At the end of last year, in an enforcement action brought by the Division of Enforcement of the Securities and Exchange Commission (SEC) against ADT Inc. (ADT), reporting companies were reminded that the SEC continues to focus on noncompliant use of non-GAAP financial measures.
The SEC found that ADT disclosed non-GAAP financial measures in two earnings releases without presenting the most directly comparable GAAP figure with “equal or greater prominence,” as required by Item 10(e) of Regulation S-K.
Specifically, ADT presented adjusted earnings before interest, tax, depreciation and amortization (EBITDA) in a headline to its full year financial results headline for 2017 and adjusted EBITDA, adjusted net income and adjusted net income per share in the highlights section of its 2018 first quarter earnings release without preceding such disclosure with the most directly comparable GAAP financial measure. ADT agreed to pay a civil penalty of $100,000 to settle the enforcement action.
A copy of the SEC’s final order in the ADT action can be accessed here.
The SEC May Use Enforcement Actions to Address Noncompliant Disclosures of Non-GAAP Financial Measures
The ADT enforcement action marked the first time the SEC found a violation of Section 13(a) of the Exchange Act of 1934 without finding that the disclosure in question was also a material misstatement or omission.
In addition, and equally noteworthy, the ADT enforcement action signaled a departure from the SEC’s past practice of generally using comment letters to address technical rule violations, and demonstrated the SEC’s willingness to utilize enforcement actions, when appropriate, to address noncompliant disclosures of non-GAAP financial measures.
Disclosure Process Considerations
While the 2016 enforcement sweep by the SEC may be in the rearview mirror, the SEC has, at a minimum, signaled that it has noticed a relaxation in attentiveness to the presentation requirements for non-GAAP financial measures. Reporting companies should consider whether their non-GAAP presentation practices require modification to ensure compliance with the equal or greater prominence requirement and the other provisions of Item 10(e).
To that end, reporting companies are encouraged to review the Compliance and Disclosure Interpretations (C&DIs) issued by the SEC regarding non-GAAP financial measures, which were last updated in April 2018, in connection with the preparation of filings containing non-GAAP financial measures. In particular, as it relates to the issues raised in the ADT enforcement action, reporting companies should refer to Question 102.10 of the C&DIs, which provides examples of disclosures that would cause a non-GAAP financial measure to be more prominent than a GAAP financial measure.
In the answer to Question 102.10 the SEC, among other things, specifically mentions the following as being noncompliant with the equal or greater prominence requirement of Item 10(e):
- Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures
- Presenting a non-GAAP measure before the most directly comparable GAAP measure (including in an earnings release headline or caption)
- Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent description to the comparable GAAP measure
- Providing discussion and analysis of a non-GAAP measure without similarly discussing the comparable GAAP measure in a location of equal or greater prominence
If you have questions about this or other issues related to securities filings, please contact any member of our Corporate & Securities Practice for more information.
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