SEC Updates Guidance on Non-GAAP Financial Measures

While the SEC accepts that non-GAAP measures can provide useful information to investors in appropriate circumstances, such measures have been an area of SEC scrutiny in recent years, with particular focus on the prominence of non-GAAP measures in company reports and the potential for non-GAAP measures to be misleading.  

On December 13, 2022, the SEC's Division of Corporation Finance released new and revised CDIs addressing the use of non-GAAP financial measures, which underscore the SEC's continued focus on this area and increased attention on specific company practices.  

This Commentary highlights the updated CDIs.  

Non-GAAP Measures That May Be "Misleading"

Question 100.01. This updated CDI elaborates on the SEC staff's long-standing view that certain adjustments, although not explicitly prohibited, may result in a misleading non-GAAP financial measure. Whether a non-GAAP financial may be misleading will depend on the particular facts and circumstances.  

Elaborating on an existing example, the updated CDI notes that the SEC staff's evaluation of whether the exclusion of "normal, recurring, cash operating expenses" is misleading will consider the nature and effect of the non-GAAP adjustment and how it relates to the company's operations, revenue-generating activities, business strategy, industry, and regulatory environment. The updated CDI also notes that both repeatedly occurring expenses and occasionally occurring expenses, including those occurring at irregular intervals, will be considered "recurring." 

Question 100.04. The updated CDI broadens the SEC staff's prior guidance regarding individually tailored revenue recognition and measurement methods, putting forward a general principle that a non-GAAP measure could be misleading if the non-GAAP adjustment alters the recognition and measurement principles required under GAAP.  

In particular, the updated CDI provides examples of problematic adjustments under this general principle, including: (i) acceleration of revenue as though earned when billed, where GAAP would require recognition ratably over time; (ii) presentation of revenue on a gross basis, where GAAP would require net presentation; (iii) deduction of transaction costs, as if the company acted as an agent, where GAAP would require gross presentation, as principal; and (iv) cash basis accounting for revenue or expenses in a performance measure, where GAAP would require accrual basis accounting. 

Question 100.05. This new CDI reiterates the SEC staff's position that a non-GAAP measure can be misleading if it (and any adjustments to the GAAP measure) are not appropriately labeled and clearly described. In particular, the CDI provides specific examples of failures to identify measures as non-GAAP and the use of labels that do not reflect the nature of the non-GAAP measure—e.g., the use of a "pro forma" label for measures not calculated in accordance with Regulation S-X, Article 11.

Question 100.06. This new CDI notes, without providing examples, that the SEC staff's view is that a non-GAAP measure could be misleading even where it is accompanied by extensive, detailed disclosure about the nature and effect of each adjustment.  

Prominence of Non-GAAP Measures 

Question 102.10. This CDI, which has been expanded and divided into sub-parts, addresses Regulation S-K, Item 10(e)'s requirement that when a company presents a non-GAAP financial measure, it must present the most directly comparable GAAP financial measure with equal or greater prominence. It is important to note that the equal or greater prominence requirement specifically applies to earnings releases in addition to disclosures in filed SEC reports and registration statements. 

In reiterating the equal or greater prominence requirement, the updated CDI highlights that this requirement applies both to the presentation of the relevant measures as well as to any related discussion and analysis that may be included in earnings releases or other disclosures.  

Subpart (a) of the CDI provides an updated and expanded list of examples where the SEC staff would find that a non-GAAP financial measure was given greater prominence than the comparable GAAP financial measure, such as disclosing a characterization of a non-GAAP financial measure as "exceptional" or "record performance" without providing a characterization of the comparable GAAP measure with equal prominence. These examples clearly illustrate that the SEC staff is paying close attention to what it views as departures from the principles of Regulation G that the staff has observed in its review of earnings releases and filed SEC reports and registration statements.  

New subpart (b) provides examples of reconciliation practices that would give undue prominence to a non-GAAP measure. Examples cited in the CDI include: starting the reconciliation with the non-GAAP financial measure; presenting a non-GAAP income statement; or, when presenting a forward-looking non-GAAP measure, failing to provide adequate disclosure identifying information that is unavailable (and its probable significance) in a location of equal or greater prominence when relying on the exception under Item 10(e)(1)(i)(B) allowing for the exclusion of a quantitative reconciliation for the forward-looking non-GAAP measure.  

New subpart (c) reiterates that the SEC staff considers the presentation of a non-GAAP income statement—i.e., one that comprises non-GAAP measures and includes all or most of the line items and subtotals found in a GAAP income statement—either alone or as part of a reconciliation as giving undue prominence to non-GAAP measures.