Background

Mr Greenberg, former head of AIG, in 2016 had appeared in court for an accounting fraud case dated back in 2005 to boost the prices of the stocks. In the early times of year 2000, the allegation was that Mr Greenberg presided over many accounting scandal case (Npr, 2016). Most of the cases were successfully settled outside of the court but the case against Mr Greenberg for the fraud charges in civil accounting is going on for more than a decade. In the early 2017, Mr Greenberg now 91, and Howard Smith former AIG CFO as the co-defended reached to a settlement in the form of an agreement with the attorney general of New York Eric T S Schneiderman (Smith, 2017).

 As part of the agreement two defended acknowledge and revealed their participation is two inaccurate projections based financial transaction for the AIG. They also agreed in giving up the performance bonus received in the following four years from 2001. But this giving up amount of $9.9 m is far less than the demanded amount of $50 m by the attorney general (Smith, 2017). The falling reserve of AIG lead to fall in the share price and to recover that AIG with ‘General Re Corporation’ struck a deal of fraudulent nature where AIG was able to add close to $500 m in their reserve in the form of acquired premium by supporting through phone documents (Kirchgaessne, 2006). This led to false inflation of the company’s valuation by close to $100m from the year 2000. Considering this introductory note of this report the following section of this report would provide case background, presentation, detection, investigation, impact analysis and finally recommending measures through learned lesson.

Background

AIG is one of the largest companies in the insurance industry worldwide. The Q3 result of AIG in the year 2000, october 26, were able to show the increment in the amount of premium for the insurance but the reserve of the company of the company significantly by an amount of $59m (Hass et al., 2012). This was a great setback for the market at that time and that led to a %6 falls in the share price of the company in the New York stock exchange (casact, 2009). The stock price fall is the result of two down gradation report from two different analysts. Under this circumstances the head of AIG, Mr Greenberg had to take some action to stop the fall of share price.

Considering this Mr Greenberg then called CEO of Gen Re Mr Ferguson for a transaction structuring. In this meeting of October 31 2000, Mr Greenberg sought help from Mr Ferguson to transfer an amount ranging from $200-500 m to the account of AIG by the end of the year and the transaction would be treated as the agreement of reinsurance between Gen Re and AIG (casact, 2009). In the form of risk less approach AIG should not incur any loss from this transaction. Prior to this situation AIG used to have a very good relation with Gen Re as AIG was the largest customer for the Gen Re. The CEO of Gen Re specifically understood the fact that the demand of AG was not a reinsurance transaction of bona fide nature. To make this deal bona fide AIG has to bear the risk for actual insurance (casact, 2009). 

Presentation

Here AIG was asking a transaction that would be like the reinsurance in the accounting term but actual would have no risk. In the early part of the November of 2000, CFO, vice president and the CEO of Gen Re decided that to go ahead with the deal considering their good relationship with AIG (Hass et al., 2012). This was the actual scenario of fraud before it was perpetrated and detected.

Presentation of fraud case

This transaction fraud was widely known in the year 2004. This was the result of the ongoing investigation for the accounting practices of the insurance industry. During this time the ‘NY insurance department’ and the office of attorney general started to look into the matter of AIG more seriously. Earlier the SEC showed their suspicion because of theirs one insurance product named ‘loss mitigation insurance’. But the fraud case came into light slowly and the subsequent steps are as follows.

SEC in the 2001 came to know about the AIG’s assistant to their clients for balance sheet bolstering through the approach of insurance transaction of fraud nature. This case was investigated by SEC and in presence of department of justice AIG had to settle for a civil penalty of $10m (Hass et al., 2012). Under this continuous investigation in 2005 February, IAG disclosed their earning of 2004. In the March of the 2005 AIG disclosed through deal with Gen Re for the reinsurance. In the following court preceding the company Gen Re’s top executive revealed that they were also aware about the deal and also had the knowledge that AIG would use this transaction through applying accounting procedure to fulfil the gap in loss reserve. After the deal AIG added close to $500m in the reserve account of their balance sheet at the last and first quarter of the 2000 and 2001 financial year (casact, 2009).

