IntroductionAIG, American International Group Inc., is one of the top multinational insurance corporations. AIG, with asset of 556 billion, provides insurance service for more than 150 different countries and it has over 630, 000 employees over the world. Even though AIG is such a giant corporation, it has encountered financial problems in the early 2000s. Under financial pressure and a lack of internal control, AIG have committed frauds resulting in several scandals. One of the accounting scandals was disclosed during 2005 which involved a material mis-statement due to false transactions during 2000. This scandal set to prelude leading the downfall of AIG in 2008. In this paper, I will analyze the cause, the transactions and finally effects of the scandal. The Accounting Scandal The Players The CEO of AIG was Maurice “Hank” Greenberg. Greenberg joined AIG in 1962 and led AIG for thirty eight years until his retirement in March 2005. Greenberg was not only the CEO, but also the chairman of the board of AIG. AIG also have several subsidiaries, which include National Union Fire Insurance Company of Pittsburgh (NUFIC) and Hartford Steam Boiler Inspection (HSB). Their financial information are consolidated in AIG‟s financial statements. The scandal also involves another corporation General Re Corporation. General Re is a subsidiary of Berkshire Hathaway, Inc., an investment group run by the billionaire Warren Buffet. General Re also has subsidiaries all over the world and together and it is one of the biggest reinsurance companies in the World. Reinsurance companies are entities that insure the insurance companies. They help insurance companies share risk by selling reinsurance plans that would help pay off a share of a claim from the insurance companies. The CEO of General Re was Ron Ferguson when the fraud was committed. General‟s RE subsidiary in Dublin, Ireland, known as Cologne Re Dublin (CRD) was also heavily involved in the fraud. The Deal On October, 26, 2000, AIG released its third quarter earnings. It showed that there was an increase of premium, but a decrease in loss reserves by 59 million. Loss reserve is a liability account which represents the estimate of loss future claims. Loss reserve is an important indicator for whether management of company is sufficiently anticipating for future claims. Since the premiums has increased, AIG‟s loss premium should be increased as well. A decline could imply that AIG had cash or reserve problems. Because of the decline in loss reserves, analysts have downgraded AIG two days after release of earnings. How CDR paid $10 million without paying: In order for AIG to pay General Re $5.3 on NYSE. AIG actually did not want to assume any risk.6 to $93. However. Of that $500 million. senior managements of AIG and General RE agreed to engage in “non-mirror image accounting”. NUFIC and CRD.2 million fees secretly and for CDR to pay $10 million in order to make the transaction believable and under the radar from investigators. while CDR(General Re) recorded the transaction as a deposit which did not violate GAAP. However. By using both the subsidiaries of AIG and General RE. It was then that Greenberg called Ferguson. Senior management of AIG and General Re constructed a . The transaction itself is called Loss Portfolio Transfer and it is legal.Hence. Therefore. Greenberg wanted to increase AIG loss reserves. 10 million would be paid to NUFIC (AIG) and $490 million would be withheld in CRD. AIG secretly agreed to AIG NUFIC Asset + 10M Premium Paid by CDR + 490M Premium Receivable (withheld by CDR) Liability + 500M Loss Reserve Transection recorded by AIG: AIG NUFIC Asset + 10M Premium Paid by CDR + 490M Premium Receivable (withheld by CDR) Liability + 500M Loss Reserve Transaction recorded by AIG: Pay General Re 5 million as a fee for doing the deal. he and Greenberg had drafted a deal. Following GAAP (general accepted accounting principle). Also. The $500 million represented two contracts where each contract was paid in different times. NUFIC (AIG) would assume the risk of losses from CRD‟s policies for about $600 million for $500 million of premium. the stock price of AIG dropped 6% from $99. The contracts that CRD transferred were in fact risk-free. the nature of the transaction could not be classified as Loss Portfolio Transfer as there was no transfer of risk. which NUFIC recorded the transaction as a Loss Portfolio Transfer. The claim would eventually be paid out by AIG for exactly $500 million. 8 payable to HSB) Commute $7.2 million directly to General RE from AIG. CDR/General Re was left with $5. Reinsurance $0. CDR then paid General RE $0.1-13 +0. HSB. CDR made the $10 million payment to NUFIC. Therefore.4 = $2.4 million premium for a fake reinsurance and received a loss payment $13 million.4 = $2.4 = $2. There were existing contract between where General Re owned $31. General Re paid NUFIC $9.4 M Reinsurance $9. In the end.paper trail which would hide the transaction of $5.5 million to commute an existing contract with AIG subsidiary.5 M Loss Payment $13 M CDR $10 M Premium Gen Re = 31. General Re paid $7.1M AIG HSB NUFIC General RE ($31.6M .6 M Reinsurance $0.1-13 +0.6M CDR = 13 – 10 – 0.8 -7.1M AIG HSB NUFIC General RE ($31.8 payable to HSB) Commute $7. Finally.5 M Loss Payment $13 M CDR $10 M Premium Gen Re = 31.1 million premium to reinsure the loss that was just commuted to HSB.4 M Reinsurance $9.8M payable to AIG.2 million in total. Furthermore.5-9.8 -7.5-9. We added $63 million to AIG's general insurance net loss and loss adjustment reserves for the quarter.0 billion at March 31. In March 2005. On 2nd December." What went wrong? The Securities and Exchange Commission (SEC) had already been probing into AIG during early 