General Electric - Accounting Scandal goes Mainstream

scene from Pulp Fiction

Where is the Winston Wolf of GE ? GE has a situation on its hands. It needs a problem solver extraordinaire to help them out of this one. 

GE is ultimately a sound Enterprise.  Owners need to determine what they believe is a reasonable price to own GE. Gudovac stands by his $6 share value, despite the accounting scandal.  

Readers were made aware of persistent questions regarding GE's books in every article posted on this site. Gudovac responded to a reader's query about GE's quality of earnings a few weeks ago, stating GE's earnings consistency was only matched by Bernie Madoff's. Gudovac wondered a few days ago why nothing was published about the accounting scandal revealed this week.  Now it appears the delay was due to editors determining what angle to present on the topic. It isn't pretty - NYTs article follows signiature

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Inside GE: A Little Bit of Enron

by Floyd Norris

Friday, August 7, 2009

provided by

A decade ago, General Electric was the shining star of American business. Its longtime chief executive, Jack Welch, was named manager of the century by Fortune Magazine, and its stock seemed always to go up.

It ran a bewildering array of businesses but somehow always managed to make the expected profits. That record was viewed as proof of superior management, and the battle to succeed Mr. Welch in 2001 was watched all over the business universe. When a winner emerged, the losers quickly were hired to run other major companies.

G.E. is different now. The stock has fallen and the aura has dissipated.

This week General Electric agreed to pay $50 million to settle a suit filed by the Securities and Exchange Commission that said the company fiddled with its books repeatedly early in this decade. In at least one case, that allowed it to preserve its reputation for making the numbers. Some of the details are eerily reminiscent of Enron.

As is customary in such settlements, G.E. neither admitted nor denied the charges. But it sounded contrite. "The errors at issue fell short of our standards, and we have implemented numerous remedial actions and internal control enhancements to prevent such errors from recurring," said a company statement.

Another view of G.E.'s accounting standards emerged a few years ago in a book written by a man who worked there for six years in the early 1980s, before concluding the corporate life was not for him and entering a seminary. James Martin may be the only Jesuit priest with a degree from the Wharton School of the University of Pennsylvania.

"The primary task of my first job was to issue very long, monthly statistical reports," he wrote in his book, "In Good Company: The Fast Track From the Corporate World to Poverty, Chastity and Obedience." "The first month," he recalled, "I informed one executive that our results were coming in low" because of losses in overseas operations.

"So what?" replied the executive. "Just reverse a few journal entries." Corporate headquarters, he explained, would come down hard on them if they missed the numbers.

Another boss told him he was "taking those accounting courses way too seriously."

The S.E.C. complaint makes it sound as if those days came back, assuming they ever left. It tells of corporate accountants discovering misstatements and secret side deals, and of more senior executives telling them to sign off on the books anyway. It outlines four separate violations, two of which it says descended to the level of fraud.

It is notable how this investigation came to be. Post-Enron, the commission used its authority to look at G.E.'s books to figure out whether there were violations in the area of so-called hedge accounting, which determines whether companies can avoid reporting profits and losses from a variety of derivative securities.

The commission evidently found three violations, two in hedge accounting and the other in an Enronesque scheme to inflate profits with fake sales.

"It was like peeling an onion," said David P. Bergers, the director of the Boston office of the S.E.C., as one accounting issue led to another.

The fourth violation appears to have been reported by G.E. All have been fixed in restatements.

While it may seem odd to view the government as an underdog, it was. G.E. says it spent $200 million on outside lawyers and accountants in dealing with the investigation. By contrast, the S.E.C.'s entire annual enforcement budget, spread over thousands of inquiries and investigations, was less than $300 million when this investigation began in 2005.

You can be sure that G.E. spent a lot of time arguing that the amounts involved, only a few hundred million per violation, were not really material to a company its size.

There may be more to come. The S.E.C. said that its investigation of G.E. was over, but it did not say that about any of the accounting officials at the company, or any of the people at KPMG, G.E.'s longtime auditor.

KPMG's role is interesting. The complaint indicates that unnamed accounting officials at G.E. failed to provide important information to KPMG, but G.E. says that information was later given to the auditors.

The S.E.C. filing says that on one of the hedge accounting issues, the KPMG auditors consulted the accounting firm's national office. But when push came to shove, and the question was whether to approve accounting that the S.E.C. now says was clearly wrong, the local auditors signed off without telling the national office what was going on. Could it be that the local auditor feared the national office experts would have backbone, and force him to anger a very important client?

A KPMG spokesman declined to discuss any aspect of the case.

This all took place in January 2003, days before G.E. was to announce its annual profits for 2002, Jeff Immelt's first full year as chief executive. Had G.E. not fudged the accounting, it would have missed its profit forecast by $200 million. Not since 1994 had G.E. failed to make the numbers.

You may recall something similar happened at Arthur Andersen when it was auditing Enron. In that case, the local auditors chose to ignore the national office.

It is easy to have some sympathy for G.E. on the hedge accounting issues. The rules are devilishly complicated, and the accounting penalties for a small deviation can seem excessive. For good reason, the rules are being rewritten.

But that sympathy vanishes when considering the accounting alchemy that G.E. used to make its numbers at the end of 2003. In a move reminiscent of Enron's Nigerian barges deal, it "sold" some railroad locomotives to banks, with side letters and verbal promises to assure the banks they could not lose money. That enabled G.E. to book profits early and make the numbers.

The banks, facing S.E.C. actions for doing similar deals with Enron, asked G.E. to reassure them that KPMG knew about the side deals and concurred with the accounting. The banks had reason to be worried, given that G.E. executives had asked them not to refer to the side deals in documents seen by auditors.

At G.E., a spokeswoman, Anne Eisele, told me that it was wrong to think these violations were "indicative of some larger problem in G.E.'s overall culture, its finance function or compliance practices. G.E. is committed to the highest standards of accounting and good corporate governance. We are confident in our controls and culture, which have been made even stronger through the process that we've just completed."

It is interesting to compare the G.E. and S.E.C. versions of the locomotive deal. In a company filing in 2007, G.E. said "several individuals in our rail business and in our capital markets group engaged in intentional misconduct that misled those responsible for accounting oversight." It added that the accounting oversight team failed to adequately review the transactions.

The S.E.C.'s complaint makes it sound as if the matter was thoroughly aired inside G.E. in 2002, when it was first used, and again in 2003. The corporate audit staff challenged the accounting in 2002, but was overruled by a "senior accountant," the S.E.C. said.

G.E. added that the amounts involved were so small that they were not material, "less than 0.2 percent" of the company's total revenue or profits each year. The S.E.C. says the fudges caused quarterly profits of the G.E. Transportation Systems business to be overstated by as much as 40 percent.

All those numbers are accurate. Tricks to take profits in the wrong quarter, as in this case, are not likely to change annual earnings very much, particularly for the conglomerate. I doubt anyone at G.E. thought at the time it would have been immaterial if the company missed its profit forecasts.

I called Father Martin, now an editor at America magazine, a Jesuit publication, and asked him to read the S.E.C. complaint and call me back. He did.

"Little of this is surprising," he said.

"I was sometimes asked to squirrel away 'excess earnings' in fake accounts with made-up names, to be used when earnings were down in later months," he said. One such account was called "Plug."

Ms. Eisele, the G.E. spokeswoman, declined to comment on Father Martin's book. Much has changed at G.E. since Father Martin was hired. The long paper spreadsheets that he used have been replaced by computers. Some of the financial instruments involved in G.E.'s hedge accounting violations had not been invented.

But some things, it appears, never change.