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Phoenix West Agency: the 'investigative memorandum'

EDITOR'S NOTE: This report was among documents regarding an investigation of Prudential Insurance Co. of America that were released in December 1997 by the Florida Department of Insurance.

This 22-page document is an internal Prudential memo detailing a 1995 investigation into churning by several agents in the Phoenix West Agency in Phoenix, Ariz. The document, dated Dec. 15, 1995, is marked "confidential," and "attorney/client privileged."

The investigation found several agents in the Phoenix West Agency had churned customers, and their supervisors -- both in the agency itself and further up the chain of command -- had largely failed to take any action.


PREPARED IN ANTICIPATION OF LITIGATION - CONFIDENTIAL
ATTORNEY/CLIENT PRIVILEGED

INVESTIGATIVE MEMORANDUM - PHOENIX WEST AGENCY

TO: Sue Lanergan, Assistant General Counsel
WO Law Department

FROM: Dan Parsons and Bob Engdale
Compliance and Marketing Practices

DATE: December 15, 1995

INTRODUCTION

Because of allegations raised by Representative Carol Whinery pertaining to the overall sales practices of the Phoenix West Agency (PHNW), the Marketing Practices Unit of the Integrated Compliance Division initiated its investigation in June 1995.

BACKGROUND

Mike Burke became the District Manager in PHNW in October 1988. Burke requested an investigation into the high financing rates of Representatives Joe Balogh, Harold Kotler and Wade Cardon in 1990. There were no serious problems indicated as a result of that investigation except for signature irregularities and misappropriation of funds by Cardon, who was subsequently terminated for the activities. Dick Grimm, Manager, Marketing Practices, went back into PHNW in 1992 to investigate excessively high financing rata, excluding dividends. It was discovered during the course of that investigation that the rates were related to a term conversion campaign.

On August 20, 1992, Representative Daryl Moenke wrote to Gary Budish, Vice President, Regional Marketing, Western Opera ions, copying Jim Novack, Sr. Vice President, WO, Don Southwell, President, PIPS, an attorney and Burke. Moenke raised allegations related to the conduct of Sales Manager John Vetter in a transaction involving a policyholder named Keller. Moenke alleged that Mr. Keller was sold a policy by Vetter that was seriously misrepresented. Moenke stated that Vetter had told Keller that he would get a much better return on the money currently in his existing policies by investing in stocks, that it would not cost him anything and he would get $60,000 of free insurance. Moenke also states that Keller was unaware that loans were being taken on his existing policies, that he was unaware that interest would be due and that he was unaware of the effects of the transaction on his existing policies. Moenke also states in his letter that he felt that this is not an isolated case and requested a full investigation of Vetter's staff regarding these types of business practices. (See exhibit #1). Company records indicate that the Keller matter was found to be a valid complaint and corrective action was taken in favor of the customer. There was no indication in any of the records reviewed that disciplinary action was taken against Vetter or that any investigation was conducted into the activities of Vetter's staff.

On April 11, 1994, ex-Representative William Gormly wrote to the Governor of the State of Arizona alleging massive fraud perpetrated on Prudential policyholders in PHNW. Gormly alleged high levels of financed insurance where the customer did not understand the source of the financing, REG T violations; kickbacks, forgeries and other violations of securities laws; and management cover-ups and tolerance for improper practices if the Representative is a big producer. The "big producer" referenced in Gormly's letter was former representative Stephen Ingrassia. Prudential Chairman and Chief Executive Officer Bob Winters was copied on this letter. (See exhibit #2). Winters' copy of the letter was forwarded to the Corporate Law Department and Rick Meade asked that the Western Law Department take the lead in following up on the allegations in Gormly's letter. Donal Kinney, Vice President and Counsel, WO Law, requested that Sue Lanergan, Assistant General Counsel, work with Grimm to investigate Gormly's allegations. An investigation was conducted in which records were reviewed and Lanergan and Grimm visited the PHNW office to interview local management, Representatives and field service staff. The results of the investigation were summarized in a memo to Kinney from Lanergan and Grimm on August 1, 1994. (See exhibit #3).

The memo indicated that PHNW had a history of high financed insurance rates relative to the rest of the ROC as indicated in the Business Practices reports. The memo noted that Burke admitted that 19% of his total business involved dividends, loans or cash surrenders. It was also noted that PHNW experienced a higher number of complaints than other Districts in the ROC and the bulk of those complaints were related to financed sales. The memo indicated that a total of 49 complaints were filed against PHNW Representatives over a 2 to 3 year period and that 29 of those complaints involved financed insurance with many customers alleging that loans or policies were created without the insured's knowledge. It was noted that the active Representatives with the most complaints were Joe Balogh, John Vetter, Harold Kotler, Ray Yonan and Dave Stallings. (Stallings was no longer employed with the Company at the time that we began our investigation). It was also noted that the same individuals were the high producers and had higher incidents of disbursements.

Based upon the results of their investigation, it was determined that they would send audit letters to select customers with outstanding loans. From what we have been able to determine, 100 to 200 letters were sent out. We received 43 responses and 8 insureds had questions. Former Marketing Practices investigator Bob Keller indicated that none had problems. Audit letters were also sent to 97 of former Representative Steve Ingrassia's clients. Of these, 17 responded, two had questions and none were found to have problems per Keller. Lanergan indicated that she continued to follow with Business Practices during the period in which responses to the letters were being received. She said, however, that these activities stopped when Grimm, Sega and Keller all retired under Combo 7 but they were started again once new marketing practices personnel were hired. Interviews or follow-ups with clients were not done immediately based on the new staff and workloads. Additional issues were also coming to light which required reopening the investigation questioning the effectiveness of the audit letters and the need for further follow up on these letters. Parsons and Engdale were asked to reopen aspects of the investigation and accelerate the process. In a conversation with Kinney, he indicated that it would have been his practice to have reviewed the Lanergan/Grimm report with Novack but he has no specific recollection of having done so.

