Shares  of General Electric (GE) were sent reeling after Bernie Madoff Whistleblower, Harry Markopolos, accused the company of fraud:

Forensic accountant Harry Markopolos—who correctly identified the Bernie Madoff Ponzi scheme—released a 175-page report Thursday. In it he claims General Electric is a larger accounting fraud than Enron.

“GE’s $38 Billion in accounting fraud amounts to over 40% of GE’s market capitalization,” writes Markopolos. “Making it far more serious than either the Enron or WorldCom accounting frauds.”

The report focuses on General Electric’s (ticker: GE) former long-term care insurance business. Markopolos says GE needs an additional $29 billion in insurance reserves to cover the remaining policies. According to The Wall Street Journal, Markopolos shared the report with an unidentified hedge fund before its release and will share in the profits, if any. The Journal also said Markopolos hopes to collect a cash reward as a whistleblower.

GE fell by double-digits, though it rebounded somewhat Friday. The crux of Markolopolos’ argument surrounds the long-term care (“LTC”) policies at GE Capital’s (“GECC”) insurance unit. As policyholders who bought these LTC policies continue to age and file claims, it could impact the insurance company’s reserves.  Last year GE announced it would make statutory reserve contributions of approximately $15 billion over the next seven years. The company also took an after-tax loss of $6 billion.

Many LTC operators have been forced increase to reserves for contracts that may have been written many years ago. How do we know that GE increased its reserves enough? I believe the investment community simply took management’s word that the reserves were accurate. Markolopos is challenging the strength of those reserves, which he has every right to do. Management can simply have outside actuaries (1) provide a report on the strength of GE’s reserves based on the company’s actual claims experience and (2) compare its reserve strength to other companies with a similar book of business.

Larry Culp Responds

GE CEO Larry Culp responded rather quickly. He suggested that Markolpolos’ report was market manipulation:

“GE will always take any allegation of financial misconduct seriously. But this is market manipulation – pure and simple,” Lawrence Culp, chairman and chief executive officer of GE said in a statement. “Mr. Markopolos’s report contains false statements of fact and these claims could have been corrected if he had checked them with GE before publishing the report.”

Culp said the fact that Markopolos never talked to company officials before publishing the report “goes to show that he is not interested in accurate financial analysis, but solely in generating downward volatility in GE stock so that he and his undisclosed hedge fund partner can personally profit.”

Culp stated several facts in his response, but did he speak the truth? Markopolos admitted he was working with an investor who likely shorted GE’s stock before the report was released. Markopolos and the short seller may have made a decent return on their investment, depending on how much they invested up front and if they were able to sell be GE rebounded. However, I am not buying Culp’s claim that the report was purely market manipulation. Markopolos could also potentially make money by filing an SEC complaint against GE. If the SEC agreed with such complaint then it could potentially generate more fees for Markopolos.

Culp claimed the fact that Markopolos never spoke with company officials prior to the report’s release showed he “is not interested in accurate financial analysis.” I beg to differ. First, there is likely not much to talk about. Markopolos and his team believes GE’s reserves are understated and its accounting policies need to be corrected. It is now up to GE to respond to Markopolos point by point, with factual information. Secondly, even if he had spoken to GE officials, Markopolos would never have known as much as insiders like management or the auditors. I doubt if a conversation with management would have generated any more insights beyond what has been disclosed in GE’s public filings.

Markopolos Likely Will Not Go Quietly

Bernie Madoff was formerly the head of Madoff Investment Securities LLC (“BMIS”). In December 2008 Madoff’s $50 billion Ponzi scheme was discovered, shocking the nation for its sheer brazenness. Prior to Madoff turning himself into authorities, Markopolos had spent several years trying to convince the SEC Madoff was running a Ponzi scheme. Markopolos eventually received national acclaim for his dogged pursuit of the truth in the Madoff saga. I doubt he will be any less dogged in his pursuit of GE.

Besides, external signs already suggest GE is in financial straits. The company is on its third CEO in less than two years. After Culp took the reins in October 2018 investors remained patient while the new CEO came up to speed on the operations. Three CEOs in less than two years and the recent exit of the CFO would be cause for alarm, in my opinion. Just because investors have been patient does not mean the company’s problems will magically go away.

Markopolos is not the only person to suggest there could be a black hole inside GECC. In October 2018 a UBS analyst laid out a scenario where GECC could have negative value. The notion that GECC’s equity could be overstated has been out there for a while, yet Culp has not responded in a detailed way. In December I questioned whether GECC had experienced a run on the bank after GE abandoned its commercial program. Management still has not walked investors through how the loss of GECC’s low cost of capital impacted its profit margins.

Lastly, I estimate GE’s debt is currently at junk status. GE’s credit quality will likely be at junk levels even after its sale of GE Biopharma for $21 billion. In talking up asset sales, management has changed the narrative away from GE’s poor credit quality and the diminution at GECC. Markopolos compared the company to Enron and Worldcom, and he was loud about it. If GE does not respond to these accusations in a more detailed way then investors may start to believe there is merit in Markopolos’ comments.


GE may have to answer questions about its accounting and insurance reserves. This could get ugly. Sell GE.


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