Featured Case: AIG

In In re American International Group, Inc. 2008 Securities Litigation, Barrack Rodos & Bacine serves as Co-Lead Counsel on behalf of the Lead Plaintiff, The State Treasurer of Michigan, as custodian of the Michigan Public School Employees Retirement System, the State Employees’ Retirement System, the Michigan State Police Retirement System, and the Michigan Judges Retirement System (“SMRS”). This securities fraud case seeks compensation for American International Group (“AIG”) investors who lost tens of billions of dollars after the full extent of the risks arising from AIG’s exposure to the U.S. residential housing market, including subprime mortgage debt, was revealed, leading to a massive liquidity crisis for AIG that would have forced it into bankruptcy proceedings were it not for the $85 billion U.S. Government bailout announced on September 17, 2008.

In March 2009, after a vigorously contested lead plaintiff selection process, United States District Judge Laura Taylor Swain appointed SMRS as the sole Lead Plaintiff, and approved its selection of BR&B and The Miller Law Firm, P.C., of Rochester, Michigan as Co-Lead Counsel, in the consolidated securities litigation pending against AIG in the United States District Court for the Southern District of New York.

On May 19, 2009, SMRS, together with various other named Plaintiffs, filed a Consolidated Class Action Complaint against AIG, certain of its executives and directors, its outside auditor, PricewaterhouseCoopers, and certain underwriters of its public offerings, on behalf of purchasers of AIG’s publicly issued securities during the period from March 16, 2006 through September 16, 2008 (“Class Period”). The Complaint alleges that Defendants violated the federal securities laws by making materially false and misleading statements concerning the Company’s financial results, business operations, and condition, including its exposure to risky subprime mortgage debt, which caused the prices of AIG securities to be artificially inflated over the course of the Class Period. When the truth about AIG’s financial condition was ultimately revealed, AIG’s stock price had plunged to $2.05 per share on September 17, 2008, from a Class Period high of $72.65 per share.

On August 5, 2009, each of the defendants, either individually or as part of a group of defendants, filed a motion to dismiss the Consolidated Class Action Complaint. We responded on behalf of the Lead Plaintiff and other named plaintiffs on October 2, 2009 with an omnibus opposition to the 12 motions, filing a 232-page memorandum of law and a supporting Declaration of Jeffrey W. Golan. Defendants filed their reply briefs in further support of their motions to dismiss on December 3, 2009, after which the parties submitted to the court several notices of supplemental authorities and responses thereto.

On September 27, 2010, Judge Swain denied the 12 motions to dismiss the Consolidated Class Action Complaint. In the decision, the court held that the Complaint adequately alleges material misstatements and omissions concerning AIG’s credit default swap portfolio as well as its securities lending program. The court upheld all of lead plaintiff’s claims under sections 10(b) and 20(a) of the Securities Exchange Act of 1934 for purchasers of AIG common stock and other publicly-traded securities during the period from March 16, 2006 through September 16, 2008. In denying the motions to dismiss the 10(b) claims, the court held that the “various general disclosures cited by [the defendants] were insufficient to fulfill defendants’ disclosure obligations,” and that the facts alleged in the Complaint support a strong inference of fraudulent intent on the part of the company and certain corporate executives at AIG and its London-based subsidiary, AIGFP. The court also upheld each of claims brought under sections 11, 12(a)(2) and 15 of the Securities Act of 1933 for stock and bonds issued by AIG during the class period.

On November 5, 2010, the Court held a conference with counsel for all parties, and entered case management orders setting a schedule for the prosecution of the case. Beginning on November 19, 2010, BR&B and our co-counsel issued, on behalf of the Lead Plaintiff, requests for documents addressed to each of the sets of defendants, as well as subpoenas calling for the production of documents to certain non-party entities. Beginning in mid-December 2009, defendants and the non-parties began producing millions of pages of documents responsive to Lead Plaintiff’s requests, which BR&B and our co-counsel have been reviewing and analyzing for future use in the case.

On April 1, 2011, in accordance with the case management orders entered by the Court, Lead Plaintiff SMRS filed a motion for class certification, requesting that the Court certify a class consisting of all persons or entities, other than defendants and their affiliates, who purchased American International Group, Inc. common stock, preferred stock and other securities that traded on a U.S. public exchange from March 16, 2006 through September 16, 2008, including all persons or entities who, during the Class Period, purchased AIG common stock, preferred stock and other securities in or traceable to a public offering by AIG, and suffered damages as a result. The motion further requests that the Court certify SMRS and the other plaintiffs named in the complaint (see below) as representatives of the Class, and appoint Barrack, Rodos & Bacine and The Miller Law Firm, P.C., as Class Counsel. Lead Plaintiff’s memorandum of law in support of the motion analyzes cases relevant to the motion and cites to evidence supporting the motion. Under the case management order, defendants’ responses to the motion must be filed by July 1, 2011, and Lead Plaintiff’s reply submissions must be filed by September 15, 2011.

