[Federal Register Volume 85, Number 169 (Monday, August 31, 2020)]
[Rules and Regulations]
[Pages 54002-54074]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11479]



[[Page 54001]]

Vol. 85

Monday,

No. 169

August 31, 2020

Part III





Securities and Exchange Commission





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17 CFR Parts 210, 230, 239, et al.





Amendments to Financial Disclosures About Acquired and Disposed 
Businesses; Final Rule

  Federal Register / Vol. 85, No. 169 / Monday, August 31, 2020 / Rules 
and Regulations  

[[Page 54002]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 230, 239, 240, 249, 270 and 274

[Release No. 33-10786; 34-88914; IC-33872; File No. S7-05-19]
RIN 3235-AL77


Amendments to Financial Disclosures About Acquired and Disposed 
Businesses

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting amendments to our rules and forms to improve 
their application, assist registrants in making more meaningful 
determinations of whether a subsidiary or an acquired or disposed 
business is significant, and to improve the disclosure requirements for 
financial statements relating to acquisitions and dispositions of 
businesses, including real estate operations and investment companies. 
The changes are intended to improve for investors the financial 
information about acquired or disposed businesses, facilitate more 
timely access to capital, and reduce the complexity and costs to 
prepare the disclosure.

DATES: Effective Date: The final rules are effective on January 1, 
2021.
    Compliance Dates: See Section II.F. for further information on 
transitioning to the final rules.

FOR FURTHER INFORMATION CONTACT: Todd E. Hardiman, Associate Chief 
Accountant, at (202) 551-3516, Jessica Barberich, Associate Chief 
Accountant, at (202) 551-3782, or Craig Olinger, Senior Advisor to the 
Chief Accountant, at (202) 551-3400, or Steven G. Hearne, Senior 
Special Counsel, at (202) 551-3430, in the Division of Corporation 
Finance; Joel Cavanaugh, Senior Counsel, at (202) 551-3173, Jenson 
Wayne, Assistant Chief Accountant, at (202) 551-6918, or Mark T. Uyeda, 
Senior Special Counsel, at (202) 551-6792, in the Division of 
Investment Management, U.S. Securities and Exchange Commission, 100 F 
Street, NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We are adopting amendments to:

------------------------------------------------------------------------
            Commission reference                CFR citation (17 CFR)
------------------------------------------------------------------------
Regulation S-X.............................  Sec.  Sec.   210.1-01
                                              through 210.13-02.
    Rule 1-02(w)...........................  Sec.   210.1-02(w).
    Rule 3-05..............................  Sec.   210.3-05.
    Rule 3-06..............................  Sec.   210.3-06.
    Rule 3-09..............................  Sec.   210.3-09.
    Rule 3-14..............................  Sec.   210.3-14.
    Rule 3-18..............................  Sec.   210.3-18.
    Rule 5-01..............................  Sec.   210.5-01.
    Rule 6-01..............................  Sec.   210.6-01.
    Rule 6-02..............................  Sec.   210.6-02.
    Rule 6-03..............................  Sec.   210.6-03.
Article 8:
    Rule 8-01..............................  Sec.   210.8-01.
    Rule 8-03..............................  Sec.   210.8-03.
    Rule 8-04..............................  Sec.   210.8-04.
    Rule 8-05..............................  Sec.   210.8-05.
    Rule 8-06..............................  Sec.   210.8-06.
Article 11:
    Rule 11-01.............................  Sec.   210.11-01.
    Rule 11-02.............................  Sec.   210.11-02.
    Rule 11-03.............................  Sec.   210.11-03.
Securities Act of 1933 (Securities Act):
 \1\
    Securities Act Rule 405................  Sec.   230.405.
    Form S-11..............................  Sec.   239.18.
    Form N-2...............................  Sec.  Sec.   239.14 and
                                              274.11a-1.
    Form N-14..............................  Sec.   239.23.
    Form 1-A...............................  Sec.   239.90.
Securities Exchange Act of 1934 (Exchange
 Act): \2\
    Exchange Act Rule 12b-2................  Sec.   240.12b-2.
    Form 8-K...............................  Sec.   249.308.
    Form 10-K..............................  Sec.   249.310.
Investment Company Act of 1940 (Investment
 Company Act): \3\
    Rule 8b-2..............................  Sec.   270.8b-2.
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    We also are adding 17 CFR 210.6-11 (new ``Rule 6-11'') to 
Regulation S-X.
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    \1\ 15 U.S.C. 77a et seq.
    \2\ 15 U.S.C. 78a et seq.
    \3\ 15 U.S.C. 80a-1 et seq.
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Table of Contents

I. Introduction and Background
II. Discussion of Final Amendments
    A. Amendments to the Definition of ``Significant Subsidiary'' 
and Generally Applicable Financial Statement Requirements for 
Acquired Businesses
    1. Significance Tests
    2. Audited Financial Statements for Significant Acquisitions
    3. Financial Statements for Net Assets That Constitute a 
Business
    4. Financial Statements of a Business That Includes Oil and Gas 
Producing Activities
    5. Timing and Terminology of Financial Statement Requirements
    6. Foreign Businesses
    7. Smaller Reporting Companies and Issuers Relying on Regulation 
A
    B. Amendments Relating to Rule 3-05 Financial Statements 
Included in Registration Statements and Proxy Statements
    1. Omission of Rule 3-05 Financial Statements for Businesses 
That Have Been Included in the Registrant's Financial Statements
    2. Use of Pro Forma Financial Information To Measure 
Significance
    3. Disclosure Requirements for Individually Insignificant 
Acquisitions
    C. Rule 3-14--Financial Statements of Real Estate Operations 
Acquired or To Be Acquired
    1. Align Rule 3-14 With Rule 3-05
    2. Definition of Real Estate Operation
    3. Significance Tests
    4. Interim Financial Statements
    5. Smaller Reporting Companies and Issuers Relying on Regulation 
A
    6. Blind Pool Real Estate Offerings
    D. Pro Forma Financial Information
    1. Adjustment Criteria and Presentation Requirements
    2. Significance and Business Dispositions
    3. Smaller Reporting Companies and Issuers Relying on Regulation 
A
    E. Amendments to Financial Disclosure About Acquisitions 
Specific to Investment Companies
    1. Amendments to Significance Tests for Investment Companies
    2. Proposed Rule 6-11 of Regulation S-X
    3. Pro Forma Financial Information and Supplemental Financial 
Information
    4. Amendments to Form N-14
    F. Transition
III. Other Matters
IV. Economic Analysis
    A. Introduction
    B. Baseline and Affected Parties
    C. Potential Benefits and Costs of the Final Rule
    1. Potential Benefits
    2. Potential Costs
    D. Economic Effects of Specific Amendments
    1. Significance Tests
    2. Audited Financial Statements for Significant Acquisitions
    3. Financial Statements for Net Assets That Constitute a 
Business
    4. Financial Statements of a Business That Includes Oil and Gas 
Producing Activities
    5. Timing and Terminology of Financial Statement Requirements
    6. Foreign Businesses
    7. Smaller Reporting Companies and Issuers Relying on Regulation 
A
    8. Omission of Rule 3-05 and Rule 3-14 Financial Statements and 
Related Pro Forma Financial Information for Businesses That Have 
Been Included in the Registrant's Financial Statements
    9. Use of Pro Forma Financial Information To Measure 
Significance
    10. Disclosure Requirements for Individually Insignificant 
Acquisitions
    11. Rule 3-14--Financial Statements of Real Estate Operations 
Acquired or To Be Acquired
    12. Pro Forma Financial Information
    13. Significance and Business Dispositions
    14. Amendments to Financial Disclosure About Acquisitions 
Specific to Investment Companies
    E. The Effects on Efficiency, Competition, and Capital Formation
    F. Alternatives Considered
    1. Approaches to the Significance Tests
    2. Approaches to Financial Statement Requirements
    3. Approaches to Adopting Pro Forma Adjustments
    4. Alternatives to the Income Test for Investment Companies

[[Page 54003]]

V. Paperwork Reduction Act
    A. Summary of the Collection of Information
    B. Effect of the Amendments on Existing Collections of 
Information
    1. Estimated Effects on Burdens for Registrants Other Than 
Investment Companies
    2. Estimated Effects of the Proposed Amendments on Paperwork 
Burdens for Investment Company Registrants
    C. Aggregate Burden and Cost Estimates for the Amendments
VI. Final Regulatory Flexibility Act Analysis
    A. Reasons for, and Objectives of, the Final Amendments
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Proposed Rules
    D. Reporting, Recordkeeping, and Other Compliance Requirements
    E. Agency Action To Minimize Effect on Small Entities
VII. Statutory Authority

I. Introduction and Background

    On May 3, 2019, the Commission proposed amendments to improve for 
investors the financial information about acquired and disposed 
businesses, facilitate more timely access to capital, and reduce the 
complexity and costs to prepare the disclosure.\4\ Specifically, the 
Commission proposed amendments to the requirements for financial 
statements relating to acquisitions and dispositions of businesses, 
including real estate operations, in Regulation S-X Rule 3-05,\5\ 
Financial statements of businesses acquired or to be acquired; Rule 3-
14, Special instructions for real estate operations to be acquired; 
Article 11, Pro Forma Financial Information; and other related rules 
and forms.\6\ The proposed amendments resulted from an ongoing, 
comprehensive evaluation of our disclosure requirements.\7\ The 
Commission also proposed new Rule 6-11 and amendments to Form N-14 to 
specifically govern financial reporting for acquisitions involving 
investment companies.
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    \4\ See Amendments to Financial Disclosures about Acquired and 
Disposed Businesses, Release No. 33-10635 (May 3, 2019) [84 FR 24600 
(May 28, 2019)] (``Proposing Release'').
    \5\ Unless otherwise noted, references in this release to 
``Rule'' or ``Rules'' are to the rules under Regulation S-X.
    \6\ The Commission also proposed related amendments to 
Regulation S-X with respect to the definition of ``significant 
subsidiary'' in Rule 1-02(w); Rule 3-06, Financial statements 
covering a period of nine to twelve months; and Article 8, Smaller 
Reporting Companies. In addition, the Commission proposed amendments 
to Form 8-K for current reports, Form 10-K for annual and transition 
reports, and the definition of ``significant subsidiary'' in 
Exchange Act Rule 12b-2, Securities Act Rule 405, and Rule 8b-2 
under the Investment Company Act.
    \7\ The staff, under its Disclosure Effectiveness Initiative, is 
reviewing the disclosure requirements in Regulation S-X and in 17 
CFR 229.10 through 229.1305 (``Regulation S-K'') and is considering 
ways to improve the disclosure regime for the benefit of both 
companies and investors. The goal is to comprehensively review the 
requirements and make recommendations on how to update them to 
facilitate timely, material disclosure by companies and 
shareholders' access to that information.
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    Under Rule 3-05, a registrant that acquires a business \8\ other 
than a real estate operation \9\ is generally required to provide 
separate audited annual and unaudited interim pre-acquisition financial 
statements of the business if it is significant to the registrant 
(``Rule 3-05 Financial Statements''). Recognizing that certain 
acquisitions have a greater impact on a registrant than others, Rule 3-
05 addresses the reporting requirements for businesses acquired or to 
be acquired based on the ``significant subsidiary'' definition in Rule 
1-02(w) using a sliding scale approach.\10\ A registrant that has 
acquired, or proposes to acquire, a significant real estate operation 
\11\ similarly must file separate audited annual and unaudited interim 
abbreviated income statements with respect to such operations (``Rule 
3-14 Financial Statements'').\12\ Additionally, registrants required to 
file Rule 3-05 Financial Statements or Rule 3-14 Financial Statements 
also are required to file unaudited pro forma financial information as 
prescribed by Article 11.\13\ The pro forma financial information is 
based on the historical financial statements of the registrant and the 
acquired or disposed business, and generally includes adjustments 
intended to show how the acquisition or disposition might have affected 
those financial statements had the transaction occurred at an earlier 
time.
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    \8\ Rule 3-05 requires disclosure if the ``business combination 
has occurred or is probable.'' See 17 CFR 210.3-05(a). Registrants 
determine whether a ``business'' has been acquired by applying Rule 
11-01(d) of Regulation S-X. The definition of ``business'' in 
Regulation S-X focuses primarily on whether the nature of the 
revenue-producing activity of the acquired business will remain 
generally the same as before the transaction. This determination is 
separate and distinct from a determination made under the applicable 
accounting standards.
    \9\ Rule 3-05 also applies to registrants that are registered 
investment companies and business development companies.
    \10\ Instructions for the Presentation and Preparation of Pro 
Forma Financial Information and Requirements for Financial 
Statements of Businesses Acquired or To Be Acquired, Release No. 33-
6413 (Jun. 24, 1982) [47 FR 29832 (Jul. 9, 1982)] (``Rule 3-05 
Adopting Release'').
    \11\ Neither Regulation S-X nor any other Securities Act or 
Exchange Act rule provides a definition of a ``real estate 
operation'' or an explanation of what is meant by the reference to 
``properties'' in Rule 3-14.
    \12\ See Rule 3-14. Rule 3-14 was adopted as part of the 
Commission's effort to establish a centralized set of instructions 
in Regulation S-X and is based on the disclosure requirements in 
Item 6(b) for Form S-11 as adopted in 1961. See Uniform Instructions 
as to Financial Statements--Regulation S-X, Release No. 33-6234 
(Sept. 2, 1980) [45 FR 63682 (Sept. 25, 1980)]. Rule 3-14 Financial 
Statements are abbreviated because the rule requires that they 
exclude historical items that are not comparable to the proposed 
future operations of the real estate operation such as mortgage 
interest, leasehold rental, depreciation, corporate expenses, and 
federal and state income taxes. Additionally, Rule 3-14 generally 
only requires one year of Rule 3-14 Financial Statements.
    \13\ See Rules 11-01 and 11-02. Pro forma financial information 
typically includes a pro forma balance sheet as of the end of the 
most recent period for which a consolidated balance sheet of the 
registrant is required and pro forma statements of comprehensive 
income for the registrant's most recent fiscal year and for the 
period from the most recent fiscal year end to the most recent 
interim date for which a balance sheet is required.
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    Form 8-K generally requires registrants to file Rule 3-05 Financial 
Statements, Rule 3-14 Financial Statements, and related pro forma 
financial information within 75 days after consummation of the 
acquisition.\14\ A similar 75-day filing period applies to registration 
statements and proxy statements for acquired or to be acquired 
businesses requiring Rule 3-05 Financial Statements,\15\ but not for 
acquired or to be acquired businesses requiring Rule 3-14 Financial 
Statements.
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    \14\ Item 2.01 of Form 8-K requires that registrants make 
certain disclosures upon the acquisition or disposition of a 
significant amount of assets, including assets that constitute a 
business, within four business days after the consummation of the 
transaction. It does not require reporting for probable acquisitions 
or dispositions. Item 9.01 of Form 8-K provides that the required 
financial statements and pro forma financial information for the 
acquired business (including a real estate operation) may be filed 
not later than 71 calendar days after the initial report on Form 8-K 
is required to be filed, providing approximately 75 calendar days to 
file the acquired business financial statements and related pro 
forma financial information. A registrant may need to update the 
periods presented in Form 8-K in certain subsequently filed 
registration statements and proxy statements. See 17 CFR 210.3-12.
    \15\ Rule 3-05(b)(4) and Rule 11-01(c) provide that registration 
statements not subject to the provisions of 17 CFR 230.419 and proxy 
statements need not include separate financial statements of the 
acquired or to be acquired business and related pro forma financial 
information if the business does not exceed any of the conditions of 
significance in the definition of ``significant subsidiary'' in Rule 
1-02(w) at the 50 percent level, and either (A) the consummation of 
the acquisition has not yet occurred; or (B) the date of the final 
prospectus or prospectus supplement relating to an offering as filed 
with the Commission pursuant to 17 CFR 230.424(b) or the mailing 
date in the case of a proxy statement, is no more than 74 days after 
consummation of the business combination, and the financial 
statements have not previously been filed by the registrant. A 
similar provision applies to smaller reporting companies, but it is 
linked to the effective date of the registration statement instead 
of the date of the final prospectus or prospectus supplement. See 
Rule 8-04(c)(4).
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    In addition, certain registration statements \16\ and proxy 
statements

[[Page 54004]]

require audited financial statements and unaudited pro forma financial 
information for the substantial majority of individually insignificant 
consummated and probable acquisitions since the date of the most recent 
audited balance sheet if a significance test exceeds 50 percent for any 
combination of acquisitions subject to Rule 3-05.\17\
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    \16\ This additional requirement does not apply to all 
registration statements, such as registration statements filed on 17 
CFR 239.16b (``Form S-8'').
    \17\ See Rule 3-05(b)(2)(i). Smaller reporting companies provide 
the same disclosure under Rule 8-04(c)(3).
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    Commenters broadly supported the objectives of the proposed rules 
or were generally in favor of the proposals.\18\ While commenters were 
largely supportive of the proposals, we also received recommendations 
for modifying or further considering aspects of the proposed amendments 
that commenters believed could be clarified and improved.\19\ After 
reviewing and considering the public comments and recommendations, we 
are adopting the amendments largely as proposed. As we discuss further 
below, in certain cases we are adopting the proposed rules with 
modifications that are intended to address comments received.
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    \18\ Comment letters related to the Proposing Release are 
available at https://www.sec.gov/comments/s7-05-19/s70519.htm.
    \19\ In addition, the SEC's Small Business Capital Formation 
Advisory Committee (``SBCFAC'') adopted a recommendation generally 
supportive of the proposed rules subject to their specific 
recommendations. See U.S. Securities & Exchange Commission Small 
Business Capital Formation Advisory Committee, Recommendation on the 
Commission's Proposal to Amend Financial Disclosure Requirements 
Relating to Acquisitions and Dispositions of Businesses (Aug. 23, 
2019) (``SBCFAC Recommendations''), available at https://www.sec.gov/spotlight/sbcfac/recommendations-rule-3-05-and-accelerated-filer-definition.pdf.
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II. Discussion of Final Amendments \20\
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    \20\ Generally, the final amendments will not affect the 
financial statements related to the acquisition of a business that 
is the subject of a proxy statement or registration statement on 17 
CFR 239.25 (``Form S-4'') or 17 CFR 239.34 (``Form F-4''); however, 
in certain circumstances application of the amended significance 
tests may affect whether the financial statements of a subject 
business that is not an Exchange Act reporting company are required 
to be included in such a proxy statement or registration statement. 
The final amendments will apply to pro forma financial information 
provided pursuant to Article 11 and financial information for 
acquisitions and dispositions otherwise required to be disclosed 
pursuant to Rule 3-05 or Rule 3-14. These amendments also do not 
affect the requirements in 17 CFR 210.3-02 (``Rule 3-02'') or Rule 
8-01 relating to predecessor companies.
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    We are amending the requirements in Rule 1-02(w), Rule 3-05, Rule 
3-14, Article 11, and related rules and forms. The amendments 
generally:
     Update the significance tests used under these and other 
rules to generally improve their application and assist registrants in 
making more meaningful significance determinations;
     Expand the use of pro forma financial information in 
measuring significance;
     Conform, to the extent applicable, the significance 
threshold and tests for a disposed business to those used for an 
acquired business;
     Require the financial statements of the acquired business 
to cover only up to the two most recent fiscal years;
     Permit disclosure of abbreviated financial statements for 
certain acquisitions of a component of an entity;
     Permit the use of, or reconciliation to, International 
Financial Reporting Standards as issued by the International Accounting 
Standards Board (``IFRS-IASB'') in certain circumstances;
     No longer require separate acquired business financial 
statements once the business has been included in the registrant's 
post-acquisition audited annual financial statements for either nine 
months or a complete fiscal year, depending on significance;
     Modify and enhance the required disclosure for the 
aggregate effect of acquisitions for which financial statements are not 
required or are not yet required;
     Align Rule 3-14 with Rule 3-05 where no unique industry 
considerations exist;
     Clarify the application of Rule 3-14 regarding the 
determination of significance, the need for interim income statements, 
special provisions for blind pool offerings,\21\ and the scope of the 
rule's requirements;
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    \21\ See Section II.C.6 below for a description of a blind pool 
offering.
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     Amend the pro forma financial information requirements to 
improve the content and relevance of such information;
     Clarify when financial statements and pro forma financial 
information are required, and update the language used in our rules to 
take into account concepts that have developed since adoption of the 
rules over 30 years ago; and
     Make corresponding changes to the smaller reporting 
company requirements in Article 8 of Regulation S-X.
    In addition, we are amending regulatory requirements specific to 
investment companies registered under the Investment Company Act and 
business development companies \22\ (collectively, ``investment 
companies'') as discussed in more detail in Section II.E. below.
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    \22\ ``Business development company'' is defined in Section 
2(a)(48) of the Investment Company Act, 15 U.S.C. 80a-2(a)(48).
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A. Amendments to the Definition of ``Significant Subsidiary'' and 
Generally Applicable Financial Statement Requirements for Acquired 
Businesses

    The ``significant subsidiary'' definition in Rule 1-02(w) includes 
investment, asset, and income tests that are applied when determining 
if a subsidiary is deemed significant for the purposes of certain 
Regulation S-X and Regulation S-K requirements as well as certain 
Securities and Exchange Act rules and forms.\23\ Whether an acquisition 
is significant under Rule 3-05 is determined by applying these 
tests,\24\ which generally can be described as follows:
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    \23\ In addition to its use in Rule 3-05 and Rule 3-14, the Rule 
1-02(w) definition of ``significant subsidiary'' is used in the 
following rules:
     17 CFR 210.9-03, which requires bank holding companies 
and banks to reflect on their balance sheets certain loans and 
indebtedness of their significant subsidiaries;
     17 CFR 210.11-01(b), which specifies when a business 
combination or disposition of a business shall be considered 
significant;
     17 CFR 210.3-09, 17 CFR 210.4-08(g) (``4-08(g)''), and 
Item 17(c)(2) of 17 CFR 249.220f (``Form 20-F''), which rely on the 
significance tests to determine the financial statements and 
summarized financial information required for the registrant's 
equity method investees;
     17 CFR 229.601(b)(21) and Instruction 8 as to Exhibits 
of Form 20-F, to determine the subsidiaries that must be included in 
the list of subsidiaries required as an exhibit;
     Item 17(b)(7) of Form S-4, to determine the financial 
statements required for domestic target companies being acquired 
that do not meet the requirements to use 17 CFR 239.34 (``Form S-
3'');
     Item 17(b)(5) of Form F-4, to determine the financial 
statements required for foreign companies being acquired that do not 
meet the requirements to use 17 CFR 239.34 (``Form F-3'');
     Item 4.C of Form 20-F, which requires a detailed list 
of the registrant's significant subsidiaries;
     17 CFR 229.304(a)(1) and (2), Item 9(d) of 17 CFR 
240.14a-101 (``Schedule 14A''), Item 4.01 of Form 8-K, Item 4 of 17 
CFR 239.93 (``Form 1-U''), and Item 16F of Form 20-F, which require 
disclosure about changes in the auditors of the registrant (or 
issuer, as applicable) or its significant subsidiaries;
     Item 3 of 17 CFR 249.308a (``Form 10-Q'') and Item 13 
of Form 20-F, which require disclosure about defaults of the 
registrant and its significant subsidiaries and material arrearages/
delinquencies in the payment of dividends on preferred stock of the 
registrant or any of its significant subsidiaries;
     17 CFR 229.101(a)(1), which requires certain 
disclosures, such as bankruptcy, receivership or similar proceedings 
and the nature and results of any other material reclassification, 
merger, or consolidation, of the registrant and any of its 
significant subsidiaries;
     17 CFR 229.103, which requires disclosure of certain 
legal proceedings, including bankruptcy and similar proceedings, for 
the registrant and any of its significant subsidiaries; and
     Item 4.A.4 of Form 20-F, which requires general 
disclosure about the development of and structural changes in the 
business of the registrant and its significant subsidiaries.
    \24\ Rule 3-05 provides for use of a 20 percent significance 
threshold, rather than the 10 percent threshold indicated in Rule 1-
02(w). The Commission raised the threshold in Rule 3-05 from 10 
percent to 20 percent in 1996 in order to reduce compliance burdens 
in response to concerns that the requirement to obtain audited 
financial statements for a business acquisition may have caused 
companies to forgo public offerings and to undertake private or 
offshore offerings. See Streamlining Disclosure Requirements 
Relating to Significant Business Acquisitions, Release No. 33-7355 
(Oct. 10, 1996) [61 FR 54509 (Oct. 18, 1996)] (``1996 Streamlining 
Release''). As a result of this amendment, the significance 
thresholds in Rule 3-05 have diverged from those used for Rule 3-14 
and for dispositions since that time.

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[[Page 54005]]

     ``Investment Test''--the registrant's and its other 
subsidiaries' investments in and advances to the acquired business are 
compared to the total assets of the registrant reflected in its most 
recent annual financial statements required to be filed at or prior to 
the acquisition date;
     ``Asset Test''--the registrant's and its other 
subsidiaries' proportionate share of the acquired business's total 
assets reflected in the business's most recent annual pre-acquisition 
financial statements is compared to the total assets of the registrant 
reflected in its most recent annual financial statements required to be 
filed at or prior to the acquisition date; and
     ``Income Test''--the registrant's and its other 
subsidiaries' equity in the income from continuing operations of the 
acquired business before income taxes, exclusive of amounts 
attributable to any noncontrolling interests, as reflected in the 
business's most recent annual pre-acquisition financial statements, is 
compared to the same measure reflected in the registrant's most recent 
annual financial statements required to be filed at or prior to the 
acquisition date.
1. Significance Tests
    We are amending the significance tests provided in Rule 1-02(w) to 
improve their application and to assist registrants in making more 
meaningful determinations of whether a subsidiary or an acquired or 
disposed business is significant. Specifically, we are revising the 
Investment Test and the Income Test and making other conforming 
changes. The Commission did not propose to substantively revise the 
Asset Test; however, a number of non-substantive revisions to the 
significance tests generally were proposed and are being adopted.\25\ 
The final amendments also provide that, for acquisitions, intercompany 
transactions with the acquired business must be eliminated from the 
registrant's and its subsidiaries' consolidated total assets when 
computing the Asset Test.
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    \25\ For example, the final amendments label the conditions as 
the ``Investment Test,'' the ``Asset Test,'' and the ``Income Test'' 
and clarify that the significance tests compare the ``tested'' 
subsidiary's amounts to the registrant's.
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a. Investment Test
    The Investment Test compares the registrant's and its other 
subsidiaries' investments in and advances to the tested subsidiary to 
the total assets of the registrant and its subsidiaries consolidated 
reflected at the end of the most recently completed fiscal year, or in 
the case of an acquired business, in the registrant's most recent 
annual financial statements required to be filed at or prior to the 
acquisition date.
i. Proposed Amendments
    The Commission proposed to revise the Investment Test to compare 
the registrant's and its other subsidiaries' investments in and 
advances to the tested subsidiary to the aggregate worldwide market 
value of the registrant's voting and non-voting common equity 
(``aggregate worldwide market value''), when available, and to retain 
the existing test when the registrant does not have an aggregate 
worldwide market value.\26\ As proposed, aggregate worldwide market 
value would be determined as of the last business day of the 
registrant's most recently completed fiscal year, which for 
acquisitions and dispositions would be at or prior to the date of 
acquisition or disposition. The Commission additionally proposed 
amendments relating to contingent consideration \27\ and combinations 
between entities or businesses under common control.\28\
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    \26\ The value under the proposed rule would have differed from 
the value currently used by registrants to determine accelerated 
filer status under Exchange Act Rule 12b-2 because it would include 
the value of common equity held by affiliates and it would be 
determined as of the last business day of the registrant's most 
recently completed fiscal year. By contrast, Exchange Act Rule 12b-2 
looks to the value of common equity held by non-affiliates and is 
determined as of the last business day of the registrant's most 
recently completed second fiscal quarter. See Exchange Act Rule 12b-
2.
    \27\ The Commission proposed to require that the ``investment 
in'' the tested subsidiary in an acquisition include the fair value 
of contingent consideration required to be recognized at fair value 
by the registrant at the acquisition date under U.S. Generally 
Accepted Accounting Principles (``U.S. GAAP'') or IFRS-IASB, as 
applicable. If recognition at fair value is not required, the 
proposed amendment would require all contingent consideration to be 
included, except sales-based milestones and royalties, unless the 
likelihood of payment is remote. For similar reasons, the Commission 
proposed that the ``investment in'' the tested subsidiary in a 
disposition equal the fair value of the consideration, which would 
include contingent consideration, for the disposed subsidiary when 
comparing it to the registrant's aggregate worldwide market value or 
the carrying value of the disposed subsidiary when comparing it to 
the registrant's total assets.
    \28\ The Commission proposed that the Investment Test would be 
met for a combination between entities or businesses under common 
control when either net book value of the tested subsidiary exceeds 
10 percent of the registrants' and its subsidiaries' consolidated 
total assets or the number of common shares exchanged or to be 
exchanged by the registrant exceeds 10 percent of its total common 
shares outstanding.
---------------------------------------------------------------------------

    The Commission proposed the use of aggregate worldwide market value 
in the Investment Test to address a measurement mismatch: The 
comparison of the registrant's and its other subsidiaries' investments 
in and advances to the tested subsidiary,\29\ which for an acquisition 
or disposition is typically the purchase or sales price and is 
generally consistent with fair value, to the registrant's total assets 
measured at book value. Using aggregate worldwide market value instead 
of total assets was intended to address this mismatch for acquisitions 
and dispositions by comparing measures that are generally consistent 
with fair value, thereby providing a more meaningful measure of 
significance.
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    \29\ Rules 3-05 and 3-14 use the conditions in Rule 1-02(w) when 
establishing the test for registrants to determine whether financial 
statements are required for businesses acquired or to be acquired. 
While we recognize that acquired businesses are often not 
subsidiaries, we use the term ``tested subsidiary'' throughout this 
release, rather than ``tested business'' or another term, when 
referring to the conditions in Rule 1-02(w) in connection with the 
determination in Rule 3-05 and Rule 3-14.
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ii. Comments
    Commenters generally supported the proposal to revise the 
Investment Test.\30\ Many commenters expressly supported the proposed 
use of aggregate worldwide market value of the registrant's voting and 
non-voting common equity, when available.\31\ Some commenters who 
supported the use of aggregate worldwide market value recommended 
measuring it closer to the date of the acquisition or disposition 
because of the potential fluctuation and

[[Page 54006]]

volatility of the stock price.\32\ Other commenters recommended 
extending the use of a fair value measure to initial public offerings, 
such as by allowing issuers to estimate their aggregate worldwide 
market value at the anticipated offering date.\33\
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    \30\ See, e.g., letters from Bass Berry & Sims PLC (``Bass 
Berry''), Cravath, Swaine & Moore LLP (``Cravath''), Deloitte & 
Touche LLP (``DT''), Eli Lilly and Company (``Eli Lilly''), 
Institute of Management Accountants (``IMA''), KPMG LLP (``KPMG''), 
PNC Financial Services Group, Inc. (``PNC''), Securities Industry 
and Financial Markets Association (``SIFMA''), and The Williams 
Companies, Inc. (``Williams''). We received no comments specific to 
our proposals to provide further instructions on a registrant's and 
its other subsidiaries' ``investments in'' the tested subsidiary for 
acquisitions and dispositions or to clarify the applicability of the 
Investment Test to combinations between entities under common 
control.
    \31\ See, e.g., letters from Ball Corporation (``Ball''), CFA 
Institute (``CFA''), Cravath, Davis Polk and Wardwell LLP (``Davis 
Polk''), DT, Eli Lilly, Financial Executives International 
(``FEI''), KPMG, MTBC, Inc. (``MTBC''), RSM US LLP (``RSM''), SIFMA, 
Shearman and Sterling LLP (``Shearman''), and Williams. See also 
SBCFAC Recommendations.
    \32\ See, e.g., letters from BDO USA LLP (``BDO''), Center for 
Audit Quality (``CAQ''), CFA, Cravath, Crowe LLP (``Crowe''), Davis 
Polk, DT, Ernst & Young LLP (``EY''), Grant Thornton LLP (``GT''), 
IMA, Liberty Global plc (``Liberty''), MTBC, KPMG, RSM, Sullivan & 
Cromwell LLP (``S&C''), and Shearman. Commenters recommended a 
variety of alternatives including particular dates, ranges of dates 
or averages linked to the announcement, agreement or transaction 
dates, the most recently completed fiscal quarter, or confidential 
submission or filing dates of registration statements. See, e.g., 
BDO, CAQ, Crowe, Davis Polk, GT, RSM, S&C, SIFMA, and Shearman.
    \33\ See, e.g., letters from BDO, Crowe, EY, and RSM. See also 
letters from Cravath and Davis Polk suggesting additional 
accommodations for initial public offerings.
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    A number of commenters, however, expressed concern relating to the 
use of aggregate worldwide market value.\34\ One of these commenters 
suggested that aggregate worldwide market value would introduce market 
volatility into the test.\35\ Other commenters suggested that aggregate 
worldwide market value would not reflect fair value when significant 
amounts of stock are held by affiliates, the registrant is highly 
leveraged or its capital structure is complicated.\36\ Two commenters 
supported the use of aggregate worldwide market value for acquisitions 
and dispositions, but expressed concern about its use for measuring 
significance of equity method investees because it introduces a 
historical cost versus fair value disparity (e.g., comparing 
investments in and advances to the equity method investee to the 
registrant's aggregate worldwide market value).\37\
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    \34\ See letters from The Allstate Corporation (``Allstate''), 
Affiliated Managers Group, Inc. (``AMG''), Bass Berry, Council of 
Institutional Investors (``CII''), Davis Polk, Denbury Resources 
Inc. (``Denbury''), DT, GT, IMA, and Liberty.
    \35\ See letter from AMG.
    \36\ See letters from Allstate, Bass Berry, DT, and GT. But see 
letter from CFA (recommending using a lower significance threshold 
or supplementing the revised test in such circumstances).
    \37\ See letters from DT and Williams. DT recommended that the 
Commission consider any potential impact of such changes on Rules 3-
09 and 4-08(g) and other existing rules and staff guidance, while 
Williams recommended expressly retaining the existing requirement 
when evaluating equity method investments for significance under 
Rule 4-08(g).
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    Some commenters recommended using the ``enterprise value'' of the 
registrant as a more accurate reflection of the fair value of the 
entities,\38\ despite acknowledging a lack of agreed-upon definition of 
the term \39\ or that enterprise value may necessitate adjustment to 
the numerator of the Investment Test to reflect leverage.\40\ These 
commenters recommended a variety of potential definitions for 
enterprise value or adjustments to equity market value that could be 
made to calculate enterprise value.\41\ Some commenters offered other 
alternatives, such as using the lower of the existing Investment Test 
denominator (the registrant's consolidated total assets) or aggregate 
worldwide market value.\42\ One commenter expressed concern that the 
proposed Investment Test could encourage certain transactions that, in 
the long-term, may not be in the best interest of an acquirer's 
shareholders.\43\
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    \38\ See letters from Bass Berry, Cravath, Davis Polk, Denbury, 
IMA, Liberty, and Shearman. Liberty went further and suggested that 
an Investment Test using enterprise value obviates the need for 
other significance tests.
    \39\ See letters from IMA and Shearman.
    \40\ See letter from Shearman. The commenter noted that if 
enterprise value is used, the numerator would also need to be 
revised to account for leverage by using the sum of the purchase 
price paid and the amount of debt, net of cash and cash equivalents, 
assumed.
    \41\ See letters from Bass Berry, Davis Polk, IMA, and Shearman. 
Bass Berry recommended defining ``enterprise value'' as ``(a) the 
equity value of the registrant (that is, the aggregate worldwide 
market value of the registrant's common equity as set forth above), 
plus (b) the value of the registrant's indebtedness, minority 
interests and preferred stock . . . , less (c) the cash and cash 
equivalents of the registrant as of the end of its most recent 
fiscal year.'' Cravath recommended using the sum of the investments 
in and advances to the tested subsidiary, plus total debt to be 
assumed compared to the sum of the aggregate worldwide market value 
plus total debt without eliminating cash. Shearman noted that the 
basic definition takes the fair value of the equity and adds total 
debt and subtracts cash and cash equivalents and suggested if the 
Commission were to use ``net debt,'' it would also need to adjust 
the purchase price to the sum of the purchase price paid and the 
amount of net debt assumed. IMA recommended that the Commission 
include the registrant's common and preferred stock, as well as its 
debt (including finance lease obligations) and that a registrant be 
permitted to use either the carrying amount of debt and/or preferred 
stock without a readily-determinable fair value or the carrying 
amount of debt, preferred stock and the residual equity. Davis Polk 
recommended ``the addition of the principal amount of the acquirer's 
outstanding debt to its equity market value.''
    \42\ See letters from Allstate and New York City Bar 
Association, Committee on Securities Regulation (``NYCBA--Sec.'').
    \43\ See letter from CII. See also infra at note 454 and 
accompanying text.
---------------------------------------------------------------------------

    In response to the Commission's proposal to require that the 
registrant's and its other subsidiaries' ``investments in'' the tested 
subsidiary include contingent consideration, some commenters supported 
including the fair value of contingent consideration when it is 
required to be measured at fair value under U.S. GAAP \44\ but 
expressed opposition or concern about including contingent 
consideration when the acquired business will be accounted for as an 
asset acquisition under U.S. GAAP.\45\ Other commenters recommended 
permitting registrants to determine significance using the fair value 
of the contingent consideration arrangement when fair value is not 
required by U.S. GAAP or IFRS-IASB, as applicable,\46\ or extending the 
proposed sales-based milestones and royalties exception.\47\ One 
commenter more broadly recommended not requiring the inclusion of 
contingent consideration that is not required to be recognized under 
applicable accounting standards.\48\ However, another commenter 
expressed concern that the exclusion of sales-based milestones and 
royalties from the Investment Test for acquisitions for which U.S. GAAP 
does not require contingent consideration to be measured at fair value 
may result in under-identification of acquisitions that would 
materially affect the registrant's financial statements.\49\
---------------------------------------------------------------------------

    \44\ See, e.g., letters from Allstate, AMG, Pfizer, Inc. 
(``Pfizer''), and SIFMA.
    \45\ See, e.g., letters from Pfizer, and SIFMA.
    \46\ See letter from IMA.
    \47\ See letters from IMA and SIFMA. See also Section II.A.1.a. 
of the Proposing Release.
    \48\ See letter from Cravath.
    \49\ See letter from GT. Separately, GT also recommended 
clarifying whether all contingent consideration should be included 
in the numerator if the likelihood of payment of all contingent 
consideration or any part thereof is more than remote.
---------------------------------------------------------------------------

iii. Final Amendments
    We are adopting amendments to the Investment Test, with 
modifications from what was proposed in response to comments received.
Aggregate Worldwide Market Value
    We are adopting amendments to the Investment Test, substantially as 
proposed, to compare the registrant's and its other subsidiaries' 
investments in and advances to the tested subsidiary to the aggregate 
worldwide market value of the registrant's voting and non-voting common 
equity, when available,\50\ but expressly limiting this amendment to 
acquisitions and dispositions.\51\ As proposed, we are retaining the 
existing test for acquisitions and dispositions in circumstances where 
the registrant does not have an aggregate worldwide market value. We 
are also retaining the existing test when used for the additional 
purposes for which the Rule 1-02(w) definition is applicable.\52\
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    \50\ As with the proposed rule, the value under the final rule 
differs from the value currently used by registrants to determine 
accelerated filer status under Exchange Act Rule 12b-2. See supra 
note 26.
    \51\ See Section II.A.1.c.iii below for a discussion about 
retaining the existing Investment Test in other circumstances. The 
final rules reorganize and renumber proposed Rule 1-02(w)(1)(i) to 
effect these changes.
    \52\ See Rule 1-02(w)(1)(i)(C) and the discussion on Conforming 
Changes supra Section II.A.1.c.

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[[Page 54007]]

    In an acquisition or disposition, the registrant's and its other 
subsidiaries' ``investments in'' \53\ the tested subsidiary are 
generally the consideration transferred or received (i.e., the purchase 
or sales price) for the net assets acquired or sold. For acquisitions 
and dispositions, we believe that aggregate worldwide market value more 
closely aligns with the purchase or sale price used in the numerator of 
the Investment Test and provides a measure that is readily available 
and objectively determined by the market. Use of aggregate worldwide 
market value in these circumstances will address the mismatch whereby 
purchase or sale price is a measure of net assets generally consistent 
with fair value while the registrant's total assets to which it is 
currently compared reflects gross assets measured at book value.\54\
---------------------------------------------------------------------------

    \53\ The Investment Test uses the phrase ``investments in and 
advances to.'' In this way, the numerator of the Investment Test 
includes two parts: ``investments in'' and ``advances to.'' Our 
references to ``investments in'' in this release are intended to 
focus the particular discussion on the first part of the numerator 
of the Investment Test. Any such reference should not be read to 
suggest the numerator of the Investment Test excludes the second 
part, ``advances to.''
    \54\ The book value of the registrant's total assets may not 
fully reflect the registrant's current fair value. For example, the 
Investment Test uses the carrying value of a registrant's total 
assets as of the most recent annual balance sheet date, which 
represents a combination of fair value for certain assets (e.g., 
financial instruments) and historical cost for other assets (e.g., 
property, plant and equipment and intangible assets). The test 
further excludes the value of certain assets not permitted to be 
recognized (e.g., certain internally developed intangible assets) 
and is not reduced by the value of liabilities.
---------------------------------------------------------------------------

    We are not adopting the suggestion of some commenters to use 
``enterprise value'' for the Investment Test. The use of aggregate 
worldwide market value, unlike ``enterprise value,'' will avoid the 
need to define a term that does not have an agreed-upon definition. 
Moreover, it avoids having to establish additional adjustments to the 
``investments in and advances to'' the tested subsidiary in order to 
convert the Investment Test numerator from essentially an equity value 
to an enterprise value, which we believe would be necessary if an 
enterprise value denominator were used. We also are not adopting the 
suggestion to use the lower of the existing Investment Test denominator 
(i.e., the registrant's consolidated total assets) or aggregate 
worldwide market value. While we note the observation that a company 
with substantial assets that is highly leveraged may have a relatively 
small market capitalization, the suggested ``lower of'' standard is not 
linked to leverage nor do we believe the existence of leverage 
necessarily precludes the need for disclosure about acquired and 
disposed businesses.
    In response to commenters' suggestions and concerns regarding 
market volatility, we are modifying the proposal to require registrants 
to use the average of aggregate worldwide market value calculated daily 
for the last five trading days of the registrant's most recently 
completed month ending prior to the earlier of the registrant's 
announcement date or agreement date of the acquisition or disposition. 
We are persuaded by commenters who suggested that market volatility and 
changes in market value unrelated to the acquisition could affect the 
determination of aggregate worldwide market value. We believe that 
using a more recent measurement period that is averaged to moderate 
daily variability more accurately reflects aggregate worldwide market 
value for purposes of computing significance based on the purchase or 
sale price while retaining a readily available and easily determinable 
measure of aggregate worldwide market value.
    As proposed, the final rules will continue to require use of the 
total assets of the registrant and its subsidiaries consolidated when a 
registrant does not have an aggregate worldwide market value. We did 
not modify the final rule to permit, as suggested by some commenters, 
the estimation of aggregate worldwide market value when no such market 
value exists because we believe such an approach could introduce, 
rather than eliminate, complexity, and would be inconsistent with our 
intent of requiring that the determination, where possible, be based on 
readily available and easily and objectively determinable amounts that 
exist at the earlier of the announcement or agreement date.\55\
---------------------------------------------------------------------------

    \55\ For example, a public float approach similar to that in 17 
CFR 229.10(f)(1) (``Item 10(f)(1) of Regulation S-K'') relies on an 
estimated public offering price measured relative to the filing 
date, which could cause the estimate to already encompass the value 
of the tested business when the acquisition has already occurred or 
when the anticipated offering or filing date occurs after the 
earlier of the announcement or agreement date.
---------------------------------------------------------------------------

Contingent Consideration
    We are amending the Investment Test, substantially as proposed, to 
clarify that for acquisitions, the registrant's and its other 
subsidiaries' ``investments in'' \56\ the tested subsidiary is the 
consideration transferred, adjusted to exclude the registrant's and its 
subsidiaries' proportionate interest in the carrying value of assets 
transferred by the registrant and its subsidiaries consolidated to the 
tested subsidiary that will remain with the combined entity after the 
acquisition. The amendments further indicate that the registrant's and 
its other subsidiaries' ``investments in'' the tested subsidiary shall 
include the fair value of contingent consideration if required to be 
recognized at fair value by the registrant at the acquisition date 
under U.S. GAAP or IFRS-IASB, as applicable; however if recognition at 
fair value is not required, it shall include all contingent 
consideration, except contingent consideration for which the likelihood 
of payment is remote. We believe inclusion of contingent consideration 
provides a more accurate measure of an acquired business's relative 
significance. We were not persuaded by commenters that contingent 
consideration should be excluded from the Investment Test when the 
acquired business (as defined in Rule 11-01(d)) will be accounted for 
as an asset acquisition under U.S. GAAP. Contingent consideration can 
be a material component of the consideration provided to acquire a Rule 
11-01(d) business and its exclusion from the significance tests could 
result in the under-identification of acquisitions for which financial 
statements are necessary to reasonably inform investors.
---------------------------------------------------------------------------

    \56\ See supra note 53.
---------------------------------------------------------------------------

    The proposed amendment would have permitted the exclusion of 
contingent consideration in the form of sales-based milestones and 
royalties from the Investment Test when recognition of contingent 
consideration at fair value is not required under U.S. GAAP or IFRS-
IASB, as applicable. The proposal was intended to promote ease of 
calculation while maintaining the objective of the test as a reliable 
indicator of relative significance; however, commenter feedback made 
evident that there are a wide variety of contingent consideration 
arrangements with variable terms that require estimation beyond sales-
based milestones and royalties. Rather than expanding the exclusion to 
encompass these other arrangements, we are persuaded by the commenter 
who observed that the exclusion of such consideration from the 
significance tests when the likelihood of their payment was more than 
remote could result in under-identification of acquisitions that would 
materially affect the registrant's financial statements. Therefore, the 
final amendments do not provide for any such exception.\57\
---------------------------------------------------------------------------

    \57\ In order to further clarify the requirements related to the 
amount of contingent consideration to include in the Investment Test 
when recognition at fair value is not required under U.S. GAAP or 
IFRS-IASB, as applicable, the final rules modify the proposed 
language, which provided for inclusion of ``all contingent 
consideration unless the likelihood of payment is remote,'' to 
require inclusion of ``all contingent consideration, except 
contingent consideration for which the likelihood of payment is 
remote.''

