Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431.
This opinion is uncorrected and subject to revision before publication in the Official Reports.
Gonzalez, P.J., Tom, Saxe, Catterson, Richter, JJ.
Order, Supreme Court, New York County (Charles E. Ramos, J.), entered October 21, 2010, which, to the extent appealed from, denied defendants Maurice R. Greenberg's and Howard I. Smith's motions for summary judgment dismissing the Martin Act (General Business Law § 352-c[a] and [c]) and Executive Law § 63(12) claims as against them, and granted the Attorney General's motion for summary judgment on the issue of liability with respect to one of two challenged transactions, modified, on the law, to deny the Attorney General's motion, and otherwise affirmed, without costs. Introduction
The Attorney General brought this action against American International Group (AIG), its former CEO (Maurice R. Greenberg) and its former CFO (Howard I. Smith) alleging that defendants violated Executive Law § 63(12) and the Martin Act based upon their role in fraudulent transactions designed to portray an unduly positive picture of AIG's loss reserves and underwriting performance. AIG, formerly the largest insurance company in the world, entered into a settlement agreement with the Attorney General with respect to these and other claims, paying over $1 billion in damages and penalties. The details of the challenged transactions are as follows. The GenRe Transaction
In the third quarter of 2000, AIG reported that its loss reserves (funds set aside to pay future claims on policies) had declined by $59 million from the previous quarter, while its net premiums increased by 8.1%. In the industry, this could be viewed as an indication of a company's deteriorating financial condition. In an effort to shore up its loss reserves, Greenberg called Ronald Ferguson, the CEO of General Reinsurance Corporation (GenRe), to discuss the possibility of AIG's entering into a loss portfolio transfer (LPT) involving "finite reinsurance" with GenRe. Greenberg testified at his deposition that he made the call in October 2000, based upon his concerns about AIG's loss reserves. He testified that he remembered inquiring about borrowing some of GenRe's reserves through an LPT. He did not remember the details of the conversation but testified that he told Ferguson that AIG would pay GenRe if it was willing to accommodate the request.
After the conversation, Ferguson designated Richard Napier, a senior GenRe executive, to handle the details from GenRe's end. Greenberg appointed Chris Milton, a senior vice president at AIG and the head of reinsurance, to work out the details for AIG.
Greenberg testified that he had a second telephone conversation with Ferguson in November 2000 and that Ferguson told him that GenRe could provide AIG the product it had requested. Greenberg also testified that he had contemporaneous discussions with Milton and Smith concerning the GenRe transaction, but denied any knowledge of its fraudulent nature. Smith testified at his deposition that Milton advised him of the general terms of the GenRe deal. The actuaries testified that Smith was responsible for recording the transaction. Moreover, Smith participated in the meeting regarding commuting the GenRe transaction from an LPT to profits. Although AIG's underwriting practices required internal actuarial review of any proposed insurance agreement over $20 million, no underwriting analysis of the GenRe transaction was directed or performed.
The draft contract between AIG and GenRe provided, in general terms, that GenRe would pay AIG $10 million to assume a specified amount of risk, namely $100 million for six to nine months. The premium was $500 million on a 98% funds withheld basis, meaning that GenRe could charge AIG only for losses beyond the $500 million premium (up to a $600 million cap on losses).
The Attorney General alleges that the $100 million loss exposure was illusory, that at least half of the contracts covered by the GenRe transaction had already been reinsured by other carriers and thereby carried no risk to AIG, and that AIG and GenRe had separately agreed that, for accommodating AIG in its request to structure the transaction as no risk, GenRe was paid a $5 million fee, and the $10 million premium payment was secretly returned to GenRe through other, unrelated agreements. In his deposition in this litigation, Napier testified that the parties "involved" in the separate side deal included Greenberg, Ferguson, and Milton. Greenberg denied knowledge of both the no-risk nature of the GenRe transaction and the side deal concerning the fee and the return of the premium.
According to generally accepted accounting principles, an LPT can only be recorded as loss reserves if the risk insured exceeds a 10% chance of a 10% loss. If, as the parties presently concede, there was no risk of loss in the GenRe transaction, it should have been recorded on AIG's financials as a deposit. Instead, AIG recorded $250 million in loss reserves for the fourth quarter of 2000 based upon the GenRe transaction and an additional $250 million in loss reserves for the first quarter of 2001, consistent with Greenberg's intent when he reached out to Ferguson, to shore up the reserves. Had these amounts not been credited in this manner, AIG would have had a $187 million decline in its loss reserves by the first-quarter of 2001. In a press release regarding AIG's 2001 first-quarter financial picture, Greenberg is quoted as being pleased with a number of favorable financial indicators, including the reversal of the loss reserve declines.
