"All I Want in Life is an Unfair Advantage"
Hank Greenberg built AIG into a monument to his own genius. How did he do it? By pushing hardball tactics to the limit--and then some. As the CEO liked to say before his fall ...

(FORTUNE Magazine) – Not long after starting a prestigious new job as general counsel at American International Group, 48-year-old E. Michael Joye received an alarming piece of news. AIG, an employee confided, had for years been improperly booking premiums it received for workers' compensation insurance. If true, it meant that the insurance company was cheating state governments out of tens of millions of dollars used to pay benefits to injured workers.

Joye, a former Navy lieutenant who had left a blue-chip law-firm partnership to join AIG, investigated the matter personally. He soon heard even more shocking news: that AIG chief Maurice R. "Hank" Greenberg knew about the practice--and had done nothing to stop it. Greenberg was one of the all-time great American CEOs. Could it really be true?

Greenberg's name--or his initials, by which he was known inside the company--kept coming up. In some 40 pages of handwritten notes, Joye scribbled down employees' accounts, including such comments as "MRG knows the whole prog. & that he wants it this way." And "You should be aware that MRG knows about this and has approved it." According to Joye's notes, one employee even described a meeting about the matter at which Greenberg had asked, "Are we legal?" When an employee responded, "If we were legal, we wouldn't be in business," Greenberg "began laughing, and that was the end of it."

Nonetheless, Joye reported what he had learned in meetings with Greenberg and Thomas Tizzio, then AIG's president. Then he wrote them a memo that couldn't have been blunter. AIG's behavior was "permeated with illegality," he wrote; these "intentional violations" could produce criminal fraud and racketeering charges and "expose AIG to fines and penalties in the hundreds of millions of dollars," as well as civil suits producing "astronomical damages awards." AIG, Joye wrote, needed to end the illegal practices immediately, fire all those involved, report the violations, and make restitution.

After finishing the memo, Joye met with Tizzio. What was Greenberg going to do? Nothing, Tizzio told him, according to Joye's later account. Greenberg had decided that correcting the problem would be too expensive. (Tizzio declined to comment.) Appalled at the news, Joye tendered his letter of resignation on the spot, packed up his office, and left the building. He had been at AIG for eight months.

AIG soon hired two outside law firms to look into the issues Joye had raised. They agreed that his concerns were valid, but the company dragged its feet. AIG now says it will pay restitution if it is warranted; the matter is currently under investigation by the New York State Insurance Department.

Hank Greenberg, however, did move quickly to deal with the thorny problem of a former general counsel who might publicly accuse him of condoning fraud. Two weeks after Joye quit, Greenberg sent a short note to Jules Kroll, founder of the well-known corporate-intelligence firm, forwarding background material about Joye. It is unclear whether Kroll actually dispatched private detectives to investigate Joye, although it is known that Greenberg commissioned Kroll on at least one other occasion to investigate people who accused his company of impropriety. (Kroll wouldn't comment.) Greenberg declined to speak to FORTUNE for this story.

Joye's abrupt parting with AIG was not a case of skittishness brought about by the current spate of investigations into insurance industry accounting. No, Joye left AIG in January 1992, and for 13 years he remained silent about what he had discovered there. (AIG says the workers' compensation accounting problem was finally cleared up by 2000.) Joye went on to a successful career as general counsel for two other insurance companies. Greenberg, meanwhile, grew ever more widely acclaimed and powerful, remaining unchallenged atop AIG, which he built into the industry's colossus.

But Joye never forgot his glimpse of the way AIG's CEO did business. Even after retiring to his home near Princeton, N.J., he kept his AIG files. And so, this past spring, after New York attorney general Eliot Spitzer began an investigation into Greenberg's long-buried secrets, Joye came forward to offer one of them up.

Of all the corporate scandals that have unfolded in recent years, the fall of Hank Greenberg may well loom as the strangest. Even by the account of his enemies--and Greenberg has collected plenty of those--the man is a business genius. He was toppled just months before his 80th birthday, still at the pinnacle of his field, with no intention of ending a career so long and glorious that it seemed to defy the laws of nature.

Most corporate scandals are born of desperation or greed. Not this one. AIG is no Enron. Greenberg wasn't playing tricks with the numbers to keep his company afloat; even after a multibillion-dollar restatement, AIG remains a thriving, profitable company. Nor does what happened at AIG resemble the misdeeds at Tyco, where former CEO Dennis Kozlowski spent $1 million in company funds on a toga party in Sardinia to celebrate his wife's birthday. Though Greenberg's AIG stock is worth more than $2.8 billion, he has never reveled in his wealth. A thrifty workaholic, he claims to have never sold an AIG share.

To be sure, Greenberg was famously brutal with competitors, employees, analysts, customers--even members of AIG's board, who would occasionally pose probing questions, only to have Greenberg dismiss them as "stupid." He ran roughshod over state insurance regulators. But all that was viewed as part of his genius, evidence of how much smarter and tougher he was than anyone else.

Greenberg got away with it because he produced spectacular results: Since he took the company public back in 1968, AIG's market value has soared from $300 million to $158 billion, reflecting profits that just kept rising, defying every historical pattern in a notoriously cyclical business whose costs are determined by terrorist attacks, hurricanes, and earthquakes.

