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Quackenbush's Agency Hid Purpose of Insurer's Payment

Probe: Invoice said $400,000, actually used for legal fees, was for "educational briefings."

By VIRGINIA ELLIS, Times Staff Writer

Wednesday, February 21, 2001

SACRAMENTO--The Department of Insurance under former chief Chuck Quackenbush covered up $400,000 that insurance giant Lloyd's of London paid the state after Quackenbush took the insurer's side in a fraud suit filed by another state agency.

Against the advice of at least one Insurance Department lawyer, Quackenbush's staff produced a phony invoice to hide the money, billing it as payment for "educational briefings."

The money actually was used to pay legal fees that Quackenbush ran up working on behalf of Lloyd's, whose representatives dictated the wording of the invoice.

Quackenbush, who maintained a close relationship with a lawyer representing Lloyd's and who later visited London at Lloyd's expense, is credited by participants with playing a critical role in the settlement of the securities fraud case. The settlement saved Lloyd's from losing its right to do business in California.

The department was scrambling to pay the huge legal bills it was racking up in the Lloyd's case without drawing attention to the expenditures, because lawmakers were cracking down on outside legal fees.

Officials worried about the costs and feared their methods would be exposed, internal memos reveal.

"The last thing you want is [Assistant . Atty. Gen.] Mark Richelson . . . reviewing all the accounting," Deputy Chief Counsel Richard Krenz wrote in a memo to Quackenbush's chief aide, William Palmer.

Another memo reported that a Lloyd's lawyer was concerned about "political repercussions" if the payment wasn't "structured with great sensitivity."

Lloyd's officials said the British insurer had no part in covering up the true use of its payment to the Department of Insurance. Joseph P. Gunset, general counsel for U.S. regulatory affairs for Lloyd's, said the insurer believed that its payment was for the purposes outlined in the state's invoice.

"Lloyd's did not reimburse the California Department of Insurance for legal expenses," Gunset said in a written statement. "Any reclassifying of legal expenses is an internal issue for the [insurance department]."

State Senate Insurance Committee Chairwoman Jackie Speier (D-Hillsborough), whose investigation of Quackenbush's activities last year helped force him from office, said state records provide "evidence that there was a systematic effort by the commissioner to deceive and obscure what he was doing."

Current department officials said they could not comment on the Lloyd's transaction because it is being investigated by a task force that includes the FBI, the Sacramento U.S. attorney and the California attorney general's office. California law does not provide for such reimbursements for this kind of state business.

Law enforcement authorities would not comment on whether they believe laws were violated.

Quackenbush's successor, Harry Low, asked the Legislature in November to order an audit that would include examination of the $400,000 payment.

Quackenbush's support for Lloyd's came at a critical time. Lloyd's was being bombarded with lawsuits by public agencies and private investors who claimed it had lured American investors without adequately disclosing that it was facing costly asbestos claims and expected many more. The 300-year-old London insurer argued that it had not defrauded anyone, and that investors had been made well aware of the risks they were taking.

But when Lloyd's was faced with five straight years of ruinous losses on asbestos claims and a string of catastrophes, some investors were forced into bankruptcy. A lawsuit by the Department of Corporations accused Lloyd's of defrauding hundreds of California investors and of selling securities that should have been registered under state law.

The lawsuit prompted an angry response from Quackenbush, who began to marshal support for Lloyd's, although it put him at odds with a fellow Republican, then-Gov. Pete Wilson, who had endorsed the suit. As commissioner, Quackenbush said he had to protect Lloyd's policyholders.

But the Lloyd's investors were dismayed.

"We were aghast when the California Department of Insurance sided with Lloyd's in a court case initiated by its sister agency," said Jeffrey Peterson, executive director of American Names Assn. Lloyd's investors are called Names.

Support at Critical Time
The payment that law enforcement officials are scrutinizing was made in April 1999, three years after Quackenbush launched an unusual legal and public relations offensive on behalf of Lloyd's. The Republican insurance commissioner had close ties to Lloyd's through a major law firm that represents it in the United States.

The firm, LeBoeuf, Lamb, Greene & MacRae, which has offices in San Francisco, was named as a defendant in the corporation department's lawsuit for "materially [assisting] in the California Corporations Code violations by Lloyds."

Entering the fray on behalf of Lloyd's, Quackenbush hired one of the top law firms in the country--Washington-based Manatt, Phelps & Phillips--to begin a flurry of legal activity. On his behalf, Manatt filed a petition to intervene in the corporations department case. Then it filed friend-of-the-court briefs in three private lawsuits, including one in Virginia, brought against the British insurer by investors. One brief also countered the position taken by the U.S. Securities and Exchange Commission that Lloyd's should be governed by American securities laws.

Meanwhile, at the National Assn. of Insurance Commissioners, Quackenbush successfully lobbied for the organization to take a formal position opposing Lloyd's investors. He urged other insurance commissioners to file friend-of-the-court briefs mirroring his position. Officials at the Louisiana insurance commissioner's office recalled that the brief they wrote in the lawsuit was filed by Manatt, with the costs billed to the California Department of Insurance.

Quackenbush hired a second law firm, Kroll & Tract, to represent him in New York, where Lloyd's funds for its U.S. business are held in trust.

Peterson, of the Names association, said that at the time he questioned how Quackenbush was getting so much state money for such extensive legal work. Told recently of the $400,000 from Lloyd's, he said: "We are outraged that the [department] would allow an insurance enterprise . . . to pay for the department's support in litigation."

