Perspectives

SEC proposes improvements to disclosures for business acquisitions and dispositions

This issue discusses the SEC’s recently issued proposed rule, "Amendments to Financial Disclosures About Acquired and Disposed Businesses," which would amend the financial statement requirements for acquisitions and dispositions of businesses, including real estate operations, and related pro forma financial information. These changes are intended to improve the information investors receive regarding acquired or disposed businesses, reduce complexity and costs of preparing the required disclosures, and facilitate timely access to capital.

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Introduction

On May 3, 2019, the SEC issued a proposed rule that would amend the financial statement requirements for acquisitions and dispositions of businesses, including real estate operations, and related pro forma financial information. These changes are intended to improve the information investors receive regarding acquired or disposed businesses, reduce complexity and costs of preparing the required disclosures, and facilitate timely access to capital. The proposed amendments include changes to improve the disclosure requirements for (1) acquired or to be acquired businesses in SEC Regulation S-X, Rule 3-05; (2) real estate operations in SEC Regulation S-X, Rule 3-14; and (3) pro forma financial information in SEC Regulation S-X, Article 11, as well as modifications to the significance tests in SEC Regulation S-X, Rule 1-02(w). In addition, the proposed rule includes amendments to financial disclosures specific to smaller reporting companies (SRCs) and investment companies.

Volume 26, Issue 7 | May 9, 2019

Background and Key Provisions of the Proposed Rule

Rule 3-05 requires registrants, including entities undertaking an initial public offering (IPO), to file the separate preacquisition financial statements for a significant acquired or to be acquired business (acquiree). Similarly, Rule 3-14 may require a registrant to provide preacquisition financial statements for a significant acquired or to be acquired real estate operation (real estate acquiree). The financial statement periods required to be filed are based on the significance levels determined after performing the applicable significance tests in Rule 1-02(w) (i.e., the investment, asset, and income tests). Further, Article 11 requires a registrant to provide pro forma financial information depicting the impact of a significant acquisition or disposition. These disclosures can be important to investors because an acquisition or disposition will generally affect a registrant’s financial condition, results of operations, liquidity, and future prospects.

As described in further detail below, key items in the proposed rule would:

  • Change the investment test to use aggregate worldwide market value of common equity of the registrant.
  • Change the income test to use the lower of (1) income from continuing operations after taxes or (2) revenue.
  • Reduce acquiree annual financial statement periods required to a maximum of the two most recent fiscal years.
  • Result in fewer circumstances requiring acquiree financial statements for an IPO and for individually insignificant acquirees.
  • Permit use of abbreviated financial statements for an acquiree in certain circumstances without a request for SEC staff permission.
  • Allow the use of, or reconciliation to, IFRS® Standards as issued by the International Accounting Standards Board (IASB®) (IFRS-IASB) in certain circumstances.
  • Amend the pro forma financial information disclosures to require adjustments and certain disclosures for (1) “Transaction Accounting Adjustments” and (2) “Management’s Adjustments” (e.g., reasonably estimable synergies and other impacts of the acquisition).
  • Align certain requirements for a real estate acquiree with those in Rule 3-05.
  • 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.

While the changes summarized above may be significant for some registrants, many elements of Rule 3-05 would be retained under the proposed rule. Although the significance tests would be modified, the proposed rule would retain certain bright line significance thresholds. The proposed rule explains that bright line tests may allow registrants to evaluate significance more quickly than a model based on judgment would. In addition, the proposed rule would maintain the current definition of a business for SEC reporting purposes. This definition, which is outlined in SEC Regulation S-X, Rule 11-01(d), focuses on the continuity of operations, including revenue-producing activities, before and after the acquisition and is different from the definition in ASC 805 or IFRS 3. The proposed rule states that “because the definitions serve different purposes, we have not proposed to conform our rules with the applicable accounting standards.” Further, some of the proposed changes may only codify current SEC staff practice or interpretation and thus may not result in a significant change in practice. For more information on Rules 3-05 and 3-14 as well as on Article 11, see Deloitte’s A Roadmap to SEC Reporting Considerations for Business Combinations.

Connecting the Dots
Although the proposed rule may reduce the financial statement requirements under Rule 3-05 (e.g., by eliminating a third year of acquiree financial statements), it does not extend to (1) target companies included in a proxy statement or registration statement on Form S-4 or (2) a company that is considered the predecessor of a registrant.

Requests for Comment

The SEC is interested in feedback from investors, companies, and other market participants on the proposed rule and does not require a specific format for the submission of comments. The proposed rule includes 98 numbered requests for comment. Some commenters may choose to present their views in a narrative format without any reference to specific questions posed by the SEC, and others may choose to answer all, or only some, of the specific requests for comment. Any format is acceptable, and the SEC encourages all types of feedback. Comments can be submitted through the SEC’s Web site and are due 60 days after publication of the proposed rule in the Federal Register. Any comments submitted will be posted to the SEC’s Web site.

Looking Ahead

The proposed rule continues the SEC’s ongoing effort to facilitate capital formation and improve disclosure effectiveness. The proposed rule takes into consideration feedback received from the SEC’s September 2015 request for comment on the effectiveness of financial disclosures about entities other than the registrant.

Still on the SEC’s agenda, among other items, are proposed changes to the definitions of an accelerated filer and large accelerated filer. These definitions affect, among other matters, the deadlines for certain periodic reports as well as whether a registrant is required to obtain auditor attestation on the effectiveness of its internal control over financial reporting. The SEC is expected to propose changes in the near future. Stay tuned for further developments.

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