By DAN REYNOLDS, senior editor of Risk & Insurance®
If the Bernard Madoff fraud is as complex as it appears, with thousands of victims spread across the globe, it could very well be the legal costs of it that sting carriers and their clients the most, regardless of what coverage is involved.
"These are going to be very expensive cases to defend for a number of reasons,"' said Kevin LaCroix, a director of Beachwood, Ohio-based Oakbridge Insurance Services, who also blogs regularly on the D&O sector.
"You have multiple defendants, you have very complex legal and factual allegations, there is complicated procedural wrangling, there are jurisdictional issues," LaCroix said.
"The legal issues on the securities side are complex because of the context of the hedge funds or the funds to the funds, and this is outside the public companies securities law context," LaCroix continued. "And so it is an unusual arena, and there may be new law made in this arena. And so as a result they are going to be very expensive to defend."
The international breadth of the case isn't limited to the fraud itself, it is also expanding because of the changing legal environment in many developed countries.
"The United States has always been the home for litigation with respect to these types of claims, but we are seeing it grow outside the United States, and we're seeing changes in laws around the world that are making the types of cases that are brought in the United States easier to file," said Lauri Floresca, a senior managing director with Carpenter Moore based in San Francisco.
COMPLEX OR NOT?
"When you peal back the dynamic related to this particular situation, it's a Byzantine trading relationship involving fund managers and asset managers, advisors and a myriad of related entities. And so now, plaintiffs are peppering anybody associated with these transactions, which is creating as lot of noise in the early analysis as carriers and industry followers try to quantify exactly what this is going to amount to," said David Bell, the president of the Professional Liability Underwriting Society.
Because there are those that posit that the fraud itself was not that complex. After all, smoke and mirrors is just smoke and mirrors, what is there to it really?
"You know, I've been thinking about it, was it that complex? They seemed to be running bookkeeping out of a storefront in upstate New York," said Scott Schechter, an attorney with Kaufman, Borgeest & Ryan LLP.
"So how complex was the accounting? On the other hand, it was a fairly sizable operation that arguably was doing what it was doing for 25, 30-plus years, and so that begs the question maybe it was pretty complex and sophisticated," Schechter said. "But I can imagine that these cases will be vigorously pursued because people are never going to get all of their money back and you'd rather get 10 cents than nothing."
But in terms of how successful those lawsuits will be, Schechter said there may be precedence that they won't be.
"There was that Bayou Capital case about a year or two ago. Well, that got thrown out, and that involved a Ponzi scheme with funds of funds. I would suggest you look at that, and if that is a barometer for this case, maybe the funds of funds walk away on this one," Schechter said.
"Maybe they did due diligence. It could be at the end of the day that Madoff's scheme was so complex that a court might rule that even sophisticated money managers of funds of funds would not have been able to figure it out and they have a liability defense. But on the other hand it's not that sophisticated," Schechter allowed.
That's why so many people go to law school, one might guess. Fraud and other conflicts will always be present, and in the Madoff case it may very well be only the lawyers defending and bringing these cases that profit, and those that have been around long enough, at least in the professional liability side of insurance, accept that view of the world.
"I would suggest that we're not surprised by it," said Mike Smith, president and CEO of Chartis Executive Liability.
"Sarbanes-Oxley was designed to as much as possible post-Enron and WorldCom to take fraud and misbehavior out of the board room. It's impossible. Greed and avarice have been around forever and they will be around forever and that is one of the reasons you buy a crime policy, a fidelity policy, because crime exists," Smith said.
"I guarantee that if you live long enough you will see cycles, and you will never eliminate fraud by definition. I am fairly confident it has been since biblical times. You're not surprised by it, you try to underwrite it as best you can and you try to price for it. Obviously, we are in the insurance industry managing a book of business, and so you expect losses."
October 15, 2009
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