2010 plus international conference the fraud monster: the effects of fraud on professional lines...

2010 PLUS International Conference2010 PLUS International Conference

The Fraud Monster:The Effects of Fraud on

Professional Lines Coverage

2010 PLUS International Conference

The Round Up…

MODERATOR:• Peter J. Biging, Esq., Partner, Lewis Brisbois Bisgaard

& Smith LLP (New York, NY)

PANELISTS:• Serge Adam, Esq., Managing Claims Attorney, Monitor

Liability Managers, Inc.

• Sally Combs, Technical Director - Professional Liability Claims, Fireman’s Fund Insurance Company

• Timothy J. Covello, JD, President, AXIS PRO, AXIS Insurance

2010 PLUS International Conference

Introduction

“No drug . . . causes the fundamental ills of society. If we’re looking for the source of our troubles, we

shouldn’t test people for drugs, we should test them for stupidity, ignorance, greed and love of power.”

- P.J. O’Rourke

“His lack of education is more than compensated for by his keenly developed moral bankruptcy.”

- Woody Allen

2010 PLUS International Conference

What’s Up…

• What is the impact of fraud on various business sectors?

• What is the impact of SOX on the detection of corporate financial fraud?

• What are key trends from SEC enforcement proceedings?

2010 PLUS International Conference

Impact of Fraud on the Economy

• Jobs

• Corporate Investment

• Distortion of Resource AllocationAmongst Firms

2010 PLUS International Conference

Does Fraud Go Up or Down Relative to the Economy?

• Prevailing Opinion

• Impact of Fraud on Various Business Sectors

2010 PLUS International Conference

Fraud Across Multiple Business Sectors

• Top 3 Business Sectors for 2008 were:

Natural Resources

Construction and Engineering

Financial Services

2010 PLUS International Conference

Fraud Across Multiple Business Sectors for 2009

• Top 3 Business Sectors for 2009 were:

Financial Services

Retail and Wholesale Distribution

Healthcare, Pharmaceuticals and Biotechnology

2010 PLUS International Conference

Prevailing Views on Who has Primary Responsibility to Detect Fraud

• Legal View

• Finance View

2010 PLUS International Conference

Fraud Detectors

• SEC

• Lawyers

• Journalists

• Auditors

• Analysts

• Employees

2010 PLUS International Conference

Compare Pre-SOX and Post-SOX

• SEC

• Lawyers

• Journalists

• Auditors

• Analysts

• Employees

2010 PLUS International Conference

Incentives for Whistle blowing

• Altruism

• Reputation

• Career

• Money

• Revenge

2010 PLUS International Conference

SEC Fraud Investigation Trends

• During 10 year period 1998-2007, the SEC alleged fraud involving 347 companies as described in 1,335 individual AAERs

• By comparison, the previous ten year study involved 300 companies described in 700AAERs

2010 PLUS International Conference

Key Characteristics of Fraudulent Companies

• Size• Exchange Listing• Primary Industry• Duration of Fraud• Location• Management• Fraud Techniques

2010 PLUS International Conference

Board Comparison of Fraudulent versus No Fraud Firms

• Size of Board

• Tenure

• Stock Ownership

• Audit Committee

• Experience

2010 PLUS International Conference

Underwriting Fraud

2010 PLUS International Conference

Underwriting Fraud

Question 12: Are you a lying, cheating grifter?

2010 PLUS International Conference

Underwriting Fraud

• If only there were evil people somewhere insidiously committing evil deeds, and it were necessary only to separate them from the rest of us and destroy them. But the line dividing between good and evil cuts through the heart of every human being. And who is willing to destroy a piece of his own heart?

Aleksandr Solzhenitsyn, The Gulag Archipelago, 1973 Mandy de Waal, The Psychology of Fraud, 2009

2010 PLUS International Conference

Underwriting Fraud

• Fraud Triangle Environmental Individual

• “Hot” Environments Securities and Commodities Fraud Mortgage Fraud Insurance Fraud

• Profile of a Fraudster

2010 PLUS International Conference

Underwriting Fraud

• Financial Fraud Predicting Material Accounting Misstatements

Stanford Law School-Securities Class Action Clearinghouse

PLUS

D&O Diary

2010 PLUS International Conference

Underwriting Fraud

• Liability Associated with Fraud Committed by Clients

Accountants Lawyers Central Bank of Denver and Stoneridge Investment

Partners Client Intake Insurance Agents

2010 PLUS International Conference

Policy Features and Claims Issues

2010 PLUS International Conference

“Fraud” Exclusion

“Based upon or arising out of any dishonest, fraudulent, criminal, malicious, intentional or willful act or omission by the Insured or any Loss expected or intended by the Insured;”

2010 PLUS International Conference

Guiding Maxim

“ The duty to defend is broader than the duty to indemnify…”

2010 PLUS International Conference

Excluded conduct “in fact”

Pendergast-Holt v. Certain Underwriters atLloyd’s of London (S.D. TX August 2010)

• Only a judge could decide if coverage was voided by CFO’s guilty plea to three felony counts and admission that the insured business was a fraudulent enterprise

• Carrier must defend until a lower court can formally decide the matter

2010 PLUS International Conference

“Final Adjudication”

“…this exclusion shall not apply unless there is a judgment, final adjudication or admission adverse to such Insured establishing that such Insured committed such conduct.”

2010 PLUS International Conference

Separation of Insureds/Innocent Insured

“…and applies only to the Insured who participated in, acted with knowledge of, or acquiesced to such conduct.”

2010 PLUS International Conference

Other Policy Provisionsand Concepts

• Definition of Wrongful Act

• Unjust Enrichment Exclusion

• Definition of Claim

• Fortuity Doctrine

2010 PLUS International Conference

Warranties

• Known Circumstances

• Severability

• Impact on Claims

2010 PLUS International Conference

Carrier Remedies

• Disclaimer of Coverage• Rescission based on Misrepresentation • Declaratory Relief Action• Reservation of Rights and Compromise

Settlement/Allocation• (Side Issue-Implications of “Shaving” for Excess

Layers)• Post-Adjudication Recovery

2010 PLUS International Conference

Fraud Issues for Defense Counsel

• What are defense counsel’s ethical duties/concerns in reporting to the insurer?

• What are defense counsel’s duties/responsibilities in regards to corporate client in addressing evidence of fraud by employee?

• What are defense counsel’s duties/responsibilities with regard to reporting of fraud by client to regulatory authorities?

• Can evidence of actual fraud be used as leverage in settlement negotiations?

2010 PLUS International Conference

Ethical and Moral Issues for Defense Counsel

• What can you report to insurance carrier?• Can you/must you report fraud to corporate client?• What, if any, obligations do you have to the victims

of the apparent fraud?• What, if any, obligations do you have to report the

fraud generally?• What do you do to navigate this sinking ship to shore

in the context of the litigation?

2010 PLUS International Conference

Questions&

Answers

2010 PLUS International Conference

Many Thanks To…

• Peter Biging

• Serge Adam

• Sally Combs

• Tim Covello