SEC Scrutinizing Non-GAAP Disclosures in Financial Statements

Everybody has at least one of those friends who seem to insist on making everything more complicated than it needs to be. They ask for multiple substitutions when ordering at a restaurant. They try to convince everyone to watch the obscure foreign language film instead of the latest blockbuster. They give you directions that involve a convoluted “shortcut” to save you 60 seconds driving across town.

Think of companies that use so-called non-GAAP reporting in their financial statements as those overly complicated friends. In addition to disclosing their quarterly and annual results according to generally accepted accounting principles, these corporations insist on putting their own spin on the financials using alternative metrics. As part of its renewed interest in accounting enforcement, the Securities and Exchange Commission is taking a longer look at how issuers are using these non-GAAP methods.

In December, the SEC Division of Corporation Finance (CorpFin) updated its guidance regarding the rules and regulations for non-GAAP financial measures. Among the major takeaways, non-GAAP metrics excluding “normal, recurring, cash operating expenses necessary to operate a registrant’s business” could be deemed misleading. Additionally, non-GAAP metrics could give financial statement users the wrong impression if the metrics are “calculated using recognition and measurement principles that are inconsistent with the comparable GAAP measure.” Finally, a non-GAAP metric could still qualify as misleading despite “extensive, detailed disclosure about the nature and effect of each adjustment.”

The updates now seem like a warning to companies to get their non-GAAP stories straight. An article published last month in The Wall Street Journal delved into the SEC’s plans to dig deeper on alternative accounting, with critics arguing that companies generally cite non-GAAP metrics to paint an overly rosy picture of their performance. The commission reached out to 20 companies, including rideshare service Lyft Inc. and mattress company Sleep Number Corp., in the first two months of the year with questions about their uses of non-GAAP metrics. In the same period last year, it questioned only 11 issuers.

Meanwhile, the SEC went beyond just asking questions about non-GAAP disclosures by Virginia-based DXC Technology Co. The agency tagged the IT services provider with making misleading disclosures to the public between 2018 and 2020. The order against DXC alleged that the company bumped up the non-GAAP income metrics it was reporting by “negligently misclassifying” expenses as transaction, separation, and integration-related (TSI) costs. Moreover, the commission said DXC lacked adequate controls and procedures for making sure its descriptions of TSI costs matched how the company was classifying its expenses.

Without admitting guilt, DXC agreed to an $8 million penalty among other sanctions as part of its settlement with the SEC. It probably won’t be the last publicly traded company to cut such a deal with the agency.