The Securities and Exchange Commission (SEC) recently proposed amendments to the financial disclosure requirements included in SEC Regulation S-X (Reg. S-X) for acquisitions and disposals of businesses by public companies. The amendments1 are intended to reduce both the complexity of the rules and the burden placed on public companies engaging in these transactions.
Current rules require SEC registrants to provide increasing levels of financial information for an acquired business based on increasing levels of “significance” of the acquisition using three tests – an investment test, an asset test and an income test.2 Up to three years of audited financial statements of an acquired company can be required based on the level of significance using these tests.
The SEC’s proposed rulemaking would modify the application of these three tests and make other related changes, including:
- Revising the income test to use after-tax income (instead of pre-tax income) and to add a component based on revenue, which will benefit companies with little or no earnings;
- Revising the investment test to compare the registrant’s investment in the acquired business to the registrant’s aggregate worldwide market value of voting and non-voting common equity (instead of assets);
- Eliminating the requirement for a third year of acquired business audited financial statements, so that the maximum number of years for which such statements are required will be two;
- Eliminating the requirement to file audited financial statements for individually insignificant acquisitions which make up a mathematical majority of a group of recent acquisitions which in the aggregate exceed 50% significance;
- Increasing the significance threshold for providing pro forma financial information in connection with a disposition of a business from 10% to 20%;
- Permitting the use of abbreviated financial statements for the acquisition of a component of a separate entity that constitutes a business (e.g., an acquired product line);
- Revising the pro forma financial information presentation to include separate columns for transaction accounting adjustments and management’s adjustments which reflect reasonably estimable synergies and other effects of the transaction, while simplifying the standards for including such adjustments; and
- Allowing the registrant to use pro forma financial information to measure significance in additional circumstances.
Revising the Income Test
The proposal would substitute after-tax income from continuing operations for the current pre-tax income when applying the income test. The after-tax figure can be obtained directly from the financial statements, simplifying the application of the test. The proposal also allows for a revenue alternative. Under the revenue alternative of the income test, the registrant would compare the registrant’s share of the acquired business’s consolidated total revenues to the consolidated total revenues for the registrant’s most recently completed fiscal year. If both the registrant and the acquired business have recurring annual revenue, the registrant may use the lower of the result from the calculation of after-tax income and the calculation of revenues in measuring significance. If either of the entities lacks recurring revenue, the registrant would be required to use the after-tax income to measure significance.
Reducing the Number of Years of Audited Financial Statements
Rule 3-05 of Reg. S-X currently requires three years of audited financial statements of the acquired business where any of the significance tests exceeds the 50% level. The proposal would eliminate this requirement. The proposal would retain the current requirement to provide two years of audited financial statements for an acquisition at the 40% significance level and one year at the 20% significance level.
The proposal also provides specific relief for certain classes of registrants, such as real estate companies, investment companies, and companies in the oil and gas industry.
For additional information about the proposed rulemaking, or to discuss any questions that you may have, please contact a member of Maynard Cooper’s Public Company Advisory team.
1 The amendments are found in SEC Rel. No.33-10635 available at https://www.sec.gov/rules/proposed/2019/33-10635.pdf (proposal). Comments on the proposal are due by July 29, 2019.
2 See Rule 1-02(w) of Reg. S-X. The SEC rule proposal retains the tests with modifications, as discussed herein.
This client alert is for information purposes only and should not be construed as legal advice.
This information in this client alert is not intended to create and will not constitute as a lawyer-client relationship.