The US Securities and Exchange Commission (SEC) recently gave a strong reminder of the importance of providing equal or greater prominence to the most directly comparable financial measures calculated and presented in accordance with Generally Accepted Accounting Principles (GAAP) in disclosures containing non-GAAP financial measures. On December 26, 2018, the SEC issued a cease and desist order and imposed a $100,000 civil penalty on a company for including non-GAAP financial measures (such as adjusted EBITDA, adjusted net income and free cash flow before special items) in two earnings releases without giving equal or greater prominence to the most directly comparable GAAP financial measures.
The SEC’s order specifically noted that the earnings releases’ headlines presented a non-GAAP financial measure without mentioning the comparable GAAP financial measure. Its order also pointed out that the bullet points in the highlights section on the first page of one of the earnings releases contained non-GAAP financial measures but did not include the comparable GAAP financial measures. According to the SEC order, although the comparable GAAP financial measures were contained later in the body of the earnings release, the failure to include them in the headlines and the highlights that contained the non-GAAP financial measures constituted a violation of the Securities Exchange Act of 1934 and the applicable rules thereunder.
Item 10(e)(1)(i)(A) of Regulation S-K requires that a presentation in an SEC filing of a non-GAAP financial measure must be accompanied, with equal or greater prominence, by the most directly comparable GAAP financial measure. Since an earnings press release is included in a filing with the SEC, the earnings press release is subject to this requirement, as Instruction 2 to Item 2.02 of Form 8-K makes clear.
The staff of the SEC’s Division of Corporation Finance (Staff) provided guidance on the use of non-GAAP financial measures in May 2016 by issuing and revising a dozen Compliance and Disclosure Interpretations (C&DIs) on non-GAAP financial measures. While indicating that facts and circumstances determine whether a non-GAAP financial measure is presented more prominently than the comparable GAAP financial measure, C&DI 102.10 identified several types of presentations for which the Staff would consider the non-GAAP disclosures to be impermissibly prominent. Among those specified examples are the following:
- Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
- Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure;
- Including a non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption);
- Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure; and
- Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence.
For more information on the non-GAAP C&DIs, see our Legal Update “SEC Provides Guidance on Non-GAAP Financial Measures,” dated May 26, 2016.
Since issuing the May 2016 C&DIs on non-GAAP financial measures, the Staff has continued to closely review presentations filed and furnished to the SEC for compliance with the disclosure requirements for use of non-GAAP financial measures, issuing numerous comment letters. Many of the Staff’s comments have been directed at the requirements for presenting the most directly comparable GAAP financial measure with equal or greater prominence.
The recent cease and desist order serves as a warning that failure to heed the SEC’s guidance on the presentation of non-GAAP financial measures can have consequences far more serious than responding to a comment letter. In particular, companies must give equal or greater prominence to comparable GAAP financial measures when presenting non-GAAP financial measures in an SEC filing—including in earnings release headlines and bullet point highlights. In light of the SEC’s order, companies should take the time to carefully review any upcoming presentations containing non-GAAP financial measures for compliance with applicable SEC rules and guidance in this area.