Tough Questions For AIG's Auditors

Regulators are probing if PwC let the financial shenanigans slip through

Where were the auditors? Now that American International Group Inc. has admitted to a clutch of accounting improprieties and is mulling whether to restate its past results, an all-too-familiar question is emerging: Why didn't the auditor catch what was going on?

Were misdoings hidden from AIG's longtime auditing firm, PricewaterhouseCoopers, or did the firm turn a blind eye to problems it should have seen? Indeed, some of the searing heat that has so far felled AIG Chief Executive Maurice R. "Hank" Greenberg and several other execs could soon scorch the $17.5 billion accounting giant. "I'm sure they will be under suspicion," says J. Edward Ketz, associate professor of accounting at Pennsylvania State University.

Because of its role as a dominant force in auditing and accounting for insurance companies, PricewaterhouseCoopers' work for the outfit is bound to get an especially close going-over from regulators and shareholders alike. Certainly, the outfits were close. PwC or its predecessor companies, such as Coopers & Lybrand, had done work for AIG going back more than 20 years. How deep were the ties? Recently ousted Chief Financial Officer Howard I. Smith, whom AIG fired for refusing to cooperate with investigators in the latest probes, had worked at Coopers & Lybrand for 19 years and was the head partner in its New York insurance practice before joining AIG in 1984.

More important, PwC was AIG's auditor through its long years of questionable dealings. AIG on Mar. 30 said that deals with a Barbados-based insurance company, for instance, may have been incorrectly accounted for over the past 14 years, because an AIG-affiliated company may have been secretly covering that insurer's losses. If AIG has to unwind its dealings with the Barbados company, it may be forced to take a big earnings hit. More recently, PwC appears to have dropped the ball on the now-notorious reinsurance deals between AIG and Berkshire Hathaway Inc.'s General Re Corp.

In those deals, General Re transferred $500 million in anticipated claims and premiums to AIG. At issue for PwC: Did the auditor do its job by verifying that AIG was assuming risk on claims beyond the $500 million, thus allowing AIG to account for the deal as insurance? That's Accounting 101 in any reinsurance transaction. But the company itself now admits the business should have been accounted for as a deposit rather than as insurance. "The auditor obviously should really stop and think about this because the transaction really doesn't pass the smell test," says Penn State's Ketz.

In its statement, AIG has admitted that some of the paperwork associated with the deals was improper -- but it's not clear whether the deals were illegal or how much PwC was told about them. AIG says much of the information only recently came to light. And PwC could have been duped or denied information. But given PWC's long-standing relationship with AIG, the thoroughness of its auditing over many years will surely come under question. "These seem like things you'd expect an auditor to look at," says New York attorney Gerald H. Silk, a plaintiffs' lawyer whose firm has brought cases against Arthur Andersen and other big auditing firms. "There are sufficient red flags." PwC declined comment, citing client confidentiality requirements, although the firm is said to be cooperating with investigators.

How vulnerable could PwC be? Already, institutional shareholders, who sued AIG last fall when its stock began a 21% plunge amid the investigations, are considering roping the auditing firm into a class action. "As the case develops we'll be bringing in other responsible parties," says Thomas A. Dubbs, a New York lawyer for three big Ohio pension funds that have lost tens of millions of dollars on their AIG holdings. Dubbs, working on behalf of the Ohio Attorney General in the class action, adds that PwC may be among the shareholder targets. And regulators say PwC could also face regulatory action.

PwC's level of culpability could take years to sort out. Just what the firm knew, or should have known, is bound to be a much-contested issue. Already, though, it is looking at a hefty blemish on its role as a leader in insurance accounting. The growing tumult born of AIG's questionable accounting is just beginning.

By Joseph Weber in Chicago, with Mike McNamee in Washington and Marcia Vickers and Diane Brady in New York

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