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[[Page 54008]]

    We are not persuaded by the suggestion to permit registrants to 
determine significance of an acquisition using the fair value of the 
contingent consideration arrangement when fair value is not required by 
U.S. GAAP or IFRS-IASB, as applicable, as a means to mitigate the risk 
that an acquisition may be deemed significant for arrangements for 
which there is a wide range of possible outcomes in the eventual amount 
of contingent consideration that may be owed. We note that the standard 
we are adopting is one employed in practice today. To the extent that 
unique facts and circumstances may trigger significance when financial 
statements are not reasonably necessary to inform investors, we believe 
such a situation is best addressed through 17 CFR 210.3-13 (``Rule 3-
13'').\58\
---------------------------------------------------------------------------

    \58\ See Rule 3-13 of Regulation S-X, which provides that the 
Commission may, upon the request of the registrant, and where 
consistent with the protection of investors, permit the omission of 
one or more required financial statements or the filing in 
substitution therefor of appropriate statements of comparable 
character. The Commission has delegated authority to the staff in 
the Division of Corporation Finance to grant requests for relief 
under Rule 3-13.
---------------------------------------------------------------------------

Other Amendments
    The final amendments provide, as proposed, that the registrant's 
and its other subsidiaries' ``investments in'' the tested subsidiary 
exclude the registrant's and its other subsidiaries' proportionate 
interest in the carrying value of assets transferred by the registrant 
to the tested subsidiary that will remain with the combined entity 
after the acquisition. The final amendments also provide, as proposed, 
that in a disposition, the registrant's and its other subsidiaries' 
``investments in'' the tested subsidiary equal the fair value of the 
consideration (which includes contingent consideration) for the 
disposed subsidiary when comparing it to the registrant's aggregate 
worldwide market value or, when the registrant has no such aggregate 
worldwide market value, the carrying value of the disposed subsidiary 
when comparing it to the registrant's total assets. The final 
amendments additionally provide, as proposed, that the Investment Test 
is met when either net book value of the tested subsidiary exceeds 10 
percent of the registrant's and its subsidiaries' consolidated total 
assets or the number of common shares exchanged or to be exchanged by 
the registrant exceeds 10 percent of its total common shares 
outstanding at the date the combination is initiated for combinations 
between entities or businesses under common control.\59\
---------------------------------------------------------------------------

    \59\ The addition of net book value to the test recognizes that 
such combinations may be effected by transferring net assets, rather 
than exchanging shares, and that the resulting accounting by the 
entity who receives net assets or equity interests (i.e., the 
receiving entity) typically recognizes the combination using the 
parent's historical carrying value of the transferred entity or 
business. See, e.g., FASB ASC 805-50-30-5.
---------------------------------------------------------------------------

b. Income Test
    The Income Test compares the registrant's equity in the tested 
subsidiary's income from continuing operations before income taxes 
exclusive of amounts attributable to any noncontrolling interests to 
such income of the registrant for the most recently completed fiscal 
year. In the case of an acquisition, the Income Test similarly compares 
the registrant's equity in the income from continuing operations of the 
acquired business before income taxes, exclusive of amounts 
attributable to any noncontrolling interests, as reflected in the 
business's most recent annual pre-acquisition financial statements, to 
the same measure of the registrant reflected in its most recent annual 
financial statements required to be filed at or prior to the 
acquisition date.
i. Proposed Amendments
    The Commission proposed to revise the Income Test to reduce the 
anomalous results that may occur by relying solely on net income \60\ 
and to reduce complexity and preparation costs without sacrificing 
material information for investors. The Commission proposed to:
---------------------------------------------------------------------------

    \60\ Net income can include infrequent expenses, gains, or 
losses that can distort the determination of relative significance.
---------------------------------------------------------------------------

     Add a new revenue component to the test;
     Revise the net income component to use income or loss from 
continuing operations after income taxes, instead of before income 
taxes;
     Calculate the net income component using absolute values;
     Revise the Income Test to use the average of the absolute 
value of net income when the existing 10 percent threshold in 
Computational Note 2 to Rule 1-02(w) is met and the proposed revenue 
component does not apply; and
     Make additional clarifications and simplifications.\61\
---------------------------------------------------------------------------

    \61\ Specifically, the Commission proposed to clarify that the 
Income Test may be determined using the acquired business's revenues 
less the expenses permitted to be omitted by proposed Rules 3-05(e) 
and 3-05(f) under certain conditions and to make additional non-
substantive amendments to the net income component in order to 
simplify the description and application.
---------------------------------------------------------------------------

    The proposed revenue component would compare the registrant's and 
its other subsidiaries' proportionate share of the tested subsidiary's 
consolidated total revenues (after intercompany eliminations) to such 
consolidated total revenues of the registrant for the most recently 
completed fiscal year. Under the proposal, where the registrant and its 
subsidiaries consolidated and the tested subsidiary have recurring 
annual revenue,\62\ the tested subsidiary must meet both the new 
revenue component and the net income component, and in the case of the 
application of the test in Rule 3-05, could use the lower percentage of 
the revenue component and the net income component to determine the 
number of periods for which Rule 3-05 Financial Statements are 
required.
---------------------------------------------------------------------------

    \62\ Where a registrant or tested subsidiary does not have 
recurring annual revenues, the revenue component is less likely to 
produce a meaningful assessment and therefore only the net income 
component would apply.
---------------------------------------------------------------------------

ii. Comments
    Commenters broadly supported the revisions to the Income Test and 
made various recommendations to improve specific components of the 
Income Test.\63\
---------------------------------------------------------------------------

    \63\ See, e.g., letters from Bass Berry, Cravath, DT, Eli Lilly, 
IMA, KPMG, PNC, SIFMA, and Williams. We received no comments on the 
additional clarifications and simplifications.
---------------------------------------------------------------------------

Revenue Component
    Commenters broadly supported the addition of a revenue component to 
the Income Test.\64\ One commenter recommended establishing 
significance when registrants meet either revenue or net income.\65\ 
Another commenter noted that the inclusion of the revenue component 
would reduce instances of anomalous significance results, but noted 
that using a lower of revenue or net income approach could result in 
under-identification of acquisitions expected to have a material future 
impact and suggested considering the use of a lower revenue 
threshold.\66\

[[Page 54009]]

Another commenter suggested requiring only the revenue component, and 
not the income component, for smaller reporting companies.\67\
---------------------------------------------------------------------------

    \64\ See, e.g., letters from AMG, Ball, Bass Berry, BDO, 
Cravath, Eli Lilly, FEI, GT, Liberty, NYCBA--Sec., Pfizer, 
PricewaterhouseCoopers LLP (``PWC''), SIFMA, Shearman, and Williams. 
See also SBCFAC Recommendations. Some of these commenters suggested 
further accommodations for equity method investees. See, e.g., 
letters from GT and AMG.
    \65\ See letter from CFA.
    \66\ See letter from GT. In contrast, one commenter explicitly 
supported using the same percentage thresholds for the revenue 
component and the income component and indicated its belief that 
there was no meaningful risk that the income component of the Income 
Test would under-identify material transactions. See letter from 
Cravath.
    \67\ See letter from MTBC.
---------------------------------------------------------------------------

Recurring Annual Revenues
    A number of commenters, particularly accounting and auditing firms, 
expressed concern that the term ``recurring annual revenues'' may not 
be clear and requested additional guidance as to the meaning.\68\ One 
commenter recommended using ``two or more years of revenue'' as an 
alternative.\69\
---------------------------------------------------------------------------

    \68\ See, e.g., letters from BDO, CAQ, Cravath, Crowe, DT, EY, 
GT, KPMG, MTBC, PWC, RSM, and SIFMA.
    \69\ See letter from MTBC.
---------------------------------------------------------------------------

Income Taxes
    A few commenters supported the proposal to use income from 
continuing operations after income taxes because it would simplify the 
calculation and would permit registrants to use information directly 
from the income statement.\70\ However, many other commenters 
recommended that the Commission continue to use income or loss from 
continuing operations before income taxes in the Income Test.\71\ While 
using after-tax amounts may simplify the determinations, these 
commenters expressed concern that after-tax numbers could distort the 
significance determination due to factors such as the tax status of the 
entity (such as for a pass-through entity) \72\ or the volatility of 
income taxes (due to changes in tax laws or valuation allowances).\73\
---------------------------------------------------------------------------

    \70\ See letters from Ball and Eli Lilly.
    \71\ See, e.g., letters from AMG, BDO, CAQ, Cravath, Crowe, EY, 
FEI, GT, KPMG, Pfizer, PWC, Ira Rosner (``Rosner''), RSM, Shearman, 
and Williams.
    \72\ See, e.g., letters from AMG, BDO, CAQ, Cravath, Crowe, EY, 
GT, KPMG, PWC, Rosner, RSM, and Williams.
    \73\ See, e.g., letters from CAQ, EY, FEI, KPMG, Pfizer, PWC, 
and RSM.
---------------------------------------------------------------------------

Income Averaging and Use of Absolute Values
    Commenters generally supported the revisions relating to income 
averaging calculations \74\ and the use of absolute values.\75\ Some 
commenters recommended further revisions, such as using three-year 
averaging or permitting five-year averaging for all registrants 
regardless of recurring revenue.\76\
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    \74\ See letters from AMG, BDO, and Pfizer.
    \75\ See letters from AMG, Eli Lilly, IMA, and Pfizer.
    \76\ See, e.g., letters from AMG, BDO, and IMA.
---------------------------------------------------------------------------

iii. Final Amendments
    As discussed in more detail below, we are adopting the amendments 
to the Income Test substantially as proposed, but with some 
modifications to improve its application and to assist registrants in 
making more meaningful significance determinations.
Revenue Component
    As proposed, we are revising the Income Test to add a revenue 
component in order to reduce the anomalous result that registrants with 
marginal or break-even net income or loss in a recent fiscal year may 
be more likely to have tested subsidiaries deemed significant where 
they otherwise would not. This anomalous result is particularly 
relevant where it would require Rule 3-05 Financial Statements for 
acquisitions that otherwise would not be considered material to 
investors. To satisfy the Income Test under the final amendments, the 
tested subsidiary must meet both the revenue component and the net 
income component when the revenue component applies, and for purposes 
of the application of Rule 3-05, may use the lower of the revenue 
component and the net income component to determine the number of 
periods for which Rule 3-05 Financial Statements are required. The new 
revenue component compares a registrant's and its other subsidiaries' 
proportionate share of the tested subsidiary's consolidated total 
revenues (after intercompany eliminations) to such consolidated total 
revenues of the registrant for the most recently completed fiscal year. 
We are modifying the description of the tested subsidiary's 
consolidated total revenue to clarify that consolidated total revenue 
refers to consolidated total revenue from continuing operations (after 
intercompany eliminations).\77\
---------------------------------------------------------------------------

    \77\ See Rule 1-02(w)(1)(iii).
---------------------------------------------------------------------------

    Revenue is an important indicator of the operations of a business 
and generally has less variability than net income. For example, 
expenses related to historical capitalization that will no longer be 
incurred (e.g., interest expense) as well as infrequent expenses, such 
as those for litigation or impairment, can affect net income, but not 
revenue. The effect of historical expenses that will no longer be 
incurred and infrequent expenses on an income-based test may be to 
either deem as insignificant an acquired business that is expected to 
have a material future impact on the registrant or deem as significant 
an acquired business that is not expected to have a material future 
impact on the registrant. While we considered other metrics, we believe 
the addition of ``revenue'' is a more appropriate indicator to help 
avoid anomalous results, and therefore, we added a revenue component to 
the net income component of the Income Test rather than have separate 
tests based on revenue and net income.\78\ By revising the Income Test 
to require that the registrant exceed both the revenue and net income 
components when the revenue component applies, we believe the test will 
more accurately determine whether a tested subsidiary is significant to 
the registrant. This will also reduce the frequency of immaterial 
acquisitions being deemed significant for purposes of Rule 3-05.
---------------------------------------------------------------------------

    \78\ Prior to 1974, the ``significant subsidiary'' definition 
included a revenue test, but not a net income test. In 1974, the 
Commission added a separate net income test. In 1981, the Commission 
eliminated the revenue test and retained the net income test noting 
in part that ``. . . the presentation of additional financial 
disclosures of an affiliated entity may not be meaningful if the 
affiliate has a high sales volume but a relatively low profit 
margin'' and observing that in such circumstances, the affiliate has 
little financial effect on the operating results of the consolidated 
group. See Separate Financial Statements Required by Regulation S-X, 
Rels. No. 33-6359 (Nov. 6, 1981) [46 FR 56171 (Nov. 16, 1981)].
---------------------------------------------------------------------------

    We are not adopting the recommendation to use a lower significance 
threshold for the revenue component to mitigate the potential risk that 
use of a lower of revenue or net income approach could result in under-
identification of significant subsidiaries, and in particular of 
acquisitions expected to have a material future impact on the 
registrant. The risk of under-identification is not unique to a ``lower 
of'' approach, but rather is inherent in basing the requirement to 
provide financial information on percentage threshold tests. We believe 
under-identification risk is mitigated, however, because even if the 
Income Test is not satisfied, the definition of ``significant 
subsidiary'' could be met by satisfying either the Asset Test or the 
Investment Test. Further, to simplify compliance, the significant 
subsidiary percentage threshold historically has been the same for all 
tests included in the ``significant subsidiary'' definition, 
notwithstanding that the threshold has been changed from time to time. 
In light of these considerations, we do not find a compelling reason at 
this time to differentiate the threshold for the revenue component of 
the Income Test from the threshold used in the net income component of 
the Income Test and in the Asset and Investment Tests.
    We also are not adopting the recommendation to apply only the

[[Page 54010]]

revenue component, and not the income component, for smaller reporting 
companies. We continue to believe both components taken together are 
important indicators in determining the need for financial information 
about acquired and disposed businesses.
Recurring Annual Revenue
    Under the proposed amendments, where either a registrant and its 
subsidiaries consolidated or the tested subsidiary did not have 
recurring annual revenue, the new revenue component would not have been 
available to determine the number of periods for which Rule 3-05 
Financial Statements are required. However, we are persuaded by 
commenters who noted that the term ``recurring annual revenue,'' as 
proposed, was not sufficiently clear to determine when the revenue 
component would apply and may have inappropriately suggested that there 
would be discretion in determining the amount of revenue to be 
included. The revenue component is unlikely to produce a meaningful 
assessment where the registrant or the tested subsidiary does not have 
material revenue over the course of time. We are therefore modifying 
the Income Test consistent with a comment we received, to provide that 
the revenue component does not apply if either the registrant and its 
subsidiaries consolidated or the tested subsidiary did not have 
material revenue in each of the two most recently completed fiscal 
years. We believe the amendment will allow registrants to determine 
more easily whether the revenue component applies, and when it does 
apply, will clarify that all revenues must be included.
Income Taxes
    The Commission proposed to calculate income or loss from continuing 
operations after income taxes, permitting a registrant to use line item 
disclosure from its financial statements, to simplify the 
determination. We are persuaded by commenters that using after tax 
information may result in significance determinations that are less 
consistent and meaningful because they could be distorted due to 
factors such as the tax status of the entity or the volatility of 
income taxes. We are therefore not adopting the proposed amendment to 
calculate income or loss from continuing operations after income taxes 
and are retaining the requirement to use income or loss from continuing 
operations before income taxes.
Income Averaging and Use of Absolute Values
    We are adopting amendments, as proposed, to clarify the net income 
component by inserting references to the absolute value of equity in 
the tested subsidiary's consolidated income or loss from continuing 
operations, which we believe will mitigate the potential for 
misinterpretation that may result from inclusion of a negative amount 
in the computation. We are also adopting as proposed the use of 
absolute values for calculating average net income. As noted above, 
commenters generally supported the improvements to income averaging 
calculations \79\ and the use of absolute values.\80\
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    \79\ See letters from AMG, BDO, and Pfizer. We are not adopting 
one commenter's recommendation to use a three-year average. The 
five-year average is a longstanding standard and it is not clear 
that a three-year average would yield a more meaningful outcome. We 
also are not adopting the recommendation to extend the use of income 
averaging when the revenue component applies. Under existing 
requirements, income averaging is required when its conditions for 
use are met. However, those conditions also limit its use to 
mitigating anomalous results. We believe the adoption of a revenue 
component will mitigate anomalous results more effectively while 
simplifying the Income Test, and that use of income averaging to 
mitigate anomalous results should therefore be necessary only when 
the revenue component does not apply.
    \80\ See letters from AMG, Eli Lilly, IMA, and Pfizer.
---------------------------------------------------------------------------

Additional Clarifications and Simplifications
    We are additionally amending Rules 3-05(b)(3) and 11-01(b)(3) as 
proposed to clarify that the Income Test may be determined using the 
acquired business's revenues less the expenses permitted to be omitted 
by new Rules 3-05(e) and 3-05(f) if the business meets the conditions 
in those rules, as well as making additional non-substantive amendments 
to the net income component in order to simplify the description of the 
test. Specifically, we are replacing, as proposed, the phrase 
``exclusive of amounts attributable to any noncontrolling interests'' 
in the net income component with the phrase ``attributable to the 
controlling interests.''
    We are also revising Rule 1-02(w) to remove the Computational Note 
designation but retaining the substance of the notes in the rule and 
making conforming amendments consistent with the amendments to the 
revised Income Test. Additionally, we are revising Rule 1-
02(w)(1)(iii)(B)(3) to clarify that the rule is not intended to modify 
the existing Rule 3-05(a)(3) requirement that acquisitions of a group 
of related businesses must be treated as if they are a single 
acquisition. Finally, we are moving the Note to Rule 1-02(w) into the 
rule itself.
c. Conforming Changes
i. Proposed Amendments
    As noted above, several of our rules and forms require disclosure 
related to ``significant subsidiaries'' or otherwise rely on the 
significance tests in Rule 1-02(w) to determine the disclosure 
required.\81\ The Commission's proposed amendments to Rule 1-02(w) 
would update the definition and the tests therein, but would 
nonetheless result in these tests continuing to apply consistently 
across these applications. The term ``significant subsidiary'' is also 
defined in Securities Act Rule 405, Exchange Act Rule 12b-2, and 
Investment Company Act Rule 8b-2. The Securities Act Rule 405 and 
Exchange Act Rule 12b-2 definitions historically have been generally 
consistent with the Rule 1-02(w) definition. Accordingly, the 
Commission proposed to conform the definitions of ``significant 
subsidiary'' in Securities Act Rule 405 and Exchange Act Rule 12b-2 to 
the amended definition in Rule 1-02(w).\82\
---------------------------------------------------------------------------

    \81\ See supra note 23.
    \82\ In the Proposing Release, the Commission proposed to 
exclude from the definition of ``significant subsidiary'' in 
Securities Act Rule 405 and Exchange Act Rule 12b-2 the proposed 
amendments to Rule 1-02(w) that would be applicable only to 
disclosure requirements under Regulation S-X, specifically proposed 
Rule 1-02(w)(1)(iii)(B)(3). Unlike these other rules, the definition 
of ``significant subsidiary'' in Rule 8b-2 historically has differed 
from the Rule 1-02(w) definition. As proposed, we also are 
conforming the Rule 8b-2 definition of ``significant subsidiary'' to 
the new definition added to Rule 1-02(w)(2) that is specifically 
tailored for investment companies. See Section II.E below.
---------------------------------------------------------------------------

ii. Comments
    With the exception of equity method investments, commenters did not 
address the specific proposed conforming changes. Some commenters 
suggested that the use of aggregate worldwide market value in the 
proposed Investment Test could introduce a new historical cost versus 
fair value disparity when evaluating equity method investments under 
Rules 3-09 and 17 CFR 210.4-08(g) (``4-08(g)'') because the 
registrant's and its other subsidiaries' ``investments in and advances 
to'' the investee may not be equivalent to a fair value amount when the 
investee is not newly acquired.\83\ In expressing support for the 
addition of a revenue component to the Income Test when testing the 
significance of equity method investees under Rules 3-09 and 4-08(g), 
one of these commenters

[[Page 54011]]

suggested several changes to the manner in which the revenue component 
would be calculated for equity method investees under Rules 3-09 and 4-
08(g).\84\ Another commenter noted that for equity method investees, 
whose revenues are not consolidated in the registrant's financial 
statements, the results of the proposed revenue component of the Income 
Test may not be meaningful.\85\
---------------------------------------------------------------------------

    \83\ See, e.g., letters from AMG, DT, and Williams.
    \84\ See letter from AMG. Specifically, the commenter 
recommended modifying the denominator of the revenue component to 
include all of the equity method investee's GAAP revenue such that 
the revenue component would compare the registrant's ``proportionate 
share'' of the equity method investee's revenue to the sum of the 
registrant's GAAP revenue and 100 percent of the equity method 
investee's GAAP revenue, without which the commenter suggested the 
proposal would produce incongruous comparisons. The commenter 
further recommended guidance on how to calculate ``proportionate 
share'' to address situations where a registrant may receive a share 
of revenue from an equity method investee that is different from the 
percentage of equity that the registrant may own and requested that 
the guidance include some level of discretion to allow registrants 
to use a method reasonably calculated to reflect the economic 
benefit the registrant receives relative to the equity method 
investee's GAAP revenue.
    \85\ See letter from GT.
---------------------------------------------------------------------------

iii. Final Amendments
    We are adopting the conforming amendments substantially as proposed 
with certain modifications in response to comments. The amendments are 
intended to reflect more accurately the relative significance to a 
registrant of a tested subsidiary and to reduce anomalous results in 
the application of the definition of ``significant subsidiary.'' As 
discussed in the Proposing Release, by maintaining the historical 
conformity between the ``significant subsidiary'' definitions, these 
amendments will avoid unnecessary regulatory complexity through 
consistent application of significance determinations made at the 
acquisition date and those made post-acquisition when the acquired 
business is a subsidiary of the registrant.\86\ In a change from the 
proposal and in order to simplify and maintain uniformity of the 
definition throughout our rules, the amendments to Securities Act Rule 
405 and Exchange Act Rule 12b-2 will fully conform with the definition 
in Rule 1-02(w), including Rule 1-02(w)(1)(iii)(B)(3).
---------------------------------------------------------------------------

    \86\ See Proposing Release at Section II.A.1.
---------------------------------------------------------------------------

    We are persuaded by commenters that using the registrant's 
aggregate worldwide market value instead of the registrant's total 
assets in the Investment Test would have inadvertently introduced a 
mismatch when evaluating equity method investments under Rules 3-09 and 
4-08(g) because the registrant's and its other subsidiaries' 
``investments in and advances to'' the investee may not be equivalent 
to a fair value amount when the investee is not newly acquired. Because 
a registrant's and its other subsidiaries' ``investments in and 
advances to'' would not necessarily be equivalent to fair value for 
purposes other than acquisitions or dispositions, we are also persuaded 
that the registrant's aggregate worldwide market value should not be 
used in place of the registrant's total assets for the additional 
purposes for which the ``significant subsidiary'' definition is 
used.\87\ Accordingly, we are retaining the comparison to the 
registrant's total assets used in the existing Investment Test for 
testing significance of equity method investees under Rules 3-09 and 4-
08(g), as well as for the additional purposes for which the definition 
is used.\88\
---------------------------------------------------------------------------

    \87\ See supra note 23.
    \88\ Id.
---------------------------------------------------------------------------

    We are not adopting any modifications to the proposed Income Test 
in response to comments received related to its application under Rules 
3-09 and 4-08(g) to investments accounted for using the equity method. 
We added the revenue component for acquisitions and dispositions of 
businesses to mitigate anomalous results produced by the current test 
based only on net income. We believe the revenue component can serve a 
similar role related to the application of Rules 3-09 and 4-08(g) to 
equity method investments.\89\ Additionally, using a test based on an 
amount that is not consolidated is not unprecedented for investments 
accounted for using the equity method. As the Commission has noted, the 
Asset Test applies to Rule 4-08(g), even though the total assets of the 
equity method investee are not consolidated by the registrant.\90\ 
Further, we believe the fact that significance is not determined on the 
basis of a single test and that Rule 4-08(g) disclosure about equity 
method investees is required if significance is met either individually 
or on an aggregated basis by any combination of investees at the 10 
percent level will help mitigate any potential adverse effects and help 
to provide an appropriate level of financial information about equity 
method investees.\91\
---------------------------------------------------------------------------

    \89\ The staff considers this additional factor when exercising 
its delegated authority under Rule 3-13 when a registrant makes a 
request to omit Rule 3-09 financial statements on the basis that the 
current income test produces an anomalous result.
    \90\ See Request for Comment on the Effectiveness of Financial 
Disclosures About Entities Other Than the Registrant, Release No. 
33-9929 (Sept. 25, 2015) [80 FR 59083 (Oct. 1, 2015)] at note 51 
(``In 1994, Rule 3-09 was revised to eliminate the asset test; 
however, the test was retained for Rule 4-08(g) to ensure a minimum 
level of financial information about an investee when the investment 
test was small, but a registrant's proportionate interest in the 
Investee's assets was material, as might be the case for a highly-
leveraged Investee. See Financial Statements of Significant Foreign 
Equity Investees and Acquired Foreign Businesses of Domestic Issuers 
and Financial Schedules, Release No. 33-7118 (Dec. 13, 1994) [59 FR 
65632].'').
    \91\ We are not persuaded to provide additional guidance on 
determining ``proportionate interest'' for the revenue component. We 
observe that ``proportionate interest'' is required to determine 
basis difference under U.S. GAAP or IFRS-IASB, as applicable, as 
well as the equity in the income of the investee. We believe 
proportionate interest used for those purposes will inform its use 
for the revenue component. Similarly, we are not persuaded that the 
equity method investee's revenue should be added to the registrant's 
revenue as it is not part of that revenue.
---------------------------------------------------------------------------

2. Audited Financial Statements for Significant Acquisitions
    Depending on the relative significance of the acquired or to be 
acquired business, Rule 3-05 Financial Statements may be required for 
up to three years.\92\
---------------------------------------------------------------------------

    \92\ Rule 3-05 Financial Statements are required for the most 
recent fiscal year and any required interim periods if any of the 
Rule 3-05 significance tests exceeds 20 percent, but none exceeds 40 
percent, a second year is required if any test exceeds 40 percent, 
but none exceeds 50 percent, and a third year is generally required 
if any of the tests exceeds 50 percent. Rule 3-05 contains an 
additional requirement for certain registration statements and proxy 
statements related to the aggregate effect of individually 
insignificant businesses, which may trigger a requirement for Rule 
3-05 Financial Statements for a business for which none of the 
significance tests exceeds 20 percent. See 17 CFR 210.3-05(b)(2). A 
smaller reporting company is subject to similar requirements under 
Rule 8-04 of Regulation S-X, but financial statements are only 
required for up to two fiscal years.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to revise Rule 3-05 to require only up to 
two years of Rule 3-05 Financial Statements. The Commission also 
proposed to revise Rule 3-05 for acquisitions where a significance test 
exceeds 20 percent, but none exceeds 40 percent, to require financial 
statements for the ``most recent'' interim period specified in 17 CFR 
210.3-01 and 210.3-02 (``Rules 3-01 and 3-02'') rather than ``any'' 
interim period. This proposed revision would eliminate the need to 
provide a comparative interim period when only one year of audited Rule 
3-05 Financial Statements is required.
b. Comments
    Commenters broadly supported the proposals,\93\ with no commenters 
opposing the changes.
---------------------------------------------------------------------------

    \93\ See, e.g., letters from Ball, Bass Berry, CFA, Cravath, Eli 
Lilly, FEI, Liberty, National Association of Real Estate Investment 
Trusts (``NAREIT''), Nasdaq, Inc. (``Nasdaq''), NYCBA--Sec., S&C, 
and SIFMA. See also SBCFAC Recommendations.

---------------------------------------------------------------------------

[[Page 54012]]

c. Final Amendments
    We are adopting the amendments as proposed to revise Rule 3-05 to 
require up to two years of Rule 3-05 Financial Statements. Unlike the 
historical financial statements of the registrant upon which investors 
rely to make investment decisions about the registrant, Rule 3-05 
Financial Statements are used, along with pro forma financial 
information, to discern how the acquired business may affect the 
registrant. Due to their age, the third year of Rule 3-05 Financial 
Statements is less likely to be indicative of the current financial 
condition, changes in financial condition, and results of operations of 
the acquired business. Such financial statements also do not reflect 
the changes in the acquired business or combined entity that occur 
post-acquisition or the accounting required by the registrant's 
comprehensive basis of accounting. Moreover, the requirement to prepare 
and obtain an audit of the third year of pre-acquisition financial 
statements can add significant incremental cost and time to the 
preparation of the disclosure. Such burdens are further exacerbated if 
a change in the acquired business's management or independent auditor 
has occurred, which may also delay a registrant's time to market and 
access to capital.
    We are additionally amending Rule 3-05 as proposed for acquisitions 
where a significance test exceeds 20 percent, but none exceeds 40 
percent, to require financial statements for the ``most recent'' 
interim period specified in Rules 3-01 and 3-02 rather than ``any'' 
interim period. The revision eliminates the need to provide a 
comparative interim period when only one year of audited Rule 3-05 
Financial Statements is required. In these circumstances, we believe 
that the most recent interim period provides the most relevant and 
material information to investors. Requiring a comparative interim 
period when there is no requirement for a corresponding comparative 
annual period would have limited utility for investors and imposes an 
additional burden on registrants to prepare such information.
    In adopting these changes, we note that regardless of the number of 
years presented, if trends depicted in Rule 3-05 Financial Statements 
are not indicative or are otherwise incomplete, 17 CFR 210.4-01(a) 
(``Rule 4-01(a)'') requires that a registrant provide ``such further 
material information as is necessary to make the required statements, 
in light of the circumstances under which they are made, not 
misleading.''
3. Financial Statements for Net Assets That Constitute a Business
    Registrants frequently acquire a component of an entity that is a 
business as defined in Rule 11-01(d) but does not constitute a separate 
entity, subsidiary, or division, such as a product line or a line of 
business contained in more than one subsidiary of the selling entity. 
These businesses may not have separate financial statements or maintain 
separate and distinct accounts necessary to prepare Rule 3-05 Financial 
Statements because they often represent only a small portion of the 
selling entity. In these circumstances, making relevant allocations of 
the selling entity's corporate overhead, interest, and income tax 
expenses necessary to provide Rule 3-05 Financial Statements may be 
impracticable and Commission staff has permitted registrants to instead 
provide audited abbreviated financial statements of the acquired 
business in the form of statements of assets acquired and liabilities 
assumed and statements of revenues and expenses.\94\
---------------------------------------------------------------------------

    \94\ Commission staff has exercised delegated authority pursuant 
to Rule 3-13 in these circumstances. In addition, Commission staff 
has provided informal guidance to address practical questions 
related to these and other financial reporting issues in the 
Division of Corporation Finance's Financial Reporting Manual 
(``FRM''), available at https://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf (last updated Dec. 1, 2017). The FRM 
is not a rule, regulation or statement of the Commission and the 
Commission has neither approved nor disapproved its content. See FRM 
at Section 2065 Acquisition of Selected Parts of an Entity may 
Result in Less than Full Financial Statements (``FRM 2065'').
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed Rule 3-05(e) to permit registrants to 
provide audited abbreviated financial statements in the form of 
statements of assets acquired and liabilities assumed, and statements 
of revenues and expenses (exclusive of corporate overhead, interest and 
income tax expenses) if the acquired business met certain qualifying 
and presentation conditions.\95\ More specifically, under proposed Rule 
3-05(e), a registrant would be permitted to present audited abbreviated 
financial statements of an acquired or to be acquired business \96\ if:
---------------------------------------------------------------------------

    \95\ The proposal did not specifically label the conditions as 
``qualifying conditions'' and ``presentation conditions.'' However, 
we are using these labels, in part, to clarify the requirements and, 
in part, to simplify the comparison between the final amendments and 
the proposed amendments.
    \96\ Neither the proposal nor the rules we are adopting affect 
the requirements in Rule 3-02 or 17 CFR 210.8-01 relating to 
predecessors.
---------------------------------------------------------------------------

     The business constitutes less than substantially all of 
the assets and liabilities of the seller and was not a separate entity, 
subsidiary, segment, or division during the periods for which the 
acquired business financial statements would be required;
     Separate financial statements for the business have not 
previously been prepared; and
     The seller has not maintained the distinct and separate 
accounts necessary to present financial statements that include the 
omitted expenses and it is impracticable to prepare such financial 
statements.
    Under proposed Rule 3-05(e), if the acquired or to be acquired 
business satisfies the above conditions, the audited abbreviated 
financial statements must also conform to certain presentation 
conditions, including:
     Interest expense may only be excluded from the statements 
if the debt to which the interest expense relates will not be assumed 
by the registrant or its subsidiaries consolidated;
     The statements of revenues and expenses do not omit 
selling, distribution, marketing, general and administrative, and 
research and development expenses incurred by or on behalf of the 
acquired business during the periods to be presented; and
     The notes to the financial statements include certain 
additional disclosures.\97\
---------------------------------------------------------------------------

    \97\ Specifically, the additional disclosure would include: The 
type of omitted expenses and the reasons why they are excluded from 
the financial statements; information about the business's 
operating, investing, and financing cash flows, to the extent 
available; an explanation of the impracticability of preparing 
financial statements that include the omitted expenses; and a 
description of how the financial statements presented are not 
indicative of the financial condition or results of operations of 
the acquired business going forward because of the omitted expenses.
---------------------------------------------------------------------------

b. Comments
    Commenters generally supported permitting abbreviated financial 
statements,\98\ although one commenter recommended that the Commission 
consider whether abbreviated financial statements satisfy investors' 
needs when the acquired business is a significant portion of the 
selling entity.\99\ This commenter recommended the Commission provide a 
threshold on what constitutes ``substantially all'' \100\ and 
questioned whether using a ``small

[[Page 54013]]

portion of the selling entity'' might be a better standard than ``less 
than substantially all of the assets and liabilities of the seller.'' 
\101\ Another commenter recommended requiring registrants to indicate 
how abbreviated financial statement information is integrated into the 
pro forma financial information and suggested that the Commission 
clarify what type of auditor assurance would be provided for 
abbreviated financial statement information.\102\
---------------------------------------------------------------------------

    \98\ See, e.g., letters from BDO, CAQ, Cravath, Debevoise & 
Plimpton LLP (``Debevoise''), DT, Eli Lilly, EY, FEI, GT, IMA, PWC, 
RSM, and S&C.
    \99\ See letter from GT.
    \100\ Id. GT noted that absent any threshold, there would likely 
be diversity in how registrants interpret this phrase.
    \101\ See letter from GT. This commenter noted that in the 
Proposing Release the Commission had recognized that there could be 
challenges in making allocations of the selling entity's corporate 
overhead, interest, and taxes when the acquired business constitutes 
only a small portion of the selling entity. However, the commenter 
stated its view that the language in the proposed rule would allow 
registrants that acquire a significant portion of the selling entity 
to present abbreviated financial statements, as long as such 
business does not meet any of the other conditions outlined in the 
proposal.
    \102\ See letter from CFA.
---------------------------------------------------------------------------

    Some commenters sought additional clarification of the terms, such 
as defining ``separate entity,'' ``subsidiary,'' ``segment,'' and 
``division'' in the context of an acquisition.\103\ Other commenters 
questioned the use of ``impracticable'' recommending further 
clarification or a reduced standard.\104\ One commenter sought 
clarification on the meaning of ``previously prepared.'' \105\ Another 
commenter requested that the Commission clarify the nature of expenses 
to be included in the abbreviated financial statements by describing 
those that may be omitted or those that must be presented, but not 
both, noting that it is unclear whether the identified expenses are 
intended to be all-inclusive.\106\
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    \103\ See, e.g., letters from CAQ, Crowe, DT, PWC, and RSM.
    \104\ See, e.g., letters from Debevoise, EY and GT.
    \105\ See letter from GT.
    \106\ See letter from DT. Another commenter recommended that the 
Commission also permit registrants to exclude any remaining amounts 
classified as other income or other expense, subject to the same or 
similar requirements. See letter from IMA.
---------------------------------------------------------------------------

    Some commenters sought clarification of when carve-out financial 
statements of an acquired business would be appropriate.\107\ One 
commenter suggested that in the absence of clarification, the more 
comprehensive carve-out financial statements may be less commonly 
used,\108\ while another commenter recommended that the Commission 
codify certain staff practices \109\ as they relate to presenting 
carve-out financial statements.\110\
---------------------------------------------------------------------------

    \107\ See letters from BDO, CAQ, Crowe, DT, EY, GT, PWC, and 
RSM. Neither our proposal nor the final rule addresses carve-out 
financial statements. ``Carve-out financial statements'' is a 
generic term used to describe separate financial statements that are 
derived from the financial statements of a larger parent company. 
They are often differentiated from abbreviated financial statements 
in that reasonable allocations of corporate overhead expenses can be 
made such that the underlying preparation issues involve the scope 
of the businesses to be included in the historical financial 
statements, not whether financial statements can be prepared.
    \108\ See letter from DT.
    \109\ See FRM supra note 94 at Section 2065; Staff Accounting 
Bulletin No. 1.B., Allocation Of Expenses And Related Disclosure In 
Financial Statements Of Subsidiaries, Divisions Or Lesser Business 
Components Of Another Entity.
    \110\ See letter from GT.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting amendments to our rules to permit registrants to 
provide audited annual and unaudited interim abbreviated financial 
statements substantially as proposed, with certain modifications 
described below. Recognizing the difficulty registrants face in 
obtaining and the cost of preparing Rule 3-05 Financial Statements in 
these circumstances, we believe permitting abbreviated financial 
statements coupled with the additional required disclosures 
appropriately balances the cost of preparing the financial disclosures 
with the protection of investors.
    The following chart compares our proposal to the final rules.

------------------------------------------------------------------------
                                    Proposed               Adopted
------------------------------------------------------------------------
Qualifying conditions.......  The business          The total assets and
                               constitutes less      total revenues
                               than substantially    (both after
                               all of the assets     intercompany
                               and liabilities of    eliminations) of
                               the seller.           the acquired or to
                                                     be acquired
                                                     business constitute
                                                     20 percent or less
                                                     of such
                                                     corresponding
                                                     amounts of the
                                                     seller and its
                                                     subsidiaries
                                                     consolidated as of
                                                     and for the most
                                                     recently completed
                                                     fiscal year.
                              The business was not  The acquired
                               a separate entity,    business was not a
                               subsidiary,           separate entity,
                               segment, or           subsidiary,
                               division during the   operating segment
                               periods for which     (as defined in U.S.
                               the acquired          GAAP or IFRS-IASB,
                               business financial    as applicable), or
                               statements would be   division during the
                               required.             periods for which
                                                     the acquired
                                                     business financial
                                                     statements would be
                                                     required.
                              Separate financial    No substantive
                               statements for the    change.
                               business have not
                               previously been
                               prepared.
                              The seller has not    No substantive
                               maintained the        change.
                               distinct and
                               separate accounts
                               necessary to
                               present financial
                               statements that
                               include the omitted
                               expenses and it is
                               impracticable to
                               prepare such
                               financial
                               statements.
Presentation requirements...  The balance sheet     No substantive
                               may be a statement    change.
                               of assets acquired
                               and liabilities
                               assumed.
                              The statement of      No substantive
                               comprehensive         change. The title
                               income may be a       of the statement of
                               statement of          comprehensive
                               revenues and          income must be
                               expenses (exclusive   appropriately
                               of corporate          modified to
                               overhead, interest    indicate it omits
                               and income tax        certain expenses.
                               expenses) if
                               certain
                               presentation
                               requirements are
                               met.
                              Corporate overhead    The statement of
                               expenses may be       comprehensive
                               excluded from the     income must include
                               statement of          expenses incurred
                               comprehensive         by or on behalf of
                               income provided       the acquired
                               that the statement    business during the
                               does not omit         pre-acquisition
                               selling,              financial statement
                               distribution,         periods to be
                               marketing, general    presented
                               and administrative,   including, but not
                               and research and      limited to, costs
                               development           of sales or
                               expenses incurred     services, selling,
                               by or on behalf of    distribution,
                               the acquired          marketing, general
                               business during the   and administrative,
                               periods to be         depreciation and
                               presented.            amortization, and
                                                     research and
                                                     development, but
                                                     may otherwise omit
                                                     corporate overhead
                                                     expenses.

[[Page 54014]]

 
                              Interest expense may  No substantive
                               be excluded from      change.
                               the statements if
                               the debt to which
                               the interest
                               expense relates
                               will not be assumed
                               by the registrant
                               or its subsidiaries
                               consolidated.
                              Income tax expense    No substantive
                               may be omitted.       change.
                              The notes to the      No substantive
                               financial             change.
                               statements include
                               the following
                               additional
                               disclosures:.
                              (i) The type of
                               omitted expenses
                               and the reason(s)
                               why they are
                               excluded from the
                               financial
                               statements;.
                              (ii) An explanation
                               of the
                               impracticability of
                               preparing financial
                               statements that
                               include the omitted
                               expenses;.
                              (iii) A description
                               of how the
                               financial
                               statements
                               presented are not
                               indicative of the
                               financial condition
                               or results of
                               operations of the
                               acquired business
                               going forward
                               because of the
                               omitted expenses;
                               and.
                              (iv) Information
                               about the
                               business's
                               operating,
                               investing and
                               financing cash
                               flows, to the
                               extent available.
------------------------------------------------------------------------

    We are persuaded by commenter feedback that a condition focused on 
whether the acquired business is a small portion of the selling entity 
would be a more appropriate standard than ``less than substantially all 
of the assets and liabilities of the seller'' for permitting the use of 
abbreviated financial statements. A ``small portion of the selling 
entity'' standard would help ensure that abbreviated financial 
statements are not used when the component of the selling entity 
acquired is sufficiently large such that presentation of the seller's 
financial statements, along with pro forma financial information that 
removes the portion of the seller not acquired, would best inform 
investors about the business acquired. We are also persuaded that 
absent any threshold, there would likely be divergence in how 
registrants interpret ``small portion of the selling entity.'' \111\ 
Accordingly, we are adopting amendments to replace the proposed ``less 
than substantially all of the assets and liabilities of the seller'' 
condition for use of abbreviated financial statements with a condition 
that ``the total assets and total revenues (both after intercompany 
eliminations) of the acquired or to be acquired business constitute 20 
percent or less of such corresponding amounts of the seller and its 
subsidiaries consolidated as of and for the most recently completed 
fiscal year.'' \112\ We believe that 20 percent or less is an 
appropriate level for identifying when the acquired business is a small 
portion of the selling entity because, at that level, it is reasonable 
to expect that expenses would not be fully allocated and that 
comparisons of total assets and total revenues will be sufficient for 
this purpose.\113\ A 20 percent threshold also is generally consistent 
with the staff's granting of relief pursuant to Rule 3-13 in such 
situations. In situations where an acquired business exceeds the 20 
percent threshold but the registrant nonetheless confronts unique 
challenges in making the relevant allocations necessary to provide Rule 
3-05 Financial Statements, the registrant could continue to seek relief 
pursuant to Rule 3-13.
---------------------------------------------------------------------------

    \111\ See letter from GT.
    \112\ See amended Rule 3-05(e)(1)(i).
    \113\ A comparison of pre-tax income will not ordinarily be 
meaningful because pre-tax income will seldom be readily 
determinable for acquisitions of this nature.
---------------------------------------------------------------------------

    Of the various terms recommended by commenters for definition or 
clarification, we were persuaded that the term ``segment'' should be 
further refined to clarify that it refers to an ``operating segment (as 
defined in U.S. GAAP or IFRS-IASB, as applicable)'' rather than, for 
example, a reportable segment. We note that many of the other terms 
cited by commenters have long been associated with the historical 
practice of using abbreviated financial statements and we believe their 
meanings are generally understood. To the extent registrants have 
unique circumstances relating to the application of these terms in the 
context of a transaction, the registrant could seek relief pursuant to 
Rule 3-13. We are therefore not persuaded that further clarification is 
necessary in order to implement proposed Rule 3-05(e).
    We believe that the qualifying conditions for use of abbreviated 
financial statements included in the final rule are appropriate to 
delineate the circumstances for their permitted use and provide an 
appropriate balance between investor protection and capital access. As 
noted above, one commenter requested clarity on the expenses to be 
included in abbreviated financial statements. In response to this 
comment, we have sought to improve the description of required expenses 
by:
     Reorganizing the rule text into ``qualifying conditions'' 
and ``presentation requirements'' and shortening the introductory 
paragraph; \114\
---------------------------------------------------------------------------

    \114\ See amended Rule 3-05(e).
---------------------------------------------------------------------------

     Clarifying that the expenses required in the statement of 
comprehensive income must include expenses incurred by or on behalf of 
the acquired business during the pre-acquisition financial statement 
periods to be presented, but may otherwise omit corporate overhead 
expense, interest expense for debt that will not be assumed by the 
registrant or its subsidiaries consolidated, and income tax expense; 
and
     Adding cost of sales or services and depreciation and 
amortization expense to the list of expenses that must be included in 
abbreviated financial statements and clarifying that it is an 
illustrative list.\115\
---------------------------------------------------------------------------

    \115\ The title of the statement of comprehensive income must be 
appropriately modified to indicate it omits certain expenses.
---------------------------------------------------------------------------

    As previously noted, neither our proposal nor the final rule 
address ``carve-out financial statements.'' Given that carve-out 
financial statements are not addressed by this release and because 
issues relating to carve-out financial statements may require unique 
judgments that involve the balance between investor protection and 
capital access, we believe questions relating to carve-out financial 
statements are best addressed on the basis of their unique facts and 
circumstances through the staff consultation process.\116\
---------------------------------------------------------------------------

    \116\ See Rule 3-13, supra note 58.

