# Smaller Reporting Company Definition

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2018-14306

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** July 10, 2018
- **Citation:** 83 FR 31992

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210, 229, 230, 239, 240, and 249
[Release Nos. 33-10513; 34-83550; File No. S7-12-16]
RIN 3235-AL90
Smaller Reporting Company Definition

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rules.

SUMMARY:

We are adopting amendments to the definition of “smaller reporting company” as used in our rules and regulations. The amendments expand the number of registrants that qualify as smaller reporting companies and are intended to reduce compliance costs for these registrants and promote capital formation, while maintaining appropriate investor protections. We are amending the definition of “smaller reporting company” to include registrants with a public float of less than $250 million, as well as registrants with annual revenues of less than $100 million for the previous year and either no public float or a public float of less than $700 million. We also are amending other rules and forms in light of the new definition of “smaller reporting company,” including amendments to the definitions of “accelerated filer” and “large accelerated filer” to preserve the existing thresholds in those definitions. Qualifying as a “smaller reporting company” will no longer automatically make a registrant a non-accelerated filer. The Chairman, however, has directed the staff to formulate recommendations to the Commission for possible additional changes to the “accelerated filer” definition that, if adopted, would have the effect of reducing the number of registrants that qualify as accelerated filers.

DATES:

The final rules are effective September 10, 2018.

FOR FURTHER INFORMATION CONTACT:

Amy Reischauer or Jennifer Riegel, Office of Small Business Policy, Division of Corporation Finance, at (202) 551-3460, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-3628.

SUPPLEMENTARY INFORMATION:

We are adopting amendments to 17 CFR 230.405 (“Rule 405”) and Forms S-1,
1

S-3,
2

S-4,
3

S-8,
4

and S-11
5

under the Securities Act of 1933 (“Securities Act”);
6

17 CFR 240.12b-2 (“Rule 12b-2”) and Forms 10,
7

10-Q,
8

and 10-K
9

under the Securities Exchange Act of 1934 (“Exchange Act”);
10

17 CFR 210.3-05 (“Rule 3-05” of Regulation S-X);
11

and 17 CFR 229.10(f) (“Item 10(f)” of Regulation S-K).
12

1
17 CFR 239.11.

2
17 CFR.239.13.

3
17 CFR 239.25.

4
17 CFR 239.16b.

5
17 CFR 239.18.

6
15 U.S.C. 77a
et seq.

7
17 CFR 249.210.

8
17 CFR 249.308a.

9
17 CFR 249.310.

10
15 U.S.C. 78a
et seq.

11
17 CFR 210.1-01 through 210.12-29.

12
17 CFR 229.10 through 229.1208.

Table of Contents

I. Introduction

II. Final Amendments

A. Amendments to Smaller Reporting Company Definition

1. Public Float Test

2. Revenue Test

B. Amendments to Rule 3-05(b)(2)(iv) of Regulation S-X

C. Amendments to Accelerated Filer and Large Accelerated Filer Definitions

1. Proposed Amendments

2. Comments

3. Final Amendments

III. Other Matters

IV. Economic Analysis

A. Baseline

B. Potential Economic Effects

1. Introduction

2. Impact on Eligibility for Smaller Reporting Company Status

3. Estimation of Potential Costs and Benefits

4. Affiliated Ownership and Adverse Selection

5. Effects on Efficiency, Competition and Capital Formation

C. Possible Alternatives

V. Paperwork Reduction Act

A. Background

B. Summary of the Final Amendments

C. Summary of Comment Letters

D. Revisions to Burden and Cost Estimates

1. Form 10-K

2. Form 10-Q

3. Form 8-K

4. Schedule 14A

5. Schedule 14C

6. Form 10

7. Form S-1

8. Form S-3

9. Form S-4

10. Form S-11

VI. Final Regulatory Flexibility Analysis

A. Need for, and Objectives of, the Final Rules

B. Significant Issues Raised by Public Comments

C. Small Entities Subject to the Final Rules

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

E. Agency Action To Minimize Effect on Small Entities

VII. Statutory Amendments and Text of Final Rules

I. Introduction

On June 27, 2016, the Commission proposed amendments that would increase the financial thresholds in the “smaller reporting company” (“SRC”) definition and would have the effect of expanding the number of companies that benefit from the scaled disclosure accommodations available to SRCs.
13

In developing final rules, we considered comment letters received in response to the Proposing Release,
14

as well as recommendations made by the Securities and Exchange Commission Advisory Committee on Small and Emerging Companies (“ACSEC”)
15

and the SEC Government-Business Forum on Small Business Capital Formation (“Small Business Forum”).
16

The

Commission last revised the SRC definition in 2008.
17

Our amendments reflect the need to solicit input and retrospectively review our rules in order to determine whether they are outdated or are not functioning as intended. Today, we are amending the SRC definition in an effort to promote capital formation and reduce compliance costs for specified registrants by expanding the number of registrants that are eligible to provide scaled disclosure while maintaining appropriate investor protections.

13

See
Amendments to Smaller Reporting Company Definition, Release No. 33-10107 (Jun. 27, 2016) [81 FR 43130 (Jul. 1, 2016)] (“Proposing Release”). As the Commission noted in the Proposing Release, raising the financial thresholds in the SRC definition would be responsive to the Fixing America's Surface Transportation Act of 2015 (“FAST Act”) because it would reduce the burden on the specified registrants by increasing the number of registrants eligible for scaled disclosure.
See
Public Law 114-94, 129 Stat. 1312 (2015).

14
The comment letters received in response to the Proposing Release are available at
https://www.sec.gov/comments/s7-12-16/s71216.htm
.

15
In September 2015 and March 2013, the ACSEC recommended revising the SRC definition to include registrants with a public float of up to $250 million. The recommendations made by ACSEC in March 2013 also included a recommendation to revise the SRC definition for registrants that are unable to calculate their public float to include registrants with less than $100 million in annual revenues. ACSEC Recommendations about Expanding Simplified Disclosure for Smaller Issuers (Sept. 23, 2015), available at
https://www.sec.gov/info/smallbus/acsec/acsec-recommendations-expanding-simplified-disclosure-for-smaller-issuers.pdf
and ACSEC Recommendations Regarding Disclosure and Other Requirements for Smaller Public Companies (Mar. 21, 2013), available at
https://www.sec.gov/info/smallbus/acsec/acsec-recommendation-032113-smaller-public-co-ltr.pdf
. Both of these recommendations also included a recommendation that the Commission revise the “accelerated filer” definition to include registrants with a public float of $250 million or more, but less than $700 million. The accelerated filer definition currently includes registrants with a public float of $75 million or more, but less than $700 million.
See
Exchange Act Rule 12b-2.
See
Section II.C for a discussion of the accelerated filer definition.

16
The 2017 Small Business Forum recommended that the SRC definition be revised to include registrants with a public float of less than $250 million or registrants with annual revenues of less than $100 million, excluding large accelerated filers.
See
Final Report of the 2017 SEC Government Business Forum on Small Business Capital Formation (Mar. 2018), available at
https://www.sec.gov/files/gbfor36.pdf
. Registrants with a public float of $700 million or more generally qualify as large accelerated filers.
See
Exchange Act Rule 12b-2. Prior Small Business Forums made the same or similar recommendations. Final Small Business Forum reports are available at

https://

www.sec.gov/info/smallbus/sbforumreps.htm
. Information about the Small Business Forum is available at
http://www.sec.gov/info/smallbus/sbforum.shtml
. These recommendations also included a recommendation that the Commission revise the “accelerated filer” definition consistent with the recommended changes to the SRC definition.
See
Section II.C for a discussion of the accelerated filer definition.

17

See
Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)] (“SRC Adopting Release”).

We are adopting the amendments generally as proposed with two changes. As proposed, we are amending the SRC definition to include registrants with a public float of less than $250 million, as well as registrants with annual revenues of less than $100 million for the previous year and no public float. In a change from the proposal, the SRC definition in the final rules also includes registrants with annual revenues of less than $100 million for the previous year and a public float of less than $700 million. Specifically, we are amending Securities Act Rule 405, Exchange Act Rule 12b-2, and Item 10(f) of Regulation S-K to effect these changes. In another change from the proposal, we are amending Rule 3-05(b)(2)(iv) of Regulation S-X to increase the revenue threshold under which certain acquirers may omit the earliest of the three fiscal years of audited financial statements of certain targets. Finally, we are adopting amendments to the “accelerated filer” and “large accelerated filer” definitions in Exchange Act Rule 12b-2, as proposed, to preserve the application of the current public float thresholds in those definitions.
18

The Chairman, however, has directed the staff to formulate recommendations to the Commission for possible additional changes to the “accelerated filer” definition that, if adopted, would have the effect of reducing the number of registrants that qualify as accelerated filers in order to promote capital formation by reducing compliance costs for certain registrants, while maintaining appropriate investor protections. As part of the staff's consideration of possible recommended amendments, the Chairman has directed the staff to consider, among other things, the historical and current relationship between the SRC and “accelerated filer” definitions. The staff has begun work to prepare these recommendations.

18
The definitions of accelerated filer and large accelerated filer are based on public float, but currently contain a provision excluding registrants that are eligible to use the SRC requirements in Regulation S-K for their annual and quarterly reports. As a result, raising the SRC public float threshold without eliminating that provision effectively would raise the accelerated filer public float threshold.
See
Section II.C for a discussion of the amendments to the accelerated filer and large accelerated filer definitions.

Consistent with the proposal, we are not amending any of the scaled disclosure accommodations available to SRCs in Regulation S-K and Regulation S-X.
19

SRCs may comply with the scaled disclosure requirements available to them on an item-by-item basis.
20

The following table summarizes these scaled disclosure accommodations.
21

19
Several of these scaled disclosure accommodations, such as the scaled executive compensation disclosures under Item 402(l) through (r) of Regulation S-K [17 CFR 229.402(l) through (r)], are similar to the disclosure accommodations available to an emerging growth company (“EGC”).
See
Securities Act Rule 405 [17 CFR 230.405] and Exchange Act Rule 12b-2 [17 CFR 240.12b-2]. EGCs also are exempt from the Sarbanes-Oxley Act Section 404(b) auditor attestation of internal control over financial reporting. For a discussion of scaled disclosure accommodations available to EGCs,
see
Business and Financial Disclosure Required by Regulation S-K, Release No. 33-10064 (Apr. 13, 2016) [81 FR 23915 (April 22, 2016)] (“Regulation S-K Concept Release”).

20

See
SRC Adopting Release, 73 FR at 940. Where a disclosure requirement applicable to SRCs is more stringent than the corresponding requirement for non-SRCs, however, SRCs must comply with the more stringent standard. The SRC Adopting Release identified Item 404 of Regulation S-K [17 CFR 229.404] as the only instance in Regulation S-K in which the disclosure requirements applicable to SRCs could be more stringent.

21
In addition to the accommodations itemized in the table, SRCs using Form S-1 may incorporate by reference information filed prior and subsequent to the effectiveness of the registration statement if they meet the eligibility requirements in General Instruction VII of Form S-1.
See
Item 12(b) of Form S-1;
see also
Simplification of Disclosure Requirements for Emerging Growth Companies and Forward Incorporation by Reference on Form S-1 for Smaller Reporting Companies, Release No. 33-10003 (Jan. 19, 2016) [81 FR 2743 (Jan. 19, 2016)].

Item
Scaled disclosure accommodation

Regulation S-K

101—Description of Business
May satisfy disclosure obligations by describing the development of the registrant's business during the last three years rather than five years. Business development description requirements are less detailed than disclosure requirements for non-SRCs.

201—Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters
Stock performance graph not required.

301—Selected Financial Data
Not required.

302—Supplementary Financial Information
Not required.

303—Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

Two-year MD&A comparison rather than three-year comparison.
Two year discussion of impact of inflation and changes in prices rather than three years.
Tabular disclosure of contractual obligations not required.

305—Quantitative and Qualitative Disclosures About Market Risk
Not required.

402—Executive Compensation
Three named executive officers rather than five.

Two years of summary compensation table information rather than three.

Not required:

• Compensation discussion and analysis.

• Grants of plan-based awards table.

