This excerpt taken from the MBI 8-K filed Aug 8, 2008.
This excerpt taken from the MBI 8-K filed Jan 31, 2007.
1. This proceeding arises out of a fraudulent transaction that MBIA executed to mask the true financial impact of a massive loss it suffered on its guarantee of municipal bonds. In 1998, MBIA learned that it would have to make good on its guarantee of $256 million of bonds issued by a set of hospitals owned by the Allegheny Health, Education and Research Foundation (AHERF), which had defaulted. The default would have resulted in the first quarterly loss in MBIAs corporate history. To counter the potential negative market reaction, senior MBIA executives devised a scheme to obtain retroactive reinsurance that would cover the entire net present value of the anticipated loss, or about $170 million, for a nominal premium. The effect of the transaction was to offset the entire $170 million loss MBIA recorded on its income statement in the third quarter of 1998 with a roughly equivalent reinsurance recoverable, thus masking the AHERF loss and converting a quarterly loss into a gain. The transaction was a sham.
2. MBIA entered into three purported reinsurance contracts under which the reinsurers agreed to provide retroactive coverage of up to $170 million for the AHERF loss (the excess of loss or reinsurance contracts). The excess of loss contracts were written as if it was unclear whether the reinsurers would have to provide the full amount of the agreed upon coverage, and MBIAs files were likewise papered to make this appear to be the case. This purported uncertainty about the extent of the reinsurers payout to MBIA was critical to the desired accounting. To the extent that the reinsurers payments under the excess of loss contracts were not expected to vary significantly, such payments could not be treated as reinsurance for accounting purposes, and MBIA would not be able to mask the effect of the AHERF loss on its income statement by offsetting the reinsurance recoveries against the loss. In fact, MBIA expected that the reinsurers would be called upon to pay out under the excess of loss contracts.
3. Because the reinsurers expected to pay out under the reinsurance contracts, they protected themselves against loss on the transaction by entering into separate agreements by which MBIA agreed to cede to them future business (the quota share contracts). The quota share contracts, which covered a significant percentage of MBIAs portfolio, ceded to the reinsurers hundreds of millions of dollars in premiums on future business. Although the ceding contracts did not on their face constitute compensation to the reinsurers (because the reinsurers were undertaking some limited risk associated with the ceded premiums), in substance, they were compensation, because the contracts ceded so little risk associated with the amount of premium received. Indeed, in the case of one reinsurer, which had agreed to pay $70 million of MBIAs AHERF loss, MBA ceded $101 million in net premiums (resenting $13 billion of underlying insurance risk), but then secretly agreed to re-assume all but $13 million of the risk in an oral side agreement, leaving the reinsurer with all the ceded premium and virtually no risk. With respect to the other two reinsurers, which each paid $50 million of the AHERF loss, MBIA ceded a tremendous volume of business based upon a formula that virtually assured that the reinsurers would be repaid in full for their payments under the excess of loss contracts, even taking into account the risk they would be undertaking on the ceded business.
4. In September 2004, the reinsurer with the oral side agreement sued MBIA to enforce the side agreement. The lawsuit led to an investigation by the Audit Committee of MBIAs Board of Directors, which concluded, in March 2005, that it appears likely that such an [oral side] agreement existed, and resulted in MBIAs restatement of its consolidated financial statements for the years 1998 through 2003. However, MBIA restated only the $70 million of reinsurance associated with the side agreement. It did not restate the remaining $100 million, which was improperly accounted for and which had been the subject of numerous misleading press releases and periodic filings.
5. As a result of the foregoing conduct, MBIA, directly and indirectly, has engaged, and may again engage, in violations of Sections 17(a) of the Securities Act of 1933 (Securities Act), and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 (Exchange Act), and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 13b2-1 thereunder.