Impact of the Economic Crisis on Traditional Professionals

1. Impact of the Economic Crisis on Traditional Professionals San Diego, CA ~ April 29 & 30, 2009

2. THE IMPACT OF THE ECONOMIC CRISIS ON "TRADITIONAL" PROFESSIONALS MODERATOR: John E. Ianotti, Esq, Vice President, Financial Institutions, Everest Reinsurance Company PANELISTS: Brian E. Cropp, Assistant Vice President, Victor O’Schinnerer Jeffrey Day, CPCU, Assistant Vice President, CNA H. Steven Vogel, Esq., Of Counsel, Wilson Elser Moskowitz Edelman & Dicker LLP

3. Underwriters’ Perspective • Professional Services Firms • Accounting Firms • Real Estate Professionals • Claim Defense Perspective • What the economic crunch has changed

4. Professionals’ ExposureChanges Driven by the Economy Challenged financial condition of the professional firm Acceptance of work for firm’s survival Lax screening for conflict of interest Lax consideration of firm’s core expertise Lax consideration of locale of work and firm’s knowledge of that locale Lax risk management

5. Professionals’ ExposureChanges Driven by the Economy (cont’d) Staff reductions driving down the quality of their work Projects where banks have pulled funding Professional firms and contractors have filed liens Banks are suing lien holders to claim right to property

6. Professionals’ ExposureChanges Driven by the Economy (cont’d) When Professional firms file for bankruptcy: Projects/clients left in the lurch Owners bringing legal action - Professional Liability Insurance Limits of Liability become an asset of the bankruptcy estate

7. Professionals’ ExposureChanges Driven by the Economy (cont’d) Financial condition of clients Insolvency/bankruptcy of a client Large damage backdrops Potential for liability to owners, shareholders and other constituents The longer the relationship had been, the larger the potential exposure

8. Professionals’ ExposureChanges Driven by the Economy (cont’d) Professional Services: trustee in bankruptcy Lucrative but highly contentious Target for class action litigation

9. Professional Liability Underwriting Impact • Need to analyze the professional firm’s financials • Monitor press on major publicly held clients • Need ever greater integration of business intelligence sources • Less underwriting intelligence means higher risk level

10. Impact of the Economic Crisis on Accountants Sub-prime Credit crisis, recession and Ponzi schemes Going concerns Business bankruptcy Tax enforcement & collection activity

11. Impact of the Economic Crisis on Accountants Timing Impact to CPA firms delayed due to “trickle down” effect Full impact won’t start to be felt until after tax season

12. Impact of the Economic Crisis on Accountants Effect on Areas of Practice Consulting work likely to decline Exceptions: Bankruptcy, Business Valuation, Litigation Support Many small businesses will fail Loss of bookkeeping, compilation & tax services Tax and audit work remain core services However, clients looking to “trade down” to review

13. Impact of the Economic Crisis on Accountants Increased competition: “reverse” cascade effect…..here comes the Big 4! Lost billings will pressure firms on: Expense management Client acceptance and continuance

14. Impact of economic downturn on APL • How will small firms react? • “My book of business” • Owners protective of their clients • More likely to allow delinquencies to mount • More likely to act as client advocate and attempt to assist with financing • More likely to SUE FOR FEES when they hit “crisis” mode • Delay in retirement

15. Impact of the Economic Crisis on Accountants Retirements, mergers and acquisitions What retirement? “Work until you drop” Many mid-sized firms will seek to be acquired, but few will be Likely “shakeout” among small regional firms Some will shrink; a few may even break up Some will be acquired by larger regional firms

16. Impact of the Economic Crisis on Accountants Summary- Increased frequency Subpoena assistance, potentials, and actuals going up Increased severity Business bankruptcies and ponzi schemes Increased competition; flat or declining billings Competition increases “dabbling”, pressure on client acceptance/continuance, and work quality issues Increased insurance price sensitivity Requests for lower limits, higher deductibles Some small firms have gone bare

17. Impact of the Economic Crisis on Real Estate Professionals Real Estate Professional Liability Appraisers Professional Liability Mortgage Broker Professional Liability

18. Impact of the Economic Crisis on Real Estate Professionals Real Estate Professional Liability Stagnant Housing Foreclosures Bank-Owned Properties

19. Impact of the Economic Crisis on Real Estate Professionals Real Estate Professional Liability Rating basis Number of Agents/Brokers Gross Commission Income

20. Impact of the Economic Crisis on Real Estate Professionals Real Estate Professional Liability Rating basis Number of Agents/Brokers Many employees are leaving to find greener pastures Commissions and number of sales are decreasing

21. Impact of the Economic Crisis on Real Estate Professionals Real Estate Professional Liability Rating basis Commission Sales Turn in marketplace causing premiums to decrease Writing new business with prior acts will pick up exposures from prior years

