Risk Scenario

Babes in Lawsuit Land

A risk manager's improper reporting catches the SEC's attention.
By: | August 30, 2012 • 11 min read
Risk Scenarios are created by Risk & Insurance editors along with leading industry partners. The hypothetical, yet realistic stories, showcase emerging risks that can result in significant losses if not properly addressed.

Disclaimer: The events depicted in this scenario are fictitious. Any similarity to any corporation or person, living or dead, is merely coincidental.

Part One

Paul Ferranzo took a deep breath and surveyed the fairway of the Par Four 16th as it banked left and around the stand of maple trees that blocked a player’s view of much of the green. He was strongly tempted to intentionally hook the ball and try to cut 25 yards off of his second shot if he could.

Scenario_BabesLawsuit

A Tiger Swallowtail butterfly chose that moment to visit the hydrangea bushes next to the ball-washing machine that flanked the tee. Paul tried to blank the butterfly out of his mind. He had $500 on this game and his opponent, who was also his insurance broker, was standing about 25 feet away.

The broker was ostensibly staring at the face of his iPhone, reading a text message, maybe. But if Ferranzo knew him like he thought he did, he knew the broker was secretly wishing Paul would shank one.

“Screw it,” he said to himself. “I’m going to bend this baby.”

Paul settled his feet, dropped his head, drew the head of the driver back and swung through, letting the club face linger on the ball just a millisecond longer than he normally would. He brought his head up just in time to see the ball begin to descend from the peak of the drive. The ball took a nice, midsummer grassy bounce, heading left, just where Paul had wanted it to.

“Holy crap!,” his broker said with a real edge in his voice.

“Wasn’t that great a shot,” Paul said, turning to see his broker still staring at his iPhone.

The broker looked up with concern in his eyes. Then cast a quick glance to where he last saw the golf ball.

“Not that. Don’t you have a distribution center near Lincoln?”

Paul felt ice water enter his bloodstream.

“Yeah, why?”

“Two tornadoes touched down in Lincoln, or just outside of Lincoln, about an hour ago. Big ones, one an F3, the other an F4,” the broker said.

Scenario_Logo_Riskonnect

Scenario Partner

“Can you drive?” Paul said, motioning to the golf cart. The broker nodded and headed briskly to the cart, sheathing his driver in his golf bag with practiced alacrity.

By the time they got to the club house, Paul, the risk manager for the Beamish Babe retail line, had learned that the company’s distribution center near Lincoln had been torn that very day into unproductive pieces.

Game over. Game on.

The supply chain implications of the loss of the distribution center were sobering, to say the least. Paul had a feeling the implications were big. He really couldn’t say just how big. It would probably be days before the company knew the full extent of this.

In the back of his mind was the company’s 10K for 2011, which it had published a scant three months ago. The work Paul and the company’s finance committee had put into that report was beyond anything they had ever taken on. But that was the atmosphere these days, with the SEC demanding more and more detail on risk exposures from publicly traded companies.

This supply chain loss loomed large. Paul now worried that the company’s reporting in this area might have been inadequate.

“Who knows,” he said to himself as he drove home for what was probably not going to be a very good night’s sleep. “Who knows what the SEC will make of this,” he said.

“Or the shareholders.”

Part Two

Scenario_BabesLawsuitLand

Beamish Babe was publicly traded and had built up its business by being lightning quick to market with the latest style trends. It had stayed on top, even in this tough economy, because management had been aggressive, almost merciless in cost cutting. They’d had to be, it was a jungle out there these days.

That cost cutting, and what it had meant to risk management, was now gnawing at Paul Ferranzo’s belly.

In the past fiscal year, Paul had faithfully carried out the Board of Director’s orders, as carried to him by the CEO, that he exhaustively research and report on the company’s material risks, be they credit, financial, property, operational or reputation; the whole range. His work included interviewing regional vice presidents, members of the treasury, and the company’s corporate communications team, on the whole menu of the company’s risks.

Paul had turned in a report on those risks, which had become the backbone of the Risk Factors section of the company’s 10K.

Paul had done what he could, but there was only so much he could control.

The CFO had his own agenda, as did the procurement arm. After Paul filed his report, with the publication date of the 10K still two months away, procurement had sold to the CFO the idea of cutting down the company’s number of Midwestern distribution centers from two to one.

They would keep Lincoln, shut down Little Rock and then sell that distribution center. No less a company than Apple itself wanted to buy the building and the land.

The CFO loved this move. It represented a $20 million one-shot swing and $7 million annually in savings going forward.

