Experienced Attorneys Assisting with Smaller Reporting Companies (SRCs)
On June 28, 2018, the Securities and Exchange Commission (SEC) adopted the much-anticipated amendments to the definition of a “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2, and Item 10(f) of Regulation S-K.
Among other benefits, the change is hoped to help encourage smaller companies to access U.S. public markets. The amendment expands the number of companies that qualify as smaller reporting companies (SRC) and thus qualify for the scaled disclosure requirements in Regulation S-K and Regulation S-X. The SEC estimates that an additional 966 companies will be eligible for SRC status in the first year under the new definition.
As proposed and as recommended by various market participants, the new definition of an SRC will now include companies with less than a $250 million public float compared to the $75 million threshold in the prior report. In addition, if a company does not have an ascertainable public float or has a public float of less than $700 million, an SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The prior revenue threshold was $50 million, including companies with no ascertainable public float.
Once considered an SRC, a company would maintain that status unless its float drops below $200 million if it previously had a public float of $250 million or more. The revenue thresholds have been increased for requalification such that a company can requalify if it has less than $80 million of annual revenues if it previously had $100 million or more, and less than $560 million of public float if it previously had $700 million or more.
The SEC also made related rule changes to flow through the increased threshold concept. In particular, Rule 3-05 of Regulation S-X has been amended to increase the net revenue threshold in the rule from $50 million to $100 million. 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.
Furthermore, the conforming changes include changes to the cover page for most SEC registration statements and reports, including, but not limited to, Forms S-1, S-3, S-4, S-11, 10-Q and 10-K.
The new rules did not change the definitions of “accelerated filer” or “large accelerated filer.” As a result, companies with $75 million or more of public float that qualifies as SRCs will remain subject to the requirements that apply to accelerated filers, including the accelerated timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act. However, Chair Clayton has directed the SEC staff to make recommendations for additional changes to the definitions to reduce the number of companies that would qualify as accelerated filers.
Background
The topic of disclosure requirements under Regulation S-K as pertains to disclosures made in reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) have come to the forefront over the past couple of years. Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act.
A public company with a class of securities registered under either Section 12 or which is subject to Section 15(d) of the Exchange Act must file reports with the SEC (“Reporting Requirements”). The underlying basis of the Reporting Requirements is to keep shareholders and the markets transparently informed regularly. Over the years, Regulation S-K has not been kept current with other Rule changes, the arduous reporting requirements for smaller companies have resulted in stifled capital formation and fewer smaller IPOs, and investors have questioned the quality and relevancy of information required to be included in reports.
The SEC disclosure requirements are scaled based on company size, and the SEC established the smaller reporting company category in 2007 to provide general regulatory relief to these entities. Before this rule change, a “smaller reporting company,” as defined in Securities Act rule 405, Exchange Act Rule 12b-2, and Item 10(f) of Regulation S-K, as one that: (i) has a public float of less than $75 million as of the last day of their most recently completed second fiscal quarter, or (ii) a zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.
The following table, copied from the SEC rule release, summarizes the scaled disclosure accommodations available to smaller reporting companies:
| Regulation S-K | |
| Item | Scaled Disclosure Accommodation |
| 101 − Description of Business | May satisfy disclosure obligations by describing the development of its business during the last three years rather than five years. Business development description requirements are less detailed than disclosure requirements for non-smaller reporting companies. |
| 201 − Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters | Stock performance graph not required. |
| 301 – Selected Financial Data | It is not required. |
| 302 – Supplementary Financial Information | It is not required. |
| 303 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) | Two-year MD&A comparison rather than a three-year comparison.
Two-year discussion of the impact of inflation and price changes rather than three years. Tabular disclosure of contractual obligations is not required. |
| 305 – Quantitative and Qualitative Disclosures About Market Risk | Not required. |
| 402 – Executive Compensation | Three named executive officers rather than five.
Two years of summary compensation table information rather than three. Not required: · Compensation discussion and analysis. · Grants of plan-based awards table. · Option exercises and stock vested table. · Pension benefits table. · Nonqualified deferred compensation table. · Disclosure of compensation policies and practices related to risk management. · Pay ratio disclosure. |
| Regulation S-K | |
| Item | Scaled Disclosure Accommodation |
| 404 – Transactions With Related Persons, Promoters, and Certain Control Persons 16 | Description of policies/procedures for the review, approval, or ratification of related party transactions is not required. |
| 407 – Corporate Governance | Audit committee and financial expert disclosure is not required in the first year.
Compensation committee interlocks, and insider participation disclosure are not required. A compensation committee report is not required. |
| 503 – Prospectus Summary, Risk Factors, and Ratio of Earnings to Fixed Charges | No ratio of earnings to fixed charges disclosure is required. No risk factors are needed in Exchange Act filings. |
| 601 – Exhibits | Statements regarding the computation of ratios are not required. |
| Regulation S-X | |
| Rule | Scaled Disclosure |
| 8-02 – Annual Financial Statements | Two years of income statements rather than three years. Two years of cash flow statements rather than three years.
