Amendments to Financial Disclosures About Acquired and Disposed Businesses

Federal RegisterMay 28, 2019

Ask Donna

What actually matters in this document.

Text

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 230, 239, 240, 249, 270, and 274

[Release No. 33-10635; 34-85765; IC-33465; File No. S7-05-19]

RIN 3235-AL77

Amendments to Financial Disclosures About Acquired and Disposed Businesses

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

We are proposing amendments to our rules and forms to improve the disclosure requirements for financial statements relating to acquisitions and dispositions of businesses, including real estate operations and investment companies. The proposed changes are intended to improve for investors the financial information about acquired or disposed businesses, facilitate more timely access to capital, and reduce the complexity and costs to prepare the disclosure.

DATES:

Comments should be received on or before July 29, 2019.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use our internet comment form (

http://www.sec.gov/rules/other.shtml

);

• Send an email to

rule-comments@sec.gov.

Please include File Number S7-05-19 on the subject line; or

Paper Comments

• Send paper comments in triplicate to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-05-19. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method of submission. We will post all comments on our website (

http://www.sec.gov/rules/other.shtml

). Comments also are available for website viewing and printing in our Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make publicly available.

We or the staff may add studies, memoranda, or other substantive items to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on our website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at

www.sec.gov

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Todd E. Hardiman, Associate Chief Accountant, at (202) 551-3516, or Jessica Barberich, Associate Chief Accountant, at (202) 551-3782 or Craig Olinger, Senior Advisor to the Chief Accountant, at (202) 551-3400, or Steven G. Hearne, Senior Special Counsel at (202) 551-3430 in the Division of Corporation Finance; Jenson Wayne, Assistant Chief Accountant, at (202) 551-6918, or Mark T. Uyeda, Senior Special Counsel, at (202) 551-6792, in the Division of Investment Management, 100 F Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

The Commission is proposing to amend:

Commission

reference

CFR citation

(17 CFR)

Regulation S-X:

Rules 1-01

et seq

§ 210.01

et seq.

Rule 1-02(w)

§ 210.1-02(w)

Rule 3-05

§ 210.3-05

Rule 3-06

§ 210.3-06

Rule 3-14

§ 210.3-14

Rule 3-18

§ 210.3-18

Rule 5-01

§ 210.5-01

Rule 6-01

§ 210.6-01

Rule 6-02

§ 210.6-02

Rule 6-03

§ 210.6-03

Article 8:

Rule 8-01

§ 210.8-01

Rule 8-03

§ 210.8-03

Rule 8-04

§ 210.8-04

Rule 8-05

§ 210.8-05

Rule 8-06

§ 210.8-06

Article 11:

Rule 11-01

§ 210.11-01

Rule 11-02

§ 210.11-02

Rule 11-03

§ 210.11-03

Securities Act of 1933 (Securities Act):

Securities Act Rule 405

§ 230.405

Rule 405 of Regulation S-T

§ 232.405

Form N-2

§ 239.14 and § 274.11a-1

Form N-14

§ 239.23

Securities Exchange Act of 1934 (Exchange Act):

Rule 12b-2

§ 240.12b-2

Rule 14a-101

§ 240.14a-101

Form 8-K

§ 249.308

Form 10-K

§ 249.310

Investment Company Act of 1940 (Investment Company Act):

Rule 8b-2

§ 270.8b-2

15 U.S.C. 77a

et seq.

15 U.S.C. 78a

et seq.

15 U.S.C. 80a-1

et seq.

We also are proposing to add 17 CFR 210.6-11 (new “Rule 6-11”) to Regulation S-X.

Table of Contents

I. Introduction and Background

II. Discussion of Proposed Amendments

A. Proposed Amendments to Generally Applicable Financial Statement Requirements for Acquired Businesses

1. Significance Tests

a. Investment Test

b. Income Test

2. Audited Financial Statements for Significant Acquisitions

3. Financial Statements for Net Assets That Constitute a Business

4. Financial Statements of a Business That Includes Oil and Gas Producing Activities

5. Timing and Terminology of Financial Statement Requirements

6. Foreign Businesses

a. Definition

b. Reconciliation Requirement

7. Smaller Reporting Companies and Issuers Relying on Regulation A

B. Proposed Amendments Relating to Rule 3-05 Financial Statements Included in Registration Statements and Proxy Statements

1. Omission of Rule 3-05 Financial Statements for Businesses That Have Been Included in the Registrant's Financial Statements

2. Use of Pro Forma Financial Information To Measure Significance

3. Disclosure Requirements for Individually Insignificant Acquisitions

C. Rule 3-14—Financial Statements of Real Estate Operations Acquired or To Be Acquired

1. Align Rule 3-14 With Rule 3-05

2. Definition of Real Estate Operation

3. Significance Tests

4. Interim Financial Statements

5. Smaller Reporting Companies and Issuers Relying on Regulation A

6. Blind Pool Real Estate Offerings

7. Triple Net Leases

D. Pro Forma Financial Information

1. Adjustment Criteria and Presentation Requirements

2. Significance and Business Dispositions

3. Smaller Reporting Companies and Issuers Relying on Regulation A

E. Amendments to Financial Disclosure About Acquisitions Specific to Investment Companies

1. Amendments to Significance Tests for Investment Companies

a. Investment Test

b. Asset Test

c. Income Test

2. Proposed Rule 6-11 of Regulation S-X

3. Pro Forma Financial Information and Supplemental Financial Information

4. Amendments to Form N-14

III. General Request for Comment

IV. Economic Analysis

A. Introduction

B. Baseline and Affected Parties

C. Potential Benefits and Costs of the Proposed Amendments

1. Significance Tests

2. Audited Financial Statements for Significant Acquisitions

3. Financial Statements for Net Assets That Constitute a Business and Financial Statements of a Business That includes Oil-and-Gas-Producing Activities

4. Timing and Terminology of Financial Statement Requirements

5. Foreign Businesses

6. Omission of Rule 3-05 and Rule 3-14 Financial Statements and Related Pro Forma Financial Information for Businesses That Have Been Included in the Registrant's Financial Statements

7. Use of Pro Forma Financial Information To Measure Significance

8. Disclosure Requirements for Individually Insignificant Acquisitions

9. Rule 3-14—Financial Statements of Real Estate Operations Acquired or To Be Acquired

10. Pro Forma Financial Information

11. Significance and Business Dispositions

12. Smaller Reporting Companies and Regulation A

13. Amendments to Financial Disclosure About Acquisitions Specific to Investment Companies

D. The Effects on Efficiency, Competition, and Capital Formation

E. Alternatives Considered

1. Approaches to the Significance Tests

2. Approaches to Proposed Financial Statement Requirements

3. Approaches to Proposed Pro Forma Adjustments

4. Alternatives to the Proposed Income Test for Investment Companies

V. Paperwork Reduction Act

A. Summary of the Collection of Information

B. Proposed Amendments' Effect on Existing Collections of Information

1. Estimated Effects of the Proposed Amendments on Paperwork Burdens for Registrants Other Than Investment Companies

a. Proposed Amendments to Rules 3-05 and 3-14

b. Proposed Amendments to Pro Forma Financial Information Requirements

2. Estimated Effects of the Proposed Amendments on Paperwork Burdens for Investment Company Registrants

C. Aggregate Burden and Cost Estimates for the Proposed Amendments

VI. Small Business Regulatory Enforcement Fairness Act

VII. Initial Regulatory Flexibility Act Analysis

A. Reasons for, and Objectives of, the Proposed Action

B. Legal Basis

C. Small Entities Subject to the Proposed Rules

D. Reporting, Recordkeeping, and Other Compliance Requirements

E. Duplicative, Overlapping, or Conflicting Federal Rules

F. Significant Alternatives

VIII. Statutory Authority

I. Introduction and Background

We are proposing changes to the requirements for financial statements relating to acquisitions and dispositions of businesses, including real estate operations, in Rule 3-05,

Financial Statements of Businesses Acquired or to be Acquired,

Rule 3-14,

Special Instructions for Real Estate Operations to be Acquired,

Article 11,

Pro Forma Financial Information

of Regulation S-X and other related rules and forms.

We are also proposing new Rule 6-11 of Regulation S-X and amendments to Form N-14 to specifically govern financial reporting for acquisitions involving investment companies. The proposed amendments are intended to improve for investors the financial information about acquired or disposed businesses, facilitate more timely access to capital, and reduce the complexity and costs to prepare the disclosure.

Unless otherwise noted, references in this release to “Rule” or “Rules” are to the rules under Regulation S-X.

We are also proposing related amendments in Regulation S-X to the definition of

significant subsidiary

in Rule 1-02(w); Rule 3-06,

Financial statements covering a period of nine to twelve months;

and Article 8,

Smaller Reporting Companies.

In addition, we are proposing amendments to Form 8-K for current reports, Form 10-K for annual and transition reports, and the definition of

significant subsidiary

in Rule 12b-2 under the Exchange Act, Rule 405 under the Securities Act, and Rule 8b-2 under the Investment Company Act.

The proposed amendments would not apply to financial statements related to the acquisition of a business that is the subject of a proxy statement or registration statement on Form S-4 (17 CFR 239.25) or Form F-4 (17 CFR 239.34), but would apply to pro forma information provided pursuant to Article 11 and financial information for acquisitions and dispositions otherwise required to be disclosed pursuant to Rule 3-05 or Rule 3-14. These amendments also would not affect the requirements in 17 CFR 210.3-02 (“Rule 3-02”) or 17 CFR 210.8-01 relating to predecessor companies.

This proposal results from an ongoing, comprehensive evaluation of our disclosure requirements.

As part of this evaluation, in September 2015, the Commission issued a

Request for Comment on the Effectiveness of Financial Disclosures About Entities Other Than the Registrant

(“2015 Request for Comment”).

The 2015 Request for Comment sought feedback on, among other things, the financial disclosure requirements in Regulation S-X for certain entities other than the registrant. More specifically, the Commission solicited comment on how investors use the disclosures required by these rules to make investment decisions, the challenges that registrants and others face in providing the required disclosures, and potential changes to these requirements that could enhance the information provided to investors and promote efficiency, competition, and capital formation. We received approximately 50 comment letters discussing Rule 3-05, Rule 3-14, Article 8, and Article 11

and these comments were considered carefully in developing these proposals.

The staff, under its Disclosure Effectiveness Initiative, is reviewing the disclosure requirements in Regulation S-X and 17 CFR 229.10 through 1208 (“Regulation S-K”) and is considering ways to improve the disclosure regime for the benefit of both companies and investors. The goal is to comprehensively review the requirements and make recommendations on how to update them to facilitate timely, material disclosure by companies and shareholders' access to that information.

See https://www.sec.gov/spotlight/disclosure-effectiveness.shtml.

Request for Comment on the Effectiveness of Financial Disclosures About Entities Other Than the Registrant,

Release No. 33-9929 (Sept. 25, 2015) [80 FR 59083 (Oct. 1, 2015)].

Comments that we received in response to the 2015 Request for Comment are available at

https://www.sec.gov/comments/s7-20-15/s72015.shtml.

References to comment letters in this release refer to the comments on the 2015 Request for Comment unless otherwise specified.

