[Federal Register Volume 84, Number 102 (Tuesday, May 28, 2019)]
[Proposed Rules]
[Pages 24600-24661]
[FR Doc No: 2019-09472]

Vol. 84

Tuesday,

No. 102

May 28, 2019

Part II

Securities and Exchange Commission

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17 CFR Parts 210, 230, 239, et al.

Amendments to Financial Disclosures About Acquired and Disposed
Businesses; Proposed Rule

Federal Register / Vol. 84 , No. 102 / Tuesday, May 28, 2019 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 230, 239, 240, 249, 270, and 274

[Release No. 33-10635; 34-85765; IC-33465; File No. S7-05-19]
RIN 3235-AL77

Amendments to Financial Disclosures About Acquired and Disposed
Businesses

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: We are proposing amendments to our rules and forms to improve
the disclosure requirements for financial statements relating to
acquisitions and dispositions of businesses, including real estate
operations and investment companies. The proposed changes are intended
to improve for investors the financial information about acquired or
disposed businesses, facilitate more timely access to capital, and
reduce the complexity and costs to prepare the disclosure.

DATES: Comments should be received on or before July 29, 2019.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use our internet comment form (http://www.sec.gov/rules/other.shtml);
     Send an email to<EMAIL_ADDRESS>Please include
File Number S7-05-19 on the subject line; or

Paper Comments

     Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-05-19. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method of submission. We will post all comments on our website (http://www.sec.gov/rules/other.shtml). Comments also are available for website
viewing and printing in our Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. All comments received will be posted without
change. Persons submitting comments are cautioned that we do not redact
or edit personal identifying information from comment submissions. You
should submit only information that you wish to make publicly
available.
    We or the staff may add studies, memoranda, or other substantive
items to the comment file during this rulemaking. A notification of the
inclusion in the comment file of any such materials will be made
available on our website. To ensure direct electronic receipt of such
notifications, sign up through the ``Stay Connected'' option at
www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Todd E. Hardiman, Associate Chief
Accountant, at<PHONE_NUMBER>, or Jessica Barberich, Associate Chief
Accountant, at<PHONE_NUMBER> or Craig Olinger, Senior Advisor to the
Chief Accountant, at<PHONE_NUMBER>, or Steven G. Hearne, Senior
Special Counsel at<PHONE_NUMBER> in the Division of Corporation
Finance; Jenson Wayne, Assistant Chief Accountant, at<PHONE_NUMBER>,
or Mark T. Uyeda, Senior Special Counsel, at<PHONE_NUMBER>, in the
Division of Investment Management, 100 F Street NE, Washington, DC
20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing to amend:

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           Commission reference                CFR citation (17 CFR)
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Regulation S-X:
  Rules 1-01 et seq......................  Sec.   210.01 et seq.
  Rule 1-02(w)...........................  Sec.   210.1-02(w)
  Rule 3-05..............................  Sec.   210.3-05
  Rule 3-06..............................  Sec.   210.3-06
  Rule 3-14..............................  Sec.   210.3-14
  Rule 3-18..............................  Sec.   210.3-18
  Rule 5-01..............................  Sec.   210.5-01
  Rule 6-01..............................  Sec.   210.6-01
  Rule 6-02..............................  Sec.   210.6-02
  Rule 6-03..............................  Sec.   210.6-03
Article 8:
  Rule 8-01..............................  Sec.   210.8-01
  Rule 8-03..............................  Sec.   210.8-03
  Rule 8-04..............................  Sec.   210.8-04
  Rule 8-05..............................  Sec.   210.8-05
  Rule 8-06..............................  Sec.   210.8-06
Article 11:
  Rule 11-01.............................  Sec.   210.11-01
  Rule 11-02.............................  Sec.   210.11-02
  Rule 11-03.............................  Sec.   210.11-03
Securities Act of 1933 (Securities Act):
 \1\
  Securities Act Rule 405................  Sec.   230.405
  Rule 405 of Regulation S-T.............  Sec.   232.405
  Form N-2...............................  Sec.   239.14 and Sec.
                                            274.11a-1
  Form N-14..............................  Sec.   239.23
Securities Exchange Act of 1934 (Exchange
 Act): \2\
  Rule 12b-2.............................  Sec.   240.12b-2
  Rule 14a-101...........................  Sec.   240.14a-101
  Form 8-K...............................  Sec.   249.308
  Form 10-K..............................  Sec.   249.310
Investment Company Act of 1940
 (Investment Company Act): \3\
  Rule 8b-2..............................  Sec.   270.8b-2
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\1\ 15 U.S.C. 77a et seq.
\2\ 15 U.S.C. 78a et seq.
\3\ 15 U.S.C. 80a-1 et seq.

    We also are proposing to add 17 CFR 210.6-11 (new ``Rule 6-11'') to
Regulation S-X.

Table of Contents

I. Introduction and Background
II. Discussion of Proposed Amendments
    A. Proposed Amendments to Generally Applicable Financial
Statement Requirements for Acquired Businesses
    1. Significance Tests
    a. Investment Test
    b. Income Test
    2. Audited Financial Statements for Significant Acquisitions
    3. Financial Statements for Net Assets That Constitute a
Business
    4. Financial Statements of a Business That Includes Oil and Gas
Producing Activities
    5. Timing and Terminology of Financial Statement Requirements
    6. Foreign Businesses
    a. Definition
    b. Reconciliation Requirement
    7. Smaller Reporting Companies and Issuers Relying on Regulation
A
    B. Proposed Amendments Relating to Rule 3-05 Financial
Statements Included in Registration Statements and Proxy Statements
    1. Omission of Rule 3-05 Financial Statements for Businesses
That Have Been Included in the Registrant's Financial Statements
    2. Use of Pro Forma Financial Information To Measure
Significance
    3. Disclosure Requirements for Individually Insignificant
Acquisitions
    C. Rule 3-14--Financial Statements of Real Estate Operations
Acquired or To Be Acquired
    1. Align Rule 3-14 With Rule 3-05
    2. Definition of Real Estate Operation
    3. Significance Tests
    4. Interim Financial Statements
    5. Smaller Reporting Companies and Issuers Relying on Regulation
A
    6. Blind Pool Real Estate Offerings
    7. Triple Net Leases
    D. Pro Forma Financial Information
    1. Adjustment Criteria and Presentation Requirements
    2. Significance and Business Dispositions
    3. Smaller Reporting Companies and Issuers Relying on Regulation
A
    E. Amendments to Financial Disclosure About Acquisitions
Specific to Investment Companies
    1. Amendments to Significance Tests for Investment Companies
    a. Investment Test
    b. Asset Test
    c. Income Test
    2. Proposed Rule 6-11 of Regulation S-X
    3. Pro Forma Financial Information and Supplemental Financial
Information
    4. Amendments to Form N-14
III. General Request for Comment
IV. Economic Analysis
    A. Introduction
    B. Baseline and Affected Parties
    C. Potential Benefits and Costs of the Proposed Amendments
    1. Significance Tests

    2. Audited Financial Statements for Significant Acquisitions
    3. Financial Statements for Net Assets That Constitute a
Business and Financial Statements of a Business That includes Oil-
and-Gas-Producing Activities
    4. Timing and Terminology of Financial Statement Requirements
    5. Foreign Businesses
    6. Omission of Rule 3-05 and Rule 3-14 Financial Statements and
Related Pro Forma Financial Information for Businesses That Have
Been Included in the Registrant's Financial Statements
    7. Use of Pro Forma Financial Information To Measure
Significance
    8. Disclosure Requirements for Individually Insignificant
Acquisitions
    9. Rule 3-14--Financial Statements of Real Estate Operations
Acquired or To Be Acquired
    10. Pro Forma Financial Information
    11. Significance and Business Dispositions
    12. Smaller Reporting Companies and Regulation A
    13. Amendments to Financial Disclosure About Acquisitions
Specific to Investment Companies
    D. The Effects on Efficiency, Competition, and Capital Formation
    E. Alternatives Considered
    1. Approaches to the Significance Tests
    2. Approaches to Proposed Financial Statement Requirements
    3. Approaches to Proposed Pro Forma Adjustments
    4. Alternatives to the Proposed Income Test for Investment
Companies
V. Paperwork Reduction Act
    A. Summary of the Collection of Information
    B. Proposed Amendments' Effect on Existing Collections of
Information
    1. Estimated Effects of the Proposed Amendments on Paperwork
Burdens for Registrants Other Than Investment Companies
    a. Proposed Amendments to Rules 3-05 and 3-14
    b. Proposed Amendments to Pro Forma Financial Information
Requirements
    2. Estimated Effects of the Proposed Amendments on Paperwork
Burdens for Investment Company Registrants
    C. Aggregate Burden and Cost Estimates for the Proposed
Amendments
VI. Small Business Regulatory Enforcement Fairness Act
VII. Initial Regulatory Flexibility Act Analysis
    A. Reasons for, and Objectives of, the Proposed Action
    B. Legal Basis
    C. Small Entities Subject to the Proposed Rules
    D. Reporting, Recordkeeping, and Other Compliance Requirements
    E. Duplicative, Overlapping, or Conflicting Federal Rules
    F. Significant Alternatives
VIII. Statutory Authority

I. Introduction and Background

    We are proposing changes to the requirements for financial
statements relating to acquisitions and dispositions of businesses,
including real estate operations, in Rule 3-05,\4\ Financial Statements
of Businesses Acquired or to be Acquired, Rule 3-14, Special
Instructions for Real Estate Operations to be Acquired, Article 11, Pro
Forma Financial Information of Regulation S-X and other related rules
and forms.\5\ We are also proposing new Rule 6-11 of Regulation S-X and
amendments to Form N-14 to specifically govern financial reporting for
acquisitions involving investment companies. The proposed amendments
are intended to improve for investors the financial information about
acquired or disposed businesses, facilitate more timely access to
capital, and reduce the complexity and costs to prepare the
disclosure.\6\
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    \4\ Unless otherwise noted, references in this release to
``Rule'' or ``Rules'' are to the rules under Regulation S-X.
    \5\ We are also proposing related amendments in Regulation S-X
to the definition of significant subsidiary in Rule 1-02(w); Rule 3-
06, Financial statements covering a period of nine to twelve months;
and Article 8, Smaller Reporting Companies. In addition, we are
proposing amendments to Form 8-K for current reports, Form 10-K for
annual and transition reports, and the definition of significant
subsidiary in Rule 12b-2 under the Exchange Act, Rule 405 under the
Securities Act, and Rule 8b-2 under the Investment Company Act.
    \6\ The proposed amendments would not apply to financial
statements related to the acquisition of a business that is the
subject of a proxy statement or registration statement on Form S-4
(17 CFR 239.25) or Form F-4 (17 CFR 239.34), but would apply to pro
forma information provided pursuant to Article 11 and financial
information for acquisitions and dispositions otherwise required to
be disclosed pursuant to Rule 3-05 or Rule 3-14. These amendments
also would not affect the requirements in 17 CFR 210.3-02 (``Rule 3-
02'') or 17 CFR 210.8-01 relating to predecessor companies.
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    This proposal results from an ongoing, comprehensive evaluation of
our disclosure requirements.\7\ As part of this evaluation, in
September 2015, the Commission issued a Request for Comment on the
Effectiveness of Financial Disclosures About Entities Other Than the
Registrant (``2015 Request for Comment'').\8\ The 2015 Request for
Comment sought feedback on, among other things, the financial
disclosure requirements in Regulation S-X for certain entities other
than the registrant. More specifically, the Commission solicited
comment on how investors use the disclosures required by these rules to
make investment decisions, the challenges that registrants and others
face in providing the required disclosures, and potential changes to
these requirements that could enhance the information provided to
investors and promote efficiency, competition, and capital formation.
We received approximately 50 comment letters discussing Rule 3-05, Rule
3-14, Article 8, and Article 11 \9\ and these comments were considered
carefully in developing these proposals.
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    \7\ The staff, under its Disclosure Effectiveness Initiative, is
reviewing the disclosure requirements in Regulation S-X and 17 CFR
229.10 through 1208 (``Regulation S-K'') and is considering ways to
improve the disclosure regime for the benefit of both companies and
investors. The goal is to comprehensively review the requirements
and make recommendations on how to update them to facilitate timely,
material disclosure by companies and shareholders' access to that
information. See https://www.sec.gov/spotlight/disclosure-effectiveness.shtml.
    \8\ Request for Comment on the Effectiveness of Financial
Disclosures About Entities Other Than the Registrant, Release No.
33-9929 (Sept. 25, 2015) [80 FR 59083 (Oct. 1, 2015)].
    \9\ Comments that we received in response to the 2015 Request
for Comment are available at https://www.sec.gov/comments/s7-20-15/s72015.shtml. References to comment letters in this release refer to
the comments on the 2015 Request for Comment unless otherwise
specified.
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    When a registrant acquires a business \10\ other than a real estate
operation, Rule 3-05 of Regulation S-X generally requires a registrant
to provide separate audited annual and unaudited interim pre-
acquisition financial statements of the business if it is significant
to the registrant (``Rule 3-05 Financial Statements''). Recognizing
that certain acquisitions have a greater impact on a registrant than
others, the Commission adopted Rule 3-05 to address the reporting
requirements for businesses acquired or to be acquired based on the
significant subsidiary definition in Rule 1-02(w) using a sliding scale
approach.\11\ Rule 3-05 also applies to registrants that are registered
investment companies and business development companies. The Commission
later adopted Rule 8-04,

