Maurice "Hank" Greenberg is "wicked," at least as seen by the Attorney General of the State of New York.That is so because Greenberg is accused of being responsible for an extensive array of accounting distortions providing false and misleading financial statements of American International Group, the highly esteemed and successful insurance enterprise that Greenberg helped create and headed for some 40 years.

Even before the attorney general's charges were proved to be just, Greenberg had already fallen and suffered a nexus of "desserts." Among them:

* He was ousted peremptorily by the board of directors of his corporation.

* He found it prudent to resign from the many philanthropic and cultural organizations of which he was a director.

* He found it advisable to "plead the Fifth" when asked to testify.

* He found it desirable to transfer $2 billion of AIG stock to his wife to insulate that fund from the reach of creditors. (This transfer was later reversed.)

* He was toppled from his pedestal in the pantheon of the great leaders of business and finance of the 20th and 21st centuries.

In fact, the Greenberg saga is much like a Greek tragedy, along the lines of Oedipus. Thus, both Greenberg and Sophocles' tragic hero were struck down at the moment when their power and glory were at their highest. But there is a difference, one that is invidious, thus: Oedipus was afflicted with his critical flaw by the gods at the moment of conception. Greenberg's affliction was self-induced, i.e., hubris.

But this essay is less to probe the wickedness of Greenberg than to probe the mischief, which the very virtuous are responsible for, in the years of false and misleading financial statements by AIG. Therefore, I will consider principally the important avenue of the alleged accounting distortions, i.e., that related to the use and abuse of reinsurance arrangements.

First, a brief tutorial regarding reinsurance arrangements, transactions that are of special interest to this commentary.

Reinsurance arrangements between insurer and reinsurer are formal agreements regularly negotiated at the very highest levels of the parties to the undertakings. Understandably so! These arrangements involve hundreds of millions of dollars of risk transfers between the insurer and reinsurer.

So formal and elaborate are the resultant contracts that they are frequently referred to as "reinsurance treaties." Thus, they are not run-of-the-mill contracts like property and casualty insurance policies.

So I turn to the nexus of Bahamian reinsurance entities that AIG created and utilized to pick up its liabilities and/or losses while endeavoring to avoid the inclusion of these negatives in its consolidated financial statements. This illicit practice we now recognize as the kind sparkling with the "Enron cachet."

The practices and procedures were spelled out in a May 2, 2005, civil complaint against Greenberg and chief financial officer Howard I. Smith.

Beginning at least in the mid-1980s, AIG set up several offshore entities for the purpose of reinsuring AIG and its subsidiaries. AIG has repeatedly misled regulators about the nature of its relationships with these entities.

In 1987, AIG set up Coral Re, a Barbados-based reinsurer, for the purpose of reinsuring AIG business. By 1991, AIG had purchased from Coral Re approximately $1 billion in reinsurance, although Coral Re had a capitalization of only $15 million.

By the early 1990s, Coral Re had come under regulatory scrutiny from insurance departments in Delaware, New York and Pennsylvania. In 1995, the New York Insurance Department raised concerns that AIG might control Coral Re. Pursuant to GAAP accounting on a consolidated basis, if an insurer purchases reinsurance from a reinsurance company that it owns or controls, the insurer cannot claim on its books a reinsurance recoverable, i.e., protection against potential losses covered by the reinsurance, because the insurer is effectively reinsuring itself.

As a condition of resolving the New York Insurance Department's examination, the department mandated that AIG agree to stop purchasing reinsurance from Coral Re, and that AIG would "report any reinsurer that has characteristics similar to Coral Re as an affiliate reinsurer in future filings with state insurance regulators."

At no time during the negotiations for the resolution of the Coral Re examination or thereafter did AIG disclose to the New York Insurance Department that it already had two pre-existing offshore affiliates with "characteristics similar to Coral Re."

In 1986, AIG had formed Richmond Reinsurance Co., a Bermuda holding company with a Barbados reinsurance subsidiary similar to Coral Re, and having a similar purpose. And in 1991, AIG had formed Union Excess Reinsurance Co. Ltd., under a different name, a Barbados reinsurer similar to Coral Re, also for a similar purpose. Although there were minor variations, Richmond, Union Excess and Coral Re shared the following "characteristics:"

* They were created by AIG;

* AIG found the investors and drafted all documents related to the initial capitalization;

* They were undercapitalized;

* They had passive investors backed by AIG or its affiliates;

* The management and administrative functions of each were performed by the same AIG affiliate; and,

* Officers of the three offshore entities had numerous relationships with AIG and with each other.