On January 3, 1995 an article was published in the Wall Street Journal in which Representative John Vetter was personally named as having been involved in tricking a policyholder into purchasing new policies with the dividends from existing policies. When the policyholder finally got her new policies reversed, she was advised, in writing, that the Representatives would be disciplined. It was noted in the article that no disciplinary action was taken. Another Representative from PHNW was quoted in the article, stating that he overhears agents telling policyholders that they will "set this up so it's nothing out of pocket." He goes on to say that, "The guys who do the churning are among the leading agents in the office...". (See exhibit #4).

On May 16, 1995, Don DeFazio met with and interviewed PHNW Representative Carol Whinery regarding issues that she had raised initially in a grievance and then subsequently in conversations with Mike Burke which she had taped. Whinery felt that she was getting no satisfaction from those courses of action and turned to the Compliance area in NCHO to report, in particular, issues related to a customer named St. John and sales practices in general in the PHNW Agency. The issues that were being raised by Whinery were referred to the Corporate Compliance Unit. The Corporate Compliance Unit asked DeFazio to interview Whinery. Following that interview, DeFazio recommended an investigation into the activities of Representatives Vetter, Balogh, Cullaro and Kotler. (See exhibit #5). We were then asked to conduct the investigation into Whinery's allegations.

SCOPE OF INVESTIGATION

The preliminary steps in our investigation included, reviews of the prior investigations into PHNW as well as Core reports. There was also an in-depth analysis of formal complaints that had been logged into the system. It was noted in the review of the Core reports that there were a number of Representatives that were extremely high in total financing related complaints. We targeted our review toward those Representatives. Utilizing this criteria, a selection was made to identify those clients who had purchased new policies using values from their earlier contracts. We focused on those policies where the values were depleted and the continuation of the contracts were in jeopardy. A total of 36 face-to-face customer interviews were conducted by Marketing Practices investigators.

We focused initially on the customers of Vetter and Balogh. Interviews were arranged and Bob Engdale and Joe Willcutt went to Phoenix to meet with these customers. We inventoried each individual client's policies with them and attempted to verify all of the transactions that had occurred related to those policies. An attempt was made to determine the customer's understanding of how these policies were being paid for and their understanding of any special payment arrangements. We also attempted to determine the motivation for the customer's purchase of the policies where funding with values of previously-owned policies was involved. The current status of their insurance, whether their policies were premium paying, paid-to dates, and the outstanding loan balances were also confirmed with the customers.

If a customer expressed concerns or dissatisfaction with the current status of their policies which included misrepresentation on the part of the Representatives, we would ask the customers for a written statement which conveyed their understanding of their purchase and the method of payment for their insurance and also what they would request that the Company do to correct the situation. During this visit to Phoenix and following the interviews of the customers, Engdale and Willcutt also interviewed Vetter and Balogh and obtained written statements from the Representatives.

Joe Willcutt, Pete Sanchez and Scott Kirn made a subsequent visit to Phoenix to meet with customers of Kotler, Yonan and Cullaro. The same process was used during this visit to Phoenix for the interviews with the customers. Cullaro was interviewed by the investigators while they were in Phoenix. Kotler and Yonan were asked to respond to specific questions through current GM Mat Martinez following the customer interviews.

Bob Engdale and Dan Parsons then went to Phoenix to interview a sampling of current management, Representatives and field service staff in the PHNW office. Engdale and Parsons also reviewed files in the PHNW office, including current and former Representative files as well as the file that was maintained in the office on the disbursement reporting process that Burke had implemented. Subsequent to these interviews, Engdale and Parsons went to San Diego to interview Burke. At the conclusion of this interview, Burke was requested to provide a written statement to Engdale and Parsons by the following Thursday. Parsons received a fax from Burke indicated that there would be a delay in providing his statement while he had an opportunity to review his files for documentation that would support his statement. Parsons sent a message to Burke indicating that he should provide his statement at that time and then forward any supporting documentation after he had provided the statement. Burke provided a cursory statement at that time and, finally provided supporting documentation after being contacted again by Parsons. (See exhibit #6). Subsequent to these interviews, Engdale and Parsons went to the Woodland Hills office and interviewed Gary Budish, Jim Novack, Dick Grimm, Bill Spangler, Frank Baggett, and conducted a telephone interview with former Business Practices Investigator Jack Sega.

Complaints

It became apparent during the course of our investigation that we couldn't rely on the WO customer complaint information in the Company's complaint database as an indicator of activity as we normally would in the course of an investigation. Complaints were not being logged into the Company's complaint database as required by Company guidelines. While there were significant numbers of complaints logged in on Vetter, Balogh and Kotler, it was discovered that there were complaints being directed to Budish from Burke requesting reversals. There was a sampling of such complaints in the Regional Unit in which the reversals had been approved by Budish but the complaints were never logged into the system. The failure to properly log complaints into the Company's system prevents the Company from protecting customers from unscrupulous Representatives and from performing our regulatory complaint reporting responsibilities.

It was also learned from interviews with the PHNW service staff that numerous complaints were coming into PHNW by phone. Virtually all of the service staff members interviewed identified the primary targets of the complaints as Vetter, Balogh, Kotler and sometimes Yonan. One service staff member indicated that they received as many as one per day with customers questioning the receipt of premium or loan notices. We were advised by the service staff that the complaints would be referred to the representative for handling. If the customer called back two or three times, the complaint would be referred to a Sales Manager. If the Sales Manager could not resolve the complaint, a request would be made for a written statement from the customer and a reversal would be recommended to Budish by Burke. Burke would only become directly involved with a customer complaint if the complainant insisted on talking to him or if the customer came into the office and the service staff couldn't resolve the problem.

Anna Wolfley, regional coordinator, said that she received more requests for reversals from PHNW than any of the other offices in Region T. Dick Grimm confirmed that he had discussions with Wolfley regarding the number of requests for reversals coming in from that office. Grimm said that he did not have those cases logged into the system, because the VP,RM was already aware of them.

Once it was realized that many complaints were not logged into the Company database or on file in the ROC we went back into PHNW office and obtained the office complaint files. We also reviewed the detail data on delayed not-takens noted in the Core Reports. We requested application files on the identified delayed not-takers and discovered that many of them were related to complaints that were forwarded into the ROC from PHNW with a request for reversal and never logged into the complaint database. (see exhibit #7).

