SEC Updates Non-GAAP C&DIs for Business Combinations

On October 17, 2017, the SEC released two new updates to the Compliance & Disclosure Interpretations (“C&DIs”). The C&DIs comprise the Division’s interpretations of the rules and regulations on the use of non-GAAP financial measures. The two updates focus on the applicability of Regulation G to business combinations.

Question 101.01 clarifies that financial metrics provided to the financial adviser are exempt from Regulation G if the following conditions are met:

  • the financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and
  • the forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial adviser’s analyses or substantive work.

Question 101.02 explains that while Regulation G exemption is applicable to metrics used in certain types of business-combination communications, the same metrics would still be subject to Regulation G requirements if used in proxies, registration statements or tender offers.

Before the interpretation was updated, we came across a number of SEC comment letters that questioned the lack of reconciliation of the forward-looking statements and projections. For example, on May 6, 2016, the SEC issued a comment letter to Brocade Communications requesting the company to provide reconciliation of the forecast to  comparable GAAP numbers. In response, Brocade Communications argued that Regulation G is not applicable:

the projected financial information is disclosed in the Registration Statement pursuant to Item 1015 of Regulation M-A because it was provided to and/or used by Ruckus’ financial advisor for purposes of rendering its fairness opinion in connection with the transaction and is therefore provided pursuant to Item 1015 of Regulation M-A.

The Company respectfully submits that it is therefore exempt from Rule 100(a) of Regulation G pursuant to Rule 100(d) of Regulation G”

Brocade Communications further argued that even if Regulation G was applicable, the company would not be able to provide the requested reconciliation of the forward-looking information without unreasonable efforts.

Monster Worldwide and ColonyNorth Star also received SEC non-GAAP comments in connection with their respective M&A activity.

Further, incomplete or vague non-GAAP presentations may expose a company to potential legal liability. We first discussed violations of non-GAAP financial measures in an enforcement case brought by the SEC against MDC Partners. More recently, we have seen a number of class action legal cases focusing on the non-GAAP presentation. At least one of the class action cases, Collura v. Time Warner Inc et al, involved non-GAAP presentation in the context of M&A activity.

The alleged violations occurred in connection with the proposed acquisition of Time Warner, Inc. by AT&T. Plaintiffs (represented by Levi & Korsinsky LLP) alleged that the proxy statement on a Schedule 14A that was filed with the SEC on January 9th, 2017, was materially deficient and misleading in that it failed to disclose information regarding GAAP reconciliation of the non-GAAP financial measures contained in Time Warner’s projections. The plaintiff sought to enjoin the defendants from conducting the stockholder vote on the transaction or, in the event the transaction is consummated, to recover damages for the alleged violations. In response, Time Warner filed an 8-K supplementing the disclosures in the proxy with additional information.

Time Warner believes that the claims asserted in the Merger Litigation are without merit and no supplemental disclosure is required under applicable law.  However, in order to avoid the risk of the Merger Litigation delaying or adversely affecting the Transaction and to minimize the costs, risks and uncertainties inherent in litigation, and without admitting any liability or wrongdoing, Time Warner has determined to voluntarily supplement the Proxy Statement as described in this Current Report on Form 8-K…

The stockholders voted and approved the Supplemental Disclosures and the case was voluntarily dismissed on February 17, 2017.

This case demonstrates that companies and stockholders may see non-GAAP disclosure in two different lights. But sometimes it may be preferable to provide more information than what is required.

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