11 to clarify when Rule 3-05 Financial Statements and pro forma
financial information are required and to update the language in the
rules to take into account concepts that have developed since their
original adoption over 30 years ago.
b. Comments
    Commenters were generally supportive of the proposed changes.\129\
Some commenters sought clarification that the ``applicable independence
standards'' in the proposed requirement that financial statements be
``prepared in accordance with this regulation (including the
independence standards in Sec.  210.2-01 or, alternatively if the
business is not a registrant, the applicable independence standards)''
would be those related to the auditing standards under which the
required financial statements of the acquired or to-be-acquired
business were audited.\130\

One commenter further recommended clarifying whether the reference to
``filed'' in the phrase in proposed Rule 11-01(b)(3) ``most recent
annual consolidated financial statements filed at or prior to the date
of acquisition or disposition'' is the same as ``required to be filed''
and how the phrase ``most recent annual financial statements of each
such business'' applies to nonpublic acquired or to-be-acquired
businesses.\131\ Another commenter recommended that the timing of the
pro forma financial information be accelerated to a date closer to when
the deal is announced to the public.\132\ Another commenter recommended
that the ``significant subsidiary'' definition should explicitly state
that the amounts used for testing should be derived from
``consolidated'' financial statements of the tested subsidiary and of
the registrant.\133\
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    \129\ See, e.g., letters from Cravath and Eli Lily.
    \130\ See letters from CAQ, Crowe, and RSM. See also letters
from KPMG (recommending ``independence standards would be those
applicable under the auditing standards used to perform the audit of
the acquired or to be acquired business'') and Deloitte
(recommending clarification as to whether ``applicable independence
standards'' refers to any independence standards other than those
described in either Article 2, Qualifications and Reports of
Accountants, or the independence standards of the AICPA).
    \131\ See letter from Deloitte.
    \132\ See letter from CFA (recommending four business days after
the occurrence of the event with the ability to extend the deadline
to a maximum of 30 days in order to balance the compliance burden
with the imperative of timely disclosure to the market). Item 9.01
of Form 8-K currently permits up to approximately 75 days after
consummation of an acquisition.
    \133\ See letter from Eli Lily.
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c. Final Amendments
    We are adopting the amendments substantially as proposed with some
additional changes reflecting the suggestions of commenters and our
further consideration of the proposals. Specifically, we are amending
Rule 3-05 and Article 11, as proposed, to:
     Specify that financial statements are required if a
business acquisition has occurred during the most recent fiscal year or
subsequent interim period for which a balance sheet is required by 17
CFR 210.3-01 of Regulation S-X (``Rule 3-01''), or if a business
acquisition has occurred or is probable after the date that the most
recent balance sheet has been filed; \134\ and
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    \134\ We are amending Rule 3-05(a)(1) to clarify when financial
statements are required and to conform the language in those
requirements with the current requirements in Rule 11-01(a).
Additionally, in conforming Rule 3-05(a)(1) with Rule 11-01(a), the
explanation that the acquisition of a business encompasses the
acquisition of an interest in a business accounted for by the equity
method was moved from Rule 3-05(a)(1)(i) to Rule 3-05(a)(2)(ii).
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     Provide in Rules 3-05(b)(3) and 11-01(b)(3)(i)(C) that a
registrant may continue to determine significance using amounts
reported in its Form 10-K for the most recent fiscal year when the
registrant has filed its Form 10-K after the acquisition consummation
date, but before the date the registrant is required to file financial
statements of the acquired business on Form 8-K.\135\
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    \135\ Pursuant to Rule 3-13, registrants have been permitted to
omit Rule 3-05 Financial Statements if an acquired business is not
significant using these amounts. We are establishing by rule that
registrants are permitted, rather than required, to use the Form 10-
K filed after consummation to measure significance in this
circumstance to avoid creating an incentive for registrants to delay
the filing of their Form 10-K.
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    We additionally are updating the terminology and language used by
revising Rule 3-05 and Article 11, as proposed, to:
     Clarify that ``financial statements'' need not include
related schedules specified in 17 CFR 210.12 (``Article 12''); \136\
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    \136\ Item 9.01(a)(2) of Form 8-K already provides that
supporting schedules of financial statements need not be filed and
the staff further applies this approach to acquired business
financial statements required in registration statements and proxy
statements. See FRM supra note 94 at Section 2005.2.
---------------------------------------------------------------------------

     Clarify that a ``business'' that is a real estate
operation is subject to Rule 3-14 instead of Rule 3-05;
     Clarify in Rule 3-05(a)(2)(ii) that Rule 3-05 applies when
the fair value option is used in lieu of the equity method to account
for an acquisition because the disclosure required by U.S. GAAP on a
post-acquisition basis, and related disclosure provided pursuant to
Rules 3-09 and 4-08(g), includes summarized financial information or
separate financial statements of the business after the acquisition;
     Replace the term ``furnish'' with ``file'' to make clear
that the information required by Rule 3-05 and Article 11 must be filed
with the Commission; \137\
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    \137\ Throughout Rule 3-05 and Article 11, the regulatory text
indicates that financial statements ``shall be furnished.'' See Rule
3-05(a)(1), (b)(1), (b)(2)(i), (ii), (iii), and (iv), and (b)(4)(ii)
and (iii), Rule 11-01(a) and Instruction 2 to Rule 11-02(b). At the
time the Commission adopted Rule 3-05, the Commission made no
distinction between ``furnished'' and ``filed.'' See Rule 3-05
Adopting Release.
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     Clarify that references to ``Regulation S-X'' in Rule 3-
05, Rule 3-14, and Rule 6-11 include the independence standards in 17
CFR 210.2-01 (``Rule 2-01'') unless the business is not a registrant,
in which case the applicable independence standards would apply;
     Replace references to the terms ``business combination''
and ``combination between entities under common control'' with the term
``business acquisition'' to make clear that Rule 3-05 and Article 11
are not limited to ``business combinations'' as that term is used in
U.S. GAAP and IFRS-IASB; \138\ and
---------------------------------------------------------------------------

    \138\ We similarly are adopting a conforming amendment to the
Instruction to Item 9.01 of Form 8-K.
---------------------------------------------------------------------------

     Replace the term ``majority-owned'' with the term
``subsidiaries consolidated,'' as that term more accurately conveys
which subsidiaries are required to be included in the registrant's
financial statements.\139\
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    \139\ Rule 3-05 uses the term ``subsidiaries consolidated'' to
conform to the term used elsewhere in Regulation S-X. See, e.g.,
Rule 1-02(w), Rule 3-01, and Rule 3-02. We additionally are
replacing the term in Item 2.01 of Form 8-K.
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    Finally, we are adopting the following clarifying amendments, as
proposed, to Rules 1-02(w), 3-05, Form 8-K and Article 11 to:
     Replace the reference to ``total assets'' of the tested
subsidiary in the Asset Test with the tested subsidiary's
``consolidated total assets'' as that term conveys more accurately the
amount to be used in the Asset Test; \140\
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    \140\ Consistent with a comment we received, we are adopting
this change to clarify that all amounts used in the significant
subsidiary tests that are derived from financial statements of the
tested subsidiary and the registrant should be based on consolidated
amounts. See supra note 133. The Investment Test and Income Test, as
proposed, already specified the requirement to use consolidated
amounts.
---------------------------------------------------------------------------

     Replace the term ``shall'' with clearer language, such as
by indicating when a registrant ``must'' file or disclose certain
information;
     Revise proposed Rule 11-01(b)(3) to:
    [cir] Simplify its organization;
    [cir] Clarify that it does not apply to the continuous real estate
offerings described in new Rule 11-01(b)(4); \141\
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    \141\ See Section II.C.6. Proposed Rule 3-14(b)(2)(iii) was
relocated and relabeled as Rule 11-01(b)(4).
---------------------------------------------------------------------------

    [cir] Replace the reference to ``filed'' with ``required to be
filed'' to more clearly reflect existing practice; \142\
---------------------------------------------------------------------------

    \142\ Use of ``required to be filed'' would also clarify that
the 15-day extension provided by Form 12b-25 does not serve to
revert the significance determination to an earlier year during the
15-day extension.
---------------------------------------------------------------------------

    [cir] Remove the reference to related real estate operations for
combined pre-acquisition financial statements; \143\ and
---------------------------------------------------------------------------

    \143\ The reference to related real estate operations is not
necessary in this context because only a modified Investment Test is
required for significance testing of these acquisitions.
---------------------------------------------------------------------------

    [cir] Clarify what financial statements of a nonpublic acquired or
to-be-acquired business must be used in the significance determination;
\144\
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    \144\ The amended rules replace the phrase ``most recent annual
financial statements of each such business'' with ``the business's
pre-acquisition or pre-disposition financial statements for the same
fiscal year as the registrant or, if the fiscal years differ, the
business's most recent fiscal year that would be required if the
business had the same filer status as the registrant.''

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     Revise Instruction 4 to Item 2.01 of Form 8-K to include
the same clarification of the scope of Rule 3-05 with regards to
interests in businesses that will be accounted for under the equity
method or, in lieu of the equity method, the fair value option; \145\
and
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    \145\ Item 2.01 of Form 8-K does not explicitly clarify the
treatment of interests in businesses that will be accounted for
under the equity method or, in lieu of the equity method, the fair
value option. However, the determination of whether an acquisition
involves a business is consistent between Item 2.01 of Form 8-K and
Rule 3-05, because both Instruction 4 to Item 2.01 of Form 8-K and
Rule 3-05(a)(2)(ii) refer to the same definition of a business in
Rule 11-01(d), and the requirements of Item 2.01 of Form 8-K are
linked to the requirements of Rule 3-05 through Item 9.01 of Form 8-
K. This amendment conforms Item 2.01 of Form 8-K to include the
additional clarification from Rule 3-05.
---------------------------------------------------------------------------

     Conform technical terminology inconsistencies throughout
the rules.\146\
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    \146\ For example, proposed Rule 3-05(c) has been amended to
include a reference to the definition of a foreign business in Rule
1-02(l) to be consistent with proposed Rule 3-05(d) which already
included the reference.
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    We are not adopting modifications to clarify, as requested by
commenters, the ``applicable independence standards'' in the proposed
requirement that financial statements be ``prepared in accordance with
this regulation (including the independence standards in Sec.  210.2-01
or, alternatively if the business is not a registrant, the applicable
independence standards)'' because the independence standards applicable
for a particular audit are not necessarily linked to the auditing
standards used for such an audit. For example, for purposes of auditing
non-issuer Rule 3-05 or Rule 3-14 Financial Statements, an auditor may
follow AICPA auditing and independence standards but also may elect to
perform the audit under PCAOB auditing standards. Our amendments are
not intended to change practice by referring to ``applicable
independence standards,'' but rather to acknowledge that for an
acquired or to be acquired business that is a non-issuer, an auditor is
not required to follow the independence standards in Rule 2-01 for
purposes of auditing Rule 3-05 and Rule 3-14 Financial Statements. As a
result, if the acquired or to be acquired business is not an issuer,
the auditor should look to the applicable ethics and independence
standards that would apply in issuing the audit report for such
business in satisfying the audit requirement for purposes of the Rule
3-05 and Rule 3-14 Financial Statements.
    We are also not adopting requirements to accelerate the timing of
providing pro forma financial information, as one commenter suggested.
For acquisitions, pro forma financial information is based on the
audited financial statements of the acquired business for periods prior
to the acquisition of the business by the registrant. In these
circumstances, our requirements provide additional time for registrants
to obtain acquired business pre-acquisition historical financial
statements, which we believe should also continue to extend to pro
forma financial information.\147\
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    \147\ See, e.g., Item 9.01 of Form 8-K.
---------------------------------------------------------------------------

