SEC v. Hank Greenberg

Plaintiff Securities and Exchange Commission ("Commission"), for its Complaint against Defendants Maurice R. Greenberg and Howard 1. Smith (collectively, "Defendants"), alleges as follows:



SUMMARY OF ALLEGATIONS



I. From at least 2000 until 2005, Maurice R. Greenberg, the former chairman and chief executive officer ofAmerican International Group, Inc. ("AIG"), and Howard 1. Smith, AIG's former chieffinancial officer, directed several different accounting transactions to materially affect AIG's reported financial results. The transactions affected multiple reporting periods and one ofthem did not conclude until 2005, when Greenberg and Smith left the company.



2. Greenberg publicly described AIG as the leader in the insurance and financial services industry with a history of delivering consistent double-digit growth in key financial perfonnance measures. Investors rewarded AlG for this consistency by trading the stock at a premium compared to the company's competitors. In reality, AIG under Greenberg faced a number of financial challenges that, had they been properly reported or accounted for, would have exposed significant missteps in AlG's operations and caused the company to miss certain key earnings and growth targets. Greenberg, as a control person ofAIG, and Smith, as AIG's . chief financial officer, were aware oftransactions that enabled AlG to create the false impression that it consistently met or exceeded expectations for these key financial measures, and Smith .'.: knew or recklessly disregarded that AIG's accounting for these transactions was not in conformity with generally accepted accounting principles ("GA,AP").



3. The three primary areas of fraud were: (1) transactions with General Re Corporation ("GenRe") in which AlG purportedly increased its loan loss reserves; (2) transactions with Capco Reinsurance Company Ltd. ("Capco"), a special purpose entity AIG created and used to conceal underwriting losses by converting them improperly to capital losses; and (3) transactions to misstate net investment income or capital gains.



4. The Gen Re Transactions. In 2000, after analysts criticized AlG for its declining loss reserves and investors punished the stock, Greenberg initiated two reinsurance transactions with a foreign subsidiary ofGeneral Re Corporation ("Gen Re"). By accounting for them improperly as real reinsurance, AlG falsely reported increases to both loss reserves and premiums written. These two key perfonnance measures remained inflated in AIG's financial statements until its 2005 restatement. Smith, as AIG's chieffinancial officer, knew or recklessly disregarded that AIG's accounting for these transactions as reinsurance was not in confonnity with GAAP and Greenberg publicly described the purported improvement in reserves. The transactions had no economic substance, amounting to a round trip ofcash, but they were designed to, and did, have a specific and false accounting effect. Without the phony loss reserves added to AIG's balance sheet, AIG's reported loss reserves would have been $250 million less in the fourth quarter of2000 and an additional $250 million less in the first quarter of2001.



5. During the period when AIG's financial tesu~ts were misstated as a result of the phony loss reserves added to its balance sheet, AIG distributed its stock in connection with its August 29,2001 acquisition ofAmerican General Corporation ("American General") to .... ' American General stockholders. Greenberg and Smith signed a registration statement for this distribution that incorporated by reference AIG financial statements containing the phony loss reserves.



6. . The Capco Transactions. Underwriting was ArG's core business. When AIG's auto warranty underwriting business was suffering in 2000, AIG was facing projected losses of approximately $210 million. Instead ofreporting th'ese underwriting losses, Greenberg initiated and approved a reinsurance transaction with Capco, an offshore shell company funded and controlled by AIG, to inaccurately re-characterize and report the underwriting losses as capital losses. Capital losses were less troublesome to investors because they viewed them as not relating to AIG's core business. To avoid consolidation of the shell company on AIG's financial . statements, Greenberg proposed finding purported investors for the shell company through a contact in Switzerland, and Smith approved funding by AIG of non-recourse loans to the investors to pay for their purported investment. Smith also approved AIG's accounting for the transactions. Greenberg and Smith then approved as AIG spread the impact ofthe capital losses over several reporting periods. By using Capco to convert improperly the underwriting losses to capital losses, AIG materially overstated its adjusted underwriting profits for its general insurance operations in 2001 by over 100 percent (or 11 percent excluding the losses associated with the World Trade Center attacks that year).



