An interesting debate is currently taking place at with regard to whether or not the SEC´s rules for non-GAAP reporting are too stringent.

In 2003, the Securities and Exchange Commission (SEC) enacted Regulation G requiring public companies to include in any disclosed non-GAAP financial measure a presentation and reconciliation of the most directly comparable GAAP financial measure. Prompted by a series of major corporate accounting scandals (Enron, AOL, Xerox, etc.), the objective of the Regulation was to prevent companies from presenting a rosier picture of their finances than was justified and to provide investors with a balanced financial disclosure.

In 2010 and 2016, the SEC issued compliance and disclosure interpretations that first (in 2010) relaxed prohibitions on excluding recurring expenses and then (in 2016) tightened interpretations of the Regulation in order to prevent non-GAAP measures being given greater prominence than comparable GAAP measures. The consequence of the 2016 update varies according to whose opinion you read. Some experts feel that the SEC´s rules for non-GAAP reporting are too stringent, while others feel they don´t go far enough.

The SEC´s Rules for Non-GAAP Reporting are Too Stringent

One expert clearly of the opinion that the SEC´s rules for non-GAAP reporting are too stringent is Charles Lundilius – Managing Director of the Berkeley Research Group. Mr. Lundilius disapproves of the rules for non-GAAP reporting that prohibit a company from recognizing revenue at the point when a customer is billed. Although claiming to understand the SEC’s concern about misleading revenue data, he finds it difficult to understand why this information cannot be provided as a non-GAAP metric.

“It merely reflects the fact that a bill was sent to a customer on a certain date”, Mr Lundilius argues on, “and it has a social benefit in that it provides a useful and comparable tool to analysts and other users of financial statements”. He continues his argument by claiming certain SEC´s rules for non-GAAP reporting prevent forensic accountants from monitoring and analyzing fraud, and concludes it with the statement – “The sales-as-billed prohibition is just one example of SEC overreach”.

The Rules are Needed to Keep Companies Honest

Two experts sharing opposing views are Jennifer Biundo and Kris Hutton. Ms. Biundo – a Senior Audit Manager at Mazars USA – argues that non-GAAP reporting can be relevant to help a company present critical operating measures of its business, but if not presented properly and consistently – and within the SEC´s rules for non-GAAP reporting – they can create ambiguities that can disrupt the true picture of a company´s financial health.

Both she and Kris Hutton – the Director of Product Management at ACL – believe the SEC´s rules are a response to faulty reporting standards. Mr. Hutton acknowledges traditional accounting metrics may not always be the most accurate way to judge a company’s value – especially in a fast-moving and evolving economy – but believes the SEC´s rules for non-GAAP reporting encourage better transparency, comparability, and consistency in non-GAAP disclosures.

Maybe it is Too Early to Decide

A fourth expert – Vincent Papa, the Interim Head of Financial Reporting Policy at the CFA Institute – joins the debate by commenting that it may be too early to tell whether the 2016 tightened interpretations of the SEC´s rules for non-GAAP reporting are too stringent. Although concurring with Charles Lundilius on the point that last year’s C&DIs may have adversely affected the usefulness of non-GAAP metrics, he adds that many investors expect sufficient regulatory oversight to ensure reporting is accurate.

The key appears to be balance. If companies only report such metrics to the extent management feels they are important for investors measuring the health of the business, this will likely create friction between analysts and company management. However, as Mr. Papa concludes his argument, the SEC objective of increasing transparency and pushing for greater comparability is aligned with investor interests and should continue – at least until the SEC ´s rules for non-GAAP reporting are universally considered too stringent.