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Otter Creek
MANAGEMENT
Institutional Shareholder Services
Financial Industries Corporation
July 9, 2003
2:00 p.m.
7/9/2003
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Otter Creek
MANAGEMENT
Table of Contents
1. Otter Creek Management Background
2. Developments Leading to Roy F. Mitte Termination
3. Affidavit of Roger Keith Long
4. FIC Financial Services New Era Marketing Initiative
5. Prior Americo Marketing Initiative Resulting in Law Suit and $10 Million
Settlement
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Management
R. Keith Long, President
o Began his career in May 1973 as portfolio manager for Lionel Edie & Co. (a
wholly owned subsidiary of Merrill Lynch focused on large growth stocks)
o Joined Delphi Capital Management in 1979 and served as an equity portfolio
manager and analyst
o Moved to the CBOT as a fixed income trader specializing in cash/futures
arbitrage for Tradelink in 1980
o Joined Kidder Peabody in 1981 as a fixed income analyst and arbitrageur,
focused on cash/futures arbitrage of the 10-year T-Note
o Moved to Morgan Stanley in 1983 and was responsible for long bond
cash/futures arbitrage
o Formed Otter Creek Management in 1991
o Mr. Long received his undergraduate and MBA degrees from Indiana
University
Joseph W. O'Neill, Jr., CFO
o Joined Otter Creek Management in 2002
o Experience includes:
- Management consulting for Intertrade Corporation
- Business development for Florida Crystals Corporation
- Managing electronic banking and residential lending for Ocwen
Financial Corporation
- Program management for Rockwell International
- International business development, manufacturing analysis, and
production assembly for Chrysler Corporation
o Received his BS Industrial Engineering degree from Lehigh University and
his MBA from the University of Michigan, Ann Arbor.
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Otter Creek
MANAGEMENT
Management
Jeffrey K. Racenstein, Portfolio Manager
o Joined Otter Creek Management in 1999 as Portfolio Manager
o Experience includes small cap long/short equity research at Avalon
Research Group, finance at a public heating oil company, and accounting
experience at Price Waterhouse, where he received his CPA license
o Received a BBA in Accounting from the University of Michigan and earned
his MBA from the Stern School of Business at New York University
Neil A. Levy, Portfolio Manager
o Joined Otter Creek Management in 2001 as Portfolio Manager
o Experience includes equity research in the contract manufacturing space at
Needham & Co., and controller of an investment management firm in
Manhattan
o Began his career at Goldstein Golub Kessler PLCA, where he received his
CPA license.
o Received a BS in Accounting at Lehigh University and earned his MBA from
the Stern School of Business at New York University.
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Otter Creek
MANAGEMENT
Investment Entities & Approach
Investment Entities
Assets Under Management (6/30/03)
Otter Creek Partners I, LP $107 million
Otter Creek International, Ltd. 181
HHMI XIII, LLC 28
----
Total AUM $316 million
Investment Approach
o U.S. securities on a long/short basis with low net market exposure
utilizing a bottom-up, value-driven approach
o All investment decisions are driven by intensive balance sheet analysis
o The fund will take debt positions when relative value opportunities are
identified in the capital structure
o Low turnover (1.32) and long time horizon investment approach
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Otter Creek
MANAGEMENT
Historical Performance
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD
- ---------------------------------------------------------------------------------------------------------------------------
1991 1.21% 1.73% -0.97% 4.41% 2.36% 8.97%
1992 2.50% 1.05% 2.76% 0.46% 2.47% 0.35% 0.49% 0.94% 0.74% 0.63% 1.51% 1.43% 16.41%
1993 3.77% 2.52% 2.68% 0.00% 1.07% 0.80% 2.58% 1.26% 1.10% 1.17% 2.00% 1.79% 22.75%
1994 2.52% 0.48% -0.13% 0.00% 1.09% 3.63% 0.43% 0.83% 1.48% 0.12% -0.76% 0.25% 10.30%
1995 -0.08% 2.16% 1.69% 2.61% 1.54% 2.25% -0.07% 1.51% -0.54% 1.16% -0.01% 2.20% 15.34%
1996 1.94% 1.68% 0.85% 0.95% -4.82% 1.15% 1.29% 3.32% 1.68% 3.30% 3.29% 1.67% 17.27%
1997 -1.55% 3.27% 2.89% -0.13% -2.45% -0.27% -3.29% 1.63% -2.97% 2.09% -2.59% 3.49% -0.26%
1998 3.07% 1.29% -0.92% 0.56% 0.31% 1.78% 7.03% 2.92% 0.63% 1.94% -0.43% -1.63% 17.55%
1999 -0.60% 0.39% -0.78% 0.90% 5.13% 0.27% 2.69% 1.24% 0.61% 2.83% 1.72% 3.20% 18.92%
2000 1.45% 2.90% 6.41% 3.65% 3.22% 0.94% 1.03% 1.44% 2.01% 3.30% 1.34% 1.99% 33.92%
2001 5.02% -0.04% 0.49% 1.76% 1.35% 0.15% 1.29% 0.39% -2.06% 2.62% -0.54% 1.13% 12.01%
2002 0.40% -0.22% 1.59% 0.47% -0.24% -1.44% -2.59% -0.06% -1.13% 2.63% 3.85% 0.77% 3.93%
2003 2.05% 1.16% 1.56% 0.50% 2.12% 0.33% 7.96%
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Otter Creek
MANAGEMENT
Prior Relevant Experience
o Initiated investment in Financial Institutions Insurance Group circa
1991/1992.
o Requested and was granted Board seat in 1991
o Elected Chairman of the Board in 1995
o Company sold to Castle Harland in 1996
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Otter Creek
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Financial Institutions
Insurance Group, Ltd.
STATEMENTS OF INCOME
Year Ended December 31,
-----------------------------------------------------------------------
1995 1994 1993 1992 1991
-----------------------------------------------------------------------
Premiums earned .......................... $11,356,083 $ 7,819,784 $ 7,433,716 $ 7,344,128 $ 8,872,195
Net imvestment income .................... 4,050,602 3,277,864 3,470,202 3,344,198 3,936,098
Net realized gains (losses) on investments 1,193,780 570,231 1,275,142 1,031,977 830,722
Other income ............................. 556,941 742,546 582,465 427,072 138,896
-----------------------------------------------------------------------
TOTAL REVENUE .......................... 17,157,406 12,410,425 12,761,525 12,147,375 3,777,911
=======================================================================
NET INCOME ............................. $ 4,321,799 $ 3,738,818 $ 3,211,945 $ 2,945,764 $2,409,8l8
=======================================================================
PER SHARE(**) ............................ $ 1.30 $ 1.13 $ 0.99 $ 0.81 $ 0.61
=======================================================================
DIVIDENDS DECLARED PER SHARE(*) .......... $ 0.22 $ 0.18 $ 0.17 $ 0.16 $ 0.12
=======================================================================
(**) As of 12/10/93 a 2-for-l stock split to shareholders of record om January
20, 1994 was recorded.
As of 6/7/95 a 20% stock dividend was declared payable to stockholders of
record om July 27, 1995.
As of 12/6/95 a 20% stock dividend was declared payable to stockholders of
record om January 26, 1996.
Earnings per share were restated to reflect the stock dividend dilution.
(*) As of 12/6/95 $.075 of dividends were declared payable to stockholders of
record on January 26, 1996 and were accrued by FIIG as part of the other
liabilities.
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Otter Creek
MANAGEMENT
Financial Institutions
Insurance Group, Ltd.
BALANCE SHEET DATA
December 31,
-----------------------------------------------------------------------
1995 1994 1993 1992 1991
-----------------------------------------------------------------------
Assets
Investments ......................... $75,184,832 $65,235,902 $63,968,135 $49,763,479 $53,474,614
Other assets ........................ 19,015,441 20,892,630 19,242,906 29,368,699 28,456,009
-----------------------------------------------------------------------
TOTAL ASSETS ...................... $94,200,273 $86,128,532 $83,211,041 $79,132,178 $81,930,623
=======================================================================
Liabilities and stockholders' equity
Reserves for unpaid losses and loss
adjustment expenses ............ $32,455,874 $32,967,809 $33,502,333 $33,179,237 $24,686,8ll
Other liabilities ................. l5,781,277 14,377,067 12,136,749 11,135,083 18,666,723
-----------------------------------------------------------------------
TOTAL LIABILITIES ................... 48,237,151 47,344,876 45,639,082 44,314,320 43,353,534
Stockholders' equity ................ 45,963,122 38,783,656 37,571,959 34,817,858 38,577,089
-----------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY ............ $94,200,273 $86,128,532 $83,211,041 $79,132,178 $81,930,623
=======================================================================
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Otter Creek
MANAGEMENT
Financial Institutions
Insurance Group, Ltd.
SIGNATURES
Pursuant to the requirements of Section 12 or 15(d) of the Securities Exchange
Act of 1924, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, as of the 20th day of
March, 1996.
FINANCIAL INSTITUTIONS INSURANCE GROUP, LTD.
R. Keith Long
By R. Keith Long
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1924, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and as of the dates indicated.
SIGNATURES TITLE DATE
- ------------- --------------------- --------------
R. Keith Long Chairman of the Board March 28, 1996
- ------------- and Director
R. Keith Long
William S. O'Connell Vice Chairman of the March 28, 1996
- -------------------- Board and Director
William S. O'Connell
John A. Dore President, Chief March 28, 1996
- ------------ Executive Officer
John A. Dore and Director
Richard P. Ackerman Director March 28, 1996
- -------------------
Richard P. Ackerman
Dale C. Bottom Director March 28, 1996
- --------------
Dale C. Bottom
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Otter Creek
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Otter Creek Nominees
Name Age Principal Occupation
- ---- --- --------------------
R. Keith Long 55 Mr. Long has served as president of Otter Creek
Management Inc. since founding it in 1991. From
1983 through 1991 he worked at Morgan Stanley in
long bond cash/futures arbitrage. As chairman of
the board of Financial Institutions Insurance
Group he oversaw its sale in a leveraged buy-out
in 1996. Mr. Long has bachelors and MBA degrees
from Indiana University.
J. Bruce Boisture 53 Mr. Boisture serves as president of Trinity
Capital Alliance, Inc., an investment banking
company he founded in 1992, specializing in
leveraged buy-outs, start-up investments,
turnarounds and venture capital financings, in
connection with which he has served temporarily
in a number of senior management positions in
various companies. From 1986 through 1991 he was
a partner and chief operating officer of
Rosecliff Inc./Acadia Partners L.P., a $1.7
billion investment fund. Mr. Boisture has a
bachelors degree from Princeton University, a
bachelors in philosophy degree from Oxford
University and a law degree from Yale Law
School.
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Otter Creek
MANAGEMENT
Otter Creek Nominees
Name Age Principal Occupation
- ---- --- --------------------
Salvador 51 Since 1991 Mr. Diaz-Verson has served as
Diaz-Verson Jr. chairman and president of Diaz-Verson Capital
Investment LLC. From 1979 through 1991 he served
as president and chief investment officer of
American Family Life Assurance Co., a New York
Stock exchange company. A native of Cuba, Mr.
Diaz-Verson has a bachelors degree from Florida
State University.
Richard H. Gudeman 65 Mr. Gudeman served as executive vice president
at SunGard Insurance Systems Inc., and as an
actuary at Country Life Insurance Co.,
Washington National Insurance Co., State Farm
Life Insurance Co. and Federal Life Insurance
Co. over the last 30 years. He has a bachelors
degree from Illinois State University and a
masters degree from Northeastern University.
Patrick E. Falconio 61 From 1988 through his retirement in 1999 Mr.
Falconio served as executive vice president and
chief investment officer of Aegon USA Inc. Prior
to that he worked at Life Investors Insurance
Co., Lincoln National Life Insurance Co. and
Prudential Insurance Co. He has a bachelors
degree from Duquesne University and an MBA from
the University of Georgia.
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Otter Creek
MANAGEMENT
Otter Creek Nominees
Name Age Principal Occupation
- ---- --- --------------------
Steven A. Haxton 45 A certified public accountant, Mr. Haxton is the
principal in Haxton Advisors, a consulting firm.
Previously he was an executive vice president at
ING, president of Aetna Financial Services'
Financial Intermediary Group, senior vice
president of Aetna Investment Services and
president of Nationwide Distributors Inc. He has
a bachelors degree from Malone College.
Lonnie L. Steffen 53 Since 1997 Mr. Steffen has served as president
and chief financial officer of Dearborn Risk
Management. From 1991 through 1997 he served as
chief financial officer of Financial
Institutions Insurance Group. From 1986 through
1991 he served as chief financial officer of
First Reinsurance Co. of Hartford. A certified
public accountant, Mr. Steffen has a bachelors
degree from Northern Illinois University.
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Otter Creek
MANAGEMENT
Developments Leading to
Roy F. Mitte Termination
Highlights of the Report of the FIC Audit Committee
o Company-paid personal expenses of approximately $500,000 (pgs. 17-18)
o Details concerning $1 million transfer from FIC to Mitte Foundation (pgs.
34-35)
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REPORT OF THE AUDIT COMMITTEE
OF THE BOARD OF DIRECTORS
CONCERNING PAYMENT OF
PERSONAL EXPENSES OF THE CHAIRMAN
I. INTRODUCTION.
On August 13, 2002, the Audit Committee (the "Committee") of the Board of
Directors of Financial Industries Corporation(1) (the "Company") held its
regularly-scheduled quarterly meeting, with representatives of the Company's
independent auditors, PriceWaterhouseCoopers LLP ("PwC"), in attendance. The
Committee was informed that according to Company records, personal expenses of
the Chairman and Chief Executive Officer, Roy F. Mitte (the "Chairman" or "Mr.
Mitte"), had for several years been routinely paid with Company funds. PwC, in
turn, informed the Committee that in light of this information, the firm could
not complete its review of the Company's financial statements for the second
quarter of 2002 in time to permit a timely filing of the Company's Report on
Form l0-Q (the "10-Q") for the period.
The Committee voted unanimously to conduct an investigation, including a
review of Company books and records and interviews of persons with knowledge of
the relevant facts, for the purposes of: determining, to the extent reasonably
possible, the nature and extent of any payment of officers' personal expenses
with Company funds; furnishing such reports to the Committee and PwC as might
enable the filing of the Company's l0-Q for the second quarter of 2002; making
recommendations to the Committee with respect to whether, and in what amount,
the Committee should recommend that the Board direct the Company's management to
seek the
- ----------
(1) InterContinental Life Corporation ("ILCO") became a fully-owned subsidiary
of Financial Industries Corporation on May 18, 2001 by merger with ILCO
Acquisition Company.
2
reimbursement of funds from the Chairman; and recommending the adoption of
additional controls, if any, to avoid such payment of personal expense with
Company funds in the future. The Committee did not undertake to suggest any
disciplinary action or to make any recommendation as to whether Mr. Mitte should
be re-elected as Chairman and Chief Executive Officer by the Board of Directors.
II. THE AUDIT COMMITTEE'S INVESTIGATION.
On August 15, 2002, the Committee met with representatives from the Dallas
office of the law firm of Weil, Gotshal & Manges LLP ("WGM"), and retained WGM
to conduct an investigation. The questions directed to WGM were as follows:
1. Did the Company in fact pay, or reimburse the Chairman for, expenses
that were personal in nature?
2. If so, how extensive were the payments, and over what period of time
did they occur?
3. Were there other instances--involving other officers or employees--of
payment of substantial amounts of personal expenses with Company funds?
III. SUMMARY OF CONCLUSIONS.
1. The Company did, in fact, pay (or reimburse the Chairman for) expenses
that were personal in nature.
2. The payments occurred at least over the period of time from 1992 to
August of 2002. The Company made direct payments of amounts charged to an MBNA
MasterCard in the name of Mr. Mitte in amounts totalling $455,561 from August of
1992 through August of 2002; most of those expenses appear to have been personal
in nature. In addition, the Company reimbursed the Chairman's Administrative
Assistant, Bob Bender, for expenditures in the total amount of $17,983, which
similarly appear to have involved personal expenses of the Chairman
3
or his family. Finally, the Company has made direct payments to vendors in the
total amount of $70,880 for personal expenses of the Chairman and his family.
3. We examined the records of other cost centers which--like the
Chairman's "Executive" Cost Center, #900--were not subject to periodic
budgetary review. We did not find evidence of similar payment of or
reimbursement for expenses that were personal in nature.
IV. SUMMARY OF RECOMMENDATIONS.
1. The Committee recommends that the Chairman be required to reimburse
improperly-paid personal expenses, and that the amount to be reimbursed be
communicated o the Chairman, through his counsel, as quickly as reasonably
possible.
2. The Committee recommends that the Board seek from the Roy F. Joann Cole
Mitte Foundation (the "Foundation" or "Mitte Foundation ") the repayment of the
$1 million transferred from the Company to the Foundation in January of this
year.(2) In the event that the Foundation will not voluntarily return the funds,
the Committee recommends that the Board consider further action, as necessary,
to bring about the return of the donation.