Financial Statements of Businesses Acquired or to be Acquired, in order
to provide comparable requirements for smaller reporting companies.\12\
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    \10\ Rule 3-05 requires disclosure if the ``business combination
has occurred or is probable.'' See 17 CFR 210.3-05(a). Registrants
determine whether a ``business'' has been acquired by applying Rule
11-01(d) of Regulation S-X. The definition of ``business'' in
Regulation S-X focuses primarily on whether the nature of the
revenue-producing activity of the acquired business will remain
generally the same as before the transaction. This determination is
separate and distinct from a determination made under the applicable
accounting standards. Because the definitions serve different
purposes, we have not proposed to conform our rules with the
applicable accounting standards.
    \11\ 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 (Jun. 24, 1982) [47 FR 29832 (Jul. 9, 1982)] (``Rule 3-05
Adopting Release''). The requirements are based on the significant
subsidiary tests using a sliding scale so that the requirements for
filing such financial statements as well as the periods covered by
such financial statements will vary with the percentage impact of
the acquisition on the registrant. In adopting the sliding scale
approach, the Commission stated its belief that the selected
percentages ``meet the objectives of providing adequate financial
information to investors, shareholders and other users while at the
same time reducing the reporting burdens of registrants involved in
acquisitions.''
    \12\ Smaller Reporting Company Regulatory Relief and
Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan.
4, 2008)] (``SRC Relief Adopting Release''). For financial
disclosure requirements, the SRC Relief Adopting Release
predominantly effectuated a relocation of the requirements in 17 CFR
228, Regulation S-B, into Regulation S-K and Regulation S-X.
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    Whether an acquisition is significant under Rule 3-05 is determined
by applying the investment, asset, and income tests provided in the
``significant subsidiary'' definition in Rule 1-02(w).\13\ These tests
generally can be described as follows:
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    \13\ Rule 3-05 provides for use of a 20% significance threshold,
rather than the 10% threshold indicated in Rule 1-02(w). The
Commission raised the threshold in Rule 3-05 from 10% to 20% in 1996
in order to reduce compliance burdens in response to concerns that
the requirement to obtain audited financial statements for a
business acquisition may have caused companies to forgo public
offerings in favor of private or offshore offerings. See
Streamlining Disclosure Requirements Relating to Significant
Business Acquisitions, Release No. 33-7355 (Oct. 10, 1996) [61 FR
54509 (Oct. 18, 1996)] (``1996 Streamlining Release''). As a result
of this amendment, the significance thresholds in Rule 3-05 diverged
from those used for Rule 3-14 and for dispositions at that time.
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     ``Investment Test''--the investment in and advances to the
acquired business are compared to the total assets of a registrant
reflected in its most recent annual financial statements required to be
filed at or prior to the acquisition date;
     ``Asset Test''--a registrant's proportionate share of the
acquired business's total assets reflected in the business's most
recent annual pre-acquisition financial statements is compared to the
total assets of the registrant reflected in its most recent annual
financial statements required to be filed at or prior to the
acquisition date; and
     ``Income Test''--a registrant's equity in the income from
continuing operations of the acquired business before income taxes,
exclusive of amounts attributable to any noncontrolling interests, as
reflected in the business's most recent annual pre-acquisition
financial statements, is compared to the same measure of the registrant
reflected in its most recent annual financial statements required to be
filed at or prior to the acquisition date.
    If none of the Rule 3-05 significance tests exceeds 20%, a
registrant is not required to file Rule 3-05 Financial Statements.\14\
If any of the Rule 3-05 significance tests exceeds 20%, but none
exceeds 40%, Rule 3-05 Financial Statements are required for the most
recent fiscal year and any required interim periods. If any Rule 3-05
significance test exceeds 40%, but none exceeds 50%, a second fiscal
year of Rule 3-05 Financial Statements is required. When at least one
Rule 3-05 significance test exceeds 50%, a third fiscal year \15\ of
Rule 3-05 Financial Statements is required unless net revenues of the
acquired business were less than $100 million in its most recent fiscal
year.\16\ Rule 3-05 Financial Statements are not required once the
operating results of the acquired business have been reflected in the
audited consolidated financial statements of the registrant for a
complete fiscal year, unless the financial statements have not been
previously filed or the acquisition is of major significance.\17\ An
acquisition is considered to be of major significance when the acquired
business is of such significance to the registrant that omission of
Rule 3-05 Financial Statements would materially impair an investor's
ability to understand the historical financial results of the
registrant; for example, if, at the date of acquisition, the acquired
business met at least one of the conditions in the significance tests
at the 80% level.
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    \14\ Rule 3-05 contains an additional requirement for certain
registration statements and proxy statements related to the
aggregate effect of individually insignificant businesses, which may
trigger a requirement for Rule 3-05 Financial Statements for a
business for which none of the significance tests exceed 20%. See
further discussion at note 118 below.
    \15\ A smaller reporting company is subject to similar
requirements under Rule 8-04 of Regulation S-X, but financial
statements are only required for up to two fiscal years.
    \16\ 17 CFR 210.3-05(b)(2). The revenue threshold to this
exception is based on the ``smaller reporting company'' definition.
The threshold was recently increased from $50 million to $100
million as part of amendments to the ``smaller reporting company''
definition. See Amendments to Smaller Reporting Company Definition,
Release No. 33-10513 (June 28, 2018) [83 FR 31992 (July 10, 2018)]
(``2018 SRC Amendments'').
    \17\ 17 CFR 210.3-05(b)(4)(iii).
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    Under Rule 3-14, a registrant that has acquired (and in the case of
certain registration statements and proxy statements, proposes to
acquire) a significant real estate operation similarly must file
financial statements with respect to such operations; however, the
required financial statements only include separate audited annual and
unaudited interim abbreviated income statements (``Rule 3-14 Financial
Statements'').\18\ While Rule 3-14 refers to real estate acquisitions
that are ``significant,'' it does not refer specifically to the
conditions in the definition of ``significant subsidiary'' in Rule 1-
02(w).\19\ Additionally, Rule 3-14 generally only requires one year of
Rule 3-14 Financial Statements.\20\
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    \18\ See Rule 3-14. Rule 3-14 was adopted as part of the
Commission's effort to establish a centralized set of instructions
in Regulation S-X and is based on the disclosure requirements in
Item 6(b) for Form S-11 (17 CFR 239.18) as adopted in 1961. See
Uniform Instructions as to Financial Statements--Regulation S-X,
Release No. 33-6234 (Sept. 2, 1980) [45 FR 63682 (Sept. 25, 1980)].
Rule 3-14 Financial Statements are abbreviated because the rule
requires that they exclude historical items that are not comparable
to the proposed future operations of the real estate operation such
as mortgage interest, leasehold rental, depreciation, corporate
expenses, and federal and state income taxes. While Rule 3-14 does
not require interim financial information, in practice registrants
relying on Rule 3-14 also provide unaudited interim pre-acquisition
income statements for the most recent year-to-date interim period
because they are substantially required in most circumstances by
Article 11 of Regulation S-X to provide pro forma information for
the most recent year-to-date interim period. See Section II.D.
below.
    \19\ Neither ``significant property'' nor ``significant real
estate operation'' is defined in Regulation S-X.
    \20\ See Rule 3-14(a)(1). Only one year of Rule 3-14 Financial
Statements is required if the real estate operation is not acquired
from a related party, the registrant discloses the material factors
considered in assessing the real estate operation, and the
registrant indicates it is not aware of material factors that would
cause the reported financial information not to be indicative of
future operating results. If the registrant does not meet these
conditions, three years of Rule 3-14 Financial Statements are
required. A smaller reporting company is subject to similar
requirements under Rule 8-06 of Regulation S-X, but financial
statements are only required for up to two fiscal years for
acquisitions from related parties, instead of three years.
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    Registrants required to file Rule 3-05 Financial Statements or Rule
3-14 Financial Statements are additionally required to file unaudited
pro forma financial information as prescribed by Article 11 of
Regulation S-X.\21\ Pro forma financial information typically includes
a pro forma balance sheet as of the end of the most recent period for
which a consolidated balance sheet of the registrant is required and
pro forma income statements for the registrant's most recent fiscal
year and for the period from the most recent fiscal year end to the
most recent interim date for which a balance sheet is required. The pro
forma financial information is based on the historical financial
statements of the registrant and the acquired or disposed business, and
generally includes adjustments intended to show how the acquisition or
disposition might have affected those financial

statements had the transaction occurred at an earlier time.
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    \21\ See Rules 11-01 and 11-02. A smaller reporting company
provides the pro forma financial information described in Rule 8-05
of Regulation S-X. Although the preliminary notes to Article 8
indicate that smaller reporting companies may wish to consider the
enhanced guidelines in Article 11, smaller reporting companies are
not required to comply with these items.
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    Form 8-K generally requires registrants to file Rule 3-05 Financial
Statements, Rule 3-14 Financial Statements, and related pro forma
financial information within 75 days after consummation of the
acquisition.\22\ A similar 75-day filing period exists in registration
statements and proxy statements for acquired or to be acquired
businesses requiring Rule 3-05 Financial Statements, but not for
acquired or to be acquired businesses requiring Rule 3-14 Financial
Statements.\23\
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    \22\ Item 2.01 of Form 8-K requires that registrants make
certain disclosures upon the acquisition or disposition of a
significant amount of assets, including assets that constitute a
business, within four business days of the consummation of the
transaction. It does not require reporting for probable acquisitions
or dispositions. Item 9.01 of Form 8-K provides that the required
financial statements and pro forma financial information for the
acquired business (including a real estate operation) may be filed
not later than 71 calendar days after the initial report on Form 8-K
is required to be filed, providing approximately 75 calendar days to
file the acquired business financial statements and related pro
forma financial information. A registrant may need to update the
periods presented in Form 8-K in certain subsequently filed
registration statements and proxy statements. See 17 CFR 210.3-12.
    \23\ Rule 3-05(b)(4) and Rule 11-01(c) provide that registration
statements not subject to the provisions of 17 CFR 230.419 and proxy
statements need not include separate financial statements of the
acquired or to be acquired business and related pro forma financial
information if the business does not exceed any of the conditions of
significance in the definition of ``significant subsidiary'' in Rule
1-02(w) at the 50% level, and either (A) the consummation of the
acquisition has not yet occurred; or (B) the date of the final
prospectus or prospectus supplement relating to an offering as filed
with the Commission pursuant to 17 CFR 230.424(b) or the mailing
date in the case of a proxy statement, is no more than 74 days after
consummation of the business combination, and the financial
statements have not previously been filed by the registrant. A
similar provision applies to smaller reporting companies, but it is
linked to the effective date of the registration statement instead
of the date of the final prospectus or prospectus supplement. See
Rule 8-04(c)(4).
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    In addition, certain registration statements \24\ and proxy
statements require audited financial statements and unaudited pro forma
financial information for the substantial majority of individually
insignificant consummated and probable acquisitions since the date of
the most recent audited balance sheet if a significance test exceeds
50% for any combination of acquisitions subject to Rule 3-05.\25\ Also,
Rule 3-14 Financial Statements are required when the registrant has
acquired or proposes to acquire a group of properties which in the
aggregate are significant.\26\
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    \24\ This additional requirement does not apply to all
registration statements, such as registration statements filed on
Form S-8 (17 CFR 239.16b).
    \25\ See Rule 3-05(b)(2)(i). Smaller reporting companies provide
the same disclosure under Rule 8-04(c)(3).
    \26\ See Rule 3-14(a) and, for smaller reporting companies, Rule
8-06.
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II. Discussion of Proposed Amendments