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[[Page 54015]]

4. Financial Statements of a Business That Includes Oil and Gas 
Producing Activities
    Rule 3-05 applies to acquisitions of a significant business \117\ 
that includes oil and gas producing activities.\118\ However, Rule 3-05 
does not specify industry-specific disclosures regarding such 
activities. In the absence of specific requirements, registrants 
generally provide certain industry-specific disclosures specified in 
FASB ASC Topic 932 Extractive Activities--Oil and Gas (``ASC 932 
Disclosures'') \119\ on an unaudited basis for each full year of 
operations presented for the acquired business.
---------------------------------------------------------------------------

    \117\ See Rule 11-01(d).
    \118\ See the definition of ``oil and gas producing activities'' 
at 17 CFR 210.4-10(a)(16).
    \119\ See FASB ASC Topic 932 Extractive Activities--Oil and Gas, 
932-235-50-3 through 50-11 and 932-235-50-29 through 50-36, and FRM 
supra note 94 at Section 2065.12. These supplemental disclosures are 
a subset of those required in the financial statements of publicly 
traded companies with significant oil- and gas-producing activities 
and provide additional context for those financial statements.
---------------------------------------------------------------------------

    Rule 3-05 also does not specify the form and content of Rule 3-05 
Financial Statements when the acquired business generates substantially 
all of its revenues from oil and gas producing activities. Often, this 
type of business represents a component of an entity, but does not 
constitute a separate entity, subsidiary, operating segment (as defined 
in U.S. GAAP or IFRS-IASB, as applicable), or division for which 
separate financial statements exist and for which historical 
depreciation, depletion and amortization expense is likely not 
meaningful to an understanding of the potential effects of the acquired 
business on the registrant.\120\ In these circumstances when certain 
criteria are met, Commission staff, pursuant to Rule 3-13 and delegated 
authority, has permitted registrants to provide abbreviated financial 
statements that consist of income statements modified to exclude 
expenses that are not expected to be comparable to future 
operations.\121\
---------------------------------------------------------------------------

    \120\ Historical depreciation, depletion and amortization 
expense is frequently not maintained at the property level and does 
not reflect the acquiring company's basis in the properties.
    \121\ See FRM supra note 94 at Section 2065.6, 2065.11, and 
2065.12. Permitting registrants in these circumstances to substitute 
abbreviated income statements that omit expenses not comparable to 
future operations is consistent with the financial statement 
requirements specified in Rule 3-14 for acquired real estate 
operations. Rule 3-14 specifies that Rule 3-14 Financial Statements 
must omit depreciation expenses not comparable to future operations.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed Rule 3-05(f) to codify the reporting 
practices for oil and gas producing activities by requiring certain ASC 
932 Disclosures on an unaudited basis for each full year of operations 
presented for the acquired business. In addition, where the oil and gas 
producing business represents a component of an entity that does not 
constitute a separate entity, subsidiary, segment, or division for 
which separate financial statements exist and for which historical 
depreciation, depletion and amortization expense is likely not 
meaningful to an understanding of the potential effects of the acquired 
business on the registrant, the Commission proposed to permit 
registrants to provide abbreviated financial statements that consist of 
income statements modified to exclude expenses not comparable to future 
operations.
b. Comments
    One commenter specifically supported the codification of current 
practices relating to a business that includes oil and gas producing 
activities as proposed \122\ while another commenter supported the 
proposal generally but suggested removing one of the conditions.\123\ 
No commenters opposed the proposed amendments.
---------------------------------------------------------------------------

    \122\ See letter from KPMG. KPMG also suggested permitting 
abbreviated financial statements for businesses that service oil and 
gas fields (e.g., the acquisition of a midstream facility or storage 
facility).
    \123\ See letter from Cravath. Cravath recommended removing the 
condition that the business ``was not a separate entity, subsidiary, 
segment, or division.''
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments substantially as proposed. 
Specifically, for a significant acquired business that includes 
significant oil- and gas-producing activities (as defined in the FASB 
ASC Master Glossary),\124\ Rule 3-05 Financial Statements must include 
certain ASC 932 Disclosures, which may be presented as unaudited 
supplementary information for each full year of operations presented 
for the acquired business.\125\ Additionally, Rule 3-05 Financial 
Statements may consist of only audited statements of revenues and 
expenses that exclude depreciation, depletion and amortization expense, 
corporate overhead expense, income taxes, and interest expense that are 
not comparable to the proposed future operations if: (1) Substantially 
all of the revenues of the business are generated from oil-and gas-
producing activities (as defined in Sec.  210.4-10(a)(16)), and (2) the 
qualifying conditions for abbreviated financial statements described in 
Section II.A.3.c above are met.\126\ In these circumstances, the 
footnote disclosures described in Section II.A.3.c above must also be 
provided.\127\ As discussed in the Proposing Release, we believe that 
codifying these practices provides clarity for registrants regarding 
the application of Commission rules in these circumstances, which we 
believe will facilitate compliance to the benefit of both registrants 
and investors.\128\
---------------------------------------------------------------------------

    \124\ We are adopting this definition of significant oil- and 
gas-producing activities to be consistent with current practice. 
Accordingly, the FASB's threshold for determining when ASC 932 
Disclosures of unaudited supplemental information is required will 
be applied in determining specified disclosures in ASC 932-235-50 
for purposes of Rule 3-05 Financial Statements, even if the acquired 
business is not a publicly-traded company.
    \125\ See ASC 932-235-50-3 through 50-11 and ASC 932-235-50-29 
through 50-36.
    \126\ We were not persuaded by the commenter suggesting the 
condition that the business ``was not a separate entity, subsidiary, 
segment, or division'' should be removed. We believe this condition 
can be indicative of circumstances where reasonable allocations 
necessary to prepare financial statements can be made.
    \127\ The amendments revise proposed Rule 3-05(f) to simplify 
its text and to reference the applicable qualifying and presentation 
conditions of amended Rule 3-05(e).
    \128\ See Section II.A.4 of the Proposing Release.
---------------------------------------------------------------------------

5. Timing and Terminology of Financial Statement Requirements
a. Proposed Amendments
    The Commission proposed several revisions to Rule 3-05 and Article 
11 to clarify when Rule 3-05 Financial Statements and pro forma 
financial information are required and to update the language in the 
rules to take into account concepts that have developed since their 
original adoption over 30 years ago.
b. Comments
    Commenters were generally supportive of the proposed changes.\129\ 
Some commenters sought clarification that the ``applicable independence 
standards'' in the proposed requirement that financial statements be 
``prepared in accordance with this regulation (including the 
independence standards in Sec.  210.2-01 or, alternatively if the 
business is not a registrant, the applicable independence standards)'' 
would be those related to the auditing standards under which the 
required financial statements of the acquired or to-be-acquired 
business were audited.\130\

[[Page 54016]]

One commenter further recommended clarifying whether the reference to 
``filed'' in the phrase in proposed Rule 11-01(b)(3) ``most recent 
annual consolidated financial statements filed at or prior to the date 
of acquisition or disposition'' is the same as ``required to be filed'' 
and how the phrase ``most recent annual financial statements of each 
such business'' applies to nonpublic acquired or to-be-acquired 
businesses.\131\ Another commenter recommended that the timing of the 
pro forma financial information be accelerated to a date closer to when 
the deal is announced to the public.\132\ Another commenter recommended 
that the ``significant subsidiary'' definition should explicitly state 
that the amounts used for testing should be derived from 
``consolidated'' financial statements of the tested subsidiary and of 
the registrant.\133\
---------------------------------------------------------------------------

    \129\ See, e.g., letters from Cravath and Eli Lily.
    \130\ See letters from CAQ, Crowe, and RSM. See also letters 
from KPMG (recommending ``independence standards would be those 
applicable under the auditing standards used to perform the audit of 
the acquired or to be acquired business'') and Deloitte 
(recommending clarification as to whether ``applicable independence 
standards'' refers to any independence standards other than those 
described in either Article 2, Qualifications and Reports of 
Accountants, or the independence standards of the AICPA).
    \131\ See letter from Deloitte.
    \132\ See letter from CFA (recommending four business days after 
the occurrence of the event with the ability to extend the deadline 
to a maximum of 30 days in order to balance the compliance burden 
with the imperative of timely disclosure to the market). Item 9.01 
of Form 8-K currently permits up to approximately 75 days after 
consummation of an acquisition.
    \133\ See letter from Eli Lily.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments substantially as proposed with some 
additional changes reflecting the suggestions of commenters and our 
further consideration of the proposals. Specifically, we are amending 
Rule 3-05 and Article 11, as proposed, to:
     Specify that financial statements are required if a 
business acquisition has occurred during the most recent fiscal year or 
subsequent interim period for which a balance sheet is required by 17 
CFR 210.3-01 of Regulation S-X (``Rule 3-01''), or if a business 
acquisition has occurred or is probable after the date that the most 
recent balance sheet has been filed; \134\ and
---------------------------------------------------------------------------

    \134\ We are amending Rule 3-05(a)(1) to clarify when financial 
statements are required and to conform the language in those 
requirements with the current requirements in Rule 11-01(a). 
Additionally, in conforming Rule 3-05(a)(1) with Rule 11-01(a), the 
explanation that the acquisition of a business encompasses the 
acquisition of an interest in a business accounted for by the equity 
method was moved from Rule 3-05(a)(1)(i) to Rule 3-05(a)(2)(ii).
---------------------------------------------------------------------------

     Provide in Rules 3-05(b)(3) and 11-01(b)(3)(i)(C) that a 
registrant may continue to determine significance using amounts 
reported in its Form 10-K for the most recent fiscal year when the 
registrant has filed its Form 10-K after the acquisition consummation 
date, but before the date the registrant is required to file financial 
statements of the acquired business on Form 8-K.\135\
---------------------------------------------------------------------------

    \135\ Pursuant to Rule 3-13, registrants have been permitted to 
omit Rule 3-05 Financial Statements if an acquired business is not 
significant using these amounts. We are establishing by rule that 
registrants are permitted, rather than required, to use the Form 10-
K filed after consummation to measure significance in this 
circumstance to avoid creating an incentive for registrants to delay 
the filing of their Form 10-K.
---------------------------------------------------------------------------

    We additionally are updating the terminology and language used by 
revising Rule 3-05 and Article 11, as proposed, to:
     Clarify that ``financial statements'' need not include 
related schedules specified in 17 CFR 210.12 (``Article 12''); \136\
---------------------------------------------------------------------------

    \136\ Item 9.01(a)(2) of Form 8-K already provides that 
supporting schedules of financial statements need not be filed and 
the staff further applies this approach to acquired business 
financial statements required in registration statements and proxy 
statements. See FRM supra note 94 at Section 2005.2.
---------------------------------------------------------------------------

     Clarify that a ``business'' that is a real estate 
operation is subject to Rule 3-14 instead of Rule 3-05;
     Clarify in Rule 3-05(a)(2)(ii) that Rule 3-05 applies when 
the fair value option is used in lieu of the equity method to account 
for an acquisition because the disclosure required by U.S. GAAP on a 
post-acquisition basis, and related disclosure provided pursuant to 
Rules 3-09 and 4-08(g), includes summarized financial information or 
separate financial statements of the business after the acquisition;
     Replace the term ``furnish'' with ``file'' to make clear 
that the information required by Rule 3-05 and Article 11 must be filed 
with the Commission; \137\
---------------------------------------------------------------------------

    \137\ Throughout Rule 3-05 and Article 11, the regulatory text 
indicates that financial statements ``shall be furnished.'' See Rule 
3-05(a)(1), (b)(1), (b)(2)(i), (ii), (iii), and (iv), and (b)(4)(ii) 
and (iii), Rule 11-01(a) and Instruction 2 to Rule 11-02(b). At the 
time the Commission adopted Rule 3-05, the Commission made no 
distinction between ``furnished'' and ``filed.'' See Rule 3-05 
Adopting Release.
---------------------------------------------------------------------------

     Clarify that references to ``Regulation S-X'' in Rule 3-
05, Rule 3-14, and Rule 6-11 include the independence standards in 17 
CFR 210.2-01 (``Rule 2-01'') unless the business is not a registrant, 
in which case the applicable independence standards would apply;
     Replace references to the terms ``business combination'' 
and ``combination between entities under common control'' with the term 
``business acquisition'' to make clear that Rule 3-05 and Article 11 
are not limited to ``business combinations'' as that term is used in 
U.S. GAAP and IFRS-IASB; \138\ and
---------------------------------------------------------------------------

    \138\ We similarly are adopting a conforming amendment to the 
Instruction to Item 9.01 of Form 8-K.
---------------------------------------------------------------------------

     Replace the term ``majority-owned'' with the term 
``subsidiaries consolidated,'' as that term more accurately conveys 
which subsidiaries are required to be included in the registrant's 
financial statements.\139\
---------------------------------------------------------------------------

    \139\ Rule 3-05 uses the term ``subsidiaries consolidated'' to 
conform to the term used elsewhere in Regulation S-X. See, e.g., 
Rule 1-02(w), Rule 3-01, and Rule 3-02. We additionally are 
replacing the term in Item 2.01 of Form 8-K.
---------------------------------------------------------------------------

    Finally, we are adopting the following clarifying amendments, as 
proposed, to Rules 1-02(w), 3-05, Form 8-K and Article 11 to:
     Replace the reference to ``total assets'' of the tested 
subsidiary in the Asset Test with the tested subsidiary's 
``consolidated total assets'' as that term conveys more accurately the 
amount to be used in the Asset Test; \140\
---------------------------------------------------------------------------

    \140\ Consistent with a comment we received, we are adopting 
this change to clarify that all amounts used in the significant 
subsidiary tests that are derived from financial statements of the 
tested subsidiary and the registrant should be based on consolidated 
amounts. See supra note 133. The Investment Test and Income Test, as 
proposed, already specified the requirement to use consolidated 
amounts.
---------------------------------------------------------------------------

     Replace the term ``shall'' with clearer language, such as 
by indicating when a registrant ``must'' file or disclose certain 
information;
     Revise proposed Rule 11-01(b)(3) to:
    [cir] Simplify its organization;
    [cir] Clarify that it does not apply to the continuous real estate 
offerings described in new Rule 11-01(b)(4); \141\
---------------------------------------------------------------------------

    \141\ See Section II.C.6. Proposed Rule 3-14(b)(2)(iii) was 
relocated and relabeled as Rule 11-01(b)(4).
---------------------------------------------------------------------------

    [cir] Replace the reference to ``filed'' with ``required to be 
filed'' to more clearly reflect existing practice; \142\
---------------------------------------------------------------------------

    \142\ Use of ``required to be filed'' would also clarify that 
the 15-day extension provided by Form 12b-25 does not serve to 
revert the significance determination to an earlier year during the 
15-day extension.
---------------------------------------------------------------------------

    [cir] Remove the reference to related real estate operations for 
combined pre-acquisition financial statements; \143\ and
---------------------------------------------------------------------------

    \143\ The reference to related real estate operations is not 
necessary in this context because only a modified Investment Test is 
required for significance testing of these acquisitions.
---------------------------------------------------------------------------

    [cir] Clarify what financial statements of a nonpublic acquired or 
to-be-acquired business must be used in the significance determination; 
\144\
---------------------------------------------------------------------------

    \144\ The amended rules replace the phrase ``most recent annual 
financial statements of each such business'' with ``the business's 
pre-acquisition or pre-disposition financial statements for the same 
fiscal year as the registrant or, if the fiscal years differ, the 
business's most recent fiscal year that would be required if the 
business had the same filer status as the registrant.''

---------------------------------------------------------------------------

[[Page 54017]]

     Revise Instruction 4 to Item 2.01 of Form 8-K to include 
the same clarification of the scope of Rule 3-05 with regards to 
interests in businesses that will be accounted for under the equity 
method or, in lieu of the equity method, the fair value option; \145\ 
and
---------------------------------------------------------------------------

    \145\ Item 2.01 of Form 8-K does not explicitly clarify the 
treatment of interests in businesses that will be accounted for 
under the equity method or, in lieu of the equity method, the fair 
value option. However, the determination of whether an acquisition 
involves a business is consistent between Item 2.01 of Form 8-K and 
Rule 3-05, because both Instruction 4 to Item 2.01 of Form 8-K and 
Rule 3-05(a)(2)(ii) refer to the same definition of a business in 
Rule 11-01(d), and the requirements of Item 2.01 of Form 8-K are 
linked to the requirements of Rule 3-05 through Item 9.01 of Form 8-
K. This amendment conforms Item 2.01 of Form 8-K to include the 
additional clarification from Rule 3-05.
---------------------------------------------------------------------------

     Conform technical terminology inconsistencies throughout 
the rules.\146\
---------------------------------------------------------------------------

    \146\ For example, proposed Rule 3-05(c) has been amended to 
include a reference to the definition of a foreign business in Rule 
1-02(l) to be consistent with proposed Rule 3-05(d) which already 
included the reference.
---------------------------------------------------------------------------

    We are not adopting modifications to clarify, as requested by 
commenters, the ``applicable independence standards'' in the proposed 
requirement that financial statements be ``prepared in accordance with 
this regulation (including the independence standards in Sec.  210.2-01 
or, alternatively if the business is not a registrant, the applicable 
independence standards)'' because the independence standards applicable 
for a particular audit are not necessarily linked to the auditing 
standards used for such an audit. For example, for purposes of auditing 
non-issuer Rule 3-05 or Rule 3-14 Financial Statements, an auditor may 
follow AICPA auditing and independence standards but also may elect to 
perform the audit under PCAOB auditing standards. Our amendments are 
not intended to change practice by referring to ``applicable 
independence standards,'' but rather to acknowledge that for an 
acquired or to be acquired business that is a non-issuer, an auditor is 
not required to follow the independence standards in Rule 2-01 for 
purposes of auditing Rule 3-05 and Rule 3-14 Financial Statements. As a 
result, if the acquired or to be acquired business is not an issuer, 
the auditor should look to the applicable ethics and independence 
standards that would apply in issuing the audit report for such 
business in satisfying the audit requirement for purposes of the Rule 
3-05 and Rule 3-14 Financial Statements.
    We are also not adopting requirements to accelerate the timing of 
providing pro forma financial information, as one commenter suggested. 
For acquisitions, pro forma financial information is based on the 
audited financial statements of the acquired business for periods prior 
to the acquisition of the business by the registrant. In these 
circumstances, our requirements provide additional time for registrants 
to obtain acquired business pre-acquisition historical financial 
statements, which we believe should also continue to extend to pro 
forma financial information.\147\
---------------------------------------------------------------------------

    \147\ See, e.g., Item 9.01 of Form 8-K.
---------------------------------------------------------------------------

6. Foreign Businesses
    Regulation S-X permits the use of IFRS-IASB without reconciliation 
to U.S. GAAP in financial statements of foreign private issuers.\148\ 
Rule 3-05 similarly permits the use of IFRS-IASB in financial 
statements of foreign businesses. However, if Rule 3-05 Financial 
Statements of a foreign business are prepared on a basis of accounting 
other than U.S. GAAP or IFRS-IASB, such as home-country GAAP, the Rule 
3-05 Financial Statements are required to be reconciled to U.S. GAAP 
even if the registrant is a foreign private issuer that prepares its 
financial statements in accordance with IFRS-IASB.\149\
---------------------------------------------------------------------------

    \148\ See 17 CFR 210.4-01.
    \149\ See Item 17 of Form 20-F and Financial Statements of 
Significant Foreign Equity Investees and Acquired Foreign Businesses 
of Domestic Issuers and Financial Schedules, Release No. 33-7118 
(Dec. 13, 1994) [59 FR 65632 (Dec. 20, 1994)] (``1994 Acquired 
Foreign Business Release'').
---------------------------------------------------------------------------

    Further, while the definitions of ``foreign private issuer'' \150\ 
and ``foreign business'' \151\ have similarities, they have different 
ownership requirements such that a business could qualify to be a 
``foreign private issuer'' if it were a registrant, but not qualify to 
be a ``foreign business'' when it is acquired by a registrant. In this 
circumstance, a registrant acquiring such a business is not permitted 
to present Rule 3-05 Financial Statements of the acquired business 
prepared in accordance with IFRS-IASB, even when those financial 
statements are already available and even though the acquired business 
could present IFRS-IASB financial statements if it were a registrant. 
Instead, the Rule 3-05 Financial Statements must be prepared in 
accordance with U.S. GAAP.\152\
---------------------------------------------------------------------------

    \150\ See Securities Act Rule 405. The term ``foreign private 
issuer'' means any foreign issuer, other than a foreign government, 
that does not meet the following criteria as of the last business 
day of its most recently completed second fiscal quarter: (i) More 
than 50 percent of the outstanding voting securities of such issuer 
are directly or indirectly owned of record by residents of the 
United States; and (ii) Any of the following: (a) The majority of 
the executive officers or directors are United States citizens or 
residents; (b) More than 50 percent of the assets of the issuer are 
located in the United States; or (c) The business of the issuer is 
administered principally in the United States.
    \151\ See 17 CFR 210.1-02(l). The term ``foreign business'' 
means a business that is majority owned by persons who are not 
citizens or residents of the United States and is not organized 
under the laws of the United States or any state thereof, and 
either: (1) More than 50 percent of its assets are located outside 
the United States; or (2) The majority of its executive officers and 
directors are not United States citizens or residents.
    \152\ Alternatively, the Rule 3-05 Financial Statements may be 
prepared in accordance with a basis of accounting other than U.S. 
GAAP provided a reconciliation to U.S. GAAP under Item 18 of Form 
20-F is included. See 1994 Acquired Foreign Business Release.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to permit Rule 3-05 Financial Statements 
for an acquired foreign business prepared using home country GAAP to be 
reconciled to IFRS-IASB rather than U.S. GAAP if the registrant is a 
foreign private issuer that prepares its financial statements using 
IFRS-IASB. The Commission also proposed to permit Rule 3-05 Financial 
Statements to be prepared in accordance with IFRS-IASB without 
reconciliation to U.S. GAAP if the acquired business would be a foreign 
private issuer if it were a registrant.
b. Comments
    Commenters generally supported the proposal,\153\ with some 
recommending providing additional relief by allowing reconciliation to 
IFRS-IASB rather than U.S. GAAP for a business that prepares its 
financial statements using home-country GAAP and does not meet the 
definition of a foreign business but that would be a foreign private 
issuer if it were a registrant.\154\ One commenter additionally 
suggested that the Commission provide guidance on the applicability of 
IFRS 1, First-time Adoption of IFRS,\155\ and accommodations under Form 
20-F when reconciling to IFRS-IASB.\156\

[[Page 54018]]

Irrespective of the GAAP being applied or reconciled to, some 
commenters recommended that the Commission consider permitting required 
audit reports on the financial statements of acquired foreign 
businesses to be prepared in accordance with International Standards on 
Auditing (``ISAs'') issued by the International Auditing and Assurance 
Standards Board.\157\
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    \153\ See, e.g., letters from Chris Barnard (``Barnard''), 
Cravath, DT, NAREIT, Nasdaq, and PWC.
    \154\ See, e.g., letters from BDO, CAQ, DT, EY, KPMG, and RSM. 
Some of these commenters recommended simplifying the rules by 
expanding proposed Rule 3-05(c) and eliminating proposed Rule 3-
05(d). See, e.g., letters from CAQ, EY, KPMG, and RSM.
    \155\ IFRS 1 provides recognition, measurement, and disclosure 
requirements, as well as certain transitional exceptions, for 
entities that present IFRS-IASB financial statements for the first 
time.
    \156\ See letter from DT. DT indicated that certain 
accommodations offered under Form 20-F, Item 17, such as to not 
remove the effects of inflation accounting pursuant to Item 
17(c)(2)(iv)(2) when the conditions of IAS 29, Reporting in 
Hyperinflationary Economies, are not met, or to not reconcile the 
effects of proportionate consolidation for investments in joint 
ventures pursuant to Item 17(c)(2)(vii), may be inconsistent with 
IFRS- IASB requirements.
    \157\ See letters from Barnard, BDO, KPMG, and PWC.
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c. Final Amendments
    We are adopting the amendments substantially as proposed, but with 
some modifications after consideration of the comments received. We are 
amending the rules in order to increase the consistency between the 
basis of accounting used by acquired businesses and foreign private 
issuers, as well as to permit acquired businesses and registrants to 
avoid unnecessary costs, such as one-time presentations of the U.S. 
GAAP reconciling information where such information would not be 
material to investors.
    Specifically, we are adopting the proposed amendments to Rule 3-
05(c) to permit foreign private issuers that prepare their financial 
statements using IFRS-IASB to reconcile Rule 3-05 Financial Statements 
of foreign businesses prepared using home country GAAP to IFRS-IASB 
rather than U.S. GAAP because this will provide more comparable 
information and better facilitate analysis of the financial statements. 
The reconciliation to IFRS-IASB is required generally to follow the 
form and content requirements in Item 17(c) of Form 20-F.
    Additionally, we are adopting, as proposed, Rule 3-05(d) to permit 
Rule 3-05 Financial Statements to be prepared in accordance with IFRS-
IASB without reconciliation to U.S. GAAP \158\ if the acquired business 
would qualify as a foreign private issuer if it were a registrant. As 
discussed in the Proposing Release, we believe financial statements 
prepared in accordance with IFRS-IASB provide sufficient information 
for investors for this purpose.\159\ In circumstances where the 
registrant presents its financial statements in U.S. GAAP, the pro 
forma financial information reflecting the acquisition will continue to 
be required to be presented in U.S. GAAP.
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    \158\ Under the rule, acquired foreign business financial 
statements may use IFRS-IASB without reconciliation to U.S. GAAP, 
even when the registrant prepares its financial statement using U.S. 
GAAP.
    \159\ See Section II.A.6.a. of the Proposing Release.
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    After considering comments received on the proposals, we are 
modifying the proposed amendments to additionally permit an acquired 
business that would qualify as a foreign private issuer if it were a 
registrant to reconcile to IFRS-IASB rather than U.S. GAAP when the 
registrant is a foreign private issuer that uses IFRS-IASB. We agree 
with commenters that reconciliation to IFRS-IASB will provide more 
comparable information and better facilitate analysis of the financial 
statements in this circumstance as well.
    In response to comments, we are adopting two additional 
modifications to the proposed amendments to clarify that:
     IFRS 1, First-time Adoption of IFRS, will be applicable 
when reconciling to IFRS-IASB; and
     Form 20-F accommodations that are inconsistent with IFRS-
IASB will not be available when reconciling to IFRS-IASB.
    We believe it is appropriate to specify that IFRS 1 will be 
applicable when reconciling Rule 3-05 Financial Statements to IFRS-
IASB, because a business that is reconciling to IFRS-IASB for the first 
time will face many of the same challenges in determining the relevant 
financial statement amounts as it would if it were directly presenting 
its financial statements under IFRS-IASB for the first time. Similarly, 
we believe it is appropriate to specify that Form 20-F accommodations 
that are inconsistent with IFRS-IASB will not be available when 
reconciling to IFRS-IASB. These accommodations, such as to not remove 
the effects of inflation accounting when the conditions of IAS 29 are 
not met or to not reconcile the effects of proportionate consolidation 
in joint ventures,\160\ were adopted in the context of reconciling to 
U.S. GAAP rather than IFRS-IASB. They were also adopted when the range 
of accounting practices around the world was wider than it is today and 
before IFRS-IASB was established in its current form. We believe that 
use of accommodations that are inconsistent with IFRS-IASB would not 
result in sufficient information for investors in this context.
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    \160\ See supra note 156.
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    We are not combining proposed Rule 3-05(c) and 3-05(d) as suggested 
by some commenters. Rule 3-05(c) addresses the financial statement 
requirements for an acquired business that meets the definition of a 
foreign business. Rule 3-05(d) addresses the financial statement 
requirements for an acquired business that does not meet the definition 
of a foreign business but that would be a foreign private issuer if it 
were a registrant. We believe that separate paragraphs will permit 
registrants to more easily determine which requirements apply to their 
acquired businesses. Separate paragraphs will also help to clarify that 
foreign businesses under Rule 3-05(c) may apply the other applicable 
accommodations in Form 20-F while the businesses that fall under Rule 
3-05(d) cannot.\161\
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    \161\ For example, foreign businesses under Rule 3-05(c) may 
apply the age of financial statement requirements in Item 8 of Form 
20-F, and may apply the accommodation in Item 17(c)(2)(v) of Form 
20-F that allows them to not reconcile their financial statements to 
U.S. GAAP if the significance of the foreign business is below 30 
percent.
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    Finally, we are not adopting revisions to accept ISAs in audit 
reports on Rule 3-05 Financial Statements of foreign businesses as 
suggested by some commenters. Use of ISAs in Commission filings would 
involve broader considerations than Rule 3-05 Financial Statements, 
potentially including the appropriateness of their use for audits of 
foreign private issuer financial statements. We believe such an 
approach would require a thorough evaluation of the appropriateness of 
the use of ISAs and is beyond the scope of these amendments.
7. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-04 provides smaller reporting company disclosure 
requirements for the financial statements of businesses acquired or to 
be acquired. Part F/S of Form 1-A (``Part F/S'') \162\ directs an 
issuer relying on 17 CFR 230.251 through 230.263 \163\ to present 
financial statements of businesses acquired or to be acquired,\164\ as 
specified by Rule 8-04, but permits the periods presented to be the 
shorter of those applicable to issuers relying on Regulation A and the 
periods specified by Article 8.\165\
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    \162\ 17 CFR 239.90.
    \163\ Regulation A--Conditional Small Issues Exemption 
(``Regulation A'').
    \164\ See paragraph (b)(7)(iii) of Part F/S of Form 1-A.
    \165\ See paragraph (b)(7) of Part F/S of Form 1-A.
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a. Proposed Amendments
    The Commission proposed to revise Rule 8-04 to reference to Rule 3-
05 for the requirements relating to the financial statements of 
businesses acquired or to be acquired, other than for form and content 
requirements for such financial statements, which would continue to be 
prepared in accordance with 17 CFR 210.8-02 (``Rule 8-02'') and Rule 8-
03.\166\
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    \166\ Rule 3-05(b)(1) currently requires financial statements 
specified in Rule 3-01 and 3-02 for the business to be acquired. 
Similarly, Rule 3-05(b)(2) also references Rule 3-01 and 3-02. Under 
the proposal, smaller reporting companies would apply Rule 3-05 but 
would substitute Rule 8-02 and Rule 8-03, as applicable, wherever 
Rule 3-05 references Rule 3-01 and 3-02. In this way, the proposal 
was intended to apply the election permitted for smaller reporting 
companies to prepare their financial statements in accordance with 
the form and content requirements in Article 8 rather than the other 
form and content requirements specified elsewhere in Regulation S-X 
(subject to the exceptions noted in Rule 8-01 Preliminary Note 2 to 
Article 8) to businesses acquired by smaller reporting companies.

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[[Page 54019]]

    Additionally, because Part F/S of Form 1-A refers to Rule 8-04, the 
proposed revisions to Rule 8-04 would apply to issuers relying on 
Regulation A. As a result, under the proposed amendments, smaller 
reporting companies would continue to be required to provide up to two 
years of acquired business historical financial statements and issuers 
relying on Regulation A would continue to be permitted to present the 
shorter of the periods applicable under Regulation A and the periods 
specified by Article 8.\167\
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    \167\ Additionally, the proposed revisions would have expressly 
permitted smaller reporting companies and issuers relying on 
Regulation A to omit such financial statements if the acquired 
business has been included in the registrant's results for a 
complete fiscal year. See further discussion of omission of Rule 3-
05 Financial Statements in Section II.B.1 above. We also proposed to 
add references to Rule 8-04 in Rule 3-06 and to Rule 3-06 in Note 6 
to Article 8 to expressly permit smaller reporting companies and 
issuers relying on Regulation A to file financial statements 
covering a period of nine to 12 months to satisfy the requirement 
for filing financial statements for a period of one year for an 
acquired business.
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b. Comments
    A few commenters provided comments specifically related to smaller 
reporting companies and smaller issuers.\168\ One commenter expressly 
supported the proposal to conform the rules applicable to smaller 
reporting companies to the generally applicable rules.\169\ Other 
commenters offered specific recommendations relating to smaller 
registrants \170\ or generally suggested the Commission consider 
whether issuers relying on Regulation A warrant different 
treatment.\171\
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    \168\ See, e.g., letters from BDO, EY, MTBC, and RSM. See also 
SBCFAC Recommendations.
    \169\ See letter from BDO.
    \170\ See letter from MTBC (recommending that smaller 
registrants only apply the revenue component of the Income Test).
    \171\ See SBCFAC Recommendations (recommending that the 
Commission continue to look at ``Regulation A companies and whether 
they warrant different treatment under these rules'').
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c. Final Amendments
    We are adopting the amendments substantially as proposed. We are 
revising Rule 8-04 to reference to Rule 3-05 for the requirements 
relating to the financial statements of businesses acquired or to be 
acquired, other than for form and content requirements for such 
financial statements, which would continue to be prepared in accordance 
with Rules 8-02 and 8-03. These revisions should ease compliance 
burdens and clarify the application of our rules for smaller reporting 
companies and issuers relying on Regulation A by focusing them on the 
more complete and better understood provisions of Rule 3-05. They will 
also expressly permit smaller reporting companies and issuers relying 
on Regulation A to omit historical acquired business financial 
statements if the acquired business has been included in the 
registrant's results for either nine months or a complete fiscal year, 
depending on significance.
    We are also revising Rule 8-01 as proposed, to add a paragraph 
expressly permitting application of Rule 3-06 to the preparation of 
financial statements of smaller reporting companies and issuers relying 
on Regulation A \172\ and to amend the instruction in Item 9.01 of Form 
8-K to include references to Rule 8-04 in order to conform the 
instruction to the text of Item 9.01, which already addresses the rules 
applicable to smaller reporting companies.
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    \172\ In addition, we are revising Rule 8-01 to remove the 
reference to the instruction relating to pro forma presentation 
requirements. See Section II.D.3. In a non-substantive change from 
our proposal, we are also renaming Rule 8-01 ``General Requirements 
for Article 8'' and re-designating Notes 1 through 5 of Rule 8-01 as 
paragraphs (a) through (e).
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    We considered whether issuers relying on Regulation A should be 
treated differently or whether smaller registrants should be subject to 
further differentiated requirements, such as only complying with the 
revenue component of the Income Test, as one commenter suggested. We 
determined not to further differentiate disclosure for issuers relying 
on Regulation A and smaller reporting companies because we think the 
rules as adopted result in important investor information that we do 
not believe should be further reduced or modified.\173\ We believe that 
existing accommodations should offset some of the burden associated 
with the disclosures that would be required by the rules. For example, 
Rule 8-01(b) provides, with limited exceptions, that smaller reporting 
companies electing to prepare their financial statements with the form 
and content required by Article 8 need not apply the other form and 
content requirements in Regulation S-X, and Form 1-A Part F/S provides 
that, in certain circumstances, financial statements of businesses 
acquired or to be acquired may be unaudited, may be for shorter periods 
than provided in Rule 8-04, and need not be updated if the most recent 
annual or interim balance sheet is not older than nine months. Further, 
as discussed below, the final rules contain a number of provisions 
that, while applicable to issuers of all sizes, should help ease the 
burden of providing the required financial information for smaller 
reporting companies and issuers relying on Regulation A.\174\
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    \173\ For example, we believe it is important that smaller 
reporting companies and issuers relying on Regulation A be required 
to provide pro forma financial information when consummation of 
other transactions has occurred or is probable for which disclosure 
of pro forma financial information would be material to investors. 
See Section II.D.3. We also note that significance tests are not 
one-size-fits-all tests, but instead contemplate the unique facts 
and circumstances of a registrant or issuer because they measure 
significance of the acquired or disposed business relative to the 
registrant or issuer.
    \174\ For example, we believe the significance tests we are 
adopting will provide more meaningful indicators of significance and 
mitigate anomalous significance results.
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    As revised, Rule 8-04 continues to require up to two years of 
acquired business historical financial statements. Additionally, and in 
accordance with current practice, the revised rule expressly permits 
smaller reporting companies to omit such financial statements if the 
acquired business has been included in the registrant's results for a 
complete fiscal year.\175\ We are also adding references to Rule 8-04 
in Rule 3-06 and to Rule 3-06 in Article 8, as proposed, to expressly 
permit smaller reporting companies to file audited financial statements 
covering a period of nine to 12 months to satisfy the requirement for 
filing financial statements for a period of one year for an acquired 
business.
---------------------------------------------------------------------------

    \175\ See further discussion of omission of Rule 3-05 Financial 
Statements in Section B.1. above.
---------------------------------------------------------------------------

    The amendments also provide that a smaller reporting company is 
eligible to exclude acquired business financial statements from a 
registration statement if the business acquisition was consummated no 
more than 74 days prior to the date of the relevant final prospectus or 
prospectus supplement, rather than 74 days prior to the effective date 
of the registration statement as under current Rule 8-04(c)(4).\176\ We 
believe it is appropriate to consistently look to the date of the final 
prospectus or prospectus supplement for registrants,\177\ as Rule 3-05 
currently

[[Page 54020]]

does, because that date could be later than the effective date, 
particularly in the case of a delayed offering, which some smaller 
reporting companies are now permitted to conduct.\178\ We are also 
making conforming changes to Rule 8-05 for smaller reporting companies 
to be consistent with the changes we are making to Article 11.\179\
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    \176\ See proposed Rule 3-05(b)(4)(i)(B).
    \177\ See 1996 Streamlining Release supra note 24 (noting that 
the date of an offering is specified as the date of the final 
prospectus or prospectus supplement relating to the offering).
    \178\ See General Instruction I.B.6 of Form S-3 and Amendments 
to Smaller Reporting Company Definition, Release No. 33-10513 (June 
28, 2018) [83 FR 31992 (July 10, 2018)].
    \179\ See Section II.D.3 below.
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B. Amendments Relating to Rule 3-05 Financial Statements Included in 
Registration Statements and Proxy Statements

1. Omission of Rule 3-05 Financial Statements for Businesses That Have 
Been Included in the Registrant's Financial Statements
    Rule 3-05(b)(4)(iii) generally permits Rule 3-05 Financial 
Statements to be omitted once the operating results of the acquired 
business have been reflected in the audited consolidated financial 
statements of the registrant for a complete fiscal year. However, Rule 
3-05 Financial Statements are required to be included when they have 
not been previously filed, or when the Rule 3-05 Financial Statements 
have been previously filed but the acquired business is of major 
significance to the registrant.
    If Rule 3-05 Financial Statements have not been previously filed, 
they must be provided even if the acquired business is included in 
post-acquisition audited results. The staff has historically not 
objected, however, to registrants reducing the Rule 3-05 Financial 
Statement periods presented by the equivalent period that the acquired 
business is included in the registrant's post-acquisition audited 
results.\180\
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    \180\ The staff's position has been limited to circumstances 
where there is no gap between the latest date of the pre-acquisition 
audited financial statements of the acquired business and the 
earliest date of the registrant's audited post-acquisition results. 
See FRM supra note 94 at Section 2030.4 ``Initial Registration 
Statements--Using Pre-Acquisition and Post-Acquisition Audited 
Results.''
---------------------------------------------------------------------------

    Registrants must also continue to present Rule 3-05 Financial 
Statements that have been previously filed if the acquired business is 
of such significance to the registrant that omission of those Rule 3-05 
Financial Statements would materially impair an investor's ability to 
understand the historical financial results of the registrant. Rule 3-
05 provides, as an example, that an acquired business meeting at least 
one of the significance tests set forth in Rule 1-02(w) at the 80 
percent level at the date of the acquisition would require the 
registrant to continue to file the financial statements of the acquired 
business. Notwithstanding the rule's reference to materiality, in 
practice the rule is typically applied, consistent with this example, 
on the basis of quantitative significance determinations.\181\
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    \181\ See, e.g., FRM supra note 94 at Section 2040.2 `` `Major 
Significance' and Previously Filed Acquiree Financial Statements.''
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to no longer require Rule 3-05 Financial 
Statements in registration statements and proxy statements once the 
acquired business is reflected in filed post-acquisition registrant 
financial statements for a complete fiscal year. The Commission also 
proposed to eliminate the ``major significance'' exception.
b. Comments
    Commenters generally supported the proposed amendments.\182\ One 
commenter, however, encouraged the Commission to seek additional input 
and consider whether the proposed amendments would provide investors 
with sufficient information and whether additional financial statements 
may be necessary above a certain significance threshold.\183\
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    \182\ See, e.g., letters from Bass Berry, BDO, CAQ, Cravath, DT, 
Eli Lilly, FEI, KPMG, Pillsbury Winthrop Shaw Pittman, LLP, PWC, and 
Nasdaq.
    \183\ See letter from GT. This commenter cited an example where 
an initial public offering registrant consummates a very large 
acquisition in the year prior to the most recently completed fiscal 
year for which financial statements are being provided for the 
registrant. The commenter noted that while the registrant would be 
required to provide its historical financial statements for two 
years, the acquired business's financial statements would be limited 
to the period for which it is included in the registrant's post-
acquisition results. The commenter further observed that, in its 
experience, disclosure pursuant to Regulation S-K, Item 303, 
Management's discussion and analysis of financial condition and 
results of operations, may not clearly isolate the effects of the 
acquisition on results of operations. The commenter suggested as an 
example that the Commission could consider requiring an initial 
public offering registrant to provide financial statements for the 
same number of periods as required in subsequent Securities Act and 
Exchange Act filings or for the same number of periods as the 50 
percent threshold would require, prior to proceeding with a 
securities offering.
---------------------------------------------------------------------------

    A number of commenters recommended permitting registrants to 
exclude separate financial statements once the acquired business has 
been included in the post-acquisition audited financial statements for 
at least nine months.\184\ Commenters analogized to the Rule 3-06 
requirements, noting that Rule 3-06 only requires nine months of pre-
acquisition audited financial statements for an acquisition that 
exceeds 20 percent, but does not exceed 40 percent, significance.\185\ 
In expressing support for using nine months, one of these commenters 
noted that the Commission could consider a requirement to disclose any 
material information impacting any pre-acquisition period that would 
otherwise be required absent the use of Rule 3-06 to supplement 
required financial statements.\186\
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    \184\ See, e.g., letters from BDO, CAQ, Crowe, DT, EY, GT, KPMG, 
PWC, and RSM.
    \185\ See, e.g., letters from BDO and DT. One of these 
commenters further noted that staff practice as documented in FRM 
2040.2 generally permits omission of previously filed acquired 
business financial information once it is included in the 
registrant's post-acquisition results for nine months. See letter 
from DT. The other commenter recommended allowing omission of pre-
acquisition financial statements for businesses that exceed 20 
percent, but do not exceed 40 percent, significance once they are 
included in the registrant's audited post-acquisition results for 
nine months and for businesses that exceed 40 percent significance 
once they are included in the registrant's post-acquisition results 
for a complete fiscal year. See letter from BDO.
    \186\ See letter from Crowe.
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c. Final Amendments
    We are adopting revisions substantially as proposed with some 
modifications in response to comments received. Specifically, we are 
adopting the proposed elimination of the requirement to include Rule 3-
05 Financial Statements in registration statements and proxy statements 
once the acquired business is reflected in filed post-acquisition 
registrant financial statements. However, in response to comments, we 
are modifying the requisite time period.
    We are persuaded by commenters that our proposal unnecessarily 
perpetuates existing differences in the length of reporting periods 
that exist between Rule 3-05 and Rule 3-06 for an acquisition that is 
at least 20 percent, but not more than 40 percent, significant. One 
condition in Rule 3-05 for omitting Rule 3-05 Financial Statements is 
that the acquired business has been included in the registrant's post-
acquisition results for a complete fiscal year. However, Rule 3-06 
permits the filing of Rule 3-05 Financial Statements covering a period 
of nine months to satisfy the Rule 3-05 requirement for filing 
financial statements for a period of one year. While these reporting 
periods relate to different circumstances, omission under Rule 3-05 as 
compared to inclusion

[[Page 54021]]

under Rule 3-06, we do not believe those circumstances are sufficiently 
different for acquisitions that are at least 20 percent, but not more 
than 40 percent, significant (i.e., significant at the one year level) 
to warrant disclosures for different time periods. To provide 
consistency between the Rule 3-05 and Rule 3-06 requirements, the 
amendments will allow omission of pre-acquisition financial statements 
for businesses that exceed 20 percent but do not exceed 40 percent 
significance once they are included in the registrant's audited post-
acquisition results for nine months (rather than the proposed complete 
fiscal year).\187\
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    \187\ Rule 3-06 does not require incremental disclosure in order 
for the filing of financial statements covering a period of nine 
months to be deemed to satisfy a requirement for filing financial 
statements for a period of one year. Because our amendments seek to 
make Rule 3-05 more consistent with Rule 3-06, the final amendments 
do not include an incremental disclosure requirement within Rule 3-
05 to disclose material information impacting any pre-acquisition 
period that would otherwise be required absent the use of amended 
Rules 3-05 and 3-06. However, we observe that existing requirements, 
such as those in Item 303 of Regulation S-K, Management's discussion 
and analysis of financial condition and results of operations, and 
Rule 4-01(a) would require such disclosure when it is material to 
the registrant, and we believe that information would be sufficient 
for this purpose.
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    Because Rule 3-06 limits the use of a nine month period to 
financial statements that would otherwise be required for a period of 
one year, the amendments retain the existing complete fiscal year Rule 
3-05 requirement when Rule 3-05 Financial Statements for a period of 
two years are required (i.e., significance exceeds 40 percent). 
Specifically, the amendments allow omission of pre-acquisition 
financial statements for businesses that exceed 40 percent significance 
once they are included in the registrant's post-acquisition results for 
a complete fiscal year.
    These final amendments also eliminate the requirement that Rule 3-
05 Financial Statements be provided when they have not been previously 
filed or when they have been previously filed but the acquired business 
is of major significance. This requirement can delay a registrant's 
offering and thereby its access to capital, while providing information 
that is often less meaningful to investors, because the utility of pre-
acquisition periods diminishes over time after the acquired business is 
reflected in post-acquisition results, and because the post-acquisition 
results of the combined business are generally not comparable to the 
pre-acquisition results of the acquired business.\188\ Similarly for 
financial information provided regarding acquisitions of ``major 
significance,'' the utility of pre-acquisition periods diminishes over 
time after the acquired business is reflected in post-acquisition 
results. Additionally, with electronic filing requirements, which were 
established after the ``major significance'' rule, previously filed 
financial information about the acquired business is readily accessible 
through the Commission's EDGAR filing system.
---------------------------------------------------------------------------

    \188\ See FRM supra note 94 at Section 2030.4. The accommodation 
provided by Commission staff did not sufficiently ameliorate these 
effects and often resulted in financial statements of the acquired 
business that depicted partial, rather than complete, reporting 
periods that did not coincide with the end of either the acquired 
business's or the registrant's fiscal periods.
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    We believe inclusion of post-acquisition results in the 
registrant's audited financial statements for the requisite time period 
should generally provide investors with sufficient information to make 
informed investment decisions about the registrant. Further, even 
without the major significance requirement to include some, but not 
all, of the previously filed pre-acquisition financial statements of 
the acquired business, Regulation S-X provides that a registrant must 
provide ``such further material information as is necessary to make the 
required statements, in light of the circumstances under which they are 
made, not misleading.'' \189\
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    \189\ See Rule 4-01(a).
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    We are not persuaded that additional financial statements of 
acquired businesses should be provided in initial registration 
statements when an acquisition is reflected in post-acquisition audited 
results for nine months when the acquisition is significant at the one 
year level or included for a complete fiscal year when the acquisition 
is significant at the two year level. Pre-acquisition financial 
statements by their nature are less likely to be indicative of the 
current financial condition, changes in financial condition, and 
results of operations of the acquired business as they age. If, in an 
unusual circumstance, pre-acquisition financial statements are 
necessary for the protection of investors even though the acquired 
business has been included in the registrant's post-acquisition results 
for a complete fiscal year, then Rule 3-13 permits the Commission staff 
by delegated authority to require the filing of the pre-acquisition 
financial statements.
    We also believe that rightsizing our acquired business financial 
statement requirements appropriately balances the need to provide 
investors with information necessary for making informed investment 
decisions with the goal of minimizing compliance costs that can delay 
or preclude access to public markets, particularly when going public 
may not have been contemplated at the time an acquisition 
occurred.\190\
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    \190\ In adopting these changes, we note that Item 303 of 
Regulation S-K requires identification of known trends, demand, 
commitments, events and uncertainties and Rule 4-01(a) of Regulation 
S-X requires that a registrant provide ``such further material 
information as is necessary to make the required statements, in 
light of the circumstances under which they are made, not 
misleading.''
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2. Use of Pro Forma Financial Information To Measure Significance
    A registrant is generally permitted to use pro forma, rather than 
historical, financial information to test significance of a 
subsequently acquired business if the registrant made a significant 
acquisition after the latest fiscal year-end and filed its Rule 3-05 
Financial Statements and pro forma financial information on Form 8-
K.\191\ However, this Form 8-K filing requirement has the practical 
effect of precluding the use of pro forma financial information that 
gives effect to a significant acquisition subsequent to the latest 
fiscal year-end to test significance of a subsequently acquired 
business when determining Rule 3-05 disclosure requirements in initial 
registration statements. While Commission staff has considered the 
results of significance tests using pro forma financial information in 
considering whether to permit omission or substitution of acquired 
business financial statements in initial registration statements of 
registrants growing through acquisition, those circumstances have been 
limited.\192\ Further, Regulation S-X does not provide for dispositions 
of significant businesses to be included in the pro forma financial 
information used for testing significance of a subsequently acquired or 
subsequently disposed business.
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    \191\ See Rule 3-05(b)(3).
    \192\ Consistent with the staff's exercise of delegated 
authority in response to requests under Rule 3-13, Staff Accounting 
Bulletin No. 80, Application of Rule 3-05 in Initial Public 
Offerings (``SAB 80'') states that the staff will not object if 
significance is measured using the alternative method specified in 
SAB 80. The SAB 80 method is similar to Rule 3-05, but the 
accommodations in SAB 80 are complex and seldom used by registrants.
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a. Proposed Amendments
    For all filings that require Rule 3-05 Financial Statements and 
Rule 3-14 Financial Statements, the Commission proposed to expand the 
circumstances in which a registrant can use pro forma

[[Page 54022]]

financial information for significance testing by permitting 
registrants to measure significance using filed pro forma financial 
information that only depicts significant business acquisitions and 
dispositions consummated after the latest fiscal year-end for which the 
registrant's financial statements are required to be filed, subject to 
certain conditions.
b. Comments
    Commenters generally supported the amendments.\193\ However, one 
commenter stated that once a registrant chooses to use pro forma 
financial information for significance testing, the registrant should 
be required to use the approach consistently until the next annual 
report on Form 10-K is filed,\194\ consistent with current staff 
guidance.\195\
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    \193\ See letters from Cravath, Eli Lilly, FEI, GT, Nasdaq, and 
S&C.
    \194\ See letter from GT. GT additionally recommended that the 
Commission clarify in the final rules that pro forma financial 
information used to determine significance may be different from pro 
forma financial information that was previously filed if it gave 
effect to other transactions. They also recommended that the 
Commission clarify how pro forma financial information for previous 
acquisitions or dispositions be used for determining the 
significance of subsequent acquisitions or dispositions in 
connection with an initial registration statement, given that pre-
acquisition financial statements and pro forma financial information 
for the previous transactions could not have been previously filed 
in the case of a confidential submission and the first public filing 
of an IPO registration statement.
    \195\ See FRM supra note 94 at Section 2025.3, which indicates 
registrants should use a consistent approach for determining 
significance until the filing of the next annual report on Form 10-
K.
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c. Final Amendments
    We are adopting the amendments substantially as proposed, but with 
some modifications after consideration of the comments received. 
Specifically, for filings that require Rule 3-05 Financial Statements 
and Rule 3-14 Financial Statements, we are amending Rule 11-01(b)(3) to 
permit registrants to measure significance using filed pro forma 
financial information that only depicts significant business 
acquisitions and dispositions consummated after the latest fiscal year-
end for which the registrant's financial statements are required to be 
filed, subject to the following conditions:
     The registrant has filed Rule 3-05 Financial Statements or 
Rule 3-14 Financial Statements for any such acquired business; \196\ 
and
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    \196\ We believe this condition clarifies that if the required 
Rule 3-05 Financial Statements and pro forma financial information 
for one or more significant business acquisitions consummated after 
the registrant's most recently completed fiscal year required to be 
filed are included in an initial registration statement, then those 
acquisitions may be included in the pro forma financial information 
used to measure significance of a business acquired subsequent to 
those acquisitions for purposes of determining whether Rule 3-05 
Financial Statements of the subsequently acquired business, and 
related pro forma financial information, are required in the initial 
registration statement.
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     The registrant has filed the pro forma financial 
information required by Article 11 for any such acquired or disposed 
business.\197\
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    \197\ We are revising Rule 3-05(b)(3) and Rule 3-14(b)(2) to 
replace the existing guidance with a specific reference to Rule 11-
01(b)(3). We are also including in Rule 11-01(b)(3) the statement in 
the current rule that the tests may not be made by ``annualizing'' 
data.
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    We additionally are amending Rule 11-01(b)(3) as proposed to add a 
reference to Rule 11-02(b)(6)(i), but relocating it within amended Rule 
11-01(b)(3), to clarify that when determining significance the pro 
forma financial information must be limited to the applicable amounts 
that combine the historical financial information of the registrant and 
the acquired business and Transaction Accounting Adjustments.\198\ We 
also are amending Rule 11-01(b)(3) to indicate that the pro forma 
financial information that is used to measure significance may only 
give effect to the subsequently acquired or disposed business and may 
not give effect to Autonomous Entity Adjustments, Management's 
Adjustments, if any, or other transactions, such as the use of proceeds 
from an offering. Further, we are persuaded to modify the proposal to 
clarify that once a registrant uses pro forma financial information to 
measure significance, it must continue to use pro forma financial 
information to measure significance until the next annual report on 
Form 10-K or Form 20-F. This modification will codify current 
practice,\199\ provide for a more relevant indicator of significance, 
and ensure greater consistency in the significance determinations.
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    \198\ See Section II.D.1.c.
    \199\ See supra text accompanying note 195.
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    We believe these amendments will provide registrants with the 
flexibility to more accurately determine the relative significance of 
an acquired or disposed business to the ongoing operations of the 
registrant, including for those filing an initial registration 
statement, without inadvertently delaying or accelerating the filing of 
pro forma financial information that might occur if we required use of 
such pro forma financial information to determine significance.
3. Disclosure Requirements for Individually Insignificant Acquisitions
    Under the existing rules, audited historical pre-acquisition 
financial statements are generally not required if an acquired or to be 
acquired business: (1) Does not exceed 20 percent significance, or (2) 
does not exceed 50 percent significance and the acquisition has not yet 
occurred or the date of the final prospectus or prospectus supplement 
relating to an offering (as filed with the Commission pursuant to 17 
CFR 230.424(b)) is no more than 74 days after consummation and the 
financial statements have not been previously filed.\200\ However, if 
the aggregate impact of ``individually insignificant businesses'' \201\ 
acquired since the date of the most recent audited balance sheet filed 
for the registrant exceeds 50 percent, audited historical pre-
acquisition financial statements covering at least the substantial 
majority of the businesses acquired must be included in a registration 
statement or proxy statement.\202\ Registrants also must provide 
related pro forma financial information based on the requirements of 
Article 11.\203\
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    \200\ See Rule 3-05(b)(4)(i).
    \201\ In the 1996 Streamlining Release (see supra note 24), Rule 
3-05 was amended to permit the exclusion of historical financial 
statements for certain significant acquisitions that did not exceed 
50 percent significance. See Rule 3-05(b)(4)(i). Commission staff 
has interpreted ``individually insignificant businesses'' to 
include: (a) Any acquisition consummated after the registrant's 
audited balance sheet date whose significance does not exceed 20 
percent; (b) Any probable acquisition whose significance does not 
exceed 50 percent; and (c) Any consummated acquisition whose 
significance exceeds 20 percent, but does not exceed 50 percent, for 
which financial statements are not yet required by Rule 3-05(b)(4) 
because of the 75-day filing period. See FRM supra note 94 at 
Section 2035.2.
    \202\ See Rule 3-05(b)(2)(i). ``Substantial majority'' has been 
applied in practice to be the mathematical majority (i.e., 
businesses constituting more than 50 percent of the relevant test 
(investment, asset or income) on which the businesses were 
determined to be significant in the aggregate) See FRM supra note 94 
at Section 2035.3 ``Financial Statements Required--Mathematical 
Majority.''
    \203\ Rule 11-01(a) specifies conditions for which pro forma 
financial information must be presented. Those conditions do not 
explicitly discuss the aggregate significance of individually 
insignificant businesses, however they do include, ``consummation of 
a significant business combination or a combination of entities 
under common control [that] has occurred or is probable'' and 
``consummation of other events or transactions has occurred or is 
probable for which disclosure of pro forma financial information 
would be material to investors.'' Further, Rule 11-01(c) links the 
requirement for pro forma financial information for a significant 
business acquisition to the presentation of separate financial 
statements of the acquired business. Taken together, these 
requirements provide that if separate financial statements of the 
substantial majority of individually insignificant businesses are 
presented, pro forma financial information depicting their effects 
must also be presented.
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a. Proposed Amendments
    The Commission proposed amending Rule 3-05 to no longer require 
separate