3. The Committee recommends that the Board enact a resolution confirming
that the policy of the Company has been, and remains, that the Company will not
pay--whether directly or indirectly--expenses of officers, employees, or
directors that are not reasonably related to business conducted on behalf of the
Company.
4. The Committee recommends that the Board adopt internal controls to
implement the policy of the company as set forth above, and that the Chief
Financial Officer, with the assistance (as needed) of the Company's outside
auditors, be instructed to draft such controls for consideration by the Board.
- ----------
(2) A separate internal audit report will address expenses paid or borne by
the Company for the benefit of the Foundation.
4
5. Neither the Chief Financial Officer nor the Company's outside auditors
are implicated in the practice of payment of the Chairman's personal expenses
described in this Report; indeed, both responded promptly and responsibly upon
discovery of the problem. Accordingly, the Committee perceives no reason to
recommend that the Board usurp the normal functions of the Chief Financial
Officer or the Company's outside auditors in determining materiality with
respect to the matters discussed in this Report and making adjustments to
financial statements, if appropriate.
6. The Committee--in consultation with the Company's counsel and its
outside auditors--intends to comply with the requirements of the Sarbanes-Oxley
Act by establishing procedures for accepting, investigating, and resolving
"whistle-blower" information concerning accounting matters. In the interim, the
Committee recommends that the full Board pass an appropriate resolution
informing the Company's officers and employees that communications of legitimate
concerns with respect to Company accounting are welcomed and will be handled in
confidence to the extent reasonably possible, and that acts of discrimination,
recrimination or retribution against persons presenting such reports will not be
tolerated.
7. The Chief Financial Officer, in consultation with the General Counsel,
should determine whether appropriate Forms 1099 have been sent to the Chairman
(and filed with the Internal Revenue Service) with respect to the expense of
owning, maintaining, and operating the Company automobiles furnished for the
Chairman's use, as well as for any other expenses paid by the Company on behalf
of the Chairman for which it is determined that reimbursement by the Chairman is
not required.
5
V. RESPONSIBLE OFFICERS AND EMPLOYEES.
A. Roy F. Mitte.
Mr. Mitte is the Chief Executive Officer of the Company and Chairman of
its Board of Directors. He has been with the Company or its predecessors since
1976. Mr. Mitte has been on administrative leave since August 19, 2002.
B. Robert Bender.
Mr. J3ender is the Vice President for Administration. Mr. Bender drives
the Chairman's car and performs other functions necessitated by Mr. Mitte's
physical condition. He has been employed by the Company in this capacity under
various titles since January of 1994.
C. Joseph F. Crowe.
Mr. Crowe was formerly a Vice President--a position from which he took
early retirement in 1997--and was a member of the Company's Board of Directors
until he resigned December of 2001.
D. Jeffrey H. Demgen.
Mr. Demgen is Vice President and Chief Financial Officer of the Company
and a member of its Board of Directors. A graduate of Valparaiso with an MBA
from Illinois Benedictine, Mr. Demgen has been an officer or employee of the
Company or subsidiaries since 1992.
E. Theodore A. Fleron.
Mr. Fleron is Vice President, Assistant Secretary and General Counsel of
the Company and a member of its Board of Directors. A graduate of the University
of Pennsylvania School of Law, Mr. Fleron has been with the Company or its
predecessors since the 1970s.
6
F. James M. Grace.
Mr. Grace was formerly Executive Vice President and Chief Financial
Officer of the, Company, a position from which he resigned in May of 200l. He
remained a member of its Board of Directors until his resignation effective
December 31, 2001. Mr. Grace, a graduate of Notre Dame, has been with the
Company or its predecessors since 1971.
G. David C. Hopkins.
Mr. Hopkins is Senior Vice President and Controller of Investors Life. A
graduate of the University of Illinois, Mr. Hopkins has been with the Company
since 1982.
H. Sheryl L. Kinlaw.
Ms. Kinlaw is Counsel to the Company and Vice President of the life
insurance subsidiaries. She is a graduate of the University of Texas School of
Law.
I. M. Scott Mitte.
Scott Mitte is a member of the Company's Board of Directors and was the
Executive Director and Vice President of the Mitte Foundation until his
resignation in August of this year.
J. John W. Peasley.
Mr. Peasley is Senior Vice President of Budget and Planning of the Company
as well as of Investors Life and Family Life. A graduate of LaSalle, Mr. Peasley
joined CIGNA in 1982 and joined the Company when it purchased CIGNA in 1988.
K. Thomas C. Richmond.
Mr. Richmond is Secretary of the Company and a member of its Board of
Directors. He was appointed Interim Chief Executive Officer of the Company on
August 24, 2002. He has been an officer of the Company or subsidiaries since
1993.
7
L. Steven P. Schmitt.
Mr. Schmitt was formerly a Vice President of the Company and a member of
its Board of Directors.
M. Nigel S. Walker.
Mr. Walker is Senior Vice President and Controller of Family Life.
The Committee's counsel interviewed all of the above-referenced individuals
except for the Chairman and Scott Mitte.
VI. THE CHAIRMAN'S EXPENSES.
A. The Expense Reimbursement Process.
Expense reimbursements are initiated by filling out an "Accounts
Payable--Check Request" and submitting it to the Accounts Payable Department. An
example of such a check request is the first page of the collection of documents
attached as Appendix A. So long as the person submitting the form is recognized
as having authority to do so, the reimbursement request is not questioned and a
check is issued as requested.(3) Depending on the instruction marked on the
form, the check when issued is mailed to a vendor or returned to the requesting
party.
Copies of the check requests reflecting the action taken by the Accounts
Payable Department are maintained in the Accounts Payable files, along with the
vendor invoice or other backup submitted with the check request and,
occasionally, a copy of the check itself. A specimen copy of such a collection
of papers from the Accounts Payable files is attached as Appendix A.
- ----------
(3) Among the matters that should be considered by the Chief Financial Officer
and the Company's outside auditors, in connection with Recommendation No.
4 at page 4 above, is whether the current procedure for approving expense
reimbursements is adequate, or whether additional controls should be added
in this area.
8
B. The MBNA MasterCard.
Account No. 5329 0315 4980 8283 at MBNA America in Wilmington, Delaware
(the "MBNA Account") is assigned to a MasterCard in the name of Roy Mitte; the
statements are sent to the Company's offices (6500 River Place Blvd #1, Austin,
TX 78730-112301). From August of 1992 through July of 2002, the charges to this
account have totaled at least $471,474; of this total, $455,661, or 96.65%, was
paid by the Company. The percentage paid by the Company in 2002 is even
higher--99.14%.
The set of accounts payable expense records attached as Appendix A (FIC
INV 00689 - 693) is art example of a check request and account statement/invoice
for the MBNA Account for May 2002. The check request (dated May 23, 2002) was
submitted and signed by Mr. Bender, who listed "RFM Co. Expenses" as the reason
for the check. Of the $16,015.87 due for the month, Mr. Bender requested a
Company check in the amount of $l5,884.01, or 99.18% of the total. The
difference, or $131.86, apparently consists of five automobile service station
charges (marked on the MBNA account statement). in the "Special instructions"
section, Mr. Bender wrote, "Please mail w/ RFM's check...;" presumably a
personal check from the Chairman was submitted with the check request, although
no copy of such a check has been preserved with the file.
It appears that in the early months of the period for which records were
examined, the Chairman paid the majority of the expenses charged on the MBNA
MasterCard. For example, the current charges on the MBNA Account statement
received in December of 1992 totaled $1,786.73; Mr. Mitte's assistant, Laura
Kroah, submitted a Check Request dated January 13, 1993, for a check payable to
MBNA America in that amount, but also tendered the Chairman's personal check in
the amount of $l,625.29. The difference, $161.44, is the sum of charges on the
MBNA Account statement from gasoline stations, and Ms. Kroah filled in "Gas
reimb.
9
($161.44)" as the Reason for Check on the check request. Copies of the Check
Request dated January 13, 1993 and supporting documentation (FIC INV 00010-13)
are attached as Appendix B. This pattern--with the Chairman reimbursing the
Company for the lion's share of the MBNA account charges--continued for the MBNA
Account statements received in January, February, and March of 1993. However, on
May 28, 1993, Ms. Kroah submitted a Check Request in the amount of $5,887.82,
for which the payee was "Roy F. Mitte" and the Reason for Check was "Mastercard
Reimb." For the first time, Ms. Kroah added the words "Per RFM" in the line
designated "Approved By" on the check request. The sum of $5,887.82 was in fact
paid to the Chairman pursuant to the check request. Copies of the Check Request
dated May 28, 1993 and the supporting documentation (FIC INV 00040 - 62) are
attached as Appendix C.
From and after the June 1993 MBNA Account payments, the earlier
pattern--with the Chairman reimbursing the Company for all but the service
station charges--was reversed. The MBNA Account statement received in June of
1993 reflected new charges of $2,385.44. Ms. Kroah submitted a Check Request
dated June 17, 1993 in that amount, which was paid by the Company; the Chairman
gave the Company a personal check payable to the Company in the amount of
$87.13, the total of three service station charges on the June 1993 MBNA Account
Statement. Copies of the June 17, 1993 Check Request, the MBNA Account
Statement, the Chairman's $87.13 check and the Check Receipt in that amount (FIC
INV 00068-69), are attached as Appendix D.
The check requests with respect to the MBNA Account payments typically
directed a debit to the 900 "Executive" Cost Center, specifically to Expense
Code 1204, which is designated "Automobile Operating" in the Company's
accounting system. As is discussed in
10
more detail below, the preponderance of the charges on the MBNA Account
statements do not appear to involve automobile operating expenses.
C. The Bender Reimbursements.
Each month, from March of 1994 through July of 2002, Mr. Bender submitted
check requests for reimbursement of charges paid by Mr. Bender. A specimen copy
of one such check request with supporting documentation (FIC INV 00301-303) is
attached as Appendix B. Mr. Bender has submitted check requests for
reimbursement of--and has been reimbursed for--a variety of business-related
expenditures, including business lunches, travel expenses, gifts purchased for
officers at the Chairman's instruction, and gasoline and service for the
company-owned automobile that is used to transport the Chairman. In addition,
as is discussed below, Mr. Bender has been reimbursed for expenses incurred on
behalf of the Chairman that appear to have been personal in nature.
D. The Chairman's Company Car.
The Company provides an automobile for the Chairman's use, driven by his
administrative assistant--Mr. Bender, since January of 1994. Mr. Bender drives
the Chairman to the office in the morning; takes him back home in the late
morning or afternoon; and uses the car for other duties as directed by the
Chairman.
The various automobiles provided by the Company for the Chairman's use
during Mr. Bender's tenure have been as follows:
1986 Rolls Royce Silver Spur: In use when Mr. Bender arrived in
January of 1994, this automobile was apparently used for the
Chairman's transportation until February of 1995.
11
1992 Mercedes 600 SEL: Formerly used by Mrs. Mitte, this automobile
was purchased by the Company from the Chairman in February of 1995.
1998 Mercedes CL 500: This automobile was purchased by the Company
in February of 2000; the 1992 Mercedes 600 SEL was traded in as part
of the purchase price.
E. Supporting Documentation.
A chronological set of documents from the Company's Accounts Payable
Department reflecting checks evidencing the Company's payment of apparent
personal expenses of the Chairman, bearing document control numbers FIC INV
00001-733 (excerpts from which are referred to throughout this Report and
included as appendices thereto) is bound separately as Appendix FF.
VII. THE MBNA ACCOUNT.
A. Generally.
The Committee's counsel and accounting advisers examined Accounts Payable
records for the MBNA Account from and after August of 1992. As set forth above,
for the first several months of the period for which the records were reviewed,
the Company paid only a small portion of the monthly invoice--typically the
automobile service station charges--with the remainder apparently paid from the
Chairman's personal account.
However, by the time Bob Bender was hired as the Chairman's administrative
assistant in January of 1994, the practice had essentially reversed, so that the
Company paid all charges against the MBNA Account other than the gasoline
charges.
From August of 1992 through August of 2002, the Company paid approximately
$455,561 to MBNA with respect to the MBNA Account. The following is an
illustration of the nature of the charges. From and after 1996, the MBNA Card
charges paid by the Company total
12
$373,146; of those charges, $132,313 are from department stores, drug stores,
grocery stores, and home improvement retailers, as follows:
- --------------------------------------------------------------------------------
Type of charge Amount Percent of Subtotal Percent of Total
- --------------------------------------------------------------------------------
Department Stores $ 22,164 16.75% 5.94%
- --------------------------------------------------------------------------------
Drug Stores $ 22,099 16.70% 5.92%
- --------------------------------------------------------------------------------
Grocery Stores $ 39,134 29.58% 13.11%
- --------------------------------------------------------------------------------
Home Improvement $ 48,916 36.97% 13.11%
- --------------------------------------------------------------------------------
SUBTOTAL $133,313 35.46%
- --------------------------------------------------------------------------------
A spreadsheet reflecting the charges from the listed categories of
establishments from 1996 to 2002, with a listing of the individual charges, is
attached as Appendix F.
B. Mr. Bender's Practice With Respect to the MBNA Account.
Mr. Bender was hired to assist Mr. Mitte in January of 1994. The first
check request for payment of charges to the MBNA Account that Mr. Bender
submitted was dated March 2, 1994, and requested a Company check in the amount
of $731.39; the total MBNA charges for the month in question, as evidenced by
the attached account statement, were $878.40. The Check Request recited "Co.
Expenses for Mr. R. F. Mitte" as the Reason for Check, and included Special
Instructions as follows: "Please mail the co. check & his check in." The
attached account statement reflects Chevron charges totaling $147.01--the
difference between the $878.40 in new charges for the month and the $731.39 for
which Mr. Bender sought a Company check. Copies of the Check Request and the
account statement (FIC INV 00090-91) are attached as Appendix G.
The Committee's Counsel and accounting advisers interviewed Mr. Bender on
August 22 and 23, 2002 at the Company's offices in the presence of the
Chairman's attorneys. When questioned concerning the MBNA Account charges, Mr.
Bender responded as follows.
13
When Mr. Bender prepared his first check request for payment of an MBNA
invoice (FIC INV 00090), the Chairman instructed him as to the allocation of
payment--that the Chairman was to pay the gasoline charges (which were for Mrs.
Mitte's car) by personal check, which Mr. Bender should prepare for the
Chairman's signature, and Mr. Bender should obtain a Company check for all other
amounts. The Chairman marked an "x" beside all amounts that he would pay with
his personal check. (On the account statement that accompanied this first check
request--FIC INV 00091--the Chairman apparently neglected to mark his "x" beside
one of the five Chevron charges, but Mr. Bender nevertheless included it in the
total to be paid by the Chairman's personal check.) Mr. Bender was not yet
familiar with the process of allocating charges between the Company and the
Chairman; he found the proposed allocation to be sufficiently unusual that he
thought it might have been a "flip-flop"--an error in communication resulting
from aphasia accompanying the Chairman's stroke-impaired condition. He was
sufficiently concerned that he sought verification in several ways:
1. He went back to the Chairman and asked whether he actually meant
what he had said, or whether he intended the reverse (with the
Company paying the gasoline charges and the Chairman paying the
remainder). The Chairman assured Mr. Bender that he had meant for
the Company to pay all but the gasoline charges;
2. He questioned Paul Vandevere, who was then Vice President for Human
Resources (and who had hired Mr. Bender), who told him that "the
Company pays Mr. Mitte's personal expenses. That's the way he wants
it done...;"
3. He questioned Jim Grace, who was then Chief Financial Officer. Mr.
Bender could not recall Mr. Grace's exact words, but did recall that
after their conversation, "I was confident that that was the way it
is here--the company has decided to pay for Mr. Mitte's expenses.
All expenses incurred by Mr. Mitte or his wife, or anything he had a
desire for, the Company would pay for."
4. He reviewed earlier check requests submitted by his predecessors in
the position of Administrative Assistant to the Chairman, and found
them consistent.
14
Mr. Bender also considered the fact that no question was ever raised with
respect to a check request that he signed and submitted, to be a form of
subsequent verification of the allocation. Mr. Bender coded the check requests
for payment of the MBNA Account charges under Expense Code 1204--"Automobile
Operating"--because his predecessors had done so.
Mr. Bender stated that there was no doubt in his mind that the Chairman
intended for the Company to pay the bulk of the MBNA MasterCard charges, and was
aware that the Company was doing so.
Mr. Bender stated that as time went by, he and the Chairman generally
omitted the step in the payment process by which Mr. Bender would submit the
MBNA statement to the Chairman for marking of the charges to be paid by the
Chairman's personal check. Mr. Bender considered that he understood the
Chairman's intentions and could prepare the check request and the personal
check, consistent with past practice, on his own.
