On Wednesday, the

Securities and Exchange Commission


Trump Hotels & Casino Resorts


with making misleading statements in a 1999 earnings release, bringing into sharp focus the issue of pro forma earnings reporting. The move came just as fourth-quarter earnings season launched into full swing this week.

Jeff Brotman,
Adjunct Professor of Accounting,
Univ. of Penn. Law School

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The widespread practice of pro forma reporting, or reporting that deviates from generally accepted accounting principles (GAAP), gained in popularity in the '90s as fast-growing companies sought to exclude acquisition-related and other charges that might have obscured their growth. But pro forma reporting has since become a more controversial topic.

Pro forma reporting allows companies to exclude reams of unspecified charges from their earnings, which often makes it difficult to assess a company's true fortunes. Last month, in a written warning, the SEC threatened to bring civil cases against companies that hide deviations from regular accounting principles in their earnings releases.


spoke with Jeff Brotman, adjunct professor of accounting at Penn Law, the University of Pennsylvania's law school, about how pro forma reporting is shaping up so far this season, and where the SEC goes from here. Among other things, Brotman believes that even getting all companies to report earnings on a GAAP basis wouldn't solve everything, and that to change things substantially, it might well take a huge lawsuit against a company accused of manipulating its numbers in order to mislead investors.

TSC: So far this earnings season, have there been any really egregious examples of misleading pro forma reporting?


Well, it's funny because

on Wednesday


was talking about


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numbers. There were two numbers they were showing on the graphic -- one was EPS, or regular earnings per share, and the other was CONS EPS, or consolidated earnings per share, and


anchor Mark Haines was confused. He actually said, "if I'm confused, some of our viewers must be confused."

What eBay announced was consolidated net for the quarter of 9 cents per share, and pro forma consolidated net income, which was 14 cents a share for the quarter. So the concept here is they're adding that extra word. Everybody is consolidated. GAAP means consolidated. But trying to follow what's going on is not that easy.

So I looked at eBay's press release on their site, and on page one, it says that the pro forma number excludes "certain charges." But then you have to really work your way through the report. At the very end, on page nine, are the pro forma entries, and you can see what gets added and what gets subtracted to get from the reported number to the pro forma number. But you have to search for it.

Now, everybody has been talking about


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. Intel actually shows per share earnings of 7 cents, which is the real reported number, but then right away, in its release, it goes into the pro forma number after acquisition-related costs. So that's relatively straightforward.

Still, we've got pro-forma numbers that mean "excluding certain charges" and pro-forma that means "after acquisition-related charges."


Wells Fargo

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reported a headline number that is the real number, with 69 cents. But the first thing they talk about in their fourth-quarter release is cash earnings, or earnings before non-qualifying core-deposited tangible amortization and the reduction of un-amortized goodwill due to the sale of assets.

I thought, maybe you can compare bank to bank, so I looked at

J.P. Morgan

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, which announced earnings Wednesday. But they use operating earnings, and they don't call these pro forma. In their release, they say operating earnings were 12 cents per share. In the next paragraph, though, they talk about reported net income, which includes merger and restructuring costs, and came to a loss of 18 cents per share.

The one that really got me was

Tyco International

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. I'm an accountant and a lawyer and I had to read the

release four times to understand it.


wrote about

Tyco's fiscal first-quarter earnings Tuesday.

So in just four days of earnings, you can have cash earnings, pro forma earnings, operating earnings, fully diluted earnings and consolidated earnings.

TSC: Do you think this violates the spirit or the letter of the warning put out by the SEC last month?


It doesn't violate the letter of the warning, and that's the interesting thing. The SEC said they're concerned about it, and everybody is providing the information. If you read the releases you can put it together.

But does it violate the spirit? I think so. Basically what the SEC was saying was that it would prefer that companies use GAAP numbers. I haven't spoken to anybody at the SEC, but I think the SEC wouldn't think it was violating the spirit if people were showing the net income number and then in the next graph pointing out the pro forma number, kind of like what Intel did.

