60 Minutes investigation of lawyers should caution the captive insurance industry, too

About two weeks ago, the popular Sunday evening investigative journalism program, 60 Minutes, aired a segment with Steve Kroft which purported to show “what happens when hidden cameras capture New York lawyers being asked to move highly questionable funds into the U.S.”  In short, CBS broadcasted video evidence that 15 out of 16 attorneys in Manhattan sat down to discuss legal strategies and techniques for a potential client – who purposefully hoisted a series of red flags - for laundering tainted, corrupt profits into the United States. The New York Times published a similar story.  Although the formation of a domestic or foreign captive insurer was never mentioned by name in either piece, both stories are a reminder of the importance of ethical conduct within the captive industry.

The CBS segment – largely shot with hidden cameras by the international non-profit Global Witness – showed German-accented man acting as a financial consultant for a potential client who was a mining minister of a west African nation. Global Witness was able to secure consultations with 16 lawyers in Manhattan, even though the consultations were set up by reading from a script purposefully designed to set off a number of red flags.

The representative of the potential client disclosed that the Mining Minister earned a salary similar to a teacher in the United States, but sought to transfer substantial sums – possibly over $300 million – into the United States in order to purchase real estate, a $10 million brownstone apartment, a Gulfstream jet, and commission a yacht. This money was “earned” by the fictional minister by awarding non-U.S. foreign mining companies favorable mining concessions in Africa.

Out of the 16 separate lawyers which were shown on hidden camera, only 1 attorney refused to continue the conversation with the potential client after a few minutes. Some of the attorneys seemed delighted at the prospect of the new client, and even began to discuss fee arrangements. The remainder of the attorneys, suggested 60 Minutes, gave general legal advice on the ways “that the suspicious funds could be moved into the U.S. without compromising the minister’s identity.” This included setting up a series of shell companies, both domestic and offshore or in European domiciles such as the Isle of Man or Lichtenstein, the use of straw men, the avoidance of large international (and regulated) banks, and the use of individual or small partnership money managers who are less concerned about corporate reputation. At one point, an attorney advised setting up a complicated transaction and then doing a test with an expendable amount of money – perhaps only $1 million – so that “if anything goes wrong, it’ll be painful, but it won’t be life threatening.” Another advised that it would be important to avoid banks and countries that are “vigilant about money laundering.”

The Global Witness report, and the accompanying 60 Minutes segment and NY Times story, are turning a bright light onto legal ethics. Only 1 out of 16 attorneys ended the consultation because of the red flags. Two others specifically told the potential client that, if they did go forward with the representation, “if [they became] aware that a crime was being committed, [they] have an obligation to report that.” That obligation stems from New York State Bar’s Rules of Professional Conduct.

Professionals in the captive insurance industry should always be aware of the same types of clients. In the investigation, the potential client even used the word “bribes” at one point, to describe how the funds were originally obtained. The red flags included:

• Government officials in the position to accept bribes;
• An intense desire for secrecy;
• No seemingly legitimate source of the income (recall that the potential client only earned a salary equivalent to a teacher in the United States, yet sought to purchase a $10 million brownstone);
• A requirement to move the money from where the corrupt proceeds were obtained (Africa) to where they can be enjoyed (the United States);
• The need for a number of financial intermediaries and professional assistance (rather than simply depositing the money into a large international bank).

 

Although there are no reported instances of captive insurance companies being used for money laundering, if the industry wants to continue building its reputation as a legitimate risk finance tool, it must remain vigilant about the potential for abuse. Towards that end, domestic state regulators typically already have the statutory authority to oversee the licensing and operation of captive insurers. Working hand-in-glove, captive professionals need to also be aware of the red flags raised above.

Similarly, the North Carolina Captive Insurance Association has adopted an aspirational Code of Professional Conduct. That Code has several canons of conduct which would apply if the fictional African mining minister or his representative appeared in your office. Canon 2 states that “[c]aptive professionals must not willfully violate any laws or regulations, in both their personal conduct and in their advice to clients. Captive professionals should be familiar with the laws of the domiciles where they advise clients and operate captives, as well as applicable federal law. Captive professionals should avoid conduct or activities that are reasonably certain to cause unjust harm to others.” Underlying this ethical canons is the commentary that professionals should conform their conduct to the policies, rules, laws, and regulations within the applicable jurisdiction; should not seek to aid, abet, or assist a client in the commission of a felony; and should not allow personal financial gain (the prospect of earning a large fee) from interfering with professional judgment and adherence to the law.

