On December 13, 2022, the Securities and Exchange Commission (SEC) issued seven new or revised Compliance and Disclosure Interpretations (C&DIs) on topics regarding the use of non-GAAP financial measures in SEC filings. Typically, the release of C&DIs, whether new or revised, indicates that a certain subject will be an area of heightened focus in SEC comment letters and enforcement actions.
A June 2023 study published by MyLogIQ, LLC (the Study) revealed that, between January 2022 and May 2023, the following non-GAAP issues were the areas about which the SEC most frequently issued comment letters: (1) prominence of non-GAAP measures, (2) normal, recurring, cash operating expenses and (3) individually tailored accounting measures.
The non-GAAP issue that received the most focus was the prominence of non-GAAP measures in SEC filings and earnings releases furnished to the SEC; it made up approximately 33% of all non-GAAP-related comment letters during the period covered by the Study.
In its response to Question 102.10(a) in the Non-GAAP Financial Measures CD&I (the Non-GAAP CD&I), the SEC stated that, when presenting non-GAAP financial measures, issuers must present the most directly comparable GAAP measure with equal or greater prominence. A review of recent comment letters indicates that the SEC focuses on (1) the order in which GAAP and non-GAAP measures are presented and (2) the depth at which each is analyzed.
Issuers should be sure to present GAAP measures immediately prior to presenting any non-GAAP measures in SEC filings and earnings releases.
A common mistake, frequently commented upon by the SEC is not sufficiently addressing GAAP measures in the headlines or bullets of an earnings release, such as presenting a non-GAAP metric (e.g., Adjusted EBITDA), prior to the corresponding GAAP metric, net income. To that end, issuers should ensure that non-GAAP measures are not more prominent than the corresponding GAAP measurement (e.g., using the same size font or typeface).
The second most commented upon issue was the topic of normal, recurring, cash operating expenses; it accounted for approximately 20% of all non-GAAP comment letters during the period analyzed in the Study. In its response to Question 100.01 in the Non-GAAP CD&I, the SEC clarified that the presentation of non-GAAP financial measures that exclude “normal, recurring, cash operating expenses” may be misleading to investors. In performing its analysis, the SEC considers “the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry and regulatory environment.”
Whether an expense is deemed normal and incurred in the ordinary course is scrutinized on a case-by-case basis. Recent comment letters show that the SEC will analyze a current filing or release against an issuer’s prior filings to determine whether an expense is recurring. The SEC has recently objected to a number of adjustments, including the following: (1) the cost of being a public company beyond initial public offering expense; (2) the cost of acquired in-process research and development assets, or upfront and contingent milestone payments for research and development arrangements, for pharmaceutical companies; (3) store pre-opening, opening, relocation and closing costs for retail companies; and (4) rent expense for retail, airline and gaming companies. Thus, issuers should consider whether any normal, recurring, cash operating expenses have been used to adjust non-GAAP measures in past disclosures and avoid adjusting non-GAAP measures for normal, recurring expenses in future filings.
The last most popular non-GAAP topic in SEC comment letters was individually tailored accounting measures; this topic accounted for approximately 16% of all non-GAAP comment letters during the period measured by the Study. In its response to Question 100.04 in the Non-GAAP CD&I, the SEC noted 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.”
According to the SEC, no amount of disclosure can overcome the determination that individually tailored accounting measures are misleading. Recent SEC comment letters indicate that the SEC will analyze an individual registrant’s inclusions and exclusions from revenue and other measures to determine whether an issuer’s accounting method is generally applicable or individually tailored. Some examples of individually tailored accounting principles that the SEC has recently objected to include (1) excluding the effect of a new accounting standard; (2) adjusting fair value recorded in purchase accounting; (3) normalizing the effective tax rate for an adjustment; (4) accelerating the recognition of deferred revenue or adding back lost revenue; (5) changing an item from an accrual to cash basis or from gross to net tax; and (6) deconsolidating one or more consolidated entities. Thus, issuers should focus on including metrics required by GAAP principles and favor excluding metrics that may be deemed individually tailored to their own financials.
The Non-GAAP CD&I may be found at this link.
Additional author: Justin Hay
