Stroock Special Bulletin
SEC Adopts Final Rules on Use of Non-GAAP Financial Measures
Section 401(b) of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) directs the Securities and Exchange Commission (the “SEC”) to adopt rules requiring that pro forma financial information included in any periodic or other report filed with the SEC pursuant to the securities laws, or in any public disclosure or press or other release, be presented in a manner that:
- does not contain an untrue statement of a material fact or omit to state a material fact necessary in order to make the pro forma financial information, in light of the circumstances under which it is presented, not misleading; and
- reconciles it with the financial condition and results of operations of the issuer under generally accepted accounting principles (“GAAP”).
On January 22, 2003, the SEC released rules and amendments (the “Final Rules”) that implement the requirements of Section 401(b). The centerpiece of the Final Rules is Regulation G, which requires public companies, other than investment companies, that disclose or release non-GAAP financial measures (defined below), to include in that disclosure or release a presentation of “the most directly comparable” GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure to “the most directly comparable” GAAP financial measure.
The Final Rules also include:
- amendments to Item 10 of Regulation S-K and Item 10 of Regulation S-B to provide additional guidance to registrants regarding the use of non-GAAP financial measures in filings with the SEC;
- amendments to Form 20-F that incorporate the amendments to Item 10 of Regulation S-K into that form; and
- amendments that require registrants to furnish to the SEC, on Form 8-K, earnings releases or similar announcements.
This Stroock Special Bulletin summarizes Regulation G, the amendments to Form 8-K, and certain related issues.
The Final Rules will be effective March 28, 2003. Regulation G will apply to all subject disclosures as of March 28, 2003. The requirement to furnish earnings releases and similar materials to the SEC on Form 8-K will apply to earnings releases and similar announcements made after March 28, 2003. The amendments to Item 10 of Regulation S-K, Item 10 of Regulation S-B and Form 20-F will apply to any annual or quarterly report filed with respect to a fiscal period ending after March 28, 2003.
Definition of Non-GAAP Financial Measures
A non-GAAP financial measure is defined, for purposes of Regulation G, as a numerical measure of a registrant's historical or future financial performance, financial position or cash flows that:
- excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the issuer; or
- includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented.
The SEC adopting release (the “Release”) lists two examples of non-GAAP financial measures:
- a measure of operating income that excludes one or more expense or revenue items that are identified as "non-recurring"; and
- EBITDA, which could be calculated using elements derived from GAAP financial presentations but, in any event, is not presented in accordance with GAAP.
The Release notes that for foreign private issuers whose primary financial statements are prepared in accordance with U.S. generally accepted accounting principles, “GAAP” refers to the principles under which those primary financial statements are prepared. In the case of foreign private issuers that include a non-GAAP financial measure derived from or based on a measure calculated in accordance with U.S. generally accepted accounting principles, “GAAP” refers to U.S. generally accepted accounting principles for purposes of the application of the requirements of Regulation G to the disclosure of that measure.
Financial Measures Excluded from Regulation G
The Release lists two general exclusions from the definition of “non-GAAP financial measures”:
- operating and other statistical measures (such as unit sales, numbers of employees, numbers of subscribers, or numbers of advertisers); and
- ratios or statistical measures that are calculated using exclusively one or both of (i) financial measures calculated in accordance with GAAP; and (ii) operating measures or other measures that are not non-GAAP financial measures.
According to the Release, the definition does not include financial information “that does not have the effect of providing numerical measures that are different from the comparable GAAP measure.” The Release lists the following specific examples of measures to which Regulation G does not apply:
- disclosure of amounts of expected indebtedness, including contracted and anticipated amounts;
- disclosure of amounts of repayments that have been planned or decided upon, but not yet made;
- disclosure of estimated revenues or expenses of a new product line, so long as such amounts were estimated in the same manner as would be computed under GAAP; and
- measures of profit or loss and total assets for each segment required to be disclosed in accordance with GAAP.
