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By Gary Illiano, CPA, Grant
Thornton LLP

The SEC has adopted amendments to, among others, Rule 3-05 of Regulation S-X. The final rules, which are significantly less stringent than the proposed rules, address the difficulty in providing the required financial information pertaining to business acquisitions in a registration statement. In short, information relating to acquired companies is less likely to be required, and if it is required, it may not have to be provided as soon as before.

When unable to meet the financial statement requirements for an acquisition to be included in a registered public offering, companies have been seeking alternative means of financing. The SEC has expressed concern, however, about abusive practices associated with certain of those financings, in particular offshore securities offerings pursuant to Regulation S. By reducing the requirements for presenting audited financial statements of an acquired company in a registration statement, the new rules are intended to enable more companies to turn to the public markets to meet their financing needs. The SEC believes that easing the requirements for acquisitions will therefore reduce abusive practices related to alternate financings, especially those under Regulation S.

Requirements Relaxed in 1933
Act Registration Statements

Previously, audited financial statements of businesses acquired or to be acquired were required to be included in 1933 Act registration statements before a company could proceed with a registered offering. However, registrants filing periodic reports under the 1934 Act were permitted to file audited statements of significant acquired businesses on Form 8-K up to 75 days after the transaction date. This inconsistency prevented 1934 Act reporting companies from a public offering of their securities if the financial statements of a target business were not available at the time of the 1933 Act registration. With this release, the SEC has conformed the rules for separate financial statements to be included in a 1933 Act registration statement to the 1934 Act requirements.

With certain exceptions, a registration statement may now be declared effective without including the separate financial statements of the target company, unless those statements had previously been filed with the SEC. In most cases, a registrant will not have to include financial statements for probable business acquisitions, or for business acquisitions that were consummated 74 or fewer days before the registered offering of securities. The separate financial statements would be required in a subsequent 1934 Act filing, most likely on Form 8-K. "Blank Check" companies, as defined in Rule 419 of Regulation C, are not eligible for this relief.

The financial statements of probable acquisitions and recently acquired companies would continue to be required when the significance of the target company exceeds 50%, using the tests that have previously been established. Registrants may choose to include the financial statements of businesses below the 50% significance level on a voluntary basis. The SEC chose to omit the "readily available" criterion for including the financial statements during the 75 day period. The SEC reasoned that "readily available" provides so much discretion it is unlikely to result in a more prompt filing, and is likely to result in inconsistent application. The SEC believes the revised rules will be less subjective in their application.

The current relief for registered offerings that are not primarily of a capital raising nature and certain private placements is unchanged. For example, the offerings listed in the Instructions to Item 7 of Form 8-K may go forward without the financial statements of the acquired businesses, regardless of the level of significance, until 75 days following the acquisition.

The new rules also affect small business issuers (SBIs) and proxy statements. SBIs do not have to include the financial statements of acquired companies when the effective date of the registration statement is no more than 74 days after consummation of the business combination. This time frame, which keys off the effective date, is slightly less rigorous than the S-X Rule 3-05 requirement, which keys off the date of the final prospectus as filed with the SEC pursuant to Rule 424(b).

Consequently, an SBI may have an extra few days to maneuver that S-X registrants may not have when requesting acceleration of effectiveness, but small business registrants should be cautious, because the staff has not yet provided any interpretations on this or any part of the release. In the case of proxies, the mailing date of the proxy must be no more than 74 days after consummation of the business combination, for both Regulation S-B and Regulation S-X filers.

