[Federal Register Volume 85, Number 169 (Monday, August 31, 2020)]
[Rules and Regulations]
[Pages 54002-54074]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11479]
[[Page 54001]]
Vol. 85
Monday,
No. 169
August 31, 2020
Part III
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Parts 210, 230, 239, et al.
Amendments to Financial Disclosures About Acquired and Disposed
Businesses; Final Rule
Federal Register / Vol. 85, No. 169 / Monday, August 31, 2020 / Rules
and Regulations
[[Page 54002]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210, 230, 239, 240, 249, 270 and 274
[Release No. 33-10786; 34-88914; IC-33872; File No. S7-05-19]
RIN 3235-AL77
Amendments to Financial Disclosures About Acquired and Disposed
Businesses
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: We are adopting amendments to our rules and forms to improve
their application, assist registrants in making more meaningful
determinations of whether a subsidiary or an acquired or disposed
business is significant, and to improve the disclosure requirements for
financial statements relating to acquisitions and dispositions of
businesses, including real estate operations and investment companies.
The 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: Effective Date: The final rules are effective on January 1,
2021.
Compliance Dates: See Section II.F. for further information on
transitioning to the final rules.
FOR FURTHER INFORMATION CONTACT: Todd E. Hardiman, Associate Chief
Accountant, at (202) 551-3516, 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; Joel Cavanaugh, Senior Counsel, at (202) 551-3173, 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, U.S. Securities and Exchange Commission, 100 F
Street, NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are adopting amendments to:
------------------------------------------------------------------------
Commission reference CFR citation (17 CFR)
------------------------------------------------------------------------
Regulation S-X............................. Sec. Sec. 210.1-01
through 210.13-02.
Rule 1-02(w)........................... Sec. 210.1-02(w).
Rule 3-05.............................. Sec. 210.3-05.
Rule 3-06.............................. Sec. 210.3-06.
Rule 3-09.............................. Sec. 210.3-09.
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.
Form S-11.............................. Sec. 239.18.
Form N-2............................... Sec. Sec. 239.14 and
274.11a-1.
Form N-14.............................. Sec. 239.23.
Form 1-A............................... Sec. 239.90.
Securities Exchange Act of 1934 (Exchange
Act): \2\
Exchange Act Rule 12b-2................ Sec. 240.12b-2.
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.
------------------------------------------------------------------------
We also are adding 17 CFR 210.6-11 (new ``Rule 6-11'') to
Regulation S-X.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
Table of Contents
I. Introduction and Background
II. Discussion of Final Amendments
A. Amendments to the Definition of ``Significant Subsidiary''
and Generally Applicable Financial Statement Requirements for
Acquired Businesses
1. Significance Tests
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
7. Smaller Reporting Companies and Issuers Relying on Regulation
A
B. 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
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
2. Proposed Rule 6-11 of Regulation S-X
3. Pro Forma Financial Information and Supplemental Financial
Information
4. Amendments to Form N-14
F. Transition
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Baseline and Affected Parties
C. Potential Benefits and Costs of the Final Rule
1. Potential Benefits
2. Potential Costs
D. Economic Effects of Specific Amendments
1. Significance Tests
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
7. Smaller Reporting Companies and Issuers Relying on Regulation
A
8. 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
9. Use of Pro Forma Financial Information To Measure
Significance
10. Disclosure Requirements for Individually Insignificant
Acquisitions
11. Rule 3-14--Financial Statements of Real Estate Operations
Acquired or To Be Acquired
12. Pro Forma Financial Information
13. Significance and Business Dispositions
14. Amendments to Financial Disclosure About Acquisitions
Specific to Investment Companies
E. The Effects on Efficiency, Competition, and Capital Formation
F. Alternatives Considered
1. Approaches to the Significance Tests
2. Approaches to Financial Statement Requirements
3. Approaches to Adopting Pro Forma Adjustments
4. Alternatives to the Income Test for Investment Companies
[[Page 54003]]
V. Paperwork Reduction Act
A. Summary of the Collection of Information
B. Effect of the Amendments on Existing Collections of
Information
1. Estimated Effects on Burdens for Registrants Other Than
Investment Companies
2. Estimated Effects of the Proposed Amendments on Paperwork
Burdens for Investment Company Registrants
C. Aggregate Burden and Cost Estimates for the Amendments
VI. Final Regulatory Flexibility Act Analysis
A. Reasons for, and Objectives of, the Final Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Proposed Rules
D. Reporting, Recordkeeping, and Other Compliance Requirements
E. Agency Action To Minimize Effect on Small Entities
VII. Statutory Authority
I. Introduction and Background
On May 3, 2019, the Commission proposed amendments to improve for
investors the financial information about acquired and disposed
businesses, facilitate more timely access to capital, and reduce the
complexity and costs to prepare the disclosure.\4\ Specifically, the
Commission proposed amendments to the requirements for financial
statements relating to acquisitions and dispositions of businesses,
including real estate operations, in Regulation S-X Rule 3-05,\5\
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; and other related rules
and forms.\6\ The proposed amendments resulted from an ongoing,
comprehensive evaluation of our disclosure requirements.\7\ The
Commission also proposed new Rule 6-11 and amendments to Form N-14 to
specifically govern financial reporting for acquisitions involving
investment companies.
---------------------------------------------------------------------------
\4\ See Amendments to Financial Disclosures about Acquired and
Disposed Businesses, Release No. 33-10635 (May 3, 2019) [84 FR 24600
(May 28, 2019)] (``Proposing Release'').
\5\ Unless otherwise noted, references in this release to
``Rule'' or ``Rules'' are to the rules under Regulation S-X.
\6\ The Commission also proposed related amendments to
Regulation S-X with respect 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, the Commission proposed amendments
to Form 8-K for current reports, Form 10-K for annual and transition
reports, and the definition of ``significant subsidiary'' in
Exchange Act Rule 12b-2, Securities Act Rule 405, and Rule 8b-2
under the Investment Company Act.
\7\ The staff, under its Disclosure Effectiveness Initiative, is
reviewing the disclosure requirements in Regulation S-X and in 17
CFR 229.10 through 229.1305 (``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.
---------------------------------------------------------------------------
Under Rule 3-05, a registrant that acquires a business \8\ other
than a real estate operation \9\ is generally required 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, Rule 3-
05 addresses 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.\10\ A registrant that has
acquired, or proposes to acquire, a significant real estate operation
\11\ similarly must file separate audited annual and unaudited interim
abbreviated income statements with respect to such operations (``Rule
3-14 Financial Statements'').\12\ Additionally, registrants required to
file Rule 3-05 Financial Statements or Rule 3-14 Financial Statements
also are required to file unaudited pro forma financial information as
prescribed by Article 11.\13\ 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 statements had the transaction occurred at an earlier
time.
---------------------------------------------------------------------------
\8\ 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.
\9\ Rule 3-05 also applies to registrants that are registered
investment companies and business development companies.
\10\ 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'').
\11\ 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.
\12\ 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 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. Additionally, Rule 3-14 generally
only requires one year of Rule 3-14 Financial Statements.
\13\ See Rules 11-01 and 11-02. 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 statements of comprehensive
income 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.
---------------------------------------------------------------------------
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.\14\ A similar 75-day filing period applies to registration
statements and proxy statements for acquired or to be acquired
businesses requiring Rule 3-05 Financial Statements,\15\ but not for
acquired or to be acquired businesses requiring Rule 3-14 Financial
Statements.
---------------------------------------------------------------------------
\14\ 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 after 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.
\15\ 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 percent 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).
---------------------------------------------------------------------------
In addition, certain registration statements \16\ and proxy
statements
[[Page 54004]]
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 percent for any
combination of acquisitions subject to Rule 3-05.\17\
---------------------------------------------------------------------------
\16\ This additional requirement does not apply to all
registration statements, such as registration statements filed on 17
CFR 239.16b (``Form S-8'').
\17\ See Rule 3-05(b)(2)(i). Smaller reporting companies provide
the same disclosure under Rule 8-04(c)(3).
---------------------------------------------------------------------------
Commenters broadly supported the objectives of the proposed rules
or were generally in favor of the proposals.\18\ While commenters were
largely supportive of the proposals, we also received recommendations
for modifying or further considering aspects of the proposed amendments
that commenters believed could be clarified and improved.\19\ After
reviewing and considering the public comments and recommendations, we
are adopting the amendments largely as proposed. As we discuss further
below, in certain cases we are adopting the proposed rules with
modifications that are intended to address comments received.
---------------------------------------------------------------------------
\18\ Comment letters related to the Proposing Release are
available at https://www.sec.gov/comments/s7-05-19/s70519.htm.
\19\ In addition, the SEC's Small Business Capital Formation
Advisory Committee (``SBCFAC'') adopted a recommendation generally
supportive of the proposed rules subject to their specific
recommendations. See U.S. Securities & Exchange Commission Small
Business Capital Formation Advisory Committee, Recommendation on the
Commission's Proposal to Amend Financial Disclosure Requirements
Relating to Acquisitions and Dispositions of Businesses (Aug. 23,
2019) (``SBCFAC Recommendations''), available at https://www.sec.gov/spotlight/sbcfac/recommendations-rule-3-05-and-accelerated-filer-definition.pdf.
---------------------------------------------------------------------------
II. Discussion of Final Amendments \20\
---------------------------------------------------------------------------
\20\ Generally, the final amendments will not affect the
financial statements related to the acquisition of a business that
is the subject of a proxy statement or registration statement on 17
CFR 239.25 (``Form S-4'') or 17 CFR 239.34 (``Form F-4''); however,
in certain circumstances application of the amended significance
tests may affect whether the financial statements of a subject
business that is not an Exchange Act reporting company are required
to be included in such a proxy statement or registration statement.
The final amendments will apply to pro forma financial 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 do not
affect the requirements in 17 CFR 210.3-02 (``Rule 3-02'') or Rule
8-01 relating to predecessor companies.
---------------------------------------------------------------------------
We are amending the requirements in Rule 1-02(w), Rule 3-05, Rule
3-14, Article 11, and related rules and forms. The amendments
generally:
Update the significance tests used under these and other
rules to generally improve their application and assist registrants in
making more meaningful significance determinations;
Expand the use of pro forma financial information in
measuring significance;
Conform, to the extent applicable, the significance
threshold and tests for a disposed business to those used for an
acquired business;
Require the financial statements of the acquired business
to cover only up to the two most recent fiscal years;
Permit disclosure of abbreviated financial statements for
certain acquisitions of a component of an entity;
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 audited annual financial statements for either nine
months or a complete fiscal year, depending on significance;
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,\21\ and the scope of the
rule's requirements;
---------------------------------------------------------------------------
\21\ See Section II.C.6 below for a description of a blind pool
offering.
---------------------------------------------------------------------------
Amend the pro forma financial information requirements to
improve the content and relevance of such information;
Clarify when financial statements and pro forma financial
information are required, and update the language used in our rules to
take into account concepts that have developed since adoption of the
rules over 30 years ago; and
Make corresponding changes to the smaller reporting
company requirements in Article 8 of Regulation S-X.
In addition, we are amending regulatory requirements specific to
investment companies registered under the Investment Company Act and
business development companies \22\ (collectively, ``investment
companies'') as discussed in more detail in Section II.E. below.
---------------------------------------------------------------------------
\22\ ``Business development company'' is defined in Section
2(a)(48) of the Investment Company Act, 15 U.S.C. 80a-2(a)(48).
---------------------------------------------------------------------------
A. Amendments to the Definition of ``Significant Subsidiary'' and
Generally Applicable Financial Statement Requirements for Acquired
Businesses
The ``significant subsidiary'' definition in Rule 1-02(w) includes
investment, asset, and income tests that are applied when determining
if a subsidiary is deemed significant for the purposes of certain
Regulation S-X and Regulation S-K requirements as well as certain
Securities and Exchange Act rules and forms.\23\ Whether an acquisition
is significant under Rule 3-05 is determined by applying these
tests,\24\ which generally can be described as follows:
---------------------------------------------------------------------------
\23\ In addition to its use in Rule 3-05 and Rule 3-14, the Rule
1-02(w) definition of ``significant subsidiary'' is used in the
following rules:
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;
17 CFR 210.11-01(b), which specifies when a business
combination or disposition of a business shall be considered
significant;
17 CFR 210.3-09, 17 CFR 210.4-08(g) (``4-08(g)''), and
Item 17(c)(2) of 17 CFR 249.220f (``Form 20-F''), which rely on the
significance tests 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, to determine the subsidiaries that must be included in
the list of subsidiaries required as an exhibit;
Item 17(b)(7) of Form S-4, to determine the financial
statements required for domestic target companies being acquired
that do not meet the requirements to use 17 CFR 239.34 (``Form S-
3'');
Item 17(b)(5) of Form F-4, 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 bankruptcy, receivership or similar proceedings
and the nature and results of any other material reclassification,
merger, or consolidation, of 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.
\24\ Rule 3-05 provides for use of a 20 percent significance
threshold, rather than the 10 percent threshold indicated in Rule 1-
02(w). The Commission raised the threshold in Rule 3-05 from 10
percent to 20 percent 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 and to undertake 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 have diverged from those used for Rule 3-14
and for dispositions since that time.
---------------------------------------------------------------------------
[[Page 54005]]
``Investment Test''--the registrant's and its other
subsidiaries' investments in and advances to the acquired business are
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;
``Asset Test''--the registrant's and its other
subsidiaries' 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''--the registrant's and its other
subsidiaries' 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 reflected in the registrant's most recent
annual financial statements required to be filed at or prior to the
acquisition date.
1. Significance Tests
We are amending the significance tests provided in Rule 1-02(w) to
improve their application and to assist registrants in making more
meaningful determinations of whether a subsidiary or an acquired or
disposed business is significant. Specifically, we are revising the
Investment Test and the Income Test and making other conforming
changes. The Commission did not propose to substantively revise the
Asset Test; however, a number of non-substantive revisions to the
significance tests generally were proposed and are being adopted.\25\
The final amendments also provide that, for acquisitions, intercompany
transactions with the acquired business must be eliminated from the
registrant's and its subsidiaries' consolidated total assets when
computing the Asset Test.
---------------------------------------------------------------------------
\25\ For example, the final amendments label the conditions as
the ``Investment Test,'' the ``Asset Test,'' and the ``Income Test''
and clarify that the significance tests compare the ``tested''
subsidiary's amounts to the registrant's.
---------------------------------------------------------------------------
a. Investment Test
The Investment Test compares the registrant's and its other
subsidiaries' investments in and advances to the tested subsidiary to
the total assets of the registrant and its subsidiaries consolidated
reflected at the end of the most recently completed fiscal year, or in
the case of an acquired business, in the registrant's most recent
annual financial statements required to be filed at or prior to the
acquisition date.
i. Proposed Amendments
The Commission proposed to revise the Investment Test to compare
the registrant's and its other subsidiaries' investments in and
advances to the tested subsidiary to the aggregate worldwide market
value of the registrant's voting and non-voting common equity
(``aggregate worldwide market value''), when available, and to retain
the existing test when the registrant does not have an aggregate
worldwide market value.\26\ As proposed, aggregate worldwide market
value would be determined as of the last business day of the
registrant's most recently completed fiscal year, which for
acquisitions and dispositions would be at or prior to the date of
acquisition or disposition. The Commission additionally proposed
amendments relating to contingent consideration \27\ and combinations
between entities or businesses under common control.\28\
---------------------------------------------------------------------------
\26\ The value under the proposed rule would have differed from
the value currently used by registrants to determine accelerated
filer status under Exchange Act Rule 12b-2 because it would include
the value of common equity held by affiliates and it would be
determined as of the last business day of the registrant's most
recently completed fiscal year. By contrast, Exchange Act 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 Exchange Act Rule 12b-
2.
\27\ The Commission 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. Generally
Accepted Accounting Principles (``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. For similar reasons, the Commission
proposed 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.
\28\ The Commission proposed that the Investment Test would be
met for a combination between entities or businesses under common
control when either net book value of the tested subsidiary exceeds
10 percent 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 percent of its total common
shares outstanding.
---------------------------------------------------------------------------
The Commission proposed the use of aggregate worldwide market value
in the Investment Test to address a measurement mismatch: The
comparison of the registrant's and its other subsidiaries' investments
in and advances to the tested subsidiary,\29\ which for an acquisition
or disposition is typically the purchase or sales price and is
generally consistent with fair value, to the registrant's total assets
measured at book value. Using aggregate worldwide market value instead
of total assets was intended to address this mismatch for acquisitions
and dispositions by comparing measures that are generally consistent
with fair value, thereby providing a more meaningful measure of
significance.
---------------------------------------------------------------------------
\29\ 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, when
referring to the conditions in Rule 1-02(w) in connection with the
determination in Rule 3-05 and Rule 3-14.
---------------------------------------------------------------------------
ii. Comments
Commenters generally supported the proposal to revise the
Investment Test.\30\ Many commenters expressly supported the proposed
use of aggregate worldwide market value of the registrant's voting and
non-voting common equity, when available.\31\ Some commenters who
supported the use of aggregate worldwide market value recommended
measuring it closer to the date of the acquisition or disposition
because of the potential fluctuation and
[[Page 54006]]
volatility of the stock price.\32\ Other commenters recommended
extending the use of a fair value measure to initial public offerings,
such as by allowing issuers to estimate their aggregate worldwide
market value at the anticipated offering date.\33\
---------------------------------------------------------------------------
\30\ See, e.g., letters from Bass Berry & Sims PLC (``Bass
Berry''), Cravath, Swaine & Moore LLP (``Cravath''), Deloitte &
Touche LLP (``DT''), Eli Lilly and Company (``Eli Lilly''),
Institute of Management Accountants (``IMA''), KPMG LLP (``KPMG''),
PNC Financial Services Group, Inc. (``PNC''), Securities Industry
and Financial Markets Association (``SIFMA''), and The Williams
Companies, Inc. (``Williams''). We received no comments specific to
our proposals to provide further instructions on a registrant's and
its other subsidiaries' ``investments in'' the tested subsidiary for
acquisitions and dispositions or to clarify the applicability of the
Investment Test to combinations between entities under common
control.
\31\ See, e.g., letters from Ball Corporation (``Ball''), CFA
Institute (``CFA''), Cravath, Davis Polk and Wardwell LLP (``Davis
Polk''), DT, Eli Lilly, Financial Executives International
(``FEI''), KPMG, MTBC, Inc. (``MTBC''), RSM US LLP (``RSM''), SIFMA,
Shearman and Sterling LLP (``Shearman''), and Williams. See also
SBCFAC Recommendations.
\32\ See, e.g., letters from BDO USA LLP (``BDO''), Center for
Audit Quality (``CAQ''), CFA, Cravath, Crowe LLP (``Crowe''), Davis
Polk, DT, Ernst & Young LLP (``EY''), Grant Thornton LLP (``GT''),
IMA, Liberty Global plc (``Liberty''), MTBC, KPMG, RSM, Sullivan &
Cromwell LLP (``S&C''), and Shearman. Commenters recommended a
variety of alternatives including particular dates, ranges of dates
or averages linked to the announcement, agreement or transaction
dates, the most recently completed fiscal quarter, or confidential
submission or filing dates of registration statements. See, e.g.,
BDO, CAQ, Crowe, Davis Polk, GT, RSM, S&C, SIFMA, and Shearman.
\33\ See, e.g., letters from BDO, Crowe, EY, and RSM. See also
letters from Cravath and Davis Polk suggesting additional
accommodations for initial public offerings.
---------------------------------------------------------------------------
A number of commenters, however, expressed concern relating to the
use of aggregate worldwide market value.\34\ One of these commenters
suggested that aggregate worldwide market value would introduce market
volatility into the test.\35\ Other commenters suggested that aggregate
worldwide market value would not reflect fair value when significant
amounts of stock are held by affiliates, the registrant is highly
leveraged or its capital structure is complicated.\36\ Two commenters
supported the use of aggregate worldwide market value for acquisitions
and dispositions, but expressed concern about its use for measuring
significance of equity method investees because it introduces a
historical cost versus fair value disparity (e.g., comparing
investments in and advances to the equity method investee to the
registrant's aggregate worldwide market value).\37\
---------------------------------------------------------------------------
\34\ See letters from The Allstate Corporation (``Allstate''),
Affiliated Managers Group, Inc. (``AMG''), Bass Berry, Council of
Institutional Investors (``CII''), Davis Polk, Denbury Resources
Inc. (``Denbury''), DT, GT, IMA, and Liberty.
\35\ See letter from AMG.
\36\ See letters from Allstate, Bass Berry, DT, and GT. But see
letter from CFA (recommending using a lower significance threshold
or supplementing the revised test in such circumstances).
\37\ See letters from DT and Williams. DT recommended that the
Commission consider any potential impact of such changes on Rules 3-
09 and 4-08(g) and other existing rules and staff guidance, while
Williams recommended expressly retaining the existing requirement
when evaluating equity method investments for significance under
Rule 4-08(g).
---------------------------------------------------------------------------
Some commenters recommended using the ``enterprise value'' of the
registrant as a more accurate reflection of the fair value of the
entities,\38\ despite acknowledging a lack of agreed-upon definition of
the term \39\ or that enterprise value may necessitate adjustment to
the numerator of the Investment Test to reflect leverage.\40\ These
commenters recommended a variety of potential definitions for
enterprise value or adjustments to equity market value that could be
made to calculate enterprise value.\41\ Some commenters offered other
alternatives, such as using the lower of the existing Investment Test
denominator (the registrant's consolidated total assets) or aggregate
worldwide market value.\42\ One commenter expressed concern that the
proposed Investment Test could encourage certain transactions that, in
the long-term, may not be in the best interest of an acquirer's
shareholders.\43\
---------------------------------------------------------------------------
\38\ See letters from Bass Berry, Cravath, Davis Polk, Denbury,
IMA, Liberty, and Shearman. Liberty went further and suggested that
an Investment Test using enterprise value obviates the need for
other significance tests.
\39\ See letters from IMA and Shearman.
\40\ See letter from Shearman. The commenter noted that if
enterprise value is used, the numerator would also need to be
revised to account for leverage by using the sum of the purchase
price paid and the amount of debt, net of cash and cash equivalents,
assumed.
\41\ See letters from Bass Berry, Davis Polk, IMA, and Shearman.
Bass Berry recommended defining ``enterprise value'' as ``(a) the
equity value of the registrant (that is, the aggregate worldwide
market value of the registrant's common equity as set forth above),
plus (b) the value of the registrant's indebtedness, minority
interests and preferred stock . . . , less (c) the cash and cash
equivalents of the registrant as of the end of its most recent
fiscal year.'' Cravath recommended using the sum of the investments
in and advances to the tested subsidiary, plus total debt to be
assumed compared to the sum of the aggregate worldwide market value
plus total debt without eliminating cash. Shearman noted that the
basic definition takes the fair value of the equity and adds total
debt and subtracts cash and cash equivalents and suggested if the
Commission were to use ``net debt,'' it would also need to adjust
the purchase price to the sum of the purchase price paid and the
amount of net debt assumed. IMA recommended that the Commission
include the registrant's common and preferred stock, as well as its
debt (including finance lease obligations) and that a registrant be
permitted to use either the carrying amount of debt and/or preferred
stock without a readily-determinable fair value or the carrying
amount of debt, preferred stock and the residual equity. Davis Polk
recommended ``the addition of the principal amount of the acquirer's
outstanding debt to its equity market value.''
\42\ See letters from Allstate and New York City Bar
Association, Committee on Securities Regulation (``NYCBA--Sec.'').
\43\ See letter from CII. See also infra at note 454 and
accompanying text.
---------------------------------------------------------------------------
In response to the Commission's proposal to require that the
registrant's and its other subsidiaries' ``investments in'' the tested
subsidiary include contingent consideration, some commenters supported
including the fair value of contingent consideration when it is
required to be measured at fair value under U.S. GAAP \44\ but
expressed opposition or concern about including contingent
consideration when the acquired business will be accounted for as an
asset acquisition under U.S. GAAP.\45\ Other commenters recommended
permitting registrants to determine significance using the fair value
of the contingent consideration arrangement when fair value is not
required by U.S. GAAP or IFRS-IASB, as applicable,\46\ or extending the
proposed sales-based milestones and royalties exception.\47\ One
commenter more broadly recommended not requiring the inclusion of
contingent consideration that is not required to be recognized under
applicable accounting standards.\48\ However, another commenter
expressed concern that the exclusion of sales-based milestones and
royalties from the Investment Test for acquisitions for which U.S. GAAP
does not require contingent consideration to be measured at fair value
may result in under-identification of acquisitions that would
materially affect the registrant's financial statements.\49\
---------------------------------------------------------------------------
\44\ See, e.g., letters from Allstate, AMG, Pfizer, Inc.
(``Pfizer''), and SIFMA.
\45\ See, e.g., letters from Pfizer, and SIFMA.
\46\ See letter from IMA.
\47\ See letters from IMA and SIFMA. See also Section II.A.1.a.
of the Proposing Release.
\48\ See letter from Cravath.
\49\ See letter from GT. Separately, GT also recommended
clarifying whether all contingent consideration should be included
in the numerator if the likelihood of payment of all contingent
consideration or any part thereof is more than remote.
---------------------------------------------------------------------------
iii. Final Amendments
We are adopting amendments to the Investment Test, with
modifications from what was proposed in response to comments received.
Aggregate Worldwide Market Value
We are adopting amendments to the Investment Test, substantially as
proposed, to compare the registrant's and its other subsidiaries'
investments in and advances to the tested subsidiary to the aggregate
worldwide market value of the registrant's voting and non-voting common
equity, when available,\50\ but expressly limiting this amendment to
acquisitions and dispositions.\51\ As proposed, we are retaining the
existing test for acquisitions and dispositions in circumstances where
the registrant does not have an aggregate worldwide market value. We
are also retaining the existing test when used for the additional
purposes for which the Rule 1-02(w) definition is applicable.\52\
---------------------------------------------------------------------------
\50\ As with the proposed rule, the value under the final rule
differs from the value currently used by registrants to determine
accelerated filer status under Exchange Act Rule 12b-2. See supra
note 26.
\51\ See Section II.A.1.c.iii below for a discussion about
retaining the existing Investment Test in other circumstances. The
final rules reorganize and renumber proposed Rule 1-02(w)(1)(i) to
effect these changes.
\52\ See Rule 1-02(w)(1)(i)(C) and the discussion on Conforming
Changes supra Section II.A.1.c.
---------------------------------------------------------------------------
[[Page 54007]]
In an acquisition or disposition, the registrant's and its other
subsidiaries' ``investments in'' \53\ the tested subsidiary are
generally the consideration transferred or received (i.e., the purchase
or sales price) for the net assets acquired or sold. For acquisitions
and dispositions, we believe that aggregate worldwide market value more
closely aligns with the purchase or sale price used in the numerator of
the Investment Test and provides a measure that is readily available
and objectively determined by the market. Use of aggregate worldwide
market value in these circumstances will address the mismatch whereby
purchase or sale price is a measure of net assets generally consistent
with fair value while the registrant's total assets to which it is
currently compared reflects gross assets measured at book value.\54\
---------------------------------------------------------------------------
\53\ The Investment Test uses the phrase ``investments in and
advances to.'' In this way, the numerator of the Investment Test
includes two parts: ``investments in'' and ``advances to.'' Our
references to ``investments in'' in this release are intended to
focus the particular discussion on the first part of the numerator
of the Investment Test. Any such reference should not be read to
suggest the numerator of the Investment Test excludes the second
part, ``advances to.''
\54\ The book value of the registrant's total assets may not
fully reflect the registrant's current fair value. For example, the
Investment Test uses the carrying value of a registrant's total
assets as of the most recent annual 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.
---------------------------------------------------------------------------
We are not adopting the suggestion of some commenters to use
``enterprise value'' for the Investment Test. The use of aggregate
worldwide market value, unlike ``enterprise value,'' will avoid the
need to define a term that does not have an agreed-upon definition.
Moreover, it avoids having to establish additional adjustments to the
``investments in and advances to'' the tested subsidiary in order to
convert the Investment Test numerator from essentially an equity value
to an enterprise value, which we believe would be necessary if an
enterprise value denominator were used. We also are not adopting the
suggestion to use the lower of the existing Investment Test denominator
(i.e., the registrant's consolidated total assets) or aggregate
worldwide market value. While we note the observation that a company
with substantial assets that is highly leveraged may have a relatively
small market capitalization, the suggested ``lower of'' standard is not
linked to leverage nor do we believe the existence of leverage
necessarily precludes the need for disclosure about acquired and
disposed businesses.
In response to commenters' suggestions and concerns regarding
market volatility, we are modifying the proposal to require registrants
to use the average of aggregate worldwide market value calculated daily
for the last five trading days of the registrant's most recently
completed month ending prior to the earlier of the registrant's
announcement date or agreement date of the acquisition or disposition.
We are persuaded by commenters who suggested that market volatility and
changes in market value unrelated to the acquisition could affect the
determination of aggregate worldwide market value. We believe that
using a more recent measurement period that is averaged to moderate
daily variability more accurately reflects aggregate worldwide market
value for purposes of computing significance based on the purchase or
sale price while retaining a readily available and easily determinable
measure of aggregate worldwide market value.
As proposed, the final rules will continue to require use of the
total assets of the registrant and its subsidiaries consolidated when a
registrant does not have an aggregate worldwide market value. We did
not modify the final rule to permit, as suggested by some commenters,
the estimation of aggregate worldwide market value when no such market
value exists because we believe such an approach could introduce,
rather than eliminate, complexity, and would be inconsistent with our
intent of requiring that the determination, where possible, be based on
readily available and easily and objectively determinable amounts that
exist at the earlier of the announcement or agreement date.\55\
---------------------------------------------------------------------------
\55\ For example, a public float approach similar to that in 17
CFR 229.10(f)(1) (``Item 10(f)(1) of Regulation S-K'') relies on an
estimated public offering price measured relative to the filing
date, which could cause the estimate to already encompass the value
of the tested business when the acquisition has already occurred or
when the anticipated offering or filing date occurs after the
earlier of the announcement or agreement date.
---------------------------------------------------------------------------
Contingent Consideration
We are amending the Investment Test, substantially as proposed, to
clarify that for acquisitions, the registrant's and its other
subsidiaries' ``investments in'' \56\ the tested subsidiary is the
consideration transferred, adjusted to exclude 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. The amendments further indicate that the registrant's and
its other subsidiaries' ``investments 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, it shall include all contingent
consideration, except contingent consideration for which the likelihood
of payment is remote. We believe inclusion of contingent consideration
provides a more accurate measure of an acquired business's relative
significance. We were not persuaded by commenters that contingent
consideration should be excluded from the Investment Test when the
acquired business (as defined in Rule 11-01(d)) will be accounted for
as an asset acquisition under U.S. GAAP. Contingent consideration can
be a material component of the consideration provided to acquire a Rule
11-01(d) business and its exclusion from the significance tests could
result in the under-identification of acquisitions for which financial
statements are necessary to reasonably inform investors.
---------------------------------------------------------------------------
\56\ See supra note 53.
---------------------------------------------------------------------------
The proposed amendment would have permitted the exclusion of
contingent consideration in the form of sales-based milestones and
royalties from the Investment Test when recognition of contingent
consideration at fair value is not required under U.S. GAAP or IFRS-
IASB, as applicable. The proposal was intended to promote ease of
calculation while maintaining the objective of the test as a reliable
indicator of relative significance; however, commenter feedback made
evident that there are a wide variety of contingent consideration
arrangements with variable terms that require estimation beyond sales-
based milestones and royalties. Rather than expanding the exclusion to
encompass these other arrangements, we are persuaded by the commenter
who observed that the exclusion of such consideration from the
significance tests when the likelihood of their payment was more than
remote could result in under-identification of acquisitions that would
materially affect the registrant's financial statements. Therefore, the
final amendments do not provide for any such exception.\57\
---------------------------------------------------------------------------
\57\ In order to further clarify the requirements related to the
amount of contingent consideration to include in the Investment Test
when recognition at fair value is not required under U.S. GAAP or
IFRS-IASB, as applicable, the final rules modify the proposed
language, which provided for inclusion of ``all contingent
consideration unless the likelihood of payment is remote,'' to
require inclusion of ``all contingent consideration, except
contingent consideration for which the likelihood of payment is
remote.''
---------------------------------------------------------------------------
[[Page 54008]]
We are not persuaded by the suggestion to permit registrants to
determine significance of an acquisition using the fair value of the
contingent consideration arrangement when fair value is not required by
U.S. GAAP or IFRS-IASB, as applicable, as a means to mitigate the risk
that an acquisition may be deemed significant for arrangements for
which there is a wide range of possible outcomes in the eventual amount
of contingent consideration that may be owed. We note that the standard
we are adopting is one employed in practice today. To the extent that
unique facts and circumstances may trigger significance when financial
statements are not reasonably necessary to inform investors, we believe
such a situation is best addressed through 17 CFR 210.3-13 (``Rule 3-
13'').\58\
---------------------------------------------------------------------------
\58\ See Rule 3-13 of Regulation S-X, which provides that 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.
---------------------------------------------------------------------------
Other Amendments
The final amendments provide, as proposed, that the registrant's
and its other subsidiaries' ``investments in'' the tested subsidiary
exclude the registrant's and its other subsidiaries' 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. The final amendments also provide, as proposed,
that in a disposition, the registrant's and its other subsidiaries'
``investments in'' the tested subsidiary equal the fair value of the
consideration (which includes contingent consideration) for the
disposed subsidiary when comparing it to the registrant's aggregate
worldwide market value or, when the registrant has no such aggregate
worldwide market value, the carrying value of the disposed subsidiary
when comparing it to the registrant's total assets. The final
amendments additionally provide, as proposed, that the Investment Test
is met when either 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 for combinations
between entities or businesses under common control.\59\
---------------------------------------------------------------------------
\59\ The addition of net book value to the test recognizes that
such combinations may be effected by transferring net assets, rather
than exchanging shares, and that the resulting accounting by the
entity who receives net assets or equity interests (i.e., the
receiving entity) typically recognizes the combination using the
parent's historical carrying value of the transferred entity or
business. See, e.g., FASB ASC 805-50-30-5.
---------------------------------------------------------------------------
b. Income Test
The Income Test compares the registrant's equity in the tested
subsidiary's income from continuing operations before income taxes
exclusive of amounts attributable to any noncontrolling interests to
such income of the registrant for the most recently completed fiscal
year. In the case of an acquisition, the Income Test similarly compares
the 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, 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.
i. Proposed Amendments
The Commission proposed to revise the Income Test to reduce the
anomalous results that may occur by relying solely on net income \60\
and to reduce complexity and preparation costs without sacrificing
material information for investors. The Commission proposed to:
---------------------------------------------------------------------------
\60\ Net income can include infrequent expenses, gains, or
losses that can distort the determination of relative significance.
---------------------------------------------------------------------------
Add a new revenue component to the test;
Revise the net income component to use income or loss from
continuing operations after income taxes, instead of before income
taxes;
Calculate the net income component using absolute values;
Revise the Income Test to use the average of the absolute
value of net income when the existing 10 percent threshold in
Computational Note 2 to Rule 1-02(w) is met and the proposed revenue
component does not apply; and
Make additional clarifications and simplifications.\61\
---------------------------------------------------------------------------
\61\ Specifically, the Commission proposed to 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) under certain conditions and to make additional non-
substantive amendments to the net income component in order to
simplify the description and application.
---------------------------------------------------------------------------
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 eliminations) to such
consolidated total revenues of the registrant for the most recently
completed fiscal year. Under the proposal, where the registrant and its
subsidiaries consolidated and the tested subsidiary have recurring
annual revenue,\62\ the tested subsidiary must meet both the new
revenue component and the net income component, and in the case of the
application of the test in Rule 3-05, could use the lower percentage of
the revenue component and the net income component to determine the
number of periods for which Rule 3-05 Financial Statements are
required.
---------------------------------------------------------------------------
\62\ 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.
---------------------------------------------------------------------------
ii. Comments
Commenters broadly supported the revisions to the Income Test and
made various recommendations to improve specific components of the
Income Test.\63\
---------------------------------------------------------------------------
\63\ See, e.g., letters from Bass Berry, Cravath, DT, Eli Lilly,
IMA, KPMG, PNC, SIFMA, and Williams. We received no comments on the
additional clarifications and simplifications.
---------------------------------------------------------------------------
Revenue Component
Commenters broadly supported the addition of a revenue component to
the Income Test.\64\ One commenter recommended establishing
significance when registrants meet either revenue or net income.\65\
Another commenter noted that the inclusion of the revenue component
would reduce instances of anomalous significance results, but noted
that using a lower of revenue or net income approach could result in
under-identification of acquisitions expected to have a material future
impact and suggested considering the use of a lower revenue
threshold.\66\
[[Page 54009]]
Another commenter suggested requiring only the revenue component, and
not the income component, for smaller reporting companies.\67\
---------------------------------------------------------------------------
\64\ See, e.g., letters from AMG, Ball, Bass Berry, BDO,
Cravath, Eli Lilly, FEI, GT, Liberty, NYCBA--Sec., Pfizer,
PricewaterhouseCoopers LLP (``PWC''), SIFMA, Shearman, and Williams.
See also SBCFAC Recommendations. Some of these commenters suggested
further accommodations for equity method investees. See, e.g.,
letters from GT and AMG.
\65\ See letter from CFA.
\66\ See letter from GT. In contrast, one commenter explicitly
supported using the same percentage thresholds for the revenue
component and the income component and indicated its belief that
there was no meaningful risk that the income component of the Income
Test would under-identify material transactions. See letter from
Cravath.
\67\ See letter from MTBC.
---------------------------------------------------------------------------
Recurring Annual Revenues
A number of commenters, particularly accounting and auditing firms,
expressed concern that the term ``recurring annual revenues'' may not
be clear and requested additional guidance as to the meaning.\68\ One
commenter recommended using ``two or more years of revenue'' as an
alternative.\69\
---------------------------------------------------------------------------
\68\ See, e.g., letters from BDO, CAQ, Cravath, Crowe, DT, EY,
GT, KPMG, MTBC, PWC, RSM, and SIFMA.
\69\ See letter from MTBC.
---------------------------------------------------------------------------
Income Taxes
A few commenters supported the proposal to use income from
continuing operations after income taxes because it would simplify the
calculation and would permit registrants to use information directly
from the income statement.\70\ However, many other commenters
recommended that the Commission continue to use income or loss from
continuing operations before income taxes in the Income Test.\71\ While
using after-tax amounts may simplify the determinations, these
commenters expressed concern that after-tax numbers could distort the
significance determination due to factors such as the tax status of the
entity (such as for a pass-through entity) \72\ or the volatility of
income taxes (due to changes in tax laws or valuation allowances).\73\
---------------------------------------------------------------------------
\70\ See letters from Ball and Eli Lilly.
\71\ See, e.g., letters from AMG, BDO, CAQ, Cravath, Crowe, EY,
FEI, GT, KPMG, Pfizer, PWC, Ira Rosner (``Rosner''), RSM, Shearman,
and Williams.
\72\ See, e.g., letters from AMG, BDO, CAQ, Cravath, Crowe, EY,
GT, KPMG, PWC, Rosner, RSM, and Williams.
\73\ See, e.g., letters from CAQ, EY, FEI, KPMG, Pfizer, PWC,
and RSM.
---------------------------------------------------------------------------
Income Averaging and Use of Absolute Values
Commenters generally supported the revisions relating to income
averaging calculations \74\ and the use of absolute values.\75\ Some
commenters recommended further revisions, such as using three-year
averaging or permitting five-year averaging for all registrants
regardless of recurring revenue.\76\
---------------------------------------------------------------------------
\74\ See letters from AMG, BDO, and Pfizer.
\75\ See letters from AMG, Eli Lilly, IMA, and Pfizer.
\76\ See, e.g., letters from AMG, BDO, and IMA.
---------------------------------------------------------------------------
iii. Final Amendments
As discussed in more detail below, we are adopting the amendments
to the Income Test substantially as proposed, but with some
modifications to improve its application and to assist registrants in
making more meaningful significance determinations.
