If an advisor defrauds a client, and the advisor’s managing general agent (MGA) had been tipped off that the advisor had a criminal record and serious allegations of fraud levied against him yet did not act on those allegations, can that MGA be held liable for damages resulting from the advisor’s actions?

That is the focus of an ongoing lawsuit filed by two elderly brothers in Connecticut, who had been told they would earn high returns if they allowed the advisor to manage or invest their money in annuities that were supposed to be placed with two carriers.

By the time the advisor was arrested in January 2007, the advisor—currently serving a 7-year prison sentence after pleading guilty to a variety of federal fraud charges after an FBI investigation—had spent more than $1.2 million of the brothers’ money on exotic cars, fine jewelry, Las Vegas gambling junkets and exotic dancers.

The brothers allege that the MGA committed unfair and deceptive business and insurance practices by, among other things, vouching for the character of the advisor despite its knowledge that the advisor had a prior criminal record for fraud.

The suit further alleges the MGA continued to act as an intermediary for the advisor even after receiving reports of his forgery, embezzlement, and pattern of lies, and failed to disclose these reports to potentially affected insurance consumers and to carriers who, based on the same information, would most likely have taken steps to terminate their relationship with the advisor.

An Appeals Court’s recent decision on the brothers’ appeal substantially broadens the potential duties of general agents under G.L. c. 93A (Massachusetts General Law chapter 93A, referring to consumer protection) to disclose to insureds, annuitants or insurance companies credible allegations of a producer’s possible fraud or embezzlement.

The Appeals Court said:

  •  “Given the reports it had received about [the advisor], particularly the notification, in writing, that he had stolen money from another client, [the MGA’s] inaction could fairly be deemed unfair and unethical, and a foreseeable cause of the [brothers’] injuries”
  • “A fact finder could determine that [the MGA’s] failures to act in the face of likely and substantial injury to [the advisor’s] clients, as alleged, constituted violations of the broad remedial language of c. 93A.”

The Appeals Court also put forth this statement of how the MGA might have ultimately avoided this lawsuit:

  • “Had [the MGA] acted in some fashion (whether by investigating or, absent an investigation, simply informing interested parties), it is foreseeable that the [brothers] would not have suffered the losses they did.”

The case raises a variety of ethical issues, which I asked Stephen R. McCarty, Chairman of the National Ethics Association, to address. Not being an attorney, McCarty said he can’t comment on the legal aspects of the case but was happy to weigh in on the ethical issues.

“First, doing business ethically always demands careful balancing of the concerns of multiple constituencies. Here, we have the needs of a marketing intermediary, the agent, the ultimate consumer, and the life insurance companies all vying to be heard and resolved fairly. Unfortunately, it appears as if [the MGA] failed miserably at achieving an equitable balance,” McCarty said.

“Problem is, [the MGA] tiled the balance so far in the direction of serving its own interests (and that of its contracted producers) that it failed to act to protect the [brothers] against [the agent’s] predatory actions or to protect the interests of [the carriers],” McCarty continued.

McCarty said he thinks the problem may well have preceded the notice the MGA received about the agent’s behavior. “Most financial predators just don’t emerge full blown from the brow of Zeus. They exhibit bad conduct for years, leaving a trail of complaints that regulatory systems fail to adequately identify or address,” McCarty said. “Had [the MGA] done adequate due diligence, I’d be willing to bet they would have uncovered problems and could have rightly decided not to contract with [the agent].”

Once they did, another ethical question, McCarty said, is whether the MGA tolerated inappropriate sales practices. “Had there been signs of egregious self-dealing to which [the MGA cast a blind eye? The fact that [the MGA] received a tip-off letter suggesting as much tells me problems already existed, but [the MGA] never took them seriously,” McCarty said.

“When everything hit the fan, [the MGA] made the fateful decision to not report the matter to authorities, to the [brothers], to other clients [of the agent], or to the insurers. Perhaps they wrongly believed they bore no responsibility for [the agent’s] crimes or maybe they were blinded by [the agent’s] financial contribution to the agency. Either way, their decision not to raise a red flag was ethically dubious, flying in the face of all notions of fairness, justice, and transparency,” McCarty said. “How they made—and could later justify—this decision is frankly a mystery to me. Even more troubling is the fact they had another two years to rethink the decision before [the agent’s] arrest. Again, they failed to do the right thing for any of the parties involved.”

McCarty had one more point to add regarding the case. In financial services, an industry in which trust plays such a large part, a company’s ethics are only as good as the ethics of all its partners.

“Unfortunately, [the MGA’s] failure to report and cast out [the agent] spawned the lawsuit and presumably a ton of negative press. When it decided to do business—and keep doing business—with [the agent], [the MGA] basically emptied a mud pail on its good name and reputation.” McCarty said. “Thanks to the Internet’s eternal memory, it will never be able to wash out the dirt.”