Exhibit 10.84

SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK

 

 

 

X

  THE PEOPLE OF THE STATE OF NEW YORK,   :  

by ELIOT SPITZER, Attorney General of the State

of New York,

  :   Index No.

Plaintiff,

  :  

-against-

  :  

MBIA, INC., MBIA INSURANCE

CORPORATION,

  :  

Defendants.

  :  

 

 

X

 

ASSURANCE OF DISCONTINUANCE

PURSUANT TO EXECUTIVE LAW § 63(15)

Pursuant to the provisions of Executive Law § 63(12) and Article 23-A of the
General Business Law (the “Martin Act”), Eliot Spitzer, Attorney General of the
State of New York caused an investigation to be made of MBIA, Inc., and MBIA
Insurance Corporation (collectively “MBIA”) related to MBIA’s scheme to mask the
earnings effect of a major loss it suffered when a Pennsylvania hospital chain,
Allegheny Health, Education and Research Foundation (“AHERF”) defaulted on
$256 million of bonds MBIA had insured (the “Attorney General’s Investigation”);
and the Superintendent of Insurance of the State of New York (the
“Superintendent”), pursuant to Insurance Law Section 309, conducted an
examination of MBIA (the “Examination”) and issued a Report on Examination as of
December 31, 2003, dated September 21, 2005 (“Report on

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Examination”). Based upon the Attorney General’s Investigation, and the
Superintendent’s Examination, the following findings have been made:

PRELIMINARY STATEMENT

1. MBIA, Inc. through its subsidiary MBIA Insurance Corporation is the leading
insurance company in the business of providing financial guarantees for bond
issuers such as states and municipalities. Through these guarantees, MBIA
assures purchasers of a given bond that the bond’s issuer will make its interest
and principal payments on time. This makes the bond more attractive as an
investment because the investor has MBIA, with a Triple-A credit rating, as a
backstop in case the bond issuer defaults on its obligations. MBIA receives fees
called premiums from the issuer in return for such a guarantee.

2. MBIA holds itself out to the investing public as a company that does not risk
significant losses on the insurance it writes. It prides itself on its ability
to choose bonds for its guarantees that will not default — what it calls in its
most recent annual report “top quality risk management with a no-loss
underwriting standard.” (MBIA 2004 Annual Report at 7).1 Pursuant to this
“no-loss” standard, MBIA has held itself out to the public as an insurance
company that will be unaffected by major losses.

3. The apparent success of this strategy has led to consecutive years of double
digit earnings and a steadily rising stock price. As MBIA declared in its 1998
annual report: “This conservative approach has paid off for our shareholders
with

 

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1 Documents referenced in this Assurance of Discontinuance are appended in a
separate volume entitled “Exhibits to Assurance.”

 

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remarkable consistency. From January 1, 1989 through December 31, 1998, MBIA has
produced a 14.2% average return on equity ... MBIA’s market value has increased
by a factor of 9, and our core earnings have grown by an average of 15%.” (MBIA
1998 Annual Report at 12). The strategy has continued to work for MBIA to the
present day: “This long-term discipline has worked well for MBIA and its
shareholders. For the past 5-year period, operating earnings per share have
grown 12% on average. . . our 5-year average annual return to shareholders has
been 14.04%, compared with a loss of 2.3% for the S&P 500.” (MBIA 2004 Annual
Report at 13).

4. In fact, however, MBIA’s winning streak came to an end in 1998, when a
Pennsylvania hospital chain named the Allegheny Health, Education and Research
Foundation (“AHERF”) defaulted on $256 million of bonds that MBIA had
guaranteed. Rather than take a loss that would dwarf any previous loss it had
suffered, MBIA entered into a fraudulent scheme to avoid booking the loss. It
borrowed the money to cover the AHERF losses then disguised its loan payments as
insurance premiums.

5. To carry out the scheme, MBIA’s then Chief Financial Officer, Juiliette S.
Tehrani, found three insurance companies willing to enter into “reinsurance”
policies with MBIA covering the AHERF exposure. Reinsurance is a term for
insurance bought by an insurance company to cover risks on its own books. Since
the AHERF bankruptcy had already occurred, however, no rational reinsurer would
issue a policy covering MBIA’s loss unless it was certain it would recoup its
payments. To obtain the “reinsurance,” MBIA had to agree to pay the three
reinsurers back every cent of their money, plus a profit.

 

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6. Had the investing public been aware of this arrangement, it would have
understood that: (1) MBIA had borrowed money to cover a massive loss relating to
AHERF; (2) it had agreed to pay the money back; and (3) the AHERF loss properly
should be charged to earnings.

7. In late November 1998, after the “reinsurance” contracts were in place, MBIA
sent the three reinsurers claims for $170 million, MBIA’s entire exposure on the
AHERF transaction, which the reinsurers paid.2 In its 1998 financials, MBIA
fraudulently treated the $170 million received from the reinsurers as
reinsurance payments rather than as loans. As a result, MBIA avoided taking a
$170 million charge to its 1998 earnings and its 1998 financials fraudulently
overstated net income by approximately 25%.

8. The AHERF fraud created the perception that MBIA had put the AHERF loss
behind it without a hit to earnings and led to a recovery in its stock price,
which had declined after the AHERF bankruptcy.

9. In 2003, when questions arose about the AHERF loss, MBIA’s response was to
state on its website that “MBIA did not have any agreement to reimburse the
reinsurers for the loss they paid.” In fact, the only reason the reinsurers
agreed to pay the AHERF loss was because such an agreement existed.

 

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2 $170 million represents the net present value of MBIA’s obligation to pay
interest and principal on the $256 million of bonds.

 

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10. MBIA also stated misleadingly in a 2003 e-mail to a reporter that: “Th[e]
premium [received by the reinsurers on future reinsurance business as repayment
for the $170 million loan] was not compensation for the $170 million of stop
loss coverage they provided to MBIA but rather they received a premium for the
new risk they were assuming.” In 2004, when the same reporter reiterated his
questions about the AHERF loss, MBIA’s Executive Chairman Jay Brown observed in
an internal e-mail: “clearly the reinsurers entered the [Loss Contracts] because
of the premium and the [Repayment Contracts]. To say anything different is
inaccurate.” MBIA, however, took no steps to correct the misleading impression
created by its 2003 statements.

11. In March of 2005, MBIA restated its books to reflect $70 million of the
AHERF transaction as a loan, stating that it appeared likely that MBIA had made
an undisclosed “oral agreement” with one of the AHERF “reinsurers.” However,
MBIA has yet to reveal to investors the full truth about the AHERF payments and
continues to account for the remaining $100 million of the AHERF money as
“reinsurance.”

FACTS

 

I. Background.

12. MBIA is the largest financial guarantor in the world, standing behind
billions of dollars in obligations through its subsidiary, MBIA Insurance
Corporation. MBIA’s guarantees are a form of insurance. In return for premiums,
MBIA agrees to make timely principal and interest payments on an underlying
obligation if there is a default. MBIA is able to provide an extremely credible
guarantee because it has the highest possible credit rating, Triple-A.
Maintenance of its Triple-A rating is critical to MBIA’s business.

 

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13. MBIA is able to maintain a Triple-A rating partly because of its careful
selection of risks. As explained in MBIA’s 1998 annual report, “[w]e have honed
our core competency — the management of risk — to a keen edge with one purpose
in mind: to protect our Triple-A ratings.” (MBIA 1998 Annual Report at 3). MBIA
contrasts itself with other insurance companies that “tolerate higher levels of
underwriting risk in the hope of making up losses through greater investment
returns.” (MBIA 1998 Annual Report at 10). MBIA continues to emphasize the same
theme to the present day, stating in its most recent annual report: “Our
orientation is long-term, and we simply won’t compromise our strict no-loss
underwriting standards, shirk our commitment to act in the best interests of our
shareholders or renege on our pledge to protect our Triple-A ratings for the
short-term gratification of top line growth.” (MBIA 2004 Annual Report at 13).

14. Prior to 1998, there were no major defaults on the financial obligations
MBIA guaranteed. This changed on July 21, 1998, however, when AHERF, an entity
whose bonds MBIA had guaranteed, filed for bankruptcy protection. MBIA had
guaranteed $300 million of AHERF’s debt and was liable for making timely
principal and interest payments on the debt.

