SEC Proposes Rule Amendments to Improve Disclosures Relating to Acquisitions and Dispositions of Businesses
On May 3, the Securities and Exchange Commission (“SEC”) proposed rule amendments to improve disclosures about acquisitions and dispositions of businesses. The proposed amendments are also intended to facilitate more timely access to capital and eliminate unnecessary costs and burdens of these financial disclosures.
The proposed amendments, available here, will have a 60-day public comment period following publication in the Federal Register.
The proposed rule amendments relate to the financial disclosure requirements in Rules 3-05, 3-14, and Article 11 of Regulation S-X and related rules and forms for financial statements of business acquisitions and dispositions. The SEC also proposed a new Rule 6-11 of Regulation S-X and amendments to Form N-14 for financial reporting of acquisitions involving investment companies. The proposed rule amendments are the result of the SEC’s ongoing comprehensive evaluation of disclosure requirements.
Currently, Rule 3-05 requires disclosure of certain financial statements of an acquired business, depending on the significance of the acquisition. Whether an acquisition is significant is determined by applying investment, asset, and income tests set forth in the SEC rules. Likewise, with respect to real estate operations, Rule 3-14 requires a registrant that has acquired a significant real estate operation to file financial statements with respect to such acquired operation.
Article 11 sets forth when a registrant is required to file unaudited pro forma financial information relating to an acquisition or disposition. Pro forma financial information typically includes a pro forma balance sheet and pro forma income statements based on the historical financial statements of the registrant and the acquired or disposed business, including adjustments intended to show how the acquisition or disposition might have affected those financial statements.
If approved as proposed, the revised rules would include many significant changes, including:
Amendments to Financial Statement Requirements for Acquired Businesses
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Significance Tests – the proposed rules would significantly revise the investment test and the income test:
- Investment Test - Revises the investment test to compare a registrant’s investment in, and advances to the acquired business, to the aggregate worldwide market value of the registrant’s voting and non-voting common equity;
- Income Test - Revises the income test to add a new revenue component and simplify the calculation of the net income component by using income or loss from continuing operations after income taxes;
- Reduce Disclosure to Two Years of Audited Financial Statements for Major Acquisitions - Requires audited financial statements of an acquired business that exceeds 50% significance to cover up to the two most recent fiscal years, rather than up to the three most recent fiscal years;
- Provides Clarifying Language - Updates language to clarify when disclosure of audited financial statements and pro forma financial information are required; and
- IFRS Updates - Expands the use of IFRS-ISAB in financial statements of acquired businesses.
Amendments Relating to Financial Statements Included in Registration Statements and Proxy Statements
- Previously Included Financial Statements - Eliminates the need for Rule 3-05 financial statements in registration statements and proxy statements once the acquired business is reflected in the registrant’s financial statements filed post-acquisition for a complete fiscal year, therefore removing the current requirement to include financial statements when they have not been previously filed or when they have been previously filed but the acquired business is of major significance;
- Pro Forma Significance Testing - Expands the circumstances in which a registrant can use pro forma financial information for significance testing, allowing the registrant, for all filings, to measure significance using filed pro forma financial information that only depicts significant business acquisitions/dispositions consummated after the latest fiscal year-end for which the registrant’s financial statements are required to be filed, subject to satisfaction of specified conditions; and
- Individually Immaterial Acquisitions - Reduces financial disclosure requirements of individually immaterial acquisitions by requiring a registrant to provide pro forma financial information depicting the aggregate effects of all such businesses in all material respects and pre-acquisition historical financial statements only for those businesses whose individual significance exceeds 20 percent but are not yet required to file financial statements.
Amendments to Rule 3-14 - Financial Statements of Real Estate Operations Acquired or to be Acquired
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Aligns Rule 3-14 with proposed Rule 3-05 for financial statements for real estate operations acquisitions and provides other updates to Rule 3-14, including:
- Defines real estate operations as “a business that generates substantially all of its revenues through the leasing of real property";
- Provides for the use of a modified investment test;
- Requires interim financial statements; and
- Permits the determination of significance for acquisitions of real estate operations in blind pool offerings to be made using pro forma total assets as of the end of the most recently completed fiscal year included in the Annual Report on Form 10-K.
Article 11 - Pro Forma Financial Information Amendments
- Simplified Adjustment Criteria - Replaces the existing pro forma adjustment criteria with simplified requirements to (1) depict the accounting for the transaction and (2) present the reasonably estimable synergies and other transaction effects identified by management that have occurred or are reasonably expected to occur;
- Increased Significance Threshold - Revises Rule 11-01(b) to raise the significance threshold for required disclosure in the case of disposition of a business from 10 percent to 20 percent, to conform to the threshold at which an acquired business is significant under Rule 3-05; and
- Smaller Reporting Companies - Revises Rule 8-05 to require the preparation, presentation and disclosure of pro forma financial information by smaller reporting companies to substantially comply with Article 11.
Amendments to Financial Disclosure About Acquisitions Specific to Investment Companies
- Amended Significance Test - Clarifies the financial reporting requirements for investment companies with respect to acquisitions of investment companies and other types of acquired funds by adding a definition of significant subsidiary in Regulation S-X specifically tailored for investment companies;
- New Rule 6-11 - Proposes a new Rule 6-11, modeled after proposed Rules 3-05 and 3-14, to address the financial statements of funds acquired or to be acquired, which also calls for a facts and circumstances evaluation as to whether a fund acquisition has occurred or is probable;
- Eliminate Pro Forma Information – Removes the requirement to provide pro forma financial information for investment company registrants and, instead, requires relevant supplemental information; and
- Amendments to Registration Statement - Amends Form N-14 used by investment companies to register securities issued in business acquisition transactions so that investors who acquire securities in a registered offering have the same disclosure that investors receive through financial statement disclosure in shareholder reports.