Accounting Ethical Issues of American International Group - Case Study Example

AIG – Accounting Ethical Issues Introduction American International Group, Inc. (AIG) is a leading insurance and financial services company with operations in more than 130 countries across the globe. The company serves individual customers, commercial ventures as well as institutional customers through its network. In addition AIG group companies are leading providers of retirement services, financial services, Auto Insurance, Health Insurance and asset management around the world. Company is listed on the New York, London, Paris, Switzerland and Tokyo Stock Exchanges. AIG is a company with strong financials, respected the world over for its financial might, but this controversy resulted in lot of its energy and resources being diverted towards undoing the charges. What began as an investigation into two reinsurance transactions later mushroomed into a growing scandal that tarnished the reputation of one of Americas premier corporations. On Mar. 30, AIG acknowledged that it had improperly accounted for the reinsurance transaction to bolster reserves, and detailed numerous other examples of problematic accounting. Subsequently the company took corrective measures and fortunately for investors, employees and other stakeholders in many countries, continues to conduct all its operations smoothly, unlike ENRON, WorldCom and some other companies. While these companies appeared to have had flawed business models and hid the real and rapidly deteriorating financial conditions, at AIG it appears to have taken place on account of some wrong practices. AIG is once again on course to having an important impact on social and economic development issues, infrastructure investment, education and training etc. How the Issue Surfaced In fact, this is not the first time that AIG is stuck up in controversies. Nature and scale might be smaller but AIG has had a taste of controversies earlier as well. In 2004, the insurer paid $126 million in fines to the Securities & Exchange Commission and Justice Dept. for deals it structured for outside clients that allegedly violated insurance accounting rules, although AIG admitted no wrongdoing. The company also came under the glare of New York Attorney General Eliot Spitzer for its role in bid-rigging with broker Marsh & McLennan Cos., which led to the ouster of Hanks son Jeffrey as CEO there. AIG admitted no wrongdoing, but two of its executives pleaded guilty and had to leave the company. In this era of cut-throat competition, such issues keep cropping up involving many big names. Sometimes such controversies erupt as some company officials in their urge to excel resort in improper tactics. In fact AIG may not be the only company resorting to such practices, but there could be many more still resorting to similar kinds of practices, without coming to notice (so far). What matters the most is the intention behind such moves and responses of the company once such issues come to surface. The present controversy erupted when investigators focused on two transactions involving Berkshire Hathaways General Re Corp. unit. The deals essentially amounted to a $500 million loan that was dressed up on the books as premium revenue. This allowed AIG to boost its reserves. The problem: AIG never assumed any of the risk associated with insurance underwriting. On Mar. 30, the company acknowledged that “the transaction documentation was improper” and should never have been classified as insurance premiums. In fact, there’s a code of conduct in place at AIG which states that, “Any director, executive officer, or senior financial officer who is aware of a transaction or relationship that could reasonably be expected to give rise to a conflict of interest should discuss the situation with AIG’s General Counsel.” But these are the times of competition, so nobody thought it fit to recall the code of conduct till the investigators highlighted the issue. The Impact On the same day of AIG’s announcement about the existence of ‘improper’ accounting practices, Standard & Poors Ratings Services, downgraded its long-term counterparty credit and senior debt ratings, as well as financial strength ratings on most of AIGs subsidiaries, from "AAA" to "AAplus," while Fitch Ratings placed its "AA-plus" long-term issuer rating and unsecured senior debt obligations on "Rating Watch Negative." Company’s stock price fell by about 25% after the revelations. After the controversy broke out AIG took its time to react but once it admitted to the impropriety in accounting practices, on March 30, 2005, the company subsequently took couple of corrective measures; AIG restated its consolidated financial statements for the years ended December 31, 2004, 2003 and 2002, along with affected Selected Consolidated Financial Data for 2001 and 2000 and quarterly financial information for 2004 and 2003. The company signed an agreement with the New York state Attorney General, on January 18, 2006, under which AIG acknowledged misconduct, adopted a series of groundbreaking reforms and agreed to pay more than $1.6 billion in restitution and penalties. Under the agreements, $800 million was for investors deceived by false financial statements, $375 million for AIG policyholders harmed by bid rigging activities and $344 million for states harmed by AIGs practices between 1986 and 1995 involving workers compensation funds. In addition, New York and the SEC each assessed $100 million in penalties against the company. The SECs penalty went into the fund for investors. After there resignations cases are pending against the companys former Chairman and Chief Executive Officer, Maurice R. "Hank" Greenberg, and its former Chief Financial Officer, Howard