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NEW YORK--Federal regulators have brought civil fraud charges against three former top executives of RenaissanceRe Holdings Ltd. for allegedly orchestrating a finite reinsurance scheme designed to smooth the reinsurer's earnings and mislead investors.
The Securities and Exchange Commission's complaint, filed last week in a Manhattan federal court, levels various charges against RenaissanceRe's former chairman and chief executive officer, James N. Stanard--along with former Controller Martin J. Merritt and former Senior Vp Michael W. Cash--for their alleged roles in orchestrating a two-part sham reinsurance deal with Inter-Ocean Reinsurance Co. Ltd., a finite risk reinsurer now in runoff.
The effect of that transaction, the suit says, was to smooth and defer $26.2 million of Pembroke, Bermuda-based RenaissanceRe's income from 2001 to 2002 and 2003 (see story page 21).
According to the complaint, the purpose of the two contracts was "to have a material impact during a future period when RenRe needed an earnings boost."
The former RenaissanceRe executives are not the first to be investigated or face charges in connection with the SEC's investigation of finite reinsurance.
"This is another case arising from our ongoing investigation of the misuse of finite reinsurance to commit securities fraud," Mark K. Schonfeld, director of the SEC's Northeast regional office, said in a statement. "The defendants enabled RenRe to take excess revenue from one good year and, in effect, 'park' it with a counterparty so it would be available to bring back in a future year when the company's financial picture was not as bright."
Additionally, the SEC in its complaint said that Mr. Merritt--with the knowledge of Mr. Stanard--intentionally misrepresented or omitted key facts to RenaissanceRe's auditors surrounding the Inter-Ocean deal, including its lack of risk transfer and income smoothing purpose.
The phony nature of the Inter-Ocean transaction also had a "distorting" effect on RenaissanceRe's financial reports to regulators and investors, the suit alleges.
Furthermore, the company's March 2005 three-year restatement of earnings itself was problematic, as the "description of the reasons for the restatement and the nature of the Inter-Ocean transaction was misleading," the SEC said in the complaint. The company, in disclosing its restatement, was not "candid about the reasons for the restatement" and failed to disclose that "the entire transaction was a sham," the SEC says in its complaint.
In 2004, RenaissanceRe acknowledged that the two contracts had been improperly booked as insurance and failed to transfer enough risk to meet general accounting standards; in February 2005 the company announced it would restate three years of earnings due to those transactions.
The effect of that restatement, contained in a 10-K report filed with the SEC one month later, caused the reinsurer's 2001 net income to increase by $26.4 million, and 2002 and 2003 net income to decrease by $25.0 million and $1.4 million, respectively.
A spokesman for RenaissanceRe said last week that "at this time we are not aware of any matter that would give rise to a further restatement."
The SEC's suit against RenaissanceRe's former officers seeks permanent injunctive relief, disgorgement of ill-gotten gains, if any, plus prejudgment interest, civil monetary penalties and orders barring each defendant from acting as an officer or director of any public company.
The civil enforcement action last week follows so-called "Wells notices" issued by the agency last year to Messrs. Stanard and Cash and to RenaissanceRe itself. Wells notices are a warning that SEC officials plan to recommend that the agency levy charges of violating federal securities laws.
Of the three individuals charged in the complaint, only Mr. Merritt did not receive a Wells notice, said his attorney, Robert Plotkin of the Washington-based law firm McGuire Woods L.L.P.
Mr. Merritt was also the only one of the trio who agreed to simultaneously enter a partial settlement of the commission's claims against him, the SEC said.
As part of his settlement agreement, Mr. Merritt neither admitted nor denied any wrongdoing, and he consented to the entry of an antifraud injunction and other relief, deferring the settlement of any monetary charges.
In a statement, Mr. Stanard's attorney, James D. Mathias of DLA Piper U.S. L.L.P., denied any wrongdoing by his client, noting that Mr. Stanard engaged in due diligence with regulators following the discovery of RenaissanceRe's accounting errors.
"Mr. Stanard did not commit fraud or engage in any misconduct. While we are disappointed that the SEC has made these allegations, Mr. Stanard looks forward to the opportunity to vindicate himself," Mr. Mathias said.
"The single, two-part 2001 transaction that is the subject of the SEC complaint was restated in February 2005 at Mr. Stanard's direction after an internal investigation, voluntarily initiated by Mr. Stanard, of RenaissanceRe's reinsurance contracts and business practices found only one transaction that was incorrectly accounted for, out of thousands that were subject to the review. Mr. Stanard and RenaissanceRe brought this transaction to the SEC's attention, and Mr. Stanard has cooperated fully throughout the resulting government investigation," Mr. Mathias said.
"The independent directors of RenRe's board, advised by the law firm that conducted the internal investigation, concluded that the single accounting error was the result of mistakes, not misconduct," he said.
Representatives for Mr. Cash issued a statement denying the allegations in the SEC's complaint.
"Indeed, Mr. Cash was never responsible for RenRe's publicly filed financial statements. He should not have been named as a defendant in this case," the statement said.
According to Julius A. Rousseau, a reinsurance attorney with Herrick, Feinstein L.L.P. in New York, regulators are concerned about certain finite reinsurance transactions because they can mask the true performance of a company. "They want to see the fluctuations (in income) for solvency purposes."
What is notable in the charges against RenaissanceRe, Mr. Rousseau said, is they allege the company "was moving money around so they don't recognize income," which "doesn't give a true picture to stockholders."
Company sees no impact
RenaissanceRe--which in July announced a settlement offer related to the SEC's investigation of the company's March 2005 restatement of earnings--last week reported that it does not expect the charges leveled against its former officers to impact the company.
Under the proposed settlement, RenaissanceRe would not admit or deny any wrongdoing, and would pay the SEC $15 million in civil penalties (BI, Aug. 7).
The SEC staff has recommended the proposed settlement to SEC commissioners, and RenaissanceRe believes that the civil enforcement action against its former CEO and other top executives "will have no impact on the company's business going forward," the reinsurer said in a statement.
Robert J. Keyes, assistant regional director in the SEC's Northeast regional office in New York, declined to comment on the status of RenaissanceRe's proposed settlement.
In addition, RenaissanceRe continues to face shareholder class action lawsuits, which were consolidated in February in a U.S. District Court in Manhattan.
"The litigation remains at a very early stage," said a RenaissanceRe spokesman in a statement. "As we have disclosed in our SEC filings, we believe the private actions are without merit and we will defend ourselves vigorously."