Minding the Gaps in Your Non-GAAP Disclosure Controls

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On March 14, 2023, the Securities and Exchange Commission (the “SEC”) announced that it charged DXC Technology Company, an IT services company (“DXC”), with making misleading disclosures about its non-GAAP financial performance measures[1] during periods from 2018 until 2020. DXC settled the charges with the SEC and agreed to pay a penalty of $8 million and implement new policies and disclosure controls and procedures designed to prevent future violations[2].

Inappropriate Exclusion of Items from Non-GAAP Measures

DXC presented non-GAAP financial performance measures, including non-GAAP net income and non-GAAP diluted earnings per share (“EPS”), in multiple quarterly and annual reports and earnings releases. Beginning with the end of the company’s fiscal year 2018, DXC disclosed that it excluded transaction, separation, and integration-related (“TSI”) costs from its non-GAAP net income, non-GAAP EPS, and other non-GAAP measures. DXC described TSI costs as those “related to integration planning, financing, and advisory fees associated with” the merger that formed DXC, other acquisitions, and the spin-off of a business.

According to the SEC charges, DXC misclassified a material amount of expenses as TSI costs and improperly excluded them in its reporting of non-GAAP measures, and DXC provided misleading descriptions of the items. By excluding these expenses, DXC materially overstated its non-GAAP net income for three fiscal quarters.

Regulation G under the Exchange Act prohibits registrants from making public a non-GAAP financial measure that contains an untrue statement of material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading. The SEC charged DXC with violations of Regulation G and several other provisions of the securities laws related to registrants’ duties to provide disclosures that are not misleading.

Disclosure Controls and Procedures

The SEC also charged DXC with violating the Exchange Act’s requirements with respect to disclosure controls and procedures. Exchange Act Rule 13a-15 requires issuers such as DXC to maintain “disclosure controls and procedures,” which are defined to include, among other things, “procedures . . . designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the [Exchange] Act . . . is recorded, processed, summarized, and reported, within the time periods specified in the Commission’s rules and forms.”

In its investigation, the SEC found that the controllership function within DXC was unable to prevent the Regulation G violations because DXC’s informal procedures were inadequate and DXC lacked formal disclosure controls and procedures to ensure an adequate review of the non-GAAP measures. In addition, DXC lacked any written policy regarding the use of non-GAAP measures. The SEC also found that some controllership employees raised concerns about the TSI costs, but the concerns were not addressed adequately due to a lack of information and effective procedures.

As part of its settlement with the SEC, DXC agreed to develop and implement the following policies and disclosure controls and procedures:

1. for the disclosure of its non-GAAP financial performance, such that its non-GAAP financial measures, including expenses, are described accurately in future periodic filings and public statements, and that its non-GAAP disclosures are consistent with the company’s actual processes for identifying, reviewing, and approving non-GAAP adjustments, including, but not limited to costs;
2. for its disclosure committee, or other charged committee, to review and document, on a periodic basis, the company’s non-GAAP policy to assess consistency with its non-GAAP disclosures and its publicly-reported non-GAAP financial performance measures;
3. for controllership staff who are familiar with SEC reporting requirements and DXC’s non-GAAP policy and non-GAAP disclosures to approve and document the classification of items included in non-GAAP adjustments; and
4. for timely reviewing, considering, and addressing negative sub-certification survey comments relating to GAAP and non-GAAP financial results or disclosures, or that may impact the “Management’s Discussion and Analysis of Operations” section within its filings.

Although the order in the DXC case did not mention audit committees, the SEC staff has previously stated that it expects “audit committees to be actively engaged in the review and presentation of non-GAAP measures and metrics to understand how management uses them to evaluate performance, whether they are consistently prepared and presented from period to period and the company’s related policies and disclosure controls and procedures.”[3]

Conclusion

Given the SEC’s focus on policies and disclosure controls and procedures relating to non-GAAP measures, we encourage issuers to make sure they have developed and reviewed such policies and procedures with the full involvement of management and the audit committee. We believe the SEC expects issuers to have in place policies and procedures similar to the ones described above that were required as part of the DXC settlement.

Maynard’s Public Company Advisory Team can assist with developing or reviewing your non-GAAP policy. For additional information about any of the above developments, or to discuss any questions that you may have, please contact a member of Maynard’s Public Company Advisory Group.

^{[1] Regulation G under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), defines a “non-GAAP financial measure” as a numerical measure of a registrant's historical or future financial performance, financial position or cash flows that: (i) excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the issuer; or (ii) includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented.}

^{[2] Matter of DXC Technologies Company (SEC, March 14, 2023) available at https://www.sec.gov/litigation/admin/2023/33-11166.pdf.}

^{[3] Jay Clayton, Chairman, Sagar Teotia, Chief Accountant, and William H. Hinman, Director, Division of Corporation Finance, Statement on Role of Audit Committees in Financial Reporting and Key Reminders Regarding Oversight Responsibilities (December 30, 2019), available at https://www.sec.gov/news/public-statement/statement-role-audit-committees-financial-reporting.}