Risk Scenario

It Happened Here

An ill-advised merger sparks shareholder lawsuits and major losses.
By: | April 22, 2014 • 8 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.

A Promising Prospect

Hal Landis walked into the boardroom at Stratton Bank headquarters in Chesapeake, Va. with a glow building inside of him.

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The chairman and CEO of the bank, he carried in his briefcase paperwork that detailed the possible acquisition of Stratton by Manhattan-based Global Corp.

Global Corp., with about $100 billion in assets, liked the look of the mid-sized Stratton, which held about $30 billion in assets.

With its roots as a lender to the conservative farmers and fishermen of the Middle Atlantic, Stratton had a reputation for producing modest, steady returns and never taking unnecessary risks.

“Shall we get started everyone?” Landis said with a confident grin.

At 63, Landis was in good shape physically and financially, and with what Global was offering on a per-share basis, he couldn’t help but fantasize about the sort of retirement he might now be able to afford if this deal went through.

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Two hours later, the rest of the board of directors was won over. They voted to accept Global’s offer, conditional on the approval of that corporation’s board of directors.

The Global board meeting to discuss the Stratton acquisition did not go quite as smoothly.

The audit committee had barely completed its report on Stratton’s financials when Augie Desmond, a junior staffer in the bank’s risk management department, spoke up.

“Mr. Bedford,” Desmond began, addressing the bank’s chairman, the formidable Alan Bedford.

Eyebrows were raised. It wasn’t common for junior employees to punctuate Global meetings with unsolicited remarks or questions.

“Nice working with you kid,” the CFO said to himself.

“Yes, Mr. …” Bedford began.

“Desmond, sir, Augie Desmond, from risk management,” Desmond said.

“Yes, Mr. Desmond?” Bedford said, throwing a questioning look at Desmond’s boss, CRO John Fairmount.

“I have serious concerns about this acquisition, sir,” Desmond said.

“There was a piece in the Journal today on a steam-generating solar plant in Nevada,” Desmond said.

Fairmount shot Desmond a look.

“Sorry John,” Desmond said. “I didn’t have time to tell you.”

Desmond continued.

“According to a report from Stanford, the heat from the plant is killing wildlife — lots of it — including the state bird,” Desmond said.

“Wha….?” Bedford began.

“The solar company, Daedalus, is based in Virginia,” Desmond said. “Stratton is the primary advisor on the company’s upcoming IPO. Daedalus is applying for a second permit, an even bigger plant with about $30 million in investment. If the politicians get hold of this thing, and they will …”

“What thing?” Bedford said.

“The bluebird thing sir, that’s the state bird. If this second plant application goes south, that solar company is at serious risk and so is Stratton — I don’t like it sir … I don’t like it one bit.”

“Mr. Desmond what is your background?” Bedford asked.

“I have a Master’s Degree in astrophysics from MIT,” Desmond said.

“And how long have you been in the banking industry?” Bradford said.

“Three months sir,” Desmond said.

“I’ll take that under advisement,” Bedford said.

Without much further debate, they followed the recommendation of the audit committee and approved the Stratton acquisition.

Nevada Down

The meeting of the Stratton Bank stockholders to vote on the approval of the Global Corp. offer was held in the conference rooms at the Chesapeake Madison Hotel. Before the vote, the floor was opened up for discussion.

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As he was at every meeting, Smitty Ackles, a shareholder and crabber from Havre de Grace, was first to the mike.

With his enormous gut protruding from between the bands of his cherry red suspenders, Ackles stood at the mike, smiling with wizened eyes at Hal Landis.

“Good afternoon, Mr. Landis,” Smitty said.

“Good afternoon, Mr. Ackles,” Landis said in what the audience recognizes as their standard opening schtick.

There are chuckles throughout the room.

“What I’d like to know, Mr. Landis, is why in the world the shareholders should accept this deal? We have been doin’ alright for 35 years, nobody’s complainin’ about their returns. Why do it?”

“Well, a 20 percent premium on our shares is one reason,” Landis said.

“Not worth it,” countered Ackles. “These boys from New York will bring more trouble than they’re worth, I guarantee you.”

“I’ve known you since you were a boy, Hal Landis, and I’m here to tell you, you’re making a mistake,” Smitty said before ambling away from the mike.

There are more chuckles, but nobody really listens to Smitty. Stratton shareholders approve the deal 2,010 to 15.

Not even a week later, the Nevada Department of Environmental Protection issues a surprise ruling that condemns the second Daedalus plant.