• Option exercises and stock vested table.

• Pension benefits table.

• Nonqualified deferred compensation table.

• Disclosure of compensation policies and practices related to risk management.

• Pay ratio disclosure.

404—Transactions With Related Persons, Promoters and Certain Control Persons
22

Description of policies/procedures for the review, approval or ratification of related party transactions not required.

407—Corporate Governance

Audit committee financial expert disclosure not required in first annual report.
Compensation committee interlocks and insider participation disclosure not required.
Compensation committee report not required.

503—Prospectus Summary, Risk Factors and Ratio of Earnings to Fixed Charges

No ratio of earnings to fixed charges disclosure required.
No risk factors required in Exchange Act filings.

601—Exhibits
Statements regarding computation of ratios not required.

Regulation S-X

Rule
Scaled disclosure

8-02—Annual Financial Statements

Two years of income statements rather than three years.
Two years of cash flow statements rather than three years.
Two years of changes in stockholders' equity statements rather than three years.

8-03—Interim Financial Statements
Permits certain historical financial data in lieu of separate historical financial statements of equity investees.

8-04—Financial Statements of Businesses Acquired or to Be Acquired
Maximum of two years of acquiree financial statements rather than three years.

8-05—Pro forma Financial Information
Fewer circumstances under which pro forma financial statements are required.

8-06—Real Estate Operations Acquired or to Be Acquired
Maximum of two years of financial statements for acquisition of properties from related parties rather than three years.

8-08—Age of Financial Statements
Less stringent age of financial statements requirements.

II. Final Amendments

A. Amendments to Smaller Reporting Company Definition

22
Item 404 also contains the following
expanded
disclosure requirements applicable to SRCs: (1) Rather than a flat $120,000 disclosure threshold, the threshold is the lesser of $120,000 or 1% of total assets, (2) disclosures are required about underwriting discounts and commissions where a related person is a principal underwriter or a controlling person or member of a firm that was or is going to be a principal underwriter, (3) disclosures are required about the issuer's parent(s) and their basis of control, and (4) an additional year of Item 404 disclosure is required in filings other than registration statements.

We are adopting amendments to the SRC definition to expand the number of registrants that qualify as SRCs and thereby benefit from scaled disclosure requirements. These amendments will enable a registrant to qualify as a SRC based on a public float test or a revenue test.
23

23

See
Item 10(f)(1)(i) and (ii) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

Under the final rules, SRCs generally
24

are registrants with:

24
Consistent with the current definition, the SRC definition in the final rules specifically excludes investment companies, asset-backed issuers (as defined in Item 1101 of Regulation AB [17 CFR 229.1101]) and majority-owned subsidiaries of a parent that is not a SRC.
See
Item 10(f)(1) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2. Lower public float and revenue thresholds apply to registrants that determined that they did not qualify as SRCs in the prior year, but are eligible to transition to SRC status.
See
Item 10(f)(2)(iii) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.
See also
Section II.A for a discussion of the amendments to these thresholds.

• A public float of less than $250 million;
25

or

25
Consistent with the current definition, public float is computed under the final rules by multiplying the aggregate worldwide number of shares of a registrant's voting and non-voting common equity held by non-affiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity.
See
Item 10(f)(1)(i) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2. The determination of public float is premised on the existence of a public trading market for the issuer's equity securities. Therefore, an entity with equity securities outstanding but not trading in any public trading market would not be able to qualify on the basis of a public float test. In contrast to public float, market capitalization reflects the value of a registrant's voting and non-voting common equity held by all holders, whether affiliates or non-affiliates.

A reporting registrant calculates its public float as of the last business day of its most recently completed second fiscal quarter.
See
Item 10(f)(2)(i) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2. A registrant filing its initial registration statement under the Securities Act or Exchange Act calculates its public float as of a date within 30 days of the date the registration statement is filed by multiplying the aggregate worldwide number of shares of its voting and non-voting common equity held by non-affiliates before the registration plus, in the case of a Securities Act registration statement, the number of such shares included in the registration statement by the estimated public offering price of the shares.
See
Item 10(f)(2)(ii)(A) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

• annual revenues of less than $100 million
26

and either no public float
27

or a public float of less than $700 million.
28

26
Consistent with the current definition, annual revenues are as of the most recently completed fiscal year for which audited financial statements are available. Item 10(f)(2)(i)(B) and (f)(2)(ii)(B) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

27

See
Item 10(f)(1)(ii)(A) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2. A registrant may have no public float because it has no public common equity outstanding or no market price for its common equity exists. Based on data compiled by our Division of Economic and Risk Analysis (“DERA”), in calendar year 2016, approximately 21.5% of registrants that qualified as SRCs (and 7.7% of all registrants) had no public float. The estimated number of registrants with no public float here and elsewhere in this release may be over-inclusive due to the difficulty of ascertaining this status based on data extracted from registrants' filings.
See
note 141 for a discussion of the methodology used by the staff to obtain this data.

28

See
Item 10(f)(1)(ii)(B) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

As proposed, the final rules increase the threshold for determining SRC status based on public float from $75 million to $250 million. A registrant that qualifies as a SRC under the public float test would qualify regardless of its revenues.
29

In a change from the proposal, the final rules will expand the SRC definition to include registrants with a public float of less than $700 million, if they also have annual revenues of less than $100 million.
30

The following table summarizes the amendments to the SRC definition for a registrant making an initial determination under the amendments

31

or a current SRC seeking to continue to qualify.

29

See
Instruction to Paragraph (f) of Item 10 of Regulation S-K; Instruction to definition of “smaller reporting company” in Securities Act Rule 405; Instruction to definition of “smaller reporting company” in Exchange Act Rule 12b-2.

30

See
Item 10(f)(1)(ii)(B) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

31
For purposes of the first fiscal year ending after effectiveness of the amendments, a registrant will qualify as a SRC if it meets one of the initial qualification thresholds in the revised definition as of the date it is required to measure its public float or revenues (the “measurement date”), even if such

registrant previously did not qualify as a SRC.
See
Item 10(f)(2)(i) and (ii) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2 for additional information about the measurement date. For example, a registrant with a September 30 fiscal year end that previously was not a SRC and that had a public float of $220 million as of March 30, 2018 (the last business day of its most recently completed second quarter) will qualify as a SRC for the fiscal year ending September 30, 2018.

Criteria
Current definition
Revised definition

Public Float
Public float of less than $75 million
Public float of less than $250 million.

Revenues
Less than $50 million of annual revenues and no public float

Less than $100 million of annual revenues and
• no public float, or
• public float of less than $700 million.

Consistent with the current definition, and as proposed, under the final rules, a registrant that determines that it does not qualify as a SRC under the initial qualification thresholds will remain unqualified unless and until it determines that it meets one or more lower qualification thresholds. The subsequent qualification thresholds, set forth in the table below, are set at 80% of the initial qualification thresholds.
32

32

See
Item 10(f)(2)(iii) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

Criteria
33

Current definition
Revised definition

Public Float
Public float of less than $50 million

Public float of less than $200 million, if it previously had $250 million or more of public float.
34

Revenues
Less than $40 million of annual revenues and no public float

Less than $80 million of annual revenues, if it previously had $100 million or more of annual revenues; and
Less than $560 million of public float, if it previously had $700 million or more of public float.

1. Public Float Test

a. Proposed Amendments

33
A registrant that does not qualify as a SRC may subsequently seek to qualify under either test.

34
A registrant that previously was not a SRC that subsequently qualifies based on a public float of less than $200 million will qualify as a SRC regardless of its revenues.
See
Instruction to Paragraph (f) of Item 10 of Regulation S-K; Instruction to definition of “smaller reporting company” in Securities Act Rule 405; Instruction to definition of “smaller reporting company” in Exchange Act Rule 12b-2.

As proposed, a registrant with a public float of less than $250 million would qualify as a SRC.
35

Consistent with the current definition, the Commission proposed that once a registrant does not qualify as a SRC,
36

it would remain unqualified until its public float falls below another, lower threshold. Specifically, the Commission proposed amending the rules to provide that a registrant that previously did
not
qualify as a SRC would qualify as a SRC if it has a public float of less than $200 million as of its most recently completed second fiscal quarter.
37

35

See
Proposed Item 10(f)(1)(i) and (ii) of Regulation S-K; Proposed Securities Act Rule 405; Proposed Exchange Act Rule 12b-2.

36
This applies either upon an initial determination in the case of registrants filing an initial registration statement, or as of an annual determination in the case of reporting registrants.

37
The proposed $200 million subsequent qualification threshold represents 80% of the proposed $250 million initial qualification threshold. Under the current definition, a registrant that previously determined that it did not qualify as a SRC because its public float exceeded the current $75 million threshold may qualify based on a subsequent determination if it has a public float of less than $50 million. That registrant would then remain a SRC until its public float again exceeded $75 million. Consistent with the current definition, under the proposed definition, a registrant that subsequently qualifies under the $200 million public float threshold would remain qualified until its public float exceeds $250 million.

b. Comments

Most commenters addressed the overall costs and benefits of expanding the pool of registrants eligible for SRC status. Many of these commenters expressed general support for the proposed amendments to the SRC definition.
38

Several of these commenters stated that the proposed definition appropriately considers the objectives of capital formation and investor protection
39

and promotes capital formation or liquidity for smaller registrants.
40

38

See
Letter from Acorda Therapeutics, Inc. et al., August 23, 2016 (“Acorda, et al.”); Letter from Advanced Medical Technology Association, August 20, 2016 (“AMTA”); Letter from Biotechnology Innovation Organization, August 30, 2016 (“BIO”); Letter from BDO USA, LLP, August 29, 2016 (“BDO”); Letter from Center for Audit Quality and Counsel of Institutional Investors, August 30, 2016 (“CAQ/CII”); Letter from CONNECT, August 4, 2016 (“CONNECT”); Letter from Corporate Governance Coalition for Investor Value, August 30, 2016 (“Coalition”); Letter from Independent Community Bankers of America, August 29, 2016 (“ICBA”); Letter from MidSouth Bancorp, Inc., August 24, 2016 (“MidSouth”); Letter from Nasdaq, August 30, 2016 (“Nasdaq”); Letter from NYSE Group, July 25, 2016 (“NYSE”); Letter from National Venture Capital Association, August 25, 2016 (“NVCA”); Letter from Seneca Foods Corporation, August 2, 2016 (“Seneca”); and Letter from The Small Business Financial and Regulatory Affairs Committee of the Institute of Management Accountants, August 24, 2016 (“IMA”).

39

See
AMTA; BDO; BIO; Coalition; ICBA.

40

See
AMTA; BDO; BIO; Coalition; ICBA; NVCA; and NYSE.
See also
CONNECT (supporting the proposal to amend the SRC definition to encompass a wider range of emerging businesses for which regulatory costs present a significant burden to growth).

On the other hand, three commenters generally opposed the proposed amendments to the SRC definition or generally opposed accommodations based on company size.
41

One of these commenters stated that the accommodations for SRCs exist solely for the expedience of issuers and must be balanced against the cost to market participants who have less information from which to draw conclusions.
42

Another of these commenters stated that it was concerned that the scaled disclosure regime for SRCs may prevent investors from receiving all of the material information needed to conduct a thorough analysis.
43

This commenter

also noted that allowing different sized entities to use different disclosure regimes would signal to investors that the entities lack comparable quality.
44

The third commenter recommended that the Commission consider adopting disclosure objectives that would mitigate the need to scale disclosure requirements based on the size or nature of a reporting entity.
45

41

See
Letter from Cable Car Capital LLC, June 28, 2016 (“Cable Car”); Letter from CFA Institute, August 30, 2016 (“CFA Institute”); Letter from Ernst & Young LLP, September 8, 2016 (“EY”).

42

See
Cable Car.

43

See
CFA Institute (noting that “the pension benefits table and a disclosure of compensation policies and practices related to risk management (both of which can be deleted under scaled disclosure) are more vital than certain other disclosures”).

44

See
CFA Institute.