    We are proposing changes to the requirements in Rule 3-05, Rule 3-
14, and Article 11 of Regulation S-X and related rules and forms to
improve the financial disclosure requirements about significant
business acquisitions and dispositions.\27\ The proposed amendments
would generally:
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    \27\ As discussed in Section II.D.2., infra, Rule 11-01(a)(4)
requires registrants to provide pro forma financial information upon
the disposition or probable disposition of a significant portion of
a business. Rule 11-01(b)(2) requires significance of a disposition
to be determined by applying the definition of a significant
subsidiary under Rule 1-02(w). Throughout this release, we discuss
how the proposed amendments to the definition of significant
subsidiary would impact disclosures for business dispositions.
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     Update the significance tests under these rules by:
    [cir] Revising the Investment Test and the Income Test;
    [cir] expanding the use of pro forma financial information in
measuring significance; and
    [cir] conforming the significance threshold and tests for a
disposed business;
     require the financial statements of the acquired business
to cover up to the two most recent fiscal years rather than up to the
three most recent fiscal years;
     permit disclosure of financial statements that omit
certain expenses for certain acquisitions of a component of an entity;
     clarify when financial statements and pro forma financial
information are required and update the language used in our rules;
     permit the use of, or reconciliation to, International
Financial Reporting Standards as issued by the International Accounting
Standards Board (``IFRS-IASB'') in certain circumstances;
     no longer require separate acquired business financial
statements once the business has been included in the registrant's
post-acquisition financial statements for a complete fiscal year;
     modify and enhance the required disclosure for the
aggregate effect of acquisitions for which financial statements are not
required or are not yet required;
     align Rule 3-14 with Rule 3-05 where no unique industry
considerations exist;
     clarify the application of Rule 3-14 regarding the
determination of significance, the need for interim income statements,
special provisions for blind pool offerings, and the scope of the
rule's requirements;
     amend the pro forma financial information requirements to
improve the content and relevance of such information; and
     make corresponding changes to the smaller reporting
company requirements in Article 8 of Regulation S-X.
    In addition, we are proposing regulatory requirements specific to
investment companies registered under the Investment Company Act and
business development companies \28\ (collectively, ``investment
companies'') to address the unique attributes of this group of
registrants as discussed in more detail in Section II.E. below.
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    \28\ ``Business development company'' is defined in Section
2(a)(48) of the Investment Company Act, 15 U.S.C. 80a-2(a)(48).
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A. Proposed Amendments to Generally Applicable Financial Statement
Requirements for Acquired Businesses

    We are proposing amendments to the requirements in Rule 3-05 and
related requirements in Rule 1-02(w), as described below.\29\
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    \29\ In addition to the proposed changes to the significance
tests, we are proposing clarifying amendments to the definition of
``significant subsidiary'' to label the conditions as the Investment
Test, the Asset Test, and the Income Test.
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1. Significance Tests
    We propose to revise the significance tests provided in Rule 1-
02(w) \30\ to improve their application and to assist registrants in
making more meaningful significance determinations. Specifically, we
propose to revise the Investment Test and the Income Test.\31\
Additionally, for investment companies, we are proposing amendments to
each of the Investment Test, Asset Test, and

Income Test as described in Section II.E.1 below.
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    \30\ The term ``significant subsidiary'' is also defined in
Securities Act Rule 405, Exchange Act Rule 12b-2, and Investment
Company Act Rule 8b-2. The Rule 405 and Rule 12b-2 definitions
historically have been generally consistent with the Rule 1-02(w)
definition. Accordingly, we are proposing to conform the definitions
of significant subsidiary in Rule 405 and Rule 12b-2 to the proposed
definition in Rule 1-02(w). However, as under the existing rules,
the proposed amendments to Rule 1-02(w) that are only applicable to
disclosure requirements under Regulation S-X, specifically proposed
Rule 1-02(w)(1)(iii)(b)(3), would continue to be excluded from the
proposed definitions in Rule 405 or Rule 12b-2. Unlike the other
definitions, the definition in Rule 8b-2 has differed from the Rule
1-02(w) definition. We are proposing to conform the Rule 8b-2
definition of ``significant subsidiary'' to the proposed definition
in Rule 1-02(w)(2) that is specifically tailored for investment
companies. See Section II.E below.
    \31\ We are not proposing to substantively revise the Asset
Test; however, we are proposing a number of non-substantive
revisions to the significance tests generally, such as clarifying
that the significance tests compare the ``tested'' subsidiary's
amounts to the registrant's.
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    We note that, in addition to Rule 3-05, several of our other rules
and forms require disclosure related to ``significant subsidiaries'' or
otherwise rely on the significance tests in Rule 1-02(w) to determine
the disclosure required.\32\ We believe it is appropriate to apply
consistent significance tests for each of these purposes. The proposed
amendments are intended to reflect more accurately the relative
significance to the registrant of the acquired business and to reduce
anomalous results in the application of the definition of ``significant
subsidiary.'' In addition, maintaining the historical conformity
between the ``significant subsidiary'' definitions would avoid
unnecessary regulatory complexity through consistent application of
significance determinations made at the acquisition date and those made
post-acquisition when the acquired business is a subsidiary of the
registrant.
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    \32\ See, e.g., 17 CFR 210.9-03, which requires bank holding
companies and banks to reflect on their balance sheets certain loans
and indebtedness of their significant subsidiaries as defined in
Rule 1-02(w); 17 CFR 210.3-09, 17 CFR 210.4-08(g), and Item 17(c)(2)
of 17 CFR 249.220f (``Form 20-F''), which rely on the significance
tests in Rule 1-02(w) to determine the financial statements and
summarized financial information required for the registrant's
equity method investees; 17 CFR 229.601(b)(21) and Instruction 8 as
to Exhibits of Form 20-F, which both rely on Rule1-02(w) to
determine the subsidiaries that must be included in the list of
subsidiaries required as an exhibit; Item 17(b)(6)(3) of Form F-4,
which relies on the significance tests in Rule 1-02(w) to determine
the financial statements required for foreign companies being
acquired that do not meet the requirements to use 17 CFR 239.34
(``Form F-3''); Item 4.C of Form 20-F, which requires a detailed
list of the registrant's significant subsidiaries; 17 CFR
229.304(a)(1) and (2), Item 9(d) of 17 CFR 240.14a-101 (``Schedule
14A''), Item 4.01 of Form 8-K, Item 4 of 17 CFR 239.93 (``Form 1-
U''), and Item 16F of Form 20-F, which require disclosure about
changes in the auditors of the registrant (or issuer, as applicable)
or its significant subsidiaries; Item 3 of 17 CFR 249.308a (``Form
10-Q'') and Item 13 of Form 20-F, which require disclosure about
defaults of the registrant and its significant subsidiaries and
material arrearages/delinquencies in the payment of dividends on
preferred stock of the registrant or any of its significant
subsidiaries; 17 CFR 229.101(a)(1), which requires certain
disclosures, such as year and form of organization, bankruptcy, and
others, for the registrant and any of its significant subsidiaries;
17 CFR 229.103, which requires disclosure of certain legal
proceedings, including bankruptcy and similar proceedings, for the
registrant and any of its significant subsidiaries; and Item 4.A.4
of Form 20-F, which requires general disclosure about the
development of and structural changes in the business of the
registrant and its significant subsidiaries. See also Rule 11-01(b)
and Proposed Rule 11-01(b).
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a. Investment Test
    Currently, the Investment Test compares the registrant's investment
in and advances to the acquired business to the carrying value of the
registrant's total assets. We propose to revise the Investment Test to
compare the registrant's investment in and advances to the acquired
business to the aggregate worldwide market value of the registrant's
voting and non-voting common equity (``aggregate worldwide market
value''), when available.\33\ If the registrant does not have an
aggregate worldwide market value, we propose to retain the existing
test.
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    \33\ The value under the proposed rule differs from the value
currently used by registrants to determine accelerated filer status
under Rule 12b-2 because it includes the value of common equity held
by affiliates and it is determined as of the last business day of
the registrant's most recently completed fiscal year. By contrast,
Rule 12b-2 looks to the value of common equity held by non-
affiliates and is determined as of the last business day of the
registrant's most recently completed second fiscal quarter. See Rule
12b-2.
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    We believe that using the registrant's aggregate worldwide market
value would align the Investment Test more closely with the economic
significance of the acquisition to the registrant. While the purchase
price for a recent or probable acquisition is generally consistent with
the fair value of the underlying business, the measure against which
the purchase price is compared under the current test (i.e., total
assets) may not fully reflect the registrant's current fair value.\34\
In response to the 2015 Request for Comment, commenters supported
revising the Investment Test to use a measure of the registrant's fair
value instead of its total assets.\35\ While commenters recommended
various methods of determining fair value, we are proposing aggregate
worldwide market value because it is readily available and objectively
determined by the market.
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    \34\ For example, the Investment Test uses the carrying value of
a registrant's total assets as of the most recent balance sheet
date, which represents a combination of fair value for certain
assets (e.g., financial instruments) and historical cost for other
assets (e.g., property, plant and equipment and intangible assets).
The test further excludes the value of certain assets not permitted
to be recognized (e.g., certain internally developed intangible
assets) and is not reduced by the value of liabilities.
    \35\ See, e.g., letters from the American Bar Association (Nov.
14, 2014) (``ABA''), BDO USA, LLP (Dec. 7, 2015) (``BDO''), Center
for Audit Quality (Nov. 25, 2015) (``CAQ''), CFA Institute (Mar. 2,
2016) (``CFA''), Davis Polk & Wardwell LLP (Nov. 30, 2015) (``Davis
Polk'') Polk, Deloitte & Touche LLP (Nov. 23, 2015) (``DT''), Ernst
& Young LLP (Nov. 20, 2015) (``EY''), Grant Thornton LLP (Dec. 1,
2015) (``Grant''), KPMG LLP (Nov. 30, 2015) (``KPMG''), and
PricewaterhouseCoopers LLP (Nov. 30, 2015) (``PwC'').
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    In order to further improve the Investment Test, we propose to
address when the registrant's aggregate worldwide market value shall be
determined, \36\ provide further instructions on a registrant's
``investments in'' the tested subsidiary \37\ for acquisitions and
dispositions,\38\ and clarify the applicability of the test to
combinations between entities under common control.\39\ These proposed
amendments

