[Federal Register Volume 84, Number 102 (Tuesday, May 28, 2019)]
[Proposed Rules]
[Pages 24600-24661]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-09472]
[[Page 24599]]
Vol. 84
Tuesday,
No. 102
May 28, 2019
Part II
Securities and Exchange Commission
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17 CFR Parts 210, 230, 239, et al.
Amendments to Financial Disclosures About Acquired and Disposed
Businesses; Proposed Rule
Federal Register / Vol. 84 , No. 102 / Tuesday, May 28, 2019 /
Proposed Rules
[[Page 24600]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210, 230, 239, 240, 249, 270, and 274
[Release No. 33-10635; 34-85765; IC-33465; File No. S7-05-19]
RIN 3235-AL77
Amendments to Financial Disclosures About Acquired and Disposed
Businesses
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: We are proposing amendments to our rules and forms to improve
the disclosure requirements for financial statements relating to
acquisitions and dispositions of businesses, including real estate
operations and investment companies. The proposed changes are intended
to improve for investors the financial information about acquired or
disposed businesses, facilitate more timely access to capital, and
reduce the complexity and costs to prepare the disclosure.
DATES: Comments should be received on or before July 29, 2019.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use our internet comment form (http://www.sec.gov/rules/other.shtml);
Send an email to [email protected]. Please include
File Number S7-05-19 on the subject line; or
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-05-19. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method of submission. We will post all comments on our website (http://www.sec.gov/rules/other.shtml). Comments also are available for website
viewing and printing in our Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. All comments received will be posted without
change. Persons submitting comments are cautioned that we do not redact
or edit personal identifying information from comment submissions. You
should submit only information that you wish to make publicly
available.
We or the staff may add studies, memoranda, or other substantive
items to the comment file during this rulemaking. A notification of the
inclusion in the comment file of any such materials will be made
available on our website. To ensure direct electronic receipt of such
notifications, sign up through the ``Stay Connected'' option at
www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Todd E. Hardiman, Associate Chief
Accountant, at (202) 551-3516, or Jessica Barberich, Associate Chief
Accountant, at (202) 551-3782 or Craig Olinger, Senior Advisor to the
Chief Accountant, at (202) 551-3400, or Steven G. Hearne, Senior
Special Counsel at (202) 551-3430 in the Division of Corporation
Finance; Jenson Wayne, Assistant Chief Accountant, at (202) 551-6918,
or Mark T. Uyeda, Senior Special Counsel, at (202) 551-6792, in the
Division of Investment Management, 100 F Street NE, Washington, DC
20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing to amend:
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Commission reference CFR citation (17 CFR)
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Regulation S-X:
Rules 1-01 et seq...................... Sec. 210.01 et seq.
Rule 1-02(w)........................... Sec. 210.1-02(w)
Rule 3-05.............................. Sec. 210.3-05
Rule 3-06.............................. Sec. 210.3-06
Rule 3-14.............................. Sec. 210.3-14
Rule 3-18.............................. Sec. 210.3-18
Rule 5-01.............................. Sec. 210.5-01
Rule 6-01.............................. Sec. 210.6-01
Rule 6-02.............................. Sec. 210.6-02
Rule 6-03.............................. Sec. 210.6-03
Article 8:
Rule 8-01.............................. Sec. 210.8-01
Rule 8-03.............................. Sec. 210.8-03
Rule 8-04.............................. Sec. 210.8-04
Rule 8-05.............................. Sec. 210.8-05
Rule 8-06.............................. Sec. 210.8-06
Article 11:
Rule 11-01............................. Sec. 210.11-01
Rule 11-02............................. Sec. 210.11-02
Rule 11-03............................. Sec. 210.11-03
Securities Act of 1933 (Securities Act):
\1\
Securities Act Rule 405................ Sec. 230.405
Rule 405 of Regulation S-T............. Sec. 232.405
Form N-2............................... Sec. 239.14 and Sec.
274.11a-1
Form N-14.............................. Sec. 239.23
Securities Exchange Act of 1934 (Exchange
Act): \2\
Rule 12b-2............................. Sec. 240.12b-2
Rule 14a-101........................... Sec. 240.14a-101
Form 8-K............................... Sec. 249.308
Form 10-K.............................. Sec. 249.310
Investment Company Act of 1940
(Investment Company Act): \3\
Rule 8b-2.............................. Sec. 270.8b-2
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\1\ 15 U.S.C. 77a et seq.
\2\ 15 U.S.C. 78a et seq.
\3\ 15 U.S.C. 80a-1 et seq.
We also are proposing to add 17 CFR 210.6-11 (new ``Rule 6-11'') to
Regulation S-X.
Table of Contents
I. Introduction and Background
II. Discussion of Proposed Amendments
A. Proposed Amendments to Generally Applicable Financial
Statement Requirements for Acquired Businesses
1. Significance Tests
a. Investment Test
b. Income Test
2. Audited Financial Statements for Significant Acquisitions
3. Financial Statements for Net Assets That Constitute a
Business
4. Financial Statements of a Business That Includes Oil and Gas
Producing Activities
5. Timing and Terminology of Financial Statement Requirements
6. Foreign Businesses
a. Definition
b. Reconciliation Requirement
7. Smaller Reporting Companies and Issuers Relying on Regulation
A
B. Proposed Amendments Relating to Rule 3-05 Financial
Statements Included in Registration Statements and Proxy Statements
1. Omission of Rule 3-05 Financial Statements for Businesses
That Have Been Included in the Registrant's Financial Statements
2. Use of Pro Forma Financial Information To Measure
Significance
3. Disclosure Requirements for Individually Insignificant
Acquisitions
C. Rule 3-14--Financial Statements of Real Estate Operations
Acquired or To Be Acquired
1. Align Rule 3-14 With Rule 3-05
2. Definition of Real Estate Operation
3. Significance Tests
4. Interim Financial Statements
5. Smaller Reporting Companies and Issuers Relying on Regulation
A
6. Blind Pool Real Estate Offerings
7. Triple Net Leases
D. Pro Forma Financial Information
1. Adjustment Criteria and Presentation Requirements
2. Significance and Business Dispositions
3. Smaller Reporting Companies and Issuers Relying on Regulation
A
E. Amendments to Financial Disclosure About Acquisitions
Specific to Investment Companies
1. Amendments to Significance Tests for Investment Companies
a. Investment Test
b. Asset Test
c. Income Test
2. Proposed Rule 6-11 of Regulation S-X
3. Pro Forma Financial Information and Supplemental Financial
Information
4. Amendments to Form N-14
III. General Request for Comment
IV. Economic Analysis
A. Introduction
B. Baseline and Affected Parties
C. Potential Benefits and Costs of the Proposed Amendments
1. Significance Tests
[[Page 24601]]
2. Audited Financial Statements for Significant Acquisitions
3. Financial Statements for Net Assets That Constitute a
Business and Financial Statements of a Business That includes Oil-
and-Gas-Producing Activities
4. Timing and Terminology of Financial Statement Requirements
5. Foreign Businesses
6. Omission of Rule 3-05 and Rule 3-14 Financial Statements and
Related Pro Forma Financial Information for Businesses That Have
Been Included in the Registrant's Financial Statements
7. Use of Pro Forma Financial Information To Measure
Significance
8. Disclosure Requirements for Individually Insignificant
Acquisitions
9. Rule 3-14--Financial Statements of Real Estate Operations
Acquired or To Be Acquired
10. Pro Forma Financial Information
11. Significance and Business Dispositions
12. Smaller Reporting Companies and Regulation A
13. Amendments to Financial Disclosure About Acquisitions
Specific to Investment Companies
D. The Effects on Efficiency, Competition, and Capital Formation
E. Alternatives Considered
1. Approaches to the Significance Tests
2. Approaches to Proposed Financial Statement Requirements
3. Approaches to Proposed Pro Forma Adjustments
4. Alternatives to the Proposed Income Test for Investment
Companies
V. Paperwork Reduction Act
A. Summary of the Collection of Information
B. Proposed Amendments' Effect on Existing Collections of
Information
1. Estimated Effects of the Proposed Amendments on Paperwork
Burdens for Registrants Other Than Investment Companies
a. Proposed Amendments to Rules 3-05 and 3-14
b. Proposed Amendments to Pro Forma Financial Information
Requirements
2. Estimated Effects of the Proposed Amendments on Paperwork
Burdens for Investment Company Registrants
C. Aggregate Burden and Cost Estimates for the Proposed
Amendments
VI. Small Business Regulatory Enforcement Fairness Act
VII. Initial Regulatory Flexibility Act Analysis
A. Reasons for, and Objectives of, the Proposed Action
B. Legal Basis
C. Small Entities Subject to the Proposed Rules
D. Reporting, Recordkeeping, and Other Compliance Requirements
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
VIII. Statutory Authority
I. Introduction and Background
We are proposing changes to the requirements for financial
statements relating to acquisitions and dispositions of businesses,
including real estate operations, in Rule 3-05,\4\ Financial Statements
of Businesses Acquired or to be Acquired, Rule 3-14, Special
Instructions for Real Estate Operations to be Acquired, Article 11, Pro
Forma Financial Information of Regulation S-X and other related rules
and forms.\5\ We are also proposing new Rule 6-11 of Regulation S-X and
amendments to Form N-14 to specifically govern financial reporting for
acquisitions involving investment companies. The proposed amendments
are intended to improve for investors the financial information about
acquired or disposed businesses, facilitate more timely access to
capital, and reduce the complexity and costs to prepare the
disclosure.\6\
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\4\ Unless otherwise noted, references in this release to
``Rule'' or ``Rules'' are to the rules under Regulation S-X.
\5\ We are also proposing related amendments in Regulation S-X
to the definition of significant subsidiary in Rule 1-02(w); Rule 3-
06, Financial statements covering a period of nine to twelve months;
and Article 8, Smaller Reporting Companies. In addition, we are
proposing amendments to Form 8-K for current reports, Form 10-K for
annual and transition reports, and the definition of significant
subsidiary in Rule 12b-2 under the Exchange Act, Rule 405 under the
Securities Act, and Rule 8b-2 under the Investment Company Act.
\6\ The proposed amendments would not apply to financial
statements related to the acquisition of a business that is the
subject of a proxy statement or registration statement on Form S-4
(17 CFR 239.25) or Form F-4 (17 CFR 239.34), but would apply to pro
forma information provided pursuant to Article 11 and financial
information for acquisitions and dispositions otherwise required to
be disclosed pursuant to Rule 3-05 or Rule 3-14. These amendments
also would not affect the requirements in 17 CFR 210.3-02 (``Rule 3-
02'') or 17 CFR 210.8-01 relating to predecessor companies.
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This proposal results from an ongoing, comprehensive evaluation of
our disclosure requirements.\7\ As part of this evaluation, in
September 2015, the Commission issued a Request for Comment on the
Effectiveness of Financial Disclosures About Entities Other Than the
Registrant (``2015 Request for Comment'').\8\ The 2015 Request for
Comment sought feedback on, among other things, the financial
disclosure requirements in Regulation S-X for certain entities other
than the registrant. More specifically, the Commission solicited
comment on how investors use the disclosures required by these rules to
make investment decisions, the challenges that registrants and others
face in providing the required disclosures, and potential changes to
these requirements that could enhance the information provided to
investors and promote efficiency, competition, and capital formation.
We received approximately 50 comment letters discussing Rule 3-05, Rule
3-14, Article 8, and Article 11 \9\ and these comments were considered
carefully in developing these proposals.
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\7\ The staff, under its Disclosure Effectiveness Initiative, is
reviewing the disclosure requirements in Regulation S-X and 17 CFR
229.10 through 1208 (``Regulation S-K'') and is considering ways to
improve the disclosure regime for the benefit of both companies and
investors. The goal is to comprehensively review the requirements
and make recommendations on how to update them to facilitate timely,
material disclosure by companies and shareholders' access to that
information. See https://www.sec.gov/spotlight/disclosure-effectiveness.shtml.
\8\ Request for Comment on the Effectiveness of Financial
Disclosures About Entities Other Than the Registrant, Release No.
33-9929 (Sept. 25, 2015) [80 FR 59083 (Oct. 1, 2015)].
\9\ Comments that we received in response to the 2015 Request
for Comment are available at https://www.sec.gov/comments/s7-20-15/s72015.shtml. References to comment letters in this release refer to
the comments on the 2015 Request for Comment unless otherwise
specified.
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When a registrant acquires a business \10\ other than a real estate
operation, Rule 3-05 of Regulation S-X generally requires a registrant
to provide separate audited annual and unaudited interim pre-
acquisition financial statements of the business if it is significant
to the registrant (``Rule 3-05 Financial Statements''). Recognizing
that certain acquisitions have a greater impact on a registrant than
others, the Commission adopted Rule 3-05 to address the reporting
requirements for businesses acquired or to be acquired based on the
significant subsidiary definition in Rule 1-02(w) using a sliding scale
approach.\11\ Rule 3-05 also applies to registrants that are registered
investment companies and business development companies. The Commission
later adopted Rule 8-04,
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Financial Statements of Businesses Acquired or to be Acquired, in order
to provide comparable requirements for smaller reporting companies.\12\
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\10\ Rule 3-05 requires disclosure if the ``business combination
has occurred or is probable.'' See 17 CFR 210.3-05(a). Registrants
determine whether a ``business'' has been acquired by applying Rule
11-01(d) of Regulation S-X. The definition of ``business'' in
Regulation S-X focuses primarily on whether the nature of the
revenue-producing activity of the acquired business will remain
generally the same as before the transaction. This determination is
separate and distinct from a determination made under the applicable
accounting standards. Because the definitions serve different
purposes, we have not proposed to conform our rules with the
applicable accounting standards.
\11\ Instructions for the Presentation and Preparation of Pro
Forma Financial Information and Requirements for Financial
Statements of Businesses Acquired or To Be Acquired, Release No. 33-
6413 (Jun. 24, 1982) [47 FR 29832 (Jul. 9, 1982)] (``Rule 3-05
Adopting Release''). The requirements are based on the significant
subsidiary tests using a sliding scale so that the requirements for
filing such financial statements as well as the periods covered by
such financial statements will vary with the percentage impact of
the acquisition on the registrant. In adopting the sliding scale
approach, the Commission stated its belief that the selected
percentages ``meet the objectives of providing adequate financial
information to investors, shareholders and other users while at the
same time reducing the reporting burdens of registrants involved in
acquisitions.''
\12\ Smaller Reporting Company Regulatory Relief and
Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan.
4, 2008)] (``SRC Relief Adopting Release''). For financial
disclosure requirements, the SRC Relief Adopting Release
predominantly effectuated a relocation of the requirements in 17 CFR
228, Regulation S-B, into Regulation S-K and Regulation S-X.
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Whether an acquisition is significant under Rule 3-05 is determined
by applying the investment, asset, and income tests provided in the
``significant subsidiary'' definition in Rule 1-02(w).\13\ These tests
generally can be described as follows:
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\13\ Rule 3-05 provides for use of a 20% significance threshold,
rather than the 10% threshold indicated in Rule 1-02(w). The
Commission raised the threshold in Rule 3-05 from 10% to 20% in 1996
in order to reduce compliance burdens in response to concerns that
the requirement to obtain audited financial statements for a
business acquisition may have caused companies to forgo public
offerings in favor of private or offshore offerings. See
Streamlining Disclosure Requirements Relating to Significant
Business Acquisitions, Release No. 33-7355 (Oct. 10, 1996) [61 FR
54509 (Oct. 18, 1996)] (``1996 Streamlining Release''). As a result
of this amendment, the significance thresholds in Rule 3-05 diverged
from those used for Rule 3-14 and for dispositions at that time.
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``Investment Test''--the investment in and advances to the
acquired business are compared to the total assets of a registrant
reflected in its most recent annual financial statements required to be
filed at or prior to the acquisition date;
``Asset Test''--a registrant's proportionate share of the
acquired business's total assets reflected in the business's most
recent annual pre-acquisition financial statements is compared to the
total assets of the registrant reflected in its most recent annual
financial statements required to be filed at or prior to the
acquisition date; and
``Income Test''--a registrant's equity in the income from
continuing operations of the acquired business before income taxes,
exclusive of amounts attributable to any noncontrolling interests, as
reflected in the business's most recent annual pre-acquisition
financial statements, is compared to the same measure of the registrant
reflected in its most recent annual financial statements required to be
filed at or prior to the acquisition date.
If none of the Rule 3-05 significance tests exceeds 20%, a
registrant is not required to file Rule 3-05 Financial Statements.\14\
If any of the Rule 3-05 significance tests exceeds 20%, but none
exceeds 40%, Rule 3-05 Financial Statements are required for the most
recent fiscal year and any required interim periods. If any Rule 3-05
significance test exceeds 40%, but none exceeds 50%, a second fiscal
year of Rule 3-05 Financial Statements is required. When at least one
Rule 3-05 significance test exceeds 50%, a third fiscal year \15\ of
Rule 3-05 Financial Statements is required unless net revenues of the
acquired business were less than $100 million in its most recent fiscal
year.\16\ Rule 3-05 Financial Statements are not required once the
operating results of the acquired business have been reflected in the
audited consolidated financial statements of the registrant for a
complete fiscal year, unless the financial statements have not been
previously filed or the acquisition is of major significance.\17\ An
acquisition is considered to be of major significance when the acquired
business is of such significance to the registrant that omission of
Rule 3-05 Financial Statements would materially impair an investor's
ability to understand the historical financial results of the
registrant; for example, if, at the date of acquisition, the acquired
business met at least one of the conditions in the significance tests
at the 80% level.
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\14\ Rule 3-05 contains an additional requirement for certain
registration statements and proxy statements related to the
aggregate effect of individually insignificant businesses, which may
trigger a requirement for Rule 3-05 Financial Statements for a
business for which none of the significance tests exceed 20%. See
further discussion at note 118 below.
\15\ A smaller reporting company is subject to similar
requirements under Rule 8-04 of Regulation S-X, but financial
statements are only required for up to two fiscal years.
\16\ 17 CFR 210.3-05(b)(2). The revenue threshold to this
exception is based on the ``smaller reporting company'' definition.
The threshold was recently increased from $50 million to $100
million as part of amendments to the ``smaller reporting company''
definition. See Amendments to Smaller Reporting Company Definition,
Release No. 33-10513 (June 28, 2018) [83 FR 31992 (July 10, 2018)]
(``2018 SRC Amendments'').
\17\ 17 CFR 210.3-05(b)(4)(iii).
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Under Rule 3-14, a registrant that has acquired (and in the case of
certain registration statements and proxy statements, proposes to
acquire) a significant real estate operation similarly must file
financial statements with respect to such operations; however, the
required financial statements only include separate audited annual and
unaudited interim abbreviated income statements (``Rule 3-14 Financial
Statements'').\18\ While Rule 3-14 refers to real estate acquisitions
that are ``significant,'' it does not refer specifically to the
conditions in the definition of ``significant subsidiary'' in Rule 1-
02(w).\19\ Additionally, Rule 3-14 generally only requires one year of
Rule 3-14 Financial Statements.\20\
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\18\ See Rule 3-14. Rule 3-14 was adopted as part of the
Commission's effort to establish a centralized set of instructions
in Regulation S-X and is based on the disclosure requirements in
Item 6(b) for Form S-11 (17 CFR 239.18) as adopted in 1961. See
Uniform Instructions as to Financial Statements--Regulation S-X,
Release No. 33-6234 (Sept. 2, 1980) [45 FR 63682 (Sept. 25, 1980)].
Rule 3-14 Financial Statements are abbreviated because the rule
requires that they exclude historical items that are not comparable
to the proposed future operations of the real estate operation such
as mortgage interest, leasehold rental, depreciation, corporate
expenses, and federal and state income taxes. While Rule 3-14 does
not require interim financial information, in practice registrants
relying on Rule 3-14 also provide unaudited interim pre-acquisition
income statements for the most recent year-to-date interim period
because they are substantially required in most circumstances by
Article 11 of Regulation S-X to provide pro forma information for
the most recent year-to-date interim period. See Section II.D.
below.
\19\ Neither ``significant property'' nor ``significant real
estate operation'' is defined in Regulation S-X.
\20\ See Rule 3-14(a)(1). Only one year of Rule 3-14 Financial
Statements is required if the real estate operation is not acquired
from a related party, the registrant discloses the material factors
considered in assessing the real estate operation, and the
registrant indicates it is not aware of material factors that would
cause the reported financial information not to be indicative of
future operating results. If the registrant does not meet these
conditions, three years of Rule 3-14 Financial Statements are
required. A smaller reporting company is subject to similar
requirements under Rule 8-06 of Regulation S-X, but financial
statements are only required for up to two fiscal years for
acquisitions from related parties, instead of three years.
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Registrants required to file Rule 3-05 Financial Statements or Rule
3-14 Financial Statements are additionally required to file unaudited
pro forma financial information as prescribed by Article 11 of
Regulation S-X.\21\ Pro forma financial information typically includes
a pro forma balance sheet as of the end of the most recent period for
which a consolidated balance sheet of the registrant is required and
pro forma income statements for the registrant's most recent fiscal
year and for the period from the most recent fiscal year end to the
most recent interim date for which a balance sheet is required. The pro
forma financial information is based on the historical financial
statements of the registrant and the acquired or disposed business, and
generally includes adjustments intended to show how the acquisition or
disposition might have affected those financial
[[Page 24603]]
statements had the transaction occurred at an earlier time.
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\21\ See Rules 11-01 and 11-02. A smaller reporting company
provides the pro forma financial information described in Rule 8-05
of Regulation S-X. Although the preliminary notes to Article 8
indicate that smaller reporting companies may wish to consider the
enhanced guidelines in Article 11, smaller reporting companies are
not required to comply with these items.
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Form 8-K generally requires registrants to file Rule 3-05 Financial
Statements, Rule 3-14 Financial Statements, and related pro forma
financial information within 75 days after consummation of the
acquisition.\22\ A similar 75-day filing period exists in registration
statements and proxy statements for acquired or to be acquired
businesses requiring Rule 3-05 Financial Statements, but not for
acquired or to be acquired businesses requiring Rule 3-14 Financial
Statements.\23\
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\22\ Item 2.01 of Form 8-K requires that registrants make
certain disclosures upon the acquisition or disposition of a
significant amount of assets, including assets that constitute a
business, within four business days of the consummation of the
transaction. It does not require reporting for probable acquisitions
or dispositions. Item 9.01 of Form 8-K provides that the required
financial statements and pro forma financial information for the
acquired business (including a real estate operation) may be filed
not later than 71 calendar days after the initial report on Form 8-K
is required to be filed, providing approximately 75 calendar days to
file the acquired business financial statements and related pro
forma financial information. A registrant may need to update the
periods presented in Form 8-K in certain subsequently filed
registration statements and proxy statements. See 17 CFR 210.3-12.
\23\ Rule 3-05(b)(4) and Rule 11-01(c) provide that registration
statements not subject to the provisions of 17 CFR 230.419 and proxy
statements need not include separate financial statements of the
acquired or to be acquired business and related pro forma financial
information if the business does not exceed any of the conditions of
significance in the definition of ``significant subsidiary'' in Rule
1-02(w) at the 50% level, and either (A) the consummation of the
acquisition has not yet occurred; or (B) the date of the final
prospectus or prospectus supplement relating to an offering as filed
with the Commission pursuant to 17 CFR 230.424(b) or the mailing
date in the case of a proxy statement, is no more than 74 days after
consummation of the business combination, and the financial
statements have not previously been filed by the registrant. A
similar provision applies to smaller reporting companies, but it is
linked to the effective date of the registration statement instead
of the date of the final prospectus or prospectus supplement. See
Rule 8-04(c)(4).
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In addition, certain registration statements \24\ and proxy
statements require audited financial statements and unaudited pro forma
financial information for the substantial majority of individually
insignificant consummated and probable acquisitions since the date of
the most recent audited balance sheet if a significance test exceeds
50% for any combination of acquisitions subject to Rule 3-05.\25\ Also,
Rule 3-14 Financial Statements are required when the registrant has
acquired or proposes to acquire a group of properties which in the
aggregate are significant.\26\
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\24\ This additional requirement does not apply to all
registration statements, such as registration statements filed on
Form S-8 (17 CFR 239.16b).
\25\ See Rule 3-05(b)(2)(i). Smaller reporting companies provide
the same disclosure under Rule 8-04(c)(3).
\26\ See Rule 3-14(a) and, for smaller reporting companies, Rule
8-06.
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II. Discussion of Proposed Amendments
We are proposing changes to the requirements in Rule 3-05, Rule 3-
14, and Article 11 of Regulation S-X and related rules and forms to
improve the financial disclosure requirements about significant
business acquisitions and dispositions.\27\ The proposed amendments
would generally:
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\27\ As discussed in Section II.D.2., infra, Rule 11-01(a)(4)
requires registrants to provide pro forma financial information upon
the disposition or probable disposition of a significant portion of
a business. Rule 11-01(b)(2) requires significance of a disposition
to be determined by applying the definition of a significant
subsidiary under Rule 1-02(w). Throughout this release, we discuss
how the proposed amendments to the definition of significant
subsidiary would impact disclosures for business dispositions.
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Update the significance tests under these rules by:
[cir] Revising the Investment Test and the Income Test;
[cir] expanding the use of pro forma financial information in
measuring significance; and
[cir] conforming the significance threshold and tests for a
disposed business;
require the financial statements of the acquired business
to cover up to the two most recent fiscal years rather than up to the
three most recent fiscal years;
permit disclosure of financial statements that omit
certain expenses for certain acquisitions of a component of an entity;
clarify when financial statements and pro forma financial
information are required and update the language used in our rules;
permit the use of, or reconciliation to, International
Financial Reporting Standards as issued by the International Accounting
Standards Board (``IFRS-IASB'') in certain circumstances;
no longer require separate acquired business financial
statements once the business has been included in the registrant's
post-acquisition financial statements for a complete fiscal year;
modify and enhance the required disclosure for the
aggregate effect of acquisitions for which financial statements are not
required or are not yet required;
align Rule 3-14 with Rule 3-05 where no unique industry
considerations exist;
clarify the application of Rule 3-14 regarding the
determination of significance, the need for interim income statements,
special provisions for blind pool offerings, and the scope of the
rule's requirements;
amend the pro forma financial information requirements to
improve the content and relevance of such information; and
make corresponding changes to the smaller reporting
company requirements in Article 8 of Regulation S-X.
In addition, we are proposing regulatory requirements specific to
investment companies registered under the Investment Company Act and
business development companies \28\ (collectively, ``investment
companies'') to address the unique attributes of this group of
registrants as discussed in more detail in Section II.E. below.
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\28\ ``Business development company'' is defined in Section
2(a)(48) of the Investment Company Act, 15 U.S.C. 80a-2(a)(48).
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A. Proposed Amendments to Generally Applicable Financial Statement
Requirements for Acquired Businesses
We are proposing amendments to the requirements in Rule 3-05 and
related requirements in Rule 1-02(w), as described below.\29\
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\29\ In addition to the proposed changes to the significance
tests, we are proposing clarifying amendments to the definition of
``significant subsidiary'' to label the conditions as the Investment
Test, the Asset Test, and the Income Test.
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1. Significance Tests
We propose to revise the significance tests provided in Rule 1-
02(w) \30\ to improve their application and to assist registrants in
making more meaningful significance determinations. Specifically, we
propose to revise the Investment Test and the Income Test.\31\
Additionally, for investment companies, we are proposing amendments to
each of the Investment Test, Asset Test, and
[[Page 24604]]
Income Test as described in Section II.E.1 below.
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\30\ The term ``significant subsidiary'' is also defined in
Securities Act Rule 405, Exchange Act Rule 12b-2, and Investment
Company Act Rule 8b-2. The Rule 405 and Rule 12b-2 definitions
historically have been generally consistent with the Rule 1-02(w)
definition. Accordingly, we are proposing to conform the definitions
of significant subsidiary in Rule 405 and Rule 12b-2 to the proposed
definition in Rule 1-02(w). However, as under the existing rules,
the proposed amendments to Rule 1-02(w) that are only applicable to
disclosure requirements under Regulation S-X, specifically proposed
Rule 1-02(w)(1)(iii)(b)(3), would continue to be excluded from the
proposed definitions in Rule 405 or Rule 12b-2. Unlike the other
definitions, the definition in Rule 8b-2 has differed from the Rule
1-02(w) definition. We are proposing to conform the Rule 8b-2
definition of ``significant subsidiary'' to the proposed definition
in Rule 1-02(w)(2) that is specifically tailored for investment
companies. See Section II.E below.
\31\ We are not proposing to substantively revise the Asset
Test; however, we are proposing a number of non-substantive
revisions to the significance tests generally, such as clarifying
that the significance tests compare the ``tested'' subsidiary's
amounts to the registrant's.
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We note that, in addition to Rule 3-05, several of our other rules
and forms require disclosure related to ``significant subsidiaries'' or
otherwise rely on the significance tests in Rule 1-02(w) to determine
the disclosure required.\32\ We believe it is appropriate to apply
consistent significance tests for each of these purposes. The proposed
amendments are intended to reflect more accurately the relative
significance to the registrant of the acquired business and to reduce
anomalous results in the application of the definition of ``significant
subsidiary.'' In addition, maintaining the historical conformity
between the ``significant subsidiary'' definitions would avoid
unnecessary regulatory complexity through consistent application of
significance determinations made at the acquisition date and those made
post-acquisition when the acquired business is a subsidiary of the
registrant.
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\32\ See, e.g., 17 CFR 210.9-03, which requires bank holding
companies and banks to reflect on their balance sheets certain loans
and indebtedness of their significant subsidiaries as defined in
Rule 1-02(w); 17 CFR 210.3-09, 17 CFR 210.4-08(g), and Item 17(c)(2)
of 17 CFR 249.220f (``Form 20-F''), which rely on the significance
tests in Rule 1-02(w) to determine the financial statements and
summarized financial information required for the registrant's
equity method investees; 17 CFR 229.601(b)(21) and Instruction 8 as
to Exhibits of Form 20-F, which both rely on Rule1-02(w) to
determine the subsidiaries that must be included in the list of
subsidiaries required as an exhibit; Item 17(b)(6)(3) of Form F-4,
which relies on the significance tests in Rule 1-02(w) to determine
the financial statements required for foreign companies being
acquired that do not meet the requirements to use 17 CFR 239.34
(``Form F-3''); Item 4.C of Form 20-F, which requires a detailed
list of the registrant's significant subsidiaries; 17 CFR
229.304(a)(1) and (2), Item 9(d) of 17 CFR 240.14a-101 (``Schedule
14A''), Item 4.01 of Form 8-K, Item 4 of 17 CFR 239.93 (``Form 1-
U''), and Item 16F of Form 20-F, which require disclosure about
changes in the auditors of the registrant (or issuer, as applicable)
or its significant subsidiaries; Item 3 of 17 CFR 249.308a (``Form
10-Q'') and Item 13 of Form 20-F, which require disclosure about
defaults of the registrant and its significant subsidiaries and
material arrearages/delinquencies in the payment of dividends on
preferred stock of the registrant or any of its significant
subsidiaries; 17 CFR 229.101(a)(1), which requires certain
disclosures, such as year and form of organization, bankruptcy, and
others, for the registrant and any of its significant subsidiaries;
17 CFR 229.103, which requires disclosure of certain legal
proceedings, including bankruptcy and similar proceedings, for the
registrant and any of its significant subsidiaries; and Item 4.A.4
of Form 20-F, which requires general disclosure about the
development of and structural changes in the business of the
registrant and its significant subsidiaries. See also Rule 11-01(b)
and Proposed Rule 11-01(b).
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a. Investment Test
Currently, the Investment Test compares the registrant's investment
in and advances to the acquired business to the carrying value of the
registrant's total assets. We propose to revise the Investment Test to
compare the 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 (``aggregate worldwide market
value''), when available.\33\ If the registrant does not have an
aggregate worldwide market value, we propose to retain the existing
test.
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\33\ The value under the proposed rule differs from the value
currently used by registrants to determine accelerated filer status
under Rule 12b-2 because it includes the value of common equity held
by affiliates and it is determined as of the last business day of
the registrant's most recently completed fiscal year. By contrast,
Rule 12b-2 looks to the value of common equity held by non-
affiliates and is determined as of the last business day of the
registrant's most recently completed second fiscal quarter. See Rule
12b-2.
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We believe that using the registrant's aggregate worldwide market
value would align the Investment Test more closely with the economic
significance of the acquisition to the registrant. While the purchase
price for a recent or probable acquisition is generally consistent with
the fair value of the underlying business, the measure against which
the purchase price is compared under the current test (i.e., total
assets) may not fully reflect the registrant's current fair value.\34\
In response to the 2015 Request for Comment, commenters supported
revising the Investment Test to use a measure of the registrant's fair
value instead of its total assets.\35\ While commenters recommended
various methods of determining fair value, we are proposing aggregate
worldwide market value because it is readily available and objectively
determined by the market.
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\34\ For example, the Investment Test uses the carrying value of
a registrant's total assets as of the most recent balance sheet
date, which represents a combination of fair value for certain
assets (e.g., financial instruments) and historical cost for other
assets (e.g., property, plant and equipment and intangible assets).
The test further excludes the value of certain assets not permitted
to be recognized (e.g., certain internally developed intangible
assets) and is not reduced by the value of liabilities.
\35\ See, e.g., letters from the American Bar Association (Nov.
14, 2014) (``ABA''), BDO USA, LLP (Dec. 7, 2015) (``BDO''), Center
for Audit Quality (Nov. 25, 2015) (``CAQ''), CFA Institute (Mar. 2,
2016) (``CFA''), Davis Polk & Wardwell LLP (Nov. 30, 2015) (``Davis
Polk'') Polk, Deloitte & Touche LLP (Nov. 23, 2015) (``DT''), Ernst
& Young LLP (Nov. 20, 2015) (``EY''), Grant Thornton LLP (Dec. 1,
2015) (``Grant''), KPMG LLP (Nov. 30, 2015) (``KPMG''), and
PricewaterhouseCoopers LLP (Nov. 30, 2015) (``PwC'').
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In order to further improve the Investment Test, we propose to
address when the registrant's aggregate worldwide market value shall be
determined, \36\ provide further instructions on a registrant's
``investments in'' the tested subsidiary \37\ for acquisitions and
dispositions,\38\ and clarify the applicability of the test to
combinations between entities under common control.\39\ These proposed
amendments
[[Page 24605]]
would address certain practical questions \40\ that may arise when
applying the proposed Investment Test and should therefore simplify
compliance by registrants.\41\
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\36\ We propose Paragraph (w)(1)(i)(A) to provide that aggregate
worldwide market value of the registrant's voting and non-voting
common equity shall be determined as of the last business day of the
registrant's most recently completed fiscal year, which for
acquisitions and dispositions shall be at or prior to the date of
acquisition or disposition.
\37\ Rule 1-02(w) defines the term ``significant subsidiary.''
Rules 3-05 and 3-14 use the conditions in Rule 1-02(w) when
establishing the test for registrants to determine whether financial
statements are required for businesses acquired or to be acquired.
While we recognize that acquired businesses are often not
subsidiaries, we use the term ``tested subsidiary'' throughout this
release, rather than ``tested business'' or another term, to avoid
confusion when using the conditions in Rule 1-02(w) in connection
with the determination in Rule 3-05 and Rule 3-14.
\38\ We propose Paragraph (w)(1)(i)(C) to require that the
``investment in'' the tested subsidiary in an acquisition include
the fair value of contingent consideration required to be recognized
at fair value by the registrant at the acquisition date under U.S.
GAAP or IFRS-IASB, as applicable. If recognition at fair value is
not required, the proposed amendment would require all contingent
consideration to be included, except sales-based milestones and
royalties, unless the likelihood of payment is remote. The
``investment in'' the tested subsidiary also would exclude the
registrant's proportionate interest in the carrying value of assets
transferred by the registrant to the tested subsidiary that will
remain with the combined entity after the acquisition because we
believe this would provide a more accurate measure of the tested
subsidiary's relative significance. We believe our proposal is
consistent with FASB standard setting for business combinations that
clarified that for acquisition accounting the consideration
transferred should exclude such amounts. See FASB ASC 805-30-30-8.
For similar reasons, we also propose providing in Paragraph
(w)(1)(i)(D) that the ``investment in'' the tested subsidiary in a
disposition equal the fair value of the consideration, which would
include contingent consideration, for the disposed subsidiary when
comparing it to the registrant's aggregate worldwide market value or
the carrying value of the disposed subsidiary when comparing it to
the registrant's total assets.
\39\ Rule 1-02(w)(1) provides that for a proposed combination
between entities under common control, when the number of common
shares exchanged or to be exchanged exceeds 10% of the registrant's
common shares outstanding at the date the combination is initiated,
the Investment Test for significance is met. We are proposing Rule
1-02(w)(1)(i)(B) to similarly provide that the Investment Test would
be met when either net book value of the tested subsidiary exceeds
10% of the registrants' and its subsidiaries consolidated total
assets or the number of common shares exchanged or to be exchanged
by the registrant exceeds 10% of its total common shares outstanding
at the date the combination is initiated. The addition of net book
value to the test as proposed recognizes that such combinations may
be effected by transferring net assets, rather than exchanging
shares, and that the resulting accounting by the registrant
typically recognizes the combination using the parent's historical
carrying value of the transferred entity or business. See, e.g.,
FASB ASC 805-50. We also propose to add a reference to
``businesses'' in Rule 1-02(w) such that the resulting phrasing is
``combinations between entities or businesses under common control''
for circumstances where the significant subsidiary definition is
referenced by rules establishing requirements for acquired
businesses.
\40\ Commission staff has provided informal guidance to address
practical questions. For example, see U.S. Sec. & Exch. Comm'n.,
Division of Corporation Finance's Financial Reporting Manual,
available at https://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf (last updated Dec. 1, 2017)
(``FRM''). The FRM sets forth the informal guidance of the staff in
the Division of Corporation Finance related to various financial
reporting matters. The FRM is not a rule, regulation, or statement
of the Commission.
\41\ See FRM, supra note 40, at Sections 2015.5 ``Investment
Test--Acquisition Accounting'' and 2015.7 ``Investment Test--
Reorganization of Entities Under Common Control.''
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b. Income Test
Currently, the Income Test focuses on a single component, net
income,\42\ which can include infrequent expenses, gains or losses that
can distort the determination of relative significance. For registrants
with marginal or break-even net income or loss in a recent fiscal year,
the use of a net income component by itself can also have the effect of
requiring financial statements for acquisitions that otherwise would
not be considered material to investors. In these circumstances
comparatively small entities may trigger the requirement for Rule 3-05
Financial Statements, which can be costly to prepare. Commission staff
regularly receives and grants under delegated authority requests for
relief in these circumstances where the disclosure of these
acquisitions would not be material to investors.\43\ A number of
commenters expressed concern with the existing Income Test, with many
of these commenters recommending replacing or supplementing the net
income test with a revenue component.\44\
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\42\ Specifically, the current Income Test uses income from
continuing operations before income taxes. Prior to 1981, the
``significant subsidiary'' definition included a revenue test. The
Commission eliminated the revenue test in favor of the net income
test noting in part that ``. . . the presentation of additional
financial disclosures of an affiliated entity may not be meaningful
if the affiliate has a high sales volume but a relatively low profit
margin'' and observing that in such circumstances, the affiliate has
little financial effect on the operating results of the consolidated
group. See Separate Financial Statements Required by Regulation S-X,
Rels. No. 33-6359 (Nov. 6, 1981)[46 FR 56171 (Nov. 16, 1981)]. For
these reasons, we believe it is important to retain a net income
component as part of the Income Test rather than rely exclusively on
a revenue component.
\43\ Pursuant to 17 CFR 210.3-13 (``Rule 3-13'') of Regulation
S-X, the Commission may, upon the request of the registrant, and
where consistent with the protection of investors, permit the
omission of one or more required financial statements or the filing
in substitution therefor of appropriate statements of comparable
character. The Commission has delegated authority to the staff in
the Division of Corporation Finance to grant requests for relief
under Rule 3-13.
\44\ See, e.g., letters from ABA, CAQ, U.S. Chamber of Commerce
(Nov. 30, 2015), Davis Polk, EY, and PWC. Two commenters
specifically recommended supplementing the Income Test with a
revenue component. See letters from CFA and KPMG.
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We propose to revise the Income Test by adding a new revenue
component \45\ and to simplify the calculation of the net income
component by using income or loss from continuing operations after
income taxes. We expect adding a revenue component would reduce the
anomalous results that may occur by relying solely on net income.\46\
We believe that this change, along with simplifying these calculations,
would reduce complexity and preparation costs without sacrificing
material information that investors may need to evaluate these
transactions.
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\45\ The proposed revenue component would compare the
registrant's and its other subsidiaries' proportionate share of the
tested subsidiary's consolidated total revenues (after intercompany
elimination) to such consolidated total revenues for the
registrant's most recently completed fiscal year.
\46\ We believe that revenue is an important indicator of the
operations of a business and generally has less variability than net
income. For example, expenses related to historical capitalization
(e.g., interest expense) as well as infrequent expenses, such as
those for litigation or impairment, can affect net income and the
existing Income Test. That impact may be to either deem as
insignificant an acquired business that is expected to have material
future impact on the registrant or deem as significant an acquired
business that is not expected to have a material future impact on
the registrant. The potential for these effects suggests that the
Income Test should be revised to include an income statement metric
that is less subject to such effects. Because not all registrants
report metrics such as ``profit margin'' and ``operating income,''
and these metrics could also have similar potential variability, we
believe ``revenue'' is a more appropriate indicator. Consistent with
the Commission's past observations about a revenue test that is not
linked to net income (see supra note 42), we propose to retain net
income and add a revenue component when both the registrant and
tested subsidiary have recurring annual revenues.
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Under the proposed amendments, the Income Test would require that,
where the registrant and its subsidiaries consolidated and the tested
subsidiary have recurring annual revenue, the tested subsidiary must
meet both the new revenue component and the net income component. In
this case, the registrant would use the lower of the revenue component
and the net income component to determine the number of periods for
which Rule 3-05 Financial Statements are required.\47\ Where a
registrant or tested subsidiary does not have recurring annual
revenues, the revenue component is less likely to produce a meaningful
assessment and therefore only the net income component would apply. To
reduce anomalous results in these circumstances, we also propose
revising the Income Test to use the average of the absolute value of
net income when the existing 10% threshold in Computational Note 2 to
Rule 1-02(w) \48\ is met and the proposed revenue component of the
Income Test does not apply.
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\47\ See proposed Rule 3-05(b)(2) of Regulation S-X.
\48\ See Computational Note 2 to Rule 1-02(w) of Regulation S-X.
Average income should be substituted for purposes of the computation
if income of the registrant and its subsidiaries consolidated
exclusive of amounts attributable to any noncontrolling interests
for the most recent fiscal year is at least 10% lower than the
average of the income for the last five fiscal years. See proposed
Rule 1-02(w)(1)(iii)(B)(2).
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By revising the Income Test to require that the registrant exceed
both revenue and net income components when the registrant and the
tested subsidiary have recurring annual revenue, we believe the test
would more accurately determine whether a business is significant to
the registrant and would reduce the frequency of the anomalous result
of immaterial acquisitions being deemed significant.
We also propose to revise the net income component calculation so
that it is based on income or loss from continuing operations after
income taxes. Income tax is a recurring and often material line item.
Further, the current calculation, which is based on income from
continuing operations before income taxes, may require additional
calculations for components of net income that are presented on a post-
tax basis \49\ with the result that a registrant may not be able to use
amounts directly from the financial statements. Instead, the proposed
amendments refer to income or loss from continuing operations after
income taxes, which would permit a registrant to use line item
disclosure from its financial statements, simplifying the
determination.
We are also proposing to clarify the net income component by
inserting a reference to the absolute value of equity in the tested
subsidiary's consolidated income or loss from continuing operations,
which we believe will mitigate the potential for misinterpretation that
may result from inclusion of a negative amount in the computation.\50\
We propose to calculate net income and average net income using
absolute values. For net income, we believe this would serve to clarify
that the test applies when a net loss
[[Page 24606]]
exists, and is to be used when either the tested subsidiary or the
registrant, but not both, has a net loss. For average income, our
proposal differs from current staff interpretation, which indicates
that ``zero'' should be used for loss years in computing the
average.\51\ We believe calculating average net income using the
absolute value of the loss or income amounts for each year and then
calculating the average would make the average income test more
indicative of relative significance.
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\49\ See, e.g., 17 CFR 210.5-03(b)12 (``Rule 5-03(b)12''). Rule
5-03(b)12, Equity in Earnings of Unconsolidated Subsidiaries and 50
Percent or Less Owned Persons, provides for a component of net
income from continuing operations to be presented net of tax.
\50\ See proposed Rule 1-02(w)(1)(iii)(B)(2).
\51\ See FRM, supra note 40, at Section 2015.8.
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In addition, proposed Rules 3-05(b)(3) and 11-01(b)(3) will also
clarify that the Income Test may be determined using the acquired
business's revenues less the expenses permitted to be omitted by
proposed Rules 3-05(e) and 3-05(f) if the business meets the conditions
in those proposed rules.\52\ Finally, we are proposing additional non-
substantive amendments to the net income component that we believe will
simplify the description and application of the test.\53\
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\52\ See discussion relating to Rule 3-05(e) in Section II.A.3
and Rule 3-05(f) in Section II.A.4. below.
\53\ Specifically, we are proposing to replace the phrase
``exclusive of amounts attributable to any noncontrolling
interests'' in the net income component with the phrase
``attributable to the controlling interests.'' We are also proposing
to revise Rule 1-02(w) to remove the Computational Note designation
but retain the substance of the notes in the rule and make
conforming amendments consistent with the proposed amendments to the
revised Income Test. Additionally, Paragraph (w)(1)(iii)(B)(3) would
clarify that the rule is not intended to modify the existing Rule 3-
05(a)(3) requirement that acquisitions of a group of related
businesses shall be treated as if they are a single acquisition.
Finally, we are incorporating the Note to Paragraph (w) into
Paragraph (w).
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Request for Comment
1. We are proposing to revise the significance tests to improve
their application and assist registrants in making more meaningful
significance determinations. Are the proposed revisions appropriate?
Are there additional revisions we should consider to further improve
the significance tests?
