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Friday, November 9, 2012

America! Meet Your Puppet Master

How Eddie Bernays got you to buy books, wear hairnets, and eat bacon for breakfast.

One could argue that the birth of modern public relations is really the story of bacon and eggs. Prior to the 1920s, breakfast was toast and a cup of coffee. When a company called Beech-Nut Packing wanted to boost its bacon sales, they called PR man Edwards Bernays.

Bernays didn't place ads in magazines or post billboards with catchy slogans. Instead, he commissioned a research study on the eating habits of Americans. A doctor concluded that, because the body loses energy during the night, a robust breakfast is healthier than a light one. Bernays saw to it that thousands of physicians got the report, along with a publicity packet touting bacon and eggs as a hearty way to start the day. Pretty soon, doctors were recommending it to their patients, and the all-American breakfast was born.

bSyphilis and Propaganda

Edwards Bernays was born in Vienna to Jewish parents and immigrated to the United States with his family when he was an infant. The elder Bernays had been a wealthy farmer, and he hoped his son would follow in his footsteps. So, he enrolled young Eddie in Cornell's esteemed College of Agriculture. Eddie complied, albeit unwillingly. A child of the Manhattan brownstone, he'd grown accustomed to the bustling pace of the big city. Upon receiving his degree in 1912, the only thing Eddie seemed certain of was that farm life was not for him. And that's when fate intervened.

One day while boarding the Ninth Avenue trolley on Manhattan, Eddie crossed paths with an old friend named Fred Robinson. Robinson offered Bernays a job managing two monthly journals, the Medical Review of Reviews and the Dietetic and Hygienic Gazette. Eddie accepted, although he knew little about publishing or medicine. Fortunately, none of that mattered a few months later, when he used the journals to publish a review of the play Damaged Goods. That may not sound like a big deal, but Damaged Goods was about a man who had syphilis. Sex was such a taboo subject at the time that New York censors had previously shut down George Bernard Shaw's Mrs. Warren's Profession because it dealt with prostitution. Regardless, Eddie published a rave review and even offered to help produce the show. But the real trick was convincing censors to look the other way.

Employing a technique that would later become one of his trademarks, Eddie created a "third party authority" called the Sociological Fund Committee. It was a fake organization tailor-made to legitimize the play as a crusade against the prevailing attitude of "sex-pruriency." After lobbying prominent society figures, Eddie had supporters like John D. Rockefeller and Franklin Roosevelt on his side. Although critics lampooned the play, Bernays made syphilis a cause célèbre, and turned the production into a huge financial success.

Id, Ego, and Super-Uncle

The future looked bright for Bernays the Producer, but then fate stepped in again with the outbreak of World War I. Eddie tried to enlist, but was turned away due to flat feet and poor vision. Undeterred, he set his sights on the Committee on Public Information -the propaganda machine responsible for Uncle Sam's "I Want You" recruitment poster. There, as co-head of  the Latin American section, Bernays honed his manipulative propaganda skills.

Although the agency's propaganda helped America win the war, its methods were sharply criticized by members of Congress, who suspected the CPI of censoring the media. The organization was dismantled, the profession of public relations came under heavy scrutiny, and Bernays was left severely disillusioned.

Salvation came in the form of Sigmund Freud, Bernays' famous uncle. In 1919, Eddie translated a series of Freud's lectured into English, and the work brought the psychiatrist widespread attention in America. Despite being derided by some critics as a "professional nephew," Eddie largely benefitted from having a famous uncle. Freud's theories on human behavior ignited a new fire in Bernays. He realized that if propaganda could be used to manipulate Americans during times of war, it could also be used in times of peace to influence trends, habits, and -most importantly- consumer spending.

Bookshelves, Hairnets, and Children Who Love to Wash Their Hands

Buoyed by Freud's success, Bernays embarked upon a series of campaigns that secured him as the master of marketing. When a group of major book publishers asked him to bolster sales, he proclaimed, "Where there are bookshelves, there will be books." Bernays then convinced architects, construction companies, and interior designers to install bookshelves in new homes. The scheme paid off, and the book business skyrocketed.

nIn another campaign, Bernays helped a company named Venida salvage lagging hairnet sales. Short hairstyles were in, thanks to dancehall icon Irene Castle. And without long locks, women had no need for hairnets. Bernays created a new market, repurposing the beauty accessory as safety gear. He asked experts to issue reports explaining the hazards of hair falling into food or getting caught in machinery. Soon, Venida hairnets became essential for all restaurant and factory workers.

His genius didn't stop there, either. When client Proctor & Gamble approached Bernays in the 1920s to help make its soap more appealing to children, Eddie promised that "Children, the enemies of soap, would be conditioned to enjoy using Ivory." And just like Pavlov and his dogs, Eddie trained America's youth to associate soap with fun. He created the National Soap Sculpture Contest, complete with heavily publicized cash prizes. A sweeping success, it became an annual tradition that kept children whittling away at Ivory for the next 38 years.

Torches of Freedom

Not all of Bernays' campaigns were so wholesome. One of his most well-known, if not controversial, projects was for Lucky Strike cigarettes. In the late 1920s, American Tobacco Company chairman George Washington Hill charged Bernays' PR firm with acquiring a new market for its cigarettes -women. In Eddie's words, "Hill become obsessed with the prospect of winning over the largest potential female market for Luckies. 'If I can crack that market.' he said to me one day, "it will be like opening a new goldmine right in our front yard.'"

For the campaign, Bernays enlisted the help of his wife, fellow marketing genius Doris Fleischman. First, they worked to brand cigarettes as an alternative to candy. When that didn't work, they tried to convince women that green -the official color of Luckies- was the new black. With assistance from editors at Vogue and Harper's Bazaar, green began to dominate the fashion world. The duo even orchestrated a "Green Ball" in New York, featuring some of the city's most prominent socialites. Although Lucky Strikes' sales climbed, it wasn't enough. Bernays and Fleischman realized that true success would require overcoming a major taboo. In society's eyes, women still weren't allowed to smoke in public. Armed with the knowledge that many women smoked in private, they staged an event that captivated the nation.

On Easter Sunday in 1929, a group of ten women strolled down Fifth Avenue in full view of church-going families (as well as conveniently-placed photographers) flaunting lit cigarettes, which they called their "Torches of Freedom." The news story caught fire, and controversy raged between women's groups on both sides of the issue. Around the nation, copycat "Torches of Freedom" sparked up, and millions of dollars poured into the coffers of American Tobacco.

