In December 2007, the Securities and Exchange Commission (the “SEC”) released its final rules relating to the reporting requirements for “smaller reporting companies.”[1]  These new rules include, among other things, several changes to:

• the required financial statements for “smaller reporting companies,” as defined in SEC Rule 405;
• the required age of financial statements (“going stale”) in registration statements for these companies; and
• the required financial statements for businesses acquired or to be acquired.

Accordingly, for the convenience of our clients, we set forth in this client alert summary tables and explanations as to these requirements, as they apply to registration statements filed by U.S. issuers (both large and small) under the Securities Act of 1933 (the “Securities Act”).  This information gives effect to the new rules, which became effective on February 4, 2008.

The rules relating to foreign private issuers were not revised in connection with the recent amendments, although the new rules give all foreign private issuers the option to report as smaller reporting companies.[2]  For the sake of completeness, where appropriate, this client alert will indicate the applicable rules relating to foreign private issuers that do not make this election.[3]

Of course, we remind readers that this client alert is only a summary, and issuers and their underwriters should discuss the specific financial statement requirements of any registration statement or report filed under the Securities Exchange Act of 1934 (the “Exchange Act”) with the applicable auditing firm at the earliest possible stage of the offering or filing process.[4]

Highlights of the New Rules

Under the amended rules:

• smaller reporting companies will only be required to furnish two years of audited income statements and statements of cash flows;
• smaller reporting companies will not be required to file “selected financial information,” “supplementary financial information” or a “ratio of earnings to fixed charges”;
• at the time of the initial filing of a registration statement, a smaller reporting company will only be required to file financial statements that are as recent as the most recent annual or quarterly report that it would otherwise be required to file with the SEC as of the filing date; and
• smaller reporting companies that make significant acquisitions will not be required to file more than two years of audited financial statements of the target.

In addition, the SEC revised Regulation S-X to provide that, regardless of an acquiror’s size, only a maximum of two years of audited financial statements of the target need to be filed if the net revenues of the target in the most recent fiscal year were less than $50 million.

Part I: Required Financial Statements

The following table sets forth the basic issuer financial information that must be contained in a registration statement filed under the Securities Act.  In the case of a company that is eligible to file a registration statement on Form S-3,[5] the financial statement requirements are typically satisfied through the incorporation by reference of the company’s annual and quarterly reports filed under the Exchange Act.  The different rules that apply to smaller reporting companies are set forth in italicized text.

Part II: Age of Financial Statements: “Going Stale”

An organizational meeting for a public offering is rarely complete without a discussion of when the issuer’s financial statements “go stale.”[9]  As set forth below, a registration statement cannot be declared effective without financial statements that conform to the SEC’s requirements as to age.

Please note that for purposes of the dates described in this section, if the last day that any financial statements may be used under the “going stale” rules falls on a weekend or a holiday, SEC Rule 417 under the Securities Act permits the filing to be made on the next business day.  This rule often has the effect of postponing the “staleness date” one or two calendar days.

Audited Financial Statements

Please note that if, notwithstanding the table above, audited financials for the most recently ended fiscal year are in fact available before the “staleness date,” they must be included in the registration statement.  (Rule 3-01(b); Rule 3-12(b); Rule 8-08(a))

Unaudited Interim Financial Statements

As to unaudited financial statements, staleness is generally measured from the end of the issuer’s most recent fiscal year.

The interim financial statements in the registration statement must be at least as current as the financial statements included in the issuer’s most recent Form 10-Q filing.  (Rule 3-01(f); Rule 3-12(a); Rule 8-03)

Shelf Registration Statements

The “going stale” rules described in this client alert generally relate to a company’s state of affairs as of the filing date and/or the effective date of the registration statement.

In the case of a shelf offering on Form S-3 or F-3, the “going stale” rules are applied as of those two measurement dates.  In addition, after nine months have passed from the effective date of the registration statement, the audited balance sheet can be no more than 16 months old.  (See Rule 427 under the Securities Act, which relates to Section 10(a)(3) of the Securities Act.)

Part III: Financial Statements Relating to Acquisitions

Both completed and proposed acquisition transactions can have a material impact upon how investors view an acquiror’s prior financial results and its prospects.  Accordingly, the SEC’s rules require an acquiror to include in its registration statements the financial statements of a significant acquired “business” that has closed.  For this purpose, the term “business” includes not only an entire company or entity, but may also include the acquisition of a line of business in the form of an asset purchase.  Financial statements of the target may also be required when the acquisition becomes “probable.”[12]

In order for an investor to better understand the impact of an acquisition, Article 11 of Regulation S-X requires pro forma financial information[13] for the most recent fiscal year and for the most recent interim period when a material acquisition has occurred, or is “probable.”  The pro forma information is designed to show the combined results of the acquiror and the target, as if the two entities had actually been combined during the relevant fiscal periods.

As will be seen below, the extent of the financial statements to be required depends upon the “significance” of the acquisition.  Significance of an acquisition is generally evaluated under Rule 1-02(w) (the “significant subsidiary” test)[14] based upon three tests, as applied (in most cases) to acquiror’s most recent audited financial statements:

• the amount of the acquiror’s investment in the acquired business compared to the acquiror’s total assets;
• the total assets of the acquired business compared to the acquiror’s total assets; or
• the pre-tax income (or loss) of the acquired business compared to the acquiror’s pre-tax income (or loss).

In each case, this comparison is expressed as a percentage.  The acquisition is deemed to be at the highest significance level generated by the above three tests.  For example, if an acquiror with $50 million in assets spends $26 million to buy the target, the acquisition will be above the 50% significance level, notwithstanding the results of the analysis under the other two tests.

The following table summarizes the required financial statements that must be set forth under these rules.  The different rules that apply to smaller reporting companies are set forth in italicized text.

Please note that under Rule 3-06, financial statements covering a period of nine to 12 months may be used to satisfy a requirement for filing financial statements for a period of one year of an acquired company’s financials.

In the case of an acquisition structured as a stock-for-stock merger, in which the acquiror files a registration statement on Form S-4 or Form F-4 to register the securities that it will issue in the acquisition, these forms describe some of the financial statements of the target that need to be filed, depending in part on whether (a) the target is a U.S. or foreign issuer, (b) whether it is registered under the Exchange Act and (c) whether it is Form S-3 (or F-3) eligible.

In the case of an acquiror that is a smaller reporting company, the balance sheet of the acquired business is not required when the smaller reporting company’s most recent audited balance sheet is stated as of a date after the closing of the acquisition.  (Rule 8-04(c)(2))

For acquisitions below the 50% significance level, no audited financial statements are required for probable acquisitions or for completed acquisitions that closed up to 74 days before the date of the offering, and such financial statements have not yet been otherwise filed.  (Rule 3-05(b)(4)(i); Rule 8-04(c)(4))  Of course, for a material acquisition, there may be good reason for a company or its underwriters to consider the adequacy of the financial disclosure in the prospectus without this information.

Foreign private issuers are not required to provide these financial statements in the case of an annual report filed on Form 20-F; instead, these requirements are only applicable to them in the case of a registration statement filed under the Securities Act or the Exchange Act.  However, in March 2008, the SEC proposed to require foreign private issuers to file financial statements as to a completed acquisition (but not a probable acquisition) if that acquisition exceeds the 50% significance test.[17]