AIG Combed for Side Deal

Sources say the investigation is looking at Greenberg's alleged role in the General Re deal.
By Matthew Goldstein ,

Maurice Greenberg's unceremonious ouster from the top of

American International Group

(AIG) - Get Report

occurred just as regulators stepped up their scrutiny of how personal a role he played in a now infamous finite reinsurance deal, sources said.

Greenberg, under pressure from AIG's board, stepped down last week as CEO after 38 years at the helm. The 79-year-old Greenberg's forced retirement came in the face of mounting regulatory scrutiny of his curious role in a four-year-old insurance deal between AIG and reinsurance firm

General Re

.

New York Attorney General Eliot Spitzer and the

Securities and Exchange Commission

are intrigued by Greenberg's apparent personal involvement in negotiating the transaction that bolstered AIG's reserves at a time when Wall Street was demanding balance-sheet improvement.

Investigators are scouring the internal emails and phone logs of AIG and Gen Re employees, looking for evidence that the deal was just financial engineering designed to fool investors and regulators. People familiar with the inquiry say investigators want to determine whether General Re took on any actual risk of paying out on the projected claims. The transaction helped AIG boost its balance sheet reserves by $500 million.

In recent months, finite insurance transactions -- deals between insurers and reinsurance firms to transfer a portion of a projected claim -- have become the scourge of the industry because they are easily abused and lend themselves to earnings manipulation. While many finite insurance contracts are legitimate, others are nothing more than disguised loans from one insurer to another with little or no actual transfer of risk.

People familiar with the similar inquiries say investigators are most likely looking for evidence of an undisclosed side agreement between AIG and Gen Re that essentially negated the stated purpose of the deal, which theoretically transferred some of the risk of a potential loss payout to Gen Re from AIG. If such a side agreement exists, investigators suspect Greenberg may have had a role in negotiating it, sources said.

For prosecutors in an accounting fraud case, such side agreements are often telltale evidence that someone is trying to hide something and manipulate earnings. In the case of Enron, for instance, federal prosecutors found a series of illegal side deals called the "global galactic agreement," which guaranteed that LJM2, a partnership at the heart of Enron's accounting fraud, would never lose money in its dealing with the former energy trading giant.

"Traditionally, what prosecutors will look for in cases like these are side agreements that have been negotiated," says Ira Lee Sorkin, a former federal prosecutor and white-collar defense attorney.

But uncovering evidence of a side agreement can be a monumental task, particularly in an industry in which it's not uncommon for multimillion dollar insurance policies to take effect even before they are ever put into writing.

The hunt for an elusive side agreement to the Gen Re deal may explain the timing of Greenberg's hasty resignation as CEO. AIG's board demanded that Greenberg step down just days before he was supposed to submit to a deposition by Spitzer's investigators. The board may have feared that Greenberg might have to invoke his constitutional protection against self-incrimination if the subject of side agreements came up during questioning.

"If he had to testify and take the Fifth, he couldn't have been CEO," says one attorney familiar with the investigation.

Robert Morvillo, the former federal prosecutor and white-collar defense attorney hired by Greenberg, declined to comment.

The deposition was postponed after Greenberg stepped aside and has yet to be rescheduled.

But a recent disclosure by bond insurer

MBIA

(MBI) - Get Report

, another firm under investigation for allegedly relying on finite insurance deals to juice its earnings, is likely to only embolden the investigators looking into AIG and Greenberg.

Earlier this month, MBIA announced it was restating earnings for the past seven years after an internal investigation found "likely" evidence of an "oral agreement" that effectively changed the terms of a 1998 insurance transaction. The previously undisclosed side agreement effectively limited the transfer of risk in the transaction and meant that a $70 million insurance recovery was really a disguised loan.

In light of the suspected side deal, MBIA reduced earnings over the period by $70 million. For a firm that has earned $4 billion since 1998, the $70 million restatement is small potatoes.

But the MBIA disclosure is indicative of the type of potential side deals that may have been used by insurers to manipulate earnings. Investigators appear to believe they'll find similar arrangements at AIG, as they dig deep into the giant insurer's business dealings.

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