On June 28, 2018, the Securities and Exchange Commission issued a release amending the definition of “smaller reporting company” (“SRC”) to expand the number of reporting companies eligible for relaxed or scaled disclosure. The change is estimated to benefit nearly 1,000 additional small public companies currently outside the SRC definition. But equally noteworthy in the SRC release is that the Commission staff has been directed, and has begun, to formulate recommendations to the Commission for possible changes to another definition, that of “accelerated filer”, to reduce the number of companies that qualify as accelerated filers in order to further reduce compliance costs. That change would likely be more significant than expanding the SRC definition because “accelerated filer” status triggers the expensive requirement to obtain auditor attestation for management’s assessment of internal control over financial reporting.
Smaller Reporting Company
The Commission established the SRC category in 2008 in an effort to provide general regulatory relief for smaller companies. SRCs are allowed to provide scaled disclosures under Regulation S-K and Regulation S-X. Under the previous SRC definition, SRCs generally were companies with less than $75 million in public float (i.e., aggregate market capitalization of a company’s shares held by non-affiliates). Companies with no public float − because they have no public equity outstanding or no market price for their public equity − were considered SRCs if they had less than $50 million in annual revenues.
Examples of scaled disclosure available to SRCs are two year management discussion and analysis comparisons rather than three years, no compensation discussion and analysis and no risk factor disclosure in Exchange Act filings. A table summarizing the scaled disclosure accommodations for SRCs can be found in the Annex at the bottom of this post.
Under previous rules, SRCs were also automatically excluded from being categorized as “accelerated filers” or “large accelerated filers”, the requirements of which are discussed below. As a result, existing public float thresholds in the accelerated filer definition aligned with the public float threshold in the SRC definition.
In December 2005, the SEC voted to adopt amendments that redefined “accelerated filers” as companies that have at least $75 million, but less than $700 million, in public float, and created a new category of “large accelerated filers” that includes companies with a public float of $700 million or more. In addition to the requirement to file periodic reports on an accelerated basis, accelerated filers must also have their auditor provide an attestation report on management’s assessment of internal control over financial reporting under Section 404(b) of Sarbanes-Oxley.
The determinations of public float thresholds for SRC and accelerated filer status are both made as of the last business day of a registrant’s most recently completed second fiscal quarter for purposes of the following fiscal year.
Amendments to Smaller Reporting Company and Accelerated Filer Definitions
The new rules define SRCs as companies with less than $250 million of public float, as compared with the $75 million threshold under the previous definition. The final rules also expand the definition to include companies with less than $100 million in annual revenues if they have either no public float or a public float of less than $700 million. This reflects a change from the revenue test in the prior definition, under which a company would be categorized as an SRC only if it had no public float and less than $50 million in annual revenues.
The final rules will become effective September 10, 2018.
The amended SRC thresholds are summarized in the following chart:
|Public float of less than $75 million
|Public float of less than $250 million
|Less than $50 million of annual revenue and no public float
|Less than $100 million of annual revenues and:
The increase in SRC public float thresholds will lead to a dramatic expansion in companies eligible for scaled disclosure. The Commission estimates that 966 additional registrants will be eligible for SRC status in the first year under the new definition. These registrants estimated to be eligible in the first year comprise 779 registrants with a public float of $75 million or more and less than $250 million, 26 registrants with no public float and revenues of $50 million or more and less than $100 million, and 161 registrants with revenues below $100 million and a public float of $250 million or more and less than $700 million.
The SRC amendments also eliminate the automatic exclusion of SRCs from accelerated filer status. The definitions of accelerated filer and large accelerated filer are based on public float, but previously contained a provision excluding SRCs from accelerated filer status. As a result, raising the SRC public float threshold without eliminating that provision effectively would raise the accelerated filer public float threshold as well.
