Client Alert

SEC Adopts Amendments to Financial Disclosure Requirements for Acquisitions and Dispositions

02 Jun 2020

On May 20, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments to the financial statement and other disclosure requirements related to acquisitions and dispositions of businesses, including real estate operations.[1] The amendments will be effective on January 1, 2021; however, the SEC is permitting voluntary compliance before that date. The SEC, which originally proposed the amendments in May 2019, adopted the amendments largely as proposed, with certain modifications based on comments received.

Executive Summary

The amendments significantly clarify and simplify the disclosures required in connection with acquisitions and dispositions. The details with regard to the availability of the revised requirements, however, will continue to necessitate significant planning and preparation on the part of registrants and acquired entities.

The amendments relate to the significance tests in the definition of “significant subsidiary” and the historical and pro forma financial statement disclosure requirements in Regulation S-X for acquisitions and dispositions of businesses, including real estate operations. Specifically, the SEC amended Rules 3-05, 3-14, 8-04, 8-05, and 8-06 and Article 11 of Regulation S-X, as well as other related rules and forms, including with respect to the inclusion of such financial statements in registration statements and proxy statements and the impact on Item 2.01 of Form 8-K.

Some of the key amendments include the following:

  • update the significance tests used to determine whether acquisitions or dispositions will require the presentation of historical financial statements and/or pro forma financial information, including the addition of a revenue component to the income test and the use of the market value of the registrant’s common equity, if available, rather than total assets for the investment test;
  • require the financial statements of the acquired business to cover only up to the two most recent fiscal years (reduced from three)—one year if greater than 20% significant but less than 40% significant and two years if greater than 40% significant;
  • align Rule 3-14 (acquisition of real estate operations) to Rule 3-05 where no unique industry considerations exist, including raising the significance threshold from 10% to 20% and eliminating the requirement to provide three years of financial statements for acquisitions from related parties;
  • modify the presentation and adjustment requirements for pro forma financial information, including the use of optional “management’s adjustments” that reflect forward-looking information regarding synergies identified by management in connection with the transaction;
  • increase the significance threshold for dispositions from 10% to 20% and conform the significance tests to those used for acquisitions;
  • permit disclosure of abbreviated financial statements for acquisitions of a component of an entity, subject to certain “qualifying conditions” and “presentation conditions”;
  • 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 the level of significance;
  • eliminate the requirement that acquired business financial statements continue to be provided when they have been previously filed but the acquired business is of “major significance”;
  • for foreign businesses, permit the use of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS-IASB”) in certain circumstances;
  • expand the use of pro forma financial information in measuring significance; and
  • modify and enhance the required disclosure for the aggregate effect of acquisitions for which financial statements are not required or are not yet required.

Background

Very broadly, the requirements under the rules and forms in existence prior to the newly adopted amendments include the following:

  • Rule 3-05 of Regulation S-X generally requires a registrant that has acquired, or proposes to acquire, a business, other than a real estate operation, to provide separate audited annual and unaudited interim pre-acquisition financial statements of the business if it is significant to the registrant (“Rule 3-05 Financial Statements”), with significance based on the asset, income, and investment tests under the “significant subsidiary” definition in Rule 1-02(w) of Regulation S-X. Under the old rules, the required number of years of audited Rule 3-05 Financial Statements was (i) one year if any test exceeded 20% but none exceeded 40%, (ii) two years if any test exceeded 40% but none exceeded 50%, and (iii) three years if any test exceeded 50%.
  • Rule 3-14 of Regulation S-X requires a registrant that has acquired, or proposes to acquire, a significant real estate operation to provide separate audited annual and unaudited interim abbreviated income statements with respect to the acquired real estate operation (“Rule 3-14 Financial Statements”). Under current practice prior to the amendments, Rule 3-14 Financial Statements were required if the registrant’s investment in the property is 10% or greater than the registrant’s total assets as of its latest audited balance sheet filed with the SEC. Rule 3-14 generally requires only one year of audited Rule 3-14 Financial Statements; however, prior to the amendments, three years of audited Rule 3-14 Financial Statements were required if the real estate operation was acquired from a related party.
  • Article 11 of Regulation S-X prescribes the pro forma financial information required when registrants are required to file Rule 3-05 Financial Statements or Rule 3-14 Financial Statements or when registrants have disposed of a business that is 10% significant under the asset, income, or investment tests under the “significant subsidiary” definition in Rule 1-02(w).
  • Items 2.01 and 9.01 of Form 8-K require that registrants make certain disclosures within four business days following the consummation of the acquisition or disposition of a significant amount of assets, including assets that constitute a business within the meaning of Rule 11-01(d) of Regulation S-X. Form 8-K generally requires registrants to file Rule 3-05 Financial Statements, Rule 3-14 Financial Statements, and related pro forma financial information, within 75 days after consummation of the acquisition.[2] The 75-day grace period does not apply to the pro forma financial information required in connection with significant dispositions.
  • Rule 8-04 (business acquisitions), Rule 8-05 (pro forma financial information), and Rule 8-06 (real estate acquisitions) of Regulation S-X apply to smaller reporting companies and are generally similar to the requirements of Rule 3-05, Rule 3-14, and Article 11; however, two years of audited financial statements of an acquired business or real estate operation are the most that could be required under Rule 8-04 or Rule 8-06.