Smoke and Mirrors

Unfortunately, the tobacco campaign backfired on Bernays. His wife Doris joined the legions of female smokers and became a lifelong tobacco user, despite protests from Eddie and their children.

Overcome with guilt, Bernays launched a radical plan in 1964 to eradicate smoking from society. Wielding medical research on the harmful effects of tobacco, he campaigned to convince America that smoking was an "antisocial action which no self-respecting person carries on in the presence of others." His efforts led to a ban on cigarette advertising from radio and television, which dealt a major blow to companies he once served.

Eddie felt guilty about other things, too. In the early 1950s, the United Fruit Company enlisted his help in Guatemala. The company was trying to hold onto the land leased to them by the government -land that national officials wanted to reclaim for the Guatemalan people. Bernays responded by waging a propaganda war that made president Jacobo Arbenz out to be a Communist. The claim was categorically untrue, but McCarthy-era politicos seized the rhetoric and rallied for war against the tiny nation. Bernays enlisted the CIA's help and orchestrated an elaborate liberation campaign to replace the democratically-elected president with a United Fruit Company puppet. The resulting Banana Republic lasted for decades.

Bernays must have felt his greatest moment of self-doubt in 1933 when foreign correspondent Karl von Weigand contacted him upon his return from Nazi Germany. During an interview with Joseph Goebbels, Hitler's devoted friend and minister of propaganda, von Weigand had noticed a familiar book sitting prominently on Goebbels' desk; it was Bernays' seminal work Crystallizing Public Opinion. Ironically, Eddie was Jewish.

The Sultan of Spin

Bernays formally retired in the early 1960s, but he kept working as a consultant until he was 100 years old. In 1990, he was voted to LIFE magazine's list of the 100 Most Influential People of the 20th Century. Bernays died on March 9, 1995 in Cambridge, Mass. at the age of 103.

Through his long and storied career, it's estimated that Bernays had 435 clients, not to mention countless disciples. His exhaustive list of clients included General Motors, the NAACP, the Multiple Sclerosis Society, and CBS, as well as famed individuals like playwright Eugene O'Neill, painter Georgia O'Keefe, and presidents Calvin Coolidge and Herbert Hoover.

Despite his controversial campaigns, Bernays always demanded that PR professional adhere to a strict moral code. He believed the field should be licensed, like that of lawyers or doctors, so that only qualified professionals could practice. After all, he -more than anyone- understood that with the power of public persuasion came great responsibilities.

