tailor pro forma disclosures to particular events and circumstances.
The presentation requirements for the pro forma condensed statement of
comprehensive income were designed to elicit disclosures that
distinguish between the one-time impact and the on-going impact of a
transaction.\282\ The rules call for pro forma financial information to
show the impact of the transaction on income from continuing operations
of the registrant.\283\
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    \282\ See Instructions for the Presentation and Preparation of
Pro Forma Financial Information and Requirements for Financial
Statements of Businesses Acquired or To Be Acquired, Release No. 33-
6413 (June 24, 1982) [47 FR 29832 (July 9, 1982)] indicating that
``[t]he presentation requirements for the pro forma condensed
statement of income are designed to elicit disclosures that clearly
distinguish between the one-time impact and the on-going impact of
the transaction and thereby assist investors in focusing on the
transaction at hand.''
    \283\ Discontinued operations would not be reflected in the
condensed historical financial statements used as the starting point
for the pro forma presentation.
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    Article 11 provides that the only adjustments that are appropriate
in the presentation of the pro forma condensed statement of
comprehensive income are those that are:
     Directly attributable to the transaction;
     Expected to have a continuing impact on the registrant;
and
     Factually supportable.\284\
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    \284\ See Rule 11-02(b)(6). Material non-recurring charges or
credits which result directly from the transaction and which will
impact the income statement during the next 12 months are not
reflected in the pro forma condensed statement of comprehensive
income.

The pro forma condensed balance sheet, on the other hand, reflects pro
forma adjustments that are directly attributable to the transaction and
factually supportable, regardless of whether the impact is expected to
be continuing or nonrecurring because the objective of the pro forma
balance sheet is to reflect the impact of the transaction on the
financial position of the registrant as of the balance sheet date.
a. Proposed Amendments
    The Commission proposed to revise Article 11 by replacing the
existing pro forma adjustment criteria with simplified requirements to
depict the accounting for the transaction (``Transaction Accounting
Adjustments'') \285\ and present the

reasonably estimable synergies and other transaction effects that have
occurred or are reasonably expected to occur (Management's
Adjustments'').\286\ In addition, the Commission proposed other changes
to simplify and clarify Article 11 and to provide more consistent use
of terminology. The Commission proposed these changes because the
existing pro forma adjustment criteria are not clearly defined, can
yield inconsistent presentations for similar fact patterns, and
preclude the inclusion of adjustments for the potential effects of
post-acquisition actions expected to be taken by management.
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    \285\ Under the proposed rule, Transaction Accounting
Adjustments would depict: (1) In the pro forma condensed balance
sheet the accounting for the transaction required by U.S. GAAP or
IFRS-IASB, and (2) In the pro forma condensed income statements, the
effects of those pro forma balance sheet adjustments assuming the
adjustments were made as of the beginning of the fiscal year
presented. If the condition in Rule 11-01(a) that is met does not
have a balance sheet effect, then our proposal would require that
Transaction Accounting Adjustments depict the accounting for the
transaction required by U.S. GAAP or, if applicable, IFRS-IASB.
Under the proposed rule, Transaction Accounting Adjustments would be
limited to adjustments to account for the transaction using the
measurement date and method prescribed by the applicable accounting
standard. For probable transactions, the measurement date would be
as of the most recent practicable date prior to the effective date
(for registration statements) or the mailing date (for proxy
statements).
    \286\ Under the proposed rule, Management's Adjustments would be
required for and limited to synergies and other effects of the
transaction, such as closing facilities, discontinuing product
lines, terminating employees, and executing new or modifying
existing agreements, that are both reasonably estimable and have
occurred or are reasonably expected to occur. However, if the
registrant previously was a part of another entity and presentation
of pro forma financial information was necessary to reflect the
operations and financial position of the registrant as an autonomous
entity, the proposed rules would provide that the adjustments
necessary to show the registrant as an autonomous entity be included
in Management's Adjustments. For example, where a company (the
registrant) operates as a subsidiary of another entity and files a
registration statement under the Securities Act in connection with
an initial public offering, and presentation of pro forma financial
information is necessary to reflect the operations and financial
position of the registrant as an autonomous entity, the registration
statement would include Article 11 pro forma financial information,
which under our proposal would include such adjustments in
Management's Adjustments. The proposed rule also included
presentation requirements for Management's Adjustments, requiring
that they be presented through a separate column in the pro forma
financial information after the presentation of the combined
historical statements and Transaction Accounting Adjustments. This
presentation would permit investors to distinguish the accounting
effects on the registrant of the underlying acquired business from
operational effects of management's plans that are subject to
management's discretion or other uncertainties. Similarly, the
proposed rules would require that per share data be presented in two
separate columns. One column would present the pro forma total
depicting the combined historical statements with only the
Transaction Accounting Adjustments, and the second column would
present the combined historical statements with both the Transaction
Accounting Adjustments and Management's Adjustments. Further, the
proposed rule would include specific disclosures for each
Management's Adjustments including: A description, including the
material uncertainties, of the synergy or other transaction effects;
disclosure of the underlying material assumptions, the method of
calculation, and the estimated time frame for completion;
qualitative information necessary to give a fair and balanced
presentation of the pro forma financial information; and to the
extent known, the reportable segments, products, services, and
processes involved; the material resources required, if any; and the
anticipated timing. For synergies and other transaction effects that
are not reasonably estimable and will not be included in
Management's Adjustments, the proposed rule would require that
qualitative information necessary for a fair and balanced
presentation of the pro forma financial information also be
provided.
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b. Comments
    While commenters were generally supportive of replacing the
existing pro forma adjustment criteria with the proposed Transaction
Accounting Adjustments,\287\ one commenter recommended retaining the
existing methodology.\288\ Several commenters recommended changes or
sought clarification regarding the application of the rules to
Transaction Accounting Adjustments.\289\ However, most of the comments
received relating to pro forma financial information were focused on
Management's Adjustments. Commenters were mixed in their support \290\
or opposition \291\ to the proposed Management's Adjustments depicting
synergies and other transaction effects.
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    \287\ See letters from Ball, Davis Polk, DT, FEI, New York City
Bar Association, Committee on Mergers and Acquisitions (``NYCBA-
M&A''), Pfizer, and SIFMA. One of these commenters noted that under
the existing rules, pro forma financial statements can be difficult
for registrants to prepare and are among the most prolific sources
of questions for the staff. See letter from NYCBA-M&A.
    \288\ See letter from Cravath. Cravath indicated that it does
not believe that there is significant confusion among preparers of
financial information or investors with respect to the current
Article 11 pro forma adjustment methodology, including using the
current ``continuing impact'' criterion, or the benefits and
limitations of such disclosure. However, Cravath also indicated that
it had significant concerns regarding the proposal to require
Management's Adjustments and opposed the inclusion of such a
requirement in the final rules. Accordingly, Cravath recommended
retaining the existing methodology.
    \289\ See, e.g., letters from BDO, Davis Polk, DT, and FEI. For
example, one of these commenters recommended the final rule permit
the inclusion of pro forma adjustments for additional events that
are directly related to the transaction, (e.g. adjusting for the
effects of additional financing necessary to complete the
acquisition). See letter from FEI. Another commenter recommended
continuing to exclude nonrecurring items from the pro forma
statement of comprehensive income and providing clarity about how to
define non-recurring items. See letter from Davis Polk.
    \290\ See, e.g., letters from Allstate, Ball, CFA, Davis Polk,
IMA, MTBC, and PWC.
    \291\ See, e.g., letters from Cravath, Eli Lilly, FEI, GT,
Nasdaq, NYCBA-M&A, Pfizer, SIFMA, Shearman, and Williams. See also
SBCFAC Recommendations, recommending that ``the proposed amendments
to the pro forma financial information requirements with respect to
whether the proposed addition of Management's Adjustments, which are
intended to reflect reasonably estimable synergies and transaction
effects, should be optional or not required at all.''
---------------------------------------------------------------------------

    Many commenters recommended against including the proposed
Management's Adjustments in pro forma financial statement
requirements.\292\ Some of these commenters suggested that pro forma
financial information is an inapt means for communicating the
anticipated synergies from a transaction.\293\ These commenters also
expressed concerns relating to: The inherent uncertainty/subjectivity
of synergy expectations; the burden of preparing the disclosure; the
potential liability; the risk of synergy disclosure changing over time
and confusing or misleading investors; and other unintended
consequences.\294\ In contrast, commenters supportive of the
requirement indicated that the proposed Management's Adjustments would
provide investors insight into the potential effects of the acquisition
and post-acquisition plans expected to be taken by management \295\ and
provide greater flexibility for management to include forward-looking
information and provide investors with insight into their decision to
enter into the transaction.\296\
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    \292\ See, e.g., letters from Eli Lilly, Liberty, NYCBA-M&A,
NYCBA--Sec., Pfizer, S&C, and SIFMA. See also SBCFAC
Recommendations.
    \293\ See, e.g., letters from S&C and NYCBA-M&A.
    \294\ See, e.g., letters from Cravath, Debevoise, Eli Lilly,
FEI, GT, KPMG, Liberty, Nasdaq, NYCBA-M&A, Pfizer, S&C, SIFMA,
Shearman, and Williams. Some of these commenters further suggested
the reasonably expected synergy disclosure requirement could, among
other things, result in premature disclosure of sensitive
information that could affect important relationships with
stakeholders, impact boards of directors, auditors, and
underwriters, and have a chilling effect on disclosure. See, e.g.,
letters from FEI and Pfizer.
    \295\ See, e.g., letters from Ball, CFA, IMA, and PWC. One of
these commenters supported inclusion of the disclosure because, in
the commenter's view, the information provided to investors in
connection with marketing the deal should be consistent with, if not
reconciled to, management projections provided to the board and
shareholders, or the projections provided to financial advisors in
connection with the fairness opinion. See letter from CFA.
    \296\ See, e.g., letters from Ball and CAQ.
---------------------------------------------------------------------------

    Many commenters, whether supportive of or opposed to the proposed
requirements, recommended that the Commission provide additional
guidance or clarification about their application, particularly with
respect to the proposed Management's Adjustments.\297\ Commenters
recommended that the Commission provide examples of synergies and other
transaction effects and the treatment of nonrecurring costs to achieve
them.\298\ Commenters also requested other implementation guidance,
such as guidance on: The criteria for determining ``reasonably
estimable'' and the permissible range; the timing parameters relating
to realization and ``reasonably expected'' to occur; what would
constitute a ``fair and balanced presentation''; the relationship
between

Management's Adjustments on the pro forma statements of comprehensive
income and those on the balance sheet; updating requirements for
Management's Adjustments in subsequent filings; the presentation of
multiple transactions; and treatment of overlap between Transaction
Accounting Adjustments and Management's Adjustments.\299\
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    \297\ See, e.g., letters from DT, Liberty, Pfizer, and PWC.
    \298\ See, e.g., letters from BDO, CAQ, Crowe, Davis Polk, DT,
EY, GT, KPMG, PWC, and RSM.
    \299\ See, e.g., letters from BDO, CFA, Crowe, Debevoise, DT,
EY, FEI, GT, IMA, KPMG, RSM, and S&C.
---------------------------------------------------------------------------

    Some commenters that expressed concern relating to liability for
the disclosure sought by the proposed amendments supported the
application of the forward-looking information safe harbors under 17
CFR 230.175 (``Securities Act Rule 175'') and 17 CFR 240.3b-6
(``Exchange Act Rule 3b-6''),\300\ while other commenters recommended
further protections, such as a safe harbor for forward-looking
information similar to that found in the Private Securities Litigation
Reform Act safe harbor,\301\ permitting Article 11 information to be
``furnished'' rather than ``filed,'' \302\ or an exception or safe
harbor for cases where synergies are not a material element of the
transaction.\303\
---------------------------------------------------------------------------

