Monday, March 6, 2017

No. 207: The Hank Greenberg/Howard Smith/New York Attorney General Settlement of Civil Charges—A Follow-Up

In No. 205 (posted February 21, 2017), I discussed the recent settlement of civil charges by the New York Attorney General (NYAG) against Maurice ("Hank") Greenberg and Howard Smith, former executives of American International Group, Inc. (AIG). Greenberg's attorneys are in the firm of Boies, Schiller & Flexner LLP. When I posted No. 205, I sent it as a courtesy to a Boies spokesman. He sent me eight "factual points," which he asked me to "fix in the interests of accuracy." I asked him for several documents, and he provided all but two. This follow-up shows his eight points and my comments on them. I also expand here on my brief reference in No. 205 to AIG's 2006 global settlement with federal and state agencies. That settlement is relevant to several of the points and comments below.

Point 1: You write that, "Over the years since, Greenberg and Smith settled most of the state charges." That is not the case. The other claims and the pursuit of damages were all dropped by the NYAG, not settled.

Comment 1: The documents I received from the Boies spokesman in response to my request show that the NYAG dropped the charges against Greenberg and Smith, other than the two recently settled charges, and did not pursue damages relating to the dropped charges. I stand corrected.

Point 2: You also write the following: "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.'" This is misleading because the bulk of the White Paper on the Restatement had to do with other items.

Comment 2: In response to my request, the Boies spokesman sent me the "White Paper on the Restatement," which I called the "July 2005 memorandum from Greenberg's attorneys." The 49-page document includes a three-page discussion (on pages 16-19 of the PDF) of the Gen Re transaction and the question of what constitutes a sufficient transfer of risk to qualify a transaction for accounting treatment as reinsurance. In the statement that is part of the recent settlement with the NYAG, and as shown in No. 205, Greenberg said: "The accounting for the Gen Re transaction was correctly restated by AIG in AIG's 2005 Restatement." So that readers can understand the full context of the three-page discussion of the Gen Re transaction, I am including the 49-page document as part of the package offered at the end of this post. I believe that my characterization of the document as challenging AIG's restatements was not misleading.

Point 3: You state as fact: "Security analysts pay closer attention to underwriting losses than to investment losses." That is disputed, and in fact the effect of the Capco transaction on AIG's Combined Ratio was immaterial (less than 0.5 percent in any year).

Comment 3: I asked the Boies spokesman for documents showing that one or more persons think security analysts do not pay closer attention to underwriting losses than to investment losses. He sent me an excerpt from trial testimony by Greenberg that "The combined ratio is the key ratio for that in determining whether you make a profit." He also sent me excerpts from the testimony of other AIG witnesses. I still believe that security analysts pay closer attention to underwriting losses than to investment losses, and that Greenberg's concern about the matter prompted the Capco transaction. Also, I said nothing in No. 205 about materiality.

Point 4: You also state about the transaction with Gen Re, "The reinsurance was a sham because it did not transfer risk." There was no finding of that—that's just the allegation.

Comment 4: I asked the Boies spokesman for documents showing the reasoning of one or more persons who believe that the Gen Re transaction transferred risk. He sent me excerpts from trial testimony by Greenberg, Smith, and other AIG witnesses, such as the statement that "AIG reasonably believed that the transaction transferred risk and could be accounted for as reinsurance." However, in the trial of the "Hartford Five," the transcripts of the telephone conversations show that Gen Re executives viewed the absence of risk transfer as the key problem with the transaction. Gen Re treated the transaction as a deposit rather than as reinsurance, and in 2005 AIG restated its financial statements to treat the transaction as a deposit rather than as reinsurance. I still believe that the transaction was a sham that did not transfer risk and therefore did not qualify as reinsurance for accounting purposes.

Point 5: Regarding the statement that you have not seen the settlement agreement, you have in fact seen all the documents, including Feinberg's recommendations, which contain the provisions of the settlement. (The only thing you haven't seen, as far as I know, is the Mediation Agreement.)

Comment 5: I am not sure what the Boies spokesman's complaint is on this point, because he agrees with me that I have not seen the settlement agreement, which he calls the "Mediation Agreement." Perhaps he is saying I do not need to see that document. In any case, I asked him for the original version and the amended version of it. He said they are confidential. He said the original version is simply an agreement to enter into mediation before Feinberg and identifies the procedures to be followed. He said the amended version simply extends the schedule for completion of the mediation process. I fail to see why such documents should be confidential.

Point 6: Also, you suggest that Greenberg and Smith paid interest on top of the $9 million for Greenberg and $900,000 for Smith. In fact those amounts were inclusive of interest.

