I posted a story Monday about the DoJ dropping prosecution of General Reinsurance (GenRe) after reassigning David Maguire, a career prosecutor, who'd worked on the case for three years. Turns out this isn't the only problem General Insurance is facing; they're in trouble for similar shenanigans in Australia via their subsidiary HIH Insurance. In fact, it's the largest corporate collapse in that country's history, and it's making big waves down under. Sydney Morning Herald, 4/16/05:
It's rare to see a chief executive heading to Silverwater jail. More ominously, there are many signs that Williams is not the only executive to have been tempted by the same method of falsifying accounts.
Former GenRe executives in Germany & Ireland are currently cooling their heels in the slammer as well.
Cross-posted at ePluribusMedia
GENERAL REINSURANCE AUSTRALIA
The core problem is something called "side letters", which are not unlike President Bush's ubiquitous signing statements. Business or governmental versions of "keeping your fingers crossed" behind your back to negate a schoolyard promise. With, of course, far bigger consequences.
Wall Street Journal 6/29/07:
An Australian regulator found that General Reinsurance Australia Ltd., a unit of U.S. investor Warren Buffett's Berkshire Hathaway Inc., engaged in "questionable behavior" in the lead-up to the 2001 collapse of HIH Insurance Ltd.
According to Australia's Brisbane Times 6/29/07, Buffet made some efforts to clean up the business. Though obviously not enough:
After Berkshire Hathaway took over the General Reinsurance Group in 1998, Berkshire's legendary chief executive Warren Buffett began to change the culture. ... Five years later, he sent an internal memo on the subject of reinsurers helping their clients to "fool" readers of their financial statements.
...
Unfortunately for the Australian general insurance industry, by the time Mr Buffett started imposing controls on General Re, its Australian arm had written sham reinsurance contracts with FAI Insurances, Zurich Australia Insurance and New Cap Reinsurance.
In a follow-up story on 7/12/07 in the Sydney Herald, the same reporter (Elizabeth Sexton) mentions an accounting firm familiar to Americans thanks to the Enron scandal:
Almost seven years after Arthur Andersen auditors gave HIH Insurance [of which General Reinsurance was the parent corporation] a clean bill of financial health, the firm has agreed to compensate the company's creditors.
HIH became Australia's largest corporate collapse in 2001, five months after its year 2000 accounts were signed by the auditors without qualification.
The problem that led to the HIH collapse? Secret side agreements, much like Enron.
The HIH Royal Commission found that the auditors had been misled about the the most serious accounting issue, the use of sham reinsurance to inflate assets and profits.
But Justice Neville Owen concluded the audits were "insufficiently rigorous". "The pressure on the Andersen partners to maximise their fees from non-audit work giving rise to a potential conflict with their audit obligations was also a cause for concern."
AP on the GenRe subsidiary discussed in my previous entry:
General Re has been under investigation over some reinsurance transactions with the insurance heavyweight American International Group Inc. and with Virginia-based Reciprocal of America, a former liability insurer of doctors, hospitals and lawyers.
Oh, yeah. There's other arms (tentacles?) of the globalized General Reinsurance corporate presence:
General Re subsidiary Cologne Re has also been investigated by the German Federal Financial Supervisory Authority regarding some of Cologne Re's reinsurance products and transactions with New York-based AIG, Berkshire has said.
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A day earlier, John Houldsworth, a former chief executive at an Irish subsidiary of General Re, pleaded guilty to an identical charge.
Both men have agreed to cooperate with prosecutors' investigation of the case.
But Gonzo's DoJ? Nothing there! Reassign a conscientious prosecutor who's already drafted an indictment after three years of investigation, then abandon the case.
Maybe that talk about Arthur Andersen being unfairly tarred in the Enron scandal was completely and absolutely wrong. One wonders that they have been party to similar fraud in different industries on separate continents. Heckuva coincidence! Ultimately, one probably can conclude, as does Mr. Gober (see below), that misleading, nay fraudulent, secret book-cooking agreements are more common than what's come to light to date.
SIDE LETTERS
Yesterday's McClatchy article quoted a forensic accountant called Thomas Gober. Curious about other implications of the story, I did a little exploring on his website. There's something called "side letters", discussed by Gober in Fraud Magazine a year ago. (Yes, there is a publication called Fraud Magazine, published by the Association of Certified Fraud Examiners. What is the world coming to?? Aren't auditors supposed to check for fraud? What's next? The Fraud Uncoverers Council of Knock Offs = FUCK-O? Who are supposed to make sure the Fraud Examiners aren't cheating?)
Undisclosed agreements - side letters - between an insurance company and a reinsurer can hide egregious and fraudulent transactions from regulators, investors, and consumers. Here's how to find them.
