The SEC’s Division of Corporation Finance last issued a major update to the Division’s guidance on non-GAAP financial measures in 2016. In the months following that update, SEC staff commented extensively via the filing review process on how companies were complying (or not complying) with the updated Compliance and Disclosure Interpretations (C&DIs). Then, as now, SEC staff were concerned about whether companies were presenting non-GAAP measures in a manner that is more prominent than the most directly comparable GAAP financial measures. The Division’s December 2022 update attempts to further clarify how non-GAAP financial measures must be presented in order that they are not potentially misleading to investors.
By way of background, the latest non-GAAP financial measure C&DIs include four entirely new C&DIs, but also revise three existing C&DIs. The old versions of the revised C&DIs, i.e., Questions 100.01, 100.04, and 102.10, may be compared to the new versions by linking to the following PDFs (Section 100. General; Section 102. Item 10(e) of Regulation S-K).
General considerations for non-GAAP measures. The first set of new and revised non-GAAP financial measure C&DIs addresses topics of general interest. Here, SEC staff has attempted to clarify and expand the guidance available regarding adjustments that are not explicitly prohibited, the role of recognition and measurement principles, the use of labels and other descriptions, and the making of disclosures to avoid misleading investors with a non-GAAP measure.
- Question 100.01—The revised question reiterates prior guidance that “presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading.” The revised C&DI, however, explains that the analysis of when such measures are misleading is a facts and circumstances determination. The revision also noted that SEC staff consider the nature and effect of a non-GAAP measure adjustment in the context of a company’s operations, revenues, business strategy, industry, and regulatory environment when determining if an item is a normal operating expense. Moreover, the revised C&DI states that an operating expense would be “recurring” if it happens “repeatedly or occasionally, including at irregular intervals.”
- Question 100.04—According to the revised question, earlier guidance that would find an adjustment is improperly tailored because it would “accelerate revenue recognized ratably over time” remains valid. The revised C&DI further clarifies the reasoning for why such measures could be misleading: “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.”
- Question 100.05—This new C&DI addresses whether a non-GAAP measure that is not appropriately labeled or described can be misleading. Thus: “Without an appropriate label and clear description, a non-GAAP measure and/or any adjustment made to arrive at that measure could be misleading to investors.” The C&DI offers several specific examples of potentially misleading non-GAAP measures, but these examples fall into two broader categories: (1) those that fail to label a non-GAAP measure as a non-GAAP measure; and (2) those that are labeled in a manner that does not accurately reflect the nature of the non-GAAP measure.
- Question 100.06—This new C&DI considers whether fulsome disclosure about a non-GAAP measure can avoid the situation in which the non-GAAP measure would nevertheless be misleading. According to the C&DI: “It is the staff’s view that a non-GAAP measure could mislead investors to such a degree that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent the non-GAAP measure from being materially misleading.”
- Question 102.10(a)—New Question 102.10(a), formerly Question 102.10, contains most of the same examples that appeared in the former question, although phrased slightly differently, regarding when a non-GAAP measure would be presented in a manner that is more prominent than the most directly comparable GAAP measure for purposes of Item 10(e)(1)(i)(A) of Regulation S-K. However, the new variant of the staff guidance includes a new example of when a non-GAAP measure would be more prominent than the most directly comparable GAAP measure: “Presenting a ratio where a non-GAAP financial 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.”
- Question 102.10(b)—New Question 102.10(b) contains examples of disclosures that would cause the non-GAAP reconciliation required by Item 10(e)(1)(i)(B) of Regulation S-K to give undue prominence to a non-GAAP measure. These examples include: (1) a reconciliation that begins with a non-GAAP measure; (2) the presentation of a non-GAAP income statement when making the reconciliation (but see new Question 102.10(c) for a definition of “non-GAAP income statement”); and (3) presenting a non-GAAP measure eligible for an exception contained in Item 10(e)(1)(i)(B) without also, among other things, disclosing reliance on the exception.
- Question 102.10(c)—This last new question asks what is a non-GAAP income statement? The answer: “[t]he staff considers 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.”