G.E. vowed to cooperate with the investigation, just like every company does, and Ms. Miller said that “there is nothing here that I am overly concerned about.”
But accounting investigations tend to take on a life of their own. They require a company and its outside auditor to explain a wide range of decisions that raise questions about the propriety of its internal controls. And as with any investigation, where the S.E.C. starts is not necessarily where the agency will end up if other issues come to the surface.
A starting point will be the insurance charge that G.E. said will total $15 billion over seven years because of issues estimating the costs of long-term care and other policies. That is a substantial underestimation. The S.E.C. will want to know whether the failure to recognize the losses earlier was a means to keep the company’s earnings afloat, and why it took this long to disclose them.
Revenue recognition related to service agreements is an area of concern for the S.E.C. because aggressive accounting can hide a deterioration in a business line. Some companies book revenue early, robbing from the future to make the present look better in the hope that things will turn around.
The S.E.C. rule prohibiting accounting fraud is quite broad: “No person shall directly or indirectly, falsify or cause to be falsified, any book, record or account.” One limitation is that any misstatement has to be “material,” although the size of G.E.’s insurance charge and the importance of its service agreements likely means any problems uncovered will meet that standard.
This is not the first time G.E. has dealt with questions about its accounting. In 2009, the company settled civil fraud and accounting charges with the S.E.C. for using improper methods to steadily increase its reported earnings to meet or exceed the consensus earnings estimates of analysts and avoid any negative results. G.E. agreed to pay a $50 million penalty as part of the settlement, a substantial price for smoothing out earnings to remain in the good graces of investors.
Accounting fraud goes to the heart of the markets. Investors rely on financial statements to assess the future prospects of a company and expect one plus one will equal two. Any indication that the numbers were fudged puts at risk the trust investors have in management, further damaging an enterprise like G.E. that is already dealing with a host of challenges.