80. Under our proposal, a five-year average would be used for the
income test for investment companies if the registrant and its
subsidiaries consolidated has an insignificant change in net assets
resulting from operations for the most recent fiscal year. Should the
five-year average also be required for the tested subsidiary under
similar circumstances? Should this proposed amendment be more similar
to the one for non-investment company registrants? Should a five-year
average be required only if the absolute value of the change in net
assets resulting from operations 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 years?
    81. We are proposing amendments to Rule 1-02(w)(2) to assist
investment company registrants in making significance determinations.
Are the proposed amendments appropriate? If not, are there different or
additional amendments we should consider?
    82. Should we make further modifications to the proposed income
test for investment companies in situations where the tested subsidiary
is not an investment company? For example, should we require the use of
net income for a non-investment company subsidiary when compared to the
registrant's change in net assets resulting from operations?
    83. Instead of having specific percentage conditions, should we
adopt a materiality standard? For example, should we adopt a standard
that deems a subsidiary as significant if it is material to an
understanding of the registrant's financial condition?
2. Proposed Rule 6-11 of Regulation S-X
    We are proposing new Rule 6-11 to address the financial statements
of funds acquired or to be acquired, if probable, which would be based
on proposed Rules 3-05 and 3-14 but modified to meet the needs of
investment companies and their investors. Proposed Rule 6-11 would only
apply to the acquisition of a fund, including any investment company as
defined in Section 3(a) of the Investment Company Act, any private fund
that would be an investment company but for the exclusions provided by
Sections 3(c)(1) or 3(c)(7) of that Act, or any private account managed
by an investment adviser. Proposed Rule 6-11 calls for a facts and
circumstances evaluation as to whether a fund acquisition has occurred
or is probable. We believe this approach captures the appropriate
universe of fund acquisitions where additional disclosures may be
appropriate, as it is based on the economic substance of a transaction
rather than legal form. Under proposed Rule 6-11, the acquisition of
all or substantially all portfolio investments held by another fund
would be considered a fund acquisition; otherwise, potential disclosure
obligations could be avoided by structuring an acquisition transaction
as a sale of all assets rather than a merger.
    We propose to require only one year of audited financial statements
for fund acquisitions, a change from the existing Rule 3-05
requirements that require between one and three years of audited
financial statements. This proposed change would make the obligations
more aligned with the financial statement obligations applicable to
investment company registration statements. Rule 3-18 allows registered
investment management companies to file financial statements covering
only the most recent fiscal year, except for an audited statement of
changes in net assets which must cover the two most recent fiscal
years.\235\ Older historical financial statements are generally less
relevant to fund investors because the price of investment company
shares or interests is established by the value of its investment
portfolio, even for closed-end funds that may trade at a discount to
net asset value and private funds that do not readily trade. Moreover,
the proposed change would also be consistent with the practice of our
disclosure review staff during consultations, which have permitted
investment company registrants to provide financial statements for
acquired funds for the periods set forth in Rule 3-18 rather than Rule
3-05.\236\
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    \235\ Business development companies are also permitted to use
Rule 3-18 pursuant to the instructions set forth in Form N-2.
    \236\ See supra note 215.
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    Under proposed Rule 6-11, the related schedules specified in
Article 12 would need to be provided for an acquired or to be acquired
fund. These schedules, such as the schedule of investments, are
important for investment company registrants because they permit an
investor to know the specific portfolio investments being acquired. The
nature of investment companies, whose assets largely consist of
portfolio investments that are carried at market value, if available,
or fair value, makes other historical financial statement information
less relevant than for non-investment companies.
    Acquisitions of a group of related funds would be considered as a
single acquisition under proposed Rule 6-11(a)(3) \237\ and a
registrant would have the option of presenting the required financial
statements either on an individual or combined basis for any periods
they are under common control or management. This provision is
comparable to the treatment of related businesses under current and
proposed Rule 3-05 and for similar reasons we believe it would be
appropriate in the context of fund acquisitions.
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    \237\ Funds are considered related if they are under common
control or management, the acquisition of one fund is conditional on
the acquisition of each other fund, or each acquisition is
conditioned on a single common event.
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    In the investment company context, we believe that information
about the composition of the acquired fund's investment portfolio is
the most important and relevant information for investors. We
understand that a significant number of private funds currently prepare
audited financial statements under U.S. GAAP due to

investor demand and for regulatory compliance purposes.\238\ Therefore,
we propose to allow investment companies to provide financial
statements for private funds that were prepared in accordance with U.S.
GAAP. However, we also are proposing to require the investment company
registrant to file schedules for the acquired fund that comply with
Article 12 of Regulation S-X, which requires each investment to be
listed separately. Because the proposed rule would require the schedule
of investments as set forth in Article 12, a private fund would not be
permitted to present a condensed schedule of investments. We believe
that our proposed approach with respect to acquisitions of private
funds will reduce the costs related to re-issuing audited financial
statements in compliance with Regulation S-X, but still provide
investors appropriate information about the acquired fund.
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    \238\ For example, one reason would be to satisfy custody rule
obligations under the Investment Advisers Act. See 17 CFR
275.206(4)-2.
---------------------------------------------------------------------------

    Private fund financial statements prepared in accordance with U.S.
GAAP do not require the same level of granular information or
disclosure as financial statements prepared in compliance with
Regulation S-X. For example, certain financial statements prepared in
compliance with Regulation S-X require separate disclosure of major
categories or accounts greater than a certain percentage of total
assets, liabilities, income or expenses while U.S. GAAP requirements
are less specific. Additionally, under Regulation S-X, registered
investment companies and business development companies must separately
show certain financial statement accounts within the financial
statements, regardless of their materiality, based on their affiliate
classification in relation to the fund.\239\
---------------------------------------------------------------------------

    \239\ See, e.g., the financial reporting requirements of Rule 6-
07 and FASB ASC 946-210-50-4 and 946-210-50-6.
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    Currently, a registrant that acquires a private fund typically must
revise the historical financial statements of the acquired fund so that
they comply with all applicable rules of Regulation S-X and possibly
re-audit those statements. This is the case because the financial
statements of private funds are generally prepared, in practice, in
accordance with U.S. GAAP only. This can be costly both in terms of
time and resources and, given the information contained in the acquired
private fund audited financial statements that comply with U.S. GAAP,
it is not clear that there is a commensurate benefit to investors by
requiring financial statements of the acquired fund that comply with
all provisions of Regulation S-X. Therefore, our proposal is intended
to achieve an appropriate balance by permitting registrants to file
U.S. GAAP financial statements for acquired private funds, but
supplementing those financial statements with schedules listing each
investment as required by Article 12.
    To determine whether financial statements of a fund acquired or to
be acquired must be provided under proposed Rule 6-11, the conditions
specified in the definition of significant subsidiary under proposed
Rule 1-02(w)(2) would be applied, using the investment test and the
alternate income test for investment companies and substituting 20% for
10% for each place it appears therein. We have based the 20%
significance test on comparable conditions in current Rule 3-05 and
have not identified any reason to use a different threshold. The income
test for investment companies with the 80% condition would not be used
for purposes of proposed Rule 6-11 because we believe, in the
acquisition context, significance matters principally with respect to
the portfolio investments and the amount of assets being acquired,
since investment income and realized and unrealized gains/losses from
the investments acquired will be immediately reflected in the daily net
asset value of the registrant. If either of the tests is satisfied at
the 20% condition, the registrant would be required to file the
financial statements for the acquired fund as set forth in proposed
Rule 6-11. Otherwise, filing financial statements of the acquired fund
would not be necessary.
    If the aggregate impact of individually insignificant funds
acquired or to be acquired since the most recent audited balance sheet
exceeds the conditions of the investment test and the alternate income
test for investment companies, substituting 50% for 10%, then the
registrant would be required to provide the financial statements for
each individually insignificant fund and the supplemental financial
information. We have based the 50% condition on the provision in
current Rule 3-05(b)(2)(i). Unlike the existing rule, however, proposed
Rule 6-11 would require financial statements for each individually
insignificant fund acquired or to be acquired, rather than the
``substantial majority'' requirement for businesses acquired under the
current rule.
    In determining whether financial statements of funds acquired or to
be acquired must be filed, the registrant may use pro forma amounts
that give effect to an acquisition consummated after the registrant's
latest fiscal year-end for which the registrant has filed audited
financial statements of such acquired fund as required by proposed Rule
6-11. Any requirement to file financial statements of an acquired fund
would cease once an audited balance sheet required by Rules 3-01 or 3-
18 is filed for a date after the date the acquisition was consummated.
At such time, the acquired investments would be reflected on the
balance sheet or statement of net assets and accompanying schedules. In
these circumstances, we believe that historical financial statements of
acquired funds would be of less importance to investors and continued
filing obligations would impose unnecessary costs since any realized
and unrealized gains/losses on the acquired investments would be
reflected in the daily net asset value calculation as well as fund
performance measures on a going-forward basis.
Request for Comment
    84. Should we adopt proposed Rule 6-11 for acquisitions of funds by
registrants? Have we appropriately defined what constitutes a fund
acquisition? Are there other types of private funds not covered by the
Section 3(c)(1) or 3(c)(7) exclusion that should be covered? Is it
appropriate to use a facts and circumstances-based evaluation to
determine whether a fund acquisition has or will occur? Are there are
other factors that should be considered in defining a fund acquisition?
    85. Should we permit the presentation of audited financial
statements of acquired funds for only the most recent fiscal year?
Should we require the same reporting periods required by Rule 3-18
instead? If so, should we permit any registered investment company
registrant, such as unit investment trusts, to use Rule 3-18 and not
limit it to only registered management investment companies?
    86. Should we treat business development companies and registered
investment companies the same? Should business development companies
follow the reporting periods set forth in proposed Rule 3-05 instead of
proposed Rule 6-11?
    87. Should we require registrants to provide the audited schedules
required by Article 12 for an acquired private fund, including a
schedule of investments that requires each investment to be listed
separately? Should we require only a smaller set of schedules required
by Article 12, such as those required by Rules 12-12, 12-12A, 12-12B,
12-12C, and 12-13? Should we allow registrants to provide

schedules that are permitted under U.S. GAAP rather than Article 12?
    88. Is there any other disclosure by a registrant or an acquired
fund that would be important to a fund investor? If so, please specify
in detail.
    89. Should we permit registrants to have the option to file
financial statements on an individual or a combined basis for acquired
funds that are part of a group of related funds for any periods they
are under common control or management?
    90. Should we continue to use the significant subsidiary definition
as the basis for evaluating whether financial statements of an acquired
fund should be filed? If so, is 20% the appropriate threshold? If not,
what would be the appropriate threshold?
    91. Should we not apply the 80% income test for purposes of
determining whether financial statements of an acquired fund should be
filed?
    92. Should we permit a registrant to cease providing audited
financial statements of the acquired fund once an audited balance sheet
for the registrant is filed that reflects the assets of the acquired
fund? Should the registrant be required to continue to file audited
financial statements of the acquired fund until an audited statement of
operations for a complete fiscal year reflecting the acquired fund has
been filed?
    93. Is it appropriate to permit the financial statements of an
acquired private fund to comply with U.S. GAAP and only the schedule
requirements in Article 12? Should we require Article 12 schedules to
be filed with respect to the acquired private fund, even though it may
be likely to result in additional costs?
    94. Is the proposed language related to independence standards
sufficiently clear? Should we specify the ``applicable independence
standards''? If so, how should they be specified? Are there
circumstances where there are no ``applicable independence standards''?
In those circumstances, which independence standards should apply?
3. Pro Forma Financial Information and Supplemental Financial
Information
    We propose to eliminate the requirement to provide pro forma
financial information for investment company registrants in connection
with fund acquisitions and to provide more relevant disclosures in its
place. Rule 11-01 requires an investment company to furnish pro forma
financial information when a significant business acquisition has
occurred or is probable, with significance being determined using the
tests set forth in Rule 1-02(w) and substituting 20% for 10%. In the
staff's experience, investment companies often file Rule 3-05 Financial
Statements in transactions in which an investment company with limited
assets and operating history is created for the purpose of acquiring
one or more private funds. After such an acquisition, the portfolio
investments of the acquired fund will represent nearly all of the
portfolio investments of the registrant, rendering the pro forma
financial statements of the registrant to be substantially similar to
the historical financial statements of the acquired fund that are
already provided in the registration statement. Rule 11-02 permits
investment companies to provide a narrative description of the pro
forma effects of the transaction in lieu of pro forma financial
statements, if there are a limited number of required pro forma
adjustments and they are easily understood.\240\
---------------------------------------------------------------------------

