Tuesday, February 21, 2017

No. 205: Hank Greenberg and Howard Smith Settle with the New York Attorney General over Accounting Practices

On February 10, 2017, the office of the New York Attorney General (NYAG) issued a press release about the settlement of civil charges against Maurice ("Hank") Greenberg and Howard Smith, former executives of American International Group (AIG). Eliot Spitzer, the NYAG at the time, filed charges in 2005 over accounting practices relating to transactions that dated back to 2000.

The Departures
In March 2005, amid reports of accounting improprieties in AIG's financial statements, Chief Executive Officer Greenberg and Chief Financial Officer Smith refused to cooperate with investigators, and invoked their Fifth Amendment rights. AIG's board of directors fired Smith and forced Greenberg to resign.

The State Charges
In May 2005, Spitzer, together with Howard Mills, the New York superintendent of insurance at the time, filed civil charges in state court against AIG, Greenberg, and Smith. The complaint addressed eight matters. AIG settled the charges and restated its financial statements. Over the years since, Greenberg and Smith settled most of the state charges.

The recent settlement involved the remaining two charges. One of them involved a sham reinsurance transaction between AIG and General Reinsurance Corporation (Gen Re), a Berkshire Hathaway company. The reinsurance was a sham because it did not transfer risk.

The other remaining charge involved characterizing automobile warranty losses as investment losses rather than underwriting losses. Security analysts pay closer attention to underwriting losses than to investment losses. The recharacterization was accomplished through Capco Reinsurance Company (Capco), a Barbados company.

In July 2005, Greenberg's attorneys prepared an extraordinary memorandum challenging the restatements that AIG had made in its financial statements. The memorandum also discussed Greenberg's role in the transactions that had prompted the restatements.

The Federal Charges
In February 2006, the Securities and Exchange Commission (SEC) filed civil charges against AIG. The firm settled with the SEC, and at the same time settled with the U.S. Department of Justice (DOJ) to avoid the filing of criminal charges. AIG acknowledged that the accounting for the transactions was improper, had already restated its financial statements, and agreed to a global settlement of more than $1.6 billion to settle the state and federal charges.

That same month, the DOJ indicted four individuals—one from AIG and three from Gen Re—involved in the sham reinsurance. In September 2006, the DOJ filed an amended indictment adding another individual from Gen Re. The defendants became known as the "Hartford Five" because the federal jury trial was held in Hartford. The DOJ had powerful evidence in the form of tape recordings; a Gen Re affiliate involved in the transaction was located in Ireland, where it was routine to record telephone conversations. The jury convicted the Hartford Five, but a federal appellate court overturned the ruling on technical legal grounds. The DOJ decided not to retry the case, and entered into non-prosecution agreements under which the defendants paid substantial fines.

In August 2009, the SEC filed civil charges against Greenberg and Smith. They settled the charges the same day. Greenberg and Smith paid $15 million and $1.5 million, respectively, and neither admitted nor denied the allegations.

The Recent Settlement
The bench trial relating to the two remaining state charges against Greenberg and Smith was interrupted while the parties sought to settle the case. Kenneth Feinberg was the mediator. On February 10, 2017, Feinberg issued his recommendations. He referred to an "Agreement" that was "dated November 28, 2016, and subsequently amended." I asked the NYAG's press office for a copy of the agreement, but received no reply. I then asked the NYAG's office for the agreement pursuant to the New York Freedom of Information Law. I do not know when I will receive it.

On February 10, the NYAG announced the settlement in a press release entitled "A.G. Schneiderman Announces Settlement of Martin Act Case Against Former AIG CEO Maurice R. Greenberg and Former AIG CFO Howard I. Smith." The press release includes links to the statements Greenberg and Smith made as part of the settlement. The statements describe their roles in the Gen Re and Capco transactions. For example, Greenberg's statement reads in part:
The Gen Re transaction was done for the purpose of increasing AIG's loss reserves, and the Capco transaction was done for the purpose of converting underwriting losses into investment losses. I knew these facts at the time that I initiated, participated in and approved these two transactions.... I certified AIG's publicly-filed annual consolidated financial statements aware that the financial effects of these transactions were and continued to be reflected in those statements. As a result of these transactions, AIG's publicly-filed consolidated financial statements inaccurately portrayed the accounting, and thus the financial condition and performance for AIG's loss reserves and underwriting income. The accounting for the Gen Re transaction was correctly restated by AIG in AIG's 2005 Restatement.... The accounting for the Capco transaction was also restated by AIG in AIG's 2005 Restatement of the Company's financial results.
Greenberg agreed to pay $9 million (with interest), and Smith agreed to pay $900,000 (with interest). Those amounts were tied to cash bonuses they received in 2001 to 2004.