No one could really understand how Greenberg produced his magic numbers. AIG was so complicated that it defied explanation, operating in 130 countries and supplementing its insurance income with profits from exotic sidelines such as aircraft leasing and derivatives trading. It was easier simply to embrace the corporate line: Greenberg was a wizard, and the company he built was like no other. He was AIG's secret--the only worry was that he couldn't last forever. As Morgan Stanley insurance analyst Alice Schroeder put it in 2002, "What investors really want is for Hank to become immortal."

Then, after 38 triumphant years as CEO, Greenberg resigned in March in the midst of an event that hit his company harder than any earthquake: the New York attorney general's investigation of alleged accounting fraud at AIG. Spitzer's probe opened up a Pandora's box at the insurance giant, out of which spilled so many allegations of impropriety that in May, AIG shaved $3.9 billion off the net income it had reported for the past five years.

The schemes were myriad, and according to a lawsuit that Spitzer and the New York State Insurance Department filed against AIG and its former CEO, Greenberg's fingerprints could be found on most of them. AIG divulged that it had done billions of dollars in business with companies in Barbados and Bermuda that it secretly controlled. The company admitted beautifying its income statement by playing games on its derivatives trading desk and vastly understating its loss reserves. Most conspicuously, AIG unwound an elaborate scheme that Greenberg personally initiated with General Re, a Berkshire Hathaway subsidiary, to increase AIG's reserves through an allegedly fraudulent "nontraditional" insurance deal. In June two General Re executives pleaded guilty to conspiring to violate securities laws. Greenberg's role in the deal is under criminal investigation by federal prosecutors.

A simple, mystifying question looms over all this: Why? Why would such an iconic corporate figure--Spitzer calls him "the most powerful businessman in the world," and it's only a slight stretch--engage in so many deceptions that ultimately made little difference to his company's rise? After sifting through the questionable transactions, AIG reduced its net worth by $2.26 billion--a decrease of only 2.7% and less than the company makes in a typical quarter. The games Greenberg is accused of playing were intended to address mundane problems: a short-term stock decline, the failure of a new business venture, an analyst's criticism that AIG was under-reserved for potential losses.

Those are the everyday headaches that CEOs learn to live with because, after all, they are not perfect. But Greenberg poured his entire being into AIG, pursuing perfection until it cost him everything. "At the end of the day, he got trapped," says former UBS insurance analyst Michael Lewis, who has followed Greenberg for more than 20 years. "He got trapped in his own little world."

These days Greenberg operates like a deposed autocrat living in exile, railing to old members of his court about the unjust fates--and unfair men--that produced his fall. But a four-month FORTUNE search to understand Greenberg's remarkable career at AIG, and the events that brought it to an end, reveals a long record of self-inflicted wounds.

Greenberg, for example, continually pressed his equities traders to buy back AIG stock to keep the price from falling. Such trades are subject to rules aimed at keeping companies from manipulating the price of their shares; for instance, companies aren't allowed to buy their own stock within ten minutes of the market's close. At one point a trader asked by Greenberg to buy AIG stock said he couldn't--Kathy Shannon, AIG's deputy general counsel, had told him it would be improper. The phone line crackled with Greenberg's response: "I don't give a fuck what Kathy Shannon says!" (Phone conversations on AIG's trading desk were taped; transcripts of Greenberg's exchanges have been sent to federal prosecutors.)

As Michael Joye had learned a decade earlier, the problem at AIG was that Greenberg built a company accountable to no one--not lawyers, not regulators, not auditors, not even directors. No one, that is, but himself.

People who visited Hank Greenberg on the 18th floor of AIG's art deco skyscraper just off Wall Street were greeted by what a former executive describes as "a triple-black-belt, super-badass, former CIA guy." Once the guard had looked them over, guests were ushered into an anteroom decorated with Asian art and framed photos of Greenberg with world leaders and several U.S. Presidents. After a while the imperial CEO would enter ceremoniously through a side door. It wasn't unusual for Greenberg's visitors to sit uncomfortably while he was served tea and they were offered nothing at all.

Visitors accepted such condescension from Greenberg because they knew he was capable of much worse. He could be intensely loyal to his employees, but he was also a bully of epic proportions. The son of a candy store owner on New York's Lower East Side, Greenberg landed on Omaha Beach on D-Day and served in the infantry unit that liberated Dachau. He was famous for screaming like a drill sergeant at his underlings, even his eldest two sons, Jeffrey and Evan, both of whom were groomed to succeed him but quit AIG and went on to run other insurance companies. (For more about the Greenbergs' difficult family relationships, read "Greenberg & Sons" on fortune.com.)

No story sums up the two sides of the CEO better than this one told by K.C. Shabani, who retired from AIG two years ago after 46 years with the company. Shabani, an Iranian American, had been working at AIG in San Francisco for 16 years when his boss summoned him to New York in 1972 for a meeting. The CEO had learned that Shabani knew members of the Shah of Iran's family. The Shah had never allowed a foreign insurer to operate in his country, and Greenberg wanted AIG to be the first. "Go to Iran and find out what we can do to get AIG admitted," Greenberg told Shabani.

Shabani traveled to Tehran and found that the only way AIG would be able to do business there would be to persuade the Iranian government to pass a law inviting the insurer into the country. He returned to New York and explained to the CEO that this was unlikely: "If I were you, I'd give up."

