For more than a year, the SEC has been on something of a crusade against what it considers a swell in the misleading use of non-GAAP measures in financial reports. The agency not only issued comment letters to several companies questioning and criticizing their use of the figures, several agency officials disparaged the practice in a series of speeches, where they suggested that some companies are pushing the envelope on using non-GAAP measures in financial reports. The SEC was so miffed at how Valeant pharmaceuticals has used non-GAAP measures that it dinged the company twice through comment letters.
In May, the regulator attempted to influence how companies use the figures by issuing new guidance in the form of a Compliance & Disclosures Interpretations document that provided 39 questions and answers on what the SEC would consider acceptable and what it would take issue with. Using metrics in financial statements that aren't approved by Generally Accepted Accounting Principles (GAAP) isn't necessarily a violation of reporting rules, the guidance points out, but using them to mislead investors is a violation of the rules, the SEC warned.
Earlier this month, research company Audit Analytics looked at how companies are responding to the guidance in a new report. The firm finds that companies aren’t playing it safe by abandoning the use of non-GAAP measures. Indeed, they remain in use by most large companies, even after the warning by the SEC. Of Fortune 500 companies, 475 included at least one non-GAAP metric in financial reports issued in the period from July to September, after the guidance was issued, actually up one from the 474 that used a non-GAAP figure in the second quarter.
“The SEC guidance did not cause companies to completely drop the use of non-GAAP financial measures, a result likely not expected or encouraged because many companies believe that non-GAAP measures provide the public with useful information,” the Audit Analytics report states. “One should not conclude, however, that a company’s decision to continue using non-GAAP measures is an indication that it has not scaled back its usage or made adjustments in response to the guidance provided by the C&DIs,” said Don Whalen, director of research at Audit Analytics.
Making Changes to Use of Non-GAAP
Indeed, many companies made changes to how they use non-GAAP measures. One of the problems the SEC cited in its guidance is when companies use non-GAAP measures more prominently than the accepted measures, such as in a headline, caption, in the earnings release, or before citing the GAAP version of the measure. Here, companies did make progress, the AA report finds. “In Period 1, a total of 202 companies disclosed the non-GAAP measure more prominently in a headline, but this number dropped by 174 companies to a total of 28 companies in Period 2. The drop represents the largest improvement discovered in the analysis,” the report states.
Another no-no the SEC addressed in the guidance was using the non-GAAP measure without also presenting its GAAP equivalent in the text and reconciling the two. Here, too, companies took notice of the SEC’s finger wagging. The number of companies that provided a non-GAAP outlook or guidance (forward looking) without providing a comparable GAAP measure dropped from 133 to 86 from Period 1 to 2. “This decrease of 47 companies represents a substantial improvement, and other companies invoked the 'unreasonable effort' exception,” says Whalen. Companies can make the claim that reconciling the two would take an unreasonable amount of effort, and skip that step, according to the SEC guidance. And more companies jumped through that loophole, with 42 claiming the exception in period 2, up from just 7 in period 1.
Still a Concern?
It remains to be seen if the changes in how companies are using non-GAAP figures will satisfy the SEC, even if their use doesn’t seem to be declining. It’s also unclear if a changing of the guard at the SEC, expected next month as Chairman Mary White steps down, will have any effect on how the agency views the use of non-GAAP measures.
In a speech last year, White stated that the use of non-GAAP measures “deserves close attention” and “may be a source of confusion” for investors. It’s possible, maybe even likely, that a SEC under a new chairman that will be appointed by President-elect Donald Trump may not see it as such a concern.