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This week the SEC staff expanded relief for the disclosure of
non-GAAP financial forecasts used in business combinations.
In these transactions, public companies routinely obtain
fairness opinions from an investment bank regarding the value of
the consideration to be paid to shareholders, and the fairness
opinions normally rely on financial projections provided by the
company. These projections are often prepared in a way that varies
from GAAP and, as a result, one or more of the figures included in
the projections may constitute "non-GAAP financial
measures" under SEC rules. The disclosure of non-GAAP
financial measures in an SEC filing ordinarily triggers a
requirement (under Item 10(e) of Regulation S-K) to disclose the
most directly comparable measure calculated under GAAP, provide a
numerical reconciliation of the two numbers and make other
disclosures about the company's use of the non-GAAP measures.
These disclosure requirements can sometimes be onerous, at times to
such an extent that companies determine that the burden of the
required disclosures exceeds the anticipated benefit of disclosing
the non-GAAP financial measures.
In the context of a business combination, however, companies are
often compelled by state law to provide extensive disclosure about
the fairness opinion and other factors considered by the board of
directors in making its recommendation to shareholders to approve
the transaction. These disclosures include a detailed description
of the financial analyses performed by the investment bank, such as
a discounted cash flow analysis based on the company's
financial projections. Under case law interpreting the Delaware
General Corporation Law, companies are well advised to disclose the
financial projections given to the investment bank. When those
projections include non-GAAP information, companies would
ordinarily have to comply with the SEC's rules regarding
non-GAAP disclosures.
Last October, the staff clarified that, when public companies
disclose financial forecasts in connection with a business
combination transaction in order to comply with state law, they do
not have to provide the additional disclosures that would otherwise
be required by the non-GAAP rules. (Non-GAAP C&DI 101.01) In the staff's
view, these non-GAAP figures benefit from Item 10(e)(5) of
Regulation S-K, which excludes from the definition of non-GAAP
financial measure any measure "required to be disclosed by
GAAP, Commission rules, or a system of regulation of a government
or governmental authority or self-regulatory organization that is
applicable to the" company. However, this relief was made
available only when the forecast is provided to a financial advisor
for the purpose of rendering an opinion material to the transaction
and the forecast is being disclosed in order to comply with SEC
rules or state or foreign law regarding disclosure of the financial
advisor's work. When this guidance was issued, some
practitioners questioned whether the relief was available if the
same non-GAAP forecasts were provided to others, such as bidders or
the company's board of directors.
This week, the SEC staff sensibly clarified that the relief
remains available even if the non-GAAP forecasts are also provided
to the company's board of directors. (Non-GAAP C&DI 101.02) Note, however, that
the relief would not be available for other non-GAAP forecasts
provided only to the board and not to the financial advisor, such
as alternative forecasts based on different assumptions.
At the same time, the SEC staff also clarified that companies
generally need not comply with the non-GAAP rules when disclosing
non-GAAP forecasts provided to bidders in a business combination
transaction. (Non-GAAP C&DI 101.03) In this case, the
relief is available when such disclosures are material and are made
in order to comply with the antifraud or other liability provisions
of the federal securities laws, which would also appear to fall
under Item 10(e)(5) of Regulation S-K.
The rationale for this exclusion is rather broad, and some
companies may try to drive the proverbial truck through it. It will
be interesting to see how far the SEC staff will allow companies to
push this exclusion, since most disclosures – including
non-GAAP disclosures – are arguably made in order to avoid
misleading investors.
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