SEC Adopts Amendments to Improve Financial Disclosures about Acquisitions and Dispositions of Businesses

On May 20, 2020, the SEC issued a final rule that amends the financial statement requirements for acquisitions and dispositions of businesses, including real estate operations, and related pro forma financial information, required by Regulation S-X’s Rule 3-05 (Financial Statements of Business Acquired or to be Acquired (Rule 3-05)), Rule 3-14 (Special Instructions for Real Estate Operations to be Acquired), Article 11 on Pro Forma Financial Information, and other related ruled and forms.

In the past, registrants have encountered challenges in preparing and filing the required financial statements for acquired businesses. At times, those challenges have impacted a registrant’s ability to have access to the capital markets, which would be used to pay for the acquisition or assist in other capital needs. This action by the SEC is meant to enhance the quality of information made available to investors as to the potential effects of significant acquisitions and dispositions, while reducing the complexity of the rules along with the costs associated to disclose this information, in an effort to promote capital formation.

Key amendments in the final rule:

• Change the investment test to use the aggregate worldwide market value of common equity of the registrant when available.
• Change the income test to use the lower measure of significance based on income from continuing operations before taxes or revenue.
• Reduce the number of acquiree annual financial statement periods required to a maximum of the two most recent fiscal years.
• Require acquiree financial statements for an IPO in fewer circumstances.
• Modify the disclosure requirements for individually insignificant acquirees.
• Permit use of abbreviated financial statements for an acquiree in certain circumstances without a request for SEC staff permission.
• Amend the pro forma financial information disclosures to require adjustments and certain disclosures for “Transaction Accounting Adjustments” and “Autonomous Entity Adjustments” when a registrant was previously part of another entity.
• Permit a registrant to present “Management’s Adjustments” (e.g., synergies or dis-synergies for which there is a reasonable basis) in the explanatory notes to the pro forma financial information if certain conditions are met.
• Raise the significance threshold for reporting dispositions of a business from 10 percent to 20 percent to conform the threshold with that of a significant acquisition.
• Make other changes specific to SRCs and investment companies.

Effectiveness and Transition

The Amended Rules are effective January 1, 2021 for calendar-year-end companies. Registrants will not be required to apply the Amended Rules until the beginning of their first fiscal year beginning after December 31, 2020 (the mandatory compliance date).

If a registrant has completed an acquisition or is likely to complete the acquisition after the mandatory compliance date, the acquisition must be evaluated for significance using the Amended Rules.

Registrants filing initial registration statements are not required to apply the Amended Rules until an initial registration statement is first filed on or after their mandatory compliance date. In such an initial registration statement, all probable or consummated acquisitions, including those consummated prior to the mandatory compliance date, must be evaluated for significance using the Amended Rules.

Registrants may choose to comply voluntarily with the Amended Rules prior to the mandatory compliance date.

Conclusion

The Amended Rules provide increased simplification of the disclosure requirements for business acquisitions and dispositions. They will ease burdens and costs in the preparation of financial statements and disclosures. Some key points to remember with the Amended Rules, which will impact a vast majority of registrants when contemplating business acquisitions or dispositions are:

• Maximum of two (instead of three) years of audited annual financials.
• Corresponding prior year interim period required only at more than 40% significance.
• Increased significance threshold for dispositions from 10% to 20%.