SEC Proposes Amendments to Smaller Reporting Company Definition
By Karrissa Chatergoon, Senior Manager, Assurance Services
Over the years, the SEC has sought to promote capital formation and reduce the compliance costs for smaller registrants while also maintaining investor protection. In line with this objective, on June 27, 2016, the Commission voted to propose amendments to the definition of a “smaller reporting company.” One main benefit of being qualified as a smaller reporting company is the accommodations related to scaled disclosure. The proposed amendments would increase the number of registrants that would fall into this “smaller reporting company” category thereby allowing a larger number of registrants to be eligible for scaled disclosure.
A smaller reporting company is defined in the Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K. The definitions provided by all three substantially define a smaller reporting company to be registrants with less than $75 million in public float as of the last business day of their most recently completed second fiscal quarter or; registrants with zero public float and annual revenues of less than $50 million during the most recently completed fiscal year for which the audited statements are available.
To be defined as a smaller reporting company, the SEC is proposing that the current $75 million of public float at the end of the second fiscal quarter be increased to $250 million for a reporting registrant. Similarly, the increased threshold applies to registrants filing their initial registration statement under the Securities Act or Exchange Act, and would calculate its public float as of a date within 30 days of filing the registration statement.
If the company does not have a public float, it would be eligible to meet the smaller reporting company definition if the annual revenues are less than $100 million in the most recent fiscal year compared to the current threshold of $50 million. Additionally, if a company exceeds either the public float or annual revenue thresholds, it will no longer qualify as a smaller reporting company until the public float or revenues decrease below a lower threshold. Under these circumstances, the proposal is that a company would qualify again only if its public float is less than $200 million, currently at $50 million or, if it has no public float, its annual revenues are less than $80 million, currently at $40 million. As per the SEC’s proposal, based on public float values disclosed by registrants in their Form 10-K filings, 3,159 or approximately 42% of the 7,557 registrants that filed a Form 10-K in 2015 reported having a public float of less than $250 million compared to 2,408 or 32% of registrants with a public float less than $75 million. Similarly, based on public float values and revenues disclosed by registrants in their Form 10-K filings, 806 of the 7,557 registrants that filed a Form 10-K in 2015 have zero public float and less than $100 million in annual revenues compared to 775 registrants with no public float and annual revenues of less than $50 million. This would mean that with the proposed increase to the public float and revenue thresholds, possibly over 750 additional registrants would qualify as smaller reporting companies.
In 2015, the top 5 industries for smaller reporting companies were business services, financial trading, banking, petroleum and natural gas and pharmaceutical products in that order. Under the proposed change, of the possible additional 750 plus registrants that would qualify for smaller reporting company status, we see a noticeable increase in the banking and pharmaceutical industries, accounting for approximately 30% of the increase.
The main benefit stemming from the proposed amendments would be reduction in compliance costs for the registrants that would newly qualify. Additionally, a lower disclosure burden could spur growth in smaller registrants to the extent that the compliance cost savings and other resources devoted to disclosure and compliance are productively deployed in alternative ways. The cost savings arising out of the proposed amendments will most likely include internal costs, such as employee and managerial resources and external costs, such as fees from outside professionals such as audit and legal fees. The amendments could also encourage capital formation because companies that may have been hesitant to go public may choose to do so if they faced reduced disclosure, this may lead to increased competitive advantage of newly eligible registrants relative to unregistered companies. The SEC believes that with regards to certain filings, a few being the Form 10-K, Form 10-Q, Schedule 14A and Schedule 14C, that if the proposed amendments were adopted the total burden hours and external costs would decrease by approximately 220,357 and $36 million, respectively. The potential set back of the proposed amendments is the reduction in the amount of information available to investors and thereby possible reduction of investor protection. Additionally, the newly eligible smaller reporting companies would not be required to provide certain disclosures related to executive compensation, potentially decreasing corporate governance transparency of those registrants.
The proposed rule does not alter the $75 million threshold in the “accelerated filer” definition. Companies with $75 million or more in public float that would newly qualify as smaller reporting companies would be subject to the requirements that apply currently to accelerated filers, including the timing of the filing of a periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002.
The proposal is open for public comment and to name a few, the SEC is asking for contributions on alternative metric recommendations, for example, equity market value instead of public float, alternative thresholds other than those proposed, additional cost savings not considered and possible amendments to already scaled disclosures.
Finally, if the proposed amendments are adopted, the newly eligible registrants are expected to weigh the costs and benefits of the scaled disclosure for themselves on a company by company basis, and decide if it is worth taking advantage of these accommodations. The new registrants will remain subject to liability for disclosures and will be required to provide any material information that may be deemed necessary.