The Securities and Exchange Commission (“SEC”), in a release dated December 19, 2007, published changes to various rules regarding disclosure and reporting requirements of smaller public companies under the Securities Act of 1933 and the Securities Exchange Act of 1934. The rules create the new category of “smaller reporting company” for issuers with less than $75 million of public float in their equity securities. Qualifying companies will be required to check the “smaller reporting company” box on their Form 10-Ks whether they use the scaled disclosure standards or not. This is a change from the use of separate periodic reporting forms under current Regulation S-B, which will be eliminated. As a consequence, public companies qualifying as smaller reporting companies will now be able to use the same disclosure forms as larger public companies, but with the ability to pick and choose among some of the more burdensome line item requirements.
The new rules will take effect on February 4, 2008. A company qualifying as a “smaller reporting company” may apply the new scaled disclosure rules when filing its next periodic report after the effective date. This means that qualifying smaller reporting companies on a calendar fiscal year may use the scaled disclosure requirements for their upcoming 2007 Form 10-K.
Expanded Definition of “Smaller Reporting Company”
The new designation of “smaller reporting company” is substantially broader than the previous category of “small business issuer,” bringing regulatory relief to an estimated 1,600 additional issuers who will now qualify for the simplified disclosure and reporting. An issuer is a “smaller reporting company” if:
- it has less than $75 million in public float; or
- if it has no calculable public float, it had revenues of less than $50 million in the previous fiscal year.
For most companies, the status of a “smaller reporting company” will be contingent solely on public float. This is calculated by multiplying the aggregate worldwide number of shares of the voting and non-voting common equity held by non-affiliates by the last sale price for the shares, or the average of the bid and ask prices of the shares in their principal market. In most cases, “affiliate” would include directors, executive officers and shareholders owning 10% or more of the shares. The new rules do not address the definition of an affiliate.
Unlike the previous test for “small business issuer” under Regulation S-B, a small company can qualify under the new rules based solely on public float, without regard to its annual revenues. As with the current rules, investment companies, business development companies and asset-backed issuers will remain ineligible to qualify as a “smaller reporting company.”
For reporting companies, smaller reporting company eligibility will be determined as of the last business day of a company’s second fiscal quarter – the same time for determining “accelerated filer” status – according to the public float test or revenue test described above.
Private companies filing an initial registration statement, such as an IPO, will determine their smaller reporting company eligibility on a date, chosen by the company, that falls within a 30-day window of filing its initial registration statement with the SEC. Eligibility will be based on the per share offering price at the time of filing, the number of shares being offered, and the number of outstanding shares held by non-affiliates prior to the offering. The company will have the option of recalculating its public float based on the results of the IPO for purposes of eligibility for the next periodic report. Thus, if the company, after the IPO, recalculates its public float and determines it is under the $75 million limit, it would qualify as a smaller reporting company and could use scaled disclosure in its first periodic report due after the registration statement is declared effective.
Elimination of Regulation S-B and Integration into Regulation S-K
The new rules will phase out Regulation S-B and all of its associated forms. Form 10-QSB may be used until October 31, 2008, and Form 10-KSB may be used until March 15, 2009. Twelve non-financial item requirements providing scaled disclosure unique to Regulation S-B will be moved to separate paragraphs within Regulation S-K. The remaining 24 non-financial items in Regulation S-B are substantially similar to comparable items in Regulation S-K and thus will not be relocated.
Of the 12 items of scaled disclosure available to smaller reporting companies, the most substantive will be the changes to Item 402 (Executive Compensation). Among the changes to Item 402 are the following: ( To see table click here)
Some other noteworthy changes to Regulation S-K for smaller reporting companies include (To see table click here)
Financial Statement Changes
The amended rules move the financial statement requirements for smaller reporting companies to new Article 8 of Regulation S-X. New Article 8 allows smaller reporting companies to provide comparative balance sheet data and income statements covering only two years as opposed to the three years of information required for larger reporting companies.
To accommodate the new definition of smaller reporting company, Rule 3-05 of Regulation S-X (which currently permits reporting companies to include only two years of audited financial statements of an acquired company if the net revenues for the acquired company in the last fiscal year are below $25 million) is relaxed to increase the net revenue threshold for an acquired company to $50 million.
“A la Carte” Reporting
The rules represent a new approach for the SEC – that of allowing smaller reporting companies to choose the level of disclosure that makes the most sense for each company and its investors. Smaller reporting companies will have the option to pick and choose on an “a-la-carte” basis among the various new scaled disclosure requirements, or they may choose to comply with some or all of the more rigorous corresponding requirements for larger companies in Regulation S-K.
If a smaller reporting company includes items not required by the amended Regulation S-K (such as including a CD&A), the SEC has indicated that it will not provide comments based on the higher disclosure standards of larger companies, but rather will comment only to the extent the scaled disclosure requirements are not met or there are questions as to whether the disclosures comply with general anti-fraud rules, such as Rule 10b-5.
While smaller reporting companies will no longer be required to provide a CD&A, some may choose to continue to provide a limited form of CD&A, particularly if they provided a CD&A last year. Smaller reporting companies that wish to provide some form of limited CD&A may want to label it by another name (such as “Compensation Overview”) so as to not to create the higher expectations that accompany a full-blown CD&A.
According to the SEC, in 2006, an estimated 350 small business issuers eligible under Regulation S-B used the full-scale forms applicable to larger companies. The most probable reason for this practice was to avoid the stigma perceived to be attached to less-than-full disclosure and the categorization as a “small business.” By these amendments, the SEC hopes to minimize this disparity and predicts that more companies will take advantage of the less stringent “smaller reporting company” requirements.