The SEC has stepped up its enforcement of public companies’ misleading use of non-GAAP (generally accepted accounting principles) financial measures. These measures are susceptible to abuse, and they can distort financial statements and mislead investors. The collapse of Enron exemplifies how unconventional accounting methods can defraud investors.
The SEC has established an internal task force to investigate public companies’ use of misleading non-GAAP financial measures, and their internal controls around the calculation of non-GAAP financial measures.
Non-GAAP Financial Accounting Requirements
Under SEC Rules, companies are required to meet certain disclosure and reporting requirements in order to issue non-GAAP financial measures. These requirements include but are not limited to compliance with:
- Regulation G, which requires public companies that disclose or release non-GAAP financial measures to include a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure with the most directly comparable GAAP financial measure; and
- Item 10 of Regulation S-K and Item 10 of Regulation S-B, which require public companies to include a statement concerning the use of non-GAAP financial measures in filings. This statement should include: (1) reasons why management believes that the non-GAAP presentation provides useful information to investors regarding the company’s financial condition and results of operations; and (2) to the extent that they are material, any additional purposes for which the company uses the non-GAAP financial measures.
Deceptive Non-GAAP Financial Measures
In addition to complying with the stated SEC Rules, issuers that report non-GAAP financial measures must ensure that the financial statements and disclosures are not deceptive. In new guidance, the SEC explains that certain adjustments, although not explicitly prohibited, may violate Rule 100(b) of Regulation G if they cause the presentation of the non-GAAP measures to be misleading. For example, a company would violate Regulation G by failing to present information consistently from one period to the next.
SEC Chair Mary Jo White highlighted the agency’s focus on non-GAAP measures in a December 2015 speech:
This area deserves close attention, both to make sure that our current rules are being followed and to ask whether they are sufficiently robust in light of current market practices. Non-GAAP measures are allowed in order to convey information to investors that the issuer believes is relevant and useful in understanding its performance. By some indications, such as analyst coverage and press commentary, non-GAAP measures are used extensively and, in some instances, may be a source of confusion.
SEC Enforcement Actions for Use of Non-GAAP Financial Measures
In its first enforcement action brought under Regulation G, the SEC brought charges against SafeNet Inc. for using non-GAAP financial measures to issue materially false and misleading information concerning its financial condition. According to the SEC’s complaint, SafeNet’s management used improper adjustments to meet or exceed quarterly earnings targets. These adjustments included the improper classification of ordinary operating expenses as non-recurring integration expenses, and the improper reduction of accruals for professional fees and inventory reserves. The SEC required SafeNet to pay a civil penalty of $1 million.
In another enforcement action, on January 18, 2017, the SEC charged New York-based marketing company, MCD Partners, a $1.5 million penalty for improper use of non-GAAP measures. According to the SEC’s order, the company presented inconsistent non-GAAP measures without disclosing investors of the changes. This inconsistency allowed the company to deceptively inflate its “organic revenue growth” results. In addition, MDC Partners also failed to give GAAP metrics equal or greater prominence to non-GAAP metrics in its earnings releases.
SEC Whistleblower Bounties
Under the SEC Whistleblower Program, whistleblowers may be eligible for monetary awards if they voluntarily provide the SEC with original information about violations of federal securities laws that leads the SEC to bring a successful enforcement action that results in monetary sanctions exceeding $1 million.
Dodd-Frank SEC Whistleblower Porgram
Whistleblowers are eligible to receive between 10% and 30% of the monetary sanctions collected. On September 22, 2014, a whistleblower was awarded more than $30 million for providing key information that led to a successful enforcement action.
Protections for SEC Whistleblowers
The SEC Whistleblower Program also protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity. Furthermore, the Dodd-Frank Act and Sarbanes-Oxley Act protect whistleblowers from retaliation by their employers for reporting violations of securities laws.
SEC Whistleblower Law Firm