Exhibit #7, the complaint summary report, shows a history of complaint activity on Vetter, Balogh, Kotler, Ingrassia and Yonan from 1992 to present with allegations and indications of churning, replacement, misrepresentation and the lack of understanding by customers that loans were being used to fund new business. In total, there were 20 complaints on Vetter, 20 on Balogh, 20 on Kotler, 18 on Ingrassia and 10 on Yonan. It is also important to note that Vetter was the Sales Manager involved in many of the complaints involving Balogh and Kotler and that Burke and Budish were also involved in the complaint resolution for many of the complains.

INVESTIGATIVE RESULTS

John Vetter, Representative

Representative Vetter started with Prudential on October 11, 1976 in Northeastern Operations, Region GNY. He transferred to PHNW as a representative May 30, 1983. He was promoted to Sales Manager May 29, 1989 and returned to personal production December 20, 1993. Vetter was the number one agent for 1994 in PHNW and Region T with 71,494 commission credits and 96.5 life sales.

Vetter was highlighted in the Core Report in every quarter after his return to personal production for total financing rates (1/94, 34.8%; 2/94, 74.3%; 3/94, 64.3%; 4/94, 50%; 1/95, 38.1%, 2/95, 42.9%). His rates by far exceeded the ROC average of 8.13%. He was also highlighted for various other issues during this same period, including loans and cash surrenders (1/94, 13%; 2/95, 28.6%), delayed not-takens (1/95), and automatic premium loans (3/94, 8; 1/95, 5). (See exhibit #8). These are significant indicators of potential churning activity. Vetter had 11 complaints against him logged into the system and 9 that were not logged into the system. Most of the complaints were related to financing and misrepresentation.

Vetter frequently worked with Balogh. A sampling of nine Vetter and Balogh customers were interviewed during the course of our investigation. Vetter was involved in six of the cases either as the sole representative or on a split commission basis with Balogh. In two of the six cases, the customers were unaware that a new policy had been written. In all six cases, there was a serious misunderstanding of the transaction by the customer. Five out of the six customers were told that no future out-of-pocket premiums would be required. The majority of the customers interviewed had no understanding of the effects of loans on their policies and some were unaware that loans were being used to fund the new business. Frequently, when customers would inquire about premium or loan interest notices, they would be told by the representative that the notice should be disregarded or that it had been taken care of.

Vetter admitted that he made some questionable sales. He said that your judgment gets clouded out in the field when you are pressured to sell, sell, sell. In response to questions on how he could explain a case where he had rewritten a policy instead of reinstating it when the rewrite resulted in a higher premium for the insured. He responded that it was "pure greed."

Vetter was the subject of the Moenke letter written in 1992. He was also identified as being involved in churning in the Wall Street Journal article of January 3, 1995 and was mentioned in the Connecticut class action suit filed earlier this year. The WO Law Department asked Marketing Practices to take a look at Vetter in April when his recognition materials for RBC 1995 came in for approval. Cammie Neumann, associate counsel recalled Vetter's name from the Wall Street Journal article and the Connecticut class action suit. We began our investigation in May and, until that time, the Law Department review was the only one that had targeted Vetter and there had been no disciplinary action initiated against Vetter. At the conclusion of our investigation, we recommended that Vetter's services and agreement with the Company be terminated. He resigned in-lieu of termination on August 14, 1995.

Joseph Balogh, Representative

Representative Balogh first started with Prudential September 24, 1979 in Central Atlantic Operations, Region P. The Company's District Agencies Profile lists him as having a chargeable termination January 25, 1982. He was rehired in PHNW July 10, 1989. He was on Vetter's staff from the time he was rehired until Vetter returned to personal production December 20, 1993. Balogh was the number two agent in PHNW in 1994 with 68,624 commission credits and 112.3 life sales.

Balogh was highlighted for total financing every quarter on the Core Report since its inception in the first quarter of 1992. (1/92, 57.7%; 2/92, 53.8%, 3/92, 57.1%; 4/92, 56.8%; 1/93, 69.4%; 2/93, 46.3%; 3/93, 63.6%; 1/94, 56.5%; 2/94, 66.7%; 3/94, 65.5%; 4/94, 56.9%;, 1/95, 57.1%: 2/95, 48%). (Core info not available for 4/93). (See exhibit #8). His rates were grossly higher than that ROC average of 8.13%. He was also highlighted from time-to-time for other issues, including ex-dividend sales (1/94, 16.2%: 2/94, 20.5%), less than 90-day not takens (2/93, 12; 4/94, 17; 1/95, 18), four-to-six month replacements (3/93, 6) and automatic premium loans (1/94, 5; 1/95, 5). (See exhibit #8). This activity is a clear indicator of potential churning and circumvention of the business practices screen. There were 16 formal complaints against Balogh logged into the system most of which were related to financing and misrepresentation.

Balogh continued to work closely with Vetter on a split commission basis after Vetter returned to representative status. Of the nine Balogh and Vetter customers interviewed, three were cases in which Balogh was the sole representative and four were cases worked jointly by Balogh and Vetter. There was evidence of churning in all of the cases where Balogh was involved. In six of the seven cases involving Balogh, the customers were told that they would have no future out-of-pocket premium expenses. Most of the customers interviewed had a serious misunderstanding of the transactions and one was unaware that a new policy had been written. Several of the customers expressed a lack of understanding of the impact of loans on their policies or that they were unaware that loans were being used to fund the new business.

Balogh admitted in our interview with him that some of the sales that he and Vetter made were questionable and the funding would not work. He said that sometimes they would work only off of the OPSR and guess whether there were sufficient values to support the sale. He said that he would prospect off of the OPSR and Vetter would make the presentation in most cases. Balogh also admitted that he and Vetter would go into the interviews with the customer planning to recommend the purchase of new insurance based on the use of values in the customer's older policies.

At the time we began our investigation, no review, other than that mentioned immediately above, or discipline had been initiated on Balogh. Upon completion of our investigation, we recommended that Balogh's services and agreement be terminated. He resigned in-lieu of termination on August 7, 1995.