would address certain practical questions \40\ that may arise when
applying the proposed Investment Test and should therefore simplify
compliance by registrants.\41\
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    \36\ We propose Paragraph (w)(1)(i)(A) to provide that aggregate
worldwide market value of the registrant's voting and non-voting
common equity shall be determined as of the last business day of the
registrant's most recently completed fiscal year, which for
acquisitions and dispositions shall be at or prior to the date of
acquisition or disposition.
    \37\ Rule 1-02(w) defines the term ``significant subsidiary.''
Rules 3-05 and 3-14 use the conditions in Rule 1-02(w) when
establishing the test for registrants to determine whether financial
statements are required for businesses acquired or to be acquired.
While we recognize that acquired businesses are often not
subsidiaries, we use the term ``tested subsidiary'' throughout this
release, rather than ``tested business'' or another term, to avoid
confusion when using the conditions in Rule 1-02(w) in connection
with the determination in Rule 3-05 and Rule 3-14.
    \38\ We propose Paragraph (w)(1)(i)(C) to require that the
``investment in'' the tested subsidiary in an acquisition include
the fair value of contingent consideration required to be recognized
at fair value by the registrant at the acquisition date under U.S.
GAAP or IFRS-IASB, as applicable. If recognition at fair value is
not required, the proposed amendment would require all contingent
consideration to be included, except sales-based milestones and
royalties, unless the likelihood of payment is remote. The
``investment in'' the tested subsidiary also would exclude the
registrant's proportionate interest in the carrying value of assets
transferred by the registrant to the tested subsidiary that will
remain with the combined entity after the acquisition because we
believe this would provide a more accurate measure of the tested
subsidiary's relative significance. We believe our proposal is
consistent with FASB standard setting for business combinations that
clarified that for acquisition accounting the consideration
transferred should exclude such amounts. See FASB ASC 805-30-30-8.
For similar reasons, we also propose providing in Paragraph
(w)(1)(i)(D) that the ``investment in'' the tested subsidiary in a
disposition equal the fair value of the consideration, which would
include contingent consideration, for the disposed subsidiary when
comparing it to the registrant's aggregate worldwide market value or
the carrying value of the disposed subsidiary when comparing it to
the registrant's total assets.
    \39\ Rule 1-02(w)(1) provides that for a proposed combination
between entities under common control, when the number of common
shares exchanged or to be exchanged exceeds 10% of the registrant's
common shares outstanding at the date the combination is initiated,
the Investment Test for significance is met. We are proposing Rule
1-02(w)(1)(i)(B) to similarly provide that the Investment Test would
be met when either net book value of the tested subsidiary exceeds
10% of the registrants' and its subsidiaries consolidated total
assets or the number of common shares exchanged or to be exchanged
by the registrant exceeds 10% of its total common shares outstanding
at the date the combination is initiated. The addition of net book
value to the test as proposed recognizes that such combinations may
be effected by transferring net assets, rather than exchanging
shares, and that the resulting accounting by the registrant
typically recognizes the combination using the parent's historical
carrying value of the transferred entity or business. See, e.g.,
FASB ASC 805-50. We also propose to add a reference to
``businesses'' in Rule 1-02(w) such that the resulting phrasing is
``combinations between entities or businesses under common control''
for circumstances where the significant subsidiary definition is
referenced by rules establishing requirements for acquired
businesses.
    \40\ Commission staff has provided informal guidance to address
practical questions. For example, see U.S. Sec. & Exch. Comm'n.,
Division of Corporation Finance's Financial Reporting Manual,
available at https://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf (last updated Dec. 1, 2017)
(``FRM''). The FRM sets forth the informal guidance of the staff in
the Division of Corporation Finance related to various financial
reporting matters. The FRM is not a rule, regulation, or statement
of the Commission.
    \41\ See FRM, supra note 40, at Sections 2015.5 ``Investment
Test--Acquisition Accounting'' and 2015.7 ``Investment Test--
Reorganization of Entities Under Common Control.''
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b. Income Test
    Currently, the Income Test focuses on a single component, net
income,\42\ which can include infrequent expenses, gains or losses that
can distort the determination of relative significance. For registrants
with marginal or break-even net income or loss in a recent fiscal year,
the use of a net income component by itself can also have the effect of
requiring financial statements for acquisitions that otherwise would
not be considered material to investors. In these circumstances
comparatively small entities may trigger the requirement for Rule 3-05
Financial Statements, which can be costly to prepare. Commission staff
regularly receives and grants under delegated authority requests for
relief in these circumstances where the disclosure of these
acquisitions would not be material to investors.\43\ A number of
commenters expressed concern with the existing Income Test, with many
of these commenters recommending replacing or supplementing the net
income test with a revenue component.\44\
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    \42\ Specifically, the current Income Test uses income from
continuing operations before income taxes. Prior to 1981, the
``significant subsidiary'' definition included a revenue test. The
Commission eliminated the revenue test in favor of the net income
test noting in part that ``. . . the presentation of additional
financial disclosures of an affiliated entity may not be meaningful
if the affiliate has a high sales volume but a relatively low profit
margin'' and observing that in such circumstances, the affiliate has
little financial effect on the operating results of the consolidated
group. See Separate Financial Statements Required by Regulation S-X,
Rels. No. 33-6359 (Nov. 6, 1981)[46 FR 56171 (Nov. 16, 1981)]. For
these reasons, we believe it is important to retain a net income
component as part of the Income Test rather than rely exclusively on
a revenue component.
    \43\ Pursuant to 17 CFR 210.3-13 (``Rule 3-13'') of Regulation
S-X, the Commission may, upon the request of the registrant, and
where consistent with the protection of investors, permit the
omission of one or more required financial statements or the filing
in substitution therefor of appropriate statements of comparable
character. The Commission has delegated authority to the staff in
the Division of Corporation Finance to grant requests for relief
under Rule 3-13.
    \44\ See, e.g., letters from ABA, CAQ, U.S. Chamber of Commerce
(Nov. 30, 2015), Davis Polk, EY, and PWC. Two commenters
specifically recommended supplementing the Income Test with a
revenue component. See letters from CFA and KPMG.
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    We propose to revise the Income Test by adding a new revenue
component \45\ and to simplify the calculation of the net income
component by using income or loss from continuing operations after
income taxes. We expect adding a revenue component would reduce the
anomalous results that may occur by relying solely on net income.\46\
We believe that this change, along with simplifying these calculations,
would reduce complexity and preparation costs without sacrificing
material information that investors may need to evaluate these
transactions.
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    \45\ The proposed revenue component would compare the
registrant's and its other subsidiaries' proportionate share of the
tested subsidiary's consolidated total revenues (after intercompany
elimination) to such consolidated total revenues for the
registrant's most recently completed fiscal year.
    \46\ We believe that revenue is an important indicator of the
operations of a business and generally has less variability than net
income. For example, expenses related to historical capitalization
(e.g., interest expense) as well as infrequent expenses, such as
those for litigation or impairment, can affect net income and the
existing Income Test. That impact may be to either deem as
insignificant an acquired business that is expected to have material
future impact on the registrant or deem as significant an acquired
business that is not expected to have a material future impact on
the registrant. The potential for these effects suggests that the
Income Test should be revised to include an income statement metric
that is less subject to such effects. Because not all registrants
report metrics such as ``profit margin'' and ``operating income,''
and these metrics could also have similar potential variability, we
believe ``revenue'' is a more appropriate indicator. Consistent with
the Commission's past observations about a revenue test that is not
linked to net income (see supra note 42), we propose to retain net
income and add a revenue component when both the registrant and
tested subsidiary have recurring annual revenues.
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    Under the proposed amendments, the Income Test would require that,
where the registrant and its subsidiaries consolidated and the tested
subsidiary have recurring annual revenue, the tested subsidiary must
meet both the new revenue component and the net income component. In
this case, the registrant would use the lower of the revenue component
and the net income component to determine the number of periods for
which Rule 3-05 Financial Statements are required.\47\ Where a
registrant or tested subsidiary does not have recurring annual
revenues, the revenue component is less likely to produce a meaningful
assessment and therefore only the net income component would apply. To
reduce anomalous results in these circumstances, we also propose
revising the Income Test to use the average of the absolute value of
net income when the existing 10% threshold in Computational Note 2 to
Rule 1-02(w) \48\ is met and the proposed revenue component of the
Income Test does not apply.
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    \47\ See proposed Rule 3-05(b)(2) of Regulation S-X.
    \48\ See Computational Note 2 to Rule 1-02(w) of Regulation S-X.
Average income should be substituted for purposes of the computation
if income of the registrant and its subsidiaries consolidated
exclusive of amounts attributable to any noncontrolling interests
for the most recent fiscal year is at least 10% lower than the
average of the income for the last five fiscal years. See proposed
Rule 1-02(w)(1)(iii)(B)(2).
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    By revising the Income Test to require that the registrant exceed
both revenue and net income components when the registrant and the
tested subsidiary have recurring annual revenue, we believe the test
would more accurately determine whether a business is significant to
the registrant and would reduce the frequency of the anomalous result
of immaterial acquisitions being deemed significant.
    We also propose to revise the net income component calculation so
that it is based on income or loss from continuing operations after
income taxes. Income tax is a recurring and often material line item.
Further, the current calculation, which is based on income from
continuing operations before income taxes, may require additional
calculations for components of net income that are presented on a post-
tax basis \49\ with the result that a registrant may not be able to use
amounts directly from the financial statements. Instead, the proposed
amendments refer to income or loss from continuing operations after
income taxes, which would permit a registrant to use line item
disclosure from its financial statements, simplifying the
determination.
    We are also proposing to clarify the net income component by
inserting a reference to the absolute value of equity in the tested
subsidiary's consolidated income or loss from continuing operations,
which we believe will mitigate the potential for misinterpretation that
may result from inclusion of a negative amount in the computation.\50\
We propose to calculate net income and average net income using
absolute values. For net income, we believe this would serve to clarify
that the test applies when a net loss

exists, and is to be used when either the tested subsidiary or the
registrant, but not both, has a net loss. For average income, our
proposal differs from current staff interpretation, which indicates
that ``zero'' should be used for loss years in computing the
average.\51\ We believe calculating average net income using the
absolute value of the loss or income amounts for each year and then
calculating the average would make the average income test more
indicative of relative significance.
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    \49\ See, e.g., 17 CFR 210.5-03(b)12 (``Rule 5-03(b)12''). Rule
5-03(b)12, Equity in Earnings of Unconsolidated Subsidiaries and 50
Percent or Less Owned Persons, provides for a component of net
income from continuing operations to be presented net of tax.
    \50\ See proposed Rule 1-02(w)(1)(iii)(B)(2).
    \51\ See FRM, supra note 40, at Section 2015.8.
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    In addition, proposed Rules 3-05(b)(3) and 11-01(b)(3) will also
clarify that the Income Test may be determined using the acquired
business's revenues less the expenses permitted to be omitted by
proposed Rules 3-05(e) and 3-05(f) if the business meets the conditions
in those proposed rules.\52\ Finally, we are proposing additional non-
substantive amendments to the net income component that we believe will
simplify the description and application of the test.\53\
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    \52\ See discussion relating to Rule 3-05(e) in Section II.A.3
and Rule 3-05(f) in Section II.A.4. below.
    \53\ Specifically, we are proposing to replace the phrase
``exclusive of amounts attributable to any noncontrolling
interests'' in the net income component with the phrase
``attributable to the controlling interests.'' We are also proposing
to revise Rule 1-02(w) to remove the Computational Note designation
but retain the substance of the notes in the rule and make
conforming amendments consistent with the proposed amendments to the
revised Income Test. Additionally, Paragraph (w)(1)(iii)(B)(3) would
clarify that the rule is not intended to modify the existing Rule 3-
05(a)(3) requirement that acquisitions of a group of related
businesses shall be treated as if they are a single acquisition.
Finally, we are incorporating the Note to Paragraph (w) into
Paragraph (w).
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Request for Comment
    1. We are proposing to revise the significance tests to improve
their application and assist registrants in making more meaningful
significance determinations. Are the proposed revisions appropriate?
Are there additional revisions we should consider to further improve
the significance tests?
    2. We are proposing to revise the Investment Test to use aggregate
worldwide market value to reflect the size of the acquirer while
retaining investment in and advances to the acquired business to
reflect the size of the acquired business. Are these measures
sufficiently comparable? Are there particular types of transactions for
which these measures would lead to a less-informative indicator of
significance? Does our proposed use of aggregate worldwide market value
in the Investment Test more closely reflect the relative significance
of the acquisition to the registrant? Is there a better proxy that we
could use for fair value in the Investment Test? For example, would
aggregate worldwide market value of the registrant's voting and non-
voting common equity held by its non-affiliates, a value based on the
expected offering price in an initial public offering, enterprise
value, or some other market valuation be a more appropriate proxy? Why
or why not?
    3. We have proposed to require that the ``investment in'' the
tested subsidiary in an acquisition include the fair value of
contingent consideration required to be recognized at fair value by the
registrant at the acquisition date under U.S. GAAP or IFRS-IASB, as
applicable. If recognition at fair value is not required, the proposed
amendment would require all contingent consideration to be included,
except sales-based milestones and royalties, unless the likelihood of
payment is remote. Generally, would the inclusion of contingent
consideration provide a more accurate determination of significance?
Why or why not? Are there practical impediments to our proposed
approach to the inclusion of contingent consideration? If so, what are
they and how would they best be mitigated? For example, should we
require the gross amount of contingent consideration, rather than its
fair value, be used in significance determinations regardless of the
accounting the registrant is required to apply at the acquisition date?
Why or why not? If contingent consideration is not required to be
recognized at fair value, would inclusion of contingent consideration
unless the likelihood of payment is remote provide a more accurate
determination of significance? In this circumstance, is the exclusion
of sales-based milestones and royalties an appropriate practical
expedient to the determination of significance? Alternatively, should
we require registrants to estimate these amounts in order to determine
significance? Why or why not? Does the phrase ``sales-based milestones
or royalties'' capture consideration that is contingent on sales or
should it be further refined or defined?
    4. For dispositions, would the use of the fair value of
consideration, which would include contingent consideration, provide a
more accurate determination of significance than the gross amount of
consideration when comparing to the aggregate worldwide market value of
the registrant? Why or why not? Are there practical impediments to our
proposed approach to the inclusion of contingent consideration? If so,
what are they and how would they best be mitigated? Should we exclude
contingent consideration from the determination of the significance of
a disposed business when comparing to the aggregate worldwide market
value of the registrant? Why or why not? Should we exclude from the
determination of significance contingent consideration in the form of
sale-based milestones or royalties when comparing to the aggregate
worldwide market value of the registrant? Why or why not? When the
registrant has no such aggregate worldwide market value, will comparing
the carrying value of the disposed subsidiary to total assets of the
registrant appropriately reflect the relative significance of the
disposed business to the registrant? Why or why not?
    5. We have proposed to add a revenue component to the Income Test.
Would this approach more accurately reflect the significance of the
acquisition or could it result in material acquisitions not triggering
financial statement disclosures? Would it reduce incidents of otherwise
insignificant acquisitions being deemed significant by registrants that
have marginal or break-even net income?
    6. Would using different percentage thresholds for the revenue
component and the income component mitigate the potential that the
proposed Income Test would under-identify transactions? Why or why not?
For example, would the proposed Income Test be a better indicator of
relative significance if the revenue component used a lower percentage
threshold, for example 15% or 10%, than that used for the income
component? Why or why not? If the revenue component and income
component were to have different percentage thresholds, what should
those percentages be? Are there other ways to modify the Income Test
that would better address this issue?
    7. Will our proposal to require recurring annual revenue
appropriately limit the circumstances when the revenue component would
not provide a meaningful result? Should we instead provide that the
revenue component would not apply if either the registrant or tested
subsidiary had no or nominal revenue? Why or why not? If so, should we
define nominal revenue and what definition should we propose?
    8. We are proposing that registrants use the lower of the total
revenue or the net income components of the proposed Income Test to
determine the number of years of required audited financial statements.
Would the use of the lower of the two components provide an

