tni mar 30 aig series of unfortunate events

News Analysis: AIG’s Series ofUnfortunate Events

by Joann M. Weiner

Reprinted from Tax Notes Int’l, March 30, 2009, p. 1155

Volume 53, Number 13 March 30, 2009

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News Analysis: AIG’s Series ofUnfortunate Events

by Joann M. Weiner

This story does not have a happy ending. Just asLemony Snicket warned in his Series of UnfortunateEvents about the orphaned Baudelaire children, if youare interested in stories with happy endings, you wouldbe better off reading some other story.

For those who won’t take my advice, here is theunhappy ending: The American International Grouphas failed.

No matter how loudly AIG claims that it is still aleading international insurance organization with morethan $850 billion in assets and 160,000 employeesworking in more than 4,300 operations in 130 jurisdic-tions, it lost more than $100 billion last year.

AIG has failed. Yet AIG Chief Executive Edward J.Liddy has made it clear why the U.S. government can-not allow AIG to fail.

Liddy said in a March 2 earnings call:

We are the world’s largest property casualty in-surer. . . . We are the largest provider of retire-ment savings for primary and secondary schoolteachers and healthcare workers. . . . We insurethe property of 94 percent of the Fortune 500companies.

Extolling the global reach of the insurance giantwas not why Liddy, a retired Allstate insurance com-pany chief executive and director of a private equityfirm who former Treasury Secretary Henry Paulsonhad picked to lead AIG, was calling. No, Liddy was onthe phone because AIG was again on its deathbed, de-spite the $85 billion lifeline the federal government hadthrown AIG in September and two additional injec-tions that had brought the bailout to $150 billion bythe end of 2008. Liddy was on the phone pleading fora fourth taxpayer-funded bailout to prevent his nomi-nally solvent company from joining Lehman Brothersin bankruptcy. As Liddy warned, AIG’s global reachextends so deep into so many nooks and crannies ofthe world’s financial system that a formal AIG bank-ruptcy risked igniting a global financial meltdown.

Taxpayer-Financed BailoutThe Federal Reserve complied and gave AIG an-

other $30 billion from the Troubled Asset Relief Pro-gram that allowed AIG to survive. AIG needed an-other multibillion-dollar lifeline to forestall ananticipated and deserved ratings credit downgrade tonear junk status that would have triggered collateralcalls from its swap counterparties that it could notmeet. Although it had not yet admitted it, AIG hadalready spent almost every penny of the funds it hadreceived from the U.S. government.

And because the government believed AIG and itscounterparties had to survive, the Treasury Departmentand the Federal Reserve conceded yet again that AIGcould not go bankrupt, arguing in a joint statementissued March 2 that an AIG failure posed a ‘‘systemicrisk’’ to the ‘‘entire financial system.’’ Treasury and theFed adopted the populist tone necessary to justify fur-ther financial support to AIG:

AIG provides insurance protection to more than100,000 entities, including small businesses, mu-nicipalities, 401(k) plans, and Fortune 500 compa-nies who together employ over 100 millionAmericans. AIG has over 30 million policyhold-ers in the U.S., and is a major source of retire-ment insurance for, among others, teachers andnonprofit organizations.

Protecting innocent small businesses, municipalities,and nonprofit organizations became of paramount im-portance to the U.S. government. Unfortunately, savingthose entities required saving the counterparties thatenabled AIG to fall or, as Lemony Snicket might say,be pushed into its financial black hole. Predictably, tax-payers were outraged that U.S. taxpayer bailout fundssupported AIG’s swap counterparties.

AIG’s EnablersAs is now well known, by 2008 AIG had become

much more than an insurance company. Beginning inthe late 1980s, it had expanded into the financial ser-vices business, and its most profitable line of businesswas selling an insurance-like product known as a creditdefault swap. The idea of a credit default swap issimple. Lending institutions pay intermediaries, such asAIG, a premium to provide insurance against defaultby the creditor. AIG’s triple-A credit rating, which itheld until March 2005, allowed its financial products

Reprinted from Tax Notes Int’l, March 30, 2009, p. 1155

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TAX NOTES INTERNATIONAL MARCH 30, 2009 • 1

unit to obtain the most favorable terms from its coun-terparties. These counterparties were typically financialinstitutions that held packaged securities known as col-lateralized debt obligations, many of which werebacked by residential and commercial mortgages.

