Corporate Finance AIG Accounting Scandal Essay

On February 9th, 2006, the SEC and the Justice part settled with AIG for an mensuration in excess of $1. 6B related to alleged improper score, bid rigging (defined by Investopedia as a scheme in which duty organisationes collude so that a competing business give the axe arrest a contract for goods or services at a pre-determined price), and practices involving workers compensation funds. Both the chief executive officer and chief financial officer of AIG were replaced amidst the scandal.This closure ended a 5-year period, beginning in 2001, which tarnished the 80-year old institutions reputation that had shape the worlds largest reinsurers, and include Buffets Berkshire Hathaway as an owner. Several of frauds culprits were convicted of Conspiracy, Securities Fraud, specious Statements to the SEC, and Mail Fraud. Each offender was handed various degrees of penalties, including jail sentences.AIGs CEO Hank Greenberg was left unindicted and appeal the 5th. What led these exec utives down a path that would forever change their c atomic number 18ers and left m whatever convinced that corporations are allowing to go to any extent to satisfy their greed for profits? This paper will turn egress the intricacies of AIGs invoice fraud, and discuss the hypothesis that accounting fraud and early(a) un honest decisions focused on short-term profits are positively correlated to long-term value ending. The corporate scandals are acquire bigger and bigger.In a speech on Wall Street, President Bush spoke out on corporate responsibility, and he warned executives not to cook the books. Afterwards, Martha Stewart said the correct term was to saute the books. Conan OBrien While thither are many techniques to distort the financial condition of a publicly traded company, the around frequent types of improprieties involve revenue science, cost or expense recognition, accounting for reserves, and accounting related to business combinations. Below are the laws that El liot Spitzers prosecution based their AIG fortune on ? ? ? ? ?Using or employing manipulative devices, in connection the purchase or sale of securities Making untrue statement of a hooey fact or to omit to state that a material fact Engaging in any practice or business which operates or would operate as fraud or deceit disproof of accounting records and conformity with GAAP Conspiracy of cardinal or more persons to commit offense or to defraud United States What does this mean in laymans terms? Essentially, AIG improperly accounted for the reinsurance doing to bolster reserves, and detailed numerous other examples of problematic accounting. PricewaterhouseCoopers LLP, 2009)For example, AIG booked as income $500 million in reward for the loss portfolio transfer and then added $500 million in reserves against future day claims to its balance sheet. AIG counted the transaction as an insurance relieve oneself it away, but later concluded that, the Gen Re transaction documentati on was improper and, in light of the lack of evidence of risk transfer, the transaction should not have been recorded as insurance. (Hulburt, Ph. D. , H. , 2005) What turns the deal from mistake to blatant fraud was that no underwriting risk transferred in the deal.Instead, the loss portfolio transfer was legally a $500 million loan from Gen Re to AIG that AIG would repay through $500 million in claims payments to Gen Re. (Hulburt, Ph. D. , H. , 2005) In the end, AIGs revised financial statements lowered 2004 net income by $1. 3 billion, or 12%, and reduced 2004 shareholders equity by $2. 3 billion, or 3%. Details of the adjustments required 22 pages in the AIG 2004 10K, which was included into the Annual Report to Shareholders. The restatement reduced net income by more than 10% everyplace the 5-year period. (Verschoor, C. , 2005)Ethics is recognition of the difference between what you have a right to do and what is right to do. Potter Stewart AIGs ending and lack of ethical controls exemplify how the greed of few can impact the value of many. Some have attempted to use this case as an example to SOXs failure to everywherehaul corporate accounting practices. However, in AIGs first report mandated by the Sarbanes Oxley Act of 2002, a number of material weaknesses in control were disclosed, emphasizing that the first and most extensive weakness was in the ethical finale of AIG or its control environment.The report states verbatim Certain of AIGs controls within its control environment were not effective to prevent sure members of senior management, including the former Chief Executive Officer and former Chief fiscal Officer, from having the ability, which in certain instances was utilized, to override certain controls and effect certain transactions and accounting entries. In certain of these instances, much(prenominal) transactions and accounting entries appear to have been largely motivated to achieve desired accounting results and were not properly accounted for in accordance with GAAP. (McGee, S. , 2005) Specific overrides noted resulted in (1) creation of a peculiar(a) purpose entity to improperly convert underwriting losses to investment losses, (2) improper recording of reinsurance transactions, (3) improper top take adjustments and covered call transactions, and (4) unsupported top level adjustment of loss reserves. (KnowledgeWharton, 2005)Leadership is the capacity and will to rally men and women to a common purpose and the character which inspires confidence. Bernard Montgomery Tom Lins name titled The corporate constitution of iconic executives. explored corporate governance challenges posed by iconic executives such as Hank Greenberg. To better understand the state of AIG, it is beneficial to discuss the iconic executive that led them to water. Hank Greenberg grew up on a New York dairy farm, joined the U. S. Army during World War II, became an Army Ranger, and stormed the strand at Normandy. He attended the U niversity of Miami and New York Law School, where he earned his LLB. As a captain, he received a Bronze Star in the Korean War Greenberg then entered the insurance business in 1952.He became the youngest person to be appointed vice president at the Continental incident Company. As president of AIGs major subsidiary American Home Assurance Company, Greenberg was credited with ontogenesis substantial reinsurance facilities, which allowed insurers who were forced to take unwanted assignments, or bad risks, the opportunity to reinsure those risks. Greenbergs outline enabled American Home to write large quantities of major-risks policies and thus control the pricing of those policies. He established a bottom-line philosophy on underwriting only those companies that made profits.Greenbergs business was successful, aggressive and profitable. Greenberg would acquire