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.