Tuesday, September 28, 2010

Federal Judge Allows Claims Against AIG Management and Outside Auditor to Go Forward

A federal judge (SD NY) has ruled that an  investor's securities fraud action against AIG senior management could proceed since the investor adequately pleaded that the  general disclosures cired by the executieves were insufficient to fulfill their disclosure obligations under the federal securities laws in light of the undisclosed “hard facts critical to 

appreciating the magnitude of the risks described, \such as, to name but a few, the known weaknesses of company models; the deliberate weakening of risk controls. the scope of the exposure to mortgage-backed securities, and the securities lending program and the valuation and 0collateral risk presented by the credit default swap portfolio that rendered misleading the company's frequent placement of emphasis on the remote credit risk.  (In re American International Group, Inc. 2008 Securities Litigation, SD NY, No. 08 Civ 4772, Sept. 27, 2010).

The court also allowed the action to go forward against AIG's audit firm under alleged Section 11 of the Securities Act violations. The investors alleged that the audited financial statements of AIG were not prepared in accordance with GAAP and that the firm did not conduct is audit of the financials in accordance with GAAS. The investors alleged that the audit firm had certain obligations to disclose the scope of AIG’s potential collateral obligations pursuant to FIN 45, which sets forth disclosure requirements for guarantees. The auditor's alleged failure to meet these obligations resulted in its signing unqualified opinions that were included in the 

company’s 10-K that did not disclose adequately the risks posed by the credit default swap portfolio, the securities lending program, and the concentration of exposure to the subprime mortgage market, in violation of various accounting standards, including FAS 107 and 133.

The court said that it is inappropriate to dismiss well-pleaded allegations at a motion to dismiss stage that an accountant blessed financial statementgs that violated certain identified GAAP principles and were fundamentally misleading to investorfs. Rather, because eventual evidence on industry practice or expert testimony are likely to shed light on this question, the determinatio  of whether AIG's accounting treatment of its credit default swap portfolio and its exposure to the subprime mortgage market comported with GAAP in the audited financial statements included in its Form 10-K cannot be determined in advance of the development of the record.