General Electric (GE -1.75%) had more negative news for shareholders on Tuesday. The struggling industrial conglomerate disclosed that it recently received a Wells notice from the SEC, indicating that staffers at the regulatory agency are "considering recommending to the SEC that it bring a civil injunctive action against GE for possible violations of the securities laws."
An SEC enforcement action could potentially entail fines, required changes in business practices, or other sanctions. However, investors shouldn't worry too much about this disclosure, as the underlying issues are old news, and any SEC penalty is likely to be modest.
Old demons aren't quite gone
The SEC has been investigating GE for several years, following a collapse in its profitability and the disclosure of a $9.5 billion pre-tax special charge related to its legacy insurance business. Initially, the investigation covered GE's accounting practices related to long-term service agreements. During 2018, the SEC expanded the scope of its inquiry to include the increase in its insurance reserves and a $22 billion pre-tax goodwill impairment charge related to GE Power that was announced in October 2018.
Image source: General Electric.
The Wells notice sent by the SEC last week covers the massive charge for premium deficiencies in its run-off insurance operations. Many investors and pundits are skeptical that problems in the insurance unit could have built up so quickly that they would require a special charge of that size all at once. The implication is that GE was covering up losses in its insurance business prior to 2018.
As the company noted: "The Wells notice is neither a formal allegation nor a finding of wrongdoing. It allows GE the opportunity to provide its perspective and to address the issues raised by the SEC staff before any decision is made by the SEC on whether to authorize the commencement of an enforcement proceeding." However, while GE disagrees with the SEC's position, it now seems quite likely that the regulator will proceed with an enforcement action, eventually.
A slap on the wrist
The SEC is unlikely to slap a harsh fine on General Electric. For one thing, the company has cooperated in the investigation from the beginning. Additionally, the allegations revolve around accounting issues that inherently require judgment calls by management. The SEC may conclude that GE did not account for its insurance liabilities properly or provide adequate disclosures, but the industrial conglomerate doesn't appear to have violated any black-and-white rules.
For example, in 2009, the SEC fined GE just $50 million for using improper accounting standards in order to manipulate earnings to meet analysts' estimates. More recently, the SEC fined Wells Fargo $500 million for misleading investors about the success of its business -- but in this case, the underlying wrongdoing was a clear-cut case of fraud (opening fake customer accounts).
A fine in the $100-million range would not be material for a company GE's size. Such a sum would be equivalent to about $0.01 per share.
Is accounting mischief continuing?
Given that a big fine is unlikely to materialize, the best explanation for GE stock falling 3.7% on Tuesday (the day that GE disclosed the Wells notice) is that investors are worried that the company is still playing games with its accounting. General Electric is an extremely complex business, which arguably makes it easier for management to get away with accounting misdeeds.
However, bears are exaggerating the likelihood that GE still has lots of skeletons hiding in the closet. The conglomerate has thoroughly shaken up its management in recent years. Whereas General Electric traditionally promoted from within, over the past three years, it has hired a new CEO, a new CFO, and new heads of its insurance business (GE Aviation) and investor relations, all from outside the company. It has also started providing more detailed information in its annual reports.
These moves don't provide an absolute guarantee that General Electric has cleaned up its act. Still, the prospect of an SEC enforcement action against the company related to its prior conduct shouldn't scare investors away today.
