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Zenefits Compliance Problems Cost Them a CEO — and Perhaps Millions

Things happen fast in the start-up world. Earlier today I wrote a LinkedIn post on how Zenefits’ compliance challenges in Washington state could cost the company millions of dollars in lost commissions. While noting that it was only a matter of time before someone at Zenefits lost their job over the situation, I had no idea at the time that Zenefits CEO Parker Conrad would resign today citing the compliance problems.

In a press release cited by VentureBeat.com announcing Mr. Conrad’s departure, Zenefits new CEO (and until now, its COO) David Sacks, declared” I believe that Zenefits has a great future ahead, but only if we do the right things. We sell insurance in a highly regulated industry. In order to do that, we must be properly licensed. For us, compliance is like oxygen. Without it, we die. The fact is that many of our internal processes, controls, and actions around compliance have been inadequate, and some decisions have just been plain wrong. As a result, Parker has resigned.” (The entire press release is worth reading).

The loss of a founder and CEO is another cost Zenefits will pay for their alleged failure to comply with states’ insurance laws. I don’t believe they’re done paying for their mistake, however.

What follows is a slightly edited version of my my earlier LinkedIn article I had prepared for posting on this blog tomorrow morning under the title:

A Zenefits Felony Conviction Could Cost Company Millions in Commissions

Washington regulators are investigating Zenefits’ alleged use of unlicensed agents selling insurance policies in the state. This is not only embarrassing for a company as brash and boastful as Zenefits, but the company’s finances could be substantially impacted, too. Not just because, if found guilty of this felony, Zenefits could face a multi-million dollar fine. The far greater risk to Zenefits is the prospect of losing commission income — a lot of it.

William Alden at BuzzFeed News has done a great job pursuing the story of Zenefits’ unlicensed sales. Now Mr. Alden is reporting that, based on public records it seems “83% of the insurance policies sold or serviced by the company through August 2015 were peddled by employees without necessary state licenses ….”

The potential fallout is quite substantial even though only a small number of sales are involved–just 110 policies out of 132 sold or serviced by Zenefits in Washington between November 2013 through August 2015. “Soft dollar” costs include a damaged brand due to the bad press, distractions at all levels of the company, and needing to address whether the company is ignoring other consumer protections.

Then there are the hard costs. 110 policies times the maximum $25,000 per violation Washington can impose means fines of up to $2.75 million. Financial penalties imposed by other states could add to this figure. While paying a $2.75 million fine is no laughing matter for a company losing money every month, this represents less than 0.5% Zenefits has raised from investors. However, the legal fines are, potentially, just the tip of the proverbial iceberg. As Mr. Alden points out, the fallout from this investigation could result in carriers dumping Zenefits and that could cost the company far more than any criminal fines.

Carriers require agents to meet several requirements before contracting with them and agents must continue to meet these requirements to keep the agreement in-force. Common provisions include being appropriately licensed, maintaining adequate errors and omissions coverage, and not committing felonies or breaching fiduciary responsibilities. Fail to meet any of these requirements and agents can find their contract terminated for cause.

Terminations for cause usually allow insurance companies to withhold future commissions from the agent and, depending on the specific terms of the contract, from the agent’s agency as well. If an agency or agent knows or should have known they were in violation of contract terms when executing the agreement, carriers may be able to rescind the contract and demand repayment of commissions already paid out.

Being found guilty of a felony in Washington state could allow a carrier–any carrier, anywhere in the country–to terminate Zenefits’ agent contract for cause. Rumor has it that only about half of Zenefits’ revenues now come from insurance commissions. Late last year Zenefits CEO Parker Conrad claimed the company was on track to earn $80 million in 2015. So, let’s see, millions times 50% … carry the one … yeah, this hurts. A lot.

A nuclear outcome is highly unlikely. The Washington state investigation into Zenefits is ongoing and Zenefits, to date, has been found guilty of nothing.

Even if Washington regulators find Zenefits committed a felony, for reasons described in a previous post, the outcome is highly unlikely to be a fatal blow to the company. Insurance regulators have considerable leeway in determining fines and penalties. Absent proof that Zenefits knowingly and intentionally violated state law or that consumers experienced actual harm, the Washington State Department of Insurance is likely to conclude this situation resulted from incompetence. They might then impose a modest fine on Zenefits and subjected the company to enhanced review of their licensing practices for a few years.

Let’s put this in perspective. Richard Nixon resigned the presidency as the result of what started off as a two-bit break-in. That kind of cascading escalation is extremely rare. What we’re seeing unfold in Washington state is probably not Zenefits’ Watergate moment.

Zenefits has already paid a small price for what they’ve allegedly done. I’m guess the whole mess has been a bit distracting to management. And the fact remains: mishandling more than 80% of their sales in a state is a sign of immense ineptitude, arrogance, or both. Having this reality aired publicly is not good for Zenefits’ brand and resources will need to be expended to make sure it doesn’t happen again. I’m not aware the company has fired anyone as a direct result of their lax licensing controls, but that could happen.

As a result of this fiasco, Zenefits has already taken down their controversial broker comparison pages in which the company used carefully selected criteria to compare themselves to community-based agents. (I guess they were reluctant to add “being investigated for multiple felonies” as one of the comparison points). This is a small sacrifice as the comparison page was likely an attempt to enhance their search engine optimization rather than an effort to take business from their competition.

Zenefits has paid a small price. The open question is, how large a price will the company ultimately pay? For that, it will be well worth following Mr. Alden’s future stories.

 

One thought on “Zenefits Compliance Problems Cost Them a CEO — and Perhaps Millions

  1. Alan,
    We saw this coming. This was a high priced fly by night operation that was doomed to crash and burn.
    It did. Selling insurance without a license. I mean, how silly is that?

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