The OSC has issued Staff Notice 52-722 Report on Staff’s Review of Non-GAAP Financial Measures and Additional GAAP Measures.
In the OSC’s terminology, “non-GAAP financial measures are often found in public documents, such as Management Discussion & Analysis (MD&A), press releases, prospectus filings, websites and marketing materials. Additional GAAP measures presented in the financial statements under IFRS are also often found in the above mentioned documents. Issuers choose to present these measures as they believe they provide additional insight into an entity’s overall performance, financial position, or cash flow.”
The new staff notice follows a review of 50 issuers, and generated the following summary comments:
- “The results of our review were disappointing. Many issuers need to improve the quality of their disclosure related to non-GAAP financial measures or additional GAAP measures. Eighty-two percent of issuers reviewed committed to enhance the disclosure in their future filings including changes to address missing or inadequate quantitative reconciliations to the most directly comparable GAAP measure, disclosures explaining why the measures are meaningful to investors and the additional purposes, if any, for why management uses these measures and providing meaningful names when additional GAAP measures are presented in the financial statements. We are concerned that absent improvements in these areas, investors may be confused or potentially misled when non-GAAP financial measures or additional GAAP measures are not presented appropriately.”
Of course, regulators have been worrying about this area for years, although the nature of their concerns was forced to shift somewhat after the transition to IFRS, which is actually quite liberal about the use of such measures. There’s no question the measures can be used to mislead investors, for example by coaxing them into focusing solely on advantageously adjusted earnings numbers; it’s even more misleading where the nature of the adjustments varies between periods. But the worst excesses in this area were curtailed quite a while ago by CSA Staff Notice 52-306, which sets out the regulators’ expectations for presenting items such as EBITDA, including in particular that they be sufficiently caveated and explained, and reconciled to the most comparable amounts in the financial statements.
On these core matters, the new study reports that “20% of issuers did not clearly reconcile the non-GAAP financial measure to the most directly comparable GAAP measure, or did not disclose a reconciliation at all.” This seems like a strangely high percentage given that Staff Notice 52-306 is so well-established, but the notice doesn’t provide any more detail, so it may come down to minor disagreements about what constitutes “clearly” reconciling one thing to another. In other respects, it s hard to share the staff’s supposed disappointment at what they found, the problems being mostly trivial.
Income before the undernoted
For instance, the notice reports: “In some instances, issuers presented ‘income before the undernoted’ on the face of the statement of comprehensive income as an additional GAAP measure. Staff believe that this name is not meaningful nor relevant as this term does not sufficiently describe the measure as it does not tell users which elements are missing from the IFRS measure of income…(and therefore) should not be presented in the financial statements.” But where it’s plain on the face of the statement what the “undernoted” items consist of (interest and tax for example), it’s bizarre to say users can’t just use their eyes (if they can’t, then the fix of laboriously spelling it out in the caption won’t help them anyway). The primary real concern may be more that such captions might be lifted and deployed elsewhere, where the context wouldn’t be obvious, but it’s a dubious strategy to try addressing that issue by twisting behavioural logic into a knot.
The report also makes much of avoiding “boilerplate” about why a particular non-GAAP measure provides useful explanation to investors. For example, whereas “EBITDA is used to provide additional useful information to investors and analysts” typifies boilerplate language, the OSC holds out the following as an example of more acceptable entity-specific disclosure: “Adjusted EBITDA is an important indicator of the issuer’s ability to generate liquidity through operating cash flow to fund future working capital needs, service outstanding debt, and fund future capital expenditures and uses the metric for this purpose. The exclusion of impairment charges eliminates the non-cash impact. Adjusted EBITDA is also used by investors and analysts for the purpose of valuing an issuer.” But this only seems to me like more artful “boilerplate” – it still doesn’t say anything for example about the limitations of the measure in the issuer’s own circumstances, or about how the external focus on this measure aligns with internal decision-making practices.
My basic point is that this area has long become something of a compliance game, measured against benchmarks and standards that may or may not constitute significant protection in the real world; indeed, in some cases, an issuer that perfectly implemented the expectations of the notice might only thereby do a better job of obscuring how ill-suited its disclosure really is, as a window through which to assess its own distinct weaknesses. One would happily trade the notice for a single pointed enforcement case built on investor losses that were demonstrably caused by misusing such measures, but that doesn’t seem imminent.
The opinions expressed are solely those of the author