Applying some accounting principle AIG showed it revenue. AIG hope that this addition of $500m in their reserve would be able to satisfy the critic in the stock market. This was a false way of inflating the valuation of the company. Later many executive of AIG also stated that the deal transaction in the balance sheet must have been stated as loan and not the insurance. In the insurance business the risk is reinsured (Carter, 2013). Here the firm 1 would insure the risk of the insurance policy written by firm 2 to fir 2’s customer. this was a finite insure that firm 2 purchased from firm 1 and in the finite insurance policy the insured firm distribute the insure policy cost over the long period of time (Carter, 2013). Therefore if firm 2 had to pay the cover amount to their customer within the few year of the start of those policies, firm 2 would be able to claim against their reinsurance with firm.

1. Because of this reinsurance policy firm 1 received a large amount as premium from firm 2. In this insures under the condition of claim scenario to firm 2 from their customer, the reinsurance amount paid by the firm 2 to firm 1 would return back to firm 2 (Blanchard, 2014).  In this specific insurance type context the present account principles were based on the open interpretation. The accounting question come as to state this transaction as reinsurance or the deposit.

Detection

AIG treated it reinsurance and Gen Re treated it a deposit process of accounting. Actually AIG in exchange of $5m of payment got insurance contract of worth $500m and subsequent $500m premium into AIG. This transaction increased cash reserve by the same amount. This $5m is the payment of premium from the AIG to Gen Re. Two separate contract under the condition of reinsurance were formulated and in two part $250m amount entered into AIG (securities.stanford, 2005). But under the circumstances of no claim in Gen Re the amount would go back to Gen Re from AIG.  Therefore the amount can be classified as loan in the account. If it had to be a insurance then some amount of risk factor must have been transferred in to AIG which is not the case as AIG already asked for no risk. Under this scenario of no risk the loan would be treated as liability. The fraudulent approach is that these contracts are not the reinsurance contract. This lack of economic substantial argument of these contracts makes them unworthy of accounted for.

Detection of fraud case

The agreement of the contract is created by the Houldsworth. Along with the reinsurance vice president and others, Houldsworth wrote the contract. As per the contract Gen Re would receive a payment of $5.2 m from AIG as fee of this deal. Then for the payment of $5.2m and another $10m as pre-fund premium, National Union is to be paid through the CRD obligation (Hass et al., 2012). In this context AIG and Gen Re went for unrelated separate reinsurance contract and that happened between subsidiary of AIG and Gen Re.  

The subsidiary is the ‘Hartford steam boiler inspection and Insurance Company’ or HSB. This route was specifically taken for masking the Gen Re and AIG’s transfer and its real reason. In this total transaction process actually AIG solicited this transaction deal. But Gen Re created a documentation that is a sham as that made it look like Gen Re solicited for the deal.

In the process of leveraging this contract AIG was supposed to receive $31.8m from the Gen Re. Here a payment of $7.5m is done by the Gen Re for the commutation of existing contract with HSB. Then around $9.1m as premium is paid by Gen Re for the HSB’s reinsure loss (securities.stanford, 2005). The sham contract of reinsurance is used to pay $0.4m as premium by CRD whereas it received a payment for loss of $13M. This AIG received around $10m as LPT premium from CRD. After all of these CRD and Gen Re used this $5.2m for the fee covering. 

 Therefore at the end AIG paid $5m to Gen Re as fee but the payment of $10m was not followed by AIG as per the written contract (casact, 2009). The daft contract also discussed the no-risk part of the deal. All of these are used as the prosecution evidence.

Aftermath and investigation of fraud case

In the prosecution process US Code is used. Under that ‘Security investor protection laws’ and under that ‘code of federal regulation’ is used. The conspiracy law, mail fraud law, were also used in this case for the prosecution process. After the investigation process is over the several personnel involved in this case were prosecuted. Gen Re CEO, Ron Ferguson was convicted on 1 count of conspiracy, 7 counts of security fraud, 5 counts of false statement and 3 counts of mail fraud (casact, 2009). After this he was sentenced to prison for 2 years, supervision release for 2 years, $200k in fine. Christopher Garand, chief underwriter and senior vice president of Gen Re also got similar conviction and sentenced to 1 year prison, supervision release for 1 years and $150k in fine.