    \240\ See Rule 11-02(b)(1).
---------------------------------------------------------------------------

    Applying the current pro forma financial information requirements,
based on rules that are principally designed for non-investment
companies, to fund acquisitions by investment companies may increase
costs borne by investors without yielding significant benefit. Pro
forma financial information in the investment company context may be
less informative than other financial information. For example, non-
investment company registrants are required to include historical
financial statements and pro forma financial information in the
registrant's prospectus. For investment companies, this information is
placed in the statement of additional information (SAI) and not the
prospectus. The absence of pro forma information from the prospectus is
notable because the Commission has previously concluded that the
prospectus, standing alone, contains all of ``the information that is
necessary or appropriate in the public interest or for the protection
of investors.'' \241\ The SAI, on the other hand, contains information
not required in the prospectus but which ``may be of interest to at
least some investors.'' \242\
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    \241\ Registration Form Used by Open-End Management Investment
Companies; Guidelines, Release No. IC-13436 (Aug. 12, 1983) [(48 FR
37928, 37930) (Aug. 22, 1983)] (``Form N-1A Adopting Release'').
    \242\ Id. at 37928. Today, all SAIs and the rest of an
investment company's registration statements and other filings are
available to investors on the Commission's EDGAR system. In
addition, for investment companies that use a summary prospectus,
the SAI must be posted to the fund's website. See 17 CFR 230.498(e).
---------------------------------------------------------------------------

    Preparation of pro forma financial information imposes costs on
investment company registrants, and a significant percentage of filings
on Form N-14 contain pro forma financial information. Our staff
reviewed approximately 450 filings on Form N-14 over the past three
years, using analytical tools to identify filings with pro forma
information and found that approximately 50% of N-14 filings included
pro forma financial statements and an additional 25% included narrative
pro forma information.
    When the Commission adopted Form N-14 in 1985, it stated that pro
forma and historical financial information ``may be useful'' to
investors, even though some commenters indicated that the information
was not material.\243\ In response to the 2015 Request for Comment,
several commenters suggested that historical financial statements and
pro forma financial information were not material, particularly if an
audited schedule of investments from the acquired fund was
provided.\244\ We believe that it is appropriate to re-consider whether
pro forma financial information is necessary in light of the costs to
prepare such disclosures.
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    \243\ Business Combination Transactions; New Registration Form
for Investment Companies, Release No. IC-14796 (Nov. 14, 1985) [50
FR 48379 (Nov. 25, 1985)].
    \244\ See letters from CAQ, Crowe, and RSM.
---------------------------------------------------------------------------

    In place of the current pro forma financial information
requirements, we propose new Rule 6-11(d) to require that investment
companies provide supplemental information about the newly combined
entity that we believe will be more relevant to investors. The
supplemental information would include: (1) A pro forma fee table,
setting forth the post-transaction fee structure of the combined
entity; (2) if the transaction will result in a material change in the
acquired fund's investment portfolio due to investment
restrictions,\245\ a schedule of investments of the acquired fund
modified to show the effects of such change and accompanied by
narrative disclosure describing the change; and (3) narrative
disclosure about material differences in accounting policies of the
acquired fund when compared to the newly combined entity. We believe
that this amendment would provide material information to investors
because it would highlight important changes resulting from a fund
acquisition (i.e., changes in fees and expenses, changes to acquired
fund's holdings, and

changes in accounting policies) to provide appropriate context to the
acquired fund's financial statements.
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    \245\ One example is if the registrant and the acquired fund
both have positions in the same portfolio investment and, when
combined, the registrant would exceed an investment restriction on
any single holding. In this situation, a certain percentage of the
portfolio investment may need to be divested.
---------------------------------------------------------------------------

Request for Comment
    95. Should we eliminate the requirement for investment companies to
provide pro forma financial statements for the combined entity after a
business acquisition? To what extent does pro forma financial
information remain material in the investment company context? Please
provide specific examples of how the current pro forma financial
information is utilized.
    96. Should we require the pro forma fee table, schedule of
investments, and narrative disclosure as outlined above? Is there other
information we should require in lieu of pro forma financial statements
of the combined entity? If so, what other information would be material
to investors?
4. Amendments to Form N-14
    Item 14 of Form N-14, the form used by investment companies to
register securities issued in business acquisition transactions,\246\
provides, subject to certain exceptions, that the corresponding
Statement of Additional Information ``shall contain the financial
statements and schedules of the acquiring company and the company to be
acquired required by Regulation S-X.'' \247\ We propose to amend Form
N-14 so that its disclosure requirements are consistent with the
disclosures required in proposed Rule 6-11 because we believe it is
appropriate for investors who acquire securities in a registered
offering to have the same disclosure that investors receive through
financial statement disclosure in shareholder reports. In the case of a
fund acquisition, any financial statements and schedules required by
Regulation S-X would only be required for the most recent fiscal year
and the most recent interim period.\248\ Similarly, we propose to
permit private funds to provide financial statements and schedules that
conform to U.S. GAAP and Article 12 of the Regulation S-X. We also
propose to require inclusion of the supplemental financial information
described in proposed Rule 6-11(d), except for the pro forma fee table.
We are excluding the pro forma fee table from Item 14 of Form N-14
because it is already required in the prospectus under Item 3 of that
Form. We also propose to remove provisions no longer relevant because
of prior amendments.\249\ We further propose to remove the existing
exclusion in Form N-14 for pro forma financial statements required by
Rule 11-01 of Regulation S-X if the net asset value of the company
being acquired does not exceed 10% of the registrant's net asset value
because pro forma financial statements would be no longer required for
fund acquisitions and, for non-fund acquisitions, the significance
measure for pro forma statements in Rule 11-01(b)(1) is and would
remain 20%.
---------------------------------------------------------------------------

    \246\ See 17 CFR 239.23 (setting forth the requirement for an
investment company to file Form N-14 to register securities in
business combination transactions) and 17 CFR 230.145 (specifying
the types of transactions that trigger the Form N-14 filing
requirement).
    \247\ See Item 14 of Form N-14. Currently, the disclosures are
to be for the periods specified in Article 3 of Regulation S-X. Id.
    \248\ Non-fund acquisitions would be required to follow the
other financial statement disclosure requirements set forth in
Regulation S-X for the periods required by Rule 3-05, including any
pro forma financial information required by Article 11.
    \249\ Specifically, we are removing the ability to place columns
C and D of Schedule II under Rule 12-14 to Part C of the
registration statement, with the remainder of the schedule being
provided in the SAI. When originally adopted, Form N-14 was based on
Form N-1A, which had a similar provision. See Form N-1A Adopting
Release. This provision was removed from Form N-1A in 1998. See
Registration Form Used by Open-End Management Investment Companies,
Release No. 33-7512 [63 FR 13916 (Mar. 23, 1998)].
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Request for Comment
    97. Should we conform the financial statement disclosure
requirements in Item 14 of Form N-14 with proposed Rule 6-11? If not,
how and why should the disclosures differ?
    98. Should we require the supplemental financial information to be
disclosed in Form N-14?

III. General Request for Comment

    We request and encourage any interested person to submit comments
on any aspect of the proposal, other matters that might have an impact
on the amendments, and any suggestions for additional changes. With
respect to any comments, we note that they are of greatest assistance
to our rulemaking initiative if accompanied by supporting data and
analysis of the issues addressed in those comments, particularly
quantitative information as to the costs and benefits, and by
alternatives to the proposals where appropriate. Where alternatives to
the proposals are suggested, please include information as to the costs
and benefits of those alternatives.

IV. Economic Analysis

A. Introduction

    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 intended economic effects of
the proposed amendments are to reduce the burden on registrants of
complying with financial statement disclosure requirements related to
their business acquisitions and business dispositions, facilitate
timely access to capital, and provide more relevant information to
investors. This reduced compliance burden also may encourage
registrants to engage in more potentially value-enhancing mergers and
acquisitions than they otherwise would engage in without the proposed
amendments. However, business acquisitions and dispositions take place
for many reasons, which could make it difficult to isolate the effects
of the proposal from the effects of a host of potentially confounding
factors.
    Providing timely, accurate, and transparent information, especially
financial information, about acquired or disposed businesses is
important to mitigate the information asymmetry that exists between
corporate insiders (managers and majority shareholders) and outsiders
(minority shareholders, creditors, etc.). This is especially true in
the context of major corporate transactions such as mergers,
acquisitions, and dispositions, as investors rely on the financial
information of the acquired and disposed businesses to assess the
potential effects of these activities on the registrant. A properly
functioning market for corporate control serves as an important
external governance mechanism involving transactions that potentially
create shareholder value through synergy generation or transferring
assets to more efficient management.\250\ However, in the absence of
appropriate disclosures, investors may not be able to fully assess the
effects of this important external governance mechanism on the firms in
which they invest.
---------------------------------------------------------------------------

    \250\ See, e.g., M. Mitchell and K. Lehn, 1990, ``Do Bad Bidders
Become Good Targets?'', Journal of Political Economy, Vol. 98; A.
Agrawal and J. Jaffe, 2003, ``Do Takeover Targets Underperform?
Evidence from Operating and Stock Returns'', Journal of Financial
and Quantitative Analysis, Vol 38.
---------------------------------------------------------------------------

    At the same time, such disclosure requirements impose costs on
registrants that could deter them from engaging in, or diminish the
benefits associated with, acquisitions that are value-enhancing, for
example, where the acquirer has to negotiate for information that may
be costly and burdensome for the acquiree to prepare and provide.
Further, a registrant's ability to provide such disclosure for

periods prior to its acquisition is often dependent on both the
acquired business and the acquired business's independent auditor. A
registrant's inability to timely obtain such disclosure from these
parties may impact its ability to comply with its reporting
requirements and to access capital within the timeframes it desires.
Thus, streamlining and clarifying acquired business financial
disclosure requirements should reduce the likelihood that such
requirements undermine the economic benefits of potentially value-
enhancing transactions, or otherwise discourage registrants from
engaging in such transactions, while maintaining investors' access to
information that is likely to be material to an understanding of the
potential effects of an acquired or to be acquired business on the
registrant.
    We are mindful of the costs imposed by and the benefits obtained
from our rules and amendments. Section 2(b) of the Securities Act,\251\
Section 3(f) of the Exchange Act,\252\ and Section 2(c) of the
Investment Company Act \253\ require the Commission, when engaging in
rulemaking where it is required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider,
in addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation. Additionally,
Section 23(a)(2) of the Exchange Act \254\ requires us, when adopting
rules under the Exchange Act, to consider, among other things, the
impact that any new rule would have on competition and not to adopt any
rule that would impose a burden on competition that is not necessary or
appropriate in furtherance of the Exchange Act.
---------------------------------------------------------------------------

    \251\ 15 U.S.C. 77b(b).
    \252\ 17 U.S.C. 78c(f).
    \253\ 15 U.S.C. 80a-2(c).
    \254\ 15 U.S.C. 78w(a)(2).
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    Below we address the potential economic effects of the proposed
amendments, including the likely benefits and costs, as well as the
likely effects on efficiency, competition, and capital formation. We
attempt to quantify these economic effects when possible; however, due
to data limitations, we are not able to quantify all of the economic
effects.

