News

Final rules regarding smaller company regulatory relief and simplification

News Brief
January 3, 2008

By Cydney Posner

The SEC has posted the final rules providing regulatory relief for smaller public companies. The new rules expand the number of companies that qualify for the SEC's scaled disclosure requirements for smaller reporting companies and streamline and simplify those regulations by eliminating Reg S-B and incorporating the S-B requirements into Reg S-K.. Under the new amendments, companies that have less than $75 million in public equity float will qualify for the scaled disclosure requirements, and companies without a calculable public equity float will qualify if their revenues were below $50 million in the previous year. The new rules become effective February 4, 2008.

General

As with several other recent rule amendments, the genesis of these new amendments was the Report by the SEC's Advisory Committee on Smaller Public Companies. In 2006, 3,395 reporting companies filed reports using the scaled disclosure and reporting requirements of Form 10-KSB (which used a $25 million public float or revenues test). The SEC estimates that a total of 4,976 companies will be eligible to use the scaled disclosure requirements under new amendments, a difference of 1,581 additional companies (about 13% of the total 11,898 companies that filed annual reports in 2006).

The amendments:

  • Establish a category of "smaller reporting companies" eligible to use the scaled disclosure requirements, defined as companies with less than $75 million in public float; however, when a company is unable to calculate public float (e.g., if it has no common equity outstanding or no market price for its outstanding common equity), the standard will be less than $50 million in revenue in the last fiscal year;
  • Move 12 non-financial scaled disclosure item requirements, which will be available only for smaller reporting companies, from Reg S-B into Reg S-K;
  • Move the scaled financial statement requirements in Item 310 of Reg S-B into new Article 8 of Reg S-X, and amend these requirements to provide a scaled disclosure option for smaller reporting companies, requiring two years of balance sheet data instead of one year;
  • Permit smaller reporting companies to elect to comply with scaled financial and non-financial disclosure on an item-by-item or "a la carte" basis. As adopted, eligible companies may elect on a quarterly basis to follow scaled financial statement requirements or to provide the larger company financial statement presentation;
  • Eliminate the "SB" forms, but allow a phase-out period for small business issuers transitioning to smaller reporting company status;
  • Combine some of the elements relating to the accelerated filer definition with qualifying standards for smaller reporting companies;
  • Permit all foreign companies to qualify as "smaller reporting companies" if they otherwise qualify and choose to file on domestic company forms and provide financial statements prepared in accordance with U.S. GAAP; and
  • Eliminate the transitional small business issuer format associated with Form SB-1 and 10-KSB reports.

Description of the Amendments

Moving Scaled Disclosure Item Requirements from Reg S-B into Reg S-K

The amendments consolidate the S-B and S-K disclosure systems, including 12 non-financial Reg S-B scaled item requirements that will be incorporated into separate paragraphs within Reg S-K. An index of scaled disclosure requirements is included in the definition of smaller reporting company at the beginning of Reg S-K. In some cases, smaller reporting companies are not required to provide disclosures required of larger companies, e.g., the maze in Item 305 regarding derivatives and market risk. Currently, Forms 10-SB, 10-KSB and 10-QSB do not require risk factor disclosure, and this difference is continued in the disclosure requirements of Forms 10, 10-K and 10-Q applicable to smaller reporting companies..

Moving Smaller Reporting Company Financial Statement Requirements from Item 310 of Regulation S-B into New Article 8 of Regulation S-X; Additional Regulation S-X Changes

In response to comments, the financial statement rules for smaller reporting companies are being incorporated into a new Article 8 of Reg S-X and will require two years of comparative audited balance sheet data. Technical and conforming changes are also being made, including amending Rule 3-05(b)(2)(iv) of Reg S-X to increase to $50 million the $25 million in revenues threshold currently used to limit to two the number of years of audited financial statements required for an acquired business, as suggested by commenters.