C. Total Personal Charges Paid by Company Through MBNA Account.
As set forth above, the total amount paid by the Company on the MBNA
Account since August of 1992 is $455,661; a spreadsheet reflecting the division
of company-paid and total MBNA charges by year is attached as Appendix H. Copies
of the underlying Accounts Payable records with respect to the MBNA
Account--including copies of check requests, account statements, and any other
documents (such as copies of the Chairman's personal checks)--.are included in
the chronological set of Accounts Payable records bound separately as Appendix
FF.
From a review of the documents and the interview of Mr. Bender by the
Committee's counsel and accounting advisers, it is not clear that any of those
amounts constitute expenditures incurred for business purposes as opposed to
personal expenses of the Chairman or his family.
15
VIII. OTHER EXPENSE REIMBURSEMENTS.
A. Generally.
In addition to the MBNA Account charges, the Company has reimbursed Mr.
Bender for sums paid by Mr. Bender--either in cash, by personal check, or by
personal credit card--for both personal and Company-related expenses of the
Chairman. These payments were made in response to check requests signed and
submitted by Mr. Bender. An example (and the first such check request submitted
by Mr. Bender) is the check request dated February 18, 1994, with supporting
documentation, a copy of which is attached as Appendix I; these documents
reflect that Mr. Bender paid for the repair of the Company's Rolls Royce with
his personal credit card, and also paid for a taxi ride to or from the
dealership (id.), and was thereafter reimbursed in the total amount of $426.37.
The Company's Accounts Payable records reflect numerous and frequent
expenditures by Mr. Bender, and reimbursement by the Company, for
presumably-valid Company-related expenses such as business meals and travel
expenses in addition to repairs to Company automobiles and similar expenses.
In addition, however, Mr. Bender also paid or charged--and was
subsequently reimbursed by the Company for--items that can only be characterized
as personal expenses of the Chairman or his family. These expenditures were for
purposes such as: repairs to Mrs. Mitte's automobile (see FIC INV 000301-303,
attached as Appendix J) or truck (see FIC INV 00325-333, attached as Appendix
K); repairs to the Chairman's shoes (see FIC INV 00707-709, attached as Appendix
L) and purchases of new shoes (see FIC INV 00533-536, attached as
16
Appendix M);(4) and purchases of electric razors for the Chairman (see FIC INV
00633-636, attached as Appendix N).(5)
B. Mr. Bender's Practice With Respect to Expense Reimbursements.
Mr. Bender stated that he did not question the notion of being reimbursed
for expenditures that were personal in nature because he had been informed (as
set forth above) that the Company paid the Chairman's living expenses. He stated
that in instances where a question might have been raised--such as Company
reimbursement of expenses incurred in repairing Mrs. Mitte's automobile or
truck--he justified or rationalized his submission of the check request by
telling himself that if Mrs. Mitte had picked up the car and paid for the repair
with the MBNA MasterCard, the Company would have paid for the repair by its
regular monthly check to MBNA. The only respect in which Mr. Bender sought
approval for such reimbursements was a question to Paul Vandevere as to whether
it was appropriate for Mr. Bender to accumulate and retain the airline miles or
Discover Card points that flowed from the use of his personal credit card for
the purchases. Mr. Vandevere assured him that "everybody keeps their own [credit
card] miles."
C. Other Company Payment of Personal Expenses of the Chairman.
1. Home Sidewalk Repairs.
In the fall of 2001, Mr. Bender submitted three check requests in amounts
totaling $5,200 for reimbursement of amounts paid by Mrs. Mitte for repairs to
the sidewalk outside the
- ----------
(4) Shoe repairs and shoe purchases were recurring items for which Mr. Bender
repeatedly sought and obtained reimbursement. Mr. Bender informed the
Committee's counsel and advisers that the Chairman was aware of and
concerned about the slightest amount of wear on the heel of the shoe on
the foot with which he pivots in moving from his wheelchair to another
chair (or vice versa), and would send Mr. Bender to either purchase new
shoes, or to have the old ones re-soled, at any sign of such wear.
(5) Mr. Bender informed the Committee's counsel and advisers that because the
Chairman had the use of only one arm, he was hard on electric razors,
frequently dropping and damaging them. Mr. Bender recalled purchasing so
17
Chairman's home; the Company reimbursed the Chairman by two Company checks
totalling that amount. Copies of the Accounts Payable files for these
expenditures (including documents numbered FIC INV 00629-630; 00642-644; and two
additional un-numbered pages) are attached as Appendix O. With respect to the
first such check request, dated September 27, 2001, Mr. Bender stated that the
Chairman informed him that the sidewalk in question provided outside access to a
separate part of the house that the Chairman might thereafter use as a home
office, and that it was therefore appropriate for the Company to reimburse the
Mittes for the repairs. Mr. Bender prepared the check request, filling in, as
the stated "Reason for Check," the words "Reimbursement for sidewalk repairs
(home office)." Mr. Bender had the Chairman sign this Request (in addition to
Mr. Bender's signature), apparently evidencing his own uncertainty about the
payment. (Mr. Bender signed the two subsequent check requests without asking for
the Chairman's concurring signature.) Neither the Board nor any other officer
approved the reimbursement. Mr. Bender informed the Committee's counsel and
accounting advisers that the Chairman has not, to date, built an office at his
home; the room in question has, instead, been built out as servants'
quarters.(6)
2. Anniversary Party.
In early August of this year a Company check (#21123514) in the amount of
$18,113.98 was issued payable to Hoffman & Company Catering, in response to an
August 1, 2002 check request signed by Julie Gunn with the stated purpose "1/2
total anniversary party catering/entertainment fee (deposit)." Copies of the
Accounts Payable files for these
- ----------
many electric razors in one particular period of weeks that he joked to
John Peasley that he must think that Mr. Bender was running an electric
razor business.
(6) The Committee's accounting advisers were unable to find any evidence that
the Company actually paid the first check request (dated September 27,
2001, in the amount of $2,400.00), despite the fact that the check request
is in the Accounts Payable files. Accordingly, the amount of this request
is not included in the $455,561 total, and the check request and
supporting documentation have not been included in Appendix FF.
18
expenditures (FIC INV 00717-723) are attached as Appendix P. An anniversary
party has been planned for the Chairman and his wife for September 14; Mr.
Bender stated that Scott Mitte. came to the Chairman's office one day with an
estimate of the cost, and after a closed-door meeting involving only Scott Mitte
and the Chairman, Scott Mitte emerged from the office and told Mr. Bender that
the Chairman had instructed that the Company was to pay the expenses of the
party. Neither the Board nor any other officer approved the Company's payment of
the expense of the anniversary party.
3. Cable Television Charges.
From April of 2000 to June of 2002, the Company made payments to Time
Warner Cable in the total amount of $2,646, covering cable television and
internet service at the Mitte home. A spreadsheet itemizing the Time Warner
invoices paid by the Company is attached as Appendix Q; copies of the Accounts
Payable files for these expenditures are included, chronologically, in Appendix
FF. The check requests (again, submitted and signed by Mr. Bender) typically
listed "RFM Internet" or "RFM Cable/Internet" as the reason for the check. Mr.
Bender stated that Scott Mitte decided it was important for the Chairman to have
internet access at his house, and that Scott therefore caused the purchase of "a
bunch of computer equipment" for the Mitte home.(7) Mr. Bender stated that he
was concerned as to whether the monthly internet access expense and the cost of
the computer equipment should be a Foundation expense or a Company expense. He
stated that he asked that question of Jim Grace, who replied that as far as he
was concerned, nothing precluded a company paying for a senior executive to have
computer use at home.
- ----------
(7) We assume, but have not yet been able to determine, that this equipment is
reflected on Company depreciation schedules.
19
Mr. Bender was shown a copy of a monthly invoice, which appeared to
reflect cable television service (listed variously as "Standard Plus Package" or
"New Standard" or "Digital") as well as internet service ("Road Runner"). Mr.
Bender admitted that the check requests should only have covered the internet
access portion of the invoices.
The total amount apparently paid for Mitte home cable television service
by the Company from and after April of 2000 appears to be at least $910.
4. Insurance on Mrs. Mitte's Automobile.
During our investigation we learned that the Company currently pays the
annual premiums for insurance, not only on the Company-owned automobile used by
the Chairman, but also on the 1999 Mercedes S500 driven by Mrs. Mitte. For the
past three years, the Company-paid insurance premiums with respect to Mrs.
Mitte's automobile have been as follows:
2000 $1,651
2001 1,960
2002 1,960
------
TOTAL $5,571
D. Total Personal Charges Paid by Company Through Expense
Reimbursements.
From a review of the documents and the interview of Mr. Bender by the
Committee's counsel end accounting advisers, it would appear that the Company
has reimbursed Mr. Bender for expenditures related to personal expenses of the
Chairman or his family, in the total amount of $17,983. An itemization of these
charges is attached as Appendix R, and copies of all of the Accounts Payable
records with respect to these charges--including copies of check requests,
account statements, any oilier documents (such as copies of the Chairman's
personal checks)--are included within the chronological set bound separately as
Appendix FF.
In addition, as set forth above, it would appear that since at least June
of 1999, the Company has made payment to the Miles, and direct payment to
vendors other than MBNA, for
20
personal expenses of the Chairman or his family in the total amount of $70,880.
A spreadsheet reflecting the apparent personal charges from other vendors paid
through the 900 Account is attached as Appendix S.
IX. KNOWLEDGE OF, OR AUTHORIZATION FOR, THE COMPANY'S PAYMENT OF THE
CHAIRMAN'S PERSONAL EXPENSES.
A. The Chairman's Compensation as Approved by, the Boards of
Directors.
The Chairman's compensation package is recommended annually by the
Compensation Committee of the Board of Directors and, thereafter, approved by
the full Board. For the year 2001, the Compensation Committees of the Boards of
Directors of Financial Industries Corporation and ILCO recommended, and the
respective Pull Boards of Directors of each corporation approved, compensation
to the Chairman as follows:
- --------------------------------------------------------------------------------
CORPORATION SALARY BONUS
- --------------------------------------------------------------------------------
FIC $ 146,821 $ 965,000
- --------------------------------------------------------------------------------
ILCO $ 356,679 $1,535,000
- --------------------------------------------------------------------------------
Total $ 503,500 $2,500,000
- --------------------------------------------------------------------------------
See Minutes of the Meeting of the Compensation Committee of the Board of
Directors of Financial industries Corporation, January 8, 2001, a copy of which
is attached as Appendix T; Minutes of the Meeting of the Compensation Committee
of the Board of Directors of InterContinental Life Corporation, January 8, 2001,
a copy of which is attached as Appendix U. Significantly, each Compensation
Committee expressly considered the Chairman's request for donations by the
Company to the Mitte Foundation in 2001--in the amount of $375,000 from each
corporation--in setting the Chairman's salary and bonus;(8) the Boards of
Directors of each
- ----------
(8) See, e.g., Minutes of the Meeting of the Compensation Committee of the
Board of Directors of Financial Industries Corporation, January 8, 2001
(Appendix T):
Mr. Barnett informed the Committee that the Board of Directors of
the Company will be requested to consider a donation to the Roy F.
Mitte and Joann Cole Mitte Foundation in the amount of $375,000.
Following a discussion, the Committee concluded that, in making a
recommendation In the Board of
21
corporation approved donations of $375,000 to the Foundation in the same
meetings in which the Chairman's compensation--in the amounts approved by the
respective Compensation Committees--was also approved.(9) Id.
For the year 2002, the Compensation Committee recommended that the
Chairman be paid a salary of $800,000 and a cash bonus, to be paid in January of
2002, of $2,500,000. See Minutes of the Meeting of the Compensation Committee of
the Board of Directors of Financial Industries Corporation, December 8, 2001, a
copy of which is attached as Appendix X. During consideration of the Chairman's
compensation package by the Compensation Committee, the representation was made
on behalf of the Chairman that he would not seek a donation from the Company to
the Mitte foundation during the year 2002. The Compensation Committee
accordingly voted to recommend an increase in the Chairman's salary for
2002--from $503,500 to $800,000. The recommendation of the Compensation
Committee (including the $2,500,000 bonus) was approved by the Board. See
Minutes of the Meeting of the Board of Directors, Financial Industries
Corporation, December 8, 2001, a copy of which is attached is Appendix Y.(10)
The minutes of the Boards of Directors of the Company (and, prior to the
merger, of ILCO) do not reflect consideration or approval of an arrangement by
virtue of which personal expenses of the Chairman would be borne by the Company
or ILCO. The same is true with respect to the minutes of the Compensation
Committees of the Boards of Directors of the two
- ----------
Directors as to the salary and bonus of Mr. Mitte for the year 2000
(sic), it would inform the Board of Directors that recognition had
been given to the donation proposal in establishing the Committees
recommendation.
(9) See Minutes of the Meeting of the Board of Directors, Financial Industries
Corporation, January 17, 2001 (Appendix V); Minutes of the Meetings of the
Board of Directors, InterContinental Life Corporation, January 17, 2000
(Appendix W).
(10) Unlike in previous years, the Board did not approve a donation to the
Mitte foundation for the year 2002.
22
corporations. The Committee is informed that neither the Company nor, prior to
the merger, ILCO, has ever filed with the Internal Revenue Service a Form 1099
or W-2 reflecting compensation to the Chairman in the form of payment of his or
his family's personal expenses.
B. Lack of Knowledge of Company Payment of Chairman's Personal
Expenses.
None of the members of the Committee were aware, at any time prior to
August of 2002, of any occurrence or practice of payment by the Company of
personal expenses of the Chairman or his family, or the existence of the MBNA
Account or the Company's payment of all or part of the charges thereto.
Except as specifically noted herein, none of the persons interviewed by
the Committee's counsel and accounting advisers stated that they were aware, at
any time prior to August of 2002, of the payment by the Company of personal
expenses of the Chairman.
During an interview by counsel on August 16, 2002, Mr. Grace was asked
whether he had known of possible Company payment of personal expenses of
officers at any time in the past. Mr. Grace answered that he had learned of the
issue only during the week of the interview. With respect to the MBNA Account,
Mr. Grace did recall that the Chairman and his Administrative Assistant would
review the bills each month and determine the proper allocation of expenditures
between the Company and the Chairman. He said that the Chairman had sole
authority over what he called the "900 Automobile Account," and that at the
Chairman's level, there was no requirement of review of a check request before
payment was made. In Mr. Grace's words, Roy can approve anything." Asked whether
he ever recalled any issue being raised with respect to the use of Company funds
to pay personal expenses, he reiterated that he had not. Asked about any rumors
on the subject, Mr. Grace recalled that either Mr. Demgen or Mr. Richmond, after
Mr. Grace had retired as CEO, told Mr. Grace of a desire to talk with him about
how the Chairman's expenses were handled, but that the call never took place.
23
Mr. Peasley, during his interview by counsel on the same date, stated that
he recalled that at the end of 2001, Mr. Schmitt had a conversation with Mr.
Peasley concerning the MBNA Account.(11) According to Mr. Peasley's
recollection, Mr. Schmitt examined an account statement for the MBNA Account and
wondered why the amount invoiced did not agree with the amount of the Company's
check--and commented that the charges appeared personal in nature. Mr. Peasley
stated that he agreed that the charges looked personal--and further stated that
he had not been aware that the MBNA MasterCard was for the Chairman's personal
use until he examined the account statement with Mr. Schmitt. There were no
further conversations between Mr. Peasley and Mr. Schmitt, and apparently
neither of them undertook any further investigation.
Mr. Schmitt, who was interviewed by telephone on August 23, only vaguely
remembered any mention of the subject of credit card bills, and in fact was not
certain that he had a conversation with Mr. Peasley on the subject (although he
remarked that it would have been a normal occurrence, since Mr. Peasley reported
to him and the two did discuss expenses from time to time). Mr. Schmitt recalled
seeing some sort of expense reimbursement documentation including some credit
card bills that were being paid by the Company, during the course of a broad
review of Company expenses. He stated that he didn't remember the details; he
thought he recalled something about someone asking whether the Company should be
paying a supermarket charge. Mr. Schmitt said that he wasn't especially
concerned, since, "You can buy anything at a supermarket."
No one else who was interviewed admitted having prior knowledge of payment
of personal expenses--whether of the Chairman or anyone else--with Company
funds.
- ----------
(11) Mr. Peasley was not aware of the reason for Mr. Schmitt's concern--whether
a response to a regulatory inquiry (or anticipation of an upcoming
regulatory examination), a question by the PwC auditors, or simply a
proactive inquiry on Mr. Schmitt's part
24
C. The Company's Budget Review Process.
The Company operates under a budget that is established during a process
directed by Mr. Peasley, beginning annually in September when Mr. Peasley
compiles financial information and submits it to a consulting actuarial firm,
Wise & Associates. The actuaries prepare a target budget; Mr. Peasley then
informs the Company's various departments of the anticipated increase or
decrease in their department budgets from the previous year. The department head
then completes a form haling anticipated monthly line-item expenses for the
coming year. After the completed forms are received, Mr. Peasley meets with each
Executive Vice President and the officers who report directly to him to review
and revise the department budgets. The overall Company budget for the coming
year is typically approved in November. The final, approved budget is loaded
into an Access database.
