At its June convening, the SEC’s Investor Advisory Committee (IAC) turned its attention to two perennially thorny issues in US capital markets governance: the use of non-GAAP (Generally Accepted Accounting Principles) financial disclosures by public companies, and the proliferation of mandatory arbitration clauses in investment advisory agreements.

With regulatory credibility and investor trust at stake, both panels sparked vigorous discussion: less about reinventing the wheel, and more about balancing innovation with investor protection in an evolving financial landscape.

Statements from regulators

Non-GAAP metrics have long occupied a paradoxical place in corporate financial reporting. While they can illuminate how management views operational performance, they also risk painting rosier pictures than GAAP would allow.

Commissioner Caroline Crenshaw underscored this ambivalence, noting that although non-GAAP measures “help paint a picture of a company’s health,” they are equally susceptible to manipulation. “They may be misused or used in a misleading fashion,” she cautioned.

Her remarks served as a reminder of the regulatory scaffolding already in place. Regulation G and Item 10(e) of Regulation S-K, both designed to prevent abuse, mandate that non-GAAP figures be reconciled to the most comparable GAAP metrics and be presented with equal prominence.

Still, Crenshaw pushed for a “survey” of current practices to determine whether the guardrails are being respected, and whether additional disclosure requirements could serve investors better.

Chairman Paul Atkins echoed her concerns but struck a more measured tone. Non-GAAP metrics, he suggested, can offer “meaningful context” to investors, provided they are “consistent over time” and clearly reconciled. For Atkins, the key is transparency, not prohibition.

Commissioner Mark Uyeda brought an international lens to the discussion. Noting the coexistence of IFRS (International Financial Reporting Standards) and GAAP standards, he placed non-GAAP and non-IFRS measures on a similar analytical plane: as interpretive lenses that analysts, boards, and investors alike must learn to evaluate with a critical eye.

Commissioner Hester Peirce added a cautionary note: efforts to standardize non-GAAP measures risk “undermining their inherent value” as nuanced, firm-specific performance indicators.

“Are there additional protections in this space that would lead to more accurate and standardized reporting?”

Caroline Crenshaw, SEC Commissioner

Yet it was Crenshaw who asked the most pointed question of the day: “Are there additional protections in this space that would lead to more accurate and standardized reporting?” That query now hangs over any future SEC rulemaking agenda on financial transparency.

The second issue on the table was the use of mandatory arbitration clauses in investment advisor contracts: a subject that has grown more urgent since the SEC’s own Ombuds Office published its 2023 study on investor dispute mechanisms. As the industry shifts toward mandatory pre-dispute arbitration, critics warn that such clauses often deprive retail investors of meaningful recourse.

Crenshaw, again assuming a reformist mantle, advocated for harmonizing arbitration standards between broker-dealers (already regulated under FINRA’s Rule 2268) and registered investment advisors (RIAs), who currently operate in a more loosely defined space.

She called for eliminating class action waivers, imposing limits on arbitrator discretion, and ensuring that venue selection respects the investor’s location. “Ultimately, we want investors to have a fair, just, and accessible forum,” she said.

Uyeda adopted a more historical perspective, emphasizing arbitration’s longstanding roots under the Federal Arbitration Act of 1925. While acknowledging that arbitration offers efficiency, especially for claims too small to justify litigation, he also cautioned against oversimplification. “There are pros and cons with each [forum],” he noted, urging the Committee to weigh trade-offs carefully.

Peirce went further in critiquing the proposed harmonization. “Freedom of contract is a bedrock principle,” she asserted. She questioned whether applying FINRA standards to RIAs, a sector without a self-regulatory organization, made regulatory or legal sense. She also challenged the need for aggressive rulemaking, given that only 5% of retail advisory contracts currently contain mandatory arbitration clauses.

Still, the consensus among most Committee members leaned toward greater transparency and client choice. Whether that results in harmonized federal rulemaking or selective state-level interventions remains to be seen. As Crenshaw noted, the proposed recommendation may be just a “first step.”

Non-GAAP financial measures

The panel on non-GAAP financial measures opened by underscoring how non-GAAP disclosures, originally limited to niche sectors, are now widespread and controversial, often providing companies a tool to frame financial narratives more favorably than their GAAP-compliant statements would.

