Pitt and the Pendulum: SEC Warns About Growing Use of Pro Forma Earnings

Turning loss to profit -- without a valid explanation -- will likely be considered an act of fraud.

CFOs beware: If your pro forma financial statements make a loss look like a profit — and you don’t offer an adequate explanation for your financial sleight of hand — the statement will probably be deemed fraudulent or confusing.

That was the word from Securities and Exchange Commission chairman Harvey Pitt last week. Speaking to the Consumer Federation of America, Pitt said pro forma financials can be valuable only if they contain candid explanations. “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,” he said, according to Reuters.

“Companies that choose to do pro forma financials as a means of focusing people’s attention have to be on notice that … there can be absolutely no possibility an investor who sees the pro formas will misunderstand what really happened,” he said.

Pitt has made the misuse of pro forma results a major issue since he became chairman.

However, in a recent CFO.com poll, a majority of corporate finance managers said they issue pro forma results, and most see nothing wrong with it. In fact, 48 companies on the Standard & Poor’s 500 index this year issued pro forma results, up from just a few as recently as 1998, according to Thomson Financial/First Call.

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