[[Page 54023]]

financial statements for the majority of the individually insignificant 
acquired businesses when the aggregate impact of businesses acquired or 
to be acquired since the date of the most recent audited balance sheet 
filed for the registrant, for which financial statements are either not 
required or not yet required because of the registration (or proxy) 
statement grace period, exceeds 50 percent. In conjunction with this 
change, the proposed amendments would require registrants to provide 
pro forma financial information depicting the aggregate effects of all 
such businesses in all material respects. In addition, the proposed 
amendments would have required pre-acquisition historical financial 
statements only for those businesses whose individual significance 
exceeds 20 percent, but that are not yet required to file financial 
statements.
b. Comments
    Commenters generally supported the proposal to no longer require 
Rule 3-05 Financial Statements for businesses whose individual 
significance does not exceed 20 percent.\204\ One commenter recommended 
the Commission consider including both Rule 3-05 businesses and Rule 3-
14 real estate operations when determining the aggregate impact for 
individually insignificant acquisitions and providing guidance on how 
to perform the aggregations.\205\ Another commenter recommended against 
including them both together due to the difference in the types of 
transactions covered.\206\
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    \204\ See, e.g., letters from Cravath, DT, Eli Lilly, FEI, and 
GT.
    \205\ See letter from GT.
    \206\ See letter from Cravath.
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    Some commenters expressed concern that the new requirements could 
create burdens for registrants relating to the proposed requirements to 
file financial statements for multiple significant acquisitions or the 
proposed requirements to provide detailed financial information about 
individually insignificant acquisitions that may not be readily 
available or may not have been provided to the registrant during its 
due diligence.\207\ Other commenters expressed concern that requiring 
pro forma financial information that depicts aggregate impacts in ``all 
material respects'' could lead to interpretive issues necessitating a 
definition or examples.\208\ Some commenters also expressed concern 
that accountants may not be able to provide negative assurance to 
underwriters on the combined pro forma financial information where 
historical financial statements included in the pro forma financial 
information for individually insignificant acquisitions have not been 
reviewed or audited.\209\ In contrast, one commenter suggested that the 
procedures required for auditors to provide negative assurance to 
underwriters on comfort letters are fairly limited and that the 
proposed changes should not materially impact the auditor's ability in 
this regard.\210\
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    \207\ See letters from GT and DT. See also letter from Cravath 
(recommending retaining an option permitting a registrant to include 
a majority of the acquired businesses in the pro forma presentation 
or alternatively only requiring historical pre-acquisition financial 
statements and pro forma financial information if the individually 
insignificant businesses together exceed 50 percent under the Income 
Test).
    \208\ See letters from GT and RSM.
    \209\ See letters from BDO, CAQ, Cravath, Crowe, DT, GT, and 
RSM. Some commenters noted that PCAOB AS 6101 would prohibit 
accountants from providing negative assurance on combined pro forma 
financial information for which historical financial statements have 
not been audited or reviewed. See letters from BDO, CAQ, Crowe, GT, 
and RSM.
    \210\ See letter from CFA.
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c. Final Amendments
    We are adopting the amendments substantially as proposed, but with 
some modifications after consideration of the comments received. The 
amendments to Rule 3-05 are intended to reduce the burdens of preparing 
disclosure about immaterial acquisitions and negotiating with sellers 
to timely provide historical financial statements, while the new 
requirement to provide pro forma financial information that shows the 
aggregate effect of the acquired businesses in all material respects 
should make it easier for investors to understand the overall effect of 
those acquisitions on the registrant. Under current rules, registrants 
often provided separate, audited historical financial statements for 
acquired businesses that were individually not material to the 
registrant, and pro forma financial information that did not fully 
depict the aggregate effect of the ``individually insignificant 
businesses'' because currently Article 11 only requires pro forma 
financial information for an acquisition for which Rule 3-05 Financial 
Statements are required.\211\ The proposed amendments should address 
these anomalies, to the benefit of both registrants and investors.
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    \211\ For example, if the aggregate of 16 individually 
insignificant acquisitions is 80 percent significant, with each at 
five percent, a registrant would be required to provide pre-
acquisition audited historical financial statements for nine of the 
individually insignificant businesses. Thus, the pro forma financial 
information would only depict the effect of those nine acquisitions 
constituting 45 percent of the registrant's pre-acquisition assets 
or income.
---------------------------------------------------------------------------

    Similar to existing requirements, and as proposed, amended Rule 3-
05(b)(2)(iv) will require disclosure if the aggregate impact of 
businesses acquired or to be acquired since the date of the most recent 
audited balance sheet filed for the registrant, for which financial 
statements are either not required by paragraph (b)(2)(i) or are not 
yet required based on paragraph (b)(4)(i), exceeds 50 percent for any 
condition.\212\ In this way, the amendments clarify that ``individually 
insignificant businesses'' include: (a) Any acquisition consummated 
after the registrant's audited balance sheet date whose significance 
does not exceed 20 percent; (b) Any probable acquisition whose 
significance does not exceed 50 percent; and (c) Any consummated 
acquisition whose significance exceeds 20 percent, but does not exceed 
50 percent, for which financial statements are not yet required by Rule 
3-05(b)(4) because of the 75-day filing period.\213\
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    \212\ For clarity, we specifically describe the affected 
businesses in the final rule without reference to the term 
``individually insignificant businesses.'' We also inserted ``for 
any condition'' to clarify that the aggregation is done separately 
for each condition (e.g. the investment, asset and income test); 
that is, the conditions are not combined when assessing whether the 
``exceeds 50 percent'' threshold is met.
    \213\ This amendment is consistent with existing practice. See 
FRM supra note 94 at Section 2035.2.
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    As proposed, the amended rule will require registrants to provide 
pre-acquisition historical financial statements only for those 
businesses whose individual significance exceeds 20 percent.\214\ In 
conjunction with this change, the amended rule, also as proposed, will 
require registrants to provide pro forma financial information 
depicting the aggregate effects of all ``individually insignificant 
businesses'' in all material respects.\215\ Further, we are revising 
Rule 11-01(c) to clarify that the exception that would otherwise permit 
pro forma financial information not to be provided when separate 
financial statements of the acquired

[[Page 54024]]

business are not included in the filing does not apply where the 
aggregate impact is significant as determined by amended Rules 3-
05(b)(2)(iv) or 3-14(b)(2)(i)(C). While several commenters suggested 
that this requirement could raise interpretive issues, we believe the 
concept of materiality is well established in our rules, and we are not 
persuaded at this time that additional guidance is necessary in order 
for registrants to make this determination.
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    \214\ Registrants will have to negotiate the timely provision of 
historical balance sheet and income statement information for each 
acquisition necessary to present pro forma financial information 
depicting their aggregate effects in all material respects when 
aggregate significance exceeds 50 percent, but historical financial 
statements only for acquisitions that will be required to be 
reported on Form 8-K (i.e., individual significance exceeds 20 
percent). The amendments could accelerate reporting of historical 
financial statements for these acquisitions (i.e., individual 
significance exceeds 20 percent) in certain registration statements 
and proxy statements if the combined acquisitions exceed 50 percent 
significance.
    \215\ See amended Rule 3-05(b)(2)(iv) and revisions to Rule 11-
01(c).
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    After considering comments received, we are modifying the proposed 
rule to require registrants to include both Rule 3-05 businesses and 
Rule 3-14 real estate operations when determining the aggregate impact 
of the Investment Test for individually insignificant acquisitions. We 
are persuaded that such a modification is consistent with our objective 
of aligning Rule 3-14 with Rule 3-05 because unique industry 
considerations do not warrant differentiating Rule 3-05 businesses and 
Rule 3-14 real estate operations, particularly as the modification will 
apply only to registrants that acquire both Rule 3-05 businesses and 
Rule 3-14 real estate operations. The final amendments limit this 
modification to the Investment Test because the Asset Test and Income 
Test do not apply to Rule 3-14 real estate operations.
    Consistent with the existing requirement, \216\ we have modified 
the proposed amendments to Rule 3-05 to indicate that, in determining 
whether the Income Test condition (i.e. both the revenue component and 
the net income component) exceeds 50 percent, the businesses specified 
in Rule 3-05(b)(2)(iv) reporting losses must be aggregated separately 
from those reporting income. We also have modified the rule to clarify 
that if either group exceeds 50 percent, the disclosure requirements 
apply to all of the businesses subject to the aggregate test and must 
not be limited to either the businesses with losses or those with 
income.
---------------------------------------------------------------------------

    \216\ See Computational Note 1 to Rule 1-02(w). See also FRM 
supra note 94 at Section 2035.5.
---------------------------------------------------------------------------

    We acknowledge that, consistent with existing requirements, the 
amended aggregate test applies to businesses acquired or to be acquired 
subsequent to the most recently completed fiscal year. Because some of 
those acquisitions may have already occurred upon the effective date of 
the amended rules, we are persuaded that the concern expressed by some 
commenters about the availability of information to comply with the 
amended aggregate test necessitates transition guidance.\217\
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    \217\ See Section II.F.
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    Separately, we acknowledge concerns expressed as to whether 
accountants will be able to provide negative assurance to underwriters 
on the combined pro forma financial information where historical 
financial statements included in the pro forma financial information 
for individually insignificant acquisitions have not been reviewed or 
audited. We recognize that, in some circumstances, accountants may need 
to perform additional work to be able to provide negative assurance. We 
also observe that the ``reasonable investigation'' and ``reasonable 
care'' provisions of Sections 11 and 12 of the Securities Act are also 
fact specific and depend on a variety of factors. Whether steps taken 
to provide the required disclosures satisfy ``reasonable 
investigation'' or ``reasonable care,'' or whether additional work is 
needed to provide negative assurance, should be determined by 
accountants and their clients based on facts and circumstances. 
Although accountants and their clients may need to take additional 
steps in certain circumstances, we believe those concerns are 
outweighed by the need to improve the usefulness of information 
provided to investors when the aggregate impact of the specified 
acquired or to be acquired businesses exceed 50 percent, rather than 
requiring audited financial statements that are not necessary to 
reasonably inform investors or pro forma financial information that is 
materially incomplete in its depiction of the aggregate impact.

C. Rule 3-14--Financial Statements of Real Estate Operations Acquired 
or To Be Acquired

    Rule 3-14 differs from Rule 3-05, in part, because unique industry 
considerations for real estate operations warrant differentiated 
disclosure. If a registrant has acquired or, in certain circumstances, 
proposes to acquire one or more properties which in the aggregate are 
significant, Rule 3-14 requires the registrant to file only abbreviated 
income statements. If the real estate operation is not acquired from a 
related party, audited Rule 3-14 Financial Statements are required for 
only one year. In those circumstances where a registrant is permitted 
to provide one year of financial statements, Rule 3-14 also requires a 
registrant to describe with specificity the material factors it 
considered in assessing the real estate operation.\218\
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    \218\ See Rules 3-14(a)(1)(ii) and 3-14(a)(1)(iii). The material 
factors include sources of revenue (including, but not limited to, 
competition in the rental market, comparative rents, and occupancy 
rates) and expense (including, but not limited to, utility rates, 
property tax rates, maintenance expenses, and capital improvements 
anticipated). The disclosure must also indicate that the registrant 
is not aware of any other material factors relating to the specific 
real estate operation that would cause the reported financial 
statements not to be indicative of future operating results. If the 
registrant does not meet the Rule 3-14(a)(1) conditions, three years 
of Rule 3-14 Financial Statements are required.
---------------------------------------------------------------------------

    The Commission proposed to further align Rule 3-14 with Rule 3-05 
where no unique industry considerations exist because the rules have 
similar objectives. The Commission also proposed to clarify the 
application of Rule 3-14 regarding scope of the requirements,\219\ 
determination of significance, need for interim income statements, and 
special provisions for blind pool offerings.\220\
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    \219\ In some circumstances, registrants acquire a real estate 
operation subject to a triple net lease with a single lessee. A 
triple net lease typically requires the lessee to pay costs normally 
associated with ownership of the property, such as property taxes, 
insurance, utilities, and maintenance costs. Under existing 
practice, registrants often provide audited financial statements of 
the lessee or guarantor of the lease, instead of the Rule 3-14 
Financial Statements of the real estate operation, when the lessee 
is considered significant. The proposal did not, and these 
amendments do not, differentiate this type of acquisition or specify 
alternatives to Rule 3-14 for this type of acquisition, because the 
activity depicted in the Rule 3-14 Financial Statements is 
consistent with how the triple net lease arrangement may affect the 
registrant's results of operations. No commenters that commented on 
this topic recommended that the Commission require audited financial 
statements of the lessee or guarantor. See letters from EY, BDO, and 
GT.
    \220\ See Section II.C.6 below.
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1. Align Rule 3-14 With Rule 3-05
    Under the current rules, Rule 3-14 and Rule 3-05 diverge in a 
number of areas. Rule 3-14 refers to acquisitions that are 
``significant''; however, neither ``significant property'' nor 
``significant real estate operation'' are defined in Regulation S-X. 
Current practice looks to the 10 percent significance threshold in the 
definition of ``significant subsidiary'' in Rule 1-02(w) when 
determining ``significance'' under Rule 3-14.\221\ Additionally, Rule 
3-14 Financial Statements are currently required when the registrant 
has acquired or proposes to acquire a group of properties that are 
significant in the aggregate. In practice, consummated and probable 
acquisitions since the date of the most recent audited balance sheet 
that are less than 10 percent significant are aggregated and, if the 
significance of the aggregated group exceeds 10 percent, Rule 3-14 
Financial Statements are provided for each acquisition that is five 
percent or more significant and for

[[Page 54025]]

enough other acquisitions in order to cover the substantial majority of 
the group.\222\ Additionally, Rule 3-14 requires registrants to provide 
three years of financial statements for significant acquisitions from 
related parties.
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    \221\ See FRM supra note 94 at Section 2310.1 ``Registration 
Statements and Proxy Statements--Requirements.''
    \222\ See FRM supra note 94 at Section 2320.
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed amendments to align Rule 3-14 with Rule 3-
05 where no unique industry considerations warranted differentiated 
treatment. Specifically, the proposed amendments would have, among 
other things:
     Aligned thresholds in Rule 3-14 with the 20 percent 
significance threshold and 50 percent aggregate impact significance 
threshold in Rule 3-05;
     Eliminated the Rule 3-14 requirement to provide three 
years of Rule 3-14 Financial Statements for acquisitions from related 
parties;
     Applied Rule 3-06 to Rule 3-14 acquisitions;
     Included the same timing requirements for Rule 3-14 
Financial Statements in registration statements and proxy statements as 
Rule 3-05; and
     Permitted Rule 3-14 Financial Statements to be omitted 
once the acquired real estate operation had been reflected in filed 
post-acquisition registrant financial statements for a complete fiscal 
year.
    The Commission additionally proposed to align Rule 3-14 with the 
relevant proposed Rule 3-05 amendments discussed in Sections II.A. and 
II.B. above.
b. Comments
    Commenters that specifically addressed Rule 3-14 generally 
supported the proposals.\223\ However, some commenters noted that 
proposed Rule 3-14(c)(2)(iii) would require that the notes to the Rule 
3-14 Financial Statements include information about the real estate 
operation's operating, investing and financing cash flows, to the 
extent available, and questioned whether such historical information 
would be comparable to proposed future operations and why such 
disclosure should be required since Rule 3-14 Financial Statements 
include only statements of revenues and expenses that may omit expenses 
not comparable to proposed future operations.\224\
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    \223\ See, e.g., letters from Barnard, Cravath, BDO, CAQ, 
Deloitte, EY, GT, KPMG, NAREIT, and RSM.
    \224\ See letters from BDO, CAQ, and RSM.
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c. Final Amendments
    We are adopting the amendments as proposed. As discussed in the 
Proposing Release, we believe that further aligning Rule 3-14 with Rule 
3-05 will reduce complexity by standardizing the requirements for 
acquired businesses overall while retaining the industry specific 
disclosure necessary for investors to make informed investment 
decisions.\225\
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    \225\ See Section II.C.1 of the Proposing Release.
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    Specifically, we are adopting amendments as proposed regarding:
    Significance Thresholds. We are aligning the Rule 3-14 significance 
threshold for individual acquisitions to the 20 percent threshold for 
acquired businesses in Rule 3-05.\226\ We are also aligning the Rule 3-
14 significance threshold for the aggregate impact of acquisitions to 
the 50 percent threshold in Rule 3-05. Aligning Rule 3-14 with Rule 3-
05 will remove ambiguity by defining which businesses must be 
aggregated and the significance threshold that applies, and by 
clarifying that this requirement applies only to certain registration 
statements and proxy statements and not to Form 8-K.
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    \226\ The Commission raised the threshold in Rule 3-05 from 10 
percent to 20 percent in 1996 in order to reduce compliance burdens 
in response to concerns that the requirement to obtain audited 
financial statements for a business acquisition may have caused 
companies to forgo public offerings and to undertake private or 
offshore offerings. See 1996 Streamlining Release supra note 24. As 
a result of this amendment, the significance thresholds in Rule 3-05 
have diverged from those used for Rule 3-14 since that time.
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    Years of Required Financial Statements for Acquisitions from 
Related Parties.\227\ We are aligning Rule 3-14 with Rule 3-05 by 
eliminating the specific requirement to provide three years of 
financial statements for acquisitions from related parties. Rule 3-05 
does not differentiate the number of periods for which historical 
financial statements are required based on whether the seller is a 
related party or not, and we are not aware of any unique industry 
considerations that warrant different requirements for Rule 3-14.
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    \227\ It is common for transactions in initial registration 
statements in the real estate industry to involve the combination of 
multiple entities with related or common ownership. In those 
circumstances, certain acquired entities may be designated as a 
predecessor of the registrant. For purposes of financial statements, 
an acquired business is designated as a predecessor when a 
registrant succeeds to substantially all of the business (or a 
separately identifiable line of business) of another entity (or 
group of entities) and the registrant's own operations before the 
succession appear insignificant relative to the operations assumed 
or acquired. See the definition of ``predecessor'' in Securities Act 
Rule 405. Financial statements specified in Rules 3-01 and 3-02 are 
required for acquisitions of a predecessor, including those from 
related parties, rather than Rule 3-05 or Rule 3-14 Financial 
Statements. These amendments will not affect those requirements.
---------------------------------------------------------------------------

    Application of Rule 3-06. We are aligning the application of Rule 
3-14 with Rule 3-05 by revising Rule 3-06 to permit the filing of 
financial statements covering a period of nine to 12 months to satisfy 
the requirement for filing financial statements for a period of one 
year for an acquired or to be acquired real estate operation. Existing 
Rule 3-06(b) provides that financial statements required under Rule 3-
05 ``covering a period of 9 to 12 months shall be deemed to satisfy a 
requirement for filing financial statements for a period of 1 year,'' 
but it did not address acquired real estate operations under Rule 3-14.
    Timing of filings. We are amending Rule 3-14 to include the same 
period for the filing of Rule 3-14 Financial Statements in registration 
statements and proxy statements as exists under Rule 3-05.\228\
---------------------------------------------------------------------------

    \228\ See supra note 15 and accompanying text discussing the 
Rule 3-05 filing period.
---------------------------------------------------------------------------

    Omission of Rule 3-14 Financial Statements for Real Estate 
Operations That Have Been Included in the Registrant's Financial 
Statements. We are aligning the application of Rule 3-14 with the 
amendments to Rule 3-05 by no longer requiring Rule 3-14 Financial 
Statements in registration statements and proxy statements once the 
acquired real estate operation is reflected in filed post-acquisition 
registrant financial statements for nine months.\229\
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    \229\ See discussion of the omission of Rule 3-05 Financial 
Statements in Section 1II.1B.3. above. The provision in Rule 3-05 
regarding omission of financial statements for acquisitions 
exceeding 40 percent significance is inapplicable in Rule 3-14.
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    Additional Amendments. We are making additional amendments, as 
proposed, to align Rule 3-14 with Rule 3-05 where there are no unique 
industry considerations that suggest a business subject to Rule 3-14 
should be treated differently than a business subject to Rule 3-05. 
Many of these amendments will not affect how registrants currently 
comply with Rule 3-14 because existing practice already analogizes to 
Rule 3-05 for guidance. Specifically, we are clarifying that:
     ``To be acquired'' real estate operations must be 
evaluated under the rule only if they are probable of acquisition; 
\230\
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    \230\ Rule 3-14 currently uses the phrase ``proposes to 
acquire'' when discussing ``to be acquired'' real estate operations 
and does not explicitly limit the scope to acquisitions probable of 
acquisition. The amendment codifies the current practice of 
interpreting this phrase to mean ``probable of acquisition.'' See 
FRM supra note 94 at Section 2310.1

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[[Page 54026]]

     The acquisition of an interest in a real estate operation 
accounted for using the equity method \231\ or, in lieu of the equity 
method, the fair value option, is considered the acquisition of a real 
estate operation;
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    \231\ See FRM supra note 94 at Section 2305.4.
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     Rule 3-14 does not apply to a real estate operation that 
is totally held by the registrant prior to consummation of the 
transaction; \232\
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    \232\ See Rule 3-05(a)(4), as amended. See also Rule 1-02(y) for 
the definition of the term ``totally held subsidiary.''
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     If registering an offering of securities to the security 
holders of the real estate operation to be acquired, the financial 
statements for the acquired real estate operation must cover the 
periods specified in Rules 3-01 and 3-02, except as provided otherwise 
for filings on Forms N-14, S-4 or F-4, and that the financial 
statements covering those fiscal years must be audited except as 
provided in Item 14 of Schedule 14A with respect to certain proxy 
statements or in registration statements filed on Forms N-14, S-4, or 
F-4; \233\
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    \233\ See Rule 3-05(b)(1), as amended.
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     Related real estate operations must be treated as a single 
acquisition for significance testing; \234\ and
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    \234\ See Rules 3-05(a)(3) and 3-14(a)(3), as amended. Real 
estate operations are considered related if they are under common 
control or management, the acquisition of one real estate operation 
is conditional on the acquisition of each other real estate 
operation, or each acquisition is conditioned on a single common 
event.
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     Pro forma amounts are permitted for significance testing 
in certain circumstances consistent with the application in Rule 3-
05.\235\
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    \235\ See Rules 3-05(b)(3) and 11-01(b)(3), as amended.
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    The amendments also clarify that Rule 3-14 Financial Statements 
should be prepared and audited in accordance with Regulation S-X and 
that they should be for the period that the real estate operation has 
been in existence, if that period is shorter than the period explicitly 
required for the financial statements.\236\ In addition, the amendments 
conform the requirements related to acquisitions of foreign real estate 
operations in Rule 3-14 to the analogous provisions in Rule 3-05.\237\
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    \236\ See Rules 3-05(a)(1), 3-05(b)(2), 3-14(a)(1), and 3-
14(b)(2), as amended.
    \237\ See Rules 3-05(c) and 3-14(d), as amended, and Rules 3-
05(d) and 3-14(e).
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    Aside from the substance of the rules, the amendments also conform 
the organization and format of certain related rules and forms, as 
appropriate. We are amending Item 8 of Form 10-K which currently 
excepts registrants from complying with Rule 3-05 and Article 11, to 
include Rule 3-14,\238\ instead of retaining the exception in Rule 3-14 
itself. We are also conforming the general format and wording of Rule 
3-14 to Rule 3-05, as appropriate, for consistency and to make the rule 
easier to follow.\239\
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    \238\ See Item 8(a) of Form 10-K.
    \239\ The changes in Rule 3-14 to conform wording include the 
addition of a paragraph similar to amended Rule 3-05(b)(1) about 
financial statements for certain proxy statements and registration 
statements on Forms S-4 and F-4, as well as the elimination of 
outdated industry-specific paragraphs (a)(2) and (3), which specify 
certain disclosures for circumstances that seldom occur today. We 
are also eliminating the Instruction in Item 9 of Form S-11, which 
refers back to the guidance in paragraphs (a)(2) and (3) of Rule 3-
14.
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    Finally, we are also revising Form 8-K to:
     Clarify that Item 2.01 requires the disclosure of the 
acquisition or disposition of assets that constitute a significant real 
estate operation as defined in Rule 3-14; \240\
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    \240\ While Item 2.01 currently only requires that significant 
acquisitions and dispositions be reported if they are not in the 
ordinary course of business, in practice registrants provide Item 
2.01 disclosure for acquisitions of significant real estate 
operations regardless of whether the acquisition or disposition was 
in the ordinary course of business. See Note to FRM supra note 94 at 
Section 2310.3.
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     Address the filing requirements in Item 9.01(a) 
consistently for all business acquisitions, including real estate 
operations; and
     Revise Item 2.01 Instruction 4 to reference Rule 3-14 to 
make clear that, as with Rule 3-05, the aggregate impact of 
acquisitions of real estate operations is not required to be reported 
unless these acquisitions are related real estate operations and 
significant in the aggregate.
    Also, as proposed, we are adopting amendments to conform Rule 3-14 
to the Rule 3-05 amendments being adopted in this release where no 
unique industry considerations exist. Specifically, we are amending 
Rule 3-14 to conform to the amendments described in Section II.A.1.c 
(Investment Test only), Section II.A.3.c (related only to certain 
required footnote disclosures),\241\ Section II.A.5.c, Section 
II.A.6.c, Section II.B.1.c (excluding the requirement related to 
acquisitions that exceed 40 percent significance, which does not apply 
to Rule 3-14), Section II.B.2.c and Section II.B.3.c.
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    \241\ The footnote disclosure to provide an explanation of the 
impracticability of preparing financial statements that include the 
omitted expenses is not applicable to Rule 3-14 Financial Statements 
because Rule 3-14 does not contain an impracticability condition. 
See note 12. With respect to the footnote disclosure related to 
historical cash flows, we acknowledge, as observed by some 
commenters, that certain historical cash flows of a real estate 
operation may not be comparable to proposed future operations. 
However, we believe that there is also cash flow information that 
would be meaningful to investors if available, for example, 
disclosure regarding historical cash flows for capital improvements. 
We are, therefore, adopting this requirement as proposed.
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2. Definition of Real Estate Operation
    Neither Regulation S-X nor any other Securities Act or Exchange Act 
rule provides a definition of a ``real estate operation'' or an 
explanation of what is meant by the reference to ``properties'' in Rule 
3-14. Because the terms are open to interpretation, Commission staff 
has provided guidance as to the meaning of these terms.\242\ The 
Commission staff has interpreted, for purposes of Rule 3-14, a real 
estate operation to refer to properties that generate revenues solely 
through leasing,\243\ but has not interpreted this definition to 
preclude a property that includes a limited amount of non-leasing 
revenues (like property management or other services related to the 
leasing) from being considered a real estate operation.\244\ The 
Commission staff has additionally provided guidance that a real estate 
operation includes real properties that will be held directly by the 
registrant or through an equity interest in a pre-existing legal entity 
that holds the real property under lease and related debt.\245\
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    \242\ See FRM supra note 94 at Section 2305.1 ``Applicability of 
S-X 3-14,'' and Section 2305.2, ``Nature of Real Estate 
Operations.''
    \243\ See FRM supra note 94 at Section 2305.2.
    \244\ Examples of such properties include office, apartment, and 
industrial buildings, as well as shopping centers and malls. A real 
estate operation excludes properties that generate revenues from 
operations other than leasing, such as nursing homes, hotels, 
motels, golf courses, auto dealerships, and equipment rental 
operations because these operations are more susceptible to 
variations in revenues and costs over shorter periods due to market 
and managerial factors.
    \245\ See FRM supra note 94 at Section 2305.3 ``Investment in a 
Pre-Existing Legal Entity.''
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a. Proposed Amendments
    The Commission proposed to amend Rule 3-14 to define a real estate 
operation as ``a business that generates substantially all of its 
revenues through the leasing of real property,'' which is consistent 
with current practice and staff interpretations \246\ and to remove the 
unnecessary condition in Rule 11-01(a)(5) that clarifies that Article 
11 applies to real estate operations.
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    \246\ The proposed amendment used the term ``business (as set 
forth in Sec.  210.11-01(d))'' in the definition of a real estate 
operation to address the fact that the acquisition of a real estate 
operation may be through an entity holding real property under lease 
or of a direct interest in the real property. See proposed Rule 3-
14(a)(2).
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b. Comments
    We received limited comment specific to the proposed definition of 
real estate

[[Page 54027]]

operations. Two commenters explicitly supported the definition, and no 
commenters opposed it.\247\ One of these commenters recommended adding 
``or substantially all the assets of which are held for lease'' in 
order to include real property that is not currently leased, but is 
being acquired with the intention of leasing and has more than a 
nominal leasing history.\248\ This commenter further recommended 
amending Rule 11-01(d) to clarify that there is a presumption that real 
property that is leased or held for lease to third parties constitutes 
a business. In addition, the same commenter recommended that we 
consider explicitly addressing real properties that have a limited 
leasing history or leasing history that is unrepresentative of expected 
future operations.\249\ Another commenter recommended the Commission 
further clarify the meaning of ``substantially all.'' \250\
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    \247\ See letter from Cravath and NAREIT.
    \248\ See letter from NAREIT.
    \249\ See letter from NAREIT. See also FRM supra note 94 at 
Section 2330.8 ``Rental History of Less Than Nine Months,'' Section 
2330.9, ``Exception for Demolition'' and Section 2330.10 ``Exception 
for Properties with No or Nominal Leasing History'' for related 
staff guidance.
    \250\ See letter from GT.
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c. Final Amendments
    We are amending Rule 3-14 to define a real estate operation as 
proposed as ``a business that generates substantially all of its 
revenues through the leasing of real property.'' We considered 
clarifying what is meant by ``substantially all'' in this context, as 
one commenter suggested. However, this term is not meant to be a bright 
line, and its application will depend on specific facts and 
circumstances. Accordingly, we are not making any changes in this 
regard.
    We also considered whether additional language is necessary to 
address an acquisition of real property that is not leased and 
generating revenues upon acquisition, but was historically leased and 
is intended to be leased again in the near future. However, we do not 
believe that the definition, as proposed, requires any changes, because 
in these circumstances a registrant should consider whether the lack of 
revenues at acquisition may be unrepresentative based on the existence 
of a leasing history and the expected continuation of the leasing 
operation, and thus could still conclude that it is a business that 
generates substantially all of its revenues through the leasing of real 
property. We also considered whether we should add language to address 
acquisitions of real property with a limited leasing history or a 
leasing history that is unrepresentative of expected future operations. 
However, we believe those situations are best addressed through Rule 3-
13.\251\
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    \251\ See Rule 3-13 supra note 58.
---------------------------------------------------------------------------

    We believe the definition we are adopting appropriately frames the 
application of Rule 3-14, reduces uncertainty regarding the meaning of 
the term, and serves to clarify the rule without changing the substance 
of how it is currently applied. In light of the adopted definition that 
clarifies that a real estate operation is a ``business'' as that term 
is used in Article 11, we are removing the condition in Rule 11-
01(a)(5) as it is no longer necessary.\252\
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    \252\ We considered whether Rule 11-01(d) should include a 
presumption that real property that is leased or held for lease is a 
business, but we believe it is more appropriate for registrants to 
evaluate for each acquisition the facts and circumstances included 
in the rule to determine if it constitutes a business.
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3. Significance Tests
    As noted above, Rule 3-14 does not provide explicit guidance on how 
to determine whether a real estate operation is significant. Due to the 
nature of a real estate operation, staff interpretations have sought to 
focus registrants on the Investment Test in Rule 1-02(w), adapted to 
compare the registrant's and its other subsidiaries' ``investments in'' 
\253\ the real estate operation, including any debt secured by the real 
properties that is assumed by the registrant, to the registrant's total 
assets at the last audited fiscal year end when determining 
``significance'' under Rule 3-14.\254\ When determining whether an 
acquisition is ``significant,'' the use of the Asset or Income Tests 
generally is not practical for a real estate operation because the 
historical amounts of assets and income of the acquired or to be 
acquired real estate operation are not available.\255\
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    \253\ See supra note 53.
    \254\ See FRM supra note 94 at Section 2315 ``Real Estate 
Operations--Measuring Significance.''
    \255\ The amounts are not available because most real estate 
managers do not maintain their books on a U.S. GAAP basis or obtain 
audits. Furthermore, because Rule 3-14 only requires abbreviated 
income statements to be filed, additional financial statements would 
have to be prepared solely for purposes of significance testing if 
the Asset and Income Tests applied to acquisitions of real estate 
operations.
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a. Proposed Amendments
    The Commission proposed to amend Rule 3-14 to specify that 
significance should be based on the Investment Test in Rule 1-02(w). 
Thus, consistent with the proposed amendments for Rule 3-05 
acquisitions discussed above, the Commission proposed to require 
comparison with the registrant's aggregate worldwide market value. If 
aggregate worldwide market value is not available, then the Investment 
Test would be based on total assets. When the test is based on total 
assets for real estate acquisitions, the Commission also proposed to 
modify the investment amount to include any debt secured by the real 
properties that is assumed by the registrant.
b. Comments
    We received limited comment addressing the significance tests as 
they relate to real estate operations.\256\ One commenter recommended 
allowing registrants that do not have an aggregate worldwide market 
value (such as non-traded REITs) to use net asset value of their common 
equity as the denominator for the Investment Test.\257\
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    \256\ See e.g., letter from EY.
    \257\ See letter from EY. This commenter further recommended 
that, if such a registrant is not permitted to use net asset value, 
the numerator should be limited to the consideration transferred and 
exclude any debt assumed by the buyer.
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c. Final Amendments
    We are amending Rule 3-14(b)(2) as proposed to require use of the 
Investment Test in Rule 1-02(w).\258\ We believe this amendment will 
reduce uncertainty regarding the significance tests and clarify the 
rule without changing the substance of how it is currently applied. 
When based on total assets, the final amendments specify, as proposed, 
that the test should be adapted to compare the registrant's and its 
other subsidiaries' ``investments in'' \259\ the real estate operation, 
including any debt secured by the real properties that is assumed by 
the registrant, to the registrant's total assets as of the end of the 
most recently completed fiscal year. We believe a modified Investment 
Test is necessary to appropriately determine significance for 
acquisitions of real estate operations because it takes into 
consideration the unique structure of these types of acquisitions, 
which typically involve assumed debt that is secured by the real 
properties that offsets the value of the real estate operation being 
acquired.
---------------------------------------------------------------------------

    \258\ We are not adopting amendments to permit non-traded REITs 
to use net asset value instead of aggregate worldwide market value 
due to the potential application complexities; however, we are 
adopting the modified investment test addressed in Section II.C.6., 
below, for blind pool offerings that will be applicable to non-
traded REITs.
    \259\ See supra note 53.

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[[Page 54028]]

4. Interim Financial Statements
    Unlike Rule 3-05,\260\ Rule 3-14 does not include an express 
requirement for registrants to provide interim financial statements. 
Article 11, however, requires pro forma financial information to be 
filed when the registrant has acquired one or more real estate 
operations which in the aggregate are significant.\261\ Article 11 
further provides that the pro forma condensed statement of 
comprehensive income must be filed for the most recent fiscal year and 
the period from the most recent fiscal year to the most recent interim 
date for which a balance sheet is required.\262\ As a result of Article 
11 and related staff interpretations, existing registrant practice is 
to provide interim financial statements for acquisitions of real estate 
operations.\263\
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    \260\ See Rule 3-05(b)(2)(i) through (iv). The rule refers 
explicitly to the most recent fiscal year and any interim periods 
specified in Rules 3-01 and 3-02.
    \261\ See Rule 11-01.
    \262\ See Rule 11-02(c)(2)(i). To meet this pro forma 
requirement, registrants must prepare and present substantially the 
same information for the most recent interim period, if applicable, 
that would be included in Rule 3-14 Financial Statements in most 
circumstances.
    \263\ See Rule 11-02(c)(2)(i) and FRM supra note 94 at Section 
2330.2 ``Periods to be Presented--Properties Acquired from Related 
Parties'' and Section 2330.3 ``Periods to be Presented--Properties 
Acquired from Third Parties.''
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to amend Rule 3-14 to specifically require 
Rule 3-14 Financial Statements for the most recent year-to-date interim 
period prior to the acquisition.
b. Comments and Final Amendments
    We received no comments specifically related to this proposal, so 
we are adopting the amendment to Rule 3-14(b)(2)(i) as proposed.\264\
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    \264\ See Section II.C.4 of the Proposing Release.
---------------------------------------------------------------------------

5. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-06 provides smaller reporting company disclosure 
requirements for the financial statements of real estate operations 
acquired or to be acquired that are substantially similar to the 
requirements in Rule 3-14. Part F/S of Form 1-A directs an issuer 
relying on Regulation A to present financial statements of real estate 
operations acquired or to be acquired as specified by Rule 8-06.\265\
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    \265\ See paragraph (b)(7)(v) of Part F/S. Part F/S of Form 1-A 
permits the periods presented to be the shorter of those applicable 
to issuers relying on Regulation A and the periods specified by 
Article 8.
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a. Proposed Amendments
    The Commission proposed amendments to Article 8 to further simplify 
and conform the application of Rule 3-14 and our related proposals to 
smaller reporting companies.
b. Comments
    None of the commenters that provided comments related to smaller 
reporting companies and smaller issuers commented on the proposed 
amendments to Rule 3-14.
c. Final Amendments
    We are amending Rule 8-06 as proposed to direct registrants to Rule 
3-14 for the requirements relating to financial statement disclosures 
of real estate operations acquired or to be acquired,\266\ while still 
permitting smaller reporting companies to rely on the form and content 
for annual and interim financial statements provided in Rules 8-02 and 
8-03. Rule 8-06 as amended will newly require smaller reporting 
companies to combine the discussion of material factors that they 
considered in assessing the acquisition with the disclosure required by 
Item 15 of Form S-11 when financial statements are presented in Form S-
11.\267\ We are also adding a reference to Rule 8-06 in Rule 3-06 to 
conform the requirements of Rule 8-06 and Rule 3-14 and adding Rule 8-
01(f) to expressly permit smaller reporting companies to file financial 
statements covering a period of nine to 12 months to satisfy the 
requirement for filing financial statements for a period of one year 
for an acquired real estate operation.\268\
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    \266\ We are also amending the instruction in Item 9.01 of Form 
8-K to include references to Rule 8-06 in order to conform the 
instruction to the text of Item 9.01, which already addresses the 
rules applicable to smaller reporting companies.
    \267\ See Instruction to Paragraph (f) in Rule 3-14. Since Item 
15 of Form S-11 already applies to smaller reporting companies, the 
Instruction changes only the location of the discussion.
    \268\ See Rule 8-01(f) and the discussion related to Rule 3-06 
in Section II.C.1 above.
---------------------------------------------------------------------------

    Additionally, because Part F/S of Form 1-A refers to Rule 8-06, the 
revisions to Rule 8-06 apply to issuers relying on Regulation A. As 
discussed in the Proposing Release, we believe these amendments will 
simplify these rules and reduce burdens for smaller reporting companies 
and issuers relying on Regulation A.\269\
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    \269\ See Section II.C.5 of the Proposing Release.
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6. Blind Pool Real Estate Offerings
    Certain registrants, typically non-traded real estate investment 
trusts (``REITs''),\270\ that conduct continuous offerings over an 
extended period of time follow the disclosure guidance provided under 
Industry Guide 5 Preparation of Registration Statements Relating to 
Interests in Real Estate Limited Partnerships (``Industry Guide 
5'').\271\ These registrants generally do not initially own any real 
estate assets, and the specific intended use of the proceeds raised 
from investors is not initially identified because such registrants 
have not yet selected any assets for their portfolios. Registrants in 
these blind pool offerings also typically provide only limited 
liquidity through restricted share redemption programs. However, these 
registrants provide certain undertakings \272\ to disclose information 
about significant acquisitions to investors in addition to Rule 3-14 
Financial Statements.
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    \270\ Non-traded REITs do not have securities listed for trading 
on a national securities exchange. Their purpose is to own and 
operate income-producing real estate or real estate-related assets.
    \271\ See Publication of Revisions to the Division of 
Corporation Finance's Guide 5 and Amendment of Related Disclosure 
Provisions, Release No. 33-6405 (June 3, 1982) [47 FR 25120 (June 
10, 1982)]. While Industry Guide 5, by its terms, applies only to 
real estate limited partnerships, in 1991 the Commission stated that 
``the requirements contained in the Guide should be considered, as 
appropriate, in the preparation of registration statements for real 
estate investment trusts and for all other limited partnership 
offerings.'' See Limited Partnership Reorganizations and Public 
Offerings of Limited Partnership Interests, Release No. 33-6900 
(June 25, 1991) [56 FR 28979 (June 25, 1991)].
    \272\ See Item 20.D. of Industry Guide 5, Disclosure Guidance: 
Topic No. 6--Staff Observations Regarding Disclosures of Non-Traded 
Real Estate Investment Trusts and FRM supra note 94 at Section 
2325.2. ```Blind Pool' Offerings--During the Distribution Period--
Undertakings.'' The undertakings include use of sticker supplements 
related to certain significant properties that will be acquired and 
post-effective amendments.
---------------------------------------------------------------------------

    Due to the nature of a blind pool investment as well as the 
supplemental undertakings provided, these registrants typically apply 
adapted significance tests when making the determination of whether 
they are required to provide Rule 3-14 Financial Statements.\273\ 
Commission staff has interpreted significance during the distribution 
period to be computed by comparing the registrant's and its other 
subsidiaries' ``investments in'' \274\ the real estate operation to the 
sum of: (1) The registrant's total assets as of the date of the 
acquisition, and (2) The proceeds (net of commissions) in good faith 
expected to be raised in the registered offering over the next 12 
months.\275\

[[Page 54029]]

After the distribution period has ended, the registrant determines 
significance using the total assets as of the acquisition date until 
the registrant files its next Form 10-K. After that next Form 10-K is 
filed, the registrant, following the staff's guidance, can determine 
significance using total assets as of the end of the most recently 
completed fiscal year included in the Form 10-K.\276\
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    \273\ In certain circumstances, registrants in blind pool 
offerings acquire businesses that are within the scope of Rule 3-05 
(for example, hotels) rather than Rule 3-14, but the registrants 
provide the Industry Guide 5 undertakings because they are 
conducting a blind pool offering. Currently, there is no special 
practice for measuring significance of Rule 3-05 acquisitions in 
these circumstances.
    \274\ See supra note 53.
    \275\ See FRM supra note 94 at Section 2325.3 ```Blind Pool' 
Offerings--During the Distribution Period--Significance.'' 
Calculation of the investment includes any debt secured by the real 
properties that is assumed by the purchaser. In addition, in 
estimating the offering proceeds, the registrant, following the 
staff's guidance, could consider the pace of fundraising as of the 
measurement date, the sponsor or dealer-manager's prior public 
fundraising experience, and offerings by similar companies.
    \276\ See FRM supra note 94 at Section 2325.5 ```Blind Pool'' 
Offerings--After the Distribution Period.''
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a. Proposed Amendments
    The Commission proposed amendments to codify existing staff 
guidance by specifying that significance for blind pool offerings must 
be computed by comparing the registrant's and its other subsidiaries' 
``investments in'' the real estate operation to the sum of: (1) The 
registrant's total assets as of the date of the acquisition, and (2) 
The proceeds (net of commissions) in good faith expected to be raised 
in the registered offering over the next 12 months.
b. Comments
    Commenters generally supported the proposed amendments.\277\ These 
commenters, however, recommended that, for registrants conducting blind 
pool offerings, the Commission extend the accommodations to 
acquisitions within the scope of Rule 3-05.\278\ In support of this 
change, one commenter noted that staff guidance and Guide 5 do not 
distinguish between acquisitions of real estate and other operations 
with regards to the expected reporting of undertakings.\279\
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    \277\ See letters from BDO, CAQ, DT, EY, GT, NAREIT, PWC, and 
RSM.
    \278\ See id.
    \279\ See letter from NAREIT.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments as proposed, but with modifications 
after considering comments received. We are codifying staff 
interpretations in this area to provide that significance for blind 
pool offerings must be computed by comparing the registrant's and its 
other subsidiaries' ``investments in'' the real estate operation to the 
sum of: (1) The registrant's total assets as of the date of the 
acquisition, and (2) The proceeds (net of commissions) in good faith 
expected to be raised in the registered offering over the next 12 
months as more fully described above. Without this accommodation, 
virtually all acquisitions in the early part of the distribution period 
would be deemed significant regardless of their size.
    We are also adopting amendments, as suggested by commenters, to 
extend the adapted significance test to Rule 3-05 acquisitions by 
registrants in blind pool offerings because the accommodation is based 
on the unique characteristics of the offering and registrants, rather 
than the type of acquisition.
    In light of the extension of the accommodation to Rule 3-05 
acquisitions, we revised the location of these amendments for blind 
pool offerings to Rule 11-01(b), which addresses how to determine 
significance for both Rule 3-05 acquisitions and Rule 3-14 
acquisitions.\280\
---------------------------------------------------------------------------

    \280\ See Rule 11-01(b)(4). Rules 3-05 and 3-14 were also 
revised to refer to new Rule 11-01(b)(4).
---------------------------------------------------------------------------

D. Pro Forma Financial Information

    The pro forma financial information described in Article 11 of 
Regulation S-X must accompany Rule 3-05 Financial Statements and Rule 
3-14 Financial Statements. Typically, pro forma financial information 
includes the most recent balance sheet and most recent annual and 
interim period income statements. Pro forma financial information for a 
business acquisition combines the historical financial statements of 
the registrant and the acquired business and is adjusted for certain 
items if specified criteria are met. As discussed above, pro forma 
financial information for an acquired business is required at the 20 
percent and 10 percent significance thresholds under Rule 3-05 and Rule 
3-14, respectively.\281\ The rules also require pro forma financial 
information for a significant disposed business at a 10 percent 
significance threshold for all registrants.
---------------------------------------------------------------------------

    \281\ See 1996 Streamlining Release supra note 24.
---------------------------------------------------------------------------

1. Adjustment Criteria and Presentation Requirements
    Rule 11-02 contains rules and instructions for the presentation of 
pro forma financial information. The rules provide some flexibility to 
tailor pro forma disclosures to particular events and circumstances. 
The presentation requirements for the pro forma condensed statement of 
comprehensive income were designed to elicit disclosures that 
distinguish between the one-time impact and the on-going impact of a 
transaction.\282\ The rules call for pro forma financial information to 
show the impact of the transaction on income from continuing operations 
of the registrant.\283\
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    \282\ See Instructions for the Presentation and Preparation of 
Pro Forma Financial Information and Requirements for Financial 
Statements of Businesses Acquired or To Be Acquired, Release No. 33-
6413 (June 24, 1982) [47 FR 29832 (July 9, 1982)] indicating that 
``[t]he presentation requirements for the pro forma condensed 
statement of income are designed to elicit disclosures that clearly 
distinguish between the one-time impact and the on-going impact of 
the transaction and thereby assist investors in focusing on the 
transaction at hand.''
    \283\ Discontinued operations would not be reflected in the 
condensed historical financial statements used as the starting point 
for the pro forma presentation.
---------------------------------------------------------------------------

    Article 11 provides that the only adjustments that are appropriate 
in the presentation of the pro forma condensed statement of 
comprehensive income are those that are:
     Directly attributable to the transaction;
     Expected to have a continuing impact on the registrant; 
and
     Factually supportable.\284\
---------------------------------------------------------------------------

    \284\ See Rule 11-02(b)(6). Material non-recurring charges or 
credits which result directly from the transaction and which will 
impact the income statement during the next 12 months are not 
reflected in the pro forma condensed statement of comprehensive 
income.

