Court Denies MGUs Recovery on Crime Fidelity Bond After Alleged Theft By Owner and Officer Accomplice (Tactical Stop-Loss LLC, et al. v. Travelers Casualty & Surety Co. of America, No. 08-0962-cv-W-FJG, In the United States District Court for the Western District of Missouri, Western Division, July 14, 2010).

Comment:  I will start with the moral of the story: pay attention to the exclusions.  That’s an odd admonition to be serving up to an audience of stop loss industry types, but it is fully apropos in the circumstances of this case. 

According to the facts as described in the Court’s opinion, Plaintiffs Tactical Stop-Loss, LLC (“TSL”) and American Trust Administrators (“ATA”) were Managing General Underwriters for various stop loss insurers.  TSL was owned 40% by James E. Fox, with the remaining 60% share owned equally by Kevin Westrope and Joseph Timmons.  TSL Holdings, Inc. (“TSL Holdings”), also owned by Fox, Westrope, and Timmons, owned 100% of the other MGU, ATA.  The Court thus characterized the three individuals’ ownership interest in ATA as “indirect.”

Fox served as President of the two MGUs, TSL and ATA, until he was terminated in November 2007.  One Terry Griffith concurrently served as Vice-President and Chief Operating Officer of the two MGU entities.  Unlike Fox, she had no ownership interest in any of the entities.

From the Court’s opinion we can infer that TSL and ATA operated much like most MGUs, maintaining separate dedicated trust accounts into which policy premium, which included, management fees, fronting fees, taxes and other items, was deposited.  They also each maintained a general operating account representing their own funds.

The trouble began when Mr. Fox allegedly began transferring monies out of the fiduciary premium trust accounts into the MGU operating accounts, and from there, transferring money into his personal bank accounts.  The Plaintiffs alleged that Fox pocketed more than $930,000 in this way, and diverted more than $1.8 million from the trust accounts to the MGU operating accounts, where it was used to fund operating expenses and the like, some of which were allegedly used to pay Griffith’s exorbitant salary/bonus (solely determined by Fox), and the salaries of Griffith’s son, daughter-in-law, and then-husband—all of whom were allegedly hired and worked at the MGUs with Fox’s approval.

Allegations were made that Griffith was fully aware of Fox’s untoward activities and actively assisted him in concealing them, by, among other things: 1) failing to report them to the other owners of the businesses, though obligated to do so as an officer-fiduciary; 2) keeping two sets of spreadsheets, one showing “what should have been going on and [one showing] what was actually going on”; 3) doctoring bank statements to hide discrepancies; and 4) misleading auditors for stop loss insurers Gerber and Companion by hiding discrepancies in the premium and claims accounts of the companies. Plaintiffs admitted, however, that Fox personally participated in every transfer of funds to his personal account.

As a result of all the foregoing, Plaintiffs had to enter into various repayment agreements with their stop loss carriers to avoid litigation with them, and Messrs. Westrope and Timmons were forced to inject substantial personal funds into the companies to keep them afloat and avoid bankruptcy.

So---one might think that one’s Fidelity Crime Bond would be just the thing to protect against a loss such as this, but one would be wrong, at least in this case.  The Travelers policy excluded “loss resulting directly or indirectly from any fraudulent, dishonest or criminal act committed by…any LLC Member or Officer-Shareholder, whether acting alone or in collusion with others….”  The Court granted summary judgment against the insureds and in favor of Travelers because Fox was both an LLC member and an Officer-Shareholder.  Griffith, while neither, was, in the Court’s view, simply “aiding and abetting” Fox, and thus her activities were all “in collusion” with Fox, and thus likewise excluded. 

The rationale for an exclusion like this one, according to the Court, “is to prevent a wrongdoer (i.e., the policy holder or its member/owner) from profiting from his wrongdoing.”  While that may be, the language of the exclusion accomplishes much more for the insurer, as it lets it off the hook where the wrongdoer-owner is no longer in a position to benefit from his misconduct, as here. 

I frankly don’t know whether such exclusions are common in Crime Bond policies issued to MGUs, but I’ll bet that this case sends several scurrying to check their own policies.

Read the Court's Opinion Here