Bernard Madoff could not be convinced to buy professionalliability insurance for his investment services, but legalrequirements did force him to purchase a fidelity bond, a specialtybroker revealed at an industry conference.

Christopher Cavallaro, managing director for ARC Excess andSurplus, a Garden City, N.Y.-based wholesale broker, said thatalthough he pushed for a professional liability insurance sale"each and every year," Mr. Madoff only wanted a financialinstitution bond.

The carrier has since rescinded, leaving more unansweredquestions about coverage than a fidelity bond might otherwisepresent.

Mr. Cavallaro spoke during a session of the 22^ndinternational conference of the Minneapolis-based ProfessionalLiability Underwriter Society earlier this month.

He explained that the $25 million bond was required for Mr.Madoff's firm, because the investment manager, who has since beenconvicted of orchestrating an elaborate $65 billion Ponzi scheme,also operated a clearing trade business.

That was "a viable business where he cleared trades forFidelity, Vanguard and companies like that."

"He was as smooth as silk," Mr. Cavallaro said, recalling hisimpression of Mr. Madoff during the two years he dealt with him inbrokering the bond prior to the discovery of the massive fraud.

The business came to Mr. Cavallaro's office through a retailinsurance agent, who also happened to be Mr. Madoff'sbrother-in-law, Mr. Cavallaro said, reporting that the retailer wasamong the individual investors who entrusted–and lost–millions ofdollars to Mr. Madoff.

The carrier, who was on the risk for 15 years, "immediatelyfiled a recission action to the bond," Mr. Cavallaro alsoreported.

Although he did not reveal the name of the carrier for thefinancial institution bond, he did say the insurer returned thelast year's policy, and that the check has since been forwarded tothe bankruptcy trustee.

"The trustee never cashed it," he said.

Regarding possible coverage under the bond (had it not beenrescinded), Mr. Cavallaro said Mr. Madoff was the principal underthe bond, "so there was probably no coverage anyway. He went on tospeculate, however, that the bond could come into play eventuallybecause other employees of Madoff's firm might be found to becomplicit to the fraud.

Mr. Cavallaro's remarks came after another broker, PhyllisChechile, managing director of Frank Crystal & Company,recounted a rash of Ponzi schemes emerging during the economicdownturn in the wake of the credit crisis.

His talk also followed an explanation from legal expert DavidDiBiase, a managing partner with the Los Angeles-based law firmAnderson, McPharlin & Conners LLP, of the limitations of bondsand crime insurance policies for financial institutions that mightface actions from third-party victims of fraud seeking restitutionfor their losses.

"Simply because a crime has been committed does not mean therewill be coverage available for the consequent loss under a crimepolicy" or financial institution bond, he said, noting that thesefirst-party policies typically pay off in the event of employeedishonesty or other situations that insured financial institutionscan't simply guard against with good controls and risk managementpractices.

Edward Gallagher, general counsel for the Washington-basedSurety & Fidelity Association of America, suggested thatinsured institutions that appeared to have adequate controls, whichhave since been exposed as inadequate as the result of frauds, mayface tougher insurance underwriting scrutiny when their policiescome up for renewal.

Later, Mr. DiBiase quoted language of a 1993 courtdecision–related to the Michael Milken junk bond scandal–tounderscore the negative answer to the question of whether afinancial institution bond covers an insured entity for third-partyclaims brought against it by customers.

"While Milken [and] others were engaged in dishonest actsagainst members of the investing public,…they did not cause a lossunder the bond. In short, they did not steal from Drexel Burnham.They stole for Drexel Burnham," the court said, referring to thefirm where Mr. Milken worked when he hatched his scheme.

"Drexel Burnham was the insured," and the insurer was not goingto "pay Drexel Burnham because its people stole from other people,"Mr. DiBiase said, summarizing the court's view.

"I'm not surprised Mr. Madoff's crime insurer is of that sameview," Mr. DiBiase added, referring to Mr. Cavallaro's revelationthat the financial institution bond carrier chose to rescind thebond.

Mr. Cavallaro went on to share a story about the lengths towhich insureds and brokers will go to "stuff" their investmentlosses "into the insurance box" by trying to find coverage underany policies available.

He related that the retail agent for a private company that had$20 million of its employee benefits funds invested with Mr. Madoffcalled the wholesale broker, saying "We need to get some kind ofrestitution out of insurance."

Mr. Cavallaro's firm speculated that there might only be a smallamount of coverage under a $500,000 ERISA bond (coverage requiredby the Employee Retirement Income Security Act for employee benefitplan fiduciaries), and that even that was uncertain. Mr.Cavallaro's firm had not placed that particular bond, but he saidthere could be some coverage if the bond had some kind ofthird-party coverage provision.

Mr. Cavallaro didn't go into any further detail about how thatcoverage might kick in if it was available, instead focusing on theretailer's reaction for the PLUS crowd.

"Let's sue the fiduciary," the retailer said.

Mr. Cavallaro explained that the private company had a fiduciaryliability insurance policy with a $3 million limit, and what theretailer was suggesting was for the wholesaler to try to encourageemployees of the private company to sue the insured to recover that$3 million limit.

"What happens if they win and it's $20 million?" Mr. Cavallarosaid. Then the $17 million would come out of the pocket of theinsured–the retailer's customer, he pointed out.

"That's the way people's minds work," he exclaimed, seeminglyexasperated by the notion of this retail agent hanging his clientout to dry with a short-sighted plan to get at professionalliability insurance coverage.