Smith. GAAP the Perpetual Problem Area? The Generally Accepted Accounting Principles (GAAP) are being discussed for quite a while as the main culprits in ‘encouraging’ such wrongdoings. The scenario has changed a lot since the days of Asian financial crisis in 1997-98, when American commentators and experts were urging not only Asian countries, but others as well, to adopt the key features of the U.S. disclosure system. But after Enron, WorldCom, AOL/Time Warner, Xerox etc it is been suggested (Benston et al, 2003) that all could be resolved if U.S. accounting standards simply were replaced with the international standards developed by the IASB (International Accounting Standards Board). Broadly the philosophical difference between IFRS and U.S. GAAP (and some other national GAAPs) lies in their styles: IFRS is usually described as principles based, whereas the GAAP is seen as rules based. Thought GAAP is more voluminous than IFRS, because it contains specific details and guidance not only for special transactions, but also for many specific industries like financial institutions, insurance companies, business development and investment companies, mineral exploration etc. The popular criticism of the rules-based approach to accounting standards is that it appears to provide incentives for companies to circumvent the spirit of a rule by designing transactions specifically to avoid meeting its exacting criteria. There are indeed couple of other differences, and the debate is still on. To be sure, an organization based in London that sets standards followed by many countries might be less prone to political influence, at least from narrowly drawn groups in the United States. But politics may surface in a different form in the international arena. Furthermore, an international accounting body with representatives from many different countries is as likely to become bogged down over time in developing new rules, as is now the case with the FASB in the United States. The Road Ahead Going by the events that have taken place since the eruption of the controversy, it can be said for sure that AIG showed the maturity and resilience to take on the issue. While presenting the financial figures for the year 2005, AIG President and CEO Martin J. Sullivan said, “In what was a most challenging year for the company, AIG demonstrated its true resilience by generating net income of $10.48 billion for the full year and $444 million for the fourth quarter, after taking charges to settle legal and regulatory issues, increasing general insurance loss reserves and sustaining record catastrophe losses, all while initiating significant change throughout the organization. These results are a testament to AIG’s diversified portfolio of market-leading businesses and the commitment of our 97,000 employees who, throughout this challenging year, remained focused on executing the strategies we have in place.” After the signing of agreement with the New York State, even the Attorney General Eliot Spitzer said, (NY State, 2006) "AIG was and is a solid company that didnt need to cheat. It finds itself in this position solely because some senior managers thought it was acceptable to deceive the investing public and regulators. However, by changing management, implementing reforms and providing restitution to injured investors, customers and states, the company has placed itself on a path toward resurgence." The company has also initiated a series of reforms including; Sharp curtailment in the use of contingent commissions. Agreeing to stop paying such commissions in any line of insurance where companies with 65 percent of gross written premiums do not do so. Support to legislation banning contingent commissions and requiring greater disclosure of compensation to brokers and agents. Provisioning for additional reinsurance reporting obligations by AIG to the Insurance Department and monitoring of financial reporting and corporate governance practices by the Insurance Department and the SEC. AIG now emerges wiser and stronger with the realization that even the slightest tolerance of accounting fraud creates a climate that inevitably leads to more fraud. Once on that road, it proves difficult (or extremely costly) to get off. The final lesson applicable not just to insurers, but to all businesses, is that in the end the truth always prevails and those who commit financial transgressions get exposed and punished. AIG remains a solid powerhouse in the industry. References: 1. AIG Director, Executive Officer and Senior Financial Officer Code of Business Conduct and Ethics, http://media.corporate-ir.net/media_files/irol/76/76115/corpgov/CoC-DO-SFO.pdf 2. AIG Settlement Website, available online at http://home.aig.com/creative/excesscasualty/index.html 3. NY State, Attorney General (2006), Press Release Dated Feb, 9, 2006, available at http://www.oag.state.ny.us/press/2006/feb/feb09a_06.html (Accessed Jan 28, 2007). 4. Brady, Diane, Vickers, Marcia, McNamee, Mike (2005), AIG: What Went Wrong, Business Week, 4/11/2005, Issue 3928 5. Editorial, ‘The lessons to be learned from AIGs improprieties’, Business Insurance, 4/4/2005, Vol. 39, Issue 14 6. Benston, George Michael Bromwich, Robert E. Litan, and Alfred Wagenhofer (2003), Following the Money: The Enron Failure and the State of Corporate Disclosure’, AEI Brookings Joint centre for Regulatory Studies, Washington 7. Ha, Michael And Daniel Hays (2005), ‘AIG Admits ImproperAccounting On’, National Underwriter Property & Casualty, April 4,2005 8. Schlosser, Julie (2005) CNN, CNNMoney.com (May 30, 2005), ‘The risky rewards of AIG’ http://money.cnn.com/magazines/fortune/fortune_archive/2005/05/30/8261252/index.htm 9. Google Finance, http://finance.google.com/finance?q=AIG Read More