Why AIG Suing America Isn't as Crazy as You Think

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Just over four years ago, AIG was rescued from the financial abyss by the United States Treasury and Federal Reserve. This week, the board will weigh whether to join a lawsuit against the United States over the terms of its bailout.

Most people reading this news, first reported in The New York Times, probably could not make up their minds whether the notion was more absurd than repugnant or vice versa. It does sound a bit like suing the lifeguard for the way you were evacuated from the pool where you had passed out after too many country club cocktails.

The real story is at least a bit more complex than that.

The lawsuit AIG's board is considering joining was brought by Hank Greenberg, the former company's chief executive who is still one of its largest shareholders, on behalf of shareholders. Greenberg claims that the terms of the bailout—which eventually resulted in the government owning 92 percent of the company—were too onerous. The government deprived shareholders of billions of dollars and the violated the Fifth Amendment's ban on the government seizure of property without just compensation to the owners, Greenberg lawsuit claims.

But can seizing control of a company that was on the brink of failure really be seen as an illegal taking? A judge on the Federal Claims court ruled last summer that if what Greenberg argues is true, the government may really have acted illegally.

Greenberg's legal team, led by David Boies, argues that the government pushed away sovereign wealth-funds and other foreign investors who might have been willing to invest in the company before it was bailed out. This, they argue, prevented AIG from being able to raise capital and contributed to its downgrading by ratings agencies, which in turn put the company into even more dire straits. This forced AIG to accept the unfair terms the government offered in its loan agreement, the lawyers say.

Greenberg's lawyers also raise questions about the events around one of the oddest episodes of the AIG-Treasury relationship. You might recall that in the summer of 2009, the government converted its preferred shares into 79.9 percent of the common stock of AIG, something that it was entitled to do under the terms of the government's loan. This was accomplished by means of a reverse 20:1 stock split.

You might not recall precisely why the stock split occurred. At the time, then-chief executive Ed Liddy said it was necessary to prevent the stock from being delisted on the New York Stock Exchange. That might be true. But it is also true that the split was a necessary part of the conversion from preferred shares because AIG's charter didn't authorize enough common stock to allow the government to take 79.9 percent of the common stock. So when the government converted to common, it was issued unauthorized common stock.

When common shareholders were asked to authorize the additional common stock—which would have badly diluted their interest in the company—they voted no. Because the government's stake was in unauthorized shares, it didn't get a vote.

So another vote was held about the reverse split of all issued stock—including the government's unauthorized shares. This time, the government got to vote its 79.9 percent stake on this question because its unauthorized shares were also affected. And so the measure prevailed. After the split, the total number of shares outstanding no longer exceeded the number authorized in AIG's charter, so the government's shares were now officially authorized.

That's more than a little bit confusing, I'll admit. And it does sound more than a bit questionable, even to someone as jaded about shareholder rights as I am. But Greenberg's lawyers say it's even worse. They say that this procedure was engineered to circumvent a Delaware court order meant to protect the rights of the common shareholders when the government took over the company.

Under that order, AIG was barred from diluting the shareholders without their consent. The reverse split, as we've seen, accomplished the same thing.

In the decision upholding Greenberg's right to bring the suit, the federal claims judge said "the Government appears to have violated the spirit, if not the letter, of the order by not holding a common shareholder vote on the reverse stock split, which led to the dilution of the common shareholders' equity and voting interests."

Greenberg also claims that the government was wrong to use AIG funds to buy at par value the collateralized debt obligations that were insured by AIG. This move was widely criticized by politicians and the media as a "backdoor bailout" of AIG's counterparties—and Greenberg's lawyers also adopt that phrase in their argument. Instead, Greenberg's lawyers say, the government should have driven a harder bargain with the counterparties.

I have less sympathy with this argument. I'm not sure the counterparties of AIG would have sold their claims for less than par, especially once they knew the government wasn't going to let the company go bankrupt. I'm sure then-Treasury Secretary Hank Paulson could have forced Goldman Sachs and the rest to accept discounts on their AIG claims. But certainly AIG's shareholders have no right to have expected the government to cajole AIG's customers into taking haircuts.

What's more, it seems to me that once you become a ward of state you should also expect to become its tool. Your assets are not really your own. But the takings clause may put limits on exactly how far the government can go in exploiting the resources of companies that still have non-government shareholders.

So far all we have is Greenberg's claims. There's nothing in the public record to support, for example, the claim that the government chased off private investors.

But that's what trials are for. If Greenberg can show the AIG board that he will be able to back up his allegations, it may not be so crazy for AIG to sue its rescuer. At the very least, AIG's board owes a fiduciary duty to the shareholders to give Greenberg a fair hearing.

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