The Securities and Exchange Commission today filed civil fraud and other charges against General Electric (GE), alleging that it misled investors by reporting materially false and misleading results in its financial statements for 2002 and 2003, according to a press release put out by the agency.
The SEC alleges that GE used improper accounting methods to increase its reported earnings or revenues and avoid reporting negative financial results, its press release says. GE has agreed to pay a $50 million penalty to settle the SEC's charges.
And in an embarrassing development for the industrial conglomerate, GE consented to the SEC's permanent injunction against violating the antifraud, reporting, record-keeping and internal controls provisions of the federal securities laws. Permanent injunctions are a black mark against a company, according to market regulators.
The SEC also recently hit Bank of America with a $33 mn fine and a permanent injunction for violating securities disclosure laws when it withheld from bank shareholders who were voting on the Merrill Lynch acquisition the $5.8 bn in bonuses it had agreed in September 2008 to pay Merrill Lynch workers.
The SEC's suit is the culmination of a four and a half year probe into GE's financials. And in its suit the SEC acknowledged that GE, long snickered at on Wall Street for beating its earnings estimates by a penny a share for years, had booked results that met or exceeded analysts' consensus forecasts in every quarter from 1995 through 2004.
GE has been struggling with its GE Capital unit, the cause of the lionshare of its accounting problems. Through its finance unit, GE has been able to repeatedly hit its consensus earnings estimates by letting GE Capital, known as a 'black box' operation on Wall Street, make various abstruse moves, including the use of derivatives to smooth earnings or last minute asset sales such as offloading commercial real estate to hit its numbers--the reason why it stunned Wall Street with a rare, big whiff on earnings in April 2008, which shot its shares lower in trading.
But when the recent economic crisis left the credit markets frozen solid, GE through its finance unit couldn't manipulate its numbers with these moves as it has so adeptly done in the past. GE recently said it may have to inject $2 bn to $7 bn into GE Capital.
GE has been the recipient of government bailout programs, as it let its finance unit dangerously bulk up on all sorts of bad assets during the bubble years, including commercial real estate ($230 bn) and consumer finance ($183 bn). GE has lost some $270 bn in market share during the credit crisis.
GE has since lobbied the government to let it gain access to the FDIC's debt insurance program, and it's now the single biggest corporate user of this program, which lets it borrowly cheaply in the credit markets to fund its operations. GE also accesses the Federal Reserve's commercial paper backstop, a maximum $98 bn here, and it may access the Fed's Term Asset-backed Securities Loan Facility program.
"GE bent the accounting rules beyond the breaking point," said Robert Khuzami, director of the SEC's division of enforcement said in a statement. "Overly aggressive accounting can distort a company's true financial condition and mislead investors."
David P. Bergers, director of the SEC's Boston regional office, added in a written statement, "Every accounting decision at a company should be driven by a desire to get it right, not to achieve a particular business objective. GE misapplied the accounting rules to cast its financial results in a better light."
The SEC uncovered the accounting violations in a risk-based investigation of GE's accounting practices.
GE says in a statement that it settled with the SEC "without admitting or denying allegations of any wrongdoing" and that the "settlement relates to four accounting matters in 2002 and 2003." In particular, its since-discontinued commercial paper hedging program; certain swap derivatives; a change in accounting for profits on spare parts in the commercial aviation engine business; and fraudulently booking revenues on more than 100 locomotives before the sales actually occurred.
GE says it has already corrected its SEC filings made between May 2005 and February 2008, and that "no further corrections are required."
However, on four separate occasions in 2002 and 2003, high-level GE accounting executives or other finance personnel bent the accounting rules letting the company either inflate or smooth earnings, or letting it hit its analysts' consensus earnings expectations.
The four accounting violations were:
1. An improper application of the accounting standards to GE's commercial paper funding program to avoid unfavorable disclosures. GE also avoided an estimated $200 mn pre-tax charge to earnings. The move resulted in GE overstating its fourth quarter 2002 net income by an estimated 5.4%. Booking the $200 mn pre-tax charge would have caused "GE to miss its quarterly and annual consensus EPS estimates by approximately 1.5 cents. Noting GE's penchant for aggressively managing its Wall Street earnings expectations with such moves, the SEC says: "GE had last missed final consensus EPS estimates in 1994, some eight years beforehand";
2. A 2003 failure to correct a misapplication of financial accounting standards to GE interest-rate swaps, moves which helped smooth GE's earnings. Although GE had failed to book a net $381 mn in profits with this move from the first quarter of 2001 to 2005, (after netting out reported profits and losses), the "restated results reflected significantly increased volatility from quarter to quarter," the SEC says;
3. In 2002 and 2003, reported end-of-year sales of locomotives that had not yet occurred in order to accelerate more than $370 million in revenue; "GE personnel at the business level orchestrated these transactions in order to improperly accelerate revenue recognition," the SEC says, adding that GE "admitted that the revenues and profit for the reported business segments containing the year-end rail transactions were overstated by 8.8% and 14.6%, respectively, in the fourth quarter of 2002 and overstated by 22.6% and 16.7%, respectively, in the fourth quarter of 2003";
4. In 2002, an improper change to GE's accounting for sales of commercial aircraft engines' spare parts that increased GE's 2002 net earnings by $585 million.
In a prepared statement GE says:
"GE is committed to the highest standards of accounting. GE cooperated with the SEC over the course of its investigation, and GE and its audit committee conducted their own comprehensive review in conjunction with the investigation."
"The company reviewed and produced approximately 2.9 million pages of e-mails and other documents to the SEC and incurred approximately $200 million in external legal and accounting expenses to ensure that all issues were addressed appropriately."
"We have concluded that it is in the best interests of GE and its shareholders to resolve this matter and put it behind us on the basis announced today, pursuant to which, consistent with standard SEC practice, we neither admit nor deny the SEC's allegations."
"The errors at issue fell short of our standards, and we have implemented numerous remedial actions and internal control enhancements to prevent such errors from recurring, as previously described in our SEC filings, including measures to strengthen our controllership and technical accounting resources and capabilities."