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AIG fesses up

The mega-insurer admits to a slew of accounting no-nos, ensnaring Warren Buffett's Berkshire Hathaway

By James M. Pethokoukis and Marianne Lavelle
http://www.usnews.com/usnews/biztech/art...

When Enron was imploding, Wall Street wags loved to point out that the energy company's corporate logo--the now infamous crooked "E" --had a devilishly appropriate double meaning. Now in the case of business insurer American International Group, which last week revealed it had made some $1.7 billion worth of accounting errors during the past 14 years, there's a different literary device in play--irony. AIG's corporate slogan? "We Know Money."

Today, there's more than a bit of irony about such hubris, after the world's largest insurer made an extraordinary admission: An internal probe had uncovered a broad range of accounting improprieties that caused it to delay (for the second time) filing its 2004 annual report and may require the company to restate past financial results. In addition, AIG's legendary chairman, Maurice "Hank" Greenberg, said he was stepping aside just two weeks after relinquishing the title of chief executive. That initial resignation was prompted by investigations begun last month by the Securities and Exchange Commission and New York Attorney General Eliot Spitzer. Both are looking into AIG deals--Greenberg is scheduled to talk to prosecutors on April 12--that may have misled investors about the true state of the company's finances.

Attention getter. One transaction squarely in the cross hairs is a late-2000 deal between AIG and General Re, a subsidiary of Warren Buffett's Berkshire Hathaway. The deal made AIG's books look better at a time when analysts were raising questions about the insurer's finances. In that transaction, AIG took over $500 million in potential claims, known as a "loss portfolio," from General Re, along with about $500 million in premiums. One insurance company can legitimately transfer risk to another, but in this case, it appeared that AIG was assuming no risk. The company admitted in a press release that "in light of the lack of evidence of risk transfer, these transactions should not have been recorded as insurance."

And there may be more hits coming, the company acknowledges: "AIG cannot presently determine whether additional matters will be discovered or further adjustments will be required." On top of the General Re admission, which will result in a $250 million cut in AIG's loss reserves, the company said that more than a decade of transactions worth $1.1 billion with Union Excess Reinsurance Co. were improperly accounted for. The Barbados-based insurer was incorrectly treated as an independent company since its ownership is closely linked to Starr International, a private offshore company that owns 12 percent of AIG stock and whose board is filled with current and former AIG executives.

Although still sporting a hefty $133 billion market capitalization, AIG has lost nearly $60 billion in value since the brouhaha began, including an 8.4 percent drop last week. Little wonder investors are disappointed. AIG's reputation was always a Steady-Eddy, blue-chip performer. "I'm just not sure where this is all heading," says David Anthony, an analyst with Argus Research. "I don't know what else the company will find."

Certainly the bond rating agencies have seen more than enough. Both Moody's Investor Service and Standard & Poor's have cut AIG's formerly AAA debt rating. If the worst of the news is out, the stellar ratings could eventually be restored. Many investors are betting that's indeed the case. After all, the decline has been far from a collapse, as many traders conclude AIG is not going to be another Enron. Paul Newsome, an equity analyst at A. G. Edwards, last week advised clients that AIG stock was at "an attractive entry point" and assigned it a $75 price target. (The stock currently trades around $51.) He noted that although $1.7 billion may seem like a pretty big number, "that's less than what AIG earns in a quarter." Still, Newsome noted that the "total risk is unknown at this point."

In coming clean, legal experts say, AIG took a big step to protect itself against criminal prosecution. In recent years, the Justice Department has made clear its policy of not prosecuting corporations if they cooperate in probes of potential wrongdoing. For that reason, AIG may be looking at a settlement, in which it would have to pay penalties and agree to new controls and compliance measures.

Risky talk. Things look a bit more dicey for Greenberg. Even in cases where evidence of wrongdoing is weak, meetings with prosecutors can prove hazardous--ask Martha Stewart. Especially since that case, New York securities lawyer Gregory Wallance says, attorneys are advising clients to keep mum unless they get some hard assurances. "If a lawyer feels the client could potentially become a target," Wallance says, "in those circumstances, there's no benefit and a lot of risk" to talking to investigators.

It's not yet known how much officials at General Re knew about the questionable AIG transaction. Buffett's firm can't be held responsible if it merely sold a product--the loss portfolio--to AIG that was later misused, says David Schiff, editor of Schiff's Insurance Observer. But questions have been raised as to whether there was a separate side agreement that made it clear that AIG was assuming no risk. "Now that's dangerous," says Andrew Barile, an insurance industry consultant. "I've tried to tell buyers and sellers that side agreements are red flags because why can't you put whatever it is in the agreement itself."

As for Buffett, Spitzer's office has emphasized that the Oracle of Omaha, who will meet with the investigators the day before Greenberg, is a witness in the inquiry--not a target of it. So far, Buffett's reputation as a corporate do-gooder--he was a major critic of mutual fund directors during the fund scandals of 2003--remains intact. "Warren Buffett has a record that is absolutely unblemished," says David Dreman, chairman of Dreman Value Management. Any criticisms of Buffett are all conjecture, says Dreman. But, he hastens to add, "if it turns out he was hypocritical in any way, it would disillusion a lot of people."

On its website, Berkshire has rejected allegations of Buffett's knowledge of the "nature" of the General Re transaction, a rare move for a company that has no official public relations department. Berkshire stated that Buffett was "not briefed on how the transactions were to be structured or on any improper use or purpose of the transactions." The company stressed that Buffett speaks infrequently with his business unit managers and leaves operating decisions to them. The comments suggest that Buffett is offering a defense now common among beleaguered CEOs--that he simply didn't know of improprieties by his companies.

It remains to be seen whether AIG has the same reservoir of goodwill with investors that Buffett enjoys. One investor-friendly move, says Argus Research's Anthony, would be to increase the company's dividend or repurchase shares as a way of compensating shareholders "for putting up with all this crap for the past two or three months." The company might also work to become more transparent, as AIG is far less forthcoming with financial data than many of its peers. After all, better your shareholders ask questions about your numbers than the feds.
With Paul J. Lim

-- posted by Kirk