6. Foreign Businesses
    Regulation S-X permits the use of IFRS-IASB without reconciliation
to U.S. GAAP in financial statements of foreign private issuers.\148\
Rule 3-05 similarly permits the use of IFRS-IASB in financial
statements of foreign businesses. However, if Rule 3-05 Financial
Statements of a foreign business are prepared on a basis of accounting
other than U.S. GAAP or IFRS-IASB, such as home-country GAAP, the Rule
3-05 Financial Statements are required to be reconciled to U.S. GAAP
even if the registrant is a foreign private issuer that prepares its
financial statements in accordance with IFRS-IASB.\149\
---------------------------------------------------------------------------

    \148\ See 17 CFR 210.4-01.
    \149\ See Item 17 of Form 20-F and Financial Statements of
Significant Foreign Equity Investees and Acquired Foreign Businesses
of Domestic Issuers and Financial Schedules, Release No. 33-7118
(Dec. 13, 1994) [59 FR 65632 (Dec. 20, 1994)] (``1994 Acquired
Foreign Business Release'').
---------------------------------------------------------------------------

    Further, while the definitions of ``foreign private issuer'' \150\
and ``foreign business'' \151\ have similarities, they have different
ownership requirements such that a business could qualify to be a
``foreign private issuer'' if it were a registrant, but not qualify to
be a ``foreign business'' when it is acquired by a registrant. In this
circumstance, a registrant acquiring such a business is not permitted
to present Rule 3-05 Financial Statements of the acquired business
prepared in accordance with IFRS-IASB, even when those financial
statements are already available and even though the acquired business
could present IFRS-IASB financial statements if it were a registrant.
Instead, the Rule 3-05 Financial Statements must be prepared in
accordance with U.S. GAAP.\152\
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    \150\ See Securities Act Rule 405. The term ``foreign private
issuer'' means any foreign issuer, other than a foreign government,
that does not meet the following criteria as of the last business
day of its most recently completed second fiscal quarter: (i) More
than 50 percent of the outstanding voting securities of such issuer
are directly or indirectly owned of record by residents of the
United States; and (ii) Any of the following: (a) The majority of
the executive officers or directors are United States citizens or
residents; (b) More than 50 percent of the assets of the issuer are
located in the United States; or (c) The business of the issuer is
administered principally in the United States.
    \151\ See 17 CFR 210.1-02(l). The term ``foreign business''
means a business that is majority owned by persons who are not
citizens or residents of the United States and is not organized
under the laws of the United States or any state thereof, and
either: (1) More than 50 percent of its assets are located outside
the United States; or (2) The majority of its executive officers and
directors are not United States citizens or residents.
    \152\ Alternatively, the Rule 3-05 Financial Statements may be
prepared in accordance with a basis of accounting other than U.S.
GAAP provided a reconciliation to U.S. GAAP under Item 18 of Form
20-F is included. See 1994 Acquired Foreign Business Release.
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a. Proposed Amendments
    The Commission proposed to permit Rule 3-05 Financial Statements
for an acquired foreign business prepared using home country GAAP to be
reconciled to IFRS-IASB rather than U.S. GAAP if the registrant is a
foreign private issuer that prepares its financial statements using
IFRS-IASB. The Commission also proposed to permit Rule 3-05 Financial
Statements to be prepared in accordance with IFRS-IASB without
reconciliation to U.S. GAAP if the acquired business would be a foreign
private issuer if it were a registrant.
b. Comments
    Commenters generally supported the proposal,\153\ with some
recommending providing additional relief by allowing reconciliation to
IFRS-IASB rather than U.S. GAAP for a business that prepares its
financial statements using home-country GAAP and does not meet the
definition of a foreign business but that would be a foreign private
issuer if it were a registrant.\154\ One commenter additionally
suggested that the Commission provide guidance on the applicability of
IFRS 1, First-time Adoption of IFRS,\155\ and accommodations under Form
20-F when reconciling to IFRS-IASB.\156\

Irrespective of the GAAP being applied or reconciled to, some
commenters recommended that the Commission consider permitting required
audit reports on the financial statements of acquired foreign
businesses to be prepared in accordance with International Standards on
Auditing (``ISAs'') issued by the International Auditing and Assurance
Standards Board.\157\
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    \153\ See, e.g., letters from Chris Barnard (``Barnard''),
Cravath, DT, NAREIT, Nasdaq, and PWC.
    \154\ See, e.g., letters from BDO, CAQ, DT, EY, KPMG, and RSM.
Some of these commenters recommended simplifying the rules by
expanding proposed Rule 3-05(c) and eliminating proposed Rule 3-
05(d). See, e.g., letters from CAQ, EY, KPMG, and RSM.
    \155\ IFRS 1 provides recognition, measurement, and disclosure
requirements, as well as certain transitional exceptions, for
entities that present IFRS-IASB financial statements for the first
time.
    \156\ See letter from DT. DT indicated that certain
accommodations offered under Form 20-F, Item 17, such as to not
remove the effects of inflation accounting pursuant to Item
17(c)(2)(iv)(2) when the conditions of IAS 29, Reporting in
Hyperinflationary Economies, are not met, or to not reconcile the
effects of proportionate consolidation for investments in joint
ventures pursuant to Item 17(c)(2)(vii), may be inconsistent with
IFRS- IASB requirements.
    \157\ See letters from Barnard, BDO, KPMG, and PWC.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments substantially as proposed, but with
some modifications after consideration of the comments received. We are
amending the rules in order to increase the consistency between the
basis of accounting used by acquired businesses and foreign private
issuers, as well as to permit acquired businesses and registrants to
avoid unnecessary costs, such as one-time presentations of the U.S.
GAAP reconciling information where such information would not be
material to investors.
    Specifically, we are adopting the proposed amendments to Rule 3-
05(c) to permit foreign private issuers that prepare their financial
statements using IFRS-IASB to reconcile Rule 3-05 Financial Statements
of foreign businesses prepared using home country GAAP to IFRS-IASB
rather than U.S. GAAP because this will provide more comparable
information and better facilitate analysis of the financial statements.
The reconciliation to IFRS-IASB is required generally to follow the
form and content requirements in Item 17(c) of Form 20-F.
    Additionally, we are adopting, as proposed, Rule 3-05(d) to permit
Rule 3-05 Financial Statements to be prepared in accordance with IFRS-
IASB without reconciliation to U.S. GAAP \158\ if the acquired business
would qualify as a foreign private issuer if it were a registrant. As
discussed in the Proposing Release, we believe financial statements
prepared in accordance with IFRS-IASB provide sufficient information
for investors for this purpose.\159\ In circumstances where the
registrant presents its financial statements in U.S. GAAP, the pro
forma financial information reflecting the acquisition will continue to
be required to be presented in U.S. GAAP.
---------------------------------------------------------------------------

    \158\ Under the rule, acquired foreign business financial
statements may use IFRS-IASB without reconciliation to U.S. GAAP,
even when the registrant prepares its financial statement using U.S.
GAAP.
    \159\ See Section II.A.6.a. of the Proposing Release.
---------------------------------------------------------------------------

    After considering comments received on the proposals, we are
modifying the proposed amendments to additionally permit an acquired
business that would qualify as a foreign private issuer if it were a
registrant to reconcile to IFRS-IASB rather than U.S. GAAP when the
registrant is a foreign private issuer that uses IFRS-IASB. We agree
with commenters that reconciliation to IFRS-IASB will provide more
comparable information and better facilitate analysis of the financial
statements in this circumstance as well.
    In response to comments, we are adopting two additional
modifications to the proposed amendments to clarify that:
     IFRS 1, First-time Adoption of IFRS, will be applicable
when reconciling to IFRS-IASB; and
     Form 20-F accommodations that are inconsistent with IFRS-
IASB will not be available when reconciling to IFRS-IASB.
    We believe it is appropriate to specify that IFRS 1 will be
applicable when reconciling Rule 3-05 Financial Statements to IFRS-
IASB, because a business that is reconciling to IFRS-IASB for the first
time will face many of the same challenges in determining the relevant
financial statement amounts as it would if it were directly presenting
its financial statements under IFRS-IASB for the first time. Similarly,
we believe it is appropriate to specify that Form 20-F accommodations
that are inconsistent with IFRS-IASB will not be available when
reconciling to IFRS-IASB. These accommodations, such as to not remove
the effects of inflation accounting when the conditions of IAS 29 are
not met or to not reconcile the effects of proportionate consolidation
in joint ventures,\160\ were adopted in the context of reconciling to
U.S. GAAP rather than IFRS-IASB. They were also adopted when the range
of accounting practices around the world was wider than it is today and
before IFRS-IASB was established in its current form. We believe that
use of accommodations that are inconsistent with IFRS-IASB would not
result in sufficient information for investors in this context.
---------------------------------------------------------------------------

    \160\ See supra note 156.
---------------------------------------------------------------------------

    We are not combining proposed Rule 3-05(c) and 3-05(d) as suggested
by some commenters. Rule 3-05(c) addresses the financial statement
requirements for an acquired business that meets the definition of a
foreign business. Rule 3-05(d) addresses the financial statement
requirements for an acquired business that does not meet the definition
of a foreign business but that would be a foreign private issuer if it
were a registrant. We believe that separate paragraphs will permit
registrants to more easily determine which requirements apply to their
acquired businesses. Separate paragraphs will also help to clarify that
foreign businesses under Rule 3-05(c) may apply the other applicable
accommodations in Form 20-F while the businesses that fall under Rule
3-05(d) cannot.\161\
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    \161\ For example, foreign businesses under Rule 3-05(c) may
apply the age of financial statement requirements in Item 8 of Form
20-F, and may apply the accommodation in Item 17(c)(2)(v) of Form
20-F that allows them to not reconcile their financial statements to
U.S. GAAP if the significance of the foreign business is below 30
percent.
---------------------------------------------------------------------------

    Finally, we are not adopting revisions to accept ISAs in audit
reports on Rule 3-05 Financial Statements of foreign businesses as
suggested by some commenters. Use of ISAs in Commission filings would
involve broader considerations than Rule 3-05 Financial Statements,
potentially including the appropriateness of their use for audits of
foreign private issuer financial statements. We believe such an
approach would require a thorough evaluation of the appropriateness of
the use of ISAs and is beyond the scope of these amendments.
7. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-04 provides smaller reporting company disclosure
requirements for the financial statements of businesses acquired or to
be acquired. Part F/S of Form 1-A (``Part F/S'') \162\ directs an
issuer relying on 17 CFR 230.251 through 230.263 \163\ to present
financial statements of businesses acquired or to be acquired,\164\ as
specified by Rule 8-04, but permits the periods presented to be the
shorter of those applicable to issuers relying on Regulation A and the
periods specified by Article 8.\165\
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    \162\ 17 CFR 239.90.
    \163\ Regulation A--Conditional Small Issues Exemption
(``Regulation A'').
    \164\ See paragraph (b)(7)(iii) of Part F/S of Form 1-A.
    \165\ See paragraph (b)(7) of Part F/S of Form 1-A.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to revise Rule 8-04 to reference to Rule 3-
05 for the requirements relating to the financial statements of
businesses acquired or to be acquired, other than for form and content
requirements for such financial statements, which would continue to be
prepared in accordance with 17 CFR 210.8-02 (``Rule 8-02'') and Rule 8-
03.\166\
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    \166\ Rule 3-05(b)(1) currently requires financial statements
specified in Rule 3-01 and 3-02 for the business to be acquired.
Similarly, Rule 3-05(b)(2) also references Rule 3-01 and 3-02. Under
the proposal, smaller reporting companies would apply Rule 3-05 but
would substitute Rule 8-02 and Rule 8-03, as applicable, wherever
Rule 3-05 references Rule 3-01 and 3-02. In this way, the proposal
was intended to apply the election permitted for smaller reporting
companies to prepare their financial statements in accordance with
the form and content requirements in Article 8 rather than the other
form and content requirements specified elsewhere in Regulation S-X
(subject to the exceptions noted in Rule 8-01 Preliminary Note 2 to
Article 8) to businesses acquired by smaller reporting companies.