7. Transactions to Misstate Net Investment Income or Capital Gains. Smith also knew about or recklessly disregarded AIG's improper accounting for three sets of transactions that enabled AIG to manufacture and report improper gains that were material to AIG's financial statements. Two of these transactions, one involving covered calls and the other involving hedge fund investments, resulted in AIG's improper recognition ofthe unrealized appreciation on its investment portfolio as general insurance net investment income (''NIl''), one ofAIG's key financial barometers, and the third set oftransactions resulted in understatements ofAIG's reported capital losses. Greenberg made materially inaccurate public statements relating to at least two of the sets of transactions in 2002.



8. . In the economically senseless covered calls transactions during 2001, AIG recognized as NIl the unrealized appreciation in AIG's municipal bond portfolio without actually selling or otherwise extinguishing AIG's ownership interest in those bonds. Smith knew or recklessly disregarded thatAIG's accounting for the covered calls transactions was not in conformity with GAAP. As a result, AIG's financial statements overstated NIl for its general insurance segment by $60 million or 9 percent for the third quarter of2001; by $86 million or 13 percent for the fourth quarter of2001; and by $146 million or 5.3 percent for the 2001 fiscal year.



9. During 2001, Smith knew about or recklessly disregarded AIG's improper accounting in connection with another set of transactions to overstate reported NIl. These transactions were designed to "harvest" unrealized gains in AIG's hedge fund investments without relinquishing AIG's financial interest in the hedge funds. As part ofthese hedge fund transactions, Smith directed AIG to enter into round trip transactions in which AIG appeared to redeem a portion ofits interest in certain hedge funds back to the hedge funds, recorded the resulting cash payment from the funds as net investment income, and agreed at the time of the purported redemption to return the cash payment to the hedge funds, thereby simultaneously reestablishing AIG's interest in the fund. In at least one ofthese instances, Smith approved a loan ofcash from AIG to a hedge fund so that the fund could distribute the same amount ofmoney back to AIG. As a result ofthe hedge fund transactions, AIG overstated NIl for its general insurancesegment by$104million or 17.3 percentforthesecondquarter of2001; by $133 million or 22.5 percent in the third quarter of2001; and by $165 million or 6.1 percent for the 2001 fiscal year.



10. A similar deceptive set oftransactions falsified AIG's capital gains. In these transactions, which began in 2000 and affected reporting periods during 2001,.Smith approved AIG's transfer of certain municipal bonds from its investment portfolio to municipal tender option bond trusts ("Muni Tobs") that AIG controlled, improperly recorded capital gains from the transfer, caused the trusts to be extinguished, then re-acquired the same bonds that AIG had temporarily placed in the trusts. As a result of the Muni Tobs transactions, AIG understated its reported realized capital losses for its general insurance segment by $46 million or 55.5 percent inthesecondquarter of2001, by$83 millionor48percentinthethirdquarter of2001;andby $205 million or 61.3 percent for the 2001 fiscal year.



11. With respect to these three matters, Smith knew or recklessly disregarded that AIG's accounting for them was not in conformity with GAAP and he is liable for the material misstatements in AIG's financial statements resulting from them. Greenberg, who knew about the effects of these transactions on AIG's reported financial results, is liable, as a control person, with Smith for false and misleading public statements and material omissions in press releases, investor conference calls and in AIG's Forms lO-Q relating to the impact of two of them, the covered calls and the hedge fund transactions, on the reasons for the reported decline in AIG's NIl in the second and third quarters of2002.



12. In 2005, AIG restated its prior accounting for these and other matters. In its restatement, AIG admitted riot only that its accounting for certain transactions had been improper, but also that the purpose behind those transactions was to show improvements in financial measurements that the company believed were important to the market. AIG conceded in its restatement that certain transactions may have "involved documentation that did not accurately reflect the true nature ofthe arrangements ... [and] misrepresentations to members of management, regulators and AIG's independent auditors." AIG's restatement shaved approximately $2.26 billion from shareholders' equity as ofDecember 31, 2004, and exposed an overstatement in AIG's retained earnings of 10 percent through December 31, 2003.



