Case 1:17-cv-08457-JMF Document 83 Filed 04/10/18 Page 1 of 284 UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK JIHAD A. HACHEM, LEAD CASE: No. 17-CV-8457 (JMF) Hon. Jesse M. Furman Plaintiff, v. CLASS ACTION GENERAL ELECTRIC COMPANY, JEFFREY R. IMMELT, JEFFREY S. JURY TRIAL DEMANDED BORNSTEIN, JOHN L. FLANNERY, JAMIE MILLER, AND KEITH S. SHERIN, Defendants. SECOND AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS Case 1:17-cv-08457-JMF Document 83 Filed 04/10/18 Page 2 of 284 TABLE OF CONTENTS Page I. NATURE OF THE ACTION ............................................................................................ 2 II. JURISDICTION AND VENUE ...................................................................................... 12 III. PARTIES ......................................................................................................................... 12 A. Lead Plaintiff .......................................................................................................... 12 B. Defendants .............................................................................................................. 13 IV. CONTROL PERSON ALLEGATIONS.......................................................................... 16 V. COMPANY BACKGROUND ........................................................................................ 18 A. GE Capital ............................................................................................................... 18 B. GE Power ................................................................................................................ 19 VI. SUBSTANTIVE ALLEGATIONS ................................................................................. 21 A. Background of GE Capital’s LTC Insurance Exposure .......................................... 21 1. The Genworth Spin-Off ................................................................................. 22 2. GE Retained and Reinsured the Worst Blocks of its LTC Business in Connection with the Genworth Spin-off .................................................... 24 3. ERAC and UFLIC Reinsurance Subsidiaries ................................................ 29 4. GE Capital’s SIFI Designation and the GE Capital Exit Plan ....................... 31 5. During the Class Period, Members of GE’s Board of Directors and GE’s Senior Management Oversaw the Adequacy and Effectiveness of GE Capital’s Risk Management Functions ......................... 36 B. Defendants Knew or Recklessly Disregarded the Stale Assumptions and Inadequate LTC Reserve Situation at GE Capital ............................................ 38 C. GE Failed to Set Appropriate LTC Reserves in Violation of GAAP and SEC Regulations .............................................................................................. 51 1. Defendants Violated GAAP by Failing to Properly Calculate and Update GE’s LTC Reserves ........................................................................... 57 (a) Summary of LTC Reserve Charges ...................................................... 59 i Case 1:17-cv-08457-JMF Document 83 Filed 04/10/18 Page 3 of 284 (b) GAAP Applicable to LTC Reserves ..................................................... 60 (c) Benefit Reserve Assumptions Are “Locked-In” When Policies Are Issued, but Should Be Unlocked When Assumptions Change ............................................................................ 64 2. GE Tells Investors that its Claims Experience Was Different from Other LTC Insurers, Until 2017 ..................................................................... 65 3. Adverse LTC Experience Was Known to Defendants by at Least 2015................................................................................................................ 66 (a) GE’s New Disclosures Also Reveal That Adverse LTC Experience Was Systemic Before 2017 ................................................ 68 4. GE Failed to Adequately Increase its LTC Reserves as Trends and Assumptions in the LTC Market Drastically Changed and GE’s Peers in the LTC Market Increased Their LTC Reserves .............................. 69 (a) Genworth............................................................................................... 70 (b) Other LTC Insurers Were Reporting Adverse Claims Experience ............................................................................................. 72 (c) HHS Study Examines Why Insurers Were Leaving the LTC Market ................................................................................................... 73 (d) In 2015, Moody’s Assessed the Credit Impact of the Adverse Experience Widely Reported in the LTC Industry ............................... 74 (e) Recent Studies Confirm Adverse Experience in LTC Market .............. 75 5. GE’s Failure to Timely Record Increases its LTC Reserves Was Exacerbated by its Failure to Disclose the Enormous Exposure in its LTC Portfolio ............................................................................................ 75 6. GE Failed to Provide the Most Basic Disclosures Required by GAAP Regarding its LTC Reserves .............................................................. 75 7. GE Failed to Disclose the Risks and Uncertainties Associated With its LTC Exposure in its MD&A ..................................................................... 78 8. GE Also Improperly Excluded LTC Commitments From its Disclosure of Contractual Obligations ........................................................... 80 9. GE Violated Additional GAAP Provisions and SEC Regulations by Failing to Appropriately Account for and Disclose its LTC Reserves ......................................................................................................... 81 ii Case 1:17-cv-08457-JMF Document 83 Filed 04/10/18 Page 4 of 284 (a) GE’s Accounting Errors Should Result in a Restatement .................... 84 D. GE’s Statutory LTC Reserves Were More Severely Understated than Even its GAAP LTC Reserves ........................................................................ 86 1. ERAC and UFLIC’s Statutory Financial Statements ..................................... 86 2. An Analysis of Ceding Companies’ LTC Experience Forms Reveals Significant Deficiencies in GE’s LTC Active Life Reserves and Disabled Life Reserves and Worsening Trends ....................... 90 (a) Actual Incurred Claims ......................................................................... 90 (b) GE’s Active Life Reserves Were Materially Understated due to Stale Morbidity and Persistency Assumptions ................................. 92 (c) GE Failed to Properly Update the Projection Assumptions Used in its Annual Asset Adequacy Testing......................................... 93 E. GE Violated GAAP and Employed Unsustainable Business Practices to Record Revenue and Earnings on its LTSAs and to Conceal the Truth About its Contract Asset Balance ............................................. 94 1. Background on GE’s LTSAs and Contract Assets ........................................ 96 2. GE’s Unsustainable Reliance on Cumulative Catch-Up Adjustments and its Impact on GE’s Contract Asset Balance ....................... 99 3. The “Black Box” of GE’s Contract Assets .................................................. 105 4. GE’s Accounting for Contract Assets Violated GAAP ............................... 111 (a) GE Failed to Implement Adequate Internal Controls to Ensure GAAP was Appropriately Applied to Contract Assets ........... 114 (b) GE Used Monetization and Cumulative Catch-up Adjustments to Mask the Declines in the Power Segment and Manipulate GE’s Earnings and Cash Flow ......................................... 118 (c) GE Failed to Provide Adequate Disclosure Regarding Contract Assets ................................................................................... 124 F. Defendants Also Failed to Disclose a Known Trend or Uncertainty at GE ..................................................................................................................... 131 G. GE Failed to Maintain Adequate Internal Controls Over its Financial Reporting ............................................................................................... 132 (a) GE’s SOX 404 Assertions .................................................................. 133 iii Case 1:17-cv-08457-JMF Document 83 Filed 04/10/18 Page 5 of 284 (b) GE’s SOX 302 Certifications .............................................................. 136 (c) GE’s “Audit” Personnel Were Not Competent to Assess LTC Reserves .............................................................................................. 139 (d) Defendants Violated SOX and Relevant SEC Regulations ................ 142 VII. GE’S MATERIALLY FALSE AND MISLEADING FINANCIAL STATEMENTS.............................................................................................................. 144 VIII. DEFENDANTS’ ADDITIONAL MATERIALLY FALSE AND MISLEADING STATEMENTS AND OMISSIONS REGARDING LTC RESERVES AND CONTRACT ASSETS .................................................................... 149 A. Defendants’ Statements ........................................................................................ 149 1. Fourth Quarter and Full Year 2014 .............................................................. 149 2. GE’s February 2, 2015 Letter to the Fed ..................................................... 153 3. Barclays Industrial Select Conference