An appellate court in New York has cleared the way for a trial on allegations that Maurice “Hank” Greenberg and Howard Smith, then CEO and CFO of American International Group, respectively, committed fraud in connection with two reinsurance transactions that allowed AIG to inflate loss reserves without transferring risk.

The litigation has been underway since 2005, and was prompted by an investigation by then New York attorney general Elliot Spitzer.

Greenberg and Smith said they would seek to appeal the ruling to the state’s highest court in order to have it totally dismissed.

At the same time, Vincent Sima, Smith’s lawyer at Kaye Scholer, said, Greenberg and Smith expect that the federal court, which has preliminarily approved a settlement of federal securities claims on behalf of a class of AIG shareholders, will approve that settlement resulting in additional grounds for the dismissal of this wasteful action.”

A panel of the Appellate Division, First Department, of the Supreme Court of New York, did rule, however, that the trial court judge was premature to hold Greenberg and Howard Smith liable in October 2010 for damages without a trial over an auto warranty insurance transaction with Capco Reinsurance Co, which the state called a sham that helped AIG hide more $200 million of losses.

Through its decision, the court cleared the way for a trial on whether the two committed fraud in connection with both transactions.

The decision partially reversed a decision by state Supreme Court Justice Charles Ramos.

In the case, current New York attorney general Eric Schneiderman is accusing Greenberg and Smith of a transaction with reinsurer General Re Corp. that helped AIG inflate loss reserves by $500 million without transferring risk.

James Freedland, a spokesman for Schneiderman in the Attorney General’s New York City office, said: “We are pleased that the court has paved the way for a trial to hold the defendants accountable for perpetrating a major reinsurance scheme to defraud investors.”

After the decision was handed down by a five-judge panel, lawyers for Greenberg and Smith said they would appeal the decision clearing the way for a trial of the case to the Court of Appeals, the state’s highest court.

“Greenberg and Smith are pleased that the Appellate Division agreed that the prior grant of summary judgment to the Attorney General must be reversed,” said Greenberg’s lawyers, David Boies of Boies Schiller and Skadden Arps partner John Gardiner. 

“They believe the Appellate Division should have gone even further, however, and, as stated in the well reasoned opinion of Judge James Catterson, dismissed the Attorney General’s action in its entirety because the claims of the Attorney General conflict with the federal securities laws and the Attorney General also failed to develop and present any proper, admissible evidence to support its allegations against Greenberg and Smith,” Boies and Gardiner said.

Vincent Sama, of Kaye Scholer, who represents Smith, called the proceedings a “misguided action” in 2005 by then-state Attorney General Elliot Spitzer, and said the entire state case should be “conclusively dismissed.”

AIG, formerly the largest insurance company in the world, entered into a settlement agreement with the Attorney General with respect to the two transactions and other claims, paying over $1billion in damages and penalties.

The issue came to a head in March 2005, when AIG issued a press release admitting that the GenRe transaction documentation was improper, stating that in light of the lack of evidence of risk transfer, the transactions should have been recorded as deposits.

Greenberg and Smith subsequently resigned their positions as CEO and CFO of the company. In May 2005, AIG restated its results for 2000 through 2004.

According to the court decision, “In the restatement, AIG explained that “[GenRe] was done to accommodate a desired accounting result and did not entail sufficient qualifying risk transfer.”

“As a result, AIG has determined that the transaction(s) should not have been recorded as insurance.”

In June 2005, two GenRe executives pleaded guilty to participating in a conspiracy to commit securities fraud for their role in the GenRe transaction.

In February 2008, four other GenRe executives were convicted on federal criminal charges with respect to the GenRe transaction. Those convictions were reversed by a federal appellate court panel in 2011 and a new trial ordered.