---------------------------------------------------------------------------

    Additionally, because Part F/S of Form 1-A refers to Rule 8-04, the
proposed revisions to Rule 8-04 would apply to issuers relying on
Regulation A. As a result, under the proposed amendments, smaller
reporting companies would continue to be required to provide up to two
years of acquired business historical financial statements and issuers
relying on Regulation A would continue to be permitted to present the
shorter of the periods applicable under Regulation A and the periods
specified by Article 8.\167\
---------------------------------------------------------------------------

    \167\ Additionally, the proposed revisions would have expressly
permitted smaller reporting companies and issuers relying on
Regulation A to omit such financial statements if the acquired
business has been included in the registrant's results for a
complete fiscal year. See further discussion of omission of Rule 3-
05 Financial Statements in Section II.B.1 above. We also proposed to
add references to Rule 8-04 in Rule 3-06 and to Rule 3-06 in Note 6
to Article 8 to expressly permit smaller reporting companies and
issuers relying on Regulation A to file financial statements
covering a period of nine to 12 months to satisfy the requirement
for filing financial statements for a period of one year for an
acquired business.
---------------------------------------------------------------------------

b. Comments
    A few commenters provided comments specifically related to smaller
reporting companies and smaller issuers.\168\ One commenter expressly
supported the proposal to conform the rules applicable to smaller
reporting companies to the generally applicable rules.\169\ Other
commenters offered specific recommendations relating to smaller
registrants \170\ or generally suggested the Commission consider
whether issuers relying on Regulation A warrant different
treatment.\171\
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    \168\ See, e.g., letters from BDO, EY, MTBC, and RSM. See also
SBCFAC Recommendations.
    \169\ See letter from BDO.
    \170\ See letter from MTBC (recommending that smaller
registrants only apply the revenue component of the Income Test).
    \171\ See SBCFAC Recommendations (recommending that the
Commission continue to look at ``Regulation A companies and whether
they warrant different treatment under these rules'').
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments substantially as proposed. We are
revising Rule 8-04 to reference to Rule 3-05 for the requirements
relating to the financial statements of businesses acquired or to be
acquired, other than for form and content requirements for such
financial statements, which would continue to be prepared in accordance
with Rules 8-02 and 8-03. These revisions should ease compliance
burdens and clarify the application of our rules for smaller reporting
companies and issuers relying on Regulation A by focusing them on the
more complete and better understood provisions of Rule 3-05. They will
also expressly permit smaller reporting companies and issuers relying
on Regulation A to omit historical acquired business financial
statements if the acquired business has been included in the
registrant's results for either nine months or a complete fiscal year,
depending on significance.
    We are also revising Rule 8-01 as proposed, to add a paragraph
expressly permitting application of Rule 3-06 to the preparation of
financial statements of smaller reporting companies and issuers relying
on Regulation A \172\ and to amend the instruction in Item 9.01 of Form
8-K to include references to Rule 8-04 in order to conform the
instruction to the text of Item 9.01, which already addresses the rules
applicable to smaller reporting companies.
---------------------------------------------------------------------------

    \172\ In addition, we are revising Rule 8-01 to remove the
reference to the instruction relating to pro forma presentation
requirements. See Section II.D.3. In a non-substantive change from
our proposal, we are also renaming Rule 8-01 ``General Requirements
for Article 8'' and re-designating Notes 1 through 5 of Rule 8-01 as
paragraphs (a) through (e).
---------------------------------------------------------------------------

    We considered whether issuers relying on Regulation A should be
treated differently or whether smaller registrants should be subject to
further differentiated requirements, such as only complying with the
revenue component of the Income Test, as one commenter suggested. We
determined not to further differentiate disclosure for issuers relying
on Regulation A and smaller reporting companies because we think the
rules as adopted result in important investor information that we do
not believe should be further reduced or modified.\173\ We believe that
existing accommodations should offset some of the burden associated
with the disclosures that would be required by the rules. For example,
Rule 8-01(b) provides, with limited exceptions, that smaller reporting
companies electing to prepare their financial statements with the form
and content required by Article 8 need not apply the other form and
content requirements in Regulation S-X, and Form 1-A Part F/S provides
that, in certain circumstances, financial statements of businesses
acquired or to be acquired may be unaudited, may be for shorter periods
than provided in Rule 8-04, and need not be updated if the most recent
annual or interim balance sheet is not older than nine months. Further,
as discussed below, the final rules contain a number of provisions
that, while applicable to issuers of all sizes, should help ease the
burden of providing the required financial information for smaller
reporting companies and issuers relying on Regulation A.\174\
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    \173\ For example, we believe it is important that smaller
reporting companies and issuers relying on Regulation A be required
to provide pro forma financial information when consummation of
other transactions has occurred or is probable for which disclosure
of pro forma financial information would be material to investors.
See Section II.D.3. We also note that significance tests are not
one-size-fits-all tests, but instead contemplate the unique facts
and circumstances of a registrant or issuer because they measure
significance of the acquired or disposed business relative to the
registrant or issuer.
    \174\ For example, we believe the significance tests we are
adopting will provide more meaningful indicators of significance and
mitigate anomalous significance results.
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    As revised, Rule 8-04 continues to require up to two years of
acquired business historical financial statements. Additionally, and in
accordance with current practice, the revised rule expressly permits
smaller reporting companies to omit such financial statements if the
acquired business has been included in the registrant's results for a
complete fiscal year.\175\ We are also adding references to Rule 8-04
in Rule 3-06 and to Rule 3-06 in Article 8, as proposed, to expressly
permit smaller reporting companies to file audited financial statements
covering a period of nine to 12 months to satisfy the requirement for
filing financial statements for a period of one year for an acquired
business.
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    \175\ See further discussion of omission of Rule 3-05 Financial
Statements in Section B.1. above.
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    The amendments also provide that a smaller reporting company is
eligible to exclude acquired business financial statements from a
registration statement if the business acquisition was consummated no
more than 74 days prior to the date of the relevant final prospectus or
prospectus supplement, rather than 74 days prior to the effective date
of the registration statement as under current Rule 8-04(c)(4).\176\ We
believe it is appropriate to consistently look to the date of the final
prospectus or prospectus supplement for registrants,\177\ as Rule 3-05
currently

does, because that date could be later than the effective date,
particularly in the case of a delayed offering, which some smaller
reporting companies are now permitted to conduct.\178\ We are also
making conforming changes to Rule 8-05 for smaller reporting companies
to be consistent with the changes we are making to Article 11.\179\
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    \176\ See proposed Rule 3-05(b)(4)(i)(B).
    \177\ See 1996 Streamlining Release supra note 24 (noting that
the date of an offering is specified as the date of the final
prospectus or prospectus supplement relating to the offering).
    \178\ See General Instruction I.B.6 of Form S-3 and Amendments
to Smaller Reporting Company Definition, Release No. 33-10513 (June
28, 2018) [83 FR 31992 (July 10, 2018)].
    \179\ See Section II.D.3 below.
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B. Amendments Relating to Rule 3-05 Financial Statements Included in
Registration Statements and Proxy Statements

1. Omission of Rule 3-05 Financial Statements for Businesses That Have
Been Included in the Registrant's Financial Statements
    Rule 3-05(b)(4)(iii) generally permits Rule 3-05 Financial
Statements to be omitted once the operating results of the acquired
business have been reflected in the audited consolidated financial
statements of the registrant for a complete fiscal year. However, Rule
3-05 Financial Statements are required to be included when they have
not been previously filed, or when the Rule 3-05 Financial Statements
have been previously filed but the acquired business is of major
significance to the registrant.
    If Rule 3-05 Financial Statements have not been previously filed,
they must be provided even if the acquired business is included in
post-acquisition audited results. The staff has historically not
objected, however, to registrants reducing the Rule 3-05 Financial
Statement periods presented by the equivalent period that the acquired
business is included in the registrant's post-acquisition audited
results.\180\
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    \180\ The staff's position has been limited to circumstances
where there is no gap between the latest date of the pre-acquisition
audited financial statements of the acquired business and the
earliest date of the registrant's audited post-acquisition results.
See FRM supra note 94 at Section 2030.4 ``Initial Registration
Statements--Using Pre-Acquisition and Post-Acquisition Audited
Results.''
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    Registrants must also continue to present Rule 3-05 Financial
Statements that have been previously filed if the acquired business is
of such significance to the registrant that omission of those Rule 3-05
Financial Statements would materially impair an investor's ability to
understand the historical financial results of the registrant. Rule 3-
05 provides, as an example, that an acquired business meeting at least
one of the significance tests set forth in Rule 1-02(w) at the 80
percent level at the date of the acquisition would require the
registrant to continue to file the financial statements of the acquired
business. Notwithstanding the rule's reference to materiality, in
practice the rule is typically applied, consistent with this example,
on the basis of quantitative significance determinations.\181\
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    \181\ See, e.g., FRM supra note 94 at Section 2040.2 `` `Major
Significance' and Previously Filed Acquiree Financial Statements.''
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a. Proposed Amendments
    The Commission proposed to no longer require Rule 3-05 Financial
Statements in registration statements and proxy statements once the
acquired business is reflected in filed post-acquisition registrant
financial statements for a complete fiscal year. The Commission also
proposed to eliminate the ``major significance'' exception.
b. Comments
    Commenters generally supported the proposed amendments.\182\ One
commenter, however, encouraged the Commission to seek additional input
and consider whether the proposed amendments would provide investors
with sufficient information and whether additional financial statements
may be necessary above a certain significance threshold.\183\
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    \182\ See, e.g., letters from Bass Berry, BDO, CAQ, Cravath, DT,
Eli Lilly, FEI, KPMG, Pillsbury Winthrop Shaw Pittman, LLP, PWC, and
Nasdaq.
    \183\ See letter from GT. This commenter cited an example where
an initial public offering registrant consummates a very large
acquisition in the year prior to the most recently completed fiscal
year for which financial statements are being provided for the
registrant. The commenter noted that while the registrant would be
required to provide its historical financial statements for two
years, the acquired business's financial statements would be limited
to the period for which it is included in the registrant's post-
acquisition results. The commenter further observed that, in its
experience, disclosure pursuant to Regulation S-K, Item 303,
Management's discussion and analysis of financial condition and
results of operations, may not clearly isolate the effects of the
acquisition on results of operations. The commenter suggested as an
example that the Commission could consider requiring an initial
public offering registrant to provide financial statements for the
same number of periods as required in subsequent Securities Act and
Exchange Act filings or for the same number of periods as the 50
percent threshold would require, prior to proceeding with a
securities offering.
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    A number of commenters recommended permitting registrants to
exclude separate financial statements once the acquired business has
been included in the post-acquisition audited financial statements for
at least nine months.\184\ Commenters analogized to the Rule 3-06
requirements, noting that Rule 3-06 only requires nine months of pre-
acquisition audited financial statements for an acquisition that
exceeds 20 percent, but does not exceed 40 percent, significance.\185\
In expressing support for using nine months, one of these commenters
noted that the Commission could consider a requirement to disclose any
material information impacting any pre-acquisition period that would
otherwise be required absent the use of Rule 3-06 to supplement
required financial statements.\186\
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    \184\ See, e.g., letters from BDO, CAQ, Crowe, DT, EY, GT, KPMG,
PWC, and RSM.
    \185\ See, e.g., letters from BDO and DT. One of these
commenters further noted that staff practice as documented in FRM
2040.2 generally permits omission of previously filed acquired
business financial information once it is included in the
registrant's post-acquisition results for nine months. See letter
from DT. The other commenter recommended allowing omission of pre-
acquisition financial statements for businesses that exceed 20
percent, but do not exceed 40 percent, significance once they are
included in the registrant's audited post-acquisition results for
nine months and for businesses that exceed 40 percent significance
once they are included in the registrant's post-acquisition results
for a complete fiscal year. See letter from BDO.
    \186\ See letter from Crowe.
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c. Final Amendments
    We are adopting revisions substantially as proposed with some
modifications in response to comments received. Specifically, we are
adopting the proposed elimination of the requirement to include Rule 3-
05 Financial Statements in registration statements and proxy statements
once the acquired business is reflected in filed post-acquisition
registrant financial statements. However, in response to comments, we
are modifying the requisite time period.
    We are persuaded by commenters that our proposal unnecessarily
perpetuates existing differences in the length of reporting periods
that exist between Rule 3-05 and Rule 3-06 for an acquisition that is
at least 20 percent, but not more than 40 percent, significant. One
condition in Rule 3-05 for omitting Rule 3-05 Financial Statements is
that the acquired business has been included in the registrant's post-
acquisition results for a complete fiscal year. However, Rule 3-06
permits the filing of Rule 3-05 Financial Statements covering a period
of nine months to satisfy the Rule 3-05 requirement for filing
financial statements for a period of one year. While these reporting
periods relate to different circumstances, omission under Rule 3-05 as
compared to inclusion

