General Electric Is 'One Recession Away' From Bankruptcy
Harry Markopulos is a financial fraud investigator best known for uncovering evidence of Bernie Madoff's Ponzi scheme in the early 2000s. Last week, he made waves by publishing a report alleging that General Electric Co. (NYSE:GE) has been engaging in fraudulent business practices and that its financial results do not represent an accurate picture of what is happening inside the company.
The news caused GE's stock to plunge 10%, though it has since recovered somewhat as investors have bought the dip.
What is in the report?
Markopulos believes GE is headed for bankruptcy. He claims the company has engaged in a $38 billion accounting fraud, amounting to over 40% of its market capitalization. If true, this would make it the biggest such fraud in history as he said it would be "bigger than Enron and WorldCom combined."
The crux of Markopulos' argument is the industrial conglomerate is hiding enormous losses in long-term care liabilities. Long-term care reinsurance is part of GE Capital, the financial services division of General Electric. The investigators have accused the company of claiming insurance premiums as earnings for decades, without setting aside adequate capital reserves to pay policyholders. This was all fine when the policyholders were younger, but now that they are a rapidly-aging cohort, the losses will start to mount.
Markopulos cites industry data that shows less than 14% of these claims have been filed, and yet those have resulted in a $15 billion realized loss already. He concluded: "Simple math tells you what the other 86% will do to GE's balance sheet."
What techniques did the investigators use?
The report also contains a discussion on the ways Markopulos and his team went about uncovering the fraud. Even if it turns out they came to the wrong conclusions, the techniques used are still worth paying attention to:
"One mantra I teach in my advanced forensic accounting seminars to Certified Fraud Examiners, Internal Auditors and Chartered Financial Analysts is, 'Listen to what is said and then look at what they do. Where there's a difference, dig in, because that's where the fraud is.'
GE tells investors it owns a portfolio of operating companies and that it will buy and sell companies in order to assure its continued growth. Now look at what they do, they don't provide standalone financial statements listing each business units' expenses such that investors or outsiders interested in buying GE's businesses can properly value them. I believe this is a willful concealment to hide how poorly these units are really doing. It would be much easier to spin off units, sell units, and value units that kept stand-alone books and records, yet GE doesn't do that."
Takeaways
The 175-page report is much too long and detailed to effectively summarize, but if you are interested in accounting and the ways in which investigators approach the daunting task of analyzing a behemoth like GE, I would recommend reading the whole thing.
Disclosure: The author owns no stocks mentioned.
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