AIG

[Miklos Vasarhelyi <miklosv@andromeda.rutgers.edu>]

May 26, 2005

Spitzer Sues A.I.G. and Ex-Executives for Fraud

By
JENNY
ANDERSON 

Attorney General Eliot Spitzer of New York and the state's Insurance
Department filed a civil lawsuit this afternoon against the insurance
giant
American
International Group and its former top executives, accusing them of
manipulating the company's finances to deceive regulators and
investors.

The lawsuit, which was filed in State Supreme Court in Manhattan, said
A.I.G.'s former chairman and chief executive, Maurice R. Greenberg, and
the former chief financial officer, Howard I. Smith, engaged in numerous
fraudulent business transactions that exaggerated the strength of the
company's finance position in an effort to increase A.I.G.'s stock
price.

"The irony of this case is that A.I.G. was a well-run and profitable
company that didn't need to cheat," Mr. Spitzer said in a statement.
"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."

Mr. Spitzer's office said in the statement that the lawsuit attributed
the misconduct at A.I.G. directly to Mr. Greenberg. It noted that the
suit cited e-mails and other evidence showing that Mr. Greenberg was
personally involved in negotiating some improper transactions and that he
directed other A.I.G. employees to set up other improper
transactions.

A.I.G. has already acknowledged that many of these transactions were
improper and has announced plans to restate its earnings. The company is
cooperating with authorities, Mr. Spitzer's office said.

The filing of the complaint has been widely expected and will not
preclude the attorney general from pursuing criminal charges against the
individuals. 

Mr. Spitzer has convened a New York grand jury to weigh charges against
certain individuals, according to a person briefed on the grand jury
proceedings.

At the heart of Mr. Spitzer's case are transactions intended to make
A.I.G.'s core underwriting business look better than it was. While the
transactions did not erase losses, they shifted them around so as to be
more palatable to investors watching the results and regulators trying to
police the movement of money in complex insurance companies.

In one attempt to hide underwriting losses in A.I.G. auto warranty
business, A.I.G. decided to convert the losses to investment losses.
Securities analysts are more concerned with underwriting losses, or a
mismatch between the premiums received and claims paid, rather than
investment losses or capital losses, which would be perceived to be
negative but not as damaging to the core business.

In 1999, A.I.G.'s National Union Fire Insurance subsidiary had a loss of
$210 million. Mr. Smith, Mr. Greenberg and Joseph Umansky, who helped
with special projects, set up an off shore reinsurance company,
pretending to invest in it, dumping its auto warranty losses into it and
then letting it fail, making it appear to be an investment loss rather
than an underwriting loss. To do this, A.I.G. took control of Capco
Reinsurance Company, a Barbados insurer run by Western General Insurance
Ltd. while creating the appearance that it was not controlling the
entity. According to one memo from Mr. Umansky to Mr. Greenberg and Mr.
Smith, "The Capco structure needs to be revamped in order to put us
farther from criticism in today's environment." The transaction
allowed A.I.G. to book an investment loss rather than showing to the
world that its auto warranty underwriting business was
suffering.

"Mr. Umansky has cooperated fully with the attorney general's office
in its investigation into these matters and with A.I.G. in connection
with its investigation of them," said Seth Rosenberg, a lawyer with
Clayman & Rosenberg who is representing Mr. Umansky.

Mr. Spitzer's civil lawsuit is expected steal the limelight from the
company's long-awaited annual financial report, which is expected to be
filed with the Securities and Exchange Commission next Tuesday. 

After delaying the filing of the report for the third time, on May 1, the
company said that the accounting issues in aggregate would reduce its net
worth by $2.7 billion, or 3.3 percent, as of Dec. 31, 2004. It also said
it would recognize a credit of $2.4 billion after adjusting the
accounting on certain derivatives. 

According to a person briefed on the company's more recent estimates,
A.I.G. is expected to announce that the accounting changes will reduce
its net worth by about $3 billion, slightly more than the previous
figure. Its credit for the derivatives accounting is expected to be
smaller than previously disclosed. 

