Non-GAAP reporting is a problem not just with explaining financial results, but also in explaining executive compensation, according to an investor group asking regulators to change their rules.
The Council of Institutional Investors has petitioned the Securities and Exchange Commission with a request that the SEC reconsider its rules regarding uses of non-GAAP accounting metrics in compensation discussion and analysis contained in proxy statements. The CII is appealing to the SEC to amend Regulation S-K to remove an exemption that allows companies to use non-GAAP measures that are not reconciled to GAAP figures in their proxy CD&A.
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Companies are required under SEC rules to reconcile any non-GAAP figures to their nearest GAAP counterparts when used in financial reporting, including earnings releases or other communication with investors. In fact, the SEC began a crackdown on errant non-GAAP reporting a few years ago, grilling companies to use reconciliations and assure they were not presented to investors more prominently than results computed using Generally Accepted Accounting Principles.
Now investors are telling the SEC that non-GAAP reporting is obscuring executive compensation disclosures, and they want the same reconciliation requirements to be imposed there to make it easier for investors to understand executive compensation packages. “Given the complexity in executive pay plans, and confusion about the links between pay and performance, investors need greater transparency about the measures boards use to determine incentive pay,” said Ken Bertsch, executive director of the CII, in a statement.
Shareholders vote on executive compensation during proxy season, and they rely on proxy statements to evaluate whether executives achieved performance targets set by the board of directors for incentive pay. Too many companies are overstating performing using non-GAAP measures that are not adequately explained or related to GAAP results, the CII says, making it impossible to evaluate compensation.
Non-GAAP metrics used to be the exception in compensation committee reports, said Robert Pozen, senior lecturer at MIT Sloan School of Management and an advocate with the CII in petitioning the SEC to revise its rules. “Now they’ve become the rule,” said Pozen during a press briefing.
Between 60 percent and 80 percent of companies use some variation of non-GAAP accounting metrics in setting executive compensation, said Pozen. “This has become a major problem. People really are confused. It’s very, very hard to tell what is the concept of performance that is being used by the company.”
The SEC did not immediately respond to the petition, but at least one member of the five-member commission has already publicly stated support for revising the rules. Pozen co-authored an opinion article with SEC member Robert Jackson calling for new disclosure rules. “The SEC’s disclosure rules have not kept pace with changes in compensation practices, so investors cannot easily distinguish between high pay based on good performance and bloated pay justified by accounting gimmicks,” they wrote.