Impact of Spitzer Broker Fraud Charges Felt at Marsh and Beyond

October 18, 2004

New York Attorney General Eliot Spitzer’s filing last Thursday of charges against giant insurance broker Marsh for alleged commercial account steering and bid rigging has already had significant impact on Marsh and is expected to reach into the insurance brokerage community at large.

Many observers expect the impact to deepen as Spitzer expands his probe to other companies and lines of insurance and as other courts and states get involved.

On Wall Street, shares of Marsh fell 37 percent in just two days. Shares of AIG, ACE and Hartford Financial Services Group — three carriers cited in the big-rigging aspect of the complaint— all dropped as well. Even some companies not implicated by Spitzer — Aon and Willis — saw their shares fall. European insurance shares also took a tumble after news of the U.S. lawsuit was learned.

At Marsh, the world’s largest insurance broker, the charges have brought about several internal changes. The brokerage firm named a former trial lawyer as its new chief executive; announced that its board of directors had ordered an independent internal investigation; and suspended all contingency contracts of the type that have gotten it in trouble.

Marsh named Michael G. Cherkasky as chairman and chief executive officer. Formerly with Marsh Kroll, a risk consulting subsidiary, Cherkasky has a background as a manager, prosecutor, investigator, and trial attorney. Prior to joining Kroll, Cherkasky spent 16 years in the criminal justice system, including serving as chief of the Investigations Division for the New York County District Attorney’s Office.

Marsh also learned that a class action lawsuit on behalf of shareholders has been filed against it. The complaint alleges that defendants violated federal securities laws by failing to disclose that hundreds of millions of dollars of the company’s profits derive from illegal activities, namely “contingent commissions.”

Marsh is not alone in being targeted in a class action suit. A Chicago judge in late July approved a class action lawsuit against Aon Corp. alleging that the insurance brokerage breached its fiduciary duty by taking contingent commissions from insurers without disclosing them to policyholders.

Observers are predicting that there will be additional lawsuits against brokers on behalf of shareholders and customers.

In addition to fostering costly litigation, the charges initiated by Spitzer are expected to affect the revenue and profitability structure of the broker sector over the long term, according to industry insiders and security analysts who follow insurance.

Cochran, Caronia Securities LLC, out of Chicago, notes that contingent commissions comprise 5 percent of revenues and 15 percent of earnings for publicly traded brokers. “Reduction or elimination of revenues related to these arrangements would have an obvious negative effect on profitability,” the analysts noted in a report.

The revenue adjustments will likely be harder on global brokers than on regional brokerage firms, which may have more flexibility, Cochran, Caronia Securities suggested. Other sectors, including commercial insurers, reinsurance, specialty lines and personal lines should be affected only marginally, if at all.

J.P. Morgan Chase & Co. analysts predicted the Spitzer effort would produce to a “seismic shift” in property casualty business practices.

American International Group (AIG) Chairman Maurice Greenberg said that while he does not think his own company’s business will be hurt, he agreed that the controversy could lead to changes in the way brokers are paid. He suggested that AIG would stop agreeing to brokers contingent commissions.

The impact was also felt beyond property/casualty with the acknowledgement by MetLife that it had received four subpoenas from Spitzer’s office, including ones pertaining to possible inflated bids.

Also, National Financial Partners Corp., which sells investments and insurance, said it has received subpoenas.

In addition, there were signs other states might get involved. While New York was the first state to press charges, Connecticut also has an investigation underway and Connecticut Attorney General Richard Blumenthal confirmed that he might soon follow with a suit of his own.

“This action by New York is a significant and positive step toward fair, transparent business practices in this industry. Our own investigation is active and ongoing. We are compiling information and considering possible action if appropriate – making progress in our efforts with our insurance department and in cooperation with other authorities,” Blumethal said.

Jeffrey W. Greenberg, chairman and chief executive officer of MMC, said that his firm has taken “strong and immediate action,” including suspending all marketing services agreements (MSAs) under which contingent commissions are paid and “actively reviewing every aspect of Marsh’s business.”

But that might not be enough to appease Spitzer. TIME magazine is reporting that Spitzer is looking to oust Marsh’s Greenberg, who the attorney general claims stonewalled the investigation. “I didn’t see in their management a desire for reform,” Spitzer told TIME. “I won’t settle and leave in place a CEO whose behavior has been unhelpful, distortive and unresponsive,” TIME reported Spitzer as saying.

Meanwhile, Patricia Abrams, an assistant vice president with Bermuda-based insurer ACE Ltd., has reportedly pled guilty to a felony charge connected to Spitzer’s investigation. Two executives at the AIG excess casualty subsidiary, American Home, previously agreed to guilty pleas.

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