SEC Comment Letters Show Slow Trend Toward Cracking Down on Non-GAAP Earnings Metrics

By:
Chris Gaetano
Published Date:
Nov 26, 2019
An analysis from MarketWatch shows that the Securities and Exchange Commission has been less and less tolerant of "adjusted earnings" metrics that depart from traditional U.S. Generally Accepted Accounting Principles (GAAP), although progress has been slow and its application uneven.

MarketWatch examined comment letters issued by the SEC in 2018 and 2019 that had revenue-related non-GAAP keywords and found many voiced concerns about custom adjusted earnings metrics from various companies such as Square, BlackRock, and Ribbon Communications.

The use of non-GAAP metrics like adjusted earnings has been steadily rising over the past few decades. A study conducted by Audit Analytics, found that the percentage of S&P 500 companies using such metrics went from 59 percent in 1996 to 96 percent, in 2016. This has had the effect of causing an increase in the number of earnings reports that exceed analysts expectations, according to another study presented at an  American Accounting Association conference. That study found that, between 2000 and 2016, the number of companies that beat expectations by between 5 and 15 cents per share more than doubled. This is a dramatic change from before, when firms would typically report earnings that either met or just exceeded analyst expectations. The authors believe the rise in positive surprise announcements in S&P 500 companies can be attributed at least partially to the increased use of non-GAAP financial metrics, such as WeWork's "community adjusted EBITDA.

The SEC's recent actions indicate that the commission is aware of this issue and taking it seriously, although MarketWatch indicated that its approach has been inconsistent. For example, the firms Square, Ribbon, and BlackBerry were all criticized for adding back deferred revenue as part of a custom earnings metric, but the firm Black Knight, which used the same metric in the same way, was not.

This means that while the SEC has taken more action on adjusted earnings, MarketWatch said it is unknown whether it has the political will further crack down, given the inconsistent treatment among companies. 

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