In February, Canada’s securities regulators published for comment a revised version of the proposed rules on the presentation of non-GAAP financial measures. The first iteration of the proposed rules was published in 2018 and received substantial feedback from stakeholders—the new version of the proposed rules has been simplified to address many of the comments raised1. The comment period in respect of the proposed rules runs to June 29, 2020. Given the extensive comments already received and considered by regulators, we expect the rules will come into force substantially as proposed.
The proposed rules do not apply to:
- investment funds;
- disclosures required under National Instrument 43-101 Standards of Disclosure for Mineral Projects and National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities (other than voluntarily disclosed oil and gas metrics under section 5.14 of NI 51-101); or
- financial measures disclosed in compliance with a requirement under law or by an SRO (no longer limited to the laws of a jurisdiction of Canada).
The proposed rules apply to disclosure included in any document that is intended to be, or reasonably likely to be, made available to the public (including documents posted on a website and through social media).
Companies may satisfy certain disclosure requirements under the proposed rules by incorporating by reference information included in their MD&A. Importantly, however, incorporation by reference is not permitted in a news release issued or filed by the company—this means that companies will need to include all of the required disclosures (including reconciliation tables) in their earnings releases.
For non-reporting issuers, the proposed rules apply only to disclosures in a document that is subject to prospectus requirements, filed in connection with reliance on the offering memorandum exemption and listing statements, circulars and other similar documents submitted to a recognized exchange in connection with certain significant transactions.
Designated foreign issuers are exempt from the requirements of the proposed rules (which is a change from the prior proposal). Foreign issuers who are otherwise SEC-reporting issuers are also not subject to the proposed rules. This is consistent with how the SEC treats Canadian foreign private issuers (i.e., they are generally exempt from the U.S. rules on non-GAAP financial measures).
Overview of the revised proposed regime
The rules do not prohibit any particular types of non-GAAP measures or impose any industry-specific requirements. Instead, the rules formalize and expand on existing staff guidance regarding non-GAAP disclosure.
The proposed rules have the force of law, unlike the existing regulatory guidance on non-GAAP financial measures. This means that the regulators would have stronger compliance and enforcement tools if a company’s non-GAAP financial measures, like “adjusted earnings”, “adjusted EBITDA”, “free cash flow”, “pro forma earnings”, “distributable cash”, “earnings before non-recurring items” and others, are misleading. While the proposed rules are relatively brief in length, the regulators have helpfully provided extensive guidance on the application of the rules in the proposed companion policy.
The new regime classifies financial measures into five mutually exclusive categories, each of which are subject to different disclosure requirements as described below.
1. Non-GAAP financial measures
A non-GAAP financial measure is defined as a measure that:
- is a financial measure that depicts the historical or expected future financial performance, financial position or cash flow,
- with respect to its composition, excludes an amount that is included in, or includes an amount that is excluded from, the composition of the most comparable financial measure presented in the primary financial statements2,
- is not presented in the financial statements, and
- is not a “ratio” (described further below).
Historical non-GAAP financial measures
Disclosure of non-GAAP financial measures relating to historical periods must comply with the following:
- Labelling. Consistent with the initial proposal and existing regulatory guidance, non-GAAP financial measures must be labelled appropriately and distinctly from line items, subtotals and totals in the financial statements. The proposed companion policy provides several examples of expectations for labelling non-GAAP financial measures, including:
- It would be misleading to label a non-GAAP measure “cash flows from operations,” calculated as cash flows from operating activities before changes in non-cash working capital items, because the term is confusingly similar to “cash flows from operating activities” specified in IAS 7 Statement of Cash Flows.
- Labels that may cause confusion based on the financial measure’s composition may be considered misleading and therefore not in compliance. For example, if EBITDA is presented as a non-GAAP financial measure, it should only adjust for interest, taxes, depreciation and amortization.
- Comparable Financial Measures and Prominence of Non-GAAP Financial Measures. Consistent with existing regulatory guidance, non-GAAP financial measures must be presented with no more prominence than the most comparable financial measure that is presented in the issuer’s financial statements (which must also be presented in the document). The proposed companion policy provides the following examples of disclosure of non-GAAP measures that would not comply with the prominence requirement:
- Omitting the most comparable GAAP measure from a news release headline or caption that also includes a non-GAAP measure.
- Presenting a non-GAAP measure using a style of presentation (e.g., bold, underlined, italicized, or larger font) that emphasizes the non-GAAP measure over the corresponding GAAP measure.
- Using graphics or tables to present non-GAAP measures without similar graphics or tables presenting the corresponding GAAP measures.
- Comparative Information. Non-GAAP financial measures must be presented for comparative periods (unless it is impracticable to present the measure for the comparative period; increased costs are not considered a basis for impracticability).
- Proximity. Consistent with existing regulatory guidance, in proximity to the first instance of the non-GAAP financial information, the issuer must: (i) identify the measure as a non-GAAP financial measure; (ii) explain the non-GAAP financial measure is not a standardized financial measure; (iii) explain the composition of the non-GAAP financial measure; (iv) explain the usefulness of the non-GAAP financial measure and the additional purposes for which management uses the non-GAAP financial measure; (v) provide a quantitative reconciliation to the most comparable financial measure that is presented in the primary financial statements; and (vi) explain the reason for a change from the comparative period, if any, in the label or composition of the non-GAAP financial measure.
The proposed rules and companion policy expand on existing regulatory guidance in the following respects:
- The method of calculating non-GAAP measures must be explained and disaggregated in a manner that permits a reasonable person to understand each reconciling item.
- Significant management judgements or estimates used in developing reconciling items used in the reconciliation of non-GAAP measures must be disclosed, along with the circumstances giving rise to reconciling items, e.g., an adjustment for impairment of goodwill should be supported by the cause of the impairment.
