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AIG Brightpoint. By Youjung Byon Edward Urban Tim Nguyen. The case of AIG Brightpoint centers on the idea of “roundtripping.”

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Aig brightpoint
AIG Brightpoint

By Youjung Byon

Edward Urban

Tim Nguyen


Art of roundtripping

The case of AIG Brightpoint centers on the idea of “roundtripping.”

According to the PWC fraud report, roundtripping involves “transactions between companies for which there is no economic benefit for either company because there is an equal revenue and cost element.”

Other companies involved in roundtripping consist of Enron, Dynegy, and Qwest.

Art of Roundtripping


Company info

Brightpoint “roundtripping.”

Distributor of cell phones.

Total Assets: $336 Million

Revenue: $1.2 Billion

Company Info

  • American Int. Group (AIG)

    • Largest US-based international insurance organization.

    • Total Assets: $621 Billion

    • Revenue: $4.2 Billion


What happened
What Happened? “roundtripping.”

  • Oct 1998: Brightopint publicly announce $13M - $18M loss

  • Dec 1998

    • Actual loss: $29 Million

    • Delaney and Harcharik negotiate with the Loss Mitigation Unit(LMU) of National Union Fire Insurance

    • LMU offered “insurance” to “smooth” the loss (Follow the White Paper)


Policy
Policy “roundtripping.”

  • Limit A: “retroactive coverage” fully pre-funded by Brightpoint.

  • Limit B: Prospective fidelity coverage

  • Finalized in Jan 1999, dated Aug 1998

  • Enabled Brightpoint to record an insurance receivable of $11.9M, bringing net loss to within the $13M-$18M range


Payment plan
Payment Plan “roundtripping.”

  • Goal: Avoid the auditors from realizing the $15.3M sum

  • Three Part, 3-yr Plan

    (1) Initial Payment: $199,200

    (2) 32 MonthlyPayments of $237,600 from Jan 1999 through Aug 2001

    (3) Letter of Credit: $7.5M


Gain from the deal

AIG “roundtripping.”

$100,000 for putting the deal together

$202,400 in premium for Limit B

Gain from the Deal

  • Brightpoint

    • Overstate net income by 61% in 1998

    • Smooth $29M loss over 3 yrs


What was wrong with the policy
What was wrong with the Policy? “roundtripping.”

  • Limit A: Not an insurance, Not a loan arrangement, but a mechanism to deposit money

  • Limit B: Coverage for Limit A

  • Backdated

  • No trasnfer of risk

  • Fake letter of confirmation from AIG to Brightpoint's auditor

  • Allow Brightpoint to overstate its net income

  • Fundamental Problem: White Paper


Aftermath
Aftermath “roundtripping.”

  • Brightpoint: $450,000 civil fine

    • Delaney (Controller)

      • $100,000 fine

      • Permanent bar from serving as officer/director of any public company

    • Harcharik (Dir of Risk Mangt): Resigned

    • Bounsall (CEO): $450,000 fine for recklessness

  • AIG: $10M civil fine

    • Forfeit $100,000 fee paid by Brightpoint

    • Lucello (Assist. VP): Resigned


How was the fraud detected
How Was The Fraud Detected? “roundtripping.”

  • In October 2001, the SEC sent a formal inquiry to Brightpoint’s auditors, Ernst & Young.

  • Auditors determined the policy was non-traditional, retroactive coverage and required Brightpoint to restate 1998 earnings by the full value of premiums paid – $15.3M.

  • In January 2002, auditors learned Brightpoint had cancelled the policy and received a full refund in the amount of premiums paid. Fraud became apparent.

  • Brightpoint was required to restate 1998 earnings a second time, reflecting the “premiums” as deposits.


What went wrong
What Went Wrong? “roundtripping.”

  • Brightpoint’s senior managers responsible for internal controls (Chief Accounting Officer and Director of Risk Management) lacked integrity.