"K.C.," Greenberg curtly replied, "I didn't ask you to tell me what was necessary to do this. I just asked you to get it done."

So Shabani spent a year and a half lobbying the Iranian Finance Minister, an old friend, and in 1975 the Iranian government passed a law permitting AIG to become the country's first foreign insurer. AIG made quite a bit of money there until the Shah fled the country in 1979 and Ayatollah Ruhollah Khomeini, a radical Islamic cleric, became the nation's leader. The new regime seized AIG's assets. Shabani was accused of being a CIA operative and thrown in jail. (He says the real reason was that AIG disputed the amount of a claim filed by a businessman who became a powerful figure under Khomeini.)

After spending a year in jail so harrowing that his hair turned white, Shabani was released from prison, but he still couldn't leave the country. Then he got a call from someone telling him that AIG had arranged to get him out. One day a car pulled up at his sister's house, where Shabani was staying. The driver of the car never identified himself, but Shabani recognized the other two occupants as former ministers of the Shah's regime who had been in hiding. The driver transported the three men 800 miles to the Turkish border. "This was during the war with Iraq," says Shabani. "The airports were closed. There were no cars on the road. We could have been stopped and killed at any moment."

Shabani says AIG spent nearly $1 million to get him out of prison and out of the country, including $300,000 paid to an Iranian doctor who arranged for his trip to the border. He says Greenberg wouldn't discuss the matter with him but smiled when asked about it. "He would go through anything to help his people," Shabani says.

The insurance industry has always been known for its creative accounting. It is one of a few industries in which you know your income--every month your mailbox is flooded with checks from policyholders--but your costs are a mystery. Just look at the claims that insurers are being asked to pay today for asbestos exposure dating back to an era when men wore hats and drove cars with wondrous fins.

Insurance companies aren't regulated by the federal government; they answer to state insurance commissioners, who are primarily concerned about their solvency. It's not difficult for a company with the resources of AIG--its revenue last year was $98 billion--to run circles around them. AIG's organization chart contained so many hundreds of subsidiaries, listed in such tiny type, that it was best read with a magnifying glass. One state insurance official took a look at it and exclaimed, "We regulate that?" Greenberg treated state oversight as an annoyance. Examiners had to pry data out of the company. "No one wanted to do the AIG exam because it was always a battle," says New York State insurance superintendent Howard Mills. "There was a disdain for regulators, and it fostered a corporate ethos that wasn't good for the company."

Greenberg's defenders don't deny that he may have played games with AIG's numbers to dress up its financial results. They argue that any such accounting moves don't constitute criminal acts and ultimately had little effect on the net worth of AIG, a company that meant everything to its former CEO. "Whatever faults he might have, he was dedicated to the company," says Ernest Stempel, a former AIG director. "Whether some of the things he did were a little bit dicey, I don't know. Probably yes. But he was always thinking about some way to help the company."

"They're not black-and-white transactions," says audit committee chairman Frank Hoenemeyer, a Greenberg admirer who is stepping down from the board. "Even if you take the worst view of what he did, it was not for any personal gain."

Greenberg's allies argue further that it is unfair to prosecute him for some of the misdeeds when the industry's rules are so murky. Henry Kissinger, a Greenberg friend who has consulted for AIG, calls his plight "a terrible human tragedy." He finds it hard to believe that Greenberg did anything illegal. "I can imagine an excess of perfectionism," says Kissinger. "I can imagine [him] going to the edge of what was permissible. But I cannot imagine that he would deliberately go over it."

Spitzer has a dramatically different view. "These things were fundamentally wrong," he told FORTUNE, "and it was known at the time that they were fundamentally wrong."

Either way, no one doubts that Greenberg was exceptionally skilled at exploiting the complexities of the business. As he said on more than one occasion: "All I want in life is an unfair advantage."

Every so often a strange man from AIG's Bermuda office showed up at the company's New York headquarters with a battered leather briefcase. His name was Michael Murphy. He didn't bother to comb his hair or iron his shirts. "He's one of those people who start a conversation in the middle of a thought, and you are like, 'Did I miss the first two paragraphs?' " says a former AIG top executive. "After you finally catch up, you realize he's a very sharp guy and a very sharp tax lawyer."

Murphy had an encyclopedic memory for international tax law. He was such an expert that Sir John Swan, Bermuda's former Premier, took him to Washington to help negotiate the U.S.-Bermuda tax treaty of 1988--which was a boon to the island's insurers because it exempted them from U.S. premium taxes. "He has a brilliant legal mind," Swan says. Greenberg felt the same way. He wanted Murphy to move to New York and become AIG's general counsel. Murphy declined--he wanted to stay at AIG's five-story office building in Hamilton, Bermuda, and row his skiff to work each morning across the bay.

Murphy's official title at AIG was vice president--special projects. But he wore many hats in the world of AIG. On some of his New York visits, for example, he was representing two private companies closely tied to AIG, C.V. Starr & Co. and Bermuda-based Starr International Co. (SICO), which together formed an unusual retention program. Both held substantial amounts of AIG stock and were used to reward top employees. SICO beneficiaries were given stock every other year, but there was a catch: They couldn't cash in until they were 65. C.V. Starr was reserved for Greenberg's inner circle. It held its own insurance agencies that did business with AIG and paid "Starr partners" additional compensation.

