Earlier this week, the staff of the SEC’s Division of Corporation Finance issued several new, and rewrote several existing, Compliance and Disclosure Interpretations (“C&DIs”) relating to Non-GAAP Financial Measures. Recently, the SEC has been signaling that it intends to crack down on company disclosures of Non-GAAP Financial Measures. While some are likely to welcome additional guidance from the staff, the C&DI’s raise an important Administrative Law question – If the SEC wants to establish new rules, is it required do so pursuant to the notice and comment provisions of the Administrative Procedure Act?
In 2003, the SEC adopted Regulation G which requires public companies that disclose or release Non-GAAP financial measures to include, in that disclosure or release, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed Non-GAAP financial measure to the most directly comparable GAAP financial measure. At the same time, the SEC amended Item 10 of Regulation S-K to provide additional guidance to companies that include Non-GAAP financial measures in SEC filings. The SEC took these actions in accordance with the “notice and comment” rule making requirement of the Administrative Procedure Act, 5 U.S.C. § 553. This essentially involves a three-step process:
- First, the agency must issue a “[g]eneral notice of proposed rule making,” ordinarily by publication in the Federal Register. § 553(b).
- Second, if “notice [is] required,” the agency must “give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments.” § 553(c). An agency must consider and respond to significant comments received during the period for public comment. See Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U. S. 402, 416 (1971); Thompson v. Clark, 741 F. 2d 401, 408 (1984).
- Third, when the agency promulgates the final rule, it must include in the rule’s text “a concise general statement of [its] basis and purpose.” § 553(c).
The APA, however, exempts from the notice and comment requirements “interpretative rules, general statements of policy, or rules of agency organization, procedure, or practice.” 5 U. S. C. §553(b)(A). The line between legislative rules and interpretive rules is indistinct at best. In general, an interpretive rule is “issued by an agency to advise the public of the agency’s construction of the statutes and rules which it administers.” Shalala v. Guernsey Memorial Hospital, 514 U. S. 87, 99 (1995) (internal quotation marks omitted). California’s Administrative Procedure Act, in contrast, includes interpretations within the definition of a “regulation”. Cal. Gov’t. Code 11342.600 (“‘Regulation’ means every rule, regulation, order, or standard of general application or the amendment, supplement, or revision of any rule, regulation, order or standard adopted by any state agency to implement, interpret, or make specific the law enforced or administered by it, or to govern its procedure.”).
The staff must, of necessity, believe that its C&DIs fall within the category of exempt interpretive rules. However, I agree with the D.C. Circuit’s position that “”allow[ing]an agency to make a fundamental change in its interpretation of a substantive regulation without notice and comment” would undermine the APA’s procedural framework. Paralyzed Veterans of Am. v. D. C. Arena L. P., 117 F. 3d 579, 586 (1997), which was overruled in part last year by the Supreme Court in Perez v. Mortg. Bankers Ass’n, 135 S. Ct. 1199 (2015). The SEC’s choice to forego notice and comment rulemaking does come with a significant downside. Interpretive rules “do not have the force and effect of law and are not accorded that weight in the adjudicatory process.” Shalala, 514 U.S. at 99.
Ethical Issues for In-House Counsel
I will be speaking on May 25 to the Orange County Bar Association’s Business and Corporate Law Section on ethical issues for in-house counsel. Information on attending is available here.