The SEC has brought its first enforcement action charging violations of Reg G, which relates to public disclosure of "non-GAAP financial measures." The complaint was filed against SafeNet and certain of its officers and accounting employees, claiming option backdating and earnings management, which resulted in material misstatements of the company's financial statements. The charges were settled on the basis described in the release.
Non-GAAP financial measures often involve the exclusion of non-recurring, infrequent or unusual expenses. Reg G prohibits companies from disseminating false or misleading non-GAAP financial measures or presenting them in a way that obscures the company's GAAP results. SafeNet apparently regularly gave guidance as to both GAAP and non-GAAP EPS targets, and the complaint alleges that senior management exerted tremendous pressure on SafeNet's accounting and finance staff to meet earnings targets. In this case, to meet consensus earnings estimates, the individuals charged were alleged to have made accounting adjustments that improperly classified ordinary recurring operating expenses (e.g., all of the company's advertising expenses) as non-recurring integration expenses (costs incurred to integrate acquired companies into current operations), and improperly reduced accruals for professional services and reserves for inventory adjustments. Then, the individuals represented to investors that the company's non-GAAP earnings results excluded expenses that were non-recurring when in fact they were actually ordinary recurring expenses. According to the complaint, these adjustments were improper because they "(i) were made solely for the purpose of meeting or exceeding earnings targets; (ii) were made without any support or as a result of unsupported assumptions, (iii) created the false and misleading appearance that SafeNet had met or exceeded its quarterly earnings targets through its normal business operations; and (iv) in a number of instances, resulted in SafeNet not complying with GAAP." Interestingly, they seem to have pulled off these manipulations notwithstanding several challenges by the auditors, including, in one instance, a characterization by the auditors of the accounting as "abusive."