawsuit states the Benensons were supposed to pay approximately $23.5 million in premiums in the first three years of the policy, and get back $3.7 million as a partial surrender. The death benefit was due to decrease from $60 million to a constant $48.5 million in year four.

What could go wrong? To obtain lower premiums and meet MassMutual's requirements (the company does not issue such policies on those over age 80 and Jane was age 81 at the time the policy was being underwritten), the policy was backdated more than one year. MassMutual underwriters made a note of the request for backdating in the Benensons' file, ultimately approving it. The plaintiffs, however, are alleging that backdating the policy, a practice more common in the insurance industry than many would admit, changed the amount the policy would cost and pay out. For instance, the backdating triggered the need for an additional two years worth of premium payments that the Benensons maintain they were never told about. They also allege that the backdating, and the costs associated with it, was not in the policy illustrations they were given.

As a result, the Benensons contend, the defendants misrepresented the future annual cash values and death benefits of the policy. In addition, they were not able to take the $3.7 million partial surrender allegedly promised them without seriously impairing the policy, according to the lawsuit. To keep the policy from lapsing, the need for additional premiums of $1.5 million also surfaced. The Benensons maintain they were not aware of any of these issues until one of their agents, Louis Kreisberg, asked for an additional $577,616 premium in June 2001. The suit maintains that "despite being on notice of the discrepancies with the Benensons' policy, the defendants did not fully investigate or respond to the material discrepancies" that were brought to their attention.

The Benensons are also claiming that spreadsheets they were given, which were supposed to detail competing policies, instead contained underwriting information that was advantageous to MassMutual in a manner that effectively violated California's insurance code, according to the lawsuit. (The Benensons are California residents, but Benenson is chairman emeritus of Benenson Capital Partners LLC, based in New York City. Since 1933, he has been actively engaged in the development, ownership and rental of residential, commercial and industrial property in the United States, Canada and Europe.)

The Benensons are also alleging that they were told they would pay commissions in the $2 million to $2.5 million range, when in fact the sales commissions cost them $4.5 million. They also allege that Blattmachr and Kreisberg told the Benensons that Milbank's $970,000 fee for rendering a tax opinion would be credited to the insurance policy, but they say it never was.

The plaintiffs also allege that Blattmachr used an Alaska-based trust company while failing to disclose that it is owned by his brother, or that the state tax benefits he allegedly promised as a result of setting up the trust in Alaska were not available because of the size of the insurance policy in question.

The Benenson suit makes no claim that Blattmachr or his firm shared commissions with the agents who sold the life insurance policy in this case. But some people in insurance, trust and estate planning circles who asked not to be named say that when Blattmachr helped other law firms package similar deals-as many as 40 such arrangements in total-he may have shared in commissions. That may not be illegal, but lack of disclosure regarding the compensation may have violated certain fiduciary obligations and American Bar Association rules requiring disclosure of fee-splitting, says Daniel Evans, an estate planning attorney in Wyndmoor, Pa. In fact the pivotal role that such disclosure, or the lack thereof, will play in this case is the one thing on which attorneys and advisors across the country seem to agree.

Experts also question where the line will be drawn on Blattmachr's and his firm's scope of engagement and responsibility for performing due diligence and commission negotiation on behalf of the Benensons.

"I do think this hinges on disclosure," says Alabama investment advisor Stewart Welch, who adds that the responsibility of estate attorneys can vary depending on whether they are doing arms' length referrals to insurance agents or others or are packaging entire arrangements as central figures. "I would suggest attorneys do not have zero responsibility if they're bringing parties together," says Welch, who, as president of the Birmingham Estate Planning Council, escorted Blattmachr to one of the group's meetings in May 2002.

At the time, no one could have foreseen that Blattmachr, who discussed the benefits of reverse split-dollar arrangements at the seminar, would be the subject of such a lawsuit, but Welch says today that it was obvious to most of the people who heard Blattmachr speak that his recommendations were fairly aggressive. "There's nothing wrong with aggressive, as long as you understand and are willing to accept the risks," says Welch, president of Welch Group. He finds himself advising some of his own clients to seek redress for questionable insurance-based estate planning arrangements sold to them by outside vendors. "Sometimes it's clear that these deals were commission-motivated and just won't work, so we're advising clients on their options," he says.

Arnold H. Graf, an estate attorney and president of Nebsco Financial Services in Newtown Square, Pa., says: "The cautionary tale here is full disclosure. I think this one blew up in their faces, bad. The tax-shelter deals have persistently been denied by Uncle Sam. I'm surprised they don't settle. I'd predict that's what will happen with MassMutual. I just don't see winning this kind of thing."

Says New York City estate planning attorney Gideon Rothschild, who is a partner with Moses & Singer and chair of the American Bar Association Committee on Asset Protection: "The lesson to be learned is that if you're pushing the envelope too far, there may be consequences you don't want to live with, like seeing yourself in The New York Times, or served with a complaint, or losing your livelihood to practice law or sell insurance. We don't issue tax opinion letters because of the liability. But there are those who are willing to quantify the risks if the price is high enough."

Rothschild maintains, however, that it is not an attorney's responsibility to evaluate insurance policies that go into a trust. "If an agent doesn't do it, then I think the valid claim is against the agent," he says.