Expenses for each department are reviewed with the department head in
periodic meetings with Mr. Peasley the Executive Vice President to whom the
department head reports. Mr. Peasley distributes, in advance, a printout of all
expenses incurred by the cost center and a budget-to-actual comparison. The
meetings generally take between ten and forty-five minutes, depending on the
size and complexity of the budget, and are typically spread over a two-week
period. Expenses are reviewed both for comparison to budgeted expenses and for
the nature of large expense items. Mr. Peasley recalled that Mr. Grace, during
his tenure as Chief Financial Officer, would question every expense item
exceeding $1,000.
Until recently, the expense reviews occurred on a quarterly basis. Since
May of this year, however, expenses have been reviewed monthly. The change to
more frequent reviews was initiated by Messrs. Peasley, Demgen, Richmond, and
Annarino, in response to the Chairman's
25
expressed concerns that in recent months, actual expenses had been significantly
higher than anticipated expenses in several areas)(12)
Only a few cost centers are not subject to these periodic reviews. These
include:
(1) The 900, "Executive" Cost Center, which includes expenses associated
with the Chairman, Mr. Bender, and a receptionist (and, until his
retirement as CFO in May of 2001, Mr. Grace);
(2) The cost centers of Mr. Richmond (510) and Mr. Demgen (720); and
(3) Corporate cost accounts for the non-life companies--for example, 030
for the Company and 035 for ILCO, and 005 for ILG Securities.
These cost centers will be referred to hereinafter as the "non-reviewed cost
centers."
In particular, Mr. Peasley informed us that with respect to the
nonreviewed cost centers, he provides the same level of detail (a printout of
all expenses and a comparison to budget) to the responsible officer, who may
(but is not required to) consult with Mr. Peasley concerning any questions
arising from the printout.
D. Discovery of the 900 Account Reimbursements.
The inquiry that led to the current investigation was the result of a
budget review ordered by the Chairman in the second quarter of this year.
Expressing concern over the amount by which actual expenses were exceeding
budget expenses, the Chairman ordered research into any cost centers for which
actual expenditures were higher than planned expenditures by a significant
amount. Mr. Demgen initiated a cash flow analysis. In the course of his review,
Mr. Demgen noticed a large expense payment in the 900 Cost Center (apparently
the $15,884.01 payment to
- ----------
(12) Particular areas in which actual expenses significantly exceeded
anticipated expenses included underwriting; sales marketing; website
maintenance; the "conservation program" (monetary rewards paid to three
employees who "save" policies for which the policyholder has given or
received notice of surrender); legal expenses, especially the
26
MBNA for the month of May, reflected in Appendix A) and requested an analysis of
the expenditure by John Peasley. Mr. Peasley obtained a copy of the account
statement and furnished it to Mr. Demgen, who says that his review of this
account statement was the first time he knew that there was a credit card under
the Chairman's name for which invoices were sent to the Company address. Mr.
Demgen says that he noticed that the expenses in question seemed to him to be
personal expenses of the Chairman or his family, and that only a small amount of
the bill had been paid by the Chairman. He says that he questioned Mr. Peasley
about the allocation of the charges between the Company and Mr.
Mitte--commenting that the split reflected by the payment "can't be right, it
should be the opposite"--but was assured by Mr. Peasley that the allocation was
consistent with past practice. Mr. Demgen then questioned Bob Bender, who had
prepared the check request reflecting the allocation. Mr. Demgen recalled that
Mr. Bender stated, "This is the way Roy wanted it. He was absolutely insistent
that he [the Chairman] pay for the gas...," which was for the Chairman's wife's
car (Mr. Bender used his personal credit card for gas for the company car). Mr.
Bender explained that every month he (Mr. Bender) prepared a personal check,
drawn on the Chairman's personal checking account, to cover the gasoline charges
and presented it to the Chairman for signature, and submitted a check request
for the remainder of the charge.
Mr. Demgen said that, having "realized that [he] might have stumbled into
a hornet's nest...," he discussed the issue with both Mr. Peasley and Mr.
Richmond, and found both of them hesitant to confront the Chairman about the
charges. Mr. Demgen believed that the likely result would have been termination,
and assumed that the other two men did as well. Not knowing
- ----------
Lemon class action; product development and actuarial expenses (primarily
consulting fees paid to consulting actuaries for development of new
products); and the print shop.
27
what else to do, Mr. Demgen decided to shelve the issue until the end of the
quarter, and perhaps discuss it then with PwC.
Mr. Demgen next addressed the issue in preparation for meetings of the
Audit Committee, and with PwC's engagement partner for the Company's audit,
Scott Elphingstone, scheduled for August 13. Mr. Demgen obtained a detail of the
MBNA America account for the year 2002, and upon reviewing it, realized for the
first time that the charges exceeded $44,000 for the year to date. Questioning
Mr. Peasley about the amount, Mr. Demgen stated that he was told that the
charges "went back years." He said that he next spoke to Mr. Bender--as the
person who had signed and submitted most of the check requests in question--to
inform him that the issue would be raised with the Chairman. Mr. Demgen says
that he asked Mr. Bender whether he (Mr. Bender) was certain that the Chairman
had been aware of the handling and allocation of the charges on the MBNA
account. According to Mr. Demgen. Mr. Bender replied that the allocation had
indeed been as intended by the Chairman, and volunteered that, "Jim Grace knows
it." According to Mr. Demgen, Mr. Bender asked, "Are you sure you want to take
this on?"
During his interview, Mr. Bender informed the Committee's counsel and
advisers (in the presence of Mr. Mitte's attorneys) that he recalled that Mr.
Demgen questioned Mr. Bender concerning the MBNA Account charges in late July or
early August (of 2002).(13) Mr. Bender recalled that Mr. Demgen seemed genuinely
surprised when Mr. Bender explained the history of the MBNA Account; Mr. Bender
believes that Mr. Demgen, who had only recently become the CFO, had not
previously been aware of the account or the purposes for which it was used.(14)
Mr.
- ----------
(13) Mr. Bender was out of the office on a vacation during the week of
August 5.
(14) Mr. Bender stated that Mr. Demgen had "thought we were paying off a car or
something."
28
Bender stated that he explained what he had been told by Mr. Grace concerning
the Company's payment of the Chairman's expenses. Mr. Bender recalled Mr. Demgen
saying something to the effect of, "This is going to be big."
On August 13, 2002, the Audit Committee and Mr. Elphingstone were informed
of the problem charges. The Audit Committee, in consultation with PwC. made the
decision to announce that the Form 10-Q would not be timely filed, and to
initiate this investigation.
X. THE CHAIRMAN'S RESPONSES TO INQUIRIES CONCERNING PERSONAL EXPENSES.
Mr. Demgen informed the Committee's counsel and accounting advisers that
late in the week of July 29, 2002 (perhaps on August 1 or 2), he and Mr.
Richmond sat down with the Chairman to discuss the cash flow analysis. Mr.
Demgen stated that he expressed to the Chairman his concern over the dividend
which Mr. Mitte insisted be paid (3% of the share price) and over the Company's
donations to the Mitte Foundation, telling the Chairman that he was concerned
with the Company's ability to meet its obligations in the future, that the
Company would "go negative" in 2003 at the rate of current expenditures and
dividends, and that the Company would effectively be dividending 100% of the
cash flow of the insurance company subsidiaries, thereby precluding any increase
in reserves. Mr. Demgen stated that at this time, he did not discuss the issue
of personal expenses. Mr. Demgen stated that, ten minutes after the meeting
concluded, the Chairman called Mr. Demgen to the Chairman's office and
terminated Mr. Demgen--but that Mr. Richmond was able to talk the Chairman into
rescinding the termination.
On Monday, August 5, 2002, the Chairman summoned Mr. Fleron and Ms. Kinlaw
to his office. On a piece of paper he wrote "J.D. div," apparently meaning that
Mr. Demgen was involved in divorce proceedings. Mr. Fleron and Ms. Kinlaw
responded that they were not
29
aware of whether or not Mr. Demgen was going through a divorce. The Chairman
then added to the piece of paper some lines that resembled the following:
X_____
X_____
X_____
Mr. Fleron and Ms. Kinlaw questioned the Chairman as to what he was looking for.
The Chairman added to the piece of paper some combination of "Florida, L.A.,
Austin." Eventually Mr. Fleron and Ms. Kinlaw understood the Chairman to be
communicating that he thought (or had heard) that Mr. Demgen had had girlfriends
or affairs in cities to which he traveled art business, and that he wanted Mr.
Fleron and Ms. Kinlaw to find out about them. The Chairman further wrote
"letters," which Mr. Fleron and Ms. Kinlaw took to mean that he wanted a
memorandum concerning this information.
Mr. Fleron and Ms. Kinlaw checked the domestic relations filings in Travis
County; as best they could tell, no divorce proceedings had been filed at that
time. A few hours later, they went back to the Chairman's office and informed
him that they had found no information concerning Mr. Demgen's divorce in the
Travis County records. Mr. Fleron, in an effort to defuse the situation, told
the Chairman that he had no way to know or find out about any alleged
girlfriends--except to ask Mr. Demgen. The Chairman made it clear that he did
not want them to interview Mr. Demgen.
A few days later, the Chairman called Ms. Kinlaw and asked her to call an
Austin attorney, Bill Brown, to request that he come meet with the Chairman the
next day. Ms. Kinlaw did so; on Friday, August 9, Mr. Brown came to the
Company's offices, and Ms. Kinlaw accompanied him to the Chairman's office. The
Chairman again wrote down "J.D." and drew lines, and then pointed to Ms. Kinlaw
as if to have her explain what it was that he wanted. Ms.
30
Kinlaw informed Mr. Brown that the Chairman wanted Mr. Brown to investigate
potential girlfriends of Mr. Demgen. Mr. Brown responded that he didn't think
he'd be able to find anything but that he would see what he could do.
On Tuesday, August 13, Messrs. Richmond, Demgen, and Fleron walked to the
Chairman's office and presented him with a copy of the Audit Committee's letter
of that date (a copy of which is attached as Appendix Z).(15) During his
interview, Mr. Bender informed the Committee's counsel and accounting advisers
that he (Mr. Bender) met with the Chairman after Messrs. Richmond, Demgen, and
Fleron left, and again the next day (August 14), to discuss the actions that
had been taken with respect to the Form 10-Q and the investigation. Mr. Bender
stated that he felt, personally, that the issue should have been handled
differently--perhaps simply informing the Chairman that the Company would no
longer pay his personal expenses.(16) Mr. Bender stated that he expressed that
view to the Chairman, especially on August 14, and that as he considered Mr.
Bender's words, the Chairman grew increasingly angry, ultimately
deciding--again--to fire Mr. Demgen. At the Chairman's instructions, Mr. Bender
called Mr. Demgen to the Chairman's office; when Mr. Demgen arrived, the
Chairman wrote and said the word "fire" and pointed to Mr. Demgen.(17) According
to Mr. Demgen, Mr. Bender--speaking
- ----------
(15) The Committee's letter of August 13, 2002 erroneously stated that the
investigation was being conducted by Messrs. Demgen and Richmond. The
misstatement in the August 13 letter was corrected in a letter dated
August 16, 2002, a copy of which is attached as Appendix AA.
(16) Mr. Bender stated that he told the Chairman, "I thought they were going to
tell you they didn't think you should be doing this--I didn't know they
were basically going to shut down the company.
(17) Mr. Bender stated that the Chairman also decided he should fire Mr.
Richmond, because Mr. Richmond agreed with what Jeff had done." Summoned
to the Chairman's office, Mr. Richmond (according to Mr. Bender) pleaded
with the Chairman to reconsider, to "let the process work." The Chairman
asked Mr. Bender's opinion; Mr. Bender responded that it would be a "big
mistake" to fire Mr. Richmond, who was a loyal employee and was needed as
the Company "sorted through it" (the issue of the personal expenses).
Agreeing, the Chairman decided not to fire Mr. Richmond.
31
for the Chairman--stated, "Roy wants to know why this was okay for 10 years and
now it's not okay."
The Chairman then had Mr. Bender call a meeting of all officers of the
Company and its subsidiaries at the levels of Assistant Vice President and
above, and had Mr. Bender prepare a letter to be read and distributed at the
meeting. Mr. Bender prepared a first draft, which mentioned the issue of the
personal expense investigation and the Chairman's promise to repay any sums
found to have been improperly paid. After reading the first draft, the Chairman
instructed Mr. Bender to add a paragraph announcing the firing of Mr. Demgen.
Mr. Bender did so, but recommended that this second paragraph be deleted; he
informed the Chairman that there was no reason to discuss the termination at the
meeting. The Chairman considered Mr. Bender's advice, and consulted with
Assistant General Counsel Sheryl Kinlaw, who concurred with Mr. Bender; the
Chairman ultimately agreed, and the information concerning the Demgen
termination was removed from the letter. A copy of the letter, as revised, is
attached as Appendix BB. However, shortly before the meeting, Mr. Mitte was
informed that an emergency meeting of the Board of Directors had been called, to
consider reinstating Mr. Demgen. Accordingly, when the officers gathered in
response to the Chairman's summons, the Chairman instructed Mr. Bender to read
the earlier draft of his letter (including the portion concerning Mr. Demgen's
termination) as well as a 1998 letter announcing an earlier termination of Mr.
Demgen (which the Chairman had rescinded).(18) The meeting ended on that note.
- ----------
(18) In his interview, Mr. Demgen informed the Committee's counsel and
accounting advisers that the Chairman, in Mr. Demgen's presence in
rescinding the 1998 termination, had torn up what Mr. Demgen had
previously believed to be the only copy of the 1998 termination letter.
32
The Members of the Board of Directors will recall that, later in the day
on August 14, at the emergency meeting of the Board of Directors, Mr. Demgen was
reinstated pending the results of the Committee's investigation.
On Saturday, August 17, 2002, with the Audit Committee and the full Board
scheduled to meet, the Chairman sought to intimidate Messrs. Richmond and Demgen
with allegations of personal improprieties not related to financial misconduct
(or, for that matter, to Company business). The Chairman called Mr. Richmond to
the Chairman's office and presented Mr. Richmond with a typewritten sheet of
paper insinuating that Mr. Richmond's wife had had an affair with an unnamed
individual. Shortly thereafter, the Chairman knocked loudly on the locked door
of Mr. Richmond's office, where Mr. Richmond and Mr. Demgen were conferring; in
his hand was another sheet of paper, apparently consisting of similar
insinuations concerning Mr. Demgen. Refused entry to the office, the Chairman
shouted loudly, and by pointing to the doorknob instructed Mr. Bender to unlock
the door. When Mr. Bender did so and opened the door--which was pushed closed
from the inside--the Chairman again shouted at the occupants of the office.
Scott Mitte eventually arrived and was able to convince his father to return to
his office at the other end of the hail.(19)
The Chairman's responses to the allegations of improper use of Company
funds (and to the Committee's expressed intention to investigate same) were
offensive and entirely inappropriate. Under the recently-enacted Sarbanes-Oxley
Act of 2002, this Committee must establish procedures for the receipt, retention
and treatment of complaints regarding accounting,
- ----------
(19) The Committee's counsel was informed by David Hopkins of another apparent
effort, by persons associated with the Chairman, to acquire information
injurious to his accusers. Dyna Mitte, the former wife of Scott Mitte and
a former employee of the Company in property management, has maintained a
friendship with Homer Cantu, who is also a former Company employee. Ms.
Mitte informed Mr. Cantu that she bad received a call from "the Mittes,"
in her words, in the early hoots of August 17 (the morning of the Audit
Committee meeting and Board meeting); she was asked if she had any adverse
information concerning affairs involving either Mr. Richmond or Mr. Demgen
and people who worked for them. Mr. Cantu informed Mr. Hopkins of the call
at a social gathering several days later.
33
internal accounting controls or auditing matters and for the confidential,
anonymous submission by employees of concerns regarding questionable accounting
or auditing matters. The Sarbanes-Oxley Act further prohibits the Company from
discharging, demoting or otherwise discriminating against any employee who
lawfully provides information regarding any conduct the employee reasonably
believes constitutes a violation of the securities laws or financial fraud
statutes. Had the Chairman been successful in discharging Mr. Demgen or Mr.
Richmond, or in preventing the Committee from carrying out its investigation,
the Company could have faced liability to the affected officer(s). The
Committee--in consultation with the Company's counsel and its outside
auditors--intends to comply with the requirements of the Sarbanes-Oxley Act by
establishing the requisite procedures for accepting, investigating, and
resolving "whistle-blower" information concerning accounting matters. In the
interim, the Committee recommends that the full Board pass an appropriate
resolution informing the Company's officers and employees that communications of
legitimate concerns with respect to Company accounting are welcomed and will be
handled in confidence to the extent reasonably possible, and that acts of
discrimination, recrimination or retribution against persons presenting such
reports will not be tolerated.
