I wrote in February at MarketWatch about a real estate REIT called Brixmor that used non-GAAP metrics to determine executive compensation, and how a few executives there likely manipulated them to juice their pay. The were all fired for their efforts.
The SEC has yet to weigh in on that case but there’s been no lack of commentary in the last year or so about the use —and abuse—of non-GAAP metrics from the SEC, the lawyers who work with the SEC on their clients’ behalf, and the media.
By May my colleagues at the WSJ had caught on:
Reported earnings faltered last year; to help set bonus payments, many companies relied on pro forma measures
Before that, though, various staff, a Commissioner and the Chairwoman of the SEC had said in several speeches that they were fed up and warning companies that new regulation may be in the works if they didn’t start following the rules, Regulation G, that were already in place.
On April 6, in an article for MarketWatch that attempted to predict which non-GAAP metrics and usage would be most likely to catch the SEC’s eyes and catch trouble for companies, I wrote:
In recent speeches SEC Chairwoman Mary Jo White, SEC chief accountant James Schnurr and SEC Commissioner Kara Stein have all commented on a recent uptick in the use of non-GAAP metrics.
White says the use of non-GAAP metrics can, in some cases, be confusing. Companies, however, say the use of metrics that adjust numbers reported according to Generally Accepted Accounting Principles, or GAAP, in earnings releases, investor presentations and annual and quarterly reports is necessary to tell a better story for investors.James Doty, the chairman of the Public Company Accounting Oversight Board, the audit firm regulator, chimed on the issue while requesting a larger budget from the SEC for the PCAOB’s oversight of the auditors who scrutinize company compliance. “Companies’ use of unaudited and non-GAAP metrics proliferates,” he said.
At that same meeting to approve the PCAOB budget on March 16, Commissioner Kara Stein brought up a recent reversal by Herbalife HLF, +1.51% whose stock price declined by 7% when it disclosed a significant error in calculating a previously advertised measure of growth in new customers. “It appears that investors,” said Stein, “in this case, were relying on this metric.” At a meeting in December of the American Institute for CPAs, the accounting industry trade association, White specifically highlighted this issue. White asked the audience of auditing professionals, “Are there appropriate controls over the calculation of non-GAAP measures?”
The SEC’s Schnurr spelled out the problem for investors in a speech on March 16 to accountants and lawyers who serve pharmaceutical and biotech companies. He reminded the professionals, who were there to learn more about the trends in financial reporting in their industry, that non-GAAP measures are supposed to supplement the information in the financial statements and not substitute for it. The media focus on the figures that move markets doesn’t help. Lately, “when the financial news networks report quarterly earnings,” said Schnurr, “they very frequently report the non-GAAP measure of earnings with no reference to the actual GAAP earnings, often not even identifying it as having been adjusted.”
On April 13 SEC Commissioner Kara Stein later cited my article in a statement to the Commission and others opening a public meeting on a “Concept Release on the Business and Financial Disclosure Required by Regulation S-K”.
I followed up with three stories back-to-back that showed popular usage of non-GAAP metrics—usage that was, and was not, exemplary of what the SEC expects.
The same day my colleague in New York wrote about several other financial reporting issues that have arisen, including non-GAAP metrics, that have made it difficult for journalists, and therefore investors, to get the most out of company earnings announcements.
Here’s how investors are duped each earnings season May 31, 2016 | By Ciara Linnane