U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 18985 / November 30, 2004
Accounting and Auditing Enforcement
Release No. 2145 / November 30, 2004
Securities and Exchange Commission v. American International Group, Inc., Civil Action No. 1:04CV02070 (GK)(D.D.C. filed November 30, 2004)
AMERICAN INTERNATIONAL GROUP, INC. AGREES TO SETTLE CHARGES OF VIOLATIONS OF ANTIFRAUD AND OTHER PROVISIONS OF THE FEDERAL SECURITIES LAWS
The Securities and Exchange Commission ("Commission") today filed a civil action against American International Group, Inc. ("Defendant AIG") for violating antifraud provisions of the federal securities laws and for aiding and abetting violations of reporting and record-keeping provisions of those laws. The Commission's action arises out of the conduct of Defendant AIG, primarily through its wholly owned subsidiary AIG Financial Products Corp. ("AIG-FP"), (collectively referred to as "AIG") in developing, marketing, and entering into transactions that purported to enable a public company to remove certain assets from its balance sheet. Defendant AIG, without admitting or denying the allegations in the Commission's Complaint has consented to the issuance of a final judgment (1) permanently enjoining it from violating, and from aiding and abetting violations of, certain provisions of the federal securities laws, (2) ordering it to comply with its undertaking to retain an independent consultant to examine certain prior transactions and to establish a transaction review committee to review future transactions, and (3) ordering Defendant AIG to disgorge the amount of fees that it received. In consenting to settle the Commission's action and related, criminal charges, AIG has agreed to pay disgorgement, plus prejudgment interest, and penalties totaling $126,366,000.
In its Complaint, filed in the United States District Court for the District of Columbia, the Commission alleged that from at least March 2001 through January 2002, Defendant AIG, primarily through AIG-FP, developed a product called a Contributed Guaranteed Alternative Investment Trust Security ("C-GAITS"), marketed that product to several public companies, and ultimately entered into three C-GAITS transactions with one such company, The PNC Financial Services Group, Inc. ("PNC"). For a fee, AIG offered to establish a special purpose entity ("SPE") to which the counter-party would transfer troubled or other potentially volatile assets. AIG represented that, under generally accepted accounting principles ("GAAP"), the SPE would not be consolidated on the counter-party's financial statements. The counter-party thus would be able to avoid charges to its income statement resulting from declines in the value of the assets transferred to the SPE. The transaction that AIG developed and marketed, however, did not satisfy the requirements of GAAP for nonconsolidation of SPEs.
The Commission alleged that while AIG was marketing the product, independent auditors for some potential counter-parties raised issues about whether certain features of the C-GAITS product could cause the product not to satisfy the GAAP requirements for nonconsolidation of SPEs. AIG did not inform the other potential counter-parties of these issues, except in one instance in which a potential counter-party used the same independent auditor as the potential counter-party that had communicated the issue to AIG. The Commission further alleged that AIG entered into three C-GAITS transactions with PNC to enable PNC to remove a total of $762 million in loan and venture-capital assets from its balance sheet. AIG was reckless in not knowing that these transactions did not satisfy the GAAP requirements for nonconsolidation of the assets by PNC.
In its Complaint, the Commission alleged the following:
- The applicable accounting standards, GAAP, in part, provided that, for nonconsolidation by the counter-party to be appropriate, the majority owner of the SPE, i.e. AIG, had to be an independent third party who made a substantive capital investment in the SPE and had substantive risks and rewards of ownership of the assets of the SPE. Three percent was the minimally acceptable amount to indicate a substantive capital investment. Fees paid to the owner of the SPE for structuring the transaction would be treated as a return of the owner's initial capital investment.
- The C-GAITS product provided for the counter-party to contribute troubled or other potentially volatile assets and cash to the SPE. In exchange, the counter-party would receive a class of nonvoting, noncumulative convertible preferred stock. The cash that the counter-party contributed would be used to purchase a 30-year zero coupon note that, at maturity, would pay an amount equal to the counter-party's initial capital investment in the SPE. As initially proposed, AIG would issue the zero coupon note. The C-GAITS product additionally provided for AIG to contribute cash equal to 3% of the total assets of the SPE. In return, AIG would receive a separate class of preferred stock and voting common stock. The cash that AIG contributed would be used to purchase highly rated debt securities. The earnings on those securities would be used to pay AIG a dividend, which AIG would receive regardless of the performance of the assets that the counter-party had contributed. The C-GAITS product also provided for AIG to be paid an annual fee from assets or earnings on assets contributed by the counter-party.
- AIG retained a national accounting firm, National Accounting Firm A, to provide advice in the development and marketing of the C-GAITS product. National Accounting Firm A provided AIG with opinion letters (each a "SAS-50 letter") regarding the treatment under GAAP of the C-GAITS product by the counter-party. Those opinion letters, however, did not address certain features of the C-GAITS product that AIG proposed to prospective counter-parties.
- On or about April 23, 2001, a partner at National Accounting Firm A informed an AIG employee of a concern that National Accounting Firm A had that the purchase of a zero coupon note issued by AIG in connection with a proposed C-GAITS transaction could be treated as a return of AIG's capital investment. National Accounting Firm A finalized a SAS-50 letter without identifying an issuer of the zero coupon note or specifying whether AIG could be the issuer. AIG, however, continued to propose the C-GAITS product to prospective counter-parties with a zero coupon note issued by AIG but did not inform those prospective counter-parties of National Accounting Firm A's concerns about the issuance of such a note. AIG's marketing material informed prospective counter-parties that the contemplated accounting treatment for the C-GAITS transaction was "based upon advice from [National Accounting Firm A]."
