AIG's never-ending corporate divorce

AIG's legendary former CEO Maurice 'Hank' Greenberg.

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(Fortune) -- The legal battle between insurance giant AIG and its legendary former CEO Maurice "Hank" Greenberg is heating up, as the two sides stake their claims to a disputed $16 billion block of AIG stock.

In perhaps the most bitter corporate divorce in recent memory, Greenberg and AIG (AIG, Fortune 500) are deploying some of the priciest lawyers in Manhattan to file a flurry of motions over the disposition of the assets of Greenberg's Starr International Co. AIG is seeking both to halt Greenberg's new business ventures and most importantly, to halt the sales of AIG stock that are funding it.

Starr, also known as SICO, is an obscure Bermuda-based holding company that played a crucial role in AIG's growth during Greenberg's long reign as CEO. Its primary assets were AIG stock acquired during a complicated three-way corporate reorganization in 1970 (in which SICO exchanged its operating assets to AIG in return for a block of stock.) By 2005, this block had grown to 310 million shares, or 12% of AIG. By holding stock that could be doled out to top AIG managers when they retired, SICO allowed the insurance colossus to handsomely compensate as many as 700 senior management, at no cost to AIG shareholders. Just as importantly, SICO's block of stock - and the fact that SICO's chairman was AIG's Greenberg - posed a virtually insurmountable obstacle to any company attempting a hostile takeover of AIG.

The SICO-AIG drama began to unfold in 2005, when Greenberg made a hasty departure from AIG as the New York state attorney general's office - then headed by Eliot Spitzer - investigated the insurer's accounting practices. The AG's office dropped two of the civil accounting fraud charges last year against Greenberg, but four counts are still pending. Greenberg stayed on as chairman of SICO however and with the help of former colleagues like ex-AIG chief financial officer Howard Smith (who also was named in the AG's suit) and a squad of AIG's former founding executives set about remaking the company.

Six months later AIG's new management sued Greenberg in federal court, alleging that soon after Greenberg departed AIG, he and his former colleagues - including 91-year-old AIG co-founder Ernest Stempel - improperly seized control of SICO via what AIG calls a "coup d'etat." AIG contends Greenberg, Smith and others are using Starr's assets to enrich themselves.

In late March of this year, AIG upped the ante by suing Greenberg and SICO board members in New York state court for many of the same reasons. Specifically, AIG's complaints argue that Greenberg and his colleagues misappropriated a "special block" of the company's stock then worth $20 billion and engineered a coup that resulted in nine AIG executives from the 12 member SICO board being removed.

The lawsuits mark a sharp escalation in a battle that can be best described as a corporate civil war. AIG, which is headed by Martin Sullivan, is warring with the men who created and built AIG, and who hired, promoted and made very rich the very same senior management now pursuing the case. To call this conflict "bitter" or "personal" would be an understatement; every motion is contested, every decision is appealed.

AIG's concerns over SICO's block of AIG stock are hardly idle: SICO, at Greenberg's direction, has been selling the stock with frequency, raising nearly $4 billion over the past two years and putting the proceeds to work in areas that directly compete with their former employer, like investing in a private Moscow real estate development deal that yielded a 200% return in just over nine months.

In October, SICO purchased Berkshire Hathaway's (BRKA, Fortune 500) Republic Insurance unit and as of last week, was in conversations with A.M. Best over a possible rating for the company. In effect, Greenberg is turning SICO into a combination of an insurance company with specialty lines of business such as aviation and a remarkably well-capitalized private equity firm with interests across Asia and the Middle East.

There can be little debate that SICO's role as AIG management's little-known piggy bank is dead and that it is now a multi-faceted for-profit entity. The question is: Are these shifts permissable?

Documents obtained by Fortune appear to cast doubts on some of the central premises of AIG's complaints, specifically that the resignation of SICO's former board of directors - consisting of AIG's then-senior management - was a coup engineered by Greenberg at AIG's expense.

There is no doubt that Greenberg, considered one of the most hands-on, detail-oriented and, in all candor, domineering executives in recent corporate history, played a large role in shaping SICO's board after his departure from AIG. But demonstrating a questionably legal usurpation of power may prove difficult for AIG in this case.

According to the minutes of a March 28, 2005 SICO board meeting, while nine senior AIG executives were indeed removed from SICO's board, four AIG executives voted with Greenberg to formalize the removal. Shortly after, according to Greenberg's lawyers, AIG asked three of those executives to resign from SICO as well (two of them resigned at that meeting), which they did on April 14 and April 15 of 2005. In short, if this was a "coup," as AIG has argued repeatedly in legal filings, it appears to have been one that was unusually collegial, with one resignation letter from executive vice-president Ken Nottingham noting that "It has been an honor to serve."

While notions of "coups" make for interesting reading and fodder for the press, the crux of the case is whether SICO can break away from AIG.

Greenberg's lawyers at Boies, Schiller & Flexner argue that there is no contract binding SICO's board to oversight from AIG, nor is there one committing SICO to permanently funding compensation plans. SICO's role in funding compensation plans for AIG executives was a situation arising from "Not an obligation, not a trust, not a contract, [but] a tradition," according to lead Greenberg attorney David Boies, who made this argument in federal court in December.