The Release states that the definition of non-GAAP financial measures is not intended to capture “all measures that have the effect of depicting either a measure of performance that is different from that presented in the financial statements, such as income or loss before taxes or net income or loss, as calculated in accordance with GAAP; or a measure of liquidity that is different from cash flow or cash flow from operations computed in accordance with GAAP.” Among the ratios and measures that would not be “non-GAAP financial measures” are:
- sales per square foot (assuming that the sales figure was calculated in accordance with GAAP);
- same store sales (again assuming the sales figures for the stores were calculated in accordance with GAAP); and
- a measure of operating margin calculated by dividing revenues into operating income, where both revenue and operating income are calculated in accordance with GAAP. Conversely, if either revenue or operating income, or both,were not calculated in accordance with GAAP, the ratio would be considered a “non-GAAP financial measure.”
The Release notes that there is an exclusion from the definition of "non-GAAP financial measure” for financial measures required to be disclosed by GAAP, SEC rules, or a system of regulation of a government or governmental authority or self-regulatory organization that is applicable to the company. Examples of such financial measures are measures of capital or reserves calculated for such a regulatory purpose.
Scope of Regulation G
Regulation G applies to any entity that is required to file reports pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), other than a registered investment company. Regulation G “applies whenever such a registrant, or a person acting on its behalf, discloses publicly or releases publicly any material information that includes a non-GAAP financial measure.”
Foreign Private Issuers
Regulation G does not apply to public disclosure of a non-GAAP financial measure by, or on behalf of, a foreign private issuer if:
- the foreign private issuer’s securities are listed or quoted on a securities exchange or inter-dealer quotation system outside the United States;
- the non-GAAP financial measure is not derived from, or based on, a measure calculated and presented in accordance with U.S., GAAP; and
- the disclosure is made by or on behalf of the foreign private issuer outside the United States, or is included in a written communication that is released by or on behalf of the foreign private issuer outside the United States.
According to the Release, because of the worldwide availability of information properly disclosed outside the United States, and the interests of U.S. investors in information communicated by, or on behalf of, issuers outside the United States, the exception for foreign private issuers should continue to apply even where any one or more of the following circumstances are present:
- a written communication is released in the United States, as well as outside the United States, so long as the communication is released in the United States contemporaneously with or after the release outside the United States and is not otherwise targeted at persons located in the United States;
- foreign journalists, U.S. journalists or other third parties have access to the information;
- the information appears on one or more web sites maintained by the registrant, so long as the web sites, taken together, are not available exclusively to, or targeted at, persons located in the United States; or
- following the disclosure or release of the information outside the United States, the information is included in a submission to the SEC made under cover of a Form 6-K.
Disclosure Relating to Proposed Business Combination Transactions
Regulation G includes an exception for non-GAAP financial measures included in disclosure that relates to a proposed business combination transaction, the entity resulting from the business combination transaction, or an entity that is a party to the business combination transaction, provided the disclosure is contained in a communication that is subject to the SEC communications rules applicable to business combination transactions.
Disclosure Required by Regulation G
Regulation G provides that a registrant, or a person acting on its behalf, “shall not make public a non-GAAP financial measure that, taken together with the information accompanying 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.”
The Release advises registrants to consider “whether a change in the method of calculating or presenting a non-GAAP financial measure from one period to another, without a complete description of the change in that methodology,” complies with this requirement of Regulation G.
Under Regulation G, whenever a company that is subject to Regulation G, or a person acting on its behalf, publicly discloses any material information that includes a non-GAAP financial measure, the following information is required as part of that disclosure:
- a presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP; and
- a reconciliation (by schedule or other clearly understandable method), which shall be quantitative for historic measures and quantitative, to the extent available without unreasonable efforts, for prospective measures, of the differences between the non-GAAP financial measure presented and the most directly comparable financial measure or measures calculated and presented in accordance with GAAP.
If a non-GAAP financial measure is released “orally, telephonically, by webcast, by broadcast, or by similar means,” the registrant may provide the required Regulation G disclosure by:
- posting that information on the registrant's web site; and
- disclosing the location and availability of the required accompanying information during its presentation.