  • CEO and CFO of Brightpoint were either complicit in the fraud or irresponsible in their questioning of the results of the UK operation.

  • AIG actively marketed deceptive insurance products designed to manage reported earnings.

  • Auditors faced great difficulty in uncovering side-agreements. Round-trip transaction obscured by clauses designed to appear as legitimate risk transfer.


Who violated what
Who Violated What? “roundtripping.”

  • In Violation of Rule 10b-5 = Brightpoint, AIG, Delaney, & Harcharik

  • In Violation of Rule 17(a) = Brightpoint & Delaney

  • In Violation of Rule 13(a) = Brightpoint & Delaney

  • In Violation of Rule 13(b)(2) = Brightpoint

  • In Violation of Rule 13b2-1 = Brightpoint, Bounsall, Delaney, & Harcharik

  • In Violation of Rule 13(b)(5) = Delaney & Harcharik

  • In Violation of Rule 13b2-2 = AIG, Delaney, & Harcharik


Prevention the double headed hydra
Prevention: The Double Headed Hydra “roundtripping.”

Brightpoint

  • Delaney = He is a licensed CPA in the state of Ohio. He served as Corporate Controller & Chief Accounting Officer since June 1996.

  • Harcharik = He was an Independent Contractor, serving as Brightpoint’s Director of Risk management since June 1997.

  • Bounsall = He is a CPA. He served as Brightpoint’s EVP and Chief Financial Officer & Treasurer since October 1996.

    AIG—specifically the Loss Mitigation Unit (“LMU”) of National

    Union Fire Insurance Company of Pittsburgh, a subsidiary of AIG

  • Lucollo = He is an Assistant Vice President involved of Risk Management.


The lmu white paper
The “LMU White Paper” “roundtripping.”

  • Paper disseminated to 32 management level AIG and National Union employees in October 1997, including National Union’s President, the President of AIG’s Financial Lines Claims Division, and 2 other senior officers.

  • Paper provided a guide on how to treat accounting and regulatory issues in LMU products designed to “smooth” earnings and income.

  • Paper outlined artfully principal “attributes” of non-traditional insurance.

  • Paper acknowledged openly that the current accounting rules were specifically designed to avoid “income smoothing” techniques & effects.

  • Paper required that measures should be done in an oral side agreement.


Lmu white paper continued
“LMU White Paper” Continued… “roundtripping.”

  • AIG advertised these “income smoothing” products to AIG’s various divisions and regions on a large scale

  • AIG marketed products directly to third parties.

  • Marketing materials proudly touted the following benefits:

    1) “Smoothing of expenses over several operating quarters, allowing a company to avoid a one-time charge resulting in the dilution of earnings” [; and]

    2) “Favorable disclosure or potential elimination of disclosure requirement, which can mitigate or even eliminate potential lawsuits”

  • Brightpoint strictly followed this blueprint.


Prevention aig
Prevention: AIG “roundtripping.”

  • Company has designed a unit and allocated intellectual and economic resources to circumvent existing accounting rules.

  • Corporate policy outlined ways and methods of circumventing existing accounting rules through what is known as the “LMU White Paper” (See next slide for in-depth discussion)

    • Recommendation: Having units, like the LMU, designed for the sole purpose of “smoothing out corporate earnings or income” should be dismantled and discouraged.

  • Transaction was carried out orally.

    • Recommendation: All transactions require paper trails.


Prevention brightpoint
Prevention: Brightpoint “roundtripping.”

  • Seniors were involved.

    • Recommendation: (1) Corporate Governance Issues, (2) Linking incentives to fraud-prevention

  • This transaction was done orally.

    • Recommendation: All transactions must require paper trail.

  • Bounsall negligently approved transaction without reviewing any written documents and examining the Binder (the Policy) itself

    • Recommendation: Perhaps this is an HR issue. Need to find quality individuals who are serious and care about their job.


Questions
Questions “roundtripping.”


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