On April 4, 2018, the Securities and Exchange Commission issued new guidance clarifying that the financial measures included in certain forecasts used in business combination transactions would not be subject to the GAAP reconciliation requirements of Item 10(e) of Regulation S-K and Regulation G. The guidance is included in new Compliance and Disclosure Interpretations (C&DIs) that can be found here (See C&DIs 101.02 and 101.03).
This new guidance closely follows the SEC's October 2017 guidance clarifying that financial measures included in forecasts provided to a financial advisor and used in connection with a business combination transaction are exempt from being non-GAAP financial measures that must be reconciled to GAAP if and to the extent (1) they are included in forecasts provided to the financial advisor to render an opinion materially related to the business combination transaction and (2) the forecasts are disclosed to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor's analyses or substantive work. The prior SEC guidance can be found here (See C&DI 101.01).
The new guidance goes further to clarify that the exemption in the SEC's October 2017 guidance will apply even where the same financial measures and forecasts provided to its financial advisor are also provided to the company's board of directors or a committee thereof.
Additionally, the new guidance clarifies that the financial measures in forecasts provided to bidders in a business combination transaction will also be exempt from the GAAP reconciliation requirements of non-GAAP financial measures where the financial measures are being disclosed to investors because the company has determined that the financial measures are material and are required to be disclosed to comply with the anti-fraud and other liability provisions of the federal securities laws.
The new guidance and the October 2017 guidance serve to confirm existing practice in business combination transactions relating to existing exemptions from GAAP reconciliations for, among other things, financial measures required to be disclosed under SEC rules or by another governmental authority (See Rule 100(d) of Regulation G and Item 10(e)(5) and (6) of Regulation S-K). While the financial measures in business combination forecasts are indeed often "non-GAAP," many practitioners did not consider Regulation G or Regulation S-K to require those financial measures to be reconciled to GAAP. Whereas Regulation G or Regulation S-K were intended to prohibit a company from using non-GAAP financial measures to mislead investors about its financial position and results of operations under GAAP, business combinations forecasts are required to be disclosed because they can be material and because financial advisors have used them for purposes of their fairness opinions. As a result, the financial measures in these forecasts are required to be disclosed under SEC rules or by another governmental authority, and therefore do not require GAAP reconciliation.
Despite this existing practice and the SEC’s October 2017 guidance, the plaintiff's bar continued to bring disclosure claims seeking GAAP reconciliation of financial measures in business combination transactions on the basis that the related forecasts were shared with either board directors or bidders in the transaction. The new SEC guidance should limit the ability of the plaintiff's bar to bring claims seeking reconciliations of financial forecasts that are now specifically deemed unnecessary.
By clarifying the rules of the road, the new SEC guidance will likely further diminish the volume of merger litigation, consistent with recent Delaware caselaw regarding disclosure-only based settlements, forum selection bylaws, and attorney fee award applications. As such, we expect the new guidance will be welcomed by companies.