The public finally got a look at the trio who ran AIG aground before the bailout in 2008 when they appeared before the Financial Crisis Inquiry Commission yesterday. Joseph Cassano, Martin Sullivan and Robert Lewis seemed defiant and pained, still stunned and humiliated, respectively. The New York Times articles (here and here) and the questioning yesterday explain the sheepishness and shame on display with the AIG executives who testified. At AIG-FP (Financial Products), Cassano had encumbered the AIG holding company with enormous uncapitalized and unhedged long-term risk based on a single market trend: the upswing in US housing prices. This is like betting your house that one horse will win the Derby because it’s been winning up until now. In this case, we now know that the horse was feeling queasy by 2005, so why Cassano did this remains unclear. Based on yesterday’s testimony, neither Sullivan nor Lewis ever asked him.

What is clear is that AIG-FP under Cassano had inexplicable corporate autonomy, even after senior management knew that he was sinking the ship. By 2006, AIG-FP had stopped insuring CDSs (credit default swaps) based on mortgage-backed securities because even the “experts” working for Cassano knew the deals were rotten. These guys were careful to keep this to themselves, however, and James Cole, the Independent Consultant installed at AIG by the SEC and the Justice Department to review AIG-FP transactions from 2000 – 2005, failed to spot it. Part of the reason for the blind spot that affected Cole is explained by the recommendations for compliance (p87) that he himself set out in 2007. When Cole recommended the establishment of a Committee to oversee the transacting of derivatives, which would have encompassed oversight of the CDSs insured by AIG-FP, he wrote:

The Derivatives Committee 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”).

These recommendations, made in September 2007, show Cole’s explicit intention to keep his eye off the ball, even though, a 2004 deferred prosecution agreement between AIG, the Department of Justice (DOJ), the SEC and the New York State Insurance Commission– placed him at AIG to review potentially fraudulent AIG-FP transactions.

Cole, of course, has now been nominated to serve as the Deputy Attorney General at DOJ, where he would help to decide who should and should not be prosecuted. Cole does not appear to be the ideal candidate for this slot, based on his performance at AIG.

Bea Edwards is the International Reform Director for the Government Accountability Project, the nation's leading whistleblower advocacy organization.

On Sunday, June 27^th, the G-20 Toronto meeting of heads of government issued a declaration in which anti-corruption initiatives figured strongly. The leaders recognized that corruption, particularly in the financial services sector, had played a significant role in bringing on the economic crisis of 2008/2009.

We agree that corruption threatens the integrity of markets, undermines fair competition, distorts resource allocation, destroys public trust and undermines the rule of law.

 

In addressing the relationship between strong anti-corruption measures and the health of the international financial system, the G-20 placed an emphasis on the importance of whistleblowers and set out the intention to cooperate in international efforts to protect those who stand up against corruption.

The declaration made specific reference to the UN Convention Against Corruption, which calls upon signatories to take active steps to shield witnesses from retaliation when they disclose corruption and fraud. Article 32 is explicit in assigning to member countries of the United Nations an obligation to provide for the physical safety of whistleblowers and victim/witnesses, as well as for their protection from “unjustified treatment,” i.e. reprisal.

Article 32. Protection of witnesses, experts and victims

1. Each State Party shall take appropriate measures in accordance with its domestic legal system and within its means to provide effective protection from potential retaliation or intimidation for witnesses and experts who give testimony concerning offences established in accordance with this Convention and, as appropriate, for their relatives and other persons close to them.

 

Article 33. Protection of reporting persons

Each State Party shall consider incorporating into its domestic legal system appropriate measures to provide protection against any unjustified treatment for any person who reports in good faith and on reasonable grounds to the competent authorities any facts concerning offences established in accordance with this Convention.

 

In the run up to the Toronto G-20, the US Congress agreed on a financial regulatory reform that also includes strong whistleblower protection at the US Securities Exchange Commission (SEC). The new legislation is designed to “encourage” whistleblowers because it:

Creates a program within the SEC to encourage people to report securities violations, creating rewards of up to 30% of funds recovered for information provided.

As we examine more closely the circumstances in the US financial services sector and its offshore franchises that preceded the meltdown of banks, investment firms and credit markets in 2008, we can see how important an early warning system could have been. In the banking and insurance sectors it is clear that as early as 2005, many experts realized that the coming collapse was only a matter of time – a question of “when” and not “if.” As the world’s political leaders assess global efforts to recover from the economic crisis, it is encouraging to note that the US financial reform package and the G-20 Declaration of the heads of government are recognizing the centrality of whistleblowers to maintaining stability in the financial system. Cooperation, not just among governments, but also among governments and international financial institutions, is essential to strengthening the recovery and ensuring that crises like the most recent one cannot recur.

