Trump Hotels Settles First SEC Action Alleging Misleading Pro Forma Numbers

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Trump Hotels & Casino Resorts Inc. Jan. 16 agreed to cease and desist from antifraud violations in settling Securities and Exchange Commission charges that it issued a quarterly earnings release with misleading pro forma numbers—the first such case brought by the SEC.

In reaching the settlement of the administrative proceeding regarding the third-quarter 1999 earnings release, Trump Hotels neither admitted nor denied the SEC's charges.

In a news release, Stephen M. Cutler, director of the SEC's Division of Enforcement, emphasized that the case is “the first Commission enforcement action addressing the abuse of pro forma earnings figures.” Cutler summarized, “In this case, the method of presenting the pro forma numbers and the positive spin the Company put on them were materially misleading.”

Pro forma financial information presents to the public the company's earnings and results of operations based on methodologies other than generally accepted accounting principles (GAAP).

Investor Alerts

In December, the SEC published cautionary advice to companies that issue pro forma financial statements, and an investor alert giving tips to investors on how to analyze such statements—and on avoiding the pitfalls of their use.

In a telephone press conference concerning the Trump Hotels settlement Jan. 16, Wayne Carlin, director of the SEC's Northeast Regional Office, which handled the case, said that “each of the items in the pro forma statement was literally, nominally true to a small degree,” but that the release was fraudulent overall essentially because it failed to disclose that the stated net income included a one-time gain of $17.2 million.

According to the commission's release, Trump Hotels' Oct. 25, 1999 quarterly earnings release used pro forma net income and earnings-per-share (EPS) figures. The figures were not in conformity with generally accepted accounting principles because they expressly excluded a one-time $81.4 million charge, the release said. “By stating that this one-time charge was excluded from its stated net income, the Company implied that no other significant one-time items were included in that figure,” the release said.

However, contrary to that implication, the stated net income included an undisclosed one-time gain of $17.2 million, according to the commission. That gain was the result of the termination of a restaurant's lease of space at the Trump Taj Mahal Casino Resort in Atlantic City. Thus, the SEC concluded, the earnings release was fraudulent because “it created the false and misleading impression that the Company had exceeded earnings expectations primarily through operational improvements.”

One-Time Gain Cited

According to Carlin, there were two additional problems with the quarterly release, in addition to the failure to disclose the one-time gain. First, the company asserted that it had beaten analysts' expectations with the pro forma numbers. “[Trump Hotels'] earnings per share of $0.63 exceeded First Call estimates of $0.54,” the release said, according to the SEC.

Second, Carlin said, the company's earnings release included assertions by Trump Hotels' chief executive officer about operational improvements—increased operating margins, decreased marketing costs, and increased noncash revenues—during the quarter that caused the stated positive results. These all contributed to the overall misleading nature of the release, Carlin said.

“On Oct. 25, the day the earnings release was issued, the Company's stock rose 7.8 percent in price,” the SEC said. Three days later, when an analyst's report and a news article revealed the impact of the one-time gain, the stock fell about 6 percent, the agency recounted.

Explain Basis

Carlin acknowledged to reporters that using pro forma numbers is “not necessarily inherently misleading.” However, he emphasized that the SEC has “made very clear that this is an area of concern.” In addition, Carlin said, those who use pro forma reporting must explain the basis for arriving at the pro forma numbers and explain how those numbers differ from GAAP numbers.

“In the area of pro forma,” he said, “literal truth is not necessarily a defense. Being able to pull apart individual statements and argue technically that it is a true fact [is no defense], if the statements taken as a whole are misleading.”