The Canadian Securities Administrators (CSA) have published for comment Proposed National Instrument 52-112 Non-GAAP and Other Financial Measures Disclosure, which establishes disclosure requirements for issuers that disclose non-GAAP and other financial measures.

We’ve covered this topic here many times before (certainly more than I intended to). In a nutshell, the main Canadian regulatory reference point at present is CSA Staff Notice 52-306, which “provides guidance to an issuer that discloses non-GAAP financial measures…intended to help ensure that the information disclosed does not mislead investors.” CSA staff members refer to the notice frequently in their reviews and speeches, and it’s certainly had a widespread influence on the quality of disclosures, but a staff notice doesn’t inherently carry the force of a formal regulatory instrument, and so doesn’t provide as clear a basis for identifying certain practices as being in violation of securities law. As the CSA Chair puts it in the accompanying news release, the new instrument will “provide CSA Staff with a stronger tool to take appropriate regulatory action, when warranted.”

Put very simply, the proposed instrument would take much of what CSN52-306 currently describes as things an issuer “should” do (that is, implicitly, should do in CSA staff’s opinion) and recast it as things the issuer “must” or “must not” do in order to remain compliant. In concept, that might not sound like such a difficult thing to draft, but in practice it entails much more attention to the specificity of the definitions and their application (it seems that the project’s been in the pipeline for at least two years – I alluded to it here in October 2016). For many observers, the key point is likely to be the following:

• The Proposed Instrument does not contain specific limitations or industry-specific requirements; rather, it includes comprehensive disclosure requirements whose overall goal is to improve the quality of information provided to investors.
• We acknowledge that some stakeholders may prefer that we:
•   limit, in specific circumstances, the disclosure of certain financial measures, and
•   develop industry-specific requirements for certain financial measures.
• However, due to the numerous types of ever-evolving financial measures disclosed across a range of industries, we believe that comprehensive disclosure requirements are best suited to respond to investor needs for quality information. These requirements allow investors to better analyze different financial measures within an industry or among different industries.

That’s certainly fine with me, but the commentary on these issues often seems to be implying that something stronger is needed. In that same October 2016 article, I quoted a Globe and Mail article that referred to a “host of gerrymandered measures (of which) the effect is often to deceive investors,” and cited Antony Scilipoti of Veritas Investment Research Corp, as follows:

• “This is the root of all evil, the current No. 1 problem in financial reporting…The regulators, investors, the auditors – this is a challenge for everyone involved. … It’s gotten out of control, and investors can’t assess what the truth is.”

And yet, even in that same article, it was clear that Veritas wasn’t calling for the root-of-all-evil practice to be banned. This isn’t hard to understand: if a company sees value in using a certain measure to communicate some aspect of its performance, it’s hard to say it should be flatly prohibited from doing so. If nothing else, you might say, the more plainly selective and crummy the measure is, the more revealing the company’s reliance on it as a spotlight on its corporate character and philosophy. That assumes of course that the crumminess is evident to those who care to look for it. But this leads to a recurring problem in the complaints about this area: their reliance on an incoherent concept of investors. For example, in another previous article I quoted the following extract from a CFA Institute report.

• “A particular worry is the risk of some investors mispricing companies’ securities by applying multiples-based valuation methods (e.g., value determined as a multiple, such as the price-to-earnings ratio [P/E]). Mispricing can occur if an investor fails to discriminate between a GAAP/IFRS-based earnings per share EPS and an adjusted EPS measure in the P/E denominator. Investor caution with NGFMs is also necessary for interpreting return on equity ROE or return on invested capital that is based on adjusted earnings in the numerator but a GAAP/IFRS-based denominator (i.e., equity), because such return calculations would give a misleading and overstated picture of headline profitability.”

As I said at the time, that’s fine, but an investor who makes a major resource allocation decision based solely on applying some multiple to a single number is doing little more than gambling anyway. If he or she then compounds the superficiality of the approach by carelessly applying the calculation to the wrong number (and, presumably, by not meaningfully engaging with anything else in the financial statements or MD&A), then how well are things ever going to turn out? Trying to help such people (if they exist as more than theoretical illustrations) is inherently futile. To varying degrees, the articulation of the problem seldom gets past this same problem of trying to save investors from themselves, many of whom don’t want to be saved anyway.

It’ll be interesting to see how prominently this strain of thinking manifests itself in the reaction to the CSA proposal. I imagine there’ll be quite a lot of reaction, a lot of it perhaps of the “good start, but…” variety. The comment period runs to December 5, 2018.

The opinions expressed are solely those of the author.