Although the historical default rate on these pack-aged securities was low, in 2007 the securities underly-ing the swaps began to default and AIG was forced tomake payments on an increasing number of deals. AsAIG’s financial position deteriorated, the ratings agen-cies downgraded AIG, and triggers in the swap con-tracts that required it to post additional collateral incase of a downgrade led its counterparties to demandmore collateral.

AIG had already raised $20 billion of new capital inthe spring of 2008, which it hoped would cover themounting losses at its financial products unit. Thatamount was insufficient, and over the weekend of Sep-tember 13, 2008, the credit ratings agencies indicatedthat AIG’s continuing financial problems would lead toa further downgrade. On September 15, LehmanBrothers filed for bankruptcy. The next day, it was clearthat AIG could not meet the anticipated $15 billion incollateral calls that the credit downgrade would trigger.To avoid what it perceived as financial calamity, thefederal government stepped in and gave AIG the fundsto meet its collateral calls.

The Unfortunate TruthAs Liddy ominously noted on March 2, nearly six

months after nearly falling into bankruptcy, AIG stillhad a $2 trillion financial products operation. Morethan $1 trillion of that amount was concentrated with12 major global financial institutions. The fate ofAIG’s counterparties appeared indistinguishable fromAIG’s fate.

Without counterparties, AIG could not have enteredinto a single swap transaction it would be like having asupply without a demand. Counterparties are vital en-ablers to AIG’s series of unfortunate events. AIG’scounterparties covered the financial spectrum, frombanks and investment banks to pension funds, corpora-tions, foundations and endowments, insurance compa-nies, hedge funds, money managers, high-net-worthindividuals, municipalities, sovereigns, and suprana-tional entities.

On March 15 AIG released a list of its major coun-terparties. Goldman Sachs, which had denied having alarge exposure, received $12.9 billion in collateral post-ings, payments in the securities lending program, andswap cancellation payments. Other counterparties in-cluded Deutsche Bank ($11.8 billion), Société Générale($11.9 billion), Merrill Lynch ($6.8 billion), Barclays($8.5 billion), J.P. Morgan ($0.4 billion), UBS ($5 bil-lion), HSBC ($3.5 billion), Bank of Montreal ($1.1 bil-lion), and the hedge fund Citadel ($0.2 billion). In to-tal, from September 16 to the end of December 2008,AIG posted more than $22 billion collateral to those

counterparties and others and an additional $80 billionfor other AIGFP transactions. (For details on the trans-actions involving UBS, see Doc 2009-5732 or 2009 WTD49-3.)

AIG has spent more than $100 billion of its federalbailout funds to meet demands from its counterparties.What is unfortunate in this deal is that those counter-parties are being made whole in this transaction at atime when the swaps are valued at most at 60 cents onthe dollar.

Winding Down ExposureThere is some slightly good news to this story. AIG

is winding down its credit default swap business. Atthe end of 2008, it had $302 billion in notional valueof credit default swaps, down from the $527 billion itheld a year earlier. As in 2007, most of AIG’s expo-sure remains in Europe, with nearly 70 percent relatedto swaps European institutions used to facilitate regula-tory capital relief in Europe. AIG structured theseswaps with its French subsidiary, Banque AIG.

But with $300 billion of possibly toxic credit defaultswaps outstanding and a $1.6 trillion derivatives portfo-lio that includes complicated bespoke transactions thatit still has to unwind this sad story is far from over.

Offshore TroublesAIG is a tangled web of global operations. As

shown in the chart, each of its four main operatingsegments, including AIGFP, the main source of itswoes, is a miniature multinational enterprise in itself.

Recently AIG earned nearly $15 billion from its glo-bal operations. But that was then, and this is now. In2008 AIG wiped out those gains and more with its$61.7 billon loss in the fourth quarter of 2008, the larg-est in U.S. corporate history. For all of 2008, each ofAIG’s operations lost money, and the company as awhole lost more than $100 billion before taxes and mi-nority interests. AIG’s Financial Services sector re-ported more than $40 billion in operating losses lastyear.

