On December 13, 2022, the staff of the U.S. Securities and Exchange Commission (SEC) Division of Corporation Finance released updated Compliance & Disclosure Interpretations (CDIs) regarding the use of financial measures that are not calculated in accordance with U.S. generally accepted accounting principles (GAAP). The updates reflect the SEC staff’s continued focus on registrants’ use of these financial measures and are the most significant updates to the non-GAAP CDIs since May 2016.
The updates, which include new and revised interpretations, generally reflect the views of the SEC staff that it has been providing to registrants through its review and comment process, including its views that non-GAAP financial measures with certain characteristics can be misleading and that GAAP financial measures should be presented with equal or greater prominence than the comparable non-GAAP financial measures.
Updated Non-GAAP Financial Measures CDIs
Revised Question 100.01 provides that certain adjustments to a GAAP measure, although not expressly prohibited, can render a non-GAAP measure misleading and clarifies that whether or not an adjustment results in a misleading non-GAAP measure depends on the registrant’s facts and circumstances. It goes on to note that the presentation of a non-GAAP measure that would exclude “normal, recurring, cash operating expenses” necessary to operate the business is only one example of a measure that could be misleading.
New Question 100.04 illustrates a potential violation of Rule 100(b) of Regulation G when the recognition and measurement principles used to calculate a non-GAAP measure are inconsistent with GAAP (e.g., changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis). The SEC staff’s guidance provides that non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading.
New Question 100.05 advises that a non-GAAP measure can be misleading to investors and violate Rule 100(b) of Regulation G if it is not accurately and appropriately labeled and clearly described. It also provides specific examples that would violate Rule 100(b) of Regulation G.
New Question 100.06 highlights the SEC staff’s position that a non-GAAP measure could still be misleading, and in violation of Rule 100(b) of Regulation G, even if accompanied by disclosure about the nature and effect of each adjustment made to the most directly comparable GAAP measure.
Question 102.10, which addresses the SEC staff’s position on the “equal or greater prominence” requirement, has been divided into three parts — Questions 102.10(a), (b) and (c). Revised Question 102.10(a) clarifies that the prominence requirement applies to the presentation of a non-GAAP measure and the discussion and analysis thereof. It continues to provide that whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made and provides specific examples of non-GAAP measures that the SEC staff would consider to be more prominent than the comparable GAAP measures. The examples now include the presentation of a ratio where a non-GAAP measure is the numerator and/or denominator without also presenting the ratio calculated using the most directly comparable GAAP measure(s) with equal or greater prominence.
Revised Question 102.10(b) presents examples of disclosures that the SEC staff believes would cause the non-GAAP reconciliation required by Item 10(e)(1)(i)(B) of Regulation S-K to give undue and inappropriate prominence to a non-GAAP measure, including starting the reconciliation with a non-GAAP measure.
Revised Question 102.10(c) confirms the SEC staff’s longstanding position that the presentation of a non-GAAP income statement, by itself or as part of the required non-GAAP reconciliation, gives undue prominence to the non-GAAP measures and, therefore, would run afoul of the prominence requirement. It also provides that the SEC staff would consider a non-GAAP income statement to be one that is comprised of non-GAAP measures and includes all or most of the line items and subtotals found in a GAAP income statement.
Given the SEC staff’s continued focus on the use of non-GAAP financial measures, prior to releasing earnings information and filing quarterly and annual periodic reports on Form 10-Q and Form 10-K, registrants should review their disclosures of non-GAAP measures against the updated CDIs.
Registrants should (1) focus on all non-GAAP adjustments to ensure that they are appropriate given the registrant’s individual facts and circumstances and are appropriately labeled and clearly described and (2) confirm that each non-GAAP measure is presented with the comparable GAAP measure and that the GAAP measure is presented with equal or greater prominence.
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