Most importantly, captive professionals should simply be aware that unscrupulous individuals are moving within the American economy and seeking professional assistance in the laundering of large sums of tainted money. No captive professional wants to be the focus of the next hidden camera investigation. For the good of individual professional reputations and for the good of the industry, professionals should be aware of the hallmarks of money-laundering, consider ethical codes of conduct, and apply common sense to any potential new client or proposed transaction.

Corporate duties of bank directors in North Carolina (part 3)

In Part 1, we introduced you to the history of Cooperative Bank and the background of Federal Deposit Insurance Corporation v. Rippy, 799 F.3d 301 (4th Cir. 2015), also known as FDIC v. Willetts. In Part 2, we further explained the history of the litigation. 


The Fourth Circuit’s ruling is in harmony with the majority of cases regarding the business judgment rule.
What the Fourth Circuit does not say is just as important as what it does. The Fourth Circuit does not say that the ultimate decision to make these 86 lot loans and 9 commercial loans was actionable. It did not rule that the business judgment rule prohibited making these failed loans. Instead, Rippy is in alignment with most other business judgment rule cases.

The FDIC had a qualified expert witness who testified that the process used to approve the loans, which ultimately soured, did not meet generally accepted sound banking practices. This was enough to rebut the presumption of the business judgment rule. The Court was not second-guessing the decision to make these loans; but it concluded that the officers had failed in the process of deliberation and consideration before funding the loans. In other words, judges “do not measure, weigh, or quantify directors’ judgments. We do not even decide if [a director’s judgment] is reasonable . . . Due care in the decision-making context is process due care only. Irrationality is the outer limit of the business judgment rule.” Brehm v. Eisner, 746 A.2d 244, 264 (Del. 2000) (emphasis in original) (and stating “irrationality” can equate with the waste of corporate assets test); State v. Custard, 2010 NCBC 6, 18 (N.C. Sup. Ct. 2010) (“North Carolina courts have frequently looked to the well-developed case law of corporate governance in Delaware for guidance.”).

Under North Carolina (and Delaware) law, absent bad faith, conflict of interest, or disloyalty, an officer or director’s business decisions “will not be second-guessed if they are the product of a rational process, and the officers and directors have availed themselves of all material and reasonably available information.” State v. Custard, 2010 NCBC 6, 18 (N.C. Sup. Ct. 2010) (citing In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 124 (Del. Ch. 2009). As quoted with approval by the North Carolina Business Court:

[C]ompliance with a director's duty of care can never appropriately be judicially determined by reference to the content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed. That is, whether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule-one that permitted an “objective” evaluation of the decision-would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests. Thus, the business judgment rule is process oriented and informed by a deep respect for all good faith board decisions.

State v. Custard, 2010 NCBC 6, 18 (N.C. Sup. Ct. 2010) (citing In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 124 (Del. Ch. 2009) (emphasis removed in part, added in part).

Courts will not second-guess the ultimate decision arrived at, so long as the procedure utilized by boards and officers is sufficient. Directors and officers are reasonably informed in making corporate decisions if they have considered the material facts to a transaction which were reasonably available at the time. Ehrenhaus v. Baker, 2008 NCBC 20 (N.C. Sup. Ct. 2008) (citing Smith v. Van Gorkom, 488 A.2d 858, 874 (Del. 1985).

Without expressly stating it, Rippy means that procedure matters. The officer’s failed to comply with recognized banking practices in obtaining loan approvals. When the officers failed to “avail themselves of all material and reasonably available information” they “did not act on an informed basis” and thus were not entitled to the protection of the business judgment rule.

The Fourth Circuit also ruled that the Great Recession was not an intervening or superseding proximate cause as a matter of law.

Intertwined and underlying the manager’s defenses is the narrative that the real estate bubble and financial collapse of the late 2000s was the real proximate cause of the bank’s failure or was an intervening or superseding cause. Indeed, the managers argued that the burden was on the FDIC to prove that the manager’s conduct in approving 86 loans, and not the exogenous factors of a nationwide real estate collapse, frozen credit markets, and a bank panic, was the real (proximate) cause of the bank’s failure. The Fourth Circuit took note of this argument, stating:

Certainly, it is convenient to blame the Great Recession for the failure of Cooperative, and in turn for the losses sustained by the FDIC-R when it took over the Bank. However, there is evidence in the record, as outlined above, that suggests that “in the exercise of reasonable care,” the Bank officers could have “foreseen that some injury would result from their acts or omissions, or that consequences of a generally injurious nature might have been expected.” Even before the Recession, exam reports from both of Cooperative’s regulators indicated that the Bank was utilizing unsafe practices. And while the Recession undoubtedly contributed to the failure of the Bank, it may have been only one of many contributing factors. This is a genuine issue of material fact, and thus this is a question for a jury.

