On March 14, 2023, the Securities and Exchange Commission (“SEC”) issued a cease-and-desist order (the “Order”)1 and charged DXC Technology Company (“DXC”), an IT company based in Virginia, with violations of Rule 100(b) of Regulation G and various other securities laws based on material misstatements in DXC’s non-GAAP financial measures reported in its earnings releases and annual and quarterly reports. The SEC concluded that DXC’s misclassification of costs resulted in the improper exclusion of tens of millions of dollars of expenses in DXC’s reporting of non-GAAP financial measures, thus materially overstating DXC’s non-GAAP net income for several periods. The SEC also concluded that DXC did not have adequate controls around its use of non-GAAP financial measures. The Order reflects the SEC’s increasing scrutiny of non-GAAP financial measures and provides issuers with insight into best practices with respect to internal controls and procedures related to non-GAAP financial measures.
DXC’s Non-GAAP Reporting Procedures
Non-GAAP financial measures are numerical measures of a company’s historical or future financial performance, financial position, or cash flows that exclude or include amounts, or are subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as applicable, in the most directly comparable measure calculated and presented in accordance with Generally Accepted Accounting Principles (“GAAP”).2 Many issuers include non-GAAP financial measures, such as earnings before interest, taxes, depreciation, and amortization (“EBITDA”), in their public filings to provide additional insight into their financial results and to adjust for irregular or non-recurring events.
Like many issuers, DXC chose to report non-GAAP financial measures in its earnings releases and annual and quarterly reports filed with the SEC, including net income and diluted earnings per share (“EPS”). DXC also disclosed to shareholders that it excluded transaction, separation, and integration-related (“TSI”) costs from its non-GAAP financial measures. DXC described TSI costs as those “‘related to integration planning, financing, and advisory fees associated with’ the merger that formed DXC, other acquisitions, and the spin-off of a business.”3
However, internally, DXC did not have a non-GAAP policy in place or adequate disclosure controls and procedures related to its non-GAAP financial measures. In particular, DXC lacked formal guidance for classifying costs as TSI costs or sufficient processes to ensure that costs classified as TSI were, in fact, consistent with DXC’s description of TSI costs in its public disclosures. Instead, the classification of a TSI cost was largely left to employees’ subjective determinations as to whether expenses were related to an actual or contemplated transaction, and DXC’s controllership did not, and arguably could not, effectively review the purported TSI costs because of the large quantity of TSI cost line items, lack of information about the costs, and limited time. The former Assistant Corporate Controller for External Reporting of DXC had expressed concern about the lack of supporting documentation for the TSI costs in response to the company’s quarterly sub‑certification survey on multiple occasions, but these concerns went unaddressed.
As a result, DXC included many costs as TSI costs that were inconsistent with DXC’s description of TSI costs in its public filings. For instance, in six consecutive quarters DXC categorized over $38 million of expenses related to relocating to a new data center as TSI costs. Although the relocation involved two companies that merged to create DXC, the relocation was related to the landlord’s refusal to renew the lease, not the merger. Thus, this expense, like many others, was improperly categorized as a TSI cost, leading to non-GAAP net income being overstated by at least $29 million, $30 million, and $24 million in the second and fourth quarters of 2019 and the first quarter of 2020, respectively.
The SEC Order
The SEC concluded that these misstatements were material to investors, noting that “the company recognized that the non-GAAP measures were material because they allowed investors to better understand the core performance of the company.”4 Accordingly, the SEC concluded that DXC’s negligent misclassification of TSI costs and the resulting misleading non-GAAP measures constituted a violation of Rule 100(b) of Regulation G of the Exchange Act. Rule 100(b) prohibits a registrant from making an untrue statement of material fact or an omission of a material fact in a public non-GAAP financial measure such that it is misleading. The SEC also found that DXC violated Securities Act of 1933 (“Securities Act”) Section 17(a)(2), which prohibits the offer or sale of securities by means of untrue or misleading statements; Securities Act Section 17(a)(3), which prohibits fraud or deceit upon the purchaser of securities; Securities Exchange Act of 1934 (“Exchange Act”) Section 13(a) and various rules thereunder, which prohibit misleading statements in periodic reports to the SEC; and Exchange Act Rule 13a-15(a), which mandates that every issuer maintain disclosure controls and procedures.
The SEC recognized that DXC undertook remedial measures, such as “reviewing and supplementing its procedures concerning non-GAAP adjustments and reporting,” “proactively enhancing its disclosures of TSI costs[,]” “reduc[ing] the volume of its TSI costs in more recent quarters[,]” and “replac[ing] nearly all of its senior executive and financial leadership personnel who were present during the relevant period.”5
In addition to these remedial measures, the SEC ordered DXC to develop and implement policies and disclosure controls and procedures:
- For the disclosure of its non-GAAP financial performance;
- For the disclosure committee, or another charged committee, to periodically review and document DXC’s non-GAAP policy to assess consistency between its non-GAAP disclosures and its publicly reported non-GAAP financial performance measures;
- For the controllership staff to approve and document the classification of items included in non-GAAP adjustments; and
- For the timely review and remedy of negative sub-certification survey comments relating to GAAP and non-GAAP financial results or disclosures or that may impact Management’s Discussion and Analysis of Operations.
DXC agreed to pay an $8,000,000 civil penalty in settlement.
What Does the SEC’s Order Mean for You?
The SEC’s Order demonstrates its continued scrutiny of non-GAAP financial measures. Issuers that choose to report non-GAAP financial measures should create and adhere to formal policies, procedures, and controls for non‑GAAP reporting, including with respect to compliance with SEC rules and guidance and ensuring consistent and accurate presentation of non-GAAP measures across periods. These policies and procedures should be reviewed periodically by the disclosure committee or another designated committee.
In particular, the undertakings ordered by the SEC provide some insight into the sorts of internal controls and procedures the SEC may find beneficial with respect to non-GAAP financial measures.
For example, issuers should ensure that their review and approval process for non-GAAP adjustments includes a review of the descriptions of non-GAAP financial measures in their public filings and ensures that the adjustments are appropriately described and still accurate. Additionally, issuers should clarify roles and responsibilities among the various levels of review of non-GAAP adjustments and require supporting documentation for decisions made at each level of review. This is particularly important to ensure consistency when adjustments to non-GAAP measures may be reported by multiple business or reporting lines. Issuers should also establish a process for timely review, consideration, and resolution of negative sub-certification comments, including by reviewers that are familiar with both the company’s financial statements and with the SEC’s rules for presentation of non-GAAP financial measures.
1 DXC Technology Co., Securities Act Release No. 111,666, Exchange Act Release No. 97,140 (Mar. 14, 2023).
2 Conditions for Use of Non-GAAP Financial Measures, Release No. 33-8176, File No. S7-43-02, https://www.sec.gov/rules/final/33-8176.htm (last updated Jan. 24, 2002).
3 Supra note 1, at ¶ 1.
4 Id. at ¶ 25.
5 Id. at ¶ 36.