45

See
EY (noting that it “previously recommended that the Commission consider adopting disclosure objectives that would mitigate the need for scaling disclosure requirements based on the size or nature of a reporting entity” and citing to its letter dated July 21, 2016 responding to the SEC's concept release on business and financial disclosures required by Regulation S-K (Release No. 33-10064; File No. S7-06-16)).

Two commenters stated that the proposed amendments would potentially provide only marginal cost savings.
46

One of these commenters did not support the proposal and instead encouraged the Commission to continue its review of scaled disclosure to determine which disclosures are repetitive and should be deleted and which should be retained.
47

The other commenter stated that the proposed change and the resulting reduced disclosure requirements for additional registrants would have a minimal effect on its annual compliance costs.
48

46

See
CFA Institute; and Seneca.

47

See
CFA Institute.

48

See
Seneca.

Many commenters expressed support for the proposed increases in both the public float and revenue thresholds.
49

One commenter supported the amendments and viewed them as an acknowledgement that the current public float threshold is overly restrictive.
50

Another commenter specifically stated that it supported the proposed approach to adjusting the thresholds rather than simply relying on inflation adjustments.
51

49

See
Acorda et al; AMTA; BDO; BIO; CAQ/CII; CONNECT; Coalition; ICBA; MidSouth; Nasdaq; NVCA; NYSE; Seneca; and IMA.

50

See
Letter from Council of State Bioscience Associations, August 26, 2016 (“CSBA”) (stating that the Commission should similarly reform the accelerated filer definition and institute an alternative revenue test for both the SRC and accelerated filer definitions).

51

See
NYSE.

Two commenters recommended that the Commission review the SRC definition periodically to determine whether the thresholds being used remain appropriate.
52

One of these commenters specifically recommended that the Commission revisit the thresholds after three years.
53

52

See
CFA Institute; and Letter from Kermit Kubitz, August 31, 2016 (“Kubitz”).

53

See
Kubitz.

c. Final Amendments

After considering the comments received, as well as the recommendations made by the ACSEC
54

and the Small Business Forum,
55

consistent with the proposal, we are adopting amendments to the SRC definition that will permit registrants with a public float of less than $250 million to qualify as SRCs.
56

As is the case with the current definition, once a registrant determines that it does not qualify as a SRC under the applicable thresholds,
57

it will not subsequently qualify until its public float falls below another, lower threshold, set at 80% of the initial qualification threshold. While we did not receive any comments on the subsequent qualification thresholds, we continue to believe that these thresholds are necessary to avoid situations in which registrants frequently enter and exit SRC status due to small fluctuations in their public float and that the thresholds do not impose an undue burden on registrants seeking to qualify for SRC status. Accordingly, we are amending the rules to permit a registrant that previously did not qualify as a SRC because its public float was $250 million or more to qualify as a SRC if it has a public float of less than $200 million, regardless of its revenues.
58

54

See
note 19.

55

See
note 20.

56

See
Item 10(f)(1)(i) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2.

57
This applies either upon an initial determination in the case of registrants filing an initial registration statement, or as of an annual determination in the case of reporting registrants.

58

See
Item 10(f)(2)(iii)(A) and Instruction to Paragraph (f) of Item 10 of Regulation S-K; Securities Act Rule 405 and Instruction to definition of “smaller reporting company” in Securities Act Rule 405; Exchange Act Rule 12b-2 and Instruction to definition of “smaller reporting company” in Exchange Act Rule 12b-2. Consistent with the current definition, under the amended definition, a registrant that subsequently qualifies under the $200 million public float threshold would remain qualified until its public float exceeds $250 million.

We are not revising the method of calculating public float, as suggested by one commenter.
59

The staff is not aware of significant incidence of manipulation or stock price volatility affecting qualification under the public float test. In addition, the method of calculating public float is consistent with the existing rules and with the method of determining eligibility to use Form S-3 or Form F-3 to register a primary offering.
60

This consistency will avoid additional burdens or confusion for registrants and investors that may result if registrants were required to calculate their public float in one manner for determining SRC status and in another manner for Form S-3 or Form F-3 eligibility.

59

See
Letter from Paul W. Zeller, July 18, 2016 (“Zeller”) (suggesting that the Commission, in the calculation of public float, adopt a revenue test for thinly traded registrants to address price manipulation and volatility concerns).

60

See
Instructions I.B.1 and I.B.6 of Form S-3; Instructions I.B.1 and I.B.5 of Form F-3. Certain newly eligible SRCs under the new definition will continue to be eligible to rely on Instruction I.B.1 of Form S-3 and Form F-3 to register primary offerings.

We believe that these amendments will promote capital formation through a modest reduction in compliance costs for newly eligible SRCs while maintaining appropriate investor protections.
61

In 2016, approximately 28% of registrants had less than $75 million in public float,
62

compared to approximately 42% of registrants when the SRC definition was established.
63

Increasing the public float threshold to $250 million would have resulted in approximately 39% of registrants qualifying as SRCs in 2016 based on their public float.
64

61

See
Section IV.B.

62
Based on public float values disclosed by registrants in their Form 10-K filings, 2,072, or 28.0%, of the 7,395 registrants that filed a Form 10-K in 2016 reported having a public float of less than $75 million.

63
Approximately 4,976, or 41.8%, of the 11,898 registrants that filed Exchange Act annual reports in 2006 had a public float of less than $75 million.
See
SRC Adopting Release. The release cites data from the Commission's EDGAR filing system and Thomson Financial (“Datastream”). The Datastream data included all registered public firms trading on the New York Stock Exchange, the American Stock Exchange, the Nasdaq, the Over-the-Counter Bulletin Board and the Pink Sheets and excluded closed end funds, exchange traded funds, American depositary receipts and direct foreign listings.

64
Based on public float values disclosed by registrants in their Form 10-K filings, 2,851, or 38.6%, of the 7,395 registrants that filed a Form 10-K in 2016 reported having a public float of less than $250 million.

We believe the existing scaled disclosure accommodations have reduced compliance costs for SRCs.
65

These amendments will extend those benefits to a broader pool of registrants, consistent with the intent of the Commission when it adopted the SRC definition in 2007.
66

Although the amendments will permit a broader group of registrants to make scaled disclosure to their investors, we do not believe that this scaling of disclosure

will detract substantially from the investor protection objectives of our disclosure regime in light of the other protections available under current law and regulations. First, the additional registrants that will qualify for scaled disclosure, like all registrants, will remain liable for their disclosures
67

and, in addition to the disclosure expressly required by the rules, will continue to be required to provide such further material information, if any, as may be necessary to make any required statements, in the light of the circumstances under which they are made, not misleading.
68

Moreover, their disclosure also will continue to be subject to the Division of Corporation Finance's filing review process. These measures of investor protection will remain unchanged.

65

See
Section IV.B.3.a.

66

See
SRC Adopting Release, 73 FR at 934 and 942 (stating that the Commission was “adopting amendments to its disclosure and reporting requirements . . . to expand the number of companies that qualify for its scaled disclosure requirements for smaller reporting companies;” and “[w]e believe this standard is appropriately scaled in that it reduces costs to smaller companies caused by unnecessary information requirements, consistent with investor protection.”).

67

See, e.
g.,
Sections 11, 12, and 17 of the Securities Act, Sections 10(b) and 18 of the Exchange Act, and Exchange Act Rule 10b-5 [17 CFR 240.10b-5].

68

See
Securities Act Rule 408 [17 CFR 230.408] and Exchange Act Rule 12b-20 [17 CFR 240.12b-20].

2. Revenue Test

a. Proposed Amendments

As proposed, a registrant with no public float would qualify as a SRC if it had annual revenues of less than $100 million during its most recently completed fiscal year.
69

Consistent with the current definition, the Commission proposed that once a registrant determines that it does not qualify as a SRC,
70

it would not subsequently qualify until its revenues fall below another, lower threshold. Specifically the Commission proposed amending the rules to provide that a registrant with no public float that previously determined that it did not qualify as a SRC would qualify as a SRC if it had annual revenues of less than $80 million as of the relevant measurement date.
71

The proposed $80 million subsequent qualification threshold would maintain the 80% ratio that exists between the $50 million initial qualification threshold and $40 million subsequent qualification threshold in the current SRC definition.

69

See
Proposed Item 10(f)(1)(ii)(A) of Regulation S-K; Proposed Securities Act Rule 405; Proposed Exchange Act Rule 12b-2.

70
This applies either upon an initial determination in the case of registrants filing an initial registration statement, or as of an annual determination in the case of reporting registrants.

71
Under the current definition, a registrant that previously determined that it did not qualify as a SRC because it had no public float and its revenues exceeded the current $50 million threshold may qualify based on a subsequent determination if it had annual revenues of less than $40 million. That registrant would then remain a SRC until its revenues exceeded $50 million. Consistent with the current definition, under the proposed definition, a registrant with no public float that subsequently qualifies under the $80 million revenue threshold would remain qualified until its revenue exceeds $100 million.

The Proposing Release noted that the 2015 Small Business Forum recommended that the SRC definition be revised to include, in addition to registrants with a public float of less than $250 million, registrants with a public float of less than $700 million and annual revenues of less than $100 million.
72

The Proposing Release also solicited comment on whether the Commission should revise the SRC definition to include an alternative revenue test.

72

See
Proposing Release at text accompanying note 22.

b. Comments

Many commenters recommended that the Commission add a revenue test to the SRC definition for companies with a public float.
73

Several commenters stated that businesses below $100 million in revenue are viewed by reasonable observers as “small.”
74

One commenter believed that a revenue test would stimulate innovation and drive business growth.
75

Another commenter stated that a revenue test would ensure that pre-revenue companies are not “forced to divert investment funds . . . from science to compliance.”
76

Another commenter supported an alternative revenue test for highly valued pre-revenue companies “to avoid stifling the advancement” of these companies with costly compliance.
77

Two commenters suggested that we adopt a revenue test without a limitation on the public float or market capitalization of the company.
78

Another two commenters specifically recommended that the Commission adopt a definition based on revenues of less than $100 million and a public float of less than $700 million, as recommended by the Small Business Forum.
79

73

See
Acorda, et al. (recommending a revenue test, stating that public float is largely a marker of future value but paints an inaccurate picture of small businesses in the present); AMTA; BIO (stating that the Commission should move away from its reliance on public float as the ultimate arbiter of company size); Letter from Calithera Biosciences, August 8, 2016 (“Calithera”); CONNECT; CSBA; Nasdaq (recommending a well-crafted revenue only threshold); NYSE (recommending a simple revenue test without a limitation on market capitalization); and Zeller (recommending a revenue test for any issuers that are thinly traded).
See also
Section II.A.1.b for a discussion of comments addressing the overall costs and benefits of expanding the pool of registrants eligible for SRC status, including the proposed revision to expand the revenue threshold for registrants with no public float.

74

See
Acorda, et al.; BIO; and Calithera.

75

See
BIO (stating that pre-revenue small businesses should remain focused on innovation and do not have the capital to pay for expensive compliance requirements, and therefore allowing them to qualify as SRCs until they generate revenue would stimulate innovation and drive business growth).

76

See
Acorda, et al.

77

See
AMTA.

78

See
NYSE; and Nasdaq.

79

See
BIO; and Calithera.

c. Final Amendments

After considering the comments received as well as the recommendations made by the ACSEC
80

and the Small Business Forum,
81

we are adopting the proposed amendments to the revenue test of the SRC definition and expanding the revenue test to include certain registrants with a public float. The definition in the final rules will include, in addition to registrants with a public float of less than $250 million, registrants with annual revenues of less than $100 million during their most recently completed fiscal year and either no public float (calculated as discussed in Section II.A.1) or a public float of less than $700 million.
82

We are persuaded by commenters' suggestions that it is appropriate to provide a measure by which a registrant with a public float but limited revenues may qualify as a SRC.
83

This amended revenue test expands the proposed revenue threshold for companies with no public float to permit registrants with a public float that is less than $700 million to qualify based on their revenues. The $700 million public float threshold included in this amended revenue test was recommended by two commenters
84

and the Small Business Forum.
85

This change from the proposal

permits some additional registrants to qualify as SRCs,
86

and we believe that these low-revenue registrants would benefit from the cost savings of scaled disclosure accommodations and could redirect those savings into growing their businesses without significantly detracting from investor protections. For example, these registrants will remain liable for their disclosures, will continue to be required to provide all material information necessary to make any required statements not misleading, and will continue to be subject to the Division of Corporation Finance's filing review process.