under Rule 3-06, we do not believe those circumstances are sufficiently
different for acquisitions that are at least 20 percent, but not more
than 40 percent, significant (i.e., significant at the one year level)
to warrant disclosures for different time periods. To provide
consistency between the Rule 3-05 and Rule 3-06 requirements, the
amendments will allow omission of pre-acquisition financial statements
for businesses that exceed 20 percent but do not exceed 40 percent
significance once they are included in the registrant's audited post-
acquisition results for nine months (rather than the proposed complete
fiscal year).\187\
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    \187\ Rule 3-06 does not require incremental disclosure in order
for the filing of financial statements covering a period of nine
months to be deemed to satisfy a requirement for filing financial
statements for a period of one year. Because our amendments seek to
make Rule 3-05 more consistent with Rule 3-06, the final amendments
do not include an incremental disclosure requirement within Rule 3-
05 to disclose material information impacting any pre-acquisition
period that would otherwise be required absent the use of amended
Rules 3-05 and 3-06. However, we observe that existing requirements,
such as those in Item 303 of Regulation S-K, Management's discussion
and analysis of financial condition and results of operations, and
Rule 4-01(a) would require such disclosure when it is material to
the registrant, and we believe that information would be sufficient
for this purpose.
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    Because Rule 3-06 limits the use of a nine month period to
financial statements that would otherwise be required for a period of
one year, the amendments retain the existing complete fiscal year Rule
3-05 requirement when Rule 3-05 Financial Statements for a period of
two years are required (i.e., significance exceeds 40 percent).
Specifically, the amendments allow omission of pre-acquisition
financial statements for businesses that exceed 40 percent significance
once they are included in the registrant's post-acquisition results for
a complete fiscal year.
    These final amendments also eliminate the requirement that Rule 3-
05 Financial Statements be provided when they have not been previously
filed or when they have been previously filed but the acquired business
is of major significance. This requirement can delay a registrant's
offering and thereby its access to capital, while providing information
that is often less meaningful to investors, because the utility of pre-
acquisition periods diminishes over time after the acquired business is
reflected in post-acquisition results, and because the post-acquisition
results of the combined business are generally not comparable to the
pre-acquisition results of the acquired business.\188\ Similarly for
financial information provided regarding acquisitions of ``major
significance,'' the utility of pre-acquisition periods diminishes over
time after the acquired business is reflected in post-acquisition
results. Additionally, with electronic filing requirements, which were
established after the ``major significance'' rule, previously filed
financial information about the acquired business is readily accessible
through the Commission's EDGAR filing system.
---------------------------------------------------------------------------

    \188\ See FRM supra note 94 at Section 2030.4. The accommodation
provided by Commission staff did not sufficiently ameliorate these
effects and often resulted in financial statements of the acquired
business that depicted partial, rather than complete, reporting
periods that did not coincide with the end of either the acquired
business's or the registrant's fiscal periods.
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    We believe inclusion of post-acquisition results in the
registrant's audited financial statements for the requisite time period
should generally provide investors with sufficient information to make
informed investment decisions about the registrant. Further, even
without the major significance requirement to include some, but not
all, of the previously filed pre-acquisition financial statements of
the acquired business, Regulation S-X provides that a registrant must
provide ``such further material information as is necessary to make the
required statements, in light of the circumstances under which they are
made, not misleading.'' \189\
---------------------------------------------------------------------------

    \189\ See Rule 4-01(a).
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    We are not persuaded that additional financial statements of
acquired businesses should be provided in initial registration
statements when an acquisition is reflected in post-acquisition audited
results for nine months when the acquisition is significant at the one
year level or included for a complete fiscal year when the acquisition
is significant at the two year level. Pre-acquisition financial
statements by their nature are less likely to be indicative of the
current financial condition, changes in financial condition, and
results of operations of the acquired business as they age. If, in an
unusual circumstance, pre-acquisition financial statements are
necessary for the protection of investors even though the acquired
business has been included in the registrant's post-acquisition results
for a complete fiscal year, then Rule 3-13 permits the Commission staff
by delegated authority to require the filing of the pre-acquisition
financial statements.
    We also believe that rightsizing our acquired business financial
statement requirements appropriately balances the need to provide
investors with information necessary for making informed investment
decisions with the goal of minimizing compliance costs that can delay
or preclude access to public markets, particularly when going public
may not have been contemplated at the time an acquisition
occurred.\190\
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    \190\ In adopting these changes, we note that Item 303 of
Regulation S-K requires identification of known trends, demand,
commitments, events and uncertainties and Rule 4-01(a) of Regulation
S-X requires that a registrant provide ``such further material
information as is necessary to make the required statements, in
light of the circumstances under which they are made, not
misleading.''
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2. Use of Pro Forma Financial Information To Measure Significance
    A registrant is generally permitted to use pro forma, rather than
historical, financial information to test significance of a
subsequently acquired business if the registrant made a significant
acquisition after the latest fiscal year-end and filed its Rule 3-05
Financial Statements and pro forma financial information on Form 8-
K.\191\ However, this Form 8-K filing requirement has the practical
effect of precluding the use of pro forma financial information that
gives effect to a significant acquisition subsequent to the latest
fiscal year-end to test significance of a subsequently acquired
business when determining Rule 3-05 disclosure requirements in initial
registration statements. While Commission staff has considered the
results of significance tests using pro forma financial information in
considering whether to permit omission or substitution of acquired
business financial statements in initial registration statements of
registrants growing through acquisition, those circumstances have been
limited.\192\ Further, Regulation S-X does not provide for dispositions
of significant businesses to be included in the pro forma financial
information used for testing significance of a subsequently acquired or
subsequently disposed business.
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    \191\ See Rule 3-05(b)(3).
    \192\ Consistent with the staff's exercise of delegated
authority in response to requests under Rule 3-13, Staff Accounting
Bulletin No. 80, Application of Rule 3-05 in Initial Public
Offerings (``SAB 80'') states that the staff will not object if
significance is measured using the alternative method specified in
SAB 80. The SAB 80 method is similar to Rule 3-05, but the
accommodations in SAB 80 are complex and seldom used by registrants.
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a. Proposed Amendments
    For all filings that require Rule 3-05 Financial Statements and
Rule 3-14 Financial Statements, the Commission proposed to expand the
circumstances in which a registrant can use pro forma

financial information for significance testing by permitting
registrants to measure significance using filed pro forma financial
information that only depicts significant business acquisitions and
dispositions consummated after the latest fiscal year-end for which the
registrant's financial statements are required to be filed, subject to
certain conditions.
b. Comments
    Commenters generally supported the amendments.\193\ However, one
commenter stated that once a registrant chooses to use pro forma
financial information for significance testing, the registrant should
be required to use the approach consistently until the next annual
report on Form 10-K is filed,\194\ consistent with current staff
guidance.\195\
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    \193\ See letters from Cravath, Eli Lilly, FEI, GT, Nasdaq, and
S&C.
    \194\ See letter from GT. GT additionally recommended that the
Commission clarify in the final rules that pro forma financial
information used to determine significance may be different from pro
forma financial information that was previously filed if it gave
effect to other transactions. They also recommended that the
Commission clarify how pro forma financial information for previous
acquisitions or dispositions be used for determining the
significance of subsequent acquisitions or dispositions in
connection with an initial registration statement, given that pre-
acquisition financial statements and pro forma financial information
for the previous transactions could not have been previously filed
in the case of a confidential submission and the first public filing
of an IPO registration statement.
    \195\ See FRM supra note 94 at Section 2025.3, which indicates
registrants should use a consistent approach for determining
significance until the filing of the next annual report on Form 10-
K.
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c. Final Amendments
    We are adopting the amendments substantially as proposed, but with
some modifications after consideration of the comments received.
Specifically, for filings that require Rule 3-05 Financial Statements
and Rule 3-14 Financial Statements, we are amending Rule 11-01(b)(3) to
permit registrants to measure significance using filed pro forma
financial information that only depicts significant business
acquisitions and dispositions consummated after the latest fiscal year-
end for which the registrant's financial statements are required to be
filed, subject to the following conditions:
     The registrant has filed Rule 3-05 Financial Statements or
Rule 3-14 Financial Statements for any such acquired business; \196\
and
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    \196\ We believe this condition clarifies that if the required
Rule 3-05 Financial Statements and pro forma financial information
for one or more significant business acquisitions consummated after
the registrant's most recently completed fiscal year required to be
filed are included in an initial registration statement, then those
acquisitions may be included in the pro forma financial information
used to measure significance of a business acquired subsequent to
those acquisitions for purposes of determining whether Rule 3-05
Financial Statements of the subsequently acquired business, and
related pro forma financial information, are required in the initial
registration statement.
---------------------------------------------------------------------------

     The registrant has filed the pro forma financial
information required by Article 11 for any such acquired or disposed
business.\197\
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    \197\ We are revising Rule 3-05(b)(3) and Rule 3-14(b)(2) to
replace the existing guidance with a specific reference to Rule 11-
01(b)(3). We are also including in Rule 11-01(b)(3) the statement in
the current rule that the tests may not be made by ``annualizing''
data.
---------------------------------------------------------------------------

    We additionally are amending Rule 11-01(b)(3) as proposed to add a
reference to Rule 11-02(b)(6)(i), but relocating it within amended Rule
11-01(b)(3), to clarify that when determining significance the pro
forma financial information must be limited to the applicable amounts
that combine the historical financial information of the registrant and
the acquired business and Transaction Accounting Adjustments.\198\ We
also are amending Rule 11-01(b)(3) to indicate that the pro forma
financial information that is used to measure significance may only
give effect to the subsequently acquired or disposed business and may
not give effect to Autonomous Entity Adjustments, Management's
Adjustments, if any, or other transactions, such as the use of proceeds
from an offering. Further, we are persuaded to modify the proposal to
clarify that once a registrant uses pro forma financial information to
measure significance, it must continue to use pro forma financial
information to measure significance until the next annual report on
Form 10-K or Form 20-F. This modification will codify current
practice,\199\ provide for a more relevant indicator of significance,
and ensure greater consistency in the significance determinations.
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    \198\ See Section II.D.1.c.
    \199\ See supra text accompanying note 195.
---------------------------------------------------------------------------

