Down To Cases

A spectacular example of being out of trust and its consequencesWhen an insured writes a check to his insurance agent or broker, he expects the funds to be paid to the insurer. Professional agents and brokers keep these funds in a trust account at a local bank. The amount of money held in trust can be huge, since insurers usually allow agents and brokers to hold the funds for up to 45 days before forwarding them. Some agents and brokers cannot overcome the temptation to “borrow” this money for personal use, believing they can pay it back from current sales. When the time comes to pay the insurers, the funds may not be available. A widely followed case, United States of America v. Michael Segal and Near North Insurance Brokerage Inc., vividly illustrates that money held in trust can be used for only one purpose–payment of premiums for which it was originally delivered. Failure to keep the trust money separate is a crime that will be seriously punished. An Illinois broker and his brokerage were charged with 27 counts of racketeering, mail and wire fraud, making false statements, embezzlement and conspiring to impede the Internal Revenue Service. A jury returned guilty verdicts on 26 counts (the government dismissed the other), but a federal district court granted acquittals on seven of the counts, affirming the convictions on the remaining 19. The brokerage was ordered to pay a $1.4 million fine and restitution of $841,527.96. Separately, the broker, who was also the brokerage’s owner and sole shareholder, was sentenced to prison for 10 years, ordered to pay $841,527.96 in restitution and to forfeit $30 million as well as his interest in the racketeering enterprise. The broker appealed.Illinois law requires insurance brokers to maintain a premium fund trust account (PFTA) in which all premiums are to be held in a fiduciary capacity until the carriers demand the payments. Commissions, interest, credit and other non-premium money can be withdrawn, but brokers are required to maintain PFTAs in trust with sufficient funds. PFTAs cannot be used as operating accounts. Failure to properly maintain a PFTA is grounds for suspension or revocation of the broker’s license. Conversion of more than $150 is a felony.During the 1990s, the brokerage was earning close to $50 million annually. It had both a PFTA and an operating account, but it deposited all receipts into the PFTA and maintained the operating account with a zero balance. Funds were transferred to the operating account from the PFTA to pay expenses, then anything left was transferred back to the PFTA. The brokerage’s CFO from 1990 to 1998 considered this practice a violation of regulations, as did his two successors.Nevertheless, the broker expanded his business, buying brokerages in New York, California, Texas and Florida. He bought several other companies and funded the acquisitions via the PFTA. Most of the companies lost money, so he regularly transferred funds to them from the PFTA to keep them solvent. By the end of 1989, the PFTA was more than $7 million out of trust. At the end of 1995 it was $10 million short, and by August 2001 the deficit had grown to $30 million. Auditors regularly told the broker he was converting PFTA money for unauthorized purposes. He contended that every insurance company operated similarly. Two auditing firms resigned.In 2001, the brokerage’s CFO drafted a letter to the broker outlining a plan intended to bring the company into legal compliance. It proposed placing the brokerage under the control of an executive committee that would report to the broker but be free to act without his approval. The plan called for selling off money-losing affiliates, segregating the PFTA from operating funds and obtaining an outside audit. The letter noted that the PFTA was $17 million in deficit and that the broker was intentionally committing a felony. He rejected the plan.The broker retained a financial consultant to evaluate the prospects of raising capital by attracting new investors. The consultant concluded that the PFTA was out of trust by $24 million–even after the broker deposited $10 million from his home mortgage into the account. The imbalance was finally corrected when the consultant secured loans of $10 million each from two insurers. The loans, however, came with restrictions on the broker’s ability to dispose of assets, effectively giving the insurers control of his brokerage.Failure to keep in trust was hardly the broker’s only transgression. The broker provided insurance for a Chicago Transit Authority reconstruction project. The contract was fee-based, with no commissions for the broker. However, before the contract was signed, the broker arranged to have one of his subsidiaries broker some of the coverages, earning a commission of $370,000–an arrangement not revealed to the CTA.The brokerage also had a policy of writing off customer credits. Account executives were trained not to notify customers they were owed credits. After a credit had been on the books for a while without a payment demand, it was simply written off. The broker personally approved of these write-offs and was ordered to pay $471,000 in restitution to the victims in the judgment against him.One of the issues that the broker and his brokerage raised on appeal was that there was a fatal variance between the indictment and the proof at trial. Much summarized, the indictment charged the defendants with a single scheme to defraud and obtain money and things of value from the PFTA by creating the false appearance that payments to the brokerage would be held in trust for payment of premiums, that credits due customers would be refunded to them and that the customers would receive honest services. The broker