GE Is Still Haunted by a '$15 Billion Problem'

(Bloomberg Opinion) -- Try as it might, General Electric Co. can't escape its past. The latest reminder came on Tuesday when the embattled industrial giant said it had received a “Wells notice” from staff at the Securities and Exchange Commission — a warning that the regulator may pursue civil action over the potential violation of securities laws.

At issue is GE's handling of a legacy insurance business and its disclosure in 2018 of a surprise $15 billion shortfall in reserves that were supposedly stress-tested each year. As Vertical Research analyst Jeff Sprague put it when the massive deficiency was first announced, “It is hard to imagine a $15 billion problem materialized in the course of the year." 

The government hasn't officially accused GE of wrongdoing. Tuesday's update is more procedural in nature, and the company now has the opportunity to respond to issues raised by SEC staff before the agency formally decides to pursue an enforcement action. What that might ultimately look like ranges from monetary penalties to restated financials or even added governance and operational guardrails meant to prevent future violations. In a statement, GE said it “has fully cooperated with the SEC's investigation related to past reserve practices at our run-off insurance subsidiary, as we have disclosed since 2018. We strongly disagree with the recommendation of the SEC staff and will provide a response through the Wells notice process.”

GE CEO Larry Culp has now been in his job for two years. It's been a difficult slog, made only more so by a global pandemic that crippled the company's crown-jewel aviation unit and stilted progress on a turnaround of its gas turbine business. Say what you will about his tenure, there have been few new unpleasant surprises under his watch. But resolving past trouble spots has been difficult enough.

A positive reading of Tuesday's disclosure of the Wells notice is that GE may be one step closer to finally putting this matter behind it. Most analysts have assumed the company will eventually pay some sort of penalty to settle the SEC's investigations into its accounting practices. When GE announced in January 2019 that it had reached an agreement with the Department of Justice to pay $1.5 billion to settle a long-standing investigation into its WMC subprime mortgage business, the shares actually staged a double-digit relief rally. Tying a bow on the SEC investigation arguably might have a similar effect. The problem is, there remain too many loose ends. 

For one, SEC penalties aside, GE still has to fund its insurance reserves. Speaking at the Morgan Stanley conference last month, Culp indicated no major surprises had come up when the company conducted one of two annual tests on the adequacy of the company's reserve assumptions in the third quarter, but the obligations vary with interest rates and remain at risk of growing further in a lower-for -onger environment. The looming implementation of new accounting rules could also prompt a charge. What's more, the SEC wasn't just investigating the insurance shortfall. Before the Wells notice, the agency was focused on GE's revenue recognition practices and internal controls related to long-term service agreements, which are much more core to its current business model than insurance. The inquiry was later expanded to include a $22 billion goodwill writedown largely tied to GE's disastrous acquisition of Alstom SA's energy business. In its disclosure Tuesday, GE said the SEC staff has not made a preliminary decision on whether to recommend action on these other matters. And the same issues are being probed by the DOJ. 

In short, it's unlikely to be the last investors hear of these legacy issues. That in and of itself is a problem.

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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