26 May Jonanthan Cartu Reported Blog: SEC adopts final amendments for M&A financial stateme…
Yesterday, once again without an open meeting, the SEC voted (with a dissent from Commissioner Allison Lee) to adopt amendments to the requirements for financial statements relating to acquisitions and dispositions of businesses. According to the press release, the amendments are intended to improve disclosure of financial information, facilitate more timely access to capital and reduce the complexity and costs to prepare the disclosure. The final amendments were adopted largely as proposed, but with some modifications to virtually every component of the proposal. Notably, as adopted, the final amendments modify the rules for determining whether an acquisition or disposition is significant and require companies to file the financial statements of acquired businesses for only up to the two most recent fiscal years, instead of the current three. In addition, the existing adjustment criteria for pro forma financial statements will be replaced with simplified requirements to depict the accounting for the transaction and, in response to some controversy over the proposal, provide the option to “depict synergies and dis-synergies of the acquisitions and dispositions for which pro forma effect is being given.” The final amendments will become effective on January 1, 2021. Companies may early adopt the final amendments, but only in their entirety.
The final amendments affect Rules 3-05 and Article 11 of Reg S-X, as well as related rules and forms. Under Rule 3-05, acquiring companies must provide separate audited annual and unaudited interim pre-acquisition financial statements of a “significant” acquired business, with the number of years required determined on the basis of the relative significance of the acquisition. Article 11 applies to pro forma financial statements, and requires the company to file unaudited pro forma financial information with regard to the acquisition or disposition, including adjustments that show how the acquisition or disposition might have affected the historic financial statements.
(The final amendments also affect the rules and forms related to real estate businesses and investment companies, not discussed in this post.)
As summarized by the SEC, the amendments will:
- “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, and the scope of the rule’s requirements;
- 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.”
More specifically, the final amendments provide the following:
Significance test. Currently, to determine the significance of an acquisition (and therefore the extent of the required financial disclosure), under Rule 3-05, companies apply prescribed investment, asset and income tests set forth in the “significant subsidiary” definition in Rule 1-02(w). The final amendments revise the significance tests by modifying the investment test and the income test.
The new investment test will compare the company’s (and its other subsidiaries’) investments in and advances to the tested subsidiary to the aggregate worldwide market value of the company’s voting and non-voting common equity, when available; however, this amendment will be limited to acquisitions and dispositions (excluding, for example, use in evaluating equity method investments). Aggregate worldwide market value will be calculated daily for the last five trading days of the company’s most recently completed month ending prior to the earlier of the company’s announcement date or agreement date of the acquisition or disposition. The existing test will continue to apply if the company does not have an aggregate worldwide market value and for any additional purposes for which the Rule 1-02(w) definition is applicable. There are additional changes clarifying the meaning of “investments in” the tested subsidiary and providing for inclusion of the fair value of contingent consideration in certain circumstances.
The new income test adds a revenue component. The intent of the addition is to reduce the frequency of immaterial acquisitions being deemed significant and other anomalous results that occur from relying solely on the net income component. The new revenue component compares the company’s (and its other subsidiaries’) share of the tested subsidiary’s consolidated total revenues (after intercompany eliminations) to the company’s consolidated total revenues for the most recently completed fiscal year. The new test will require that “the tested subsidiary 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, [companies] 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 revenue component will not apply if either the company and its consolidated subsidiaries or the tested subsidiary did not have material revenue in each of the two most recently completed fiscal years. The final amendments retain the current requirement to use pre-tax income from continuing operations. Additional changes…