In Banking World, Fraud Is an Epidemic

In Banking World, Fraud Is an Epidemic

Truthout is serializing Beatrice Edwards’ book, The Rise of the American Corporate Security State. To read more excerpts from this book, click here.

Reason to be afraid #6:

Systemic corruption and a fundamental conflict of interest are driving us toward the precipice of new economic crises.

In the early spring of 2010, my phone rang, and the caller ID read “Unknown.” On the other end of the line was an AIG whistleblower. Until the 2008 financial crisis, AIG was a rogue elephant in the zoo of the US financial world, unknown to most Americans. After that, though, everyone who read a newspaper knew what AIG was. AIG Financial Products Division (AIG-FP), the London-based unit that took on the risk for the Wall Street banks, became a familiar villain in the developing story of fraud and corruption underlying the Great Recession of 2008–2009.

My caller spoke tentatively at first, without specifics, as cautious whistleblowers do, but she was concerned about the way in which the AIG compliance office at corporate headquarters worked. This was the office responsible for ensuring that the huge insurer did not break the law in any one of the 145 or so countries where it operated.

According to the caller that morning, the mainstay of AIG’s compliance program was “a joke,” and it had been for a long time. For years the program consisted mainly of a list of about four hundred email addresses for compliance and law enforcement officials around the world, many of which were defunct (either the addresses, the officials, or both). Whenever AIG wanted to inform the offices abroad and their government counterparts of a new legal or ethical obligation, AIG Compliance would blast out the news using this listserv. Then the office director would order the deletion of the plethora of bounce-backs and consider her mission accomplished.

Over the next few weeks, we started getting names and numbers of other sources at AIG who would validate the fact that much of the compliance work there was substandard, leading up to and away from the weekend in September 2008 when the financial captains at the helm of the banking world finally realized they had steered it off a cliff. The AIG allegations we heard were awful, and the people who made them were afraid to have their names used in any public way. All of the claims hung together, though. One corroborated another. And the charges were quite specific.

Everyone I talked to mentioned James Cole, who worked in the office as an independent consultant for the SEC. He was positioned in the compliance office, went to AIG board meetings, wrote reports, interviewed people, and generally hung around. The Wall Street Journal reported that this assignment earned his law firm, Bryan Cave, around $20 million, for about five years work.

Sources at AIG pointed out that an independent consultant/ monitor for the SEC in the compliance and regulatory office was a condition of a deferred prosecution agreement that AIG struck with the SEC, the Bush administration’s Department of Justice, and the New York State Department of Insurance to settle allegations of aiding and abetting securities fraud dating back to 2000. At the time, deferred prosecution agreements (DPAs) were typically used to deal with low-level narcotics cases, and the New York Times called the agreement “somewhat unusual in white collar cases.”

Under the terms of the DPA, AIG paid a fine and appointed Cole to report to the SEC and the Justice Department on compliance. In this position, he reviewed the dubious financial transactions from 2000 forward, structured by AIG that supposedly violated accounting regulations and securities laws. These transactions were developed and handled by AIGFP PAGIC Equity Holding in London, headed by Joseph Cassano. At the time, Cassano was also the also the head of AIG Financial Products Corporation, the unit that sank AIG, its banking counterparties, and the US economy in 2008.

Then US deputy attorney general Eric Holder established the first guidelines relevant to DPAs for corporations in 1999 in a document that came to be known as “the Holder memo.” In the years since then, the memo has been criticized for its failure to address the DPA scenario specifically and the nebulous standards it set out. Among other things, the Holder memo failed to define compliance or to specify the requirements for selecting external monitors of corporate governance. The lack of definition caused great power to default to prosecutors, and left the door open to more and more flexible DPAs. These agreements have increased in number substantially, surging to thirty-eight in 2007, up from four in 2003.

Despite Cole’s monitoring after 2004, AIG was once again in trouble with the SEC and the Justice Department by 2006. The corporation faced charges of additional financial improprieties and bid-rigging but settled with a second DPA, despite the fact that one of the factors applied to assess eligibility for a DPA under the guidelines of the Holder memo is the lack of an earlier offense. Under the 2006 agreement, admittedly, the fine was much stiffer than that exacted in 2004: AIG paid $1.6 billion in 2006 and broadened the scope of Cole’s monitoring authority. At that point he became responsible for examining AIG’s controls on financial reporting as well as corporate governance in the compliance area. In exchange for this deal and the two payments, the charges against AIG were resolved two years before AIG-FP was identified as the epicenter of the 2008 financial cataclysm.

As the AIG monitor, Cole was to file reports with the Justice Department and the SEC. The reports, which were pages and pages of nothingness, were secret, but we obtained those Cole filed with the SEC. They were not for public consumption even in 2010, when the American public owned AIG, or 90 percent of it. Also, in light of what had happened there, the fact that Cole’s reports to the SEC in 2006, 2007, and 2008 were uniformly basic and abstract was important in itself. In August and September 2007, he issued 215 pages of stupefying, mundane recommendations that read as if they came directly from a fraud examiner’s manual somewhere. There was no meaningful interpretation, no analysis of how the law applied to AIG, even in the United States, never mind how it might affect overseas operations. There was no review of the corporation’s actual practices, nor of the adaptations required to ensure that the crimes addressed in the DPA did not recur. The whole job looked like a cut and paste, until page eight-seven of the September 30 report. There, Cole wrote:

The Derivatives Committee [of the AIG Board] should be responsible for providing an independent review of proposed derivative transactions or programs entered into by all AIG entities other than AIG Financial Products Corp. (“AIG-FP”).

He elaborated this exemption further:

For derivative transactions or programs entered into by AIG-FP, the appropriate independent review of the proposed derivative transactions or programs should be conducted by AIG-FP.

If AIG-FP reviews AIG-FP’s transactions, though, that isn’t really an independent review, is it?

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