Forensic Accounting: A Case Study of AIG and Gen Re Fraudulent Transaction

This report provides a case study of AIG and Gen Re fraudulent transaction, its presentation, detection, investigation, impact analysis, and recommendations for robust internal control procedures.

Forensic Accounting

Introduction
• Mr Greenberg, former head of AIG, in 2016 had appeared in court for an
accounting fraud case dated back in 2005 to boost the prices of the
stocks. In the early times of year 2000, the allegation was that Mr
Greenberg presided over many accounting scandal case (Npr, 2016). Most
of the cases were successfully settled outside of the court but the case
against Mr Greenberg for the fraud charges in civil accounting is going on
for more than a decade. In the early 2017, Mr Greenberg now 91, and
Howard Smith former AIG CFO as the co-defended reached to a
settlement in the form of an agreement with the attorney general of New
York Eric T S Schneiderman (Smith, 2017). As part of the agreement two
defended acknowledge and revealed their participation is two inaccurate
projections based financial transaction for the AIG. They also agreed in
giving up the performance bonus received in the following four years
from 2001.

• But this giving up amount of $9.9 m is far less than the demanded
amount of $50 m by the attorney general (Smith, 2017). The falling
reserve of AIG lead to fall in the share price and to recover that
AIG with ‘General Re Corporation’ struck a deal of fraudulent
nature where AIG was able to add close to $500 m in their reserve
in the form of acquired premium by supporting through phone
documents (Kirchgaessne, 2006). This led to false inflation of the
company’s valuation by close to $100m from the year 2000.
Considering this introductory note of this report the following
section of this report would provide case background,
presentation, detection, investigation, impact analysis and finally
recommending measures through learned lesson.

Background
• AIG is one of the largest companies in the insurance industry worldwide. The
Q3 result of AIG in the year 2000, October 26, were able to show the
increment in the amount of premium for the insurance but the reserve of the
company of the company significantly by an amount of $59m (Hass et al.,
2012). This was a great setback for the market at that time and that led to a
%6 falls in the share price of the company in the New York stock exchange
(casact, 2009). The stock price fall is the result of two down gradation report
from two different analysts. Under this circumstances the head of AIG, Mr
Greenberg had to take some action to stop the fall of share price. Considering
this Mr Greenberg then called CEO of Gen Re Mr Ferguson for a transaction
structuring. In this meeting of October 31 2000, Mr Greenberg sought help
from Mr Ferguson to transfer an amount ranging from $200-500 m to the
account of AIG by the end of the year and the transaction would be treated
as the agreement of reinsurance between Gen Re and AIG (casact, 2009).

• In the form of risk less approach AIG should not incur any loss from
this transaction. Prior to this situation AIG used to have a very good
relation with Gen Re as AIG was the largest customer for the Gen
Re. The CEO of Gen Re specifically understood the fact that the
demand of AG was not a reinsurance transaction of bona fide
nature. To make this deal bona fide AIG has to bear the risk for
actual insurance (casact, 2009). Here AIG was asking a transaction
that would be like the reinsurance in the accounting term but actual
would have no risk. In the early part of the November of 2000, CFO,
vice president and the CEO of Gen Re decided that to go ahead with
the deal considering their good relationship with AIG (Hass et al.,
2012). This was the actual scenario of fraud before it was
perpetrated and detected.

Presentation of fraud case
• This transaction fraud was widely known in the year
2004. This was the result of the ongoing
investigation for the accounting practices of the
insurance industry. During this time the ‘NY
insurance department’ and the office of attorney
general started to look into the matter of AIG more
seriously. Earlier the SEC showed their suspicion
because of theirs one insurance product named ‘loss
mitigation insurance’. But the fraud case came into
light slowly and the subsequent steps are as follows.

• SEC in the 2001 came to know about the AIG’s assistant to their clients
for balance sheet bolstering through the approach of insurance
transaction of fraud nature. This case was investigated by SEC and in
presence of department of justice AIG had to settle for a civil penalty of
$10m (Hass et al., 2012). Under this continuous investigation in 2005
February, IAG disclosed their earning of 2004. In the March of the 2005
AIG disclosed through deal with Gen Re for the reinsurance. In the
following court preceding the company Gen Re’s top executive revealed
that they were also aware about the deal and also had the knowledge
that AIG would use this transaction through applying accounting
procedure to fulfil the gap in loss reserve. After the deal AIG added close
to $500m in the reserve account of their balance sheet at the last and
first quarter of the 2000 and 2001 financial year (casact, 2009

• Applying some accounting principle AIG showed it revenue.
AIG hope that this addition of $500m in their reserve would be
able to satisfy the critic in the stock market. This was a false
way of inflating the valuation of the company. Later many
executive of AIG also stated that the deal transaction in the
balance sheet must have been stated as loan and not the
insurance. In the insurance business the risk is reinsured
(Carter, 2013). Here the firm 1 would insure the risk of the
insurance policy written by firm 2 to fir 2’s customer. this was a
finite insure that firm 2 purchased from firm 1 and in the finite
insurance policy the insured firm distribute the insure policy
cost over the long period of time (Carter, 2013).

• Therefore if firm 2 had to pay the cover amount to their
customer within the few year of the start of those policies,
firm 2 would be able to claim against their reinsurance with
firm 1. Because of this reinsurance policy firm 1 received a
large amount as premium from firm 2. In this insures under
the condition of claim scenario to firm 2 from their customer,
the reinsurance amount paid by the firm 2 to firm 1 would
return back to firm 2 (Blanchard, 2014). In this specific
insurance type context the present account principles were
based on the open interpretation. The accounting question
come as to state this transaction as reinsurance or the deposit.

