SEC Will Require Companies to Explain `Pro Forma' Earnings
By Neil Roland
quote.bloomberg.com
Washington, Oct. 2 (Bloomberg) -- The Securities and Exchange Commission, under orders from Congress, is preparing a rule to require companies that publish ``pro forma'' financial results to explain how they differ from earnings that follow U.S. accounting standards.
Pro forma figures, which exclude costs such as merger expenses, grew popular in the 1990s stock boom as technology companies tried to cast their finances in a more favorable light. About 1,500 companies used pro forma results in press releases last year before filing official reports under generally accepted accounting principles, according to industry estimates.
A new law requires companies that use pro forma results to show how they compare with earnings that follow U.S. rules, and forbids companies from issuing press releases that omit ``material'' facts. Some accountants say the legislation doesn't go far enough. The SEC plans to propose a rule this month to spell out the law's requirements.
``You have pro formas that on their face are flat-out misleading, and it occurs often enough to be troubling,'' SEC Corporation Finance Director Alan Beller said in an interview. ``Reconciling the figures is a pretty clear way of dealing with the problem.''
The law, which tightens oversight of U.S. corporations, was a reaction to audit failures at Enron Corp., WorldCom Inc. and other companies. It required the SEC to appoint an accounting oversight panel, made company boards and auditors more independent, and increased corporate disclosure.
Grade A
Under the planned SEC rule, if a company issues a press release saying its pro forma earnings will be $1 million and its official earnings are to be only $800,000, the company will have to disclose both figures and explain what expenses are excluded from the pro forma figures and why, Beller said.
Some accounting experts said the SEC should ban the use of pro forma releases entirely, or require them to be issued at the same time as official quarterly reports.
``When a company picks its own metric to evaluate itself, it always gives itself an `A,''' said Howard Schilit, head of the Center for Financial Research and Analysis in Bethesda, Maryland.
Companies often use pro forma accounting, for which there are no standard rules, to convey what results would be without expenses such as costs associated with mergers, non-cash compensation and research. Executives say pro forma earnings give a better picture of a company's growth, while opponents say the results often are misleading because they omit recurring expenses.
Trump Hotels
The SEC has brought one enforcement action for pro forma results using existing law. In January, Trump Hotels & Casino Resorts Inc., led by developer Donald Trump, settled SEC fraud charges that the company issued misleading pro forma results in counting a one-time gain as operating revenue. Trump Hotels agreed to be subject to stiffer penalties in the future while paying no fine and neither admitting nor denying wrongdoing.
Trump Hotels' shares rose 7.8 percent after its pro forma release in October 1999. The stock fell 6 percent three days later after analysts questioned the company's accounting.
SEC Chairman Harvey Pitt has said the agency is investigating other cases where pro forma accounting may have been misleading. In December, the SEC threatened to sue companies that use misleading figures in the pro forma press releases and warned investors to view those reports with suspicion.
While some companies now don't explain their pro forma numbers, hundreds of others -- including Amazon.com Inc., J.P. Morgan Chase & Co. and Yahoo Inc. -- do relate in the press releases what their numbers are under U.S. accounting rules.
Taking Tools Away
In a survey of 133 companies, about 10 percent weren't complying with industry guidelines for reconciling pro forma numbers with official figures, the National Investor Relations Institute has said.
``Ten percent is higher than what we should accept,'' the SEC's Beller said. The SEC is required by law to adopt a pro forma rule by January.
A spokesman for the Financial Executives Institute, which represents senior financial officers at corporations, said pro forma releases help companies explain their earnings.
``Analysts look for those kinds of measures to further understand results,'' said Dean Krogman, an FEI vice president. ``We would hate to see that tool taken away.''
During the late 1990s, securities firms that arranged initial public offerings often used those companies' pro forma results as justification for recommending purchase of the shares.
Common Sense
``Stock analysts at the Wall Street firms blindly accepted company pro formas that made no common sense,'' said Douglas Carmichael, a Baruch College accounting professor. ``The SEC rule is a necessary first step, but it has to be coupled with aggressive enforcement.''
Clear Channel Communications Inc., the biggest owner of U.S. radio stations, issued a press release in May that identified $17 billion in one-time expenses while not computing their effect on first-quarter earnings.
The company's chief financial officer, Randall Mays, said at the time that including the costs would have given Clear Channel a $16.9 billion loss, rather than the profit reported in the release. The company later officially reported a $16.7 billion loss for the quarter.
Clear Channel spokesman Eric Whittington said last month that treatment of the expenses ``was well understood by Wall Street.'' He said the company has changed its presentations. |
