Last week, whistle-blower Harry Markopolos, famous for warning the world in advance of the Bernie Madoff Ponzi scheme, set his sights on a new target: GE. In a blistering 170-page report conducted using a team of forensic accounting experts and analyzing reams of public information, Markopolos announced that the storied company's management is basically committing a $38 billion "fraud," and it's even bigger than both the landmark Enron and WorldCom debacles.
Markopolos not only gave quite a few detailed reasons for his conclusion but--worryingly--said his number is just "the tip of the iceberg."
He believes that GE's future liabilities for its long term care business are woefully under-reserved. He says that the company has inadequately reported margins and expenses for many of its businesses. He accuses the company of frequently changing its financial reporting so as to make it difficult for investors to draw comparisons with prior periods. He believes the company is hiding losses from a recently ill-conceived acquisition. All of this, he says, is adding up to an enormous deficiency in the company's working capital, and it's because of either gross managerial incompetency or out-and-out fraud. GE's management, in a statement today, denies these claims and says its reserves are "well-supported for our portfolio characteristics" and that the company operates "with absolute integrity and stands behind our financial reporting."
You can take the position, as GE does, that Markopolos's statements are "market manipulation--pure and simple." Or you may find, as Markopolos contends, that the slide deck contained in his report is a "gripping read."
Regardless, the whole situation is eerily reminiscent of other big financial failures--and their effects on the overall stock market. Don't believe me?
Remember WorldCom, which had a peak market value of $186 billion in April 1999? In June 2000 the company admitted to inflating earnings and saw its stock wiped out. A little more than a year later, Enron, the giant energy company which, at its zenith, was worth $70 billion, found itself and its auditors publicly outed for fraud and mismanagement. What happened soon after both of these events? The famous dot-com crash, where the stock market lost 77 percent of its value.
Fast forward to December 2008, when the $65 billion Madoff Ponzi scheme was uncovered. The Great Recession was also under way, but this news--coupled with the failure of some of the country's largest institutions--contributed to a more than 50 percent drop in the stock market, as it fell to its bottom just a few months later.
Now we have GE. A Fortune 100 company currently worth $76 billion. If Markopolos's allegations are true, what happens next?
The markets are based on confidence, and that confidence is based on our largest institutions--and their auditors--assuring us that their financial statements are complete and accurate. When that doesn't happen, investors get nervous, and that fall in confidence spreads throughout. But aren't there controls in place? Aren't the auditors and regulators protecting investors? Didn't we learn anything from Enron, WorldCom, and Madoff?
Nope. The problem--and I can speak to this as a former Big Four auditor--is that there are too many people with too much to risk when things go bad.
There are financial people, who rely on their livelihoods from the companies where they work, and they don't want to lose their big salaries and platinum health insurance plans, right? There are the auditors, who enjoy the big fees from their marquee clients, as well as the references and other business opportunities those relationships bring, correct? There are the analysts, who rely on a company's financial information to make investments and advise their clients, and they don't want to look foolish, do they? And then there are all the other indirect beneficiaries of a giant company's success--the politicians, local business owners, schools, suppliers, and partners--that are quick to turn a blind eye and hope that the money keeps coming in.
That can last for a while. But if the economy slows, stock prices fall, and a wary media begins to stir--as they did in 2001 and 2008--big accounting problems are inevitably exposed.
Do you trust that GE--and its auditors KPMG--are doing their jobs correctly? Did they do the same analysis and ask the same questions that Markopolos asked? Should they have issued a "going concern," as Markopolos contends? Are they comfortable with GE's reserves, working capital, and financial disclosures? Have they merely reached independent yet different conclusions than the forensic accountant and his investigators?
If they have, then...phew.
But if they haven't, I bet there's a team of KPMG staffers and their counterparts at GE nervously crunching the numbers in some conference room somewhere right at this moment. Because if the GE situation is anything like Enron, WorldCom, or Madoff, it will not only spell big trouble for all the people involved, but even bigger trouble for the markets in the coming months.