When a registrant acquires a business

other than a real estate operation, Rule 3-05 of Regulation S-X generally requires a registrant to provide separate audited annual and unaudited interim pre-acquisition financial statements of the business if it is significant to the registrant (“Rule 3-05 Financial Statements”). Recognizing that certain acquisitions have a greater impact on a registrant than others, the Commission adopted Rule 3-05 to address the reporting requirements for businesses acquired or to be acquired based on the significant subsidiary definition in Rule 1-02(w) using a sliding scale approach.

Rule 3-05 also applies to registrants that are registered investment companies and business development companies. The Commission later adopted Rule 8-04,

Financial Statements of Businesses Acquired or to be Acquired,

in order to provide comparable requirements for smaller reporting companies.

Rule 3-05 requires disclosure if the “business combination has occurred or is probable.”

See

17 CFR 210.3-05(a). Registrants determine whether a “business” has been acquired by applying Rule 11-01(d) of Regulation S-X. The definition of “business” in Regulation S-X focuses primarily on whether the nature of the revenue-producing activity of the acquired business will remain generally the same as before the transaction. This determination is separate and distinct from a determination made under the applicable accounting standards. Because the definitions serve different purposes, we have not proposed to conform our rules with the applicable accounting standards.

Instructions for the Presentation and Preparation of Pro Forma Financial Information and Requirements for Financial Statements of Businesses Acquired or To Be Acquired,

Release No. 33-6413 (Jun. 24, 1982) [47 FR 29832 (Jul. 9, 1982)] (“Rule 3-05 Adopting Release”). The requirements are based on the significant subsidiary tests using a sliding scale so that the requirements for filing such financial statements as well as the periods covered by such financial statements will vary with the percentage impact of the acquisition on the registrant. In adopting the sliding scale approach, the Commission stated its belief that the selected percentages “meet the objectives of providing adequate financial information to investors, shareholders and other users while at the same time reducing the reporting burdens of registrants involved in acquisitions.”

Smaller Reporting Company Regulatory Relief and Simplification,

Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)] (“SRC Relief Adopting Release”). For financial disclosure requirements, the SRC Relief Adopting Release predominantly effectuated a relocation of the requirements in 17 CFR 228, Regulation S-B, into Regulation S-K and Regulation S-X.

Whether an acquisition is significant under Rule 3-05 is determined by applying the investment, asset, and income tests provided in the “significant subsidiary” definition in Rule 1-02(w).

These tests generally can be described as follows:

Rule 3-05 provides for use of a 20% significance threshold, rather than the 10% threshold indicated in Rule 1-02(w). The Commission raised the threshold in Rule 3-05 from 10% to 20% in 1996 in order to reduce compliance burdens in response to concerns that the requirement to obtain audited financial statements for a business acquisition may have caused companies to forgo public offerings in favor of private or offshore offerings.

See Streamlining Disclosure Requirements Relating to Significant Business Acquisitions,

Release No. 33-7355 (Oct. 10, 1996) [61 FR 54509 (Oct. 18, 1996)] (“1996 Streamlining Release”). As a result of this amendment, the significance thresholds in Rule 3-05 diverged from those used for Rule 3-14 and for dispositions at that time.

• “Investment Test”—the investment in and advances to the acquired business are compared to the total assets of a registrant reflected in its most recent annual financial statements required to be filed at or prior to the acquisition date;

• “Asset Test”—a registrant's proportionate share of the acquired business's total assets reflected in the business's most recent annual pre-acquisition financial statements is compared to the total assets of the registrant reflected in its most recent annual financial statements required to be filed at or prior to the acquisition date; and

• “Income Test”—a registrant's equity in the income from continuing operations of the acquired business before income taxes, exclusive of amounts attributable to any noncontrolling interests, as reflected in the business's most recent annual pre-acquisition financial statements, is compared to the same measure of the registrant reflected in its most recent annual financial statements required to be filed at or prior to the acquisition date.

If none of the Rule 3-05 significance tests exceeds 20%, a registrant is not required to file Rule 3-05 Financial Statements.

If any of the Rule 3-05 significance tests exceeds 20%, but none exceeds 40%, Rule 3-05 Financial Statements are required for the most recent fiscal year and any required interim periods. If any Rule 3-05 significance test exceeds 40%, but none exceeds 50%, a second fiscal year of Rule 3-05 Financial Statements is required. When at least one Rule 3-05 significance test exceeds 50%, a third fiscal year

of Rule 3-05 Financial Statements is required unless net revenues of the acquired business were less than $100 million in its most recent fiscal year.

Rule 3-05 Financial Statements are not required once the operating results of the acquired business have been reflected in the audited consolidated financial statements of the registrant for a complete fiscal year, unless the financial statements have not been previously filed or the acquisition is of major significance.

An acquisition is considered to be of major significance when the acquired business is of such significance to the registrant that omission of Rule 3-05 Financial Statements would materially impair an investor's ability to understand the historical financial results of the registrant; for example, if, at the date of acquisition, the acquired business met at least one of the conditions in the significance tests at the 80% level.

Rule 3-05 contains an additional requirement for certain registration statements and proxy statements related to the aggregate effect of individually insignificant businesses, which may trigger a requirement for Rule 3-05 Financial Statements for a business for which none of the significance tests exceed 20%.

See

further discussion at note 118 below.

A smaller reporting company is subject to similar requirements under Rule 8-04 of Regulation S-X, but financial statements are only required for up to two fiscal years.

17 CFR 210.3-05(b)(2). The revenue threshold to this exception is based on the “smaller reporting company” definition. The threshold was recently increased from $50 million to $100 million as part of amendments to the “smaller reporting company” definition.

See Amendments to Smaller Reporting Company Definition,

Release No. 33-10513 (June 28, 2018) [83 FR 31992 (July 10, 2018)] (“2018 SRC Amendments”).

17 CFR 210.3-05(b)(4)(iii).

Under Rule 3-14, a registrant that has acquired (and in the case of certain registration statements and proxy statements, proposes to acquire) a significant real estate operation similarly must file financial statements with respect to such operations; however, the required financial statements only include separate audited annual and unaudited interim abbreviated income statements (“Rule 3-14 Financial Statements”).

While Rule 3-14 refers to real estate acquisitions that are “significant,” it does not refer specifically to the conditions in the definition of “significant subsidiary” in Rule 1-02(w).

Additionally, Rule 3-14 generally only requires one year of Rule 3-14 Financial Statements.

See

Rule 3-14. Rule 3-14 was adopted as part of the Commission's effort to establish a centralized set of instructions in Regulation S-X and is based on the disclosure requirements in Item 6(b) for Form S-11 (17 CFR 239.18) as adopted in 1961.

See Uniform Instructions as to Financial Statements—Regulation S-X,

Release No. 33-6234 (Sept. 2, 1980) [45 FR 63682 (Sept. 25, 1980)]. Rule 3-14 Financial Statements are abbreviated because the rule requires that they exclude historical items that are not comparable to the proposed future operations of the real estate operation such as mortgage interest, leasehold rental, depreciation, corporate expenses, and federal and state income taxes. While Rule 3-14 does not require interim financial information, in practice registrants relying on Rule 3-14 also provide unaudited interim pre-acquisition income statements for the most recent year-to-date interim period because they are substantially required in most circumstances by Article 11 of Regulation S-X to provide pro forma information for the most recent year-to-date interim period.

See

Section II.D. below.

Neither “significant property” nor “significant real estate operation” is defined in Regulation S-X.

See

Rule 3-14(a)(1). Only one year of Rule 3-14 Financial Statements is required if the real estate operation is not acquired from a related party, the registrant discloses the material factors considered in assessing the real estate operation, and the registrant indicates it is not aware of material factors that would cause the reported financial information not to be indicative of future operating results. If the registrant does not meet these conditions, three years of Rule 3-14 Financial Statements are required. A smaller reporting company is subject to similar requirements under Rule 8-06 of Regulation S-X, but financial statements are only required for up to two fiscal years for acquisitions from related parties, instead of three years.

Registrants required to file Rule 3-05 Financial Statements or Rule 3-14 Financial Statements are additionally required to file unaudited pro forma financial information as prescribed by Article 11 of Regulation S-X.

Pro forma financial information typically includes a pro forma balance sheet as of the end of the most recent period for which a consolidated balance sheet of the registrant is required and pro forma income statements for the registrant's most recent fiscal year and for the period from the most recent fiscal year end to the most recent interim date for which a balance sheet is required. The pro forma financial information is based on the historical financial statements of the registrant and the acquired or disposed business, and generally includes adjustments intended to show how the acquisition or disposition might have affected those financial

statements had the transaction occurred at an earlier time.

See Rules 11-01 and 11-02. A smaller reporting company provides the pro forma financial information described in Rule 8-05 of Regulation S-X. Although the preliminary notes to Article 8 indicate that smaller reporting companies may wish to consider the enhanced guidelines in Article 11, smaller reporting companies are not required to comply with these items.

Form 8-K generally requires registrants to file Rule 3-05 Financial Statements, Rule 3-14 Financial Statements, and related pro forma financial information within 75 days after consummation of the acquisition.

A similar 75-day filing period exists in registration statements and proxy statements for acquired or to be acquired businesses requiring Rule 3-05 Financial Statements, but not for acquired or to be acquired businesses requiring Rule 3-14 Financial Statements.

Item 2.01 of Form 8-K requires that registrants make certain disclosures upon the acquisition or disposition of a significant amount of assets, including assets that constitute a business, within four business days of the consummation of the transaction. It does not require reporting for probable acquisitions or dispositions. Item 9.01 of Form 8-K provides that the required financial statements and pro forma financial information for the acquired business (including a real estate operation) may be filed not later than 71 calendar days after the initial report on Form 8-K is required to be filed, providing approximately 75 calendar days to file the acquired business financial statements and related pro forma financial information. A registrant may need to update the periods presented in Form 8-K in certain subsequently filed registration statements and proxy statements.

See

17 CFR 210.3-12.

Rule 3-05(b)(4) and Rule 11-01(c) provide that registration statements not subject to the provisions of 17 CFR 230.419 and proxy statements need not include separate financial statements of the acquired or to be acquired business and related pro forma financial information if the business does not exceed any of the conditions of significance in the definition of “significant subsidiary” in Rule 1-02(w) at the 50% level, and either (A) the consummation of the acquisition has not yet occurred; or (B) the date of the final prospectus or prospectus supplement relating to an offering as filed with the Commission pursuant to 17 CFR 230.424(b) or the mailing date in the case of a proxy statement, is no more than 74 days after consummation of the business combination, and the financial statements have not previously been filed by the registrant. A similar provision applies to smaller reporting companies, but it is linked to the effective date of the registration statement instead of the date of the final prospectus or prospectus supplement.

See

Rule 8-04(c)(4).

In addition, certain registration statements

and proxy statements require audited financial statements and unaudited pro forma financial information for the substantial majority of individually insignificant consummated and probable acquisitions since the date of the most recent audited balance sheet if a significance test exceeds 50% for any combination of acquisitions subject to Rule 3-05.

Also, Rule 3-14 Financial Statements are required when the registrant has acquired or proposes to acquire a group of properties which in the aggregate are significant.

