Who is this man? A. Maurice Greenberg B. George Bush C. Warren Buffett D. Eliot Spitzer E. None of the above
Eliot Spitzer is a name that will come up throughout the presentation so who do you think Eliot Spitzer is? A. Resigned as the Governor of New York in 2008 B. New York Attorney General for 8 years who was brilliant at prosecuting Wall Street fraud C. Client 9 of a prostitution ring D. Son of a multimillionaire real estate developer E. All of the above
Fraud: Not a New Issue Other large companies have been found guilty of fraud Enron Corp. WorldCom Inc.
American International Group Inc. “We Know Money” Largest U.S. commercial insurer 93,000 employees Does work from insurance to asset management in 130 countries Main customers are businesses, but it also sells life and property insurance to individuals One of the largest, most profitable companies in the world Known for its steady earnings growth CEO: Maurice “Hank” Greenberg World’s biggest reinsurance buyer
Initial Warning Signs at AIG A company founded in 1987 called Coral Reinsurance in Barbados only had one customer: AIG In 1991, Coral Re held more than $1 billion in estimated losses from AIG but only had $15 million in capital Regulator’s became convinced that Coral Re was under AIG’s control and no real risk was being transferred AIG eventually agreed to stop its business with Coral Re, but AIG never admitted Coral Re was an affiliate and never was fined
Initial Warning Signs at AIG cont… Eliot Spitzer named AIG as a participant in a bid-rigging scheme with other major insurers and insurance broker Marsh & McLennan Cos. 2 former AIG employees pleaded guilty in the scheme Marsh & McLennan’s CEO at the time was AIG CEO Maurice R. “Hank” Greenberg’s son (Jeffrey Greenberg)
AIG’s Previous Fraudulent Encounters Brightpoint Small mobile phone distributor PNC Financial Services Group Inc. Pittsburgh banking company
Brightpoint AIG helped Brightpoint design a retroactive “insurance policy” to spread out losses that should have been recognized immediately SEC accused AIG of both fraud and helping Brightpoint falsify its earnings in 1998 Overstated earnings by 61% Hid some of Brightpoint’s $29 million in losses Fraud surfaced in 2003 AIG agreed to pay $10 million fine in a settlement of civil charges with the SEC
PNC Financial Services Group Inc. AIG helped PNC Financial Services create 3 special-purpose, off-balance-sheet investment vehicles in 2001 SEC charged that AIG acted as a counterparty to move $762 million of underperforming loans or volatile assets off PNC’s balance sheet
Brightpoint and PNC Financial Services In both cases, AIG helped these companies hide adverse financial developments from their shareholders AIG never admitted or denied wrongdoing in either case Settlement- AIG pays: $80 million penalty to the Justice Department $46 million to a SEC restitution fund
Additional Provision of Settlement Provision of settlement requires AIG to hire an independent consultant jointly chosen by the company, the SEC, and the Justice Dept. to review certain transactions between 2000 and 2004 to determine whether they were used to violate accounting rules or manipulate financial results When asked about the regulatory environment Greenberg said the crackdown was excessive and “When you begin to look at foot faults and make them into a murder charge, then you have gone too far."
