Summary
Despite being barred from the securities industry, Martin Frankel is alleged to have anonymously acquired and controlled insurance companies in several states and to have exercised secret control over a small securities firm, using it to take custody of insurance company assets and provided false documents on investment activity. He allegedly diverted these assets to other accounts he controlled to support the scam and his lavish lifestyle. Weaknesses in insurance regulatory oversight, including inadequate analysis of security investments and failure to detect misappropriate of assets, delayed detection of the scam. GAO has noted regulatory weaknesses in regard to change of ownership approvals, route financial analyses, and periodic on-site examinations. Furthermore, the National Association of Insurance Commissioners lacks effective interstate coordination oversight of entities under holding companies and has gaps in control to prevent the migration of unscrupulous securities brokers to other sectors of the financial services industry. The Gramm-Leach-Bliley Act of 1999 underscores the importance of consultation and information-sharing among federal financial regulators and state insurance regulators. Regulators recognize the need to improve their coordination and have taken or plan to take several measures. GAO summarized this report in testimony before Congress; see: Insurance Regulation: Scandal Highlights Need for States to Strengthen Regulatory Oversight, by Richard J. Hillman, Associate Director for Financial Institutions and Market Issues, before the House Subcommittee on Finance and Hazardous Materials, Committee on Commerce. GAO/T-GGD-00-209, Sept. 19 (16 pages).
GAO noted that: (1) throughout the 1990s, Martin Frankel, with assistance from others, allegedly obtained secret control of entities in both the insurance and securities industries; (2) he is alleged to have anonymously acquired and controlled insurance companies in several states and, despite being barred from the securities industry, to have exercised secret control over a small securities firm; (3) using the name of this securities firm, Mr. Frankel allegedly took custody of insurance company assets and provided false documents on investment activity to disguise his actual purpose; (4) GAO observed some regulatory weaknesses in multiple states over several years during each of the key phases of insurance regulatory oversight--change of ownership approvals, routine financial analyses, and periodic on-site examinations; (5) specifically GAO observed inadequate measures for assessing the appropriateness of buyers of insurance companies, analyzing securities investments, evaluating the appropriateness of asset custodians, verifying the insurers' assets, and sharing information within and outside the insurance industry; (6) GAO also found some weaknesses in support services provided by the National Association of Insurance Commissioners (NAIC), a voluntary association of state insurance regulators; (7) some of these weaknesses were similar to those GAO identified in its previous reports, including weaknesses in interstate coordination, oversight of entities under holding companies, and gaps in controls to prevent migration of unscrupulous securities brokers to other sectors of the financial services industry; (8) NAIC and the Tennessee Comptroller of the Treasury have also conducted parallel reviews of the scam and disclosed similar weaknesses along with recommendations for corrective actions; (9) the GLB Act financial modernization legislation highlights the importance of consultation and information-sharing among federal regulators and state regulators when banks and insurance companies are affiliated; (10) the fraudulent activities allegedly perpetrated by Mr. Frankel further demonstrate the need for heightened coordination of oversight activities among regulators in cases where affiliated entities exist; and (11) although the legislation is recent, regulators have recognized the need to improve their coordination and have taken or plan to take a number of actions.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change
from "In process" to "Implemented" or "Not implemented" based on our follow up work.
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Matters for Congressional Consideration
Recommendation: In order to encourage and monitor progress by insurance regulators, Congress may want to consider requesting that NAIC periodically report on the status of corrective actions recommended in this report and by NAIC's Ad Hoc Task Force on Solvency and Anti-Fraud, including a discussions of states' adoption of appropriate laws, regulations, and processes to safeguard and verify insurer's assets that are not in the physical possession of the insurer.
Status: Implemented
Comments: The NAIC's Financial Examiners Handbook Technical Group was tasked to modify NAIC's model law and regulation that identifies requirements for asset custodians. The technical group adopted amendments to the model law and regulation at the NAIC 2000 Winter National Meeting (December 2000) to require the custodian to provide independent notification to a state insurance department when a custodial agreement has been terminated or when the insurer withdraws 100 percent of the account balance in any one custody account. The model was eventually adopted by NAIC in 2001. Additionally, Congress requested a follow-on report from GAO (GAO-01-885R) to assess the status of corrective actions to correct deficiencies identified in the original report (GGD-00-198), including the status of NAIC actions to update its model law and regulation to strengthen controls related to asset custodians.
