SEC Regulation G Requirements for Non-GAAP Measures

The Securities and Exchange Commission (SEC) instituted Regulation G to govern how public companies present financial information that falls outside of Generally Accepted Accounting Principles (GAAP). This regulation was a direct result of the Sarbanes-Oxley Act of 2002, enacted after accounting scandals damaged investor trust. The objective of Regulation G is to ensure that any alternative financial metrics are presented in a way that is not misleading. It mandates that companies present non-GAAP measures in a balanced manner, helping investors make informed decisions by preventing a skewed picture of financial performance.

Understanding Non-GAAP Financial Measures

A non-GAAP financial measure is a numerical depiction of a company’s historical or future financial performance, position, or cash flows calculated differently than standard accounting rules dictate. It either excludes amounts that are normally included in a comparable GAAP measure or includes amounts that are typically excluded. Companies use these alternative metrics to provide a different perspective on their operations, believing they offer a clearer view of underlying business performance or liquidity.

One common example is EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This measure is used to approximate a company’s operating cash flow before accounting for financing decisions, tax strategies, and non-cash expenses. Another prevalent metric is Adjusted Net Income, where a company takes its standard net income and adjusts for items like restructuring costs or one-time legal settlements to show what it considers its “core” earnings.

Free Cash Flow is another widely used non-GAAP measure, calculated by taking operating cash flow from the GAAP Statement of Cash Flows and subtracting capital expenditures. The intent is to show the cash a company generates after accounting for investments required to maintain or expand its asset base. This metric is popular with investors as it indicates a company’s ability to repay debt, pay dividends, and fund future growth.

Core Disclosure Requirements

Regulation G requires that companies present the most directly comparable GAAP financial measure with equal or greater prominence. This means a company cannot headline a press release with a large, bold “Adjusted Net Income” figure while burying the standard GAAP net income figure in a less visible location or smaller font. For instance, if a company reports its non-GAAP earnings per share on the first page of an earnings release, the corresponding GAAP earnings per share must also appear there and be just as easy to find.

The other primary requirement is a clear quantitative reconciliation between the non-GAAP measure and its most comparable GAAP counterpart. This reconciliation must be a schedule or table that numerically details each adjustment made to the GAAP figure to arrive at the non-GAAP number. For example, a company reporting an “Adjusted Net Income” of $150 million must include a reconciliation that starts with its GAAP Net Income of $100 million. The schedule would then list each specific adjustment, such as adding back $60 million in “Restructuring Costs” and subtracting a $10 million “Gain on Asset Sale” to arrive at the non-GAAP figure.

Prohibited Disclosures and Practices

Regulation G and the related Item 10(e) of Regulation S-K also forbid several practices to prevent misleading presentations. Companies are prohibited from making certain types of adjustments or presenting information in a way that obscures GAAP results.

Prohibited practices include:

• Excluding normal, recurring cash operating expenses necessary to run the business. For example, a software company cannot present a performance measure that excludes its routine sales and marketing expenses.
• Presenting non-GAAP liquidity measures as a substitute for the statement of cash flows. A company cannot present a measure like “Adjusted EBITDA” as the primary indicator of its cash-generating ability on a per-share basis, as this can overstate the cash available to shareholders.
• Using misleading titles or descriptions for non-GAAP metrics. A measure cannot be labeled “Operating Income” if it does not conform to the specific definition of operating income under GAAP.
• Creating individually tailored accounting principles that deviate from standard recognition and measurement practices, such as presenting revenue on a cash basis when GAAP requires the accrual basis.

The SEC has also cautioned that certain adjustments, even with detailed disclosure, can be so misleading that they violate the rules. The presentation, taken as a whole, must not obscure the company’s true financial condition or performance as reported under GAAP.

Scope and Enforcement

Regulation G applies broadly to nearly all public disclosures by companies filing with the SEC, including press releases, investor presentations, and website materials. A related, more stringent set of rules in Item 10(e) of Regulation S-K applies specifically to non-GAAP measures included in official filings like annual (Form 10-K) and quarterly (Form 10-Q) reports.

Non-compliance carries significant consequences. The SEC staff frequently reviews company disclosures and may issue a public comment letter identifying a potential violation. These letters request that the company either revise its presentation in future filings or justify its approach, a process that can draw negative attention.

For more severe or persistent issues, the SEC can pursue formal enforcement actions, which may result in cease-and-desist orders and financial penalties. Improper non-GAAP disclosures can also increase liability risk under federal anti-fraud provisions, such as Rule 10b-5. This creates potential exposure to shareholder lawsuits if the measures are deemed materially misleading.