The allegations in the Complaint relate primarily to financial products called credit default swaps (“CDSs”) that were issued by the AIG Financial Products unit (“AIGFP”), many of which insured collateralized debt obligations (“CDOs”) backed by U.S. residential mortgages, including subprime debt (“multi-sector CDOs”). While Defendants repeatedly assured the market that there could never be any losses on this CDS portfolio, Plaintiffs allege that AIG and the Executive Defendants identified in the Complaint knew or were reckless in not knowing that the risks inherent in this portfolio, including that AIG could be required to post tens of billions of dollars in collateral or record billions of dollars in unrealized losses on its balance sheet that would be charged against AIG’s income, were massive and could cripple the entire Company.

The Complaint also alleges that the manner in which AIG invested and made disclosures concerning the cash collateral it received from its securities lending program (75% of which was directed for investment after the end of 2005 in residential mortgage-backed (“RMBS”) and asset-backed securities) violated the federal securities laws. Specifically, Plaintiffs allege that AIG and the Executive Defendants knew or were reckless in not knowing that if a sufficient number of borrowers demanded the return of their cash collateral without a sufficient injection of new borrowers and new cash collateral into the program, AIG would be facing a liquidity crisis and would be required to raise enormous amounts of cash to stay afloat.

As alleged in the Complaint:

AIG’s CDS portfolio and its investments in RMBS were like ticking time bombs. Although AIG claimed that the CDS portfolio was well-insulated against the risk of loss because a catastrophic level of defaults would need to be realized before it was required to pay the “counterparties” it was insuring, the CDS portfolio posed other significant risks. Because a credit default swap is a form of guarantee, the contracts contained provisions establishing conditions that would require AIG to “post collateral” as an assurance that it would be able to perform its obligation in the event of a default. Generally, AIG could be required to post collateral if its own credit rating was downgraded or if the underlying CDOs were subject to ratings downgrades or experienced a decline in value. Thus, apart from the risk of making payments arising from defaults, the CDS portfolio subjected AIG to the risk of being required to make tens of billions of dollars in collateral postings if the underlying CDOs declined in value due to a downturn in the U.S. residential housing market.

AIG’s securities lending investments in RMBS also carried great risk. In a declining housing market, the RMBS investments would also decline in value and become less liquid than traditional securities lending investments such as Treasury bonds. The securities lending division was obligated to repay or roll over most of its loans every 30 days, but much of the RMBS investments matured in two to five years. Thus, if a sufficient number of borrowers demanded the return of their cash collateral without a sufficient injection of new borrowers and new cash collateral into the program, AIG could be forced to sell its RMBS investments at depressed prices or would need to raise funds elsewhere. Its options in this regard were limited since most of the funds invested by AIG Investments were needed for statutory and other capital requirements of the Company’s insurance subsidiaries. As a result, both the securities lending business and the CDS portfolio, with its collateral posting requirements, posed a great risk that AIG would need to raise enormous amounts of cash, placing the Company in a liquidity vise.

The Class:

The case is brought on behalf of all persons or entities (a) who purchased AIG common stock or other securities that traded on a U.S. public exchange during the Class Period (March 16, 2006 through September 16, 2008) or (b) who purchased or acquired securities in or traceable to a public offering by AIG during the Class Period, and who suffered damages as a result.

The Class Period begins with the filing of AIG’s 2005 annual report on Form 10–K and ends the day before the $85 billion Government bailout was announced.

The Claims Made in the Complaint:

Fraud claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on behalf of purchasers of common stock and other U.S. exchange-traded AIG securities during the Class Period (the “fraud claims”)
Strict liability and negligence claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 on behalf of members of the Class who purchased or acquired AIG securities in or traceable to the Class Period offerings (the “offering claims”)

The Defendants:

AIG (defendant on the fraud claims and offering claims)
Senior Executives of AIG: Sullivan (Chief Executive Officer), Bensinger (Chief Financial Officer), Herzog (Chief Accounting Officer), and Lewis (Chief Risk Officer) (defendants on the fraud claims and offering claims)
Senior Executives of AIGFP: Cassano (President), Frost, Forster, and Athan (defendants on the fraud claims and offering claims)
AIG’s outside directors (defendants only on negligence-based offering claims)
PricewaterhouseCoopers, AIG’s outside auditor (defendant only on negligence-based offering claims)
Underwriters of the more than 70 public bond and stock offerings during the Class Period (defendants only on negligence-based offering claims)