Amendments to Definition of “Significant Subsidiary”

As discussed above, the “significant subsidiary” definition in Rule 1-02(w) includes asset, income, and investment tests that are applied when determining if a subsidiary is deemed significant. For acquisitions of businesses, other than real estate operations, these tests are used to determine whether Rule 3-05 Financial Statements are required and, if so, how many years of audited financial statements must be presented. For dispositions, these tests are used to determine whether a Form 8-K and related pro forma financial information are required. The amendments to the significance tests under Rule 1-02(w) include the following:

  • Investment Test – solely for acquisitions and dispositions, amended to compare the registrant’s investments in and advances to the acquired or disposed business to the aggregate worldwide market value of the registrant’s voting and non-voting common equity, if available, rather than the registrant’s total assets as of its most recent audited balance sheet. The aggregate worldwide market value is calculated daily for the last five trading days of the registrant’s most recently completed month ending prior to the earlier of the registrant’s announcement date or agreement date of the acquisition of disposition.
  • Income Test – amended to add a revenue component in order to reduce anomalous results for registrants with marginal or break-even net income. Under the amended test, the tested subsidiary must meet both the net income component and the revenue component when the revenue component applies. The revenue component does not apply if either the registrant and its consolidated subsidiaries or the tested subsidiary did not have material revenue in each of the two most recently completed fiscal years. For purposes of Rule 3-05, registrants 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.

In addition to Rule 1-02(w), the SEC made conforming amendments to the definition of “significant subsidiary” under Securities Act Rule 405 under the Securities Act of 1933 (the “Securities Act”) and Rule 12b-2 under the Securities Exchange Act of 1934 (the “Exchange Act”).

When evaluating financial statement requirements for acquisitions, registrants need to be mindful that the investment test is now based on the market value of their common equity and thus results can fluctuate more significantly than under the prior test.

The addition of the revenue component to the income test is a welcome change and should reduce the number of anomalous results and the need to seek relief from the staff of the SEC’s Division of Corporation Finance (the “Staff”) under Rule 3-13 of Regulation S-X.

Amendments to Required Financial Statements for Acquisitions of Significant Businesses

As described above, prior to the amendments, depending on the relative significance of the acquired or to-be-acquired business, a registrant was required to provide up to three years of financial statements of the acquired or to-be-acquired business. The requirement were amended to:

  • require only up to two years of Rule 3-05 Financial Statements (i.e., one year if greater than 20% significant but less than 40% significant and two years if greater than 40% significant); and
  • eliminate the need to present a comparative interim period when only one year of audited Rule 3-05 Financial Statements is required (i.e., when significance is greater than 20% but less than 40%).

