Thursday, May 21. 2020
When a registrant acquires a significant business (other than a real estate operation), Rule 3-05 of Regulation S-X generally requires this registrant to 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 generally depends on the relative significance of the acquisition to the registrant. For real estate operations, Rule 3-14 of Regulation S-X addresses their unique nature. This rule requires a registrant that has acquired a significant real estate operation to file financial statements with respect to such acquired operation.
Rule 3-05 also applies to registered investment companies and business development companies. Investment company registrants principally invest for returns from capital appreciation and/or investment income, which is different from non-investment companies. Because of these investment goals, they are required to recognize changes in value to their portfolio investments each reporting period and generally do not consolidate entities they control or use equity method accounting. Due to the nature of registered investment companies and business development companies, it can be ambiguous under the current rules how to apply the reporting requirements to funds that have been acquired.
In addition, Article 11 of Regulation S-X requires registrants to file unaudited pro forma financial information relating to an acquisition or disposition. Pro forma financial information usually includes a pro forma balance sheet and pro forma income statements that are based on the historical financial statements of the registrant and the acquired or disposed business. This includes adjustments to show how the acquisition or disposition may have affected that financial information.
The amendments pertain to Rules 3-05, 3-14, 8-04, 8-05, 8-06, and Article 11, as well as in other related rules and forms. Among other things, the amendments will:
- update the significance tests in Rule 1-02(w), Securities Act Rule 405, and Exchange Act Rule 12b-2 through:
- revising the investment test to compare the registrant’s investments in and advances to the acquired or disposed business to the registrant’s aggregate worldwide market value if available;
- revising the income test by adding a revenue component;
- expanding the use of pro forma financial information in measuring significance; and
- conforming the significance threshold and tests for disposed businesses to those used for acquired businesses to the extent applicable.
- modify and enhance the required disclosure for the aggregate effect of acquisitions for which financial statements are not required or are not yet required. This would be done by eliminating historical financial statements for insignificant businesses and expanding the pro forma financial information to depict the aggregate effect in all material respects
- mandate that the financial statements of the acquired business to cover no more than the two most recent fiscal years
- permit disclosure of financial statements that omit some expenses for certain acquisitions of a component of an entity
- no longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance
- 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
- “Transaction Accounting Adjustments” that reflect only the application of required accounting to the transaction;
- “Autonomous Entity Adjustments” that reflect the operations and financial position of the registrant as an autonomous entity if the registrant was previously part of another entity; and
- optional “Management’s Adjustments” that depict synergies and dis-synergies of the acquisitions and dispositions for which pro forma effect is being given. This would apply if, in management’s opinion, such adjustments would enhance an understanding of the pro forma effects of the transaction and certain conditions related to the basis and the form of presentation are met
The amendments will be effective on January 1, 2021. Voluntary compliance with the final amendments will be permitted in advance of the effective date