Cross examination

I will now put some questions to AIG's legal counsel, thus:

* You were undoubtedly involved in the covenant to report "any reinsurer that has characteristics similar to Coral Re as an affiliate reinsurer in future filings with state insurance regulators." Did you not deem it necessary to review AIG's other reinsurance arrangements at the time of the 1995 undertaking to see if there were such similar captive Bahamian subsidiaries?

* Did you proceed with due diligence subsequent to the 1995 covenant to determine whether such captive enterprises were involved in the AIG reinsurance arrangements?

* Did you, from time to time, or as the reinsurance arrangements may have been renewed, request financial statements from Richmond and Union Excess to determine whether they were, in fact, financially responsible for the very substantial liabilities that were being ceded to them by AIG?

* Did you consider your responsibility for making these judgment calls to rest entirely with the financial people?

* If so, where was the system of internal control, of checks and balances?

* Finally, was AIG's board of directors informed of the 1995 accord and covenant? If so, did you inform the board from year to year regarding AIG's compliance with the covenant?

I will then put the foregoing catechism to AIG's auditors, both internal and external, but very much more stridently. In addition, I would ask:

* In view of the fact that these off-shore, off-balance sheet enterprises had prevailed for more than a decade, and in view of the amounts that were involved in these illicit activities, how did the perversity which prevailed escape your attention and action?

* Going further, you were alerted to the perversity by the insurance regulators back in 1995; should that not have served as a shrill signal that the internal controls environment was seriously deficient?

* According to a March 2005 article in Barron's, there were signals that indicated that there may have been some entangling alliances that prevailed between AIG and Richmond and Union Excess down in the Bahamas. According to the article, as of the end of 2003, AIG was carrying on its books $1.2 billion of reinsured losses receivable from Richmond and Union Excess, out of a total of $3.6 billion of such assets owing to AIG by all offshore reinsurers. Why did not such indicators of special arrangements lead to further probes by PricewaterhouseCoopers?

* Is it conceivable that you were distracted or diverted from that festering perversity by charismatic management, or did you find it convenient or beneficial to avoid probing to see whether the perversity had metastasized?

In short, I just cannot comprehend a condition of that nature and magnitude festering undetected by competent auditors, both internal and external, under the circumstances here alleged by the AG!

A definitive response to many of these questions should develop as a consequence of shareholder litigation; for the present, only a hypothetical response is possible, based on experience from various other accounting sagas.

The external independent audit firm is presently PwC, which was formed as the result of the 1998 merger between Price Waterhouse and a second Big Six firm, Coopers and Lybrand. Especially noteworthy in this regard is that Howard I. Smith, who was ousted as AIG's CFO concurrently with Greenberg's departure, and who is Greenberg's co-defendant in the AG's action, had devoted a score of years of his professional career to C&L before joining AIG in 1984.

While at C&L, Smith had become the head of the firm's insurance practice. So it is that the erstwhile C&L executive moved to become an AIG executive, with his erstwhile firm continuing to serve as AIG's independent external auditor.

Other forensic probes inform me that such corresponding, symbiotic relationships may tarnish the independence of the external auditors. The incumbent auditors may look with awe on the extraordinary accomplishments of their erstwhile colleague; then, too, the incumbent auditors may sense that if they find favor with the AIG executive, who knows but that they, too, might be tapped to join on the trail to AIG's executive suite?

From the other direction, the new CFO might well be in possession of the audit program being followed by his erstwhile firm, permitting him to steer a course within the cracks.

And now I will provide a collateral series of questions directed to the accounting firms, presumed to be other than C&L or PwC, responsible for the independent audit of the Bahamian enterprises:

* Did you, during the course of your audits, take note of the apparently incongruous relationship between the liabilities on the books of these enterprises and their shareholder equity?

* Did the foregoing relationships raise "going-concern" questions for you? If not, why not?

* During the course of your audits, did you observe the circumstances under which your clients were operating, e.g., their process of decision-making and administration?