Comment 6: I said this in No. 205: "Greenberg agreed to pay $9 million (with interest), and Smith agreed to pay $900,000 (with interest)." My comments about interest were based on an ambiguous statement in the Feinberg recommendations that Greenberg and Smith "personally disgorge a total amount of $9,900,000 from cash bonuses received plus interest, with Mr. Greenberg personally paying $9,000,000 and Mr. Smith personally paying $900,000." I asked the Boies spokesman for the original and amended agreements in an effort to clear up the ambiguity.

Point 7: Where you say "The DOJ had powerful evidence in the form of tape recordings"—that evidence implicated the Gen Re defendants, not Milton (the AIG defendant).

Comment 7: Christian Milton, from 1985 to 2005, was an AIG vice president with responsibility for reinsurance. His name appeared only once in the Gen Re recordings, but the context implicated him in the AIG/Gen Re transaction. See Comment 8 below showing that he paid a larger fine than two others of the Hartford Five. He also received the longest prison term, although the Hartford Five did not serve their prison terms because the convictions were overturned on appeal.

Point 8: Finally, you write that the Hartford "defendants paid substantial fines." These amounts were not "substantial," and you also fail to mention that the reason the case wasn't retried was the severe criticism of the Government's principal witness (Napier).

Comment 8: John Houldsworth and Richard Napier, both of Gen Re, pleaded guilty. Napier testified for the government during the trial, and questions have been raised about the veracity of his testimony. However, I have no insight into the minds of the prosecutors about why they decided not to retry the case. Also, I think the fines were substantial. So that readers can decide, I show below the fines the district court judge imposed. In parentheses are the prison terms the judge imposed. The defendants did not serve prison time because the convictions were overturned on appeal and the case was not retried. They paid the fines pursuant to deferred prosecution agreements.
Ronald Ferguson of Gen Re: $200,000 (24 months)
Christopher Garand of Gen Re: $150,000 (12 months)
Robert Graham of Gen Re: $100,000 (12 months)
Christopher Milton of AIG: $200,000 (48 months)
Elizabeth Monrad of Gen Re: $250,000 (18 months)
The 2006 Global Settlement
On February 9, 2006, in an 8-K (significant event) report filed with the Securities and Exchange Commission (SEC), and in a press release, AIG announced four settlements—an agreement with the DOJ, a final judgment and consent with the SEC, a settlement agreement with the NYAG, and a stipulation with the New York Department of Insurance. AIG said: "As a result of these settlements, AIG will make payments totaling approximately $1.64 billion." The settlements were attached to the 8-K report as exhibits.

One of the settlements was a February 6, 2006 letter agreement between the DOJ and AIG. The letter was signed by a DOJ official, an attorney for AIG, and Martin Sullivan, the AIG chief executive officer who succeeded Greenberg. The letter focused on the Gen Re and Capco transactions. Here are excerpts about them:
On or about May 31, 2005, AIG filed its 2004 Form 10-K with the SEC which reversed and restated the $500 million increase in loss reserves relating to the AIG/Gen Re [transaction] and stated in part: "AIG has concluded that the transaction was done to accomplish a desired accounting result and did not entail sufficient qualifying risk transfer. As a result, AIG has determined that the transaction should not have been recorded as insurance. AIG's restated financial statements recharacterize the transaction as a deposit rather than as insurance."
In 2000, AIG initiated a scheme to hide approximately $200 million in underwriting losses in its general insurance business by improperly converting them into capital losses (i.e., investment losses) that were less important to the investment community, and thus would blunt the attention of investors and analysts.... In its restatement filed with the SEC in 2005, AIG admitted that the Capco transaction "involved an improper structure created to recharacterize underwriting losses relating to auto warranty business as capital losses. That structure ... appears to have not been properly disclosed to appropriate AIG personnel or its independent auditors."
General Observations
In No. 205, I said Greenberg would never give up. The response from the Boies spokesman supports that statement. The response and the assembling of the documents I requested must have required the expenditure of a substantial (from my viewpoint) amount of time and money by the Boies firm and therefore by Greenberg. However, the amount is surely trivial relative to the total expenses incurred by Greenberg in his 12-year legal battle with federal and state agencies.

The relatively small amount of feedback I received from No. 205 suggests little interest currently among readers. Nonetheless, at the request of the Boies spokesman, I decided to post this follow-up.

Available Material
The 63-page PDF I offered in No. 205 is still available. Now I am offering another complimentary 57-page PDF consisting of AIG's 3-page 2006 press release, the 5-page 2006 AIG/DOJ settlement, and the 49-page "White Paper on the Restatement." Email and ask for the March 2017 package relating to AIG's 2006 settlements.