Harold Kotler, Representative

Kotler started with Prudential in PHNW March 15, 1985. He was assigned to Staff J in June 1987. He was on Vetter's staff from the time Vetter was promoted to Sales Manager in May 1989 until Vetter returned to personal production. Kotler has been highlighted on the Core Report nine times for total financing (1/92, 37.5%; 29/92, 38.5%; 3/92, 73.7%; 4/92, 37.5%; 1/93, 40%; 2/93, 40%; 1/94, 44.4%; 4/94, 75%; 1/95, 46.2%) and five times for ex-dividend sales (1/92, 25%; 3/92, 15.8%; 1/94, 11.1%; 2/94, 15.4%; 4/94, 37.5%) out of 13 quarters since the report's inception. (See exhibit #8). His total financing rates were significantly higher than the ROC average of 8.13%. Kotler ranked 16 in the Agency for 1994 with 17,302 commission credits and 33.8 life sales.

Eleven Kotler customers were interviewed during our investigation into his activities. In most instances, the idea for the new policy was initiated by Kotler. Six of the customers indicated that they were told that they would have no future out-of pocket premium expenses related to the new policy. Four of the customers said that they did not know that loans were being used to fund the new policies. In Kotler's written statements regarding the transactions involving the customers we interviewed, he admitted that he knew that a number of these transactions were not in the customer's best interest. He indicated that he was pressured by Vetter to make these sales. He said that, if he didn't make the sales, Vetter would give leads off of his agency to other agents.

Kotler had 18 formal complaints against him entered into the complaint database between September 1992 and October 1995. The Allegations included misrepresentation, financed insurance, twisting, churning and inadequate explanations. There was no indication in any of the information that we reviewed that there was ever an investigation into Kotler's activities or disciplinary action initiated against Kotler as a result of these complaints. Kotler retired effective September 11, 1995 while we were still in the process of reviewing his activities.

Thomas Cullaro, Representative

Cullaro started with Prudential in Central Atlantic Operations, Region SNJ in April 1967. He transferred to Western Operations. PHNW office in October 1978. Cullaro is listed as having a chargeable termination from PHNW in March 1984. He was rehired in PHNW in July 1989. He was assigned to Vetter's staff from the time he was rehired until Vetter returned to personal production in December 1993. Cullaro was ranked number 20 in PHNW for 1994 with 13,380 commission credits and 32 life sales. He was frequently highlighted on the Core Report for total financing rates (1/92, 44%; 2/92, 45.5%; 3/92, 52.4%; 4/92, 63.6%; 1/93, 62.5%; 2/93, 50%; 1/94, 33.3%; 4/94, 50%). His total financing rates were significantly higher than the ROC average of 8.13%. He was also frequently highlighted for ex-dividend sales (1/92, 12%; 2/92, 13.6%; 1/93, 12.5%; 2/93, 16.7%; 3/94, 14.3%; 4/94, 10%; 1/95, 12.5%). (See exhibit #8).

A sampling of eleven of Cullaro's customers we interviewed during our investigation. All but one of the cases followed the pattern of the use of dividends and then loans to fund the new business. Of the eleven customers interviewed, seven indicated that they were told that there were sufficient dividends to pay for the new policies and that they would not incur any additional out-of-pocket expenses. Four of the customers interviewed were unaware of loans being used to pay for the new policies. When they questioned Cullaro about the loan interest notices, they were told that "it would all balance out in the future." One of the customers did not recall purchasing the new policy.

Cullaro said that he would use the words "using cash values" instead of loan or borrowing when presenting the funding proposal to the customer. He also said that he didn't recall explaining the impact of loans on the source policies or explaining to customers that they could ultimately lose the source policy.

One particularly troubling case involved both Cullaro and Sales Manager Vetter was with customers named St. John. The St. Johns had a Discovery Life policy (1987), a VAL (1988), an AL (1991) and another VAL (1993). The 1988 policy was sold by former representative Don Pawley with the St. Johns understanding that they would have to make payments for four years and then have no further out-of-pocket premiums. The 1991 and 1993 policies were sold by Cullaro and Vetter. It is the St. Johns' understanding that the earnings on the two previous policies were to fund the premiums on the two later policies. When the issue of the St. John transactions were first called into question by Carol Whinery, the transactions were supported by Cullaro, Vetter and General Manager Burke. We discovered during our review that the St Johns' initial $340,000 in face amount coverage had been reduced to $257,379 due to loan activity and that their policies were in serious danger of collapsing due to the exhausting of cash value and the policies reaching loan-equals-reserve status.

A special exception was obtained through Paul Lang to provide the St. Johns with the benefit of their bargain due to the inconsistencies in the information that we received from the various Prudential associates involved in these transactions and the subsequent reviews, as well as the history of similar transactions by Cullaro and Vetter.

Based upon the our review of the information developed during the course of this investigation, we have concluded that Cullaro made material misrepresentations and used deceptive tactics in his sales activities. We recommend that his services and agreement with the Company, as well as his registration with Pruco Securities, be terminated.

Raymond Yonan, Representative

Yonan started with Prudential in January 1984 in PHNW. He was promoted to Sales Manager in January 1990 and returned to personal production in March 1992. Yonan was ranked number four in PHNW for 1994 with 48,874 in commission credits and 85.6 life sales. He does not stand out with regard to percentage of business being highlighted on the Core Report. However, because of the number of cases that he writes (1992, 95; 1993, 164: 1994, 120), what appears to be a reasonable percentage of matches results in a significant number of financed cases. He has had 10 formal complaints from 1993 through present, four of which were not logged into the system. The allegations include misrepresentation, financed insurance, unsuitability and guarantees and risks.

Yonan has a significant history of disciplinary action:

December 1990: Warning letter for two-job violation

April 1994: Warning letter for paying a client interest on funds intended to purchase a mutual fund, failure to review the prospectus with the client and unauthorized sales correspondence.

October 1994: Probation for express commission abuse

Pending: Unauthorized marketing materials

A sampling of four customers of Yonan's were interviewed during our investigation. Two indicated that they understood the transactions. The other two indicated that they were unaware that loans were being used to fund the new business. In one instance, the customer questioned who authorized the loan. Yonan said that he was present when the authorization form was signed. The customer said that she and her husband were away from home for six weeks prior to the loan being transacted and that there was no way that they could have been reached for such authorization.

