SEC Proposes Amendments to Accelerated and Large Accelerated Filer Definitions
As promised by SEC Chair Jay Clayton almost a year ago when the SEC amended the definition of a “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K (see HERE ), on May 9, 2019, the SEC proposed amendments to the definitions of an “accelerated filer” and “large accelerated filer.”
In June 2018, the SEC amended the definition of a smaller reporting company (SRC) to include companies with less than a $250 million public float or if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC is one with less than $100 million in annual revenues during its most recently completed fiscal year. At that time the SEC did not amend the definitions an accelerated filer or large accelerated filer. As a result, companies with $75 million or more of public float that qualify as SRCs remained subject to the requirements that apply to accelerated filers or large accelerated filers, including the accelerated timing of the filing of periodic reports and the requirement that these accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act (SOX).
Under the proposed amendments, smaller reporting companies with less than $100 million in revenues would not be required to obtain an attestation of their internal control over financial reporting (ICFR) from an independent outside auditor under Section 404 of SOX. In particular, the proposed amendments would exclude from the accelerated and large accelerated filer definitions a company that is eligible to be an SRC and had no revenues or annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available.
The proposed amendments also would increase the transition thresholds for accelerated and large accelerated filers becoming a non-accelerated filer from $50 million to $60 million and for exiting large accelerated filer status from $500 million to $560 million and add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status.
Like the change to the definition of an SRC, it is thought the new proposed amendments will assist with capital formation for smaller companies. The SEC also notes that the proposed amendments are targeted at companies that have delayed going public in recent years and as such, may help stimulate entry into the U.S. capital markets. Making a reference to a statement by SEC Commissioner Hester Peirce at the time of the amendment to the definition of an SRC expressing her disappointment that the definition of accelerated filer and large accelerated filer were not concurrently changed, in the press release announcing the new proposed rule changes Chair Clayton points out, “[I]nvestors in these lower-revenue companies will benefit from more tailored control requirements. Many of these smaller companies – including biotech and health care companies – will be able to redirect the savings into growing their companies by investing in research and human capital.”
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”) has been fairly constant over the past few years with a slew of rule changes and proposed rule changes. 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 categorized companies as non-accelerated, accelerated and large accelerated in 2002 and the introduced the smaller reporting company category in 2007 to provide general regulatory relief to these entities. The only difference between the requirements for accelerated and large accelerated filers is that large accelerated filers are subject to a filing deadline for their annual reports on Form 10-K that is 15 days shorter than the deadline for accelerated filers.
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|
Significantly, both accelerated filers and large accelerated filers are required to have an independent auditor attest to and report on management’s assessment of internal control over financial reporting in compliance with Section 404(b) of SOX. Non-accelerated filers are not subject to Section 404(b) requirements. Under Section 404(a) of SOX, all companies subject to SEC Reporting Requirements, regardless of size or classification, must establish and maintain internal controls over financial reporting (ICFR), have management assess such ICFR, and file CEO and CFO certifications regarding such assessment (see HERE).
An ICFR system must be sufficient to provide reasonable assurances that transactions are executed in accordance with management’s general or specific authorization and recorded as necessary to permit preparation of financial statements in conformity with US GAAP or International Financial Reporting Standards (IFRS) and to maintain accountability for assets. Access to assets must only be had in accordance with management’s instructions or authorization and recorded accountability for assets must be compared with the existing assets at reasonable intervals and appropriate action be taken with respect to any differences. These requirements apply to any and all companies subject to the SEC Reporting Requirements.
Likewise, all companies subject to the SEC Reporting Requirements are required to provide CEO and CFO certifications with all forms 10-Q and 10-K certifying that such person is responsible for establishing and maintaining ICFR, have designed ICFR to ensure material information relating to the company and its subsidiaries is made known to such officers by others within those entities, and evaluated and reported on the effectiveness of the company’s ICFR.
Furthermore, auditors review ICFR even where companies are not subject to 404(b). Audit risk assessment standards allow an auditor to rely on internal controls to reduce substantive testing in the financial statement audit. A necessary precondition is testing such controls. Also, an auditor must test the controls related to each relevant financial statement assertion for which substantive procedures alone cannot provide sufficient appropriate audit evidence. Naturally, a lower revenue company has less risk of improper revenue recognition and likely less complex financial systems and controls. In any event, in my experience auditors not only test ICFR but make substantive comments and recommendations to management in the process.
The Section 404(b) independent auditor attestation requirements are considerably more cumbersome and expensive for a company to comply with. In addition to the company requirement, Section 404(b) requires the company’s independent auditor to effectively audit the ICFR and management’s assessment. The auditor’s report must contain specific information about this assessment (see HERE). As all reporting companies are aware, audit costs are significant and that is no less true for this additional audit layer. In fact, companies generally find Section 404(b) the most costly aspect of the SEC Reporting Requirements. Where a company has low revenues, the requirement can essentially be prohibitive to successful implementation of a business plan, especially for emerging and growing biotechnology companies that are almost always pre-revenue but have significant capital needs.
The SEC has come to the conclusion that the added benefits from 404(b) are outweighed by the additional costs and burdens for SRC’s and now lower revenue companies. I am a strong proponent of supporting capital markets for smaller companies, such as those with less than a $700 million market cap and less than $100 million in revenues. I hope the proposed rule changes move quickly through the system.
