FUZZY EARNINGS MATH DRAWS WRATH OF SEC
Companies are using non- GAAP rules to make numbers look better than they are, so Securities and Exchange Commission cracks down
Prompted by federal regulators, Tesla urged its numbers crunchers to do their work a bit differently last year.
Alarmed by publicly traded companies’ increasing ways to be creative with their income statements, the Securities and Exchange Commission last May updated its standards on how earnings and revenue should be reported in quarterly financial statements. The electric automaker, founded by Elon Musk, became one of the most promi- nent examples of companies working to meet the new standards after being sent a letter from the regulatory agency.
The SEC’s changes aim to crack down on the use of socalled non- GAAP ( Generally Accepted Accounting Principles) in financial results that often look more favorable than the numbers resulting from GAAP, which is the standard guideline for financial accounting in the U. S. The practice is widespread, and the SEC allows some non- GAAP metrics.
“Substantial progress has been made in addressing the problematic practices,” Wesley
Earnings “should be straightforward. If ( a company) had a negative figure and transformed that into a positive, you should know that easily.” Paul Zarowin, an accounting professor at New York University
Bricker, the SEC’s chief accountant, said in a speech in December.
Companies typically use non- GAAP earnings — also called pro forma earnings — to remove the negative impact from one- time special events or revenue that are difficult to record within a specific period. And, while GAAP rules consider stock options awarded to executives a cost, many companies exclude them in non- GAAP presentations to enhance the bottom line.
Companies argue non- GAAP figures allow them to tell a more nuanced story about their performance. But some industry watchdogs say their use hurts investors and undermines transparency.
“I don’t think you ( as an investor) should work that hard,” says Paul Zaro- win, a professor at New York University. Earnings “should be straightforward. If ( a company) had a negative figure and transformed that into a positive, you should know that easily.”
The SEC’s updates technically aren’t rules but are staff interpretation of existing rules. But companies and their lawyers accept the changes as new standards, says Ryan Castillo, a securities attorney at Morrison & Foerster.
Companies found lacking in compliance are sent a letter by the SEC. The SEC can penalize by withholding clearance for paperwork needed for companies’ capital financing, issue fines or bring civil enforcement actions for violations of federal securities laws, he says. Since May, there has been an “uptick” in comment letters issued by the SEC’s Division of Corporation Finance to companies seeking compliance.
Tesla, whose earning statements were notorious for use of non- GAAP figures, said in October it would stop issuing non- GAAP revenue and related financial metrics related to a now- discontinued program that allowed customers to sell a vehicle back at a predetermined price after a few years.
Other companies receiving “please comply” letters include Valeant Pharmaceuticals International, Brookdale Senior Living, Salem Media, Radio One and Lending Club.
Among the SEC’s recent updates on non- GAAP rules:
Recurring events. Companies should no longer strip out recurring, cash operating expenses, particularly if an item is likely to recur or has occurred within two years.
Apples-to- apples comparison. A result comparison must be consistent. The SEC frowns on a measure that adjusts a charge or gain in the current period when a similar charge or gain was not adjusted in prior periods.