WASHINGTON: The Securities and Exchange Commission delivered its final decision on the use of so-called "pro forma" earnings and several other disclosure topics in a mid-January ruling that has significant implications for IR professionals.
The SEC ruled that companies must identify pro-forma results as such in all releases.
Pro-forma accounting is a convention that allows companies to stray from standard accounting procedures, known widely as the Generally Accepted Accounting Principles (GAAP).
Pro-forma accounting, which has no formal or agreed-upon structure, usually looks to make earnings results more straightforward by excluding large one-time costs and gains that might distort results, when investors are attempting to evaluate the strength of the ongoing business.
For instance, a company might exclude the cost or gain from a legal settlement because such a figure would cloud the true performance of the company's underlying business.
Nevertheless, while many still view pro forma as a helpful, even necessary accounting tool, many feel that it was abused by some members of corporate America in recent years. Instead of using pro forma as a way of highlighting a firm's underlying financial performance, some companies used it to make their financials look rosier than they really were.
The SEC will now also require companies that use pro-forma results in earnings releases to explain how these figures were derived using the standard GAAP financials as the starting point. Companies are also prohibited from using pro-forma financials in a way that can be considered "misleading."
Some say the word "misleading" gives the SEC more recourse to action.
"The standard for proving something as 'misleading' is not (as strict) as the standard for 'fraud,'" said Lou Thompson, president and CEO of NIRI. "For fraud, you must prove the intention to deceive."
In a step that was perhaps as key for IR pros, companies will also have to file earnings press releases with the SEC within 48 hours of the original release. Historically, earnings releases have been out of SEC jurisdiction, except in cases of blatant fraud.
Donald Eagon, head of global communications for Diebold and current NIRI chairman, said, "This gives the SEC the jurisdiction it needs to really police the earnings release process. It also offers more guidance to companies that this earnings-release document is a serious exercise in corporate disclosure."
The SEC also passed a rule that requires companies to disclose whether their board of directors' audit committee has a "financial expert" on it as defined by the SEC. A company's audit committee works closely with both outside and internal auditors to help verify financial statements.
The SEC rule changes come in response to the corporate reform legislations signed into law by President Bush last summer during the height of several major corporate scandals involving accounting chicanery. The law, know as the Sarbanes-Oxley Act, tasked the SEC with developing new regulations that would encourage increased corporate transparency.
SEC DISCLOSURE RULE CHANGES
- Public companies must clearly identify when they are using pro-forma
accounting in their earnings releases
- Companies cannot employ pro forma in a misleading manner
- Companies must explain how they derive their pro-forma earnings
- A company must disclose whether a "financial expert" sits on its board
of directors' audit committee. The SEC has published the criteria for
defining who qualifies as such an expert