On March 14, 2023, the Securities and Exchange Commission (SEC) instituted cease-and-desist proceedings against DXC Technology Company (DXC) for alleged violations of Regulation G and other federal securities laws in its reporting of certain non-GAAP adjustments. To settle the proceedings, DXC agreed, among other things, to (i) cease and desist from future violations of federal securities laws, (ii) develop and implement policies and disclosure controls and procedures for non-GAAP measures, and (iii) pay an $8 million penalty. The action is the latest example of the SEC’s ongoing focus on non-GAAP measures.
What Happened?
DXC was formed in 2017 through the merger of Computer Sciences Corporation and the Enterprise Services business of Hewlett Packard Enterprise Company. Following the merger, DXC included in its periodic reports a variety of non-GAAP measures that excluded certain transaction, separation, and integration (TSI) expenses related to the merger and other M&A activity. Such exclusions—particularly around M&A activity—are relatively common based on the theory that excluding these types of non-recurring expenses better enables investors to evaluate a company’s core operating performance on a period-over-period basis.
The SEC found that DXC failed to properly implement a non-GAAP policy or adequate disclosure controls and procedures for its non-GAAP financial measures. According to the SEC, DXC “had no process by which its employees evaluated whether proposed TSI costs were consistent with the description of TSI costs included in its non-GAAP disclosure.” Instead, DXC relied on an informal process where DXC’s Financial Planning & Analysis group (FP&A), which had responsibility for the initial approval of the classification of expenses that were proposed by DXC’s business units as potential TSI costs, did not require the business units to document: (i) the basis on which a proposed expense might be classified as a TSI cost; (ii) how the expense related to a transaction or integration project; or (iii) the expected amount or duration of the cost. FP&A also did not consistently document the reason for its own approvals of TSI cost classification and did not annually reassess if such classifications were appropriate. In addition, although DXC’s controller circulated multiple draft policies on non-GAAP reporting, no policy was ever approved or adopted, and employees were not given formal training or guidance on classifying TSI costs. The SEC alleged that, on multiple occasions, members of the controller’s office questioned the classification of certain costs as TSI costs and requested supporting documentation, but such documentation was never provided or was incomplete or inaccurate.
According to the SEC, DXC’s disclosure controls and procedures deficiencies resulted in DXC making materially misleading statements by negligently misclassifying certain expenses as TSI costs. For example, for a period of six consecutive quarters, DXC included over $38 million of expenses related to relocating operations at a data center as TSI costs, even though the need to relocate was not dependent on the merger or any other M&A activity. And in a later report, DXC classified certain audit and accounting costs and litigation settlement amounts as TSI costs, even though these costs were inconsistent with DXC’s public disclosure of TSI costs. The SEC found that these misclassifications led to an overstatement of DXC’s non-GAAP net income for three quarters by at least $29 million, $30 million, and $24 million, respectively. Importantly, the SEC noted that DXC recognized that “the non-GAAP measures were material because they allowed investors to better understand the core performance of the company,” and that therefore “[r]easonable investors would have considered the foregoing information to have been material in deciding whether to purchase DXC securities.”
Without admitting or denying the findings in the SEC’s order, DXC agreed to a cease-and-desist order, to pay an $8 million penalty, and to develop and implement appropriate non-GAAP policies and disclosure controls and procedures.
What Were the Violations?
The SEC charged DXC with violations of (i) Section 17(a)(2) of the Securities Act of 1933 (the Securities Act), which prohibits issuers from selling securities by means of an untrue statement of material fact or misleading omission; (ii) Section 17(a)(3) of the Securities Act, which prohibits issuers from engaging in any transaction that operates as a fraud upon the purchaser; (iii) Rules 13a-1, 13a-11, 13a-13 and 12b-20 of Section 13(a) of the Exchange Act of 1934 (the Exchange Act), which require issuers to file periodic reports with material information necessary to make the required statements not misleading; (iv) Rule 13a-15(a) of the Exchange Act, which required issuers to maintain disclosure controls and procedures; and (v) Rule 100(b) of Regulation G, which prohibits issuers from making public non-GAAP financial measures that contain untrue statements of material fact or omit to state a material fact necessary to make the presentation of the information not misleading.
What Are the Takeaways?
In December 2022, the SEC’s staff issued fresh guidance on the presentation of non-GAAP financial measures indicating that certain non-GAAP measures may be materially misleading to investors even when presented with explanatory disclosure. The SEC’s action in this case demonstrates the SEC’s continuing focus on non-GAAP measures and the related disclosures, as well as the importance of disclosure controls and procedures in this area.
The case also underscores that the SEC may even consider language explaining why management discloses non-GAAP information as an acknowledgement that the non-GAAP disclosure is inherently material to investors. As such, companies should take care to ensure that non-GAAP measures are properly used and presented and are described accurately in their periodic reports and public statements. Just as with GAAP reporting, companies should have disclosure controls and procedures for non-GAAP measures. Finally, companies should regularly review their non-GAAP measures and each of the component adjustments to ensure that they are accurate, consistent with the company’s description of the measures, up-to-date and in compliance with the SEC’s disclosure rules.
