The Fraud Monster: The Effects of Fraud on Professional Lines Coverage

1. The Fraud Monster: The Effects of Fraud on Professional Lines Coverage

2. 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

3. 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

4. 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?

5. Impact of Fraud on the Economy • Jobs • Corporate Investment • Distortion of Resource AllocationAmongst Firms

6. Does Fraud Go Up or Down Relative to the Economy? • Prevailing Opinion • Impact of Fraud on Various Business Sectors

7. Fraud Across Multiple Business Sectors • Top 3 Business Sectors for 2008 were: • Natural Resources • Construction and Engineering • Financial Services

8. Fraud Across Multiple Business Sectors for 2009 • Top 3 Business Sectors for 2009 were: • Financial Services • Retail and Wholesale Distribution • Healthcare, Pharmaceuticals and Biotechnology

9. Prevailing Views on Who has Primary Responsibility to Detect Fraud • Legal View • Finance View

10. Fraud Detectors • SEC • Lawyers • Journalists • Auditors • Analysts • Employees

11. Compare Pre-SOX and Post-SOX • SEC • Lawyers • Journalists • Auditors • Analysts • Employees

12. Incentives for Whistle blowing • Altruism • Reputation • Career • Money • Revenge

13. 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

14. Key Characteristics of Fraudulent Companies • Size • Exchange Listing • Primary Industry • Duration of Fraud • Location • Management • Fraud Techniques

15. Board Comparison of Fraudulent versus No Fraud Firms • Size of Board • Tenure • Stock Ownership • Audit Committee • Experience

16. Underwriting Fraud

17. Underwriting Fraud Question 12: Are you a lying, cheating grifter?

18. 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

19. Underwriting Fraud Fraud Triangle Environmental Individual “Hot” Environments Securities and Commodities Fraud Mortgage Fraud Insurance Fraud Profile of a Fraudster

20. Underwriting Fraud Financial Fraud Predicting Material Accounting Misstatements Stanford Law School-Securities Class Action Clearinghouse PLUS D&O Diary

21. Underwriting Fraud Liability Associated with Fraud Committed by Clients Accountants Lawyers Central Bank of Denver and Stoneridge Investment Partners Client Intake Insurance Agents

22. Policy Features and Claims Issues

23. “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;” “Fraud” Exclusion

24. “ The duty to defend is broader than the duty to indemnify…” Guiding Maxim

25. 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 Excluded conduct “in fact”

26. “…this exclusion shall not apply unless there is a judgment, final adjudication or admission adverse to such Insuredestablishing that such Insuredcommitted such conduct.” “Final Adjudication”

27. “…and applies only to the Insuredwho participated in, acted with knowledge of, or acquiesced to such conduct.” Separation of Insureds/Innocent Insured

28. Other Policy Provisionsand Concepts Definition of Wrongful Act Unjust Enrichment Exclusion Definition of Claim Fortuity Doctrine

29. Warranties Known Circumstances Severability Impact on Claims

30. 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 Carrier Remedies

31. 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?

32. 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?

33. Questions&Answers

34. Many Thanks To… • Peter Biging • Serge Adam • Sally Combs • Tim Covello