Will GE Hedge Accounting Pass Muster?

The conglomerate recieves a Wells notice from the SEC, signaling a potential civil action.
Stephen TaubSeptember 8, 2008

General Electric said it faces possible civil action by the Securities and Exchange Commission stemming from an investigation into its use of hedge accounting for derivatives. The conglomerate said in a regulatory filing released on Friday that the SEC staff issued a “Wells notice” recommending that the commission considers bringing a civil injunctive action against GE for possible violations of securities laws.

“We disagree with the SEC staff with respect to this recommendation and understand that we will have the opportunity to discuss the matter with the staff and to address the issues through the Wells process with the full Commission,” GE said in a regulatory filing.

The company said the Wells notice relates to the application of the hedge accounting rule known as FAS 133, during the 2002 and 2003 time period. Specifically, the SEC is examining several aspects of GE’s hedge accounting, including: accounting for derivatives once used to hedge the risk of interest rate changes linked to commercial paper, and derivatives in which a fee was a part of the consideration for the instrument; a change in 2002 in its accounting for profits on certain aftermarket spare parts primarily in its aviation business; some transactions taking place in 2003 and earlier involving financial intermediaries in GE’s rail business; and historical accounting for revenue recognition on product sales subject to in-transit risk of damage, principally in the company’s healthcare, infrastructure and industrial segments.

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GE said these items reduced net earnings by a total of $300 million from 2001 through 2007.

The company added that it has implemented a number of remedial actions and internal control enhancements. All of these items were reviewed or discussed with KPMG, which audited its financial statements throughout the periods in question.

GE said if the SEC were to authorize an action, the regulator could seek an injunction against future violations of provisions of the federal securities laws. GE noted in its filing that if it were to resolve the matter, the company would neither admit nor deny the proposed allegations, but would agree to the resolution and entry of an injunction. “There can be no assurance that we and the SEC would reach agreement on a proposed settlement as a result of our discussions, “GE added.

In January 2005, the SEC launched an investigation and requested documents and information from GE related to the use of hedge accounting for derivatives by the company and General Electric Capital Corp. In August 2005, the SEC upped its probe to a formal order of investigation.

“We continue to cooperate with the ongoing SEC investigation and to discuss the investigation and issues arising in that investigation and our internal review of certain accounting matters with the SEC staff with a goal of completing our review and resolving these matters,” GE assured investors in its filing.

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