Purpose – This article examines the first action by the US Securities and Exchange Commission to enforce the ''equal-or-greater-prominence'' requirement of its rules governing the presentation by SECreporting companies, in their SEC filings and earnings releases, of financial measures not prepared in accordance with generally accepted accounting principles (GAAP).
Design/methodology/approach – This article provides an in-depth analysis of the equal-or-greaterprominence rule and the SEC's enforcement posture in the context of the SEC's concern that some companies present non-GAAP financial measures in a manner that inappropriately gives the non-GAAP measures greater authority than the comparable GAAP financialmeasures.
Findings – Although the appropriate use of non-GAAP financial measures can enhance investor understanding of a company's business and operating results, investors could be misled about the company's GAAP results by disclosures that unduly highlight non-GAAP measures. The SEC's enforcement action signals a focus on the manner in which companies present non-GAAP financial measures as well as on how they calculate the measures.
Originality/value – This article provides expert guidance on a major SEC disclosure requirement from an experienced securities lawyer.
Keywords US Securities Exchange Act of 1934, US Securities Act of 1933, Non-GAAP financial measures, Regulation G, Item 10(e) of Regulation S-K
Paper type Technical paper
When a public company presents a non-GAAP financial measure in a filing with the US Securities and Exchange Commission (SEC) or in an earnings release, SEC rules direct it to present "with equal or greater prominence" the most directly comparable financial measure calculated in accordance with generally accepted accounting principles (GAAP). Before the SEC's Division of Corporation Finance in May 2016 issued updated interpretive guidance on the use of non-GAAP financial measures, market practice on prominence issues had evolved to encompass a variety of presentation formats. The SEC staff's guidance dispelled some of the uncertainty over the contours of the equal-or-greater-prominence requirement by identifying specific presentations the staff considers noncompliant.
In December 2018 the SEC sounded a warning to the public-company community about the potential consequences of failing to observe the staff's 2016 prominence guidance. The SEC instituted cease-and-desist proceedings against a company for violating Section 13(a) of the US Securities Exchange Act of 1934 (Exchange Act) and Rule 13a-11 under the Exchange Act by including non-GAAP financial measures in two of its earnings releases without presenting the most directly comparable GAAP financial measures with equal or greater prominence1. The non-GAAP measures appeared in the headlines and a highlights section of the earnings releases. The company agreed to pay a $100,000 civil money penalty in settlement of the enforcement action.
The proceeding represented the SEC's first action to enforce compliance with the equal-orgreater- prominence requirement since publication of the staff's guidance. It is useful to view the SEC's current enforcement posture on the prominence issue against the background of evolving agency concern over the manner in which companies present non-GAAP financial measures to investors.
Presentation of GAAP measures with equal or greater prominence
The equal-or-greater-prominence requirement has been part of the SEC's rules on non- GAAP financial measures since their adoption. Effective on March 28, 2003, as required by the Sarbanes-Oxley Act of 2002, the SEC adopted Regulation G and Item 10(e) of Regulation S-K2 to implement the statutory mandate that publicly disclosed non-GAAP financial measures be presented in a manner that is:
- not materially misleading; and
- reconciled with the most directly comparable GAAP financial measures3.
Item 10(e)(1)(i)(A) of Regulation S-K4 states that, whenever a registrant includes one or more non-GAAP financial measures in an SEC filing, the registrant must include in the filing:
A presentation, with equal or greater prominence, of the most directly comparable financial measure or measures calculated and presented in accordance with Generally Accepted Accounting Principles (GAAP). (emphasis supplied)
With limited exceptions the non-GAAP rules, including the equal-or-greater-prominence requirement, apply to non-GAAP disclosures contained in reports, registration statements and other information filed with the SEC under the Exchange Act or the US Securities Act of 1933. Registrants also must comply with the prominence requirement in earnings releases that announce results for a completed fiscal period when they "furnish" (rather than "file") the announcements under Item 2.02 of SEC Form 8-K5.
The SEC's releases discussing the proposed and final non-GAAP rules did not offer much insight into the agency's views on the scope of the equal-or-greater-prominence requirement. The SEC noted in its rule proposal that for filed disclosures the new rules would prohibit "presenting a non-GAAP financial measure in a manner that would give it greater authority or prominence than the comparable GAAP financial measure or measures6". The SEC did not solicit specific comment on the substance of the equal-orgreater- prominence proposal, and adopted it unchanged in the final rules. Although many aspects of the proposed rules attracted extensive comment, the prominence proposal does not appear to have elicited debate. In its adopting release the SEC did not identify any considerations following the comment period that had influenced it in approving the prominence requirement7.
The SEC staff published little interpretive guidance on the equal-or-greater-prominence requirement in "frequently asked questions" (FAQs) on the new rules it issued in June 2003 or in more extensive Compliance and Disclosure Interpretations (C&DIs) it issued in January 2010. Instead, until it issued a C&DI on the prominence requirement in May 2016, the staff primarily conveyed its interpretive position on the requirement through the comment letter process it administers in its review of filings and furnished earnings releases. Although they provided helpful clues to the staff's views on prominence issues, the comments issued to individual registrants fell short of the more authoritative guidance that would have been afforded by publication of general guidelines.
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1. In the Matter of ADT Inc., Release No. 34-84956 (Dec. 26, 2018), available at www.sec.gov/ litigation/admin/2018/34-84956.pdf (last accessed 19 Aug. 2019).
2. Conditions for Use of Non-GAAP Financial Measures, Release No. 33-8176, Release No. 34-47226, 68 Fed. Reg. 4820 (Jan. 30, 2003).
3. Regulation G applies to any "registrant", which is any entity that has a class of securities registered under Section 12 of the Exchange Act or is required to file reports under Section 15(d) of the Exchange Act, other than an investment company registered under Section 8 of the US Investment Company Act of 1940. Item 10(e) applies to such registrants as well as to the issuer of securities for which a registration statement is filed under the US Securities Act of 1933. Although registrants that are non-U.S. companies, or "foreign private issuers", generally must comply with the SEC's non- GAAP rules, they may qualify for exceptions that are not available to US registrants.
4. 17 C.F.R. § 229.10(e)(1)(i)(A)(2019).
5. Instruction 1 of Item 2.02 of Form 8-K states that the "requirements of this Item 2.02 are triggered by the disclosure of material non-public information regarding a completed fiscal year or quarter. Release of additional or updated material non-public information regarding a completed fiscal year or quarter would trigger an additional Item 2.02 requirement". Instruction 2 of Item 2.02 of Form 8-K states that the "requirements of paragraph (e)(1)(i) of Item 10 of Regulation SK (17 CFR 229.10(e) (1)(i)) shall apply to disclosures under this Item 2.02".
6. Conditions for Use of Non-GAAP Financial Measures, Release No. 33-8145, Release No. 34-46768, 67 Fed. Reg. 68790, 68795 (Nov. 13, 2002).
7. See note 2, supra.
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