A Matter of Emphasis

Regulation G was supposed to end the abuses of pro forma reporting. Has it succeeded?

When the Securities and Exchange Commission issued Regulation G in January 2003, some people thought the death knell had been sounded for the abuse of pro forma numbers.

From that date on, any non-GAAP number used in an earnings release had to be accompanied by — and reconciled to — the “most directly comparable” GAAP number. Anything excluded from the pro forma metric had to be disclosed. At the same time, the SEC also amended existing rules to narrow the field of what could be excluded from pro forma measures in filed information.

Today, though, there’s little evidence that Reg G has had much effect on pro forma reporting. About 60 percent of companies continued to report non-GAAP information in their first-quarter earnings releases this year, according to a National Investor Relations Institute (NIRI) survey of 360 companies, down from the 70 percent that reported doing so in the quarter before Reg G took effect. Of those that stopped using pro forma, only about a quarter attributed the move to Reg G.

Some observers, in fact, charge that abuses of pro forma still flourish. “There seem to be a lot of companies that are pushing the envelope on Reg G,” says Chuck Hill, former director of research at Thomson Financial First Call. While few are blatantly breaking the law by omitting GAAP equivalents or reconciliation tables, Hill says some companies are taking advantage of the relatively lax enforcement of regulations on press releases to spin their numbers in ways that would be illegal in official filings.

Consider Intuit, a Mountain View, California-based provider of business and financial software. Pro forma earnings have actually moved higher up in the company’s earnings releases since Reg G took effect, with this year’s third-quarter release (dated May 19) headlining a 14 percent growth in pro forma earnings per share. GAAP EPS, which was higher in absolute terms but reflected a decline from last year’s numbers, shows up immediately below, halfway down the page. And the difference between the two is explained only in general terms in a footnote to the release, with details following in a separate file.

Such placement, charges Hill, may not be a technical violation, but it “is definitely a violation of the spirit of the law” requiring that GAAP numbers get equal or greater prominence than pro forma. He adds that “everybody ought to at least start in the same place — GAAP — before moving into adjustments.”

Intuit is hardly alone; a host of other companies, particularly software and biotech firms, continue to give pro forma first place, according to Hill (see “Pro Pro Forma,” at the end of this article). But they do so at their own peril, in view of what many securities lawyers advise. “Given that the SEC says non-GAAP financial measures can lend themselves to being misleading, it’s important to put them in context,” says Katharine Martin of Wilson Sonsini Goodrich & Rosati. “I would personally not recommend that you use non-GAAP financial measures in the lead, because there’s a chance that it could get more prominence, particularly in wire stories.”

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