This additional requirement does not apply to all registration statements, such as registration statements filed on Form S-8 (17 CFR 239.16b).

See

Rule 3-05(b)(2)(i). Smaller reporting companies provide the same disclosure under Rule 8-04(c)(3).

See

Rule 3-14(a) and, for smaller reporting companies, Rule 8-06.

II. Discussion of Proposed Amendments

We are proposing changes to the requirements in Rule 3-05, Rule 3-14, and Article 11 of Regulation S-X and related rules and forms to improve the financial disclosure requirements about significant business acquisitions and dispositions.

The proposed amendments would generally:

As discussed in Section II.D.2.,

infra,

Rule 11-01(a)(4) requires registrants to provide pro forma financial information upon the disposition or probable disposition of a significant portion of a business. Rule 11-01(b)(2) requires significance of a disposition to be determined by applying the definition of a significant subsidiary under Rule 1-02(w). Throughout this release, we discuss how the proposed amendments to the definition of significant subsidiary would impact disclosures for business dispositions.

• Update the significance tests under these rules by:

○ Revising the Investment Test and the Income Test;

○ expanding the use of pro forma financial information in measuring significance; and

○ conforming the significance threshold and tests for a disposed business;

• require the financial statements of the acquired business to cover up to the two most recent fiscal years rather than up to the three most recent fiscal years;

• permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;

• clarify when financial statements and pro forma financial information are required and update the language used in our rules;

• permit the use of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS-IASB”) in certain circumstances;

• no longer require separate acquired business financial statements once the business has been included in the registrant's post-acquisition financial statements for a complete fiscal year;

• modify and enhance the required disclosure for the aggregate effect of acquisitions for which financial statements are not required or are not yet required;

• align Rule 3-14 with Rule 3-05 where no unique industry considerations exist;

• clarify the application of Rule 3-14 regarding the determination of significance, the need for interim income statements, special provisions for blind pool offerings, and the scope of the rule's requirements;

• amend the pro forma financial information requirements to improve the content and relevance of such information; and

• make corresponding changes to the smaller reporting company requirements in Article 8 of Regulation S-X.

In addition, we are proposing regulatory requirements specific to investment companies registered under the Investment Company Act and business development companies

(collectively, “investment companies”) to address the unique attributes of this group of registrants as discussed in more detail in Section II.E. below.

“Business development company” is defined in Section 2(a)(48) of the Investment Company Act, 15 U.S.C. 80a-2(a)(48).

A. Proposed Amendments to Generally Applicable Financial Statement Requirements for Acquired Businesses

We are proposing amendments to the requirements in Rule 3-05 and related requirements in Rule 1-02(w), as described below.

In addition to the proposed changes to the significance tests, we are proposing clarifying amendments to the definition of “significant subsidiary” to label the conditions as the Investment Test, the Asset Test, and the Income Test.

1. Significance Tests

We propose to revise the significance tests provided in Rule 1-02(w)

to improve their application and to assist registrants in making more meaningful significance determinations. Specifically, we propose to revise the Investment Test and the Income Test.

Additionally, for investment companies, we are proposing amendments to each of the Investment Test, Asset Test, and

Income Test as described in Section II.E.1 below.

The term “significant subsidiary” is also defined in Securities Act Rule 405, Exchange Act Rule 12b-2, and Investment Company Act Rule 8b-2. The Rule 405 and Rule 12b-2 definitions historically have been generally consistent with the Rule 1-02(w) definition. Accordingly, we are proposing to conform the definitions of significant subsidiary in Rule 405 and Rule 12b-2 to the proposed definition in Rule 1-02(w). However, as under the existing rules, the proposed amendments to Rule 1-02(w) that are only applicable to disclosure requirements under Regulation S-X, specifically proposed Rule 1-02(w)(1)(iii)(b)(3), would continue to be excluded from the proposed definitions in Rule 405 or Rule 12b-2. Unlike the other definitions, the definition in Rule 8b-2 has differed from the Rule 1-02(w) definition. We are proposing to conform the Rule 8b-2 definition of “significant subsidiary” to the proposed definition in Rule 1-02(w)(2) that is specifically tailored for investment companies.

See

Section II.E below.

We are not proposing to substantively revise the Asset Test; however, we are proposing a number of non-substantive revisions to the significance tests generally, such as clarifying that the significance tests compare the “tested” subsidiary's amounts to the registrant's.

We note that, in addition to Rule 3-05, several of our other rules and forms require disclosure related to “significant subsidiaries” or otherwise rely on the significance tests in Rule 1-02(w) to determine the disclosure required.

We believe it is appropriate to apply consistent significance tests for each of these purposes. The proposed amendments are intended to reflect more accurately the relative significance to the registrant of the acquired business and to reduce anomalous results in the application of the definition of “significant subsidiary.” In addition, maintaining the historical conformity between the “significant subsidiary” definitions would avoid unnecessary regulatory complexity through consistent application of significance determinations made at the acquisition date and those made post-acquisition when the acquired business is a subsidiary of the registrant.

See, e.g.,

17 CFR 210.9-03, which requires bank holding companies and banks to reflect on their balance sheets certain loans and indebtedness of their significant subsidiaries as defined in Rule 1-02(w); 17 CFR 210.3-09, 17 CFR 210.4-08(g), and Item 17(c)(2) of 17 CFR 249.220f (“Form 20-F”), which rely on the significance tests in Rule 1-02(w) to determine the financial statements and summarized financial information required for the registrant's equity method investees; 17 CFR 229.601(b)(21) and Instruction 8 as to Exhibits of Form 20-F, which both rely on Rule1-02(w) to determine the subsidiaries that must be included in the list of subsidiaries required as an exhibit; Item 17(b)(6)(3) of Form F-4, which relies on the significance tests in Rule 1-02(w) to determine the financial statements required for foreign companies being acquired that do not meet the requirements to use 17 CFR 239.34 (“Form F-3”); Item 4.C of Form 20-F, which requires a detailed list of the registrant's significant subsidiaries; 17 CFR 229.304(a)(1) and (2), Item 9(d) of 17 CFR 240.14a-101 (“Schedule 14A”), Item 4.01 of Form 8-K, Item 4 of 17 CFR 239.93 (“Form 1-U”), and Item 16F of Form 20-F, which require disclosure about changes in the auditors of the registrant (or issuer, as applicable) or its significant subsidiaries; Item 3 of 17 CFR 249.308a (“Form 10-Q”) and Item 13 of Form 20-F, which require disclosure about defaults of the registrant and its significant subsidiaries and material arrearages/delinquencies in the payment of dividends on preferred stock of the registrant or any of its significant subsidiaries; 17 CFR 229.101(a)(1), which requires certain disclosures, such as year and form of organization, bankruptcy, and others, for the registrant and any of its significant subsidiaries; 17 CFR 229.103, which requires disclosure of certain legal proceedings, including bankruptcy and similar proceedings, for the registrant and any of its significant subsidiaries; and Item 4.A.4 of Form 20-F, which requires general disclosure about the development of and structural changes in the business of the registrant and its significant subsidiaries.

See also

Rule 11-01(b) and Proposed Rule 11-01(b).

a. Investment Test

Currently, the Investment Test compares the registrant's investment in and advances to the acquired business to the carrying value of the registrant's total assets. We propose to revise the Investment Test to compare the registrant's investment in and advances to the acquired business to the aggregate worldwide market value of the registrant's voting and non-voting common equity (“aggregate worldwide market value”), when available.

If the registrant does not have an aggregate worldwide market value, we propose to retain the existing test.

The value under the proposed rule differs from the value currently used by registrants to determine accelerated filer status under Rule 12b-2 because it includes the value of common equity held by affiliates and it is determined as of the last business day of the registrant's most recently completed fiscal year. By contrast, Rule 12b-2 looks to the value of common equity held by non-affiliates and is determined as of the last business day of the registrant's most recently completed second fiscal quarter.

See

Rule 12b-2.

We believe that using the registrant's aggregate worldwide market value would align the Investment Test more closely with the economic significance of the acquisition to the registrant. While the purchase price for a recent or probable acquisition is generally consistent with the fair value of the underlying business, the measure against which the purchase price is compared under the current test (

i.e.,

total assets) may not fully reflect the registrant's current fair value.

In response to the 2015 Request for Comment, commenters supported revising the Investment Test to use a measure of the registrant's fair value instead of its total assets.

While commenters recommended various methods of determining fair value, we are proposing aggregate worldwide market value because it is readily available and objectively determined by the market.

For example, the Investment Test uses the carrying value of a registrant's total assets as of the most recent balance sheet date, which represents a combination of fair value for certain assets (

e.g.,

financial instruments) and historical cost for other assets (

e.g.,

property, plant and equipment and intangible assets). The test further excludes the value of certain assets not permitted to be recognized (

e.g.,

certain internally developed intangible assets) and is not reduced by the value of liabilities.

See, e.g.,

letters from the American Bar Association (Nov. 14, 2014) (“ABA”), BDO USA, LLP (Dec. 7, 2015) (“BDO”), Center for Audit Quality (Nov. 25, 2015) (“CAQ”), CFA Institute (Mar. 2, 2016) (“CFA”), Davis Polk & Wardwell LLP (Nov. 30, 2015) (“Davis Polk”) Polk, Deloitte & Touche LLP (Nov. 23, 2015) (“DT”), Ernst & Young LLP (Nov. 20, 2015) (“EY”), Grant Thornton LLP (Dec. 1, 2015) (“Grant”), KPMG LLP (Nov. 30, 2015) (“KPMG”), and PricewaterhouseCoopers LLP (Nov. 30, 2015) (“PwC”).

In order to further improve the Investment Test, we propose to address when the registrant's aggregate worldwide market value shall be determined,

provide further instructions on a registrant's “investments in” the tested subsidiary

for acquisitions and dispositions,

and clarify the applicability of the test to combinations between entities under common control.

These proposed amendments

would address certain practical questions

that may arise when applying the proposed Investment Test and should therefore simplify compliance by registrants.

We propose Paragraph (w)(1)(i)(A) to provide that aggregate worldwide market value of the registrant's voting and non-voting common equity shall be determined as of the last business day of the registrant's most recently completed fiscal year, which for acquisitions and dispositions shall be at or prior to the date of acquisition or disposition.

Rule 1-02(w) defines the term “significant subsidiary.” Rules 3-05 and 3-14 use the conditions in Rule 1-02(w) when establishing the test for registrants to determine whether financial statements are required for businesses acquired or to be acquired. While we recognize that acquired businesses are often not subsidiaries, we use the term “tested subsidiary” throughout this release, rather than “tested business” or another term, to avoid confusion when using the conditions in Rule 1-02(w) in connection with the determination in Rule 3-05 and Rule 3-14.

We propose Paragraph (w)(1)(i)(C) to require that the “investment in” the tested subsidiary in an acquisition include the fair value of contingent consideration required to be recognized at fair value by the registrant at the acquisition date under U.S. GAAP or IFRS-IASB, as applicable. If recognition at fair value is not required, the proposed amendment would require all contingent consideration to be included, except sales-based milestones and royalties, unless the likelihood of payment is remote. The “investment in” the tested subsidiary also would exclude the registrant's proportionate interest in the carrying value of assets transferred by the registrant to the tested subsidiary that will remain with the combined entity after the acquisition because we believe this would provide a more accurate measure of the tested subsidiary's relative significance. We believe our proposal is consistent with FASB standard setting for business combinations that clarified that for acquisition accounting the consideration transferred should exclude such amounts.