appropriate number of periods of pre-acquisition financial statements
when an acquired business is significant? If not, why not? Is there a
more appropriate way to determine the number of periods that should be
presented if the Income Test is met? If yes, why would this alternative
approach be more appropriate?
    9. Would the Income Test better determine relative significance if
we eliminated the net income component entirely and relied solely on
the proposed revenue component? Why or why not?
    10. Would the Income Test better determine relative significance if
we required using the proposed revenue component in place of the
proposed income component only when the acquirer's income or loss is
small? Why or why not? If we required use of the revenue component only
when the acquirer's income or loss is small, how should we define when
this switch from the income component to the revenue component must
occur? For example, should we require use of the revenue component when
the absolute value of the acquirer's return on assets was less than 1%?
Why or why not? Would a ``less than 1%'' standard be appropriate or
would a different percentage be a more appropriate standard? If we
required the switch to be made based on the acquirer's return on
assets, how could we mitigate the inconsistent results that might occur
across industries depending on the extent of an acquirer's reliance on
human capital versus material capital? For acquirers that have large
asset bases, would a return on asset approach be subsumed by the
existing Asset Test?
    11. Would the Income Test be improved by using a different income
statement-metric test like gross profit (loss) or operating income
(loss) in place of our proposed revenue component? Why or why not? If
we eliminated the net income component and replaced it with a gross
profit (loss) or operating income (loss) test, how would it apply to
tested subsidiaries and registrants that do not report gross profit
(loss) or operating income (loss)?
    12. We are proposing to simplify the net income component of the
Income Test by using after-tax net income and absolute values. Would
the proposed revision to use after tax net income and absolute values
simplify the determination while still accurately identifying
significance? Why or why not? Should we retain use of pre-tax net
income? Why or why not?
    13. Under our proposal, average income must be used to calculate
the income component of the Income Test if the registrant or the tested
subsidiary does not have recurring annual revenue and the absolute
value of the registrant's income or loss from continuing operations
attributable to the controlling interests for the most recent fiscal
year is at least 10% lower than the average of the absolute value of
such amounts for the registrant for each of its last five fiscal years.
    [cir] Would it be appropriate to require income averaging where the
10% threshold is met and registrants are able to rely on the revenue
component? Are there modifications that we should consider to the
average income computation? Are there other circumstances where the
determination would be more accurate by removing the revenue component
or applying income averaging?
    [cir] If the 10% threshold is retained, calculating the average
using absolute values may increase the frequency with which the average
must be used. Does calculating average income using the absolute value
of losses rather than the current practice of assigning a value of zero
to those years result in a better indicator of relative significance?
Why or why not? Would modifying the existing 10% threshold in
Computational Note 2 to Rule 1-02(w) in lieu of our proposal to use
absolute values better reflect when an average should be used? If so,
what percentage should we use and why? Are there other ways to modify
the calculation of average income to be a better indicator of relative
significance in the circumstances to which we propose to apply it?
    14. Are there other revisions to the Investment Test, Income Test
or Asset Test that we should consider?
    15. Are there other tests that would be a more appropriate
indicator of relative significance? For example, should we add a test
based on cash flows from operating, investing or financing activities?
Why or why not?
    16. The term ``significant subsidiary'' is defined in Rule 1-02(w)
and also in Securities Act Rule 405 and Exchange Act Rule 12b-2. These
definitions historically have been generally consistent with the
exception of current Computational Note 3 relating to the aggregation
of combined entities, which is generally not relevant for purposes of
Rule 405 or 12b-2. Is it appropriate to consistently apply the
definition of significant subsidiary across these rules while
continuing to exclude the language relating to aggregation of combined
entities? Would these rules be better implemented if the definitions
further diverged? If so, how?
    17. Is it clear that ``significant subsidiary'' determinations
should be made using amounts derived from consolidated financial
statements of the tested subsidiary and consolidated financial
statements of the registrant? Should we revise our rules to more
explicitly state that?
    18. Should we revise the ``significant subsidiary'' determination
to deem a subsidiary as significant if it is material to the registrant
rather than using specific percentage conditions? Why or why not? If we
should revise the determination to use a materiality standard, how
should that standard be applied? Would a materiality standard yield
consistent determinations between registrants? How would a materiality
standard impact the disclosure provided and a registrant's ability to
timely access capital?
2. Audited Financial Statements for Significant Acquisitions
    As noted above, Rule 3-05 Financial Statements may be required for
up to three years depending on the relative significance of the
acquired or to be acquired business. We propose to revise Rule 3-05 to
require up to two years depending on the relative significance. Unlike
the historical financial statements of the registrant upon which
investors rely to make investment decisions about the registrant, the
Rule 3-05 Financial Statements are used, along with pro forma financial
information, to discern how the acquired business may affect the
registrant. We believe two years of pre-acquisition financial
statements, would be sufficient to allow investors to understand the
possible effects of the acquired business on the registrant. Relatedly,
we are also proposing to require the inclusion of certain forward-
looking information in pro forma financial information.\54\
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    \54\ See the discussion in Section II.D.1. below.
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    We note that older financial statements, such as the third year of
Rule 3-05 Financial Statements, can be less relevant for evaluating an
acquisition because, due to their age, they are less likely to be
indicative of the current financial condition, changes in financial
condition and results of operations of the acquired business.\55\ Pre-
acquisition financial statements can also have less utility because
they do

not reflect the changes in the acquired business or combined entity
that occur post-acquisition or the accounting required by the
registrant's comprehensive basis of accounting. Moreover, regardless of
the number of years presented, if trends depicted in Rule 3-05
Financial Statements are not indicative or are otherwise incomplete, 17
CFR 210.4-01(a) (``Rule 4-01(a)'') requires that a registrant provide
``such further material information as is necessary to make the
required statements, in light of the circumstances under which they are
made, not misleading.'' Further, the requirement to prepare and obtain
an audit of the third year of pre-acquisition financial statements can
add significant incremental cost and time to the preparation of
required disclosure, which is further exacerbated if a change in the
acquired business's management or independent auditor has occurred, and
may delay a registrant's time to market and access to capital.
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    \55\ In some circumstances, Rule 3-05 Financial Statements can
depict a year beginning more than four years before consummation of
the acquisition. For example, the third year of Rule 3-05 Financial
Statements for a calendar year-end business acquired on February 27,
2018 would be 2014. If the business were acquired at a later date in
2018, the third year of Rule 3-05 Financial Statements would be
2015.
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    Accordingly, we propose eliminating the requirement to file the
third year of Rule 3-05 Financial Statements for an acquisition that
exceeds 50% significance.\56\ In response to the 2015 Request for
Comment, several commenters recommended eliminating the requirement to
provide three years of Rule 3-05 Financial Statements,\57\ while only
one recommended retaining the current periods.\58\
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    \56\ See proposed Rule 3-05(b)(2).
    \57\ See letters from BDO, CAQ, Crowe Horwath LLP (Nov. 30,
2015) (``Crowe''), DT, Edison Electric Institute and American Gas
Association (Nov. 30, 2015) (``EEI/AGA''), EY, Grant, KPMG, and RSM
US LLP (Nov. 30, 2015) (``RSM'').
    \58\ See letter from California Public Employees' Retirement
System (Nov. 30, 2015) (``CalPERS'').
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    We also propose to revise Rule 3-05 for acquisitions where a
significance test exceeds 20%, but none exceeds 40%, to require
financial statements for the ``most recent'' interim period specified
in Rule 3-01 and 3-02 rather than ``any'' interim period. This proposed
revision would eliminate the need to provide a comparative interim
period when only one year of audited Rule 3-05 Financial Statements is
required. Providing a comparative interim period when there is no
requirement for a corresponding comparative annual period may have
limited utility for investors and creates an additional burden on
registrants to prepare such information. Moreover, we believe that
focusing on the most recent interim period would provide the most
relevant and material information to investors.
Request for Comment
    19. Is our proposal to eliminate the third year of pre-acquisition
audited financial statements required for business acquisitions
exceeding 50% significance in Rule 3-05(b)(2)(iv) appropriate? Why or
why not? Are there other changes that we should consider that would
reduce compliance burdens for issuers but continue to provide the
material information investors need to make informed investment
decisions?
    20. Is our proposal to eliminate the comparative interim period
when only one year of audited Rule 3-05 Financial Statements is
required appropriate? Why or why not? Are there other changes that we
should consider?
3. Financial Statements for Net Assets That Constitute a Business
    Registrants frequently acquire a component of an entity, such as a
product line or a line of business contained in more than one
subsidiary of the selling entity, that is a business as defined in Rule
11-01(d) but does not constitute a separate entity, subsidiary, or
division. These businesses may not have separate financial statements
or maintain separate and distinct accounts necessary to prepare Rule 3-
05 Financial Statements because they often represent only a small
portion of the selling entity. In these circumstances, making relevant
allocations of the selling entity's corporate overhead, interest, and
income tax expenses necessary to provide Rule 3-05 Financial Statements
for the business may be impracticable.
    We propose to permit \59\ registrants to provide audited financial
statements of assets acquired and liabilities assumed, and statements
of revenues and expenses (exclusive of corporate overhead, interest and
income tax expenses) \60\ if:
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    \59\ See proposed Rule 3-05(e). Our proposal is generally
consistent with Commission staff's exercise of delegated authority
pursuant to Rule 3-13 of Regulation S-X in these circumstances. See
also FRM, supra note 40, at Section 2065 ``Acquisition of Selected
Parts of an Entity may Result in Less than Full Financial
Statements.''
    \60\ The proposed rule clarifies that federal and state income
tax may be excluded.
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     The business constitutes less than substantially all of
the assets and liabilities of the seller and was not a separate entity,
subsidiary, segment, or division during the periods for which the
acquired business financial statements would be required;
     separate financial statements for the business have not
previously been prepared;
     the seller has not maintained the distinct and separate
accounts necessary to present financial statements that include the
omitted expenses and it is impracticable to prepare such financial
statements;
     interest expense may only be excluded from the statements
if the debt to which the interest expense relates will not be assumed
by the registrant or its subsidiaries consolidated;
     the statements of revenues and expenses do not omit
selling, distribution, marketing, general and administrative, and
research and development expenses incurred by or on behalf of the
acquired business during the periods to be presented; and
     the notes to the financial statements include certain
additional disclosures, specifically: The type of omitted expenses and
the reasons why they are excluded from the financial statements;
information about the business's operating, investing, and financing
cash flows, to the extent available; an explanation of the
impracticability of preparing financial statements that include the
omitted expenses; and a description of how the financial statements
presented are not indicative of the financial condition or results of
operations of the acquired business going forward because of the
omitted expenses.
    Recognizing the difficulty registrants face in obtaining and the
cost of preparing financial statements that include the expenses
proposed to be omitted, we believe permitting registrants to provide
abbreviated financial statements as proposed, while requiring the
proposed additional disclosures, appropriately balances the cost of
preparing financial disclosure with the protection of investors. In
response to the 2015 Request for Comment, commenters generally
supported permitting the use of abbreviated financial statements
without first seeking relief from the Commission.\61\
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    \61\ See, e.g., letters from ABA-Committees, BDO, CAQ, Cyprus
Energy Partners, L.P. (Nov. 30, 2015), DT, EEI/AGA, EY, Grant, KPMG,
and RSM.
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Request for Comment
    21. Are the proposed conditions for permitting registrants to
provide abbreviated financial statements appropriate? Are there other
conditions that should be applied or other disclosures that should be
required? Are any of the conditions unnecessary or counterproductive?
    22. Acquired product lines typically meet the definition of a
business, but can have minimal historical balance sheet information
associated with them, such as the carrying value of acquired

