On September 30, 2020, amidst a blizzard of cases filed at the end of the Securities and Exchange Commission’s fiscal year, the SEC announced a settlement with BGC Partners, Inc. (“BGC”) involving allegedly misleading disclosures concerning how it calculated a key non-GAAP financial measure (“NGFM”).[1]   This settlement is the latest in a string of enforcement actions relating to what the SEC views as improper uses of NGFMs.  In advance of year-end reporting, this action is a useful reminder to companies to carefully consider the SEC guidance and recent enforcement actions related to NGFMs.  At least 95% of all Fortune 500 companies publish NGFMs, and the SEC has indicated that it will be reviewing NGFMs with particular scrutiny this year-end in light of the challenges of reporting on performance during the COVID-19 pandemic.

SEC Focus on NGFMs

In addition to the general antifraud provisions of the federal securities laws governing false or misleading financial disclosures, two other provisions specifically govern companies’ use of NGFMs.  The first is Item 10(e) of Regulation S-K of the Securities Act of 1933, which applies when a reporting company uses NGFMs in a 10-K, a 10-Q or an earnings release.  The second is Regulation G of the Securities Exchange Act of 1934, which applies when a reporting company uses NGFMs in other public disclosures.

Following an increased use of NGFMs by reporting companies and growing concern over their possibly misleading impact on investors, the SEC issued Compliance & Disclosure Interpretations in 2016 that set forth its interpretations of these rules.[2]  Since then, the SEC has issued a number of comment letters on the use of NGFMs, providing companies with additional guidance on the use of these measures, and initiated a number of enforcement actions.  It is thus critical for registrants to understand both the SEC’s guidance as well as the recent actions it has brought in the space.

The SEC’s focus on the use of NGFMs appears to have increased during the global pandemic.  At the onset of the pandemic, the SEC’s Division of Corporation Finance issued guidance related to the use of NGFMs in the context of COVID-19.[3]  That guidance provided that subject to certain conditions, the SEC “would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results” in instances where “a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by COVID-19-related adjustments that may require additional information and analysis to complete.”  In such a situation, the SEC advised that companies using NGFMs should address “why management finds the measure or metric useful and how it helps investors assess the impact of COVID-19 on the company’s financial position and results of operations.”  In addition, the SEC reminded companies that it “do[es] not believe it is appropriate for a company to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company.”

Bill Hinman, the Director of the Division of Corporation Finance, commented on the types of NGFMs that the Division has been seeing in light of the pandemic, noting that some—such as measures that purport to estimate the impact of the pandemic on revenues—have been “pushing the envelope.”[4]  Similarly, at the 2020 “SEC Speaks” program conducted in partnership with the Practicing Law Institute, Division of Enforcement Associate Director Anita B. Bandy stated that the SEC remains focused on enforcement of misleading uses of NGFMs and will be closely reviewing the disclosures of reporting companies at year-end.   And in its 2020 Annual Report, the Division of Enforcement noted that “[a]nother priority for the Division is recommending actions against issuers that distort non-GAAP metrics, key performance indicators, and related disclosures.”[5]

Against this backdrop, the SEC’s recent settlements relating to the use of NGFMs, including against BGC, highlight some useful lessons for reporting companies.

Recent Enforcement Actions Concerning Use of NGFMs

BGC Partners, Inc.

The SEC found that BGC made false and misleading disclosures concerning how it calculated a NGFM called post-tax distributable earnings or “Post-Tax DE.”  To arrive at Post-Tax DE, BGC begins with distributable earnings before taxes or “Pre-Tax DE.”  Then, it multiplies Pre-Tax DE by a distributable earnings (“DE”) tax rate.  From the first quarter of 2015 through the first quarter of 2016, BGC excluded certain expenses from its calculation of Pre-Tax DE; however, it then took into account deductions associated with those same expenses in calculating its DE tax provisions.  In other words, “when calculating Post-Tax DE, BGC took the benefit of a tax deduction without reducing Pre-Tax DE by the amount of the expense that was the basis for the deduction.”  This resulted in artificially low effective DE tax provisions, and artificially inflated Post-Tax DE figures.[6]  Notably, in the 2016 CD&Is, the SEC seemed to warn against precisely this type of treatment, noting that “[a] registrant should provide income tax effects on its non-GAAP measures depending on the nature of the measures,” and that “[i]f a measure is a performance measure, the registrant should include current and deferred income tax expense commensurate with the non-GAAP measure of profitability.”[7]

As a result, the SEC found that BGC made materially false and misleading statements in earnings releases from the first quarter of 2015 through the first quarter of 2016.  BGC had stated that the tax provisions took into account all of the adjustments made in arriving at Pre-Tax DE, and BGC had repeatedly emphasized Post-Tax DE as a key financial measure of its after-tax profitability.[8]

The SEC accordingly found that BGC violated the antifraud provisions of Sections 17(a)(2)–(3) of the Securities Act as well as Sections 13(a) and Rules 13a-11 and 100(b) of Regulation G of the Securities Exchange Act.  BGC was ordered to pay a $1.4 million penalty and to cease and desist from committing future violations.

