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AIG investigated over CDS valuation

Shares in American International Group Inc (AIG) fell 7 percent to close at $33.93 Friday after it emerged the company is being investigated by the Securities and Exchange Commission (SEC) over its valuation of contracts linked to sub-prime mortgages.

The probe is looking at whether the insurance giant overstated the value of credit default swaps (CDS), including those backed by sub-prime mortgages.

As previously reported, AIG slumped to consecutive record losses in the last two quarters, driven by combined pre-tax writedowns of more than $20bn on its CDS portfolio.

With net writedowns of $11.5bn and $9.1bn in AIG’s fourth quarter 2007 and first quarter 2008 results respectively, the company booked losses of $5.3bn and $7.8bn in the respective periods.

The insurer’s shares have more than halved over the last 12 months, with AIG facing a series of class action lawsuits alleging that it made false and misleading statements that artificially raised the price of its stock.

The Wall Street Journal reported sources as saying that criminal prosecutors from the Justice Department in Washington and its US attorney’s office in New York have told the SEC they want to see information the regulator is gathering in its probe.

The paper said that officials for AIG, the SEC, the Justice Department and the US attorney’s office declined to comment on the investigation.

AIG took the first writedown on the portfolio after its 11 February revelation that auditors had found “material weaknesses” in its CDS portfolio monitoring and its method of calculating expected collateralised debt obligation (CDO) losses.

The insurer sold the swaps to CDO holders, with the investments backed in part by sub-prime mortgages. The method of calculating expected losses on the CDOs drives the value of the CDS, and in turn the level of collateral, AIG posts in relation to the contracts.

As at the end of April, AIG posted $9.7bn collateral behind the CDS, up from $5.3bn two months earlier.

News of the investigation comes at a time of mounting pressure on AIG management, including CEO Martin Sullivan.

Despite last month’s boardroom vote of confidence, Martin Sullivan is facing renewed pressure from investors, driven by some of the insurer’s largest shareholders, according to reports.

The Wall Street Journal has claimed a number of significant investors are considering the possibility of a special shareholder meeting if directors do not take further action to address the insurer’s performance and dwindling share price.

Last month, three major shareholders who control around 4 percent of AIG’s stock had written to the board citing a “staggering breakdown of risk controls”.

In the letter, former director Eli Broad and two major fund managers Shelby Davis of Davis Selected Advisers LP and Bill Miller of Legg Mason Inc also highlighted an “unequivocal loss of investor confidence”.

The investors reportedly met with AIG chairman Robert Willumstad and director Morris Offitt to express their concerns.

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