Non-GAAP Earnings: SEC Drumbeats Are Getting Louder

Non-GAAP earnings presentations have been flourishing for years. Why? Possible reasons: sometimes they’re actually useful; companies like showing them because they’re generally more upbeat than straight GAAP presentations; the SEC’s Regulation G provides a cozy, easily-complied-with safe harbor; a general belief by investors that accounting figures are not telling the right story, aggravated by managers who disdain accounting standards that force them to record equity-based compensation; and managements whose compensation is determined by non-GAAP earnings targets want Wall Street to understand why they’re managing the firm in a particular way. There are probably many more reasons.

We’ve been studying non-GAAP earnings empirically each year since 2013, and each year has always been more amazing than the last. We’re currently working on the 2015 study of the practice in the S&P 500, and it’s far more shocking than last year’s 2014 study, which showed that the S&P 500 companies engaging in the practice had total non-GAAP earnings higher than GAAP net income by over 22%. The 2015 difference, so far, makes that look minor.

At a conference yesterday, SEC Chairman Mary Jo White mentioned that the practice is “something that we are really looking at—whether we need to rein that in a bit even by regulation,” The Wall Street Journal reports. She’s kicked it up a notch from a conference last December in which she declared that “This area deserves close attention, both to make sure that our current rules are being followed and to ask whether they are sufficiently robust in light of current market practices.”

 Regulation G was enacted in 2002 and hasn’t been modified since; in that time space, non-GAAP earnings have grown like weeds. For years, the SEC has pursued a low-key path on issuing regulations in the financial reporting area; they’ve pursued a vigorous company-directed letter-writing strategy instead. To hear that they’re considering reining in non-GAAP earnings “a bit, even by regulation” may demonstrate an unusual level of concern.

 

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