An air of mystery surrounded these perks. One former Starr partner recalls receiving a sheet of paper with two numbers: "You'd say, 'What's this?' And Murphy would say, 'Oh, that's what you had last year, and that's what you have this year.' You'd say, 'Oh, great. Is there anything behind these numbers?' He'd say, 'Yup.' You'd say, 'Can I see it?' He'd say, 'Nope.' "

There were a lot of things at AIG that you couldn't see. There was an archipelago of offshore subsidiaries that, like SICO, operated outside the jurisdiction of U.S. regulators. These obscure companies were keys to AIG's astounding growth, allowing the parent to shift risk off its books and hold down its reserve requirements. They were also the breeding ground for the kinds of controversial deals that ultimately led to Greenberg's downfall. One of the threads linking most of these affiliates together was that, until AIG fired him last March, Murphy was their treasurer.

Bermuda has a pleasant climate for business--no corporate income tax--but it is especially alluring to insurance companies because of its generous rules on discounting loss reserves. U.S. insurers are required to immediately establish a reserve--that is, send a cost through their income statements--for the full amount of their anticipated losses. In Bermuda the authorities make allowances for the fact that insurers won't have to pay out their losses immediately, so insurers there can assess themselves right away with a smaller cost. That means that U.S. companies recognize their profit slowly, while Bermuda insurers can take it upfront, benefiting from the "discount" of their reserves. The same is true in Barbados, another haven for AIG subsidiaries.

Most people don't want to buy their insurance from a company in a distant land, however; they want a local address if they have to make a claim. So during the past 20 years or so, the islands have become havens for reinsurers, the behind-the-scenes companies that sell insurance to insurers, mitigating their risk and letting them shrink their loss reserves.

From its earliest days, AIG was especially aggressive in using large amounts of reinsurance to grow. It wrote risky policies covering companies for things like terrorism and expropriation of property by foreign governments, then reinsured those policies to keep its required reserves down. Its U.S. competitors reinsured perhaps 10% of their premiums; AIG funneled as much as 70% to reinsurance companies. This meant relinquishing some of the profits, but it let the company use its limited capital for growth.

That strategy looked like genius when the global recession hit the insurance industry hard in 1984. Many U.S. insurers didn't have the cash flow to cover their underwriting losses with investment profits, so they stopped writing high-risk policies like product-liability and hazardous-waste coverage. The supply of those products dried up, and the price skyrocketed. AIG was one of the few insurers with enough capital to stay in the game, and for it, the crisis became a gold rush. "We were suddenly the only game in town," says a former senior vice president. "So in a lot of cases it was move-the-decimal-point time. I remember there was one [directors and officers liability] policy that leaped from $70,000 a year to $7.5 million." The trick was finding reinsurers that could accept the huge amounts of new premiums that AIG needed to get off its books--reinsurers had been hit by the recession too, and several big ones that did business with AIG had failed.

On Dec. 14, 1987, a company called Coral Reinsurance was founded in Barbados. Four days later it accepted $160 million in premiums from AIG covering $400 million in estimated losses. Coral Re had only $52 million in capital, which meant it was in no position to cover those losses. By 1991 it was holding more than $1 billion in estimated losses from AIG, and its capital had dwindled to $15 million. That caught the attention of regulators in several states.

It soon became clear that Coral Re had one customer: AIG. Furthermore, much of the business that AIG handed off to Coral Re had previously been in the hands of its now insolvent reinsurers. By shifting those deals to Coral Re, AIG avoided having to bring the losses back on its own books. The more regulators examined Coral Re, the more they were convinced that it was under AIG's control. This was no small matter. Insurers must submit reinsurance deals with affiliated companies to state authorities so that they can judge whether they are truly arm's-length transactions. AIG, however, insisted that Coral was not an affiliate and refused some of the regulators' requests for information, saying the offshore company simply didn't want to make it available.

Finally, the Delaware insurance department did something extraordinary: It filed a Freedom of Information Act request with the Arkansas Development and Finance Authority--one of Coral Re's shareholders--and obtained a "confidential private-placement memorandum" prepared for investors by Goldman Sachs. It stated that AIG had created Coral Re so that AIG could do more business in the U.S. While AIG had no direct ownership in Coral Re, it lined up the company's shareholders and arranged for a bank to finance their investments in the reinsurer.

AIG pushed back hard. Greenberg called Donna Lee Williams, then the Delaware insurance commissioner, to inform her of his displeasure. Williams won't discuss the details, but she sums up the exchange this way: "Mr. Greenberg is not always the most pleasant person to deal with." (One of her subordinates says Williams was so offended by what he said that she hung up on him.) Private detectives from Kroll showed up in neighborhoods where two Delaware regulators lived, knocking on doors, asking questions. The detectives made it known that they were acting on behalf of AIG. "They were clearly trying to intimidate us," says a former regulator.

In the mid-1990s several states ruled that AIG's dealings with Coral Re were sham transactions that had been accounted for improperly because there was no real risk transferred between the companies. AIG grudgingly agreed to wind up its business with Coral Re. But it declared victory in its dustup with the regulators. It never admitted that Coral Re was an affiliate. It was never fined. The states simply made AIG promise to report any similar reinsurance transactions in the future.

