SEC Removes Roadblocks to
Use of Non-GAAP Measures in Filings

January 28, 2010

New SEC staff guidance published this month indicates a more nuanced and sophisticated view of non-GAAP measures than has tended to apply since Regulation G was enacted in 2003.  New Compliance & Disclosures Interpretations (C&DIs) replace previously published interpretations and permit companies to use non-GAAP measures to exclude even items that do not meet the SEC definition of “nonrecurring”.  The C&DIs suggest that the staff increasingly recognizes that non-GAAP measures can be an important tool for giving investors insight into what is really going on behind the GAAP numbers.  The new guidance also reflects an awareness that the staff’s prior view was causing companies to tell the story one way in its SEC filings and another way in press releases and other communications.


By way of reminder, the SEC expressly regulates the use of non-GAAP measures at two levels.  Regulation G, which applies to all communications made by companies, is an antifraud provision that prohibits the misleading use of non-GAAP measures and that requires that these measures be reconciled to the corresponding GAAP measures.  The more detailed Item 10(e) of Regulation S-K, which applies to the use of non-GAAP measures in SEC filings, says among other things that a company may not adjust, eliminate or smooth items identified as non-recurring, infrequent or unusual, where the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years.


Exclusion of Recurring Items No Longer Prohibited 

The lead story in the new C&DIs is the omission of language contained in the prior interpretations that had effectively blocked the use in SEC filings of non-GAAP measures that excluded recurring items. 


The SEC had previously said that companies seeking to exclude a recurring item in a non-GAAP measure in a filing would need to “meet the burden of demonstrating the usefulness” of that measure”.  This hurdle, as elaborated upon in comment letters issued by the staff in the early years after the adoption of the rule, effectively precluded the use of these measures in filings (although not in press releases, investor presentations, and other unfiled communications). The new C&DIs omit this language and revert to what the rule actually says: companies may not call an item “non-recurring, infrequent or unusual” (or, even worse, “one-time”) if it meets the two year rule described above. But an item that is deemed recurring under this test may still be excluded in a non-GAAP measure so long as the company discloses why management believes the measure to be useful to investors and otherwise complies with the requirements of Item 10(e).


Use of Non-GAAP Measure in Managing Business No Longer a Prerequisite to Use 

Item 10(e) of Regulation S-K also requires disclosure, to the extent material, of the additional purposes, if any, for which a company’s management uses the non-GAAP financial measure. The staff had previously suggested that this meant that only non-GAAP measures used by management in managing the business could be presented in filings. The new C&DIs provide that there is no prohibition against disclosing a non-GAAP measure that is not used by management. In keeping with this point, the C&DIs omit the suggestion in the prior interpretation that it would be difficult to justify the use of segment measures that were not reported to or used by the chief operating decision maker.


Constant Currency 

The C&DIs also provide that companies can satisfy the Regulation G and Item 10(e) reconciliation requirements with respect to financial information presented in constant currency by simply presenting the historical amounts and constant currency amounts along with a description of the process for calculating the constant currency amounts and the basis of presentation. For companies that have operations in various foreign countries, this is a helpful confirmation that no further reconciliation is required.


Practical Implications 

Translating this to a real world context, the staff’s prior position meant that non-GAAP measures backing out restructuring charges and other non-operating items have generally been excluded from filings, either in response to or in anticipation of staff comments, even though investors are often acutely interested in these measures and even though companies have routinely provided this information in other contexts. The change in SEC policy is designed to bring the worlds of SEC filings and of other communications closer together.


Based on preliminary discussions with the Division of Corporation Finance, we expect that going forward the staff will be looking for a greater degree of consistency between a company’s use of permitted non-GAAP measures in its filings and in other investor communications.  Companies should consider whether it is appropriate in their filings to continue to omit permitted non-GAAP measures that are provided elsewhere, and should be prepared to justify the approach they take in anticipation of staff comments.   And so we may be coming full circle: companies that have in the past sought to use non-GAAP measures in their filings and eventually, under pressure from the staff, given up, may now conclude that they are required to use non-GAAP measures in their filings.




If you have any questions regarding this memorandum, please contact any of the lawyers listed below or your regular Davis Polk contact.

Richard J. Sandler 212 450
William M. Kelly650 752
Richard D. Truesdell, Jr. 212 450
Joseph A. Hall212 450
Michael Kaplan 212 450 4111
Janice Brunner 212 450
Notice: This is a summary that we believe may be of interest to you for general information. It is not a full analysis of the matters presented and should not be relied upon as legal advice. If you would rather not receive these memoranda, please respond to this email and indicate that you would like to be removed from our distribution list. If you have any questions about the matters covered in this publication, the names and office locations of all of our partners appear on our website,
© 2010 Davis Polk & Wardwell LLP