Wednesday, November 7, 2012

Joseph Caramadre Is A Robin Hood Or Con Artist Depending On Who You Ask

By Jake Bernstein

Joseph Caramadre has spent a lifetime scouring the fine print. He's hardwired to seek the angle, an overlooked clause in a contract that allows him to transform a company's carelessness into a personal windfall. He calls these insights his "creations," and he numbers them. There have been about 19 in his lifetime, he says. For example, there was number four, which involved an office superstore coupon he parlayed into enough nearly free office furniture to fill a three-car garage. Number three consisted of a sure-fire but short-lived system for winning money at the local dog track. But the one that landed him on the evening news as a suspect in a criminal conspiracy was number 18, which promised investors a unique arrangement: You can keep your winnings and have someone else cover your losses.
Caramadre portrays himself as a modern-day Robin Hood. He's an Italian kid from Providence, R.I., who grew up modestly, became a certified public accountant and then put himself through night school to get a law degree. He has given millions to charities and the Catholic Church. As he tells his life story, his native ability helps him outsmart a phalanx of high-priced lawyers, actuaries and corporate suits. Number 18 came to fruition, he says, when a sizeable segment of the life insurance industry ignored centuries of experience and commonsense in a heated competition for market share.
Federal prosecutors in Rhode Island and insurance companies paint a very different picture of Caramadre: They say he's an unscrupulous con artist who engaged in identity theft, conspiracy and two different kinds of fraud. Prosecutors contend he deceived the terminally ill to make millions for himself and his clients. For them, Caramadre's can't-miss investment strategy was an illusion in which he preyed on the sick and vulnerable.
ProPublica has taken a close look at the Caramadre case because it offers a window into a larger issue: The transformation of the life insurance industry away from its traditional business of insuring lives to peddling complex financial products. This shift has not been a smooth one. Particularly during the lead up to the financial crisis, companies wrote billions worth of contracts that now imperil their financial health.
In a series of detailed interviews, Caramadre said the companies designed the rules; all he did was exploit them. Their hunger for profits in a period of dizzying growth and competition, he contends, left them vulnerable to someone with his unusual acumen. The companies have argued in court that Caramadre is a fraud artist who should return every last dime he made. In his rulings to date, the federal judge hearing the civil cases has agreed with Caramadre's contention that he was doing what the fine print allowed.
The secret to Caramadre's scheme can be glimpsed in a 2006 brochure for the ING GoldenSelect Variable Annuity. On the cover is a photo of a youthful older couple. The woman sits next to a computer, sporting a stylish haircut and wire-framed glasses. A man with graying hair and an open collared shirt, presumably her husband, is draped over her in a casual loving way. Images of happy vibrant seniors enjoying their golden years together — frolicking on the beach, laughing in chinos next to a gleaming classic car, enjoying the company of grandkids — populate the sales material for life insurance's hottest product — the variable annuity.
As outlined in the brochure and in countless others like it, the contracts worked this way: The smiling couple gives money to ING in return for the promise of future payments. The consumer chooses how the money is invested, usually in mutual-like funds that have stocks, bonds or money market instruments. This is the "variable" part of the equation.
There are two main benefits to this arrangement not found in the ordinary mutual funds sold by brokers and financial advisers. Taxes on variable annuities are deferred until the consumer takes out cash, which means it's possible to move your money among funds without paying taxes until the money is withdrawn. (An investor who cashes in shares of a mutual fund must pay taxes on any gains.)
Variable annuities also typically include a life insurance component called a guaranteed death benefit. With this guarantee, if the market crashes — but you die before your investment recovers — your beneficiary still gets a lump sum equal to either the death benefit or the value of the investments in your account, whichever is greater.
The target audience for brochures like that of ING's are people nearing retirement with a nest egg to safeguard and perhaps grow a bit. It's a huge and growing market. In 2011, as the first wave of baby boomers began to retire, there were more than 40 million people age 65 or over. Between 2001 and 2010, life insurance companies sold about $1.4 trillion worth of variable annuities, according to LIMRA, an industry association.
Caramadre got the seeds of his idea in the mid-90s when he attended an investment seminar for insurance agents. He quickly saw how variable annuities could be a hot product for insurance companies — particularly when they could charge hefty fees for attractive goodies like the guaranteed death benefit.
Caramadre decided that he wouldn't offer variable annuities to clients in the way the insurance companies envisioned. It was too expensive. "They are just whacking you for fees," he says.
What Caramadre wanted was a way to get his clients the benefits without their having to die.
* * *
Society has long frowned on certain behaviors. Taking out an insurance policy on a friend or neighbor and killing them? Not acceptable. Taking out a life insurance policy that gambles your neighbor will die soon, even without your help, also crosses the line. Today, it is well-established law that one must have what is called an "insurable interest" before purchasing an insurance policy on someone else's life. The person who benefits from the policy must be a relative or business associate who himself would face financial or familial loss from the death.
Insurable interest worked fine for 200 years or so until the life insurance business itself changed. Despite its name, the industry doesn't sell as much "life insurance" anymore. Life companies now peddle financial services, particularly annuities. Variable annuities were developed in the 1950s, initially as a way to give teachers retirement options. Insurable interest was not an issue and could have been an impediment to widespread adoption of the product.
Caramadre did his research and concluded that Rhode Island law did not require that people buying variable annuities have an insurable interest.
As imagined by the insurance companies, variable annuities have two participants. There's the investor, the person who puts up the money. That person typically also serves as the annuitant, or the "measuring life." If that person dies, the death benefit is paid to the beneficiary, usually a spouse or child.
Caramadre realized it didn't have to be that way. There was no requirement that the investor and the annuitant be the same person. In fact, as he read the contracts, the annuitant didn't need to have a relationship with the investor at all. Caramadre or one of his clients could buy an annuity on the life of someone who was not expected to live long and then pocket any profit when that person died.
"All we need to do is replace the necessity of the investor having to die, with someone else, dying," says Caramadre.
If they chose well, the account went up and they reaped the benefits. If they chose poorly, the death benefit kicked in and they recouped their original investment.
"If you won, you keep the winnings. If you lose, they give you your money back," says Caramadre.
There is something morally unsettling about this. Put simply: Caramadre was setting himself and his clients up to profit from the demise of strangers. While the macabre aspect of his scheme offends many, it did not make Caramadre squeamish. He rationalized that a lot of people — funeral homes, hospitals and cemeteries — make money from the dead and dying, why not him?
Caramadre's insight might have remained a curiosity were it not for something called "the arms race." As competition intensified in the mid-2000s, many life insurance companies launched an unprecedented war for customers, offering benefits they now acknowledge were far, far too favorable.
The insurance companies' contracts provided little defense against Caramadre's approach. For policies under a million dollars, they didn't check the health status of people receiving variable annuities. Instead, they limited the ages of annuitants or the amount that could be invested. All that the companies required for persons to serve as a measuring life was their signature, birthdate and Social Security number. Some didn't even require the signature.
There was usually only a single line that touched on insurable interest in the contract. Companies would ask if a relationship existed between the investor and the annuitant. Caramadre and the men with whom he worked would either leave the answer blank or type in "none." The companies, eager for business, took the policy anyway.
There have been at least eight lawsuits filed in Rhode Island's federal district court relating to Caramadre's scheme. Insurance companies Nationwide, Transamerica and Western Reserve have all sued. The companies have not fared well in civil court. United States District Court Judge William Smith keeps knocking out claims. The companies then re-file new ones. As of this writing, Western Reserve has filed five successive complaints against Caramadre in the same case. When he dismissed Nationwide's complaint, Judge Smith questioned whether the company ignored its own contracts. In the Western Reserve case, Judge Smith wrote, "It is a bit ironic for Plaintiffs [the insurance companies] to suggest that they did not know the true nature of contracts that they themselves drafted."
The lawyer who represents both Transamerica and Western Reserve declined to comment.
