Buffett's Weak Defense

Updated from 7:11 a.m. EST

This can't be Warren Buffett's best defense.

Berkshire Hathaway ( BRKA), of which Buffett is CEO, is being targeted by regulators because its insurance subsidiaries have been involved in deals that look like they were designed to give an artificial boost to the financial statements of other companies.

Tuesday, Berkshire released a statement disputing details of recent press coverage of the deals. The Berkshire release also commented on a reinsurance deal that General Re, one of its subsidiaries, did with American International Group ( AIG) in 2000. The reinsurance transaction is currently being investigated by New York Attorney General Eliot Spitzer and the Securities and Exchange Commission.

The plot thickened Wednesday when AIG conceded the deal shouldn't have been treated as an insurance transaction. For that story, click here.

Buffett rarely gives interviews to the press and almost never responds to criticism of his company with a press release like this. As a result, Berkshire fans were hoping this communication would win back some ground for Buffett.

But Tuesday's response from Berkshire should come as a big disappointment to the legions of investors, small and large, who have held up the billionaire Buffett as a model investor and a clean corporate citizen.

The painfully careful wording and the narrow focus of the release suggest that Berkshire isn't able to mount a wide-ranging and robust defense of the reinsurance policies being probed. It also shows that Berkshire now realizes that Buffett's position as CEO could be threatened.

Berkshire stock rose $200 to $87,000 Tuesday.

The most important part of the release is the comment on the AIG deals, which are being probed to see whether they were done simply to give an artificial boost to AIG's financial statements. A Wall Street Journal report said Tuesday that Buffett is scheduled to be interviewed by the SEC and Spitzer's office on April 11. Citing an unnamed source, the article added that the regulators have "documents and witnesses that they believe indicate Buffett was involved early on in discussions about the transaction between General Re and AIG, including its structure."

On Tuesday, Berkshire retorted in its press statement, "To the contrary, Mr. Buffett was not briefed on how the transactions were to be structured or on any improper use or purpose of the transactions."

But the wording of that statement is too oblique and weak to give anyone any solid assurance that Buffett had nothing to do with the AIG transaction.

First off, Buffett could have taken the opportunity to say that the company has found absolutely nothing wrong with the AIG deal. That, conspicuously, didn't happen -- and would seem even less likely to after AIG's admissions Wednesday.

Next best would have been some sort of statement indicating that Buffett had no knowledge of the structure or nature of the deals until they were reported on by the press earlier this year.

The issue here isn't when Buffett came to know of the deal's details, but whether he knew them at any time. Even if Buffett came to know the details of the AIG transaction after it was set up, he should have ordered that it be terminated immediately, if it were found to have anything improper in it.

The other parts of the release do nothing to bolster Berkshire's case. In disputing a March 28 New York Times article, it says that a Berkshire subsidiary National Indemnity didn't use a "side letter" in a Berkshire reinsurance deal with an Australian insurance company called FAI in 1998. FAI used the reinsurance bought from Berkshire's National Indemnity to make its balance sheet look much healthier than it was in 1998, according to an Australian government report. FAI was acquired by HIH and its financial problems contributed to HIH's collapse and bankruptcy. Australian regulators are investigating the deal.

True, maybe a "side letter" wasn't used in the FAI deal. The Australian government report doesn't mention one existing in the final stages of the negotiations, though the possibility of using one was suggested early on. However, investors would be feeling a lot more confident if Berkshire had come out with a strongly worded response to the main findings of the New York Times' story, rather than a possible correction of one detail of the story.

Berkshire has had enough time to come clean on the FAI deal. The Australian government report -- which can be read here -- shows unequivocally how FAI used the reinsurance it bought from Berkshire to give a fake boost to its financial statements. Also, this column first raised the FAI deal in detail 18 months ago and Berkshire apparently hasn't seen fit to correct what allegedly happened with FAI.

Some observers have wondered whether the regulators have the will, guts or evidence to take on Buffett, given his much-revered status in the markets. But going by Tuesday's release from Berkshire, they have nothing to fear. Buffett's defense does not look very strong at all.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to peter.eavis@thestreet.com.

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