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SEC Cautions on Use of Pro Formas

December 2001
By Paul Berkowitz, Ira Rosner and Ileana Gomez, Greenberg Traurig, Miami Office

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Paul Berkowitz
"Public companies should consider carefully the SEC’s advice when preparing year-end financial announcements."

The Securities and Exchange Commission issued "cautionary advice" last week regarding the use of "pro forma" financial information in earnings releases.1  The Release is intended to guide public companies and their advisors in the use of pro forma financial information and to alert investors to the potential dangers of reliance on such information. Public companies should consider carefully the SEC’s advice when preparing year-end financial announcements.

Pro forma statements have been used for the past six years  without serious negative comment. Essentially, these earnings reports provide financial information to investors using methodologies other than those complying with Generally Accepted Accounting Principles ("GAAP"). Originally, pro forma statements were principally used when a company had undergone major changes, such as an acquisition, that made comparisons of the current year with prior years difficult or confusing.

In recent years, there has been a marked increase in the use of pro forma presentations in earnings releases. In these releases companies communicate results reflecting the occurrence or non-occurrence of certain events. These always contain a certain degree of subjective analysis. Until very recently, analysts and investors failed to question the procedures used by companies to arrive at pro forma results — provided the results met or exceeded their expectations.2

Now, partially because of the downturn in the economy, analysts, investors, auditors and SEC officials are requiring companies to provide explanations of their financial statements that deviate in any respect from GAAP.3  These requirements, while not new, have been overlooked in many cases. Federal law requires publicly held companies to file financial statements prepared in accordance with GAAP and prohibits misleading statements and omissions in communications to investors. In addition to the requirements of the federal securities laws, the New York Stock Exchange, American Stock Exchange and the Nasdaq Stock Market each have their own rules governing the content of press releases. In general, announcements should be prompt, balanced and fair, and avoid the following: (i) the omission or undue minimization of important unfavorable facts, or unduly minimizing such facts; (ii) the presentation of favorable possibilities as certain, or as more probable than actually is the case; (iii) the presentation of projections without sufficient qualification or without sufficient factual basis; (iv) negative statements phrased in such a way as to create a positive implication; and (v) the use of promotional jargon calculated to excite rather than to inform. Pro forma statements are now being more closely scrutinized pursuant to these prerogatives.

Critics contend that the use of pro forma statements undermines the notion of consistency in financial reporting.4 "There are no accounting standards for pro forma[s]. It is whatever management wants," at least one critic has stated.5 Harvey L. Pitt, Chairman of the SEC, recently described pro forma statements as an "unstructured and undisciplined form of financial disclosure that rejects the bedrock of [the SEC’s] financial disclosure requirements – GAAP."6

Advocates of pro forma statements believe that the statements are an "informal and effective way for investors to get a true sense of a company’s health because one-time charges and other isolated events do not drag down an otherwise thriving company’s bottom line."7 According to these advocates, pro forma presentations allow management the ability to reflect the true operations of a company thereby providing investors with current, simplified and comprehensible financial reports which are not always communicated with mandated GAAP disclosures.8

Pro forma statements, some critics say, make it difficult, if not impossible, for analysts and investors to track a company’s business accurately or consistently. However, in a recent survey of portfolio managers, more than three-quarters of 223 managers agreed that pro forma reporting is useful and most said that they want to see pro forma figures in press releases, albeit with more detail.9

The SEC deems GAAP accounting conventions "accurate, truthful and complete."10  Use of these accounting conventions allows investors to compare one company’s results with another’s and to track a company’s changes from one quarter to another.