The more serious charges are the criminal ones. Caramadre usually paid dying people between $3,000 and $10,000 for agreeing to serve as annuitants. He characterizes the arrangement as a win-win for everybody but the insurance companies. Prosecutors charge that he instructed participants in the scheme to lie, to steal identity information and to forge the signatures of annuitants in an effort to defraud insurance and bond companies.
The story as told by prosecutors goes like this: In an effort to get rich, Caramadre and his associates enticed the dying to give up their vital information by offering them $2,000 as a charitable donation. More than 150 people received the $2,000. Of those, at least 44 went on to play a role in number 18.
The government alleges that Caramadre directed his associates to lie to both the annuitants and the insurance companies. Sometimes, prosecutors assert, the dying people had no idea someone else stood to profit. In other instances, the indictment says, dying people were told that their signatures were just for the receipt of the charitable donation. A Caramadre employee allegedly told other family members they would be the beneficiaries. In five cases, the government says, signatures were forged.
Caramadre denies the accusations. He says that he instructed his employees to properly explain the program to the annuitants and that he would never permit forgeries.
Youthful looking with a round expressive face etched with deep lines across his brow, Caramadre appears more like an eager-to-please bulldog than a criminal mastermind. During the arms race, he says, companies did not complain when Caramadre paid their hefty fees and later filed claims seeking death benefits. Family members didn't object either. Everything changed in 2009 with the financial crisis. Companies started to feel the consequences of the arms race, the insurance companies sued and the FBI began visiting relatives and surviving annuitants. Today, some of those family members are the strongest witnesses for the prosecution.
"I lose my mom, who is my best friend, my world, and in me, losing my mother forever at the age of 64, you, in turn, profit and get X amount of dollars," says Stephanie Porter, whose mother received $2,000 from Caramadre before she died of cancer. "It's slimy what the man did."
* * *
Caramadre learned to hustle early. He graduated from the University of Rhode Island in three years with an accounting and finance degree, supporting himself through odd jobs that included running his church's weekly bingo game. After graduation, he took a job at a bank preparing documents for trusts. A friend convinced him that his fastest track to becoming a millionaire would be to sell life insurance, so he took a job as an agent with the Penn Mutual Life Insurance Company.
Caramadre had landed in an industry on the cusp of a historic transformation.
Life insurance used to be safe and profitable. Many insurance companies had begun in the 1800s as mutual aid societies. They were ostensibly owned by their customers who sometimes even received dividends. The idea behind the business was simple: Collect premiums from lots of people at a price high enough to account for mortality, which can be quite accurately predicted. The companies invested their pools of money. When they wandered into trouble, it almost always involved poor investment choices rather than unforeseen behavior by policyholders. By 1985, annual compensation for a top company CEO could be in the high six figures. While this was not a Wall Street salary, the business had the benefit of comfortably predictable profits.
Insurance agents worked for specific companies and offered products only from that firm. The agent was a man of the community, hawking a service that few young and healthy people want to contemplate. The old adage in life insurance is that "it's sold, not bought." Agents sold a relationship and a vision for the future, encouraging clients to protect their family from a tragic event and, possibly, give their heirs a leg up.
By the 1990s, the business was changing.
Under pressure from banks offering new retirement products including annuities, insurance companies decided to shed the cost of keeping large numbers of agents on their payroll. Rather than train, staff and equip insurance agents, the industry moved increasingly to a freelance model. "Independent" insurance agents paid for their own offices and expenses solely through commissions earned on the policies they sold. Insurance companies like Prudential, which once had as many as 18,000 agents, whittled their in-house force down to about 2,500.
The rise of independent agents was accompanied by the widespread transformation of mutual companies. Between 1985 and 2003, more than 20 mutual life insurance firms converted themselves into stock companies, most of which were traded on Wall Street. This process heightened the focus on quarterly earnings and eventually helped lead to an increase in executives' pay. Rising stock prices meant bigger bonuses.
The change in culture and incentives in the life insurance business created the perfect conditions for the arms race. It also made the business a prime target for Caramadre.
It wasn't until the 1990s that the growth of variable annuities took off. Between 1990 and 1999, the amount of variable annuities individuals purchased in the U.S. leapt from $3.5 billion to nearly $63 billion in 1999, according to the American Council of Life Insurers.
For the companies, it was easier to sell a product customers could use while still alive. Unlike life insurance, annuities did not require an expensive health examination. Life insurance was based on premium payments that remained steady. But the yearly fees charged on annuities, which sometimes topped 4 percent of the value of the account, would rise in line with those values. More money under management meant more fees, which buoyed the companies' stock prices and their executives' compensation.
Annuities were not a terrible idea. They fit a growing gap in the nation's pension system. The defined benefit plan, a retirement approach where the employer guaranteed a pension based on salary and years of service, was disappearing. From 1980 through 2008, the proportion of private sector American workers covered by company pensions fell from 38 percent to 20 percent, according to the Bureau of Labor Statistics. Meanwhile, a demographic bubble of baby boomers needed other retirement options. Annuities seemed to be tailor-made.
At Penn Mutual, Caramadre broke sales records, becoming at age 24 one of the youngest Golden Eagles — a recognition the company bestowed on top sales performers. Caramadre left Penn Mutual two years before the company ended its captive agent system. As an independent agent he could find better deals for his customers on the open market. He became a student of insurance products, deconstructing the product software provided by the companies, delving deep into the contracts. It became almost like scouting a ball player, he says.
* * *
Caramadre says annuities provided only about five percent of the profits he made from his business. He says he took out policies for himself, family members and clients. When he offered his "creation" to investors, Caramadre would either share the commission on the policy with brokers who worked in his office or, in a few cases, he would take a percentage of the gain on the account, he says. He says his lawyers have advised him not to reveal how much he made but it was likely in the millions. Prosecutors allege that he and his accomplices fraudulently obtained $15 million from insurance companies.
Caramadre anticipated that eventually companies would close the loopholes and shut him down. But what began in 1995 with AIDs patients grew over time to an effort that advertised weekly in a Catholic newspaper aimed at hospice patients.
By 2006, Caramadre had several people combing through the fine print of variable annuity prospectuses. He claims they looked at 680 of them that year. Most he could eliminate quickly. The companies were too small or had sub-par ratings. If they lost millions, they might go out of business which would be bad for both Caramadre and the company.
Caramadre found that the companies with the best benefits were the ones who were most eager to expand their market share. ING Group, for example, was a favorite selection. The Netherlands-based company went on an acquisition spree in the 1990s in an effort to become a dominant player in the U.S. annuities business. ING spent most of the arms race fighting to stay in the top 10 life insurance companies in variable annuity sales. In 2004, ING had new annual variable annuity sales of $7.7 billion. Four years later, that number had increased to $12.3 billion, according to Morningstar.
"When a company is pushing hard to sell bells and whistles on a product — they are desperate to get money through the door — either because they are in an expansionary phase or they want more assets under management in order to sell themselves to a bigger company," Caramadre says.
ING offered a bevy of benefits. It started with a "bonus credit." This became common by late 2006. In the case of ING's Golden Select Premium Plus variable annuity, the company promised to add 5 percent of the value of the contract. If you deposited a million dollars, the insurance company would add $50,000 on top of it.
Why would ING give away free money?
It never expected to pay the majority of the benefits it offered.
The 5 percent was added to the death benefit, which was held in a separate account known as a shadow account. The insurance company only paid the shadow account if the policyholder died and the money — the million dollars — in the real account had shrunk to a lesser value.
The companies' models of customer behavior, which were based on data collected before the 2008 financial collapse, predicted that the death benefit would rarely be paid. Something would happen. Policymakers would take the money out for a big purchase, surrendering their account. If the policyholder annuitized — started taking a stream of monthly payments — the shadow account disappeared. In any event, the rising market made it likely that the account would outperform the promises.
But the models turned out to be the insurance industry equivalent of the housing bubble. When the market crashed, consumers began acting differently than they had in the past.
