Everyone Gets Hurt: A Study in Workers' Compensation Fraud

MICHAEL SPUTO

A man sat at his kitchen table. Spread out before him were bond paper, a utility knife and a glue stick. The laptop, printer and cell phone were fired up. The address of a PO Box was scribbled on a sticky note. From these humble beginnings, a $100 million fraud was born.

Beverly Hills, California, was home to the rich and famous and those who seek riches and fame. Phillip Logan was different from the wannabe starlets who lunched on Rodeo Drive, wishing the paparazzi were interested in what they were doing and fantasizing about being on TMZ. Logan only cared about the riches.

A law school graduate who never passed the bar, Logan bounced around for years as an entrepreneur who could not quite seem to make it work. Eventually, Logan found his calling. Middle age and married, a family man with children who relied on him, Logan used his undergraduate business degree to set up shop as an investment banker — but not the type of investment banker you would find on Wall Street. No, Logan was the type of investment banker who specialized in the murky business of balance sheet enhancement. Logan's specialty was creating shell companies that he could use to find assets to put on the financial statements of his clients' companies for pennies on the dollar. How is it possible to pay thousands of dollars for control of millions of dollars of assets? The short answer is to mix in a bit of fraud and deceit.

Try as he might, Logan could not completely avoid the spotlight as he sought his fortune. Logan and his shell companies were mentioned in various lawsuits and news reports, and not in a good way. Words like bankruptcy, slumlord, bogus financial documents, and defrauding cemetery trust funds were often mentioned in reports of his business ventures. It was once reported that Logan installed a family pet as president of one of his shell companies.

Fort Lauderdale, Florida, once primarily the winter playground of snowbirds and college students seeking the warmth of the sun and miles of sandy beaches, had evolved into an affluent oceanside community, attracting year-round residents who enjoyed the beautiful weather and low taxes. One of these people was John Davis. In many ways Davis was like any other chief executive officer (CEO) of a public company. Married and in his 50s, Davis certainly looked the part, with his deep tan and silver hair. No one would have guessed that he was not a college graduate and had risen from his start in the hardscrabble trucking industry to become the CEO of a series of public companies. His friends described Davis as a man who got to where he was by relying on instinct and common sense. Almost all of his employees liked his down-to-earth, agreeable nature. With his children grown and out of the house, Davis was ready to settle down in south Florida as CEO of his latest venture, Precision Payroll Services (Precision).

Bundled and Bungled

Precision could best be described as a payroll processing company on steroids. It was a public company with several offices in Florida and clients across the United States. Precision was a professional employer organization, known in the insurance industry as a PEO. Sometimes called employee leasing companies, PEOs combine the employees of separate companies into one large group or pool of employees. In what is described as a co-employee relationship, the PEO assumes responsibility for certain functions, including paying payroll taxes and obtaining workers' compensation insurance. Client companies retain management control over their employees and their daily operations. Client companies write a check to the PEO every week to cover payroll, taxes and benefits. These companies also pay administrative fees, which are where the PEO makes its money.

The theory behind a PEO is that by combining employees from smaller, mom-and-pop businesses into one large group, the PEO can negotiate better rates for certain benefits, including workers' compensation insurance. The reality is that workers' compensation insurance, required by law, is expensive and difficult to obtain. The ability to get it at a reasonable price is the driving force for PEOs to retain clients and charge them for other services — without it, the PEO would soon be out of business.

The reality of many PEOs is far different from the theory. What makes sense on paper sometimes is unwieldy in reality. Merriam-Webster's Dictionary defines unwieldy as “too big or badly organized to function efficiently.” Precision, like many PEOs during their heyday, was exactly that. Handling almost $1 billion in payroll a year at its peak, with hundreds of client companies employing thousands of workers, whose names changed each week as employees were hired and fired, Precision's management soon found that it could not accurately tell on a timely basis how many employees were on the books and how much they were paid. The growing problem Precision faced was that this type of uncertainty just doesn't mix well with the insurance industry.

Upper Darby Insurance (UDI) was a relative newcomer to the insurance industry, getting its start in Baltimore providing property and casualty insurance to GIs returning from World War II. From humble beginnings, UDI had grown to one of the largest insurance companies in North America, providing a full range of products including, of course, workers' compensation insurance. UDI, with a reputation for being fair and running a tight ship, seemed an unlikely match for Precision, which was quickly earning a reputation in the Wild West of the PEO industry as a company that was mostly interested in growing the business and less concerned with running it.