VIOLATIONS



13. By their conduct, Greenberg and Smith are liable as control persons for AIG's violations of Sections 1O(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.c. §§ 78j(b), 78m(a), 78(m)(b)(2)(A), and 78(m)(b)(2)(B)] and Rules lOb-5, 12b-20, 13a-l,.and 13a-13 [17 C.F.R. §§ 240.10b-5, 240. 12b-20, 240. 13a-l , and 240.13a-13]. By his conduct, Smith violated Section 17(a) of the Securities Act [15 U.S.c. § 77q(a)] and Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. §§ 78j(b) and 78m(b)(5)) and Rules lOb-5, 13a-14, 13b2-1, and 13b2-2 (17 C.F.R. §§ 240.lOb-5, 240.13a-14, 240.13b2-1, and 240.13b2-2). JURISDICTION AND VENUE



14. The Commission brings this action pursuant to the authority conferred upon it by Section20(b) ofthe Securities Act[15 U.S.C. §77t(b)) andSection21(d)(1) oftheExchange Act [15 USc. § 78u(d)(1)) seeking a final judgment: (i) permanently enjoining the defendants from violating and/or from controlling any person who violates certain specified provisions of the federal securities laws; (ii) requiring Greenberg and Smith to disgorge any ill-gotten gains; (iii) imposing civil moneypenalties against Greenberg pursuantto Section 21(d)(3) ofthe Exchange Act [15 U.S.C. § 78u(d)(3)) and against Smith pursuant to Section 20(d) ofthe Securities Act [15 U.S.C. § 77t(d)] and Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)] and (iv) barring Smith from serving as an officer or director ofany issuer that has a classofsecuritiesregisteredunderSection 12oftheExchangeAct[15 U.S.c. §781]orthatis required to file reports pursuant to Section 15(d)ofthe Exchange Act [15 U.S.c. § 780(d)] for a period ofthree years from the date ofentry ofthe final judgment.



15. This Court has jurisdiction over this action pursuant to Section 22{a) of the Securities Act [15 U.S.c. § 77v(a)] and Sections21(e) and 27 ofthe Exchange Act [15 U.S.c. §§ 78u(e) and 78aa].



16. Venue lies in the Southern District of New York, pursuant to Section 22(a) of the Securities Act (15 U.S.c. § 77v(a)) and Section 27 ofthe Exchange Act [15 U.S.c. §§ 78u(e) and 78aa]. AIG's principal corporate offices are located in New York, New York.



17. Defendants, directly or indirectly, singly or in concert, have made use of the means and instrumentalities ofinterstate commerce, or of the mails, in connection with the



THE DEFENDANTS



18. Maurice R. "Hank" Greenberg, age 84, is a resident ofNew York, New York. At all relevant times, Greenberg was a person who controlled AIG, and he was the chairman of . AIG's board ofdirectors and chief executive officer. Greenberg joined AIG in 1960 and became chiefexecutive officer in 1967. In 1989, he also became Chairman. On March 14,2005, AIG's board ofdirectors required Greenberg to step down from his position as chiefexecutive officer. Although the AIGboard permitted Greenberg to remain non-executive chairman ofAIG, he resigned from that position on June 8, 2005.



19. Howard I. Smith, age 64, is a resident ofWoodbury, New York. At all relevant timesSmithwasAIG's chieffinancialofficerandamember ofAIG'sboardofdirectors. AIG terminated his employment on or about March 22, 2005. Smith formerly was an audit partner at a major accounting firm. At all relevant times, Smith was a certified public accountant.



OTHER RELEVANT ENTITIES



20. AIG, a Delaware corporation, is a holding company that, through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG's common stock is registered with the Commission pursuant to Section l2(b) ofthe Exchange Act and is listed on the New York Stock Exchange. On February 9, 2006, the Commission filed a complaint against AIG in this Court (No. 06 CV 1000) alleging, among other things, that AIG violated Section 10(b) of the Exchange Act [15 U.S.c. § 78j(b)] and Rule lObS.



Without admitting or denying the allegations ofthe complaint, AIG consented to a final judgment that, among other things, permanently enjoined it from violating Section 1O(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 [17 C.F.R. § 240.lOb-5]. The Court entered the consent judgment on February 17,2006.



21. Gen Re is a Connecticut corporation with its principal corporate offices located in Stamford, Connecticut. Gen Re is a holding company for global reinsurance and related risk assessment, risk transfer, and risk management operations. Gen Re became a wholly owned subsidiary of Berkshire Hathaway, Inc. on December 21, 1998. Berkshire Hathaway's Class A and Class B common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and is traded on the New York Stock Exchange.



