02.05.2003

|

Updates

The Securities and Exchange Commission (SEC) has issued final rules for public companies' disclosure of non-GAAP financial measures. The new rules, which implement Sections 401(b) and 409 of the Sarbanes-Oxley Act, adopt new "Regulation G," and amendments to Regulation S-K and Form 8-K. Under these new rules a company must:

    • in any release of non-GAAP financial information, present the most directly comparable GAAP information and a reconciliation of the non-GAAP information to the GAAP information;

    • in any disclosure of non-GAAP financial information that is filed (as opposed to furnished) with the SEC, comply with new requirements concerning the contents and presentation of such information;
    • furnish to the SEC under Form 8-K within five days any earnings release or other material disclosure relating to a completed fiscal period; and
    • for earnings calls and other oral disclosures of material information concerning completed fiscal periods, ensure that the 8-K for the related earnings release is on file prior to the time of the call (or file a second 8-K within five days relating to the contents of the call).

The SEC modified the final rules from the November 5, 2002 proposals in a number of ways:

    • Companies may use non-GAAP EPS or other per share measures.

    • Companies will be permitted to include EBIT and EBITDA liquidity measures in documents filed with the SEC.
    • Earnings releases will be considered "furnished" rather than "filed" under new Item 12 of Form 8-K.
    • The limited exception to the application of Regulation G for foreign private issuers has been clarified.
    • The rules will not apply to a non-GAAP financial measure included in a disclosure relating to mergers and other business combinations, so long as the disclosure was subject to Regulation M-A, the communication rules that govern business combinations.

Regulation G and the amendments to Form 8-K apply to disclosures made after March 28, 2003. The amendments to Regulation S-K apply to annual or quarterly reports for fiscal periods ending after March 28, 2003.

Regulating Non-GAAP Financial Information: Regulation G and Regulation S-K

The SEC believes that non-GAAP, or "pro forma," financial measures can confuse investors by obscuring GAAP results or making more difficult "apple-to-apple" comparisons between companies and even between reporting periods of the same company. Regulation G will apply whenever a company publicly discloses material information that includes a non-GAAP financial measure, whether or not in an earnings release.

What is a Non-GAAP Financial Measure?

The SEC defines "non-GAAP financial measure" as "a numerical measure of historical or future financial performance, financial position or cash flow" that:

  • effectively excludes amounts that are included in the most directly comparable GAAP measure presented in the financial statements; or
  • effectively includes amounts that are excluded from the most directly comparable GAAP measure in the financial statements.

SEC Permits Limited Non-GAAP Financial Information

Regulation G and the amendments to Regulation S-K cast a wide net—they cover all performance measures that differ from those presented in the financial statements, and liquidity measures that differ from cash flow computed in accordance with GAAP—but they do not encompass all financial information that may be derived from non-GAAP methodologies. For example, the definition of non-GAAP financial measures does not include:

  • operating and statistical measures (such as unit sales or number of employees);
  • ratios calculated using only GAAP financial measures (such as operating margin that is calculated by dividing revenues into operating income, where both revenue and operating income are calculated in accordance with GAAP); or
  • operating measures that are not non-GAAP financial measures (such as amounts of expected indebtedness).

Requirements of Regulation G: Disclosure and Reconciliation

Regulation G applies whenever a company publicly releases material information that contains a non-GAAP financial measure in writing, orally, telephonically, in a Web cast or by similar means. Regulation G mandates:

  • Disclosure: Companies may not present non-GAAP financial measures in ways that are misleading to investors.
  • Reconciliation: Companies must present the most directly comparable GAAP measures, and a clearly understandable reconciliation of the GAAP and non-GAAP measures. For forward-looking information, this reconciliation is required to the extent available without unreasonable efforts.

Trap for the Unwary: Regulation G Applies to All Public Communications. Although Regulation G will likely have its most significant impact on earnings releases and SEC filings, it is important to recognize that the new rules apply to any corporate communication that is made public, including press releases, analyst calls and documents that are disclosed publicly in order to comply with Regulation FD, such as slide shows from investor conferences. Personnel from a company's legal, finance and investor relations departments need to be aware of Regulation G and carefully vet any communications before they are made public to identify non-GAAP information and make sure the disclosures required by Regulation G are included.

If the non-GAAP information is disclosed orally (e.g., on an earnings call or Web cast), the required Regulation G disclosure may be provided by:

  • Simultaneously posting the Regulation G-required disclosure on the company's Web site and
  • Providing the Web site address during the oral presentation.

The SEC encourages companies to provide access to the Web site postings for at least one year.

Trap for the Unwary: Unscripted Responses.

A senior executive may inadvertently violate Regulation G by disclosing non-GAAP financial information during an earnings call (for instance in responding to a question during an unscripted Q&A session) if the required Regulation G disclosures have not been posted on the company's Web site in advance. Management should be aware of what Regulation G information has been posted to the company's Web site prior to any oral presentation and should limit disclosure of non-GAAP numbers accordingly.


Requirements of Amended Regulation S-K: Reconciliation, Prominence and Explanation

New Regulation S-K will require enhanced disclosure in financial statements filed with the SEC (as opposed to furnished under new Item 12 of Form 8-K). Like Regulation G, the Regulation S-K amendments will require a quantitative reconciliation of the differences between GAAP and the most directly comparable non-GAAP measures. However, Regulation S-K will also require:

    • Prominence: Companies must present the comparable GAAP measure with equal or greater prominence to the non-GAAP measure.

