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Non-GAAP Measures Hit With Crackdown

SEC staffers are stepping up efforts to restrict the use of non-GAAP measurements in company earnings releases and regulatory filings. Market regulators have grown concerned that the practice is misleading investors and providing inaccurate information about companies’ financial performance.

Frustrated with the widespread use of so-called non-GAAP measures in company press releases and other public statements, SEC staffers are stepping up efforts to restrict the practice.

“We are going to crack down,” said Mark Kronforst, chief accountant with the SEC’s Corporation Finance Division at a May 5, 2016, conference at Baruch College in New York. In the coming weeks, the SEC expects to make public comment letters the division has sent to companies making use of non-GAAP measures for some tax-related items.

The SEC’s focus on tax items that are reported with non-GAAP adjustments is a relatively new development, but the agency appears to be moving aggressively now that it has made the issue a priority. The Corporation Finance staff is assessing companies’ current quarterly and annual filings, evaluating how the companies might perform over the long-term, and drawing some conclusions about the long-term tax liabilities and likelihood that the companies can continue using some write-offs that have lowered their tax payments.

The SEC has sent some of the companies comment letters questioning the tax adjustments that Kronforst said should become public in the next few weeks. The letters challenge some companies’ assumptions that as their earnings increase over the next several years, they can still make use of the deductions currently available to them.

“We get the feeling that companies really haven’t thought through that,” Kronforst. Until recently, the agency has not focused on the issue, but now that it is, it wants companies to exercise more discipline in their use of non-GAAP measurements.

“The challenges are coming,” Kronforst said. “We are going to challenge these measures.”

The staff has also questioned companies on their use of cash flow as a measurement of financial performance. Companies have presented investors with made-up measurements like free cash flow per share, which is operating cash flow as defined by U.S. GAAP less a company’s capital costs. The Corporation Finance staff disagrees with attempts by companies to treat the measurement as if it is an indicator of their financial performance, in part because the staffers view the figure as misleading for investors.

“Let’s be honest, it’s not a performance measure,” he said.

The crackdown amounts to a sharp turn in policy for the market regulator, which had been in the practice of sometimes deferring to companies that wanted to use non-GAAP measurements based on the reasoning that executives know their company and industry well enough to support the use of financial data that is not covered by accounting standards.

“We’re going to end that deference, if you will,” Kronforst said.

Kronforst also singled out other items like adjusted-EBITDA, for earnings before interest, taxes, depreciation, and amortization.

“It encompasses anything you can come up with,” Kronforst said.

The SEC’s rules for non-GAAP measurements were established in 2003 in Release No. 33-8176, Conditions for Use of Non-GAAP Financial Measures, which established Regulation G. In 2010 the agency published interpretive guidance for the rule in Compliance and Disclosure Interpretations. The interpretive guidance was updated in 2011.