B. Baseline and Affected Parties

    The current disclosure requirements in Rule 3-05, Rule 3-14,
Article 11, and the related smaller reporting company requirements in
Article 8 of Regulation S-X, together with the current disclosure
practices registrants have adopted to comply with these requirements
form the baseline from which we estimate the likely economic effects of
the proposed amendments.\255\
---------------------------------------------------------------------------

    \255\ See supra Section I.
---------------------------------------------------------------------------

    The proposals are likely to affect investors both directly and
indirectly through other users of the disclosure (e.g., security
analysts, investment advisers, and portfolio managers), auditors, and
registrants subject to Regulation S-X. Additionally, entities other
than registrants may be affected, such as significant acquirees for
which financial statements are required under Rule 3-05 and Rule 3-14.
    The proposed amendments may affect both domestic registrants and
foreign private issuers.\256\ We estimate that during calendar year
2018, approximately 6,919 registrants filed on domestic forms \257\ and
806 foreign private issuers filed on F-forms, other than registered
investment companies. Among the registrants that file on domestic
forms, approximately 29% are large accelerated filers, 19% are
accelerated filers, 19% are non-accelerated filers, and 33% are smaller
reporting companies. In addition, we estimate that approximately 21.3%
of these domestic issuers were emerging growth companies.\258\ About
19.8% of foreign private issuers that filed on Forms 20-F and 40-F were
emerging growth companies. With respect to foreign private issuer
accounting standards, approximately 38% of foreign private issuers
reported under U.S. GAAP, 61% reported under IFRS-IASB, and
approximately 1% reported under Another Comprehensive Body of
Accounting Principles with a reconciliation to U.S. GAAP. Certain of
the proposed amendments may also affect requirements applicable to
issuers that rely on Regulation A and investment companies that must
comply with the requirements of Regulation S-X.
---------------------------------------------------------------------------

    \256\ The number of domestic registrants and foreign private
issuers affected by the proposed amendments is estimated as the
number of unique companies, identified by Central Index Key (CIK),
that filed Form 10-K, Form 10-Q, Form 20-F, and Form 40-F or an
amendment thereto with the Commission during calendar year 2018. The
estimates for the percentages of smaller reporting companies are
based on information from Form 10-K, Form 20-F, and Form 40-F. The
estimates for the percentages of foreign private issuers' basis of
accounting used to prepare the financial statements are derived from
the information in Forms 20-F and 40-F. These estimates do not
include issuers that filed only initial registration statements
during calendar year 2018, which will also be affected by the
amendments
    \257\ This number includes fewer than 25 foreign private issuers
that file on domestic forms and approximately 100 business
development companies.
    \258\ Staff determined whether a registrant claimed emerging
growth company status by parsing several types of filings (e.g.,
Forms S-1, S-1/A, 10-K, 10-Q, 8-K, 20-F/40-F, and 6-K) filed by the
registrant, with supplemental data drawn from Ives Group Audit
Analytics.
---------------------------------------------------------------------------

    Registrants are required to file separate audited annual and
unaudited interim pre-acquisition financial statements of the acquired
business if the acquisition triggers the Rule 1-02(w) significance
tests as modified by Rule 3-05 and Rule 3-14. Because the United States
has one of the most active markets for mergers and acquisitions,\259\
the proposed amendments could affect disclosure for a large number of
businesses. Registrants would potentially be affected by the proposed
amendments if they engage in an acquisition or disposition transaction
(or series of transactions) that is deemed significant under the Rule
1-02(w) significance tests as modified by Rule 3-05 and Rule 3-14 or
the related smaller reporting company requirements in Article 8.
---------------------------------------------------------------------------

    \259\ A. K. Sundaram, 2004, ``Mergers and Acquisitions and
Corporate Governance,'' Mergers and Acquisitions 3: 193-219; and
2018 J.P. Morgan Global M&A Outlook, available at: https://www.jpmorgan.com/jpmpdf/1320746694177.pdf.
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    We are not able to observe the universe of acquisitions by all
registrants, as acquisitions made by registrants that are not deemed
significant or where the acquired businesses are not public firms might
not be identified. For purposes of our Paperwork Reduction Act
(``PRA'') analysis, we searched various form types filed from January
1, 2017 to October 1, 2018 for indications of acquisition or
disposition disclosure.\260\ In the reviewed period there were
approximately 1,261 filings on various forms that included Rule 3-05
Financial Statements or Rule 3-14 Financial Statements, representing
between approximately 1% and 12% of such filings, depending on the
specific form.\261\ To get a sense of overall market activity for
mergers and acquisitions, we also examined mergers and acquisitions
data from Thomson Reuters' Security Data Company (``SDC''). During the
period from January 1, 2016 to December 31, 2018, there were 6,310
mergers and acquisitions entered into by publicly-listed U.S. firms.
Among these transactions, 1,388 acquisitions involved non-U.S. targets
and 442 were conducted by entities in the real estate

industry.\262\ Additionally, 294 of the 6,310 transactions were
conducted by smaller reporting companies. These estimates constitute an
upper bound on the number of transactions that may have triggered
disclosure requirements under Rule 3-05 or Rule 3-14, and the related
requirements for smaller reporting companies,\263\ as many of these
transactions may have involved acquisitions that are small relative to
the size of the registrant.\264\
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    \260\ See Section V.B.1. below for our review of forms filed by
operating companies. We discuss our similar review of investment
company forms in Section V.B.2. below.
    \261\ Based on a review of Forms 10, S-1, S-3, F-1, F-3, and 8-
K. See Table 2 in Section V.B.1.
    \262\ Real estate industries are defined based on Standard
Industry Classification code (SIC) in 6500s where either the
acquiring companies or the acquiree has the primary SIC code in
6500s.
    \263\ Acquisitions that triggered Rule 3-05 or Rule 3-14
Financial Statements requirements are observed by searching EDGAR
filings. Databases such as SDC have some coverage of mergers and
acquisitions conducted by public listed firms in the U.S. However,
when the acquired entities are privately owned, we do not have data
in terms of their assets, income, and often the purchase prices paid
by the acquiring firms. Thus we are not able to provide statistics
on the relative size of these transactions.
    \264\ R. Masulis, C. Wang, and F. Xie, 2007 ``Corporate
Governance and Acquirer Returns'' Journal of Finance, 62(4), 1851-
1899 (reporting that the mean (median) relative size of the mergers
in their sample is around 16% (6%) for the period of 1990-2003).
Relative size in this study is measured as the ratio of target
market cap to the acquirer market cap, and the sample is limited to
public firms. We expect the relative size of the acquisitions for
non-public acquirees would be even smaller, but we do not have data
on the size of private firms to provide comparable statistics about
these transactions.
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    All investment companies that make fund acquisitions significant
enough to trigger Rule 3-05 disclosure requirements would potentially
be affected by the proposed amendments. Among registered investment
companies, as of the end of calendar year 2018, there were 8,059 open-
end funds, 1,988 exchange-traded funds, and 518 closed-end funds. In
addition, there were 102 business development companies. We are not
able to observe the universe of the fund acquisitions, however, we are
able to observe those transactions that triggered the filing of
acquired fund financial statements. In our PRA analysis, we searched
various form types over a three-year period ended October 1, 2018 for
indications of fund acquisition disclosure. Among the 152 filings on
Form N-14 for fund transactions, about 70 filings or 46% included
acquired fund financial statements. There were only a few filings on
Form N-1A and Form N-2 that included acquired fund financial statements
(12 filings out of 8,936 filings on Form N-1A and two filings out of
132 filings on Form N-2).\265\
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    \265\ See infra Section V.B.2, Table 5.
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C. Potential Benefits and Costs of the Proposed Amendments Potential
Benefits

    We anticipate the proposed amendments \266\ would improve the
financial information about acquired or disposed businesses, facilitate
more timely access to capital, and reduce the complexity and costs to
prepare the disclosure. Improved disclosure benefits users of financial
information and can facilitate more efficient allocations of capital,
while a reduced disclosure burden can shorten the time period to
prepare disclosures necessary to access capital and typically generates
cost savings for registrants, which can result in more capital being
available for investment.
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    \266\ See supra Sections II.A. through II.E.
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    The proposed amendments may increase the utility of acquisition and
disposition related disclosures to investors by making these
disclosures more relevant. The proposed amendments should improve the
salience of the information for investors by reducing the volume of
information presented about acquired businesses and focusing the
disclosures on more decision-relevant information. This, in turn, could
lead to more informed investment decisions and improved capital
allocation efficiency.
    The proposed amendments may also permit more timely access to
capital. A registrant's ability to provide existing required disclosure
for periods prior to an acquisition is often dependent on both the
acquired (or to be acquired) business and its independent auditor. The
age of the acquired or to be acquired business's required financial
statements, as well as changes in the acquired business's personnel or
its independent auditor that occurred during the historical periods for
which financial statements may be required through the acquisition
date, can impair a registrant's ability to comply with its reporting
requirements and access capital within the timeframes it needs to
operate its business and make investments. By focusing on more recent
historical periods, relying on more relevant disclosure triggers and
definitions, and increasing the relevance of pro forma financial
information, the proposed amendments should help to ameliorate these
impediments, as we discuss in more detail below.
    Further, to the extent that the proposed amendments reduce the
compliance burden, they may reduce the cost of merger and acquisition
activity. Well-functioning markets for corporate control are, on
average, beneficial to investors as they serve as a disciplinary
mechanism in which less efficiently managed assets are transferred to
more efficient management. Mergers and acquisitions may also generate
synergies by combining two entities, and may result in firms with more
efficient scale or scope.
Potential Costs
    We do not expect the proposed amendments to generate significant
costs for registrants. However, in certain situations the proposed
amendments could cause some acquisitions to be significant that are not
currently deemed significant by acquirers. In these situations,
registrants would need to file Rule 3-05 Financial Statements,
resulting in costs to registrants but potential benefits to investors
in the form of enhanced disclosure related to the transaction. We also
do not anticipate significant costs to investors associated with the
proposed amendments. We acknowledge that in some cases, the proposed
amendments would reduce disclosure. However, we anticipate that the
potential loss of information would be partially mitigated by a
registrant's obligation under Rule 4-01(a) Regulation S-X to include
such further material information as is necessary to make the required
statements, in light of the circumstances under which they are made,
not misleading. Below we discuss the anticipated economic benefits and
costs of specific aspects of the proposed amendments in further detail.
1. Significance Tests
    The proposed changes to the significance tests used under Rules 3-
05 and 3-14 should help facilitate registrants' application of the
tests. The proposed amendments could potentially increase the
likelihood that the Investment Test is more in line with the economic
significance of transactions and reduce anomalous results from the
Income Test. This, in turn, should help reduce compliance burdens
associated with preparing Rule 3-05 or Rule 3-14 Financial Statements
for an acquired business.
    First, the proposed change to the Investment Test using the
registrant's aggregate worldwide market value rather than its
historical book value of total assets may better reflect the relative
size of the transaction in economic terms. The investment in and
advances to the acquired business generally reflect an acquirer's
expectation of the fundamental value of

