KeyBank 2004 Annual Report Download - page 84

82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
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The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy
issued by North American Specialty Insurance Company (a subsidiary or
affiliate of Swiss Re) (“the NAS Policy”). Tri-Arc Financial Services, Inc.
(“Tri-Arc”) acted as agent for Reliance, Swiss Re and NAS. From
February 2000 through September 2004, Key Bank USA filed claims, and
since October 2004, KBNA (successor to Key Bank USA) has been
filing claims under the Policies, but none of these claims has been paid.
In July 2000, Key Bank USA filed a claim for arbitration against Reliance,
Swiss Re, NAS and Tri-Arc seeking, among other things, a declaration of
the scope of coverage under the Policies and for damages. On January 8,
2001, Reliance filed an action (litigation) against Key Bank USA in
Federal District Court in Ohio seeking rescission or reformation of the
Policies because they allegedly do not reflect the intent of the parties with
respect to the scope of coverage and how and when claims were to be paid.
Key filed an answer and counterclaim against Reliance, Swiss Re, NAS and
Tri-Arc seeking, among other things, declaratory relief as to the scope of
coverage under the Policies, damages for breach of contract and failure to
act in good faith, and punitive damages. The parties agreed to proceed with
this court action and to dismiss the arbitration without prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered
an order placing Reliance in a court supervised “rehabilitation” and
purporting to stay all litigation against Reliance. On July 23, 2001, the
Federal District Court in Ohio stayed the litigation to allow the
rehabilitator to complete her task. On October 3, 2001, the court in
Pennsylvania entered an order placing Reliance into liquidation and
canceling all Reliance insurance policies as of November 2, 2001. On
November 20, 2001, the Federal District Court in Ohio entered an order
that, among other things, required Reliance to report to the Court on
the progress of the liquidation. On January 15, 2002, Reliance filed a
status report requesting the continuance of the stay for an indefinite
period. On February 20, 2002, Key Bank USA asked the Court to
allow the case to proceed against the parties other than Reliance, and the
Court granted that motion on May 17, 2002. As of February 19, 2003,
all claims against Tri-Arc were dismissed through a combination of court
action and voluntary dismissal by Key Bank USA.
On August 4, 2004, the Court ruled on Key’s and Swiss Re’s motions
for summary judgment on issues related to liability. In its written
decision, which is publicly available, the Court held as a matter of law
that Swiss Re breached its Letter Agreement with Key by not issuing a
replacement policy covering the leases insured under Key’s 4011 Policy
that were booked between October 1, 1998, and April 30, 2000. With
respect to Key’s claims under the 4019 Policy, the Court held that
Swiss Re is not entitled to judgment as a matter of law on Key’s claim
that Swiss Re authorized Tri-Arc to issue the REINS-1 Endorsement. The
Court also held that Swiss Re is not entitled to judgment as a matter of
law on Key’s claim that Swiss Re acted in bad faith. On January 20,
2005, the Court granted the parties’ joint motion for an extension of the
damages discovery deadline, which will likely result in an extension of
the previously reported May 13, 2005 deadline for submitting summary
judgment motions on issues related to damages to July or August 2005.
Management believes that KBNA (successor to Key Bank USA) has valid
insurance coverage or claims for damages relating to the residual value
of automobiles leased through Key Bank USA during the four-year
period ending January 1, 2001. With respect to each individual lease,
however, it is not until the lease expires and the vehicle is sold that the
existence and amount of any actual loss (i.e., the difference between the
residual value provided for in the lease agreement and the vehicle’s actual
market value at lease expiration) can be determined.
Accordingly, the total expected loss on the portfolio for which KBNA
(and Key Bank USA) will have filed claims cannot be determined with
certainty at this time. Claims filed through December 31, 2004, totaled
approximately $379 million, and management currently estimates that
approximately $9 million of additional claims may be filed through year-
end 2006, bringing the total aggregate amount of actual and potential
claims to $388 million.
Key is filing insurance claims for its losses and is recording as a receivable
on its balance sheet a portion of the amount of the insurance claims as
and when they are filed. Management believes the amount being recorded
as a receivable due from the insurance carriers is appropriate to reflect
the collectibility risk associated with the insurance litigation; however,
litigation is inherently not without risk, and any actual recovery from the
litigation may be more or less than the receivable. While management does
not expect an adverse decision, if a court were to make an adverse final
determination, such result would cause Key to record a material one-time
expense during the period when such determination is made. An adverse
determination would not have a material effect on Key’s financial
condition, but could have a material adverse effect on Key’s results of
operations in the quarter it occurs.
Investigations and inquiries involving the mutual fund, brokerage and
annuity industry. As previously reported, McDonald Investments Inc.
(“McDonald”), a registered broker-dealer subsidiary of KeyCorp, has
received subpoenas from the Securities and Exchange Commission and
inquiries from the National Association of Securities Dealers (“NASD”)
and the State of New York Attorney General, seeking documents and
information as part of their investigations into trading activity involving
the mutual fund, brokerage and annuity businesses. McDonald has
responded to the various regulatory authorities and has been cooperating
fully with their inquiries and investigation. McDonald has also conducted
an internal review of its procedures and processes for executing customer
orders for mutual fund share transactions. That review revealed no
systemic late trading arrangements, although it did reveal four isolated
instances of late trading from among the mutual fund transactions
made during the relevant review period. None of those late trading
transactions involved Key’s Victory Funds. In October 2004, the NASD
notified McDonald that it had preliminarily determined to recommend
unspecified disciplinary action against McDonald for its alleged failure
to establish and maintain supervisory procedures reasonably designed to
achieve compliance with regulations governing late trading and market
timing of mutual funds. The NASD also cited McDonald’s alleged
failure to appropriately supervise the market timing activities of certain
former registered representatives at McDonald’s Chicago retail office,
which McDonald closed in December 2003. McDonald has responded
to the NASD’s preliminary determination and presented its views to the
NASD. It is not known whether, and then to what extent, McDonald
could receive further requests or be required to take action related to this
matter in the future.