SEC v. Zurich Financial
It is important for reinsurance to transfer risk because that is the entire point of reinsurance. Any reinsurance that does not transfer risk is not reinsurance at all, by definition. The transfer of risk is key -- insurance companies bear risk in the course of their business. When they pay another firm to take on that risk, that risk needs to transfer in order for this to be a valid transaction. Should the risk not transfer, it begs the question of why the company is paying the other company. The SEC would rightly consider a payment for nothing with suspicion. Accounting fraud can be said to occur when a company is booking revenue in a situation where no service is being provided. Given that the service provided by reinsurance is risk transfer, any transaction that does not feature risk transfer cannot be reinsurance, and therefore may be considered fraudulent. At worst, such a transaction would at the very least not be considered reinsurance, but some other type of transaction.
2. The purchasers of Converium's IPO stock could have filed suit against the auditors if it was shown that the auditors were aware of the circular transactions. The IPO was issued on the basis of faulty accounting statements for Converium. Those statements artificially inflated Converium's performance, by using reinsurance accounting for transactions that did not transfer risk. As a result, investors paid more than they should have for Converium, and the company sold more Converium stock at issue than it otherwise could have. Zurich thus raised a lot more money than it should have. The buyers of the Converium IPO were therefore defrauded. The external auditors may be held to strict liability in this instance anyway,...
But if the external auditors knew about the nature of the transaction, then this is likely to increase the damages, and expose the auditors to charges relating to the fraud. In essence, knowledge of the transactions would take the auditors from the position of incompetent to co-conspirators, which would have implications particularly in the punishment phase of legal action. The shareholders are apt to include the auditors in any action anyway, but how negatively this will affect the auditors will reflect how much the auditors knew about the transactions.
3. Ethics are a separate matter from law, as the legal system is not overly concerned with matters of right and wrong. In this case, however, both come to the same conclusion. There is no ethical dilemma here -- Zurich managers simply chose to commit a fraud. That is ethically wrong by any code. No religious code permits theft. No non-religious moral code permits theft. Ultimately, Zurich's managers sought to create the illusion of reinsurance, but without actually transferring risk. They did this specifically to inflate the financial performance of the reinsurance division, in order that…
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