the equity of the acquired business.\267\ Similarly, using market value
of the registrant would be more in line with the market expectation of
the registrant's discounted future free cash flow to equity holders,
and thus may more accurately reflect the fundamental value of the
registrant's equity. By better aligning these two components of the
Investment Test, the proposed amendments would potentially avoid
classifying transactions as significant when they are actually
insignificant in economic substance to the registrant. Further, market
values may better reflect the relative size of the transaction,
especially for high growth acquiring registrants whose market value is
significantly different from their book value.\268\
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    \267\ The fundamental value of an entity's equity refers to the
value of equity determined through fundamental analysis. For
example, fundamental value of a firm's equity can be estimated by
summing the discounted stream of expected future free cash flow to
the firm's equity holders.
    \268\ See, e.g., A. Shleifer and R. Vishny, 2003, ``Stock Market
Driven Acquisitions'', Journal of Financial Economics.
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    Second, the proposed changes to the Income Test to simplify the
calculations and to add a revenue component should improve the
application of the Income Test. These proposed changes are likely to
mitigate the effect of infrequent expenses, gains, and losses on the
calculation and also potentially prevent deeming as significant
immaterial acquisitions by registrants with net income or loss near
zero. Moreover, the proposed change to require the use of readily
available income or loss after tax likely would reduce compliance
burden for registrants as in some cases, the calculation of income
before taxes requires adjustment of line items that are generally
presented on an after-tax basis.
    Both proposed amendments to the significance tests are expected to
better capture the importance of the acquisitions relative to the
registrant. To the extent that the proposed changes reduce the risk of
deeming an insignificant acquisition to be significant, they may
benefit registrants by reducing the number of instances in which
registrants are required to file Rule 3-05 Financial Statements or Rule
3-14 Financial Statements, thus reducing compliance burdens. To the
extent that the proposed modifications to the significance tests
capture more significant acquisitions and fewer insignificant ones,
they may directly benefit investors by improving the overall salience
of the information disclosed to them. Investors may also indirectly
benefit from the proposed changes to the significance tests as the
potential cost savings from reduced compliance burdens could be
translated to more capital available to the registrants for future
profitable investments and possibly the ability to access capital
sooner than under existing requirements.
    The use of market capitalization instead of book value could raise
questions relating to whether market price reflects a registrant's
fundamental value and the appropriate measurement period to be used. If
a firm's stock price is informationally efficient, it will reflect the
fundamental value of the firm's equity. Any new information, including
information about mergers or acquisitions, might lead investors to
revise their expectations of the firm's risk and future cash flow,
resulting in possible changes in stock price. Information about a
transaction sometimes starts seeping into the stock market several
months before an announcement, leading investors to speculate around
potential mergers or acquisitions.\269\ Thus, the market price of the
registrant's shares might fluctuate depending on the information
available. These and other factors could potentially affect stock price
or the firm's market value. Thus, it is possible that the proposed
changes to the Investment Test might introduce errors or bias into the
determination of the significance of an acquisition.
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    \269\ P.J. Halpern, 1973 ``Empirical Estimates of the Amount and
Distribution of Gains to Companies in Mergers'' The Journal of
Business, 46, (4), 554-575; G. Mandelker, 1974 ``Risk and Return:
The Case of Merging Firms'' Journal of Financial Economics, 1, (4),
303-335.
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    Additionally, inclusion of a revenue component in the Income Test
may result in an acquired business that has a significant impact on net
income, but not on revenues, not being deemed significant. When the
registrant and its subsidiaries consolidated and the tested subsidiary
have recurring annual revenue, the proposed Income Test would require
both the new revenue component and the net income component to be
met.\270\ As a result, when the profitability of the registrant differs
significantly from the profitability of the acquired business, the
income component could generate a very different result from the
revenue component. This could lead to under-identification of
significant transactions when, for example, a high revenue, low profit
firm acquires a low revenue, high profit firm.
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    \270\ 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. See proposed Rule 3-05(b)(2) of Regulation S-X.
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    In Section II above, we solicit comment on the impact of these
measurement issues on investors and registrants. We preliminarily
believe, however, that the proposed changes to the significance tests
would improve the application of the tests and their ability to capture
the economic substance of acquisitions and dispositions, which would
benefit investors by helping ensure that they are provided with
decision-relevant information about those acquisitions.
2. Audited Financial Statements for Significant Acquisitions
    The proposed amendment to eliminate the requirement to file the
third year of Rule 3-05 Financial Statements would reduce registrants'
disclosure burden. Currently, Rule 3-05 Financial Statements are
required for up to three years prior to the acquisition depending on
the significance of the transaction and the amount of net revenues
reported by the acquired business in its most recent fiscal year. To
the extent that information from three years prior might be less
relevant to investors' analysis of an acquisition, we preliminarily
believe the benefits from the potential reduction in disclosure burden
and audit costs could justify investors' loss of the incremental value
of the third year of financial information. For purposes of the PRA, we
expect the average reduction in registrants' compliance burden as a
result of the proposed amendments would be approximately 125 hours per
Rule 3-05 Financial Statement filing.\271\ In addition to these
compliance cost savings, there could be other and more substantial
benefits from the proposed amendments. For example, if the preparation
and audit of pre-acquisition financial statements are outside of the
registrant's control, and the target company is unable to prepare and
obtain an audit of any required financial statements for the third
year, the registrant will be unable to comply with its disclosure
requirements under Rule 3-05, which could delay the filing of a
registration statement and hence its capital raising efforts.
---------------------------------------------------------------------------

    \271\ See Table 1 in Section V.B.1.
---------------------------------------------------------------------------

    The impact of the proposed amendment on investors depends, in part,
on the value of information about the third year. In an efficient
market, information for the third year before an acquisition may not
generally provide significant incremental value to investors to
evaluate a transaction. However, in some cases the omission of

the third year of Rule 3-05 Financial Statements could result in loss
of information to investors, such as in those limited cases where the
acquired business has an operating cycle that extends beyond two years
and has not previously filed any financial reports. We expect this
potential loss of information to be partially mitigated by a
registrant's Rule 4-01(a) obligation to include such further material
information as is necessary to make the required statements, in light
of the circumstances under which they are made, not misleading.
3. Financial Statements for Net Assets That Constitute a Business and
Financial Statements of a Business That Includes Oil-and-Gas-Producing
Activities
    The proposed amendment to permit the use of abbreviated financial
statements in circumstances where providing full audited financial
statements would be impractical should reduce registrants' disclosure
burdens, decrease compliance costs, and facilitate the application of
Rule 3-05. Registrants frequently acquire a component of an entity that
is a business as defined in Rule 11-01(d), but does not constitute a
separate entity, subsidiary, or division, such as a product line, a
line of business contained in more than one subsidiary of the selling
entity, or an interest in oil and gas producing activities that
generates substantially all of its revenues from oil and gas producing
activities. 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 smaller
portion of the selling entity. As a result, a registrant may be unable
to provide the financial statements required under the current rule. In
these circumstances, the proposed amendments provide specific
conditions under which registrants would be permitted to file
abbreviated financial statements to comply with Rule 3-05. There would
be no need for the registrant to seek relief from the staff, thus
reducing the compliance burden. We believe allowing for abbreviated
financial statements in these circumstances could help reduce costs for
registrants, and because registrants must otherwise disclose material
information about the acquisition that is necessary to make the
required statements not misleading, we expect that these cost
reductions could be realized without negatively affecting investors.
4. Timing and Terminology of Financial Statement Requirements
    The proposed amendments include several revisions that clarify the
timing and some terminology related to the disclosure requirements.
These clarifications should benefit registrants by avoiding any
confusion that may arise from application of the current requirements,
thereby enhancing the overall efficiency of their compliance efforts.
Because the proposed changes do not modify the information required to
be disclosed, we do not believe investors would be negatively affected
by these proposed changes. To the extent that these proposed changes
make compliance more efficient for registrants, investors may
indirectly benefit as cost savings could be passed through to them.
5. Foreign Businesses
    The proposed amendments would allow Rule 3-05 and Rule 3-14
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. Preparing financial
statements without reconciliation to U.S. GAAP in these circumstances
would reduce the compliance costs where an acquired business in a
cross-border acquisition does not have U.S. GAAP financial statements.
It may also expand the pool of foreign entities that would be
considered valuable potential acquisition targets. For example, a
registrant might be discouraged under the current rules from completing
a cross-border acquisition in situations where it would be costly for
the foreign target to prepare its financial statements using U.S. GAAP
as required by the current rules.
    The proposals would also permit foreign private issuers that
prepare their financial statements using IFRS-IASB to provide Rule 3-05
and Rule 3-14 Financial Statements prepared using home country GAAP to
be reconciled to IFRS-IASB rather than U.S. GAAP. Permitting use of
Rule 3-05 and Rule 3-14 Financial Statements reconciled to IFRS-IASB in
these circumstances potentially benefits investors by providing them
with information about the acquired business that is more comparable to
the registrant. This may allow investors to analyze the impact of these
acquisitions more expeditiously.
    By providing flexibility to prepare an acquired (or to be acquired)
business's financial statements using, or reconciling to, IFRS-IASB in
these circumstances, the proposed amendment may facilitate certain
cross-border mergers that might otherwise not take place due to
compliance costs associated with preparing financial statements using,
or reconciling to, U.S. GAAP. Based on data from the SDC merger
database for the three year period from January 2015 to January 2018,
about 20% of acquisitions by U.S. companies involved non-U.S. targets.
To the extent that the proposed amendment leads to increased cross-
border mergers and acquisitions, shareholders could potentially benefit
from greater growth potential in new markets, more efficient
distribution systems, or improved managerial processes, among other
benefits.\272\
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    \272\ See, e.g., K. Ahern, 2015, ``Lost In Translation? The
Effect of Culture on Mergers Around the World'', Journal of
Financial Economics, 117, P165-189.
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    A possible consequence from the proposed amendments would be
inconsistencies in financial disclosure about acquired (or to be
acquired) businesses where IFRS-IASB and U.S. GAAP differ significantly
in reporting practices. For example, there are certain differences in
the recognition, measurement, and impairment of long-lived assets
between IFRS-IASB and U.S. GAAP.\273\ Such inconsistencies could lead
to confusion and a loss of comparability for investors of domestic
registrants familiar with U.S. GAAP financial statements. Despite
potential inconsistencies, we preliminarily do not expect the proposed
amendment to impose substantial costs on investors. Foreign private
issuers have been permitted to file IFRS-IASB financial statements
without reconciliation to U.S. GAAP for some time,\274\ and IFRS-IASB
is widely used for financial reporting purposes in other jurisdictions.
In that respect, we do not believe using or reconciling to IFRS-IASB
financial statements for businesses in foreign jurisdictions would
necessarily lower the disclosure standard or cause undue confusion. In
addition, pro forma financial information for the acquisition is
required to reflect the acquired foreign business on the same basis of
accounting as that of the registrant. For a U.S. registrant, that basis
would be U.S. GAAP, which should mitigate any potential inconsistencies
in the pre-acquisition historical financial

