Bristol-Myers Squibb Co. announced yesterday that it had increased the reserves related to the government’s investigation of the company’s accounting by $110 million, indicating that the matter may be coming to a head soon. The company’s press release (here) states rather cryptically: ""In today’s Form 10-Q, pre-tax earnings were reduced by $110 million, reflecting litigation reserves for previously disclosed matters recorded after the issuance of the earnings release. The previously disclosed matters are wholesaler inventory issues and certain other accounting matters. Together with the $30 million reserve previously recorded for such matters, of which $14 million had been reflected in the previously announced first quarter results, total reserves for these matters reported in the Form 10-Q are currently $140 million." The "previously disclosed matters" involve civil and criminal investigations of alleged channel stuffing by the company, a method to prop up revenue when a corporation’s sales begin to slide unexpectedly (see earlier post here about Coke’s settlement of similar charges). A New York Times article (here) notes that the company is represented by former Southern District U.S. Attorney Mary Jo White, so it certainly has brought in the first team. Whether Bristol-Myers is able to achieve a global settlement that will not cost it more money is still up in the air, and look for the government to seek a substantial penalty. (ph)
Category: Investigations
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For aficionados of "classic rock" stations — "old people music" according to one of my teenagers who mistakenly thinks I’m old — it’s always nice to hear an old favorite tune and turn up the volume even higher (the Volokh Conspiracy had a fun listing of "Top Ten Songs By Relatively Obscure Artists" here). Well, an oldie came up today while surveying recently published circuit court decisions (see how much fun it is to find material to write a blog entry for a Saturday): In re: Madison Guaranty Savings & Loan. For those waiting for me to hum a few bars (please don’t!), this one goes by another name: Whitewater — now you can start playing your air guitar. With Bill Clinton 4+ years removed from the White House and the Starr Report long since faded from memory (the current "Starr" everyone is paying attention to is the one attached to AIG), you’d think this one was completely off the charts. Well, the attorney’s fees provision of the since-expired Independent Counsel law keeps cases bouncing around for years.
The D.C. Circuit (maybe Power DCC should be the station ID) issued an opinion (here) reviewing the attorney’s fee application of Matthew L. Moore, a self-described junior member of the White House Office of Administration who got caught up in the travel office imbroglio in which seven staffers were fired. Now how’s that for another oldie — "Did Hillary Clinton order the mass firings?" you might recall was the refrain of the day. Moore was caught up in the investigation, which was rolled into the larger Whitewater investigation conducted by Independent Counsel (and now Dean at Pepperdine) Ken Starr, and sought reimbursement of $74,477.04 of attorney’s fees and expenses (what is the four cents for?). Alas, the D.C. Circuit rejected that claim. Under the expired statute, a claimant must meet a four-part test: (1) the person is a subject of the investigation, (2) the fees were incurred during the investigation, (3) the fees would not have been incurred but for the requirements of the Act, and (4) the fees are reasonable. Moore did not meet the "but for" test, as laboriously explained by the court. The DC Circuit did award Moore $7,447.70 in fees related to filing a response to the Independent Counsel’s final report, a separate basis for recovering fees. At least he got something for getting caught up in the Whitewater maelstrom.
Now, for today’s trivia question: Who was the Assistant to the President for Management and Administration who fired the seven travel office employees? The answer is in the D.C. Circuit opinion. Let’s get back to the music with a tune from a favorite duo briefly popular in the 1980s, Wang Chung! (ph)
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The New York Times reports (here) that federal prosecutors are looking at whether former American International Group CEO Maurice Greenberg engaged in market manipulation in AIG shares in February. According to the report, there is a tape of a telephone conversation between Greenberg and a trader at the company in which Greenberg orders the trader to purchase its stock at the time that the government issued subpoenas in connection with the General Re transaction that led to Greenberg’s downfall. The government investigation focuses on whether the purchases were designed to manipulate the price of AIG’s stock in the face of the negative publicity generated by the investigation. There is no lack of motive to keep the share price high, given Greenberg’s large share holdings (including the 41 million shares he gave his wife a month later — see earlier post here ("Do You Trust Your Wife?") and Form 4 here) and the even larger ownership held by Starr International Co. (12% of AIG’s shares) and C.V. Starr & Co. (18.8 million shares), two entities led by Greenberg — see AIG 2004 proxy statement here.