AIG’s Tax ProblemsTaxes, or more accurately, structuring transactions to

minimize taxes often using offshore entities, are re-sponsible for a large part of AIG’s historical and con-tinuing financial troubles. Recall that AIG began as aninsurance company in 1919 in Shanghai and enteredthe U.S. market only three decades later. Several ofthese tax troubles are described below, starting from thebeginning.

Benefiting From the Celtic AdvantageGood business managers always seek ways to maxi-

mize their revenue while minimizing their taxes. Unfor-tunately, at times these executives may enter into trans-actions that appear sound but in fact are standing on

HIGHLIGHTS Reprinted from Tax Notes Int’l, March 30, 2009, p. 1155

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2 • MARCH 30, 2009 TAX NOTES INTERNATIONAL

shaky ground. That may describe the transaction thatAIG entered into in late 2000 that may have seemedsolid but turned out to be anything but.

The origins of AIG’s demise may lie in a common-place transaction between two companies that werethen led by two titans in the insurance industry, Mau-rice R. ‘‘Hank’’ Greenberg of AIG and Warren Buffettof Berkshire Hathaway. In October 2000, Greenbergcalled Ronald Ferguson, who was then the CEO ofGeneral Reinsurance Corp. (Gen Re), a Connecticut-

based subsidiary of Warren Buffett’s holding company,Berkshire Hathaway, to discuss a possible insurancetransaction.

The complicated details of the transaction are setforth in various legal proceedings. In late 2000 andearly 2001, AIG entered into two reinsurance transac-tions involving an Irish subsidiary of Gen Re that weredesigned to boost AIG’s loss reserves. The main trans-action concerned a transaction between Gen Re’s Co-logne Re Dublin (CRD) subsidiary and AIG’sBermuda-based National Union insurance subsidiary.

HIGHLIGHTSReprinted from Tax Notes Int’l, March 30, 2009, p. 1155

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The transactions involved a then-common practiceof using finite risk insurance, a form of insurance de-signed to transfer risk and smooth earnings over time.These transactions made it appear as if Gen Re waspaying $500 million in premiums for AIG to reinsureGen Re for up to $600 million in liability. The $100million difference between the liability limit and theexpected premium made it appear as if AIG had takenon a risk of $100 million in losses. AIG applied rein-surance accounting to the transaction and booked atotal of $100 million in additional reserves over twoquarters. Gen Re applied a different accounting inter-pretation. In a separate side transaction, AIG arrangedto pay Gen Re $5.2 million for its services.

Why Ireland?

Of all the low-tax countries in the world, AIG choseIreland. Why?

In Ireland CRD benefited from the tax breaks of-fered in Dublin’s International Financial Services Cen-ter and from Ireland’s extensive income tax treaty net-work that allows companies to reduce or eliminatewithholding taxes on cross-border payments. Irelandalso is a member of both the European Union and theOECD, which distinguishes it from other low-tax juris-dictions. Participants in the reinsurance scheme wereaware of Ireland’s generous benefits.

Four Gen Re executives (Ronald E. Ferguson, Chris-topher P. Garand, Robert D. Graham, and ElizabethA. Monrad) and an AIG executive (Christian M. Mil-ton) used Gen Re’s Dublin operation to avoid whatwas referred to as the ‘‘North American problem,’’ arule requiring domestic reinsurance companies to file aSchedule F with state regulators to provide detailsabout each reinsurance transaction. Since Gen Re andAIG were reporting the transaction differently, U.S.state regulators might have noticed and started lookingmore closely at it. Ireland does not impose such strin-gent reporting obligations.1

Concealment With Little Gain

In late November 2000, Graham proposed structur-ing the transaction using offshore entities so that ‘‘anyreviewer of the AIG U.S. entity’s statements wouldn’tbe able to connect the dots to CRD and beyond.’’ Theparties also designed elaborate transactions to hide thesource of the side payments. AIG used a different sub-sidiary, Hartford Steam Boiler Inspection and Insur-ance Co. in Connecticut, to transfer payment to GenRe rather than use National Union, the party to thefraudulent reinsurance contracts, to pay CRD, the partyto the sham contract.

Graham also knew how to fool U.S. state regulators.In tape-recorded conversations, Graham explained that

‘‘if it’s split up enough among AIG’s U.S. entities, thetransaction would probably not reach the [state insur-ance] regulatory prior approval threshold for any ofthem.’’