UDI's contract with Precision relied heavily on taking Precision's word about how many employees it had and the payroll amounts to be covered by UDI's workers' comp. Precision reported payroll and employee counts to UDI periodically, and UDI billed Precision based on these numbers. UDI audited the figures only once a year and then adjusted the premium due. When these audits consistently revealed Precision's payroll — and UDI's exposure — to be greater than was reported, UDI began to require more and more collateral, in the form of bank letters of credit (LOCs), to secure unpaid premiums. A bank letter of credit, if authentic, is the next best thing to cash; in the event that Precision defaulted on its premium payments, UDI could cash these LOCs and be made whole. Eventually, UDI held more than $40 million in LOCs from Precision.

As UDI required Precision to provide more and more collateral, Davis and Precision had a problem. Precision did not have the assets to secure bank LOCs in the amounts that UDI required; typically, these letters are secured by providing 100 percent in cash or other collateral to the issuing bank. While reporting gross revenues of almost $1 billion at its peak, Precision actually held little cash of its own — these gross revenues were made up almost wholly of the payroll turned over to Precision, most of which left Precision as soon as it came in, with the bulk of the remaining cash supposed to be put into escrow accounts to pay the Internal Revenue Service (IRS) and state taxing authorities when due. Without collateral, Precision would lose its workers' compensation insurance, and most if not all of its clients would leave, putting the company out of business. Enter Phillip Logan, promising the solution to Precision's collateral problems.

Unlikely Rescuer

Through a series of intermediaries, Logan offered to provide LOCs from well-known U.S. banks for less than five cents on the dollar, which Precision could afford. Precision paid a middleman, who paid Logan, who provided the LOCs submitted by Precision to UDI to secure unpaid premiums. No one, including Davis, asked too many questions about how Logan was able to provide $40 million in LOCs from banks insured by the Federal Deposit Insurance Corporation (FDIC) for less than $4 million. Logan explained to those who asked that he was securing the LOCs with other funds he had under management, and no one cared to look too deeply into the matter. Everyone was happy. Precision had its collateral at an affordable price and could remain in business. Logan had his millions of dollars and could finally be the high roller he always wanted to be. UDI, unaware that Logan was involved and unaware that Precision was paying only pennies on the dollar for the LOCs, verified that the banks providing the letters were FDIC insured and put them in its collateral vault, thinking it was fully secured.

Eventually, UDI came to the conclusion that providing workers' compensation insurance to PEOs was too risky and notified Precision, and its other PEO clients, that it would cease to provide this service. UDI was one of the few reputable insurance companies that provided workers' compensation to PEOs. John Davis could not find another insurance company to replace UDI and had to either think fast and find a solution or close shop.

I, of course, did not know any of this when I reviewed a new insurance fraud case that landed on my desk. There wasn't much to review. The case had been opened based on a complaint from a walk-in — which is exactly what it sounds like: someone walks into their local Federal Bureau of Investigation (FBI) office and tells an agent what is on their mind. According to the complaint, the walk-in said that until she had been recently fired, she had worked at Precision as a clerk. She explained that Precision was a PEO and from what she had observed and overheard while working there, she believed that Precision was issuing certificates of insurance to clients for workers' compensation insurance that did not exist. The complaint did not have much detail, and I made a mental note to go out and interview the person sometime in the next few weeks to see if she had any more information. I was working on several fraud investigations at the same time, and this vague complaint from a fired worker wasn't a high priority for me. I also had never heard of a PEO and knew almost nothing about the workers' compensation industry. This would soon change. At the time, I had been an FBI agent for more than 20 years, most of it spent investigating white-collar crime, and knew that a lucky break in a case never hurts. I was about to get one.

A few nights later, my cell phone rang about 8 p.m., and the caller ID showed that it was the office. The person working the night switchboard had just taken a call from Robert Tyler, a current Precision employee, who was upset at what was happening at work and wanted to talk to someone at the FBI about it. I called Tyler, and after a short conversation, he agreed to meet me and another agent at a local diner the following evening.

Crash Course in Insurance

It was early July, and the diner was almost empty. When my partner and I entered the diner, 15 minutes early, Tyler was already there and waved us over. He explained that he had just finished his workday and had already ordered dinner. After I introduced myself and my partner, I asked Tyler to tell me a little about his background. Tyler explained that he worked in the workers' compensation insurance department at Precision and was very familiar with that specialty, having held several jobs in the workers' compensation insurance over the last few years.

“I contacted the FBI because there are things going on at Precision that are just plain wrong.” Tyler explained further. “I can't just stand by and do nothing while Precision's employees do things that hurt innocent companies and workers.”

