On December 13, 2022, the staff of the Division of Corporation Finance (the “Staff") of the Securities and Exchange Commission announced an update to its Compliance and Disclosure Interpretations (“C&DIs") on Non-GAAP Financial Measures under Questions 100.01, 100.04 – 100.06, and 102.10(a)(b)(c). Many of the changes memorialize positions the Staff has taken in comment letters or provide additional detail about those positions.
Significant changes are discussed below, and Appendix A (attached as a pdf) is a marked version of the impacted C&DIs showing all of the revisions and additions.
Question 100.01 – Misleading Adjustments
Question 100.01 was revised to emphasize that a company's individual facts and circumstances affect whether an adjustment makes a non-GAAP measure misleading. Using the pre-update example (i.e., a non-GAAP performance measure that excludes normal, recurring, cash operating expenses may be misleading), the updated C&DI illustrates this by noting that:
- When evaluating what is a “normal, operating expense," the Staff considers 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 Staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as “recurring."
Question 100.04 – Individually Tailored Accounting Principles
Question 100.04, which was completely re-written, continues to include a prohibition on individually tailored accounting principles, but has now been supplemented with the following additional examples of adjustments that would run afoul of this prohibition:
- adjusting performance measures to accelerate revenue that GAAP requires to be recognized ratably over time as though revenue was earned when customers were billed;
- presenting revenue on a net basis when GAAP requires it to be presented on a gross basis (and vice versa); and
- changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis.
100.05 – Improper Labels and Descriptions
New Question 100.05 memorializes the Staff's position, often made clear through comment letters, that a non-GAAP measure can be misleading if it (or any adjustment made to the GAAP measure) is not appropriately labeled and clearly described. Three examples are provided of labels that would be misleading because they do not reflect the nature of the non-GAAP measure:
- a contribution margin that is calculated as GAAP revenue less certain expenses, labeled “net revenue";
- a non-GAAP measure labeled the same as a GAAP line item or subtotal even though it is calculated differently than the similarly labeled GAAP measure, such as “Gross Profit" or “Sales"; and
- a non-GAAP measure labeled “pro forma" that does not meet the pro forma requirements in Article 11 of Regulation S-X.
100.06 – Limits of Explanatory Disclosure
New Question 100.06 explains that a non-GAAP measure could be so inherently misleading that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent it from being materially misleading. No examples are provided.
102.10 – Equal or Greater Prominence
Question 102.10, which relates to the equal or greater prominence rule, was broken into subparts and supplemented with more detailed explanations and additional examples of disclosures that the Staff believes violate the rule, including the following situations:
- Ratios. When a ratio is calculated using a non-GAAP financial measure and a ratio calculated using the most directly comparable GAAP measure(s) is not presented with equal or greater prominence.
- Charts/tables/graphs. When charts, tables or graphs of non-GAAP financial measures are used and charts, tables or graphs of the comparable GAAP measures are not presented with equal or greater prominence.
- Reconciliations. When a reconciliation begins with the non-GAAP financial measure or constitutes a non-GAAP income statement.
Non-GAAP Income Statements. When a non-GAAP income statement is presented, even if it is not a full income statement and only includes “most of the line items and subtotals found in a GAAP income statement."
We would like to thank Rodrigo Surcan in our New York office for his work on this article.