HIGHLIGHTS AND PITFALLS Taking a Closer Look at the Earnings Disclosure Process

Transcription

1 Vol. XLII, No. 1 JANUARY-FEBRUARY 2017 HIGHLIGHTS AND PITFALLS Taking a Closer Look at the Earnings Disclosure Process The Staff s recent crackdown on non-gaap financial measures (see our May-June 2016 issue, at pg 1, our July-August 2016 issue, at pg 1 and our September-October 2016 issue, at pg 8) has put the spotlight on earnings releases and earnings calls, given that non-gaap financial measures are typically communicated through those channels. In some instances, issuers have had to substantially revise their overall presentation of financial information, particularly in earnings releases, as a result of the Staff s focus on equal or greater prominence issues, while some issuers had to give up on non-gaap financial measures completely in light of the Staff s interpretation regarding individually tailored accounting principles. The crackdown also resurfaced questions about how far an issuer can go with non-gaap financial measure presentations in an earnings call versus an earnings release, as well as the applicability of the non-gaap financial measure rules to materials such as supplemental earnings call presentations and other investor presentations. At the same time, we have observed changes in the way issuers go about informing the market about their financial results, while age-old questions such as when to prerelease earnings information continue to come up time and time again. With all of this activity, we thought this would be an opportune time to take another look at the earnings disclosure process. Background on Releasing Earnings The practice of releasing earnings in advance of the filing the Form 10-K/Q has been an integral part of the disclosure process for a long time. While the federal securities laws do not explicitly compel issuers to release earnings in advance of filing required SEC reports, a variety of factors encourage widelyfollowed issuers to do so. First and foremost, the practice is expected by the investment community, which looks for quarterly financial results beginning in January, April, July and October for calendar year issuers. Issuers often report quarterly financial results in a timeframe when others in their industry are reporting results, which means that the earnings season will stretch over a several week period, as issuers in different industries complete closing the books on their quarterly financial results. Given the demand for the information on a timely basis coming from investors, an issuer would be hard-pressed to stop the practice of releasing earnings in the traditional way, even if it chose instead to accelerate the filing of the Form 10-K/Q to the same day that it would otherwise issue an earnings release and conduct an earnings call. Another reason for releasing earnings at the earliest practicable point is that most insider trading policies allow the trading window to open for insiders and other designated employees within a period shortly after the release of earnings, even if the issuer has not yet filed the Form 10-K/Q (see our Special Supplement to the January-February 2011 issue, at pg 1). The desire to open the trading window as quickly as possible is advantageous for obvious reasons, and the ability to do so is predicated on the theory that the earnings release (along with the related earnings call, if one is conducted) provide all of the material information about an issuer s financial performance necessary to avoid claims that the issuer (conducting repurchases, for example) or any insiders are trading on the basis of material nonpublic information. Further, it is often suggested that issuers may be compelled to disclose the information for the completed fiscal period because of stock exchange prompt disclosure rules (e.g., Nasdaq IM and Section COPYRIGHT 2017 EP EXECUTIVE PRESS, INC., AUSTIN, TEXAS 78767

2 of the NYSE Listed Company Manual), which call for the prompt disclosure of information that could be expected to affect the market for the issuer s securities. The earnings release has also historically served as the means by which issuers communicate earnings guidance. Issuers are usually not inclined to include forward looking projections, including earnings guidance, in SEC reports such as the Form 10-K/Q, and instead prefer utilizing the earnings release that is furnished and not filed with the SEC. The furnished status of the earnings release results in a lower liability profile, and avoids incorporation by reference into registration statements/prospectuses. With the acceleration of periodic report filing deadlines, it seems that the time between earnings release issuance and periodic report filing has been shrinking, such that now we see many issuers actually filing the Form 10-Q on the same day that earnings release is issued. We see this phenomenon occurring to a lesser extent with the Form 10-K, given the complexities of completing the audit work on such an expedited basis. As with so many things these days, the march of technology and the insatiable demand for immediate gratification leads to an inevitable acceleration of the financial reporting schedule. Anatomy of the Earnings Release The point of the earnings releases is to communicate the issuer s financial information in a concise manner to the investment community; however, it is commonly understood that not just investors are closely scrutinizing earnings releases. The earnings release is also intended for the press (perhaps more appropriately, the media ), which may include anyone from bloggers/tweeters to local reporters in the issuer s hometown, as well as reporters for major financial publications. A third group of potential users of the earnings release is plaintiffs lawyers, who are constantly looking for opportunities to allege that earnings releases include false and misleading statements or omit material information. A fourth group reading the earnings release is the issuer s competitors, who look for signs of weakness or strength that might be communicated in the reported quarterly financial results. Moreover, it is now obvious, particularly following the Staff s 2016 crackdown on non-gaap financial measures, that the Staff pays close attention to what is said in an issuer s earnings release (and the earnings call). Given all of these audiences, issuers must carefully consider the information that is included in the earnings release and how it is presented. Liability Considerations. When earnings releases are furnished and not filed with the SEC, the