80

See
note 19.

81

See
note 20.

82

See
Item 10(f)(1)(ii) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2. Under the public float test discussed in Section II.A.1., a registrant with public float of less than $250 million will qualify as a SRC regardless of its revenues.
See
Instruction to Paragraph (f) of Item 10 of Regulation S-K; Instruction to definition of “smaller reporting company” in Securities Act Rule 405; Instruction to definition of “smaller reporting company” in Exchange Act Rule 12b-2.

83

See
Acorda, et al.; AMTA; BIO; Calithera; CONNECT; and CSBA.

84

See
BIO and Calithera.

85

See
note 20. In 2016 and 2017, the Small Business Forum recommended that the SRC definition be revised to include registrants with a public float of less than $250 million or registrants with annual revenues of less than $100 million, excluding large accelerated filers. Registrants with a public float of $700 million or more generally qualify as large accelerated filers.
See
Exchange Act Rule 12b-2. In prior years, the Small Business Forum recommended that the Commission revise the SRC definition to include registrants with a public float of less than $250 million or registrants with a public float of less than $700 million and annual revenues of less than $100 million.
See, e.g.,
Final Report of the 2015 SEC Government Business

Forum on Small Business Capital Formation (Apr. 2016), available at
https://www.sec.gov/info/smallbus/gbfor34.pdf
.

86
Excluding the 2,851 registrants that based on their 2016 data would qualify under the public float test described in Section II.A.1 and the 594 registrants that would qualify under the proposed no public float and less than $100 million in annual revenues test, we estimate that this change would permit an additional 161 registrants to qualify as a SRC.

The amended revenue test that we are adopting is consistent with the position expressed by several commenters
87

that it is not necessary to subject capital-intensive, low-revenue registrants with larger public floats or market capitalizations to the same reporting requirements as registrants with larger public floats and more well-established, revenue-generating businesses. Although two commenters suggested that we adopt a revenue test without a limitation on the public float or market capitalization of the company,
88

we believe that it is appropriate to include a public float limitation because, as a registrant's business and public float grows, investors should benefit from greater disclosure. The additional information provided by the registrant in these circumstances will assist a growing investor base in making informed investment decisions and also should lead to a lower cost of capital for the business as it grows. In this way, the amended revenue test in the final rules will enable some additional capital-intensive, low-revenue registrants to benefit from the cost-savings of scaled reporting, while continuing to require larger registrants to comply with the disclosure requirements applicable to non-SRCs.

87

See
Acorda, et al.; AMTA; BIO; Calithera; CONNECT; CSBA; NYSE; and Nasdaq.

88

See
NYSE; and Nasdaq.

In 2016, approximately 7.7% of registrants qualified as SRCs by having no public float and less than $50 million in annual revenues.
89

The number of registrants that would qualify as SRCs would have increased by 26, or 0.4%, under the new $100 million annual revenue threshold for registrants with no public float.
90

Expanding the definition further to include registrants with annual revenues of less than $100 million and public float of less than $700 million would have increased the number of eligible registrants by an additional 161, or 2.2%.
91

89
Based on public float values and revenues disclosed by registrants in their Form 10-K filings in 2016, 568, or 7.7%, of the 7,395 registrants that filed a Form 10-K in 2016 reported having no public float and less than $50 million in annual revenues.

90
Based on public float values and revenues disclosed by registrants in their Form 10-K filings in 2016, 26, or 0.4%, of the 7,395 registrants that filed a Form 10-K in 2016 had no public float and $50 million or more but less than $100 million in annual revenues.

91
Based on public float values and revenues disclosed by registrants in their Form 10-K filings in 2016, 161, or 2.2%, of the 7,395 registrants that filed a Form 10-K in 2016 had $250 million or more but less than $700 million of public float and less than $100 million in annual revenues.

Under the current definition, and as proposed, once a registrant with no public float determines that it does not qualify as a SRC,
92

it cannot subsequently qualify based on revenues until its revenues fall below another, lower threshold. As discussed above with respect to the public float test, while we did not receive any comments on the subsequent qualification thresholds, we believe that a separate, lower revenue threshold for these registrants helps to avoid situations in which registrants enter and exit SRC status due to small fluctuations in their revenues and does not impose an undue burden on registrants seeking to qualify for SRC status. Therefore, consistent with the proposal, once an issuer with no public float determines that it does not qualify for SRC status because its annual revenues exceeded $100 million, it will remain unqualified unless and until its annual revenues are less than $80 million as of the measurement date.
93

92
This applies either upon an initial determination in the case of registrants filing an initial registration statement, or as of an annual determination in the case of reporting registrants.

93

See
Item 10(f)(2)(iii)(B) of Regulation S-K; Securities Act Rule 405; Exchange Act Rule 12b-2. Consistent with the current definition, under the amended definition, a registrant with no public float that subsequently qualifies under the $80 million revenue threshold remains qualified until its revenue exceeds $100 million.

Consistent with the 80% ratio we are adopting for the other subsequent qualification thresholds, under the amended revenue test, once a registrant with public float determines that it does not qualify as a SRC because it exceeds either or both of the $100 million annual revenue and $700 million public float thresholds, it will remain unqualified unless and until it meets a lower threshold for the criteria on which it previously failed to qualify ($80 million of annual revenue and $560 million of public float) and continues to meet any threshold it previously satisfied ($100 million of annual revenue or $700 million of public float).
94

By requiring that a registrant satisfy a lower threshold only with respect to a threshold it previously exceeded, we are attempting to strike a balance between avoiding situations in which registrants frequently enter and exit SRC status due to small fluctuations and not imposing an undue burden on registrants seeking to qualify for SRC status. A registrant that exceeded both the public float threshold and the revenue threshold, however, would not qualify unless and until it met both lower thresholds in order to avoid situations in which registrants enter and exit SRC status due to small fluctuations in either their revenues or public float. The table below sets forth the thresholds for qualification as of the respective measurement date under the amended revenue test after one or both thresholds have been exceeded:

94

Id.
Consistent with the current definition, under the amended definition, a registrant that subsequently qualifies under the $560 million public float threshold or $80 million revenue threshold remains qualified until its public float exceeds $700 million or its revenue exceeds $100 million.

Prior annual revenues
Prior public float

None or less than $700
million

$700 million or more

Less than $100 million
Neither threshold exceeded
Public float—Less than $560 million; and

Revenues—Less than $100 million.

$100 million or more
Public float—None or less than $700 million; and
Public float—Less than $560 million; and

Revenues—Less than $80 million
Revenues—Less than $80 million.

B. Amendments to Rule 3-05(b)(2)(iv) of Regulation S-X

In the Proposing Release, the Commission asked whether, if the revenue threshold in the SRC definition is increased, the threshold in Rule 3-05 of Regulation S-X also should increase. Rule 3-05 of Regulation S-X provides the requirements for financial statements of businesses acquired or to be acquired in certain registration statements and current reports. Current paragraph (b)(2)(iv) allows certain registrants to omit such financial statements for the earliest of the three fiscal years required if the net revenues of the business to be acquired are less than $50 million.
95

The $50 million threshold is based on the revenue threshold in the SRC definition.
96

95
Rule 3-05(b)(2) sets forth the requirements for financial statements of an acquired business or to be acquired business to be provided other than when registering securities to be offered to the security holders of the business to be acquired.

96
In 1996, the Commission revised Rule 3-05 to streamline the requirements for financial statements of significant business acquisitions in filings made under the Securities Act and the Exchange Act, stating:

“The threshold at which audited financial statements of an acquired business are required for three years, as required for the issuer itself (except for small business issuers), has been raised from 40% to 50% in recognition of the significant burden imposed by the lower threshold. In addition, consistent with the criteria for small business issuers, financial statements for periods preceding the most recent two fiscal years would not be required for acquired businesses reporting revenues below $25 million.”
See
Streamlining Disclosure Requirements Relating to Significant Business Acquisitions. Release No. 33-7355 (Oct. 10, 1996) [61 FR 54509 (Oct. 18, 1996)] (“1996 Rule 3-05 Adopting Release”).

When the Commission adopted the SRC definition (which replaced the small business issuer definition) in 2007, it noted:

“Several comment letters noted that in light of the $50 million in revenues threshold proposed for determining a company's qualification as a SRC if a company is unable to calculate public float, the Commission should consider revising [Rule 3-05(b)(2)(iv)] to raise to $50 million the $25 million threshold currently used to limit to two the periods required for audited financial statements of an acquired business. The $25 million threshold was based on the $25 million in revenues standard in Regulation S-B that we are rescinding. We are amending this standard to increase the threshold to $50 million in revenues, as suggested by the commenters.”
See
SRC Adopting Release.

Two commenters recommended amending Rule 3-05 to increase the revenue threshold in paragraph (b)(2)(iv) to $100 million to maintain the alignment between Rule 3-05 and the definition of a SRC.
97

One commenter noted that this alignment should be retained to “maintain the objective the Commission expressed when it adopted the 2007 S-X Rule 3-05 relief.”
98

The other commenter noted that this amendment would avoid having the financial statement requirements for a SRC-sized target company exceed those of a similarly sized registrant.
99

97

See
EY; and BDO. No other commenters addressed whether to amend Rule 3-05 of Regulation S-X.

98

See
EY;
see also
SRC Adopting Release.

99

See
BDO.

Consistent with these comments, we are amending Rule 3-05 to increase the net revenue threshold in Rule 3-05(b)(2)(iv) of Regulation S-X to $100 million.
100

Given that the current $50 million revenue threshold in Rule 3-05(b)(2)(iv) was based on the revenue threshold in the SRC definition, and in light of our decision to increase the revenue threshold in the SRC definition from $50 million to $100 million, we are raising the net revenue threshold in Rule 3-05(b)(2)(iv) of Regulation S-X from $50 million to $100 million.

100

See
Rule 3-05(b)(2)(iv) of Regulation S-X.

C. Amendments to Accelerated Filer and Large Accelerated Filer Definitions

1. Proposed Amendments

The Commission proposed amending the definitions of “accelerated filer” and “large accelerated filer” to remove the automatic exclusion from these definitions of any registrant that qualifies as an SRC
101

and solicited comment on a number of questions related to this issue.
102

Among other requirements,
103

being an accelerated filer or a large accelerated filer triggers the requirement contained in Section 404(b) of the Sarbanes-Oxley Act
104

to have the auditor provide an attestation report on internal control over financial reporting. Currently, the accelerated filer and large accelerated filer definitions include a provision that specifically excludes registrants that are eligible to use the SRC requirements under Regulation S-K for their annual and quarterly reports.
105

As a result, the existing public float threshold in the accelerated filer definition aligns with the current public float threshold in the SRC definition.
106

101

See
Proposing Release, 81 FR at 43136.

102

See
Proposing Release, 81 FR at 43137. As discussed in the Proposing Release, the ACSEC and the Small Business Forum have recommended increasing the thresholds in both the SRC and the accelerated filer definitions.
See
notes 19 and 20.

103
Accelerated and large accelerated filers are subject to accelerated periodic report filing deadlines. In addition, they must provide their internet address and disclosure regarding the availability of their filings required by Items 101(e)(3) and (4) of Regulation S-K [17 CFR 229.101(e)(3) and (4)], as well as disclosure required by Item 1B of Form 10-K about unresolved staff comments on their periodic or current reports.

104
Public Law 107-204, Sec. 404(b) 116 Stat. 745 (2002).

105
Paragraphs (1)(iv) of the accelerated filer definition and (2)(iv) of the large accelerated filer definition in Exchange Act Rule 12b-2.

106
The public float thresholds for exiting SRC status and entering accelerated filer status currently are both $75 million, and the determinations are both made as of the last business day of a registrant's most recently completed second fiscal quarter for purposes of the following fiscal year.

ER10JY18.000

Increasing the SRC public float threshold to $250 million without eliminating the SRC provision from the accelerated filer definition would exclude from the definition of accelerated filer those registrants that are newly eligible to use the SRC disclosure requirements, keeping the thresholds for both definitions linked as they have been historically.