Recommendation: In order to encourage and monitor progress by insurance regulators, Congress may want to consider requesting that NAIC periodically report on the status of corrective actions recommended in this report and by NAIC's Ad Hoc Task Force on Solvency and Anti-Fraud, including a discussion of regulators' ability to access criminal history data to meet the requirements of federal insurance fraud prevention requirements, as identified in 18 U.S.C. 1033, and insurer.
Status: Implemented
Comments: On March 6, 2001, Congress asked NAIC to report on the status of efforts to enable insurance regulators to access criminal history information from nationwide criminal history databases. To further help augment the state's legislative efforts to provide insurance regulators this capability, the House passed a bill (H.R.1408) supported by NAIC, to safeguard the public from fraud in the financial services industry, to streamline and facilitate the antifraud information-sharing efforts of Federal and State regulators, and for other purposes. Specifically, the bill included proposed improvements in regulators' ability to access antifraud databases by facilitating the establishment, maintenance, and use of an antifraud information network maintained by regulators. In addition to the proposed legislation, Congress requested a follow-on report from GAO (GAO-01-885R) to assess the status of corrective actions to correct deficiencies identified in the original report (GGD-00-198), including those related to NAIC's actions/efforts to facilitate access to nationwide criminal history data by state insurance regulators.
Recommendation: In order to encourage and monitor progress by insurance regulators, Congress may want to consider requesting that NAIC periodically report on the status of corrective actions recommended in this report and by NAIC's Ad Hoc Task Force on Solvency and Anti-Fraud, including a discussion of efforts and agreements between insurance regulators and banking and securities regulators to oversee insurance-related entities of affiliated financial institutions, including the methods for safeguarding and verifying insurer assets held by an affiliated institution and mechanisms to access individual disciplinary data from other financial services regulators.
Status: Implemented
Comments: On March 6, 2001, Congress asked GAO, NAIC, and several other financial regualtors to report on the status of corrective actions and potential barriers to improve the sharing of regulatory information between financial regulators. Congress also requested a follow-on report from GAO (GAO-01-885R) to assess the status of corrective actions to correct deficiencies identified in the original report (GGD-00-198), including the status of NAIC actions to share regulatory information with other federal regulators. Later in 2001, the House passed the Financial Services Antifraud Network Act of 2001 (H.R. 1408)to safeguard the public from fraud in the financial services industry, to streamline and facilitate the antifraud information-sharing efforts of Federal and State regulators, and for other purposes. In 2001, NAIC also adopted amendments to their Model Law and Regulation that would require the custodian to provide independent notification to a state insurance department when a custodial agreement has been terminated or when the insurer withdraws 100 percent of the account balance in any one custody account. NAIC also formed the Database Working Group of the Anti-fraud Task Force, tasked to develop a report detailing the most useful regulatory databases.
Recommendations for Executive Action
Recommendation: The NAIC should develop and adopt the appropriate mechanisms to adequately safeguard and verify insurer assets that are not in the physical possession of the insurance company, including requirements for ensuring the appropriateness of asset custodians.
Agency Affected: National Association of Insurance Commissioners
Status: Implemented
Comments: The NAIC's Financial Examiners Handbook Technical Group was tasked to modify NAIC's model law and regulation that identifies requirements for asset custodians. The technical group adopted amendments to the model law and regulation at the NAIC 2000 Winter National Meeting (December 2000) to require the custodian to provide independent notification to a state insurance department when a custodial agreement has been terminated or when the insurer withdraws 100 percent of the account balance in any one custodial account. The model was exposed for public comment until May 23, 2001, and was adopted at the NAIC Summer National Meeting (June 2001). It will be considered by the Plenary and Executive Committee at the Fall National Meeting (September 2001). NAIC subsequently adopted changes to the model law and regulation (No. 295 and 298, respectively) to strengthen controls related to asset custodians. NAIC also adopted changes to the information collected through insurer's financial statements to better ascertain the status of insurer assets, as we reported in July 2001 (GAO-01-885R).
Recommendation: The NAIC should improve information-sharing by developing mechanisms for routinely obtaining regulatory data from individuals and firms from other financial services regulators.
