Last Update: 4:00 AM ET Apr 2, 2005

SAN FRANCISCO (MarketWatch) — Reports that an American International Group employee destroyed company records put the giant insurer in even deeper legal trouble, experts said.

New York Attorney General Eliot Spitzer, the Securities and Exchange Commission and the Department of Justice are investigating AIG’s AIG -0.86% use of complex reinsurance transactions to manipulate its financial statements.

The probes precipitated the departure of longtime AIG Chief Executive Maurice “Hank” Greenberg and this week forced the company to admit to a series of accounting improprieties that may wipe $1.77 billion off its net worth.

However, a Wall Street Journal report Friday that an AIG employee destroyed computer records and tapes of business meetings at the company’s Bermuda offices has changed everything. See full story on WSJ.com.

“Destruction of documents is very, very serious and has enormous repercussions both for a company and for how its officers and directors will be treated,” Harvey Pitt, former chairman of the SEC, said Friday. “It’s the worst thing anyone can do in an evolving investigation because you lose virtually all of your credibility with the government.”

Pitt, who now runs corporate governance consultant Kalorama Partners, said he was speaking about general issues only and couldn’t comment on AIG’s situation specifically.

When he headed the SEC, Pitt said he told the agency’s staff that anyone found to have destroyed evidence or lied during an investigation should be dealt with “harshly.”

“When people lie to the SEC or destroy documents they imperil the entire regulatory and enforcement system,” he said. “This type of action nullifies the commission’s ability to find out what happened and figure out the most appropriate actions.”

If the report turns out to be true, government prosecutors will be able to charge the company and any people involved with the criminal offense of obstruction of justice, legal experts said.

That’s a lot easier than trying to prove the way AIG accounted for complex reinsurance deals was fraud, they explained.

“Prosecutors’ eyes light up like a Christmas tree when evidence of this type of wrongdoing falls in their laps,” Andrew Stoltmann, a securities lawyer in Chicago, said.

AIG’s problems are beginning to look like high-profile criminal cases against Arthur Andersen, Frank Quattrone and Martha Stewart, Stoltmann said.

In all three of those cases, what really got companies and individuals into trouble were efforts to cover things up, rather than their alleged, original misdeeds, he said.

Stewart, Quattrone, Andersen

Stewart, head of Martha Stewart Living Omnimedia MSO -0.98% , was jailed for lying to investigators. Fraud charges related to allegedly improper share sales were dropped.

Quattrone, a former Credit Suisse First Boston CSR +0.22% investment banker, was charged with obstruction of justice and jailed after he emailed colleagues asking them to destroy documents.

Arthur Andersen, the auditor of Enron, the energy trading giant that went bust spectacularly, was also charged with destroying evidence. Those criminal charges felled the accounting firm.

AIG slump

AIG shares slumped 8 % to a 2-year low on Friday as investors and analysts realized how much trouble the company could now be in.

A.G. Edwards analyst Paul Newsome cut his rating on AIG stock to “hold” from “buy” after he read the Wall Street Journal report about destruction of records.

Newsome had held his “buy” rating on AIG shares in recent months because he thought the company could bounce back from investigations into its accounting. Now he’s not so sure.

“The concern now is that there’s serious criminal wrongdoing connected with AIG,” Newsome said. “Financial markets will be more uneasy about dealing with the company in future, which means investors and lenders will charge more for financing the company.”

“It probably won’t break the company, but it starts to add up,” he added.

Spitzer threat

AIG probably won’t be criminally charged because the insurer’s board of directors has helped investigators so much, legal experts said.

“AIG has done exemplary job of working with government attorneys to unravel this mess and get to the bottom of it,” Christopher Bebel, a former SEC attorney and Federal prosecutor, said. “That level of cooperation means the chance of criminal charges against the company is very slender.”

Spitzer threatened to indict AIG earlier this week, but backed down after the board agreed to oust Greenberg from his new role as non-executive chairman, the Wall Street Journal reported Friday.

However, AIG will now be at a distinct disadvantage when it tries to negotiate a settlement with regulators.

Government authorities will take the conduct of AIG employees into account when deciding how big a fine the insurer will have to pay.

“Depending on the general character of the evidence that was destroyed, AIG could end up paying a hefty monetary penalty,” Bebel explained.

AIG will also suffer if shareholders file civil lawsuits against the company, Bebel said.

In any suit, investors will likely seek “adverse inference instruction” from courts. This means that jurors will be told that they can presume any destroyed evidence would have hurt AIG’s case, Bebel explained.

“This will give attorneys representing shareholders a marked degree of leverage over the firm when it comes to negotiating a settlement,” he said.

Individuals

What’s clear is that individuals at AIG who were involved in destroying potential evidence will be indicted for the criminal offense of obstruction of justice, legal experts said.

This will also include any senior executives who may have ordered the AIG employee to act, they added.

“It’s a virtual certainty that prosecutors will try to indict the employee who destroyed records in Bermuda,” Bebel said. “However, prosecutors will also do their best to try to determine whether these instructions came from the highest regions of the company.”

An AIG spokesman declined to say who destroyed company records and also wouldn’t comment on anything else.

Greenberg’s attorney, David Boies, didn’t return calls seeking comment.

Spitzer’s office also declined to comment, while a representative from the SEC didn’t return calls.

Alistair Barr is a reporter for MarketWatch in San Francisco.

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