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One of the most serious financial crises of 2000s was seen in the collapse of the insurance giant American International Group (hereinafter referred to as ‘AIG’). AIG is a global company holding the assets worth $1 trillion approximately. AIG was caught in a scandal (American International Group Scam) for fraudulent accounting with the help of General Reinsurance Corporation (hereinafter referred as ‘GRC’). The company declared the loss of revenue by $60 million approximately which also led to a drop in its stocks in the New York Stock Exchange as it was seen as a measure of the falling financial health of the company. To rescue the situation, AIG sought help from the GRC. GRC created two sham transactions of $250 million each to boost the losses in revenue of AIG. These two transactions helped to cover up the losses as AID need not mention the amount in its income statement as no actual risk was transferred but they mentioned the $500 million in their premium revenue which made up the loss reserves to pay claims. As a result of this, there was a false increase in the loss reserves as well as in their total increase for the year 2000 and 2001. For the next five years, at least, AIG crated misleading account statements to deceive investors, regulators and policyholders into believing that the company is running into usual and sometimes exceptional profits.This came into catch when the Attorney General’s office and the Insurance Department started investigating against the malpractices of AIG in the year 2004. Soon after, the U.S. Securities and Exchange Commission (hereinafter referred to as ‘SEC’) joined the investigation accusing AIG of fraud. The officers of the company who provided for this fraud did not face any criminal charges whereas the AIG had to pay a penalty of $1.64 billion to SEC.
American International Group
The AIG is an American multinational insurance corporation and finance operation. It is functional in more than 130 states currently. The company is headquartered at New York City and has its offices throughout the world. It is a public company founded in the year 1919 by Comelius Vandar Starr incorporated in Shanghai, China under the name of American Asiatic Underwriters, later renamed as American International Underwriters, finally establishing its current name ‘American Insurance Group’ in the year 1967 as a general insurance agency. Soon, the business grew manifold and within two years, Starr formed a life insurance corporation. The company had its operations in many Latin American countries, China, Southeast Asia, Philippines, Indonesia and Malaysia which was steadily growing. The AIU faced the first decline in its business during the years preceding the Second World War. AIU moved its headquarters from Shanghai, China to New York City in 1939, right before the World War II began. After the World War II, American International Underwriters entered Japan and Germany for providing insurance for American military personnel. Later, it expanded throughout the Europe. In 1950s, AIU began to focus in the American Market to expand the company. After the American International Group Scam, the U.S. Treasury Department gave a loan to the company for its restructuring. As per the 2016 Forbes Global list, AIG was declared the 87th largest public company in the world. The company serves individuals and commercial organisations through a worldwide network of any insurer. Currently, the company mainly deals in three businesses- General insurances, life and retirement plans and a standalone subsidy which is technology enabled.
American International Group Scam
In the first case against AIG for American International Group Scam, in September 2003, the SEC had made accusations of fraud for selling sham insurances for enabling itself to report false and misleading financial information to public. This matter was settled by imposing a penalty of $10 million civil penalty on AIG.
Again in November 2004, the SEC again charged AIG for securities fraud for developing, marketing and entering into transactions that enabled another public company to remove certain underperforming and troubled loans off its balance sheet. This matter was settled by AIG paying a disgorgements and penalty of $126 million on the criminal charges that were proved against it.
The company, therefore, was always in the radar of the department for their unfair accounting practices. In 2005, AIG was caught for an alleged fraud by the SEC, Justice Department and New York State Attorney General’s office. Investigations were conducted by independent counsel on the request of AIG’s audit committee. The company was asked to present its account statements for the last five years, which it could not do within the time provided. Therefore, the inquiry against it began.
A place to start the discussion about how did it happen is Mr Maurice R. Greenberg, who was the CEO of AIG for a term of four decades. He is also the largest shareholder of AIG till date. Additionally, an important role was played by Ron Ferguson, who was the CEO of GRC, the company which assisted AIG in executing the fraud. In late 2004, the Attorney General’s office and the Insurance Department began its investigations for bid rigging against AIG as a part of the general probe in the insurance industry for misconduct. As the errors were found to be grave, the SEC began investigating the matter jointly. It was found that there existed fictional transactions in the accounts of AIG. AIG was assisted by GRC in late 2000 and early 2001 in the form of sham transfers for loss reserves. This allowed the company to bolster its accounts and hide its losses. The following charges were pressed against AIG after the inquiry-
- There have been sham transactions in order to inflate the reserves.
- Fake transactions have been created to conceal losses by converting them into capital losses.
- Misled the Insurance Department about offshore affiliates of AIG.
- Improper reporting of worker’s compensation premiums.
The United States District Court of Southern District of New York held the company guilty on all charges. The SEC alleged that from 2000 to 2005 AIG falsified its financial statements through a variety of sham transactions to false a rosy picture of AIG’s financial result to analysts. It restructured two sham transactions with GRC to add a total of $500 million in the loss accounts of AIG. During the period of fraud, AIG sold its shares in a stock-for-stock corporate acquisition.
The violations- AIG, by the foregoing acts, directly or indirectly, as a company or by the officers as individuals, is engaged in practices and course of business which constitutes violations of various provisions of the Securities Act, 1933, the Exchange Act, 1934. The SEC in its complaint to the Court was seeking a permanent restraint on AIG’s actions violating the said laws for all this time. AIG made use of the means and instrumentalities of interstate commerce, or of the mails, in connection with the transactions, acts, practices and course of business. Further, AIG circumvented the system of internal accounting and knowingly falsified the records related to accounts of the company.
