The name is bond, fake bond

Trump and the NY AG agreed to a weird arrangement for the bond in his civil fraud case. Here's what happened.

There is nothing normal about a Donald Trump case. Nothing is ever done by the book. There is always something weird, something off. This was on display yet again yesterday in the latest episode in the New York AG’s civil fraud case against Trump — you know, the one where the Trumps lost a judgment for $464 million for issuing phony inflated financial statements on their properties for over a decade.

Well, Trump struck a deal with the AG yesterday on the bond for the appeal, and let’s just say it was unorthodox. But there may be a silver lining here.

Here’s what happened so far:

Trump is appealing that $464 million judgment, but in the meantime, to stop the AG from collecting on said judgment, Trump was required to do one of two things: (a) post the amount with the court, or (b) produce a bond from a third party, in effect promising to pay the amount even if Trump doesn’t. This procedure is generally required in civil judgments, so that the court is assured that the defendant will pay the judgment if he ultimately loses the appeal.

Trump whined and moaned and kicked and screamed (as he does), and, sadly, the Appellate Division, First Department, agreed with him partially, lowering the amount of the bond required here to $175 million. (This also is unfortunately a harbinger of what’s to come, as the First Department — the intermediate state appellate court that covers Manhattan — will now likely lower the amount of the judgment on the appeal, I believe, but that’s a topic for another time.)

Then Trump managed to produce a bond, but not from an entity anyone was expecting: Knight Specialty Insurance, which does not usually underwrite surety bonds at all and seems to have gotten involved mostly because its principal, Don Hankey, is a Trump supporter (and, fittingly, has been investigated for massive frauds of his own).

The AG then challenged the bond, arguing that it had numerous flaws.

And it turned out that that was a massive understatement.

Simply put, Knight does not appear to have the funds to cover the bond. If they had to pay the $175 million tomorrow, they’d likely have to borrow part of it. Or maybe all of it!

Solvent insurance companies have what is called a policyholder surplus: the amount of policyholder assets, minus the liabilities owed. On first glance, Knight does have a policyholder surplus — of $138 million.

And if that number sounds suspiciously low given the circumstances here, why yes, you’d be right, Sherlock. Turns out $138 million is less than $175 million.

But wait, there’s more. New York law requires that an insurer not take on a single risk in excess of 10% of its policyholder surplus. For Knight, that means a maximum risk size of $13.8 million.

So by purporting to take on Trump’s bond, Knight has assumed a risk 1260% greater than what it is allowed to under New York law.

Oh, but then it gets even worse. Turns out that Knight may engage in what New York regulators have deemed “shadow insurance,” using an affiliate in the Cayman Islands (which does not exactly take a strong approach to regulation) to reduce its liabilities by $366 million.

So Knight’s purported $138 million policyholder surplus may in fact be a deficit of $191 million.

This is classic Trump, I have to say. Trump found the Trump of insurance: an insurer that itself may be cooking the books, cash-strapped, surviving on a sleight of hand that constitutes shenanigans at best and might be outright fraud.

So what did Trump and New York AG agree to? The collateral that Trump put up for the bond is a brokerage account that purports to contain $175 million worth of assets, which Trump characterizes as “cash” but are really in the form of fixed-income bond assets. Trump still controlled the account, and there was only a very shaky procedure in place to ensure that the account would retain $175 million worth of value. Now, under the agreement reached yesterday, Knight will control the account, and there are safeguards in place to make sure that the value cannot dip below $175 million.

If this all sounds strange, it’s because it is. An insurer is supposed to backstop the bond, promising to pay it if the defendant does not. Here, Knight does not appear to have the proper financial resources to pay the $175 million and would have to rob Peter to pay Paul. Instead, Trump has put up the collateral and is serving as his own surety — which is forbidden under New York law.

It also defies common sense. Why have a surety at all if the surety is, if anything, even more shaky than the defendant?

Knight is not really a surety, promising to pay. Knight is basically acting as a trustee, merely watching over the collateral and making sure it does not disappear or depreciate. And a trustee of Trump’s own choosing, rather than one mutually agreed upon by the parties.

This is even more cockamamie when we remember that there is already effectively a trustee in this case — the court-ordered monitor, Barbara Jones, a retired federal judge. Jones is already tasked with watching over the Trump Organization. She, not Knight, should be the one overseeing the collateral Trump has posted.

So we are left with a mixed outcome. Trump has at least been forced to surrender control over $175 million of assets, which are now basically being put into a vault while the appeal is pending. But Trump got to choose the security guard to watch over the vault.

I hope the court is prepared to keep a close eye on Knight in this situation. The fox appears to have picked another fox to watch over the henhouse.