The Wall Street Journal reported yesterday (Feb. 19, 2008) that General Electric Co. (GE) "…is expected to make changes to its accounting policies and procedures in an effort to end a long-running Securities and Exchange Commission probe…. The formal investigation has prompted GE to twice restate its financial results and to make three disclosures over additional accounting errors since 2005." Here's some context to the WSJ story that might be of interest.
Jack Welch, the iconic CEO of GE retired in 2001 after twenty years at the top. Soon after, he wrote a best-selling autobiography, Straight from the Gut; it's considered by many to be essential reading on leadership and management. However, one passage (which was brought to my attention a few years ago by my friend, mentor and colleague Ray Stephens) reveals an attitude towards financial reporting that presages the current mess GE finds itself in:
GE, under Welch's leadership, had acquired Kidder-Peabody in the mid-1980s. It was ultimately determined that much of the earnings that Kidder had reported were bogus. As a consequence, GE was about to take a non-cash write-off of $350 million. The quarterly earnings release was two days away; here’s how Jack — "There was only one way – the straight way" Welch described the discussion in Straight from the Gut:
"The response of our business leaders to the crisis was typical of the GE culture [my emphasis]. Even though the books had closed on the quarter, many immediately offered to pitch in to cover the Kidder gap. Some said they could find an extra $10 million, $20 million, and even $30 million from their businesses to offset the surprise. Though it was too late, their willingness to help was a dramatic contrast to the excuses I had been hearing from the Kidder people." [p. 225]
I doubt if, in this post-Enron and S-OX 404 environment, a CEO today would so openly express such a blatant disregard for reporting to investors — even though the thought itself might be deeply burned into one's neurons by their stock options and/or ego. Top managers aspiring to Welch's inner circle evidently must not only have been required to fill their own accounting cookie jars, but as team players they were expected to share with their playmates. I doubt if nary a one packed their bags when Welch left; so, it's safe to say that this aspect of team "culture" was a Welch legacy.
The WSJ article also mentions that in addition to the firing of some division managers (perhaps one or more of the same cookie sharers), the SEC probe lead to the resignation of Phil Ameen, long-time VP and comptroller — and prime specimen of the accounting equivalent of a wolf in sheep's clothing let loose in the barnyard. (Whew, that was a long way to go for a metaphor!) Believe it or not, Ameen was a member of the FASB's Emerging Issues Task Force (EITF) during much of the 1990s. He was also an active and influential FASB lobbyist. Separately, out of one side of this mouth came forth exhortations to simplify accounting, and out the other side to ditch simple solutions that might have impaired GE's ability to manage its earnings and reported debt:
"The board has tried hard to address off-balance-sheet abuses. Too many times, though, it has run up against corporate pressure applied through Congress, not least in the case of special-purpose entities, the trick that Enron used. In 1999-2000, FASB was moving towards a concept of effective control rather than ownership to determine whether or not a special-purpose entity should be consolidated into a company's accounts. If the more subjective idea of control is used for standards on consolidation, as it is in Britain and elsewhere, it is easier for an auditor to exercise his judgment and insist that an entity be brought on to the balance sheet.
But FASB's initiative would have created difficulties for companies that rely on such entities. Richard Causey, Enron's former chief accountant, wrote in to object. So did Philip Ameen [emphasis supplied], head of Financial Executives International, a corporate lobby group, and a top financial officer at GE, itself a heavy user of SPEs. In January 2001, nine months before Enron went bankrupt, FASB announced that it was putting the project on hold." [The Economist, May 2, 2002]
Whatever Ameen's influence on the EITF, the current debacle at GE on his watch taints the rules that were promulgated while he was there. When considering issues like accounting complexity and what constitutes appropriate influence by preparers on standards of reporting to investors, the case of Phil Ameen should not be considered an outlier, but a cautionary tale.
And, the same goes for Jack Welch. Kudos to the SEC for refusing to let GE off the hook; I still hold out hope that the same tenacity is applied to recent (alas, getting staler by the day) accounting shenanigans at other behemoths: Merrill and GM. If you're not too depressed by the GE story, see my posts here and here for more variations on the same theme.