    \300\ See letters from Allstate, CFA, Cravath, Debevoise, PWC,
and SIFMA. One of these commenters recommended that the final rules
expressly provide a safe harbor for forward-looking information and
that it include express language that the safe harbors apply to any
pro forma financial information that includes both historical and
forward-looking information. This commenter also expressed concern
that the proposed requirement to provide qualitative information
necessary for a fair and balanced presentation of the pro forma
financial information when synergies and other transaction effects
would not be included in Management's Adjustments because they are
not reasonably estimable represented a new disclosure liability
standard. See letter from Cravath.
    \301\ See letter from Davis Polk.
    \302\ See letter from S&C.
    \303\ See letter from NYCBA--M&A.
---------------------------------------------------------------------------

    Several commenters recommended the Commission consider whether such
disclosure should be optional.\304\ Other commenters recommended other
ways to limit the proposed Management's Adjustments disclosure
requirements while still providing useful information.\305\ For
example, two commenters recommended limiting the requirement to
narrative disclosure of synergies information in transactions where the
information has otherwise been publicly disclosed.\306\ Another
commenter recommended comprehensive disclosure in the footnotes of the
related non-recurring costs and anticipated timing of the run-rate
synergies.\307\
---------------------------------------------------------------------------

    \304\ See, e.g., letters from BDO, Cravath, EY, and Williams.
One of these commenters suggested that if Management's Adjustments
were optional they could be removed from the pro forma financial
information and underwriters could receive customary comfort as part
of their due diligence process. See letter from BDO. Another
commenter recommended the disclosure be optional or not required for
smaller reporting companies. See SBCFAC Recommendations.
    \305\ See, e.g., letters from Davis Polk, FEI, and S&C.
    \306\ See letters from Cravath and S&C.
    \307\ See letter from Davis Polk.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments with modifications after considering
comments received. We are amending Article 11, as proposed, by
replacing the existing pro forma adjustment criteria with simplified
requirements to depict the accounting for the transaction and to
provide the option to depict synergies and dis-synergies of the
acquisitions and dispositions for which pro forma effect is being
given. We also are adopting, as proposed, other changes to simplify and
clarify Article 11 and use terminology more consistently.\308\
Additionally, we are, as proposed, deleting existing Rule 11-02(a),
which describes the objectives of the preparation requirements, to
avoid confusion and focus registrants on the requirements of the rule.
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    \308\ Specifically, we are amending Article 11, as proposed, to
refer to ``pro forma financial information,'' ``potential common
stock'' as defined in U.S. GAAP, and ``pro forma basic'' per share
data throughout, as well as amending existing Rule 11-02(b)(5) to
require the pro forma condensed statement of comprehensive income to
also disclose income (loss) from continuing operations attributable
to the controlling interests because that amount is used to
calculate earnings per share under U.S. GAAP. See amended Rule 11-
02(a)(5). We are also, as proposed, amending existing Rule 11-
01(a)(8) to remove the reference to other ``events'' as the concept
of other events is encompassed by the reference to ``other
transactions'' and amending existing Rule 11-02(b)(2) to refer to
``each transaction for which pro forma effect is being given'' in
recognition that the information may be required to give effect to
more than one transaction. See amended Rules 11-01(a)(8) and 11-
02(a)(2).
---------------------------------------------------------------------------

    The revised pro forma adjustment criteria we are adopting are
broken out into three categories:
    (i) ``Transaction Accounting Adjustments;''
    (ii) ``Autonomous Entity Adjustments;'' and
    (iii) ``Management's Adjustments.'' \309\
---------------------------------------------------------------------------

    \309\ As proposed, the amendments: (i) Eliminate the substance
of the first sentence of Instruction 2 as well as Instruction 4 and
Instruction 5 of Rule 11-02(b) as this guidance is superseded by the
requirements for Transaction Accounting Adjustments and Autonomous
Entity Adjustments; (ii) Eliminate Instruction 3 regarding business
dispositions as it is no longer necessary given the adoption of
proposed Rules 11-02(a)(4), 11-02(a)(6), and 11-02(b)(3); (iii)
Incorporate the substance of Instruction 1, using income from
continuing operations, into amended Rule11-02(b)(1) and Instruction
2 guidance on financial institutions into amended Rule 11-02(b)(2);
(iv) Add new Rule 11-02(b)(4) in place of Instruction 6 to clarify
that each transaction for which pro forma effect is required to be
given must be presented in separate columns; and (v) Add new Rule
11-02(b)(5) to replace Instruction 7 to Rule 11-02(b), which will
codify pro forma tax effect guidance from Staff Accounting Bulletin
No. 1.B., Allocation Of Expenses And Related Disclosure In Financial
Statements Of Subsidiaries, Divisions Or Lesser Business Components
Of Another Entity, 1. Costs reflected in historical financial
statements.

The Transaction Accounting Adjustments reflect only the application of
required accounting to the acquisition, disposition, or other
transaction linking the effects of the acquired business to the
registrant's audited historical financial statements. Autonomous Entity
Adjustments are adjustments necessary to reflect the operations and
financial position of the registrant as an autonomous entity when the
registrant was previously part of another entity. Management's
Adjustments provide both flexibility to registrants to include forward-
looking information that depicts the synergies and dis-synergies
identified by management in determining to consummate or integrate the
transaction for which pro forma effect is being given and insight to
investors into the potential effects of the acquisition and the post-
acquisition plans expected to be taken by management. Under the final
amendments, Transaction Accounting Adjustments and Autonomous Entity
Adjustments are required adjustments. Management's Adjustments, as
discussed further below, are optional under the final amendments.
Transaction Accounting Adjustments and Autonomous Entity Adjustments
    We are adopting the Transaction Accounting Adjustments, as
proposed, in amended Rule 11-02(a)(6)(i) to require registrants to
depict: (1) In the pro forma condensed balance sheet the accounting for
the transaction required by U.S. GAAP or IFRS-IASB, as applicable,\310\
and (2) In the pro forma condensed income statements, the effects of
those pro forma balance sheet adjustments assuming the adjustments were
made as of the beginning of the fiscal year presented.\311\ Consistent
with the proposal, the amendment indicates that if the condition in
Rule 11-01(a) that is met does not have a balance sheet effect, then
the Transaction Accounting Adjustments to the pro forma statement

of comprehensive income should depict the accounting for the
transaction required by U.S. GAAP or IFRS-IASB, as applicable. Further,
in a modification from the proposal made in response to comments, the
amendments clarify that pro forma statement of comprehensive income
``adjustments must be made whether or not the pro forma balance sheet
is presented pursuant to paragraph (c)(1) of this section.''
---------------------------------------------------------------------------

    \310\ Transaction Accounting Adjustments are limited to
adjustments to account for the transaction using the measurement
date and method prescribed by the applicable accounting standard.
For probable transactions, the measurement date is as of the most
recent practicable date prior to the effective date (for
registration statements) or the mailing date (for proxy statements).
    \311\ See Rule 11-02(a)(6)(i)(B).
---------------------------------------------------------------------------

    In order to effect the changes described below to our Management's
Adjustments proposal, the requirement to show the registrant as an
autonomous entity if the condition in Rule 11-01(a)(7) is met has been
relabeled as ``Autonomous Entity Adjustments'' and relocated from the
subparagraph concerning Management's Adjustments to Rule 11-
02(a)(6)(ii) to clarify that such adjustments are required when the
condition for their presentation is met and that they must be presented
in a separate column from Transaction Accounting Adjustments.\312\
---------------------------------------------------------------------------

    \312\ We believe this requirement is appropriate given the
different purposes for which Transaction Accounting Adjustments and
Autonomous Entity Adjustments are used. It will also facilitate
compliance with the requirements for determining significance of
acquisitions and dispositions using pro forma financial information,
which as proposed will only include Transaction Accounting
Adjustments. See Rule 11-01(b)(3)(i)(B).
---------------------------------------------------------------------------

    As proposed, the amendments will require that historical and pro
forma per share data must be presented on the face of the pro forma
condensed statement of comprehensive income and give effect to
Transaction Accounting Adjustments. However, in a further modification
from the proposal \313\ to effect the changes described below to our
Management's Adjustment proposal, the amendments require that such pro
forma per share data also give effect to Autonomous Entity
Adjustments.\314\ We believe that including all adjustments required by
our amendments to be presented on the face of the pro forma financial
information, whether deemed recurring or nonrecurring by a registrant's
management, will help achieve consistency in the application of our pro
forma requirements and simplify compliance. This requirement, coupled
with the requirement to disclose revenues, expenses, gains and losses
and related tax effects that will not recur in the income of the
registrant beyond 12 months after the transaction, will also enhance
transparency.
---------------------------------------------------------------------------

    \313\ We do not believe it is necessary, as some commenters
suggested, to modify our proposal to permit the inclusion of pro
forma adjustments for additional events that are directly related to
the transaction (e.g. adjusting for the effects of additional
financing necessary to complete the acquisition) because Rule 11-
01(a)(8) requires giving pro forma effect when consummation of other
transactions has occurred or is probable for which disclosure of pro
forma financial information would be material to investors.
    \314\ We were not persuaded by the suggestion to further modify
our proposal to permit exclusion of nonrecurring items from the pro
forma statement of comprehensive income or to define non-recurring
items.
---------------------------------------------------------------------------

Management's Adjustments
    We agree with commenters that providing forward-looking
information, subject to appropriate safe harbors, about synergies and
related-transaction effects contemplated by the board and management in
determining to execute the acquisition or disposition of a business
would provide useful information for understanding the effects of the
transaction. However, having considered the comments received, we are
persuaded that the line-item specificity and the one year time horizon
presented in our proposed pro forma requirements is not necessarily
consistent with the manner in which synergy estimates are made and that
not all transactions attach the same level of importance to synergies
as a rationale for choosing to pursue the transaction. We are further
persuaded that there may be different levels of confidence about
different types of synergies and transaction effects and that
disclosure requirements should be crafted with appropriate flexibility
to permit management to depict full run-rate synergies and the
nonrecurring costs to achieve them if, and in a manner, they deem
appropriate. For example, we believe cost synergies should be permitted
to be presented without revenue synergies provided that they
incorporate related dis-synergies and the related disclosure describes
the nature, uncertainties, and limitations of the amounts presented and
the time-frames and uncertainties inherent in achieving them. We also
believe such disclosure should be linked to pro forma financial
information as a means to more fully demonstrate how historical amounts
could change based on the transaction.
    After considering comments received on the proposals, we are
modifying the amendments to provide that Management's Adjustments
depicting synergies and dis-synergies of the acquisitions and
dispositions for which pro forma financial information is being given
may, in the registrant's discretion, be presented if in its
management's opinion, such adjustments would enhance an understanding
of the pro forma effects of the transaction.\315\ We encourage
registrants to provide Management's Adjustments in these circumstances
when certain additional conditions are met. Because under the final
amendments the presentation of Management's Adjustments is optional, we
are modifying the proposed rules such that, in order to present
Management's Adjustments, certain conditions related to the basis for
Management's Adjustments and the form of presentation must be met.
These amendments are intended to ensure that if Management's
Adjustments are presented, they are done so consistently and in a
manner that would not be misleading to investors. Specifically, as
modified, the Basis for Management's Adjustments in Rule 11-02(a)(7)(i)
requires as conditions for presenting Management's Adjustments that:
---------------------------------------------------------------------------

    \315\ See Rule 11-02(a)(7).
---------------------------------------------------------------------------