general antifraud provisions of 1934 Act Section 10(b) and Rule 10b-5 apply, which prohibit material misstatements or omissions in the earnings release. By furnishing and not filing the earnings release with the SEC, issuers avoid potential liability under 1934 Act Section 18, as well as 1933 Act liability for information incorporated by reference into a registration statement/prospectus (unless the issuer chooses to have the information incorporated by reference, as discussed below). General antifraud liability also could arise with respect to related earnings material, such as the earnings call and the supplemental earnings material (e.g., the slide presentation used in conjunction with the earnings call). Disclosure. While there are no line item disclosure requirements applicable to earnings releases, typically they will include unaudited financial tables (e.g., balance sheet, income statement, statement of cash flows), key operating and other metrics, a discussion of the financial performance and other material developments occurring during the quarter, and often a quote from the CEO and/or the CFO addressing key points about the quarter. The earnings release may contain guidance, or an update to previous guidance. The earnings release usually references the related conference call (although the call is typically announced well in advance of the earnings release date), and includes a forward-looking statement disclaimer and any required Reg G (e.g., a reconciliation) and Item 10 of Reg S-K (by virtue of Item 2.02 of Form 8-K) information if non-gaap financial measures are included in the release. The main considerations in drafting and reviewing the disclosure is that it must comply with the applicable SEC requirements (e.g., the non-gaap financial measure requirements), and it must be free of material misstatements or omissions. In many cases, a considerable amount of attention is focused on what information is not included in the earnings release the release must be accurate and complete, but it obviously cannot be as extensive as a Form 10-K/Q. Further, the disclosure must be written for the various audiences noted above, and that often means paying particular attention to how the press will The Corporate Counsel 2

3 report the information that is included in the release. Finally, while additional information may be conveyed in the earnings call and in supplemental materials, that information should be complementary to the material information that is in included in the earnings release. Issuance Mechanics. The earnings release must be issued in a Reg FD-compliant manner. While the SEC has provided guidance about disseminating material information through the use of corporate websites and social media channels (see our March-April 2013 issue, at pg 3), the vast majority of issuers have elected to stick with press releases as the means for achieving broad dissemination of the information, usually issuing the releases through wire services such as PRNewswire and Business Wire. The earnings release is simultaneously posted on the issuer s website, and in some cases issuers may use social media channels to announce the availability of the information and/or to highlight information that is provided in the earnings release. Many issuers have outsourced the hosting of their investor relations website to third parties, and that trend (in addition to in-house human error) has led to some issues in recent years, including when: (i) information that was not intended to be released has been released; (ii) information has been released in a form that was not intended to be released (i.e., the release of a draft document), or (iii) information is released prior to the time that such information was intended to be released. The potential consequences of an inadvertent release of sensitive information for an issuer may include: (i) abnormal trading in the issuer s securities as a result of the release that could substantially affect the value of the issuer s securities; (ii) insider trading based on the misappropriated information; (iii) reputational damage associated with releasing sensitive information that was not intended to be released in the form that it was released, or that was released prior to when the issuer expected the information to be released; (iv) regulatory risks, including actions by the applicable stock exchange and/or the SEC for violations of applicable provisions, which could include Reg FD and antifraud provisions; and (v) potential investor lawsuits. These incidents point out the need to maintain strict control of the information prior to release, including ensuring that third parties have controls in place to prevent premature or inadvertent disclosure. In the event of an inadvertent release of information, time is typically of the essence. We recommend that the inadvertently released information be removed from the investor relations website as soon as reasonably practicable following discovery of the error. The issuer should try to determine how long the inadvertently released information has been available, and determine, to the extent possible, whether and how the information has been further disseminated, including how many users may have accessed the information during the time that it was available. After analyzing the situation, the issuer should consider whether any potential remedial measures may be necessary, including whether any corrective statements need to be issued, whether regulators need to be contacted and whether any other additional measures are necessary. NYSE-listed issuers must give the NYSE at least ten minutes prior notice of the issuer s intended announcement of material news during the period between 7:00 a.m. and 4:00 p.m. Eastern Time. Issuers intending to release material news after the close of NYSE trading may do so only after the earlier of: (i) the publication of the listed security s official closing price on the NYSE; and (ii) 15 minutes after the close of NYSE trading. Nasdaq issuers must notify Nasdaq at least ten minutes prior to the release to the public of material information that involves certain events (including, e.g., financialrelated disclosures, including quarterly or yearly earnings, earnings restatements, pre-announcements or guidance ) when the public release of the information is made between 7:00 a.m. to 8:00 p.m. Eastern Time. If the public release of the material information is made outside of 7:00 a.m. to 8:00 p.m. Eastern Time, Nasdaq issuers must notify the exchange of the material information prior to 6:50 a.m. Eastern Time on the day of the intended release. An issue that issuers face from time to time is to what extent should they consider providing the earnings release on an embargoed basis to select members of the financial press. The practice is seen as necessary to ensure that the press gets the story right when the earnings release is actually issued, because reporters only have a very limited time to digest the information before they have to publish their stories. The discussion of this topic can often make counsel very nervous, given the prospect for having an earnings release in the hands of someone outside of the issuer prior to its release. When 3 The Corporate Counsel