inventory. Similarly, income statement information beyond revenue and
costs of sales may have limited utility when the selling effort relates
to a larger product portfolio that includes the acquired product line,
rather than the acquired product line itself, and when historical
research and development expense is not specific to the acquired
product line. In these and similar circumstances, should we permit
registrants to provide other information, such as revenue and cost of
revenues, in lieu of abbreviated financial statements? Why or why not?
Should we require the other information to be audited? Why or why not?
Is it practicable to audit the other information? Why or why not? If
the other information is unaudited, how would that affect investors and
other market participants that use the information? If we should permit
other information, what conditions best identify and limit the
circumstances when it would be appropriate to permit the other
information? If we permit other information, should the 75-day filing
period specified in Rule 3-05 for registration statements and proxy
statements and in Item 9.01 of Form 8-K apply? Should Article 11 of
Regulation S-X pro forma financial information be required?
    23. As proposed, statements of revenues and expenses must include
selling, distribution, marketing, general and administrative, and
research and development expenses incurred to generate the revenue
reflected in the statements. Does the proposed requirement provide
sufficient clarity regarding the expenses that must be included? Does
the proposed requirement provide sufficient clarity regarding the
expenses that may be omitted? Why or why not? If not, how can we better
make these distinctions?
4. Financial Statements of a Business That Includes Oil and Gas
Producing Activities
    Rule 3-05 applies to acquisitions of a significant business \62\
that includes oil and gas producing activities.\63\ However, Rule 3-05
does not specify industry-specific disclosures that may be useful to
understand such activities. In the absence of specific requirements,
registrants generally provide certain industry-specific disclosures
specified in FASB ASC Topic 932 Extractive Activities--Oil and Gas
(``ASC 932 Disclosures'') \64\ on an unaudited basis for each full year
of operations presented for the acquired business.
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    \62\ See Rule 11-01(d).
    \63\ See the definition of ``oil and gas producing activities''
at Sec.  210.4-10(a)(16).
    \64\ See FASB ASC Topic 932 Extractive Activities--Oil and Gas,
932-235-50-3 through 50-11 and 932-235-50-29 through 50-36, and FRM,
supra note 40, at Section 2065.12. These supplemental disclosures
are required in the financial statements of publicly traded
companies with significant oil- and gas- producing activities and
provide additional context for those financial statements.
---------------------------------------------------------------------------

    Rule 3-05 also does not specify the form and content of Rule 3-05
Financial Statements when the acquired business generates substantially
all of its revenues from oil and gas producing activities. Often, this
type of business represents a component of an entity that does not
constitute a separate entity, subsidiary, segment, or division for
which separate financial statements exist and for which historical
depreciation, depletion, and amortization expense is likely not
meaningful to an understanding of the potential effects of the acquired
business on the registrant.\65\ In these circumstances and when certain
additional criteria are met, pursuant to Rule 3-13 and delegated
authority, Commission staff has permitted registrants to provide
abbreviated financial statements that consist of income statements
modified to exclude expenses not comparable to future operations.\66\
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    \65\ Historical depreciation, depletion, and amortization
expense is frequently not maintained at the property level and does
not reflect the acquiring company's basis in the properties.
    \66\ See FRM, supra note 40, at Section 2065.6, 2065.11, and
2065.12. Permitting registrants in these circumstances to substitute
abbreviated income statements that omit expenses not comparable to
future operations is consistent with the financial statement
requirements specified in Rule 3-14 for acquired real estate
operations. Rule 3-14 specifies that Rule 3-14 Financial Statements
must omit depreciation expenses not comparable to future operations.
---------------------------------------------------------------------------

    Proposed Rule 3-05(f) would codify these reporting practices.
Specifically, for a significant acquired business that includes
significant oil- and gas-producing activities (as defined in the FASB
ASC Master Glossary), we propose that Rule 3-05 Financial Statements
include the ASC 932 Disclosures on an unaudited basis for each full
year of operations presented for the acquired business.\67\
Additionally, we propose that the Rule 3-05 Financial Statements may be
audited statements of revenues and expenses that exclude depletion,
depreciation, and amortization expense, corporate overhead expense,
income taxes, and interest expense that are not comparable to the
proposed future operations if: (1) Substantially all of the revenues of
the business are generated from oil and gas producing activities,\68\
and (2) the conditions of proposed Rule 3-05(e)(1) through (4) and
(e)(6) are met.\69\ We believe these conditions would appropriately
balance the cost of preparing the disclosure with the protection of
investors. We also believe codifying these practices would provide
clarity for registrants regarding the application of Commission rules
in these circumstances and could facilitate compliance to the benefit
of both registrants and investors.
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    \67\ See ASC 932-235-50-3 through 50-11 and 932-235-50-29
through 50-36, which may be presented as unaudited supplemental
information. We are proposing this definition of significant oil-
and gas-producing activities to be consistent with current practice
whereby the FASB's significance threshold is applied in determining
whether to present the ASC 932 Disclosures in Rule 3-05 Financial
Statements, even if the acquired business is not a publicly-traded
company.
    \68\ Under our proposal, ``oil and gas producing activities''
would be defined by reference to Sec.  210.4-10(a)(16).
    \69\ See discussion in Section II.A.3 above.
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Request for Comment
    24. Are the proposed conditions for permitting businesses that have
oil and gas producing activities to provide abbreviated financial
statements and requiring them to provide industry-specific supplemental
information appropriate? Are there other conditions that should be
applied or other disclosures that should be required?
5. Timing and Terminology of Financial Statement Requirements
    We propose revising Rule 3-05 and Article 11 to clarify when
financial statements \70\ and pro forma financial information are
required, and to update the language to take into account concepts that
have developed since adoption of the rules over 30 years ago.\71\
Specifically, the proposed amendments would specify that financial
statements are required if a business acquisition has occurred during
the most recent fiscal year or subsequent interim period for which a
balance sheet is required by 17 CFR 210.3-01 of Regulation S-X (``Rule
3-01''), or if a business acquisition has occurred or is probable after
the date that the most recent balance sheet has

been filed.\72\ We also propose to clarify that Rule 3-05 applies when
the fair value option is used in lieu of the equity method to account
for an acquisition because the disclosure required by U.S. GAAP on a
post-acquisition basis, and related requirements in Rules 4-08(g) and
3-09, includes summarized financial information or separate financial
statements of the business after the acquisition.\73\ We further
propose replacing the term ``furnish'' with ``file'' throughout Rule 3-
05 and Article 11 to make clear that the information required by Rule
3-05 and Article 11 must be filed with the Commission, as we believe
that, at the time of adoption, the use of the term ``furnished'' in
Rule 3-05 and Article 11 was not intended to mean that those
disclosures were ``not filed.'' \74\ In addition, Rule 3-05 requires
``financial statements prepared and audited in accordance with this
regulation.'' \75\ Consistent with current practice, the proposed
amendments to Rule 3-05 would clarify that references to ``this
regulation'' include the independence standards in Rule Sec.  210.2-01
unless the business is not a registrant, in which case the applicable
independence standards would apply. We are also proposing conforming
clarifications in Rule 3-14 and proposed Rule 6-11.\76\
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    \70\ We additionally propose to clarify that ``financial
statements'' need not include related schedules specified in Article
12 (17 CFR 210.12). Item 9.01(a)(2) of Form 8-K already provides
that supporting schedules of financial statements need not be filed
in these circumstances. The staff further applies this approach to
acquired business financial statements required in registration
statements and proxy statements. See FRM, supra note 40, at Section
2005.2.
    \71\ In addition we are proposing changes to Rule 8-05 for
smaller reporting companies to conform with the proposed changes to
Article 11.
    \72\ As discussed in Section II.B.1 below, we are proposing to
no longer require Rule 3-05 Financial Statements in Securities Act
registration statements and proxy statements once the acquired
business is reflected in filed post-acquisition registrant financial
statements for a complete fiscal year. In conjunction with that
proposal, we are proposing conforming amendments to Rule 3-05(a)(1)
to clarify when financial statements are required and to conform the
language in those requirements with the current requirements in Rule
11-01(a). Additionally, in conforming Rule 3-05(a)(1) with Rule 11-
01(a), we propose to move the explanation that the acquisition of a
business encompasses the acquisition of an interest in a business
accounted for by the equity method from Rule 3-05(a)(1)(i) to
proposed Rule 3-05(a)(2)(ii). Finally, we propose to clarify that a
``business'' that is a real estate operation is subject to Rule 3-14
instead of Rule 3-05.
    \73\ See proposed Rules 3-05(a)(2)(ii) and 3-14(a)(2)(ii).
    \74\ Throughout Rule 3-05 and Article 11, the regulatory text
indicates that financial statements ``shall be furnished.'' See Rule
3-05(a)(1), (b)(1), (b)(2)(i), (b)(2)(ii), (b)(2)(iii), (b)(2)(iv),
(b)4)(ii), (b)(4)(iii), Rule 11-01(a) and Instruction 2 to Rule 11-
02(b). At the time the Commission adopted Rule 3-05, there was no
distinction between ``furnished'' and ``filed.'' See Rule 3-05
Adopting Release. As Securities Act and Exchange Act rules
subsequently began to converge, with documents filed pursuant to the
Exchange Act having exposure to Securities Act liability, some
disclosure was required or permitted to be furnished but ``not
filed'' for certain purposes. We believe that replacing the use of
the term ``furnished'' with ``filed'' in the proposed amendment is
consistent with the original intent and application of the
securities laws.
    \75\ See Rule 3-05(a)(1).
    \76\ See proposed Rules 3-05(a)(1), 3-14(a)(1), and 6-11(a)(1).
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    As another clarification, we propose to replace references to
``business combination'' with the term ``business acquisition'' to make
clear that Rule 3-05 and Article 11 are not limited to ``business
combinations'' as that term is used in U.S. GAAP and IFRS-IASB.\77\ The
term ``business combination'' is defined by reference to the term
``business,'' which has developed differently under U.S. GAAP and IFRS-
IASB from that term as defined in Rule 11-01(d). Because ``business
acquisition'' also encompasses a ``combination between entities under
common control,'' the proposed amendments would also replace this term
in Rule 3-05 and Article 11.
---------------------------------------------------------------------------

    \77\ See supra note 10. We similarly propose to replace the term
in the Instruction to Item 9.01 of Form 8-K.
---------------------------------------------------------------------------

