It’s amazing to me that Nigerian banker scams continue to appear in my inbox every now and then. After all these years, businesspeople apparently continue to fall for them. Click here for a pretty good fact sheet from the Australian government on how these scams work, and how to avoid them.
Recently, a Minnesota bank (Avon State Bank) fell victim to a scam involving a supposed multi-million dollar estate of a “deceased African businessman.” (The key words there are “supposed,” followed by “deceased African businessman.”) Reading the fact pattern is like watching a man sitting on a branch and sawing off the wrong end.
A long-time customer of the bank, Herdering, was contacted by “Gibson,” who claimed that his father had passed away, leaving a $9 million estate in Africa. Gibson told Herdering that the family wanted to transfer the funds to the United States, but the money was tied up in the Netherlands, and the transfer required upfront payment of taxes and other fees. (This is the garden-variety advance money scam.) Herdering (ridiculously) bought the story, and foolishly sent funds to Gibson. Herdering then approached Carlson, an Assistant Vice-President and Loan Officer at Avon, and asked for help in transferring the estate to the US, in exchange for huge returns. (Note: If it sounds too good to be true…it is!) Carlson, relishing the prospect of easy money, arranged for a loan to Herdering from the bank, and contributed $60,000 of his own money, to be used for transferring the “estate.”
After Carlson made the loan, Avon’s president, Diedrich, told Carslon he was worried that the estate might be a scam. Carlson didn’t tell Diedrich about the personal contribution, which I presume would’ve set off even more alarm bells. (When Diedrich found out later about the personal contribution, in fact, he fired Diedrich.)
The scam artist, “Gibson,” later requested that Herdering and Carlson cover half of a $750,000 “tax” on the estate. Carlson, although worried that he was ensnared in a scam, inexplicably recruited two other people, Imdieke and Froseth, to contribute funds, and they did (almost $500K). Carlson wired Froseth’s funds to an account in Hong Kong, apparently on Gibson’s directions. (This was a violation of Avon’s policy that prohibited the wiring of money for non- bank customers.)
Naturally, there was no African estate, and everyone (except “Gibson”!) lost their money. So Froseth and Imdieke sued Avon for negligent and fraudulent misrepresentation. Avon’s insurance company, BancInsure, agreed to provide coverage under a D & O policy. Before trial, though, Froseth and Imdieke dropped their claim for negligent misrepresentation and proceeded only with the fraudulent misrepresentation claim, arguing that Avon was vicariously liable for Carlson’s conduct. Because the case went to trial on the question of fraud only, BancInsure informed Avon that the D & O policy did not cover the loss, because the policy excluded coverage for fraud. To make matters worse, BancInsure demanded that Avon reimburse defense costs already paid by BancInsure. Avon challenged the denial of coverage, and argued that not only the D & O policy provided coverage – but, um, what about this fidelity bond you sold us?
The Eighth Circuit agreed that the fidelity bond provided coverage, and, as a result, saw no need to reach the D&O question.
Let’s take a look at BancInsure’s defenses, and how the appeals court dealt with them.
First, BancInsure argued that the jury verdict didn’t constitute a “direct” loss under the terms of the bond, because the case essentially involved a third-party (and not first-party) claim. According to BancInsure, the bond wasn’t intended to cover situations where third parties suffered the loss resulting from employee dishonesty, rather than Avon itself suffering loss through employee actions. The Court held that the bond was “loosely worded,” and that no such limitation appeared in the bond’s language. The bond “simply provides coverage for a loss ‘resulting from dishonest or fraudulent acts committed by an Employee,’ which precisely describes the loss Avon suffered through Carlson’s fraudulent conduct.” Avon, after all, was being held liable for the misappropriation of funds.
Second, BancInsure argued that there was no “direct” loss because Avon was merely a “conduit,” didn’t own or hold the funds, and wasn’t legally liable for them. Wrong, said the Eighth Circuit: “Avon held the funds, even if it did so fleetingly… Avon possessed Froseth’s and Imdieke’s funds by a lawful title. Carlson solicited the money from Froseth and Imdieke, represented that Avon would be handling the money, obtained checks made payable to Avon, deposited the checks into Avon’s accounts, and wired the money out of Avon’s accounts.”
Third, BancInsure argued that Avon’s liability didn’t “directly” result from Carlson’s fraudulent acts. According to BancInsure, when a third party is a target of the employee’s act, the insured-employer’s liability for loss doesn’t “directly” result from the employee’s actions. (I’m sure that Avon was pleased to hear that, after being tagged with a jury verdict.) Wrong again, said the Eighth Circuit: “The loss to Avon from Carlson’s fraudulent conduct is a direct loss because Carlson acted fraudulently to benefit himself by protecting his interest and did so through acts which would necessarily make Avon liable to third parties.”
Fourth, BancInsure argued that Carlson didn’t act with “manifest intent” to cause Avon a loss or to obtain an improper financial benefit to himself or another, which were alternative requirements under the bond. The Eighth Circuit again disagreed: “Carlson acted with manifest intent to obtain improper financial benefit to himself because he committed the fraudulent acts to preserve his investment in the advance money scheme.”
Finally, BancInsure fell back upon the last refuge of an insurance scoundrel (sorry for the hyperbole): Late Notice. The bond required that Avon provide a proof of loss form within six months of discovery of the loss, which Avon hadn’t done. But the Court found that BancInsure was estopped from asserting the requirement, because it had led Avon to believe that the D & O policy covered the loss, and that pursuing coverage under the bond was pointless. The Court also noted that BancInsure suffered no prejudice from the delay, since it had been defending the lawsuit under the D & O policy anyway.
It’s great that Avon was able to enforce coverage under the bond, but what went wrong here at an operations level? A lot of things. First example: The idea that a corporate officer couldn’t recognize a garden-variety advance money scheme is frightening. Proper training should be given to all corporate officers and employees with respect to recognizing and avoiding such schemes. (You can start by having them read the Australian government’s bulletin linked at the beginning of this post.) Another example: When the bank president became suspicious that a scam was in progress, he shouldn’t simply have “mentioned” his worries to Carlson – he should have demanded to see all relevant documentation, and taken appropriate action against Carslon immediately.
This blog is about insurance coverage, but insurance coverage is usually the Alamo – the last stand. And you know what happened at the Alamo! So pay attention to your internal controls.
You can read the full Eighth Circuit decision here.