XI. THE JANUARY 2002 DONATION TO THE MITTE FOUNDATION.
As set forth above, the Board established the Chairman's compensation for
the year 2002--increasing the salary component from $503,500, as originally
considered by the Compensation Committee, to $800,000 upon the express
representation that the Company would not be requested to make a donation to the
Mitte Foundation in 2002. However, on January 2, 2002, a Request for Wire
Transfer (a copy of which is attached as Appendix CC) requesting the transfer of
$1 million to the Roy F. and Joann Cole Mitte Foundation was submitted to the
Company's Cash Operations Department; the Request was signed by Mr. Bender, as
well as by
34
Ricardo Cruz and Melissa Ortiz of the Company's Investments Department. The Wire
Transfer was completed later the same day.
A few days thereafter, the Chairman instructed Assistant General Counsel
Sheryl Kinlaw to prepare, and circulate to members of the Board of Directors, a
unanimous consent resolution approving the previously-consummated transfer to
the Mitte Foundation. Mr. Grace declined to sign the resolution, and instead
resigned from the Board of Directors.(20) Although a number of directors did
sign the resolution,(21) all of the required signatures were not obtained, and
the resolution accordingly never became effective as an expression of unanimous
consent. The Board of Directors has never met to ratify or approve the donation.
XII. NO OTHER KNOWN PAYMENT OF OFFICERS' PERSONAL EXPENSES.
During his interview, Mr. Peasley informed the Committee's counsel and
accounting advisers that in addition to the "Executive" 900 Cost Center, there
are six other cost centers for which there is no automatic, periodic budgetary
review of expenses charged:
Cost Center Description
----------- -----------
005 ILG Securities Corp.
030 FIC (Corporate Related Costs)
035 ILCO Holding Company
040 Mitte Foundation
510 Executive Operations (Tom Richmond)
720 Financial Operations (Jeff Demgen)
- ----------
(20) Mr. Grace's resignation was accepted by the Board of Directors by
Unanimous Written Consent dated January 25, 2002. Interviewed by the
Committee's counsel, Mr. Grace did not mention being presented with the
resolution or choosing to resign rather than sign it; Mr. Grace stated
that he had already left the Board at the time the resolution was
circulated. However, Ms. Kinlaw informed the Committees counsel that she
actually had to prepare a new signature page--deleting Mr. Grace's
signature block--when Mr. Grace declined to sign, and that his handwritten
letter of resignation, although dated "December 31, 2001." was actually
written in her presence and handed to her on January 4, 2002.
(21) The Committee's counsel were informed that at least some of the directors
who did sign the resolution were not aware that the funds had already been
transferred.
35
Accordingly, the Committee's accounting advisers reviewed the expense records
for each of the non-reviewed cost centers for the period from 1996 through July
of 2002 to determine whether any similar pattern of payment of personal expenses
might have occurred therein.
Attached as Appendix DD is a spreadsheet prepared by Committee's
accounting advisers tabulating the expenses charged to each of the listed cost
centers for the period.
A. Cost Centers 510 (Richmond) and 720 (Demgen).
Expenses charged to Cost Centers 510 720 were an order of magnitude
smaller than expense charged to the Executive (900) Cost Center during the
period--11.5% and 5.5%, respectively, of the amounts charged to the 900 Cost
Center. The highest single annual expense charged through either Cost Center--$
104,948 in Cost Center 510 in 1997, when Mr. Demgen was in national sales and
accordingly expected to incur higher expenses than are necessitated by his
current position as Chief Financial Officer--was less than a third of the amount
charged through the 900 Cost Center for the same year.
None of the persons interviewed by the Committee's counsel were aware of
any instance or practice of Company payment of personal expenses for any officer
or employee--including Mr. Demgen or Mr. Richmond--other than the Chairman.
B. Cost Centers 030 (FIC--Corporate Related Costs) and 035 (ILCO
Holding Company).
Merger-related expenses significantly increased the amounts charged to
these cost centers in 2001: $1,053,137 to 035 and $562,166 to 030. However,
these amounts consist primarily of allocated general and administrative ("G&A")
costs and fees paid to outside counsel, actuaries, and other consultants.
The $477,810 in expenses charged to the ILCO 035 Cost Center in 1996
consisted primarily of fees paid to outside legal counsel, consultants and
actuaries. The $276,578 and
36
$234,022 charged to the FIC Corporate Related Costs in 1998 and 2002,
respectively, consisted primarily of legal fees and actuarial consulting fees.
C. Cost Center 040 (Mitte Foundation).
Check requests submitted by authorized officers on behalf of the Mitte
Foundation are routinely paid without further review, and there is no automatic
budgetary review of such expenses. However, the Company's accounting personnel
routinely invoice the Foundation for, and receive reimbursement of, expenses
charged to this Cost Center. We were informed by Mr. Peasley, among others, that
a review process is underway to determine whether additional expenditures should
be reimbursed by the Foundation. Earlier, Mr. Peasley prepared a schedule
detailing $150,729 in expenses originally charged to Account 900 for
Foundation-related expenses during 2000; in January 2001 the Mitte Foundation
reimbursed the Company for these costs.
A separate Report of Internal Audit Concerning Payment of Mitte Foundation
Expenses has been reviewed and approved by the Committee for forwarding to the
Board.
D. Cost Center 005 (ILG Securities Corp.).
Expenses charged to this Cost Center are only a fraction of the amounts
charged to the Executive Cost Center and have not exceeded $30,000 in any year
from and after 1996.
In short, none of the identified cost centers reflect the consistent
volume of expenditures as are reflected, from 1996 to the present, in the
Chairman's 900 "Executive" Cost Center, nor do there appear to be examples of
consistent payment of personal expenses with Company funds. In extensive
interviews of present and former officers who might be expected to have relevant
knowledge, none have stated a belief that the Company has paid personal expenses
of any officer or director other than the Chairman.
37
E. Unlikelihood of Similar Abuses involving Other Officers.
The Committee has concluded that the practice of payment of personal
expenses with Company funds was almost certainly limited to the office of the
Chairman. As set forth above, the expense flow through the other nonreviewed
cost centers has been substantially less--typically an order of magnitude
smaller--than the expenses of Cost Center 900. Neither the Committee nor its
counsel or accounting advisers were informed, during the course of the
investigation, of any belief or rumor within the Company of expense account
abuse by officers or employees other than the Chairman. Further, the attitude
within the Company with respect to justification of expenses--requiring, for
example, the entry of cost center codes to track photocopying expenses, a
practice that is relatively unusual outside of consulting or service
industries--is so strict as to render it relatively unlikely that expense abuse
could succeed absent the power of the office of the Chairman and the autocratic
manner of its occupant. Further, neither the Chairman nor his counsel have even
suggested any practice of improper expense reimbursement by others within the
Company--even while the Chairman was seeking to undermine the investigation with
insinuations of non-business-related, personal improprieties of some officers of
the Company.
Accordingly, while the Committee does recommend that all of the Company's
cost centers be subjected to the same periodic budgetary review, the Committee
concludes that the practices made the subject of its investigation have been
confined to the office of the Chairman.
XIII. CONCLUSION OF INVESTIGATION.
The Committee believes that no further investigation of the matter of
payment of personal expenses of officers or directors is necessary. The
Committee, with the aid of its counsel and accounting advisers, has conducted
and completed an investigation that was as complete as was reasonably possible
given the Committee's lack of subpoena power.
38
Report of Internal Audit
Concerning Payment of Mitte Foundation Expenses
To the Audit Committee of Financial Industries Corporation:
In connection with the audit committee investigation concerning payment of
personal expenses of the Chairman of Financial Industries Corporation ("FIC"),
senior management of FIC requested a complete internal audit to review the
payments by FIC of expenses of the Roy F. and Joann Cole Mitte Foundation (the
"Foundation"). The purpose of the internal audit was to review expenses of the
Foundation which were submitted to FIC for payment, or otherwise paid by FIC, to
determine whether such expenses had been properly recorded and reimbursed to
FIC.
Background
In 1997, the Foundation began its operations. At that time, at the
direction of Roy F. Mitte, the Foundation began submitting payment requests to
FIC through FIC's accounts payable process. In order to handle these payment
requests, FIC set up a receivable account (labeled cost center 040) to track the
Foundation expenses. From July 1997 through August 31, 2002, $2,617,601.74 has
been paid by FIC through cost center 040. These expenses have been reviewed for
this report. In addition to cost center 040 expenses, the internal review of
Foundation expenses included: (1) $300,747.22 of expenses of the Foundation that
were paid by other FIC cost centers; (2) rental expenses of the Foundation
incurred as a Tenant of FIC's subsidiary; (3) employee benefit expenses of the
Foundation paid by FIC; (4) FIC's furniture and PC equipment used by the
Foundation; and (5) use of FIC's staff for Foundation purposes. A review of
these
Page 1 of 10
expenses shows, that as of August 31, 2002, expenses in the amount of $1,705,962
plus interest need to be reimbursed to FIC.
On September 16, 2002, the Foundation tendered a check to FIC in the
amount of $481,849.52. Of this amount, $475,538.83 is from expenses billed to
cost center 040, $2,307.69 was for Scott Mitte's salary expensed to cost center
900, and $4,003.00 was for Tony Bennett tickets expensed to FIC's cost center
900. Although this reduces the amount above to $1,224,112.50, the numbers
presented in the report below still represent the amounts owed as of August 31,
2002, as this is the date of the report.
Expenses
I. Foundation Expenses Submitted through Cost Center 040
o Total Amount owed to FIC = $617,229.37 plus interest
Since July 1997, $2,617,601.74 has been paid by FIC on behalf of the
Foundation through cost center 040. Types of expenses submitted through cost
center 040 include payroll expenses for Foundation employees, general purchases
of the Foundation, and reimbursement expenses. As discussed above, for most of
the expenses, FIC receives a payment request from the Foundation and then pays
these expenses on behalf of the Foundation. Payroll expenses were set up on cost
center 040 at the insistence of Roy F. Mitte and M. Scott Mitte (see attached
report of Sharon Rickey at Attachment II(c)). After FIC paid the expenses, FIC
would send an invoice, on a monthly basis, to the Foundation, requesting
reimbursement for the payments.(1) Most of these charges were then reimbursed,
interest free, on a quarterly basis by the Foundation. The total amount
- ----------
(1) From 1997 through 1999, the Foundation did not offer to reimburse FIC for
any of its expenses that were paid by FIC. Starting in January 2000, FIC
began to invoice the Foundation for cost center 040 payments that were
made by FIC.
Page 2 of 10
reimbursed by the Foundation for cost center 040 expenses through August 31,
2002 is $2,000,372.37. The items that were not reimbursed consist of Foundation
expenses from 1997 through 1999 along with those items that the Foundation chose
not to pay. Since FIC has not included interest on its monthly invoices to the
Foundation, the Foundation has received the benefit of the use of FIC funds, on
art interest free basis.
As of August 31, 2002, the total of unreimbursed expenses from cost center
040 was $617,229.37, not including interest. Most of this amount consists of
2002 expenses with some expenses from other years that remain unpaid. A detail
listing of the expenses and reimbursements from cost center 040 can be found on
Attachment I(a).
During the review of the cost center 040 expenses, it was discovered that
there were many instances of what appear to be personal expenses of Scott Mitte
which have been paid by FIC through cost center 040. The total amount paid by
FIC for these expenses is $120,410.52.(2) Examples of this type of expense
include: a $4,037.77 purchase from Tom James for a custom made tuxedo for Scott
Mitte, and a $7,000 reimbursement payment by FIC to Scott Mitte that was
submitted by Scott Mitte in both June and July of 2002 for a single payment he
allegedly made to Custom Coach.(3) Numerous other reimbursements were made to
Scott Mitte where the amount reimbursed far exceeded the receipts and detailed
back up provided. Although $104,872.98 of these apparently personal expenses of
Scott Mitte have been reimbursed to FIC, it should be noted that the
transactions involve an Interest free use of FIC funds. A detailed listing of
- ----------
(2) Out of the $120,410.52 paid by FIC through cost center 040 for what appear
to be personal expenses of Scott Mitte, $104,872.98 has been reimbursed to
FIC and $1 5,537.54 has not been reimbursed. The unreimbursed amount is
included in the $617,229.37 amount that has not been paid by the
Foundation to FIC.
Page 3 of 10
the expenses can be found on Attachment I(b) for unreimbursed funds and
Attachment I(c) for reimbursed funds.
II. Foundation Expenses Paid by FIC Cost Centers
o Total Amount Owed to FIC=$121,556.33 plus interest
In addition to Foundation expenses that were submitted through cost center
040, there were also Foundation expenses that were billed to other FIC cost
centers, mostly through FIC cost center 900 (FIC's executive cost center)
instead of the Foundation cost center, 040. This was generally done by
submissions to FIC's account payable department that were approved by a person
authorized to sign on cost center 900, usually Roy F. Mitte or Bob Bender. The
amount of Foundation expenses submitted through FIC cost centers, not including
salary expenses which are described in the paragraph below, totals $208,135.71.
Out of this amount, $130,729.25 has been reimbursed to FIC and $77,406.46
remains unreimbursed. Examples of Foundation expenses submitted through these
FIC cost centers include: a $4,200 purchase from Aus-Tex Printing and Mailing
for Foundation brochures, and a $6,090.15 purchase from Stripling Blake for I
interior and 5 exterior doors that according to Stripling Blake, were delivered
to the residence of Scott Mitte. This appears to be a personal expense of Scott
Mitte. A detailed listing of the expenses of the Foundation submitted through
cost center 900 (not including salary expenses, described in the paragraph
below) can be found on Attachment II(a).
In addition to the regular Foundation payroll expenses submitted to FIC
through cost center 040, certain salary expenses of Foundation employees were
submitted through cost center 900. The total amount of Foundation salaries paid
by FIC cost center 900 is
- ----------
(3) Although Scott Mitte received two $7,000 reimbursements for what appears
to be a single payment made by him, only one $7,000 amount is included in
this section since the single payment appears to be for a
Page 4 of 10
$92,611.51. The Foundation has reimbursed FIC for $48,461.64 of this amount and
$44,149.87 remains unreimbursed. Attachment II(b) sets forth the details of
these payroll expenses. These salary expenses consist of an annual salary of
$20,000 that Scott Mitte receives in addition to his cost center 040 Foundation
salary, as an executive consultant for Roy F. Mitte, the entire salary of Julie
Gunn, a Foundation employee, and salary for Glenda Espinosa, a previous
Foundation Employee. The Foundation has stated that they would not reimburse FIC
for Julie Gunn's salary because she is an FIC 900 executive assistant. In an
interview with Ms. Gunn, she acknowledged that she worked solely for the
Foundation. These salaries were set up this way due to the direction of Roy F.
Mitte. A report from Sharon Rickey, Senior Vice President of Human Resources,
has been attached (Attachment II(c)). This report states that Roy F. Mitte and
Scott Mitte made it clear that certain Foundation employees were to be charged
to cost center 900 and that such Foundation employees would participate in FIC
benefit plans.
III. Rent Expense and Tenant Improvement Costs
o Total Amount Owed to FIC = $857,087 plus interest
Since July 2000, the Foundation has conducted its operations on a portion
of the 4th floor in Building One of River Place Pointe. Mr. Mitte has never
authorized a written lease between the Foundation and Investors Life Insurance
Company of North America, the owner of the building. Because a written lease was
never authorized, no rent was charged for use of this space until April 2002.
Since April 2002, a nominal rate of $4.32 sq./ft. was used to calculate the
Foundation's rent, compared to the market rate of $28.00 sq/ft. for other
tenants of River Place Pointe who negotiated leases to occupy River Place Pointe
during 2000-2001.
- ----------
Foundation, rather than a personal, expense.
Page 5 of 10
The office space on the 4th floor from where the Foundation operates is a
separate wing; however, it is used by both FIC and the Foundation. The total
area consists of 4,755 sq./ft., of which 2,919 sq./ft. is used solely for
Foundation operations. Rent calculations herein are based on 2,919 sq/ft. of
Foundation space. In addition to the office space, the Foundation uses five
reserved parking spaces underneath Building One. Based upon the market rental
rate of $28.00 sq./ft, along with the fee, for reserved parking spaces charged
to other tenants, the Foundation accumulated $190,086, not including interest,
in base rental expenses since July 2000. (See Attachment III(a) for
calculation). Only $2,100 has been paid to FIC by the Foundation for rent.