These tape recordings, which were introduced intothe court proceedings, provide powerful evidence ofthe executives’ interest in structuring a transaction thatwould both minimize taxes and avoid regulatory scru-tiny.

This clever tax planning adds many unhappy ele-ments to the story. The five executives were foundguilty on February 25, 2008, of conspiracy, securitiesfraud, and making false statements to the Securitiesand Exchange Commission and faced long prison sen-tences for their acts. Following a determination thatAIG shareholders had lost more than $500 million inthis fake insurance transaction, the federal sentencingguidelines could have resulted in a sentence of life inprison. The harshest penalty to date has been Milton’sfour years in prison. Ferguson was sentenced to twoyears and Garand to one year and a day in prison.

Thus, with the sentencing nearly finished, the four-year-old case regarding a transaction that took placeeight years ago is nearly over.

What was the direct economic gain in this affair?Very little. AIG paid Gen Re $5.2 million for puttingthe deal together.

What was the business gain? By reporting higherreserves than otherwise, AIG avoided a potentiallynegative analyst report that might have caused its shareprice to fall, preventing it from purchasing the life in-surance company American General.

What were the costs? Greenberg, who was an unin-dicted alleged coconspirator, still faces a civil trial overhis role in the fraudulent reinsurance transaction. Aspart of a settlement with the SEC and the New Yorkattorney general’s office, AIG paid $1.64 billion in2006 to settle investigations related to these transac-tions. Also as part of the settlement, AIG restated its2000 to 2004 earnings by $3.9 billion.

The actual cost of the transaction is immeasurable.It led to the ouster of Greenberg and quite possibly theeventual demise of AIG and the current financial cri-sis.

Generating Foreign Tax Credits in Three Easy Steps

The series of unfortunate events continues. In itssecond-quarter SEC filing in 2008, AIG reported that ithad received a statutory notice of deficiency from theIRS asserting that it owed additional taxes, primarilybecause of disallowed foreign tax credits. AIG madethe payments, but then filed a refund for $306 millionand claimed a $26 million refund related to the tax

1For more information, see http://www.usdoj.gov/usao/ct/Documents/FERGUSON_SS_Indictment.pdf.


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effects from income restatements related to the fraudu-lent reinsurance transactions in late 2000.2

The foreign tax credit issue concerns a tax strategythat essentially involves a company structuring a trans-action primarily to generate creditable foreign-sourceincome. AIG is challenging the IRS over cross-borderfinancing transactions that AIGFP entered into in the1990s. Joseph Cassano, who is now notorious for hisrole in the credit default swaps debacle, led AIGFP’sTransaction Development Group, which structuredtransactions to arbitrage cross-country tax differences.

With operations in 130 countries and low-tax ha-vens, AIG could readily find cross-country tax differ-ences to arbitrage, and its foreign-tax-credit-structuredtransactions span the globe. In its lawsuit, AIG identi-fies seven specific cross-border financing transactionsinvolving the Cayman Islands, the Netherlands Anti-lles, Ireland, France, New Zealand, the Netherlands,and Italy.

These transactions largely took advantage of incon-sistencies between U.S. and foreign tax law. For ex-ample, one of AIG’s financial transactions involved acontrolled foreign corporation, Lumagrove, incorpo-rated in the Cayman Islands but managed and con-trolled in Ireland.

Lumagrove

The facts of the Lumagrove transaction are straight-forward. In 1997 AIGFP created Pinestead Holdings asa wholly owned subsidiary for its offshore financialoperations and established Lumagrove Finance Co. asan exempt company in the Cayman Islands. Pinesteadwas considered a U.S. shareholder and owned at least10 percent of the voting stock of Lumagrove, whichmade Lumagrove a CFC for U.S. tax purposes andsubjected its portfolio income to current taxation undersubpart F. Pinestead managed and controlled the com-pany from Ireland, which made it a resident of Irelandfor tax purposes.

Initially, this structure appears unusual, since com-panies don’t often wish to create transactions that willincrease their tax liability. But AIGFP knew how tostructure a transaction to obtain the maximum tax ben-efits.

Although AIGFP is now known for its credit defaultswaps business (it conducted its first credit defaultswap in 1998), in 1997 AIGFP’s specialty was tax arbi-trage.