* Did you observe that the source for your clients' business was essentially a single source, i.e., AIG?

* Assuming that you observed any of the foregoing or other corresponding incestuous relationships implying a direct, more-than-casual involvement by AIG in your clients, did you consider it your professional, ethical responsibility to advise AIG's independent registered auditors of your concern? If not, why not?

In short, the creation of offshore special purpose enterprises, where the independent audit responsibilities are unhinged, should not leave the public unhinged or out on a limb!

Six guys from Chicago

As a coda to AIG's Bahamian involvements, we have the Barron's article noting the very special circumstances that gave rise to the creation of Coral Re back in 1987.

As the story goes, Goldman Sachs, acting as the financial intermediary (really as the "panderer," in this context), assembled six rich guys mostly from Chicago to become "shareholders." None had to ante up a cent; instead, the required capital contribution was provided by a Japanese bank on a risk-free, non-recourse basis. Coral Re paid as a dividend amounts equal to the interest requirements, and to leave something of a pourboire for the six guys from Chicago assembled by Goldman Sachs. It appears that they accepted their desserts on what appears to have been a "don't ask, don't tell" basis.

But then, I am left with the gnawing question: While the rich guys from Chicago were willing to sell their identities for whatever fell into their laps, how do we justify the role of a Goldman Sachs?

So we are now led to Greenberg's tour de force, in the Berkshire Hathaway General Re/AIG Faustian bargain in late 2000.

According to Allegations 28ff of the AG's complaint, on Oct. 31, 2000, Greenberg initiated a scheme to falsely inflate AIG's reserves for the next two quarters. The scheme began that day when Greenberg called Ronald Ferguson, president of GenRe. In that call, Greenberg suggested that GenRe purchase up to $500 million in reinsurance from AIG, because he wanted AIG to show increased reserves. But, in the same conversation, Greenberg also said that he wanted the deal to be risk-free. A riskless transaction that creates reserves is nonsensical. An insurer can properly generate and record reserves only if it is taking on genuine risk that there may be claims that would require future payment. Greenberg wanted AIG to be able to book hundreds of millions of dollars in reserves from GenRe, but he did not want there to be any risk that AIG would actually have to pay any claims.

On or about Nov. 17, 2000, according to the AG, Greenberg called Ferguson to discuss the deal. Ferguson told Greenberg that he thought they had put together a structure that would accomplish Greenberg's objectives. They also discussed the fact that AIG would "not bear real risk" in the transaction, and that, in the end, AIG would pay GenRe a $5 million fee. Greenberg told Ferguson that defendant Smith and Milton would handle the transaction on AIG's end. Later that day, a GenRe employee e-mailed Milton at AIG to provide details of the proposed transaction, along with a draft contract.

Ultimately, AIG's subsidiary, National Union, and GenRe's subsidiary, Cologne Re of Dublin, entered into two contracts. In form, GenRe was to pay a total of $500 million to AIG, and AIG was to provide $600 million of reinsurance coverage. As a consequence of this fiction, AIG would be able to show reserves of $500 million, in accordance with Greenberg's original design. The first of the sham contracts would allow AIG to book $250 million of reserves in the fourth quarter of 2000, and the second sham contract would allow AIG to book another $250 million of reserves in the first quarter of 2001. In fact, GenRe did not pay premiums. And in fact, AIG did not reinsure genuine risk. To the contrary, AIG paid GenRe $5 million, and the only genuine service performed by either party was that GenRe created false and misleading documentation to satisfy Greenberg's illicit goals.

The entire AIG/General Re transaction, the AG alleges, was a fraud.

It was explicitly designed by Greenberg from the beginning to create no risk for either party - AIG never even created an underwriting file in connection with the deal. Indeed, the true nature of the deal is clear if one follows the money: AIG paid GenRe $5 million for the deal -exactly the opposite of what would happen if AIG were actually taking on potential liabilities from GenRe.

The June 2005 Securities and Exchange Commission criminal complaint against GenRe executive John Houldsworth referred to a conference among the conspirators during mid-November 2000, which includes some especially remarkable observations.

First, the conspirators note that, insofar as GenRe was concerned, the risk was only to its reputation.