    Consistent with current practice, the proposed amendments would
further provide that a registrant may continue to determine
significance using amounts reported in its Form 10-K for the most
recent fiscal year when the registrant has filed its Form 10-K after
the acquisition consummation date, but before the date the registrant
is required to file financial statements of the acquired business on
Form 8-K.\78\ We propose to permit rather than require use of the more
recent Form 10-K in this circumstance to avoid creating an incentive
for registrants to delay the filing of their Form 10-K.
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    \78\ See proposed Rules 3-05(b)(3) and 11-01(b)(3)(ii). Pursuant
to Rule 3-13, registrants have been permitted to omit Rule 3-05
Financial Statements if an acquired business is not significant
using these amounts.
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    Finally, the proposed amendments would replace the term ``majority-
owned'' as used in Item 2.01 of Form 8-K with the term ``subsidiaries
consolidated,'' as that term more accurately conveys which subsidiaries
are required to be included in the registrant's financial
statements.\79\ We believe these changes would not substantively alter
the current Rule 3-05 requirements, but would facilitate compliance by
providing clarity, codifying current practice, and updating the
terminology used in our rules.
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    \79\ Proposed Rule 3-05 uses the term ``subsidiaries
consolidated'' to conform with the term as it is used elsewhere in
Regulation S-X. See, e.g., Rule 1-02(w), Rule 3-01, and Rule 3-02.
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Request for Comment

    25. We propose to clarify when financial statements and pro forma
financial information are required and to update the language used in
our rules. Are the proposed clarifications and updates appropriate? Are
there further clarifications or other updates we should consider?
    26. Is the proposed language related to independence standards
sufficiently clear? Should we specify the ``applicable independence
standards''? If so, how should the ``applicable independence
standards'' be specified? Are there circumstances where there are no
``applicable independence standards''? In those circumstances, which
independence standards should apply?
6. Foreign Businesses
    Regulation S-X permits the use of IFRS-IASB without reconciliation
to U.S. GAAP in financial statements of foreign private issuers.\80\
Rule 3-05 similarly permits the use of IFRS-IASB in financial
statements of foreign businesses. We are proposing limited
modifications to Rule 3-05 to permit Rule 3-05 Financial Statements to
be prepared in accordance with IFRS-IASB without reconciliation to U.S.
GAAP if the acquired business would qualify to use IFRS-IASB if it were
a registrant,\81\ and to permit foreign private issuers that prepare
their financial statements using IFRS-IASB to provide Rule 3-05
Financial Statements prepared using home country GAAP to be reconciled
to IFRS-IASB rather than U.S. GAAP. In response to the 2015 Request for
Comments, commenters generally supported expanding use of IFRS-IASB in
financial statements of acquired businesses.\82\
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    \80\ See 17 CFR 210.4-01.
    \81\ This proposed amendment would be applicable to domestic and
foreign registrants.
    \82\ See, e.g., letters from BDO, CalPERS, CAQ, DT, EY, Grant,
KPMG, and PwC.
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a. Definition
    Currently, the definitions of ``foreign private issuer'' \83\ and
``foreign business'' \84\ have different ownership requirements such
that an acquired business could qualify to be a ``foreign private
issuer,'' but not qualify to be a ``foreign business.'' For example, an
acquired business may be majority-owned by persons who are U.S.
citizens or residents and still qualify to be a ``foreign private
issuer'' if it were a registrant and certain additional criteria

were met,\85\ but to qualify as a ``foreign business,'' it must be
majority-owned by persons who are not U.S. citizens or residents. The
divergent ownership criteria in the two definitions has created a
circumstance where an acquired business that does not meet the
definition of foreign business, but would otherwise be permitted to
present its financial statements using IFRS-IASB as a foreign private
issuer, is not permitted to use financial statements prepared in
accordance with IFRS-IASB for its Rule 3-05 Financial Statements even
when those financial statements are already available. Instead, the
Rule 3-05 Financial Statements must be prepared in accordance with U.S.
GAAP,\86\ which can result in a significant cost to the registrant. In
circumstances where the acquired business has a sufficient foreign
nexus to meet the definition of a foreign private issuer, we believe
financial statements prepared in accordance with IFRS-IASB would
provide sufficient information for investors.
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    \83\ See Rule 405. The term ``foreign private issuer'' means any
foreign issuer, other than a foreign government, that does not meet
the following criteria as of the last business day of its most
recently completed second fiscal quarter: (i) More than 50% of the
outstanding voting securities of such issuer are directly or
indirectly owned of record by residents of the United States; and
(ii) any of the following: (a) The majority of the executive
officers or directors are United States citizens or residents; (b)
more than 50% of the assets of the issuer are located in the United
States; or (c) the business of the issuer is administered
principally in the United States.
    \84\ See 17 CFR 210.1-02(l).
    \85\ See supra note 83.
    \86\ Alternatively, the Rule 3-05 Financial Statements may be
prepared in accordance with a basis of accounting other than U.S.
GAAP provided a reconciliation to U.S. GAAP under Item 18 of Form
20-F is included. See Financial Statements of Significant Foreign
Equity Investees and Acquired Foreign Businesses of Domestic Issuers
and Financial Schedules, Release No. 33-7118 (Dec. 13, 1994) [59 FR
65632 (Dec. 20, 1994)] (``1994 Acquired Foreign Business Release'').
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    We therefore propose to revise Rule 3-05 to permit Rule 3-05
Financial Statements to be prepared in accordance with IFRS-IASB
without reconciliation to U.S. GAAP \87\ if the acquired business would
qualify to use IFRS-IASB if it were a registrant.\88\ In circumstances
where the registrant presents its financial statements in U.S. GAAP,
the pro forma financial information reflecting the acquisition will
continue to be required to be presented in U.S. GAAP.
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    \87\ Under the existing and the proposed rule, acquired foreign
business financial statements may use IFRS-IASB without
reconciliation to U.S. GAAP, even when the registrant prepares its
financial statement using U.S. GAAP.
    \88\ See proposed Rule 3-05(d).
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b. Reconciliation Requirement
    Currently, if Rule 3-05 Financial Statements of a foreign business
are prepared on a basis of accounting other than U.S. GAAP or IFRS-
IASB, such as home-country GAAP, the Rule 3-05 Financial Statements
must be reconciled to U.S. GAAP.\89\ If the registrant in this case
were a foreign private issuer that presents its financial statements
using IFRS-IASB, this one-time presentation of the U.S. GAAP
reconciling information in financial statements of the acquired
business would likely be the only required U.S. GAAP information in any
of the registrant's filings and could be costly to produce. We believe
that Rule 3-05 Financial Statements that include IFRS-IASB reconciling
information of the acquired foreign business would provide more
comparable information and better facilitate analysis of the financial
statements.
---------------------------------------------------------------------------

    \89\ See Item 17 of Form 20-F and 1994 Acquired Foreign Business
Release.
---------------------------------------------------------------------------

    We therefore propose to permit foreign private issuers that prepare
their financial statements using IFRS-IASB to reconcile Rule 3-05
Financial Statements prepared using home country GAAP to IFRS-IASB
rather than U.S. GAAP.\90\ The reconciliation to IFRS-IASB would be
required generally to follow the form and content requirements in Item
17(c) of Form 20-F.
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    \90\ See proposed Rule 3-05(c).
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Request for Comment
    27. Is the proposed revision to permit in certain circumstances
Rule 3-05 Financial Statements to be prepared in accordance with IFRS-
IASB without reconciliation to U.S. GAAP appropriate? Are there other
requirements that could improve the information to investors?
    28. Is the proposed revision to permit foreign private issuers that
prepare their financial statements using IFRS-IASB to reconcile
acquired foreign business financial statements to IFRS-IASB
appropriate? Would continuing to require reconciliation to U.S. GAAP
provide better information to investors? Are there other requirements
that could improve the information to investors?
7. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-04 provides smaller reporting company disclosure
requirements for the financial statements of businesses acquired or to
be acquired that substantively differ from the existing requirements in
Rule 3-05 in four ways:
     Rule 8-04 permits acquired business financial statements
to be prepared in accordance with the form and content required by
Article 8, rather than the form and content specified elsewhere in
Regulation S-X; \91\
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    \91\ Article 8 allows smaller reporting companies to, among
other things, omit certain footnote disclosures that would be
required by Article 4. Article 8 also requires fewer line items on
the face of interim financial statements.
---------------------------------------------------------------------------

     Rule 8-04 only requires up to two years of acquired
business historical financial statements;
     Rule 8-04 does not explicitly permit the omission of
previously filed financial statements once the operating results of the
acquired business have been included in the audited consolidated
financial statements of the registrant for a complete fiscal year; and
     the ability to exclude from a registration statement
separate financial statements of the acquired or to be acquired
business in certain circumstances is based on the effective date of the
registration statement rather than the date of the relevant final
prospectus or prospectus supplement.
    In connection with offerings made pursuant to Regulation A,\92\
Part F/S of Form 1-A (``Part F/S'') \93\ directs an entity relying on
Regulation A to present financial statements of businesses acquired or
to be acquired,\94\ as specified by Rule 8-04, but permits the periods
presented to be those applicable to Regulation A issuers rather than
the periods specified by Article 8.\95\
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    \92\ 17 CFR 230.251 through 263.
    \93\ 17 CFR 239.90.
    \94\ See paragraph (b)(7)(iii) of Part F/S.
    \95\ As mandated by the Economic Growth, Regulatory Relief, and
Consumer Protection Act (Pub. L. 115-174, 132 Stat. 1296 (2018)),
the Commission in December 2018 revised Rule 251(b) under the
Securities Act to permit entities subject to the reporting
requirements of Section 13 or 15(d) of the Exchange Act to conduct
exempt offerings under Regulation A. See Amendments to Regulation A,
Release No. 33-10591 (Dec. 19, 2018) [84 FR 520 (Jan. 31, 2019)].
Such reporting companies are required, at a minimum, to comply with
the requirements of Part F/S of Form 1-A. However, if at the time a
reporting company files a Form 1-A, it has made publicly available
more recent audited or reviewed financial statements prepared in
accordance with the standard required for the registrant's Exchange
Act reports, including such financial statements in the offering
statement may be necessary to make the required statements therein,
in light of the circumstances under which they are being made, not
misleading. See 17 CFR 230.252.
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    In order to simplify the application of our rules by focusing
registrants on the more detailed and better understood provisions of
Rule 3-05, we propose to revise Rule 8-04 to direct registrants to Rule
3-05 for the requirements relating to the financial statements of
businesses acquired or to be acquired, other than for form and content
requirements for such financial statements, which would continue to be
prepared in accordance with Rules 8-02 and 8-03.\96\

