Skip to main content
diversification.com
← Back to R Definitions

Regulation g

What Is Regulation G?

Regulation G is a rule established by the Securities and Exchange Commission (SEC) that governs the public disclosure of non-GAAP financial measures by public companies. It falls under the broader category of financial regulation and aims to enhance transparency and protect investors by ensuring that non-GAAP financial information is presented with appropriate context and a clear reconciliation to the most comparable GAAP (Generally Accepted Accounting Principles) measure. The regulation applies whenever a company publicly discloses material information that includes a non-GAAP financial measure.

History and Origin

Regulation G was adopted by the SEC on January 15, 2002, and became effective on March 28, 2003, as mandated by Section 401(b) of the Sarbanes-Oxley Act of 2002 (SOX). The enactment of SOX followed a series of significant corporate accounting scandals, such as those involving Enron and WorldCom, which severely eroded public confidence in corporate financial reporting. These scandals often involved companies presenting financial results using non-GAAP measures that could potentially mislead investors by obscuring underlying financial realities. The SEC's objective with Regulation G was to provide a structured framework for the use of non-GAAP financial measures, ensuring that investors receive balanced financial disclosure. The final rules, including Regulation G, aimed to address concerns about the selective use of non-GAAP information and improve the quality and reliability of financial disclosures9,8. The official release from the SEC outlines the specific conditions under which these measures can be used7.

Key Takeaways

  • Regulation G requires companies to reconcile non-GAAP financial measures to the most directly comparable GAAP financial measure.
  • It mandates that the comparable GAAP measure be presented with equal or greater prominence than the non-GAAP measure.
  • The regulation applies to all public disclosures of material information, whether oral or written, that include non-GAAP financial measures.
  • Regulation G aims to prevent misleading presentations of financial information and enhance investor protection.

Interpreting Regulation G

Regulation G mandates specific requirements for companies that choose to disclose non-GAAP financial measures. When a company presents a non-GAAP financial measure, it must also include a presentation of the most directly comparable GAAP financial measure. This comparable GAAP measure must be given "equal or greater prominence" in the disclosure. Furthermore, the company must provide a reconciliation of the non-GAAP financial measure to its GAAP counterpart. This reconciliation must be quantitative for historical information. For forward-looking non-GAAP measures, a quantitative reconciliation is required if available without unreasonable effort; otherwise, the company must disclose why it is not available and its probable significance6. The rule also prohibits companies from presenting a non-GAAP financial measure that, taken together with accompanying information, contains an untrue statement of a material fact or omits a material fact necessary to make the presentation not misleading5.

Hypothetical Example

Consider a hypothetical public company, "InnovateTech Inc.," which is preparing its quarterly earnings releases. InnovateTech wants to highlight its "Adjusted EBITDA" (Earnings Before Interest, Taxes, Depreciation, and Amortization) in its press release, as it believes this measure better reflects the operational performance of the core business, excluding certain one-time expenses.

Under Regulation G, when InnovateTech publicly discloses its Adjusted EBITDA, it must also:

  1. Present its GAAP-compliant Net Income (the most directly comparable GAAP measure) with equal or greater prominence.
  2. Provide a clear, quantitative reconciliation table showing how Net Income is adjusted to arrive at Adjusted EBITDA. This table would typically start with Net Income, add back interest expense, income tax expense, depreciation, amortization, and then any other non-GAAP adjustments (e.g., restructuring charges, impairment losses), clearly labeling each adjustment and explaining its nature.

By following Regulation G, InnovateTech ensures that investors can easily understand the differences between its Adjusted EBITDA and its official GAAP Net Income, promoting transparency in its financial reporting.

Practical Applications

Regulation G applies broadly to virtually all public disclosures of material information by companies that are required to file reports under the Securities Exchange Act of 1934. This includes not only documents filed with the SEC, such as Form 8-K for earnings announcements, but also press releases, investor presentations, conference calls, and company websites4,3. The rule aims to ensure consistent and comparable disclosure of non-GAAP financial measures across different communication channels.

