ANALYSIS:The probity of the Irish regulatory system has been hit by a case of reinsurance fraud, writes JUSTIN O'BRIEN.
‘YOUR HONOUR, I would just like to say I am sorry. From the bottom of my heart, I would like to apologise to anyone who has suffered as a result of the transaction.” With these words and what prosecutors described as “truly extraordinary” co-operation, one of the most notorious figures in reinsurance escaped jail in the United States this week.
John Houldsworth, the former chief executive of Cologne Re in Dublin, was once one of the world’s most experienced financial engineers. He played a central role in developing the reinsurance industry in Ireland. As chairman of the Dublin International Insurance and Management Association, his declared aim was for the Irish capital to displace Bermuda as the global headquarters of the reinsurance industry.
But increased market share in a competition for regulatory laxity came at an enormous cost. Houldsworth’s alchemy played a significant role in destroying the international reputation of the IFSC and the probity of the broader Irish regulatory framework.
Houldsworth was centrally involved in executing two retrocession reinsurance contracts through his Dublin office that artificially inflated the earnings of American International Group (AIG) in 2000 and 2001. Once the biggest insurance company in the world, AIG is now a ward of the US taxpayer, kept afloat through capital injections of more than $150 billion (€107 billion).
At the time, AIG needed to demonstrate to investors that it had sufficient loss reserves. To do this it orchestrated a series of sham transactions. The transactions were retrocession contracts, the reinsurance of reinsurance. It appeared that AIG would receive $500 million in premiums. In reality, General Re was provided with a $5 million payment. The transactions had no economic substance. They were designed to, and did achieve, an accounting sleight of hand.
Houldsworth executed the transactions through the alternative solutions unit of General Re, in which he served as chief underwriter. Houldsworth was neither naive nor misled. In an e-mail to General Re staff he noted the importance of retaining secrecy: “Note to all – let’s keep the circle of people involved in this as tight as possible.”
In addition, he directed that the file be kept in a locked drawer, with permission to review dependent on his authorisation or that of the chief executive of Cologne Re in Germany.
Electronic records show that Houldsworth was aware that AIG intended to mislead the market. He noted that he “would be staggered if they got away with it”. This did not prevent him or his firm from executing the transaction.
Houldsworth’s downfall came when the US Securities and Exchange Commission and the US Department of Justice were alerted and began investigating accounting irregularities within AIG. Faced with the possibility of 20 years’ imprisonment, Houldsworth opted to co-operate.
His testimony helped secure the convictions of five senior colleagues within General Re. Among those now in jail are the chief executive of General Re, Ronald Ferguson, and its chief financial officer, Elizabeth Monrad.
District Judge Christopher Droney, in Hartford, Connecticut, praised the former executive for helping “the government and ultimately the jury understand the nature and depth of the fraud, and its concealment”.
In sentencing him to two years’ probation and 400 hours of community service, the judge said he hoped Houldsworth would set an example for other executives to “blow the whistle” on market fraud.
Although Houldsworth declined to comment, his lawyer, Lance Croffoot-Suede, claimed “this sort of deal was not uncommon. The reinsurance companies were merely doing what was asked of them. It’s easy to see that John did something wrong. I think he would do everything in his power to roll back the tape, as it were.”
The evidence of remorse is, at best, partial.
Houldsworth had earlier conducted a similar scam for FAI in Australia. FAI’s acquisition by HIH Insurance, which was concluded on the basis of the flawed overvaluation, led to the latter’s collapse. The failure of HIH prompted a Royal Commission of Inquiry. Houldsworth refused to give evidence. He was subsequently banned from operating in the Australian marketplace.
Despite this, Houldsworth continued to operate with impunity in Dublin. The Financial Regulator did not send a representative to the Australian Royal Commission, citing, somewhat implausibly, budgetary restraints. Instead, it relied on an internal investigation provided by Cologne Re’s own lawyers.
It is arguable that if more effort had been placed on understanding how Houldsworth operated, his deviance could have been curtailed. Here responsibility lies not only in Dublin but also in Washington and New York.
This week the Obama administration announced what it termed the most sweeping reform of financial regulation since the New Deal. One of the most controversial elements is the authorisation for the Securities and Exchange Commission to establish a fund to pay whistleblowers for giving evidence.
The evidence from the Houldsworth case, however, is that remorse is an insufficient driver. He only came forward when faced with the might of the Department of Justice. This suggests that the threat and delivery of aggressive enforcement drives compliance.
US prosecutorial imperatives, however, flatter disproportionately those who capitulate first. The infamous insider trading scandal that engulfed the auction houses Sotheby’s and Christie’s in 2001 demonstrate the iniquities of the system. The socially inept chairman of Sotheby’s, Alfred Taubman, took the fall for a cartel arrangement orchestrated, largely, by his rivals at Christie’s, who evaded responsibility by co-operating.
Unfortunately, the lesson emanating from the court in Hartford is that corporate crime does pay. Given the reputational damage that Houldsworth and his ilk have caused, it is a lesson that Ireland has a moral and legal duty to learn from.
Justin O’Brien is a research professor at the faculty of law and faculty of business, Queensland University of Technology.
His book on the global financial crisis, Engineering a Financial Bloodbath, is published this month by Imperial College Press