statements. However, we encourage commenters to provide us with
information about these potential costs.
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    \273\ As an example, IFRS-IASB permits the recognition of
internally-generated intangible assets in limited circumstances;
U.S. GAAP does not.
    \274\ See Acceptance From Foreign Private Issuers of Financial
Statements Prepared in Accordance With International Financial
Reporting Standards Without Reconciliation to U.S. GAAP, Release No.
33-8879 (Dec. 21, 2007) [73 FR 986 (January 4, 2008)].
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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
    The proposed amendments allowing registrants to omit Rule 3-05 and
Rule 3-14 Financial Statements from Securities Act registration
statements and proxy statements after inclusion in post-acquisition
results for a complete fiscal year could improve such registrants'
timely access to capital. For example, registrants currently have to
test the significance of acquisitions that occurred during the earliest
years for which the registrant is required to provide historical
financial statements and, if significant, to provide pre-acquisition
financial statements of the acquired business. We expect the proposed
amendments to be especially useful for registrants that complete an
initial public offering, as those registrants are most likely not to
have been required to file Rule 3-05 and Rule 3-14 Financial Statements
before filing their initial registration statements. In these
instances, a registrant might need to spend additional time or
resources, or both, to prepare Rule 3-05 and Rule 3-14 Financial
Statements for inclusion in a registration statement, which can delay a
registrant's offering and hence delay its access to capital. In
addition to anticipated benefits resulting from more timely access to
capital, registrants may benefit from reduced compliance costs.
    We believe that information from the historical pre-acquisition
period is not as relevant once integration of the acquisition is
completed. Additionally, in acquisitions where integration takes longer
than a year, investors would still receive disclosure about material
effects of the acquisition through the registrant's management's
discussion and analysis.\275\ We therefore do not expect the proposed
amendments to result in a meaningful loss of material information to
investors. Instead, the reduction in compliance burdens and the timely
access to capital may indirectly benefit investors.
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    \275\ See 17 CFR 229.303.
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7. Use of Pro Forma Financial Information To Measure Significance
    The proposed amendments permit the use of pro forma financial
information to measure significance in initial registration statements.
This approach provides registrants with certain flexibility to more
accurately measure the relative significance of an acquisition or
disposition, which in turn may help reduce their disclosure burden and
compliance costs and facilitate capital formation. Because pro forma
financial statements may capture the likely effects of significant
acquisitions and dispositions that are not fully reflected in the
registrant's historical financial statements (financial statements that
would otherwise be used to measure significance), these amendments
could enable registrants to more accurately determine the significance
of these transactions.
    The proposed amendments could potentially reduce the amount of
information presented to investors if significance determinations on
the basis of pro forma financial statement information fail to identify
acquisitions that are economically significant to a registrant.
However, as noted above, Rule 4-01(a) requires registrants to include
such further material information as is necessary to make the required
statements, in light of the circumstances under which they are made,
not misleading. We expect this requirement to address concerns about
any loss of relevant information to investors.
8. Disclosure Requirements for Individually Insignificant Acquisitions
    Registrants are currently required to provide certain audited,
historical pre-acquisition financial statements if the aggregate impact
of ``individually insignificant businesses'' acquired since the date of
the most recent audited balance sheet exceeds 50%.\276\ In these
circumstances, pro forma financial information is also required
pursuant to Article 11 for the ``individually insignificant
businesses'' for which audited, historical pre-acquisition financial
statements are required.\277\ To comply with these requirements,
registrants may need to provide audited financial statements of
acquired businesses that are not material to the registrant, and pro
forma financial information that might not reflect the aggregate effect
of the ``individually insignificant businesses.''
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    \276\ See supra note 115.
    \277\ See supra note 118.
---------------------------------------------------------------------------

    The proposed amendments would affect disclosure requirements for
individually insignificant businesses in several ways. First, the
proposed amendments would require the registrants to provide audited
historical financial statements only for those acquired businesses
whose individual significance exceeds 20%. Reducing required disclosure
of audited historical financial statements for insignificant
acquisitions could improve registrants' access to capital since
preparing such disclosure for these acquisitions typically entails
negotiating with the seller to timely provide this information, a
process that can be costly and time-consuming. By simplifying and
streamlining the historical financial statement disclosure requirement
for individually insignificant acquisitions, the proposed amendments
may make it easier, quicker, and cheaper for registrants to access
capital. The proposed amendments would also reduce registrants'
disclosure burdens leading to cost savings that may ultimately benefit
shareholders.
    Second, the proposed amendments could improve the completeness of
information provided to investors by requiring pro forma financial
information that depicts the aggregate effect in all material respects
of the acquired businesses, rather than only a mathematical majority of
the individually insignificant businesses acquired. Investors might
benefit by being able to more effectively assess the aggregate effect
of these acquisitions on the registrant as a result of the proposed
amendments.
    The proposed amendment might impose additional compliance burdens
on registrants because it could require registrants to present
information about acquisitions, albeit in an aggregated form, that they
have not disclosed in the past. Because we do not have information
available to estimate the number of acquisitions that would be subject
to this proposed requirement in aggregate or for any given registrant,
we cannot quantify these compliance costs. However, we do not expect
registrants to incur substantial costs to prepare disclosure about such
acquisitions because these are activities that typically underpin the
decision to make an acquisition.
9. Rule 3-14--Financial Statements of Real Estate Operations Acquired
or To Be Acquired
    The proposed amendments would align Rule 3-14 with Rule 3-05 where
no unique industry considerations warrant differentiated treatment of
real estate operations. For example, the proposed amendments would
align the threshold for individual significance for both rules at
``exceeds 20%'' and the threshold for aggregate significance for both
rules at ``exceeds 50%''. The proposed amendments would also align Rule
3-14 and Rule 3-05 in terms of the years of required financial
statements for acquisitions from related parties, the timing of
filings, application of Rule 3-

06, which permits the filing of financial statements covering a period
of nine to 12 months, and other less significant changes.
    The proposed amendments are expected to benefit registrants as
greater consistency in application of the rules may reduce the costs of
preparing disclosure, especially for registrants that make both real
estate and non-real estate acquisitions. In addition to the alignment
between Rule 3-14 and Rule 3-05, the proposed amendments also define
real estate operation as a business that generates substantially all of
its revenues through the leasing of real property. This may reduce
potential uncertainty and ambiguity in applying Rule 3-14 without
negatively affecting investors.
    The proposed amendments would also establish or clarify the
application of Rule 3-14 regarding scope of the requirements,
determination of significance, need for interim income statements, and
special provisions for blind pool offerings. The proposed amendments
related to blind pool offerings are consistent with current practice
for these offerings. Thus, while they may reduce potential compliance
uncertainty and ambiguity for registrants, we do not expect the
proposed amendments to have a substantial effect on current disclosure
practices.
10. Pro Forma Financial Information
    The proposed amendments to replace the existing pro forma
adjustment criteria in Article 11 of Regulation S-X with Transaction
Accounting Adjustments and Management's Adjustments would simplify
these requirements and reduce potential inconsistency in preparing pro
forma financial information. The proposed amendments to Article 11
could benefit investors in several ways. First, the proposed
Transaction Accounting Adjustments may lead to more consistent pro
forma presentations than the current adjustment criteria, which may be
subject to some interpretation. In addition, the proposed Transaction
Accounting Adjustments may permit registrants to better reflect the
acquisition, disposition, or other transaction, which could help
investors better understand the effects of the acquired business to the
registrant's audited historical financial statements. Likewise, the
proposed Management's Adjustments, which require disclosure of
reasonably estimable synergies and other transaction effects, such as
closing facilities, discontinuing product lines, terminating employees,
and executing new or modifying existing agreements, that have occurred
or are reasonably expected to occur, may give investors better insight
into the potential effects of the transaction as contemplated by the
company. This would potentially benefit investors in helping them to
distinguish the accounting effects of the acquisitions from
management's judgment as to the expected operational effects based on
management plans. Altogether, the proposed amendments are expected to
improve the relevance of the information disclosed to investors and
help investors process information more effectively.
    The proposed revisions to Article 11 could impose costs on
registrants because they would be required to meet new presentation
requirements for pro forma adjustments. For purposes of the PRA, we
estimate the average incremental compliance burden for these new
requirements would be around 25 hours per affected registrant.\278\
Further, synergy estimation by registrants may introduce certain
subjective judgments into the pro forma financial statements,
potentially making them more difficult for investors to interpret.
However, the proposed amendments also would require registrants to
disclose uncertainties, assumptions, and calculation methods underlying
the Management's Adjustments. This could mitigate the risk of biased
pro forma adjustments by providing investors with more information to
evaluate Management's Adjustments when analyzing the impact of an
acquisition.
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    \278\ See Table 1 in Section V.B.1.
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11. Significance and Business Dispositions
    The proposed amendment to conform the significance threshold for a
disposed business to that of an acquired business and eliminate
disclosure of less significant dispositions would reduce
inconsistencies in reporting between acquisitions and dispositions and
potentially reduce registrants' compliance burden.\279\ For example,
under the proposed amendments, registrants would not have to file pro
forma financial information for insignificant dispositions (e.g.,
dispositions with significance levels exceeding 10% but not 20%), thus
reducing compliance costs. In addition, there could be some positive
spillover effect for registrants from applying the same thresholds to
determine the significance of their transaction. For example, a
registrant might engage in both acquisitions and dispositions during
the same reporting period. Identical thresholds might help achieve
internal consistency in financial reporting in evaluating the impact of
both types of transactions as well as the net effects. For investors,
the proposed amendment to conform the significance threshold for a
disposed business to that of an acquired business could facilitate
understanding and analysis of Rule 3-05 and Rule 11-01(b) disclosures
by eliminating the inconsistency in reporting between acquisitions and
dispositions.
---------------------------------------------------------------------------

    \279\ Under current requirements, pro forma financial
information is required upon the disposition (and for certain
registration statements and proxy statements, the probable
disposition of a significant portion of a business if the business
to be disposed of meets the conditions of a significant subsidiary
under Rule 1-02(w)). Rule 1-02(w) uses a 10% significance threshold,
not the 20% threshold used for business acquisitions under Rules 3-
05 and 11-01(b).
---------------------------------------------------------------------------

