Greenberg Traurig Alert
SEC Cautions on Use of Pro Formas
By Paul Berkowitz,
Ira Rosner and Ileana Gomez,
Greenberg Traurig, Miami Office
View or download the PDF version of this Alert
|"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
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
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
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:
- 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.
- 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.
- Companies must pay close attention to the materiality of the information
that is omitted from a pro forma presentation.
- 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.
- 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
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
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
2 Andrew Hill, Companies and Markets – Earnings
Reports Fail Grade, Financial Times, Nov. 12, 2001, at 2001 WL
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 http://www.lexis.com.
8 See Harvey L. Pitt, supra note
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.
15 See supra note 9.
16 Pitt, supra note 6.
17 See id.
© 2001 Greenberg Traurig
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