Other Recent Actions

As noted above, the SEC has for some time been focused on NGFMs.  On July 31, 2020, the SEC settled charges against Bausch Health Companies Inc., formerly known as Valeant Pharmaceuticals International, Inc., for violations of Regulation G and other securities laws in connection with its reporting of certain NGFMs in 2014 and 2015, including “same store organic growth” (growth rates for businesses owned for one year or more) and “cash EPS.”[9]  Valeant’s presentations of these measures were allegedly misleading because they failed to explain the material impacts caused by 1) transactions with a mail order pharmacy that Valeant had ties to, and 2) certain credits Valeant received from wholesalers in connection with the price increase of one of Valeant’s drugs.  The SEC ordered Bausch to pay a $45 million penalty for violations of Regulation G and other securities laws.  It also settled charges against Bausch’s former CEO, CFO, and controller, finding that they violated Regulation G and other securities laws and ordering penalties totaling $375,000.[10]

On August 1, 2019, the SEC settled charges against Brixmor Property Group Inc., a real estate investment trust that is one of the nation’s largest owners and operators of open-air shopping centers, in connection with Brixmor’s alleged manipulation and misstatement of its NGFM “same property net operating income growth rate” between the third quarter of 2013 and the third quarter of 2015.  The SEC found that over a multi-year period, Brixmor made improper accounting adjustments so that this NGFM would appear stable and would fit within Brixmor’s projected ranges, when in fact, the measure was volatile and often fell outside the range of annual guidance.  The SEC found that Brixmor had violated Regulation G and other securities laws and ordered a $7 million penalty.[11]

And on December 26, 2018, the SEC settled charges against the home security business ADT Inc. for violating Item 10(e)(1)(i)(A) of Regulation S-K.  ADT included certain NGFMs in its disclosures, and the SEC found that it failed to afford equal or greater prominence to its GAAP measures.[12]  For example, in the headline of one earnings release, ADT stated that its adjusted EBITDA, a NGFM, was up 8% year-over-year, without mentioning ADT’s net income or loss (the comparable GAAP financial measure) in the headline. Notably, “[o]mitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures” is specifically provided in the 2016 CD&Is as an example of a disclosure that makes NGFMs more prominent in violation of Regulation S-K.[13]

Key Takeaways

The BGC settlement serves as yet another reminder that the SEC has made NGFMs an enforcement priority.  In the context of the pandemic and in light of the significant guidance and the enforcement actions in the last two years, issuers should be mindful of this focus and should review whether their practices around NGFMs are consistent with SEC guidance and recent enforcement settlements.

The 2016 CD&Is, which set forth the SEC’s positions on a number of specific questions, are a useful tool for companies that use NGFMs.  Indeed, as noted above, some of the SEC’s recent enforcement actions against companies for their presentation of NGFMs involve factual circumstances that are addressed in the 2016 CD&Is.  Companies should also verify that they have processes in place to ensure that their NGFMs meet SEC guidance and that any disclosure judgments are documented.  Companies should explain why the metrics are useful to investors and not include them solely to present themselves in a more favorable light.  Finally, issuers should be cognizant that—in addition to the specific provisions addressing the use of NGFMs—the Commission is willing to use the general antifraud provisions of the securities laws to address non-GAAP disclosures it considers false or misleading.

[1] See In the Matter of BGC Partners, Inc., SEC Rel. Nos. 33-10867, 34-90050 (Sept. 30, 2020).

[2] Div. of Corp. Fin., Compliance & Disclosure Interpretations: Non-GAAP Financial Measures, SEC (May 17, 2016, updated Apr. 4, 2018), https://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.

[3] Div. of Corp. Fin., Disclosure Guidance: Topic No. 9, Coronavirus (COVID-19), SEC (Mar. 25, 2020).

[4] Center for Audit Quality, Profession in Focus: A Conversation w/ SEC Division of Corporation Finance Director during COVID-19 at 11:44–14:40, YouTube (Oct. 1, 2020), https://www.youtube.com/watch?v=G2vmhUKg9sk.

[5] Div. of Enf’t, 2020 Annual Report at 10, SEC (Nov. 2, 2020), https://www.sec.gov/files/enforcement-annual-report-2020.pdf; see also From Government Shutdown to COVID-19: SEC Enforcement Division Releases Final Chapter of Jay Clayton-led SEC, Cleary Gottlieb Steen & Hamilton (Nov. 9, 2020), https://www.clearyenforcementwatch.com/2020/11/from-government-shutdown-to-covid-19-sec-enforcement-division-releases-final-chapter-of-jay-clayton-led-sec/.

[6] The expenses at issue involved a lawsuit settlement, partnership unit expenses, and charitable contributions.  For example, BGC did not reduce its Pre-Tax DE to account for a $100 million legal settlement, but then included a $100 million tax deduction associated with that legal settlement expense when it calculated the tax rate in its 2015 Post-Tax DE.  As a result, BGC’s Post-Tax DE was approximately 19% greater in its 2015 earnings release than it would have been had BGC’s calculation not included a tax deduction for that expense.

[7] 2016 CD&Is, supra n.2, at Question 102.11.

[8] In the Matter of BGC Partners, Inc., supra n.1, at 2.

[9] See In the Matter of Valeant Pharms. Int’l, SEC. Rel. Nos. 33-10809, 34-89442 (July 31, 2020).

[10] See In the Matter of J. Michael Pearson, SEC Rel. Nos. 33-10810, 34-89443 (July 31, 2020); In the Matter of Howard B. Schiller, SEC Rel. Nos. 33-10811, 34-89444 (July 31, 2020); In the Matter of Tanya R. Carro, CPA, SEC Rel. Nos. 33-10812, 34-89445 (July 31, 2020).

[11] See In the Matter of Brixmor Prop. Grp., SEC Rel. No. 34-86538 (Aug. 1, 2019).

[12] See In the Matter of ADT Inc., SEC Rel. No. 34-84956 (Dec. 26, 2018); see also SEC Sanctions ADT Over Non-GAAP Financial Measures in Earnings Releases, Cleary Gottlieb Steen & Hamilton (Jan. 9, 2019), https://www.clearygottlieb.com/-/media/files/alert-memos-2019/sec-sanctions-adt-over-non-gaap-financial-measures-in-earnings-releases.pdf.

[13] 2016 CD&Is, supra n.2, at Question 102.10.