Revenue Component
As proposed, we are revising the Income Test to add a revenue
component in order to reduce the anomalous result that registrants with
marginal or break-even net income or loss in a recent fiscal year may
be more likely to have tested subsidiaries deemed significant where
they otherwise would not. This anomalous result is particularly
relevant where it would require Rule 3-05 Financial Statements for
acquisitions that otherwise would not be considered material to
investors. To satisfy the Income Test under the final amendments, the
tested subsidiary must meet both the revenue component and the net
income component when the revenue component applies, and for purposes
of the application of Rule 3-05, may 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. The new
revenue component compares a registrant's and its other subsidiaries'
proportionate share of the tested subsidiary's consolidated total
revenues (after intercompany eliminations) to such consolidated total
revenues of the registrant for the most recently completed fiscal year.
We are modifying the description of the tested subsidiary's
consolidated total revenue to clarify that consolidated total revenue
refers to consolidated total revenue from continuing operations (after
intercompany eliminations).\77\
---------------------------------------------------------------------------
\77\ See Rule 1-02(w)(1)(iii).
---------------------------------------------------------------------------
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 that will no longer be
incurred (e.g., interest expense) as well as infrequent expenses, such
as those for litigation or impairment, can affect net income, but not
revenue. The effect of historical expenses that will no longer be
incurred and infrequent expenses on an income-based test may be to
either deem as insignificant an acquired business that is expected to
have a 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. While we considered other metrics, we believe
the addition of ``revenue'' is a more appropriate indicator to help
avoid anomalous results, and therefore, we added a revenue component to
the net income component of the Income Test rather than have separate
tests based on revenue and net income.\78\ By revising the Income Test
to require that the registrant exceed both the revenue and net income
components when the revenue component applies, we believe the test will
more accurately determine whether a tested subsidiary is significant to
the registrant. This will also reduce the frequency of immaterial
acquisitions being deemed significant for purposes of Rule 3-05.
---------------------------------------------------------------------------
\78\ Prior to 1974, the ``significant subsidiary'' definition
included a revenue test, but not a net income test. In 1974, the
Commission added a separate net income test. In 1981, the Commission
eliminated the revenue test and retained 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)].
---------------------------------------------------------------------------
We are not adopting the recommendation to use a lower significance
threshold for the revenue component to mitigate the potential risk that
use of a lower of revenue or net income approach could result in under-
identification of significant subsidiaries, and in particular of
acquisitions expected to have a material future impact on the
registrant. The risk of under-identification is not unique to a ``lower
of'' approach, but rather is inherent in basing the requirement to
provide financial information on percentage threshold tests. We believe
under-identification risk is mitigated, however, because even if the
Income Test is not satisfied, the definition of ``significant
subsidiary'' could be met by satisfying either the Asset Test or the
Investment Test. Further, to simplify compliance, the significant
subsidiary percentage threshold historically has been the same for all
tests included in the ``significant subsidiary'' definition,
notwithstanding that the threshold has been changed from time to time.
In light of these considerations, we do not find a compelling reason at
this time to differentiate the threshold for the revenue component of
the Income Test from the threshold used in the net income component of
the Income Test and in the Asset and Investment Tests.
We also are not adopting the recommendation to apply only the
[[Page 54010]]
revenue component, and not the income component, for smaller reporting
companies. We continue to believe both components taken together are
important indicators in determining the need for financial information
about acquired and disposed businesses.
Recurring Annual Revenue
Under the proposed amendments, where either a registrant and its
subsidiaries consolidated or the tested subsidiary did not have
recurring annual revenue, the new revenue component would not have been
available to determine the number of periods for which Rule 3-05
Financial Statements are required. However, we are persuaded by
commenters who noted that the term ``recurring annual revenue,'' as
proposed, was not sufficiently clear to determine when the revenue
component would apply and may have inappropriately suggested that there
would be discretion in determining the amount of revenue to be
included. The revenue component is unlikely to produce a meaningful
assessment where the registrant or the tested subsidiary does not have
material revenue over the course of time. We are therefore modifying
the Income Test consistent with a comment we received, to provide that
the revenue component does not apply if either the registrant and its
subsidiaries consolidated or the tested subsidiary did not have
material revenue in each of the two most recently completed fiscal
years. We believe the amendment will allow registrants to determine
more easily whether the revenue component applies, and when it does
apply, will clarify that all revenues must be included.
Income Taxes
The Commission proposed to calculate income or loss from continuing
operations after income taxes, permitting a registrant to use line item
disclosure from its financial statements, to simplify the
determination. We are persuaded by commenters that using after tax
information may result in significance determinations that are less
consistent and meaningful because they could be distorted due to
factors such as the tax status of the entity or the volatility of
income taxes. We are therefore not adopting the proposed amendment to
calculate income or loss from continuing operations after income taxes
and are retaining the requirement to use income or loss from continuing
operations before income taxes.
Income Averaging and Use of Absolute Values
We are adopting amendments, as proposed, to clarify the net income
component by inserting references 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. We are also adopting as proposed the use of
absolute values for calculating average net income. As noted above,
commenters generally supported the improvements to income averaging
calculations \79\ and the use of absolute values.\80\
---------------------------------------------------------------------------
\79\ See letters from AMG, BDO, and Pfizer. We are not adopting
one commenter's recommendation to use a three-year average. The
five-year average is a longstanding standard and it is not clear
that a three-year average would yield a more meaningful outcome. We
also are not adopting the recommendation to extend the use of income
averaging when the revenue component applies. Under existing
requirements, income averaging is required when its conditions for
use are met. However, those conditions also limit its use to
mitigating anomalous results. We believe the adoption of a revenue
component will mitigate anomalous results more effectively while
simplifying the Income Test, and that use of income averaging to
mitigate anomalous results should therefore be necessary only when
the revenue component does not apply.
\80\ See letters from AMG, Eli Lilly, IMA, and Pfizer.
---------------------------------------------------------------------------
Additional Clarifications and Simplifications
We are additionally amending Rules 3-05(b)(3) and 11-01(b)(3) as
proposed to clarify that the Income Test may be determined using the
acquired business's revenues less the expenses permitted to be omitted
by new Rules 3-05(e) and 3-05(f) if the business meets the conditions
in those rules, as well as making additional non-substantive amendments
to the net income component in order to simplify the description of the
test. Specifically, we are replacing, as proposed, 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 revising Rule 1-02(w) to remove the Computational Note
designation but retaining the substance of the notes in the rule and
making conforming amendments consistent with the amendments to the
revised Income Test. Additionally, we are revising Rule 1-
02(w)(1)(iii)(B)(3) to 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 must be treated as if they are a single
acquisition. Finally, we are moving the Note to Rule 1-02(w) into the
rule itself.
c. Conforming Changes
i. Proposed Amendments
As noted above, several of our 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.\81\ The Commission's proposed amendments to Rule 1-02(w)
would update the definition and the tests therein, but would
nonetheless result in these tests continuing to apply consistently
across these applications. 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 Securities Act Rule 405 and
Exchange Act Rule 12b-2 definitions historically have been generally
consistent with the Rule 1-02(w) definition. Accordingly, the
Commission proposed to conform the definitions of ``significant
subsidiary'' in Securities Act Rule 405 and Exchange Act Rule 12b-2 to
the amended definition in Rule 1-02(w).\82\
---------------------------------------------------------------------------
\81\ See supra note 23.
\82\ In the Proposing Release, the Commission proposed to
exclude from the definition of ``significant subsidiary'' in
Securities Act Rule 405 and Exchange Act Rule 12b-2 the proposed
amendments to Rule 1-02(w) that would be applicable only to
disclosure requirements under Regulation S-X, specifically proposed
Rule 1-02(w)(1)(iii)(B)(3). Unlike these other rules, the definition
of ``significant subsidiary'' in Rule 8b-2 historically has differed
from the Rule 1-02(w) definition. As proposed, we also are
conforming the Rule 8b-2 definition of ``significant subsidiary'' to
the new definition added to Rule 1-02(w)(2) that is specifically
tailored for investment companies. See Section II.E below.
---------------------------------------------------------------------------
ii. Comments
With the exception of equity method investments, commenters did not
address the specific proposed conforming changes. Some commenters
suggested that the use of aggregate worldwide market value in the
proposed Investment Test could introduce a new historical cost versus
fair value disparity when evaluating equity method investments under
Rules 3-09 and 17 CFR 210.4-08(g) (``4-08(g)'') because the
registrant's and its other subsidiaries' ``investments in and advances
to'' the investee may not be equivalent to a fair value amount when the
investee is not newly acquired.\83\ In expressing support for the
addition of a revenue component to the Income Test when testing the
significance of equity method investees under Rules 3-09 and 4-08(g),
one of these commenters
[[Page 54011]]
suggested several changes to the manner in which the revenue component
would be calculated for equity method investees under Rules 3-09 and 4-
08(g).\84\ Another commenter noted that for equity method investees,
whose revenues are not consolidated in the registrant's financial
statements, the results of the proposed revenue component of the Income
Test may not be meaningful.\85\
---------------------------------------------------------------------------
\83\ See, e.g., letters from AMG, DT, and Williams.
\84\ See letter from AMG. Specifically, the commenter
recommended modifying the denominator of the revenue component to
include all of the equity method investee's GAAP revenue such that
the revenue component would compare the registrant's ``proportionate
share'' of the equity method investee's revenue to the sum of the
registrant's GAAP revenue and 100 percent of the equity method
investee's GAAP revenue, without which the commenter suggested the
proposal would produce incongruous comparisons. The commenter
further recommended guidance on how to calculate ``proportionate
share'' to address situations where a registrant may receive a share
of revenue from an equity method investee that is different from the
percentage of equity that the registrant may own and requested that
the guidance include some level of discretion to allow registrants
to use a method reasonably calculated to reflect the economic
benefit the registrant receives relative to the equity method
investee's GAAP revenue.
\85\ See letter from GT.
---------------------------------------------------------------------------
iii. Final Amendments
We are adopting the conforming amendments substantially as proposed
with certain modifications in response to comments. The amendments are
intended to reflect more accurately the relative significance to a
registrant of a tested subsidiary and to reduce anomalous results in
the application of the definition of ``significant subsidiary.'' As
discussed in the Proposing Release, by maintaining the historical
conformity between the ``significant subsidiary'' definitions, these
amendments will 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.\86\ In a change from the
proposal and in order to simplify and maintain uniformity of the
definition throughout our rules, the amendments to Securities Act Rule
405 and Exchange Act Rule 12b-2 will fully conform with the definition
in Rule 1-02(w), including Rule 1-02(w)(1)(iii)(B)(3).
---------------------------------------------------------------------------
\86\ See Proposing Release at Section II.A.1.
---------------------------------------------------------------------------
We are persuaded by commenters that using the registrant's
aggregate worldwide market value instead of the registrant's total
assets in the Investment Test would have inadvertently introduced a
mismatch when evaluating equity method investments under Rules 3-09 and
4-08(g) because the registrant's and its other subsidiaries'
``investments in and advances to'' the investee may not be equivalent
to a fair value amount when the investee is not newly acquired. Because
a registrant's and its other subsidiaries' ``investments in and
advances to'' would not necessarily be equivalent to fair value for
purposes other than acquisitions or dispositions, we are also persuaded
that the registrant's aggregate worldwide market value should not be
used in place of the registrant's total assets for the additional
purposes for which the ``significant subsidiary'' definition is
used.\87\ Accordingly, we are retaining the comparison to the
registrant's total assets used in the existing Investment Test for
testing significance of equity method investees under Rules 3-09 and 4-
08(g), as well as for the additional purposes for which the definition
is used.\88\
---------------------------------------------------------------------------
\87\ See supra note 23.
\88\ Id.
---------------------------------------------------------------------------
We are not adopting any modifications to the proposed Income Test
in response to comments received related to its application under Rules
3-09 and 4-08(g) to investments accounted for using the equity method.
We added the revenue component for acquisitions and dispositions of
businesses to mitigate anomalous results produced by the current test
based only on net income. We believe the revenue component can serve a
similar role related to the application of Rules 3-09 and 4-08(g) to
equity method investments.\89\ Additionally, using a test based on an
amount that is not consolidated is not unprecedented for investments
accounted for using the equity method. As the Commission has noted, the
Asset Test applies to Rule 4-08(g), even though the total assets of the
equity method investee are not consolidated by the registrant.\90\
Further, we believe the fact that significance is not determined on the
basis of a single test and that Rule 4-08(g) disclosure about equity
method investees is required if significance is met either individually
or on an aggregated basis by any combination of investees at the 10
percent level will help mitigate any potential adverse effects and help
to provide an appropriate level of financial information about equity
method investees.\91\
---------------------------------------------------------------------------
\89\ The staff considers this additional factor when exercising
its delegated authority under Rule 3-13 when a registrant makes a
request to omit Rule 3-09 financial statements on the basis that the
current income test produces an anomalous result.
\90\ See 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)] at note 51
(``In 1994, Rule 3-09 was revised to eliminate the asset test;
however, the test was retained for Rule 4-08(g) to ensure a minimum
level of financial information about an investee when the investment
test was small, but a registrant's proportionate interest in the
Investee's assets was material, as might be the case for a highly-
leveraged Investee. 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].'').
\91\ We are not persuaded to provide additional guidance on
determining ``proportionate interest'' for the revenue component. We
observe that ``proportionate interest'' is required to determine
basis difference under U.S. GAAP or IFRS-IASB, as applicable, as
well as the equity in the income of the investee. We believe
proportionate interest used for those purposes will inform its use
for the revenue component. Similarly, we are not persuaded that the
equity method investee's revenue should be added to the registrant's
revenue as it is not part of that revenue.
---------------------------------------------------------------------------
2. Audited Financial Statements for Significant Acquisitions
Depending on the relative significance of the acquired or to be
acquired business, Rule 3-05 Financial Statements may be required for
up to three years.\92\
---------------------------------------------------------------------------
\92\ Rule 3-05 Financial Statements are required for the most
recent fiscal year and any required interim periods if any of the
Rule 3-05 significance tests exceeds 20 percent, but none exceeds 40
percent, a second year is required if any test exceeds 40 percent,
but none exceeds 50 percent, and a third year is generally required
if any of the tests exceeds 50 percent. 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 exceeds 20 percent. See 17 CFR 210.3-05(b)(2). 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.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to revise Rule 3-05 to require only up to
two years of Rule 3-05 Financial Statements. The Commission also
proposed to revise Rule 3-05 for acquisitions where a significance test
exceeds 20 percent, but none exceeds 40 percent, to require financial
statements for the ``most recent'' interim period specified in 17 CFR
210.3-01 and 210.3-02 (``Rules 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.
b. Comments
Commenters broadly supported the proposals,\93\ with no commenters
opposing the changes.
---------------------------------------------------------------------------
\93\ See, e.g., letters from Ball, Bass Berry, CFA, Cravath, Eli
Lilly, FEI, Liberty, National Association of Real Estate Investment
Trusts (``NAREIT''), Nasdaq, Inc. (``Nasdaq''), NYCBA--Sec., S&C,
and SIFMA. See also SBCFAC Recommendations.
---------------------------------------------------------------------------
[[Page 54012]]
c. Final Amendments
We are adopting the amendments as proposed to revise Rule 3-05 to
require up to two years of Rule 3-05 Financial Statements. Unlike the
historical financial statements of the registrant upon which investors
rely to make investment decisions about the registrant, Rule 3-05
Financial Statements are used, along with pro forma financial
information, to discern how the acquired business may affect the
registrant. Due to their age, the third year of Rule 3-05 Financial
Statements is less likely to be indicative of the current financial
condition, changes in financial condition, and results of operations of
the acquired business. Such financial statements also do 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, 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 the disclosure. Such burdens are further exacerbated if
a change in the acquired business's management or independent auditor
has occurred, which may also delay a registrant's time to market and
access to capital.
We are additionally amending Rule 3-05 as proposed for acquisitions
where a significance test exceeds 20 percent, but none exceeds 40
percent, to require financial statements for the ``most recent''
interim period specified in Rules 3-01 and 3-02 rather than ``any''
interim period. The revision eliminates the need to provide a
comparative interim period when only one year of audited Rule 3-05
Financial Statements is required. In these circumstances, we believe
that the most recent interim period provides the most relevant and
material information to investors. Requiring a comparative interim
period when there is no requirement for a corresponding comparative
annual period would have limited utility for investors and imposes an
additional burden on registrants to prepare such information.
In adopting these changes, we note that 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.''
3. Financial Statements for Net Assets That Constitute a Business
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 or a line of
business contained in more than one subsidiary of the selling entity.
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 may be
impracticable and Commission staff has permitted registrants to instead
provide audited abbreviated financial statements of the acquired
business in the form of statements of assets acquired and liabilities
assumed and statements of revenues and expenses.\94\
---------------------------------------------------------------------------
\94\ Commission staff has exercised delegated authority pursuant
to Rule 3-13 in these circumstances. In addition, Commission staff
has provided informal guidance to address practical questions
related to these and other financial reporting issues in the
Division of Corporation Finance's Financial Reporting Manual
(``FRM''), available at https://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf (last updated Dec. 1, 2017). The FRM
is not a rule, regulation or statement of the Commission and the
Commission has neither approved nor disapproved its content. See FRM
at Section 2065 Acquisition of Selected Parts of an Entity may
Result in Less than Full Financial Statements (``FRM 2065'').
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed Rule 3-05(e) to permit registrants to
provide audited abbreviated financial statements in the form of
statements of assets acquired and liabilities assumed, and statements
of revenues and expenses (exclusive of corporate overhead, interest and
income tax expenses) if the acquired business met certain qualifying
and presentation conditions.\95\ More specifically, under proposed Rule
3-05(e), a registrant would be permitted to present audited abbreviated
financial statements of an acquired or to be acquired business \96\ if:
---------------------------------------------------------------------------
\95\ The proposal did not specifically label the conditions as
``qualifying conditions'' and ``presentation conditions.'' However,
we are using these labels, in part, to clarify the requirements and,
in part, to simplify the comparison between the final amendments and
the proposed amendments.
\96\ Neither the proposal nor the rules we are adopting affect
the requirements in Rule 3-02 or 17 CFR 210.8-01 relating to
predecessors.
---------------------------------------------------------------------------
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; and
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.
Under proposed Rule 3-05(e), if the acquired or to be acquired
business satisfies the above conditions, the audited abbreviated
financial statements must also conform to certain presentation
conditions, including:
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.\97\
---------------------------------------------------------------------------
\97\ Specifically, the additional disclosure would include: 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.
---------------------------------------------------------------------------
b. Comments
Commenters generally supported permitting abbreviated financial
statements,\98\ although one commenter recommended that the Commission
consider whether abbreviated financial statements satisfy investors'
needs when the acquired business is a significant portion of the
selling entity.\99\ This commenter recommended the Commission provide a
threshold on what constitutes ``substantially all'' \100\ and
questioned whether using a ``small
[[Page 54013]]
portion of the selling entity'' might be a better standard than ``less
than substantially all of the assets and liabilities of the seller.''
\101\ Another commenter recommended requiring registrants to indicate
how abbreviated financial statement information is integrated into the
pro forma financial information and suggested that the Commission
clarify what type of auditor assurance would be provided for
abbreviated financial statement information.\102\
---------------------------------------------------------------------------
\98\ See, e.g., letters from BDO, CAQ, Cravath, Debevoise &
Plimpton LLP (``Debevoise''), DT, Eli Lilly, EY, FEI, GT, IMA, PWC,
RSM, and S&C.
\99\ See letter from GT.
\100\ Id. GT noted that absent any threshold, there would likely
be diversity in how registrants interpret this phrase.
\101\ See letter from GT. This commenter noted that in the
Proposing Release the Commission had recognized that there could be
challenges in making allocations of the selling entity's corporate
overhead, interest, and taxes when the acquired business constitutes
only a small portion of the selling entity. However, the commenter
stated its view that the language in the proposed rule would allow
registrants that acquire a significant portion of the selling entity
to present abbreviated financial statements, as long as such
business does not meet any of the other conditions outlined in the
proposal.
\102\ See letter from CFA.
---------------------------------------------------------------------------
Some commenters sought additional clarification of the terms, such
as defining ``separate entity,'' ``subsidiary,'' ``segment,'' and
``division'' in the context of an acquisition.\103\ Other commenters
questioned the use of ``impracticable'' recommending further
clarification or a reduced standard.\104\ One commenter sought
clarification on the meaning of ``previously prepared.'' \105\ Another
commenter requested that the Commission clarify the nature of expenses
to be included in the abbreviated financial statements by describing
those that may be omitted or those that must be presented, but not
both, noting that it is unclear whether the identified expenses are
intended to be all-inclusive.\106\
---------------------------------------------------------------------------
\103\ See, e.g., letters from CAQ, Crowe, DT, PWC, and RSM.
\104\ See, e.g., letters from Debevoise, EY and GT.
\105\ See letter from GT.
\106\ See letter from DT. Another commenter recommended that the
Commission also permit registrants to exclude any remaining amounts
classified as other income or other expense, subject to the same or
similar requirements. See letter from IMA.
---------------------------------------------------------------------------
Some commenters sought clarification of when carve-out financial
statements of an acquired business would be appropriate.\107\ One
commenter suggested that in the absence of clarification, the more
comprehensive carve-out financial statements may be less commonly
used,\108\ while another commenter recommended that the Commission
codify certain staff practices \109\ as they relate to presenting
carve-out financial statements.\110\
---------------------------------------------------------------------------
\107\ See letters from BDO, CAQ, Crowe, DT, EY, GT, PWC, and
RSM. Neither our proposal nor the final rule addresses carve-out
financial statements. ``Carve-out financial statements'' is a
generic term used to describe separate financial statements that are
derived from the financial statements of a larger parent company.
They are often differentiated from abbreviated financial statements
in that reasonable allocations of corporate overhead expenses can be
made such that the underlying preparation issues involve the scope
of the businesses to be included in the historical financial
statements, not whether financial statements can be prepared.
\108\ See letter from DT.
\109\ See FRM supra note 94 at Section 2065; 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.
\110\ See letter from GT.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting amendments to our rules to permit registrants to
provide audited annual and unaudited interim abbreviated financial
statements substantially as proposed, with certain modifications
described below. Recognizing the difficulty registrants face in
obtaining and the cost of preparing Rule 3-05 Financial Statements in
these circumstances, we believe permitting abbreviated financial
statements coupled with the additional required disclosures
appropriately balances the cost of preparing the financial disclosures
with the protection of investors.
The following chart compares our proposal to the final rules.
------------------------------------------------------------------------
Proposed Adopted
------------------------------------------------------------------------
Qualifying conditions....... The business The total assets and
constitutes less total revenues
than substantially (both after
all of the assets intercompany
and liabilities of eliminations) of
the seller. the acquired or to
be acquired
business constitute
20 percent or less
of such
corresponding
amounts of the
seller and its
subsidiaries
consolidated as of
and for the most
recently completed
fiscal year.
The business was not The acquired
a separate entity, business was not a
subsidiary, separate entity,
segment, or subsidiary,
division during the operating segment
periods for which (as defined in U.S.
the acquired GAAP or IFRS-IASB,
business financial as applicable), or
statements would be division during the
required. periods for which
the acquired
business financial
statements would be
required.
Separate financial No substantive
statements for the change.
business have not
previously been
prepared.
The seller has not No substantive
maintained the change.
distinct and
separate accounts
necessary to
present financial
statements that
include the omitted
expenses and it is
impracticable to
prepare such
financial
statements.
Presentation requirements... The balance sheet No substantive
may be a statement change.
of assets acquired
and liabilities
assumed.
The statement of No substantive
comprehensive change. The title
income may be a of the statement of
statement of comprehensive
revenues and income must be
expenses (exclusive appropriately
of corporate modified to
overhead, interest indicate it omits
and income tax certain expenses.
expenses) if
certain
presentation
requirements are
met.
Corporate overhead The statement of
expenses may be comprehensive
excluded from the income must include
statement of expenses incurred
comprehensive by or on behalf of
income provided the acquired
that the statement business during the
does not omit pre-acquisition
selling, financial statement
distribution, periods to be
marketing, general presented
and administrative, including, but not
and research and limited to, costs
development of sales or
expenses incurred services, selling,
by or on behalf of distribution,
the acquired marketing, general
business during the and administrative,
periods to be depreciation and
presented. amortization, and
research and
development, but
may otherwise omit
corporate overhead
expenses.
[[Page 54014]]
Interest expense may No substantive
be excluded from change.
the statements if
the debt to which
the interest
expense relates
will not be assumed
by the registrant
or its subsidiaries
consolidated.
Income tax expense No substantive
may be omitted. change.
The notes to the No substantive
financial change.
statements include
the following
additional
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;
and.
(iv) Information
about the
business's
operating,
investing and
financing cash
flows, to the
extent available.
------------------------------------------------------------------------
We are persuaded by commenter feedback that a condition focused on
whether the acquired business is a small portion of the selling entity
would be a more appropriate standard than ``less than substantially all
of the assets and liabilities of the seller'' for permitting the use of
abbreviated financial statements. A ``small portion of the selling
entity'' standard would help ensure that abbreviated financial
statements are not used when the component of the selling entity
acquired is sufficiently large such that presentation of the seller's
financial statements, along with pro forma financial information that
removes the portion of the seller not acquired, would best inform
investors about the business acquired. We are also persuaded that
absent any threshold, there would likely be divergence in how
registrants interpret ``small portion of the selling entity.'' \111\
Accordingly, we are adopting amendments to replace the proposed ``less
than substantially all of the assets and liabilities of the seller''
condition for use of abbreviated financial statements with a condition
that ``the total assets and total revenues (both after intercompany
eliminations) of the acquired or to be acquired business constitute 20
percent or less of such corresponding amounts of the seller and its
subsidiaries consolidated as of and for the most recently completed
fiscal year.'' \112\ We believe that 20 percent or less is an
appropriate level for identifying when the acquired business is a small
portion of the selling entity because, at that level, it is reasonable
to expect that expenses would not be fully allocated and that
comparisons of total assets and total revenues will be sufficient for
this purpose.\113\ A 20 percent threshold also is generally consistent
with the staff's granting of relief pursuant to Rule 3-13 in such
situations. In situations where an acquired business exceeds the 20
percent threshold but the registrant nonetheless confronts unique
challenges in making the relevant allocations necessary to provide Rule
3-05 Financial Statements, the registrant could continue to seek relief
pursuant to Rule 3-13.
---------------------------------------------------------------------------
\111\ See letter from GT.
\112\ See amended Rule 3-05(e)(1)(i).
\113\ A comparison of pre-tax income will not ordinarily be
meaningful because pre-tax income will seldom be readily
determinable for acquisitions of this nature.
---------------------------------------------------------------------------
Of the various terms recommended by commenters for definition or
clarification, we were persuaded that the term ``segment'' should be
further refined to clarify that it refers to an ``operating segment (as
defined in U.S. GAAP or IFRS-IASB, as applicable)'' rather than, for
example, a reportable segment. We note that many of the other terms
cited by commenters have long been associated with the historical
practice of using abbreviated financial statements and we believe their
meanings are generally understood. To the extent registrants have
unique circumstances relating to the application of these terms in the
context of a transaction, the registrant could seek relief pursuant to
Rule 3-13. We are therefore not persuaded that further clarification is
necessary in order to implement proposed Rule 3-05(e).
We believe that the qualifying conditions for use of abbreviated
financial statements included in the final rule are appropriate to
delineate the circumstances for their permitted use and provide an
appropriate balance between investor protection and capital access. As
noted above, one commenter requested clarity on the expenses to be
included in abbreviated financial statements. In response to this
comment, we have sought to improve the description of required expenses
by:
Reorganizing the rule text into ``qualifying conditions''
and ``presentation requirements'' and shortening the introductory
paragraph; \114\
---------------------------------------------------------------------------
\114\ See amended Rule 3-05(e).
---------------------------------------------------------------------------
Clarifying that the expenses required in the statement of
comprehensive income must include expenses incurred by or on behalf of
the acquired business during the pre-acquisition financial statement
periods to be presented, but may otherwise omit corporate overhead
expense, interest expense for debt that will not be assumed by the
registrant or its subsidiaries consolidated, and income tax expense;
and
Adding cost of sales or services and depreciation and
amortization expense to the list of expenses that must be included in
abbreviated financial statements and clarifying that it is an
illustrative list.\115\
---------------------------------------------------------------------------
\115\ The title of the statement of comprehensive income must be
appropriately modified to indicate it omits certain expenses.
---------------------------------------------------------------------------
As previously noted, neither our proposal nor the final rule
address ``carve-out financial statements.'' Given that carve-out
financial statements are not addressed by this release and because
issues relating to carve-out financial statements may require unique
judgments that involve the balance between investor protection and
capital access, we believe questions relating to carve-out financial
statements are best addressed on the basis of their unique facts and
circumstances through the staff consultation process.\116\
---------------------------------------------------------------------------
\116\ See Rule 3-13, supra note 58.
---------------------------------------------------------------------------
[[Page 54015]]
4. Financial Statements of a Business That Includes Oil and Gas
Producing Activities
Rule 3-05 applies to acquisitions of a significant business \117\
that includes oil and gas producing activities.\118\ However, Rule 3-05
does not specify industry-specific disclosures regarding 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'') \119\ on an unaudited basis for each full year of
operations presented for the acquired business.
---------------------------------------------------------------------------
\117\ See Rule 11-01(d).
\118\ See the definition of ``oil and gas producing activities''
at 17 CFR 210.4-10(a)(16).
\119\ 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 94 at Section 2065.12. These supplemental disclosures are
a subset of those required in the financial statements of publicly
traded companies with significant oil- and gas-producing activities
and provide additional context for those financial statements.
---------------------------------------------------------------------------
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, but does not
constitute a separate entity, subsidiary, operating segment (as defined
in U.S. GAAP or IFRS-IASB, as applicable), 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.\120\ In these circumstances when certain
criteria are met, Commission staff, pursuant to Rule 3-13 and delegated
authority, has permitted registrants to provide abbreviated financial
statements that consist of income statements modified to exclude
expenses that are not expected to be comparable to future
operations.\121\
---------------------------------------------------------------------------
\120\ 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.
\121\ See FRM supra note 94 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.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed Rule 3-05(f) to codify the reporting
practices for oil and gas producing activities by requiring certain ASC
932 Disclosures on an unaudited basis for each full year of operations
presented for the acquired business. In addition, where the oil and gas
producing 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, the Commission proposed to permit
registrants to provide abbreviated financial statements that consist of
income statements modified to exclude expenses not comparable to future
operations.
b. Comments
One commenter specifically supported the codification of current
practices relating to a business that includes oil and gas producing
activities as proposed \122\ while another commenter supported the
proposal generally but suggested removing one of the conditions.\123\
No commenters opposed the proposed amendments.
---------------------------------------------------------------------------
\122\ See letter from KPMG. KPMG also suggested permitting
abbreviated financial statements for businesses that service oil and
gas fields (e.g., the acquisition of a midstream facility or storage
facility).
\123\ See letter from Cravath. Cravath recommended removing the
condition that the business ``was not a separate entity, subsidiary,
segment, or division.''
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed.
Specifically, for a significant acquired business that includes
significant oil- and gas-producing activities (as defined in the FASB
ASC Master Glossary),\124\ Rule 3-05 Financial Statements must include
certain ASC 932 Disclosures, which may be presented as unaudited
supplementary information for each full year of operations presented
for the acquired business.\125\ Additionally, Rule 3-05 Financial
Statements may consist of only audited statements of revenues and
expenses that exclude depreciation, depletion 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 (as defined in Sec. 210.4-10(a)(16)), and (2) the
qualifying conditions for abbreviated financial statements described in
Section II.A.3.c above are met.\126\ In these circumstances, the
footnote disclosures described in Section II.A.3.c above must also be
provided.\127\ As discussed in the Proposing Release, we believe that
codifying these practices provides clarity for registrants regarding
the application of Commission rules in these circumstances, which we
believe will facilitate compliance to the benefit of both registrants
and investors.\128\
---------------------------------------------------------------------------
\124\ We are adopting this definition of significant oil- and
gas-producing activities to be consistent with current practice.
Accordingly, the FASB's threshold for determining when ASC 932
Disclosures of unaudited supplemental information is required will
be applied in determining specified disclosures in ASC 932-235-50
for purposes of Rule 3-05 Financial Statements, even if the acquired
business is not a publicly-traded company.
\125\ See ASC 932-235-50-3 through 50-11 and ASC 932-235-50-29
through 50-36.
\126\ We were not persuaded by the commenter suggesting the
condition that the business ``was not a separate entity, subsidiary,
segment, or division'' should be removed. We believe this condition
can be indicative of circumstances where reasonable allocations
necessary to prepare financial statements can be made.
\127\ The amendments revise proposed Rule 3-05(f) to simplify
its text and to reference the applicable qualifying and presentation
conditions of amended Rule 3-05(e).
\128\ See Section II.A.4 of the Proposing Release.
---------------------------------------------------------------------------
5. Timing and Terminology of Financial Statement Requirements
a. Proposed Amendments
The Commission proposed several revisions to Rule 3-05 and Article
11 to clarify when Rule 3-05 Financial Statements and pro forma
financial information are required and to update the language in the
rules to take into account concepts that have developed since their
original adoption over 30 years ago.
b. Comments
Commenters were generally supportive of the proposed changes.\129\
Some commenters sought clarification that the ``applicable independence
standards'' in the proposed requirement that financial statements be
``prepared 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)''
would be those related to the auditing standards under which the
required financial statements of the acquired or to-be-acquired
business were audited.\130\
[[Page 54016]]
One commenter further recommended clarifying whether the reference to
``filed'' in the phrase in proposed Rule 11-01(b)(3) ``most recent
annual consolidated financial statements filed at or prior to the date
of acquisition or disposition'' is the same as ``required to be filed''
and how the phrase ``most recent annual financial statements of each
such business'' applies to nonpublic acquired or to-be-acquired
businesses.\131\ Another commenter recommended that the timing of the
pro forma financial information be accelerated to a date closer to when
the deal is announced to the public.\132\ Another commenter recommended
that the ``significant subsidiary'' definition should explicitly state
that the amounts used for testing should be derived from
``consolidated'' financial statements of the tested subsidiary and of
the registrant.\133\
---------------------------------------------------------------------------
\129\ See, e.g., letters from Cravath and Eli Lily.
\130\ See letters from CAQ, Crowe, and RSM. See also letters
from KPMG (recommending ``independence standards would be those
applicable under the auditing standards used to perform the audit of
the acquired or to be acquired business'') and Deloitte
(recommending clarification as to whether ``applicable independence
standards'' refers to any independence standards other than those
described in either Article 2, Qualifications and Reports of
Accountants, or the independence standards of the AICPA).
\131\ See letter from Deloitte.
\132\ See letter from CFA (recommending four business days after
the occurrence of the event with the ability to extend the deadline
to a maximum of 30 days in order to balance the compliance burden
with the imperative of timely disclosure to the market). Item 9.01
of Form 8-K currently permits up to approximately 75 days after
consummation of an acquisition.
\133\ See letter from Eli Lily.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed with some
additional changes reflecting the suggestions of commenters and our
further consideration of the proposals. Specifically, we are amending
Rule 3-05 and Article 11, as proposed, to:
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 been filed; \134\ and
---------------------------------------------------------------------------
\134\ We are amending 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), the
explanation that the acquisition of a business encompasses the
acquisition of an interest in a business accounted for by the equity
method was moved from Rule 3-05(a)(1)(i) to Rule 3-05(a)(2)(ii).
---------------------------------------------------------------------------
Provide in Rules 3-05(b)(3) and 11-01(b)(3)(i)(C) 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.\135\
---------------------------------------------------------------------------
\135\ 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. We are establishing by rule that
registrants are permitted, rather than required, to use the Form 10-
K filed after consummation to measure significance in this
circumstance to avoid creating an incentive for registrants to delay
the filing of their Form 10-K.
---------------------------------------------------------------------------
We additionally are updating the terminology and language used by
revising Rule 3-05 and Article 11, as proposed, to:
Clarify that ``financial statements'' need not include
related schedules specified in 17 CFR 210.12 (``Article 12''); \136\
---------------------------------------------------------------------------
\136\ Item 9.01(a)(2) of Form 8-K already provides that
supporting schedules of financial statements need not be filed and
the staff further applies this approach to acquired business
financial statements required in registration statements and proxy
statements. See FRM supra note 94 at Section 2005.2.
---------------------------------------------------------------------------
Clarify that a ``business'' that is a real estate
operation is subject to Rule 3-14 instead of Rule 3-05;
Clarify in Rule 3-05(a)(2)(ii) 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 disclosure provided pursuant to
Rules 3-09 and 4-08(g), includes summarized financial information or
separate financial statements of the business after the acquisition;
Replace the term ``furnish'' with ``file'' to make clear
that the information required by Rule 3-05 and Article 11 must be filed
with the Commission; \137\
---------------------------------------------------------------------------
\137\ 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), (ii), (iii), and (iv), and (b)(4)(ii)
and (iii), Rule 11-01(a) and Instruction 2 to Rule 11-02(b). At the
time the Commission adopted Rule 3-05, the Commission made no
distinction between ``furnished'' and ``filed.'' See Rule 3-05
Adopting Release.
---------------------------------------------------------------------------
Clarify that references to ``Regulation S-X'' in Rule 3-
05, Rule 3-14, and Rule 6-11 include the independence standards in 17
CFR 210.2-01 (``Rule 2-01'') unless the business is not a registrant,
in which case the applicable independence standards would apply;
Replace references to the terms ``business combination''
and ``combination between entities under common control'' 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; \138\ and
---------------------------------------------------------------------------
\138\ We similarly are adopting a conforming amendment to the
Instruction to Item 9.01 of Form 8-K.
---------------------------------------------------------------------------
Replace the term ``majority-owned'' with the term
``subsidiaries consolidated,'' as that term more accurately conveys
which subsidiaries are required to be included in the registrant's
financial statements.\139\
---------------------------------------------------------------------------
\139\ Rule 3-05 uses the term ``subsidiaries consolidated'' to
conform to the term used elsewhere in Regulation S-X. See, e.g.,
Rule 1-02(w), Rule 3-01, and Rule 3-02. We additionally are
replacing the term in Item 2.01 of Form 8-K.
---------------------------------------------------------------------------
Finally, we are adopting the following clarifying amendments, as
proposed, to Rules 1-02(w), 3-05, Form 8-K and Article 11 to:
Replace the reference to ``total assets'' of the tested
subsidiary in the Asset Test with the tested subsidiary's
``consolidated total assets'' as that term conveys more accurately the
amount to be used in the Asset Test; \140\
---------------------------------------------------------------------------
\140\ Consistent with a comment we received, we are adopting
this change to clarify that all amounts used in the significant
subsidiary tests that are derived from financial statements of the
tested subsidiary and the registrant should be based on consolidated
amounts. See supra note 133. The Investment Test and Income Test, as
proposed, already specified the requirement to use consolidated
amounts.
---------------------------------------------------------------------------
Replace the term ``shall'' with clearer language, such as
by indicating when a registrant ``must'' file or disclose certain
information;
Revise proposed Rule 11-01(b)(3) to:
[cir] Simplify its organization;
[cir] Clarify that it does not apply to the continuous real estate
offerings described in new Rule 11-01(b)(4); \141\
---------------------------------------------------------------------------
\141\ See Section II.C.6. Proposed Rule 3-14(b)(2)(iii) was
relocated and relabeled as Rule 11-01(b)(4).
---------------------------------------------------------------------------
[cir] Replace the reference to ``filed'' with ``required to be
filed'' to more clearly reflect existing practice; \142\
---------------------------------------------------------------------------
\142\ Use of ``required to be filed'' would also clarify that
the 15-day extension provided by Form 12b-25 does not serve to
revert the significance determination to an earlier year during the
15-day extension.
---------------------------------------------------------------------------
[cir] Remove the reference to related real estate operations for
combined pre-acquisition financial statements; \143\ and
---------------------------------------------------------------------------
\143\ The reference to related real estate operations is not
necessary in this context because only a modified Investment Test is
required for significance testing of these acquisitions.