Additionally, because Part F/S of Form 1-A refers to Rule 8-04, the
proposed revisions to Rule 8-04 would apply to issuers relying on
Regulation A. As a result, under the proposed amendments, smaller
reporting companies would continue to be required to provide up to two
years of acquired business historical financial statements and
Regulation A issuers would continue to be permitted to present the
periods applicable under Regulation A.\97\
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    \96\ Rule 3-05(b)(1) currently requires financial statements
specified in Sec. Sec.  210.3-01 and 210.3-02 for the business to be
acquired. Similarly, Rule 3-05(b)(2) also references Sec. Sec.
210.3-01 and 210.3-02. Under our proposal, smaller reporting
companies would apply Sec.  210.3-05 but would substitute Sec. Sec.
210.8-02 and 210.8-03, as applicable, wherever Sec.  210.3-05
references Sec. Sec.  210.3-01 and 210.3-02. In this way, our
proposal is intended to apply the election permitted for smaller
reporting companies to prepare their financial statements in
accordance with the form and content requirements in Article 8
rather than the other form and content requirements specified
elsewhere in Regulation S-X (subject to the exceptions noted in
Sec.  210.8-01 Preliminary Note 2 to Article 8) to businesses
acquired by smaller reporting companies.
    \97\ Additionally, in accordance with current practice, the
proposed rule would expressly permit smaller reporting companies to
omit such financial statements if the acquired business has been
included in the registrant's results for a complete fiscal year. See
further discussion of omission of Rule 3-05 Financial Statements in
Section II.B.1 above. We also propose to add references to Rule 8-04
in Rule 3-06 and to Rule 3-06 in Note 6 to Article 8 to expressly
permit smaller reporting companies to file financial statements
covering a period of nine to 12 months to satisfy the requirement
for filing financial statements for a period of one year for an
acquired business.
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    Additionally, under the proposed amendments, a smaller reporting
company would be eligible to exclude acquired business financial
statements from a registration statement if the business acquisition
was consummated no more than 74 days prior to the date of the relevant
final prospectus or prospectus supplement, rather than 74 days prior to
the effective date of the registration statement as under current Rule
8-04(c)(4).\98\ We believe it is appropriate to consistently look to
the date of the final prospectus or prospectus supplement,\99\ as Rule
3-05 currently does, because that date could be later than the
effective date, particularly in the case of a delayed offering, which
some smaller reporting companies are now permitted to conduct.\100\
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    \98\ See proposed Rule 3-05(b)(4)(i)(B).
    \99\ See 1996 Streamlining Release, supra note 13 (noting that
the date of an offering is specified as the date of the final
prospectus or prospectus supplement relating to the offering).
    \100\ See General Instruction I.B.6 of Form S-3 and 2018 SRC
Amendments, supra note 16.
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Request for Comment
    29. Would the proposed revisions to Rule 8-04 to direct smaller
reporting companies and Regulation A issuers to Rule 3-05 while still
permitting them to rely on the form and content requirements in Rules
8-02 and 8-03 simplify the application of our rules by focusing
registrants on the more detailed and better understood provisions of
Rule 3-05? Are there other changes to the Rule 8-04 requirements that
we should consider?
    30. For purposes of excluding acquired business financial
statements from a registration statement, is the proposed revision to
require smaller reporting companies to look to the date of the relevant
final prospectus or prospectus supplement instead of the effective date
of the registration statement appropriate? Why or why not?
    31. Our proposal to no longer require Rule 3-05 Financial
Statements once the operating results of the acquired business have
been included in the audited consolidated financial statements of the
registrant for a complete fiscal year (see Section II.B.1 above) would
also apply to smaller reporting companies pursuant to our proposed
revisions to Rule 8-04. Is permitting smaller reporting companies to
omit financial statements under these circumstances appropriate? Are
there specific revisions or information requirements we should consider
for smaller reporting companies?
    32. Should the proposed changes to Rule 8-04 apply to offerings
made pursuant to Regulation A? Should we revise the proposals to better
accommodate Regulation A issuers and investors? If so, what revisions
should we make and why?

B. Proposed Amendments Relating to Rule 3-05 Financial Statements
Included in Registration Statements and Proxy Statements

1. Omission of Rule 3-05 Financial Statements for Businesses That Have
Been Included in the Registrant's Financial Statements
Overview of the Application of the Current Rule
    Current Rule 3-05(b)(4)(iii) generally permits Rule 3-05 Financial
Statements to be omitted once the operating results of the acquired
business have been reflected in the audited consolidated financial
statements of the registrant for a complete fiscal year. However, Rule
3-05 Financial Statements are required to be included when they have
not been previously filed or when the Rule 3-05 Financial Statements
have been previously filed, but the acquired business is of major
significance to the registrant.
Rule 3-05 Financial Statements Not Previously Filed
    If Rule 3-05 Financial Statements have not been previously filed,
they must be provided even if the acquired business is included in
post-acquisition audited results. Thus, a registrant that acquired a
significant business during the earliest of the three years for which
it presents financial statements, and has reported the combined results
in audited financial statements since the acquisition, would still be
required to file separate Rule 3-05 Financial Statements for that
acquired business if the Rule 3-05 Financial Statements have not been
previously filed.\101\ The staff has historically not objected,
however, to registrants reducing the Rule 3-05 Financial Statement
periods presented by the equivalent period that the acquired business
is included in the registrant's post-acquisition audited results.\102\
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    \101\ This issue arises most often for initial registration
statements under the Securities Act and Exchange Act since an
existing Exchange Act reporting company would generally have been
required to file Rule 3-05 Financial Statements on a Form 8-K within
approximately 75 days after acquisition of a significant business.
    \102\ This is limited to circumstances where there is no gap
between the latest date of the pre-acquisition audited financial
statements of the acquired business and the earliest date of the
registrant's audited post-acquisition results. See FRM, supra note
40, at Section 2030.4 ``Initial Registration Statements--Using Pre-
Acquisition and Post-Acquisition Audited Results.''
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Rule 3-05 Financial Statements Previously Filed for an Acquisition That
Was of Major Significance
    Under current Rule 3-05(b)(4)(iii), registrants must also continue
to present Rule 3-05 Financial Statements that have been previously
filed if the acquired business is of such significance to the
registrant that omission of those Rule 3-05 Financial Statements would
materially impair an investor's ability to understand the historical
financial results of the registrant. Rule 3-05 provides as an example
that an acquired business that met at least one of the significance
tests at the 80% level at the date of the acquisition would require the
registrant to continue to file the financial statements of the acquired
business for such periods prior to the purchase as may be necessary
when added to the time for which audited income statements after the
purchase are filed to cover the equivalent of the period specified in
Rule 3-02.\103\ Notwithstanding the rule's reference to materiality, in
practice the rule is

typically applied, consistent with this example, on the basis of
quantitative significance determinations.\104\ The result of the
practical application of the ``major significance'' exception is that,
for example, if an acquisition that occurred two years ago was
significant at the 80% level at the time of the acquisition, one year
of previously filed Rule 3-05 Financial Statements will continue to be
provided regardless of whether post-acquisition activities have
diminished the relative significance of the acquired business.
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    \103\ See Rule 3-05(b)(4)(iii). Rule 3-02 states that there
shall be filed, for the registrant and its subsidiaries consolidated
and for its predecessors, audited statements of income and cash
flows for each of the three fiscal years preceding the date of the
most recent audited balance sheet being filed or such shorter period
as the registrant (including predecessors) has been in existence. An
emerging growth company may provide audited statements of income and
cash flows for each of the two fiscal years preceding the date of
the most recent audited balance sheet (or such shorter period as the
registrant has been in existence) in its initial registration
statement.
    \104\ See, e.g., FRM, supra note 40, at Section 2040.2 ``Major
Significance'' and ``Previously Filed Acquiree Financial
Statements.''
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Proposed Amendments Regarding the Omission of Rule 3-05 Financial
Statements
    We are proposing to no longer require Rule 3-05 Financial
Statements in registration statements and proxy statements once the
acquired business is reflected in filed post-acquisition registrant
financial statements for a complete fiscal year.\105\ This change would
eliminate the requirement that Rule 3-05 Financial Statements be
provided when they have not been previously filed or when they have
been previously filed but the acquired business is of major
significance.
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    \105\ The proposed amendments would require inclusion in all
twelve months of the registrant's most recently completed audited
fiscal year. They do not permit reducing the twelve month period
through analogy to Rule 3-06 or by the number of months of pre-
acquisition historical financial statements that may be provided.
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    The ``not previously filed'' exception requires those registrants
filing initial registration statements to test the significance of
acquisitions that occurred during the earliest years for which the
registrant is required to provide its historical financial statements
and, if significant, to provide pre-acquisition financial statements of
the acquired business. This requirement can delay a registrant's
offering and thereby its access to capital while providing information
that is often less meaningful to investors because the utility of pre-
acquisition periods diminishes over time after the acquired business is
reflected in post-acquisition results and the post-acquisition results
of the combined business are generally not comparable to the pre-
acquisition results of the acquired business.\106\
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    \106\ See FRM, supra note 40, at Section 2030.4. The
accommodation currently provided by Commission staff does not
sufficiently ameliorate these effects and often results in financial
statements of the acquired business for a pre-acquisition stub
period ending at a date during a fiscal period such that the
financial statements depict partial, rather than complete, reporting
periods that do not coincide with the end of either the acquired
business's or the registrant's fiscal periods. Moreover, because
these are staff accommodations, they lack the legal significance of
a Commission rule.
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    We also propose to eliminate the ``major significance'' exception.
As with not previously filed information, the utility of pre-
acquisition periods diminishes over time after the acquired business is
reflected in post-acquisition results. We further observe that the
``major significance'' exception was established prior to requirements
for electronic filing, which has made previously filed financial
information about the acquired business more readily accessible through
the Commission's EDGAR filing system. Consequently, we believe this
exception is no longer necessary.
    We believe inclusion of post-acquisition results in the
registrant's audited financial statements for a complete fiscal year
should generally provide investors with sufficient information to make
informed investment decisions about the registrant.\107\ The
requirement for management to prepare Rule 3-05 Financial Statements
and a third party to audit those financial statements can be costly and
adds preparation time for the financial statements, which can affect a
registrant's time to market and delay its access to capital. Where the
significant acquisition will have occurred over a year before, and
information about the acquired business that is material to the
registrant would generally have been incorporated into the registrant's
audited historical financial statements for a complete fiscal year or
otherwise provided pursuant to the requirements of 17 CFR 210.4-01(a)
and 17 CFR 229.303, we do not believe it is necessary to require
registrants to provide Rule 3-05 Financial Statements.
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    \107\ Further, even without the major significance requirement
to include some, but not all, of the previously filed pre-
acquisition financial statements of the acquired business,
Regulation S-X provides that a registrant shall provide ``such
further material information as is necessary to make the required
statements, in light of the circumstances under which they are made,
not misleading.'' See 17 CFR 210.4-01(a).
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Request for Comment
    33. Is our proposal to no longer require Rule 3-05 Financial
Statements once the acquired business is reflected in filed post-
acquisition audited consolidated financial statements of the registrant
for a complete fiscal year appropriate? Would the proposed revisions
simplify the application of the rule and reduce costs for registrants?
    34. Would the proposed amendments affect the sufficiency of
information available to investors? If so, should we continue to
require Rule 3-05 Financial Statements if they have not been previously
filed or if the acquisition was of major significance? Alternatively,
what information about an acquired business is most important to
investors once the acquired business has been depicted in the
registrant's post-acquisition audited consolidated financial statements
for a complete fiscal year that is not otherwise provided pursuant to
existing requirements, like those for management's discussion and
analysis, and what changes could we make to ensure that investors
receive such information while reducing the burden on registrants of
preparing unnecessary disclosure?
2. Use of Pro Forma Financial Information To Measure Significance
    Significance determinations are required to be made by comparing
the most recent annual consolidated financial statements of the
acquired business to those of the registrant filed at or prior to the
date of acquisition. A registrant is permitted to use pro forma, rather
than historical, financial information if the registrant made a
significant acquisition subsequent to the latest fiscal year-end and
filed its Rule 3-05 Financial Statements and pro forma financial
information on Form 8-K.\108\ There is no analogous provision in Rule
3-05 for registrants to use pro forma financial information depicting
significant dispositions or for registrants filing initial registration
statements. In considering whether, pursuant to Rule 3-13 and delegated
authority, to permit omission or substitution of acquired business
financial statements in initial registration statements of registrants
growing through acquisition, Commission staff has considered the
results of significance tests using pro forma financial
information.\109\ In response to the 2015 Request for Comment, some
commenters

recommended establishing requirements to determine significance in
these circumstances in a manner that reduces complexity and provides
financial statements that are meaningful to investors.\110\
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    \108\ 17 CFR 210.3-05(b)(3).
    \109\ See supra note 43. See also Staff Accounting Bulletin No.
80, Application of Rule 3-05 in Initial Public Offerings (``SAB
80''). Consistent with the staff's exercise of delegated authority
in response to requests under Rule 3-13, SAB 80 states that the
staff will not object if significance is measured using the
alternative method specified in SAB 80. The SAB 80 method is similar
to Rule 3-05 in its use of more recent pro forma financial
information of the registrant. It differs from Rule 3-05 in that it:
Uses pro forma rather than historical financial information of the
acquired business; uses pro forma financial information of the
registrant that was not previously filed; and does not reflect the
current, higher significance thresholds in Rule 3-05. The
accommodations in SAB 80 are complex and seldom used by registrants,
in part because they require the acquired businesses to remain
discrete and substantially intact after acquisition.
    \110\ See, e.g., letters from ABA-Committees, CAQ, DT, EY, and
Grant.
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    We propose to expand the circumstances in which a registrant can
use pro forma financial information for significance testing.
Specifically, for all filings that require Rule 3-05 Financial
Statements and Rule 3-14 Financial Statements, we propose to permit