New York Sues AIG, Greenberg For Improper Accounting Practices

Attorney General Eliot Spitzer and Superintendent of Insurance Howard Mills allege the company and executives:

o Engaged in "two sham insurance transactions" that gave investors the impression the company had larger reserves for claims than it did.

The transactions, personally approved and negotiated by Mr. Greenberg, involved the former CEO of General Reinsurance Corporation Inc., the complaint alleges.

o Hid losses from its underwriting business by converting the underwriting losses into capital losses.

o Created false underwriting income by falsely reporting income from the purchase of life insurance policies as underwriting income.

This scheme was personally approved by both Mr. Greenberg and Mr. Smith, the complaint said.

The complaint further claims that Mr. Greenberg manipulated AIG's stock price, instructing traders to "aggressively purchase" the stock and increase the worth of his and Mr. Smith's holdings.

The company is also accused of booking workers' compensation insurance premiums as general liability insurance revenue, which may have reduced AIG's contribution to the state's workers' comp system and avoided payment of taxes on the premiums.

AIG is further accused of deceiving New York state and other insurance regulators about offshore relationships with reinsurers. Documents related to this investigation were destroyed by AIG, the suit alleges.

The practices alleges in the suit began in the 1980′s and continued until Mr. Greenberg left the company this year, the complaint said.

One scheme began in October of 2000, after AIG reported earnings for the third quarter of 2000, the complaint alleges. The complaint noted that AIG's stock dropped after the earnings report was released indicating a $59 million decrease in loss reserves. Mr. Greenberg set up a scheme with Ronald Ferguson, then CEO of General Re, aimed at fraudulently increasing AIG's reserves with the purchase of $500 million in reinsurance from AIG, the complaint said.

Mr. Ferguson stepped down as CEO of General Re in October of 2001, and remained a consultant. The company recently severed all ties with him. (See related story, page 24.)

The complaint also alleges that AIG adjusted its books with unsupported accounting entries designed to increase the company's reserve levels before issuing its quarterly reports. Mr. Smith is accused of personally supervising the entries, referred to as "topside or "top level" adjustments, instructing employees to make changes.

Both Mr. Greenberg and Mr. Smith are accused of creating a shell corporation to hide $210 million in losses from an auto warranty business in 1999. The company used CAPCO Reinsurance Company, Ltd., a Barbados insurance company, for this scheme, which involved a complex set of steps including investing in a shell corporation and reinsuring the auto warranty losses into the corporation which would fail. That would leave AIG with an investment loss, instead of underwriting losses, the complaint contends. The company was liquidated in 2002 after serving its purpose.

In another scheme, hatched in 1999, AIG disguised underwriting losses from its Brazilian life business as investment losses.

Another part of the suit, covering the scheme to hide workers' comp premiums, quotes AIG's general counsel saying that practices were "permeated with illegality," and "the situation [was] so serious that it could threaten the continued existence of senior management."

AIG is also accused of hiding its ownership of a number of reinsurance facilities, deceiving the New York Insurance Department by either not disclosing the relationships or expressly stating it had no relationship. The companies named are Union Excess Reinsurance Company in Barbados and Richmond Reinsurance Company in Bermuda.

The complaint seeks payment of punitive damages and court costs, restitution and other payments.

In a statement, Joseph Norton, AIG's director of public relations, said the company has reviewed the complaint and is pleased the attorney general recognized the company's cooperation in the investigation.

"There are no new charges raised in the complaint," he said, adding that Mr. Spitzer "has previously indicated his expectation of reaching a civil settlement with AIG."

Mr. Spitzer's civil complaint is the culmination of the initial phase of the still-continuing, multipronged investigations into the world's largest insurance company.

In April, Mr. Spitzer said he expected "a civil resolution with [AIG] will ultimately be achievable."

In a statement announcing the complaint last week, Mr. Spitzer said: "The irony of this case is that AIG was a well-run and profitable company that didn't need to cheat. And yet, the former top management routinely and persistently resorted to deception and fraud in an apparent effort to improve the company's financial results."

Still to come in the future are possible enforcement actions from the Department of Justice and the Securities and Exchange Commission, which are also examining AIG's past accounting practices.

Last week's civil suit proceeded from probes that first surfaced on Feb. 14, 2005, when AIG acknowledged it was subpoenaed by the SEC and Mr. Spitzer regarding nontraditional insurance products.

AIG has a history of past problems with regulators over nontraditional or finite products–first as a seller and then as a buyer.

Back in 2001, the SEC began looking into AIG's sale of a nontraditional product to phone distributor Brightpoint Inc. of Plainfield, Ind. According to regulators, the transaction helped Brightpoint hide $11.9 million of losses in 1998.

AIG was also scrutinized over its deal with the Pittsburgh-based PNC Financial Services Group Inc., which allegedly allowed PNC to cover $762 million in loans from its balance sheet.

AIG settled these two allegations last November, paying $126 million in penalties and restitution. But when those investigations ended, regulators stumbled onto the question of whether AIG itself abused these types of finite products to manipulate its own accounting.

The regulators' probes this year zeroed in on the transaction between AIG and Berkshire Hathaway's General Re, which allegedly helped AIG inflate its reserves by reinsuring General Re, making AIG's balance sheet look better than it actually was.

AIG has since admitted that its deal with General Re should have been recorded as a loan–not an insurance transaction–since no risk was actually transferred.

In March, this General Re-AIG scandal culminated in what was once almost unthinkable for AIG observers–the ouster of Mr. Greenberg as chairman and CEO after he had led the carrier for nearly four decades.

In March, two other top AIG executives, Mr. Smith and Christian Milton, vice president for reinsurance, also became casualties of regulatory probes, when they were fired for failing to cooperate with the investigation.

The dismissed executives may still face criminal indictments over their alleged roles in manipulating AIG accounting.

The General Re-AIG transaction also spotlights how finite reinsurance deals in general can be used to manipulate insurers' accounting.

Currently, various oversight groups–including the National Association of Insurance Commissioners, the Financial Accounting Standards Board and the International Accounting Standards Board–are all considering the question of risk transfer in reinsurance accounting.

Mr. Spitzer's civil complaint came as AIG and its auditors are working to finish the insurer's much-delayed 10-K annual report for 2004. AIG is scheduled to file its 10-K annual report with regulators sometime early this week. AIG said in May that correcting its accounting irregularities could cut its book value by $2.7 billion, or 3.3 percent, as of Dec. 31, 2004.

"Former top management routinely and persistently resorted to deception and fraud in an apparent effort to improve the company's financial results."

Eliot Spitzer

With Greenberg mug:

Former Chair Maurice "Hank" Greenberg is accused of having personally negotiated and approved transactions to provide reinsurance to General Re. The "sham transactions" were made in an effort to allay concerns of investment analysts about falling loss reserve levels.