contended that evidence at trial revealed three separate schemes: failure to maintain sufficient funds in the PFTA, writing off customer credits and collection of the CTA commission.As part of their argument, the defendants characterized the misuse of the PFTA account as improper borrowing that did not actually harm anyone or benefit themselves. The appeals court disagreed, ruling that unauthorized use of money from an insurance premium trust account is mail fraud even if the defendant did not gain and the victim did not lose (United States v. Vincent, 416 F.3d 593, 7th Cir. 2005). The broker’s claim that the carriers were at little risk ignored the fact that the brokerage was often late in making payments and had to hold checks to carriers until it obtained sufficient funds to send them. By 2001, the brokerage had to obtain cash from affiliates to pay premiums, and by the end of that year had to borrow $30 million to meet its obligations.In addition, the court said, it was difficult to see how the credit write-offs were unrelated to the larger scheme. Withholding credits directly deprived customers of money they were owed and of the honest services of their broker. It also reduced the PFTA deficit to a degree. Proceeds from other acts, such as the CTA fraud, were commingled in the PFTA and used for a variety of unauthorized purposes. The court held that the evidence supported a finding of an overarching scheme involving the misuse of the PFTA account.The broker also questioned the $30 million forfeiture. The law provided that a person convicted of a RICO violation shall forfeit the enterprise “which the person has established, operated, controlled, conducted, or participated in the conduct of” and “any property constituting, or derived from, any proceeds which the person obtained, directly or indirectly, from racketeering activity or unlawful debt collection….” The judgment against the broker required forfeiture of both.The broker said there was insufficient evidence to support the amount of the ordered forfeiture ($30 million). The indictment charged that the broker’s interest subject to forfeiture was at least $20 million, including but not limited to all salary, bonuses, dividends, pension and profit-sharing benefits received from 1990 through 2001. The broker argued that the indictment must be interpreted to mean that only his executive salary of $120,000 per year, some funds he took from petty cash and claims for personal expenses were subject to forfeiture, and that the government must show what proportion of his executive compensation consisted of racketeering proceeds.The appeals court disagreed, stating that the items the broker mentioned were indeed subject to forfeiture, but so was some of the money he stole from the PFTA, which had reached a deficit of $30 million. The court said there was no requirement that proceeds be in the form of more or less legitimate salary payments or shady small reimbursements. The indictment did not limit the forfeiture to the specific items mentioned nor the ones the broker acknowledged.The broker argued that he paid the PFTA money back and for that reason apparently thought the $30 million was not subject to forfeiture. The appeals court disagreed. “We have trouble seeing why paying the money back means that he did not take it in the first place.” The court also noted that the broker did not repay the money personally but rather used the proceeds from the loans obtained from the two insurance companies, which were secured by the brokerage’s assets.The appeals court acknowledged, however, that it was not clear from the record how much of the $30 million taken from the PFTA was poured back into the enterprise and how much went to the broker personally. The broker already was required to forfeit the enterprise. Therefore, to the extent that the $30 million went into the enterprise, charging the broker for it too would be double-billing, the court said. Consequently, it remanded the case to the district court for a determination of what part of the $30 million benefited the broker personally.Finally, the broker argued that the forfeiture violated the excessive fines clause of the U.S. Constitution. The appeals court noted that in United States v. Bajakajian (524 U.S. 321, 334 [1998]), the U.S. Supreme Court held that “a punitive forfeiture violates the excessive fines clause if it is grossly disproportional to the gravity of a defendant’s offense.” In the case at hand, the appeals court said the forfeiture was not disproportional to the offense. “This was a massive fraud,” the court said. “When a defendant commits a multimillion-dollar crime, he can be required to forfeit assets also running into the millions.”The appeals court vacated the forfeiture judgment in connection with the racketeering activity and remanded the case to the district court for further proceedings on this issue. In all other respects, the judgment against the broker and brokerage was upheld.United States Of America v. Michael Segal and Near North Insurance Brokerage Inc., in the United States Court of Appeals for the Seventh Circuit, Nos. 05-4601 & 05-4756, 2007.C07.0000707 (Aug. 2, 2007).Barry Zalma, Esq., CFE, is a California attorney. His practice emphasizes the representation of insurers and others in the business of insurance. He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He provides expert witness testimony and consults with plaintiffs and defendants concerning insurance coverage, insurance claims handling and bad faith. He has qualified as an expert in state and federal courts in California, Mississippi, Texas and New Mexico, as well as in the Grand Caymans. He can be reached at [email protected]. His consulting practice’s Web site is www.zic.bz.