AIGFP’s Pinestead Holdings purchased shares inLumagrove for $479 million. Lumagrove invested thesefunds in securities that generated a $6.8 million profit,on which Lumagrove paid $3.8 million in Irish corpo-rate income taxes.

AIGFP’s Pinestead holding company sold shares inLumagrove to a subsidiary of the Bank of Ireland andsimultaneously agreed to buy those shares back. Pine-grove obtained $295 million from the bank.

The story does not end here because it is not yetclear why AIG needed Irish income and the subse-quent tax liability. Because Lumagrove’s portfolio in-come was treated as subpart F income and Pinesteadwas a qualifying shareholder for CFC purposes, Pinest-ead was required to include its pro rata share ofLumagrove’s income in its gross income for U.S. taxpurposes. Pinestead then claimed a $3.8 million foreigntax credit in the financial services category for the Irishtaxes. Because AIG had sufficient excess liability in thefinancial services foreign tax credit basket, it was ableto use the Lumagrove tax credit in full.

AIGFP does not reveal how much excess liability ithad in the financial services basket, but it’s a safe betthat it was at least $3.8 million. In total, AIG claimednearly $62 million in foreign tax credits on the transac-tions described in its lawsuit against the United States.

As taxpayers, we may not be happy that AIG is su-ing the IRS for a refund (although the case helped re-veal the inner workings of the tax avoidance scheme),but AIG has the right to claim that it is entitled to arefund if the tax law allowed the transactions at thattime.

The Offshore CharityAIG’s offshore tax troubles are not limited to rein-

surance scams or foreign tax credits. AIG and itsformer chairman are in a long-running dispute overcontrol of a block of shares held by Starr InternationalCo. (SICO), a private holding company that Greenbergheads. The case began with a relatively simple matterconcerning the ownership of some artwork. Shortlyafter Greenberg resigned from AIG on March 14,2005, SICO sued AIG, claiming that AIG was refusingto return Greenberg’s works of art and other itemsworth $15 million that it held in its Bermuda office.

With the bad blood between AIG and Greenberg, itwas inevitable that AIG would countersue, which it didin September 2005, asserting breach of contract, unjustenrichment, and other matters relating to SICO’s fail-ure to use AIG’s shares solely for the benefit of AIGand its employees. SICO had established a deferredcompensation profit participation plan in 1975 thatprovided compensation to top AIG managers. WhenGreenberg left AIG, he removed all AIG directors fromSICO’s board of directors, ended SICO’s participationin AIG’s deferred compensation plan, and began di-recting the funds from SICO to a new internationalcharity.

Like so many of AIG’s transactions, this one hasextensive offshore links. SICO is a Panamanian corpo-ration domiciled in Bermuda, managed in Ireland, andwith a principal office in Zug, Switzerland. Ever seek-ing the most tax-efficient location for its business, in

2AIG v. U.S., 09-cv-1871, U.S. District Court, Southern Dis-trict of New York (Manhattan).


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2004 SICO relocated its tax residence from Bermuda toIreland partly to take advantage of the Ireland-U.S. taxtreaty that reduced the dividend withholding tax onAIG dividends.

In 2005 SICO held 311 million AIG shares, whichat one time were worth more than $31 billion. Theshares SICO now hold are worth less than $300 mil-lion. AIG claimed that SICO held the shares as de-ferred compensation for AIG’s employees. Greenberginsists that such a deal was never in place and thatSICO has control over the shares. Should Greenbergprevail, the shares would be ceded to the Starr Interna-tional Charitable Trust, an Ireland-based charity thatGreenberg controls and that would benefit from Ire-land’s tax exemption scheme for charities.

Based on what we know about Ireland’s practices inother areas, we might anticipate that this offshore char-ity may one day be involved in an international taxcontroversy.

An 80/20 IssueAlthough the foreign tax credit claim has generated

public interest, some of AIG’s tax issues lie just belowthe surface. One such issue reported February 20 byProPublica, an organization that describes itself as aproducer of investigative journalism in the public inter-est, involves a tax position with one of AIG’s opera-tions that is up for sale.

