CLS Blue Sky Blog

Cleary Gottlieb explains SEC’s New Guidance on Non-GAAP Financial Measures

On May 17, 2016, the Division of Corporation Finance of the Securities and Exchange Commission (the “SEC”) released new and updated Compliance and Disclosure Interpretations (“C&DIs”) on the use of non-GAAP financial measures (“NGFMs”).  The release of the C&DIs follows a series of recent speeches by SEC Chair Mary Jo White, Chief Accountant James Schnurr and other staff that expressed concerns over prevalent and liberal use of NGFMs.  The C&DIs signal a tightening of the SEC’s policy toward NGFMs and renewed SEC focus on their use.

One new C&DI deserves special attention.

Among the new and updated C&DIs, Question 100.04 merits highlighting, as it interprets Regulation G to prohibit one type of non-GAAP adjustment that was previously considered permissible.

Question: A registrant presents a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when customers are billed. Can this measure be presented in documents filed or furnished with the Commission or provided elsewhere, such as on company websites?

Answer: No. Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G.

Under this view, if a company presents a non-GAAP revenue measure that backs out the effect of GAAP revenue recognition principles applicable to the company’s business, that measure could be per se misleading and impermissible whether or not the company is otherwise in compliance with the disclosure requirements of Regulation G or Item 10(e) of Regulation S-K.  And the C&DI explicitly states that adding back revenue that would be deferred and recognized ratably over time under GAAP is not permitted.  The C&DI notes that a similar approach to financial statement line items other than revenue may also be problematic.  Furthermore, the applicability of this C&DI to NGFMs subject to Regulation G (and not just Item 10(e) of Regulation S-K) means that non-GAAP adjusted revenue raises concerns when presented in any public disclosure by a SEC-reporting company (including its website and presentation slides that are publicly available) and not just SEC filings or earnings releases.

The SEC’s new stance on non-GAAP adjusted revenue was presaged a few weeks ago in a speech by SEC Deputy Chief Accountant Wesley Bricker at the 2016 Baruch College Financial Reporting Conference.  In this speech, Mr. Bricker provided a more detailed example that illustrates the SEC’s concern:

[C]onsider a company that has a subscription-based business. The company bills for the full subscription at the outset, but since it will deliver over time, it earns and recognizes GAAP revenue over that same period. Now assume this company calculates non-GAAP revenue as though it had a different business. That is, it calculates what revenue it would have had, had it not sold a subscription, but rather had sold a product. The effect of the measure is that the company accelerates revenue recognition to the billing date and proceeds to calculate earnings based on this non-GAAP revenue. . . . In this instance, the measure does not appear to help investors understand and analyze core operating results. Rather, it is a replacement of an important accounting principle with an alternate accounting model that does not match the company’s subscriptions business or earnings process, which is over time.[1]

Mr. Bricker concluded that if a company uses a NGFM that adjusts revenue, it will likely get a comment from the SEC staff, and any justification for the adjustment that the company provides in response will be scrutinized “closely, and skeptically.”

This new C&DI is particularly important because this kind of non-GAAP revenue adjustment, if appropriately presented and explained, was previously thought to be acceptable.  Many companies, including those with a subscription-based business as highlighted by Mr. Bricker, as well as those delivering multiple elements or using percentage-of-completion accounting, have used an adjusted revenue non-GAAP measure to illustrate the amount of new business won in a given period, in contrast to when the related revenue (and cost) will be recognized under GAAP.  These companies will need to reassess their use of this measure in light of the new C&DI.

More generally, this and other C&DIs highlight the importance in the SEC staff’s eyes of the general prohibition on misleading measures, even when the reconciliation and other disclosure requirements of the rules are met.  We expect to publish a more detailed discussion of the other new and updated C&DIs soon.

A blackline of the changes to the C&DI is available as Annex A.


[1] Deputy Chief Accountant Wesley R. Bricker, Remarks before the 2016 Baruch College Financial Reporting Conference (May 5, 2016), available at

The preceding post is based on a memorandum produced by Cleary Gottlieb on May 18, 2016, which is available here.

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