     There is a reasonable basis for each such adjustment;
     The adjustments are limited to the effect of such
synergies and dis-synergies on the historical financial statements that
form the basis for the pro forma statement of comprehensive income as
if the synergies and dis-synergies existed as of the beginning of the
fiscal year presented. If such adjustments reduce expenses, the
reduction shall not exceed the amount of the related expense
historically incurred during the pro forma period presented; and
     The pro forma financial information reflects all
Management's Adjustments that are, in the opinion of management,
necessary to a fair statement of the pro forma financial information
presented and a statement to that effect is disclosed. When synergies
are presented, any related dis-synergies shall also be presented.
    Further, as modified, the Form of Presentation in Rule 11-
02(a)(7)(ii) requires as additional conditions for presenting
Management's Adjustments that:
     If presented, Management's Adjustments must be presented
in the explanatory notes to the pro forma financial information in the
form of reconciliations of pro forma net income from continuing
operations attributable to the controlling interest and the related pro
forma earnings per share data to such amounts after giving effect to
Management's Adjustments.
     If presented, Management's Adjustments included or
incorporated by reference into a registration statement, proxy
statement, offering statement or Form 8-K should be as of the most
recent practicable date prior to the effective date, mail date,
qualified date, or filing date as applicable, which may require that
they be updated if previously provided in a Form 8-K that

is appropriately incorporated by reference.
     If Management's Adjustments will change the number of
shares or potential common shares, the change must be reflected within
Management's Adjustments in accordance with U.S. GAAP or IFRS-IASB, as
applicable, as if the common stock or potential common stock were
outstanding as of the beginning of the period presented.
     The explanatory notes must also include disclosure of the
basis for and material limitations of each Management's Adjustment,
including any material assumptions or uncertainties of such adjustment,
an explanation of the method of the calculation of the adjustment, if
material, and the estimated time frame for achieving the synergies and
dis-synergies of such adjustment.\316\
---------------------------------------------------------------------------

    \316\ See Rule 11-02(a)(11)(iii).
---------------------------------------------------------------------------

    We believe these requirements are necessary to better enable an
investor to understand Management's Adjustments being made in the pro
forma financial information and that this presentation will clearly
distinguish the accounting effects on the registrant of the underlying
acquired business from operational effects of management's plans that
are subject to management's discretion and other uncertainties.
    Some commenters cited similarities between pro forma Management's
Adjustments and projections. While we believe they are distinct,
because Management's Adjustments may include measures that require
similar judgments to projections, we have looked to the Commission's
policy statement on projections in developing a framework for optional
disclosure of Management's Adjustments.\317\ Specifically, the amended
rules include disclosure requirements related to the Basis for
Management's Adjustments and Form of Management's Presentation.\318\
Likewise, the final amendments require that there is a reasonable basis
for each such adjustment and that the pro forma financial information
reflects all Management's Adjustments that are, in the opinion of
management, necessary to a fair statement of the pro forma financial
information presented and a statement to that effect is disclosed.\319\
The final amendments also require disclosure of both the basis for and
material limitations of each Management's Adjustment, including any
material assumptions or uncertainties of such adjustment, an
explanation of the method of the calculation of the adjustment, if
material, and the estimated time frame for achieving the synergies and
dis-synergies of such adjustment.\320\ The amendments also provide
practical limits tailored to the pro forma financial information
presentation.\321\
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    \317\ See Item 10(b) of Regulation S-K.
    \318\ See Rule 11-02(a)(7)(i) and (ii).
    \319\ See Rule 11-02(a)(7)(i)(A). This requirement is similar to
the representation management must disclose in historical interim
financial statements subject to Article 10, Interim financial
statements, (see 17 CFR 210.10-01(b)(8) (``Rule 10-01(b)(8)'')) and
taken together with the requirement to include dis-synergies if
synergies are depicted (see Rule 11-02(a)(7)(i)(C)), we believe it
will help achieve much the same purpose as our proposed requirement
that pro forma presentations that include Management's Adjustments
be fair and balanced. Because we are persuaded that the line-item
specificity in our proposed pro forma requirements is not
necessarily consistent with the manner in which synergy estimates
are made, the amended rules do not include that proposed requirement
or the one to disclose for each Management's Adjustment, to the
extent known, the reportable segments, products, services, and
processes involved; the material resources required, if any, and the
anticipated timing.
    \320\ See Rule 11-02(a)(7)(ii)(C).
    \321\ For example, the amended rules limit the adjustments to
the effect of such synergies and dis-synergies on the historical
financial statements that form the basis for the pro forma statement
of comprehensive income as if the synergies and dis-synergies
existed as of the beginning of the fiscal year presented. The
amended rules further require that if such adjustments reduce
expenses, the reduction shall not exceed the amount of the related
expense historically incurred during the pro forma period presented.
See Rule 11-02(a)(7)(i)(B).
---------------------------------------------------------------------------

    While we encourage registrants to include Management's Adjustments
in pro forma financial information, we recognize that such adjustments
may not be appropriate for all circumstances. In order to achieve
consistency between pro forma financial information presentations that
include Management's Adjustments and those that do not, and in
recognition that the line item format of pro forma financial
information may not be well-suited to Management's Adjustments, the
amended rules provide that Management's Adjustments shall be presented
in the explanatory notes to the pro forma financial information in the
form of reconciliations of pro forma net income from continuing
operations attributable to the controlling interest and the related pro
forma earnings per share data to such amounts after giving effect to
Management's Adjustments. Because Management's Adjustments might
contain forward-looking information, we are amending the rule, as
proposed, to include an instruction indicating that any forward-looking
information supplied is expressly covered by the safe harbor provisions
under 17 CFR 230.175 and 17 CFR 240.3b-6.\322\ Given the reference to
these safe harbors in the adopted rule and the other modifications we
are making with respect to Management's Adjustments, we do not believe
there is a need to create new safe harbors or to reference additional
safe harbors.
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    \322\ See the Instruction to Rule 11-02(a)(6)(ii).
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Explanatory Notes
    To further clarify the pro forma financial information disclosure,
we are adopting, as proposed, amendments to require disclosure of
revenues, expenses, gains and losses, and related tax effects that will
not recur in the income of the registrant beyond 12 months after the
transaction.\323\ Additionally, for Transaction Accounting Adjustments,
the final amendments will require, as proposed, disclosure of:
---------------------------------------------------------------------------

    \323\ See Rule 11-02(a)(10)(i), based on existing Rule 11-
02(b)(5).
---------------------------------------------------------------------------

     Total consideration transferred or received, including its
components and how they were measured. If total consideration includes
contingent consideration, the amendments will require disclosure of the
contingent consideration arrangement(s),\324\ the basis for determining
the amount of payment(s) or receipt(s), and an estimate of the range of
outcomes (undiscounted) or, if a range cannot be estimated, that fact
and the reasons why; and
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    \324\ In a modification from the proposal, the amended rule
inserts ``contingent consideration'' before ``arrangements'' to
clarify that the proposed rule's reference to ``arrangement(s)''
means ``contingent consideration arrangement(s).''
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     When the initial accounting is incomplete: A prominent
statement to this effect, the items for which the accounting depicted
is incomplete, a description of the information that the registrant
requires, including, uncertainties affecting the pro forma financial
information and the possible consequences of their resolution, an
indication of when the accounting is expected to be finalized, and
other available information regarding the magnitude of any potential
adjustments.\325\
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    \325\ See Rule 11-02(a)(11)(ii).
---------------------------------------------------------------------------

    In order to effect the changes described above to our Management's
Adjustments proposal, we are relocating the proposed explanatory note
disclosures for Management's Adjustments that we believe also apply to
Autonomous Entity Adjustments from the subparagraph concerning
Management's Adjustments to Rule 11-02(a)(11)(iii). Specifically, the
amended rules provide that the accompanying explanatory notes shall
disclose for each Autonomous Entity Adjustment, a description of the
adjustment (including the material uncertainties), the material
assumptions, the calculation of the

adjustment, and qualitative information about the Autonomous Entity
Adjustments necessary to give a fair and balanced presentation of the
pro forma financial information.\326\ The amendments also tailor the
proposed disclosure to reference Autonomous Entity Adjustments and to
remove proposed disclosure that related to synergies and other
transaction effects rather than to Autonomous Entity Adjustments.
Further, the amendments retain for Autonomous Entity Adjustments the
proposed requirement to disclose qualitative information about the
Autonomous Entity Adjustments necessary to give a fair and balanced
presentation of the pro forma financial information.\327\
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    \326\ The amendments to provide required disclosure for
Autonomous Entity Adjustments do not include the following proposed
explanatory note disclosures for Management's Adjustments, which we
believe may be less relevant to Autonomous Entity Adjustments: The
estimated time frame for completion and, to the extent known, the
reportable segments, products, services, and processes involved; the
material resources required, if any, and the anticipated timing.
    \327\ Some commenters requested clarification about what
disclosure would be necessary to satisfy this requirement, with at
least one of these commenters stating its belief that the proposed
requirement is a subjective standard. See, e.g., letters from Crowe,
DT, EY, and RSM. We observe that the Rule 11-01(a)(7) requirement
for pro forma financial information that includes Autonomous Entity
Adjustments--namely, that the registrant previously was a part of
another entity and such presentation is necessary to reflect
operations and financial position of the registrant as an autonomous
entity--involves a facts and circumstances determination that does
not lend itself to developing an all-inclusive list of disclosures.
Instead, the amended rule requires application of judgment to
identify ``additional'' qualitative disclosures, ``if any,''
necessary to achieve a fair and balanced presentation in light of a
registrant's unique facts and circumstances. As with other
disclosure obligations, this requirement should be assessed from the
perspective of the reasonable investor.
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    We are additionally clarifying, as proposed, that: Pro forma
financial information must be appropriately labeled and presented as
required by Article 11; \328\ requiring that each transaction for which
pro forma effect is required to be given must be presented in a
separate column; \329\ and requiring that, if pro forma financial
information includes another entity's statement of comprehensive
income, such as that of an acquired business, it must be brought up to
within one fiscal quarter, if practicable.\330\
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    \328\ See Rule 11-02(a)(11) and Rule 11-02(c)(2). We are
explicitly requiring this labeling and presentation in Article 11 to
avoid confusing or inconsistent disclosure. The rules also generally
preclude: (i) Presentation of pro forma financial information on the
face of the historical financial statements, except where such
presentation is specifically required by U.S. GAAP or IFRS-IASB,
(ii) presentation of summaries of pro forma financial information
that exclude material transactions, (iii) presentation of pro forma
amounts that reflect Management's Adjustments elsewhere in a filing
without also presenting with equal or greater prominence the amounts
to which they are required to be reconciled and a cross-reference to
that reconciliation, or (iv) presentations that give pro forma
effect to the adoption of accounting standards.
    \329\ See Rule 11-02(b)(4).
    \330\ See Rule 11-02(c)(3). This change better accommodates
registrants and acquired businesses that have 52-53 week fiscal
years than the current requirement to bring the financial
information to within 93 days of the registrant's most recent fiscal
year end, if practicable.
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2. Significance and Business Dispositions
    Rule 11-01(a)(4) provides that pro forma financial information is
required upon the disposition or probable disposition of a significant
portion of a business either by sale, abandonment, or distribution to
shareholders by means of a spin-off, split-up, or split-off, if that
disposition is not fully reflected in the financial statements of the
registrant. Rule 11-01(b) further provides that a disposition of a
business is significant if the business to be disposed of meets the
conditions of a significant subsidiary under Rule 1-02(w). Rule 1-02(w)
uses a 10 percent significance threshold, rather than the 20 percent
threshold used for business acquisitions under Rules 3-05 and 11-01(b).
When a registrant determines that it has an acquisition or disposition
of a significant amount of assets that do not constitute a business,
Item 2.01 of Form 8-K uses a 10 percent threshold for both acquisitions
and dispositions to require disclosure of certain details of the
transaction.\331\ The terms ``business'' and ``significant'' used in
Form 8-K specifically reference Article 11 of Regulation S-X.
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    \331\ For acquisitions and dispositions of assets that do not
constitute a business, Item 2.01 of Form 8-K specifies the tests to
be used rather than referencing the tests in Rule 1-02(w).
Specifically, Item 2.01 states that, ``an acquisition or disposition
shall be deemed to involve a significant amount of assets: (i) If
the registrant's and its other subsidiaries' equity in the net book
value of such assets or the amount paid or received for the assets
upon such acquisition or disposition exceeded 10 percent of the
total assets of the registrant and its consolidated subsidiaries; or
(ii) if it involved a business (see Rule 11-01(d)) that is
significant (see Rule 11-01(b)).''
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a. Proposed Amendments
    The Commission proposed to:
     Raise the significance threshold for the disposition of a
business from 10 percent to 20 percent to conform to the threshold at
which an acquired business is significant under Rule 3-05;
     To the extent applicable, conform the tests used to
determine significance of a disposed business to those used to
determine significance of an acquired business; and
     Require smaller reporting companies to provide pro forma
financial information for disposition of a significant business in Form
8-K and in certain registration statements and proxy statements when
the disposition occurs during or after the most recently completed
fiscal year.
b. Comments
    Commenters generally supported raising the threshold for
significant dispositions.\332\ One commenter recommended aligning the
criteria for measuring the significance of the disposition of a real
estate operation with the criteria for measuring an acquisition.\333\
---------------------------------------------------------------------------