For the reconciliation of non-GAAP financial measures that are forward-looking, Regulation G requires a schedule or other presentation detailing the differences between the forward-looking non-GAAP financial measure and the appropriate forward-looking GAAP financial measure.“If the GAAP financial measure is not accessible on a forward-looking basis, the registrant must disclose that fact and provide reconciling information that is available without an unreasonable effort.” Additionally, the registrant must identify information that is unavailable and disclose its probable significance.
Guidance on Determination of Most Directly Comparable Financial Measure
The SEC states in the Release that “it is most appropriate to provide registrants with the flexibility to best make the determination as to which is the ‘most directly comparable financial measure’ calculated and presented in accordance with GAAP.” Consequently, the Release does not include a specific definition of that term, although it does contain the following general guidance:
[O]ur staff has been, and continues to be, of the view that (1) non-GAAP financial measures that measure cash or ‘funds’ generated from operations (liquidity) should be balanced with disclosure of amounts from the statement of cash flows (cash flows from operating, investing and financing activities); and (2) non-GAAP financial measures that depict performance, should be balanced with net income, or income from continuing operations, taken from the statement of operations.
The Release notes that neither the requirements of Regulation G nor a person's compliance or non-compliance with those requirements will, in itself, affect any person's liability under Section 10(b) of the Exchange Act or Rule 10b-5 thereunder. However, “[d]isclosure pursuant to Regulation G that is materially deficient may, in addition to violating Regulation G, give rise to a violation of Section 10(b) or Rule 10b-5 thereunder if all the elements for such a violation are present.”
In addition, under Section 3(b) of Sarbanes-Oxley, a violation of Sarbanes-Oxley or the SEC's rules thereunder will be treated for all purposes as a violation of the Exchange Act. If a registrant, or any person acting on its behalf, does not comply with Regulation G, either or both of them could be subject to an SEC enforcement action alleging violations of Regulation G. Additionally, if the facts and circumstances warrant, it is possible for the SEC to bring an action under both Regulation G and Rule 10b-5.
New Item 12 of Form 8-K: Disclosure of Results of Operations and Financial Condition
Item 12 Requirement to Furnish Form 8-K to SEC
The Final Rules amend Form 8-K to add new Item 12, "Disclosure of Results of Operations and Financial Condition," which requires registrants to furnish to the SEC all releases or announcements disclosing material non-public financial information about completed annual or quarterly fiscal periods. The Release notes that Item 12 does not obligate companies to issue earnings releases or similar announcements; however, such releases and announcements will trigger the requirements of Item 12.
Under Item 12, registrants must furnish a Form 8-K to the SEC within five business days of making any “public announcement or release disclosing material non-public information regarding a registrant's results of operations or financial condition for an annual or quarterly fiscal period that has ended.” This requirement applies regardless of whether the release or announcement includes disclosure of a non-GAAP financial measure. Item 12 also requires the registrant to identify the announcement or release and include it as an exhibit to the Form 8-K.
Item 12 Requirements in the Event of Repeated, Additional, or Updated Disclosure
The disclosure requirements of Item 12 would not be triggered by additional, subsequent public disclosure of the same information, or disclosure in a different form (for example, in an interim or annual report to shareholders), of information that was publicly disclosed previously. According to the Release, this would be true even if the repeated information were accompanied by additional information, whether or not already public, provided that additional information was not material. However, the release of “additional or updated material non-public information regarding the registrant's results of operations or financial condition for a completed fiscal year or quarter would trigger an additional Item 12 obligation.” (Emphasis added).
According to the Release, registrants that make earnings announcements or other disclosures of material non-public information regarding a completed fiscal quarter or year in an interim or annual report to shareholders are permitted to specify in the Form 8-K which portion of that report contains the information required to be furnished under Item 12. The requirement to furnish a Form 8-K under Item 12 would not apply to registrants that make these announcements and disclosures only in their quarterly reports filed with the SEC on Form 10-Q (or 10-QSB) or their annual reports filed with the SEC on Form 10-K (or 10-KSB).
