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Increased Use of Non-GAAP Numbers Draws Investor Advocate’s Attention

The SEC’s Investor Advocate in his most recent report to Congress said he will continue to pay close attention to public companies’ increasing use of non-GAAP measurements in the coming year. He also plans to consider if regulatory action will be needed. SEC officials have been troubled that the use of some non-GAAP metrics may mislead investors, and they have been speaking out about the practice.

The SEC’s Investor Advocate said in a June 30, 2016, report to Congress that he will continue to pay close attention to public companies’ increasing use of non-GAAP measurements in the coming year, and he plans to consider if regulatory action is needed.

Companies in the past few years have increasingly used non-GAAP numbers in quarterly and yearly earnings announcements because the numbers tend to paint a rosier picture of their financial performance than the comparable U.S. GAAP figures and can boost their stock prices. But the market regulator has been troubled that the use of some non-GAAP metrics may mislead investors. In the past year, several senior SEC officials, including Chair Mary Jo White and Chief Accountant James Schnurr, have spoken out on several occasions about practices they consider problematic.

“We will consider whether rulemaking is needed to clarify the law or enhance the commission’s ability to deter abusive practices,” SEC Investor Advocate Rick Fleming wrote in his “Report on Objectives” for the coming fiscal year, which begins on October 1.

Staffers in the SEC’s Division of Corporation Finance have also said they are directly questioning companies about their use of non-GAAP numbers. In May 2016, the SEC updated its Compliance and Disclosure Interpretations (C&DIs) to spell out what it considers acceptable in presenting non-GAAP numbers under Regulation G. The rule says that non-GAAP numbers must not be misleading and must be reconciled to U.S. GAAP.

According to the transcript of Chair White’s June 27 speech to a conference in San Francisco, the SEC is “poised to act through the filing review process, enforcement, and further rulemaking if necessary to achieve the optimal disclosures for investors and the markets.”

On other issues, Fleming said his office plans to conduct more outreach with investors to solicit their input into the agency’s regulatory decisions and counteract what he called a “structural imbalance” in the rulemaking process. Public companies, business trade groups, and public accounting firms tend to comment extensively on SEC rules. Investors rarely do, and the one-sided nature of the public comment process can sometimes frustrate regulators.

“This outreach will inform our thinking about ways to enhance the effectiveness of disclosure for actual users of the data, and we will share our insights with policy makers,” Fleming said.

Fleming also wrote that his office is paying attention to the regulatory efforts to expand the audit firm reports and audit committee disclosures that appear in regulatory filings because he views them as important to adding to investors’ understanding of a company’s financial performance.

“Enhancements to either report would be of major significance to investors,” Fleming wrote in reference to the SEC’s July 2015 Concept Release No. 33-9862,Possible Revisions to Audit Committee Disclosures. The preliminary rulemaking document solicited comments about the value of expanded disclosures of an audit committee’s oversight of the auditors in proxy filings. The SEC is evaluating the comments submitted but has not decided on its next step.

At the same time, the PCAOB is working to adopt rules in early 2017 based on the requirements in Release No. 2016-003 , Proposed Auditing Standard — the Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards. The document was issued in May with comments due on August 15.

Release No. 2016-003 asks auditors to provide more insight into their client’s financial health in audit reports by describing the issues they share with a client’s audit committee. The information would have to be considered useful, or material, to investors to be included in the expanded audit report.

Fleming’s other priorities include the FASB’s project on materiality.

The accounting board in September 2015 issued two proposals to clarify the disclosure requirements in its reporting standards, help companies stress the more important information, and make financial statements easier for investors to read.

Proposed Amendments to Statement of Financial Accounting Concepts (CON) No. 2015-300, Conceptual Framework for Financial Reporting Chapter 3: Qualitative Characteristics of Useful Financial Information, and Proposed Accounting Standards Update (ASU) No. 2015-310, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, describe materiality as a legal concept that should be the basis for company decisions about the information in the footnotes to the financial statements.

Some investors believe the FASB proposals will give too much discretion to management to exclude information from financial statement footnotes and deny investors information they need to assess companies’ finances. Schnurr and FASB officials say this is not the proposal’s intent.

The FASB plans to hold a November roundtable before it finalizes the proposals.

Fleming said his office “will monitor developments closely and prepare to advocate for the best interest of investors as these proposals are considered.”