Risk Management

Unfit Reporting: Bally Settles SEC Fraud Charges

From 1997 to 2003, the fitness-center operator massively overstated stockholders' equity and understated net losses.
Stephen TaubFebruary 28, 2008

Bally Total Fitness Holding, just out of bankruptcy and under a new private ownership, settled financial fraud charges with the Securities and Exchange Commission stemming from “more than two dozen accounting improprieties” that led to a series of erroneous financial reports.

The SEC alleged that from at least 1997 through 2003 Bally’s financial-statement errors caused Bally to overstate its originally reported year-end 2001 stockholders’ equity by nearly $1.8 billion, or more than 340 percent. The errors led the nationwide operator of fitness centers to understate its originally reported 2002 net loss by $92.4 million and to understate its 2003 net loss by $90.8 million.

Bally fraudulently accounted for three types of revenue it received from its members, according to the complaint: initiation fees, prepaid dues, and reactivation fees. In addition, Bally fraudulently accounted for its membership acquisition costs.

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These frauds account for $1.2 billion of the $1.8 billion overstatement of Bally’s originally reported year-end 2001 stockholders’ equity, according to the SEC.

In addition, Bally’s accounting for more than 20 other revenue or expense items failed to conform to Generally Accepted Accounting Principles. These failures account for the remaining $600 million of the $1.8 billion overstatement of Bally’s originally reported year-end 2001 stockholders’ equity, according to the complaint.

The SEC said that without admitting or denying the Commission’s allegations, Bally consented to the entry of a court order enjoining it from violating these provisions. In determining to accept Bally’s settlement offer, the commission said, it considered Bally’s cooperation with the SEC staff in the investigation leading to this action, along with prompt remedial action.

On May 2007 trading in Bally common stock on the New York Stock Exchange was suspended. On July 31, Bally filed for a pre-packaged bankruptcy. On Oct. 1 it emerged from reorganization as a privately held corporation.

In March 2004, Bally revised its 2003 results to correct revenue errors amounting to about $43 million over seven years. According to the company at the time, the revenue errors accelerated dues recognition for certain prepaying members.

The $43 million was part of a $675 million non-cash charge related to a 2003 change in the company’s accounting system in 2003, the company had said at the time.

The company’s auditor, Ernst & Young LLP, resigned later that month. In late April 2004, CFO and director John Dwyer resigned as the SEC launched its investigation into the company’s restatement.

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