Two years of changes in stockholders’ equity statements rather than three years. |
| 8-03 – Interim Financial Statements | Permits specific historical financial data instead of separate financial statements of equity investees. |
| 8-04 – Financial Statements of Businesses Acquired or to Be Acquired | Maximum of two years of acquiree financial statements rather than three years. |
| 8-05 – Pro forma Financial Information | Fewer circumstances under which pro forma financial statements are required. |
| 8-06 – Real Estate Operations Acquired or to Be Acquired | Maximum of two years of financial statements for acquiring properties from related parties rather than three years. |
| 8-08 – Age of Financial Statements | Less stringent age of financial statements requirements. |
Final Amendments To Smaller Reporting Company Definition
The SEC has competing goals of protecting investors and the marketplace by requiring companies to provide disclosure needed to make informed investment and voting decisions, promoting capital formation, and reducing compliance costs for smaller companies. The SEC believes that by raising the financial thresholds for the minor reporting company definition and thereby expanding the number of companies eligible to use the available scaled disclosure, it will be satisfying its goals and appropriately responding to comments and recommendations by the Advisory Committee on Small and Emerging Growth Companies, the SEC Government-Business Forum on Small Business Capital Formation, Congress and industry commenters.
The SEC summarizes many of these recommendations, initiatives, and comments in its rule release. For example, in September 2015, the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. The FAST Act passed into law on December 4, 2015, required the SEC to scale or eliminate duplicative, antiquated, or unnecessary disclosure requirements for emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers in Regulation S-K.
The SEC considered comments it received to the initially proposed rule release and comments it received in response to the published concept release and request for public comment on Regulation S-K. As indicated above, the new definition of an SRC will now include companies with less than a $250 million public float compared to the $75 million threshold in the prior definition. In addition, if a company does not have an ascertainable public float or has a public float of less than $700 million, an SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The prior revenue threshold was $50 million, including companies with no ascertainable public float.
Once considered an SRC, a company would maintain that status unless its float drops below $200 million if it previously had a public float of $250 million or more. The revenue thresholds have been increased for requalification such that a company can requalify if it has less than $80 million of annual revenues if it previously had $100 million or more, and less than $560 million of public float if it previously had $700 million or more.
The SEC also made related rule changes to flow through the increased threshold concept. In particular, Rule 3-05 of Regulation S-X has been amended to increase the net revenue threshold in the rule from $50 million to $100 million. 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.
Furthermore, the conforming changes include changes to the cover page for most SEC registration statements and reports, including, but not limited to, Forms S-1, S-3, S-4, S-11, 10-Q and 10-K.
The following summarizes the scaled disclosures available to smaller reporting companies. In addition, the FAST Act passed into law on December 4, 2015, amended Form S-1 to allow for forward incorporation by reference by smaller reporting companies. A smaller reporting company may now incorporate any documents filed by the company, following the effective date of a registration statement, into such an effective registration statement. In what was probably unintended in the drafting, the FAST Act changes only include smaller reporting companies, not emerging growth companies or non-accelerated filers. Other categories of filers, including accelerated and large accelerated filers, were already allowed to forward incorporated by reference. Accordingly, among the other benefits of the current proposed rule change, the number of companies that can utilize forward incorporation by reference in a Form S-1 will increase.
Amendments To Accelerated Filer And Large Accelerated Filer Definitions
The new rules did not change the definitions of “accelerated filer” or “large accelerated filer.” As a result, companies with $75 million or more of public float that qualifies as SRCs will remain subject to the requirements that apply to accelerated filers, including the accelerated timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act. However, Chair Clayton has directed the SEC staff to make recommendations for additional changes to the definitions to reduce the number of companies that would qualify as accelerated filers.
The public float threshold for an accelerated filer is $75 million. Companies that currently file as accelerated filers would continue to do so under the new rules but would benefit from the scaled disclosure requirements available to smaller reporting companies. The filing deadlines for each category of filer are:
| Filer Category | Form 10-K | Form 10-Q |
| Large Accelerated Filer | 60 days after fiscal year-end | 40 days after quarter-end |
| Accelerated Filer | 75 days after fiscal year-end | 40 days after quarter-end |
| Non-accelerated Filer | 90 days after fiscal year-end | 45 days after quarter-end |
| Smaller Reporting Company | 90 days after fiscal year-end | 45 days after quarter-end |
Statements Of Commissioners On Rule Amendment
Commissioners Hester Peirce and Michael Piwowar made public statements regarding the rule change, both supporting the amendment and expressing disappointment that it did not include a difference in the definition of an accelerated filer. Both commissioners think it is insufficient to reduce regulatory burdens and encourage more companies to go public. Section 404(b) of the Sarbanes-Oxley Act is among smaller public companies’ most significant responsibilities. Commissioner Piwowar believes that until that is changed, there will be no improvement in efforts to raise capital by smaller companies. Ms. Peirce goes further, stating that the failure to conform to the definition of an accelerated filer will be confusing to companies. Before the rule change, a smaller reporting company was permanently exempted from Section 404(b) compliance; however, that will not be the case now.
Ms. Peirce points to a poignant example from the comment letters. A group of biotech companies stated that money spent on compliance is less on research and development and that investors in a smaller biotech company are more interested in getting FDA approval than the auditors’ blessing on internal controls.
On the upside, Chair Clayton has committed to continue to review this matter and work on changes to the definition of accelerated filer and the requirements of 404(b) compliance.
ANTHONY, LINDER & CACOMANOLIS, PLLC, Can Assist Your Organization
We can help you discover if your business entity meets the financial and regulatory requirements to be labeled an SRC. Call 877-541-3263 or complete our contact form to schedule an initial consultation today.