As we have previously discussed, the Regulation CF disclosure requirement for thefinancial condition of the issuer has the potential to get inexperienced companies in trouble. It is in this section of the disclosure that optimistic entrepreneurs may provide misleading information by not providing the full details of performance measurements, or by not including information on the assumptions underlying any financial projections. Such statements may be misleading in their own right, or may omit information necessary to make the provided information not misleading – also known as securities fraud(link is external) (see paragraph (c)).
As we have also previously discussed, financial information presented to investors must be prepared in accordance with generally accepted accounting principles (“GAAP”). This applies even to financial statements that are merely certified by the management of the company.
The SEC recently articulated in a series of Compliance and Disclosure Interpretations(link is external) just why financial information should be presented according to GAAP. While the SEC’s interpretations are specifically applicable to public companies, the analysis applies equally to companies raising funds under Regulation CF. The short and sweet of it is that financial performance measures that are non-GAAP can be misleading unless steps are taken to ensure the information presented is done consistently and with a full explanation of the measurement.
For instance, the SEC cites the example of presenting a performance measure that excludes normal, recurring, cash operating expenses. Such a measure could be misleading to investors and result in liability to the company (and the intermediary).
Other examples of commonly used non-GAAP practices that could be misleading are when charges or gains are adjusted in one accounting period when that adjustment was not made in other accounting periods, as well as adjustments for non-recurring charges when there were no adjustments for non-recurring gains. These practices, identified by the SEC, are commonplace among early stage companies looking to publicize month-over-month growth figures, or other eye catching figures that are not fully supported by GAAP measurements.
For any company, when it comes time to discuss financial results in your Regulation CF disclosure, is the gain of disclosing non-GAAP measurements without complete disclosure worth the risk of securities fraud liability? Similarly, for any platform, is the risk of allowing these measurements worth it?
Sara Hanks, co-founder and CEO of CrowdCheck, is an attorney with over 30 years of experience in the corporate and securities field. Crowd Check provides due diligence and compliance services for online alternative securities offerings. Its services help entrepreneurs and project sponsors through the disclosure and due diligence process, give investors the information they need to make an informed investment decision and avoid fraud and help intermediaries avoid liability. Sara’s prior position was General Counsel of the bipartisan Congressional Oversight Panel, the overseer of the Troubled Asset Relief Program (TARP). Prior to that, Sara spent many years as a partner of Clifford Chance, one of the world’s largest law firms. While at Clifford Chance, she advised on capital markets transactions and corporate matters for companies throughout the world.Sara began her career with the London law firm Norton Rose. She later joined the Securities and Exchange Commission and as Chief of the Office of International Corporate Finance led the team drafting regulations that put into place a new generation of rules governing the capital-raising process. Sara received her law degree from Oxford University and is a member of the New York and DC bars and a Solicitor of the Supreme Court of England and Wales. She serves on the SEC’s Advisory Council on Small and Emerging Companies. She holds a Series 65 securities license as a registered investment advisor. Sara is an aunt, Army wife, skier, cyclist, gardener and animal lover.