4 considering the situation, it should be noted that members of the press are not among the enumerated persons specified in Reg FD, and, in the embargoed release situation, the reporters are instructed to hold the information in confidence prior to its release. As a result, there is no Reg FD concern with providing the embargoed earnings release. In order to properly manage the process, the investor relations/public relations team must be clear with the reporters as to the status of the information and the need to maintain it in the strictest of confidence until it is released, which is usually (at most) the following day. The issuer s personnel are also typically available to answer questions about the embargoed information prior to its release, so as to maximize the benefit of providing the information to the reporters in advance of the earnings release date. Furnishing Mechanics. Item 2.02 of Form 8-K is triggered by the release of material, nonpublic information regarding the issuer s results of operations or financial condition for a completed quarterly or annual fiscal period. This release of the information can be either in written form or in oral form, e.g., through a conference call or webcast. In Exchange Act Form 8-K CDI Question , the Staff indicates that even when an issuer reports preliminary earnings and results of operations for a completed quarterly period, which may include some amounts as estimates, the issuer must comply with the requirements of, and instructions to, Item 2.02 of Form 8-K. When triggered, the Item 2.02 Form 8-K must: (i) disclose the date of the announcement or release; (ii) briefly identify the announcement or release; and (iii) include the text of that announcement or release as an exhibit to the Form 8-K. While the filing deadline under Item 2.02 of Form 8-K is within four business days of the triggering event, issuers usually furnish the earnings release to the SEC by filing the Form 8-K on EDGAR at the same time the earnings release is issued through, e.g., the wire services, so that the issuer may rely on the exemption in Item 2.02 of Form 8-K for filing oral, telephonic, webcast or similar communications that take place promptly after the issuer files the Form 8-K. Under this exemption, the issuer does not need to disclose any further information from the oral communication (such as a transcript of the earnings conference call) on a subsequent Form 8-K, even if the issuer discloses additional material nonpublic information about the completed earnings period. This exemption is only available if: (i) the communication complements, and occurs within 48 hours after, the related written communication previously furnished on Form 8-K; (ii) the company pre-announces the communication by a widely disseminated press release, and makes the communication broadly accessible to the public by dial in conference call, webcast, broadcast or similar means; and (iii) the issuer posts on its website the previously undisclosed material financial and statistical information contained in the presentation (and any additional information required with regard to non-gaap measures). An issuer may satisfy this website posting requirement by: (i) providing through the issuer s website public access to an audio file that contains all the material financial and statistical information not disclosed prior to the presentation; or (ii) posting on the website, before the time of the presentation, slides or a presentation that contains the information. The SEC encourages companies to provide access to these website postings for at least 12 months. This conditional exemption can create a potential pitfall for issuers. For example, as noted in Exchange Act Form 8-K CDI Question , an issuer that disseminates its earnings release after the close of the market and holds its properly noticed conference call to discuss its earnings two hours later may be unable to furnish its earnings release on a Form 8-K before the start of the conference call, which would mean that the issuer has to furnish the material, previously nonpublic, financial and other statistical information required to be furnished under Item 2.02 of Form 8-K as an exhibit to a Form 8-K and satisfy the other requirements of Item 2.02 of Form 8-K. The Staff indicates that a transcript of those particular portions of the conference call (including, e.g., information provided in connection with any questions and answers), or slides or a similar presentation including such information, will satisfy this requirement. Further, a condition of the exemption is that the issuer must provide on its website any material financial and other statistical information not previously disclosed and contained in the presentation, together with any information that would be required by Regulation G. In Exchange Act Form 8-K CDI Question , the Staff notes that the required information must appear on the issuer s website at the time the oral presentation is made. Further, with respect to information that is not provided in a presentation itself but, rather, is disclosed unexpectedly in connection with the question The Corporate Counsel 4

