AIG Executive to be Sentenced for Fraud Conviction

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In the flurry of financial crisis stories, the media has neglected to mention the recent conviction of an AIG executive for accounting fraud. The crime is for "side letters" - much like the off-book arrangements that figured centrally in the Enron debacle.

Cross-posted at Daily Kos

Reuters, 9/5/08:

The defendants were convicted (this past Feburary) in connection with a reinsurance deal that prosecutors said misled AIG investors because it enabled the company to improperly inflate its loss reserves, painting an artificially bright picture of its financial results. AIG previously acknowledged accounting improprieties and restated $3.8 billion in earnings from 2000 through 2004 and agreed to a $1.64 billion regulatory settlement in 2006.

It’s good to know that someone bearing responsibility for this mess is going to jail. The AIG failure is probably the result of ginormous fraud schemes, with the bursting subprime mortgage bubble only a contributing factor. It defies credulity that over a trillion in assets reported earlier this year were all wiped out by the mortgage mess, given the regulations governing investment of insurance company assets. There's more to the story.

There was a sentencing hearing early this month in Connecticut, where the case was tried. From Bloomberg News 9/6/08:

The executives were convicted for using a sham transaction in 2000 to help AIG add $500 million in loss reserves, a key indicator of an insurer's health. Jurors convicted Ferguson, 66; Monrad, 53; Garand, 61, a former senior vice president; Graham, 60, a former General Re assistant general counsel; and Christian Milton, 60, AIG's former head of reinsurance.

Back to Reuters (linked above)::

In a sentencing memorandum filed late on Friday, prosecutors argued that sentences for the five defendants should be stiffer than the range of 168 months to 210 months calculated in a pre-sentence report.

The government also said losses to AIG investors could be estimated at more than $400 million -- with the government's expert calculating fraud-related losses as much as $1.4 billion -- a factor that should enhance the defendants' sentences.

International Herald Tribune, 9/12/08:

The former officers were accused of breaching fiduciary duties by redirecting insurance business that generated hundreds of millions of dollars in commissions to another company they controlled.

Simultaneously, Maurice Greenberg, AIG's former chief executive and one of the former officers, began the first of what is expected to be three grueling days of depositions in a civil lawsuit brought against him by the office of the New York State attorney general, Andrew Cuomo. The lawsuit accuses Greenberg of devising transactions to make AIG's financial condition look stronger.

AIG's board removed Greenberg in 2005, after regulators served AIG with subpoenas.

I think it’s curious that the traditional media have neglected to mention the sentencing scheduled this month at the same time the company’s going into receivership and a massive bailout. Curious? It’s downright bizarre!

And, one might wonder, was this Enron-style fraud an isolated incident? Or merely the one that got caught? We should consider, at least in passing, the possibility that this is but the tip of the iceberg. Only one of the five convicted criminals being sentenced is from AIG. The others facing time in the Big House are with General Reinsurance (GenRe), a subsidiary of Berkshire Hathaway - Warren Buffett's financial empire.

Another Little-Noticed Insurance Scandal from 2007
I’m no expert in accounting or finance or insurance. But back in the summer of 2007, I noticed a story about the Justice Department quashing a prosecution of a Virginia insurance fraud. It had some connection to the US Attorney scandal that was raging that year. I posted a little-noticed diary about it that gathered a few dozen recs & comments: DoJ Kills Big Enron-style Fraud Case

Shortly thereafter, I got an email out of the blue from someone mentioned in the diary: one Thomas Gober, forensic accountant and expert in ferreting out fraud in the insurance and reinsurance (wholesale insurance) industries. He was upset that the case had been unceremoniously dumped on the eve of indictments. Mr. Gober probably knows as much about the dirty secrets of the insurance industry as anyone. The collapse of AIG has moved him to speak out.

Gober’s prepared some videos about the AIG collapse. It’s nearly half an hour all told, in 4 separate YouTubes, available at his website. If you’re in the mood for a sound bite, this is not the place to go. However, if you want to listen to someone who knows the ins and outs of insurance industry three-card-monte, he’s as good as it gets. I took the time to transcribe the videos (with the invaluable efforts of standingup, or I'd still be working on it). A selection of quotes are offered below. If anyone wants to interview Gober to followup on this story, there’s an email link at his website. (I can also be of assistance in making telephone contact.)