2. We are proposing to revise the Investment Test to use aggregate
worldwide market value to reflect the size of the acquirer while
retaining investment in and advances to the acquired business to
reflect the size of the acquired business. Are these measures
sufficiently comparable? Are there particular types of transactions for
which these measures would lead to a less-informative indicator of
significance? Does our proposed use of aggregate worldwide market value
in the Investment Test more closely reflect the relative significance
of the acquisition to the registrant? Is there a better proxy that we
could use for fair value in the Investment Test? For example, would
aggregate worldwide market value of the registrant's voting and non-
voting common equity held by its non-affiliates, a value based on the
expected offering price in an initial public offering, enterprise
value, or some other market valuation be a more appropriate proxy? Why
or why not?
3. We have proposed to require that the ``investment in'' the
tested subsidiary in an acquisition include the fair value of
contingent consideration required to be recognized at fair value by the
registrant at the acquisition date under U.S. GAAP or IFRS-IASB, as
applicable. If recognition at fair value is not required, the proposed
amendment would require all contingent consideration to be included,
except sales-based milestones and royalties, unless the likelihood of
payment is remote. Generally, would the inclusion of contingent
consideration provide a more accurate determination of significance?
Why or why not? Are there practical impediments to our proposed
approach to the inclusion of contingent consideration? If so, what are
they and how would they best be mitigated? For example, should we
require the gross amount of contingent consideration, rather than its
fair value, be used in significance determinations regardless of the
accounting the registrant is required to apply at the acquisition date?
Why or why not? If contingent consideration is not required to be
recognized at fair value, would inclusion of contingent consideration
unless the likelihood of payment is remote provide a more accurate
determination of significance? In this circumstance, is the exclusion
of sales-based milestones and royalties an appropriate practical
expedient to the determination of significance? Alternatively, should
we require registrants to estimate these amounts in order to determine
significance? Why or why not? Does the phrase ``sales-based milestones
or royalties'' capture consideration that is contingent on sales or
should it be further refined or defined?
4. For dispositions, would the use of the fair value of
consideration, which would include contingent consideration, provide a
more accurate determination of significance than the gross amount of
consideration when comparing to the aggregate worldwide market value of
the registrant? Why or why not? Are there practical impediments to our
proposed approach to the inclusion of contingent consideration? If so,
what are they and how would they best be mitigated? Should we exclude
contingent consideration from the determination of the significance of
a disposed business when comparing to the aggregate worldwide market
value of the registrant? Why or why not? Should we exclude from the
determination of significance contingent consideration in the form of
sale-based milestones or royalties when comparing to the aggregate
worldwide market value of the registrant? Why or why not? When the
registrant has no such aggregate worldwide market value, will comparing
the carrying value of the disposed subsidiary to total assets of the
registrant appropriately reflect the relative significance of the
disposed business to the registrant? Why or why not?
5. We have proposed to add a revenue component to the Income Test.
Would this approach more accurately reflect the significance of the
acquisition or could it result in material acquisitions not triggering
financial statement disclosures? Would it reduce incidents of otherwise
insignificant acquisitions being deemed significant by registrants that
have marginal or break-even net income?
6. Would using different percentage thresholds for the revenue
component and the income component mitigate the potential that the
proposed Income Test would under-identify transactions? Why or why not?
For example, would the proposed Income Test be a better indicator of
relative significance if the revenue component used a lower percentage
threshold, for example 15% or 10%, than that used for the income
component? Why or why not? If the revenue component and income
component were to have different percentage thresholds, what should
those percentages be? Are there other ways to modify the Income Test
that would better address this issue?
7. Will our proposal to require recurring annual revenue
appropriately limit the circumstances when the revenue component would
not provide a meaningful result? Should we instead provide that the
revenue component would not apply if either the registrant or tested
subsidiary had no or nominal revenue? Why or why not? If so, should we
define nominal revenue and what definition should we propose?
8. We are proposing that registrants use the lower of the total
revenue or the net income components of the proposed Income Test to
determine the number of years of required audited financial statements.
Would the use of the lower of the two components provide an
[[Page 24607]]
appropriate number of periods of pre-acquisition financial statements
when an acquired business is significant? If not, why not? Is there a
more appropriate way to determine the number of periods that should be
presented if the Income Test is met? If yes, why would this alternative
approach be more appropriate?
9. Would the Income Test better determine relative significance if
we eliminated the net income component entirely and relied solely on
the proposed revenue component? Why or why not?
10. Would the Income Test better determine relative significance if
we required using the proposed revenue component in place of the
proposed income component only when the acquirer's income or loss is
small? Why or why not? If we required use of the revenue component only
when the acquirer's income or loss is small, how should we define when
this switch from the income component to the revenue component must
occur? For example, should we require use of the revenue component when
the absolute value of the acquirer's return on assets was less than 1%?
Why or why not? Would a ``less than 1%'' standard be appropriate or
would a different percentage be a more appropriate standard? If we
required the switch to be made based on the acquirer's return on
assets, how could we mitigate the inconsistent results that might occur
across industries depending on the extent of an acquirer's reliance on
human capital versus material capital? For acquirers that have large
asset bases, would a return on asset approach be subsumed by the
existing Asset Test?
11. Would the Income Test be improved by using a different income
statement-metric test like gross profit (loss) or operating income
(loss) in place of our proposed revenue component? Why or why not? If
we eliminated the net income component and replaced it with a gross
profit (loss) or operating income (loss) test, how would it apply to
tested subsidiaries and registrants that do not report gross profit
(loss) or operating income (loss)?
12. We are proposing to simplify the net income component of the
Income Test by using after-tax net income and absolute values. Would
the proposed revision to use after tax net income and absolute values
simplify the determination while still accurately identifying
significance? Why or why not? Should we retain use of pre-tax net
income? Why or why not?
13. Under our proposal, average income must be used to calculate
the income component of the Income Test if the registrant or the tested
subsidiary does not have recurring annual revenue and the absolute
value of the registrant's income or loss from continuing operations
attributable to the controlling interests for the most recent fiscal
year is at least 10% lower than the average of the absolute value of
such amounts for the registrant for each of its last five fiscal years.
[cir] Would it be appropriate to require income averaging where the
10% threshold is met and registrants are able to rely on the revenue
component? Are there modifications that we should consider to the
average income computation? Are there other circumstances where the
determination would be more accurate by removing the revenue component
or applying income averaging?
[cir] If the 10% threshold is retained, calculating the average
using absolute values may increase the frequency with which the average
must be used. Does calculating average income using the absolute value
of losses rather than the current practice of assigning a value of zero
to those years result in a better indicator of relative significance?
Why or why not? Would modifying the existing 10% threshold in
Computational Note 2 to Rule 1-02(w) in lieu of our proposal to use
absolute values better reflect when an average should be used? If so,
what percentage should we use and why? Are there other ways to modify
the calculation of average income to be a better indicator of relative
significance in the circumstances to which we propose to apply it?
14. Are there other revisions to the Investment Test, Income Test
or Asset Test that we should consider?
15. Are there other tests that would be a more appropriate
indicator of relative significance? For example, should we add a test
based on cash flows from operating, investing or financing activities?
Why or why not?
16. The term ``significant subsidiary'' is defined in Rule 1-02(w)
and also in Securities Act Rule 405 and Exchange Act Rule 12b-2. These
definitions historically have been generally consistent with the
exception of current Computational Note 3 relating to the aggregation
of combined entities, which is generally not relevant for purposes of
Rule 405 or 12b-2. Is it appropriate to consistently apply the
definition of significant subsidiary across these rules while
continuing to exclude the language relating to aggregation of combined
entities? Would these rules be better implemented if the definitions
further diverged? If so, how?
17. Is it clear that ``significant subsidiary'' determinations
should be made using amounts derived from consolidated financial
statements of the tested subsidiary and consolidated financial
statements of the registrant? Should we revise our rules to more
explicitly state that?
18. Should we revise the ``significant subsidiary'' determination
to deem a subsidiary as significant if it is material to the registrant
rather than using specific percentage conditions? Why or why not? If we
should revise the determination to use a materiality standard, how
should that standard be applied? Would a materiality standard yield
consistent determinations between registrants? How would a materiality
standard impact the disclosure provided and a registrant's ability to
timely access capital?
2. Audited Financial Statements for Significant Acquisitions
As noted above, Rule 3-05 Financial Statements may be required for
up to three years depending on the relative significance of the
acquired or to be acquired business. We propose to revise Rule 3-05 to
require up to two years depending on the relative significance. Unlike
the historical financial statements of the registrant upon which
investors rely to make investment decisions about the registrant, the
Rule 3-05 Financial Statements are used, along with pro forma financial
information, to discern how the acquired business may affect the
registrant. We believe two years of pre-acquisition financial
statements, would be sufficient to allow investors to understand the
possible effects of the acquired business on the registrant. Relatedly,
we are also proposing to require the inclusion of certain forward-
looking information in pro forma financial information.\54\
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\54\ See the discussion in Section II.D.1. below.
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We note that older financial statements, such as the third year of
Rule 3-05 Financial Statements, can be less relevant for evaluating an
acquisition because, due to their age, they are less likely to be
indicative of the current financial condition, changes in financial
condition and results of operations of the acquired business.\55\ Pre-
acquisition financial statements can also have less utility because
they do
[[Page 24608]]
not reflect the changes in the acquired business or combined entity
that occur post-acquisition or the accounting required by the
registrant's comprehensive basis of accounting. Moreover, regardless of
the number of years presented, if trends depicted in Rule 3-05
Financial Statements are not indicative or are otherwise incomplete, 17
CFR 210.4-01(a) (``Rule 4-01(a)'') requires that a registrant provide
``such further material information as is necessary to make the
required statements, in light of the circumstances under which they are
made, not misleading.'' Further, the requirement to prepare and obtain
an audit of the third year of pre-acquisition financial statements can
add significant incremental cost and time to the preparation of
required disclosure, which is further exacerbated if a change in the
acquired business's management or independent auditor has occurred, and
may delay a registrant's time to market and access to capital.
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\55\ In some circumstances, Rule 3-05 Financial Statements can
depict a year beginning more than four years before consummation of
the acquisition. For example, the third year of Rule 3-05 Financial
Statements for a calendar year-end business acquired on February 27,
2018 would be 2014. If the business were acquired at a later date in
2018, the third year of Rule 3-05 Financial Statements would be
2015.
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Accordingly, we propose eliminating the requirement to file the
third year of Rule 3-05 Financial Statements for an acquisition that
exceeds 50% significance.\56\ In response to the 2015 Request for
Comment, several commenters recommended eliminating the requirement to
provide three years of Rule 3-05 Financial Statements,\57\ while only
one recommended retaining the current periods.\58\
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\56\ See proposed Rule 3-05(b)(2).
\57\ See letters from BDO, CAQ, Crowe Horwath LLP (Nov. 30,
2015) (``Crowe''), DT, Edison Electric Institute and American Gas
Association (Nov. 30, 2015) (``EEI/AGA''), EY, Grant, KPMG, and RSM
US LLP (Nov. 30, 2015) (``RSM'').
\58\ See letter from California Public Employees' Retirement
System (Nov. 30, 2015) (``CalPERS'').
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We also propose to revise Rule 3-05 for acquisitions where a
significance test exceeds 20%, but none exceeds 40%, to require
financial statements for the ``most recent'' interim period specified
in Rule 3-01 and 3-02 rather than ``any'' interim period. This proposed
revision would eliminate the need to provide a comparative interim
period when only one year of audited Rule 3-05 Financial Statements is
required. Providing a comparative interim period when there is no
requirement for a corresponding comparative annual period may have
limited utility for investors and creates an additional burden on
registrants to prepare such information. Moreover, we believe that
focusing on the most recent interim period would provide the most
relevant and material information to investors.
Request for Comment
19. Is our proposal to eliminate the third year of pre-acquisition
audited financial statements required for business acquisitions
exceeding 50% significance in Rule 3-05(b)(2)(iv) appropriate? Why or
why not? Are there other changes that we should consider that would
reduce compliance burdens for issuers but continue to provide the
material information investors need to make informed investment
decisions?
20. Is our proposal to eliminate the comparative interim period
when only one year of audited Rule 3-05 Financial Statements is
required appropriate? Why or why not? Are there other changes that we
should consider?
3. Financial Statements for Net Assets That Constitute a Business
Registrants frequently acquire a component of an entity, such as a
product line or a line of business contained in more than one
subsidiary of the selling entity, that is a business as defined in Rule
11-01(d) but does not constitute a separate entity, subsidiary, or
division. These businesses may not have separate financial statements
or maintain separate and distinct accounts necessary to prepare Rule 3-
05 Financial Statements because they often represent only a small
portion of the selling entity. In these circumstances, making relevant
allocations of the selling entity's corporate overhead, interest, and
income tax expenses necessary to provide Rule 3-05 Financial Statements
for the business may be impracticable.
We propose to permit \59\ registrants to provide audited financial
statements of assets acquired and liabilities assumed, and statements
of revenues and expenses (exclusive of corporate overhead, interest and
income tax expenses) \60\ if:
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\59\ See proposed Rule 3-05(e). Our proposal is generally
consistent with Commission staff's exercise of delegated authority
pursuant to Rule 3-13 of Regulation S-X in these circumstances. See
also FRM, supra note 40, at Section 2065 ``Acquisition of Selected
Parts of an Entity may Result in Less than Full Financial
Statements.''
\60\ The proposed rule clarifies that federal and state income
tax may be excluded.
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The business constitutes less than substantially all of
the assets and liabilities of the seller and was not a separate entity,
subsidiary, segment, or division during the periods for which the
acquired business financial statements would be required;
separate financial statements for the business have not
previously been prepared;
the seller has not maintained the distinct and separate
accounts necessary to present financial statements that include the
omitted expenses and it is impracticable to prepare such financial
statements;
interest expense may only be excluded from the statements
if the debt to which the interest expense relates will not be assumed
by the registrant or its subsidiaries consolidated;
the statements of revenues and expenses do not omit
selling, distribution, marketing, general and administrative, and
research and development expenses incurred by or on behalf of the
acquired business during the periods to be presented; and
the notes to the financial statements include certain
additional disclosures, specifically: The type of omitted expenses and
the reasons why they are excluded from the financial statements;
information about the business's operating, investing, and financing
cash flows, to the extent available; an explanation of the
impracticability of preparing financial statements that include the
omitted expenses; and a description of how the financial statements
presented are not indicative of the financial condition or results of
operations of the acquired business going forward because of the
omitted expenses.
Recognizing the difficulty registrants face in obtaining and the
cost of preparing financial statements that include the expenses
proposed to be omitted, we believe permitting registrants to provide
abbreviated financial statements as proposed, while requiring the
proposed additional disclosures, appropriately balances the cost of
preparing financial disclosure with the protection of investors. In
response to the 2015 Request for Comment, commenters generally
supported permitting the use of abbreviated financial statements
without first seeking relief from the Commission.\61\
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\61\ See, e.g., letters from ABA-Committees, BDO, CAQ, Cyprus
Energy Partners, L.P. (Nov. 30, 2015), DT, EEI/AGA, EY, Grant, KPMG,
and RSM.
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Request for Comment
21. Are the proposed conditions for permitting registrants to
provide abbreviated financial statements appropriate? Are there other
conditions that should be applied or other disclosures that should be
required? Are any of the conditions unnecessary or counterproductive?
22. Acquired product lines typically meet the definition of a
business, but can have minimal historical balance sheet information
associated with them, such as the carrying value of acquired
[[Page 24609]]
inventory. Similarly, income statement information beyond revenue and
costs of sales may have limited utility when the selling effort relates
to a larger product portfolio that includes the acquired product line,
rather than the acquired product line itself, and when historical
research and development expense is not specific to the acquired
product line. In these and similar circumstances, should we permit
registrants to provide other information, such as revenue and cost of
revenues, in lieu of abbreviated financial statements? Why or why not?
Should we require the other information to be audited? Why or why not?
Is it practicable to audit the other information? Why or why not? If
the other information is unaudited, how would that affect investors and
other market participants that use the information? If we should permit
other information, what conditions best identify and limit the
circumstances when it would be appropriate to permit the other
information? If we permit other information, should the 75-day filing
period specified in Rule 3-05 for registration statements and proxy
statements and in Item 9.01 of Form 8-K apply? Should Article 11 of
Regulation S-X pro forma financial information be required?
23. As proposed, statements of revenues and expenses must include
selling, distribution, marketing, general and administrative, and
research and development expenses incurred to generate the revenue
reflected in the statements. Does the proposed requirement provide
sufficient clarity regarding the expenses that must be included? Does
the proposed requirement provide sufficient clarity regarding the
expenses that may be omitted? Why or why not? If not, how can we better
make these distinctions?
4. Financial Statements of a Business That Includes Oil and Gas
Producing Activities
Rule 3-05 applies to acquisitions of a significant business \62\
that includes oil and gas producing activities.\63\ However, Rule 3-05
does not specify industry-specific disclosures that may be useful to
understand such activities. In the absence of specific requirements,
registrants generally provide certain industry-specific disclosures
specified in FASB ASC Topic 932 Extractive Activities--Oil and Gas
(``ASC 932 Disclosures'') \64\ on an unaudited basis for each full year
of operations presented for the acquired business.
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\62\ See Rule 11-01(d).
\63\ See the definition of ``oil and gas producing activities''
at Sec. 210.4-10(a)(16).
\64\ See FASB ASC Topic 932 Extractive Activities--Oil and Gas,
932-235-50-3 through 50-11 and 932-235-50-29 through 50-36, and FRM,
supra note 40, at Section 2065.12. These supplemental disclosures
are required in the financial statements of publicly traded
companies with significant oil- and gas- producing activities and
provide additional context for those financial statements.
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Rule 3-05 also does not specify the form and content of Rule 3-05
Financial Statements when the acquired business generates substantially
all of its revenues from oil and gas producing activities. Often, this
type of business represents a component of an entity that does not
constitute a separate entity, subsidiary, segment, or division for
which separate financial statements exist and for which historical
depreciation, depletion, and amortization expense is likely not
meaningful to an understanding of the potential effects of the acquired
business on the registrant.\65\ In these circumstances and when certain
additional criteria are met, pursuant to Rule 3-13 and delegated
authority, Commission staff has permitted registrants to provide
abbreviated financial statements that consist of income statements
modified to exclude expenses not comparable to future operations.\66\
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\65\ Historical depreciation, depletion, and amortization
expense is frequently not maintained at the property level and does
not reflect the acquiring company's basis in the properties.
\66\ See FRM, supra note 40, at Section 2065.6, 2065.11, and
2065.12. Permitting registrants in these circumstances to substitute
abbreviated income statements that omit expenses not comparable to
future operations is consistent with the financial statement
requirements specified in Rule 3-14 for acquired real estate
operations. Rule 3-14 specifies that Rule 3-14 Financial Statements
must omit depreciation expenses not comparable to future operations.
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Proposed Rule 3-05(f) would codify these reporting practices.
Specifically, for a significant acquired business that includes
significant oil- and gas-producing activities (as defined in the FASB
ASC Master Glossary), we propose that Rule 3-05 Financial Statements
include the ASC 932 Disclosures on an unaudited basis for each full
year of operations presented for the acquired business.\67\
Additionally, we propose that the Rule 3-05 Financial Statements may be
audited statements of revenues and expenses that exclude depletion,
depreciation, and amortization expense, corporate overhead expense,
income taxes, and interest expense that are not comparable to the
proposed future operations if: (1) Substantially all of the revenues of
the business are generated from oil and gas producing activities,\68\
and (2) the conditions of proposed Rule 3-05(e)(1) through (4) and
(e)(6) are met.\69\ We believe these conditions would appropriately
balance the cost of preparing the disclosure with the protection of
investors. We also believe codifying these practices would provide
clarity for registrants regarding the application of Commission rules
in these circumstances and could facilitate compliance to the benefit
of both registrants and investors.
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\67\ See ASC 932-235-50-3 through 50-11 and 932-235-50-29
through 50-36, which may be presented as unaudited supplemental
information. We are proposing this definition of significant oil-
and gas-producing activities to be consistent with current practice
whereby the FASB's significance threshold is applied in determining
whether to present the ASC 932 Disclosures in Rule 3-05 Financial
Statements, even if the acquired business is not a publicly-traded
company.
\68\ Under our proposal, ``oil and gas producing activities''
would be defined by reference to Sec. 210.4-10(a)(16).
\69\ See discussion in Section II.A.3 above.
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Request for Comment
24. Are the proposed conditions for permitting businesses that have
oil and gas producing activities to provide abbreviated financial
statements and requiring them to provide industry-specific supplemental
information appropriate? Are there other conditions that should be
applied or other disclosures that should be required?
5. Timing and Terminology of Financial Statement Requirements
We propose revising Rule 3-05 and Article 11 to clarify when
financial statements \70\ and pro forma financial information are
required, and to update the language to take into account concepts that
have developed since adoption of the rules over 30 years ago.\71\
Specifically, the proposed amendments would specify that financial
statements are required if a business acquisition has occurred during
the most recent fiscal year or subsequent interim period for which a
balance sheet is required by 17 CFR 210.3-01 of Regulation S-X (``Rule
3-01''), or if a business acquisition has occurred or is probable after
the date that the most recent balance sheet has
[[Page 24610]]
been filed.\72\ We also propose to clarify that Rule 3-05 applies when
the fair value option is used in lieu of the equity method to account
for an acquisition because the disclosure required by U.S. GAAP on a
post-acquisition basis, and related requirements in Rules 4-08(g) and
3-09, includes summarized financial information or separate financial
statements of the business after the acquisition.\73\ We further
propose replacing the term ``furnish'' with ``file'' throughout Rule 3-
05 and Article 11 to make clear that the information required by Rule
3-05 and Article 11 must be filed with the Commission, as we believe
that, at the time of adoption, the use of the term ``furnished'' in
Rule 3-05 and Article 11 was not intended to mean that those
disclosures were ``not filed.'' \74\ In addition, Rule 3-05 requires
``financial statements prepared and audited in accordance with this
regulation.'' \75\ Consistent with current practice, the proposed
amendments to Rule 3-05 would clarify that references to ``this
regulation'' include the independence standards in Rule Sec. 210.2-01
unless the business is not a registrant, in which case the applicable
independence standards would apply. We are also proposing conforming
clarifications in Rule 3-14 and proposed Rule 6-11.\76\
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\70\ We additionally propose to clarify that ``financial
statements'' need not include related schedules specified in Article
12 (17 CFR 210.12). Item 9.01(a)(2) of Form 8-K already provides
that supporting schedules of financial statements need not be filed
in these circumstances. The staff further applies this approach to
acquired business financial statements required in registration
statements and proxy statements. See FRM, supra note 40, at Section
2005.2.
\71\ In addition we are proposing changes to Rule 8-05 for
smaller reporting companies to conform with the proposed changes to
Article 11.
\72\ As discussed in Section II.B.1 below, we are proposing to
no longer require Rule 3-05 Financial Statements in Securities Act
registration statements and proxy statements once the acquired
business is reflected in filed post-acquisition registrant financial
statements for a complete fiscal year. In conjunction with that
proposal, we are proposing conforming amendments to Rule 3-05(a)(1)
to clarify when financial statements are required and to conform the
language in those requirements with the current requirements in Rule
11-01(a). Additionally, in conforming Rule 3-05(a)(1) with Rule 11-
01(a), we propose to move the explanation that the acquisition of a
business encompasses the acquisition of an interest in a business
accounted for by the equity method from Rule 3-05(a)(1)(i) to
proposed Rule 3-05(a)(2)(ii). Finally, we propose to clarify that a
``business'' that is a real estate operation is subject to Rule 3-14
instead of Rule 3-05.
\73\ See proposed Rules 3-05(a)(2)(ii) and 3-14(a)(2)(ii).
\74\ Throughout Rule 3-05 and Article 11, the regulatory text
indicates that financial statements ``shall be furnished.'' See Rule
3-05(a)(1), (b)(1), (b)(2)(i), (b)(2)(ii), (b)(2)(iii), (b)(2)(iv),
(b)4)(ii), (b)(4)(iii), Rule 11-01(a) and Instruction 2 to Rule 11-
02(b). At the time the Commission adopted Rule 3-05, there was no
distinction between ``furnished'' and ``filed.'' See Rule 3-05
Adopting Release. As Securities Act and Exchange Act rules
subsequently began to converge, with documents filed pursuant to the
Exchange Act having exposure to Securities Act liability, some
disclosure was required or permitted to be furnished but ``not
filed'' for certain purposes. We believe that replacing the use of
the term ``furnished'' with ``filed'' in the proposed amendment is
consistent with the original intent and application of the
securities laws.
\75\ See Rule 3-05(a)(1).
\76\ See proposed Rules 3-05(a)(1), 3-14(a)(1), and 6-11(a)(1).
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As another clarification, we propose to replace references to
``business combination'' with the term ``business acquisition'' to make
clear that Rule 3-05 and Article 11 are not limited to ``business
combinations'' as that term is used in U.S. GAAP and IFRS-IASB.\77\ The
term ``business combination'' is defined by reference to the term
``business,'' which has developed differently under U.S. GAAP and IFRS-
IASB from that term as defined in Rule 11-01(d). Because ``business
acquisition'' also encompasses a ``combination between entities under
common control,'' the proposed amendments would also replace this term
in Rule 3-05 and Article 11.
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\77\ See supra note 10. We similarly propose to replace the term
in the Instruction to Item 9.01 of Form 8-K.
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Consistent with current practice, the proposed amendments would
further provide that a registrant may continue to determine
significance using amounts reported in its Form 10-K for the most
recent fiscal year when the registrant has filed its Form 10-K after
the acquisition consummation date, but before the date the registrant
is required to file financial statements of the acquired business on
Form 8-K.\78\ We propose to permit rather than require use of the more
recent Form 10-K in this circumstance to avoid creating an incentive
for registrants to delay the filing of their Form 10-K.
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\78\ See proposed Rules 3-05(b)(3) and 11-01(b)(3)(ii). Pursuant
to Rule 3-13, registrants have been permitted to omit Rule 3-05
Financial Statements if an acquired business is not significant
using these amounts.
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Finally, the proposed amendments would replace the term ``majority-
owned'' as used in Item 2.01 of Form 8-K with the term ``subsidiaries
consolidated,'' as that term more accurately conveys which subsidiaries
are required to be included in the registrant's financial
statements.\79\ We believe these changes would not substantively alter
the current Rule 3-05 requirements, but would facilitate compliance by
providing clarity, codifying current practice, and updating the
terminology used in our rules.
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\79\ Proposed Rule 3-05 uses the term ``subsidiaries
consolidated'' to conform with the term as it is used elsewhere in
Regulation S-X. See, e.g., Rule 1-02(w), Rule 3-01, and Rule 3-02.
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Request for Comment
25. We propose to clarify when financial statements and pro forma
financial information are required and to update the language used in
our rules. Are the proposed clarifications and updates appropriate? Are
there further clarifications or other updates we should consider?
26. Is the proposed language related to independence standards
sufficiently clear? Should we specify the ``applicable independence
standards''? If so, how should the ``applicable independence
standards'' be specified? Are there circumstances where there are no
``applicable independence standards''? In those circumstances, which
independence standards should apply?
6. Foreign Businesses
Regulation S-X permits the use of IFRS-IASB without reconciliation
to U.S. GAAP in financial statements of foreign private issuers.\80\
Rule 3-05 similarly permits the use of IFRS-IASB in financial
statements of foreign businesses. We are proposing limited
modifications to Rule 3-05 to permit Rule 3-05 Financial Statements to
be prepared in accordance with IFRS-IASB without reconciliation to U.S.
GAAP if the acquired business would qualify to use IFRS-IASB if it were
a registrant,\81\ and to permit foreign private issuers that prepare
their financial statements using IFRS-IASB to provide Rule 3-05
Financial Statements prepared using home country GAAP to be reconciled
to IFRS-IASB rather than U.S. GAAP. In response to the 2015 Request for
Comments, commenters generally supported expanding use of IFRS-IASB in
financial statements of acquired businesses.\82\
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\80\ See 17 CFR 210.4-01.
\81\ This proposed amendment would be applicable to domestic and
foreign registrants.
\82\ See, e.g., letters from BDO, CalPERS, CAQ, DT, EY, Grant,
KPMG, and PwC.
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a. Definition
Currently, the definitions of ``foreign private issuer'' \83\ and
``foreign business'' \84\ have different ownership requirements such
that an acquired business could qualify to be a ``foreign private
issuer,'' but not qualify to be a ``foreign business.'' For example, an
acquired business may be majority-owned by persons who are U.S.
citizens or residents and still qualify to be a ``foreign private
issuer'' if it were a registrant and certain additional criteria
[[Page 24611]]
were met,\85\ but to qualify as a ``foreign business,'' it must be
majority-owned by persons who are not U.S. citizens or residents. The
divergent ownership criteria in the two definitions has created a
circumstance where an acquired business that does not meet the
definition of foreign business, but would otherwise be permitted to
present its financial statements using IFRS-IASB as a foreign private
issuer, is not permitted to use financial statements prepared in
accordance with IFRS-IASB for its Rule 3-05 Financial Statements even
when those financial statements are already available. Instead, the
Rule 3-05 Financial Statements must be prepared in accordance with U.S.
GAAP,\86\ which can result in a significant cost to the registrant. In
circumstances where the acquired business has a sufficient foreign
nexus to meet the definition of a foreign private issuer, we believe
financial statements prepared in accordance with IFRS-IASB would
provide sufficient information for investors.
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\83\ See Rule 405. The term ``foreign private issuer'' means any
foreign issuer, other than a foreign government, that does not meet
the following criteria as of the last business day of its most
recently completed second fiscal quarter: (i) More than 50% of the
outstanding voting securities of such issuer are directly or
indirectly owned of record by residents of the United States; and
(ii) any of the following: (a) The majority of the executive
officers or directors are United States citizens or residents; (b)
more than 50% of the assets of the issuer are located in the United
States; or (c) the business of the issuer is administered
principally in the United States.
\84\ See 17 CFR 210.1-02(l).
\85\ See supra note 83.
\86\ Alternatively, the Rule 3-05 Financial Statements may be
prepared in accordance with a basis of accounting other than U.S.
GAAP provided a reconciliation to U.S. GAAP under Item 18 of Form
20-F is included. See Financial Statements of Significant Foreign
Equity Investees and Acquired Foreign Businesses of Domestic Issuers
and Financial Schedules, Release No. 33-7118 (Dec. 13, 1994) [59 FR
65632 (Dec. 20, 1994)] (``1994 Acquired Foreign Business Release'').
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We therefore propose to revise Rule 3-05 to permit Rule 3-05
Financial Statements to be prepared in accordance with IFRS-IASB
without reconciliation to U.S. GAAP \87\ if the acquired business would
qualify to use IFRS-IASB if it were a registrant.\88\ In circumstances
where the registrant presents its financial statements in U.S. GAAP,
the pro forma financial information reflecting the acquisition will
continue to be required to be presented in U.S. GAAP.
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\87\ Under the existing and the proposed rule, acquired foreign
business financial statements may use IFRS-IASB without
reconciliation to U.S. GAAP, even when the registrant prepares its
financial statement using U.S. GAAP.
\88\ See proposed Rule 3-05(d).
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b. Reconciliation Requirement
Currently, if Rule 3-05 Financial Statements of a foreign business
are prepared on a basis of accounting other than U.S. GAAP or IFRS-
IASB, such as home-country GAAP, the Rule 3-05 Financial Statements
must be reconciled to U.S. GAAP.\89\ If the registrant in this case
were a foreign private issuer that presents its financial statements
using IFRS-IASB, this one-time presentation of the U.S. GAAP
reconciling information in financial statements of the acquired
business would likely be the only required U.S. GAAP information in any
of the registrant's filings and could be costly to produce. We believe
that Rule 3-05 Financial Statements that include IFRS-IASB reconciling
information of the acquired foreign business would provide more
comparable information and better facilitate analysis of the financial
statements.
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\89\ See Item 17 of Form 20-F and 1994 Acquired Foreign Business
Release.
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We therefore propose to permit foreign private issuers that prepare
their financial statements using IFRS-IASB to reconcile Rule 3-05
Financial Statements prepared using home country GAAP to IFRS-IASB
rather than U.S. GAAP.\90\ The reconciliation to IFRS-IASB would be
required generally to follow the form and content requirements in Item
17(c) of Form 20-F.
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\90\ See proposed Rule 3-05(c).
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Request for Comment
27. Is the proposed revision to permit in certain circumstances
Rule 3-05 Financial Statements to be prepared in accordance with IFRS-
IASB without reconciliation to U.S. GAAP appropriate? Are there other
requirements that could improve the information to investors?
28. Is the proposed revision to permit foreign private issuers that
prepare their financial statements using IFRS-IASB to reconcile
acquired foreign business financial statements to IFRS-IASB
appropriate? Would continuing to require reconciliation to U.S. GAAP
provide better information to investors? Are there other requirements
that could improve the information to investors?
7. Smaller Reporting Companies and Issuers Relying on Regulation A
Rule 8-04 provides smaller reporting company disclosure
requirements for the financial statements of businesses acquired or to
be acquired that substantively differ from the existing requirements in
Rule 3-05 in four ways:
Rule 8-04 permits acquired business financial statements
to be prepared in accordance with the form and content required by
Article 8, rather than the form and content specified elsewhere in
Regulation S-X; \91\
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\91\ Article 8 allows smaller reporting companies to, among
other things, omit certain footnote disclosures that would be
required by Article 4. Article 8 also requires fewer line items on
the face of interim financial statements.
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Rule 8-04 only requires up to two years of acquired
business historical financial statements;
Rule 8-04 does not explicitly permit the omission of
previously filed financial statements once the operating results of the
acquired business have been included in the audited consolidated
financial statements of the registrant for a complete fiscal year; and
the ability to exclude from a registration statement
separate financial statements of the acquired or to be acquired
business in certain circumstances is based on the effective date of the
registration statement rather than the date of the relevant final
prospectus or prospectus supplement.
In connection with offerings made pursuant to Regulation A,\92\
Part F/S of Form 1-A (``Part F/S'') \93\ directs an entity relying on
Regulation A to present financial statements of businesses acquired or
to be acquired,\94\ as specified by Rule 8-04, but permits the periods
presented to be those applicable to Regulation A issuers rather than
the periods specified by Article 8.\95\
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\92\ 17 CFR 230.251 through 263.
\93\ 17 CFR 239.90.
\94\ See paragraph (b)(7)(iii) of Part F/S.
\95\ As mandated by the Economic Growth, Regulatory Relief, and
Consumer Protection Act (Pub. L. 115-174, 132 Stat. 1296 (2018)),
the Commission in December 2018 revised Rule 251(b) under the
Securities Act to permit entities subject to the reporting
requirements of Section 13 or 15(d) of the Exchange Act to conduct
exempt offerings under Regulation A. See Amendments to Regulation A,
Release No. 33-10591 (Dec. 19, 2018) [84 FR 520 (Jan. 31, 2019)].
Such reporting companies are required, at a minimum, to comply with
the requirements of Part F/S of Form 1-A. However, if at the time a
reporting company files a Form 1-A, it has made publicly available
more recent audited or reviewed financial statements prepared in
accordance with the standard required for the registrant's Exchange
Act reports, including such financial statements in the offering
statement may be necessary to make the required statements therein,
in light of the circumstances under which they are being made, not
misleading. See 17 CFR 230.252.
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In order to simplify the application of our rules by focusing
registrants on the more detailed and better understood provisions of
Rule 3-05, we propose to revise Rule 8-04 to direct registrants to Rule
3-05 for the requirements relating to the financial statements of
businesses acquired or to be acquired, other than for form and content
requirements for such financial statements, which would continue to be
prepared in accordance with Rules 8-02 and 8-03.\96\
[[Page 24612]]
Additionally, because Part F/S of Form 1-A refers to Rule 8-04, the
proposed revisions to Rule 8-04 would apply to issuers relying on
Regulation A. As a result, under the proposed amendments, smaller
reporting companies would continue to be required to provide up to two
years of acquired business historical financial statements and
Regulation A issuers would continue to be permitted to present the
periods applicable under Regulation A.\97\
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\96\ Rule 3-05(b)(1) currently requires financial statements
specified in Sec. Sec. 210.3-01 and 210.3-02 for the business to be
acquired. Similarly, Rule 3-05(b)(2) also references Sec. Sec.
210.3-01 and 210.3-02. Under our proposal, smaller reporting
companies would apply Sec. 210.3-05 but would substitute Sec. Sec.
210.8-02 and 210.8-03, as applicable, wherever Sec. 210.3-05
references Sec. Sec. 210.3-01 and 210.3-02. In this way, our
proposal is intended to apply the election permitted for smaller
reporting companies to prepare their financial statements in
accordance with the form and content requirements in Article 8
rather than the other form and content requirements specified
elsewhere in Regulation S-X (subject to the exceptions noted in
Sec. 210.8-01 Preliminary Note 2 to Article 8) to businesses
acquired by smaller reporting companies.
\97\ Additionally, in accordance with current practice, the
proposed rule would expressly permit smaller reporting companies to
omit such financial statements if the acquired business has been
included in the registrant's results for a complete fiscal year. See
further discussion of omission of Rule 3-05 Financial Statements in
Section II.B.1 above. We also propose to add references to Rule 8-04
in Rule 3-06 and to Rule 3-06 in Note 6 to Article 8 to expressly
permit smaller reporting companies to file financial statements
covering a period of nine to 12 months to satisfy the requirement
for filing financial statements for a period of one year for an
acquired business.
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Additionally, under the proposed amendments, a smaller reporting
company would be eligible to exclude acquired business financial
statements from a registration statement if the business acquisition
was consummated no more than 74 days prior to the date of the relevant
final prospectus or prospectus supplement, rather than 74 days prior to
the effective date of the registration statement as under current Rule
8-04(c)(4).\98\ We believe it is appropriate to consistently look to
the date of the final prospectus or prospectus supplement,\99\ as Rule
3-05 currently does, because that date could be later than the
effective date, particularly in the case of a delayed offering, which
some smaller reporting companies are now permitted to conduct.\100\
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\98\ See proposed Rule 3-05(b)(4)(i)(B).
\99\ See 1996 Streamlining Release, supra note 13 (noting that
the date of an offering is specified as the date of the final
prospectus or prospectus supplement relating to the offering).
\100\ See General Instruction I.B.6 of Form S-3 and 2018 SRC
Amendments, supra note 16.
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Request for Comment
29. Would the proposed revisions to Rule 8-04 to direct smaller
reporting companies and Regulation A issuers to Rule 3-05 while still
permitting them to rely on the form and content requirements in Rules
8-02 and 8-03 simplify the application of our rules by focusing
registrants on the more detailed and better understood provisions of
Rule 3-05? Are there other changes to the Rule 8-04 requirements that
we should consider?
30. For purposes of excluding acquired business financial
statements from a registration statement, is the proposed revision to
require smaller reporting companies to look to the date of the relevant
final prospectus or prospectus supplement instead of the effective date
of the registration statement appropriate? Why or why not?
31. Our proposal to no longer require Rule 3-05 Financial
Statements once the operating results of the acquired business have
been included in the audited consolidated financial statements of the
registrant for a complete fiscal year (see Section II.B.1 above) would
also apply to smaller reporting companies pursuant to our proposed
revisions to Rule 8-04. Is permitting smaller reporting companies to
omit financial statements under these circumstances appropriate? Are
there specific revisions or information requirements we should consider
for smaller reporting companies?
32. Should the proposed changes to Rule 8-04 apply to offerings
made pursuant to Regulation A? Should we revise the proposals to better
accommodate Regulation A issuers and investors? If so, what revisions
should we make and why?
B. Proposed Amendments Relating to Rule 3-05 Financial Statements
Included in Registration Statements and Proxy Statements
1. Omission of Rule 3-05 Financial Statements for Businesses That Have
Been Included in the Registrant's Financial Statements
Overview of the Application of the Current Rule
Current Rule 3-05(b)(4)(iii) generally permits Rule 3-05 Financial
Statements to be omitted once the operating results of the acquired
business have been reflected in the audited consolidated financial
statements of the registrant for a complete fiscal year. However, Rule
3-05 Financial Statements are required to be included when they have
not been previously filed or when the Rule 3-05 Financial Statements
have been previously filed, but the acquired business is of major
significance to the registrant.
Rule 3-05 Financial Statements Not Previously Filed
If Rule 3-05 Financial Statements have not been previously filed,
they must be provided even if the acquired business is included in
post-acquisition audited results. Thus, a registrant that acquired a
significant business during the earliest of the three years for which
it presents financial statements, and has reported the combined results
in audited financial statements since the acquisition, would still be
required to file separate Rule 3-05 Financial Statements for that
acquired business if the Rule 3-05 Financial Statements have not been
previously filed.\101\ The staff has historically not objected,
however, to registrants reducing the Rule 3-05 Financial Statement
periods presented by the equivalent period that the acquired business
is included in the registrant's post-acquisition audited results.\102\
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\101\ This issue arises most often for initial registration
statements under the Securities Act and Exchange Act since an
existing Exchange Act reporting company would generally have been
required to file Rule 3-05 Financial Statements on a Form 8-K within
approximately 75 days after acquisition of a significant business.
\102\ This is limited to circumstances where there is no gap
between the latest date of the pre-acquisition audited financial
statements of the acquired business and the earliest date of the
registrant's audited post-acquisition results. See FRM, supra note
40, at Section 2030.4 ``Initial Registration Statements--Using Pre-
Acquisition and Post-Acquisition Audited Results.''
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Rule 3-05 Financial Statements Previously Filed for an Acquisition That
Was of Major Significance
Under current Rule 3-05(b)(4)(iii), registrants must also continue
to present Rule 3-05 Financial Statements that have been previously
filed if the acquired business is of such significance to the
registrant that omission of those Rule 3-05 Financial Statements would
materially impair an investor's ability to understand the historical
financial results of the registrant. Rule 3-05 provides as an example
that an acquired business that met at least one of the significance
tests at the 80% level at the date of the acquisition would require the
registrant to continue to file the financial statements of the acquired
business for such periods prior to the purchase as may be necessary
when added to the time for which audited income statements after the
purchase are filed to cover the equivalent of the period specified in
Rule 3-02.\103\ Notwithstanding the rule's reference to materiality, in
practice the rule is
[[Page 24613]]
typically applied, consistent with this example, on the basis of
quantitative significance determinations.\104\ The result of the
practical application of the ``major significance'' exception is that,
for example, if an acquisition that occurred two years ago was
significant at the 80% level at the time of the acquisition, one year
of previously filed Rule 3-05 Financial Statements will continue to be
provided regardless of whether post-acquisition activities have
diminished the relative significance of the acquired business.
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\103\ See Rule 3-05(b)(4)(iii). Rule 3-02 states that there
shall be filed, for the registrant and its subsidiaries consolidated
and for its predecessors, audited statements of income and cash
flows for each of the three fiscal years preceding the date of the
most recent audited balance sheet being filed or such shorter period
as the registrant (including predecessors) has been in existence. An
emerging growth company may provide audited statements of income and
cash flows for each of the two fiscal years preceding the date of
the most recent audited balance sheet (or such shorter period as the
registrant has been in existence) in its initial registration
statement.
\104\ See, e.g., FRM, supra note 40, at Section 2040.2 ``Major
Significance'' and ``Previously Filed Acquiree Financial
Statements.''
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Proposed Amendments Regarding the Omission of Rule 3-05 Financial
Statements
We are proposing to no longer require Rule 3-05 Financial
Statements in registration statements and proxy statements once the
acquired business is reflected in filed post-acquisition registrant
financial statements for a complete fiscal year.\105\ This change would
eliminate the requirement that Rule 3-05 Financial Statements be
provided when they have not been previously filed or when they have
been previously filed but the acquired business is of major
significance.
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\105\ The proposed amendments would require inclusion in all
twelve months of the registrant's most recently completed audited
fiscal year. They do not permit reducing the twelve month period
through analogy to Rule 3-06 or by the number of months of pre-
acquisition historical financial statements that may be provided.
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The ``not previously filed'' exception requires those registrants
filing initial registration statements to test the significance of
acquisitions that occurred during the earliest years for which the
registrant is required to provide its historical financial statements
and, if significant, to provide pre-acquisition financial statements of
the acquired business. This requirement can delay a registrant's
offering and thereby its access to capital while providing information
that is often less meaningful to investors because the utility of pre-
acquisition periods diminishes over time after the acquired business is
reflected in post-acquisition results and the post-acquisition results
of the combined business are generally not comparable to the pre-
acquisition results of the acquired business.\106\
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\106\ See FRM, supra note 40, at Section 2030.4. The
accommodation currently provided by Commission staff does not
sufficiently ameliorate these effects and often results in financial
statements of the acquired business for a pre-acquisition stub
period ending at a date during a fiscal period such that the
financial statements depict partial, rather than complete, reporting
periods that do not coincide with the end of either the acquired
business's or the registrant's fiscal periods. Moreover, because
these are staff accommodations, they lack the legal significance of
a Commission rule.
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We also propose to eliminate the ``major significance'' exception.
As with not previously filed information, the utility of pre-
acquisition periods diminishes over time after the acquired business is
reflected in post-acquisition results. We further observe that the
``major significance'' exception was established prior to requirements
for electronic filing, which has made previously filed financial
information about the acquired business more readily accessible through
the Commission's EDGAR filing system. Consequently, we believe this
exception is no longer necessary.
We believe inclusion of post-acquisition results in the
registrant's audited financial statements for a complete fiscal year
should generally provide investors with sufficient information to make
informed investment decisions about the registrant.\107\ The
requirement for management to prepare Rule 3-05 Financial Statements
and a third party to audit those financial statements can be costly and
adds preparation time for the financial statements, which can affect a
registrant's time to market and delay its access to capital. Where the
significant acquisition will have occurred over a year before, and
information about the acquired business that is material to the
registrant would generally have been incorporated into the registrant's
audited historical financial statements for a complete fiscal year or
otherwise provided pursuant to the requirements of 17 CFR 210.4-01(a)
and 17 CFR 229.303, we do not believe it is necessary to require
registrants to provide Rule 3-05 Financial Statements.
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\107\ Further, even without the major significance requirement
to include some, but not all, of the previously filed pre-
acquisition financial statements of the acquired business,
Regulation S-X provides that a registrant shall provide ``such
further material information as is necessary to make the required
statements, in light of the circumstances under which they are made,
not misleading.'' See 17 CFR 210.4-01(a).
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Request for Comment
33. Is our proposal to no longer require Rule 3-05 Financial
Statements once the acquired business is reflected in filed post-
acquisition audited consolidated financial statements of the registrant
for a complete fiscal year appropriate? Would the proposed revisions
simplify the application of the rule and reduce costs for registrants?