See

FASB ASC 805-30-30-8. For similar reasons, we also propose providing in Paragraph (w)(1)(i)(D) that the “investment in” the tested subsidiary in a disposition equal the fair value of the consideration, which would include contingent consideration, for the disposed subsidiary when comparing it to the registrant's aggregate worldwide market value or the carrying value of the disposed subsidiary when comparing it to the registrant's total assets.

Rule 1-02(w)(1) provides that for a proposed combination between entities under common control, when the number of common shares exchanged or to be exchanged exceeds 10% of the registrant's common shares outstanding at the date the combination is initiated, the Investment Test for significance is met. We are proposing Rule 1-02(w)(1)(i)(B) to similarly provide that the Investment Test would be met when either net book value of the tested subsidiary exceeds 10% of the registrants' and its subsidiaries consolidated total assets or the number of common shares exchanged or to be exchanged by the registrant exceeds 10% of its total common shares outstanding at the date the combination is initiated. The addition of net book value to the test as proposed recognizes that such combinations may be effected by transferring net assets, rather than exchanging shares, and that the resulting accounting by the registrant typically recognizes the combination using the parent's historical carrying value of the transferred entity or business.

See, e.g.,

FASB ASC 805-50. We also propose to add a reference to “businesses” in Rule 1-02(w) such that the resulting phrasing is “combinations between entities or businesses under common control” for circumstances where the significant subsidiary definition is referenced by

rules establishing requirements for acquired businesses.

Commission staff has provided informal guidance to address practical questions. For example,

see

U.S. Sec. & Exch. Comm'n., Division of Corporation Finance's Financial Reporting Manual, available at

https://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf

(last updated Dec. 1, 2017) (“FRM”). The FRM sets forth the informal guidance of the staff in the Division of Corporation Finance related to various financial reporting matters. The FRM is not a rule, regulation, or statement of the Commission.

See

FRM,

supra

note 40, at Sections 2015.5 “

Investment Test—Acquisition Accounting”

and 2015.7 “

Investment Test—Reorganization of Entities Under Common Control.”

b. Income Test

Currently, the Income Test focuses on a single component, net income,

which can include infrequent expenses, gains or losses that can distort the determination of relative significance. For registrants with marginal or break-even net income or loss in a recent fiscal year, the use of a net income component by itself can also have the effect of requiring financial statements for acquisitions that otherwise would not be considered material to investors. In these circumstances comparatively small entities may trigger the requirement for Rule 3-05 Financial Statements, which can be costly to prepare. Commission staff regularly receives and grants under delegated authority requests for relief in these circumstances where the disclosure of these acquisitions would not be material to investors.

A number of commenters expressed concern with the existing Income Test, with many of these commenters recommending replacing or supplementing the net income test with a revenue component.

Specifically, the current Income Test uses income from continuing operations before income taxes. Prior to 1981, the “significant subsidiary” definition included a revenue test. The Commission eliminated the revenue test in favor of the net income test noting in part that “. . . the presentation of additional financial disclosures of an affiliated entity may not be meaningful if the affiliate has a high sales volume but a relatively low profit margin” and observing that in such circumstances, the affiliate has little financial effect on the operating results of the consolidated group.

See Separate Financial Statements Required by Regulation S-X,

Rels. No. 33-6359 (Nov. 6, 1981)[46 FR 56171 (Nov. 16, 1981)]. For these reasons, we believe it is important to retain a net income component as part of the Income Test rather than rely exclusively on a revenue component.

Pursuant to 17 CFR 210.3-13 (“Rule 3-13”) of Regulation S-X, the Commission may, upon the request of the registrant, and where consistent with the protection of investors, permit the omission of one or more required financial statements or the filing in substitution therefor of appropriate statements of comparable character. The Commission has delegated authority to the staff in the Division of Corporation Finance to grant requests for relief under Rule 3-13.

See, e.g.,

letters from ABA, CAQ, U.S. Chamber of Commerce (Nov. 30, 2015), Davis Polk, EY, and PWC. Two commenters specifically recommended supplementing the Income Test with a revenue component.

See

letters from CFA and KPMG.

We propose to revise the Income Test by adding a new revenue component

and to simplify the calculation of the net income component by using income or loss from continuing operations

after

income taxes. We expect adding a revenue component would reduce the anomalous results that may occur by relying solely on net income.

We believe that this change, along with simplifying these calculations, would reduce complexity and preparation costs without sacrificing material information that investors may need to evaluate these transactions.

The proposed revenue component would compare the registrant's and its other subsidiaries' proportionate share of the tested subsidiary's consolidated total revenues (after intercompany elimination) to such consolidated total revenues for the registrant's most recently completed fiscal year.

We believe that revenue is an important indicator of the operations of a business and generally has less variability than net income. For example, expenses related to historical capitalization (

e.g.,

interest expense) as well as infrequent expenses, such as those for litigation or impairment, can affect net income and the existing Income Test. That impact may be to either deem as insignificant an acquired business that is expected to have material future impact on the registrant or deem as significant an acquired business that is not expected to have a material future impact on the registrant. The potential for these effects suggests that the Income Test should be revised to include an income statement metric that is less subject to such effects. Because not all registrants report metrics such as “profit margin” and “operating income,” and these metrics could also have similar potential variability, we believe “revenue” is a more appropriate indicator. Consistent with the Commission's past observations about a revenue test that is not linked to net income (

see supra

note 42), we propose to retain net income and add a revenue component when both the registrant and tested subsidiary have recurring annual revenues.

Under the proposed amendments, the Income Test would require that, where the registrant and its subsidiaries consolidated and the tested subsidiary have recurring annual revenue, the tested subsidiary must meet both the new revenue component and the net income component. In this case, the registrant would use the lower of the revenue component and the net income component to determine the number of periods for which Rule 3-05 Financial Statements are required.

Where a registrant or tested subsidiary does not have recurring annual revenues, the revenue component is less likely to produce a meaningful assessment and therefore only the net income component would apply. To reduce anomalous results in these circumstances, we also propose revising the Income Test to use the average of the absolute value of net income when the existing 10% threshold in Computational Note 2 to Rule 1-02(w)

is met and the proposed revenue component of the Income Test does not apply.

See

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

See

Computational Note 2 to Rule 1-02(w) of Regulation S-X. Average income should be substituted for purposes of the computation if income of the registrant and its subsidiaries consolidated exclusive of amounts attributable to any noncontrolling interests for the most recent fiscal year is at least 10% lower than the average of the income for the last five fiscal years.

See

proposed Rule 1-02(w)(1)(iii)(B)(

By revising the Income Test to require that the registrant exceed both revenue and net income components when the registrant and the tested subsidiary have recurring annual revenue, we believe the test would more accurately determine whether a business is significant to the registrant and would reduce the frequency of the anomalous result of immaterial acquisitions being deemed significant.

We also propose to revise the net income component calculation so that it is based on income or loss from continuing operations

after

income taxes. Income tax is a recurring and often material line item. Further, the current calculation, which is based on income from continuing operations

before

income taxes, may require additional calculations for components of net income that are presented on a post-tax basis

with the result that a registrant may not be able to use amounts directly from the financial statements. Instead, the proposed amendments refer to income or loss from continuing operations after income taxes, which would permit a registrant to use line item disclosure from its financial statements, simplifying the determination.

We are also proposing to clarify the net income component by inserting a reference to the

absolute value

of equity in the tested subsidiary's consolidated income or loss from continuing operations, which we believe will mitigate the potential for misinterpretation that may result from inclusion of a negative amount in the computation.

We propose to calculate net income and average net income using absolute values. For net income, we believe this would serve to clarify that the test applies when a net loss

exists, and is to be used when either the tested subsidiary or the registrant, but not both, has a net loss. For average income, our proposal differs from current staff interpretation, which indicates that “zero” should be used for loss years in computing the average.

We believe calculating average net income using the absolute value of the loss or income amounts for each year and then calculating the average would make the average income test more indicative of relative significance.

See, e.g.,

17 CFR 210.5-03(b)12 (“Rule 5-03(b)12”). Rule 5-03(b)12,

Equity in Earnings of Unconsolidated Subsidiaries and 50 Percent or Less Owned Persons,

provides for a component of net income from continuing operations to be presented net of tax.

See

proposed Rule 1-02(w)(1)(iii)(B)(2).

See FRM,

supra

note 40, at Section 2015.8.

In addition, proposed Rules 3-05(b)(3) and 11-01(b)(3) will also clarify that the Income Test may be determined using the acquired business's revenues less the expenses permitted to be omitted by proposed Rules 3-05(e) and 3-05(f) if the business meets the conditions in those proposed rules.

Finally, we are proposing additional non-substantive amendments to the net income component that we believe will simplify the description and application of the test.

See

discussion relating to Rule 3-05(e) in Section II.A.3 and Rule 3-05(f) in Section II.A.4. below.

Specifically, we are proposing to replace the phrase “exclusive of amounts attributable to any noncontrolling interests” in the net income component with the phrase “attributable to the controlling interests.” We are also proposing to revise Rule 1-02(w) to remove the Computational Note designation but retain the substance of the notes in the rule and make conforming amendments consistent with the proposed amendments to the revised Income Test. Additionally, Paragraph (w)(1)(iii)(B)(3) would clarify that the rule is not intended to modify the existing Rule 3-05(a)(3) requirement that acquisitions of a group of related businesses shall be treated as if they are a single acquisition. Finally, we are incorporating the Note to Paragraph (w) into Paragraph (w).

Request for Comment

1. We are proposing to revise the significance tests to improve their application and assist registrants in making more meaningful significance determinations. Are the proposed revisions appropriate? Are there additional revisions we should consider to further improve the significance tests?

2. We are proposing to revise the Investment Test to use aggregate worldwide market value to reflect the size of the acquirer while retaining investment in and advances to the acquired business to reflect the size of the acquired business. Are these measures sufficiently comparable? Are there particular types of transactions for which these measures would lead to a less-informative indicator of significance? Does our proposed use of aggregate worldwide market value in the Investment Test more closely reflect the relative significance of the acquisition to the registrant? Is there a better proxy that we could use for fair value in the Investment Test? For example, would aggregate worldwide market value of the registrant's voting and non-voting common equity held by its non-affiliates, a value based on the expected offering price in an initial public offering, enterprise value, or some other market valuation be a more appropriate proxy? Why or why not?