There were also discrepancies between what Yonan told us and what a number of the customers told us regarding whether funding plans were discussed at the time of sale. Yonan repeatedly said that funding plans were not discussed. However, the customers told us that the financing plans were in place from the start and that they were told that the policies would "take care of themselves." In some of the cases, the customers requested that the transactions be reversed. In other cases, the customers were satisfied with the transactions. There are other cases identified in our review in which it appears that the values are close to being exhausted. We have not yet contacted these customers but we believe that such contact will be required.

During his tenure as Sales Manager, he supervised Ingrassia (one of the subjects of the Gormly letter). Ingrassia was subsequently terminated for a two-job violation. He was the target of 14 customer complaints with numerous allegations of misrepresentation, financed insurance and incorrect information. There was no indication of any investigation into Ingrassia's sales activities and no indication of the initiation of any disciplinary action against him except for the two-job violations. (It should be noted that Ingrassia was also a rehire who had a chargeable termination out of NEO, Region H listed in the District Agencies Profile system).

Our investigation has led us to conclude that Yonan was involved in material misrepresentations and deceptive activities in the marketing and sale of Prudential products. Based upon Yonan's past disciplinary history, his complaint history and what we discovered in the course of our investigation into his activities, we recommend that his services and agreement with the Company, as well as his registration with Pruco Securities, be terminated.

SUPERVISION

There are certain fundamental responsibilities that are common to all levels of management in Prudential Insurance and Financial Services. Chief among these fundamental responsibilities is the obligation to "promote the success and welfare of the Company." This means that our management people are expected and required to conduct themselves in a manner that will enhance the Company's image and opportunities to compete for the limited resources of the financial security consumer public. This also means that our management is expected to live up to the District Agencies' Priorities and the Company's Core Values. Paramount among those as they relate to sales practices supervision are:

Ethics and Customer Satisfaction

Increasing customer satisfaction by improving business practices and client relationships. Selling the right product, to the right client, in the right way.

and;

Customer Focused

To earn the loyalty of our customers, we will offer quality products and services that satisfy customer needs. We believe person-to-person service adds value. By providing quality and value, we will ensure that our customers stay with us, do repeat business with us and recommend us to their friends.

Pruco Securities Supervisory Procedures

In addition to upholding the Company's commitment to high ethical standards and customer satisfaction, our General Managers, VPs,RM and ROC Sr. VPs are all Registered Principals of Pruco Securities (PruSec). As Registered Principals, they have special responsibilities regarding the supervision of the sales activities of those within their respective marketing areas as described in the PruSec Marketing Procedures. (See exhibit #9).

General Manager

The General Manager is identified as the Branch Manager under PruSec's Supervisory Procedures. As Branch Managers, they have supervisory responsibility for their Branch Office and assigned Registered Representatives, The Branch Manager's duties include training the Registered Representatives assigned to them, reviewing their activities, and immediately reporting to the Regional Compliance Unit any complaints or violations. The Regional Compliance Unit was at one time located in PLPO and is now located in Minneapolis. All complaints related to registered products should be forwarded to Minneapolis for handling in accordance with Company complaint handling procedures.

The Marketing Procedures required that the Branch Manager must work closely enough with assigned registered representatives to supervise them and to ascertain that their marketing practices are in compliance. Additionally, the Procedures require that any customer complaint received in the Branch Office or satellite locations should be copied for Branch Office files, annoted to indicate disposition and referred immediately to the Regional Compliance Unit for handling, with a copy to the Regional Marketing Principal (VP,RM).

The Procedures also state that the Branch Manager should monitor office activity as part of the ongoing review of registered representative activity and advise the Regional Compliance Unit and Regional Marketing Principal of any activity which might constitute a violation, regardless of how the possible infraction is detected. The Procedures state that it is the Branch Manager's responsibility to take actions which will prevent violations as well as the actions necessary to detect them. Included as examples of violations that must be acted upon are:

  • Unsuitable recommendations to customers;
  • Suggesting or arranging for loans to enable a prospect to finance securities; and
  • Engaging in manipulative, deceptive or fraudulent activities

The General Manager's duties as described in the Manual of Instructions for Managers and Sales Managers require that the General Manager supervise, instruct and train the members of the staff in all matters pertaining to the business of the Company. The General Manager is also required to conform to and abide by the instructions, rules and requirements of the Company, as issued or modified by the Company from time to time, and see that they are observed by members of the staff. The Manual of Instructions states that the General Manager should know at all times the condition of Agents' records from the standpoints of production, conservation and condition of the agency, giving attention to the individual Agent whenever necessary and extending assistance and encouragement. (Section GR, 1 (a) and (b)).

The Manual of Instructions also calls for the General Manager to direct the sales activities of their Agents so that applications are for the type of insurance, kind of policy and manner of paying premiums suited to the applicants' circumstances. It states that the new business of Agents should be reviewed at intervals to be sure that they are using proper sales methods and writing satisfactory risks. (Section FO, 36 (a) and (b)).

Vice Presidents, Regional Marketing (VPs, RM)

The VPs,RM are Regional Marketing Principals in the PruSec supervisory chain. As Regional Marketing Principals, they are responsible to the Sr. VP for supervising, monitoring and periodically inspecting the activity within their region to ensure compliance.

Under the Marketing Procedures, VPs,RM are required to have regular contact throughout the year and continuously review activity to ensure that the Branch Managers are fulfilling their compliance responsibilities. Any customer complaints received by the VP,RM are to be copied for RMO flies, annotated to indicate disposition, and referred to the responsible Regional Compliance Unit for handling. Again, Minneapolis is the responsible Regional Compliance Unit for WO. VPs,RM are also to notify the responsible Regional Compliance Unit immediately if they become aware of a potential or actual securities/compliance violation. The violations are the same as those listed for Branch Managers.

There are two sections in the Guide for Vice Presidents, Regional Marketing that relate to the supervision of Representative activities. The section on Business Practices describes the Business Practices Program as being designed to identify sales practices involving:

  • increased replacement activity;
  • increased use of financed insurance;
  • significant increases in loan and cash surrender transactions and reversals;
  • improper use of Automatic Premium Loans; and
  • failure to comply with signature requirements, or misrepresentation of the sale.