34. Would the proposed amendments affect the sufficiency of
information available to investors? If so, should we continue to
require Rule 3-05 Financial Statements if they have not been previously
filed or if the acquisition was of major significance? Alternatively,
what information about an acquired business is most important to
investors once the acquired business has been depicted in the
registrant's post-acquisition audited consolidated financial statements
for a complete fiscal year that is not otherwise provided pursuant to
existing requirements, like those for management's discussion and
analysis, and what changes could we make to ensure that investors
receive such information while reducing the burden on registrants of
preparing unnecessary disclosure?
2. Use of Pro Forma Financial Information To Measure Significance
Significance determinations are required to be made by comparing
the most recent annual consolidated financial statements of the
acquired business to those of the registrant filed at or prior to the
date of acquisition. A registrant is permitted to use pro forma, rather
than historical, financial information if the registrant made a
significant acquisition subsequent to the latest fiscal year-end and
filed its Rule 3-05 Financial Statements and pro forma financial
information on Form 8-K.\108\ There is no analogous provision in Rule
3-05 for registrants to use pro forma financial information depicting
significant dispositions or for registrants filing initial registration
statements. In considering whether, pursuant to Rule 3-13 and delegated
authority, to permit omission or substitution of acquired business
financial statements in initial registration statements of registrants
growing through acquisition, Commission staff has considered the
results of significance tests using pro forma financial
information.\109\ In response to the 2015 Request for Comment, some
commenters
[[Page 24614]]
recommended establishing requirements to determine significance in
these circumstances in a manner that reduces complexity and provides
financial statements that are meaningful to investors.\110\
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\108\ 17 CFR 210.3-05(b)(3).
\109\ See supra note 43. See also Staff Accounting Bulletin No.
80, Application of Rule 3-05 in Initial Public Offerings (``SAB
80''). Consistent with the staff's exercise of delegated authority
in response to requests under Rule 3-13, SAB 80 states that the
staff will not object if significance is measured using the
alternative method specified in SAB 80. The SAB 80 method is similar
to Rule 3-05 in its use of more recent pro forma financial
information of the registrant. It differs from Rule 3-05 in that it:
Uses pro forma rather than historical financial information of the
acquired business; uses pro forma financial information of the
registrant that was not previously filed; and does not reflect the
current, higher significance thresholds in Rule 3-05. The
accommodations in SAB 80 are complex and seldom used by registrants,
in part because they require the acquired businesses to remain
discrete and substantially intact after acquisition.
\110\ See, e.g., letters from ABA-Committees, CAQ, DT, EY, and
Grant.
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We propose to expand the circumstances in which a registrant can
use pro forma financial information for significance testing.
Specifically, for all filings that require Rule 3-05 Financial
Statements and Rule 3-14 Financial Statements, we propose to permit
registrants to measure significance using filed pro forma financial
information that only depicts significant business acquisitions and
dispositions consummated after the latest fiscal year-end for which the
registrant's financial statements are required to be filed, subject to
the following conditions:
--The registrant has filed Rule 3-05 Financial Statements or Rule 3-14
Financial Statements for any such acquired business; and
--the registrant has filed the pro forma financial information required
by Article 11 for any such acquired or disposed business.\111\
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\111\ We propose to include these provisions in Rule 11-01(b)(3)
and to further revise Rule 3-05(b)(3) and Rule 3-14(b)(2) to replace
the existing guidance with a specific reference to Rule 11-01(b)(3).
We additionally propose to revise Rule 11-01(b)(1) to add a
reference to Rule 11-02 to clarify that registrants may not include
Management's Adjustments \112\ when using pro forma financial
information to determine significance. Rather, the pro forma financial
information must be limited to the applicable subtotals that combine
the historical financial information of the registrant and the acquired
business and Transaction Accounting Adjustments.\113\
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\112\ See Section II.D.1. below.
\113\ See id. We also are proposing amendments to Rule 11-
01(b)(3) to indicate that the pro forma information that is used to
measure significance may only give effect to the subsequently
acquired or disposed business and may not give effect to other
transactions, such as the use of proceeds from an offering.
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We believe that these proposed amendments and clarifications would
provide registrants with the flexibility to more accurately determine
the relative significance of an acquired or disposed business to the
ongoing operations of the registrant, including for those filing an
initial registration statement, without inadvertently delaying or
accelerating the filing of pro forma financial information that might
occur if we required use of such pro forma financial information to
determine significance. The proposed amendments would also simplify the
application of the rule by including in a single location the
description of the financial statements used to measure significance
for purposes of Rules 3-05 and 3-14 and Form 8-K.
Request for Comment
35. Are the proposed revisions to permit significance testing based
on pro forma financial information in these circumstances appropriate?
Are the proposed revisions to permit the use of pro forma financial
information for all filings that require Rule 3-05 Financial Statements
and Rule 3-14 Financial Statements appropriate? Should certain filings
that require such financial statements be precluded from using pro
forma financial information to measure significance?
36. Would the amendments provide flexibility to make a more
accurate determination of significance without delaying or accelerating
the required filing of pro forma financial information? Should we
require significance to be determined using pro forma financial
information in the circumstances we describe? Why or why not? If yes,
how could we modify our proposal so that it does not delay or
accelerate the required filing of pro forma financial information?
Would the amendments simplify application of the rule? Would they
reduce costs for registrants?
3. Disclosure Requirements for Individually Insignificant Acquisitions
Under the existing rules, audited historical pre-acquisition
financial statements are generally not required if an acquired or to be
acquired business: (1) Does not exceed 20% significance, or (2) does
not exceed 50% significance and the acquisition has not yet occurred or
the date of the final prospectus or prospectus supplement relating to
an offering as filed with the Commission pursuant to Sec. 230.424(b)
of this chapter is no more than 74 days after consummation and the
financial statements have not been previously filed.\114\ However, if
the aggregate impact of ``individually insignificant businesses'' \115\
acquired since the date of the most recent audited balance sheet filed
for the registrant exceeds 50%, audited historical pre-acquisition
financial statements covering at least the substantial majority of the
businesses acquired must be included in a registration statement or
proxy statement.\116\ Registrants also must provide related pro forma
financial information based on the requirements of Article 11.\117\
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\114\ See Rule 3-05(b)(4)(i).
\115\ In the 1996 Streamlining Release, Rule 3-05 was amended to
permit the exclusion of historical financial statements for certain
significant acquisitions that did not exceed 50% significance. See
Rule 3-05(b)(4)(i). However, we believe that Rule 3-05(b)(4) was not
intended to circumvent the requirement in Rule 3-05(b)(2) to
consider the aggregate significance of all acquired businesses for
which financial statements were not yet filed. To do otherwise could
lead to the presentation of financial statements for less than a
mathematical majority of businesses acquired since the most recent
audited balance sheet that have an aggregate significance in excess
of 50%. For these reasons, the proposals would codify staff
interpretation that ``individually insignificant businesses''
include: (a) Any acquisition consummated after the registrant's
audited balance sheet date whose significance does not exceed 20%;
(b) any probable acquisition whose significance does not exceed 50%;
and (c) any consummated acquisition whose significance exceeds 20%,
but does not exceed 50%, for which financial statements are not yet
required by Rule 3-05(b)(4) because of the 75-day filing period. See
FRM, supra note 40, at Section 2035.2.
\116\ 17 CFR 210.3-05(b)(2)(i). ``Substantial majority'' has
been applied in practice to be the mathematical majority (i.e.,
businesses constituting more than 50% of the relevant test
(investment, asset or income) on which the businesses were
determined to be significant in the aggregate) See FRM, supra note
40, at Section 2035.3 ``Financial Statements Required--Mathematical
Majority.''
\117\ Rule 11-01(a) specifies conditions for which pro forma
financial information must be presented. Those conditions do not
explicitly discuss the aggregate significance of individually
insignificant businesses, however they do include, ``consummation of
a significant business combination or a combination of entities
under common control [that] has occurred or is probable'' and
``consummation of other events or transactions has occurred or is
probable for which disclosure of pro forma financial information
would be material to investors.'' Further, Rule 11-01(c) links the
requirement for pro forma financial information for a significant
business acquisition to the presentation of separate financial
statements of the acquired business. Taken together, these
requirements provide that if separate financial statements of the
substantial majority of individually insignificant businesses are
presented, pro forma financial information depicting their effects
must also be presented.
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The practical effect of this requirement is that registrants often
provide separate, audited historical financial statements for acquired
businesses that are individually not material to the registrant, and
pro forma financial information that does not fully depict the
aggregate effect of the ``individually insignificant businesses.''
\118\ Further, the
[[Page 24615]]
requirements can have implications for business acquisition
negotiations, as registrants may need to negotiate a requirement for
the seller to timely provide historical financial statements of an
insignificant business to cover the possibility that a future
acquisition may trigger the Rule 3-05 ``individually insignificant
businesses'' requirements.\119\ In response to the 2015 Request for
Comment, commenters questioned the utility of audited financial
statement requirements for individually insignificant
acquisitions.\120\ Some of these commenters recommended more frequent
and timely reporting of pro forma financial information for
individually insignificant acquisitions instead of the current
requirements.\121\
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\118\ Article 11 only requires pro forma financial information
for an acquisition for which Rule 3-05 Financial Statements are
required, and the pro forma financial information will only reflect
the acquisitions selected for the Rule 3-05 Financial Statements.
Thus, for example, if the aggregate of 16 individually insignificant
acquisitions is 80% significant, with each at 5%, a registrant would
currently be required to provide pre-acquisition audited historical
financial statements for nine of the individually insignificant
businesses. Thus, the pro forma financial information would only
depict the effect of those nine acquisitions constituting 45% of the
registrant's post-acquisition assets or income.
\119\ Under the proposal, registrants would have to negotiate
the timely provision of historical balance sheet and income
statement information for each acquisition necessary to present pro
forma financial information depicting their aggregate effects in all
material respects when aggregate significance exceeds 50%, but
historical financial statements only for acquisitions that are
required to be reported on Form 8-K (i.e., individual significance
exceeds 20%). However, the proposed rule could accelerate reporting
of historical financial statements for these acquisitions (i.e.,
individual significance exceeds 20%) in certain registration
statements and proxy statements if the combined acquisitions exceed
the 50% threshold.
\120\ See letters from ABA, BDO, CAQ, DT, EEI/AGA, EY, Grant,
and PwC.
\121\ See letters from ABA, EY, and PwC. ABA and EY indicated
that a registrant should provide pro forma information when the
aggregate effect of individually insignificant acquisitions
completed in a fiscal year becomes significant to the registrant.
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We propose revising our rules to improve the information provided
to investors, reduce immaterial disclosure and clarify the
requirements. Similar to existing requirements, proposed Rule 3-
05(b)(2)(iv) would require disclosure if the aggregate impact of
businesses acquired or to be acquired since the date of the most recent
audited balance sheet filed for the registrant, for which financial
statements are either not required by paragraph (b)(2)(i) or are not
yet required based on paragraph (b)(4)(i), exceeds 50%.\122\ The
proposed rule, however, would require registrants 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% but are not yet required to file financial
statements.\123\
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\122\ For clarity, we are proposing to specifically describe the
affected businesses in the rule without reference to the term
``individually insignificant businesses.''
\123\ See proposed Rule 3-05(b)(2)(iv) and proposed revisions to
Rule 11-01(c). Further, we propose to revise Rule 11-01(c) to
clarify that the exception that would otherwise permit pro forma
financial information not to be provided when separate financial
statements of the acquired business are not included in the filing
does not apply where the aggregate impact is significant as
determined by proposed Rules 3-05(b)(2)(iv) or 3-14(b)(2)(i)(C).
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We believe the proposed amendments would both improve the
information provided to investors and reduce burdens on registrants of
providing audited historical financial statements for immaterial
acquisitions. Preparing disclosure about immaterial acquisitions and
negotiating with sellers to timely provide historical financial
statements for them can increase the cost of registration and delay
access to capital. In addition, requiring pro forma financial
information that shows the aggregate effect of the acquired businesses
for which financial statements are either not required or not yet
required in all material respects rather than only giving effect to a
mathematical majority of such businesses, would make it easier for
investors to understand the overall effect of those acquisitions on the
registrant.
Request for Comment
37. Is the proposed amendment to require registrants to provide
Rule 3-05 Financial Statements only for those acquisitions whose
individual significance exceeds 20% appropriate? Would the proposed
amendment improve the information provided to investors? Would it
instead reduce the amount of material information that is available? If
so, would this reduction be mitigated by the proposal to require pro
forma financial information depicting the aggregate impact of the
acquisitions for which financial statements are either not required or
not yet required in all material respects? Would the proposed amendment
simplify the application of the rule and reduce the burden of preparing
the information for registrants?
38. Is the proposed amendment to require registrants to provide pro
forma financial information depicting the aggregate impact of the
acquisitions for which financial statements are either not required or
not yet required in all material respects appropriate? Would the
proposed revision improve the information provided to investors? Would
the proposed amendment simplify the application of the rule and reduce
the burden of preparing the information for registrants?
39. As proposed, the aggregate impact determination in Rule 3-
05(b)(2)(iv) would exclude acquired businesses subject to Rule 3-14.
Similarly, the proposed Rule 3-14(b)(2)(i)(C) aggregate impact
determination described in Section II.C. below would exclude acquired
businesses subject to Rule 3-05. Since a registrant could have both
types of acquisitions within a reporting period, should we revise the
proposed aggregate impact determinations in Rule 3-05 and Rule 3-14 to
include all such acquired business?
C. Rule 3-14--Financial Statements of Real Estate Operations Acquired
or To Be Acquired
Rule 3-14 differs from Rule 3-05, in part, because unique industry
considerations warrant differentiated disclosure. For example, in
previous amendments to Rule 3-14 to require only one year of Rule 3-14
Financial Statements to be provided in most circumstances, the
Commission recognized that audited financial statements for a real
estate operation are rarely available from the seller without
additional effort and expense because most real estate managers do not
maintain their books on a U.S. GAAP basis or obtain audits.\124\ The
Commission further noted that historical financial statements for real
property do not usually provide significant information about the
trends and factors that are most likely to affect future operations,
such as demographic information, application of managerial techniques,
and competition.\125\ As a result, in addition to requiring Rule 3-14
Financial Statements for one year in most circumstances, Rule 3-14 also
requires the registrant to describe with specificity in the filing the
material factors it considered in assessing the real estate operation,
including sources of revenue (including, but not limited to,
competition in the rental market, comparative rents, and occupancy
rates) and expense (including, but not limited to, utility rates,
property tax rates, maintenance expenses, and capital improvements
anticipated). The disclosure must also indicate that the registrant is
not aware of any other material factors relating to the specific real
estate operation that would cause the reported financial statements not
to
[[Page 24616]]
be indicative of future operating results.\126\
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\124\ See Publication of Revisions to the Division of
Corporation Finance's Guide 5 and Amendment of Related Disclosure
Provisions, Release No. 33-6405 (June 3, 1982) [47 FR 25120 (June
10, 1982)] and Proposed Revision of Guide 60 and Related Disclosure
Provisions, Release No. 33-6354 (Oct. 7, 1981) [46 FR 50553 (Oct.
14, 1981)]. When Rule 3-14 was initially adopted, it required
audited abbreviated income statements for the three most recent
years. The requirements have not been substantively modified since
they were first introduced in Form S-11 in 1961, except to reduce
the number of years of financial statements required in most
circumstances from three to one.
\125\ Id., at 50558.
\126\ See Rules 3-14(a)(1)(ii) and 3-14(a)(1)(iii).
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We propose to align Rule 3-14 with Rule 3-05 where no unique
industry considerations exist because the rules have similar
objectives. We also propose to establish or clarify the application of
Rule 3-14 regarding scope of the requirements, determination of
significance, need for interim income statements, and special
provisions for blind pool offerings.
1. Align Rule 3-14 With Rule 3-05
We are proposing amendments to Rule 3-14 consistent with the new
proposals for Rule 3-05 discussed above.\127\ We have found no unique
industry considerations that warrant differentiated treatment of real
estate operations in these areas, and believe that aligning Rule 3-14
with Rule 3-05 will reduce complexity by standardizing the requirements
for acquired businesses overall while retaining the industry specific
disclosure necessary for investors to make informed investment
decisions. In response to the 2015 Request for Comment, commenters
generally supported aligning these rules where appropriate.\128\
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\127\ We are also proposing to align the rules regarding the
timing of financial statements and use of the term ``furnished''
discussed in Section II.A.5 and note 74; the Investment Test
discussed in Section II.A.1; and the required disclosures discussed
in Section II.A.4, II.A.6, II.B.1, II.B.2, and II. B.3.
\128\ See, e.g., letters from CAQ, DT, EY, Grant, and PwC.
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Significance Thresholds. We propose to align the Rule 3-14
significance threshold for individual acquisitions to the 20% threshold
\129\ for acquired businesses in Rule 3-05. We also propose to align
the Rule 3-14 significance threshold for the aggregate impact of
acquisitions for which financial statements are not required or not yet
required and for individual probable acquisitions to the exceeds 50%
level for registration statements and proxy statements.\130\ When the
Commission last increased the significance thresholds for Rule 3-05 in
1996, it noted that commenters supported modification of Rule 3-14 as
well, but it deferred any changes until the rule could be evaluated as
part of a more comprehensive disclosure scheme.\131\ We believe that
these significance thresholds should be the same for all acquired and
to be acquired businesses, regardless of whether the business is a real
estate operation.
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\129\ Rule 3-14 refers to acquisitions that are ``significant;''
however, neither ``significant property'' nor ``significant real
estate operation'' are defined in Regulation S-X. Current practice
looks to the 10% significance threshold in the definition of
``significant subsidiary'' in Rule 1-02(w) when determining
``significance'' under Rule 3-14. See FRM, supra note 40, at Section
2310.1 ``Registration Statements and Proxy Statements--
Requirements.'' The proposed amendments would make the 20% threshold
explicit in Rule 3-14.
\130\ Rule 3-14 Financial Statements are currently required when
the registrant has acquired or proposes to acquire a group of
properties which in the aggregate are significant. In practice,
consummated and probable acquisitions since the date of the most
recent audited balance sheet that are less than 10% significant are
aggregated and, if the significance of the aggregated group exceeds
10%, Rule 3-14 Financial Statements are provided for each
acquisition that is 5% or more significant and for enough other
acquisitions in order to cover the substantial majority of the
group. See FRM, supra note 40, at Section 2320. By aligning proposed
Rule 3-14 with proposed Rule 3-05, the proposals would remove
ambiguity by defining which businesses must be aggregated and the
significance threshold that applies and by clarifying that this
requirement applies only to certain registration statements and
proxy statements and not to Form 8-K.
\131\ See 1996 Streamlining Release, supra note 13.
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Years of Required Financial Statements for Acquisitions from
Related Parties. We propose to eliminate the Rule 3-14 requirement to
provide three years of financial statements for acquisitions from
related parties to conform it to Rule 3-05.\132\ The Rule 3-05 Adopting
Release states that because certain acquisitions have a greater impact
on a registrant than others, the number of years of financial
statements required for Rule 3-05 Financial Statements is based on
significance using a sliding scale approach.\133\ Furthermore, the
release does not identify the source of acquisitions (i.e., from
related parties versus third parties) as a factor driving the potential
impact of acquisitions on the registrant. Thus, because we are not
aware of any unique industry considerations that warrant different
requirements in Rule 3-14 for acquisitions from related parties, we
believe that acquisitions of real estate operations should be treated
similarly to other businesses \134\ and conformed to Rule 3-05, which
does not differentiate the number of periods for which historical
financial statements are required based on whether the seller is a
related party or not.\135\
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\132\ When the Commission adopted Rule 3-14 in 1980, it was
based on Item 6(b) of Form S-11. Item 6(b) required audited summary
financial data of a property or group of properties in an
abbreviated form similar to what is required today in Rule 3-14
Financial Statements. In 1982, when the Commission reduced the
number of years of required Rule 3-14 Financial Statements from
three years to one year for most acquisitions, the Commission
retained the requirement for three years for acquisitions from
related parties.
\133\ See Rule 3-05 Adopting Release, supra note 11.
\134\ It is common for transactions in initial registration
statements in the real estate industry to involve the combination of
multiple entities with related or common ownership. In those
circumstances, certain acquired entities may be designated as a
predecessor of the registrant. For purposes of financial statements,
an acquired business is designated as a predecessor when a
registrant succeeds to substantially all of the business (or a
separately identifiable line of business) of another entity (or
group of entities) and the registrant's own operations before the
succession appear insignificant relative to the operations assumed
or acquired. See the definition of ``predecessor'' in Securities Act
Rule 405. Financial statements specified in Rules 3-01 and 3-02 are
required for acquisitions of a predecessor, including those from
related parties, rather than Rule 3-05 or Rule 3-14 Financial
Statements. This proposal will not affect those requirements.
\135\ While the need for Rule 3-14 Financial Statements is based
on significance, Rule 3-14 does not use a sliding scale type
requirement; rather, due to the nature of the acquisitions, only one
year of financial statements is required, if significant, along with
supplemental information disclosing the material factors considered
by the registrant in assessing the real estate operation. See supra
note 124.
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Application of Rule 3-06. We propose to align the application of
Rule 3-14 with Rule 3-05 by revising Rule 3-06 to permit the filing of
financial statements covering a period of nine to 12 months to satisfy
the requirement for filing financial statements for a period of one
year for an acquired or to be acquired real estate operation.\136\ The
Commission adopted Rule 3-06 in 1989 to codify staff practice at the
time regarding Rule 3-05 Financial Statements.\137\ Although Rule 3-06
only addresses financial statements of business acquisitions under Rule
3-05, we believe that there are no industry-specific reasons for
applying Rule 3-14 differently and therefore that Rule 3-06 should
equally apply to Rule 3-14 Financial Statements due to the similar
purposes of Rule 3-05 and Rule 3-14.
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\136\ See Rule 3-06.
\137\ See Reporting Requirements for Issuer's Change of Fiscal
Year; Financial Reporting Changes; Period to be Covered by First
Quarterly Report After Effective Date of Initial Registration
Statement, Release No. 33-6823 (Mar. 2, 1989) [54 FR 10306 (Mar. 13,
1989)].
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Timing of filings. We propose to amend Rule 3-14 to include the
same period for the filing of Rule 3-14 Financial Statements in
registration statements and proxy statements as exists under Rule 3-
05.\138\ When the Commission adopted the current filing period for Rule
3-05 in 1996,\139\ it noted that commenters supported modification of
Rule 3-14 as well, but deferred any changes to the rule. As with the
other conforming amendments to Rule 3-14, we see no reason to provide a
different regulatory treatment for acquisitions of real estate
operations in this regard.
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\138\ See discussion of the Rule 3-05 filing period in Section
I.A. above.
\139\ See supra note 13.
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Omission of Rule 3-14 Financial Statements for Real Estate
Operations
[[Page 24617]]
That Have Been Included in the Registrant's Financial Statements. We
propose to align the application of Rule 3-14 with the proposed
amendments to Rule 3-05 by no longer requiring Rule 3-14 Financial
Statements in registration statements and proxy statements once the
acquired real estate operation is reflected in filed post-acquisition
registrant financial statements for a complete fiscal year.\140\ As
with the other conforming amendments to Rule 3-14, we see no reason to
provide a different regulatory treatment for acquisitions of real
estate operations in this regard.
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\140\ See proposed Rule 3-14(b)(3)(iii).
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Additional Amendments. We are also proposing other, less
significant changes to align Rule 3-14 with Rule 3-05 where there are
no unique industry considerations that suggest a business subject to
Rule 3-14 should be treated differently than a business subject to Rule
3-05. We do not expect these proposed changes to affect how Rule 3-14
is applied in the following areas because existing practice already
analogizes to Rule 3-05 for guidance. Specifically, we propose to
clarify that:
To be acquired real estate operations should be evaluated
under the rule only if they are probable of acquisition; \141\
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\141\ Rule 3-14 currently uses the phrase ``proposes to
acquire'' when discussing ``to be acquired'' real estate operations
and does not explicitly limit the scope to acquisitions probable of
acquisition. The Commission's proposed amendment would codify the
current practice of interpreting this phrase to mean ``probable of
acquisition.'' See FRM, supra note 40, at Section 2310.1
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The acquisition of an interest in a real estate operation
accounted for using the equity method \142\ or, in lieu of the equity
method, the fair value option, should be considered the acquisition of
a real estate operation;
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\142\ See FRM, supra note 40, at Section 2305.4.
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Rule 3-14 should not apply to a real estate operation
which is totally held by the registrant prior to consummation of the
transaction; \143\ and
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\143\ See proposed Rule 3-05(a)(4).
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Where a real estate operation to be acquired is the
subject of a proxy statement or registration statement on Forms S-4 or
F-4, the financial statement periods to be presented are those
specified by Rules 3-01 and 3-02 of Regulation S-X.\144\
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\144\ See proposed Rule 3-05(b)(1).
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Additionally, in regard to significance testing, we propose to
clarify that:
Related real estate operations should be treated as a
single acquisition for significance testing; \145\ and
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\145\ See proposed Rule 3-05(a)(3) and proposed Rule 3-14(a)(3).
Real estate operations are considered related if they are under
common control or management, the acquisition of one real estate
operation is conditional on the acquisition of each other real
estate operation, or each acquisition is conditioned on a single
common event.
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pro forma amounts are permitted for significance testing
in certain circumstances consistent with the application in Rule 3-
05.\146\
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\146\ See proposed Rules 3-05(b)(3) and 11-01(b)(3).
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We also propose to clarify that Rule 3-14 Financial Statements
should be prepared and audited in accordance with Regulation S-X and
that they should be for the period that the real estate operation has
been in existence, if that period is shorter than the period explicitly
required for the financial statements.\147\ In addition, the proposed
amendments would conform the requirements related to acquisitions of
foreign real estate operations in Rule 3-14 to the analogous provision
in Rule 3-05.\148\
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\147\ See proposed Rules 3-05(a)(1), 3-05(b)(2), 3-14(a)(1), and
3-14(b)(2). See also, discussion at note 76 above.
\148\ See proposed Rules 3-05(c) and 3-14(d).
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Aside from the substance of the rules, the proposed amendments
would also conform the organization and format of certain related rules
and forms, as appropriate. For example, Item 8 of Form 10-K currently
excepts registrants from complying with Rule 3-05 and Article 11, but
does not mention Rule 3-14.\149\ Instead, the exception exists in Rule
3-14 itself.\150\ We propose to move this exception to Form 10-K for
consistency. We also propose to conform the general format and wording
of Rule 3-14 to Rule 3-05, as appropriate, for consistency and to make
the rule easier to follow.\151\
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\149\ See Item 8(a) of Form 10-K.
\150\ Rule 3-14(b).
\151\ The proposed changes in Rule 3-14 to conform wording
include the addition of a paragraph similar to 3-05(b)(1) about
financial statements for certain proxy statements and registration
statements on Forms S-4 and F-4 as well as the elimination of
outdated industry-specific paragraphs (a)(2) and (a)(3), which
specify certain disclosures for circumstances that seldom occur
today.
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We are also proposing to revise Form 8-K, as follows:
Clarify that Item 2.01 requires the disclosure of the
acquisition or disposition of assets that constitute a significant real
estate operation as defined in Rule 3-14; \152\
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\152\ While Item 2.01 currently only requires that significant
acquisitions and dispositions be reported if they are not in the
ordinary course of business, registrants provide Item 2.01
disclosure for acquisitions of significant real estate operations
regardless of whether the acquisition or disposition was in the
ordinary course of business. See Note to FRM, supra note 40, at
Section 2310.3. We propose to revise Item 2.01 to achieve this same
reporting outcome, because we believe this information is generally
material to investors.
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address the filing requirements in Item 9.01(a)
consistently for all business acquisitions, including real estate
operations; and
revise Item 2.01 Instruction 4 to reference Rule 3-14 to
make clear that, as with Rule 3-05, the aggregate impact of
acquisitions of real estate operations is not required to be reported
unless these acquisitions are related real estate operations and
significant in the aggregate.
Request for Comment
40. We are proposing to align Rule 3-14 with Rule 3-05 where no
unique industry considerations warrant differentiated requirements. Are
the proposed significance thresholds appropriate for acquisitions of
real estate operations? Are the other changes we have proposed to Rule
3-14 appropriate? Are there unique industry considerations that suggest
we should not make certain of the proposed amendments? If so, what are
those considerations and which amendments should we not make? In these
instances, are there different amendments we should consider?
41. Would the proposed amendments to align Rule 3-14 with Rule 3-05
assist preparers in the application of Rule 3-14? Would such amendments
provide investors with more consistent disclosure for acquisitions of
all types of businesses?
42. Are there other areas that we should consider for further
alignment?
2. Definition of Real Estate Operation
Neither Regulation S-X nor any other Securities Act or Exchange Act
rule provides a definition of a real estate operation or an explanation
of what is meant by the reference to properties in Rule 3-14. Because
the terms are open to interpretation, Commission staff has provided
guidance as to the meaning of a real estate operation and regarding
properties subject to the rule.\153\ The Commission staff has
interpreted, for purposes of Rule 3-14, a real estate operation to
refer to properties that generate revenues solely through leasing,\154\
but has not interpreted this definition to preclude a property that
includes a limited amount of non-leasing revenues (like property
management or other services related to the leasing) from being
considered a real estate operation. Examples of such properties include
office, apartment, and industrial buildings, as well as
[[Page 24618]]
shopping centers and malls. A real estate operation excludes properties
that generate revenues from operations other than leasing, such as
nursing homes, hotels, motels, golf courses, auto dealerships, and
equipment rental operations because these operations are more
susceptible to variations in revenues and costs over shorter periods
due to market and managerial factors. The Commission staff has
additionally provided guidance that a real estate operation includes
real properties that will be held directly by the registrant or through
an equity interest in a pre-existing legal entity that holds the real
property under lease and related debt.\155\
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\153\ See FRM, supra note 40, at Section 2305.1 ``Applicability
of S-X 3-14,'' and Section 2305.2, ``Nature of Real Estate
Operations.''
\154\ See FRM, supra note 40, at Section 2305.2 ``Nature of Real
Estate Operations.''
\155\ See FRM, supra note 40, at Section 2305.3 ``Investment in
a Pre-Existing Legal Entity.''
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We are proposing to amend Rule 3-14 to define a real estate
operation as ``a business that generates substantially all of its
revenues through the leasing of real property,'' which is consistent
with current practice described above.\156\ We believe that adding this
definition to Rule 3-14 would appropriately limit the application of
Rule 3-14, reduce uncertainty regarding the meaning of the term, and
serve to clarify the rule without changing the substance of how it is
currently applied. In addition, this change would make clear that a
real estate operation is a ``business'' as that term is used in Article
11. We therefore further propose to remove the unnecessary condition in
Rule 11-01(a)(5) that clarifies that Article 11 applies to real estate
operations.
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\156\ See proposed Rule 3-14(a)(2). The proposed amendment uses
the term ``business (as set forth in Sec. 210.11-01(d))'' in the
definition of a real estate operation to address the fact that the
acquisition of a real estate operation may be of an entity holding
real property under lease or a direct interest in the real property.
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Request for Comment
43. We propose to define a real estate operation in Rule 3-14 as
``a business that generates substantially all of its revenues through
the leasing of real property.'' Is the proposed definition and scope of
the rule appropriate? Are there revisions we should consider to the
definition to further clarify its meaning or alter the types of
businesses to which it applies?
3. Significance Tests
Due to the nature of a real estate operation, staff interpretations
have sought to focus registrants on the Investment Test in Rule 1-
02(w), adapted to compare the registrant's investment in the real
estate operation, including any debt secured by the real properties
that is assumed by the registrant, to the registrant's total assets at
the last audited fiscal year end filed with the Commission when
determining ``significance'' under Rule 3-14.\157\ When determining
whether an acquisition is ``significant,'' the use of the Asset or
Income Tests generally is not practical for a real estate operation,
because the historical amounts of assets and income of the acquired or
to be acquired real estate operation are not available.\158\
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\157\ See FRM, supra note 40, at Section 2315 ``Real Estate
Operations--Measuring Significance.''
\158\ The amounts are not available, because most real estate
managers do not maintain their books on a U.S. GAAP basis or obtain
audits. Furthermore, because Rule 3-14 only requires abbreviated
income statements to be filed, additional financial statements would
have to be prepared solely for purposes of significance testing if
the Asset and Income Tests applied to acquisitions of real estate
operations. See supra note 124 and accompanying discussion.
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We propose to amend Rule 3-14 to specify the use of a modified
investment test, which is consistent with current practice described
above.\159\ As with the definition of a real estate operation, we
believe this proposed amendment would reduce uncertainty regarding the
significance tests and clarify the rule without changing the substance
of how it is currently applied. We also believe that a modified
investment test is necessary to appropriately determine significance
for acquisitions of real estate operations because it considers the
unique structure of these types of acquisitions, which typically
involve assumed debt that is secured by the real properties that
offsets the value of the real estate operation being acquired.
---------------------------------------------------------------------------
\159\ See proposed Rule 3-14(b)(2).
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Request for Comment
44. We propose to amend Rule 3-14 to quantify the applicable
significance thresholds and specify the use of a modified investment
test in applying those thresholds for real estate operations. Are the
proposed revisions to clarify the applicable significance tests and
thresholds appropriate for acquisitions of real estate operations? Are
there any unique industry considerations that suggest we should use
different tests of significance than we have proposed?
4. Interim Financial Statements
Unlike Rule 3-05,\160\ Rule 3-14 does not include an express
requirement for registrants to provide interim financial statements.
Article 11, however, requires pro forma financial information to be
filed when the registrant has acquired one or more real estate
operations which in the aggregate are significant.\161\ Article 11
further provides that the pro forma condensed statement of
comprehensive income shall be filed for the most recent fiscal year and
the period from the most recent fiscal year to the most recent interim
date for which a balance sheet is required.\162\
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\160\ See Rule 3-05(b)(2)(i)-(iv). The rule refers explicitly to
the most recent fiscal year and any interim periods specified in
Section 210.3-01 and 210.3-02.
\161\ 17 CFR 210.11-01.
\162\ 17 CFR 210.11-02(c)(2)(i). To meet this pro forma
requirement, registrants must prepare and present substantially the
same information for the most recent interim period, if applicable,
that would be included in Rule 3-14 Financial Statements in most
circumstances.
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We propose to amend Rule 3-14 to specifically require Rule 3-14
Financial Statements for the most recent year-to-date interim period
prior to the acquisition.\163\ We believe requiring these financial
statements, in addition to the annual financial statements, would
enhance an investor's ability to understand the historical operating
results of the acquisition without creating significant additional
burden. It would also reflect existing registrant practice regarding
the provision of interim financial statements to investors, which stems
from Article 11 and related staff interpretation.\164\
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\163\ See proposed Rule 3-14(b)(2)(i).
\164\ See Rule 11-02(c)(2)(i) and FRM, supra note 40, at Section
2330.2 ``Periods to be Presented--Properties Acquired from Related
Parties'' and Section 2330.3 ``Periods to be Presented--Properties
Acquired from Third Parties.''
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Request for Comment
45. We propose to amend Rule 3-14 to specifically require
historical financial statements for the most recent interim period
prior to the acquisition. Are the proposed revisions appropriate for
acquisitions of real estate operations? Are there any unique industry
considerations that suggest we should consider alternatives to the
inclusion of financial statements for the most recent interim period
prior to the acquisition for real estate operations?
5. Smaller Reporting Companies and Issuers Relying on Regulation A
We propose amendments to Article 8 to further simplify and conform
the application of Rule 3-14 and our related proposals to smaller
reporting companies. Rule 8-06 provides smaller reporting company
disclosure requirements for the financial statements of real estate
operations acquired or to be acquired that are substantially similar to
the requirements in Rule 3-14. Part F/S of Form 1-A directs an entity
relying on Regulation A to present financial statements of real estate
operations acquired or to be
[[Page 24619]]
acquired as specified by Rule 8-06.\165\ In order to simplify the
application of our rules, we propose to revise Rule 8-06 to direct
registrants to proposed Rule 3-14 for the requirements relating to
financial statement disclosures of real estate operations acquired or
to be acquired, while still permitting smaller reporting companies to
rely on the form and content for annual and interim financial
statements provided in Rules 8-02 and 8-03.\166\ Additionally, because
Part F/S of Form 1-A refers to Rule 8-06, the proposed revisions to
Rule 8-06 would apply to issuers relying on Regulation A.
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\165\ See paragraph (b)(7)(v) of Part F/S. Part F/S of Form 1-A
permits the periods presented to be those applicable to Regulation A
issuers rather than the periods specified by Article 8.
\166\ Under proposed Rule 8-06, there would be one change to the
smaller reporting requirements for acquired real estate operations,
namely that when financial statements are presented in Form S-11,
the discussion of material factors that the registrant considered in
assessing the acquisition shall be combined with the disclosure
required by Item 15 of Form S-11. See the proposed Instruction to
Paragraph (f) in proposed Rule 3-14. Since Item 15 of Form S-11
already applies to smaller reporting companies, the proposed
Instruction would potentially change only the location of the
discussion. We do not believe that it would require any new
disclosure or add a burden to registrants. We additionally propose
to add a reference to Rule 8-06 in Rule 3-06 to conform the
requirements of proposed Rule 8-06 and proposed Rule 3-14 and to add
a Note to Article 8 to expressly permit smaller reporting companies
to file financial statements covering a period of nine to 12 months
to satisfy the requirement for filing financial statements for a
period of one year for an acquired real estate operation. See
proposed Note 6 to Article 8 and the discussion related to Rule 3-06
in Section II.C.1 above.
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We believe that simplifying these rules and using the more well-
established practice and guidance applicable to Rule 3-14 would reduce
burdens for smaller reporting companies and issuers relying on
Regulation A.
Request for Comment
46. Would the proposed revisions to Rule 8-06 to direct smaller
reporting companies to Rule 3-14 while still permitting them to rely on
the relief in Rules 8-02 and 8-03 simplify the application of our rules
and reduce costs for registrants? Would the proposed revisions improve
the disclosure available to investors by focusing registrants on the
more detailed and better understood provisions of Rule 3-14? Are there
other changes to the Rule 8-06 requirements that we should consider?
47. Should the proposed changes to Rule 8-06 apply to offerings
made pursuant to Regulation A? Should we revise the proposals to better
accommodate Regulation A issuers and investors? If so, what revisions
should we make and why?
6. Blind Pool Real Estate Offerings
Certain registrants \167\ conducting continuous offerings over an
extended period of time follow the guidance provided under Industry
Guide 5 Preparation of Registration Statements Relating to Interests in
Real Estate Limited Partnerships (``Industry Guide 5'').\168\ These
registrants generally do not initially own any real estate assets, and
the specific intended use of the proceeds raised from investors is not
initially identified because such registrants have not yet selected any
assets for their portfolios. Registrants in these ``blind pool''
offerings also typically provide only limited liquidity through
restricted share redemption programs. However, these registrants
provide certain undertakings \169\ to disclose information about
significant acquisitions to investors in addition to Rule 3-14
Financial Statements. Due to the nature of a blind pool investment as
well as the supplemental undertakings provided, Commission staff has
advised these registrants to apply adapted significance tests when
making the determination of whether they are required to provide Rule
3-14 Financial Statements. Specifically, the staff has interpreted
significance during the distribution period to be computed by comparing
the registrant's investment in the real estate operation to the sum of:
(1) The registrant's total assets as of the date of the acquisition,
and (2) the proceeds (net of commissions) in good faith expected to be
raised in the registered offering over the next 12 months.\170\ After
the distribution period has ended, the staff has understood the
registrant to be able to determine significance using the total assets
as of the acquisition date until the registrant files its next Form 10-
K. After that next Form 10-K is filed, the registrant, following the
staff's guidance, can determine significance using total assets as of
the end of the most recently completed fiscal year included in the Form
10-K.\171\
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\167\ These registrants are typically real estate investment
trusts (``REITs'') that do not have securities listed for trading on
a national securities exchange and often are referred to as ``non-
traded REITs.'' Their purpose is to own and operate income-producing
real estate or real estate-related assets.
\168\ Industry Guide 5 was originally published as Securities
Act Guide 60 in 1976 to provide disclosure guidance for preparing
registration statements relating to offers and sales of interests in
real estate limited partnerships. The Commission stated that the
guide ``is not a Commission rule nor is it published as bearing the
Commission's official approval.'' See Guide for Preparation of
Registration Statements Relating to Interests In Real Estate Limited
Partnerships, Release No. 33-5692 (Mar. 17, 1976) [41 FR 17403 (Apr.
26, 1976)] (``Guide 60 Release''). In 1982, Securities Act Guide 60
was redesignated as Securities Act Industry Guide 5. See Rescission
of Guides and Redesignation of Industry Guides, Release No. 33-6384
(Mar. 16, 1982) [47 FR 11476 (Mar. 16, 1982)], Publication of
Revisions to the Division of Corporation Finance's Guide 5 and
Amendment of Related Disclosure Provisions, Release No. 33-6405
(June 3, 1982) [47 FR 25120 (June 10, 1982)]. While Industry Guide
5, by its terms, applies only to real estate limited partnerships,
in 1991 the Commission stated that ``the requirements contained in
the Guide should be considered, as appropriate, in the preparation
of registration statements for real estate investment trusts and for
all other limited partnership offerings.'' See Limited Partnership
Reorganizations and Public Offerings of Limited Partnership
Interests, Release No. 33-6900 (June 25, 1991) [56 FR 28979 (June
25, 1991)].
\169\ See Item 20.D. of Industry Guide 5, Disclosure Guidance:
Topic No. 6--Staff Observations Regarding Disclosures of Non-Traded
Real Estate Investment Trusts and FRM, supra note 40, at Section
2325.2. ```Blind Pool' Offerings--During the Distribution Period--
Undertakings.'' The undertakings include use of sticker supplements
related to certain significant properties that will be acquired and
post-effective amendments.
\170\ See FRM, supra note 40, at Section 2325.3 ```Blind Pool'
Offerings--During the Distribution Period--Significance.''
Calculation of the investment includes any debt secured by the real
properties that is assumed by the purchaser. In addition, in
estimating the offering proceeds, the registrant, following the
staff's guidance, could consider the pace of fundraising as of the
measurement date, the sponsor or dealer-manager's prior public
fundraising experience, and offerings by similar companies.
\171\ See FRM, supra note 40, at Section 2325.5 ```Blind Pool'
Offerings--After the Distribution Period.''
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We propose to codify staff interpretation in this area by revising
Rule 3-14 to add Rule 3-14(b)(2)(iii) to provide that significance for
blind pool offerings shall be computed as described above. Similar to
proposed Rule 3-05, we are also proposing to permit 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 Form 10-K.\172\
Otherwise, virtually all acquisitions in the early part of the
distribution period would be deemed significant regardless of their
size. Additionally, because blind pool investors are generally not able
to freely sell their investments, basing the significance analysis only
on total assets while the distribution is continuing is less useful to
investors because the registrant is still growing its portfolio at this
stage.
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\172\ See proposed Rules 11-01(b)(3)(i) and 11-01(b)(3)(ii).
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Request for Comment
48. Are the amendments we propose for blind pool offerings
appropriate? Are there changes to the requirements that we should
consider?
49. Is the scope of proposed Rule 3-14(b)(2)(iii) sufficiently
clear?
[[Page 24620]]
50. In certain circumstances, registrants in blind pool offerings
acquire businesses that are within the scope of Rule 3-05 (for example,
hotels) rather than Rule 3-14, but the registrants provide the Industry
Guide 5 undertakings because they are conducting a blind pool offering.
Currently, there is no special practice for measuring significance of
Rule 3-05 acquisitions in these circumstances. Should we also consider
applying the adapted significance tests described above for
acquisitions of real estate operations in blind pool offerings to Rule
3-05 acquisitions in these circumstances? For example, as described in
further detail above, should we permit adding the proceeds (net of
commissions) in good faith expected to be raised in the registered
offering over the next 12 months to the total assets of the registrant
in computing the Investment and Asset Tests and permit registrants to
exclude the Income Test from their significance determinations for part
of the distribution period? Are there other modifications we should
consider?
7. Triple Net Leases
In some circumstances, registrants acquire a real estate operation
subject to a triple net lease with a single lessee. A triple net lease
typically requires the lessee to pay costs normally associated with
ownership of the property, such as property taxes, insurance,
utilities, and maintenance costs. Based on these attributes, the
arrangement is similar to a financing for the lessee. The Rule 3-14
Financial Statements for a real estate operation subject to a triple
net lease will ordinarily consist only of lease revenues. Under
existing practice, registrants often provide full audited financial
statements of the lessee or guarantor of the lease, instead of the Rule
3-14 Financial Statements of the real estate operation, when the lessee
is considered significant. Our proposal does not differentiate this
type of acquisition or specify alternative requirements, because the
activity depicted in the Rule 3-14 Financial Statements is consistent
with how the triple net lease arrangement may affect the registrant's
results of operations.\173\ We believe financial statements of the
acquired real estate operation more appropriately achieve Rule 3-14's
objective to provide investors with information about how the acquired
business may affect the registrant.
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\173\ The proposal diverges from staff interpretation with
respect to time-of-acquisition reporting, which has indicated that
when a real estate operation subject to a triple net lease
represents a significant portion of the registrant's total assets,
an investor may need to consider the lessee's financial statements
in order to evaluate the risk to the registrant from the asset
concentration. See FRM, supra note 40, at Section 2340.
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Request for Comment
51. Should we consider different financial statement requirements
in Rule 3-14 for circumstances where a registrant acquires a real
estate operation subject to a triple net lease with a single lessee
where the lessee is significant to the registrant (for example, full
audited financial statements of the lessee or guarantor of the lease)?
If not, are there additional disclosures (for example, summarized
unaudited financial information) we should require about the lessee or
guarantor of the lease in addition to the Rule 3-14 Financial
Statements?
D. Pro Forma Financial Information
The pro forma financial information described in Article 11 of
Regulation S-X must accompany Rule 3-05 Financial Statements and Rule
3-14 Financial Statements. Typically, pro forma financial information
includes the most recent balance sheet and most recent annual and
interim period income statements. Pro forma financial information for a
business acquisition combines the historical financial statements of
the registrant and the acquired business and is adjusted for certain
items if specified criteria are met. As discussed above, pro forma
financial information for an acquired business is required at the 20%
and 10% significance thresholds under Rule 3-05 and Rule 3-14,
respectively.\174\ The rules also require pro forma financial
information for a significant disposed business at a 10% significance
threshold for all registrants.
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\174\ See 1996 Streamlining Release, supra note 13.
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1. Adjustment Criteria and Presentation Requirements
Rule 11-02 contains rules and instructions for the presentation of
pro forma financial information. The rules provide some flexibility to
tailor pro forma disclosures to particular events and circumstances.
