GE is $200 Million Poorer, $200 Billion Wiser
(Bloomberg Opinion) -- For General Electric Co., a true recovery “must entail a restoration of credibility and a reckoning with the tendency toward obfuscation that allowed its cash-flow and balance-sheet challenges to lurk beneath the surface for so long.” I wrote that sentence in 2019, but it could have appeared in any number of columns over the past three-plus years. And on this front, GE took a major step forward on Wednesday.
The company agreed to pay $200 million to settle a Securities and Exchange Commission charge that it misled investors about the financial circumstances leading up to its drastic drop in market value in 2017 and 2018 and painted an aggrandized picture of its material operating results. This included: failing to disclose that large chunks of the “profits” in its power division came from adjusting previous cost estimates on an accounting basis; declining to tell investors that it bolstered the cash-flow numbers for that unit by borrowing from future years and selling accounts-receivable balances to its GE Capital financial arm; and not being clear with shareholders about the risks it was taking by lowering projections for claims in a legacy long-term care insurance business at a time when the costs associated with such policies were climbing and it should have been doing the opposite. In short, GE appears to have pulled a variety of levers to make its financial statements look a lot healthier than its businesses actually were.
Nothing in the SEC’s filing should come as a surprise to observers of the company. In January 2018, GE disclosed a $15 billion shortfall in its long-term care insurance reserves. Later that year, it took a $22 billion writedown on the goodwill in its power division. The company's market value is down nearly $200 billion from what it was at the start of 2017. The SEC findings still make for some fairly brutal reading, though. “Investors are entitled to an accurate picture of a company’s material operating results,” Stephanie Avakian, director of the SEC’s division of enforcement, said in a statement. “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.”
GE neither admitted nor denied wrongdoing, which is fairly common for these sorts of proceedings. But the important thing for investors today is that GE isn’t the company described in this SEC order anymore.
CEO Larry Culp’s turnaround efforts are gaining traction, even amid the pandemic, with the company reporting a surprise positive free-cash-flow number for the third quarter and committing to taking in at least $2.5 billion in the fourth quarter. I’d like to see the company go further to improve accountability and transparency. Presentation “errors” that later have to be corrected, the careful micromanagement of Wall Street’s earnings expectations and GE’s continued reliance on a heavily adjusted method for calculating earnings per share haven’t made for the best look at times. But Culp has added new disclosures to the company’s annual and quarterly filings, particularly around the troublesome insurance business, and is switching to a new auditor after more than 100 years with KPMG. He’s also overhauled the board, refreshed the management team (including hiring an outside chief financial officer in Carolina Dybeck Happe) and shrunk GE’s historically bloated headquarters in favor of giving more operational control to the businesses themselves.
In just one example of how far GE has come, the company first disclosed the SEC’s investigation in the middle of a 2018 earnings call, catching many investors and analysts off guard. By contrast, earlier this year, when the SEC issued a Wells Notice indicating it may pursue action over the violation of securities laws, GE publicly disclosed that development in a filing soon after, even though it didn’t technically have to. These are basics, I know, but it’s progress. The $200 million fine isn’t going to break the bank. GE had said in October that it reserved $100 million for the matters under investigation, so this is a higher settlement than it appears to have expected. But the SEC has fairly wide latitude to punish companies for the kinds of infractions described in this order, and some investors had worried that the cost would be much larger or that the agency would require financial restatements and behavioral remedies. While GE will have to report additional details to the SEC around its accounting and disclosure controls for the insurance and power businesses for a year, that’s nothing the company can’t handle.
No company wants to pay a large fine to the SEC, but putting this issue in GE’s past rather than its future removes a big lingering risk for a company that is slowly, but surely, starting to change.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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