The following table compares the requirements under the current rules to the requirements under the amendments:

Significance Level

Historical Financial Statement Requirements

Current Rules

Amended Rules

Less than 20%

No financial statements required

No financial statements required

Greater than 20% but less than 40%

One year of audited financial statements and unaudited financial statements for most recent interim period and corresponding prior year interim period

One year of audited financial statements and unaudited financial statements for onlythe most recent interim period (not the corresponding prior year interim period)

Greater than 40% but less than 50%

Two years of audited financial statements and unaudited financial statements for the most recent interim period and the corresponding prior year interim period

Two years of audited financial statements and unaudited financial statements for the most recent interim period and the corresponding prior year interim period

Greater than 50%

Three years of audited financial statements and unaudited financial statements for the most recent interim period and the corresponding prior year interim period

In the Release, the SEC noted that, regardless of the number of years presented, if trends depicted in Rule 3-05 Financial Statements are not indicative of the financial condition or results of operations of the acquired business going forward or are otherwise incomplete, Rule 4-01(a) of Regulation S-X requires that a registrant provide “such further material information as is necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”

Amendments to Required Financial Statements for Net Assets that Constitute a Business

The SEC noted that “registrants frequently acquire a component of an entity that is a business as defined in Rule 11-01(d) but does not constitute a separate entity, subsidiary, or division, such as a product line or a line of business contained in more than one subsidiary of the selling entity. These businesses may not have separate financial statements or maintain separate and distinct accounts necessary to prepare Rule 3-05 Financial Statements because they often represent only a small portion of the selling entity.” Recognizing the cost and difficulties registrants face in obtaining Rule 3-05 Financial Statements in these circumstances, the SEC adopted amendments to Rule 3-05 that permit registrants to provide audited abbreviated financial statements (statements of assets acquired and liabilities assumed and statements of revenues and expenses) if the acquired business meets certain “qualifying conditions” and “presentation conditions” set forth in Rule 3-05(e) of Regulation S-X.

The qualifying conditions include the following:

  • the total assets and total revenues (both after intercompany eliminations) of the acquired or to-be-acquired business constitute 20% or less of such corresponding amounts of the seller and its consolidated subsidiaries as of and for the most recently completed fiscal year;
  • separate financial statements for the business have not previously been prepared;
  • the acquired business was not a separate entity, subsidiary, operating segment (as defined in U.S. GAAP or IFRS-IASB, as applicable), or division during the periods for which the acquired business financial statements would be required; and
  • the seller has not maintained the distinct and separate accounts necessary to present financial statements that would satisfy Rule 3-05 and it is impracticable to prepare such financial statements.

The SEC noted that the 20% threshold is generally consistent with the Staff’s granting of relief pursuant to Rule 3-13 of Regulation S-X and that, in situations where an acquired business exceeds the 20% threshold but the registrant faces unique challenges in making the relevant allocations necessary to provide Rule 3-05 Financial Statements, the registrant should continue to seek relief from the Staff pursuant to Rule 3-13 of Regulation S-X.

Although this amendment is generally consistent with current practice, it will reduce the frequency with which registrants need to seek relief under Rule 3-13 and should result in more consistent financial reporting for similar transactions due to the presentation conditions.

The SEC also noted that the final rules do not address carve-out financial statements and that questions relating to carve-out financial statements are best addressed through the Staff consultation process due to their unique facts and circumstances.

Amendments Regarding Financial Statements of Foreign Businesses

Rule 3-05 permits the use of IFRS-IASB without reconciliation to U.S. GAAP in financial statements of foreign businesses. Where required financial statements of a foreign business are prepared on a basis of accounting other than U.S. GAAP or IFRS-IASB (such as “home country GAAP”), the Rule 3-05 Financial Statements are required to be reconciled to U.S. GAAP. This reconciliation is required even if the registrant is a foreign private issuer that prepares its financial statements in accordance with IFRS-IASB. Further, due to the definitions of “foreign private issuer” and “foreign business,” a business could qualify to be a “foreign private issuer” if it were a registrant, but not qualify to be a “foreign business” when it is acquired by a registrant. The amendments address these issues by:

  • permitting foreign private issuers that prepare their financial statements using IFRS-IASB to reconcile Rule 3-05 Financial Statements of foreign businesses prepared using home country GAAP to IFRS-IASB, rather than U.S. GAAP; and
  • permitting Rule 3-05 Financial Statements to be prepared in accordance with IFRS-IASB without reconciliation to U.S. GAAP if the acquired business would qualify as a foreign private issuer if it were a registrant.

