A company that is classified as an accelerated or large accelerated filer is subject to, among other things, the requirement that its outside auditor attest to, and report on, management’s assessment of the effectiveness of the issuer’s internal control over financial reporting (ICFR) as required by Section 404(b) of the Sarbanes-Oxley Act (SOX). The JOBS Act exempted emerging growth companies (EGCs) from this requirement. Moreover, historically the definition of a smaller reporting company (SRC) was set such that an SRC could never be an accelerated or large accelerated filer, and as such would never be subject to Section 404(b) of SOX.
In June 2018, the SEC amended the definition of an SRC to include companies with less than a $250 million public float (increased from $75 million) or if a company does not have an ascertainable public float or has a public float of less than $700 million, an SRC is one with less than $100 million in annual revenues during its most recently completed fiscal year (see HERE). At that time the SEC did not amend the definitions of an accelerated filer or large accelerated filer. As a result, companies with $75 million or more of public float that qualify as SRC’s 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 SOX.
Under the new rules, smaller reporting companies with less than $100 million in revenues are not required to obtain an attestation of their internal controls over financial reporting (ICFR) from an independent outside auditor under Section 404(b) of SOX. In particular, the amendments exclude from the accelerated and large accelerated filer definitions a company that is eligible to be an SRC and that had no revenues or annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available.
All Exchange Act reporting companies, whether an SRC or accelerated filer, will continue to be required to comply with SOX Rule 404(a) requiring the company to establish and maintain ICFR and disclosure control and procedures and have their management assess the effectiveness of each. This management assessment is contained in the body of all quarterly and annual reports and amended reports and in separate certifications by the company’s principal executive officer and the principal financial officer.
The new rules also 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 rules will assist with capital formation for smaller companies and reduce compliance burdens while maintaining investor protections. The SEC also hopes that the amendments will catch the attention of companies that have delayed going public in recent years and as such, may help stimulate entry into the U.S. capital markets.
In the press release announcing the rule change, Chair Jay Clayton stated: “[T]he JOBS Act provided a well-reasoned exemption from the ICFR attestation requirement for emerging growth companies during the first five years after an IPO. These amendments would allow smaller reporting companies that have made it to that five-year point, but have not yet reached $100 million in revenues, to continue to benefit from that exemption as they build their businesses, while still subjecting those companies to important investor protection 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”) has been prolific 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.
The SEC disclosure requirements are scaled based on company size. The SEC categorized companies as non-accelerated, accelerated and large accelerated in 2002 and 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 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.
Detail on 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 has now amended the accelerated and large accelerated filer definitions in Exchange Act Rule 12b-2 to exclude any company that is eligible to be an SRC and that had annual revenues of less than $100 million during its most recently completed fiscal year for which audited financial statements are available. The effect of this change is that such a company will not be subject to accelerated or large accelerated filing deadlines for its annual and quarterly reports or to the ICFR auditor attestation requirement under SOX Section 404(b).
The rule change does 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 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 amendments:
|Relationships between SRC’s and Non-Accelerated and Accelerated Filers|
|Status||Non-Affiliated Public Float||Annual Revenues|
|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|
|Large Accelerated Filer (not SRC)||Over $700 million||N/A|
The amendments also revise the public float transition threshold for accelerated and large accelerated filers to become a non-accelerated filer from $50 million to $60 million and 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 amendments 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 amendments on transition provisions:
|Amendments to the Non-Affiliate 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|
Determining Non-Affiliated Public Float
To determine the value of the public float, a company must multiply the aggregate worldwide number of shares of common equity held by non-affiliates by the price at which it was last sold, or the average of the bid and asked prices, in the principal trading market. Derivative securities such as options, warrants and other convertible or non-vested securities are not included in the calculation. An “affiliate” of, or a person “affiliated” with, a company, is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the company. The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a company, whether through the ownership of voting securities, by contract, or otherwise.
From a top line, directors, executive officers and their spouses and relatives living with them are always considered affiliates as are trusts and corporations of which that director, executive officer or their spouses control in excess of 10%. There is a rebuttable presumption that 10% or greater stockholders are affiliates. Beyond that, the SEC has consistently refused to provide definitive guidance on the matter, rather requiring companies and their management to make an analysis based on their individual facts and circumstances.
Through various guidance, including comment letters and SEC enforcement actions, important facts to consider in determining control/affiliate status include:
- Distribution of voting shares among all stockholders – Consider whether a stockholder has a large percentage of the company’s voting stock as compared to all other stockholders;
- Impact of possible resale – if a particular larger shareholder threatens to sell their stock into the market unless management takes certain actions, and management believes that such sale would have a material negative impact on the stock price, that person could be considered to have control;
- Influence of a stockholder – a particular stockholder could have influence because of their general position or power over other stockholders – this could be because of a direct or indirect relationship with other stockholders or because of the person’s reputation as a whole. For example, certain activist shareholders such as Carl Icahn can exert control over management of companies in which they invest;
- Voting agreements – if a person has the right to vote on behalf of other people’s shares, they may have control;
- Contractual arrangements – any other contract that gives a person the right to assert control over management decisions.