2000 due to a various misconducts of AIG. 2001. Greenberg stepped down from the CEO position. bringing the total of those reserves to $25. The AIG shareholders filed several complaints on PwC to have violated the securities laws in providing AIG auditing services and giving unqualified opinions on AIG financial statements and demanded damages. AIG was able to manipulate numbers and added $106 million of loss reserves in Q4 2000 and $63 million Q1 2001 to the balance sheet masking the actually decline of loss reserves of $144 million and $187million. analysts thought that the earnings of AIG in those two quarters were great. In the release of earnings in Q1 2001. AIG received a subpoena from SEC relating to finite reinsurance accounting. In May 2005. Greenberg even wrote “"AIG had a solid first quarter.. the counsel of General RE phoned SEC representatives to disclose the entirety LPT transaction. AIG issued a restated financial statement for fiscal years from 2000 through 2003. its auditor PricewaterhouseCoopers LLP were also under scrutiny because they signed off the financial statements of AIG.32 billion. Many criticized PwC that it did not detect the unusual transactions.. AIG disclosed the LPT scheme to the public. a settlement finally reached that PwC had to provide 97. the New York Attorney General filed a civil case against AIG. 2010. In January 2005. With the additional premium and loss reserve.6 M Effects after the Transaction With the reserves set up and a lack of transparency. but PwC ignored the „red flags‟ regarding AIG‟s .CDR = 13 – 10 – 0. but it appeared that PwC has not been exerting full professional efforts. PwC has a long business relationship with AIG for over 30 years. Also Eliot Splizer.4 = $2. On February 14 2005. The investigation of the charges against PwC revealed that the Audit Committee of AIG‟s own board of directors had repeated stated that it could not verify the AIG‟s accounting methods.5 million in settlement for the AIG shareholders. which reduced the income for 2004 for 1. Responsibility of the Auditors With litigation going on for AIG. And 3 days later. They were already suspicious of the integrity of the financial information provided by AIG. Opportunity and . But can the fraud be prevented in this case? We can analyze the situation using the Fraud Triangle. However the damage was done. It is obvious that there were many internal controls problems for AIG. If PwC was on high alert. 4 executive members of General Re and AIG were convicted. including Greenberg and Ferguson. it might have worked closely with AIG and prohibited AIG from classifying the $ 500 million as revenue. the charges were all overturned by the federal court of appeal in 1st Aug. Pressure. Because of this scheme. Conclusion In the end of the civil case trial.poor accounting practices. However. 2008 that shareholders lost around $544 million to $597 million. it was estimated on Oct 31. AIG almost went bankrupt at the start of the finical crisis. Pressure * Downgrade of Stock * Decline in Loss Reserve * Avoid Critism Opportunity * AIG being big client of General Re Rationalization * Increase stock price * Splizer file civil suit just for election Pressure * Downgrade of Stock * Decline in Loss Reserve * Avoid Critism Opportunity * AIG being big client of General Re Rationalization * Increase stock price * Splizer file civil suit just for election We can see that that all three elements. 2011. Actuarial Accounting:A Cautionary Report. ( 2010. Retrieved from businessweek.gov: http://www. John Houldsworth: Securities and Exchange Commission Litigation Complaint. February 11). (2009.html Schonfeld.com/ AIG: What Went Wrong. December 2). Retrieved from justice. I believe that large corporations and audit firms alike should learn from mistakes and exercise high professional and ethical principles to prevent frauds and account scandals.com: http://www. There Was the Fraud. it almost seemed that fraud was inevitable.d. June 1). PwC Off Hook In AIG Shareholder Fraud Suit. AIG: Before the Crash.html Kay. References AGREED STATEMENT OF FACTS.justice. Retrieved from AIG SECURITIES LITIGATION-PwC SETTLEMENT: http://www. D.gov/criminal/pr/documents/01-20-1%20gen-reagreedstatement.law360. D. 4 10). March 24).Rationalization exist in this case. M.com: http://www. September 2013). Starkman. P. Top insurance company mired in allegations of accounting fraud. after the financial crisis.org/wiki/American_International_Group CALLAHAN. May 6).com/accounting-fraud/2010/11/8/aig-before-thecrash-there-was-the-fraud. Retrieved from International Committee of the Fourth International (ICFI): http://www. (2005 ). (20. However. D. Retrieved from law360.wikipedia.com: http://www.com/wpdyn/content/article/2005/05/31/AR2005053101589.). (2005. .washingtonpost.org/en/articles/2005/03/aig-m24. (2009.html Wilkinson.aigsecuritieslitigationpwcsettlement. we have experienced the financial frauds and illegal acts incurred huge costs with far reaching damages affecting the lives of many people for years Government agencies all over the world have been working hard to improve regulations for tighter controls. (2005. J. Retrieved from The Washington Post: http://www. (2010.cheatingculture.com/articles/87034/pwcoff-hook-in-aig-shareholder-fraud-suit Young. R. Also with the lack of internal control in AIG and the negligence of its auditor PwC. (2005.pdf AIG SECURITIES LITIGATION-PwC SETTLEMENT. November 8). Retrieved from cheatingculture. New York. (n.wsws.businessweek.com/stories/2005-04-10/aig-what-went-wrong American International Group. AIG Comes Clean on Accounting. Retrieved from Wikipedia: http://en. In addition. casact.org/education/spring/2009/handouts/young.pdf .Retrieved from casact.org: http://www.