The presentation requirements for the pro forma condensed statement of
comprehensive income were designed to elicit disclosures that
distinguish between the one-time impact and the on-going impact of a
transaction.\175\ The rules call for the pro forma financial
information to show the impact of the transaction on income from
continuing operations of the registrant.\176\
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\175\ See Instructions for the Presentation and Preparation of
Pro Forma Financial Information and Requirements for Financial
Statements of Businesses Acquired or To Be Acquired, Release No. 33-
6413 (June 24, 1982) [47 FR 29832 (July 9, 1982)] indicating that
``[t]he presentation requirements for the pro forma condensed
statement of income are designed to elicit disclosures that clearly
distinguish between the one-time impact and the on-going impact of
the transaction and thereby assist investors in focusing on the
transaction at hand.''
\176\ Discontinued operations would not be reflected in the
condensed historical financial statements used as the starting point
for the pro forma presentation.
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Article 11 provides that the only adjustments that are appropriate
in the presentation of the pro forma condensed statement of
comprehensive income are those that are:
Directly attributable to the transaction,
expected to have a continuing impact on the registrant,
and
factually supportable.\177\
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\177\ See 17 CFR 210.11-02(b)(6). Material non-recurring charges
or credits which result directly from the transaction and which will
impact the income statement during the next 12 months are not
reflected in the pro forma condensed statement of comprehensive
income.
The pro forma condensed balance sheet, on the other hand, reflects pro
forma adjustments that are directly attributable to the transaction and
factually supportable, regardless of whether the impact is expected to
be continuing or nonrecurring because the objective of the pro forma
balance sheet is to reflect the impact of the transaction on the
financial position of the registrant as of the balance sheet date.
We propose to revise Article 11 by replacing the existing pro forma
adjustment criteria with simplified requirements to depict the
accounting for the transaction and present the reasonably estimable
synergies and other transaction effects that have occurred or are
reasonably expected to occur.\178\ We are proposing to replace
[[Page 24621]]
the existing pro forma adjustment criteria because they are not clearly
defined nor easily applied and, in practice, can yield inconsistent
presentations for similar fact patterns. The existing adjustments also
preclude the inclusion of adjustments for the potential effects of
post-acquisition actions expected to be taken by management, which can
be important to investors. Commenters generally recommended allowing
more flexibility with respect to the types of pro forma adjustments
allowed.\179\
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\178\ We propose several other changes to simplify and clarify
Article 11 and to provide more consistent use of terminology. For
example, we propose to make changes throughout Article 11 to refer
to ``pro forma financial information,'' ``potential common stock''
as defined in U.S. GAAP, and ``pro forma basic'' per share data. In
a further effort to simplify and clarify, we propose deleting Rule
11-02(a), which describes the objectives of the preparation
requirements, to avoid confusion and focus registrants on the
requirements of the rule. We propose amending Rule 11-01(a)(8) to
remove the reference to other ``events'' as we believe the concept
of other events is encompassed by the reference to ``other
transactions.'' We also propose amending Rule 11-02(b)(2), which
relates to the introductory paragraph, to refer to ``each
transaction for which pro forma effect is being given'' rather than
``the transaction'' in recognition that the information may be
required to give effect to more than one transaction. See proposed
Rule 11-02(a)(2). Additionally, we propose revising Rule 11-02(b)(5)
to require the pro forma condensed statement of comprehensive income
to also disclose income (loss) from continuing operations
attributable to the controlling interests, in addition to income
(loss) from continuing operations, because that is the amount
currently used to calculate earnings per share under U.S. GAAP. See
proposed Rule 11-02(a)(5).
\179\ See, e.g., letters from ABA-Committees, CalPERS, CAQ,
Comcast Corporation (Dec. 11, 2015), DT, EEI/AGA, EY, and Grant. One
commenter noted, among other points, that the pro forma financial
statements would be much more relevant if they allowed for more
forward-looking information and articulation of management's
expectations to be incorporated. See letter from CFA.
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The proposed adjustments would be broken out into two categories:
(i) ``Transaction Accounting Adjustments''; and
(ii) ``Management's Adjustments.'' \180\
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\180\ Under these proposed revisions to Article 11, some of the
current guidance and instructions would no longer apply. We propose
to eliminate the instructions and incorporate the substance of the
relevant instructions into other provisions, particularly proposed
Rule 11-02(b) Implementation Guidance. We propose to eliminate the
substance of the first sentence of Instruction 2 as well as
Instruction 4 and Instruction 5 of Rule 11-02(b) as this guidance
would be superseded by the requirements for Transaction Accounting
Adjustments and Management's Adjustments. Similarly, Instruction 3
regarding business dispositions would no longer be necessary given
the guidance in proposed Rules 11-02(a)(4), 11-02(a)(6), and 11-
02(b)(3). We propose to incorporate, subject to revisions to update
terminology and clarify language, the substance of Instruction 1,
using income from continuing operations, into proposed Rule11-
02(b)(1) and Instruction 2 guidance on financial institutions into
proposed Rule 11-02(b)(2). We propose to add new Rule 11-02(b)(4) in
place of Instruction 6 to clarify that each transaction for which
pro forma effect is required to be given shall be presented in
separate columns. We also propose to add new Rule 11-02(b)(5) to
replace Instruction 7 to Rule 11-02(b) which would incorporate pro
forma tax effect guidance from Staff Accounting Bulletin No. 1.B.,
Allocation Of Expenses And Related Disclosure In Financial
Statements Of Subsidiaries, Divisions Or Lesser Business Components
Of Another Entity, 1. Costs reflected in historical financial
statements.
Transaction Accounting Adjustments would depict: (1) In the pro
forma condensed balance sheet the accounting for the transaction
required by U.S. GAAP or IFRS-IASB,\181\ and (2) in the pro forma
condensed income statements, the effects of those pro forma balance
sheet adjustments assuming the adjustments were made as of the
beginning of the fiscal year presented.\182\ The Transaction Accounting
Adjustments are intended to reflect only the application of required
accounting to the acquisition, disposition, or other transaction. We
believe the Transaction Accounting Adjustments would link the effects
of the acquired business to the registrant's audited historical
financial statements while the Management's Adjustments would provide
flexibility to include forward-looking information that depicts the
synergies and other transaction effects identified by management in
determining to consummate or integrate the transaction for which pro
forma effect is being given.
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\181\ If the condition in Rule 11-01(a) that is met does not
have a balance sheet effect, then our proposal would require that
Transaction Accounting Adjustments depict the accounting for the
transaction required by U.S. GAAP or, if applicable, IFRS-IASB.
Transaction Accounting Adjustments would be limited to adjustments
to account for the transaction using the measurement date and method
prescribed by the applicable accounting standard. For probable
transactions, the measurement date would be as of the most recent
practicable date prior to the effective date (for registration
statements) or the mailing date (for proxy statements).
\182\ See proposed Rule 11-02(a)(6)(i)(B).
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Management's Adjustments would be required for and limited to
synergies and other effects of the transaction, such as closing
facilities, discontinuing product lines, terminating employees, and
executing new or modifying existing agreements, that are both
reasonably estimable and have occurred or are reasonably expected to
occur.\183\ We believe it is appropriate to require disclosure of
synergies and other transaction effects in these circumstances in order
to provide investors insight into the potential effects of the
acquisition and the post-acquisition plans expected to be taken by
management. Limiting Management's Adjustments to those that are
reasonably estimable and that have occurred or are reasonably expected
to occur will serve to define the population of effects subject to
inclusion in pro forma financial information. While not all information
is appropriate for reflecting an adjustment in the pro forma financial
information, some information where the synergies and other transaction
effects are not reasonably estimable would still be important to
investors. We believe that any information necessary to give a fair and
balanced presentation of the pro forma financial information should be
provided to investors. Thus, we propose to require registrants to
additionally provide qualitative disclosure of such information in the
explanatory notes to the pro forma financial information to further
elicit appropriately balanced disclosure.
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\183\ See proposed Rule 11-02(a)(6)(ii). However, if the
registrant previously was a part of another entity and presentation
of pro forma financial information is necessary to reflect
operations and financial position of the registrant as an autonomous
entity, the proposed rules would provide that the adjustments
necessary to show the registrant as an autonomous entity be included
in Management's Adjustments. See proposed Rules 11-01(a)(7) and 11-
02(a)(6)(ii)(B). For example, where a company (the registrant)
operates as a subsidiary of another entity and files a registration
statement under the Securities Act of 1933 in connection with an
initial public offering, and presentation of pro forma financial
information is necessary to reflect the operations and financial
position of the registrant as an autonomous entity, the registration
statement would include Article 11 pro forma financial information,
which under our proposal would include such adjustments in
Management's Adjustments.
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We also propose to include presentation requirements for
Management's Adjustments. The presentation requirements would provide
that Management's Adjustments be presented through a separate column in
the pro forma financial information after the presentation of the
combined historical statements and Transaction Accounting
Adjustments.\184\ This presentation would permit investors to
distinguish the accounting effects on the registrant of the underlying
acquired business from operational effects of management's plans that
are subject to management's discretion or other uncertainties.
Similarly, we propose that per share data be presented in two separate
columns. One column would present the pro forma total depicting the
combined historical statements with only the Transaction Accounting
Adjustments, and the second column would present the combined
historical statements with both the Transaction Accounting Adjustments
and Management's Adjustments.
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\184\ Management's Adjustments might contain forward-looking
information. To the extent Management's Adjustments contain forward-
looking information, the safe harbor provisions under 17 CFR 230.175
and 17 CFR 240.3b-6 would be available for the disclosures. We
propose clarifying the availability of the safe harbor within
Article 11. See the Instruction to proposed Rule 11-02(a)(6)(ii).
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To clarify the required disclosure in the explanatory notes
accompanying the pro forma financial information, we propose to add
requirements based on existing rules, practice, and staff
interpretation that would require disclosure of:
Revenues, expenses, gains and losses, and related tax
effects which will not recur in the income of the registrant beyond 12
months after the transaction; \185\
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\185\ See proposed Rule 11-02(a)(10)(i). See also current Rule
11-02(b)(5).
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total consideration transferred or received, including its
components and
[[Page 24622]]
how they were measured. If total consideration includes contingent
consideration, the proposed amendments would require disclosure of the
arrangement(s), the basis for determining the amount of payment(s) or
receipt(s), and an estimate of the range of outcomes (undiscounted) or,
if a range cannot be estimated, that fact and the reasons why; and
information about Transaction Accounting Adjustments when
the initial accounting is incomplete.\186\
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\186\ See proposed Rule 11-02(a)(10)(ii). See also FRM, supra
note 40, at Section 3250 1.f., 3250 1.g., and 3250 1.h.
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For each Management's Adjustment, we propose to require:
A description, including the material uncertainties, of
the synergy or other transaction effects;
disclosure of the underlying material assumptions, the
method of calculation, and the estimated time frame for completion;
qualitative information necessary to give a fair and
balanced presentation of the pro forma financial information; and
to the extent known, the reportable segments, products,
services, and processes involved; the material resources required, if
any; and the anticipated timing.\187\
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\187\ See proposed Rule 11-02(a)(10)(iii).
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We believe these disclosures are necessary for an investor to be
able to understand the Management's Adjustments. For synergies and
other transaction effects that are not reasonably estimable and will
not be included in Management's Adjustments, we additionally propose to
require that qualitative information necessary for a fair and balanced
presentation of the pro forma financial information also be
provided.\188\
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\188\ See proposed Rule 11-02(a)(10)(iv).
We additionally propose to clarify that pro forma financial information
must be appropriately labeled and presented as required by Article
11.\189\ We also propose to require that each transaction for which pro
forma effect is required to be given shall be presented in a separate
column.\190\ Finally, we propose to require that if pro forma financial
information includes another entity's statement of comprehensive
income, such as that of an acquired business, it shall be brought up to
within one fiscal quarter, if practicable.\191\ This change will better
accommodate registrants and acquired businesses that have 52-53 week
fiscal years than the current requirement to bring the financial
information to within 93 days of the registrant's most recent fiscal
year end, if practicable.
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\189\ See proposed Rule 11-02(a)(11) and 11-02(c)(2). We propose
to explicitly require this labeling and presentation in Article 11
to avoid confusing or inconsistent disclosure. The proposed rules
would also generally preclude presentation of pro forma financial
information on the face of the historical financial statements,
except where such presentation is specifically required by U.S. GAAP
or IFRS-IASB, presentation of summaries of pro forma financial
information that exclude material transactions, or presentations
that give pro forma effect to the adoption of accounting standards.
\190\ See proposed Rule 11-02(b)(4).
\191\ See proposed Rule 11-02(c)(3).
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Request for Comment
52. Are the proposed amendments to the pro forma financial
information requirements appropriate? Is our Transaction Accounting
Adjustments proposal sufficiently clear? Will our Transaction
Accounting Adjustment proposal simplify preparation of pro forma
financial information and improve consistency?
53. The proposed Transaction Accounting Adjustments would
incorporate the accounting required by U.S. GAAP or IFRS-IASB. However,
there remain areas where the pro forma disclosure requirements in the
proposed amendments and U.S. GAAP are not the same. Is this likely to
cause confusion among investors? If so, what could be done to remedy
the confusion?
54. Are the criteria for determining when Management's Adjustments
are required sufficiently clear? Are there other criteria we should
consider?
55. Should we instead retain the existing pro forma adjustment
criteria? Why or why not? If we retained the existing criteria, would
they be operational if we deleted the existing ``continuing impact''
criterion? If we retained the existing criteria, would pro forma
presentations be improved by eliminating the continuing impact
adjustment criterion and replacing this criterion with a revised
requirement to disclose revenues, expenses, gains and losses, and
related tax effects which will not recur in the income of the
registrant beyond 12 months after the transaction in the explanatory
notes to the pro forma financial statements? For example, would that
resolve diversity in practice related to adjustments to items like
deferred revenue, costs of goods sold, and interest expense for short-
term bridge financings that may be refinanced?
56. Under the proposed amendments, Management's Adjustments must be
reasonably estimable and have occurred or be reasonably expected to
occur. Do these conditions adequately serve to distinguish which
Management's Adjustments can be made? Are they appropriate? Why or why
not?
57. Are the proposed Management's Adjustments appropriate? What
other conditions, if any, should we consider establishing? For example,
should we limit Management's Adjustments to synergies and other
transaction effects that have previously been furnished or filed in
disclosure with the Commission? If we limited Management's Adjustments
in this way, how would we ensure that the adjustments are balanced to
include both the positive and negative effects?
58. To the extent that Management's Adjustments require forward-
looking information, what safe harbors should apply? As proposed,
Securities Act Rule 175 and Exchange Act Rule 3b-6 would expressly
apply. Are there different protections that would be appropriate?
59. Is the proposed amendment to require that pro forma financial
information be brought up to within one fiscal quarter if the pro forma
financial information includes another entity's statement of
comprehensive income appropriate? Is there another more appropriate
time frame we should consider?
60. Will the proposed disclosures in the explanatory notes provide
material information for investors? Are the proposed requirements for
the format and presentation of pro forma information appropriate? Are
there other amendments we should consider to improve the presentation
requirements of Article 11?
61. Rule 11-01(a)(8) requires presentation of pro forma financial
information when, ``[c]onsummation of other events or transactions has
occurred or is probable for which disclosure of pro forma financial
information would be material to investors.'' We propose to delete the
reference to ``events.'' Is deletion of the reference to ``events''
appropriate? Would its deletion unintentionally narrow the population
of items for which pro forma financial information must be provided? If
so, what items would not be captured, what term appropriately describes
those items for which pro forma effect should be given, and why is it a
better descriptor than ``transactions?'' If ``events'' is retained,
should the term be included in other parts of our proposal? Why or why
not?
62. Should we further clarify that under the proposed amendments
Management's Adjustments are only permitted when they relate to the
transaction for which pro forma effect is being given? If so, what
changes should we consider?
63. Proposed Rule 11-02(b)(3) retains the existing guidance in
current Rule 11-02(b)(3) for condensing information
[[Page 24623]]
on the face of the pro forma financial statements. This guidance
differs from the guidance in Rules 10-01(a)(2) and 10-01(a)(3) for
preparing the registrant's interim financial statements. Should we
conform proposed Rule 11-02(b)(3) to Rules 10-01(a)(2) and 10-01(a)(3)?
Why or why not? If so, should we limit the changes to selected parts of
Rules 10-01(a)(2) and (a)(3), such as the percentage thresholds?
2. Significance and Business Dispositions
Rule 11-01(a)(4) provides that pro forma financial information is
required upon the disposition or probable disposition of a significant
portion of a business either by sale, abandonment, or distribution to
shareholders by means of a spin-off, split-up, or split-off, if that
disposition is not fully reflected in the financial statements of the
registrant. Rule 11-01(b) further provides that a disposition of a
business is significant if the business to be disposed of meets the
conditions of a significant subsidiary under Rule 1-02(w). Rule 1-02(w)
uses a 10% significance threshold, not the 20% threshold used for
business acquisitions under Rules 3-05 and 11-01(b). When a registrant
determines that it has an acquisition or disposition of a significant
amount of assets that do not constitute a business, Item 2.01 of Form
8-K uses a 10% threshold for both acquisitions and dispositions to
require disclosure of certain details of the transaction.\192\ The
terms ``business'' and ``significant'' used in Form 8-K specifically
reference Article 11 of Regulation S-X.
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\192\ For acquisitions and dispositions of assets that do not
constitute a business, Item 2.01 of Form 8-K specifies the tests to
be used rather than referencing the tests in Rule 1-02(w).
Specifically, Item 2.01 states that, ``an acquisition or disposition
shall be deemed to involve a significant amount of assets: (i) if
the registrant's and its other subsidiaries' equity in the net book
value of such assets or the amount paid or received for the assets
upon such acquisition or disposition exceeded 10% of the total
assets of the registrant and its consolidated subsidiaries; or (ii)
if it involved a business (see 17 CFR 210.11-01(d)) that is
significant (see 17 CFR 210.11-01(b)). ''
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We propose revising Rule 11-01(b) to raise the significance
threshold for the disposition of a business from 10% to 20%, to conform
to the threshold at which an acquired business is significant under
Rule 3-05.\193\ We also propose conforming, to the extent applicable,
the tests used to determine significance of a disposed business to
those used to determine significance of an acquired business.\194\ This
change would be consistent with the symmetrical treatment in Form 8-K
provided to acquisitions and dispositions of assets that do not
constitute a business.\195\ Finally, we propose revising Form 8-K and
Article 8 to require smaller reporting companies to provide pro forma
financial information for disposition of a significant business in Form
8-K and in certain registration statements and proxy statements when
the disposition occurs during or after the most recently completed
fiscal year.\196\
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\193\ See proposed Rule 11-01(b). We propose to revise Rule 11-
01(b) to clearly provide for business acquisitions and dispositions,
indicating that registrants should look to the conditions of a
significant subsidiary in Rule 1-02(w), but substitute a 20%
threshold for the 10% threshold provided in Rule 1-02(w) for both
acquisitions and dispositions of businesses. We also propose to
substitute a 20% threshold for the current 10% threshold for real
estate operations. See proposed Rule 3-14(b)(2) and the related
discussions in Section II.C. above.
\194\ See Section II.D.2. and proposed Rule 11-01(b)(2).
\195\ See supra note 192.
\196\ The Form 8-K requirement for smaller reporting companies
to provide pro forma financial information cites to Rule 8-05. Rule
8-05, however, only applies to acquisitions. While Article 8 has a
requirement in Rule 8-03(b)(4) to provide pro forma financial
information about dispositions of significant businesses, the
provision only applies to the registrant's interim financial
statements. In order to address the anomalous outcome where pro
forma financial information is required when interim financial
statements are presented but not when annual financial statements
are presented, we propose to remove Rule 8-03(b)(4) and revise Rule
8-05 to require disclosure of pro forma financial information when
any of the conditions in Rule 11-01 is met. See further discussion
in Section II.D.3.
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The proposed revisions would also apply to dispositions of real
estate operations as defined in Sec. 210.3-14(a)(2).\197\ Unlike for
acquisitions of real estate operations, the investment, asset, and
income tests would apply. Where real estate operations have been
included in the consolidated financial statements of the registrant,
the information necessary to apply these tests would be available, and
we are aware of no unique industry considerations that might warrant
limiting the significance determination to only the investment test.
However, similar to acquisitions of real estate operations, we propose
that debt secured by the real properties that is assumed by the buyer
would be included in the investment test when the ``investment in''
real estate operations is being compared to total assets of the
registrant.\198\
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\197\ See proposed Rule 11-01(b)(2).
\198\ See proposed Rule 1.02(w)(1)(i)(D).
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We believe that having the same threshold and tests for the
disposition of a business would simplify compliance for registrants. We
further see no compelling reason why the subset of businesses for which
investors need information should differ depending on whether the
business is being acquired or disposed. The Commission previously
raised the significance threshold for acquisitions to 20%,\199\ and we
received no comment in response to the 2015 Request for Comment
suggesting that the higher significance threshold has created issues
for investors regarding the sufficiency of information provided.
Rather, a number of commenters recommended conforming the significance
threshold to present pro forma financial information for a material
disposition to the threshold for acquisitions.\200\
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\199\ See 1996 Streamlining Release, supra note 13.
\200\ See, e.g., letters from ABA, BDO, CAQ, EY, Grant, and
KPMG.
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Request for Comment
64. Is our proposal to raise the significance threshold for the
disposition of a business from 10% to 20% appropriate? Why or why not?
65. Is our proposal to conform the tests used to determine
significance of a disposed business to those used to determine
significance of an acquired business appropriate? Why or why not? Does
the guidance in Instruction 4 of Item 2.01 of Form 8-K related to
determining the significance of an asset acquisition or disposition
that does not constitute a business (see Rule 11-01(d)) require
clarification or adjustment? If so, what clarifications or adjustments
are required and why?
66. Are there other changes that we should consider with respect to
the financial information required for a disposed business that would
reduce compliance burdens for issuers but continue to provide the
material information investors need to make informed investment
decisions?
67. Should the investment, asset, and income tests apply to real
estate operations in determining the significance for dispositions as
proposed? Why or why not? Should the significance determination be
limited to the investment test? If so, why?
68. Should debt secured by the real properties that is assumed by
the buyer be included in the investment test as proposed when the
``investment in'' a real estate operation is being compared to total
assets of the registrant for purposes of measuring significance of a
disposed real estate operation? Why or why not?
3. Smaller Reporting Companies and Issuers Relying on Regulation A
Rule 8-05 sets forth pro forma financial information requirements
for business acquisitions by smaller reporting companies. Additionally,
Part
[[Page 24624]]
F/S of Form 1-A directs an entity relying on Regulation A to present
the pro forma financial information specified by Rule 8-05.\201\ Like
Article 11, Rule 8-05(a) requires pro forma financial information only
if financial statements of a business acquired or to be acquired are
presented. Like Article 11, Rule 8-05(b) provides that pro forma
financial statements must consist of a pro forma balance sheet and a
pro forma statement of comprehensive income presented in condensed,
columnar form for the most recent year and interim period. Rule 8-
05(b), however, does not provide further preparation guidance, such as
the types of pro forma adjustments that can be made. Note 2 of the
Preliminary Notes to Article 8 provides that, to the extent that
Article 11-01 offers enhanced guidelines for the preparation,
presentation, and disclosure of pro forma financial information,
smaller reporting companies may wish to consider these items.
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\201\ See paragraph (b)(7)(iv) of Part F/S. Part F/S of Form 1-A
permits the periods presented to be those applicable to Regulation A
issuers rather than the periods specified by Article 8.
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We are proposing to revise Rule 8-05 to require that the
preparation, presentation, and disclosure of pro forma financial
information by smaller reporting companies substantially comply with
Article 11.\202\ Additionally, because Part F/S of Form 1-A refers to
Rule 8-05, the proposed revisions to Rule 8-05 would apply to issuers
relying on Regulation A. We believe the primary differences between
Rule 8-05 and Article 11 relate to the types of pro forma adjustments
that can be made and the number of periods required to be
depicted.\203\ The proposed amendments would therefor provide the same
benefits to smaller reporting companies and issuers relying on
Regulation A with respect to pro forma financial information as would
be available to other registrants under the proposed revisions to
Article 11. For example, the proposed rules would permit smaller
reporting companies and issuers relying on Regulation A to disclose
Transaction Accounting Adjustments and Management's Adjustments on a
basis consistent with other registrants.\204\ These amendments would
also provide investors with more uniform information upon which to make
their investment decisions.
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\202\ See proposed Rule 8-05(b). The one exception would relate
to the requirement to present pro forma financial information in
condensed format. Rule 8-05 requires presentation of pro forma
financial information in condensed, columnar form, but does not
define ``condensed.'' However, Rule 8-03(a) provides requirements
for presenting interim financial statements of smaller reporting
companies in condensed format. These requirements differ from the
similar requirements in Rule 11-02(b)(3) for presenting
``condensed'' pro forma financial information under Article 11.
Because pro forma financial information begins with the historical
financial statements of the registrant, proposed Rule 8-05 would
require application of Rule 8-03(a) requirements for condensed
format rather than the requirement in Rule 11-02(b)(3).
\203\ Article 11 requires presentation of pro forma financial
information for all periods for which historical income statements
of the registrant are required when the transaction for which pro
forma effect is being given will be reflected in the registrant's
historical financial statements by retrospectively revising those
financial statements for all periods presented. Rule 8-05 does not
have a similar provision. One effect of conforming Rule 8-05 to
Article 11 is that smaller reporting companies would have to provide
pro forma financial information for two years in these
circumstances. Because the circumstances requiring retrospective
revision are generally within the registrant's control and the
registrant must eventually revise its previously filed historical
financial statements for all periods to reflect these circumstances,
we do not believe our pro forma proposal will be a significant
incremental burden to smaller reporting companies. We welcome
commenters' views on whether our belief is correct.
\204\ See Section II.D.1. We believe the proposed Transaction
Accounting Adjustments, which would depict in the pro forma
condensed balance sheet the accounting for the transaction required
by U.S. GAAP or IFRS-IASB and the effects of those pro forma balance
sheet adjustments, would benefit smaller reporting companies and
their investors by simplifying preparation of the pro forma
financial information. The proposed Management's Adjustments, which
would require information that depicts reasonably estimable
synergies and other transaction effects that have occurred or are
reasonably expected to occur, would also benefit smaller reporting
companies and their investors by eliciting more transaction related
disclosure, including forward-looking information.
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We are also proposing to revise Rule 8-05 to require presentation
of pro forma financial information when the conditions in Rule 11-01
exist.\205\ Because Rule 8-05 currently requires pro forma financial
information only for business acquisitions,\206\ conforming the
conditions would require smaller reporting companies and issuers
relying on Regulation A to provide pro forma financial information
whenever it is material to investors, regardless of the nature of the
underlying transactions.\207\ Based on a staff analysis of 2017
disclosures of acquisitions and dispositions by smaller reporting
companies, we believe that most already comply with the conditions in
existing Rule 11-01.\208\
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\205\ See proposed Rule 8-05(a).
\206\ See supra Section II.D.2.
\207\ The incremental conditions that would require a smaller
reporting company to present pro forma financial information under
this proposal would include: Roll-up transactions as defined in 17
CFR 229.901(c); when such presentation is necessary to reflect the
operations and financial position of the smaller reporting company
as an autonomous entity; and other transactions for which disclosure
of pro forma financial information would be material to investors.
\208\ Commission staff found that out of 191 disclosures of
acquisitions and dispositions by smaller reporting companies in
2017, 178 appeared to comply with Article 11 requirements.
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Request for Comment
69. Would the proposed revisions to Rule 8-05 to require
Transaction Accounting Adjustments and Management's Adjustments
simplify the application of our rules and reduce costs for registrants?
Would the proposed revisions improve the disclosure available to
investors without introducing significant incremental costs or burdens?
Are there unique considerations that suggest smaller reporting
companies should have different pro forma adjustment requirements? If
so, what are those considerations, what different requirements should
apply and why? Will the proposed Article 11 implementation guidance be
beneficial to smaller reporting companies? Why or why not? Is there
different implementation guidance that would be more beneficial? Are
there other changes to the Rule 8-05 requirements that we should
consider?
70. Our proposal to require pro forma financial information for
disposition of a significant business in Form 8-K and in certain
registration statements and proxy statements when the disposition
occurs during or after the most recently completed fiscal year and to
permit the use of pro forma financial information to determine
significance in the context of business dispositions would also apply
to smaller reporting companies based on our proposed revisions to Rule
8-05. Is requiring smaller reporting companies to provide pro forma
information and permitting them to determine significance using pro
forma financial information in the context of business dispositions
appropriate? Are there other changes or information requirements we
should consider for smaller reporting companies?
71. Is our proposal to require presentation of pro forma financial
information when the conditions in Rule 11-01 exist, such that smaller
reporting companies would be required to provide the information
whenever it is material to investors, appropriate? If not, when should
smaller reporting companies be required to provide pro forma financial
information?
72. Should the proposed changes to Rule 8-05 apply to offerings
made pursuant to Regulation A? If not, how should we revise the
proposals to better accommodate Regulation A issuers and investors?
[[Page 24625]]
E. Amendments to Financial Disclosure About Acquisitions Specific to
Investment Companies
For financial reporting purposes, investment company registrants,
including business development companies, must apply the general
provisions in Articles 1, 2, 3, and 4 of Regulation S-X,\209\ unless
subject to the special rules \210\ set forth in 17 CFR 210.6-01 through
6-10 (``Article 6''). Investment company registrants differ from non-
investment company registrants in several respects. Investment
companies invest in securities principally for returns from capital
appreciation and/or investment income. Investment companies are
required to value \211\ their portfolio investments, with changes in
value recognized in the statement of operations for each reporting
period.\212\ Also, investment companies generally do not consolidate
entities they control and do not account for portfolio investments
using the equity method.\213\
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\209\ In October 2016, as part of a broader investment company
reporting modernization rulemaking, the Commission adopted certain
amendments to Regulation S-X that would expressly apply Article 6 to
business development companies. See Investment Company Reporting
Modernization, Release No. IC-32314 (Oct. 13, 2016) [81 FR 81870
(Nov. 18, 2016)].
\210\ See 17 CFR 210.6-03.
\211\ See 17 CFR 210.6-02(b) (``the term value shall have the
same meaning given in Section 2(a)(41)(B) of the Investment Company
Act'').
\212\ See FASB ASC 946-320-35, FASB ASC 946-323, FASB ASC 946-
325-35, FASB ASC 946-810, and FASB ASC 815-10-35.
\213\ See FASB ASC 946-810-45-2 (general consolidation guidance)
and FASB ASC 946-810-45-3 (the exception to that guidance when
considering an investment in an operating company that provides
services to the investment company).
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The proposed amendments are designed to tailor the financial
reporting requirements for investment companies with respect to
acquisitions of investment companies and other types of funds
(collectively, ``acquired funds'').\214\ There are no specific rules or
requirements in Article 6 for investment companies relating to the
financial statements of acquired funds. Instead, investment companies
apply the general requirements of Rule 3-05 and the pro forma financial
information requirements in Article 11, although it is often unclear
how to apply these reporting requirements in the context of acquired
funds. As a result, investment company registrants frequently consult
with Commission staff on the application of Rule 3-05 and Article 11 as
part of the registration or filing process to seek relief from those
requirements pursuant to Rule 3-13 and delegated authority,\215\ a
time-consuming process for both the registrant and the staff.
Currently, investment companies typically file Rule 3-05 Financial
Statements in transactions in which an investment company with limited
assets and operating history is created for the purpose of acquiring
one or more private funds operating under the exemptions provided by
Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. This type of
acquisition typically occurs early in the life of the acquiring
investment company when it has few or no portfolio investment assets of
its own. In these cases, Rule 3-05 Financial Statements of the acquired
fund or funds may be the primary financial information considered by
investors when making investment decisions with respect to the
investment company.
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\214\ Because securities from acquired funds become part of the
acquiring fund's investment portfolio, the concept of a disposition
of a business is inapt for investment companies. See, e.g., Rule 11-
01(d).
\215\ See supra note 43. The Commission has delegated authority
to the staff in the Division of Investment Management to grant
requests for relief under Rule 3-13 with respect to investment
companies.
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We are proposing to add a definition of significant subsidiary in
Regulation S-X that is specifically tailored for investment companies
based on the current Rule 8b-2 definition with some modifications.\216\
Investment companies are required to use the significant subsidiary
tests in Rule 1-02(w) when applying Rule 3-05 and other rules within
Regulation S-X. However, the tests in Rule 1-02(w) were not written for
the specific characteristics of investment companies.\217\ Further,
there is a different definition of significant subsidiary set forth in
Rule 8b-2 that is applicable to the filing of registration statements
and reports under the Investment Company Act,\218\ which creates
inconsistencies with the Regulation S-X definition.\219\ Moreover, the
rules promulgated pursuant to Section 8 of the Investment Company Act
are not applicable to business development companies.\220\ Commission
staff has previously described its views as to how certain Regulation
S-X provisions apply to business development companies in connection
with registration statements filed under the Securities Act.\221\ In
light of these circumstances, we believe that a specific test for
investment companies would provide a more appropriate measure of
significance given the differences in financial reporting of investment
companies as compared to non-investment companies.
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\216\ See proposed Rule 1-02(w)(2). We additionally propose to
amend Rule 1-02(w) to provide that, with respect to the condition in
proposed Rule 1-02(w)(2)(ii), the value of investments shall be
determined in accordance with U.S. GAAP and, if applicable, Section
2(a)(41) of the Investment Company Act (15 U.S.C. 80a-2(a)(41)).
\217\ For example, one condition of the significant subsidiary
definition examines the investment company's ``equity in the income
from continuing operations before income taxes exclusive of amounts
attributable to any noncontrolling interests'' of the subsidiary,
which are concepts not generally applicable for investment company
financial reporting.
\218\ See 17 CFR 270.8b-2 (stating that terms defined in the
rule, when used in registration statements pursuant to Section 8 of
the Investment Company Act and all reports pursuant to Section 30(a)
or (b) of the Investment Company Act, shall have the meaning
indicated in the rule). Investment Company Act forms that reference
the term ``significant subsidiary'' include Form N-8B-4 for issuers
of face-amount certificates, Form N-5 for small business investment
companies, and Item B.11 of Form N-CEN.
\219\ For example, Form N-14 used by registered investment
companies and business development companies in connection with a
business combination is a registration statement only under the
Securities Act and not the Investment Company Act. Therefore, the
definitions in Rule 8b-2 would not apply to a Form N-14 registration
statement. See General Instruction A to Form N-14.
\220\ See Section 59 of the Investment Company Act (15 U.S.C.
80a-58).
\221\ See, e.g., Investment Management Guidance Update No. 2013-
07, Business Development Companies--Separate Financial Statements or
Summarized Financial Information of Certain Subsidiaries, available
at https://www.sec.gov/divisions/investment/guidance/im-guidance-2013-07.pdf.
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We also are proposing new Rule 6-11 of Regulation S-X, which would
specifically cover financial reporting in the event of a fund
acquisition and is modeled after proposed Rules 3-05 and 3-14.\222\
Proposed Rule 6-11 would apply to the acquisition of another investment
company, including a business development company, a private fund, and
any private account managed by an investment adviser. Because the
definition of business in Rule 11-01(d) is not readily applicable in
the context of a fund acquisition, we propose a facts and circumstances
test as to whether a fund acquisition has occurred, including when one
fund acquires all or substantially all of another fund's portfolio
investments.
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\222\ In the event of a non-fund acquisition, investment
companies would follow Rule 3-05.
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Investment companies are also required to file audited financial
statements for acquired funds, which can include private funds. Those
private funds often have prepared audited financial statements in
accordance with U.S. GAAP. However, private funds are not required to
comply with the additional requirements set forth in Regulation S-X and
therefore generally have not prepared their financial statements in
accordance, nor had an audit conducted in compliance, with
[[Page 24626]]
Regulation S-X. In these situations, an investment company registrant
typically must revise or re-audit the historical financial statements
of acquired funds so that they comply with all applicable rules within
Regulation S-X.
We additionally propose to eliminate the current pro forma
financial information requirement for investment companies and replace
it with proposed Rule 6-11(d), which would require investment companies
to provide supplemental financial information that we believe will be
more relevant to investors.
1. Amendments to Significance Tests for Investment Companies
As described in Section II.A.1, the definition of significant
subsidiary in Rule 1-02(w) has three separate tests: The Investment
Test, the Asset Test, and the Income Test. In contrast, the definition
of significant subsidiary in Rule 8b-2 under the Investment Company Act
has two tests:
The Rule 8b-2 investment test, which looks to whether
value of the investments in and advances to the subsidiary by its
parent and the parent's other subsidiaries, if any exceed 10% of the
value of the assets of the parent or, if a consolidated balance sheet
is filed, the value of the assets of the parent and its consolidated
subsidiaries; or
the Rule 8b-2 income test, which looks to whether total
investment income of the subsidiary or, in the case of a noninvestment
company subsidiary, the net income exceeds 10% of the total investment
income of the parent or, if consolidated statements are filed, 10% of
the total investment income of the parent and its consolidated
subsidiaries.
Calculations for these tests are made using amounts determined
under U.S. GAAP.\223\ Rule 8b-2 does not include an asset test.
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\223\ See Rule 1-02(w).
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We propose to add new Rule 1-02(w)(2) to create a separate
definition of significant subsidiary for investment companies in
Regulation S-X, which would use an investment test and an income test,
but not an asset test. The proposed definition would use a modified
version of the current Rule 8b-2 tests. We also propose conforming
amendments to Rule 8b-2 to make it consistent with proposed Rule 1-
02(w)(2).\224\ The changes to the significant subsidiary definition in
Regulation S-X would affect disclosures for fund acquisitions and also
have effects on investment company application of Rule 3-09 regarding
separate financial statements for significant subsidiaries and Rule 4-
08(g) regarding summarized financial information of subsidiaries not
consolidated. We believe that it is appropriate to apply consistent
significance tests for each of these provisions, particularly as
proposed Rule 1-02(w)(2) is intended to be specifically tailored for
investment companies. We believe that the proposed definition would
avoid unnecessary regulatory complexity and the potential confusion
associated with the existing definitions and provide more appropriate
standards for determining significance for financial disclosure.
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\224\ In conforming Rule 8b-2, we propose to eliminate paragraph
(k)(3) of that rule and instead follow the syntax of proposed Rule
1-02(w) which more simply states that a significant subsidiary means
a subsidiary, including its subsidiaries, which meets any of the
specified conditions.
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a. Investment Test
The Investment Test for significant subsidiary in Regulation S-X
determines significance by determining whether the investments in and
advances to the tested subsidiary \225\ exceed 10% of the registrant's
total assets. Rule 8b-2 similarly determines significance using an
investment test. For investment companies, we propose to establish an
investment test that compares whether the value of the registrant's and
its other subsidiaries' investment in and advances to the tested
subsidiary exceeds 10% of the value of the total investments of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year.
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\225\ See supra note 37 (regarding the use of the term ``tested
subsidiary''). Rule 1-02(w) defines the term ``significant
subsidiary.'' Proposed Rule 6-11 as well as Rules 3-09 and 4-08(g)
use the conditions in Rule 1-02(w) when establishing the test for
registrants to determine whether additional financial disclosures
are required for investment company registrants.
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Our proposed investment test would be similar to the existing
Investment Test, but modified so that the comparison would be to the
value of the registrant's total investments \226\ rather than total
assets. Value of the investments would be determined in accordance with
U.S. GAAP \227\ and, if applicable, such as in the case of investment
company registrants, Section 2(a)(41) of the Investment Company Act. We
believe that the proposed total investments measure would be more
appropriate for investment companies and more relevant than the
existing tests, because it would focus the significance determination
on the impact to the registrant's investment portfolio as opposed to
other non-investment assets that may be held.
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\226\ See 17 CFR 210.6-04.4.
\227\ See FASB ASC 820 (fair value measurements).
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In addition, under Rule 6-05 of Regulation S-X, investment company
registrants may substitute a statement of net assets in lieu of a
balance sheet if at least 95% of total assets are represented by
investments in securities of unaffiliated issuers. In such situations,
the registrant will not file with the Commission a balance sheet that
discloses total assets. We believe using total investments for the
proposed investment test for investment companies would be a more
transparent measure than total assets for registrants that use a
statement of net assets instead of a balance sheet.
b. Asset Test
The Asset Test in Rule 1-02(w) compares the proportionate share of
the total assets (after intercompany eliminations) of the tested
subsidiary to the total assets of the registrant and its subsidiaries
consolidated as of the end of the most recent fiscal year. There is no
equivalent test under the Rule 8b-2 definition of significant
subsidiary. We propose eliminating the Asset Test from Regulation S-X
as a measure of significance for investment companies because we
believe doing so would simplify compliance without changing the
information available to investors.
The Asset Test is generally not meaningful when applied to
investment companies. For example, if the tested subsidiary is another
investment company, comparing the value of the registrant's
proportionate share in that subsidiary to the registrant's total assets
creates a test nearly identical to the proposed investment test.
Because total investments is a component of total assets on the balance
sheet of an investment company, the condition under the proposed
investment test would always be satisfied before the condition of the
Asset Test. In this context, the Asset Test becomes superfluous.
Additionally, applying the Asset Test is less straightforward for
investment companies than for non-investment companies when the tested
subsidiary is not an investment company.\228\ The assets of non-
investment companies are generally based on historical cost, while the
assets of investment companies are based on market price or fair value.
Thus, applying the Asset Test becomes less meaningful for investment
companies as it requires comparing
[[Page 24627]]
assets measured under different methodologies and therefore may be a
less reliable indicator of significance.
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\228\ In the event the tested subsidiary is another investment
company, the assets of that subsidiary would principally be
portfolio investments valued under U.S. GAAP and, if applicable,
Section 2(a)(41) of the Investment Company Act.
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c. Income Test
The Income Test in Rule 1-02(w) compares the registrant's and its
other subsidiaries' equity in the income from continuing operations
before income taxes exclusive of amounts attributable to any
noncontrolling interests. The income test in Rule 8b-2, however,
compares the total investment income of the tested subsidiary with the
total investment income of the parent and its consolidated
subsidiaries. Both tests find significance if the result is greater
than 10%. We believe that the income test in Rule 8b-2 is more
appropriate because it uses income elements that are actually reported
by investment companies. We propose to use that test, but modified to
include any net realized gains and losses and net change in unrealized
gains and losses.
The proposed income test for investment companies specifically uses
components from the statement of operations required by Rule 6-07. In
particular, the proposed income test for investment companies would
include, in the numerator, the following amounts for the most recently
completed pre-acquisition fiscal year of the tested subsidiary: (1)
Investment income, such as dividends, interest, and other income; (2)
the net realized gains and losses on investments; and (3) the net
change in unrealized gains and losses.\229\ We believe that including
changes in realized and unrealized gains/losses can better reflect the
impact of the tested subsidiary on an investment portfolio rather than
investment income alone, especially if volatility in the value of the
investment portfolio is significantly greater than investment income or
if there are significant holdings of securities that do not produce
investment income. The sum of the absolute value of these amounts would
be compared to the absolute value of the registrant and its
subsidiaries' consolidated change in net assets resulting from
operations.\230\ We propose using the change in net assets resulting
from operations because it is the equivalent to net income for non-
investment companies.
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\229\ See, e.g., descriptions of these terms in Rules 6-07.1, 6-
07.7(a), and 6-07.7(d) and equivalents under U.S. GAAP for non-
registrants.
\230\ See Rule 6-07.9. The absolute value would be calculated
using the amounts set forth in the statement of operations.
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We also propose to amend the significance threshold for the income
test in Rule 1-02(w) as it applies to investment companies. We propose
that a tested subsidiary will be deemed significant under the income
test for investment companies if the test yields a condition of greater
than either (1) 80% by itself or (2) 10% and the investment test for
investment companies yields a result of greater than 5% (``alternate
income test''). As with non-investment companies, the current Income
Test may indicate significance and can result in additional financial
information about the tested subsidiary being required \231\ even
though the tested subsidiary represents a very small component of the
registrant's investment portfolio. We believe that the proposed
threshold changes would reduce the need to produce additional financial
information in situations where a registrant's change in net assets
resulting from operations is relatively small and better identify
situations of significance in which additional disclosure is warranted.
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\231\ See Rules 3-09 and 4-08(g).
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We have proposed the 80% threshold based on the view that it
represents a level of significance that more accurately indicates the
need for additional financial disclosure, especially for funds with
relatively small amounts of income.\232\ In these situations, the
proposed income test threshold for investment companies, which is eight
times greater, should result in fewer registrants with significance
findings than under the current Income Test that uses a 10% threshold.
To further mitigate the potential adverse effects of the proposed
income test for investment companies with insignificant changes in net
assets resulting from operations for the most recently completed fiscal
year, we propose an instruction that permits the registrant to compute
the income test for investment companies using the average of the
absolute value of the changes in net assets for the past five fiscal
years.\233\
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\232\ See Rule 3-05(b)(4)(iii).
\233\ This approach is similar to that proposed when applying
the revenue test for non-investment company registrants that have no
recurring annual revenues. See supra note 48 and accompanying text.
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We believe that a bright-line threshold for the proposed income
test for investment companies would be less costly to apply than a
principles-based approach as an initial determination of significance.
To the extent that an investment company registrant exceeds the 80%
threshold under the income test for investment companies and believes
that the tested subsidiary is not significant, the registrant can
engage with our staff and seek to omit separate financial statements
for that subsidiary or substitute financial statements, which the staff
may grant pursuant to Rule 3-13 and delegated authority.\234\ For
situations where the 80% threshold is not exceeded but the impact of a
tested subsidiary's income may be significant, we believe that the
proposed alternate income test would appropriately capture significance
for financial reporting purposes.
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\234\ See supra note 215.
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The proposed alternate income test for investment companies would
retain the existing 10% threshold for income significance but add an
additional condition of more than 5% under the proposed investment
test. We believe that the addition of a minimal percentage of the
investment portfolio will eliminate many of the anomalous findings of
significance as compared to the current 10% condition for net income
alone. We have chosen 5% for the minimum because it is consistent with
the 5% threshold utilized in Rule 6-05 for purposes of allowing the
presentation of a statement of net assets in lieu of a balance sheet.
Request for Comment
73. Should we create a separate definition of significant
subsidiary in Rule 1-02(w) of Regulation S-X specifically for
investment companies? If so, is the proposed definition appropriate
when used for Rules 3-09 and 4-08(g) and proposed Rule 6-11 with
respect to investment companies?
