SEC focuses on use of Non-GAAP measurements

In 2003, the Securities and Exchange Commission (“SEC”) adopted rules related to the use of non-GAAP measurements. Fast forward over a decade, and the SEC continues to have many of those same concerns as it did in 2003 and has recently updated its guidance in this area.

Companies creating entity-specific GAAP

There continues to be a proliferation in the use of non-GAAP measurements by companies disclosing financial performance.  Companies are regularly adjusting GAAP measurements for transactions deemed to be non-recurring, non-routine, non-essential, or not truly reflective of the business.  While non-GAAP measurements are permissible, the SEC continues to be concerned.  In a recent speech, James Schnurr, the SEC Chief Accountant stated, “I am particularly troubled by the extent and nature of the adjustments to arrive at alternative financial measures of profitability, as compared to net income, and alternative measures of cash generation, as compared to the measures of liquidity or cash generation.”  Companies disclosure of non-GAAP measurements is in ways creating entity-specific GAAP.

Back to the future

Like it did back in 2003, the SEC has advised companies that it may be violating SEC rules by non-GAAP disclosures which are among other things:

  • more prominently displayed than GAAP measurements (e.g., present non-GAAP measures before GAAP measures, present non-GAAP measures in bold or larger fonts)
  • misleading (e.g., exclude normal, recurring cash operating expenses necessary to operate the business, are presented inconsistently between periods without adequate disclosure of the change)
  • present “individually tailored” recognition and measurement methods in calculating a performance measure (e.g., accelerate the recognition of revenue to the time of sale that under GAAP would be recognized ratably over the performance period)
  • present liquidity measures on a per-share basis (e.g., present earnings before income taxes or earnings before income taxes, depreciation and amortization (EBITDA) on a per-share basis, an adjusted EBITDA per-share measure that could in substance be a liquidity measure)
  • do not adjust non-GAAP adjustment for tax effects

The SEC staff has been quite clear of its focus on use of non-GAAP measurements.  Mary Jo White, SEC Chairwoman, stated in a speech, “We are watching this space very closely and are poised to act through the filing review process, enforcement and further rule-making if necessary to achieve the optimal disclosures for investors and the markets.”  With this level of SEC focus, companies may periodically assess whether each non-GAAP measurement provides useful and meaningful information to stakeholders beyond what is currently disclosed under GAAP.