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Hence, the stock price of AIG dropped 6% from $99.6 to $93.3 on NYSE. It was
then that Greenberg called Ferguson.
Greenberg wanted to increase AIG loss reserves. Therefore, he and Greenberg
had drafted a deal. By using both the subsidiaries of AIG and General RE,
NUFIC and CRD. NUFIC (AIG) would assume the risk of losses from CRDs
policies for about $600 million for $500 million of premium. The $500 million
represented two contracts where each contract was paid in different times. Of
that $500 million, 10 million would be paid to NUFIC (AIG) and $490 million
would be withheld in CRD. The transaction itself is called Loss Portfolio
Transfer and it is legal. However, AIG actually did not want to assume any risk.
The contracts that CRD transferred were in fact risk-free. The claim would
eventually be paid out by AIG for exactly $500 million. Also, AIG secretly
agreed to AIG NUFIC
Asset
+ 10M Premium Paid by CDR
+ 490M Premium Receivable (withheld by CDR)
Liability
+ 500M Loss Reserve
Transection recorded by AIG:
AIG NUFIC
Asset
+ 10M Premium Paid by CDR
+ 490M Premium Receivable (withheld by CDR)
Liability
+ 500M Loss Reserve
Transaction recorded by AIG:
Pay General Re 5 million as a fee for doing the deal. Following GAAP (general
accepted accounting principle), the nature of the transaction could not be
classified as Loss Portfolio Transfer as there was no transfer of risk. However,
senior managements of AIG and General RE agreed to engage in non-mirror
image accounting, which NUFIC recorded the transaction as a Loss Portfolio
Transfer, while CDR(General Re) recorded the transaction as a deposit which
did not violate GAAP.
How CDR paid $10 million without paying:
In order for AIG to pay General Re $5.2 million fees secretly and for CDR to
pay $10 million in order to make the transaction believable and under the radar
from investigators. Senior management of AIG and General Re constructed a
paper trail which would hide the transaction of $5.2 million directly to General
RE from AIG. There were existing contract between where General Re owned
$31.8M payable to AIG. Therefore, General Re paid $7.5 million to commute an
existing contract with AIG subsidiary, HSB. Furthermore, General Re paid
NUFIC $9.1 million premium to reinsure the loss that was just commuted to
HSB. CDR then paid General RE $0.4 million premium for a fake reinsurance
and received a loss payment $13 million. Finally, CDR made the $10 million
payment to NUFIC. In the end, CDR/General Re was left with $5.2 million in
total.
Reinsurance $0.4 M
Reinsurance $9.1M
AIG
HSB
NUFIC
General RE
($31.8 payable to HSB)
Commute $7.5 M
Loss Payment
$13 M
CDR
$10 M Premium
Gen Re = 31.8 -7.5-9.1-13 +0.4 = $2.6M
CDR = 13 10 0.4 = $2.6 M
Reinsurance $0.4 M
Reinsurance
$9.1M
AIG
HSB
NUFIC
General RE
($31.8 payable to HSB)
Commute $7.5 M
Loss Payment
$13 M
CDR
$10 M Premium
Gen Re = 31.8 -7.5-9.1-13 +0.4 = $2.6M
poor accounting practices. If PwC was on high alert, it might have worked
closely with AIG and prohibited AIG from classifying the $ 500 million as
revenue.
Conclusion
In the end of the civil case trial, 4 executive members of General Re and AIG
were convicted. However, the charges were all overturned by the federal court
of appeal in 1st Aug, 2011, including Greenberg and Ferguson. However the
damage was done. Because of this scheme, it was estimated on Oct 31, 2008
that shareholders lost around $544 million to $597 million. AIG almost went
bankrupt at the start of the finical crisis. It is obvious that there were many
internal controls problems for AIG. But can the fraud be prevented in this case?
We can analyze the situation using the Fraud Triangle.
Pressure
* Downgrade of Stock
* Decline in Loss Reserve
* Avoid Critism
Opportunity
* AIG being big client of General Re
Rationalization
* Increase stock price
* Splizer file civil suit just for election
Pressure
* Downgrade of Stock
* Decline in Loss Reserve
* Avoid Critism
Opportunity
* AIG being big client of General Re
Rationalization
* Increase stock price
* Splizer file civil suit just for election
We can see that that all three elements. Pressure, Opportunity and
Rationalization exist in this case. Also with the lack of internal control in AIG
and the negligence of its auditor PwC, it almost seemed that fraud was inevitable.
However, after the financial crisis, we have experienced the financial frauds and
illegal acts incurred huge costs with far reaching damages affecting the lives of
many people for years Government agencies all over the world have been
working hard to improve regulations for tighter controls. In addition, I believe
that large corporations and audit firms alike should learn from mistakes and
exercise high professional and ethical principles to prevent frauds and account
scandals.
References
AGREED STATEMENT OF FACTS. (n.d.). Retrieved from justice.gov:
http://www.justice.gov/criminal/pr/documents/01-20-1%20gen-reagreedstatement.pdf
AIG SECURITIES LITIGATION-PwC SETTLEMENT. ( 2010, December 2).
Retrieved from AIG SECURITIES LITIGATION-PwC SETTLEMENT:
http://www.aigsecuritieslitigationpwcsettlement.com/
AIG: What Went Wrong. (2005, 4 10). Retrieved from businessweek.com:
http://www.businessweek.com/stories/2005-04-10/aig-what-went-wrong
American International Group. (20, September 2013). Retrieved from Wikipedia:
http://en.wikipedia.org/wiki/American_International_Group
CALLAHAN, D. (2010, November 8). AIG: Before the Crash, There Was the
Fraud. Retrieved from cheatingculture.com:
http://www.cheatingculture.com/accounting-fraud/2010/11/8/aig-before-thecrash-there-was-the-fraud.html
Kay, J. (2005, March 24). Top insurance company mired in allegations of
accounting fraud. Retrieved from International Committee of the Fourth
International (ICFI): http://www.wsws.org/en/articles/2005/03/aig-m24.html
Schonfeld, M. (2005 ). John Houldsworth: Securities and Exchange Commission
Litigation Complaint. New York.
Starkman, D. (2005, June 1). AIG Comes Clean on Accounting. Retrieved from
The Washington Post: http://www.washingtonpost.com/wpdyn/content/article/2005/05/31/AR2005053101589.html
Wilkinson, P. (2009, February 11). PwC Off Hook In AIG Shareholder Fraud
Suit. Retrieved from law360.com: http://www.law360.com/articles/87034/pwcoff-hook-in-aig-shareholder-fraud-suit
Young, D. R. (2009, May 6). Actuarial Accounting:A Cautionary Report.