Current SEC Proposals and What to Monitor for in 2020
By Gregory Zoll, Partner, Assurance Services
Understanding, analyzing and evaluating the Securities Exchange Commission’s (“SEC” or “Commission”) current proposals is crucial in allowing entities to prepare for any changes that could significantly affect operations. Some current, noteworthy proposed rule changes could have significant impacts for a vast array of entities. Distinguishing which SEC changes may be applicable to your company, monitoring updates to the proposed rule changes, composing a plan, determining the best ways to navigate, and taking your company through applicable changes expeditiously helps companies maintain compliance and therefore access to liquidity, or in areas where practical expedients are offered, provides advantages. Some key proposed rule changes on the horizon include amendments to the definition of accelerated and large accelerated filers, disclosures of acquired and disposed businesses, earnings releases and quarterly reports, and modernization of management discussion and analysis and related financial disclosure requirements. The Following is a summary of the major changes included in these proposals that you should be monitoring in 2020.
Proposed Amendments to the Accelerated Filer and Large Accelerated Filer Definitions
The SEC has proposed to amend the definitions of an accelerated filer and large accelerated filer. The benefit for certain registrants, should the proposal be adopted, would result in the requirement for an audit of internal controls under Sarbanes-Oxley Act (“SOX”) Section 404(b) to be lifted, which will provide for more capital to be re-invested into the entity. The proposed amendments will not change other SOX requirements such as those related to independent audit committees, CEO and CFO financial reporting certifications, or the requirement for management to establish, maintain and assess the effectiveness of internal controls over financial reporting.
The proposed amendments include:
- Exclusion from the accelerated filer and large accelerated filer definitions of any registrant that would normally meet the qualification of an accelerated filer or large accelerated filer but has annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available, thus making that registrant eligible to be a “smaller reporting company” (“SRC”).
- Increasing the public float thresholds for exiting a status as follows:
|Status||Current Threshold for Exiting Status||Proposed Threshold for Exiting Status|
|Accelerated filer||Public float is less than $50 million at end of second fiscal quarter||Public float is less than $60 million (80% of $75 million initial qualification threshold), at end of second fiscal quarter|
|Large Accelerated filer||Public float is less than $500 million at end of second fiscal quarter||Public float is less than $560 million (80% of $700 million initial qualification threshold), at end of second fiscal quarter|
- Attaching a revenue test to the transition thresholds for companies exiting both accelerated and large accelerated filer status.
Should the proposed amendment be adopted, the table below shows what would be the relationship between SRCs and both non-accelerated and accelerated filers:
|Status||Public Float||Annual Revenues|
|SRC and non-accelerated filer||Less than $75 million||N/A|
|SRC and non-accelerated filer||$75 million to less than $700 million||Less than $100 million|
|SRC and accelerated filer||$75 million to less than $250 million||$100 million or more|
|Accelerated filer (non SRCs)||$250 million to less than $700 million||$100 million or more|
Information Source: (https://www.sec.gov/rules/proposed/2019/34-85814.pdf).
Disclosures of Acquired and Disposed Businesses
The SEC has proposed amendments to improve the disclosure requirements for financial statements relating to acquisitions and dispositions of businesses. In addition to improving disclosure requirements, the proposed amendments also revise the significance tests, which are used to determine whether a registrant needs to provide financial statements of a business it acquires and, if so, how many periods must be presented. The SEC expects the revisions to help registrants make more meaningful significance determinations and improve financial information about acquired or disposed businesses, facilitate more timely access to capital, and reduce the complexity and costs to prepare required disclosures. Following is a summary of proposed changes:
- The investment test currently compares the fair value of purchase consideration to the total assets of a registrant as reported on its latest audited balance sheet. Under this proposal, the investment test would be revised to compare the fair value of purchase consideration to the market value of the registrant’s voting and non-voting common equity.
- The income test currently requires registrants to compare both their revenue and income to that of the acquired business. Under this proposal, a revised test would use after-tax income from continuing operations instead of pre-tax income from continuing operations, thus lowering the significance from the calculation.
- The “significance threshold” for Form 8-K reporting of disposals is currently 10% and under this proposal would be raised to 20% to be aligned with requirements for acquisitions.
