You have to give Maurice Greenberg credit. There's something wonderfully Mr. Burns-ian about the litigious nonagenarian billionaire and former CEO of American International Group, and AIG's largest shareholder during the 2008 financial crisis, suing the United States government for bailing out AIG. I haven't seen the Ipsos poll, but I'm going to guess this wasn't a popular move.
Mr. Greenberg's successful lawsuit proceeded on two theories of liability. Both theories were based on the Federal Reserve Board of Governors' acquisition of a 79.9-per-cent equity ownership in AIG at the height of the 2008 crisis. The government acquired the equity in return for extending a 12-per-cent loan to AIG to rescue it from bankruptcy and, you know, save the global financial system. The somewhat draconian terms were approved by AIG's board of directors, who accepted them while looking into the financial abyss, and were designed to avoid the problem of moral hazard; namely, that if the terms weren't sufficiently harsh, the bailout would motivate future financial institutions to engage in high-risk/high-reward behaviour.
The government took its equity in the form of voting preferred stock, which eventually would be converted into common shares when the government wished to sell its stake. The shares were held in a trust specially created to avoid direct ownership by the Federal Reserve because, as former Treasury secretary Tim Geithner eloquently put it: "Under section 13(3) of the Federal Reserve Act, the Fed is prohibited from taking equity or unsecured debt positions in a firm."
But before we get to the obvious legal problem, the federal government faced another problem – namely, under Delaware law, it couldn't convert its preferred shares into common shares without the approval of the common shareholders who stood to be massively diluted, as the conversion required AIG to issue more stock than it was authorized to do. This problem was solved by an awkwardly named "reverse stock split" or "stock consolidation," which required the vote of all shareholders together and not the approval of one distinct class. By consolidating its stock at a ratio of 20 to 1 but not decreasing the amount of stock it was authorized to issue, AIG made room for the Federal Reserve to convert its preferred shares into common shares. Clearly, the federal government (as well as 85 per cent of the common shareholders) voted in favour of consolidation.
So here are the two questions Judge Thomas Wheeler of the U.S. Court of Federal Claims had to decide: Did the Federal Reserve exceed its authority by acquiring equity ownership in AIG? And did AIG and the Federal Reserve circumvent the shareholder class vote?
The answer to the second question is easy: no. The consolidation was done in order to avoid AIG's common shares falling below $1, a threshold that would have required delisting by the New York Stock Exchange. Nor was it atypical to engage in such a consolidation without decreasing the amount of authorized shares AIG could issue. In other words, the ability for the government to exchange its preferred shares and exit its position was good fortune.
The government was not so lucky on the administrative count. The punchline is this: Mr. Geithner was on the money – the Federal Reserve was not authorized to take a stake in AIG by its statute, making the equity acquisition an illegal extraction; and acceptance by AIG's board of the plan could not absolve the government of its illegality. And no, the trust was never going to work. The court took a substance-over-form approach, finding that, among other things, the federal government retained beneficial ownership over the shares and operated in the best interest of the U.S. Treasury.
Sure, Mr. Greenberg was right that the government exceeded its authority. The problem is, there were no damages. As the court wrote, quoting one witness, "twenty per cent of something is better than 100 per cent of nothing." Just as the court giveth, the court taketh away.
For most of us, this is litigation 101: Even if you've got a winner of a lawsuit, it doesn't make sense to throw away legal fees when there aren't any damages for you to recover. For the government, this is good news: Feel free to exceed your authority, just be sure that you actually are saving the company from bankruptcy. The government and its advisers knew it may not have done everything by the book, but Judge Wheeler recognized that this did much more good than harm. It almost sounds like the legal version of moral hazard – the government's loss is limited if it breaks the rules, but it better be breaking those rules for a darn good purpose.
Now, some out there are calling Mr. Greenberg's victory over the federal government "Pyrrhic." I'm not so sure. For what I'm sure are a truckload of legal fees, he got to put Mr. Geithner, Henry Paulson, Ben Bernanke and others on the stand in front of super litigator David Boise. And he got a court to say that the government broke the law.
Adrian Myers is a lawyer at Torkin Manes LLP.