AIG bonusgate: Part II

NEW YORK (CNNMoney.com) -- The AIG story that just won't go away is entering phase two.

The last of the controversial retention payments that have plagued AIG for more than a year were set to be paid out to current and former employees of the insurer's troubled Financial Products unit on Monday.

Instead, AIG paid out a total of $46 million but withheld $21 million. Many were paid the full amount owed to them, but others had part or all of their compensation withheld, according to a person with knowledge of the matter.

Between 60 and 70 former employees received reduced payments, according to Gary Phelan, a partner at Outten & Golden, who represents eight former AIG Financial Products employees. AIG Financial Products at one time had about 400 employees that were owed retention payments, but that number has steadily been falling as AIG winds down the unit.

The Financial Products division made risky bets on derivatives, which nearly ran AIG into the ground and necessitated the company's taxpayer-funded $182 billion bailout. The retention payments were agreed upon before the bailout, and sparked enormous controversy when they were first publicly discovered in March 2009.

That AIG withheld some of the payments surprised those affected, according to Phelan, who anticipates he'll wind up taking AIG to court. The former employees he represents said they discovered that their payments were reduced only after they checked their direct deposits.

"We're looking at all of our options now, but suing AIG remains a very likely option and perhaps an inevitable one," Phelan said. "It's outrageous that they would pull a stunt like this on the very day that the money was due, not even at the 11th hour, but at the 12th hour."

Each reduction was made due to an issue specific to that employee, according a person with knowledge of the arrangements. Many of the reductions likely stemmed from a stipulation in the retention payment contracts that says AIG has the right to reduce the total payment by the amount that the employees earned from other jobs after they left AIG.

But it's the manner in which AIG appears to have reduced some employees' compensation that may have been unlawful.

In several cases, AIG paid the affected employees 75% of their expected payments and, at the same time, asked for information about their outside compensation. After reviewing that information, AIG told those employees that it would return none, part or all of the remaining 25%.

"The law requires payments of wages when they are due," said Wilson Funkhouser, founding member of law firm Funkhouser, Vegosen, Liebman & Dunn. "AIG had a responsibility to get those questions answered closer to the end of 2009. AIG's position strikes me as a stretch."

Since there is no arbitration clause in the contracts, the cases can go directly to court. Phelan said he believes that the $21 million in withheld wages are subject to double damages, according to the Connecticut wage statute. AIG Financial Products offices are in Wilton, Conn.

AIG declined to comment for this story.

Funkhouser and Phelan both said they believed AIG was pressured from the U.S. government to withhold as much of the compensation as it could. The Treasury Department's "pay czar" Kenneth Feinberg previously had demanded that AIG recoup at least $45 million of the payments. Until Monday, AIG had only gotten voluntary returns of some $40 million.

"This is all about perception, all about politics, and AIG is disregarding the law," said Phelan. "The fact that the payments may be politically unpopular is not a defense."

Feinberg told the Fox Business Network on Tuesday that the matter, at least in his eyes, is closed.

"It's history," Feinberg said. "AIG has sought and recovered the $45 million in bonus pledges that were promised by those employees to be repaid to the taxpayer."

The news represents just the latest headache in a long, painful saga surrounding AIG's retention payments.

The payments were issued in 2008 and were designed to keep the unit's staff on board to wind down the company's trillions of dollars in credit default swaps.

AIG scheduled them in three installments: $69 million in December 2008, $168 million in March 2009 and, initially, $198 million had been set to be paid in March 2010.

When the March 2009 payment became public, lawmakers and the public went into a frenzy. House Democrats drafted legislation so that the retention payments would not be paid out, but the bill was halted after AIG asked Financial Products employees who took home more than $100,000 in retention awards to give back half of their bonuses.

Though it received pledges of $45 million worth of returned payments, AIG found it difficult to collect that total. As an incentive, the insurer paid about $100 million in early payments last month to employees who agreed to accept reductions.

AIG argued that the payments were necessary to retain employees who were uniquely qualified to unwind the insurer's controversial portfolio of derivatives. But an October report from Neil Barofsky, special inspector general for the $700 billion bailout program, found that bonuses were paid to non-essential personnel at the Financial Products unit, including $7,700 to a kitchen assistant, $700 to a file administrator and $7,000 to a mailroom assistant.

AIG (AIG, Fortune 500) last month announced that it is changing the way it pays out bonuses to its employees, opting to determine compensation based on performance. The company said it will not extend any more retention payments, and it will instead grade and compare employees' performance to their peers to determine their annual compensation, including bonuses.