On May 3, the SEC proposed significant changes to its financial disclosures required upon the acquisition or disposition of businesses, including real estate operations and investment companies. The proposal is a result of the SEC’s ongoing evaluation of its disclosure requirements and incorporates feedback from its 2015 request for public input. The financial disclosure requirements addressed in the proposal are largely contained in Rules 1-02(w), 3-05 and 3-14 and Articles 8 and 11 of Regulation S-X.
Whether an SEC registrant is required to provide financial information relating to business acquisitions and dispositions is driven by whether the tested business meets the SEC’s definition of a significant subsidiary. The definition of a significant subsidiary is generally evaluated with three tests, referred to as the investment, income and asset tests.
The proposed changes would update the SEC’s significance tests in several respects, including:
- Revising the investment test to compare, under certain circumstances, the registrant’s investment in and advances to the tested business to the registrant’s aggregate worldwide market value of voting and non-voting common equity;
- Revising the income test to include, under certain circumstances, a two part trigger--one based on revenue and one based on income or loss from continuing operations attributable to controlling interests; and
- Expanding the instances in which pro forma financial information is used to measure significance.
The proposed changes would also:
- Reduce the maximum number of years for which audited financial statements are required under Rule 3-05 from three to two;
- Increase the significance threshold for providing pro forma information in connection with a disposal of a business from 10% to 20%;
- Permit the use, under certain circumstances, of abbreviated financial statements in connection with the acquisition of net assets that constitute a business but that is not a separate entity, subsidiary, segment or division (e.g., an acquired product line);
- Codify existing practice by requiring the presentation (on a supplemental, unaudited basis) of specified oil and gas-related disclosures in connection with the acquisition of a business that includes significant oil- and gas-producing activities and permitting the use, under certain circumstances, of abbreviated financial statements in connection with the acquisition of a business that generates substantially all of its revenues from oil- and gas-producing activities but is not a separate entity, subsidiary, segment or division;
- Amend the pro forma financial information requirements to include separate disclosure of “Transaction Accounting Adjustments,” reflecting the accounting for the transaction, and “Management’s Adjustments,” reflecting reasonably estimable synergies and other effects of the transaction;
- Eliminate the requirement for separate acquired business financial statements once the business has been included in the registrant’s post-acquisition audited financial statements for a complete fiscal year;
- Make corresponding changes to the smaller reporting company requirements in Article 8 of Regulation S-X; and
- Permit the financial statements of an acquired business that would meet the definition of a foreign private issuer if it were a registrant to be prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS-IASB) even if that business does not meet the definition of a foreign business, and permit the financial statements of an acquired foreign business that are prepared under “local GAAP” to be reconciled to IFRS-IASB if the registrant is a foreign private issuer that prepares its financial statements in accordance with IFRS-IASB (instead of requiring a reconciliation to US GAAP).
Specific to real estate operations, the proposal would:
- Align Rule 3-14 with Rule 3-05 when no unique industry considerations exist;
- Eliminate existing practice that frequently led to the filing of financial statements of the lessee or guarantor in connection with the acquisition of a real estate operation that is subject to a triple net lease with a single lessee; and
- Explicitly require interim financial statements.
Specific to investment companies, the proposal would:
- Expand Rule 1-02(w) to create a separate definition of significant subsidiary for investment companies, which would use an investment test and an income test, but not an asset test.
- Add a new Rule 6-11 to Regulation S-X to address specific issues unique to acquisitions by investment companies; and
- Amend Form N-14 to include financial statement requirements in accordance with Rule 6-11.