An A.I.G. spokesman declined to comment on Wednesday. 

Mr. Spitzer's complaint brings to an end the first chapter of a complex
multitiered investigation of the insurance giant. 

In 2001, the S.E.C. began investigating the sale of a
"nontraditional insurance product" by A.I.G. to
Brightpoint,
a Midwest distributor of cellphones, that allowed Brightpoint to hide
$11.9 million in losses in 1998. Regulators later began investigating
transactions that A.I.G. arranged for PNC Financial Services that enabled
PNC to move $762 million in loans from its balance sheet. In November,
A.I.G. paid $126 million in penalties and restitution to settle those
investigations. But as regulators wrapped up those inquiries, they were
preparing to look at whether A.I.G. itself used questionable
transactions.

Mr. Spitzer struck first in the current round of investigations, but he
is not alone: the Department of Justice and the S.E.C. are also examining
the insurance company and its accounting practices. Neither agency is
expected to take an enforcement action soon.

With the filing of his lawsuit, Mr. Spitzer released long-awaited details
surrounding a number of questionable transactions, including one between
A.I.G and General Re, a unit of
Berkshire
Hathaway, that allowed A.I.G. to inflate its reserves artificially by
$500 million over two quarters. 

A.I.G. has acknowledged that that transaction should have been considered
a loan and not an insurance deal because no risk was transferred. That
2000 deal, begun by Mr. Greenberg, set into motion the current
investigations. 

In 2000 the company reported alarmingly low reserves, a fact highlighted
by the analysts who cover A.I.G.. In response to that, Mr. Greenberg
initiated a transaction with General Re to bolster its reserves without
assuming any of the risk of having to pay claims. 

According to the suit, Mr. Greenberg called General Re's president,
Ronald Ferguson, to suggest that General Re buy $500 million in
reinsurance from A.I.G. so A.I.G. could show an increase in reserves. But
Mr. Greenberg said he wanted the transaction to be risk free, meaning
A.I.G. would not be responsible for any claims made to it.

"Greenberg wanted to be able to book hundreds of millions of dollars
in reserves from GenRe, but he did not want there to be any risk that
A.I.G. would actually have to pay any claims," the lawsuit
said.

Another deal that is part of Mr. Spitzer's complaint concerns the Union
Excess Reinsurance Company, an entity based in Barbados that did all its
reinsurance business with A.I.G. even though A.I.G. effectively
controlled the entity. Reinsurance is the offloading of risk; A.I.G. has
acknowledged that it should have consolidated Union Excess's accounts on
its own book.

The lawsuit accuses A.I.G. of lying to state insurance regulators about
the true status of Union Excess. For years, insurance regulators have
questioned A.I.G. about whether its deals with Union Excess involved any
legitimate transfer of risk. Regulators are expected to focus on Union
Excess's relationship with A.I.G. and another entity, Starr
International, a Panamanian-registered, Ireland-domiciled company
controlled by Mr. Greenberg.

The board of Starr International met on Wednesday in Ireland to discuss
its future. The entity, which has served primarily as a
long-term-compensation vehicle for a select group of A.I.G. officers and
directors, controls about $16 billion in A.I.G. stock. It is unclear what
happened at the meeting. 

"There is no news as to what we will be in the future," said
Edward Matthews, a former A.I.G. executive who continues to serve on the
board of Starr International. 

David Boies, Mr. Greenberg's lawyer, has said that his client should have
participated in any restatements by A.I.G. and that all accounting
decisions were made by an extensive group of people.

"Those decisions were made not merely by former senior management,
but by present senior management, including operational heads, and the
company's present directors and auditors as well," he has said.

Jack Lynch contributed reporting for this article.

Miklos A. Vasarhelyi
KPMG Professor of AIS
Rutgers University
Director Rutgers Accounting Research Center
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