    \332\ See letters from Bass Berry, Cravath, Eli Lilly, FEI,
Liberty, NAREIT, Shearman, and Williams.
    \333\ See letter from DT.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments substantially as proposed. We
believe these amendments will simplify compliance for registrants, and
we see no compelling reason why the subset of businesses for which
investors need information should differ depending on whether the
business is being acquired or disposed.
    We are amending Rule 11-01(b) to raise the significance threshold
for the disposition of a business from 10 percent to 20 percent and to
conform, to the extent applicable, the tests used to determine
significance of a disposed business to those used to determine
significance of an acquired business. We are also adopting as proposed
the amendment to Form 8-K and Article 8 to require smaller reporting
companies to provide pro forma financial information for disposition of
a significant business in Form 8-K and in certain registration
statements and proxy statements when the disposition occurs during or
after the most recently completed fiscal year.\334\
---------------------------------------------------------------------------

    \334\ The Form 8-K requirement for smaller reporting companies
to provide pro forma financial information refers to Rule 8-05. Rule
8-05, however, only applies to acquisitions. While Article 8 has a
requirement in Rule 8-03(b)(4) to provide pro forma financial
information about dispositions of significant businesses, the
provision only applies to the registrant's interim financial
statements. In order to address the anomalous outcome where pro
forma financial information is required when interim financial
statements are presented but not when annual financial statements
are presented, as proposed, we are removing Rule 8-03(b)(4) and
revising Rule 8-05 to require disclosure of pro forma financial
information when any of the conditions in Rule 11-01 is met.
---------------------------------------------------------------------------

    The amendments apply to dispositions of real estate operations as
defined in Rule 3-14(a)(2).\335\ We are

not adopting for dispositions of real estate operations the last
sentence of proposed Rule 1-02(w)(1)(i)(D), which modified the
Investment Test to include debt secured by the real properties that is
assumed by the buyer when the registrant's and its other subsidiaries'
investments in and advances to the real estate operations are being
compared to total assets of the registrant. Where real estate
operations have been included in the consolidated financial statements
of the registrant, the information necessary to apply the Investment,
Asset and Income Tests is available. Thus, unlike for acquisitions of
real estate operations, there are no unique industry considerations
warranting limiting the significance determination to only the
Investment Test or modifying that test.
---------------------------------------------------------------------------

    \335\ See Rule 11-01(b)(2).
---------------------------------------------------------------------------

3. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-05 sets forth pro forma financial information requirements
for business acquisitions by smaller reporting companies. Additionally,
Part F/S of Form 1-A directs an issuer relying on Regulation A to
present the pro forma financial information specified by Rule 8-
05.\336\ Like Article 11, Rule 8-05(a) requires pro forma financial
information only if financial statements of a business acquired or to
be acquired are presented. Like Article 11, Rule 8-05(b) provides that
pro forma financial information must consist of a pro forma balance
sheet and a pro forma statement of comprehensive income presented in
condensed, columnar form for the most recent year and interim period.
Rule 8-05(b), however, does not provide further preparation guidance,
such as the types of pro forma adjustments that can be made. Note 2 of
the Preliminary Notes to Article 8 provides that, to the extent that
Article 11-01 offers enhanced guidelines for the preparation,
presentation, and disclosure of pro forma financial information,
smaller reporting companies may wish to consider these items.
---------------------------------------------------------------------------

    \336\ See paragraph (b)(7)(iv) 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.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to revise Rule 8-05 to require that the
preparation, presentation, and disclosure of pro forma financial
information by smaller reporting companies substantially comply with
Article 11.
b. Comments
    No commenters offered specific comment on these proposed
amendments. Two commenters generally supported the proposal to conform
the rules applicable to smaller reporting companies to the generally
applicable rules stating that it will codify current practice, reduce
confusion, and simplify application of the rules.\337\ In contrast,
another commenter recommended that the Commission consider whether
issuers relying on Regulation A warrant different treatment under the
rules.\338\ Another commenter recommended that smaller registrants be
exempt from mandatory Management's Adjustments disclosure in pro forma
financial information.\339\
---------------------------------------------------------------------------

    \337\ See letters from BDO and Cravath.
    \338\ See SBCFAC Recommendations.
    \339\ See letter from EY.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments to Rule 8-05 as proposed to require
that the preparation, presentation, and disclosure of pro forma
financial information by smaller reporting companies substantially
comply with Article 11.\340\ Additionally, because Part F/S of Form 1-A
refers to Rule 8-05, the amendments to Rule 8-05 will apply to issuers
relying on Regulation A.\341\
---------------------------------------------------------------------------

    \340\ See 8-05(b). However, because pro forma financial
information begins with the historical financial statements of the
registrant, revised Rule 8-05 requires application of Rule 8-03(a)
requirements for condensed format rather than the requirement in
Rule 11-02(b)(3).
    \341\ Certain related requirements applicable to smaller
reporting companies do not apply to issuers relying on Regulation A.
For example, issuers relying on Regulation A are not required to
file reports on Form 8-K or proxy statements.
---------------------------------------------------------------------------

    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 Article 11 and provide investors with
more uniform information upon which to make their investment
decisions.\342\ As revised, in limited circumstances smaller reporting
companies and issuers relying on Regulation A will now have to provide
pro forma financial information for two years when the transaction for
which pro forma effect is being given, such as a combination of
entities under common control or discontinued operation, will be
retrospectively reflected in the historical financial statements of
smaller reporting companies and issuers relying on Regulation A for all
periods presented as required by U.S. GAAP.\343\
---------------------------------------------------------------------------

    \342\ See Section II.D.1.
    \343\ Rule 8-05 did not have a similar provision. However, the
incremental burden on smaller reporting companies and issuers
relying on Regulation A is not expected to be significant because
the circumstances requiring retrospective revision are generally
within their control and they must eventually revise their
previously filed historical financial statements for all periods to
reflect these circumstances.
---------------------------------------------------------------------------

    We are also amending Rule 8-05 as proposed to require presentation
of pro forma financial information when the conditions in Rule 11-01
exist.\344\ Because Rule 8-05 currently requires pro forma financial
information only for business acquisitions,\345\ when Rule 8-05
applies, conforming its conditions to Rule 11-01 will require smaller
reporting companies and issuers relying on Regulation A to provide pro
forma financial information for significant acquisitions and
dispositions \346\ and when a roll-up transaction as defined in 17 CFR
229.901(c) occurs, the registrant previously was a part of another
entity and such presentation is necessary to reflect operations and
financial position of the registrant as an autonomous entity, or
consummation of one or more transactions has occurred or is probable
for which disclosure of pro forma financial information would be
material to investors.\347\
---------------------------------------------------------------------------

    \344\ See Rules 8-05(a) and 11-01(a), as amended.
    \345\ See supra Section II.D.2.
    \346\ Based on an analysis of 2017 disclosures of acquisitions
and dispositions by smaller reporting companies, Commission staff
found that out of 191 disclosures of acquisitions and dispositions
by smaller reporting companies in 2017, 178 already appeared to
comply with Article 11 requirements. Based on an analysis of
disclosures of acquisitions and dispositions in Forms 1-A originally
filed in 2019, Commission staff found that out of 12 Forms 1-A that
disclosed acquisitions subject to Rule 8-04 or Rule 8-06, 9 already
appeared to comply with Article 11 requirements.
    \347\ Form 1-A requires the pro forma financial information
described in Rule 8-05 only when financial statements are required
for businesses acquired or to be acquired. We have amended Part F/S
of Form 1-A to remove this limitation to be consistent with our
amendments, as proposed, to Rule 8-05 to require presentation of pro
forma financial information when the conditions in Rule 11-01 exist.
---------------------------------------------------------------------------

E. Amendments to Financial Disclosure About Acquisitions Specific to
Investment Companies

    For financial reporting purposes, investment company registrants,
including business development companies, must apply the general
provisions in Articles 1, 2, 3, and 4 of Regulation S-X,\348\ unless
subject to the

special rules set forth in 17 CFR 210.6-01 through 210.6-10 (``Article
6'').\349\ Investment company registrants differ from non-investment
company registrants in several respects.\350\ The Commission proposed
amendments to tailor the financial reporting requirements for
investment companies with respect to their acquisitions of investment
companies and other types of funds (collectively, ``acquired funds'').
Specifically, the Commission proposed:
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    \348\ In October 2016, as part of a broader investment company
reporting modernization rulemaking, the Commission adopted certain
amendments to Regulation S-X that expressly apply Article 6 to
business development companies. See Investment Company Reporting
Modernization, Release No. IC-32314 (Oct. 13, 2016) [81 FR 81870
(Nov. 18, 2016)].
    \349\ See Rule 6-03.
    \350\ See Section II.E. of the Proposing Release. Investment
companies invest in securities principally for returns from capital
appreciation and investment income. Investment companies are
required to value their portfolio investments, with changes in value
recognized in the statement of operations for each reporting period.
See Rule 6-02(b) (``the term value shall have the same meaning given
in Section 2(a)(41)(B) of the Investment Company Act''); see also
FASB ASC 946-320-35, FASB ASC 946-323, FASB ASC 946-325-35, FASB ASC
946-810, and FASB ASC 815-10-35. Also, investment companies
generally do not consolidate entities they control and do not
account for portfolio investments using the equity method. See FASB
ASC 946-810-45-2 (general consolidation guidance) and FASB ASC 946-
810-45-3 (the exception to that guidance when considering an
investment in an operating company that provides services to the
investment company).
---------------------------------------------------------------------------

     To add a definition of ``significant subsidiary'' in
Regulation S-X that is specifically tailored for investment companies
based on the current Rule 8b-2 definition with some modifications;
\351\
---------------------------------------------------------------------------

    \351\ The Commission additionally proposed to amend Rule 1-02(w)
to provide that, with respect to the condition in proposed Rule 1-
02(w)(2)(ii), the value of investments shall be determined in
accordance with U.S. GAAP and, if applicable, Section 2(a)(41) of
the Investment Company Act (15 U.S.C. 80a-2(a)(41)).
---------------------------------------------------------------------------

     To add new Rule 6-11 of Regulation S-X, which would
specifically cover financial reporting in the event of a fund
acquisition; and
     To eliminate the pro forma financial information
requirement for investment companies and replace it with proposed
supplemental financial information that the Commission believed would
be more relevant to fund investors.
    Commenters generally supported the Commission's objective of
tailoring financial reporting requirements for investment companies
with respect to acquired funds.\352\ As discussed below, we are
adopting these requirements substantially as proposed, with certain
modifications based on comments received.
---------------------------------------------------------------------------

    \352\ See letters from BDO, CAQ, Deloitte, and Investment
Company Institute (``ICI'').
---------------------------------------------------------------------------

1. Amendments to Significance Tests for Investment Companies
    Investment companies are required to use the significant subsidiary
tests in Rule 1-02(w) when applying Rule 3-05 and other rules within
Regulation S-X.\353\ However, the tests in Rule 1-02(w) were not
written for the specific characteristics of investment companies.\354\
As detailed in the Proposing Release, the definition of ``significant
subsidiary'' in current Rule 1-02(w) has an Investment Test, an Asset
Test, and an Income Test, while the definition of ``significant
subsidiary'' in Rule 8b-2 has an investment test and an income test,
but no asset test.\355\ The Commission proposed to add new Rule 1-
02(w)(2) to create a separate definition of ``significant subsidiary''
for investment companies in Regulation S-X, which--like Rule 8b-2--
would use an investment test and an income test, but not an asset
test.\356\
---------------------------------------------------------------------------