More significantly, the conspirators were of the view that the real accounting problem was with AIG. But even there, "there was no real risk." That was because the paper trail being developed should mislead the auditors, because the documentation would pass the auditors' "smell test" - as though PwC were serving as AIG's independent olfactories.

Casting aside the conspiracy notion, the first smell test for good accountants demands that the auditors probe reinsurance arrangements to make certain that they require an appropriate transfer of risks from the ceding enterprise to the reinsurer. The Financial Accounting Standards Board's Statement of Financial Accounting Standards 113, Accounting and Reporting for Reinsurance, promulgated in December 1992, sets forth at Paragraph 8 a provision especially relevant in this context:

Indemnification against Loss or Liability Relating to Insurance Risk. Determining whether a contract with a reinsurer provides indemnification against loss or liability relating to insurance risk requires a complete understanding of that contract and others or agreements between the ceding enterprise and related reinsurers. This understanding includes an evaluation of all contractual features that (a) limit the amount of insurance risk to which the reinsurer is subject (such as through experience refunds, cancellation provisions, adjustable features or additions of profitable lines of business to the reinsurance contract) or (b) delay the timely reimbursement of claims by the reinsurer (such as through payment schedules or accumulating retentions from multiple years).

These risk-transfer provisions were pointed up especially by a July 1993 promulgation by FASB's Emerging Issues Task Force, when schemes that had been pursued by some insurers in the wake of Hurricane Andrew were put in question.

In these instances, as with AIG and General Re, a paper trail was developed to meet the smell test of reinsurance, but lacked the risk-transfer standard. That the auditor, confronted with a reinsurance arrangement, was constrained to probe the documentation most circumspectly is pointed up by the following from the EITF: "A task force member asked whether a contract could be split for purposes of evaluating risk transfer. A staff representative responded that Statement 113 applies to 'contract,' and that determining the substance of a contract is a judgmental matter. If an agreement with a reinsurer consists of both risk-transfer and non-risk-transfer coverages that have been combined into a single legal document, those coverages must be considered separately for accounting purposes."

Accepting the allegations by the AG in his complaint, had the PwC auditors fulfilled their mission, they would have determined that there was no substance to the whole paper trail, other than the $5 million paid by AIG to General Re.

If, then, we accept the AG's allegations regarding the absence of the flow of money, as well as the absence of an underwriting file, then the precondition to a valid reinsurance arrangement would not exist. Accordingly, I cannot see how the arrangements in question were acceptable to PwC as AIG's independent auditor. And then, as noted, a priori, even on a smell test basis, the arrangement should have emitted a disagreeable stench. It is especially noteworthy that AIG did not create an underwriting file to reflect the presumed assumed risks under the arrangement with General Re. Then, too, assuming PwC was able to somehow rationalize the arrangement with General Re, should they not have deemed it appropriate, possibly even necessary, to discuss the contracts with AIG's independent audit committee?

If not, why not?

But now my olfactories have put the whole transaction into question. Note that in the typical reinsurance arrangement, the ceding party is the insurer, the insurance company that finds that it has undertaken excessive risks in a particular context, so that it is willing to pay a premium to a reinsurer to be relieved of the risk burden.

The General Re/AIG arrangement turns that usual condition on its head, i.e., reinsurer Gen Re was presumed to be paying a hefty premium to a direct-writing insurer (AIG) to be relieved of some kind of risk.

This very inversion of the typical arrangement should have sent the "smellers" scurrying over to the underwriting files to see (rather than just smell) what kinds of risks were being assumed by AIG. And, if you believe the AG, there was nothing to see, probably also nothing even to smell.

Remember, they were dealing with a transaction involving a half-billion dollars of presumed premiums, and an even greater amount of risks presumed to have been assumed by AIG.

More mischief

There is yet another manifestation of the "mischief of the virtuous" that calls for comment at this point.

Accepting Warren Buffett as the exemplar of the highest standards of business ethics, and that it is those standards that he endeavors to sound as the "tone at the top" at Berkshire Hathaway, what is clear is that such a tone did not penetrate down into General Re.

Accordingly, that failure must represent a serious disappointment to Warren Buffett, and to his fellow shareholders in Berkshire Hathaway.