AIG's rebuttal to Greenberg is simple: SICO had no other purpose or basis for existence other than that of providing deferred compensation plans for AIG executives. Moreover, as long as Greenberg has the SICO board's approval, he can implement any strategy he and his management see fit. Martin Flumenbaum, an attorney from Paul, Weiss, Rifkin, Wharton & Garrison and AIG's lead counsel in the SICO battle, argued in the same December hearing that there is ample documentary evidence Greenberg himself viewed SICO and its assets as a trust for the benefit of AIG workers.

There is "a very strong case, based on history, documents, statements, videotapes of Mr. Greenberg standing in front of an AIG banner, swearing to his employees that we've put this in trust and nobody can invade this trust for you," said Flumenbaum. Seen this way, the use of the word "trust" by Greenberg would imply a specific legal status for SICO, one that presumably could not be broken by a simple change in its board of directors.

AIG's beef here isn't just legal or even strategic - the company took a $905 million reduction to its retained earnings account in 2005 to essentially cover the value of deferred compensation plans lost to its employees when the AIG-SICO relationship was severed. To be fair, the discretionary charge (part of a broader $4 billion restatement) actually had no effect on AIG's shareholder equity because of an off-setting credit to its paid-in capital account.

On a more human note, the anger felt towards Greenberg who was initially lionized and seen as a victim of then-AG Spitzer's prosecutorial zeal among AIG's rank-and-file - internally at AIG's headquarters at 70 Pine Street is palpable. While moot from a legal perspective, AIG executives argued to Fortune that whatever the legal merits of Greenberg's case, they feel that the use of SICO as anything other than a deferred-compensation vehicle is simply bad faith.

The counter-rebuttal from Boies Schiller is equally simple: In the many thousands of pages of legal and corporate filings resulting from SICO's 1970 formation, there is absolutely no reference to SICO's formal obligation or contract to provide the deferred compensation plans. Pursuing this line of thought, they argue that under the direction of Greenberg and other AIG founders, SICO's connection to AIG was a purely voluntary arrangement.

They appear to have a point.

Buried deep in the AIG 10-K, a footnote described the deferred compensation profit participation plans as a product of the decision of SICO's voting shareholders and board of directors to do so - not from any contractual obligation. AIG's recently filed proxy notes that participation in the SICO plans was at the "sole discretion of SICO's Board of Directors."

A copy of the last plan offered, from 2003-2004, does not mention any contract or obligation for SICO to fund future plans. Also, while the plan does state under the heading of "Purpose" that its goal is to "Reward' SICO and AIG employees," it does so only to ensure their continued contribution to the future "growth of SICO."

One other consideration at hand here: If AIG is concerned that a block of $20 billion was misappropriated, then why hasn't it sought a preliminary injunction, the traditional remedy against alleged corporate theft and misappropriation? Presumably, were SICO doing something that violated the law, a judge could immediately order the share sales at least temporarily halted. Federal magistrate judge Michael Dolinger noted this in an order from December 2006, saying that AIG has chosen to rest on its "litigative oars." In January, in open court, Judge Dolinger said AIG appeared to be "allergic to making preliminary injunction motions."

In this pitched war of filings and counter-motions, Greenberg's lawyers point to AIG's decision not to pursue the temporary restraining order as a tacit admission of the legality of its share sales.

An AIG spokesman said that this isn't the case at all, but that seeking a preliminary injunction was not the best strategy for the company, given that AIG would have to clearly demonstrate so-called irreparable harm - something that's not easy for a company with nearly $1.1 trillion in assets on its balance sheet, according to its last quarterly report.

There is also the notion of practicality for AIG: If SICO loses, can it promptly return the assets? Greenberg's lawyers assured Fortune that in the event of an adverse ruling, forcing them to return some or all of the remaining AIG stock, SICO would be able to honor any court order.

Putting aside the back and forth over long-ignored legal filings, the stakes for both SICO and AIG are quite real.

Current AIG executives still have $1 billion in unvested deferred compensation plans with SICO; SICO has pledged that at retirement they will get their money, and according to Boies Schiller, has been releasing stock to AIG executives on a regular basis pursuant to their contracts.

SICO and Greenberg personally still control nearly 10% of AIG stock and could, if they wished, sell the shares to an institution or a fund whose intention could conceivably be hostile to AIG management - something that has historically been unthinkable.

Even with a favorable outcome in this case, however, Greenberg is far from out of the woods, because matters in the Attorney General's case appear to be heating up.

According to transcripts, New York State Supreme Court Judge Charles Ramos lost his cool two weeks ago when Greenberg's lawyers tried to parry the attorney general's office's demands that he sit for a deposition. As deputy attorney general David Ellenhorn noted, Greenberg has had three years to submit to a deposition, but has used attempts to obtain documents from various sources as a reason to avoid answering the AG's questions. A visibly angry Judge Ramos overruled the repeated attempts of Boies Schiller partner Nicholas Gravante to argue and ordered the depositions of Greenberg and Howard Smith for late this month.