companies that were troubled or fighting off takeovers, buying controlling interests in the companies, and ultimately integr ating them into the AIG corporate structure. When AIGs fracture and CEO Cornelius van der Starr died, Green was named to head the company. Two years later AIG went public with Greenberg as the CEO where he would reign with an iron fist, terrorizing underlings, intimidating a compliant board and delivering stunningly impressive pelf for the next 40 years.As Tom Lin described, Iconic executives are complex, bittersweet figures in corporate governance narratives. They are alluring, larger-than-life corporate figures who often govern freely. Iconic executives frequently rule like monarchs over their firms, offering lofty promises to shareholders, directors, and managers under their reign. But like many stories of powerful and influential figures, the narratives of iconic executives in addition contain adversity and danger resulting from excessive deference, overconfidence, and licentiousness. Lin, T. , 2011) Money is like a sixth sense- and you cant make use of the other five without it William Maugham Contemporary economic thought presumes that individuals in a orderliness always act according to their self-interest or private economic fillips, while important ethical motivations for action, such as a concern for others and public interest, are largely ignored. (Kulshreshtha, P. , 2005) As is often the case in accounting cases, the CFO tends to be a central enabler to the fraudulent activities. at that place are two primary schools of thought when attempting to understand the incentive for CFOs to become involved in these ethical dilemmas. The first school of thought states that CFOs may instigate accounting manipulations for immediate personalised financial gain. There also has been research indicating that CFO equity incentives are more important than CEO equity incentives in explaining earnings management, measured by accruals and frequency of meeting earnings benchmarks (Feing, M. , 2011). bodied boards have reduced CFOs incentive compensation after passage of the Sarbanes-Oxley Act in an effort to undermine this conduct. Bhagat, Sanjai Romano, Roberta, 2009) Looking at AIGs share price over the reporting time frame of these actions, the fraudulent accounting did not expect to have significant impact on its market valuation. Analyzing the share price over the months that AIG reported their yearly statement in 2002, 2003, and 2004, AIGs market share price moved approximately -4%, -3% and . 5% respectively. Although a hypothesis could be made that the fraud occurred as a defense against stock devaluation rather than an enabler of change magnitude valuation.The second thought states that CFOs may become involved in accounting manipulations because of pressure from CEOs. As CFOs superiors, CEOs can exert pressure on financial reporting decisions through their influence on CFOs future opportunities and compensation (Feing, M. , 2011). This aligns to what we understand of Hank Greenbergs style of management. When the judge handed o ut sentencing to Elizabeth Monrad, the CFO of Gen Re, he made the following statements. ? ? ? The fact that she did not benefit personally from the scheme, does not excuse her conduct.Her involvement in the fraudulent scheme was central to its success. There were many opportunities for her to shake this shady deal, but she never did Although these two schools of thought help one to better understand the drivers behind the accounting fraud in AIG and other cases academically, they are not mutually independent. In practice, pressure grows like a virus when it attaches to personal gain. Without personal gain, there is hardly a sustainable environment for pressure, which indicates some level of correlation to realizing a self-involved objective.Some of the best lessons are learned from past mistakes. The error of the past is the wisdom of the future. Dale Turner hotshot may never be able to understand the full extent of the motivations at AIG that resulted in over $1. 6B in penaltie s, $2. 3B in reduction of shareholder equity, and the destruction of lives and careers. There appeared to be a significant amount of both pressure and personal gain involved. In the end, the AIG case became another brick in the wall for opponents of capitalist economy pointing to the greed of executives and their boards.With the benefit of writing this in 2012, we know this was merely a minor speed give way in comparison to what would come for AIG in the future global financial crisis of 2008. We now live in a world where greed, profit, share price, and financial institutions are synonymous to each other. However tarnished the reputation of corporations are, there are glimmers of hope in the details. The numbers and results of these actions begin to illustrate a telling story that greed, fraud, and dissembling are destroyers of value rather than enablers.Cases such as AIG can be reference points to dissuade future decisions of unethical nature. In AIGs case, their share price fell more than 30% from the period of 1/2/2001 to 5/22/2006 further strengthening our initial hypothesis. The announcement also caused Standard & ridiculouss (MHP) to downgrade AIGs debt rating from AAA to AA+, leading to higher funding costs and decrease long-term value. We may not be able to prove that all of the AIGs value destruction is directly related to the case beyond a reasonable doubt, it can be arguably presume that a significant portion is directly related.Even if that destruction is associated to confidence over financial health. (McGee, S. , 2005) In the time since this case, AIG has made considerable steps to prevent future occurrences of financial misrepresentation. The AIG management report on internal control related remediation efforts emphasizing the need for higher integrity and a culture of ethical values throughout the organization. The report notes AIG has taken, and is developing further plans to take, significant actions to improve its control environment, get-go with a clear statement of the tone and philosophy set by its current senior management.The Corporate Governance delegation Report in the 2005 AIG Proxy Statement gives further details AIG enhanced its cypher of Conduct for employees, mandated that all employees complete formal ethics training, and implemented a Director, Executive Officer, and Senior fiscal Officer Code of Business Conduct and Ethics to provide reasonable assurance that all members of the scorecard of Directors, executive officers, and senior financial officers adhere to the stated principles and procedures set forth in that Code.At the Committees recommendation, AIG is developing a corporate level compliance framework, including implementation of compliance programs at AIGs major business areas.