This paragraph has particular salience. Under the Fourth Circuit panel’s opinion, the FDIC’s case survives summary judgment while admitting that the Recession “undoubtedly” was a partial proximate cause of the bank’s failure.

The Fourth Circuit also affirmed the entry of summary judgment on all claims of gross negligence against all directors and officers.

Settlement.

The panel remanded the case back to Judge Boyle for a trial on the ordinary negligence and breach of fiduciary duty claims against the officers. However, the Bank had the option of petitioning for en banc review before the full Fourth Circuit rather than just a three-judge panel.

Ultimately, on January 6, 2016, a consent order and settlement agreement were filed with the Court. The document stated that The Cincinnati Insurance Company would pay $4.1 million on behalf of the remaining defendants to settle all outstanding claims, and that "no additional funds will be sought from the remaining defendants."

Takeaways for bank directors purchasing D&O insurance

Corporate boards and officers, and particular bank boards and officers, should review and follow their internal procedures regarding corporate decision-making in accordance with Rippy. In addition, banks should always have adequate D&O insurance coverage to protect their directors and officers against these types of claims.

Bank directors and officers must also be aware of the FDIC’s recent warnings regarding the increased use of exclusions in commercial market D&O policies. The FDIC did not point out any particular exclusions, although it was most likely referring to the regulatory action exclusion. Post-recession litigation by the FDIC has already generated coverage litigation, some of which has upheld a broad regulatory exclusion in certain D&O policies.

In that statement, the FDIC has encouraged “each board member and executive officer to fully understand the answers” to at least four specific questions regarding D&O insurance coverage:

• What protections do I want from my institution’s D&O policy?
• What exclusions exist in my institution’s D&O policy?
• Are any of the exclusions new, and if so, how do they change my coverage? 
• What is my potential personal financial exposure arising from each policy exclusion?

The FDIC’s guidance also reminds bank managers that “FDIC regulations prohibit an insured depository institution or depository institution holding company from purchasing insurance that would be used to pay or reimburse an institution-affiliated party (IAP) for the cost of any civil money penalty (CMP) assessed against such person in an administrative proceeding or civil action commenced by any federal banking agency.” This prohibition prevents the purchase of insurance to indemnify the bank for paying civil money penalties on behalf of its managers. This would include penalties imposed when an officer or director violates a law or regulation, commits an unsafe banking practice, breaches a fiduciary duty, or engages in willful misconduct. The FDIC did not give any guidance regarding whether an individual manager can purchase their own personal umbrella policy to indemnify them for civil monetary penalties.

While this decision is interesting, it does not actually change the law in North Carolina regarding the legal liability of corporate directors and officers. What the opinion does is highlight the need for a bank’s directors and officers to follow their own procedures and for the bank to provide D&O insurance for its directors and offices in case these procedures were not followed.
A version of this article originally appeared in the Professional Liability Underwriting Society's Journal.
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11 Id. at 312.

12 Note that defendant Fredrick Willetts, III was both CEO and Chairman of the Board of Directors. He was both an officer and a director. The exculpation statute provides no protection to Mr. Willetts for violations of the duty of care committed as an officer.

13 Rippy, 799 F.3d at 313.

14 In this way, the business judgment rule operates as a standard of judicial review, and not simply as a standard of board and officer conduct.

15 Rippy, 799 F.3d at 316.

16 Advisory Statement on Director and Officer Liability Insurance Policies, Exclusions and Indemnification for Civil Money Penalties, FDIC FINANCIAL INSTITUTIONS LETTER, FIL-47-2013 (Oct. 10, 2013).

17 See, e.g., Reis et al. v. Federal Insurance Co.,No. CV 11-09835 RSWL (C.D. Cal. July 12, 2013).

UIM Coverage in North Carolina: A Novel Interpretation Rejected

In Bacon v. Universal Insurance Co., No. COA 15-370, decided on January 5, 2016, the North Carolina Court of Appeals was called upon to address an insurance company’s novel interpretation of North Carolina’s underinsured motorist statute. In an underinsured motorist (UIM) coverage case, the North Carolina Court of Appeals held that while the Plaintiff’s insurance policy with Universal had bodily injury limits of $1 million, his UIM coverage was only $50,000, not $1 million. 

