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JOHNSON v. NATIONWIDE GEN. INS. CO.

July 31, 1997

SHELLY A. JOHNSON and WAYNE D. JOHNSON, Plaintiffs,
v.
NATIONWIDE GENERAL INSURANCE COMPANY, NATIONWIDE FINANCIAL SERVICES, INC., NATIONWIDE LIFE INSURANCE COMPANY, and NATIONWIDE CREDIT UNION, Defendants.



The opinion of the court was delivered by: HURD

 I. INTRODUCTION

 The plaintiff, Shelly A. Johnson ("Mrs. Johnson" or "plaintiff") and her husband Wayne D. Johnson, brought this action in the New York State Supreme Court of Oneida County. The defendants, Nationwide General Insurance Company and its affiliates ("Nationwide"), removed it to this court on the basis of diversity pursuant to 28 U.S.C ยง 1332.

 Mrs. Johnson alleges that on or about December 30, 1991, Michael P. Donnelly ("Donnelly"), an apparent agent of the defendants, induced her to invest $ 70,000 in a Nationwide tax free mutual fund, and then misappropriated the money. Mrs. Johnson originally made three claims against the defendants, but in a motion for summary judgment, two of the claims were dismissed. Issues of fact remained for trial in the remaining cause of action against Nationwide for the alleged fraudulent conversion or misappropriation by an apparent agent. Johnson v. Nationwide Gen. Ins. Co., 937 F. Supp. 186 (N.D.N.Y. 1996). Familiarity with the prior decision is assumed.

 II. TRIAL

 A two day bench trial was conducted on January 22 and 23, 1997, in Utica, New York. The plaintiff testified on her own behalf. Donnelly, Mary Donnelly, *fn1" and the plaintiff's mother, Margaret Kelly ("Mrs. Kelly"), also testified in support of the plaintiff. Donald K. Groves ("Groves"), an Asset Protection Manager in Nationwide's Corporate Security Department; Dennis Aultman ("Aultman"), a Nationwide Human Resources Consultant for the New England States; and John T. Lana ("Lana"), a Nationwide Sales Manager who supervised Donnelly, all testified on behalf of the defendants. The defense also called the plaintiff's husband, Wayne D. Johnson, as a hostile witness. Most of the voluminous exhibits introduced by both sides were Nationwide records. At the close of the proof, the derivative claim of Wayne Johnson was discontinued.

 Post trial briefs and supplemental proposed findings of fact and conclusions of law were filed on March 24, 1997. Based upon all the evidence and the credibility of the witnesses, the court makes the following Findings of Fact and Conclusions of Law pursuant to Rule 52 of the Federal Rules of Civil Procedure.

 III. FINDINGS OF FACT

 A. Donnelly's Employment History

 Donnelly was a Roman Catholic priest from 1971 to 1976. In 1976, he left the priesthood and began working for Nationwide in Frankfort, New York as an employee agent. *fn2" At this time, Nationwide registered Donnelly with the Securities Exchange Commission as a Nationwide agent authorized to sell securities. He later became a registered representative of the National Association of Securities Dealers ("NASD") because of his employment with Nationwide. Donnelly worked as an employee agent selling Nationwide insurance and securities for three years until he transferred to Columbus, Ohio to train for a position as a sales manager. After completing the required training, he moved to the Buffalo, New York area to work as a sales manager. As a sales manager, he supervised Nationwide's employee agents and represented independent contract agents. In Buffalo, Donnelly married his wife, Mary Donnelly. In 1981, Donnelly returned to Columbus to work as a trainer for Nationwide. As a trainer, he taught new agents Nationwide procedures and sales techniques. Three and a half years later, Donnelly moved to Connecticut to work as a Nationwide financial planner. At that time, he was still part of Nationwide management.

 In 1988, Donnelly returned to sales and became an employee agent in Hartford, Connecticut. To start his business, Nationwide gave him the accounts of a recently retired agent and subsidized some of his expenses. At his Hartford office, Donnelly worked with another agent and sold all types of Nationwide products. Finally, in 1989, Donnelly became an independent contract agent. Donnelly was a very successful Nationwide agent. In fact, he was one of its best. Nationwide recognized Donnelly's success by giving him awards and publicizing his accomplishments in the press. Donnelly won Nationwide's Champion Award in 1988, 1989, and 1990, and also won Nationwide's top sales award, the President's Award, in 1989 and 1990. When Donnelly won the President's Award, Nationwide published his photograph in the New England edition of Time Magazine. Donnelly worked as an independent agent until June 21, 1991, when he was terminated for treasury policy violations and his business practices

 B. Donnelly's Fraud and Nationwide's Knowledge

 Although Nationwide terminated Donnelly for treasury policy violations and business practices, the evidence demonstrates that Nationwide had knowledge of his fraudulent activity.