- The C-GAITS product provided for AIG to be paid an annual fee by either the counter-party directly or the SPE from assets or earnings on assets contributed by the counter-party. On May 29, 2001, an employee of a prospective counter-party, National Insurance Company A, informed at least one AIG employee of AIG of "soft spots" in the accounting for the C-GAITS product that National Insurance Company A's outside auditor, National Accounting Firm B, had discussed earlier that day. Those "soft spots" included whether AIG's capital investment might fall below the minimum (3%) capital investment required by GAAP for nonconsolidation of the SPE by National Insurance Company A if AIG received a "large prepayment" of its fees or if its fees were not received in exchange for services rendered by AIG. By the end of that day, AIG modified the proposed C GAITS structure for National Insurance Company A to increase AIG's capital investment from 3% to 5%. AIG did not inform other potential counter-parties of the issues that National Insurance Company A had raised, except in one instance involving a potential C-GAITS transaction with National Insurance Company B, which used the same outside auditor as National Insurance Company A.
- Only PNC entered into a C-GAITS transaction. From June 28, 2001, through November 30, 2001, PNC and AIG entered into three C-GAITS transactions. Through these transactions (each known as a "PAGIC" transaction), PNC sought to remove a total of $762 million of loan and venture capital assets from its balance sheet and thus to avoid charges to its income statement from declines in the value of these assets.
- The C-GAITS transaction that AIG initially proposed to PNC provided for AIG to issue a 30-year zero coupon note to be purchased and held by the SPE. On June 18, 2001, PNC requested that AIG change the issuer. PNC explained to an AIG employee that National Accounting Firm A, which also was PNC's outside auditor, had informed PNC that it believed there was a risk that the Commission might view the issuance of a zero coupon note by AIG to be a return of the capital invested by AIG. AIG agreed to the requested change.
- Even with the change in the issuer of the zero coupon note, the PAGIC transactions did not satisfy the GAAP requirements for nonconsolidation. As AIG intended, the fees that it was were primarily for structuring the PAGIC transactions and, as a result, reduced AIG's capital investment below the 3% level. Also, the PAGIC transactions did not satisfy GAAP requirements because AIG did not have substantive risks and rewards of ownership of the assets of the SPE. Because PNC improperly treated the transfers of assets in the PAGIC transactions as sales of those assets that permitted PNC not to report them in its financial statements and regulatory reports, PNC made materially false and misleading disclosures about its financial condition and performance in filings with the Commission and in press releases.
- AIG received $39.821 million in fees for entering into the three PAGIC transactions.
The Commission further alleged in its Complaint that Defendant AIG (a) recklessly made misstatements of material facts, and omitted to state material facts, about whether the C-GAITS product satisfied the GAAP requirements for nonconsolidation of an SPE and (b) entered into the three PAGIC transactions with PNC that it was reckless in not knowing did not satisfy the GAAP requirements for nonconsolidation of the SPEs by PNC.
Defendant AIG, without admitting or denying the allegations in the Complaint, has consented to the issuance of a final judgment (a) permanently enjoining it from violating of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), Exchange Act Rule 10b-5, and Section 17(a) of the Securities Act of 1933 and from aiding and abetting violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Exchange Act Rules 12b-1, 13a-1, and 13a-13, (b) ordering it to disgorge the $39,821,000 in fees that it received, plus prejudgment interest of $6,545,000, which will be paid to the victim restitution fund established in connection with the prior resolution of criminal charges by the Department of Justice against a PNC subsidiary and (c) ordering Defendant AIG to retain an independent consultant to examine certain of its prior transactions and to establish a Transaction Review Committee to review the appropriateness of certain future transactions. The independent consultant will conduct an examination of transactions that Defendant AIG entered into with a public company between January 1, 2000 and the date of the final judgment that involved the use of SPEs or variable interest entities, or that were marketed or entered into by Defendant AIG with a primary purpose of enabling a public company to obtain an accounting or financial reporting result. The Transaction Review Committee will review transactions proposed to be undertaken with a public company that were or are developed, marketed, or proposed by Defenant AIG or a public company and that involve heightened legal, reputational, or regulatory risk, including transactions with a primary purpose of enabling a public company to obtain an accounting or financial result. The independent consultant will conduct a review related to certain policies and procedures adopted by the Transactional Review Committee.
Separately today, the Fraud Section of the Criminal Division of the Department of Justice ("Fraud Section") announced a resolution of related, criminal charges against Defendant AIG and two of its subsidiaries. In resolving the civil and criminal charges, AIG has agreed to pay disgorgement and penalties totaling $126 million. Today's civil and criminal actions are the result of investigations by the Commission, the Fraud Section, and the Pittsburgh office of the Federal Bureau of Investigation.
The Commission previously brought a prior settled proceeding against PNC. For further information See In the Matter of The PNC Financial Services Group, Inc., Securities Act Release No. 33-8112, Exchange Act Release No. 34-46225, July 18, 2002. The Commission's investigation is continuing as to the conduct of others.
SEC Complaint in this matter