Amendments Relating to Rule 3-05 Financial Statements for Businesses that Have Been Included in the Registrant’s Historical Financial Statements

Rule 3-05 generally permits a registrant to omit Rule 3-05 Financial Statements once the operating results of the acquired business have been reflected in the audited consolidated financial statements of the registrant for a complete fiscal year. Prior to the amendments, despite this permitted omission, Rule 3-05 Financial Statements were required when they have not been previously filed, or when the Rule 3-05 Financial Statements have been previously filed but the acquired business is of “major significance” to the registrant, which is generally defined as equal to or greater than 70% significance. In practice, this required registrants to continue to incorporate Rule 3-05 Financial Statements of the acquired business in registration statements until the acquired business was included in the registrant’s audited results for at least 21 months (if significance was equal to or greater than 70% but less than 80%) or 33 months (if significance was greater than 80%). The amendments:

  • eliminate the requirement to include Rule 3-05 Financial Statements in registration statements and proxy statements once the acquired business is reflected in post-acquisition registrant financial statements for (i) nine months for acquisitions that exceed 20% significance but are less than 40% significance and (ii) a complete fiscal year for acquisitions that exceed 40% significance; and
  • eliminate the requirement that Rule 3-05 Financial Statements be provided when they have been previously filed but the acquired business is of major significance.

The SEC noted that the utility of pre-acquisition financial statements diminishes over time and that, with electronic filing requirements, previously filed financial information about the acquired business is readily available through the SEC’s website. However, the SEC also noted that, even without the major significance requirement, Rule 4-01(a) of Regulation S-X requires that a registrant provide “such further material information as is necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”

These amendments are particularly helpful to private companies that have had significant acquisitions and are considering an IPO because the Rule 3-05 Financial Statements of the acquired business could be omitted once they have been included in the registrant’s financial statements for nine months or one year, depending on significance. 

Use of Pro Form Information to Measure Significance

Prior to the amendments, a registrant generally was permitted to use pro forma, rather than historical, financial information to test significance of a subsequently acquired business only if the registrant made a significant acquisition after the latest fiscal year-end and filed its Rule 3-05 Financial Statements and pro forma financial information on Form 8-K. The Form 8-K filing requirement, however, precluded registrants from using pro forma financial information to measure significance when determining Rule 3-05 disclosure requirements in initial registration statements or from voluntarily filing Rule 3-05 Financial Statements and pro forma financial information on Form 8-K in order to use higher denominators in calculating the significance of subsequent acquisitions.

The amendments eliminate the Form 8-K filing requirement as a prerequisite to using pro forma financial information to measure significance. More specifically, for filings that require Rule 3-05 Financial Statements or Rule 3-14 Financial Statements, the SEC amended Rule 11-01(b)(3) to permit registrants to measure significance using pro forma financial information that only depicts significant business acquisitions and dispositions consummated after the latest fiscal year-end for which the registrant’s financial statements are required to be filed, provided that the registrant has filed (i) the Rule 3-05 Financial Statements or Rule 3-14 Financial Statements for any such acquired business or real estate operation, as applicable, and (ii) the Article 11 pro forma financial information for any such acquired or disposed business or real estate operation.

The pro forma financial information that is used to measure significance may only give effect to the subsequently acquired or disposed business and may not give effect to “autonomous entity adjustments” or “management’s adjustments” that are described below or any other transactions, such as the use of proceeds from an offering. Consistent with existing practice, once a registrant uses pro forma financial information to measure significance, it must continue to use pro forma financial information to measure significance until its next annual report.

Amendments to Requirements for Individually Insignificant Acquisitions

Under certain circumstances, Rule 3-05 requires registrants to file financial statements of “individually insignificant businesses” (generally, acquired businesses that are not, by themselves, significant at the 20% level or greater) in registration statements and proxies.[3] Prior to the amendments, Rule 3-05 provided that audited historical pre-acquisition financial statements were generally not required if an acquired or to-be-acquired business: (i) did not exceed 20% significance or (ii) did not exceed 50% significance and the acquisition has not yet occurred or the date of the final prospectus or prospectus supplement relating to an offering is no more than 74 days after consummation and the financial statements have not been previously filed. However, under the rules in existence prior to the amendments, if the aggregate significance of “individually insignificant businesses” acquired since the date of the most recent audited balance sheet filed for the registrant exceeded 50%, audited historical pre-acquisition financial statements covering at least the substantial majority of the businesses acquired, as well as the related pro forma financial information, were required to be included in a registration statement or transactional proxy statement.   