 Donnelly began defrauding Nationwide customers at least as early as October 1990. The first known Nationwide customers that Donnelly defrauded were his mother-in-law, Mrs. Kelly, Ms. Grobsmith, *fn3" and Thomas Grobsmith. *fn4" Donnelly sold them Nationwide tax free mutual funds, and when the Gulf War began, he falsely informed them that their investments were no longer insured and were not collecting interest. He further recommended that they transfer the funds to his checking account so he could reinvest them in an annuity. Mrs. Kelly and the Grobsmiths agreed to the transfer. However, instead of transferring their investments into an annuity, Donnelly misappropriated the funds. This transfer violated NASD rules and the misappropriation was fraudulent.

 An employee at the Nationwide home office spotted these transactions and alerted their investigative department to Donnelly's improper commingling of his clients' and his personal funds. Nationwide investigated and discovered that several documents contained forged signatures. The investigators also determined that Donnelly had not reinvested the money. Several Nationwide managers held a meeting and concluded that "we needed to have Donnelly produce a written account of these transactions and have him sign a document that would allow us to examine his CuChex *fn5" account to see where the money went." (Pl.'s Ex. 13.) However, Nationwide failed to follow through with the investigation and never determined for certain whether Donnelly had embezzled the money.

 Shortly after he defrauded his wife's relatives, Donnelly began over drafting checks and submitting his clients' payments late. He over drafted sixteen checks over a six month period. Nationwide recognized that Donnelly was acting improperly and repeatedly investigated and made attempts to remedy the situation. Nationwide asked Donnelly to explain his transactions, forced him to change his accounting procedures, and placed him on a cash only basis. Donnelly claimed that his bank had made mistakes or that the clients had over drafted the checks; however, Nationwide knew that he was lying. Finally, on June 21, 1990, Nationwide officially terminated Donnelly for these practices.

 Although Nationwide did not have conclusive evidence that Donnelly was defrauding its clients when it made the initial decision to terminate him, Nationwide received this proof before the termination process was concluded. Nationwide received direct evidence of Donnelly's fraud on July 10,1991. One of Donnelly's clients, Mr. Fiondella ("Fiondella"), contacted Nationwide and informed them that he had purchased an apartment insurance policy and that Donnelly never submitted it to the company. On July 31, 1991, Nationwide learned that another client, Mr. Desso ("Desso"), had purchased a $ 2,000 mutual fund from Donnelly, and that Donnelly kept the money for himself. In fact, Nationwide discovered that Donnelly had endorsed Desso's check to pay his American Express bill. Finally, a third client, Ms. Demonte ("Demonte"), purchased a car insurance policy and Donnelly kept the money. Nationwide discovered this fraud on August 27, 1991. Donnelly was eventually forced to repay Fiondella, Desso, and Demonte with funds from his deferred compensation accounts. Nationwide had knowledge of the Fiondella and Desso transactions before Donnelly was evicted from his office, and an attempt was made to confiscate his supplies before Nationwide informed the Connecticut State Insurance Department ("Insurance Department") of his termination; and more than six months before his fraudulent dealings with the plaintiff.

 There is further conclusive evidence that Nationwide had knowledge of Donnelly's fraudulent activity. When Nationwide notified the Insurance Department about Donnelly's termination through a Uniform Termination Notice for Securities Registration form dated August 8, 1991, it wrote that Donnelly was being terminated for "diverting an investor's check for his own personal use." (Pl.'s Ex. 57-1 Item No. 12.) On this form, Nationwide checked a box stating that Donnelly "currently, is or at termination was, . . . under internal review for fraud of wrongful taking of property or violating investment-related statutes, regulations, rules, or industry standards of conduct?" Id. at Item 15. In the same document, Nationwide checked a box stating that Donnelly was "the subject of an investment related, consumer-initiated complaint that: (1) alleged compensatory damages of $ 10,000 or more, fraud, or the wrongful taking of property?" Id. at Item 13. (emphasis added). Thus, while the official reason Nationwide terminated Donnelly was his business improprieties, an additional reason was his fraudulent activities and the danger he posed to Nationwide's customers.

