GENERAL ELECTRIC SETTLES AN ACCOUNTING CASE WITH THE SEC
In SEC v. General Electric Co., Civil Action 3:09 cv 1235 (D. Conn. Aug. 4, 2009) the Commission filed a settled accounting case based on four alleged improprieties. To resolve the action, GE consented to the entry of a permanent injunction prohibiting future violations of Sections 17(a) of the Securities Act and Sections 10(b), 13(a) and 13(b)(2)(A)&(B) of the Exchange Act. The company also agreed to pay a $50 million civil penalty. With the filing of this action, the Commission announced that it had concluded its investigation as to the company. There was no indication as to whether the investigation has concluded as to the individuals referenced in the complaint. See also Lit. Rel. 21166 (Aug. 4, 2009).
Two of the four errors relate to hedge accounting. The first issue related to the commercial paper program. Under that program, the company issued commercial paper with various interest rates. Interest rate hedges were used to smooth fluctuations. In late 2002 when the company learned that it would have to recognize the impact of certain fluctuations, it changed accounting methods to one which is not appropriate under GAAP to avoid the result. This permitted GE to avoid recognition of a pre-tax charge of about $200 million. As a result income for the fourth quarter of 2002 was overstated by over 5% and the company was able to meet earnings expectations.
The second is based on the so-called “short cut” exception under FAS 133 which the company used prior to 2003. Under the shortcut the company could assume that its hedge relationships were perfect and avoid the assessment and measurement requirements. In early 2003, the company learned that it was not eligible to use this method and stopped. It did not at that time go back and make corrections however.
A third error stemmed from the premature recognition of revenue from the sale of certain locomotives. Specifically, in the fourth quarter of 2002 and again in the fourth quarter of 2003, the company prematurely recognized $223 million and $158 million, respectively, in revenue from the sale of locomotives to financial intermediaries. The locomotives were to be resold in the first quarter of the next year in each instance to GE railroad customers. In fact, GE was not entitled to accelerate the recognition of the revenue in either instance under GAAP.
Finally, in March 2002 GE changed its accounting for the sale of commercial aircraft engine spare parts. This change would have resulted in an immediate charge of about $844 million. To offset this charge, the company made another change to its accounting model. This second change did not comply with GAAP. As a result of the second change, the company overstated 2002 net earnings by $585 million.
GE announced three of the four errors and took corrective action prior to the filing of the Commission’s action. Specifically, in January 2007 the company issued a press release stating that the Office of the Chief Accountant concluded its commercial paper hedge program as structured did not meet FAS 133’s specificity requirements. GE then amended and restated the appropriate financial statements. In May 2005, the company filed amended and restated financial statements related to its use of the “short cut” method. And, in July 2007 the company announced that its acceleration of the locomotive revenue was improper and took corrective action.
In its press release about the case, the Commission stated that the inquiry into GE began as a risk based investigation. Those investigations identify a potential risk related to an industry or a company and create an investigative plan to test the theory. In this instance, the plan was based on a potential misuse of hedge accounting. The SEC did not indicate whether its investigation began before the first corrective action by GE in May 2005.