The Commission proposed to eliminate the provision in the accelerated filer definition that excludes SRCs to maintain the current thresholds at which registrants are subject to the accelerated filer disclosure and filing requirements. As a result, as illustrated in Figure 2, some registrants would qualify as both SRCs and accelerated filers.

ER10JY18.001

As discussed in the Proposing Release, the public float threshold for entering large accelerated filer status currently is $700 million, so newly eligible SRCs under the proposed increased public float threshold of $250 million would not include any registrants that currently qualify as large accelerated filers. Nevertheless, the Commission proposed to eliminate this provision because it currently does not capture any registrants, would not have captured any registrants under the proposed amendments, and could lead to confusion if retained.

2. Comments

Some commenters responded to the Commission's solicitation of comment on this issue by supporting the elimination of the provisions in the accelerated filer and large accelerated filer definitions that specifically exclude registrants that are eligible to use the SRC disclosure requirements for their annual or quarterly reports.
107

One commenter stated that it found no compelling argument to support what it sees as a weakening of investor protections, particularly in light of the 2011 Staff Section 404(b) Study
108

finding that accelerated filers subject to Section 404(b) had a lower restatement rate compared to non-accelerated filers not subject to Section 404(b).
109

Another commenter recommended that the Commission undertake a separate rulemaking before deciding whether to change the Section 404(b) requirements.
110

A third commenter recommended that the Commission provide more time for registrants with a public float of less than $250 million to file their periodic reports.
111

107

See
BDO; CAQ/CII; CFA Institute; Letter from Deloitte, August 23, 2016 (“Deloitte”); and EY.

108
Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 For Issuers With Public Float Between $75 and $250 Million (Apr. 2011), available at
https://www.sec.gov/news/studies/2011/404bfloat-study.pdf
.

109

See
CFA Institute, citing 2011 Staff Section 404(b) Study.

110

See
EY.

111

See
BDO.

In contrast, many commenters responded to the Commission's solicitation of comment on this issue by recommending that the Commission increase the thresholds in the accelerated filer definition, consistent with the changes to the SRC definition.
112

Commenters recommended increasing the public float threshold in the accelerated filer definition to reduce compliance costs
113

and to maintain uniformity across our rules.
114

Many of these commenters stated that Section 404(b) is particularly costly for SRCs and emerging businesses
115

and that audit costs associated with Section 404(b) divert capital from core business needs.
116

112

See
Acorda, et al.; AMTA; BIO; Calithera; CONNECT; Coalition; CSBA; ICBA; Letter from The Dixie Group, Inc., July 11, 2016 (“Dixie”); MidSouth; Nasdaq; NVCA; NYSE; and Seneca.

113

See
Acorda, et al.; AMTA; BIO; Calithera; CONNECT; Coalition; CSBA; ICBA; Dixie; MidSouth; Nasdaq; NVCA; NYSE; and Seneca.

114

See
BIO (stating that uniformity alone is a sufficiently compelling argument to align the two definitions, that avoiding investor confusion is an important responsibility of the SEC, and that issuers and investors alike are used to having one standard for small company status); Coalition; Nasdaq; NVCA; and NYSE.

115

See
Acorda, et al.; AMTA; BIO; Calithera; Coalition; CONNECT; CSBA; and Seneca.
See also
Dixie.

116

See
Acorda, et al.; BIO; CSBA; ICBA; and NVCA.

Several commenters addressed the costs associated with complying with the requirements of Section 404(b).
117

A few commenters stated that, for many growing biotechnology companies, the Section 404(b) audit represents over $1 million of capital diversion.
118

One commenter indicated that Section 404(b) compliance imposes a significant burden on emerging biotech companies, citing the 2011 Staff Section 404(b) Study that estimated that companies with a public float between $75 million and $250 million spend, on average, $840,276 to comply with Section 404(b).
119

Another commenter estimated that it will spend more than $400,000 annually on compliance with Section 404(b).
120

One commenter that

stated that its public float was more than $75 million but less than $250 million estimated that relief from Section 404(b) would result in a 35% reduction in compliance costs whereas there would be no material change in such costs from the proposed amendments.
121

Another commenter noted that, while most firms already take an integrated accounting approach to Section 404(b) requirements that includes a complete internal control review, if smaller companies were exempt from Section 404(b), they would avoid the added legal liability of the auditor attestation, providing a savings opportunity and lowering the cost of being public for those companies.
122

117

See
Acorda, et al.; BIO; Calithera; CONNECT; CSBA (stating that “accelerated filers spend, on average, more than $1 million complying with Section 404(b)”); Dixie; and Seneca.

118

See
Acorda, et al.; and CONNECT.
See also
CSBA.

119

See
BIO.

120

See
Calithera. This estimate is generally consistent with the estimate set forth by a presenter at a recent ACSEC meeting. The presenter stated that some biotechnology companies that anticipate losing their status as EGCs in the next few years “believe they will incur somewhere between $150,000 to $350,000 in additional audit fees, $50,000 to $150,000 in other consulting costs and either $40,000 or as much as $200,000 for internal

labor.”
See
Transcript of Presentation by William Newell at September 13, 2017 ACSEC Meeting available at
https://www.sec.gov/info/smallbus/acsec/acsec-transcript-091317.pdf
(pages 49 to 54);
see also
Newell, William J., “Sarbanes-Oxley Section 404(b): Costs of Compliance and Proposed Reforms”, presentation at ACSEC meeting on Sept. 13, 2017 available at
https://www.sec.gov/info/smallbus/acsec/william-newell-acsec-091317.pdf
.

121

See
Seneca.

122

See
Dixie.

A few commenters stated that the market does not value the audit of such internal control
123

or that the costs of Section 404(b) outweigh the benefits.
124

Another commenter stated that expanding relief from Section 404(b) to registrants with a public float of less than $250 million would encourage capital formation because reduced audit and disclosure requirements may encourage companies that have been hesitant to go public to do so.
125

123

See
Acorda, et al. (stating that the market does not demand a Section 404(b) audit as a prerequisite for investing in emerging, innovative companies and that virtually no EGCs are voluntarily forgoing their exemption from Section 404(b)).
See also
Dixie.

124

See
MidSouth.

125

See
ICBA (citing a 2005 ICBA study that estimated that audit fees for publicly held bank holding companies would drop dramatically—some by as much as 50%—if they were exempted from Section 404(b)).

A number of commenters recommended that the Commission allow a revenue test for the accelerated filer definition, similar to the amended revenue test being adopted by the Commission in the SRC definition.
126

126

See
Acorda, et al.; AMTA; BIO; CONNECT; Calithera; CSBA; Nasdaq; and NYSE.

3. Final Amendments

As proposed, we are adopting amendments to the “accelerated filer” and “large accelerated filer” definitions in Exchange Act Rule 12b-2 to preserve the application of the current thresholds contained in those definitions.
127

Specifically, we are eliminating from the definitions of accelerated filer and large accelerated filer the exclusions for registrants that are eligible to use the SRC requirements under Regulation S-K for their annual and quarterly reports. After the amendments to the SRC definition become effective, some SRCs will exceed the public float thresholds for initial or subsequent qualification in the accelerated filer definition, and a few of these registrants also may exceed the public float threshold for subsequent qualification in the large accelerated filer definition.
128

127

See
“accelerated filer” and “large accelerated filer” definitions in Exchange Act Rule 12b-2.

128
The only registrants that would qualify as both SRCs and large accelerated filers would be those companies (1) that previously qualified as large accelerated filers because at one time their public float was $700 million or more, (2) whose revenues for the most recent fiscal year were less than $100 million, and (3) whose public float as of the end of the most recent second quarter was less than $560 million, such that they now qualify as SRCs, but not less than $500 million, such that they are not eligible to exit large accelerated filer status.

Although we are not raising the accelerated filer public float threshold or modifying the Section 404(b) requirements for registrants with a public float between $75 million and $250 million in this release, as stated above, the Chairman has directed the staff to formulate recommendations to the Commission for possible changes to reduce the number of registrants that our rules define as accelerated filers. Eliminating the SRC provision in the accelerated filer and large accelerated filer definitions will maintain the current thresholds at which registrants are subject to the accelerated filer and large accelerated filer disclosure and filing requirements. In 2007, the Commission noted that aligning the SRC public float threshold based on the levels established for non-accelerated filers
129

was practical and avoided regulatory complexity.
130

These amendments will change the current relationship between the SRC and “accelerated filer” definitions by allowing a registrant to qualify as both a SRC and an accelerated filer.
131

We acknowledge the regulatory complexity created by this potential overlap between the SRC and “accelerated filer” definitions.
132

As part of the staff's consideration of possible recommended amendments to the “accelerated filer” definition, the Chairman has directed the staff to consider, among other things, the historical and current relationship between the SRC and “accelerated filer” definitions.

129
A non-accelerated filer is a filer that is not an “accelerated filer” or a “large accelerated filer.”
See
subpart (3) of the accelerated filer and large accelerated filer definitions in Exchange Act Rule 12b-2 [17 CFR 240.12b-2].

130

See
SRC Adopting Release 73 FR at 942.

131
In conjunction with these amendments, we also are adopting technical revisions to Securities Act Forms S-1, S-3, S-4, S-8, and S-11 and Exchange Act Forms 10, 10-Q and 10-K. These amendments modify the cover page of the specified forms to remove the parenthetical next to the “non-accelerated filer” definition that states “(Do not check if a smaller reporting company).” After these amendments, a registrant should check all applicable boxes on the cover page addressing, among other things, non-accelerated, accelerated, and large accelerated filer status, SRC status, and emerging growth company status.

132
Several commenters specifically recommended increasing the public float threshold in the accelerated filer definition to, among other things, maintain uniformity across our rules.
See
BIO; Coalition; Nasdaq; NVCA; and NYSE.

III. Other Matters

If any of the provisions of these amendments, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application.

IV. Economic Analysis

As discussed above, we are adopting amendments to the definition of SRC as used in our rules and regulations. The amendments expand the number of registrants that are eligible to provide scaled disclosure to their investors and are intended to reduce compliance costs for these registrants and promote capital formation, while maintaining appropriate investor protections. Registrants with a public float of less than $250 million (an increase from the current $75 million threshold) will qualify as SRCs, as will registrants with no public float if their revenues are less than $100 million (an increase from the current $50 million threshold).
133

In addition, registrants with a public float of less than $700 million will qualify as SRCs if their revenues are less than $100 million.
134

133

See
note 29 and related text for a discussion of how and when public float is calculated and when revenues are measured.

134
The Commission received a number of comments in support of expanding the definition of SRC to include a revenue test for registrants with a public float.
See
Section II.A.1.b.

We also are making corresponding amendments to other rules in light of the new SRC definition. As proposed, we are adopting amendments to the “accelerated filer” and “large accelerated filer” definitions in Exchange Act Rule 12b-2 to preserve the application of the public float thresholds in those definitions. In addition, we are amending Rule 3-05(b)(2)(iv) of Regulation S-X to increase the revenue threshold under which certain registrants may omit the earliest of the three fiscal years of

audited financial statements of an acquired business or business to be acquired.

We are mindful of the costs and benefits of the amendments. In this economic analysis, we examine the existing baseline, which consists of the current regulatory framework and market practices, and discuss the potential costs and benefits of the amendments, relative to this baseline, and their potential effects on efficiency, competition, and capital formation.
135

We also consider the potential costs and benefits of reasonable alternatives to the amendments. Where practicable, we have attempted to quantify the economic effects of the amendments; however, in certain cases, we are unable to do so because either the necessary data are unavailable or the economic effects are not quantifiable. In these cases, we provide a qualitative assessment of the likely economic effects.

135
Section 23(a)(2) of the Exchange Act requires us, when adopting rules, to consider the impact that any new rule would have on competition. In addition, Section 2(b) of the Securities Act and Section 3(f) of the Exchange Act direct us, when engaging in rulemaking that requires us to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.