12. Smaller Reporting Companies and Regulation A
    The proposed amendments would revise Rule 8-04 to direct smaller
reporting companies to Rule 3-05 for requirements relating to the
financial statements of businesses acquired or to be acquired, although
the form and content requirements for these financial statements would
continue to be governed by Article 8. The proposed revisions to Rule 8-
04 would also apply to issuers relying on Regulation A. Since the form
and content of the required financial statements would continue to be
prepared in accordance with Article 8, we do not believe the proposed
amendments would impose additional compliance costs on affected
entities and do not expect the amendments to reduce information
available to investors.
    The proposed amendments to require smaller reporting companies to
provide pro forma financial information for significant acquisitions
and dispositions made during annual periods and to use the enhanced
guidelines in Article 11 when preparing pro forma financial information
would increase the burden on smaller reporting companies. However,
based on a staff analysis of 2017 disclosures of acquisitions and
dispositions by smaller reporting companies, we believe most already
comply with the conditions in Article 11.\280\ As a result, we do not
expect that the proposed amendments would impose significant new costs
on these entities. At the same time, the proposed amendments to require
smaller reporting companies to provide pro forma financial information
for significant acquisitions and dispositions made during annual
periods and to use the enhanced guidelines in Article 11

when preparing pro forma financial information may provide more
relevant information to investors, although this benefit also would be
limited to the extent that smaller reporting companies already comply
with these requirements in practice.
---------------------------------------------------------------------------

    \280\ See supra note 208.
---------------------------------------------------------------------------

13. Amendments to Financial Disclosure About Acquisitions Specific to
Investment Companies
    We believe the proposed amendments related to investment companies
would reduce compliance burdens by streamlining the disclosure
requirements in a way that is tailored to the specific attributes of
acquisitions made among investment companies. We do not anticipate
significant costs to investors related to the proposed amendments,
because we do not believe the proposed amendments would result in a
reduction in the volume of material information available to investors.
    Currently, there are no specific rules or requirements in
Regulation S-X for investment companies relating to the financial
statements of acquired funds. Instead, these entities apply the general
requirements of Rule 3-05 and the pro forma financial information
requirements in Article 11. However, investment company registrants
differ from non-investment company registrants in several respects. For
example, investment companies' income mainly stems from capital
appreciation and investment income; \281\ investment companies are
required to report their net asset value on a daily basis using fair
value for portfolio investments; and investment companies do not
account for their investments using the equity method. As a result,
investment companies have faced challenges applying the general
requirements of Rule 3-05 and Article 11 in the context of fund
acquisitions.
---------------------------------------------------------------------------

    \281\ Investment income includes dividend, interest on
securities, and other income, but does not include net realized and
unrealized gains and losses on investments. See Rule 6-07 of
Regulation S-X.
---------------------------------------------------------------------------

    The proposed amendments include a separate definition of
significant subsidiary and separate significance tests specifically
tailored for investment companies. The proposed amendments focus the
significance determination for investment companies on the impact to
the registrant's investment portfolio held by the registrant. Further,
the proposed test would capture sources of income such as dividends,
interest, and the net realized and unrealized gains and losses on
investment that are most relevant to investment companies. We expect
that together the proposed amendments would benefit both investment
companies and their investors by providing more appropriate standards
for determining the significance of fund acquisitions. For example, the
proposed income test would better align income from a particular
investment or acquisition for purposes of analyzing the effect on the
income of the investment company as a whole. We thus expect the
proposed income test to better reflect the impact of the tested
subsidiary on an investment portfolio rather than a test based solely
on investment income as used in current Rule 8b-2. This is because
changes in the market value of an investment portfolio due to market
volatility may be substantial even when the securities held in the
portfolio do not produce investment income.
    As a result of these changes, the proposed amendments may more
accurately identify acquisitions that are economically significant to
investment company registrants. This would benefit registrants as they
would not be required to prepare separate financial disclosure for
economically insignificant acquisitions. The proposed amendments also
may benefit investors to the extent that investors' attention now is
inappropriately focused on economically insignificant acquisitions that
are deemed significant under current rules. Furthermore, we do not
anticipate the proposed significance tests would impose substantial
costs on registrants to implement because we believe the required
measures should be readily available to registrants.
    The proposed change in the significance thresholds for the income
test in Rule 1-02(w) when it applies to investment companies has two
prongs--either a threshold of 80% for income alone or a 10% threshold
with the investment test result higher than 5%. This proposed threshold
change might reduce the compliance burden faced by investment companies
as there would be less need to produce additional financial information
when a registrant's net income is relatively small. Smaller net income
could produce anomalous results under the current income test as it may
make it appear as if an acquisition or investment is a significant
contribution to a registrant's net income when it represents only a
very small portion of the registrant's portfolio of investments. By
effectively conditioning the income test for investment companies on
the investment test for investment companies, the proposed amendments
would potentially better identify fund acquisitions that warrant
additional disclosure. This proposed change also could benefit
investors to the extent that they place a higher weight on the value of
investments, relative to the income produced by investments, when
considering the economic impact of an acquisition.
    The proposed elimination of an asset-based test for investment
companies would simplify compliance while likely not resulting in a
significant loss in information. An asset-based test is generally not
meaningful when applied to investment companies and, when the acquired
entity is another investment company, would be largely superfluous in
light of the proposed investment test. Additionally, applying the asset
test could be less meaningful when the tested subsidiary is not another
investment company. Because the asset test in these circumstances would
involve comparing assets measured under different methodologies, it may
be a less reliable indicator of significance, causing registrants to
incur costs to prepare disclosures for acquisitions that are not
economically significant--and therefore of little benefit to investors.
    Proposed new Rule 6-11 potentially reduces compliance burdens by
setting forth financial statement requirements for acquired funds that
are specifically tailored for investment companies as compared to Rule
3-05. Proposed Rule 6-11 would consider the acquisition of all or
substantially all portfolio investments held by another fund as a fund
acquisition. This principles-based facts and circumstances evaluation
of whether a fund acquisition has occurred could potentially reduce
avoidance of any required acquired fund disclosures by focusing on
economic substance rather than legal form. The proposed requirement of
one year of audited financial statements for fund acquisitions and
elimination of pro forma financial statements would also reduce
compliance burdens for registrants. We do not believe these proposed
amendments would lead to loss of relevant information to investors, as
the price of investment company shares is calculated daily based on the
fair value of its investment portfolio and older historical financial
statements are in general less relevant to fund investors. The proposed
amendments also would be consistent with the accommodations typically
provided by our disclosure review staff during consultations. The
proposed use of permitting investment companies to provide financial
statements for private funds that were prepared in accordance with U.S.
GAAP would reduce compliance burdens for investment companies by
potentially reducing the costs related to re-issuing audited

financial statements in compliance with Regulation S-X. Any loss of
information arising from these amendments would be mitigated by that
fact that we are proposing to require investment companies to file the
schedules required under Article 12 of Regulation S-X and to provide
certain supplemental information regarding the acquired funds. We
believe this information would be more relevant and potentially enhance
the efficiency in processing the information by fund investors. These
supplemental disclosures, however, would entail costs to registrants.
For purposes of the PRA, we estimate the average incremental compliance
burden for this additional disclosure would be around 25 hours per
affected registrant. We further estimate that proposed Rule 6-11 would
reduce a registrant's compliance burden by approximately 100 hours.

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

    We anticipate that the proposed amendments would have favorable
effects on efficiency, competition, and capital formation for both
operating companies and investment companies. Amendments that reduce
disclosure burdens for registrants regarding business acquisitions
would tend to facilitate registrants' engagement in acquisitions that
otherwise might not take place due to barriers to compliance or other
compliance costs. An active takeover market creates efficiencies by
transferring inefficiently managed assets to more efficient management
or by creating synergies through economy of scale or economy of scope.
On average mergers and acquisitions benefit investors in the acquired
business.\282\
---------------------------------------------------------------------------

    \282\ Empirical studies have shown that around M&A
announcements, the target firms earn a significant abnormal return
(See, e.g., G. Mandelker, 1974, ``Risk and Return: The Case of
Merging Firms'' Journal of Financial Economics, 1, (4), 303-335;
M.C. Jensen & R.S. Ruback, 1983, ``The Market for Corporate Control:
The Scientific Evidence'' Journal of Financial Economics, 11, (1-4),
5-50.
---------------------------------------------------------------------------

    The proposed amendments to revise the disclosure relating to
acquired and disposed businesses would benefit registrants by
potentially reducing compliance burdens and facilitating more timely
access to capital. Considering all registrants, including both
operating companies and investment companies, for PRA purposes, the
estimated reduction in the total number of incremental burden hours
required for compliance with all forms from the proposed amendments is
about 82,225 company hours.\283\ The resulting total incremental
professional costs for all forms under the proposed amendments would be
a reduction of approximately $21,470,000.\284\ We believe the potential
cost savings from the proposed amendments are significant.
---------------------------------------------------------------------------

    \283\ See Column E of Table 9 in Section V.C. below.
    \284\ See Column F of Table 9 in Section V.C. below.
---------------------------------------------------------------------------

    At the same time, we do not believe investors would face a
significant loss in information as a result of the proposed amendments.
Instead, we expect that the proposed amendments would provide investors
with more relevant information, which may allow them to process the
information more efficiently, enhancing their investment decisions and
thus potentially facilitating capital formation. Additionally, reduced
regulatory complexity may lead to an increase in mergers and
acquisitions. Under the existing disclosure requirements related to
acquired businesses, some mergers may not be feasible due to the
impracticality of compliance with Rule 3-05 Financial Statement
requirements (e.g., a private business may not have more than two years
of audited financial statements, but the transaction may trigger
additional disclosure because the business crosses the highest
significance threshold). Under the proposed amendments, registrants
might have access to a larger set of potential acquisitions. The
proposed amendments may also facilitate potentially value-enhancing
acquisitions that might otherwise not take place due to the
impracticability of compliance with current rules. For example, the
proposed amendments permitting the use of abbreviated financial
statements when acquiring certain business lines may decrease the
acquisition costs for registrants. This could promote competition in
the market for mergers and acquisitions and potentially benefit
shareholders of acquired businesses. Better disclosure quality and an
improved information environment could also facilitate the market for
mergers and acquisitions, which would help achieve efficient capital
allocation and exert effective external control mechanisms on public
firms, leading to an overall increase in efficiency.\285\
---------------------------------------------------------------------------

    \285\ Studies have found that mergers may create shareholder
value when the assets are transferred from inefficient management to
more efficient management. M. Mitchell and K. Lehn, 1990, ``Do Bad
Bidders Become Good Targets?'', Journal of Political Economy, Vol.
98; A. Agrawal and J. Jaffe, 2003, ``Do Takeover Targets
Underperform? Evidence from Operating and Stock Returns'', Journal
of Financial and Quantitative Analysis, Vol 38. K. Lehn and M. Zhao,
2006, ``CEO Turnovers after Acquisitions: Are Bad Bidders Fired?'',
Journal of Finance, Vol 61.
---------------------------------------------------------------------------

