Cauaht Off Guard.

An official review has found that the Tennessee insurance department was not equipped to detect Martin Frankel's alleged scam.

After a yearlong review, Tennessee's Comptroller of the Treasury issued a report criticizing the state insurance department for its failure to detect Martin Frankel's alleged scam before May 1999. The report cites, among other things, "insufficient professional skepticism," by the insurance regulators.

But the report by Comptroller John G. Morgan does not accuse anyone in the Tennessee Department of Commerce and Insurance at that time of misconduct. Morgan's report notes that proper department action allowed Tennessee to recover about $57 million, when other states that also had been victimized by the bond trader's fraudulent activities could not. Frankel allegedly stole more than $200 million from the insurance company Franklin American and other related corporate entities.

Morgan said the review did not find that any of the insurance department's "inadequacies" were intentional, nor was there anything in the review to substantiate charges that Franklin American had been given special treatment by the department.

The National Association of Insurance Commissioners suspended the accreditation of the Tennessee insurance department, in part because of the state's failure to protect Franklin American Corp. from being defrauded.

In Over Its Head

The 81-page report provides a detailed picture of a department that was in over its head in trying to understand a complex scam that involved insurance as well as securities.

Arthur A. Hayes Jr., director of state audits, who works under Morgan and helped prepare the report, said it was the insurance department's "failure of judgment" that allowed this to happen.

"This was bureaucracy at work," Hayes said. "If it doesn't fit in a round hole-and all they're used to are round holes-they punt. This got punted all over the place, and everybody was wishing and hoping it would work itself out."

Hayes said, in fairness to those in the department at the time, "I think the facts of this case would have presented difficulties for any regulators."

Former Tennessee Insurance Commissioner Douglas M. Sizemore, under whose watch Frankel allegedly drained the assets of several insurance companies virtually unnoticed, resigned a year ago. Tennessee Gov. Don Sundquist appointed Sizemore to lead the Department of Commerce and Insurance after Sundquist was elected in 1994. Sizemore resigned to return to the private sector, according to the governor's office. Before becoming insurance commissioner, Sizemore was president of Johnson City Wofford Brothers Insurance Agency.

Announcement of Sizemore's resignation came a month after the Wall Street Journal reported that in 1993, regulators in the Tennessee insurance department had questioned Franklin's heavy bond trading, which was more than 90 times the total assets of the company in some years. Regulators also noted that the company didn't comply with regulations requiring insurers to place assets in bank custody. But officials took no action against Franklin until just before Frankel fled.

Tennessee Insurance Commissioner Ann Pope, who was appointed last November to replace Sizemore, issued a statement on Morgan's report. She said her priorities when she was appointed were to identify the weaknesses that allowed the scheme to go undetected, cooperate with the comptroller's investigation and make improvements as quickly, thoroughly and efficiently as possible.

Morgan's report said the review by his office began in July 1999 after receiving information from state officials and the national news media that Tennessee's Department of Commerce and Insurance "failed to appropriately react to significant warning signs and information available to them" regarding Franklin American Life Insurance Co. and liberty National Securities Inc.

Unusual Circumstances

Morgan's report states that as far back as late 1991, there were "unusual circumstances" for the department to consider. Established in 1986 as Franklin American Life Insurance Co., the company did not appear to be significantly different in organization or operations from most other insurers, Morgan's report states. In August 1991, the company was placed under administrative supervision due to insufficient capital and surplus. Later that year, the company was acquired by Thunor Trust.

The acquisition by Thunor appeared to rescue the insurance company, "even though department staff realized it was unusual for a trust to acquire an insurance company," the report states, adding that the trust was unusually structured because it was an irrevocable trust that placed control of the acquisition funds and operation of Frank]in American into the hands of a sole trustee.

"This was strange from the beginning," Hayes said. "As an auditor, when I see strange, I attack it. Some people just ponder it."

Over the seven and a half years the department regulated Franklin American, it continued to use "routine basic approaches" before the company ceased operations in May 1999. Morgan wrote that the department had several opportunities to take more aggressive action.

Morgan's report said there were many situations and business operations that were confusing and not easily understood, but instead of demanding explanations or trying to understand the company's representations, insurance department staff and officials decided that even though the circumstances appeared unusual, unless a law, regulation or policy was broken, they could take no action.

Hayes said Morgan's report also includes recommendations for improvements within Tennessee's insurance department. Hayes said the department has agreed with and has developed procedures for changing.

In her statement, Pope said some of those improvements include strengthened procedures for confirming investment information, maintaining more complete records and retaining examination papers for at least 10 years for all companies and longer for problematic companies; intensifying scrutiny of annual and quarterly financial reviews by analysts and using insurance industry benchmarks to identify inappropriate investment-trading practices; training staff to recognize fraud indicators; and introducing a law to allow the insurance department to provide more competitive pay to contract examiners and industry specialists.

Millions Stolen

An unlicensed securities broker from Greenwich, Conn., Frankel allegedly stole more than $200 million from Franklin American and other related corporate entities, according to Morgan's report. These companies invested their reserves with Liberty National Securities Inc., a brokerage firm Frankel anonymously controlled.

Frankel fled to Europe last year and has been fighting extradition from German since his capture. In June, a German state court sentenced Frankel to thee years in prison following his conviction on charges of tax evasion and carrying falsified passports. Along with the jail time, Frankel has been ordered to surrender $1.6 million worth of diamonds from those he smuggled into Europe.

In the United States, federal and state prosecutors and insurance commissioners say Frankel led a scheme to buy several preneed funeral insurance companies though Thunor Trust, Franklin American Corp., International Financial Corp. and other businesses. He then allegedly drained them of their assets so he and his cohorts could buy real estate, diamonds, cars, airplanes and other assets.

Frankel faces criminal charges in Mississippi and Tennessee, along with a U.S. indictment charging him with 20 counts of wire fraud, 13 counts of money laundering and one count each of racketeering, securities fraud and conspiracy. If he is convicted of the 36 federal charges, he could spend the rest of his life in jail.

He also faces a battle in civil court. Insurance regulators in Tennessee, Missouri, Mississippi, Arkansas and Oklahoma filed a lawsuit against Frankel, along with Franklin American Corp. Chief Executive Officer John A. Hackney and Chief Financial Officer Gary Atnip. Hackney was also sole trustee of Frankel's Thunor Trust.

The lawsuit said Frankel and friends carried out the scheme by repeating the same pattern. First, they acquired insurance companies through the holding companies or another entity, with Frankel appointing Hackney as CEO in each case. Then, Hackney and Atnip transferred the company assets to Frankel's control though a company called liberty National Securities. Ultimately, the assets were transferred to various bank accounts or used to buy other assets.

The Accused

Martin Frankel, a former bond trader, is accused of absconding with between $215 million and $300 million in insurance company assets invested through his Liberty National Securities trading firm, base d in Greenwich, Conn. He used at least 11 different aliases in a scheme to buy and gain control of preneed funeral insurance companies throughout the United States by using a number of companies, including American Life Acquisitions, Franklin American Corp. and International Financial Corp., according to the suit filed in U.S. District Court for the Southern District of Mississippi.