On July 24, 2018, the Securities and Exchange Commission (SEC) proposed amendments to the financial disclosure requirements in Rules 3-10 and 3-16 of Regulation S-X, in an effort to simplify and streamline disclosures by registrants in registered debt offerings with respect to guaranteed or collateralized debt securities. Rule 3-10 addresses the financial disclosure requirements for guarantors and issuers of guaranteed securities, while Rule 3-16 focuses on financial disclosure requirements for affiliates whose securities constitute a substantial portion of the collateral for securities offered. Both sets of disclosure requirements affect not only the issuer’s offering documents, but also its periodic filings. The SEC stated that the proposed amendments are “intended to provide investors with material information given the specific facts and circumstances, make the disclosures easier to understand, and reduce the costs and burdens to registrants.” The review of the requirements and proposed amendments to Rule 3-10 and 3-16 stem from the SEC’s Disclosure Effectiveness Initiative. The proposed rules follow the SEC’s 2015 request for comments on these requirements. This Legal Update summarizes the SEC’s proposed amendments.
The Center for Audit Quality (CAQ) recently published “Non-GAAP Measures: A Roadmap for Audit Committees” (CAQ Roadmap), which examines themes that emerged from a series of 2017 roundtables hosted by CAQ with various stakeholders. The CAQ publication notes that audit committees have an important responsibility to oversee the financial reporting process and external audit.
The CAQ report notes that the audit committee can act as a bridge between management and investors, assess management’s reasons for presenting non-GAAP measures and evaluate the sufficiency of related disclosures. It adds that the audit committee can determine whether the measures present a fair and balanced view of company performance. CAQ lays out a three-fold roadmap for audit committee members: (1) identify key discussion topics with management, counsel and external auditors, (2) understand the external auditor’s role regarding non-GAAP measures and (3) adopt leading practices to support the presentation of high-quality non-GAAP measures. With respect to item (1), CAQ suggests that audit committee members consider topics for dialogue including: asking management whether it has internal guidelines for determining how non-GAAP measures are generated, calculated and presented; seeking the perspective of counsel on non-GAAP measures; asking the company to benchmark such measures to those of its peers; and finding out what disclosure controls and procedures are in place. With respect to item (2), while external auditors do not audit non-GAAP measures as part of their financial statement or ICFR audits, audit committees and management may consider external auditors as a resource when evaluating such measures and may ask them to perform certain procedures, such as testing controls related to the preparation and use of such measures in light of management’s polices, and to report such results to them. Last, the audit committee and management should consider adopting best practices, such as subjecting non-GAAP measures to robust disclosure controls, and adopting guidelines to follow when preparing and presenting non-GAAP measures to stakeholders.
On April 4, 2018, the staff of the SEC’s Division of Corporation Finance (Staff) updated its Compliance & Disclosure Interpretations on the use of non-GAAP financial measures (C&DIs), by issuing two new C&DIs (C&DI 101.02 and C&DI 101.03). These new C&DIs provide that, under certain conditions, financial measures included in forecasts used in business combination transactions are excluded from the definition of non-GAAP financial measures.
To recall, in October 2017, the Staff clarified in C&DI 101.01 that financial measures provided to a financial advisor would be excluded from the definition of non-GAAP financial measures, and therefore not subject to Item 10(e) of Regulation S-K and Regulation G, if and to the extent: (1) the financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and (2) the forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor’s analyses or substantive work.
New C&DI 101.02 now provides that a registrant can rely on the exemption provided by C&DI 101.01 if the same forecasts provided to its financial advisor are also provided to its board of directors or a board committee. In addition, new C&DI 101.03 clarifies that financial measures in forecasts provided by a registrant to bidders in business combinations would also be excluded from the definition of non-GAAP financial measures, if a registrant determines that such forecasts are material and that disclosure of such forecasts is required to comply with the anti-fraud and other liability provisions of the federal securities laws.
A copy of the updated C&DIs is available here.