Adopting Scaled Disclosure Item Requirements in Reg S-K

The Reg S-K item requirements that are amended to incorporate the substance of the scaled disclosure standards for smaller reporting companies include:

  • Item 101 (Description of Business). The alternative disclosure standards are set forth in new paragraph (h). Generally, less detail is required for smaller reporting companies. For example, segment reporting is not required.
  • Item 102 (Description of Property).References to the Industry Guides have been added.
  • Item 201 (Market Price of and Dividends on Registrant’s Common Equity and Related Stockholder Matters). Smaller reporting companies are not required to provide a performance graph.
  • Item 301 (Selected Financial Data). This item is not required for smaller reporting companies.
  • Item 302 (Supplementary Financial Information). This item is not required for smaller reporting companies.
  • Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations). Smaller reporting companies will be required to provide only two years of analysis if the company is presenting only two years of financial statements and will not be required to provide tabular disclosure of contractual obligations.
  • Item 305 (Quantitative and Qualitative Disclosures about Market Risk). This item is not required for smaller reporting companies.
  • Item 401 (Directors, Executive Officers, Promoters and Control Persons).Smaller reporting companies will now be required to comply with the additional Reg S-K requirement to disclose any petitions filed under the Federal bankruptcy laws or any state insolvency laws filed by or against a director or officer of the company
  • Item 402 (Executive Compensation).Smaller reporting companies will:
    • Be required to provide executive compensation disclosure for only three NEOs (specifically including the PEO but not the PFO);
    • Be required to Provide the SCT disclosure for only two years;
    • Not be required to provide a CD&A;
    • Be required to provide only three of the seven tables required of larger companies (the SCT, the Outstanding Equity Awards at Fiscal Year End Table, and the DCT);
    • Be required to provide alternative narrative disclosures; and
    • Not be required to include footnote disclosure of the grant date fair value of equity awards in the DCT.
  • Item 404 (Transactions with Related Persons, Promoters and Certain Control Persons). Smaller reporting companies will:
    • Not be required to disclose policies and procedures for reviewing related-person transactions;
    • Be required to provide disclosure regarding a transaction where the amount exceeds the lesser of 1% of a smaller company’s total assets or $120,000;
    • Be required to provide additional specific information about underwriting discounts and commissions and corporate parents; and
    • Be required to provide disclosure regarding promoters and certain control persons.

For smaller reporting companies, the calculation of total assets under this item is based on the average of total assets at year end for the last two completed fiscal years. Note that, for larger companies, there is no assets test; however, the rules provide that, to the extent the scaled disclosure requirement is more rigorous than the same larger company item requirement, smaller reporting companies will be required to comply with the more rigorous smaller reporting company requirement.

  • Item 407 (Corporate Governance).Smaller reporting companies are not required to provide Compensation Committee Interlock and Insider Participation disclosure or a Compensation Committee Report. In addition, a smaller reporting company is not required to provide an Audit Committee Report until its first annual report after its initial registration statement is filed with the SEC and becomes effective.
  • Item 503 (Prospectus Summary, Risk Factors, and Ratio of Earnings to Fixed Charges). Smaller reporting companies need not provide the information required by paragraph (d) of Item 503 regarding the ratio of earnings to fixed charges, when a registrant issues debt, or the ratio of combined fixed charges and preference dividends to earnings, when a registrant issues preference equity securities. In addition, they are not required to provide risk factor disclosure.
  • Item 504 (Use of Proceeds). New Article 8 of Reg S-X, rather than the other articles of Reg S-X, will govern whether financial statements of businesses proposed to be acquired must be included in the filings of smaller reporting companies.
  • Item 601 (Exhibits). Smaller reporting companies need not provide Exhibit 12 (Statements re Computation of Ratios).