15. On July 20, 1998, the day before AHERF’s bankruptcy filing, MBIA’s
Surveillance Department, which was responsible for preparing loss estimates for
senior management, prepared a memorandum advising MBIA’s President on reserving

 

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alternatives and press strategy regarding AHERF. The memo advised MBIA’s
President that a reasonable estimate of the AHERF loss was between $95 and
$100 million. (MBIA 4994). Despite this estimate, MBIA issued a press release
the next day stating that its unallocated loss reserve of $75 million would
cover the loss and that it did “not expect losses from this insured credit to
affect its earnings.” (MBIA 16094).

16. When it made these assurances to the public, MBIA’s management knew the
company faced the prospect of a very large AHERF loss. To avoid taking the loss
and consequent charge to 1998 earnings, which would have likely shaken public
confidence in MBIA, MBIA decided to enter into a fraudulent scheme to negate the
effect of the AHERF loss.

17. The principal element of the scheme was for MBIA to negotiate reinsurance
agreements which would cover the AHERF loss. At the direction of MBIA’s then
CFO, Julliette S. Tehrani (“Tehrani”), Guy Carpenter & Company, Inc. (“Guy
Carpenter”), the reinsurance brokerage arm of Marsh & McLennan Companies, Inc.,
contacted a number of reinsurers on MBIA’s behalf. Munich Re (Am Re) (“Munich
Re”) and Axa Re Finance (“Axa Re”) expressed interest, and MBIA commenced
negotiations with them in late July.

18. Through August and September of 1998, Tehrani negotiated agreements to
retroactively cover the AHERF loss with Munich Re and Axa Re. The parties
reached an agreement in principle at the earliest on September 2, 1998 and the
two reinsurers signed slip agreements with MBIA for the first $100 million of
coverage

 

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(Munich covered losses from 0-$50 million; Axa from $50 to $100 million) on
September 15 and 21.3 (MR 9788; MBIA 92).

19. On September 1, 1998, the day before MBIA reached agreements in principle
with Munich Re and Axa Re, MBIA’s Surveillance Department briefed senior MBIA
executives on its estimate of the AHERF loss. It reported that: “[a]t expected
Ch. 11 auction sales ranges of $500–650 [million], MBIA will suffer a [net
present value] loss of $100–150 [million] on [its AHERF bond] exposure of
$256 million net.” (MBIA 97729). Thus, by the day MBIA reached an agreement in
principle with Munich Re and Axa Re regarding the purported reinsurance
agreements, MBIA’s loss estimates had climbed to approximately $100–150 million.

20. The new estimate demonstrated that the $100 million of coverage secured
through Munich Re and Axa Re would not be enough to negate the effect of the
AHERF loss. Tehrani therefore sought coverage for an additional $70 million from
a third reinsurer, Zurich Reinsurance (North America), Inc. (“Zurich Re”). (MBIA
4342).

21. During the August-September period that Tehrani was arranging the
reinsurance facilities, MBIA’s stock declined. Morgan Stanley noted on August 3,
1998: “MBIA shares are under pressure—falling three points on Friday to $67 and
off from a high of $81. The chief investor concern seems to be the likely loss
on a health care bond issue insured by MBIA.” (MBIA 97554). Merrill Lynch noted
on August 4, 1998 that MBIA stock was “down 24% from the peak (versus the S&P
500’s 10% decline from its high)....” (MBIA 97566). By September 10, MBIA’s
stock had fallen to approximately $46 per share.

 

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3 A slip agreement is the term used in the insurance industry to describe
binding term sheets setting forth the essential terns of the agreements.

 

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22. On September 11, 1998, MBIA held a conference call for investors and
analysts to address “the sharp and precipitous decline in MBIA’s stock price
over the last two weeks.” On the call, MBIA’s President and the CEO announced
that MBIA was negotiating reinsurance arrangements to cover the AHERF loss
without any earnings impact. MBIA’s senior management knew at the time, however,
that the arrangements were not reinsurance and were in substance loans. The
following day, MBIA’s stock price increased 12.4% over the previous day’s close.
MBIA then followed up the conference call with an announcement on September 29,
1998 that it had obtained “$170 million of reinsurance that it expects will
cover” the AHERF losses. The announcement further said that as a result MBIA did
“not expect exposure to this insured credit to affect its earnings or reduce its
unallocated loss reserve.”

23. The September 29th announcement had a positive effect. The next day, Merrill
Lynch published a research report with the title “Allegheny Effect on MBIA
Largely Resolved.” (MBIA 25371). The report described the reinsurance facility
MBIA had announced as “innovative” and noted that while MBIA’s revelation of a
greater than expected loss of $170 million was “a legitimate disappointment,”
the loss was “mitigated through the unique reinsurance solution.” (MBIA 25372).
The report concluded that “[w]ith the Allegheny-related uncertainty mainly in
the past and the company’s earnings reliability intact, MBIA shares offer
significant rebound potential.” (MBIA 25371).

 

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24. In the months after MBIA announced that the AHERF loss was covered by
reinsurance, its stock began to rise. By the end of December, the stock had
risen by more than 30% compared to its price on September 30, 1998.

 

II. MBIA deceived the investing public by treating the AHERF transaction as
reinsurance.

25. In fact, MBIA’s “unique reinsurance solution” to the AHERF problem was a
series of loans disguised as “reinsurance.” MBIA told the investing public on
September 29, 1998 that it had “entered into strategic business relationships”
with the reinsurers. What MBIA did not tell investors was that these
“relationships” amounted to agreements to repay the full $170 million plus
interest. The complex arrangement consisted of two dependent parts. First, money
flowed to MBIA via a set of “excess of loss” contracts with each of the three
reinsurers which provided a total of $170 million in coverage to MBIA,
ostensibly in exchange for approximately $3 million in premiums (hereinafter
“The Loss Contracts”) (MBIA 8–22; 101–117; 340–351). Second, the money (plus
profit) flowed back to the reinsurers over time via $300 million in reinsurance
business (hereinafter “The Repayment Contracts”) (MBIA 35–55; 69–87; 129–147;
165–183; 590–602).

26. The Repayment Contracts assured reimbursement to the reinsurers by providing
for hundreds of millions of dollars of premiums to reinsure risks that
historically had few if any losses. There was virtually no chance that the
reinsurers would ever have to pay claims on the Repayment Contracts that
approached the amount of premiums they received. The reinsurers made sure of
this by conducting detailed cash

 

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flow analyses that factored in MBIA’s historical loss ratios and the time value
of money to assure that the reinsurers would realize a profit (through the
Repayment Contracts) on the loans they were extending to MBIA through the Loss
Contracts. (MR 8724; MR 9048; TM 0001). The reinsurers also required a number of
structural features that ensured compensation, the most prominent of which was a
“sliding scale commission” whereby, if there were losses, MBIA would absorb them
up to 15% of the premium amount paid under the Repayment Contract. Furthermore,
some of the Repayment Contracts had language allowing the reinsurer to pick and
choose the risks it would reinsure. (MBIA 72, 133).4 The chances that, if there
were losses at all, they would exceed the amount of premiums paid by MBIA for
this reinsurance were remote.

27. The chronology set forth below shows that MBIA and the reinsurers understood
perfectly that the Loss Contracts were loans and that the Repayment Contracts
were specifically designed to pay risk-free reimbursement to the reinsurers.
Further, in order to ensure that there was no risk transfer whatsoever under
these arrangements, in at least two cases MBIA and the reinsurers entered into
secret side agreements.

 

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4 All the Repayment Contracts had special features designed to ensure the
reinsurers would receive full compensation. One of the Repayment Contracts
specified that a majority of the premiums paid under the contract should be
“upfront premiums” that would be paid in an accelerated fashion. (MBIA 133). A
2000 MBIA e-mail notes that this is “an unusual requirement.” (MBIA 1964).
Additionally, as noted in the text above, some of the Repayment Contracts had
language allowing the reinsurers to decline to reinsure risks. (MBIA 72,133). In
a memo to MBIA dated February 6, 2003, Axa Re stated why these features were
added. It said: “To strengthen the reimbursement characteristics of these two
SRF Agreements [ the Repayment Contracts], a sliding scale reinsurance
commission and the ability by [Axa Re] to individually select each policy to be
[paid] to these treaties were introduced in the contracts wordings.” (MBIA
5350).

 

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  A. MBIA’s arrangement with Munich Re

28. To cover the first $50 million of loss from the AHERF bankruptcy, MBIA,
acting primarily through Tehrani, sought coverage from Munich Re. Before
negotiations with Munich Re began, however, the MBIA team that was monitoring
the bankruptcy had told the then President of MBIA, Richard Weill, that a “best
case” outcome for MBIA from the bankruptcy would be a loss of at least
$57 million and that the most likely loss would be between $95 and $100 million.
(MBIA 4994). MBIA’s management thus knew at the outset of negotiations that a
$50 million loss at least, was virtually certain.