I told Tyler that we would stay as long as it took for him to tell his story, but I needed some background information about PEOs and how they worked in general, and asked him to explain. For about an hour, Tyler answered question after question about PEOs and workers' compensation insurance in general and Precision in particular. This was important; in order to understand what, if anything, Precision was doing wrong, I had to understand how things should be done if everything was being done the right way.

Tyler explained that workers' compensation insurance is regulated by individual states and that all states required most businesses, with few exceptions, to provide this coverage to protect their employees if they are hurt on the job. Insurance companies apply to various states to become “admitted carriers,” allowing them to write insurance in that state. In an important part of this process, state agents review assets held by each insurance company to be sure they are solvent and are in a financial position to pay claims. They also periodically review their admitted carriers' operations to make sure everything is in order.

“About a year ago, when UDI stopped writing workers' comp policies for Precision, Davis tried but couldn't find a replacement. All of a sudden, I started seeing workers' comp certificates of coverage being issued in the names of two insurance companies I never heard of: Torchwood Casualty and Benton Coastal Holdings. When I asked Davis about it, he told me not to worry, which made me nervous.” Tyler continued, “Now, workers' compensation claims aren't being paid on these supposed policies, and when clients complain about their coverage, they are switched back and forth between Torchwood and Benton. Injured workers aren't getting their replacement wages and medical bills paid, and no one at the top can give us any answers on how to handle those claims.”

I asked Tyler if he would be in a position to get copies of some of the Torchwood and Benton insurance certificates that Precision had issued as well as the names of a few of the client companies and injured workers whose claims weren't being paid, and he readily agreed. “Someone has to stop this before more people get hurt,” Tyler said, agreeing to meet me again in a few days with the paperwork. Tyler's information corroborated the original complaint of the walk-in, with one difference. Tyler still worked at Precision and was in a better position to provide evidence. He could also be tasked to get information that the walk-in could not. I decided to concentrate on Tyler for the moment.

The next day, I called UDI to see if I could corroborate what Tyler told me about UDI ending its business relationship with Precision and to get more information about how things worked when an admitted carrier wrote workers' compensation insurance for a PEO. After a few phone calls, I received a call back from UDI's head of security, John Saunders, who split my single investigation into two directions.

Tracking the Letters of Credit

Saunders explained that UDI had stopped its relationship with Precision and was owed millions of dollars for unpaid insurance premiums. When payment didn't come, UDI tried to draw down on some of the bank LOCs that Precision provided as collateral. Saunders continued, “When we submitted the LOCs to Fowler National Bank, they said they were fraudulent and wouldn't pay. We hired a private investigator to try to get to the bottom of it, and he thinks the fake LOCs were provided by a guy named Phillip Logan in California.” Saunders said UDI was probably going to sue Precision for the unpaid premiums and that UDI would cooperate fully with the FBI. Saunders agreed to overnight me copies of the fraudulent LOCs so I could start my own investigation.

Once I received the LOCs, I looked at them closely. They appeared to be written on bank letterhead, and provided a bank branch address in California and a phone number. They were signed by a bank officer named George Tenor. I did a quick Internet search and couldn't tie the address or phone number to any Fowler National branch. A quick call to bank security confirmed that no one named George Tenor worked at Fowler National, and the address and telephone number were not associated with any Fowler National branch.

Since I knew the key to finding out who was behind these fake LOCs was finding who was behind the address and telephone number on them, I prepared a summary of what I knew and sent a memo to our Los Angeles office. No matter where you go in the United States, there is an FBI office that covers that area. Sometimes parts of an investigation can be done over the telephone, but something like this needed to be done by an FBI agent in person. I sent my lead to the Los Angeles office, asking an agent to investigate the address and telephone number. I also passed along UDI's suspicion that Phillip Logan might be involved. The more information I could give the local agent, the better.

While waiting to hear back from L.A., I refocused my attention on Tyler's allegation. The following week, Tyler called to say he had some documents to show me, and we met again at the diner after he got off work. As I sat down, he handed me a folder of documents and said, “I think this will help.” The folder contained copies of insurance certificates issued by Precision to several client companies, showing that their employees were insured by Torchwood and Benton. Tyler told me that these were some of the companies whose injured workers' claims weren't being paid. Tyler explained that Precision kept all the files on the “problem claims” related to Torchwood and Benton in a specific area of their Fort Lauderdale office.

Now the real work could begin. Tyler's information was invaluable, but I could not rely on it by itself. What if Tyler had a grudge against the company's leadership and made up the paperwork? Just because someone says something, it doesn't mean it is true. I needed to thoroughly investigate his information to see what I could prove.