In 2001, 2002, and 2003, Greenberg and Smith certified AIG's 10-K financial disclosure reports with the SEC, each year recording the $500 million from GenRe as loss reserves. In 2003 and 2004, Greenberg participated in decisions regarding characterizing the GenRe transaction, and, in late 2004, $250 million was commuted to profits.
In early 2005, AIG received subpoenas from the Attorney General and the SEC for information regarding the GenRe transaction. AIG retained outside counsel to perform an internal investigation, and Pricewaterhouse Coopers (PwC), the auditor, initiated an expanded audit to review AIG's prior financials and certain transactions. Barry Winograd, the PwC partner in charge of the audit, testified at his deposition that he had frequent contact with Greenberg throughout the investigation and that Greenberg was particularly interested in PwC's findings with respect to GenRe.
In March 2005, AIG issued a press release admitting that the GenRe transaction documentation was improper, stating that in light of the lack of evidence of risk transfer, the transactions should have been recorded as deposits. Defendants subsequently resigned their positions as CEO and CFO of the company. On May 31, 2005, following defendants' departures from AIG, the company's new management filed AIG's 10-K for 2004, restating the financials submitted from 2000 to 2004. In the restatement, AIG explained that "[GenRe] was done to accommodate a desired accounting result and did not entail sufficient qualifying risk transfer. As a result, AIG has determined that the transaction(s) should not have been recorded as insurance."
In June 2005, two GenRe executives pleaded guilty to participating in a conspiracy to commit securities fraud for their role in the GenRe transaction. In February 2008, four other GenRe executives were convicted on federal criminal charges with respect to the GenRe transaction. Those convictions were reversed upon evidentiary errors and the case was remanded for a new trial (see United States v Ferguson, 553 F Supp 2d 145 [D Conn 2008], revd __ F3d __, 2011 WL 6351862, 2011 US App LEXIS 26115 ). The Capco Transaction
Beginning in the early 1990s, various AIG subsidiaries were writing auto warranty insurance policies. In late 1999, an actuarial consultant retained by AIG concluded that the company was facing an underwriting loss ratio of 265% in this area. At his deposition, Greenberg admitted that AIG's auto warranty business up until the late 1990s "was not handled properly," that he was annoyed about the situation, and that he may have referred to the situation as a "debacle." Greenberg also admitted giving specific instructions to Charles Schader, about reforming the auto warranty business, and testified that he had regular calls with Schader, and other employees, about his concerns, including on weekends. These calls concerned "everything from ... consultation of outstanding contracts and policies, claims handling, and mitigation of loss."
Greenberg also testified that he directed an internal audit of AIG's auto insurance business to review the auto warranty business and to explore ways to mitigate projected losses. The parties do not dispute the details of the transaction structured to meet these objectives between AIG and Capco Reinsurance Company, Ltd. (CAPCO), an offshore shell company controlled by AIG. AIG, which did not treat CAPCO as a consolidated entity on its financial statements, sold shares in the shell company over time so as to trigger recognition of $162.7 million in capital losses (which the investing public would not deem as significant to the company's financial well-being). The amount corresponded to AIG's payment of over $183 million in underwriting losses.
Both Greenberg and Smith defended their approval of the CAPCO transaction, testifying that Joseph Umansky, the Senior Vice President of AIG, had assured them that it would be structured to properly comply with all legal, accounting, and regulatory guidelines. By contrast, the Attorney General claims that Smith directed Umansky to develop a transaction to convert underwriting losses into capital losses, that both defendants received an April 2000 memo from Umansky proposing the CAPCO deal, and that Greenberg personally directed Umansky to contact the president of an AIG private bank in Switzerland to locate outside investors to buy the CAPCO common stock. After Greenberg and Smith left the company in 2005, AIG announced that CAPCO involved an improper structure created to characterize underwriting losses relating to the auto warranty business as capital losses. Procedural History
In September 2009, the Attorney General, Greenberg and Smith all filed motions for summary judgment. The motion court denied Greenberg's and Smith's motions in their entirety. It granted the Attorney General's motion in part, finding that Greenberg and Smith's knowledge and participation in the CAPCO transaction constituted a violation of the Martin Act and Executive Law § 63(12) as a matter of law. Greenberg and Smith each appeal from the denial of their motions and the partial grant of the Attorney General's motion. The Attorney General appeals from the portion of its motion that was denied. Appellate Contentions
The issues before us include (1) whether the action is preempted by federal law; (2) whether the court properly denied defendants' motions for summary judgment regarding the GenRe transaction; and (3) whether the court properly granted the Attorney General summary judgment on liability regarding the CAPCO transaction. Preemption
The Supremacy Clause of the United States Constitution provides that the laws of the United States "shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding" (US Const, art VI, cl 2). This broad language gives Congress the power to supersede State statutory, regulatory and common law (People v First Am. Corp., 18 NY3d 173, 179 ; Guice v Charles Schwab & Co., 89 NY2d 31, 39 , cert denied 520 US 1118 ). Preemption can arise by: (i) Congress's express preemption; (ii) Congress establishing a comprehensive regulatory scheme in an area effectively removing the field from the state's realm; or (iii) an irreconcilable conflict between federal and state law (Matter of People v Applied Card Sys., Inc., 11 NY3d 105, 113 , cert denied 555 US 1136 , citing Balbuena v IDR Realty LLC, 6 NY3d 338, 356 ). The United States Supreme Court has instructed that, in determining whether federal law preempts state law, a court's "sole task is to ascertain the intent of Congress" (California Fed. Sav. & Loan Assn. v Guerra, 479 US 272, 280 ; see also Medtronic, Inc. v Lohr, 518 US 470, 485  ["(T)he purpose of Congress is the ultimate touchstone in every pre-emption case"] [internal quotation marks omitted]; Matter of People v Applied Card Sys., Inc., 11 NY3d at 113).