A. Baseline

In calendar year 2016, 7,395 registrants filed a Form 10-K with the Commission. Excluding investment companies, business development companies, and ABS issuers, which are not eligible for SRC status, 6,739 registrants filed a Form 10-K in calendar year 2016. Of these registrants, 2,592 (35.1% of all registrants) claimed SRC status by checking the box on the cover page of their Forms 10-K indicating that the registrant was a SRC. Under the current definition, a registrant with a public float may qualify as a SRC if its public float is less than $75 million or a registrant with no public float may qualify as a SRC if its annual revenues are less than $50 million. An additional 232 filers in calendar year 2016 reported public float of less than $75 million or no public float and revenues of less than $50 million, but did not check the box on the cover page of their Forms 10-K indicating that they were SRCs.
136

Of the 2,592 registrants that claimed SRC status in 2016, 1,899 registrants (25.7% of all registrants) reported having a public float that was less than $75 million and 509 registrants (6.9% of all registrants) reported having no public float and revenues of less than $50 million.
137

Of the 2,592 SRCs, 833 (11.3% of all registrants) also indicated in their filings that they were EGCs.
138

136
There are two potential explanations for why the number of registrants meeting the SRC thresholds exceeds the number of reported SRCs. First, the public float and revenue thresholds establish eligibility for SRC status, but do not require eligible registrants to take advantage of the scaled disclosure requirements. Thus, some registrants may be opting out of SRC status if they do not find the reduced compliance costs to be net beneficial. Second, some registrants that appear to be eligible may not be if they previously exceeded the SRC threshold and were required to meet the lower eligibility threshold (
i.e.,
public float of less than $50 million or revenues of less than $40 million) to subsequently qualify as a SRC.

137
Based on analysis by DERA of available data. Staff obtained the SRC status and public float data from information extracted from exhibits to corporate financial reports filed with the Commission using eXtensible Business Reporting Language (“XBRL”), available at:
http://www.sec.gov/dera/data/financial-statement-data-sets.html
. Staff also extracted the SRC status and public float directly from Forms 10-K using a computer program. For robustness, staff compared the SRC status and public float information between the two sources and corrected discrepancies using data from Ives Group Audit Analytics. Staff extracted annual revenue data from the Compustat database and XBRL data in Form 10-K filings.

138
Staff determined whether a registrant claimed EGC status by parsing several types of filings (for example, Forms S-1, S-1/A, 10-K, 10-Q, 8-K, 20-F/40-F, and 6-K) filed by that registrant with supplemental data drawn from Ives Group Audit Analytics.

Table 1 summarizes the number and percentage of registrants that claimed SRC status in each calendar year over the 2013-2016 period.

Table 1—SRCs in 2013-2016 Period

Filing year

Total # of
registrants

# of SRCs
% of total

Qualified based on
public float
<$75 million
(% of Total)

Qualified based on no public float and revenue <$50 million
(% of Total)

2013
7,624
3,380
44.3
33.5
10.8

2014
7,642
3,179
41.6
32.7
8.9

2015
7,557
2,900
38.4
29.7
8.7

2016
7,395
2,592
35.1
25.7
6.9

Table 2 shows that, while registrants claiming SRC status with available data account for a substantial percentage of the total number of registrants in calendar year 2016, they account for less than one percent of the entire public float, market value and revenue of all registrants.
139

139
Compustat data on market value is obtained for calendar year 2016 filings. Staff obtained revenue data either from XBRL data in Form 10-K filings or directly from the filing itself. The summary statistics presented in Table 2 represent those registrants for which information on public float and revenue is concurrently available. Market value, as used throughout this Economic Analysis, is equivalent to market capitalization and presented for registrants with available data (described in footnote 25).

Table 2—Size Proxies for SRCs in 2016

Public float
Market value
Revenue

Mean
$14.7 million
$57.2 million
$42.8 million.

Median
4.3 million
14.1 million
1.9 million.

Aggregate size
40.1 billion
98.7 billion
96.2 billion.

% of the aggregate size of all registrants
0.15%
0.34%
0.66%.

Table 3 shows the distribution of registrants that were eligible for SRC status based on available data in calendar year 2016 using the Fama-French 49-industry classification.
140

The “Business Services” industry accounts for 10.6% of all SRCs, followed by “Financial Trading” (9.8%), “Pharmaceutical Products” (8.5%), “Banking” (7.1%), “Petroleum and Natural Gas” (5.6%), and “Computer Software” (5.2%).
141

We note that industries with a larger fixed component of operating costs, such as shipping, defense, and aircraft, tend to have fewer SRCs.

140
The standard Fama-French classification sorts Standard Industry Classification codes into 49 main industrial categories; available at:
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_49_ind_port.html.

141
In 2016, SRCs accounted for 57% of all Form 10-K filers in “Business Services,” 37% in “Financial Trading,” 20% in “Banking,” 39% in “Pharmaceutical Products,” 50% in “Petroleum and Natural Gas” and 47% in “Computer Software,” suggesting that these industries all have a fairly high concentration of small registrants.

Table 3—Industry Distribution of SRCs in 2016

Industry ID
Industry
# of SRCs
% of all SRCs
Industry ID
Industry
# of SRCs
% of all SRCs

1
Agriculture
26
1.0
26
Defense
2
0.1

2
Food Products
35
1.3
27
Precious Metals
38
1.4

3
Candy & Soda
3
0.1
28
Non-Metallic and Industrial Metal Mining
76
2.9

4
Beer & Liquor
18
0.7
29
Coal
3
0.1

5
Tobacco Products
9
0.3
30
Petroleum and Natural Gas
149
5.6

6
Recreation
23
0.8
31
Utilities
15
0.6

7
Entertainment
55
2.0
32
Communication
45
1.7

8
Printing and Publishing
8
0.3
33
Personal Services
37
1.4

9
Consumer Goods
40
1.6
34
Business Services
281
10.7

10
Apparel
17
0.6
35
Computers
22
0.8

11
Healthcare
37
1.4
36
Computer Software
136
5.2

12
Medical Equipment
116
4.4
37
Electronic Equipment
102
3.9

13
Pharmaceutical Products
225
8.5
38
Measuring and Control Equipment
41
1.6

14
Chemicals
54
2.1
39
Business Supplies
6
0.2

15
Rubber and Plastic Products
20
0.8
40
Shipping Containers
2
0.1

16
Textiles
4
0.2
41
Transportation
24
0.9

17
Construction Materials
29
1.1
42
Wholesale
78
3.0

18
Construction
22
0.8
43
Retail
82
3.1

19
Steel Works
9
0.3
44
Restaurants, Hotels, Motels
28
1.1

20
Fabricated Products
5
0.2
45
Banking
187
7.1

21
Machinery
54
2.0
46
Insurance
20
0.8

22
Electrical Equipment
39
1.5
47
Real Estate
96
3.6

23
Automobiles and Trucks
21
0.8
48
Financial Trading
258
9.8

24
Aircraft
8
0.3

Other and Unknown
30
1.1

25
Shipbuilding, Railroad Equipment
3
0.1

As discussed above, we are amending Rule 3-05(b)(2)(iv) of Regulation S-X to increase the revenue threshold under which certain registrants may omit the earliest of the three fiscal years of audited financial statements of an acquired business or business to be acquired. Rule 3-05 applies to registrants that are not SRCs.
142

Rule 3-05(b)(2)(iv) provides that, if the acquired business is large enough relative to the registrant (
i.e.,
any of the significant subsidiary tests for the acquired business exceed 50%), the registrant must file three years of historical financial statements of the acquired business unless the acquired business has revenues of less than $50 million, in which case only two years of the acquired business's most recent financial statements need to be filed. Given the difficulty in accurately identifying registrants that have acquisitions (1) that meet any of the significant subsidiary tests at the 50% level and (2) where the acquired business has revenues of less than $50 million, we are unable to estimate the number of registrants that were affected by the $50 million revenue threshold in

Rule 3-05(b)(2)(iv) in 2016. We do not believe the disclosure accommodation in Rule 3-05(b)(2)(iv) is frequently used because the acquired business not only would need to meet one of the significant subsidiary thresholds at the 50% level compared to the non-SRC acquirer, but also would need to have less than $50 million of revenues in its most recent fiscal year.

142
Rule 8-04 of Regulation S-X [17 CFR 210.8-04] applies to financial statements of business acquired or to be acquired by SRCs.

B. Potential Economic Effects

1. Introduction

The primary benefit stemming from the amendments is a reduction in compliance costs for the registrants that will newly qualify for SRC status. To the extent that the reduced compliance costs have a fixed cost component,
143

which typically burdens smaller registrants disproportionately, the cost savings may be particularly helpful for those registrants.

143

See, e.g.,
William A. Brock & David S. Evans,
The Economics of Small Businesses: Their Role and Regulation in the U.S. Economy
65 at 70 (1986); C. Steven Bradford,
Does Size Matter? An Economic Analysis of Small Business Exemptions from Regulation,
College of Law, Faculty Publications. 72 (2004).
See also
Cindy R. Alexander et al.,
Economic Effects of SOX Section 404 Compliance: A Corporate Insider Perspective,
56 J. Account. & Econ. 267-290 at 285 (2013) (noting, among other things, that they found “evidence of fixed costs that weigh disproportionately on smaller firms”).

As a secondary effect of the amendments, a lower disclosure burden could spur growth in the registrants that will newly qualify for SRC status to the extent that the compliance cost savings and other resources (
e.g.,
managerial effort) otherwise devoted to disclosure and compliance are productively deployed in alternative ways. It also could encourage capital formation because companies that may have been hesitant to go public may choose to do so if they face reduced disclosure requirements.

With respect to costs, we expect that the amendments to the SRC definition will result in a modest change in some indicators of the overall quality of the information environment. Generally, a decrease in the amount of direct disclosure could increase the information asymmetry between investors and company insiders, leading to lower liquidity and higher costs of capital for the affected registrants. For example, one study found that, during the three-month period following the establishment of the SRC definition, registrants with public floats of $25 million or more and less than $75 million that claimed SRC status experienced a significant reduction in liquidity relative to comparable registrants.
144

In addition, one of the sources of information asymmetry under the amendments will be that the newly eligible SRCs will not be required to provide certain executive compensation disclosures, potentially lowering corporate governance transparency of these registrants.
145

Furthermore, by introducing overlap between the SRC and the accelerated filer definitions, the amendments we are adopting would increase regulatory complexity.
146

144

See
Lin Cheng, Scott Liao, and Haiwen Zhang,
Commitment Effect versus Information Effect of Disclosure: Evidence from Smaller Reporting Companies,
88 Account. Rev. 1239 (Jul. 2013).

145
For a review of the effects of executive compensation disclosures on compensation practices,
see
Kevin J. Murphy, “Executive compensation: Where we are, and how we got there,” Handbook of the Economics of Finance, Vol. 2. Elsevier (2013) 211-356.
See also
Benjamin E. Hermalin and Michael S. Weisbach,
Information Disclosure and Corporate Governance,
67 J. Fin. 195 (2012), and Anya Kleymenova and Irem A. Tuna, Regulation of Compensation (June 21, 2017), Chicago Booth Research Paper No. 16-07,
available at
SSRN:
https://ssrn.com/abstract=2755621.

146

See
SRC Adopting Release 73 FR at 942.

The number of affected registrants that will make scaled disclosures will ultimately depend on the choices of those registrants. That is, the SRC definition establishes eligibility for, but does not mandate reliance on, any of the scaled disclosure accommodations.
147

We identified 232 registrants in 2016 that met either the $75 million public float threshold or the $50 million revenue threshold for SRC status but did not claim SRC status. While some of these registrants may not have been eligible (for example, a registrant that previously did not qualify as a SRC because it exceeded the thresholds and is now subject to a lower threshold), it is possible that some elected not to avail themselves of the scaled disclosure requirements.
148

147
If a disclosure requirement applicable to SRCs is more stringent than for non-SRCs, however, SRCs must comply with the more stringent standard. Item 404 is the only Regulation S-K disclosure requirement that could be more stringent.

