A potential legal blockbuster involving top executives at General Re and AIG was disclosed in today’s New York Times. According to the Times’ report, three former top executives at Berkshire Hathaway’s General Re subsidiary and the former head of AIG’s reinsurance operation are to be charged today with civil and criminal complaints stemming from AIG’s alleged use of improper financial transactions to boost reserves.
The charges have been brewing for months, and are among the most serious offenses that emerged from NY Attorney General Eliot Spitzer’s investigations into AIG. Of note, unlike previous charges which were filed at the state level by Spitzer and other state attorneys general, the complaints will be filed at the Federal level by the US Justice Department and the SEC. The reason is these charges are related to stock manipulation, a Federal issue.
At the risk of way over-simplifying the situation, it appears that AIG and General Re are charged with entering into a financial transaction designed to artificially add $500 million to AIG’s reserves in 2000 and 2001. However, the transaction did not meet the legal test necessary to qualify as an insurance policy, and was actually a loan. Why is that important? Unlike a straight insurance claim that transfers cash based on a legal claim from the insurer to the policyholder (your house burns down, the insurance company sends you a check for $400,000), a loan counts as a liability on the balance sheet (you take out a mortgage on your house for $400,000) (and the cash proceeds count as an asset).
This is not just a one-and-done thing, as it appears AIG and its chairman engaged in an ongoing effort to pump up the balance sheet, smoothing out earnings to keep the stock price heading ever upward.
This particular part of the mess arises out of the allegedly fraudulent accounting for the policy/loan. The deal served to make AIG’s financial statements appear stronger than they actually were. It appears this was an attempt to manipulate AIG’s stock price, a charge that has been levied against Hank Greenberg, the ousted chairman of AIG.
General Re is owned by Berkshire Hathaway, whose chairman Warren Buffett was not aware of the nature of the transaction. There are back and forth claims about what he knew and when he knew it, but the Times article is pretty clear that Buffett’s participation was likely after the fact and did not cross the line into illegal activity.
What does this mean for you?
The insurance scandals just will not go away, and this announcement means they’ll be with us for a while.
Feb
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