But now look what had happened. The tornadoes had punched out Beamish’s sole Midwestern distribution center.

Scenario_BabesLawsuitLand

Early news coverage was taking things in the wrong direction, fast. The mayor of Lincoln was quoted on CNN decrying the number of jobs the tornado had wiped out.

The mayor had pulled a tax increment financing deal together to land the Beamish Babe distribution center and he couldn’t control himself, he painted the loss of the distribution center as a regional economic disaster.

The vice president of the Beamish Babe distribution center stood next to the mayor at the site of the loss, they were friendly after all, and corporate communications had been too slow to foresee all the possible angles and warn him away from the television cameras and the microphones.

“Don’t say anything,” Paul said out loud as he watched the coverage with the CFO. “Don’t say anything.”

But just then a television reporter swung her microphone over to the vice president.

“This is a total loss, I don’t know how we come back from this,” the Beamish vice president said.

Paul and the CFO each gave the other a look that said, “Oh well, there goes that.”

The comments from the vice president and the mayor’s emotional statements had to get the SEC’s attention.

Paul was uneasy but had no time to waste. He wasn’t cc’d on every e-mail but word was getting around that stores in the Midwest and the West were clawing at each other’s eyes for product, putting in orders for inventory that just wasn’t there.

The company was mobilizing to try to shift inventory from the East Coast, but who wanted to under-supply New York, Boston and Miami? Those cats needed to get fed. Procurement could have fun with itself now, Paul thought to himself bitterly.

A review of his notes from his interview with the Midwest regional vice president made Paul more than uneasy. With the business and contingent business interruptions that were piling up now, they had vastly under-reported their possible losses in that area.

The models they’d used just weren’t accurate enough to have predicted a strike this bad.

Paul watched a pair of high school girls dressed in Beamish Babe sweatpants, with the letters “BMB” printed on the back, walk past his office building on their way to the local coffee shop.

“Enjoy them while supplies last, girls,” he said out loud, shaking his head and turning his face back to his computer monitor.

Part Three

Scenario_BabesLawsuitLand

It was a few months until the day came when Paul looked up to see Ray Sachs, the CEO of the company, standing in his doorway. Ray, who preferred casual dress, was wearing his ubiquitous designer polo shirt and jeans. In his hands was a two-page letter.

“You got a second?” Ray said.

Like he wouldn’t say yes.

“Sure, Paul said.

Ray stepped into Paul’s office and closed the door.

As he sat down in front of Paul, Ray threw the two-page letter on Paul’s desk.

It was a Wells notice from the United States Securities and Exchange Commission. The letter said that the SEC had begun an investigation into shareholder allegations that Beamish Babe had substantially misrepresented its material risks in its 2011 10K.

“This is on you,” Ray said.

“I know,” Paul said.

Ray had another letter in an envelope in the back pocket of his jeans.

It was Paul’s letter of resignation.

It wasn’t like the supply chain interruptions from the tornadoes that struck Lincoln in June of 2012 had devastated the company because they hadn’t. In terms of what fell to the company’s bottom line, the supply chain issues stemming from the loss of the distribution center had resulted in revenue losses. But it was hard to pin down in exact numbers to what degree.

Company-wide revenues for the first quarter were off 8 percent, though. Net income was off 25 percent. Retail analysts for the investment banks hadn’t seen that coming and the stock price plummeted 15 percent in one day.

In its first quarter release to investors, the company’s corporate communications team gamely tried to spread the blame for the company’s reductions in net income and revenue, but successful shareholder lawsuits have been built on lesser losses and Beamish Babe was just not going to get off Scott-free on this one.

The SEC concluded that the board of directors of Beamish Babe breached its fiduciary responsibilities by accepting and turning in a report to the SEC that underreported its Midwestern property risks and its risks to its supply chain. The SEC used its subpeona powers to order copies of Pauls’ notes from his interviews with his regional vice president.

Those notes clearly showed that Paul and the vice president had relied too much on inconclusive models and had failed to take into account the impacts of possible supply chain interruptions.

For his documented part in failing to fully comprehend and report the risks to the company’s supply chain, the regional vice president was fired.

But Beamish Babe now had problems that firing someone couldn’t fix.

Attorneys for the shareholders picked up the SEC report and threw it at the company’s D&O and E&O policies like a big spear.

The company’s D&O and E&O policies responded, but Beamish Babe’s total cost of risk would never again look the same.

Summary

Paul Ferranzo, the risk manager for a large retailer, does a diligent job of documenting his company’s risks in its annual report to the U. S. Securities and Exchange Commission. But Ferranzo ends up losing his job when a sequence of events undermines his company’s best reporting efforts, leading to an SEC investigation.

