Brightpoint Inc.'s former director of risk management is a target of a federal grand jury criminal investigation into a 1999 deal regulators say allowed the Plainfield company to conceal more than $11 million in losses.
The U.S. Attorney's Office in Indianapolis filed papers in a Manhattan federal court April 12 identifying Timothy Harcharik, Brightpoint's director of risk management from 1997 until his dismissal in 2002, as one of the targets of the nearly complete securities-fraud probe.
On the other side of the 1999 deal was the world's largest insurer, New York-based American International Group, which identified itself as a criminal target in November and reached a settlement a month later.
While a Securities and Exchange Commission civil probe into the deal several years ago targeted Harcharik and former Brightpoint Chief Accounting Officer John Delaney, the Manhattan filing reveals for the first time that the criminal probe extends beyond AIG.
"The grand jury is actively pursing this investigation through its subpoena power and the investigative efforts of this office, the FBI and the [U.S. Postal Inspection Service]," the filing by Assistant U.S. Attorney Winfield Ong says.
Grand jury investigations are normally secret. Ong made the filing in the SEC's civil fraud lawsuit against Harcharik because he wants that regulator to put its case on hold while the grand jury wraps up its work. The U.S. Attorney's Office might seek to indict Harcharik within 10 weeks, the filing says.
The 13-page document does not identify other targets, and First Assistant U.S. Attorney Timothy Morrison would not comment. Brightpoint officials, as well as Harcharik and his attorney, did not return calls. Delaney declined to comment.
Unlike AIG, Brightpoint has not disclosed the criminal inquiry in recent SEC filings. Corporate governance experts say that probably means neither Brightpoint nor any of its current employees have been identified as targets.
Like the SEC probe, the criminal investigation focuses on Brightpoint's purchase of a product from AIG that allegedly allowed it to manipulate its financial statements, spreading out $11.9 million in losses that should have been reported in 1998.
The SEC's inquiry threw into the spotlight a little-known corner of the insurance industry-the marketing of products under the insurance banner that some insurers and clients abused in order to dupe investors.
Controversy over AIG's role in the Brightpoint deal and other questionable transactions contributed to the ouster last month of AIG CEO Maurice R. "Hank" Greenberg. AIG and Greenberg remain the focus of multiple investigations, including one led by New York Attorney General Eliot Spitzer. So far, Brightpoint, a cell phone distrib- utor with operations around the globe, has had only a bit part in the drama, receiving occasional mentions in the national press in stories detailing AIG's woes.
Brightpoint's board, along with founder and CEO Robert Laikin, launched a series of moves several years ago to reduce the risk of future accounting problems, including tightening internal controls and sharpening corporate governance.
Both Brightpoint and AIG settled the SEC civil case in September 2003 without admitting wrongdoing. Brightpoint agreed to pay $450,000 and AIG $10 million. At that time, SEC official Mark Schonfeld lambasted AIG, saying that during the investigation, "AIG did not come clean. On the contrary, AIG withheld documents and committed other abuses."
Last November, AIG agreed to pay an additional $126 million in penalties to settle civil and criminal investigations into the deal with Brightpoint and transactions with Pittsburgh-based PNC Financial Services Group Inc.
AIG still may have exposure from the Brightpoint deal, however. The pact included conditions, such as AIG's continued cooperation with government investigations. And individuals within the firm could face criminal prosecution.
In his filing in Manhattan, Ong offered few specifics but made the probe sound sweeping.
"The investigation involves a significant fraudulent scheme," Ong wrote. "In addition to the charges of securities fraud, wire fraud and bank fraud, the grand jury is investigating allegations of obstruction of justice."
None of the Brightpoint employees identified by the SEC as having a hand in the AIG deal remain with the Plainfield company. It dismissed Delaney in February 2002, and two months later Chief Financial Officer Phil Bounsall left as well, collecting $1 million in severance. Bounsall, now executive vice president at Indianapolis-based Walker Information, couldn't be reached for comment.
Delaney settled with the SEC in 2003, agreeing to pay $100,000. Bounsall, accused by the SEC of failing to adequately review the AIG deal, also settled, for $45,000.
Harcharik, an independent contractor who owned a risk-management firm with Laikin's father, was the sole target of the SEC probe not to cut a deal. The SEC's suit against him has been pending in Manhattan federal court for 18 months.
According to the SEC, Delaney and Harcharik hatched the fraud in December 1998, after the company discovered losses from closing a United Kingdom division were going to approach $29 million-far higher than the $13 million to $18 million it publicly estimated two months earlier.
At the time, Brightpoint shares already had fallen 60 percent for the year. More bad news might have dealt further blows. Instead, according to the SEC, Delaney and Harcharik "devised a scheme to cover up these additional, unanticipated losses, rather than disclose them."
The solution? A product hawked by an AIG subsidiary that helped companies "smooth" financial results. In return for a $100,000 fee, the SEC says, AIG fashioned $15 million in "retroactive" coverage at a cost to Brightpoint of $15 million.
Retroactive insurance may sound like an oxymoron, but in itself it's not improper. A company facing lawsuits from a chemical spill, for instance, might buy the coverage to limit its exposure from unfavorable court verdicts.
However, in such cases, there must be a true transfer of risk. SEC investigators say there was no risk transfer between Brightpoint and AIG. They say the "premiums" Brightpoint provided AIG were really deposits, since AIG agreed to give them all back.
While improper in itself, the arrangement wasn't enough to hide Brightpoint's loss, according to the SEC, since accounting rules require booking the cost of retroactive insurance up front. Brightpoint wanted it spread over several years to obscure the U.K. loss, investigators say.
So Brightpoint and AIG agreed to combine the retroactive coverage with other insurance, the SEC alleged. And in a further effort to avoid detection, they ratcheted back the effective date to August 1998, even though by then it was January 1999.
"Most of the meetings that go on with AIG and Brightpoint [back then] involve how to avoid having Brightpoint's auditors find things," SEC official Andy Calamari told IBJ in 2003. "There were constant discussions about red flags."
After the SEC began an inquiry in the fall of 2001, auditors from Ernst & Young took a closer look at the arrangement. At the very least, E&Y concluded, the coverage was retroactive, requiring the booking of all premiums up front. In November 2001, Brightpoint restated financials to reflect that view.
Just two months later, it restated again. The reason: Auditors had learned that a day before the first restatement, Brightpoint had canceled the AIG coverage and received a full refund, the SEC says. The regulatory body says the auditors took that as proof Brightpoint's payments had always been intended as deposits, not premiums.
According to the SEC, even though the arrangement with AIG enabled Brightpoint to overstate 1998 pretax profit 61 percent, Bounsall "did not review any drafts of the ... policy or any other written documentation" relating to the deal.