22. Capco was a Barbados reinsurer and shell company thatAIG, through a subsidiary, recapitalized for use as a special purpose entity. Capco was liquidated in 2002. FACTS



I. Transactions to Create the Appearance of Increased Loss Reserves



23. On October 26,2000, AIG issued its third quarter earnings release showing an approximate $59 million decline in general insurance reserves.



24. This reduction in general insurance reserves drew criticism from certain analysts. For example, one analyst wrote: "One concern over the past several quarters has been reserve growth, which has been minimal or even has declined in certain quarters. There has been concern that AIG is releasing reserves to make its numbers." Other analysts voiced similar concerns.



25. At least two analysts downgraded AIG after the earnings release.



26. Following AIG's third quarter 2000 earnings release, issued on October 26,2000, AIG's stock price dropped 6%.



27. Greenberg was unhappy about these developments. Just a few days later, on approximatelyOctober31,2000, Greenbergcalled GenRe'schiefexecutiveofficertoproposea transaction whereby Gen Re would transfer $200 million to $500 million ofl08s reserves to AIG by year-end. He wanted the transfer ofloss reserves to be short term, for six to nine months. Greenberg later said that he wanted the portfolio to contain "long-tailed lines," which means that ifany losses had to be paid, they would be paid in later years -well after the anticipated life of the transaction.



28. In conversations regarding this proposed transaction, Greenberg made it clear that he wanted a transaction that increased ArG's reserves, but which would have no net impact on ArG's income statement.



29. But obtaining additionaUoss reserves was not possible because Greenberg did not want to have any negative impact on ArG's income statement. For the transaction to have the, desired effect on AIG's loss reserves, it had to qualify as reinsurance, and this means that it had to involve a transfer ofrisk to AIG.



30. Smith knew about the proposed Gen Re transaction and followed up to ensure that what Greenberg wanted was being done. Smith also was involved in the decision to structure the Gen Re deal as two transactions. He was aware ofthe details ofthe transactions and knew or recklessly disregarded that no underwriting analysis was done in connection with the deal. Smith also was involved in structuring and executing side agreements to conceal that AIG, through a subsidiary, was paying a $5 million fee to Gen Re to compensate Gen Re for executing the transactions and that AIG was refunding a $10 million purported premium that Gen Re, through its offshore subsidiary, paid to AIG. Smith also approved reinsurance accounting for the ·.transactions although he knew, or recklessly disregarded, that such accounting was not in conformity with GAAP.



A. The Sham Reinsurance Transactions



30. Greenberg assigned an AIG senior executive to structure the deal with Gyn Re. Gen Re's chief executive officer turned to several Gen Re senior executives, including Gen Re's chieffinancial officer, to work out the details ofthe transaction.



31. AIG and Gen Re then fashioned two contracts between National Union Fire Insurance Company ofPittsburgh, PA ("National Union"), an AlG subsidiary, and Cologne Re Dublin ("CRD"), a Dublin, Ireland-based subsidiary ofa Gen Re subsidiary. These purportedly were retrocession contracts, or contracts in which a reinsurer cedes to another reinsurer all or part ofa reinsured risk itpreviously assumed -in other words, reinsurance ofreinsurance.



32. The contracts show reinsurance transactions that appeared to transfer risk to AlG, but the transactions did not transfer risk. On the·face ofthe contracts National Union appeared to assume $100 million ofrisk over and above the $500 million in premiums CRD was obligated to pay, but this extra $100 million ofrisk was pure fiction added to make it appear that the contracts transferred risk to National Union. In fact, National Union assumed no risk and CRD incurred no premium liability. Ofthe $500 million in premiums set forth in the contracts, $490 million was on a "funds withheld" basis (i.e., the money was never paid to National Union but was retained by CRD). CRD was supposed to pay the remaining $10 million to National Union according to the contracts, but AlG "prefunded" the $10 million to CRD in what amounted to a round trip ofcash in a side deal that was not reflected in the contracts.



33. The purported reinsurance transactions had no real economic substance. The sole purpose ofthe transactions was to manipulate AIG's financial statements. AIG paid Gen Re a $5 million fee for putting the deal together -a side deal not reflected in the contracts. Moreover, a phony paper trail was concocted to create the false appearance that Gen Re had solicited the reinsurance from AIG when iIi fact Greenberg had solicited it from Gen Re.