Other Plaintiffs:

Maine Public Employees Retirement System
Port Authority of Alleghany County Retirement and Disability Allowance Plan for Employees Represented by Local 85 of the Amalgamated Transit Union
Epstein Real Estate Advisory
Lynette J. Yee, Michael Conte, Roger Wilson, and Randy Lewis Decker

Examples of Alleged False Statements:

AIG’s mantra was that there could never be losses on its CDS portfolio. For example:

On August 9, 2007, AIG executives represented that the risk undertaken in the CDS portfolio “is very modest and remote, and has been structured and managed effectively” and “[w]e see no dollar loss associated with any of [the CDS] business.” Joseph Cassano, the former head of AIGFP, declared in reference to the Company’s CDS portfolio that “it is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing $1 in any of those transactions.”
On November 8, 2007, Company executives reiterated that AIG did not expect to pay any losses “on this carefully structured and well-managed [CDS] portfolio.”
On December 5, 2007, further assurances concerning the CDS portfolio were provided at an investor meeting, where AIG’s Chief Executive Officer, Martin Sullivan, stated that the possibility that these swaps would sustain a loss was “close to zero” and that AIG’s valuation models had proven to be “very reliable” and provided AIG “with a very high level of comfort.”

According to the Complaint, unbeknownst to the investing public, starting in August 2007, AIGFP began receiving multi-billion dollar collateral calls on certain of its CDS contracts with underlying pools of subprime mortgages; in October 2007, a senior AIG accountant was forced to resign after being excluded from discussions about the value of the CDS portfolio; in late November 2007, AIG’s outside auditors, PwC, identified significant deficiencies, and possibly a material weakness, in AIG’s risk management and internal controls regarding AIG’s valuation of the CDS portfolio; and, in March 2008, the Office of Thrift Supervision communicated to AIG senior management significant supervisory problems over disclosures in AIG’s SEC filings and AIG’s unsatisfactory handling of risk management over AIGFP.

As further alleged in the Complaint, unbeknownst to the investing public, at the end of 2005, senior executives within AIG and AIG Investments decided that up to 75% of the cash collateral received through its securities lending program should be invested in residential mortgage-backed securities and similar asset-backed securities, including subprime debt. Thus, at the same time AIGFP determined that the U.S. residential housing and mortgage market was too risky to be a basis for issuing new CDS contracts, AIG Investments ramped up its investments in these very same types of securities, all in order to gain additional profits through the securities lending business.

Eventually, starting in February 2008 and continuing for the next half year, AIG began to reveal its exposure to tens of billions of potential actual losses on its CDS portfolio, and took write-downs in the tens of billions of dollars, all leading to substantial declines in the prices of AIG’s stock and bonds.

It further revealed other losses and facts relating to AIG’s investments keyed to the subprime mortgage market through its securities lending program that had not been adequately disclosed earlier in the Company’s statements.

As alleged in the Complaint, all of this eventually led to a near total collapse in the price of AIG’s stock, and the Government bailout of AIG after the close of the market on September 16, 2008.

The New Information Alleged in the Complaint:

BR&B and its co-lead counsel undertook an extensive investigation of the claims alleged in the Complaint, and thereby uncovered a wealth of previously unreported facts, including the following:

Although AIG could have protected itself by hedging its CDS deals, it did not do so because “their [AIGFP management’s] bonuses were highly dependent on revenue out of that book of business” and if they had incurred the added cost of hedging “it wouldn’t have been much of a business.” That sentiment was echoed by a former AIGFP executive familiar with the CDS portfolio, who stated that “if you had to hedge the business it would not be an economically viable line of business.” Based in part on this information, Plaintiffs allege that even though AIG was plainly aware of the downward turn of the mortgage market, Defendants chose not to hedge the CDS portfolio because doing so would have undercut the profitability of the business as well as the compensation of the AIGFP executives named as Defendants in the Complaint.
Contrary to AIG’s public pronouncements that it only insured CDOs of the highest quality, AIGFP actually tended to prefer CDOs known as “mezzanine deals,” which were comprised of lower quality collateral, including in many cases up to 100% of subprime risk exposure, because AIGFP could write more of them than the high grade deals and thereby generate more revenue. Whereas in earlier multi-sector CDO deals, where there were many different types of uncorrelated assets, the CDOs at issue in the case became “almost entirely all subprime” by late 2005. Based on this information, Plaintiffs allege in the Complaint that Defendants recklessly ignored the fact that these CDOs would fall in value much faster—since they included overall lesser credit-worthy loans—and would result in even faster collateral calls and balance sheet losses.
AIGFP failed to adequately review the CDSs into which it was entering, even though AIGFP executives were telling the public that they engaged in a thorough and adequate review of the underlying CDOs. For instance, AIGFP would routinely ask a potential counterparty to provide only the “underlying and offering documents,” but would not request the counterparties’ own loan level valuation or analysis materials, which would have allowed AIGFP to properly price and evaluate the risks associated with the CDS deals. Moreover, unbeknownst to AIG investors, many of the CDS contracts written by AIGFP were “very biased in favor of the banks.” These contracts typically contained an “unusual feature” whereby the counterparty bank was designated as the calculation agent for determining the valuation of the referenced CDO for purposes of determining when collateral had to be posted. Thus, the banks were the presumptive prevailing party as to the valuation of the CDOs, since it was the counterparties’ “decision on how they mark it and that’s how collateral is posted.”
AIGFP’s Asset/Credit group, which was headed by defendant Joseph Cassano and which was responsible for writing the multi-sector CDO-based credit default swaps at issue in the case, had effectively separated itself from the rest of the AIGFP unit and from the parent company (AIG). The Asset/Credit business was “definitely treated differently and wasn’t as transparent as the other businesses.” For example, the Assets/Credit group did not utilize AIG’s standard, company-wide, Windows-based management information system that housed all the data sent to AIG’s risk management, accounting, and other departments to make business decisions pertaining to AIGFP. Instead, Cassano maintained information regarding the CDS business on a separate spreadsheet, which was managed out of the London office and to which the risk management and accounting functions at AIG did not have access. In a similar vein, AIGFP executives would attend weekly marketing and trading meetings headed by defendant Cassano, where the performance of each of AIGFP’s businesses was reviewed, and pertinent risk management issues were discussed. However, the CDS business was an exception, as risk management issues pertaining to this business were not covered at these weekly meetings. Indeed, it is not clear that the Asset/Credit group ever provided risk analyses to corporate management with respect to the CDS portfolio.
Moreover, the CDS business was “purposely isolated in London” and its risk management and exposure were “never subject to [the] rigorous process” that applied to the rest of AIG. Indeed, the head of global risk management at AIGFP was reportedly excluded by certain of the AIGFP executives identified as defendants in the Complaint from adequately performing the risk management function with respect to the Asset/Credit group. The financial reporting decisions concerning the CDS portfolio were made separately by certain AIGFP executives and the valuation process relating to the CDS portfolio was deliberately conducted outside the purview of AIG’s and AIGFP’s risk management and financial and accounting functions. Thus, as Plaintiffs allege in the Complaint, despite AIG’s impressive internal controls for most of its businesses, the absence of effective controls over the CDS business allowed a huge area of potential exposure to be uncontrolled.
AIGFP’s models for valuing its CDSs allowed Defendants to repeatedly underestimate the market valuation losses it was experiencing in connection with the CDS portfolio. For example, as alleged in the Complaint, AIGFP’s valuation models were based on theoretical default rates for the underlying CDOs, whereas the counterparties relied on actual market data. Similarly, AIGFP’s valuation models were intended only to predict whether the level of defaults in the underlying collateral would rise to the point where AIGFP’s obligation to make payments to the counterparties would be triggered; they were not, however, intended to predict whether or when the referenced CDOs would decline in value or whether the collateral posting triggers would be reached. Thus, as alleged in the Complaint, unbeknownst to the investing public, the models failed to measure or predict important asset valuation and liquidity risks posed by the CDS portfolio.

The BR&B AIG Team

BR&B’s prosecution of the AIG securities class action is being handled by Senior Partner Leonard Barrack, Partners Jeff Golan, Rick Komins, Rob Hoffman and Jeff Gittleman and Associates Lisa Lamb, Chad Carder and Julie Palley.

The BR&B team for the AIG case brings a wealth of experience and record of success in prior securities cases. Among other notable cases: Len Barrack and Jeff Golan were BR&B’s lead attorneys on the WorldCom and Cendant cases, and Jeff further headed up the Firm’s prosecution of the DaimlerChrysler and Mills Corporation litigation; Len and Rick Komins were the Firm’s lead attorneys in the McKesson and Merrill Lynch securities litigation; Rob Hoffman served as the Firm’s lead attorney in the Schering-Plough case; Jeff Gittleman was extensively involved in the Schering-Plough and Mills litigation; Lisa Lamb was part of the trial team in the WorldCom case, and also assisted in the R&G Financial and Mills litigation; Chad Carder assisted in the Firm’s WorldCom, Mills and MF Global litigation; and Julie Palley assisted in the Merrill Lynch case.

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