Background on Gober
Strangely, DoJ swooped down on all relevant offices involved in the Virginia investigation within days, and confiscated all the evidence - 100+ of boxes gathered over a 2+-year investigation. This limited indictments to a few mid-level executives in the Virginia company, despite evidence implicating a much more pervasive culture of Enron-style white collar crime. Right after that hatchet job, Paul McNulty got promoted to Alberto Gonzales’s main office in DC. From the Corporate Crime Reporter (Oct 2007):

"Did you, or to your knowledge, did any other Department of Justice employee, discuss these cases with any individuals associated with or speaking for General Reinsurance, Berkshire Hathaway, or (Berkshire CEO) Mr. Warren Buffett?" the letter asks McNulty.
[F]ederal officials may have incinerated more than 100 boxes of grand jury information in April 2007, just days after the Virginia Lawyer’s Weekly published an article titled "Further Federal Indictments In Reciprocal Case Unlikely."

This bonfire was highly unusual. Usually evidence from suspended investigations are placed in storage in an evidence warehouse somewhere. Disturbed (to say the least) that years of work from an investigative team on verge of indictments, was literally going up in smoke, Gober wrote to Judge James Spencer, who presided over the case:

Gober is concerned also because the case "has exposed a serious problem in the reinsurance industry which is going to have to be addressed and corrected"...

"Hundreds of millions of dollars are at stake, and very powerful people are interested in this matter simply dying," he wrote. "I am not one of them. Nothing would be worse than to see a case like this one pushed 'under the radar' by greedy people who simply want more and more money through fraud. Based on what has been going on lately at the Justice Department, I am very worried about how all of this has happened and what should be done to correct it."

This was a year and a half ago. Another one of those "red flag" warnings that went unheeded. Yup, this baby touched the US Attorney scandal, and skirted around financial guru Warren Buffet himself!

My initial diary was one of very few google hits Gober found in his search to see who’d picked up the McClatchy story on the matter. He flew in to Chicago for YearlyKos and several ePluribusMedia (EPM) folks, including myself, spent some time listening to (some of) his story. (Incidentally, he was completely astonished at our vibrant community, as a conservative accountant from Alabama, he had no idea what he would find! Many preconceptions and stereotypes got blown out of the water.) Gober knows a lot, and there was only time for a very sketchy debriefing. I wrote another diary about it after I got home which attracted even less attention than the first one:

Insurance Industry “Signing Statements”

What I’d learned from Mr. Gober can be summed up thusly:

  • There’s a lot of “off book” liabilities that don’t show up on insurance balance sheets, especially in the reinsurance sector
  • Assets at stake in the insurance industry dwarf those in the banking sector of the global economy.
  • There’s some very cloak-and-dagger international money laundering processed through the reinsurance sector. It’s there in the reports for anyone to find; but hardly anyone knows how to read the reports.
  • Gober knows a lot more than he’s telling, because much of his knowledge is of material in sealed grand jury records. He’s not interested in contempt of court for publicizing such things, but there’s probably plenty of interest Congress could learn from him were they to have the good sense to call upon him to testify.
  • There’s gonna be a lot more ugly stuff come to light before this is over. (Unless, of course, the “bailout” goes for opacity.) The end is not in sight.

Quotes from the videos filmed in response to the AIG bailout. (And no, there’s not copyright issues, as he’s asked for assistance in getting this out):

As a forensic accountant, I do to a large set of financial documents what a forensic pathologist does to a cadaver. I try to figure out what happened, who did it, where’d the money go, and basically how did they cook the books to cover up the fraud.

