General Electric (GE) has agreed to pay a $200 million penalty to settle claims by the U.S. Securities and Exchange Commission (SEC) that the company misled investors when it failed to disclose material information related to its power and insurance businesses.
In an order on Dec. 9 capping an investigation that the SEC opened in January 2018, the federal agency said GE misled investors when it failed to disclose that more than a quarter of GE Power’s reported profits in 2016, and almost half of its reported profits in the first three quarters of 2017, resulted from reductions in estimates of the cost to complete multiyear agreements to provide repairs and service for customers’ power turbines.
The order outlines a series of events related to the claim, starting with a May 2015 investor conference, when GE’s then-CEO Jeff Immelt described a framework for future earnings growth, even as GE Power was undergoing substantial changes. As POWER has reported, in 2015, the company marked a major milestone as it took over competitor Alstom in a $10.1 billion deal, and in integrating the giant global equipment firm’s products and services into its portfolio, it separated its renewables business into a separate segment. The year before, GE had launched the HA heavy-duty gas turbine, a new gas turbine technology that GE’s engineers leveraged to achieve a 62.22% combined cycle net efficiency.
The order, citing internal planning documents in 2014 and 2015, suggests GE Power was already facing marketplace challenges. It “described its power markets as ‘flat’ and a ‘challenging environment’ and noted increasing price pressure and excess industry capacity. As a result, GE Power increasingly depended on existing maintenance contracts in its GE Power Services division to achieve operating earnings and cash targets,” the order says. “A significant portion of GE Power Services’ earnings and cash came from highly profitable contractual service agreements lasting anywhere from 15 to 30 years, through which GE shared the risk of maintaining covered power turbines with its customers, the power plant operators.”
GE Power Services in 2016 was responsible for 83% of GE Power’s segment profits and 89% of its operating cash flows. In 2017, the business was responsible for 98% of GE Power’s segment profits and all its operating cash flows, the order notes. However, internal risk assessments from 2014 and 2015 showed Power Services was facing the same challenges as other GE Power divisions. Internally, Power Services acknowledged “that it had increased risk that its service agreements would need to be renegotiated due to lower than anticipated power consumption and increasing competition from other companies that offered servicing and repair of the power turbines after GE Power had sold them to customers,” the order says. “The business also faced the prospect that customers would exercise termination clauses in the service agreements if they did not receive price and terms concessions from GE Power, which created further risk to GE Power Services.”
A key issue was that GE Power had a $5 billion “deferred balance” of unbilled revenue, which was reported in GE’s financial statements as a part of the “contract assets” on its balance sheet. Under GE’s accounting method, the company recognized revenue from service agreements when it incurred costs—typically earlier than when it billed under the agreements, the order says. That was risky, because, “Were a customer to stop using a turbine, use it less, or exercise its termination rights under a service agreement, GE Power Services faced the potential that it would be unable to collect the ‘deferred balance’ related to that contract,” the order says. However, “GE Power Services endeavored to meet internal operating profit targets set by GE, in part, through reducing its costs and correspondingly reducing estimates of costs required to perform its obligations under service agreements.”
Under the accounting method, “these reductions in cost estimates resulted in large revenue and earnings increases in the period in which the estimates were changed,” the order says. “In public disclosures, GE misled investors by describing its Power segment profits without explaining that more than $1.4 billion in 2016 and $1.1 billion in the first three quarters of 2017 stemmed from reductions in cost estimates.” It adds: “Without GE Power Services’ reductions in cost estimates, GE would have missed the forecast it provided to investors for its non-GAAP industrial operating profit metric in 2016.”
The SEC also alleged that GE reported industrial cash collections commensurate with increased Power segment profits in 2016 and 2017 by changing its practices to sell—or factor—longer-term receivables from its Power service multiyear agreements, mostly to GE’s own subsidiary GE Capital. This allowed “GE immediately to report increased industrial cash flow, without disclosing that GE was depleting future cash flows by moving them into the present,” the SEC said. “As a result of this new practice, called ‘deferred monetization,’ GE boosted a publicly reported cash flow measure by more than $1.4 billion in 2016 and more than $500 million in the first three quarters of 2017.”
However, “GE failed to disclose to investors its adoption and reliance on deferred monetization which increased present industrial cash flow at the expense of future years,” said the SEC. The agency also claimed that from the third quarter of 2015 through the first quarter of 2017, GE failed to disclose to investors worsening trends in its insurance business and the potential for substantial losses.
In 2017 and 2018, GE made a series of public announcements describing “disappointing cash and earnings results in its GE Power business as well as the $9.5 billion pre-tax insurance charge and required capital contributions of approximately $15 billion over seven years,” the SEC said. These issues contributed to a 75% stock decline at the company during those years, the SEC said.
The SEC’s order says that GE violated the antifraud, reporting, disclosure controls, and accounting controls provisions of the securities laws.
“Investors are entitled to an accurate picture of a company’s material operating results,” said Stephanie Avakian, Director of the SEC Division of Enforcement, on Wednesday. “GE’s repeated disclosure failures across multiple businesses materially misled investors about how it was generating reported earnings and cash growth as well as latent risks in its insurance business.”
In a financial filing on Wednesday, GE told investors that under the terms of the settlement, along with the $200 million civil penalty, the company agreed to “cease and desist from violations of specified provisions of the federal securities laws and rules promulgated thereunder.” However, it stressed that consistent with common SEC practice, the company “neither admits nor denies the findings in the administrative order.”
The company also said: “The SEC’s order makes no allegation that prior period financial statements were misstated. This settlement does not require corrections or restatements of GE’s previously reported financial statements, and GE stands behind its financial reporting.”
A GE spokesperson told POWER on Thursday that the announcement brings the entire scope of the SEC investigation of GE to a close.
“We have concluded that it is in the best interests of GE and its shareholders to settle this matter on the basis announced today in which, consistent with common SEC practice, we neither admit nor deny the SEC’s allegations. We are pleased to have reached an agreement that puts the matter behind us. Under the current leadership team, we have significantly enhanced our disclosures and internal controls and are a stronger company today,” the spokesperson added.
In the order, the SEC acknowledged GE’s remedial efforts. Among other things, “GE has replaced management at its insurance and power subsidiaries, revised investor disclosures to address insurance and power trends and risks, added internal controls on its insurance loss recognition testing process, and added disclosure controls and procedures concerning its insurance liabilities,” it said.
As part of CEO Larry Culp’s turnaround efforts, the company has taken notable measures to reduce debt and de-risk its balance sheet. GE on Dec. 8 GE announced $4 billion of actions to further solidify GE’s financial position, including voluntarily pre-funding $2.5 billion of estimated minimum ERISA GE Pension Plan funding requirements for 2021, 2022, and into 2023, and repaying $1.5 billion of GE’s inter-company loan to GE Capital. The measures, which build on a series of proactive actions in 2019 and 2020 that, when combined with scheduled maturities in the fourth quarter, will put the company on track to reduce debt by approximately $14.5 billion in 2020 and by approximately $28 billion since the beginning of 2019.