Monday, May 9, 2005

Who Stole the Cookie from the Cookie Jar?

Today's round of American International Group revelations, courtesy of the New York Times (here), is that the company routinely used reserves from its Directors & Officers (D&O) insurance policies to prop up earnings.  Reserves are cookie jars for most companies, available pots of money that can be dribbled out to prop up earnings because the amounts are based on reasonable estimates of future liabilities and those estimates can change -- especially at the end of a quarter or year when the real earnings are going to fall a bit short.  D&O reserves are especially tempting because claims tend to come years down the road, once litigation is settled, and rates can be raised to pay for impending claims, thus postponing the effect of drawing down the reserves.  At some point in time, of course, the reserves have to be rebuilt, and that can come at a bad time in the economic cycle, as the banking industry learned in the early 1990s.  One of the reasons AIG entered into the reinsurance agreement with General Re that it has admitted was not properly accounted for was to prop up its reserves, which analysts felt had dropped to a sufficiently low level to call into question the value of AIG's stock, anathema to former CEO Maurice Greenberg. 

The revelations in the Times story are not new -- AIG's release on May 1 acknowledged misuse of reserves -- but show where the government investigators will be looking for evidence of financial fraud.  The accounting rules related to reserves are quite vague, so proving a fraud case will be difficult absent testimony or documentary evidence showing the manipulation of the accounts.  For the government to bring a civil or criminal case, it will need the cooperation of senior AIG executives, so cooperation agreements or plea deals in the near future may signal the direction of the investigation if they include any admissions of wrongdoing related to reserves.

Civil Enforcement, Fraud, Securities | Permalink

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