SEC Amends “Smaller Reporting Company” Definition
The Securities and Exchange Commission has approved amendments to its "smaller reporting company" (SRC) definition, which, effective on or around September 10, 2018, will expand the number of companies that qualify for certain existing "scaled" disclosure accommodations, resulting in reduced disclosure requirements versus larger companies.
Expansion of Companies Eligible to be SRCs
The new definition: The revised SRC definition now includes companies with less than $250 million of public float (the market cap of a company’s equity held by non-affiliates), as compared to $75 million under the prior definition, and companies with less than $100 million in annual revenues that also have either no public float or a public float that is less than $700 million, as compared to no public float and less than $50 million in annual revenues under the prior definition. The $700 million threshold in particular may help life sciences and other development companies that have significant public floats but have not yet recognized significant revenues.
Becoming a SRC after not previously qualifying: Companies meeting the new definition after the effective date that previously did not exceed the new thresholds, for example a company with $220 million in public float, will immediately be able to take advantage of their new SRC status. The amendments also revise the lower qualification thresholds that a company must meet to qualify as a SRC if it did not previously qualify as a SRC even under the new thresholds. The lower qualification thresholds to be met by a previous non-SRC will be 80% of the initial qualification thresholds. As a result, a company with $250 million or more of public float will not qualify as a SRC until it has a public float of less than $200 million. Similarly, a company that previously had less than $100 million in annual revenues but more than $700 million in public float will not qualify as a SRC until it has less than $560 million of public float, a company that previously had $100 or more in annual revenues under the revenue test will not qualify as a SRC until it has less than $80 million of annual revenues, and a company that previously exceeded both thresholds would need to be below both $80 million in annual revenues and $560 million of public float to qualify as a SRC.
Changes impacting all public companies: The SEC also revised the net revenues threshold for Rule 3-05(b) of Regulation S-X, from $50 million to $100 million, consistent with the SRC definition amendments. As a result, companies may omit financial statements of businesses acquired or to be acquired for the earliest of the three fiscal years otherwise required by Rule 3-05 if the net revenues of that business are less than $100 million.
All public companies, whether or not SRCs, should also be aware that in connection with the amendments, the SEC adopted minor, technical revisions to the cover pages of Forms S-1, S-3, S-4, S-8 and S-11, as well as Forms 10, 10-Q and 10-K.
Scaled Disclosure Accommodations – But No Relief From SOX 404 (Yet)
Companies qualifying as SRCs under the revised definition benefit from a number of scaled disclosure accommodations. In particular, SRCs have fewer disclosure requirements regarding financial statements, including a two-year period rather than three for (1) income, cash flow and changes in stockholders’ equity statements, and (2) MEDIA (Management’s Discussion and Analysis of Financial Condition and Results of Operations) year-to-year comparisons, as well as reduced requirements regarding the filing of historical and pro forma financial statements for businesses acquired or to be acquired and longer grace periods before historical financial statements become "stale." Another major concession for SRCs is in the area of executive compensation disclosures, as SRCs do not have to provide a Compensation Discussion and Analysis section (or related Compensation Committee report) or CEO to median employee pay ratio, and are required to provide fewer compensation tables and information on a smaller number of executive officers and for only two years instead of three. On the other hand, SRCs also have slightly expanded disclosure requirements regarding disclosures of related person transactions under Item 404 of Regulation S-K, though they do not have to describe their policies and procedures for approval of related person transactions.
Other areas with scaled disclosures for SRCs include (1) no requirement for risk factors in periodic reports, (2) no requirement for stock performance graphs in annual reports to shareholders, (3) no requirement for selected financial data, (4) no requirement for quantitative and qualitative disclosure about market risk, (5) no requirement for tables of contractual obligations, (6) no requirement to provide ratios of earnings to fixed charges, and (7) less detail and a shorter history in business descriptions. While critics of the amendments decry the reduced disclosure levels, these scaled disclosure accommodations can greatly reduce regulatory and compliance costs and time for SRCs. Of course, SRCs can voluntarily give a greater level of information than is required. For example, even though SRCs are eligible to omit risk factors from their periodic reports, many current SRCs choose to include these.
The amendments did not change the threshold for the somewhat related "accelerated filer" definition, creating a confusing overlap in requirements for companies with between $75 million and $250 million public floats, at least for the time being. Notably, accelerated filers must meet earlier filing deadlines for annual and quarterly reports than smaller "non-accelerated filers," and accelerated filers must provide an auditor’s attestation regarding their internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002. As a result, companies between the $75 million and $250 million public float threshold, despite qualifying as a SRC, will still need to provide a SOX 404 audit report even if they take advantage of the scaled disclosures in other areas. However, the SEC stated that it has begun to formulate recommendations for possible additional changes to the "accelerated filer" definition to reduce the number of companies that qualify as accelerated filers.
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If you would like further information regarding these changes, the definitions of SRC or accelerated filer, or with respect to scaled disclosure accommodations for SRCs, please contact the lawyer at Sullivan & Worcester LLP with whom you regularly consult, or any of the lawyers listed above.