AIG plans to sell its American Life Insurance Co.(ALICO) to help pay for the U.S. government loan.However, in 2004 the IRS ruled that life insurance andannuity products sold to foreign clients are subject to a30 percent U.S. withholding tax. ALICO, one of AIG’slife insurance subsidiaries, has not been withholdingthis tax on these products on the basis that it is an80/20 company and so is not subject to the 2004 rul-ing, which did not cover 80/20 companies, which areU.S. incorporated entities that conduct at least 80 per-cent of their activity outside the United States.

H. David Rosenbloom, an attorney with Caplin &Drysdale in Washington, advises ALICO and clarifiedhis client’s position with Tax Analysts. Rosenbloomsaid the issue concerning ALICO’s potential tax liabil-ity is not the size of the withholding tax but the proce-dures and forms involved in instituting a withholdingtax. ‘‘The amount of tax at stake is minuscule, andmost of the income would be exempt from withholdingtax by the applicable bilateral tax treaty,’’ Rosenbloomsaid, ‘‘but asking all of ALICO’s policy holders, mostof whom are foreigners, to sign a W8-BEN form ishighly impractical for the firm.’’

Rosenbloom explained that the problem largelyarises because some countries, such as the UnitedKingdom, where ALICO writes many of its policies,treat the product as life insurance rather than as amoney market fund. As Rosenbloom noted, once theforeign country classifies the product as insurance, theincome on the contract falls into its own special cat-

egory of tax treatment because of Internal RevenueCode section 7702 (Life Insurance Contract Defined).

Rosenbloom stressed that ALICO should be treatedas an 80/20 company and be exempt from the with-holding tax. Even though the company is domiciled inDelaware, it earns more than 90 percent of its incomeoutside the United States. The company has asked theIRS for a private ruling to clarify the position.

AIG recognizes the complexity of the tax situationassociated with ALICO and the other insurance entity,American International Assurance Co. Ltd., which thefederal government is putting into special purpose ve-hicles. For example, in the March 2 earnings call,Paula Reynolds, AIG’s chief restructuring officer, said,‘‘There is a lot of complexity with respect to the taxissues associated with those two entities. . . . You know,we laughed last night. I said to Ed [Liddy] that itmight be better to go to jail than it would be to have todeal with the intricacies of securities laws.’’

Interest Deductions and the Bailout

Another tax issue involving AIG has a purely do-mestic aspect. In September 2008 the U.S. governmenttook a 79.9 percent ownership in AIG. Although thegovernment has now effectively taken full ownership,there was a clear tax benefit to the ownership decision.Under IRC section 163, interest is tax deductible, butonly if the interest is paid on a loan from an entitythat controls less than 80 percent of the corporation’svoting power and value. If the government had pur-chased 80 percent of AIG, the company would havelost a tax deduction for the interest paid on its original$85 billion loan at the London interbank offered rate(LIBOR) plus 8.5 percent.

The Financial Products Group

In true Lemony Snicket fashion, we have saved theworst for last. Another of AIG’s offshore troubles con-cerns a lawsuit that Greenberg filed against AIG onFebruary 27, alleging that AIG committed securitiesfraud by materially misrepresenting and omitting factsconcerning its true financial position.

Greenberg alleges that AIG misrepresented its finan-cial position in its December 5, 2007, earnings callwhen then-CEO Martin J. Sullivan said that the possi-bility that AIGFP, the AIG unit that issued the creditdefault swaps, would sustain a loss was ‘‘close tozero.’’ In August 2007 Cassano, who earned $280 mil-lion over eight years as head of AIGFP, famously saidhe could not envision a scenario in which his AIGFPunit would lose more than $1 on its transactions.

AIG’s annual report for 2007 noted that a down-grade could lead to $1.4 billion in collateral calls. Itoptimistically but erroneously said that events thatmight lead it to post collateral would have no materialeffect on its financial condition.


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Greenberg says that on the basis of representationsby AIG’s senior executives, he purchased on or aboutJanuary 30, 2008, more than 3.6 million AIG shares at$54.37 per share. Greenberg paid more than $70 mil-lion in ordinary income tax on that transaction.

AIG countered that Greenberg is the source of hisown problems. He created AIG’s financial productsunit in 1987 following the advice of J.P. Morgan invest-ment bankers.

