Wayne M. Carlin, Regional Director of the Commission's Northeast Regional Office, said of the settlements: "In this case, AIG worked hand in hand with Brightpoint personnel to custom-design a purported insurance policy that allowed Brightpoint to overstate its earnings by a staggering 61 percent. This transaction was simply a 'round-trip' of cash from Brightpoint to AIG and back to Brightpoint. By disguising the money as 'insurance,' AIG enabled Brightpoint to spread over several years a loss that should have been recognized immediately."
Mark K. Schonfeld, Associate Regional Director of the Commission's Northeast Regional Office, said, "The $10 million penalty against AIG reflects the gravity of its misconduct. It also reflects the fact that, in the course of the Commission's investigation, AIG did not come clean. On the contrary, AIG withheld documents and committed other abuses, as outlined in the administrative order, compounding its overall misconduct."
In addition to AIG and Brightpoint, the Commission charged the following individuals:
- Philip Bounsall, former Brightpoint chief financial officer;
- John Delaney, Brightpoint's former chief accounting officer;
- Timothy Harcharik, Brightpoint's former director of risk management; and
- Louis Lucullo, an AIG assistant vice president.
AIG developed and marketed a so-called "non-traditional" insurance product for the stated purpose of "income statement smoothing," i.e., enabling a public reporting company to spread the recognition of known and quantified one-time losses over several future reporting periods. In this case, the key to achieving the desired accounting result was to create the appearance of "insurance." Specifically, AIG agreed to make it appear that the "insured" (Brightpoint) was paying premiums in return for an assumption of risk by AIG. In fact, Brightpoint was merely depositing cash with AIG that AIG refunded to Brightpoint.
AIG issued the purported insurance policy to Brightpoint for the purpose of assisting Brightpoint to conceal $11.9 million in losses that Brightpoint sustained in 1998. Brightpoint's chief accounting officer, Delaney, and its director of risk management, Harcharik, negotiated the arrangement with Lucullo, then an AIG assistant vice president. Brightpoint's chief financial officer, Bounsall, approved the insurance transaction without adequately reviewing it. As a result of the transaction, Brightpoint's 1998 financial statements overstated Brightpoint's actual net income before taxes by 61 percent.
The Brightpoint Fraud
Specifically, the Commission's Orders make the following findings of fact, which the respective respondents neither admit nor deny:
- In October 1998, Brightpoint publicly announced that in the fourth quarter ending December 31, it would recognize a one-time charge, ranging from $13 million to $18 million, arising out of losses sustained by one of its divisions in the United Kingdom. By December 1998, Brightpoint determined that the UK losses were actually about $29 million, and Brightpoint's corporate controller, Delaney, and its director of risk management, Harcharik, devised a scheme to cover up these additional, unanticipated losses, rather than disclose them.
- In December 1998, Delaney and Harcharik turned to the Loss Mitigation Unit (LMU) of National Union Fire Insurance Company of Pittsburgh, Pa., one of AIG's principal general insurance company subsidiaries. LMU offered "insurance" products specifically designed to "smooth" the financial statement impact of losses sustained by AIG clients. Brightpoint and AIG negotiated the terms of a $15 million "retroactive" insurance policy that covered all of the extra UK losses. The parties agreed to combine this "retroactive coverage" with prospective fidelity coverage (together, the Policy) in an effort to avoid scrutiny from Brightpoint's auditors. The "cost" of the $15 million "retroactive coverage" to Brightpoint was about $15 million, which Brightpoint was to pay in monthly "premiums" over the prospective three-year term of the Policy. The Policy, finalized in January 1999, enabled Brightpoint to record in 1998 an insurance receivable of $11.9 million, which Brightpoint netted against the total UK losses of about $29 million, bringing the net loss to within the previously disclosed $13 million to $18 million range.
