Tag: non-GAAP financial measures
Some highlights of the 2023 PLI Securities Regulation Institute
This year’s PLI Securities Regulation Institute was a source for a lot of useful information and interesting perspectives. Panelists discussed a variety of topics, including climate disclosure (although no one shared any insights into the timing of the SEC’s final rules), proxy season issues, accounting issues, ESG and anti-ESG, and some of the most recent SEC rulemakings, such as pay versus performance, cybersecurity, buybacks and 10b5-1 plans. Some of the panels focused on these recent rulemakings echoed concerns expressed last year about the difficulty and complexity of implementation of these new rules, only this time, we also heard a few panelists questioning the rationale and effectiveness of these new mandates. What was the purpose of all this complication? Was it addressing real problems or just theoretical ones? Are investors really taking the disclosure into account? Is it all for naught? Pay versus performance, for example, was described as “a lot of work,” but, according to one of the program co-chairs, in terms of its impact, a “nothingburger.” (Was “nothingburger” the word of the week?) Aside from the agita over the need to implement the volume of complex rules, a key theme seemed to be the importance of controls and process—the need to have them, follow them and document that you followed them—as well as an intensified focus on cross-functional teams and avoiding silos. In addition, geopolitical uncertainty seems to be affecting just about everything. (For Commissioner Mark Uyeda’s perspective on the rulemaking process presented in his remarks before the Institute, see this PubCo post.) Below are just some of the takeaways, in no particular order.
SEC charges Newell with misleading disclosure and control failures
In this settled action, the SEC charged Newell Brands and its former CEO with providing misleading disclosure about a prominently featured non-GAAP financial measure—“core sales,” a key NGFM that Newell portrayed as providing “a more complete understanding of underlying sales trends.” As described in the Order and press release, Newell and its CEO took a number of actions—reclassifications, accrual reductions, order pull-forwards—that increased “core sales” growth, but the resulting increases “were out of step with Newell’s actual but undisclosed sales trends, allowing the company to announce ‘strong’ or ‘solid’ results in quarters it internally described as disappointing due to shortfalls in sales.” In fact, the SEC charged, Newell misled investors, depriving them of “information relevant to an accurate and complete understanding of Newell’s actual sales trends.” Moreover, in Newell’s effort to manage revenues, what began as tinkering with an NGFM metastasized into problems with GAAP accounting. According to the Associate Director of Enforcement, the SEC found that “Newell’s former CEO issued an instruction to ‘scrub’ the company’s accruals after he learned that the company was projecting a ‘massive’ and ‘disappointing’ miss for the quarter….Senior executives of public companies hold positions of trust, and they risk abusing the duties attendant to their offices when they reach into a company’s accounting control processes as a way of making up for performance shortfalls.” Newell agreed to pay a civil penalty of $12.5 million and its CEO to pay $110,000.
Audit committee oversight of non-GAAP financial measures
According to audit firm PwC, non-GAAP financial measures play an important role in financial reporting, “showing a view of the company’s financial or operational results to supplement what is captured in the financial statements,” and help to tell the company’s financial story, as the SEC has advocated in connection with MD&A, “through the eyes of management.” Yet, they also have the potential to open the proverbial can of worms, subjecting the company to serious SEC scrutiny and possible SEC enforcement if misused. Just a couple of weeks ago, the SEC announced settled charges against DXC Technology Company, a multi-national information technology company, for making misleading disclosures about its non-GAAP financial performance. According to the Order, DXC materially increased its reported non-GAAP net income “by negligently misclassifying tens of millions of dollars of expenses ” and improperly excluding them from its reported non-GAAP earnings. In addition to misclassification, DXC allegedly provided a misleading description of the scope of the expenses included in the company’s non-GAAP adjustment and failed to adopt a non-GAAP policy or to have adequate disclosure controls and procedures in place specific to its non-GAAP financial measures. Consequently, DXC “negligently failed to evaluate the company’s non-GAAP disclosures adequately.” DXC agreed to pay a civil penalty of $8 million. (See this PubCo post.) So what can a company’s audit committee do to help prevent the types of problems that have arisen at DXC and elsewhere? Audit committees may find helpful this recent article from PwC providing guidance for committees tasked with oversight of the use of non-GAAP financial measures.
SEC charges DXC with misleading non-GAAP disclosures and absence of non-GAAP disclosure controls
The SEC has announced settled charges against DXC Technology Company, a multi-national information technology company, for making misleading disclosures about its non-GAAP financial performance in multiple reporting periods from 2018 until early 2020. According to the Order, DXC materially increased its reported non-GAAP net income “by negligently misclassifying tens of millions of dollars of expenses ” as non-GAAP adjustments related to strategic transactions and integration and improperly excluding them from its reported non-GAAP earnings. In addition to misclassification, DXC allegedly failed to accurately describe the scope of the expenses included in the company’s non-GAAP adjustment, with the result that “its non-GAAP net income and non-GAAP diluted EPS in periodic reports and earnings releases were materially misleading.” What’s more, the SEC alleged, DXC’s disclosure committee “negligently failed to evaluate the company’s non-GAAP disclosures adequately,…and failed to implement an appropriate non-GAAP policy” or adequate disclosure controls and procedures specific to its non-GAAP financial measures. Consequently, DXC “negligently failed to evaluate the company’s non-GAAP disclosures adequately.” DXC agreed to pay a civil penalty of $8 million. According to the SEC’s Associate Director of Enforcement, “[i]ssuers that choose to report non-GAAP financial metrics must accurately describe those metrics in their public disclosures….As the order finds, DXC’s informal procedures and controls were not up to the task, and, as a result, investors were repeatedly misled about its non-GAAP financial performance.”