---------------------------------------------------------------------------
[cir] Clarify what financial statements of a nonpublic acquired or
to-be-acquired business must be used in the significance determination;
\144\
---------------------------------------------------------------------------
\144\ The amended rules replace the phrase ``most recent annual
financial statements of each such business'' with ``the business's
pre-acquisition or pre-disposition financial statements for the same
fiscal year as the registrant or, if the fiscal years differ, the
business's most recent fiscal year that would be required if the
business had the same filer status as the registrant.''
---------------------------------------------------------------------------
[[Page 54017]]
Revise Instruction 4 to Item 2.01 of Form 8-K to include
the same clarification of the scope of Rule 3-05 with regards to
interests in businesses that will be accounted for under the equity
method or, in lieu of the equity method, the fair value option; \145\
and
---------------------------------------------------------------------------
\145\ Item 2.01 of Form 8-K does not explicitly clarify the
treatment of interests in businesses that will be accounted for
under the equity method or, in lieu of the equity method, the fair
value option. However, the determination of whether an acquisition
involves a business is consistent between Item 2.01 of Form 8-K and
Rule 3-05, because both Instruction 4 to Item 2.01 of Form 8-K and
Rule 3-05(a)(2)(ii) refer to the same definition of a business in
Rule 11-01(d), and the requirements of Item 2.01 of Form 8-K are
linked to the requirements of Rule 3-05 through Item 9.01 of Form 8-
K. This amendment conforms Item 2.01 of Form 8-K to include the
additional clarification from Rule 3-05.
---------------------------------------------------------------------------
Conform technical terminology inconsistencies throughout
the rules.\146\
---------------------------------------------------------------------------
\146\ For example, proposed Rule 3-05(c) has been amended to
include a reference to the definition of a foreign business in Rule
1-02(l) to be consistent with proposed Rule 3-05(d) which already
included the reference.
---------------------------------------------------------------------------
We are not adopting modifications to clarify, as requested by
commenters, the ``applicable independence standards'' in the proposed
requirement that financial statements be ``prepared 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)'' because the independence standards applicable
for a particular audit are not necessarily linked to the auditing
standards used for such an audit. For example, for purposes of auditing
non-issuer Rule 3-05 or Rule 3-14 Financial Statements, an auditor may
follow AICPA auditing and independence standards but also may elect to
perform the audit under PCAOB auditing standards. Our amendments are
not intended to change practice by referring to ``applicable
independence standards,'' but rather to acknowledge that for an
acquired or to be acquired business that is a non-issuer, an auditor is
not required to follow the independence standards in Rule 2-01 for
purposes of auditing Rule 3-05 and Rule 3-14 Financial Statements. As a
result, if the acquired or to be acquired business is not an issuer,
the auditor should look to the applicable ethics and independence
standards that would apply in issuing the audit report for such
business in satisfying the audit requirement for purposes of the Rule
3-05 and Rule 3-14 Financial Statements.
We are also not adopting requirements to accelerate the timing of
providing pro forma financial information, as one commenter suggested.
For acquisitions, pro forma financial information is based on the
audited financial statements of the acquired business for periods prior
to the acquisition of the business by the registrant. In these
circumstances, our requirements provide additional time for registrants
to obtain acquired business pre-acquisition historical financial
statements, which we believe should also continue to extend to pro
forma financial information.\147\
---------------------------------------------------------------------------
\147\ See, e.g., Item 9.01 of Form 8-K.
---------------------------------------------------------------------------
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.\148\
Rule 3-05 similarly permits the use of IFRS-IASB in financial
statements of foreign businesses. However, 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 are required to be reconciled to U.S. GAAP
even if the registrant is a foreign private issuer that prepares its
financial statements in accordance with IFRS-IASB.\149\
---------------------------------------------------------------------------
\148\ See 17 CFR 210.4-01.
\149\ See Item 17 of Form 20-F and 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'').
---------------------------------------------------------------------------
Further, while the definitions of ``foreign private issuer'' \150\
and ``foreign business'' \151\ have similarities, they have different
ownership requirements such that a business could qualify to be a
``foreign private issuer'' if it were a registrant, but not qualify to
be a ``foreign business'' when it is acquired by a registrant. In this
circumstance, a registrant acquiring such a business is not permitted
to present Rule 3-05 Financial Statements of the acquired business
prepared in accordance with IFRS-IASB, even when those financial
statements are already available and even though the acquired business
could present IFRS-IASB financial statements if it were a registrant.
Instead, the Rule 3-05 Financial Statements must be prepared in
accordance with U.S. GAAP.\152\
---------------------------------------------------------------------------
\150\ See Securities Act 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 percent 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 percent 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.
\151\ See 17 CFR 210.1-02(l). The term ``foreign business''
means a business that is majority owned by persons who are not
citizens or residents of the United States and is not organized
under the laws of the United States or any state thereof, and
either: (1) More than 50 percent of its assets are located outside
the United States; or (2) The majority of its executive officers and
directors are not United States citizens or residents.
\152\ 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 1994 Acquired Foreign Business Release.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to permit Rule 3-05 Financial Statements
for an acquired foreign business prepared using home country GAAP to be
reconciled to IFRS-IASB rather than U.S. GAAP if the registrant is a
foreign private issuer that prepares its financial statements using
IFRS-IASB. The Commission also proposed 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 be a foreign
private issuer if it were a registrant.
b. Comments
Commenters generally supported the proposal,\153\ with some
recommending providing additional relief by allowing reconciliation to
IFRS-IASB rather than U.S. GAAP for a business that prepares its
financial statements using home-country GAAP and does not meet the
definition of a foreign business but that would be a foreign private
issuer if it were a registrant.\154\ One commenter additionally
suggested that the Commission provide guidance on the applicability of
IFRS 1, First-time Adoption of IFRS,\155\ and accommodations under Form
20-F when reconciling to IFRS-IASB.\156\
[[Page 54018]]
Irrespective of the GAAP being applied or reconciled to, some
commenters recommended that the Commission consider permitting required
audit reports on the financial statements of acquired foreign
businesses to be prepared in accordance with International Standards on
Auditing (``ISAs'') issued by the International Auditing and Assurance
Standards Board.\157\
---------------------------------------------------------------------------
\153\ See, e.g., letters from Chris Barnard (``Barnard''),
Cravath, DT, NAREIT, Nasdaq, and PWC.
\154\ See, e.g., letters from BDO, CAQ, DT, EY, KPMG, and RSM.
Some of these commenters recommended simplifying the rules by
expanding proposed Rule 3-05(c) and eliminating proposed Rule 3-
05(d). See, e.g., letters from CAQ, EY, KPMG, and RSM.
\155\ IFRS 1 provides recognition, measurement, and disclosure
requirements, as well as certain transitional exceptions, for
entities that present IFRS-IASB financial statements for the first
time.
\156\ See letter from DT. DT indicated that certain
accommodations offered under Form 20-F, Item 17, such as to not
remove the effects of inflation accounting pursuant to Item
17(c)(2)(iv)(2) when the conditions of IAS 29, Reporting in
Hyperinflationary Economies, are not met, or to not reconcile the
effects of proportionate consolidation for investments in joint
ventures pursuant to Item 17(c)(2)(vii), may be inconsistent with
IFRS- IASB requirements.
\157\ See letters from Barnard, BDO, KPMG, and PWC.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed, but with
some modifications after consideration of the comments received. We are
amending the rules in order to increase the consistency between the
basis of accounting used by acquired businesses and foreign private
issuers, as well as to permit acquired businesses and registrants to
avoid unnecessary costs, such as one-time presentations of the U.S.
GAAP reconciling information where such information would not be
material to investors.
Specifically, we are adopting the proposed amendments to Rule 3-
05(c) to permit foreign private issuers that prepare their financial
statements using IFRS-IASB to reconcile Rule 3-05 Financial Statements
of foreign businesses prepared using home country GAAP to IFRS-IASB
rather than U.S. GAAP because this will provide more comparable
information and better facilitate analysis of the financial statements.
The reconciliation to IFRS-IASB is required generally to follow the
form and content requirements in Item 17(c) of Form 20-F.
Additionally, we are adopting, as proposed, Rule 3-05(d) to permit
Rule 3-05 Financial Statements to be prepared in accordance with IFRS-
IASB without reconciliation to U.S. GAAP \158\ if the acquired business
would qualify as a foreign private issuer if it were a registrant. As
discussed in the Proposing Release, we believe financial statements
prepared in accordance with IFRS-IASB provide sufficient information
for investors for this purpose.\159\ 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.
---------------------------------------------------------------------------
\158\ Under the 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.
\159\ See Section II.A.6.a. of the Proposing Release.
---------------------------------------------------------------------------
After considering comments received on the proposals, we are
modifying the proposed amendments to additionally permit an acquired
business that would qualify as a foreign private issuer if it were a
registrant to reconcile to IFRS-IASB rather than U.S. GAAP when the
registrant is a foreign private issuer that uses IFRS-IASB. We agree
with commenters that reconciliation to IFRS-IASB will provide more
comparable information and better facilitate analysis of the financial
statements in this circumstance as well.
In response to comments, we are adopting two additional
modifications to the proposed amendments to clarify that:
IFRS 1, First-time Adoption of IFRS, will be applicable
when reconciling to IFRS-IASB; and
Form 20-F accommodations that are inconsistent with IFRS-
IASB will not be available when reconciling to IFRS-IASB.
We believe it is appropriate to specify that IFRS 1 will be
applicable when reconciling Rule 3-05 Financial Statements to IFRS-
IASB, because a business that is reconciling to IFRS-IASB for the first
time will face many of the same challenges in determining the relevant
financial statement amounts as it would if it were directly presenting
its financial statements under IFRS-IASB for the first time. Similarly,
we believe it is appropriate to specify that Form 20-F accommodations
that are inconsistent with IFRS-IASB will not be available when
reconciling to IFRS-IASB. These accommodations, such as to not remove
the effects of inflation accounting when the conditions of IAS 29 are
not met or to not reconcile the effects of proportionate consolidation
in joint ventures,\160\ were adopted in the context of reconciling to
U.S. GAAP rather than IFRS-IASB. They were also adopted when the range
of accounting practices around the world was wider than it is today and
before IFRS-IASB was established in its current form. We believe that
use of accommodations that are inconsistent with IFRS-IASB would not
result in sufficient information for investors in this context.
---------------------------------------------------------------------------
\160\ See supra note 156.
---------------------------------------------------------------------------
We are not combining proposed Rule 3-05(c) and 3-05(d) as suggested
by some commenters. Rule 3-05(c) addresses the financial statement
requirements for an acquired business that meets the definition of a
foreign business. Rule 3-05(d) addresses the financial statement
requirements for an acquired business that does not meet the definition
of a foreign business but that would be a foreign private issuer if it
were a registrant. We believe that separate paragraphs will permit
registrants to more easily determine which requirements apply to their
acquired businesses. Separate paragraphs will also help to clarify that
foreign businesses under Rule 3-05(c) may apply the other applicable
accommodations in Form 20-F while the businesses that fall under Rule
3-05(d) cannot.\161\
---------------------------------------------------------------------------
\161\ For example, foreign businesses under Rule 3-05(c) may
apply the age of financial statement requirements in Item 8 of Form
20-F, and may apply the accommodation in Item 17(c)(2)(v) of Form
20-F that allows them to not reconcile their financial statements to
U.S. GAAP if the significance of the foreign business is below 30
percent.
---------------------------------------------------------------------------
Finally, we are not adopting revisions to accept ISAs in audit
reports on Rule 3-05 Financial Statements of foreign businesses as
suggested by some commenters. Use of ISAs in Commission filings would
involve broader considerations than Rule 3-05 Financial Statements,
potentially including the appropriateness of their use for audits of
foreign private issuer financial statements. We believe such an
approach would require a thorough evaluation of the appropriateness of
the use of ISAs and is beyond the scope of these amendments.
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. Part F/S of Form 1-A (``Part F/S'') \162\ directs an
issuer relying on 17 CFR 230.251 through 230.263 \163\ to present
financial statements of businesses acquired or to be acquired,\164\ as
specified by Rule 8-04, but permits the periods presented to be the
shorter of those applicable to issuers relying on Regulation A and the
periods specified by Article 8.\165\
---------------------------------------------------------------------------
\162\ 17 CFR 239.90.
\163\ Regulation A--Conditional Small Issues Exemption
(``Regulation A'').
\164\ See paragraph (b)(7)(iii) of Part F/S of Form 1-A.
\165\ See paragraph (b)(7) of Part F/S of Form 1-A.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to revise Rule 8-04 to reference 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 17 CFR 210.8-02 (``Rule 8-02'') and Rule 8-
03.\166\
---------------------------------------------------------------------------
\166\ Rule 3-05(b)(1) currently requires financial statements
specified in Rule 3-01 and 3-02 for the business to be acquired.
Similarly, Rule 3-05(b)(2) also references Rule 3-01 and 3-02. Under
the proposal, smaller reporting companies would apply Rule 3-05 but
would substitute Rule 8-02 and Rule 8-03, as applicable, wherever
Rule 3-05 references Rule 3-01 and 3-02. In this way, the proposal
was 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 Rule 8-01 Preliminary Note 2 to
Article 8) to businesses acquired by smaller reporting companies.
---------------------------------------------------------------------------
[[Page 54019]]
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 issuers
relying on Regulation A would continue to be permitted to present the
shorter of the periods applicable under Regulation A and the periods
specified by Article 8.\167\
---------------------------------------------------------------------------
\167\ Additionally, the proposed revisions would have expressly
permitted smaller reporting companies and issuers relying on
Regulation A 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 proposed 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 and
issuers relying on Regulation A 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.
---------------------------------------------------------------------------
b. Comments
A few commenters provided comments specifically related to smaller
reporting companies and smaller issuers.\168\ One commenter expressly
supported the proposal to conform the rules applicable to smaller
reporting companies to the generally applicable rules.\169\ Other
commenters offered specific recommendations relating to smaller
registrants \170\ or generally suggested the Commission consider
whether issuers relying on Regulation A warrant different
treatment.\171\
---------------------------------------------------------------------------
\168\ See, e.g., letters from BDO, EY, MTBC, and RSM. See also
SBCFAC Recommendations.
\169\ See letter from BDO.
\170\ See letter from MTBC (recommending that smaller
registrants only apply the revenue component of the Income Test).
\171\ See SBCFAC Recommendations (recommending that the
Commission continue to look at ``Regulation A companies and whether
they warrant different treatment under these rules'').
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed. We are
revising Rule 8-04 to reference 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. These revisions should ease compliance
burdens and clarify the application of our rules for smaller reporting
companies and issuers relying on Regulation A by focusing them on the
more complete and better understood provisions of Rule 3-05. They will
also expressly permit smaller reporting companies and issuers relying
on Regulation A to omit historical acquired business financial
statements if the acquired business has been included in the
registrant's results for either nine months or a complete fiscal year,
depending on significance.
We are also revising Rule 8-01 as proposed, to add a paragraph
expressly permitting application of Rule 3-06 to the preparation of
financial statements of smaller reporting companies and issuers relying
on Regulation A \172\ and to amend the instruction in Item 9.01 of Form
8-K to include references to Rule 8-04 in order to conform the
instruction to the text of Item 9.01, which already addresses the rules
applicable to smaller reporting companies.
---------------------------------------------------------------------------
\172\ In addition, we are revising Rule 8-01 to remove the
reference to the instruction relating to pro forma presentation
requirements. See Section II.D.3. In a non-substantive change from
our proposal, we are also renaming Rule 8-01 ``General Requirements
for Article 8'' and re-designating Notes 1 through 5 of Rule 8-01 as
paragraphs (a) through (e).
---------------------------------------------------------------------------
We considered whether issuers relying on Regulation A should be
treated differently or whether smaller registrants should be subject to
further differentiated requirements, such as only complying with the
revenue component of the Income Test, as one commenter suggested. We
determined not to further differentiate disclosure for issuers relying
on Regulation A and smaller reporting companies because we think the
rules as adopted result in important investor information that we do
not believe should be further reduced or modified.\173\ We believe that
existing accommodations should offset some of the burden associated
with the disclosures that would be required by the rules. For example,
Rule 8-01(b) provides, with limited exceptions, that smaller reporting
companies electing to prepare their financial statements with the form
and content required by Article 8 need not apply the other form and
content requirements in Regulation S-X, and Form 1-A Part F/S provides
that, in certain circumstances, financial statements of businesses
acquired or to be acquired may be unaudited, may be for shorter periods
than provided in Rule 8-04, and need not be updated if the most recent
annual or interim balance sheet is not older than nine months. Further,
as discussed below, the final rules contain a number of provisions
that, while applicable to issuers of all sizes, should help ease the
burden of providing the required financial information for smaller
reporting companies and issuers relying on Regulation A.\174\
---------------------------------------------------------------------------
\173\ For example, we believe it is important that smaller
reporting companies and issuers relying on Regulation A be required
to provide pro forma financial information when consummation of
other transactions has occurred or is probable for which disclosure
of pro forma financial information would be material to investors.
See Section II.D.3. We also note that significance tests are not
one-size-fits-all tests, but instead contemplate the unique facts
and circumstances of a registrant or issuer because they measure
significance of the acquired or disposed business relative to the
registrant or issuer.
\174\ For example, we believe the significance tests we are
adopting will provide more meaningful indicators of significance and
mitigate anomalous significance results.
---------------------------------------------------------------------------
As revised, Rule 8-04 continues to require up to two years of
acquired business historical financial statements. Additionally, and in
accordance with current practice, the revised rule expressly permits
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.\175\ We are also adding references to Rule 8-04
in Rule 3-06 and to Rule 3-06 in Article 8, as proposed, to expressly
permit smaller reporting companies to file audited 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.
---------------------------------------------------------------------------
\175\ See further discussion of omission of Rule 3-05 Financial
Statements in Section B.1. above.
---------------------------------------------------------------------------
The amendments also provide that a smaller reporting company is
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).\176\ We
believe it is appropriate to consistently look to the date of the final
prospectus or prospectus supplement for registrants,\177\ as Rule 3-05
currently
[[Page 54020]]
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.\178\ We are also
making conforming changes to Rule 8-05 for smaller reporting companies
to be consistent with the changes we are making to Article 11.\179\
---------------------------------------------------------------------------
\176\ See proposed Rule 3-05(b)(4)(i)(B).
\177\ See 1996 Streamlining Release supra note 24 (noting that
the date of an offering is specified as the date of the final
prospectus or prospectus supplement relating to the offering).
\178\ See General Instruction I.B.6 of Form S-3 and Amendments
to Smaller Reporting Company Definition, Release No. 33-10513 (June
28, 2018) [83 FR 31992 (July 10, 2018)].
\179\ See Section II.D.3 below.
---------------------------------------------------------------------------
B. 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
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.
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. 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.\180\
---------------------------------------------------------------------------
\180\ The staff's position has been 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 94 at Section 2030.4 ``Initial Registration
Statements--Using Pre-Acquisition and Post-Acquisition Audited
Results.''
---------------------------------------------------------------------------
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 meeting at least
one of the significance tests set forth in Rule 1-02(w) at the 80
percent level at the date of the acquisition would require the
registrant to continue to file the financial statements of the acquired
business. Notwithstanding the rule's reference to materiality, in
practice the rule is typically applied, consistent with this example,
on the basis of quantitative significance determinations.\181\
---------------------------------------------------------------------------
\181\ See, e.g., FRM supra note 94 at Section 2040.2 `` `Major
Significance' and Previously Filed Acquiree Financial Statements.''
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed 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. The Commission also
proposed to eliminate the ``major significance'' exception.
b. Comments
Commenters generally supported the proposed amendments.\182\ One
commenter, however, encouraged the Commission to seek additional input
and consider whether the proposed amendments would provide investors
with sufficient information and whether additional financial statements
may be necessary above a certain significance threshold.\183\
---------------------------------------------------------------------------
\182\ See, e.g., letters from Bass Berry, BDO, CAQ, Cravath, DT,
Eli Lilly, FEI, KPMG, Pillsbury Winthrop Shaw Pittman, LLP, PWC, and
Nasdaq.
\183\ See letter from GT. This commenter cited an example where
an initial public offering registrant consummates a very large
acquisition in the year prior to the most recently completed fiscal
year for which financial statements are being provided for the
registrant. The commenter noted that while the registrant would be
required to provide its historical financial statements for two
years, the acquired business's financial statements would be limited
to the period for which it is included in the registrant's post-
acquisition results. The commenter further observed that, in its
experience, disclosure pursuant to Regulation S-K, Item 303,
Management's discussion and analysis of financial condition and
results of operations, may not clearly isolate the effects of the
acquisition on results of operations. The commenter suggested as an
example that the Commission could consider requiring an initial
public offering registrant to provide financial statements for the
same number of periods as required in subsequent Securities Act and
Exchange Act filings or for the same number of periods as the 50
percent threshold would require, prior to proceeding with a
securities offering.
---------------------------------------------------------------------------
A number of commenters recommended permitting registrants to
exclude separate financial statements once the acquired business has
been included in the post-acquisition audited financial statements for
at least nine months.\184\ Commenters analogized to the Rule 3-06
requirements, noting that Rule 3-06 only requires nine months of pre-
acquisition audited financial statements for an acquisition that
exceeds 20 percent, but does not exceed 40 percent, significance.\185\
In expressing support for using nine months, one of these commenters
noted that the Commission could consider a requirement to disclose any
material information impacting any pre-acquisition period that would
otherwise be required absent the use of Rule 3-06 to supplement
required financial statements.\186\
---------------------------------------------------------------------------
\184\ See, e.g., letters from BDO, CAQ, Crowe, DT, EY, GT, KPMG,
PWC, and RSM.
\185\ See, e.g., letters from BDO and DT. One of these
commenters further noted that staff practice as documented in FRM
2040.2 generally permits omission of previously filed acquired
business financial information once it is included in the
registrant's post-acquisition results for nine months. See letter
from DT. The other commenter recommended allowing omission of pre-
acquisition financial statements for businesses that exceed 20
percent, but do not exceed 40 percent, significance once they are
included in the registrant's audited post-acquisition results for
nine months and for businesses that exceed 40 percent significance
once they are included in the registrant's post-acquisition results
for a complete fiscal year. See letter from BDO.
\186\ See letter from Crowe.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting revisions substantially as proposed with some
modifications in response to comments received. Specifically, we are
adopting the proposed elimination of the requirement to include Rule 3-
05 Financial Statements in registration statements and proxy statements
once the acquired business is reflected in filed post-acquisition
registrant financial statements. However, in response to comments, we
are modifying the requisite time period.
We are persuaded by commenters that our proposal unnecessarily
perpetuates existing differences in the length of reporting periods
that exist between Rule 3-05 and Rule 3-06 for an acquisition that is
at least 20 percent, but not more than 40 percent, significant. One
condition in Rule 3-05 for omitting Rule 3-05 Financial Statements is
that the acquired business has been included in the registrant's post-
acquisition results for a complete fiscal year. However, Rule 3-06
permits the filing of Rule 3-05 Financial Statements covering a period
of nine months to satisfy the Rule 3-05 requirement for filing
financial statements for a period of one year. While these reporting
periods relate to different circumstances, omission under Rule 3-05 as
compared to inclusion
[[Page 54021]]
under Rule 3-06, we do not believe those circumstances are sufficiently
different for acquisitions that are at least 20 percent, but not more
than 40 percent, significant (i.e., significant at the one year level)
to warrant disclosures for different time periods. To provide
consistency between the Rule 3-05 and Rule 3-06 requirements, the
amendments will allow omission of pre-acquisition financial statements
for businesses that exceed 20 percent but do not exceed 40 percent
significance once they are included in the registrant's audited post-
acquisition results for nine months (rather than the proposed complete
fiscal year).\187\
---------------------------------------------------------------------------
\187\ Rule 3-06 does not require incremental disclosure in order
for the filing of financial statements covering a period of nine
months to be deemed to satisfy a requirement for filing financial
statements for a period of one year. Because our amendments seek to
make Rule 3-05 more consistent with Rule 3-06, the final amendments
do not include an incremental disclosure requirement within Rule 3-
05 to disclose material information impacting any pre-acquisition
period that would otherwise be required absent the use of amended
Rules 3-05 and 3-06. However, we observe that existing requirements,
such as those in Item 303 of Regulation S-K, Management's discussion
and analysis of financial condition and results of operations, and
Rule 4-01(a) would require such disclosure when it is material to
the registrant, and we believe that information would be sufficient
for this purpose.
---------------------------------------------------------------------------
Because Rule 3-06 limits the use of a nine month period to
financial statements that would otherwise be required for a period of
one year, the amendments retain the existing complete fiscal year Rule
3-05 requirement when Rule 3-05 Financial Statements for a period of
two years are required (i.e., significance exceeds 40 percent).
Specifically, the amendments allow omission of pre-acquisition
financial statements for businesses that exceed 40 percent significance
once they are included in the registrant's post-acquisition results for
a complete fiscal year.
These final amendments also 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. 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 because the post-acquisition
results of the combined business are generally not comparable to the
pre-acquisition results of the acquired business.\188\ Similarly for
financial information provided regarding acquisitions of ``major
significance,'' the utility of pre-acquisition periods diminishes over
time after the acquired business is reflected in post-acquisition
results. Additionally, with electronic filing requirements, which were
established after the ``major significance'' rule, previously filed
financial information about the acquired business is readily accessible
through the Commission's EDGAR filing system.
---------------------------------------------------------------------------
\188\ See FRM supra note 94 at Section 2030.4. The accommodation
provided by Commission staff did not sufficiently ameliorate these
effects and often resulted in financial statements of the acquired
business that depicted partial, rather than complete, reporting
periods that did not coincide with the end of either the acquired
business's or the registrant's fiscal periods.
---------------------------------------------------------------------------
We believe inclusion of post-acquisition results in the
registrant's audited financial statements for the requisite time period
should generally provide investors with sufficient information to make
informed investment decisions about the registrant. 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 must
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.'' \189\
---------------------------------------------------------------------------
\189\ See Rule 4-01(a).
---------------------------------------------------------------------------
We are not persuaded that additional financial statements of
acquired businesses should be provided in initial registration
statements when an acquisition is reflected in post-acquisition audited
results for nine months when the acquisition is significant at the one
year level or included for a complete fiscal year when the acquisition
is significant at the two year level. Pre-acquisition financial
statements by their nature are less likely to be indicative of the
current financial condition, changes in financial condition, and
results of operations of the acquired business as they age. If, in an
unusual circumstance, pre-acquisition financial statements are
necessary for the protection of investors even though the acquired
business has been included in the registrant's post-acquisition results
for a complete fiscal year, then Rule 3-13 permits the Commission staff
by delegated authority to require the filing of the pre-acquisition
financial statements.
We also believe that rightsizing our acquired business financial
statement requirements appropriately balances the need to provide
investors with information necessary for making informed investment
decisions with the goal of minimizing compliance costs that can delay
or preclude access to public markets, particularly when going public
may not have been contemplated at the time an acquisition
occurred.\190\
---------------------------------------------------------------------------
\190\ In adopting these changes, we note that Item 303 of
Regulation S-K requires identification of known trends, demand,
commitments, events and uncertainties and Rule 4-01(a) of Regulation
S-X 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.''
---------------------------------------------------------------------------
2. Use of Pro Forma Financial Information To Measure Significance
A registrant is generally permitted to use pro forma, rather than
historical, financial information to test significance of a
subsequently acquired business if the registrant made a significant
acquisition after the latest fiscal year-end and filed its Rule 3-05
Financial Statements and pro forma financial information on Form 8-
K.\191\ However, this Form 8-K filing requirement has the practical
effect of precluding the use of pro forma financial information that
gives effect to a significant acquisition subsequent to the latest
fiscal year-end to test significance of a subsequently acquired
business when determining Rule 3-05 disclosure requirements in initial
registration statements. While Commission staff has considered the
results of significance tests using pro forma financial information in
considering whether to permit omission or substitution of acquired
business financial statements in initial registration statements of
registrants growing through acquisition, those circumstances have been
limited.\192\ Further, Regulation S-X does not provide for dispositions
of significant businesses to be included in the pro forma financial
information used for testing significance of a subsequently acquired or
subsequently disposed business.
---------------------------------------------------------------------------
\191\ See Rule 3-05(b)(3).
\192\ Consistent with the staff's exercise of delegated
authority in response to requests under Rule 3-13, Staff Accounting
Bulletin No. 80, Application of Rule 3-05 in Initial Public
Offerings (``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, but the
accommodations in SAB 80 are complex and seldom used by registrants.
---------------------------------------------------------------------------
a. Proposed Amendments
For all filings that require Rule 3-05 Financial Statements and
Rule 3-14 Financial Statements, the Commission proposed to expand the
circumstances in which a registrant can use pro forma
[[Page 54022]]
financial information for significance testing by permitting
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
certain conditions.
b. Comments
Commenters generally supported the amendments.\193\ However, one
commenter stated that once a registrant chooses to use pro forma
financial information for significance testing, the registrant should
be required to use the approach consistently until the next annual
report on Form 10-K is filed,\194\ consistent with current staff
guidance.\195\
---------------------------------------------------------------------------
\193\ See letters from Cravath, Eli Lilly, FEI, GT, Nasdaq, and
S&C.
\194\ See letter from GT. GT additionally recommended that the
Commission clarify in the final rules that pro forma financial
information used to determine significance may be different from pro
forma financial information that was previously filed if it gave
effect to other transactions. They also recommended that the
Commission clarify how pro forma financial information for previous
acquisitions or dispositions be used for determining the
significance of subsequent acquisitions or dispositions in
connection with an initial registration statement, given that pre-
acquisition financial statements and pro forma financial information
for the previous transactions could not have been previously filed
in the case of a confidential submission and the first public filing
of an IPO registration statement.
\195\ See FRM supra note 94 at Section 2025.3, which indicates
registrants should use a consistent approach for determining
significance until the filing of the next annual report on Form 10-
K.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed, but with
some modifications after consideration of the comments received.
Specifically, for filings that require Rule 3-05 Financial Statements
and Rule 3-14 Financial Statements, we are amending Rule 11-01(b)(3) 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; \196\
and
---------------------------------------------------------------------------
\196\ We believe this condition clarifies that if the required
Rule 3-05 Financial Statements and pro forma financial information
for one or more significant business acquisitions consummated after
the registrant's most recently completed fiscal year required to be
filed are included in an initial registration statement, then those
acquisitions may be included in the pro forma financial information
used to measure significance of a business acquired subsequent to
those acquisitions for purposes of determining whether Rule 3-05
Financial Statements of the subsequently acquired business, and
related pro forma financial information, are required in the initial
registration statement.
---------------------------------------------------------------------------
The registrant has filed the pro forma financial
information required by Article 11 for any such acquired or disposed
business.\197\
---------------------------------------------------------------------------
\197\ We are revising 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 are also including in Rule 11-01(b)(3) the statement in
the current rule that the tests may not be made by ``annualizing''
data.
---------------------------------------------------------------------------
We additionally are amending Rule 11-01(b)(3) as proposed to add a
reference to Rule 11-02(b)(6)(i), but relocating it within amended Rule
11-01(b)(3), to clarify that when determining significance the pro
forma financial information must be limited to the applicable amounts
that combine the historical financial information of the registrant and
the acquired business and Transaction Accounting Adjustments.\198\ We
also are amending Rule 11-01(b)(3) to indicate that the pro forma
financial information that is used to measure significance may only
give effect to the subsequently acquired or disposed business and may
not give effect to Autonomous Entity Adjustments, Management's
Adjustments, if any, or other transactions, such as the use of proceeds
from an offering. Further, we are persuaded to modify the proposal to
clarify that once a registrant uses pro forma financial information to
measure significance, it must continue to use pro forma financial
information to measure significance until the next annual report on
Form 10-K or Form 20-F. This modification will codify current
practice,\199\ provide for a more relevant indicator of significance,
and ensure greater consistency in the significance determinations.
---------------------------------------------------------------------------
\198\ See Section II.D.1.c.
\199\ See supra text accompanying note 195.
---------------------------------------------------------------------------
We believe these amendments will 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.
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 percent significance, or (2)
does not exceed 50 percent 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 17
CFR 230.424(b)) is no more than 74 days after consummation and the
financial statements have not been previously filed.\200\ However, if
the aggregate impact of ``individually insignificant businesses'' \201\
acquired since the date of the most recent audited balance sheet filed
for the registrant exceeds 50 percent, 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.\202\ Registrants also must provide
related pro forma financial information based on the requirements of
Article 11.\203\
---------------------------------------------------------------------------
\200\ See Rule 3-05(b)(4)(i).
\201\ In the 1996 Streamlining Release (see supra note 24), Rule
3-05 was amended to permit the exclusion of historical financial
statements for certain significant acquisitions that did not exceed
50 percent significance. See Rule 3-05(b)(4)(i). Commission staff
has interpreted ``individually insignificant businesses'' to
include: (a) Any acquisition consummated after the registrant's
audited balance sheet date whose significance does not exceed 20
percent; (b) Any probable acquisition whose significance does not
exceed 50 percent; and (c) Any consummated acquisition whose
significance exceeds 20 percent, but does not exceed 50 percent, 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 94 at
Section 2035.2.
\202\ See Rule 3-05(b)(2)(i). ``Substantial majority'' has been
applied in practice to be the mathematical majority (i.e.,
businesses constituting more than 50 percent of the relevant test
(investment, asset or income) on which the businesses were
determined to be significant in the aggregate) See FRM supra note 94
at Section 2035.3 ``Financial Statements Required--Mathematical
Majority.''
\203\ 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.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed amending Rule 3-05 to no longer require
separate
[[Page 54023]]
financial statements for the majority of the individually insignificant
acquired businesses when 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 or not yet required because of the registration (or proxy)
statement grace period, exceeds 50 percent. In conjunction with this
change, the proposed amendments would require registrants to provide
pro forma financial information depicting the aggregate effects of all
such businesses in all material respects. In addition, the proposed
amendments would have required pre-acquisition historical financial
statements only for those businesses whose individual significance
exceeds 20 percent, but that are not yet required to file financial
statements.
b. Comments
Commenters generally supported the proposal to no longer require
Rule 3-05 Financial Statements for businesses whose individual
significance does not exceed 20 percent.\204\ One commenter recommended
the Commission consider including both Rule 3-05 businesses and Rule 3-
14 real estate operations when determining the aggregate impact for
individually insignificant acquisitions and providing guidance on how
to perform the aggregations.\205\ Another commenter recommended against
including them both together due to the difference in the types of
transactions covered.\206\
---------------------------------------------------------------------------
\204\ See, e.g., letters from Cravath, DT, Eli Lilly, FEI, and
GT.
\205\ See letter from GT.
\206\ See letter from Cravath.
---------------------------------------------------------------------------
Some commenters expressed concern that the new requirements could
create burdens for registrants relating to the proposed requirements to
file financial statements for multiple significant acquisitions or the
proposed requirements to provide detailed financial information about
individually insignificant acquisitions that may not be readily
available or may not have been provided to the registrant during its
due diligence.\207\ Other commenters expressed concern that requiring
pro forma financial information that depicts aggregate impacts in ``all
material respects'' could lead to interpretive issues necessitating a
definition or examples.\208\ Some commenters also expressed concern
that accountants may not be able to provide negative assurance to
underwriters on the combined pro forma financial information where
historical financial statements included in the pro forma financial
information for individually insignificant acquisitions have not been
reviewed or audited.\209\ In contrast, one commenter suggested that the
procedures required for auditors to provide negative assurance to
underwriters on comfort letters are fairly limited and that the
proposed changes should not materially impact the auditor's ability in
this regard.\210\
---------------------------------------------------------------------------
\207\ See letters from GT and DT. See also letter from Cravath
(recommending retaining an option permitting a registrant to include
a majority of the acquired businesses in the pro forma presentation
or alternatively only requiring historical pre-acquisition financial
statements and pro forma financial information if the individually
insignificant businesses together exceed 50 percent under the Income
Test).
\208\ See letters from GT and RSM.
\209\ See letters from BDO, CAQ, Cravath, Crowe, DT, GT, and
RSM. Some commenters noted that PCAOB AS 6101 would prohibit
accountants from providing negative assurance on combined pro forma
financial information for which historical financial statements have
not been audited or reviewed. See letters from BDO, CAQ, Crowe, GT,
and RSM.
\210\ See letter from CFA.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed, but with
some modifications after consideration of the comments received. The
amendments to Rule 3-05 are intended to reduce the burdens of preparing
disclosure about immaterial acquisitions and negotiating with sellers
to timely provide historical financial statements, while the new
requirement to provide pro forma financial information that shows the
aggregate effect of the acquired businesses in all material respects
should make it easier for investors to understand the overall effect of
those acquisitions on the registrant. Under current rules, registrants
often provided separate, audited historical financial statements for
acquired businesses that were individually not material to the
registrant, and pro forma financial information that did not fully
depict the aggregate effect of the ``individually insignificant
businesses'' because currently Article 11 only requires pro forma
financial information for an acquisition for which Rule 3-05 Financial
Statements are required.\211\ The proposed amendments should address
these anomalies, to the benefit of both registrants and investors.
---------------------------------------------------------------------------
\211\ For example, if the aggregate of 16 individually
insignificant acquisitions is 80 percent significant, with each at
five percent, a registrant would 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 percent of the registrant's pre-acquisition assets
or income.
---------------------------------------------------------------------------
Similar to existing requirements, and as proposed, amended Rule 3-
05(b)(2)(iv) will 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 percent for any
condition.\212\ In this way, the amendments clarify that ``individually
insignificant businesses'' include: (a) Any acquisition consummated
after the registrant's audited balance sheet date whose significance
does not exceed 20 percent; (b) Any probable acquisition whose
significance does not exceed 50 percent; and (c) Any consummated
acquisition whose significance exceeds 20 percent, but does not exceed
50 percent, for which financial statements are not yet required by Rule
3-05(b)(4) because of the 75-day filing period.\213\
---------------------------------------------------------------------------
\212\ For clarity, we specifically describe the affected
businesses in the final rule without reference to the term
``individually insignificant businesses.'' We also inserted ``for
any condition'' to clarify that the aggregation is done separately
for each condition (e.g. the investment, asset and income test);
that is, the conditions are not combined when assessing whether the
``exceeds 50 percent'' threshold is met.
\213\ This amendment is consistent with existing practice. See
FRM supra note 94 at Section 2035.2.
---------------------------------------------------------------------------
As proposed, the amended rule will require registrants to provide
pre-acquisition historical financial statements only for those
businesses whose individual significance exceeds 20 percent.\214\ In
conjunction with this change, the amended rule, also as proposed, will
require registrants to provide pro forma financial information
depicting the aggregate effects of all ``individually insignificant
businesses'' in all material respects.\215\ Further, we are revising
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
[[Page 54024]]
business are not included in the filing does not apply where the
aggregate impact is significant as determined by amended Rules 3-
05(b)(2)(iv) or 3-14(b)(2)(i)(C). While several commenters suggested
that this requirement could raise interpretive issues, we believe the
concept of materiality is well established in our rules, and we are not
persuaded at this time that additional guidance is necessary in order
for registrants to make this determination.
---------------------------------------------------------------------------
\214\ Registrants will 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 percent, but historical financial
statements only for acquisitions that will be required to be
reported on Form 8-K (i.e., individual significance exceeds 20
percent). The amendments could accelerate reporting of historical
financial statements for these acquisitions (i.e., individual
significance exceeds 20 percent) in certain registration statements
and proxy statements if the combined acquisitions exceed 50 percent
significance.
\215\ See amended Rule 3-05(b)(2)(iv) and revisions to Rule 11-
01(c).