Defendants argue that this action is precluded by the express language of Title I of the Securities Litigation Uniform Standards Act of 1998 (SLUSA) (15 USC § 78bb[f] and ). They also claim that the claims asserted by the Attorney General conflict with Congress's intent to create a uniform federal standard for securities litigation as evidenced by governing securities litigation, namely, the Private Securities Litigation Reform Act of 1995 (PSLRA)( 15 USC § 77z-1), the National Securities Markets Improvement Act of 1996 (NSMIA)(15 USC § 77r) and SLUSA, and the cases which construe these statutes. However, nothing in the language or legislative history of the cited legislation indicates Congress intended to preempt this civil enforcement action under the Martin Act and the Executive Law (People v Applied Card Sys, Inc., at 115). In fact, the cited statutes, their legislative histories and the caselaw presuppose an important role for state Attorneys General in investigating fraud and bringing civil actions to enjoin wrongful conduct, vindicate the rights of those injured thereby, deter future fraud, and maintain the public trust.
The NSMIA, codified at 15 USC § 77r(a)(2)(b), expressly preempts any state law that "directly or indirectly prohibit[s], limit[s], or impose[s] any conditions upon the use of ... any proxy statement, report to shareholders, or other disclosure document relating to a covered security" registered under 15 USC § 78o-3.
As the motion court stated, the purpose of NSMIA is to preempt any state Blue Sky Laws that would require the issuers of securities to comply with certain state registration requirements prior to marketing in the state, in recognition of the redundancy and inefficiency of such requirements (see Zuri-Invest AG v NatWest Fin., Inc., 177 F Supp2d 189, 192 ). Accordingly, NSMIA precludes states from imposing their own requirements for disclosure on prospectuses, traditional offering documents, and sales literature relating to covered securities (id.).
However, a savings clause in the NSMIA permits states to retain jurisdiction to police fraudulent conduct: "Consistent with this section, the securities commission (or any agency or office performing like functions) of any State shall retain jurisdiction under the laws of such State to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by a broker or dealer, in connection with securities or securities transactions" (15 USC § 77r[c] [emphasis added]). The legislative history of NSMIA confirms Congress's intent "not to alter, limit, expand, or otherwise affect in any way any State statutory or common law with respect to fraud or deceit ... in connection with securities or securities transactions" (House Report of Committee on Commerce, HR Rep 104-622, 104th Cong., 2d Sess., 34 , reprinted in 1996 U.S.C.C.A.N. 3877, 3897).
The PSLRA was enacted in 1995 to set uniform federal standards for private plaintiffs seeking to bring actions against issuers of publicly traded securities. Because the PSLRA set heightened pleading standards for cases brought in federal court, the statute had the unintended effect of what Congress termed a "migration" of frivolous class action securities litigations to state court, undermining PSLRA's aim [*fn1]. Accordingly, in 1998, Congress passed SLUSA, which provides, as relevant, that "[n]o covered class action based upon the statutory or common law of any State or subdivision thereof may be maintained in any State or Federal court by any private party alleging . . . a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security" (15 USC § 78bb[f]).
Defendants argue that SLUSA preempts this action because the state Attorney General is seeking, in a de facto representative capacity, to litigate claims on behalf of a "covered class" of AIG investors seeking to recover for their financial losses, in frustration of the legislation's intent to create uniform federal standards for such litigation. However, this is not a shareholder derivative lawsuit, and in fact, there is such an action presently pending in federal court against defendants.[*fn2] Rather, after years of joint federal and state investigation, the Attorney General exercised the discretion of his office to bring this enforcement action pursuant to the Executive Law and the Martin Act, to protect the citizens of this State and the integrity of the securities marketplace in New York, to enjoin allegedly fraudulent practices, and to direct restitution and damages to deter future similar misconduct (see People v Applied Card ...