That appeared to be the end of AIG's problems with questionable links to offshore reinsurers. In truth, it was only the beginning. In a routine filing with Delaware authorities in 1996, an AIG division reported that it had transferred large pieces of reinsurance from Coral Re to a Barbados company called Union Excess. Union had been secretly created in 1991 by Joseph Umansky, president of AIG's Reinsurance Advisors unit. According to the Spitzer suit, Umansky testified that he modeled Union Excess on Coral Re, and that Greenberg was aware of it. AIG never told regulators this. Last May, when AIG finally acknowledged that it controlled Union Excess and consolidated the reinsurer, it had to write down $951 million.

By the mid-1990s Hank Greenberg had blown past all his competitors. More than an insurer, AIG was now a blue-chip financial services company with a high-powered derivatives trading desk and a lucrative aircraft-leasing business.

In the insurance business, most companies actually lose money writing policies and earn their profits by investing premiums. But Greenberg had always preached that underwriting was paramount--and AIG's record of making money on underwriting gave it a premium multiple on Wall Street. The market valued underwriting profits far more highly than volatile investing results.

But now the insurance industry was settling into the doldrums. Prices began to fall. So did interest rates, making it harder for companies to make up the difference with investment income. "That put the double whammy on us," says a former top AIG executive. "Everybody was desperate for new business."

The answer at AIG increasingly was "finite insurance," perhaps the most controversial product ever conjured up by the industry. Finite insurance began as a financial product that insurers bought from reinsurers to smooth their earnings. It morphed into a financial product that insurers sold to their customers who were looking for prettier numbers themselves.

Finite insurance comes in many shapes, but the one that has been most problematic for insurers like AIG has been the "loss-portfolio transfer." A loss-portfolio deal works something like this: Say a company has $100 million in legal claims involving asbestos liabilities that it needs to get off its books on the eve of a bond issue. It hands this entire "loss portfolio" to an insurance company for an $80 million premium. The insurer is happy to do the deal because it believes it can park the premium in a bond, where the premium can grow beyond the loss amount before it has to pay the claim.That's especially easy if the insurer is located in a tax-friendly locale like Bermuda.

A lot of tricks can be played with such transactions. Because they almost always involve losses that have already occurred, insurers can sometimes calculate almost down to the penny how high a premium is needed to match the losses. But insurance regulators take a dim view of such deals because they can involve virtually no risk transfer from the customer to the insurer. If there's no risk, regulators say, they should be treated as financing deals, not insurance, which means their accounting benefits evaporate.

How do insurance companies get around that? They try to structure transactions with just enough risk to make them legal. And how much is that? The rules are astoundingly vague, requiring only that it be "reasonably possible" that an insurer incur a "significant loss." Sometimes the insurer and its customer circumvent them entirely with a secret side letter stating that the deal is off if the losses turn out to be more than the insurer predicted.

The more habitually its customers used finite insurance to beautify their numbers, the more AIG itself became addicted to it. "All of a sudden you have this product that makes the difference between whether you make your budget or whether you are way under," says a former AIG vice president. "It made huge money for us, and it was considered a sure bet because you didn't have the risks that you had with traditional insurance."

Loss-portfolio transactions became so hot that a division sprang up within AIG called the Loss Mitigation Unit. In 1998 the LMU tailored a policy that made $11 million in losses disappear from the financial statements of Brightpoint, a cellular-phone company in Plainfield, Ind. As the SEC would later put it, the deal was "merely a roundtrip of cash--a mechanism for Brightpoint to deposit money with AIG in the form of monthly premiums, which AIG was then to return to Brightpoint as purported 'insurance claim payments.' "

In 2003 the SEC accused AIG in a civil suit of committing accounting fraud with Brightpoint. AIG paid a $10 million fine to settle the case. The agency doubled the fine because of AIG's failure to cooperate with the investigation--and chastised the company for its delay in turning over subpoenaed documents, including an internal white paper on how to market these policies. "It completely contradicted everything they'd been saying about how this was just the fault of one [LMU] guy who wasn't getting supervised," says Mark Schonfeld, the SEC's Northeast regional director.

After the Brightpoint settlement, AIG publicly cast the episode as an isolated incident. In fact, as company executives knew, regulators were already digging into another AIG deal aimed at dressing up a company's financial statements.

Earlier in 2003 the U.S. Justice Department had entered into a "deferred-prosecution" agreement with a big AIG customer: a subsidiary of PNC Financial Services, the nation's seventh-largest bank-holding company. The agreement covered criminal charges for conspiracy to violate securities laws in connection with PNC's fraudulent transfer of $762 million in troubled assets to off-balance-sheet entities. Its deal with the feds required PNC to pay $115 million in restitution and fines and provide "complete cooperation" in the government's investigation.

The target of that investigation was AIG. In three transactions reminiscent of Enron, AIG had formed special-purpose entities to let PNC tidy up its financial statements by removing bad assets from its balance sheet. The work had been lucrative for AIG, generating $40 million in fees. But the structures failed to meet accounting requirements for off-balance-sheet treatment, putting AIG once again in regulators' cross hairs.

If Brightpoint was "strike one" for Greenberg, PNC soon became "strike two." Once again AIG was "basically uncooperative" with the SEC's investigation, says a senior regulator involved in the case: "They kept talking about their impeccable reputation." But by the summer of 2004, AIG reached a tentative settlement with both the Justice Department and the SEC. The SEC set a deadline for signing the papers.