 C. Nationwide's Response

 Nationwide terminated Donnelly as an actual agent by letter of Robert V. Meier, Regional Sales Manager, dated June 21, 1991, effective September 20, 1991. It terminated Donnelly's actual authority to bind business on behalf of the defendant by memo of John T. Lana, dated June 28, 1991. Upon learning of this termination, Donnelly requested a hearing with a review board to reconsider his termination. The hearing was held on July 12, 1991, and the review board denied his appeal. Although the review board's decision was final, Donnelly remained a licensed agent for several months since Connecticut law prohibits an agent from being terminated without ninety (90) days notice. Therefore, Donnelly's license as a Nationwide agent was not revoked until September 20, 1991. After the review board's determination, Nationwide informed Donnelly by telephone and by written statement on July 21, 1991. On the phone and in the letter, Nationwide reminded Donnelly of the termination clauses in his contract that stated that he must vacate his office, return all Nationwide supplies, adhere to a non-compete clause, and could not contact any of his former clients. Donnelly did not voluntarily comply with these requests. Instead, he continued to sell Nationwide products and did not return all of Nationwide's supplies. Finally, Donnelly did not vacate his office until two supervisors appeared approximately one month later to remove him on or about August 15, 1991. Nationwide was unable to produce any records of this visit as to the date, inventory, or persons present.

 When Nationwide terminated Donnelly, they took no action to inform his customers or the general public. There is no credible evidence in the record that Nationwide notified Donnelly's clients. Nationwide was unable to produce any documents or records to prove that they sent out such a notice. Nationwide did introduce a form letter which they claim should have been sent to Donnelly's customers, but this form letter was written in 1995 and obviously could not have been sent to Donnelly's customers in 1991. Lana, Donnelly's supervisor, testified that he received calls from Donnelly's clients who were concerned about the termination. However, Lana's testimony was not admitted to show that Nationwide had given notice, but rather to show that it had received calls. It is unknown when or how the former clients may have learned about Donnelly's termination. It may very well have been from the rumor mill. Furthermore, Donnelly had well over one thousand clients and Nationwide failed to produce a single one who could testify that they had received written notice of Donnelly's termination. In fact, the only direct evidence regarding whether or not Nationwide informed its customers came from Mrs. Kelly, who owned a Nationwide Life Insurance Policy and was a client of her son in-law. Mrs. Kelly testified that she never received notice of Donnelly's termination. Finally, Nationwide admitted that they never gave any type of public notice about Donnelly's termination. Nationwide claims that it was not necessary to give notice because they did not know about Donnelly's fraudulent practice upon Nationwide clients.

 After Donnelly was terminated, he was investigated by the Connecticut State Insurance Department. The Insurance Department temporarily suspended his license for ninety (90) days, but Donnelly was allowed to continue working in Connecticut after the suspension and he started with Pawson, another agency, and sold insurance for ITT Hartford. While selling for ITT, Donnelly defrauded its customers out of approximately $ 250,000. After working for ITT for several months, Donnelly transferred to another agency where he continued to defraud customers. In the fall of 1992, Donnelly confessed that he had defrauded his clients, and was criminally prosecuted. He pled guilty to grand larceny and spent several years in prison.

 D. The Present Action

 The case at bar arises from a transaction that occurred after Donnelly was terminated by Nationwide. His sister-in-law, the plaintiff, received a large cash settlement from a personal injury lawsuit. Donnelly knew about this settlement, and during Thanksgiving 1991, he suggested to her that she invest it in a Nationwide tax free mutual fund similar to the one that her mother, Mrs. Kelly had owned. Donnelly then showed her a Nationwide prospectus for the fund. Mrs. Johnson asked Donnelly if he was still able to sell Nationwide products and Donnelly responded that he was no longer working exclusively for Nationwide and could not sell their insurance, but he was still authorized to sell Nationwide tax free mutual funds. Mrs. Johnson accepted this explanation. She asked her mother if she was satisfied with her investment and Mrs. Kelly recommended that her daughter invest in the fund. On December 30, 1991, Mrs. Johnson invested $ 70,000 with Donnelly for a Nationwide tax free mutual fund. In response, Donnelly sent her an altered statement signifying that she had purchased the fund and sent her periodic statements. These statements were on Nationwide forms that Donnelly had retained. Donnelly then misappropriated the money for his own personal use. However, before ...


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