Plaintiff was involved in an automobile accident sustaining serious injuries. The other driver, who was determined to be at fault, had an insurance policy with State Farm with limits of $50,000 which was tendered to the Plaintiff. Shortly thereafter, Plaintiff tendered an underinsured motorist claim to his own insurance company, Universal.

Plaintiff contended that because $1 million was the limit for bodily injury liability coverage under his policy with Universal, he was entitled to $1 million in UIM coverage based on the first clause of N.C. Gen. Stat. §20-279.21(b)(4) which reads as follows: “the limits of such underinsured motorists bodily injury coverage shall be equal to the highest limits of bodily injury liability coverage for any one vehicle insured under the policy.” Although there is language later in subdivision (b)(4) allowing the insured to purchase greater or lesser UIM limits, Plaintiff contended that that language contradicted the first clause and therefore the first clause should be given effect. Universal rejected Plaintiff’s claim and Plaintiff filed suit against Universal seeking a declaration that he was entitled to $1 million in underinsured motorist coverage. The trial court granted summary judgment for Universal and Plaintiff appealed.

On appeal, the North Carolina Court of Appeals rejected Plaintiff’s claim, stating that “it is clear that the statutory requirements that an insurance policy’s UIM coverage ‘shall be equal to the highest limits of bodily injury coverage for any one vehicle insured under the policy’ … is only applicable when the insured does not select a greater or lesser limit. The act provides a default UIM coverage limit in an amount equal to the bodily injury limit under the policy (up to maximum limits of $1 million per person and $1 million per accident) but permits an insured to deviate from this default coverage limit by purchasing UIM coverage in a greater or lesser amount, so long as the policy’s UIM coverage exceeds $30,000 per person and $60,000 per accident.” In this case, Plaintiff had purchased from Universal an insurance policy providing $1 million in liability coverage and $50,000 per person and $100,000 per accident in UIM coverage for bodily injury. Therefore, the policy only provided Plaintiff with $50,000 – rather than $1 million – in UIM coverage.

Finance Fox: The Future of Insurance?

By Gemma Saluta and Jonathan Reich

It is common for North American insurance companies to take inspiration from international markets.  One new product of interest is Switzerland based, FinanceFox.  From an app that you download on your phone, you can compare insurance companies and receive personal advice.  Finance Fox advertises that you can compare insurance policies from different insurers and across multiple lines of insurance from their app.  The customer pays nothing, and Finance Fox receives payments from the insurance companies “for reducing administrative tasks and managing insurance contracts on their behalf.”  This is typically a broker’s fee that is anywhere from 8% to 15% of the premium.  The user appoints Finance Fox to be its personal broker, so that the company can represent the user in any insurance matter.  As with many benefits that get renewed every year, the company likely has the opportunity to realize a larger profit margin as customers renew policies. 

So the question then becomes, is this viable for the US market?  We certainly see current insurance companies putting out their own apps, but we rarely see on that tries to compare products from multiple companies, let alone act as a broker.  In order for this product to take hold in the US, we have identified several issue areas that would have to be addressed:

•  Multiple state licensing requirements
•  Licensing requirements across different lines of insurance
• The practicality by the user of reviewing insurance documents over a small screen
• Clarification regarding issues of procurement
• Multiple state laws regarding agency 
• Ensuring adequate communication so that the customer receives the policy he or she requests
• Data Security

Our economy is pushed by innovation.  This online marketplace for multiple policies across multiple insurers is a novel concept.  Hopefully, we can learn from the European market response whether this concept is worth pursuing in the United States.

Does the FDIC only sue bankers who have D&O insurance?

No. At least, that is the conclusion put forward in Why does the FDIC sue? by Christoffer Koch (Federal Reserve Bank of Dallas) and Ken Okamura (Said Business School,  University of Oxford), which was recently posted on SSRN.

This paper is the first which empirically investigates the litigation strategy of the FDIC with regards to failed commercial banks. 

Anyone familiar with litigation and regulatory action can see there are two competing hypotheses:  either (1) the FDIC is primarily motivated in replenishing governmental coffers and thus seeks out "deep pocket" defendants who are backed up by ample directors & officers insurance or (2) the FDIC is motivated primarily by regulatory concerns and litigates to shape bank executive behavior and  correct poor governance.