It goes on to describe the cornerstone of the program as a series of reports, some of which are prepared in the Regional Home Office and others in Corporate, which identify the extent to which new business sales are associated with disbursements. The instructions state that the General Managers are to review the reports to identify patterns of new business sales associated with disbursements. It states that any patterns should be thoroughly investigated, including contact with insureds if necessary. Remedial action calls for compliance with state regulations and referral to the VP, RM for consideration of disciplinary action in serious cases. The guidelines go on to recommend that the VP,RM use the quarterly reports for discussion with the General Manager during field office visits.

The other section in the Guide for VPs,RM that relates to supervisory responsibility is the NASD Supervision section. This section states that the VP,RMs' responsibilities fall into two categories, Representative selection and supervision of the Representatives' sales practices. The section specifically states that supervision of sales practices can be delegated to the General Manager but such delegation does not relieve the VP,RM of the responsibility. It is also stated in this section that complaints are an indicator of improper conduct on the part of a Representative. It is further stated, however, that the VP,RM has an ongoing requirement to be alert to any indication of impropriety because relying on complaints alone is inadequate to detect and prevent wrongdoing.

Sr. Vice President-ROC

The Sr. VP is the Marketing OSJ Principal in the PruSec supervisory chain. The Sr. VP is responsible to the President of PruSec for supervising, monitoring and periodically inspecting activity to ensure compliance within their marketing OSJ territories.

The Procedures require the Sr. VP to copy any complaints received for the ROC files, annotated to indicated disposition and refer the complaint immediately to the responsible Regional Compliance Unit for handling. The Procedures also state that the responsible Compliance Unit should bc notified immediately if the Sr. VP becomes aware of a potential or actual securities/compliance violation. Again, the violations are listed in the Branch Manager section.

The Sr. VP is also required in the Procedures to inspect the Regional Marketing Offices and complete checklists to be filed in the ROC.

Who is a supervisor?

The cover article in the August 1993 edition of Registered Principal defined who is considered a supervisor. (See exhibit #10). The article quotes and paraphrases a speech delivered by a Securities and Exchange Commission Commissioner on the SEC's position on supervision of registered product activity,

Thc SEC has taken the position that a person is a supervisor if they have:

  • Knowledge and awareness of allegedly improper conduct, and
  • Some ability to affect or prevent the conduct at issue.

The SEC, according to the article, has found those who become aware of violative behavior and are in a position to affect or prevent its recurrence liable if they do not act responsibly. Sanctions for such a finding can include warnings, fines and suspension or termination of registration.

In the July 1994 edition of Registered Principal another article appeared that outlined the SEC's initiatives concerning sales practices. (See exhibit #10). In this article, SEC Chairman Arthur Levitt was quoted from an address he made at the NASD's Securities Conference in which Levitt called for the permanent removal of unethical representatives from the industry. He went on to say that supervisors who see unethical behavior but do not report it are just as bad as the representatives themselves and should be removed.

It is obvious from the definition of supervisor provided by the Commissioner of the SEC that our General Managers, VPs,RM and Sr. VPs all have supervisory responsibility for those within their respective marketing areas. With regard to the activity of the Representatives in PHNW, Burke, Budish and Novack were all made aware of the activity and were in a position affect the behavior and prevent it from continuing. The following is a review of the findings of our investigation related to those in the PruSec supervisory chain and how the standards above apply to what was found.

Mike Burke, General Manager

During the course of our interview with Burke, he clearly admitted his knowledge of the excessive financing and complaint activity with regard to Representatives Vetter, Balogh, Kotler and Yonan. Burke stated that he could not control the activities of these Representatives. He stated that he had forwarded complaints on these Representatives to Gary Budish requesting reversals. He also indicated that he assumed that any necessary disciplinary action would be processed through the Home Office. He said that he never followed up on any of the complaints or activities to pursue disciplinary action. He also indicated that he never attempted to compile information on any of the Representatives to demonstrate a pattern of activity in pursuit of disciplinary action.

Burke did indicate that he had made Budish aware that there were problems and that he needed help to correct the behavior. Burke said, however, that these issues were not discussed with Budish when Budish would visit his Agency. There was nothing in writing in any of the files we reviewed in PHNW or in the ROC that indicated that Burke was seeking anyone's assistance to get control of the activity.

Burke said that he had done some training in the office to discourage financed insurance. He also said that he would discuss the high financing issues with Vetter, both as a Sales Manager and a Representative, and encourage him to use more direct mail to solicit new customers. Burke indicated that there would be some improvement following their discussions but that Vetter would revert back to the financing of new business. Burke provided some copies of reports on which notes appeared to be directed at Vetter suggesting that he needed to reduce the financing rates of his staff and also documents that indicated that he was addressing the financing issue in PHNW. (See exhibit #6). There was also one memo from 1989 in Vetter's PHNW office file that focused on reducing both the total financing rates and the cash surrender and loan rates of his staff. However, there was no indication of follow-up by Burke to make sure that the behavior was corrected. In fact, there was no indication that the activity was reduced. While the ex-dividend financing rates would go down, the activity turned to using dividends first and then loans to avoid the business practices screen. This activity would have been obvious by a review of the disbursement reports and other reports available to Burke in PHNW.

Burke said that he requested a Marketing Practices investigation into the financing of Representatives Balogh, Kotler and Cardon in late '90 or early '91. There was also an investigation into high financing in '92 that was not, however, initiated by Burke. Burke stated that he never conducted any local investigations. He said that he would refer information to the Home Office and rely on the Home Office to conduct investigations and administer discipline as they felt necessary.

Burke said that he attempted to combat the financed sales by referring complaints into the ROC for reversals. He said that this would deprive the Representatives of commissions on the cases and felt that this would deter the behavior. Burke forwarded numerous cases into either Client Relations or Budish requesting reversals. However, there was nothing to indicate that he took any other action to correct the behavior or the Representatives.

He also noted his implementation of the disbursement reporting process as an attempt to control the behavior. Our review of the disbursement reporting process revealed significant flaws in the administration of the process. There were numerous requests for information from Representatives that was never received. Also, when information was provided by the Representatives, there was no indication that any action was taken or follow-up conducted based upon that information.