Had investors known then that Lloyd's would be asked to pay for the litigation, he said, it would have been a powerful tool in the effort to neutralize the impact of Quackenbush's action.

As it was, Peterson and others involved in the cases against Lloyd's said, the commissioner's intervention helped turn the tide against the regulators and private citizens who were accusing the British giant of fraud.

"It had the effect of making California government look divided and uncoordinated, which are not favorable attributes when you are looking to bring litigation against someone," said Peter Kezirian, former Department of Corporations general counsel.

The case was dismissed on a technicality. Rather than refile, the department settled with the British insurer in what Time magazine would later say "was widely viewed as a wrist-slap victory for Lloyd's."

While Quackenbush was supporting Lloyd's in court, state officials were maneuvering to find a way to pay their mounting legal fees. Initially, the department avoided lawmakers' scrutiny, with action that some legal experts considered highly risky. They paid 75% of the fees out of the assets of bankrupt insurance companies that had been taken over by the commissioner.

"It was absolutely wrong to use those moneys," said Richards Barger, an insurance commissioner under former Gov. Ronald Reagan and now a private attorney.

"Those funds are to be used solely for the purpose of defraying legitimate administrative expenses and for the payment of eligible creditors. Any other use is contrary to law."

Neither state auditors nor the Legislature has jurisdiction over those accounts.

Second Thoughts
Courts overseeing the liquidation of the companies did approve the payment. The department had argued that each of those companies had an interest in protecting Lloyd's, a reinsurer that had sold them policies. Reinsurance, often called "insurance on insurance," provides payment for claims that exceed a certain amount.

Low, the current commissioner and a former judge, said the courts probably approved the expenditure with little scrutiny, assuming that a government agency would not be proposing something inappropriate.

In his request for an audit, Low noted that the placement of the assets from liquidated companies "outside the state's centralized treasury systems [gives] rise to the potential of great abuse and the history of this activity over the last decade should be examined."

By 1998, department officials were having second thoughts about using the assets of bankrupt companies, called estates, to pay legal bills in the Lloyd's cases. Gunset, the attorney for Lloyd's, said the first request for reimbursement came that summer.

A memo from Palmer, the Quackenbush aide, to insurance department lawyers in December reported that "Chuck [Quackenbush] called and said he received a call from the chairman of Lloyd's, who allegedly told him they intend to pay."

By January, when officials had heard nothing more from Lloyd's, they turned up the heat. On Jan. 12, they wrote to LeBoeuf lawyer William Marcoux and reminded him of Quackenbush's vital role in beating back the legal challenges, especially in the appellate court.

"It is safe to conclude, judging by the justices' comments, that the commissioner's amicus brief was at least in part responsible for Lloyd's victory in this hotly contested litigation," the department wrote in a letter drafted for Palmer by insurance staff attorney Jennifer Chambers.

The letter noted that Quackenbush had acted after "the commissioner was besieged with calls from Lloyd's representatives requesting [his] intercession in the lawsuit."

A month later, she e-mailed Palmer that Marcoux was concerned that the law did not provide a way for Lloyd's to reimburse the estates.

"He felt that such repayments would . . . arouse the suspicion of auditors conducting an audit of the estates," she wrote. "He felt that perhaps the repayments could be . . . identified as examination fees."

Records show Chambers repeatedly warned her superiors not to follow that course. "I would have to advise against our billing them as exam fees, however, since that is not what they are reimbursing us for," she wrote general counsel Brian Soublet.

On Feb. 18 she reported that Lloyd's had agreed to pay $400,000. Krenz wrote back that Palmer wanted her to contact Lloyd's lawyer "and have him script out the letter he would like us to send his client."

Marcoux sent back "draft language we would propose for the invoice to Lloyd's." He said Lloyd's would be "grateful" if it included a reference to educational briefings because that "will help avoid a potentially costly U.K. tax issue."

Lloyd's officials acknowledged in an interview that no serious tax issue existed.

The department followed Marcoux's draft almost verbatim, billing Lloyd's $400,000 "in connection with efforts of the [department] to review and respond to changes in the reporting structure, capital base and regulation of the Lloyd's insurance market and educational briefing to regulators."

In an interview, Lloyd's officials said they believed the invoice reflected the true purpose of their $400,000 payment.

Gunset said the insurer's discussions with the department had touched on two topics--reimbursement for legal fees and reimbursement for financial examinations. When Lloyd's took the position that there was no "statutory basis" for repaying the legal fees, he said it assumed "that effort for reimbursement from Lloyd's had been abandoned."

"What we are saying is that there were two parallel conversations going on, one about audit fees and . . . the other was about legal fees for litigation," said Caroline Wagstaff, head of marketing and communications. "We are saying we paid one and not the other."

But department memorandums show that state officials never abandoned their plans to use the payment as reimbursement for legal fees.

In a July 1999 letter to Speier, Quackenbush bragged that Palmer had "pursued Lloyd's for reimbursement of the funds expended in the litigation. . . . Mr. Palmer received no additional compensation for this work, which resulted in a recovery of $400,000."

State documents show that $300,000 of the Lloyd's money went to the six estates that had initially paid the legal fees. Another $37,000 was used by Palmer to pay an architect to redesign the department's offices in San Francisco. The remainder was transferred to the agency's general account in October, about three months after Quackenbush left office.

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