Regulator to accountants: Pro Forma is bad form

New York, Dec 6: Corporate accounting magicians, with the wave of a wand, can make a loss look like a profit, or hide expenses up their sleeves. But, signs are that the magic wand will not be able to pull off accounting tricks so quickly anymore. The use of so-called pro forma earnings calculations — earnings that strip out expenses ranging from merger costs to advertising and unsold goods — to dazzle shareholders, is being eyed more critically these days.

Everyone, from ratings agencies to regulators, has started to crack down on the practice. The latest salvo came on Tuesday from the US Securities and Exchange Commission (SEC), which vowed to take a tougher stance against companies that highlight such figures in their press releases, including suing companies under anti-fraud provisions. The stock market cop’s action was welcome news to professional investors who are starting to get fed up with the increasing use of dubious pro-forma earnings.

“It’s about time,” said John Valentine, founder and president of money manager Valentine Capital Retirement Planning Group. Mr Valentine, whose firm manages $550 million, said he has been burned by companies twisting their profits, though he declined to name names, and has seen the practice occur more frequently in recent years. “It’s something we have seen many times,” he said.

Investors — even professional stock pickers who are savvy when it comes to scrutinizing corporate profits — say holding companies to higher standards will prove beneficial and may reduce market volatility. Forcing corporations to cough up more financial detail and spell out expenses they exclude from their pro forma results can only help investors, said Peter Vlachos, president of New York money manager Austin Investment Management. “I suppose companies may be fearful it will hurt their stock,” he said. “But the lifeblood of this industry is disclosure. You could argue from here to doomsday that the SEC is requiring too much. But all they have pursued in the area of disclosure has helped us.”

Investors and other critics have railed against pro forma results, which often exclude one-time charges and other ugly expenses and paint a prettier portrait of a company’s financial health, and the criticism intensified.

— Reuters