Here's a description of a generic side letter transaction. It's also how it's done in real life, and people have gone to jail for it:
An insurance company executive faces tremendous pressure as Dec. 31 approaches especially because the company's balance sheet has deteriorated below the financial ratio red-flag alerts.
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The desperate executive e-mails a friend and colleague who is a vice president at a large reinsurance company and explains the situation. The executive needs an "off the balance sheet loan" that provides a cash infusion, or at least the appearance of one, without having to book the associated liability. But the infusion must appear to have no strings attached so the regulator won't become suspicious. The executive promises the perfect solution: the two key executives can enter into what appears to be a "plain vanilla" reinsurance contract that, on its face, transfers millions of dollars of risk from the insurance company to the reinsurer. In secret, the parties agree to enter into a side letter that actually spells out the true terms of the reinsurance contract. The undisclosed side letter reveals the true nature of the contract - it's actually an "off the balance sheet loan." For obvious reasons the two parties swear the side letter to secrecy.
The article's well worth reading in full. It includes a "plain English" description of financial, regulatory and contractual matters relevant to side letters. A big part of the GenRe problem is "side letters", which are not unlike the fake Enron transactions which make the company look solvent on paper when it wasn't.
GONZO'S DoJ ABANDONS THE CASE
DoJ investigators aren't going pursue their case against GenRe:
"The bottom line has always been what do we want to do with Gen Re," Joshua Hochberg, the Justice Department's then chief of the fraud section, wrote to Maguire. "Indicting the company would have enormous collateral consequences."
But what if those "collateral consequences" are deserved? Like if they let a subsidiary go under, while they reaped profits and insurance customers were left holding the bag to the tune of 100s of millions of dollars? What if there were shady, fraudulent side letters in place? FWIW, one of the likely collateral consequences of prosecution, or even being under investigation by DoJ, is to be downrated by Moody's, Standard and Poors or other ratings companies. From CFO.com:
Criminal investigations that suggest a failure of corporate governance or control--which could potentially come with legal penalties and restrictions--tends to warrant a lower credit rating, says Moody's.
As it happens, the article cites the example of General Reinsurance:
Last year, Fitch, the third largest ratings firm, said that it was not changing its rating of General Reinsurance Corp. after the DOJ indicted three of its former executives on criminal charges. However, it said at the time, if the company or any of its current executives faced criminal charges, it could face "negative ratings consequences."
Yikes! The company will look better if we don't indict them? Since when is that DoJ's job? At any rate, at least two state attorneys general will continue to pursue the case, even if Gonzo's crew can't be bothered. A lot of good it does to pass legislation like Sarbanes-Oxley if the DoJ declines to enforce it.
I think Eliot Spitzer would be a good replacement for Alberto Gonzales, one of the sorriest excuses for an Attorney General our nation's ever seen. More from Sydney Herald last year (before Spitzer moved from NY state AG to the Governor's mansion) about the current "surge" of insurance fraud:
Known as the misuse of "financial reinsurance", the issue recently exploded on Wall Street where New York Attorney-General Eliot Spitzer has turned his crusading zeal to it. It has flared again in Australia with a fresh regulatory crackdown. On March 28, Spitzer claimed the scalp of Hank Greenberg, who quit after running America's largest insurer, American International Group, for 37 years, as the company acknowledged it had "improperly" accounted for a $US500 million contract. Spitzer said: "The evidence is overwhelming that these were transactions created for the purpose of deceiving the market. We call that fraud. It is deceptive. It is wrong. It is illegal."
I don't see this one entirely as a Republican Culture of Corruption issue, per se. Except for the role of Gonzo's DoJ in covering it up. GenRe employees give largely to Republicans in campaign contributions, but a lot of them - who live in Connecticut, a big insurance state - have made donations to Sen. Chris Dodd, too.
But Warren Buffett mostly gives on the Democratic side of the aisle, where there's plenty of corporatists to be found, too. Buffett's already maxxed out on Clinton & Obama for 2008 ($4600 each), and has donated to Nebraska home state senators Ben Nelson and Bob Kerry, but not Chuck Hagel. In Connecticut, to both Christophers: Dodd and Shays (hardly a "loyal Bushie"). So, this is a corporatist problem, which actually does date back to the Clinton years, and reaches beyond U.S. borders, too.
However, it appears that Buffett's biggest culpability lies in a lack of due diligence before purchasing GenRe. He's apologized for that, and made numerous steps to clean the place up. He would probably have been well advised to spend some money on one of those Forensic Accountants like Thomas Gober up front. Not unlike getting a house inspected for termites before closing a purchase.