- The SEC also proposed replacing the requirement that registration statements include financial statements and pro forma financial information for the “mathematical majority” of the acquisitions that are significant in the aggregate with a requirement that they include only the financial statements of those acquisitions that individually exceed 20% significance, along with pro forma financial information about the aggregate effect of all the acquisitions.
Note that the asset test currently compares the assets of the acquired business to those of the registrant as reported on its latest audited balance sheet and there are no changes to this test in the proposal.
Earnings Releases and Quarterly Reports
The SEC has not yet made any rule proposals related to earnings releases and quarterly reporting; however, it has issued a concept release and has sought public comment on meaningful changes in a way that protects important disclosures for investors and reduces the administrative burdens on registrants. One way the Commission hopes this can be accomplished is if reporting efficiency can be improved by reducing unnecessary duplication of information that registrants must disclose. In short, the SEC has posed the question: can the existing reporting system, earnings releases, and earnings results be a root cause of market participants steering their organizational focus toward “short-termism” instead of sustained growth and transparency? There has been a mixed bag of public comments received thus far, as some believe in the necessity for quarterly reporting as short-term investments play an integral role in the market while others believe quarterly reporting places undue pressures for registrants to provide positive short-term results at the detriment of long-term growth and performance.
Information Source: (https://www.sec.gov/rules/other/2018/33-10588.pdf)
Modernization of Management Discussion and Analysis and Related Financial Disclosure Requirements
The SEC has proposed amendments to simplify compliance efforts for registrants by drastically reducing management discussion and analysis (“MD&A”) to both enhance disclosures by providing more clarity on items that should be discussed and reduce duplicative efforts. This amendment along with related SEC interpretations seeks to provide more meaningful information to users of the financial statements by providing transparency of the key performance indicators (“KPIs”) and metrics management of registrants use to evaluate operational performance.
Following is a summary of proposed changes:
- Eliminate Item 301 – selected financial data as a result of its duplicative nature
- Eliminate Item 302 – supplementary financial data as a result of its duplicative nature
- Eliminate Item 303(a)(5) – MD&A, Tabular disclosure of contractual obligations
- Amend Item 303 – MD&A with major amendments as follows:
- Add a new Item 303(a), Objective, which will concisely state the purpose of MD&A
- Rename current Item 303(a), Full fiscal years, as Item 303(b) to clarify and streamline its content
- Rename current Item 303(b), Interim periods, as Item 303(c) to clarify and streamline its content
- Eliminate the current Item 303(c), Safe harbor
- Replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction about the need to discuss off-balance sheet arrangements in the broader context of MD&A
- Add a new Item 303(b)(4), Critical accounting estimates, to both clarify and codify SEC guidance on critical accounting estimates
- Revise the interim MD&A requirements in Item 303(b) to allow flexibility for companies to compare the most recent quarter to either the corresponding quarter of the prior year (current requirement) or to the immediate preceding quarter
- Eliminate Item 303(d), Smaller reporting companies
As it relates to KPIs and metrics to be included in MD&A, the SEC has provided examples such as:
- Operating margin
- Same store sales
- Sales per square foot
- Total customers/subscribers
- Average revenue per user
- Daily/monthly active users/usage
- Active customers
- Net customer additions
- Number of memberships
- Traffic growth
- Comparable customer transactions increase
- Voluntary or involuntary employee turnover rate
- Percentage breakdown of workforce
- Total energy consumed
- Data security measures (i.e. number of data breaches or number of account holders affected by data breaches)
The SEC has also indicated that they expect the following disclosures to accompany any KPIs and metrics:
- A clear and concise definition of the metric and how it is calculated
- A statement indicating reasons as to why the metric provides useful information to the users
- A statement indicating how management uses the metric in managing or monitoring operating performance of the business
Information Source: (https://www.sec.gov/rules/proposed/2020/33-10750.pdf)
We will see how these proposals and changes evolve, but it is evident the SEC’s initiatives are centered around providing better access to and freeing up capital for smaller to mid-market registrants. Monitoring these proposals will allow companies to manage risk, ensure compliance, and appropriately plan for potential changes.