Burke was questioned with regard to his aggressive pursuit of issues like two-jobs while he made no apparent attempt to pursue the financing or complaint activity for disciplinary action against the Representatives involved in this activity. His only response was that he relied on the Home Office. He also said that he "never protected these guys." There were a number of incidents in the Representatives' files in PHNW of substantial efforts by Burke to develop cases against Representatives for such company rule violations as two-job violations and non-reporting or missing meetings. However, there was no indication that Burke tried to prevent or restrict the activities detected in reports or through customer complaints.

Burke admitted that he was aware of the activities of Vetter, Balogh, Kotler and Yonan. The Company's reports and the complaint activity clearly indicated that these Representatives were involved in deceptive and manipulative sales practices. Burke did nothing more than forward in complaints that his Representatives or Managers could not resolve in the field. Based on this review, we have concluded that Burke condoned and acquiesced in these activities and failed to control or supervise these Representatives to the detriment of Prudential customers over the course of several years. We recommend that his services and agreement with the Company and his registration with Pruco Securities be terminated.

Gary Budish, Vice President, Regional Marketing

Generally, Budish's comments indicated that he was not aware that there was a problem in PHNW. He said that he had acknowledged that their financing rates excluding dividends were higher than the ROC average but that they were within the Company's standards. Budish said that the Company's system really only monitored the rates excluding dividends. He also indicated that when the Company began to focus on financed insurance excluding dividends that the Representatives found a way around the system to avoid the Business Practices screen.

It should be noted that Budish's incentive compensation was withheld this year because it was discovered that he was coaching field associates on how to avoid the Business Practices screen.

Budish indicated that Sandy Allen came to him in late '94 or early '95 with a couple of complaints and expressed concern that customers were not aware of loans and that they didn't believe that any additional out-of-pocket expenses would be needed. Budish said that at that time they began to pursue Vetter and Balogh in response to those complaints. He then indicated that they were asked to drop their investigation when we began ours. When asked what distinguished these two complaints from other complaints that he had received out of PHNW, he stated that, in these complaints, the customers were expressing concerns about the fact that they were not aware that loans were being taken on their policies and that they were not aware that additional out-of-pocket expenses would be required. He said that these were common themes between the two complaints.

It should be noted here that the nature of these complaints were consistent with numerous other complaints that had been coming into PHNW, including some that were sent into Budish from Burke for reversals. The complaint records indicate that Budish received a number of complaints from Burke with recommendations for reversal based upon these same types of allegations from customers dating as far back as 1992 and continuing through the first quarter of 1995. In fact, the records indicate Budish personally signed off on the reversals of policies in response to such complaints in seven separate cases involving the agents named above. The records also indicated that Budish was put on notice of such complaints through either letters from Burke, memos from Client Relations or carbons on response to customer complaints in at least 16 other cases involving these same agents. This is a total of 23 recorded instances in which Budish clearly knew or should have known of the Company having to reverse or make significant adjustments to transactions due to customer complaints consistently alleging the same type of conduct by these agents. (See exhibit #7).

We checked to see when the investigation into Vetter and Balogh actually began and what had caused us to begin looking at the Representatives. It was learned that the review of their activity was initiated by Cammie Neumann, WO Law, when the recognition piece for RBC came in on Vetter for approval in April and she recognized the name from the Wall Street Journal and the Connecticut class action. Cammie asked Marketing Practices to review Vetter's business activities. Marketing Support was notified by WO Law that RBC material featuring John Vetter would not be approved, and express concern over any recognition being given to him at RBC. Bill Spangler continued to inquire whether we would be able to release recognition materials on Vetter and we advised him that the materials should not be released when it became apparent that his activities would result in serious disciplinary action. Up until that time WO continued to consider recognizing him as the number one Representative for Region T at the business conference.

Budish was questioned about whether he bad ever noticed anything out of the ordinary during his Compliance visits to the Phoenix West Agency. He indicated that he never noticed that anything was out of line during those visits. When Budish was questioned regarding Burke's comment that he had called him and asked for help to control these Representatives, Budish responded that he was sorry that Burke had said that but that Burke had never called him and asked him for help to control the Representatives.

Budish completed checklists during annual compliance visits to PHNW indicating that he had reviewed the complaint files in the agency. (See exhibit #11). The complaint files contained numerous complaints alleging misrepresentations and deceptive financing transactions against Representatives Vetter, Balogh, Kotler, Yonan and Ingrassia. The reports that the VP,RM's Guide suggested that he review would have confirmed that there was excessive use of dividend and loan activity to fund new business. It was also indicated by Burke that these issues wore not discussed during the visits. Budish's allegation that he was not aware that there was a problem would indicate that he was not performing the review of these materials in a reasonable fashion or that he chose to ignore the signs.

When questioned regarding the Moenke letter from 1992, Budish didn't recall the letter. When shown a copy of the letter Budish stated that he recalled more about the commission split issue between the Representatives than the serious allegations of misrepresentation and wrongful conduct on the part of Vetter. He said that he thought that the customer had been taken care of and that the conflict between the Representatives on the commissions had bees worked out locally in the Agency. He didn't recall what occurred, if anything, regarding an investigation or disciplinary action regarding Vetter's conduct here, even though Moenke stated that this activity was common on Vetter's staff and requested that Budish investigate the activity.

In response to our inquiries regarding the Gormly matter, Budish said they took the 1994 Gormly letter very seriously and that an investigation was conducted by Lanergan and Grimm. Budish indicated, however, that Gormly did not have much creditability with him because of the fact that Gormly was with the Company for only three months and never placed a piece of business. He indicated that it made him mad to think that somebody that had never placed a piece of business with the Company would come back and make these types of allegations. It was pointed out to Budish that many of the things that Gormly was alleging had been shown to be true during the course of our investigation. Budish indicated that Gormly was trying to make it appear as though the problem was more wide spread than it was. Lanergan has stated that Budish would inquire from time-to-time as to how the Gormly investigation was going. By the time the Gormly letter was received, the allegations in the numerous complaints on Vetter, Balogh and Kotler clearly paralleled many of the charges in Gormly's letter.