    We believe these amendments will provide registrants with the
flexibility to more accurately determine the relative significance of
an acquired or disposed business to the ongoing operations of the
registrant, including for those filing an initial registration
statement, without inadvertently delaying or accelerating the filing of
pro forma financial information that might occur if we required use of
such pro forma financial information to determine significance.
3. Disclosure Requirements for Individually Insignificant Acquisitions
    Under the existing rules, audited historical pre-acquisition
financial statements are generally not required if an acquired or to be
acquired business: (1) Does not exceed 20 percent significance, or (2)
does not exceed 50 percent significance and the acquisition has not yet
occurred or the date of the final prospectus or prospectus supplement
relating to an offering (as filed with the Commission pursuant to 17
CFR 230.424(b)) is no more than 74 days after consummation and the
financial statements have not been previously filed.\200\ However, if
the aggregate impact of ``individually insignificant businesses'' \201\
acquired since the date of the most recent audited balance sheet filed
for the registrant exceeds 50 percent, audited historical pre-
acquisition financial statements covering at least the substantial
majority of the businesses acquired must be included in a registration
statement or proxy statement.\202\ Registrants also must provide
related pro forma financial information based on the requirements of
Article 11.\203\
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    \200\ See Rule 3-05(b)(4)(i).
    \201\ In the 1996 Streamlining Release (see supra note 24), Rule
3-05 was amended to permit the exclusion of historical financial
statements for certain significant acquisitions that did not exceed
50 percent significance. See Rule 3-05(b)(4)(i). Commission staff
has interpreted ``individually insignificant businesses'' to
include: (a) Any acquisition consummated after the registrant's
audited balance sheet date whose significance does not exceed 20
percent; (b) Any probable acquisition whose significance does not
exceed 50 percent; and (c) Any consummated acquisition whose
significance exceeds 20 percent, but does not exceed 50 percent, for
which financial statements are not yet required by Rule 3-05(b)(4)
because of the 75-day filing period. See FRM supra note 94 at
Section 2035.2.
    \202\ See Rule 3-05(b)(2)(i). ``Substantial majority'' has been
applied in practice to be the mathematical majority (i.e.,
businesses constituting more than 50 percent of the relevant test
(investment, asset or income) on which the businesses were
determined to be significant in the aggregate) See FRM supra note 94
at Section 2035.3 ``Financial Statements Required--Mathematical
Majority.''
    \203\ Rule 11-01(a) specifies conditions for which pro forma
financial information must be presented. Those conditions do not
explicitly discuss the aggregate significance of individually
insignificant businesses, however they do include, ``consummation of
a significant business combination or a combination of entities
under common control [that] has occurred or is probable'' and
``consummation of other events or transactions has occurred or is
probable for which disclosure of pro forma financial information
would be material to investors.'' Further, Rule 11-01(c) links the
requirement for pro forma financial information for a significant
business acquisition to the presentation of separate financial
statements of the acquired business. Taken together, these
requirements provide that if separate financial statements of the
substantial majority of individually insignificant businesses are
presented, pro forma financial information depicting their effects
must also be presented.
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a. Proposed Amendments
    The Commission proposed amending Rule 3-05 to no longer require
separate

financial statements for the majority of the individually insignificant
acquired businesses when the aggregate impact of businesses acquired or
to be acquired since the date of the most recent audited balance sheet
filed for the registrant, for which financial statements are either not
required or not yet required because of the registration (or proxy)
statement grace period, exceeds 50 percent. In conjunction with this
change, the proposed amendments would require registrants to provide
pro forma financial information depicting the aggregate effects of all
such businesses in all material respects. In addition, the proposed
amendments would have required pre-acquisition historical financial
statements only for those businesses whose individual significance
exceeds 20 percent, but that are not yet required to file financial
statements.
b. Comments
    Commenters generally supported the proposal to no longer require
Rule 3-05 Financial Statements for businesses whose individual
significance does not exceed 20 percent.\204\ One commenter recommended
the Commission consider including both Rule 3-05 businesses and Rule 3-
14 real estate operations when determining the aggregate impact for
individually insignificant acquisitions and providing guidance on how
to perform the aggregations.\205\ Another commenter recommended against
including them both together due to the difference in the types of
transactions covered.\206\
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    \204\ See, e.g., letters from Cravath, DT, Eli Lilly, FEI, and
GT.
    \205\ See letter from GT.
    \206\ See letter from Cravath.
---------------------------------------------------------------------------

    Some commenters expressed concern that the new requirements could
create burdens for registrants relating to the proposed requirements to
file financial statements for multiple significant acquisitions or the
proposed requirements to provide detailed financial information about
individually insignificant acquisitions that may not be readily
available or may not have been provided to the registrant during its
due diligence.\207\ Other commenters expressed concern that requiring
pro forma financial information that depicts aggregate impacts in ``all
material respects'' could lead to interpretive issues necessitating a
definition or examples.\208\ Some commenters also expressed concern
that accountants may not be able to provide negative assurance to
underwriters on the combined pro forma financial information where
historical financial statements included in the pro forma financial
information for individually insignificant acquisitions have not been
reviewed or audited.\209\ In contrast, one commenter suggested that the
procedures required for auditors to provide negative assurance to
underwriters on comfort letters are fairly limited and that the
proposed changes should not materially impact the auditor's ability in
this regard.\210\
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    \207\ See letters from GT and DT. See also letter from Cravath
(recommending retaining an option permitting a registrant to include
a majority of the acquired businesses in the pro forma presentation
or alternatively only requiring historical pre-acquisition financial
statements and pro forma financial information if the individually
insignificant businesses together exceed 50 percent under the Income
Test).
    \208\ See letters from GT and RSM.
    \209\ See letters from BDO, CAQ, Cravath, Crowe, DT, GT, and
RSM. Some commenters noted that PCAOB AS 6101 would prohibit
accountants from providing negative assurance on combined pro forma
financial information for which historical financial statements have
not been audited or reviewed. See letters from BDO, CAQ, Crowe, GT,
and RSM.
    \210\ See letter from CFA.
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c. Final Amendments
    We are adopting the amendments substantially as proposed, but with
some modifications after consideration of the comments received. The
amendments to Rule 3-05 are intended to reduce the burdens of preparing
disclosure about immaterial acquisitions and negotiating with sellers
to timely provide historical financial statements, while the new
requirement to provide pro forma financial information that shows the
aggregate effect of the acquired businesses in all material respects
should make it easier for investors to understand the overall effect of
those acquisitions on the registrant. Under current rules, registrants
often provided separate, audited historical financial statements for
acquired businesses that were individually not material to the
registrant, and pro forma financial information that did not fully
depict the aggregate effect of the ``individually insignificant
businesses'' because currently Article 11 only requires pro forma
financial information for an acquisition for which Rule 3-05 Financial
Statements are required.\211\ The proposed amendments should address
these anomalies, to the benefit of both registrants and investors.
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    \211\ For example, if the aggregate of 16 individually
insignificant acquisitions is 80 percent significant, with each at
five percent, a registrant would be required to provide pre-
acquisition audited historical financial statements for nine of the
individually insignificant businesses. Thus, the pro forma financial
information would only depict the effect of those nine acquisitions
constituting 45 percent of the registrant's pre-acquisition assets
or income.
---------------------------------------------------------------------------

    Similar to existing requirements, and as proposed, amended Rule 3-
05(b)(2)(iv) will require disclosure if the aggregate impact of
businesses acquired or to be acquired since the date of the most recent
audited balance sheet filed for the registrant, for which financial
statements are either not required by paragraph (b)(2)(i) or are not
yet required based on paragraph (b)(4)(i), exceeds 50 percent for any
condition.\212\ In this way, the amendments clarify that ``individually
insignificant businesses'' include: (a) Any acquisition consummated
after the registrant's audited balance sheet date whose significance
does not exceed 20 percent; (b) Any probable acquisition whose
significance does not exceed 50 percent; and (c) Any consummated
acquisition whose significance exceeds 20 percent, but does not exceed
50 percent, for which financial statements are not yet required by Rule
3-05(b)(4) because of the 75-day filing period.\213\
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    \212\ For clarity, we specifically describe the affected
businesses in the final rule without reference to the term
``individually insignificant businesses.'' We also inserted ``for
any condition'' to clarify that the aggregation is done separately
for each condition (e.g. the investment, asset and income test);
that is, the conditions are not combined when assessing whether the
``exceeds 50 percent'' threshold is met.
    \213\ This amendment is consistent with existing practice. See
FRM supra note 94 at Section 2035.2.
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    As proposed, the amended rule will require registrants to provide
pre-acquisition historical financial statements only for those
businesses whose individual significance exceeds 20 percent.\214\ In
conjunction with this change, the amended rule, also as proposed, will
require registrants to provide pro forma financial information
depicting the aggregate effects of all ``individually insignificant
businesses'' in all material respects.\215\ Further, we are revising
Rule 11-01(c) to clarify that the exception that would otherwise permit
pro forma financial information not to be provided when separate
financial statements of the acquired

business are not included in the filing does not apply where the
aggregate impact is significant as determined by amended Rules 3-
05(b)(2)(iv) or 3-14(b)(2)(i)(C). While several commenters suggested
that this requirement could raise interpretive issues, we believe the
concept of materiality is well established in our rules, and we are not
persuaded at this time that additional guidance is necessary in order
for registrants to make this determination.
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    \214\ Registrants will have to negotiate the timely provision of
historical balance sheet and income statement information for each
acquisition necessary to present pro forma financial information
depicting their aggregate effects in all material respects when
aggregate significance exceeds 50 percent, but historical financial
statements only for acquisitions that will be required to be
reported on Form 8-K (i.e., individual significance exceeds 20
percent). The amendments could accelerate reporting of historical
financial statements for these acquisitions (i.e., individual
significance exceeds 20 percent) in certain registration statements
and proxy statements if the combined acquisitions exceed 50 percent
significance.
    \215\ See amended Rule 3-05(b)(2)(iv) and revisions to Rule 11-
01(c).
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    After considering comments received, we are modifying the proposed
rule to require registrants to include both Rule 3-05 businesses and
Rule 3-14 real estate operations when determining the aggregate impact
of the Investment Test for individually insignificant acquisitions. We
are persuaded that such a modification is consistent with our objective
of aligning Rule 3-14 with Rule 3-05 because unique industry
considerations do not warrant differentiating Rule 3-05 businesses and
Rule 3-14 real estate operations, particularly as the modification will
apply only to registrants that acquire both Rule 3-05 businesses and
Rule 3-14 real estate operations. The final amendments limit this
modification to the Investment Test because the Asset Test and Income
Test do not apply to Rule 3-14 real estate operations.
    Consistent with the existing requirement, \216\ we have modified
the proposed amendments to Rule 3-05 to indicate that, in determining
whether the Income Test condition (i.e. both the revenue component and
the net income component) exceeds 50 percent, the businesses specified
in Rule 3-05(b)(2)(iv) reporting losses must be aggregated separately
from those reporting income. We also have modified the rule to clarify
that if either group exceeds 50 percent, the disclosure requirements
apply to all of the businesses subject to the aggregate test and must
not be limited to either the businesses with losses or those with
income.
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    \216\ See Computational Note 1 to Rule 1-02(w). See also FRM
supra note 94 at Section 2035.5.
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    We acknowledge that, consistent with existing requirements, the
amended aggregate test applies to businesses acquired or to be acquired
subsequent to the most recently completed fiscal year. Because some of
those acquisitions may have already occurred upon the effective date of
the amended rules, we are persuaded that the concern expressed by some
commenters about the availability of information to comply with the
amended aggregate test necessitates transition guidance.\217\
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    \217\ See Section II.F.
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    Separately, we acknowledge concerns expressed as to whether
accountants will be able to provide negative assurance to underwriters
on the combined pro forma financial information where historical
financial statements included in the pro forma financial information
for individually insignificant acquisitions have not been reviewed or
audited. We recognize that, in some circumstances, accountants may need
to perform additional work to be able to provide negative assurance. We
also observe that the ``reasonable investigation'' and ``reasonable
care'' provisions of Sections 11 and 12 of the Securities Act are also
fact specific and depend on a variety of factors. Whether steps taken
to provide the required disclosures satisfy ``reasonable
investigation'' or ``reasonable care,'' or whether additional work is
needed to provide negative assurance, should be determined by
accountants and their clients based on facts and circumstances.
Although accountants and their clients may need to take additional
steps in certain circumstances, we believe those concerns are
outweighed by the need to improve the usefulness of information
provided to investors when the aggregate impact of the specified
acquired or to be acquired businesses exceed 50 percent, rather than
requiring audited financial statements that are not necessary to
reasonably inform investors or pro forma financial information that is
materially incomplete in its depiction of the aggregate impact.

