On June 27, 2016, the SEC published proposed amendments to the definition of “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K. The amendments would expand the number of companies that qualify as a smaller reporting company and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The rule change follows the SEC concept release and request for public comment on sweeping changes to the business and financial disclosure requirements in Regulation S-K. Throughout the SEC Concept Release, it referenced the scaled and different disclosure requirements for the different categories of company and affirmed that it was evaluating and considering changes to the eligibility criteria for each.
If the rule change is passed, the number of companies qualifying as a smaller reporting company will increase from 32% to 42% of all reporting companies.
The proposed rule change follows the SEC Advisory Committee on Small and Emerging Companies recommendations to the SEC on the point. In particular, the SEC proposes to amend the definition of a smaller reporting company to include companies with less than a $250 million public float as compared to the $75 million threshold in the current definition. In addition, if a company does not have an ascertainable public float, a smaller reporting company would be one with less than $100 million in annual revenues, as compared to the current threshold of less than $50 million. Once considered a smaller reporting company, a company would maintain that status unless its float drops below $200 million or its annual revenues below $80 million.
In addition, the SEC proposes to change the definition of “accelerated filer” and “large accelerated filer” to eliminate an exclusion from such definitions for smaller reporting companies. That is, the SEC specifically chose not to increase the $75 million threshold in the “accelerated filer” definition. Accordingly, companies with $75 million or more in public float would still be subject to the accelerated filer rules, including shorter periods in which to file its periodic reports and the requirement to provide auditor attestation over internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002.
In its press release accompanying the proposed rule changes, SEC Chair Mary Jo White was quoted as saying, “[R]aising the financial thresholds in the smaller reporting company definition is intended to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections. The Commission will benefit greatly from the public comments we receive from investors, issuers and other affected market participants on today’s proposal, as well as comments we receive on the Regulation S-K concept release, which will help inform any changes to the scaled disclosure system or other changes to our disclosure requirements.”
The topic of disclosure requirements under Regulation S-K as pertains to disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) have come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Exchange Act must file reports with the SEC (“Reporting Requirements”). The underlying basis of the Reporting Requirements is to keep shareholders and the markets informed on a regular basis in a transparent manner.
The SEC disclosure requirements are scaled based on company size. The SEC established the smaller reporting company category in 2007 to provide general regulatory relief to these entities. A “smaller reporting company” is currently defined in Securities Act rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K, as one that: (i) has a public float of less than $75 million as of the last day of their most recently completed second fiscal quarter; or (ii) a zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.
The following table, copied from the SEC rule release, summarizes the scaled disclosure accommodations available to smaller reporting companies:
|Item||Scaled Disclosure Accommodation|
|101 − Description of Business||May satisfy disclosure obligations by describing the development of its business during the last three years rather than five years. Business development description requirements are less detailed than disclosure requirements for non- smaller reporting companies.|
|201 − Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters||Stock performance graph not required.|
|301 – Selected Financial Data||Not required.|
|302 – Supplementary Financial Information||Not required.|
|303 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)||Two-year MD&A comparison rather than three-year comparison.
Two year discussion of impact of inflation and changes in prices rather than three years.
Tabular disclosure of contractual obligations not required.
|305 – Quantitative and Qualitative Disclosures About Market Risk||Not required.|
|402 – Executive Compensation||Three named executive officers rather than five.
Two years of summary compensation table information rather than three. Not required:
|Item||Scaled Disclosure Accommodation|
|404 – Transactions With Related Persons, Promoters and Certain Control Persons||Description of policies/procedures for the review, approval or ratification of related party transactions not required.|
|407 – Corporate Governance||Audit committee financial expert disclosure not required in first year.
Compensation committee interlocks and insider participation disclosure not required.
Compensation committee report not required.
|503 – Prospectus Summary, Risk Factors and Ratio of Earnings to Fixed Charges||No ratio of earnings to fixed charges disclosure required. No risk factors required in Exchange Act filings.|
|601 – Exhibits||Statements regarding computation of ratios not required.|
|8-02 – Annual Financial Statements||Two years of income statements rather than three years. Two years of cash flow statements rather than three years.
