GE Warns of Likely SEC Action in Probe of Insurance Reserves

(Bloomberg) -- General Electric Co. warned that it's likely to face U.S. Securities and Exchange Commission allegations of accounting misdeeds, setting back Chief Executive Officer Larry Culp's effort to put the company's rocky past behind it.

GE received a Wells notice Sept. 30 advising that the SEC may pursue a civil enforcement action over possible securities violations tied to an old insurance business, according to a company regulatory filing Tuesday. The agency has yet to decide whether to recommend action on issues related to GE's power-equipment business that are also under investigation.

The Wells notice reopens old wounds from a previously disclosed SEC investigation just as the company is trying to restart a turnaround upended by the coronavirus pandemic. In early 2018, about six months after Culp predecessor John Flannery took over from Jeffrey Immelt, GE disclosed a $6.2 billion charge related to an insurance portfolio of long-term care policies and said it would pay $15 billion over seven years to fill a shortfall in reserves.

“Most investors seem to believe that the government ultimately is likely to slap GE with a nominal fine. However, the matter could also result in more significant consequences,” John Inch, an analyst at Gordon Haskett, said in a note to clients.

“The largest risk(s) could pertain to GE's possible future requirement to restate past financials and/or incur additional write-offs -- potentially materially squeezing the trajectory for a return to higher future reported profitability,” Inch said.

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The Boston-based company said it is cooperating with SEC investigators and vowed to defend itself against any accusations.

“We strongly disagree with the recommendation of the SEC staff and will provide a response through the Wells notice process,” GE said by email.

The SEC declined to comment.

GE erased gains following the disclosure, falling 3.7% to close at $6.17 in New York on Tuesday. The shares have tumbled 45% this year, compared with a 4.2% decline in a Standard & Poor's index of U.S. industrial companies.

Long-Term Care

The SEC uses Wells notices to notify companies about potential civil enforcement actions. The advisories typically touch off quiet negotiations between the agency and the target of an investigation over the merits of a potential penalty, and often result in a compromise and settlement, said Columbia Law School professor John Coffee.

“Here GE has gone public and criticized the SEC in a public statement; that is less common,” Coffee said in an email.

While GE hadn't conducted any new insurance business in the long-term care market since 2006, by early 2018 it was still saddled with obligations to pay for nursing home care or similar benefits on contracts written years earlier. The liabilities can swell when claims costs are higher than expected or when investment income fails to meet projections -- a problem exacerbated by low interest rates.

Last year, a prominent financial examiner working with an unidentified short seller said GE would need to increase its reserves immediately by $18.5 billion in cash. The examiner, Harry Markopolos, who had raised concerns over investment manager Bernie Madoff before his fraud was exposed, said GE would also need to take an additional noncash charge of $10.5 billion when new accounting rules take effect.

Markopolos's report spurred GE's biggest decline in 11 years, and the company pushed back with questions about the accuracy of the analysis. The shares more than recovered the lost ground by the end of the year.

“GE probably thought it had defeated Markopolos when GE's price went back to its prior level, but apparently the issue still lives,” Coffee said.

Future Risks

The company revealed the SEC probes of its insurance reserves and power division during an epic two-year corporate collapse in which GE shed more than $200 billion in market value.

Separately, GE took a $22 billion charge in the power-equipment unit in October 2018, shortly after Culp became CEO. The SEC, which was already looking into GE's long-term service agreements with power customers, expanded its inquiry to include the charge as well. GE has also said the Justice Department is investigating the insurance and power-business issues.

RBC Capital Markets analyst Deane Dray said the insurance and power issues under investigation by the SEC are “old news” that date back to prior regimes and have since been addressed through changes to personnel, business practices and additional financial disclosures.

“I think investors will look at this as rear-view mirror issues,” he said.

GE in April 2019 agreed to pay $1.5 billion to settle a separate Justice Department investigation of the company's defunct subprime-mortgage business. The civil settlement, in which GE didn't admit liability, resolved claims that the unit misrepresented the quality of residential mortgage-backed securities.

In 2009, GE agreed to pay $50 million to settle U.S. regulatory claims it manipulated earnings to meet analysts' estimates.

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