Changes in Significance Levels Pertaining to Acquired Businesses

The thresholds at which a business will be considered significant enough to include its financial statements in the 1933 Act registration statement or 1934 Act filing have been raised. The Regulation S-X thresholds of 10%, 20%, and 40% for including one, two, or three years of financial statements, respectively, have been raised to 20%, 40%, and 50%. The thresholds under Regulation S-B, 20% and 40% for one and two years, respectively, were not changed. Under the revised rules, if the significance of the acquiree exceeds 20%, audited financial statements should be provided for one year. If the significance of the acquiree exceeds 40%, audited financial statements should be provided for two years. If the significance of the acquiree exceeds 50%, audited financial statements should be provided for three years, except if the issuer is making the offering under Regulation S-B or the acquired business reports annual revenues of less than $25 million. Therefore, consistent with the unchanged Regulation S-B thresholds, SBIs would only have to provide audited statements for the most recent two years once significance exceeds 40%. In addition, any registrant that acquires a company with less than $25 million in revenues may now omit the earliest of the three years where otherwise required at the 50% level of significance.

No financial statements of acquired businesses are required when the significance of the acquiree is 20% or less. The "readily available criterion" was deleted from Item 310 of Regulation S-B and omitted from Rule 3-05 of Regulation S-X. The reasoning of the SEC on this issue is discussed above.

Foreign Private Issuers

Currently not subject to the quarterly or Form 8-K reporting rules, foreign private issuers will not be required to file a separate report that includes the financial statements of the acquired company. However, three years of audited financial statements of the foreign businesses would be required in a registration statement if the recent or contemplated acquisition exceeds the 50% significance level. If the target company falls below the 50% threshold, the foreign private issuer is not required to furnish those financial statements in any later 1934 Act filing, unless they are required by the issuer's home country rules or are otherwise furnished in the issuer's domestic market.

Individually Insignificant Acquirees

The new rules provide that if individually insignificant businesses are acquired subsequent to the issuer's latest audited balance sheet date that are, in the aggregate, significant at the 50% level, then the registrant is required to provide one year of audited financial statements for a majority of those businesses. This raises the threshold from the prior 20% to the new 50% level. A business will be individually insignificant unless it exceeds the 20% level of significance.

However, consistent with current interpretations by the staff concerning acquisitions of businesses that are related, the new rules provide that the acquisition of "related businesses" should be treated as a single business combination for purposes of determining the level of significance. Related businesses are defined as businesses under common ownership or management or whose acquisitions are conditional on each other or on a single common condition.

Changes in Pro Forma Requirements

Under the new rules, pro forma information required by Regulation S-X need not be furnished unless the financial statements of the acquiree are furnished. Article 11 of Regulation S-X has been amended to conform the significance threshold for providing pro forma financial statements in connection with business acquisitions to the minimum 20% significance level in Rule 3-05 of Regulation S-X and Item 310 of Regulation S-B.

What the Release Does Not Change

Several related rules were not amended.

Reporting of Acquisitions; Reporting Acquisitions on Form 8-K. Form 8-K was not amended with respect to the reporting of significant acquisitions. The SEC staff has indicated that registrants would be required to report asset acquisition that exceeds 10% significance, but a form 8-K would not be required for business acquisitions until the 20% significance level. The staff would not object to the reporting of business acquisitions that are significant at a level greater than 10% but not greater than 20% under item 5 of Form 8-K, even if financial information is not provided.

Other Information Required. Other information requirements regarding significant acquisitions are generally unchanged. For example, discussion in MD&A of the likely effects of probable or recently consummated business combinations that are material or GAAP required disclosures regarding the terms and effects of material business combinations would be unaffected by the new rules. The SEC did not address the need for a safe harbor for disclosures pertaining to significant acquisitions until audited financial statements are available.

Securities Registered in Connection with a Business Combination. There is no change to the requirement to provide audited financial statements of a business to be acquired if securities are being registered in connection with the acquisition of that business (see Rule 3-05(b)). However, registrants can rely on the new rules regarding the omission of other pending or recently completed acquisitions.

Real Estate Companies. In the current release, there is no change to the Rule 3-14 requirements governing the financial statements required for acquired operating real estate properties. The SEC did say that in the future it may consider revisions in this area.

Effective Date

The new rules became effective on November 18, 1996. A copy of the release (Nos. 33-7355, 34-37802) is available in the Federal Register or on the SEC's home page at http://www.sec.gov. *

Gary Illiano, CPA
Grant Thornton LLP

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