---------------------------------------------------------------------------
After considering comments received, we are modifying the proposed
rule to require registrants to include both Rule 3-05 businesses and
Rule 3-14 real estate operations when determining the aggregate impact
of the Investment Test for individually insignificant acquisitions. We
are persuaded that such a modification is consistent with our objective
of aligning Rule 3-14 with Rule 3-05 because unique industry
considerations do not warrant differentiating Rule 3-05 businesses and
Rule 3-14 real estate operations, particularly as the modification will
apply only to registrants that acquire both Rule 3-05 businesses and
Rule 3-14 real estate operations. The final amendments limit this
modification to the Investment Test because the Asset Test and Income
Test do not apply to Rule 3-14 real estate operations.
Consistent with the existing requirement, \216\ we have modified
the proposed amendments to Rule 3-05 to indicate that, in determining
whether the Income Test condition (i.e. both the revenue component and
the net income component) exceeds 50 percent, the businesses specified
in Rule 3-05(b)(2)(iv) reporting losses must be aggregated separately
from those reporting income. We also have modified the rule to clarify
that if either group exceeds 50 percent, the disclosure requirements
apply to all of the businesses subject to the aggregate test and must
not be limited to either the businesses with losses or those with
income.
---------------------------------------------------------------------------
\216\ See Computational Note 1 to Rule 1-02(w). See also FRM
supra note 94 at Section 2035.5.
---------------------------------------------------------------------------
We acknowledge that, consistent with existing requirements, the
amended aggregate test applies to businesses acquired or to be acquired
subsequent to the most recently completed fiscal year. Because some of
those acquisitions may have already occurred upon the effective date of
the amended rules, we are persuaded that the concern expressed by some
commenters about the availability of information to comply with the
amended aggregate test necessitates transition guidance.\217\
---------------------------------------------------------------------------
\217\ See Section II.F.
---------------------------------------------------------------------------
Separately, we acknowledge concerns expressed as to whether
accountants will be able to provide negative assurance to underwriters
on the combined pro forma financial information where historical
financial statements included in the pro forma financial information
for individually insignificant acquisitions have not been reviewed or
audited. We recognize that, in some circumstances, accountants may need
to perform additional work to be able to provide negative assurance. We
also observe that the ``reasonable investigation'' and ``reasonable
care'' provisions of Sections 11 and 12 of the Securities Act are also
fact specific and depend on a variety of factors. Whether steps taken
to provide the required disclosures satisfy ``reasonable
investigation'' or ``reasonable care,'' or whether additional work is
needed to provide negative assurance, should be determined by
accountants and their clients based on facts and circumstances.
Although accountants and their clients may need to take additional
steps in certain circumstances, we believe those concerns are
outweighed by the need to improve the usefulness of information
provided to investors when the aggregate impact of the specified
acquired or to be acquired businesses exceed 50 percent, rather than
requiring audited financial statements that are not necessary to
reasonably inform investors or pro forma financial information that is
materially incomplete in its depiction of the aggregate impact.
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 for real estate operations warrant differentiated
disclosure. If a registrant has acquired or, in certain circumstances,
proposes to acquire one or more properties which in the aggregate are
significant, Rule 3-14 requires the registrant to file only abbreviated
income statements. If the real estate operation is not acquired from a
related party, audited Rule 3-14 Financial Statements are required for
only one year. In those circumstances where a registrant is permitted
to provide one year of financial statements, Rule 3-14 also requires a
registrant to describe with specificity the material factors it
considered in assessing the real estate operation.\218\
---------------------------------------------------------------------------
\218\ See Rules 3-14(a)(1)(ii) and 3-14(a)(1)(iii). The material
factors include 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. If the
registrant does not meet the Rule 3-14(a)(1) conditions, three years
of Rule 3-14 Financial Statements are required.
---------------------------------------------------------------------------
The Commission proposed to further align Rule 3-14 with Rule 3-05
where no unique industry considerations exist because the rules have
similar objectives. The Commission also proposed to clarify the
application of Rule 3-14 regarding scope of the requirements,\219\
determination of significance, need for interim income statements, and
special provisions for blind pool offerings.\220\
---------------------------------------------------------------------------
\219\ 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. Under existing
practice, registrants often provide 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. The proposal did not, and these
amendments do not, differentiate this type of acquisition or specify
alternatives to Rule 3-14 for this type of acquisition, 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. No commenters that commented on
this topic recommended that the Commission require audited financial
statements of the lessee or guarantor. See letters from EY, BDO, and
GT.
\220\ See Section II.C.6 below.
---------------------------------------------------------------------------
1. Align Rule 3-14 With Rule 3-05
Under the current rules, Rule 3-14 and Rule 3-05 diverge in a
number of areas. 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 percent significance threshold in the
definition of ``significant subsidiary'' in Rule 1-02(w) when
determining ``significance'' under Rule 3-14.\221\ Additionally, Rule
3-14 Financial Statements are currently required when the registrant
has acquired or proposes to acquire a group of properties that are
significant in the aggregate. In practice, consummated and probable
acquisitions since the date of the most recent audited balance sheet
that are less than 10 percent significant are aggregated and, if the
significance of the aggregated group exceeds 10 percent, Rule 3-14
Financial Statements are provided for each acquisition that is five
percent or more significant and for
[[Page 54025]]
enough other acquisitions in order to cover the substantial majority of
the group.\222\ Additionally, Rule 3-14 requires registrants to provide
three years of financial statements for significant acquisitions from
related parties.
---------------------------------------------------------------------------
\221\ See FRM supra note 94 at Section 2310.1 ``Registration
Statements and Proxy Statements--Requirements.''
\222\ See FRM supra note 94 at Section 2320.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed amendments to align Rule 3-14 with Rule 3-
05 where no unique industry considerations warranted differentiated
treatment. Specifically, the proposed amendments would have, among
other things:
Aligned thresholds in Rule 3-14 with the 20 percent
significance threshold and 50 percent aggregate impact significance
threshold in Rule 3-05;
Eliminated the Rule 3-14 requirement to provide three
years of Rule 3-14 Financial Statements for acquisitions from related
parties;
Applied Rule 3-06 to Rule 3-14 acquisitions;
Included the same timing requirements for Rule 3-14
Financial Statements in registration statements and proxy statements as
Rule 3-05; and
Permitted Rule 3-14 Financial Statements to be omitted
once the acquired real estate operation had been reflected in filed
post-acquisition registrant financial statements for a complete fiscal
year.
The Commission additionally proposed to align Rule 3-14 with the
relevant proposed Rule 3-05 amendments discussed in Sections II.A. and
II.B. above.
b. Comments
Commenters that specifically addressed Rule 3-14 generally
supported the proposals.\223\ However, some commenters noted that
proposed Rule 3-14(c)(2)(iii) would require that the notes to the Rule
3-14 Financial Statements include information about the real estate
operation's operating, investing and financing cash flows, to the
extent available, and questioned whether such historical information
would be comparable to proposed future operations and why such
disclosure should be required since Rule 3-14 Financial Statements
include only statements of revenues and expenses that may omit expenses
not comparable to proposed future operations.\224\
---------------------------------------------------------------------------
\223\ See, e.g., letters from Barnard, Cravath, BDO, CAQ,
Deloitte, EY, GT, KPMG, NAREIT, and RSM.
\224\ See letters from BDO, CAQ, and RSM.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments as proposed. As discussed in the
Proposing Release, we believe that further 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.\225\
---------------------------------------------------------------------------
\225\ See Section II.C.1 of the Proposing Release.
---------------------------------------------------------------------------
Specifically, we are adopting amendments as proposed regarding:
Significance Thresholds. We are aligning the Rule 3-14 significance
threshold for individual acquisitions to the 20 percent threshold for
acquired businesses in Rule 3-05.\226\ We are also aligning the Rule 3-
14 significance threshold for the aggregate impact of acquisitions to
the 50 percent threshold in Rule 3-05. Aligning Rule 3-14 with Rule 3-
05 will 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.
---------------------------------------------------------------------------
\226\ The Commission raised the threshold in Rule 3-05 from 10
percent to 20 percent 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 and to undertake private or
offshore offerings. See 1996 Streamlining Release supra note 24. As
a result of this amendment, the significance thresholds in Rule 3-05
have diverged from those used for Rule 3-14 since that time.
---------------------------------------------------------------------------
Years of Required Financial Statements for Acquisitions from
Related Parties.\227\ We are aligning Rule 3-14 with Rule 3-05 by
eliminating the specific requirement to provide three years of
financial statements for acquisitions from related parties. Rule 3-05
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, and we are not aware of any unique industry
considerations that warrant different requirements for Rule 3-14.
---------------------------------------------------------------------------
\227\ 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. These amendments will not affect those requirements.
---------------------------------------------------------------------------
Application of Rule 3-06. We are aligning 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. Existing
Rule 3-06(b) provides that financial statements required under Rule 3-
05 ``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,''
but it did not address acquired real estate operations under Rule 3-14.
Timing of filings. We are amending 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.\228\
---------------------------------------------------------------------------
\228\ See supra note 15 and accompanying text discussing the
Rule 3-05 filing period.
---------------------------------------------------------------------------
Omission of Rule 3-14 Financial Statements for Real Estate
Operations That Have Been Included in the Registrant's Financial
Statements. We are aligning the application of Rule 3-14 with the
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 nine months.\229\
---------------------------------------------------------------------------
\229\ See discussion of the omission of Rule 3-05 Financial
Statements in Section 1II.1B.3. above. The provision in Rule 3-05
regarding omission of financial statements for acquisitions
exceeding 40 percent significance is inapplicable in Rule 3-14.
---------------------------------------------------------------------------
Additional Amendments. We are making additional amendments, as
proposed, 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.
Many of these amendments will not affect how registrants currently
comply with Rule 3-14 because existing practice already analogizes to
Rule 3-05 for guidance. Specifically, we are clarifying that:
``To be acquired'' real estate operations must be
evaluated under the rule only if they are probable of acquisition;
\230\
---------------------------------------------------------------------------
\230\ 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 amendment codifies the current practice of
interpreting this phrase to mean ``probable of acquisition.'' See
FRM supra note 94 at Section 2310.1
---------------------------------------------------------------------------
[[Page 54026]]
The acquisition of an interest in a real estate operation
accounted for using the equity method \231\ or, in lieu of the equity
method, the fair value option, is considered the acquisition of a real
estate operation;
---------------------------------------------------------------------------
\231\ See FRM supra note 94 at Section 2305.4.
---------------------------------------------------------------------------
Rule 3-14 does not apply to a real estate operation that
is totally held by the registrant prior to consummation of the
transaction; \232\
---------------------------------------------------------------------------
\232\ See Rule 3-05(a)(4), as amended. See also Rule 1-02(y) for
the definition of the term ``totally held subsidiary.''
---------------------------------------------------------------------------
If registering an offering of securities to the security
holders of the real estate operation to be acquired, the financial
statements for the acquired real estate operation must cover the
periods specified in Rules 3-01 and 3-02, except as provided otherwise
for filings on Forms N-14, S-4 or F-4, and that the financial
statements covering those fiscal years must be audited except as
provided in Item 14 of Schedule 14A with respect to certain proxy
statements or in registration statements filed on Forms N-14, S-4, or
F-4; \233\
---------------------------------------------------------------------------
\233\ See Rule 3-05(b)(1), as amended.
---------------------------------------------------------------------------
Related real estate operations must be treated as a single
acquisition for significance testing; \234\ and
---------------------------------------------------------------------------
\234\ See Rules 3-05(a)(3) and 3-14(a)(3), as amended. 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.
---------------------------------------------------------------------------
Pro forma amounts are permitted for significance testing
in certain circumstances consistent with the application in Rule 3-
05.\235\
---------------------------------------------------------------------------
\235\ See Rules 3-05(b)(3) and 11-01(b)(3), as amended.
---------------------------------------------------------------------------
The amendments also 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.\236\ In addition, the amendments
conform the requirements related to acquisitions of foreign real estate
operations in Rule 3-14 to the analogous provisions in Rule 3-05.\237\
---------------------------------------------------------------------------
\236\ See Rules 3-05(a)(1), 3-05(b)(2), 3-14(a)(1), and 3-
14(b)(2), as amended.
\237\ See Rules 3-05(c) and 3-14(d), as amended, and Rules 3-
05(d) and 3-14(e).
---------------------------------------------------------------------------
Aside from the substance of the rules, the amendments also conform
the organization and format of certain related rules and forms, as
appropriate. We are amending Item 8 of Form 10-K which currently
excepts registrants from complying with Rule 3-05 and Article 11, to
include Rule 3-14,\238\ instead of retaining the exception in Rule 3-14
itself. We are also conforming 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.\239\
---------------------------------------------------------------------------
\238\ See Item 8(a) of Form 10-K.
\239\ The changes in Rule 3-14 to conform wording include the
addition of a paragraph similar to amended Rule 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 (3), which specify
certain disclosures for circumstances that seldom occur today. We
are also eliminating the Instruction in Item 9 of Form S-11, which
refers back to the guidance in paragraphs (a)(2) and (3) of Rule 3-
14.
---------------------------------------------------------------------------
Finally, we are also revising Form 8-K to:
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; \240\
---------------------------------------------------------------------------
\240\ While Item 2.01 currently only requires that significant
acquisitions and dispositions be reported if they are not in the
ordinary course of business, in practice 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 94 at
Section 2310.3.
---------------------------------------------------------------------------
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.
Also, as proposed, we are adopting amendments to conform Rule 3-14
to the Rule 3-05 amendments being adopted in this release where no
unique industry considerations exist. Specifically, we are amending
Rule 3-14 to conform to the amendments described in Section II.A.1.c
(Investment Test only), Section II.A.3.c (related only to certain
required footnote disclosures),\241\ Section II.A.5.c, Section
II.A.6.c, Section II.B.1.c (excluding the requirement related to
acquisitions that exceed 40 percent significance, which does not apply
to Rule 3-14), Section II.B.2.c and Section II.B.3.c.
---------------------------------------------------------------------------
\241\ The footnote disclosure to provide an explanation of the
impracticability of preparing financial statements that include the
omitted expenses is not applicable to Rule 3-14 Financial Statements
because Rule 3-14 does not contain an impracticability condition.
See note 12. With respect to the footnote disclosure related to
historical cash flows, we acknowledge, as observed by some
commenters, that certain historical cash flows of a real estate
operation may not be comparable to proposed future operations.
However, we believe that there is also cash flow information that
would be meaningful to investors if available, for example,
disclosure regarding historical cash flows for capital improvements.
We are, therefore, adopting this requirement as proposed.
---------------------------------------------------------------------------
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 these terms.\242\ 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,\243\ 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.\244\ 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.\245\
---------------------------------------------------------------------------
\242\ See FRM supra note 94 at Section 2305.1 ``Applicability of
S-X 3-14,'' and Section 2305.2, ``Nature of Real Estate
Operations.''
\243\ See FRM supra note 94 at Section 2305.2.
\244\ Examples of such properties include office, apartment, and
industrial buildings, as well as 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.
\245\ See FRM supra note 94 at Section 2305.3 ``Investment in a
Pre-Existing Legal Entity.''
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed 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 and staff interpretations \246\ and to remove the
unnecessary condition in Rule 11-01(a)(5) that clarifies that Article
11 applies to real estate operations.
---------------------------------------------------------------------------
\246\ The proposed amendment used 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 through an entity holding real property under lease
or of a direct interest in the real property. See proposed Rule 3-
14(a)(2).
---------------------------------------------------------------------------
b. Comments
We received limited comment specific to the proposed definition of
real estate
[[Page 54027]]
operations. Two commenters explicitly supported the definition, and no
commenters opposed it.\247\ One of these commenters recommended adding
``or substantially all the assets of which are held for lease'' in
order to include real property that is not currently leased, but is
being acquired with the intention of leasing and has more than a
nominal leasing history.\248\ This commenter further recommended
amending Rule 11-01(d) to clarify that there is a presumption that real
property that is leased or held for lease to third parties constitutes
a business. In addition, the same commenter recommended that we
consider explicitly addressing real properties that have a limited
leasing history or leasing history that is unrepresentative of expected
future operations.\249\ Another commenter recommended the Commission
further clarify the meaning of ``substantially all.'' \250\
---------------------------------------------------------------------------
\247\ See letter from Cravath and NAREIT.
\248\ See letter from NAREIT.
\249\ See letter from NAREIT. See also FRM supra note 94 at
Section 2330.8 ``Rental History of Less Than Nine Months,'' Section
2330.9, ``Exception for Demolition'' and Section 2330.10 ``Exception
for Properties with No or Nominal Leasing History'' for related
staff guidance.
\250\ See letter from GT.
---------------------------------------------------------------------------
c. Final Amendments
We are amending Rule 3-14 to define a real estate operation as
proposed as ``a business that generates substantially all of its
revenues through the leasing of real property.'' We considered
clarifying what is meant by ``substantially all'' in this context, as
one commenter suggested. However, this term is not meant to be a bright
line, and its application will depend on specific facts and
circumstances. Accordingly, we are not making any changes in this
regard.
We also considered whether additional language is necessary to
address an acquisition of real property that is not leased and
generating revenues upon acquisition, but was historically leased and
is intended to be leased again in the near future. However, we do not
believe that the definition, as proposed, requires any changes, because
in these circumstances a registrant should consider whether the lack of
revenues at acquisition may be unrepresentative based on the existence
of a leasing history and the expected continuation of the leasing
operation, and thus could still conclude that it is a business that
generates substantially all of its revenues through the leasing of real
property. We also considered whether we should add language to address
acquisitions of real property with a limited leasing history or a
leasing history that is unrepresentative of expected future operations.
However, we believe those situations are best addressed through Rule 3-
13.\251\
---------------------------------------------------------------------------
\251\ See Rule 3-13 supra note 58.
---------------------------------------------------------------------------
We believe the definition we are adopting appropriately frames the
application of Rule 3-14, reduces uncertainty regarding the meaning of
the term, and serves to clarify the rule without changing the substance
of how it is currently applied. In light of the adopted definition that
clarifies that a real estate operation is a ``business'' as that term
is used in Article 11, we are removing the condition in Rule 11-
01(a)(5) as it is no longer necessary.\252\
---------------------------------------------------------------------------
\252\ We considered whether Rule 11-01(d) should include a
presumption that real property that is leased or held for lease is a
business, but we believe it is more appropriate for registrants to
evaluate for each acquisition the facts and circumstances included
in the rule to determine if it constitutes a business.
---------------------------------------------------------------------------
3. Significance Tests
As noted above, Rule 3-14 does not provide explicit guidance on how
to determine whether a real estate operation is significant. 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 and its other subsidiaries' ``investments in''
\253\ 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 when determining
``significance'' under Rule 3-14.\254\ 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.\255\
---------------------------------------------------------------------------
\253\ See supra note 53.
\254\ See FRM supra note 94 at Section 2315 ``Real Estate
Operations--Measuring Significance.''
\255\ 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.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to amend Rule 3-14 to specify that
significance should be based on the Investment Test in Rule 1-02(w).
Thus, consistent with the proposed amendments for Rule 3-05
acquisitions discussed above, the Commission proposed to require
comparison with the registrant's aggregate worldwide market value. If
aggregate worldwide market value is not available, then the Investment
Test would be based on total assets. When the test is based on total
assets for real estate acquisitions, the Commission also proposed to
modify the investment amount to include any debt secured by the real
properties that is assumed by the registrant.
b. Comments
We received limited comment addressing the significance tests as
they relate to real estate operations.\256\ One commenter recommended
allowing registrants that do not have an aggregate worldwide market
value (such as non-traded REITs) to use net asset value of their common
equity as the denominator for the Investment Test.\257\
---------------------------------------------------------------------------
\256\ See e.g., letter from EY.
\257\ See letter from EY. This commenter further recommended
that, if such a registrant is not permitted to use net asset value,
the numerator should be limited to the consideration transferred and
exclude any debt assumed by the buyer.
---------------------------------------------------------------------------
c. Final Amendments
We are amending Rule 3-14(b)(2) as proposed to require use of the
Investment Test in Rule 1-02(w).\258\ We believe this amendment will
reduce uncertainty regarding the significance tests and clarify the
rule without changing the substance of how it is currently applied.
When based on total assets, the final amendments specify, as proposed,
that the test should be adapted to compare the registrant's and its
other subsidiaries' ``investments in'' \259\ the real estate operation,
including any debt secured by the real properties that is assumed by
the registrant, to the registrant's total assets as of the end of the
most recently completed fiscal year. We believe a modified Investment
Test is necessary to appropriately determine significance for
acquisitions of real estate operations because it takes into
consideration 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.
---------------------------------------------------------------------------
\258\ We are not adopting amendments to permit non-traded REITs
to use net asset value instead of aggregate worldwide market value
due to the potential application complexities; however, we are
adopting the modified investment test addressed in Section II.C.6.,
below, for blind pool offerings that will be applicable to non-
traded REITs.
\259\ See supra note 53.
---------------------------------------------------------------------------
[[Page 54028]]
4. Interim Financial Statements
Unlike Rule 3-05,\260\ 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.\261\ Article 11
further provides that the pro forma condensed statement of
comprehensive income must 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.\262\ As a result of Article
11 and related staff interpretations, existing registrant practice is
to provide interim financial statements for acquisitions of real estate
operations.\263\
---------------------------------------------------------------------------
\260\ See Rule 3-05(b)(2)(i) through (iv). The rule refers
explicitly to the most recent fiscal year and any interim periods
specified in Rules 3-01 and 3-02.
\261\ See Rule 11-01.
\262\ See Rule 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.
\263\ See Rule 11-02(c)(2)(i) and FRM supra note 94 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.''
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed 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.
b. Comments and Final Amendments
We received no comments specifically related to this proposal, so
we are adopting the amendment to Rule 3-14(b)(2)(i) as proposed.\264\
---------------------------------------------------------------------------
\264\ See Section II.C.4 of the Proposing Release.
---------------------------------------------------------------------------
5. Smaller Reporting Companies and Issuers Relying on Regulation A
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 issuer
relying on Regulation A to present financial statements of real estate
operations acquired or to be acquired as specified by Rule 8-06.\265\
---------------------------------------------------------------------------
\265\ See paragraph (b)(7)(v) of Part F/S. Part F/S of Form 1-A
permits the periods presented to be the shorter of those applicable
to issuers relying on Regulation A and the periods specified by
Article 8.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed amendments to Article 8 to further simplify
and conform the application of Rule 3-14 and our related proposals to
smaller reporting companies.
b. Comments
None of the commenters that provided comments related to smaller
reporting companies and smaller issuers commented on the proposed
amendments to Rule 3-14.
c. Final Amendments
We are amending Rule 8-06 as proposed to direct registrants to Rule
3-14 for the requirements relating to financial statement disclosures
of real estate operations acquired or to be acquired,\266\ 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. Rule 8-06 as amended will newly require smaller reporting
companies to combine the discussion of material factors that they
considered in assessing the acquisition with the disclosure required by
Item 15 of Form S-11 when financial statements are presented in Form S-
11.\267\ We are also adding a reference to Rule 8-06 in Rule 3-06 to
conform the requirements of Rule 8-06 and Rule 3-14 and adding Rule 8-
01(f) 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.\268\
---------------------------------------------------------------------------
\266\ We are also amending the instruction in Item 9.01 of Form
8-K to include references to Rule 8-06 in order to conform the
instruction to the text of Item 9.01, which already addresses the
rules applicable to smaller reporting companies.
\267\ See Instruction to Paragraph (f) in Rule 3-14. Since Item
15 of Form S-11 already applies to smaller reporting companies, the
Instruction changes only the location of the discussion.
\268\ See Rule 8-01(f) and the discussion related to Rule 3-06
in Section II.C.1 above.
---------------------------------------------------------------------------
Additionally, because Part F/S of Form 1-A refers to Rule 8-06, the
revisions to Rule 8-06 apply to issuers relying on Regulation A. As
discussed in the Proposing Release, we believe these amendments will
simplify these rules and reduce burdens for smaller reporting companies
and issuers relying on Regulation A.\269\
---------------------------------------------------------------------------
\269\ See Section II.C.5 of the Proposing Release.
---------------------------------------------------------------------------
6. Blind Pool Real Estate Offerings
Certain registrants, typically non-traded real estate investment
trusts (``REITs''),\270\ that conduct continuous offerings over an
extended period of time follow the disclosure guidance provided under
Industry Guide 5 Preparation of Registration Statements Relating to
Interests in Real Estate Limited Partnerships (``Industry Guide
5'').\271\ 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 \272\ to disclose information
about significant acquisitions to investors in addition to Rule 3-14
Financial Statements.
---------------------------------------------------------------------------
\270\ Non-traded REITs do not have securities listed for trading
on a national securities exchange. Their purpose is to own and
operate income-producing real estate or real estate-related assets.
\271\ 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)]. 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)].
\272\ 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 94 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.
---------------------------------------------------------------------------
Due to the nature of a blind pool investment as well as the
supplemental undertakings provided, these registrants typically apply
adapted significance tests when making the determination of whether
they are required to provide Rule 3-14 Financial Statements.\273\
Commission staff has interpreted significance during the distribution
period to be computed by comparing the registrant's and its other
subsidiaries' ``investments in'' \274\ 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.\275\
[[Page 54029]]
After the distribution period has ended, the registrant determines
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.\276\
---------------------------------------------------------------------------
\273\ 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.
\274\ See supra note 53.
\275\ See FRM supra note 94 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.
\276\ See FRM supra note 94 at Section 2325.5 ```Blind Pool''
Offerings--After the Distribution Period.''
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed amendments to codify existing staff
guidance by specifying that significance for blind pool offerings must
be computed by comparing the registrant's and its other subsidiaries'
``investments 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.
b. Comments
Commenters generally supported the proposed amendments.\277\ These
commenters, however, recommended that, for registrants conducting blind
pool offerings, the Commission extend the accommodations to
acquisitions within the scope of Rule 3-05.\278\ In support of this
change, one commenter noted that staff guidance and Guide 5 do not
distinguish between acquisitions of real estate and other operations
with regards to the expected reporting of undertakings.\279\
---------------------------------------------------------------------------
\277\ See letters from BDO, CAQ, DT, EY, GT, NAREIT, PWC, and
RSM.
\278\ See id.
\279\ See letter from NAREIT.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments as proposed, but with modifications
after considering comments received. We are codifying staff
interpretations in this area to provide that significance for blind
pool offerings must be computed by comparing the registrant's and its
other subsidiaries' ``investments 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 as more fully described above. Without this accommodation,
virtually all acquisitions in the early part of the distribution period
would be deemed significant regardless of their size.
We are also adopting amendments, as suggested by commenters, to
extend the adapted significance test to Rule 3-05 acquisitions by
registrants in blind pool offerings because the accommodation is based
on the unique characteristics of the offering and registrants, rather
than the type of acquisition.
In light of the extension of the accommodation to Rule 3-05
acquisitions, we revised the location of these amendments for blind
pool offerings to Rule 11-01(b), which addresses how to determine
significance for both Rule 3-05 acquisitions and Rule 3-14
acquisitions.\280\
---------------------------------------------------------------------------
\280\ See Rule 11-01(b)(4). Rules 3-05 and 3-14 were also
revised to refer to new Rule 11-01(b)(4).
---------------------------------------------------------------------------
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
percent and 10 percent significance thresholds under Rule 3-05 and Rule
3-14, respectively.\281\ The rules also require pro forma financial
information for a significant disposed business at a 10 percent
significance threshold for all registrants.
---------------------------------------------------------------------------
\281\ See 1996 Streamlining Release supra note 24.
---------------------------------------------------------------------------
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.\282\ The rules call for pro forma financial information to
show the impact of the transaction on income from continuing operations
of the registrant.\283\
---------------------------------------------------------------------------
\282\ 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.''
\283\ Discontinued operations would not be reflected in the
condensed historical financial statements used as the starting point
for the pro forma presentation.
---------------------------------------------------------------------------
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.\284\
---------------------------------------------------------------------------
\284\ See Rule 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.
a. Proposed Amendments
The Commission proposed to revise Article 11 by replacing the
existing pro forma adjustment criteria with simplified requirements to
depict the accounting for the transaction (``Transaction Accounting
Adjustments'') \285\ and present the
[[Page 54030]]
reasonably estimable synergies and other transaction effects that have
occurred or are reasonably expected to occur (Management's
Adjustments'').\286\ In addition, the Commission proposed other changes
to simplify and clarify Article 11 and to provide more consistent use
of terminology. The Commission proposed these changes because the
existing pro forma adjustment criteria are not clearly defined, can
yield inconsistent presentations for similar fact patterns, and
preclude the inclusion of adjustments for the potential effects of
post-acquisition actions expected to be taken by management.
---------------------------------------------------------------------------
\285\ Under the proposed rule, 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, 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. 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.
Under the proposed rule, 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).
\286\ Under the proposed rule, 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. However, if the
registrant previously was a part of another entity and presentation
of pro forma financial information was necessary to reflect the
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. For example, where a company (the
registrant) operates as a subsidiary of another entity and files a
registration statement under the Securities Act 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. The proposed rule also included
presentation requirements for Management's Adjustments, requiring
that they be presented through a separate column in the pro forma
financial information after the presentation of the combined
historical statements and Transaction Accounting Adjustments. 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, the
proposed rules would require 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. Further, the
proposed rule would include specific disclosures for each
Management's Adjustments including: 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. For synergies and other transaction effects that
are not reasonably estimable and will not be included in
Management's Adjustments, the proposed rule would require that
qualitative information necessary for a fair and balanced
presentation of the pro forma financial information also be
provided.
---------------------------------------------------------------------------
b. Comments
While commenters were generally supportive of replacing the
existing pro forma adjustment criteria with the proposed Transaction
Accounting Adjustments,\287\ one commenter recommended retaining the
existing methodology.\288\ Several commenters recommended changes or
sought clarification regarding the application of the rules to
Transaction Accounting Adjustments.\289\ However, most of the comments
received relating to pro forma financial information were focused on
Management's Adjustments. Commenters were mixed in their support \290\
or opposition \291\ to the proposed Management's Adjustments depicting
synergies and other transaction effects.
---------------------------------------------------------------------------
\287\ See letters from Ball, Davis Polk, DT, FEI, New York City
Bar Association, Committee on Mergers and Acquisitions (``NYCBA-
M&A''), Pfizer, and SIFMA. One of these commenters noted that under
the existing rules, pro forma financial statements can be difficult
for registrants to prepare and are among the most prolific sources
of questions for the staff. See letter from NYCBA-M&A.
\288\ See letter from Cravath. Cravath indicated that it does
not believe that there is significant confusion among preparers of
financial information or investors with respect to the current
Article 11 pro forma adjustment methodology, including using the
current ``continuing impact'' criterion, or the benefits and
limitations of such disclosure. However, Cravath also indicated that
it had significant concerns regarding the proposal to require
Management's Adjustments and opposed the inclusion of such a
requirement in the final rules. Accordingly, Cravath recommended
retaining the existing methodology.
\289\ See, e.g., letters from BDO, Davis Polk, DT, and FEI. For
example, one of these commenters recommended the final rule permit
the inclusion of pro forma adjustments for additional events that
are directly related to the transaction, (e.g. adjusting for the
effects of additional financing necessary to complete the
acquisition). See letter from FEI. Another commenter recommended
continuing to exclude nonrecurring items from the pro forma
statement of comprehensive income and providing clarity about how to
define non-recurring items. See letter from Davis Polk.
\290\ See, e.g., letters from Allstate, Ball, CFA, Davis Polk,
IMA, MTBC, and PWC.
\291\ See, e.g., letters from Cravath, Eli Lilly, FEI, GT,
Nasdaq, NYCBA-M&A, Pfizer, SIFMA, Shearman, and Williams. See also
SBCFAC Recommendations, recommending that ``the proposed amendments
to the pro forma financial information requirements with respect to
whether the proposed addition of Management's Adjustments, which are
intended to reflect reasonably estimable synergies and transaction
effects, should be optional or not required at all.''
---------------------------------------------------------------------------
Many commenters recommended against including the proposed
Management's Adjustments in pro forma financial statement
requirements.\292\ Some of these commenters suggested that pro forma
financial information is an inapt means for communicating the
anticipated synergies from a transaction.\293\ These commenters also
expressed concerns relating to: The inherent uncertainty/subjectivity
of synergy expectations; the burden of preparing the disclosure; the
potential liability; the risk of synergy disclosure changing over time
and confusing or misleading investors; and other unintended
consequences.\294\ In contrast, commenters supportive of the
requirement indicated that the proposed Management's Adjustments would
provide investors insight into the potential effects of the acquisition
and post-acquisition plans expected to be taken by management \295\ and
provide greater flexibility for management to include forward-looking
information and provide investors with insight into their decision to
enter into the transaction.\296\
---------------------------------------------------------------------------
\292\ See, e.g., letters from Eli Lilly, Liberty, NYCBA-M&A,
NYCBA--Sec., Pfizer, S&C, and SIFMA. See also SBCFAC
Recommendations.
\293\ See, e.g., letters from S&C and NYCBA-M&A.
\294\ See, e.g., letters from Cravath, Debevoise, Eli Lilly,
FEI, GT, KPMG, Liberty, Nasdaq, NYCBA-M&A, Pfizer, S&C, SIFMA,
Shearman, and Williams. Some of these commenters further suggested
the reasonably expected synergy disclosure requirement could, among
other things, result in premature disclosure of sensitive
information that could affect important relationships with
stakeholders, impact boards of directors, auditors, and
underwriters, and have a chilling effect on disclosure. See, e.g.,
letters from FEI and Pfizer.
\295\ See, e.g., letters from Ball, CFA, IMA, and PWC. One of
these commenters supported inclusion of the disclosure because, in
the commenter's view, the information provided to investors in
connection with marketing the deal should be consistent with, if not
reconciled to, management projections provided to the board and
shareholders, or the projections provided to financial advisors in
connection with the fairness opinion. See letter from CFA.
\296\ See, e.g., letters from Ball and CAQ.
---------------------------------------------------------------------------
Many commenters, whether supportive of or opposed to the proposed
requirements, recommended that the Commission provide additional
guidance or clarification about their application, particularly with
respect to the proposed Management's Adjustments.\297\ Commenters
recommended that the Commission provide examples of synergies and other
transaction effects and the treatment of nonrecurring costs to achieve
them.\298\ Commenters also requested other implementation guidance,
such as guidance on: The criteria for determining ``reasonably
estimable'' and the permissible range; the timing parameters relating
to realization and ``reasonably expected'' to occur; what would
constitute a ``fair and balanced presentation''; the relationship
between
[[Page 54031]]
Management's Adjustments on the pro forma statements of comprehensive
income and those on the balance sheet; updating requirements for
Management's Adjustments in subsequent filings; the presentation of
multiple transactions; and treatment of overlap between Transaction
Accounting Adjustments and Management's Adjustments.\299\
---------------------------------------------------------------------------
\297\ See, e.g., letters from DT, Liberty, Pfizer, and PWC.
\298\ See, e.g., letters from BDO, CAQ, Crowe, Davis Polk, DT,
EY, GT, KPMG, PWC, and RSM.
\299\ See, e.g., letters from BDO, CFA, Crowe, Debevoise, DT,
EY, FEI, GT, IMA, KPMG, RSM, and S&C.
---------------------------------------------------------------------------
Some commenters that expressed concern relating to liability for
the disclosure sought by the proposed amendments supported the
application of the forward-looking information safe harbors under 17
CFR 230.175 (``Securities Act Rule 175'') and 17 CFR 240.3b-6
(``Exchange Act Rule 3b-6''),\300\ while other commenters recommended
further protections, such as a safe harbor for forward-looking
information similar to that found in the Private Securities Litigation
Reform Act safe harbor,\301\ permitting Article 11 information to be
``furnished'' rather than ``filed,'' \302\ or an exception or safe
harbor for cases where synergies are not a material element of the
transaction.\303\
---------------------------------------------------------------------------
\300\ See letters from Allstate, CFA, Cravath, Debevoise, PWC,
and SIFMA. One of these commenters recommended that the final rules
expressly provide a safe harbor for forward-looking information and
that it include express language that the safe harbors apply to any
pro forma financial information that includes both historical and
forward-looking information. This commenter also expressed concern
that the proposed requirement to provide qualitative information
necessary for a fair and balanced presentation of the pro forma
financial information when synergies and other transaction effects
would not be included in Management's Adjustments because they are
not reasonably estimable represented a new disclosure liability
standard. See letter from Cravath.
\301\ See letter from Davis Polk.
\302\ See letter from S&C.
\303\ See letter from NYCBA--M&A.
---------------------------------------------------------------------------
Several commenters recommended the Commission consider whether such
disclosure should be optional.\304\ Other commenters recommended other
ways to limit the proposed Management's Adjustments disclosure
requirements while still providing useful information.\305\ For
example, two commenters recommended limiting the requirement to
narrative disclosure of synergies information in transactions where the
information has otherwise been publicly disclosed.\306\ Another
commenter recommended comprehensive disclosure in the footnotes of the
related non-recurring costs and anticipated timing of the run-rate
synergies.\307\
---------------------------------------------------------------------------
\304\ See, e.g., letters from BDO, Cravath, EY, and Williams.
One of these commenters suggested that if Management's Adjustments
were optional they could be removed from the pro forma financial
information and underwriters could receive customary comfort as part
of their due diligence process. See letter from BDO. Another
commenter recommended the disclosure be optional or not required for
smaller reporting companies. See SBCFAC Recommendations.
\305\ See, e.g., letters from Davis Polk, FEI, and S&C.
\306\ See letters from Cravath and S&C.
\307\ See letter from Davis Polk.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments with modifications after considering
comments received. We are amending Article 11, as proposed, by
replacing the existing pro forma adjustment criteria with simplified
requirements to depict the accounting for the transaction and to
provide the option to depict synergies and dis-synergies of the
acquisitions and dispositions for which pro forma effect is being
given. We also are adopting, as proposed, other changes to simplify and
clarify Article 11 and use terminology more consistently.\308\
Additionally, we are, as proposed, deleting existing Rule 11-02(a),
which describes the objectives of the preparation requirements, to
avoid confusion and focus registrants on the requirements of the rule.
---------------------------------------------------------------------------
\308\ Specifically, we are amending Article 11, as proposed, to
refer to ``pro forma financial information,'' ``potential common
stock'' as defined in U.S. GAAP, and ``pro forma basic'' per share
data throughout, as well as amending existing 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 because that amount is used to
calculate earnings per share under U.S. GAAP. See amended Rule 11-
02(a)(5). We are also, as proposed, amending existing Rule 11-
01(a)(8) to remove the reference to other ``events'' as the concept
of other events is encompassed by the reference to ``other
transactions'' and amending existing Rule 11-02(b)(2) to refer to
``each transaction for which pro forma effect is being given'' in
recognition that the information may be required to give effect to
more than one transaction. See amended Rules 11-01(a)(8) and 11-
02(a)(2).
---------------------------------------------------------------------------
The revised pro forma adjustment criteria we are adopting are
broken out into three categories:
(i) ``Transaction Accounting Adjustments;''
(ii) ``Autonomous Entity Adjustments;'' and
(iii) ``Management's Adjustments.'' \309\
---------------------------------------------------------------------------
\309\ As proposed, the amendments: (i) 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 is superseded by the
requirements for Transaction Accounting Adjustments and Autonomous
Entity Adjustments; (ii) Eliminate Instruction 3 regarding business
dispositions as it is no longer necessary given the adoption of
proposed Rules 11-02(a)(4), 11-02(a)(6), and 11-02(b)(3); (iii)
Incorporate the substance of Instruction 1, using income from
continuing operations, into amended Rule11-02(b)(1) and Instruction
2 guidance on financial institutions into amended Rule 11-02(b)(2);
(iv) 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 must be presented in separate columns; and (v) Add new Rule
11-02(b)(5) to replace Instruction 7 to Rule 11-02(b), which will
codify 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.