I contacted the Florida Department of Insurance (FDOI) and spoke to an agent who confirmed that insurance companies writing workers' compensation insurance in Florida had to be approved by the FDOI. The agent confirmed that Torchwood and Benton were not approved. Using the information on the insurance certificates Tyler provided, I contacted some of Precision's clients who were paying for workers' compensation insurance but had employees' claims go unpaid for extended periods of time. They sent me copies of their insurance certificates, which matched those that Tyler provided. I was able to tie one of the addresses on a Torchwood document to Precision's address, which made it appear to me that Torchwood might be related to Precision.

Torchwood appeared to be nothing more than a shell company. Other than the address, I could find no evidence of its existence or operations. Benton did appear to actually exist; however, it was the subject of several lawsuits. From these lawsuits, it looked like Benton was providing some sort of unapproved alternative to workers' compensation insurance. A quick check with the FDOI found that this was not permitted, and the client companies I contacted said they were told they had standard workers' compensation insurance, not an alternative.

This information, coupled with what Tyler told me about the location of records at the Precision office, gave me enough probable cause to try to get a search warrant. I could get records that would help me identify the extent of the fraud and more potential victims who could provide evidence. Additionally, a warrant would put Davis and other Precision executives on notice that they were under investigation and, I hoped, stop the fraudulent activity. If I notified anyone at Precision before getting the search warrant, evidence could be moved or destroyed.

It All Comes Together

In August, the agent in Los Angeles sent me the results of his investigation. A physical inspection of the address on the fraudulent LOCs showed it was a PO Box rented by Phillip Logan. The agent tried to interview Logan, but he refused to talk. Logan got an attorney, and, after some negotiating, Logan and his attorney agreed to meet with me and the prosecutor on the case.

In September, Logan flew to Miami and met with us, with his attorney present. Logan said that in the course of his balance sheet enhancement business, he learned that Precision needed some bank LOCs to use as collateral. Logan agreed to provide these for a 3 percent fee. Upon further questioning, Logan admitted to creating the fake LOCs and receiving more than $1 million from Precision in exchange. Logan said he started by getting a PO Box, which he rented in the name of Fowler National, and a disposable cell phone. He then found Fowler National letterhead on the Internet and printed it out. Using sample LOCs he already had, Logan created the text of the LOCs to meet Precision's specific needs. He made up the name of a bank officer and used the disposable cell phone and PO Box as the contact information, in case anyone tried to verify the LOCs. After printing a LOC on high-quality bond paper, Logan cut out the Fowler letterhead and glued it to the LOC. It was that simple.

I could now redirect my efforts to the workers' compensation insurance fraud. By December, I was able to establish probable cause and obtain a search warrant for Precision's offices. We obtained files that allowed us to fully identify all of the victim companies and injured workers who did not get the insurance they paid for. Several Precision employees approached me while I was executing the search warrant and agreed to cooperate with the FBI. Over the next year, they provided information regarding this and several other fraud schemes.

Eventually, as the evidence mounted and one subordinate after another pleaded guilty, John Davis decided to take responsibility for his actions. Davis told me that when Precision lost its workers' compensation insurance agreement with UDI, he tried to find replacement coverage but could not. Due to the size of Precision's payroll, no insurance company would take the risk. Eventually, after trying to find alternatives, Davis decided that Precision would self-insure the risk by charging clients for insurance, keeping the premiums and paying the claims. This explained why Benton and Precision shared an address at one point. His plan worked for a while, but as claims increased, Precision was unable to pay them. Davis also admitted that Precision did not turn over all of the payroll taxes it collected to the IRS as required and spent the money instead. Davis denied knowing that the LOCs were fraudulent.

John Davis pleaded guilty to conspiracy to commit wire fraud and to a charge of willfully failing to pay taxes. He was sentenced to 60 months in federal prison. Phillip Logan pleaded guilty in federal court to a charge of conspiracy to commit wire fraud for his role in providing the fake LOCs and was sentenced to 57 months in federal prison.

Including Davis and Logan, a total of six individuals pleaded guilty in federal court to their involvement in the fraud. All received prison sentences and were ordered to pay varying amounts of restitution. Total losses in this case to UDI, the IRS, and various Precision clients and their workers exceeded $100 million.

About the Author

Special Agent Michael Sputo, CFE, has investigated white-collar crime for the Federal Bureau of Investigation since 1987. He graduated magna cum laude from Boston College with a B.S. degree in accounting and worked as an auditor for Price Waterhouse prior to his employment with the FBI. SA Sputo has been a Certified Fraud Examiner since 2007.*