148
Data from 2008 show that registrants do not always take advantage of scaled disclosure. In a sample of 283 registrants that were newly eligible for scaled disclosure in 2008, the evidence from Form 10-K and proxy filings by those registrants shows that 109 of the registrants chose to maintain their disclosure level for all ten eligible items, while 174 of the registrants reduced the disclosure level for at least one eligible item.
See
Lin Cheng, Scott Liao, and Haiwen Zhang,
Commitment Effect versus Information Effect of Disclosure: Evidence from Smaller Reporting Companies,
88 Account. Rev. 1239 (Jul. 2013) at 1247.

Under the amendments, we expect registrants will weigh their own costs and benefits of scaled disclosure and decide whether to take advantage of any of the scaled disclosure accommodations for which they are newly eligible. Some registrants may determine that the costs of potentially reduced liquidity for their securities and higher cost of capital exceed the benefits of the lower compliance costs. Those registrants may elect not to rely on the scaled disclosure accommodations available to them. On the other hand, expanding SRC eligibility could provide opportunities for adverse selection in a greater number of registrants. For example, registrants whose outside investors would have benefited from more disclosure might choose the less burdensome disclosure requirement once becoming eligible. The net benefit or cost for each newly eligible registrant and its investors will ultimately depend on the specific facts and circumstances.

Expanding the pool of registrants eligible for SRC status to include registrants with revenues of less than $100 million and a public float of $250 million or more and less than $700 million will increase the cost savings, information asymmetries, and other effects of scaled disclosure in proportion to the increase in the number of registrants that become newly eligible at those higher thresholds and choose to avail themselves of the scaled disclosure accommodation. This number is likely to be small, as indicated by the evidence that 161 (2.2%) of the registrants that filed a Form 10-K in 2016 would have met the thresholds in the amended revenue test for registrants with public float.

The effects of scaled disclosure for registrants with a public float of $250 million or more and less than $700 million and revenues of less than $100 million may be different from the effects of scaled disclosure for registrants with public float nearer to the current threshold of $75 million. This is because the characteristics of registrants eligible for SRC status under the final rules may be different from those of registrants close to the current threshold. For example, differences in the relationships between management and outside investors in registrants with higher public float could affect the level of information asymmetries between those registrants and investors. This may cause those registrants to make different decisions about how much information they choose to disclose and whether to rely on the scaled disclosure accommodations, leading to differences in the observed use of scaled disclosure by different registrants of the same size. The 161 additional registrants had an average public float of $396 million, while those that qualify under the current definition had an average public float of $15 million, and those that would have qualified under the proposed rules had an average public

float of $55 million. These differences can affect whether a registrant decides to rely on scaled disclosure and how that decision affects the registrant's investors. We do not have sufficient information about the experiences of registrants at the higher public float levels with lower revenues implementing scaled disclosure to estimate the frequency with which these registrants will implement scaled disclosure, if available.

Similarly, increasing the revenue threshold below which registrants are eligible to provide two rather than three years of certain acquired businesses' historical financial statements under Rule 3-05(b)(2)(iv) from $50 million to $100 million will increase the cost savings, information asymmetries, and other effects of the reduced historical financial statement disclosure that investors receive at or around the time of the acquisition in proportion to the increase in the number of registrants that acquire businesses with revenues below the higher threshold and choose to avail themselves of this disclosure accommodation.

Overall, we expect the effect of raising the revenue threshold in Rule 3-05(b)(2)(iv) of Regulation S-X from $50 million to $100 million on information disclosed by registrants and its consequences for registrants and investors to be modest. This reflects our appraisal that few registrants are eligible to provide two rather than three years of an acquired business's historical financial statements under Rule 3-05(b)(2)(iv), because the acquired business not only would need to meet one of the significant subsidiary thresholds at the 50% level compared to the non-SRC acquirer, but the acquired business also would need to have less than the $50 million of revenues in its most recent fiscal year.
149

The amendments we are adopting will have two potentially countervailing effects on the number of registrants that are eligible for the disclosure accommodation in Rule 3-05(b)(2)(iv). First, they will increase the number of registrants that are eligible to provide two rather than three years of an acquired business's historical financial statements under Rule 3-05(b)(2)(iv) by raising the revenue threshold for eligibility. Second, they will reduce the number of registrants that are required to comply with Rule 3-05, because Rule 3-05 is only applicable to registrants that are not SRCs, and our final rules are likely to increase the number of SRCs. Thus, the net effect may be to increase the number of registrants eligible to provide two rather than three years of an acquired business's historical financial statements under Rule 3-05(b)(2)(iv), but we do not expect the net increase to be significant.

149

See
text accompanying note 146.

2. Impact on Eligibility for Smaller Reporting Company Status

By increasing the public float threshold from $75 million to $250 million, increasing the annual revenue threshold for registrants with no public float from $50 million to $100 million, and expanding the revenue test to include registrants with a public float of less than $700 million and revenues of less than $100 million in the SRC definition, the amendments will permit more registrants to qualify as SRCs. To estimate the number of additional registrants that are likely to be affected by the amendments, we use public float data and revenue data from Form 10-K filings.
150

Our estimate of the number of registrants likely to be eligible in the first year under the new definition that would not have qualified under the current definition is the number that would have been eligible had the rule been in effect. We use evidence on the composition of those registrants from the 2016 data to estimate the likely composition of the registrants that would be eligible in the first year under the new definition.

150
Float and revenue values are from data in Form 10-K filings filed in calendar year 2016 and extracted from XBRL exhibits.

We estimate that 966 additional registrants will be eligible for SRC status in the first year under the new definition. These registrants estimated to be eligible in the first year comprise 779 registrants with a public float of $75 million or more and less than $250 million, 26 registrants with no public float and revenues of $50 million or more and less than $100 million, and 161 registrants with a public float of $250 million or more and less than $700 million and revenues of less than $100 million.

The 966 registrants that we estimate will be newly eligible for SRC status are characterized by an average public float of $191 million (median $162 million), an average market value of $279 million (median $201 million), and average revenues of $196 million (median $68 million). Of these registrants, 365 currently are EGCs and are eligible for certain scaled disclosure under Title I of the JOBS Act, including the scaled executive compensation disclosures available to SRCs under Item 402 of Regulation S-K. The newly eligible registrants with available data in 2016 were concentrated in the following industries: “Pharmaceutical Products” (17.3%), “Banking” (15.2%), “Financial Trading” (11.8%), “Business Services” (5.2%), and “Electronic Equipment” (3.7%). If the distribution of eligible registrants does not change over time, and if all of them claim SRC status, the amendments will lead to a noticeable increase in the presence of “Pharmaceutical Products” and “Banking” registrants in the pool of SRCs.

Registrants eligible for SRC status with available data using the public float threshold of less than $250 million represent approximately 38.6% of all registrants, while only 28.0% of all registrants qualify under the existing public float threshold of less than $75 million. The 38.6% of all registrants that will qualify under the public float threshold would be more in line with the 42% of registrants that qualified under the public float threshold when the Commission first established the definition of SRC.
151

An additional 8.0% of registrants will qualify based on having no public float and revenues of less than $100 million, while currently 7.7% of registrants reported having no public float and less than $50 million in revenues.
152

Finally, based on the 2016 data, 2.2% of registrants had a public float of $250 million or more and less than $700 million and revenues of less than $100 million.

151
These percentages reflect the estimated number of registrants that qualify under the respective public float tests and do not include any registrants that are estimated to qualify under the respective revenue tests.

152
Using 2016 data, we estimate that, of the 7,395 total registrants that filed Forms 10-K with available data, 3,606 registrants will meet one of the SRC thresholds under the amendments. In particular, we estimate that 2,851 registrants reported public float below $250 million and greater than zero in 2016, resulting in a percentage of 38.6% (2,851/7,395) of registrants potentially qualifying as SRCs under the amended public float threshold, and 2,072 registrants reported a public float below $75 million in 2016, resulting in a percentage of 28.0% (2,072/7,395). Also, we estimate that 594 registrants reported no public float and annual revenues below $100 million in 2016, resulting in a percentage of 8.0% (594/7,395) of registrants potentially qualifying as SRCs under the amended revenue threshold, and 568 registrants reported no public float and annual revenues below $50 million in 2016, resulting in a percentage of 7.7% (568/7,395). Finally, we estimate that 161 registrants reported public float of $250 million or more and less than $700 million and annual revenues below $100 million in 2016, resulting in an additional 2.2% (161/7,395) of registrants potentially qualifying as SRCs.

Increasing the percentage of registrants that will qualify under the public float threshold to align more closely with the 2007 level is consistent with the rise in market capitalization of public companies that has occurred

since that time.
153

We do not have sufficient data to be able to compare the percentage of registrants qualifying under the revenue threshold when the Commission first established the definition of SRC to the estimated 8.0% that will qualify using a revenue threshold of $100 million. Table 4 summarizes the size of the potential SRCs in terms of public float, market value, and annual revenue under the amendments.

153
For example, the S&P 500 index grew by more than 80 percent over the decade ending with the fourth quarter of 2017. Source: CRSP and St. Louis Fed (
https://fred.stlouisfed.org/series/GDPDEF
).

Table 4—Size Proxies for SRCs Eligible Under the Amendments

Public float
Market value
Revenue

Mean
$59.9 million
$480.1 million
$317.7 million.

Median
$12.1 million
$40.9 million
$10.3 million.

Aggregate size
$202.6 billion
$1,220.5 billion
$1,074.0 billion.

% of the aggregate size of all registrants
0.9%
4.8%
8.7%.

As discussed above, we are amending Rule 3-05(b)(2)(iv) of Regulation S-X to increase the revenue threshold under which certain registrants may omit the earliest of the three fiscal years of audited financial statements of an acquired business or business to be acquired. Similar to the baseline discussion of Rule 3-05, given the difficulty in accurately identifying registrants that have acquisitions (1) that meet any of the significant subsidiary tests at the 50% level and (2) where the acquired business has revenues of less than $100 million, we are unable to estimate the number of registrants that will be affected by raising the revenue threshold in Rule 3-05(b)(2)(iv) from $50 million to $100 million. The amendments we are adopting today increase the number of registrants that qualify as SRCs (which will likely decrease the application of Rule 3-05) but also increase the revenue threshold in Rule 3-05(b)(2)(iv) (which may offset the decreased number of companies affected by Rule 3-05). Therefore, we do not expect that the amendments will significantly alter the number of registrants that will be eligible to omit the earliest of three years of financial statements of an acquired business pursuant to Rule 3-05(b)(2)(iv).

3. Estimation of Potential Costs and Benefits

In this section, we estimate the incremental costs and benefits associated with SRC-related scaled disclosures, using a multivariate empirical analysis. We cannot isolate the costs and benefits associated with scaled disclosures using available data from SRCs, because we cannot with the data isolate the effects of scaled disclosures from the effects of some other accommodations, such as the exemption from Section 404(b) that is currently available to all SRCs through their status as non-accelerated filers.
154

Under the final rules, some newly eligible SRCs will be able to provide scaled disclosures but will continue to be subject to Section 404(b) as accelerated filers.

154
Although there is a clear threshold for eligibility, we cannot use the well-known empirical method of Regression Discontinuity Design to assess the treatment effect of scaled disclosures for SRCs. This method requires that the assignment of the treatment among registrants be “as good as random” around the threshold. Under this assumption, the registrants that receive the treatment of scaled disclosure (
i.e.,
SRCs) should be comparable to those registrants that do not receive the treatment because their public float is just above the $75 million threshold. Given the exemption from Section 404(b) available to current SRCs with public float below $75 million, this assumption does not hold.

It is possible, however, to isolate the effects of scaled disclosures on registrants with public float slightly below or above the current $75 million public float threshold using 2006-2009 data. This is because, as a result of the rules that established the SRC definition in 2007, registrants with public float of $25 million or more and less than $75 million experienced no change in the Section 404(b) exemption (that is, they remained exempt from the requirement), but became eligible for the SRC scaled disclosures. Our empirical method is a difference-in-difference estimation between a treatment group and a control group that is the basis for comparison.
155

In particular, the treatment group (“Treatment Group”) consists of registrants with public float of $25 million or more and less than $75 million that claimed SRC status in 2008. Two natural control groups exist. The first (“Control Group 1”) consists of registrants that did not qualify for SRC status because they had public float at or just above $75 million ($75 million or more and less than $125 million).
156

The second (“Control Group 2”) consists of registrants with public float and revenues below $25 million that were already eligible for scaled disclosures at that time and thus not affected by the Commission's 2007 rules.
157

155
Difference-in-difference is a technique used to calculate the effect of a variable on a treatment group versus a control group. In particular, in the analysis below, the average change over time in the outcome of a variable for the treatment group is compared to the average change over time in the outcome of that variable for the control group.

