As part of its overall initiative to improve and streamline disclosure, the U.S. Securities and Exchange Commission recently proposed amendments to the requirements of Regulation S-X for financial statements relating to acquisitions and dispositions of businesses, including the requirements to disclose “target company” financial statements and pro forma financial statements reflecting the transaction. The SEC proposal will be subject to a 60-day public comment period following its publication in the Federal Register, with comments due likely by mid-July.
The proposed changes to the rules would, among other things:
- revise the “investment test” and “income test” used to determine the “significance” of an acquisition or disposition and expand the use of pro forma financial information in measuring significance;
- shorten the maximum period for which historical financial statements for an acquired business are required from three fiscal years to two fiscal years (in addition to any interim period disclosure);
- eliminate any requirement for financial statements of an acquired business once the results of the acquired business have been reflected in the acquiring company’s financial statements for a complete fiscal year, regardless of the significance of the acquisition;
- reduce the disclosure requirements for individually insignificant acquisitions;
- increase the significance threshold for dispositions from 10% to 20%, to conform with the minimum significance threshold for acquisitions, and to otherwise conform the disposition tests with the acquisition tests;
- align the target company financial statement rules for real estate companies with the general target company financial statement rules, where no unique industry considerations exist;
- formally codify existing practices relating to aspects of target company financial statements that are unique to oil and gas acquisitions;
- permit the use in certain circumstances of, or reconciliation to, International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB); and
- amend the pro forma financial information requirements to permit, in addition to customary transaction adjustments, “management adjustments” reflecting reasonably estimable synergies and efficiencies resulting from the transaction.
All of these proposed changes are welcome and, in our view, would move the relevant U.S. disclosure requirements toward a more principles-based regime. In particular, the change allowing pro forma financial statements to reflect future synergies and efficiencies from a business combination is a significant liberalization of the current rules, and would provide management with considerable latitude in incorporating its estimate of the anticipated impact of the transaction on pro forma operating results.
The proposal also includes changes specific to investment companies and companies that qualify as smaller reporting companies, which we do not discuss in this Sidley Update.
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