AIG’s sub-prime losses spur probe

Regulators are examining American International Group Inc.’s accounting practices after derivatives tied to sub-prime mortgages led to record losses at the world’s largest insurer.

The Securities and Exchange Commission and the Justice Department are probing the way AIG valued credit-default swaps that wiped out profit for two quarters, the New York-based insurer said Friday. AIG had downplayed the potential for losses in December, then said Feb. 11 that its auditor had found a “material weakness� in its accounting for the financial instruments.

AIG shares fell 6.8% on Friday, leading the 3.1% decline in the Dow Jones industrial average. Two years after the insurer agreed to pay $1.64 billion to settle state and federal probes of reinsurance accounting and sales practices, it joins a growing list of firms facing government scrutiny over losses tied to sub-prime mortgages.

Regulators may examine whether the weakness found by auditors “could’ve been corrected and whether it may have been permitted to exist because it was beneficial,� said Jacob Frenkel, a Maryland attorney and former federal prosecutor. “Still, the existence of an inquiry, even involving a high-profile company, doesn’t mean that the SEC must bring an enforcement action.�

SEC spokesman John Nester declined to comment.

AIG shares fell $2.48 to $33.93. The company has lost more than half its market value in the last 12 months, and Chief Executive Martin Sullivan is facing lawsuits from investors claiming that he misled them about the potential damage from the credit-default swaps.

AIG shares plunged 12% on Feb. 11, the biggest one-day drop in two decades, when the company disclosed the accounting weakness and said its swaps had declined by $4.88 billion in October and November. The instruments are based on bonds and loans and are used to speculate on a borrower’s ability to repay debt.

Sullivan told investors at a Dec. 5 conference that write-downs from the U.S. housing market would be “manageable.� That same day, Joseph Cassano, head of the company’s unit selling credit-default swaps, said the contracts declined by $1.1 billion in the first two months of the fourth quarter. “The effectiveness of our risk-management efforts will show through in our results,� he said.

Cassano later stepped down, and the write-downs have since triggered net losses of $5.29 billion for the fourth quarter and $7.81 billion for the first quarter.

An SEC task force has opened more than three dozen inquiries tied to sub-prime home loans. Merrill Lynch & Co., Goldman Sachs Group Inc., Morgan Stanley and others have said they are cooperating with regulators.

The 2006 settlement with the SEC and then-New York Atty. Gen. Eliot Spitzer covered claims that AIG misstated its accounting, faked bids on policies and cheated workers’ compensation programs.