GE Fraud Claim Doesn’t Have to Be True to Hurt
General Electric GE 9.74% had enough on its plate before Harry Markopolos showed up.
The researcher, who gained fame a decade ago for pointing out Bernie Madoff ’s Ponzi scheme, issued a report Thursday saying that the industrial conglomerate is hiding problems “more serious than either the Enron or WorldCom accounting frauds.”
The company stands by its financial statements and has noted that Mr. Markopolos is being paid by a hedge fund betting that GE’s stock will fall. It said that Mr. Markopolos hadn’t contacted them prior to publishing his report online.
Chief Executive Larry Culp dubbed the report “market manipulation.” Leslie Seidman, the chair of GE’s audit committee and former chair of the group overseeing the accounting industry, told CNBC that the report was “full of misleading, inaccurate and inflammatory statements.”
The fact is, though, that the combination of Mr. Markopolos’s pedigree, GE’s recent history and general stock-market jitters gave his story heft on the stock market. GE’s stock fell more than 11% on Thursday—its worst single-day drop since the financial crisis. It already had shed nearly 14% of its value so far this month. Much of GE’s share-price meltdown in the past two years can be traced to fears of nasty surprises not necessarily visible in its public accounts.
The report sees the biggest problems in the company’s legacy insurance business. It claims GE needs an additional $18.5 billion in cash immediately and will take a $10.5 billion charge by 2021 to boost long-term-care reserves as a result of a new accounting standard. That would come on top of a $15 billion reserve boost over seven years that GE already has said that it needs.
Mr. Markopolos also highlights Baker Hughes , the oil-field-service company in which GE owns slightly more than a 50% stake. He says GE should be taking more than $9 billion of losses on the investment, claiming it is “strictly an investment.” GE has disclosed that reducing its stake below 50% will trigger it to stop reporting Baker Hughes’s financial results as part of its own, which could result in some accounting losses—the paper loss on its Baker Hughes investment is about $7.4 billion as of July 24, according to the company’s 10-Q report. At the same time, any additional sale of shares would raise cash.
GE was a “show me” stock before Mr. Markopolos sent its shares crashing. The conglomerate needs to demonstrate that its core industrial businesses can produce positive free cash flow for several consecutive quarters before shareholders can be confident in a turnaround. It has said it expects adjusted industrial free cash flow for 2019 ranging from negative $1 billion to positive $1 billion. The urgency of improving that measure has lessened, though, following a number of disposals overseen by Mr. Culp and his predecessor that raised cash.
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Much of what Mr. Markopolos alleges rehashes existing worries about GE’s financial statements. The company is under investigation by the Securities and Exchange Commission and Justice Department for potential accounting issues related to its insurance holdings and its power division.
Investors’ main concerns with GE are more prosaic, though. The aviation group, the company’s largest by revenue, could hit headwinds as it is the sole engine provider for Boeing ’s grounded 737 MAX jetliner through its joint venture with France’s Safran SA. And global economic growth, which drives all of GE’s businesses, is looking wobbly. But equating a series of mostly known accounting issues at GE to outright frauds at the likes of Enron is inflammatory.
When a company faces balance-sheet pressure, though, perception can become reality. Late last year, GE registered a selloff in its bonds suggesting distress. GE has faced pressure to hire a new auditing firm after using the same one for over a century and it also is searching for a new chief financial officer.
Mr. Markopolos’s report hit GE at a sensitive juncture.
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