Frankel's Tale Puts Focus
On What Regulators Knew
By SCOT J. PALTROW
Staff Reporter of THE WALL STREET JOURNAL
NASHVILLE, Tenn. -- If vanished financier Martin Frankel has
masterminded a huge insurance heist, he did it all under the nose of state
regulators.
Insurance regulators in Tennessee for at least six
years were aware of unusual trading activities at
Frankel-controlled insurers -- including purported
trades of Treasury bonds that typically totaled
more than 90 times the total assets of the
companies each year -- according to interviews
and records in the files of the Tennessee
Department of Commerce and Insurance.
Yet the regulators failed to take action until after at
least $215 million -- and maybe much more -- had
disappeared from the companies.
Such heavy turnover should have drawn the attention of regulators, some
insurance specialists say. The purported trading at the Frankel-controlled
insurers was "astonishing," asserts Richard Schwartz, portfolio manager
and senior vice president at New York Life Asset Management. "Turnover
of 90 times assets is ridiculous." Turning over assets once is considered
high, Mr. Schwartz says.
There were other warning flags. Tennessee
regulators didn't act against Franklin American
Life Insurance Co., an insurer controlled by
Mr. Frankel, even though for four years the
company stated in its annual statements that
the bonds in its portfolio were being held
outside a bank -- a violation of a state
regulation.
Tennessee regulators say they were keeping
an eye on the activity but argue that action
wasn't needed. "There was an awful lot of trading," concedes Bill W.
Hosea, director of financial analysis for the Tennessee department. But
he
says the department concluded that "the trading strategy wasn't clearly
illegal, and we just kind of monitored it."
Now, federal prosecutors and insurance regulators from several states
including Tennessee are scrambling to figure out what happened to Mr.
Frankel and the money he supposedly managed through his Liberty
National Securities brokerage operation. Mr. Frankel has been missing
since May 5, when firefighters were called to his mansion, where they
found smoldering documents.
The Tennessee officials say they had no reason to give special treatment
to
Franklin American. But it's clear that from its inception Franklin American
had a number of connections with the insurance department. The company
was founded in the mid-1980s by a former Tennessee insurance
commissioner, Richard F. Keathley, and the lawyer representing the
company in dealings with the department was a former general counsel of
the department.
Following the Money
Estimates of money transferred to Martin Frankel's Liberty National
Securities-a
Company
State
of domicile
Lost-b
(millions)
First National Life Insurance Co. of America
Mississippi
$156
International Financial Services Life
Missouri
57
Family Guaranty Life Insurance Co.
Mississippi
19
Franklin American Life Insurance Co.
Tennessee
17
Franklin Protective Service
Mississippi
12
Farmers & Ranchers Life
Oklahoma
8
Old Southwest Life Insurance Co.
Arkansas
5
a-Far more money allegedly was contributed by Thunor Trust, but can't be
verified.
b-Of the total, $58 milion was returned to a Tennessee company.
Source: Missouri Department of Insurance
In recent months, regulators in several states placed a group of seven
insurance companies, owned by a trust controlled by Tennessee
businessman John A. Hackney, into receivership. The action came after
several of the companies, under the umbrella of Franklin American Corp.,
said their invested assets had disappeared. The companies at least since
1991 had invested nearly all of their funds through Mr. Frankel's Liberty
National Securities, Greenwich, Conn.
Tennessee and other states' insurance departments received regular
quarterly and annual financial statements from the companies showing
astronomical levels of trading. For example, the 1997 annual statement
for
Franklin American Life shows that the company, which had total assets of
$60.9 million, repeatedly bought and sold the same group of bonds in
trades that totaled $5.57 billion that year.
In addition, Tennessee has an unusual state regulation requiring insurance
companies to put investments such as bonds in the physical custody of a
bank. But Tennessee regulators until late last year didn't act, even though
Franklin American Life from 1994 through 1997 stated truthfully in its
annual statements that the bonds weren't being held in a bank but by its
brokerage firm, Liberty National. Until just a few months ago, Franklin
American wasn't required to file a standard custody statement saying that
the bonds were being held by a bank.
Mr. Hosea, the Tennessee department executive, says the trading and
failure to place bonds in a bank did raise questions in his office as early
as
1992, when it conducted a regular five-year financial exam of Franklin
American. But the examination report contained no mention of it, and Mr.
Hosea said he was satisfied with the company's explanation about the
trading.
That explanation, given to examiners by Mr. Hackney, was that Liberty
National was engaging in numerous short-term trades of Treasury bonds
and making a reliable profit for the company every quarter.
But analysts at insurance-ratings service A.M. Best Co. said the excessive
trading didn't boost the insurers' profitability noticeably. "I don't see
the
benefit" to the insurance companies, said Richard Kirk, an assistant vice
president with A.M. Best. He said the units' investment-portfolio-realized
capital gains "are nominal."