Perhaps the gaudiest of the benefits the companies never expected to pay was known as the "rachet." The idea was perfect for a steadily rising market. Say you had $1 million in your account in 2007 and your investment did well, boosting the value to $1.2 million. That amount would be set on a given date as your death benefit which you would be paid no matter what had happened to your investment.
If stocks cratered, as they did in 2008, and your account fell to, say, $600,000? The insurance company would still owe you $1.2 million when you died.
ING offered a quarterly ratchet — it set every four months — and charged only about a quarter of a percent annual fee to customers who wanted it. Many companies, including Nationwide Life and Annuity Insurance Company and Transamerica Life Insurance Company, offered monthly ratchets.
To differentiate themselves, companies also sold exotic investment options into which the buyers of the annuity could invest their funds. ING featured funds managed by reputable companies like Pimco, Fidelity and T. Rowe Price. Each fund carried a fee that ING split with the fund manager. While ING provided aggressive growth and real estate funds, many annuity companies went beyond that to give consumers a choice of funds that used derivatives to bet for or against the market, sometimes with multipliers, so-called double betas. For example, if the stock market plunged, investors could double their money.
"Double betas were crazy funds," says Caramadre. "It hyper inflates the problem."
Caramadre's first step was to make sure his clients qualified for every incentive. If there was a monthly ratchet and bonus, he might invest the funds in a money market account until the ratchet set with the bonus.
It was as if Caramadre was playing with the house's money and going straight to the blackjack tables. With decent gains locked in, he would take flyers on the riskiest investments possible. Sometimes, he would invest his clients' money in two variable annuities, one that paid out if the market went up and the other if it declined. It didn't matter. When the annuitant died, Caramadre's client, at the very least, would get both principals back plus the gains from whichever fund paid out.
Caramadre kept increasing the number of annuitants and placing big bets.
"It was pretty fun being in the market without the risk," he says.
* * *
The fun ended in 2009 when the insurance companies began to investigate. In March, Nationwide formally complained to the Rhode Island insurance supervisor who didn't take any action.
Nationwide had calculated the fees it charged and the guarantees it offered based on the assumption that the policyholder would keep the product for a certain period of time, it told Rhode Island officials. Caramadre's treatment of the annuity as a short-term investment caused "a negative economic impact on annuity issuers such as Nationwide," the company wrote in its complaint.
Nationwide's main allegation involved a lack of insurable interest, the relationship between the investor and the annuitant. "It is Nationwide's position that the insurable interest statute applies to annuity contracts," the company wrote.
Attorneys for the two insurance brokers who worked with Caramadre, Edward Hanrahan and Edward Maggiacomo Jr., filed detailed responses to the Nationwide complaint with the Rhode Island state insurance regulator.
The company, the attorneys argued, had "no one to blame but itself."
"Having attracted buyers, Nationwide now seeks to evade its payment obligations, which arise from the very documents that Nationwide itself drafted," Hanrahan's response read.
In 2009, Alaska and Nebraska were the only two states with insurable interest statutes that encompassed annuities in all circumstances, according to Adler, Pollock & Sheehan, one of the law firms that prepared the response. It said Rhode Island has no such requirement.
Nationwide filed suit against one of Caramadre's investors in May of that year, a suit it would lose. Transamerica and Western Reserve would wait until November to file their suits.
In June, Caramadre got word that the FBI had contacted one of the hospice nurses who had referred annuitants to him.
His lawyer, Robert Flanders Jr., a former state Supreme Court justice, asked for a meeting with prosecutors. He hoped to persuade them that the matter was best left to the civil courts. According to Flanders, at the meeting prosecutors let him know they didn't like Caramadre's creation regardless of whether it was criminal or not. "Here was a guy who was just throwing a few shekels at some poor sick people at the end of their lives, and he was reaping the lion's share," says Flanders. "They didn't like what they considered the inequity of it."
Flanders says he took the prosecutors' remarks as a threat. "At one point, the lead attorney there said to me, 'You know all that money your client made from the insurance companies?' I said, 'Yeah, what about it?' 'All that is now going to go from him to you, because during the course of this investigation, this is going to be a thing where he is going to be drained of all the money he made.'"
Asked specifically about the meeting and this accusation, a Department of Justice spokesman declined to comment.
An FBI agent started conducting interviews with hospice workers, investors and family members of annuitants.
Investigators learned that most of the contact with the dying participants had occurred with Raymour Radhakrishnan, an employee Caramadre hired in the summer of 2007. A graduate of Wheaton College in Boston, Radhakrishnan was only 23 years old at the time. His job would be to interact with the annuitants: assess their health, explain the program, get their signatures and dispense the cash. Mainly, he would oversee a growing corporate bond program (Creation 19).
The bond program had similarities to the variable annuity scheme. Caramadre would buy certain corporate bonds on the secondary market. After the financial crisis, these bonds were selling at a steep discount. As a sweetener, the companies that originally sold the bonds had included survivorship rights for co-owners.
For example, if you owned the bonds with your wife and she died, you didn't have to wait decades to redeem them. The company would buy them back at full value. Caramadre would "co-own" the bonds with a terminally ill person. When that person died, he would redeem the bonds at face value, reaping the value of the discount.
Radhakrishnan is a co-defendant along with Caramadre in what the government contends was a vast criminal conspiracy. Reached through his public defender, Radhakrishnan declined to comment. He has pleaded not guilty to the charges.
Radhakrishnan's conversations with the terminally ill are at the heart of the criminal case against both men. Caramadre seldom met with the annuitants directly, but prosecutors allege that he instructed Radhakrishnan to deceive the potential annuitants. FBI reports, depositions and interviews suggest that Radhakrishnan told different stories to different potential annuitants. The most serious charges against the men involve allegations that they forged signatures.
One forgery count in the indictment involves Stephanie Porter's mother, Bertha Howard. In January 2008, Radhakrishnan met with Howard and Porter at Fatima Hospital where she was being treated for lung cancer that had spread to her brain and spine, according to Porter. Radhakrishnan gave her mother a check for $2,000 and explained how Howard might be able to get more if she signed more documents. The next meeting between Radhakrishnan and Howard occurred in a nursing home a few weeks later. Porter was also present. She says her mother, shaky and heavily medicated, struggled to sign some forms. There was no additional explanation from Radhakrishnan, according to Porter. A week later, Howard died. Shortly after that Radhakrishnan called Porter to tell her that the company would not accept the signatures so there would be no more money forthcoming. Porter said it didn't matter since her mother was dead.
But a bond account was opened under Howard's name nonetheless. On the account are signatures that Porter does not recognize as those of her mother. The indictment charges that they are forgeries. Caramadre says it was a mistake and documents he provided to ProPublica show that no money was ever put into the account.
The prosecution persuaded a judge to allow it to take depositions of dying participants in the schemes even though no charges had been filed at the time. Over a few weeks in hospitals and private homes, with tubes in their noses and a variety of high-powered medications in their blood streams, the annuitants testified that they did not understand the arrangement they had entered into with Caramadre and Radhakrishnan. Some denied writing their signatures on forms submitted to insurance and bond companies.
Caramadre believes the depositions show that the FBI and prosecutors misled witnesses and thus tainted their testimony. (See video clips from the depositions.) An FBI spokesman said the agency does not comment on active cases.
The Wall Street Journal wrote two stories on Caramadre's cases, one in February 2010 on variable annuities and another a month later on the corporate bond program.
Two months later, the National Association of Insurance Commissioners held a hearing on stranger-originated annuities. Thomas R. Sullivan, a former Hartford Insurance executive and the state regulator from ING's home state of Connecticut, chaired the meeting.
"This is about embarrassment," says Caramadre. "Nobody ever complained about what I did until the insurance companies and the FBI came knocking."
In November 2011, after almost two years of work, a Rhode Island grand jury issued a 66-count indictment against Caramadre and Radhakrishnan.
Their criminal trial is scheduled to begin in November.
Today, several of the companies Caramadre targeted have stopped selling variable annuities. ING has been forced to get out of the business and write down billions in losses. Others have had to boost their reserves. Transamerica is trying to buy back some of the variable annuities it sold to policyholders. The French insurer Axa is offering its variable annuity holders money if they surrender their death benefit guarantees.