3. We have proposed to require that the “investment in” the tested subsidiary in an acquisition include the fair value of contingent consideration required to be recognized at fair value by the registrant at the acquisition date under U.S. GAAP or IFRS-IASB, as applicable. If recognition at fair value is not required, the proposed amendment would require all contingent consideration to be included, except sales-based milestones and royalties, unless the likelihood of payment is remote. Generally, would the inclusion of contingent consideration provide a more accurate determination of significance? Why or why not? Are there practical impediments to our proposed approach to the inclusion of contingent consideration? If so, what are they and how would they best be mitigated? For example, should we require the gross amount of contingent consideration, rather than its fair value, be used in significance determinations regardless of the accounting the registrant is required to apply at the acquisition date? Why or why not? If contingent consideration is not required to be recognized at fair value, would inclusion of contingent consideration unless the likelihood of payment is remote provide a more accurate determination of significance? In this circumstance, is the exclusion of sales-based milestones and royalties an appropriate practical expedient to the determination of significance? Alternatively, should we require registrants to estimate these amounts in order to determine significance? Why or why not? Does the phrase “sales-based milestones or royalties” capture consideration that is contingent on sales or should it be further refined or defined?

4. For dispositions, would the use of the fair value of consideration, which would include contingent consideration, provide a more accurate determination of significance than the gross amount of consideration when comparing to the aggregate worldwide market value of the registrant? Why or why not? Are there practical impediments to our proposed approach to the inclusion of contingent consideration? If so, what are they and how would they best be mitigated? Should we exclude contingent consideration from the determination of the significance of a disposed business when comparing to the aggregate worldwide market value of the registrant? Why or why not? Should we exclude from the determination of significance contingent consideration in the form of sale-based milestones or royalties when comparing to the aggregate worldwide market value of the registrant? Why or why not? When the registrant has no such aggregate worldwide market value, will comparing the carrying value of the disposed subsidiary to total assets of the registrant appropriately reflect the relative significance of the disposed business to the registrant? Why or why not?

5. We have proposed to add a revenue component to the Income Test. Would this approach more accurately reflect the significance of the acquisition or could it result in material acquisitions not triggering financial statement disclosures? Would it reduce incidents of otherwise insignificant acquisitions being deemed significant by registrants that have marginal or break-even net income?

6. Would using different percentage thresholds for the revenue component and the income component mitigate the potential that the proposed Income Test would under-identify transactions? Why or why not? For example, would the proposed Income Test be a better indicator of relative significance if the revenue component used a lower percentage threshold, for example 15% or 10%, than that used for the income component? Why or why not? If the revenue component and income component were to have different percentage thresholds, what should those percentages be? Are there other ways to modify the Income Test that would better address this issue?

7. Will our proposal to require recurring annual revenue appropriately limit the circumstances when the revenue component would not provide a meaningful result? Should we instead provide that the revenue component would not apply if either the registrant or tested subsidiary had no or nominal revenue? Why or why not? If so, should we define nominal revenue and what definition should we propose?

8. We are proposing that registrants use the lower of the total revenue or the net income components of the proposed Income Test to determine the number of years of required audited financial statements. Would the use of the lower of the two components provide an

appropriate number of periods of pre-acquisition financial statements when an acquired business is significant? If not, why not? Is there a more appropriate way to determine the number of periods that should be presented if the Income Test is met? If yes, why would this alternative approach be more appropriate?

9. Would the Income Test better determine relative significance if we eliminated the net income component entirely and relied solely on the proposed revenue component? Why or why not?

10. Would the Income Test better determine relative significance if we required using the proposed revenue component in place of the proposed income component only when the acquirer's income or loss is small? Why or why not? If we required use of the revenue component only when the acquirer's income or loss is small, how should we define when this switch from the income component to the revenue component must occur? For example, should we require use of the revenue component when the absolute value of the acquirer's return on assets was less than 1%? Why or why not? Would a “less than 1%” standard be appropriate or would a different percentage be a more appropriate standard? If we required the switch to be made based on the acquirer's return on assets, how could we mitigate the inconsistent results that might occur across industries depending on the extent of an acquirer's reliance on human capital versus material capital? For acquirers that have large asset bases, would a return on asset approach be subsumed by the existing Asset Test?

11. Would the Income Test be improved by using a different income statement-metric test like gross profit (loss) or operating income (loss) in place of our proposed revenue component? Why or why not? If we eliminated the net income component and replaced it with a gross profit (loss) or operating income (loss) test, how would it apply to tested subsidiaries and registrants that do not report gross profit (loss) or operating income (loss)?

12. We are proposing to simplify the net income component of the Income Test by using after-tax net income and absolute values. Would the proposed revision to use after tax net income and absolute values simplify the determination while still accurately identifying significance? Why or why not? Should we retain use of pre-tax net income? Why or why not?

13. Under our proposal, average income must be used to calculate the income component of the Income Test if the registrant or the tested subsidiary does not have recurring annual revenue and the absolute value of the registrant's income or loss from continuing operations attributable to the controlling interests for the most recent fiscal year is at least 10% lower than the average of the absolute value of such amounts for the registrant for each of its last five fiscal years.

○ Would it be appropriate to require income averaging where the 10% threshold is met and registrants are able to rely on the revenue component? Are there modifications that we should consider to the average income computation? Are there other circumstances where the determination would be more accurate by removing the revenue component or applying income averaging?

○ If the 10% threshold is retained, calculating the average using absolute values may increase the frequency with which the average must be used. Does calculating average income using the absolute value of losses rather than the current practice of assigning a value of zero to those years result in a better indicator of relative significance? Why or why not? Would modifying the existing 10% threshold in Computational Note 2 to Rule 1-02(w) in lieu of our proposal to use absolute values better reflect when an average should be used? If so, what percentage should we use and why? Are there other ways to modify the calculation of average income to be a better indicator of relative significance in the circumstances to which we propose to apply it?

14. Are there other revisions to the Investment Test, Income Test or Asset Test that we should consider?

15. Are there other tests that would be a more appropriate indicator of relative significance? For example, should we add a test based on cash flows from operating, investing or financing activities? Why or why not?

16. The term “significant subsidiary” is defined in Rule 1-02(w) and also in Securities Act Rule 405 and Exchange Act Rule 12b-2. These definitions historically have been generally consistent with the exception of current Computational Note 3 relating to the aggregation of combined entities, which is generally not relevant for purposes of Rule 405 or 12b-2. Is it appropriate to consistently apply the definition of significant subsidiary across these rules while continuing to exclude the language relating to aggregation of combined entities? Would these rules be better implemented if the definitions further diverged? If so, how?

17. Is it clear that “significant subsidiary” determinations should be made using amounts derived from consolidated financial statements of the tested subsidiary and consolidated financial statements of the registrant? Should we revise our rules to more explicitly state that?

18. Should we revise the “significant subsidiary” determination to deem a subsidiary as significant if it is material to the registrant rather than using specific percentage conditions? Why or why not? If we should revise the determination to use a materiality standard, how should that standard be applied? Would a materiality standard yield consistent determinations between registrants? How would a materiality standard impact the disclosure provided and a registrant's ability to timely access capital?

2. Audited Financial Statements for Significant Acquisitions

As noted above, Rule 3-05 Financial Statements may be required for up to three years depending on the relative significance of the acquired or to be acquired business. We propose to revise Rule 3-05 to require up to two years depending on the relative significance. Unlike the historical financial statements of the registrant upon which investors rely to make investment decisions about the registrant, the Rule 3-05 Financial Statements are used, along with pro forma financial information, to discern how the acquired business may affect the registrant. We believe two years of pre-acquisition financial statements, would be sufficient to allow investors to understand the possible effects of the acquired business on the registrant. Relatedly, we are also proposing to require the inclusion of certain forward-looking information in pro forma financial information.

See

the discussion in Section II.D.1. below.

We note that older financial statements, such as the third year of Rule 3-05 Financial Statements, can be less relevant for evaluating an acquisition because, due to their age, they are less likely to be indicative of the current financial condition, changes in financial condition and results of operations of the acquired business.

Pre-acquisition financial statements can also have less utility because they do

not reflect the changes in the acquired business or combined entity that occur post-acquisition or the accounting required by the registrant's comprehensive basis of accounting. Moreover, regardless of the number of years presented, if trends depicted in Rule 3-05 Financial Statements are not indicative or are otherwise incomplete, 17 CFR 210.4-01(a) (“Rule 4-01(a)”) requires that a registrant provide “such further material information as is necessary to make the required statements, in light of the circumstances under which they are made, not misleading.” Further, the requirement to prepare and obtain an audit of the third year of pre-acquisition financial statements can add significant incremental cost and time to the preparation of required disclosure, which is further exacerbated if a change in the acquired business's management or independent auditor has occurred, and may delay a registrant's time to market and access to capital.

In some circumstances, Rule 3-05 Financial Statements can depict a year beginning more than four years before consummation of the acquisition. For example, the third year of Rule 3-05 Financial Statements for a calendar year-end business acquired on February 27, 2018 would be 2014. If the business were acquired at a later date in 2018, the third year of Rule 3-05 Financial Statements would be 2015.

Accordingly, we propose eliminating the requirement to file the third year of Rule 3-05 Financial Statements for an acquisition that exceeds 50% significance.

In response to the 2015 Request for Comment, several commenters recommended eliminating the requirement to provide three years of Rule 3-05 Financial Statements,

while only one recommended retaining the current periods.

See

proposed Rule 3-05(b)(2).

See

letters from BDO, CAQ, Crowe Horwath LLP (Nov. 30, 2015) (“Crowe”), DT, Edison Electric Institute and American Gas Association (Nov. 30, 2015) (“EEI/AGA”), EY, Grant, KPMG, and RSM US LLP (Nov. 30, 2015) (“RSM”).

See

letter from California Public Employees' Retirement System (Nov. 30, 2015) (“CalPERS”).

We also propose to revise Rule 3-05 for acquisitions where a significance test exceeds 20%, but none exceeds 40%, to require financial statements for the “most recent” interim period specified in Rule 3-01 and 3-02 rather than “any” interim period. This proposed revision would eliminate the need to provide a comparative interim period when only one year of audited Rule 3-05 Financial Statements is required. Providing a comparative interim period when there is no requirement for a corresponding comparative annual period may have limited utility for investors and creates an additional burden on registrants to prepare such information. Moreover, we believe that focusing on the most recent interim period would provide the most relevant and material information to investors.

Request for Comment

19. Is our proposal to eliminate the third year of pre-acquisition audited financial statements required for business acquisitions exceeding 50% significance in Rule 3-05(b)(2)(iv) appropriate? Why or why not? Are there other changes that we should consider that would reduce compliance burdens for issuers but continue to provide the material information investors need to make informed investment decisions?

20. Is our proposal to eliminate the comparative interim period when only one year of audited Rule 3-05 Financial Statements is required appropriate? Why or why not? Are there other changes that we should consider?

3. Financial Statements for Net Assets That Constitute a Business

Registrants frequently acquire a component of an entity, such as a product line or a line of business contained in more than one subsidiary of the selling entity, that is a business as defined in Rule 11-01(d) but does not constitute a separate entity, subsidiary, or division. These businesses may not have separate financial statements or maintain separate and distinct accounts necessary to prepare Rule 3-05 Financial Statements because they often represent only a small portion of the selling entity. In these circumstances, making relevant allocations of the selling entity's corporate overhead, interest, and income tax expenses necessary to provide Rule 3-05 Financial Statements for the business may be impracticable.

We propose to permit

registrants to provide audited financial statements of assets acquired and liabilities assumed, and statements of revenues and expenses (exclusive of corporate overhead, interest and income tax expenses)

if:

See

proposed Rule 3-05(e). Our proposal is generally consistent with Commission staff's exercise of delegated authority pursuant to Rule 3-13 of Regulation S-X in these circumstances.