Budish acknowledged that he attended quarterly Marketing Practices meetings with Novack, the other VPs,RM and Grimm. He said that when these meetings did not take place he would review the alert report that Jack Sega had prepared and also the twelve month rolling complaint report. He indicated that he did not recall excessive complaint activity ever coming up as an issue in the quarterly Marketing Practices meetings. Both Grimm and Sega indicated that issues regarding total financing rates and Vetter, Balogh and Kotler were repeatedly raised during the quarterly Marketing Practices meetings attended by Novack and the VPs,RM and individually with Budish after the meetings stopped.

It should be noted that our review of Company records and the files that Budish maintained on PRNW and Burke revealed no indication of any communication between Budish and Burke or any effort on Budish's part to address the sales practices activities or complaint activity of Representatives Vetter, Balogh, Kotler or Yonan. The only indication of any act on Budish's part to address the complaint activity with a Representative was to recommend training for Kotler on replacement when the Department of Insurance was investigating a complaint.

Budish did forward complaints that he received to the WO Client Services unit for review and reversal. However, there was no indication that any information was reported to the responsible Regional Compliance Unit. There was also no indication that any remedial or disciplinary action was taken or even considered in response to the complaint activity that was being reviewed by Budish except as mentioned in the paragraph immediately above.

The results of our investigation has led us to conclude that Budish failed to perform his supervisory responsibilities to respond to numerous indications of serious regulatory and sales practices violations by several Representatives in PHNW to the detriment of Prudential customers. As a result, this activity continued over a period of several years. We recommend that his services with the Company and his registration with Pruco Securities be terminated.

Jim Novack, Sr. Vice President

In our interview with Jim Novack, we asked him for an explanation of what type of exchanges occurred between him and Budish or Burke regarding the activities in PHNW. Novack said that he had no particular recollection of conversations with Budish, Burke or Grimm regarding sales practices or complaints in PHNW. He also indicated that he had no recollection of how these problems came to his attention. Novack also stated that he did not recall problems in PHNW being raised during his quarterly Marketing Practices reviews with Grimm. He stated that he had no indication of any problems with Vetter and Balogh until recently.

It was Novack's responsibility to ensure that marketing activities in his marketing area were in compliance with state and federal regulatory authorities as well as Company and PruSec rules and guidelines. He was copied on the 1992 Moenke letter. He was present at numerous quarterly Marketing Practices meetings in which PHNW was repeatedly highlighted for total financing and ex-dividend financing. He received monthly complaint reports in which PHNW appeared with excessive complaint activity related to other offices in his ROC. Vetter and Balogh consistently were highlighted for total financing on the Core Reports with rates in excess of 50% while the ROC average was 8.13%. He was aware that there was an investigation being conducted into Gormly's allegations and Vetter was then highlighted in a front-page article in the Wall Street Journal along with another active Representative alleging that churning was a common practice in PHNW.

There were no indications that Novack did anything to inquire, pursue or follow-up on any of these indicators of serious sales practices problems in PHNW, even though Vetter was the number one Representative in Region T and was scheduled to be recognized at WO's RBC. Novack was, however, quick to criticize the investigation into these matters. These activities went on for several years to the detriment of possibly hundreds of Prudential customers as information was directed to him, available to him and ultimately publicized in one of the nation's top business publications. Novack served in the capacity of Representative, Sales Manager, General Manager and VP,RM prior to becoming Sr. VP. It is safe to assume that he understands the information provided in the Company's reports, the nature of the allegations made by Moenke, Gormly, and the Representative quoted in the Wall Street Journal and the information being provided to him by the WO Marketing Practices Unit.

Novack signed numerous inspection reports for Region T, indicating that complaints and violations were being forwarded to the responsible Regional Compliance Unit. (See exhibit #12). However, he had reason to know that violations were being committed by Vetter and, possibly, others that were not being reported. The COSO model clearly indicates that the environment for controls to protect the interests of the organization must be set by the executives at the top. The controls in WO clearly failed.

The results of our investigation have led us to conclude that Novack failed to perform his supervisory responsibilities on numerous occasions and allowed this activity to continue for several years to the detriment of Prudential customers. Therefore, we recommend, if he is allowed to remain in the position of Sr. Vice President, he should be put under very close supervision under strict supervisory conditions. He should also receive clear warning that any similar conduct in the future will result in the termination of his services with the Company and his registration with Pruco Securities. His personnel file should be appropriately noted. Serious consideration should also be given to a significant fine for his failure to supervise.

CONCLUSION

The indications of sales practices problems in the PHNW, including excessive financing and misrepresentation, were repeated and obvious. The Agency was repeatedly highlighted in the Marketing Practices alerts prepared by Western Operations Marketing Practices Unit and in the quarterly Marketing Practices meetings. Certain Representatives from the Phoenix West Agency were repeatedly highlighted for high financing rates on the same Marketing Practices alerts and also on the core reports. These Representatives included, particularly, Vetter, Balogh and Kotler. There was the 1992 letter from then current Representative (now retired) Moenke with allegations of serious misrepresentation by Vetter and also the request that a complete investigation of the sales practices activities of Vetter's staff be conducted. There was the letter from ex-Representative Gormly to the Governor of the State of Arizona alleging numerous serious sales practices violations occurring in the Phoenix West Agency. And, finally, there was the January 3, 1995 Wall Street Journal Article with allegations of churning by a current Representative in PHNW and identifying Vetter as a perpetrator of this activity. All of these matters were brought to the attention of Mike Burke, Gary Budish and Jim Novack. Mike Burke admitted knowledge of these problems and yet failed to make any serious attempt to address them. Both Gary Budish and Jim Novack denied any knowledge or awareness that these problems existed in PHNW and there was no indication from either of them that there was any attempt to address these problems until months after the article appeared in the Wall Street Journal on January 3, 1995. The lack of any real attempt to control this activity of the Representatives in PHNW by Mike Burke and the alleged lack of awareness of any problems by Gary Budish and Jim Novack would indicate a clear and complete failure by all three to execute their supervisory responsibilities.

FOLLOW-UP

The follow-up activity that will be required as a result of the findings of the investigation into the activities in the PHNW will include a review of the findings to determine what sanctions and disciplinary action will be appropriate for Burke, Budish and Novack. We will also need to perform a further review of our business systems to determine additional clients in the Phoenix West Agency that may have been harmed by this conduct so that they will be contacted to determine if corrective action is warranted.

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