Corp Fin posts revised and new non-GAAP CDIs
The Corp Fin staff has issued a group of revised and new compliance & disclosure interpretations on the use of non-GAAP financial measures. The CDIs are more detailed and expansive in describing disclosure that the staff considers to be misleading as well as presentations that the staff believes reflect excessive non-GAAP prominence over the comparable GAAP number under Reg S-K Item 10(e). Summaries are below.
Happy Holidays!
SEC staff takes issue with widely used pharma non-GAAP financial measure
Pharmas, biotechs and others may want to take notice—if they haven’t already—of a series of SEC comment letters to global biopharmaceutical company, Biogen, about one of the company’s non-GAAP financial measures. More specifically, in 2021, the SEC staff objected to the company’s exclusion from non-GAAP R&D and non-GAAP net income of material upfront and premium payments made in connection with collaboration agreements. In the end, Biogen agreed to discontinue these adjustments going forward and to recast prior period information. As reported in this article in MarketWatch, this year a number of biopharmas have taken a lesson from the exchange between Biogen and the SEC staff and have included language in their earnings releases explaining similar changes in practice, following guidance from the SEC staff, regarding exclusion of upfront payments from non-GAAP R&D. Moreover, the article indicated, the impact of the changes was “not insignificant,” leading, in one example, to a change of $0.15 in EPS for a single quarter.
Is there a resurgence in the use of non-GAAP financial measures?
In 2016 and early 2017, the SEC made a big push—through a series of staff oral admonitions and written guidance, as well as an enforcement action—to require issuers to be more transparent and more consistent in the use of non-GAAP financial measures and to avoid altogether non-GAAP measures that were misleading. In May 2016, the Corp Fin chief accountant, as reported in CFO.com, cautioned companies in neon lights that, with regard to non-GAAP financial measures, “[f]or lack of a better way to say it, we are going to crack down.” (See, e.g., this PubCo post and this PubCo post.) By early 2017, the SEC staff were apparently sufficiently satisfied (see this PubCo post) with the responses to their campaign that the pendulum swung back, and the relentless finger-wagging by the staff about non-GAAP financial measures appeared to have tailed off. (See this PubCo post.) And, according to this analysis from Audit Analytics, in 2018, SEC staff comments regarding non-GAAP financial measures actually began to decline. But, MarketWatch has reported, with the onset of COVID-19, there seems to have been something of a resurgence in the use of non-GAAP measures. Will we see another crackdown?
Auditors address non-GAAP financial measures in the context of COVID-19
Is EBITDAC a thing? Yes, according to the FT. This article describes the use of a new non-GAAP metric: “earnings before interest, tax, depreciation, amortisation—and coronavirus.” Applying the new metric, a few companies have actually added back profits they contend they would have earned but for the mandatory lockdowns resulting from COVID-19. Hmmm. While, according to the article, the add-back has “bemused some observers,” it does raise the question: how should companies employ non-GAAP financial measures (NGFMs) in the context of COVID-19? How should audit committees conduct oversight of the use of NGFMs that have been adjusted for coronavirus-related effects? Auditors weigh in.
Corp Fin issues Disclosure Guidance: Topic No. 9 Coronavirus (COVID-19)
Today, the staff of Corp Fin issued Disclosure Guidance Topic No. 9, which offers the staff’s views regarding disclosure considerations, trading on material inside information and reporting financial results in the context of COVID-19 and related uncertainties. The guidance includes a valuable series of questions designed to help companies assess, and to stimulate effective disclosure regarding, the impact of the coronavirus. As always these days, the guidance makes clear that it represents only the views of the staff, is not binding and has no legal force or effect.
Secret sauce, sausages and cookie jars…
No, it’s not an episode of Top Chef, but it is about “cooking the books.” And those are just some of the ingredients and tools used by Brixmor Property Group, a publicly traded REIT, and four of its executives to do the cooking: manipulation of a key non-GAAP financial measure, according to this SEC complaint and order and, even more to the point, this SDNY criminal indictment of the executives. As alleged, management sought to create the impression that a static pool of its existing properties showed steady and predictable income growth across a number of quarters. In contrast, however, Brixmor’s actual income growth rate was “volatile and frequently fell above or below the company’s publically issued guidance range” for the period. So, according to the order, the company architected the desired illusion—touted as its “secret sauce”—by engaging in some “sausage-making” with regular hits to the “cookie jar.” While it doesn’t sound very appetizing, it did create the desired deception—until, of course, it didn’t. The lesson is that manipulation of a non-GAAP measure, together with violations of GAAP, to mislead the public can be trouble—and perhaps even criminal. Although cases of accounting fraud may not be as common as they once were, this case should serve as a reminder that the SEC and the Justice Department are still on the lookout for it.
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