5 and answer session that was part of that oral presentation, the information must be posted on the issuer s web site promptly after it is disclosed. The Staff notes that a webcast of the oral presentation would meet this requirement. While the requirements in Item 2.02 of Form 8-K can present some real timing challenges for issuers, the Staff has noted (in Exchange Act Form 8-K CDI Question ) that an issuer s failure to furnish to the SEC the Form 8-K required by Item 2.02 in a timely manner does not affect the issuer s eligibility to use Form S-3, because an Item 2.02 Form 8-K is furnished rather than filed. The Staff notes that the failure to furnish the information would be a violation of 1934 Act Section 13(a) and the rules thereunder. In some cases, an issuer may actually want to incorporate by reference some or all of the earnings information that is provided in the earnings release into a registration statement/prospectus. For example, an issuer may wish to conduct a takedown off of its shelf registration statement, or recommence sales under an at-the-market offering program, between the time when the earnings information is released and the Form 10-K/Q is filed. Form 8-K specifically contemplates a process for filing materials under Item General Instruction B.2. to Form 8-K specifies that information in a report furnished pursuant to Item 2.02 shall not be deemed to be filed for purposes of Section 18 of the 1934 Act or otherwise subject to the liabilities of that section, unless the issuer specifically states that the information is to be considered filed under the 1934 Act or incorporates it by reference into a filing under the 1933 Act or the 1934 Act. General Instruction B.2. also provides that, if a report on Form 8-K contains disclosures under Item 2.02, whether or not the report contains disclosures regarding other items, all exhibits to such report relating to Item 2.02 will be deemed furnished, and not filed, unless the issuer specifies, under Item 9.01, which exhibits, or portions of exhibits, are intended to be deemed filed rather than furnished pursuant to the instruction. Notwithstanding the process outlined in General Instruction B.2. to Form 8-K, issuers (and their underwriters) have concerns with the prospect of incorporating by reference the earnings release in its entirety into 1933 Act registration statements/prospectuses. In particular, they tend to be concerned with incorporating by reference forward-looking information such as statements about guidance, as well as the soft statements in the earnings release, such as the CEO/CFO quotes. As a result, it is common practice to excerpt out of the earnings release those portions that the issuer wishes to have incorporated by reference, and file those portions under cover of an Item 8.01 Form 8-K. Underwriters will generally seek customary comfort on the numbers that are reported in this manner. Non-GAAP Financial Measures. The earnings release is subject to Reg G, which requires a presentation of the most directly comparable GAAP financial measure(s) and a reconciliation of the disclosed non-gaap financial measure(s) to the most directly comparable GAAP financial measure(s). Reg G also provides that an issuer is not permitted to disclose a non-gaap financial measure that, taken together with the information accompanying that measure and any other accompanying discussion of that measure, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the presentation of the non-gaap financial measure, in light of the circumstances under which it is presented, not misleading. Instruction 2 to Item 2.02 of Form 8-K goes on to provide that the requirements of paragraph (e)(1)(i) of Item 10 of Reg S-K apply to disclosures under Item As a result, in addition to complying with Reg G, the issuer also must: (i) present, with equal or greater prominence, the most directly comparable financial measure calculated and presented in accordance with GAAP; (ii) reconcile the differences between the non-gaap financial measure and the comparable GAAP measure; (iii) disclose the reasons why the issuer s management believes that the presentation of the non-gaap financial measure provides useful information to investors regarding the issuer s financial condition and results of operations; and (iv) to the extent material, disclose the additional purposes, if any, for which the issuer s management uses such non-gaap financial measure. The issue of providing the most directly comparable GAAP measure with equal or greater prominence proved to be one of the most frequent concerns during the Staff s 2016 non-gaap financial measures crackdown, as we discussed in our May-June 2016 issue (at pg 1), our July-August 2016 issue (at pg 1) and our September-October 2016 issue (at pg 8). Further, through the comment process, the Staff has often focused on the adequacy of an issuer s disclosure about the usefulness of non-gaap financial measures, as well as the ways in which management utilizes the non-gaap financial measures, and will 5 The Corporate Counsel

6 often request additional details about the usefulness and uses of each particular non-gaap financial measure. The Staff typically objects to boilerplate statements intended to apply to all of the presented non-gaap financial measures. The patchwork of non-gaap financial measure requirements results in different approaches to those measures across the various components of the earnings disclosure process. The earnings release is subject to the highest level of regulation, with the requirements of both Reg G and Item 2.02 of Form 8-K applicable to any non-gaap financial measures, as discussed above. When the earnings call and related materials are not required to be furnished under Item 2.02 of Form 8-K because the issuer is relying on the conditional exemption described above, references to non-gaap financial measures during the earnings call and non-gaap financial measures included in the supplemental materials referenced in the call are subject only to Reg G, i.e., the presentation of the most directly comparable GAAP measure and a reconciliation. As outlined below, Reg G permits an issuer to reference the reconciliation posted on its website as a means for providing the required information during the course of the earnings call. With respect to the supplemental materials, the directly comparable GAAP number and the reconciliation should be provided within the presentation materials themselves. The Earnings Call The earnings call, with its scripted commentary and obligatory analyst/investor question and answer period, has been a fixture of the earnings disclosure process for many years. The role of the earnings call and its importance to the overall process seems to be changing in recent years, as the necessity of what some may view as a Kabuki theater presentation may be waning. There is no obligation under the federal securities laws for issuers to conduct an earnings call, just as there no requirement that issuers provide an earnings release. Earnings Call Process. If an issuer elects to conduct an earnings call in connection with its earnings release, it must first issue a press release announcing the earnings call, disclosing: (i) when the earnings call is to be held; (ii) how to access the call; and (iii) where to obtain the