See

also FRM,

supra

note 40, at Section 2065 “

Acquisition of Selected Parts of an Entity may Result in Less than Full Financial Statements.”

The proposed rule clarifies that federal and state income tax may be excluded.

• The business constitutes less than substantially all of the assets and liabilities of the seller and was not a separate entity, subsidiary, segment, or division during the periods for which the acquired business financial statements would be required;

• separate financial statements for the business have not previously been prepared;

• the seller has not maintained the distinct and separate accounts necessary to present financial statements that include the omitted expenses and it is impracticable to prepare such financial statements;

• interest expense may only be excluded from the statements if the debt to which the interest expense relates will not be assumed by the registrant or its subsidiaries consolidated;

• the statements of revenues and expenses do not omit selling, distribution, marketing, general and administrative, and research and development expenses incurred by or on behalf of the acquired business during the periods to be presented; and

• the notes to the financial statements include certain additional disclosures, specifically: The type of omitted expenses and the reasons why they are excluded from the financial statements; information about the business's operating, investing, and financing cash flows, to the extent available; an explanation of the impracticability of preparing financial statements that include the omitted expenses; and a description of how the financial statements presented are not indicative of the financial condition or results of operations of the acquired business going forward because of the omitted expenses.

Recognizing the difficulty registrants face in obtaining and the cost of preparing financial statements that include the expenses proposed to be omitted, we believe permitting registrants to provide abbreviated financial statements as proposed, while requiring the proposed additional disclosures, appropriately balances the cost of preparing financial disclosure with the protection of investors. In response to the 2015 Request for Comment, commenters generally supported permitting the use of abbreviated financial statements without first seeking relief from the Commission.

See, e.g.,

letters from ABA-Committees, BDO, CAQ, Cyprus Energy Partners, L.P. (Nov. 30, 2015), DT, EEI/AGA, EY, Grant, KPMG, and RSM.

Request for Comment

21. Are the proposed conditions for permitting registrants to provide abbreviated financial statements appropriate? Are there other conditions that should be applied or other disclosures that should be required? Are any of the conditions unnecessary or counterproductive?

22. Acquired product lines typically meet the definition of a business, but can have minimal historical balance sheet information associated with them, such as the carrying value of acquired

inventory. Similarly, income statement information beyond revenue and costs of sales may have limited utility when the selling effort relates to a larger product portfolio that includes the acquired product line, rather than the acquired product line itself, and when historical research and development expense is not specific to the acquired product line. In these and similar circumstances, should we permit registrants to provide other information, such as revenue and cost of revenues, in lieu of abbreviated financial statements? Why or why not? Should we require the other information to be audited? Why or why not? Is it practicable to audit the other information? Why or why not? If the other information is unaudited, how would that affect investors and other market participants that use the information? If we should permit other information, what conditions best identify and limit the circumstances when it would be appropriate to permit the other information? If we permit other information, should the 75-day filing period specified in Rule 3-05 for registration statements and proxy statements and in Item 9.01 of Form 8-K apply? Should Article 11 of Regulation S-X pro forma financial information be required?

23. As proposed, statements of revenues and expenses must include selling, distribution, marketing, general and administrative, and research and development expenses incurred to generate the revenue reflected in the statements. Does the proposed requirement provide sufficient clarity regarding the expenses that must be included? Does the proposed requirement provide sufficient clarity regarding the expenses that may be omitted? Why or why not? If not, how can we better make these distinctions?

4. Financial Statements of a Business That Includes Oil and Gas Producing Activities

Rule 3-05 applies to acquisitions of a significant business

that includes oil and gas producing activities.

However, Rule 3-05 does not specify industry-specific disclosures that may be useful to understand such activities. In the absence of specific requirements, registrants generally provide certain industry-specific disclosures specified in FASB ASC Topic 932

Extractive Activities—Oil and Gas

(“ASC 932 Disclosures”)

on an unaudited basis for each full year of operations presented for the acquired business.

See

Rule 11-01(d).

See

the definition of “oil and gas producing activities” at § 210.4-10(a)(16).

See

FASB ASC Topic 932

Extractive Activities—Oil and Gas,

932-235-50-3 through 50-11 and 932-235-50-29 through 50-36, and FRM,

supra

note 40, at Section 2065.12. These supplemental disclosures are required in the financial statements of publicly traded companies with significant oil- and gas- producing activities and provide additional context for those financial statements.

Rule 3-05 also does not specify the form and content of Rule 3-05 Financial Statements when the acquired business generates substantially all of its revenues from oil and gas producing activities. Often, this type of business represents a component of an entity that does not constitute a separate entity, subsidiary, segment, or division for which separate financial statements exist and for which historical depreciation, depletion, and amortization expense is likely not meaningful to an understanding of the potential effects of the acquired business on the registrant.

In these circumstances and when certain additional criteria are met, pursuant to Rule 3-13 and delegated authority, Commission staff has permitted registrants to provide abbreviated financial statements that consist of income statements modified to exclude expenses not comparable to future operations.

Historical depreciation, depletion, and amortization expense is frequently not maintained at the property level and does not reflect the acquiring company's basis in the properties.

See

FRM,

supra

note 40, at Section 2065.6, 2065.11, and 2065.12. Permitting registrants in these circumstances to substitute abbreviated income statements that omit expenses not comparable to future operations is consistent with the financial statement requirements specified in Rule 3-14 for acquired real estate operations. Rule 3-14 specifies that Rule 3-14 Financial Statements must omit depreciation expenses not comparable to future operations.

Proposed Rule 3-05(f) would codify these reporting practices. Specifically, for a significant acquired business that includes

significant oil- and gas-producing activities

(as defined in the FASB ASC Master Glossary), we propose that Rule 3-05 Financial Statements include the ASC 932 Disclosures on an unaudited basis for each full year of operations presented for the acquired business.

Additionally, we propose that the Rule 3-05 Financial Statements may be audited statements of revenues and expenses that exclude depletion, depreciation, and amortization expense, corporate overhead expense, income taxes, and interest expense that are not comparable to the proposed future operations if: (1) Substantially all of the revenues of the business are generated from oil and gas producing activities,

and (2) the conditions of proposed Rule 3-05(e)(1) through (4) and (e)(6) are met.

We believe these conditions would appropriately balance the cost of preparing the disclosure with the protection of investors. We also believe codifying these practices would provide clarity for registrants regarding the application of Commission rules in these circumstances and could facilitate compliance to the benefit of both registrants and investors.

See

ASC 932-235-50-3 through 50-11 and 932-235-50-29 through 50-36, which may be presented as unaudited supplemental information. We are proposing this definition of

significant oil- and gas-producing activities

to be consistent with current practice whereby the FASB's significance threshold is applied in determining whether to present the ASC 932 Disclosures in Rule 3-05 Financial Statements, even if the acquired business is not a publicly-traded company.

Under our proposal, “oil and gas producing activities” would be defined by reference to § 210.4-10(a)(16).

See

discussion in Section II.A.3 above.

Request for Comment

24. Are the proposed conditions for permitting businesses that have oil and gas producing activities to provide abbreviated financial statements and requiring them to provide industry-specific supplemental information appropriate? Are there other conditions that should be applied or other disclosures that should be required?

5. Timing and Terminology of Financial Statement Requirements

We propose revising Rule 3-05 and Article 11 to clarify when financial statements

and pro forma financial information are required, and to update the language to take into account concepts that have developed since adoption of the rules over 30 years ago.

Specifically, the proposed amendments would specify that financial statements are required if a business acquisition has occurred during the most recent fiscal year or subsequent interim period for which a balance sheet is required by 17 CFR 210.3-01 of Regulation S-X (“Rule 3-01”), or if a business acquisition has occurred or is probable after the date that the most recent balance sheet has

been filed.

We also propose to clarify that Rule 3-05 applies when the fair value option is used in lieu of the equity method to account for an acquisition because the disclosure required by U.S. GAAP on a post-acquisition basis, and related requirements in Rules 4-08(g) and 3-09, includes summarized financial information or separate financial statements of the business after the acquisition.

We further propose replacing the term “furnish” with “file” throughout Rule 3-05 and Article 11 to make clear that the information required by Rule 3-05 and Article 11 must be filed with the Commission, as we believe that, at the time of adoption, the use of the term “furnished” in Rule 3-05 and Article 11 was not intended to mean that those disclosures were “not filed.”

In addition, Rule 3-05 requires “financial statements prepared and audited in accordance with this regulation.”

Consistent with current practice, the proposed amendments to Rule 3-05 would clarify that references to “this regulation” include the independence standards in Rule § 210.2-01 unless the business is not a registrant, in which case the applicable independence standards would apply. We are also proposing conforming clarifications in Rule 3-14 and proposed Rule 6-11.

We additionally propose to clarify that “financial statements” need not include related schedules specified in Article 12 (17 CFR 210.12). Item 9.01(a)(2) of Form 8-K already provides that supporting schedules of financial statements need not be filed in these circumstances. The staff further applies this approach to acquired business financial statements required in registration statements and proxy statements.

See

FRM,

supra

note 40, at Section 2005.2.

In addition we are proposing changes to Rule 8-05 for smaller reporting companies to conform with the proposed changes to Article 11.

As discussed in Section II.B.1 below, we are proposing to no longer require Rule 3-05 Financial Statements in Securities Act registration statements and proxy statements once the acquired business is reflected in filed post-acquisition registrant financial statements for a complete fiscal year. In conjunction with that proposal, we are proposing conforming amendments to Rule 3-05(a)(1) to clarify when financial statements are required and to conform the language in those requirements with the current requirements in Rule 11-01(a). Additionally, in conforming Rule 3-05(a)(1) with Rule 11-01(a), we propose to move the explanation that the acquisition of a business encompasses the acquisition of an interest in a business accounted for by the equity method from Rule 3-05(a)(1)(i) to proposed Rule 3-05(a)(2)(ii). Finally, we propose to clarify that a “business” that is a real estate operation is subject to Rule 3-14 instead of Rule 3-05.

See

proposed Rules 3-05(a)(2)(ii) and 3-14(a)(2)(ii).

Throughout Rule 3-05 and Article 11, the regulatory text indicates that financial statements “shall be furnished.”

See

Rule 3-05(a)(1), (b)(1), (b)(2)(i), (b)(2)(ii), (b)(2)(iii), (b)(2)(iv), (b)4)(ii), (b)(4)(iii), Rule 11-01(a) and Instruction 2 to Rule 11-02(b). At the time the Commission adopted Rule 3-05, there was no distinction between “furnished” and “filed.”

See

Rule 3-05 Adopting Release. As Securities Act and Exchange Act rules subsequently began to converge, with documents filed pursuant to the Exchange Act having exposure to Securities Act liability, some disclosure was required or permitted to be furnished but “not filed” for certain purposes. We believe that replacing the use of the term “furnished” with “filed” in the proposed amendment is consistent with the original intent and application of the securities laws.

See

Rule 3-05(a)(1).

See

proposed Rules 3-05(a)(1), 3-14(a)(1), and 6-11(a)(1).