    \353\ The changes to the ``significant subsidiary'' definition
in Regulation S-X will affect disclosures for fund acquisitions and
also have effects on investment company application of Rule 3-09
regarding separate financial statements for significant subsidiaries
and Rule 4-08(g) regarding summarized financial information of
subsidiaries not consolidated.
    \354\ See Proposing Release at n. 217 and accompanying text.
    \355\ See Section II.E.1. of Proposing Release.
    \356\ Id. The Commission also proposed conforming amendments to
the definition of ``significant subsidiary'' in Securities Act Rule
405, Exchange Act Rule 12b-2, and Investment Company Act Rule 8b-2
to make them consistent with proposed Rule 1-02(w)(2).
---------------------------------------------------------------------------

    Two commenters supported adding a definition of ``significant
subsidiary'' specifically tailored for investment companies.\357\ One
commenter noted that certain language in proposed Rule 1-02(w)(1)
appeared inconsistent with proposed Rule 1-02(w)(2).\358\
---------------------------------------------------------------------------

    \357\ See letters from ICI and KPMG.
    \358\ See letter from EY. Specifically, proposed Rule 1-02(w)(1)
stated that the conditions of paragraph (w)(2) would apply if the
``subsidiary'' is a registered investment company or a business
development company, but paragraph (w)(2) stated that its provisions
apply to a ``registrant'' that is a registered investment company or
a business development company. We have revised Rule 1-02(w)(1) to
state that the tests in Rule 1-02(w)(2) apply if the registrant is a
registered investment company or a business development company.
---------------------------------------------------------------------------

a. Investment Test
    Currently, the Investment Test for a significant subsidiary in
Regulation S-X determines significance by evaluating whether the
registrant's and its other subsidiaries' investments in and advances to
the tested subsidiary \359\ exceed 10 percent of the registrant's total
assets. Rule 8b-2 similarly determines significance using an investment
test. For investment companies, the Commission proposed an investment
test that would assess whether the value of the registrant's and its
other subsidiaries' investments in and advances to the tested
subsidiary exceeds 10 percent of the value of the total investments of
the registrant and its subsidiaries consolidated as of the end of the
most recently completed fiscal year. The proposed investment test would
be similar to the existing Investment Test, but modified so that the
comparison would be to the value of the registrant's total investments
rather than total assets.\360\
---------------------------------------------------------------------------

    \359\ See supra note 29 (regarding the use of the term ``tested
subsidiary'').
    \360\ See 17 CFR 210.6-04, item 4.
---------------------------------------------------------------------------

    We are adopting, as proposed, the investment test for investment
companies as part of the definition of ``significant subsidiary.'' We
received one comment on the proposed investment test. This commenter
supported the proposed investment test for investment companies,
agreeing that investment in the tested subsidiary in the context of its
relative exposure to total investments at fair value is the appropriate
metric in evaluating its significance.\361\ We continue to believe that
a total investments measure is more appropriate for investment
companies and more relevant than the existing tests, as it would focus
the significance determination on the impact to the registrant's
investment portfolio as opposed to other non-investment assets that may
be held.\362\
---------------------------------------------------------------------------

    \361\ See letter from Ares Capital Corporation (``Ares'').
    \362\ We also continue to believe that using total investments
for this test would be a more transparent measure than total assets
for registrants that use a statement of net assets instead of a
balance sheet. See Section II.E.1.a. of Proposing Release.
---------------------------------------------------------------------------

b. Asset Test
    The Asset Test in current Rule 1-02(w) compares the proportionate
share of the total assets (after intercompany eliminations) of the
tested subsidiary to the total assets of the registrant and its
subsidiaries consolidated as of the end of the most recent fiscal year.
There is no equivalent test under the Rule 8b-2 definition of
``significant subsidiary''.
    As proposed, we are eliminating the Asset Test as a measure of
significance for investment companies because we continue to believe
that doing so would simplify compliance without changing the
information available to investors as the Asset Test is generally not
meaningful when applied to investment companies. The only commenter who
addressed this aspect of the proposal expressed support for the
elimination of

the Asset Test, stating that it is not meaningful when applied to
investment companies and has been confusing for business development
companies to practically apply.\363\
---------------------------------------------------------------------------

    \363\ See letter from Ares.
---------------------------------------------------------------------------

c. Income Test
    The Income Test in current Rule 1-02(w) compares the registrant's
and its other subsidiaries' equity in the income from continuing
operations before income taxes of the tested subsidiary exclusive of
amounts attributable to any noncontrolling interests with the income of
the registrant and its subsidiaries consolidated for the most recently
completed fiscal year. The income test in Rule 8b-2, however, compares
the total investment income of the tested subsidiary with the total
investment income of the parent and its consolidated subsidiaries. Both
tests find significance if the result is greater than 10 percent.
i. Proposed Amendments
    The Commission proposed to amend the income test for investment
companies to use the income test in Rule 8b-2, but modified to include
any net realized gains and losses and net change in unrealized gains
and losses. The proposed income test for investment companies would use
components from the statement of operations required by 17 CFR 210.6-07
(``Rule 6-07''). In particular, the proposed income test for investment
companies would include, in the numerator, the following amounts for
the most recently completed pre-acquisition fiscal year of the tested
subsidiary: (1) Investment income, such as dividends, interest, and
other income; (2) The net realized gains and losses on investments; and
(3) The net change in unrealized gains and losses. The absolute value
of the sum of these amounts would be compared to the absolute value of
the registrant and its subsidiaries' consolidated change in net assets
resulting from operations. The Commission also proposed that a tested
subsidiary would be deemed significant under the income test for
investment companies if the test yields a condition of greater than
either: (1) 80 percent by itself, or (2) 10 percent and the investment
test for investment companies yields a result of greater than 5 percent
(``alternate income test'').
    To further mitigate the potential adverse effects of the proposed
income test for investment companies with insignificant changes in net
assets resulting from operations for the most recently completed fiscal
year, the Commission proposed an instruction that would permit the
registrant to compute the income test for investment companies using
the average of the absolute value of the changes in net assets for the
past five fiscal years.
ii. Comments
    One commenter specifically supported the proposed income test for
investment companies with an 80 percent threshold and the proposed
alternate income test with 10 percent and five percent thresholds.\364\
However, a different commenter requested that the Commission increase
the five percent threshold for the investment component of the
alternate income test to 10 percent, consistent with the investment
test and Rule 8b-2(b),\365\ and another commenter suggested that the
Commission eliminate the proposed primary income test and adopt only
the alternate income test.\366\
---------------------------------------------------------------------------

    \364\ See letter from ICI.
    \365\ See letter from Ares.
    \366\ See letter from KPMG.
---------------------------------------------------------------------------

    Several commenters recommended the Commission clarify the order of
operations for the proposed income test, in particular whether the
numerator should be the absolute value of the sum of the constituent
elements or, instead, the sum of the absolute value of each of the
constituent elements.\367\ Commenters generally supported the former
approach because it would avoid double counting of a gain (or loss)
related to a sale previously recorded as an unrealized gain (or
loss).\368\ One commenter recommended that the income test be limited
only to investment income as changes in gains and losses would be
captured by the investment test.\369\ Two commenters also observed that
the methods for determining the numerator and the denominator of the
income test were different and questioned the potential impact on the
test.\370\
---------------------------------------------------------------------------

    \367\ See letters from Ares, BDO, CAQ, Deloitte, KPMG, ICI, and
RSM.
    \368\ See letters from BDO, CAQ, Deloitte, EY, and KPMG.
    \369\ See letter from Ares.
    \370\ See letters from Ares and IMA.
---------------------------------------------------------------------------

    One commenter expressed support for the ability of the registrant
to use the five-year average of the change in net assets from
operations where the most recent fiscal year's change in net assets is
insignificant.\371\ Several commenters, however, preferred a bright-
line threshold of 10 percent lower than the average change in net
assets resulting from operations for the past five years rather than
the ``insignificant'' standard.\372\ Several commenters also
recommended that five-year averaging be used for the 80 percent test as
well as the alternate income test.\373\
---------------------------------------------------------------------------

    \371\ See letter from ICI.
    \372\ See letters from BDO, CAQ, KPMG, and EY.
    \373\ See letters from BDO, CAQ, EY, ICI, PwC, Small Business
Investor Alliance (``SBIA''), and RSM.
---------------------------------------------------------------------------

iii. Final Amendments
    We are adopting amendments to the income test substantially as
proposed, but with some modifications after consideration of the
comments received. Commenters supported the percentage thresholds in
the income test. We are not increasing the investment component of the
alternate income test to 10 percent of total investments, as one
commenter suggested, because we believe that would render the alternate
income test duplicative of the 10 percent threshold in the investment
test. We also continue to believe that exceeding an 80 percent
threshold in income alone may indicate significance for financial
reporting purposes for a subsidiary even if the related assets
represent less than 5 percent of total investments. We are, therefore,
adopting this prong of the income test as proposed.
    In response to commenters, we have revised the calculation of
income to be the absolute value of ``the sum'' of combined investment
income from dividends, interest, and other income, the net realized
gains and losses on investments, and the net change in unrealized gains
and losses on investments. We believe this modification will prevent
confusion in applying absolute value with respect to income and avoid
the potential double counting of gains or losses. We continue to
believe that changes in realized and unrealized gains/losses can better
reflect the impact of the tested subsidiary on an investment portfolio
rather than investment income alone.\374\ We also believe it is
appropriate to compare the specified income elements received from the
tested subsidiary \375\ with the investment company registrant's change
in net assets resulting from operations in order to evaluate the impact
on the registrant's net income, particularly in the context of the
subsidiary being a single portfolio investment. However, we agree that
this approach is less relevant in the event of a fund acquisition since
the acquired fund is likely to have fund-level expenses that should be
netted against income. We have, therefore, modified the language