Agency Affected: National Association of Insurance Commissioners
Status: In process
Comments: NAIC has taken steps to improve regualtory information-sharing but obtaining regualtory data in a routine, systematic fashion has not yet materialized. In 2001, the House passed a bill, the Financial Services Antifraud Network Act of 2001 (H.R. 1408), supported by NAIC, to help facilitate antifraud information-sharing efforts of Federal and state regulators. Specifically, the bill aimed at improving regulatory access to antifraud databases by facilitating the establishment, maintenance, and use of an antifraud information network maintained by regulators. However, H.R. 1408 was not acted upon by the Senate. NAIC has also worked with other regulators (e.g. SEC, state securities regulators, etc.) in an Anti-Fraud Task Force to identify regualtory databases of mutual interest among financial regualtors. Later, Congress asked GAO to assess the status of regulatory information-sharing efforts (GAO-04-882R), where we identified continued barriers to regulatory information sharing and mechanisms to conduct regulatory history checks in a routine, systematic fashion. Currently, the House Financial Services Committee has drafted new legislation to improve regualtory information-sharing and reduce barriers in the proposed insurance reform bill--State Modernization and Regulatory Transparency (SMART) Act (2004).
Recommendation: The NAIC should improve information-sharing by implementing policies and procedures for proactively sharing regulatory concerns with other state insurance departments.
Agency Affected: National Association of Insurance Commissioners
Status: Implemented
Comments: Recognizing the absence of critical information available to regulators as they reviewed Change In Ownership (Form A) applications, insurance regualtors and NAIC proposed establishing a Form A database to alert regulators of other Form A applications filed by individuals/firms to obtain insurance companies in other states. In the Frankel case, such information could have alerted regualtors to peculiar actions and descrepancies that were associated with other Form A applications that Frankel and his accomplices used to obtain control over insurance companies. NAIC launched the new "Form A Database" in March 2002 to aid regulators in their review of Form A applications. Furthermore, NAIC continues to build its database of regulatory enforcement actions associated with individuals/firms to provide regulators a history of an applicant's activities in the insurance industry.
Recommendation: The NAIC should increase the level of securities expertise available to their departments' staff and ensure that insurance analysts and examiners have appropriate training, tools, and procedures to analyze securities assets and to recognize unusual investment strategies.
Agency Affected: National Association of Insurance Commissioners
Status: Implemented
Comments: NAIC's Financial Regulation Standards and Accreditation Committee was tasked to consider adding a review team guideline to its "Use of Specialists" standard in the Accreditation Program, reguiring states to maintain the appropriate investment expertise. This review team guidline relating to investment specialists was adopted at the NAIC Spring National Meeting (3/2001) and provides examples of when an investment specialist may be necessary. This guideline will become effective January 1, 2002. In addition, the Financial Analysis Handbook Working Group adopted procedures to include an evaluation of investment management practices during the NAIC 2000 Fall National Meeting (September 2000). Finally, examination procedures to evaluate the risk factors and coordinate the use of investment specialists have been added to the Financial Condition Examiners Handbook, effective January 1, 2001.
Recommendation: The President of NAIC should ensure that the corrective actions identified by the Ad Hoc Task Force on Solvency and Anti-Fraud are implemented as quickly and fully as possible, in particular those that NAIC can accomplish unilaterally.
Agency Affected: National Association of Insurance Commissioners
Status: Implemented
Comments: The NAIC's Ad Hoc Task Force on Solvency and Anti-Fraud is currently acting on a number of near- and long-term corrective actions. These corrective actions are categorized by NAIC into three levels: (1) generally considered by NAIC to be the highest-priority items that can be accomplished relatively quickly and should not involve significant NAIC or state resources; (2) considered by NAIC to ovedrlap current projects of other working groups, and (3) considered by NAIC to require lengthy discussions and development or that involve significant additional NAIC or state resources. During a subsequent review of NAIC's actions, GAO found substantial progress on many of the corrective actions identified by the Ad Hoc Task Force, as reported in July 2001 (GAO-01-885R). Initially, NAIC made immediate changes to its financial analysis handbook and financial statements, instructing insurers to provide additional informaiton to better verify insurer assets. Subsequently, NAIC updated and developed Model Laws and Regulations including those to better verify insurer assets (Model Law and Regulation 295 & 298, respectively.) Longer-term actions have also been completed, including the development of a Model Law enabling states to access FBI criminal history information (Authorization for Criminal History Record Check Model Law).
Recommendation: The President of NAIC should ensure that the accreditation program requires the states to have adequate controls for safeguarding and verifying assets that are not in the physical possession of the insurer and to have access to securities-related expertise.