As amended, Rule 3-05 now provides that, in situations where the aggregate significance of individually insignificant businesses exceeds 50%, registrants must provide pre-acquisition historical financial statements only for those businesses whose individual significance exceeds 20%. Under the amendments, however, registrants will be required to provide pro forma financial information depicting the aggregate effects of all individually insignificant businesses in all material respects. The amendments also clarify that, consistent with existing practice, “individually insignificant businesses” include the following:

  • any acquisition consummated after the registrant’s most-recent audited balance sheet date whose significance does not exceed 20%;
  • any probable acquisition whose significance does not exceed 50%; and
  • any consummated acquisition whose significance exceeds 20%, but does not exceed 50%, for which financial statements are not yet required because of the 75-day filing grace period.

Eliminating the requirement to provide historical financial statements of acquired businesses that individually are below 20% significance is a positive development for registrants and will reduce the need to provide historical financial statements of acquired businesses that are not, by themselves, material. However, the requirement to include the aggregate effects of such acquisitions in the pro forma financial information may create issues for accountants in providing negative assurance on the combined pro forma financial information where historical financial statements included in the pro forma financial information for individually insignificant acquisitions have not been reviewed or audited. In connection with securities offerings, registrants, underwriters, and their advisors should be mindful that accountants may need to do additional work in order to provide negative assurance on such pro forma financial information in a comfort letter and that, in the absence of such negative assurance, the underwriters and their counsel may need additional time to diligence the financial information related to such individually insignificant acquisitions.

Amendments to Rule 3-14 (Real Estate Operations)

Amendments to Align Rule 3-14 with Rule 3-05

Rule 3-14 and Rule 3-05 have historically diverged in a number of ways. In the Release, the SEC adopted amendments to align Rule 3-14 with Rule 3-05 “where no unique industry considerations warranted differentiated treatment.” The amendments:

  • align the Rule 3-14 “significance” thresholds with the 20% significance threshold for individual business acquisitions and the 50% significance threshold for aggregating individually insignificant acquisitions in Rule 3-05;
  • eliminate the requirement to provide three years of Rule 3-14 Financial Statements for acquisitions from related parties;
  • apply Rule 3-06 to Rule 3-14 acquisitions, which permits the filing of financial statements covering a period of nine to 12 months to satisfy the requirement for filing financial statements for a period of one year for an acquired or to-be-acquired real estate operation;
  • include the same timing requirements for Rule 3-14 Financial Statements in registration statements and proxy statements as Rule 3-05, which means that the Rule 3-14 Financial Statements of the acquired or to-be-acquired real estate operation are not required if the acquisition is less than 50% significant and either (i) the acquisition has not yet occurred or (ii) the date of the final prospectus or prospectus supplement relating to an offering, or mailing date in the case of a proxy statement, is no more than 74 days after consummation of the acquisition and the financial statements have not been previously filed by the registrant;
  • permit Rule 3-14 Financial Statements to be omitted once the operating results of the acquired real estate operation have been reflected in the audited consolidated financial statements of the registrant for at least nine months; and
  • permit the use of pro forma financial information for significance testing in certain circumstances, consistent with the application in Rule 3-05.
Properties Subject to Triple-Net Leases

The SEC specifically noted that the amendments to Rule 3-14 do not treat the acquisition of a property subject to a triple-net lease differently than the acquisition of other real estate operations because the information included in Rule 3-14 Financial Statements is consistent with how triple-net leases may affect the registrant’s results of operations. This should eliminate the existing practice of providing audited financial statements of the lessee or guarantor of a triple-net lease property that exceeded 20% significance, which was the Staff’s position pursuant to Section 2340 of the Division of Corporation Finance’s Financial Reporting Manual (the “FRM”).