29. A July 31, 1998 Munich Re internal e-mail reflects that Tehrani and the head
of MBIA’s reinsurance operations had informed Munich Re that the loss would be
at least $50 million: “MBIA currently expects to incur a loss of $50 million
related to this event. However, this loss estimate is very uncertain at this
stage and may be quite a lot more.” (MR 8726). Munich Re thereafter assumed it
would have to pay $50 million. A September 1, 1998 Munich Re e-mail observed
“that in all of our analyses, we have assumed we would incur a $50 million loss
up-front. . . .” (MR 0009034).

30. The certainty that there would be a loss of $50 million or more created
several problems. The first was that neither Munich Re nor any other reinsurer
could be expected to reinsure a certain $50 million loss unless the premiums for
such

 

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insurance approached or exceeded $50 million. Premiums in that amount would
defeat MBIA’s purpose of avoiding a $50 million charge to its income statement.

31. To solve this problem, MBIA devised a two-pronged proposal. (MR 8726):
(a) MBIA and Munich Re would enter into a Loss Contract obligating it to pay the
first $50 million of the AHERF loss in return for a nominal $2 million premium;
and (b) simultaneously, MBIA and Munich Re would enter into a Repayment Contract
under which MBIA would agree to repay Munich Re under the guise of reinsurance
premiums. The transaction was structured to “ensure that [Munich Re] [would be]
fully reimbursed for any payments made as a consequence of [the AHERF loss].”
(MR 8724).

32. A second obstacle was not so easily solved. MBIA knew that the transaction
would have to pass the scrutiny of its accountants, Pricewaterhouse Coopers
(“PWC”), who would apply Statement of Financial Accounting Standards (“SFAS”)
No. 113, which governs reinsurance contracts, to determine if a transaction can
be accounted for as reinsurance. There were two issues related to SFAS No. 113.

33. The first accounting issue related to the Loss Contract and hinged on
whether Munich Re would have to pay the full $50 million of coverage to MBIA or
whether there was a significant probability that Munich Re could pay less than
$50 million. SFAS No. 113 precludes treating a transaction as reinsurance when
“the probability of a significant variation in either the amount or timing of
the payments by the reinsurer is remote.” (SFAS No. 113 ¶ 9). MBIA had been
advised by PWC that unless MBIA could document a loss estimate under
$50 million, the transaction would not pass SFAS No. 113’s risk transfer test.
(MBIA 111761).

 

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34. To satisfy PWC, MBIA provided false information about its estimate of loss
to PWC in order to create a paper trail which would justify treating the
transaction as reinsurance. MBIA’s July 20, 1998 estimate regarding the AHERF
loss had been that a “best case” outcome would involve a loss of $57 million and
a more likely outcome was a loss of $95 million. By September 1, 1998, MBIA’s
loss estimate had climbed to approximately $100–150 million. (MBIA 97729).
Ignoring these estimates, MBIA falsely represented to PWC that its estimate of
loss from the AHERF bankruptcy was $0 to $117 million. (MBIA 111762).

35. MBIA’s false representation regarding its estimate had the desired effect.
Based on MBIA’s misrepresentation, PWC approved treating the Munich Re
$50 million Loss Contract as reinsurance in a memorandum dated October 22, 1998.
(PWC A0000633). Had MBIA not misrepresented to PWC that its estimate of loss was
$0 to 117 million, PWC would have required MBIA to account for the payment as a
loan, which could not be used to offset the AHERF loss.

36. The second accounting issue related to the Repayment Contract and hinged on
whether the premiums paid under the Repayment Contract would fully compensate
Munich Re for its $50 million payment under the Loss Contract. If so, there was
a problem: MBIA knew that PWC could not allow it to treat the Loss Contract as
reinsurance if Munich Re was fully compensated for its $50 million payment
through a separate $98 million Repayment Contract. Paragraph 58 of SFAS No. 113
provides: “[a] contract does not meet the conditions for reinsurance accounting
if features of the reinsurance contract or other contracts or agreements
directly or indirectly compensate

 

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the reinsurer or related reinsurers for losses.” (SFAS No. 113, ¶ 58). In
reviewing the Munich Re proposal, PWC had concluded that if MBIA paid
$98 million in future premiums to Munich Re in exchange for its $50 million
payment under the Loss Contract, there would be no reasonable chance that Munich
Re would lose money on the transaction and the Loss Contract would not qualify
as reinsurance.5 (MR 8724).

37. To meet PWC’s concerns, MBIA split the Repayment Contract into two Repayment
Contracts — one providing for $70 million in premiums with a sliding scale
commission and the second providing for $28 million without a sliding scale
commission. This change, which PWC was fully aware of, did not alter the
important economics of the transaction, however: Munich Re was getting the same
total of $98 million in premiums, an amount that compensated it in full, and
there was no reasonable possibility that Munich Re would lose money on the
transaction. (MR 9201).

 

  B. MBIA’s arrangement with Axa Re

38. Since MBIA knew from the outset that the likely AHERF loss would be
$95 million or more, it knew the $50 million coverage provided by the Munich Re
Loss Contract would not be sufficient to cover the loss. Tehrani therefore
simultaneously sought an additional $50 million Loss policy from Axa Re, a
French reinsurer.

 

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5 PWC reached its conclusion by doing a cash flow analysis of the combined
contracts which compared the premium revenues that would be received by the
reinsurer against its reasonably possible losses. Accountants use this analysis
to determine whether a transaction involves enough risk of loss to qualify as
reinsurance under SFAS No. 113. If the analysis shows that the total premiums
the reinsurer will receive will be greater than the total payments for losses it
is reasonably possible it will make, the risk of loss from the transaction is
deemed too remote for the transaction to be classified as reinsurance.

 

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39. Tehrani proposed to Axa Re’s representatives the same two-pronged structure
that had been proposed to Munich Re: (a) a $50 million Loss Contract that would
carry a nominal premium; and (b) a Repayment Contract that would repay Axa Re
under the guise of reinsurance premiums. (MBIA 482-83).

40. Similar to Munich Re, Axa Re calculated that $97 million in premiums on the
Repayment Contract would be necessary to compensate it for making the
$50 million payment provided for under the Loss Contract. An Axa Re negotiator
made this clear in an August 25 e-mail to MBIA concerning a preliminary
proposal, which stated: “we want to be compensated fully through the [Repayment
Contract payments],” and that if Axa Re had to pay the full $50 million under
the Loss Contract, it would “need the full $97m . . . premium to compensate the
$50m paid upfront.” (MBIA 494).

41. As it had with Munich Re, Axa Re’s demand for full compensation through
$97 million in premiums created an accounting problem for MBIA. If MBIA paid
$97 million in future premiums to a reinsurer that provided $50 million in
coverage under a Loss Contract, there would be no reasonable chance that the
reinsurer would lose money and the transaction would then not qualify as
reinsurance under SFAS No. 113’s requirement that a reinsurer cannot be
compensated for its losses. To accede to Axa Re’s demand for full compensation
would therefore preclude MBIA from treating its arrangement with Axa Re as
reinsurance.

 

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42. To obtain favorable accounting treatment from PWC, MBIA and Axa Re entered
into a Repayment Contract ceding only $60 million in premiums to Axa Re while
simultaneously entering into a side agreement — which was not reflected in any
of the written agreements and therefore presumably would not be part of PWC’s
analysis — obligating MBIA to pay to Axa Re an additional $37 million in
premiums if Axa Re had to pay $30 million or more under the Loss Contract.

43. The side agreement was temporarily set aside on September 2, 1998, when
Tehrani informed Axa Re by e-mail that MBIA had an all-day meeting with its
accountants, PWC, and that “we have eliminated the need for side agreements, all
agreements will be in the contract.” Tehrani informed Axa Re that MBIA’s broker
Guy Carpenter would be faxing new documents reflecting the change. (M 000053).

44. Guy Carpenter faxed Axa Re slip agreements for the Loss and Repayment
Contracts with a fax cover page that explained the changes. The fax stated that
the slips had been changed based on a revised point of view from MBIA’s auditors
and that “no side agreement is necessary based on our current understanding of
the rules.” (M 2603). After providing for only $60 million in premiums, the
attached Repayment Contract slip incorporated the side agreement Axa Re and MBIA
had previously agreed to, stating: “In the event that the amount of reinsurance
recoveries under the Company’s [Loss Contract] exceed $30,000,000, the Company
agrees to [pay] and [sic] additional $37,000,000 of [premiums].” (M 002616).