In addition to its rental expense, the Foundation has never paid FIC for
the cost of excess tenant improvements incurred for the Foundation's office
space. During construction of the office space, the Foundation chose not to use
the same architectural firm used by FIC for the remainder of Building One. This
separate firm was hired by and worked exclusively with Scott Mitte. The total
tenant improvement costs for the office space were $184.58 sq./ft. When other
tenants in River Place Pointe spent more than the standard $18 sq./ft. for
tenant improvements, the Company would charge 10% interest on the balance that
exceeded the $18 sq./ft. amount until that balance was paid in full. If the same
calculations used for other tenants were applied to the Foundation, and the same
10% interest rate is applied, the cost of excess tenant improvements owed to
FIC, as of August 2002 would be $627,101. (See Attachment III(a) for
calculation)
Prior to moving its operations to River Place Pointe, the Foundation
offices were located at the FIC's previous address of 701 Brazos. The Foundation
operated at this location rent free from July 1998 until their move to River
Place Pointe in July 2000.
Page 6 of 10
Based upon the rental charge FIC paid for rent, the Foundation would have
accumulated $42,000 plus interest in rental expenses for the 24 month period.
(See Attachment III(a) for calculation).
IV. Employee Benefit, Payroll Tax and Payroll Processing Expenses
o Total Amount Owed to FIC = $59,760 plus interest
At the insistence of Roy F. Mitte, employees of the Foundation have been
improperly enrolled in various employee benefit plans sponsored by FIC
subsidiaries. The Foundation is not a participating employer in any of these
plans. These benefits include medical, basic life, 401k matching contributions,
and administrative expenses related to such plans. Starting in 1997 through
August 31, 2002, the value of benefits provided to Foundation employees was
$41,849, none of which has been reimbursed to FIC. The Company also pays the
FICA and FUTA taxes for those same employees. Through August 31, 2002, the total
unreimbursed expense was $13,077.80 plus interest.
In addition to paying for benefits and the required taxes, FIC also incurs
costs for payroll processing for the Foundation employees. Through August 31,
2002, the total of unreimbursed payroll expenses was $4,834 plus interest.
A breakdown of expenses in this category are attached as Attachment IV(a),
V. Furniture and PC Equipment
o Total Amount Owed to FIC = $30.35 8 plus interest
Over the course of several years, and at the request of the Foundation,
FIC has purchased $116,889 of furniture and PC equipment for use by the
Foundation. The Foundation has never paid FIC for the usage of this furniture
and equipment. Based on the total amount of depreciation that has accumulated on
this furniture and equipment
Page 7 of 10
through August 2002, the Foundation owes FIC $30,358 for their use. A detailed
listing of the furniture and equipment items purchased by FIC and used by the
Foundation can be found on Attachment V(a).
VI. FIC Support Staff
o Total Amount Owed to FIC = $19,970 plus interest
The Foundation has relied upon the staff of FIC to conduct many of its
routine functions. These functions include accounts payable, benefits
administration, payroll administration, and recruiting. In addition to these
routine functions, several individuals and departments were called upon from
time to time due to their expertise. These areas included the Legal department,
Human Resource department, and the Information Systems department. In many
instances, the time spent by these departments was to protect the interests of
FIC and its subsidiaries and would not have been necessary if the two entities
were truly independent. The time these individuals and departments spent
assisting the Foundation adversely affected their productivity to FIC. Based
upon a conservative estimate of time spent by each area/individual and using
their average pay rate, the Foundation would owe FIC $19,970 plus interest. A
detailed listing of the hours spent and the pay rates can be found on Attachment
VI(a).
Additional Amounts Owed to FIC
On September 13, 2002, as I was completing this report, it came to the
attention of John Peasley, Senior Vice President, Budget & Planning, that
another FIC cost center, 420, has been paying for the Xerox copier used by the
Foundation. This copier was added on to the contract that FIC entered into in
July of 2000 for use and maintenance of the copiers in FIC's home office. This
amount has not been included in this report, and
Page 8 of 10
there may be other expenses that have been paid by other FIC cost centers which
are not included in this report. Additionally, it should be noted, that no
interest has been included on any calculations of amounts owed to FIC herein.
Other Information
During April 2001, Roy P. Mitte, through Bob Bender, asked the Internal
Audit department to conduct an audit of the year to date expenses charged by the
Mitte Foundation to cost centers 040 and 900. Internal Audit was instructed to
give special attention to those charges submitted and paid to Scott Mitte. This
audit was to be in the form of spreadsheets that detailed the different
classifications of expenses. It was instructed that the completed audit should
not contain a written summary of the findings, nor were recommendations to be
given. Once completed, the audit report was given directly to, and only to Roy
F. Mitte and Bob Bender. A copy of the items given to Roy F. Mitte and Bob
Bender can be found on Attachment VII(a).
Following receipt of the report, Roy Mitte and Bob Bender had questions
regarding certain charges and reimbursements. Most of these questions dealt with
wanting more information about specific charges, such as the item(s) purchased,
dates, etc. It is not known what action, if any, was taken after the information
was furnished. It should be noted however, that certain expenses, such as the
Tom James custom made tuxedo, that are included on Attachment I(c) of this
report, were also included in the 2001 audit.
Page 9 of 10
Conclusion & Recommendation
It is the recommendation of internal Audit that FIC seek reimbursement for
all amounts owed to FIC by the Foundation, including interest on all amounts
owed.
Completed by: Chad J. Johnson, Vice President of Internal Audit
/s/ Chad J. Johnson
Page 10 of 10
[LOGO]
Otter Creek
MANAGEMENT
Affidavit of Roger Keith Long
Details of FIC and Mitte Settlement Agreement (pgs. 4-5)
o Mitte receives $3 million in three equal annual installments
o FIC receives proxy to vote Mitte Foundation 17% stock ownership
o FIC may use proxy to increase shareholder ownership threshold required to
call special meeting from 10% to 30% as of 2004
o FIC may use proxy to vote to eliminate cumulative voting as of 2004
7/9/2003
CAUSE. No._____
OTTER CREEK PARTNERS I, L.P. ss. IN THE DISTRICT COURT
ss.
Plaintiff, ss.
ss.
v. ss. TRAVIS COUNTY, TEXAS
ss.
FINANCIAL INDUSTRIES CORP. ss.
ss.
Defendant. ss. ___JUDICIAL DISTRICT
- --------------------------------------------------------------------------------
AFFIDAVIT OF ROGER KEITH LONG
- --------------------------------------------------------------------------------
State of Florida
County of_________
On the date and year entered below, Roger Keith Long, who is personally
known to me, appeared before me and under oath, attested as follows:
1. My name is Roger Keith Long. I am over the age of eighteen years and
fully competent to give this affidavit. I have personal knowledge of all facts
stated herein and all such facts are true and correct.
2. I am the owner and president of Otter Creek Management, Inc., a
Delaware corporation, the general partner and contracted investment advisor to
Otter Creek Partners I, L.P. ("Otter Creek"), a Delaware limited partnership
whose principal place of business is in Palm Beach, Florida. Otter Creek
currently owns and has owned since May 30, 2001 shares of common stock of
Financial Industries Corporation ("FIC").
3. I have become aware of facts concerning FIC from filings with the
Securities and Exchange Commission ("SEC") made by FIC and others. Attached
hereto as Exhibits 1, 2 and 3, respectively, are true and correct copies of
FIC's annual report on Form 10-K for the year
1
ended December 31, 2002 ("FIC 10-K"), FIC' s quarterly report on Form 10-Q for
the period ended March 31, 2003 ("FIC 10-Q") and FIC's preliminary proxy
statement for its 2003 annual meeting filed with the SEC on April 18, 2003 ("FIC
Preliminary Proxy"). The relevant portions of each Exhibit have been highlighted
to more readily point out the facts that I will refer to herein. These SEC
filings indicate that in August 2002, the FIC board of directors placed Roy
Mitte, president and chief executive officer of FIC ("Mitte"), on administrative
leave pending the FIC Audit Committee's completion of an investigation into
allegations that Mitte had charged personal expenses to FIC over a long period
of time without the knowledge and approval of FIC's officers and directors. FIC
also alleged that Mitte had caused FIC to make an unauthorized $1,000,000
contribution to the Roy F. and Joann Cole Mitte Foundation (the "Mitte
Foundation"). The Audit Committee engaged the accounting firm of Ernst & Young
to assist it in the investigation. On September 17, 2002, the Audit Committee
issued its report, which concluded that Mitte had improperly caused FIC to pay
approximately $540,000 of Mitte's personal living expenses and, without proper
board authority, had caused FIC to transfer 81,000,000 to the Mitte Foundation.
The FIC SEC filings further indicate that the board of directors terminated
Mitte as president and chief executive officer effective October 31, 2002
because of disability and the improper conduct described in the Audit
Committee's report and demanded reimbursement for the improper payments.
4. According to a preliminary proxy statement filed by the Mitte
Foundation on March 27, 2003, a copy of which is attached hereto as Exhibit 4
(the "Mitte Proxy Statement"), on January 20, 2003, the Mitte Foundation
requested that FIC conduct a special shareholders meeting. The Mitte Foundation
later filed the Mitte Proxy Statement, stating its intention to nominate an
alternate slate of candidates for election to the board of directors.
2
5. FIC sued Mitte, Mitte's wife and the Mitte Foundation, contesting the
Mitte Foundation's request for a special shareholders meeting and seeking to
recover for the improperly charged personal expenses and the unauthorized
transfer of funds. That suit, styled Financial Industries Corp. v. The Roy F.
and Joann Cole Mitte Foundation, Roy F. Mitte and Joann Cole Mitte, was filed in
the United States District Court for the Western District of Texas and was
assigned Civil Action No. A03 CA 033 SS. Mitte counterclaimed against FIC,
alleging, among other things, breach of his employment agreement.
6. On March 18, 2003, Otter Creek requested that FIC conduct a special
shareholders' meeting. Otter Creek also filed with the SEC a preliminary proxy
statement proposing the election of a slate of eight named directors not
affiliated with Mitte or the current board of directors. FIC also denied Otter
Creek's request for a special meeting.
7. Otter Creek has continued to diligently pursue its proxy solicitation
efforts by making additional revised SEC filings of preliminary proxy material
in preparation for the 2003 annual meeting. However, FIC's refusal to call and
hold the required annual meeting has prevented Otter Creek from exercising its
rights as a shareholder of FIC to solicit proxies for its slate of nominees for
election to the board of directors and to contest the election of the board of
directors of FIC. FIC' s actions and inactions have also caused Offer Creek's
efforts to be more costly and time-consuming than they otherwise would have
been.
8. A copy of FIC's bylaws is attached as Exhibit 5 hereto. Section 2.2 of
those bylaws requires that an annual meeting be held on the fourth Tuesday in
April. For 2003, the required meeting date was April 22. FIC, in violation of
its bylaws and Texas law, failed to hold the meeting on the required date for
2003. FIC's last shareholders' meeting was June 4, 2002.
3
9. On April 18, 2003, the incumbent board of directors filed the FIC
Preliminary Proxy which stated that a shareholders' meeting would be held on May
9, 2003 for the purpose of electing directors. In the FIC Preliminary Proxy,
FIC's management and board of directors also nominated and recommended their own
slate of eleven directors, most of whom were incumbents. FIC did not, however,
hold the scheduled May 9 meeting nor inform shareholders of the reason for the
delay or any date for a new meeting, and has not since set a new meeting date or
a record date for such meeting.
10. The reason FIC called off the May 9 meeting became apparent when a May
15, 2003 settlement agreement between FIC and Mitte, Mitte's immediate family
members and the Mitte Foundation (collectively, the "Mitte Parties") was made
public. A copy of this agreement (the "Mitte Agreement") was filed with the SEC
as an exhibit to amendment No. 1 to the FIC 10-Q, a true and correct copy of
which is attached hereto as Exhibit 6. The Mitte Agreement reveals that the FIC
directors and management have sought to entrench themselves in office by using
corporate assets to buy the voting rights to Mitte and the Mitte Foundation's
combined 17% ownership interest in FIC. The ownership interest of Mitte and the
Mitte Foundation has since been reduced to approximately 11% as discussed below.
The Mitte Parties have also withdrawn their request for a special shareholders'
meeting and abandoned their proxy solicitation efforts.
11. The Mitte Agreement provides that:
o FIC will pay Mitte $3,000,000, payable in equal annual installments over
three years;
o Mitte does not have to pay back the approximately $540,000 in personal
expenses that FIC concluded that Roy Mitte caused FIC to pay on his
behalf;
o Neither Mitte nor the Mitte Foundation has to repay the $1 million
donation to the Mitte Foundation that FIC concluded was unauthorized;
4
o The Mitte Parties gave FIC management an irrevocable proxy to vote all of
their shares for management's recommended slate of directors and against
other director candidates, provided FIC assists the Mitte Foundation in
selling its stock as described below.
o A change in control of FIC will automatically accelerate the $3 million
owed to the Mitte Agreement, making it immediately due and payable in
full;
o FIC will use its best efforts to locate a buyer or buyers for 1,552,206
shares of FIC common stock held by the Mitte Foundation at a price of at
least $14.64 per share. FIC will try to market at least one-quarter of the
shares (388,052) by each of four deadlines: August 15, 2003; May 15, 2004;
November 15, 2004; and May 15, 2005. As long as FIC produces purchasers
for the required number of shares, the above-described proxy will remain
in effect and FIC management will be entitled to vote the Mitte Parties'
stock until May 15, 2005;
o On or before June 1, 2003, FIC or another bona fide purchaser will:
- - purchase 39,820 shares of FIC common stock held by Mitte for $14.64 per
share (total = $582,964.80);
- - purchase 35,502 shares of common stock attributable to Mitte under FIC's
employee stock ownership plan at $14.64 per share (total = $519,749.28);
and
- - pay Mitte $42,636 for the cancellation of 6,600 options exercisable for
shares of common stock that he holds;
o FIC will defend and indemnify the Mitte Parties from and against any
litigation arising from the Mitte Agreement;
o The parties agreed that Mitte's employment agreement is cancelled, and the
parties exchanged broad form releases;
5
o The Mitte Parties agreed to withdraw their request for a special
shareholders' meeting and to abandon all proxy solicitation efforts; and
o The Mitte Parties and FIC recite that they had agreed to extend the date
for the annual shareholders' meeting to no later than June 12, 2003. (The
full details of the postponement deal have not been announced to FIC's
other shareholders and FIC has not yet called an annual meeting or set a
record date for such meeting.);
12. On June 5, 2003, American Physicians Service Group, Inc. ("APS") filed
a report on Form 8-K with the SEC, a true and correct copy of which is attached
hereto as Exhibit 7 (the "APS 8-K"). The APS 8-K includes a Stock Purchase
Agreement and a Stock Purchase and Option Agreement whereby APS purchased FIC
common stock from the Mitte Foundation and acquired an option to purchase FIC
common stock from FIC, thereby enabling FIC to fulfill some of its obligations
to market the Mitte Foundation stock under the Mitte Agreement. Despite the fact
that the Mitte Agreement provides that upon a sale of any of the Mitte Parties'
stock in compliance with the Mitte Agreement the proxy related to such shares
terminates, the Stock Purchase and Option Agreement by and between FIC and APS
explicitly provides that all of the shares of common stock acquired by APS from
the Mitte Parties remain subject to the proxy set forth in the Mitte Agreement
for the FIC 2003 annual meeting.
13. FIC's incumbent management and board of directors are denying Otter
Creek the full and fair exercise of its voting rights. First, they have failed
to call an annual meeting, even though, according to FIC's bylaws, it should
have been held the fourth Tuesday in April, which this year was April 22. In
other words, the incumbent management and directors are seeking to avoid a
directors' election by the simple expedient of not holding a meeting. Second,
they have gained an unfair advantage over shareholders by buying votes with
FIC's assets so that they can
6
[LOGO]
Otter Creek
MANAGEMENT
FIC Financial Services
----------------------------
FIC Financial Services, Inc.
William P. Tedrow, President
----------------------------
|
--------------------------------------------------------------
| | |
- ------------------------ ----------------------------- -------
JNT Group, Inc. Total Compensation Paragon
Group Consulting, Inc. -------
Earl Johnson, President |
& Director Arthur A. Howard, CEO & Dir. |
John Pesce, Director Mike Cochran, Pres. & Dir. |
John Pesce, Vice Pres. & Sec. |
PO Box 57770 |
Webster, TX 77598-7770 3160 Bee Caves Road |
Suite 300 |
15158 Hwy. 3 Austin, TX 78746 |
Webster, TX 77598 |
Reg. Agent: Arthur A. Howard |
Reg. Agent: Earl Johnson |
- ------------------------ ----------------------------- |
|
----------------------------------------------------------------
| | |
- ----------------------- ----------------------- -----------------------
Paragon National, Inc. The Paragon Group, Inc. Paragon Benefits, Inc
f/k/a The 403(b) Store.
Scott Bell, Pres., Dir. Scott Bell, Pres., Dir.
Wayne Desselle, Dir. Wayne Desselle, Dir. Scott Bell, Pres., Dir.
Wayne Desselle, Dir.