presentation materials to be referenced during the call. In addition to alerting prospective attendees to the existence of the call, the announcement satisfies one of the conditions in the exemption provided in Item 2.02 of Form 8-K from furnishing the content of the earnings call, because the call is a complementary discussion held within 48 hours of the release of earnings. The announcement of the call also establishes that the public has received reasonable advance notice of the call and an opportunity to join the call for the purposes of Reg FD. We generally believe that two weeks constitutes reasonable notice of the earnings call in most circumstances, but many issuers announce the call further in advance. A shorter timeframe may also be justified, depending on the particular circumstances. An important procedural step that issuers must take during the earnings call is to take advantage of the safe harbor for forward-looking statements. Section 21E of the 1934 Act provides a safe harbor from liability for material misstatements or omissions in statements that an issuer makes in, e.g., its SEC filings, press releases, investor presentations, earnings calls and other public statements that are identified as forward-looking statements and, among other things, are accompanied by meaningful cautionary statements. In order to take advantage of the safe harbor with respect to an oral communication, the issuer must state in the oral communication that: (i) the issuer may make forward-looking statements; (ii) actual results could differ from what is described in those statements; and (iii) additional information on factors that could cause results to differ is available in the issuer s most recent Form 10-K or more recent SEC filing, if applicable. As a result of these safe harbor conditions, an issuer representative must read a statement meeting these requirements at the beginning of the earnings call. Another statement may be necessary at the outset of the earnings call if non-gaap financial measures are to be discussed during the call. Note 1 to Rule 100 of Reg G specifies that if a non-gaap financial measure is made public orally, telephonically, by webcast, by broadcast, or by similar means, the requirements to provide the most directly comparable GAAP measure and a reconciliation of that measure is satisfied if: (i) the required information is provided on the issuer s website at the time the non-gaap financial measure is made public; and (ii) the location of the website is made public in the same presentation in which the non-gaap financial measure is made public. The Corporate Counsel 6

7 The earnings call must be widely accessible (typically through telephone access and webcast), although the question and answer portion of the webcast does not need to allow questions from the general public. Generally, the only persons recognized for questions during the earnings call are analysts/ investors that the issuer is familiar with, and usually management is prepared for the types of questions that those persons usually raise. Social Media and the Earnings Call. A recent innovation has been live-tweeting the earnings call. In this case, the use of the popular social media channel is complementary to, rather than in place of, the traditional earnings call format. Proponents of the practice see it as a means to achieve broader dissemination of the earnings call content. The practice usually involves tweeting a series of selected statements from the earnings call script as they are said, following the communication of the disclaimers referenced above through the use of hyperlinks (so as to avoid running into the 140 character limitation). The live-tweeting typically does not extend to the question and answer portion of the earnings call. Evolution of the Earnings Call Process. In recent years, issuers have sought ways to potentially streamline the earnings call portion of the earnings disclosure process. In some cases, issuers elect to pre-record the scripted portion of the earnings call, and then play that scripted portion back at the preannounced time, followed by a live question and answer period with analysts/investors. Other issuers have experimented with the approach of just releasing the written script for the earnings call, without actually conducting the earnings call itself. Further, some issuers have elected to forego conducting the earnings call altogether, and instead rely on the earnings release and supplemental information to communicate all material information about the completed fiscal period, as well as any forward-looking guidance. While we do not see the traditional earnings call going away any time soon, we do observe that efforts to experiment with alternative disclosure approaches may signal that the earnings call is no longer as significant as it once was in the overall disclosure process. Giving Guidance An undoubtedly integral part of the earnings disclosure process is the practice of providing earnings guidance. No federal securities laws or stock exchange requirements compel issuers to give guidance as to future financial performance; rather, guidance is driven by investor/analyst demands for information and an issuer s desire to guide analyst/investor expectations for the purposes of developing their models and formulating their investment decisions. The practice of providing guidance has its detractors, who principally focus on the short-termism that guidance tends to promote, the management time needed to provide good guidance, and the difficult positions that guidance puts issuers in when they have to revisit their guidance due to unforeseen circumstances. Several years ago, a movement emerged which sought to discourage the practice of giving guidance, and some notable issuers did in fact discontinue the practice. That movement was not successful in encouraging a large number of issuers to discontinue the practice, so guidance is still prevalent in earnings releases today. From a legal perspective, the principal considerations with giving guidance are: (i) preserving the argument that the public statements about earnings guidance are protected by the safe harbor for forward-looking statements, which means that appropriately-tailored disclaimers should be utilized in the earnings release, on the earnings call and in any supplemental materials; (ii) ensuring that the issuer complies with Reg G and, to the extent applicable, Item 2.02 of Form 8-K and the relevant portions of Item 10(e) of Reg S-K, when providing guidance with respect to non-gaap financial measures, including providing the appropriate disclosures when a required reconciliation cannot be provided without unreasonable efforts (see, e.g., Non-GAAP Financial Measures CDI Question , our September-October 2016 issue, at pg 1 and our May-June 2016 issue, at pg 8); and (iii) appropriately considering whether guidance is being updated and whether that update constitutes material nonpublic information for the purpose of Reg FD (see, e.g., Regulation FD CDI Question ). In the event that an issuer elects to discontinue providing guidance, we generally believe that such information should be communicated in a Reg FD-compliant manner, similar to the process used for issuing the earnings release. A preferable approach would be to announce the discontinuance of guidance as part of the regular earnings disclosure process. 7 The Corporate Counsel