Bea Edwards is the International Reform Director for the Government Accountability Project, the nation's leading whistleblower advocacy organization.

For the past two months, GAP has criticized the nomination of James Cole to be Deputy Attorney General at the Justice Department (DOJ). We have argued that because Cole, who served as Independent Consultant at AIG during the critical time period from 2005 through 2009, missed clear signals of malfeasance, he is unsuited to serve as the second-in-command at the DOJ.

Last week, after four senators requested Cole’s reports to DOJ about AIG, prior to deciding on his nomination, a DOJ spokeswoman defended Cole’s role at AIG, telling Main Justice that

Critics who suggest that Mr. Cole was somehow too close to AIG misunderstand his relationship with the company,” …. “His presence was imposed on the company by a federal court. In fact, as the [Congressional Research Service] report notes, AIG executives tried to have him removed.

“[Cole] was never a general overseer or monitor of AIG’s entire operation nor was he assigned to examine many of the issues involving AIG’s near collapse, such as credit-default swaps or retention bonuses…”

This statement did more to obscure Cole’s role at AIG than to clarify it. First, although it’s true that in late 2008, Chief Compliance Officer Suzanne Folsom mounted an effort to remove Cole, it was not because he was insisting on a tough compliance regime. Folsom wanted him out because he was pocketing too much AIG money. His costs, as Independent Consultant, included not just the $20 million paid to his law firm, but tens of millions more for the consultants, who, we understand, were both expensive and incompetent.

A substantial part of the consulting fees apparently went to DLA Piper, the law firm where Anastasia Kelly, AIG General Counsel, parked herself in 2010, after fleeing AIG in order to avoid pay caps imposed by the TARP regulations.

Second, although it’s also true that Cole was not a general overseer of AIG, he failed to object when Folsom dismissed half the team that was working on compliance and oversight just after AIG had to be rescued by taxpayers in 2008. Many of these people had written to the board and to the CEO to expose AIG’s weak compliance program before the meltdown. When Cole did finally interview them, he acceded to Folsom’s demand that she or her designee be present to observe the conversations. This collaboration is simply inconsistent with the responsibility of an independent monitor.

Third, it’s also true that Cole did not monitor many of the issues which sank the AIG balance sheet, most of which were trades arranged in AIG-FP. But as we pointed out earlier, Cole himself made the decision to exempt the problem division from his oversight (p.87).

Fourth, Cole was assigned under the 2004 deferred prosecution agreement to review five years of transactions effected by the problem division, AIG-FP. This assignment would specifically have included credit default swaps as well as other fraudulent maneuvers designed to conceal liabilities.

Finally, no one has suggested that the retention bonuses paid in 2009 were involved in AIG’s near collapse. The bonuses were paid after the collapse, and critics questioned the propriety of paying bonuses to those responsible for the crisis. More cynical critics have instead suggested that the putative ‘retention bonuses’ were, in fact, hush money, since a number of people who received them have left the firm. Critics are also wondering if the second round of retention bonuses was paid in 2010.

 

The Senate Judiciary Committee held James Cole’s confirmation hearing yesterday morning for the post of Deputy Attorney General. It was not exactly an aggressive interrogation. Democratic members of the committee sought Cole’s commitment to continuing the reforms at the heretofore highly politicized Justice Department (DOJ), and Republican committee members wanted assurances that Cole, as the new Deputy Attorney General, would not guarantee Miranda rights to suspected terrorists. There were three or four allusions to Cole's role as an independent monitor at AIG in the years leading up to the financial crisis that brought the company down and wrecked the US economy, but no specific questions were forthcoming. Not from anyone.

In fact, the entire proceeding had the feel of a pro forma procedure along the way to confirming James Cole to be the second-in-command at DOJ. There were various ironic moments, however. For one thing, a number of senators sought assurances from Cole that he would hold BP accountable for the damage now being sustained by states along the Gulf coast as a result of the ongoing oil spill. For his part, Cole guaranteed that, if confirmed, he would make every effort to extract compensation from BP for those whose livelihoods were endangered by the thickening and widening slick of scum.

Asking Cole about corporate accountability in the BP case is like asking “Brownie” how he would handle another hurricane in New Orleans. It’s beside the point. Cole has a five-year record of responsibility for corporate oversight and compliance at AIG, where he failed to hold either individual managers or the corporation itself accountable for the catastrophe they visited upon US credit markets. In throw-away comments at yesterday’s hearing, Cole assured the committee that as Deputy Attorney General he would dedicate himself to combating mortgage fraud and financial fraud. When he made this statement, neither he nor his questioner (Senator Ted Kauffman, D-De.) made any reference to his recent past at AIG, where the Financial Products Corporation encumbered the corporate balance sheet with tens of billions of dollars in worthless real estate bonds as Cole looked the other way.