I love my work. I’ve had the pleasure of working with the FBI and the US Attorney’s office on a series of very complex insurance company fraud schemes where insurance companies have collapsed. When I say criminal case, I mean with prison sentences for the executives, not just paying back the money that was stolen. In those cases, when we recover the money, that money went to the policy holders who had lost everything.
Insurance is a very special product. You pay and you pay and you pay premium dollars, often for your entire life. In return you only get a promise. A promise that if you ultimately have a covered claim, and you’re paid up, they must pay that claim. The problem is that they must have that money, for years and years, kept safely and invested legally in order to be able to pay your claim if they so choose. It’s that special relationship of trust that imposes on an insurance company an obligation of truthful financial reporting in their financial statements. This is the foundation of insurance accounting. No one should argue that point
You might ask: How did it get so bad so quickly? I’m here to tell you that it did not happen quickly. This has been tucked away in financial statements that are far too indecipherable, and have been that way for years. Several factors led us to this point, some of them political in nature. First: Inadequate regulatory oversight of the insurance companies.
Just this year, in 2008, executives of AIG and a reinsurance company called General Reinsurance were convicted of criminal charges related to a very serious financial crime referred to as “reinsurance fraud”. Or, more specifically, “side letter fraud”. In this particular instance, those schemes began in the year 2000.

Note: Side letter fraud is very similar to the kind of stuff that brought on the collapse of Enron - where liabilities are hidden in offshore agreements that make a balance sheet look much rosier than it should.

It is essential that forensic accountants scour the financial statements and financial records of AIG. It is simply not believable that a downturn in mortgage markets or mortgage derivative products is solely responsible for this monumental mess.
I know for a fact that insurance companies are not permitted to invest too high a percentage of their surplus or their assets in any one type of investment, or certainly not an investment that has limited marketability. Insurance companies can invest virtually unlimited amounts in treasury bonds, U.S. Treasury bonds, money market accounts, cash, other highly liquid corporate bonds. But legal limitations are placed for a reason on too much concentration in limited marketability investments. Putting all of your eggs in one basket is simply imprudent. So how can it possibly be true that the AIG financial deterioration is due to the increase in mortgage defaults?
I'd like to talk briefly about AIG's own reporting of their financial condition. I'm showing a slide here from the AIG 2007 Annual Report, straight from their records. You'll notice that it shows in the 2007 column it has total figures coming down in the left column. On the far left where you see just below financial highlights note that it says in millions. It's highlighted in parentheses in millions. This is rare that you will see a financial statement where the financials is shown in millions as opposed to thousands. My point here is that when you go down to the asset number that $1,060,505 is over one trillion dollars. This is just filed this year in 2008 and now they're talking about $85 billion simply to keep them afloat
In this next slide is a photograph of the then CEO Martin Sullivan. And I've captured just a couple of major comments from his write up in his letter to the shareholders. Notice that he's commenting on how they increased assets to $1.061 trillion. But then look at this large quote that was blown out in the letter to stockholders, "We remain confident in our strategy to leverage our financial strength..." How can in 2008, just months ago, he be bragging about the financial strength and then we are facing this bailout?
Here is the problem and this can get very tricky. If surplus drops, let's say surplus drops to a negative figure. In insurance accounting the regulator must take over a company that goes to a negative surplus. How can you can you increase a surplus? You can only increase it by increasing assets or dropping liabilities and it's dropping liabilities that we want to talk about. There are very secretive ways of monkeying around with these liabilities that are much harder to spot than lying about how many bonds you have.
I've seen a trend that has gone, it shifted towards where the fear of consequence, the fear of consequence of the insurance company for mistreating their policyholders has all but disappeared, truly. In the early years of my career insurance companies would quickly pay a claim for fear that it might be detected that they were holding back when they shouldn't be and they were facing the potential for a punitive damage or to be punished for mistreating the policyholder. I'm not seeing that now. ...And if an insurance company is not punished when they do wrong, where is the incentive to do the right thing in the fear of consequence?

OK, this is a super long diary. Sorry. But it’s a super serious subject. The fraud, including criminal convictions for Enron-style “cooking the books” is going almost completely unnoticed in news coverage of the bailout story. I think it’s worth at least passing consideration. Gober knows what he’s talking about, and his take on the story is worth listening to. He isn’t trying to sensationalize - the story’s pretty friggin’ sensational without a mild-mannered accountant and investigator trying to go all “Drama Queen” on it. For anyone who lasted through this whole long diary? Thanks for reading!

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Hope you don't mind, I fixed some of the links that were bad.

Which links were bad? I should fix 'em over on Kos, too.

Just checked Kos, all is well there!