Regulators’ Role in Policing Non- GAAP Measures: How Much is Enough?


A recent study suggests that the SEC's recent crack-down on non-GAAP financial measures (NGFM) isn’t helping investors gain a better understanding of the company’s financial position and insights into future performance. Instead, it might be adding more confusion to the narrative.

A Special Report: Non- GAAP Reporting, released Feb. 21, 2017, by Deb Wasser, Lauren Tarola, Edelman Financial Communications and Brian Matt from Ipreo—a market intelligence firm, asked investment reporting officers from 74 companies “how the new guidance for non-GAAP reporting affected their companies’ quarterly earnings communications and the impact these changes, if any, have had on their investment narrative.”

Their results showed that: 

  • 93 percent of companies had reported some form of non- GAAP metric over the past two years- most commonly were adjusted net income and adjusted or core earnings per share;

  • after the SEC’s update, 80 percent of respondents adjusted the placement and prominence of non-GAAP metrics in their public documents;

  •  86 percent made changes to the press release, 37percent adjusting the earnings call script, while 22 percent made adjustments to their filed documents (including 10 Q /K).

NGFM are financial measures that are neither calculated nor presented in accordance with U.S. generally accepted accounting principles (GAAP). Companies have had to comply with the Securities and Exchange Commission standards since Reg. G was first issued in 2003 to curtail misleading reporting of these measures in the U.S. 

DIDN'T MAKE INVESTMENT STORY CLEARER.

The researchers told Bloomberg BNA Feb, 17 that more than three-quarters of respondents said that adjusting the placement and prominence of the non-GAAP measures wasn’t helpful. Seventy seven percent said the new non-GAAP guidance “has complicated the earnings process and made the press release unnecessarily long and complex.”

Only 8 percent of investment reporting officers received requests from analysts or investors to adjust their display of non-GAAP metrics.  

One investment reporting officer said in the survey that the analysts were complaining that “the changes made the release too difficult to understand, particularly on the interpretation of forward- looking assumptions.”

Gerry Gould, head of investor relations for Haemonetics, said that most companies are already compliant because Reg. G was issued over 10 years ago.

LARGER STUDY BY CFA INSTITUTE.

 Sandra Peters, head of financial reporting policy at the CFA Institute and Vincent Papa, interim head of financial reporting policy for the CFA Institute in London, co-authored Bridging the Gap: Ensuring Effective Non-GAAP and Performance Reporting.

The CFA said that regulators such as the Financial Accounting Standards Board and the International Accounting Standards Board should take a preemptive role in solving this global problem. CFA’s survey results discussed in the paper, showed that 65 percent of respondents expect accounting standard setters to provide guidance related to NGFM. The CFA Institute said that its conclusions were based on a survey of 558 respondents (3.5% response rate). Of the 19 questions asked in the survey, response levels varied from about 400 to 558 responses.

REGULATORS’ PREEMPTIVE ROLE.
Regulators should focus on strengthening the overall performance reporting frameworks so that non-GAAP measures remain only as "supplemental and informative measures—and not to undermine or supplant GAAP/IFRS measures of performance, liquidity, and financial performance, Papa said.

Other regulators such as the European Securities Markets Authority (ESMA) and the International Organization of Securities Commission (IOSCO) have issued similar guidance to the SEC May 17 update of the Non-GAAP rules and guidelines with specific examples that spell out what measures the commission would consider “misleading,” Papa told Bloomberg BNA Jan. 25, 2017.

‘INSUPERABLE GOAL.’
Papa said CFA acknowledged that NGFM will likely be needed by investors for the foreseeable future since existing financial statements are general purpose in nature and it is likely an “insuperable” goal to have a one-size -fits -all performance-reporting model that reflects every conceivable business model for different industries.
The best damage control would be done, Papa suggested, by involving a “range of actors.”

Companies should exercise “robust oversight” of their use of NGFMs. Audit committees, described by Papa as the “voice of the investor within companies,” should push for greater oversight and exercise professional skepticism in evaluating the NGFMs used.

The CFA Institute survey found that 80.8 percent of survey respondents did not consider NGFMs to be sufficiently reliable without some form of auditor assurance.

The Center for Audit Quality’s executive director Cindy Fornelli said Dec. 5, 2016 that while auditors don’t audit non-GAAP metrics, it would be a good idea if audit committees and management used auditors as a resource to assist in their evaluation.