The SEC, in its "cautionary advice," points out that while pro forma information may appropriately focus investors’ attention on isolated events, "[t]o a large extent, this has been the intended function of disclosures in a company’s Management Discussion and Analysis section of its reports."11

Given the lack of standards governing the use of pro forma statements, the Release "alerts" public companies to the following guidelines:

  1. A company issuing pro forma financial information is bound by the antifraud provisions of the federal securities laws and must be mindful of its obligation not to mislead investors when using this information.
  2. Companies providing financial results on a limited feature of the company’s financial performance or setting forth calculations on a basis other than GAAP must disclose the principles underlying the presentation in order to fully inform and not mislead investors.
  3. Companies must pay close attention to the materiality of the information that is omitted from a pro forma presentation.
  4. Before deciding whether to use pro forma results and in determining the structure of a pro forma statement, companies should review and follow the earnings press-release guidelines developed jointly by Financial Executives International ("FEI") and the National Investors Relations Institute. The guidelines are intended to improve consistency among companies in the presentation and analysis of results, and advise companies to include "‘reported’ results for the period presented and pro forma ‘cash basis’ or ‘adjusted,’ ‘underlying,’ ‘ongoing’ or ‘core’ results to supplement the period’s GAAP results."12 If pro forma results are provided, they should be accompanied by a plain English explanation and quantitative information indicating how the pro forma results deviate from GAAP.
  5. Companies are expected to provide greater disclosure when using pro forma results and investors are advised to compare pro forma financial information with the results included in reported GAAP financials of the same company.

While the Release does not prohibit the use of pro forma financials, it does echo the statements of SEC Commissioner Isaac C. Hunt Jr., that the "best use of pro forma statements is a limited one."13 Commissioner Hunt also urged companies to follow FEI guidelines, which state that "pro forma results should always be accompanied by clearly described reconciliation to GAAP results."14  Company releases should include analyses or operating results and a discussion of both positive and negative factors significantly affecting revenue, profitability and other key financial indicators that measure the health of the enterprise.15  The releases should also include discussions of significant enterprise, natural and economic phenomena.

The Release and recent statements by the SEC Chairman indicate that the SEC is reconsidering its "financial disclosure model, with an eye toward simplifying it so that everyone can understand the fundamentals of every company and find absolute comparability from firm to firm."16  The goal is to achieve clear, verifiable and consistently presented information.17

Accordingly, as we approach year end, companies and their managers should carefully evaluate the manner in which they plan to disclose financial results to investors, analysts, and the general public. If a company elects to use a pro forma presentation it should, at a minimum, pay close attention to describing the procedures used for arriving at the financial results and strongly consider providing a clear reconciliation of the pro forma results to GAAP results. It should be assumed that the SEC will be reviewing press releases containing pro forma statements to assess compliance with the Release and consider enforcement action in certain cases.



1 Rel. No. 33-8039 (Dec. 4, 2001). Full text available at

2 Andrew Hill, Companies and Markets – Earnings Reports Fail Grade, Financial Times, Nov. 12, 2001, at 2001 WL 30139473.

3 Id. The Financial Accounting Standards Board has also criticized the increased use of pro forma statements.

4 Bill Deener, Reporting Methods Can Blur Bottom Line: Accounting Tools Allow Firms to Give Earnings a Positive Spin, The Dallas Morning News, October 30, 2001, at 2001 WL 29581699.

5 Id. Quoting a statement by Georgene Palacky, an associate at the Association for Investment Management and Research.

6 Harvey L. Pitt, Address before the AICPA Governing Council (October 22,2001) at 2001 WL 1299917 (S.E.C.).

7 Financial Executives News October 2001 available at

8 See Harvey L. Pitt, supra note 6.

9 Elizabeth Wine, Global Investing – Strong Support for Standardized Earnings Reports, Financial Times, Nov. 9, 2001, at 2001 WL 30139079.

10 "‘Pro Forma’ Financial Information: Tips for Investors," available at

11 Rel. No. 33-8039 (Dec. 4, 2001).

12 "FEI and NIRI Issue Earnings Press Release Guidance; Encourage Inclusion of GAAP Financial Results," available at

13 Isaac C. Hunt, Jr., Address at the Federation of Schools of Accountancy (Oct. 26, 2001) at 2001 WL 1299915.

14 Id.

15 See supra note 9.

16 Pitt, supra note 6.

17 See id.


© 2001 Greenberg Traurig

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