8 The Pre-Release/Pre-Announcement Conundrum As we all know, an issuer is not obligated to disclose material, nonpublic information unless it has a duty to do so. There are obviously times when an issuer s management knows material information about the issuer s financial performance during the course of a quarter, but would prefer to disclose that information only when it chooses to do so (i.e., in the earnings release), and/or when it is obligated to do so (i.e., in the Form 10-K/Q). This issue is often complicated by the concept of pre-announcement or pre-release, i.e., announcing the quarterly financial information or guidance in advance of the regularly scheduled earnings call. The pre-release/pre-announcement situation is always a difficult one to address, given our very human qualities that we do not want to disappoint, and we tend to want to hold back bad news until the latest possible time for disclosure. To Pre-Release or to not Pre-Release? The practice of pre-releasing financial information is traditionally seen as a way to soften the blow for investors, while at the same time it is criticized because an issuer pre-releasing the financial information is able to get that information into the marketplace before its competitors, who typically release financial information at around the same. As a result, the issuer may avoid comparisons with its peers. Among the most common reasons cited for pre-releasing financial information include: (i) updating previous guidance; (ii) missing (or beating) analyst expectations; (iii) dealing with new circumstances, such as a share repurchase program or an acquisition; or (iv) communicating the information broadly so it can be discussed with investors and analysts under Reg FD (e.g., at an upcoming investor meeting). Given the significance of the information being communicated and the potential market reaction that the pre-announcement can cause (i.e., a very large drop in the issuer s stock price), it is important to have broad internal buy-in with the decision to pre-release, and a coordinated plan for releasing the information. The discussion of a pre-release situation usually involves a multi-disciplinary team within the issuer, including the CFO and controller, the investor relations staff, internal and outside legal counsel, the CEO, the audit committee and the disclosure committee. In assessing a pre-release situation, it is important to look closely at all of the relevant circumstances. The decision is ultimately going to be driven by a desire to preserve the issuer s credibility with the investment community and to maintain a positive relationship with analysts and investors, who do not like to be blind-sided by unexpected news. While there are certainly no specific rules, Wall Street convention generally appears to favor pre-release of financial information when an issuer is going to miss estimates by a significant margin. What constitutes a significant margin is more difficult to define, with some indicating that a 5% difference would be considered significant, while others say that a 10% difference would be considered significant. We have noted issuers who pre-release financial information even in situations where the difference is significantly lower that 5% it depends entirely on the particular circumstances. We note that analysts/investors appear to expect issuers to pre-release when results fall short of analyst expectations, even if the issuer does not provide earnings guidance. In conducting the analysis regarding a potential pre-release situation, there are a number of factors that an issuer should consider. Such factors include: (i) the extent to which management is certain of the potential shortfall, and whether there is a possibility that expectations and/or guidance for the quarter could ultimately be met; (ii) the amount of information known about the underlying situation and the extent to which that information can be communicated in the pre-announcement; (iii) the timing of when management learned of the situation, and the juxtaposition of any trading by insiders in and around the time when the situation was discovered; (iv) the likelihood of leaks; (v) the issuer s past practices, including how frequently the issuer chooses to disclose material information; and (vi) the content of any relevant past forecasts, statements or other disclosures regarding the issuer s operating performance and related cautionary statements. Pre-Release Mechanics. As with earnings releases, pre-announcements take place within what is effectively a pre-announcement season. The pre-announcement season roughly runs from a few weeks before the end of the fiscal quarter at issue to a week or so into the next fiscal quarter. The general view is that if investors/analysts do not hear anything from an issuer in this pre-announcement season, they are generally going to assume that earnings will be in line with expectations and are likely to make investment decisions accordingly. Therefore, if an issuer makes a pre-announcement too late, The Corporate Counsel 8