to state that, for purposes of Rule 6-11, the income determination is
made by comparing the absolute value of the change in net assets
resulting from operations of the tested subsidiary with that of the
investment company registrant.
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    \374\ See Section II.E.1.c. of Proposing Release.
    \375\ Rule 1-02(w)(2)(ii) covers the specified income elements
``from the tested subsidiary'' and is calculated at the registrant-
level.
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    We are modifying the five-year income averaging provision, as
suggested by commenters, to provide a bright-line threshold at 10
percent lower than the average change in net assets resulting from
operations for the past five years rather than the ``insignificant''
standard in order to reduce potential inconsistencies in
application.\376\ As proposed, the five-year averaging provision
applies to the income test, which would include both the 80 percent
condition in the primary income test and the 10 percent condition in
the alternate income test; however, in light of commenter confusion, we
have clarified the rule text to expressly state that it applies to both
conditions.\377\
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    \376\ See Rule 1-02(w)(2)(ii).
    \377\ Id.
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2. Proposed Rule 6-11 of Regulation S-X
    Currently, there are no specific rules or requirements in Article 6
for investment companies relating to the financial statements of
acquired funds. Instead, investment companies apply the general
requirements of Rule 3-05 and the pro forma financial information
requirements in Article 11, although it is often unclear how to apply
these reporting requirements in the context of acquired funds.
Investment companies typically file Rule 3-05 Financial Statements in
transactions in which an investment company with limited assets and
operating history is created for the purpose of acquiring one or more
private funds operating under the exclusions provided by Sections
3(c)(1) or 3(c)(7) of the Investment Company Act. These private funds
often have prepared audited financial statements in accordance with
U.S. GAAP, but generally have not prepared their financial statements
in accordance, nor had an audit conducted in compliance, with
Regulation S-X. A registrant that acquires a private fund typically
must revise the historical financial statements of the acquired fund so
that they comply with all applicable rules of Regulation S-X and
possibly re-audit those statements.
a. Proposed Amendments
    The Commission proposed Rule 6-11, which would specifically cover
financial reporting in the event of a fund acquisition. Proposed Rule
6-11 would only apply to the acquisition of a fund, including any
investment company as defined in Section 3(a) of the Investment Company
Act, any private fund that would be an investment company but for the
exclusions provided by Sections 3(c)(1) or 3(c)(7) of that Act, or any
private account managed by an investment adviser. Because the
definition of business in Rule 11-01(d) is not readily applicable in
the context of a fund acquisition, the Commission proposed a facts and
circumstances test as to whether a fund acquisition has occurred,
including when one fund acquires all or substantially all of another
fund's portfolio investments.
    The Commission proposed to require only one year of audited
financial statements for fund acquisitions, a change from the existing
Rule 3-05 requirements that require between one and three years of
audited financial statements, and to make the obligations more aligned
with the financial statement obligations applicable to investment
company registration statements.\378\ Proposed Rule 6-11 would require
the related schedules specified in Article 12, such as the schedule of
investments, to be provided for an acquired or to be acquired fund.
Acquisitions of a group of related funds would be considered as a
single acquisition under proposed Rule 6-11(a)(3) \379\ and a
registrant would have the option of presenting the required financial
statements either on an individual or combined basis for any periods
they are under common control or management.
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    \378\ Rule 3-18 allows registered investment management
companies to file financial statements covering only the most recent
fiscal year, except for an audited statement of changes in net
assets which must cover the two most recent fiscal years.
    \379\ Funds would be considered related if they are under common
control or management, the acquisition of one fund is conditional on
the acquisition of each other fund, or each acquisition is
conditioned on a single common event.
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    The Commission proposed to allow investment companies to provide
financial statements for private funds that were prepared in accordance
with U.S. GAAP. The Commission also proposed to require the investment
company registrant to file schedules for the acquired fund that comply
with Article 12 of Regulation S-X, which requires each investment to be
listed separately.\380\
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    \380\ Because proposed Rule 6-11 would require the schedule of
investments as set forth in Article 12, a private fund would not be
permitted to present a condensed schedule of investments.
---------------------------------------------------------------------------

    To determine whether financial statements of a fund acquired or to
be acquired must be provided under proposed Rule 6-11, the conditions
specified in the definition of ``significant subsidiary'' under
proposed Rule 1-02(w)(2) would be applied, using the investment test
and the alternate income test for investment companies and substituting
20 percent for 10 percent for each place it appears therein.\381\ If
either of the tests were satisfied at the 20 percent condition, the
registrant would be required to file the financial statements for the
acquired fund as set forth in proposed Rule 6-11. Otherwise, filing
financial statements of the acquired fund would not be necessary. If
the aggregate impact of individually insignificant funds acquired or to
be acquired since the most recent audited balance sheet were to exceed
the conditions of the investment test and the alternate income test for
investment companies, substituting 50 percent for 10 percent, then the
registrant would be required to provide the financial statements for
each individually insignificant fund and the supplemental financial
information.\382\ In determining whether financial statements of funds
acquired or to be acquired must be filed, the registrant would be
permitted to use pro forma amounts that give effect to an acquisition
consummated after the registrant's latest fiscal year-end for which the
registrant has filed audited financial statements of such acquired fund
as required by proposed Rule 6-11. Any requirement to file financial
statements of an acquired fund would cease once an audited balance
sheet required by Rules 3-01 or 3-18 is filed for a date after the date
the acquisition was consummated.\383\
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    \381\ As proposed, the primary income test for investment
companies with the 80 percent condition would not be used for
purposes of proposed Rule 6-11.
    \382\ The Commission based the 50 percent condition on the
provision in current Rule 3-05(b)(2)(i). Unlike the existing rule,
however, proposed Rule 6-11 would require financial statements for
each individually insignificant fund acquired or to be acquired,
rather than the ``substantial majority'' requirement for businesses
acquired under the current rule.
    \383\ At such time, the acquired investments would be reflected
on the balance sheet or statement of net assets and accompanying
schedules. In proposing this approach, the Commission expressed its
belief that in these circumstances historical financial statements
of acquired funds would be of less importance to investors and
continued filing obligations would impose unnecessary costs since
any realized and unrealized gains and losses on the acquired
investments would be reflected in the daily net asset value
calculation as well as fund performance measures on a going-forward
basis. See Section II.E.2. of Proposing Release.
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b. Comments
    Commenters generally supported the Commission's objective of
tailoring

financial reporting requirements for investment companies with respect
to acquired funds.\384\ Commenters questioned the scope of the
definition of fund acquisition, suggesting that proposed Rule 6-11
might technically apply whenever a fund acquires an equity interest in
another fund \385\ or when the portfolio securities acquired represent
only a portion of another fund's holdings but will represent
substantially all of the initial assets of a new registrant.\386\ A
number of commenters also requested guidance on when Rule 3-05 would
apply to non-fund acquisitions by investment company registrants.\387\
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    \384\ See letters from BDO, CAQ, Deloitte, and ICI.
    \385\ See letters from CAQ, EY, and GT.
    \386\ See letters from EY and KPMG.
    \387\ See letters from CAQ, Deloitte, EY, GT, ICI, KPMG, and
PwC.
---------------------------------------------------------------------------

    One commenter supported proposed Rule 6-11's use of the
``significant subsidiary'' definition, modified to set the investment
test at the 20 percent condition and to exclude the primary income test
with the 80 percent condition.\388\ This commenter recommended that the
alternate income test be changed from five percent to 10 percent of
total investments because the size of the acquired fund should be the
principal determinant of significance. Two commenters questioned
whether the significance tests would only apply to fund acquisitions
covered in proposed Rule 6-11(b)(2) and not proposed Rule 6-
11(b)(1).\389\
---------------------------------------------------------------------------

    \388\ See letter from ICI.
    \389\ See letter from EY and ICI.
---------------------------------------------------------------------------

    One commenter supported the proposed alignment of financial
statement requirements with Rule 3-18, but expressed confusion about
whether acquired fund financial statements would need to be included in
subsequent filings until a post-acquisition audited balance sheet is
filed.\390\ Another commenter indicated that it was unclear as to the
number of fiscal years for which financial statements must be presented
for acquired funds, whether only for the past fiscal year or for the
periods set forth in Rule 3-18.\391\ A third commenter stated that
proposed Rule 6-11 should eliminate reporting requirements for acquired
companies that have previously filed audited financial statements with
the Commission in accordance with Regulation S-X and allow unaudited
financial statements for other acquired companies due to cost.\392\
---------------------------------------------------------------------------

    \390\ See letter from ICI.
    \391\ See letter from EY.
    \392\ See letter from Ares.
---------------------------------------------------------------------------

    Regarding the proposal to permit acquired private funds to provide
financial statements prepared in accordance with U.S. GAAP and
schedules that comply with Article 12, one commenter supported the
proposed approach.\393\ Two commenters requested that the Commission
consider alternatives that would provide full transparency of the
portfolio holdings of the acquired fund but not require audited Article
12 schedules.\394\
---------------------------------------------------------------------------

    \393\ See letter from ICI.
    \394\ See letters from ICI and KPMG.
---------------------------------------------------------------------------

    Several commenters suggested that the Commission make various
amendments to Rules 3-09, 4-08(g), and 10-01(b)(1) of Regulation S-X,
involving financial disclosures outside of the acquisition
context.\395\
---------------------------------------------------------------------------

    \395\ See letters from Ares, BDO, KPMG, and SBIA.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting new Rule 6-11 to address the financial disclosure
obligations for acquired funds, with certain modifications in response
to comments received.\396\ Investment company registrants will follow
Rule 6-11, rather than Rule 3-05, in the event that a fund acquisition
occurs or is probable to occur.\397\ With respect to whether a fund
acquisition has occurred, in response to commenters who sought further
clarity, we have revised Rule 6-11(a)(2)(ii) to state that in
evaluating the facts and circumstances as to whether an acquisition has
occurred or is probable, a registrant should consider whether it will
result in the acquisition of all or substantially all of the portfolio
investments held by another fund.\398\ We have also removed language
that suggests acquired fund financial disclosure would be required if
the registrant acquired a non-substantial portion of another fund's
portfolio investments that would constitute all or substantially all of
the initial assets of the registrant.\399\ The intent of the facts and
circumstances evaluation is to capture all situations where additional
disclosure about the acquired fund is appropriate, regardless of the
legal form, such as merger, consolidation, or asset sale, used to
structure the transaction.
---------------------------------------------------------------------------

    \396\ We also are adopting, as proposed, conforming amendments
to Rules 3-18(d), 5-01(a), 6-01, 6-02(b) and (c), and 6-03 of
Regulation S-X to reflect the addition of Rule 6-11.
    \397\ Investment company registrants are currently subject to
the requirements of Rule 3-05, provided the conditions set forth in
that rule are satisfied. Rule 3-05, as revised, will continue to
apply to investment company registrants with respect to acquired and
disposed businesses that do not involve a fund acquisition covered
by Rule 6-11.
    \398\ Rule 6-11(a).
    \399\ Id.
---------------------------------------------------------------------------

    We are adopting the use of the ``significant subsidiary''
definition in Rule l-02(w)(2) as the basis for determining whether
financial statements for the acquired fund must be filed under Rule 6-
11, but modified, as proposed, to use the investment test at the 20
percent condition and to exclude the 80 percent condition of the
primary income test. We are not altering the investment component of
the alternate income test, as one commenter suggested, because we
continue to believe that five percent of total investments represents a
material threshold.\400\ As adopted without change from the proposal,
the significance tests in Rule 6-11 only apply to situations covered in
paragraph (b)(2) and not paragraph (b)(1). Thus, an investment company
registrant filing a registration statement on Form N-14 in connection
with the acquisition of another fund will not apply the significance
tests in Rule 6-11(b)(2).
---------------------------------------------------------------------------

    \400\ The modified conditions in Rule 6-11 only substitute 20
percent for 10 percent for the investment test and alternate income
test described in Rule 1-02(w)(2). Thus, for purposes of Rule 6-11,
a registrant would apply an investment test condition of 20 percent
of the value of total investments and the alternate income test
conditions of 20 percent of the absolute value of the change in net
assets resulting from operations and five percent of the value of
total investments.
---------------------------------------------------------------------------

    As proposed, Rule 6-11 would have required an investment company
registrant to include acquired fund financial statements as part of the
registrant's financial statements until its next audited balance sheet
after the acquisition was consummated. Given the availability of the
acquired fund financial statements on the Commission's EDGAR system
once filed and that the price of investment company shares or interests
is established by the value of its current investment portfolio, we
agree with commenters that acquired fund financial statements need not
be included in future filings. Accordingly, we have modified the rule
to require acquired fund financial statements to be filed only
once.\401\
---------------------------------------------------------------------------

    \401\ Rule 6-11(b)(4). Proposed Item 14(d)(5) of Schedule 14A
[17 CFR 240.14a-101] would have required proxy statements filed by a
fund, with respect to a merger, consolidation, acquisition, or
similar matter, to include financial statements of the acquiring
fund, including those required by Rules 3-05 and 6-11 and Article 11
of Regulation S-X ``with respect to transactions other than that as
to which action is to be taken as described'' in the proxy
statement. Since Rule 6-11 only requires acquired fund financial
statements to be filed once, we are not adopting the proposed
amendment to Item 14(d)(5) of Schedule 14A.
---------------------------------------------------------------------------

    One commenter requested clarification of the number of fiscal

years for which financial statements must be presented in Rule 6-11 and
whether the requirement should be consistent with Rule 3-18.\402\ In
response, we have revised Rule 6-11 to make clear that if the acquired
fund is subject to Rule 3-18, then the financial statements for the
periods described in Rule 3-18 shall be filed.\403\ For all other
acquired funds, such as private funds, only the financial statements
for the most recent fiscal year and the most recent interim period need
to be filed.\404\ We are not following the suggestion, made by one
commenter, to eliminate the filing of acquired fund financial
statements if they were previously filed with the Commission in
accordance with Regulation S-X by the acquired fund, because the
disclosure is predominantly for the benefit of the acquiring fund's
shareholders, not the acquired fund's shareholders.\405\
---------------------------------------------------------------------------