74. Should we make corresponding changes to the definition of
significant subsidiary in Rule 8b-2? Are there reasons, with respect to
investment companies, that the definitions of significant subsidiary in
Rule 8b-2 and Regulation S-X should differ?
75. Should we utilize the value of total investments of an
investment company as a denominator rather than total assets for the
proposed investment test for investment companies? Should we change the
numerator to a different metric than value of investments in and
advances to the tested subsidiary? If so, which metric and why? Should
we use the definition of value from the Investment Company Act for
purposes of the Regulation S-X definition of significant subsidiary?
76. Should an asset test apply to investment companies? Are there
situations in which an asset test would uniquely identify a significant
subsidiary? If we were to retain an asset test for investment
companies, how could it be modified to better reflect measures of
significance relevant to investment companies?
[[Page 24628]]
77. Should we establish an income test for investment companies to
utilize the absolute value of the sum of: (1) Investment income, such
as interest, dividend, and other income; (2) change in unrealized gain/
loss; and (3) realized gain/loss as the numerator? If so, should we
also change the denominator to be the investment company's absolute
value of change in assets resulting from operations? Should we use
absolute values of these entries from the statement of operations or
should we use the absolute value of the gain or loss on each individual
portfolio security? Are there other measures we should consider?
78. Should we increase the threshold of the income test for
investment companies to 80%? Should we make the proposed income test
for investment companies conjunctive with the proposed investment test
for investment companies? Are the proposed thresholds of 10% and 5%
appropriate or should they be different? If different, what thresholds
should we use to make the proposed income test conjunctive with the
proposed investment test?
79. Should we base the proposed income test for investment
companies on the individual absolute value of the components rather
than netting them out? For example, in a fund with significant
investment income, that income could be offset by an equal amount of
realized and unrealized losses, creating a relatively small change in
net assets resulting from operations. If we were to use the absolute
value of each of the components, should we reduce the threshold of the
proposed income test?
80. Under our proposal, a five-year average would be used for the
income test for investment companies if the registrant and its
subsidiaries consolidated has an insignificant change in net assets
resulting from operations for the most recent fiscal year. Should the
five-year average also be required for the tested subsidiary under
similar circumstances? Should this proposed amendment be more similar
to the one for non-investment company registrants? Should a five-year
average be required only if the absolute value of the change in net
assets resulting from operations for the most recent fiscal year is at
least 10% lower than the average of the absolute value of such amounts
for the registrant for each of its last five years?
81. We are proposing amendments to Rule 1-02(w)(2) to assist
investment company registrants in making significance determinations.
Are the proposed amendments appropriate? If not, are there different or
additional amendments we should consider?
82. Should we make further modifications to the proposed income
test for investment companies in situations where the tested subsidiary
is not an investment company? For example, should we require the use of
net income for a non-investment company subsidiary when compared to the
registrant's change in net assets resulting from operations?
83. Instead of having specific percentage conditions, should we
adopt a materiality standard? For example, should we adopt a standard
that deems a subsidiary as significant if it is material to an
understanding of the registrant's financial condition?
2. Proposed Rule 6-11 of Regulation S-X
We are proposing new Rule 6-11 to address the financial statements
of funds acquired or to be acquired, if probable, which would be based
on proposed Rules 3-05 and 3-14 but modified to meet the needs of
investment companies and their investors. Proposed Rule 6-11 would only
apply to the acquisition of a fund, including any investment company as
defined in Section 3(a) of the Investment Company Act, any private fund
that would be an investment company but for the exclusions provided by
Sections 3(c)(1) or 3(c)(7) of that Act, or any private account managed
by an investment adviser. Proposed Rule 6-11 calls for a facts and
circumstances evaluation as to whether a fund acquisition has occurred
or is probable. We believe this approach captures the appropriate
universe of fund acquisitions where additional disclosures may be
appropriate, as it is based on the economic substance of a transaction
rather than legal form. Under proposed Rule 6-11, the acquisition of
all or substantially all portfolio investments held by another fund
would be considered a fund acquisition; otherwise, potential disclosure
obligations could be avoided by structuring an acquisition transaction
as a sale of all assets rather than a merger.
We propose to require only one year of audited financial statements
for fund acquisitions, a change from the existing Rule 3-05
requirements that require between one and three years of audited
financial statements. This proposed change would make the obligations
more aligned with the financial statement obligations applicable to
investment company registration statements. Rule 3-18 allows registered
investment management companies to file financial statements covering
only the most recent fiscal year, except for an audited statement of
changes in net assets which must cover the two most recent fiscal
years.\235\ Older historical financial statements are generally less
relevant to fund investors because the price of investment company
shares or interests is established by the value of its investment
portfolio, even for closed-end funds that may trade at a discount to
net asset value and private funds that do not readily trade. Moreover,
the proposed change would also be consistent with the practice of our
disclosure review staff during consultations, which have permitted
investment company registrants to provide financial statements for
acquired funds for the periods set forth in Rule 3-18 rather than Rule
3-05.\236\
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\235\ Business development companies are also permitted to use
Rule 3-18 pursuant to the instructions set forth in Form N-2.
\236\ See supra note 215.
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Under proposed Rule 6-11, the related schedules specified in
Article 12 would need to be provided for an acquired or to be acquired
fund. These schedules, such as the schedule of investments, are
important for investment company registrants because they permit an
investor to know the specific portfolio investments being acquired. The
nature of investment companies, whose assets largely consist of
portfolio investments that are carried at market value, if available,
or fair value, makes other historical financial statement information
less relevant than for non-investment companies.
Acquisitions of a group of related funds would be considered as a
single acquisition under proposed Rule 6-11(a)(3) \237\ and a
registrant would have the option of presenting the required financial
statements either on an individual or combined basis for any periods
they are under common control or management. This provision is
comparable to the treatment of related businesses under current and
proposed Rule 3-05 and for similar reasons we believe it would be
appropriate in the context of fund acquisitions.
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\237\ Funds are considered related if they are under common
control or management, the acquisition of one fund is conditional on
the acquisition of each other fund, or each acquisition is
conditioned on a single common event.
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In the investment company context, we believe that information
about the composition of the acquired fund's investment portfolio is
the most important and relevant information for investors. We
understand that a significant number of private funds currently prepare
audited financial statements under U.S. GAAP due to
[[Page 24629]]
investor demand and for regulatory compliance purposes.\238\ Therefore,
we propose to allow investment companies to provide financial
statements for private funds that were prepared in accordance with U.S.
GAAP. However, we also are proposing to require the investment company
registrant to file schedules for the acquired fund that comply with
Article 12 of Regulation S-X, which requires each investment to be
listed separately. Because the proposed rule would require the schedule
of investments as set forth in Article 12, a private fund would not be
permitted to present a condensed schedule of investments. We believe
that our proposed approach with respect to acquisitions of private
funds will reduce the costs related to re-issuing audited financial
statements in compliance with Regulation S-X, but still provide
investors appropriate information about the acquired fund.
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\238\ For example, one reason would be to satisfy custody rule
obligations under the Investment Advisers Act. See 17 CFR
275.206(4)-2.
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Private fund financial statements prepared in accordance with U.S.
GAAP do not require the same level of granular information or
disclosure as financial statements prepared in compliance with
Regulation S-X. For example, certain financial statements prepared in
compliance with Regulation S-X require separate disclosure of major
categories or accounts greater than a certain percentage of total
assets, liabilities, income or expenses while U.S. GAAP requirements
are less specific. Additionally, under Regulation S-X, registered
investment companies and business development companies must separately
show certain financial statement accounts within the financial
statements, regardless of their materiality, based on their affiliate
classification in relation to the fund.\239\
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\239\ See, e.g., the financial reporting requirements of Rule 6-
07 and FASB ASC 946-210-50-4 and 946-210-50-6.
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Currently, a registrant that acquires a private fund typically must
revise the historical financial statements of the acquired fund so that
they comply with all applicable rules of Regulation S-X and possibly
re-audit those statements. This is the case because the financial
statements of private funds are generally prepared, in practice, in
accordance with U.S. GAAP only. This can be costly both in terms of
time and resources and, given the information contained in the acquired
private fund audited financial statements that comply with U.S. GAAP,
it is not clear that there is a commensurate benefit to investors by
requiring financial statements of the acquired fund that comply with
all provisions of Regulation S-X. Therefore, our proposal is intended
to achieve an appropriate balance by permitting registrants to file
U.S. GAAP financial statements for acquired private funds, but
supplementing those financial statements with schedules listing each
investment as required by Article 12.
To determine whether financial statements of a fund acquired or to
be acquired must be provided under proposed Rule 6-11, the conditions
specified in the definition of significant subsidiary under proposed
Rule 1-02(w)(2) would be applied, using the investment test and the
alternate income test for investment companies and substituting 20% for
10% for each place it appears therein. We have based the 20%
significance test on comparable conditions in current Rule 3-05 and
have not identified any reason to use a different threshold. The income
test for investment companies with the 80% condition would not be used
for purposes of proposed Rule 6-11 because we believe, in the
acquisition context, significance matters principally with respect to
the portfolio investments and the amount of assets being acquired,
since investment income and realized and unrealized gains/losses from
the investments acquired will be immediately reflected in the daily net
asset value of the registrant. If either of the tests is satisfied at
the 20% condition, the registrant would be required to file the
financial statements for the acquired fund as set forth in proposed
Rule 6-11. Otherwise, filing financial statements of the acquired fund
would not be necessary.
If the aggregate impact of individually insignificant funds
acquired or to be acquired since the most recent audited balance sheet
exceeds the conditions of the investment test and the alternate income
test for investment companies, substituting 50% for 10%, then the
registrant would be required to provide the financial statements for
each individually insignificant fund and the supplemental financial
information. We have based the 50% condition on the provision in
current Rule 3-05(b)(2)(i). Unlike the existing rule, however, proposed
Rule 6-11 would require financial statements for each individually
insignificant fund acquired or to be acquired, rather than the
``substantial majority'' requirement for businesses acquired under the
current rule.
In determining whether financial statements of funds acquired or to
be acquired must be filed, the registrant may use pro forma amounts
that give effect to an acquisition consummated after the registrant's
latest fiscal year-end for which the registrant has filed audited
financial statements of such acquired fund as required by proposed Rule
6-11. Any requirement to file financial statements of an acquired fund
would cease once an audited balance sheet required by Rules 3-01 or 3-
18 is filed for a date after the date the acquisition was consummated.
At such time, the acquired investments would be reflected on the
balance sheet or statement of net assets and accompanying schedules. In
these circumstances, we believe that historical financial statements of
acquired funds would be of less importance to investors and continued
filing obligations would impose unnecessary costs since any realized
and unrealized gains/losses on the acquired investments would be
reflected in the daily net asset value calculation as well as fund
performance measures on a going-forward basis.
Request for Comment
84. Should we adopt proposed Rule 6-11 for acquisitions of funds by
registrants? Have we appropriately defined what constitutes a fund
acquisition? Are there other types of private funds not covered by the
Section 3(c)(1) or 3(c)(7) exclusion that should be covered? Is it
appropriate to use a facts and circumstances-based evaluation to
determine whether a fund acquisition has or will occur? Are there are
other factors that should be considered in defining a fund acquisition?
85. Should we permit the presentation of audited financial
statements of acquired funds for only the most recent fiscal year?
Should we require the same reporting periods required by Rule 3-18
instead? If so, should we permit any registered investment company
registrant, such as unit investment trusts, to use Rule 3-18 and not
limit it to only registered management investment companies?
86. Should we treat business development companies and registered
investment companies the same? Should business development companies
follow the reporting periods set forth in proposed Rule 3-05 instead of
proposed Rule 6-11?
87. Should we require registrants to provide the audited schedules
required by Article 12 for an acquired private fund, including a
schedule of investments that requires each investment to be listed
separately? Should we require only a smaller set of schedules required
by Article 12, such as those required by Rules 12-12, 12-12A, 12-12B,
12-12C, and 12-13? Should we allow registrants to provide
[[Page 24630]]
schedules that are permitted under U.S. GAAP rather than Article 12?
88. Is there any other disclosure by a registrant or an acquired
fund that would be important to a fund investor? If so, please specify
in detail.
89. Should we permit registrants to have the option to file
financial statements on an individual or a combined basis for acquired
funds that are part of a group of related funds for any periods they
are under common control or management?
90. Should we continue to use the significant subsidiary definition
as the basis for evaluating whether financial statements of an acquired
fund should be filed? If so, is 20% the appropriate threshold? If not,
what would be the appropriate threshold?
91. Should we not apply the 80% income test for purposes of
determining whether financial statements of an acquired fund should be
filed?
92. Should we permit a registrant to cease providing audited
financial statements of the acquired fund once an audited balance sheet
for the registrant is filed that reflects the assets of the acquired
fund? Should the registrant be required to continue to file audited
financial statements of the acquired fund until an audited statement of
operations for a complete fiscal year reflecting the acquired fund has
been filed?
93. Is it appropriate to permit the financial statements of an
acquired private fund to comply with U.S. GAAP and only the schedule
requirements in Article 12? Should we require Article 12 schedules to
be filed with respect to the acquired private fund, even though it may
be likely to result in additional costs?
94. Is the proposed language related to independence standards
sufficiently clear? Should we specify the ``applicable independence
standards''? If so, how should they be specified? Are there
circumstances where there are no ``applicable independence standards''?
In those circumstances, which independence standards should apply?
3. Pro Forma Financial Information and Supplemental Financial
Information
We propose to eliminate the requirement to provide pro forma
financial information for investment company registrants in connection
with fund acquisitions and to provide more relevant disclosures in its
place. Rule 11-01 requires an investment company to furnish pro forma
financial information when a significant business acquisition has
occurred or is probable, with significance being determined using the
tests set forth in Rule 1-02(w) and substituting 20% for 10%. In the
staff's experience, investment companies often file Rule 3-05 Financial
Statements in transactions in which an investment company with limited
assets and operating history is created for the purpose of acquiring
one or more private funds. After such an acquisition, the portfolio
investments of the acquired fund will represent nearly all of the
portfolio investments of the registrant, rendering the pro forma
financial statements of the registrant to be substantially similar to
the historical financial statements of the acquired fund that are
already provided in the registration statement. Rule 11-02 permits
investment companies to provide a narrative description of the pro
forma effects of the transaction in lieu of pro forma financial
statements, if there are a limited number of required pro forma
adjustments and they are easily understood.\240\
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\240\ See Rule 11-02(b)(1).
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Applying the current pro forma financial information requirements,
based on rules that are principally designed for non-investment
companies, to fund acquisitions by investment companies may increase
costs borne by investors without yielding significant benefit. Pro
forma financial information in the investment company context may be
less informative than other financial information. For example, non-
investment company registrants are required to include historical
financial statements and pro forma financial information in the
registrant's prospectus. For investment companies, this information is
placed in the statement of additional information (SAI) and not the
prospectus. The absence of pro forma information from the prospectus is
notable because the Commission has previously concluded that the
prospectus, standing alone, contains all of ``the information that is
necessary or appropriate in the public interest or for the protection
of investors.'' \241\ The SAI, on the other hand, contains information
not required in the prospectus but which ``may be of interest to at
least some investors.'' \242\
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\241\ Registration Form Used by Open-End Management Investment
Companies; Guidelines, Release No. IC-13436 (Aug. 12, 1983) [(48 FR
37928, 37930) (Aug. 22, 1983)] (``Form N-1A Adopting Release'').
\242\ Id. at 37928. Today, all SAIs and the rest of an
investment company's registration statements and other filings are
available to investors on the Commission's EDGAR system. In
addition, for investment companies that use a summary prospectus,
the SAI must be posted to the fund's website. See 17 CFR 230.498(e).
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Preparation of pro forma financial information imposes costs on
investment company registrants, and a significant percentage of filings
on Form N-14 contain pro forma financial information. Our staff
reviewed approximately 450 filings on Form N-14 over the past three
years, using analytical tools to identify filings with pro forma
information and found that approximately 50% of N-14 filings included
pro forma financial statements and an additional 25% included narrative
pro forma information.
When the Commission adopted Form N-14 in 1985, it stated that pro
forma and historical financial information ``may be useful'' to
investors, even though some commenters indicated that the information
was not material.\243\ In response to the 2015 Request for Comment,
several commenters suggested that historical financial statements and
pro forma financial information were not material, particularly if an
audited schedule of investments from the acquired fund was
provided.\244\ We believe that it is appropriate to re-consider whether
pro forma financial information is necessary in light of the costs to
prepare such disclosures.
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\243\ Business Combination Transactions; New Registration Form
for Investment Companies, Release No. IC-14796 (Nov. 14, 1985) [50
FR 48379 (Nov. 25, 1985)].
\244\ See letters from CAQ, Crowe, and RSM.
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In place of the current pro forma financial information
requirements, we propose new Rule 6-11(d) to require that investment
companies provide supplemental information about the newly combined
entity that we believe will be more relevant to investors. The
supplemental information would include: (1) A pro forma fee table,
setting forth the post-transaction fee structure of the combined
entity; (2) if the transaction will result in a material change in the
acquired fund's investment portfolio due to investment
restrictions,\245\ a schedule of investments of the acquired fund
modified to show the effects of such change and accompanied by
narrative disclosure describing the change; and (3) narrative
disclosure about material differences in accounting policies of the
acquired fund when compared to the newly combined entity. We believe
that this amendment would provide material information to investors
because it would highlight important changes resulting from a fund
acquisition (i.e., changes in fees and expenses, changes to acquired
fund's holdings, and
[[Page 24631]]
changes in accounting policies) to provide appropriate context to the
acquired fund's financial statements.
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\245\ One example is if the registrant and the acquired fund
both have positions in the same portfolio investment and, when
combined, the registrant would exceed an investment restriction on
any single holding. In this situation, a certain percentage of the
portfolio investment may need to be divested.
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Request for Comment
95. Should we eliminate the requirement for investment companies to
provide pro forma financial statements for the combined entity after a
business acquisition? To what extent does pro forma financial
information remain material in the investment company context? Please
provide specific examples of how the current pro forma financial
information is utilized.
96. Should we require the pro forma fee table, schedule of
investments, and narrative disclosure as outlined above? Is there other
information we should require in lieu of pro forma financial statements
of the combined entity? If so, what other information would be material
to investors?
4. Amendments to Form N-14
Item 14 of Form N-14, the form used by investment companies to
register securities issued in business acquisition transactions,\246\
provides, subject to certain exceptions, that the corresponding
Statement of Additional Information ``shall contain the financial
statements and schedules of the acquiring company and the company to be
acquired required by Regulation S-X.'' \247\ We propose to amend Form
N-14 so that its disclosure requirements are consistent with the
disclosures required in proposed Rule 6-11 because we believe it is
appropriate for investors who acquire securities in a registered
offering to have the same disclosure that investors receive through
financial statement disclosure in shareholder reports. In the case of a
fund acquisition, any financial statements and schedules required by
Regulation S-X would only be required for the most recent fiscal year
and the most recent interim period.\248\ Similarly, we propose to
permit private funds to provide financial statements and schedules that
conform to U.S. GAAP and Article 12 of the Regulation S-X. We also
propose to require inclusion of the supplemental financial information
described in proposed Rule 6-11(d), except for the pro forma fee table.
We are excluding the pro forma fee table from Item 14 of Form N-14
because it is already required in the prospectus under Item 3 of that
Form. We also propose to remove provisions no longer relevant because
of prior amendments.\249\ We further propose to remove the existing
exclusion in Form N-14 for pro forma financial statements required by
Rule 11-01 of Regulation S-X if the net asset value of the company
being acquired does not exceed 10% of the registrant's net asset value
because pro forma financial statements would be no longer required for
fund acquisitions and, for non-fund acquisitions, the significance
measure for pro forma statements in Rule 11-01(b)(1) is and would
remain 20%.
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\246\ See 17 CFR 239.23 (setting forth the requirement for an
investment company to file Form N-14 to register securities in
business combination transactions) and 17 CFR 230.145 (specifying
the types of transactions that trigger the Form N-14 filing
requirement).
\247\ See Item 14 of Form N-14. Currently, the disclosures are
to be for the periods specified in Article 3 of Regulation S-X. Id.
\248\ Non-fund acquisitions would be required to follow the
other financial statement disclosure requirements set forth in
Regulation S-X for the periods required by Rule 3-05, including any
pro forma financial information required by Article 11.
\249\ Specifically, we are removing the ability to place columns
C and D of Schedule II under Rule 12-14 to Part C of the
registration statement, with the remainder of the schedule being
provided in the SAI. When originally adopted, Form N-14 was based on
Form N-1A, which had a similar provision. See Form N-1A Adopting
Release. This provision was removed from Form N-1A in 1998. See
Registration Form Used by Open-End Management Investment Companies,
Release No. 33-7512 [63 FR 13916 (Mar. 23, 1998)].
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Request for Comment
97. Should we conform the financial statement disclosure
requirements in Item 14 of Form N-14 with proposed Rule 6-11? If not,
how and why should the disclosures differ?
98. Should we require the supplemental financial information to be
disclosed in Form N-14?
III. General Request for Comment
We request and encourage any interested person to submit comments
on any aspect of the proposal, other matters that might have an impact
on the amendments, and any suggestions for additional changes. With
respect to any comments, we note that they are of greatest assistance
to our rulemaking initiative if accompanied by supporting data and
analysis of the issues addressed in those comments, particularly
quantitative information as to the costs and benefits, and by
alternatives to the proposals where appropriate. Where alternatives to
the proposals are suggested, please include information as to the costs
and benefits of those alternatives.
IV. Economic Analysis
A. Introduction
We are proposing amendments to our rules and forms to improve the
disclosure requirements for financial statements relating to
acquisitions and dispositions of businesses, including real estate
operations and investment companies. The intended economic effects of
the proposed amendments are to reduce the burden on registrants of
complying with financial statement disclosure requirements related to
their business acquisitions and business dispositions, facilitate
timely access to capital, and provide more relevant information to
investors. This reduced compliance burden also may encourage
registrants to engage in more potentially value-enhancing mergers and
acquisitions than they otherwise would engage in without the proposed
amendments. However, business acquisitions and dispositions take place
for many reasons, which could make it difficult to isolate the effects
of the proposal from the effects of a host of potentially confounding
factors.
Providing timely, accurate, and transparent information, especially
financial information, about acquired or disposed businesses is
important to mitigate the information asymmetry that exists between
corporate insiders (managers and majority shareholders) and outsiders
(minority shareholders, creditors, etc.). This is especially true in
the context of major corporate transactions such as mergers,
acquisitions, and dispositions, as investors rely on the financial
information of the acquired and disposed businesses to assess the
potential effects of these activities on the registrant. A properly
functioning market for corporate control serves as an important
external governance mechanism involving transactions that potentially
create shareholder value through synergy generation or transferring
assets to more efficient management.\250\ However, in the absence of
appropriate disclosures, investors may not be able to fully assess the
effects of this important external governance mechanism on the firms in
which they invest.
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\250\ See, e.g., M. Mitchell and K. Lehn, 1990, ``Do Bad Bidders
Become Good Targets?'', Journal of Political Economy, Vol. 98; A.
Agrawal and J. Jaffe, 2003, ``Do Takeover Targets Underperform?
Evidence from Operating and Stock Returns'', Journal of Financial
and Quantitative Analysis, Vol 38.
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At the same time, such disclosure requirements impose costs on
registrants that could deter them from engaging in, or diminish the
benefits associated with, acquisitions that are value-enhancing, for
example, where the acquirer has to negotiate for information that may
be costly and burdensome for the acquiree to prepare and provide.
Further, a registrant's ability to provide such disclosure for
[[Page 24632]]
periods prior to its acquisition is often dependent on both the
acquired business and the acquired business's independent auditor. A
registrant's inability to timely obtain such disclosure from these
parties may impact its ability to comply with its reporting
requirements and to access capital within the timeframes it desires.
Thus, streamlining and clarifying acquired business financial
disclosure requirements should reduce the likelihood that such
requirements undermine the economic benefits of potentially value-
enhancing transactions, or otherwise discourage registrants from
engaging in such transactions, while maintaining investors' access to
information that is likely to be material to an understanding of the
potential effects of an acquired or to be acquired business on the
registrant.
We are mindful of the costs imposed by and the benefits obtained
from our rules and amendments. Section 2(b) of the Securities Act,\251\
Section 3(f) of the Exchange Act,\252\ and Section 2(c) of the
Investment Company Act \253\ require the Commission, when engaging in
rulemaking where it is required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider,
in addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation. Additionally,
Section 23(a)(2) of the Exchange Act \254\ requires us, when adopting
rules under the Exchange Act, to consider, among other things, the
impact that any new rule would have on competition and not to adopt any
rule that would impose a burden on competition that is not necessary or
appropriate in furtherance of the Exchange Act.
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\251\ 15 U.S.C. 77b(b).
\252\ 17 U.S.C. 78c(f).
\253\ 15 U.S.C. 80a-2(c).
\254\ 15 U.S.C. 78w(a)(2).
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Below we address the potential economic effects of the proposed
amendments, including the likely benefits and costs, as well as the
likely effects on efficiency, competition, and capital formation. We
attempt to quantify these economic effects when possible; however, due
to data limitations, we are not able to quantify all of the economic
effects.
B. Baseline and Affected Parties
The current disclosure requirements in Rule 3-05, Rule 3-14,
Article 11, and the related smaller reporting company requirements in
Article 8 of Regulation S-X, together with the current disclosure
practices registrants have adopted to comply with these requirements
form the baseline from which we estimate the likely economic effects of
the proposed amendments.\255\
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\255\ See supra Section I.
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The proposals are likely to affect investors both directly and
indirectly through other users of the disclosure (e.g., security
analysts, investment advisers, and portfolio managers), auditors, and
registrants subject to Regulation S-X. Additionally, entities other
than registrants may be affected, such as significant acquirees for
which financial statements are required under Rule 3-05 and Rule 3-14.
The proposed amendments may affect both domestic registrants and
foreign private issuers.\256\ We estimate that during calendar year
2018, approximately 6,919 registrants filed on domestic forms \257\ and
806 foreign private issuers filed on F-forms, other than registered
investment companies. Among the registrants that file on domestic
forms, approximately 29% are large accelerated filers, 19% are
accelerated filers, 19% are non-accelerated filers, and 33% are smaller
reporting companies. In addition, we estimate that approximately 21.3%
of these domestic issuers were emerging growth companies.\258\ About
19.8% of foreign private issuers that filed on Forms 20-F and 40-F were
emerging growth companies. With respect to foreign private issuer
accounting standards, approximately 38% of foreign private issuers
reported under U.S. GAAP, 61% reported under IFRS-IASB, and
approximately 1% reported under Another Comprehensive Body of
Accounting Principles with a reconciliation to U.S. GAAP. Certain of
the proposed amendments may also affect requirements applicable to
issuers that rely on Regulation A and investment companies that must
comply with the requirements of Regulation S-X.
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\256\ The number of domestic registrants and foreign private
issuers affected by the proposed amendments is estimated as the
number of unique companies, identified by Central Index Key (CIK),
that filed Form 10-K, Form 10-Q, Form 20-F, and Form 40-F or an
amendment thereto with the Commission during calendar year 2018. The
estimates for the percentages of smaller reporting companies are
based on information from Form 10-K, Form 20-F, and Form 40-F. The
estimates for the percentages of foreign private issuers' basis of
accounting used to prepare the financial statements are derived from
the information in Forms 20-F and 40-F. These estimates do not
include issuers that filed only initial registration statements
during calendar year 2018, which will also be affected by the
amendments
\257\ This number includes fewer than 25 foreign private issuers
that file on domestic forms and approximately 100 business
development companies.
\258\ Staff determined whether a registrant claimed emerging
growth company status by parsing several types of filings (e.g.,
Forms S-1, S-1/A, 10-K, 10-Q, 8-K, 20-F/40-F, and 6-K) filed by the
registrant, with supplemental data drawn from Ives Group Audit
Analytics.
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Registrants are required to file separate audited annual and
unaudited interim pre-acquisition financial statements of the acquired
business if the acquisition triggers the Rule 1-02(w) significance
tests as modified by Rule 3-05 and Rule 3-14. Because the United States
has one of the most active markets for mergers and acquisitions,\259\
the proposed amendments could affect disclosure for a large number of
businesses. Registrants would potentially be affected by the proposed
amendments if they engage in an acquisition or disposition transaction
(or series of transactions) that is deemed significant under the Rule
1-02(w) significance tests as modified by Rule 3-05 and Rule 3-14 or
the related smaller reporting company requirements in Article 8.
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\259\ A. K. Sundaram, 2004, ``Mergers and Acquisitions and
Corporate Governance,'' Mergers and Acquisitions 3: 193-219; and
2018 J.P. Morgan Global M&A Outlook, available at: https://www.jpmorgan.com/jpmpdf/1320746694177.pdf.
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We are not able to observe the universe of acquisitions by all
registrants, as acquisitions made by registrants that are not deemed
significant or where the acquired businesses are not public firms might
not be identified. For purposes of our Paperwork Reduction Act
(``PRA'') analysis, we searched various form types filed from January
1, 2017 to October 1, 2018 for indications of acquisition or
disposition disclosure.\260\ In the reviewed period there were
approximately 1,261 filings on various forms that included Rule 3-05
Financial Statements or Rule 3-14 Financial Statements, representing
between approximately 1% and 12% of such filings, depending on the
specific form.\261\ To get a sense of overall market activity for
mergers and acquisitions, we also examined mergers and acquisitions
data from Thomson Reuters' Security Data Company (``SDC''). During the
period from January 1, 2016 to December 31, 2018, there were 6,310
mergers and acquisitions entered into by publicly-listed U.S. firms.
Among these transactions, 1,388 acquisitions involved non-U.S. targets
and 442 were conducted by entities in the real estate
[[Page 24633]]
industry.\262\ Additionally, 294 of the 6,310 transactions were
conducted by smaller reporting companies. These estimates constitute an
upper bound on the number of transactions that may have triggered
disclosure requirements under Rule 3-05 or Rule 3-14, and the related
requirements for smaller reporting companies,\263\ as many of these
transactions may have involved acquisitions that are small relative to
the size of the registrant.\264\
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\260\ See Section V.B.1. below for our review of forms filed by
operating companies. We discuss our similar review of investment
company forms in Section V.B.2. below.
\261\ Based on a review of Forms 10, S-1, S-3, F-1, F-3, and 8-
K. See Table 2 in Section V.B.1.
\262\ Real estate industries are defined based on Standard
Industry Classification code (SIC) in 6500s where either the
acquiring companies or the acquiree has the primary SIC code in
6500s.
\263\ Acquisitions that triggered Rule 3-05 or Rule 3-14
Financial Statements requirements are observed by searching EDGAR
filings. Databases such as SDC have some coverage of mergers and
acquisitions conducted by public listed firms in the U.S. However,
when the acquired entities are privately owned, we do not have data
in terms of their assets, income, and often the purchase prices paid
by the acquiring firms. Thus we are not able to provide statistics
on the relative size of these transactions.
\264\ R. Masulis, C. Wang, and F. Xie, 2007 ``Corporate
Governance and Acquirer Returns'' Journal of Finance, 62(4), 1851-
1899 (reporting that the mean (median) relative size of the mergers
in their sample is around 16% (6%) for the period of 1990-2003).
Relative size in this study is measured as the ratio of target
market cap to the acquirer market cap, and the sample is limited to
public firms. We expect the relative size of the acquisitions for
non-public acquirees would be even smaller, but we do not have data
on the size of private firms to provide comparable statistics about
these transactions.
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All investment companies that make fund acquisitions significant
enough to trigger Rule 3-05 disclosure requirements would potentially
be affected by the proposed amendments. Among registered investment
companies, as of the end of calendar year 2018, there were 8,059 open-
end funds, 1,988 exchange-traded funds, and 518 closed-end funds. In
addition, there were 102 business development companies. We are not
able to observe the universe of the fund acquisitions, however, we are
able to observe those transactions that triggered the filing of
acquired fund financial statements. In our PRA analysis, we searched
various form types over a three-year period ended October 1, 2018 for
indications of fund acquisition disclosure. Among the 152 filings on
Form N-14 for fund transactions, about 70 filings or 46% included
acquired fund financial statements. There were only a few filings on
Form N-1A and Form N-2 that included acquired fund financial statements
(12 filings out of 8,936 filings on Form N-1A and two filings out of
132 filings on Form N-2).\265\
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\265\ See infra Section V.B.2, Table 5.
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C. Potential Benefits and Costs of the Proposed Amendments Potential
Benefits
We anticipate the proposed amendments \266\ would improve the
financial information about acquired or disposed businesses, facilitate
more timely access to capital, and reduce the complexity and costs to
prepare the disclosure. Improved disclosure benefits users of financial
information and can facilitate more efficient allocations of capital,
while a reduced disclosure burden can shorten the time period to
prepare disclosures necessary to access capital and typically generates
cost savings for registrants, which can result in more capital being
available for investment.
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\266\ See supra Sections II.A. through II.E.
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The proposed amendments may increase the utility of acquisition and
disposition related disclosures to investors by making these
disclosures more relevant. The proposed amendments should improve the
salience of the information for investors by reducing the volume of
information presented about acquired businesses and focusing the
disclosures on more decision-relevant information. This, in turn, could
lead to more informed investment decisions and improved capital
allocation efficiency.
The proposed amendments may also permit more timely access to
capital. A registrant's ability to provide existing required disclosure
for periods prior to an acquisition is often dependent on both the
acquired (or to be acquired) business and its independent auditor. The
age of the acquired or to be acquired business's required financial
statements, as well as changes in the acquired business's personnel or
its independent auditor that occurred during the historical periods for
which financial statements may be required through the acquisition
date, can impair a registrant's ability to comply with its reporting
requirements and access capital within the timeframes it needs to
operate its business and make investments. By focusing on more recent
historical periods, relying on more relevant disclosure triggers and
definitions, and increasing the relevance of pro forma financial
information, the proposed amendments should help to ameliorate these
impediments, as we discuss in more detail below.
Further, to the extent that the proposed amendments reduce the
compliance burden, they may reduce the cost of merger and acquisition
activity. Well-functioning markets for corporate control are, on
average, beneficial to investors as they serve as a disciplinary
mechanism in which less efficiently managed assets are transferred to
more efficient management. Mergers and acquisitions may also generate
synergies by combining two entities, and may result in firms with more
efficient scale or scope.
Potential Costs
We do not expect the proposed amendments to generate significant
costs for registrants. However, in certain situations the proposed
amendments could cause some acquisitions to be significant that are not
currently deemed significant by acquirers. In these situations,
registrants would need to file Rule 3-05 Financial Statements,
resulting in costs to registrants but potential benefits to investors
in the form of enhanced disclosure related to the transaction. We also
do not anticipate significant costs to investors associated with the
proposed amendments. We acknowledge that in some cases, the proposed
amendments would reduce disclosure. However, we anticipate that the
potential loss of information would be partially mitigated by a
registrant's obligation under Rule 4-01(a) Regulation S-X to include
such further material information as is necessary to make the required
statements, in light of the circumstances under which they are made,
not misleading. Below we discuss the anticipated economic benefits and
costs of specific aspects of the proposed amendments in further detail.
1. Significance Tests
The proposed changes to the significance tests used under Rules 3-
05 and 3-14 should help facilitate registrants' application of the
tests. The proposed amendments could potentially increase the
likelihood that the Investment Test is more in line with the economic
significance of transactions and reduce anomalous results from the
Income Test. This, in turn, should help reduce compliance burdens
associated with preparing Rule 3-05 or Rule 3-14 Financial Statements
for an acquired business.
First, the proposed change to the Investment Test using the
registrant's aggregate worldwide market value rather than its
historical book value of total assets may better reflect the relative
size of the transaction in economic terms. The investment in and
advances to the acquired business generally reflect an acquirer's
expectation of the fundamental value of
[[Page 24634]]
the equity of the acquired business.\267\ Similarly, using market value
of the registrant would be more in line with the market expectation of
the registrant's discounted future free cash flow to equity holders,
and thus may more accurately reflect the fundamental value of the
registrant's equity. By better aligning these two components of the
Investment Test, the proposed amendments would potentially avoid
classifying transactions as significant when they are actually
insignificant in economic substance to the registrant. Further, market
values may better reflect the relative size of the transaction,
especially for high growth acquiring registrants whose market value is
significantly different from their book value.\268\
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\267\ The fundamental value of an entity's equity refers to the
value of equity determined through fundamental analysis. For
example, fundamental value of a firm's equity can be estimated by
summing the discounted stream of expected future free cash flow to
the firm's equity holders.
\268\ See, e.g., A. Shleifer and R. Vishny, 2003, ``Stock Market
Driven Acquisitions'', Journal of Financial Economics.
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Second, the proposed changes to the Income Test to simplify the
calculations and to add a revenue component should improve the
application of the Income Test. These proposed changes are likely to
mitigate the effect of infrequent expenses, gains, and losses on the
calculation and also potentially prevent deeming as significant
immaterial acquisitions by registrants with net income or loss near
zero. Moreover, the proposed change to require the use of readily
available income or loss after tax likely would reduce compliance
burden for registrants as in some cases, the calculation of income
before taxes requires adjustment of line items that are generally
presented on an after-tax basis.
Both proposed amendments to the significance tests are expected to
better capture the importance of the acquisitions relative to the
registrant. To the extent that the proposed changes reduce the risk of
deeming an insignificant acquisition to be significant, they may
benefit registrants by reducing the number of instances in which
registrants are required to file Rule 3-05 Financial Statements or Rule
3-14 Financial Statements, thus reducing compliance burdens. To the
extent that the proposed modifications to the significance tests
capture more significant acquisitions and fewer insignificant ones,
they may directly benefit investors by improving the overall salience
of the information disclosed to them. Investors may also indirectly
benefit from the proposed changes to the significance tests as the
potential cost savings from reduced compliance burdens could be
translated to more capital available to the registrants for future
profitable investments and possibly the ability to access capital
sooner than under existing requirements.
The use of market capitalization instead of book value could raise
questions relating to whether market price reflects a registrant's
fundamental value and the appropriate measurement period to be used. If
a firm's stock price is informationally efficient, it will reflect the
fundamental value of the firm's equity. Any new information, including
information about mergers or acquisitions, might lead investors to
revise their expectations of the firm's risk and future cash flow,
resulting in possible changes in stock price. Information about a
transaction sometimes starts seeping into the stock market several
months before an announcement, leading investors to speculate around
potential mergers or acquisitions.\269\ Thus, the market price of the
registrant's shares might fluctuate depending on the information
available. These and other factors could potentially affect stock price
or the firm's market value. Thus, it is possible that the proposed
changes to the Investment Test might introduce errors or bias into the
determination of the significance of an acquisition.
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\269\ P.J. Halpern, 1973 ``Empirical Estimates of the Amount and
Distribution of Gains to Companies in Mergers'' The Journal of
Business, 46, (4), 554-575; G. Mandelker, 1974 ``Risk and Return:
The Case of Merging Firms'' Journal of Financial Economics, 1, (4),
303-335.
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Additionally, inclusion of a revenue component in the Income Test
may result in an acquired business that has a significant impact on net
income, but not on revenues, not being deemed significant. When the
registrant and its subsidiaries consolidated and the tested subsidiary
have recurring annual revenue, the proposed Income Test would require
both the new revenue component and the net income component to be
met.\270\ As a result, when the profitability of the registrant differs
significantly from the profitability of the acquired business, the
income component could generate a very different result from the
revenue component. This could lead to under-identification of
significant transactions when, for example, a high revenue, low profit
firm acquires a low revenue, high profit firm.
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\270\ In this case, the registrant would use the lower of the
revenue component and the net income component to determine the
number of periods for which Rule 3-05 Financial Statements are
required. See proposed Rule 3-05(b)(2) of Regulation S-X.
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In Section II above, we solicit comment on the impact of these
measurement issues on investors and registrants. We preliminarily
believe, however, that the proposed changes to the significance tests
would improve the application of the tests and their ability to capture
the economic substance of acquisitions and dispositions, which would
benefit investors by helping ensure that they are provided with
decision-relevant information about those acquisitions.
2. Audited Financial Statements for Significant Acquisitions
The proposed amendment to eliminate the requirement to file the
third year of Rule 3-05 Financial Statements would reduce registrants'
disclosure burden. Currently, Rule 3-05 Financial Statements are
required for up to three years prior to the acquisition depending on
the significance of the transaction and the amount of net revenues
reported by the acquired business in its most recent fiscal year. To
the extent that information from three years prior might be less
relevant to investors' analysis of an acquisition, we preliminarily
believe the benefits from the potential reduction in disclosure burden
and audit costs could justify investors' loss of the incremental value
of the third year of financial information. For purposes of the PRA, we
expect the average reduction in registrants' compliance burden as a
result of the proposed amendments would be approximately 125 hours per
Rule 3-05 Financial Statement filing.\271\ In addition to these
compliance cost savings, there could be other and more substantial
benefits from the proposed amendments. For example, if the preparation
and audit of pre-acquisition financial statements are outside of the
registrant's control, and the target company is unable to prepare and
obtain an audit of any required financial statements for the third
year, the registrant will be unable to comply with its disclosure
requirements under Rule 3-05, which could delay the filing of a
registration statement and hence its capital raising efforts.
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\271\ See Table 1 in Section V.B.1.
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The impact of the proposed amendment on investors depends, in part,
on the value of information about the third year. In an efficient
market, information for the third year before an acquisition may not
generally provide significant incremental value to investors to
evaluate a transaction. However, in some cases the omission of
[[Page 24635]]
the third year of Rule 3-05 Financial Statements could result in loss
of information to investors, such as in those limited cases where the
acquired business has an operating cycle that extends beyond two years
and has not previously filed any financial reports. We expect this
potential loss of information to be partially mitigated by a
registrant's Rule 4-01(a) obligation to include such further material
information as is necessary to make the required statements, in light
of the circumstances under which they are made, not misleading.
3. Financial Statements for Net Assets That Constitute a Business and
Financial Statements of a Business That Includes Oil-and-Gas-Producing
Activities
The proposed amendment to permit the use of abbreviated financial
statements in circumstances where providing full audited financial
statements would be impractical should reduce registrants' disclosure
burdens, decrease compliance costs, and facilitate the application of
Rule 3-05. Registrants frequently acquire a component of an entity that
is a business as defined in Rule 11-01(d), but does not constitute a
separate entity, subsidiary, or division, such as a product line, a
line of business contained in more than one subsidiary of the selling
entity, or an interest in oil and gas producing activities that
generates substantially all of its revenues from oil and gas producing
activities. These businesses may not have separate financial statements
or maintain separate and distinct accounts necessary to prepare Rule 3-
05 Financial Statements because they often represent only a smaller
portion of the selling entity. As a result, a registrant may be unable
to provide the financial statements required under the current rule. In
these circumstances, the proposed amendments provide specific
conditions under which registrants would be permitted to file
abbreviated financial statements to comply with Rule 3-05. There would
be no need for the registrant to seek relief from the staff, thus
reducing the compliance burden. We believe allowing for abbreviated
financial statements in these circumstances could help reduce costs for
registrants, and because registrants must otherwise disclose material
information about the acquisition that is necessary to make the
required statements not misleading, we expect that these cost
reductions could be realized without negatively affecting investors.
4. Timing and Terminology of Financial Statement Requirements
The proposed amendments include several revisions that clarify the
timing and some terminology related to the disclosure requirements.
These clarifications should benefit registrants by avoiding any
confusion that may arise from application of the current requirements,
thereby enhancing the overall efficiency of their compliance efforts.
Because the proposed changes do not modify the information required to
be disclosed, we do not believe investors would be negatively affected
by these proposed changes. To the extent that these proposed changes
make compliance more efficient for registrants, investors may
indirectly benefit as cost savings could be passed through to them.
5. Foreign Businesses
The proposed amendments would allow Rule 3-05 and Rule 3-14
Financial Statements to be prepared in accordance with IFRS-IASB
without reconciliation to U.S. GAAP if the acquired business would
qualify to use IFRS-IASB if it were a registrant. Preparing financial
statements without reconciliation to U.S. GAAP in these circumstances
would reduce the compliance costs where an acquired business in a
cross-border acquisition does not have U.S. GAAP financial statements.
It may also expand the pool of foreign entities that would be
considered valuable potential acquisition targets. For example, a
registrant might be discouraged under the current rules from completing
a cross-border acquisition in situations where it would be costly for
the foreign target to prepare its financial statements using U.S. GAAP
as required by the current rules.
The proposals would also permit foreign private issuers that
prepare their financial statements using IFRS-IASB to provide Rule 3-05
and Rule 3-14 Financial Statements prepared using home country GAAP to
be reconciled to IFRS-IASB rather than U.S. GAAP. Permitting use of
Rule 3-05 and Rule 3-14 Financial Statements reconciled to IFRS-IASB in
these circumstances potentially benefits investors by providing them
with information about the acquired business that is more comparable to
the registrant. This may allow investors to analyze the impact of these
acquisitions more expeditiously.
By providing flexibility to prepare an acquired (or to be acquired)
business's financial statements using, or reconciling to, IFRS-IASB in
these circumstances, the proposed amendment may facilitate certain
cross-border mergers that might otherwise not take place due to
compliance costs associated with preparing financial statements using,
or reconciling to, U.S. GAAP. Based on data from the SDC merger
database for the three year period from January 2015 to January 2018,
about 20% of acquisitions by U.S. companies involved non-U.S. targets.
To the extent that the proposed amendment leads to increased cross-
border mergers and acquisitions, shareholders could potentially benefit
from greater growth potential in new markets, more efficient
distribution systems, or improved managerial processes, among other
benefits.\272\
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\272\ See, e.g., K. Ahern, 2015, ``Lost In Translation? The
Effect of Culture on Mergers Around the World'', Journal of
Financial Economics, 117, P165-189.
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A possible consequence from the proposed amendments would be
inconsistencies in financial disclosure about acquired (or to be
acquired) businesses where IFRS-IASB and U.S. GAAP differ significantly
in reporting practices. For example, there are certain differences in
the recognition, measurement, and impairment of long-lived assets
between IFRS-IASB and U.S. GAAP.\273\ Such inconsistencies could lead
to confusion and a loss of comparability for investors of domestic
registrants familiar with U.S. GAAP financial statements. Despite
potential inconsistencies, we preliminarily do not expect the proposed
amendment to impose substantial costs on investors. Foreign private
issuers have been permitted to file IFRS-IASB financial statements
without reconciliation to U.S. GAAP for some time,\274\ and IFRS-IASB
is widely used for financial reporting purposes in other jurisdictions.
