Feds Rope AIG Into Subprime-Related Probe

[WSJ_law_blog]

If AG Michael Mukasey wants to leave mortgage-related prosecutions to local law enforcers (click here), he can rest assured that a veritable alphabet soup of federal law enforcers is on the case. The WSJ’s Amir Efrati and Liam Plevin are reporting that the SEC is investigating whether insurer AIG, which settled an accounting scandal for $1.6 billion in 2006, overstated the value of contracts linked to subprime mortgages. And that’s not all: the DOJ and EDNY have reportedly told the SEC they want information the agency is gathering in its AIG investigation, meaning a criminal investigation could be in the offing.



Officials for AIG, the SEC, the DOJ and the EDNY declined to comment on the new probe.

At issue is the way the company valued credit default swaps, which are contracts that insure against default of securities, including those backed by subprime mortgages. In February, AIG said its auditor had found a “material weakness” in its accounting.

As the WSJ explains, AIG sold credit default swaps to holders of investments called collateralized-debt obligations, or CDOs, backed in part by subprime mortgages. The buyers were protecting their investments in the event of default on the underlying debt. In question is how the CDOs were valued, which drives both the value of the credit default swaps and the amount of collateral AIG must “post,” or essentially hand over, to the buyer of the swap to offset the buyer’s credit risk.

AIG has said valuing its swap portfolio has been difficult because of severe problems in the credit markets, and that its methodologies have evolved. Defense lawyers in general say difficulties in valuing complex securities can be a company’s best defense.

In its most recent quarterly filing, AIG said that in some cases, its counterparties in some of the swap contracts made valuation estimates that “differed significantly” from the company’s. AIG said that in “almost all cases” its financial products unit has been able to resolve the issues.