On March 2, 2020, the SEC adopted amendments to Rule 3-10 of Regulation S-X in order to simplify and streamline the financial disclosure requirements applicable to registered offerings of guaranteed debt securities. The SEC said that the final amendments are intended to improve the quality of disclosure required by Rule 3-10 and increase the likelihood that issuers will conduct debt offerings on a registered basis.

The final amendments will provide publicly traded REITs that operate through an umbrella partnership REIT (UPREIT) structure with more flexibility to cause their operating partnership (OP) subsidiaries to offer and sell guaranteed debt securities in SEC-registered offerings, without incurring the additional costs and expenses of causing their OPs to register as separate SEC-reporting companies as currently required.

The final amendments are available on the SEC’s website and take effect on January 4, 2021. Voluntary compliance will be accepted in advance of the effective date.

Background

Rule 3-10 generally requires separate financial statements to be filed for subsidiary issuers and guarantors of debt securities, with several exceptions. In order to take advantage of an exception and avoid filing stand-alone subsidiary issuer or guarantor financial statements, the subsidiary issuer or guarantor must be 100% owned by the parent company and the guarantee must be full and unconditional. If all of the conditions are satisfied, stand-alone subsidiary issuer or guarantor financial statements are not required to be filed and the parent company can instead include consolidating financial information in a footnote to the parent company’s consolidated financial statements. The parent company’s obligation to include consolidating financial information continues for as long as the guaranteed securities are outstanding. By taking advantage of a Rule 3-10 exception and including consolidating financial information in a footnote to the parent company’s consolidated financial statements, subsidiary issuers and guarantors are exempt from the registration and periodic reporting obligations under the Securities Exchange Act of 1934 (Exchange Act).

If the parent company has not previously prepared the consolidating financial information required by Rule 3-10, significant time and cost can be incurred in producing this information. Further, because the consolidating financial information must be included in a footnote to the parent company’s audited annual and unaudited interim financial statements for so long as the guaranteed securities are outstanding, the consolidating financial information must be audited or reviewed, as applicable, for the same periods for which the parent company’s audited annual and unaudited interim financial statements are required.

Final Amendments

Under the final amendments, Rule 3-10 will continue to allow the omission of stand-alone subsidiary issuer and guarantor financial statements when certain conditions are met and the parent company provides supplemental financial and non-financial disclosure about the subsidiary issuer and/or guarantors and the guarantees. Similar to the current formulation of Rule 3-10, the amended rule will provide the conditions that must be met in order to omit stand-alone subsidiary issuer or guarantor financial statements. New Rule 13-01 of Regulation S-X will specify the amended disclosure requirements.

The final amendments will, among other things:

  • Replace 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.
  • Replace the consolidating financial information currently required by Rule 3-10 with certain new financial and non-financial disclosures.
    • The amended financial disclosures will consist of summarized financial information, as defined in Rule 1-02(bb)(1) of Regulation S-X, of the subsidiary issuers and guarantors, which may be presented on a combined basis. The final amendments also reduce the number of periods required to be presented. New Rule 13-01 will require summarized financial information to be provided only as of, and for, the most recently ended fiscal year and year-to-date interim period, if applicable, included in the parent company’s consolidated financial statements.
    • The amended non-financial disclosures will expand the qualitative disclosures about the subsidiary issuers and guarantors, the terms and conditions of the guarantees and how other factors may affect payments to holders of the guaranteed securities.
  • Permit the amended financial and non-financial disclosures to be provided outside the footnotes to the parent company’s consolidated financial statements in all filings.
  • Require the amended financial and non-financial disclosures for as long as a subsidiary issuer or guarantor has an Exchange Act reporting obligation with respect to the guaranteed debt securities, rather than for as long as the guaranteed debt securities are outstanding.

Impact of Final Amendments on UPREITs

We believe the final amendments to Rule 3-10 will be beneficial to publicly traded REITs that operate through an UPREIT structure and currently rely on their OPs to issue debt securities in SEC-registered offerings.

In a typical UPREIT structure, a publicly traded REIT controls the OP as the OP’s general partner and consolidates the OP in its financial statements, but generally does not own 100% of the equity interests in the OP. Because the publicly traded REIT generally does not own 100% of the equity interests in the OP, the OP is ineligible for a Rule 3-10 exception under the current formulation of the rule. As a result, most publicly traded REITs that operate through an UPREIT structure generally issue debt securities in unregistered offerings or, alternatively, cause their OPs to become separate SEC-reporting companies, thereby incurring additional costs and expenses. This is the case even though the financial statements of the publicly traded REIT are substantially similar to the financial statements of the OP because the publicly traded REIT is functionally a holding company with a single asset – its OP units in the OP.

By replacing the current condition for the Rule 3-10 exception that a subsidiary issuer be 100% owned by its parent company with a condition that it be consolidated in its parent company’s consolidated financial statements, publicly traded REITs operating through an UPREIT structure will have increased flexibility to offer and sell debt securities in SEC-registered offerings without incurring additional costs and expenses of causing their OPs to register as separate SEC-reporting companies. At the same time, investors in SEC-registered debt securities issued by these companies will continue to receive all material information relevant to their investment and should benefit from reduced costs of raising capital.