Electing Scaled Disclosure Standards on "A La Carte" Basis

Under the new rules, smaller reporting companies will be able to choose whether to comply with scaled disclosure requirements or the larger company disclosure requirements in Reg S-K on an item-by-item or "a la carte" basis (unless the requirements specify that smaller reporting companies must comply with specific smaller reporting company requirements). However, the release stresses that these disclosures must be provided consistently and consistent with the legal requirements under the federal securities laws, including Rule 408 and Rule 12b-20 (i.e., provide any additional information beyond those minimum disclosure requirements to avoid a misleading presentation). Additionally, the SEC emphasizes the importance of providing disclosure that permits investors to make period-to-period comparisons, whether quarterly or annually.

The release observes that the staff will evaluate item-by-item compliance by smaller reporting companies with only those Reg S-K requirements applicable to smaller reporting companies, and not with the requirements applicable to larger companies, even if the company chooses to comply with the larger company requirements. To the extent the smaller reporting company scaled item requirement is more rigorous than the same larger company item requirement, smaller reporting companies will be required to comply with the more rigorous, smaller reporting company item requirement. Accordingly, a smaller reporting company will not be able to choose to comply with a larger reporting company requirement if that requirement sets a higher threshold that would obviate the need for disclosure. For example, under Item 404, smaller reporting companies have a !% of assets threshold for reporting and are required to disclose additional specific information about underwriting discounts and commissions and corporate parents. In that case, smaller reporting companies would be required to provide the additional disclosure. Note, however, that currently, Item 404 represents the only instance where the scaled requirements are potentially more rigorous than the larger company standards.

Qualifying Standards for Treatment as "Smaller Reporting Company"

To qualify as a smaller reporting company, under Item 10(f) of Reg S-K, the company must have a public float of less than $75 million. Alternatively, if a company has no common equity outstanding or if no market price for its outstanding common equity exists at the time of its eligibility determination, the company would qualify as a smaller reporting company if it had less than $50 million in revenues in the last fiscal year.

Eligibility and Exclusions.The new rules expand eligibility for smaller reporting company status to non-U.S. companies using domestic company forms. Foreign companies will qualify as smaller reporting companies if they are eligible to file on a form that permits disclosure based on the standards for smaller reporting companies, such as Forms S-1, S-3, S-4, 10-Q and 10-K, all of which require U.S. GAAP. Investment companies, including business development companies, and asset-backed issuers are excluded from eligibility.

Determination Dates. The determination dates are based on three categories of companies: reporting companies with a public float, non-reporting companies filing a registration statement, probably an initial registration statement, under either the Securities Act or the Exchange Act, and reporting or non-reporting companies without a public float.

Reporting Companies.Public float will be calculated using the same method currently used to determine accelerated filer status: $75 million in public float, as of the last business day of a company’s second fiscal quarter, computed by multiplying the aggregate worldwide number of shares of voting and non-voting common equity held by non-affiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity. If a reporting company determines that it qualifies as a larger reporting company (rather than a smaller reporting company) on the last day of its second fiscal quarter, it will be required to comply with the larger company disclosure standards when it files its first quarterly report in the fiscal year following the fiscal year of the determination date. If a larger reporting company determines that it is eligible for scaled disclosure as of the last business day of its second fiscal quarter, it may, however, start to follow the scaled disclosure requirements beginning with the Form 10-Q for that second fiscal quarter.

Non-Reporting Companies Filing an Initial Registration Statement.For an IPO, a company will be able to choose a date within 30 days of filing to determine eligibility. In this context, public float will be based on three components:

  • Estimated offering price per share at the time of filing the registration statement;
  • Number of shares of common stock outstanding that are held by non-affiliates before the offering; and
  • Number of shares of common stock to be sold at the estimated offering price.

