ENCOURAGING COOPERATION
SEC Enforcement Director Robert Khuzami has frequently discussed the need to encourage cooperation as a means of strengthening Enforcement. Last week, for example, the Division Director announced new provisions to encourage individuals and business organizations to cooperate with the SEC as discussed here. A settlement with General Re Corporation this week may signal an important part of the Commission’s efforts to encourage cooperation. SEC v. General Re Corporation, Case No. 10 CV 458 (S.D.N.Y. Filed Jan. 20, 2010).
The settlement with General Re is one of a series of civil and criminal cases based on two financial fraud schemes. In one General Re, a wholly owned subsidiary of Berkshire Hathaway, Inc., aided and abetted a scheme from 2000 to 2001 by American International Group, Inc. to falsify its financial reports. In the second, the company participated in a scheme from 1997 to 2002 by Prudential Financial, Inc.
In the AIG scheme, a subsidiary of General Re is alleged to have entered into two sham reinsurance transactions with AIG. As a result of this transaction, AIG falsely reported increases to both its loss reserves and premiums written. The transaction made it appear that the AIG had increased its loss reserve in 2000 and 2001 by $500 million when in fact it had not. The reserves continued to be inflated until a restatement was issued in 2005. AIG’s reported financial results were, accordingly, incorrect, beginning in 2001. Absent the fraud in 2000 and 2001, the reported reserves of the company would have been $250,000 less in each year. AIG previously settled an enforcement action based in part on these transactions. SEC v. American International Group, Inc., Case No. 06 CV 1000 (S.D.N.Y. Filed Feb. 9, 2006). See also SEC v. Greenberg, Case No. Civil Action No. 09 Civ 6939 (S.D.N.Y. Filed Aug. 6, 2009) (discussed here).
In the Prudential scheme, General Re is alleged to have entered into a series of sham reinsurance contracts with the company. The agreements were written to look like they met the requirements to qualify for reinsurance accounting. In fact, they were subject to an oral side agreement that effectively eliminated any risk to either party and made the accounting improper. The transactions, however, permitted Prudential, through a subsidiary, to essentially create an off balance sheet asset that it could draw down to falsify its financial results. Over a three year period beginning in 2000, Prudential improperly recognized over $200 million in revenues, according to the SEC. General Re received a fee for its services. Prudential previously settled and enforcement action based on these transactions. SEC v. Prudential Financial, Inc., Case No. 08 Civ. 3916 (D.N.J. Filed Aug. 6, 2008). Related criminal cases against former employees of General Re have been resolved either with guilty pleas or by a guilty verdict as to six individuals. One former AIG executive was also convicted. All of the individuals have been sentenced.
General Re’s settlement with the SEC was entered into in conjunction with a resolution of the parallel criminal inquiry and a of a private securities fraud action. With the SEC, the company consented to the entry of a permanent injunction prohibiting it from aiding and abetting violations of Exchange Act Sections 13(b)(2)(A) & (B) and to pay $12.2 as disgorgement and prejudgment interest. In the criminal inquiry, the company agreed to pay $19.5 million and execute a non-prosecution agreement. Previously, General Re paid $5 million to the U.S. Postal Inspection Service Consumer Fraud Fund as the forfeiture of the fee it received from AIG. The company also agreed to pay $60.5 million to resolve the private suit. See also Litig. Rel. 21384 (Jan. 20, 2010).
The resolution with General Re represents the conclusion of a series of fraud actions. What is perhaps more significant is the fact the SEC articulated the factors that earned the company cooperation credit. Those factors included:
• General Re’s comprehensive, independent review of it operations conducted at the outset of the government investigations;
• The fact that the results of the inquiry were shared with the government;
• Its substantial assistance in the government’s successful civil and criminal actions against the individuals involved; and
• The internal corporate reforms designed to strengthen oversight of its operations which included dissolving the subsidiary involved in the AIG transactions, appointing an independent director to the board of directors, forming a committee consisting of senior managers to review and approve complex transactions, requiring legal review of proposed finite or loss mitigation contracts and fortifying its internal audit functions and underwriting rules. The non-prosecution agreement with DOJ requires that the company fully comply with these undertakings.
Typically, the SEC acknowledges cooperation with a simple statement or perhaps by adding a brief description such as “extraordinary.” Rarely does it set forth the factors which are considered in awarding cooperation credit, although there is a similar statement in the AIG case.
This is the second time in two weeks, however, that the SEC has detailed the factors which it considered in awarding cooperation credit. Earlier this month in discussing the settlement of In the Matter of NATCO Group, Inc., Adm. Proc. File No. 3-13742 (Filed Jan. 11, 2010) (discussed here), filed the day before Mr. Khuzami’s announcement about new cooperation initiatives, the Commission also detailed the factors it considered in awarding credit. This practice provides those considering a decision on self-reporting and cooperation with valuable guidance. While two cases cannot be called a trend, continuing this practice would assist the Division of Enforcement in its efforts to encourage cooperation.