AIG’s own accounting goes under review New York Attorney General Eliot Spitzer and the SEC had been focusing on the relationships between AIG and their clients Now focus is shifting to AIG’s own financial statements Regulators are interested in whether AIG has aided their own results with the techniques they pioneered and marketed in years past AIG maintains its own accounting is not an issue
Could AIG be manipulating its own earnings and/or balance sheet? New Questions Regulators gain interest in AIG and transactions it has had with General Re possibly dating back 3 or 4 years
What is General Re? A. A reinsurance company that is part of Berkshire Hathaway and is owned by Warren Buffett B. A electric company based in Dublin that bought “insurance” from AIG C. An insurance company owned by Eliot Spitzer D. A reinsurance company that is a subsidiary of AIG E. None of the above
AIG/General Re Deal Regulators focus on a deal AIG cut with General Re, a reinsurance company Investigators say AIG bought insurance from General Re and accounted for it in a way that overstated revenue
AIG Fesses Up! AIG admits to: using insurers in Bermuda and Barbados that were secretly controlled by AIG to bolster its financial results, including shifting some liabilities off its books a broad range of improper accounting that could slash its net worth by $1.77 billion improperly accounting for a reinsurance transaction with Berkshire Hathaway Inc.’s General Re in 2000- 2001
After the admission Investigators now are examining actions of top AIG officials The SEC could bring civil fraud charges against the company or executives AIG’s shares fell 1.8% continuing to slide On Feb. 14, 2005 AIG’s shares are down 22% since closing on Friday, Feb. 11
After the admission cont… Standard & Poor’s and Moody’s downgraded AIG’s long-term bonds and certain other debt by a notch from its top AAA and Aa1 rating A.M. Best put AIG under review with “negative” implications Fitch Ratings put AIG under “Rating Watch Negative”
After the admission cont… Company says accounting problems probably will not deplete its net worth (shareholders’ equity) by more than 2% AIG CEO “Hank” Greenberg resigns in March 2005 and retired as AIG’s chairman days later
How and why? How and why did AIG use insurers in Bermuda and Barbados that were secretly controlled by AIG to bolster its financial results, including shifting some liabilities off its books?
Richmond Insurance Co. A Bermuda-based reinsurance company that AIG transferred hundreds of millions of dollars in liabilities to in recent years AIG owns 19.9% of this company, but AIG’s internal review found that AIG controlled the company Richmond shares a mailing address with AIG’s Bermuda offices and is managed by a unit of AIG
Richmond Insurance Co. cont… Why? If a reinsurer is wrongly classified as unaffiliated, that means that any policy claims counted as being covered by the reinsurer are actually the original insurer's own liabilities AIG says the financial impact of consolidating Richmond will be minimal
Union Excess Reinsurance Co. Barbados based reinsurance company in which AIG had done business that was similar to Richmond AIG does not own stake in Union Excess, but a significant part of the ownership interests are protected under agreements with Starr International Co.
Union Excess Reinsurance Co. cont… Why? Transactions generated income Allowed AIG to reflect lower obligations on its own balance sheet because of differences in accounting between Barbados and the U.S. Consolidating Union Excess would reduce AIG’s net worth by $1.1 billion
Capco Reinsurance Co. Another reinsurance company in Barbados that AIG had transactions with to help improperly characterize losses on insurance policies as another type of loss Capco should have been treated as a subsidiary of AIG
Capco Reinsurance Co. cont… Why? AIG has had some of the lowest underwriting losses in the industry and wanted to keep it that way AIG will have to restate $200 million of the other losses as underwriting losses from its auto-warranty business
Other problems identified Investment Income Bad debts Commission Costs Compensation Costs Underreporting premium income from workers’ comp policies
How and Why? How and why did AIG improperly account for a reinsurance transaction with Berkshire Hathaway Inc.’s General Re in 2000-2001?
Reinsurance Deal with General Re In late 2000 and 2001, Gen Re shifted $500 million of expected claims to AIG along with $500 million of premiums Gen Re accounted for this transaction properly AIG recorded the premiums as revenue and added $500 million to its reserves to show its obligation to pay claims
The Problem The transaction was improperly recorded by AIG as a reinsurance deal when it was more like a loan If AIG was receiving the premiums to ensure that it didn't lose anything in the deal, then it faced no risk AIG wasn't really insuring anything and the $500 million shouldn't have been treated as premium revenue
Loan vs. Reinsurance If not enough risk is transferred it is considered a loan and not an insurance policy Accounting for reinsurance policies is more favorable than that for loans because insurers can use reinsurance proceeds to offset their losses Proceeds from loans cannot be used to offset losses; instead, loans have to be counted as liabilities
Why would AIG do this? Possible reasons: Some AIG shareholders were questioning whether the insurance company had enough money set aside to cover potential claims AIG has an outstanding record of earnings growth, and perhaps an obsession to keep that record intact led to the decisions to fudge the books Raise its stock price
Significant issue for General Re Did General Re aid AIG with the improper accounting? Buffett's firm can't be held responsible if it merely sold a product--the loss portfolio--to AIG that was later misused
More Investigation Spitzer’s approach: Considers Buffett a witness in the probe Focusing investigation on AIG and its former CEO Maurice (Hank) Greenberg SEC’s approach: Examining whether Buffett or others at his company had any knowledge that the AIG transaction was being used improperly
Is Possible Failed Regulation to Blame? State regulators failed Outside auditors failed Financial industry specialists failed Future solution: national regulation???
