June 25, 2019

June 25, 2019

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June 24, 2019

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SEC Reins in Use of Non-GAAP Financial Measures with New Guidance

On May 17, 2016, the Securities and Exchange Commission issued six new Compliance & Disclosure Interpretations (C&DIs) and modified other existing C&DIs to provide additional guidance on the use of non-GAAP financial measures under Regulation G. The new guidance reflects concerns recently voiced by the SEC about the proliferation of the use of non-GAAP financial measures, including the types of adjustments taken, the prominence of such adjustments and the focus given to these non-GAAP financial measures by the financial news media who often report the non-GAAP measure without reference to the related GAAP measure.   

In Depth

On May 17, 2016, the Securities and Exchange Commission issued six new Compliance & Disclosure Interpretations (C&DIs) and modified other existing C&DIs to provide additional guidance on the use of non-GAAP financial measures under Regulation G.  Since 2003, the SEC has required companies that disclose or release non-GAAP financial measures to include in that disclosure or release a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure.  The new guidance reflects concerns recently voiced by the SEC about the proliferation of the use of non-GAAP financial measures, including the types of adjustments taken, the prominence of such adjustments and the focus given to these non-GAAP financial measures by the financial news media who often report the non-GAAP measure without reference to the related GAAP measure.  

Highlights of the new guidance include the following:

  • Adjustments to a GAAP financial measure may violate Regulation G because they are misleading even though they are not expressly prohibited by Regulation G.

  • Adjustments to GAAP measures that are inconsistently applied between financial reporting periods may be misleading.  An adjustment for a particular charge or gain that creates a non-GAAP financial measure in a current period could be misleading unless adjustments for similar charges and gains are made in past periods.  Changes in adjustments between periods that are not significant may be permitted if the change between periods and the reasons for the change are disclosed. 

  • A non-GAAP financial measure adjusting for non-recurring charges could be misleading if it does not also adjust for non-recurring gains that occur in the same period.

  • A non-GAAP financial measure may not be presented with greater prominence than the comparable GAAP measure.  Examples of non-GAAP presentations that are more prominent and may violate Item 10(e) of Regulation S-K, include:

    • Presenting a full income statement of non-GAAP financial measures, even if the presentation is used to reconcile these non-GAAP measures to the most directly comparable GAAP measures;

    • An earnings release headline or caption that includes non-GAAP financial measures but not comparable GAAP measures;

    • Emphasizing a non-GAAP measure with the style of presentation (e.g., bold or larger font) compared to the GAAP measure;

    • A non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline, caption or table);

    • Describing a non-GAAP measure as “record performance” or “exceptional” without at least an equally prominent description of the comparable GAAP measure;

    • Excluding a quantitative reconciliation with respect to a forward-looking non-GAAP measure in reliance on the “unreasonable efforts” exception in Item 10(e)(1)(i)(B) of Regulation S-K without disclosing that fact and identifying the information that is unavailable and its probable significance in a location of equal or greater prominence; and

    • Providing a discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence.

    • Non-GAAP financial measures that substitute individually tailored recognition and measurement methods for financial statement line items may violate Rule 100(b) of Regulation G.  For example, non-GAAP financial measures that make adjustments to revenue recognition so that earned revenue is recognized when a customer is billed, rather than ratably over time in accordance with GAAP, is not permitted under Regulation G.

    • A per share non-GAAP financial measure that can be used as a liquidity measure violates Item 10(e) of Regulation S-K, even if presented by management as a performance measure.  When reviewing the use of a per share non-GAAP financial measure, the SEC will focus on the substance of a non-GAAP financial measure rather than management’s characterization of a non-GAAP financial measure. 

    • Free cash flow, EBIT and EBITDA may never be presented on a per share basis. 

    • Income tax effects related to adjustments that create a non-GAAP measure should be provided depending on the nature of the non-GAAP measure.  For a liquidity non-GAAP measure that includes income taxes, it may be acceptable to adjust GAAP taxes to show taxes paid in cash.  For a performance measure, current and deferred income tax expense commensurate with the non-GAAP measure of profitability should be included.  No adjustments that create a non-GAAP financial measure should be shown “net of tax”; instead, income taxes should be shown as a separate adjustment and clearly explained.

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David A. Cifrino, McDermott Will Emery Law Firm, Corporate Attorney
Partner

David Cifrino is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Boston office.  He is co-head of its Public Companies group.  David represents financial services, industrial, high technology, consumer products and other companies, public and private (from start-ups to Fortune 50), in securities, merger, acquisition, disposition, commercial, strategic, governance and executive compensation matters.  He represents clients in both public and privately placed equity and debt financings under the Securities Act of 1933 and...

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Robert H. Cohen, Corporate Attorney with McDermott Will law firm
Partner

Robert H. Cohen is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s New York office.  He focuses his practice on transactional and securities work for a broad range of clients, including initial and follow-on public offerings, registered direct and PIPE financings, private placements, bridge financings, equity line and reverse mergers.

Bob has extensive experience in the areas of mergers and acquisitions, joint ventures, 1933 & 1944 Act representation and licensing and distribution arrangements.

From his years of experience, Bob has developed industry-specific knowledge across numerous markets, particularly in the life sciences industry having represented the financing and mergers & acquisitions activity for  pharmaceutical and medical device companies.

He is admitted to practice in New York and before the U.S. District Court for the Eastern District of New York and U.S. District Court for the Southern District of New York.

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Thomas P. Conaghan, Mcdermott Will Emery law Firm,  (M&A), joint ventures, strategic investments, spin-offs,
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Thomas P. Conaghan is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s Washington, D.C., office.  Tom represents both publicly held and closely held businesses, underwriters and other sources of capital, corporate boards and board committees and corporate executives.  He advises both U.S. and foreign-based public companies on issues relating to public and private offerings of securities, disclosure, periodic reporting, corporate governance, executive compensation, the rules of the New York Stock Exchange and the Nasdaq Stock Market and compliance with the...

202-756-8161
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Gary Emmanuel is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s New York office. He focuses his practice on corporate securities matters.

With over 15 years of experience, Gary represents both domestic and foreign companies that are navigating the process of capital raising including initial public offerings, registered direct offerings, follow-on offerings, private placements, PIPEs and bridge financings. Gary has worked extensively with biotechnology and other life science companies, both as company counsel...

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Mark J. Mihanovic, McDermott Will Emery, Corporate Finance Attorney, Mergers Acquisitions Lawyer,
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Mark J. Mihanovic is a partner in the law firm of McDermott Will & Emery LLP.  Mark heads our Firm’s California corporate practice and serves as corporate liaison partner in the Firm’s strategic alliance with MWE China Law Offices based in Shanghai.  His practice is primarily focused in the areas of corporate finance and mergers and acquisitions involving companies in a broad range of industries, with a particular emphasis on technology, life science and health care companies.  Mark has served as lead counsel on behalf of issuers and underwriters in numerous public...

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