Saturday, November 3, 2012

Fresh food fixation becomes a business for Wash. U student

Fresh food fixation becomes a business for Wash. U student

On a recent weekday afternoon, Sarah Haselkorn sat table-side at a restaurant in the Central West End, wearing shorts, a T-shirt and running shoes, with her hair pulled back in a ponytail and a backpack at her side.
She looked a lot like a typical college student — which she is. Sort of.
Haselkorn is, in fact, a senior at Washington University. But, between classes, exams and the demands of a her systems engineering major, she has also managed to co-launch and run Green Bean, a quick-service restaurant that serves fresh salads and wraps.
In the process, she’s tapped into a growing national trend — and an exploding market for fast, healthy food.
Haselkorn and her concept have, in fairly short order, caught the eye of a prestigious national entrepreneur organization, and a week from Monday she’ll give a presentation to its members on the floor of the New York Stock Exchange. She has another non-restaurant concept in development, and probably a lot more floating around in her head.
Oh, and she’s a triathlete. And she’s only 20.
Haselkorn moved to St. Louis from her hometown of Washington when she was 17, and soon determined the city’s food landscape was missing something.
“I noticed quickly there weren’t very many healthy restaurants in St. Louis where you could get something fast,” she remembers.
Healthy and fast are important attributes for a busy student who happens to run the odd triathlon. So rather than complain about the lack of quick-service, healthy restaurants, she opened one herself.
Haselkorn got in touch with a friend from her hometown, Nick Guzman, who had recently graduated from Amherst College, and the two started developing a business plan via email.
After a couple months trading ideas and doing research — Haselkorn spent hours watching customers come and go inside other area restaurants — the two had a formal pitch.
Based loosely on salad-centric restaurants they’d been to in New York and Washington, Green Bean would be fast and healthy.
It also would go a step beyond that: Green Bean, the concept went, would use recycled materials in all its packaging, reuse building materials, compost and recycle everything, and order food daily, tailoring it to the ebbs and flows of daily traffic to minimize waste.
“We wanted to have real, whole food and transparent nutrition,” Haselkorn says. “But we also wanted to focus on sustainability. We wanted to be better, different. We wanted it to be Green Bean.”
The two were confident in their concept, Haselkorn says, but were less so about their menu. So they approached James-Beard-award-winning chef, Peter Pastan — who is the father of one of Guzman’s friends — and asked him to develop a menu.
“I was 18 when I went to him,” Haselkorn remembers. “He said: Are you sure you want to do this?”
A few months later, they had found a space in the 200 block of North Euclid Avenue, and a few months after that they were tearing the place apart. Acting as their own general contractors, Haselkorn and Guzman oversaw the renovation and did much of the work themselves, using materials recovered during demolition.
Today Green Bean employs eight people, with Haselkorn and Guzman doing much of the work themselves, from maintenance to ordering.
When asked whether there’s anything she’s not involved in, Haselkorn says: “No. Not really. Well, maybe. We have a tax accountant.”
The restaurant does a steady business, mostly from health-conscious customers in the neighborhood and medical students from Wash U. It has been in business for about a year, and Haselkorn is already thinking about expansion possibilities.
“I think there’s room in the market in St. Louis, but the other option is to franchise,” she says. “We want to make sure it’s perfect first. You don’t want to replicate any imperfections.”
Analysts see more potential, too.
A “fast casual” restaurant — the category that Green Bean finds itself in — serves food that’s a notch or two higher in quality than typical fast food, but is not a full-service restaurant. Food usually is ordered at a counter, with a server sometimes delivering it to a table.
The category has boomed in the past decade as people seek out healthier, convenient food.
“Fast casual continues to outperform the rest of the industry,” said industry analyst Darren Tristano of Chicago-based Technomic. “ The drivers are from customers moving up from fast food, and diners moving down from full-service.”
Technomic estimates that the fast-casual category represented about $27 billion of the $370 billion restaurant market in 2011.
“It’s still very small,” Tristano said. “But there’s growth at double digits for the past 10 years, and it’s growing. We’re going to see more ethnic food concepts, and more healthy concepts.”
On Nov. 12, Haselkorn will present the Green Bean concept to a group of judges with the Entrepreneurs’ Organization’s Global Student Entrepreneur Awards. She’s one of 30 finalists from 42 countries.
Haselkorn — to her surprise — was selected to compete in a regional competition earlier this year, taking first place and earning the spot in New York.
That she won comes as no real surprise to her Wash U professor, Clifford Holekamp. He teaches a highly popular class for entrepreneurs called The Hatchery, which has launched dozens of successful businesses.
“Part of the award is based not just on the business, but on the entrepreneur,” Holekamp explained. “She’s a very talented young lady. She’s balancing an engineering curriculum, minoring in entrepreneurship and running a successful business, and that is just extraordinary.”
Indeed, sitting in Green Bean, Haselkorn has to remind herself that she should start preparing for the competition, which will dole out $250,000 in cash and in-kind business services.
But she also takes the prospect of not winning the title like a wise old pro.
“Just going to New York City is enough,” she says. “Even the opportunity to be there will affect my entire future.”
Then she left her restaurant and headed to class.