245 Whispering Valley 245 Whispering Valley
Wimberly, TX 78676 Wimberly, TX 78676 3160 Bee Caves Road
Suite 200B
Incorporator: Incorporator: Austin, TX 78746
Arthur A. Howard Arthur A. Howard
Incorporator:
Arthur A. Howard
- ----------------------- ----------------------- -----------------------
7/9/2003
Press Release
Source: Financial Industries Corporation
Financial Industries Corporation Acquires Three
Companies
Thursday June 5, 8:30 am ET
Creates Niche in the Secondary Education Market
AUSTIN, Texas--(BUSINESS WIRE)--June 5, 2003--Financial Industries Corporation
(Nasdaq:FNIN - News; FIC) announced today that it has acquired three companies
in the secondary education financial services market, and is now positioned to
become an industry leader in that market.
The acquisitions were executed as a component of the strategic business plan
outlined last spring by FIC's new management team, and are part of its vision to
implement a comprehensive marketing plan for the company.
The acquired companies will operate through a newly created, wholly owned
subsidiary called FIC Financial Services Inc., and include:
o Total Compensation Group Consulting Inc., a consulting firm and
registered investment advisor;
o Paragon, a group of three companies providing employee benefits
products and services;
o JNT Group Inc., an independent fee-based third-party administrator.
The total consideration for these acquisition transactions is $6.9 million,
payable 56% in cash and 44% in FIC stock. The FIC stock is subject to forfeiture
in the event that certain business targets are not met. The company received a
favorable fairness opinion on these transactions from its financial advisor,
Advest Inc., and the transactions were approved last week by the company's Board
of Directors.
"Each of these three companies brings to FIC knowledgeable people with developed
relationships, and a proven track record providing benefit plan services and
products for the educator and school administrator marketplace," said Eugene
Payne, CEO, president and chairman of FIC. "When they come together as FIC
Financial Services, FIC expects to be transformed from a company offering a
limited number of life insurance and fixed annuity products to a financial
services organization offering a wide range of products."
Payne also announced that William P. Tedrow, an insurance industry veteran with
over 30 years experience, has been named president of FIC Financial Services
Inc. The founders of each of the three acquired companies have entered into
employment agreements with the newly created subsidiary of FIC, which will
employ approximately 32 people in addition to its managed agency force. It will
be located with parent company FIC in Austin, Texas.
"The entire new management team at FIC is excited by the business prospects
these three acquisitions bring to our company," said Payne. "FIC is now
positioned to become a premier player in an important market niche, while the
growth from the new subsidiary will result in a significant improvement in FIC's
overall cost structure."
The complete acquisition package was facilitated for FIC by representatives of
American Physicians Service Group Inc. (APS)
[LOGO]
Otter Creek
MANAGEMENT
Transaction Facilitators
------------------------
Transaction Facilitators
------------------------
|
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| | |
- -------------------------------- ------------------------------ --------------------------
Equita Financial and M&W Insurance Services, Inc. American Physician
Insurance Services, Inc. Service Group, Inc.
Richard G. Wolfe, Pres., Dir. Nasdaq: AMPH
Richard G. Wolfe, Pres. & Dir. Robert L. Myer, Director
Robert L. Myer, Dir. Robert L. Myer, Director
1013 Centre Road
3755 Capital of Texas Hwy. South Wilmington, DE 19805
Suite 148 1301 Capital of Texas Hwy.
Austin, TX 78704 Incorporator: Michael Ginsburg Austin, TX 78746
Reg. Agent: Michael Ginsburg
- -------------------------------- ------------------------------ --------------------------
| | |
- ------------------------- -------------------------------- --------------------------------
Transaction Facilitator Purchased Mitte Foundation Stock Transaction Facilitator
Received Options from FIC Purchased Mitte Foundation Stock
Received Options from FIC
- ------------------------- -------------------------------- --------------------------------
7/9/2003
and Equita Financial and Insurance Services, a new marketing partner for FIC.
APS and Equita will receive options to purchase 492,000 shares of FIC stock at
$16.42 per share (120% of the average closing price for the 15 trading days
ended June 3, 2003) exercisable only if the newly formed subsidiary, FIC
Financial Services Inc., produces over $200 million in sales between July 1,
2003, and Dec. 31, 2005. No options can be exercised if the new sales target is
not reached.
Equita was also granted an option to purchase 158,000 shares of FIC stock at
$16.42 per share, fully exercisable only if its marketing activities generate
over $360 million in sales. Last year FIC produced a total of $22 million in
annuity and life insurance sales; 74 percent in annuities. A designated
representative of each APS and Equita will fill two vacancies on FIC's Board of
Directors created by the resignations of Roy and Scott Mitte.
In a separate transaction, APS and an affiliate of Equita also announced today
that they had purchased approximately 312,484 shares and 204,918 shares,
respectively, of FIC stock. A majority of this stock was purchased from the
Mitte Foundation, and represents a reduction in shares for which FIC was to
locate a purchaser in connection with the previously announced settlement
between FIC, Mitte family members and the Mitte Foundation. An additional 27,395
shares were purchased by APS from FIC, and represent some of the shares FIC
purchased from Roy Mitte in connection with the same settlement agreement.
About Total Compensation Group Consulting Inc.
TCG Consulting focuses on large employer group consulting and investment
advisory services to educators' groups. The company provides retirement plan
design and management services on a for-fee basis.
About Paragon
Paragon generates its revenue principally through the direct sales of
supplemental insurance products, life insurance and annuity products. These
products are sold to educators, city and state employees. Currently, Paragon
employs 20 managed agents and has more than 450 broker relationships selling a
broad range of products from a variety of insurers.
About JNT Group Inc.
JNT Group is a fee-only third-party administrative services company. JNT's
revenues are driven by administration fees paid by employers who receive JNT
services. JNT currently administers plans for more than 60 school districts.
About Financial Industries Corporation
FIC, through its various subsidiaries, owns real estate, an actuarial consulting
firm, and markets and underwrites individual life insurance and annuity
products. For more information on FIC, go to http://www.ficgroup.com.
This release may be considered proxy solicitation material. Information about
the participants in such solicitation may be found in a filing on Schedule 14A
made with the Securities and Exchange Commission (SEC) on April 18, 2003, or by
contacting the Company at 512/404-5000. Shareholders are urged to read the
Company's proxy statement carefully when it becomes available because it will
contain important information. The proxy statement and other relevant documents
will be available for free at the SEC's Web site at www.sec.gov, or by
contacting the Company at 512/404-5000.
This release may contain "forward-looking statements" within the meaning of the
United States Private Securities Litigation Reform Act of 1995. These statements
are based on management's current expectations and are subject to risks,
uncertainty and changes in circumstances, which may cause actual results,
performance or achievements to differ materially from anticipated results,
performance or achievements. Investors are reminded that these forward-looking
statements must be considered in conjunction with the cautionary warnings and
risk factors which are detailed in the Company's most recent Annual Report on
Form 1 0-K, Quarterly Report on Form 10-Q and its other filings with the
Securities and Exchange Commission. FIC is under no obligation to (and expressly
disclaims any such obligation to) update or alter its forward-looking statements
whether as a result of new information, future events or otherwise.
- ----------
Contact:
Financial Industries Corporation, Austin
Bob Bender, 512/404-5080
bbender@ficgroup.com
Deceptive Marketing Of 'Pension Maximization' Life insurance
by Cynthia E. Hvizdos
General Counsel. State Teachers Retirement System of Ohio
STRS Ohio recently won temporary and permanent injunctions against a Texas
insurance brokerage known as Equita Financial and Insurance Services and several
of its officers and representatives prohibiting continued misleading and
deceptive marketing practices.
Although the company is not registered or licensed to conduct an insurance
business in Ohio, it has sold "pension maximization" life insurance here in
recent years under a variety of names, including "Retirement for State Teachers
Systems", and "RSTS." "STRS Alternative," "EFS." The name "Educators Financial
Services" AND "American Teachers Association" have also been used on similar
solicitations, though we are still trying to verify whether there are
connections to Equita or its president Richard G. Wolfe or another of its
corporate representatives, Judy Hudson.
Their pitch to sell life insurance in lieu of joint survivor annuity options is
delivered by "notices" that look like official communications. Ads styled to
look like government documents purport to inform members of recent legislative
changes (even when no such changes have taken place) that require members to act
immediately to protect their retirement accounts. They offer information about
STRS accounts and benefits. The solicitations create the appearance that the
retirement system is urging members to send it a business reply return card,
evidently known in this business as a "lead card." But the reply cards actually
go to a marketer at a post office box most often in Ohio. but also Texas,
California, the District of Columbia.
Follow up contacts are by local insurance who seem to members to be STRS field
counselors. They tell members that they will be doing field visits at their
schools on a specified date and try to schedule successive appointments in the
teachers' lounges to provide "account information." The agents come to the
meetings equipped with ..printouts" of the members' SIRS accounts and benefit
"estimates."
We have not been able to learn how the company gets member names/addresses or
how it prepares listings of a member's yearly earnings and contributions. Member
names and address lists sorted by zip code are public records under the0hio
statutes. But STRS Ohio tracks all such requests. We have never been able to
identify a public records request that appears to relate to or correlate with
the solicitations. So it appears that the names and addresses for the
solicitation must come either from the employer where they would be a matter of
public record or from coworkers or local teacher organizations.
Under the Ohio statutes, however, member service credit and contribution records
may be released only upon a member's written authorization. And no release or
authorization for release of SIRS account information had taken place in any of
the specific cases we've been able to identify. Since most employee information
including salaries and service are public records of the employer, the best
guess is that the printouts" and "estimates" supplied by the agent are
constructed by applying the statutory contribution rates and benefit formulas to
service and salary data publicly available from employers. Perhaps avoidance of
discovery on the issue is one reason the company did not oppose the application
for a temporary restraining Now order and immediately agreed to a permanent
restriction.
Shortly before suit was filed last summer, I sat at a table in an elementary
school library, next to a teacher there who was both alert to our warnings about
misleading marketers and willing to testify if needed. The local agent answered
questions about purchasing service credit and purported to provide other STRS
information
But the pitch is that when a member retires, they can be money ahead by
selecting a single life annuity and protecting any survivor by purchasing life
insurance. Our retirement statutes automatically provide the higher of a
formula or money purchase calculation, payable for the life of the retirant.
Under another statute a member may choose a benefit reduced for his or her
lifetime, but continuing after death to another beneficiary under any one of
several actuarially equivalent optional plans of payment. Most of the optional
plans are joint/survivorannuities, where all or part of the benefit continues
for the life of the survivor beneficiary.
The reduction the retirant must take in his or her own benefit, of course,
depends upon the age of the retirant, the age of the survivor beneficiary and
the portion of the benefit that is to continue after the death of the
retirantbased on membership mortality experience. The company's salespeople
emphasize that the same monthly amount could be provided under a life insurance
policy purchased at retirement, with a monthly premium less than the actuarial
reduction needed to choose an optional plan. Not surprisingly, the salespeople
do not mention that survivor beneficiaries receive annual COLA adjustments. Or
that survivor beneficiaries receive the same supple mental "thirteenth check"
that retirants receive. Or that SIRS Ohio has sought and achieved legislation
providing ad hoc benefit in creases for survivor beneficiaries every few years.
Or that a survivor beneficiary steps into the retirant's shoes as the primary
beneficiary of health coverage.
So for most members, the insurance these companies are trying to sell is not a
good bargain. But even if it were, the problem over the past ten years has been
marketing that consciously and purposely misleads members into thinking that it
is their retirement system contacting them or that their retirement system
endorses or encourages what is being sold! We've done a repeated series of
demand letters to this company and its officers and agents. And they've usually
promptly replied demands from SIRS and from the Assistant Attorneys General who
represent SIRS Ohio with letters saying that they certainly have no intention to
mislead, that they've changed the lead card, that they'll instruct their local
agents, etc. But nothing changes' except that the marketing that if anything the
solicitations have become increasingly misleading.
The Texas company and its officers are not registered to do business in Ohio and
are not licensed by the Ohio Department of Insurance. Since the Department
primarily enforces the state insurance laws through license revocation
proceedings, we did not succeed in trying to get the Department to investigate
or pursue criminal charges. When we not able to get various Ohio law enforcement
and regulatory officials to act, eventually we decided to initiate a lawsuit in
the Ohio courts, alleging a violation of the Ohio Deceptive Trade Practices Act.
Assistant Attorney General Christopher S. Cook won a TRO in Cincinnati from the
Hamilton County Court of Common Pleas on August 22, 2000, with a permanent
restraining order entered September 14, 2000, in State Teachers Retirement
System of Ohio v. Equita Financial and Insurance Service, Inc., et al., Case No.
A0004723.
The order enjoins Equita and its Texas officers Richard G. Wolfe, President, and
Judy Hudson, as well as an Ohio agent, Herbert F. Baldhoff from doing business
within Ohio as R.S.T.S. and/or Retirement for State Teachers Systems. Further,
all defendants and their agents, representatives, servants, employees, partners,
directors, share holders, successors and assigns, personally and through any
corporate or other device are enjoined from any further actions in violation of
the Deceptive Trade Practices act, as well as from any and all actions
representing themselves as affiliated with or endorsed by the State Teachers
Retirement System of Ohio.
We expected the company to continue its practice under one or more of the other
names it has used or a new name. Our goal was to have a basis for being able to
promptly initiate contempt proceedings. But we were surprised that it continued
using the same leader cards during the period between the TRO and the permanent
injunction. The ink was barely dry on the permanent en" when we began receiving
reports of the same solicitation, only this time with the lead card returned to
"EFS" at a Columbus Post Office. So we will shortly be filing a show cause
motion.
The response to message I recently posted on the NAPPA list serve indicated that
the same company may be using the same misleading marketing methods in Idaho,
California and Texas. G. Wade Caldwell of Martin Drought & Torres in San Antonio
has brought a number of suits against insurance companies that sell fraudulent
403(b) products, so we are currently trying to determine whether the same
companies sell the life insurance products Equita tries peddle to our members.
We have also recently supplied information to an investigator with the Texas
Department of Insurance. We will most likely be discussing federal mail fraud or
RICO charges through FBI offices here in Ohio. Effectively, these operators have
slithered through the cracks between state insurance and Consumer protection
laws. We will be grateful for information and assistance from other public funds
encountering the same problems. In the long run, of course, an educated and
informed membership is the best protection against deception.
That is why we continue the newsletter articles, employer bulletins, alerts for
employer bulletin boards, etc., we've done regularly in recent years. But until
this summer, the misleading marketers have operated here with impunity, with
absolutely no cost or consequence for deception. We plan to up the stakes!
Page 1 of 1
11% IRR Always!!
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FIC
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FIC Financial Services, Inc. ILNA FLIC
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|--------|------------| ^ ^
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TCG Paragon JNT Group | |
--- ------- --------- | 50% |
| | |
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TCG RIA | Ceded |
- ------- | Reinsurance |
| | Premium
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A / A+ Carrier |
|
Strategic |
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Premium | |
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Independent marketing Organizations
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#1 #2 #3
200 MM LNA Future Strategic Future Strategic
200 MM Strategic Alliance Partner Alliance Partner
Alliance Partner
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Key Producers Key Producers Key Producers
Managers Managers Managers
Partners Partners partners
IMOs IMOs IMOs
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[LOGO]
Otter Creek
MANAGEMENT
Entities in Class Action Law Suit
-----------------------------------
Americo Insurance Group, Inc.
f/k/a College Insurance Group, Inc.
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Americo Financial Services, Inc.
3755 Capital of Texas Hwy. South
Suite 220
Austin, TX 78704-6600
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Americo Financial Services, Inc. Pension Consultants Hudpac Holdings, Inc. (12/30/99)
f/k/a NAP Partners, Inc. and Administrators, Inc. f/k/a The NAP Group
f/k/a Annuity Service Corp. of Texas, Inc. (2/16/93)
Robert L. Myer Controls f/k/a Marketing Systems
Robert L. Myer, President Michael Cochran, President Group, Inc. (2/1/99)
John Pesce, Sales Development School Acct. Administration f/k/a/ Flexplus Marketing (3/29/93)
3755 Capital of Texas Hwy. South 3755 Capital of Texas Hwy. South William P. Tedrow, CEO ('97-'99)
Suite 300 Suite 300 Robert L. Myer, Pres. & Dir.
Austin, TX 78704-6600 Austin, TX 78704-6600 Bill Hudson, Vice Pres. & Dir.
Carolyn Griffin, Sec., Treas. & Dir.
Reg. Agent: Robert L. Myer Reg. Agent: Robert L. Myer
3755 Capital of Texas Hwy. South
Suite 300
Austin, TX 78704-6600
Reg. Agent: Robert L. Myer
- -------------------------------- -------------------------------- ------------------------------------
7/9/2003
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Fort Worth Star-Telegram (TX)
November 10, 2002
Section: News
Edition: FINAL
Page: 1
Schools skimmed on homework on benefit consultants
YAMIL BERARD
Star-Telegram Staff Writer
Teacher retirement and benefit accounts were a headache for Texas school
districts, so many snapped up a company's offer to administer the accounts for
free.