For example, a company like Newell Brands, in its quarterly results announcement, explicitly states that its release and accompanying remarks contain "non-GAAP financial measures within the meaning of Regulation G promulgated by the U.S. Securities and Exchange Commission (the "SEC") and includes a reconciliation of non-GAAP financial measures to the most directly comparable financial measures calculated in accordance with GAAP"2. This demonstrates how companies apply Regulation G in their routine public financial disclosures. The regulation helps investors make more informed decisions by providing a standardized way to evaluate a company's performance metrics that are not explicitly defined by GAAP.

Limitations and Criticisms

While Regulation G was designed to address concerns about misleading non-GAAP financial measures and enhance investor protection, it has faced some limitations and criticisms. One common critique is that despite the reconciliation requirement, companies can still emphasize non-GAAP figures that present a more favorable view of their performance, potentially diverting attention from less flattering GAAP results. The flexibility in defining and adjusting non-GAAP measures can lead to a lack of comparability between different companies or even for the same company across different reporting periods if the adjustments are not consistently applied or clearly explained.

Some argue that while Regulation G provides a framework for transparency, it doesn't entirely prevent companies from selectively highlighting certain metrics or using complex adjustments that can still be difficult for average investors to fully comprehend. Academics have also explored the broader impact of regulation on corporate behavior, suggesting that in some instances, there can be a point of "over-regulation" where stringent rules might have unintended consequences or prove burdensome without proportional benefits, though this is a general observation on regulation and not specific to a failure of Regulation G itself1. The ongoing challenge for regulators is to strike a balance between providing companies with flexibility to communicate their performance and ensuring that investors receive clear, unbiased financial information that facilitates sound investment decisions.

Regulation G vs. GAAP

Regulation G and GAAP (Generally Accepted Accounting Principles) serve distinct but complementary roles in financial reporting. GAAP represents the comprehensive set of standardized principles, rules, and procedures that companies use to compile their financial statements. It dictates how revenues, expenses, assets, and liabilities are recognized, measured, and presented, ensuring a baseline of consistency and comparability across companies.

In contrast, Regulation G is a rule about the disclosure of financial information that does not conform to GAAP. It does not define how financial statements should be prepared but rather governs how companies publicly present and reconcile any financial measures that deviate from GAAP. The purpose of Regulation G is to prevent companies from using non-GAAP financial measures in a way that misleads investors by requiring a clear link and context to the equivalent GAAP figures. Essentially, GAAP provides the standard, while Regulation G regulates the presentation of deviations from that standard in public disclosures.

FAQs

Q1: What is the primary purpose of Regulation G?
A1: The primary purpose of Regulation G is to ensure that when public companies publicly disclose financial information that is not prepared in accordance with GAAP, they also provide a clear reconciliation to the most directly comparable GAAP measure. This promotes transparency and helps prevent investors from being misled by selective financial reporting.

Q2: Does Regulation G apply to all company communications?
A2: Yes, Regulation G applies to all public disclosures of material information that include non-GAAP financial measures, regardless of whether the disclosure is oral (e.g., conference calls), written (e.g., press releases, investor presentations), or electronic (e.g., company websites).

Q3: What is a "non-GAAP financial measure"?
A3: A non-GAAP financial measure is a numerical measure of a company's historical or future financial performance, financial position, or cash flows that either excludes amounts included in, or includes amounts excluded from, the most directly comparable measure calculated and presented in accordance with GAAP. Common examples include "Adjusted EBITDA" or "Free Cash Flow" if they are calculated differently from their GAAP counterparts.

Q4: How does Regulation G protect investors?
A4: Regulation G protects investors by requiring companies to provide context and clarity around non-GAAP financial measures. By mandating the presentation of comparable GAAP figures and a detailed reconciliation, it allows investors to understand how non-GAAP measures are derived and evaluate a company's performance using standardized accounting principles, thereby fostering more informed investment decisions.