As another clarification, we propose to replace references to “business combination” with the term “business acquisition” to make clear that Rule 3-05 and Article 11 are not limited to “business combinations” as that term is used in U.S. GAAP and IFRS-IASB.

The term “business combination” is defined by reference to the term “business,” which has developed differently under U.S. GAAP and IFRS-IASB from that term as defined in Rule 11-01(d). Because “business acquisition” also encompasses a “combination between entities under common control,” the proposed amendments would also replace this term in Rule 3-05 and Article 11.

See supra

note 10. We similarly propose to replace the term in the Instruction to Item 9.01 of Form 8-K.

Consistent with current practice, the proposed amendments would further provide that a registrant may continue to determine significance using amounts reported in its Form 10-K for the most recent fiscal year when the registrant has filed its Form 10-K after the acquisition consummation date, but before the date the registrant is required to file financial statements of the acquired business on Form 8-K.

We propose to permit rather than require use of the more recent Form 10-K in this circumstance to avoid creating an incentive for registrants to delay the filing of their Form 10-K.

See

proposed Rules 3-05(b)(3) and 11-01(b)(3)(ii). Pursuant to Rule 3-13, registrants have been permitted to omit Rule 3-05 Financial Statements if an acquired business is not significant using these amounts.

Finally, the proposed amendments would replace the term “majority-owned” as used in Item 2.01 of Form 8-K with the term “subsidiaries consolidated,” as that term more accurately conveys which subsidiaries are required to be included in the registrant's financial statements.

We believe these changes would not substantively alter the current Rule 3-05 requirements, but would facilitate compliance by providing clarity, codifying current practice, and updating the terminology used in our rules.

Proposed Rule 3-05 uses the term “subsidiaries consolidated” to conform with the term as it is used elsewhere in Regulation S-X.

See, e.g.,

Rule 1-02(w), Rule 3-01, and Rule 3-02.

Request for Comment

25. We propose to clarify when financial statements and pro forma financial information are required and to update the language used in our rules. Are the proposed clarifications and updates appropriate? Are there further clarifications or other updates we should consider?

26. Is the proposed language related to independence standards sufficiently clear? Should we specify the “applicable independence standards”? If so, how should the “applicable independence standards” be specified? Are there circumstances where there are no “applicable independence standards”? In those circumstances, which independence standards should apply?

6. Foreign Businesses

Regulation S-X permits the use of IFRS-IASB without reconciliation to U.S. GAAP in financial statements of foreign private issuers.

Rule 3-05 similarly permits the use of IFRS-IASB in financial statements of foreign businesses. We are proposing limited modifications to Rule 3-05 to permit Rule 3-05 Financial Statements to be prepared in accordance with IFRS-IASB without reconciliation to U.S. GAAP if the acquired business would qualify to use IFRS-IASB if it were a registrant,

and to permit foreign private issuers that prepare their financial statements using IFRS-IASB to provide Rule 3-05 Financial Statements prepared using home country GAAP to be reconciled to IFRS-IASB rather than U.S. GAAP. In response to the 2015 Request for Comments, commenters generally supported expanding use of IFRS-IASB in financial statements of acquired businesses.

See

17 CFR 210.4-01.

This proposed amendment would be applicable to domestic and foreign registrants.

See, e.g.,

letters from BDO, CalPERS, CAQ, DT, EY, Grant, KPMG, and PwC.

a. Definition

Currently, the definitions of “foreign private issuer”

and “foreign business”

have different ownership requirements such that an acquired business could qualify to be a “foreign private issuer,” but not qualify to be a “foreign business.” For example, an acquired business may be majority-owned by persons who are U.S. citizens or residents and still qualify to be a “foreign private issuer” if it were a registrant and certain additional criteria

were met,

but to qualify as a “foreign business,” it must be majority-owned by persons who are not U.S. citizens or residents. The divergent ownership criteria in the two definitions has created a circumstance where an acquired business that does not meet the definition of foreign business, but would otherwise be permitted to present its financial statements using IFRS-IASB as a foreign private issuer, is not permitted to use financial statements prepared in accordance with IFRS-IASB for its Rule 3-05 Financial Statements even when those financial statements are already available. Instead, the Rule 3-05 Financial Statements must be prepared in accordance with U.S. GAAP,

which can result in a significant cost to the registrant. In circumstances where the acquired business has a sufficient foreign nexus to meet the definition of a foreign private issuer, we believe financial statements prepared in accordance with IFRS-IASB would provide sufficient information for investors.

See

Rule 405. The term “foreign private issuer” means any foreign issuer, other than a foreign government, that does not meet the following criteria as of the last business day of its most recently completed second fiscal quarter: (i) More than 50% of the outstanding voting securities of such issuer are directly or indirectly owned of record by residents of the United States; and (ii) any of the following: (a) The majority of the executive officers or directors are United States citizens or residents; (b) more than 50% of the assets of the issuer are located in the United States; or (c) the business of the issuer is administered principally in the United States.

See

17 CFR 210.1-02(l).

See supra

note 83.

Alternatively, the Rule 3-05 Financial Statements may be prepared in accordance with a basis of accounting other than U.S. GAAP provided a reconciliation to U.S. GAAP under Item 18 of Form 20-F is included.

See Financial Statements of Significant Foreign Equity Investees and Acquired Foreign Businesses of Domestic Issuers and Financial Schedules,

Release No. 33-7118 (Dec. 13, 1994) [59 FR 65632 (Dec. 20, 1994)] (“1994 Acquired Foreign Business Release”).

We therefore propose to revise Rule 3-05 to permit Rule 3-05 Financial Statements to be prepared in accordance with IFRS-IASB without reconciliation to U.S. GAAP

if the acquired business would qualify to use IFRS-IASB if it were a registrant.

In circumstances where the registrant presents its financial statements in U.S. GAAP, the pro forma financial information reflecting the acquisition will continue to be required to be presented in U.S. GAAP.

Under the existing and the proposed rule, acquired foreign business financial statements may use IFRS-IASB without reconciliation to U.S. GAAP, even when the registrant prepares its financial statement using U.S. GAAP.

See

proposed Rule 3-05(d).

b. Reconciliation Requirement

Currently, if Rule 3-05 Financial Statements of a foreign business are prepared on a basis of accounting other than U.S. GAAP or IFRS-IASB, such as home-country GAAP, the Rule 3-05 Financial Statements must be reconciled to U.S. GAAP.

If the registrant in this case were a foreign private issuer that presents its financial statements using IFRS-IASB, this one-time presentation of the U.S. GAAP reconciling information in financial statements of the acquired business would likely be the only required U.S. GAAP information in any of the registrant's filings and could be costly to produce. We believe that Rule 3-05 Financial Statements that include IFRS-IASB reconciling information of the acquired foreign business would provide more comparable information and better facilitate analysis of the financial statements.

See

Item 17 of Form 20-F and 1994 Acquired Foreign Business Release.

We therefore propose to permit foreign private issuers that prepare their financial statements using IFRS-IASB to reconcile Rule 3-05 Financial Statements prepared using home country GAAP to IFRS-IASB rather than U.S. GAAP.

The reconciliation to IFRS-IASB would be required generally to follow the form and content requirements in Item 17(c) of Form 20-F.

See

proposed Rule 3-05(c).

Request for Comment

27. Is the proposed revision to permit in certain circumstances Rule 3-05 Financial Statements to be prepared in accordance with IFRS-IASB without reconciliation to U.S. GAAP appropriate? Are there other requirements that could improve the information to investors?

28. Is the proposed revision to permit foreign private issuers that prepare their financial statements using IFRS-IASB to reconcile acquired foreign business financial statements to IFRS-IASB appropriate? Would continuing to require reconciliation to U.S. GAAP provide better information to investors? Are there other requirements that could improve the information to investors?

7. Smaller Reporting Companies and Issuers Relying on Regulation A

Rule 8-04 provides smaller reporting company disclosure requirements for the financial statements of businesses acquired or to be acquired that substantively differ from the existing requirements in Rule 3-05 in four ways:

• Rule 8-04 permits acquired business financial statements to be prepared in accordance with the form and content required by Article 8, rather than the form and content specified elsewhere in Regulation S-X;

Article 8 allows smaller reporting companies to, among other things, omit certain footnote disclosures that would be required by Article 4. Article 8 also requires fewer line items on the face of interim financial statements.

• Rule 8-04 only requires up to two years of acquired business historical financial statements;

• Rule 8-04 does not explicitly permit the omission of previously filed financial statements once the operating results of the acquired business have been included in the audited consolidated financial statements of the registrant for a complete fiscal year; and

• the ability to exclude from a registration statement separate financial statements of the acquired or to be acquired business in certain circumstances is based on the effective date of the registration statement rather than the date of the relevant final prospectus or prospectus supplement.

In connection with offerings made pursuant to Regulation A,

Part F/S of Form 1-A (“Part F/S”)

directs an entity relying on Regulation A to present financial statements of businesses acquired or to be acquired,

as specified by Rule 8-04, but permits the periods presented to be those applicable to Regulation A issuers rather than the periods specified by Article 8.

17 CFR 230.251 through 263.

17 CFR 239.90.

See

paragraph (b)(7)(iii) of Part F/S.

As mandated by the Economic Growth, Regulatory Relief, and Consumer Protection Act (Pub. L. 115-174, 132 Stat. 1296 (2018)), the Commission in December 2018 revised Rule 251(b) under the Securities Act to permit entities subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act to conduct exempt offerings under Regulation A.

See Amendments to Regulation A,

Release No. 33-10591 (Dec. 19, 2018) [84 FR 520 (Jan. 31, 2019)]. Such reporting companies are required, at a minimum, to comply with the requirements of Part F/S of Form 1-A. However, if at the time a reporting company files a Form 1-A, it has made publicly available more recent audited or reviewed financial statements prepared in accordance with the standard required for the registrant's Exchange Act reports, including such financial statements in the offering statement may be necessary to make the required statements therein, in light of the circumstances under which they are being made, not misleading.

See

17 CFR 230.252.

In order to simplify the application of our rules by focusing registrants on the more detailed and better understood provisions of Rule 3-05, we propose to revise Rule 8-04 to direct registrants to Rule 3-05 for the requirements relating to the financial statements of businesses acquired or to be acquired, other than for form and content requirements for such financial statements, which would continue to be prepared in accordance with Rules 8-02 and 8-03.

Additionally, because Part F/S of Form 1-A refers to Rule 8-04, the proposed revisions to Rule 8-04 would apply to issuers relying on Regulation A. As a result, under the proposed amendments, smaller reporting companies would continue to be required to provide up to two years of acquired business historical financial statements and Regulation A issuers would continue to be permitted to present the periods applicable under Regulation A.

Rule 3-05(b)(1) currently requires financial statements specified in §§ 210.3-01 and 210.3-02 for the business to be acquired. Similarly, Rule 3-05(b)(2) also references §§ 210.3-01 and 210.3-02. Under our proposal, smaller reporting companies would apply § 210.3-05 but would substitute §§ 210.8-02 and 210.8-03, as applicable, wherever § 210.3-05 references §§ 210.3-01 and 210.3-02. In this way, our proposal is intended to apply the election permitted for smaller reporting companies

to prepare their financial statements in accordance with the form and content requirements in Article 8 rather than the other form and content requirements specified elsewhere in Regulation S-X (subject to the exceptions noted in § 210.8-01 Preliminary Note 2 to Article 8) to businesses acquired by smaller reporting companies.