In return, districts required teachers to attend meetings with representatives
of the company, who explained how to enroll in school benefit plans -- and
promoted the purchase of insurance annuities for an optional investment program.
Teachers didn't know that the representatives were sales agents working for high
commissions from another company. Teachers weren't told that the administrative
costs had been shifted to them. Some teachers were misled on investment returns,
and they filed a class-action lawsuit.
Early this year, teachers won $10 million through the settlement of that
lawsuit, which claimed that they were victims of fraudulent marketing by the
companies. The settlement affected about 100,000 teachers and other school
employees in Texas and California.
Now, two former executives of those companies have started a firm that has
contracted with more than 80 Texas school districts, including the Dallas
district and four districts in Northeast Tarrant County, to guide and review
teacher retirement and benefit plans.
Some teachers groups have questioned whether the two former executives were
involved in the practices targeted by the lawsuit and whether the districts
scrutinized their backgrounds before signing on.
Officials of several school districts, including Keller Superintendent Charles
Bradberry, Keller board President Jac Irvine and Northwest Superintendent Keith
Sockwell, said they were not told about the class-action lawsuit when they
signed up. They learned of the suit, which was filed by a group of Laredo
teachers in July 1999, from the Star-Telegram.
"That raises a flag that says we may need to look at this more closely," said
Irvine. "We want to make sure that everything has been thoroughly checked."
In interviews, the two owners of the firm, Mike Cochran and John Pesce,
maintained that school districts knew of that lawsuit. "We, I, know that all the
superintendents definitely know our
NewsLibrary Document Delivery Page 2 of 8
background," Pesce said.
Cochran said: "Most people know my background or are somewhat aware of it."
After the Star-Telegram's inquiries, Cochran sent a memo to the Northeast
Tarrant superintendents, saying that he and Pesce were not involved in improper
activity.
Some problems did occur with the former family of companies for which they
worked, Cochran wrote, because the cost of services was included in the products
teachers purchased and because commissioned salespeople did not fully disclose
investment information, despite the companies' best efforts.
Cochran and Pesce also said they were forced out after they objected to abuses
when control of the companies changed hands.
Testimony in the class-action lawsuit paints a different picture.
Pesce and Cochran worked for Texas companies initially controlled by Bob Myer,
who also had a stake in College Life insurance company. Pesce oversaw marketing
at Myer's marketing company, NAP Partners, whose agents sold annuities and life
insurance products on commission. Cochran was president of Pension Consultants
and Administrators, which administered the school accounts.
About 90 percent to 95 percent of the annuities the agents sold were from
College Life; the rest of the annuities were from another Myer company, Pesce
said.
Pesce testified that the training that agents were given was weak, and that many
agents provided misleading information about investments.
But Pesce and Cochran both maintained that practices didn't cross the line until
Myer sold his interest in the companies to Americo in 1998.
Myer's attorney, Jody Scheske, also blames problems on Americo. Myer has a "high
regard" for Pesce and Cochran, who he believes are "very knowledgeable" about
teacher retirement plans, the attorney said.
An attorney for Americo, which is based in Kansas City, Mo., declined comment.
However, the teachers' attorney said that many of the lawsuit's complaints
concern actions that occurred when Myer ran the companies. Americo was Myer's
partner, then bought him out nine months before the suit was filed, attorney
Wade Caldwell said. Americo is seeking to have Myer reimburse it for the $10
million settlement, and the two are in arbitration.
The class-action lawsuit alleged that Myer had created a financial house of
cards. It also said that Myer intended to steer teachers to inferior
investments.
Cochran and Pesce were not defendants in the lawsuit, and no court has declared
them responsible for actions targeted by the lawsuit. But both were heavily
involved in those activities, Caldwell said. "They were definitely in the thick
of it," he said. "When they quit, they tried to distance themselves."
Caldwell had also sued a Myer company on behalf of teachers in the early 1990s
in another class-action case that resulted in an $11 million settlement.
Sales strategy
NewsLibrary Document Delivery Page 3 of 8
Cochran and Pesce helped Myer map a strategy that sent sales soaring.
Cochran joined Myer in 1993. In 1994 he helped Myer win an endorsement from the
Texas Association of School Administrators, for which Myer paid $15,000 to
$20,000, testimony shows. Myer wanted to tap the endorsement to get a foot in
the door at school districts to sell annuities.
At the time, Myer's business with school districts was primarily administering
benefit plans for a fee, but cases came and left at an alarming rate. Also, a
crowded field of companies were selling investment products to teachers for the
optional retirement plan known as 403(b).
When Pesce joined Myer in 1995, he brought a new business strategy: free
administration in exchange for the right to sell products. School districts
would have to pay only if they didn't go along with the sales deal.
Districts flocked in. "So in 1995 we went from 10,000 participants under
management to about 40,000 in about an eight-month time period," Cochran
testified.
Most districts did not bother to see whether other companies would offer the
same deal, Pesce testified. If some districts wanted to, Pension Consultants and
Administrators supplied a sample request for proposal, a move that Caldwell said
was intended to steer business to one company.
With the programs, College Life annuities sales "went through the roof," Pesce
testified.
The arrangement helped elbow out competitors because agents had guaranteed
access to teachers, their payroll information, and the district's apparent stamp
of approval, according to testimony.
Among those who reaped the profits was Pesce, who shared in what he called the
"house's money" of commissions after agents and other expenses were paid. "We
ran it as just as a pool, a profit pool, if you will, and we shared in the
profits. 'We' being Bob Myer, myself, and through the years it had been three or
four people...," he testified.
But the class-action lawsuit said that Myer's business was built on deception.
Insurance law
Pesce testified that "to put them at ease," school districts were told that
agents were salaried. But he said that agents were commissioned.
Teachers often didn't know that they were paying the administrative costs,
Cochran testified. Those costs were significant -- districts saved hundreds of
thousands of dollars a year. But the arrangement cost more to teachers than if
districts paid a fee, Cochran said.
The agents were presented to teachers as representatives of the administrative
company, Pension Consultants and Administrators. But they primarily were College
Life salespeople from the marketing company, NAP Partners.
The distinction between administration and marketing is key under state
insurance law. In Texas, a third-party administrator cannot at the same time
market insurance products. The provision is intended to avoid potential
conflicts of interest, state officials said.
"They must keep those activities separate," said Lee Jones, a spokesman for the
Texas Department of Insurance.
The agents weren't supposed to talk about the optional investments at the group
meetings, but many did, Pesce said, despite some company efforts to stop them.
NewsLibrary Document Delivery Page 4 of 8
Pension Consultants and Administrators had only three employees to monitor all
its agents in California and Texas, Cochran said.
In the individual meetings, agents would discuss employees' benefits, complete
their enrollment, and then make a sales pitch, Pesce testified.
The Department of Insurance was concerned that the dual roles violated the law,
Cochran testified. The company decided that it could meet the letter of the law
if it disclosed when agents were acting as administrators, and when they were
sales agents. He described the separation as a "Chinese wall" that was hard to
maintain.
Teachers also were misinformed about investment products, testimony shows.
The brochure touting one College Life product had a sticker on the front showing
a "current bonus rate of 7.01 percent." Pesce testified he was concerned that
most teachers wrongly thought they would get that return on their money, and
agents didn't understand what they were selling. But he also said, "I didn't
have a problem with using this product, obviously. I mean, we sold a lot of it."
Inadequate training was one reason that agents often did a poor job of
explaining investments, Pesce testified.
"We trained them wherever we could, at night in a hotel room. ... Sometimes we
would do it just wherever we would get them trained because we had so many
business [sic] coming in that we were just trying to keep up with it.
"And then it just got to a point where -- the training program was always in
place, but sometimes it had to be bypassed because of the demands of the
market."
Executives leave
In October 1998, Myer sold his interest in the companies to his partner Americo
in a $40 million deal that retained him as a marketing consultant, court
documents show.
In their testimony, Pesce and Cochran said that's when the problems began.
They testified that Americo removed any distinction between administration and
marketing.
"It was, as I call it, a free-for-all, basically," Pesce said.
Pesce said that when he objected, Americo dismissed his concern.
He said that he also objected to a new annuity product that seemed to promise a
return based on a stock market index. The returns were much less, he said.
What's more, Americo offered commissions that encouraged agents to roll over
other investments into the annuity, though teachers had to pay a stiff penalty.
Myer's attorney also blames Americo, tracing the problems to Americo's annuity.
"All that occurred after Myer sold the company," Scheske said.
But for months after the lawsuit was filed, Pesce defended Americo to school
district clients.
Pesce was fired in October 1999, accused by Americo of leaking confidential
information. Cochran resigned in November 1999.
NewsLibrary Document Delivery Page 5 of 8
"In any business, you can have an evolution from something good to something
that isn't so good," Cochran told the Star-Telegram. "I was there at a time when
I felt I was doing something of value for schools, and when I didn't, I left."
Their departure from the company aided the teachers' lawsuit.
Cochran, in a nine-page memo to Myer when he resigned, listed ethical violations
he said Americo had committed. Because of those, he wrote, Americo had violated
his employment contract. Pesce and Cochran say that the letter helped the
teachers win the settlement.
"Wade [Caldwell] would be able to tell you that we're the ones that exposed that
company," Pesce said.
Caldwell said that the letter was helpful but that Cochran's goal in writing it
was to establish reasons that he should be free to compete for Americo's
clients. "That was his primary motivation," Caldwell said.
Caldwell said that Myer was the mastermind behind the companies' structure and
culture that resulted in teachers being steered to bad investments.
Myer's strategy also left the companies financially shaky by the time they were
sold, the class-action lawsuit contends.
Best Insurance Reports had said in 1998 that College Life's capital and surplus
levels had declined for four straight years, the suit states.
College Life had paid out so much in commissions to agents -- $16.5 million --
and so much to owners and shareholders of its parent companies that it had to
reinsure part of its annuity business with weak affiliated companies, which also
had bleak outlooks, Best Reports said, according to the suit.
Americo alleges that Myer sold his interest in the companies because he knew
they were a likely lawsuit target, Caldwell said. It now wants Myer to reimburse
it for the costs of settling the class-action suit, Scheske said.
'Almost sole source'
By a court-approved settlement, Cochran and Pesce could not solicit business
with NAP Partners or the school district clients of Pension Consultants and
Administrators until this past January. The clients included the Mansfield,
Northwest, Carroll and Birdville districts.
Now, their company, Total Compensation Group Consulting, formed in late November
1999, has a hefty share of the North Texas school market for handling a variety
of services.
"They just have a growing reputation in the state," said Bill Smith, associate
director of Education Service Center Region 10. Total Compensation Group
Consulting created a plan this year for the 81 school districts in the region.
"They're almost the sole source, as far as the education community is
concerned," Smith said.
What attracted the attention of several districts was TCG Consulting's promotion
of a teacher retirement account that would create incentives for recruitment,
retention or attendance.
Under the plan, a district would contribute money to the accounts of teachers
who meet specified
NewsLibrary Document Delivery Page 6 of 8
goals for attendance and service. The plan can also be written to reward
teachers in competitive fields, such as math and science.
In the Hurst-Euless-Bedford district, which signed on, "The whole purpose is to
improve attendance among teachers and other key personnel," Superintendent Gene
Buinger said.
TCG Consulting has also contracted with school districts to establish and
administer other retirement accounts. With one-third of its clients, TCG
Consulting also serves as an investment adviser, helping oversee investment
choices and administration, Pesce said.
TCG Consulting charges districts a flat fee, usually $10,000 to $25,000,
depending on the size of the district. In some districts, it also receives a fee
based on a percentage of investment assets, paid either by district funds or the
teachers' investment pool.
"We're cheap, we're a small company. We don't have any overhead," Cochran said.
TCG Consulting plans carry lower fees than those charged by insurance companies,
who compete for these accounts, said Caldwell, who reviewed some of the plans at
the request of the Star-Telegram.
"I think generally that Cochran and Pesce have tried to break away from the
business model that these companies were using that we sued," Caldwell said.
Issue of disclosure
But in their pitch, TCG Consulting has made some statements that seem to fall
short of full disclosure.
The company emphasizes that if it is hired as an investment adviser, it will
provide districts with another wall of protection from lawsuits if investments
go bad.
"The more protection for school districts, the better," Pesce said.
But Texas school districts are immune from most lawsuits, including those
related to poor investment decisions or market downturns, said Tom Myers, the
attorney for the Grapevine-Colleyville and Keller school districts.
Pesce and Cochran have also told districts that they aren't affiliated with any
insurance company or securities firm. The company's Web site makes the same
claim, stating, "TCG Consulting is completely independent. ..."
However, according to Pesce's filing with the National Association of Securities
Dealers, he is a principal of and stockbroker for QA3 Financial Corp., a
broker-dealer company listed with the same address as TCG Consulting in Austin.
Pesce is licensed to sell various securities. He is also listed with the Texas
Department of Insurance as an active agent, licensed to do business with more
than 20 companies.
Pesce said he worked as an agent more than 10 years ago and only receives
residual commissions from two companies.
As a school consultant, he said, "all I'm doing is providing information for the
districts to set up an investment advisory committee and procedures for how to
set up the committees.
"If you look ... I don't direct the funds. I don't invest the funds, I'm simply
there as a consultant."
NewsLibrary Document Delivery Page 7 of 8
On the Web site, Pesce and Cochran claim credit for the growth of Myer's
companies, but the site does not disclose the lawsuit.
Pesce told the Star-Telegram that he was not aware of improper practices for
most of the time he was with NAP Partners.
"When I did find out what was happening, I stepped up to the plate and made
noise about it and was fired."
But experts on business management said that executives in positions such as
those that Pesce and Cochran held had to be aware of company policies and
actions, and that they are considered responsible for actions by subordinates.
"Generally speaking, the CEO or the president of an organization is held
accountable for the behavior of his subordinates," said John Slocum, a professor
of management and organization at Southern Methodist University.
Andrew Szilagyi, professor of management at the University of Houston, agreed.
"There's a basic management principle that says 'No surprises for the boss.'
That's Management 101," he added.
In his memo to districts, Cochran indicated that he and Pesce might be targeted
by critics because of their financial acumen.
"Not many people who do consulting in this arena have the type of hands-on
experience and understanding of these products that we have," Cochran wrote.
"Thus, our analysis of the insurance and financial services companies' charges
and fees often reveal what some would consider to be fees that are 'hidden' to
the average buyer. Revealing all of these costs in our analyses has made us less
than popular at times with some of these companies."
District recommendations
For their part, many school districts did perfunctory background checks. The
Hurst-Euless-Bedford school district relied on the Securities and Exchange
Commission, which licenses investment advisers, to weed out any problems, said
Buinger, the superintendent. H-E-B has chosen TCG Consulting to consult on
accounts and serve as investment adviser, he said.
Some districts hired TCG Consulting after obtaining a recommendation from other
districts. Other districts asked their attorney to determine if there was any
reason not to hire them, and the attorneys cleared them for approval. Several
district officials said attorneys didn't tell them of the class-action lawsuit.
After Cochran sent his letter, the attorneys checked the class-action lawsuit,
then advised the districts that Pesce and Cochran were not defendants and that
their testimony had helped the teachers, officials told the Star-Telegram.
After receiving Cochran's letter, the Grapevine-Colleyville district put the
brakes on an Oct. 28 vote on hiring TCG Consulting as investment adviser.
Grapevine-Colleyville Superintendent Kevin Singer said that he consulted with
his business officer and that they decided to check other information before
making a recommendation.
"It wasn't pressing for us to name them as the investment adviser right now," he
said.
Sockwell, the superintendent of the Northwest district, said that after
receiving Cochran's letter, he was comfortable with TCG Consulting. The district
has named the company as its consultant and investment adviser.
Bradberry, superintendent of the Keller district, said he is waiting for a
report from the district's attorney, who was looking into the background of TCG
Consulting officials.
NewsLibrary Document Delivery Page 8 of 8
Teachers groups said they want assurances that Cochran and Pesce weren't
involved in activities that misled teachers.
"The whole thing is a great concern," said Aimee Bolender, president of the
Alliance-American Federation of Teachers, Dallas chapter. "We want to be sure
that teachers are getting the best possible product available, and we want to be
sure that the people delivering are of the highest quality and character that
they can possibly be."
Teachers groups say they are disappointed with the low level of scrutiny school
districts provided.
The Grapevine-Colleyville school board was among the rare boards that questioned
TCG Consulting's work, said Steven Poole, associate director of the United
Educators Association. The Keller board had limited discussion.
Thorough discussions might have revealed the class-action lawsuit, Poole said.
"Our members attended many school board meetings where the [retirement] plans
were discussed. This information was never shared by TCG at any time," Poole
said. "It's very disappointing that this information is being revealed now."
- --------------------------------------------------------------------------------
Copyright 2002 Star-Telegram, Inc.