October 19, 2021

Volume XI, Number 292


October 18, 2021

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Non-GAAP Update: SEC Continues Its Scrutiny of Financial Measures

As companies prepare their third quarter disclosures, we recommend careful scrutiny of any non-GAAP financial measures, especially in light of the SEC’s continuing focus in this area.

As we have previously reported, the SEC Staff has voiced increasing concern about the pervasive use and oftentimes misuse of non-GAAP financial disclosures by public companies.  Against this backdrop, in May 2016, the SEC’s Division of Corporation Finance issued new and revised Compliance and Disclosure Interpretations (CDIs) relating to the rules and regulations on the use of non-GAAP financial measures.

Since the publication of the new CDIs, the Staff has continued to emphasize its increasing attention on non-GAAP financial measures. In a June 2016 address to the International Corporate Governance Network, SEC Chair Mary Jo White discussed the flexibility provided by non-GAAP disclosures while noting “significant concerns about companies taking this flexibility too far and beyond what is intended and allowed by our rules.” Chair White warned that, “In too many cases, the non-GAAP information, which is meant to supplement the GAAP information, has become the key message to investors, crowding out and effectively supplanting the GAAP presentation.”  Chair White noted that the Staff would be closely monitoring companies’ presentations of non-GAAP measures and would act accordingly thoughout the filing review and comment process, enforcement and further rulemaking, as necessary.

Industry groups are also focused on the new guidance related to non-GAAP measures.  For example, the National Association of Real Estate Investment Trusts (NAREIT) has been in discussions with the SEC Staff regarding the presentation of certain non-GAAP measures commonly used in the REIT industry.

In the last few months alone, the Staff has issued a substantial number of comment letters addressing the use of non-GAAP measures in light of the new CDIs. Recent comment letters have frequently addressed the following non-GAAP topics in particular:

The “equal or greater prominence” requirement (CDI Question 102.10)

  • One recent comment letter notes that “[i]t appears that you have disclosed the non-GAAP financial measure Net operating income… with greater prominence than your results of operations prepared in conformity with U.S. GAAP….”

Usefulness disclosure (Regulation S-K Item 10(e)(1)(i)(C))

  • One recent comment letter states “the company considers your non-GAAP measures to be important financial indicators of your operational strength and the performance of your business; however, it is unclear why management believes this information is useful to investors or how they use this information, to the extent material, in managing your business.”

Liquidity versus performance measures (CDI Question 102.05)

  • One recent comment letter addresses an issuer’s characterization of Cash Available for Dividends as both a performance and liquidity measure while noting that such non-GAAP financial measure was historically characterized solely as a liquidity measure.The comment requests additional information supporting the position that Cash Available for Dividends is a performance measure.

  • The CDIs clarify that non-GAAP liquidity measures may not be presented on a per-share basis.

Reconciliations to comparable GAAP measure (Regulation S-K Item 10(e)(1)(i)(B))

  • A recent comment addresses an issuer’s inclusion of non-GAAP line items within a tabulation summarizing the issuer’s segment GAAP results and requests that the non-GAAP measures be repositioned apart from the GAAP tabulation and be presented with separate reconciliations.

Adjustments (CDI Question 100.1)

  • For example, a recent comment letter notes that a non-GAAP financial measure “adds back rent expense to operating income in order to treat your operating leases as though they were capitalized.”The comment raises the propriety of this adjustment in light of CDI Question 100.01 because “it appears that rent expense may be a normal, recurring, cash operating expense necessary to operate your business.”

These are just a sampling of numerous recent Staff comments relating to non-GAAP financial measures.  Even if companies did make adjustments to their use of non-GAAP measures in their second quarter reporting cycle and did not receive SEC staff comment letters, we recommend careful review of the use of non-GAAP financial measures, including those historically presented, in light of the new CDIs, Regulation S-K Item 10(e) and recent Staff comments issued in respect of these CDIs.

© 2021 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume VI, Number 295

About this Author

Bonnie Barsamian, Drinker Biddle Law Firm, New York, Corporate and Finance Law Attorney

Bonnie A. Barsamian is a seasoned legal and business advisor with more than 25 years of experience advising public and private companies, investment banks, financial sponsors, executive leadership and boards of directors in complex securities/capital markets, mergers and acquisitions and other corporate transactional, advisory and regulatory matters.

Bonnie represents issuers, underwriters and financial sponsors in the full range of public and private securities offerings and other corporate finance transactions, including IPOs...

(212) 248-3188
Elizabeth A. Diffley, Corporate, Securities Attorney, Drinker Biddle, Law Firm

Elizabeth A. Diffley is an accomplished and pragmatic advisor to public and private clients on corporate and securities matters, including corporate governance, capital raising transactions, public company reporting and compliance, and mergers and acquisitions, as well as general corporate matters. Knowledgeable across a broad range of industries, Beth has particular experience advising insurance and other financial services companies on a variety of securities, mergers and acquisitions, governance and general corporate matters.

Ariel Greenstein, Drinker Biddle Law Firm, Securities Transactions Attorney

Ariel Greenstein concentrates her practice on securities transactions, ongoing compliance under U.S. securities laws, corporate governance and general corporate representations. Ariel has advised domestic and foreign companies and financial institutions in a range of corporate matters, including initial public offerings, follow-on and secondary offerings, high-yield debt offerings, tender offers, private placements of debt and equity securities, mergers and acquisitions and derivatives transactions. She has represented clients operating in the healthcare...