That's when Greenberg decided to fight instead, rejecting the deal at the 11th hour. Furious, the government lawyers quickly shifted into combat mode. "We were just going to war," says one. In October 2004--after AIG issued press releases disclosing that both the SEC and the Justice Department were considering legal action, describing the investigations, and calling them "unwarranted"--the SEC formally warned the company that it faced possible civil action for "misleading" statements in its press releases. Justice warned the company too.

An AIG director says the board was shocked when Greenberg blew up the PNC settlement. They urged him to settle; he couldn't treat the feds like state insurance regulators. "You can't win in this situation," one director told him. (A spokesman for Greenberg says that he kept the board informed about his handling of the matter, and that the board was supportive.)

There was more bad news that month. Spitzer filed a civil suit in a wide-ranging investigation of kickbacks and bid rigging in the insurance business. AIG was named in the suit without being charged (the central player was Marsh & McLennan, the big insurance broker run by Greenberg's son Jeffrey, who was quickly removed as CEO). AIG also publicly revealed that it was facing possible federal criminal charges for Brightpoint.

On Oct. 25, Greenberg finally sent up the white flag. An AIG press release reported that the company "intends to seek a prompt resolution of outstanding issues" with both the SEC and the Justice Department.

But the price had risen in the weeks since Greenberg had rejected the deal. The penalty had jumped by $20 million, to $126 million. The government would also require AIG to hire a consultant to scrutinize any questionable deals it had completed for other companies since 2000. By the end of November the settlement was signed. The Justice Department agreed to defer prosecution of criminal fraud charges against an AIG subsidiary in connection with the PNC transaction. If the company kept its nose clean through the end of 2005, the case would be dropped.

For years the AIG board had given Hank Greenberg free rein to run the company as he wished. But now directors started to doubt him. Greenberg's handling of the Brightpoint and PNC problems had been a disaster. And it had all been so unnecessary! After Brightpoint, the board's outside directors retained their own attorney, Simpson Thacher & Bartlett chairman Richard Beattie, to provide counsel and a back channel to regulators. The directors began to pressure the 79-year-old CEO to announce a corporate succession plan. Greenberg could go out in a blaze of glory--perhaps on his 80th birthday.

For a few months it looked as though that might happen. On Feb. 9, Greenberg announced a record year for AIG. For the first time profits had soared over $11 billion. What's more, Greenberg declared in a conference call with analysts, the company was putting its regulatory problems to rest. When a questioner asked about the "hostile regulatory environment toward business," Greenberg couldn't help himself. The crackdown was excessive, he said. "When you begin to look at foot faults and make them into a murder charge, then you have gone too far."

That evening Spitzer, who had read about Greenberg's remarks on the Internet, was the dinner speaker at the offices of Goldman Sachs, where the firm was conducting a compliance program for its managing directors. Spitzer departed from his speech to address the AIG chief's comments. "Hank Greenberg should be very, very careful talking about foot faults," he warned. "Too many foot faults, and you can lose the match. But more importantly, these aren't just foot faults."

Although it wouldn't be publicly disclosed for five more days, that very evening Spitzer's office was serving AIG with the subpoena that would end Greenberg's career.

The tip that led to Hank Greenberg's office came from an improbable source: Berkshire Hathaway. Warren Buffett's company was already under scrutiny from both the Justice Department and the SEC. Regulators were investigating a Berkshire reinsurance subsidiary, General Re, for selling finite coverage used to hide the deteriorating financial condition of a Virginia malpractice insurer. That deal prompted a question: Who else had Gen Re helped to dress up financial statements?

While the federal prosecutors wanted to know the answer to that question, they wanted to get it quietly. Buffett's company was a big fish, and they didn't want to tip off witnesses--or, for that matter, Spitzer, lest he end up moving first and taking the credit, as often happened. So instead of a subpoena, they sent Berkshire more informal "information requests." But to the feds' surprise, Berkshire, on Dec. 30, disclosed the federal inquiry anyway. Spitzer instantly jumped in, sending Berkshire a subpoena demanding information about Gen Re's finite insurance business.

On Feb. 8, Berkshire's lawyers arrived in Spitzer's office to tell the regulators about a deal certain to grab their interest: a finite insurance transaction between Gen Re and AIG. In this deal it was Greenberg's company buying the stuff. What's more, explained the visiting lawyers, it wasn't some midlevel transaction between flunkies. Greenberg had initiated it personally. The Berkshire lawyers had presented Spitzer's staff with an inch-thick, three-ring binder filled with tabbed documents; now they walked them through the entire deal.

It started with an Oct. 31, 2000, phone call by Greenberg to Gen Re CEO Ron Ferguson. Greenberg had been stung by analysts' concerns that AIG's loss reserves were too low. The analysts suspected that AIG had drawn down reserves to boost quarterly profits, and the issue was hurting AIG's stock, which had fallen 6%. According to Spitzer's suit and filings by the SEC and the Justice Department, Greenberg, in his call to Ferguson, proposed to solve this problem through a phony reinsurance deal. Through a complex series of transactions, it would work like this: Gen Re would ostensibly buy $600 million in reinsurance coverage from AIG for a $500 million premium, creating the appearance of a $100 million risk. AIG would boost its reserves by $500 million. But Greenberg told Ferguson he didn't want to assume any actual risk, according to the state and federal filings. To accomplish this, according to the SEC, the deal's "purported terms were all undone in undisclosed side agreements," rendering the deal a "sham."