But, then, what I find especially incomprehensible is that a bevy of General Re executives could have lent themselves to this Faustian bargain with AIG. Remember, there was naught but a panderer's fee of a mere $5 million involved - paltry reward for the risks of exposure undertaken by General Re and its executives.

I turn now to a consideration of the "mischief" that might be attributed to AIG's especially virtuous independent audit committee. In this regard, a caveat included in the committee's report to shareholders included in the proxy material for the 2002 meeting, and essentially consistent with that included in the 2001 submission (relating to the 2001 and 2000 financial statements, respectively), reads as follows:

The role of the audit committee ... is to assist the board of directors in its oversight of AIG's financial reporting process. The board of directors, in its business judgment, has determined that all members of the committee are "independent," as required by applicable listing standards of the New York Stock Exchange. ... As set forth in the audit committee's charter, the management of AIG is responsible for the preparation, presentation and integrity of AIG's financial statements, AIG's accounting and financial reporting principles and internal controls, and procedures designed to assure compliance with accounting standards and applicable laws and regulations. The independent accountants are responsible for auditing AIG's financial statements and expressing an opinion as to their conformity with generally accepted accounting principles.

In the performance of its oversight function, the committee has considered and discussed the audited financial statements with management and the independent accountants. The committee has also discussed with the independent accountants the matters required to be discussed by Statement on Auditing Standards No. 61, Communication with Audit Committees, as currently in effect. Finally, the committee has received the written disclosures and the letter from the independent accountants required by Independence Standards Board Standard No.1, Independence Discussions with Audit Committees, as currently in effect, has considered whether the provision of non-audit services by the independent accountants to AIG is compatible with maintaining their independence, and has discussed with the accountants their independence."

It may well be that, given this abdication of responsibility by AIG's audit committee, the internal control system could be seen to have been lacking a critical "concentric ring of protection," so that PwC should have been constrained to deny its certification of the company's 2000 and 2001 financials.

We now have AIG's Form 10-K for 2004, filed with the SEC on May 27, 2005, as well as the company's financial statements for the year sent to shareholders in mid-July, together with the proxy material in advance of the shareholders' meeting scheduled for Aug. 11, 2005.

Each of these documents discourses extensively on the "internal examination" undertaken by the board of directors and management. This endeavor was described in the report of the audit committee, as follows:

In connection with the preparation of AIG's annual report on Form 10-K for the year ended Dec. 31, 2004, AIG's current management initiated an internal review of AIG's books and records, which was substantially expanded in mid-March 2005. The review was conducted under the direction of senior management with the oversight of the audit committee, and was complemented by investigations by outside counsel for AIG and for the audit committee. PricewaterhouseCoopers LLP, AIG's independent registered public accounting firm, was consulted on the scope of the internal review as well as on the results.

This review culminated in the restatement of AIG's financial results [for the years 2003, 2002 and 2001], a delay in AIG filing its annual report on Form 10-K for the year ended Dec. 31, 2004, and its quarterly report on Form 10-Q for the quarter ended March 31, 2005, and the conclusion that there were several [sic!] material weaknesses in AIG's internal control over financial reporting.

How many comprise "several?" Could a dozen be shoe-horned into "several?"

PwC would have had to have withdrawn its 2004 certification as well, had it not been for the AG's "sounding the tocsin" early the spring of 2005. Thus, from an April 29, 2005, Financial Times article titled "AIG set to delay annual report for a second time:"

A spokesman for Mr. Greenberg said a review of AIG's controls by PwC had signed off on the account this year and had found "no material exceptions."

"As required by federal law, AIG engaged PwC to review its internal controls. That report, with no material exceptions noted, was presented to AIG's audit committee and accepted by them in February of this year," the spokesman said.

I will now pause to set forth my reaction to the way in which this probe was undertaken and the related terms of engagement. We do not have a situation where an enterprise confronted with a critical problem in corporate governance and accountability submits the responsibility for an extensive and intensive probe to an independent firm of lawyers and accountants experienced in forensic audits, with an unfettered mandate to pursue the facts and find the truth no matter where it might lead.

Instead, as I read the limited mandate bestowed on the investigators (who do not appear to have been identified in the documents) the investigation was oriented more towards producing a "white paper," to limit the liabilities and responsibilities of the parties involved, rather than to get at the roots of the critical problems at AIG.