Moreover, Franklin American's investment-portfolio total return was a
moderate 6.40% in 1998, according to A.M. Best, while the average total
return for a life insurer last year was nearly 7.7%, according to industry
experts.
Investigators now suspect that much of the reported trading never took
place. Instead, they believe that money was regularly being removed from
the company through Liberty National, and that the reported heavy trading
was a ruse to explain why the bonds weren't physically deposited with a
bank: Mr. Hackney told regulators that Liberty National needed to have
control of the bonds to be able to carry out its strategy of short-term
trades, according to a document filed with regulators.
Examiners on Mr. Hosea's staff from 1992 on repeatedly urged the
department to launch a full-scale inquiry and take action on the trading,
investigators and people close to the department say, but the examiners
were rebuffed. Mr. Hosea confirms that his staff expressed bewilderment
about the trading, but denies that they urged action.
Around 1990, Franklin American's capital dipped below the minimum
required by regulators. Records at the insurance department reflect
criticism of management practices, including a real-estate transaction
and
large advance payments of commissions to agents. But instead of putting
the company into receivership, the regulators placed it "under supervision,"
a status that allowed management to retain ownership.
In 1991, Mr. Hackney, the Tennessee businessman with ties to Mr.
Frankel, created Thunor Trust, and sought to acquire Franklin American.
At the time, people close to the investigations say, an official in the
insurance department raised questions about the transaction, because it
was being treated as a merger instead of a sale, which under Tennessee
rules would have required more extensive disclosure and review. But the
deal was approved anyway.
In an interview, Mr. Keathley says the acquisition by Thunor saved him
from losing any money on Franklin American, and he said he has retained
a
minority interest in the company ever since. Robert Moore, the insurance
department's chief counsel, denies that the department gave any special
treatment to Franklin American. "There was no favoritism given to these
people," he said.
The acquisition vehicle, an investment trust, is extremely unusual in the
insurance industry, says Patrick Finnegan, a senior insurance analyst at
Moody's Investors Service Inc.
Yet Tennessee officials confirm that the unusual arrangement didn't prompt
the department to look closely at the credentials of the individuals behind
the trust.
Had they done so, they could have turned up unsettling information: At
least two of the three parties alleged to have contributed money to the
trust
dispute that they contributed any such funds. And one professes no
knowledge of the trust.
For his part, Mr. Hosea says the trust acquisition was approved because
it
appeared to comply with the law.
Irregularities at Franklin American weren't acted upon until late last
year,
when the company was due for its next regular five-year examination by
the Tennessee department.
Its chief examiner, Donnie Spann, who works under Mr. Hosea, had
continuing strong concerns about the company, according to people close
to the department, and arranged for a respected outside examiner, Billy
Lovelady, to be hired to conduct the exam.
In interviews, officials confirmed that when he began work in September
1998, Mr. Lovelady detected irregularities relating to the investments,
and
by late December the department called in Mr. Hackney and insisted that
Franklin American physically produce the bonds and deposit them in a
bank. Mr. Hackney did so, and more than $60 million in bonds were
placed in a Georgia bank.
Mr. Moore, the chief counsel, said the department later was shocked to
learn that at the beginning of January 1999, just days after depositing
the
bonds, Franklin American pulled them out again.
"It went back to Liberty National," Mr. Moore says. The department
didn't discover this, however, until mid-March, he adds.
At that point, Mr. Moore says, the department became convinced that
something was seriously amiss. Regulators insisted that the bonds be
returned and this time deposited with a bank in Tennessee. Franklin
American complied.
Soon, however, when Mississippi officials asked a Mississippi subsidiary
of Franklin American to produce its bonds, the company wasn't able to.
Mississippi officials placed the company in receivership, leading to the
takeover of the whole chain of companies by state regulators.
Mr. Hackney's lawyer, Aubrey Harwell Jr., says Mr. Hackney was duped
by Mr. Frankel and believed that all the trading was legitimate. Mr.
Harwell says Mr. Hackney had no knowledge of bonds being pulled out of
the Georgia bank in January. Mr. Hackney has declined to speak with
reporters.
Mr. Hosea says he is basically satisfied with the department's monitoring
of
Franklin American over the years. He asserts that the department devoted
the proper amount of vigilance given what it knew, although he adds: "Any
time you have a bad ending, you're always looking for some way that you
might improve."
Officials say the department deserves credit for making the company
produce the bonds, which means that Franklin American, unlike other
companies in the group, is still solvent.
Meantime, some regulators are philosophical about the whole affair. Says
Mr. Moore, the Tennessee insurance department's chief counsel: "If
someone is intent on defrauding a regulator, they can sure do it."
--Deborah Lohse and Leslie Scism contributed to this article.