Ferguson's deputies at Gen Re, which would receive a $5 million fee, dubbed the operation "Project Alpha." A memo noted: "Specific guidance has been received from Ron Ferguson that this contract is to be kept confidential," locked in a supervisor's desk "at all times." To carry out the deal, Gen Re turned to a subsidiary in Dublin, whose CEO, John Houldsworth, also served as chief underwriter for Gen Re's "alternative solutions" business. Houldsworth noted in an e-mail that AIG had "the intention that no real risk is transferred." Houldsworth was caught on tape remarking about AIG, "If there's enough pressure on their end, they'll find ways to cook the books, won't they?"

And so it was that on the day that Greenberg was railing about "foot faults," Spitzer's investigators served AIG with a shockingly detailed subpoena. Although Justice and the SEC soon requested documents, too, it was Spitzer's office that turned the knife, two days later, by issuing a subpoena for Greenberg's deposition.

This development put Greenberg--and AIG--in an exceedingly difficult position. After Brightpoint, the AIG board had proclaimed that any employee who didn't cooperate with regulators would be fired. But Greenberg's newly hired criminal lawyers were certain to tell him to take the Fifth--and Spitzer was insisting that Greenberg give his deposition no later than March 17.

The AIG board launched an internal investigation. When the directors asked about the Gen Re deal, Greenberg told them little, blustering, "This is my business judgment!" The board sent emissaries to urge him to resign: Pete Peterson, chairman of Blackstone and former Commerce Secretary, and Frank Zarb, the AIG board's lead independent director, who had once run Nasdaq.

On Sunday, March 13, AIG's independent directors gathered at the Midtown law offices of Simpson Thacher with their attorney, Beattie. They met for eight hours. Greenberg called in from a yacht, called Serendipity II, off the Florida coast. "You're going to destroy the company!" he warned. "You don't understand the insurance business! If I have to go, the stock is going to tank." Would he take the Fifth? the board asked. Greenberg said he wasn't sure. (Ultimately he did.)

By nightfall the directors had agreed unanimously to ask for Greenberg's resignation as CEO. He would be permitted to remain as nonexecutive chairman. Greenberg was replaced as CEO by Martin Sullivan, the company's 50-year-old co-COO, an affable Briton who had started with AIG at the age of 17. He was Greenberg's choice.

In the days after Greenberg's resignation as CEO, attention shifted to Bermuda, where AIG's internal investigation focused on offshore operations and the role of SICO. By March 22 a legal team from Paul Weiss Rifkind, one of the two firms conducting the internal inquiry, arrived at the AIG building in Hamilton, where SICO also had offices, to review documents and conduct interviews. Spitzer and the SEC had both issued broad subpoenas for AIG materials and were soon likely to zero in on the offshore records.

On Wednesday, March 23, a group from David Boies's New York firm, representing Greenberg and SICO, arrived on the scene. The AIG lawyers had placed boxes of SICO records in a fourth-floor office and marked files with stickers, yellow for AIG files and blue for "non-AIG" files. The Boies team began reviewing the records under the supervision of an AIG employee posted outside the room--and after receiving explicit instructions that no documents could be removed. (Greenberg's lawyers insist they never agreed to such a condition.)

On Thursday, after orders had gone out across the company to secure files for regulators, AIG employees in Dublin seized a computer used by a single SICO official sharing company office space there, confiscated her key, and changed the door locks. The SICO team reacted quickly. That night, while the Paul Weiss attorneys returned to the U.S. for the long Easter weekend, Mike Murphy, the Greenberg loyalist who worked for both AIG and SICO, leased secure storage space in Bermuda. The AIG building was officially closed the next day for Good Friday, but the Boies team used Murphy's electronic passkey to gain entry that morning. Then, with the help of movers, they hauled 82 boxes of SICO and "non-AIG" documents out of the building.

A member of Greenberg's legal team says they were merely seeking to "secure" records that belonged to SICO, prompted by the episode in Dublin. "There was absolutely no reason to seek anyone's permission," a Boies partner insists. "It was not their files."

At 10:45 A.M. on Saturday the Boies group returned to look for any files that may have been left behind. But this time they were confronted by attorneys from AIG's Bermuda law firm and the head of the company's Bermuda office, who ordered them to leave the premises.

Back in New York, the news that Greenberg's attorneys had taken possession of 82 boxes of possible interest to regulators produced an instant firestorm. SICO was incorporated in Panama. Was Greenberg moving evidence beyond the reach of U.S. regulators? "Looks like they're destroying documents in Bermuda" was the message relayed to a top SEC official. Beattie alerted Zarb, saying, "Happy Easter! We have a problem."

The SEC and Spitzer's office issued subpoenas to Boies's firm, SICO, and AIG for the records. Spitzer himself, reached on a ski vacation in Vail, Colo., warned AIG's outside lawyers that this "document caper" was unacceptable--and he would hold the company responsible for Greenberg's actions. Wasn't Greenberg still AIG's chairman? If something wasn't done quickly, Spitzer warned, the company could face indictment for obstruction of justice. AIG, he warned, had "criminal exposure."

