Recently, the Securities and Exchange Commission (the “SEC”) approved amendments to the definition of the “smaller reporting company” (“SRC”) category of issuers. These amendments expand the number of companies that can take advantage of the scaled disclosure and reporting requirements afforded to SRCs.
Background and Benefits of Qualifying as an SRC
Issuers registered in the United States can fall into one of four reporting company categories: “large accelerated filers”; “accelerated filers”; “non-accelerated filers”; and “smaller reporting companies”. An issuer’s filer type is determined largely by its public float (i.e., the number of shares of stock held by nonaffiliates), among other criteria. The category of filer under which an issuer qualifies will affect the timing and content of its public filings. The SRC category of filer provides several benefits for those issuers that qualify under its thresholds.
One major benefit of qualifying as an SRC is the requirement to file only two years of audited financial statements rather than three years for larger reporting companies. Also, Regulation S-K under the Securities Act of 1933, as amended (the “Securities Act”), allows SRCs a reduced level of disclosure for their annual and quarterly reports, proxy statements, and registration statements. The scaled disclosure includes less detailed disclosure requirements for business history, management discussion and analysis, and compensation information, and the omission of certain items such as selected financial data, supplementary financial information, stock performance graphs, market risk disclosures, executive pay ratio disclosure, and compensation discussion and analysis.
Amendments Expand the Scope of Issuers that Qualify as SRCs
The new SRC definition expands the two thresholds at which an issuer qualifies for the scaled disclosure and reporting accommodations. First, the new definition enables an issuer with a public float of less than $250 million to provide scaled disclosure. This is an increase from the previous $75 million threshold. Second, the new definition also includes issuers with less than $100 million in annual revenues if they have either no public float or a public float that is less than $700 million. This is broader than the previous test which permitted issuers to provide scaled disclosure only if they had less than $50 million in annual revenues and no public float.
In addition to the public float and revenue tests above, an issuer must not be an investment company, an issuer of asset-backed securities or a majority-owned subsidiary of a parent that is not a smaller reporting company. If an issuer meets all of these tests, it may take advantage of certain benefits afforded to SRCs.1 The determination of an issuer’s filer category is made at the time of its initial registration and annually at the end of the issuer’s most recently completed second fiscal quarter.
While the definition of SRC is being amended, the new rules will not amend the “accelerated filer” and “large accelerated filer” definitions. Therefore, issuers with a public float of over $75 million that now qualify as SRCs will still remain subject to the requirements that apply to accelerated filers. This includes the timing of the filing of periodic reports and requirements to provide an auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002.
As under the previous definition, if an issuer does not meet the SRC threshold (either at the time of its initial registration or annual determination) it will remain unqualified as an SRC until it determines that it meets one or more of the lower qualification thresholds for subsequent annual determinations. Therefore, an issuer that previously had $250 million or more of public float will qualify if it has a public float of less than $200 million at its subsequent determination. An issuer can also qualify if it previously had $100 million or more of annual revenues and a public float of $700 million or more if, at a subsequent determination, it has less than $80 million of annual revenues and less than $560 million of public float.
There will also be an amendment to Rule 3-05(b)(2)(iv) of Regulation S-X under the Securities Act to increase the net revenue threshold in that rule from $50 million to $100 million. This allows companies to omit financial statements of businesses acquired or to be acquired for the earliest of the three fiscal years otherwise required by Rule 3-05 if the net revenues of such business are less than $100 million.
The SEC estimates that 966 additional companies will be eligible for SRC status in the first year under this new definition. These amendments are intended to reduce compliance costs and provide access to the capital markets for more companies while still providing adequate protection for investors. Although the amendments do not change the definition of “accelerated filer”, the SEC has stated that it is formulating recommendations for additional changes to that category of issuers. The amended rules will become effective 60 days after publication in the Federal Register.