Failure to present GAAP financial measures “with equal or greater prominence” to non-GAAP measures results in cease-and-desist order and civil fine

Takeaways

• The SEC continues to focus on noncompliant use of non-GAAP financial measures, including in earnings releases.
• This action is the first concerning the requirement that comparable GAAP financial measures be presented with equal or greater prominence with non-GAAP financial measures.
• Reporting companies should continue to carefully review their use of non-GAAP financial measures, including in earnings releases, to confirm full compliance with Regulation G and Item 10(e) of Regulation S-K.

The SEC has adopted several rules and regulations governing the use of non-GAAP financial information in public disclosures. Regulation G applies to all public disclosures by reporting companies that contain non-GAAP measures. Item 10(e) of Regulation S-K applies to non-GAAP financial measures included in filings with the SEC. Both Regulation G and Item 10(e) of Regulation S-K require that any non-GAAP financial measures be accompanied by a presentation of the most directly comparable GAAP financial measure and a reconciliation of the differences between such measures. In addition, Item 10(e)(i)(A) of Regulation S-K requires that the most directly comparable GAAP financial measure must be presented with “equal or greater prominence” to the non-GAAP measure. Item 10(e) of Regulation S-K also requires, in certain filings, disclosure of the reasons why the company’s management believes that such non-GAAP financial measures provide useful information to investors and any additional purpose for providing such measures.

The use of non-GAAP financial measures has dramatically increased in recent years and, in response, the SEC has demonstrated renewed interest in the use and presentation of these measures by reporting companies. In May 2016, the SEC issued a number of Compliance & Disclosure Interpretations (C&DIs) addressing the use of non-GAAP financial measures in a manner that could potentially mislead investors. The C&DIs included a list of examples of circumstances in which the SEC would consider disclosure of non-GAAP measures to be more prominent than GAAP measures. Notably, “omitting comparable GAAP measures from an earnings release headline or caption that included non-GAAP measures” and “a non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption)” were among the list of examples. Since 2016, non-GAAP disclosures have been one of the most frequent areas of focus in comment letters issued by the SEC. Enforcement actions, however, have been relatively rare.

The ADT Enforcement Action
In ADT, the SEC found that ADT disclosed non-GAAP financial measures in two recently filed earnings releases without giving equal or greater prominence to comparable GAAP financial measures. Specifically, ADT presented adjusted EBITDA in the headline of its 2017 fiscal year end earnings release and adjusted EBITDA, adjusted net income and adjusted net income per share in the highlights of its 2018 first quarter earnings release without mentioning the comparable GAAP financial measures. Instead, ADT reported the comparable GAAP financial measures several paragraphs later. The SEC found ADT’s conduct to be a clear violation of Item 10(e) of Regulation S-K, which in part provides that whenever a non-GAAP financial measure is included in a filing with the SEC, the registrant must include a presentation, with equal or greater prominence, of the most directly comparable GAAP financial measure.

This is the first enforcement action concerning the disclosure of non-GAAP financial measures where the SEC found a violation of Section 13(a) of the Exchange Act without an accompanying finding that the registrant’s disclosure also constituted a material misstatement or omission. The ADT case is a departure from past practice of using comments letters to address technical violations in the use of non-GAAP financial measures, and is an indication that, in appropriate cases, the SEC is prepared to bring enforcement actions against reporting companies over noncompliant disclosures of non-GAAP financial measures. In light of the ADT order, reporting companies should continue to carefully review their use of non-GAAP financial measures in all public disclosure, including in headlines and highlights of earnings releases, to confirm full compliance with Regulation G and Item 10(e) of Regulation S-K.

To access the SEC’s final order In the Matter of ADT Inc., please click here.