By Sunday, new CEO Sullivan had flown the company's corporate security director to Bermuda to lock down the island facilities. After an angry exchange of e-mails--and a threat of legal action by the SEC--the regulators, AIG, and Greenberg's lawyers reached an agreement to grant everyone access to the records, which remained sealed and secure in storage. On Sunday, March 27, Sullivan fired Murphy, both for his part in the document caper and for refusing to answer questions from the outside AIG lawyers conducting the company's investigation. Murphy's attorney says he has done nothing wrong.

The next day the board convened again, prepared to oust Greenberg as chairman. Minutes before the meeting, Boies passed word that Greenberg would retire, ending his 45-year career with AIG.

Greenberg's departure was followed by a widening of the investigations into AIG's finances. The outside lawyers, who were gathering information that would guide AIG's preparation of the accounting restatement, received dozens of tips from employees. Now bending over backwards to cooperate, AIG passed evidence of possible misdeeds to Spitzer's staff, the Justice Department, and the SEC.

By late spring a distinct picture had emerged: For years Greenberg had employed sleight of hand to improve AIG's results. Several manipulations polished AIG's cherished image as the industry's best underwriter. Greenberg and his top deputies--including CFO Howard Smith, who was fired on March 14 and later named in Spitzer's suit--cooked up schemes to disguise underwriting debacles as investment losses. One example cited in the complaint was AIG's disastrous entry into the car-warranty business, which was projecting a $210 million loss in 1999. Rather than admit the problem, AIG executives, with Greenberg's blessing, put the business in an offshore shell company, then booked losses on its ownership stake in the company. Voila! The underwriting failure became an investment loss. In another example, an Alaska subsidiary was tapped to convert an investing gain into an underwriting profit.

When all else failed, Spitzer's complaint charges, AIG simply made numbers up. CFO Smith created fictitious "topside" adjustments, increasing reserves to the levels analysts wanted, according to the complaint. Smith personally directed the changes, rattling them off to a subordinate who jotted them down in a spiral notebook, the suit claims. AIG says it could find no documentation or analysis to justify the changes, which Smith had begun making at least as far back as the early 1990s, according to Spitzer's suit. "For quarter after quarter," says the complaint, "AIG's official books and records were altered on the basis of nothing more than Smith's say-so and [the] handwritten sheets, with hundreds of millions of dollars shifting from account to account." Smith's lawyer says the adjustments were approved by the company's auditors.

When AIG in May restated its results, besides acknowledging that it secretly controlled Union Excess and other offshore reinsurers, it said it had suffered from "control deficiencies, including the ability of certain former members of senior management to circumvent internal controls over financial reporting in certain circumstances." The restated earnings revealed AIG's vaunted underwriting business to have been unprofitable for four years--much like the rest of the insurance industry.

On May 4, Hank Greenberg celebrated his 80th birthday with his family at his home in Manhattan. It was an emotional day for the ex-CEO. His sons Evan and Jeffrey, whose relationship with their father has been strained, came with their wives and children. His son Scott, a venture capitalist, showed up with his family. His daughter, Cathleen London, came alone.

They sat down for dinner. Hank Greenberg grew angrier and angrier as he and his sons discussed Eliot Spitzer. Finally London shushed everybody and gave her father a birthday toast. She recalled his achievements as AIG's head and said it had to end sometime. "God had to create this way to get you out."

Greenberg smiled. "Well," he said, "you could have found an easier way."

London says her father has been doing some soul-searching. He has visited a rabbi in Canada and a guru in India. (A Greenberg spokesman denies that he has engaged in any "soul-searching.") Says London: "He's mostly okay. I feel like my job as his daughter is to get him thinking about other things beyond this."

It now seems unlikely that the New York attorney general will file criminal charges against Greenberg, preferring to leave that fight to the feds, who are focusing intently on the AIG-Gen Re deal. Negotiations for the settlement of Spitzer's suit against AIG are expected to move swiftly. A settlement with Greenberg will be far more difficult. Spitzer says, "If there's ever a resolution, he's going to have to admit he committed fraud."

Greenberg remains chairman of SICO--which continues to hold billions in AIG stock--and he has set up shop in that company's new Park Avenue offices. On July 6, SICO sued AIG, demanding that it hand over a $15 million art collection, business records, stock certificates, and keys to safe-deposit boxes in offices SICO shared with AIG. Earlier Greenberg blasted his former company for refusing to let him collect his personal office possessions, including the medical records for his dog, Snowball. (The records have since been handed over.)

Greenberg is considering voting the AIG shares that he controls against the company's auditor and some members of the board at the annual meeting Aug. 11, on the grounds that the company's restatement was unnecessary. "It's just outrageous," Greenberg said of his predicament in a brief phone conversation with a FORTUNE writer not long ago. "I can't believe I'm in America. I wouldn't do anything dumb in the last inning of a ballgame."

AIG's CEO Martin Sullivan responds simply: "We did what was right." In the future, he adds, AIG will prosper "with the right controls and checks and balances in place, and the right level of compliance. And candidly, they're not mutually exclusive." A new era has begun at AIG, he says: "I have a different style. One of my abilities is to get the best out of people, in the right way. It's the parts that make up the whole. It's not a one-man band."

Reporter Associate Doris Burke

FEEDBACK dleonard@fortunemail.com; pelkind@fortunemail.com