Market manipulation cases are notoriously difficult to prove, however, because they are all about intent and inferring it from everyday legal conduct can be quite difficult to establish. There is nothing illegal about a company buying its own shares, nor is there anything wrong about buying stock in the hope that it will increase in price — that’s what investing is all about. Unlike insider trading, in which the person purchases or sells to take advantage of undisclosed information, these purchases were contrary to the negative information. Unlike the easier link that can be made between material nonpublic information and subsequent transactions in insider trading, these transactions are not as easily identified as fraudulent. Greenberg was notorious for the attention he paid to AIG’s stock price, but that’s not unique among CEOs and is hardly proof of an intent to manipulate the market. This new front will likely prove problematic for Greenberg and AIG because it brings a different focus to the investigation, with the likely effect of prolonging an already complex, multifaceted probe. (ph)
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Former American International Group CEO Maurice Greenberg fired back with a letter to the board of directors disputing the company’s assertion that former management skirted internal controls and was not forthcoming about certain transactions (see earlier post here with link to AIG’s statement). Greenberg challenges the conclusions drawn from the internal investigation that accounting rules were violated, asserting that those decisions were made in "good faith" and approved by the auditors but are now being subjected to a "hindsight analysis." The letter, written on C.V. Starr & Co. stationary — which is one of the off-shore entities headed by Greenberg that controls a substantial block of AIG stock — ends with an attack on the company’s unwillingness to share information or consult him about the transactions:
I have known many of you for a long time and am puzzled by your refusal to share sufficient information with me to permit me to respond to the vile accusations being made against me and to provide input which could make the Board’s findings more complete and accurate.
The battle is joined, on Greenberg’s 80th birthday no less. A copy of Greenberg’s letter is below. (ph)
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The split between American International Group and its former long-time CEO Maurice Greenberg has all the hallmarks of a nasty divorce, according to a front-page Wall Street Journal story here. Among the items being fought over are a Remington sculpture, Chinese vases, and a Van Gogh painting. While celebrity divorces are always an interesting side show for the gossip-minded (think Jennifer, Brad, and Angelina), the more interesting aspect to me is that among the items Greenberg seeks to recover from his office are personal files containing documents. While those files apparently contain letters from his mother during his military service in World War II, they may also contain information that will be of interest to the government regulators focusing on Greenberg’s involvement in the accounting problems disclosed by the company this past Sunday (see earlier post here). In addition, records from two off-shore entities led by Greenberg that have had substantial dealings with AIG (and control approximately 15% of the company’s stock) may still be in his AIG office, no doubt enjoying the fine art in close proximity.
The distinction between "personal" and "business" records is crucial for Fifth Amendment purposes — documents in the former category may be subject to a self-incrimination claim regarding the act of production that can ultimately thwart the government’s ability to obtain them (U.S. v. Hubbell is the key recent case), while a corporation’s documents are not protected by the Fifth Amendment (although check Lance Cole’s recent article on extending the Fifth Amendment privilege to organizations discussed here). Given that AIG is scrambling to demonstrate its cooperation to fend off any threat of a criminal charge, the company likely will be more than happy to turn over whatever records it can get its hands on that the regulators may want to review. Greenberg, on the other hand, will not want his personal files reviewed by the government, and the records of the off-shore companies (Starr International and C.V. Starr Foundation) will not be easy to obtain if they are returned to the countries of incorporation: Bermuda and Panama. While fighting over baubles is commonplace in a divorce — recall the nasty fight between Jack Welch and his former wife Jane over the perks in his GE retirement package — the issues here run in a very different direction as the government seeks documents. While hell hath no fury like a forced-out CEO, Eliot Spitzer, the SEC, and the DOJ probably want nothing more than a chance to rummage through Greenberg’s personal files to learn about how he ran AIG and any "bodies" that may be buried in the company. This one is going to go on for quite a while, and may implicate the government’s interest in enforcing its subpoenas. (ph)
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The General Electric Company joined the crowd of insurers under the microspope (AIG, General Re, Marsh Mac, AON) by disclosing that it received a subpoena from the SEC on April 29 requiring it to produce documents related to its sales of so-called "finite risk" insurance. This type of policy, which GE describes as a "loss mitigation insurance product" (doesn’t that sound benign, just like any other plain vanilla insurance policy), is at the center of the investigation of AIG and General Re by state and federal regulators and the Department of Justice. GE’s press release (here) states:
GE understands that a number of other insurance and reinsurance companies have been subpoenaed by the SEC in relation to finite risk. One of GE’s businesses, GE Insurance Solutions, has made limited use of reinsurance with finite characteristics to manage the risks of catastrophic events such as storms or hurricanes, and to protect itself and GE shareowners from the volatility that is inherent in its business.
