by T. GormanPosted on Posted in SECActions

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.

by T. GormanPosted on Posted in SECActions

Wall Street bonuses have been the subject of much debate and criticism as the market crisis has unfolded. The public has expressed outrage; Congress has held hearings and imposed some limits; and the Administration has appointed a Bonus Czar.

Bank of America, in acquiring Merrill Lynch, tried a different approach: Shhh! Don’t tell anyone, not even the shareholders voting on the deal. The SEC found out. It filed and enforcement action. It seems that keeping things like huge bonuses quiet when soliciting votes for a merger violates the proxy provisions of the federal securities laws. SEC v. Bank of America Corporation, Case No. 09 CV 6829 (S.D.N.Y. Filed Aug. 3, 2009).

The Commission claims Bank of America and Merrill Lynch concealed from shareholders voting on the acquisition of the broker by the bank an agreement under which Merrill executives would be paid huge bonuses. According to the complaint, BA and Merrill negotiated the primary terms under which the brokerage firm would be acquired on September 13 and 14 in the wake of the Lehman Brother’s collapse. One of the key items was the agreement to pay discretionary year end bonuses for 2008 to Merrill officers and employees. The bank agreed that Merrill could make payments up to $5.8 billion with a recorded current year expense of up to $4.5 billion. Subsequently, the board of each company approved the deal. It was announced on September 15, 2008.

After the announcement, the parties negotiated the merger agreement. The text of the agreement stated that Merrill did not have authority to pay discretionary bonuses to its employees without the prior written consent of BA. This section, called the Forbearance Provision, referenced a list of exceptions. That list contained, among other things, the agreement approved by the two boards of directors regarding the payment of discretionary bonuses to Merrill employees.

On November 3, 2008, BA and Merrill mailed proxy statements regarding the merger to shareholders. The merger agreement was attached but not the list of exceptions. The text of the proxy agreement summarized the terms of the Forbearance Provision, but not the list of exceptions. The shareholder meeting was set for December 5, 2008.

Merrill’s compensation committee approved a schedule for the bonus pool with final review set for December 8 followed by payment on December 31. Merrill’s management also put together a plan to pay bonuses to its top five executives who were not covered by the agreement with BA, although the bank was aware of this plan. Those executives had not been paid a bonus the prior year because of the poor performance of the firm. The then-current performance was even worse.

The merger was approved on a vote of the shareholders. Then, Merrill gave final approval to employee bonuses, but withdrew the proposal for the five senior executives.

The complaint claims that the proxy statements furnished to voting shareholders were false and misleading regarding the Merrill bonuses in three respects:

1) The statements constituted a representation by BA that under the merger agreement Merrill was only permitted to make required payments to employees such as salary and benefits, not discretionary bonuses;

2) The statements created the impression Bank of America had not given written consent to the payment of discretionary bonuses; and

3) The $5.8 billion in discretionary bonuses constituted nearly 12% of the $50 billion that Bank of America agreed to pay for the acquisition, nearly 30% of Merrill’s stockholders equity and over 8% of the broker’s total cash and cash equivalents.

The complaint alleges violations of Section 14(a) and Rule 14a-9. The case is based on an investigation coordinated with the U.S. Attorney’s Office, the FBI and the Office of the Special Inspector General for the Troubled Asset Relief Program.

To settle the action, Bank of America consented to the entry of a permanent injunction prohibiting future violations of Section 14(a) and Rule 14a-9. The firm also agreed to pay a civil penalty, the amount of which is not disclosed in the SEC’s releases. See Lit. Rel. 21164 (Aug. 3, 2009). Bloomberg reports that the fine is $33 million. Apparently BA and Merrill got the publicity anyway.