General Electric Co.'s announcement that it's under investigation by the SEC isn't that surprising in the context of its rapid downward spiral. But it's an important reminder that the bad news is far from over.
The company disclosed this week that the regulator is looking into how it wound up having to pay $15 billion over seven years to shore up reserves for a legacy insurance business it has reviewed every year since winding it down between 2004 and 2006. More notably, the SEC is also looking into GE's revenue-recognition practices and the controls around its accounting for long-term service agreements throughout the company. That news wiped out earlier gains in GE shares after it affirmed 2018 guidance.
A Securities and Exchange Commission investigation into the insurance matter makes sense; I'd be more surprised if they weren't looking into what happened here.
It is simply unfathomable how GE could have so poorly underestimated the liabilities in its legacy insurance operations, particularly because it had supposedly significantly lowered the risks to the industrial parent by winding down the bulk of GE Capital starting in 2015. The $6.2 billion charge GE is taking in the fourth quarter is more than double the previous benchmark set by management of the $3 billion in GE Capital dividends it's withholding from the parent company.
It's also not that surprising to see the SEC investigating GE's revenue-recognition practices in light of how much its contract assets - equipment and service agreements where it's booked earnings in advance of receiving the associated cash - have ballooned over the past few years. But it is still troubling.
The underlying future profitability assumptions made in GE's service contracts are wrong by definition because they are done years in advance, and no one's crystal ball is that good. The question is how wrong. Given how significantly the power markets have deteriorated and how severely GE underestimated those trends, there is rightful concern that the company wasn't conservative enough. If there was a problem here, GE would essentially be admitting it had booked more earnings on those agreements than are actually going to come, Vertical Research Partners analyst Jeff Sprague says.
GE CFO Jamie Miller said there's nothing in the contract assets that she's "overly concerned" about after "exhaustively" reviewing the situation, but the company will "deal with it" if she does see something. That's not all that comforting. GE's CEO John Flannery said in November he had done an "exhaustive dive" into all the pieces of GE only to report the big charge in the insurance business a few months later.
It's still very early days on the SEC investigation, and there may in fact be nothing to come from it. But it bears repeating that GE is in for a very tough journey, and no one should get too comfortable.