For at least a century, it has been said that only three things matter in real estate: location, location, location. Recently, the Securities and Exchange Commission took this old saw to heart in the context of disclosure of non-GAAP financial measures. The SEC's fixation on location began this past May when the staff updated its Compliance and Disclosure Interpretations to provide numerous examples of what constitutes "equal or greater prominence".
Item 10(e)(1)(A) of Regulation S-K requires that whenever an issuer includes a non-GAAP financial measure in an SEC filing, the issuer must include a presentation, with equal or greater prominence, of the most directly comparable financial measure or measures calculated and presented in accordance GAAP. The SEC adopted Item 10(e) in response to Section 401(b) 0f the Sarbanes-Oxley Act of 2002 which directed the SEC to adopt rules with respect to the presentation of "pro forma" financial information. Section 401(b), however, makes no mention of the relative placement of GAAP and non-GAAP financial measures, requiring only that the SEC adopt rules that (i) prohibit the presentation of pro forma financial information that contains an untrue statement, or omission, of a material fact; and (ii) require the reconciliation of pro forma financial information with GAAP. Thus, the SEC's decision to require "equal or greater prominence" in Item 10(e)(1)(A) represented a significant expansion of Congress' mandate. Now, some thirteen years later, the staff has pronounced that it will consider a non-GAAP measure to be more prominent if it precedes the GAAP measure.
There is much to criticize in the staff's sudden and belated focus on location:
- If location were so important, the SEC should have said so thirteen years ago. It is obvious that when presenting GAAP and Non-GAAP financial measures, one of the two measures must necessarily come first. Yet, the the SEC in adopting Item 10(e)(1)(A) made no attempt to define "equal or greater prominence". Had the SEC considered relative position to be important, it could have easily said that the GAAP measure must precede the non-GAAP measure.
- Investors often get their information second-hand. Whether the issuer places the non-GAAP measure first or second, the issuer (and the SEC) have no ability to control how these measures will be republished. Wire services, financial analysts and business writers may choose to republish these measures in different formats and with varying emphasis. Nothing stops a financial publication from headlining an article with a non-GAAP financial measure without any disclosure of the comparable GAAP measure. Thus, the SEC's insistence on the primacy of GAAP in disclosures is as availing as King Canute's command to the incoming tide. See The Chronicle of Henry Huntingdon 199 (T. Forester ed., 1853) ("'Thou, too, art subject to my command, as the land on which I am seated is mine; and no one has ever resisted my commands with impunity. I command you, then, not to flow over my land, nor presume to wet the feet and the robe of your lord.' The tide, however, continuing to rise as usual, dashed over his [King Canute's] feet and legs without respect to his royal person.").
- Investors don't stop reading after the first disclosure. The staff's perseveration on location only makes sense if one believes that investors don't read or pay any attention to any disclosures after the first disclosure. I know of no empirical basis for this position. Even if it were true, it wouldn't matter in an efficient market so long as at least one or a handful of investors read the entire disclosure.
- If the SEC has only recently discovered the importance of location, it should amend Item 10(e)(1)(A). Because the SEC is imposing a new requirement by means of a C&DI, it has bypassed the notice and comment rulemaking provisions of the Administrative Procedure Act. This deprives the issuers of notice and the SEC of public comment. It also reduces the accountability of the Commissioners. Technically, C&DIs represent the views of the staff that have not been approved or disapproved by the Commissioners.
Last Friday, I attended the Los Angeles County Bar Association's 49th Annual Securities Regulation Institute at which the speakers repeatedly emphasized the staff's concerns about the disclosure of non-GAAP financial measures. This was timely and important advice. However, I only wish that there had been at least some questioning of whether the staff's position makes sense.
[Image is King Canute by Alphonse-Marie-Adolphe de Neuville]