45. MBIA’s insertion of the terms of the side agreement into the slip was
short-lived. The next day, September 3, 1998, Guy Carpenter faxed revised slips
to

 

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Axa Re removing the provision ceding an additional $37 million in premiums in
the event Axa Re had to pay more than $30 million under the Loss Contract. In
the fax cover page, Guy Carpenter reported: “As you know, MBIA’s auditor’s [sic]
came back again with a need to change the wording of the ... [Repayment
Contract] to delete all references to the [Loss Contract].” The fax went on to
reassure Axa Re that: “I am certain MBIA will assure you that they will make
every effort to ensure AXA Re’s long-term profitability on their overall account
at attractive rates of return.” (M 2637).

46. The final slip agreement for Axa Re’s Repayment Contract was signed on
September 15, 1998. It provided for only $60 million of future reinsurance
business to Axa Re — and contained no reference to paying an additional
$37 million if Axa Re paid more than $30 million on the Loss Contract as MBIA
assumed it would. (MBIA 121).

47. Although the obligation to provide an additional $37 million in future
premiums was not memorialized, MBIA agreed to honor the commitment in an
unwritten side agreement.

48. That the side agreement to pay an additional $37 million in premiums
survived is shown by a November 24, 1998 e-mail from a broker at Guy Carpenter,
which specifically referred to the side agreement. The e-mail stated that an
“[MBIA employee] called and the AXA deal where they must pay AXA $67M [sic] and
through a side letter an additional $37M has now been triggered. . . . Due to
accounting issues they need a separate contract for the payment of the $37M thus
can we draw up a slip ASAP . . . based on the Munich RE slip.” (GC 374)
(emphasis added).

 

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49. Other documents also reflect the side agreement. An e-mail dated October 21,
1998 from MBIA’s head of reinsurance operations to Tehrani refers to “the Axa Re
‘Side Agreement.’” (MBIA 1315). Additionally, an Axa Re fax dated October 2,
1998 to rating agencies states that while the MBIA transaction in fact paid
$97 million in premiums to Axa Re, only $60 million in premiums would be found
in the written slip agreement. The fax explains that the reason the signed
agreement would not reflect the actual agreement was “to accommodate MBIA’s
FASB 113 requirements.” (M 2508).

50. An MBIA employee sent Axa Re a bill for the full $50 million payable under
the Loss Contract in November 1998. (MBIA 15852). On or about December 17, 1998,
MBIA honored the side agreement by executing a slip agreement with Axa Re
requiring MBIA to pay Axa Re $37 million. (MBIA 127). The agreement facially
appeared to be newly negotiated and unrelated to the AHERF transaction or Axa
Re’s payment of $50 million.

51. MBIA’s removal of its obligation to pay an additional $37 million from the
written agreement with Axa Re and placement of that obligation in an unwritten
side agreement enabled the deal to pass the risk transfer analysis PWC
subsequently performed. An October 22, 1998 risk transfer memorandum prepared by
PWC considers only $60 million of premiums instead of the full $97 million
provided for. (PWC A000637). Had the hidden $37 million of premiums been
included in PWC’s analysis, the analysis would have demonstrated that it was not
reasonably possible for Axa Re to lose money on the combined Loss and Repayment
Contracts. The transaction would then have failed SFAS No. 113’s risk transfer
test, and PWC could not have permitted MBIA to book Axa Re’s $50 million as a
reinsurance payment.

 

19

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  C. MBIA’s arrangement with Zurich Re

52. The $100 million in coverage provided by Munich Re and Axa Re was not enough
to cover what MBIA had come to believe could well be a $170 million loss. In
September, therefore, MBIA approached a third reinsurer, Zurich Re, and proposed
a two pronged transaction similar to the transactions with Munich Re and Axa Re.
MBIA proposed: (a) a $70 million Loss Contract that would carry a nominal
premium; and (b) a Repayment Contract that would repay Zurich Re under the guise
of reinsurance premiums.

53. Like the other two reinsurers, Zurich Re was unwilling to accept any
reinsurance risk. This emerged in a letter from Zurich Re to MBIA’s broker, Guy
Carpenter, in which Zurich Re proposed a cap on its potential losses so that
they would never exceed the premiums Zurich Re would receive. (CR 315).

54. MBIA agreed to this approach but was forced to abandon it in October when
PWC took the position that a cap on Zurich Re’s losses would remove the risk
transfer necessary for the contract to qualify as reinsurance. (MBIA 20238; CR
269).

55. Desperate to obtain the $70 million in reinsurance from Zurich Re which MBIA
had already publicly announced and which it needed to cover the anticipated
$170 million loss from the AHERF bankruptcy, MBIA took a number of drastic steps
to give Zurich Re the cap on losses that it wanted without reflecting it in the
contract. MBIA’s first step was to induce Axa Re to cover any Zurich Re losses
above

 

20

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$13 million under the Repayment Contract. (MBIA - IM 19, 29). This would cap
Zurich Re’s potential losses as Zurich Re had required. As one memo by MBIA
explained, under this arrangement, “[r]isk retention by Zurich Re is minimal.”
(MBIA 9215).

56. While the Axa Re reinsurance solved Zurich Re’s problem — it would be
receiving more than $100 million in premiums for taking only 9% of the risk
under the Repayment Contract — it created a problem for Axa Re, which would be
receiving a mere $3 million in premiums for taking on more than 90% of the risk.
(MBIA 9215). While the risk of a loss on the Repayment Contracts was extremely
low, Axa Re had no economic incentive to take a disproportional amount of risk
for a nominal premium. To make the transaction work for Axa Re, MBIA entered
into a secret verbal agreement with Axa Re to take back the risk Axa Re was
ostensibly assuming. Under this secret agreement, MBIA agreed to replace Axa Re
as the reinsurer for Zurich Re within six years.6 This made MBIA the ultimate
bearer of risk and its own reinsurer.

57. Both the Axa Re reinsurance and the secret agreement to assume Axa Re’s risk
were negotiated by Julie Tehrani at a meeting between MBIA and Axa Re in
Portugal at the end of October 1998 that was also attended by David Elliott,
MBIA’s CEO at the time.7 Zurich Re signed a slip providing the final $70 million
of coverage a few days later, on November 2, 1998. (MBIA 4342).

--------------------------------------------------------------------------------

6 Given the nature of risks at issue in the Repayment Contract, the first six
years of coverage were extremely unlikely to yield significant losses.

7 Mr. Elliott claims to have no recollection of discussing any business on the
trip.

 

21

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58. This left MBIA with one more problem. By the time Zurich Re executed the
slip agreement, MBIA had known for over a month that the AHERF loss would be
$170 million. It therefore knew that: (a) Zurich Re would be paying the
$70 million limit provided under the Loss Contract; and (b) the Loss Contract
therefore could not qualify as reinsurance because SFAS No. 113 precludes
treating an agreement as reinsurance when “the probability of a significant
variation in either the amount or timing of the payments by the reinsurer is
remote.”

59. To meet this problem, MBIA’s CFO and CEO made a written representation to
PWC two days after the Zurich Re slip was executed falsely stating that:
(1) MBIA had reached an agreement in principle with Zurich Re six weeks earlier,
on September 22, 1998; and (2) “These were binding reinsurance agreements on
that date.” In fact, no binding agreement between the parties existed on
September 22, 1998. (Cr 00259). As of September 22nd, Zurich Re had not yet
decided or agreed to provide reinsurance to MBIA and did not bind itself to do
so until the slip was signed on November 2, 1998. By then, MBIA had known for a
month that the AHERF loss would be $170 million and that there would be no
possibility of significant variation in the amount or timing of Zurich Re’s
payment. Moreover, the agreement reached with Zurich Re in November was
materially different than the arrangement the parties had been discussing in
September.

60. In 2003, four years after making the secret agreement, MBIA denied to Axa Re
that any agreement to reassume Axa Re’s risk existed. Axa Re then sued MBIA in
2004 to enforce the secret agreement at a time when fraudulent insurance

 

22

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arrangements had become the subject of increased regulatory scrutiny. MBIA’s
Audit Committee ordered an investigation of Axa Re’s allegations. MBIA announced
on March 8, 2005, that while it had not “conclusively determined” that the
agreement existed, it appeared “likely” that there was a secret agreement with
Axa Re. On this basis, MBIA restated its 1998 income reversing the Zurich Re
portion of the AHERF reinsurance scheme.

