The GE Fiasco and How to Profit From It

Last week, the world saw the beginning of what could be the world’s next massive financial scandal. General Electric is reported to be using aggressive accounting policies to cover up losses, and although it may not constitute fraud, it is not looking good for the financial future of the company.

Harry Markopolos, a Bernie Madoff whistleblower, alleges that unusual accounting practices are being used to obscure the true financial health of the company. They’ve already settled previous charges over their accounting with a $50 million payment in 2009.

At this point in time, GE is selling off non-core assets and trying to plot a way forward. But major liabilities with long-term care insurance continue to eat away at it, and aggressive accounting practices means they have already booked earnings that may end up being losses. By not having enough cash to cover these liabilities, they are exposed to much higher potential losses than they could possibly be prepared for.

Suspicious Motivations

Now, to play devil’s advocate here, the whistleblower is working in conjunction with a hedge fund is a little bit more suspicious. As the CEO of GE said:

“The fact that he wrote a 170-page paper but never talked to company officials 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.”

This is exactly where it pays to have the time to go through some other reports and get a more unbiased perspective. Making a financial decision based on one person’s decision, especially since money is being exchanged and he will get a percentage of profits the hedge fund makes on this, is the wisest path to take.

Looking for a Path to Profit

So how do we reconcile these two beliefs to make a profit? Unfortunately, there is no way to bet on GE’s auditor, KPMG, as they are a privately held firm. But there are a few things you can do. First, you could day trade based on the volatility. Rumors like this are the perfect time to play around with a stock. And if you were looking for an in, now is definitely the time to do so.

If you were a little more sure of your position but don’t want to bet it all in any single direction, then buy some calls or puts on GE. The stock is now trading around $8.60, which represents a significant drop from $10.50 near the beginning of August.

Another perspective to take on this is by thinking of the financial markets, the last economic meltdown, and how you could have profited back then. The whistleblower is saying this could be a bigger financial scandal than Enron or WorldCom, and there’s no telling what that would mean for confidence in the economy.

During the 2008 financial crisis, GE received a $12 billion bailout from Warren Buffet, and another $139 billion from the federal government. Without those funds, it would have gone under. So the question is, with a rapidly shrinking company that is saddled with debt and constantly being examined for their accounting practices, how long can it stay afloat? Or is this report just speeding up the inevitable?

Featured image courtesy of Shutterstock. Chart via Yahoo Finance.