In that respect, we do not believe using or reconciling to IFRS-IASB
financial statements for businesses in foreign jurisdictions would
necessarily lower the disclosure standard or cause undue confusion. In
addition, pro forma financial information for the acquisition is
required to reflect the acquired foreign business on the same basis of
accounting as that of the registrant. For a U.S. registrant, that basis
would be U.S. GAAP, which should mitigate any potential inconsistencies
in the pre-acquisition historical financial
[[Page 24636]]
statements. However, we encourage commenters to provide us with
information about these potential costs.
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\273\ As an example, IFRS-IASB permits the recognition of
internally-generated intangible assets in limited circumstances;
U.S. GAAP does not.
\274\ See Acceptance From Foreign Private Issuers of Financial
Statements Prepared in Accordance With International Financial
Reporting Standards Without Reconciliation to U.S. GAAP, Release No.
33-8879 (Dec. 21, 2007) [73 FR 986 (January 4, 2008)].
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6. Omission of Rule 3-05 and Rule 3-14 Financial Statements and Related
Pro Forma Financial Information for Businesses That Have Been Included
in the Registrant's Financial Statements
The proposed amendments allowing registrants to omit Rule 3-05 and
Rule 3-14 Financial Statements from Securities Act registration
statements and proxy statements after inclusion in post-acquisition
results for a complete fiscal year could improve such registrants'
timely access to capital. For example, registrants currently have to
test the significance of acquisitions that occurred during the earliest
years for which the registrant is required to provide historical
financial statements and, if significant, to provide pre-acquisition
financial statements of the acquired business. We expect the proposed
amendments to be especially useful for registrants that complete an
initial public offering, as those registrants are most likely not to
have been required to file Rule 3-05 and Rule 3-14 Financial Statements
before filing their initial registration statements. In these
instances, a registrant might need to spend additional time or
resources, or both, to prepare Rule 3-05 and Rule 3-14 Financial
Statements for inclusion in a registration statement, which can delay a
registrant's offering and hence delay its access to capital. In
addition to anticipated benefits resulting from more timely access to
capital, registrants may benefit from reduced compliance costs.
We believe that information from the historical pre-acquisition
period is not as relevant once integration of the acquisition is
completed. Additionally, in acquisitions where integration takes longer
than a year, investors would still receive disclosure about material
effects of the acquisition through the registrant's management's
discussion and analysis.\275\ We therefore do not expect the proposed
amendments to result in a meaningful loss of material information to
investors. Instead, the reduction in compliance burdens and the timely
access to capital may indirectly benefit investors.
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\275\ See 17 CFR 229.303.
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7. Use of Pro Forma Financial Information To Measure Significance
The proposed amendments permit the use of pro forma financial
information to measure significance in initial registration statements.
This approach provides registrants with certain flexibility to more
accurately measure the relative significance of an acquisition or
disposition, which in turn may help reduce their disclosure burden and
compliance costs and facilitate capital formation. Because pro forma
financial statements may capture the likely effects of significant
acquisitions and dispositions that are not fully reflected in the
registrant's historical financial statements (financial statements that
would otherwise be used to measure significance), these amendments
could enable registrants to more accurately determine the significance
of these transactions.
The proposed amendments could potentially reduce the amount of
information presented to investors if significance determinations on
the basis of pro forma financial statement information fail to identify
acquisitions that are economically significant to a registrant.
However, as noted above, Rule 4-01(a) requires registrants to include
such further material information as is necessary to make the required
statements, in light of the circumstances under which they are made,
not misleading. We expect this requirement to address concerns about
any loss of relevant information to investors.
8. Disclosure Requirements for Individually Insignificant Acquisitions
Registrants are currently required to provide certain audited,
historical pre-acquisition financial statements if the aggregate impact
of ``individually insignificant businesses'' acquired since the date of
the most recent audited balance sheet exceeds 50%.\276\ In these
circumstances, pro forma financial information is also required
pursuant to Article 11 for the ``individually insignificant
businesses'' for which audited, historical pre-acquisition financial
statements are required.\277\ To comply with these requirements,
registrants may need to provide audited financial statements of
acquired businesses that are not material to the registrant, and pro
forma financial information that might not reflect the aggregate effect
of the ``individually insignificant businesses.''
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\276\ See supra note 115.
\277\ See supra note 118.
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The proposed amendments would affect disclosure requirements for
individually insignificant businesses in several ways. First, the
proposed amendments would require the registrants to provide audited
historical financial statements only for those acquired businesses
whose individual significance exceeds 20%. Reducing required disclosure
of audited historical financial statements for insignificant
acquisitions could improve registrants' access to capital since
preparing such disclosure for these acquisitions typically entails
negotiating with the seller to timely provide this information, a
process that can be costly and time-consuming. By simplifying and
streamlining the historical financial statement disclosure requirement
for individually insignificant acquisitions, the proposed amendments
may make it easier, quicker, and cheaper for registrants to access
capital. The proposed amendments would also reduce registrants'
disclosure burdens leading to cost savings that may ultimately benefit
shareholders.
Second, the proposed amendments could improve the completeness of
information provided to investors by requiring pro forma financial
information that depicts the aggregate effect in all material respects
of the acquired businesses, rather than only a mathematical majority of
the individually insignificant businesses acquired. Investors might
benefit by being able to more effectively assess the aggregate effect
of these acquisitions on the registrant as a result of the proposed
amendments.
The proposed amendment might impose additional compliance burdens
on registrants because it could require registrants to present
information about acquisitions, albeit in an aggregated form, that they
have not disclosed in the past. Because we do not have information
available to estimate the number of acquisitions that would be subject
to this proposed requirement in aggregate or for any given registrant,
we cannot quantify these compliance costs. However, we do not expect
registrants to incur substantial costs to prepare disclosure about such
acquisitions because these are activities that typically underpin the
decision to make an acquisition.
9. Rule 3-14--Financial Statements of Real Estate Operations Acquired
or To Be Acquired
The proposed amendments would align Rule 3-14 with Rule 3-05 where
no unique industry considerations warrant differentiated treatment of
real estate operations. For example, the proposed amendments would
align the threshold for individual significance for both rules at
``exceeds 20%'' and the threshold for aggregate significance for both
rules at ``exceeds 50%''. The proposed amendments would also align Rule
3-14 and Rule 3-05 in terms of the years of required financial
statements for acquisitions from related parties, the timing of
filings, application of Rule 3-
[[Page 24637]]
06, which permits the filing of financial statements covering a period
of nine to 12 months, and other less significant changes.
The proposed amendments are expected to benefit registrants as
greater consistency in application of the rules may reduce the costs of
preparing disclosure, especially for registrants that make both real
estate and non-real estate acquisitions. In addition to the alignment
between Rule 3-14 and Rule 3-05, the proposed amendments also define
real estate operation as a business that generates substantially all of
its revenues through the leasing of real property. This may reduce
potential uncertainty and ambiguity in applying Rule 3-14 without
negatively affecting investors.
The proposed amendments would also establish or clarify the
application of Rule 3-14 regarding scope of the requirements,
determination of significance, need for interim income statements, and
special provisions for blind pool offerings. The proposed amendments
related to blind pool offerings are consistent with current practice
for these offerings. Thus, while they may reduce potential compliance
uncertainty and ambiguity for registrants, we do not expect the
proposed amendments to have a substantial effect on current disclosure
practices.
10. Pro Forma Financial Information
The proposed amendments to replace the existing pro forma
adjustment criteria in Article 11 of Regulation S-X with Transaction
Accounting Adjustments and Management's Adjustments would simplify
these requirements and reduce potential inconsistency in preparing pro
forma financial information. The proposed amendments to Article 11
could benefit investors in several ways. First, the proposed
Transaction Accounting Adjustments may lead to more consistent pro
forma presentations than the current adjustment criteria, which may be
subject to some interpretation. In addition, the proposed Transaction
Accounting Adjustments may permit registrants to better reflect the
acquisition, disposition, or other transaction, which could help
investors better understand the effects of the acquired business to the
registrant's audited historical financial statements. Likewise, the
proposed Management's Adjustments, which require disclosure of
reasonably estimable synergies and other transaction effects, such as
closing facilities, discontinuing product lines, terminating employees,
and executing new or modifying existing agreements, that have occurred
or are reasonably expected to occur, may give investors better insight
into the potential effects of the transaction as contemplated by the
company. This would potentially benefit investors in helping them to
distinguish the accounting effects of the acquisitions from
management's judgment as to the expected operational effects based on
management plans. Altogether, the proposed amendments are expected to
improve the relevance of the information disclosed to investors and
help investors process information more effectively.
The proposed revisions to Article 11 could impose costs on
registrants because they would be required to meet new presentation
requirements for pro forma adjustments. For purposes of the PRA, we
estimate the average incremental compliance burden for these new
requirements would be around 25 hours per affected registrant.\278\
Further, synergy estimation by registrants may introduce certain
subjective judgments into the pro forma financial statements,
potentially making them more difficult for investors to interpret.
However, the proposed amendments also would require registrants to
disclose uncertainties, assumptions, and calculation methods underlying
the Management's Adjustments. This could mitigate the risk of biased
pro forma adjustments by providing investors with more information to
evaluate Management's Adjustments when analyzing the impact of an
acquisition.
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\278\ See Table 1 in Section V.B.1.
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11. Significance and Business Dispositions
The proposed amendment to conform the significance threshold for a
disposed business to that of an acquired business and eliminate
disclosure of less significant dispositions would reduce
inconsistencies in reporting between acquisitions and dispositions and
potentially reduce registrants' compliance burden.\279\ For example,
under the proposed amendments, registrants would not have to file pro
forma financial information for insignificant dispositions (e.g.,
dispositions with significance levels exceeding 10% but not 20%), thus
reducing compliance costs. In addition, there could be some positive
spillover effect for registrants from applying the same thresholds to
determine the significance of their transaction. For example, a
registrant might engage in both acquisitions and dispositions during
the same reporting period. Identical thresholds might help achieve
internal consistency in financial reporting in evaluating the impact of
both types of transactions as well as the net effects. For investors,
the proposed amendment to conform the significance threshold for a
disposed business to that of an acquired business could facilitate
understanding and analysis of Rule 3-05 and Rule 11-01(b) disclosures
by eliminating the inconsistency in reporting between acquisitions and
dispositions.
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\279\ Under current requirements, pro forma financial
information is required upon the disposition (and for certain
registration statements and proxy statements, the probable
disposition of a significant portion of a business if the business
to be disposed of meets the conditions of a significant subsidiary
under Rule 1-02(w)). Rule 1-02(w) uses a 10% significance threshold,
not the 20% threshold used for business acquisitions under Rules 3-
05 and 11-01(b).
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12. Smaller Reporting Companies and Regulation A
The proposed amendments would revise Rule 8-04 to direct smaller
reporting companies to Rule 3-05 for requirements relating to the
financial statements of businesses acquired or to be acquired, although
the form and content requirements for these financial statements would
continue to be governed by Article 8. The proposed revisions to Rule 8-
04 would also apply to issuers relying on Regulation A. Since the form
and content of the required financial statements would continue to be
prepared in accordance with Article 8, we do not believe the proposed
amendments would impose additional compliance costs on affected
entities and do not expect the amendments to reduce information
available to investors.
The proposed amendments to require smaller reporting companies to
provide pro forma financial information for significant acquisitions
and dispositions made during annual periods and to use the enhanced
guidelines in Article 11 when preparing pro forma financial information
would increase the burden on smaller reporting companies. However,
based on a staff analysis of 2017 disclosures of acquisitions and
dispositions by smaller reporting companies, we believe most already
comply with the conditions in Article 11.\280\ As a result, we do not
expect that the proposed amendments would impose significant new costs
on these entities. At the same time, the proposed amendments to require
smaller reporting companies to provide pro forma financial information
for significant acquisitions and dispositions made during annual
periods and to use the enhanced guidelines in Article 11
[[Page 24638]]
when preparing pro forma financial information may provide more
relevant information to investors, although this benefit also would be
limited to the extent that smaller reporting companies already comply
with these requirements in practice.
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\280\ See supra note 208.
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13. Amendments to Financial Disclosure About Acquisitions Specific to
Investment Companies
We believe the proposed amendments related to investment companies
would reduce compliance burdens by streamlining the disclosure
requirements in a way that is tailored to the specific attributes of
acquisitions made among investment companies. We do not anticipate
significant costs to investors related to the proposed amendments,
because we do not believe the proposed amendments would result in a
reduction in the volume of material information available to investors.
Currently, there are no specific rules or requirements in
Regulation S-X for investment companies relating to the financial
statements of acquired funds. Instead, these entities apply the general
requirements of Rule 3-05 and the pro forma financial information
requirements in Article 11. However, investment company registrants
differ from non-investment company registrants in several respects. For
example, investment companies' income mainly stems from capital
appreciation and investment income; \281\ investment companies are
required to report their net asset value on a daily basis using fair
value for portfolio investments; and investment companies do not
account for their investments using the equity method. As a result,
investment companies have faced challenges applying the general
requirements of Rule 3-05 and Article 11 in the context of fund
acquisitions.
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\281\ Investment income includes dividend, interest on
securities, and other income, but does not include net realized and
unrealized gains and losses on investments. See Rule 6-07 of
Regulation S-X.
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The proposed amendments include a separate definition of
significant subsidiary and separate significance tests specifically
tailored for investment companies. The proposed amendments focus the
significance determination for investment companies on the impact to
the registrant's investment portfolio held by the registrant. Further,
the proposed test would capture sources of income such as dividends,
interest, and the net realized and unrealized gains and losses on
investment that are most relevant to investment companies. We expect
that together the proposed amendments would benefit both investment
companies and their investors by providing more appropriate standards
for determining the significance of fund acquisitions. For example, the
proposed income test would better align income from a particular
investment or acquisition for purposes of analyzing the effect on the
income of the investment company as a whole. We thus expect the
proposed income test to better reflect the impact of the tested
subsidiary on an investment portfolio rather than a test based solely
on investment income as used in current Rule 8b-2. This is because
changes in the market value of an investment portfolio due to market
volatility may be substantial even when the securities held in the
portfolio do not produce investment income.
As a result of these changes, the proposed amendments may more
accurately identify acquisitions that are economically significant to
investment company registrants. This would benefit registrants as they
would not be required to prepare separate financial disclosure for
economically insignificant acquisitions. The proposed amendments also
may benefit investors to the extent that investors' attention now is
inappropriately focused on economically insignificant acquisitions that
are deemed significant under current rules. Furthermore, we do not
anticipate the proposed significance tests would impose substantial
costs on registrants to implement because we believe the required
measures should be readily available to registrants.
The proposed change in the significance thresholds for the income
test in Rule 1-02(w) when it applies to investment companies has two
prongs--either a threshold of 80% for income alone or a 10% threshold
with the investment test result higher than 5%. This proposed threshold
change might reduce the compliance burden faced by investment companies
as there would be less need to produce additional financial information
when a registrant's net income is relatively small. Smaller net income
could produce anomalous results under the current income test as it may
make it appear as if an acquisition or investment is a significant
contribution to a registrant's net income when it represents only a
very small portion of the registrant's portfolio of investments. By
effectively conditioning the income test for investment companies on
the investment test for investment companies, the proposed amendments
would potentially better identify fund acquisitions that warrant
additional disclosure. This proposed change also could benefit
investors to the extent that they place a higher weight on the value of
investments, relative to the income produced by investments, when
considering the economic impact of an acquisition.
The proposed elimination of an asset-based test for investment
companies would simplify compliance while likely not resulting in a
significant loss in information. An asset-based test is generally not
meaningful when applied to investment companies and, when the acquired
entity is another investment company, would be largely superfluous in
light of the proposed investment test. Additionally, applying the asset
test could be less meaningful when the tested subsidiary is not another
investment company. Because the asset test in these circumstances would
involve comparing assets measured under different methodologies, it may
be a less reliable indicator of significance, causing registrants to
incur costs to prepare disclosures for acquisitions that are not
economically significant--and therefore of little benefit to investors.
Proposed new Rule 6-11 potentially reduces compliance burdens by
setting forth financial statement requirements for acquired funds that
are specifically tailored for investment companies as compared to Rule
3-05. Proposed Rule 6-11 would consider the acquisition of all or
substantially all portfolio investments held by another fund as a fund
acquisition. This principles-based facts and circumstances evaluation
of whether a fund acquisition has occurred could potentially reduce
avoidance of any required acquired fund disclosures by focusing on
economic substance rather than legal form. The proposed requirement of
one year of audited financial statements for fund acquisitions and
elimination of pro forma financial statements would also reduce
compliance burdens for registrants. We do not believe these proposed
amendments would lead to loss of relevant information to investors, as
the price of investment company shares is calculated daily based on the
fair value of its investment portfolio and older historical financial
statements are in general less relevant to fund investors. The proposed
amendments also would be consistent with the accommodations typically
provided by our disclosure review staff during consultations. The
proposed use of permitting investment companies to provide financial
statements for private funds that were prepared in accordance with U.S.
GAAP would reduce compliance burdens for investment companies by
potentially reducing the costs related to re-issuing audited
[[Page 24639]]
financial statements in compliance with Regulation S-X. Any loss of
information arising from these amendments would be mitigated by that
fact that we are proposing to require investment companies to file the
schedules required under Article 12 of Regulation S-X and to provide
certain supplemental information regarding the acquired funds. We
believe this information would be more relevant and potentially enhance
the efficiency in processing the information by fund investors. These
supplemental disclosures, however, would entail costs to registrants.
For purposes of the PRA, we estimate the average incremental compliance
burden for this additional disclosure would be around 25 hours per
affected registrant. We further estimate that proposed Rule 6-11 would
reduce a registrant's compliance burden by approximately 100 hours.
D. The Effects on Efficiency, Competition, and Capital Formation
We anticipate that the proposed amendments would have favorable
effects on efficiency, competition, and capital formation for both
operating companies and investment companies. Amendments that reduce
disclosure burdens for registrants regarding business acquisitions
would tend to facilitate registrants' engagement in acquisitions that
otherwise might not take place due to barriers to compliance or other
compliance costs. An active takeover market creates efficiencies by
transferring inefficiently managed assets to more efficient management
or by creating synergies through economy of scale or economy of scope.
On average mergers and acquisitions benefit investors in the acquired
business.\282\
---------------------------------------------------------------------------
\282\ Empirical studies have shown that around M&A
announcements, the target firms earn a significant abnormal return
(See, e.g., G. Mandelker, 1974, ``Risk and Return: The Case of
Merging Firms'' Journal of Financial Economics, 1, (4), 303-335;
M.C. Jensen & R.S. Ruback, 1983, ``The Market for Corporate Control:
The Scientific Evidence'' Journal of Financial Economics, 11, (1-4),
5-50.
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The proposed amendments to revise the disclosure relating to
acquired and disposed businesses would benefit registrants by
potentially reducing compliance burdens and facilitating more timely
access to capital. Considering all registrants, including both
operating companies and investment companies, for PRA purposes, the
estimated reduction in the total number of incremental burden hours
required for compliance with all forms from the proposed amendments is
about 82,225 company hours.\283\ The resulting total incremental
professional costs for all forms under the proposed amendments would be
a reduction of approximately $21,470,000.\284\ We believe the potential
cost savings from the proposed amendments are significant.
---------------------------------------------------------------------------
\283\ See Column E of Table 9 in Section V.C. below.
\284\ See Column F of Table 9 in Section V.C. below.
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At the same time, we do not believe investors would face a
significant loss in information as a result of the proposed amendments.
Instead, we expect that the proposed amendments would provide investors
with more relevant information, which may allow them to process the
information more efficiently, enhancing their investment decisions and
thus potentially facilitating capital formation. Additionally, reduced
regulatory complexity may lead to an increase in mergers and
acquisitions. Under the existing disclosure requirements related to
acquired businesses, some mergers may not be feasible due to the
impracticality of compliance with Rule 3-05 Financial Statement
requirements (e.g., a private business may not have more than two years
of audited financial statements, but the transaction may trigger
additional disclosure because the business crosses the highest
significance threshold). Under the proposed amendments, registrants
might have access to a larger set of potential acquisitions. The
proposed amendments may also facilitate potentially value-enhancing
acquisitions that might otherwise not take place due to the
impracticability of compliance with current rules. For example, the
proposed amendments permitting the use of abbreviated financial
statements when acquiring certain business lines may decrease the
acquisition costs for registrants. This could promote competition in
the market for mergers and acquisitions and potentially benefit
shareholders of acquired businesses. Better disclosure quality and an
improved information environment could also facilitate the market for
mergers and acquisitions, which would help achieve efficient capital
allocation and exert effective external control mechanisms on public
firms, leading to an overall increase in efficiency.\285\
---------------------------------------------------------------------------
\285\ Studies have found that mergers may create shareholder
value when the assets are transferred from inefficient management to
more efficient management. M. Mitchell and K. Lehn, 1990, ``Do Bad
Bidders Become Good Targets?'', Journal of Political Economy, Vol.
98; A. Agrawal and J. Jaffe, 2003, ``Do Takeover Targets
Underperform? Evidence from Operating and Stock Returns'', Journal
of Financial and Quantitative Analysis, Vol 38. K. Lehn and M. Zhao,
2006, ``CEO Turnovers after Acquisitions: Are Bad Bidders Fired?'',
Journal of Finance, Vol 61.
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E. Alternatives Considered
1. Approaches to the Significance Tests
One alternative to the proposed significance tests would be to
adopt a principles-based framework, such as materiality, rather than
the current bright-line tests for determining when financial statements
of acquired or to be acquired businesses are required. The benefit of
using a principles-based approach based on materiality to determine
significance is that it would permit judgment and consideration of
unique facts and circumstances. An additional benefit of such an
approach is that materiality is a familiar concept to registrants who
currently make materiality determinations in preparing their filings
with the Commission. However, while a principles-based approach is
frequently the appropriate standard for registrants to apply when
preparing disclosures, determinations related to business acquisitions
and dispositions pose unique challenges. Unlike periodic reporting,
acquisitions and dispositions tend to be episodic, and moreover, there
is less similarity between such transactions. As a result, it can be
difficult for registrants to efficiently make a determination of
materiality in an acquisition context, where timing considerations can
be paramount.
Furthermore, unlike disclosure that relates solely to the
registrant, which is prepared by the registrant on an ongoing basis,
and where materiality is therefore evaluated regularly, in an
acquisition context registrants must rely on information provided by
third parties to make a determination of whether the acquisition is
significant and whether the related disclosure is material. A bright-
line test provides registrants with a level of certainty that allows
them to efficiently make determinations of what level of disclosure is
required in an environment where delay is costly. Also, where a
registrant determines not to provide disclosure, investors would not
receive information about the acquired business's financial impact on
the registrant until the operating results of the acquired business
have been reflected in the consolidated financial statements of the
registrant for an extended period of time. As a result, the impact of
the acquisition may be difficult for investors to disentangle from
other events at the registrant, even where the acquisition may be
economically significant. Thus, in summary, we expect a bright-line
threshold in the case of these disclosures could be less costly for
registrants and result in more consistent disclosure to investors where
[[Page 24640]]
transactions are of economic significance to a registrant.
The Investment Test under the existing Rule 3-05 compares the
registrant's investment in and advances to the acquired business
against the carrying value of the registrant's total assets. The
proposed amendment to the ``Investment Test'' would use the aggregate
worldwide market value of the registrant's voting and non-voting common
equity calculated on the last day of the most recent fiscal year at or
prior to the acquisition. As an alternative to the proposed investment
test, we could have proposed requiring registrants to use enterprise
value for the acquirer and the acquired business, rather than the value
of common equity (for the acquirer) and investment in and advances to
the acquired business. Enterprise value may more comprehensively
reflect the value of the entity because it includes equity, debt,
minority interests, and preferred shares. When a registrant makes an
acquisition, depending on the ownership structure and capital structure
of the registrant and the acquired business, the purchase price or
investment in the acquired business would not necessarily reflect the
total effect of the acquisition on the registrant, particularly if the
acquired business is highly levered. Enterprise value would take into
consideration the leverage of the acquired business and may, in such
cases, better capture the economic effects of the transaction.
Enterprise value, however, may not be appropriate for an acquirer or
acquiree that has substantial liquid assets on its balance sheet.
Additionally, enterprise value may not be a consistent indicator of
relative size across registrants because capital structure (i.e.,
leverage) may be very different among registrants in certain
industries.
With respect to the proposed modification to the Investment Test,
as noted earlier, because investors react to news and information, the
anticipation of an acquisition could cause a change in equity value of
both the potential acquirer and the potential acquired firm. More
generally, the market values of registrants are expected to change with
market conditions as well as firm-specific information. As a result, it
is possible that our proposed approach to the Investment Test, which
would require measurement of investments in an acquisition against the
acquirer's aggregate worldwide market value on the last day of the most
recent fiscal year at or prior to an acquisition, might not reflect all
the information about the value of the acquirer. As an alternative, we
could have proposed to require the registrant to use its average market
value over a period of time rather than on a specific day when
measuring the size of its investments. This approach would avoid
situations in which positive or negative market-wide or firm-specific
shocks lead to noisy measures of market value that result in inaccurate
assessments of significance, which may over- or under-identify
significant acquisitions. However, using average market value could
increase the costs and complexity of the proposed rule for registrants
and would raise questions about the appropriate choice of a required
measurement period (e.g., over a specified number of months or over the
entire reporting period).
One alternative to the proposed Income Test would be to replace the
existing income test with a revenue test. A potential benefit of this
approach is that a revenue test would be less likely to produce
anomalous results because it does not include infrequent expenses,
gains, or losses that can distort the determination of relative
significance. However, a stand-alone revenue test may not be a
meaningful indicator of significance for the reasons the Commission
described when it eliminated revenue as a standalone significance
test.\286\
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\286\ See Release No. 6359 (November 6, 1981) [46 FR 56171
(November 16, 1981)] (``The proposed amendment reflects the
Commission's view that the presentation of additional financial
disclosures of an affiliated entity may not be meaningful in
instances in which the affiliate has a high sales volume but a
relatively low profit margin, and therefore has little financial
impact on the operating results of the consolidated group.'').
---------------------------------------------------------------------------
A second alternative to the proposed Income Test would involve
switching from an income component to a revenue component when the
acquirer's net income or loss is marginal or break-even. Such an
alternative could rely on another financial ratio, such as return on
assets, to identify instances where the acquirer's net income is
sufficiently low to yield anomalous results from the income component.
For example, under such an alternative, the revenue component would be
used instead of the income component if the absolute value of the
acquirer's return on assets were less than one percent. Relative to the
proposed Income Test, such an alternative may have a lower risk of
under-identification of significant transactions if the proposed
revenue component causes transactions to not be significant under the
Income Test when the acquirer's net income is not marginal or break-
even and the Investment Test and Asset Test are not met. However, such
an approach would require identifying a financial ratio to serve as the
trigger for a switch from the income component to the revenue component
and, absent calibration, such a ratio may yield inconsistent results
across industries. For example, an appropriate threshold for return on
assets may vary across industries depending on the extent of an
acquirer's reliance on human capital versus material capital. Moreover,
for those that rely heavily on material capital, the information
provided by a return on assets threshold may be subsumed by the
existing Asset Test.
A third alternative to the proposed Income Test would be to use an
operating income or profit margin component instead of the income
component. Operating income or profit margin could be a better
indicator of significance than the income component in that it may
eliminate the effects of non-operating items such as interest expense.
However, not all registrants report these income measures, and these
measures share the same issues as net income, which could lead to
similarly anomalous results.
A final alternative to the proposed Income Test would be to lower
the threshold required to meet the revenue component, for example to
15% or 10%. A potential benefit of this approach is that it may
mitigate the risk of under-identification of significant transactions.
However, it may be difficult to calibrate the income component and
revenue component thresholds in a way that decreases the risk of under-
identification without increasing the risk of over-identification.
2. Approaches to Proposed Financial Statement Requirements
An alternative to the required Rule 3-05 or Rule 3-14 Financial
Statements would be to require U.S. GAAP or IFRS-IASB, as applicable,
business combination disclosures, which include, among other things,
supplemental pro forma information about revenue and earnings for the
two years prior to the acquisition. Under this regime, registrants are
required to disclose information that enables users of a registrant's
financial statements to evaluate the nature and financial effect of a
business combination that occurs either: (a) During the current
reporting period, or (b) after the reporting date but before the
financial statements are issued or are available to be issued.\287\
These disclosures would eventually be required to be included in
registrants' historical audited financial statements presented for the
period in which the acquisition occurred, although the supplemental
information may continue
[[Page 24641]]
to be labeled as unaudited. However, compared with our proposed
approach, less information would be disclosed to investors under this
alternative, and the information would not be audited. Further,
guidance about the presentation and preparation of supplemental pro
forma information is limited, which potentially may impact the
consistency of pro forma presentations between registrants.
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\287\ See FASB ASC 805-10-50-1.
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3. Approaches to Proposed Pro Forma Adjustments
An alternative to the proposed Management's Adjustments for pro
forma financial statements is to limit the Management's Adjustments to
those that have been previously filed or furnished in Commission
filings. A potential benefit of this approach is that it would permit
the registrant to better determine whether and, if so, when forward-
looking information should be disclosed. The disadvantage of this
alternative is that pro forma disclosures may omit known information
such as reasonably estimable synergies and other transaction effects
that have occurred or are likely to occur. Also, under this
alternative, pro forma disclosures may not depict the potential effect
of the transaction on the registrant fully.
4. Alternatives to the Proposed Income Test for Investment Companies
One alternative to the proposed income test for investment
companies would be to use the absolute value of gains and losses within
the income test components rather than netting them. Because netting
losses against gains mitigates the effect of individual securities on
overall results of the portfolio, the use of absolute value of gains
and losses for individual securities could result in a more accurate
assessment of the effects of the acquired fund securities on the income
of the acquiring fund. However, under this alternative, the registrant
would need to re-calculate the gain or loss for each individual
security using absolute value for both the acquiring fund and the
acquired fund, rather than using existing financial measures that have
already been determined for the financial statements, thereby
increasing the cost and complexity of the proposed test for registrants
without necessarily providing significant incremental benefits to
investors.
Another alternative to the proposed income test for investment
companies would be to select a percentage lower than 80% for the
significance test. One potential benefit of using a lower percentage is
that it could reduce the possibility that an investment company
registrant would not need to provide disclosure for a fund acquisition
with a material impact on the acquiring fund's income. However, it
could also increase the possibility that costly disclosure obligations
would be triggered, even though the impact on the registrant's assets
is non-material (particularly if the income of the acquiring fund is
relatively low). The proposed combination of income/investment test is
intended to mitigate this result.
Request for Comment
We request comment on all aspects of our economic analysis,
including the potential costs and benefits of the proposed amendments
and alternatives thereto, and whether the rules, if adopted, would
promote efficiency, competition, and capital formation or have an
impact on investor protection. Commenters are requested to provide
empirical data, estimation methodologies, and other factual support for
their views, in particular, on costs and benefits estimates.
V. Paperwork Reduction Act
A. Summary of the Collection of Information
Certain provisions of our rules and forms that would be affected by
the proposed amendments contain ``collection of information''
requirements within the meaning of the PRA.\288\ The Commission is
submitting the proposal to the Office of Management and Budget
(``OMB'') for review in accordance with the PRA.\289\ The hours and
costs associated with preparing and filing the forms and reports
constitute reporting and cost burdens imposed by each collection of
information. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information requirement unless
it displays a currently valid OMB control number. Compliance with the
information collections is mandatory. Responses to the information
collections are not kept confidential and there is no mandatory
retention period for the information disclosed. The titles for the
affected collections of information are: \290\
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\288\ See 44 U.S.C. 3501 et seq.
\289\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\290\ A number of forms require audited financial statements and
therefore could also include information required by Rule 3-05 and
Rule 3-14 such that the proposed amendments could affect the PRA
burden associated with those forms. Based on staff experience,
however, Rule 3-05 or Rule 3-14 Financial Statements are not
generally included in these forms. The potentially affected Forms
include ``Form S-4'' (OMB Control No. 3235-0324), ``Form S-11'' (OMB
Control No. 3235-0067), ``Form F-4'' (OMB Control No. 3235-0325),
``Form 20-F'' (OMB Control No. 3235-0288), ``Form 10-K'' (OMB
Control No. 3235-0063), ``Regulation 14A'' and ``Schedule 14A'' (OMB
Control No. 3235-0059), ``Regulation 14C'' and ``Schedule 14C'' (OMB
Control No. 3235-0057), ``Form 10-Q'' (OMB Control No. 3235-0070),
``Form 1-K'' (OMB Control No. 3235-0720), and ``Form 1-SA'' (OMB
Control No. 3235-0721). While the proposed amendments would also
apply to registered investment companies, based on staff experience,
Rule 3-05 or Rule 3-14 Financial Statements are not generally
included in ``Form N-3'' (OMB Control No. 3235-0316), ``Form N-4''
(OMB Control No. 3235-0318), ``Form N-5'' (OMB Control No. 3235-
0169), and ``Form N-6'' (OMB Control No. 3235-0503). Because we do
not expect these forms to be generally affected by the proposed
amendments, we are not adjusting the burden estimates associated
with these collections of information.
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``Regulation S-X'' (OMB Control No. 3235-0009); \291\
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\291\ The paperwork burden for Regulation S-X is imposed through
the forms that are subject to the requirements in these regulations
and are reflected in the analysis of those forms. To avoid a PRA
inventory reflecting duplicative burdens, and for administrative
convenience, we assign a one-hour burden to this regulation.
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``Form S-1'' \292\ (OMB Control No. 3235-0065);
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\292\ 17 CFR 239.11.
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``Form S-3'' \293\ (OMB Control No. 3235-0073);
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\293\ 17 CFR 239.13.
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``Form F-1'' (OMB Control No. 3235-0258);
``Form F-3'' (OMB Control No. 3235-0256);
``Form 10'' \294\ (OMB Control No. 3235-0064);
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\294\ 17 CFR 249.210.
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``Form 8-K'' (OMB Control No. 3235-0060);
``Form N-1A'' \295\ (OMB Control No. 3235-0307);
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\295\ 17 CFR 239.15A; 17 CFR 274.11A.
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``Form N-2'' \296\ (OMB Control No. 3235-0307);
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\296\ 17 CFR 239.14; 17 CFR 275.11a-1.
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``Form N-14'' (OMB Control No. 3235-0336); and
``Form 1-A'' \297\ (OMB Control No. 3235-0286).
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\297\ 17 CFR 239.90.
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The regulations, schedules, and forms listed above were adopted
under the Securities Act, the Exchange Act, and/or the Investment
Company Act and set forth the disclosure requirements for registration
statements, periodic and current reports, and distribution reports
filed by registrants to help investors make informed investment and
voting decisions.
We are proposing amendments to the financial statement requirements
for acquired and disposed businesses in Rules 3-05 and 3-14 and related
rules and forms. We are also proposing new Rule 6-11 and amendments to
Form N-14 to specifically govern financial reporting for acquisitions
involving
[[Page 24642]]
investment companies. A description of the proposed amendments,
including the need for the information and its proposed use as well as
a description of the likely respondents can be found in Section II
above, and a discussion of the economic effects of the proposed
amendments can be found in Section III above.
B. Proposed Amendments' Effect on Existing Collections of Information
1. Estimated Effects of the Proposed Amendments on Paperwork Burdens
for Registrants Other Than Investment Companies
The following table summarizes the estimated effects of the
proposed amendments on the paperwork burdens associated with the
affected forms filed by registrants with operations or that otherwise
are not investment companies.
Table 1--Estimated Paperwork Burden Effects for Registrants
[Excluding investment companies]
------------------------------------------------------------------------
Estimated effect and Brief explanation of
Amendment affected forms estimated effect
------------------------------------------------------------------------
Rule 3-05, Rule 3-14, and A reduction of 125 This
related rules (e.g., Rule 1- burden hours for reduction is the
02(w)). each of the estimated effect on
following forms: the affected forms
10, 1-A, S-1, S-3, by the proposed
F-1, F-3, and 8-K. amendments to Rules
3-05, 3-14, and the
related rules
(e.g., Rule 1-
02(w)), when
considered in the
aggregate and
compared to the
paperwork burden
under existing
requirements.
For PRA
purposes, we
estimate that
existing Rule 3-05
or Rule 3-14
Financial
Statements require
an average of 500
burden hours.\298\
Article 11 (Rules 11-01, 11- An increase of 25 This
02 and 11-03) and Rule 8-05 burden hours for increase is the
of Regulation S-X. each of the estimated effect on
following forms: the affected forms
10, 1-A, S-1, S-3, by the proposed
F-1, F-3, and 8-K. amendments to the
pro forma financial
information
requirements under
Article 11,
including the
requirement to
provide certain
forward-looking
information, and
Rule 8-05 of
Regulation S-X when
considered in the
aggregate and
compared to the
paperwork burden
under existing
requirements.
For PRA
purposes, we
estimate that
existing pro forma
financial
information
requires an average
of 100 burden
hours.\299\
------------------------------------------------------------------------
a. Proposed Amendments to Rules 3-05 and 3-14
Considering the various revisions outlined in Sections II.B and C
above, we estimate that the proposed amendments to Rule 3-05 and Rule
3-14 would generally reduce the paperwork burden for filings on an
affected form that includes existing Rule 3-05 or Rule 3-14 Financial
Statements. However, not all filings on the affected forms include
these disclosures because they are provided only in certain instances.
Therefore, to estimate the overall paperwork burden reduction from the
proposed amendments, we first estimated the number of filings that
include Rule 3-05 and Rule 3-14 Financial Statements. To do so,
Commission staff searched the various form types filed from January 1,
2017 until October 1, 2018 for indications of acquisition or
disposition disclosure.\300\ Based on the staff's findings, the table
below sets forth our estimates of the number of filings on these forms
that included Rule 3-05 or Rule 3-14 Financial Statements in calendar
year 2017 and the first nine months of 2018.
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\298\ In response to the 2015 Request for Comment, no commenter
provided information that would assist us in deriving an estimate
for the cost of Rule 3-05 or Rule 3-14 Financial Statements. In
order to develop an estimate of the number of burden hours required
for an issuer to provide the existing financial statements, we have
relied on information derived from staff discussions with
registrants and consultants and from a review of recent waiver
request letters that cited the cost of compliance. Two waiver
request letters received in 2017 cited costs of complying with the
Rule 3-05 Financial Statement requirements ranging from $43,000 to
$200,000. Additionally, a consultant suggested a typical range of
audit fees as $100,000 to $250,000 and consulting fees of $40,000 to
$100,000. Using this data, we estimate that Rule 3-05 or Rule 3-14
Financial Statements require on average approximately 500 additional
burden hours to prepare. We believe that this estimate falls within
the range of costs suggested by the recent waiver requests and
consultant's estimate and would appropriately account for company
and professional hours required.
\299\ In response to the 2015 Request for Comment, no commenter
provided information that would assist us in deriving an estimate
for the cost of pro forma financial information. In order to develop
an estimate of the number of burden hours required for an issuer to
provide pro forma financial information under existing rules, the
staff relied on its discussions with registrants and consultants.
Based on those discussions, we estimate that the required pro forma
financial information would be equivalent to approximately 20% of
the 500 total burden hours that we estimate would be required to
prepare Rule 3-05 or Rule 3-14 Financial Statements. While pro forma
financial information is an important aspect of acquired business
financial information disclosure, it is only an incremental part of
that disclosure, which also requires the production of acquired
business historical financial statements and audits of those
statements.
\300\ To develop these estimates, Commission staff searched and
analyzed filings for the calendar year 2017 and the first nine
months of 2018 on the Intelligize research platform. Commission
staff then reviewed Forms S-1, S-3, F-1, F-3, S-11, 10, and 8-K,
using text and other searches for appropriate word combinations. The
staff then manually reviewed the filings to identify and more
accurately determine which filings contained Rule 3-05 and Rule 3-14
Financial Statements.
[[Page 24643]]
Table 2--Number of Filings on Affected Forms in the Reviewed 2017-2018 Period
----------------------------------------------------------------------------------------------------------------
Number of
filings
Number of including 3-05 Percentage of
Form filings or 3-14 filings affected
financial
statements
(A) (B) (C)
----------------------------------------------------------------------------------------------------------------
10........................................................ 198 18 9.1
S-1....................................................... 1,369 118 8.6
S-3....................................................... 1,415 164 11.6
F-1....................................................... 169 4 2.4
F-3....................................................... 321 8 2.5
8-K....................................................... 118,195 949 0.8
----------------------------------------------------------------------------------------------------------------
We used this data to extrapolate the effect of these changes on the
paperwork burden. In order to appropriately adjust the current burden
estimates, we applied these percentages to the current estimates for
the number of responses in the Commission's current OMB PRA filing
inventory.\301\
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\301\ The OMB PRA filing inventories represent a three-year
average. Averages may not align with the actual number of filings in
any given year.
Table 3--Calculation of the Number of Filings on Affected Forms for PRA Purposes
----------------------------------------------------------------------------------------------------------------
Estimated number
Number of of filings
reponses in Estimated including 3-05
current PRA percentage of or 3-14
estimates filings affected financial
statements
(A) (B) (C)
----------------------------------------------------------------------------------------------------------------
10........................................................ 216 9.1 20
1-A \302\................................................. 179 10.0 18
S-1....................................................... 901 8.6 78
S-3....................................................... 1657 11.6 192
F-1....................................................... 63 2.4 2
F-3....................................................... 112 2.5 3
8-K....................................................... 118,387 0.8 947
----------------------------------------------------------------------------------------------------------------
b. Proposed Amendments to Pro Forma Financial Information Requirements
Considering the various revisions outlined in Section II.D above,
we estimate that the proposed amendments to Article 11 and Rule 8-05
would reduce a registrant's paperwork burden by simplifying disclosure
requirements generally, but may increase burdens by requiring certain
forward-looking information and, in the case of smaller reporting
companies, requiring pro forma financial information in some additional
circumstances \303\ and requiring that the information be provided in a
clearer and more robust manner. To estimate the overall paperwork
burden reduction from the proposed amendments, we first estimated the
number of filings that include Article 11 and Rule 8-05 pro forma
financial information. Because pro forma financial information is most
typically associated with acquisition and dispositions, we relied on
the estimates of affected forms that we determined for the Rule 3-05
and Rule 3-14 burden estimates, as set forth in Table 2 above.
---------------------------------------------------------------------------
\302\ Based on data from domestic registration statements, we
estimate that approximately 10% of Forms 1-A would be affected.
\303\ The additional circumstances that would require a smaller
reporting company to present pro forma financial information under
the proposed amendments would include: Roll-up transactions as
defined in 17 CFR 229.901(c); when such presentation is necessary to
reflect the operations and financial position of the smaller
reporting company as an autonomous entity; and other events
transactions for which disclosure of pro forma financial information
would be material to investors.
---------------------------------------------------------------------------
2. Estimated Effects of the Proposed Amendments on Paperwork Burdens
for Investment Company Registrants
The following table summarizes the estimated effects of the
proposed amendments on the paperwork burdens associated with the
affected forms filed by investment companies.
[[Page 24644]]
Table 4--Estimated Paperwork Burden Effects for Investment Companies
------------------------------------------------------------------------
Estimated effect and Brief explanation of
Amendment affected forms estimated effect
------------------------------------------------------------------------
Proposed Rule 6-11, Rule 1- A reduction of 100 This
02(w), Article 11 of burden hours for reduction is
Regulation S-X, and Form N- each filing that derived from an
14. contains acquired estimated reduction
fund financial of 125 burden hours
information on the resulting from the
following forms: N- proposed amendments
1A, N-2 and N-14. discussed in
Section II.E. above
\304\ compared to
existing Rule 3-05
and pro forma
financial
information
requirements.\305\
This
reduction was then
offset by an
estimated increase
of 25 burden hours
for the proposed
schedules and
supplemental
information under
proposed Rule 6-
11.\306\
------------------------------------------------------------------------
Considering the various revisions outlined in Section II.E above,
we estimate that proposed Rule 6-11 and the related amendments would
generally reduce the paperwork burden for filings on an affected form
that currently includes Rule 3-05 Financial Statements. However, not
all filings on the affected forms include these disclosures. Therefore,
to estimate the overall paperwork burden reduction from the proposed
amendments, we first estimated the number of filings that include
acquired fund financial statements. To do so, we searched the various
form types over a three-year period ended October 1, 2018 for
indications of fund acquisition disclosure.\307\ The table below sets
forth our estimates of the number of filings on these forms that
included acquired fund financial statements in that period.
---------------------------------------------------------------------------
\304\ This estimated reduction of 125 burden hours is due to the
proposed changes affecting the required reporting periods and pro
forma financial information and permitting the use of U.S. GAAP-
compliant financial statements for acquired private funds. See,
e.g., Section II.E.2.
\305\ To determine the paperwork burden for a registrant to make
disclosures in accordance with the proposed Rule 6-11 and proposed
amendments to Form N-14, we estimated the number of burden hours
required for an issuer to provide the existing financial statements.
As previously noted, for PRA purposes, we estimate that existing
Rule 3-05 Financial Statements require an average of 500 burden
hours. See supra note 298.
\306\ See supra Section II.E.2 and II.E.3.
\307\ To conduct this analysis, Commission staff used text-based
search terms of filings made through the EDGAR system to identify
filings that may contain acquired fund financial statements and pro
forma financial information from investment company registrants.
However, the use of text-based search terms may understate the
actual number of instances. Because the number of filings varied
from year to year, we use an average over a three-year period.
Table 5--Number of Filings on Affected Investment Company Forms (2016-2018)
----------------------------------------------------------------------------------------------------------------
Number of
filings
Average annual including Percentage of
Form number of acquired fund filings affected
filings financial
statements
(A) (B) (C)
----------------------------------------------------------------------------------------------------------------
N-1A...................................................... 8,936 12 0.0013
N-2....................................................... 132 2 0.15
N-14...................................................... 152 70 46
----------------------------------------------------------------------------------------------------------------
We used this data to extrapolate the effect of these changes on the
paperwork burden. In order to appropriately adjust the current burden
estimates, we applied these percentages to the estimates of the number
of responses in the Commission's current OMB PRA filing inventory.
