Lies, Damn Lies, and Pro Forma

Pro forma earnings reports may be a cause du jour of reformers, but CFOs aren't about to back down from issuing them.

This past January, the Securities and Exchange Commission administered its first spanking of a company for abusing pro forma earnings figures. The culprit: Trump Hotels & Casino Resorts Inc. The sin: a “materially misleading” quarterly earnings release dating from 1999. The punishment: Go and sin no more.

Coming a month after the SEC issued “cautionary advice” about using pro forma numbers, the Trump Hotels case should cause companies to think twice before they put too hard a spin on their earnings releases. Still, despite the SEC’s tough stance–and the status of pro forma reporting as a cause du jour of accounting watchdogs–no one expects many companies to refrain from using non-GAAP earnings numbers to describe their quarterly operating performance.

Not even the SEC expects this to happen. “[The Trump Hotels] case should not be viewed as the commission saying that pro forma reporting per se is good or bad,” says Wayne M. Carlin, director of the SEC’s northeast regional office. He adds, “The SEC enforcement division doesn’t get interested in [pro forma releases] unless [companies] use them in a misleading way.” Because earnings releases are just that–press releases, not SEC filings–the SEC bases its grounds for enforcement on the antifraud provisions of the Securities Exchange Act of 1934.

The SEC has endorsed best-practice guidelines for earnings releases (see below), which include the recommendation that companies always include GAAP results with pro forma numbers and state how they derive the latter from the former. Last November, at a Consumer Federation of America conference, SEC chairman Harvey Pitt said pro forma numbers are valuable only if their calculation is clear. What’s more, he told Reuters, “I would say in cases where pro forma statements change a loss into a profit, my view is there is an almost 100 percent chance that a company that is capable of doing that without appropriate disclosure will have defrauded or confused its investors.”


Making a small gain nearly five times larger was the effect of the October 1999 earnings release that got Trump Hotels in trouble. In that release, the company reported a pro forma profit for Q3 1999 of $14 million, excluding a one-time charge of $81.4 million, and pro forma earnings per share of 63 cents, exceeding First Call estimates of 54 cents. The release quoted then-CEO Nicholas Ribis as ascribing the better-than-expected numbers to improved operating performance.

But according to the SEC, the release failed to mention that the earnings calculation actually included a one-time accounting gain of $17.2 million, stemming from the termination of a lease agreement–the sort of nonrecurring item that pro forma earnings are supposed to ignore. Without that gain, Trump Hotels would have posted a pro forma profit of about $3 million, or 14 cents per share. The SEC considered it hardly sporting for Trump Hotels to surreptitiously include the one-time gain in the pro forma calculations while publicly excluding the one-time charge.

“In this case, the method of presenting the pro forma numbers and the positive spin the company put on them were materially misleading,” said Stephen M. Cutler, director of the SEC’s division of enforcement, in a press release. “The case starkly illustrates how pro forma numbers can be used deceptively and the mischief that can cause.” Trump Hotels’s share price rose 7.8 percent on the day of the earnings release and fell about 6 percent three days later, when an analyst revealed the one-time accounting gain.


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