CNBC Features Non-GAAP Expert: New Constructs CEO David Trainer

I'd like to welcome my first-time guest, at least first time on The Exchange, David Trainer. Thanks for taking the time on an important topic.

Great to be with you. Thank you.

All right, uh, off camera I was asking you, what is the SEC doing? Because there's been several articles that they are looking into this. And what did you tell me?

Well, the SEC has a mixed track record on non-GAAP earnings. I mean, look, we saw what happened to the tech bubble. Non-GAAP was out of, you know, off the hook back then. The SEC put out some guidance saying they didn't like it so much, and then in 2010 they loosened the reins and said, hey, we want to see non-GAAP disclosures in your annual reports, in all the places that you have to publish, in addition to the places you don't have to publish information. And so now they've come out more recently and said, you know, we want to tighten the reins a little bit on non-GAAP.

You know, Mr. Ackman comes to mind, Valeant comes to mind. You wrote an article about non-GAAP about Valeant. Obviously he looked at both sets of papers. Why is it that investors seem to pay more attention to non-GAAP versus GAAP? They both have to be released when a company shows the books.

You know, that's a great question, Rick. I mean, we wonder all the time why investors seem to be so gullible about these metrics, which are in many ways really a joke. I mean, they're going to take out like obvious operating expenses like stock-based compensation, which we now know to be a real expense, and a myriad of other expenses that really allow management to misrepresent the business. And, you know, the real problem, Rick, you know, going through— so back over history is that the reason— the main reason for non-GAAP is that executive compensation over $1 million a year is not tax deductible unless it's tied to performance metrics. And so executives said, oh, this is great, well, we'll create metrics that are really easy for us to beat And therefore we can make our compensation over a million bucks tax deductible. That's sort of where non-GAAP got its start.

All right, I guess the obvious question in our final minute or so is, is if this is used too often and non-recurring becomes the norm, why doesn't the SEC just clamp down on it in a very significant fashion? You know, when I was discussing this with traders on the floor that we're going to have this segment, Their conspiratorial kind of cynical view was because, like policy that keeps rates too low, it's all about keeping the markets moving. That's the important issue. Are they wrong? Is that a silly way to look at this?

I don't think so, really. I mean, part of the challenge with the SEC is that they're bringing a Wiffle ball bat to a gunfight. They're under-resourced when it comes to keeping up with the whiz kids on Wall Street. And so even if they really wanted to stop it, they'd have a hard time enforcing. I mean, you know, look, the rules right now stipulate that the SEC only has to review an annual report once every 3 years, once every 3 years. And we see things go on in annual reports in the footnotes that are a joke. Required disclosures are missing. Income statements don't add up. I mean, you know, the bottom line is that investors don't— shouldn't rely on anyone but themselves. They've got to do their own diligence. You can't rely on the SEC. You can't rely on Wall Street. You can't rely on FASB. You got to do your own work. It's a buyer beware market. And at the end of the day, you got to— you know, diligence is what matters. And, and, you know, there are all kinds of good theories out there, but at the end of the day, the only real answer is to do your homework.

I got you, David. Too bad we don't live in a prudent man, buyer beware society. The same institutions that we're describing that aren't doing what we think they should do, they're getting more control every day. David, thank you. Kayla, back to you.