Blog: Are “Other Key Operating Metrics” The New Non-GAAP Financial Measures?

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As reported by BNA, the top accounting staff at the SEC are quite satisfied with companies’ responses to the SEC’s assault on abuses of non-GAAP financial measures. The staff’s concern was that companies’ reporting was often inappropriately painting, through the use of non-GAAP measures, healthier-than-justified pictures of companies’ performance, potentially misleading investors.  In response, the staff mounted a campaign against the non-GAAP practices that the staff viewed as abusive. At a 2017 Baruch College Financial Reporting Conference, Mark Kronforst, chief accountant at Corp Fin,  discussing the SEC’s effort, concluded  that “I have to say, I think it was a success.” Wesley Bricker, SEC chief accountant, concurred. Is the SEC now applying that same strategy to other reporting metrics?

The SEC began wagging its finger in earnest about non-GAAP information back its 2015, when, at an AICPA national conference, then-SEC Chair Mary Jo White emphasized the need to ensure that the rules on non-GAAP financial measures were being followed and that they were “sufficiently robust in light of current market practices. By some indications, such as analyst coverage and press commentary, non-GAAP measures are used extensively and, in some instances, may be a source of confusion.” (See this PubCo post.) Subsequently, the SEC and staff (Whitethen-Chief Accountant James Schnurrthen-Corp Fin Director Keith Higgins) barnstormed the country, admonishing companies about abuses of non-GAAP measures. White also hinted at the possibility of future rulemaking (see this PubCo post).  In addition, the head of the SEC’s Financial Reporting and Audit Task Force indicated that the SEC was looking at the use of these non-GAAP measures “with an eye toward possible enforcement cases.”  (See this PubCo post.). And then, in remarks to the Baruch College Financial Reporting Conference a year ago, then-SEC Deputy Chief Accountant Bricker took the baton, reiterating and extending these admonitions about non-GAAP practices the staff considered to be dodgy and observing that the staff had issued a number of comments to companies objecting to the use of, or disclosures regarding, non-GAAP measures.  Speaking at the same conference, Kronforst outlined that admonition in neon lights, cautioning 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 this PubCo post.) Not long afterwards, Corp Fin issued some new and revised CDIs regarding the use of non-GAAP measures and then, Kronforst indicated, “waited for a quarterly reporting period for the guidance to take hold.” (See this PubCo post.)

Apparently, the staff now believe that that strategy worked well.  (See also this PubCo post.) BNA reported that “Kronforst credited companies for heeding the SEC’s message on non-GAAP measures, which sometimes was conveyed in comment letters sent to the enterprises. Kronforst said that a key part of the success of the commission’s campaign was to ensure that ‘companies took the initiative to make changes on their own.’”

Now the SEC accounting staff may be borrowing from that playbook to address another potentially problematic issue.  Analogizing to non-GAAP financial measures, Chief Accountant Bricker, in his remarks before the Financial Reporting Conference this year, took on companies’ disclosures regarding other “key operating metrics, forecasts, and other kinds of reporting, which may represent important sources of information for investors and supplement the information provided by GAAP.” Is this the beginning of a new campaign?

Bricker first expressed his belief that “much of the recent experience with non-GAAP financial metrics also provides lessons for other kinds of reporting by companies.  Similar to non-GAAP financial reporting, key operating metrics and forecasts may also be distorted via bias – for example, painting a potentially misleading picture – error, or fraud, all of which undermine the credibility of the reporting.  Therefore, it is important that companies proactively and thoughtfully address risks to their reporting.”

According to Bricker, companies should begin by getting a handle on the other information that is being reported, particularly the definitions of the key operating metrics. Next, companies need to assess the adequacy of disclosure controls and procedures surrounding these metrics. But determining the correct reporting in this case may actually be more difficult than for non-GAAP measures precisely because there may well be no established measures, like GAAP, against which to compare. “In some respects,” Bricker advised, “these other reporting processes may require more steps than some GAAP processes, not fewer.  This is because, for example, a company’s other reporting does not have the benefit of standard-setting due process, which solicits stakeholder views on a representationally faithful manner of reporting a particular event or transaction and the types of disclosures needed by financial statement users.  When a company determines a supplemental reporting framework, it does not have the benefit of a standard setter’s due process and must look to its own policies, audit committee, and other stakeholders for input.”  Finally, Bricker suggested that companies consult with persons outside of the finance and investor relations functions for their insights into the other reporting processes: “Sometimes a fresh perspective can provide new insight into potential risks and ways to maintain the effective operation of essential controls and procedures.”

SideBar: In a separate article regarding the same Conference, BNA also reported PCAOB member Jeanette M. Franzel said that the PCAOB “is ‘pretty much ready to go’” with the new auditor reporting standard that would require accountants’ audit reports to disclose “critical audit matters,” that is, any matters that were communicated, or required to be communicated, to the audit committee and that related to accounts or disclosures that were material to the financial statements and involved especially challenging, subjective or complex auditor judgments. However, she said that the PCAOB would not release the new rule before briefing new SEC Chair Jay Clayton, who was sworn in on May 4.  (See this PubCo post.)

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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