Be that as it may, however limited may have been the terms of the engagement, the investigators came forth with a litany of aberrations in accounting and auditing in internal control aspects of AIG's governance and accountability.

What was the response to that report? According to the audit committee report, changes were as follows:

New senior management. AIG appointed a new chief executive and a new chief financial officer, who, together with other senior executives, are committed to achieving transparency and clear communication with all stakeholders through effective corporate governance, a strong control environment, high ethical standards and financial reporting integrity. [Query: So what's so new about that?]

Chief risk officer. AIG has strengthened the position of chief risk officer, responsible for enterprise-wide credit, market and operation risk management and oversight.

Financial disclosure committee. AIG intends to establish a financial disclosure committee to assist Messrs. Sullivan and Bensinger in fulfilling their responsibilities for oversight of the accuracy and timeliness of AIG's disclosures.

Complex Structured Finance Transaction Committee. AIG has expanded the scope and activities of the Complex Structured Finance Transaction Committee to include the review and approval of AIG's accounting and financial reporting of identified transactions, including related-party transactions.

AIG is also actively:

* Developing procedures to ensure that risk transfer will be properly evaluated and contemporaneously documented;

* Establishing procedures and controls to ensure that reconciliations are performed;

* Evaluating alternative approaches, ensuring that hedge accounting requirements are met; and,

* Enhancing controls over deferred tax reporting.

In my view, the changes thus wrought should have been in place as a matter of course years ago; thus, the supposed "new controls" are of the kind that Coopers & Lybrand, even without Price Waterhouse, should have made certain were in place years before the serious deficiencies surfaced as a consequence of the prodding from the attorney general.

In short, the forensic probe of AIG should not have been implemented pursuant to rules of engagement determined by AIG's board and PwC; instead, they were, in my view, conflicted, and accordingly should have recused themselves. As already noted, an independent forensic probe should have been pursued with appropriate vetting by the Public Company Accounting Oversight Board.

Putting aside my impeachment of the manner in which the pathological probe of the past was initiated, implemented and concluded, we now know that there was a litany of serious deficiencies in the application of accounting principles and the application of auditing standards, as well as failures in the implementation of appropriate control procedures. In fact, the aberrations and deficiencies were so serious as to require the actual restatement of previously certified financial statements.

Given that condition, how did AIG's virtuous management and independent audit committee respond to the dismal past, insofar as it may have involved PwC - AIG's longstanding independent registered public accountant? Incredibly, as I see it!

Nearly 40 years ago, Justice William O. Douglas honored me by providing a foreword to my The Effectiveness of Accounting Communication (Praeger, 1967); that essay concluded with the following foreboding:

The author demands an understandably high price of the attesting accountant, who is preparing himself to fulfill this essential role. He expects him to undergo a "ritualistic purging" and to forego the rewards that may be derived from the rendering of management services and the other "peripheral services" that he describes.

The burdens that Mr. Briloff puts upon the profession are substantial, but, as he demonstrates, our economic society is in urgent need of this service. If the accounting profession does not respond effectively to the challenges presented, there may be little alternative but to have possibly a new profession fill the breach.

AIG and the recurrent accounting fiascos du jour make clear that Justice Douglas' challenge to the accounting profession is still extremely appropriate - even more so.

Despite prodding from the Congress, regulators, investors, the securities industry and the media, our leadership has succeeded in transmuting our profession into an industry, our professional organizations into trade associations.

How might we respond?

As Justice Douglas observed, the circumstances might call for "possibly a new profession." Until then, I have suggested in testimony before FASB, the United States Senate, and the SEC that we consider aborting the requirement that the financial statements of publicly owned enterprises be subject to independent audits by CPAs, and proclaim caveat emptor.

Is there yet time for an epiphany, a rededication and recommitment to the objectives and ideals of the profession of certified public accountancy?

I am grateful to Professor Eric Neubacher of the Baruch College Newman Library for his vital role in ferreting out the material and data required for this critique; I am most appreciative to Moyee Huei-Lambert, Cary Lange and Leonore Briloff for their important assistance in the processing and editing of successive drafts of this writing over the four months of its gestation.

Abraham Briloff, CPA, Ph.D, is a professor emeritus of Baruch College, in New York City.

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