SEC Rules Won't Eliminate Pro Forma Disclosures on Potential M & A Deals

After the SEC issued rules governing the use of non-GAAP financial measures, many companies active in the M&A markets called their lawyers and advisers with concerns about how the rules would affect the reporting of proposed business combinations. At first glance, there was concern that the rules would limit a company's ability to disclose to investors the impact that a business combination would have on the combined companies following the transaction. As explained in this article, "pro forma" is not dead when it comes to reporting proposed business combinations.

What is a Non-GAAP Financial Measure?

In order to understand the impact the rules have on reporting business combination transactions, it is important to understand the definition of a non-GAAP financial measure. In footnote 12 to the final rule release, the SEC explained that it purposely selected the phrase "non-GAAP financial measures" to identify the types of information targeted by these rules because the phrase "pro forma financial information" is used differently by the SEC in other contexts.

Generally, a non-GAAP financial measure refers to a measure that is calculated by adding or subtracting items from a GAAP financial measure. As used by the SEC, pro forma financial information refers to information that provides investors with information about the continuing impact of a particular transaction by showing how it might have affected historical financial statements if the transaction has been consummated at an earlier time.

Although the markets tend to use "non-GAAP" and "pro forma" interchangeably (and it is true that pro forma information is not prepared in accordance with GAAP because it gives effect to a transaction that has not occurred), the SEC has noted the differences between the terms. In fact, the requirements to provide the SEC's historical concept of pro forma financial information — showing the impact of an acquisition on historical financial statements — is still alive and well. However, as described below, the rules clarify that this pro formal financial information should be used only for its intended purposes.

Summary of Rules

The final rules governing the use of non-GAAP financial measures include new Regulation G that governs non-GAAP financial measures in all publicly released communications, including SEC reports, earnings releases, and webcasts or conference calls. In addition, the rules amend Item 10 of Regulation S-K (and Item 10 of Regulation S-B) to establish additional rules and restrictions on the use of non-GAAP financial measures in SEC reports. We have previously summarized these new rules generally.

Generally speaking, the rules require companies disclosing non-GAAP financial measures to provide the most directly comparable GAAP financial measure and a reconciliation of the non-GAAP and GAAP measures. In addition, the companies must disclose the reasons why management believes the non-GAAP financial measures are useful to investors and any other uses of the non-GAAP measures when non-GAAP financial measures are filed (or furnished under new Item 12 of Form 8-K) with the SEC.

After the SEC issued proposed rules to implement the regulation of non-GAAP financial measures, several commentators submitted letters to the SEC suggesting several reasons why these rules should not apply to disclosures relating to prospective business combinations. First, communications regarding pending business combination transactions are already governed by specific rules¹ that acknowledge their special nature. These communication rules acknowledge the need of parties to release pro forma financial information on the combined entity. These rules also include safeguards, such as requiring written communications to:

• be filed with the SEC on or before the date of first use,
• include a prominent legend advising investors to read the applicable registration, proxy, or tender offer statement, and
• be subject to liability under Section 10(b), Section 12, or Rule 14a-9, as applicable.

Second, commentators requested that the SEC exempt from these rules all pro forma results required to be disclosed under Item 1015 of Regulation M-A, which is the provision requiring companies to disclose the financial analysis of any financial adviser supporting the fairness opinion relating to the proposed business combination.

Disclosures Relating to a Proposed Business Combination

The SEC accepted the views expressed by the commentators who argued that proposed business combinations should be treated differently. In such circumstances, investors often find discussions of projections, forecasts, synergies, and the like very important when evaluating the proposed transaction.

Thus, under the new rules, companies may disclose pro forma financial information concerning any of the following:

• the proposed business combination,
• a constituent entity to the combination (likely including a parent entity in a triangular merger), or
• the combined entity that would result from the combination.

The communication must be subject to one of the following SEC rules, however:

• Rule 425. Providing for same-day filing of certain public announcements (such as press releases, transcripts of presentations, Q&A releases, and the like) concerning prospective business combinations in which securities will be issued.
• Rules 14a-12 and 14d-2. Providing for same-day filing of certain public announcements (such as press releases, transcripts of presentations, Q&A releases, and the like) concerning prospective business combinations, whether for cash or stock, or tender offers.
• Item 1015 of Regulation M-A. Governing the discussion of a financial adviser's fairness opinion in the registration statement or proxy statement relating to a prospective business combination.

As a result, disclosure of pro forma information about a business combination in a prospectus/registration statement, proxy statement or tender offer communication is permissible. The pro forma financial information may not be included in other SEC filings, such as Forms 10-K, 10-Q, or 8-K.²

Pro Forma Financial Statements

The new rules have caused many companies and others in the M&A markets to wonder what impact they will have on disclosing pro forma results of proposed business combination transactions. The requirement to provide pro forma results in proposed business combination transactions still exists. The new rules have some impact on these pro forma statements, however. No non-GAAP financial measure may be set forth on the face of any pro forma financial information required to be disclosed in the registration statement governing a stock-for-stock business combination (e.g., Form S-4), in any required post-acquisition reporting (e.g., on Form 8-K), or in any other non-exempt filing with the SEC. Accordingly, the items presented on the face of pro forma financial statements cannot include or exclude amounts from GAAP measures (for example, disclosure of pro forma net earnings for the combined companies, excluding certain expenses, on the face of financial statements is impermissible).

¹"Regulation of Takeovers and Security Holder Communications," SEC Release No. 34-42055 (October 22, 1999). See also Rules 165 and 425 under the Securities Act and Rules 14a-12 and 14d-2 under the Securities Exchange Act.

²One may assume that the current practice of filing a press release announcing a prospective business combination as an exhibit to an optional Form 8-K would still be acceptable. Such a press release must also be filed under one of the SEC rules expressly governing business-combination announcements, however (Rule 425, for example).