C. Rule 3-14--Financial Statements of Real Estate Operations Acquired
or To Be Acquired

    Rule 3-14 differs from Rule 3-05, in part, because unique industry
considerations for real estate operations warrant differentiated
disclosure. If a registrant has acquired or, in certain circumstances,
proposes to acquire one or more properties which in the aggregate are
significant, Rule 3-14 requires the registrant to file only abbreviated
income statements. If the real estate operation is not acquired from a
related party, audited Rule 3-14 Financial Statements are required for
only one year. In those circumstances where a registrant is permitted
to provide one year of financial statements, Rule 3-14 also requires a
registrant to describe with specificity the material factors it
considered in assessing the real estate operation.\218\
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    \218\ See Rules 3-14(a)(1)(ii) and 3-14(a)(1)(iii). The material
factors include sources of revenue (including, but not limited to,
competition in the rental market, comparative rents, and occupancy
rates) and expense (including, but not limited to, utility rates,
property tax rates, maintenance expenses, and capital improvements
anticipated). The disclosure must also indicate that the registrant
is not aware of any other material factors relating to the specific
real estate operation that would cause the reported financial
statements not to be indicative of future operating results. If the
registrant does not meet the Rule 3-14(a)(1) conditions, three years
of Rule 3-14 Financial Statements are required.
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    The Commission proposed to further align Rule 3-14 with Rule 3-05
where no unique industry considerations exist because the rules have
similar objectives. The Commission also proposed to clarify the
application of Rule 3-14 regarding scope of the requirements,\219\
determination of significance, need for interim income statements, and
special provisions for blind pool offerings.\220\
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    \219\ In some circumstances, registrants acquire a real estate
operation subject to a triple net lease with a single lessee. A
triple net lease typically requires the lessee to pay costs normally
associated with ownership of the property, such as property taxes,
insurance, utilities, and maintenance costs. Under existing
practice, registrants often provide audited financial statements of
the lessee or guarantor of the lease, instead of the Rule 3-14
Financial Statements of the real estate operation, when the lessee
is considered significant. The proposal did not, and these
amendments do not, differentiate this type of acquisition or specify
alternatives to Rule 3-14 for this type of acquisition, because the
activity depicted in the Rule 3-14 Financial Statements is
consistent with how the triple net lease arrangement may affect the
registrant's results of operations. No commenters that commented on
this topic recommended that the Commission require audited financial
statements of the lessee or guarantor. See letters from EY, BDO, and
GT.
    \220\ See Section II.C.6 below.
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1. Align Rule 3-14 With Rule 3-05
    Under the current rules, Rule 3-14 and Rule 3-05 diverge in a
number of areas. Rule 3-14 refers to acquisitions that are
``significant''; however, neither ``significant property'' nor
``significant real estate operation'' are defined in Regulation S-X.
Current practice looks to the 10 percent significance threshold in the
definition of ``significant subsidiary'' in Rule 1-02(w) when
determining ``significance'' under Rule 3-14.\221\ Additionally, Rule
3-14 Financial Statements are currently required when the registrant
has acquired or proposes to acquire a group of properties that are
significant in the aggregate. In practice, consummated and probable
acquisitions since the date of the most recent audited balance sheet
that are less than 10 percent significant are aggregated and, if the
significance of the aggregated group exceeds 10 percent, Rule 3-14
Financial Statements are provided for each acquisition that is five
percent or more significant and for

enough other acquisitions in order to cover the substantial majority of
the group.\222\ Additionally, Rule 3-14 requires registrants to provide
three years of financial statements for significant acquisitions from
related parties.
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    \221\ See FRM supra note 94 at Section 2310.1 ``Registration
Statements and Proxy Statements--Requirements.''
    \222\ See FRM supra note 94 at Section 2320.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed amendments to align Rule 3-14 with Rule 3-
05 where no unique industry considerations warranted differentiated
treatment. Specifically, the proposed amendments would have, among
other things:
     Aligned thresholds in Rule 3-14 with the 20 percent
significance threshold and 50 percent aggregate impact significance
threshold in Rule 3-05;
     Eliminated the Rule 3-14 requirement to provide three
years of Rule 3-14 Financial Statements for acquisitions from related
parties;
     Applied Rule 3-06 to Rule 3-14 acquisitions;
     Included the same timing requirements for Rule 3-14
Financial Statements in registration statements and proxy statements as
Rule 3-05; and
     Permitted Rule 3-14 Financial Statements to be omitted
once the acquired real estate operation had been reflected in filed
post-acquisition registrant financial statements for a complete fiscal
year.
    The Commission additionally proposed to align Rule 3-14 with the
relevant proposed Rule 3-05 amendments discussed in Sections II.A. and
II.B. above.
b. Comments
    Commenters that specifically addressed Rule 3-14 generally
supported the proposals.\223\ However, some commenters noted that
proposed Rule 3-14(c)(2)(iii) would require that the notes to the Rule
3-14 Financial Statements include information about the real estate
operation's operating, investing and financing cash flows, to the
extent available, and questioned whether such historical information
would be comparable to proposed future operations and why such
disclosure should be required since Rule 3-14 Financial Statements
include only statements of revenues and expenses that may omit expenses
not comparable to proposed future operations.\224\
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    \223\ See, e.g., letters from Barnard, Cravath, BDO, CAQ,
Deloitte, EY, GT, KPMG, NAREIT, and RSM.
    \224\ See letters from BDO, CAQ, and RSM.
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c. Final Amendments
    We are adopting the amendments as proposed. As discussed in the
Proposing Release, we believe that further aligning Rule 3-14 with Rule
3-05 will reduce complexity by standardizing the requirements for
acquired businesses overall while retaining the industry specific
disclosure necessary for investors to make informed investment
decisions.\225\
---------------------------------------------------------------------------

    \225\ See Section II.C.1 of the Proposing Release.
---------------------------------------------------------------------------

    Specifically, we are adopting amendments as proposed regarding:
    Significance Thresholds. We are aligning the Rule 3-14 significance
threshold for individual acquisitions to the 20 percent threshold for
acquired businesses in Rule 3-05.\226\ We are also aligning the Rule 3-
14 significance threshold for the aggregate impact of acquisitions to
the 50 percent threshold in Rule 3-05. Aligning Rule 3-14 with Rule 3-
05 will remove ambiguity by defining which businesses must be
aggregated and the significance threshold that applies, and by
clarifying that this requirement applies only to certain registration
statements and proxy statements and not to Form 8-K.
---------------------------------------------------------------------------

    \226\ The Commission raised the threshold in Rule 3-05 from 10
percent to 20 percent in 1996 in order to reduce compliance burdens
in response to concerns that the requirement to obtain audited
financial statements for a business acquisition may have caused
companies to forgo public offerings and to undertake private or
offshore offerings. See 1996 Streamlining Release supra note 24. As
a result of this amendment, the significance thresholds in Rule 3-05
have diverged from those used for Rule 3-14 since that time.
---------------------------------------------------------------------------

    Years of Required Financial Statements for Acquisitions from
Related Parties.\227\ We are aligning Rule 3-14 with Rule 3-05 by
eliminating the specific requirement to provide three years of
financial statements for acquisitions from related parties. Rule 3-05
does not differentiate the number of periods for which historical
financial statements are required based on whether the seller is a
related party or not, and we are not aware of any unique industry
considerations that warrant different requirements for Rule 3-14.
---------------------------------------------------------------------------

    \227\ It is common for transactions in initial registration
statements in the real estate industry to involve the combination of
multiple entities with related or common ownership. In those
circumstances, certain acquired entities may be designated as a
predecessor of the registrant. For purposes of financial statements,
an acquired business is designated as a predecessor when a
registrant succeeds to substantially all of the business (or a
separately identifiable line of business) of another entity (or
group of entities) and the registrant's own operations before the
succession appear insignificant relative to the operations assumed
or acquired. See the definition of ``predecessor'' in Securities Act
Rule 405. Financial statements specified in Rules 3-01 and 3-02 are
required for acquisitions of a predecessor, including those from
related parties, rather than Rule 3-05 or Rule 3-14 Financial
Statements. These amendments will not affect those requirements.
---------------------------------------------------------------------------

    Application of Rule 3-06. We are aligning the application of Rule
3-14 with Rule 3-05 by revising Rule 3-06 to permit the filing of
financial statements covering a period of nine to 12 months to satisfy
the requirement for filing financial statements for a period of one
year for an acquired or to be acquired real estate operation. Existing
Rule 3-06(b) provides that financial statements required under Rule 3-
05 ``covering a period of 9 to 12 months shall be deemed to satisfy a
requirement for filing financial statements for a period of 1 year,''
but it did not address acquired real estate operations under Rule 3-14.
    Timing of filings. We are amending Rule 3-14 to include the same
period for the filing of Rule 3-14 Financial Statements in registration
statements and proxy statements as exists under Rule 3-05.\228\
---------------------------------------------------------------------------

    \228\ See supra note 15 and accompanying text discussing the
Rule 3-05 filing period.
---------------------------------------------------------------------------

    Omission of Rule 3-14 Financial Statements for Real Estate
Operations That Have Been Included in the Registrant's Financial
Statements. We are aligning the application of Rule 3-14 with the
amendments to Rule 3-05 by no longer requiring Rule 3-14 Financial
Statements in registration statements and proxy statements once the
acquired real estate operation is reflected in filed post-acquisition
registrant financial statements for nine months.\229\
---------------------------------------------------------------------------

    \229\ See discussion of the omission of Rule 3-05 Financial
Statements in Section 1II.1B.3. above. The provision in Rule 3-05
regarding omission of financial statements for acquisitions
exceeding 40 percent significance is inapplicable in Rule 3-14.
---------------------------------------------------------------------------

    Additional Amendments. We are making additional amendments, as
proposed, to align Rule 3-14 with Rule 3-05 where there are no unique
industry considerations that suggest a business subject to Rule 3-14
should be treated differently than a business subject to Rule 3-05.
Many of these amendments will not affect how registrants currently
comply with Rule 3-14 because existing practice already analogizes to
Rule 3-05 for guidance. Specifically, we are clarifying that:
     ``To be acquired'' real estate operations must be
evaluated under the rule only if they are probable of acquisition;
\230\
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    \230\ Rule 3-14 currently uses the phrase ``proposes to
acquire'' when discussing ``to be acquired'' real estate operations
and does not explicitly limit the scope to acquisitions probable of
acquisition. The amendment codifies the current practice of
interpreting this phrase to mean ``probable of acquisition.'' See
FRM supra note 94 at Section 2310.1

---------------------------------------------------------------------------

     The acquisition of an interest in a real estate operation
accounted for using the equity method \231\ or, in lieu of the equity
method, the fair value option, is considered the acquisition of a real
estate operation;
---------------------------------------------------------------------------

    \231\ See FRM supra note 94 at Section 2305.4.
---------------------------------------------------------------------------

     Rule 3-14 does not apply to a real estate operation that
is totally held by the registrant prior to consummation of the
transaction; \232\
---------------------------------------------------------------------------

    \232\ See Rule 3-05(a)(4), as amended. See also Rule 1-02(y) for
the definition of the term ``totally held subsidiary.''
---------------------------------------------------------------------------

     If registering an offering of securities to the security
holders of the real estate operation to be acquired, the financial
statements for the acquired real estate operation must cover the
periods specified in Rules 3-01 and 3-02, except as provided otherwise
for filings on Forms N-14, S-4 or F-4, and that the financial
statements covering those fiscal years must be audited except as
provided in Item 14 of Schedule 14A with respect to certain proxy
statements or in registration statements filed on Forms N-14, S-4, or
F-4; \233\
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    \233\ See Rule 3-05(b)(1), as amended.
---------------------------------------------------------------------------

     Related real estate operations must be treated as a single
acquisition for significance testing; \234\ and
---------------------------------------------------------------------------

    \234\ See Rules 3-05(a)(3) and 3-14(a)(3), as amended. Real
estate operations are considered related if they are under common
control or management, the acquisition of one real estate operation
is conditional on the acquisition of each other real estate
operation, or each acquisition is conditioned on a single common
event.
---------------------------------------------------------------------------