The Transaction Accounting Adjustments reflect only the application of
required accounting to the acquisition, disposition, or other
transaction linking the effects of the acquired business to the
registrant's audited historical financial statements. Autonomous Entity
Adjustments are adjustments necessary to reflect the operations and
financial position of the registrant as an autonomous entity when the
registrant was previously part of another entity. Management's
Adjustments provide both flexibility to registrants to include forward-
looking information that depicts the synergies and dis-synergies
identified by management in determining to consummate or integrate the
transaction for which pro forma effect is being given and insight to
investors into the potential effects of the acquisition and the post-
acquisition plans expected to be taken by management. Under the final
amendments, Transaction Accounting Adjustments and Autonomous Entity
Adjustments are required adjustments. Management's Adjustments, as
discussed further below, are optional under the final amendments.
Transaction Accounting Adjustments and Autonomous Entity Adjustments
We are adopting the Transaction Accounting Adjustments, as
proposed, in amended Rule 11-02(a)(6)(i) to require registrants to
depict: (1) In the pro forma condensed balance sheet the accounting for
the transaction required by U.S. GAAP or IFRS-IASB, as applicable,\310\
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.\311\ Consistent
with the proposal, the amendment indicates that if the condition in
Rule 11-01(a) that is met does not have a balance sheet effect, then
the Transaction Accounting Adjustments to the pro forma statement
[[Page 54032]]
of comprehensive income should depict the accounting for the
transaction required by U.S. GAAP or IFRS-IASB, as applicable. Further,
in a modification from the proposal made in response to comments, the
amendments clarify that pro forma statement of comprehensive income
``adjustments must be made whether or not the pro forma balance sheet
is presented pursuant to paragraph (c)(1) of this section.''
---------------------------------------------------------------------------
\310\ Transaction Accounting Adjustments are 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 is as of the most
recent practicable date prior to the effective date (for
registration statements) or the mailing date (for proxy statements).
\311\ See Rule 11-02(a)(6)(i)(B).
---------------------------------------------------------------------------
In order to effect the changes described below to our Management's
Adjustments proposal, the requirement to show the registrant as an
autonomous entity if the condition in Rule 11-01(a)(7) is met has been
relabeled as ``Autonomous Entity Adjustments'' and relocated from the
subparagraph concerning Management's Adjustments to Rule 11-
02(a)(6)(ii) to clarify that such adjustments are required when the
condition for their presentation is met and that they must be presented
in a separate column from Transaction Accounting Adjustments.\312\
---------------------------------------------------------------------------
\312\ We believe this requirement is appropriate given the
different purposes for which Transaction Accounting Adjustments and
Autonomous Entity Adjustments are used. It will also facilitate
compliance with the requirements for determining significance of
acquisitions and dispositions using pro forma financial information,
which as proposed will only include Transaction Accounting
Adjustments. See Rule 11-01(b)(3)(i)(B).
---------------------------------------------------------------------------
As proposed, the amendments will require that historical and pro
forma per share data must be presented on the face of the pro forma
condensed statement of comprehensive income and give effect to
Transaction Accounting Adjustments. However, in a further modification
from the proposal \313\ to effect the changes described below to our
Management's Adjustment proposal, the amendments require that such pro
forma per share data also give effect to Autonomous Entity
Adjustments.\314\ We believe that including all adjustments required by
our amendments to be presented on the face of the pro forma financial
information, whether deemed recurring or nonrecurring by a registrant's
management, will help achieve consistency in the application of our pro
forma requirements and simplify compliance. This requirement, coupled
with the requirement to disclose revenues, expenses, gains and losses
and related tax effects that will not recur in the income of the
registrant beyond 12 months after the transaction, will also enhance
transparency.
---------------------------------------------------------------------------
\313\ We do not believe it is necessary, as some commenters
suggested, to modify our proposal to permit the inclusion of pro
forma adjustments for additional events that are directly related to
the transaction (e.g. adjusting for the effects of additional
financing necessary to complete the acquisition) because Rule 11-
01(a)(8) requires giving pro forma effect when consummation of other
transactions has occurred or is probable for which disclosure of pro
forma financial information would be material to investors.
\314\ We were not persuaded by the suggestion to further modify
our proposal to permit exclusion of nonrecurring items from the pro
forma statement of comprehensive income or to define non-recurring
items.
---------------------------------------------------------------------------
Management's Adjustments
We agree with commenters that providing forward-looking
information, subject to appropriate safe harbors, about synergies and
related-transaction effects contemplated by the board and management in
determining to execute the acquisition or disposition of a business
would provide useful information for understanding the effects of the
transaction. However, having considered the comments received, we are
persuaded that the line-item specificity and the one year time horizon
presented in our proposed pro forma requirements is not necessarily
consistent with the manner in which synergy estimates are made and that
not all transactions attach the same level of importance to synergies
as a rationale for choosing to pursue the transaction. We are further
persuaded that there may be different levels of confidence about
different types of synergies and transaction effects and that
disclosure requirements should be crafted with appropriate flexibility
to permit management to depict full run-rate synergies and the
nonrecurring costs to achieve them if, and in a manner, they deem
appropriate. For example, we believe cost synergies should be permitted
to be presented without revenue synergies provided that they
incorporate related dis-synergies and the related disclosure describes
the nature, uncertainties, and limitations of the amounts presented and
the time-frames and uncertainties inherent in achieving them. We also
believe such disclosure should be linked to pro forma financial
information as a means to more fully demonstrate how historical amounts
could change based on the transaction.
After considering comments received on the proposals, we are
modifying the amendments to provide that Management's Adjustments
depicting synergies and dis-synergies of the acquisitions and
dispositions for which pro forma financial information is being given
may, in the registrant's discretion, be presented if in its
management's opinion, such adjustments would enhance an understanding
of the pro forma effects of the transaction.\315\ We encourage
registrants to provide Management's Adjustments in these circumstances
when certain additional conditions are met. Because under the final
amendments the presentation of Management's Adjustments is optional, we
are modifying the proposed rules such that, in order to present
Management's Adjustments, certain conditions related to the basis for
Management's Adjustments and the form of presentation must be met.
These amendments are intended to ensure that if Management's
Adjustments are presented, they are done so consistently and in a
manner that would not be misleading to investors. Specifically, as
modified, the Basis for Management's Adjustments in Rule 11-02(a)(7)(i)
requires as conditions for presenting Management's Adjustments that:
---------------------------------------------------------------------------
\315\ See Rule 11-02(a)(7).
---------------------------------------------------------------------------
There is a reasonable basis for each such adjustment;
The adjustments are limited to the effect of such
synergies and dis-synergies on the historical financial statements that
form the basis for the pro forma statement of comprehensive income as
if the synergies and dis-synergies existed as of the beginning of the
fiscal year presented. If such adjustments reduce expenses, the
reduction shall not exceed the amount of the related expense
historically incurred during the pro forma period presented; and
The pro forma financial information reflects all
Management's Adjustments that are, in the opinion of management,
necessary to a fair statement of the pro forma financial information
presented and a statement to that effect is disclosed. When synergies
are presented, any related dis-synergies shall also be presented.
Further, as modified, the Form of Presentation in Rule 11-
02(a)(7)(ii) requires as additional conditions for presenting
Management's Adjustments that:
If presented, Management's Adjustments must be presented
in the explanatory notes to the pro forma financial information in the
form of reconciliations of pro forma net income from continuing
operations attributable to the controlling interest and the related pro
forma earnings per share data to such amounts after giving effect to
Management's Adjustments.
If presented, Management's Adjustments included or
incorporated by reference into a registration statement, proxy
statement, offering statement or Form 8-K should be as of the most
recent practicable date prior to the effective date, mail date,
qualified date, or filing date as applicable, which may require that
they be updated if previously provided in a Form 8-K that
[[Page 54033]]
is appropriately incorporated by reference.
If Management's Adjustments will change the number of
shares or potential common shares, the change must be reflected within
Management's Adjustments 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.
The explanatory notes must also include disclosure of the
basis for and material limitations of each Management's Adjustment,
including any material assumptions or uncertainties of such adjustment,
an explanation of the method of the calculation of the adjustment, if
material, and the estimated time frame for achieving the synergies and
dis-synergies of such adjustment.\316\
---------------------------------------------------------------------------
\316\ See Rule 11-02(a)(11)(iii).
---------------------------------------------------------------------------
We believe these requirements are necessary to better enable an
investor to understand Management's Adjustments being made in the pro
forma financial information and that this presentation will clearly
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 and other uncertainties.
Some commenters cited similarities between pro forma Management's
Adjustments and projections. While we believe they are distinct,
because Management's Adjustments may include measures that require
similar judgments to projections, we have looked to the Commission's
policy statement on projections in developing a framework for optional
disclosure of Management's Adjustments.\317\ Specifically, the amended
rules include disclosure requirements related to the Basis for
Management's Adjustments and Form of Management's Presentation.\318\
Likewise, the final amendments require that there is a reasonable basis
for each such adjustment and that the pro forma financial information
reflects all Management's Adjustments that are, in the opinion of
management, necessary to a fair statement of the pro forma financial
information presented and a statement to that effect is disclosed.\319\
The final amendments also require disclosure of both the basis for and
material limitations of each Management's Adjustment, including any
material assumptions or uncertainties of such adjustment, an
explanation of the method of the calculation of the adjustment, if
material, and the estimated time frame for achieving the synergies and
dis-synergies of such adjustment.\320\ The amendments also provide
practical limits tailored to the pro forma financial information
presentation.\321\
---------------------------------------------------------------------------
\317\ See Item 10(b) of Regulation S-K.
\318\ See Rule 11-02(a)(7)(i) and (ii).
\319\ See Rule 11-02(a)(7)(i)(A). This requirement is similar to
the representation management must disclose in historical interim
financial statements subject to Article 10, Interim financial
statements, (see 17 CFR 210.10-01(b)(8) (``Rule 10-01(b)(8)'')) and
taken together with the requirement to include dis-synergies if
synergies are depicted (see Rule 11-02(a)(7)(i)(C)), we believe it
will help achieve much the same purpose as our proposed requirement
that pro forma presentations that include Management's Adjustments
be fair and balanced. Because we are persuaded that the line-item
specificity in our proposed pro forma requirements is not
necessarily consistent with the manner in which synergy estimates
are made, the amended rules do not include that proposed requirement
or the one to disclose for each Management's Adjustment, to the
extent known, the reportable segments, products, services, and
processes involved; the material resources required, if any, and the
anticipated timing.
\320\ See Rule 11-02(a)(7)(ii)(C).
\321\ For example, the amended rules limit the adjustments to
the effect of such synergies and dis-synergies on the historical
financial statements that form the basis for the pro forma statement
of comprehensive income as if the synergies and dis-synergies
existed as of the beginning of the fiscal year presented. The
amended rules further require that if such adjustments reduce
expenses, the reduction shall not exceed the amount of the related
expense historically incurred during the pro forma period presented.
See Rule 11-02(a)(7)(i)(B).
---------------------------------------------------------------------------
While we encourage registrants to include Management's Adjustments
in pro forma financial information, we recognize that such adjustments
may not be appropriate for all circumstances. In order to achieve
consistency between pro forma financial information presentations that
include Management's Adjustments and those that do not, and in
recognition that the line item format of pro forma financial
information may not be well-suited to Management's Adjustments, the
amended rules provide that Management's Adjustments shall be presented
in the explanatory notes to the pro forma financial information in the
form of reconciliations of pro forma net income from continuing
operations attributable to the controlling interest and the related pro
forma earnings per share data to such amounts after giving effect to
Management's Adjustments. Because Management's Adjustments might
contain forward-looking information, we are amending the rule, as
proposed, to include an instruction indicating that any forward-looking
information supplied is expressly covered by the safe harbor provisions
under 17 CFR 230.175 and 17 CFR 240.3b-6.\322\ Given the reference to
these safe harbors in the adopted rule and the other modifications we
are making with respect to Management's Adjustments, we do not believe
there is a need to create new safe harbors or to reference additional
safe harbors.
---------------------------------------------------------------------------
\322\ See the Instruction to Rule 11-02(a)(6)(ii).
---------------------------------------------------------------------------
Explanatory Notes
To further clarify the pro forma financial information disclosure,
we are adopting, as proposed, amendments to require disclosure of
revenues, expenses, gains and losses, and related tax effects that will
not recur in the income of the registrant beyond 12 months after the
transaction.\323\ Additionally, for Transaction Accounting Adjustments,
the final amendments will require, as proposed, disclosure of:
---------------------------------------------------------------------------
\323\ See Rule 11-02(a)(10)(i), based on existing Rule 11-
02(b)(5).
---------------------------------------------------------------------------
Total consideration transferred or received, including its
components and how they were measured. If total consideration includes
contingent consideration, the amendments will require disclosure of the
contingent consideration arrangement(s),\324\ 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
---------------------------------------------------------------------------
\324\ In a modification from the proposal, the amended rule
inserts ``contingent consideration'' before ``arrangements'' to
clarify that the proposed rule's reference to ``arrangement(s)''
means ``contingent consideration arrangement(s).''
---------------------------------------------------------------------------
When the initial 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, 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 regarding the magnitude of any potential
adjustments.\325\
---------------------------------------------------------------------------
\325\ See Rule 11-02(a)(11)(ii).
---------------------------------------------------------------------------
In order to effect the changes described above to our Management's
Adjustments proposal, we are relocating the proposed explanatory note
disclosures for Management's Adjustments that we believe also apply to
Autonomous Entity Adjustments from the subparagraph concerning
Management's Adjustments to Rule 11-02(a)(11)(iii). Specifically, the
amended rules provide that the accompanying explanatory notes shall
disclose for each Autonomous Entity Adjustment, a description of the
adjustment (including the material uncertainties), the material
assumptions, the calculation of the
[[Page 54034]]
adjustment, and qualitative information about the Autonomous Entity
Adjustments necessary to give a fair and balanced presentation of the
pro forma financial information.\326\ The amendments also tailor the
proposed disclosure to reference Autonomous Entity Adjustments and to
remove proposed disclosure that related to synergies and other
transaction effects rather than to Autonomous Entity Adjustments.
Further, the amendments retain for Autonomous Entity Adjustments the
proposed requirement to disclose qualitative information about the
Autonomous Entity Adjustments necessary to give a fair and balanced
presentation of the pro forma financial information.\327\
---------------------------------------------------------------------------
\326\ The amendments to provide required disclosure for
Autonomous Entity Adjustments do not include the following proposed
explanatory note disclosures for Management's Adjustments, which we
believe may be less relevant to Autonomous Entity Adjustments: The
estimated time frame for completion and, to the extent known, the
reportable segments, products, services, and processes involved; the
material resources required, if any, and the anticipated timing.
\327\ Some commenters requested clarification about what
disclosure would be necessary to satisfy this requirement, with at
least one of these commenters stating its belief that the proposed
requirement is a subjective standard. See, e.g., letters from Crowe,
DT, EY, and RSM. We observe that the Rule 11-01(a)(7) requirement
for pro forma financial information that includes Autonomous Entity
Adjustments--namely, that the registrant previously was a part of
another entity and such presentation is necessary to reflect
operations and financial position of the registrant as an autonomous
entity--involves a facts and circumstances determination that does
not lend itself to developing an all-inclusive list of disclosures.
Instead, the amended rule requires application of judgment to
identify ``additional'' qualitative disclosures, ``if any,''
necessary to achieve a fair and balanced presentation in light of a
registrant's unique facts and circumstances. As with other
disclosure obligations, this requirement should be assessed from the
perspective of the reasonable investor.
---------------------------------------------------------------------------
We are additionally clarifying, as proposed, that: Pro forma
financial information must be appropriately labeled and presented as
required by Article 11; \328\ requiring that each transaction for which
pro forma effect is required to be given must be presented in a
separate column; \329\ and requiring that, if pro forma financial
information includes another entity's statement of comprehensive
income, such as that of an acquired business, it must be brought up to
within one fiscal quarter, if practicable.\330\
---------------------------------------------------------------------------
\328\ See Rule 11-02(a)(11) and Rule 11-02(c)(2). We are
explicitly requiring this labeling and presentation in Article 11 to
avoid confusing or inconsistent disclosure. The rules also generally
preclude: (i) 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,
(ii) presentation of summaries of pro forma financial information
that exclude material transactions, (iii) presentation of pro forma
amounts that reflect Management's Adjustments elsewhere in a filing
without also presenting with equal or greater prominence the amounts
to which they are required to be reconciled and a cross-reference to
that reconciliation, or (iv) presentations that give pro forma
effect to the adoption of accounting standards.
\329\ See Rule 11-02(b)(4).
\330\ See Rule 11-02(c)(3). This change better accommodates
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.
---------------------------------------------------------------------------
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 percent significance threshold, rather than the 20 percent
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 percent threshold for both acquisitions
and dispositions to require disclosure of certain details of the
transaction.\331\ The terms ``business'' and ``significant'' used in
Form 8-K specifically reference Article 11 of Regulation S-X.
---------------------------------------------------------------------------
\331\ 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 percent of the
total assets of the registrant and its consolidated subsidiaries; or
(ii) if it involved a business (see Rule 11-01(d)) that is
significant (see Rule 11-01(b)).''
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to:
Raise the significance threshold for the disposition of a
business from 10 percent to 20 percent to conform to the threshold at
which an acquired business is significant under Rule 3-05;
To the extent applicable, conform the tests used to
determine significance of a disposed business to those used to
determine significance of an acquired business; and
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.
b. Comments
Commenters generally supported raising the threshold for
significant dispositions.\332\ One commenter recommended aligning the
criteria for measuring the significance of the disposition of a real
estate operation with the criteria for measuring an acquisition.\333\
---------------------------------------------------------------------------
\332\ See letters from Bass Berry, Cravath, Eli Lilly, FEI,
Liberty, NAREIT, Shearman, and Williams.
\333\ See letter from DT.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments substantially as proposed. We
believe these amendments will simplify compliance for registrants, and
we 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.
We are amending Rule 11-01(b) to raise the significance threshold
for the disposition of a business from 10 percent to 20 percent and to
conform, to the extent applicable, the tests used to determine
significance of a disposed business to those used to determine
significance of an acquired business. We are also adopting as proposed
the amendment to 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.\334\
---------------------------------------------------------------------------
\334\ The Form 8-K requirement for smaller reporting companies
to provide pro forma financial information refers 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, as proposed, we are removing Rule 8-03(b)(4) and
revising Rule 8-05 to require disclosure of pro forma financial
information when any of the conditions in Rule 11-01 is met.
---------------------------------------------------------------------------
The amendments apply to dispositions of real estate operations as
defined in Rule 3-14(a)(2).\335\ We are
[[Page 54035]]
not adopting for dispositions of real estate operations the last
sentence of proposed Rule 1-02(w)(1)(i)(D), which modified the
Investment Test to include debt secured by the real properties that is
assumed by the buyer when the registrant's and its other subsidiaries'
investments in and advances to the real estate operations are being
compared to total assets of the registrant. Where real estate
operations have been included in the consolidated financial statements
of the registrant, the information necessary to apply the Investment,
Asset and Income Tests is available. Thus, unlike for acquisitions of
real estate operations, there are no unique industry considerations
warranting limiting the significance determination to only the
Investment Test or modifying that test.
---------------------------------------------------------------------------
\335\ See Rule 11-01(b)(2).
---------------------------------------------------------------------------
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 F/S of Form 1-A directs an issuer relying on Regulation A to
present the pro forma financial information specified by Rule 8-
05.\336\ 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 information 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.
---------------------------------------------------------------------------
\336\ See paragraph (b)(7)(iv) of Part F/S. Part F/S of Form 1-A
permits the periods presented to be the shorter of those applicable
to issuers relying on Regulation A and the periods specified by
Article 8.
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed 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.
b. Comments
No commenters offered specific comment on these proposed
amendments. Two commenters generally supported the proposal to conform
the rules applicable to smaller reporting companies to the generally
applicable rules stating that it will codify current practice, reduce
confusion, and simplify application of the rules.\337\ In contrast,
another commenter recommended that the Commission consider whether
issuers relying on Regulation A warrant different treatment under the
rules.\338\ Another commenter recommended that smaller registrants be
exempt from mandatory Management's Adjustments disclosure in pro forma
financial information.\339\
---------------------------------------------------------------------------
\337\ See letters from BDO and Cravath.
\338\ See SBCFAC Recommendations.
\339\ See letter from EY.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting the amendments to Rule 8-05 as proposed to require
that the preparation, presentation, and disclosure of pro forma
financial information by smaller reporting companies substantially
comply with Article 11.\340\ Additionally, because Part F/S of Form 1-A
refers to Rule 8-05, the amendments to Rule 8-05 will apply to issuers
relying on Regulation A.\341\
---------------------------------------------------------------------------
\340\ See 8-05(b). However, because pro forma financial
information begins with the historical financial statements of the
registrant, revised Rule 8-05 requires application of Rule 8-03(a)
requirements for condensed format rather than the requirement in
Rule 11-02(b)(3).
\341\ Certain related requirements applicable to smaller
reporting companies do not apply to issuers relying on Regulation A.
For example, issuers relying on Regulation A are not required to
file reports on Form 8-K or proxy statements.
---------------------------------------------------------------------------
These revisions should ease compliance burdens and clarify the
application of our rules for smaller reporting companies and issuers
relying on Regulation A by focusing them on the more complete and
better understood provisions of Article 11 and provide investors with
more uniform information upon which to make their investment
decisions.\342\ As revised, in limited circumstances smaller reporting
companies and issuers relying on Regulation A will now have to provide
pro forma financial information for two years when the transaction for
which pro forma effect is being given, such as a combination of
entities under common control or discontinued operation, will be
retrospectively reflected in the historical financial statements of
smaller reporting companies and issuers relying on Regulation A for all
periods presented as required by U.S. GAAP.\343\
---------------------------------------------------------------------------
\342\ See Section II.D.1.
\343\ Rule 8-05 did not have a similar provision. However, the
incremental burden on smaller reporting companies and issuers
relying on Regulation A is not expected to be significant because
the circumstances requiring retrospective revision are generally
within their control and they must eventually revise their
previously filed historical financial statements for all periods to
reflect these circumstances.
---------------------------------------------------------------------------
We are also amending Rule 8-05 as proposed to require presentation
of pro forma financial information when the conditions in Rule 11-01
exist.\344\ Because Rule 8-05 currently requires pro forma financial
information only for business acquisitions,\345\ when Rule 8-05
applies, conforming its conditions to Rule 11-01 will require smaller
reporting companies and issuers relying on Regulation A to provide pro
forma financial information for significant acquisitions and
dispositions \346\ and when a roll-up transaction as defined in 17 CFR
229.901(c) occurs, the registrant previously was a part of another
entity and such presentation is necessary to reflect operations and
financial position of the registrant as an autonomous entity, or
consummation of one or more transactions has occurred or is probable
for which disclosure of pro forma financial information would be
material to investors.\347\
---------------------------------------------------------------------------
\344\ See Rules 8-05(a) and 11-01(a), as amended.
\345\ See supra Section II.D.2.
\346\ Based on an analysis of 2017 disclosures of acquisitions
and dispositions by smaller reporting companies, Commission staff
found that out of 191 disclosures of acquisitions and dispositions
by smaller reporting companies in 2017, 178 already appeared to
comply with Article 11 requirements. Based on an analysis of
disclosures of acquisitions and dispositions in Forms 1-A originally
filed in 2019, Commission staff found that out of 12 Forms 1-A that
disclosed acquisitions subject to Rule 8-04 or Rule 8-06, 9 already
appeared to comply with Article 11 requirements.
\347\ Form 1-A requires the pro forma financial information
described in Rule 8-05 only when financial statements are required
for businesses acquired or to be acquired. We have amended Part F/S
of Form 1-A to remove this limitation to be consistent with our
amendments, as proposed, to Rule 8-05 to require presentation of pro
forma financial information when the conditions in Rule 11-01 exist.
---------------------------------------------------------------------------
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,\348\ unless
subject to the
[[Page 54036]]
special rules set forth in 17 CFR 210.6-01 through 210.6-10 (``Article
6'').\349\ Investment company registrants differ from non-investment
company registrants in several respects.\350\ The Commission proposed
amendments to tailor the financial reporting requirements for
investment companies with respect to their acquisitions of investment
companies and other types of funds (collectively, ``acquired funds'').
Specifically, the Commission proposed:
---------------------------------------------------------------------------
\348\ In October 2016, as part of a broader investment company
reporting modernization rulemaking, the Commission adopted certain
amendments to Regulation S-X that 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)].
\349\ See Rule 6-03.
\350\ See Section II.E. of the Proposing Release. Investment
companies invest in securities principally for returns from capital
appreciation and investment income. Investment companies are
required to value their portfolio investments, with changes in value
recognized in the statement of operations for each reporting period.
See Rule 6-02(b) (``the term value shall have the same meaning given
in Section 2(a)(41)(B) of the Investment Company Act''); see also
FASB ASC 946-320-35, FASB ASC 946-323, FASB ASC 946-325-35, FASB ASC
946-810, and FASB ASC 815-10-35. Also, investment companies
generally do not consolidate entities they control and do not
account for portfolio investments using the equity method. 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).
---------------------------------------------------------------------------
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;
\351\
---------------------------------------------------------------------------
\351\ The Commission additionally proposed 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)).
---------------------------------------------------------------------------
To add new Rule 6-11 of Regulation S-X, which would
specifically cover financial reporting in the event of a fund
acquisition; and
To eliminate the pro forma financial information
requirement for investment companies and replace it with proposed
supplemental financial information that the Commission believed would
be more relevant to fund investors.
Commenters generally supported the Commission's objective of
tailoring financial reporting requirements for investment companies
with respect to acquired funds.\352\ As discussed below, we are
adopting these requirements substantially as proposed, with certain
modifications based on comments received.
---------------------------------------------------------------------------
\352\ See letters from BDO, CAQ, Deloitte, and Investment
Company Institute (``ICI'').
---------------------------------------------------------------------------
1. Amendments to Significance Tests for Investment Companies
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.\353\ However, the tests in Rule 1-02(w) were not
written for the specific characteristics of investment companies.\354\
As detailed in the Proposing Release, the definition of ``significant
subsidiary'' in current Rule 1-02(w) has an Investment Test, an Asset
Test, and an Income Test, while the definition of ``significant
subsidiary'' in Rule 8b-2 has an investment test and an income test,
but no asset test.\355\ The Commission proposed to add new Rule 1-
02(w)(2) to create a separate definition of ``significant subsidiary''
for investment companies in Regulation S-X, which--like Rule 8b-2--
would use an investment test and an income test, but not an asset
test.\356\
---------------------------------------------------------------------------
\353\ The changes to the ``significant subsidiary'' definition
in Regulation S-X will 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.
\354\ See Proposing Release at n. 217 and accompanying text.
\355\ See Section II.E.1. of Proposing Release.
\356\ Id. The Commission also proposed conforming amendments to
the definition of ``significant subsidiary'' in Securities Act Rule
405, Exchange Act Rule 12b-2, and Investment Company Act Rule 8b-2
to make them consistent with proposed Rule 1-02(w)(2).
---------------------------------------------------------------------------
Two commenters supported adding a definition of ``significant
subsidiary'' specifically tailored for investment companies.\357\ One
commenter noted that certain language in proposed Rule 1-02(w)(1)
appeared inconsistent with proposed Rule 1-02(w)(2).\358\
---------------------------------------------------------------------------
\357\ See letters from ICI and KPMG.
\358\ See letter from EY. Specifically, proposed Rule 1-02(w)(1)
stated that the conditions of paragraph (w)(2) would apply if the
``subsidiary'' is a registered investment company or a business
development company, but paragraph (w)(2) stated that its provisions
apply to a ``registrant'' that is a registered investment company or
a business development company. We have revised Rule 1-02(w)(1) to
state that the tests in Rule 1-02(w)(2) apply if the registrant is a
registered investment company or a business development company.
---------------------------------------------------------------------------
a. Investment Test
Currently, the Investment Test for a significant subsidiary in
Regulation S-X determines significance by evaluating whether the
registrant's and its other subsidiaries' investments in and advances to
the tested subsidiary \359\ exceed 10 percent of the registrant's total
assets. Rule 8b-2 similarly determines significance using an investment
test. For investment companies, the Commission proposed an investment
test that would assess whether the value of the registrant's and its
other subsidiaries' investments in and advances to the tested
subsidiary exceeds 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. The 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
rather than total assets.\360\
---------------------------------------------------------------------------
\359\ See supra note 29 (regarding the use of the term ``tested
subsidiary'').
\360\ See 17 CFR 210.6-04, item 4.
---------------------------------------------------------------------------
We are adopting, as proposed, the investment test for investment
companies as part of the definition of ``significant subsidiary.'' We
received one comment on the proposed investment test. This commenter
supported the proposed investment test for investment companies,
agreeing that investment in the tested subsidiary in the context of its
relative exposure to total investments at fair value is the appropriate
metric in evaluating its significance.\361\ We continue to believe that
a total investments measure is more appropriate for investment
companies and more relevant than the existing tests, as 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.\362\
---------------------------------------------------------------------------
\361\ See letter from Ares Capital Corporation (``Ares'').
\362\ We also continue to believe that using total investments
for this test would be a more transparent measure than total assets
for registrants that use a statement of net assets instead of a
balance sheet. See Section II.E.1.a. of Proposing Release.
---------------------------------------------------------------------------
b. Asset Test
The Asset Test in current 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''.
As proposed, we are eliminating the Asset Test as a measure of
significance for investment companies because we continue to believe
that doing so would simplify compliance without changing the
information available to investors as the Asset Test is generally not
meaningful when applied to investment companies. The only commenter who
addressed this aspect of the proposal expressed support for the
elimination of
[[Page 54037]]
the Asset Test, stating that it is not meaningful when applied to
investment companies and has been confusing for business development
companies to practically apply.\363\
---------------------------------------------------------------------------
\363\ See letter from Ares.
---------------------------------------------------------------------------
c. Income Test
The Income Test in current Rule 1-02(w) compares the registrant's
and its other subsidiaries' equity in the income from continuing
operations before income taxes of the tested subsidiary exclusive of
amounts attributable to any noncontrolling interests with the income of
the registrant and its subsidiaries consolidated for the most recently
completed fiscal year. 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 percent.
i. Proposed Amendments
The Commission proposed to amend the income test for investment
companies to use the income test in Rule 8b-2, 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 would use
components from the statement of operations required by 17 CFR 210.6-07
(``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. The absolute value
of the sum of these amounts would be compared to the absolute value of
the registrant and its subsidiaries' consolidated change in net assets
resulting from operations. The Commission also proposed that a tested
subsidiary would be deemed significant under the income test for
investment companies if the test yields a condition of greater than
either: (1) 80 percent by itself, or (2) 10 percent and the investment
test for investment companies yields a result of greater than 5 percent
(``alternate income test'').
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, the Commission proposed an instruction that would permit 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.
ii. Comments
One commenter specifically supported the proposed income test for
investment companies with an 80 percent threshold and the proposed
alternate income test with 10 percent and five percent thresholds.\364\
However, a different commenter requested that the Commission increase
the five percent threshold for the investment component of the
alternate income test to 10 percent, consistent with the investment
test and Rule 8b-2(b),\365\ and another commenter suggested that the
Commission eliminate the proposed primary income test and adopt only
the alternate income test.\366\
---------------------------------------------------------------------------
\364\ See letter from ICI.
\365\ See letter from Ares.
\366\ See letter from KPMG.
---------------------------------------------------------------------------
Several commenters recommended the Commission clarify the order of
operations for the proposed income test, in particular whether the
numerator should be the absolute value of the sum of the constituent
elements or, instead, the sum of the absolute value of each of the
constituent elements.\367\ Commenters generally supported the former
approach because it would avoid double counting of a gain (or loss)
related to a sale previously recorded as an unrealized gain (or
loss).\368\ One commenter recommended that the income test be limited
only to investment income as changes in gains and losses would be
captured by the investment test.\369\ Two commenters also observed that
the methods for determining the numerator and the denominator of the
income test were different and questioned the potential impact on the
test.\370\
---------------------------------------------------------------------------
\367\ See letters from Ares, BDO, CAQ, Deloitte, KPMG, ICI, and
RSM.
\368\ See letters from BDO, CAQ, Deloitte, EY, and KPMG.
\369\ See letter from Ares.
\370\ See letters from Ares and IMA.
---------------------------------------------------------------------------
One commenter expressed support for the ability of the registrant
to use the five-year average of the change in net assets from
operations where the most recent fiscal year's change in net assets is
insignificant.\371\ Several commenters, however, preferred a bright-
line threshold of 10 percent lower than the average change in net
assets resulting from operations for the past five years rather than
the ``insignificant'' standard.\372\ Several commenters also
recommended that five-year averaging be used for the 80 percent test as
well as the alternate income test.\373\
---------------------------------------------------------------------------
\371\ See letter from ICI.
\372\ See letters from BDO, CAQ, KPMG, and EY.
\373\ See letters from BDO, CAQ, EY, ICI, PwC, Small Business
Investor Alliance (``SBIA''), and RSM.
---------------------------------------------------------------------------
iii. Final Amendments
We are adopting amendments to the income test substantially as
proposed, but with some modifications after consideration of the
comments received. Commenters supported the percentage thresholds in
the income test. We are not increasing the investment component of the
alternate income test to 10 percent of total investments, as one
commenter suggested, because we believe that would render the alternate
income test duplicative of the 10 percent threshold in the investment
test. We also continue to believe that exceeding an 80 percent
threshold in income alone may indicate significance for financial
reporting purposes for a subsidiary even if the related assets
represent less than 5 percent of total investments. We are, therefore,
adopting this prong of the income test as proposed.
In response to commenters, we have revised the calculation of
income to be the absolute value of ``the sum'' of 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. We believe this modification will prevent
confusion in applying absolute value with respect to income and avoid
the potential double counting of gains or losses. We continue to
believe that 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.\374\ We also believe it is
appropriate to compare the specified income elements received from the
tested subsidiary \375\ with the investment company registrant's change
in net assets resulting from operations in order to evaluate the impact
on the registrant's net income, particularly in the context of the
subsidiary being a single portfolio investment. However, we agree that
this approach is less relevant in the event of a fund acquisition since
the acquired fund is likely to have fund-level expenses that should be
netted against income. We have, therefore, modified the language
[[Page 54038]]
to state that, for purposes of Rule 6-11, the income determination is
made by comparing the absolute value of the change in net assets
resulting from operations of the tested subsidiary with that of the
investment company registrant.
---------------------------------------------------------------------------
\374\ See Section II.E.1.c. of Proposing Release.
\375\ Rule 1-02(w)(2)(ii) covers the specified income elements
``from the tested subsidiary'' and is calculated at the registrant-
level.
---------------------------------------------------------------------------
We are modifying the five-year income averaging provision, as
suggested by commenters, to provide a bright-line threshold at 10
percent lower than the average change in net assets resulting from
operations for the past five years rather than the ``insignificant''
standard in order to reduce potential inconsistencies in
application.\376\ As proposed, the five-year averaging provision
applies to the income test, which would include both the 80 percent
condition in the primary income test and the 10 percent condition in
the alternate income test; however, in light of commenter confusion, we
have clarified the rule text to expressly state that it applies to both
conditions.\377\
---------------------------------------------------------------------------
\376\ See Rule 1-02(w)(2)(ii).
\377\ Id.
---------------------------------------------------------------------------
2. Proposed Rule 6-11 of Regulation S-X
Currently, 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.
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 exclusions provided by Sections
3(c)(1) or 3(c)(7) of the Investment Company Act. These private funds
often have prepared audited financial statements in accordance with
U.S. GAAP, but generally have not prepared their financial statements
in accordance, nor had an audit conducted in compliance, with
Regulation S-X. 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.
a. Proposed Amendments
The Commission proposed Rule 6-11, which would specifically cover
financial reporting in the event of a fund acquisition. 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. Because the
definition of business in Rule 11-01(d) is not readily applicable in
the context of a fund acquisition, the Commission proposed 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.
The Commission proposed 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, and to make the obligations more aligned
with the financial statement obligations applicable to investment
company registration statements.\378\ Proposed Rule 6-11 would require
the related schedules specified in Article 12, such as the schedule of
investments, to be provided for an acquired or to be acquired fund.
Acquisitions of a group of related funds would be considered as a
single acquisition under proposed Rule 6-11(a)(3) \379\ 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.
---------------------------------------------------------------------------
\378\ 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.
\379\ Funds would be 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.
---------------------------------------------------------------------------
The Commission proposed to allow investment companies to provide
financial statements for private funds that were prepared in accordance
with U.S. GAAP. The Commission also proposed 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.\380\
---------------------------------------------------------------------------
\380\ Because proposed Rule 6-11 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.
---------------------------------------------------------------------------
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 percent for 10 percent for each place it appears therein.\381\ If
either of the tests were satisfied at the 20 percent 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 were to exceed
the conditions of the investment test and the alternate income test for
investment companies, substituting 50 percent for 10 percent, then the
registrant would be required to provide the financial statements for
each individually insignificant fund and the supplemental financial
information.\382\ In determining whether financial statements of funds
acquired or to be acquired must be filed, the registrant would be
permitted to 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.\383\
---------------------------------------------------------------------------
\381\ As proposed, the primary income test for investment
companies with the 80 percent condition would not be used for
purposes of proposed Rule 6-11.
\382\ The Commission based the 50 percent 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.
\383\ At such time, the acquired investments would be reflected
on the balance sheet or statement of net assets and accompanying
schedules. In proposing this approach, the Commission expressed its
belief that in these circumstances 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 and 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. See Section II.E.2. of Proposing Release.
---------------------------------------------------------------------------
b. Comments
Commenters generally supported the Commission's objective of
tailoring
[[Page 54039]]
financial reporting requirements for investment companies with respect
to acquired funds.\384\ Commenters questioned the scope of the
definition of fund acquisition, suggesting that proposed Rule 6-11
might technically apply whenever a fund acquires an equity interest in
another fund \385\ or when the portfolio securities acquired represent
only a portion of another fund's holdings but will represent
substantially all of the initial assets of a new registrant.\386\ A
number of commenters also requested guidance on when Rule 3-05 would
apply to non-fund acquisitions by investment company registrants.\387\
---------------------------------------------------------------------------
\384\ See letters from BDO, CAQ, Deloitte, and ICI.
\385\ See letters from CAQ, EY, and GT.
\386\ See letters from EY and KPMG.
\387\ See letters from CAQ, Deloitte, EY, GT, ICI, KPMG, and
PwC.
---------------------------------------------------------------------------
One commenter supported proposed Rule 6-11's use of the
``significant subsidiary'' definition, modified to set the investment
test at the 20 percent condition and to exclude the primary income test
with the 80 percent condition.\388\ This commenter recommended that the
alternate income test be changed from five percent to 10 percent of
total investments because the size of the acquired fund should be the
principal determinant of significance. Two commenters questioned
whether the significance tests would only apply to fund acquisitions
covered in proposed Rule 6-11(b)(2) and not proposed Rule 6-
11(b)(1).\389\
---------------------------------------------------------------------------
\388\ See letter from ICI.
\389\ See letter from EY and ICI.
---------------------------------------------------------------------------
One commenter supported the proposed alignment of financial
statement requirements with Rule 3-18, but expressed confusion about
whether acquired fund financial statements would need to be included in
subsequent filings until a post-acquisition audited balance sheet is
filed.\390\ Another commenter indicated that it was unclear as to the
number of fiscal years for which financial statements must be presented
for acquired funds, whether only for the past fiscal year or for the
periods set forth in Rule 3-18.\391\ A third commenter stated that
proposed Rule 6-11 should eliminate reporting requirements for acquired
companies that have previously filed audited financial statements with
the Commission in accordance with Regulation S-X and allow unaudited
financial statements for other acquired companies due to cost.\392\
---------------------------------------------------------------------------
\390\ See letter from ICI.
\391\ See letter from EY.
\392\ See letter from Ares.
---------------------------------------------------------------------------
Regarding the proposal to permit acquired private funds to provide
financial statements prepared in accordance with U.S. GAAP and
schedules that comply with Article 12, one commenter supported the
proposed approach.\393\ Two commenters requested that the Commission
consider alternatives that would provide full transparency of the
portfolio holdings of the acquired fund but not require audited Article
12 schedules.\394\
---------------------------------------------------------------------------
\393\ See letter from ICI.
\394\ See letters from ICI and KPMG.