22. Impact of the Economic Crisis on Real Estate Professionals Appraiser Professional Liability Rating basis Fees/number of appraisals Exposures- Appraisers pressured to “hit the price” to help sales go through

23. Impact of the Economic Crisis on Real Estate Professionals Appraiser Professional Liability Severity of claims Some companies are getting out of the market Others are limiting coverage

24. Impact of the Economic Crisis on Real Estate Professionals Broker Price Opinions (BPOs) A cheaper way for banks to get the value of a home instead of using a certified appraiser Legislation in many states are requiring BPOs be performed by certified appraisers

25. Impact of the Economic Crisis on Real Estate Professionals Broker Price Opinions (BPOs) could be the cause of decreasing home values. Incentive to undervalue short sales, foreclosures Inherent conflicts of interest: (Want to) sell property fast Want additional BPO and property listings from bank Many sales to investors, at depressed prices, become the comparables for appraisers Washington Post, March 28, 2009

26. Impact of the Economic Crisis on Real Estate Professionals Mortgage Broker Professional Liability Rating basis Revenue/number of mortgages

27. Impact of the Economic Crisis on Real Estate Professionals Mortgage Broker Professional Liability Sub Prime mortgage earlier this decade created some claims No Money Down No Documentation for Loans Mortgagees were under-qualified for mortgages they were offered Buyers not able to afford house for loan size offered by mortgage broker

28. Impact of the Economic Crisis on Traditional Professionals Especially • Ponzi Schemes Impact on Accountants and Lawyers • Subprime Issues Impacting Accountants and Lawyers

29. WHO IS AT RISK? • Auditors or professional advisors of any Madoff investor stand a good chance of becoming a defendant. • Auditors for the numerous feeder funds that invested all or a portion of their investors’ monies with Madoff Are likely to face lawsuits from their fund clients and their clients’ investors

30. WHO IS AT RISK? Madoff’s auditor- • Friehling & Horowitz • Three person operation: • One active CPA • One secretary • Third person living in Florida

31. WHO IS AT RISK? • CPAs and lawyers that served as trustees, and personal representatives of estates and foundations that invested with Madoff • Any lawyer or CPA who accepted finders fees from Madoff, for soliciting new investors, will have difficulty convincing a jury that their objectivity in giving advice was not compromised

32. POTENTIAL PLAINTIFFS • Entities that invested directly with Madoff will seek to recoup their losses (educational and charitable organizations and pension plans)

33. POTENTIAL PLAINTIFFS • Individual investors will likely take aim at their accountants who offered investment advice (even if- or especially if- not retained to do so), alleging failure to adequately investigate the Madoff investments

34. WARNING SIGNS • Recent lawsuits allege that feeder fund auditors failed to notice red flags: • Madoff’s investment strategy was incapable of delivering the returns he reported • Option contracts in which Madoff was supposedly invested were not reflected in the trading of the option exchanges • Investors had no electronic access to their accounts at Madoff

35. WARNING SIGNS(cont’d) • Madoff did not have an independent custodian hold its investment securities • Madoff operated under a veil of secrecy and did not allow outside audits by significant investors • Madoff went to 100% cash every December 31, irrespective of market conditions

36. HEADWAY INVESTMENT CORP V. AMERICAN EXPRESS BANK Miami Circuit Court – Filed April 6, 2009 Headway sues: • American Express Bank • Fairfield Greenwich • PriceWaterhouse Coopers • Citco

37. HEADWAY INVESTMENT CORP V. AMERICAN EXPRESS BANK • American Express recommended two Madoff funds • $10 million invested • Funds managed by Fairfield Greenwich – notdisclosed to Headway

38. HEADWAY INVESTMENT CORP V. AMERICAN EXPRESS BANK • The lawsuit includes allegations of: • Negligence • Breach of fiduciary duty • Unjust enrichment • PriceWaterhouse Coopers audited the feeder funds

39. GOLDBERG V. NATIONAL CPA FIRM • Filed in Miami Circuit Court on March 30, 2009 • Plaintiffs lost approximately $100 million in Madoff investments • Plaintiffs sue trustees, personal representatives and investment advisors

40. GOLDBERG V. NATIONAL CPA FIRM • Plaintiff allegations include: • Demand for an Accounting of all funds held by the respective trusts • Breach of fiduciary duty against the trustees • Removal of trustees/personal representatives

41. NEW CENTURY FINANCIAL CORP V. KPMG INTERNATIONAL AND LLP • Filed April 1, 2009 – among the first attempts to blame auditors for the sub-prime mortgage crisis • Suit demands $ 1Billion in compensatory and consequential damages

42. NEW CENTURY FINANCIAL CORP V. KPMG INTERNATIONAL AND LLP • KPMG performed financial statement audits of New Century • Complaint alleges that KPMG was grossly negligent in performing the audits • KPMG is “public watchdog”

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