Like a professional baseball player revealed to have been dabbling in steroids,
The charges, which include loaded terms like "fraud" and "materially false statements," likely reflect the SEC's efforts to look tough as it fights to protect its regulatory turf in Washington after having missed major scandals including the Bernard Madoff swindle. The focus on seemingly arcane accounting rules governing the treatment of interest-rate hedges shows just how important those rules are in preventing earnings manipulation, however.
"Arcane or not, this is what the SEC should be enforcing," said Charles Mulford, a professor of accounting at Georgia Tech and expert on fraud. "You can't let a company, after the fact, say whether there was a hedge or wasn't because that's direct earnings management."
All of the inflated earnings were erased in earlier restatements, and GE settled the SEC's charges without admitting or denying guilt. The SEC, in turn, said it was dropping all pending investigations against GE.
That angers critics like New York analyst Charles Ortel, who broadcast his concerns about GE's earnings quality a year ago when the stock price was still above $30 a share. The company's market value has since plunged by about $200 billion, to $13 a share, on concerns about its heavy debt load and flagging industrial businesses. It currently has about $17 billion in commercial paper outstanding under a taxpayer-guaranteed program to stabilize financial firms.
"The matters they are dealing with now are dated," said Ortel. "There is a much more serious issue over the period from Sept. 4 forward."
Ortel also called for the resignation of GE's vice chairman and chief operating officer
"They believe at GE they are faster and stronger than any regulator out there," Ortel said.
GE Chairman
In the filing in federal court in Connecticut, the SEC detailed several methods GE used to inflate revenue and earnings and dampen volatility in its reported results. To protect itself against sudden changes in interest rates, for example, the company entered into swaps that changed the floating rates on its massive commercial paper borrowings into fixed rates more equivalent to what it earned in its longer-term commercial lending operation.
To avoid reporting swings in the value of those swaps in quarterly earnings, GE opted for "cash flow" accounting that required it closely match the swaps to its borrowings. The relationship between the two started to fall apart in 2001 and 2002, however, and GE executives scrambled to fix the problem. In a December 2002 e-mail, an unnamed executive asked "isn't this an extraordinarily big deal?"
The company ultimately deviated from accounting rules to avoid reporting a $200 million pre-tax hit to earnings and continue reporting profits that met analysts' expectations. The company fessed up in 2007, correcting earnings for 2001 through 2005.
In a more egregious example of earnings manipulation, the company for two years in a row "sold" locomotives to unnamed financial partners instead of end users in transactions that left most of the risks of ownership--including starting the engines in the cold December weather--with GE.
The sales in 2003 and 2004 padded revenue by $381 million, not much for a corporation that reported $181 billion in revenue last year but possibly critical to meeting GE's end-of-year numbers. In 2007, GE said it fired several of the executives responsible.
GE's shares hit a peak of near $60 in late 2000 when former Chief Executive Jack Welch anointed Immelt as his successor. After Immelt took over in 2001, the stock went into steady decline to $23 in mid-2003, recovering to near $40 in 2007 before beginning its latest decline to a low of $5.73 in March of this year.
Such seemingly insignificant accounting moves collectively can prop up a company's stock by reassuring investors who are extraordinarily sensitive to volatility in earnings, said Mulford of Georgia Tech. Certainly GE executives were aware of their importance, agonizing in e-mails over how to avoid changes in reported earnings and whether the SEC would notice.
"They might seem arcane and insignificant, but they impact earnings, the quality of earnings and the sustainability of earnings," Mulford said. "They all impact the share values."
-- Maurna Desmond contributed to this story.