61. The existence of the side agreement was more than “likely.” Its existence is
conclusively demonstrated by: (a) contemporaneous notes by an Axa Re employee
involved in the deal documenting the side agreement (M 2951); (b) handwritten
notes by an MBIA employee attached to MBIA accounting documents confirming the
existence of the agreement (MBIA 25445); and (c) an internal MBIA memo dated
September 15, 1999 to MBIA’s then CFO, which reported that Axa Re asserted the
existence of an “Understanding between [Julie Tehrani] and AXA Re Finance” that
“MBIA assumes Zurich Re . . . exposure. . . .” (MBIA 9215).

III. MBIA’s False Statements.

62. The purpose of the convoluted AHERF “reinsurance” transaction was to allow
MBIA to mislead investors about its financial condition.

 

  A. MBIA misled investors in 1998 about the impact of AHERF

63. On July 21, 1998, the day after AHERF filed for bankruptcy, MBIA issued a
press release which stated that MBIA’s unallocated loss reserve of approximately
$75 million would “be sufficient to meet anticipated losses from the

 

23

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bankruptcy filing.” The press release went on to state that as a result, “the
company [did] not expect losses from this insured credit to affect its
earnings.”

64. The July 21 press release was false and misleading. In that one day prior to
its issuance, MBIA senior management had received a memorandum estimating the
AHERF loss at $95 million and recommending that a loss reserve of $95 million be
established. When it issued its July 21st release, MBIA therefore knew that
contrary to what the release stated, the company’s $75 million unallocated
reserve would not meet the anticipated AHERF loss, and that the company expected
the losses from AHERF to affect its earnings.

65. On September 11, 1998, MBIA held a conference call to address “the sharp and
precipitous decline in MBIA’s stock price over the last two weeks.” On the call,
which covered a number of issues, the President and the CEO announced that MBIA
was negotiating reinsurance arrangements to cover the AHERF loss without any
earnings impact. MBIA’s senior management knew at the time, however, that the
arrangements were not reinsurance and were in substance loans.

66. On September 29, 1998, MBIA issued another false and misleading press
release. The release, entitled “MBIA Announces Exposure to Bankrupt Pennsylvania
Hospital Group to be Covered by Reinsurance Agreements; Expects no Impact on
Earnings,” announced that MBIA had “obtained $170 million of reinsurance that it
expects will cover anticipated losses arising from [AHERF].”

67. The September 29 press release was false in that MBIA had not in fact
obtained $170 million in reinsurance to cover the AHERF loss. MBIA’s

 

24

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arrangements with Munich Re and Axa Re did not qualify as reinsurance under SFAS
No. 113 on multiple grounds. First, they did not meet SFAS No. 113’s requirement
that there exist a more than remote possibility of significant variation in the
amount the reinsurer would pay. MBIA estimated the AHERF loss at
$100–150 million, making it virtually certain that both reinsurers would pay the
full $50 million limit of their respective Loss Contracts. Second, the
arrangements did not meet SFAS No. 113’s requirement that there exist a
reasonable possibility that the reinsurer would realize a significant loss under
the overall arrangement. The size of the premiums MBIA had agreed to cede to the
reinsurers under the Repayment Contracts made significant loss not a reasonable
possibility.

 

  B. MBIA misstated its income in its 1998 financial statements

68. MBIA issued its 1998 financials in March of 1999. The financials
fraudulently treated the $170 million in payments MBIA had received from the
three reinsurers as reinsurance payments, and netted the payments against the
$170 million in reserves that MBIA had booked as a result of the AHERF
bankruptcy. (MBIA 16763). This enabled the Company to falsely report net income
for the year of $433 million and earnings per share of $2.88. (MBIA March 8,
2005 press release).

69. The 1998 financials MBIA issued overstated net income and earnings per share
by more than 25%. Had the financial statement properly treated the payments MBIA
received from the three reinsurers as loan proceeds, net income would have been
approximately $110 million less than the $433 million reported, and earnings per
share would have been more than $.75 less than the $2.88 reported. (MBIA
March 8, 2005 press release).

 

25

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70. MBIA’s 1998 annual report contained similar fraudulent statements. Utilizing
the false numbers contained in the financials, the report falsely claimed that
MBIA’s net income “increased 19%” over 1997. In fact, MBIA’s net income had
decreased by more than 20%. The report further falsely stated that: “[c]ore
earnings per share at $4.19 for 1998 grew by 14% over 1997 . . . continu[ing]
our unbroken streak of double-digit increases since we became a public company
in 1987” (MBIA 1998 Annual Report at 36), and boasted that: “with $170 million
of reinsurance, our loss reserves, our earnings and our Triple-A ratings were
unaffected.” (MBIA 1998 Annual Report at 5).

71. MBIA’s misleading 1998 financial results were republished in subsequent
filings made in 1999, 2000, and 2001, and continued to create the false
impression that the company had experienced an uninterrupted succession of
profitable quarters.

 

  C. MBIA’s executives benefitted from the scheme

72. The CEO and Chairman of MBIA at the time, David Elliott, personally
benefitted from the AHERF scheme because he received a $750,000 bonus and more
than $1,000,000 in stock, options, and other forms of compensation in 1998,
increasing his total compensation 79% from the prior year. (1999 Proxy Statement
at 8; MBIA 24265). This compensation was based in part on meeting performance
goals that would not have been met without the AHERF scheme.

 

26

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73. The CFO at the time, Tehrani, also personally benefitted from the AHERF
scheme. In an e-mail describing her 1998 accomplishments to David Elliott, she
wrote: “My most important achievement for the year however, was the completion
of the reinsurance program that allowed us to shelter the AHERF loss. I gain
satisfaction from this task on several fronts - the significant financial
benefit it provided MBIA, the opportunity it gave me to once again develop a
creative accounting solution as I have done so many times in the past. . . .”
(MBIA 24315). In his performance evaluation of Tehrani, Elliott wrote: “your
biggest accomplishment was the pursuit, negotiation and effectuation of the
special reinsurance program to cover AHERF and address our other needs. Your
creativity, tenacity and refusal to give up saved the day for handling this loss
and for securing the proper accounting treatment.” (MBIA 24314). Tehrani
received a bonus of $275,000 and more than $500,000 in stock, options, and other
forms of compensation in 1998, increasing her total compensation 16% from the
prior year. (MBIA 24265).

 

  D. MBIA’s 2003 statements

74. In September 2003, questions began to arise about the AHERF transaction as a
result of publicity surrounding American International Group (“AIG”)’s
transaction with Brightpoint, Inc. (“Brightpoint”).8 To distinguish the AHERF
transaction from AIG/Brightpoint, MBIA claimed in public statements that it did
not have any agreement to reimburse or compensate its reinsurers for the
$170 million they paid.

 

--------------------------------------------------------------------------------

8 On September 11, 2003, the Securities and Exchange Commission announced the
settlement of enforcement actions against AIG and Brightpoint for AIG’s sale of
a “non-traditional” insurance product to Brightpoint for the stated purpose of
“income statement smoothing.”

 

27

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75. First, in the fall of 2003, MBIA posted on its website the following
statement:

MBIA did not have any agreement to reimburse the reinsurers for the loss they
paid. As part of this reinsurance arrangement, MBIA entered into quota share
reinsurance agreements with the same reinsurers under which MBIA agreed to cede
to them a specified amount of financial guarantee business over several years.
Under these reinsurance agreements, the reinsurers agreed to assume both
existing and future risk from MBIA and MBIA ceded the related reinsurance
premiums. . . .

(MBIA 24520) (emphasis added).

76. Second, MBIA sent an October 10, 2003 e-mail in response to persistent
questioning by a reporter concerning the AHERF transaction. The reporter asked
whether “the reinsurers were compensated with future business” and whether this
would “disqualify the transaction for reinsurance accounting purposes?” (MBIA
22778). MBIA’s e-mail to the reporter stated:

This premium [from the Repayment Contracts] was not compensation for the
$170 million of stop loss coverage they provided to MBIA but rather they
received a premium for the new risk they were assuming. (MBIA 22776).

77. In fact, the Repayment Contracts were compensation to the reinsurers for the
Loss Contracts.

 

  a. A 1998 internal presentation to the MBIA Risk Management Group on the AHERF
transaction refers to the Repayment Contracts as “Repayment of Funds Sent by
Reinsurers per [the Loss Contracts].” (MBIA 26663).

