Increasingly used by REITs, non-GAAP metrics can provide insights into a company’s operating results that official GAAP metrics cannot. Such measures can demonstrate a company’s ability to deliver sustainable growth in earnings. Non-GAAP metrics can help investors better understand their investments. Consequently, nearly all large public companies (over 97% according to one report) include non-GAAP metrics in their financial statements. At the same time, given the lack of uniformity in calculations, these metrics can also potentially paint an inaccurate picture of a company’s performance and are susceptible to abuse. Specifically, the use of non-GAAP metrics by former executives of the New York-based REIT, Brixmor Property Group Inc. (the “Company”), provides an example.

On December 23, 2015, one of the Company’s employees submitted an anonymous complaint to the Audit Committee, accusing certain executives of directing the accounting team to manage the Company’s earnings through an internal ledger account, where extra income was improperly held for future use. After an internal investigation, the Company’s board concluded that certain accounting and financial reporting personnel had “smoothed” income items, both gains and losses, to show consistent quarterly same property net operating income (“SP-NOI”) growth. The calculation of SP-NOI reportedly stripped out revenues and costs that former executives deemed less relevant to the Company’s performance, such as lease termination payments. However, the investigation revealed that such “excluded” income was included in the calculation at times to conceal volatility in the Company’s earnings performance. Internally, former executives of the Company tried to cover up the deception. According to a subsequently filed indictment, when one investor relations employee inquired about the removal of certain properties from a same-property pool to reduce income from a prior comparative period, the Company’s former CFO reportedly asked “How did she find out? She must not be given access to how we make the sausage.”

Following the investigation, the Company self-reported its findings to the SEC and filed a Form 8-K on February 8, 2016, disclosing the results. According to the SEC, the Company’s SP-NOI growth rate in one quarter in 2014 was overstated by 50%, a fluctuation that even diligent investors and analysts were unaware of. By underreporting income in “up times” and overreporting income in “down times,” former executives of the Company were able to show consistent growth that attracted investors wary of market fluctuations after 2008. The first trading day following the disclosure, the Company lost around $1.6 billion in market valuation. Subsequently, the Company paid $7 million in a civil settlement with the SEC. The Company has since (i) replaced its management group, including its former CEO and CFO who have since been charged by a grand jury indictment with criminal securities fraud, conspiracy to commit fraud, and making false statements in federal securities filings, and (ii) hired an outside consultant to review its policies to ensure the accuracy of its financial reporting.

This story provides some important takeaways that are relevant to all publicly-traded REITs:

• The SEC is more closely scrutinizing non-GAAP metrics in financial statements. While extreme, the story above is just one example. Just last year, the SEC warned that it may further intensify enforcement efforts to better protect investors.
• Though garnering less publicity than a sensational coverup story, even ethical, well-intentioned executives can run into trouble with non-GAAP measures. In the first half of 2018, 22% of SEC comments on non-GAAP measures related to the “undue prominence” rule (i.e., an SEC requirement that an issuer that includes non-GAAP measures in SEC filings must present, with equal or greater prominence, the most directly comparable financial measures calculated in accordance with GAAP). At the end of last year, one issuer reached a $100,000 civil settlement after running afoul of the undue prominence rule – despite the fact that the issuer otherwise was not found guilty of misleading investors or inconsistently applying the metric.
• REIT audit committees should stay current on financial reporting requirements, which are continually evolving. As the New York SEC regional director Marc Berger stated, “A company that chooses to publicly present non-GAAP financial measures must do so truthfully.” That starts with a knowledgeable and attentive audit committee, ready to question management decisions when necessary.
• Consistency in presentation period-over-period remains a key substantive point in presenting non-GAAP information.