SEC files fraud charges against GE

By Cydney Posner

The SEC yesterday filed civil fraud and other charges against GE, alleging that it used improper accounting methods to increase its reported earnings or revenues and to avoid negative financial disclosures.  GE has agreed to pay a $50 million penalty to settle the SEC's charges.

Interestingly, the SEC said that the accounting violations were discovered as a result of a "risk-based investigation" of GE's accounting practices: "In a risk-based investigation, the SEC identifies a potential risk in an industry or at a particular issuer and develops an investigative plan to test whether the problem actually exists. In this case, the SEC identified the potential misuse of hedge accounting as a possible risk area. The SEC's investigation ultimately uncovered four separate accounting violations, and GE corrected the last of the violations in 2008." In its complaint, the SEC contended that, on four separate occasions, high-level GE accounting executives or other finance personnel approved aggressive accounting practices that were not in compliance with GAAP and, in one instance, the improper accounting allowed GE to avoid missing analysts' final consensus EPS expectations. The practices related to improperly changing (over the objections of its internal and outside auditors) GE's existing hedge accounting method for its commercial paper funding program to avoid a result that might have led to the loss of favorable hedge accounting for its entire program and to avoid reporting certain fluctuations in the value of its interest rate swaps, failing to restate its financials to correct for the use of incorrect hedge accounting, improper recognition of revenue from transactions that were not "true sales" but were orchestrated through financial intermediaries (over the objections of internal audit and notwithstanding that the financial intermediaries had requested that GE represent that the transactions had been disclosed to GE's outside auditor and accounted for in accordance with GAAP because they were concerned about their own risk of liability), and all kinds of manipulations related to reserves and sales of spare parts (even though the outside auditor advised that GE was "virtually assured" to lose any challenge). (You have to wonder how, with all their objections ignored, the outside auditors ever signed off on the audit?) While the complaint contains more than you ever want to know about hedge and spare parts accounting, it's also very instructive in describing how, at least in some of the instances, innocent mistakes morphed into (alleged) securities fraud.

And further contributing to the charged atmosphere is this uncharacteristically agitated column from Steven Pearlstein in the Washington Post, railing, in light of GE, Bank of America and other recent cases, about the levels of deceit and obfuscation in corporate disclosures, which he characterizes as "pretty much standard operating procedure in corporate America."

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