1. Link procurement and operations to risk management: Many companies struggle when it comes to creating linkage between their risk management departments and other key areas like procurement and operations. When it comes to business and supply-chain interruptions, there is simply too much at risk for risk management to be kept out of the loop when it comes to strategic business decision making like the location of a warehouse, supplier or distribution center.

2. Manage your message: Press accounts and other forms of media exposure, including social media exposure, can have an inordinate amount of influence on the mind sets of shareholders and regulators. Companies should have a crisis-response plan in place that is well-understood by all key players. That response plan should include a strategy for limiting negative media exposure. Beamish Babe should never have let one of its officials near a politician in front of a television camera during a crisis.

3. The SEC means business: In 2010, the SEC broadened is subpoena powers and made them permanent. Instead of working forward and letting business decisions strike the risk managers desk without any foresight, companies need to work backward, in a sense, and operate with the assumption that business decisions that create possible risk exposures will have to be reported on a quarterly basis. Before making a decision, publicly traded companies need to ask themselves, “What exposures will this create that I should report?”

4. Don’t over-rely on catastrophe models: More and more companies are realizing that they must take a hybrid approach to using models in managing risk. The major losses due to tornadoes in the United States in 2011 were a wake-up call for everyone. Models that concentrate mainly on wind storms in Texas, Louisiana and Florida will be of limited use to a company that has key operations in Oklahoma or Kansas. The model hasn’t been made that can predict the kind of tornado and flood damage we saw in 2011.

5. Build a proactive board of directors: Risk committees should include active board members who aren’t afraid to challenge the assumptions and actions of senior management. To ensure that accurate annual and quarterly reports are filed, board members need to have full transparency into and involvement with enterprise risk management. It takes a number of sets of eyes in many cases to adequately assess and report a risk.

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]

Exclusive | Hank Greenberg on China Trade, Starr’s Rapid Growth and 100th, Spitzer, Schneiderman and More

In a robust and frank conversation, the insurance legend provides unique insights into global trade, his past battles and what the future holds for the industry and his company.
By: | October 12, 2018 • 12 min read

In 1960, Maurice “Hank” Greenberg was hired as a vice president of C.V. Starr & Co. At age 35, he had already accomplished a great deal.

He served his country as part of the Allied Forces that stormed the beaches at Normandy and liberated the Nazi death camps. He fought again during the Korean War, earning a Bronze Star. He held a law degree from New York Law School.

Advertisement




Now he was ready to make his mark on the business world.

Even C.V. Starr himself — who hired Mr. Greenberg and later hand-picked him as the successor to the company he founded in Shanghai in 1919 — could not have imagined what a mark it would be.

Mr. Greenberg began to build AIG as a Starr subsidiary, then in 1969, he took it public. The company would, at its peak, achieve a market cap of some $180 billion and cement its place as the largest insurance and financial services company in history.

This month, Mr. Greenberg travels to China to celebrate the 100th anniversary of C.V. Starr & Co. That visit occurs at a prickly time in U.S.-Sino relations, as the Trump administration levies tariffs on hundreds of billions of dollars in Chinese goods and China retaliates.

In September, Risk & Insurance® sat down with Mr. Greenberg in his Park Avenue office to hear his thoughts on the centennial of C.V. Starr, the dynamics of U.S. trade relationships with China and the future of the U.S. insurance industry as it faces the challenges of technology development and talent recruitment and retention, among many others. What follows is an edited transcript of that discussion.


R&I: One hundred years is quite an impressive milestone for any company. Celebrating the anniversary in China signifies the importance and longevity of that relationship. Can you tell us more about C.V. Starr’s history with China?

Hank Greenberg: We have a long history in China. I first went there in 1975. There was little there, but I had business throughout Asia, and I stopped there all the time. I’d stop there a couple of times a year and build relationships.

When I first started visiting China, there was only one state-owned insurance company there, PICC (the People’s Insurance Company of China); it was tiny at the time. We helped them to grow.

I also received the first foreign life insurance license in China, for AIA (The American International Assurance Co.). To date, there has been no other foreign life insurance company in China. It took me 20 years of hard work to get that license.

We also introduced an agency system in China. They had none. Their life company employees would get a salary whether they sold something or not. With the agency system of course you get paid a commission if you sell something. Once that agency system was installed, it went on to create more than a million jobs.

R&I: So Starr’s success has meant success for the Chinese insurance industry as well.