Wednesday, May 23, 2012

Movies are Corporations (Hollywood Accounting)

By Chad Upton | Editor
One of the most interesting classes I took in College was taught by a film producer. He only taught that one class, for two hours, once a week. He shared learnings from the entire film making process, from writing a script and getting funding to shooting and distribution.
From this class, I learned is that each film is incorporated as its own corporation and there are a number of reasons why they do this.
For one, it offers limited liability. If someone sues the production, the people who financed and produced the film have some legal separation between the film and their personal assets and other businesses.
It also offers financial abstraction from the people and companies who financed the film. Here’s a little math test to help explain this concept: if it costs $300 million to make a product and then you sold $1 billion worth of it, how much was your profit? $700 million right? Yes. Unless, your product was a film or TV show.

This is almost exactly what happened with Harry Potter and the Order of the Phoenix (2007). The studio invested just over $300 million to make the film and it grossed almost $1 billion from the box office and other distribution deals. But, instead of making $700 million, it actually lost $167 million (on paper). So, what happened to all of that money?
Hollywood has their own system of accounting, often referred to as “Hollywood Accounting” or “Hollywood Bookkeeping” where only about 5% of films actually show a profit. How?
Because the film itself is a corporation, that company is loaned money by the studio to make the film. The film pays the studio interest on that loan, which is one way to channel money back to studio.
Also, the studio generally owns other verticals where the film corporation can pay for things like advertising. For example, Harry Potter was made by Warner Bros, a subsidiary of Time Warner. Time Warner owns multiple TV networks and publications where the film company could buy advertising, thus channeling more money back to the parent company.
There are also distribution costs. The parent company may also have business interests in these channels where they can pay themselves again.
All of these things are done to essentially bankrupt the corporation that was formed to make that single film. Why?
If there are no profits, they don’t have to pay partners who agreed to a share of net profits. This is why you’ll often see some heavy hitters get a share of the box office or gross income instead of net profit. Depending on how they setup the initial investment in the film entity, there may also be a payroll tax advantage to financing the film this way.

There have been plenty of lawsuits over this type of accounting and the film company often loses. Jurors have awarded favorable settlements to actors and other partners who have been shorted money due to hollywood accounting. Although one judge called it, “unconscionable” — it’s not illegal.

Tuesday, March 27, 2012

4 Tricks Restaurants Use to Make More Money

4 Tricks Restaurants Use to Make More Money
Written by Miranda Marquit

This is a guest post from my online buddy Robb Engen. He writes over at Boomer & Echo, as well as contributes to I love his look at some of the ways restaurants try and squeeze a little more out of you. Personally, even knowing this, I still like to eat out — I enjoy the experience.

We all love going out to eat to enjoy good food and wine with our friends and family. But when you go to a large chain restaurant, keep in mind that it’s a business and their aim is to boost the bottom line at the same time they’re creating an enjoyable evening out for you.

When I worked in the hospitality industry, I learned a few different techniques to get customers to spend more on their dining experience. Here are a few tricks restaurants use to get more money out of your wallet:

Menu engineering

The menu is the place where people choose their meal so a lot of time is spent trying to items more profitable. The uses of shaded boxes and borders around items on the menu are designed to catch your eye and can increase sales by 25 per cent. The word, ‘special’ or ‘new’ can increase orders by up to 20 per cent.

Often these highlighted items are dishes with the lowest food cost which means they may not the best value for you.

Each menu item is priced according to its cost. Most restaurants want to keep their food cost below 30 per cent. However, you won’t see oddball pricing of $19.31 simply because it fits a formula. Customers don’t perceive a difference between $19.31 and $19.99, so the restaurant raises the price and the extra 68 cents goes to the bottom line


In the hospitality industry, more emphasis is placed on training employees to become better sales people. The waiter, hostess, and bartender become extensions of their sales and marketing team.

Now up-selling has become the industry standard, as side dishes, appetizers, desserts and drinks all help build a higher average cheque per customer.

Your server is trained to ask if you want to add mushrooms or prawns to your steak dinner, or to try a specialty coffee with your dessert. Some restaurants expect their servers to suggest bottled water or Perrier when you ask for water, and offer a bottle of wine instead of the two glasses you asked for. The best servers take every opportunity to up-sell you on an item.

I had to say, “no thanks”, at least a half dozen times during our last restaurant experience.


Buffets aren’t a big money maker for most restaurants, which means they likely offer the best value for you. Still, a good restaurant can find ways to make money on their buffets.

Restaurants use smaller plates on their buffet line, which reduces the amount of food you can take at one time. The buffet line starts with an assortment of low-cost breads and salads to fill you (and your plate) up faster.


Some restaurants can even find savings with the smallest of items. Take drinking straws, for example. Your non-stop pop might come with the thinnest straw possible to help slow down your consumption. On the other hand, alcoholic beverages usually come with a big fat straw so you’re able to drink much faster.

Tuesday, February 7, 2012

Is Kohl's Marking Up Prices Before It Puts Items On Sale?

When you see a sale advertising "40% off" an item, what exactly does that mean? Is it 40% off the price it was selling for last week? 40% off the MSRP? There's a gray area in retail pricing that has some shoppers accusing Kohl's of inflating prices so that an "on sale" item looks to be a better deal than it actually is.

CBS Sacramento's Kurtis Ming -- one of the best named consumer reporters in the country -- looks at a few instances, including one where a Kohl's shopper thought she'd got a great deal when she bought a $210 sheet for for 50% off, only to later find a price tag showing the product had recently been selling for $170, and that the price had been marked up three times since until reaching $210.

"You always expect to see the price tag stuck on top of another one is the cheaper price," she says. "Actually, it was more expensive."

So CBS sent in hidden camera crews to several Kohl's outlets to see if this was standard operating procedure:

A CBS producer found clothes, luggage, kitchen, bath and bedding products -- 15 items in all -- marked up, some as much as $100, and price tags on top of price tags.

Other items have different price tags on different areas of the product.

One twin sheet set was listed at 50 percent off the original price of $89.99. But inside the plastic zipper, the earlier price tag shows $49.99, indicating the current sale is only $5 savings from the original tag.

