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E-MailCydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley publication.
The Corp Fin staff have been dropping hints for quite a while about potential enforcement actions in connection with abuses of non-GAAP financial measures (see, e.g., this PubCo post), and an interesting one has now materialized. In an Order released [January 18, 2017], the SEC announced settled charges against MDC Partners, Inc., a publicly traded marketing firm, for failure to comply with the rules related to non-GAAP financial measures. In addition, the company was charged with failure to disclose millions in perks awarded to its former CEO.
Violation of rules related to non-GAAP financial measures. As you know, Reg S-K Item 10(e) and Reg G require a company that uses a non-GAAP financial measure to present the comparable GAAP measure with equal or greater prominence and to provide a reconciliation of the non-GAAP measure to the comparable GAAP measure. The SEC’s Order charges that, prior to July 2014, the company issued earnings releases that included non-GAAP measures such as EBITDA, EBITDA margin and free cash flow, but failed to comply with the prominence requirement, notwithstanding assurances by the company to Corp Fin in 2012 that it would comply with the requirement in future earnings releases. (Not typically a recommended move—could it have been a pivotal factor?)
Moreover, the SEC charged, the company failed to comply with the non-GAAP disclosure requirements because it did not properly disclose all of the adjustments to one of its non-GAAP measures, “organic revenue growth.” The company described this measure as “growth in revenue, excluding the effects of two reconciling items: acquisitions and foreign exchange impacts.” However, the SEC charged, for a specified period, the company failed to disclose that there was also a third reconciling item, which was related to the company’s shift to net revenue from gross revenue accounting for two subsidiaries. According to the Order, this third item increased the amount of “organic revenue growth”: had the company “calculated ‘organic revenue growth’ consistent with its filings with the Commission, i.e. by comparing period over period growth in [the company’s] recorded GAAP revenue, and excluding the effects of acquisitions and foreign exchange impacts, [the company’s] ‘organic revenue growth’ would have been lower.” However, during the period when the company failed to disclose this third adjustment to its “organic revenue growth” calculations, its earnings releases and periodic reports did not include tabular reconciliations to GAAP revenue.
SideBar: As discussed in this PubCo post, in May 2016, Corp Fin issued a number of new CDIs, one of which emphasized and illustrated the equal prominence requirements. Below are some of the CDI’s examples of problematic presentations:
- “Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
- Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure;
- A non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption);
- Describing a non-GAAP measure as, for example, ‘record performance’ or ‘exceptional’ without at least an equally prominent descriptive characterization of the comparable GAAP measure;
- Providing tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures or including the comparable GAAP measures in the same table.”
Failure to disclose perks. The Order also indicated that, for a number of years, the company’s Chairman and CEO was awarded over $11 million in perks and personal benefits paid on the CEO’s behalf, including private aircraft usage, cosmetic surgery, expenses related to yachts and sports cars, jewelry, cash for tips and gratuities, medical expenses for the CEO and his family members and others, charitable donations in the CEO’s name, vacation and personal travel expenses, pet care, and club memberships. However, the company disclosed only about $4 million in perks, which appeared for the most part to be more standard-variety executive perks, including an annual $500,000 perquisite allowance, interest benefits received on interest-free loans, disability, medical, life insurance benefits, legal fees and the use of company aircraft and an apartment. As a result, for six years, the CEO’s reported compensation understated his perquisites and personal benefits “by an average of almost 300% each year.” These omissions affected proxies, periodic reports and offering documents, and resulted in books and records and internal control issues. In response to SEC inquiries, the company conducted an internal investigation, which led to the CEO’s resignation and return to the company of more than $21.7 million in cash bonus awards and perk repayments.
The SEC charged that the company violated, among others, the rules related to proxies, periodic reports, books and records, internal control, offerings and non-GAAP financial measures. The company consented to the SEC’s cease-and-desist order without admitting or denying the findings, took a number of remedial actions and paid a penalty of $1.5 million.
