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SEC Settles Major Disclosure Violation Allegations, Assessing $200 Million Penalty

AOL - Shareholder Lit and Enforcement

Underscoring its stated enforcement focus on fulsome disclosure of issuers’ businesses and trends in their operations, the U.S. Securities and Exchange Commission settled charges with General Electric Company on December 9, 2020. The SEC alleged that GE’s disclosures between 2015 and 2017 had misled investors concerning the nature and quality of its earnings and failed to disclose trends management was seeing in two key GE business segments—power and insurance. Under the settlement, GE consented to entry of a cease-and-desist order and to pay a $200 million penalty without admitting or denying the SEC’s charges. In addition, GE agreed to report to the SEC for one year on its policies and controls related to accounting and disclosure.

The SEC alleged that GE misled investors concerning its power business by failing to adequately disclose the nature of its reported growth in profit and cash collection that resulted from GE reducing its estimates of the costs to complete its long-term service agreements on gas turbines and from its increased use of factoring to accelerate payment on those contracts. These internal-process changes were allegedly “critical to GE’s reported results” and suggested that the business was growing faster than it was.

As for GE’s insurance arm, the SEC alleged that the company had failed to disclose worsening trends in its long-term care insurance business and the potential for substantial losses—trends that ultimately culminated in a $6.2 billion accounting charge and plans for a $15 billion capital infusion to fund expected future insurance claims. The SEC claimed that GE’s long-term care insurance policies were underpriced and that by 2016, claims on those insurance policies had been exceeding GE’s original projections for years. According to the SEC, “despite known continuing trends of increasing costs” from these long-term care insurance policies, GE lowered projected claims costs early in the relevant period, concluding that it did not have insurance losses, and did not disclose the potential for material losses from rising claim costs in the future. Invoking Item 303 of Regulation S-K, the SEC noted issuers’ obligations to disclose “known trends or uncertainties that the company believes will have a material impact on future operations,” with a specific focus on material events and uncertainties known to management “that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.” According to the SEC, because “GE had a large and risky long-term care insurance block” and was “depending on increasingly optimistic projections on future claims” while experiencing increasing historical costs, GE understood that there was the potential for material insurance losses in the future.

Commenting on the settlement, SEC Director of Enforcement Stephanie Avakian stated that “GE’s repeated disclosure failures across multiple businesses materially misled investors about how it was generating reported earnings and cash growth as well as latent risks in its insurance business” and that the “disclosure failures painted a deceptively positive picture of the state of GE’s overall business at the time.”

The settlement with GE is the latest in a series of high-profile enforcement matters the Commission has pursued against issuers that allegedly made materially misleading or incomplete disclosures, including in this past year computer manufacturer HP Inc. (alleged failure to disclose the impact of sales practices undertaken in an effort to meet quarterly sales and earnings targets) and alcohol producer Diageo plc (alleged failure to disclose known trends arising from shipments to distributors by its North American subsidiary of allegedly unneeded products).

These settlements affirm recent pronouncements from the SEC that issuers’ public disclosures are a major enforcement focus, and that companies should take a more proactive approach to disclosing reasonably-anticipated future events to their investors. Particularly in situations where trends in the business suggest that current-period results may not persist into the future, SEC guidance and this enforcement focus suggest that issuers should consider disclosing more forward-looking information to investors.

The SEC appears likely to continue scrutinizing disclosures for transparency concerning the quality of reported revenue and earnings, as well as the description of key performance metrics. Additionally, this settlement is a further indication that the Commission is serious about its admonitions that companies adequately and substantively disclose important information about their business operations both on a current basis and into the future.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.