New rules reduce financial disclosures required under Rules 3-10 and 3-16 of Regulation S-X
In an effort to encourage issuers to offer debt securities through registered (as opposed to private) offerings, the U.S. Securities and Exchange Commission (the “SEC”) recently adopted amendments that ease the financial disclosure requirements in Rule 3-10 of Regulation S-X for guarantors and issuers of guaranteed securities registered or being registered, and in Rule 3-16 of Regulation S-X for affiliates whose securities collateralize securities registered or being registered by:
- Making it easier to fall within exceptions that do not require the filing of separate full financial statements of guarantors or special purpose vehicles;
- Reducing the amount of financial information that must be disclosed in lieu of the separate financial statements (“Revised Alternative Disclosures”); and
- Permitting the Revised Alternative Disclosures to be provided outside the financial statements and thus not be subject to auditor’s review.
The amendments become effective on January 4, 2021, although voluntary compliance is permitted prior to that date.
Amendments to Rule 3-10
Existing Rule 3-10 requires that every issuer and guarantor of a registered security that is guaranteed file the financial statements required for a registrant by Regulation S-X, subject to five exceptions. The exceptions, which cover situations in which a parent company and one or more of its subsidiaries act as issuers and/or guarantors of the guaranteed securities, are guided by the principle that the investment is in the consolidated enterprise; therefore the consolidated financial statements of the parent company are the principal source of information for investors when evaluating the debt security and its guarantees.
Each exception in existing Rule 3-10 specifies conditions that must be met, including that the parent company provide certain disclosures – which can range from a brief narrative to highly detailed condensed consolidating financial information – in lieu of separate financial statements of each qualifying subsidiary issuer and guarantor. Under the existing rule, two primary conditions, included in each of the exceptions, must be satisfied for a subsidiary issuer or guarantor to be eligible to omit its separate financial statements: (1) each subsidiary issuer and guarantor must be “100%-owned” by the parent company; and (2) each guarantee must be “full and unconditional.”
The amendments to Rule 3-10:
- Make it easier to avoid filing separate full financial statements by replacing the condition that a subsidiary issuer or guarantor be 100%-owned by the parent company with a condition that it be consolidated in the parent company’s consolidated financial statements.
- Reduce the information that must by disclosed by replacing condensed consolidating financial information (as required by existing Rule 3-10) with certain new financial and non-financial disclosures. The Revised Alternative Disclosures will consist of summarized financial information of the issuers and guarantors, which may be presented on a combined basis, and the amendments reduce the number of periods presented but will expand the qualitative disclosures about the guarantees and the issuers and guarantors. Consistent with existing Rule 3-10, the amendments require disclosure of additional information about each guarantor if it would be material for investors to evaluate the sufficiency of the guarantee.
- Eliminate the need for the Revised Alternative Disclosure to be audited or reviewed by the auditors by permitting the disclosures to be provided outside the footnotes to the parent company’s audited annual and unaudited interim consolidated financial statements, in all filings.
- Reduce the length of time the Revised Alternative Disclosures must be provided by only requiring disclosure as long as an issuer or guarantor has reporting obligations under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”) with respect to the guaranteed securities, rather than for as long as the guaranteed securities are outstanding.
Amendments to Rule 3-16
Existing Rule 3-16 requires a registrant to provide separate annual and interim financial statements for each affiliate (which are almost always consolidated subsidiaries of the registrant, in practice) whose securities constitute a “substantial portion” of the collateral for any class of securities registered or being registered as if the affiliate were a separate registrant.
Similar to the Rule 3-10 amendments, the amendments to Rule 3-16 make it easier to avoid providing full separate financial statements for each affiliate whose securities are pledged as collateral. The alternative financial and non-financial disclosures that must be provided instead may also be provided outside the financial statements and thus do not need to be audited.
Foreign Private Issuers
The amendments will also apply to foreign private issuers, as Form 20-F will be amended to specifically require compliance with new Article 13 of Regulation S-X, and conforming amendments will also be made to Forms F-1 and F-3.
As originally proposed, if a parent company prepares its financial statements on a comprehensive basis other than U.S. GAAP or IFRS as issued by the International Accounting Standards Board (and thus would be required to reconcile its financial statements to U.S. GAAP), no reconciliation to U.S. GAAP would be required with respect to the amended supplemental financial and non-financial disclosure about the subsidiary issuers and/or guarantors and the guarantees. Instead, the parent company would be required to disclose any other quantitative or qualitative information that would be material to an investment decision with respect to the guaranteed security.
Please see Appendix A for a detailed comparison of the existing rules with the amended rules.
These amendments are a welcome boon to SEC-registrant issuers of debt obligations with guarantees and stock pledges. Many such issuers have offered their debt securities through Rule 144A and Regulation S in order to avoid the cost and effort associated with compliance with Rule 3-10, but these changes make SEC-registered issuances significantly more attractive. We will continue to monitor developments in this area and welcome any queries you may have.