Defying gravity: US M&A H1 2019

SEC proposal would ease burden of certain financial disclosures on public companies

Proposed revisions to current financial statement disclosure requirements for business acquisitions and dispositions would simplify compliance while ensuring investors get the information they need

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In May 2019, the Securities and Exchange Commission (SEC) proposed amendments to its rules governing disclosure of financial statements by public companies or in initial public offerings in connection with significant business acquisitions and dispositions. When a public company acquires or disposes of a business that is "significant," it may have to disclose audited financial statements and pro forma financial statements. Preparing these financial statements may be time-consuming and expensive and require various parties to cooperate, which could affect the overall transaction timeline. The proposal is part of the SEC's ongoing initiative to improve the information investors receive, facilitate access to capital, and reduce complexity and compliance costs.


Amendments to "significance" tests

Generally, the more significant the acquired business, the greater the disclosure required. Significance is determined by applying three tests, the "Investment Test," the "Asset Test," and the "Income Test", and an acquired business is considered significant if it exceeds a threshold under any of three tests, two of which are proposed to be substantively changed.

  • Investment Test. Currently, this test compares the purchase price of the acquisition to the value of the filer's consolidated total assets. The proposal would replace "total assets" with the "aggregate worldwide market value" of the filer's common equity (i.e., its total market capitalization). This approach would reflect the "fair value" of the filer more effectively than using the value of a company's total assets, which is not reduced by the value of its liabilities. 

  • Income Test. Currently, this test compares the acquired company's income from continuing operations before taxes with that of the filer. By focusing only on income, which can include non-recurring or infrequent expenses, gains or losses, this test can produce anomalous results. To address this, the proposal would split the test into two components: (i) a revenue component, which would compare the revenues of the acquired business and the filer, providing some relief to filers with little or negative net income, and (ii) an income component, which would be amended to use income from continuing operations after taxes, allowing companies to use line items directly from their financial statements. If the filer and the acquired business have recurring annual revenues, the acquired business must meet both components, and the lower of the two would be used to determine the significance level. If not, the income component would apply on its own. 

The SEC also proposed amendments to the disposition threshold. Currently, financial statements are required if a disposed business exceeds 10 percent significance. The proposal would raise the threshold to 20 percent, in line with the minimum acquisition threshold.

If implemented, these changes would, among other things, eliminate the need for financial statement disclosure in certain circumstances by defining "significance" to more accurately reflect the relative economic impact of the acquisition on the filer, and reduce the burden on companies with low or negative net income for whom acquisitions often qualify as "significant" under existing rules.


More flexibility to account for benefits in pro forma financial statements

Under existing rules, pro forma financial statements do not generally include the forward-looking benefits of a transaction. The proposal would allow management to present, in a separate column, adjustments detailing a transaction's potential operational benefits and synergies from integration, such as the effect of closing facilities, discontinuing product lines, terminating employees, and executing new 
or modifying existing agreements. This column would include both recurring and non-recurring impacts. Each such adjustment would require disclosure of material uncertainties, underlying material assumptions, material resources required and the anticipated timing.

The proposed revisions will allow public companies to better make the case to investors for pending acquisitions with detailed synergy disclosure. However, this disclosure will require additional judgment and analysis by management, and may increase preparation time. The new category of adjustments also could expose issuers and other offering participants in capital markets transactions to potential liability for forward-looking information that relies on judgments by management and estimates that are inherently uncertain.

Although the ultimate outcome of these proposed rule changes has yet to be determined, the proposal represents a clear willingness on the part of the SEC to ease the burden faced by many public companies in complying with financial disclosure requirements for acquisitions and dispositions, while continuing to encourage the flow of material information to investors.



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Defying gravity: US M&A H1 2019



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