Agency Affected: National Association of Insurance Commissioners
Status: In process
Comments: NAIC modified its Model Law and Regulation pertaining to the Use Of Clearing Corporations and Federal Reserve Book Entry By Insurance Companies, as a corrective action as a result of the Frankel scandal. Later, on January 1, 2003, the Financial Regulation Standards and Accreditation (F) Committee exposed this Model Law and Regulation for a two-year period, to be considered as possible accreditation standards. This period ends January 1, 2005. Since this exposure release, other changes to the model law have been proposed, including provisions allowing broker/dealers to act as asset custodians, with certain safeguards. Accordingly, further accreditation-related reviews are forthcoming conerning this model law and regualtion.
Recommendation: The President of NAIC should supplement existing guidance in the financial analysis and examiner handbooks reinforcing the importance of reviewers exercising an appropriate level of professional skepticism and due professional care when indicators of fraud or other irregularities surface.
Agency Affected: National Association of Insurance Commissioners
Status: Implemented
Comments: NAIC's Financial Examiners Handbook Technical Group reported that the group had adopted several significant changes to the NIAC Financial Condition Examiners Handbook during 2003 (memo dated February 13, 2003), including instructions to examiners that fraud is an important regulatory consideraton.
Recommendation: The Chairman of SEC and the President of NAIC should increase the attention given to the development of more routine processes and procedures for sharing and communicating information to address common regulatory oversight matters, including efforts to help prevent the migration of rogues between the securities and insurance industries.
Agency Affected: National Association of Insurance Commissioners
Status: In process
Comments: In March 6, 2001, NAIC and SEC testified on the barriers present to sharing regualtory information in a routine, systematic fashion. Both organization identified barriers concerning the sharing of confidential regualtory information. To help facilitate regualtory information-sharing between agencies, the House passed H.R. 1408, a bill to create an anti-fraud network to assist regulators in identifying potential rogues migrating from one industry to another. However, this bill was not acted upon by the Senate. In a follow-on study, GAO reiterated the conditions and barriers that exist that prevent more regualtory information sharing on a routine, systematic basis (see GAO-04-882R). Currently, the House Financial Services Committee has drafted new legislation, the State Modernization and Regulatory Transparency(SMART) Act, to reform several aspects of insurance regulation, which also includes direction to establish an anti-fraud regualtory information sharing network.
Agency Affected: Securities and Exchange Commission
Status: In process
Comments: On March 6, 2001, NAIC and SEC testified on the barriers present to sharing regualtory information in a routine, systematic fashion. Both organization identified barriers concerning the sharing of confidential regualtory information. To help facilitate regualtory information-sharing between agencies, the House passed H.R. 1408, a bill to create an anti-fraud network to assist regulators in identifying potential rogues migrating from one industry to another. However, this bill was not acted upon by the Senate. In a follow-on study, GAO reiterated the conditions and barriers that exist that prevent more regualtory information sharing on a routine, systematic basis (see GAO-04-882R). Currently, the House Financial Services Committee has drafted new legislation, the State Modernization and Regulatory Transparency (SMART) Act, to reform several aspects of insurance regulation, which also includes direction to establish an anti-fraud regualtory information sharing network.
Recommendation: The United States Attorney General, the President of NAIC, and state insurance commissioners should work together to establish a mechanism by which state regulators can perform criminal background checks on individuals for the purpose of meeting insurance regulators' responsibilities under the federal insurance fraud prevention provision, 18 U.S.C. 1033.
Agency Affected: National Association of Insurance Commissioners
Status: Implemented
Comments: Since this report was issued (GAO/GGD-00-198), NAIC has consulted with the Department of Justice/FBI to identify the specific state legislative language required to grant insurance regulators the appropriate authority to access the FBI's nationwide criminal history data. In turn, NAIC has developed the Authorization for Criminal History Record Check Model Act, which is in a final draft stage, as of summer 2004. Other federal legislative actions could also facilitate the accomplishment of this recommendation, but federal legislative proposals have not yet materialized into law (as of August 2004).
Agency Affected: Department of Justice
Status: Implemented
Comments: The Justice Department has assisted NAIC in its efforts to develop a model law to facilitate granting insurance regualtors authority to access FBI's nationwide criminal history data. NAIC's model law, Authorization for Criminal History Record Check Model Act, is in final draft form (as of summer 2004).
