On May 17, 2016, the SEC issued new Compliance & Disclosure Interpretations related to Regulation G. The Podium discussed the new guidance on the reporting of non-GAAP financial measures with Sullivan & Worcester Partner Howard Berkenblit.
The Podium: What do you see as the most significant changes that came out of the new SEC guidance on Reg G?
HB: There are two main themes to the changes. First there are some additional interpretations regarding what can and can’t be presented – these have the practical effect of creating new rules without technically changing the rules. For example, one of the changes makes explicit that EBITDA “must not be presented on a per share basis,” while others give new examples of adjustments that may not be made to non-GAAP measures. While some of these were implicit from the rules or prior SEC Staff speeches and comments, having them in Compliance and Disclosure Interpretations, even if theoretically not binding, gives them greater weight.
The second theme revolves around changes to presentation. These interpretations don’t directly prohibit a measure or adjustment, but do dictate the way the information appears. For example, while many companies’ quarterly earnings releases lead with a non-GAAP measure and only describe the comparable GAAP measure later in the release, that will no longer be acceptable under the new interpretations, which put tighter parameters around the presentation.
The Podium: Can you give examples of the most common mistakes companies make in presenting non-GAAP financial measures?
HB: While the concept of giving equal or greater prominence to GAAP measures over non-GAAP measures is not new, the interpretations now give several specific examples of ways in which the presentation of non-GAAP measures have been presented more prominently than the GAAP measures in violation of Reg G. These include (1) a non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption); (2) omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures, and (3) 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. Many companies will need to modify the way they draft their disclosures.
The Podium: How are you advising clients on developing headlines in earnings releases as it pertains to Reg G?
HB: While non-GAAP measures can still appear in headlines, companies can no longer present them alone or before GAAP measures. As a result of the interpretations, it’s clear now that the SEC expects any headline that contains a non-GAAP measure to only have that measure appear if the most directly comparable GAAP measure also appears and precedes it. So essentially clients must lead with the GAAP measure. For example, a headline that used to say “EBITDA increases 20% For Quarter” will now need to read along the lines of “Net Income increases 10% for Quarter; EBITDA increases 20%”.
The Podium: Were there areas that the SEC advised that they will be watching more closely as it relates to Reg G? Where have companies been skirting the Regulation to date?
HB: The SEC seems to be most bothered by adjustments to non-GAAP measures that could appear to be misleading. The examples most often given in speeches and the press seem to be more clear cut abuses – for example, backing out certain cash items from a cash-based performance measure, accelerating revenue or presenting only the “good stuff’ while leaving out conspicuous negative adjustments. In my experience most companies present non-GAAP adjustments that are appropriate and because they show how management views the measure and give investors and analysts valuable additional information. But because of the abuses, the SEC felt the need to clamp down a bit not just on the more extreme examples, but in some cases more common practices as well.
The Podium: Do you expect the SEC to become more strict with enforcement of Reg G? Should we expect to see issuers receive an increase in comment letters on filings related to Reg G?
HB: The SEC Staff has already begun to increase its comments on filings and I expect that will continue in the near future, now more directly pointing to the new interpretations as the basis for the comments. Companies are clearly expected to familiarize themselves with the interpretations and apply them and change any existing practices that don’t comply. In terms of more severe consequences, I am hopeful that the SEC enforcement staff will only get involved in cases where companies take deliberate actions to mislead or defraud.
The Podium: Do you expect the SEC to get more strict with Reg G in communications other than filings, such as conference calls and presentations?
HB: For a while now, as part of its regular reviews, the SEC has been looking outside the four corners of the registration statement or periodic filing to earnings releases, websites, presentations, etc. I expect this will continue – the SEC Staff in particular looks for inconsistencies in disclosures and non-GAAP measures play directly into this. For example, if a quarterly report on Form 10-Q presents financial information that indicates a mediocre quarter, but the parallel earnings release includes non-GAAP measures that appear to give a much rosier picture, companies should not be surprised to get questions from the Staff about the different trends.
The Podium: What are the key take-aways for issuers on the new guidance?
HB: The key is that anyone involved in preparing earnings releases, presentations or SEC filings that contain non-GAAP financial measures should read the guidance and make sure they understand it before the next disclosure event. Beyond that, any time a company is considering changes to how it calculates or presents non-GAAP financial measures, the measures and presentation should be analyzed against these interpretations, as well as recent SEC comments on other similarly situated companies and more generally in public appearances. Consistency is also very important – in the interpretations, the SEC Staff has made clear that it expects period-to-period comparisons to present the same types of information – the same adjustments, fairly presenting the negative with the positive, and not excluding recurring items.
Howard E. Berkenblit is a partner and leader of Sullivan & Worcester’s Capital Markets Group. He specializes in counseling both public and private companies involved in equity and debt financings and ongoing corporate governance and disclosure matters, stock exchange listing standards and Sarbanes-Oxley Act and Dodd-Frank Act compliance. He also advises Israeli and other international companies that seek to have their securities traded in the United States, as well as real estate investment trusts that engage in securities offerings and governance initiatives. In addition, Mr. Berkenblit works with clients on mergers and acquisitions, capital raising and general corporate matters. He has written articles and spoken on many topics including Sarbanes-Oxley, Dodd-Frank and a range of securities law issues impacting U.S. and foreign companies. He is also the editor of The SEC Pulse, a blog that provides updates and commentary from S&W’s Capital Markets Group on issues affecting publicly traded and privately owned businesses, investment banks and foreign companies that trade or raise capital in the United States, and boards of directors and company officers in securities transactions and corporate governance matters.