Client Alert

The SEC recently announced a settlement of charges in the first enforcement action brought pursuant to Regulation G. In SEC v. SafeNet, Inc., et al., the SEC charged SafeNet, Inc. and certain of its former officers and employees with orchestrating an alleged earnings management scheme involving the use of improper accounting adjustments to meet or exceed quarterly earnings targets. Whenever a company subject to the periodic reporting requirements of the Securities Exchange Act of 1934 publicly discloses material information containing a non-GAAP financial measure, Regulation G requires the company to reconcile the non-GAAP financial measure to the most directly comparable financial measure under GAAP. Regulation G also prohibits companies and their employees from disseminating false or misleading non-GAAP financial measures or presenting the non-GAAP financial measures in such a manner that they mislead investors or obscure the company’s GAAP results. The settlement should serve as a reminder to public companies that the SEC is concerned about the abuse of non-GAAP financial measures.

In the SafeNet case, the SEC alleged that, in order to meet earnings targets, SafeNet’s CEO and CFO directed SafeNet’s accounting personnel to make improper accounting adjustments to various expenses including:

• the improper classification of ordinary operating expenses (such as advertising and Sarbanes-Oxley Act compliance expenses) as integration expenses;
• the improper reduction of accruals for certain professional fees; and
• the improper reduction of inventory reserve accruals.

According to the SEC, SafeNet’s CEO and CFO also made materially inaccurate statements regarding these financial measures in conference calls with investors and continued the company’s misleading practices even after the company’s auditors had concluded that the practices were “abusive” and a “means of meeting [non-GAAP] EPS guidance.”

The SEC Staff has stated that companies should not be constrained from using non-GAAP financial measures when useful to investors. However, this case underscores the importance of ensuring that any such non-GAAP financial measures are compiled in good faith and on a reasonable basis.

If you have any questions regarding the recent SEC action, please contact Meredith Burbank (http://www.wcsr.com/MeredithBurbank), the principal drafter of this client alert, or you may contact the Womble Carlyle attorney with whom you usually work or one of our Corporate and Securities attorneys.