A study from the University of Nevada confirms what the Stanford researchers found. The plant is linked to the deaths of 1,000 Mountain Bluebirds, the state bird. Deaths of other birds number in multiples of that.

Geddy Hayes, an influential Nevada State Senator from Sparks, picked up the football and ran with it. Hayes, a gifted speaker, worked his magic from the Senate floor and killed any remaining chance the second Daedalus plant had.

The application for the plant, which the solar company spent millions on, went under.

Hayes wasn’t done with Daedalus. He pressured state regulators into burdening the existing plant with new regulations — to the point that it began to lose money.

On a Monday afternoon, Hal Landis sat in his office with CFO Dylan Reed, watching a cable news financial report.

The Daedalus IPO launched the previous week and did fairly well, with the share price rising 17 percent by week’s end. The following week was a different story.

Losses suffered by the Daedalus plant are being reported, along with the losses from the failed application for the second plant.

One week after the IPO launch, Daedalus shares are down 30 percent and are in freefall.

“How bad do you think this is for us?” Landis asked Reed.

“I don’t know, I’ve never been in this position before,” Reed said.

“None of us have,” Landis said.

Within two days, Stratton is set upon in a class action by attorneys for disgruntled Daedalus shareholders, who report millions in investment losses.

Damages

The acquisition of Stratton by Global is set to close in the third quarter. In its second quarter financials, Stratton reports a multimillion dollar write down in connection with the Daedalus fiasco.

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Weakened by the reputational hit of the Daedalus shareholder class actions, Stratton also begins to notice some alarming revenue declines.

This time, at the Global board meeting where the decision to follow through on the Stratton acquisition will be made, it’s Augie Desmond’s boss, John Fairmount, who speaks first for the risk management department.

“Mr. Bradford, it’s our opinion that we should absorb any frictional costs and abandon this acquisition,” Fairmount said.

“Based on what data?” asked Global’s CFO, Daniel Silberstein, who championed the acquisition from day one.

Fairmount turned to Desmond.

“We’ve run an algorithm that ties share price to reputational damage. Call it a reputational risk index, if you will,” Desmond said.

“Based on what we’re seeing with Stratton, we see share price deterioration tied to reputational problems plaguing the bank for at least the next six quarters,” Desmond said.

Bradford shot Fairmount a look that said, “Again with this kid?”

Bradford and Silberstein aren’t swayed. They like Stratton’s basic book of business a lot. The bank hasn’t had a quarter in 20 years when it didn’t return a dividend.

Global’s board votes 13 to 4 to go ahead with the acquisition.

In the first six months following the acquisition year, Stratton shows a revenue decline of 20 percent over the previous year.

The solar deal in Nevada that went sour is poisoning the bank’s brand with its largely conservative retail banking customers.

A sizable chunk of Global shareholders are fed up. Rather than start an internecine war with their own management, they take action against Stratton.

The allegations are that Stratton failed to disclose the risk of the Daedalus exposure to the Global board and bungled the crisis management of the failed IPO.

———-

Two years ago, if you’d asked Hal Landis who his insurance broker was, he couldn’t have told you. Now he knows him very well.

“You have $10 million in general liability coverage,” the broker explained to Landis over the phone.

“Right,” Landis said.

“Between the Daedalus IPO shareholder actions and the Global shareholder actions, you’re looking at $15 million in potential liability,” the broker said.

“Do you see any indications that your own shareholders could take action against the board?” he asked.

“Not to date,” Landis said.

“You have that much in your favor,” he said. “For the time being.”

“Well, we can self-insure the $5 million on top of the policy if we have to,” Landis said.

“Sure,” the broker said. “But I can’t think of an admitted carrier who will even talk to us next year.”

“What’s an admitted carrier?” Landis said.

“It’s a carrier who’s not going to charge you your right arm in premium,” said the broker.

No longer fantasizing about a rosy retirement, Landis wonders how long he’ll have a job.

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Risk & Insurance partnered with Aon to produce this scenario. Below are Aon’s recommendations on how to prevent the losses presented in the scenario. These lessons learned are not the editorial opinion of Risk & Insurance.

1. Risk management requires an open mind: Ignoring stakeholders that voice legitimate concerns carries a double-edged risk. The first risk is the magnitude of the exposure brought up by a colleague or shareholder that’s being overlooked. The second is the fact that an issue was raised publicly, thereby documenting a concern that went unheeded by management.

2. Risk by association: Operational risk is such a pressing risk for financial institutions in part because of the number and variety of business partners and clients they take on as part of their basic operation. An inadequate knowledge of the technology, practices and risk exposures of any given business partner can result in reputational and other damages should that business partner fail or incur a sizable liability.