How was it caught- The Attorney General’s office and the Insurance Department were investigating the AIGs accounts for bid-rigging. Bid rigging is a commercial contract which is already given to one party for the sake of formality, other parties are also present at the bidding. It is a common practice in the insurance market, which was under the probe by Insurance Department and Attorney General’s office. A whistle-blower probably gave a tip off of the possible scam to the SEC in the year 2005, after which the SEC joined the other two in the probe as well. The Attorney General and Insurance Superintendent sued AIG and its former Chairman and CEO Greenberg under various charges of fraud. American International Group Scam
Bailout by the Government
AIG had been the biggest company in its field for years. Its impact was so high on the economy that its failure would mean a bloat on the growth of the nation. Therefore, the company was provided a bailout by the government of $85 billion. The US Financial Stability Oversight Council (FSOC) declared that the financial condition of the company did not pose a serious threat to the U.S financial stability. Therefore, AIG was removed from the list of systematically risky institution with a unanimous vote on the favour. It meant that now the company will face lesser regulations and control from the government. The Federal Reserve’s Board of Governors would no longer monitor the company and its strict prudential standards including tougher capital requirements shall not apply. This status is given to such companies where the stakes of the government are too high often called the companies are “too big to fall”. By this, the credit limits of the company reduced, the amount which it had to keep in the accounts compulsorily was minimized too. Therefore, the company closely escaped bankruptcy with the help of the Federal Government. But, why was it done? Easy to say, AIG was a huge company with a humongous investment by various classes of people. There were investments in the form of mutual funds, pension funds and hedge funds. Through the failure of AIG, the money market funds, which are generally considered as secure means of investment, were also jeopardized. If AIG became insolvent, it would send shock-waves throughout the money markets affecting both the institutions as well the individual investors. It wasn’t a loss of one or two people; it would have affected millions. It was realised that the company was too global to be allowed to fail. Therefore, the government had to come to rescue by avoiding bankruptcy for the company.
The first action was taken by the Federal Reserve by issuing a loan to AIG on 80 percent of its equity capital. A total amount of $85 billion was to be repaid by the company over a period of two years at the interest rate of 8.5 percent. However, the deal was revamped and the loan amount was increased to $150 billion now. It was criticised widely as to whether it is inappropriate or not to use taxpayer’s money to revive a company which is sinking as a result of its own misdeeds. But there have been supporters also, as the wrongdoers were some officials who have already been punished and letting the company sink would mean nothing more than the suffering of innocent investors.
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The most prominent scam (American International Group Scam) in the recent history of American economy was the AIG Accounting Scandal of 2005. The company was in such a position that its failure would have meant a huge defeat for the entire economy of America. Therefore, it became imperative for the government to protect this company from failing. Such a shocking term of events unfolded in the following manner-
- September 2004- The SEC announces that it is investigating against the misdeeds of AIG in relation to its transactions with PNC Financial Services Group Inc, which it suspected of being a false transaction.
- October 2004- The office of Attorney General along with the Justice Department sued AIG among various companies for bid rigging.
- November 2004- AIG agreed to the charges and pleaded to pay $126 million as a settlement charge against the charges of bid-rigging.
- March 2005- Greenberg resigns as the CEO of AIG. In investigations, it was found that that AIG has misreported its transactions up to the limit of $500 million. The CFO of the company, Howard was removed from his position as well.
- April 2005- AIG declared that it will restate the financial statements of the previous five years. It reduced its year end equity for 2004.
- June 2005- Two former officers of GRC plead guilty in the criminal cases in matters related to AIG loss portfolio deal.
- January 2006- The charges against the present and former employees were taken back on the condition that all the benefits illegally taken by them shall be paid back to people.
The Moral Failure
For the handful of people who lost their hard earned money in this fraud, the implications were serious and heinous, so to say. What is noteworthy is that this institutional failure has more far reaching ethical implications than we understand. In a set up like a company, it is not very difficult to defraud innocent investors who don’t have much knowledge of the conniving means that the experts may use to manipulate the situation. Had the management of AIG been working under any sort of ethical framework, based on what is right, valuing the principles of honesty, fairness, justice and respect, this would not happen. Every corporate fraud is a disregard of moral values against wealth and greed for earning it. Not that it is the right thing to do, but, had this been a one-time event, the actions of the executives of the company would probably have been justified, but knowing and continuing to participate in this clearly shows the lack of ethics in one and all.
What happened in this case was exactly the opposite of utilitarianism. Utilitarianism means and states that a decision should be taken on such considerations as it does maximum benefits and minimum harms to the society. The executives of AIG put their own interests on such a prioritised position that the rights of and the harm being caused to the shareholders did not bother them.
The ethical error lies on the part of GRC as well. The company needed to be true to its job. Without the support of GRC, it would have become almost impossible for AIG to pull up this fraud for this long a period. Therefore, an important mention to GRC is a must, while we are dividing the ethical liability as it has been no less guilty in provoking, aiding and assisting AIG in its evil motives.
The attempt of AIG to manipulate the shareholders about the financial health of the company by concealing their losses led to their own downfall, to generalise. If we try to see the actual consequences, it took a toll on the entire economy of the USA. A company as big as AIG influences the growth of the economy of the nation and an institutional failure of this level surely dilapidates the growth of the nation on multiple levels. As per the records of U.S. government, AIG was too huge a company to fail. It was given a federal loan of $85 billion to revive back as well. Once an organisation a downfall of this level, it shall always become difficult for it to reach back its position as the faith of the public once lost can hardly ever be revived.No matter the issue, one conclusion that we can surely make is that the involvement of AIG in the financial crisis was necessary for the world’s economy. Whether the action of government will heal the wound or merely be a bandage still remains to be seen as the company is still trying to win back its old dominant position in the market. American International Group Scam
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