Table 6--Calculation of the Number of Filings on Affected Investment Company Forms for PRA Purposes
----------------------------------------------------------------------------------------------------------------
Estimated number
Number of of filings
responses in Estimated including
current PRA percentage of acquired fund
estimates filings affected financial
statements
(A) (B) (C)
----------------------------------------------------------------------------------------------------------------
N-1A...................................................... 6,002 0.0013 8
N-2....................................................... 166 0.15 3
N-14...................................................... 192 46 88
----------------------------------------------------------------------------------------------------------------
[[Page 24645]]
C. Aggregate Burden and Cost Estimates for the Proposed Amendments
Below we estimate the aggregate change in paperwork burden as a
result of the proposed amendments. These estimates represent the
average burden for all registrants, both large and small. In deriving
our estimates, we recognize that the burdens will likely vary among
individual registrants based on a number of factors, including the
nature of their business. The burden estimates were calculated by
multiplying the estimated number of responses by the estimated average
amount of time it would take a registrant to prepare and review
disclosure required under the proposed amendments. The portion of the
burden carried by outside professionals is reflected as a cost,\308\
while the portion of the burden carried by the registrant internally is
reflected in hours.\309\
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\308\ We recognize that the costs of retaining outside
professionals may vary depending on the nature of the professional
services, but for purposes of this PRA analysis, we estimate that
such costs would be an average of $400 per hour. This estimate is
based on consultations with several registrants, law firms, and
other persons who regularly assist registrants in preparing and
filing reports with the Commission.
\309\ For purposes of the PRA, we estimate that 75% of the
burden of preparation of Forms 8-K and 1-A is carried by the
registrant internally and that 25% of the burden of preparation is
carried by outside professionals retained by the company at an
average cost of $400 per hour. Additionally, we estimate that 25% of
the burden of preparation for Forms 10, S-1, S-3, F-1, F-3, N-1A, N-
2, and N-14 is carried by the registrant internally and that 75% of
the burden of preparation is carried by outside professionals
retained by the company at an average cost of $400 per hour.
---------------------------------------------------------------------------
The tables below illustrate the change to the total annual
compliance burden of affected forms, in hours and in costs, as a result
of the proposed amendments.
Table 7--Calculation of the Reduction in Burden Estimates of Current Responses Due to the Proposed Amendments to Rule 3-05 and Rule 3-14 and Pro Forma
Financial Information Requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
Reduction in Reduction in
Number of Burden hour Reduction in company hours professional Reduction in
Form estimated reduction per burden hours for for current hours for professional costs
affected current affected current affected affected current affected for current
reponses response responses responses responses affected responses
(A) (B) (C) = (A) x (B) (D) = (C) x 0.75 (E) = (C) x 0.25 (F) = (E) x $400
or 0.25 or 0.75
--------------------------------------------------------------------------------------------------------------------------------------------------------
10........................................ 20 (100) (2,000) (500) (1,500) ($600,000)
1-A....................................... 18 (100) (1,800) (1,350) (450) (180,000)
S-1....................................... 78 (100) (7,800) (1,950) (5,850) (2,340,000)
S-3....................................... 192 (100) (19,200) (4,800) (14,400) (5,760,000)
F-1....................................... 2 (100) (200) (50) (150) (60,000)
F-3....................................... 3 (100) (300) (75) (225) (90,000)
8-K....................................... 947 (100) ( 94,700) (71,025) (23,675) (9,470,000)
Total................................. 1,260 ................ (126,000) (79,750) (46,250) (18,500,000)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Table 8--Calculation of the Change in Burden Estimates of Current Responses Due to Proposed Rule 6-11 and Amendments to Form N-14
--------------------------------------------------------------------------------------------------------------------------------------------------------
Change in Change in
Number of Burden hour Change in burden company hours professional Change in
Form estimated change per hours for for current hours for professional costs
affected current affected current affected affected current affected for current
reponses response responses responses responses affected responses
(A) (B) (C) = (A) x (B) (D) = (C) x 0.75 (E) = (C) x 0.25 (F) = (E) x $400
or 0.25 or 0.75
--------------------------------------------------------------------------------------------------------------------------------------------------------
N-1A...................................... 8 (100) (800) (200) (600) ($240,000)
N-2....................................... 3 (100) (300) (75) (225) (90,000)
N-14...................................... 88 (100) (8,800) (2,200) (6,600) (2,640,000)
Total................................. 99 ................ (9,900) (2,475) (7,425) (2,970,000)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Table 9--Requested Paperwork Burden Under the Proposed Amendments
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Current burden Program change Requested change in burden
--------------------------------------------------------------------------------------------------------------------------------------------------------
Form Number of Reduction in
Current annual Current burden Current cost affected Reduction in professional Annual Burden hours Cost burden
responses hours burden responses company hours costs responses
(A) (B) (C) (D) \310\ (E) \311\ (F) \312\ (G) = (A) (H) = (B) + (I) = (C) + (F)
(E)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
10..................................... 216 11,774 $14,128,888 20 (500) ($600,000) 216 11,274 $13,528,888
1-A.................................... 112 63,084 8,400,000 18 (1,350) (180,000) 112 61,734 8,220,000
S-1.................................... 901 150,998 181,197,300 78 (1,950) (2,340,000) 901 149,048 178,857,300
S-3.................................... 1,657 196,930 236,322,036 192 (4,800) (5,760,000) 1,657 192,130 230,562,036
F-1.................................... 63 26,980 32,375,700 2 (50) (60,000) 63 26,930 32,315,700
F-3.................................... 112 4,760 5,712,000 3 (75) (90,000) 112 4,685 5,622,000
8-K.................................... 118,387 685,255 91,367,630 947 (71,025) (9,470,000) 118,387 614,230 81,897,630
N-1A................................... 6,002 1,596,749 129,338,408 8 (200) (240,000) 6,002 1,596,549 129,098,408
[[Page 24646]]
N-2.................................... 166 73,250 4,668,396 3 (75) (90,000) 166 73,175 4,578,396
N-14................................... 192 97,280 4,498,000 88 (2,200) (2,640,000) 192 95,080 1,858,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total.............................. 127,808 2,907,060 708,008,358 1,359 (82,225) (21,470,000) 127,808 2,824,835 686,538,358
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Request for Comment
---------------------------------------------------------------------------
\310\ From Table 3, Column (C) and Table 6, Column (C). The
affected responses will not add to the number of annual responses;
rather the requested change in burden will be averaged across all
annual responses.
\311\ From Column (D) in Tables 7 and 8.
\312\ From Column (F) in Tables 7 and 8.
---------------------------------------------------------------------------
Pursuant to 44 U.S.C. 3506(c)(2)(B), we request comment in order
to:
Evaluate whether the proposed collections of information
are necessary for the proper performance of the functions of the
Commission, including whether the information will have practical
utility;
evaluate the accuracy of our assumptions and estimates of
the burden of the proposed collection of information;
determine whether there are ways to enhance the quality,
utility, and clarity of the information to be collected;
evaluate whether there are ways to minimize the burden of
the collection of information on those who respond, including through
the use of automated collection techniques or other forms of
information technology; and
evaluate whether the proposed amendments would have any
effects on any other collection of information not previously
identified in this section.
Any member of the public may direct to us any comments concerning
the accuracy of these burden estimates and any suggestions for reducing
these burdens. Persons submitting comments on the collection of
information requirements should direct their comments to the Office of
Management and Budget, Attention: Desk Officer for the U.S. Securities
and Exchange Commission, Office of Information and Regulatory Affairs,
Washington, DC 20503, and send a copy to Secretary, U.S. Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549, with
reference to File No. S7-05-19. Requests for materials submitted to OMB
by the Commission with regard to the collection of information
requirements should be in writing, refer to File No. S7-05-19 and be
submitted to the U.S. Securities and Exchange Commission, Office of
FOIA Services, 100 F Street NE, Washington DC 20549. OMB is required to
make a decision concerning the collection of information requirements
between 30 and 60 days after publication of the proposed amendments.
Consequently, a comment to OMB is best assured of having its full
effect if the OMB receives it within 30 days of publication.
VI. Small Business Regulatory Enforcement Fairness Act
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA''),\313\ we solicit data to determine whether the
proposed amendments constitute a ``major'' rule. Under SBREFA, a rule
is considered ``major'' where, if adopted, it results or is likely to
result in:
---------------------------------------------------------------------------
\313\ Public Law 104-121, tit. II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------
An annual effect on the economy of $100 million or more
(either in the form of an increase or a decrease);
a major increase in costs or prices for consumers or
individual industries; or
significant adverse effects on competition, investment, or
innovation.
Commenters are requested to provide comment and empirical data on
(a) the potential annual effect on the U.S. economy; (b) any increase
in costs or prices for consumers or individual industries; and (c) any
potential effect on competition, investment, or innovation.
VII. Initial Regulatory Flexibility Act Analysis
This Initial Regulatory Flexibility Act Analysis has been prepared
in accordance with the Regulatory Flexibility Act.\314\ It relates to
proposed amendments to the financial disclosure requirements in
Regulation S-X relating to significant business acquisitions and
dispositions to improve those requirements for both investors and
registrants.
---------------------------------------------------------------------------
\314\ 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------
A. Reasons for, and Objectives of, the Proposed Action
The proposed amendments would include changes to the requirements
for the financial statements of acquisitions and dispositions of
businesses, including real estate operations, in Rule 3-05 and Rule 3-
14 and other related rules and forms.\315\ We are also proposing new
Rule 6-11 and amendments to Form N-14 to specifically govern financial
reporting for acquisitions involving investment companies. These
changes are intended to provide investors with the information that is
important given the specific facts and circumstances, make the
disclosures easier to understand, and reduce the costs and burdens to
registrants of preparing the disclosure. The reasons for, and
objectives of, the proposed amendments are discussed in more detail in
Sections II.A through II.E. above.
---------------------------------------------------------------------------
\315\ We are also proposing related amendments to the definition
of ``significant subsidiary'' in Rule 1-02(w) of Regulation S-X,
Exchange Act Rule 12b-2, Securities Act Rule 405, Investment Company
Act Rule 8b-2; Rule 3-06 of Regulation S-X; Article 8 of Regulation
S-X; and Article 11 of Regulation S-X. In addition, we are proposing
amendments to Form 8-K, Form 10-K, and Form N-2.
---------------------------------------------------------------------------
B. Legal Basis
We are proposing the rule and form amendments contained in this
release under the authority set forth in Sections 3, 6, 7, 8, 10,
19(a), and 28 of the Securities Act of 1933, as amended, Sections 3(b),
12, 13, 15(d), 23(a), and 36 of the Securities Exchange Act of 1934, as
amended, and Sections 6(c), 8, 24(a), 30, and 38 of the Investment
Company Act of 1940, as amended.
C. Small Entities Subject to the Proposed Rules
The proposed changes would affect some registrants that are small
entities. The Regulatory Flexibility Act defines ``small entity'' to
mean ``small business,'' ``small organization,'' or ``small
governmental jurisdiction.'' \316\ For purposes of the Regulatory
Flexibility Act, under our rules, an issuer, other than an investment
[[Page 24647]]
company, is a ``small business'' or ``small organization'' if it had
total assets of $5 million or less on the last day of its most recent
fiscal year and is engaged or proposing to engage in an offering of
securities that does not exceed $5 million.\317\ We estimate that there
are 1,173 issuers that file with the Commission, other than investment
companies, that may be considered small entities and are potentially
subject to the proposed amendments.\318\ An investment company is a
small entity if, together with other investment companies in the same
group of related investment companies, it has net assets of $50 million
or less as of the end of its most recent fiscal year.\319\ Commission
staff estimates that, as of December 31, 2018, there were approximately
90 open-end and closed-end investment companies that would be
considered small entities. Commission staff further estimates that, as
of December 31, 2018, approximately 16 BDCs are small entities.\320\
---------------------------------------------------------------------------
\316\ 5 U.S.C. 601(6).
\317\ See 17 CFR 230.157 under the Securities Act and 17 CFR
240.0-10(a) under the Exchange Act.
\318\ This estimate is based on staff analysis of issuers,
excluding coregistrants, with EDGAR filings of Form 10-K, 20-F and
40-F, or amendments, filed during the calendar year of January 1,
2018 to December 31, 2018. Analysis is based on data from XBRL
filings, Compustat, and Ives Group Audit Analytics.
\319\ 17 CFR 270.0-10(a).
\320\ These estimates are based on staff analysis of Morningstar
data and data submitted by investment company registrants in forms
filed on EDGAR between April 1, 2018 and June 30, 2018.
---------------------------------------------------------------------------
D. Reporting, Recordkeeping, and Other Compliance Requirements
As noted above, the purpose of the proposed amendments to Rules 3-
05 and 3-14 is to improve the quality and relevance of financial
information about acquired businesses and reduce the complexity and
costs of preparing the disclosure.\321\ We are also proposing specific
regulatory requirements for investment companies to address the unique
attributes of this group of registrants.\322\
---------------------------------------------------------------------------
\321\ See supra Sections II.A. through II.D. for a detailed
discussion of the proposed amendments applicable to registrants with
operations or that otherwise are not investment companies.
\322\ See supra Section II.E.
---------------------------------------------------------------------------
Many of the proposed changes would simplify and streamline existing
disclosure requirements in ways that are expected to reduce compliance
burdens for all registrants, including small entities. The proposed
changes to the pro forma financial information requirements would
incrementally increase compliance costs for registrants, although we do
not expect these additional costs to be significant.\323\ In addition,
compliance with the proposed amendments would require the use of
professional skills, including accounting and legal skills. We discuss
the economic impact, including the estimated costs and burdens, of the
proposed amendments to all registrants, including small entities, in
Sections IV and V above.
---------------------------------------------------------------------------
\323\ Specifically, the proposed amendment of Rule 8-05 would
require that for smaller reporting companies and issuers relying on
Regulation A, the preparation, presentation, and disclosure of pro
forma financial information substantially comply with Article 11
rather than directing these entities to consider the requirements of
Article 11. However, based on a staff analysis of 2017 disclosures
of acquisitions and dispositions by smaller reporting companies, we
do not expect the increase in incremental compliance costs resulting
from the proposed amendment to be significant because it appears
that most smaller reporting companies already comply with the
conditions in existing Rule 11-01. See supra Section II.D.3.
---------------------------------------------------------------------------
E. Duplicative, Overlapping, or Conflicting Federal Rules
We believe that the proposed amendments would not duplicate,
overlap, or conflict with other federal rules.
F. Significant Alternatives
The Regulatory Flexibility Act directs us to consider alternatives
that would accomplish our stated objectives, while minimizing any
significant adverse impact on small entities. In connection with the
proposed amendments, we considered the following alternatives:
Establishing different compliance or reporting
requirements that take into account the resources available to small
entities;
clarifying, consolidating, or simplifying compliance and
reporting requirements under the rules for small entities;
using performance rather than design standards; and
exempting small entities from all or part of the
requirements.
The proposed amendments generally would simplify and streamline
disclosure requirements in ways that are expected to reduce compliance
burdens for all registrants, including small entities. Revising Rule 8-
05 to require that the preparation, presentation, and disclosure of pro
forma financial information by smaller reporting companies
substantially comply with Article 11 may increase the burden of
preparing that disclosure for some registrants. However, based on staff
analysis of 2017 disclosures of acquisitions and dispositions by
smaller reporting companies, we believe that most of these companies
already comply with the conditions in existing Rule 11-01.\324\ For
investment companies, we believe that proposed Rule 6-11and related
amendments will make it easier and less costly to provide appropriate
disclosures to investors regarding fund acquisitions, which may benefit
small entities that have smaller asset levels over which to apportion
compliance costs. Accordingly, we do not believe it is necessary to
exempt small entities from all or part of the proposed amendments or to
establish different compliance or reporting requirements for such
entities. However, we are soliciting comment on whether the amendments
should permit additional or different flexibility for smaller reporting
companies and other types of issuers in light of the burdens associated
with the financial reporting requirements.
---------------------------------------------------------------------------
\324\ Commission staff found that out of 191 disclosures of
acquisitions and dispositions by smaller reporting companies in
2017, 178 appeared to comply with Article 11 requirements.
---------------------------------------------------------------------------
Finally, with respect to using performance rather than design
standards, Regulation S-X and the proposed amendments generally contain
elements similar to performance standards. For example, rather than
imposing a specific uniform metric for determining significant business
acquisitions and dispositions, the proposed amendments utilize a
flexible standard, with alternative tests (e.g., the investment,
income, or asset test) that are intended to facilitate a registrant's
determination of whether an acquisition or disposition is significant.
We believe this flexible standard is appropriate because it would allow
registrants to omit financial information that is not necessary for an
investment decision based on the facts and circumstances applicable to
that registrant and offering. We have not, however, proposed an
approach that would allow registrants to determine significance based
on materiality. Nevertheless, we have solicited comment throughout this
release on whether a materiality standard would be appropriate for
these purposes.
Request for Comment
We encourage the submission of comments with respect to any aspect
of this Initial Regulatory Flexibility Analysis. In particular, we
request comments regarding:
How the proposed rule and form amendments can achieve
their objective while lowering the burden on small entities;
The number of small entity companies that may be affected
by the proposed rule and form amendments;
[[Page 24648]]
The existence or nature of the potential effects of the
proposed amendments on small entity companies discussed in the
analysis; and
How to quantify the effects of the proposed amendments.
Commenters are asked to describe the nature of any effect and
provide empirical data supporting the extent of that effect. Comments
will be considered in the preparation of the Final Regulatory
Flexibility Analysis, if the proposed rules are adopted, and will be
placed in the same public file as comments on the proposed rules
themselves.
VIII. Statutory Authority
The amendments contained in this release are being proposed under
the authority set forth in Sections 3, 6, 7, 8, 10, 19(a), and 28 of
the Securities Act, Sections 3(b), 12, 13, 15(d), 23(a), and 36 of the
Exchange Act, and Sections 6(c), 8, 24(a), 30, and 38 of the Investment
Company Act.
List of Subjects
17 CFR Part 210
Accountants, Accounting, Banks, Banking, Employee benefit plans,
Holding companies, Insurance companies, Investment companies, Oil and
gas exploration, Reporting and recordkeeping requirements, Securities,
Utilities.
17 CFR Part 230
Investment companies, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 239
Reporting and recordkeeping requirements, Securities.
17 CFR Part 240
Brokers, Fraud, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 249
Brokers, Reporting and recordkeeping requirements, Securities.
17 CFR Parts 270 and 274
Investment companies, Reporting and recordkeeping requirements,
Securities.
Text of the Proposed Amendments
For the reasons set out in the preamble, the Commission is
proposing to amend title 17, chapter II of the Code of Federal
Regulations as follows:
PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF
1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF
1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975
0
1. The authority citation for part 210 continues to read as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3,
77aa(25), 77aa(26), 77nn(25), 77nn(26), 78c, 78j-1, 78l, 78m, 78n,
78o(d), 78q, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30,
80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, and sec. 102(c),
Pub. L. 112-106, 126 Stat. 310 (2012), unless otherwise noted.
0
2. Revise Sec. 210.1-02(w) to read as follows:
Sec. 210.1-02 Definitions of terms used in Regulation S-X (17 CFR
part 210).
* * * * *
(w) Significant subsidiary. (1) The term significant subsidiary
means a subsidiary, including its subsidiaries, which meets any of the
conditions in paragraphs (w)(1)(i), (w)(1)(ii), or (w)(1)(iii) of this
section; however if the subsidiary is a registered investment company
or a business development company, it meets any of the conditions in
paragraph (w)(2) of this section instead of any of the conditions in
this paragraph (w)(1). A registrant that files its financial statements
in accordance with or provides a reconciliation to U.S. Generally
Accepted Accounting Principles (U.S. GAAP) shall use amounts determined
under U.S. GAAP. A foreign private issuer that files its financial
statements in accordance with International Financial Reporting
Standards as issued by the International Accounting Standards Board
(IFRS-IASB) shall use amounts determined under IFRS-IASB.
(i) Investment Test. (A) The registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the aggregate worldwide market value of the
registrant's voting and non-voting common equity, or if the registrant
has no such aggregate worldwide market value the total assets of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year. Aggregate worldwide market value of the
registrant's voting and non-voting common equity shall be determined as
of the last business day of the registrant's most recently completed
fiscal year, which for acquisitions and dispositions shall be at or
prior to the date of acquisition or disposition;
(B) For a combination between entities or businesses under common
control, this test shall be met when either the net book value of the
tested subsidiary exceeds 10 percent of the registrant's and its
subsidiaries' consolidated total assets or the number of common shares
exchanged or to be exchanged by the registrant exceeds 10 percent of
its total common shares outstanding at the date the combination is
initiated;
(C) For all other acquisitions, the ``investment in'' the tested
subsidiary shall include the fair value of contingent consideration if
required to be recognized at fair value by the registrant at the
acquisition date under U.S. GAAP or IFRS-IASB, as applicable; however
if recognition at fair value is not required, include all contingent
consideration, except sales-based milestones and royalties, unless the
likelihood of payment is remote. The ``investment in'' the tested
subsidiary also excludes the registrant's and its subsidiaries'
proportionate interest in the carrying value of assets transferred by
the registrant and its subsidiaries consolidated to the tested
subsidiary that will remain with the combined entity after the
acquisition; and
(D) For dispositions, the ``investment in'' the tested subsidiary
shall equal the fair value of the consideration, which shall include
contingent consideration, for the disposed subsidiary when comparing to
the aggregate worldwide market value of the registrant or, when the
registrant has no such aggregate worldwide market value, the carrying
value of the disposed subsidiary when comparing to total assets of the
registrant. For a real estate operation as defined inSec. 210.3-
14(a)(2), when the investment test is based on the total assets of the
registrant and its subsidiaries consolidated, include any debt secured
by the real properties that is assumed by the buyer in the ``investment
in'' the tested real estate operation.
(ii) Asset Test. The registrant's and its other subsidiaries'
proportionate share of the total assets (after intercompany
eliminations) of the tested subsidiary exceeds 10 percent of such total
assets of the registrant and its subsidiaries consolidated as of the
end of the most recently completed fiscal year.
(iii) Income Test. (A)(1) The absolute value of the registrant's
and its other subsidiaries' equity in the tested subsidiary's
consolidated income or loss from continuing operations (after
intercompany eliminations) attributable to the controlling interests
exceeds 10 percent of the absolute value of such income or loss of the
registrant and its
[[Page 24649]]
subsidiaries consolidated for the most recently completed fiscal year;
and
(2) The registrant's and its other subsidiaries' proportionate
share of the tested subsidiary's consolidated total revenue (after
intercompany eliminations) exceeds 10 percent of such total revenue of
the registrant and its subsidiaries consolidated for the most recently
completed fiscal year. This component does not apply if either the
registrant and its subsidiaries consolidated or the tested subsidiary
does not have recurring annual revenue.
(B) When determining the income component in paragraph
(w)(1)(iii)(A)(1) of this section:
(1) If a net loss from continuing operations attributable to the
controlling interest has been incurred by either the registrant and its
subsidiaries consolidated or the tested subsidiary, but not both,
exclude the equity in the income or loss from continuing operations of
the tested subsidiary attributable to the controlling interest from
such income or loss of the registrant and its subsidiaries consolidated
for purposes of the computation;
(2) Compute the test using the average described herein if the
revenue component in paragraph (w)(1)(iii)(A)(2) does not apply and the
absolute value of the registrant's and its consolidated subsidiaries'
income or loss from continuing operations attributable to the
controlling interests for the most recent fiscal year is at least 10
percent lower than the average of the absolute value of such amounts
for each of its last five fiscal years; and
(3) Entities reporting losses shall not be aggregated with entities
reporting income where the test involves combined entities, as in the
case of determining whether summarized financial data should be
presented, except when determining whether related businesses meet this
test for purposes of Sec. Sec. 210.3-05 and 210.8-04.
(2) For a registrant that is a registered investment company or a
business development company, the term significant subsidiary means a
subsidiary, including its subsidiaries, which meets any of the
following conditions using amounts determined under U.S. GAAP and, if
applicable, section 2(a)(41) of the Investment Company Act of 1940 (15
U.S.C. 80a-2(a)(41)):
(i) Investment Test. The value of the registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the value of the total investments of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year; or
(ii) Income Test. The absolute value of the combined investment
income from dividends, interest, and other income, the net realized
gains and losses on investments, and the net change in unrealized gains
and losses on investments from the tested subsidiary, for the most
recently completed fiscal year exceeds:
(A) 80 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year; or
(B) 10 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year and the
Investment Test (paragraph (w)(2)(i) of this section) condition exceeds
5 percent. However, if the registrant and its subsidiaries consolidated
has an insignificant change in net assets resulting from operations for
its most recently completed fiscal year, compute the test using the
average of the absolute value of such amounts for the registrant and
its subsidiaries consolidated for each of its last five fiscal years.
* * * * *
0
3. Revise Sec. 210.3-05 to read as follows:
Sec. 210.3-05 Financial statements of businesses acquired or to be
acquired.
(a) Financial statements required. (1) Financial statements (except
the related schedules specified in Sec. 210.12) prepared and audited
in accordance with this regulation (including the independence
standards in Sec. 210.2-01 or, alternatively if the business is not a
registrant, the applicable independence standards) shall be filed for
the periods specified in paragraph (b) of this section if any of the
following conditions exist:
(i) During the most recent fiscal year or subsequent interim period
for which a balance sheet is required by Sec. 210.3-01, a business
acquisition has occurred; or
(ii) After the date of the most recent balance sheet filed pursuant
to Sec. 210.3-01, consummation of a business acquisition has occurred
or is probable.
(2) For purposes of determining whether the provisions of this rule
apply:
(i) The determination of whether a business has been acquired
should be made in accordance with the guidance set forth in Sec.
210.11-01(d); and
(ii) The acquisition of a business encompasses the acquisition of
an interest in a business accounted for by the registrant under the
equity method or, in lieu of the equity method, the fair value option.
(3) Acquisitions of a group of related businesses that are probable
or that have occurred subsequent to the latest fiscal year-end for
which audited financial statements of the registrant have been filed
shall be treated under this section as if they are a single business
acquisition. The required financial statements of related businesses
may be presented on a combined basis for any periods they are under
common control or management. For purposes of this section, businesses
shall be deemed to be related if:
(i) They are under common control or management;
(ii) The acquisition of one business is conditional on the
acquisition of each other business; or
(iii) Each acquisition is conditioned on a single common event.
(4) This rule shall not apply to a real estate operation subject to
Sec. 210.3-14 or a business which is totally held by the registrant
prior to consummation of the transaction.
(b) Periods to be presented. (1) If securities are being registered
to be offered to the security holders of the business to be acquired,
the financial statements specified in Sec. Sec. 210.3-01 and 210.3-02
shall be filed for the business to be acquired, except as provided
otherwise for filings on Form N-14, S-4, or F-4 (Sec. 239.23, Sec.
239.25, or Sec. 239.34 of this chapter). The financial statements
covering fiscal years shall be audited except as provided in Item 14 of
Schedule 14A (Sec. 240.14a-101 of this chapter) with respect to
certain proxy statements or in registration statements filed on Forms
N-14, S-4, or F-4 (Sec. 239.23, Sec. 239.25, or Sec. 239.34 of this
chapter).
(2) In all cases not specified in paragraph (b)(1) of this section,
financial statements of the business acquired or to be acquired shall
be filed for the periods specified in this paragraph (b)(2) or such
shorter period as the business has been in existence. The periods for
which such financial statements are to be filed shall be determined
using the conditions specified in the definition of significant
subsidiary in Sec. 210.1-02(w), using the lower of the total revenue
component or income or loss from continuing operations component for
evaluating the income test condition, as follows:
(i) If none of the conditions exceeds 20 percent, financial
statements are not required.
(ii) If any of the conditions exceeds 20 percent, but none exceed
40 percent, financial statements shall be filed for at least the most
recent fiscal year and the
[[Page 24650]]
most recent interim period specified in Sec. Sec. 210.3-01 and 210.3-
02.
(iii) If any of the conditions exceeds 40 percent, financial
statements shall be filed for at least the two most recent fiscal years
and any interim periods specified in Sec. Sec. 210.3-01 and 210.3-02.
(iv) If the aggregate impact of businesses acquired or to be
acquired since the date of the most recent audited balance sheet filed
for the registrant, for which financial statements are either not
required by paragraph (b)(2)(i) of this section or are not yet required
based on paragraph (b)(4)(i) of this section, exceeds 50 percent, the
registrant shall provide:
(A) Pro forma financial information pursuant to Sec. Sec. 210.11-
01 through 210.11-02 that depicts the aggregate impact of these
acquired or to be acquired businesses in all material respects; and
(B) Financial statements covering at least the most recent fiscal
year and the most recent interim period specified in Sec. Sec. 210.3-
01 and 210.3-02 for any acquired or to be acquired business for which
financial statements are not yet required based on paragraph (b)(4)(i)
of this section.
(3) The determination shall be made using Sec. 210.11-01(b)(3).
(4) Financial statements required for the periods specified in
paragraph (b)(2) of this section may be omitted to the extent specified
as follows:
(i) Registration statements not subject to the provisions of Sec.
230.419 of this chapter and proxy statements need not include separate
financial statements of an acquired or to be acquired business if
neither the business nor the aggregate impact specified in paragraph
(b)(2)(iv) of this section exceeds any of the conditions of
significance in the definition of significant subsidiary in Sec.
210.1-02 at the 50 percent level computed in accordance with paragraph
(b)(3) of this section, and either:
(A) The consummation of the acquisition has not yet occurred; or
(B) The date of the final prospectus or prospectus supplement
relating to an offering as filed with the Commission pursuant to Sec.
230.424(b) of this chapter, or mailing date in the case of a proxy
statement, is no more than 74 days after consummation of the business
acquisition, and the financial statements have not previously been
filed by the registrant.
(ii) A registrant, other than a foreign private issuer required to
file reports on Form 6-K (Sec. 249.306 of this chapter), that omits
from its initial registration statement financial statements of a
recently consummated business acquisition pursuant to paragraph
(b)(4)(i) of this section shall file those financial statements and any
pro forma information specified by Article 11 under cover of Form 8-K
(Sec. 249.308 of this chapter) no later than 75 days after
consummation of the acquisition.
(iii) Separate financial statements of the acquired business need
not be presented once the operating results of the acquired business
have been reflected in the audited consolidated financial statements of
the registrant for a complete fiscal year.
(iv) A separate audited balance sheet of the acquired business is
not required when the registrant's most recent audited balance sheet
required by Sec. 210.3-01 is for a date after the date the acquisition
was consummated.
(c) Financial statements of a foreign business. If the business
acquired or to be acquired is a foreign business, financial statements
of the business meeting the requirements of Item 17 of Form 20-F (Sec.
249.220f of this chapter) will satisfy this section. If such financial
statements are prepared according to a comprehensive body of accounting
principles other than those generally accepted in the United States
(U.S. GAAP) or International Financial Reporting Standards as issued by
the International Accounting Standards Board (IFRS-IASB), they may be
reconciled to IFRS-IASB, rather than U.S. GAAP, if the registrant is a
foreign private issuer that prepares its financial statements in
accordance with IFRS-IASB. The reconciliation to IFRS-IASB shall
generally follow the form and content requirements in Item 17(c) of
Form 20-F.
(d) Financial statements of an acquired or to be acquired business
that would be a foreign private issuer if it were a registrant. If the
acquired or to be acquired business is not a foreign business (as
defined in Sec. 210.1-02(l)), but would qualify as a foreign private
issuer (as defined in Sec. 230.405 and Sec. 240.3b-4) if it were a
registrant, financial statements of the business may be prepared in
accordance with IFRS-IASB without reconciliation to U.S. GAAP.
(e) Financial statements for net assets that constitute a business.
For an acquisition of net assets that constitutes a business (e.g., an
acquired product line), the financial statements prepared and audited
in accordance with this regulation may be statements of assets acquired
and liabilities assumed and statements of revenues and expenses
(exclusive of corporate overhead, interest and income tax expenses) if
the following conditions are met:
(1) The acquired business constitutes less than substantially all
of the assets and liabilities of the seller and was not a separate
entity, subsidiary, segment, or division during the periods for which
the acquired business financial statements would be required;
(2) Separate financial statements for the business have not
previously been prepared;
(3) The seller has not maintained the distinct and separate
accounts necessary to present financial statements that include the
omitted expenses and it is impracticable to prepare such financial
statements;
(4) Interest expense may only be excluded from the statements if
the debt to which the interest expense relates will not be assumed by
the registrant or its subsidiaries consolidated;
(5) The statements of revenues and expenses do not omit selling,
distribution, marketing, general and administrative, and research and
development expenses incurred by or on behalf of the acquired business
during the periods to be presented; and
(6) The notes to the financial statements include the following
disclosures:
(i) The type of omitted expenses and the reason(s) why they are
excluded from the financial statements.
(ii) An explanation of the impracticability of preparing financial
statements that include the omitted expenses.
(iii) A description of how the financial statements presented are
not indicative of the financial condition or results of operations of
the acquired business going forward because of the omitted expenses.
(iv) Information about the business's operating, investing and
financing cash flows, to the extent available.
(f) Financial statements of a business that includes oil and gas
producing activities. (1) If the acquisition constitutes a business
that includes significant oil- and gas-producing activities (as defined
in the FASB ASC Master Glossary), the disclosures in FASB ASC Topic 932
Extractive Activities--Oil and Gas, 932-235-50-3 through 50-11 and 932-
235-50-29 through 50-36, which may be presented as unaudited
supplemental information, shall be provided for each full year of
operations presented for the acquired business. If prior year reserve
studies were not made, they may be computed using only production and
new discovery quantities and valuation, in which case there will be no
``revision of prior estimates'' amounts. Registrants may develop these
disclosures based on a reserve study for the most recent year,
computing the changes backward if the
[[Page 24651]]
method of computation is disclosed in a footnote.
(2) Financial statements prepared and audited in accordance with
this regulation may be limited to audited statements of revenues and
expenses that exclude depletion, depreciation, and amortization
expense, corporate overhead expense, income taxes, and interest expense
that are not comparable to the proposed future operations if:
(i) The acquisition generates substantially all of its revenues
from oil and gas producing activities (as defined in Sec. 210.4-
10(a)(16)); and
(ii) The conditions specified in paragraph (e)(1) through (e)(4)
and (e)(6) of this section are met.
0
4. Revise Sec. 210.3-06 to read as follows:
Sec. 210.3-06 Financial statements covering a period of nine to
twelve months.
(a) Except with respect to registered investment companies, the
filing of financial statements covering a period of 9 to 12 months
shall be deemed to satisfy a requirement for filing financial
statements for a period of 1 year where:
(1) The issuer has changed its fiscal year;
(2) The issuer has made a significant business acquisition for
which financial statements are required under Sec. 210.3-05, Sec.
210.3-14, Sec. 210.8-04, or Sec. 210.8-06 of this chapter and the
financial statements covering the interim period pertain to the
business being acquired; or
(3) The Commission so permits pursuant to Sec. 210.3-13 or Note 5
to Sec. 210.8 of this chapter.
(b) Where there is a requirement for filing financial statements
for a time period exceeding one year but not exceeding three
consecutive years (with not more than 12 months included in any period
reported upon), the filing of financial statements covering a period of
9 to 12 months shall satisfy a filing requirement of financial
statements for one year of that time period only if the conditions
described in paragraphs (a)(1), (2) or (3) of this section exist and
financial statements are filed that cover the full fiscal year or years
for all other years in the time period.
0
5. Revise Sec. 210.3-14 to read as follows:
Sec. 210.3-14 Special instructions for financial statements of real
estate operations acquired or to be acquired.
(a) Financial statements required. (1) Financial statements (except
the related schedules specified in Sec. 210.12) prepared and audited
in accordance with Regulation S-X (including the independence standards
in Sec. 210.2-01 or, alternatively if the business is not a
registrant, the applicable independence standards) for the periods
specified in paragraph (b) of this section and the supplemental
information specified in paragraph (f) of this section shall be filed
if any of the following conditions exist:
(i) During the most recent fiscal year or subsequent interim period
for which a balance sheet is required by Sec. 210.3-01, an acquisition
of a real estate operation has occurred; or
(ii) After the date of the most recent balance sheet filed pursuant
to Sec. 210.3-01, consummation of an acquisition of a real estate
operation has occurred or is probable.
(2) For purposes of determining whether the provisions of this rule
apply:
(i) The term real estate operation means a business (as set forth
in Sec. 210.11-01(d)) that generates substantially all of its revenues
through the leasing of real property.
(ii) The acquisition of a real estate operation encompasses the
acquisition of an interest in a real estate operation accounted for by
the registrant under the equity method or, in lieu of the equity
method, the fair value option.
(3) Acquisitions of a group of related real estate operations that
are probable or that have occurred subsequent to the latest fiscal
year-end for which audited financial statements of the registrant have
been filed shall be treated under this section as if they are a single
acquisition. The required financial statements may be presented on a
combined basis for any periods they are under common control or
management. For purposes of this section, acquisitions shall be deemed
to be related if:
(i) They are under common control or management;
(ii) The acquisition of one real estate operation is conditional on
the acquisition of each other real estate operation; or
(iii) Each acquisition is conditioned on a single common event.
(4) This rule shall not apply to a real estate operation that is
totally held by the registrant prior to consummation of the
transaction.
(b) Periods to be presented. (1) If securities are being registered
to be offered to the security holders of the real estate operation to
be acquired, the financial statements specified in paragraph (c) of
this section and the supplemental information specified in paragraph
(f) of this section shall be filed for the real estate operation to be
acquired for the periods specified in Sec. Sec. 210.3-01 and 210.3-02,
except as provided otherwise for filings on Form S-4 or F-4 (Sec.
239.25 or Sec. 239.34 of this chapter). The financial statements
covering fiscal years shall be audited except as provided in Item 14 of
Schedule 14A (Sec. 240.14a-101 of this chapter) with respect to
certain proxy statements or in registration statements filed on Forms
S-4 or F-4 (Sec. 239.25 or Sec. 239.34 of this chapter).
(2) In all cases not specified in paragraph (b)(1) of this section,
financial statements of the real estate operation acquired or to be
acquired shall be filed for the periods specified in this paragraph
(b)(2) or such shorter period as the real estate operation has been in
existence. The periods for which such financial statements are to be
filed shall be determined using the condition specified in the
definition of significant subsidiary in Sec. 210.1-02(w)(1)(i)
modified as follows:
(i)(A) If the condition does not exceed 20 percent, financial
statements are not required.
(B) If the condition exceeds 20 percent, financial statements of
the real estate operation for at least the most recent fiscal year and
the most recent interim period specified in Sec. Sec. 210.3-01 and
210.3-02 shall be filed.
(C) If the aggregate impact of acquired or to be acquired real
estate operations since the date of the most recent audited balance
sheet filed for the registrant, for which financial statements are
either not required by paragraph (b)(2)(i)(A) of this section or are
not yet required based on paragraph (b)(3)(i), exceeds 50 percent, the
registrant shall provide:
(1) Pro forma financial information pursuant to Sec. Sec. 210.11-
01 through 210.11-02 that depicts the aggregate impact of these
acquired or to be acquired real estate operations in all material
respects; and
(2) Financial statements covering at least the most recent fiscal
year and the most recent interim period specified in Sec. Sec. 210.3-
01 and 210.3-02 for any acquired or to be acquired real estate
operation for which financial statements are not yet required based on
paragraph (b)(3)(i) of this section.
(ii) When the investment test is based on the total assets of the
registrant and its subsidiaries consolidated, include any assumed debt
secured by the real properties in the ``investment in'' the tested real
estate operation.
(iii) Determine total assets as of the end of the most recently
completed fiscal year included in the registrant's most recent
consolidated financial statements filed at or prior to the date of
acquisition; however, the determination may be made using Sec. 210.11-
01(b)(3)(i) and Sec. 210.11-
[[Page 24652]]
01(b)(3)(ii). When a registrant, including a real estate investment
trust, conducts a continuous offering over an extended period of time
and applies the Item 20.D Undertakings of Industry Guide 5, use the
following instead:
(A) During the distribution period, determine total assets as of
the date of acquisition plus the proceeds (net of commissions) in good
faith expected to be raised in the registered offering over the next 12
months; and
(B) After the distribution period ends and until the next Form 10-K
is filed, determine total assets as of the date of acquisition; and
(C) After that next Form 10-K is filed, determine total assets as
of the end of the most recently completed fiscal year included in the
Form 10-K. However, the determination may be made using Sec. 210.11-
01(b)(3)(i) and Sec. 210.11-01(b)(3)(ii).
(3) Financial statements required for the periods specified in
paragraph (b)(2) of this section may be omitted to the extent specified
as follows:
(i) Registration statements not subject to the provisions of Sec.
230.419 of this chapter and proxy statements need not include separate
financial statements of the acquired or to be acquired real estate
operation if neither the real estate operation nor the aggregate impact
specified in (b)(2)(i)(C) of this section exceeds the condition of
significance in the definition of significant subsidiary in Sec.
210.1-02(w)(1)(i), as modified by paragraphs (b)(2)(ii) and (iii) of
this section, at the 50 percent level computed in accordance with
paragraph (b)(2) of this section, and either:
(A) The consummation of the acquisition has not yet occurred; or
(B) The date of the final prospectus or prospectus supplement
relating to an offering as filed with the Commission pursuant to Sec.
230.424(b) of this chapter, or mailing date in the case of a proxy
statement, is no more than 74 days after consummation of the
acquisition of the real estate operation, and the financial statements
have not previously been filed by the registrant.
(ii) A registrant, other than a foreign private issuer required to
file reports on Form 6-K (Sec. 249.306 of this chapter), that omits
from its initial registration statement financial statements of a
recently consummated acquisition of a real estate operation pursuant to
paragraph (b)(3)(i) of this section shall file those financial
statements and any pro forma information specified by Sec. Sec.
210.11-01 to 210.11.03 (Article 11) of this chapter under cover of Form
8-K (Sec. 249.308 of this chapter) no later than 75 days after
consummation of the acquisition.
(iii) Separate financial statements of the acquired real estate
operation need not be presented once the operating results of the
acquired real estate operation have been reflected in the audited
consolidated financial statements of the registrant for a complete
fiscal year.
(c) Presentation of the financial statements. (1) The financial
statements prepared and audited in accordance with this regulation may
be only statements of revenues and expenses excluding expenses not
comparable to the proposed future operations such as mortgage interest,
leasehold rental, depreciation, amortization, corporate overhead and
income taxes.
(2) The notes to the financial statements shall include the
following disclosures:
(i) The type of omitted expenses and the reason(s) why they are
excluded from the financial statements;
(ii) A description of how the financial statements presented are
not indicative of the results of operations of the acquired real estate
operation going forward because of the omitted expenses; and
(iii) Information about the real estate operation's operating,
investing and financing cash flows, to the extent available.
(d) Financial statements of foreign business. If the real estate
operation acquired or to be acquired is a foreign business, financial
statements of the real estate operation specified in paragraph (c) of
this section meeting the requirements of Item 17 of Form 20-F (Sec.
249.220f of this chapter) will satisfy this section. If such financial
statements are prepared according to a comprehensive body of accounting
principles other than those generally accepted in the United States
(U.S. GAAP) or International Financial Reporting Standards as issued by
the International Accounting Standards Board (IFRS-IASB), they may be
reconciled to IFRS-IASB, rather than U.S. GAAP, if the registrant is a
foreign private issuer that prepares its financial statements in
accordance with IFRS-IASB. The reconciliation to IFRS-IASB shall
generally follow the form and content requirements in Item 17(c) of
Form 20-F.
(e) Financial statements of an acquired or to be acquired real
estate operation that would be a foreign private issuer if it were a
registrant. If the acquired or to be acquired real estate operation is
not a foreign business (as defined in Sec. 210.1-02(l)), but would
qualify as a foreign private issuer (as defined in Sec. 230.405 and
Sec. 240.3b-4) if it were a registrant, financial statements of the
real estate operation specified in paragraph (c) of this section may be
prepared in accordance with IFRS-IASB without reconciliation to U.S.
GAAP.
(f) Supplemental information. For each real estate operation for
which financial statements are required to be filed by paragraphs
(b)(2)(i)(B) and (b)(2)(i)(C)(2), material factors considered by the
registrant in assessing the real estate operation must be described
with specificity in the filing, including sources of revenue
(including, but not limited to, competition in the rental market,
comparative rents, and occupancy rates) and expense (including, but not
limited to, utility rates, property tax rates, maintenance expenses,
and capital improvements anticipated). The disclosure must also
indicate that the registrant is not aware of any other material factors
relating to the specific real estate operation that would cause the
reported financial statements not to be indicative of future operating
results.
Instruction to paragraph (f): When the financial statements are
presented in Form S-11 (Sec. 239.18 of this chapter), the discussion
of material factors considered should supplement the disclosures
required by Item 15 of Form S-11.
Sec. 210.3-18 [Amended]
0
6. Amend Sec. 210.3-18(d) by removing the phrase ``Sec. Sec. 210.6-01
to 210.6-10'' and adding in its place ``Sec. Sec. 210.6-01 to 210.6-
11''.
Sec. 210.5-01 [Amended]
0
7. Amend Sec. 210.5-01(a) by removing the phrase ``Sec. Sec. 210.6-01
to 210.6-10'' and adding in its place ``Sec. Sec. 210.6-01 to 210.6-
11''.
Sec. 210.6-01 [Amended]
0
8. Amend Sec. 210.6-01 by removing the phrases ``Sec. Sec. 210.6-01
to 210.6-10'' in the title and in the rule text and adding in each
place ``Sec. Sec. 210.6-01 to 210.6-11''.
Sec. 210.6-02 [Amended]
0
9. Amend Sec. 210.6-02(b) and (c) by removing the phrases ``Sec. Sec.
210.6-01 to 210.6-10'' and adding in each place ``Sec. Sec. 210.6-01
to 210.6-11''.
Sec. 210.6-03 [Amended]
0
10. Amend Sec. 210.6-03 by removing the phrase ``Sec. Sec. 210.6-01
to 210.6-10'' in the introductory text and paragraph (a) and adding in
each place ``Sec. Sec. 210.6-01 to 210.6-11''.
0
11. Add Sec. 210.6-11 to read as follows:
[[Page 24653]]
Sec. 210.6-11 Financial statements of funds acquired or to be
acquired.
(a) Financial statements required. (1) Financial statements,
including the schedules specified in Sec. Sec. 210.12-01 to 210.12-29
(Article 12), prepared and audited in accordance with this regulation
(including the independence standards in Sec. 210.2-01 or,
alternatively if the fund is not a registrant, the applicable
independence standards) for the periods specified in paragraph (b) of
this section and the supplemental information specified in paragraph
(d) of this section shall be filed if any of the following conditions
exist:
(i) During the most recent fiscal year or subsequent interim period
for which a balance sheet is required by Sec. Sec. 210.3-01 or 210.3-
18, a fund acquisition has occurred; or
(ii) After the date of the most recent balance sheet filed pursuant
to Sec. Sec. 210.3-01 or 210.3-18 or, if no relevant balance sheet has
been filed in connection with a post-effective amendment for a new
series submitted pursuant to Rule 485(a)(2) under the Securities Act
(Sec. 230.485(a)(2) of this chapter), the filing of such amendment,
consummation of a fund acquisition has occurred or is probable.
