General Reinsurance loaned American International Group $500 million to increase its loss reserves and improve its standing with investors, but then disguised the deal as a sham reinsurance transaction to hide it from both the investment community and government regulators, prosecutors charged last week in the opening arguments of a long-anticipated federal trial on charges tarnishing the reputation of two heavyweight carriers.

Four former executives from Gen Re and one from AIG were accused in Hartford's U.S. District Court for the District of Connecticut of using a bogus finite reinsurance deal to puff up AIG's reserves and financial results.

The five executives (see infographic) are charged in a 16-count federal indictment with violation of federal securities law, securities fraud, mail fraud, and making false statements to the U.S. Securities and Exchange Commission.

In last week's opening arguments, prosecutor Raymond Patricco told the jury that the executives engaged in a phony deal to cover up AIG's falling loss reserves.

The scheme was initiated by former AIG CEO Maurice Greenberg, prosecutors said, who allegedly approached Gen Re after AIG saw its stock drop 6 percent in 2000 and analysts were critical in their assessments of the company. The negative reaction came after AIG cut its loss reserves by $59 million in the third quarter of that year.

Mr. Greenberg--who left AIG's board and management team in March 2005 following the charges--is an unindicted co-conspirator in the federal case.

However, Mr. Greenberg--now chairman and CEO of C.V. Starr & Company, once closely affiliated with AIG--is a co-defendant along with AIG's former CFO, Howard Smith, in a state civil suit challenging the same transactions, brought by the New York Attorney General's Office, alleging market fraud. That suit is in Manhattan's New York State Supreme Court, a county-level tribunal.

According to the federal indictment in Hartford, AIG reinsured Gen Re for $600 million in exchange for $500 million in premium, which was used to shore up AIG's sagging loss reserve. Without it, prosecutors said, AIG would have had to report a reduction of $331 million in loss reserves over two quarters of 2000 and 2001.

Problems began in 2005 when AIG reported a lack of evidence of risk transfer from the deal and the contracts were canceled. The revelations led to the departure of Mr. Greenberg, as well as the firing of AIG's chief financial officer, Howard Smith, and Mr. Milton.

In their opening arguments, defense attorneys said the reinsurance transaction was in fact totally transparent, and that there was no attempt to hide anything.

Executives at the highest levels of both AIG and Gen Re--including Warren Buffet, the chief executive of Berkshire Hathaway, parent company of Gen Re--were apprised of the deal, underscoring its legitimacy, defense attorneys said.

The defense is also arguing that Gen Re executives did inform AIG the deal was being counted as a monetary exchange and not a payment of premium, adding that how AIG accounted for it was not Gen Re's responsibility.

An attorney with Ronald Ferguson's defense team--Clifford H. Schoenberg, of Cadwalader, Wickersham & Taft LLP in New York--said the former Gen Re CEO received no personal gain from the transaction, bringing into question why someone on the verge of retirement after a long career would want to risk going to jail for such a scheme.

He said the defense will question the reliability of two prosecution witnesses--John B. Houldsworth, a former CEO of Gen Re subsidiary Cologne Re Dublin, and Richard Napier, a former AIG executive.

Both have pleaded guilty to deceiving the SEC. He said questions will be raised concerning their motives for testifying in exchange for a lighter sentence and their truthfulness as witnesses.

According to court documents, close to 100 prosecution and defense witnesses could be called in a trial that is expected to last for two months.

Meanwhile, Mr. Greenberg has agreed not to seek a proxy battle over control of AIG. In a filing with the SEC, he agreed not to take any action to control any decisions the company's executives make.

The Jan. 9 filing said Mr. Greenberg and his associate holdings will not take any actions "to direct or cause the direction of the management and policies of the issuer or otherwise exercise a controlling influence" over AIG.

However, the filing continued, no decision has been made "regarding their future intentions with regards to their plans and proposals."

The move comes after New York Insurance Superintendent Eric Dinallo issued a warning to Mr. Greenberg and his group of holdings, which includes insurer C.V. Starr, that they were illegally exerting influence on AIG.

Collectively, the group owns 12 percent of AIG voting stock. Mr. Dinallo said Mr. Greenberg and his holdings must obtain permission from the superintendent before they can exert any proxy proposals as a controlling interest.

Special Reports /

Fraud Trial Targets Gen Re, AIG Execs

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