May 2005 update AIG would restate more than 4 years of financial statements which will reduce its net worth $2.7 billion AIG’s current management said there were issues with its internal controls AIG’s stock has fallen 30% New issues arise Hedge funds Derivatives
May 2005 update cont… Elizabeth Monrad, John Houldsworth, and Rick Napier each received a Wells Notice from the SEC notifying them that they could face securities-fraud charges due to their work at General Re At the end of May, AIG restated 5 years of financial results reducing its net income by 10%
First formal charges At the end of May 2005, New York state authorities sued AIG, former CEO Maurice R. “Hank” Greenberg, and former CFO Howard I. Smith These are civil charges and not criminal charges, but criminal investigation of individuals still continues
Guilty pleas from Gen Re execs 2 guilty pleas to one count of conspiracy to file false financial reports, falsify books, records, and accounts and mislead auditors in connection with the Gen Re-AIG deal John Houldsworth, former CEO of Ireland-based Gen Re unit Cologne Re Dublin Richard Napier, former senior vice president of Gen Re
AIG’s Settlement AIG resolves allegations by reaching a $1.64 billion settlement AIG will also have to submit to additional reinsurance reporting and financial reporting The settlement does not resolve the cases against Greenberg or Smith AIG has not admitted or denied allegations AIG also faces a $1.1 billion after-tax negative reserve development
Criminal Charges 3 Gen Re executives and 1 AIG executive plead innocent to 16 counts including conspiracy, securities fraud, false statements to the SEC, and mail fraud Ronald Ferguson: former CEO at Gen Re Betsy Monrad: Gen Re's former chief financial officer Robert Graham: former Gen Re assistant general counsel Christian Milton: AIG's former vice president of reinsurance 1 Gen Re executive is charged on 10 counts Christopher P. Garand: Gen Re’s senior vp and chief underwriter for finite reinsurance operations from 1994 to 2005
If Convicted… Ferguson, Graham, Milton, and Monrad each face up to 230 years in prison and $46 million in penalties if convicted of all charges outlined in the indictment Mr. Garand faces a maximum term of 160 years in jail and a fine of up to $29.5 million
What has been happening recently? Eliot Spitzer became the governor of New York and recently resigned after he was caught being part of a prostitution ring New Attorney General in NY taking Eliot Spitzer’s place in the case is Andrew Cuomo The National Workers Compensation Reinsurance Pool, which represents 600 insurers, sued AIG in May 2007 in U.S. District Court for the Northern District of Illinois seeking additional funds from AIG New York-based AIG filed its own suit against NWCRP last week in New York claiming, among other things, that it is not responsible for any amount in excess of its 2006 settlement.
What has been happening recently in the trial? Ferguson, Graham, Milton, and Monrad are all convicted on the 16 counts Garand is convicted on 10 counts The most compelling evidence in the trial were taped phone conversations and emails Lawyers for the five defendants convicted said they intend to appeal Following the verdicts, the judge set May 15, 2008 for sentencing and released each of them on a $1 million bond
What has been happening recently? The investigation is still continuing and more indictments may come Mr. Greenberg and Mr. Brandon (current CEO of Gen Re) still face no criminal charges Warren Buffett is not charged with anything and is no longer being investigated
Lessons Learned US legal system can be very unpredictable Some individuals involved with very serious fraud are acquitted Others charged with less serious fraudulent activities can face lengthy prison terms To be safe, always consider the impact of any conversation you have being made public You never know when you are being recorded Laughing about financial regulations may get you convicted of a felony - if the wrong person is out to get you or someone you work with