E. Alternatives Considered

1. Approaches to the Significance Tests
    One alternative to the proposed significance tests would be to
adopt a principles-based framework, such as materiality, rather than
the current bright-line tests for determining when financial statements
of acquired or to be acquired businesses are required. The benefit of
using a principles-based approach based on materiality to determine
significance is that it would permit judgment and consideration of
unique facts and circumstances. An additional benefit of such an
approach is that materiality is a familiar concept to registrants who
currently make materiality determinations in preparing their filings
with the Commission. However, while a principles-based approach is
frequently the appropriate standard for registrants to apply when
preparing disclosures, determinations related to business acquisitions
and dispositions pose unique challenges. Unlike periodic reporting,
acquisitions and dispositions tend to be episodic, and moreover, there
is less similarity between such transactions. As a result, it can be
difficult for registrants to efficiently make a determination of
materiality in an acquisition context, where timing considerations can
be paramount.
    Furthermore, unlike disclosure that relates solely to the
registrant, which is prepared by the registrant on an ongoing basis,
and where materiality is therefore evaluated regularly, in an
acquisition context registrants must rely on information provided by
third parties to make a determination of whether the acquisition is
significant and whether the related disclosure is material. A bright-
line test provides registrants with a level of certainty that allows
them to efficiently make determinations of what level of disclosure is
required in an environment where delay is costly. Also, where a
registrant determines not to provide disclosure, investors would not
receive information about the acquired business's financial impact on
the registrant until the operating results of the acquired business
have been reflected in the consolidated financial statements of the
registrant for an extended period of time. As a result, the impact of
the acquisition may be difficult for investors to disentangle from
other events at the registrant, even where the acquisition may be
economically significant. Thus, in summary, we expect a bright-line
threshold in the case of these disclosures could be less costly for
registrants and result in more consistent disclosure to investors where

transactions are of economic significance to a registrant.
    The Investment Test under the existing Rule 3-05 compares the
registrant's investment in and advances to the acquired business
against the carrying value of the registrant's total assets. The
proposed amendment to the ``Investment Test'' would use the aggregate
worldwide market value of the registrant's voting and non-voting common
equity calculated on the last day of the most recent fiscal year at or
prior to the acquisition. As an alternative to the proposed investment
test, we could have proposed requiring registrants to use enterprise
value for the acquirer and the acquired business, rather than the value
of common equity (for the acquirer) and investment in and advances to
the acquired business. Enterprise value may more comprehensively
reflect the value of the entity because it includes equity, debt,
minority interests, and preferred shares. When a registrant makes an
acquisition, depending on the ownership structure and capital structure
of the registrant and the acquired business, the purchase price or
investment in the acquired business would not necessarily reflect the
total effect of the acquisition on the registrant, particularly if the
acquired business is highly levered. Enterprise value would take into
consideration the leverage of the acquired business and may, in such
cases, better capture the economic effects of the transaction.
Enterprise value, however, may not be appropriate for an acquirer or
acquiree that has substantial liquid assets on its balance sheet.
Additionally, enterprise value may not be a consistent indicator of
relative size across registrants because capital structure (i.e.,
leverage) may be very different among registrants in certain
industries.
    With respect to the proposed modification to the Investment Test,
as noted earlier, because investors react to news and information, the
anticipation of an acquisition could cause a change in equity value of
both the potential acquirer and the potential acquired firm. More
generally, the market values of registrants are expected to change with
market conditions as well as firm-specific information. As a result, it
is possible that our proposed approach to the Investment Test, which
would require measurement of investments in an acquisition against the
acquirer's aggregate worldwide market value on the last day of the most
recent fiscal year at or prior to an acquisition, might not reflect all
the information about the value of the acquirer. As an alternative, we
could have proposed to require the registrant to use its average market
value over a period of time rather than on a specific day when
measuring the size of its investments. This approach would avoid
situations in which positive or negative market-wide or firm-specific
shocks lead to noisy measures of market value that result in inaccurate
assessments of significance, which may over- or under-identify
significant acquisitions. However, using average market value could
increase the costs and complexity of the proposed rule for registrants
and would raise questions about the appropriate choice of a required
measurement period (e.g., over a specified number of months or over the
entire reporting period).
    One alternative to the proposed Income Test would be to replace the
existing income test with a revenue test. A potential benefit of this
approach is that a revenue test would be less likely to produce
anomalous results because it does not include infrequent expenses,
gains, or losses that can distort the determination of relative
significance. However, a stand-alone revenue test may not be a
meaningful indicator of significance for the reasons the Commission
described when it eliminated revenue as a standalone significance
test.\286\
---------------------------------------------------------------------------

    \286\ See Release No. 6359 (November 6, 1981) [46 FR 56171
(November 16, 1981)] (``The proposed amendment reflects the
Commission's view that the presentation of additional financial
disclosures of an affiliated entity may not be meaningful in
instances in which the affiliate has a high sales volume but a
relatively low profit margin, and therefore has little financial
impact on the operating results of the consolidated group.'').
---------------------------------------------------------------------------

    A second alternative to the proposed Income Test would involve
switching from an income component to a revenue component when the
acquirer's net income or loss is marginal or break-even. Such an
alternative could rely on another financial ratio, such as return on
assets, to identify instances where the acquirer's net income is
sufficiently low to yield anomalous results from the income component.
For example, under such an alternative, the revenue component would be
used instead of the income component if the absolute value of the
acquirer's return on assets were less than one percent. Relative to the
proposed Income Test, such an alternative may have a lower risk of
under-identification of significant transactions if the proposed
revenue component causes transactions to not be significant under the
Income Test when the acquirer's net income is not marginal or break-
even and the Investment Test and Asset Test are not met. However, such
an approach would require identifying a financial ratio to serve as the
trigger for a switch from the income component to the revenue component
and, absent calibration, such a ratio may yield inconsistent results
across industries. For example, an appropriate threshold for return on
assets may vary across industries depending on the extent of an
acquirer's reliance on human capital versus material capital. Moreover,
for those that rely heavily on material capital, the information
provided by a return on assets threshold may be subsumed by the
existing Asset Test.
    A third alternative to the proposed Income Test would be to use an
operating income or profit margin component instead of the income
component. Operating income or profit margin could be a better
indicator of significance than the income component in that it may
eliminate the effects of non-operating items such as interest expense.
However, not all registrants report these income measures, and these
measures share the same issues as net income, which could lead to
similarly anomalous results.
    A final alternative to the proposed Income Test would be to lower
the threshold required to meet the revenue component, for example to
15% or 10%. A potential benefit of this approach is that it may
mitigate the risk of under-identification of significant transactions.
However, it may be difficult to calibrate the income component and
revenue component thresholds in a way that decreases the risk of under-
identification without increasing the risk of over-identification.
2. Approaches to Proposed Financial Statement Requirements
    An alternative to the required Rule 3-05 or Rule 3-14 Financial
Statements would be to require U.S. GAAP or IFRS-IASB, as applicable,
business combination disclosures, which include, among other things,
supplemental pro forma information about revenue and earnings for the
two years prior to the acquisition. Under this regime, registrants are
required to disclose information that enables users of a registrant's
financial statements to evaluate the nature and financial effect of a
business combination that occurs either: (a) During the current
reporting period, or (b) after the reporting date but before the
financial statements are issued or are available to be issued.\287\
These disclosures would eventually be required to be included in
registrants' historical audited financial statements presented for the
period in which the acquisition occurred, although the supplemental
information may continue

to be labeled as unaudited. However, compared with our proposed
approach, less information would be disclosed to investors under this
alternative, and the information would not be audited. Further,
guidance about the presentation and preparation of supplemental pro
forma information is limited, which potentially may impact the
consistency of pro forma presentations between registrants.
---------------------------------------------------------------------------

    \287\ See FASB ASC 805-10-50-1.
---------------------------------------------------------------------------

3. Approaches to Proposed Pro Forma Adjustments
    An alternative to the proposed Management's Adjustments for pro
forma financial statements is to limit the Management's Adjustments to
those that have been previously filed or furnished in Commission
filings. A potential benefit of this approach is that it would permit
the registrant to better determine whether and, if so, when forward-
looking information should be disclosed. The disadvantage of this
alternative is that pro forma disclosures may omit known information
such as reasonably estimable synergies and other transaction effects
that have occurred or are likely to occur. Also, under this
alternative, pro forma disclosures may not depict the potential effect
of the transaction on the registrant fully.
4. Alternatives to the Proposed Income Test for Investment Companies
    One alternative to the proposed income test for investment
companies would be to use the absolute value of gains and losses within
the income test components rather than netting them. Because netting
losses against gains mitigates the effect of individual securities on
overall results of the portfolio, the use of absolute value of gains
and losses for individual securities could result in a more accurate
assessment of the effects of the acquired fund securities on the income
of the acquiring fund. However, under this alternative, the registrant
would need to re-calculate the gain or loss for each individual
security using absolute value for both the acquiring fund and the
acquired fund, rather than using existing financial measures that have
already been determined for the financial statements, thereby
increasing the cost and complexity of the proposed test for registrants
without necessarily providing significant incremental benefits to
investors.
    Another alternative to the proposed income test for investment
companies would be to select a percentage lower than 80% for the
significance test. One potential benefit of using a lower percentage is
that it could reduce the possibility that an investment company
registrant would not need to provide disclosure for a fund acquisition
with a material impact on the acquiring fund's income. However, it
could also increase the possibility that costly disclosure obligations
would be triggered, even though the impact on the registrant's assets
is non-material (particularly if the income of the acquiring fund is
relatively low). The proposed combination of income/investment test is
intended to mitigate this result.
Request for Comment
    We request comment on all aspects of our economic analysis,
including the potential costs and benefits of the proposed amendments
and alternatives thereto, and whether the rules, if adopted, would
promote efficiency, competition, and capital formation or have an
impact on investor protection. Commenters are requested to provide
empirical data, estimation methodologies, and other factual support for
their views, in particular, on costs and benefits estimates.

V. Paperwork Reduction Act

A. Summary of the Collection of Information

    Certain provisions of our rules and forms that would be affected by
the proposed amendments contain ``collection of information''
requirements within the meaning of the PRA.\288\ The Commission is
submitting the proposal to the Office of Management and Budget
(``OMB'') for review in accordance with the PRA.\289\ The hours and
costs associated with preparing and filing the forms and reports
constitute reporting and cost burdens imposed by each collection of
information. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information requirement unless
it displays a currently valid OMB control number. Compliance with the
information collections is mandatory. Responses to the information
collections are not kept confidential and there is no mandatory
retention period for the information disclosed. The titles for the
affected collections of information are: \290\
---------------------------------------------------------------------------

    \288\ See 44 U.S.C. 3501 et seq.
    \289\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
    \290\ A number of forms require audited financial statements and
therefore could also include information required by Rule 3-05 and
Rule 3-14 such that the proposed amendments could affect the PRA
burden associated with those forms. Based on staff experience,
however, Rule 3-05 or Rule 3-14 Financial Statements are not
generally included in these forms. The potentially affected Forms
include ``Form S-4'' (OMB Control No. 3235-0324), ``Form S-11'' (OMB
Control No. 3235-0067), ``Form F-4'' (OMB Control No. 3235-0325),
``Form 20-F'' (OMB Control No. 3235-0288), ``Form 10-K'' (OMB
Control No. 3235-0063), ``Regulation 14A'' and ``Schedule 14A'' (OMB
Control No. 3235-0059), ``Regulation 14C'' and ``Schedule 14C'' (OMB
Control No. 3235-0057), ``Form 10-Q'' (OMB Control No. 3235-0070),
``Form 1-K'' (OMB Control No. 3235-0720), and ``Form 1-SA'' (OMB
Control No. 3235-0721). While the proposed amendments would also
apply to registered investment companies, based on staff experience,
Rule 3-05 or Rule 3-14 Financial Statements are not generally
included in ``Form N-3'' (OMB Control No. 3235-0316), ``Form N-4''
(OMB Control No. 3235-0318), ``Form N-5'' (OMB Control No. 3235-
0169), and ``Form N-6'' (OMB Control No. 3235-0503). Because we do
not expect these forms to be generally affected by the proposed
amendments, we are not adjusting the burden estimates associated
with these collections of information.
---------------------------------------------------------------------------