Experts emphasized the dual nature of these measures. One speaker likened them to a “tilt-a-whirl” amusement park ride, appealing and even useful, but often disorienting. While Regulation G (Reg G), a key SEC rule, requires companies to reconcile each non-GAAP metric to the most directly comparable GAAP measure, the absence of standardization and reliance on qualitative guidance from the SEC’s Compliance and Disclosure Interpretations (C&DIs) has created room for opportunistic reporting.

Item 10(e) of Regulation S-K further governs non-GAAP disclosures in official filings, adding more rigorous conditions, yet inconsistencies persist. “Individually tailored accounting measures” and selectively favorable adjustments have triggered extensive SEC comment letters, illustrating the enforcement gap and underscoring the need for improved investor communication and regulatory clarity.

Investor perspectives focused on the interpretive nature of all financial reporting. One fund manager emphasized that both GAAP and non-GAAP are abstractions of economic reality – “interpretations of interpretations” – and while non-GAAP numbers often reflect management’s optimistic spin, their divergence from GAAP figures can reveal important financial insights.

Auditing professionals clarified that external auditors have only limited responsibility for non-GAAP disclosures under current auditing standards. For example, Public Company Accounting Oversight Board (PCAOB) Auditing Standard 2710 treats non-GAAP data as “other information” subject only to a “read and consider” review, rather than full audit procedures.

Moreover, non-GAAP disclosures are not included in companies’ internal control assessments required under Section 404(b) of the Sarbanes-Oxley Act (SOX). However, auditors can voluntarily offer assurance services, such as verifying consistency or recalculating adjustments, if engaged by management or audit committees.

Some panelists suggested expanding this role, particularly for newly public firms or sectors heavily reliant on bespoke performance metrics.

The session concluded with a discussion on the feasibility of standardizing commonly used non-GAAP measures such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) or KPIs (Key Performance Indicators).

While some panelists supported clearer guardrails or industry-specific guidance, citing the SEC’s tacit acceptance of “Funds From Operations” (FFO) in the real estate sector, others cautioned that the very utility of non-GAAP data lies in its flexibility.

Ultimately, panelists agreed that while GAAP remains the foundation of financial reporting, non-GAAP measures, if transparently presented, contextually explained, and monitored rigorously, can enhance financial literacy and market trust. But the system’s continued integrity depends on investor diligence, board-level scrutiny, and ongoing enforcement by the SEC.

The SEC’s enforcement action against DXC Technology for misleading non-GAAP disclosures underscores the urgency of the issues raised during the SEC panel. The need for stricter oversight of non-GAAP metrics, particularly when used to mislead investors about a company’s performance, is a concern precisely mirrored in the DXC case, where informal controls led to inflated earnings and a $8 million penalty.

Mandatory arbitration and investor protection

The SEC’s Investor Advisory Committee concluded its afternoon session with a vote on a recommendation concerning the use of mandatory predispute arbitration clauses by SEC-registered investment advisers (IAs).

Building on a December 2024 panel and a 2023 study by the SEC’s Office of the Investor Advocate and Ombuds Office, the Committee proposed that IAs should be subject to investor protections similar to those that exist under the FINRA framework for broker-dealers (BDs).

“Ultimately, we want investors to have a fair, just, and accessible forum.”

Caroline Crenshaw, SEC Commissioner

The recommendation included four key points: restricting abusive arbitration terms, mandating disclosure and reporting of arbitration clauses and outcomes, collecting systematic data, and developing investor education materials. The goal is to close the regulatory gap that allows IAs to use arbitration clauses without the transparency or consumer protections present in the BD space.

Advocates emphasized that many arbitration terms, such as distant venues, costly filing fees, or limitations on liability, undermine the fiduciary duty IAs owe to clients. FINRA rules, by contrast, prohibit such terms, require arbitration venues to be proximate to the customer, and provide simplified procedures for small claims.

Proponents contended that most IA contracts are standard form agreements with limited room for negotiation, undermining arguments about freedom of contract. They noted that ensuring fairness and transparency in dispute resolution aligns with the adviser’s duty to act in the best interests of clients.

However, the recommendation was not unanimously adopted. One committee member argued that IAs and BDs are fundamentally different business models, with differing duties and regulatory structures, and that mandating parity could produce unintended consequences.

Despite this dissent, the committee passed the recommendation with majority support, highlighting growing regulatory interest in standardizing investor protections across the entire advisory industry.