(2) For purposes of this section:
(i) The term fund includes any investment company as defined in
section 3(a) of the Investment Company Act of 1940, including a
business development company, or any company that would be an
investment company but for the exclusions provided by sections 3(c)(1)
or 3(c)(7) of that Act, or any private account managed by an investment
adviser.
(ii) The determination of whether a fund has been acquired or will
be acquired should be evaluated in light of the facts and circumstances
involved. A fund acquisition includes the acquisition by the registrant
of all or substantially all of the portfolio investments held by
another fund or an acquisition of a fund's portfolio investments that
will constitute all or substantially all of the initial assets of the
registrant.
(3) Acquisitions of a group of related funds that are probable or
that have occurred subsequent to the latest fiscal year-end for which
audited financial statements of the registrant have been filed shall be
treated under this section as if they are a single acquisition. The
required financial statements may be presented either on an individual
or a combined basis for any periods they are under common control or
management. For purposes of this section, funds shall be deemed to be
related if:
(i) They are under common control or management;
(ii) The acquisition of one fund is conditional on the acquisition
of each other fund; or
(iii) Each acquisition is conditioned on a single common event.
(4) This rule shall not apply to a fund which is totally held by
the registrant prior to consummation of the transaction.
(b) Periods to be presented. (1) If securities are being registered
to be offered to the security holders of the fund to be acquired, the
financial statements specified in Sec. Sec. 210.3-01 and 210.3-02 or
Sec. 210.3-18, for the fund to be acquired and the supplemental
information specified in paragraph (d) shall be filed, except as
provided otherwise for filings on Form N-14 (Sec. 239.23 of this
chapter). The financial statements covering the fiscal year shall be
audited except as provided in Item 14 of Schedule 14A (Sec. 240.14a-
101 of this chapter) with respect to certain proxy statements or in
registration statements filed on Forms N-14 (Sec. 239.23 of this
chapter).
(2) In all cases not specified in paragraph (b)(1) of this section,
financial statements of the fund acquired or to be acquired for the
periods specified in this paragraph (b)(2) or such shorter period as
the fund has been in existence and the supplemental information
specified in paragraph (d) of this section shall be filed. Whether such
financial statements and supplemental information are to be filed shall
be determined using the conditions specified in the definition of
significant subsidiary in Sec. Sec. 210.1-02(w)(2)(i) and (ii)(B) as
follows:
(i) If none of the conditions set forth in Sec. 210.1-02(w)(2)(i)
and (ii)(B), substituting 20 percent for 10 percent each place it
appears therein, are satisfied, the financial statements and
supplemental financial information in paragraph (d) of this section are
not required.
(ii) If any of the conditions set forth in Sec. 210.1-02(w)(2)(i)
and (ii)(B), substituting 20 percent for 10 percent each place it
appears therein, are satisfied, the financial statements of the
acquired fund for the most recent fiscal year and the most recent
interim period shall be filed. The registrant shall also provide the
supplemental financial information in paragraph (d) of this section.
(iii) If the aggregate impact of funds acquired or to be acquired
since the date of the most recent audited balance sheet filed for the
registrant, for which financial statements are not required by
paragraph (b)(2)(i) of this section, satisfies any of the conditions
set forth in Sec. 210.1-02(w)(2)(i) and (ii)(B), substituting 50
percent for 10 percent each place it appears therein, the registrant
shall provide financial statements for at least the most recent fiscal
year and the most recent interim period specified in Sec. Sec. 210.3-
01 and 210.3-02, or Sec. 210.3-18, for any fund acquired or to be
acquired for which financial statements are not yet required by
paragraph (b)(2)(i) of this section. The registrant shall also provide
the supplemental financial information in paragraph (d) of this section
for such funds.
(3) The determination shall be made by comparing the most recent
annual financial statement of each such fund, or for acquisitions each
group of related funds on a combined basis, to the registrant's most
recent annual financial statements filed at or prior to the date of
acquisition. However, the determination may be made by using pro forma
amounts as calculated by the registrant for the periods specified in
Sec. 210.1-02(w)(2) that only give effect to an acquisition
consummated after the latest fiscal year-end for which the registrant's
financial statements are required to be filed when the registrant has
filed audited financial statements of such acquired fund and provided
the supplemental financial information for the periods required by this
section.
(4) Separate financial statements of the acquired fund need not be
presented after the portfolio investments of the acquired fund have
been reflected in the registrant's most recent audited balance sheet
required by Sec. Sec. 210.3-01 or 3-18 for a date after the date the
acquisition was consummated.
(c) Presentation of financial statements. If the fund to be
acquired would be an investment company under the Investment Company
Act but for the exclusion provided from that definition by either
sections 3(c)(1) or 3(c)(7) of that Act, then the required financial
statements shall comply with U.S. Generally Accepted Accounting
Principles and only Article 12 of this part. In situations of any
private account managed by an investment adviser provide the schedules
specified in Article 12 of this part for the assets to be acquired.
(d) Supplemental financial information. (1) Supplemental financial
information shall consist of:
(i) A table showing the current fees for the registrant and the
acquired fund and pro forma fees, if different, for the registrant
after giving effect to the acquisition using the format prescribed in
the appropriate registration statement under the Investment Company
Act;
[[Page 24654]]
(ii) if the transaction will result in a material change in the
acquired fund's investment portfolio due to investment restrictions, a
schedule of investments of the acquired fund modified to reflect such
change and accompanied by narrative disclosure describing the change;
and
(iii) narrative disclosure about material differences in financial
and operating policies of the acquired fund when compared to the
registrant.
(2) With respect to any fund acquisition, registered investment
companies and business development companies shall provide the
supplemental financial information required in this section in lieu of
any pro forma financial information required by Sec. Sec. 210.11-01 to
210.11-03 of this regulation.
0
12. Amend Sec. 210.8-01 by revising NOTE 2 to Sec. 210.8 to remove
the undesignated paragraph following paragraph (c) to NOTE 2, and
adding NOTE 6 to Sec. 210.8 to read as follows:
Sec. 210.8-01 Preliminary Notes to Article 8.
* * * * *
Note 6 to Sec. 210.8: Section 210.3-06 shall apply to the
preparation of financial statements of smaller reporting companies.
Sec. 210.8-03 [Amended]
0
13. Remove and reserve Sec. 210.8-03(b)(4).
0
14. Revise Sec. 210.8-04 to read as follows:
Sec. 210.8-04 Financial statements of businesses acquired or to be
acquired.
Apply Sec. 210.3-05 substituting Sec. Sec. 210.8-02 and 210.8-03,
as applicable, wherever Sec. 210.3-05 references Sec. Sec. 210.3-01
and 210.3-02.
0
15. Revise Sec. 210.8-05 to read as follows:
Sec. 210.8-05 Pro forma financial information.
(a) Pro forma financial information shall be disclosed when any of
the conditions in Sec. 210.11-01 exist.
(b) The preparation, presentation and disclosure of pro forma
financial information shall comply with Sec. Sec. 210.11-01 through
210.11-03 (Article 11), except that the pro forma financial information
may be condensed pursuant to Sec. 210.8-03(a).
0
16. Revise Sec. 210.8-06 to read as follows:
Sec. 210.8-06 Real estate operations acquired or to be acquired.
Apply Sec. 210.3-14 substituting Sec. Sec. 210.8-02 and 210.8-03,
as applicable, wherever Sec. 210.3-14 references Sec. Sec. 210.3-01
and 210.3-02.
0
17. Amend Sec. 210.11-01 by:
0
a. Removing and reserving (a)(5);
0
b. Revising the introductory text of paragraph (a), and paragraphs
(a)(1), (a)(2), (a)(6), (a)(8), (b), and (c) to read as follows:
Sec. 210.11-01 Presentation requirements.
(a) Pro forma financial information shall be filed when any of the
following conditions exist:
(1) During the most recent fiscal year or subsequent interim period
for which a balance sheet is required by Sec. 210.3-01, a significant
business acquisition has occurred (for purposes of these rules, this
encompasses the acquisition of an interest in a business accounted for
by the equity method);
(2) After the date of the most recent balance sheet filed pursuant
to Sec. 210.3-01, consummation of a significant business acquisition
or a combination of entities under common control has occurred or is
probable;
* * * * *
(5) [Reserved];
(6) Pro forma financial information required by Sec. 229.914 is
required to be provided in connection with a roll-up transaction as
defined in Sec. 229.901(c);
* * * * *
(8) Consummation of other transactions has occurred or is probable
for which disclosure of pro forma financial information would be
material to investors.
(b) A business acquisition or disposition shall be considered
significant if:
(1) The business acquisition meets:
(i) The definition of a significant subsidiary in Sec. 210.1-
02(w)(1), substituting 20 percent for 10 percent each place it appears
therein; or
(ii) If the business is a real estate operation as defined in Sec.
210.3-14(a)(2), the significant subsidiary condition in Sec. 210.1-
02(w)(1)(i), substituting 20 percent for 10 percent, as modified by the
guidance in Sec. 210.3-14(b)(2).
(2) The business disposition, including a business that is a real
estate operation as defined in Sec. 210.3-14(a)(2), meets the
definition of a significant subsidiary in Sec. 210.1-02(w)(1),
substituting 20 percent for 10 percent each place it appears therein.
(3) The determination shall be made by comparing the most recent
annual financial statements of each such business, or for acquisitions
each group of related businesses (as defined in Sec. 210.3-05(a)(3))
on a combined basis or each group of related real estate operations (as
defined in Sec. 210.3-14(a)(2)) on a combined basis, to the
registrant's most recent annual consolidated financial statements filed
at or prior to the date of acquisition or disposition, except as noted
in Sec. 210.3-14(b)(2)(iii) for real estate operations. Registrants
that acquire net assets that constitute a business or a business that
includes oil- or gas- producing activities may make the determination
using the financial statements described in Sec. 210.3-05(e) or Sec.
210.3-05(f) if the business meets the conditions for presenting those
financial statements. However, the determination may be made using:
(i) Pro forma amounts specified in Sec. 210.11-02(a)(6)(i) for the
registrant for the periods specified in Sec. 210.11-01(b)(3) that only
depict significant business acquisitions and dispositions consummated
after the latest fiscal year-end for which the registrant's financial
statements are required to be filed, provided that the registrant has
filed audited financial statements for any such acquired business for
the periods required by Sec. 210.3-05 or Sec. 210.3-14 and the pro
forma financial information required by Sec. 210.11-01 through Sec.
210.11-02 for any such acquired or disposed business. The tests may not
be made by ``annualizing'' data; or
(ii) The registrant's annual consolidated financial statements, for
the most recent fiscal year ended prior to the acquisition or
disposition, that are included in the registrant's Form 10-K (Sec.
249.310 of this chapter) filed after the acquisition or disposition,
but before the date financial statements and pro forma financial
information for the acquisition or disposition would be required to be
filed on Form 8-K (Sec. 249.308 of this chapter).
(c) The pro forma effects of a business acquisition need not be
presented pursuant to this section if separate financial statements of
the acquired business are not included in the filing, except where the
aggregate impact of businesses acquired or to be acquired is
significant as determined by Sec. Sec. 210.3-05(b)(2)(iv) or 210.3-
14(b)(2)(i)(C).
* * * * *
0
18. Revise Sec. 210.11-02 to read as follows:
Sec. 210.11-02 Preparation requirements.
(a) Form and content. (1) Pro forma financial information shall
consist of a pro forma condensed balance sheet, pro forma condensed
statements of comprehensive income, and accompanying explanatory notes.
In certain circumstances (i.e., where a limited number of pro forma
adjustments are required and those adjustments are easily understood),
a narrative description of the pro forma effects of the transaction may
be
[[Page 24655]]
disclosed in lieu of the statements described herein.
(2) The pro forma financial information shall be accompanied by an
introductory paragraph which briefly sets forth a description of:
(i) Each transaction for which pro forma effect is being given;
(ii) The entities involved;
(iii) The periods for which the pro forma financial information is
presented; and
(iv) An explanation of what the pro forma presentation shows.
(3) The pro forma condensed financial information need only include
major captions (i.e., the numbered captions) prescribed by the
applicable sections of Regulation S-X. Where any major balance sheet
caption is less than 10 percent of total assets, the caption may be
combined with others. When any major statement of comprehensive income
caption is less than 15 percent of average net income attributable to
the registrant for the most recent three fiscal years, the caption may
be combined with others. In calculating average net income attributable
to the registrant, loss years should be excluded unless losses were
incurred in each of the most recent three years, in which case the
average loss shall be used for purposes of this test. Notwithstanding
these tests, de minimis amounts need not be shown separately.
(4) Pro forma statements shall ordinarily be in columnar form
showing condensed historical statements, pro forma adjustments, and the
pro forma results.
(5) The pro forma condensed statement of comprehensive income shall
disclose income (loss) from continuing operations and income or loss
from continuing operations attributable to the controlling interest.
(6) The pro forma condensed balance sheet and pro forma condensed
statements of comprehensive income shall present in separate columns
and shall include, and be limited to, the following pro forma
adjustments:
(i) Transaction Accounting Adjustments. (A) Adjustments that depict
in the pro forma condensed balance sheet the accounting for the
transaction required by U.S. Generally Accepted Accounting Principles
(U.S. GAAP) or, as applicable, International Financial Reporting
Standards as issued by the International Accounting Standards Board
(IFRS-IASB). Calculate pro forma adjustments using the measurement date
and method prescribed by the applicable accounting standards. For a
probable transaction, calculate pro forma adjustments using, and
disclose, the most recent practicable date prior to the effective date
(for registration statements) or the mail date (for proxy statements).
(B) Adjustments that depict in the pro forma condensed statements
of comprehensive income the effects of the pro forma balance sheet
adjustments in paragraph (a)(6)(i)(A) of this section assuming those
adjustments were made as of the beginning of the fiscal year presented.
If the condition in Sec. 210.11-01(a) that is met does not have a
balance sheet effect, then depict the accounting for the transaction
required by U.S. GAAP or IFRS-IASB, as applicable.
(ii) Management's Adjustments. Management's Adjustments shall be
limited to adjustments that:
(A) Give effect to reasonably estimable synergies and other
transaction effects, such as closing facilities, discontinuing product
lines, terminating employees, and executing new or modifying existing
agreements, that have occurred or are reasonably expected to occur.
(B) Show the registrant as an autonomous entity if the condition in
Sec. 210.11-01(a)(7) is met.
Instruction to paragraph (a)(6)(ii): Any forward-looking
information supplied is expressly covered by the safe harbor rule. See
Sec. 230.175 and Sec. 240.3b-6 of this chapter.
(7) All pro forma adjustments should be referenced to notes that
clearly explain the assumptions involved. When Management's Adjustments
are presented, the pro forma condensed statements of comprehensive
income shall include a separate subtotal column that combines the
historical statements and the Transaction Accounting Adjustments before
the column depicting Management's Adjustments.
(8)(i) Historical and pro forma basic and diluted per share amounts
based on continuing operations attributable to the controlling
interests and the number of shares used to calculate such per share
amounts shall be presented on the face of the pro forma condensed
statement of comprehensive income for both the pro forma total
depicting the combined historical statements and Transaction Accounting
Adjustments as well as the pro forma total depicting the combined
historical statements, Transaction Accounting Adjustments, and
Management's Adjustments, if any.
(ii) The number of shares used in the calculation of the pro forma
per share amounts shall be based on the weighted average number of
shares outstanding during the period adjusted to give effect to the
number of shares issued or to be issued to consummate the transaction,
or if applicable whose proceeds will be used to consummate the
transaction as if the shares were outstanding as of the beginning of
the period presented. Calculate the pro forma effect of potential
common stock being issued in the transaction (e.g., a convertible
security), or the proceeds of which will be used to consummate the
transaction, on pro forma earnings per share in accordance with U.S.
GAAP or IFRS-IASB, as applicable, as if the potential common stock were
outstanding as of the beginning of the period presented. If a
Management's Adjustment will change the number of shares or potential
common shares, reflect the change within Management's Adjustment in
accordance with U.S. GAAP or IFRS-IASB, as applicable, as if the common
stock or potential common stock were outstanding as of the beginning of
the period presented.
(9) If the transaction is structured in such a manner that
significantly different results may occur, provide additional pro forma
presentations which give effect to the range of possible results.
(10) The accompanying explanatory notes shall disclose:
(i) Revenues, expenses, gains and losses and related tax effects
which will not recur in the income of the registrant beyond 12 months
after the transaction.
(ii) For Transaction Accounting Adjustments:
(A) A table showing the total consideration transferred or received
including its components and how they were measured. If total
consideration includes contingent consideration, describe the
arrangement(s), the basis for determining the amount of payment(s) or
receipt(s), and an estimate of the range of outcomes (undiscounted) or,
if a range cannot be estimated, that fact and the reasons why; and
(B) The following information when the accounting is incomplete: A
prominent statement to this effect; the items for which the accounting
depicted is incomplete; a description of the information that the
registrant requires, including, if material, the uncertainties
affecting the pro forma financial information and the possible
consequences of their resolution; an indication of when the accounting
is expected to be finalized; and other available information that will
enable a reader to understand the magnitude of any potential
adjustments to the measurements depicted.
(iii) For each Management's Adjustment, a description, including
the material uncertainties, of the synergy or other transaction effect,
the material assumptions, the calculation of the adjustment, the
estimated time frame for completion, and qualitative information
necessary to give a fair and balanced
[[Page 24656]]
presentation of the pro forma financial information. To the extent
known, the reportable segments, products, services, and processes
involved; the material resources required, if any, and the anticipated
timing.
(iv) For synergies and other transaction effects that are not
reasonably estimable, qualitative information necessary for a fair and
balanced presentation of the pro forma financial information.
(11) A registrant shall not:
(i) Present pro forma financial information on the face of the
registrant's historical financial statements or in the accompanying
notes, except where such presentation is required by U.S. GAAP or IFRS-
IASB, as applicable.
(ii) Present summaries of pro forma financial information elsewhere
in a filing that excludes material transactions for which pro forma
effect is required to be given.
(iii) Give pro forma effect to the registrant's adoption of an
accounting standard in pro forma financial information required by
Sec. Sec. 210.11-01 through 210.11-03 of this chapter.
(b) Implementation guidance. (1) Historical statement of
comprehensive income. The historical statement of comprehensive income
used in the pro forma financial information shall only be presented
through income from continuing operations (or the appropriate
modification thereof).
(2) Business acquisitions. In some transactions, such as in
financial institution acquisitions, measuring the acquired assets at
their acquisition date fair value may result in significant discounts
relative to the acquired business's historical cost of the acquired
assets. When such discounts can result in a significant effect on
earnings (losses) in periods immediately subsequent to the acquisition
that will be progressively eliminated over a relatively short period,
the effect of the discounts on reported results of operations for each
of the next five years shall be disclosed in a note.
(3) Business dispositions. Transaction Accounting Adjustments
giving effect to the disposition of a business shall not decrease
historically incurred compensation expense for employees who were not,
or will not be, transferred or terminated as of the disposition date.
Adjustments to decrease historically incurred compensation expense for
those employees shall be included in Management's Adjustments if they
meet the requirements in Sec. 210.11-02(a)(6)(ii).
(4) Multiple transactions. (i) When consummation of more than one
transaction has occurred, or is probable, the pro forma financial
information shall present in separate columns each transaction for
which pro forma presentation is required by Sec. 210.11-01.
(ii) If the pro forma financial information is presented in a proxy
or information statement for purposes of obtaining shareholder approval
of one of the transactions, the effects of that transaction must be
clearly set forth.
(5) Tax effects. (i) Tax effects, if any, of pro forma adjustments
normally should be calculated at the statutory rate in effect during
the periods for which pro forma condensed statements of comprehensive
income are presented and should be reflected as a separate pro forma
adjustment.
(ii) When the registrant's historical statements of comprehensive
income do not reflect the tax provision on the separate return basis,
pro forma statements of comprehensive income adjustments shall reflect
a tax provision calculated on the separate return basis.
(c) Periods to be presented. (1) A pro forma condensed balance
sheet as of the end of the most recent period for which a consolidated
balance sheet of the registrant is required by Sec. 210.3-01 shall be
filed unless the transaction is already reflected in such balance
sheet.
(2)(i) Pro forma condensed statements of comprehensive income shall
be filed for only the most recent fiscal year, except as noted in
paragraph (c)(2)(ii) of this section, and for the period from the most
recent fiscal year end to the most recent interim date for which a
balance sheet is required. A pro forma condensed statement of
comprehensive income may be filed for the corresponding interim period
of the preceding fiscal year. A pro forma condensed statement of
comprehensive income shall not be filed when the historical statement
of comprehensive income reflects the transaction for the entire period.
(ii) For transactions required to be accounted for under U.S. GAAP
or, as applicable, IFRS-IASB by retrospectively revising the historical
statements of comprehensive income (e.g., combination of entities under
common control and discontinued operations), pro forma statements of
comprehensive income shall be filed for all periods for which
historical financial statements of the registrant are required.
Retrospective revisions stemming from the registrant's adoption of a
new accounting principle should not be reflected in pro forma
statements of comprehensive income until they are depicted in the
registrant's historical financial statements.
(3) Pro forma condensed statements of comprehensive income shall be
presented using the registrant's fiscal year end. If the most recent
fiscal year end of any other entity involved in the transaction differs
from the registrant's most recent fiscal year end by more than one
fiscal quarter, the other entity's statement of comprehensive income
shall be brought up to within one fiscal quarter of the registrant's
most recent fiscal year end, if practicable. This updating could be
accomplished by adding subsequent interim period results to the most
recent fiscal year end information and deducting the comparable
preceding year interim period results. Disclosure shall be made of the
periods combined and of the sales or revenues and income for any
periods which were excluded from or included more than once in the
condensed pro forma statement of comprehensive income (e.g., an interim
period that is included both as part of the fiscal year and the
subsequent interim period).
Instruction to paragraph (c)(3): In circumstances where different
fiscal year ends exist, Sec. 210.3-12 may require a registrant to
include in the pro forma financial information an acquired or to be
acquired foreign business historical period that would be more current
than the periods included in the required historical financial
statements of the foreign business.
(4) Whenever unusual events enter into the determination of the
results shown for the most recently completed fiscal year, the effect
of such unusual events should be disclosed and consideration should be
given to presenting a pro forma condensed statement of comprehensive
income for the most recent twelve-month period in addition to those
required in paragraph (c)(2)(i) of this section if the most recent
twelve-month period is more representative of normal operations.
Sec. 210.11-03 [Amended]
0
19. Amend Sec. 210.11-03 by:
0
a. In paragraph (a) introductory text, removing ``Sec. 210.11-
02(b)(1)'' and adding in its place ``Sec. 210.11-02(a)(1)''; and
0
b. In paragraph (a)(2), removing ``Sec. 210.11-02(b)(3)'' and adding
in its place ``Sec. 210.11-02(a)(3)''.
0
c. In paragraph (d), removing ``generally accepted accounting
principles'' and adding in its place ``U.S. GAAP or IFRS-IASB.''
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
0
20. The authority citation for part 230 continues to read, in part, as
follows:
[[Page 24657]]
Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h,
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Pub. L. 112-106, sec. 201(a), sec. 401, 126
Stat. 313 (2012), unless otherwise noted.
* * * * *
0
21. Amend Sec. 230.405 by revising the definition of ``Significant
subsidiary'' to read as follows:
Sec. 230.405 Definitions of terms.
* * * * *
Significant subsidiary. The term significant subsidiary means a
subsidiary, including its subsidiaries, which meets any of the
conditions in paragraphs (1), (2), or (3) of this definition; however,
if the subsidiary is a registered investment company or a business
development company, it meets any of the conditions in paragraph (4) of
this definition instead of any of the conditions in paragraphs (1),
(2), or (3) of this definition. A registrant that files its financial
statements in accordance with or provides a reconciliation to U.S.
Generally Accepted Accounting Principles (U.S. GAAP) shall use amounts
determined under U.S. GAAP. A foreign private issuer that files its
financial statements in accordance with International Financial
Reporting Standards as issued by the International Accounting Standards
Board (IFRS-IASB) shall use amounts determined under IFRS-IASB.
(1) Investment test. (i) The registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the aggregate worldwide market value of the
registrant's voting and non-voting common equity, or if the registrant
has no such aggregate worldwide market value, the total assets of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year. Aggregate worldwide market value of the
registrant's voting and non-voting common equity shall be determined as
of the last business day of the registrant's most recently completed
fiscal year, which for acquisitions and dispositions shall be at or
prior to the date of acquisition or disposition;
(ii) For a combination between entities or businesses under common
control, this test shall be met when either the net book value of the
tested subsidiary exceeds 10 percent of the registrant's and its
subsidiaries' consolidated total assets or the number of common shares
exchanged or to be exchanged by the registrant exceeds 10 percent of
its total common shares outstanding at the date the combination is
initiated;
(iii) For all other acquisitions, the ``investment in'' the tested
subsidiary shall include the fair value of contingent consideration if
required to be recognized at fair value at the acquisition date;
however if recognition at fair value is not required, include all
contingent consideration, except sales-based milestones and royalties,
unless the likelihood of payment is remote. The ``investment in'' the
tested subsidiary also excludes the registrant's and its subsidiaries'
proportionate interest in the carrying value of assets transferred by
the registrant and its subsidiaries consolidated to the tested
subsidiary that will remain with the combined entity after the
acquisition; and
(iv) For dispositions, the ``investment in'' the tested subsidiary
shall equal the fair value of the consideration, which shall include
contingent consideration, for the disposed subsidiary when comparing to
the aggregate worldwide market value of the registrant or, when the
registrant has no such aggregate worldwide market value, the carrying
value of the disposed subsidiary when comparing to total assets of the
registrant. For a real estate operation as defined in Sec. 210.3-
14(a)(2), when the investment test is based on the total assets of the
registrant and its subsidiaries consolidated, include any debt secured
by the real properties that is assumed by the buyer in the ``investment
in'' the tested real estate operation.
(2) Asset test. The registrant's and its other subsidiaries'
proportionate share of the total assets (after intercompany
eliminations) of the tested subsidiary exceeds 10 percent of such total
assets of the registrant and its subsidiaries consolidated as of the
end of the most recently completed fiscal year.
(3) Income test. (i)(A) The absolute value of the registrant's and
its other subsidiaries' equity in the tested subsidiary's consolidated
income or loss from continuing operations (after intercompany
eliminations) attributable to the controlling interests exceeds 10
percent of the absolute value of such income or loss of the registrant
and its subsidiaries consolidated for the most recently completed
fiscal year; and
(B) The registrant's and its other subsidiaries' proportionate
share of the tested subsidiary's consolidated total revenue (after
intercompany eliminations) exceeds 10 percent of such total revenue of
the registrant and its subsidiaries consolidated for the most recently
completed fiscal year. This component does not apply if either the
registrant and its subsidiaries consolidated or the tested subsidiary
does not have recurring annual revenue.
(ii) When determining the income component in paragraph (3)(i)(A)
of the definition of significant subsidiary in this section:
(A) If a net loss from continuing operations attributable to the
controlling interest has been incurred by either the registrant and its
subsidiaries consolidated or the tested subsidiary, but not both,
exclude the equity in the income or loss from continuing operations of
the tested subsidiary attributable to the controlling interest from
such income or loss of the registrant and its subsidiaries consolidated
for purposes of the computation; and
(B) Compute the test using the average described herein if the
revenue component in paragraph (3)(i)(B) of the definition of
significant subsidiary in this section does not apply and the absolute
value of the registrant's and its consolidated subsidiaries' income or
loss from continuing operations attributable to the controlling
interests for the most recent fiscal year is at least 10 percent lower
than the average of the absolute value of such amounts for each of its
last five fiscal years.
(4) For a registrant that is a registered investment company or a
business development company, the term significant subsidiary means a
subsidiary, including its subsidiaries, which meets any of the
following conditions using amounts determined under U.S. GAAP and, if
applicable, section 2(a)(41) of the Investment Company Act of 1940 (15
U.S.C. 80a-2(a)(41)):
(i) Investment test. The value of the registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the value of the total investments of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year; or
(ii) Income test. The absolute value of the combined investment
income from dividends, interest, and other income, the net realized
gains and losses on investments, and the net change in unrealized gains
and losses on investments from the tested subsidiary, for the most
recently completed fiscal year exceeds:
(A) 80 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year; or
(B) 10 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its
[[Page 24658]]
subsidiaries consolidated for the most recently completed fiscal year
and the investment test condition (paragraph (4)(i) of the definition
of significant subsidiary in this section) exceeds 5 percent. However,
if the registrant and its subsidiaries consolidated has an
insignificant change in net assets resulting from operations for its
most recently completed fiscal year, compute the test using the average
of the absolute value of such amounts for the registrant and its
subsidiaries consolidated for each of its last five fiscal years.
* * * * *
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
0
22. The authority citation for part 239 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3,
77sss, 78c, 78l, 78m,78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 78ll,
78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26,
80a-29, 80a-30, and 80a-37; and sec. 107, Pub. L. 112-106, 126 Stat.
312, unless otherwise noted.
* * * * *
0
23. Form N-14 (referenced in Sec. 239.23) is amended to revise Item 14
to read as follows:
Note: The text of Form N-14 does not, and this amendment will
not, appear in the Code of Federal Regulations.
Form N-14
* * * * *
Item 14. Financial Statements
The Statement of Additional Information shall contain the financial
statements, including the schedules thereto, and supplemental financial
information of the acquiring company and the company to be acquired
required by Regulation S-X [17 CFR 210] for the periods specified in
Article 3 and Rule 6-11 of Regulation S-X, except:
1. If the company to be acquired is an investment company or would
be an investment company but for the exclusions provided by sections
3(c)(1) or 3(c)(7) of the 1940 Act [15 U.S.C. 80a-3(c)(1) and (c)(7)]
(a ``private fund''), the financial statements need only be filed for
the most recent fiscal year and the most recent interim period;
2. if the company to be acquired is a private fund, then such
company may provide the financial statements, including the schedules
thereto, described in Rule 3-18 of Regulation S-X that comply with U.S.
Generally Accepted Accounting Principles and only Article 12 of
Regulation S-X;
3. the financial statements required by Regulation S-X for any
subsidiary that is not a majority-owned subsidiary may be omitted from
Part B and included in Part C; and
4. the table showing the current fees and pro forma fees, if
different, required by Rule 6-11 of Regulation S-X (which is required
by Item 3 of this Form).
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
24. The authority citation for part 240 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.; and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350;
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602,
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
25. Amend Sec. 240.12b-2 by revising the definition of ``Significant
subsidiary'' to read as follows:
Sec. 240.12b-2 Definitions.
* * * * *
Significant subsidiary. The term significant subsidiary means a
subsidiary, including its subsidiaries, which meets any of the
conditions in the following paragraphs (1), (2), or (3) of this
definition; however, if the subsidiary is a registered investment
company or a business development company, it meets any of the
conditions in paragraph (4) of this definition instead of any of the
conditions in paragraphs (1), (2), or (3) of this definition. A
registrant that files its financial statements in accordance with or
provides a reconciliation to U.S. Generally Accepted Accounting
Principles (U.S. GAAP) shall use amounts determined under U.S. GAAP A
foreign private issuer that files its financial statements in
accordance with International Financial Reporting Standards as issued
by the International Accounting Standards Board (IFRS-IASB) shall use
amounts determined under IFRS-IASB.
(1) Investment test. (i) The registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the aggregate worldwide market value of the
registrant's voting and non-voting common equity, or if the registrant
has no such aggregate worldwide market value, the total assets of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year. Aggregate worldwide market value of the
registrant's voting and non-voting common equity shall be determined as
of the last business day of the registrant's most recently completed
fiscal year, which for acquisitions and dispositions shall be at or
prior to the date of acquisition or disposition;
(ii) For a combination between entities or businesses under common
control, this test shall be met when either the net book value of the
tested subsidiary exceeds 10 percent of the registrant's and its
subsidiaries' consolidated total assets or the number of common shares
exchanged or to be exchanged by the registrant exceeds 10 percent of
its total common shares outstanding at the date the combination is
initiated;
(iii) For all other acquisitions, the ``investment in'' the tested
subsidiary shall include the fair value of contingent consideration if
required to be recognized at fair value at the acquisition date;
however if recognition at fair value is not required, include all
contingent consideration, except sales-based milestones and royalties,
unless the likelihood of payment is remote. The ``investment in'' the
tested subsidiary also excludes the registrant's and its subsidiaries'
proportionate interest in the carrying value of assets transferred by
the registrant and its subsidiaries consolidated to the tested
subsidiary that will remain with the combined entity after the
acquisition; and
(iv) For dispositions, the ``investment in'' the tested subsidiary
shall equal the fair value of the consideration, which shall include
contingent consideration, for the disposed subsidiary when comparing to
the aggregate worldwide market value of the registrant or, when the
registrant has no such aggregate worldwide market value, the carrying
value of the disposed subsidiary when comparing to total assets of the
registrant. For a real estate operation as defined in Sec. 210.3-
14(a)(2), when the investment test is based on the total assets of the
registrant and its subsidiaries consolidated, include any debt secured
by the real properties that is assumed by the buyer in the ``investment
in'' the tested real estate operation.
(2) Asset test. The registrant's and its other subsidiaries'
proportionate share of the total assets (after intercompany
eliminations) of the tested subsidiary exceeds 10 percent of such total
assets of the registrant and its subsidiaries consolidated as of the
end of the most recently completed fiscal year.
[[Page 24659]]
(3) Income test. (i)(A) The absolute value of the registrant's and
its other subsidiaries' equity in the tested subsidiary's consolidated
income or loss from continuing operations (after intercompany
eliminations) attributable to the controlling interests exceeds 10
percent of the absolute value of such income or loss of the registrant
and its subsidiaries consolidated for the most recently completed
fiscal year; and
(B) The registrant's and its other subsidiaries' proportionate
share of the tested subsidiary's consolidated total revenue (after
intercompany eliminations) exceeds 10 percent of such total revenue of
the registrant and its subsidiaries consolidated for the most recently
completed fiscal year. This component does not apply if either the
registrant and its subsidiaries consolidated or the tested subsidiary
does not have recurring annual revenue.
(ii) When determining the income component in paragraph (3)(i)(A)
of the definition of significant subsidiary in this section:
(A) If a net loss from continuing operations attributable to the
controlling interest has been incurred by either the registrant and its
subsidiaries consolidated or the tested subsidiary, but not both,
exclude the equity in the income or loss from continuing operations of
the tested subsidiary attributable to the controlling interest from
such income or loss of the registrant and its subsidiaries consolidated
for purposes of the computation; and
(B) Compute the test using the average described herein if the
revenue component in paragraph (3)(i)(B) of the definition of
significant subsidiary in this section does not apply and the absolute
value of the registrant's and its consolidated subsidiaries' income or
loss from continuing operations attributable to the controlling
interests for the most recent fiscal year is at least 10 percent lower
than the average of the absolute value of such amounts for each of its
last five fiscal years.
(4) For a registrant that is a registered investment company or a
business development company, the term significant subsidiary means a
subsidiary, including its subsidiaries, which meets any of the
following conditions using amounts determined under U.S. GAAP and, if
applicable, section 2(a)(41) of the Investment Company Act of 1940 (15
U.S.C. 80a-2(a)(41)):
(i) Investment test. The value of the registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the value of the total investments of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year; or
(ii) Income test. The absolute value of the combined investment
income from dividends, interest, and other income, the net realized
gains and losses on investments, and the net change in unrealized gains
and losses on investments from the tested subsidiary, for the most
recently completed fiscal year exceeds:
(A) 80 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year; or
(B) 10 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year and the
Investment Test condition (paragraph (4)(i) of the definition of
significant subsidiary in this section) exceeds 5 percent. However, if
the registrant and its subsidiaries consolidated has an insignificant
change in net assets resulting from operations for its most recently
completed fiscal year, compute the test using the average of the
absolute value of such amounts for the registrant and its subsidiaries
consolidated for each of its last five fiscal years.
* * * * *
Sec. 240.14a-101 [Amended]
0
26. Amend Sec. 240.14a-101, Item 14(d)(5) by removing the phrase
``Rule 3-05 and Article 11 of Regulation S-X'' and adding in its place
``Rules 3-05, 6-11, and Article 11 of Regulation S-X''.
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
27. The authority citation for part 249 continues to read, in part, as
follows:
Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111-203, 124
Stat. 1904; Sec. 102(a)(3), Pub. L. 112-106, 126 Stat. 309 (2012);
Sec. 107, Pub. L. 112-106, 126 Stat. 313 (2012), and Sec. 72001,
Pub. L. 114-94, 129 Stat. 1312 (2015), unless otherwise noted.
* * * * *
0
28. Form 8-K (referenced in Sec. 249.308) is amended by revising the
introductory text to Item 2.01, Instruction 4 to Item 2.01, and Item
9.01.
The revisions to read as follows:
Note: The text of Form 8-K does not, and this amendment will
not, appear in the Code of Federal Regulations.
Form 8-K
* * * * *
Item 2.01 Completion of Acquisition or Disposition of Assets
If the registrant or any of its subsidiaries consolidated has
completed the acquisition or disposition of a significant amount of
assets, otherwise than in the ordinary course of business, or the
acquisition or disposition of a significant amount of assets that
constitute a real estate operation as defined in Sec. 210.3-14(a)(2)
disclose the following information:
* * * * *
Instructions. * * *
4. An acquisition or disposition shall be deemed to involve a
significant amount of assets:
(i) If the registrant's and its other subsidiaries' equity in the
net book value of such assets or the amount paid or received for the
assets upon such acquisition or disposition exceeded 10% of the total
assets of the registrant and its consolidated subsidiaries;
(ii) If it involved a business (see 17 CFR 210.11-01(d)) that is
significant (see 17 CFR 210.11-01(b)); or
(iii) In the case of a business development company, if the amount
paid for such assets exceeded 10% of the value of the total investments
of the registrant and its consolidated subsidiaries.
The aggregate impact of acquired businesses are not required to be
reported pursuant to this Item 2.01 unless they are related businesses
(see 17 CFR 210.3-05(a)(3)), related real estate operations (see 17 CFR
210.3-14(a)(3)), or related funds (see 17 CFR 210.6-11(a)(3)), and are
significant in the aggregate.
5. Attention is directed to the requirements in Item 9.01
(Financial Statements and Exhibits) with respect to the filing of:
(i) Financial statements of businesses or funds acquired;
* * * * *
Item 9.01 Financial Statements and Exhibits
List below the financial statements, pro forma financial
information and exhibits, if any, filed as a part of this report.
(a) Financial statements of businesses or funds acquired.
(1) For any business acquisition or fund acquisition required to be
described in answer to Item 2.01 of this form, file financial
statements and any applicable supplemental information, of the business
acquired specified in Rules 3-05 or 3-14 of Regulation S-X (17 CFR
210.3-05(b) and 210.3-14), or Rules 8-04 or 8-06 of Regulation S-X (17
CFR 210.8-04(b) and 210.8-06) for smaller
[[Page 24660]]
reporting companies, or of the fund acquired specified in Rule 6-11 of
Regulation S-X (17 CFR 210.6-11).
(2) The financial statements shall be prepared pursuant to
Regulation S-X except that supporting schedules need not be filed
unless required by Rule 6-11 of Regulation S-X (17 CFR 210.6-11). A
manually signed accountant's report should be provided pursuant to Rule
2-02 of Regulation S-X (17 CFR 210.2-02).
(3) Financial statements required by this item may be filed with
the initial report, or by amendment not later than 71 calendar days
after the date that the initial report on Form 8-K must be filed. If
the financial statements are not included in the initial report, the
registrant should so indicate in the Form 8-K report and state when the
required financial statements will be filed. The registrant may, at its
option, include unaudited financial statements in the initial report on
Form 8-K.
(b) Pro forma financial information.
(1) For any transaction required to be described in answer to Item
2.01 of this form, furnish any pro forma financial information that
would be required pursuant to Article 11 of Regulation S-X (17 CFR 210)
or Rule 8-05 of Regulation S-X (17 CFR 210.8-05) for smaller reporting
companies unless it involves the acquisition of a fund subject to Rule
6-11 of Regulation S-X (17 CFR 210.6-11).
(2) The provisions of paragraph (a)(3) of this Item 9.01 shall also
apply to pro forma financial information relative to the acquired
business.
(c) Shell company transactions. The provisions of paragraph (a)(3)
and (b)(2) of this Item shall not apply to the financial statements or
pro forma financial information required to be filed under this Item
with regard to any transaction required to be described in answer to
Item 2.01 of this Form by a registrant that was a shell company, other
than a business combination related shell company, as those terms are
defined in Rule 12b-2 under the Exchange Act (17 CFR 240.12b-2),
immediately before that transaction. Accordingly, with regard to any
transaction required to be described in answer to Item 2.01 of this
Form by a registrant that was a shell company, other than a business
combination related shell company, immediately before that transaction,
the financial statements and pro forma financial information required
by this Item must be filed in the initial report. Notwithstanding
General Instruction B.3. to Form 8-K, if any financial statement or any
financial information required to be filed in the initial report by
this Item 9.01(c) is previously reported, as that term is defined in
Rule 12b-2 under the Exchange Act (17 CFR 240.12b-2), the registrant
may identify the filing in which that disclosure is included instead of
including that disclosure in the initial report.
(d) Exhibits. * * *
Instruction
During the period after a registrant has reported an acquisition
pursuant to Item 2.01 of this form, until the date on which the
financial statements specified by this Item 9.01 must be filed, the
registrant will be deemed current for purposes of its reporting
obligations under Section 13(a) or 15(d) of the Exchange Act (15 U.S.C.
78m or 78o(d)). With respect to filings under the Securities Act,
however, registration statements will not be declared effective and
post-effective amendments to registration statements will not be
declared effective unless financial statements meeting the requirements
of Rule 3-05, Rule 3-14, and Rule 6-11 of Regulation S-X (17 CFR 210.3-
05, 210.3-14, and 210.6-11), as applicable, are provided. In addition,
offerings should not be made pursuant to effective registration
statements, or pursuant to Rule 506 of Regulation D (17 CFR 230.506)
where any purchasers are not accredited investors under Rule 501(a) of
that Regulation, until the audited financial statements required by
Rule 3-05, Rule 3-14, and Rule 6-11 of Regulation S-X (17 CFR 210.3-05,
210.3-14, and 210.6-11), as applicable, are filed; provided, however,
that the following offerings or sales of securities may proceed
notwithstanding that financial statements of the acquired business have
not been filed:
(a) Offerings or sales of securities upon the conversion of
outstanding convertible securities or upon the exercise of outstanding
warrants or rights;
(b) Dividend or interest reinvestment plans;
(c) Employee benefit plans;
(d) Transactions involving secondary offerings; or
(e) Sales of securities pursuant to Rule 144 (17 CFR 230.144).
* * * * *
29. Form 10-K (referenced in Sec. 249.310) is amended to revise
Item 8.(a) of PART II to read as follows:
Note: The text of Form 10-K does not, and this amendment will
not, appear in the Code of Federal Regulations.
Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
General Instructions
* * * * *
Part II. * * *
Item 8. Financial Statements and Supplementary Data
(a) Furnish financial statements meeting the requirements of
Regulation S-X (Sec. 210 of this chapter), except Sec. 210.3-05,
Sec. 210.3-14, Sec. 210.6-11, Sec. 210.8-04, Sec. 210.8-05, Sec.
210.8-06 and Article 11 thereof, and the supplementary financial
information required by Item 302 of Regulation S-K (Sec. 229.302 of
this chapter). Financial statements of the registrant and its
subsidiaries consolidated (as required by Rule 14a-3(b)) shall be filed
under this item. Other financial statements and schedules required
under Regulation S-X may be filed as ``Financial Statement Schedules''
pursuant to Item 15, Exhibits, Financial Statement Schedules, and
Reports on Form 8-K, of this form.
* * * * *
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
0
30. The general authority citation for part 270 continues to read, in
part, as follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless
otherwise noted.
* * * * *
0
31. Revise paragraph (k) of Sec. 270.8b-2 to read as follows:
* * * * *
(k) Significant subsidiary. The term ``significant subsidiary''
means a subsidiary, including its subsidiaries, which meets any of the
following conditions, using amounts determined under U.S. Generally
Accepted Accounting Principles and, if applicable, section 2(a)(41) of
the Act:
(i) Investment test. The value of the registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary
exceed 10 percent of the value of the total investments of the
registrant and its subsidiaries consolidated as of the end of the most
recently completed fiscal year; or
(ii) Income test. The absolute value of the combined investment
income from dividends, interest, and other income, the net realized
gains and losses on investments, and the net change in
[[Page 24661]]
unrealized gains and losses on investments from the tested subsidiary,
for the most recently completed fiscal year exceeds:
(A) 80 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year; or
(B) 10 percent of the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated for the most recently completed fiscal year and the
Investment Test (paragraph (k)(i)) condition exceeds 5 percent.
However, if the registrant and its subsidiaries consolidated has an
insignificant change in net assets resulting from operations for its
most recently completed fiscal year, compute the test using the average
of the absolute value of such amounts for the registrant and its
subsidiaries consolidated for each of its last five fiscal years.
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
32. The general authority citation for part 274 continues to read, in
part, as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L. 111-203,
sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.
* * * * *
0
33. Form N-2 (referenced in Sec. Sec. 239.14 and 274.11a-1) is amended
as follows:
0
a. Revise Item 8.6, paragraph (a) to Instruction 1 by removing the
phrase ``Sections 210.6-01 through 210.6-10 of Regulation S-X [17 CFR
210.6-01 through 210.6-10]'' and adding in its place ``Article 6 of
Regulation S-X [17 CFR 210.6-01 et seq.]''.
0
b. Revise Item 24, paragraph (a) to Instruction 1 by removing the
phrase ``Sections 210.6-01 through 210.6-10 of Regulation S-X [17 CFR
210.6-01 through 210.6-10]'' and adding in its place ``Article 6 of
Regulation S-X [17 CFR 210.6-01 et seq.]''.
Note: The text of Form N-2 does not, and this amendment will
not, appear in the Code of Federal Regulations.
By the Commission.
Dated: May 3, 2019.
Eduardo A. Aleman,
Deputy Secretary.
[FR Doc. 2019-09472 Filed 5-24-19; 8:45 am]
BILLING CODE 8011-01-P