3. Transparency: Companies that fail to properly assess their risk and report it to business partners face increasingly painful regulatory sanctions. A blunt assessment of an organization’s exposures is the first step in that process. Being forthright in communicating risk factors is the second.

4. Analyze cover: Regulatory pressures and a rapidly changing business environment necessitate that financial institutions assess their insurance coverage more frequently than ever before.

5. Risk management is a process, not a program: There is nothing static about risk management. New processes, products and distribution channels in the financial services industry mean that the nature of operational risk is changing constantly. Risk management needs to keep pace with that change or risk losing relevance and value.

Partner Resources

Operational Risk Solutions

Regulation and the Financial Industry



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

More from Risk & Insurance

More from Risk & Insurance

4 Companies That Rocked It by Treating Injured Workers as Equals; Not Adversaries

The 2018 Teddy Award winners built their programs around people, not claims, and offer proof that a worker-centric approach is a smarter way to operate.
By: | October 30, 2018 • 3 min read

Across the workers’ compensation industry, the concept of a worker advocacy model has been around for a while, but has only seen notable adoption in recent years.

Even among those not adopting a formal advocacy approach, mindsets are shifting. Formerly claims-centric programs are becoming worker-centric and it’s a win all around: better outcomes; greater productivity; safer, healthier employees and a stronger bottom line.

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That’s what you’ll see in this month’s issue of Risk & Insurance® when you read the profiles of the four recipients of the 2018 Theodore Roosevelt Workers’ Compensation and Disability Management Award, sponsored by PMA Companies. These four programs put workers front and center in everything they do.

“We were focused on building up a program with an eye on our partner experience. Cost was at the bottom of the list. Doing a better job by our partners was at the top,” said Steve Legg, director of risk management for Starbucks.

Starbucks put claims reporting in the hands of its partners, an exemplary act of trust. The coffee company also put itself in workers’ shoes to identify and remove points of friction.

That led to a call center run by Starbucks’ TPA and a dedicated telephonic case management team so that partners can speak to a live person without the frustration of ‘phone tag’ and unanswered questions.

“We were focused on building up a program with an eye on our partner experience. Cost was at the bottom of the list. Doing a better job by our partners was at the top.” — Steve Legg, director of risk management, Starbucks

Starbucks also implemented direct deposit for lost-time pay, eliminating stressful wait times for injured partners, and allowing them to focus on healing.

For Starbucks, as for all of the 2018 Teddy Award winners, the approach is netting measurable results. With higher partner satisfaction, it has seen a 50 percent decrease in litigation.

Teddy winner Main Line Health (MLH) adopted worker advocacy in a way that goes far beyond claims.

Employees who identify and report safety hazards can take credit for their actions by sending out a formal “Employee Safety Message” to nearly 11,000 mailboxes across the organization.

“The recognition is pretty cool,” said Steve Besack, system director, claims management and workers’ compensation for the health system.

MLH also takes a non-adversarial approach to workers with repeat injuries, seeing them as a resource for identifying areas of improvement.

“When you look at ‘repeat offenders’ in an unconventional way, they’re a great asset to the program, not a liability,” said Mike Miller, manager, workers’ compensation and employee safety for MLH.

Teddy winner Monmouth County, N.J. utilizes high-tech motion capture technology to reduce the chance of placing new hires in jobs that are likely to hurt them.

Monmouth County also adopted numerous wellness initiatives that help workers manage their weight and improve their wellbeing overall.

“You should see the looks on their faces when their cholesterol is down, they’ve lost weight and their blood sugar is better. We’ve had people lose 30 and 40 pounds,” said William McGuane, the county’s manager of benefits and workers’ compensation.

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Do these sound like minor program elements? The math says otherwise: Claims severity has plunged from $5.5 million in 2009 to $1.3 million in 2017.

At the University of Pennsylvania, putting workers first means getting out from behind the desk and finding out what each one of them is tasked with, day in, day out — and looking for ways to make each of those tasks safer.

Regular observations across the sprawling campus have resulted in a phenomenal number of process and equipment changes that seem simple on their own, but in combination have created a substantially safer, healthier campus and improved employee morale.

UPenn’s workers’ comp costs, in the seven-digit figures in 2009, have been virtually cut in half.

Risk & Insurance® is proud to honor the work of these four organizations. We hope their stories inspire other organizations to be true partners with the employees they depend on. &

Michelle Kerr is associate editor of Risk & Insurance. She can be reached at [email protected]