    \402\ Rule 3-18 applies to registered management investment
companies. Business development companies are also permitted to use
Rule 3-18 pursuant to the instructions set forth in Form N-2.
    \403\ Rule 6-11(b)(2)(ii) and (iii).
    \404\ Id.
    \405\ Some forms, such as Form N-14, permit backwards
incorporation by reference of information not included in the
prospectus. See General Instruction G to Form 14. Effective May 2,
2019, incorporation by reference on Form N-14 is allowed for all
parties who may use the form, including business development
companies. See FAST Act Modernization and Simplification of
Regulation S-K, Release No. IC-10618 (Mar. 20, 2019) [84 FR 12674
(Apr. 2, 2019)].
---------------------------------------------------------------------------

    We are not persuaded by the commenter who requested that we permit
filing of unaudited financial statements for acquired funds due to
cost. We continue to believe that a significant number of private funds
currently prepare audited financial statements under U.S. GAAP due to
investor demand and for regulatory compliance purposes.\406\ Moreover,
although auditing an acquired private fund's financial statements
involves costs, we believe that our proposed approach requiring audited
U.S. GAAP financial statements with respect to acquisitions of private
funds will reduce costs as compared to re-issuing audited financial
statements in compliance with Regulation S-X, but still will provide
investors appropriate information about the acquired fund. We also have
modified Rule 6-11(c) from the proposal to make the filing of financial
statements using U.S. GAAP permissive for private funds. Proposed Rule
6-11(c) provided that the financial statements of private funds
``shall'' comply with U.S. GAAP. Under the final rule, the financial
statements of private funds may either comply with U.S. GAAP or Article
12.\407\
---------------------------------------------------------------------------

    \406\ For example, private funds prepare audited financials,
among other reasons, to satisfy their custody rule obligations under
the Investment Advisers Act. See 17 CFR 275.206(4)-2.
    \407\ We also have made non-substantive changes to provide a
more accurate heading for paragraph (c) and to reflect the intent of
the Commission that the provision applies to a fund or private
account that is ``acquired or to be acquired.'' As proposed, the
language only referenced a fund or private account ``to be
acquired.''
---------------------------------------------------------------------------

    The Commission's proposal was intended to achieve a more
appropriate balance by permitting registrants to file audited U.S. GAAP
financial statements for acquired private funds, but supplementing
those financial statements with audited schedules listing each
investment as required by Article 12.\408\ A condensed schedule of
investments prepared under U.S. GAAP does not include the same
prescriptive level of detail when compared to an Article 12 compliant
(or full) schedule of investments. While each investment is listed
separately in a full schedule of investments, a condensed schedule
allows funds to aggregate investments by issuer or by investment type
so long as each investment is individually less than five percent of
the net assets of the fund.\409\ While providing a full unaudited
schedule of portfolio investments would provide transparency, we
believe that the incremental costs of providing an audited schedule of
investments that complies with Article 12 is minimal because the
portfolio investment account balances already have been audited, and
the incremental audit procedures therefore would be limited to the
incremental disclosures required under Article 12. In addition, an
audit will provide additional assurance for investors as to the
accuracy of that schedule.
---------------------------------------------------------------------------

    \408\ See Section II.E.2. of Proposing Release.
    \409\ See FASB ASC 946.
---------------------------------------------------------------------------

    We also are removing the sentence from proposed Rule 6-11(a)(3)
providing that the financial statements in connection with the
acquisition of a group of related funds may be presented either on an
individual or a combined basis for any periods the related funds are
under common control or management. This change is based on our
understanding that, unlike operating companies, funds generally do not
file ``combined financial statements'' as defined in FASB ASC Topic
810-10-20.
    Finally, with respect to commenters' suggestion to make substantive
amendments to Rules 3-09, 4-08(g), and 10-01(b)(1) of Regulation S-X,
we believe such amendments would be beyond the scope of this
rulemaking.\410\
---------------------------------------------------------------------------

    \410\ While we are not making substantive changes to Rule 3-09,
as a result of the changes to Rule 1-02(w) we are revising Rule 3-
09(a) to make clear that it applies to Rule 1-02(w)(1).
---------------------------------------------------------------------------

3. Pro Forma Financial Information and Supplemental Financial
Information
    Currently, Rule 11-01 requires an investment company to furnish pro
forma financial information when a significant business acquisition has
occurred or is probable, with significance being determined using the
tests set forth in Rule 1-02(w) and substituting 20 percent for 10
percent in the conditions.\411\
---------------------------------------------------------------------------

    \411\ Rule 11-02 permits investment companies to provide a
narrative description of the pro forma effects of the transaction in
lieu of pro forma financial statements, if there are a limited
number of required pro forma adjustments and they are easily
understood. See Rule 11-02(b)(1).
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to replace the pro forma financial
disclosures requirement with proposed Rule 6-11(d), which would require
that investment company registrants provide supplemental financial
information about the newly combined entity that it believed would be
more relevant to investors.\412\ The proposed supplemental financial
information would include: (1) A pro forma fee table, setting forth the
post-transaction fee structure of the combined entity; (2) If the
transaction will result in a material change in the acquired fund's
investment portfolio due to investment restrictions, a schedule of
investments of the acquired fund modified to show the effects of such
change and accompanied by narrative disclosure describing the change;
and (3) Narrative disclosure about material differences in accounting
policies of the acquired fund when compared to the newly combined
entity.
---------------------------------------------------------------------------

    \412\ See Section II.E.3. of Proposing Release.
---------------------------------------------------------------------------

b. Comments
    One commenter expressed support for the proposed replacement of the
pro forma financial information requirement, indicating that the
proposed supplemental financial information would better inform
investors and reduce costs.\413\ In addition, two commenters noted that
the rule text in proposed Rule 6-11(d)(1)(iii) would require disclosure
about material differences in ``financial and operating policies,''
while the preamble of the Proposing Release referred to material
differences in ``accounting policies'' between the acquiring and
acquired funds.\414\
---------------------------------------------------------------------------

    \413\ See letter from ICI.
    \414\ See letters from EY and ICI.

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

c. Final Amendments
    We are adopting the amendments substantially as proposed, but with
one modification in response to comments received. As proposed, we are
adopting amendments to eliminate the requirement to provide pro forma
financial information for investment company registrants in connection
with fund acquisitions and to require the supplemental financial
information in its place.\415\ We believe that the pro forma financial
information is not necessary in light of the costs to prepare such
disclosures and given that the supplemental financial information will
provide material information to investors by highlighting important
changes resulting from a fund acquisition as context for the acquired
fund's financial statements. We also are modifying Rule 6-11(d)(1)(iii)
to state that it requires narrative disclosure about material
differences in ``accounting policies'' of the acquired fund when
compared to the acquiring fund, which was the Commission's intent as
expressed in the preamble of the Proposing Release.
---------------------------------------------------------------------------

    \415\ See Section II.E.4. of Proposing Release.
---------------------------------------------------------------------------

4. Amendments to Form N-14
    Item 14 of Form N-14, the form used by investment companies to
register securities issued in business acquisition transactions,\416\
provides, subject to certain exceptions, that the corresponding
Statement of Additional Information (``SAI'') ``shall contain the
financial statements and schedules of the acquiring company and the
company to be acquired required by Regulation S-X.''
---------------------------------------------------------------------------

    \416\ See 17 CFR 239.23 (setting forth the requirement for an
investment company to file Form N-14 to register securities in
business combination transactions) and 17 CFR 230.145 (specifying
the types of transactions that trigger the Form N-14 filing
requirement).
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to amend Form N-14 to make its disclosure
requirements consistent with the disclosures required in proposed Rule
6-11. Specifically, the Commission proposed the following amendments:
     In the case of a fund acquisition, any financial
statements and schedules required by Regulation S-X would only be
required for the most recent fiscal year and the most recent interim
period; \417\
---------------------------------------------------------------------------

    \417\ Non-fund acquisitions would continue to be required to
follow the other financial statement disclosure requirements set
forth in Regulation S-X for the periods required by Rule 3-05,
including any pro forma financial information required by Article
11.
---------------------------------------------------------------------------

     Permit private funds to provide financial statements and
schedules that conform to U.S. GAAP and Article 12 of Regulation S-X;
     Require inclusion of the supplemental financial
information described in proposed Rule 6-11(d), except for the pro
forma fee table; \418\
---------------------------------------------------------------------------

    \418\ The Commission proposed to exclude the pro forma fee table
from Item 14 of Form N-14 because it is already required in the
prospectus under Item 3 of that Form.
---------------------------------------------------------------------------

     Remove provisions no longer relevant because of prior
amendments; \419\ and
---------------------------------------------------------------------------

    \419\ Specifically, the Commission proposed to remove the
ability to place columns C and D of Schedule II under 17 CFR 210.12-
14 (``Rule 12-14'') to Part C of the registration statement, with
the remainder of the schedule being provided in the SAI. When
originally adopted, Form N-14 was based on Form N-1A, which had a
similar provision. See Registration Form Used by Open-End Management
Investment Companies: Guidelines, Release No. IC-13436 (Aug. 12,
1983) [48 FR 37928 (Aug. 22, 1983)]. This provision was removed from
Form N-1A in 1998. See Registration Form Used by Open-End Management
Investment Companies, Release No. 33-7512 [63 FR 13916 (Mar. 23,
1998)].
---------------------------------------------------------------------------

     Remove the existing exclusion in Form N-14 for pro forma
financial statements required by Rule 11-01 of Regulation S-X if the
net asset value of the company being acquired does not exceed 10
percent of the registrant's net asset value, because pro forma
financial statements would no longer be required for fund acquisitions
and, for non-fund acquisitions, the significance measure for pro forma
financial statements in Rule 11-01(b)(1) is and will remain 20 percent.
b. Comments
    Two commenters noted that the rule text of the proposed amendments
to Item 14.2 of Form N-14, which describes the financial statement
requirements when the acquired fund is a private fund, differed from
the rule text of proposed Rule 6-11(c).\420\
---------------------------------------------------------------------------

    \420\ See letter from EY (stating that proposed Item 14.2 of
Form N-14 included text that was not included in proposed rule 6-
11(c)); see also letter from ICI (same).
---------------------------------------------------------------------------

c. Final Amendments
    We are amending Form N-14 substantially as proposed, but with some
modifications in response to commenters. We continue to believe that it
is appropriate for investors who acquire securities in a registered
offering to have the same disclosure that investors receive through
financial statement disclosure in shareholder reports. With respect to
Item 14.2, we agree with commenters that there should be consistency
between the Form N-14 and Rule 6-11 disclosure requirements for private
funds using U.S. GAAP, and we have made conforming amendment to Form N-
14 to reflect Rule 6-11 as adopted.\421\
---------------------------------------------------------------------------

    \421\ Item 4.2 of Form N-14.
---------------------------------------------------------------------------

F. Transition

    After considering feedback from commenters,\422\ registrants will
not be required to apply the final amendments until the beginning of
the registrant's fiscal year beginning after December 31, 2020 (the
``mandatory compliance date''). Acquisitions and dispositions that are
probable or consummated after the mandatory compliance date must be
evaluated for significance using the final amendments.\423\
---------------------------------------------------------------------------

    \422\ See e.g., letters from BDO, DT, EY, and KPMG. BDO
recommended permitting application of the amendments in filings made
on or after publication of the amendments in the Federal Register.
DT indicated it may be useful for preparers to understand whether
the new rules should be applied to all acquisitions (1) Consummated
after the effective date, (2) Reported on Form 8-K or 8-K/A filed
after the effective date, or (3) Reported in a new or amended
registration statement filed after the effective date and when
registrants would apply the new pro forma requirements, particularly
if some acquisitions were consummated before the effective date and
others were consummated after. EY recommended that registrants that
have filed a current report announcing the completion of a
significant acquisition or disposition before the effective date of
the final rule be allowed to comply with the existing rules for that
transaction and registrants that have submitted a draft or
confidential registration statement or filed a registration
statement before the effective date of the final rule be allowed to
complete their offering under the existing rules. KPMG recommended
that the Commission provide transition guidance that clarifies the
effective date, including the permissibility of early application of
the amendments and application of the amendments to transactions
consummated near the final rule's effective date.
    \423\ For registration statements filed on or after the
mandatory compliance date, registrants that are subject to the
reporting requirements of Section 13(a) or 15(d) of the Exchange Act
at the mandatory compliance date may test acquisitions and
dispositions consummated before the mandatory compliance date using
rules that were in effect when the acquisitions and dispositions
were consummated.
---------------------------------------------------------------------------

    Registrants filing initial registration statements are not required
to apply the final amendments until an initial registration statement
is first filed on or after the mandatory compliance date. For initial
registration statements first filed on or after the mandatory
compliance date, all probable or consummated acquisitions and
dispositions, including those consummated prior to the mandatory
compliance date, must be evaluated for significance using the final
amendments.\424\
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    \424\ Issuers relying on Regulation A filing initial offering
statements on Form 1-A are not required to apply the final
amendments until an initial offering statement is first filed on or
after the mandatory compliance date. For initial offering statements
first filed on or after the mandatory compliance date, all probable
or consummated acquisitions and dispositions, including those
consummated prior to the mandatory compliance date, must be
evaluated for significance using the final amendments.

