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Maybe that AIG case isn't so crazy?

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As Hester Peirce notes, AIG has rejected a shareholder demand to sue the government over the bailout that transferred ownership of AIG to taxpayers. But as John Carney notes (h/t Bainbridge), the shareholder, Hank Greenberg, no fan of frivolous litigation, may have a point:

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.

More from Professor Pirrong.

Now, of course, being allowed to proceed on a complaint means only that there is a legal cause of action if the facts alleged in the complaint are true; Greenberg still has to prove his case, and the allegations may not be true. But if they are, it wouldn't be the first time government officials shortchanged AIG shareholders and Hank Greenberg at the expense of the rule of law. Others have suggested that that earlier Spitzer action resulted in incompetent AIG management that led to its future financial problems. (Related: Manne; Ribstein in 2006; Ribstein in 2005.)

(By the way, the late Larry Ribstein's Ideoblog posts seem to have disappeared from the web. Perhaps Truth on the Market could find a way to archive them so that they remain Google-searchable? I hate to lose the wisdom of any posts I don't know to look for on archive.org.)

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.