As covered in our last Hogan Lovells REIT team SEC update, the SEC staff recently revised its non-GAAP financial measures Compliance & Disclosure Interpretations (C&DIs). The revisions have raised concerns in the REIT sector that the new guidance may signal a change in the SEC staff’s permissive approach to certain common REIT non-GAAP disclosure practices, including:

• backing G&A expenses out of property NOI (in revised C&DI 100.01, the SEC staff states that performance measures that exclude “normal, recurring, cash operating expenses necessary to operate a registrant’s business” could be misleading);
• adjusting AFFO and property NOI for GAAP rent straight-lining (in revised C&DI 100.04, the SEC staff states that adjustments that “[change] the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis” could be misleading);
• presenting an FFO-based dividend coverage ratio without presentation of the GAAP equivalent ratio (in revised C&DI 102.10, the SEC staff takes the position that disclosing a non-GAAP based ratio without disclosing as prominently the GAAP-equivalent ratio violates Item 10(e) of Regulation S-K); and
• presenting an EBITDA-based credit ratio without presentation of the GAAP equivalent ratio (same issue).

On January 11, 2023, we had a call with senior members of the Division of Corporation Finance, including from the Office of the Chief Accountant and the operations group that reviews REIT filings, to discuss with them whether the C&DIs are likely to result in changes to the SEC staff’s historical approach to the disclosures listed above. Senior officials from Nareit participated in the call.

We reviewed with the SEC staff the four non-GAAP measures listed above and reminded them why REITs believe they are useful to REIT analysts and investors. With respect to the non-GAAP dividend coverage and credit ratios, we noted that the equivalent net income-based ratios would be meaningless and likely confusing to investors. We also reminded the SEC staff that these disclosures have generally been respected by the SEC staff for many years (although importantly, the SEC staff in some cases has objected to EBITDA-based credit ratios on prominence grounds).

In response, and as expected, the SEC staff advised that they cannot opine on specific disclosures outside the context of an actual filing, since the particular facts and circumstances of the registrant and its disclosures would need to be considered. However, they reiterated the message delivered by the Chief Accountant of CF-OCA (Lindsay McCord) at the recent AICPA conference that the intent of the C&DI updates is to memorialize views the SEC staff has already communicated in speeches and through the comment letter process since the 2016 C&DI updates. They advised that the C&DIs are not intended to change the SEC staff’s approach to non-GAAP adjustments that they have historically not objected to. They also advised that the primary focus for the SEC staff on non-GAAP measures is on whether, taking into account the particular facts and circumstances of the registrant, its business and the adjustment(s) made to compute the measure, the non-GAAP measure is misleading.

The SEC staff’s helpful feedback on this call provides some comfort for REITs that the 2023 SEC staff 10-K review season should not result in significant changes to the SEC staff’s historical approach to REIT non-GAAP measures. Nevertheless, non-GAAP measures have been a significant focus for the SEC staff for years, so REITs should carefully review their non-GAAP measures in light of the new guidance.