SEC Proposal for Smaller Reporting Company Regulatory Relief and Simplification

By Cydney Posner

The SEC has posted its proposal for smaller reporting company regulatory relief and simplification. The proposal would amend the disclosure and reporting requirements to extend the benefits of the optional small company reporting regime to companies – now termed "smaller reporting companies" – with a public float of less than $75 million, up from the current $25 million. In addition, the proposal would integrate the current Reg S-B disclosure requirements into Reg S-K, and all of the special "SB" forms would be eliminated. The major proposals in the release stem from the recommendations of the SEC's Advisory Committee on Smaller Public Companies. The SEC is also soliciting suggestions for additional ways to better scale the disclosure and reporting requirements to the needs of smaller companies and their investors.

Currently, there are two major categories of smaller companies:

• "Small business issuers" are companies with both public float and revenues of less than $25 million (3,749 of the 11,898 reporting companies); and
• "Non-accelerated filers" are companies with a public float of less than $75 million (4,976 of the 11,898 reporting companies).

Small business issuers are eligible to make required disclosures based on the less detailed or scaled requirements in Reg S-B, and non-accelerated filers can benefit from later filing deadlines than are applicable to larger companies.

The SEC release describes the three primary objectives of the proposal as follows:

• Expand eligibility for scaled disclosure and reporting requirements for smaller companies by making those requirements available to most companies with a public float of less than $75 million;
• Simplify rules for smaller companies by combining the two categories of "small business issuers" and "non-accelerated filers" into one category called "smaller reporting companies;" and
• Simplify and improve disclosure and reporting rules for smaller companies by integrating Reg S-B into the disclosure requirements in Reg S-K.

Expanding Eligibility for Smaller Company Scaled Regulation

Quantitative Standards in the Proposed Definition of "Smaller Reporting Company." The proposal for the definition of "smaller reporting company" would increase significantly the number of companies eligible for the scaled disclosure and reporting rules by raising the public float eligibility ceiling currently applicable to a "small business issuer" to $75 million for most companies. Companies that did not have a public float as defined or were unable to calculate it (e.g., because they had no common equity outstanding or there was no public market for equity) would initially be eligible, for the fiscal year in which they filed registration statements under the Securities Act or Exchange Act, for scaled treatment if their revenues were below $50 million in the most recently completed fiscal year for which audited financial statements were available. (The proposed definition of "smaller reporting company" would not otherwise include a revenue test.) As a result, 42% of the 11,898 public reporting companies would be eligible as "smaller reporting companies" for scaled disclosure. To provide greater flexibility, the two ceilings would be adjusted for inflation on September 1, 2012, and every five years thereafter using the Personal Consumption Expenditures Chain-Type Price Index (PCECTP Index).

A company’s public float would be calculated as of the same date used to determine accelerated filer status today – the last business day of a company’s second fiscal quarter – using the price at which the common equity was last sold (or the average of the bid and asked prices) in the principal market for the shares, multiplied by the number of outstanding shares held by non-affiliates. For an IPO, however, a company would calculate its public float as of a date within 30 days of the date it filed the initial registration statement, computed by multiplying the aggregate worldwide number of common shares held by non-affiliates before the offering plus the number of such shares included in the registration statement by the estimated public offering price of the shares. For an initial Exchange Act registration statement, the company would calculate its public float as of a date within 30 days of the date of filing of the registration statement. Because the registration would not directly affect the amount of public float, if the issuer did not have a public float or its public float could not be calculated, the issuer’s eligibility for the scaled disclosure and reporting would be based on its revenue.

Exclusions from the Definition of "Smaller Reporting Company." Although the proposal would allow all foreign companies that met the criteria to qualify as smaller reporting companies, the forms available only to "foreign private issuers," such as Form F-1, Form F-3, Form F-4 and Form 20-F, would not permit disclosure based on the scaled standards. As a result, qualifying foreign private issuers would need to choose whether to use the domestic forms to take advantage of the scaled disclosure or to comply with the disclosure requirements of the "F" forms.

Investment companies and asset-backed issuers would be excluded from the definition.

Integrating Requirements of Current Reg S-B into Reg S-K

Reg S-B was designed to provide small business issuers with a single source for their SEC disclosure requirements. However, the complexity of

the current dual system and lack of market acceptance of the S-B forms may have deterred smaller companies from taking advantage of scaled regulation. As a result, the SEC is proposing to integrate the provisions of Reg S-B into Reg S-K.