Accordingly, the Commission had also considered increasing the public float thresholds in the accelerated filer definition, consistent with the changes to the SRC definition, to reduce compliance costs and maintain uniformity across relevant rules. Opponents viewed a parallel increase in the accelerated filer thresholds as a weakening of investor protections. Some cited a 2011 Staff Section 404(b) Study finding that accelerated filers subject to Section 404(b)’s attestation requirement had a lower restatement rate compared to non-accelerated filers not subject to Section 404(b). But supporters argued that the attestation requirement is particularly costly for SRCs and that audit costs associated with Section 404(b) divert capital from core business needs. One maintained that a Section 404(b) audit represents over $1 million of capital diversion. Another cited the same 2011 Staff Section 404(b) Study which estimated that companies with a public float between $75 million and $250 million spend, on average, $840,276 to comply with Section 404(b). Interestingly, one commenter that stated that its public float was more than $75 million but less than $250 million estimated that relief from Section 404(b) would result in a 35% reduction in compliance costs whereas there would be no material change in such costs from the SRC amendments qualifying him for scaled disclosure as an SRC.
In the final rules release, the Commission determined to eliminate the exclusion of SRCs from accelerated filer status, effectively deciding not to increase the accelerated filer thresholds.
As indicated in the chart below, the increase in the SRC thresholds coupled with the elimination of the automatic exclusion of SRCs from accelerated filer status (i.e., no increase in the accelerated filer threshold) means good news/bad news for companies with a public float between $75 million and $250 million: they benefit from scaled disclosure (unlike under previous rules), but must continue to provide auditor attestations to management’s assessment of the effectiveness of internal control over financial reporting, an enormously expensive proposition.
But as I mentioned at the top of this post, auditor attestation relief may be on the way. SEC Chairman Clayton has directed the Commission staff to formulate recommendations for possible changes to the accelerated filer definition to reduce the number of companies that fall under its requirements, including the auditor attestation requirement. Perhaps, the staff will recommend to increase the accelerated filer public float threshold to $250 million from its current $75 million. That would appear to bring far more practical regulatory relief than the expansion of the SRC definition.
Smaller Reporting Company Scaled Disclosure
|Scaled Disclosure Accommodation
|101 − Description of Business
|May satisfy disclosure obligations by describing the development of the registrant’s business during the last three years rather than five years. Business development description requirements are less detailed than disclosure requirements for non-SRCs.
|201 − Market Price of and Dividends on the Registrant’s Common Equity and Related
|Stock performance graph not required.
|301 – Selected Financial Data
|302 – Supplementary Financial Information
|303 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
Two-year MD&A comparison rather than three-year comparison.
Two year discussion of impact of inflation and changes in prices rather than three years.
Tabular disclosure of contractual obligations not required.
|305 – Quantitative and Qualitative Disclosures About Market Risk
|402 – Executive Compensation
Three named executive officers rather than five.
Two years of summary compensation table information rather than three. Not required:
· Compensation discussion and analysis.
· Grants of plan-based awards table.
· Option exercises and stock vested table.
· Pension benefits table.
· Nonqualified deferred compensation table.
· Disclosure of compensation policies and practices related to risk management.
· Pay ratio disclosure.
|404 – Transactions With Related Persons, Promoters and Certain Control Persons
|Description of policies/procedures for the review, approval or ratification of related party transactions not required.
|407 – Corporate Governance
Audit committee financial expert disclosure not required in first annual report
Compensation committee interlocks and insider participation disclosure not required.
Compensation committee report not required.
|503 – Prospectus Summary, Risk Factors and Ratio of Earnings to Fixed Charges
|No ratio of earnings to fixed charges disclosure required. No risk factors required in Exchange Act filings.
|601 – Exhibits
|Statements regarding computation of ratios not required.
|8-02 – Annual Financial Statements
Two years of income statements rather than three years. Two years of cash flow statements rather than three years.
Two years of changes in stockholders’ equity statements rather than three years.
|8-03 – Interim Financial Statements
|Permits certain historical financial data in lieu of separate historical financial statements of equity investees.
|8-04 – Financial Statements of Businesses Acquired or to Be Acquired
|Maximum of two years of acquiree financial statements rather than three years.
|8-05 – Pro forma Financial Information
|Fewer circumstances under which pro forma financial statements are required.
|8-06 – Real Estate Operations Acquired or to Be Acquired
|Maximum of two years of financial statements for acquisition of properties from related parties rather than three years.
|8-08 – Age of Financial Statements
|Less stringent age of financial statements requirements.