 

28

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  b. All three reinsurers — Munich Re, Axa Re, and Zurich Re, made clear in
their correspondence to MBIA that the Repayment Contracts compensated them for
the payment they would have to make under the Loss Contracts. (MBIA 487, 5351;
MBIA-IM 49; MR 8726).

 

  c. PWC, MBIA’s auditor, stated in its analysis of the transaction that: “we
know that the reinsurers would not have entered into the Excess contracts
without the [Repayment] agreements.” (MBIA 3272).

 

  d. An MBIA August 6, 1998 memo describing the Axa Re portion said that the
“Cost” for the Loss Contract with Axa Re would include: “A promise to [pay]
$97 million of adjusted gross premium of over 6 years. . . .” (MBIA 4679).

78. MBIA’s website posting and e-mail were also inaccurate as to the risk the
reinsurers were assuming under the Repayment Contracts. The website posting
stated without any qualification that the reinsurers agreed to assume “future
risk from MBIA,” and the e-mail stated similarly that the premium MBIA was
receiving was for “the new risk [the reinsurers] were assuming.” In fact, the
Repayment Contracts ensured that the reinsurers would have no real risk of loss.

 

29

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79. MBIA’s 2003 statements did not put the AHERF issue to rest. On October 21,
2004, the reporter again asked whether there was a “transfer of risk” to the
reinsurers. He asked whether the “guarantee of future business” was “a form of
compensation.” He also asked: “Have any other comments changed since I wrote my
original — or is there something you would like to add or clarify?” (MBIA
22717).

80. The Executive Chairman of MBIA, Jay Brown, gave his input concerning the
reporter’s questions in an e-mail to MBIA executives, stating: “clearly the
reinsurers entered the [Loss Contracts] because of the premium and the
[Repayment Contracts]. To say anything different is inaccurate.” (MBIA 22716).
The recipients of this e-mail then had a series of discussions about how to
respond to the reporter.

81. MBIA’s written response to the reporter sent on November 1, 2004 did not
correct its 2003 misstatements. (MBIA 22731).

82. On March 8, 2005, MBIA issued a press release that purported to correct its
treatment of the AHERF loss. The press release stated that MBIA was restating
its 1998 income and the income reported in subsequent years to “correct the
accounting treatment” for the payment Zurich Re made to MBIA in 1998, and that
“as a result of this restatement,” (a) MBIA’s financial result for 1998 would
reflect a third quarter incurred loss of $70 million related to the AHERF bonds
and its net income for 1998 would be reduced 11%; and (b) MBIA’s net income for
the years 1999 through 2004 was inaccurate.

83. MBIA’s March 2005 press release corrected only the portion of MBIA’s 1998
overstatement of income that was due to MBIA’s mischaracterization of

 

30

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Zurich Re’s $70 million payment; it left uncorrected the portion of MBIA’s
overstatement of 1998 and subsequent year income due to its mischaracterization
of the $100 million paid to MBIA in 1998 by Munich Re and Axa Re. MBIA continues
(a) to improperly treat those payments as reinsurance payments, (b) to overstate
its 1998 income by approximately 14%, and (c) to issue financial reports that
misstate its 1998 income.

84. The release also continued to describe the Munich Re and Axa Re Repayment
Contracts with those reinsurers as “separately entered into quota share
reinsurance agreements” under which the reinsurers “assumed new risk on a pro
rata basis in exchange for the [ ] premiums.” MBIA again failed to disclose that
the contracts had been designed to ensure that the reinsurers would have no real
risk of loss and were regarded by all parties as compensation for the payments
the reinsurers made under the Loss Contracts.

85. MBIA has advised the Attorney General and the Superintendent of its desire
and agreement to resolve all issues related to MBIA in the Attorney General’s
Investigation.

86. MBIA has fully cooperated and continues to cooperate with the Attorney
General’s Investigation and the Superintendent’s Examination.

87. The Attorney General finds the sanctions and agreements contained in this
Assurance of Discontinuance (the “Assurance”) appropriate and in the public
interest. The Attorney General is willing to accept this Assurance pursuant to
Executive Law § 63(15), in lieu of commencing a statutory proceeding.

 

31

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88. The Superintendent and MBIA will simultaneously with the Assurance enter
into a Stipulation and MBIA will accept the New York State Insurance
Department’s (“Insurance Department”) Report on Examination.

89. The Superintendent finds the relief and agreements contained in this
Assurance and the corresponding Stipulation appropriate and in the public
interest.

90. This Assurance is solely for the purpose of resolving the Attorney General’s
Investigation, and is not intended to be used for any other purpose.

NOW THEREFORE, MBIA, without admitting or denying the above allegations, and the
Attorney General hereby enter into this Assurance, pursuant to Executive Law
§ 63(15), and agree as follows:

 

I. Affirmative Relief

 

  A. Disgorgement and Civil Penalty

1. MBIA shall pay $10,000,000 in disgorgement and restitution plus a civil money
penalty in the amount of $15,000,000 for a total payment to the State of New
York of $25,000,000. The $10,000,000 disgorgement and restitution payment shall
be remitted and administered, together with the $50,000,000 payment payable in
accordance with the Consent to Final Judgment filed by MBIA in connection with
the matter captioned United States Securities and Exchange Commission v. MBIA
Inc. on or near the date hereof (“SEC Judgment”).

2. The provisions in the SEC Judgment relating to the payment, administration
and distribution of the $60,000,000 referred to in this section are incorporated
herein by reference, and such terms are agreed to as part of this Assurance

 

32

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by MBIA. The $15,000,000 amount ordered to be paid as civil money penalties
pursuant to this Assurance shall be treated as penalties paid to the State of
New York for all purposes, including tax purposes.

3. MBIA agrees that it shall not, collectively or individually, seek or accept,
directly or indirectly, reimbursement or indemnification, including, but not
limited to, payment made pursuant to any insurance policy, with regard to any or
all of the amounts payable pursuant to this Assurance.

 

  B. Independent Consultant Review

1. In accordance with the procedure specified in Paragraph 2 below, MBIA shall
retain, pay for, and enter into an agreement with an independent consultant, not
unacceptable to the Attorney General’s Office or the Insurance Department
(“Independent Consultant”), to conduct a comprehensive review of the areas
specified in subparagraphs (a) and (b) below, and to make recommendations to
MBIA’s Board of Directors, after consultation with the Attorney General’s Office
and the Insurance Department, regarding best practices in these areas. The
agreement with the Independent Consultant shall contain the following
provisions:

(a) The Independent Consultant shall review:

 

  (i) MBIA’s accounting for, and disclosures concerning, its investment in
Capital Asset Holdings GP, Inc.;

 

  (ii) MBIA’s accounting for, and disclosures concerning, its exposure on notes
issued by the US Airways 1998-1 Repackaging Trust; and

 

33

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  (iii) MBIA Inc.’s accounting for, and disclosures concerning, any remediation
transactions, during the period January 1, 1998 to the present, in connection
with which MBIA Inc. or any of its affiliates repaid or acquired all or
substantially all of an issue of insured securities insured by MBIA Insurance
Corp., whether under the rights in an insurance policy, tender, or other means,
other than as a result of (i) a claim or payment under the related policy or
(ii) the exercise of a right to repay or acquire the insured securities under
the insurance policy, tender, or other means when the outstanding amount of the
insured securities is 10% or less of the original insured amount outstanding.

(b) The Independent Consultant shall also review the design of the review
conducted on behalf of the Audit Committee of MBIA’s Board of Directors by
Promontory Financial Group LLC, of MBIA’s compliance organization and monitoring
systems, internal audit functions, governance process and other controls,
including risk management and records management policies and procedures (the
“Audit Committee Review”), and the implementation of any recommendations (or the
agreed-upon procedure for implementation) by Promontory.

 

34

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(c) The Independent Consultant shall issue a report to the Attorney General’s
Office, the Insurance Department, and MBIA’s Board of Directors within six
months of appointment, setting forth:

 

  (i) with respect to the items identified at subparagraph 1(a) above, his or
her findings on whether MBIA acted in a manner consistent with generally
accepted accounting principles (“GAAP”), statutory accounting principles and the
federal securities laws. With respect to any matter as to which he or she
concludes that MBIA acted in a manner inconsistent with GAAP, statutory
accounting principles or the federal securities laws, he or she shall propose a
plan of review designed to evaluate similar transactions or occurrences, if any,
and provide reasonable assurance that all similar conduct inconsistent with
GAAP, statutory accounting principles or the federal securities laws has been
identified; and

 

  (ii) with respect to the matters identified at Paragraph 1(b) above, his or
her findings concerning whether the Audit Committee’s Review was reasonably
designed and implemented and, if not, any recommendations for further review to
determine what policies and procedures should be implemented to achieve best
practices.