I notice that GE points out quickly that "we’re just like all those other guys" so there’s nothing to be worried about. What the heck, AIG’s shares went up 5% after it announced the scope of its accounting woes, so maybe confession is good for the stock price in addition to the soul. (ph)
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American International Group issued a statement (here) discussing the accounting adjustments that will be taken as a result of an internal investigation prompted by state and federal regulators inquiring into transactions involving the company. AIG will restate its financials going back to 2000 that will include a $2.7 billion charge to shareholder equity. The statement described the reasons for the adjustments for accounting errors:
The restatement will correct errors in prior accounting for improper or inappropriate transactions or entries that appear to have had the purpose of achieving an accounting result that would enhance measures important to the financial community and that may have involved documentation that did not accurately reflect the nature of the arrangements. In certain instances, these transactions or entries may also have involved misrepresentations to members of management, regulators and AIG’s independent auditors. The adjustments also include transactions or entries that should be restated as a result of quantitative and qualitative factors or as a result of errors, some of which had been previously identified but considered not to be material to require correction.
Translated from legalese and accounting-speak: everything was not as we made it appear. This is the stuff of criminal prosecution these days, especially when it involves a number of smaller transactions designed to meet short-term expectations spread over a number of reporting periods. An interesting question will be whether federal prosecutors will try to use the CEO/CFO financial statement certification provision 18 U.S.C.§ 1350 here) against former CEO Maurice Greenberg and former CFO Howard Smith. (ph)
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The daily dose of accounting revelations at American International Group is like water torture* for the company, with each disclosure discussing a seemingly new way in which it appears to have manipulated its premiums, quarterly income (see previous post here), and reinsurance risk (think General Re transaction). Today’s example comes via a New York Times article (here) in which former executives of the company are said to have disclosed that from the mid-1990s until 2001, the company booked premium payments before a final contract was reached with the party purchasing the insurance so that division executives could meet their monthly numbers at the American Home Assurance and National Union Fire Insurance units. The article asserts that this pre-booking of premiums did not affect AIG’s financial statements because the amounts were not large (about $1.5 billion at American Home and $100 million at National Union), and that contracts which did not come through were reversed in subsequent months. Whether it hit the bottom line or not — and I suspect that at least some of the revenue and earnings manipulation disclosed in AIG’s internal investigation would also incorporate early revenue recognition — this type of activity is further evidence of a corporate culture that viewed the rules as obstacles to profitability rather than guides for how to conduct a business properly (see earlier post here regarding AIG’s reporting of workers compensation premiums). Indeed, the article notes that AIG’s internal auditors put the early premium revenue in a category called "Games," a sure sign that things were not on the up-and-up. Drip . . . drip . . . drip. (ph)
* Although it is usually called "Chinese water torture," this item from "The Straight Dope" (here) notes that it is not really a Chinese practice but a derogatory term.
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The longer the internal investigation of American International Group goes on, the more problems seem to keep popping up. According to reports (N.Y. Times here, Wall Street Journal here), AIG’s audit committee has decided to postpone for a third time the filing of the company’s annual report, which was due in mid-March. One new area of concern, which will make it even harder to complete the audit and have management certify the financials as required by the Sarbanes-Oxley Act, are possible round-trip transactions with hedge funds that permitted AIG to recognize gains on the sale of securities repurchased in a later period. These types of transactions are window dressing for the quarterly numbers, and while the total amounts may be small, they raise substantial questions about whether false financial statements were filed with the SEC and relied upon by investors. Given Wall Street’s addiction to consistently rising earnings and making the "numbers" each quarter, even a $.01 change in earnings could be material. (ph)
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One item turned up in the internal investigation at American International Group is an accounting problem related to workers compensation policies sold by the company. According to a Wall Street Journal article (here), AIG may have treated shifted premiums from the workers comp policies, which would be subject to a 1% New York state tax to fund an insurance pool, to general liability policies to avoid paying the tax. The interesting aspect of this problem is not so much the accounting treatment or tax avoidance (except, of course, to accountants and tax lawyers), but the fact that in 1992 AIG’s general counsel, E. Michael Joye, informed senior management, including former CEO Maurice Greenberg, that the company’s accounting treatment for the premiums was illegal. Later that year, Joye resigned — or perhaps was forced out — from the company because of problems over the accounting issue.
Joye provided a copy of his memo about the workers comp issue to New York Attorney General Eliot Spitzer’s office, and the Journal article reports that the company waived its attorney-client privilege regarding the matter to permit further investigation. Under the Department of Justice guidelines for charging corporations, one important indicia of cooperation to avoid criminal charges is a willingness to waive the attorney-client privilege and work product protection, and AIG will do its utmost to cooperate to save its various insurance licenses.
If senior management did force Joye out because he was unwilling to go along with questionable, and even illegal, accounting practices, then that is an important sign of a corporate culture that regarded legal (and ethical) requirements as something to be gotten around or avoided. One conclusion from the internal investigation of AIG is that its internal controls were easily evaded, and that is a further sign that management did not regard itself as being bound by the rules. Haven’t we heard this story before? (ph)
MattBray.net 