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Non-GAAP and SOX 302

In a recent post on his blog, The Accounting Onion, Tom Selling added some thoughts to the ongoing debate surrounding non-GAAP disclosures. He proposed some additional requirements that he thinks could help improve non-GAAP reporting. One of the suggestions was that a company explicitly state that non-GAAP metrics are considered in its disclosure controls and procedures, “to assure that their calculation is specified in adequate detail, are calculated consistently and not misleading.”

This is a really interesting suggestion. Disclosure controls and procedures, defined in Section 302 of the Sarbanes-Oxley Act, cover all the disclosures that a company makes in its public filings and go beyond a company’s internal controls over financial reporting. As stated in Final Rule 33-8124, “…these procedures are intended to cover a broader range of information than is covered by an issuer’s internal controls related to financial reporting.” It is reasonable to think that SOX 302 assessments ought to cover non-GAAP metrics and the processes that go into calculating and disclosing them.

This made us wonder whether non-GAAP has ever come up in a SOX 302 assessment before. We were able to find only one example.

In an amended 10-K filing for the period ended 12/31/2013, VEREIT, Inc (formerly American Realty Capital Properties) disclosed the following material weakness (underline added):

Material Weaknesses

Material Weaknesses in Disclosure Controls and Procedures – The Company’s disclosure controls and procedures were not properly designed or implemented to ensure that the information contained in the Company’s periodic reports and other SEC filings correctly reflected the information contained in the Company’s accounting records and other supporting information and that AFFO per share (a non-GAAP measure that is an important industry metric) was correctly calculated. In addition, the Company did not have appropriate controls to ensure that its SEC filings were reviewed on a timely basis by senior management or that significant changes to amounts or other disclosures contained in a document that had previously been reviewed and approved by the Audit Committee were brought to the attention of the Audit Committee or its Chair for review and approval before the document was filed with the SEC. Finally, the Company did not have appropriate controls over the formulation of AFFO per share guidance or the periodic re-assessment of the Company’s ability to meet its guidance.

Here, VEREIT discloses a material weakness related to the calculation and disclosure of AFFO, or Adjusted Funds From Operations. (As the company mentions, this is indeed an important industry metric, and it’s one that the SEC has been paying attention to lately.) While this is the only example we could find of a company discussing a non-GAAP metric in the context of assessing the adequacy of its disclosure controls and procedures, we suspect this company isn’t the only one to have had material weaknesses or significant deficiencies in calculating non-GAAP metrics. How many companies even have explicit controls surrounding those processes?

Perhaps making the connection between non-GAAP disclosures and the requirements on SOX 302 explicit would help the quality and consistency of those disclosures. One caveat, however: Mr. Selling suggests that disclosure controls and procedures “assure that [non-gaap] calculation is specified in adequate detail, are calculated consistently and not misleading.” It’s one thing to have testable controls covering the consistent calculation of non-GAAP metrics, but we’re not sure how it would be determined whether they are “misleading”. Despite that, it seems like a good suggestion.

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