Last week, Harry Markopolos, one of the key whistleblowers exposing the Bernie Madoff fraud, announced a new "fraud" he had in his sights: General Electric (GE). GE is as famous a name in global equities as any other and is often heralded as the picture of compliance and by-the-book operations. It's legendary CEO Jack Welch was the go-to example of how to be a successful CEO in the ‘80s and ‘90s serving in the post for 20 years and growing the company by forty times during his tenure.
That was all just marketing, Markopolos claims. In his 175-page report, he claims that GE is short $38 billion, rendering it insolvent. The shortfall is mostly from insufficient reserves to cover potential losses from its reinsurance business. He also discloses he shorts the stock, meaning he has a vested interest in its bankruptcy and that he is joined by a hedge fund in betting against the company. Markopolos' claims are mostly based on "aggressive accounting" by the firm if you believe Markopolos and standard accounting procedures if you believe the company. He claims GE is short $29 billion in cash and needs to change how it has accounted for an additional $10 billion. For a company worth $90 billion, these claims (if true) would be existential in nature.
Following Markopolos' attacks, the stock lost nearly $20 billion in market capitalization. He has presumably already profited handsomely from his attacks even before anyone had the time to ascertain their veracity. And so it will be from now on it appears. By the time the public has time to understand a claim, the underlying asset may depreciate and appreciate in such a volatile way that many retail investors will be forced to bail before even realizing what just happened. Markopolos' claims pushed GE stock down 13% before rebounding to recover some of those losses the next day. Since then, the stock has continued to slide.
If I owned GE stock, I would be concerned. Not necessarily because my stocks might be in jeopardy but because I have no idea whom to believe. Despite having taken many undergraduate and graduate accounting classes, I would have to be up to date on current accounting rules to even begin to understand whether mistakes were made and would have no way to identify whether it was committed with an attempt to fool investors, the definition of fraud. This is impossible for the average retail investor to do. Even Markopolos has no idea if there is fraud because he has no idea if GE did so knowingly and in bad faith. He questions KPMG, GE's auditor, and implies they can't be trusted because they have been working with GE for over a century, impeaching their very credibility.
These types of attacks against publicly listed companies and the exchanges that list them will be problematic for all exchanges and publicly listed companies in coming years. Will we return to Enron (the company Markopolos compares GE to) and Worldcom-type bankruptcies in the coming months and will they cause confidence in markets to once again be questioned? Personally, I learned my lesson from investing in similar companies at an early age. Never invest without downside protection because any public company can share a similar fate, and once again it will be the retail investors holding the bag while c-suite executives have cashed-out long ago with statute of limitations rules shielding them from prosecution. Before investing in any company, let the buyer beware!
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