Hank Greenberg: That’s partly why we’re going to be celebrating that anniversary there next month. That celebration will occur alongside that of IBLAC (International Business Leaders’ Advisory Council), an international business advisory group that was put together when Zhu Rongji was the mayor of Shanghai [Zhu is since retired from public life]. He asked me to start that to attract foreign companies to invest in Shanghai.

“It turns out that it is harder [for China] to change, because they have one leader. My guess is that we’ll work it out sooner or later. Trump and Xi have to meet. That will result in some agreement that will get to them and they will have to finish the rest of the negotiations. I believe that will happen.” — Maurice “Hank” Greenberg, chairman and CEO, C.V. Starr & Co. Inc.

Shanghai and China in general were just coming out of the doldrums then; there was a lack of foreign investment. Zhu asked me to chair IBLAC and to help get it started, which I did. I served as chairman of that group for a couple of terms. I am still a part of that board, and it will be celebrating its 30th anniversary along with our 100th anniversary.

Advertisement




We have a good relationship with China, and we’re candid as you can tell from the op-ed I published in the Wall Street Journal. I’m told that my op-ed was received quite well in China, by both Chinese companies and foreign companies doing business there.

On August 29, Mr. Greenberg published an opinion piece in the WSJ reminding Chinese leaders of the productive history of U.S.-Sino relations and suggesting that Chinese leaders take pragmatic steps to ease trade tensions with the U.S.

R&I: What’s your outlook on current trade relations between the U.S. and China?

Hank Greenberg: As to the current environment, when you are in negotiations, every leader negotiates differently.

President Trump is negotiating based on his well-known approach. What’s different now is that President Xi (Jinping, General Secretary of the Communist Party of China) made himself the emperor. All the past presidents in China before the revolution had two terms. He’s there for life, which makes things much more difficult.

R&I: Sure does. You’ve got a one- or two-term president talking to somebody who can wait it out. It’s definitely unique.

Hank Greenberg: So, clearly a lot of change is going on in China. Some of it is good. But as I said in the op-ed, China needs to be treated like the second largest economy in the world, which it is. And it will be the number one economy in the world in not too many years. That means that you can’t use the same terms of trade that you did 25 or 30 years ago.

They want to have access to our market and other markets. Fine, but you have to have reciprocity, and they have not been very good at that.

R&I: What stands in the way of that happening?

Hank Greenberg: I think there are several substantial challenges. One, their structure makes it very difficult. They have a senior official, a regulator, who runs a division within the government for insurance. He keeps that job as long as he does what leadership wants him to do. He may not be sure what they want him to do.

For example, the president made a speech many months ago saying they are going to open up banking, insurance and a couple of additional sectors to foreign investment; nothing happened.

The reason was that the head of that division got changed. A new administrator came in who was not sure what the president wanted so he did nothing. Time went on and the international community said, “Wait a minute, you promised that you were going to do that and you didn’t do that.”

So the structure is such that it is very difficult. China can’t react as fast as it should. That will change, but it is going to take time.

R&I: That’s interesting, because during the financial crisis in 2008 there was talk that China, given their more centralized authority, could react more quickly, not less quickly.

Hank Greenberg: It turns out that it is harder to change, because they have one leader. My guess is that we’ll work it out sooner or later. Trump and Xi have to meet. That will result in some agreement that will get to them and they will have to finish the rest of the negotiations. I believe that will happen.

R&I: Obviously, you have a very unique perspective and experience in China. For American companies coming to China, what are some of the current challenges?

Advertisement




Hank Greenberg: Well, they very much want to do business in China. That’s due to the sheer size of the country, at 1.4 billion people. It’s a very big market and not just for insurance companies. It’s a whole range of companies that would like to have access to China as easily as Chinese companies have access to the United States. As I said previously, that has to be resolved.

It’s not going to be easy, because China has a history of not being treated well by other countries. The U.S. has been pretty good in that way. We haven’t taken advantage of China.

R&I: Your op-ed was very enlightening on that topic.

Hank Greenberg: President Xi wants to rebuild the “middle kingdom,” to what China was, a great country. Part of that was his takeover of the South China Sea rock islands during the Obama Administration; we did nothing. It’s a little late now to try and do something. They promised they would never militarize those islands. Then they did. That’s a real problem in Southern Asia. The other countries in that region are not happy about that.

R&I: One thing that has differentiated your company is that it is not a public company, and it is not a mutual company. We think you’re the only large insurance company with that structure at that scale. What advantages does that give you?

