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AIG Fraud Case: Using the Market to Set Jail Terms

Under new federal guidelines, defendants in big stock swindles could get 30 years to life

In coming weeks, five former insurance executives, including General Reinsurance ex-CEO Ronald Ferguson, are due to appear in federal court in Hartford. There, U.S. District Judge Christopher F. Droney will sentence them for their role in a sham transaction to boost the loss reserves of American International Group (AIG). When the deal was disclosed in 2005, prosecutors contend, it caused AIG's share price to drop 6% to 15%. Because of that, the defendants, who were convicted of fraud in February, could go to prison for life.

While the case involves events that seem far removed from the present financial crisis, it highlights an issue that's sure to be front and center if prosecutors seek retribution for the market losses of recent weeks. Under federal guidelines, the base-level sentence for someone convicted of securities fraud is zero to six months. But a variety of factors can increase time behind bars—including the size of shareholder losses, the number of victims, and whether a defendant is an officer or director at a public company. In reaction to the implosion of Enron, WorldCom, and other scandals that cost investors billions, lawmakers sharply raised the potential penalties in 2003. Now, instead of a few years in prison, fraud that results in stock losses exceeding $400 million could earn a defendant a life term.

Given the size of losses related to the subprime meltdown, prosecutors may be able to threaten alleged culprits with lifetime incarceration. Reid H. Weingarten, a Washington attorney representing Elizabeth Monrad, the convicted former Gen Re CFO, argues that "this puts unhealthy leverage in prosecutors' hands to extract unfair plea deals." Going for the maximum sentence "may be popular in these chaotic times," he says, "but it usually has absolutely no relationship to the severity of the wrongdoing." Indeed judges in some recent securities-fraud cases have found guideline sentences draconian and have meted out far less time, especially when the crime did not imperil a giant company.

In the case of AIG, the insurer's stock fell to 61.92 from 71.49 in the month following its disclosure of the Gen Re transaction and a subsequent probe by then New York Attorney General Eliot Spitzer. (Since then, AIG shares have dropped below 3 because of unrelated subprime losses that forced a massive government bailout.) Attorneys for the five defendants argue that a host of factors caused AIG's stock to swoon three years ago, including the forced departure of AIG chief Maurice "Hank" Greenberg. The defendants—including AIG's former head of reinsurance, Christian Milton—plan to appeal their convictions.

For sentencing, a lot rides on the complex and controversial discipline of determining market loss. Both sides retained financial experts to determine how much shareholder harm could be directly tied to the fraudulent inflation of AIG's loss reserves. The defendants say that amount was zero, which means under the guidelines they would face a year or two at most in prison. Prosecutors, seeking life, contend losses were as high as $1.4 billion. Such disparate conclusions are not uncommon, defense lawyers say. This points to the exercise as more art than science. "In the end, you're making a lot of sort of crude assumptions," says David Topol, a Washington attorney who monitors shareholder lawsuits for insurers. "When you get an enormous disparity, somebody's clearly wrong."

Orey covers corporations for BusinessWeek.

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