Detail on Proposed Amendments to Accelerated Filer and Large Accelerated Filer Definitions
Prior to the June 2018 SRC amendments, the SRC category of filers generally did not overlap with either the accelerated or large accelerated filer categories. However, following the amendment, a company with a public float of $75 million or more but less than $250 million regardless of revenue, or one with less than $100 million in annual revenues and a public float of $250 million or more but less than $700 million would be both an SRC and an accelerated filer.
The SEC is proposing to amend the accelerated and large accelerated filer definitions in Exchange Act Rule 12b-2 to exclude any company that is eligible to be an SRC under the SRC revenue test – i.e., one with less than $100 million in annual revenues during its most recently completed fiscal year. The effect of this proposal would be that such a company would not be subject to accelerated or large accelerated filing deadlines for its annual and quarterly reports or to the ICFR auditor attestation requirement.
The proposed rule change would not exclude all SRC’s from the definition of accelerated or large accelerated filers and as such, some companies that qualify as an SRC would still be subject to the shorter filing deadlines and Section 404(b) compliance. In particular, an SRC with a float of greater than $75 million but less than $700 million and less than $100 million in revenue would no longer qualify as either an accelerated or large accelerated filer. On the contrary, an SRC with greater than $75 million in public float and greater than $100 million in revenue will still be categorized as an accelerated filer.
The chart below illustrates the effect of the proposed amendments:
|Proposed Relationships between SRCs and Non-Accelerated and Accelerated Filers|
|Status||Public Float||Annual Revenue|
|SRC and Non-Accelerated Filer||Less than $75 million||N/A|
|$75 million to less than $700 million||Less than $100 million|
|SRC and Accelerated Filer||$75 million to less than $250 million||$100 million or more|
|Accelerated Filer (not SRC)||$250 million to less than $700 million||$100 million or more|
The proposed amendments would revise the public float transition threshold for accelerated and large accelerated filers to become a non-accelerated filer from $50 million to $60 million. Also, the proposed amendments would increase the exit threshold in the large accelerated filer transition provision from $500 million to $560 million in public float to align the SRC and large accelerated filer transition thresholds. Finally, the proposed amendments would allow an accelerated or a large accelerated filer to become a non-accelerated filer if it becomes eligible to be an SRC under the SRC revenue test.
The chart below illustrates the effect of the proposed amendments on transition provisions:
|Proposed Amendments to the Public Float Thresholds|
|Initial Public Float Determination||Resulting Filer Status||Subsequent Public Float Determination||Resulting Filer Status|
|$700 million or more||Large Accelerated Filer||$560 million or more||Large Accelerated Filer|
|Less than $560 million but$60 million or more||Accelerated Filer|
|Less than $60 million||Non-Accelerated Filer|
|Less than $700 million but $75 million or more||Accelerated Filer||Less than $700 million but$60 million or more||Accelerated Filer|
|Less than $60 million||Non-Accelerated Filer|
Statements of Commissioners on Rule Amendment
SEC Chairman Jay Clayton and Commissioners Jackson, Peirce and Roisman all made statements on the proposed rule changes at an open meeting related to the amendment. Chair Clayton’s speech focuses on the fact that most aspects of ICFR remain unchanged as do the heightened requirements that SOX imposed generally. However, the proposed rules “are aimed at the subset of issuers where the added step of an ICFR auditor attestation is likely to add significant costs and is unlikely to enhance financial reporting or investor protection.” Of course, he is hopeful the change will encourage more companies to access public markets.
Commissioner Hester Peirce (may favorite Commissioner) is true to form, supporting the proposed amendments but wishing they had gone further. As she did when the SEC amended the definition of an SRC, Commissioner Peirce criticizes the fact that there now can be overlap between an SRC and accelerated or large accelerated filer, which can cause confusion. As Commissioner Peirce notes, “[T]he process of determining whether a company is an SRC and a non-accelerated filer, or an SRC and an accelerated filer, or outside of both categories is so complicated that even we at the SEC need diagrams to figure it out. The fact that we ourselves struggling to understand our own regime does not bode well for smaller companies trying to follow our rules without the benefit of a staff of seasoned securities attorneys.” The quote hit home; in writing my blog on the SRC rule change and now this rule change, I started creating a diagram for myself until I found that the SEC had published one as well – it was the only way to follow and understand the interactions. Commissioner Peirce would advocate for a fine line whereby all SRC’s would be non-accelerated filers and exempt from Section 404(b). I agree.
Commissioner Roisman supported the proposed rule changes and, like Commissioner Peirce, wondered whether it went far enough.
Commissioner Jackson, also true to form, does not support the proposed amendment at all as he believes that the risk of corporate management fraud is too high to allow the change. Commissioner Jackson uses WorldCom and Enron as his primary example of management without auditor oversight; however, I note that these companies were behemoths compared to the sector of business affected by the current proposal. Commissioner Jackson also questions the data and analysis used by the SEC to support the proposed amendments and instead gathered his own data. Unfortunately, there is often a disconnect between statistical data and real-world applications and as such, my views remain aligned with Commissioner Peirce.