SEC Plays the Trump Card on Pro Forma Earnings

If you thought Enron was the only earnings scandal on regulators' radar screens, Wednesday's events showed otherwise.

In a case that may prompt companies to be more conservative in how they present their quarterly results, the Securities and Exchange Commission said it had charged Trump Hotels & Casino Resorts (DJT Quote) with making misleading statements in a 1999 earnings release.

The case marks the first time that the SEC has taken issue with a specific company's use of pro forma reporting -- the widespread practice of showing what results would have been had it not been for certain expenses. Considering how widespread and inconsistently applied that practice has been, particularly among the technology companies whose shares are more richly valued in the stock market than any others, reverberations from the case could be felt in Silicon Valley and on Wall Street.

Winning Ways

The crux of the Trump Hotels case is that the company said in its third-quarter 1999 financial release that it had earned $14 million, or 63 cents a share, once you excluded a one-time loss of $81.4 million from the closing of its World's Fair Casino. So far so good: Excluding losses from, say, a tornado ripping through your factory is a widely accepted practice, even if it doesn't adhere to generally accepted accounted principles (GAAP).

But what Trump Hotels didn't say is that the company had benefited from a one-time gain of $17.2 million on a lease cancellation. By excluding the charge but not the gain, the company was, in effect, using pro forma accounting only when the result suited it. Take out that gain, and Trump Hotels would have lost $3.2 million, or 14 cents a share. Meantime, in its release the company trumpeted how it had beaten the consensus estimate of 54 cents a share.

Highflier Trump's in the dumps

The SEC said Trump Hotels had consented to its so-called cease-and-desist order, which essentially admonishes the company not to break the law ever again, without admitting to or denying the findings. For its part, Trump was doing cartwheels about the very public wrist-slap.

"I have great respect for the Commission and its Chairman, Harvey Pitt," CEO Donald Trump said in an exceedingly sober press release. "I am very happy that this all worked out."

Settling

In many ways, the case itself is small potatoes. The earnings release came out more than two years ago, an analyst revealed the discrepancy shortly after it came out, and Trump Hotels -- with a market capitalization of about $38 million -- ain't exactly a widely held issue. The stock was off about 10% Wednesday.

But the action does provide a stark warning to the many public companies that have been playing fast and loose with charges. In the third quarter, for instance, the reported earnings at S&P 500 companies came out to about $98 billion, according to Thomson Financial/First Call. But on a GAAP basis, according to Standard & Poor's, they came to only $47.4 billion -- less than half as much. Why the difference? First Call uses the numbers analysts use, which are often pro forma.

"If you're going to use pro forma reporting, don't hide the ball," explained Wayne Carlin, director of the SEC's Northeast Regional Office, in a press conference. "You have to explain the basis for arriving at the pro forma numbers. You have to explain how the pro forma numbers differ from GAAP numbers. And once you've done that and given that explanation, you need to follow it and apply it consistently."

Best Foot Forward

Pro forma earnings essentially allow a company to put a happier face on financial results that might otherwise be dominated by damaging information. And the rush to distract investors from massive charges has only intensified in recent months, now that new accounting guidelines on the disposition of so-called goodwill have come into effect. (Goodwill is the difference between the value of an asset and the price paid for it; the concept wasn't involved in the Trump case.) With many tech companies having overpaid for acquisitions during the late '90s investment bubble, massive writedowns such as those at AOL Time Warner and JDS Uniphase threaten to show investors just how badly they were fleeced during the boom.

"If we find circumstances where pro forma numbers are being used in a way that's materially misleading," said Carlin, "that is something we will pursue vigorously. And if we determine enforcement action is warranted, we will recommend that to the Commission."

A word to the wise shall be sufficient, tech executives.