Beginning with the creation of its Financial Reporting and Audit Task Force in July 2013, accounting fraud has been a renewed priority for the SEC.
SEC Announces Enforcement Initiatives to Combat Fin. Reporting and Microcap Fraud and Enhance Risk Analysis, Lit. Rel. No. 2013-121, July 2, 2013. The SEC has brought numerous accounting cases of late regarding earnings management and other alleged fraud; recent activity suggests that its next focus may be the use of non-GAAP measures.
On May 17, 2016, the SEC updated its Compliance & Disclosure Interpretations (“C&DIs”) for non-GAAP financial measures, adding several new C&DIs that address Rule 100(b)’s prohibition on misleading non-GAAP financial measures. SEC,
Non-GAAP Financial Measures Compliance & Disclosure Interpretations. The first new C&DI clearly states that even adjustments that are not explicitly prohibited by Regulation G can still cause a non-GAAP measure to be misleading in a violation of Rule 100(b). For example, the SEC notes that though doing so is not literally prohibited, presenting a performance measure that excludes normal, recurring, cash operating expenses essential to a company’s business model may be misleading. Another updated C&DI states that a non-GAAP measure can be misleading if it is presented inconsistently between time periods. Others note, for example, that Rule 100(b) may be violated if a non-GAAP measure is adjusted only for non-recurring charges when non-recurring gains occurred during the same period.
With these and other new interpretations, the SEC may have effectively raised the bar for accounting and disclosure compliance. Indeed, while in the past the SEC often addressed the use of non-GAAP measures solely through comment letters, the new guidance—especially to the extent that it gives specific examples of things that the SEC staff believes would violate Regulation G—gives the SEC a roadmap to bring future enforcement actions for failure to comply.
Perhaps coincidentally, correspondence between Valeant Pharmaceuticals International Inc. and SEC staff was made public this week highlighting the SEC’s prior approach to non-GAAP measures it found problematic. Michael Rapoport,
SEC Reviewed Valeant’s Use of ‘Non-GAAP’ Financial Measures, Wall St. J., May 24, 2016. The letters show the SEC staff criticizing Valeant’s disclosures as being “potentially misleading” and stated that the SEC staff was “concerned with [Valeant’s] overall format and presentation of the non-GAAP measures.” Specifically, the SEC staff highlighted that Valeant stripped out items, like restructuring and acquisition costs, from its report, even though frequent and large acquisitions comprise a major portion of the Valeant’s business. Valeant’s non-GAAP numbers also assume a low tax rate, which the SEC staff also characterized as “potentially misleading.” Although Valeant defended its metrics as “reasonable,” it also reportedly said it will address the SEC staff’s concerns.
In the future, the SEC may be more likely to bring enforcement actions based on Regulation G, even in the absence of scienter or fraud, for any perceived improper use of non-GAAP measures.