• AIG treated it reinsurance and Gen Re treated it a
deposit process of accounting. Actually AIG in
exchange of $5m of payment got insurance contract
of worth $500m and subsequent $500m premium
into AIG. This transaction increased cash reserve by
the same amount. This $5m is the payment of
premium from the AIG to Gen Re. Two separate
contract under the condition of reinsurance were
formulated and in two part $250m amount entered
into AIG (securities.stanford, 2005).

• But under the circumstances of no claim in Gen Re the
amount would go back to Gen Re from AIG. Therefore
the amount can be classified as loan in the account. If it
had to be a insurance then some amount of risk factor
must have been transferred in to AIG which is not the
case as AIG already asked for no risk. Under this scenario
of no risk the loan would be treated as liability. The
fraudulent approach is that these contracts are not the
reinsurance contract. This lack of economic substantial
argument of these contracts makes them unworthy of
accounted for.

Detection of fraud case
• The agreement of the contract is created by the Houldsworth. Along with
the reinsurance vice president and others, Houldsworth wrote the
contract. As per the contract Gen Re would receive a payment of $5.2 m
from AIG as fee of this deal. Then for the payment of $5.2m and another
$10m as pre-fund premium, National Union is to be paid through the
CRD obligation (Hass et al., 2012). In this context AIG and Gen Re went
for unrelated separate reinsurance contract and that happened between
subsidiary of AIG and Gen Re. The subsidiary is the ‘Hartford steam
boiler inspection and Insurance Company’ or HSB. This route was
specifically taken for masking the Gen Re and AIG’s transfer and its real
reason. In this total transaction process actually AIG solicited this
transaction deal. But Gen Re created a documentation that is a sham as
that made it look like Gen Re solicited for the deal.

• In the process of leveraging this contract AIG was
supposed to receive $31.8m from the Gen Re. Here a
payment of $7.5m is done by the Gen Re for the
commutation of existing contract with HSB. Then around
$9.1m as premium is paid by Gen Re for the HSB’s
reinsure loss (securities.stanford, 2005). The sham
contract of reinsurance is used to pay $0.4m as premium
by CRD whereas it received a payment for loss of $13M.
This AIG received around $10m as LPT premium from
CRD. After all of these CRD and Gen Re used this $5.2m
for the fee covering.

• Therefore at the end AIG paid $5m to Gen Re
as fee but the payment of $10m was not
followed by AIG as per the written contract
(casact, 2009). The daft contract also
discussed the no-risk part of the deal. All of
these are used as the prosecution evidence.

Aftermath and investigation of fraud case
• In the prosecution process US Code is used. Under
that ‘Security investor protection laws’ and under
that ‘code of federal regulation’ is used. The
conspiracy law, mail fraud law, were also used in this
case for the prosecution process. After the
investigation process is over the several personnel
involved in this case were prosecuted. Gen Re CEO,
Ron Ferguson was convicted on 1 count of conspiracy,
7 counts of security fraud, 5 counts of false statement
and 3 counts of mail fraud (casact, 2009).

• After this he was sentenced to prison for 2 years, supervision release for 2
years, $200k in fine. Christopher Garand, chief underwriter and senior vice
president of Gen Re also got similar conviction and sentenced to 1 year prison,
supervision release for 1 years and $150k in fine. Then Christian Milton vice
president of AIG’s reinsurance also the similar conviction rate but the sentence
was of prison time 4 years, supervision release of 2 years and a fine of $200k.
Robert Graham the assistant general and SVP of Gen Re and Elizabeth Monrad
CFO of Gen Re also got the similar conviction. Elizabeth Monrad received a
prison term of 1.8 month adn Robert Graham received a sentence of super
vision release of 2 years and a fine of $100k (archive.boston, 2009; Johnson,
2011). In the 2017 Mr Greenberg the former head of AG and the CFO Mr Smith
reached an agreement with the office of attorney general of New York after
battling the decade long fraud charge of civil accounting. Here they would
forgo the performance bonus received during 2001 to 2004 as an amount of
$9.9m (Smith, 2017).

Fallout and impact of the case
• After the fallout of this case series of penalty had
been imposed on the perpetrator of this account
fraud case. Gen Re had agreed to pay $92.2m as
penalty to settle the case (nbcnews, 2010). This
was claimed by the shareholders and the federal
authority. The final settlement for the AIG cost
around $1.64bn which is the result of the lawsuit by
the shareholders (ifre, 2016). AIG also had to
restate the financial report of their five year
operation and lowered their 10% income.

Learned lesson
• This accounting fraud case provides a lesson for the robust for
the internal control process (Hoitash et al., 2009). Had the
auditor been independent in this case the situation would
have been averted at the first place. On the other hand the
role of the audit committee and its independence is also felt in
this case. The audit committee would have been a strong
monitoring body that would have prevented such incident to
happen in the organisation (Tanyi and Smith, 2014). Another
need is visible in this case analysis and that is the fear factor.
Had there been a strong law with stringent penalties it would
have acted as a prohibition for the top executive to engage in
such activity.

Recommendation
• Considering the above analysis the following recommendation
are provided.
• Establishing a string internal control procedure in the
organisation (Hoitash et al., 2009).
• Strictly maintain the independence of the auditor in the
organisation.
• Form an audit committee which would independent in nature.
• Provide monitoring mechanism and sufficient power to the
audit committee to detect these frauds (Tanyi and Smith, 2014).
• Create awareness about the legal, financial and criminal law
implication of these fraudulent activities.

Reference
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