The pro forma condensed balance sheet, on the other hand, reflects pro 
forma adjustments that are directly attributable to the transaction and 
factually supportable, regardless of whether the impact is expected to 
be continuing or nonrecurring because the objective of the pro forma 
balance sheet is to reflect the impact of the transaction on the 
financial position of the registrant as of the balance sheet date.
a. Proposed Amendments
    The Commission proposed to revise Article 11 by replacing the 
existing pro forma adjustment criteria with simplified requirements to 
depict the accounting for the transaction (``Transaction Accounting 
Adjustments'') \285\ and present the

[[Page 54030]]

reasonably estimable synergies and other transaction effects that have 
occurred or are reasonably expected to occur (Management's 
Adjustments'').\286\ In addition, the Commission proposed other changes 
to simplify and clarify Article 11 and to provide more consistent use 
of terminology. The Commission proposed these changes because the 
existing pro forma adjustment criteria are not clearly defined, can 
yield inconsistent presentations for similar fact patterns, and 
preclude the inclusion of adjustments for the potential effects of 
post-acquisition actions expected to be taken by management.
---------------------------------------------------------------------------

    \285\ Under the proposed rule, Transaction Accounting 
Adjustments would depict: (1) In the pro forma condensed balance 
sheet the accounting for the transaction required by U.S. GAAP or 
IFRS-IASB, and (2) In the pro forma condensed income statements, the 
effects of those pro forma balance sheet adjustments assuming the 
adjustments were made as of the beginning of the fiscal year 
presented. If the condition in Rule 11-01(a) that is met does not 
have a balance sheet effect, then our proposal would require that 
Transaction Accounting Adjustments depict the accounting for the 
transaction required by U.S. GAAP or, if applicable, IFRS-IASB. 
Under the proposed rule, Transaction Accounting Adjustments would be 
limited to adjustments to account for the transaction using the 
measurement date and method prescribed by the applicable accounting 
standard. For probable transactions, the measurement date would be 
as of the most recent practicable date prior to the effective date 
(for registration statements) or the mailing date (for proxy 
statements).
    \286\ Under the proposed rule, Management's Adjustments would be 
required for and limited to synergies and other effects of the 
transaction, such as closing facilities, discontinuing product 
lines, terminating employees, and executing new or modifying 
existing agreements, that are both reasonably estimable and have 
occurred or are reasonably expected to occur. However, if the 
registrant previously was a part of another entity and presentation 
of pro forma financial information was necessary to reflect the 
operations and financial position of the registrant as an autonomous 
entity, the proposed rules would provide that the adjustments 
necessary to show the registrant as an autonomous entity be included 
in Management's Adjustments. For example, where a company (the 
registrant) operates as a subsidiary of another entity and files a 
registration statement under the Securities Act in connection with 
an initial public offering, and presentation of pro forma financial 
information is necessary to reflect the operations and financial 
position of the registrant as an autonomous entity, the registration 
statement would include Article 11 pro forma financial information, 
which under our proposal would include such adjustments in 
Management's Adjustments. The proposed rule also included 
presentation requirements for Management's Adjustments, requiring 
that they be presented through a separate column in the pro forma 
financial information after the presentation of the combined 
historical statements and Transaction Accounting Adjustments. This 
presentation would permit investors to distinguish the accounting 
effects on the registrant of the underlying acquired business from 
operational effects of management's plans that are subject to 
management's discretion or other uncertainties. Similarly, the 
proposed rules would require that per share data be presented in two 
separate columns. One column would present the pro forma total 
depicting the combined historical statements with only the 
Transaction Accounting Adjustments, and the second column would 
present the combined historical statements with both the Transaction 
Accounting Adjustments and Management's Adjustments. Further, the 
proposed rule would include specific disclosures for each 
Management's Adjustments including: A description, including the 
material uncertainties, of the synergy or other transaction effects; 
disclosure of the underlying material assumptions, the method of 
calculation, and the estimated time frame for completion; 
qualitative information necessary to give a fair and balanced 
presentation of the pro forma financial information; and to the 
extent known, the reportable segments, products, services, and 
processes involved; the material resources required, if any; and the 
anticipated timing. For synergies and other transaction effects that 
are not reasonably estimable and will not be included in 
Management's Adjustments, the proposed rule would require that 
qualitative information necessary for a fair and balanced 
presentation of the pro forma financial information also be 
provided.
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b. Comments
    While commenters were generally supportive of replacing the 
existing pro forma adjustment criteria with the proposed Transaction 
Accounting Adjustments,\287\ one commenter recommended retaining the 
existing methodology.\288\ Several commenters recommended changes or 
sought clarification regarding the application of the rules to 
Transaction Accounting Adjustments.\289\ However, most of the comments 
received relating to pro forma financial information were focused on 
Management's Adjustments. Commenters were mixed in their support \290\ 
or opposition \291\ to the proposed Management's Adjustments depicting 
synergies and other transaction effects.
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    \287\ See letters from Ball, Davis Polk, DT, FEI, New York City 
Bar Association, Committee on Mergers and Acquisitions (``NYCBA-
M&A''), Pfizer, and SIFMA. One of these commenters noted that under 
the existing rules, pro forma financial statements can be difficult 
for registrants to prepare and are among the most prolific sources 
of questions for the staff. See letter from NYCBA-M&A.
    \288\ See letter from Cravath. Cravath indicated that it does 
not believe that there is significant confusion among preparers of 
financial information or investors with respect to the current 
Article 11 pro forma adjustment methodology, including using the 
current ``continuing impact'' criterion, or the benefits and 
limitations of such disclosure. However, Cravath also indicated that 
it had significant concerns regarding the proposal to require 
Management's Adjustments and opposed the inclusion of such a 
requirement in the final rules. Accordingly, Cravath recommended 
retaining the existing methodology.
    \289\ See, e.g., letters from BDO, Davis Polk, DT, and FEI. For 
example, one of these commenters recommended the final rule permit 
the inclusion of pro forma adjustments for additional events that 
are directly related to the transaction, (e.g. adjusting for the 
effects of additional financing necessary to complete the 
acquisition). See letter from FEI. Another commenter recommended 
continuing to exclude nonrecurring items from the pro forma 
statement of comprehensive income and providing clarity about how to 
define non-recurring items. See letter from Davis Polk.
    \290\ See, e.g., letters from Allstate, Ball, CFA, Davis Polk, 
IMA, MTBC, and PWC.
    \291\ See, e.g., letters from Cravath, Eli Lilly, FEI, GT, 
Nasdaq, NYCBA-M&A, Pfizer, SIFMA, Shearman, and Williams. See also 
SBCFAC Recommendations, recommending that ``the proposed amendments 
to the pro forma financial information requirements with respect to 
whether the proposed addition of Management's Adjustments, which are 
intended to reflect reasonably estimable synergies and transaction 
effects, should be optional or not required at all.''
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    Many commenters recommended against including the proposed 
Management's Adjustments in pro forma financial statement 
requirements.\292\ Some of these commenters suggested that pro forma 
financial information is an inapt means for communicating the 
anticipated synergies from a transaction.\293\ These commenters also 
expressed concerns relating to: The inherent uncertainty/subjectivity 
of synergy expectations; the burden of preparing the disclosure; the 
potential liability; the risk of synergy disclosure changing over time 
and confusing or misleading investors; and other unintended 
consequences.\294\ In contrast, commenters supportive of the 
requirement indicated that the proposed Management's Adjustments would 
provide investors insight into the potential effects of the acquisition 
and post-acquisition plans expected to be taken by management \295\ and 
provide greater flexibility for management to include forward-looking 
information and provide investors with insight into their decision to 
enter into the transaction.\296\
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    \292\ See, e.g., letters from Eli Lilly, Liberty, NYCBA-M&A, 
NYCBA--Sec., Pfizer, S&C, and SIFMA. See also SBCFAC 
Recommendations.
    \293\ See, e.g., letters from S&C and NYCBA-M&A.
    \294\ See, e.g., letters from Cravath, Debevoise, Eli Lilly, 
FEI, GT, KPMG, Liberty, Nasdaq, NYCBA-M&A, Pfizer, S&C, SIFMA, 
Shearman, and Williams. Some of these commenters further suggested 
the reasonably expected synergy disclosure requirement could, among 
other things, result in premature disclosure of sensitive 
information that could affect important relationships with 
stakeholders, impact boards of directors, auditors, and 
underwriters, and have a chilling effect on disclosure. See, e.g., 
letters from FEI and Pfizer.
    \295\ See, e.g., letters from Ball, CFA, IMA, and PWC. One of 
these commenters supported inclusion of the disclosure because, in 
the commenter's view, the information provided to investors in 
connection with marketing the deal should be consistent with, if not 
reconciled to, management projections provided to the board and 
shareholders, or the projections provided to financial advisors in 
connection with the fairness opinion. See letter from CFA.
    \296\ See, e.g., letters from Ball and CAQ.
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    Many commenters, whether supportive of or opposed to the proposed 
requirements, recommended that the Commission provide additional 
guidance or clarification about their application, particularly with 
respect to the proposed Management's Adjustments.\297\ Commenters 
recommended that the Commission provide examples of synergies and other 
transaction effects and the treatment of nonrecurring costs to achieve 
them.\298\ Commenters also requested other implementation guidance, 
such as guidance on: The criteria for determining ``reasonably 
estimable'' and the permissible range; the timing parameters relating 
to realization and ``reasonably expected'' to occur; what would 
constitute a ``fair and balanced presentation''; the relationship 
between

[[Page 54031]]

Management's Adjustments on the pro forma statements of comprehensive 
income and those on the balance sheet; updating requirements for 
Management's Adjustments in subsequent filings; the presentation of 
multiple transactions; and treatment of overlap between Transaction 
Accounting Adjustments and Management's Adjustments.\299\
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    \297\ See, e.g., letters from DT, Liberty, Pfizer, and PWC.
    \298\ See, e.g., letters from BDO, CAQ, Crowe, Davis Polk, DT, 
EY, GT, KPMG, PWC, and RSM.
    \299\ See, e.g., letters from BDO, CFA, Crowe, Debevoise, DT, 
EY, FEI, GT, IMA, KPMG, RSM, and S&C.
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    Some commenters that expressed concern relating to liability for 
the disclosure sought by the proposed amendments supported the 
application of the forward-looking information safe harbors under 17 
CFR 230.175 (``Securities Act Rule 175'') and 17 CFR 240.3b-6 
(``Exchange Act Rule 3b-6''),\300\ while other commenters recommended 
further protections, such as a safe harbor for forward-looking 
information similar to that found in the Private Securities Litigation 
Reform Act safe harbor,\301\ permitting Article 11 information to be 
``furnished'' rather than ``filed,'' \302\ or an exception or safe 
harbor for cases where synergies are not a material element of the 
transaction.\303\
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    \300\ See letters from Allstate, CFA, Cravath, Debevoise, PWC, 
and SIFMA. One of these commenters recommended that the final rules 
expressly provide a safe harbor for forward-looking information and 
that it include express language that the safe harbors apply to any 
pro forma financial information that includes both historical and 
forward-looking information. This commenter also expressed concern 
that the proposed requirement to provide qualitative information 
necessary for a fair and balanced presentation of the pro forma 
financial information when synergies and other transaction effects 
would not be included in Management's Adjustments because they are 
not reasonably estimable represented a new disclosure liability 
standard. See letter from Cravath.
    \301\ See letter from Davis Polk.
    \302\ See letter from S&C.
    \303\ See letter from NYCBA--M&A.
---------------------------------------------------------------------------

    Several commenters recommended the Commission consider whether such 
disclosure should be optional.\304\ Other commenters recommended other 
ways to limit the proposed Management's Adjustments disclosure 
requirements while still providing useful information.\305\ For 
example, two commenters recommended limiting the requirement to 
narrative disclosure of synergies information in transactions where the 
information has otherwise been publicly disclosed.\306\ Another 
commenter recommended comprehensive disclosure in the footnotes of the 
related non-recurring costs and anticipated timing of the run-rate 
synergies.\307\
---------------------------------------------------------------------------

    \304\ See, e.g., letters from BDO, Cravath, EY, and Williams. 
One of these commenters suggested that if Management's Adjustments 
were optional they could be removed from the pro forma financial 
information and underwriters could receive customary comfort as part 
of their due diligence process. See letter from BDO. Another 
commenter recommended the disclosure be optional or not required for 
smaller reporting companies. See SBCFAC Recommendations.
    \305\ See, e.g., letters from Davis Polk, FEI, and S&C.
    \306\ See letters from Cravath and S&C.
    \307\ See letter from Davis Polk.
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c. Final Amendments
    We are adopting the amendments with modifications after considering 
comments received. We are amending Article 11, as proposed, by 
replacing the existing pro forma adjustment criteria with simplified 
requirements to depict the accounting for the transaction and to 
provide the option to depict synergies and dis-synergies of the 
acquisitions and dispositions for which pro forma effect is being 
given. We also are adopting, as proposed, other changes to simplify and 
clarify Article 11 and use terminology more consistently.\308\ 
Additionally, we are, as proposed, deleting existing Rule 11-02(a), 
which describes the objectives of the preparation requirements, to 
avoid confusion and focus registrants on the requirements of the rule.
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    \308\ Specifically, we are amending Article 11, as proposed, to 
refer to ``pro forma financial information,'' ``potential common 
stock'' as defined in U.S. GAAP, and ``pro forma basic'' per share 
data throughout, as well as amending existing Rule 11-02(b)(5) to 
require the pro forma condensed statement of comprehensive income to 
also disclose income (loss) from continuing operations attributable 
to the controlling interests because that amount is used to 
calculate earnings per share under U.S. GAAP. See amended Rule 11-
02(a)(5). We are also, as proposed, amending existing Rule 11-
01(a)(8) to remove the reference to other ``events'' as the concept 
of other events is encompassed by the reference to ``other 
transactions'' and amending existing Rule 11-02(b)(2) to refer to 
``each transaction for which pro forma effect is being given'' in 
recognition that the information may be required to give effect to 
more than one transaction. See amended Rules 11-01(a)(8) and 11-
02(a)(2).
---------------------------------------------------------------------------

    The revised pro forma adjustment criteria we are adopting are 
broken out into three categories:
    (i) ``Transaction Accounting Adjustments;''
    (ii) ``Autonomous Entity Adjustments;'' and
    (iii) ``Management's Adjustments.'' \309\
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    \309\ As proposed, the amendments: (i) Eliminate the substance 
of the first sentence of Instruction 2 as well as Instruction 4 and 
Instruction 5 of Rule 11-02(b) as this guidance is superseded by the 
requirements for Transaction Accounting Adjustments and Autonomous 
Entity Adjustments; (ii) Eliminate Instruction 3 regarding business 
dispositions as it is no longer necessary given the adoption of 
proposed Rules 11-02(a)(4), 11-02(a)(6), and 11-02(b)(3); (iii) 
Incorporate the substance of Instruction 1, using income from 
continuing operations, into amended Rule11-02(b)(1) and Instruction 
2 guidance on financial institutions into amended Rule 11-02(b)(2); 
(iv) Add new Rule 11-02(b)(4) in place of Instruction 6 to clarify 
that each transaction for which pro forma effect is required to be 
given must be presented in separate columns; and (v) Add new Rule 
11-02(b)(5) to replace Instruction 7 to Rule 11-02(b), which will 
codify pro forma tax effect guidance from Staff Accounting Bulletin 
No. 1.B., Allocation Of Expenses And Related Disclosure In Financial 
Statements Of Subsidiaries, Divisions Or Lesser Business Components 
Of Another Entity, 1. Costs reflected in historical financial 
statements.

The Transaction Accounting Adjustments reflect only the application of 
required accounting to the acquisition, disposition, or other 
transaction linking the effects of the acquired business to the 
registrant's audited historical financial statements. Autonomous Entity 
Adjustments are adjustments necessary to reflect the operations and 
financial position of the registrant as an autonomous entity when the 
registrant was previously part of another entity. Management's 
Adjustments provide both flexibility to registrants to include forward-
looking information that depicts the synergies and dis-synergies 
identified by management in determining to consummate or integrate the 
transaction for which pro forma effect is being given and insight to 
investors into the potential effects of the acquisition and the post-
acquisition plans expected to be taken by management. Under the final 
amendments, Transaction Accounting Adjustments and Autonomous Entity 
Adjustments are required adjustments. Management's Adjustments, as 
discussed further below, are optional under the final amendments.
Transaction Accounting Adjustments and Autonomous Entity Adjustments
    We are adopting the Transaction Accounting Adjustments, as 
proposed, in amended Rule 11-02(a)(6)(i) to require registrants to 
depict: (1) In the pro forma condensed balance sheet the accounting for 
the transaction required by U.S. GAAP or IFRS-IASB, as applicable,\310\ 
and (2) In the pro forma condensed income statements, the effects of 
those pro forma balance sheet adjustments assuming the adjustments were 
made as of the beginning of the fiscal year presented.\311\ Consistent 
with the proposal, the amendment indicates that if the condition in 
Rule 11-01(a) that is met does not have a balance sheet effect, then 
the Transaction Accounting Adjustments to the pro forma statement

[[Page 54032]]

of comprehensive income should depict the accounting for the 
transaction required by U.S. GAAP or IFRS-IASB, as applicable. Further, 
in a modification from the proposal made in response to comments, the 
amendments clarify that pro forma statement of comprehensive income 
``adjustments must be made whether or not the pro forma balance sheet 
is presented pursuant to paragraph (c)(1) of this section.''
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    \310\ Transaction Accounting Adjustments are limited to 
adjustments to account for the transaction using the measurement 
date and method prescribed by the applicable accounting standard. 
For probable transactions, the measurement date is as of the most 
recent practicable date prior to the effective date (for 
registration statements) or the mailing date (for proxy statements).
    \311\ See Rule 11-02(a)(6)(i)(B).
---------------------------------------------------------------------------

    In order to effect the changes described below to our Management's 
Adjustments proposal, the requirement to show the registrant as an 
autonomous entity if the condition in Rule 11-01(a)(7) is met has been 
relabeled as ``Autonomous Entity Adjustments'' and relocated from the 
subparagraph concerning Management's Adjustments to Rule 11-
02(a)(6)(ii) to clarify that such adjustments are required when the 
condition for their presentation is met and that they must be presented 
in a separate column from Transaction Accounting Adjustments.\312\
---------------------------------------------------------------------------

    \312\ We believe this requirement is appropriate given the 
different purposes for which Transaction Accounting Adjustments and 
Autonomous Entity Adjustments are used. It will also facilitate 
compliance with the requirements for determining significance of 
acquisitions and dispositions using pro forma financial information, 
which as proposed will only include Transaction Accounting 
Adjustments. See Rule 11-01(b)(3)(i)(B).
---------------------------------------------------------------------------

    As proposed, the amendments will require that historical and pro 
forma per share data must be presented on the face of the pro forma 
condensed statement of comprehensive income and give effect to 
Transaction Accounting Adjustments. However, in a further modification 
from the proposal \313\ to effect the changes described below to our 
Management's Adjustment proposal, the amendments require that such pro 
forma per share data also give effect to Autonomous Entity 
Adjustments.\314\ We believe that including all adjustments required by 
our amendments to be presented on the face of the pro forma financial 
information, whether deemed recurring or nonrecurring by a registrant's 
management, will help achieve consistency in the application of our pro 
forma requirements and simplify compliance. This requirement, coupled 
with the requirement to disclose revenues, expenses, gains and losses 
and related tax effects that will not recur in the income of the 
registrant beyond 12 months after the transaction, will also enhance 
transparency.
---------------------------------------------------------------------------

    \313\ We do not believe it is necessary, as some commenters 
suggested, to modify our proposal to permit the inclusion of pro 
forma adjustments for additional events that are directly related to 
the transaction (e.g. adjusting for the effects of additional 
financing necessary to complete the acquisition) because Rule 11-
01(a)(8) requires giving pro forma effect when consummation of other 
transactions has occurred or is probable for which disclosure of pro 
forma financial information would be material to investors.
    \314\ We were not persuaded by the suggestion to further modify 
our proposal to permit exclusion of nonrecurring items from the pro 
forma statement of comprehensive income or to define non-recurring 
items.
---------------------------------------------------------------------------

Management's Adjustments
    We agree with commenters that providing forward-looking 
information, subject to appropriate safe harbors, about synergies and 
related-transaction effects contemplated by the board and management in 
determining to execute the acquisition or disposition of a business 
would provide useful information for understanding the effects of the 
transaction. However, having considered the comments received, we are 
persuaded that the line-item specificity and the one year time horizon 
presented in our proposed pro forma requirements is not necessarily 
consistent with the manner in which synergy estimates are made and that 
not all transactions attach the same level of importance to synergies 
as a rationale for choosing to pursue the transaction. We are further 
persuaded that there may be different levels of confidence about 
different types of synergies and transaction effects and that 
disclosure requirements should be crafted with appropriate flexibility 
to permit management to depict full run-rate synergies and the 
nonrecurring costs to achieve them if, and in a manner, they deem 
appropriate. For example, we believe cost synergies should be permitted 
to be presented without revenue synergies provided that they 
incorporate related dis-synergies and the related disclosure describes 
the nature, uncertainties, and limitations of the amounts presented and 
the time-frames and uncertainties inherent in achieving them. We also 
believe such disclosure should be linked to pro forma financial 
information as a means to more fully demonstrate how historical amounts 
could change based on the transaction.
    After considering comments received on the proposals, we are 
modifying the amendments to provide that Management's Adjustments 
depicting synergies and dis-synergies of the acquisitions and 
dispositions for which pro forma financial information is being given 
may, in the registrant's discretion, be presented if in its 
management's opinion, such adjustments would enhance an understanding 
of the pro forma effects of the transaction.\315\ We encourage 
registrants to provide Management's Adjustments in these circumstances 
when certain additional conditions are met. Because under the final 
amendments the presentation of Management's Adjustments is optional, we 
are modifying the proposed rules such that, in order to present 
Management's Adjustments, certain conditions related to the basis for 
Management's Adjustments and the form of presentation must be met. 
These amendments are intended to ensure that if Management's 
Adjustments are presented, they are done so consistently and in a 
manner that would not be misleading to investors. Specifically, as 
modified, the Basis for Management's Adjustments in Rule 11-02(a)(7)(i) 
requires as conditions for presenting Management's Adjustments that:
---------------------------------------------------------------------------

    \315\ See Rule 11-02(a)(7).
---------------------------------------------------------------------------

     There is a reasonable basis for each such adjustment;
     The adjustments are limited to the effect of such 
synergies and dis-synergies on the historical financial statements that 
form the basis for the pro forma statement of comprehensive income as 
if the synergies and dis-synergies existed as of the beginning of the 
fiscal year presented. If such adjustments reduce expenses, the 
reduction shall not exceed the amount of the related expense 
historically incurred during the pro forma period presented; and
     The pro forma financial information reflects all 
Management's Adjustments that are, in the opinion of management, 
necessary to a fair statement of the pro forma financial information 
presented and a statement to that effect is disclosed. When synergies 
are presented, any related dis-synergies shall also be presented.
    Further, as modified, the Form of Presentation in Rule 11-
02(a)(7)(ii) requires as additional conditions for presenting 
Management's Adjustments that:
     If presented, Management's Adjustments must be presented 
in the explanatory notes to the pro forma financial information in the 
form of reconciliations of pro forma net income from continuing 
operations attributable to the controlling interest and the related pro 
forma earnings per share data to such amounts after giving effect to 
Management's Adjustments.
     If presented, Management's Adjustments included or 
incorporated by reference into a registration statement, proxy 
statement, offering statement or Form 8-K should be as of the most 
recent practicable date prior to the effective date, mail date, 
qualified date, or filing date as applicable, which may require that 
they be updated if previously provided in a Form 8-K that

[[Page 54033]]

is appropriately incorporated by reference.
     If Management's Adjustments will change the number of 
shares or potential common shares, the change must be reflected within 
Management's Adjustments in accordance with U.S. GAAP or IFRS-IASB, as 
applicable, as if the common stock or potential common stock were 
outstanding as of the beginning of the period presented.
     The explanatory notes must also include disclosure of the 
basis for and material limitations of each Management's Adjustment, 
including any material assumptions or uncertainties of such adjustment, 
an explanation of the method of the calculation of the adjustment, if 
material, and the estimated time frame for achieving the synergies and 
dis-synergies of such adjustment.\316\
---------------------------------------------------------------------------

    \316\ See Rule 11-02(a)(11)(iii).
---------------------------------------------------------------------------

    We believe these requirements are necessary to better enable an 
investor to understand Management's Adjustments being made in the pro 
forma financial information and that this presentation will clearly 
distinguish the accounting effects on the registrant of the underlying 
acquired business from operational effects of management's plans that 
are subject to management's discretion and other uncertainties.
    Some commenters cited similarities between pro forma Management's 
Adjustments and projections. While we believe they are distinct, 
because Management's Adjustments may include measures that require 
similar judgments to projections, we have looked to the Commission's 
policy statement on projections in developing a framework for optional 
disclosure of Management's Adjustments.\317\ Specifically, the amended 
rules include disclosure requirements related to the Basis for 
Management's Adjustments and Form of Management's Presentation.\318\ 
Likewise, the final amendments require that there is a reasonable basis 
for each such adjustment and that the pro forma financial information 
reflects all Management's Adjustments that are, in the opinion of 
management, necessary to a fair statement of the pro forma financial 
information presented and a statement to that effect is disclosed.\319\ 
The final amendments also require disclosure of both the basis for and 
material limitations of each Management's Adjustment, including any 
material assumptions or uncertainties of such adjustment, an 
explanation of the method of the calculation of the adjustment, if 
material, and the estimated time frame for achieving the synergies and 
dis-synergies of such adjustment.\320\ The amendments also provide 
practical limits tailored to the pro forma financial information 
presentation.\321\
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    \317\ See Item 10(b) of Regulation S-K.
    \318\ See Rule 11-02(a)(7)(i) and (ii).
    \319\ See Rule 11-02(a)(7)(i)(A). This requirement is similar to 
the representation management must disclose in historical interim 
financial statements subject to Article 10, Interim financial 
statements, (see 17 CFR 210.10-01(b)(8) (``Rule 10-01(b)(8)'')) and 
taken together with the requirement to include dis-synergies if 
synergies are depicted (see Rule 11-02(a)(7)(i)(C)), we believe it 
will help achieve much the same purpose as our proposed requirement 
that pro forma presentations that include Management's Adjustments 
be fair and balanced. Because we are persuaded that the line-item 
specificity in our proposed pro forma requirements is not 
necessarily consistent with the manner in which synergy estimates 
are made, the amended rules do not include that proposed requirement 
or the one to disclose for each Management's Adjustment, to the 
extent known, the reportable segments, products, services, and 
processes involved; the material resources required, if any, and the 
anticipated timing.
    \320\ See Rule 11-02(a)(7)(ii)(C).
    \321\ For example, the amended rules limit the adjustments to 
the effect of such synergies and dis-synergies on the historical 
financial statements that form the basis for the pro forma statement 
of comprehensive income as if the synergies and dis-synergies 
existed as of the beginning of the fiscal year presented. The 
amended rules further require that if such adjustments reduce 
expenses, the reduction shall not exceed the amount of the related 
expense historically incurred during the pro forma period presented. 
See Rule 11-02(a)(7)(i)(B).
---------------------------------------------------------------------------

    While we encourage registrants to include Management's Adjustments 
in pro forma financial information, we recognize that such adjustments 
may not be appropriate for all circumstances. In order to achieve 
consistency between pro forma financial information presentations that 
include Management's Adjustments and those that do not, and in 
recognition that the line item format of pro forma financial 
information may not be well-suited to Management's Adjustments, the 
amended rules provide that Management's Adjustments shall be presented 
in the explanatory notes to the pro forma financial information in the 
form of reconciliations of pro forma net income from continuing 
operations attributable to the controlling interest and the related pro 
forma earnings per share data to such amounts after giving effect to 
Management's Adjustments. Because Management's Adjustments might 
contain forward-looking information, we are amending the rule, as 
proposed, to include an instruction indicating that any forward-looking 
information supplied is expressly covered by the safe harbor provisions 
under 17 CFR 230.175 and 17 CFR 240.3b-6.\322\ Given the reference to 
these safe harbors in the adopted rule and the other modifications we 
are making with respect to Management's Adjustments, we do not believe 
there is a need to create new safe harbors or to reference additional 
safe harbors.
---------------------------------------------------------------------------

    \322\ See the Instruction to Rule 11-02(a)(6)(ii).
---------------------------------------------------------------------------

Explanatory Notes
    To further clarify the pro forma financial information disclosure, 
we are adopting, as proposed, amendments to require disclosure of 
revenues, expenses, gains and losses, and related tax effects that will 
not recur in the income of the registrant beyond 12 months after the 
transaction.\323\ Additionally, for Transaction Accounting Adjustments, 
the final amendments will require, as proposed, disclosure of:
---------------------------------------------------------------------------

    \323\ See Rule 11-02(a)(10)(i), based on existing Rule 11-
02(b)(5).
---------------------------------------------------------------------------

     Total consideration transferred or received, including its 
components and how they were measured. If total consideration includes 
contingent consideration, the amendments will require disclosure of the 
contingent consideration arrangement(s),\324\ the basis for determining 
the amount of payment(s) or receipt(s), and an estimate of the range of 
outcomes (undiscounted) or, if a range cannot be estimated, that fact 
and the reasons why; and
---------------------------------------------------------------------------

    \324\ In a modification from the proposal, the amended rule 
inserts ``contingent consideration'' before ``arrangements'' to 
clarify that the proposed rule's reference to ``arrangement(s)'' 
means ``contingent consideration arrangement(s).''
---------------------------------------------------------------------------

     When the initial accounting is incomplete: A prominent 
statement to this effect, the items for which the accounting depicted 
is incomplete, a description of the information that the registrant 
requires, including, uncertainties affecting the pro forma financial 
information and the possible consequences of their resolution, an 
indication of when the accounting is expected to be finalized, and 
other available information regarding the magnitude of any potential 
adjustments.\325\
---------------------------------------------------------------------------

    \325\ See Rule 11-02(a)(11)(ii).
---------------------------------------------------------------------------

    In order to effect the changes described above to our Management's 
Adjustments proposal, we are relocating the proposed explanatory note 
disclosures for Management's Adjustments that we believe also apply to 
Autonomous Entity Adjustments from the subparagraph concerning 
Management's Adjustments to Rule 11-02(a)(11)(iii). Specifically, the 
amended rules provide that the accompanying explanatory notes shall 
disclose for each Autonomous Entity Adjustment, a description of the 
adjustment (including the material uncertainties), the material 
assumptions, the calculation of the

[[Page 54034]]

adjustment, and qualitative information about the Autonomous Entity 
Adjustments necessary to give a fair and balanced presentation of the 
pro forma financial information.\326\ The amendments also tailor the 
proposed disclosure to reference Autonomous Entity Adjustments and to 
remove proposed disclosure that related to synergies and other 
transaction effects rather than to Autonomous Entity Adjustments. 
Further, the amendments retain for Autonomous Entity Adjustments the 
proposed requirement to disclose qualitative information about the 
Autonomous Entity Adjustments necessary to give a fair and balanced 
presentation of the pro forma financial information.\327\
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    \326\ The amendments to provide required disclosure for 
Autonomous Entity Adjustments do not include the following proposed 
explanatory note disclosures for Management's Adjustments, which we 
believe may be less relevant to Autonomous Entity Adjustments: The 
estimated time frame for completion and, to the extent known, the 
reportable segments, products, services, and processes involved; the 
material resources required, if any, and the anticipated timing.
    \327\ Some commenters requested clarification about what 
disclosure would be necessary to satisfy this requirement, with at 
least one of these commenters stating its belief that the proposed 
requirement is a subjective standard. See, e.g., letters from Crowe, 
DT, EY, and RSM. We observe that the Rule 11-01(a)(7) requirement 
for pro forma financial information that includes Autonomous Entity 
Adjustments--namely, that the registrant previously was a part of 
another entity and such presentation is necessary to reflect 
operations and financial position of the registrant as an autonomous 
entity--involves a facts and circumstances determination that does 
not lend itself to developing an all-inclusive list of disclosures. 
Instead, the amended rule requires application of judgment to 
identify ``additional'' qualitative disclosures, ``if any,'' 
necessary to achieve a fair and balanced presentation in light of a 
registrant's unique facts and circumstances. As with other 
disclosure obligations, this requirement should be assessed from the 
perspective of the reasonable investor.
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    We are additionally clarifying, as proposed, that: Pro forma 
financial information must be appropriately labeled and presented as 
required by Article 11; \328\ requiring that each transaction for which 
pro forma effect is required to be given must be presented in a 
separate column; \329\ and requiring that, if pro forma financial 
information includes another entity's statement of comprehensive 
income, such as that of an acquired business, it must be brought up to 
within one fiscal quarter, if practicable.\330\
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    \328\ See Rule 11-02(a)(11) and Rule 11-02(c)(2). We are 
explicitly requiring this labeling and presentation in Article 11 to 
avoid confusing or inconsistent disclosure. The rules also generally 
preclude: (i) Presentation of pro forma financial information on the 
face of the historical financial statements, except where such 
presentation is specifically required by U.S. GAAP or IFRS-IASB, 
(ii) presentation of summaries of pro forma financial information 
that exclude material transactions, (iii) presentation of pro forma 
amounts that reflect Management's Adjustments elsewhere in a filing 
without also presenting with equal or greater prominence the amounts 
to which they are required to be reconciled and a cross-reference to 
that reconciliation, or (iv) presentations that give pro forma 
effect to the adoption of accounting standards.
    \329\ See Rule 11-02(b)(4).
    \330\ See Rule 11-02(c)(3). This change better accommodates 
registrants and acquired businesses that have 52-53 week fiscal 
years than the current requirement to bring the financial 
information to within 93 days of the registrant's most recent fiscal 
year end, if practicable.
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2. Significance and Business Dispositions
    Rule 11-01(a)(4) provides that pro forma financial information is 
required upon the disposition or probable disposition of a significant 
portion of a business either by sale, abandonment, or distribution to 
shareholders by means of a spin-off, split-up, or split-off, if that 
disposition is not fully reflected in the financial statements of the 
registrant. Rule 11-01(b) further provides that a disposition of a 
business is significant if the business to be disposed of meets the 
conditions of a significant subsidiary under Rule 1-02(w). Rule 1-02(w) 
uses a 10 percent significance threshold, rather than the 20 percent 
threshold used for business acquisitions under Rules 3-05 and 11-01(b). 
When a registrant determines that it has an acquisition or disposition 
of a significant amount of assets that do not constitute a business, 
Item 2.01 of Form 8-K uses a 10 percent threshold for both acquisitions 
and dispositions to require disclosure of certain details of the 
transaction.\331\ The terms ``business'' and ``significant'' used in 
Form 8-K specifically reference Article 11 of Regulation S-X.
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    \331\ For acquisitions and dispositions of assets that do not 
constitute a business, Item 2.01 of Form 8-K specifies the tests to 
be used rather than referencing the tests in Rule 1-02(w). 
Specifically, Item 2.01 states that, ``an acquisition or disposition 
shall be deemed to involve a significant amount of assets: (i) If 
the registrant's and its other subsidiaries' equity in the net book 
value of such assets or the amount paid or received for the assets 
upon such acquisition or disposition exceeded 10 percent of the 
total assets of the registrant and its consolidated subsidiaries; or 
(ii) if it involved a business (see Rule 11-01(d)) that is 
significant (see Rule 11-01(b)).''
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a. Proposed Amendments
    The Commission proposed to:
     Raise the significance threshold for the disposition of a 
business from 10 percent to 20 percent to conform to the threshold at 
which an acquired business is significant under Rule 3-05;
     To the extent applicable, conform the tests used to 
determine significance of a disposed business to those used to 
determine significance of an acquired business; and
     Require smaller reporting companies to provide pro forma 
financial information for disposition of a significant business in Form 
8-K and in certain registration statements and proxy statements when 
the disposition occurs during or after the most recently completed 
fiscal year.
b. Comments
    Commenters generally supported raising the threshold for 
significant dispositions.\332\ One commenter recommended aligning the 
criteria for measuring the significance of the disposition of a real 
estate operation with the criteria for measuring an acquisition.\333\
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    \332\ See letters from Bass Berry, Cravath, Eli Lilly, FEI, 
Liberty, NAREIT, Shearman, and Williams.
    \333\ See letter from DT.
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c. Final Amendments
    We are adopting the amendments substantially as proposed. We 
believe these amendments will simplify compliance for registrants, and 
we see no compelling reason why the subset of businesses for which 
investors need information should differ depending on whether the 
business is being acquired or disposed.
    We are amending Rule 11-01(b) to raise the significance threshold 
for the disposition of a business from 10 percent to 20 percent and to 
conform, to the extent applicable, the tests used to determine 
significance of a disposed business to those used to determine 
significance of an acquired business. We are also adopting as proposed 
the amendment to Form 8-K and Article 8 to require smaller reporting 
companies to provide pro forma financial information for disposition of 
a significant business in Form 8-K and in certain registration 
statements and proxy statements when the disposition occurs during or 
after the most recently completed fiscal year.\334\
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    \334\ The Form 8-K requirement for smaller reporting companies 
to provide pro forma financial information refers to Rule 8-05. Rule 
8-05, however, only applies to acquisitions. While Article 8 has a 
requirement in Rule 8-03(b)(4) to provide pro forma financial 
information about dispositions of significant businesses, the 
provision only applies to the registrant's interim financial 
statements. In order to address the anomalous outcome where pro 
forma financial information is required when interim financial 
statements are presented but not when annual financial statements 
are presented, as proposed, we are removing Rule 8-03(b)(4) and 
revising Rule 8-05 to require disclosure of pro forma financial 
information when any of the conditions in Rule 11-01 is met.
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    The amendments apply to dispositions of real estate operations as 
defined in Rule 3-14(a)(2).\335\ We are

[[Page 54035]]

not adopting for dispositions of real estate operations the last 
sentence of proposed Rule 1-02(w)(1)(i)(D), which modified the 
Investment Test to include debt secured by the real properties that is 
assumed by the buyer when the registrant's and its other subsidiaries' 
investments in and advances to the real estate operations are being 
compared to total assets of the registrant. Where real estate 
operations have been included in the consolidated financial statements 
of the registrant, the information necessary to apply the Investment, 
Asset and Income Tests is available. Thus, unlike for acquisitions of 
real estate operations, there are no unique industry considerations 
warranting limiting the significance determination to only the 
Investment Test or modifying that test.
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    \335\ See Rule 11-01(b)(2).
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3. Smaller Reporting Companies and Issuers Relying on Regulation A
    Rule 8-05 sets forth pro forma financial information requirements 
for business acquisitions by smaller reporting companies. Additionally, 
Part F/S of Form 1-A directs an issuer relying on Regulation A to 
present the pro forma financial information specified by Rule 8-
05.\336\ Like Article 11, Rule 8-05(a) requires pro forma financial 
information only if financial statements of a business acquired or to 
be acquired are presented. Like Article 11, Rule 8-05(b) provides that 
pro forma financial information must consist of a pro forma balance 
sheet and a pro forma statement of comprehensive income presented in 
condensed, columnar form for the most recent year and interim period. 
Rule 8-05(b), however, does not provide further preparation guidance, 
such as the types of pro forma adjustments that can be made. Note 2 of 
the Preliminary Notes to Article 8 provides that, to the extent that 
Article 11-01 offers enhanced guidelines for the preparation, 
presentation, and disclosure of pro forma financial information, 
smaller reporting companies may wish to consider these items.
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    \336\ See paragraph (b)(7)(iv) of Part F/S. Part F/S of Form 1-A 
permits the periods presented to be the shorter of those applicable 
to issuers relying on Regulation A and the periods specified by 
Article 8.
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a. Proposed Amendments
    The Commission proposed to revise Rule 8-05 to require that the 
preparation, presentation, and disclosure of pro forma financial 
information by smaller reporting companies substantially comply with 
Article 11.
b. Comments
    No commenters offered specific comment on these proposed 
amendments. Two commenters generally supported the proposal to conform 
the rules applicable to smaller reporting companies to the generally 
applicable rules stating that it will codify current practice, reduce 
confusion, and simplify application of the rules.\337\ In contrast, 
another commenter recommended that the Commission consider whether 
issuers relying on Regulation A warrant different treatment under the 
rules.\338\ Another commenter recommended that smaller registrants be 
exempt from mandatory Management's Adjustments disclosure in pro forma 
financial information.\339\
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    \337\ See letters from BDO and Cravath.
    \338\ See SBCFAC Recommendations.
    \339\ See letter from EY.
---------------------------------------------------------------------------

c. Final Amendments
    We are adopting the amendments to Rule 8-05 as proposed to require 
that the preparation, presentation, and disclosure of pro forma 
financial information by smaller reporting companies substantially 
comply with Article 11.\340\ Additionally, because Part F/S of Form 1-A 
refers to Rule 8-05, the amendments to Rule 8-05 will apply to issuers 
relying on Regulation A.\341\
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    \340\ See 8-05(b). However, because pro forma financial 
information begins with the historical financial statements of the 
registrant, revised Rule 8-05 requires application of Rule 8-03(a) 
requirements for condensed format rather than the requirement in 
Rule 11-02(b)(3).
    \341\ Certain related requirements applicable to smaller 
reporting companies do not apply to issuers relying on Regulation A. 
For example, issuers relying on Regulation A are not required to 
file reports on Form 8-K or proxy statements.
---------------------------------------------------------------------------

    These revisions should ease compliance burdens and clarify the 
application of our rules for smaller reporting companies and issuers 
relying on Regulation A by focusing them on the more complete and 
better understood provisions of Article 11 and provide investors with 
more uniform information upon which to make their investment 
decisions.\342\ As revised, in limited circumstances smaller reporting 
companies and issuers relying on Regulation A will now have to provide 
pro forma financial information for two years when the transaction for 
which pro forma effect is being given, such as a combination of 
entities under common control or discontinued operation, will be 
retrospectively reflected in the historical financial statements of 
smaller reporting companies and issuers relying on Regulation A for all 
periods presented as required by U.S. GAAP.\343\
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    \342\ See Section II.D.1.
    \343\ Rule 8-05 did not have a similar provision. However, the 
incremental burden on smaller reporting companies and issuers 
relying on Regulation A is not expected to be significant because 
the circumstances requiring retrospective revision are generally 
within their control and they must eventually revise their 
previously filed historical financial statements for all periods to 
reflect these circumstances.
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    We are also amending Rule 8-05 as proposed to require presentation 
of pro forma financial information when the conditions in Rule 11-01 
exist.\344\ Because Rule 8-05 currently requires pro forma financial 
information only for business acquisitions,\345\ when Rule 8-05 
applies, conforming its conditions to Rule 11-01 will require smaller 
reporting companies and issuers relying on Regulation A to provide pro 
forma financial information for significant acquisitions and 
dispositions \346\ and when a roll-up transaction as defined in 17 CFR 
229.901(c) occurs, the registrant previously was a part of another 
entity and such presentation is necessary to reflect operations and 
financial position of the registrant as an autonomous entity, or 
consummation of one or more transactions has occurred or is probable 
for which disclosure of pro forma financial information would be 
material to investors.\347\
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    \344\ See Rules 8-05(a) and 11-01(a), as amended.
    \345\ See supra Section II.D.2.
    \346\ Based on an analysis of 2017 disclosures of acquisitions 
and dispositions by smaller reporting companies, Commission staff 
found that out of 191 disclosures of acquisitions and dispositions 
by smaller reporting companies in 2017, 178 already appeared to 
comply with Article 11 requirements. Based on an analysis of 
disclosures of acquisitions and dispositions in Forms 1-A originally 
filed in 2019, Commission staff found that out of 12 Forms 1-A that 
disclosed acquisitions subject to Rule 8-04 or Rule 8-06, 9 already 
appeared to comply with Article 11 requirements.
    \347\ Form 1-A requires the pro forma financial information 
described in Rule 8-05 only when financial statements are required 
for businesses acquired or to be acquired. We have amended Part F/S 
of Form 1-A to remove this limitation to be consistent with our 
amendments, as proposed, to Rule 8-05 to require presentation of pro 
forma financial information when the conditions in Rule 11-01 exist.
---------------------------------------------------------------------------

E. Amendments to Financial Disclosure About Acquisitions Specific to 
Investment Companies

    For financial reporting purposes, investment company registrants, 
including business development companies, must apply the general 
provisions in Articles 1, 2, 3, and 4 of Regulation S-X,\348\ unless 
subject to the

[[Page 54036]]

special rules set forth in 17 CFR 210.6-01 through 210.6-10 (``Article 
6'').\349\ Investment company registrants differ from non-investment 
company registrants in several respects.\350\ The Commission proposed 
amendments to tailor the financial reporting requirements for 
investment companies with respect to their acquisitions of investment 
companies and other types of funds (collectively, ``acquired funds''). 
Specifically, the Commission proposed:
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    \348\ In October 2016, as part of a broader investment company 
reporting modernization rulemaking, the Commission adopted certain 
amendments to Regulation S-X that expressly apply Article 6 to 
business development companies. See Investment Company Reporting 
Modernization, Release No. IC-32314 (Oct. 13, 2016) [81 FR 81870 
(Nov. 18, 2016)].
    \349\ See Rule 6-03.
    \350\ See Section II.E. of the Proposing Release. Investment 
companies invest in securities principally for returns from capital 
appreciation and investment income. Investment companies are 
required to value their portfolio investments, with changes in value 
recognized in the statement of operations for each reporting period. 
See Rule 6-02(b) (``the term value shall have the same meaning given 
in Section 2(a)(41)(B) of the Investment Company Act''); see also 
FASB ASC 946-320-35, FASB ASC 946-323, FASB ASC 946-325-35, FASB ASC 
946-810, and FASB ASC 815-10-35. Also, investment companies 
generally do not consolidate entities they control and do not 
account for portfolio investments using the equity method. See FASB 
ASC 946-810-45-2 (general consolidation guidance) and FASB ASC 946-
810-45-3 (the exception to that guidance when considering an 
investment in an operating company that provides services to the 
investment company).
---------------------------------------------------------------------------

     To add a definition of ``significant subsidiary'' in 
Regulation S-X that is specifically tailored for investment companies 
based on the current Rule 8b-2 definition with some modifications; 
\351\
---------------------------------------------------------------------------

    \351\ The Commission additionally proposed to amend Rule 1-02(w) 
to provide that, with respect to the condition in proposed Rule 1-
02(w)(2)(ii), the value of investments shall be determined in 
accordance with U.S. GAAP and, if applicable, Section 2(a)(41) of 
the Investment Company Act (15 U.S.C. 80a-2(a)(41)).
---------------------------------------------------------------------------

     To add new Rule 6-11 of Regulation S-X, which would 
specifically cover financial reporting in the event of a fund 
acquisition; and
     To eliminate the pro forma financial information 
requirement for investment companies and replace it with proposed 
supplemental financial information that the Commission believed would 
be more relevant to fund investors.
    Commenters generally supported the Commission's objective of 
tailoring financial reporting requirements for investment companies 
with respect to acquired funds.\352\ As discussed below, we are 
adopting these requirements substantially as proposed, with certain 
modifications based on comments received.
---------------------------------------------------------------------------

    \352\ See letters from BDO, CAQ, Deloitte, and Investment 
Company Institute (``ICI'').
---------------------------------------------------------------------------

1. Amendments to Significance Tests for Investment Companies
    Investment companies are required to use the significant subsidiary 
tests in Rule 1-02(w) when applying Rule 3-05 and other rules within 
Regulation S-X.\353\ However, the tests in Rule 1-02(w) were not 
written for the specific characteristics of investment companies.\354\ 
As detailed in the Proposing Release, the definition of ``significant 
subsidiary'' in current Rule 1-02(w) has an Investment Test, an Asset 
Test, and an Income Test, while the definition of ``significant 
subsidiary'' in Rule 8b-2 has an investment test and an income test, 
but no asset test.\355\ The Commission proposed to add new Rule 1-
02(w)(2) to create a separate definition of ``significant subsidiary'' 
for investment companies in Regulation S-X, which--like Rule 8b-2--
would use an investment test and an income test, but not an asset 
test.\356\
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    \353\ The changes to the ``significant subsidiary'' definition 
in Regulation S-X will affect disclosures for fund acquisitions and 
also have effects on investment company application of Rule 3-09 
regarding separate financial statements for significant subsidiaries 
and Rule 4-08(g) regarding summarized financial information of 
subsidiaries not consolidated.
    \354\ See Proposing Release at n. 217 and accompanying text.
    \355\ See Section II.E.1. of Proposing Release.
    \356\ Id. The Commission also proposed conforming amendments to 
the definition of ``significant subsidiary'' in Securities Act Rule 
405, Exchange Act Rule 12b-2, and Investment Company Act Rule 8b-2 
to make them consistent with proposed Rule 1-02(w)(2).
---------------------------------------------------------------------------

    Two commenters supported adding a definition of ``significant 
subsidiary'' specifically tailored for investment companies.\357\ One 
commenter noted that certain language in proposed Rule 1-02(w)(1) 
appeared inconsistent with proposed Rule 1-02(w)(2).\358\
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    \357\ See letters from ICI and KPMG.
    \358\ See letter from EY. Specifically, proposed Rule 1-02(w)(1) 
stated that the conditions of paragraph (w)(2) would apply if the 
``subsidiary'' is a registered investment company or a business 
development company, but paragraph (w)(2) stated that its provisions 
apply to a ``registrant'' that is a registered investment company or 
a business development company. We have revised Rule 1-02(w)(1) to 
state that the tests in Rule 1-02(w)(2) apply if the registrant is a 
registered investment company or a business development company.
---------------------------------------------------------------------------

a. Investment Test
    Currently, the Investment Test for a significant subsidiary in 
Regulation S-X determines significance by evaluating whether the 
registrant's and its other subsidiaries' investments in and advances to 
the tested subsidiary \359\ exceed 10 percent of the registrant's total 
assets. Rule 8b-2 similarly determines significance using an investment 
test. For investment companies, the Commission proposed an investment 
test that would assess whether the value of the registrant's and its 
other subsidiaries' investments in and advances to the tested 
subsidiary exceeds 10 percent of the value of the total investments of 
the registrant and its subsidiaries consolidated as of the end of the 
most recently completed fiscal year. The proposed investment test would 
be similar to the existing Investment Test, but modified so that the 
comparison would be to the value of the registrant's total investments 
rather than total assets.\360\
---------------------------------------------------------------------------

    \359\ See supra note 29 (regarding the use of the term ``tested 
subsidiary'').
    \360\ See 17 CFR 210.6-04, item 4.
---------------------------------------------------------------------------

    We are adopting, as proposed, the investment test for investment 
companies as part of the definition of ``significant subsidiary.'' We 
received one comment on the proposed investment test. This commenter 
supported the proposed investment test for investment companies, 
agreeing that investment in the tested subsidiary in the context of its 
relative exposure to total investments at fair value is the appropriate 
metric in evaluating its significance.\361\ We continue to believe that 
a total investments measure is more appropriate for investment 
companies and more relevant than the existing tests, as it would focus 
the significance determination on the impact to the registrant's 
investment portfolio as opposed to other non-investment assets that may 
be held.\362\
---------------------------------------------------------------------------

    \361\ See letter from Ares Capital Corporation (``Ares'').
    \362\ We also continue to believe that using total investments 
for this test would be a more transparent measure than total assets 
for registrants that use a statement of net assets instead of a 
balance sheet. See Section II.E.1.a. of Proposing Release.
---------------------------------------------------------------------------

b. Asset Test
    The Asset Test in current Rule 1-02(w) compares the proportionate 
share of the total assets (after intercompany eliminations) of the 
tested subsidiary to the total assets of the registrant and its 
subsidiaries consolidated as of the end of the most recent fiscal year. 
There is no equivalent test under the Rule 8b-2 definition of 
``significant subsidiary''.
    As proposed, we are eliminating the Asset Test as a measure of 
significance for investment companies because we continue to believe 
that doing so would simplify compliance without changing the 
information available to investors as the Asset Test is generally not 
meaningful when applied to investment companies. The only commenter who 
addressed this aspect of the proposal expressed support for the 
elimination of

