Greenberg, Whistleblower Both Fault AIG Internal Controls

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October 8, 2008 Wednesday 02:58 PM EST

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Greenberg, Whistleblower Both Fault AIG Internal Controls

Raymond J Lehmann

WASHINGTON

Kept away by illness from an Oct. 7 congressional hearing on the company he helped build, long-time American International Group Inc. chief Maurice R. "Hank" Greenberg is claiming internal controls he established in his nearly 40 years at the helm of the insurance giant were abandoned following his March 2005 departure.

In written comments to the House Oversight and Government Reform Committee, Greenberg particularly faulted successors Martin Sullivan and Robert Willumstad for failing to exercise proper oversight of AIG's London-based AIG Financial Products division, whose $500 billion portfolio of credit default swaps lay at the heart of the company's recent troubles, saying "the risk controls my team and I put in place were weakened or eliminated after my retirement."

"It is my understanding that the weekly meetings we used to conduct to review all AIG's investments and risks were eliminated. These meetings kept the CEO abreast of AIGFP's credit exposure," wrote Greenberg, chief executive officer from 1968 until early 2005.

Launched in 1987, Greenberg said, "as part of AIG's philosophy that generating earnings from diverse business lines would add to earnings stability if any particular business unit encountered a downturn," AIGFP ended up being the company's downfall. Through June 30, AIG had taken $25.9 billion in mark-to-market losses on its AIGFP portfolio and has booked $50 billion of thus-far unrealized losses on the value of its CDS and on mortgage-related securities held in its investment portfolio.

Greenberg, now head of the formerly AIG-controlled C.V. Starr & Co., said AIGFP wrote as many credit default swaps on collateralized debt obligations in the nine months following his departure as it had in the entire previous seven years combined. He added that "unlike what had been true during my tenure, the majority of the credit default swaps that AIGFP wrote in the nine months after I retired were reportedly exposed to subprime mortgages."

However, Nell Minow of corporate governance research firm The Corporate Library, noted his firm initially believed transparency at AIG had improved following Greenberg's departure. The Library rated the effectiveness of AIG's board of directors a "D" in June 2002 and downgraded them to an "F" in January 2005, subsequently upgrading them to a "D" in December 2005 and a "C" in February 2006, as the company had engaged former U.S. Securities and Exchange Commission Chairman Arthur Leavitt as an advisory member and shed more than half of its former directors.

Minow and the Library ultimately downgraded AIG's board again to a "D" in November 2007, with Minow commenting that "neither of the CEOs that followed Greenberg sought to implement significant change at AIG, nor did the reconstituted board apply any real pressure on them to do so."

"One interpretation might be that they simply weren't up to it; a more cynical, but probably more accurate, interpretation would be that the house of cards constructed by Greenberg in the first place was already too fragile and too far gone for such efforts to work," Minow said. "Certainly, it is no accident that AIG was among the first of the giants to be toppled by the mounting credit crisis -- the seeds of its destruction had been sown by Mr. Greenberg, and endorsed by the AIG board, several years before."

In subpoenaed written testimony, Joseph W. St. Denis, vice president of accounting policy at AIGFP from June 2006 to October 2007, said he had been marginalized by the unit's senior executives for his insistence on sound controls.

St. Denis, a former assistant chief accountant in the SEC's Division of Enforcement, said he became "gravely concerned" about the valuation of AIGFP's portfolio of senior secured credit default swaps after the unit received a multibillion margin call on certain transactions in early September 2007.

During the hearing, Oversight Committee Chairman Henry Waxman, D-Calif., raised issues with former CEO Sullivan over his Dec. 5, 2007, statement to investors that the company was "confident in our marks and the reasonableness of our valuation methods" for the CDS portfolio, and that AIG had "a high degree of certainty in what we have booked to date." Waxman noted that auditor PricewaterhouseCoopers had told the company on Nov. 29 that it "believed that AIG could have a material weakness relating to the risk management of these areas."

According to a redacted copy of minutes from the March 11, 2008, meeting of AIG's Audit Committee, PwC auditor Tim Ryan informed the company of more material weaknesses related to AIGFP's swap portfolio, including controls over the super senior valuation process and "significant deficiency" in control over access, roles and responsibilities of critical control functions.

"He said that the new material weakness resulted from the large errors in connection with the models used by AIGFP, the lack of timely elevation of key data on the negative basis and collateral issues to the AIG level, and the fact that AIGFP had designed a valuation process that did not allow the involvement of Enterprise Risk Management and the AIG Finance function in developing the approach," the Audit Committee reported.

One day prior to the Audit Committee meeting, C.K. Lee, managing director of complex and international organizations with the federal Office of Thrift Supervision, the designated regulator of AIG's holding company, sent a letter to AIG General Counsel Anastasia Kelly demanding the company file a corrective plan to address material weaknesses in the internal controls governing AIG's valuation processes and the oversight of that unit, as well as its International Lease Finance Corp. and American General Finance Inc. subsidiaries.

"We note that two business units, AGF and AIGFP, limited their exposures to subprime markets in view of deteriorating market conditions, while two other units, United Guaranty Corp. and AIG Investments, increased their subprime exposures," Lee wrote in the March 11 letter. "The lack of a cohesive mechanism to share information on subprime exposures leads to incomplete central oversight across the conglomerate."

Faced with an inability to obtain commercial credit, and a need to post collateral in the wake of credit rating agency downgrades of its holding company, AIG accepted an $85 billion loan package from the Federal Reserve Bank of New York on Sept. 16. The company has disclosed that it has already drawn down $61 billion of that total, which accrues interest at 850 basis points above the London interbank offer rate.

(By R.J. Lehmann, Washington bureau manager: [email protected])

October 9, 2008