---------------------------------------------------------------------------
Several commenters suggested that the Commission make various
amendments to Rules 3-09, 4-08(g), and 10-01(b)(1) of Regulation S-X,
involving financial disclosures outside of the acquisition
context.\395\
---------------------------------------------------------------------------
\395\ See letters from Ares, BDO, KPMG, and SBIA.
---------------------------------------------------------------------------
c. Final Amendments
We are adopting new Rule 6-11 to address the financial disclosure
obligations for acquired funds, with certain modifications in response
to comments received.\396\ Investment company registrants will follow
Rule 6-11, rather than Rule 3-05, in the event that a fund acquisition
occurs or is probable to occur.\397\ With respect to whether a fund
acquisition has occurred, in response to commenters who sought further
clarity, we have revised Rule 6-11(a)(2)(ii) to state that in
evaluating the facts and circumstances as to whether an acquisition has
occurred or is probable, a registrant should consider whether it will
result in the acquisition of all or substantially all of the portfolio
investments held by another fund.\398\ We have also removed language
that suggests acquired fund financial disclosure would be required if
the registrant acquired a non-substantial portion of another fund's
portfolio investments that would constitute all or substantially all of
the initial assets of the registrant.\399\ The intent of the facts and
circumstances evaluation is to capture all situations where additional
disclosure about the acquired fund is appropriate, regardless of the
legal form, such as merger, consolidation, or asset sale, used to
structure the transaction.
---------------------------------------------------------------------------
\396\ We also are adopting, as proposed, conforming amendments
to Rules 3-18(d), 5-01(a), 6-01, 6-02(b) and (c), and 6-03 of
Regulation S-X to reflect the addition of Rule 6-11.
\397\ Investment company registrants are currently subject to
the requirements of Rule 3-05, provided the conditions set forth in
that rule are satisfied. Rule 3-05, as revised, will continue to
apply to investment company registrants with respect to acquired and
disposed businesses that do not involve a fund acquisition covered
by Rule 6-11.
\398\ Rule 6-11(a).
\399\ Id.
---------------------------------------------------------------------------
We are adopting the use of the ``significant subsidiary''
definition in Rule l-02(w)(2) as the basis for determining whether
financial statements for the acquired fund must be filed under Rule 6-
11, but modified, as proposed, to use the investment test at the 20
percent condition and to exclude the 80 percent condition of the
primary income test. We are not altering the investment component of
the alternate income test, as one commenter suggested, because we
continue to believe that five percent of total investments represents a
material threshold.\400\ As adopted without change from the proposal,
the significance tests in Rule 6-11 only apply to situations covered in
paragraph (b)(2) and not paragraph (b)(1). Thus, an investment company
registrant filing a registration statement on Form N-14 in connection
with the acquisition of another fund will not apply the significance
tests in Rule 6-11(b)(2).
---------------------------------------------------------------------------
\400\ The modified conditions in Rule 6-11 only substitute 20
percent for 10 percent for the investment test and alternate income
test described in Rule 1-02(w)(2). Thus, for purposes of Rule 6-11,
a registrant would apply an investment test condition of 20 percent
of the value of total investments and the alternate income test
conditions of 20 percent of the absolute value of the change in net
assets resulting from operations and five percent of the value of
total investments.
---------------------------------------------------------------------------
As proposed, Rule 6-11 would have required an investment company
registrant to include acquired fund financial statements as part of the
registrant's financial statements until its next audited balance sheet
after the acquisition was consummated. Given the availability of the
acquired fund financial statements on the Commission's EDGAR system
once filed and that the price of investment company shares or interests
is established by the value of its current investment portfolio, we
agree with commenters that acquired fund financial statements need not
be included in future filings. Accordingly, we have modified the rule
to require acquired fund financial statements to be filed only
once.\401\
---------------------------------------------------------------------------
\401\ Rule 6-11(b)(4). Proposed Item 14(d)(5) of Schedule 14A
[17 CFR 240.14a-101] would have required proxy statements filed by a
fund, with respect to a merger, consolidation, acquisition, or
similar matter, to include financial statements of the acquiring
fund, including those required by Rules 3-05 and 6-11 and Article 11
of Regulation S-X ``with respect to transactions other than that as
to which action is to be taken as described'' in the proxy
statement. Since Rule 6-11 only requires acquired fund financial
statements to be filed once, we are not adopting the proposed
amendment to Item 14(d)(5) of Schedule 14A.
---------------------------------------------------------------------------
One commenter requested clarification of the number of fiscal
[[Page 54040]]
years for which financial statements must be presented in Rule 6-11 and
whether the requirement should be consistent with Rule 3-18.\402\ In
response, we have revised Rule 6-11 to make clear that if the acquired
fund is subject to Rule 3-18, then the financial statements for the
periods described in Rule 3-18 shall be filed.\403\ For all other
acquired funds, such as private funds, only the financial statements
for the most recent fiscal year and the most recent interim period need
to be filed.\404\ We are not following the suggestion, made by one
commenter, to eliminate the filing of acquired fund financial
statements if they were previously filed with the Commission in
accordance with Regulation S-X by the acquired fund, because the
disclosure is predominantly for the benefit of the acquiring fund's
shareholders, not the acquired fund's shareholders.\405\
---------------------------------------------------------------------------
\402\ Rule 3-18 applies to registered management investment
companies. Business development companies are also permitted to use
Rule 3-18 pursuant to the instructions set forth in Form N-2.
\403\ Rule 6-11(b)(2)(ii) and (iii).
\404\ Id.
\405\ Some forms, such as Form N-14, permit backwards
incorporation by reference of information not included in the
prospectus. See General Instruction G to Form 14. Effective May 2,
2019, incorporation by reference on Form N-14 is allowed for all
parties who may use the form, including business development
companies. See FAST Act Modernization and Simplification of
Regulation S-K, Release No. IC-10618 (Mar. 20, 2019) [84 FR 12674
(Apr. 2, 2019)].
---------------------------------------------------------------------------
We are not persuaded by the commenter who requested that we permit
filing of unaudited financial statements for acquired funds due to
cost. We continue to believe that a significant number of private funds
currently prepare audited financial statements under U.S. GAAP due to
investor demand and for regulatory compliance purposes.\406\ Moreover,
although auditing an acquired private fund's financial statements
involves costs, we believe that our proposed approach requiring audited
U.S. GAAP financial statements with respect to acquisitions of private
funds will reduce costs as compared to re-issuing audited financial
statements in compliance with Regulation S-X, but still will provide
investors appropriate information about the acquired fund. We also have
modified Rule 6-11(c) from the proposal to make the filing of financial
statements using U.S. GAAP permissive for private funds. Proposed Rule
6-11(c) provided that the financial statements of private funds
``shall'' comply with U.S. GAAP. Under the final rule, the financial
statements of private funds may either comply with U.S. GAAP or Article
12.\407\
---------------------------------------------------------------------------
\406\ For example, private funds prepare audited financials,
among other reasons, to satisfy their custody rule obligations under
the Investment Advisers Act. See 17 CFR 275.206(4)-2.
\407\ We also have made non-substantive changes to provide a
more accurate heading for paragraph (c) and to reflect the intent of
the Commission that the provision applies to a fund or private
account that is ``acquired or to be acquired.'' As proposed, the
language only referenced a fund or private account ``to be
acquired.''
---------------------------------------------------------------------------
The Commission's proposal was intended to achieve a more
appropriate balance by permitting registrants to file audited U.S. GAAP
financial statements for acquired private funds, but supplementing
those financial statements with audited schedules listing each
investment as required by Article 12.\408\ A condensed schedule of
investments prepared under U.S. GAAP does not include the same
prescriptive level of detail when compared to an Article 12 compliant
(or full) schedule of investments. While each investment is listed
separately in a full schedule of investments, a condensed schedule
allows funds to aggregate investments by issuer or by investment type
so long as each investment is individually less than five percent of
the net assets of the fund.\409\ While providing a full unaudited
schedule of portfolio investments would provide transparency, we
believe that the incremental costs of providing an audited schedule of
investments that complies with Article 12 is minimal because the
portfolio investment account balances already have been audited, and
the incremental audit procedures therefore would be limited to the
incremental disclosures required under Article 12. In addition, an
audit will provide additional assurance for investors as to the
accuracy of that schedule.
---------------------------------------------------------------------------
\408\ See Section II.E.2. of Proposing Release.
\409\ See FASB ASC 946.
---------------------------------------------------------------------------
We also are removing the sentence from proposed Rule 6-11(a)(3)
providing that the financial statements in connection with the
acquisition of a group of related funds may be presented either on an
individual or a combined basis for any periods the related funds are
under common control or management. This change is based on our
understanding that, unlike operating companies, funds generally do not
file ``combined financial statements'' as defined in FASB ASC Topic
810-10-20.
Finally, with respect to commenters' suggestion to make substantive
amendments to Rules 3-09, 4-08(g), and 10-01(b)(1) of Regulation S-X,
we believe such amendments would be beyond the scope of this
rulemaking.\410\
---------------------------------------------------------------------------
\410\ While we are not making substantive changes to Rule 3-09,
as a result of the changes to Rule 1-02(w) we are revising Rule 3-
09(a) to make clear that it applies to Rule 1-02(w)(1).
---------------------------------------------------------------------------
3. Pro Forma Financial Information and Supplemental Financial
Information
Currently, 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 percent for 10
percent in the conditions.\411\
---------------------------------------------------------------------------
\411\ 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. See Rule 11-02(b)(1).
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to replace the pro forma financial
disclosures requirement with proposed Rule 6-11(d), which would require
that investment company registrants provide supplemental financial
information about the newly combined entity that it believed would be
more relevant to investors.\412\ The proposed supplemental financial
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, 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.
---------------------------------------------------------------------------
\412\ See Section II.E.3. of Proposing Release.
---------------------------------------------------------------------------
b. Comments
One commenter expressed support for the proposed replacement of the
pro forma financial information requirement, indicating that the
proposed supplemental financial information would better inform
investors and reduce costs.\413\ In addition, two commenters noted that
the rule text in proposed Rule 6-11(d)(1)(iii) would require disclosure
about material differences in ``financial and operating policies,''
while the preamble of the Proposing Release referred to material
differences in ``accounting policies'' between the acquiring and
acquired funds.\414\
---------------------------------------------------------------------------
\413\ See letter from ICI.
\414\ See letters from EY and ICI.
---------------------------------------------------------------------------
[[Page 54041]]
c. Final Amendments
We are adopting the amendments substantially as proposed, but with
one modification in response to comments received. As proposed, we are
adopting amendments to eliminate the requirement to provide pro forma
financial information for investment company registrants in connection
with fund acquisitions and to require the supplemental financial
information in its place.\415\ We believe that the pro forma financial
information is not necessary in light of the costs to prepare such
disclosures and given that the supplemental financial information will
provide material information to investors by highlighting important
changes resulting from a fund acquisition as context for the acquired
fund's financial statements. We also are modifying Rule 6-11(d)(1)(iii)
to state that it requires narrative disclosure about material
differences in ``accounting policies'' of the acquired fund when
compared to the acquiring fund, which was the Commission's intent as
expressed in the preamble of the Proposing Release.
---------------------------------------------------------------------------
\415\ See Section II.E.4. of Proposing Release.
---------------------------------------------------------------------------
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,\416\
provides, subject to certain exceptions, that the corresponding
Statement of Additional Information (``SAI'') ``shall contain the
financial statements and schedules of the acquiring company and the
company to be acquired required by Regulation S-X.''
---------------------------------------------------------------------------
\416\ 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).
---------------------------------------------------------------------------
a. Proposed Amendments
The Commission proposed to amend Form N-14 to make its disclosure
requirements consistent with the disclosures required in proposed Rule
6-11. Specifically, the Commission proposed the following amendments:
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; \417\
---------------------------------------------------------------------------
\417\ Non-fund acquisitions would continue to 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.
---------------------------------------------------------------------------
Permit private funds to provide financial statements and
schedules that conform to U.S. GAAP and Article 12 of Regulation S-X;
Require inclusion of the supplemental financial
information described in proposed Rule 6-11(d), except for the pro
forma fee table; \418\
---------------------------------------------------------------------------
\418\ The Commission proposed to exclude 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.
---------------------------------------------------------------------------
Remove provisions no longer relevant because of prior
amendments; \419\ and
---------------------------------------------------------------------------
\419\ Specifically, the Commission proposed to remove the
ability to place columns C and D of Schedule II under 17 CFR 210.12-
14 (``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 Registration Form Used by Open-End Management
Investment Companies: Guidelines, Release No. IC-13436 (Aug. 12,
1983) [48 FR 37928 (Aug. 22, 1983)]. 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)].
---------------------------------------------------------------------------
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
percent of the registrant's net asset value, because pro forma
financial statements would no longer be required for fund acquisitions
and, for non-fund acquisitions, the significance measure for pro forma
financial statements in Rule 11-01(b)(1) is and will remain 20 percent.
b. Comments
Two commenters noted that the rule text of the proposed amendments
to Item 14.2 of Form N-14, which describes the financial statement
requirements when the acquired fund is a private fund, differed from
the rule text of proposed Rule 6-11(c).\420\
---------------------------------------------------------------------------
\420\ See letter from EY (stating that proposed Item 14.2 of
Form N-14 included text that was not included in proposed rule 6-
11(c)); see also letter from ICI (same).
---------------------------------------------------------------------------
c. Final Amendments
We are amending Form N-14 substantially as proposed, but with some
modifications in response to commenters. We continue to believe that 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. With respect to
Item 14.2, we agree with commenters that there should be consistency
between the Form N-14 and Rule 6-11 disclosure requirements for private
funds using U.S. GAAP, and we have made conforming amendment to Form N-
14 to reflect Rule 6-11 as adopted.\421\
---------------------------------------------------------------------------
\421\ Item 4.2 of Form N-14.
---------------------------------------------------------------------------
F. Transition
After considering feedback from commenters,\422\ registrants will
not be required to apply the final amendments until the beginning of
the registrant's fiscal year beginning after December 31, 2020 (the
``mandatory compliance date''). Acquisitions and dispositions that are
probable or consummated after the mandatory compliance date must be
evaluated for significance using the final amendments.\423\
---------------------------------------------------------------------------
\422\ See e.g., letters from BDO, DT, EY, and KPMG. BDO
recommended permitting application of the amendments in filings made
on or after publication of the amendments in the Federal Register.
DT indicated it may be useful for preparers to understand whether
the new rules should be applied to all acquisitions (1) Consummated
after the effective date, (2) Reported on Form 8-K or 8-K/A filed
after the effective date, or (3) Reported in a new or amended
registration statement filed after the effective date and when
registrants would apply the new pro forma requirements, particularly
if some acquisitions were consummated before the effective date and
others were consummated after. EY recommended that registrants that
have filed a current report announcing the completion of a
significant acquisition or disposition before the effective date of
the final rule be allowed to comply with the existing rules for that
transaction and registrants that have submitted a draft or
confidential registration statement or filed a registration
statement before the effective date of the final rule be allowed to
complete their offering under the existing rules. KPMG recommended
that the Commission provide transition guidance that clarifies the
effective date, including the permissibility of early application of
the amendments and application of the amendments to transactions
consummated near the final rule's effective date.
\423\ For registration statements filed on or after the
mandatory compliance date, registrants that are subject to the
reporting requirements of Section 13(a) or 15(d) of the Exchange Act
at the mandatory compliance date may test acquisitions and
dispositions consummated before the mandatory compliance date using
rules that were in effect when the acquisitions and dispositions
were consummated.
---------------------------------------------------------------------------
Registrants filing initial registration statements are not required
to apply the final amendments until an initial registration statement
is first filed on or after the mandatory compliance date. For initial
registration statements first filed on or after the mandatory
compliance date, all probable or consummated acquisitions and
dispositions, including those consummated prior to the mandatory
compliance date, must be evaluated for significance using the final
amendments.\424\
---------------------------------------------------------------------------
\424\ Issuers relying on Regulation A filing initial offering
statements on Form 1-A are not required to apply the final
amendments until an initial offering statement is first filed on or
after the mandatory compliance date. For initial offering statements
first filed on or after the mandatory compliance date, all probable
or consummated acquisitions and dispositions, including those
consummated prior to the mandatory compliance date, must be
evaluated for significance using the final amendments.
---------------------------------------------------------------------------
[[Page 54042]]
Voluntary early compliance with the final amendments is permitted
\425\ in advance of the registrant's mandatory compliance date provided
that the final amendments are applied in their entirety from the date
of early compliance.\426\
---------------------------------------------------------------------------
\425\ To the extent that registrants have questions about
application of the rules in connection with early compliance, they
should reach out to Commission staff for additional transition
guidance.
\426\ For an acquisition or disposition of a business for which
the disclosure required by an Item 2.01 Form 8-K has been filed (or
was required to be filed) prior to the mandatory compliance date (or
the voluntary early compliance date, if applicable), but for which
Rule 3-05 Financial Statements and Article 11 pro forma financial
information are not required to be filed (e.g., in an Item 9.01 Form
8-K) until after the mandatory compliance date (or until after the
voluntary early compliance date, if applicable), the registrant must
file the financial statements and pro forma financial information
required by the rules in effect when the Item 2.01 Form 8-K was
required to be filed.
---------------------------------------------------------------------------
III. Other Matters
If any of the provisions of these rules, or the application thereof
to any person or circumstance, is held to be invalid, such invalidity
shall not affect other provisions or application of such provisions to
other persons or circumstances that can be given effect without the
invalid provision or application.
Pursuant to the Congressional Review Act, the Office of Information
and Regulatory Affairs has designated these rules a ``major rule,'' as
defined by 5 U.S.C. 804(2).
IV. Economic Analysis
A. Introduction
We are adopting amendments to our rules and forms to improve their
application, assist registrants in making more meaningful
determinations of whether a subsidiary or an acquired or disposed
business is significant, and improve the disclosure requirements for
financial statements relating to acquisitions and dispositions of
businesses, including real estate operations and investment companies.
The amendments are intended to improve the utility and relevance of the
financial information about acquired or disposed businesses provided to
investors, facilitate timely access to capital, and reduce the
complexity and costs to prepare required disclosures. The reduction in
compliance costs could in theory facilitate increased acquisition or
disposition activity by registrants. However, registrants engage in
acquisitions and dispositions for a variety of business reasons, and,
as a general matter, their evaluation of the advisability of
acquisitions and dispositions often involve cost and benefit
considerations much greater than compliance cost considerations. More
specifically, with respect to significant transactions which could
trigger disclosure relevant to the amendments, these other
considerations are likely to be even more important to the decision to
engage in acquisition and disposition activity than the more modest
effects of the final amendments.
Providing timely, accurate, and transparent information, especially
financial information, about acquired and 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.\427\ However, in the absence of
appropriately tailored disclosures, investors may not be able to
optimize allocation of their resources or fully assess the effects of
this important external governance mechanism on the firms in which they
invest.
---------------------------------------------------------------------------
\427\ See, e.g., Mark L. Mitchell & Kenneth Lehn, Do Bad Bidders
Become Good Targets?, 98 J. Pol. Econ. 372 (1990) (``Mitchell & Lehn
(1990)''); Anup Agrawal & Jeffrey F. Jaffe, Do Takeover Targets
Underperform? Evidence from Operating and Stock Returns, 38 J. Fin.
& Quantitative Analysis 721 (2003) (``Agrawal & Jaffe (2003)''). See
also, e.g., Xiaoyang Li, Productivity, Restructuring, and the Gains
from Takeovers, 109 J. Fin. Econ. 250 (2013) (``Li (2013)''). Based
on plant-level data, this study shows that acquirers increase
targets' productivity through more efficient use of capital and
labor, thus enhancing the value of the acquisitions.
---------------------------------------------------------------------------
Disclosure requirements also impose costs on registrants that may
seek to engage in acquisitions or dispositions. In particular, such
costs could diminish the benefits associated with an acquisition or
disposition; however, we would not expect such costs to alter a
decision to pursue a particular transaction. Further, a registrant's
ability to provide such disclosure for periods prior to an acquisition
may be dependent on the availability and assistance of both the
acquired business and the acquired business's independent auditor.
While this potential issue would be unlikely to affect a registrant's
decision to engage in an acquisition, it may impact its ability to
comply with reporting requirements for capital raising transactions
and, accordingly, to access capital in the manner and within the time
frames it most desires.
We believe the final amendments, by streamlining and clarifying
acquired business financial disclosure requirements, should reduce
compliance costs while maintaining investors' access to information
that is material to an understanding of the potential effects of an
acquired or to be acquired business (or disposed or to be disposed
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,\428\
Section 3(f) of the Exchange Act,\429\ and Section 2(c) of the
Investment Company Act \430\ 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 \431\ 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.
---------------------------------------------------------------------------
\428\ 15 U.S.C. 77b(b).
\429\ 17 U.S.C. 78c(f).
\430\ 15 U.S.C. 80a-2(c).
\431\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
Below we address the potential economic effects of the 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 whenever 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 1-02(w), Rule 3-05,
Rule 3-14, Article 11, and the related smaller reporting company
requirements in Article 8 of Regulation S-X, together with current
disclosure practices, form the baseline from which we estimate the
[[Page 54043]]
likely economic effects of the amendments.\432\
---------------------------------------------------------------------------
\432\ See supra Section II.
---------------------------------------------------------------------------
The amendments 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 amendments may affect both domestic registrants and foreign
private issuers.\433\ We estimate that during calendar year 2019,
approximately 6,792 registrants filed on domestic forms \434\ and 849
foreign private issuers filed on F-forms, other than registered
investment companies. Among the registrants that file on domestic
forms, approximately 31 percent were large accelerated filers, 19
percent were accelerated filers,\435\ and 50 percent were non-
accelerated filers. In addition, we estimate that of these domestic
issuers approximately 42.8 percent were smaller reporting companies and
17.2 percent of these domestic issuers were emerging growth
companies.\436\ About 26.1 percent 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
39 percent of foreign private issuers reported under U.S. GAAP, 60
percent reported under IFRS-IASB, and approximately 1 percent reported
under a comprehensive body of accounting principles other than U.S.
GAAP or IFRS-IASB with a reconciliation to U.S. GAAP. Certain of the
amendments may also affect issuers that rely on Regulation A and
investment companies that must comply with the requirements of
Regulation S-X. Based on staff analysis of EDGAR filings, we estimate
that during calendar year 2019 there were 106 issuers with newly
qualified Regulation A offering statements.
---------------------------------------------------------------------------
\433\ The number of domestic registrants and foreign private
issuers affected by the amendments is estimated as the number of
unique companies, identified by Central Index Key (CIK), that filed
Form 10-K, Form 20-F, and Form 40-F or an amendment thereto with the
Commission during calendar year 2019. The estimates for the
percentages of companies by accelerated filer status and the
percentage of smaller reporting companies are based on the self-
reported status provided by these registrants during calendar year
2019, with supplemental data from Ives Group Audit Analytics. 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 or an amendment thereto.
These estimates do not include issuers that filed only initial
registration statements during calendar year 2019, which will also
be affected by the amendments.
\434\ This number includes fewer than 20 foreign private issuers
that file on domestic forms and approximately 100 business
development companies. Of the foreign private issuers filing on
domestic forms in calendar year 2019, approximately 85 percent
reported under U.S. GAAP while 15 percent reported under IFRS-IASB.
\435\ See supra note 23.
\436\ 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.
---------------------------------------------------------------------------
The ``significant subsidiary'' definition in Rule 1-02(w) is
applied when determining if a subsidiary is deemed significant for the
purposes of certain Regulation S-X and Regulation S-K requirements as
well as certain Securities Act and Exchange Act rules and forms.\437\
Because the significance of a subsidiary affects the disclosure
required from registrants about the activities of those subsidiaries,
the amendments we are adopting to Rule 1-02(w) will affect registrants'
significance determinations and, as a result of those determinations,
registrants' disclosure requirements.
---------------------------------------------------------------------------
\437\ See supra Section II.A.
---------------------------------------------------------------------------
Additionally, 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,\438\ the rules we are amending are relevant to a large
number of transactions and businesses but the amendments themselves,
beyond their potential cost savings, are not expected to have a
significant effect on transactions or businesses more generally.
Registrants would be potentially affected by the 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.
---------------------------------------------------------------------------
\438\ See Anant K. Sundaram, Mergers and Acquisitions and
Corporate Governance, 3 Mergers and Acquisitions 193 (2004); and
2019 J.P. Morgan Global M&A Outlook, available at https://www.jpmorgan.com/jpmpdf/1320746694177.pdf.
---------------------------------------------------------------------------
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, Commission staff searched various form types filed
from January 1, 2017 to October 1, 2018 for indications of acquisition
or disposition disclosure and found approximately 1,261 filings on
various forms that included Rule 3-05 Financial Statements or Rule 3-14
Financial Statements.\439\ To better understand the 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, 2017 to December 31, 2019,
there were 6,057 mergers and acquisitions entered into by publicly-
listed U.S. firms. Among these transactions, 1,283 acquisitions
involved non-U.S. targets and approximately 419 involved real estate
operations.\440\ Additionally, 171 of the 6,057 transactions were
conducted by entities identified as 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,\441\
as many of these transactions may have involved acquisitions that are
small relative to the size of the registrant.\442\
---------------------------------------------------------------------------
\439\ Based on a review of Forms 10, S-1, S-3, F-1, F-3, and 8-
K. 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.
\440\ We estimate the number of real estate operation
transactions that may be within the scope of Rule 3-14 based on
transactions covered by SDC where the acquiree uses the Standard
Industry Classification code (SIC) 6798 or SIC codes in the 6500s.
These SIC codes include real estate companies and REITs generally.
The transactions identified using these SIC codes would include, but
are not necessarily limited to, real estate operations that are
within the scope of Rule 3-14.
\441\ 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.
\442\ See Ronald W. Masulis, Cong Wang, & Fei Xie, Corporate
Governance and Acquirer Returns, 62 J. Fin. 1851 (2007) (reporting
that the mean (median) relative size of the mergers in their sample
is around 16 percent (6 percent) 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.
---------------------------------------------------------------------------
All registered investment companies and business development
companies that make fund acquisitions significant enough to trigger
Rule 3-05 disclosure
[[Page 54044]]
requirements would potentially be affected by the amendments. Among
registered investment companies, as of the end of calendar year 2019,
there were 10,239 open-end funds, 2,050 exchange-traded funds, and 681
closed-end funds. In addition, there were 102 business development
companies. While we are not able to observe the universe of the fund
acquisitions, 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 December
31, 2019 for indications of fund acquisition disclosure. Among the 503
filings on Form N-14 for fund transactions, 323 filings or 64 percent
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.\443\
---------------------------------------------------------------------------
\443\ See infra Section V.B.2, Table 5.
---------------------------------------------------------------------------
C. Potential Benefits and Costs of the Final Rule
1. Potential Benefits
We anticipate the amendments \444\ will improve the application of
the significance tests and assist registrants in making more meaningful
significance determinations. We additionally anticipate the amendments
will 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.
---------------------------------------------------------------------------
\444\ See supra Sections II.A through II.E.
---------------------------------------------------------------------------
As they relate to significance determinations generally, the
amendments are expected to reduce the burden of determining
significance by improving the application of the definition. The
amendments also should improve the salience of information for
investors by focusing the applicable disclosures on significant
subsidiaries.
As they relate to acquisitions and dispositions, the amendments are
expected to increase the utility of related disclosures to investors by
making these disclosures more relevant. The 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 amendments may also permit more timely access to capital. A
registrant's ability to provide disclosure for periods prior to an
acquisition is often dependent on access to and the cooperation of 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, can impair a registrant's
ability to timely meet the financial reporting requirements for such
acquisitions, which may impact its ability to access capital within the
time frames 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 amendments should help to
ameliorate these impediments, as we discuss in more detail below.
Further, to the extent that the amendments reduce the compliance
burden, they may reduce the cost of merger, acquisition, and
disposition activity generally. We note that well-functioning markets
for corporate control are, on average, generally believed to be
beneficial to investors to the extent that they serve as a disciplinary
mechanism in which less efficiently managed assets are transferred to
more efficient management.\445\ It also has been generally observed
that mergers and acquisitions may also generate synergies by combining
two entities, and may result in firms with more efficient scale or
scope.\446\
---------------------------------------------------------------------------
\445\ See, e.g., Mark L. Mitchell & Kenneth Lehn, Do Bad Bidders
Become Good Targets?, 98 J. Pol. Econ. 372 (1990) (``Mitchell & Lehn
(1990)''); Anup Agrawal & Jeffrey F. Jaffe, Do Takeover Targets
Underperform? Evidence from Operating and Stock Returns, 38 J. Fin.
& Quantitative Analysis 721 (2003) (``Agrawal & Jaffe (2003)'').
\446\ See, e.g., Li (2013), supra note 427 (showing, based on
plant-level data, that acquirers increase target's productivity
through more efficient use of capital and labor, thus enhancing the
value of the acquisitions).
---------------------------------------------------------------------------
2. Potential Costs
We do not expect the amendments to generate significant costs for
registrants. However, in certain situations the amendments could cause
some transactions to be significant that would not be deemed so under
the current rules. Inclusion of, for example, additional Rule 3-05
Financial Statements will result in increased costs to such
registrants, though this may result in benefits to investors in the
form of additional financial disclosures related to the transaction.
We do not anticipate significant costs to investors associated with
the amendments. One commenter disagreed with our assessment of the
potential costs to investors.\447\ According to the commenter, our
analysis ignored the potential costs of mergers, manifested in the
destruction of value that mergers can cause for the shareholders of the
acquiring companies. We acknowledge that there are a significant number
of acquisitions that prove to be value-decreasing for the
acquirer.\448\ However, as discussed above, the amendments are unlikely
to affect whether a registrant engages in an acquisition or disposition
or whether, with the passage of time, any particular transaction proves
to be value-enhancing. More specifically, focusing on any disclosures
that could
[[Page 54045]]
potentially be affected by the amendments, it is clear that various
other factors are substantially more likely to affect acquisition and
disposition decisions such as, for example, the registrant's assessment
of the impact of the acquisition or disposition on its post-transaction
performance. Specifically, other factors that are likely to be
substantially more significant to post-transaction performance, and
therefore influence decision making regarding the transaction and post-
transaction performance, include but are not limited to financing
costs, integration costs, ability to achieve expected synergies in the
amounts and in the time frames anticipated, whether known and
anticipated trends continue and materialize, whether management
performs as expected, and whether the resulting actions of competitors,
suppliers, distributors, customers and others are consistent with
expectations at the time of the transaction. In this regard, we note
that one of the recent studies cited by the commenter finds that the
main predictors of post-acquisition underperformance are the method of
payment (cash versus stock), the acquirer's pre-acquisition asset
growth, and the acquirer's excess cash on the balance sheet.\449\
Disclosure of these items will be unaffected by the final amendments.
We note that, except in circumstances specifically authorized or
required by statute, it is not the role of the Commission to substitute
its judgment for that of issuers, shareholders, other relevant
regulatory authorities and other stakeholders regarding, or otherwise
exercise influence over, an acquisition or disposition transaction.
Rather, the Commission's role generally, and in particular in this
instance, is to craft rules designed to ensure that investors receive
disclosure of information regarding the transaction that is material to
an investment decision.
---------------------------------------------------------------------------
\447\ See letter from CII (generally asserting that disclosures
should allow investors to evaluate transactions, including
identifying value-decreasing acquisitions, and that recent studies
on merger activity find generally negative results of merger
activity). We acknowledge that there are varying views regarding the
costs and benefits of acquisitions, dispositions, and mergers and we
discuss in more detail below the topic of whether particular types
of transactions have in general been more value-enhancing or value-
decreasing. We also note: (1) Our conclusion that, for various
reasons, the amendments are highly unlikely to affect whether a
transaction proceeds or not, and (2) it is not the role of the
Commission to substitute its judgment for that of issuers,
shareholders, and other stakeholders regarding an acquisition or
disposition transaction. Rather, the Commission's role is to craft
rules designed to ensure that investors receive disclosure of
information regarding the transaction that is material to an
investment decision.
\448\ We note that most of the studies that document value-
decreasing acquisitions use data on acquisitions of targets that
were Exchange Act registered companies. For those targets, the final
amendments will not reduce the amount of relevant information
available. We also acknowledge that the amendments might affect
acquiring firms that acquire private targets more than those that
acquire public targets, as financial information of public targets
is readily available, regardless of whether Rule 3-05 Financial
Statements are required. Prior studies, however, have shown that the
acquisitions of private targets on average create shareholder value.
See, e.g., Kathleen Fuller, Jeffry Netter, & Mike Stegemoller, What
Do Returns to Acquiring Firms Tell Us? Evidence from Firms that Make
Many Acquisitions, 57 J. Fin. 1763 (2002) (``Fuller et al. (2002)'')
(finding that acquisitions of private targets are associated with
higher acquirer returns). We acknowledge that investors might face
some search costs as target financial information will no longer be
disclosed in connection with acquisitions. However, given the
current data-gathering capabilities, and the fact that such
disclosures will be available on EDGAR in electronic format, we do
not expect these costs to be unduly burdensome for investors.
\449\ See Richard Tortoriello et al., Mergers & Acquisitions:
The Good, the Bad, and the Ugly (and How to Tell Them Apart), S&P
Global, Aug. 2016, at 2-4, https://www.spglobal.com/marketintelligence/en/documents/mergers-and-acquisitions-the-good-the-bad-and-the-ugly-august-2016.pdf.
---------------------------------------------------------------------------
We also acknowledge that one objective of the amendments is to
reduce unnecessary disclosure and as a result, in some cases, the
amendments will reduce the amount of information provided. However, we
do not believe that there will be a reduction in the disclosure of
information that is material to investors. We anticipate that the
amendments will generally result in disclosure that is more salient and
that any potential loss of information will be mitigated by a
registrant's obligation under Rule 4-01(a) of 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. We also note that the disclosures of a registrant's own
financial statements are not affected by the rule amendments.
Below we discuss the anticipated economic benefits and costs of
specific aspects of the amendments in further detail.
D. Economic Effects of Specific Amendments
1. Significance Tests
The amendments to the significance tests should facilitate
registrants' application of the tests. The amendments are expected to
bring the Investment Test more in line with the economics of the
registrant's interest in a subsidiary or of the transaction for an
acquired business, and reduce anomalous results from the Income Test.
This, in turn, should reduce compliance burdens associated with the
application of the significance tests. In addition, these amendments
should facilitate compliance with the application of these tests under
Rule 3-05 or Rule 3-14.
The amendments to the Investment Test requiring use of the
registrant's aggregate worldwide market value rather than the
historical book value of its total assets to assess the significance of
acquisitions and dispositions may better reflect the relative size of
the business in economic terms. The investments in and advances to the
acquired business generally reflect an acquirer's expectation of the
fundamental value of the equity of the acquired business.\450\
Similarly, using the aggregate worldwide 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 for
acquisitions and dispositions, the amendments potentially will avoid
classifying transactions as significant when they are actually
relatively insignificant in economic substance to the registrant.
Further, aggregate worldwide 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.\451\
---------------------------------------------------------------------------
\450\ 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. See Tim Koller, Marc Goedhart, & David
Wessels, Valuation: Measuring and Managing the Value of Companies
(7th ed. 2020).
\451\ See, e.g., Andrei Shleifer & Robert W. Vishny, Stock
Market Driven Acquisitions, 70 J. Fin. Econ. 295 (2003) (``Shleifer
& Vishny (2003)'').
---------------------------------------------------------------------------
The use of aggregate worldwide market value 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.\452\ 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 changes to the Investment Test that we are adopting might
introduce errors or bias into the determination of the significance of
an acquisition.
---------------------------------------------------------------------------
\452\ See, e.g., Paul J. Halpern, Empirical Estimates of the
Amount and Distribution of Gains to Companies in Mergers, 46 J. Bus.
554 (1973); Gershon Mandelker, Risk and Return: The Case of Merging
Firms, 1 J. Fin. Econ. 303 (1974) (``Mandelker (1974)'').
---------------------------------------------------------------------------
In response to concerns raised by commenters, the amendments to the
Investment Test will require registrants to use the average of
aggregate worldwide market value calculated daily for the last five
trading days of the registrant's most recently completed month ending
prior to the earlier of the registrant's announcement date or agreement
date of the acquisition or disposition. Using the average aggregate
worldwide market value should reduce the risk of anomalous results
under the Investment Test as a result of market value fluctuations due
to other news or events that are unrelated to the acquisitions or
dispositions. Thus, we believe the use of the average market value of
equity in the Investment Test should better identify the significance
of the transaction while avoiding confounding events.
[[Page 54046]]
Under the amended Investment Test, some acquisitions may be
considered insignificant that would otherwise have been significant
under the existing rule. For example, this may occur when an acquiring
company's equity is highly-valued, or an acquiring company has a high
market-to-book ratio. Studies have shown that companies are more likely
to make an acquisition if their stock is overvalued.\453\ Therefore,
because it uses the aggregate worldwide market value of equity as the
denominator, the amended Investment Test may be less likely to require
Rule 3-05 or Rule 3-14 Financial Statements for some acquisitions where
the acquirer's stock is overvalued.
---------------------------------------------------------------------------
\453\ See, e.g., Shleifer & Vishny (2003), supra note 451, which
develops a model showing that over-valued firms are more likely to
make an acquisition of undervalued firms using their over-valued
stocks. See also Matthew Rhodes-Kropf, David T. Robinson, & S.
Viswanathan, Valuation Waves and Merger Activity: The Empirical
Evidence, 77 J. Fin. Econ. 561 (2005) (``Rhodes-Kropf et al.
(2005)''); Ming Dong et al., Does Investor Misvaluation Drive the
Takeover Market?, 61 J. Fin. 725 (2006) (``Dong et al. (2006)'');
James S. Ang & Yingmei Cheng, Direct Evidence on the Market-Driven
Acquisition Theory, 29 J. Fin. Res. 199 (2006) (``Ang & Cheng
(2006)''). All three papers document stock market-driven
acquisitions in which acquiring firms acquire targets using their
over-valued stocks.
---------------------------------------------------------------------------
One commenter asserted that the proposed change to the Investment
Test would result in less disclosure about acquisitions by companies
whose market value is significantly larger than their book value.\454\
The potential loss of information may be mitigated because significance
is established if any one of the three significance tests is satisfied
and Rule 3-05 Financial Statements can also be triggered by the Asset
Test or the Income Test.
---------------------------------------------------------------------------
\454\ See letter from CII (asserting that such companies are
more likely to use stock as a payment method, which is also a
predictor of post-acquisition underperformance).
---------------------------------------------------------------------------
The amendments to the Income Test adding a revenue component should
improve the application of the Income Test by mitigating the effect of
infrequent expenses, gains, and losses on the calculation and also
potentially preventing insignificant subsidiaries or acquired
businesses from being deemed significant for registrants with net
income or loss near zero. The amended rules will continue to use income
from continuing operations before income taxes for the Income Test
rather than after income taxes as proposed, which should also better
reflect the significance of a tested subsidiary or acquired business by
avoiding distortions that can occur as a result of the tax status of
the entity or the volatility of income taxes. Also, as mentioned above,
the amendments might affect acquiring firms that acquire private
targets more than those that acquire public targets, as financial
information of public targets is readily available, regardless of
whether Rule 3-05 Financial Statements are required. Prior studies,
however, have shown that the acquisitions of private targets on average
create shareholder value, which further mitigates the commenter's
concerns.\455\ The amendments also clarify the application of the
proposed revenue component by removing the reference to ``recurring
annual revenue'' and indicating that the revenue component does not
apply if either the registrant and its subsidiaries consolidated or the
tested subsidiary did not have material revenue in each of the two most
recently completed fiscal years. We believe this clarification will aid
registrants in applying the test.
---------------------------------------------------------------------------
\455\ See, e.g., Fuller et al. (2002), supra note 448 (finding
that acquisitions of private targets are associated with higher
acquirer returns).
---------------------------------------------------------------------------
The 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
material revenue in each of the two most recently completed fiscal
years, the amended Income Test would require both the new revenue
component and the net income component to be met.\456\ 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.
