Legacy business had accounting problems
By Thomas Gryta and David Benoit
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (December 1, 2018).
Federal investigators are questioning former employees of
General Electric Co. about intricate details in a legacy insurance
business that led to accounting problems at the conglomerate in the
past year.
The insurance business failed to internally acknowledge
worsening results over the years, according to several former GE
employees who said they have been interviewed by government
lawyers. They described in interviews for this article examples of
what they call lax managerial oversight and buried risks that
ultimately kept the company from booking bigger reserves.
The investigation by the Securities and Exchange Commission
started, the company said, after GE earlier this year disclosed
that a shortfall in those reserves for long-term-care policies
would require more than $15 billion in funding. That surprise was
part of a series of problems that have pushed GE shares to their
lowest levels in years and prompted GE to decide to break itself
apart and oust its chief executive.
GE has denied allegations of fraud made in a shareholder lawsuit
and says it is cooperating with the government investigators. A GE
spokeswoman said the company won't comment on the specifics of
continuing legal matters and said it is "exploring every option to
manage and mitigate risk" from the insurance business.
"We've recently brought in new seasoned leaders with deep and
diverse backgrounds to manage through the complexities," the
spokeswoman said.
The shareholder lawsuit cites accounts from several former
employees and alleges the accounting fueled a yearslong fraud that
inflated GE's results. Investigators have reviewed the lawsuit and
spoken with some of those employees, people familiar with the
matter say. GE denies the claims and has moved to have the case
dismissed.
"I wouldn't say what I saw was smoke," said a former employee at
the company's finance arm, GE Capital, who left in 2016. "But there
was enough concern that I decided to leave because I didn't want to
be there when there was smoke." This person spoke to SEC
investigators this summer, the person said.
This person was hired to help improve the governance of the
reserve process at GE's insurance business, but left after growing
concerned that senior executives in the division were changing
numbers and their methodology without providing supporting
evidence, the person said in an interview. The person detailed
examples to the SEC, the person said. The reasons for the changes
weren't clear, this person said.
The SEC's Boston office opened a probe of the company in
November 2017 that focused on revenue accounting in its power
division. After GE disclosed the insurance shortfall in January,
the probe was expanded to include that review as well, according to
the company.
Last month, GE said it was also the subject of a criminal probe
by the Department of Justice.
David Chase, a former SEC enforcement attorney now in private
practice in Miami, said the entrance of the Justice Department into
an accounting probe is unusual because of the dependence on
subjective assessments and opinion in accounting decisions.
"Accounting cases are very difficult to prove," he said, adding
that the claims can turn into a battle of expert witnesses. No
charges have been filed by the SEC or the Justice Department, and
Mr. Chase cautions that the focus of an investigation isn't always
known.
Representatives of the SEC and Justice Department declined to
comment.
Besides the insurance charge, the investigators are also looking
at how GE's power business used complex contract accounting rules
to report revenue long before the related cash actually arrived,
along with a $22 billion write-off in the same business, the
company has disclosed.
It is unclear how far along the investigators are in their work.
Some prominent former GE executives haven't been contacted, people
familiar with the matter said.
The shareholder lawsuit was brought by pension funds and other
investors in federal court in the Southern District of New York in
November 2017. The suit, several legal complaints consolidated into
one, cites testimony from unnamed GE employees who allege that
cash-flow models used to determine required reserves were altered
for unknown reasons. One person claims to have informed GE's
external auditor, according to the complaint.
GE's court filings say management mistakes, not fraud, were to
blame for the company's problems. "Federal securities laws provide
remedies only for fraud, not for unsuccessful business strategies,"
GE's lawyers wrote.
Many investors were surprised by the insurance situation, partly
because GE executives had repeatedly declared that it had shed its
insurance risk. The company spun off most of its insurance holdings
into Genworth Financial Inc. in 2004 and sold much of the rest to
Swiss Reinsurance Co. two years later.
But GE kept the risk for a bloc of long-term-care insurance
policies, written by GE Capital until 2006. 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.
GE removed the disclosure of the long-term-care liabilities from
part of its annual report for 2012 and didn't put them back until
this past February. That's when GE reported insurance liabilities
of $38 billion, up from $11.1 billion the previous year, according
to SEC filings.
In court filings, GE says the exclusion was a "normal business
decision" and reversing it doesn't mean the previous financial
statements were fraudulent. GE says the reserve increase followed a
detailed review of the long-term-care portfolio after the company
noticed a surge in claims in early 2017, which altered expectations
for the future of the business.
Another former GE Capital employee said it was clear at the time
of the 2004 Genworth IPO that a bloc of long-term-care policies
were toxic. They couldn't be part of the IPO, which was considered
the "good book" of assets, the person said, so GE agreed to cover
the risk.
The move was made to raise as much money as possible with the
Genworth IPO, people familiar with the decision said. The
shareholder lawsuit cites unnamed former employees saying this as
well.
Genworth's registration document from the time details the
arrangement, saying that the excluded policies "do not meet our
target return thresholds."
Genworth's other long-term-care policies weren't doing well
either, with losses totaling about $2 billion. Other insurers took
charges for their long-term-care policies. GE didn't make
adjustments -- until this year.
"GE Capital still sat on an undisclosed ticking time bomb," the
shareholder suit alleges, "that seriously threatened GE's long term
health."
Write to Thomas Gryta at thomas.gryta@wsj.com and David Benoit
at david.benoit@wsj.com
(END) Dow Jones Newswires
December 01, 2018 02:47 ET (07:47 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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