Much as Greenberg may be to blame for establish-ing the AIGFP operations, he appears to have a validpoint about AIG’s misleading statements. In its 2007annual report, AIG stated that it had identified a ‘‘ma-terial weakness in internal control over financial report-ing relating to the fair value valuation of the AIGFPsuper senior credit default swap portfolio.’’

The filing also admitted that AIG did not have ef-fective controls over how AIGFP valued its credit de-fault swaps, and that as a result, its oversight was ‘‘notadequate to prevent or detect misstatements in the ac-curacy of management’s fair value estimates and dis-closures on a timely basis.’’ The financial statementsaid the deficiency could result in a misstatement ofthe company’s fair value estimates that could be mate-rial to AIG’s financial statements.

On February 28, 2008, AIG reported that AIGFPhad $11.5 billion in unrealized market valuation losses.Less than three months earlier it reported that it wouldlose at most $1.5 billion on the same portfolio.

Continuing to ignore reality, AIG asserted that the$11.5 billion in unrealized market valuation losses thatit had experienced in the last three months of 2007‘‘were not indicative of the losses AIGFP may realizeover time on this portfolio’’ and stated that any ofAIGFP’s losses would not be material to AIG’s con-solidated financial condition.

Unfortunately, Cassano turned out to be very wrongin predicting that the swaps couldn’t lose. By mid-2008a significant share of AIG’s swaps were underwater.AIG and the entire financial community grossly under-estimated how those losses would drag down the glo-bal economy.

In what might be an unexpected event, perhaps theU.S. taxpayer should join Greenberg in his lawsuitagainst AIG for its flagrant and willful misrepresenta-tions about its precarious financial situation. There’snot much to lose in taking this bet against the casinoin London that may have fraudulently misrepresentedits practice for years.

The Penultimate PerilFour years ago Greenberg was forced out of AIG

for a transaction that was later determined to have costshareholders about $550 million in losses. Those lossesnow seem trivial, as AIG’s shares quickly rebounded

and rose to $70.11 a share in October 2007, thus morethan recouping what turned out to be a temporaryshareholder loss.

AIG’s current investors will not be so fortunate.AIG’s share price has hovered close to $1.00 a sharefor the past six months and will never recover even afraction of its value, the company is no longer includedin the Dow Jones Industrial Average, AIG’s credit rat-ing is abysmal, and shareholder equity stands at justunder $4 billion, down from more than $71 billion sixmonths ago. One shareholder Hank Greenberg lostmore than $3 billion during a single week in Septemberwhen the government took over AIG. In total, theholders of AIG’s nearly 3 billion shares have perma-nently lost more than $175 billion since the start of2008. Coincidentally, that figure is just about equal tothe amount that the federal government has providedAIG to keep the company in business. The global dam-age from the financial crisis that surrounds AIG’s de-mise is shocking. The Asian Development Bank esti-mated that financial markets lost $50 trillion in wealthlast year.

Have shareholders been defrauded? Should share-holders file for relief for a possible theft due to AIG’smisdeeds, like victims of the Bernard Madoff schememay receive? That chapter remains to be written.

The Unhappy EndingSnicket ended the adventures of the Baudelaire or-

phans in the 13th installment of his series of unfortu-nate events, simply titled The End. Snicket ended as hebegan, reminding readers that ‘‘the end of this un-happy chronicle is like its bad beginning, as each mis-fortune only reveals another, and another, and an-other.’’

In recounting AIG’s series of unfortunate events, itis unclear whether the story has reached its end. Al-though Greenberg is far from innocent in AIG’s down-fall, many believe that if he had not been forced out in2005, AIGFP would never have been allowed to takeon such a risky position. At the very least, it seemsclear that a shareholder with more than 300 millionshares who had led the company for more than threedecades would have taken a very strong interest in thehealth of the company. Greenberg himself objected tothe federal bailout from the start.

With the latest scandal involving AIG’smultimillion-dollar bonus payments to the so-calledbest and brightest executives whose actions triggeredthe worst of the series of unfortunate events, it seemsas if Snicket could just as easily have been describingthe unhappy chronicles of AIG, rather than of theBaudelaire orphans, where each misfortune only re-veals another, and another, and another. ◆

♦ Joann M. Weiner is a contributing editor to Tax Analysts.E-mail: [email protected]


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