     Pro forma amounts are permitted for significance testing
in certain circumstances consistent with the application in Rule 3-
05.\235\
---------------------------------------------------------------------------

    \235\ See Rules 3-05(b)(3) and 11-01(b)(3), as amended.
---------------------------------------------------------------------------

    The amendments also clarify that Rule 3-14 Financial Statements
should be prepared and audited in accordance with Regulation S-X and
that they should be for the period that the real estate operation has
been in existence, if that period is shorter than the period explicitly
required for the financial statements.\236\ In addition, the amendments
conform the requirements related to acquisitions of foreign real estate
operations in Rule 3-14 to the analogous provisions in Rule 3-05.\237\
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    \236\ See Rules 3-05(a)(1), 3-05(b)(2), 3-14(a)(1), and 3-
14(b)(2), as amended.
    \237\ See Rules 3-05(c) and 3-14(d), as amended, and Rules 3-
05(d) and 3-14(e).
---------------------------------------------------------------------------

    Aside from the substance of the rules, the amendments also conform
the organization and format of certain related rules and forms, as
appropriate. We are amending Item 8 of Form 10-K which currently
excepts registrants from complying with Rule 3-05 and Article 11, to
include Rule 3-14,\238\ instead of retaining the exception in Rule 3-14
itself. We are also conforming the general format and wording of Rule
3-14 to Rule 3-05, as appropriate, for consistency and to make the rule
easier to follow.\239\
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    \238\ See Item 8(a) of Form 10-K.
    \239\ The changes in Rule 3-14 to conform wording include the
addition of a paragraph similar to amended Rule 3-05(b)(1) about
financial statements for certain proxy statements and registration
statements on Forms S-4 and F-4, as well as the elimination of
outdated industry-specific paragraphs (a)(2) and (3), which specify
certain disclosures for circumstances that seldom occur today. We
are also eliminating the Instruction in Item 9 of Form S-11, which
refers back to the guidance in paragraphs (a)(2) and (3) of Rule 3-
14.
---------------------------------------------------------------------------

    Finally, we are also revising Form 8-K to:
     Clarify that Item 2.01 requires the disclosure of the
acquisition or disposition of assets that constitute a significant real
estate operation as defined in Rule 3-14; \240\
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    \240\ While Item 2.01 currently only requires that significant
acquisitions and dispositions be reported if they are not in the
ordinary course of business, in practice registrants provide Item
2.01 disclosure for acquisitions of significant real estate
operations regardless of whether the acquisition or disposition was
in the ordinary course of business. See Note to FRM supra note 94 at
Section 2310.3.
---------------------------------------------------------------------------

     Address the filing requirements in Item 9.01(a)
consistently for all business acquisitions, including real estate
operations; and
     Revise Item 2.01 Instruction 4 to reference Rule 3-14 to
make clear that, as with Rule 3-05, the aggregate impact of
acquisitions of real estate operations is not required to be reported
unless these acquisitions are related real estate operations and
significant in the aggregate.
    Also, as proposed, we are adopting amendments to conform Rule 3-14
to the Rule 3-05 amendments being adopted in this release where no
unique industry considerations exist. Specifically, we are amending
Rule 3-14 to conform to the amendments described in Section II.A.1.c
(Investment Test only), Section II.A.3.c (related only to certain
required footnote disclosures),\241\ Section II.A.5.c, Section
II.A.6.c, Section II.B.1.c (excluding the requirement related to
acquisitions that exceed 40 percent significance, which does not apply
to Rule 3-14), Section II.B.2.c and Section II.B.3.c.
---------------------------------------------------------------------------

    \241\ The footnote disclosure to provide an explanation of the
impracticability of preparing financial statements that include the
omitted expenses is not applicable to Rule 3-14 Financial Statements
because Rule 3-14 does not contain an impracticability condition.
See note 12. With respect to the footnote disclosure related to
historical cash flows, we acknowledge, as observed by some
commenters, that certain historical cash flows of a real estate
operation may not be comparable to proposed future operations.
However, we believe that there is also cash flow information that
would be meaningful to investors if available, for example,
disclosure regarding historical cash flows for capital improvements.
We are, therefore, adopting this requirement as proposed.
---------------------------------------------------------------------------

2. Definition of Real Estate Operation
    Neither Regulation S-X nor any other Securities Act or Exchange Act
rule provides a definition of a ``real estate operation'' or an
explanation of what is meant by the reference to ``properties'' in Rule
3-14. Because the terms are open to interpretation, Commission staff
has provided guidance as to the meaning of these terms.\242\ The
Commission staff has interpreted, for purposes of Rule 3-14, a real
estate operation to refer to properties that generate revenues solely
through leasing,\243\ but has not interpreted this definition to
preclude a property that includes a limited amount of non-leasing
revenues (like property management or other services related to the
leasing) from being considered a real estate operation.\244\ The
Commission staff has additionally provided guidance that a real estate
operation includes real properties that will be held directly by the
registrant or through an equity interest in a pre-existing legal entity
that holds the real property under lease and related debt.\245\
---------------------------------------------------------------------------

    \242\ See FRM supra note 94 at Section 2305.1 ``Applicability of
S-X 3-14,'' and Section 2305.2, ``Nature of Real Estate
Operations.''
    \243\ See FRM supra note 94 at Section 2305.2.
    \244\ Examples of such properties include office, apartment, and
industrial buildings, as well as shopping centers and malls. A real
estate operation excludes properties that generate revenues from
operations other than leasing, such as nursing homes, hotels,
motels, golf courses, auto dealerships, and equipment rental
operations because these operations are more susceptible to
variations in revenues and costs over shorter periods due to market
and managerial factors.
    \245\ See FRM supra note 94 at Section 2305.3 ``Investment in a
Pre-Existing Legal Entity.''
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a. Proposed Amendments
    The Commission proposed to amend Rule 3-14 to define a real estate
operation as ``a business that generates substantially all of its
revenues through the leasing of real property,'' which is consistent
with current practice and staff interpretations \246\ and to remove the
unnecessary condition in Rule 11-01(a)(5) that clarifies that Article
11 applies to real estate operations.
---------------------------------------------------------------------------

    \246\ The proposed amendment used the term ``business (as set
forth in Sec.  210.11-01(d))'' in the definition of a real estate
operation to address the fact that the acquisition of a real estate
operation may be through an entity holding real property under lease
or of a direct interest in the real property. See proposed Rule 3-
14(a)(2).
---------------------------------------------------------------------------

b. Comments
    We received limited comment specific to the proposed definition of
real estate

operations. Two commenters explicitly supported the definition, and no
commenters opposed it.\247\ One of these commenters recommended adding
``or substantially all the assets of which are held for lease'' in
order to include real property that is not currently leased, but is
being acquired with the intention of leasing and has more than a
nominal leasing history.\248\ This commenter further recommended
amending Rule 11-01(d) to clarify that there is a presumption that real
property that is leased or held for lease to third parties constitutes
a business. In addition, the same commenter recommended that we
consider explicitly addressing real properties that have a limited
leasing history or leasing history that is unrepresentative of expected
future operations.\249\ Another commenter recommended the Commission
further clarify the meaning of ``substantially all.'' \250\
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    \247\ See letter from Cravath and NAREIT.
    \248\ See letter from NAREIT.
    \249\ See letter from NAREIT. See also FRM supra note 94 at
Section 2330.8 ``Rental History of Less Than Nine Months,'' Section
2330.9, ``Exception for Demolition'' and Section 2330.10 ``Exception
for Properties with No or Nominal Leasing History'' for related
staff guidance.
    \250\ See letter from GT.
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c. Final Amendments
    We are amending Rule 3-14 to define a real estate operation as
proposed as ``a business that generates substantially all of its
revenues through the leasing of real property.'' We considered
clarifying what is meant by ``substantially all'' in this context, as
one commenter suggested. However, this term is not meant to be a bright
line, and its application will depend on specific facts and
circumstances. Accordingly, we are not making any changes in this
regard.
    We also considered whether additional language is necessary to
address an acquisition of real property that is not leased and
generating revenues upon acquisition, but was historically leased and
is intended to be leased again in the near future. However, we do not
believe that the definition, as proposed, requires any changes, because
in these circumstances a registrant should consider whether the lack of
revenues at acquisition may be unrepresentative based on the existence
of a leasing history and the expected continuation of the leasing
operation, and thus could still conclude that it is a business that
generates substantially all of its revenues through the leasing of real
property. We also considered whether we should add language to address
acquisitions of real property with a limited leasing history or a
leasing history that is unrepresentative of expected future operations.
However, we believe those situations are best addressed through Rule 3-
13.\251\
---------------------------------------------------------------------------

    \251\ See Rule 3-13 supra note 58.
---------------------------------------------------------------------------

    We believe the definition we are adopting appropriately frames the
application of Rule 3-14, reduces uncertainty regarding the meaning of
the term, and serves to clarify the rule without changing the substance
of how it is currently applied. In light of the adopted definition that
clarifies that a real estate operation is a ``business'' as that term
is used in Article 11, we are removing the condition in Rule 11-
01(a)(5) as it is no longer necessary.\252\
---------------------------------------------------------------------------

    \252\ We considered whether Rule 11-01(d) should include a
presumption that real property that is leased or held for lease is a
business, but we believe it is more appropriate for registrants to
evaluate for each acquisition the facts and circumstances included
in the rule to determine if it constitutes a business.
---------------------------------------------------------------------------

3. Significance Tests
    As noted above, Rule 3-14 does not provide explicit guidance on how
to determine whether a real estate operation is significant. Due to the
nature of a real estate operation, staff interpretations have sought to
focus registrants on the Investment Test in Rule 1-02(w), adapted to
compare the registrant's and its other subsidiaries' ``investments in''
\253\ the real estate operation, including any debt secured by the real
properties that is assumed by the registrant, to the registrant's total
assets at the last audited fiscal year end when determining
``significance'' under Rule 3-14.\254\ When determining whether an
acquisition is ``significant,'' the use of the Asset or Income Tests
generally is not practical for a real estate operation because the
historical amounts of assets and income of the acquired or to be
acquired real estate operation are not available.\255\
---------------------------------------------------------------------------

    \253\ See supra note 53.
    \254\ See FRM supra note 94 at Section 2315 ``Real Estate
Operations--Measuring Significance.''
    \255\ The amounts are not available because most real estate
managers do not maintain their books on a U.S. GAAP basis or obtain
audits. Furthermore, because Rule 3-14 only requires abbreviated
income statements to be filed, additional financial statements would
have to be prepared solely for purposes of significance testing if
the Asset and Income Tests applied to acquisitions of real estate
operations.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to amend Rule 3-14 to specify that
significance should be based on the Investment Test in Rule 1-02(w).
Thus, consistent with the proposed amendments for Rule 3-05
acquisitions discussed above, the Commission proposed to require
comparison with the registrant's aggregate worldwide market value. If
aggregate worldwide market value is not available, then the Investment
Test would be based on total assets. When the test is based on total
assets for real estate acquisitions, the Commission also proposed to
modify the investment amount to include any debt secured by the real
properties that is assumed by the registrant.
b. Comments
    We received limited comment addressing the significance tests as
they relate to real estate operations.\256\ One commenter recommended
allowing registrants that do not have an aggregate worldwide market
value (such as non-traded REITs) to use net asset value of their common
equity as the denominator for the Investment Test.\257\
---------------------------------------------------------------------------

    \256\ See e.g., letter from EY.
    \257\ See letter from EY. This commenter further recommended
that, if such a registrant is not permitted to use net asset value,
the numerator should be limited to the consideration transferred and
exclude any debt assumed by the buyer.
---------------------------------------------------------------------------

c. Final Amendments
    We are amending Rule 3-14(b)(2) as proposed to require use of the
Investment Test in Rule 1-02(w).\258\ We believe this amendment will
reduce uncertainty regarding the significance tests and clarify the
rule without changing the substance of how it is currently applied.
When based on total assets, the final amendments specify, as proposed,
that the test should be adapted to compare the registrant's and its
other subsidiaries' ``investments in'' \259\ the real estate operation,
including any debt secured by the real properties that is assumed by
the registrant, to the registrant's total assets as of the end of the
most recently completed fiscal year. We believe a modified Investment
Test is necessary to appropriately determine significance for
acquisitions of real estate operations because it takes into
consideration the unique structure of these types of acquisitions,
which typically involve assumed debt that is secured by the real
properties that offsets the value of the real estate operation being
acquired.
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    \258\ We are not adopting amendments to permit non-traded REITs
to use net asset value instead of aggregate worldwide market value
due to the potential application complexities; however, we are
adopting the modified investment test addressed in Section II.C.6.,
below, for blind pool offerings that will be applicable to non-
traded REITs.
    \259\ See supra note 53.