 

35

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The Report shall also include a description of the review performed, the
conclusions reached, the Independent Consultant’s recommendations for any
changes in or improvements to MBIA’s policies and procedures necessary to
conform to best practices and a procedure for implementing the recommended
changes in or improvements to MBIA’s policies and procedures.

Terms of Independent Consultant’s Retention

(d) In addition to the report identified above, the Independent Consultant shall
provide the Attorney General’s Office, the Insurance Department and the Board of
Directors with such documents or other information concerning the areas
identified in Paragraph 1(a), above, as any of them may request during the
pendency or at the conclusion of the review.

(e) The Independent Consultant shall have reasonable access to all of MBIA’s
books and records, and the ability to meet privately with MBIA personnel. MBIA
may not assert the attorney-client privilege, the protection of the work-product
doctrine, or any privilege as a ground for not providing the Independent
Consultant with contemporaneous documents or other information related to the
matters that are the subject of the review. MBIA shall cooperate with the
Independent Consultant, by, among other things, making available to the
Independent Consultant the results of the investigation of Capital Asset
conducted in 1999 by outside counsel at the direction of the Audit Committee of
MBIA’s Board of Directors. The Independent Consultant may consider and use the
results of such prior investigation to the extent he or she deems appropriate in
the course

 

36

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of conducting his or her own review. MBIA shall instruct and otherwise encourage
its officers, directors, and employees to cooperate fully with the review
conducted by the Independent Consultant, and inform its officers, directors, and
employees that failure to cooperate with the review will be grounds for
dismissal, other disciplinary actions, or other appropriate actions.

(f) The Independent Consultant shall have the right, as reasonable and necessary
in his or her judgment, to retain, at MBIA’s expense, attorneys, accountants,
and other persons or firms, other than officers, directors, or employees of
MBIA, to assist in the discharge of his or her obligations under these
Undertakings. MBIA shall pay all reasonable fees and expenses of any persons or
firms retained by the Independent Consultant.

(g) The Independent Consultant shall make and keep notes of interviews
conducted, and keep a copy of documents gathered, in connection with the
performance of his or her responsibilities, and require all persons and firms
retained to assist the Independent Consultant to do so as well.

(h) As to the Attorney General’s Office and the Insurance Department, the
Independent Consultant’s relationship with MBIA shall not be treated as one
between an attorney and client. The Independent Consultant will not assert the
attorney-client privilege, the protection of the work-product doctrine, or any
privilege as a ground for not providing any information obtained in the review
sought by the Attorney General’s Office or the Insurance Department.

 

37

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(i) If the Independent Consultant determines that he or she has a conflict with
respect to one or more of the areas described in Paragraph 1 or otherwise, the
responsibilities with respect to that subject shall be delegated to a person
selected pursuant to the procedures set forth in Paragraph 2 below.

(j) For the period of engagement and for a period of two years from completion
of the engagement, the Independent Consultant shall not enter into any
employment, consultant, attorney-client, auditing or other professional
relationship with MBIA, or any of its present or former affiliates, directors,
officers, employees, or agents acting in their capacity as such; and shall
require that any firm with which the Independent Consultant is affiliated or of
which the Independent Consultant is a member, and any person engaged to assist
the Independent Consultant in performance of the Independent Consultant’s duties
under this Assurance not, without prior written consent of the Attorney
General’s Office and the Insurance Department, enter into any employment,
consultant, attorney-client, auditing or other professional relationship with
MBIA, or any of its present or former affiliates, directors, officers,
employees, or agents acting in their capacity as such for the period of the
engagement and for a period of two years after the engagement. For the purposes
of this section, representation of a person or firm insured by MBIA shall not be
deemed a professional relationship with MBIA.

 

38

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MBIA Obligations Relating to the Independent Consultant

2. Within twenty days of the date of entry of this Assurance, MBIA will submit
to the Attorney General’s Office and the Insurance Department a proposal setting
forth the identity, qualifications, and proposed terms of retention of the
Independent Consultant. The Independent Consultant’s compensation and expenses
shall be borne exclusively by MBIA, and shall not be deducted from any amount
due under the provisions of this Assurance. After consultation and in
coordination with the U.S. Securities and Exchange Commission, the Attorney
General’s Office and the Insurance Department, within thirty days of such
notice, will either (a) approve MBIA’s choice of Independent Consultant and
proposed terms of retention or (b) require MBIA to propose an alternative
Independent Consultant and/or revised proposed terms of retention within fifteen
days. This process will continue, as necessary, until MBIA has selected an
Independent Consultant and retention terms that are not unacceptable to the
Attorney General’s Office and the Insurance Department (and the U.S. Securities
and Exchange Commission).

3. MBIA shall adopt all recommendations contained in the report of the
Independent Consultant referred to in Paragraph 1(c), above; provided, however,
that within fifteen days of receipt of the report, MBIA shall in writing advise
the Independent Consultant and the Attorney General’s Office and the Insurance
Department of any recommendations that it considers to be unnecessary or
inappropriate. With respect to any recommendation that MBIA considers
unnecessary or inappropriate, MBIA need not

 

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adopt that recommendation at that time but shall propose in writing an
alternative policy, procedure or system designed to achieve the same objective
or purpose.

4. As to any recommendation with which MBIA and the Independent Consultant do
not agree, such parties shall attempt in good faith to reach an agreement within
thirty days of the issuance of the Independent Consultant’s report referred to
in Paragraph 1(c), above. In the event MBIA and the Independent Consultant are
unable to agree on an alternative proposal, MBIA will abide by the
determinations of the Independent Consultant.

5. MBIA, including the board of directors and committees of the board of
directors of MBIA, shall not assert the attorney-client privilege, the
protection of the work-product doctrine, or any privilege as a ground for not
providing any documents, information, or testimony requested by the Attorney
General’s Office and the Insurance Department related to the review conducted by
the Independent Consultant.

6. MBIA shall retain the Independent Consultant for a period of nine months from
the date of appointment. The Attorney General’s Office and the Insurance
Department or MBIA may in either’s discretion extend the Independent
Consultant’s term of appointment.

7. Within ninety days of the receipt of the report referred to in
Paragraph 1(c), MBIA shall certify to the Attorney General’s Office and the
Insurance Department that all procedures recommended in the Independent
Consultant’s report referred to in Paragraph 1(c), and any additional or
alternative procedures agreed upon as a result of the procedure set out in
Paragraphs 3 and 4 have been implemented.

 

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Accountants’ Report

8. MBIA shall engage certified public accountants, which may be MBIA’s usual
public accounting firm, to: (a) review whether MBIA acted in a manner consistent
with GAAP, statutory accounting principles and the federal securities laws in
its accounting, for, and disclosures concerning: (i) advisory fees, and (ii) the
assets of Triple A One Funding, LLC, MBIA Global Funding, LLC, and Meridian
Funding Company, LLC, included in the consolidated financial statements of MBIA;
and (b) provide a written report of its review and conclusions to the Attorney
General’s Office and the Insurance Department within thirty days of the entry of
this Assurance (the “Accountants’ Report”).

Miscellaneous Provisions

9. After consultation and in coordination with the U.S. Securities and Exchange
Commission, the Attorney General’s Office or the Insurance Department may, in
its discretion, (a) require MBIA to expand the scope of the Independent
Consultant’s engagement to include (i) the review of similar transactions or
occurrences referred to at Paragraph l(c)(i) above, or (ii) following the
Attorney General’s Office’s and the Insurance Department’s review of the
Accountants’ Report, MBIA’s accounting for, and disclosures concerning: advisory
fees, or the assets of Triple A One Funding, LLC, MBIA Global Funding, LLC, and
Meridian Funding Company, LLC, included in the consolidated financial statements
of MBIA; and (b) extend any of the deadlines set out in Paragraphs 1-8, above.

 

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  C. Restatement of Earnings

1. MBIA shall restate its earnings on a GAAP basis for the years 1998 to 2004 in
order to properly account for the AHERF transaction.

2. MBIA agrees to make the recommended changes to its statutory financial
statements as reflected in the Insurance Department’s Report on Examination.

