General Electric Co.
agreed to pay a $200 million penalty to settle federal claims that it misled investors by failing to disclose problems in its gas-turbine power and insurance businesses, capping an investigation into what went wrong inside the conglomerate.
The Securities and Exchange Commission, after a multiyear probe into how GE recognized some costs and profits, said the company misrepresented how its power business was making money and didn’t inform investors of the rising risk in its legacy insurance portfolio that would eventually require more than $15 billion to boost its reserves.
“GE’s repeated disclosure failures across multiple businesses materially misled investors about how it was generating reported earnings and cash growth as well as latent risks in its insurance business,” said
director of the SEC’s Division of Enforcement.
GE settled the claims without admitting or denying the SEC’s allegations, and the settlement order didn’t allege GE violated U.S. accounting rules or the most serious antifraud laws. Under the resolution, the company also must report to the SEC for a one-year period on its policies and controls related to accounting and disclosure.
GE said no changes to prior financial statements are required. “We are pleased to have reached an agreement that puts the matter behind us,” the company said. “Under the current leadership team, we have significantly enhanced our disclosures and internal controls and are a stronger company today.”
The SEC said in announcing the deal that it continues to investigate the claims, which often means regulators are still probing whether individuals should be formally accused of wrongdoing.
The SEC said GE’s misconduct spanned from 2015 to 2017 and involved accounting maneuvers that boosted GE’s earnings by billions of dollars and improved a key measure of its cash flow. The moves to increase industrial cash flow, by about $1.9 billion in 2016 and 2017, involved selling receivables, or money GE was owed from customers, to GE Capital. The company didn’t disclose its increased reliance on selling receivables to goose its industrial cash flow, the SEC said in the settlement order.
The SEC and the Justice Department have been investigating GE’s accounting for about two years after the company disclosed large write-downs tied to its insurance business and its power business. The SEC had warned GE in September that it was preparing civil charges, and GE said it had set aside $100 million to resolve the matter.
The terms of GE’s settlement with the SEC make it less likely the Justice Department will pursue a case against GE or its former executives. Prosecutors typically have to prove knowledge and intent to commit fraud in order to indict individuals or charge a company.
Accounting problems surfaced in late 2017 as GE was struggling with declining profits and cash flow following the departure of former Chief Executive
The company later disclosed, in January 2018, that it needed to bolster its insurance reserves by $15 billion and booked a $6 billion charge.
GE’s stock tumbled in 2017 and 2018, erasing more than $200 billion in market value. The company slashed its dividend to a token penny a share. It also sold off various business units, cut jobs and twice switched leaders, installing
as CEO in October 2018. GE also decided to change auditors after more than a century with KPMG, hiring Deloitte starting in 2021.
The SEC’s investigation found that GE executives boosted the company’s reported profits by lowering the estimated cost of fulfilling long-term GE Power service contracts. The change resulted in higher profits when the adjustment was made but didn’t bring in cash.
As the gap between reported profits and cash flow widened, Wall Street analysts and investors raised concerns, prompting GE to generate cash by selling receivables to GE’s finance division, a practice referred to as “deferred monetization.”
The practice “was described internally as a ‘drug’ because the company needed to continue to do more deferred monetization to achieve equivalent effects period after period,” according to the SEC order. The practice was also costly for GE, as it involved offering discounts to customers and paying interest to GE Capital.
Profits in GE’s power business, which was once the company’s largest in terms of revenue, tumbled after falling demand from utilities left GE stuck with excess supply of turbines and parts. GE also booked a $22 billion charge in 2018 tied to acquisitions in the unit.
The SEC said executives “misled GE’s investors about the company’s earnings quality by making it appear as if GE Power was converting earnings to cash in the present period, when in fact GE Power was pulling forward cash from future periods.”
The insurance problem was a hangover from GE’s one-time reliance on financial services to drive its profits. At its height, GE Capital accounted for more than half of GE’s profits.
GE spun off most of its insurance holdings into
Genworth Financial Inc.
in 2004 and sold much of the rest to
two years later. But GE kept the risk for some long-term-care insurance policies. Such policies pay for nursing homes and assisted-living facilities. They proved to be an expensive problem for the insurance industry, which underestimated how much the policies would need to pay out.
The SEC said executives in GE’s insurance business and GE Capital knew the insurance losses were growing and posed a risk, but they made actuarial or accounting changes to avoid having to recognize losses. Reversing the losses also avoided a deeper examination of the insurance reserves.
For example, in August 2016, GE’s actuaries concluded an annual test of the policies that would have resulted in GE taking a $178 million hit to earnings. In response, executives in the insurance unit employed a new approach, referred to as the “rollforward,” which eliminated the potential loss, the SEC found.
Instead of using 2016 claims data to estimate costs, GE took assumptions for the end of 2015 and projected them forward nine months. The rollforward raised questions from internal auditors, the SEC said, but not until mid-2017 did actuaries determine that GE faced an even bigger problem, and the company began reviewing its insurance reserves.
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