On April 4, 2018, the SEC issued two new Compliance & Disclosure Interpretations (C&DI) related to the use of non-GAAP financial measures by public companies in connection with business combinations. The two new C&DI follow two other C&DI which were issued on October 17, 2017 (see HERE).
The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and Item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.
My prior two-part blog series on non-GAAP financial measures, Regulation G and Item 10(e) of Regulation S-K can be read HERE and HERE.
GAAP continues to be and has consistently been criticized by the marketplace in general, with many institutional investors publicly denouncing the usefulness of the accounting standard. Approximately 90% of companies provide non-GAAP financial metrics to illustrate their financial performance and prospects. As an example, EBITDA is a non-GAAP number.
On the flip side, the plaintiff’s bar has habitually used Regulation G and Item 10(e) of Regulation S-K, and in particular the GAAP reconciliation disclosure requirements, to pursue frivolous lawsuits in the context of business combinations. Business combinations as a whole are one of the most frequent targets for such litigation.
The fall 2017 C&DI was an effort by the SEC to provide some clarity on the requirements. CD&I 101.01 addressed whether forecasts provided to a financial advisor in relation to a business combination transaction would be considered non-GAAP financial measures requiring compliance with applicable rules. In particular, the SEC confirmed that providing forecasts to a financial advisor in connection with a business combination transaction would not be considered non-GAAP financial measures.
Item 10(e)(5) of Regulation S-K and Rule 101(a)(3) of Regulation G provide that a non-GAAP financial measure does not include financial measures required to be disclosed by GAAP, SEC rules, or pursuant to specific government regulations or SRO rules that are applicable to a company. Accordingly, financial measures provided to a financial advisor would be excluded from the definition of non-GAAP financial measures, and therefore not subject to Item 10(e) of Regulation S-K and Regulation G, if and to the extent: (i) the financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and (ii) the forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor’s analyses or substantive work.
Although the disclosure of projections to a financial advisor in a business combination transaction does not implicate rules related to non-GAAP financial measures, that same disclosure in a registration statement, proxy statement or tender offer statement would need to comply with Regulation G and Item 10(e) of Regulation S-K.
In the second C&DI issued in the fall, the SEC addressed the limited exemptions from the non-GAAP rules for communications relating to business combination transactions. In particular, Rule 425 of the Securities Act requires that certain business combination communications, that would not be considered solicitation materials in other contexts, be filed with the SEC, generally as part of a registration statement on Form S-4, proxy statement or tender offer statement. Likewise, limited solicitations under Exchange Act Rule 14a-12 and 14d-2(b)(2) that are made prior to filing a proxy statement are exempted from the non-GAAP measure requirements.
Other than the limited exemptions set forth in the rules listed above, and communications to a financial advisor, business combination communications must comply with Regulation G and Item 10(e) of Regulation S-K related to non-GAAP financial measures, including a reconciliation to comparable GAAP numbers and the reasons for presenting the non-GAAP numbers.
Following the issuance of those C&DI, some plaintiffs’ lawyers took advantage of a perceived lack of clarity and suggested that projections disclosed to bidders or a board of directors did require GAAP reconciliation and when none was provided, a violation had occurred.
Accordingly, on April 4, 2018, the SEC provided further clarity. New C&DI 101.02 is direct and to the point, providing:
Question: Can the registrant rely on the Answer to Question 101.01 if the same forecasts provided to its financial advisor are also provided to its board of directors or board committee?
Answer: Yes.
New question 101.03 likewise provides:
Question: A registrant provides forecasts to bidders in a business combination transaction. To avoid anti-fraud concerns under the federal securities laws or ensure that the other disclosures in the document are not misleading, it determines that such forecasts should be disclosed. Are the financial measures contained in forecasts disclosed for this purpose considered non-GAAP financial measures?
Answer: If a registrant determines that forecasts exchanged between the parties in a business combination transaction are material and that disclosure of such forecasts is required to comply with the anti-fraud and other liability provisions of the federal securities laws, the financial measures included in such forecasts would be excluded from the definition of non-GAAP financial measures and therefore not subject to Item 10(e) of Regulation S-K and Regulation G.
Refresher on Regulation G and Item 10(e) of Regulation S-K
Regulation G was adopted January 22, 2003 pursuant to Section 401(b) of the Sarbanes-Oxley Act of 2002 and applies to all companies that have a class of securities registered under the Securities Exchange Act of 1934 (“Exchange Act”) or that are required to file reports under the Exchange Act. The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and Item 10(e) of Regulation S-K.
Regulation G governs the use of non-GAAP financial measures in any public disclosures including registration statements filed under the Securities Act of 1933 (“Securities Act”), registration statement or reports filed under the Exchange Act or other communications by companies including press releases, investor presentations and conference calls. Regulation G applies to print, oral, telephonic, electronic, webcast and any and all forms of communication with the public.
