The SEC has voted to approve rule and form changes to improve financial information relating to acquired or disposed businesses for investors and while facilitating capital access and reducing the complexity and costs associated with disclosure preparation. The amendments address the financial disclosure requirements of Regulation S-X for acquisitions and dispositions of businesses, including real estate operations, and the Commission also amended the significance tests in the “significant subsidiary” definition in Rule 1-02. In addition, the SEC adopted new requirements regarding fund acquisitions specific to registered investment companies and business development companies (Amendments to Financial Disclosures about Acquired and Disposed Businesses, Release No. 33-10786, May 20, 2020).
"This action, which is designed to enhance the quality of information that investors receive while eliminating unnecessary costs and burdens, will benefit investors, registrants and the market more generally," SEC Chairman Jay Clayton said.
Existing requirements. Currently, under Rule 3-05 of Regulation S-X, a registrant that acquires a significant business other than a real estate operation must provide separate audited annual and unaudited interim pre-acquisition financial statements of that business. The number of years of financial information that must be provided depends on the relative significance of the acquisition to the registrant. Rule 3-14 addresses disclosures related to acquisition of a significant real estate operation and requires a registrant that has acquired a significant real estate operation to file financial statements with respect to the acquired operation. In addition, Article 11 requires registrants to file unaudited pro forma financial information relating to an acquisition or disposition.
Disclosure changes. The SEC noted that investment company registrants differ from non-investment company registrants in significant ways, including that they mainly invest for returns on capital appreciation and/or investment income. They are required to recognize changes in value to their portfolio investments each reporting period and generally do not consolidate entities they control. It can be unclear how to apply reporting requirements to acquired funds, the Commission stated.
As such, the SEC made changes to, among other things, update the significance tests in Rule 1-02(w), Securities Act Rule 405, and Exchange Act Rule 12b-2 to:
- compare the registrant’s investments in the acquired or disposed business to the registrant’s aggregate worldwide value (or, when the registrant has no aggregate worldwide market value, the carrying value of the disposed subsidiary when comparing it to the registrant’s total assets);
- revise the income test by adding a revenue component to reduce the anomalous result that registrants with marginal or break-even net income or loss in a recent fiscal year may be more likely to have tested subsidiaries deemed significant when they otherwise would not have done so; and
- expand the use of pro forma financial information in measuring significance.
Revised pro forma adjustment criteria will provide for “transaction accounting adjustments” reflecting only the application of required accounting to the transaction, “autonomous entity adjustments” reflecting a registrant’s operations and financial position as an autonomous entity if the registrant was previously part of another entity, and optional “management’s adjustments” if, in management’s opinion, these adjustments would enhance understanding of the pro forma effects of the transaction, subject to certain conditions.
The amendments will be effective January 1, 2021, but voluntary compliance will be permitted in advance.
The release in No. 33-10786.