Around 10 o'clock Monday morning, legendary investor Warren E. Buffett will find himself in an unusual position, sitting down for an interview at the Securities and Exchange Commission's New York offices to answer questions from the SEC, federal prosecutors from the Eastern District of Virginia and investigators from New York state Attorney General Eliot L. Spitzer's office.
The regulators and prosecutors are all probing a number of highly complex insurance transactions, including a deal between General Re Corp., a unit of Buffett's Berkshire Hathaway Inc. holding company, and New York-based insurance giant American International Group Inc.
Warren Buffett faces questions on an AIG and General Re deal.
Sources familiar with the investigation say Buffett is not a target or subject but rather a cooperating witness who, along with other Berkshire executives, has played a key role in helping investigators understand the AIG deal as well as other complex reinsurance deals that regulators think some companies, including AIG, used to inflate their bottom line.
General Re's involvement in the investigation dates to October 2003, when the U.S. Attorney for the Eastern District of Virginia first subpoenaed the company seeking information about transactions it executed with Reciprocal of America, a Virginia professional liability insurer that collapsed that year during allegations of major accounting fraud.
Sources say that in complying with the request, General Re provided prosecutors with documents on a number of potentially questionable transactions. One that especially caught the eye of both General Re and investigators involved AIG, the world's largest business insurer and a firm whose complicated finances have long drawn regulatory interest. The Wall Street Journal yesterday reported on General Re turning information about the AIG transaction over to prosecutors.
The AIG deal took place in two parts, in December 2000 and March 2001. Under terms of the agreement, described in a March 30 AIG press release, a unit of General Re sent $500 million in potential liabilities to AIG in addition to $500 million in premiums. AIG used the money to increase the cash it holds in reserve to pay claims, an amount some investors had criticized as too low, and added $500 million in revenue to its balance sheet.
The transaction was intended to be a reinsurance deal, a common transaction in which an insurer buys insurance to guard against potentially huge losses, such as from a class-action lawsuit or major accident. But in order to be legitimate, the provider of reinsurance, in this case AIG, must take on risk.
But regulators say the $500 million premium transfer to AIG indicates the deal may have involved little or no risk for AIG, and therefore the $500 million was really a loan and should not have been counted as revenue. In the March 30 statement, AIG said it had "concluded that the Gen Re transaction documentation was improper and, in light of the lack of evidence of risk transfer, these transactions should not have been recorded as insurance." AIG has said it may have inflated its net worth by as much as $1.7 billion through the General Re deal and other transactions.
While Buffett is by all accounts a cooperating witness and not a target, regulatory sources say they still have some serious questions for the Berkshire chief, who has earned a reputation as a plain-spoken advocate of straightforward accounting, reasonable executive compensation and overall good corporate governance. Buffett is a major shareholder and longtime director of The Washington Post Co.
Sources say investigators want to know precisely how much Buffett knew about the AIG transaction. They will ask exactly what former General Re chief executive Ronald E. Ferguson told Buffett about the structure of the deal, and they will compare what Buffett says with what Ferguson has already told them. Ferguson no longer has an executive role at General Re, but he maintains an office at the Stamford, Conn., firm. A message left at his office last evening was not returned.
If Buffett had detailed knowledge about how AIG planned to account for the transaction, it could be a problem, according to former prosecutor David Gourevitch. The AIG transaction is one of 14 involving General Re in which the investigators are interested.
"You cannot knowingly assist in a transaction where the purpose is for the counter-party to engage in improper accounting on their books, even if it's properly accounted for on your books," he said.
But Jacob S. Frenkel, an attorney at Shulman & Rogers in Rockville and a former SEC enforcement lawyer, said it is possible for one side of a transaction to account for a deal properly without knowing whether the other side is doing so.
And he said he thought Buffett's testimony would serve twin purposes for regulators: to provide more information about the transactions and to raise the overall profile of what is at bottom a highly complex, even arcane, probe.
"We've seen from all the cases brought by the New York attorney general, the Department of Justice and the SEC that no one is too big to escape scrutiny," Frenkel said. "Still, you can easily have some of the highest-profile names in society paraded before the government for testimony, but that does not mean they are directly or indirectly implicated in any wrongful conduct."
Buffett did not return repeated calls for comment. Calls to Berkshire were not returned. On March 29, Berkshire released a statement saying Buffett "was not briefed on how the transactions were to be structured or on any improper use or purpose of the transactions."
Gourevitch said Buffett's testimony may be a delicate affair, requiring him to walk a fine line by acknowledging he was briefed on the transaction but did not know enough to think it might be questionable.
"He's going to have some explaining to do about what he did and didn't know and what he understood the transaction to mean. He's going to have to say he saw a legitimate purpose for the deal and that it wasn't through-and-through fraud that was obvious on its face." Legal experts say Buffett could be helped by his reputation as a hands-off manager who lets executives at the many companies Berkshire owns operate with autonomy.
Staff writer Carrie Johnson and staff researcher Richard Drezen contributed to this report.