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Mutual Funds Sue AIG for Billions

(Photo: Håkan Dahlström)

(Photo: Håkan Dahlström)

Jack Bouboushian, Courthouse News Service

Twenty-five mutual funds sued AIG for its “unconscionable bets” that led to the insurance giant’s $85 billion bailout in 2008 and cost shareholders tens of billions of dollars in lost value.

The Dow 30SM Enhanced Premium & Income Fund and 24 other mutual funds sued American International Group (AIG) and eight of its corporate officers, including former CEO Martin Sullivan, in Federal Court. The University of California filed a similar lawsuit against the same defendants, in San Francisco Federal Court. All citations in this article are from the Chicago complaint.

“AIG was one of the most distinguished companies in the United States and the world prior to and throughout the relevant period,” the 237-page complaint begins.

In 1987, AIG branched into the financial sector, establishing a joint venture called American International Group Financial Products Corp, (AIGFP) which was spun off as a subsidiary in 1993.

“From its inception to 1998, AIGFP’s deals were hedged so that the firm would not risk large losses on any transaction,” the complaint states. “In 1998, however, AIGFP was approached by JP Morgan with a different type of deal – a credit default swap (CDS). For a fee, AIGFP would essentially insure a company’s corporate debt in case of default. After working the deal concept through its models, AIGFP determined that the risk was so remote ‘that the fees were almost free money.’ From 1998 until mid-March 2005, AIGFP entered into approximately 200 CDS contracts. Most of these contracts insured corporate debt.”

By 2005, AIGFP was writing a substantially greater number of CDS contracts, with significantly less oversight from its parent company, the mutual funds say.

“By the end of 2005, AIGFP became concerned that underwriting standards for subprime loans had deteriorated, and a decision was made to stop writing CDS contracts on multi-sector CDOs. By then, however, AIG was insuring about $80 billion of multi-sector CDOs, most of which were backed by subprime mortgages. Even though AIG was aware of the downward turn of the mortgage market, it did not undertake to hedge the CDS portfolio because doing so would have undercut the profitability of the business,” according to the complaint.

“During 2005, while AIG ramped up its writing of CDS contracts and its portfolio increasingly concentrated on U.S. residential mortgage loans, AIG’s oversight of AIGFP and the CDS business diminished significantly. With [Martin] Sullivan as CEO, many risk controls were weakened or eliminated. Moreover, at AIGFP, [CEO Joseph] Cassano and a handful of others there kept a tight rein on the origination, valuation and reporting functions relating to the CDS portfolio within the AIGFP group to the deliberate exclusion of key risk management and accounting personnel at AIGFP and AIG, its parent.”

AIG posted billions of dollars in income in 2005, 2006 and the first three quarters of 2007, but “scarcely mentioned credit default swaps of securities lending and the risks inherent in these exposures were continually downplayed by AIG and AIGFP executives,” the mutual funds say.

As the U.S. housing market weakened in late 2007, AIG CEO Martin Sullivan told investors that the company was “a very safe haven in stormy times,” according to the complaint. It continues:

“Similar assurances concerning AIG’s CDS portfolio were provided at an investor meeting on December 5, 2007, where Sullivan stated that the possibility that the credit default swaps would sustain a loss was ‘close to zero.’ Sullivan added that AIG’s valuation models had proven to be ‘very reliable’ and provided AIG ‘with a very high level of comfort.’ Cassano stated that ‘we are highly confident that we will have no realized losses on these portfolios’ and that it is ‘very difficult to see how there can be any losses in these portfolios.’ Sullivan also touted AIG’s ‘financial strength,’ stating that the capital base of the Company ‘will allow us to absorb volatility.’ Cassano asserted that AIG had more than enough capital ‘to withstand this aberrant period.’ Again, these assurances were made without any reference to the many billions of dollars of collateral postings that could be required from AIG as the value of the CDOs being insured by the company continued to decline. Indeed, although AIG disclosed in connection with the release of its third quarter 2007 financial results that it had received collateral calls from counterparties (without disclosing the identity of the counterparties or the amounts demanded), Defendant Cassano flatly declared that ‘we have been husbanding our liquidity all through this trying period, and we have plenty of resources and more than enough resources to meet any of the collateral calls that might come in.’ Again, at the December 5, 2007 investor meeting, Cassano effectively derided collateral calls from counterparties as frivolous ‘drive by[s].'” the complaint says. (Parentheses and brackets in complaint.)

In SEC filings in February 2008, AIG posted an $11.5 billion loss, and acknowledged that its internal accounting controls had failed to fairly evaluate its portfolio. In September 2008, “personnel from JP Morgan and Goldman Sachs met at the office of the Federal Reserve and, together with Morgan Stanley personnel, evaluated AIG’s liquidity needs and the viability of a private-sector solution. They reached an updated conclusion: AIG needed about $80 billion,” the mutual funds say.

With no private-sector solution forthcoming, the government stepped in to prevent the company’s imminent collapse, and agreed to a $85 billion bailout.

“Not only was AIG brought down by ‘unconscionable bets’ that went terribly wrong, plaintiffs suffered tens of billions of dollars of losses, at the least, based on false and materially misleading statements that AIG, certain of its executives, directors, underwriters and outside auditor made concerning the company’s financial results, business operations and condition. Defendants’ failure to disclose the true state of AIG’s financial condition and risk exposures throughout the relevant period artificially inflated the price of AIG stock, which reached as high as $72.54 per share on June 5, 2007. In the wake of the disclosures about AIG from February 2008 through the U.S. Government bailout that ends the relevant period, tens of billions of dollars in shareholder and bondholder value were lost, inflicting substantial damage to plaintiffs,” the mutual funds claim. They seek punitive damages for fraud, unjust enrichment, and violations of the Exchange Act and the Illinois Securities Act.

The funds are represented by Jason Lichtman with Lieff, Cabraser, Heimann & Bernstein in New York.

A spokesperson for AIG declined to comment.

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