Other Amendments

The SEC also made certain other amendments to Rule 3-14 and conforming amendments to related rules and forms, including the following:

  • Form 8-K – clarified that Item 2.01 requires the disclosure of the acquisition or disposition of assets that constitute a significant real estate operation as defined in Rule 3-14 and that, as with Rule 3-05, the aggregate impact of acquisitions of real estate operations is not required to be reported unless these acquisitions are related real estate operations and significant in the aggregate.
  • Definition of “Real Estate Operation” – amended Rule 3-14 to define a “real estate operation” as “a business that generates substantially all of its revenues through the leasing of real property,” which is consistent with current practice based on the definition in the FRM.
  • Determination of “Significance” – amended Rule 3-14 to specify that significance should be based on the investment test in Rule 1-02(w) of Regulation S-X, which is consistent with current practice based on Staff guidance in the FRM, although it was not explicitly addressed in Rule 3-14 prior to the amendments. The SEC also adopted a number of provisions regarding the application of the investment test to a real estate operation.
  • Interim Financial Statements – amended Rule 3-14 to specifically require Rule 3-14 Financial Statements for the most recently completed year-to-date interim period prior to the acquisition. Although this was not required under Rule 3-14 prior to the amendments, current practice was to provide this information due to the requirement to provide pro forma financial information when a registrant acquired one or more real estate operations that in the aggregate are significant, as well as related Staff interpretations.
Smaller Reporting Companies and Issuers Relying on Regulation A

Rule 8-06 of Regulation S-X provides smaller reporting company disclosure requirements for the financial statements of real estate operations acquired or to be acquired that are substantially similar to the requirements in Rule 3-14. Part F/S of Form 1-A directs an issuer relying on Regulation A to present financial statements of real estate operations acquired or to be acquired as specified by Rule 8-06.

The SEC adopted amendments to Article 8 of Regulation S-X to further simplify and conform the application of Rule 3-14 to smaller reporting companies. Because Part F/S of Form 1-A refers to Rule 8-06, the revisions to Rule 8-06 apply to issuers relying on Regulation A.

Amendments Regarding Blind Pool Real Estate Offerings

Certain registrants, such as non-traded real estate investment trusts, generally do not initially own any real estate assets and initially do not identify a specific intended use of the proceeds raised from investors. These SEC-registered offerings generally are continuous and are conducted over an extended period of time. In connection with these continuous offerings, SEC Industry Guide 5 requires that registrants undertake to disclose to investors information about significant acquisitions in the format of Ruleh 3-05 Financial Statements and Rule 3-14 Financial Statements, as applicable. Following Staff guidance, these registrants historically have utilized the Rule 3-05 and Rule 3-14 significance tests when making the determination of whether they are required to provide Rule 3-05 Financial Statements or Rule 3-14 Financial Statements.

The SEC adopted amendments specifying that significance for blind pool offerings must be computed by comparing the registrant’s and its other subsidiaries’ “investments in” the real estate operation to the sum of: (i) the registrant’s total assets as of the date of the acquisition and (ii) the proceeds (net of commissions) in good faith expected to be raised in the registered offering over the next 12 months. The SEC extended this adapted significance test to Rule 3-05 acquisitions by registrants in blind pool offerings because the accommodation is based on the unique characteristics of the offering and registrants, rather than the type of acquisition. Accordingly, the SEC placed these standards for blind pool offerings in Rule 11-01(b) of Regulation S-X, which addresses how to determine significance for both Rule 3-05 acquisitions and Rule 3-14 acquisitions.

Amendments Regarding Pro Forma Financial Information

Adjustment Criteria and Presentation Requirements

The pro forma financial information described in Article 11 of Regulation S-X must accompany Rule 3-05 Financial Statements and Rule 3-14 Financial Statements. Rule 11-02 contains rules and instructions for the presentation of pro forma financial information while providing some flexibility to tailor the disclosures to particular events and circumstances unique to the registrant.

The SEC amended Article 11 by replacing the existing pro forma adjustment criteria with simplified and clarified requirements. The amendments are intended to “depict the accounting for the transaction and to provide the option to depict synergies and dis-synergies of the acquisitions and dispositions for which pro forma effect is being given.”