[[Page 54037]]

the Asset Test, stating that it is not meaningful when applied to 
investment companies and has been confusing for business development 
companies to practically apply.\363\
---------------------------------------------------------------------------

    \363\ See letter from Ares.
---------------------------------------------------------------------------

c. Income Test
    The Income Test in current Rule 1-02(w) compares the registrant's 
and its other subsidiaries' equity in the income from continuing 
operations before income taxes of the tested subsidiary exclusive of 
amounts attributable to any noncontrolling interests with the income of 
the registrant and its subsidiaries consolidated for the most recently 
completed fiscal year. The income test in Rule 8b-2, however, compares 
the total investment income of the tested subsidiary with the total 
investment income of the parent and its consolidated subsidiaries. Both 
tests find significance if the result is greater than 10 percent.
i. Proposed Amendments
    The Commission proposed to amend the income test for investment 
companies to use the income test in Rule 8b-2, but modified to include 
any net realized gains and losses and net change in unrealized gains 
and losses. The proposed income test for investment companies would use 
components from the statement of operations required by 17 CFR 210.6-07 
(``Rule 6-07''). In particular, the proposed income test for investment 
companies would include, in the numerator, the following amounts for 
the most recently completed pre-acquisition fiscal year of the tested 
subsidiary: (1) Investment income, such as dividends, interest, and 
other income; (2) The net realized gains and losses on investments; and 
(3) The net change in unrealized gains and losses. The absolute value 
of the sum of these amounts would be compared to the absolute value of 
the registrant and its subsidiaries' consolidated change in net assets 
resulting from operations. The Commission also proposed that a tested 
subsidiary would be deemed significant under the income test for 
investment companies if the test yields a condition of greater than 
either: (1) 80 percent by itself, or (2) 10 percent and the investment 
test for investment companies yields a result of greater than 5 percent 
(``alternate income test'').
    To further mitigate the potential adverse effects of the proposed 
income test for investment companies with insignificant changes in net 
assets resulting from operations for the most recently completed fiscal 
year, the Commission proposed an instruction that would permit the 
registrant to compute the income test for investment companies using 
the average of the absolute value of the changes in net assets for the 
past five fiscal years.
ii. Comments
    One commenter specifically supported the proposed income test for 
investment companies with an 80 percent threshold and the proposed 
alternate income test with 10 percent and five percent thresholds.\364\ 
However, a different commenter requested that the Commission increase 
the five percent threshold for the investment component of the 
alternate income test to 10 percent, consistent with the investment 
test and Rule 8b-2(b),\365\ and another commenter suggested that the 
Commission eliminate the proposed primary income test and adopt only 
the alternate income test.\366\
---------------------------------------------------------------------------

    \364\ See letter from ICI.
    \365\ See letter from Ares.
    \366\ See letter from KPMG.
---------------------------------------------------------------------------

    Several commenters recommended the Commission clarify the order of 
operations for the proposed income test, in particular whether the 
numerator should be the absolute value of the sum of the constituent 
elements or, instead, the sum of the absolute value of each of the 
constituent elements.\367\ Commenters generally supported the former 
approach because it would avoid double counting of a gain (or loss) 
related to a sale previously recorded as an unrealized gain (or 
loss).\368\ One commenter recommended that the income test be limited 
only to investment income as changes in gains and losses would be 
captured by the investment test.\369\ Two commenters also observed that 
the methods for determining the numerator and the denominator of the 
income test were different and questioned the potential impact on the 
test.\370\
---------------------------------------------------------------------------

    \367\ See letters from Ares, BDO, CAQ, Deloitte, KPMG, ICI, and 
RSM.
    \368\ See letters from BDO, CAQ, Deloitte, EY, and KPMG.
    \369\ See letter from Ares.
    \370\ See letters from Ares and IMA.
---------------------------------------------------------------------------

    One commenter expressed support for the ability of the registrant 
to use the five-year average of the change in net assets from 
operations where the most recent fiscal year's change in net assets is 
insignificant.\371\ Several commenters, however, preferred a bright-
line threshold of 10 percent lower than the average change in net 
assets resulting from operations for the past five years rather than 
the ``insignificant'' standard.\372\ Several commenters also 
recommended that five-year averaging be used for the 80 percent test as 
well as the alternate income test.\373\
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    \371\ See letter from ICI.
    \372\ See letters from BDO, CAQ, KPMG, and EY.
    \373\ See letters from BDO, CAQ, EY, ICI, PwC, Small Business 
Investor Alliance (``SBIA''), and RSM.
---------------------------------------------------------------------------

iii. Final Amendments
    We are adopting amendments to the income test substantially as 
proposed, but with some modifications after consideration of the 
comments received. Commenters supported the percentage thresholds in 
the income test. We are not increasing the investment component of the 
alternate income test to 10 percent of total investments, as one 
commenter suggested, because we believe that would render the alternate 
income test duplicative of the 10 percent threshold in the investment 
test. We also continue to believe that exceeding an 80 percent 
threshold in income alone may indicate significance for financial 
reporting purposes for a subsidiary even if the related assets 
represent less than 5 percent of total investments. We are, therefore, 
adopting this prong of the income test as proposed.
    In response to commenters, we have revised the calculation of 
income to be the absolute value of ``the sum'' of combined investment 
income from dividends, interest, and other income, the net realized 
gains and losses on investments, and the net change in unrealized gains 
and losses on investments. We believe this modification will prevent 
confusion in applying absolute value with respect to income and avoid 
the potential double counting of gains or losses. We continue to 
believe that changes in realized and unrealized gains/losses can better 
reflect the impact of the tested subsidiary on an investment portfolio 
rather than investment income alone.\374\ We also believe it is 
appropriate to compare the specified income elements received from the 
tested subsidiary \375\ with the investment company registrant's change 
in net assets resulting from operations in order to evaluate the impact 
on the registrant's net income, particularly in the context of the 
subsidiary being a single portfolio investment. However, we agree that 
this approach is less relevant in the event of a fund acquisition since 
the acquired fund is likely to have fund-level expenses that should be 
netted against income. We have, therefore, modified the language

[[Page 54038]]

to state that, for purposes of Rule 6-11, the income determination is 
made by comparing the absolute value of the change in net assets 
resulting from operations of the tested subsidiary with that of the 
investment company registrant.
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    \374\ See Section II.E.1.c. of Proposing Release.
    \375\ Rule 1-02(w)(2)(ii) covers the specified income elements 
``from the tested subsidiary'' and is calculated at the registrant-
level.
---------------------------------------------------------------------------

    We are modifying the five-year income averaging provision, as 
suggested by commenters, to provide a bright-line threshold at 10 
percent lower than the average change in net assets resulting from 
operations for the past five years rather than the ``insignificant'' 
standard in order to reduce potential inconsistencies in 
application.\376\ As proposed, the five-year averaging provision 
applies to the income test, which would include both the 80 percent 
condition in the primary income test and the 10 percent condition in 
the alternate income test; however, in light of commenter confusion, we 
have clarified the rule text to expressly state that it applies to both 
conditions.\377\
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    \376\ See Rule 1-02(w)(2)(ii).
    \377\ Id.
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2. Proposed Rule 6-11 of Regulation S-X
    Currently, there are no specific rules or requirements in Article 6 
for investment companies relating to the financial statements of 
acquired funds. Instead, investment companies apply the general 
requirements of Rule 3-05 and the pro forma financial information 
requirements in Article 11, although it is often unclear how to apply 
these reporting requirements in the context of acquired funds. 
Investment companies typically file Rule 3-05 Financial Statements in 
transactions in which an investment company with limited assets and 
operating history is created for the purpose of acquiring one or more 
private funds operating under the exclusions provided by Sections 
3(c)(1) or 3(c)(7) of the Investment Company Act. These private funds 
often have prepared audited financial statements in accordance with 
U.S. GAAP, but generally have not prepared their financial statements 
in accordance, nor had an audit conducted in compliance, with 
Regulation S-X. A registrant that acquires a private fund typically 
must revise the historical financial statements of the acquired fund so 
that they comply with all applicable rules of Regulation S-X and 
possibly re-audit those statements.
a. Proposed Amendments
    The Commission proposed Rule 6-11, which would specifically cover 
financial reporting in the event of a fund acquisition. Proposed Rule 
6-11 would only apply to the acquisition of a fund, including any 
investment company as defined in Section 3(a) of the Investment Company 
Act, any private fund that would be an investment company but for the 
exclusions provided by Sections 3(c)(1) or 3(c)(7) of that Act, or any 
private account managed by an investment adviser. Because the 
definition of business in Rule 11-01(d) is not readily applicable in 
the context of a fund acquisition, the Commission proposed a facts and 
circumstances test as to whether a fund acquisition has occurred, 
including when one fund acquires all or substantially all of another 
fund's portfolio investments.
    The Commission proposed to require only one year of audited 
financial statements for fund acquisitions, a change from the existing 
Rule 3-05 requirements that require between one and three years of 
audited financial statements, and to make the obligations more aligned 
with the financial statement obligations applicable to investment 
company registration statements.\378\ Proposed Rule 6-11 would require 
the related schedules specified in Article 12, such as the schedule of 
investments, to be provided for an acquired or to be acquired fund. 
Acquisitions of a group of related funds would be considered as a 
single acquisition under proposed Rule 6-11(a)(3) \379\ and a 
registrant would have the option of presenting the required financial 
statements either on an individual or combined basis for any periods 
they are under common control or management.
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    \378\ Rule 3-18 allows registered investment management 
companies to file financial statements covering only the most recent 
fiscal year, except for an audited statement of changes in net 
assets which must cover the two most recent fiscal years.
    \379\ Funds would be considered related if they are under common 
control or management, the acquisition of one fund is conditional on 
the acquisition of each other fund, or each acquisition is 
conditioned on a single common event.
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    The Commission proposed to allow investment companies to provide 
financial statements for private funds that were prepared in accordance 
with U.S. GAAP. The Commission also proposed to require the investment 
company registrant to file schedules for the acquired fund that comply 
with Article 12 of Regulation S-X, which requires each investment to be 
listed separately.\380\
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    \380\ Because proposed Rule 6-11 would require the schedule of 
investments as set forth in Article 12, a private fund would not be 
permitted to present a condensed schedule of investments.
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    To determine whether financial statements of a fund acquired or to 
be acquired must be provided under proposed Rule 6-11, the conditions 
specified in the definition of ``significant subsidiary'' under 
proposed Rule 1-02(w)(2) would be applied, using the investment test 
and the alternate income test for investment companies and substituting 
20 percent for 10 percent for each place it appears therein.\381\ If 
either of the tests were satisfied at the 20 percent condition, the 
registrant would be required to file the financial statements for the 
acquired fund as set forth in proposed Rule 6-11. Otherwise, filing 
financial statements of the acquired fund would not be necessary. If 
the aggregate impact of individually insignificant funds acquired or to 
be acquired since the most recent audited balance sheet were to exceed 
the conditions of the investment test and the alternate income test for 
investment companies, substituting 50 percent for 10 percent, then the 
registrant would be required to provide the financial statements for 
each individually insignificant fund and the supplemental financial 
information.\382\ In determining whether financial statements of funds 
acquired or to be acquired must be filed, the registrant would be 
permitted to use pro forma amounts that give effect to an acquisition 
consummated after the registrant's latest fiscal year-end for which the 
registrant has filed audited financial statements of such acquired fund 
as required by proposed Rule 6-11. Any requirement to file financial 
statements of an acquired fund would cease once an audited balance 
sheet required by Rules 3-01 or 3-18 is filed for a date after the date 
the acquisition was consummated.\383\
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    \381\ As proposed, the primary income test for investment 
companies with the 80 percent condition would not be used for 
purposes of proposed Rule 6-11.
    \382\ The Commission based the 50 percent condition on the 
provision in current Rule 3-05(b)(2)(i). Unlike the existing rule, 
however, proposed Rule 6-11 would require financial statements for 
each individually insignificant fund acquired or to be acquired, 
rather than the ``substantial majority'' requirement for businesses 
acquired under the current rule.
    \383\ At such time, the acquired investments would be reflected 
on the balance sheet or statement of net assets and accompanying 
schedules. In proposing this approach, the Commission expressed its 
belief that in these circumstances historical financial statements 
of acquired funds would be of less importance to investors and 
continued filing obligations would impose unnecessary costs since 
any realized and unrealized gains and losses on the acquired 
investments would be reflected in the daily net asset value 
calculation as well as fund performance measures on a going-forward 
basis. See Section II.E.2. of Proposing Release.
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b. Comments
    Commenters generally supported the Commission's objective of 
tailoring

[[Page 54039]]

financial reporting requirements for investment companies with respect 
to acquired funds.\384\ Commenters questioned the scope of the 
definition of fund acquisition, suggesting that proposed Rule 6-11 
might technically apply whenever a fund acquires an equity interest in 
another fund \385\ or when the portfolio securities acquired represent 
only a portion of another fund's holdings but will represent 
substantially all of the initial assets of a new registrant.\386\ A 
number of commenters also requested guidance on when Rule 3-05 would 
apply to non-fund acquisitions by investment company registrants.\387\
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    \384\ See letters from BDO, CAQ, Deloitte, and ICI.
    \385\ See letters from CAQ, EY, and GT.
    \386\ See letters from EY and KPMG.
    \387\ See letters from CAQ, Deloitte, EY, GT, ICI, KPMG, and 
PwC.
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    One commenter supported proposed Rule 6-11's use of the 
``significant subsidiary'' definition, modified to set the investment 
test at the 20 percent condition and to exclude the primary income test 
with the 80 percent condition.\388\ This commenter recommended that the 
alternate income test be changed from five percent to 10 percent of 
total investments because the size of the acquired fund should be the 
principal determinant of significance. Two commenters questioned 
whether the significance tests would only apply to fund acquisitions 
covered in proposed Rule 6-11(b)(2) and not proposed Rule 6-
11(b)(1).\389\
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    \388\ See letter from ICI.
    \389\ See letter from EY and ICI.
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    One commenter supported the proposed alignment of financial 
statement requirements with Rule 3-18, but expressed confusion about 
whether acquired fund financial statements would need to be included in 
subsequent filings until a post-acquisition audited balance sheet is 
filed.\390\ Another commenter indicated that it was unclear as to the 
number of fiscal years for which financial statements must be presented 
for acquired funds, whether only for the past fiscal year or for the 
periods set forth in Rule 3-18.\391\ A third commenter stated that 
proposed Rule 6-11 should eliminate reporting requirements for acquired 
companies that have previously filed audited financial statements with 
the Commission in accordance with Regulation S-X and allow unaudited 
financial statements for other acquired companies due to cost.\392\
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    \390\ See letter from ICI.
    \391\ See letter from EY.
    \392\ See letter from Ares.
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    Regarding the proposal to permit acquired private funds to provide 
financial statements prepared in accordance with U.S. GAAP and 
schedules that comply with Article 12, one commenter supported the 
proposed approach.\393\ Two commenters requested that the Commission 
consider alternatives that would provide full transparency of the 
portfolio holdings of the acquired fund but not require audited Article 
12 schedules.\394\
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    \393\ See letter from ICI.
    \394\ See letters from ICI and KPMG.
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    Several commenters suggested that the Commission make various 
amendments to Rules 3-09, 4-08(g), and 10-01(b)(1) of Regulation S-X, 
involving financial disclosures outside of the acquisition 
context.\395\
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    \395\ See letters from Ares, BDO, KPMG, and SBIA.
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c. Final Amendments
    We are adopting new Rule 6-11 to address the financial disclosure 
obligations for acquired funds, with certain modifications in response 
to comments received.\396\ Investment company registrants will follow 
Rule 6-11, rather than Rule 3-05, in the event that a fund acquisition 
occurs or is probable to occur.\397\ With respect to whether a fund 
acquisition has occurred, in response to commenters who sought further 
clarity, we have revised Rule 6-11(a)(2)(ii) to state that in 
evaluating the facts and circumstances as to whether an acquisition has 
occurred or is probable, a registrant should consider whether it will 
result in the acquisition of all or substantially all of the portfolio 
investments held by another fund.\398\ We have also removed language 
that suggests acquired fund financial disclosure would be required if 
the registrant acquired a non-substantial portion of another fund's 
portfolio investments that would constitute all or substantially all of 
the initial assets of the registrant.\399\ The intent of the facts and 
circumstances evaluation is to capture all situations where additional 
disclosure about the acquired fund is appropriate, regardless of the 
legal form, such as merger, consolidation, or asset sale, used to 
structure the transaction.
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    \396\ We also are adopting, as proposed, conforming amendments 
to Rules 3-18(d), 5-01(a), 6-01, 6-02(b) and (c), and 6-03 of 
Regulation S-X to reflect the addition of Rule 6-11.
    \397\ Investment company registrants are currently subject to 
the requirements of Rule 3-05, provided the conditions set forth in 
that rule are satisfied. Rule 3-05, as revised, will continue to 
apply to investment company registrants with respect to acquired and 
disposed businesses that do not involve a fund acquisition covered 
by Rule 6-11.
    \398\ Rule 6-11(a).
    \399\ Id.
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    We are adopting the use of the ``significant subsidiary'' 
definition in Rule l-02(w)(2) as the basis for determining whether 
financial statements for the acquired fund must be filed under Rule 6-
11, but modified, as proposed, to use the investment test at the 20 
percent condition and to exclude the 80 percent condition of the 
primary income test. We are not altering the investment component of 
the alternate income test, as one commenter suggested, because we 
continue to believe that five percent of total investments represents a 
material threshold.\400\ As adopted without change from the proposal, 
the significance tests in Rule 6-11 only apply to situations covered in 
paragraph (b)(2) and not paragraph (b)(1). Thus, an investment company 
registrant filing a registration statement on Form N-14 in connection 
with the acquisition of another fund will not apply the significance 
tests in Rule 6-11(b)(2).
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    \400\ The modified conditions in Rule 6-11 only substitute 20 
percent for 10 percent for the investment test and alternate income 
test described in Rule 1-02(w)(2). Thus, for purposes of Rule 6-11, 
a registrant would apply an investment test condition of 20 percent 
of the value of total investments and the alternate income test 
conditions of 20 percent of the absolute value of the change in net 
assets resulting from operations and five percent of the value of 
total investments.
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    As proposed, Rule 6-11 would have required an investment company 
registrant to include acquired fund financial statements as part of the 
registrant's financial statements until its next audited balance sheet 
after the acquisition was consummated. Given the availability of the 
acquired fund financial statements on the Commission's EDGAR system 
once filed and that the price of investment company shares or interests 
is established by the value of its current investment portfolio, we 
agree with commenters that acquired fund financial statements need not 
be included in future filings. Accordingly, we have modified the rule 
to require acquired fund financial statements to be filed only 
once.\401\
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    \401\ Rule 6-11(b)(4). Proposed Item 14(d)(5) of Schedule 14A 
[17 CFR 240.14a-101] would have required proxy statements filed by a 
fund, with respect to a merger, consolidation, acquisition, or 
similar matter, to include financial statements of the acquiring 
fund, including those required by Rules 3-05 and 6-11 and Article 11 
of Regulation S-X ``with respect to transactions other than that as 
to which action is to be taken as described'' in the proxy 
statement. Since Rule 6-11 only requires acquired fund financial 
statements to be filed once, we are not adopting the proposed 
amendment to Item 14(d)(5) of Schedule 14A.
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    One commenter requested clarification of the number of fiscal

[[Page 54040]]

years for which financial statements must be presented in Rule 6-11 and 
whether the requirement should be consistent with Rule 3-18.\402\ In 
response, we have revised Rule 6-11 to make clear that if the acquired 
fund is subject to Rule 3-18, then the financial statements for the 
periods described in Rule 3-18 shall be filed.\403\ For all other 
acquired funds, such as private funds, only the financial statements 
for the most recent fiscal year and the most recent interim period need 
to be filed.\404\ We are not following the suggestion, made by one 
commenter, to eliminate the filing of acquired fund financial 
statements if they were previously filed with the Commission in 
accordance with Regulation S-X by the acquired fund, because the 
disclosure is predominantly for the benefit of the acquiring fund's 
shareholders, not the acquired fund's shareholders.\405\
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    \402\ Rule 3-18 applies to registered management investment 
companies. Business development companies are also permitted to use 
Rule 3-18 pursuant to the instructions set forth in Form N-2.
    \403\ Rule 6-11(b)(2)(ii) and (iii).
    \404\ Id.
    \405\ Some forms, such as Form N-14, permit backwards 
incorporation by reference of information not included in the 
prospectus. See General Instruction G to Form 14. Effective May 2, 
2019, incorporation by reference on Form N-14 is allowed for all 
parties who may use the form, including business development 
companies. See FAST Act Modernization and Simplification of 
Regulation S-K, Release No. IC-10618 (Mar. 20, 2019) [84 FR 12674 
(Apr. 2, 2019)].
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    We are not persuaded by the commenter who requested that we permit 
filing of unaudited financial statements for acquired funds due to 
cost. We continue to believe that a significant number of private funds 
currently prepare audited financial statements under U.S. GAAP due to 
investor demand and for regulatory compliance purposes.\406\ Moreover, 
although auditing an acquired private fund's financial statements 
involves costs, we believe that our proposed approach requiring audited 
U.S. GAAP financial statements with respect to acquisitions of private 
funds will reduce costs as compared to re-issuing audited financial 
statements in compliance with Regulation S-X, but still will provide 
investors appropriate information about the acquired fund. We also have 
modified Rule 6-11(c) from the proposal to make the filing of financial 
statements using U.S. GAAP permissive for private funds. Proposed Rule 
6-11(c) provided that the financial statements of private funds 
``shall'' comply with U.S. GAAP. Under the final rule, the financial 
statements of private funds may either comply with U.S. GAAP or Article 
12.\407\
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    \406\ For example, private funds prepare audited financials, 
among other reasons, to satisfy their custody rule obligations under 
the Investment Advisers Act. See 17 CFR 275.206(4)-2.
    \407\ We also have made non-substantive changes to provide a 
more accurate heading for paragraph (c) and to reflect the intent of 
the Commission that the provision applies to a fund or private 
account that is ``acquired or to be acquired.'' As proposed, the 
language only referenced a fund or private account ``to be 
acquired.''
---------------------------------------------------------------------------

    The Commission's proposal was intended to achieve a more 
appropriate balance by permitting registrants to file audited U.S. GAAP 
financial statements for acquired private funds, but supplementing 
those financial statements with audited schedules listing each 
investment as required by Article 12.\408\ A condensed schedule of 
investments prepared under U.S. GAAP does not include the same 
prescriptive level of detail when compared to an Article 12 compliant 
(or full) schedule of investments. While each investment is listed 
separately in a full schedule of investments, a condensed schedule 
allows funds to aggregate investments by issuer or by investment type 
so long as each investment is individually less than five percent of 
the net assets of the fund.\409\ While providing a full unaudited 
schedule of portfolio investments would provide transparency, we 
believe that the incremental costs of providing an audited schedule of 
investments that complies with Article 12 is minimal because the 
portfolio investment account balances already have been audited, and 
the incremental audit procedures therefore would be limited to the 
incremental disclosures required under Article 12. In addition, an 
audit will provide additional assurance for investors as to the 
accuracy of that schedule.
---------------------------------------------------------------------------

    \408\ See Section II.E.2. of Proposing Release.
    \409\ See FASB ASC 946.
---------------------------------------------------------------------------

    We also are removing the sentence from proposed Rule 6-11(a)(3) 
providing that the financial statements in connection with the 
acquisition of a group of related funds may be presented either on an 
individual or a combined basis for any periods the related funds are 
under common control or management. This change is based on our 
understanding that, unlike operating companies, funds generally do not 
file ``combined financial statements'' as defined in FASB ASC Topic 
810-10-20.
    Finally, with respect to commenters' suggestion to make substantive 
amendments to Rules 3-09, 4-08(g), and 10-01(b)(1) of Regulation S-X, 
we believe such amendments would be beyond the scope of this 
rulemaking.\410\
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    \410\ While we are not making substantive changes to Rule 3-09, 
as a result of the changes to Rule 1-02(w) we are revising Rule 3-
09(a) to make clear that it applies to Rule 1-02(w)(1).
---------------------------------------------------------------------------

3. Pro Forma Financial Information and Supplemental Financial 
Information
    Currently, Rule 11-01 requires an investment company to furnish pro 
forma financial information when a significant business acquisition has 
occurred or is probable, with significance being determined using the 
tests set forth in Rule 1-02(w) and substituting 20 percent for 10 
percent in the conditions.\411\
---------------------------------------------------------------------------

    \411\ Rule 11-02 permits investment companies to provide a 
narrative description of the pro forma effects of the transaction in 
lieu of pro forma financial statements, if there are a limited 
number of required pro forma adjustments and they are easily 
understood. See Rule 11-02(b)(1).
---------------------------------------------------------------------------

a. Proposed Amendments
    The Commission proposed to replace the pro forma financial 
disclosures requirement with proposed Rule 6-11(d), which would require 
that investment company registrants provide supplemental financial 
information about the newly combined entity that it believed would be 
more relevant to investors.\412\ The proposed supplemental financial 
information would include: (1) A pro forma fee table, setting forth the 
post-transaction fee structure of the combined entity; (2) If the 
transaction will result in a material change in the acquired fund's 
investment portfolio due to investment restrictions, a schedule of 
investments of the acquired fund modified to show the effects of such 
change and accompanied by narrative disclosure describing the change; 
and (3) Narrative disclosure about material differences in accounting 
policies of the acquired fund when compared to the newly combined 
entity.
---------------------------------------------------------------------------

    \412\ See Section II.E.3. of Proposing Release.
---------------------------------------------------------------------------

b. Comments
    One commenter expressed support for the proposed replacement of the 
pro forma financial information requirement, indicating that the 
proposed supplemental financial information would better inform 
investors and reduce costs.\413\ In addition, two commenters noted that 
the rule text in proposed Rule 6-11(d)(1)(iii) would require disclosure 
about material differences in ``financial and operating policies,'' 
while the preamble of the Proposing Release referred to material 
differences in ``accounting policies'' between the acquiring and 
acquired funds.\414\
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    \413\ See letter from ICI.
    \414\ See letters from EY and ICI.

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[[Page 54041]]

c. Final Amendments
    We are adopting the amendments substantially as proposed, but with 
one modification in response to comments received. As proposed, we are 
adopting amendments to eliminate the requirement to provide pro forma 
financial information for investment company registrants in connection 
with fund acquisitions and to require the supplemental financial 
information in its place.\415\ We believe that the pro forma financial 
information is not necessary in light of the costs to prepare such 
disclosures and given that the supplemental financial information will 
provide material information to investors by highlighting important 
changes resulting from a fund acquisition as context for the acquired 
fund's financial statements. We also are modifying Rule 6-11(d)(1)(iii) 
to state that it requires narrative disclosure about material 
differences in ``accounting policies'' of the acquired fund when 
compared to the acquiring fund, which was the Commission's intent as 
expressed in the preamble of the Proposing Release.
---------------------------------------------------------------------------

    \415\ See Section II.E.4. of Proposing Release.
---------------------------------------------------------------------------

4. Amendments to Form N-14
    Item 14 of Form N-14, the form used by investment companies to 
register securities issued in business acquisition transactions,\416\ 
provides, subject to certain exceptions, that the corresponding 
Statement of Additional Information (``SAI'') ``shall contain the 
financial statements and schedules of the acquiring company and the 
company to be acquired required by Regulation S-X.''
---------------------------------------------------------------------------

    \416\ See 17 CFR 239.23 (setting forth the requirement for an 
investment company to file Form N-14 to register securities in 
business combination transactions) and 17 CFR 230.145 (specifying 
the types of transactions that trigger the Form N-14 filing 
requirement).
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a. Proposed Amendments
    The Commission proposed to amend Form N-14 to make its disclosure 
requirements consistent with the disclosures required in proposed Rule 
6-11. Specifically, the Commission proposed the following amendments:
     In the case of a fund acquisition, any financial 
statements and schedules required by Regulation S-X would only be 
required for the most recent fiscal year and the most recent interim 
period; \417\
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    \417\ Non-fund acquisitions would continue to be required to 
follow the other financial statement disclosure requirements set 
forth in Regulation S-X for the periods required by Rule 3-05, 
including any pro forma financial information required by Article 
11.
---------------------------------------------------------------------------

     Permit private funds to provide financial statements and 
schedules that conform to U.S. GAAP and Article 12 of Regulation S-X;
     Require inclusion of the supplemental financial 
information described in proposed Rule 6-11(d), except for the pro 
forma fee table; \418\
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    \418\ The Commission proposed to exclude the pro forma fee table 
from Item 14 of Form N-14 because it is already required in the 
prospectus under Item 3 of that Form.
---------------------------------------------------------------------------

     Remove provisions no longer relevant because of prior 
amendments; \419\ and
---------------------------------------------------------------------------

    \419\ Specifically, the Commission proposed to remove the 
ability to place columns C and D of Schedule II under 17 CFR 210.12-
14 (``Rule 12-14'') to Part C of the registration statement, with 
the remainder of the schedule being provided in the SAI. When 
originally adopted, Form N-14 was based on Form N-1A, which had a 
similar provision. See Registration Form Used by Open-End Management 
Investment Companies: Guidelines, Release No. IC-13436 (Aug. 12, 
1983) [48 FR 37928 (Aug. 22, 1983)]. This provision was removed from 
Form N-1A in 1998. See Registration Form Used by Open-End Management 
Investment Companies, Release No. 33-7512 [63 FR 13916 (Mar. 23, 
1998)].
---------------------------------------------------------------------------

     Remove the existing exclusion in Form N-14 for pro forma 
financial statements required by Rule 11-01 of Regulation S-X if the 
net asset value of the company being acquired does not exceed 10 
percent of the registrant's net asset value, because pro forma 
financial statements would no longer be required for fund acquisitions 
and, for non-fund acquisitions, the significance measure for pro forma 
financial statements in Rule 11-01(b)(1) is and will remain 20 percent.
b. Comments
    Two commenters noted that the rule text of the proposed amendments 
to Item 14.2 of Form N-14, which describes the financial statement 
requirements when the acquired fund is a private fund, differed from 
the rule text of proposed Rule 6-11(c).\420\
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    \420\ See letter from EY (stating that proposed Item 14.2 of 
Form N-14 included text that was not included in proposed rule 6-
11(c)); see also letter from ICI (same).
---------------------------------------------------------------------------

c. Final Amendments
    We are amending Form N-14 substantially as proposed, but with some 
modifications in response to commenters. We continue to believe that it 
is appropriate for investors who acquire securities in a registered 
offering to have the same disclosure that investors receive through 
financial statement disclosure in shareholder reports. With respect to 
Item 14.2, we agree with commenters that there should be consistency 
between the Form N-14 and Rule 6-11 disclosure requirements for private 
funds using U.S. GAAP, and we have made conforming amendment to Form N-
14 to reflect Rule 6-11 as adopted.\421\
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    \421\ Item 4.2 of Form N-14.
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F. Transition

    After considering feedback from commenters,\422\ registrants will 
not be required to apply the final amendments until the beginning of 
the registrant's fiscal year beginning after December 31, 2020 (the 
``mandatory compliance date''). Acquisitions and dispositions that are 
probable or consummated after the mandatory compliance date must be 
evaluated for significance using the final amendments.\423\
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    \422\ See e.g., letters from BDO, DT, EY, and KPMG. BDO 
recommended permitting application of the amendments in filings made 
on or after publication of the amendments in the Federal Register. 
DT indicated it may be useful for preparers to understand whether 
the new rules should be applied to all acquisitions (1) Consummated 
after the effective date, (2) Reported on Form 8-K or 8-K/A filed 
after the effective date, or (3) Reported in a new or amended 
registration statement filed after the effective date and when 
registrants would apply the new pro forma requirements, particularly 
if some acquisitions were consummated before the effective date and 
others were consummated after. EY recommended that registrants that 
have filed a current report announcing the completion of a 
significant acquisition or disposition before the effective date of 
the final rule be allowed to comply with the existing rules for that 
transaction and registrants that have submitted a draft or 
confidential registration statement or filed a registration 
statement before the effective date of the final rule be allowed to 
complete their offering under the existing rules. KPMG recommended 
that the Commission provide transition guidance that clarifies the 
effective date, including the permissibility of early application of 
the amendments and application of the amendments to transactions 
consummated near the final rule's effective date.
    \423\ For registration statements filed on or after the 
mandatory compliance date, registrants that are subject to the 
reporting requirements of Section 13(a) or 15(d) of the Exchange Act 
at the mandatory compliance date may test acquisitions and 
dispositions consummated before the mandatory compliance date using 
rules that were in effect when the acquisitions and dispositions 
were consummated.
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    Registrants filing initial registration statements are not required 
to apply the final amendments until an initial registration statement 
is first filed on or after the mandatory compliance date. For initial 
registration statements first filed on or after the mandatory 
compliance date, all probable or consummated acquisitions and 
dispositions, including those consummated prior to the mandatory 
compliance date, must be evaluated for significance using the final 
amendments.\424\
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    \424\ Issuers relying on Regulation A filing initial offering 
statements on Form 1-A are not required to apply the final 
amendments until an initial offering statement is first filed on or 
after the mandatory compliance date. For initial offering statements 
first filed on or after the mandatory compliance date, all probable 
or consummated acquisitions and dispositions, including those 
consummated prior to the mandatory compliance date, must be 
evaluated for significance using the final amendments.

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[[Page 54042]]

    Voluntary early compliance with the final amendments is permitted 
\425\ in advance of the registrant's mandatory compliance date provided 
that the final amendments are applied in their entirety from the date 
of early compliance.\426\
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    \425\ To the extent that registrants have questions about 
application of the rules in connection with early compliance, they 
should reach out to Commission staff for additional transition 
guidance.
    \426\ For an acquisition or disposition of a business for which 
the disclosure required by an Item 2.01 Form 8-K has been filed (or 
was required to be filed) prior to the mandatory compliance date (or 
the voluntary early compliance date, if applicable), but for which 
Rule 3-05 Financial Statements and Article 11 pro forma financial 
information are not required to be filed (e.g., in an Item 9.01 Form 
8-K) until after the mandatory compliance date (or until after the 
voluntary early compliance date, if applicable), the registrant must 
file the financial statements and pro forma financial information 
required by the rules in effect when the Item 2.01 Form 8-K was 
required to be filed.
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III. Other Matters

    If any of the provisions of these rules, or the application thereof 
to any person or circumstance, is held to be invalid, such invalidity 
shall not affect other provisions or application of such provisions to 
other persons or circumstances that can be given effect without the 
invalid provision or application.
    Pursuant to the Congressional Review Act, the Office of Information 
and Regulatory Affairs has designated these rules a ``major rule,'' as 
defined by 5 U.S.C. 804(2).

IV. Economic Analysis

A. Introduction

    We are adopting amendments to our rules and forms to improve their 
application, assist registrants in making more meaningful 
determinations of whether a subsidiary or an acquired or disposed 
business is significant, and improve the disclosure requirements for 
financial statements relating to acquisitions and dispositions of 
businesses, including real estate operations and investment companies. 
The amendments are intended to improve the utility and relevance of the 
financial information about acquired or disposed businesses provided to 
investors, facilitate timely access to capital, and reduce the 
complexity and costs to prepare required disclosures. The reduction in 
compliance costs could in theory facilitate increased acquisition or 
disposition activity by registrants. However, registrants engage in 
acquisitions and dispositions for a variety of business reasons, and, 
as a general matter, their evaluation of the advisability of 
acquisitions and dispositions often involve cost and benefit 
considerations much greater than compliance cost considerations. More 
specifically, with respect to significant transactions which could 
trigger disclosure relevant to the amendments, these other 
considerations are likely to be even more important to the decision to 
engage in acquisition and disposition activity than the more modest 
effects of the final amendments.
    Providing timely, accurate, and transparent information, especially 
financial information, about acquired and disposed businesses is 
important to mitigate the information asymmetry that exists between 
corporate insiders (managers and majority shareholders) and outsiders 
(minority shareholders, creditors, etc.). This is especially true in 
the context of major corporate transactions such as mergers, 
acquisitions, and dispositions, as investors rely on the financial 
information of the acquired and disposed businesses to assess the 
potential effects of these activities on the registrant. A properly 
functioning market for corporate control serves as an important 
external governance mechanism involving transactions that potentially 
create shareholder value through synergy generation or transferring 
assets to more efficient management.\427\ However, in the absence of 
appropriately tailored disclosures, investors may not be able to 
optimize allocation of their resources or fully assess the effects of 
this important external governance mechanism on the firms in which they 
invest.
---------------------------------------------------------------------------

    \427\ See, e.g., Mark L. Mitchell & Kenneth Lehn, Do Bad Bidders 
Become Good Targets?, 98 J. Pol. Econ. 372 (1990) (``Mitchell & Lehn 
(1990)''); Anup Agrawal & Jeffrey F. Jaffe, Do Takeover Targets 
Underperform? Evidence from Operating and Stock Returns, 38 J. Fin. 
& Quantitative Analysis 721 (2003) (``Agrawal & Jaffe (2003)''). See 
also, e.g., Xiaoyang Li, Productivity, Restructuring, and the Gains 
from Takeovers, 109 J. Fin. Econ. 250 (2013) (``Li (2013)''). Based 
on plant-level data, this study shows that acquirers increase 
targets' productivity through more efficient use of capital and 
labor, thus enhancing the value of the acquisitions.
---------------------------------------------------------------------------

    Disclosure requirements also impose costs on registrants that may 
seek to engage in acquisitions or dispositions. In particular, such 
costs could diminish the benefits associated with an acquisition or 
disposition; however, we would not expect such costs to alter a 
decision to pursue a particular transaction. Further, a registrant's 
ability to provide such disclosure for periods prior to an acquisition 
may be dependent on the availability and assistance of both the 
acquired business and the acquired business's independent auditor. 
While this potential issue would be unlikely to affect a registrant's 
decision to engage in an acquisition, it may impact its ability to 
comply with reporting requirements for capital raising transactions 
and, accordingly, to access capital in the manner and within the time 
frames it most desires.
    We believe the final amendments, by streamlining and clarifying 
acquired business financial disclosure requirements, should reduce 
compliance costs while maintaining investors' access to information 
that is material to an understanding of the potential effects of an 
acquired or to be acquired business (or disposed or to be disposed 
business) on the registrant.
    We are mindful of the costs imposed by and the benefits obtained 
from our rules and amendments. Section 2(b) of the Securities Act,\428\ 
Section 3(f) of the Exchange Act,\429\ and Section 2(c) of the 
Investment Company Act \430\ require the Commission, when engaging in 
rulemaking where it is required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. Additionally, 
Section 23(a)(2) of the Exchange Act \431\ requires us, when adopting 
rules under the Exchange Act, to consider, among other things, the 
impact that any new rule would have on competition and not to adopt any 
rule that would impose a burden on competition that is not necessary or 
appropriate in furtherance of the Exchange Act.
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    \428\ 15 U.S.C. 77b(b).
    \429\ 17 U.S.C. 78c(f).
    \430\ 15 U.S.C. 80a-2(c).
    \431\ 15 U.S.C. 78w(a)(2).
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    Below we address the potential economic effects of the amendments, 
including the likely benefits and costs, as well as the likely effects 
on efficiency, competition, and capital formation. We attempt to 
quantify these economic effects whenever possible; however, due to data 
limitations, we are not able to quantify all of the economic effects.

B. Baseline and Affected Parties

    The current disclosure requirements in Rule 1-02(w), Rule 3-05, 
Rule 3-14, Article 11, and the related smaller reporting company 
requirements in Article 8 of Regulation S-X, together with current 
disclosure practices, form the baseline from which we estimate the

[[Page 54043]]

likely economic effects of the amendments.\432\
---------------------------------------------------------------------------

    \432\ See supra Section II.
---------------------------------------------------------------------------

    The amendments are likely to affect investors both directly and 
indirectly through other users of the disclosure (e.g., security 
analysts, investment advisers, and portfolio managers), auditors, and 
registrants subject to Regulation S-X. Additionally, entities other 
than registrants may be affected, such as significant acquirees for 
which financial statements are required under Rule 3-05 and Rule 3-14.
    The amendments may affect both domestic registrants and foreign 
private issuers.\433\ We estimate that during calendar year 2019, 
approximately 6,792 registrants filed on domestic forms \434\ and 849 
foreign private issuers filed on F-forms, other than registered 
investment companies. Among the registrants that file on domestic 
forms, approximately 31 percent were large accelerated filers, 19 
percent were accelerated filers,\435\ and 50 percent were non-
accelerated filers. In addition, we estimate that of these domestic 
issuers approximately 42.8 percent were smaller reporting companies and 
17.2 percent of these domestic issuers were emerging growth 
companies.\436\ About 26.1 percent of foreign private issuers that 
filed on Forms 20-F and 40-F were emerging growth companies. With 
respect to foreign private issuer accounting standards, approximately 
39 percent of foreign private issuers reported under U.S. GAAP, 60 
percent reported under IFRS-IASB, and approximately 1 percent reported 
under a comprehensive body of accounting principles other than U.S. 
GAAP or IFRS-IASB with a reconciliation to U.S. GAAP. Certain of the 
amendments may also affect issuers that rely on Regulation A and 
investment companies that must comply with the requirements of 
Regulation S-X. Based on staff analysis of EDGAR filings, we estimate 
that during calendar year 2019 there were 106 issuers with newly 
qualified Regulation A offering statements.
---------------------------------------------------------------------------

    \433\ The number of domestic registrants and foreign private 
issuers affected by the amendments is estimated as the number of 
unique companies, identified by Central Index Key (CIK), that filed 
Form 10-K, Form 20-F, and Form 40-F or an amendment thereto with the 
Commission during calendar year 2019. The estimates for the 
percentages of companies by accelerated filer status and the 
percentage of smaller reporting companies are based on the self-
reported status provided by these registrants during calendar year 
2019, with supplemental data from Ives Group Audit Analytics. The 
estimates for the percentages of foreign private issuers' basis of 
accounting used to prepare the financial statements are derived from 
the information in Forms 20-F and 40-F or an amendment thereto. 
These estimates do not include issuers that filed only initial 
registration statements during calendar year 2019, which will also 
be affected by the amendments.
    \434\ This number includes fewer than 20 foreign private issuers 
that file on domestic forms and approximately 100 business 
development companies. Of the foreign private issuers filing on 
domestic forms in calendar year 2019, approximately 85 percent 
reported under U.S. GAAP while 15 percent reported under IFRS-IASB.
    \435\ See supra note 23.
    \436\ Staff determined whether a registrant claimed emerging 
growth company status by parsing several types of filings (e.g., 
Forms S-1, S-1/A, 10-K, 10-Q, 8-K, 20-F/40-F, and 6-K) filed by the 
registrant, with supplemental data drawn from Ives Group Audit 
Analytics.
---------------------------------------------------------------------------

    The ``significant subsidiary'' definition in Rule 1-02(w) is 
applied when determining if a subsidiary is deemed significant for the 
purposes of certain Regulation S-X and Regulation S-K requirements as 
well as certain Securities Act and Exchange Act rules and forms.\437\ 
Because the significance of a subsidiary affects the disclosure 
required from registrants about the activities of those subsidiaries, 
the amendments we are adopting to Rule 1-02(w) will affect registrants' 
significance determinations and, as a result of those determinations, 
registrants' disclosure requirements.
---------------------------------------------------------------------------

    \437\ See supra Section II.A.
---------------------------------------------------------------------------

    Additionally, registrants are required to file separate audited 
annual and unaudited interim pre-acquisition financial statements of 
the acquired business if the acquisition triggers the Rule 1-02(w) 
significance tests as modified by Rule 3-05 and Rule 3-14. Because the 
United States has one of the most active markets for mergers and 
acquisitions,\438\ the rules we are amending are relevant to a large 
number of transactions and businesses but the amendments themselves, 
beyond their potential cost savings, are not expected to have a 
significant effect on transactions or businesses more generally. 
Registrants would be potentially affected by the amendments if they 
engage in an acquisition or disposition transaction (or series of 
transactions) that is deemed significant under the Rule 1-02(w) 
significance tests as modified by Rule 3-05 and Rule 3-14 or the 
related smaller reporting company requirements in Article 8.
---------------------------------------------------------------------------

    \438\ See Anant K. Sundaram, Mergers and Acquisitions and 
Corporate Governance, 3 Mergers and Acquisitions 193 (2004); and 
2019 J.P. Morgan Global M&A Outlook, available at https://www.jpmorgan.com/jpmpdf/1320746694177.pdf.
---------------------------------------------------------------------------

    We are not able to observe the universe of acquisitions by all 
registrants, as acquisitions made by registrants that are not deemed 
significant or where the acquired businesses are not public firms might 
not be identified. For purposes of our Paperwork Reduction Act 
(``PRA'') analysis, Commission staff searched various form types filed 
from January 1, 2017 to October 1, 2018 for indications of acquisition 
or disposition disclosure and found approximately 1,261 filings on 
various forms that included Rule 3-05 Financial Statements or Rule 3-14 
Financial Statements.\439\ To better understand the overall market 
activity for mergers and acquisitions, we also examined mergers and 
acquisitions data from Thomson Reuters' Security Data Company 
(``SDC''). During the period from January 1, 2017 to December 31, 2019, 
there were 6,057 mergers and acquisitions entered into by publicly-
listed U.S. firms. Among these transactions, 1,283 acquisitions 
involved non-U.S. targets and approximately 419 involved real estate 
operations.\440\ Additionally, 171 of the 6,057 transactions were 
conducted by entities identified as smaller reporting companies. These 
estimates constitute an upper bound on the number of transactions that 
may have triggered disclosure requirements under Rule 3-05 or Rule 3-
14, and the related requirements for smaller reporting companies,\441\ 
as many of these transactions may have involved acquisitions that are 
small relative to the size of the registrant.\442\
---------------------------------------------------------------------------

    \439\ Based on a review of Forms 10, S-1, S-3, F-1, F-3, and 8-
K. See Section V.B.1 below for our review of forms filed by 
operating companies. We discuss our similar review of investment 
company forms in Section V.B.2 below.
    \440\ We estimate the number of real estate operation 
transactions that may be within the scope of Rule 3-14 based on 
transactions covered by SDC where the acquiree uses the Standard 
Industry Classification code (SIC) 6798 or SIC codes in the 6500s. 
These SIC codes include real estate companies and REITs generally. 
The transactions identified using these SIC codes would include, but 
are not necessarily limited to, real estate operations that are 
within the scope of Rule 3-14.
    \441\ Acquisitions that triggered Rule 3-05 or Rule 3-14 
Financial Statements requirements are observed by searching EDGAR 
filings. Databases such as SDC have some coverage of mergers and 
acquisitions conducted by public listed firms in the U.S. However, 
when the acquired entities are privately owned, we do not have data 
in terms of their assets, income, and often the purchase prices paid 
by the acquiring firms. Thus we are not able to provide statistics 
on the relative size of these transactions.
    \442\ See Ronald W. Masulis, Cong Wang, & Fei Xie, Corporate 
Governance and Acquirer Returns, 62 J. Fin. 1851 (2007) (reporting 
that the mean (median) relative size of the mergers in their sample 
is around 16 percent (6 percent) for the period of 1990-2003). 
Relative size in this study is measured as the ratio of target 
market cap to the acquirer market cap, and the sample is limited to 
public firms. We expect the relative size of the acquisitions for 
non-public acquirees would be even smaller, but we do not have data 
on the size of private firms to provide comparable statistics about 
these transactions.
---------------------------------------------------------------------------

    All registered investment companies and business development 
companies that make fund acquisitions significant enough to trigger 
Rule 3-05 disclosure

[[Page 54044]]

requirements would potentially be affected by the amendments. Among 
registered investment companies, as of the end of calendar year 2019, 
there were 10,239 open-end funds, 2,050 exchange-traded funds, and 681 
closed-end funds. In addition, there were 102 business development 
companies. While we are not able to observe the universe of the fund 
acquisitions, we are able to observe those transactions that triggered 
the filing of acquired fund financial statements. In our PRA analysis, 
we searched various form types over a three-year period ended December 
31, 2019 for indications of fund acquisition disclosure. Among the 503 
filings on Form N-14 for fund transactions, 323 filings or 64 percent 
included acquired fund financial statements. There were only a few 
filings on Form N-1A and Form N-2 that included acquired fund financial 
statements.\443\
---------------------------------------------------------------------------

    \443\ See infra Section V.B.2, Table 5.
---------------------------------------------------------------------------

C. Potential Benefits and Costs of the Final Rule

1. Potential Benefits
    We anticipate the amendments \444\ will improve the application of 
the significance tests and assist registrants in making more meaningful 
significance determinations. We additionally anticipate the amendments 
will improve the financial information about acquired or disposed 
businesses, facilitate more timely access to capital, and reduce the 
complexity and costs to prepare the disclosure. Improved disclosure 
benefits users of financial information and can facilitate more 
efficient allocations of capital, while a reduced disclosure burden can 
shorten the time period to prepare disclosures necessary to access 
capital and typically generates cost savings for registrants, which can 
result in more capital being available for investment.
---------------------------------------------------------------------------

    \444\ See supra Sections II.A through II.E.
---------------------------------------------------------------------------

    As they relate to significance determinations generally, the 
amendments are expected to reduce the burden of determining 
significance by improving the application of the definition. The 
amendments also should improve the salience of information for 
investors by focusing the applicable disclosures on significant 
subsidiaries.
    As they relate to acquisitions and dispositions, the amendments are 
expected to increase the utility of related disclosures to investors by 
making these disclosures more relevant. The amendments should improve 
the salience of the information for investors by reducing the volume of 
information presented about acquired businesses and focusing the 
disclosures on more decision-relevant information. This, in turn, could 
lead to more informed investment decisions and improved capital 
allocation efficiency.
    The amendments may also permit more timely access to capital. A 
registrant's ability to provide disclosure for periods prior to an 
acquisition is often dependent on access to and the cooperation of both 
the acquired or to be acquired business and its independent auditor. 
The age of the acquired or to be acquired business's required financial 
statements, as well as changes in the acquired business's personnel or 
its independent auditor that occurred during the historical periods for 
which financial statements may be required, can impair a registrant's 
ability to timely meet the financial reporting requirements for such 
acquisitions, which may impact its ability to access capital within the 
time frames it needs to operate its business and make investments. By 
focusing on more recent historical periods, relying on more relevant 
disclosure triggers and definitions, and increasing the relevance of 
pro forma financial information, the amendments should help to 
ameliorate these impediments, as we discuss in more detail below.
    Further, to the extent that the amendments reduce the compliance 
burden, they may reduce the cost of merger, acquisition, and 
disposition activity generally. We note that well-functioning markets 
for corporate control are, on average, generally believed to be 
beneficial to investors to the extent that they serve as a disciplinary 
mechanism in which less efficiently managed assets are transferred to 
more efficient management.\445\ It also has been generally observed 
that mergers and acquisitions may also generate synergies by combining 
two entities, and may result in firms with more efficient scale or 
scope.\446\
---------------------------------------------------------------------------

    \445\ See, e.g., Mark L. Mitchell & Kenneth Lehn, Do Bad Bidders 
Become Good Targets?, 98 J. Pol. Econ. 372 (1990) (``Mitchell & Lehn 
(1990)''); Anup Agrawal & Jeffrey F. Jaffe, Do Takeover Targets 
Underperform? Evidence from Operating and Stock Returns, 38 J. Fin. 
& Quantitative Analysis 721 (2003) (``Agrawal & Jaffe (2003)'').
    \446\ See, e.g., Li (2013), supra note 427 (showing, based on 
plant-level data, that acquirers increase target's productivity 
through more efficient use of capital and labor, thus enhancing the 
value of the acquisitions).
---------------------------------------------------------------------------

2. Potential Costs
    We do not expect the amendments to generate significant costs for 
registrants. However, in certain situations the amendments could cause 
some transactions to be significant that would not be deemed so under 
the current rules. Inclusion of, for example, additional Rule 3-05 
Financial Statements will result in increased costs to such 
registrants, though this may result in benefits to investors in the 
form of additional financial disclosures related to the transaction.
    We do not anticipate significant costs to investors associated with 
the amendments. One commenter disagreed with our assessment of the 
potential costs to investors.\447\ According to the commenter, our 
analysis ignored the potential costs of mergers, manifested in the 
destruction of value that mergers can cause for the shareholders of the 
acquiring companies. We acknowledge that there are a significant number 
of acquisitions that prove to be value-decreasing for the 
acquirer.\448\ However, as discussed above, the amendments are unlikely 
to affect whether a registrant engages in an acquisition or disposition 
or whether, with the passage of time, any particular transaction proves 
to be value-enhancing. More specifically, focusing on any disclosures 
that could

[[Page 54045]]

potentially be affected by the amendments, it is clear that various 
other factors are substantially more likely to affect acquisition and 
disposition decisions such as, for example, the registrant's assessment 
of the impact of the acquisition or disposition on its post-transaction 
performance. Specifically, other factors that are likely to be 
substantially more significant to post-transaction performance, and 
therefore influence decision making regarding the transaction and post-
transaction performance, include but are not limited to financing 
costs, integration costs, ability to achieve expected synergies in the 
amounts and in the time frames anticipated, whether known and 
anticipated trends continue and materialize, whether management 
performs as expected, and whether the resulting actions of competitors, 
suppliers, distributors, customers and others are consistent with 
expectations at the time of the transaction. In this regard, we note 
that one of the recent studies cited by the commenter finds that the 
main predictors of post-acquisition underperformance are the method of 
payment (cash versus stock), the acquirer's pre-acquisition asset 
growth, and the acquirer's excess cash on the balance sheet.\449\ 
Disclosure of these items will be unaffected by the final amendments. 
We note that, except in circumstances specifically authorized or 
required by statute, it is not the role of the Commission to substitute 
its judgment for that of issuers, shareholders, other relevant 
regulatory authorities and other stakeholders regarding, or otherwise 
exercise influence over, an acquisition or disposition transaction. 
Rather, the Commission's role generally, and in particular in this 
instance, is to craft rules designed to ensure that investors receive 
disclosure of information regarding the transaction that is material to 
an investment decision.
---------------------------------------------------------------------------

    \447\ See letter from CII (generally asserting that disclosures 
should allow investors to evaluate transactions, including 
identifying value-decreasing acquisitions, and that recent studies 
on merger activity find generally negative results of merger 
activity). We acknowledge that there are varying views regarding the 
costs and benefits of acquisitions, dispositions, and mergers and we 
discuss in more detail below the topic of whether particular types 
of transactions have in general been more value-enhancing or value-
decreasing. We also note: (1) Our conclusion that, for various 
reasons, the amendments are highly unlikely to affect whether a 
transaction proceeds or not, and (2) it is not the role of the 
Commission to substitute its judgment for that of issuers, 
shareholders, and other stakeholders regarding an acquisition or 
disposition transaction. Rather, the Commission's role is to craft 
rules designed to ensure that investors receive disclosure of 
information regarding the transaction that is material to an 
investment decision.
    \448\ We note that most of the studies that document value-
decreasing acquisitions use data on acquisitions of targets that 
were Exchange Act registered companies. For those targets, the final 
amendments will not reduce the amount of relevant information 
available. We also acknowledge that the amendments might affect 
acquiring firms that acquire private targets more than those that 
acquire public targets, as financial information of public targets 
is readily available, regardless of whether Rule 3-05 Financial 
Statements are required. Prior studies, however, have shown that the 
acquisitions of private targets on average create shareholder value. 
See, e.g., Kathleen Fuller, Jeffry Netter, & Mike Stegemoller, What 
Do Returns to Acquiring Firms Tell Us? Evidence from Firms that Make 
Many Acquisitions, 57 J. Fin. 1763 (2002) (``Fuller et al. (2002)'') 
(finding that acquisitions of private targets are associated with 
higher acquirer returns). We acknowledge that investors might face 
some search costs as target financial information will no longer be 
disclosed in connection with acquisitions. However, given the 
current data-gathering capabilities, and the fact that such 
disclosures will be available on EDGAR in electronic format, we do 
not expect these costs to be unduly burdensome for investors.
    \449\ See Richard Tortoriello et al., Mergers & Acquisitions: 
The Good, the Bad, and the Ugly (and How to Tell Them Apart), S&P 
Global, Aug. 2016, at 2-4, https://www.spglobal.com/marketintelligence/en/documents/mergers-and-acquisitions-the-good-the-bad-and-the-ugly-august-2016.pdf.
---------------------------------------------------------------------------

    We also acknowledge that one objective of the amendments is to 
reduce unnecessary disclosure and as a result, in some cases, the 
amendments will reduce the amount of information provided. However, we 
do not believe that there will be a reduction in the disclosure of 
information that is material to investors. We anticipate that the 
amendments will generally result in disclosure that is more salient and 
that any potential loss of information will be mitigated by a 
registrant's obligation under Rule 4-01(a) of Regulation S-X to include 
such further material information as is necessary to make the required 
statements, in light of the circumstances under which they are made, 
not misleading. We also note that the disclosures of a registrant's own 
financial statements are not affected by the rule amendments.
    Below we discuss the anticipated economic benefits and costs of 
specific aspects of the amendments in further detail.

