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Over on the Proxy Season Blog, Liz recently highlighted a topic that comes up time and time again at this time of year – what rules apply to the annual letter to shareholders that is typically included as part of the Form 10-K wrap for the Rule 14a-3 annual report?

The letter to shareholders is not required by any SEC rule – instead, I classify it in the category of “free writing” communications that become integral to the disclosure process even though the SEC has not mandated the disclosure. Unfortunately, because the letter to shareholders is not required by any SEC rule, sometimes people are lulled into thinking that no rules apply to the letter to shareholders, which obviously could not be further from the truth. In general, my advice is to treat the annual letter to shareholders just as you would any other investor communication that is not filed with the SEC but is nonetheless subject to certain SEC rules.

First off, the annual letter to shareholders often includes non-GAAP financial measures as a means of describing the company’s performance over the past year or over a series of years. As with any other public communication (whether or not the communication is filed with the SEC), any non-GAAP financial measure included in the annual letter to shareholders is subject to Regulation G, and therefore the non-GAAP financial measure must be accompanied by the most directly comparable GAAP measure and a reconciliation must be provided. The additional requirements applicable to non-GAAP measures in Item 10(e) of Regulation S-K (and pursuant to Item 2.02 of Form 8-K) do not apply (e.g., equal or greater prominence in the presentation of the GAAP measure, a description of the reasons why the non-GAAP measure is useful), but the more fundamental requirements of Regulation G do apply. Depending on the non-GAAP measure that is used, sometimes the Regulation G requirements can be met using the Form 10-K contents that are included with the annual shareholders letter to make up the annual report to shareholders required under the proxy rules. However, if the annual letter to shareholders is intended to stand apart from the rest of the annual report and will be posted on the company’s website on a standalone basis, then it would need to comply with Regulation G on its own. Further, I find that the annual letter to shareholders often includes different non-GAAP measures and/or covers more periods than what is addressed by the Item 10(e) disclosures that are included in the annual report itself.

Second, the annual letter to shareholders often includes forward-looking information about the company’s plans and prospects, and therefore it is important to make sure that those forward looking statements are protected under the PSLRA safe harbor. How this is done may depend again on whether the letter is intended as a standalone document or is integrated with the annual report, but in any event it is important to consider whether the particular forward looking statements are identified as such and meaningful cautionary language is provided regarding such forward looking statements.

Finally, just like any communication, the annual letter to shareholders is subject to the antifraud provisions of the federal securities laws, so you want to make sure that the statements in the letter are consistent with other disclosures that are provided by the company, and that the statements do not verge too far into “marketing speak” that could get the company in trouble down the road. I often observe that this is not only an annual letter to shareholders, but also an annual letter to plaintiffs’ lawyers, so tread carefully!

– Dave Lynn