Thursday, May 28th, 2020
The SEC Adopts Reforms to its Financial Disclosure Requirements for Business Acquisitions and Dispositions

On May 21, 2020, the Securities and Exchange Commission (SEC) adopted amendments to its financial disclosure requirements under Regulation S-X (Reg. S-X) for acquisitions and dispositions of businesses by public companies. The amendments1 are intended to 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.  As we noted in our prior alert, the SEC proposed amendments to these financial disclosure requirements in May 2019 as part of its Disclosure Effectiveness Initiative.  These amendments to Reg. S-X are effective January 1, 2021, but early compliance is permitted.

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 applying these tests. The significance tests also are used for determining the pro forma financial information requirements for acquired and disposed businesses.

The SEC’s amendments modify the application of these three significance tests and make other related changes, including:

  • Revising the income test to add a component based on revenue, which will benefit companies with little or no earnings; 3
  • 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 that make up a mathematical majority of a group of recent acquisitions exceeding 50% significance in the aggregate;
  • 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, autonomous entity adjustments (i.e., those necessary to show the registrant as an autonomous entity if it was previously part of another entity), and management’s adjustments4 that reflect reasonably estimable synergies and other effects of the transaction, while simplifying the standards for including such adjustments;
  • Allowing the registrant to use pro forma financial information to measure significance in additional circumstances;
  • Eliminating 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 (or nine months for an acquisition whose significance does not exceed 40%); and
  • Permitting 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).

Revising the Income Test

The amendments provide for a revenue alternative to the income test. Under the revenue alternative, the registrant will 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 revenues, the registrant may use the lower of the result from the calculation of income or loss from continuing operations before taxes and the calculation of revenues in measuring significance. If either of the entities does not have material revenues for each of the two most recent fiscal years, the registrant may not use the revenue alternative.

Revising the Investment Test

The amendments revise the investment test by comparing 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 the registrant’s assets as currently used in the investment test. The registrant’s aggregate worldwide market value is measured by using the average of the 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 (i) the registrant’s announcement date or (ii) the agreement date of the acquisition or disposition. The SEC believes that using the registrant’s aggregate worldwide market value more closely measures the economic significance of the acquisition to the registrant because the purchase price usually reflects fair value while the registrant’s total assets may not fully reflect fair value.

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 amendments eliminate this requirement. The amendments 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.

Allowing the Use of Pro Forma Information to Test Significance

Under current Reg. S-X, a registrant is permitted to use pro forma, rather than historical, financial information to determine the significance of a new acquisition if the registrant previously completed a significant acquisition subsequent to the latest fiscal year end and filed its acquisition financial statements and pro forma financial information on Form 8-K.  There is no provision for registrants to use such pro forma financial information depicting significant dispositions or for registrants filing initial registration statements. The amendments allow these registrants to use such pro forma information subject to certain requirements.

However, the amendments add the condition for all registrants that they cannot use management adjustments in the pro forma data used to determine significance. The pro forma financial information must be limited to the applicable subtotals that combine the historical financial information of the registrant and the acquired business, transaction accounting adjustments, and autonomous entity adjustments.

The amendments also provide 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 amendments, 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. 33-10786, available at https://www.sec.gov/rules/final/2020/33-10786.pdf.

2 See Rule 1-02(w) of Reg. S-X. The amendments retain the tests with modifications, as discussed herein.

3 The SEC’s rule proposing release also included a proposal to revise the income test to use after-tax income instead of pre-tax income. In response to comments received, the SEC abandoned this part of the proposal. The rule proposal is found in SEC Rel. No. 33-10635, available at https://www.sec.gov/rules/proposed/2019/33-10635.pdf.

4 “Management’s adjustments” are adjustments depicting synergies and dis-synergies of the acquisitions and dispositions for which pro forma effect is being given that may, in the registrant’s discretion, be presented if in management’s opinion, such adjustments would enhance an understanding of the pro forma effects of the transaction and certain conditions are met, including a reasonable basis for the adjustments. See Rule 11-02(a)(7) of Reg. S-X, as amended.

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