D. Economic Effects of Specific Amendments

1. Significance Tests
    The amendments to the significance tests should facilitate 
registrants' application of the tests. The amendments are expected to 
bring the Investment Test more in line with the economics of the 
registrant's interest in a subsidiary or of the transaction for an 
acquired business, and reduce anomalous results from the Income Test. 
This, in turn, should reduce compliance burdens associated with the 
application of the significance tests. In addition, these amendments 
should facilitate compliance with the application of these tests under 
Rule 3-05 or Rule 3-14.
    The amendments to the Investment Test requiring use of the 
registrant's aggregate worldwide market value rather than the 
historical book value of its total assets to assess the significance of 
acquisitions and dispositions may better reflect the relative size of 
the business in economic terms. The investments in and advances to the 
acquired business generally reflect an acquirer's expectation of the 
fundamental value of the equity of the acquired business.\450\ 
Similarly, using the aggregate worldwide market value of the registrant 
would be more in line with the market expectation of the registrant's 
discounted future free cash flow to equity holders, and thus may more 
accurately reflect the fundamental value of the registrant's equity. By 
better aligning these two components of the Investment Test for 
acquisitions and dispositions, the amendments potentially will avoid 
classifying transactions as significant when they are actually 
relatively insignificant in economic substance to the registrant. 
Further, aggregate worldwide market values may better reflect the 
relative size of the transaction, especially for high-growth acquiring 
registrants whose market value is significantly different from their 
book value.\451\
---------------------------------------------------------------------------

    \450\ The fundamental value of an entity's equity refers to the 
value of equity determined through fundamental analysis. For 
example, fundamental value of a firm's equity can be estimated by 
summing the discounted stream of expected future free cash flow to 
the firm's equity holders. See Tim Koller, Marc Goedhart, & David 
Wessels, Valuation: Measuring and Managing the Value of Companies 
(7th ed. 2020).
    \451\ See, e.g., Andrei Shleifer & Robert W. Vishny, Stock 
Market Driven Acquisitions, 70 J. Fin. Econ. 295 (2003) (``Shleifer 
& Vishny (2003)'').
---------------------------------------------------------------------------

    The use of aggregate worldwide market value instead of book value 
could raise questions relating to whether market price reflects a 
registrant's fundamental value and the appropriate measurement period 
to be used. If a firm's stock price is informationally efficient, it 
will reflect the fundamental value of the firm's equity. Any new 
information, including information about mergers or acquisitions, might 
lead investors to revise their expectations of the firm's risk and 
future cash flow, resulting in possible changes in stock price. 
Information about a transaction sometimes starts seeping into the stock 
market several months before an announcement, leading investors to 
speculate around potential mergers or acquisitions.\452\ Thus, the 
market price of the registrant's shares might fluctuate depending on 
the information available. These and other factors could potentially 
affect stock price or the firm's market value. Thus, it is possible 
that the changes to the Investment Test that we are adopting might 
introduce errors or bias into the determination of the significance of 
an acquisition.
---------------------------------------------------------------------------

    \452\ See, e.g., Paul J. Halpern, Empirical Estimates of the 
Amount and Distribution of Gains to Companies in Mergers, 46 J. Bus. 
554 (1973); Gershon Mandelker, Risk and Return: The Case of Merging 
Firms, 1 J. Fin. Econ. 303 (1974) (``Mandelker (1974)'').
---------------------------------------------------------------------------

    In response to concerns raised by commenters, the amendments to the 
Investment Test will require registrants to use the average of 
aggregate worldwide market value calculated daily for the last five 
trading days of the registrant's most recently completed month ending 
prior to the earlier of the registrant's announcement date or agreement 
date of the acquisition or disposition. Using the average aggregate 
worldwide market value should reduce the risk of anomalous results 
under the Investment Test as a result of market value fluctuations due 
to other news or events that are unrelated to the acquisitions or 
dispositions. Thus, we believe the use of the average market value of 
equity in the Investment Test should better identify the significance 
of the transaction while avoiding confounding events.

[[Page 54046]]

    Under the amended Investment Test, some acquisitions may be 
considered insignificant that would otherwise have been significant 
under the existing rule. For example, this may occur when an acquiring 
company's equity is highly-valued, or an acquiring company has a high 
market-to-book ratio. Studies have shown that companies are more likely 
to make an acquisition if their stock is overvalued.\453\ Therefore, 
because it uses the aggregate worldwide market value of equity as the 
denominator, the amended Investment Test may be less likely to require 
Rule 3-05 or Rule 3-14 Financial Statements for some acquisitions where 
the acquirer's stock is overvalued.
---------------------------------------------------------------------------

    \453\ See, e.g., Shleifer & Vishny (2003), supra note 451, which 
develops a model showing that over-valued firms are more likely to 
make an acquisition of undervalued firms using their over-valued 
stocks. See also Matthew Rhodes-Kropf, David T. Robinson, & S. 
Viswanathan, Valuation Waves and Merger Activity: The Empirical 
Evidence, 77 J. Fin. Econ. 561 (2005) (``Rhodes-Kropf et al. 
(2005)''); Ming Dong et al., Does Investor Misvaluation Drive the 
Takeover Market?, 61 J. Fin. 725 (2006) (``Dong et al. (2006)''); 
James S. Ang & Yingmei Cheng, Direct Evidence on the Market-Driven 
Acquisition Theory, 29 J. Fin. Res. 199 (2006) (``Ang & Cheng 
(2006)''). All three papers document stock market-driven 
acquisitions in which acquiring firms acquire targets using their 
over-valued stocks.
---------------------------------------------------------------------------

    One commenter asserted that the proposed change to the Investment 
Test would result in less disclosure about acquisitions by companies 
whose market value is significantly larger than their book value.\454\ 
The potential loss of information may be mitigated because significance 
is established if any one of the three significance tests is satisfied 
and Rule 3-05 Financial Statements can also be triggered by the Asset 
Test or the Income Test.
---------------------------------------------------------------------------

    \454\ See letter from CII (asserting that such companies are 
more likely to use stock as a payment method, which is also a 
predictor of post-acquisition underperformance).
---------------------------------------------------------------------------

    The amendments to the Income Test adding a revenue component should 
improve the application of the Income Test by mitigating the effect of 
infrequent expenses, gains, and losses on the calculation and also 
potentially preventing insignificant subsidiaries or acquired 
businesses from being deemed significant for registrants with net 
income or loss near zero. The amended rules will continue to use income 
from continuing operations before income taxes for the Income Test 
rather than after income taxes as proposed, which should also better 
reflect the significance of a tested subsidiary or acquired business by 
avoiding distortions that can occur as a result of the tax status of 
the entity or the volatility of income taxes. Also, as mentioned above, 
the amendments might affect acquiring firms that acquire private 
targets more than those that acquire public targets, as financial 
information of public targets is readily available, regardless of 
whether Rule 3-05 Financial Statements are required. Prior studies, 
however, have shown that the acquisitions of private targets on average 
create shareholder value, which further mitigates the commenter's 
concerns.\455\ The amendments also clarify the application of the 
proposed revenue component by removing the reference to ``recurring 
annual revenue'' and indicating that the revenue component does not 
apply if either the registrant and its subsidiaries consolidated or the 
tested subsidiary did not have material revenue in each of the two most 
recently completed fiscal years. We believe this clarification will aid 
registrants in applying the test.
---------------------------------------------------------------------------

    \455\ See, e.g., Fuller et al. (2002), supra note 448 (finding 
that acquisitions of private targets are associated with higher 
acquirer returns).
---------------------------------------------------------------------------

    The inclusion of a revenue component in the Income Test may result 
in an acquired business that has a significant impact on net income, 
but not on revenues, not being deemed significant. When the registrant 
and its subsidiaries consolidated and the tested subsidiary have 
material revenue in each of the two most recently completed fiscal 
years, the amended Income Test would require both the new revenue 
component and the net income component to be met.\456\ As a result, 
when the profitability of the registrant differs significantly from the 
profitability of the acquired business, the income component could 
generate a very different result from the revenue component.
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    \456\ In this case, the registrant would use the lower of the 
revenue component and the net income component to determine the 
number of periods for which Rule 3-05 Financial Statements are 
required. See Rule 3-05(b)(2) of Regulation S-X.
---------------------------------------------------------------------------

    Any potential risks of under-identification as a result of the 
amendments may be mitigated, because significance is established if any 
one of the three significance tests are satisfied. Therefore, any 
under-identification that may result from application of one test may 
not necessarily impact the outcome of whether disclosure would be 
required. For example, acquisitions conducted by highly-valued firms 
might not trigger Rule 3-05 Financial Statements based on the 
Investment Test because of their higher aggregate worldwide market 
value of equity. However, Rule 3-05 Financial Statements might still be 
required based on the Income Test or the Asset Test, thus mitigating 
the risks of under-identification of economically significant 
transactions. Additionally, any potential risks of under-identification 
could be mitigated by the fact that registrants must otherwise disclose 
material information about the acquisition that is necessary to make 
the required statements not misleading.
    Overall, the amendments to the Investment Test and Income Test are 
expected to better capture the significance of a tested subsidiary or 
acquired business relative to the registrant, resulting in more salient 
disclosure and reducing compliance burdens. For example, to the extent 
that the amendments reduce the risk of deeming an insignificant 
acquisition to be significant, they may benefit registrants by reducing 
the number of instances in which registrants are required to file Rule 
3-05 Financial Statements or Rule 3-14 Financial Statements, thus 
reducing compliance burdens. To the extent that the amendments to the 
significance tests capture more significant businesses and acquisitions 
and fewer insignificant ones, they may directly benefit investors by 
improving the overall salience of the information disclosed to them. 
Investors may also indirectly benefit from the amendments to the 
significance tests as the potential cost savings from reduced 
compliance burdens could be translated to more capital available to the 
registrants for future profitable investments and possibly the ability 
to access capital sooner than under existing requirements.
    We believe that overall the amendments to the significance tests 
would improve the application of the tests and their ability to capture 
the economic substance of acquisitions and dispositions, which would 
benefit investors by helping ensure that they are provided with 
decision-relevant information about those acquisitions.
2. Audited Financial Statements for Significant Acquisitions
    The amendment to eliminate the requirement to file the third year 
of Rule 3-05 Financial Statements would reduce registrants' disclosure 
burden. Currently, Rule 3-05 Financial Statements are required for up 
to three years prior to the acquisition depending on the significance 
of the transaction and the amount of net revenues reported by the 
acquired business in its most recent fiscal year. To the extent that 
information from three years prior might be less relevant to investors' 
analysis of an acquisition, we believe the benefits from the reduction 
in disclosure burden and audit costs justify investors' loss of the 
incremental value of the third year of financial information. For 
purposes of

[[Page 54047]]

the PRA, we expect the average reduction in registrants' compliance 
burden as a result of the amendments would be approximately 125 hours 
per Rule 3-05 Financial Statement filing.\457\ In addition to these 
compliance cost savings, there could be other and more substantial 
benefits from the amendments. The amendments could facilitate merger 
and acquisition transactions and facilitate an acquiring company's 
access to capital. For example, if the preparation and audit of pre-
acquisition financial statements are outside of the registrant's 
control, and the target company is unable to prepare and obtain an 
audit of any required financial statements for the third year, the 
registrant will be unable to comply with its disclosure requirements 
under Rule 3-05, which could delay the filing of a registration 
statement and impede its capital raising efforts.
---------------------------------------------------------------------------

    \457\ See infra Section V.B.1, Table 1.
---------------------------------------------------------------------------

    The impact of the amendment on investors depends, in part, on the 
value of information about the third year. In an efficient market, 
information for the third year before an acquisition may not generally 
provide significant incremental value to investors to evaluate a 
transaction. However, in some cases the omission of the third year of 
Rule 3-05 Financial Statements could result in loss of information to 
investors, such as in those limited cases where the acquired business 
has an operating cycle that extends beyond two years and has not 
previously filed any financial reports. We expect this potential loss 
of information to be partially mitigated by a registrant's Rule 4-01(a) 
obligation to include such further material information as is necessary 
to make the required statements, in light of the circumstances under 
which they are made, not misleading.
3. Financial Statements for Net Assets That Constitute a Business
    The amendment to permit the use of abbreviated financial statements 
in circumstances where providing full audited financial statements 
would be impractical should reduce registrants' disclosure burdens, 
decrease compliance costs, and facilitate consummation of acquisitions. 
Registrants frequently acquire a component of an entity that is a 
business as defined in Rule 11-01(d), but does not constitute a 
separate entity, subsidiary, segment, or division, such as a product 
line or a line of business contained in more than one subsidiary of the 
selling entity. These businesses may not have separate financial 
statements or maintain separate and distinct accounts necessary to 
prepare Rule 3-05 Financial Statements because they often represent 
only a small portion of the selling entity. As a result, a registrant 
may be unable to provide the financial statements required under the 
current rule. In these circumstances, the amendments provide that 
registrants would be permitted to file abbreviated financial statements 
to comply with Rule 3-05 if the total assets and total revenues (both 
after intercompany eliminations) of the acquired or to be acquired 
business constitute 20 percent or less of such corresponding amounts of 
the seller and its subsidiaries consolidated. This bright line 
threshold is a modification from the proposal in response to commenter 
feedback. Applying a 20 percent bright line threshold will reduce 
inconsistency in interpreting ``small portion of the selling entity'' 
and should facilitate compliance by registrants. A bright line 
threshold in the disclosure requirement may lead to over- or under-
identification. However, a 20 percent threshold also is generally 
consistent with the staff's granting of relief pursuant to Rule 3-13 in 
such situations. This amendment also will help ensure that abbreviated 
financial statements are not used when the component of the selling 
entity acquired is sufficiently large such that presentation of the 
seller's financial statements, along with pro forma financial 
information that removes the portion of the seller not acquired, would 
best inform investors about the business acquired. Additionally, we are 
clarifying the meaning of the term ``segment,'' the description of 
expenses, and the presentation of the abbreviated financial statements. 
These clarifications should improve registrant's ability to comply with 
the Rule 3-05 disclosure requirements. We believe allowing for 
abbreviated financial statements in these circumstances will reduce 
costs for registrants and facilitate the consummation of acquisitions. 
We also believe any potential costs to investors as a result of 
decreases in disclosure will be mitigated by the fact that registrants 
must otherwise disclose material information about the acquisition that 
is necessary to make the required statements not misleading.
4. Financial Statements of a Business That Includes Oil and Gas 
Producing Activities
    When an acquired or to be acquired oil and gas producing business 
represents a component of an entity that does not constitute a separate 
entity, subsidiary, operating segment (as defined in U.S. GAAP or IFRS-
IASB, as applicable), or division for which separate financial 
statements exist and for which historical depreciation, depletion and 
amortization expense is likely not meaningful to an understanding of 
the potential effects of the acquired or to be acquired business on the 
registrant, the amendments would permit registrants to provide 
abbreviated financial statements that consist of income statements 
modified to exclude expenses not comparable to future operations. We 
believe allowing for abbreviated financial statements in these 
circumstances will reduce costs for registrants. As noted above, we 
believe any potential costs to investors as a result of decreases in 
disclosure will be mitigated by the fact that registrants must 
otherwise disclose material information about the acquisition that is 
necessary to make the required statements not misleading.
5. Timing and Terminology of Financial Statement Requirements
    The amendments include several revisions that clarify the timing 
and terminology related to the disclosure requirements, with some 
revisions based on commenter feedback. These clarifications should 
benefit registrants by avoiding any confusion that may arise from 
application of the current requirements, thereby enhancing the overall 
efficiency of their compliance efforts. Because these amendments do not 
modify the information required to be disclosed, we do not believe 
investors would be negatively affected by them. To the extent that 
these amendments make compliance more efficient for registrants, 
investors may indirectly benefit as cost savings could be passed 
through to them.
6. Foreign Businesses
    The amendments permit foreign private issuers that prepare their 
financial statements using IFRS-IASB to provide Rule 3-05 and Rule 3-14 
Financial Statements prepared using a comprehensive basis of accounting 
principles other than U.S. GAAP or IFRS-IASB to be reconciled to IFRS-
IASB rather than U.S. GAAP for an acquired business that is a foreign 
business (as defined in 17 CFR 210.1-02(l)). Permitting the use of Rule 
3-05 and Rule 3-14 Financial Statements reconciled to IFRS-IASB in 
these circumstances potentially benefits investors by providing them 
with information about the acquired business that is more comparable to 
the registrant. This may allow investors to analyze the impact of these 
acquisitions more expeditiously.

[[Page 54048]]

    The amendments also allow Rule 3-05 and Rule 3-14 Financial 
Statements to be prepared in accordance with IFRS-IASB without 
reconciliation to U.S. GAAP for an acquired business that is not a 
foreign business (as defined in 17 CFR 210.1-02(l)), but would qualify 
as a foreign private issuer if it were a registrant. Preparing 
financial statements without reconciliation to U.S. GAAP in these 
circumstances reduces the compliance costs where an acquired business 
in a cross-border acquisition does not have U.S. GAAP financial 
statements. It may also reduce transaction costs associated with 
acquiring foreign entities that would be considered valuable potential 
acquisition targets. For example, a registrant might be discouraged 
under the current rules from completing a cross-border acquisition in 
situations where it would be costly for the foreign target to prepare 
its financial statements using U.S. GAAP.
    The amendments further permit an acquired business that is not a 
foreign business, but would qualify as a foreign private issuer if it 
were a registrant to reconcile its financial statements prepared 
according to a comprehensive basis of accounting principles other than 
U.S. GAAP or IFRS-IASB to IFRS-IASB rather than U.S. GAAP when the 
registrant is a foreign private issuer that uses IFRS-IASB. Permitting 
use of Rule 3-05 and Rule 3-14 Financial Statements reconciled to IFRS-
IASB in these circumstances potentially benefits investors by providing 
them with more comparable information, which could be more 
expeditiously analyzed. The amendments further clarify that this 
reconciliation should generally follow the form and content 
requirements in Item 17(c) of Form 20-F; however, accommodations in 
Item 17(c)(2) of Form 20-F that would be inconsistent with IFRS-IASB 
will not be available, and IFRS 1, First-time Adoption of International 
Financial Reporting Standards, may be applied. The improved clarity in 
the amendment should improve registrants' compliance process, 
potentially reducing compliance costs.
    By providing flexibility to prepare an acquired or to be acquired 
business's financial statements using, or reconciling to, IFRS-IASB in 
these circumstances, the amendment may facilitate certain cross-border 
mergers that might otherwise not take place due to compliance costs 
associated with preparing financial statements using, or reconciling 
to, U.S. GAAP. Based on data from the SDC merger database for the three 
year period from January 2015 to January 2018, about 20 percent of 
acquisitions by U.S. companies involved non-U.S. targets. To the extent 
that the amendment leads to increased cross-border mergers and 
acquisitions, shareholders could potentially benefit from greater 
growth potential in new markets, more efficient distribution systems, 
or improved managerial processes, among other benefits.\458\
---------------------------------------------------------------------------

    \458\ See, e.g., Kenneth R. Ahern, Daniele Daminelli, & Cesare 
Fracassi, Lost in Translation? The Effect of Cultural Values on 
Mergers Around the World, 117 J. Fin. Econ. 165 (2015).
---------------------------------------------------------------------------

    A possible consequence from the amendments could be inconsistencies 
in financial disclosure about acquired or to be acquired businesses 
where IFRS-IASB and U.S. GAAP differ significantly in reporting 
practices. For example, there are certain differences in the 
recognition, measurement, and impairment of long-lived assets between 
IFRS-IASB and U.S. GAAP.\459\ Such inconsistencies could lead to 
confusion and a loss of comparability for investors of domestic 
registrants familiar with U.S. GAAP financial statements. Despite 
potential inconsistencies, we do not expect the amendments to impose 
substantial costs on investors because they should be familiar with 
IFRS-IASB financial statements from other contexts. Specifically, 
foreign private issuers have been permitted to file IFRS-IASB financial 
statements without reconciliation to U.S. GAAP for some time,\460\ and 
IFRS-IASB is widely used for financial reporting purposes in other 
jurisdictions. In that respect, we do not believe using or reconciling 
to IFRS-IASB financial statements for businesses in foreign 
jurisdictions will necessarily lower the disclosure standard or cause 
undue confusion. In addition, pro forma financial information for the 
acquisition is required to reflect the acquired foreign business on the 
same basis of accounting as that of the registrant. For a U.S. 
registrant, that basis would be U.S. GAAP, which should mitigate any 
potential inconsistencies in the pre-acquisition historical financial 
statements.
---------------------------------------------------------------------------

    \459\ As an example, IFRS-IASB permits the recognition of 
internally generated intangible assets in limited circumstances; 
U.S. GAAP does not.
    \460\ See Acceptance From Foreign Private Issuers of Financial 
Statements Prepared in Accordance With International Financial 
Reporting Standards Without Reconciliation to U.S. GAAP, Release No. 
33-8879 (Dec. 21, 2007) [73 FR 986 (Jan. 4, 2008)].
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7. Smaller Reporting Companies and Issuers Relying on Regulation A
    The amendments revise Rule 8-04 to direct smaller reporting 
companies to Rule 3-05 for requirements relating to the financial 
statements of businesses acquired or to be acquired, although the form 
and content requirements for these financial statements would continue 
to be governed by Article 8. The amendments to Rule 8-04 also apply to 
issuers relying on Regulation A. Since the form and content of the 
required financial statements will continue to be prepared in 
accordance with Article 8, we do not believe the amendments will impose 
additional compliance costs on affected entities and do not expect the 
amendments to reduce information available to investors.
    The amendments to require smaller reporting companies to provide 
pro forma financial information for significant acquisitions and 
dispositions made during annual periods and to use the enhanced 
guidelines in Article 11 when preparing pro forma financial information 
could increase the burden on smaller reporting companies. However, 
based on a staff analysis of 2017 disclosures of acquisitions and 
dispositions by smaller reporting companies, we believe most already 
comply with the conditions in Article 11.\461\ As a result, we do not 
expect that the amendments will impose significant new costs on these 
entities. At the same time, the amendments may provide more relevant 
information to investors, although this benefit also will be limited to 
the extent that smaller reporting companies already comply with these 
requirements in practice.
---------------------------------------------------------------------------

    \461\ See supra note 346.
---------------------------------------------------------------------------

    The amendments do not provide additional accommodation for smaller 
reporting companies as suggested by some commenters.\462\ As discussed 
in Section II.A.7.c above, additional accommodations might potentially 
complicate application of the rule. However, we expect the amendments 
will ease compliance burdens and simplify the application of our rules 
for all affected entities. To the extent that these compliance burdens 
entail certain fixed costs that do not scale with the size of the 
acquirer, smaller reporting companies and issuers relying on Regulation 
A may particularly benefit from the adopted changes.
---------------------------------------------------------------------------

    \462\ See supra Section II.A.7.
---------------------------------------------------------------------------

8. Omission of Rule 3-05 and Rule 3-14 Financial Statements and Related 
Pro Forma Financial Information for Businesses That Have Been Included 
in the Registrant's Financial Statements
    The amendments allow registrants to omit Rule 3-05 and Rule 3-14 
Financial Statements from Securities Act registration statements and 
proxy statements for businesses that exceed 20 percent, but do not 
exceed 40 percent, significance after inclusion in post-acquisition 
results for nine months

[[Page 54049]]

(rather than the proposed complete fiscal year) and for businesses that 
exceed 40 percent significance once they are included in the 
registrant's post-acquisition results for a complete fiscal year. These 
amendments provide consistency between Rule 3-06 and Rule 3-05 for 
acquisitions that exceed 20 percent, but do not exceed 40 percent 
significance, and could also improve registrants' timely access to 
capital. For example, registrants currently have to test the 
significance of acquisitions that occurred during the earliest years 
for which the registrant is required to provide historical financial 
statements and, if significant, to provide pre-acquisition financial 
statements of the acquired business. These modifications are in 
response to commenter feedback. We anticipate reduced compliance 
burdens on registrants and do not anticipate significant costs on 
investors. We expect the amendments to be especially useful for 
registrants that complete an initial public offering, as those 
registrants are most likely not to have been required to file Rule 3-05 
and Rule 3-14 Financial Statements before filing their initial 
registration statements. In these instances, a registrant might need to 
spend additional time or resources, or both, to prepare Rule 3-05 and 
Rule 3-14 Financial Statements for inclusion in a registration 
statement, which can delay a registrant's offering and hence delay its 
access to capital. In addition to anticipated benefits resulting from 
more timely access to capital, registrants may benefit from reduced 
compliance costs.
    We believe that information from the historical pre-acquisition 
period is not as relevant once integration of the acquisition is 
completed. Additionally, in acquisitions where integration takes longer 
than a year, investors will still receive disclosure about material 
effects of the acquisition through the registrant's management's 
discussion and analysis.\463\ We therefore do not expect the amendments 
to result in a meaningful loss of material information to investors. 
Instead, the reduction in compliance burdens and the timely access to 
capital may indirectly benefit investors.
---------------------------------------------------------------------------

    \463\ See 17 CFR 229.303.
---------------------------------------------------------------------------

9. Use of Pro Forma Financial Information To Measure Significance
    The amendments permit the use of pro forma financial information to 
measure significance in initial registration statements. The amendments 
further clarify, based on commenter input, that if a registrant uses 
pro forma financial information to measure significance, it must 
continue to use pro forma financial information to measure significance 
until the next annual report on Form 10-K. This approach provides 
registrants with certain flexibility to more accurately measure the 
relative significance of an acquisition or disposition, which in turn 
may help reduce their disclosure burden and compliance costs and 
facilitate capital formation. Because pro forma financial information 
may capture the effects of significant acquisitions and dispositions 
consummated after the latest fiscal year-end that are not reflected in 
the registrant's annual historical financial statements (financial 
statements that would otherwise be used to measure significance), these 
amendments could enable registrants to more accurately determine the 
significance of these transactions.
    The amendments could potentially reduce the amount of information 
presented to investors if significance determinations on the basis of 
pro forma financial information fail to identify acquisitions that are 
economically significant to a registrant. However, as noted above, Rule 
4-01(a) requires registrants to include such further material 
information as is necessary to make the required statements, in light 
of the circumstances under which they are made, not misleading. We 
expect this requirement to mitigate concerns about any loss of relevant 
information to investors.
10. Disclosure Requirements for Individually Insignificant Acquisitions
    Registrants are currently required to provide certain audited, 
historical pre-acquisition financial statements if the aggregate impact 
of ``individually insignificant businesses'' acquired since the date of 
the most recent audited balance sheet exceeds 50 percent.\464\ In these 
circumstances, pro forma financial information is also required 
pursuant to Article 11 for the ``individually insignificant 
businesses'' for which audited, historical pre-acquisition financial 
statements are required.\465\ To comply with these requirements, 
registrants may need to provide audited financial statements of 
acquired businesses that are not material to the registrant, and pro 
forma financial information that might not reflect the aggregate effect 
of the ``individually insignificant businesses.''
---------------------------------------------------------------------------

    \464\ See supra note 201.
    \465\ See supra note 211.
---------------------------------------------------------------------------

    The amendments will affect disclosure requirements for individually 
insignificant businesses in several ways. First, the amendments require 
the registrants to provide audited historical financial statements only 
for those acquired businesses whose individual significance exceeds 20 
percent. Reducing required disclosure of audited historical financial 
statements for insignificant acquisitions could improve registrants' 
access to capital since preparing such disclosure typically entails 
negotiating with the seller to timely provide this information, a 
process that can be costly and time-consuming. By simplifying and 
streamlining the historical financial statement disclosure requirement 
for individually insignificant acquisitions, the amendments may make it 
easier, quicker, and cheaper for registrants to access capital. The 
amendments also reduce registrants' disclosure burdens, leading to cost 
savings that may ultimately benefit shareholders.
    Second, the amendments could improve the completeness of 
information provided to investors by requiring pro forma financial 
information that depicts the aggregate effect in all material respects 
of the acquired businesses, rather than only a mathematical majority of 
the individually insignificant businesses acquired. Investors might 
benefit by being able to more effectively assess the aggregate effect 
of these acquisitions on the registrant as a result of the amendments.
    The amendments might impose additional compliance burdens on 
registrants to the extent they are required to present information 
about acquisitions, albeit in an aggregated form, that they have not 
disclosed in the past. Because we do not have information available to 
estimate the number of acquisitions that will be subject to this 
requirement in aggregate or for any given registrant, we cannot 
quantify these compliance costs. However, we do not expect registrants 
to incur substantial costs to prepare disclosure about such 
acquisitions because these are activities that typically underpin the 
decision to make an acquisition. The amendments also expand the 
aggregate impact determination to include both Rule 3-05 and Rule 3-14 
acquisitions. This modification is consistent with the objective of 
aligning Rule 3-14 with Rule 3-05. We do not believe there will be 
significant economic effects from this expansion as the modification 
will apply only to registrants that acquire both Rule 3-05 businesses 
and Rule 3-14 real estate operations.

[[Page 54050]]

11. Rule 3-14--Financial Statements of Real Estate Operations Acquired 
or To Be Acquired
    The amendments align Rule 3-14 with Rule 3-05 where no unique 
industry considerations warrant differentiated treatment of real estate 
operations. For example, the amendments align the threshold for 
individual significance for both rules at ``exceeds 20 percent'' and 
the threshold for aggregate significance for both rules at ``exceeds 50 
percent.'' The amendments also align Rule 3-14 with Rule 3-05 in terms 
of the years of required financial statements for acquisitions from 
related parties, the timing of filings, application of Rule 3-06, which 
permits the filing of financial statements covering a period of nine to 
12 months, and other less significant changes.
    The amendments are expected to benefit registrants as greater 
consistency in application of the rules may reduce the costs of 
preparing disclosure, especially for registrants that make both real 
estate and non-real estate acquisitions. In addition to the alignment 
between Rule 3-14 and Rule 3-05, the amendments also define real estate 
operation as a business that generates substantially all of its 
revenues through the leasing of real property. This may reduce 
potential uncertainty and ambiguity in applying Rule 3-14 without 
negatively affecting investors.
    The amendments also establish or clarify the application of Rule 3-
14 regarding scope of the requirements, determination of significance, 
need for interim income statements, and special significance provisions 
for blind pool offerings that are consistent with current practice. 
Thus, while these amendments may reduce potential compliance 
uncertainty and ambiguity for registrants, we do not expect them to 
have a substantial effect on current disclosure practices.
    In addition, because the special significance provisions for 
``blind pool offerings'' are based on the unique characteristics of the 
offering and the registrant, rather than the type of acquisitions, the 
amendments also extend these special significance provisions to 
business acquisitions subject to Rule 3-05 by registrants conducting 
``blind pool'' offerings. We do not believe this extension will have 
significant economic effects as the extended accommodation will only 
affect a very small population of registrants. For those it does 
impact, the amendment will increase consistency in the application of 
Rules 3-14 and 3-05, thereby reducing costs of preparation for 
registrants and immaterial disclosure to investors.
12. Pro Forma Financial Information
    The amendments to replace the existing pro forma adjustment 
criteria in Article 11 of Regulation S-X with Transaction Accounting 
Adjustments and Autonomous Entity Adjustments simplify these 
requirements and reduce potential inconsistency in preparing pro forma 
financial information. The amendments to Article 11 could benefit 
investors in several ways. First, the Transaction Accounting 
Adjustments may lead to more consistent pro forma presentations than 
the current adjustment criteria, which may be subject to some 
interpretation. In addition, the Transaction Accounting Adjustments may 
permit registrants to better reflect acquisitions, dispositions, or 
other transactions, which could help investors better understand the 
effects of these transactions on the registrant's audited historical 
financial statements. Altogether, the amendments are expected to 
improve the relevance of the information disclosed to investors and 
help investors process information more effectively.
    In a change from the proposal, under the final amendments, 
Management's Adjustments depicting synergies and dis-synergies of the 
acquisitions and dispositions for which pro forma effect is being given 
may, in the registrant's discretion, be presented if in its 
management's opinion, such adjustments would enhance an understanding 
of the pro forma effects of the transaction and specified conditions 
related to the Basis for Management's Adjustments and the Form of 
Presentation are met.\466\ On the one hand, Management's Adjustments 
may provide investors better insight into the potential effects of the 
transaction as contemplated by the company. This potentially benefits 
investors by helping them to distinguish the accounting effects of the 
acquisitions or dispositions from management's judgment as to the 
expected operational effects based on management plans. On the other 
hand, there may be different levels of confidence about forward-looking 
information related to different types of synergies and dis-synergies 
contemplated by management. Making Management's Adjustments optional 
benefits registrants by permitting them to avoid uncertainties of 
estimation and increase flexibility in compliance, thus potentially 
reducing compliance costs.
---------------------------------------------------------------------------

    \466\ See supra Section II.D.1.c.
---------------------------------------------------------------------------

    The amendments to Article 11 could impose costs on registrants 
because they would be required to meet new presentation requirements 
for required or optional pro forma adjustments. For purposes of the 
PRA, we estimate the average incremental compliance burden for these 
new requirements would be around 25 hours per affected registrant.\467\ 
However, synergy and dis-synergy estimation by registrants may 
introduce certain subjective judgments into the pro forma financial 
statements, potentially making them more difficult for investors to 
interpret. In addition, making Management's Adjustments optional could 
create risk that such adjustments would be disclosed selectively. The 
requirement that registrants disclose uncertainties, assumptions, and 
calculation methods and the requirement that when synergies are 
presented, any related dis-synergies must also be presented along with 
the Management's Adjustments, could mitigate the risk of biased pro 
forma adjustments. The amendments appear unlikely to cause significant 
loss in information for investors regarding the effects of the 
transaction; indeed investors may gain important insights to the extent 
a registrant chooses to disclose Management's Adjustments.
---------------------------------------------------------------------------

    \467\ See infra Section V.B.1, Table 1.
---------------------------------------------------------------------------

13. Significance and Business Dispositions
    The amendments to conform the significance tests for a disposed 
business to that of an acquired business and to increase the threshold 
for determining the significance of a business disposition from 10 
percent to 20 percent will reduce inconsistencies in reporting between 
acquisitions and dispositions and potentially reduce registrants' 
compliance burden.\468\ For example, under the amendments, registrants 
will not have to file pro forma financial information for insignificant 
dispositions (e.g., dispositions with significance levels exceeding 10 
percent but not 20 percent), thus reducing compliance costs. In 
addition, there could be some positive spillover effect for registrants 
from applying the same thresholds to determine the significance of 
their transactions. For example, a registrant might engage in both 
acquisitions and

[[Page 54051]]

dispositions during the same reporting period. Identical thresholds 
might help achieve internal consistency in financial reporting in 
evaluating the impact of both types of transactions as well as the net 
effects. For investors, the amendment to conform the significance 
threshold for a disposed business to that of an acquired business could 
facilitate understanding and analysis of Rule 3-05 and Rule 11-01(b) 
disclosures by eliminating the inconsistency in reporting between 
acquisitions and dispositions.
---------------------------------------------------------------------------

    \468\ Under current requirements, pro forma financial 
information is required upon the disposition (and for certain 
registration statements and proxy statements, the probable 
disposition) of a significant portion of a business, if the business 
to be disposed of meets the conditions of a significant subsidiary 
under Rule 1-02(w). Rule 1-02(w) uses a 10 percent significance 
threshold, not the 20 percent threshold used for business 
acquisitions under Rules 3-05 and 11-01(b).
---------------------------------------------------------------------------

14. Amendments to Financial Disclosure About Acquisitions Specific to 
Investment Companies
    We believe the amendments related to investment companies would 
reduce compliance burdens by streamlining the disclosure requirements 
in a way that is tailored to investment companies. We do not anticipate 
significant costs to investors related to the amendments, because we do 
not believe the amendments will result in a reduction in material 
information available to investors.
    Currently, there are no specific rules or requirements in 
Regulation S-X for investment companies relating to the financial 
statements of acquired funds. Instead, these entities apply the general 
requirements of Rule 3-05 and the pro forma financial information 
requirements in Article 11. However, investment company registrants 
differ from non-investment company registrants in several respects. For 
example, investment companies' income mainly stems from capital 
appreciation and investment income; \469\ investment companies are 
required to report their net asset value on a daily basis using fair 
value for portfolio investments; and investment companies do not 
account for their investments using the equity method. As a result, 
investment companies have faced challenges applying the general 
requirements of Rule 3-05 and Article 11 in the context of fund 
acquisitions.
---------------------------------------------------------------------------

    \469\ Investment income includes dividends, interest on 
securities, and other income, but does not include net realized and 
unrealized gains and losses on investments. See Rule 6-07 of 
Regulation S-X.
---------------------------------------------------------------------------

    The amendments include a separate definition of ``significant 
subsidiary'' and separate significance tests specifically tailored for 
investment companies. The amendments focus the significance 
determination for investment companies on the impact to the 
registrant's investment portfolio held by the registrant. Further, the 
amended significance tests capture sources of income such as dividends, 
interest, and the net realized and unrealized gains and losses on 
investment that are most relevant to investment companies. We expect 
that together the amendments will benefit both investment companies and 
their investors by providing more appropriate standards for determining 
the significance of fund acquisitions. For example, the amended Income 
Test better aligns income from a particular investment or acquisition 
for purposes of analyzing the effect on the income of the investment 
company as a whole. We thus expect the amended Income Test to better 
reflect the impact of the tested subsidiary on an investment portfolio 
rather than a test based solely on investment income as used in current 
Rule 8b-2. This is because changes in the market value of an investment 
portfolio due to market volatility may be substantial even when the 
securities held in the portfolio do not produce investment income. The 
amendments also permit the use of a five-year average for income if 
income for the past year is at least 10 percent less than the average 
income for the past five years. The amendments also revise the 
calculation of income to be the absolute value of ``the sum'' of 
combined investment income from dividends, interest, and other income, 
the net realized gains and losses on investments, and the net change in 
unrealized gains and losses on investments. These modifications were 
made to prevent confusion in applying absolute value with respect to 
income and avoid the potential double counting of gains or losses. As a 
result, the amendments may more accurately identify acquisitions that 
are economically significant to investment company registrants. This 
will benefit registrants as they will not be required to prepare 
separate financial disclosure for economically insignificant 
acquisitions. The amendments also may benefit investors by avoiding the 
need to focus on economically insignificant acquisitions that are 
deemed significant under current rules. Furthermore, we do not 
anticipate that the amended significance tests would impose substantial 
costs on registrants to implement because we believe the required 
measures should be readily available to registrants.
    The amended significance thresholds for the Income Test in Rule 1-
02(w) when applied to investment companies has two prongs: Either (i) a 
threshold of 80 percent for income alone or (ii) a 10 percent threshold 
together with an Investment Test result higher than 5 percent. This 
amended threshold might reduce the compliance burden faced by 
investment companies as there is less need to produce additional 
financial information when a registrant's net income is relatively 
small. Smaller net income could produce anomalous results under the 
current Income Test as it may make it appear as if an acquisition or 
investment is a significant contribution to a registrant's net income 
when it represents only a very small portion of the registrant's 
portfolio of investments. By effectively conditioning the income test 
for investment companies on the investment test for investment 
companies, the amendments potentially better identify fund acquisitions 
that warrant additional disclosure. This amendment also could benefit 
investors to the extent that they place a higher weight on the value of 
investments, relative to the income produced by investments, when 
considering the economic impact of an acquisition.
    The amendment to eliminate an asset-based test for investment 
companies simplifies compliance while likely not resulting in a 
significant loss in information. An asset-based test is generally not 
meaningful when applied to investment companies and, when the acquired 
entity is another investment company, is largely superfluous in light 
of the amended Investment Test for investment companies. Additionally, 
applying the asset test could be less meaningful when the tested 
subsidiary is not another investment company. Because the asset test in 
these circumstances would involve comparing assets measured under 
different methodologies, it may be a less reliable indicator of 
significance, causing registrants to incur costs to prepare disclosures 
for acquisitions that are not economically significant, and therefore 
of little benefit to investors.
    New Rule 6-11 potentially reduces compliance burdens by setting 
forth financial statement requirements for acquired funds that are 
specifically tailored for investment companies as compared to Rule 3-
05. Rule 6-11 deems the acquisition of all or substantially all 
portfolio investments held by another fund as a fund acquisition. This 
principles-based facts and circumstances evaluation of whether a fund 
acquisition has occurred could potentially reduce under-reporting of 
acquired fund disclosures by focusing on the economic substance of the 
transaction rather than its legal form. The amendments to require one 
year of audited financial statements for fund acquisitions and to 
eliminate pro forma financial statements could also reduce compliance 
burdens for

[[Page 54052]]

registrants. We do not believe these amendments will lead to loss of 
relevant information to investors, as the price of investment company 
shares is calculated daily based on the fair value of its investment 
portfolio, and older historical financial statements are in general 
less relevant to fund investors. The amendments are also consistent 
with the accommodations typically provided by our disclosure review 
staff during consultations.\470\ Permitting investment companies to 
provide financial statements for private funds that were prepared in 
accordance with U.S. GAAP will reduce compliance burdens for investment 
companies by potentially reducing the costs related to re-issuing 
audited financial statements in compliance with Regulation S-X. Any 
loss of information arising from these amendments will be mitigated by 
the requirement that investment companies file the schedules required 
under Article 12 of Regulation S-X and provide certain supplemental 
information regarding the acquired funds. We believe this information 
is more relevant and potentially enhances efficiency in processing the 
information by fund investors. These supplemental disclosures, however, 
will entail costs to registrants. For purposes of the PRA, we estimate 
the average incremental compliance burden for this additional 
disclosure is around 25 hours per affected registrant. We further 
estimate that all of these amendments taken together will reduce a 
registrant's compliance burden by approximately 100 hours.\471\
---------------------------------------------------------------------------

    \470\ See supra note 58.
    \471\ See infra Section V.B.2.
---------------------------------------------------------------------------

E. The Effects on Efficiency, Competition, and Capital Formation

    We anticipate that the amendments will have favorable effects on 
efficiency, competition, and capital formation for both operating 
companies and investment companies. By reducing disclosure burdens for 
registrants regarding business acquisitions and dispositions, the 
amendments should facilitate such activities, although, as stated 
earlier, compliance costs may be a more modest factor when a registrant 
considers whether to engage in an acquisition or disposition. An active 
mergers and acquisitions market creates efficiencies by transferring 
inefficiently managed assets to more efficient management or by 
creating synergies through economies of scale or economies of 
scope.\472\ On average, mergers and acquisitions benefit investors in 
the acquired business.\473\
---------------------------------------------------------------------------