A 10″ skillet was listed on sale for $34.99, with a regular price of $39.99, but underneath that sticker, the earlier price tag was marked $29.99 -- meaning Kohl's current price on sale is $5 more than the originally marked price.

One producer tried pointing out that a $150 sheet set marked at 30% off also had a price sticker showing a price of $90, about $15 less than what they would pay with the discount.

The producer asked the cashier if they could get 30% off the $90. A manager decided this was okay and told the undercover producer, "Sometimes when we do scratch-off coupons, we mark stuff up."

A consumer attorney tells CBS that Kohl's may be violating California state law if it is deliberately marking up prices just to make sales appear better than they should.

But Kohl's denies any such behavior, saying that prices of in-stock items went up because the cost of certain new inventory went up:

As is common in the retail industry, from time-to-time, product prices are increased due to production and raw material costs. When these types of price increases are implemented, our stores are instructed to re-ticket all items currently in our inventory to match the price tags for all in-coming merchandise...

Price increases at Kohl's are not common. However, the unprecedented increases in the cost of certain commodities such as cotton over the past 24 months have caused us to take these actions.

The retailer confirms that the price of the sheet set mentioned at the top of the story did indeed go up dramatically because they had to match the price Kohl's was going to charge for sheets made with cotton that was now costing everyone more money.

Monday, January 9, 2012

Using Buffett's Favorite Ratio To Analyze Apple And Its Industry

Many years ago while reading the Berkshire Hathaway (BRK.A) 1986 Letter to Shareholders, I discovered Warren Buffett’s ratio, which he calls "Owner Earnings". And to my amazement, in a little footnote Mr. Buffett actually explains how to use it and basically states that it is one of the key ratios that he and Charlie Munger use in analyzing stocks.

Due to the popularity of my “Buffett’s Favorite Ratio” articles, I have gotten many emails asking me to analyze Apple in that context. The following is my analysis of Apple (AAPL) and its industry using Mr. Buffett's ratio. For those new to this type of analysis please look here.

I would like to start this analysis by first showing everyone how Apple has done from a historical owner earnings perspective, going back to 1995: (Click to enlarge)
As you can see from the data above, buying Apple when its price to owner earnings broke below 15 in 2009 would have been the best time to buy its stock. Buying a company's stock when it breaks below that specific number on a price to owner earnings basis is key in doing this type of analysis. I proved that point in my back test of the DJIA 30 Index for the 60 year period of 1950-2009.

From a CapFlow perspective, Apple has consistently stayed below 50% since 2004 and the chart below will show you what that has meant for the company’s stock price
CapFlow is a key indicator of how management is conducting its cost controls. Had you been using this system at the time, you would have seen Apple's CapFlow drop from 84.62% in 2003 to 40.74% in 2004. Management cut costs by 51.85% in that year and proceeded to drop CapFlow in 2005 to 18.02%. This miraculously amounted to another drop of 55.78%. Management was clearly in charge of their destiny at the time because in just two years they were able to drop Apple's CapFlow by some 78.07%. This was a key breaking point for the company and because management has continued to keep the company's CapFlow low, it has been able to generate some serious Owner Earnings growth rates.

Before continuing with our analysis of Apple let us first look at their competitors and see how they are doing from an owner earnings perspective. The following is a table of the major companies that are in Apple’s Industry
As you can see from the table above, with my system you can zero in (within minutes) and know exactly which companies are the super stocks and which ones are the dogs with fleas. Western Digital (WDC) and Brocade (BRCD) are definitely dogs with fleas, as Western Digital comes in with two negative results and has a CapFlow of 122.64%. So one could say “look out below!”

IBM (IBM) and Dell (DELL) are definitely super stocks as they are clearly putting up strong owner earnings numbers. Unlike Apple, Dell is concentrating on consumers who are looking for a low price point. In comparing the two, one finds that Dell's computers sell for about half of what Apple's do, but even so, Apple is winning in the owner earnings game because it gives its consumers "white glove" customer service and quality. In this world you get what you pay for.

IBM's long-time CEO recently retired and I am not sure how good its new CEO will be. So I will give her some time to show me what she can do before joining Mr. Buffett in buying it.

If you are looking for value plays, then Dell, Logitech (LOGI) and Seagate Technology (STX) have insanely low price to owner earning numbers. Had you done this analysis on Seagate back in September you would have had an amazing buying opportunity as the stock was only selling in the low teens. Here is a chart of Seagate that will clearly show you what can happen to you as an investor when you get the owner earnings numbers right
Finally one stock being pumped up by analysts is Hewlett Packard (HPQ) as Meg Whitman is now the CEO. But we need to give Meg some time to get things organized as the stock is still a value trap, in my opinion. I can say this because its FROIC is still too low for a tech stock and though its CapFlow is under 50%, it is not much below that. If Whitman can shed some assets that are underperforming and bring HP's FROIC up to 20%+, you may have a great turnaround story here.

Recently Apple's stock has been in a trading range even though its Owner Earnings numbers have been fantastic. I don't know if this is a result of its CEO Steve Jobs' passing, but I believe that I may have the answer as to why this may be happening. It can be attributed to the company having way too much cash on its balance sheet. This excess cash reduces the company's Main Street performance numbers because it effects its FROIC. Remember that FROIC measures owner earnings return on total capital. Total capital is basically long term debt + shareholder’s equity. Cash which returns 1% at best makes up the lion's share of Apple's total capital. In my opinion, Apple needs to either start making acquisitions of companies that have a FROIC of 20%+ or it needs to start paying a dividend. Until the company does that, I have decided to sit on the sidelines. As you can see, FROIC is actually expected to drop from 30.64% in 2011 to 27.96% for 2012, even though Apple's owner earnings are expected to grow at 27.02%.

You can’t really be expected to move much in the stock market if the return on half of your capital is growing rapidly and the other half is dead- growing at just 1%. It is an anchor on the stock, which can be remedied very quickly by paying a one-time $20 a share dividend to shareholders. Warren Buffett has this similar problem as Berkshire Hathaway (BRK.A) generates way too much cash. He solves this problem by being proactive about it and invests the cash in companies like IBM (IBM), Intel (INTC) or MasterCard (MA) which are all monster FROIC producers in their own right. If Apple's management decides not to pay out a dividend or buy out other companies, they should at least start buying stock in other companies which have tremendous FROIC. Until they do something about all that cash, the stock should remain in a trading range as much of its total capital is only earning 1% at best.