Retailers’ ‘Borderline Misleading’ Accounting Targeted by SEC

Public companies that tout overly rosy earnings numbers that don’t comply with US accounting rules, watch out.

The Securities and Exchange Commission is blitzing businesses with questions about alternative accounting measures and asking them to justify their use. In some cases they’re telling them to quit showcasing earnings that strip out normal, recurring expenses. Retailers and consumer-facing companies face especially pointed questions, recently released comment letters show.

Academy Sports & Outdoors Inc., Dave & Buster’s Entertainment Inc., and Petco Health & Wellness Company Inc. have all drawn the SEC’s attention for excluding expenses to open new stores or close old ones from supplemental earnings metrics that don’t follow US generally accepted accounting principles, or GAAP. The missives follow new SEC guidance from December about which unofficial accounting adjustments are acceptable and which are out of bounds.

“There’s no amount of disclosure that can cure a misleading measure,” Lindsay McCord, chief accountant in the SEC’s Division of Corporation Finance, said at the time.

The market is on notice, said Matthew Franker, partner at Covington & Burling LLP and a former division attorney.

“The SEC and staff really think that some of these measures are borderline misleading or actually misleading,” Franker said.

Common themes emerge from the SEC’s inquiries: If the regulator sees companies pluck out expenses that it views as central part to their businesses, it will tell them to add the expenses back. Staff reviewers also are probing how companies label their non-GAAP measures and telling them to beef up their disclosures, the letters show. The back-and-forth between the companies and the SEC is a normal part of the agency’s regular reviews of corporate filings to ensure companies are transparent about what they disclose to the market.

SEC questions do not mean companies are in trouble. But if businesses push the envelope too hard, the regulator has power to take action.The SEC in March slapped information-technology company DXC Technology Co. with an $8 million penalty, accusing it of misleading non-GAAP disclosures. Between 2018 and 2020, the company had padded its non-GAAP earnings by stripping out millions of normal expenses and not telling investors and analysts that it did so, the SEC charged. The SEC also said the company didn’t have a non-GAAP policy or adequate controls and procedures to ensure consistent non-GAAP reporting from period to period. The company paid the penalty without admitting or denying the findings.

This most recent enforcement action shows the SEC is scrutinizing all areas of non-GAAP reporting, said Rebecca Fike, partner at Vinson & Elkins and former SEC enforcement attorney.

“You better have accurate controls and procedures at the absolute same level you would have for your audited financials,” Fike said.

Cat and Mouse

Non-GAAP reporting has long been a focus for the SEC division that reviews corporate filings. It was the No. 1 item SEC staffers asked companies about in comment letters for fiscal years 2021 and 2022, according to a report by Ernst & Young LLP.

The continual emphasis highlights the fine line businesses walk between what’s acceptable and what’s not.

“What you see is a cat-and-mouse game between companies and the SEC,” said Matthew Wieland, accounting professor at the Miami University Farmer School of Business.

Companies are allowed to report earnings numbers that don’t squarely fit the boundaries of US accounting rules—within reason. Earnings before interest, tax, depreciation and amortization, or EBITDA, is one of the most common measures, but companies present many variations on it.

Many companies choose to use these numbers because decades-old accounting rules written in a manufacturing-heavy economic era don’t necessarily capture the realities of modern businesses. Others supplement their official results with special measures to strip out one-time costs that they argue could distract the market from their overall financial health.

Shoemaker Allbirds Inc., for example, removed the cost of shoe inventory write-downs from its third-quarter 2022 non-GAAP financial results, raising SEC eyebrows. Losses from unsold shoes are a typical part of doing business, the SEC said, but the company’s response won over the regulator. The specific third-quarter write-down was unusual, Allbirds argued, because it was for discontinuing an entire product line for the first time in its history. It made the case that it wouldn’t do so again soon, and the SEC accepted that argument, correspondence shows.

The SEC was less amenable to arguments from ride-hailing Lyft Inc. when the company argued that excluding the money it sets aside to cover insurance claims—a large hit to its official GAAP earnings—wasn’t a tailored accounting metric. The SEC started asking Lyft questions last August. In February, it wound up reporting an adjusted fourth-quarter loss of $248.3 million, because including the reserve for insurance claims wiped out its non-GAAP profit.

The SEC updated its non-GAAP guidance in December in part because of what staff reviewers saw in the market. Many of the new elements in the guidance were the result of staff reviewers seeing the same patterns in company filings and needing to get the message out, said Timothy Kviz, national managing partner at BDO USA LLP.

The SEC’s thinking, Kviz said, was, “‘We issue this comment with regularity, the argument comes up and we reject it. The message isn’t getting through and let’s clarify it.’”