34. These contracts became the vehicle for fraudulently adding loss reserves to AIG's financial statements. Without the phony loss reserVes added to AIG's balance sheet and described in its earnings releases, AIG's earnings releases would have shown continued reductionsinlossreserves forthefourth quarter of2000andthefirstquarter of2001,insteadof $500 million ofadditional loss reserves.



B. Reinsurance Accounting Principles



35. Had this been real reinsurance involving a real transfer ofrisk, it would have been permissible under GAAP for AIG to record reserves in the amount ofthe loss that was probable and reasonably estimable. Under Statement ofFinancial Accounting Standards ("SFAS") No. 113, Accounting and Reportingfor Reinsurance ofShort-Duration and Long-Duration Contracts, a reinsurer may record a loss reserve pertaining to a reinsuran

The Securities and Exchange Commission today charged former American International Group Chairman and CEO Maurice "Hank" Greenberg and former Vice Chairman and CFO Howard Smith for their involvement in numerous improper accounting transactions that inflated AIG's reported financial results between 2000 and 2005. The SEC alleges that Greenberg and Smith are liable as control persons for AIG's violations of the antifraud and other provisions of the securities laws. Smith also is charged with direct violations of the antifraud and other provisions of the securities laws.



The SEC alleges that Greenberg and Smith were responsible for material misstatements that enabled AIG to create the false impression that the company consistently met or exceeded key earnings and growth targets. According to the SEC's complaint, Greenberg publicly described AIG as the leader in the insurance and financial services industry with a history of delivering consistent double-digit growth. However, AIG faced numerous financial challenges under Greenberg's leadership that were disguised through improper accounting.



Greenberg and Smith agreed to settle the SEC's charges and pay disgorgement and penalties totaling $15 million and $1.5 million, respectively. The SEC previously charged AIG in 2006 with securities fraud and improper accounting, and the company settled the charges by paying disgorgement of $700 million and a penalty of $100 million, among other remedies.



"Corporate leaders cannot avoid the truth and consequences of their companies' performance by using improper accounting gimmicks and signing off on distorted financial reports," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Greenberg and Smith oversaw various improper transactions that presented a false financial picture and allowed AIG to claim success in meeting its performance goals."



Andrew M. Calamari, Associate Director of the Commission's New York Regional Office, added, "Executives who are responsible for financial reporting and controls will be held accountable when they or their companies orchestrate fraudulent transactions to polish results and mask the truth from investors."



The SEC's complaint, filed in U.S. District Court for the Southern District of New York, charges the defendants with responsibility for the following improper accounting transactions:



*



Sham reinsurance transactions to make it appear that AIG had legitimately increased its general loss reserves. *



A purported deal with an offshore shell entity to conceal multi-million dollar underwriting losses from AIG's auto-warranty insurance business. *



Economically senseless round-trip transactions to report improper gains in investment income. *



The purported sale of tax exempt municipal bonds owned by AIG's subsidiaries to trusts that AIG controlled in order to improperly recognize realized capital gains.



The SEC's complaint alleges that Greenberg knew about the effects that certain improper transactions would have on AIG's reported financial results, and along with Smith was responsible for false and misleading public statements and material omissions in quarterly reports that AIG filed in the second and third quarters of 2002, and in related press releases and investor conference calls. In 2005, AIG restated its prior accounting for many transactions, including those that are the subject of the charges in the SEC's complaint.



Without admitting or denying the SEC's allegations, Greenberg has consented to a judgment enjoining him from violating the antifraud provisions of the Exchange Act, and from controlling any person who violates the reporting, books and records and internal control provisions of the federal securities laws, and directing him to pay a penalty of $7.5 million and disgorgement of $7.5 million.



Without admitting or denying the SEC's allegations, Smith has consented to a judgment enjoining him from violating the antifraud and other provision of the securities laws, and from controlling any person who violates the reporting, books and records and internal control provisions, directing him to pay a penalty of $750,000 and disgorgement of $750,000, and prohibiting him from acting as an officer or director of any public company for three years. Smith also consented to the entry of a Commission order that will suspend him for five years from appearing or practicing before the Commission as an accountant.