Item 10(e) of Regulation S-K governs all filings made with the SEC under the Securities Act or the Exchange Act and specifically prohibits the use of non-GAAP financial measures in financial statements or accompanying notes prepared and filed pursuant to Regulation S-X. Item 10(e) also applies to summary financial information in Securities Act and Exchange Act filings such as in MD&A.
Definition of non-GAAP financial measure and exclusions
A non-GAAP financial measure is any numerical measure of a company’s current, historical or projected future financial performance, position, earnings, or cash flows that includes, excludes, or uses any calculation not in accordance with U.S. GAAP.
Specifically, not included in non-GAAP financial measures for purposes of Regulation G and Item 10(e) are: (i) operating and statistical measures such as the number of employees, number of subscribers, number of app downloads, etc.; (ii) ratios and statistics calculated based on GAAP numbers are not considered “non-GAAP”; and (iii) financial measures required to be disclosed by GAAP (such as segment profit and loss) or by SEC or other governmental or self-regulatory organization rules and regulations (such as measures of net capital or reserves for a broker-dealer).
Non-GAAP financial measures do not include those that would not provide a measure different from a comparable GAAP measure. For example, the following would not be considered a non-GAAP financial measure: (i) disclosure of amounts of expected indebtedness over time; (ii) disclosure of repayments on debt that are planned or reserved for but not yet made; and (iii) disclosure of estimated revenues and expenses such as pro forma financial statements as long as they are prepared and computed under GAAP.
Neither Regulation G nor Item 10(e) applies to non-GAAP financial measures included in a communication related to a proposed business combination, the entity resulting from the business combination or an entity that is a party to the business combination as long as the communication is subject to and complies with SEC rules on communications related to business combination transactions. This exclusion only applies to communications made in accordance with specific business combination communications, such as those in Section 14 of the Exchange Act and the rules promulgated thereunder. As clarified in SEC C&DI on the subject, if the same non-GAAP financial measure that was included in a communication filed under one of those rules is also disclosed in a Securities Act registration statement or a proxy statement or tender offer statement, no exemption from Regulation G and Item 10(e) of Regulation S-K would be available for that non-GAAP financial measure.
Regulation G and Item 10(e) requirements
Together, Regulation G and Item 10(e) require disclosure of and a reconciliation to the most comparable GAAP numbers, the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.
As with any and all communications, non-GAAP financial measures are subject to the state and federal anti-fraud prohibitions. In addition to the standard federal anti-fraud provisions, Regulation G imposes its own targeted anti-fraud provision. Rule 100(b) of Regulation G provides that a company, or person acting on its behalf, “shall not make public a non-GAAP financial measure that, taken together with the information accompanying that measure and any other accompanying discussion of that measure, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading.” As clarified in C&DI published by the SEC on May 17, 2016, even specifically allowable non-GAAP financial measures may violate Regulation G if they are misleading.
As is generally the case with SEC reporting, companies are advised to be consistent over time. Special rules apply to foreign private issuers, which rules are not discussed in this blog.
Below is a chart explaining the Regulation G and Item 10(e) requirements, which I based on a chart posted in the Harvard Law School Forum on Corporate Governance and Financial Regulation on May 23, 2013 and authored by David Goldschmidt of Skadden, Arps, Meagher & Flom, LLP. I made several additions to the original chart created by Skadden.
| Regulation G | Item 10(e) | |
| Scope | All public disclosures by Exchange Act registrants of information that contains non-GAAP financial measures, including:
Limited exclusion for business combination communications. |
All filings with the SEC under the Securities Act and the Exchange Act, including:
Does not apply to registered investment companies. Special rules apply to foreign private issues. Limited exclusion for business combination communications. |
| Required Disclosure | Whenever a registrant makes public a non-GAAP financial measure, it must:
|
Whenever a registrant presents a non-GAAP financial measure, it must (in addition to the requirements for Regulation G):
|
| Earnings Releases | A registrant must:
|
Subsection (1)(i) of Item 10(e) applies to a registrant’s Item 2.02 Form 8-K (pursuant to which earnings releases are required to be furnished to the SEC). Registrants must either include in the body of the current report or in the earnings release itself:
|
| SEC Non-GAAP Measure Prohibitions | A registrant is not permitted to make any non-GAAP financial measure public if it contains a material misstatement or omits information needed to make the measure not misleading.
Measures of performance may be presented on a per-share basis; however, per-share presentation of measures of liquidity is prohibited.
A full non-GAAP income statement may not be used as it places undue prominence on the non-GAAP information. |
A registrant is not permitted to:
Companies may adjust for recurring charges within the two-year look-forward/look-back window, but the adjustment may not be classified as non-recurring, infrequent or unusual. |
The Author
Laura Anthony, Esq.
Founding Partner
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Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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