156
This would allow for a $50 million bandwidth similar to that used in the Commission's 2007 rules, which raised the threshold for relief from $25 million to $75 million.

157
The comparison groups help control for confounding factors that may also independently affect the economic effects associated with scaled disclosures. While we determine Treatment Group and Control Group 1 based on public float alone, we use both public float and revenues to determine Control Group 2, because, prior to the Commission's 2007 rules, registrants with public float below $25 million were not eligible for scaled disclosures if their revenues exceeded $25 million.

To analyze the economic effects of eligibility for scaled disclosures resulting from the Commission's 2007 rules by this method, we compare the Treatment Group with Control Group 1 and Control Group 2 in the following areas: Cost savings, information environment, liquidity, and growth. We then use the analysis to extrapolate the likely effects of the expansion of eligibility for SRC status under the final rules. In extrapolating the likely effects, we place particular emphasis on the comparison between the Treatment Group and Control Group 1, which represents a closer group in size to the newly eligible SRCs under the final rules.

We believe that the evidence from analysis of changes in the information environments of registrants around the 2007 amendments is a suitable basis for evaluating the effects of the current amendments on registrants with public floats at the low end of the range that are newly eligible for scaled disclosure. We included a similar analysis in the Proposing Release and solicited comments on this analysis, including ways to better quantify the effects of scaled disclosure on SRCs, but did not receive any comments in response.

While the 2007 amendments resulted in changes that are similar to what we expect will occur under the current amendments, our analysis is subject to a number of assumptions and limitations. The evidence from the 2007 amendments may be less suitable as a basis for evaluating the effects of the current amendments on registrants with relatively higher levels of public float than for evaluating potential effects of the current amendments on registrants with public float around the $75 million threshold.
158

It is thus more challenging to quantify the likely effects of the current amendments on newly eligible SRCs with public float levels that are farther from the $75 million level, such as those closer to the $250 million and $700 million levels.
159

We believe those challenges may be less pronounced for registrants that have other characteristics, such as revenue, similar to those of the registrants that were affected by the prior rules.

158
The 2007 rule amendments affected the reporting practices of registrants with public floats near the $75 million threshold (
i.e.,
$25 million or more and less than $75 million) and, accordingly, may indicate the effects of increasing the public float threshold on registrants with public float of $75 million or slightly more than $75 million.

159
One limitation of difference-in-difference and regression discontinuity design studies of the effects of changes in regulatory rules is that their results are more applicable in evaluating the effects of the changes on the registrants whose characteristics most closely resemble those who were affected by the event under the analysis than in evaluating effects on other registrants.
See, e.g.,
Leuz and Wysocki (2016).

a. Potential Cost Savings: Estimates Based on Changes in Audit Fees

The cost savings from scaled disclosures could include savings of resources that are likely to be used for the relevant parts of disclosures, for example, managerial and employee time, other internal resources, and audit fees related to certain disclosures. Among these potential savings, changes in audit fees are readily quantifiable. To the extent that the scaled disclosure accommodations affect information that must be audited, scaled disclosures of the audited portions of the filings should lead to a reduction in audit expenses. Because many of the scaled disclosures available to SRCs relate to governance and executive compensation disclosures that are not subject to audit, a reduction in audit fees is likely a small part of the total cost savings associated with scaled disclosures. However, quantifying the change in audit fees can potentially help us estimate the entire cost savings.

To estimate the cost savings from the amendments, we first examine changes in the audit fees of registrants that were newly eligible to use scaled disclosures as a result of the 2007 amendments relative to those in the control, or comparison, groups between the pre-amendment 2006-2007 period and the post-amendment 2008-2009 period. Audit fee data come from the Ives Group Audit Analytics database. We include only registrants that had both pre-amendment and post-amendment audit fee data in the analysis. Table 5 reflects the general results.

Table 5—Pre- and Post-Commission's 2007 Amendments Audit Fees for SRCs and Control Groups

Fiscal year

Treatment Group
(SRCs
w/public float
$25m-$75m)

Control Group 1
(Non-SRCs
w/public float
$75m-$125m)

Control Group 2
(SRCs
w/public float
and revenues
below $25m)

Avg. 2006-2007
$311,105
$676,194
$113,757

Avg. 2008-2009
$267,252
$654,463
$101,854

Number of Observations
1,315
694
962

For SRCs with public floats of $25 million or more and less than $75 million, in 2008-2009, average audit fees declined by $43,853. In contrast, both Control Group 1, which just missed eligibility for SRC status, and Control Group 2, which already was eligible for scaled disclosures, experienced smaller declines in average audit fees after the adoption of the 2007 amendments: $21,731 and $11,903, respectively. Thus, the difference-in-difference estimate of the savings in audit fees associated with scaled disclosures is between $22,122 and $31,950 per SRC with public float around the $75 million threshold. Although two different control groups are used to control for other factors that may have caused the changes in audit fees noted in Table 5 during the 2006-2009 period,
160

the effect of the 2008 financial crisis may not be completely ruled out and could make the estimated savings in audit fees appear larger than they actually were.

160
For example, among other factors, we note that the Commission approved Public Company Accounting Oversight Board Auditing Standard No. 5 regarding Audits of Internal Control over Financial Reporting (AS 5). Among other things, AS 5 was intended to reduce unnecessary costs by making the audit scalable to fit the size and complexity of a company. AS 5 became effective in November 2007, and registrants with fiscal years ending between July and November were allowed to avail themselves of the provision earlier. The adoption and implementation of AS 5 in 2007 could have had an impact on the audit fees of all registrants subject to Section 404(b). Given that in our analysis both Treatment Group and Control Group 1 were affected by AS 5, however, the difference-in-difference methodology should control for the potential effects of AS 5 on audit fees. In addition, based on registrants' fiscal year end, we have no reason to believe that early adopters were more or less concentrated in Treatment Group than Control Group 1.
See also
Commission Guidance Regarding Management's Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 33-8810 (Jun. 20, 2007) [72 FR 35324 (Jun. 27, 2007)].

We also estimate the savings in audit fees in terms of a percentage reduction, instead of a dollar value.
161

The audit fees for the Treatment Group declined by 14.1% in the 2008-2009 period relative to the 2006-2007 period, but only by 3.2% for Control Group 1 and 10.5% for Control Group 2. Thus, the difference-in-difference estimate of the treatment effect in terms of a percentage reduction is a 3.6% to 10.9% reduction in the audit fees.

161
If there is a fixed (dollar value) component in audit expenses that apply to registrants of all sizes, then the estimates under this alternative approach can be viewed as the upper bound of the potential audit fee savings.

For the 966 newly eligible registrants that we estimate would be potentially affected by the amendments, the average audit fees were $658,735 in fiscal year 2016. Thus, if we use the dollar value estimates of the audit fee savings, the estimated reduction in audit fees would be between $28,490 and $41,147 for this group, which are the inflation-adjusted values of the audit fee savings estimates in 2008 and 2009.
162

This estimate of savings on audit fees for the newly eligible registrants is approximately

4.3% ($28,491/$658,735) to 6.2% ($41,148/$658,735) of the audit fees.

162
The inflation adjustment was performed using the CPI calculator of the Bureau of Labor Statistics (
http://data.bls.gov/cgi-bin/cpicalc.pl
).

We recognize that this analysis of the audit fee data is subject to a number of assumptions, some of which may not be fully applicable when estimating the potential change in audit expenses as a result of the amendments.
163

As a result, there are limitations to our ability to draw conclusions from the analysis. For example, we recognize that audit expenses are only one component of costs for registrants and that changes in audit fees do not capture the full range of potential cost savings stemming from scaled disclosures. There are cost savings apart from the audit, such as cost savings resulting from a SRC not being required to prepare a compensation discussion and analysis and from other scaled disclosures in Item 402 of Regulation S-K. These cost savings likely will include both internal cost savings (such as employee and managerial time and resources) and external cost savings from fees for other outside professionals such as attorneys. Given the nature of scaled disclosures available to SRCs, we expect these other cost savings to be much larger than the cost savings in audit fees. In the Proposing Release, we assumed that 25% of the total cost savings from scaled disclosure comes from savings in audit fees and 75% of the savings comes from reduction in other expenses. We solicited comments on this assumption and on whether we should use a different assumption but did not receive any comments in response. Accordingly, we use the same assumption here.

163
Estimates based on data from 2006 to 2009 may not be directly applicable to the estimation of audit fees for the newly eligible registrants under the rule amendments. On the one hand, because auditors may charge larger registrants more for auditing the same disclosure items, our estimate could be viewed as a conservative estimate on the potential savings of audit fees for the newly eligible SRCs. On the other hand, if there were any increased competition in the auditing industry since 2009, then it could have led to lower audit expenses for the same disclosure items. Thus, our estimate could be higher or lower than the actual savings on audit fees for SRCs in 2008 and 2009.

Given this assumption, we estimate total annual cost savings per newly eligible registrant with a public float around the $75 million threshold to be between $98,439 ($24,610 × 4) and $298,052 ($74,513 × 4). The savings to registrants that become newly eligible with public floats closer to the $250 million and $700 million thresholds, will vary from this estimate by amounts that are difficult to quantify, because these registrants are less comparable to the Control Groups, and will depend on the facts and circumstances of the newly eligible registrant. For example, the audit cost for some of these registrants may be higher as a result of greater complexity in their business operations, increasing the cost savings associated with SRC status.

b. Information Environment, Liquidity, and Growth

A registrant's information environment can be measured by the amount of useful information available to investors and the quality of that information. To gauge the potential effects on the degree of external information production about the registrant that could benefit investors, we determine a registrant's percentage of institutional ownership, total 5% block institutional ownership, and analyst coverage (
i.e.,
whether a registrant is covered by at least one analyst and the number of analysts).

To measure disclosure quality, we use four discretionary accrual measures commonly used in the accounting literature as proxies for earnings management and the incidence of material restatements (based on the first year of financial statements restated and the filing year). Scaled disclosure may contribute to lowering the overall quality of the information environment, which is proxied in this analysis by the propensity for earnings management and the incidence of material restatements.
164

The data on restatements are from the Ives Group Audit Analytics database. A material restatement is defined as a restatement that is reported under Item 4.02 of Form 8-K.

164
In using these proxies, we do not mean to suggest that scaled disclosure would be expected to directly cause an increase in earnings management or an increased incidence of material restatements, as there is little direct connection between the types of disclosure governed by our scaled disclosure requirements and the disclosure affected by a restatement.

To examine the potential effects on liquidity, we focus on the share turnover ratio, which is calculated by dividing the total number of shares traded over a period by the number of shares outstanding. To assess the effects of scaled disclosures on growth, we examine a registrant's capital investment, which is measured by the capital expenditures to assets ratio, as a proxy for real growth. Because there is a high concentration of SRCs in industries for which research and development (“R&D”) investment is important (
e.g.,
pharmaceutical products and electronic equipment), we also examine a registrant's investment in R&D. Finally, we examine asset growth, which is the growth rate in book assets, which could capture a registrant's growth through both capital investment and acquisition.

Table 6 reports the estimated treatment effect. The number in the Treatment Group vs. Control Group 1 column reflects the difference between: (1) The average change in the metric for the Treatment Group, from the 2006-2007 period, when it was not eligible for scaled disclosure, to the 2008-2009 period, when it was eligible for scaled disclosure, and (2) the average change in the metric between the same periods for Control Group 1, which was never eligible for scaled disclosure. Similarly, the number in the Treatment Group vs. Control Group 2 column reflects the difference between: (1) The average change in the metric for the Treatment Group from the 2006-2007 period, when it was not eligible for scaled disclos

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2018-14306. Public record. Not legal advice.