9 e.g., three weeks into the next fiscal quarter, the pre-announcement may not have the desired effect of softening the blow, and may raise more questions than would otherwise exist about the situation that the issuer is facing. For example, a late or non-existent pre-announcement may cause investors/analysts to wonder whether the issuer was caught off-guard with respect to the situation, or whether the issuer was trying to avoid being transparent about the negative circumstances. The pre-announcement is usually accomplished by issuing a press release in a Reg FD-compliant manner, consistent with the process that the issuer utilizes for earnings releases. If the information is related to a completed fiscal quarter, then the issuer must also furnish the press release to the SEC under cover of an Item 2.02 Form 8-K, as discussed above. In many cases, it will make sense from an investor relations perspective to schedule a conference call to discuss the pre-announcement, and that conference call should be announced in a Reg FD-compliant manner. Given the accelerated timing of the pre-announcement, the conference likely will not meet all of the conditions for the exemption in Item 2.02 of Form 8-K discussed above, so a transcript of the call may need to be filed. The pre-announcement conference call may or may not have a question and answer period; however, if it does, then the question and answer period should be conducted in a manner similar to the issuer s earnings call. The pre-announcement may also create a significant amount of follow-up questions from analysts and investors, so the issuer s management and investor relations personnel need to be cognizant of what they can say about the situation within the restrictions of Reg FD. The pre-announcement typically does not obviate the need for the issuer to continue with its regular earnings announcement and earnings call (if that is the issuer s usual practice), so it may be possible to address follow-up questions more globally in the course of the issuer s regular communications. Controls A persistent question remains to this day as to how much oversight and control needs to be exercised over the earnings disclosure process. The earnings information included in the earnings release is not audited, and no line item disclosure requirements apply to the earnings release or what is said on the earnings call. As a result, many of the decisions as to what to say and how to say it remains in a gray area when it comes to earnings releases and earnings calls. Section 303A.07(b)(iii)(C) of the NYSE Listed Company Manual requires that listed issuer audit committee charters must require a discussion of the issuer s earnings press releases, as well as financial information and earnings guidance provided to analysts and rating agencies. Commentary to this Section states [a]udit committees need not discuss in advance each earnings release or instance in which [the issuer] may provide earnings guidance. There is no comparable provision in the Nasdaq rules. While the NYSE standard does not compel a review of earnings releases prior to issuance, most issuers in practice will provide earnings releases to the audit committee in advance. In addition, disclosure committees are heavily involved with the earnings release process, reviewing drafts and considering issues as they arise. With the focus on controls brought about by the Staff s non-gaap financial measures crackdown, issuers should consider taking another look at the disclosure controls that have been put in place with respect to the earnings release and earnings call. The fact that these communications are not SEC filings should not significantly change the approach to ensuring that accurate information and analysis is reflected in the earnings disclosure process. Even with controls in place, sometimes errors happen with earnings releases and statements made on earnings calls. Unlike with a Form 10-K/Q, there is no obvious mechanism for amending the earnings release once it is issued, or for revising an erroneous statement made during the course of an earnings call. Exactly how an issuer will seek to correct an earnings release or earnings call statement often depends on the timing of the discovery of the error, the materiality of the error and the timing of the earnings release or call relative to the filing of the Form 10-K/Q. Generally, when discovery of a material error in the earnings release occurs close in time to the issuance of the earnings release, it may be possible to put out a corrected release or a separate release that specifically notes the corrected information. If a significant amount of time has gone by before discovery 9 The Corporate Counsel

10 of the error and the filing of the Form 10-K/Q is imminent, it may be a better practice to make the corrective disclosures in the context of the Form 10-K/Q, rather than issuing another earnings release. With respect to the earnings call, when statements are made in error on the call, it may be possible to correct those statements while the call is actually ongoing, such as addressing the error during the question and answer portion of the call. Once the earnings call has ended, it may be necessary to correct the material error by issuing a press release in a Reg FD-compliant manner which corrects the misstatement(s) or omission(s). If a transcript or archive of the earnings call is maintained on the issuer s website, then the correcting press release should be conspicuously placed along with the transcript or archive. When an issuer has faced a situation with a material error in the earnings release, it may be necessary to revisit the effectiveness of the issuer s disclosure controls and procedures and consider what remedial measures may be necessary. NEW DEVELOPMENTS Approaching Non-GAAP Financial Measures in the Proxy Statement The Staff s non-gaap financial measures crackdown in 2016 focused on earnings releases and periodic reports, raising some uncertainty as to just how the Staff may look at the use of non-gaap financial measures in the proxy statement. The SEC s approach to use of non-gaap financial measures in the proxy statement takes a distinctly bifurcated approach. Instruction 5 to Item 402(b) provides that disclosure of target levels that are non- GAAP financial measures will not be subject to Reg G and Item 10(e) of Reg S-K, but disclosure must be provided as to how the number is calculated from the issuer s audited financial statements. This instruction has always been understood to only require a textual description of how the non-gaap financial measure is calculated, not a full reconciliation of the non-gaap financial measure to the most directly comparable GAAP financial measure as contemplated by both Reg G and Item 10(e) of Reg S-K. As noted in Regulation S-K CDI Question , Instruction 5 extends not only to the target level, but also to the number that is reported as the actual result for that non-gaap financial measure. On the other hand, proxy statements today often include detailed proxy summaries and CD&A sections which seek to highlight the issuer s performance across a number of specific metrics as a means of demonstrating the relationship between pay and performance. These