The rule requires that non-reporting companies make the calculation by adding the estimated number of shares registered for offering to the public to the total number of shares held by non-affiliates before the offering. The sum is then multiplied by the estimated offering price per share in the IPO. In light of the potential for fluctuations in these numbers, for purposes of filing the first periodic report after the offering, IPO registrants will have the option to recalculate their public float at the time of completion of the IPO. If the issuer made a bona fide determination at the time it filed the IPO registration statement that it was eligible to be a smaller reporting company, but during the pre-effective stage of the offering, its public float rose above the $75 million threshold, the issuer would nevertheless continue to be a smaller reporting company until its next annual determination date, the end of its second fiscal quarter.

In the context of an initial registration statement under the Exchange Act covering a class of securities, the company would calculate its public float as of a date within 30 days of the filing of the registration statement. Because the filing would not directly affect the issuer’s public float, if the issuer does not have a public float or its public float cannot be calculated because there is no market price for the issuer’s equity securities, the issuer’s eligibility for the scaled disclosure would be based on its revenue.

Alternative Revenue Test for Reporting and Non-Reporting Companies. .In the case of a company with no public float or no public market for its common equity, it would qualify as a smaller reporting company if it had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

Entering and Exiting Smaller Reporting Company Status

The transition rules for entering and exiting smaller reporting company status track the accelerated filer definition. If a larger reporting company determines that it is a smaller reporting company as of the last business day of its most recently completed second fiscal quarter, it may transition to the scaled disclosure requirements in the Form 10-Q for that second quarter. A smaller reporting company required to transition to the larger reporting system after its determination date calculation will not be required to satisfy the larger reporting company disclosure requirements until the first quarter after the fiscal year of the determination date. Once an issuer fails to qualify for smaller reporting company status, it will remain unqualified unless it determines that its public float was less than $50 million as of the last business day of its second fiscal quarter. Where an issuer does not have a public float or no public market for its common equity exists and it has less than $50 million in revenue, it will qualify to use the scaled disclosure item requirements until it exceeds $50 million in annual revenue. Once that issuer fails to qualify as a smaller reporting company because its revenues exceed $50 million, that issuer will not become eligible for smaller reporting company status until it has annual revenues of less than $40 million in its last fiscal year.

Miscellaneous

The SEC decided not to adopt the proposal to index the thresholds for inflation, but will consider whether the concept should be the subject of future rulemaking. The transitional small business issuer format has been eliminated as proposed. A company that qualifies as a smaller reporting company based on the appropriate eligibility test under the definition will be required to check the "smaller reporting company" box on the cover of the registration statement or periodic report filed, whether or not it chooses to rely on the scaled disclosure standards. (So remember to revise the cover pages of your upcoming Forms 10-K to reflect the new language and new box on the cover.)

Compliance Dates

Transition for Current Small Business Issuers

Current small business issuers will have the option to file their next annual reports for a fiscal year ending on or after December 15, 2007 on either Form 10-KSB or Form 10-K and may continue to file periodic reports using Reg S-B and the "SB" forms until their next annual reports are filed. After that point, "SB" forms may not be used. Accordingly, while most of the amendments will become effective on February 4, 2008, the S-B forms will continue for a transitional period. During the optional transition period, small business issuers will have the same reporting obligations as they had before these rule amendments, except to the extent that they voluntarily move to the new smaller reporting company system before they are required to do so. The "SB" registration forms will be rescinded on February 4, 2008, and companies in the midst of registration using an "SB" form will need to amend onto the correct form.

General Transition Provisions

Companies that qualify as smaller reporting companies after the effective date, whether or not they currently are small business issuers, will have the option to comply with the scaled disclosure item requirements for smaller reporting companies in their registration statements and periodic reports filed after February 4, 2008. To determine their status after the effective date, reporting companies will refer to their most recent second fiscal quarter to calculate public float. Current small business issuers will be deemed to qualify as smaller reporting companies and need not make this calculation. Companies that recently became reporting companies before the effective date, but have not yet had a completed second fiscal quarter, will base eligibility on the public float calculated after the IPO. In all cases, companies that qualify for smaller reporting company status will continue to have this status until they make their annual determinations at the end of their second fiscal quarters.

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