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4. Interim Financial Statements
    Unlike Rule 3-05,\260\ Rule 3-14 does not include an express
requirement for registrants to provide interim financial statements.
Article 11, however, requires pro forma financial information to be
filed when the registrant has acquired one or more real estate
operations which in the aggregate are significant.\261\ Article 11
further provides that the pro forma condensed statement of
comprehensive income must be filed for the most recent fiscal year and
the period from the most recent fiscal year to the most recent interim
date for which a balance sheet is required.\262\ As a result of Article
11 and related staff interpretations, existing registrant practice is
to provide interim financial statements for acquisitions of real estate
operations.\263\
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    \260\ See Rule 3-05(b)(2)(i) through (iv). The rule refers
explicitly to the most recent fiscal year and any interim periods
specified in Rules 3-01 and 3-02.
    \261\ See Rule 11-01.
    \262\ See Rule 11-02(c)(2)(i). To meet this pro forma
requirement, registrants must prepare and present substantially the
same information for the most recent interim period, if applicable,
that would be included in Rule 3-14 Financial Statements in most
circumstances.
    \263\ See Rule 11-02(c)(2)(i) and FRM supra note 94 at Section
2330.2 ``Periods to be Presented--Properties Acquired from Related
Parties'' and Section 2330.3 ``Periods to be Presented--Properties
Acquired from Third Parties.''
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a. Proposed Amendments
    The Commission proposed to amend Rule 3-14 to specifically require
Rule 3-14 Financial Statements for the most recent year-to-date interim
period prior to the acquisition.
b. Comments and Final Amendments
    We received no comments specifically related to this proposal, so
we are adopting the amendment to Rule 3-14(b)(2)(i) as proposed.\264\
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    \264\ See Section II.C.4 of the Proposing Release.
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5. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-06 provides smaller reporting company disclosure
requirements for the financial statements of real estate operations
acquired or to be acquired that are substantially similar to the
requirements in Rule 3-14. Part F/S of Form 1-A directs an issuer
relying on Regulation A to present financial statements of real estate
operations acquired or to be acquired as specified by Rule 8-06.\265\
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    \265\ See paragraph (b)(7)(v) of Part F/S. Part F/S of Form 1-A
permits the periods presented to be the shorter of those applicable
to issuers relying on Regulation A and the periods specified by
Article 8.
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a. Proposed Amendments
    The Commission proposed amendments to Article 8 to further simplify
and conform the application of Rule 3-14 and our related proposals to
smaller reporting companies.
b. Comments
    None of the commenters that provided comments related to smaller
reporting companies and smaller issuers commented on the proposed
amendments to Rule 3-14.
c. Final Amendments
    We are amending Rule 8-06 as proposed to direct registrants to Rule
3-14 for the requirements relating to financial statement disclosures
of real estate operations acquired or to be acquired,\266\ while still
permitting smaller reporting companies to rely on the form and content
for annual and interim financial statements provided in Rules 8-02 and
8-03. Rule 8-06 as amended will newly require smaller reporting
companies to combine the discussion of material factors that they
considered in assessing the acquisition with the disclosure required by
Item 15 of Form S-11 when financial statements are presented in Form S-
11.\267\ We are also adding a reference to Rule 8-06 in Rule 3-06 to
conform the requirements of Rule 8-06 and Rule 3-14 and adding Rule 8-
01(f) to expressly permit smaller reporting companies to file financial
statements covering a period of nine to 12 months to satisfy the
requirement for filing financial statements for a period of one year
for an acquired real estate operation.\268\
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    \266\ We are also amending the instruction in Item 9.01 of Form
8-K to include references to Rule 8-06 in order to conform the
instruction to the text of Item 9.01, which already addresses the
rules applicable to smaller reporting companies.
    \267\ See Instruction to Paragraph (f) in Rule 3-14. Since Item
15 of Form S-11 already applies to smaller reporting companies, the
Instruction changes only the location of the discussion.
    \268\ See Rule 8-01(f) and the discussion related to Rule 3-06
in Section II.C.1 above.
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    Additionally, because Part F/S of Form 1-A refers to Rule 8-06, the
revisions to Rule 8-06 apply to issuers relying on Regulation A. As
discussed in the Proposing Release, we believe these amendments will
simplify these rules and reduce burdens for smaller reporting companies
and issuers relying on Regulation A.\269\
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    \269\ See Section II.C.5 of the Proposing Release.
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6. Blind Pool Real Estate Offerings
    Certain registrants, typically non-traded real estate investment
trusts (``REITs''),\270\ that conduct continuous offerings over an
extended period of time follow the disclosure guidance provided under
Industry Guide 5 Preparation of Registration Statements Relating to
Interests in Real Estate Limited Partnerships (``Industry Guide
5'').\271\ These registrants generally do not initially own any real
estate assets, and the specific intended use of the proceeds raised
from investors is not initially identified because such registrants
have not yet selected any assets for their portfolios. Registrants in
these blind pool offerings also typically provide only limited
liquidity through restricted share redemption programs. However, these
registrants provide certain undertakings \272\ to disclose information
about significant acquisitions to investors in addition to Rule 3-14
Financial Statements.
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    \270\ Non-traded REITs do not have securities listed for trading
on a national securities exchange. Their purpose is to own and
operate income-producing real estate or real estate-related assets.
    \271\ See Publication of Revisions to the Division of
Corporation Finance's Guide 5 and Amendment of Related Disclosure
Provisions, Release No. 33-6405 (June 3, 1982) [47 FR 25120 (June
10, 1982)]. While Industry Guide 5, by its terms, applies only to
real estate limited partnerships, in 1991 the Commission stated that
``the requirements contained in the Guide should be considered, as
appropriate, in the preparation of registration statements for real
estate investment trusts and for all other limited partnership
offerings.'' See Limited Partnership Reorganizations and Public
Offerings of Limited Partnership Interests, Release No. 33-6900
(June 25, 1991) [56 FR 28979 (June 25, 1991)].
    \272\ See Item 20.D. of Industry Guide 5, Disclosure Guidance:
Topic No. 6--Staff Observations Regarding Disclosures of Non-Traded
Real Estate Investment Trusts and FRM supra note 94 at Section
2325.2. ```Blind Pool' Offerings--During the Distribution Period--
Undertakings.'' The undertakings include use of sticker supplements
related to certain significant properties that will be acquired and
post-effective amendments.
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    Due to the nature of a blind pool investment as well as the
supplemental undertakings provided, these registrants typically apply
adapted significance tests when making the determination of whether
they are required to provide Rule 3-14 Financial Statements.\273\
Commission staff has interpreted significance during the distribution
period to be computed by comparing the registrant's and its other
subsidiaries' ``investments in'' \274\ the real estate operation to the
sum of: (1) The registrant's total assets as of the date of the
acquisition, and (2) The proceeds (net of commissions) in good faith
expected to be raised in the registered offering over the next 12
months.\275\

After the distribution period has ended, the registrant determines
significance using the total assets as of the acquisition date until
the registrant files its next Form 10-K. After that next Form 10-K is
filed, the registrant, following the staff's guidance, can determine
significance using total assets as of the end of the most recently
completed fiscal year included in the Form 10-K.\276\
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    \273\ In certain circumstances, registrants in blind pool
offerings acquire businesses that are within the scope of Rule 3-05
(for example, hotels) rather than Rule 3-14, but the registrants
provide the Industry Guide 5 undertakings because they are
conducting a blind pool offering. Currently, there is no special
practice for measuring significance of Rule 3-05 acquisitions in
these circumstances.
    \274\ See supra note 53.
    \275\ See FRM supra note 94 at Section 2325.3 ```Blind Pool'
Offerings--During the Distribution Period--Significance.''
Calculation of the investment includes any debt secured by the real
properties that is assumed by the purchaser. In addition, in
estimating the offering proceeds, the registrant, following the
staff's guidance, could consider the pace of fundraising as of the
measurement date, the sponsor or dealer-manager's prior public
fundraising experience, and offerings by similar companies.
    \276\ See FRM supra note 94 at Section 2325.5 ```Blind Pool''
Offerings--After the Distribution Period.''
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a. Proposed Amendments
    The Commission proposed amendments to codify existing staff
guidance by specifying that significance for blind pool offerings must
be computed by comparing the registrant's and its other subsidiaries'
``investments in'' the real estate operation to the sum of: (1) The
registrant's total assets as of the date of the acquisition, and (2)
The proceeds (net of commissions) in good faith expected to be raised
in the registered offering over the next 12 months.
b. Comments
    Commenters generally supported the proposed amendments.\277\ These
commenters, however, recommended that, for registrants conducting blind
pool offerings, the Commission extend the accommodations to
acquisitions within the scope of Rule 3-05.\278\ In support of this
change, one commenter noted that staff guidance and Guide 5 do not
distinguish between acquisitions of real estate and other operations
with regards to the expected reporting of undertakings.\279\
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    \277\ See letters from BDO, CAQ, DT, EY, GT, NAREIT, PWC, and
RSM.
    \278\ See id.
    \279\ See letter from NAREIT.
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c. Final Amendments
    We are adopting the amendments as proposed, but with modifications
after considering comments received. We are codifying staff
interpretations in this area to provide that significance for blind
pool offerings must be computed by comparing the registrant's and its
other subsidiaries' ``investments in'' the real estate operation to the
sum of: (1) The registrant's total assets as of the date of the
acquisition, and (2) The proceeds (net of commissions) in good faith
expected to be raised in the registered offering over the next 12
months as more fully described above. Without this accommodation,
virtually all acquisitions in the early part of the distribution period
would be deemed significant regardless of their size.
    We are also adopting amendments, as suggested by commenters, to
extend the adapted significance test to Rule 3-05 acquisitions by
registrants in blind pool offerings because the accommodation is based
on the unique characteristics of the offering and registrants, rather
than the type of acquisition.
    In light of the extension of the accommodation to Rule 3-05
acquisitions, we revised the location of these amendments for blind
pool offerings to Rule 11-01(b), which addresses how to determine
significance for both Rule 3-05 acquisitions and Rule 3-14
acquisitions.\280\
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    \280\ See Rule 11-01(b)(4). Rules 3-05 and 3-14 were also
revised to refer to new Rule 11-01(b)(4).
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D. Pro Forma Financial Information

    The pro forma financial information described in Article 11 of
Regulation S-X must accompany Rule 3-05 Financial Statements and Rule
3-14 Financial Statements. Typically, pro forma financial information
includes the most recent balance sheet and most recent annual and
interim period income statements. Pro forma financial information for a
business acquisition combines the historical financial statements of
the registrant and the acquired business and is adjusted for certain
items if specified criteria are met. As discussed above, pro forma
financial information for an acquired business is required at the 20
percent and 10 percent significance thresholds under Rule 3-05 and Rule
3-14, respectively.\281\ The rules also require pro forma financial
information for a significant disposed business at a 10 percent
significance threshold for all registrants.
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    \281\ See 1996 Streamlining Release supra note 24.
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1. Adjustment Criteria and Presentation Requirements
    Rule 11-02 contains rules and instructions for the presentation of
pro forma financial information. The rules provide some flexibility to