- In fact, the "retroactive coverage" should not have been accounted for as insurance. It was merely a "round-trip" of cash - a mechanism for Brightpoint to deposit money with AIG, in the form of monthly "premiums," which AIG was then to refund to Brightpoint as purported "insurance claim payments." In drafting the Policy, Delaney, Harcharik and Lucullo took pains to ensure that the "retroactive coverage" raised no red flags for Brightpoint's auditors: They created a blended fidelity coverage and retroactive policy that was designed to look like traditional, non-retroactive indemnity insurance and they gave the policy an effective date of August 1998.
- In October 2001, following an inquiry by the Commission's staff, Brightpoint's auditors began looking more closely at the Policy and determined that it was not traditional insurance. Although the auditors questioned whether the Policy was insurance at all, they decided at the very least that the Policy provided retroactive coverage and, therefore, that all premium expense associated with it should have been recorded in 1998. On November 13, 2001, Brightpoint announced a restatement, which treated the Policy as real, but retroactive, insurance. In this restatement, Brightpoint expensed the full policy "premium" in the fourth quarter of 1998, amounting to $15.3 million.
- On January 31, 2002, Brightpoint announced that it would further restate its financial statements to reflect that the "premiums" for the "retroactive coverage" under the Policy were only deposits with AIG. This second restatement came about when the auditors learned that, one day before Brightpoint announced the first restatement, it had "cancelled" the "retroactive coverage" and obtained from AIG a refund in the full amount of premiums Brightpoint had paid over and above the "insurance claim payments" made to it by AIG under the "retroactive coverage." The cancellation transaction left no doubt that the "retroactive coverage" was not insurance.
AIG's Misconduct in the Commission's Investigation
During the course of the investigation of this matter, AIG failed to produce a large quantity of documents that were called for by the staff's various requests and subpoenas. In part, this failure resulted from a woefully deficient document collection effort within AIG, in which AIG failed to search various locations in which responsive documents were likely to be found. For example, AIG failed to examine the files of the former LMU president and other key individuals, and failed to conduct an adequate search of the LMU computer drive. In addition, in the fall of 2000, AIG chose to withhold a key document that the Commission believes should have been produced. AIG's misconduct in withholding this document until October 29, 2002 is compounded by the Commission's view that the document was directly relevant to positions taken by AIG in its Wells submission and in a meeting with the staff prior to that date.
Commission Findings
The Commission's settled administrative Orders make the following legal conclusions:
- AIG violated Section 10(b) of the Exchange Act and Rule 10b-5 and was a cause of Delaney's violation of Exchange Act Rule 13b2-2 by making materially false statements to Brightpoint's Auditors.
- Brightpoint violated Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 (Exchange Act) and the reporting, books-and-records, and internal controls provisions of Exchange Act Sections 13(a) and 13(b)(2) and Exchange Act Rules 12b-20, 13a-1 and 13b2-1.
- Bounsall caused Brightpoint's violations of the books-and-records provisions of Rule 13b2-1 of the Exchange Act.
- Lucullo caused Brightpoint's violations of the reporting provisions of Section 13(a) and Rules 12b-20 and 13a-1 of the Exchange Act.
The Commission's Orders direct each respondent to cease and desist from further violating the respective securities law provisions. The Commission's Order with respect to AIG also directs AIG to (i) disgorge, with prejudgment interest, the $100,000 fee it charged to Brightpoint for putting the Policy together, and (ii) retain an independent consultant to make binding recommendations concerning AIG's internal controls to ensure that AIG's insurance products will not be used in the future to violate the securities laws.
The Commission has also filed a related civil action in federal court in Manhattan. Without admitting or denying the complaint's allegations, all defendants except Harcharik have settled the civil action, with AIG agreeing to pay a $10 million civil penalty, Brightpoint agreeing to pay a $450,000 civil penalty, Bounsall agreeing to pay a $45,000 civil penalty and Delaney consenting to the entry of a permanent injunction barring future securities law violations, a permanent officer and director bar and a judgment ordering him to pay a $100,000 civil penalty.