 

  D. General Relief

1. MBIA admits the jurisdiction of the Attorney General. MBIA will cease and
desist from engaging in any acts in violation of the Martin Act and Executive
Law § 63(12) and will comply with the Martin Act and Executive Law § 63(12).

2. Evidence of a violation of this Assurance by MBIA shall constitute prima
facie proof of violation of the Martin Act and Executive Law § 63(12) in any
civil action or proceeding hereafter commenced by the Attorney General against
MBIA relating to the matters herein.

 

II. Other Provisions

 

  A. Scope Of This Assurance

1. Definition: “Attorney General’s Investigation” means the Attorney General of
New York’s investigation of MBIA’s disclosures and accounting relating to AHERF.

2. This Assurance shall conclude the Attorney General’s Investigation and any
other issues arising from or relating to the subject matter of the Attorney
General’s Investigation; provided, however, that nothing contained in this
Assurance shall be construed to cover any claims that may be brought by the
Attorney General to enforce MBIA’s obligations, either joint or several, arising
from or relating to the provisions contained in this Assurance.

 

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3. If MBIA does not make the payments as provided in section I.A. of this
Assurance (i.e., pursuant to the SEC Judgment), or MBIA defaults on any
obligation under this Assurance, the Attorney General may terminate this
Assurance, at his sole discretion, upon 10 days written notice to MBIA and MBIA
agrees that, in that event, any statute of limitations or other time related
defenses applicable to the subject of the Attorney General’s Investigation and
any claims arising from or relating thereto are tolled from the date of signing
of this Assurance to the date of any such written notice. In the event of such
termination, MBIA expressly agrees and acknowledges that this Assurance shall in
no way bar or otherwise preclude the Attorney General from commencing,
conducting or prosecuting any investigation, action or proceeding, however
denominated, related to the Attorney General’s Investigation, against MBIA or
from using in any way any statements, documents or other materials produced or
provided by MBIA prior to or after the filing of this Assurance, including,
without limitation, such statements, documents or other materials provided for
purposes of settlement negotiations.

4. Nothing herein shall preclude New York State, its departments, agencies,
boards, commissions, authorities, political subdivisions and corporations, other
than the New York State Attorney General and only to the extent set forth in
Paragraph II.A.2 above (collectively, “State Entities”) and the officers, agents
or employees of State Entities, from asserting any claims, causes of action, or
applications for compensatory, nominal and/or punitive damages, administrative,
civil or criminal or injunctive relief against MBIA arising from or relating to
the subject of the Attorney General’s Investigation.

 

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5. Except in an action by the Attorney General to enforce the obligations of
MBIA in this Assurance, neither this Assurance nor any acts performed or
documents executed in furtherance of this Assurance: (a) may be deemed or used
as an admission of, or evidence of, the validity of any alleged wrongdoing,
liability or lack of wrongdoing or liability; or (b) may be deemed or used as an
admission of or evidence of any such alleged fault or omission of MBIA in any
civil, criminal or administrative proceeding in any court, administrative agency
or other tribunal. This Assurance shall not confer any rights upon persons or
entities who are not a party to this Assurance. Nothing herein shall be
construed to prohibit the use of any e-mails or other documents of MBIA or of
others.

 

  B. Cooperation

1. MBIA shall cooperate fully and promptly with the Attorney General and shall
use its best efforts to ensure that all the current and former officers,
directors, trustees, agents and employees of MBIA cooperate fully and promptly
with the Attorney General in all respects and such cooperation shall include,
without limitation:

(a) production, voluntarily and without service of subpoena, upon the request of
the Attorney General, of all documents or other tangible evidence requested by
the Attorney General and any compilations or summaries of information or data
that the Attorney General requests that MBIA prepare;

 

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(b) without the necessity of a subpoena, having the current and former officers,
directors, trustees, agents and employees of MBIA attend any Proceedings (as
hereinafter defined) in New York State or elsewhere at which the presence of any
such persons is requested by the Attorney General and having such current and
former officers, directors, trustees, agents and employees answer any and all
inquiries that may be put by the Attorney General to any of them at any
proceedings or otherwise;

(c) fully, fairly and truthfully disclosing all information and producing all
records and other evidence in MBIA’s possession, custody or control relevant to
all inquiries made by the Attorney General;

(d) waiving, upon request by the Attorney General, all privileges including,
without limitation, attorney-client and attorney work product privileges, with
respect to all matters relating to the Attorney General’s Investigation;

(e) waiving, upon request by the Attorney General, all privileges relating to
any internal investigations concerning matters involved in the Attorney
General’s Investigation (whether conducted before or after the signing of this
Assurance), including, without limitation, production of all interview notes
taken in connection with any internal investigations; and

(f) making outside counsel reasonably available to provide comprehensive
presentations concerning any internal investigation relating to all matters
concerning the Attorney General’s Investigation and to answer questions.

 

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2. All communications relating to cooperation pursuant to this Assurance may be
made to MBIA’s attorneys as follows: John H. Hall, Esq., Debevoise & Plimpton,
LLP, 919 Third Avenue, New York, New York 10022.

3. In the event MBIA fails to comply with this section of the Assurance, the
Attorney General shall be entitled to specific performance in addition to any
other remedies in the Assurance or otherwise.

 

  C. Miscellaneous Provisions

1. This Assurance and any dispute related thereto shall be governed by the laws
of the State of New York without regard to any conflicts of laws principles.

2. No failure or delay by the Attorney General in exercising any right, power or
privilege hereunder shall operate as a waiver thereof nor shall any single or
partial exercise thereof preclude any other or further exercise thereof or the
exercise of any other right, power or privilege. The rights and remedies
provided herein shall be cumulative.

3. MBIA consents to the jurisdiction of the Attorney General in any proceeding
or action to enforce this Assurance.

4. MBIA enters into this Assurance voluntarily and represents that no threats,
offers, promises, or inducements of any kind have been made by the Attorney
General or any member, officer, employee, agent or representative of the
Attorney General to induce MBIA and to enter into this Assurance.

5. MBIA agrees not to take any action or to make or permit to be made any public
statement denying, directly or indirectly, any finding in this Assurance

 

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or the Stipulation or creating the impression that this Assurance or the
Stipulation is without factual basis. Nothing in this paragraph affects MBIA’s:
(a) testimonial obligations; or (b) right to take legal or factual positions in
defense of litigation or other legal proceedings to which the Attorney General
is not a party.

6. This Assurance may be changed, amended or modified only by a writing signed
by all parties hereto.

7. This Assurance constitutes the entire agreement between the Attorney General
and MBIA and supersedes any prior communication, understanding or agreement,
whether written or oral, concerning the subject matter of this Assurance.

8. If any provision of this Assurance is found to be unenforceable, such finding
shall not effect the enforceability of the remaining provisions hereof.

9. This Assurance shall be binding upon MBIA and its successors and assigns.

10. This Assurance shall be effective and binding only when this Assurance is
signed by all parties. This Assurance may be executed in one or more
counterparts, each of which shall be deemed an original but all of which
together shall constitute one instrument.

WHEREFORE, the following signatures are affixed hereto on the dates set forth
below.

Dated: November 2, 2005

MBIA, Inc.

 

/s/ Gary Dunton

Name: Gary Dunton

Title: Chief Executive Officer and President, MBIA, Inc.

 

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ACKNOWLEDGMENT

 

STATE OF NEW YORK   )   :ss. COUNTY OF NEW YORK   )

On this 2nd day of November, 2005, before me personally came Gary Dunton, known
to me, who, being duly sworn by me, did depose and say that he is the Chief
Executive Officer and President of MBIA, Inc., the entity described in the
foregoing Assurance, is duly authorized by MBIA Inc., to execute the same, and
that he signed his name in my presence by like authorization.

 

/s/ Barbara B. Edelmann

Notary Public My commission expires:

BARBARA B. EDELMANN

Notary Public, State of New York

No. 4858965

Qualified in Westchester County

Commission Expires May 19, 2006

 

/s/ John H. Hall, Esq.

John H. Hall, Esq. Debevoise & Plimpton, LLP Attorneys for MBIA 919 Third Avenue

New York, New York 10022

 

Dated: Jan. 24, 2007

ANDREW M. CUOMO

Attorney General of the State of New York

/s/ Gary R. Connor

Gary R. Connor Deputy Bureau Chief Office of the New York State Attorney General
Investment Protection Bureau 120 Broadway, 23rd Floor New York, New York 10271
Dated: Jan. 25, 2007

 

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