Hank Greenberg: Two things. First of all, we’re more than an insurance company. We have the traditional investment unit with the insurance company. Then we have a separate investment unit that we started, which is very successful. So we have a source of income that is diverse. We don’t have to underwrite business that is going to lose a lot of money. Not knowingly anyway.

R&I: And that’s because you are a private company?

Hank Greenberg: Yes. We attract a different type of person in a private company.

R&I: Do you think that enables you to react more quickly?

Hank Greenberg: Absolutely. When we left AIG there were three of us. Myself, Howie Smith and Ed Matthews. Howie used to run the internal financials and Ed Matthews was the investment guy coming out of Morgan Stanley when I was putting AIG together. We started with three people and now we have 3,500 and growing.

“I think technology can play a role in reducing operating expenses. In the last 70 years, you have seen the expense ratio of the industry rise, and I’m not sure the industry can afford a 35 percent expense ratio. But while technology can help, some additional fundamental changes will also be required.” — Maurice “Hank” Greenberg, chairman and CEO, C.V. Starr & Co. Inc.

R&I:  You being forced to leave AIG in 2005 really was an injustice, by the way. AIG wouldn’t have been in the position it was in 2008 if you had still been there.

Advertisement




Hank Greenberg: Absolutely not. We had all the right things in place. We met with the financial services division once a day every day to make sure they stuck to what they were supposed to do. Even Hank Paulson, the Secretary of Treasury, sat on the stand during my trial and said that if I’d been at the company, it would not have imploded the way it did.

R&I: And that fateful decision the AIG board made really affected the course of the country.

Hank Greenberg: So many people lost all of their net worth. The new management was taking on billions of dollars’ worth of risk with no collateral. They had decimated the internal risk management controls. And the government takeover of the company when the financial crisis blew up was grossly unfair.

From the time it went public, AIG’s value had increased from $300 million to $180 billion. Thanks to Eliot Spitzer, it’s now worth a fraction of that. His was a gross misuse of the Martin Act. It gives the Attorney General the power to investigate without probable cause and bring fraud charges without having to prove intent. Only in New York does the law grant the AG that much power.

R&I: It’s especially frustrating when you consider the quality of his own character, and the scandal he was involved in.

In early 2008, Spitzer was caught on a federal wiretap arranging a meeting with a prostitute at a Washington Hotel and resigned shortly thereafter.

Hank Greenberg: Yes. And it’s been successive. Look at Eric Schneiderman. He resigned earlier this year when it came out that he had abused several women. And this was after he came out so strongly against other men accused of the same thing. To me it demonstrates hypocrisy and abuse of power.

Schneiderman followed in Spitzer’s footsteps in leveraging the Martin Act against numerous corporations to generate multi-billion dollar settlements.

R&I: Starr, however, continues to thrive. You said you’re at 3,500 people and still growing. As you continue to expand, how do you deal with the challenge of attracting talent?

Hank Greenberg: We did something last week.

On September 16th, St. John’s University announced the largest gift in its 148-year history. The Starr Foundation donated $15 million to the school, establishing the Maurice R. Greenberg Leadership Initiative at St. John’s School of Risk Management, Insurance and Actuarial Science.

Hank Greenberg: We have recruited from St. John’s for many, many years. These are young people who want to be in the insurance industry. They don’t get into it by accident. They study to become proficient in this and we have recruited some very qualified individuals from that school. But we also recruit from many other universities. On the investment side, outside of the insurance industry, we also recruit from Wall Street.

R&I: We’re very interested in how you and other leaders in this industry view technology and how they’re going to use it.

Hank Greenberg: I think technology can play a role in reducing operating expenses. In the last 70 years, you have seen the expense ratio of the industry rise, and I’m not sure the industry can afford a 35 percent expense ratio. But while technology can help, some additional fundamental changes will also be required.

R&I: So as the pre-eminent leader of the insurance industry, what do you see in terms of where insurance is now an where it’s going?

Hank Greenberg: The country and the world will always need insurance. That doesn’t mean that what we have today is what we’re going to have 25 years from now.

How quickly the change comes and how far it will go will depend on individual companies and individual countries. Some will be more brave than others. But change will take place, there is no doubt about it.

Advertisement




More will go on in space, there is no question about that. We’re involved in it right now as an insurance company, and it will get broader.

One of the things you have to worry about is it’s now a nuclear world. It’s a more dangerous world. And again, we have to find some way to deal with that.

So, change is inevitable. You need people who can deal with change.

R&I:  Is there anything else, Mr. Greenberg, you want to comment on?

Hank Greenberg: I think I’ve covered it. &

The R&I Editorial Team can be reached at [email protected]