Exception for Certain Oral, Telephonic, Webcast, Broadcast or other Similar Disclosure
Item 12 also includes an exception from its requirements where non-public information is disclosed orally, telephonically, by webcast, by broadcast, or by similar means in a presentation that is complementary to, and occurs within 48 hours after, a related, written release or announcement that triggers the requirements of Item 12. Under Item 12, the registrant need not furnish an additional Form 8-K with regard to such information if:
- the related, written release or announcement has been furnished to the Commission on Form 8-K pursuant to Item 12 prior to the presentation;
- the presentation is broadly accessible to the public by dial-in conference call, webcast or similar technology;
- the financial and statistical information contained in the presentation is provided on the registrant's web site, together with any information that would be required under Regulation G; and
- the presentation was announced by a widely disseminated press release that included instructions as to when and how to access the presentation and the location on the registrant's web site where the information would be available.
Disclosure Relating to Future of Ongoing Fiscal Periods
Item 12 applies only to publicly disclosed or released material, non-public information concerning an annual or quarterly fiscal period that has ended. Though such disclosure may also include forward-looking information, the Release notes that it is the disclosure of material information about the completed fiscal period that triggers Item 12. As such, Item 12 will not apply to public disclosure solely of earnings estimates for future or ongoing fiscal periods.
Significance of “Furnishing” vs. “Filing” Form 8-K
According to the Release, the fact that Item 12 requires registrants to "furnish" a Form 8-K to the SEC, rather than to "file" a Form 8-K with the SEC is important for the following reasons:
- information that is "furnished” to the SEC is not subject to Section 18 of the Exchange Act unless the registrant specifically states that the information is to be considered "filed";
- information that is "furnished” to the SEC is not incorporated by reference into a registration statement, proxy statement or other report unless the registrant specifically incorporates that information into those documents by reference; and
- unlike “filed” information, information that is "furnished” to the SEC is not subject to the requirements of amended Item 10 of Regulation S-K or Item 10 of Regulation S-B.
Additional Disclosure Under Item 10(e)(1)(i) of Regulation S-K
Under Regulation G, registrants that include non-GAAP financial measures in earnings releases and similar disclosures, will be required to disclose:
- the reasons why the registrant’s management believes that presentation of the non-GAAP financial measure provides useful information to investors regarding the registrant's financial condition and results of operations; and
- to the extent material, any additional purposes for which the registrant's management uses the non-GAAP financial measure that are not otherwise disclosed.
Registrants may satisfy this requirement by:
- including the disclosure in the Form 8-K or in the release or announcement that is included as an exhibit to the Form 8-K; or
- including the disclosure in their most recent annual report filed with the SEC (or a more recent filing) and by updating those statements, as necessary, no later than the time the Form 8-K is furnished to the SEC.
Relationship of Item 12 to Regulation FD
Earnings releases and similar disclosures that trigger the requirements of Item 12 are also subject to Regulation FD. The requirements of Item 12 always implicate Form 8-K for those disclosures, and Form 8-K can be used as an alternative means of satisfying the requirements of Regulation FD. However, as noted in the Release:
a Form 8-K furnished to the SEC pursuant to Item 9 would satisfy an issuer's obligation under Regulation FD only if the Form 8-K were furnished to the SEC within the time frame required by Regulation FD. Regulation FD could be satisfied by public disclosure other than through the filing of a Form 8-K meeting Regulation FD's requirements; in that case, Item 12 would require that a Form 8-K be furnished to the SEC within the five business day timeframe of Item 12. A Form 8-K furnished within the timeframe required by Regulation FD, and otherwise satisfying the requirements of both Item 9 and Item 12, will satisfy both requirements and need only be furnished to the SEC once, if the Form 8-K indicates that it is being furnished under both Item 9 and Item 12.