But the other problem that you have is the financial press -- present company excluded -- which is focused on Thomson Financial/First Call. There is laziness on the part of the analysts and the press at times to do the hard work and people really rely on First Call. And if companies are guiding to the pro forma numbers, the analysts take the bait and go with the pro forma. So, then when you want to see if somebody "beat the Street," you have to use the pro forma number because that's what's used in the First Call system.

It's like the Wild West out there.

TSC: What do you think of the SEC's enforcement action against Trump Hotels, and what kind of message do you think it sends to corporate America?


It's very interesting. In the third quarter of 1999, Trump said that its net income number excluded a charge of $81.4 million. But they didn't note that it included one-time revenue from another source. So what the SEC is saying is that they used the pro forma numbers without making it clear enough that they were pro forma. And Trump's argument could be, wait a second we told everyone that they were pro forma numbers. But the SEC would say, yeah but you really mislead people. You didn't point out that there were other significant items that varied that number from GAAP earnings.

TSC: Does this move suggest that the SEC could take more drastic measures if companies continue to violate the spirit of its December warning?


You just don't know. They might. While this is a totally separate issue from



on the one hand, on the other hand, it's not. The problem is that accounting has become so complicated. Everyone is saying, we want to see GAAP numbers. But when we talk about Enron, it's like, how could they not disclose what was off balance sheet? What's off balance sheet is off balance sheet because of GAAP.

Even if Enron had followed the law, their disclosures would still have been egregious, in my mind. The way that they used these private partnerships, they broke some technical rules. When they bought one

of the partnerships back, they also guaranteed a loan, and that meant that it should have been off balance sheet. But if they hadn't guaranteed the loan, it still could have been off balance sheet, despite substantial risk to Enron.

On the one hand, pro forma lets companies tell you whatever they want. On the other hand, GAAP is no panacea. And we know that from Enron. A lot of things that Enron did were within the letter of GAAP.

What I hate is the different terminology -- cash earnings, operating earnings. Everybody is presenting on the basis that they think they ought to be and it's very hard to compare.

But I have a hard time seeing the SEC coming in and changing a lot of this. I think that what the SEC is struggling with is there are some real flaws with GAAP itself and whether or not it's adequate. The fact that no one is using GAAP shows some of the inadequacies. The SEC is trying to hold everyone to a standard but it's really hard to do.

Ultimately it's the market that's going to make that decision. Ultimately what's going to make a difference, more than technical guidance from the SEC that everyone can get around, is when somebody gets hit with a multimillion- or multibillion-dollar lawsuit verdict for having done this. That will be the market determination. Let's face it, on a different front, all of the Food and Drug Administration pressure and guidelines in the world never stopped the use of Joe Camel in tobacco adds. It was a couple of those million-dollar verdicts that got them thinking.

And I think that companies are ultimately in business to make money. If they think they can avoid getting in trouble, they'll find a way of doing what they want to do.

TSC: What do you think it would take for a big lawsuit to erupt?


I think you would need to see something like what you saw with Trump. If it's not fraud, if it's not really distorting, I think it's really hard to have a lawsuit. There have to be some changes where people are going to demand certain types of information.

Again, a big part of the problem is who's using the financial information. Intel and a couple of other companies announced earnings last night. People are watching the stuff on the financial networks, and there's no ability to absorb it. And the craziest thing in the world is you've got people trading off this stuff in the after hours, and they think they understand it. But nobody understands it. It's so complicated.

Even if everybody complied not only with the letter but the spirit of the SEC's warning, and everybody only reported under GAAP standards, you would still have problems.

I first started seeing widespread use of pro forma reporting about nine years ago, when there was a change made in GAAP for post retirement employee health benefits. You used to be able to use a pay-as-you-go system, but the Financial Accounting Standards Board decided companies had to record the liability for these charges.

As a phase in, you could either take these as a one-time charge, or draw it out over a 10-year period. And I believe this coincided, in 1992 or 1993, with the waning days of the last recession, so a lot of companies took these big one-time charges. If you look at


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reported bottom line number, for example, they had a big loss that year because they had to book this charge. That's when you got companies saying, we're going to also show what we would have made if we hadn't done this, so that you can compare from period to period.

You've always had a situation where companies reported earnings before extraordinary items. But this was one of the first instances where it was across the board. So while it may have started with the best of intentions, companies started using it to massage appearance.