AIG: Why The Feds Are Playing Hardball
American International Group Inc. is among the largest and most profitable companies in the world, with $81.3 billion in revenues and $9.3 billion in earnings last year. Chairman and CEO Maurice R. Greenberg is one of Corporate America's most powerful execs, overseeing a financial empire with some 90,000 employees peddling everything from insurance to asset management in 130 countries. But those numbers aren't getting Greenberg much respect in the halls of the Securities & Exchange Commission or the Justice Dept.
AIG (AIG ) is seriously on the outs with both law enforcement agencies. The trouble seems to have begun on Sept. 21, when the SEC informed AIG that it may bring civil securities-fraud charges against it for allegedly helping PNC Financial Services Group Inc. (PNC ) hide underperforming loans in 2001. Eight days later, the Justice Dept. told AIG that it is under criminal investigation for the same deals. Things got noticeably worse on Oct. 4, when both Justice and the SEC warned AIG that it may have misled investors when it issued three press releases that allegedly failed to reveal the full scope of the probes.
That makes four warnings in three weeks from agencies not usually known for quibbling over the wording in company press releases. AIG says it intends to cooperate -- but in its latest statements it still contends that any action by the two agencies "would be unwarranted" and that charges it misled investors are "without merit." The complaints about AIG's press releases boil down to this: The company said it was under investigation for certain deals, "including three transactions" with PNC -- but failed to mention that the investigations also covered five additional deals with two other insurers.
This is no mere quibble over wording. Law enforcement sources believe AIG helped its corporate clients deceive investors by selling insurance products or creating off-balance-sheet entities that have the effect of downplaying losses or overstating earnings. Just as important, current and former law enforcement sources say they're taking a tough stance with AIG because they believe it plays "hide the ball" by allegedly resisting requests for documents, e-mails, and other information from SEC and Justice staff. And when it's required to disclose investigations, they add, AIG downplays their seriousness in public statements. An AIG spokesman responds: "Any allegation of a breach of [responsibility and integrity] is of deep concern to us, and we look forward to presenting our case in the proper forum."
If AIG is playing games, the agencies are playing hardball. Post-Enron, investors look to them to protect their interests, and congressional overseers holler if they fail. "We're in an environment where regulators have to be aggressive, in part because they were accused of not being aggressive enough in the past," says John P. Waterman, chief investment officer at Rittenhouse Asset Management Inc. (JNC ), which has about $390 million in AIG stock.
In securities-law-speak, AIG is under investigation for aiding and abetting securities fraud. The charges echo those that Merrill Lynch (MER ), J.P.Morgan Chase (JPM ), and Citigroup (C ) all settled last year without admitting or denying guilt, for what the SEC said was financial wheeling and dealing that allowed Enron Corp. to hide troubled assets and disguise loans as income. Four Merrill bankers are on criminal trial in federal court in Houston on charges of helping Enron in late 1999 hide its ownership of electricity-producing barges parked off the coast of Nigeria and book an extra $12 million profit.
AIG's woes date back to the same go-go years -- and began with a similarly trifling amount of money. In July, 2000, the SEC first began investigating the insurer's role in helping Brightpoint Inc. (CELL ), a Plainfield (Ind.) distributor of mobile-phone data and services, hide $12 million in losses. In 1998, say SEC documents, Brightpoint discovered that a British unit's losses would be twice what Brightpoint had publicly announced, so it sought help from an AIG subsidiary, the Loss Mitigation Unit of National Union Fire Insurance Co. of Pittsburgh, Pa.
The insurer had just what Brightpoint needed: a retroactive insurance policy for which Brightpoint would pay monthly premiums for three years, say the documents. During that period, the AIG unit paid the money back in the form of insurance claims. Brightpoint recorded those payments as insurance receivables in 1998 to offset that year's losses. The round-trip payments were cleverly disguised within a legitimate insurance policy, the SEC said in a September, 2003, settlement of a civil fraud action against Brightpoint and two ex-managers. Without admitting guilt, the company and its two officers paid total penalties of $595,000.
But the SEC also fined AIG $10 million, which it paid without admitting guilt. The SEC probe uncovered evidence that allegedly showed AIG had created and marketed the Brightpoint "insurance" to help its clients smooth quarterly earnings. The SEC also believes AIG stonewalled its probe because AIG's own accountants had designed the policies to fool auditors into believing they were traditional insurance policies.
Why does the SEC think that? The SEC documents say that more than two years after the Brightpoint probe began and after several rounds of subpoenas, AIG finally handed over an internal white paper, written in 1997 by an AIG accountant and circulated widely among AIG's top insurance-unit managers. The paper outlined a new type of "nontraditional" insurance product. Its main attribute: "income statement smoothing" using retroactive insurance that let clients recognize losses over several reporting periods -- exactly what AIG did for Brightpoint. The paper, says an SEC document, conceded that accounting rules were designed to avoid such a smoothing effect and outlined ways to avoid such "unintended accounting...consequences." AIG, the SEC says, marketed the new products on a large scale.
CAUGHT IN A LIE
Yet in September, 2002 -- a month before the SEC obtained the paper -- AIG lawyers had told the SEC Enforcement Div. that the Brightpoint policy was the result of errors by a junior-level worker without proper training. Then, after the smoking gun turned up -- the SEC won't say how -- AIG gave sworn certification that it had produced all relevant documents.
Again not true, says a person with knowledge of the case. "AIG failed to conduct an even remotely reasonable search, such as checking the files and computer drives," says this source. The SEC issued another subpoena, and a welter of new documents was finally delivered -- some as late as January '03.
Now the SEC is chasing new leads, including the PNC case. There, PNC avoided writing down $762 million in underperforming loans and sour venture-capital deals by shifting them to an off-balance-sheet entity formed with the help of a different AIG unit. That let PNC show earnings in 2001 that were 52% rosier than they would have been without the special- purpose vehicle. The SEC in July, 2002, alleged that the structure violated accounting rules because PNC still was on the hook for the problem assets yet didn't reflect those risks on its balance sheet. PNC settled Justice and SEC charges without admitting wrongdoing.
Even if AIG is downplaying the probes, investors aren't. The shares have dropped 6.5%, to $66.60, since Sept. 20. Now that Justice and the SEC are working hand- in-glove against the finance giant, its woes may be just beginning.
By Paula Dwyer in Washington, with Diane Brady in New York
— With assistance by Diane Brady