AIG Brightpoint

1
AIG Brightpoint

• By Youjung Byon
• Edward Urban
• Tim Nguyen

2
Art of Roundtripping

• The case of AIG Brightpoint centers on the idea
  of roundtripping.
• According to the PWC fraud report, roundtripping
  involves transactions between companies for
  which there is no economic benefit for either
  company because there is an equal revenue and
  cost element.
• Other companies involved in roundtripping consist
  of Enron, Dynegy, and Qwest.

3
Company Info

• American Int. Group (AIG)
• Largest US-based international insurance
  organization.
• Total Assets 621 Billion
• Revenue 4.2 Billion

• Brightpoint
• Distributor of cell phones.
• Total Assets 336 Million
• Revenue 1.2 Billion

4
What Happened?

• Oct 1998 Brightopint publicly announce 13M -
  18M loss
• Dec 1998
• Actual loss 29 Million
• Delaney and Harcharik negotiate with the Loss
  Mitigation Unit(LMU) of National Union Fire
  Insurance
• LMU offered insurance to smooth the loss
  (Follow the White Paper)

5
Policy

• Limit A retroactive coverage fully pre-funded
  by Brightpoint.
• Limit B Prospective fidelity coverage
• Finalized in Jan 1999, dated Aug 1998
• Enabled Brightpoint to record an insurance
  receivable of 11.9M, bringing net loss to within
  the 13M-18M range

6
Payment Plan

• Goal Avoid the auditors from realizing the
  15.3M sum
• Three Part, 3-yr Plan
• (1) Initial Payment 199,200
• (2) 32 MonthlyPayments of 237,600 from Jan 1999
  through Aug 2001
• (3) Letter of Credit 7.5M

7
Gain from the Deal

• Brightpoint
• Overstate net income by 61 in 1998
• Smooth 29M loss over 3 yrs

• AIG
• 100,000 for putting the deal together
• 202,400 in premium for Limit B

8
What was wrong with the Policy?

• Limit A Not an insurance, Not a loan
  arrangement, but a mechanism to deposit money
• Limit B Coverage for Limit A
• Backdated
• No trasnfer of risk
• Fake letter of confirmation from AIG to
  Brightpoint's auditor
• Allow Brightpoint to overstate its net income
• Fundamental Problem White Paper

9
Aftermath

• Brightpoint 450,000 civil fine
• Delaney (Controller)
• 100,000 fine
• Permanent bar from serving as officer/director of
  any public company
• Harcharik (Dir of Risk Mangt) Resigned
• Bounsall (CEO) 450,000 fine for recklessness
• AIG 10M civil fine
• Forfeit 100,000 fee paid by Brightpoint
• Lucello (Assist. VP) Resigned

10
How Was The Fraud Detected?

• In October 2001, the SEC sent a formal inquiry to
  Brightpoints auditors, Ernst Young.
• Auditors determined the policy was
  non-traditional, retroactive coverage and
  required Brightpoint to restate 1998 earnings by
  the full value of premiums paid 15.3M.
• In January 2002, auditors learned Brightpoint had
  cancelled the policy and received a full refund
  in the amount of premiums paid. Fraud became
  apparent.
• Brightpoint was required to restate 1998 earnings
  a second time, reflecting the premiums as
  deposits.

11
What Went Wrong?

• Brightpoints senior managers responsible for
  internal controls (Chief Accounting Officer and
  Director of Risk Management) lacked integrity.
• CEO and CFO of Brightpoint were either complicit
  in the fraud or irresponsible in their
  questioning of the results of the UK operation.
• AIG actively marketed deceptive insurance
  products designed to manage reported earnings.
• Auditors faced great difficulty in uncovering
  side-agreements. Round-trip transaction obscured
  by clauses designed to appear as legitimate risk
  transfer.

12
Who Violated What?

• In Violation of Rule 10b-5 Brightpoint, AIG,
  Delaney, Harcharik
• In Violation of Rule 17(a) Brightpoint
  Delaney
• In Violation of Rule 13(a) Brightpoint
  Delaney
• In Violation of Rule 13(b)(2) Brightpoint
• In Violation of Rule 13b2-1 Brightpoint,
  Bounsall, Delaney, Harcharik
• In Violation of Rule 13(b)(5) Delaney
  Harcharik
• In Violation of Rule 13b2-2 AIG, Delaney,
  Harcharik

13
Prevention The Double Headed Hydra

• Brightpoint
• Delaney He is a licensed CPA in the state of
  Ohio. He served as Corporate Controller Chief
  Accounting Officer since June 1996.
• Harcharik He was an Independent Contractor,
  serving as Brightpoints Director of Risk
  management since June 1997.
• Bounsall He is a CPA. He served as
  Brightpoints EVP and Chief Financial Officer
  Treasurer since October 1996.
• AIGspecifically the Loss Mitigation Unit (LMU)
  of National
• Union Fire Insurance Company of Pittsburgh, a
  subsidiary of AIG
• Lucollo He is an Assistant Vice President
  involved of Risk Management.

14
The LMU White Paper

• Paper disseminated to 32 management level AIG and
  National Union employees in October 1997,
  including National Unions President, the
  President of AIGs Financial Lines Claims
  Division, and 2 other senior officers.
• Paper provided a guide on how to treat accounting
  and regulatory issues in LMU products designed to
  smooth earnings and income.
• Paper outlined artfully principal attributes of
  non-traditional insurance.
• Paper acknowledged openly that the current
  accounting rules were specifically designed to
  avoid income smoothing techniques effects.
• Paper required that measures should be done in an
  oral side agreement.

15
LMU White Paper Continued

• AIG advertised these income smoothing products
  to AIGs various divisions and regions on a large
  scale
• AIG marketed products directly to third parties.
• Marketing materials proudly touted the following
  benefits
• 1) Smoothing of expenses over several operating
  quarters, allowing a company to avoid a one-time
  charge resulting in the dilution of earnings
  and
• 2) Favorable disclosure or potential elimination
  of disclosure requirement, which can mitigate or
  even eliminate potential lawsuits
• Brightpoint strictly followed this blueprint.

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Prevention AIG

• Company has designed a unit and allocated
  intellectual and economic resources to circumvent
  existing accounting rules.
• Corporate policy outlined ways and methods of
  circumventing existing accounting rules through
  what is known as the LMU White Paper (See next
  slide for in-depth discussion)
• Recommendation Having units, like the LMU,
  designed for the sole purpose of smoothing out
  corporate earnings or income should be
  dismantled and discouraged.
• Transaction was carried out orally.
• Recommendation All transactions require paper
  trails.

17
Prevention Brightpoint

• Seniors were involved.
• Recommendation (1) Corporate Governance Issues,
  (2) Linking incentives to fraud-prevention
• This transaction was done orally.
• Recommendation All transactions must require
  paper trail.
• Bounsall negligently approved transaction without
  reviewing any written documents and examining the
  Binder (the Policy) itself
• Recommendation Perhaps this is an HR issue.
  Need to find quality individuals who are serious
  and care about their job.

18
Questions