By Thomas Gryta and Mark Maremont
An accounting expert who raised red flags about Bernie Madoff's
Ponzi scheme has a new target: General Electric Co.
In a research report posted online Thursday, Harry Markopolos
alleges the struggling conglomerate has masked the depths of its
problems, resulting in inaccurate and fraudulent financial filings
with regulators. The report, which numbers more than 170 pages, is
a mixture of detailed financial analysis and sweeping claims.
In an interview, Mr. Markopolos said his group found GE's
insurance unit will need to bolster its reserves by $18.5 billion
in cash, and he faulted the way the company is accounting for its
oil-and-gas business. All told, he said, the accounting problems
amount to $38 billion, or 40% of the conglomerate's market
value.
"This is market manipulation -- pure and simple," GE Chief
Executive Officer Larry Culp said in a statement that was released
midday Thursday. "Mr. Markopolos's report contains false statements
of fact, and these claims could have been corrected if he had
checked them with GE before publishing the report."
GE stood by its financial reporting and said the Markopolos
report was produced to help short sellers by creating volatility in
GE shares. Mr. Culp accused Mr. Markopolos of being motivated by
personal profit rather than accurate financial analysis.
GE's shares dropped 11% to $8.01, a seven-month low, in
Thursday's trading. That is the largest percentage decrease since
April 2008. Mr. Culp bought $2 million of GE stock at $7.93 a share
Thursday, after buying $3 million worth at $9.03 Monday. A
spokeswoman said the purchases reflect his confidence in the
company.
Mr. Markopolos said he and his colleagues are working with an
undisclosed hedge fund, which is betting GE's share price will
decline. Mr. Markopolos's group gave the investor access to the
research before publication and will receive a portion of any
trading proceeds. He declined to identify the hedge fund. The group
also is sharing its findings with securities regulators, hoping to
collect a cash reward as part of a whistleblower program, Mr.
Markopolos said.
Asked Thursday to respond to GE's criticism of his motivation
and methods, Mr. Markopolos was dismissive. "Who contacts the bad
guys so they can cover it up," he said.
The group's research indicates that GE is short on working
capital -- a key measure of liquidity -- and that its cash
situation is far worse than disclosed in its regulatory
filings.
GE responded that it has a "strong liquidity position, committed
credit lines, and several executable options to monetize assets."
The company said it ended the second quarter with $16.9 billion of
cash at its industrial business, excluding Baker Hughes, and $12.5
billion of liquidity at GE Capital.
The Boston-based investor-turned-investigator warned the
Securities and Exchange Commission about the Madoff investment
scheme years before it became public, but was ignored. In a more
recent campaign, Mr. Markopolos helped expose a foreign-currency
trading scandal at several banks. He has helped spawn a
cash-for-tips whistleblower industry.
GE is already under investigation by the SEC and Justice
Department for potential accounting issues that have come to light
in the past two years related to its insurance holdings and
problems in its power division. The company has denied accounting
fraud in response to lawsuits and said it is cooperating with
investigators. GE has said it is considering switching auditors
after using KPMG LLP for more than a century.
The Markopolos group said it plans to present its report to the
SEC and to meet with federal prosecutors and investigators about
its findings. In the report, the group says some information will
be given exclusively to law enforcement.
An SEC spokesman declined to comment.
After two difficult years, GE has shown signs of stability in
its business this year and recently nudged higher its financial
guidance for the first time in years. From the perspective of an
investor betting against the share price, much of the decline in GE
stock has already happened. The share price was above $30 at the
beginning of 2017 and near $7 at the end of 2018.
The Markopolos group includes John McPherson, co-founder of MMS
Advisors, forensic accountants specializing in the insurance
industry. The group worked for seven months to analyze GE's
accounting.
Mr. Markopolos said he is going public with the report now
because the group just finished its work. It had been working on
another insurance case when GE's insurance problems caught its eye,
he said.
The group claims GE's long-term-care insurance holdings are a
bigger liability than the company is letting on. The report
estimates GE will need to boost its insurance reserves by $18.5
billion in cash and take a $10.5 billion charge because of an
accounting change required by 2021.
Those figures are on top of a $15 billion reserve boost already
taken by GE over seven years to cover its exposure to
long-term-care policies, which cover expenses like nursing homes
and assisted living. The policies have proved to be a problem for
many insurers. The companies drastically underestimated the number
of future claims and how long people would draw on the coverage
before dying.
"We believe that our current reserves are well-supported for our
portfolio characteristics, and we undertake rigorous reserve
adequacy testing every year," GE said in its press release.
Mr. McPherson said the group found issues with GE's long-term
care insurance by reviewing statutory insurance filings, state
documents that require different accounting than corporate
financial statements.
The group went back a decade and, because GE's long-term-care
business involved reinsuring policies issued by other insurers, it
also examined the underlying filings for those other insurers.
The report claims that policy premiums paid to GE are low
compared with what rivals typically receive and that GE isn't
receiving any premiums at all on more than a quarter of policies,
because those contracts are considered paid in full. The group says
that, even after the $15 billion boost, GE's reserves are well
below what would be expected for such a troubled group of
policies.
GE in the early years front-loaded gains from the long-term-care
business by collecting premiums when policyholders were young, the
group claims, but failed to properly record reserves as the covered
population aged and claims ran at higher levels than originally
expected.
In March, GE executives hosted a conference call to assure
investors they had a handle on the insurance business. GE said that
it planned to push to raise policy premiums and shift investments
to boost returns and that it had adequate reserves to cover
expected claims. "We believe our assumptions are appropriate in the
aggregate," Tim Kneeland, head of the insurance unit, said at the
time.
The Markopolos group also alleges that GE's ownership of
oil-and-gas business Baker Hughes isn't being properly accounted
for and that the company should have booked about $9 billion of
losses on the investment. Last year GE recorded a $2.2 billion loss
on the sale of part of its Baker Hughes stake, reducing its
ownership from 62.5% to 50.2%.
In SEC filings, GE has disclosed that selling below 50% will
trigger it to stop reporting Baker Hughes's financial results as
part of its own results, and record its loss on the rest of its
investment. GE said its paper loss on the remaining investment was
about $7.4 billion as of July 24, according to the company's 10-Q
report.
Mr. Markopolos said that the Baker Hughes stake is now "strictly
an investment" and that GE as of 2018 has been improperly holding
back from recording the loss, thus inflating its financial results.
GE should be simply recording the value of its investment in the
company, Mr. Markopolos said, a change he said could strain GE debt
agreements.
GE responds that, as a majority shareholder of Baker Hughes it
is required to report consolidated results for Baker Hughes, under
generally accepted accounting principles. GE says it is providing
more transparent reporting by including Baker Hughes's revenues and
costs and assets and liabilities, rather than just giving a value
for the investment.
In a statement, GE director Leslie Seidman, former chairman of
the Financial Accounting Standards Board, said the report contained
"numerous novel interpretations and downright mistakes about the
actual accounting requirements," without providing details.
Write to Thomas Gryta at thomas.gryta@wsj.com and Mark Maremont
at mark.maremont@wsj.com
(END) Dow Jones Newswires
August 15, 2019 18:39 ET (22:39 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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