I mentioned earlier the July 2005 memorandum from Greenberg's attorneys challenging AIG's restatements. Now Greenberg says the "accounting for the Gen Re transaction was correctly restated by AIG."

The Aftermath
The NYAG's press release had three subtitles that included the words "fraudulent," "frauds," and "fraud," and the first sentence of the text included the word "fraud." Many prominent media outlets picked up on those words from the press release. As examples, a headline in The New York Times was "Two Ex-Executives Settle A.I.G. Fraud Case," and a headline in The Wall Street Journal was "Greenberg Settles Civil-Fraud Allegations in AIG Case."

Greenberg was furious, because the words "fraudulent," "frauds," and "fraud" are not in his statement related to the settlement with the NYAG. Greenberg announced a press conference "to set the record straight." Reportedly a member of the media asked Greenberg whether he was going to sue the NYAG, and Greenberg responded that the NYAG has immunity. The headline of a follow-up story in the Times was "Former A.I.G. Chief Tries to Fight the Headlines."

David Boies, Greenberg's attorney, issued a statement. Its final sentence reads: "Nowhere in the agreed statement by Mr. Greenberg is there any reference to any accounting being fraudulent, let alone that Mr. Greenberg was aware of any fraud."

I asked the NYAG's press office to comment on the Boies statement, but received no reply. However, a spokesman for the NYAG reportedly said that Greenberg's admission "speaks for itself: Mr. Greenberg initiated, participated in, and approved two transactions that fundamentally misrepresented AIG's financial performance to shareholders. No number of press conferences or TV interviews by Mr. Greenberg or Mr. Boies is going to change that fact."

Schiff's Writings
David Schiff wrote extensively about AIG and Greenberg in Schiff's Insurance Observer. I asked Schiff for a statement to be included in the package I am offering to readers. He provided a statement in which the final paragraph begins: "But just because he hasn't pled guilty to fraud doesn't mean he's vindicated. He is, at best, a stained legend." Schiff's statement includes a link to his "AIG Chronicles," which consist of 23 articles from 1993 to 2007.

My Writings
I wrote extensively about AIG and Greenberg in The Insurance Forum. My first article about them included in an appendix the full text of the original Spitzer/Miils complaint. Another article included in an appendix the transcripts of the tape recordings of the telephone conversations that the DOJ used in prosecuting the Hartford Five. My articles appeared in eight issues of the Forum from 2005 to 2012.

General Observations
Greenberg, now 91, will never give up. He has never admitted and will never admit he committed fraud, engaged in fraudulent transactions, or was aware of fraudulent transactions. He spent 40 years building AIG into one of the largest insurance companies in the world, and he became one of the most powerful insurance executives in the world. He does not want to be remembered as having committed fraud, engaged in fraudulent transactions, or been aware of fraudulent transactions.

The key problem is that the recent settlement agreement, which I have not yet seen, probably does not contain the language of an agreed-upon joint statement that the parties could have used in announcing the settlement. That is an important lesson to be learned from the events that occurred in the wake of the recent settlement.

Available Material
I am offering a complimentary 63-page PDF consisting of the Feinberg recommendations (1 page), the NYAG press release (2 pages), the Greenberg statement (1 page), the Smith statement (1 page), the Boies statement (2 pages), the Schiff statement (2 pages), and articles from eight issues of the Forum (54 pages). Email jmbelth@gmail.com and ask for the February 2017 package relating to the settlement of the NYAG case against Greenberg and Smith.