Financial Statements. The proposal would add a new Item 310 (Financial Statements of Smaller Reporting Companies) to Reg S-K to incorporate the alternative form and content requirements currently in Item 310 of Reg S-B. Item 310 of Reg S-B is significant because it is based solely on GAAP, not Reg S-X, and allows smaller companies to provide financial statements for only two years. Item 310 of Reg S-B also differs from Reg S-X in its requirements for historical and pro forma financial statements for significant acquired businesses, the maximum age of financial statements and limited partnerships. The only substantive change proposed in new Item 310 is to require that foreign issuers that qualify as smaller reporting companies and elect to use Item 310 disclosure present financial statements pursuant to U.S. GAAP.

Proposed Changes to Other Regulation S-K Disclosure Items. Generally, the integration would be implemented by adding a new paragraph, captioned "smaller reporting companies," to each item of Reg S-K that would contain tailored disclosure standards for smaller reporting companies. The SEC is not currently proposing any major substantive changes to Reg S-B items. Some Reg S-K items would not change at all because the disclosure standards are currently substantially the same. In addition to Item 310, the most significant changes will be to:

• Item 101, Description of Business
• less detailed description,
• only three, not five, years of business development activities
• Items 301, Selected Financial Data and 302, Supplementary Financial Information
• not required for smaller reporting companies
• Item 303, Management’s Discussion and Analysis of Financial Condition and Results of Operations
• more streamlined disclosure requirements,
• no requirement to provide tabular disclosure of contractual obligations, and
• assuming only two years of financials provided, then only two years of analysis required
• Item 305, Quantitative and Qualitative Disclosures about Market Risk
• not required for smaller reporting companies
• Item 402, Executive Compensation
• requires executive compensation disclosure for only three officers,
• Summary Compensation Table disclosure for only two years,
• no Compensation Discussion and Analysis,
• no footnote disclosure of the grant date fair value of equity awards in the Director Compensation Table,
• only three of the seven tables prescribed by Item 402 of Reg S-K, but
• requires alternative narrative disclosures
• Item 404, Transactions with Related Persons, Promoters and Certain Control Persons
• no disclosure of policies and procedures for approving related-person transactions,
• possibly reduced threshold for reporting of transactions where the amount exceeds the lesser of 1% of total assets (based on the average of total assets at year end for the last two completed fiscal years) or $120,000, but
• requires additional specific information about underwriting discounts and commissions and corporate parents
• Item 407, Corporate Governance
• no Compensation Committee Interlock and Insider Participation disclosure, and
• no Audit Committee Report until the first annual report after filing the initial registration statement
• Item 503, Prospectus Summary, Risk Factors, and Ratio of Earnings to Fixed Charges
• no disclosure regarding the ratio of earnings to fixed charges or the ratio of combined fixed charges and preference dividends to earnings
• Item 512, Undertakings
• no information about asset-backed securities, foreign private issuers and trust indenture offerings
• Item 601, Exhibits
• no Exhibit 12, Statements re Computation of Ratios, unless it discloses one of the ratios discussed in the requirement upon the registration of debt or preference equity securities.

A La Carte Approach. Here's the best part: under the proposal, qualifying smaller reporting companies could choose, on an item-by-item basis, to comply with either the scaled disclosure requirements for smaller reporting companies or the disclosure requirements for other companies in Reg S-K, electing to take advantage of one, some, all or none of the items in any one filing. However, a smaller reporting company would be required to provide its financial statements on the basis of either Item 310 of Reg S-K or Reg S-X for an entire fiscal year and could not be change back and forth in different filings within a single fiscal year. SEC review would evaluate compliance with requirements only to the level applicable to smaller reporting companies, even if the company complied with the requirements for larger companies. A new check box would be added to the cover page of all filings to indicate eligibility for "Smaller Reporting Company" status.

Transition to and from Smaller Reporting Company Status. With respect to transitioning in or out of "smaller reporting company" status, the proposal would follow the transition model currently used to determine "accelerated filer" status. Smaller reporting companies would lose eligibility to claim that status in the first fiscal year following a fiscal year in which the smaller reporting company’s public float rose above $75 million as of the last business day of the second fiscal quarter. Likewise, a reporting company that did not file reports claiming smaller reporting company status would be required to transition to that status in the next fiscal year if its public float fell below $50 million as of the last business day of the company’s second fiscal quarter. Where an issuer had no public float or no public market for its common equity and it had less than $50 million in revenue, it could use the scaled disclosure requirements until it exceeded $50 million in annual revenue. Once an issuer failed to qualify for smaller company reporting status under the revenue test, it would remain unqualified unless its annual revenues fell below $40 million during the previous fiscal year. The determination as to whether a company qualified for smaller reporting company treatment would be made at the beginning of a fiscal year on the basis of information in a Form 10-Q or an initial registration statement under the Securities Act or Exchange Act, whichever was the first to be filed during that year. If an issuer that qualified on the basis of revenue developed a public float or its public float increased during the year, the issuer would remain a smaller reporting company for the entire fiscal year.

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