Investigation

Then Christian Milton vice president of AIG’s reinsurance also the similar conviction rate but the sentence was of prison time 4 years, supervision release of 2 years and a fine of $200k. Robert Graham the assistant general and SVP of Gen Re and Elizabeth Monrad CFO of Gen Re also got the similar conviction. Elizabeth Monrad received a prison term of 1.8 month adn Robert Graham received a sentence of super vision release of 2 years and a fine of $100k (archive.boston, 2009; Johnson, 2011). In the 2017 Mr Greenberg the former head of AG and the CFO Mr Smith reached an agreement with the office of attorney general of New York after battling the decade long fraud charge of civil accounting. Here they would forgo the performance bonus received during 2001 to 2004 as an amount of $9.9m (Smith, 2017). 

Fallout and impact of the case

After the fallout of this case series of penalty had been imposed on the perpetrator of this account fraud case. Gen Re had agreed to pay $92.2m as penalty to settle the case (nbcnews,  2010). This was claimed by the shareholders and the federal authority. The final settlement for the AIG cost around $1.64bn which is the result of the lawsuit by the shareholders (ifre, 2016). AIG also had to restate the financial report of their five year operation and lowered their 10% income.

Learned lesson

This accounting fraud case provides a lesson for the robust for the internal control process (Hoitash et al., 2009). Had the auditor been independent in this case the situation would have been averted at the first place. On the other hand the role of the audit committee and its independence is also felt in this case. The audit committee would have been a strong monitoring body that would have prevented such incident to happen in the organisation (Tanyi and Smith, 2014). Another need is visible in this case analysis and that is the fear factor. Had there been a strong law with stringent penalties it would have acted as a prohibition for the top executive to engage in such activity.

Recommendation

Considering the above analysis the following recommendation are provided.

• Establishing a string internal control procedure in the organisation (Hoitash et al., 2009).
• Strictly maintain the independence of the auditor in the organisation.
• Form an audit committee which would independent in nature.
• Provide monitoring mechanism and sufficient power to the audit committee to detect these frauds (Tanyi and Smith, 2014).
• Create awareness about the legal, financial and criminal law implication of these fraudulent activities.

Reference

Blanchard, R. (2014). Accounting. Wiley StatsRef: Statistics Reference Online.

Carter, R. L. (Ed.). (2013). Reinsurance. Springer Science & Business Media.

casact, R. (2009). Actuarial Accounting: A Cautionary Report.

Hass, S., Nitkin, M., & Burnaby, P. (2012, January). AIG and General Re: Helping One Another or Reinsurance Scheme. In International Conference on Accounting and Finance (AT). Proceedings (p. 215). Global Science and Technology Forum.

Hoitash, U., Hoitash, R., & Bedard, J. C. (2009). Corporate governance and internal control over financial reporting: A comparison of regulatory regimes. The accounting review, 84(3), 839-867.

ifre,  (2016). Former AIG chief Greenberg must face New York fraud trial.

Johnson, S. (2011). Once Facing a Prison Term, Ex-CFO Could Go Free. 

Kirchgaessne, S. (2006). Ex-Gen Re and AIG executives on fraud charges. 

Maury, M. D., McCarthy, I. N., & Shoaf, V. (2007). AIG: Accounting and Ethical Lapses. In Insurance Ethics for a More Ethical World (pp. 39-53). Emerald Group Publishing Limited.

nbcnews,  (2010). Gen Re settles AIG fraud claims fo $92.2m. 

Npr. (2016). NPR Choice page.

securities.stanford,  (2005). CONSOLIDATED SECOND AMENDED CLASS ACTION COMPLAINT.

Smith, R. (2017). Former A.I.G. Executives Reach Settlement in Accounting Fraud Case.

Tanyi, P. N., & Smith, D. B. (2014). Busyness, expertise, and financial reporting quality of audit committee chairs and financial experts. Auditing: A Journal of Practice & Theory, 34(2), 59-89.