---------------------------------------------------------------------------
\456\ 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 Rule 3-05(b)(2) of Regulation S-X.
---------------------------------------------------------------------------
Any potential risks of under-identification as a result of the
amendments may be mitigated, because significance is established if any
one of the three significance tests are satisfied. Therefore, any
under-identification that may result from application of one test may
not necessarily impact the outcome of whether disclosure would be
required. For example, acquisitions conducted by highly-valued firms
might not trigger Rule 3-05 Financial Statements based on the
Investment Test because of their higher aggregate worldwide market
value of equity. However, Rule 3-05 Financial Statements might still be
required based on the Income Test or the Asset Test, thus mitigating
the risks of under-identification of economically significant
transactions. Additionally, any potential risks of under-identification
could be mitigated by the fact that registrants must otherwise disclose
material information about the acquisition that is necessary to make
the required statements not misleading.
Overall, the amendments to the Investment Test and Income Test are
expected to better capture the significance of a tested subsidiary or
acquired business relative to the registrant, resulting in more salient
disclosure and reducing compliance burdens. For example, to the extent
that the amendments 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 amendments to the
significance tests capture more significant businesses and 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 amendments 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.
We believe that overall the amendments 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 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 believe the benefits from the reduction
in disclosure burden and audit costs justify investors' loss of the
incremental value of the third year of financial information. For
purposes of
[[Page 54047]]
the PRA, we expect the average reduction in registrants' compliance
burden as a result of the amendments would be approximately 125 hours
per Rule 3-05 Financial Statement filing.\457\ In addition to these
compliance cost savings, there could be other and more substantial
benefits from the amendments. The amendments could facilitate merger
and acquisition transactions and facilitate an acquiring company's
access to capital. 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 impede its capital raising efforts.
---------------------------------------------------------------------------
\457\ See infra Section V.B.1, Table 1.
---------------------------------------------------------------------------
The impact of the 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 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
The 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 consummation of acquisitions.
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, segment, or division, such as a product
line or a line of business contained in more than one subsidiary of the
selling entity. 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. As a result, a registrant
may be unable to provide the financial statements required under the
current rule. In these circumstances, the amendments provide that
registrants would be permitted to file abbreviated financial statements
to comply with Rule 3-05 if the total assets and total revenues (both
after intercompany eliminations) of the acquired or to be acquired
business constitute 20 percent or less of such corresponding amounts of
the seller and its subsidiaries consolidated. This bright line
threshold is a modification from the proposal in response to commenter
feedback. Applying a 20 percent bright line threshold will reduce
inconsistency in interpreting ``small portion of the selling entity''
and should facilitate compliance by registrants. A bright line
threshold in the disclosure requirement may lead to over- or under-
identification. However, a 20 percent threshold also is generally
consistent with the staff's granting of relief pursuant to Rule 3-13 in
such situations. This amendment also will help ensure that abbreviated
financial statements are not used when the component of the selling
entity acquired is sufficiently large such that presentation of the
seller's financial statements, along with pro forma financial
information that removes the portion of the seller not acquired, would
best inform investors about the business acquired. Additionally, we are
clarifying the meaning of the term ``segment,'' the description of
expenses, and the presentation of the abbreviated financial statements.
These clarifications should improve registrant's ability to comply with
the Rule 3-05 disclosure requirements. We believe allowing for
abbreviated financial statements in these circumstances will reduce
costs for registrants and facilitate the consummation of acquisitions.
We also believe any potential costs to investors as a result of
decreases in disclosure will be mitigated by the fact that registrants
must otherwise disclose material information about the acquisition that
is necessary to make the required statements not misleading.
4. Financial Statements of a Business That Includes Oil and Gas
Producing Activities
When an acquired or to be acquired oil and gas producing business
represents a component of an entity that does not constitute a separate
entity, subsidiary, operating segment (as defined in U.S. GAAP or IFRS-
IASB, as applicable), 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 or to be acquired business on the
registrant, the amendments would permit registrants to provide
abbreviated financial statements that consist of income statements
modified to exclude expenses not comparable to future operations. We
believe allowing for abbreviated financial statements in these
circumstances will reduce costs for registrants. As noted above, we
believe any potential costs to investors as a result of decreases in
disclosure will be mitigated by the fact that registrants must
otherwise disclose material information about the acquisition that is
necessary to make the required statements not misleading.
5. Timing and Terminology of Financial Statement Requirements
The amendments include several revisions that clarify the timing
and terminology related to the disclosure requirements, with some
revisions based on commenter feedback. 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 these amendments do not
modify the information required to be disclosed, we do not believe
investors would be negatively affected by them. To the extent that
these amendments make compliance more efficient for registrants,
investors may indirectly benefit as cost savings could be passed
through to them.
6. Foreign Businesses
The amendments 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 a comprehensive basis of accounting
principles other than U.S. GAAP or IFRS-IASB to be reconciled to IFRS-
IASB rather than U.S. GAAP for an acquired business that is a foreign
business (as defined in 17 CFR 210.1-02(l)). Permitting the 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.
[[Page 54048]]
The amendments also allow Rule 3-05 and Rule 3-14 Financial
Statements to be prepared in accordance with IFRS-IASB without
reconciliation to U.S. GAAP for an acquired business that is not a
foreign business (as defined in 17 CFR 210.1-02(l)), but would qualify
as a foreign private issuer if it were a registrant. Preparing
financial statements without reconciliation to U.S. GAAP in these
circumstances reduces the compliance costs where an acquired business
in a cross-border acquisition does not have U.S. GAAP financial
statements. It may also reduce transaction costs associated with
acquiring 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.
The amendments further permit an acquired business that is not a
foreign business, but would qualify as a foreign private issuer if it
were a registrant to reconcile its financial statements prepared
according to a comprehensive basis of accounting principles other than
U.S. GAAP or IFRS-IASB to IFRS-IASB rather than U.S. GAAP when the
registrant is a foreign private issuer that uses IFRS-IASB. 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 more comparable information, which could be more
expeditiously analyzed. The amendments further clarify that this
reconciliation should generally follow the form and content
requirements in Item 17(c) of Form 20-F; however, accommodations in
Item 17(c)(2) of Form 20-F that would be inconsistent with IFRS-IASB
will not be available, and IFRS 1, First-time Adoption of International
Financial Reporting Standards, may be applied. The improved clarity in
the amendment should improve registrants' compliance process,
potentially reducing compliance costs.
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 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 percent of
acquisitions by U.S. companies involved non-U.S. targets. To the extent
that the 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.\458\
---------------------------------------------------------------------------
\458\ See, e.g., Kenneth R. Ahern, Daniele Daminelli, & Cesare
Fracassi, Lost in Translation? The Effect of Cultural Values on
Mergers Around the World, 117 J. Fin. Econ. 165 (2015).
---------------------------------------------------------------------------
A possible consequence from the amendments could 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.\459\ 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 do not expect the amendments to impose
substantial costs on investors because they should be familiar with
IFRS-IASB financial statements from other contexts. Specifically,
foreign private issuers have been permitted to file IFRS-IASB financial
statements without reconciliation to U.S. GAAP for some time,\460\ 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 will 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
statements.
---------------------------------------------------------------------------
\459\ As an example, IFRS-IASB permits the recognition of
internally generated intangible assets in limited circumstances;
U.S. GAAP does not.
\460\ 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 (Jan. 4, 2008)].
---------------------------------------------------------------------------
7. Smaller Reporting Companies and Issuers Relying on Regulation A
The amendments 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 amendments to Rule 8-04 also apply to
issuers relying on Regulation A. Since the form and content of the
required financial statements will continue to be prepared in
accordance with Article 8, we do not believe the amendments will impose
additional compliance costs on affected entities and do not expect the
amendments to reduce information available to investors.
The 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
could 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.\461\ As a result, we do not
expect that the amendments will impose significant new costs on these
entities. At the same time, the amendments may provide more relevant
information to investors, although this benefit also will be limited to
the extent that smaller reporting companies already comply with these
requirements in practice.
---------------------------------------------------------------------------
\461\ See supra note 346.
---------------------------------------------------------------------------
The amendments do not provide additional accommodation for smaller
reporting companies as suggested by some commenters.\462\ As discussed
in Section II.A.7.c above, additional accommodations might potentially
complicate application of the rule. However, we expect the amendments
will ease compliance burdens and simplify the application of our rules
for all affected entities. To the extent that these compliance burdens
entail certain fixed costs that do not scale with the size of the
acquirer, smaller reporting companies and issuers relying on Regulation
A may particularly benefit from the adopted changes.
---------------------------------------------------------------------------
\462\ See supra Section II.A.7.
---------------------------------------------------------------------------
8. 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 amendments allow registrants to omit Rule 3-05 and Rule 3-14
Financial Statements from Securities Act registration statements and
proxy statements for businesses that exceed 20 percent, but do not
exceed 40 percent, significance after inclusion in post-acquisition
results for nine months
[[Page 54049]]
(rather than the proposed complete fiscal year) and for businesses that
exceed 40 percent significance once they are included in the
registrant's post-acquisition results for a complete fiscal year. These
amendments provide consistency between Rule 3-06 and Rule 3-05 for
acquisitions that exceed 20 percent, but do not exceed 40 percent
significance, and could also improve 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. These modifications are in
response to commenter feedback. We anticipate reduced compliance
burdens on registrants and do not anticipate significant costs on
investors. We expect the 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 will still receive disclosure about material
effects of the acquisition through the registrant's management's
discussion and analysis.\463\ We therefore do not expect the 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.
---------------------------------------------------------------------------
\463\ See 17 CFR 229.303.
---------------------------------------------------------------------------
9. Use of Pro Forma Financial Information To Measure Significance
The amendments permit the use of pro forma financial information to
measure significance in initial registration statements. The amendments
further clarify, based on commenter input, that if a registrant uses
pro forma financial information to measure significance, it must
continue to use pro forma financial information to measure significance
until the next annual report on Form 10-K. 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 information
may capture the effects of significant acquisitions and dispositions
consummated after the latest fiscal year-end that are not reflected in
the registrant's annual 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 amendments could potentially reduce the amount of information
presented to investors if significance determinations on the basis of
pro forma financial 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 mitigate concerns about any loss of relevant
information to investors.
10. 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 percent.\464\ 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.\465\ 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.''
---------------------------------------------------------------------------
\464\ See supra note 201.
\465\ See supra note 211.
---------------------------------------------------------------------------
The amendments will affect disclosure requirements for individually
insignificant businesses in several ways. First, the amendments require
the registrants to provide audited historical financial statements only
for those acquired businesses whose individual significance exceeds 20
percent. Reducing required disclosure of audited historical financial
statements for insignificant acquisitions could improve registrants'
access to capital since preparing such disclosure 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 amendments may make it
easier, quicker, and cheaper for registrants to access capital. The
amendments also reduce registrants' disclosure burdens, leading to cost
savings that may ultimately benefit shareholders.
Second, the 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 amendments.
The amendments might impose additional compliance burdens on
registrants to the extent they are required 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 will be subject to this
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. The amendments also expand the
aggregate impact determination to include both Rule 3-05 and Rule 3-14
acquisitions. This modification is consistent with the objective of
aligning Rule 3-14 with Rule 3-05. We do not believe there will be
significant economic effects from this expansion as the modification
will apply only to registrants that acquire both Rule 3-05 businesses
and Rule 3-14 real estate operations.
[[Page 54050]]
11. Rule 3-14--Financial Statements of Real Estate Operations Acquired
or To Be Acquired
The amendments align Rule 3-14 with Rule 3-05 where no unique
industry considerations warrant differentiated treatment of real estate
operations. For example, the amendments align the threshold for
individual significance for both rules at ``exceeds 20 percent'' and
the threshold for aggregate significance for both rules at ``exceeds 50
percent.'' The amendments also align Rule 3-14 with Rule 3-05 in terms
of the years of required financial statements for acquisitions from
related parties, the timing of filings, application of Rule 3-06, which
permits the filing of financial statements covering a period of nine to
12 months, and other less significant changes.
The 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 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 amendments 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 significance provisions
for blind pool offerings that are consistent with current practice.
Thus, while these amendments may reduce potential compliance
uncertainty and ambiguity for registrants, we do not expect them to
have a substantial effect on current disclosure practices.
In addition, because the special significance provisions for
``blind pool offerings'' are based on the unique characteristics of the
offering and the registrant, rather than the type of acquisitions, the
amendments also extend these special significance provisions to
business acquisitions subject to Rule 3-05 by registrants conducting
``blind pool'' offerings. We do not believe this extension will have
significant economic effects as the extended accommodation will only
affect a very small population of registrants. For those it does
impact, the amendment will increase consistency in the application of
Rules 3-14 and 3-05, thereby reducing costs of preparation for
registrants and immaterial disclosure to investors.
12. Pro Forma Financial Information
The amendments to replace the existing pro forma adjustment
criteria in Article 11 of Regulation S-X with Transaction Accounting
Adjustments and Autonomous Entity Adjustments simplify these
requirements and reduce potential inconsistency in preparing pro forma
financial information. The amendments to Article 11 could benefit
investors in several ways. First, the 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 Transaction Accounting Adjustments may
permit registrants to better reflect acquisitions, dispositions, or
other transactions, which could help investors better understand the
effects of these transactions on the registrant's audited historical
financial statements. Altogether, the amendments are expected to
improve the relevance of the information disclosed to investors and
help investors process information more effectively.
In a change from the proposal, under the final amendments,
Management's Adjustments depicting synergies and dis-synergies of the
acquisitions and dispositions for which pro forma effect is being given
may, in the registrant's discretion, be presented if in its
management's opinion, such adjustments would enhance an understanding
of the pro forma effects of the transaction and specified conditions
related to the Basis for Management's Adjustments and the Form of
Presentation are met.\466\ On the one hand, Management's Adjustments
may provide investors better insight into the potential effects of the
transaction as contemplated by the company. This potentially benefits
investors by helping them to distinguish the accounting effects of the
acquisitions or dispositions from management's judgment as to the
expected operational effects based on management plans. On the other
hand, there may be different levels of confidence about forward-looking
information related to different types of synergies and dis-synergies
contemplated by management. Making Management's Adjustments optional
benefits registrants by permitting them to avoid uncertainties of
estimation and increase flexibility in compliance, thus potentially
reducing compliance costs.
---------------------------------------------------------------------------
\466\ See supra Section II.D.1.c.
---------------------------------------------------------------------------
The amendments to Article 11 could impose costs on registrants
because they would be required to meet new presentation requirements
for required or optional 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.\467\
However, synergy and dis-synergy estimation by registrants may
introduce certain subjective judgments into the pro forma financial
statements, potentially making them more difficult for investors to
interpret. In addition, making Management's Adjustments optional could
create risk that such adjustments would be disclosed selectively. The
requirement that registrants disclose uncertainties, assumptions, and
calculation methods and the requirement that when synergies are
presented, any related dis-synergies must also be presented along with
the Management's Adjustments, could mitigate the risk of biased pro
forma adjustments. The amendments appear unlikely to cause significant
loss in information for investors regarding the effects of the
transaction; indeed investors may gain important insights to the extent
a registrant chooses to disclose Management's Adjustments.
---------------------------------------------------------------------------
\467\ See infra Section V.B.1, Table 1.
---------------------------------------------------------------------------
13. Significance and Business Dispositions
The amendments to conform the significance tests for a disposed
business to that of an acquired business and to increase the threshold
for determining the significance of a business disposition from 10
percent to 20 percent will reduce inconsistencies in reporting between
acquisitions and dispositions and potentially reduce registrants'
compliance burden.\468\ For example, under the amendments, registrants
will not have to file pro forma financial information for insignificant
dispositions (e.g., dispositions with significance levels exceeding 10
percent but not 20 percent), 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 transactions. For example, a registrant might engage in both
acquisitions and
[[Page 54051]]
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 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.
---------------------------------------------------------------------------
\468\ 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 percent significance
threshold, not the 20 percent threshold used for business
acquisitions under Rules 3-05 and 11-01(b).
---------------------------------------------------------------------------
14. Amendments to Financial Disclosure About Acquisitions Specific to
Investment Companies
We believe the amendments related to investment companies would
reduce compliance burdens by streamlining the disclosure requirements
in a way that is tailored to investment companies. We do not anticipate
significant costs to investors related to the amendments, because we do
not believe the amendments will result in a reduction in 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; \469\ 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.
---------------------------------------------------------------------------
\469\ Investment income includes dividends, 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.
---------------------------------------------------------------------------
The amendments include a separate definition of ``significant
subsidiary'' and separate significance tests specifically tailored for
investment companies. The amendments focus the significance
determination for investment companies on the impact to the
registrant's investment portfolio held by the registrant. Further, the
amended significance tests 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 amendments will benefit both investment companies and
their investors by providing more appropriate standards for determining
the significance of fund acquisitions. For example, the amended Income
Test better aligns 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 amended 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. The
amendments also permit the use of a five-year average for income if
income for the past year is at least 10 percent less than the average
income for the past five years. The amendments also revise the
calculation of income to be the absolute value of ``the sum'' of
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. These modifications were
made to prevent confusion in applying absolute value with respect to
income and avoid the potential double counting of gains or losses. As a
result, the amendments may more accurately identify acquisitions that
are economically significant to investment company registrants. This
will benefit registrants as they will not be required to prepare
separate financial disclosure for economically insignificant
acquisitions. The amendments also may benefit investors by avoiding the
need to focus on economically insignificant acquisitions that are
deemed significant under current rules. Furthermore, we do not
anticipate that the amended significance tests would impose substantial
costs on registrants to implement because we believe the required
measures should be readily available to registrants.
The amended significance thresholds for the Income Test in Rule 1-
02(w) when applied to investment companies has two prongs: Either (i) a
threshold of 80 percent for income alone or (ii) a 10 percent threshold
together with an Investment Test result higher than 5 percent. This
amended threshold might reduce the compliance burden faced by
investment companies as there is 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 amendments potentially better identify fund acquisitions
that warrant additional disclosure. This amendment 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 amendment to eliminate an asset-based test for investment
companies simplifies 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, is largely superfluous in light
of the amended Investment Test for investment companies. 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.
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. Rule 6-11 deems 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 under-reporting of
acquired fund disclosures by focusing on the economic substance of the
transaction rather than its legal form. The amendments to require one
year of audited financial statements for fund acquisitions and to
eliminate pro forma financial statements could also reduce compliance
burdens for
[[Page 54052]]
registrants. We do not believe these amendments will 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 amendments are also consistent
with the accommodations typically provided by our disclosure review
staff during consultations.\470\ Permitting investment companies to
provide financial statements for private funds that were prepared in
accordance with U.S. GAAP will reduce compliance burdens for investment
companies by potentially reducing the costs related to re-issuing
audited financial statements in compliance with Regulation S-X. Any
loss of information arising from these amendments will be mitigated by
the requirement that investment companies file the schedules required
under Article 12 of Regulation S-X and provide certain supplemental
information regarding the acquired funds. We believe this information
is more relevant and potentially enhances efficiency in processing the
information by fund investors. These supplemental disclosures, however,
will entail costs to registrants. For purposes of the PRA, we estimate
the average incremental compliance burden for this additional
disclosure is around 25 hours per affected registrant. We further
estimate that all of these amendments taken together will reduce a
registrant's compliance burden by approximately 100 hours.\471\
---------------------------------------------------------------------------
\470\ See supra note 58.
\471\ See infra Section V.B.2.
---------------------------------------------------------------------------
E. The Effects on Efficiency, Competition, and Capital Formation
We anticipate that the amendments will have favorable effects on
efficiency, competition, and capital formation for both operating
companies and investment companies. By reducing disclosure burdens for
registrants regarding business acquisitions and dispositions, the
amendments should facilitate such activities, although, as stated
earlier, compliance costs may be a more modest factor when a registrant
considers whether to engage in an acquisition or disposition. An active
mergers and acquisitions market creates efficiencies by transferring
inefficiently managed assets to more efficient management or by
creating synergies through economies of scale or economies of
scope.\472\ On average, mergers and acquisitions benefit investors in
the acquired business.\473\
---------------------------------------------------------------------------
\472\ For a discussion of the benefits of the market for
corporate control, see, e.g., Michael C. Jensen & Richard S. Ruback,
The Market for Corporate Control: The Scientific Evidence, 11
Journal of Financial Economics. 5 (1983) (``Jensen & Ruback
(1983)'') (noting that an active takeover market can create
efficiencies by transferring inefficiently managed assets to more
efficient management--or by creating synergies through economies of
scale or scope). For a discussion of the agency costs of mergers and
acquisitions, see, e.g., Michael C. Jensen & William H. Meckling,
Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership
Structure, 3 Journal of Financial Economics, 305 (1976) (explaining
that managers have private incentives to conduct mergers and
acquisitions to increase the size of the firm in order to extract
more pay or perquisites at shareholder expense).
\473\ Empirical studies have shown that around M&A
announcements, the target firms earn a significant abnormal return.
See, e.g., Mandelker (1974), supra note 452; Jensen & Ruback (1983),
supra note 472; Joy Ishii & Yuhai Xuan, Acquirer-Target Social Ties
and Merger Outcomes, 112 J. Fin. Econ. 344 (2014).
---------------------------------------------------------------------------
The amendments to revise the disclosure relating to acquired and
disposed businesses are expected to 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 amendments is about 82,225 company
hours.\474\ The resulting total reduction in incremental professional
costs for all forms under the amendments is approximately
$21,470,000.\475\ We thus believe the potential cost savings from the
amendments are significant.
---------------------------------------------------------------------------
\474\ See infra Section V.C, Table 5 Column E.
\475\ See infra Section V.C, Table 5 Column F.
---------------------------------------------------------------------------
At the same time, we do not believe investors face a significant
loss in information as a result of the amendments. Instead, we expect
the amendments to 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 increased efficiency in the market for mergers and acquisitions.
Under the existing disclosure requirements related to acquired
businesses, some mergers may be delayed or more costly due to the
burdens 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). By decreasing the acquisition costs for registrants, the
amendments 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 could help achieve efficient capital allocation and
exert effective external control mechanisms on public firms, leading to
an overall increase in efficiency.\476\
---------------------------------------------------------------------------
\476\ Studies have found that mergers may create shareholder
value when the assets are transferred from inefficient management to
more efficient management. See Mitchell & Lehn (1990), supra note
427; Agrawal & Jaffe (2003), supra note 427; Kenneth M. Lehn &
Mengxin Zhao, CEO Turnovers after Acquisitions: Are Bad Bidders
Fired?, 61 J. Fin. 1759 (2006).
---------------------------------------------------------------------------
F. Alternatives Considered
1. Approaches to the Significance Tests
One alternative to the amended 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 disposed 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 about what level of disclosure
is required in
[[Page 54053]]
an environment where delay is costly. Also, where a registrant
misjudges materiality and fails 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. As a result, 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
transactions are significant to a registrant.
The Investment Test compares the registrant's and its other
subsidiaries' investments in and advances to the acquired business
against the carrying value of the registrant's total assets. The
amendment to the Investment Test uses the aggregate worldwide market
value of the registrant's voting and non-voting common equity
calculated as the average of such aggregate worldwide market value
calculated daily for the last five trading days of the registrant's
most recently completed fiscal quarter ending prior to the earlier of
the registrant's announcement date or agreement date of the acquisition
or disposition. As an alternative to the amended Investment Test, we
could have required registrants to use enterprise value for the
acquirer and the acquired business, rather than the value of common
equity (for the acquirer) and investments 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 amendment 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 approach to the Investment Test, which requires
measurement of investments in an acquisition against the acquirer's
aggregate worldwide market value, averaged over the last five trading
days of the registrant's most recently completed fiscal quarter ending
prior to the earlier of the registrant's announcement date or agreement
date of the acquisition or disposition, might not reflect all
information about the value of the acquirer. As an alternative, we
could have required the registrant to use its average market value over
a longer period of time rather than a five trading day window 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 over a
longer period could increase complexity 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).
With respect to the Income Test, one alternative 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.\477\
---------------------------------------------------------------------------
\477\ See Separate Financial Statements Required by Regulation
S-X, Release No. 33-6359 (Nov. 6, 1981) [46 FR 56171 (Nov. 16,
1981)] (``The 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 amended 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
amended Income Test, such an alternative may have a lower risk of
under-identification of significant transactions if the 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 physical capital. Moreover,
for those that rely heavily on tangible assets, the information
provided by a return on assets threshold may be subsumed by the
existing Asset Test.
A third alternative to the amended 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 adopting Income Test would be to lower
the threshold required to meet the revenue component, for example to 15
percent or 10 percent. A potential benefit of this approach is that it
may mitigate the risk of under-identification of significant
transactions. However, it is difficult to calibrate the income
component and revenue component thresholds in a way that decreases the
risk of under-
[[Page 54054]]
identification without increasing the risk of over-identification.
2. Approaches to 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 at the time an acquisition is
consummated or probable, which include, among other things,
supplemental pro forma information about revenue and earnings for the
two years prior to the acquisition. Under this approach, registrants
would be 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.\478\
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 to be labeled as unaudited. However, compared
with the final amendments, 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.
---------------------------------------------------------------------------
\478\ See FASB ASC 805-10-50-1.
---------------------------------------------------------------------------
3. Approaches To Adopting Pro Forma Adjustments
An alternative to the optional Management's Adjustments for pro
forma financial information is to require the disclosure of
Management's Adjustments for synergies and dis-synergies that have
occurred after the acquisition date but before filing the pro forma
financial information and for forward-looking information previously
filed with the Commission. This alternative might provide a more
complete depiction of the expected effects of the transaction and avoid
circumstances where Management's Adjustments are selectively presented
because they are optional. However, as commenters observed, this
alternative could give rise to compliance challenges for registrants as
synergies and dis-synergies may not be tracked at the line-item level
required in pro forma financial information. Also, requiring
quantification of synergies and dis-synergies that have occurred would
impose a requirement to create books and records related to synergies
and dis-synergies even when they were not a significant factor in the
decision to execute the transaction. Moreover, synergies may take more
time (e.g., more than a year) to be achieved and estimated; thus, such
a requirement might not be practical for certain transactions in
certain industries. We therefore decided not to adopt this alternative.
4. Alternatives to the Income Test for Investment Companies
One alternative to the amended 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 amended test for registrants without necessarily
providing significant incremental benefits to investors.
Another alternative to the amended income test for investment
companies would be to select a percentage lower than 80 percent 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 not material (particularly if the income of the acquiring fund is
relatively low). The combination of the amended Income Test and
Investment Test in the final amendments is intended to mitigate this
result.
V. Paperwork Reduction Act
A. Summary of the Collection of Information
Certain provisions of our rules and forms that would be affected by
the amendments contain ``collection of information'' requirements
within the meaning of the PRA.\479\ The Commission published a notice
requesting comment on the collection of information requirements in the
Proposing Release, and submitted the proposed amendments to the Office
of Management and Budget (``OMB'') for review in accordance with the
PRA.\480\ While several commenters provided comments on the potential
costs of the proposed amendments, no commenters specifically addressed
our PRA analysis.\481\
---------------------------------------------------------------------------
\479\ See 44 U.S.C. 3501 et seq.
\480\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\481\ See Section II above.
---------------------------------------------------------------------------
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: \482\
---------------------------------------------------------------------------
\482\ A number of forms could require Rule 3-05, Rule 3-14, and
other disclosure impacted by the amendments such that the 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). For example, staff
experience has shown that for filings on Form S-4, registrants most
often incorporate Rule 3-05 or Rule 3-14 Financial Statements by
reference to a previously filed Form 8-K. While the 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
amendments, we are not adjusting the burden estimates associated
with these collections of information.
---------------------------------------------------------------------------
[[Page 54055]]
``Form S-1'' (OMB Control No. 3235-0065);
``Form S-3'' (OMB Control No. 3235-0073);
``Form F-1'' (OMB Control No. 3235-0258);
``Form F-3'' (OMB Control No. 3235-0256);
``Form 10'' (OMB Control No. 3235-0064);
``Form 8-K'' (OMB Control No. 3235-0060);
``Form N-1A'' (OMB Control No. 3235-0307);
``Form N-2'' (OMB Control No. 3235-0026);
``Form N-14'' (OMB Control No. 3235-0336); and
``Form 1-A'' (OMB Control No. 3235-0286).
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. A description of the amendments, including the need
for the information and its 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 amendments can be found in Section IV above.
B. Effect of the Amendments on Existing Collections of Information
1. Estimated Effects on Burdens for Registrants Other Than Investment
Companies
The following table summarizes the estimated effects of the
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
Amendment and affected Brief explanation of
forms estimated effect
------------------------------------------------------------------------
Rule 1-02(w), Rule 3-05, Rule A reduction of This
3-14, and related rules. 125 burden hours reduction is the
for each of the estimated effect on
following forms: the affected forms
10, 1-A, S-1, S- by the amendments to
3, F-1, F-3, and Rules 3-05, 3-14,
8-K. 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
as discussed in note
298 of the Proposing
Release.
Article 11 (Rules 11-01, 11-02 An increase of 25 This
and 11-03) and Rule 8-05 of burden hours for increase is the
Regulation S-X. each of the estimated effect on
following forms: the affected forms
10, 1-A, S-1, S- by the amendments to
3, F-1, F-3, and the pro forma
8-K. financial
information
requirements under
Article 11 and Rule
8-05 of Regulation S-
X, including the
changes that permit
registrants to
provide certain
forward-looking
information, 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 as
discussed in note
299 of the Proposing
Release.
------------------------------------------------------------------------
a. Proposed Amendments to Rules 1-02(w), 3-05, and 3-14
Considering the various revisions outlined in Sections II.B. and C.
above, we estimate that the amendments to Rule 1-02(w), 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.\483\ 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
amendments, we estimated the number of filings that include Rule 3-05
and Rule 3-14 Financial Statements, used this data to extrapolate the
effect of these changes on the paperwork burden, and applied these
percentages to the current estimates for the number of responses in the
Commission's current OMB PRA filing inventory.\484\
---------------------------------------------------------------------------
\483\ The Rule 1-02(w) definition of ``significant subsidiary''
is used in a number of rules and forms, including From 20-F, Form S-
3, Form F-3, Schedule 14A, Form 8-K, Form 1-U, Form 10-Q, and Form
10-K. See supra note 23. We do not expect the changes to the
definition to materially affect the burden estimate for these rules
and forms beyond the effects for the changes related to Rule 3-05
and Rule 3-14 discussed in this PRA.
\484\ To develop these estimates, Commission staff searched and
analyzed filings for the calendar year 2017 and the first nine
months of 2018. See discussion in Section V.B.1.a. of the Proposing
Release.
---------------------------------------------------------------------------
b. Proposed Amendments to Pro Forma Financial Information Requirements
Considering the various revisions outlined in Section II.D. above,
we estimate that the amendments to Article 11 and Rule 8-05 will reduce
a registrant's paperwork burden by simplifying disclosure requirements
generally, but may increase burdens to the extent that the registrants
are required to depict pro forma financial information for the
aggregate impact in all material respects of the acquired businesses,
rather than only a mathematical majority of the individually
insignificant businesses acquired, and in the case of smaller reporting
companies, requiring pro forma financial information in some additional
circumstances \485\ and requiring that the information be provided in a
clearer and more robust manner. We are adopting amendments that permit,
rather than require, registrants to include certain forward-looking
information in the Management's Adjustments to the pro forma financial
information. We have not revised our burden estimates from the
Proposing Release as a result of this changes in order to more
conservatively estimate the burden on issuers of providing this
disclosure because these changes may additionally increase burdens to
the extent registrants provide the disclosure. To estimate the overall
paperwork burden reduction from the proposed amendments, we first
estimated the number of filings that
[[Page 54056]]
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.
---------------------------------------------------------------------------
\485\ The additional circumstances that would require a smaller
reporting company to present pro forma financial information under
the 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
amendments on the paperwork burdens associated with the affected forms
filed by investment companies.
---------------------------------------------------------------------------
\486\ This estimated reduction of 125 burden hours is due to the
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.
\487\ To determine the paperwork burden for a registrant to make
disclosures in accordance with Rule 6-11 and 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 Proposing
Release at note 298.
\488\ See supra Section II.E.2 and II.E.3.
Table 2--Estimated Paperwork Burden Effects for Investment Companies
------------------------------------------------------------------------
Estimated effect
Amendment and affected Brief explanation of
forms estimated effect
------------------------------------------------------------------------
Rule 6-11, Rule 1-02(w), A reduction of This
Article 11 of Regulation S-X, 100 burden hours reduction is derived
and Form N-14. for each filing from an estimated
that contains reduction of 125
acquired fund burden hours
financial resulting from the
information on amendments discussed
the following in Section II.E.
forms: N-1A, N-2 above \486\ compared
and N-14. to existing Rule 3-
05 and pro forma
financial
information
requirements.\487\
This
reduction was then
offset by an
estimated increase
of 25 burden hours
for the schedules
and supplemental
information under
Rule 6-11.\488\
------------------------------------------------------------------------
Considering the various revisions outlined in Section II.E above,
we estimate that Rule 6-11 and the related amendments generally will
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 amendments, we
estimated the number of filings that include acquired fund financial
statements, used this data to extrapolate the effect of these changes
on the paperwork burden, and applied these percentages to the current
estimates for the number of responses in the Commission's current OMB
PRA filing inventory.\489\
---------------------------------------------------------------------------
\489\ See discussion in Section V.B.2. of the Proposing Release.
---------------------------------------------------------------------------
C. Aggregate Burden and Cost Estimates for the Amendments
Below we estimate the aggregate change in paperwork burden as a
result of the 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 amendments. The portion of the burden carried by outside
professionals is reflected as a cost,\490\ while the portion of the
burden carried by the registrant internally is reflected in hours.\491\
---------------------------------------------------------------------------
\490\ 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.
\491\ For purposes of the PRA, we estimate that 75 percent of
the burden of preparation of Forms 8-K and 1-A is carried by the
registrant internally and that 25 percent 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 percent 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 percent 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 amendments.
Table 3--Calculation of the Reduction in Burden Estimates of Current Responses Due to the 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 Reduction in professional professional
estimated reduction per burden hours company hours hours for costs for
Form affected current for current for current current current
reponses affected affected affected affected affected
response responses responses responses responses
(A) (B) (C) = (A) x (D) = (C) x (E) = (C) x (F) = (E) x
(B) 0.75 or 0.25 0.25 or 0.75 $400
--------------------------------------------------------------------------------------------------------------------------------------------------------
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)
[[Page 54057]]
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 4--Calculation of the Change in Burden Estimates of Current Responses Due to Rule 6-11 and Amendments to Form N-14
--------------------------------------------------------------------------------------------------------------------------------------------------------
Change in Change in
Number of Burden hour Change in Change in professional professional
estimated change per burden hours company hours hours for costs for
Form affected current for current for current current current
reponses affected affected affected affected affected
response responses responses responses responses
(A) (B) (C) = (A) x (D) = (C) x (E) = (C) x (F) = (E) x
(B) 0.75 or 0.25 0.25 or 0.75 $400
--------------------------------------------------------------------------------------------------------------------------------------------------------
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 5--Requested Paperwork Burden Under the Amendments
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Current burden Program change Requested change in burden
--------------------------------------------------------------------------------------------------------------------------------
Form Current Current Current Number of Reduction Reduction in
annual burden professional affected in company professional Annual Burden Professional
responses hours cost burden responses hours costs responses hours cost burden
(A) (B) (C) (D) (E) (F) (G) = (A) (H) = (I) =
(B) + (E) (C) + (F)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
10............................................................. 216 11,855 $14,091,488 20 (500) ($600,000) 216 11,355 $13,491,488
1-A............................................................ 179 98,396 13,111,912 18 (1,350) (180,000) 179 97,046 12,931,912
S-1............................................................ 901 147,208 180,319,975 78 (1,950) (2,340,000) 901 145,259 177,979,975
S-3............................................................ 1,657 1,963,626 236,198,036 192 (4,800) (5,760,000) 1,657 188,825 230,438,036
F-1............................................................ 63 26,692 32,275,375 2 (50) (60,000) 63 26,642 32,215,375
F-3............................................................ 112 4,441 5,703,600 3 (75) (90,000) 112 4,366 5,613,600
8-K............................................................ 118,387 818,158 108,674,430 947 (71,025) (9,470,000) 118,387 747,133 99,204,430
N-1A........................................................... 6,002 1,642,490 131,139,208 8 (200) (240,000) 6,002 1,642,290 130,899,208
N-2............................................................ 166 74,145 4,718,196 3 (75) (90,000) 166 74,070 4,628,196
N-14........................................................... 253 125,820 5,842,000 88 (2,200) (2,640,000) 192 123,620 3,202,000
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
VI. Final Regulatory Flexibility Act Analysis
The Regulatory Flexibility Act (``RFA'') \492\ requires the
Commission, in promulgating rules under Section 553 of the
Administrative Procedure Act,\493\ to consider the impact of those
rules on small entities. We have prepared this Final Regulatory
Flexibility Act Analysis in accordance with Section 604 of the
RFA.\494\ It relates to the amendments to the definition of
``significant subsidiary'' and the financial disclosure requirements in
Regulation S-X relating to significant business acquisitions and
dispositions to improve those requirements for both investors and
registrants. An Initial Regulatory Flexibility Analysis (``IRFA'') was
prepared in accordance with the RFA and was included in the Proposing
Release.
---------------------------------------------------------------------------
\492\ 5 U.S.C. 601 et seq.
\493\ 5 U.S.C. 553.
\494\ 5 U.S.C. 604.
---------------------------------------------------------------------------
A. Reasons for, and Objectives of, the Final Amendments
The amendments include changes to the definition of ``significant
subsidiary'' \495\ and 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.\496\ We are also adopting new Rule 6-11 and amendments to Form
N-14 to specifically govern
[[Page 54058]]
financial reporting for acquisitions involving investment companies.
The purpose of the amendments is to improve the application of the
rules, assist registrants in making more meaningful determinations of
whether a subsidiary or an acquired or disposed business is
significant, and to improve the disclosure requirements for financial
statements relating to acquisitions and dispositions of businesses,
including real estate operations and investment companies. The reasons
for, and objectives of, the amendments are discussed in more detail in
Sections II.A through II.E. above.
---------------------------------------------------------------------------
\495\ We are amending the definition of ``significant
subsidiary'' in Rule 1-02(w) of Regulation S-X, Exchange Act Rule
12b-2, Securities Act Rule 405, and Investment Company Act Rule 8b-
2.
\496\ We are also amending Rule 3-06 and Rule 3-09, Article 8,
and Article 11 of Regulation S-X. In addition, we are making related
amendments to Form S-11, Form 1-A, Form 8-K, Form 10-K, and Form N-
2.
---------------------------------------------------------------------------
B. Significant Issues Raised by Public Comments
In the Proposing Release, we requested comment on all aspects of
the IRFA, including the number of small entities that would be affected
by the proposed amendments, the existence or natures of the potential
impact of the proposals on small entities discussed in the analysis,
and how to quantify the impact of the proposed amendments. We did not
receive any comments specifically addressing the IRFA. However, we
received a number of comments on the proposed amendments
generally,\497\ and have considered these comments in developing the
FRFA.
---------------------------------------------------------------------------
\497\ See Section II above.
---------------------------------------------------------------------------
C. Small Entities Subject to the Proposed Rules
The final amendments will affect some registrants that are small
entities. The RFA defines ``small entity'' to mean ``small business,''
``small organization,'' or ``small governmental jurisdiction.'' \498\
For purposes of the RFA, under our rules, an issuer, other than an
investment 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.\499\ We
estimate that there are 1,056 issuers that file with the Commission,
other than investment companies, that may be considered small entities
and are potentially subject to the final amendments.\500\ 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.\501\
Commission staff estimates that, as of December 31, 2019, there were
approximately 76 open-end and closed-end investment companies that
would be considered small entities. Commission staff further estimates
that, as of December 31, 2019, approximately 14 business development
companies were small entities.\502\
---------------------------------------------------------------------------
\498\ 5 U.S.C. 601(6).
