In periodic reports filed with the Securities Exchange Commission (SEC), companies may elect to supplement their publicly disclosed financial measures prepared using Generally Accepted Accounting Principles (GAAP) with other non-GAAP measures that a company believes will better inform investors of the company’s performance. The SEC has signaled in the past few months a keen interest in policing the use of non-GAAP financial measures. In a December 2015 speech, SEC Chair Mary Jo White acknowledged the value of non-GAAP measures but emphasized that the topic “deserves close attention, both to make sure that our current rules are being followed and to ask whether they are sufficiently robust in light of current market practices.” Mary Jo White, Keynote Address at the 2015 AICPA National Conference: “Maintaining High‑Quality, Reliable Financial Reporting: A Shared and Weighty Responsibility” (Dec. 9, 2015). Following Chair White’s speech, the agency released in May 2016 new Compliance & Disclosure Interpretations (C&DIs) revising and clarifying the agency’s interpretations of the rules and regulations governing the use of non-GAAP financial measures.
As defined by SEC regulations, a non-GAAP financial measure is a numerical measure of a company’s historical or future financial performance, financial position, or cash flows that includes or excludes amounts from the most directly comparable GAAP measure. SeeRegulation G, 17 C.F.R. § 244.101(a)(1). Although non-GAAP measures may in certain circumstances better educate investors of a company’s true value, the SEC grew concerned about the potential for abuse and thus adopted Regulation G in 2003 to regulate the use of these measures.
Under Regulation G, which the SEC adopted as part of its implementation of the Sarbanes-Oxley Act, registered companies that publicly release non-GAAP measures must include a presentation of (1) the most directly comparable GAAP financial measure, and (2) a reconciliation of the differences between the non-GAAP measures released with the comparable GAAP measure. See id. § 244.100(a). Regulation G applies to all non-GAAP financial measures that are publicly disclosed in print, orally, telephonically, by webcast or broadcast, or through other similar means. Additionally, in filings before the SEC, registered companies must include, among other things, statements (1) explaining the reasons why the company believes its use of non-GAAP measure provides useful information to investors, and (2) disclosing the additional purposes for which the company uses the non-GAAP measures. See Regulation S‑K, 17 C.F.R. § 229.10(e)(1)(i)(C)–(D).
The SEC’s new May 2016 C&DIs add to this regulatory framework by providing, among other things, additional guidance on the prominence that may be attached to non-GAAP measures relative to comparable GAAP measures. The C&DIs provide specific illustrations of disclosures that would cause a non-GAAP measure to be more prominent than a comparable GAAP measure. For instance, the SEC made clear in the C&DIs that it would consider a non-GAAP measure more prominent, and therefore in violation of SEC regulations, where the company omits comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures, or where the company presents a non-GAAP measure using a style of presentation that emphasizes the non-GAAP measure over the GAAP measure.
In her December 2016 speech, Chair White cautioned companies that use non-GAAP measures to consider questions such as:
Why are you using the non-GAAP measure, and how does it provide investors with useful information? Are you giving non-GAAP measures no greater prominence than the GAAP measures, as required under the rules? Are your explanations of how you are using the non-GAAP measures—and why they are useful for your investors—accurate and complete, drafted without boilerplate? Are there appropriate controls over the calculation of non-GAAP measures?
In light of the SEC’s focus on non-GAAP measures and the likelihood of future enforcement actions, companies should give serious consideration to the questions raised by Chair White and review the new C&DIs to ensure compliance. Companies should take note of the enforcement risks associated with the use of non-GAAP measures, as the SEC’s attention to non-GAAP measures may have significant implications for directors of public companies. In particular, in the same December 2016 speech, Chair White singled out members of audit committees, admonishing them to “take seriously their reporting to shareholders, a critical responsibility on which the SEC is closely focused,” and to be vigilant in “adequately review[ing] how management . . . is using non-GAAP measures.”