measures are used outside of the specific context of discussing the targets established under the compensation plans, and describe the issuer s performance in a way that is often similar to an investor presentation rather than an SEC filing. Recognizing this trend, in 2011 the Staff revisited the topic in Non-GAAP Financial Measures CDI Question (in response to inquiries from the JCEB), where the Staff indicates that, in the pay-related circumstances of the proxy statement only, where non-gaap financial information that does not relate to the disclosure of target levels is nevertheless included in CD&A or other parts of the proxy statement (for example, to explain the relationship between pay and performance), the Staff will not object if the issuer includes the required GAAP reconciliation and other information in an annex to the proxy statement, provided that the issuer includes a prominent cross-reference to such annex. If the non-gaap financial measures are the same as those included in the Form 10-K that is incorporating by reference the proxy statement s Item 402 disclosure as part of its Part III information, the Staff will not object if the issuer complies with Reg G and Item 10(e) of Reg S-K by providing a prominent cross-reference to the pages in the Form 10-K containing the required GAAP reconciliation and other information. In the Staff s May 2016 new and revised Non-GAAP Financial Measures CDIs, the Staff did not choose to revisit Non-GAAP Financial Measures CDI Question The Staff did, however, revise Non-GAAP Financial Measures CDI Question to address a wide variety of situations where the most directly comparable GAAP measure was not presented with equal or greater prominence to the non-gaap financial measure. The lack of attention to the continued application of Non-GAAP Financial Measures CDI Question may have generated some unanticipated anxiety for issuers, as they have openly The Corporate Counsel 10

11 wondered how the Staff might now read that CDI and comment on their disclosures (particularly with respect to the equal or greater prominence issue) in light of the 2016 non-gaap financial measures crackdown. To date, we have not detected a significant shift in the Staff s approach to non-target, non-gaap financial measures included in the proxy statement. In particular, we note that Non-GAAP Financial Measures CDI Question specifically refers to presenting the reconciliation and other information in the annex (or in the Form 10-K), so we read the other information component of the CDI to refer to the most directly comparable GAAP financial measure, which is provided in the annex (or the Form 10-K) as part of the required reconciliation. Consistent with the Staff s recent informal guidance, when reconciling a non-gaap financial measure to the directly comparable GAAP measure, the referenced reconciliation should start with the GAAP financial measure and work down through the adjustments to the non-gaap financial measure. The Staff believes this approach is clearer, and starting with the GAAP financial measure avoids giving greater prominence to the non-gaap financial measure (see our September-October 2016 issue, at pg 8). Further, we expect that the Staff may be concerned if issuers were to use characterizations of performance such as record performance or exceptional in the context of presenting non-gaap financial measures in the proxy statement, without at least an equally prominent descriptive characterization of the comparable GAAP measure. It remains to be seen how the Staff will address non-gaap financial measures in the upcoming review season, given all that transpired with the 2016 non-gaap financial measures crackdown. In addition, it should be noted that proxy statements appear to be a lower priority for the Staff in its review efforts, when compared with the extent to which the Staff focuses on Form 10-K/Q filings and earnings releases. Hyperlinks to Exhibits: A New Reality! As we noted in our July-August 2016 issue (at pg 8), the SEC had proposed rule and form amendments that would require issuers to include hyperlinks to exhibits. In March 2017, the SEC adopted final rules, which will require an issuer to include hyperlinks to each document listed in the exhibit index to any registration statements and reports filed with the SEC. The requirements will be effective on September 1, 2017 for most issuers, while non-accelerated filers or smaller reporting companies that submit filings in ASCII (which does not support active hyperlinks) have until September 1, The SEC encourages early compliance. Under the new requirements, all issuers must submit covered filings in HTML format, while unaffected filings such as proxy statements can still be submitted in the antiquated ASCII format. [Very few issuers actually use the old ASCII format, but the rules still had to work around the possibility for certain issuers.] Under the new requirements, active HTML hyperlinks are required for all exhibit filings, including exhibits incorporated by reference from prior filings. The list of affected filings is significant: 1933 Act Forms S-1, S-3, S-4, S-8, S-11, F-1, F-3, F-4, F-10, SF-1 and SF-3, and 1934 Act Forms 10, 10-K, 10 Q, 10-D, 8-K and 20-F. For registration statements, the hyperlink requirements will apply to the initial filing, all pre-effective amendments, and the version of the registration statement that becomes effective. The exhibit index also must now appear before the signature page of electronic filings. In accordance with Rule 105(b) of Reg S-T, all hyperlinks must be limited to documents filed within the EDGAR system. Several exhibits are not covered by the hyperlink requirement: (i) exhibits filed in paper pursuant to a temporary or continuing hardship exemption under Regulation S-T, or exhibits incorporated by reference that were filed on paper before EDGAR filing became mandatory and have not been refiled electronically (which an issuer can elect to do); (ii) XBRL exhibits; (iii) exhibits filed with Form ABS-EE; and (iv) exhibits filed in other forms under the MJDS. If an issuer discovers that an exhibit hyperlink is not accurate, then the issuer must correct it: (i) in the next periodic report that requires, or includes, an exhibit pursuant to Item 601 of Reg S K (or in the case of a foreign private issuer, pursuant to Form 20-F or Form F-10), in the case of a 1934 Act report or a registration statement that is effective; or (ii) by filing a pre-effective amendment, in the case of a registration statement that is not yet effective. 11 The Corporate Counsel