- Comparative period non-GAAP measures must be presented and reconciled.
Forward-looking non-GAAP measures
The existing regulatory guidance contains a general statement that it covers forward-looking non-GAAP measures. The proposed rules are more detailed and specify that forward-looking non-GAAP measures may only be included in a document if:
- the forward-looking non-GAAP measure is labelled using the same label as the corresponding historical non-GAAP measure;
- the document includes the corresponding historical non-GAAP measure;
- the forward-looking non-GAAP measure is not presented with more prominence in the document than the corresponding historical non-GAAP measure; and
- the first time a forward-looking non-GAAP measure appears in the document, a description of any significant differences between the forward-looking and historical non-GAAP measure is provided, either directly or through incorporation by reference.
2. Non-GAAP ratios
Non-GAAP ratios are ratios that use a non-GAAP financial measure as one of the components, such as “adjusted EBITDA per share”, “free cash flow per ounce”, “funds flow per barrel of oil equivalent” and the equivalent forecasted measures.
Under the proposed rules, non-GAAP ratios may only be included in a document if:
- the non-GAAP ratio is labelled using an appropriate descriptive term given its non-GAAP composition;
- the non-GAAP ratio is not presented with any more prominence in the document than similar financial measures;
- the same means of calculation are used for comparative periods, unless the non-GAAP ratio is forward-looking; and
- when the non-GAAP ratio is presented for the first time in the document, the document must (i) explain the composition of the non-GAAP ratio, (ii) disclose that the non-GAAP ratio is not a standardized financial measure, (iii) provide an explanation of how management uses the non-GAAP ratio and why it is useful for investors, and (iv) explain the reason if there is a change in the label or composition of the non-GAAP ratio over the comparative period.
3. Total of segment measures
The proposed rules define a “total of segment measure” as a subtotal or total of financial measures of two or more reportable segments of an entity that are presented in the notes to the financial statements of the entity but not presented in the primary financial statements of the entity. When such total of segment measures are disclosed outside of the financial statements, companies must also: (i) present the most comparable financial measure presented in the primary financial statements; (ii) ensure that the total of segment measure is not presented with more prominence than the comparable financial measure; (iii) provide a quantitative reconciliation of the total of segment measure to the most comparable financial measure in proximity to the first instance the measure appears in the document; and (iv) present the total of segment measure using the same composition as prior comparative periods.
4. Capital management measures
The proposed rules define a capital management measure as a financial measure that is disclosed in the notes to the financial statements, but is not presented in the primary financial statements, and is intended to enable a person to evaluate a company’s objectives, policies and processes for managing the company’s capital.
Under the proposed rules, when such capital management measures are disclosed outside of the financial statements, companies must also: (i) explain the composition of the measure; (ii) unless already disclosed in the notes to the financial statements, explain how the measure provides useful information to investors, how it is used be management and, unless it is a ratio, include a quantitative reconciliation to the most directly comparable financial measure from the financial statements; (iii) ensure that the measure is not presented with more prominence than the comparable financial measure; and (iv) present the measure using the same composition as prior comparative periods.
5. Supplementary financial measures
Supplementary financial measures are measures that a company discloses periodically—often key performance indicators (KPIs) like same-store sales for a retailer—to depict the historical or expected future financial performance, financial position or cash flow of a company. The definition of supplementary financial measures does not include measures presented in the financial statements of the company, non-GAAP financial measures or non-GAAP ratios.
Under the proposed rules, supplementary financial measures may be disclosed in a document if the supplementary measure is appropriately labelled and accompanied by disclosure (or a footnote referencing such disclosure), in proximity to the first instance a supplementary financial measure appears in a document, that explains the composition of the measure.
Proposed Canadian rules vs. U.S. regime
The key elements of the proposed Canadian rules are substantially the same as the U.S. rules on non-GAAP financial measures. The U.S. regime is similarly prescriptive, however the proposed Canadian regime is more detailed, especially considering the examples and guidance in the proposed companion policy. Similar to the proposed rules in Canada, U.S. Regulation G requires the following of all disclosure of non-GAAP measures:
- Non-GAAP financial measures must not be misleading.
- The most directly comparable GAAP measure must be presented.
- A reconciliation of the non-GAAP financial measure to the most comparable GAAP measure must be presented.
In addition, for all SEC filings, Item 10(e) of Regulation S-K requires, in addition to the disclosure required by Regulation G that:
- The prominence of the most directly comparable GAAP measure presented be equal to or greater than the non-GAAP measure.
- A statement from management indicating why the non-GAAP measure provides useful information to investors.
- To the extent material, a statement disclosing any additional purposes for which management uses the non-GAAP measure.
Recommended steps for companies
The proposed rules are subject to further comment by market participants (until June 29) before being finalized. The rules will not be retroactive, and the regulators have acknowledged that a sufficient transition period will be provided before the rules are made effective to give companies time to prepare amended or new disclosures of non-GAAP and other financial measures. We recommend that companies begin reviewing their disclosure documents, such as MD&A and news releases, as well other materials like investor relations documents and website content, with a view to eventual compliance with the new regime. Companies should determine whether their existing non-GAAP disclosures would be treated as non-GAAP financial measures, non-GAAP ratios, supplementary financial measures, total segment measures or capital management measures to help identify which rules would apply and any current gaps in the company’s practices compared to what the new rules would require. Doing this work will enable companies to develop a strategy for amending, if necessary, how they present financial measures once a new regime is adopted.
1 See our bulletin, Non-GAAP Financial Measures: Canada’s Securities Regulators Propose Stricter Rules, for a discussion of the first iteration of the proposal rules.
2 The “primary financial statements” consist of the balance sheet, income statement, statement of changes in equity and cash flow statement.
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