Two years of changes in stockholders’ equity statements rather than three years.
|8-03 – Interim Financial Statements||Permits certain historical financial data in lieu of separate historical financial statements of equity investees.|
|8-04 – Financial Statements of Businesses Acquired or to Be Acquired||Maximum of two years of acquiree financial statements rather than three years.|
|8-05 – Pro forma Financial Information||Fewer circumstances under which pro forma financial statements are required.|
|8-06 – Real Estate Operations Acquired or to Be Acquired||Maximum of two years of financial statements for acquisition of properties from related parties rather than three years.|
|8-08 – Age of Financial Statements||Less stringent age of financial statements requirements.|
Proposed Amendments to Smaller Reporting Company Definition
The SEC has competing goals of protecting investors and the marketplace through requiring companies to provide disclosure needed to make informed investment and voting decisions and promoting capital formation and reducing compliance costs for smaller companies. The SEC believes that by raising the financial thresholds for the smaller reporting company definition and thereby expanding the number of companies eligible to use the available scaled disclosure, it will be satisfying its goals and appropriately responding to comments and recommendations by the Advisory Committee on Small and Emerging Growth Companies, the SEC Government Business Forum on Small Business Capital Formation, Congress and industry commenters.
The SEC summarizes many of these recommendations, initiatives and comments in its rule release. For example, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For a summary of the recommendations, see my blog HERE. The FAST Act, which was passed into law on December 4, 2015, required the SEC to scale or eliminate duplicative, antiquated or unnecessary disclosure requirements for emerging growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K.
The SEC also considered comments it received in response to the recently published concept release and request for public comment on Regulation S-K. My two-part blog on that concept release can be read HERE and HERE.
The SEC proposes to amend the definition of a smaller reporting company to include companies with less than a $250 million public float, as compared to the $75 million threshold in the current definition. As it is currently, determination of qualification will be made by calculating the public float as of the last business day of the company’s most recently completed second fiscal quarter. A company filing an initial registration statement under either the Exchange or Securities Act would calculate its public float as of a date within 30 days of filing the registration statement.
In addition, if a company has a public float of zero, a smaller reporting company would be one with less than $100 million in annual revenues during its most recently completed fiscal year, as compared to the current threshold of less than $50 million. Once considered a smaller reporting company, a company would maintain that status unless its public float drops below $200 million as of the last day of its most recently completed second fiscal quarter or its annual revenues drop below $80 million during its most recent fiscal year.
My blog HERE contains a summary of the scaled disclosures available to smaller reporting companies. In addition, the FAST Act, passed into law on December 4, 2015, amended Form S-1 to allow for forward incorporation by reference by smaller reporting companies. A smaller reporting company may now incorporate any documents filed by the company, following the effective date of a registration statement, into such effective registration statement. In what was probably unintended in the drafting, the FAST Act changes only include smaller reporting companies and not emerging growth companies or non-accelerated filers. Other categories of filers, including accelerated and large accelerated filers, were already allowed to forward incorporate by reference. Accordingly, among the other benefits of the current proposed rule change, the number of companies that can utilize forward incorporation by reference in a Form S-1 will increase.
Proposed Amendments to Accelerated Filer and Large Accelerated Filer Definitions
The rule release specifically declines to amend the public float threshold qualifications for “accelerated filer” and “large accelerated filer,” but does amend the respective definitions to eliminate the current exclusion for smaller reporting companies. As a result, companies with $75 million or more in public float would still be subject to the accelerated filer rules, including shorter periods in which to file their periodic reports and the requirement to provide auditor attestation over internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002.
The public float threshold for an accelerated filer is $75 million. Companies that currently file as an accelerated filer would continue to do so under the new rules, but would be able to benefit from the scaled disclosure requirements available to smaller reporting companies. The public float threshold for large accelerated filers is $700 million and accordingly, there would never be a time when a smaller reporting company would also be a large accelerated filer; however, the SEC proposes to amend the definition of large accelerated filer to eliminate the exclusion for smaller reporting companies to avoid confusion and maintain consistency in the wording of the rules.
The filing deadlines for each category of filer are:
|Filer Category||Form 10-K||Form 10-Q|
|Large Accelerated Filer||60 days after fiscal year-end||40 days after quarter-end|
|Accelerated Filer||75 days after fiscal year-end||40 days after quarter-end|
|Non-Accelerated Filer||90 days after fiscal year-end||45 days after quarter-end|
|Smaller Reporting Company||90 days after fiscal year-end||45 days after quarter-end|
However, the SEC specifically chose not to increase the $75 million threshold in the “accelerated filer” definition. Accordingly, companies with $75 million or more in public float would still be subject to the accelerated filer rules, including shorter periods in which to file their periodic reports and the requirement to provide auditor attestation over internal controls under Section 404(b) of the Sarbanes-Oxley Act of 2002 (“SOX”).
In its rule release, the SEC specifically makes the determination that the benefit of excluding companies with a public float between $75 million and $250 million from the Section 404(b) auditor attestation requirements under SOX, would not justify the loss of investor protections. The SEC found that companies with the 404(b) auditor attestation also have a lower restatement rate than other filers. The Section 404(b) auditor attestation requirements require significant added expense and burden to public companies, and I am disappointed that the SEC has chosen not to continue to exclude smaller reporting companies, even with the higher qualification thresholds.
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