     ``Regulation S-X'' (OMB Control No. 3235-0009); \291\
---------------------------------------------------------------------------

    \291\ The paperwork burden for Regulation S-X is imposed through
the forms that are subject to the requirements in these regulations
and are reflected in the analysis of those forms. To avoid a PRA
inventory reflecting duplicative burdens, and for administrative
convenience, we assign a one-hour burden to this regulation.
---------------------------------------------------------------------------

     ``Form S-1'' \292\ (OMB Control No. 3235-0065);
---------------------------------------------------------------------------

    \292\ 17 CFR 239.11.
---------------------------------------------------------------------------

     ``Form S-3'' \293\ (OMB Control No. 3235-0073);
---------------------------------------------------------------------------

    \293\ 17 CFR 239.13.
---------------------------------------------------------------------------

     ``Form F-1'' (OMB Control No. 3235-0258);
     ``Form F-3'' (OMB Control No. 3235-0256);
     ``Form 10'' \294\ (OMB Control No. 3235-0064);
---------------------------------------------------------------------------

    \294\ 17 CFR 249.210.
---------------------------------------------------------------------------

     ``Form 8-K'' (OMB Control No. 3235-0060);
     ``Form N-1A'' \295\ (OMB Control No. 3235-0307);
---------------------------------------------------------------------------

    \295\ 17 CFR 239.15A; 17 CFR 274.11A.
---------------------------------------------------------------------------

     ``Form N-2'' \296\ (OMB Control No. 3235-0307);
---------------------------------------------------------------------------

    \296\ 17 CFR 239.14; 17 CFR 275.11a-1.
---------------------------------------------------------------------------

     ``Form N-14'' (OMB Control No. 3235-0336); and
     ``Form 1-A'' \297\ (OMB Control No. 3235-0286).
---------------------------------------------------------------------------

    \297\ 17 CFR 239.90.
---------------------------------------------------------------------------

    The regulations, schedules, and forms listed above were adopted
under the Securities Act, the Exchange Act, and/or the Investment
Company Act and set forth the disclosure requirements for registration
statements, periodic and current reports, and distribution reports
filed by registrants to help investors make informed investment and
voting decisions.
    We are proposing amendments to the financial statement requirements
for acquired and disposed businesses in Rules 3-05 and 3-14 and related
rules and forms. We are also proposing new Rule 6-11 and amendments to
Form N-14 to specifically govern financial reporting for acquisitions
involving

investment companies. A description of the proposed amendments,
including the need for the information and its proposed use as well as
a description of the likely respondents can be found in Section II
above, and a discussion of the economic effects of the proposed
amendments can be found in Section III above.

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
    The following table summarizes the estimated effects of the
proposed amendments on the paperwork burdens associated with the
affected forms filed by registrants with operations or that otherwise
are not investment companies.

       Table 1--Estimated Paperwork Burden Effects for Registrants
                    [Excluding investment companies]
------------------------------------------------------------------------
                              Estimated effect and  Brief explanation of
          Amendment              affected forms       estimated effect
------------------------------------------------------------------------
Rule 3-05, Rule 3-14, and     A reduction of 125     This
 related rules (e.g., Rule 1-  burden hours for      reduction is the
 02(w)).                       each of the           estimated effect on
                               following forms:      the affected forms
                               10, 1-A, S-1, S-3,    by the proposed
                               F-1, F-3, and 8-K.    amendments to Rules
                                                     3-05, 3-14, and the
                                                     related rules
                                                     (e.g., Rule 1-
                                                     02(w)), when
                                                     considered in the
                                                     aggregate and
                                                     compared to the
                                                     paperwork burden
                                                     under existing
                                                     requirements.
                                                     For PRA
                                                     purposes, we
                                                     estimate that
                                                     existing Rule 3-05
                                                     or Rule 3-14
                                                     Financial
                                                     Statements require
                                                     an average of 500
                                                     burden hours.\298\
Article 11 (Rules 11-01, 11-  An increase of 25      This
 02 and 11-03) and Rule 8-05   burden hours for      increase is the
 of Regulation S-X.            each of the           estimated effect on
                               following forms:      the affected forms
                               10, 1-A, S-1, S-3,    by the proposed
                               F-1, F-3, and 8-K.    amendments to the
                                                     pro forma financial
                                                     information
                                                     requirements under
                                                     Article 11,
                                                     including the
                                                     requirement to
                                                     provide certain
                                                     forward-looking
                                                     information, and
                                                     Rule 8-05 of
                                                     Regulation S-X when
                                                     considered in the
                                                     aggregate and
                                                     compared to the
                                                     paperwork burden
                                                     under existing
                                                     requirements.
                                                     For PRA
                                                     purposes, we
                                                     estimate that
                                                     existing pro forma
                                                     financial
                                                     information
                                                     requires an average
                                                     of 100 burden
                                                     hours.\299\
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a. Proposed Amendments to Rules 3-05 and 3-14
    Considering the various revisions outlined in Sections II.B and C
above, we estimate that the proposed amendments to Rule 3-05 and Rule
3-14 would generally reduce the paperwork burden for filings on an
affected form that includes existing Rule 3-05 or Rule 3-14 Financial
Statements. However, not all filings on the affected forms include
these disclosures because they are provided only in certain instances.
Therefore, to estimate the overall paperwork burden reduction from the
proposed amendments, we first estimated the number of filings that
include Rule 3-05 and Rule 3-14 Financial Statements. To do so,
Commission staff searched the various form types filed from January 1,
2017 until October 1, 2018 for indications of acquisition or
disposition disclosure.\300\ Based on the staff's findings, the table
below sets forth our estimates of the number of filings on these forms
that included Rule 3-05 or Rule 3-14 Financial Statements in calendar
year 2017 and the first nine months of 2018.
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    \298\ In response to the 2015 Request for Comment, no commenter
provided information that would assist us in deriving an estimate
for the cost of Rule 3-05 or Rule 3-14 Financial Statements. In
order to develop an estimate of the number of burden hours required
for an issuer to provide the existing financial statements, we have
relied on information derived from staff discussions with
registrants and consultants and from a review of recent waiver
request letters that cited the cost of compliance. Two waiver
request letters received in 2017 cited costs of complying with the
Rule 3-05 Financial Statement requirements ranging from $43,000 to
$200,000. Additionally, a consultant suggested a typical range of
audit fees as $100,000 to $250,000 and consulting fees of $40,000 to
$100,000. Using this data, we estimate that Rule 3-05 or Rule 3-14
Financial Statements require on average approximately 500 additional
burden hours to prepare. We believe that this estimate falls within
the range of costs suggested by the recent waiver requests and
consultant's estimate and would appropriately account for company
and professional hours required.
    \299\ In response to the 2015 Request for Comment, no commenter
provided information that would assist us in deriving an estimate
for the cost of pro forma financial information. In order to develop
an estimate of the number of burden hours required for an issuer to
provide pro forma financial information under existing rules, the
staff relied on its discussions with registrants and consultants.
Based on those discussions, we estimate that the required pro forma
financial information would be equivalent to approximately 20% of
the 500 total burden hours that we estimate would be required to
prepare Rule 3-05 or Rule 3-14 Financial Statements. While pro forma
financial information is an important aspect of acquired business
financial information disclosure, it is only an incremental part of
that disclosure, which also requires the production of acquired
business historical financial statements and audits of those
statements.
    \300\ To develop these estimates, Commission staff searched and
analyzed filings for the calendar year 2017 and the first nine
months of 2018 on the Intelligize research platform. Commission
staff then reviewed Forms S-1, S-3, F-1, F-3, S-11, 10, and 8-K,
using text and other searches for appropriate word combinations. The
staff then manually reviewed the filings to identify and more
accurately determine which filings contained Rule 3-05 and Rule 3-14
Financial Statements.

                  Table 2--Number of Filings on Affected Forms in the Reviewed 2017-2018 Period
----------------------------------------------------------------------------------------------------------------
                                                                                Number of
                                                                                filings
                                                                Number of      including 3-05     Percentage of
                           Form                                  filings           or 3-14      filings affected
                                                                                financial
                                                                                statements
                                                                         (A)               (B)               (C)
----------------------------------------------------------------------------------------------------------------
10........................................................               198                18               9.1
S-1.......................................................             1,369               118               8.6
S-3.......................................................             1,415               164              11.6
F-1.......................................................               169                 4               2.4
F-3.......................................................               321                 8               2.5
8-K.......................................................           118,195               949               0.8
----------------------------------------------------------------------------------------------------------------

    We used this data to extrapolate the effect of these changes on the
paperwork burden. In order to appropriately adjust the current burden
estimates, we applied these percentages to the current estimates for
the number of responses in the Commission's current OMB PRA filing
inventory.\301\
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    \301\ The OMB PRA filing inventories represent a three-year
average. Averages may not align with the actual number of filings in
any given year.

                Table 3--Calculation of the Number of Filings on Affected Forms for PRA Purposes
----------------------------------------------------------------------------------------------------------------
                                                                                Estimated number
                                                                Number of                          of filings
                                                               reponses in        Estimated      including 3-05
                                                               current PRA      percentage of        or 3-14
                                                                estimates     filings affected      financial
                                                                                statements
                                                                         (A)               (B)               (C)
----------------------------------------------------------------------------------------------------------------
10........................................................               216               9.1                20
1-A \302\.................................................               179              10.0                18
S-1.......................................................               901               8.6                78
S-3.......................................................              1657              11.6               192
F-1.......................................................                63               2.4                 2
F-3.......................................................               112               2.5                 3
8-K.......................................................           118,387               0.8               947
----------------------------------------------------------------------------------------------------------------

b. Proposed Amendments to Pro Forma Financial Information Requirements
    Considering the various revisions outlined in Section II.D above,
we estimate that the proposed amendments to Article 11 and Rule 8-05
would reduce a registrant's paperwork burden by simplifying disclosure
requirements generally, but may increase burdens by requiring certain
forward-looking information and, in the case of smaller reporting
companies, requiring pro forma financial information in some additional
circumstances \303\ and requiring that the information be provided in a
clearer and more robust manner. To estimate the overall paperwork
burden reduction from the proposed amendments, we first estimated the
number of filings that include Article 11 and Rule 8-05 pro forma
financial information. Because pro forma financial information is most
typically associated with acquisition and dispositions, we relied on
the estimates of affected forms that we determined for the Rule 3-05
and Rule 3-14 burden estimates, as set forth in Table 2 above.
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    \302\ Based on data from domestic registration statements, we
estimate that approximately 10% of Forms 1-A would be affected.
    \303\ The additional circumstances that would require a smaller
reporting company to present pro forma financial information under
the proposed amendments would include: Roll-up transactions as
defined in 17 CFR 229.901(c); when such presentation is necessary to
reflect the operations and financial position of the smaller
reporting company as an autonomous entity; and other events
transactions for which disclosure of pro forma financial information
would be material to investors.
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2. Estimated Effects of the Proposed Amendments on Paperwork Burdens
for Investment Company Registrants