Additionally, in accordance with current practice, the proposed rule would expressly permit smaller reporting companies to omit such financial statements if the acquired business has been included in the registrant's results for a complete fiscal year.

See

further discussion of omission of Rule 3-05 Financial Statements in Section II.B.1 above. We also propose to add references to Rule 8-04 in Rule 3-06 and to Rule 3-06 in Note 6 to Article 8 to expressly permit smaller reporting companies to file financial statements covering a period of nine to 12 months to satisfy the requirement for filing financial statements for a period of one year for an acquired business.

Additionally, under the proposed amendments, a smaller reporting company would be eligible to exclude acquired business financial statements from a registration statement if the business acquisition was consummated no more than 74 days prior to the date of the relevant final prospectus or prospectus supplement, rather than 74 days prior to the effective date of the registration statement as under current Rule 8-04(c)(4).

We believe it is appropriate to consistently look to the date of the final prospectus or prospectus supplement,

as Rule 3-05 currently does, because that date could be later than the effective date, particularly in the case of a delayed offering, which some smaller reporting companies are now permitted to conduct.

100

See

proposed Rule 3-05(b)(4)(i)(B).

See

1996 Streamlining Release,

supra

note 13 (noting that the date of an offering is specified as the date of the final prospectus or prospectus supplement relating to the offering).

100

See

General Instruction I.B.6 of Form S-3 and 2018 SRC Amendments,

supra

note 16.

Request for Comment

29. Would the proposed revisions to Rule 8-04 to direct smaller reporting companies and Regulation A issuers to Rule 3-05 while still permitting them to rely on the form and content requirements in Rules 8-02 and 8-03 simplify the application of our rules by focusing registrants on the more detailed and better understood provisions of Rule 3-05? Are there other changes to the Rule 8-04 requirements that we should consider?

30. For purposes of excluding acquired business financial statements from a registration statement, is the proposed revision to require smaller reporting companies to look to the date of the relevant final prospectus or prospectus supplement instead of the effective date of the registration statement appropriate? Why or why not?

31. Our proposal to no longer require Rule 3-05 Financial Statements once the operating results of the acquired business have been included in the audited consolidated financial statements of the registrant for a complete fiscal year (

see

Section II.B.1 above) would also apply to smaller reporting companies pursuant to our proposed revisions to Rule 8-04. Is permitting smaller reporting companies to omit financial statements under these circumstances appropriate? Are there specific revisions or information requirements we should consider for smaller reporting companies?

32. Should the proposed changes to Rule 8-04 apply to offerings made pursuant to Regulation A? Should we revise the proposals to better accommodate Regulation A issuers and investors? If so, what revisions should we make and why?

B. Proposed Amendments Relating to Rule 3-05 Financial Statements Included in Registration Statements and Proxy Statements

1. Omission of Rule 3-05 Financial Statements for Businesses That Have Been Included in the Registrant's Financial Statements

Overview of the Application of the Current Rule

Current Rule 3-05(b)(4)(iii) generally permits Rule 3-05 Financial Statements to be omitted once the operating results of the acquired business have been reflected in the audited consolidated financial statements of the registrant for a complete fiscal year. However, Rule 3-05 Financial Statements are required to be included when they have not been previously filed or when the Rule 3-05 Financial Statements have been previously filed, but the acquired business is of major significance to the registrant.

Rule 3-05 Financial Statements Not Previously Filed

If Rule 3-05 Financial Statements have not been previously filed, they must be provided even if the acquired business is included in post-acquisition audited results. Thus, a registrant that acquired a significant business during the earliest of the three years for which it presents financial statements, and has reported the combined results in audited financial statements since the acquisition, would still be required to file separate Rule 3-05 Financial Statements for that acquired business if the Rule 3-05 Financial Statements have not been previously filed.

101

The staff has historically not objected, however, to registrants reducing the Rule 3-05 Financial Statement periods presented by the equivalent period that the acquired business is included in the registrant's post-acquisition audited results.

102

101

This issue arises most often for initial registration statements under the Securities Act and Exchange Act since an existing Exchange Act reporting company would generally have been required to file Rule 3-05 Financial Statements on a Form 8-K within approximately 75 days after acquisition of a significant business.

102

This is limited to circumstances where there is no gap between the latest date of the pre-acquisition audited financial statements of the acquired business and the earliest date of the registrant's audited post-acquisition results.

See

FRM,

supra

note 40, at Section 2030.4 “

Initial Registration Statements—Using Pre-Acquisition and Post-Acquisition Audited Results.”

Rule 3-05 Financial Statements Previously Filed for an Acquisition That Was of Major Significance

Under current Rule 3-05(b)(4)(iii), registrants must also continue to present Rule 3-05 Financial Statements that have been previously filed if the acquired business is of such significance to the registrant that omission of those Rule 3-05 Financial Statements would materially impair an investor's ability to understand the historical financial results of the registrant. Rule 3-05 provides as an example that an acquired business that met at least one of the significance tests at the 80% level at the date of the acquisition would require the registrant to continue to file the financial statements of the acquired business for such periods prior to the purchase as may be necessary when added to the time for which audited income statements after the purchase are filed to cover the equivalent of the period specified in Rule 3-02.

103

Notwithstanding the rule's reference to materiality, in practice the rule is

typically applied, consistent with this example, on the basis of quantitative significance determinations.

104

The result of the practical application of the “major significance” exception is that, for example, if an acquisition that occurred two years ago was significant at the 80% level at the time of the acquisition, one year of previously filed Rule 3-05 Financial Statements will continue to be provided regardless of whether post-acquisition activities have diminished the relative significance of the acquired business.

103

See

Rule 3-05(b)(4)(iii). Rule 3-02 states that there shall be filed, for the registrant and its subsidiaries consolidated and for its predecessors, audited statements of income and cash flows for each of the three fiscal years preceding the date of the most recent audited balance sheet being filed or such shorter period as the registrant (including predecessors) has been in existence. An emerging growth company may provide audited statements of income and cash flows for each of the two fiscal years preceding the date of the most recent audited balance sheet (or such shorter period as the registrant has been in existence) in its initial registration statement.

104

See, e.g.,

FRM,

supra

note 40, at Section 2040.2 “

Major Significance” and “Previously Filed Acquiree Financial Statements.”

Proposed Amendments Regarding the Omission of Rule 3-05 Financial Statements

We are proposing to no longer require Rule 3-05 Financial Statements in registration statements and proxy statements once the acquired business is reflected in filed post-acquisition registrant financial statements for a complete fiscal year.

105

This change would eliminate the requirement that Rule 3-05 Financial Statements be provided when they have not been previously filed or when they have been previously filed but the acquired business is of major significance.

105

The proposed amendments would require inclusion in all twelve months of the registrant's most recently completed audited fiscal year. They do not permit reducing the twelve month period through analogy to Rule 3-06 or by the number of months of pre-acquisition historical financial statements that may be provided.

The “not previously filed” exception requires those registrants filing initial registration statements to test the significance of acquisitions that occurred during the earliest years for which the registrant is required to provide its historical financial statements and, if significant, to provide pre-acquisition financial statements of the acquired business. This requirement can delay a registrant's offering and thereby its access to capital while providing information that is often less meaningful to investors because the utility of pre-acquisition periods diminishes over time after the acquired business is reflected in post-acquisition results and the post-acquisition results of the combined business are generally not comparable to the pre-acquisition results of the acquired business.

106

See

FRM,

supra

note 40, at Section 2030.4. The accommodation currently provided by Commission staff does not sufficiently ameliorate these effects and often results in financial statements of the acquired business for a pre-acquisition stub period ending at a date during a fiscal period such that the financial statements depict partial, rather than complete, reporting periods that do not coincide with the end of either the acquired business's or the registrant's fiscal periods. Moreover, because these are staff accommodations, they lack the legal significance of a Commission rule.

We also propose to eliminate the “major significance” exception. As with not previously filed information, the utility of pre-acquisition periods diminishes over time after the acquired business is reflected in post-acquisition results. We further observe that the “major significance” exception was established prior to requirements for electronic filing, which has made previously filed financial information about the acquired business more readily accessible through the Commission's EDGAR filing system. Consequently, we believe this exception is no longer necessary.

We believe inclusion of post-acquisition results in the registrant's audited financial statements for a complete fiscal year should generally provide investors with sufficient information to make informed investment decisions about the registrant.

107

The requirement for management to prepare Rule 3-05 Financial Statements and a third party to audit those financial statements can be costly and adds preparation time for the financial statements, which can affect a registrant's time to market and delay its access to capital. Where the significant acquisition will have occurred over a year before, and information about the acquired business that is material to the registrant would generally have been incorporated into the registrant's audited historical financial statements for a complete fiscal year or otherwise provided pursuant to the requirements of 17 CFR 210.4-01(a) and 17 CFR 229.303, we do not believe it is necessary to require registrants to provide Rule 3-05 Financial Statements.

107

Further, even without the major significance requirement to include some, but not all, of the previously filed pre-acquisition financial statements of the acquired business, Regulation S-X provides that a registrant shall provide “such further material information as is necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”

See

17 CFR 210.4-01(a).

Request for Comment

33. Is our proposal to no longer require Rule 3-05 Financial Statements once the acquired business is reflected in filed post-acquisition audited consolidated financial statements of the registrant for a complete fiscal year appropriate? Would the proposed revisions simplify the application of the rule and reduce costs for registrants?

34. Would the proposed amendments affect the sufficiency of information available to investors? If so, should we continue to require Rule 3-05 Financial Statements if they have not been previously filed or if the acquisition was of major significance? Alternatively, what information about an acquired business is most important to investors once the acquired business has been depicted in the registrant's post-acquisition audited consolidated financial statements for a complete fiscal year that is not otherwise provided pursuant to existing requirements, like those for management's discussion and analysis, and what changes could we make to ensure that investors receive such information while reducing the burden on registrants of preparing unnecessary disclosure?

2. Use of Pro Forma Financial Information To Measure Significance

Significance determinations are required to be made by comparing the most recent annual consolidated financial statements of the acquired business to those of the registrant filed at or prior to the date of acquisition. A registrant is permitted to use pro forma, rather than historical, financial information if the registrant made a significant acquisition subsequent to the latest fiscal year-end and filed its Rule 3-05 Financial Statements and pro forma financial information on Form 8-K.

108

There is no analogous provision in Rule 3-05 for registrants to use pro forma financial information depicting significant dispositions or for registrants filing initial registration statements. In considering whether, pursuant to Rule 3-13 and delegated authority, to permit omission or substitution of acquired business financial statements in initial registration statements of registrants growing through acquisition, Commission staff has considered the results of significance tests using pro forma financial information.

109

In response to the 2015 Request for Comment, some commenters

recommended establishing requirements to determine significance in these circumstances in a manner that reduces complexity and provides financial statements that are meaningful to investors.

110

108

17 CFR 210.3-05(b)(3).

109

See supra

note 43.