The answer to this question is important to anyone buying, selling, or advising on the purchase of directors & officers insurance coverage, especially in the bank and non-insurance financial sector. The conventional wisdom and anecdotal evidence both point towards D&O insurance being the pot of gold at the end of the litigation rainbow.  Or, as the authors report, "one former banking regulator [who] said the existence of D&O insurance is the starting point for FDIC officials when they evaluate whether or not to file the suits . . . all the banking agencies are going to be bringing actions against deep pockets."  And certainly, banks often carry substantial amounts of D&O coverage.  Immediately after the financial crisis, Towers Watson reported that in 2009 the financial services sector (excluding insurance) had median coverage of $30 million and mean coverage of $81.7 million, the 25th percentile being $20 million and the 75th percentile being $100 million.

This paper, and its underlying research, was based on 161 civil tort cases against individual directors & officers litigated by the FDIC arising from 408 failures which occurred prior to June 2012.  These FDIC lawsuits have been characterized by the American Association of Bank Directors as being largely brought against former directors of community banks and based on the approval by the board or board committee of a handful of large loans that caused losses contributing to the bank's failure.

The authors found that "regardless of the recovery potential, that there is no "too-small-to-get-sued."   

Instead, the authors found evidence that FDIC litigation is largely correlated with, and directed against, bank executives who are "gambling for resurrection" (to borrow a term from game theory and international politics).  That is, bank executives who are "more optimistic, underprovisioning for losses, and more aggressively pursuing asset growth with riskier funding sources."  The authors characterize this as the FDIC "imposing a retroactive duty of care to deposit holders and a requirement that the directors and officers focus on the safety and stability of the financial institution."  As a result, bank executives who seek to "accelerate asset growth reliant on riskier funding sources" are more likely to be targets of FDIC litigation, rather than simply those who were prudent enough to purchase bountiful amounts of directors & officers insurance. 

These findings, if borne out through further research, also have interesting implications for the intersection of D&O insurance and moral hazard. 

North Carolina Court of Appeals revisits uninsured and underinsured motorist coverage

The North Carolina Court of Appeals recently issued an unpublished opinion on UIM and UM automobile insurance coverage.  Unpublished opinions, under North Carolina Rule of Appellate Procedure 30(e)(3), do "not constitute controlling legal authority" and citation to such opinions "is disfavored." 

In Bacon v. Universal Insurance Co., authored by Judge Mark Davis, the Court of Appeals held that even though the plaintiff had a commercial auto insurance policy with $1,000,000 in coverage limits, he was not entitled to $1 million (much less the treble damages for unfair claims handling practices) of uninsured or underinsured motorist coverage following an accident for the following reasons.

First, the record on appeal revealed that the Plaintiff had been informed by his insurer that UM and UIM coverage was available to him and the limits would be set equal to the highest limits for bodily injury liability coverage under the policy unless he elected different limits.  The Plaintiff chose to purchase UM coverage of $50,000 per person and $100,000 per accident, as revealed on various insurance documents which he signed. 

Second, the UM endorsement at issue in this case defined "uninsured motor vehicle" to include underinsured, as well as completely uninsured, vehicles. 

Third, the driver which hit the Plaintiff had insurance coverage, which tendered $50,000 to the Plaintiff for his injuries.  Pursuant to the terms of the UM endorsement and N.C.G.S. 20-279.21(Financial Responsibility Act), that driver who hit the Plaintiff was not underinsured, and thus the Plaintiff was not entitled to UIM benefits from his own insurer. 

After finding that Universal's denial of coverage was proper and supported by North Carolina insurance law, the Court then deemed arguments regarding unfair trade practices or bad faith to be abandoned on appeal, as such arguments wholly related to the assertions that Universal failed to honor its obligations under the insurance policy. 

The Court opinion is a mix of a review of the factual record, and the application of the canons of statutory construction to North Carolina's Financial Responsibility Act.  Importantly, the case demonstrates the importance of record keeping and documenting the policyholder's election of UM/UIM limits which were above the statutory minimum but significantly lower than the maximum allowable. 

Further, as a matter of insurance law, the Court notes that it had to look beyond the declarations page of the policy:

While the declarations page is silent as to the amount of UIM coverage available to Plaintiff under the Policy, the Act, which is “written into every automobile liability policy as a matter of law,” Hendrickson, 119 N.C. App. at 449, 459 S.E.2d at 278 (citation, quotation marks, and brackets omitted), mandates that Plaintiff be entitled to receive UIM coverage limits “equal to the limits of uninsured motorist bodily injury coverage purchased pursuant to subdivision (3) of this subsection,” N.C. Gen. Stat. § 20-279.21(b)(4). We therefore conclude that the Policy provides Plaintiff with $50,000 — rather than $1,000,000 — in UIM coverage.