On November 12, 2009, the Securities and Exchange Commission filed its first enforcement action under Regulation G. The complaint alleged that SafeNet, Inc. intentionally misclassified and reported certain ordinary operating expenses as nonrecurring expenses in order to increase its earnings per share.

The complaint, which also named former SafeNet officers, directors, and internal accountants, alleged that SafeNet engaged in two fraudulent schemes—one involving the backdating of stock options and the other involving earnings management.

Public reporting companies are required to prepare and report their financial results in accordance with generally accepted accounting principles (GAAP). However, many companies find that disclosure of non-GAAP financial measures provides helpful information to investors. Typically, non-GAAP financial measures exclude special, nonrecurring, infrequent, or unusual expenses.

Regulation G requires issuers who publicly disclose non-GAAP financial measures, most often in their earnings press releases and investor and analyst presentations, to provide (1) a presentation of the most directly comparable financial measure or measures calculated and presented in accordance with GAAP and (2) a reconciliation of the non-GAAP measures to the GAAP measures. 1 

The SafeNet complaint alleged that the named officers and internal accountants made improper accounting adjustments to various expenses, including:

  • Improper classification of ordinary expenses as integration expenses;
  • Improper accruals for certain professional fees; and
  • Improper reduction of inventory reserve accruals.

These adjustments were allegedly made without factual support. When SafeNet's independent auditor raised questions, the auditor received false and misleading explanations, according to the SEC. As a result, SafeNet's financial results were allegedly materially misstated on both a GAAP and non-GAAP basis. Without admitting or denying the allegations, each defendant agreed to settle the action.

This recent enforcement action provides a good opportunity for public companies to review their policies regarding the use and disclosure of non-GAAP financial measures.

1  In addition, Item 10(e) of Regulation S-K requires that, if non-GAAP measures are included in a filing with the SEC, issuers include a statement disclosing why management believes the non-GAAP measures are useful to investors and, to the extent material, the additional purposes, if any, for which management uses the non-GAAP measures.

Copyright © 2009 by Ballard Spahr LLP.
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