On May 3, 2019, the Securities and Exchange Commission (SEC) proposed amendments to the financial disclosure requirements in Rule 3-05 (Acquired Company Financial Information), Rule 3-14 (Real Estate Operations), and Article 11 (Pro Forma Financial Information) of Regulation S-X for financial statements of businesses acquired or to be acquired and for business dispositions. The SEC also proposed new Rule 6-11 of Regulation S-X and amendments to Form N-14 for financial reporting of acquisitions involving investment companies, as well as additional changes related to oil and gas producing activities and real estate operations, and conforming changes for smaller reporting companies, which are not discussed in this GT Alert. The proposed changes are a continuation of the SEC’s ongoing, comprehensive evaluation as part of its Disclosure Effectiveness Initiative.
The proposed changes are intended to (1) improve the financial information about acquired and disposed businesses; (2) facilitate more timely access to capital; and (3) reduce the complexity and cost to prepare the disclosure.
Overview of Current Financial Statement Requirements
When an issuer acquires a “business”, other than a real estate operation, Rule 3-05 of Regulation S-X generally requires an issuer to provide separate audited annual and unaudited interim pre-acquisition financial statements of the acquired business if it is significant to the issuer. The financial statements of the acquired business are generally the same as those as if the acquired business were a registrant, except that the number of years of audited financial statements is determined by the level of significance. Recognizing that certain acquisitions have a greater impact on the issuer than others, the SEC addresses the reporting requirements for businesses acquired or to be acquired based on the “significant subsidiary” definition in Rule 1-02(w) of Regulation S-X using a sliding scale approach.
Significance of an acquired business is evaluated under Rule 3-05 based upon three criteria (which in turn are derived from Rule 1-02(w)):
- the amount of the issuer’s investment in the acquired business compared to the issuer’s total assets (Investment Test);
- the issuer’s share of the total assets of the acquired business compared to the issuer’s total assets (Asset Test); and
- the issuer’s share of pre-tax income from continuing operations of the acquired business compared to the issuer’s pre-tax income from continuing operations (Income Test);
in each case, based upon a comparison between the issuer and acquired business’s most recent annual financial statements.
Click here for the full GT Alert, which examines the current significance criteria for acquisitions and summarizes the proposed changes.