    • Explanation: Management must disclose the reasons why it believes the non-GAAP measure is useful and, to the extent material, any additional purposes for it used the non-GAAP measure.

In addition, amended Regulation S-K specifically prohibits:

    • excluding charges or liabilities requiring cash settlement, other than the measures of EBIT and EBITDA;

    • adjusting a non-GAAP performance measure to smooth nonrecurring or unusual items when the nature of the charge or gain is reasonably likely to recur within two years or a similar charge or gain occurred in the previous two years;
    • presenting non-GAAP financial measures on the face of the financial statements (including notes) or pro forma financial statements; and using titles or descriptions for non-GAAP measures that are confusingly similar to GAAP financial measures.

Note that although Regulation S-K imposes strict regulation of most non-GAAP financial measures in filed material, the final rule no longer prohibits the disclosure of non-GAAP per share measures.

"Furnish" Earnings Releases on Form 8-K

The addition of new Item 12 to Form 8-K requires companies that issue earnings releases or disclose other material nonpublic information regarding completed annual or quarterly periods to furnish such information on Form 8-K within five days after its public announcement, whether or not the earnings release contains non-GAAP financial measures.

Like information provided under Regulation FD, the earnings releases would be considered "furnished" rather than "filed" (as was originally proposed). As a result, earnings releases will not be subject to liability under Section 18 of the Securities Exchange Act of 1934 and will not be "incorporated by reference" into shelf registration statements filed under the Securities Act of 1933. In addition, unlike other financial statements "filed" with the SEC, earnings releases furnished under this new Item 12 requirement do not need to comply with most of the requirements of Item 10 of Regulation S-K.

Practical Tip: Don't Bury GAAP in Boilerplate.

New Item 12 of Form 8-K requires that earnings releases furnished to the SEC on Form 8-K present the comparable GAAP measure with equal or greater prominence to the non-GAAP financial measure. Companies therefore should not bury GAAP measures in ways that will not get noticed. For example, headers of earnings releases that contain a non-GAAP number should also contain the comparable GAAP number. New Item 12 also requires earnings releases to include an explanation as to why the non-GAAP financial measure is useful to investors.


If the material nonpublic information is disclosed orally (e.g., an earnings call or Web cast), the issuer will need to file a transcript of the oral disclosure under Item 12 of Form 8-K unless:

    • the disclosure occurs within 48 hours of a related written release furnished on Form 8-K;
    • the information is broadly accessible to the public by conference call or Web cast;
    • the financial and statistical information contained in the presentation is provided on the company's Web site (with any information that would be required under Regulation G); and
    • the presentation was announced by a widely disseminated press release.

Practical Tip: File Form 8-K for Earnings Release in Advance of Earnings Call.

In order to avoid the obligation to file a second Form 8-K relating to oral disclosures on an earnings call (in addition to the Form 8-K for the written earnings release), a company should ensure that its earnings calls happen within 48 hours after its earnings releases and that the Form 8-K for the related earnings release has been filed with the SEC by the time of the earnings call. In addition, in light of Regulation G and Item 12 of Form 8-K's oral disclosure provisions, companies will need to post to their Web sites in advance of their earnings calls any material information to be discussed on the call that goes beyond the contents of the earnings release, including any required Regulation G disclosure if non-GAAP information is included.


Form 8-K, Item 12 Applies Only to Historical Information

Item 12 applies only to earnings releases concerning a fiscal period that has ended; it does not apply to earnings estimates for future or ongoing fiscal periods, unless those estimates accompany information about past fiscal periods as well. If an earnings release contains both past and future earnings information, the forward-looking information may be simultaneously furnished for purposes of both Regulation FD disclosure (Item 9) and new Item 12, as long as the Regulation FD time frame is met.

Repetition of previously disclosed information (or the release of the same information in a different form, such as in an annual report to shareholders) does not trigger a new requirement to furnish that information under Item 12. However, to the extent that any such financial information previously furnished under Item 12 contains a non-GAAP financial measure, the information must also satisfy the requirements of Regulation G, as well as the new Regulation S-K requirements concerning management's belief as to the utility of and reason for furnishing the non-GAAP measures.

How Are Foreign Private Issuers Affected?

Regulation G will apply to financial disclosure made by foreign private issuers, unless:

  • the issuer's securities are listed on an exchange outside the United States;
  • the non-GAAP measure is not derived from or based on a measure calculated under U.S. GAAP; and
  • the disclosure is made or released outside of the United States (even if a contemporaneous or later public disclosure is made in, but not targeted to investors in, the United States).

The amendments of Regulation S-K will apply to Form 20-F. However, a financial measure that Regulation S-K might now prohibit could be included in a Form 20-F if the non-GAAP financial measure is required or expressly permitted under the GAAP standard of the issuer's primary financial statements and if included in the annual report or financial statements used in the issuer's home jurisdiction.

Text of the Final Rules

This Update is intended only as a summary of the SEC's final rules. You are encouraged to review the full text of the rules at www.sec.gov/rules/final/33-8176.htm. You can find further discussion of the Sarbanes-Oxley Act and of other recent laws, regulations and rule proposals of interest to public companies on our website.

 

Sign up for the latest legal news and insights  >