ASIC proposes restricting companies' use of 'non-conforming financial information"

In March 2011, the Australian Securities and Investments Commission (ASIC) released for consultation a draft regulatory guide on disclosing financial information prepared other than in accordance with accounting standards (“non-conforming financial information”). This article explores the implications for corporations.

Background

In CP 150 Disclosing financial information other than in accordance with accounting standards, ASIC proposes restricting the use of non-AASB (Australian Accounting Standards Board) financials in all sorts of corporate documents, from annual reports and corporate communications to transaction documents (prospectuses, bidder’s statements and so on). This new policy proposal from the regulator could have major repercussions, given that the use of non-AASB financials is both widespread and accepted in the business community and the market.

A particular focus of the proposal is the use of “underlying profit”. ASIC says:

"Alternative profit information presented to the market often excludes particular expenses, such as impairment losses, and has sometimes been used with an objective of removing “bad news” rather than providing meaningful information to the market."

Overall, ASIC is targeting the use of what it calls “non-conforming financial information” — which is: financial information that is required to be prepared and presented in accordance with the accounting standards when it appears in a financial report prepared under the requirements of the Corporations Act, whether that information appears in the financial report or another document, but is presented on a basis that is not in accordance with all relevant accounting standards. (Or, to put it more briefly, financial information that isn’t prepared in accordance with the accounting standards.)

ASIC identifies three categories of document where it has concerns about the use of non-conforming financial information: 

• statutory financial reports; 
• documents related to statutory financial reports; and 
• transaction documents.

Statutory financial reports

Unsurprisingly, ASIC see little scope for the use of non-conforming financial information in statutory reports — given that the law requires those reports to be prepared in accordance with the accounting standards.

The regulator does, however, address the always vexed issue of departures from the accounting standards in order to present a “true and fair view”.

ASIC reiterates its longstanding position that it is only in very rare cases that the accounting standards do not give a true and fair view. On the odd occasion when non-conforming financial information is necessary to give a true and fair view, ASIC warns that it should not be misleading or given undue prominence.

Documents related to statutory financial reports

While there is little scope to depart from the AASB standards in statutory financial reports, companies increasingly use other accounting methodologies when preparing non-statutory information about financial performance, such as:

• the chairman’s and chief executive officer’s messages and directors’ report contained in the annual report; 
• market announcements; 
• investor presentations; and 
• analyst briefings.

ASIC is wary about departing from the AASB standards in these types of communications. It notes that the accounting standards are intended to ensure consistent and comparable financial information over time and between companies. Therefore, says ASIC, it can potentially be misleading to present financial information in other ways — even in non-statutory documents.

In other words, ASIC is relying on the rules in the Corporations Act 2001 (Cth) that prohibit misleading or deceptive conduct in order to regulate departures from the accounting standards.

The types of potentially misleading conduct identified by ASIC include:

• giving undue prominence to alternative profit information compared to the prominence given to AASB-compliant financial information; 
• changing the emphasis given to the statutory profit and an alternative profit information from period to period (for example, emphasising whichever profit number gives the most favourable outcome for a period); 
• presenting a hypothetical profit figure that does not reflect actual historical performance or alternative profit information based on an average of prior period profits without prominent and adequate explanation of the basis adopted; 
• disclosing alternative profit information with a footnote to say that it excludes one-offs, without detailing or explaining the one-offs; 
• describing items as “one-off” or “non-recurring” when they have occurred in the past or are likely to occur in a future period; and 
• including adjustments to the statutory profit in the current period to calculate an alternative profit number, but excluding the equivalent adjustments from the comparative disclosure. The new policy proposal sets out a long list of guidelines to be followed when using non-conforming financial information in these documents. These guidelines, ASIC says, “should help to reduce the possibility of non-conforming financial information being misleading”. They include the following principles. 
• There should be clear explanations about how the information is calculated and why it is necessary to include such information. 
• The information should not be presented with greater prominence than the statutory information. 
• There should be reconciliations between the nonconforming financial information and the statutory information. 
• The non-conforming information should be consistently presented from period to period.

Transaction documents

ASIC believes that transaction documents (prospectuses, takeover documents, related party transaction disclosures, etc.) should generally comply with the accounting standards, even when preparing pro-forma financials for combined entities (although it recognises that in hostile takeover situations the bidder will often not have the necessary financial information about the target).

ASIC proposes a very detailed set of guidelines for pro-forma financials, including the following.

• Non-conforming financial information should be accompanied by corresponding information prepared in accordance with the standards.
•  Pro-forma combined income should incorporate the effects of tax—that is, it should not stop at the levels of EBIT (earnings before interest and taxes) or EBITDA (earnings before interest, taxes, depreciation and amortisation). 
• The amount and nature of all material adjustments to the statutory financial information to derive the pro-forma financial information should be disclosed by way of a reconciliation.

Conclusion

ASIC already relies on the “misleading or deceptive” provisions of the Corporations Act as the basis for its Truth in Takeovers policy. As is well known, that policy has effectively taken on a life of its own and now forms a de facto set of rules for communications in takeover situations. The regulator is presumably hoping that its proposed guidelines for non-conforming financial information will assume the same status.

In the meantime, ASIC is taking public submissions on the proposals, with a closing date of 12 May.

This article was first published in Inhouse Counsel, Vol 14 No 6, April 2011