SEC Relaxes Guidance on Non-GAAP Financial Measures

January 15, 2010

On January 11, 2010, the Division of Corporation Finance of the Securities and Exchange Commission released new Compliance and Disclosure Interpretations (the “C&DIs”) on the use of non-GAAP financial measures (“NGFMs”). The new C&DIs clarify and, to some extent, relax the Division’s policy on NGFMs. In the past, published guidance and the Division’s comments on filings have combined to discourage companies from including NGFMs in Commission filings, and the new guidance appears intended to change that approach.

The Commission’s rules on the use of NGFMs were adopted in January 2003 pursuant to the Sarbanes-Oxley Act. They are contained in Item 10(e) of Regulation S-K, which generally applies to filings with the Commission, and Regulation G, which generally applies to other public disclosures. After the rules were adopted, on June 13, 2003, the Division published answers to frequently asked questions on NGFMs (the “2003 FAQs”).

The new C&DIs supersede the 2003 FAQs. The full text of the C&DIs is available through the link below. The full text of our memoranda of June 17, 2003 (concerning the FAQs) and January 30, 2003 (concerning the Commission’s adoption of rules governing the use of NGFMs) also are attached for your reference.

Adjusting for Recurring Items

Item 10(e) prohibits adjusting a non-GAAP performance measure for items identified as non-recurring, infrequent or unusual when the nature of the item makes it likely to recur within two years or there was a similar charge or gain within the prior two years.

The C&DIs state that this prohibition is based on the description of the item being adjusted, rather than its nature. In other words, the rule does not prohibit adjustment for recurring items. It prohibits characterizing an item as non-recurring, infrequent or unusual unless it, in fact, meets the specified criteria.

This is the most significant change compared to the 2003 FAQs, which discouraged the use of non-GAAP performance measures that adjust for recurring items. Although they did not prohibit the practice, they articulated burdens and conditions that, together with staff practices under the guidance, led companies to avoid using non-GAAP performance measures unless the adjustments were for non-recurring items only. In particular, the FAQs:

  • noted that it would be difficult to justify a NGFM that excluded restructuring charges where there was a past pattern of restructuring charges, no articulated demonstration that the charges would not continue and no other unusual reason that the issuer could substantiate to identify the special nature of the restructuring charges;
  • conditioned acceptability of a NGFM that eliminated a recurring item on all the facts and circumstances, with acceptability being more likely where management reasonably believed the financial impact of the item probably would disappear or become immaterial in the near term; and
  • indicated that a NGFM that eliminated recurring charges could be misleading absent fairly extensive disclosure addressing how management used the NGFM, the economic substance behind management’s decision to use the NGFM and the NGFM’s material limitations, among other points.

The C&DIs have eliminated this guidance. Rather than imposing additional requirements, the C&DIs appear to be emphasizing clear disclosure and explanation surrounding the use of NGFMs in accordance with Item 10(e). Notably, C&DI 102.03 says: “Registrants can make adjustments they believe are appropriate, subject to Regulation G and the other requirements of Item 10(e) of Regulation S-K.”

No Requirement that the NGFM be Used to Manage the Business

The 2003 FAQs suggested that a company could only present an NGFM if it actually used that measure in managing its business. The C&DIs clarify that a company is not required to use a NGFM in managing its business or for other purposes as a condition to being able to disclose it. Item 10(e) requires only that, to the extent material, the issuer disclose any purpose for which management in fact does use the measure.

Constant Currency Presentation

Companies with international operations often use a constant-currency presentation as a way to isolate the effects of currency variations on their financial performance. The C&DIs clarify that a company that provides a constant-currency presentation can comply with Item 10(e) by presenting the historical results, and describing the process for calculating constant currency and the basis of presentation. The 2003 FAQs were silent on how to comply with Item 10(e) in this circumstance, though many companies had already concluded that no more was required.


The C&DIs do not change the treatment of EBIT and EBITDA in the 2003 FAQs. They continue to take the view that the terms EBIT and EBITDA can only be used as described in the adopting release for the NGFM rules – i.e., as measures that begin with net income and add back interest, taxes and (for EBITDA) depreciation and amortization. In response to this provision, many companies began using other terms, especially Adjusted EBITDA, and – unlike the 2003 FAQs – the C&DIs expressly acknowledge this practice.

Foreign Private Issuers & “Expressly Permitted” NGFMs

Item 10(e) allows a foreign private issuer (“FPI”) to use an otherwise prohibited NGFM if, among other things, the NGFM is required or expressly permitted by the standard setter for the GAAP used in the issuer’s primary financial statements. There has been uncertainty about how to meet this requirement, because many FPIs present non-GAAP measures in home country filings, but it is rare for an accounting standard setter to provide express authorization.

The C&DIs indicate that an issuer can demonstrate express permission by the explicit acceptance of the presentation of the NGFM by the primary securities regulator in the issuer’s home country jurisdiction or market. Explicit acceptance includes:

  • the published views of the regulator or members of its staff; or
  • a letter from the regulator or its staff to the issuer indicating the acceptance of the presentation, which would be provided to the Commission’s staff on request.

This should make it much easier for a FPI to establish that it may use in Commission filings the same measures it presents in home-country filings.

Free Writing Prospectuses

The C&DIs confirm that Item 10(e) applies to a free writing prospectus only if it is included or incorporated by reference in a filing with the Commission. The 2003 FAQs did not cover this point because they predated the advent of free writing prospectuses.

Full Non-GAAP Income Statement

The C&DIs indicate that presenting a full non-GAAP income statement for purposes of reconciling to GAAP generally is impermissible because it may give undue prominence to the non-GAAP information. The 2003 FAQs did not address this point.

Adjusting for Tax Effects

The C&DIs allow an issuer to present an adjustment net of tax when reconciling to GAAP so long as the tax effect of each reconciling item is disclosed parenthetically or in a footnote to the reconciliation, or, alternatively, the tax effect is presented in one line in the reconciliation. The issuer also must disclose how the tax effect was calculated. The 2003 FAQs did not address this topic.

Link to C&DIs

Please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under ”Capital Markets” on this website if you have any questions.