\499\ See 17 CFR 230.157 under the Securities Act and 17 CFR
240.0-10(a) under the Exchange Act.
\500\ 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 thereto, filed during the calendar year of
January 1, 2018 to December 31st, 2018. Analysis is based on data
from XBRL filings, Compustat, and Ives Group Audit Analytics.
\501\ 17 CFR 270.0-10(a).
\502\ These estimates are based on staff analysis of Morningstar
data and data submitted by investment company registrants in forms
filed on EDGAR as of December 31, 2019.
---------------------------------------------------------------------------
D. Reporting, Recordkeeping, and Other Compliance Requirements
As noted above, the purpose of the final amendments is to improve
the application of the rules and reduce the complexity and costs of
preparing the related disclosure.\503\ We are also amending specific
regulatory requirements for investment companies to address the unique
attributes of this group of registrants.\504\
---------------------------------------------------------------------------
\503\ See supra Sections II.A. through II.D. for a detailed
discussion of the final amendments applicable to registrants with
operations or that otherwise are not investment companies.
\504\ See supra Section II.E.
---------------------------------------------------------------------------
Many of the changes simplify and streamline existing disclosure
requirements in ways that are expected to reduce compliance burdens for
all registrants, including small entities. Some, such as the rules
permitting registrants to include Management's Adjustments in their pro
forma financial information, could incrementally increase compliance
costs to the extent that an entity chooses to provide this disclosure.
In addition, compliance with the final amendments requires the use of
professional skills, including accounting and legal skills. We discuss
the economic impact, including the estimated costs and burdens, of the
final amendments to all registrants, including small entities, in
Sections IV and V above.
E. Agency Action To Minimize Effect on Small Entities
The RFA directs us to consider alternatives that would accomplish
our stated objectives, while minimizing any significant adverse impact
on small entities. Accordingly, 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 final amendments generally 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
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.\505\ For investment companies,
we believe that Rule 6-11 and 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 final amendments or to establish different
compliance or reporting requirements for such entities.
---------------------------------------------------------------------------
\505\ 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.
Commission staff also found that out of 12 Forms 1-A originally
filed in 2019 that disclosed acquisitions subject to Rule 8-04 or
Rule 8-06, 9 appeared to comply with Article 11 requirements.
---------------------------------------------------------------------------
Finally, with respect to using performance rather than design
standards, Regulation S-X and the final 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 final 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 allows
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.
[[Page 54059]]
VII. Statutory Authority
The amendments contained in this release are being adopted 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 Amendments
For the reasons set out in the preamble, the Commission amends
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. Amend Sec. 210.1-02 by revising paragraph (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 paragraph (w)(1)(i), (ii), or (iii) of this section;
however if the registrant is a registered investment company or a
business development company, the tested subsidiary 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) must 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) must use amounts determined under IFRS-IASB.
(i) Investment test. (A) For acquisitions, other than those
described in paragraph (w)(1)(i)(B) of this section, and dispositions
this test is met when 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.
(1) For acquisitions, the ``investments in'' the tested subsidiary
is the consideration transferred, adjusted to exclude the registrant's
and its other 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. It must 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, it
must include all contingent consideration, except contingent
consideration for which the likelihood of payment is remote.
(2) For dispositions, the ``investments in'' the tested subsidiary
is the fair value of the consideration, including contingent
consideration, for the disposed subsidiary when comparing to the
aggregate worldwide market value of the registrant's voting and non-
voting common equity, 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.
(3) When determining the aggregate worldwide market value of the
registrant's voting and non-voting common equity, use the average of
such aggregate worldwide market value calculated daily for the last
five trading days of the registrant's most recently completed month
ending prior to the earlier of the registrant's announcement date or
agreement date of the acquisition or disposition.
(B) For a combination between entities or businesses under common
control, this test is 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) In all other cases, this test is met when the registrant's and
its other subsidiaries' investments in and advances to the tested
subsidiary exceed 10 percent of the total assets of the registrant and
its subsidiaries consolidated as of the end of the most recently
completed fiscal year.
(ii) Asset test. This test is met when the registrant's and its
other subsidiaries' proportionate share of the tested subsidiary's
consolidated total assets (after intercompany eliminations) 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) This test is met when:
(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 before income taxes (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
(2) The registrant's and its other subsidiaries' proportionate
share of the tested subsidiary's consolidated total revenue from
continuing operations (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
paragraph (w)(1)(iii)(A)(2) does not apply if either the registrant and
its subsidiaries consolidated or the tested subsidiary
[[Page 54060]]
did not have material revenue in each of the two most recently
completed fiscal years.
(B) When determining the income component in paragraph
(w)(1)(iii)(A)(1) of this section:
(1) If a net loss from continuing operations before income taxes
(after intercompany eliminations) 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
before income taxes (after intercompany eliminations) 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 in this paragraph
(w)(1)(iii)(B)(2) if the revenue component in paragraph
(w)(1)(iii)(A)(2) of this section does not apply and the absolute value
of the registrant's and its subsidiaries' consolidated income or loss
from continuing operations before income taxes (after intercompany
eliminations) 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 must not be aggregated with entities
reporting income where the test involves combined entities, as in the
case of determining whether summarized financial data must be presented
or whether the aggregate impact specified in Sec. Sec. 210.3-
05(b)(2)(iv) and 210.3-14(b)(2)(i)(C) is met, 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 sum of 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
(except, for purposes of Sec. 210.6-11, the absolute value of the
change in net assets resulting from operations of 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 absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated is at least 10 percent lower than the average of the
absolute value of such amounts for each of its last five fiscal years,
then the registrant may compute both conditions of the income 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 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) must 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
section 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
must 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
will 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 section does 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 registering an offering of
securities to the security holders of the business to be acquired, then
the financial statements specified in Sec. Sec. 210.3-01 and 210.3-02
must 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 must 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 must be
filed for the periods specified in this paragraph (b)(2) or such
shorter period as the business has been in existence. Determine the
periods for which such financial statements are to be filed 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.
[[Page 54061]]
(ii) If any of the conditions exceeds 20 percent, but none exceed
40 percent, financial statements must be filed 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.
(iii) If any of the conditions exceeds 40 percent, financial
statements must 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 for
any condition, the registrant must provide the disclosure specified in
paragraphs (b)(2)(iv)(A) and (B) of this section, however in
determining the aggregate impact of the investment test condition also
include the aggregate impact calculated in accordance with Sec. 210.3-
14(b)(2)(ii) of any acquired or to be acquired real estate operations
specified in Sec. 210.3-14(b)(2)(i)(C). In determining whether the
income test condition (i.e. both the revenue component and the income
or loss from continuing operations component) exceeds 50 percent, the
businesses specified in this paragraph (b)(2)(iv) reporting losses must
be aggregated separately from those reporting income. If either group
exceeds 50 percent, paragraphs (b)(2)(iv)(A) and (B) of this section
will apply to all of the businesses specified in this paragraph
(b)(2)(iv) and will not be limited to either the businesses with losses
or those with income.
(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 and real estate operations, 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 or real
estate operation for which financial statements are not yet required
based on paragraph (b)(4)(i) of this section or Sec. 210.3-
14(b)(3)(i).
(3) The determination must be made using Sec. 210.11-01(b)(3) and
(4).
(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 must file those financial statements and any
pro forma information specified by Sec. Sec. 210.11-01 through 210.11-
03 (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
specified in paragraph (b)(2)(ii) of this section 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
at least nine months. Separate financial statements of the acquired
business specified in paragraph (b)(2)(iii) of this section 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. Financial
statements of an acquired or to be acquired foreign business (as
defined in Sec. 210.1-02(l)) meeting the requirements of Item 17 of
Form 20-F (Sec. 249.220f of this chapter) will satisfy this section.
Such financial statements may be reconciled to U.S. Generally Accepted
Accounting Principles (U.S. GAAP) or International Financial Reporting
Standards as issued by the International Accounting Standards Board
(IFRS-IASB) if the registrant is a foreign private issuer that prepares
its financial statements in accordance with IFRS-IASB. This
reconciliation must generally follow the form and content requirements
in Item 17(c) of Form 20-F; however, accommodations in Item 17(c)(2) of
Form 20-F that would be inconsistent with IFRS-IASB may not be applied,
and IFRS 1, First-time Adoption of International Financial Reporting
Standards, may be applied.
(d) Financial statements of an acquired or to be acquired business
that would be a foreign private issuer if it were a registrant.
Financial statements of an acquired or to be acquired business that 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. Sec. 230.405
and 240.3b-4 of this chapter) if it were a registrant may be prepared
in accordance with IFRS-IASB without reconciliation to U.S. GAAP or, if
the registrant is a foreign private issuer that prepares its financial
statements in accordance with IFRS-IASB, may be prepared according to a
comprehensive basis of accounting principles other than U.S. GAAP or
IFRS-IASB and must be reconciled to IFRS-IASB or to U.S. GAAP. This
reconciliation must generally follow the form and content requirements
in Item 17(c) of Form 20-F; however, accommodations in Item 17(c)(2) of
Form 20-F that would be inconsistent with IFRS-IASB may not be applied,
and IFRS 1, First-time Adoption of International Financial Reporting
Standards, may be applied.
(e) Financial statements for net assets that constitute a business.
For an acquisition of net assets that constitutes a business (e.g., an
acquired or to be acquired product line), the financial statements
prepared and audited in accordance with Regulation S-X may be
abbreviated financial statements prepared in accordance with paragraph
(e)(2) of this section if the business meets all of the qualifying
conditions in paragraph (e)(1) of this section.
(1) Qualifying conditions. (i) The total assets and total revenues
(both after intercompany eliminations) of the acquired or to be
acquired business constitute 20 percent or less of such corresponding
amounts of the seller and its subsidiaries consolidated as of and for
the most recently completed fiscal year.
(ii) Separate financial statements for the business have not
previously been prepared;
(iii) The acquired business was not a separate entity, subsidiary,
operating segment (as defined in U.S. GAAP or
[[Page 54062]]
IFRS-IASB, as applicable) or division during the periods for which the
acquired business financial statements would be required; and
(iv) The seller has not maintained the distinct and separate
accounts necessary to present financial statements that, absent this
paragraph (e), would satisfy the requirements of this section and it is
impracticable to prepare such financial statements.
(2) Presentation requirements. (i) The balance sheet may be a
statement of assets acquired and liabilities assumed;
(ii) The statement of comprehensive income must include expenses
incurred by or on behalf of the acquired business during the pre-
acquisition financial statement periods to be presented including, but
not limited to, costs of sales or services, selling, distribution,
marketing, general and administrative, depreciation and amortization,
and research and development, but may otherwise omit corporate overhead
expense, interest expense for debt that will not be assumed by the
registrant or its subsidiaries consolidated, and income tax expense.
The title of the statement of comprehensive income must be
appropriately modified to indicate it omits certain expenses; and
(iii) The notes to the financial statements must include:
(A) A description of the type of omitted expenses and the reason(s)
why they are excluded from the financial statements.
(B) An explanation of the impracticability of preparing financial
statements that include the omitted expenses.
(C) 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.
(D) 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) Disclosures about oil and gas producing
activities must be provided for each full year of operations presented
for an acquired or to be acquired business that includes significant
oil- and gas-producing activities (as defined in the FASB ASC Master
Glossary). The financial statements may present 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 as unaudited supplemental
information. 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. The method of computation must be disclosed in a footnote.
(2) The financial statements prepared and audited in accordance
with Regulation S-X may consist of only statements of revenues and
expenses that exclude expenses not comparable to the proposed future
operations such as depreciation, depletion and amortization, corporate
overhead, income taxes, and interest for debt that will not be assumed
by the registrant or its subsidiaries consolidated 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 qualifying conditions specified in paragraph (e)(1) of
this section are met.
(3) If the financial statements are presented in accordance with
paragraph (f)(2) of this section, the disclosures specified in
paragraph (e)(2)(iii) of this section must be provided.
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 will
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 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 Sec.
210.8-01(e).
(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 will satisfy a filing requirement of financial
statements for one year of that time period only if the conditions
described in paragraph (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. Amend Sec. 210.3-09 by revising paragraph (a) to read as follows:
Sec. 210.3-09 Separate financial statements of subsidiaries not
consolidated and 50 percent or less owned persons.
(a) If any of the conditions set forth in Sec. 210.1-02(w),
substituting 20 percent for 10 percent in the tests used therein to
determine a significant subsidiary, are met for a majority-owned
subsidiary not consolidated by the registrant or by a subsidiary of the
registrant, separate financial statements of such subsidiary must be
filed. Similarly, if either the first or third condition set forth in
Sec. 210.1-02(w)(1), substituting 20 percent for 10 percent, is met by
a 50 percent or less owned person accounted for by the equity method
either by the registrant or a subsidiary of the registrant, separate
financial statements of such 50 percent or less owned person must be
filed.
* * * * *
0
6. 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 real estate operation 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 must 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
section 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.
[[Page 54063]]
(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 will 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 will 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 section does 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 registering an offering of
securities to the security holders of the real estate operation to be
acquired, then the financial statements specified in paragraph (c) of
this section and the supplemental information specified in paragraph
(f) of this section must 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 must 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 Form 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 must 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 must be determined using the investment test 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 must 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) of this section, exceeds
50 percent, the registrant must provide the disclosures specified in
paragraphs (b)(2)(i)(C)(1) and (b)(2)(i)(C)(2) of this section. If
there are also businesses acquired or to be acquired as described in
Sec. 210.3-05(b)(2)(iv), the requirements in Sec. 210.3-05(b)(2)(iv)
will apply instead.
(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 ``investments in'' the tested
real estate operation.
(iii) The determination must be made using Sec. 210.11-01(b)(3)
and (4).
(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 paragraph (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 must file those financial
statements and any pro forma information specified by Sec. Sec.
210.11-01 through 210.11-03 (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 real estate
operation specified in paragraph (b)(2)(i)(B) of this section 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 at least nine months.
(c) Presentation of the financial statements. (1) The financial
statements prepared and audited in accordance with Regulation S-X 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 must 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 a foreign real estate operation.
Financial statements of an acquired or to be acquired foreign business
(as defined in Sec. 210.1-02(l)) that is a real estate operation,
specified in paragraph (c) of this section and meeting the requirements
of Item 17 of Form 20-F (Sec. 249.220f of this chapter), will satisfy
this section. Such financial statements may be reconciled to U.S.
Generally Accepted Accounting Principles (U.S. GAAP) or International
Financial Reporting Standards as issued by the International Accounting
Standards Board (IFRS-IASB) if the registrant is a foreign private
issuer that prepares its financial statements in accordance with
[[Page 54064]]
IFRS-IASB. This reconciliation must generally follow the form and
content requirements in Item 17(c) of Form 20-F; however,
accommodations in Item 17(c)(2) of Form 20-F that would be inconsistent
with IFRS-IASB may not be applied, and IFRS 1, First-time Adoption of
International Financial Reporting Standards, may be applied.
(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. Financial statements of an acquired or to be acquired real
estate operation that 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. Sec. 230.405 and 240.3b-4 of this chapter) if it were a
registrant, may be prepared in accordance with IFRS-IASB without
reconciliation to U.S. GAAP or, if the registrant is a foreign private
issuer that prepares its financial statements in accordance with IFRS-
IASB, may be prepared according to a comprehensive basis of accounting
principles other than U.S. GAAP or IFRS-IASB and must be reconciled to
IFRS-IASB or to U.S. GAAP. This reconciliation must generally follow
the form and content requirements in Item 17(c) of Form 20-F; however,
accommodations in Item 17(c)(2) of Form 20-F that would be inconsistent
with IFRS-IASB may not be applied, and IFRS 1, First-time Adoption of
International Financial Reporting Standards, may be applied.
(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) of this section, 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 1 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
7. Amend Sec. 210.3-18(d) by removing the text ``Sec. Sec. 210.6-01
to 210.6-10'' and adding in its place ``Sec. Sec. 210.6-01 through
210.6-11''.
Sec. 210.5-01 [Amended]
0
8. Amend Sec. 210.5-01(a) by removing the text ``Sec. Sec. 210.6-01
to 210.6-10'' and adding in its place ``Sec. Sec. 210.6-01 through
210.6-11''.
Sec. 210.6-01 [Amended]
0
9. Amend Sec. 210.6-01 by removing the text ``210.6-01 to 210.6-10''
everywhere it appears and adding in its place ``210.6-01 through 210.6-
11''.
Sec. 210.6-02 [Amended]
0
10. Amend Sec. 210.6-02(b) and (c) by removing the text ``Sec. Sec.
210.6-01 to 210.6-10'' and adding in its place ``Sec. Sec. 210.6-01
through 210.6-11''.
Sec. 210.6-03 [Amended]
0
11. Amend Sec. 210.6-03 by removing the text ``Sec. Sec. 210.6-01 to
210.6-10'' in the introductory text and paragraph (a) and adding in its
place ``Sec. Sec. 210.6-01 through 210.6-11''.
0
12. Add Sec. 210.6-11 to read as follows:
Sec. 210.6-11 Financial statements of funds acquired or to be
acquired.
(a) Financial statements required. (1) Financial statements
described in Sec. Sec. 210.3-01 and 210.3-02, or Sec. 210.3-18, as
applicable, including the schedules specified in Sec. Sec. 210.12-01
through 210.12-29 (Article 12), prepared and audited in accordance with
Regulation S-X (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 must 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 or Sec. 210.3-
18, a fund acquisition has occurred; or
(ii) After the date of the most recent balance sheet filed pursuant
to Sec. 210.3-01 or Sec. 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 Sec. 230.485(a)(2) of this chapter (Rule
485(a)(2) under the Securities Act), 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. Among the facts and circumstances which should be considered
in evaluating whether a fund acquisition has occurred or will occur are
whether it will result in the acquisition by the registrant of all or
substantially all of the portfolio investments held by another fund.
(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 will be
treated under this section as if they are a single acquisition. For
purposes of this section, funds will 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 section does 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) of this section must 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 must
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 Form 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 must be filed. Whether such
financial statements
[[Page 54065]]
and supplemental information are to be filed must be determined using
the conditions specified in the definition of significant subsidiary in
Sec. 210.1-02(w)(2)(i) and (w)(2)(ii)(B) as follows:
(i) If none of the conditions set forth in Sec. 210.1-02(w)(2)(i)
and (w)(2)(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 (w)(2)(ii)(B), substituting 20 percent for 10 percent each place it
appears therein, are satisfied, the financial statements of the
acquired fund must be filed. If the acquired fund is subject to Sec.
210.3-18, then the financial statements for the periods described
therein must be filed. For all other acquired funds, the financial
statements for the most recent fiscal year and the most recent interim
period must be filed. The registrant must 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 (w)(2)(ii)(B), substituting 50
percent for 10 percent each place it appears therein, the registrant
must provide financial statements for any fund acquired or to be
acquired for which financial statements are not yet required by
paragraph (b)(2)(i) of this section. If any of the acquired funds are
subject to Sec. 210.3-18, then the financial statements for the
periods described therein must be filed. For any other acquired funds,
the financial statements for the most recent fiscal year and the most
recent interim period must be filed. The registrant must also provide
the supplemental financial information in paragraph (d) of this section
for such funds.
(3) The determination must 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 and the
supplemental information specified in paragraph (d) of this section
need only to be filed once and not included in any subsequent filing or
shareholder report.
(c) Acquisitions involving private funds or private accounts. If
the fund acquired or 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 may comply with U.S. Generally
Accepted Accounting Principles and only Article 12. In situations of
any private account managed by an investment adviser provide the
schedules specified in Article 12 for the assets acquired or to be
acquired.
(d) Supplemental financial information. (1) Supplemental financial
information must 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;
(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 accounting
policies of the acquired fund when compared to the registrant.
(2) With respect to any fund acquisition, registered investment
companies and business development companies must provide the
supplemental financial information required in this section in lieu of
any pro forma financial information required by Sec. Sec. 210.11-01
through 210.11-03.
0
13. Revise Sec. 210.8-01 to read as follows:
Sec. 210.8-01 General requirements for Article 8.
Sections 210.8-01 through 210.8-08 (Article 8) shall be applicable
to financial statements filed for smaller reporting companies. These
sections are not applicable to financial statements prepared for the
purposes of Item 17 or Item 18 of Form 20-F.
(a) Financial statements of a smaller reporting company, as defined
by Sec. 229.10(f)(1) of this chapter, its predecessors or any
businesses to which the smaller reporting company is a successor shall
be prepared in accordance with generally accepted accounting principles
in the United States.
(b) Smaller reporting companies electing to prepare their financial
statements with the form and content required in Article 8 need not
apply the other form and content requirements in Regulation S-X with
the exception of the following:
(1) The report and qualifications of the independent accountant
shall comply with the requirements of Sec. Sec. 210.2-01 through
210.2-07 (Article 2); and
(2) The description of accounting policies shall comply with Sec.
210.4-08(n); and
(3) Smaller reporting companies engaged in oil and gas producing
activities shall follow the financial accounting and reporting
standards specified in Sec. 210.4-10 with respect to such activities.
(c) Financial statements for a subsidiary of a smaller reporting
company that issues securities guaranteed by the smaller reporting
company or guarantees securities issued by the smaller reporting
company must be presented as required by Sec. 210.3-10, except that
the periods presented are those required by Sec. 210.8-02.
(d) Financial statements for a smaller reporting company's
affiliates whose securities constitute a substantial portion of the
collateral for any class of securities registered or being registered
must be presented as required by Sec. 210.3-16, except that the
periods presented are those required by Sec. 210.8-02.
(e) The Commission, where consistent with the protection of
investors, may permit the omission of one or more of the financial
statements or the substitution of appropriate statements of comparable
character. The Commission by informal written notice may require the
filing of other financial statements where necessary or appropriate.
(f) Section 210.3-06 applies to the preparation of financial
statements of smaller reporting companies.
Sec. 210.8-03 [Amended]
0
14. Remove and reserve Sec. 210.8-03(b)(4).
0
15. Revise Sec. 210.8-04 to read as follows:
[[Page 54066]]
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
16. Revise Sec. 210.8-05 to read as follows:
Sec. 210.8-05 Pro forma financial information.
(a) Pro forma financial information must be disclosed when any of
the conditions in Sec. 210.11-01 exist.
(b) The preparation, presentation, and disclosure of pro forma
financial information must 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
17. 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
18. Amend Sec. 210.11-01 by:
0
a. Revising paragraphs (a) introductory text and (a)(1) and (2);
0
b. Removing and reserving (a)(5);
0
c. Revising paragraphs (a)(6) and (8), (b), and (c).
The revisions read as follows:
Sec. 210.11-01 Presentation requirements.
(a) Pro forma financial information must 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 this section, 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;
* * * * *
(6) Pro forma financial information required by Sec. 229.914 of
this chapter is required to be provided in connection with a roll-up
transaction as defined in Sec. 229.901(c) of this chapter;
* * * * *
(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 will 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) (i.e., the investment test condition), substituting 20
percent for 10 percent, as modified by the guidance in Sec. 210.3-
14(b)(2)(ii).
(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 must be made, except as noted in paragraph
(b)(4) of this section for the continuous offerings described therein,
by using:
(i) For amounts derived from financial statements, the registrant's
most recent annual consolidated financial statements required to be
filed at or prior to the date of acquisition or disposition and the
business's pre-acquisition or pre-disposition financial statements for
the same fiscal year as the registrant or, if the fiscal years differ,
the business's most recent fiscal year that would be required if the
business had the same filer status as the registrant, however the
determination may be made using:
(A) The financial statements for the business described in Sec.
210.3-05(e) or (f) if the business meets the conditions for presenting
those financial statements.
(B) Pro forma amounts 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 and only include Transaction Accounting Adjustments (see Sec.
210.11-02(a)(6)(i)), provided that:
(1) 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. Sec. 210.11-01 through 210.11-02 for any such acquired or
disposed business. The tests may not be made by ``annualizing'' data;
and
(2) If a registrant has used pro forma amounts to determine
significance of an acquisition or disposition, it must continue to use
pro forma amounts to determine significance of acquisitions and
dispositions through the filing date of its next annual report on Form
10-K (Sec. 249.310 of this chapter) or Form 20-F (Sec. 249.220f of
this chapter); or
(C) 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 date of 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).
(ii) If the business is a related business (see Sec. 210.3-
05(a)(3)), combined pre-acquisition financial statements of the group
of related businesses for the fiscal year specified in paragraph
(b)(3)(i) of this section.
(4) 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, the income
test condition does not apply, and the determination must be made for
the investment test condition, when it is based on the total assets of
the registrant and its subsidiaries consolidated, and the asset test
condition, if applicable, using the following for the registrant:
(i) During the distribution period, total assets as of the date of
acquisition or disposition plus the proceeds (net of commissions) in
good faith expected to be raised in the registered offering over the
next 12 months, except that for acquisitions total assets must exclude
the acquired business; and
(ii) After the distribution period ends and until the next Form 10-
K is filed, total assets as of the date of acquisition or disposition,
except that for acquisitions total assets must exclude the acquired
business; and
(iii) After that next Form 10-K is filed, the guidance in paragraph
(b)(3).
(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. 210.3-05(b)(2)(iv) or Sec. 210.3-
14(b)(2)(i)(C).
* * * * *
0
19. Revise Sec. 210.11-02 to read as follows:
Sec. 210.11-02 Preparation requirements.
(a) Form and content. (1) Pro forma financial information must
consist of a pro forma condensed balance sheet, pro
[[Page 54067]]
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 disclosed in lieu of the statements described in
this paragraph (a)(1).
(2) The pro forma financial information must 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 must be used for purposes of this test. Notwithstanding
these tests, de minimis amounts need not be shown separately.
(4) Pro forma statements will 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 must
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 must include, and be limited to, the
following pro forma adjustments, except as noted in paragraph (a)(7) of
this section:
(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), qualification date (for offering
statements under 17 CFR 230.251 through 230.263 (Regulation A)), 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.
Such adjustments must be made whether or not the pro forma balance
sheet is presented pursuant to paragraph (c)(1) of this section. 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) Autonomous Entity Adjustments. Adjustments that depict the
registrant as an autonomous entity if the condition in Sec. 210.11-
01(a)(7) is met. Autonomous Entity Adjustments must be presented in a
separate column from Transaction Accounting Adjustments.
(7) Management's Adjustments depicting synergies and dis-synergies
of the acquisitions and dispositions for which pro forma effect is
being given may, in the registrant's discretion, be presented if in its
management's opinion, such adjustments would enhance an understanding
of the pro forma effects of the transaction and the following
conditions are met:
(i) Basis for Management's Adjustments. (A) There is a reasonable
basis for each such adjustment.
(B) The adjustments are limited to the effect of such synergies and
dis-synergies on the historical financial statements that form the
basis for the pro forma statement of comprehensive income as if the
synergies and dis-synergies existed as of the beginning of the fiscal
year presented. If such adjustments reduce expenses, the reduction must
not exceed the amount of the related expense historically incurred
during the pro forma period presented.
(C) The pro forma financial information reflects all Management's
Adjustments that are, in the opinion of management, necessary to a fair
statement of the pro forma financial information presented and a
statement to that effect is disclosed. When synergies are presented,
any related dis-synergies must also be presented.
(ii) Form of presentation. (A) If presented, Management's
Adjustments must be presented in the explanatory notes to the pro forma
financial information in the form of reconciliations of pro forma net
income from continuing operations attributable to the controlling
interest and the related pro forma earnings per share data specified in
paragraph (a)(9) of this section to such amounts after giving effect to
Management's Adjustments.
(B) Management's Adjustments included or incorporated by reference
into a registration statement, proxy statement, Regulation A offering
statement, or Form 8-K should be as of the most recent practicable date
prior to the effective date, mail date, qualification date, or filing
date as applicable, which may require that they be updated if
previously provided in a Form 8-K that is appropriately incorporated by
reference.
(C) If Management's Adjustments will change the number of shares or
potential common shares, reflect the change within Management's
Adjustments 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.
(D) The explanatory notes must also include disclosure of the basis
for and material limitations of each Management's Adjustment, including
any material assumptions or uncertainties of such adjustment, an
explanation of the method of the calculation of the adjustment, if
material, and the estimated time frame for achieving the synergies and
dis-synergies of such adjustment.
Instruction 1 to paragraph (a)(7): Any forward-looking information
supplied is expressly covered by the safe harbor rules under Sec. Sec.
230.175 and 240.3b-6 of this chapter.
(8) All pro forma adjustments should be referenced to notes that
clearly explain the assumptions involved.
(9)(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 must be presented on the face of the pro forma condensed
statement of comprehensive income and only give effect to Transaction
Accounting Adjustments and Autonomous Entity Adjustments.
[[Page 54068]]
(ii) The number of shares used in the calculation of the pro forma
per share amounts must 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.
(10) 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.
(11) The accompanying explanatory notes must 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 Autonomous Entity Adjustment, a description of the
adjustment (including the material uncertainties), the material
assumptions, the calculation of the adjustment, and additional
qualitative information about the Autonomous Entity Adjustments, if
any, necessary to give a fair and balanced presentation of the pro
forma financial information.
(12) A registrant must 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 pro forma financial information, or summaries of such
information, elsewhere in a filing that excludes material transactions
for which pro forma effect is required to be given.
(iii) Present the pro forma amounts in paragraph (a)(7) of this
section elsewhere in a filing without also presenting with equal or
greater prominence the amounts specified in paragraph (a)(7) of this
section to which they are required to be reconciled and a cross-
reference to that reconciliation.
(iv) 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.
(b) Implementation guidance--(1) Historical statement of
comprehensive income. The historical statement of comprehensive income
used in the pro forma financial information must 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 must be disclosed in a note.
(3) Business dispositions. Transaction Accounting Adjustments
giving effect to the disposition of a business must not decrease
historically incurred compensation expense for employees who were not,
or will not be, transferred or terminated as of the disposition date.
(4) Multiple transactions. (i) When consummation of more than one
transaction has occurred, or is probable, the pro forma financial
information must 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 must 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 must be
filed unless the transaction is already reflected in such balance
sheet.
(2)(i) Pro forma condensed statements of comprehensive income must
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 must 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 must 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 must 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 must 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
[[Page 54069]]
statement of comprehensive income must 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 must 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 1 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
20. 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 ``rule'' and ``generally accepted
accounting principles'' and adding in their places ``section'' and
``U.S. GAAP or IFRS-IASB,'' respectively.
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
0
21. The authority citation for part 230 continues to read, in part, as
follows:
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
22. 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 paragraph (1), (2), or (3) of this definition; however,
if the registrant is a registered investment company or a business
development company, the tested subsidiary meets any of the conditions
in paragraph (4) of this definition instead of any of the conditions in
paragraph (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) must 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) must use amounts
determined under IFRS-IASB.
(1) Investment test. (i) For acquisitions, other than those
described in paragraph (1)(ii) of this definition, and dispositions
this test is met when 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.
(A) For acquisitions, the ``investments in'' the tested subsidiary
is the consideration transferred, adjusted to exclude 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. It must 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, it
must include all contingent consideration, except contingent
consideration for which the likelihood of payment is remote.
(B) For dispositions, the ``investments in'' the tested subsidiary
is the fair value of the consideration, including contingent
consideration, for the disposed subsidiary when comparing to the
aggregate worldwide market value of the registrant's voting and non-
voting common equity, 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.
(C) When determining the aggregate worldwide market value of the
registrant's voting and non-voting common equity, use the average of
such aggregate worldwide market value calculated daily for the last
five trading days of the registrant's most recently completed month
ending prior to the earlier of the registrant's announcement date or
agreement date of the acquisition or disposition.
(ii) For a combination between entities or businesses under common
control, this test is 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) In all other cases, this test is met when the registrant's
and its other subsidiaries' investments in and advances to the tested
subsidiary exceed 10 percent of the total assets of the registrant and
its subsidiaries consolidated as of the end of the most recently
completed fiscal year.
(2) Asset test. This test is met when the registrant's and its
other subsidiaries' proportionate share of the tested subsidiary's
consolidated total assets (after intercompany eliminations) 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) This test is met when:
(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 before income taxes (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 from
continuing operations (after intercompany eliminations)
[[Page 54070]]
exceeds 10 percent of such total revenue of the registrant and its
subsidiaries consolidated for the most recently completed fiscal year.
This paragraph (3)(i)(B) does not apply if either the registrant and
its subsidiaries consolidated or the tested subsidiary did not have
material revenue in each of the two most recently completed fiscal
years.
(ii) When determining the income component in paragraph (3)(i)(A)
of this definition:
(A) If a net loss from continuing operations before income taxes
(after intercompany eliminations) 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
before income taxes (after intercompany eliminations) 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;
(B) Compute the test using the average described in this paragraph
(3)(ii)(B) if the revenue component in paragraph (3)(i)(B) in this
definition does not apply and the absolute value of the registrant's
and its subsidiaries' consolidated income or loss from continuing
operations before income taxes (after intercompany eliminations)
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
(C) Entities reporting losses must not be aggregated with entities
reporting income where the test involves combined entities, as in the
case of determining whether summarized financial data must be presented
or whether the aggregate impact specified in Sec. Sec. 210.3-
05(b)(2)(iv) and 210.3-14(b)(2)(i)(C) of this chapter is met, except
when determining whether related businesses meet this test for purposes
of Sec. Sec. 210.3-05 and 210.8-04 of this chapter.
(4) Registered investment company or business development company.
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 sum of 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
(except, for purposes of Sec. 210.6-11 of this chapter, the absolute
value of the change in net assets resulting from operations of 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 (4)(i) of this definition) condition exceeds
5 percent. However, if the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated is at least 10 percent lower than the average of the
absolute value of such amounts for each of its last five fiscal years,
then the registrant may compute both conditions of the income 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
23. 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
24. Form S-11 (referenced in Sec. 239.18) is amended by revising Item
9 to read as follows:
Note: The text of Form S-11 does not, and this amendment will
not, appear in the Code of Federal Regulations.
FORM S-11
* * * * *
Item 9. Selected Financial Data
File the information required by Item 301 of Regulation S-K (Sec.
229.301 of this chapter).
0
25. Form N-14 (referenced in Sec. 239.23) is amended by revising 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 must 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, unless
it is an investment company subject to Sec. 210.3-18 in which case the
financial statements for the periods described therein must be filed;
2. if the company to be acquired is a private fund, then the
required financial statements may 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).
* * * * *
0
26. Amend Part F/S of Form 1-A (referenced in Sec. 239.90) by revising
paragraph (b)(7)(iv) to read as follows:
Note: The text of Form 1-A does not, and this amendment will
not, appear in the Code of Federal Regulations.
FORM 1-A
REGULATION A OFFERING STATEMENT UNDER THE SECURITIES ACT OF 1933
GENERAL INSTRUCTIONS
* * * * *
[[Page 54071]]
Part F/S
* * * * *
(b) Financial Statements for Tier 1 Offerings * * *
(7) * * *
(iv) Pro Forma Financial Statements. File pro forma financial
information as described in Rule 8-05 of Regulation S-X.
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
27. 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 Pub. L. 112-106,
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
28. 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 paragraph (1), (2), or (3) of this definition; however,
if the registrant is a registered investment company or a business
development company, the tested subsidiary meets any of the conditions
in paragraph (4) of this definition instead of any of the conditions in
paragraph (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) must 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) must use amounts
determined under IFRS-IASB.
(1) Investment test. (i) For acquisitions, other than those
described in paragraph (1)(ii) of this definition, and dispositions
this test is met when 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.
(A) For acquisitions, the ``investments in'' the tested subsidiary
is the consideration transferred, adjusted to exclude 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. It must 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, it
must include all contingent consideration, except contingent
consideration for which the likelihood of payment is remote.
(B) For dispositions, the ``investments in'' the tested subsidiary
is the fair value of the consideration, including contingent
consideration, for the disposed subsidiary when comparing to the
aggregate worldwide market value of the registrant's voting and non-
voting common equity, 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.
(C) When determining the aggregate worldwide market value of the
registrant's voting and non-voting common equity, use the average of
such aggregate worldwide market value calculated daily for the last
five trading days of the registrant's most recently completed month
ending prior to the earlier of the registrant's announcement date or
agreement date of the acquisition or disposition.
(ii) For a combination between entities or businesses under common
control, this test is 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) In all other cases, this test is met when the registrant's
and its other subsidiaries' investments in and advances to the tested
subsidiary exceed 10 percent of the total assets of the registrant and
its subsidiaries consolidated as of the end of the most recently
completed fiscal year.
(2) Asset test. This test is met when the registrant's and its
other subsidiaries' proportionate share of the tested subsidiary's
consolidated total assets (after intercompany eliminations) 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) This test is met when:
(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 before income taxes (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 from
continuing operations (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
paragraph (3)(i)(B) does not apply if either the registrant and its
subsidiaries consolidated or the tested subsidiary did not have
material revenue in each of the two most recently completed fiscal
years.
(ii) When determining the income component in paragraph (3)(i)(A)
of this definition:
(A) If a net loss from continuing operations before income taxes
(after intercompany eliminations) 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
before income taxes (after intercompany eliminations) 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;
(B) Compute the test using the average described in this paragraph
(3)(ii)(B) if the revenue component in paragraph (3)(i)(B) in this
definition does not apply and the absolute value of the registrant's
and its subsidiaries' consolidated income or loss from continuing
operations before income taxes (after intercompany eliminations)
attributable to the controlling interests for the most recent fiscal
year is at least 10 percent lower than the average of the absolute
[[Page 54072]]
value of such amounts for each of its last five fiscal years; and
(C) Entities reporting losses must not be aggregated with entities
reporting income where the test involves combined entities, as in the
case of determining whether summarized financial data must be presented
or whether the aggregate impact specified in Sec. Sec. 210.3-
05(b)(2)(iv) and 210.3-14(b)(2)(i)(C) of this chapter is met, except
when determining whether related businesses meet this test for purposes
of Sec. Sec. 210.3-05 and 210.8-04 of this chapter.
(4) Registered investment company or business development company.
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 sum of 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
(except, for purposes of Sec. 210.6-11 of this chapter, the absolute
value of the change in net assets resulting from operations of 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 (4)(i) of this definition) condition exceeds
5 percent. However, if the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated is at least 10 percent lower than the average of the
absolute value of such amounts for each of its last five fiscal years,
then the registrant may compute both conditions of the income 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 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
29. 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
30. 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 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 will 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 percent 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)). 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; or
(iii) in the case of a business development company, if the amount
paid for such assets exceeded 10 percent 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 and 210.3-14), or Rules 8-04 or 8-06 of Regulation S-X (17 CFR
210.8-04 and 210.8-06) for smaller 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 must 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, file any pro forma financial information that would
be required pursuant to Article 11 of Regulation S-
[[Page 54073]]
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 must 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 do 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, Rule 6-11, Rule 8-04, and Rule 8-06 of
Regulation S-X (17 CFR 210.3-05, 210.3-14, 210.6-11, 210.8-04, and
210.8-06), 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, Rule
6-11, Rule 8-04, and Rule 8-06 of Regulation S-X (17 CFR 210.3-05,
210.3-14, 210.6-11, 210.8-04, and 210.8-06), 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).
* * * * *
0
31. Form 10-K (referenced in Sec. 249.310) is amended by revising 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) File 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)) must 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
32. The general authority citation for part 270 continues to read 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
33. Amend Sec. 270.8b-2 by revising paragraph (k) to read as follows:
Sec. 270.8b-2 Definitions.
* * * * *
(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:
(1) 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
(2) Income test. The absolute value of the sum of 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:
(i) 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
(ii) 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)(1) of this section) condition exceeds 5
percent. However, if the absolute value of the change in net assets
resulting from operations of the registrant and its subsidiaries
consolidated is at least 10 percent lower than the average of the
absolute value of such amounts for each of its last five fiscal years,
then the registrant may compute both conditions of the income 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.
* * * * *
[[Page 54074]]
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
34. The general authority citation for part 274 continues to read 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
35. Amend Form N-2 (referenced in Sec. Sec. 239.14 and 274.11a-1) 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 20, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020-11479 Filed 8-28-20; 8:45 am]
BILLING CODE 8011-01-P