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    Voluntary early compliance with the final amendments is permitted
\425\ in advance of the registrant's mandatory compliance date provided
that the final amendments are applied in their entirety from the date
of early compliance.\426\
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    \425\ To the extent that registrants have questions about
application of the rules in connection with early compliance, they
should reach out to Commission staff for additional transition
guidance.
    \426\ For an acquisition or disposition of a business for which
the disclosure required by an Item 2.01 Form 8-K has been filed (or
was required to be filed) prior to the mandatory compliance date (or
the voluntary early compliance date, if applicable), but for which
Rule 3-05 Financial Statements and Article 11 pro forma financial
information are not required to be filed (e.g., in an Item 9.01 Form
8-K) until after the mandatory compliance date (or until after the
voluntary early compliance date, if applicable), the registrant must
file the financial statements and pro forma financial information
required by the rules in effect when the Item 2.01 Form 8-K was
required to be filed.
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III. Other Matters

    If any of the provisions of these rules, or the application thereof
to any person or circumstance, is held to be invalid, such invalidity
shall not affect other provisions or application of such provisions to
other persons or circumstances that can be given effect without the
invalid provision or application.
    Pursuant to the Congressional Review Act, the Office of Information
and Regulatory Affairs has designated these rules a ``major rule,'' as
defined by 5 U.S.C. 804(2).

IV. Economic Analysis

A. Introduction

    We are adopting amendments to our rules and forms to improve their
application, assist registrants in making more meaningful
determinations of whether a subsidiary or an acquired or disposed
business is significant, and improve the disclosure requirements for
financial statements relating to acquisitions and dispositions of
businesses, including real estate operations and investment companies.
The amendments are intended to improve the utility and relevance of the
financial information about acquired or disposed businesses provided to
investors, facilitate timely access to capital, and reduce the
complexity and costs to prepare required disclosures. The reduction in
compliance costs could in theory facilitate increased acquisition or
disposition activity by registrants. However, registrants engage in
acquisitions and dispositions for a variety of business reasons, and,
as a general matter, their evaluation of the advisability of
acquisitions and dispositions often involve cost and benefit
considerations much greater than compliance cost considerations. More
specifically, with respect to significant transactions which could
trigger disclosure relevant to the amendments, these other
considerations are likely to be even more important to the decision to
engage in acquisition and disposition activity than the more modest
effects of the final amendments.
    Providing timely, accurate, and transparent information, especially
financial information, about acquired and disposed businesses is
important to mitigate the information asymmetry that exists between
corporate insiders (managers and majority shareholders) and outsiders
(minority shareholders, creditors, etc.). This is especially true in
the context of major corporate transactions such as mergers,
acquisitions, and dispositions, as investors rely on the financial
information of the acquired and disposed businesses to assess the
potential effects of these activities on the registrant. A properly
functioning market for corporate control serves as an important
external governance mechanism involving transactions that potentially
create shareholder value through synergy generation or transferring
assets to more efficient management.\427\ However, in the absence of
appropriately tailored disclosures, investors may not be able to
optimize allocation of their resources or fully assess the effects of
this important external governance mechanism on the firms in which they
invest.
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    \427\ See, e.g., Mark L. Mitchell & Kenneth Lehn, Do Bad Bidders
Become Good Targets?, 98 J. Pol. Econ. 372 (1990) (``Mitchell & Lehn
(1990)''); Anup Agrawal & Jeffrey F. Jaffe, Do Takeover Targets
Underperform? Evidence from Operating and Stock Returns, 38 J. Fin.
& Quantitative Analysis 721 (2003) (``Agrawal & Jaffe (2003)''). See
also, e.g., Xiaoyang Li, Productivity, Restructuring, and the Gains
from Takeovers, 109 J. Fin. Econ. 250 (2013) (``Li (2013)''). Based
on plant-level data, this study shows that acquirers increase
targets' productivity through more efficient use of capital and
labor, thus enhancing the value of the acquisitions.
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    Disclosure requirements also impose costs on registrants that may
seek to engage in acquisitions or dispositions. In particular, such
costs could diminish the benefits associated with an acquisition or
disposition; however, we would not expect such costs to alter a
decision to pursue a particular transaction. Further, a registrant's
ability to provide such disclosure for periods prior to an acquisition
may be dependent on the availability and assistance of both the
acquired business and the acquired business's independent auditor.
While this potential issue would be unlikely to affect a registrant's
decision to engage in an acquisition, it may impact its ability to
comply with reporting requirements for capital raising transactions
and, accordingly, to access capital in the manner and within the time
frames it most desires.
    We believe the final amendments, by streamlining and clarifying
acquired business financial disclosure requirements, should reduce
compliance costs while maintaining investors' access to information
that is material to an understanding of the potential effects of an
acquired or to be acquired business (or disposed or to be disposed
business) on the registrant.
    We are mindful of the costs imposed by and the benefits obtained
from our rules and amendments. Section 2(b) of the Securities Act,\428\
Section 3(f) of the Exchange Act,\429\ and Section 2(c) of the
Investment Company Act \430\ require the Commission, when engaging in
rulemaking where it is required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider,
in addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation. Additionally,
Section 23(a)(2) of the Exchange Act \431\ requires us, when adopting
rules under the Exchange Act, to consider, among other things, the
impact that any new rule would have on competition and not to adopt any
rule that would impose a burden on competition that is not necessary or
appropriate in furtherance of the Exchange Act.
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    \428\ 15 U.S.C. 77b(b).
    \429\ 17 U.S.C. 78c(f).
    \430\ 15 U.S.C. 80a-2(c).
    \431\ 15 U.S.C. 78w(a)(2).
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    Below we address the potential economic effects of the amendments,
including the likely benefits and costs, as well as the likely effects
on efficiency, competition, and capital formation. We attempt to
quantify these economic effects whenever possible; however, due to data
limitations, we are not able to quantify all of the economic effects.

B. Baseline and Affected Parties

    The current disclosure requirements in Rule 1-02(w), Rule 3-05,
Rule 3-14, Article 11, and the related smaller reporting company
requirements in Article 8 of Regulation S-X, together with current
disclosure practices, form the baseline from which we estimate the

likely economic effects of the amendments.\432\
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    \432\ See supra Section II.
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    The amendments are likely to affect investors both directly and
indirectly through other users of the disclosure (e.g., security
analysts, investment advisers, and portfolio managers), auditors, and
registrants subject to Regulation S-X. Additionally, entities other
than registrants may be affected, such as significant acquirees for
which financial statements are required under Rule 3-05 and Rule 3-14.
    The amendments may affect both domestic registrants and foreign
private issuers.\433\ We estimate that during calendar year 2019,
approximately 6,792 registrants filed on domestic forms \434\ and 849
foreign private issuers filed on F-forms, other than registered
investment companies. Among the registrants that file on domestic
forms, approximately 31 percent were large accelerated filers, 19
percent were accelerated filers,\435\ and 50 percent were non-
accelerated filers. In addition, we estimate that of these domestic
issuers approximately 42.8 percent were smaller reporting companies and
17.2 percent of these domestic issuers were emerging growth
companies.\436\ About 26.1 percent of foreign private issuers that
filed on Forms 20-F and 40-F were emerging growth companies. With
respect to foreign private issuer accounting standards, approximately
39 percent of foreign private issuers reported under U.S. GAAP, 60
percent reported under IFRS-IASB, and approximately 1 percent reported
under a comprehensive body of accounting principles other than U.S.
GAAP or IFRS-IASB with a reconciliation to U.S. GAAP. Certain of the
amendments may also affect issuers that rely on Regulation A and
investment companies that must comply with the requirements of
Regulation S-X. Based on staff analysis of EDGAR filings, we estimate
that during calendar year 2019 there were 106 issuers with newly
qualified Regulation A offering statements.
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    \433\ The number of domestic registrants and foreign private
issuers affected by the amendments is estimated as the number of
unique companies, identified by Central Index Key (CIK), that filed
Form 10-K, Form 20-F, and Form 40-F or an amendment thereto with the
Commission during calendar year 2019. The estimates for the
percentages of companies by accelerated filer status and the
percentage of smaller reporting companies are based on the self-
reported status provided by these registrants during calendar year
2019, with supplemental data from Ives Group Audit Analytics. The
estimates for the percentages of foreign private issuers' basis of
accounting used to prepare the financial statements are derived from
the information in Forms 20-F and 40-F or an amendment thereto.
These estimates do not include issuers that filed only initial
registration statements during calendar year 2019, which will also
be affected by the amendments.
    \434\ This number includes fewer than 20 foreign private issuers
that file on domestic forms and approximately 100 business
development companies. Of the foreign private issuers filing on
domestic forms in calendar year 2019, approximately 85 percent
reported under U.S. GAAP while 15 percent reported under IFRS-IASB.
    \435\ See supra note 23.
    \436\ Staff determined whether a registrant claimed emerging
growth company status by parsing several types of filings (e.g.,
Forms S-1, S-1/A, 10-K, 10-Q, 8-K, 20-F/40-F, and 6-K) filed by the
registrant, with supplemental data drawn from Ives Group Audit
Analytics.
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    The ``significant subsidiary'' definition in Rule 1-02(w) is
applied when determining if a subsidiary is deemed significant for the
purposes of certain Regulation S-X and Regulation S-K requirements as
well as certain Securities Act and Exchange Act rules and forms.\437\
Because the significance of a subsidiary affects the disclosure
required from registrants about the activities of those subsidiaries,
the amendments we are adopting to Rule 1-02(w) will affect registrants'
significance determinations and, as a result of those determinations,
registrants' disclosure requirements.
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    \437\ See supra Section II.A.
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    Additionally, registrants are required to file separate audited
annual and unaudited interim pre-acquisition financial statements of
the acquired business if the acquisition triggers the Rule 1-02(w)
significance tests as modified by Rule 3-05 and Rule 3-14. Because the
United States has one of the most active markets for mergers and
acquisitions,\438\ the rules we are amending are relevant to a large
number of transactions and businesses but the amendments themselves,
beyond their potential cost savings, are not expected to have a
significant effect on transactions or businesses more generally.
Registrants would be potentially affected by the amendments if they
engage in an acquisition or disposition transaction (or series of
transactions) that is deemed significant under the Rule 1-02(w)
significance tests as modified by Rule 3-05 and Rule 3-14 or the
related smaller reporting company requirements in Article 8.
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    \438\ See Anant K. Sundaram, Mergers and Acquisitions and