The revised pro forma adjustment criteria fall into three categories:

  • “Transaction Accounting Adjustments,” which “reflect only the application of required accounting to the acquisition, disposition, or other transaction linking the effects of the acquired business to the registrant’s audited historical financial statements”;
  • “Autonomous Entity Adjustments,” which “are adjustments necessary to reflect the operations and financial position of the registrant as an autonomous entity when the registrant was previously part of another entity”; and
  • “Management’s Adjustments,” which “provide both flexibility to registrants to include forward-looking information that depicts the synergies and dis-synergies identified by management in determining to consummate or integrate the transaction for which pro forma effect is being given and insight to investors into the potential effects of the acquisition and the post-acquisition plans expected to be taken by management.”

The Transaction Accounting Adjustments and Autonomous Entity Adjustments are required. Management’s Adjustments are optional and are subject to specific conditions and form of presentation requirements when presented, including that they be presented in the explanatory notes to the pro forma financial information in the form of reconciliations of pro forma net income from continuing operations attributable to the controlling interest and the related pro forma earnings per share data.

Registrants and their advisors have long complained that the existing pro forma rules were too restrictive and resulted in pro forma financial information that was of limited utility to investors. The optional flexibility under the amended rules, therefore, should be a welcome change, but Management’s Adjustments will require additional judgment and could increase preparation time. Although the amendments provide that any forward-looking information is expressly covered by the safe harbor provisions under Securities Act Rule 175 and Exchange Act Rule 3b-6, registrants and underwriters may be reluctant to include quantitative forward-looking information about the potential impacts of acquisitions in reports that are filed with the SEC.

Significance and Business Dispositions

Rule 11-01(a)(4) provides that pro forma financial information is required upon the disposition or probable disposition of a significant portion of a business, if that disposition is not fully reflected in the financial statements of the registrant. Rule 11-01(b) further provides that a disposition of a business is significant if the business to be disposed of meets the conditions of a significant subsidiary under Rule 1-02(w), which uses a 10% significance threshold, rather than the 20% significance threshold used for business acquisitions under Rule 3-05 and Rule 11-01(b).

The SEC amended the requirements regarding business dispositions to:

  • raise the significance threshold for the disposition of a business, including a real estate operation, from 10% to 20% to conform to the threshold at which an acquired business is significant under Rule 3-05 and amended Rule 3-14;
  • to the extent applicable, conform the tests used to determine significance of a disposed business to those used to determine significance of an acquired business; and
  • require smaller reporting companies to provide pro forma financial information for disposition of a significant business in Form 8-K and in certain registration statements and proxy statements when the disposition occurs during or after the most recently completed fiscal year.
Smaller Reporting Companies and Issuers Relying on Regulation A

Rule 8-05 of Regulation S-X sets forth pro forma financial information requirements for business acquisitions by smaller reporting companies. Part F/S of Form 1-A directs an issuer relying on Regulation A to present the pro forma financial information specified by Rule 8-05. While Rule 8-05 provides a number of requirements that are consistent with Article 11, Rule 8-05 did not provide further preparation guidance.

The SEC amended Rule 8-05 to require that the preparation, presentation, and disclosure of pro forma financial information by smaller reporting companies substantially comply with Article 11. The amendments to Rule 8-05 will apply to issuers relying on Regulation A, due to the reference to Rule 8-05 in Part F/S of Form 1-A.


[1] SEC Release No. 33-10786, Amendments to Financial Disclosures about Acquired and Disclosed Businesses. The SEC also adopted new requirements regarding fund acquisitions by investment companies and business development companies. Those new requirements are not addressed in this Client Alert.

[2] The financial statements must be filed not later than 71 calendar days after the initial Form 8-K is required to be filed (i.e., four business days after completion of the acquisition), which results in approximately 75 calendar days to file the required financial statements, although it could be more if the period between completing the acquisition and the Form 8-K deadline includes a weekend or holiday. A similar 75-day filing period applies to registration statements and proxy statements for acquired or to-be-acquired businesses requiring Rule 3-05 Financial Statements, but not for acquired or to-be-acquired businesses requiring Rule 3-14 Financial Statements.

[3] Form 8-K does not require audited financial statements of insignificant acquirees unless they are “related businesses” and significant on a combined basis. “Related businesses” are businesses that are under common control or management, or when the acquisitions are dependent on each other or a single common event or condition.

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