    \472\ For a discussion of the benefits of the market for 
corporate control, see, e.g., Michael C. Jensen & Richard S. Ruback, 
The Market for Corporate Control: The Scientific Evidence, 11 
Journal of Financial Economics. 5 (1983) (``Jensen & Ruback 
(1983)'') (noting that an active takeover market can create 
efficiencies by transferring inefficiently managed assets to more 
efficient management--or by creating synergies through economies of 
scale or scope). For a discussion of the agency costs of mergers and 
acquisitions, see, e.g., Michael C. Jensen & William H. Meckling, 
Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership 
Structure, 3 Journal of Financial Economics, 305 (1976) (explaining 
that managers have private incentives to conduct mergers and 
acquisitions to increase the size of the firm in order to extract 
more pay or perquisites at shareholder expense).
    \473\ Empirical studies have shown that around M&A 
announcements, the target firms earn a significant abnormal return. 
See, e.g., Mandelker (1974), supra note 452; Jensen & Ruback (1983), 
supra note 472; Joy Ishii & Yuhai Xuan, Acquirer-Target Social Ties 
and Merger Outcomes, 112 J. Fin. Econ. 344 (2014).
---------------------------------------------------------------------------

    The amendments to revise the disclosure relating to acquired and 
disposed businesses are expected to benefit registrants by potentially 
reducing compliance burdens and facilitating more timely access to 
capital. Considering all registrants, including both operating 
companies and investment companies, for PRA purposes, the estimated 
reduction in the total number of incremental burden hours required for 
compliance with all forms from the amendments is about 82,225 company 
hours.\474\ The resulting total reduction in incremental professional 
costs for all forms under the amendments is approximately 
$21,470,000.\475\ We thus believe the potential cost savings from the 
amendments are significant.
---------------------------------------------------------------------------

    \474\ See infra Section V.C, Table 5 Column E.
    \475\ See infra Section V.C, Table 5 Column F.
---------------------------------------------------------------------------

    At the same time, we do not believe investors face a significant 
loss in information as a result of the amendments. Instead, we expect 
the amendments to provide investors with more relevant information, 
which may allow them to process the information more efficiently, 
enhancing their investment decisions and thus potentially facilitating 
capital formation. Additionally, reduced regulatory complexity may lead 
to increased efficiency in the market for mergers and acquisitions. 
Under the existing disclosure requirements related to acquired 
businesses, some mergers may be delayed or more costly due to the 
burdens of compliance with Rule 3-05 Financial Statement requirements 
(e.g., a private business may not have more than two years of audited 
financial statements, but the transaction may trigger additional 
disclosure because the business crosses the highest significance 
threshold). By decreasing the acquisition costs for registrants, the 
amendments could promote competition in the market for mergers and 
acquisitions and potentially benefit shareholders of acquired 
businesses. Better disclosure quality and an improved information 
environment could also facilitate the market for mergers and 
acquisitions, which could help achieve efficient capital allocation and 
exert effective external control mechanisms on public firms, leading to 
an overall increase in efficiency.\476\
---------------------------------------------------------------------------

    \476\ Studies have found that mergers may create shareholder 
value when the assets are transferred from inefficient management to 
more efficient management. See Mitchell & Lehn (1990), supra note 
427; Agrawal & Jaffe (2003), supra note 427; Kenneth M. Lehn & 
Mengxin Zhao, CEO Turnovers after Acquisitions: Are Bad Bidders 
Fired?, 61 J. Fin. 1759 (2006).
---------------------------------------------------------------------------

F. Alternatives Considered

1. Approaches to the Significance Tests
    One alternative to the amended significance tests would be to adopt 
a principles-based framework, such as materiality, rather than the 
current bright-line tests for determining when financial statements of 
acquired or disposed businesses are required. The benefit of using a 
principles-based approach based on materiality to determine 
significance is that it would permit judgment and consideration of 
unique facts and circumstances. An additional benefit of such an 
approach is that materiality is a familiar concept to registrants who 
currently make materiality determinations in preparing their filings 
with the Commission. However, while a principles-based approach is 
frequently the appropriate standard for registrants to apply when 
preparing disclosures, determinations related to business acquisitions 
and dispositions pose unique challenges. Unlike periodic reporting, 
acquisitions and dispositions tend to be episodic, and moreover, there 
is less similarity between such transactions. As a result, it can be 
difficult for registrants to efficiently make a determination of 
materiality in an acquisition context, where timing considerations can 
be paramount.
    Furthermore, unlike disclosure that relates solely to the 
registrant, which is prepared by the registrant on an ongoing basis, 
and where materiality is therefore evaluated regularly, in an 
acquisition context registrants must rely on information provided by 
third parties to make a determination of whether the acquisition is 
significant and whether the related disclosure is material. A bright-
line test provides registrants with a level of certainty that allows 
them to efficiently make determinations about what level of disclosure 
is required in

[[Page 54053]]

an environment where delay is costly. Also, where a registrant 
misjudges materiality and fails to provide disclosure, investors would 
not receive information about the acquired business's financial impact 
on the registrant until the operating results of the acquired business 
have been reflected in the consolidated financial statements of the 
registrant for an extended period of time. As a result, the impact of 
the acquisition may be difficult for investors to disentangle from 
other events at the registrant, even where the acquisition may be 
economically significant. As a result, we expect a bright-line 
threshold in the case of these disclosures could be less costly for 
registrants and result in more consistent disclosure to investors where 
transactions are significant to a registrant.
    The Investment Test compares the registrant's and its other 
subsidiaries' investments in and advances to the acquired business 
against the carrying value of the registrant's total assets. The 
amendment to the Investment Test uses the aggregate worldwide market 
value of the registrant's voting and non-voting common equity 
calculated as the average of such aggregate worldwide market value 
calculated daily for the last five trading days of the registrant's 
most recently completed fiscal quarter ending prior to the earlier of 
the registrant's announcement date or agreement date of the acquisition 
or disposition. As an alternative to the amended Investment Test, we 
could have required registrants to use enterprise value for the 
acquirer and the acquired business, rather than the value of common 
equity (for the acquirer) and investments in and advances to the 
acquired business. Enterprise value may more comprehensively reflect 
the value of the entity because it includes equity, debt, minority 
interests, and preferred shares. When a registrant makes an 
acquisition, depending on the ownership structure and capital structure 
of the registrant and the acquired business, the purchase price or 
investment in the acquired business would not necessarily reflect the 
total effect of the acquisition on the registrant, particularly if the 
acquired business is highly levered. Enterprise value would take into 
consideration the leverage of the acquired business and may, in such 
cases, better capture the economic effects of the transaction. 
Enterprise value, however, may not be appropriate for an acquirer or 
acquiree that has substantial liquid assets on its balance sheet. 
Additionally, enterprise value may not be a consistent indicator of 
relative size across registrants because capital structure (i.e., 
leverage) may be very different among registrants in certain 
industries.
    With respect to the amendment to the Investment Test, as noted 
earlier, because investors react to news and information, the 
anticipation of an acquisition could cause a change in equity value of 
both the potential acquirer and the potential acquired firm. More 
generally, the market values of registrants are expected to change with 
market conditions as well as firm-specific information. As a result, it 
is possible that our approach to the Investment Test, which requires 
measurement of investments in an acquisition against the acquirer's 
aggregate worldwide market value, averaged over the last five trading 
days of the registrant's most recently completed fiscal quarter ending 
prior to the earlier of the registrant's announcement date or agreement 
date of the acquisition or disposition, might not reflect all 
information about the value of the acquirer. As an alternative, we 
could have required the registrant to use its average market value over 
a longer period of time rather than a five trading day window when 
measuring the size of its investments. This approach would avoid 
situations in which positive or negative market-wide or firm-specific 
shocks lead to noisy measures of market value that result in inaccurate 
assessments of significance, which may over- or under-identify 
significant acquisitions. However, using average market value over a 
longer period could increase complexity and would raise questions about 
the appropriate choice of a required measurement period (e.g., over a 
specified number of months or over the entire reporting period).
    With respect to the Income Test, one alternative would be to 
replace the existing Income Test with a revenue test. A potential 
benefit of this approach is that a revenue test would be less likely to 
produce anomalous results because it does not include infrequent 
expenses, gains, or losses that can distort the determination of 
relative significance. However, a stand-alone revenue test may not be a 
meaningful indicator of significance for the reasons the Commission 
described when it eliminated revenue as a standalone significance 
test.\477\
---------------------------------------------------------------------------

    \477\ See Separate Financial Statements Required by Regulation 
S-X, Release No. 33-6359 (Nov. 6, 1981) [46 FR 56171 (Nov. 16, 
1981)] (``The amendment reflects the Commission's view that the 
presentation of additional financial disclosures of an affiliated 
entity may not be meaningful in instances in which the affiliate has 
a high sales volume but a relatively low profit margin, and 
therefore has little financial impact on the operating results of 
the consolidated group.'').
---------------------------------------------------------------------------

    A second alternative to the amended Income Test would involve 
switching from an income component to a revenue component when the 
acquirer's net income or loss is marginal or break-even. Such an 
alternative could rely on another financial ratio, such as return on 
assets, to identify instances where the acquirer's net income is 
sufficiently low to yield anomalous results from the income component. 
For example, under such an alternative, the revenue component would be 
used instead of the income component if the absolute value of the 
acquirer's return on assets were less than one percent. Relative to the 
amended Income Test, such an alternative may have a lower risk of 
under-identification of significant transactions if the revenue 
component causes transactions to not be significant under the Income 
Test when the acquirer's net income is not marginal or break-even and 
the Investment Test and Asset Test are not met. However, such an 
approach would require identifying a financial ratio to serve as the 
trigger for a switch from the income component to the revenue component 
and, absent calibration, such a ratio may yield inconsistent results 
across industries. For example, an appropriate threshold for return on 
assets may vary across industries depending on the extent of an 
acquirer's reliance on human capital versus physical capital. Moreover, 
for those that rely heavily on tangible assets, the information 
provided by a return on assets threshold may be subsumed by the 
existing Asset Test.
    A third alternative to the amended Income Test would be to use an 
operating income or profit margin component instead of the income 
component. Operating income or profit margin could be a better 
indicator of significance than the income component in that it may 
eliminate the effects of non-operating items such as interest expense. 
However, not all registrants report these income measures, and these 
measures share the same issues as net income, which could lead to 
similarly anomalous results.
    A final alternative to the adopting Income Test would be to lower 
the threshold required to meet the revenue component, for example to 15 
percent or 10 percent. A potential benefit of this approach is that it 
may mitigate the risk of under-identification of significant 
transactions. However, it is difficult to calibrate the income 
component and revenue component thresholds in a way that decreases the 
risk of under-

[[Page 54054]]

identification without increasing the risk of over-identification.
2. Approaches to Financial Statement Requirements
    An alternative to the required Rule 3-05 or Rule 3-14 Financial 
Statements would be to require U.S. GAAP or IFRS-IASB, as applicable, 
business combination disclosures at the time an acquisition is 
consummated or probable, which include, among other things, 
supplemental pro forma information about revenue and earnings for the 
two years prior to the acquisition. Under this approach, registrants 
would be required to disclose information that enables users of a 
registrant's financial statements to evaluate the nature and financial 
effect of a business combination that occurs either: (a) During the 
current reporting period; or (b) After the reporting date but before 
the financial statements are issued or are available to be issued.\478\ 
These disclosures would eventually be required to be included in 
registrants' historical audited financial statements presented for the 
period in which the acquisition occurred, although the supplemental 
information may continue to be labeled as unaudited. However, compared 
with the final amendments, less information would be disclosed to 
investors under this alternative, and the information would not be 
audited. Further, guidance about the presentation and preparation of 
supplemental pro forma information is limited, which potentially may 
impact the consistency of pro forma presentations between registrants.
---------------------------------------------------------------------------

    \478\ See FASB ASC 805-10-50-1.
---------------------------------------------------------------------------

3. Approaches To Adopting Pro Forma Adjustments
    An alternative to the optional Management's Adjustments for pro 
forma financial information is to require the disclosure of 
Management's Adjustments for synergies and dis-synergies that have 
occurred after the acquisition date but before filing the pro forma 
financial information and for forward-looking information previously 
filed with the Commission. This alternative might provide a more 
complete depiction of the expected effects of the transaction and avoid 
circumstances where Management's Adjustments are selectively presented 
because they are optional. However, as commenters observed, this 
alternative could give rise to compliance challenges for registrants as 
synergies and dis-synergies may not be tracked at the line-item level 
required in pro forma financial information. Also, requiring 
quantification of synergies and dis-synergies that have occurred would 
impose a requirement to create books and records related to synergies 
and dis-synergies even when they were not a significant factor in the 
decision to execute the transaction. Moreover, synergies may take more 
time (e.g., more than a year) to be achieved and estimated; thus, such 
a requirement might not be practical for certain transactions in 
certain industries. We therefore decided not to adopt this alternative.
4. Alternatives to the Income Test for Investment Companies
    One alternative to the amended income test for investment companies 
would be to use the absolute value of gains and losses within the 
Income Test components rather than netting them. Because netting losses 
against gains mitigates the effect of individual securities on overall 
results of the portfolio, the use of absolute value of gains and losses 
for individual securities could result in a more accurate assessment of 
the effects of the acquired fund securities on the income of the 
acquiring fund. However, under this alternative, the registrant would 
need to re-calculate the gain or loss for each individual security 
using absolute value for both the acquiring fund and the acquired fund, 
rather than using existing financial measures that have already been 
determined for the financial statements, thereby increasing the cost 
and complexity of the amended test for registrants without necessarily 
providing significant incremental benefits to investors.
    Another alternative to the amended income test for investment 
companies would be to select a percentage lower than 80 percent for the 
significance test. One potential benefit of using a lower percentage is 
that it could reduce the possibility that an investment company 
registrant would not need to provide disclosure for a fund acquisition 
with a material impact on the acquiring fund's income. However, it 
could also increase the possibility that costly disclosure obligations 
would be triggered, even though the impact on the registrant's assets 
is not material (particularly if the income of the acquiring fund is 
relatively low). The combination of the amended Income Test and 
Investment Test in the final amendments is intended to mitigate this 
result.

V. Paperwork Reduction Act

A. Summary of the Collection of Information

    Certain provisions of our rules and forms that would be affected by 
the amendments contain ``collection of information'' requirements 
within the meaning of the PRA.\479\ The Commission published a notice 
requesting comment on the collection of information requirements in the 
Proposing Release, and submitted the proposed amendments to the Office 
of Management and Budget (``OMB'') for review in accordance with the 
PRA.\480\ While several commenters provided comments on the potential 
costs of the proposed amendments, no commenters specifically addressed 
our PRA analysis.\481\
---------------------------------------------------------------------------

    \479\ See 44 U.S.C. 3501 et seq.
    \480\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
    \481\ See Section II above.
---------------------------------------------------------------------------

    The hours and costs associated with preparing and filing the forms 
and reports constitute reporting and cost burdens imposed by each 
collection of information. An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
requirement unless it displays a currently valid OMB control number. 
Compliance with the information collections is mandatory. Responses to 
the information collections are not kept confidential and there is no 
mandatory retention period for the information disclosed. The titles 
for the affected collections of information are: \482\
---------------------------------------------------------------------------

    \482\ A number of forms could require Rule 3-05, Rule 3-14, and 
other disclosure impacted by the amendments such that the amendments 
could affect the PRA burden associated with those forms. Based on 
staff experience, however, Rule 3-05 or Rule 3-14 Financial 
Statements are not generally included in these forms. The 
potentially affected Forms include ``Form S-4'' (OMB Control No. 
3235-0324), ``Form S-11'' (OMB Control No. 3235-0067), ``Form F-4'' 
(OMB Control No. 3235-0325), ``Form 20-F'' (OMB Control No. 3235-
0288), ``Form 10-K'' (OMB Control No. 3235-0063), ``Regulation 14A'' 
and ``Schedule 14A'' (OMB Control No. 3235-0059), ``Regulation 14C'' 
and ``Schedule 14C'' (OMB Control No. 3235-0057), ``Form 10-Q'' (OMB 
Control No. 3235-0070), ``Form 1-K'' (OMB Control No. 3235-0720), 
and ``Form 1-SA'' (OMB Control No. 3235-0721). For example, staff 
experience has shown that for filings on Form S-4, registrants most 
often incorporate Rule 3-05 or Rule 3-14 Financial Statements by 
reference to a previously filed Form 8-K. While the amendments would 
also apply to registered investment companies, based on staff 
experience, Rule 3-05 or Rule 3-14 Financial Statements are not 
generally included in ``Form N-3'' (OMB Control No. 3235-0316), 
``Form N-4'' (OMB Control No. 3235-0318), ``Form N-5'' (OMB Control 
No. 3235-0169), and ``Form N-6'' (OMB Control No. 3235-0503). 
Because we do not expect these forms to be generally affected by the 
amendments, we are not adjusting the burden estimates associated 
with these collections of information.

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[[Page 54055]]

     ``Form S-1'' (OMB Control No. 3235-0065);
     ``Form S-3'' (OMB Control No. 3235-0073);
     ``Form F-1'' (OMB Control No. 3235-0258);
     ``Form F-3'' (OMB Control No. 3235-0256);
     ``Form 10'' (OMB Control No. 3235-0064);
     ``Form 8-K'' (OMB Control No. 3235-0060);
     ``Form N-1A'' (OMB Control No. 3235-0307);
     ``Form N-2'' (OMB Control No. 3235-0026);
     ``Form N-14'' (OMB Control No. 3235-0336); and
     ``Form 1-A'' (OMB Control No. 3235-0286).
    The regulations, schedules, and forms listed above were adopted 
under the Securities Act, the Exchange Act, and/or the Investment 
Company Act and set forth the disclosure requirements for registration 
statements, periodic and current reports, and distribution reports 
filed by registrants to help investors make informed investment and 
voting decisions. A description of the amendments, including the need 
for the information and its use as well as a description of the likely 
respondents, can be found in Section II above, and a discussion of the 
economic effects of the amendments can be found in Section IV above.

B. Effect of the Amendments on Existing Collections of Information

1. Estimated Effects on Burdens for Registrants Other Than Investment 
Companies
    The following table summarizes the estimated effects of the 
amendments on the paperwork burdens associated with the affected forms 
filed by registrants with operations or that otherwise are not 
investment companies.

 Table 1--Estimated Paperwork Burden Effects for Registrants (Excluding
                          Investment Companies)
------------------------------------------------------------------------
                                 Estimated effect
           Amendment               and affected     Brief explanation of
                                      forms           estimated effect
------------------------------------------------------------------------
Rule 1-02(w), Rule 3-05, Rule   A reduction of      This
 3-14, and related rules.        125 burden hours   reduction is the
                                 for each of the    estimated effect on
                                 following forms:   the affected forms
                                 10, 1-A, S-1, S-   by the amendments to
                                 3, F-1, F-3, and   Rules 3-05, 3-14,
                                 8-K.               and the related
                                                    rules (e.g., Rule 1-
                                                    02(w)), when
                                                    considered in the
                                                    aggregate and
                                                    compared to the
                                                    paperwork burden
                                                    under existing
                                                    requirements.
                                                    For PRA
                                                    purposes, we
                                                    estimate that
                                                    existing Rule 3-05
                                                    or Rule 3-14
                                                    Financial Statements
                                                    require an average
                                                    of 500 burden hours
                                                    as discussed in note
                                                    298 of the Proposing
                                                    Release.
Article 11 (Rules 11-01, 11-02  An increase of 25   This
 and 11-03) and Rule 8-05 of     burden hours for   increase is the
 Regulation S-X.                 each of the        estimated effect on
                                 following forms:   the affected forms
                                 10, 1-A, S-1, S-   by the amendments to
                                 3, F-1, F-3, and   the pro forma
                                 8-K.               financial
                                                    information
                                                    requirements under
                                                    Article 11 and Rule
                                                    8-05 of Regulation S-
                                                    X, including the
                                                    changes that permit
                                                    registrants to
                                                    provide certain
                                                    forward-looking
                                                    information, when
                                                    considered in the
                                                    aggregate and
                                                    compared to the
                                                    paperwork burden
                                                    under existing
                                                    requirements.
                                                    For PRA
                                                    purposes, we
                                                    estimate that
                                                    existing pro forma
                                                    financial
                                                    information requires
                                                    an average of 100
                                                    burden hours as
                                                    discussed in note
                                                    299 of the Proposing
                                                    Release.
------------------------------------------------------------------------

a. Proposed Amendments to Rules 1-02(w), 3-05, and 3-14
    Considering the various revisions outlined in Sections II.B. and C. 
above, we estimate that the amendments to Rule 1-02(w), Rule 3-05, and 
Rule 3-14 would generally reduce the paperwork burden for filings on an 
affected form that includes existing Rule 3-05 or Rule 3-14 Financial 
Statements.\483\ However, not all filings on the affected forms include 
these disclosures because they are provided only in certain instances. 
Therefore, to estimate the overall paperwork burden reduction from the 
amendments, we estimated the number of filings that include Rule 3-05 
and Rule 3-14 Financial Statements, used this data to extrapolate the 
effect of these changes on the paperwork burden, and applied these 
percentages to the current estimates for the number of responses in the 
Commission's current OMB PRA filing inventory.\484\
---------------------------------------------------------------------------

    \483\ The Rule 1-02(w) definition of ``significant subsidiary'' 
is used in a number of rules and forms, including From 20-F, Form S-
3, Form F-3, Schedule 14A, Form 8-K, Form 1-U, Form 10-Q, and Form 
10-K. See supra note 23. We do not expect the changes to the 
definition to materially affect the burden estimate for these rules 
and forms beyond the effects for the changes related to Rule 3-05 
and Rule 3-14 discussed in this PRA.
    \484\ To develop these estimates, Commission staff searched and 
analyzed filings for the calendar year 2017 and the first nine 
months of 2018. See discussion in Section V.B.1.a. of the Proposing 
Release.
---------------------------------------------------------------------------

b. Proposed Amendments to Pro Forma Financial Information Requirements
    Considering the various revisions outlined in Section II.D. above, 
we estimate that the amendments to Article 11 and Rule 8-05 will reduce 
a registrant's paperwork burden by simplifying disclosure requirements 
generally, but may increase burdens to the extent that the registrants 
are required to depict pro forma financial information for the 
aggregate impact in all material respects of the acquired businesses, 
rather than only a mathematical majority of the individually 
insignificant businesses acquired, and in the case of smaller reporting 
companies, requiring pro forma financial information in some additional 
circumstances \485\ and requiring that the information be provided in a 
clearer and more robust manner. We are adopting amendments that permit, 
rather than require, registrants to include certain forward-looking 
information in the Management's Adjustments to the pro forma financial 
information. We have not revised our burden estimates from the 
Proposing Release as a result of this changes in order to more 
conservatively estimate the burden on issuers of providing this 
disclosure because these changes may additionally increase burdens to 
the extent registrants provide the disclosure. To estimate the overall 
paperwork burden reduction from the proposed amendments, we first 
estimated the number of filings that

[[Page 54056]]

include Article 11 and Rule 8-05 pro forma financial information. 
Because pro forma financial information is most typically associated 
with acquisition and dispositions, we relied on the estimates of 
affected forms that we determined for the Rule 3-05 and Rule 3-14 
burden estimates.
---------------------------------------------------------------------------

    \485\ The additional circumstances that would require a smaller 
reporting company to present pro forma financial information under 
the amendments would include: Roll-up transactions as defined in 17 
CFR 229.901(c); when such presentation is necessary to reflect the 
operations and financial position of the smaller reporting company 
as an autonomous entity; and other events transactions for which 
disclosure of pro forma financial information would be material to 
investors.
---------------------------------------------------------------------------

2. Estimated Effects of the Proposed Amendments on Paperwork Burdens 
for Investment Company Registrants
    The following table summarizes the estimated effects of the 
amendments on the paperwork burdens associated with the affected forms 
filed by investment companies.
---------------------------------------------------------------------------

    \486\ This estimated reduction of 125 burden hours is due to the 
changes affecting the required reporting periods and pro forma 
financial information and permitting the use of U.S. GAAP-compliant 
financial statements for acquired private funds. See, e.g., Section 
II.E.2.
    \487\ To determine the paperwork burden for a registrant to make 
disclosures in accordance with Rule 6-11 and amendments to Form N-
14, we estimated the number of burden hours required for an issuer 
to provide the existing financial statements. As previously noted, 
for PRA purposes, we estimate that existing Rule 3-05 Financial 
Statements require an average of 500 burden hours. See Proposing 
Release at note 298.
    \488\ See supra Section II.E.2 and II.E.3.

  Table 2--Estimated Paperwork Burden Effects for Investment Companies
------------------------------------------------------------------------
                                 Estimated effect
           Amendment               and affected     Brief explanation of
                                      forms           estimated effect
------------------------------------------------------------------------
Rule 6-11, Rule 1-02(w),        A reduction of      This
 Article 11 of Regulation S-X,   100 burden hours   reduction is derived
 and Form N-14.                  for each filing    from an estimated
                                 that contains      reduction of 125
                                 acquired fund      burden hours
                                 financial          resulting from the
                                 information on     amendments discussed
                                 the following      in Section II.E.
                                 forms: N-1A, N-2   above \486\ compared
                                 and N-14.          to existing Rule 3-
                                                    05 and pro forma
                                                    financial
                                                    information
                                                    requirements.\487\
                                                    This
                                                    reduction was then
                                                    offset by an
                                                    estimated increase
                                                    of 25 burden hours
                                                    for the schedules
                                                    and supplemental
                                                    information under
                                                    Rule 6-11.\488\
------------------------------------------------------------------------

    Considering the various revisions outlined in Section II.E above, 
we estimate that Rule 6-11 and the related amendments generally will 
reduce the paperwork burden for filings on an affected form that 
currently includes Rule 3-05 Financial Statements. However, not all 
filings on the affected forms include these disclosures. Therefore, to 
estimate the overall paperwork burden reduction from the amendments, we 
estimated the number of filings that include acquired fund financial 
statements, used this data to extrapolate the effect of these changes 
on the paperwork burden, and applied these percentages to the current 
estimates for the number of responses in the Commission's current OMB 
PRA filing inventory.\489\
---------------------------------------------------------------------------

    \489\ See discussion in Section V.B.2. of the Proposing Release.
---------------------------------------------------------------------------

C. Aggregate Burden and Cost Estimates for the Amendments

    Below we estimate the aggregate change in paperwork burden as a 
result of the amendments. These estimates represent the average burden 
for all registrants, both large and small. In deriving our estimates, 
we recognize that the burdens will likely vary among individual 
registrants based on a number of factors, including the nature of their 
business. The burden estimates were calculated by multiplying the 
estimated number of responses by the estimated average amount of time 
it would take a registrant to prepare and review disclosure required 
under the amendments. The portion of the burden carried by outside 
professionals is reflected as a cost,\490\ while the portion of the 
burden carried by the registrant internally is reflected in hours.\491\
---------------------------------------------------------------------------

    \490\ We recognize that the costs of retaining outside 
professionals may vary depending on the nature of the professional 
services, but for purposes of this PRA analysis, we estimate that 
such costs would be an average of $400 per hour. This estimate is 
based on consultations with several registrants, law firms, and 
other persons who regularly assist registrants in preparing and 
filing reports with the Commission.
    \491\ For purposes of the PRA, we estimate that 75 percent of 
the burden of preparation of Forms 8-K and 1-A is carried by the 
registrant internally and that 25 percent of the burden of 
preparation is carried by outside professionals retained by the 
company at an average cost of $400 per hour. Additionally, we 
estimate that 25 percent of the burden of preparation for Forms 10, 
S-1, S-3, F-1, F-3, N-1A, N-2, and N-14 is carried by the registrant 
internally and that 75 percent of the burden of preparation is 
carried by outside professionals retained by the company at an 
average cost of $400 per hour.
---------------------------------------------------------------------------

    The tables below illustrate the change to the total annual 
compliance burden of affected forms, in hours and in costs, as a result 
of the amendments.

 Table 3--Calculation of the Reduction in Burden Estimates of Current Responses Due to the Amendments to Rule 3-05 and Rule 3-14 and Pro Forma Financial
                                                                Information Requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                           Reduction in    Reduction in
                                                             Number of      Burden hour    Reduction in    Reduction in    professional    professional
                                                             estimated     reduction per   burden hours    company hours     hours for       costs for
                          Form                               affected         current       for current     for current       current         current
                                                             reponses        affected        affected        affected        affected        affected
                                                                             response        responses       responses       responses       responses
                                                                     (A)             (B)     (C) = (A) x     (D) = (C) x     (E) = (C) x     (F) = (E) x
                                                                                                     (B)    0.75 or 0.25    0.25 or 0.75            $400
--------------------------------------------------------------------------------------------------------------------------------------------------------
10......................................................              20           (100)         (2,000)           (500)         (1,500)      ($600,000)
1-A.....................................................              18           (100)         (1,800)         (1,350)           (450)       (180,000)
S-1.....................................................              78           (100)         (7,800)         (1,950)         (5,850)     (2,340,000)
S-3.....................................................             192           (100)        (19,200)         (4,800)        (14,400)     (5,760,000)
F-1.....................................................               2           (100)           (200)            (50)           (150)        (60,000)
F-3.....................................................               3           (100)           (300)            (75)           (225)        (90,000)

[[Page 54057]]

 
8-K.....................................................             947           (100)       ( 94,700)        (71,025)        (23,675)     (9,470,000)
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................           1,260  ..............       (126,000)        (79,750)        (46,250)    (18,500,000)
--------------------------------------------------------------------------------------------------------------------------------------------------------


                Table 4--Calculation of the Change in Burden Estimates of Current Responses Due to Rule 6-11 and Amendments to Form N-14
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                             Change in       Change in
                                                             Number of      Burden hour      Change in       Change in     professional    professional
                                                             estimated      change per     burden hours    company hours     hours for       costs for
                          Form                               affected         current       for current     for current       current         current
                                                             reponses        affected        affected        affected        affected        affected
                                                                             response        responses       responses       responses       responses
                                                                     (A)             (B)     (C) = (A) x     (D) = (C) x     (E) = (C) x     (F) = (E) x
                                                                                                     (B)    0.75 or 0.25    0.25 or 0.75            $400
--------------------------------------------------------------------------------------------------------------------------------------------------------
N-1A....................................................               8           (100)           (800)           (200)           (600)      ($240,000)
N-2.....................................................               3           (100)           (300)            (75)           (225)        (90,000)
N-14....................................................              88           (100)         (8,800)         (2,200)         (6,600)     (2,640,000)
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................              99  ..............         (9,900)         (2,475)         (7,425)     (2,970,000)
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                                    Table 5--Requested Paperwork Burden Under the Amendments
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Current burden                             Program change                      Requested change in burden
                                                                --------------------------------------------------------------------------------------------------------------------------------
                              Form                                   Current       Current        Current      Number of    Reduction    Reduction in
                                                                     annual         burden     professional     affected   in  company   professional      Annual       Burden     Professional
                                                                    responses       hours       cost burden    responses       hours         costs       responses      hours       cost burden
                                                                            (A)          (B)             (C)          (D)          (E)             (F)    (G) = (A)        (H) =           (I) =
                                                                                                                                                                       (B) + (E)       (C) + (F)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
10.............................................................             216       11,855     $14,091,488           20        (500)      ($600,000)          216       11,355     $13,491,488
1-A............................................................             179       98,396      13,111,912           18      (1,350)       (180,000)          179       97,046      12,931,912
S-1............................................................             901      147,208     180,319,975           78      (1,950)     (2,340,000)          901      145,259     177,979,975
S-3............................................................           1,657    1,963,626     236,198,036          192      (4,800)     (5,760,000)        1,657      188,825     230,438,036
F-1............................................................              63       26,692      32,275,375            2         (50)        (60,000)           63       26,642      32,215,375
F-3............................................................             112        4,441       5,703,600            3         (75)        (90,000)          112        4,366       5,613,600
8-K............................................................         118,387      818,158     108,674,430          947     (71,025)     (9,470,000)      118,387      747,133      99,204,430
N-1A...........................................................           6,002    1,642,490     131,139,208            8        (200)       (240,000)        6,002    1,642,290     130,899,208
N-2............................................................             166       74,145       4,718,196            3         (75)        (90,000)          166       74,070       4,628,196
N-14...........................................................             253      125,820       5,842,000           88      (2,200)     (2,640,000)          192      123,620       3,202,000
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

VI. Final Regulatory Flexibility Act Analysis

    The Regulatory Flexibility Act (``RFA'') \492\ requires the 
Commission, in promulgating rules under Section 553 of the 
Administrative Procedure Act,\493\ to consider the impact of those 
rules on small entities. We have prepared this Final Regulatory 
Flexibility Act Analysis in accordance with Section 604 of the 
RFA.\494\ It relates to the amendments to the definition of 
``significant subsidiary'' and the financial disclosure requirements in 
Regulation S-X relating to significant business acquisitions and 
dispositions to improve those requirements for both investors and 
registrants. An Initial Regulatory Flexibility Analysis (``IRFA'') was 
prepared in accordance with the RFA and was included in the Proposing 
Release.
---------------------------------------------------------------------------

    \492\ 5 U.S.C. 601 et seq.
    \493\ 5 U.S.C. 553.
    \494\ 5 U.S.C. 604.
---------------------------------------------------------------------------

A. Reasons for, and Objectives of, the Final Amendments

    The amendments include changes to the definition of ``significant 
subsidiary'' \495\ and the requirements for the financial statements of 
acquisitions and dispositions of businesses, including real estate 
operations, in Rule 3-05 and Rule 3-14 and other related rules and 
forms.\496\ We are also adopting new Rule 6-11 and amendments to Form 
N-14 to specifically govern

[[Page 54058]]

financial reporting for acquisitions involving investment companies. 
The purpose of the amendments is to improve the application of the 
rules, assist registrants in making more meaningful determinations of 
whether a subsidiary or an acquired or disposed business is 
significant, and to improve the disclosure requirements for financial 
statements relating to acquisitions and dispositions of businesses, 
including real estate operations and investment companies. The reasons 
for, and objectives of, the amendments are discussed in more detail in 
Sections II.A through II.E. above.
---------------------------------------------------------------------------

    \495\ We are amending the definition of ``significant 
subsidiary'' in Rule 1-02(w) of Regulation S-X, Exchange Act Rule 
12b-2, Securities Act Rule 405, and Investment Company Act Rule 8b-
2.
    \496\ We are also amending Rule 3-06 and Rule 3-09, Article 8, 
and Article 11 of Regulation S-X. In addition, we are making related 
amendments to Form S-11, Form 1-A, Form 8-K, Form 10-K, and Form N-
2.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comments

    In the Proposing Release, we requested comment on all aspects of 
the IRFA, including the number of small entities that would be affected 
by the proposed amendments, the existence or natures of the potential 
impact of the proposals on small entities discussed in the analysis, 
and how to quantify the impact of the proposed amendments. We did not 
receive any comments specifically addressing the IRFA. However, we 
received a number of comments on the proposed amendments 
generally,\497\ and have considered these comments in developing the 
FRFA.
---------------------------------------------------------------------------

    \497\ See Section II above.
---------------------------------------------------------------------------

C. Small Entities Subject to the Proposed Rules

    The final amendments will affect some registrants that are small 
entities. The RFA defines ``small entity'' to mean ``small business,'' 
``small organization,'' or ``small governmental jurisdiction.'' \498\ 
For purposes of the RFA, under our rules, an issuer, other than an 
investment company, is a ``small business'' or ``small organization'' 
if it had total assets of $5 million or less on the last day of its 
most recent fiscal year and is engaged or proposing to engage in an 
offering of securities that does not exceed $5 million.\499\ We 
estimate that there are 1,056 issuers that file with the Commission, 
other than investment companies, that may be considered small entities 
and are potentially subject to the final amendments.\500\ An investment 
company is a small entity if, together with other investment companies 
in the same group of related investment companies, it has net assets of 
$50 million or less as of the end of its most recent fiscal year.\501\ 
Commission staff estimates that, as of December 31, 2019, there were 
approximately 76 open-end and closed-end investment companies that 
would be considered small entities. Commission staff further estimates 
that, as of December 31, 2019, approximately 14 business development 
companies were small entities.\502\
---------------------------------------------------------------------------

    \498\ 5 U.S.C. 601(6).
    \499\ See 17 CFR 230.157 under the Securities Act and 17 CFR 
240.0-10(a) under the Exchange Act.
    \500\ This estimate is based on staff analysis of issuers, 
excluding coregistrants, with EDGAR filings of Form 10-K, 20-F and 
40-F, or amendments thereto, filed during the calendar year of 
January 1, 2018 to December 31st, 2018. Analysis is based on data 
from XBRL filings, Compustat, and Ives Group Audit Analytics.
    \501\ 17 CFR 270.0-10(a).
    \502\ These estimates are based on staff analysis of Morningstar 
data and data submitted by investment company registrants in forms 
filed on EDGAR as of December 31, 2019.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    As noted above, the purpose of the final amendments is to improve 
the application of the rules and reduce the complexity and costs of 
preparing the related disclosure.\503\ We are also amending specific 
regulatory requirements for investment companies to address the unique 
attributes of this group of registrants.\504\
---------------------------------------------------------------------------

    \503\ See supra Sections II.A. through II.D. for a detailed 
discussion of the final amendments applicable to registrants with 
operations or that otherwise are not investment companies.
    \504\ See supra Section II.E.
---------------------------------------------------------------------------

    Many of the changes simplify and streamline existing disclosure 
requirements in ways that are expected to reduce compliance burdens for 
all registrants, including small entities. Some, such as the rules 
permitting registrants to include Management's Adjustments in their pro 
forma financial information, could incrementally increase compliance 
costs to the extent that an entity chooses to provide this disclosure. 
In addition, compliance with the final amendments requires the use of 
professional skills, including accounting and legal skills. We discuss 
the economic impact, including the estimated costs and burdens, of the 
final amendments to all registrants, including small entities, in 
Sections IV and V above.

E. Agency Action To Minimize Effect on Small Entities

    The RFA directs us to consider alternatives that would accomplish 
our stated objectives, while minimizing any significant adverse impact 
on small entities. Accordingly, we considered the following 
alternatives:
     Establishing different compliance or reporting 
requirements that take into account the resources available to small 
entities;
     Clarifying, consolidating, or simplifying compliance and 
reporting requirements under the rules for small entities;
     Using performance rather than design standards; and
     Exempting small entities from all or part of the 
requirements.
    The final amendments generally simplify and streamline disclosure 
requirements in ways that are expected to reduce compliance burdens for 
all registrants, including small entities. Revising Rule 8-05 to 
require that the preparation, presentation, and disclosure of pro forma 
financial information by smaller reporting companies substantially 
comply with Article 11 may increase the burden of preparing that 
disclosure for some registrants. However, based on staff analysis of 
disclosures of acquisitions and dispositions by smaller reporting 
companies, we believe that most of these companies already comply with 
the conditions in existing Rule 11-01.\505\ For investment companies, 
we believe that Rule 6-11 and related amendments will make it easier 
and less costly to provide appropriate disclosures to investors 
regarding fund acquisitions, which may benefit small entities that have 
smaller asset levels over which to apportion compliance costs. 
Accordingly, we do not believe it is necessary to exempt small entities 
from all or part of the final amendments or to establish different 
compliance or reporting requirements for such entities.
---------------------------------------------------------------------------

    \505\ Commission staff found that out of 191 disclosures of 
acquisitions and dispositions by smaller reporting companies in 
2017, 178 appeared to comply with Article 11 requirements. 
Commission staff also found that out of 12 Forms 1-A originally 
filed in 2019 that disclosed acquisitions subject to Rule 8-04 or 
Rule 8-06, 9 appeared to comply with Article 11 requirements.
---------------------------------------------------------------------------

    Finally, with respect to using performance rather than design 
standards, Regulation S-X and the final amendments generally contain 
elements similar to performance standards. For example, rather than 
imposing a specific uniform metric for determining significant business 
acquisitions and dispositions, the final amendments utilize a flexible 
standard, with alternative tests (e.g., the investment, income, or 
asset test) that are intended to facilitate a registrant's 
determination of whether an acquisition or disposition is significant. 
We believe this flexible standard is appropriate because it allows 
registrants to omit financial information that is not necessary for an 
investment decision based on the facts and circumstances applicable to 
that registrant and offering.

[[Page 54059]]

VII. Statutory Authority

    The amendments contained in this release are being adopted under 
the authority set forth in Sections 3, 6, 7, 8, 10, 19(a), and 28 of 
the Securities Act, Sections 3(b), 12, 13, 15(d), 23(a), and 36 of the 
Exchange Act, and Sections 6(c), 8, 24(a), 30, and 38 of the Investment 
Company Act.

List of Subjects

17 CFR Part 210

    Accountants, Accounting, Banks, Banking, Employee benefit plans, 
Holding companies, Insurance companies, Investment companies, Oil and 
gas exploration, Reporting and recordkeeping requirements, Securities, 
Utilities.

17 CFR Part 230

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Part 240

    Brokers, Fraud, Reporting and recordkeeping requirements, 
Securities.

17 CFR Part 249

    Brokers, Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of the Amendments

    For the reasons set out in the preamble, the Commission amends 
title 17, chapter II of the Code of Federal Regulations as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL 
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 
1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 
1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

0
1. The authority citation for part 210 continues to read as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77aa(25), 77aa(26), 77nn(25), 77nn(26), 78c, 78j-1, 78l, 78m, 78n, 
78o(d), 78q, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30, 
80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, and sec. 102(c), 
Pub. L. 112-106, 126 Stat. 310 (2012), unless otherwise noted.

0
2. Amend Sec.  210.1-02 by revising paragraph (w) to read as follows:


Sec.  210.1-02  Definitions of terms used in Regulation S-X (17 CFR 
part 210).

* * * * *
    (w) Significant subsidiary. (1) The term significant subsidiary 
means a subsidiary, including its subsidiaries, which meets any of the 
conditions in paragraph (w)(1)(i), (ii), or (iii) of this section; 
however if the registrant is a registered investment company or a 
business development company, the tested subsidiary meets any of the 
conditions in paragraph (w)(2) of this section instead of any of the 
conditions in this paragraph (w)(1). A registrant that files its 
financial statements in accordance with or provides a reconciliation to 
U.S. Generally Accepted Accounting Principles (U.S. GAAP) must use 
amounts determined under U.S. GAAP. A foreign private issuer that files 
its financial statements in accordance with International Financial 
Reporting Standards as issued by the International Accounting Standards 
Board (IFRS-IASB) must use amounts determined under IFRS-IASB.
    (i) Investment test. (A) For acquisitions, other than those 
described in paragraph (w)(1)(i)(B) of this section, and dispositions 
this test is met when the registrant's and its other subsidiaries' 
investments in and advances to the tested subsidiary exceed 10 percent 
of the aggregate worldwide market value of the registrant's voting and 
non-voting common equity, or if the registrant has no such aggregate 
worldwide market value the total assets of the registrant and its 
subsidiaries consolidated as of the end of the most recently completed 
fiscal year.
    (1) For acquisitions, the ``investments in'' the tested subsidiary 
is the consideration transferred, adjusted to exclude the registrant's 
and its other subsidiaries' proportionate interest in the carrying 
value of assets transferred by the registrant and its subsidiaries 
consolidated to the tested subsidiary that will remain with the 
combined entity after the acquisition. It must include the fair value 
of contingent consideration if required to be recognized at fair value 
by the registrant at the acquisition date under U.S. GAAP or IFRS-IASB, 
as applicable; however if recognition at fair value is not required, it 
must include all contingent consideration, except contingent 
consideration for which the likelihood of payment is remote.
    (2) For dispositions, the ``investments in'' the tested subsidiary 
is the fair value of the consideration, including contingent 
consideration, for the disposed subsidiary when comparing to the 
aggregate worldwide market value of the registrant's voting and non-
voting common equity, or, when the registrant has no such aggregate 
worldwide market value, the carrying value of the disposed subsidiary 
when comparing to total assets of the registrant.
    (3) When determining the aggregate worldwide market value of the 
registrant's voting and non-voting common equity, use the average of 
such aggregate worldwide market value calculated daily for the last 
five trading days of the registrant's most recently completed month 
ending prior to the earlier of the registrant's announcement date or 
agreement date of the acquisition or disposition.
    (B) For a combination between entities or businesses under common 
control, this test is met when either the net book value of the tested 
subsidiary exceeds 10 percent of the registrant's and its subsidiaries' 
consolidated total assets or the number of common shares exchanged or 
to be exchanged by the registrant exceeds 10 percent of its total 
common shares outstanding at the date the combination is initiated.
    (C) In all other cases, this test is met when the registrant's and 
its other subsidiaries' investments in and advances to the tested 
subsidiary exceed 10 percent of the total assets of the registrant and 
its subsidiaries consolidated as of the end of the most recently 
completed fiscal year.
    (ii) Asset test. This test is met when the registrant's and its 
other subsidiaries' proportionate share of the tested subsidiary's 
consolidated total assets (after intercompany eliminations) exceeds 10 
percent of such total assets of the registrant and its subsidiaries 
consolidated as of the end of the most recently completed fiscal year.
    (iii) Income test. (A) This test is met when:
    (1) The absolute value of the registrant's and its other 
subsidiaries' equity in the tested subsidiary's consolidated income or 
loss from continuing operations before income taxes (after intercompany 
eliminations) attributable to the controlling interests exceeds 10 
percent of the absolute value of such income or loss of the registrant 
and its subsidiaries consolidated for the most recently completed 
fiscal year; and
    (2) The registrant's and its other subsidiaries' proportionate 
share of the tested subsidiary's consolidated total revenue from 
continuing operations (after intercompany eliminations) exceeds 10 
percent of such total revenue of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year. This 
paragraph (w)(1)(iii)(A)(2) does not apply if either the registrant and 
its subsidiaries consolidated or the tested subsidiary

[[Page 54060]]

did not have material revenue in each of the two most recently 
completed fiscal years.
    (B) When determining the income component in paragraph 
(w)(1)(iii)(A)(1) of this section:
    (1) If a net loss from continuing operations before income taxes 
(after intercompany eliminations) attributable to the controlling 
interest has been incurred by either the registrant and its 
subsidiaries consolidated or the tested subsidiary, but not both, 
exclude the equity in the income or loss from continuing operations 
before income taxes (after intercompany eliminations) of the tested 
subsidiary attributable to the controlling interest from such income or 
loss of the registrant and its subsidiaries consolidated for purposes 
of the computation;
    (2) Compute the test using the average described in this paragraph 
(w)(1)(iii)(B)(2) if the revenue component in paragraph 
(w)(1)(iii)(A)(2) of this section does not apply and the absolute value 
of the registrant's and its subsidiaries' consolidated income or loss 
from continuing operations before income taxes (after intercompany 
eliminations) attributable to the controlling interests for the most 
recent fiscal year is at least 10 percent lower than the average of the 
absolute value of such amounts for each of its last five fiscal years; 
and
    (3) Entities reporting losses must not be aggregated with entities 
reporting income where the test involves combined entities, as in the 
case of determining whether summarized financial data must be presented 
or whether the aggregate impact specified in Sec. Sec.  210.3-
05(b)(2)(iv) and 210.3-14(b)(2)(i)(C) is met, except when determining 
whether related businesses meet this test for purposes of Sec. Sec.  
210.3-05 and 210.8-04.
    (2) For a registrant that is a registered investment company or a 
business development company, the term significant subsidiary means a 
subsidiary, including its subsidiaries, which meets any of the 
following conditions using amounts determined under U.S. GAAP and, if 
applicable, section 2(a)(41) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(41)):
    (i) Investment test. The value of the registrant's and its other 
subsidiaries' investments in and advances to the tested subsidiary 
exceed 10 percent of the value of the total investments of the 
registrant and its subsidiaries consolidated as of the end of the most 
recently completed fiscal year; or
    (ii) Income test. The absolute value of the sum of combined 
investment income from dividends, interest, and other income, the net 
realized gains and losses on investments, and the net change in 
unrealized gains and losses on investments from the tested subsidiary 
(except, for purposes of Sec.  210.6-11, the absolute value of the 
change in net assets resulting from operations of the tested 
subsidiary), for the most recently completed fiscal year exceeds:
    (A) 80 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year; or
    (B) 10 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year and the 
investment test (paragraph (w)(2)(i) of this section) condition exceeds 
5 percent. However, if the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated is at least 10 percent lower than the average of the 
absolute value of such amounts for each of its last five fiscal years, 
then the registrant may compute both conditions of the income test 
using the average of the absolute value of such amounts for the 
registrant and its subsidiaries consolidated for each of its last five 
fiscal years.
* * * * *

0
3. Revise Sec.  210.3-05 to read as follows:


Sec.  210.3-05  Financial statements of businesses acquired or to be 
acquired.

    (a) Financial statements required. (1) Financial statements (except 
the related schedules specified in Sec.  210.12) prepared and audited 
in accordance with Regulation S-X (including the independence standards 
in Sec.  210.2-01 or, alternatively if the business is not a 
registrant, the applicable independence standards) must be filed for 
the periods specified in paragraph (b) of this section if any of the 
following conditions exist:
    (i) During the most recent fiscal year or subsequent interim period 
for which a balance sheet is required by Sec.  210.3-01, a business 
acquisition has occurred; or
    (ii) After the date of the most recent balance sheet filed pursuant 
to Sec.  210.3-01, consummation of a business acquisition has occurred 
or is probable.
    (2) For purposes of determining whether the provisions of this 
section apply:
    (i) The determination of whether a business has been acquired 
should be made in accordance with the guidance set forth in Sec.  
210.11-01(d); and
    (ii) The acquisition of a business encompasses the acquisition of 
an interest in a business accounted for by the registrant under the 
equity method or, in lieu of the equity method, the fair value option.
    (3) Acquisitions of a group of related businesses that are probable 
or that have occurred subsequent to the latest fiscal year-end for 
which audited financial statements of the registrant have been filed 
must be treated under this section as if they are a single business 
acquisition. The required financial statements of related businesses 
may be presented on a combined basis for any periods they are under 
common control or management. For purposes of this section, businesses 
will be deemed to be related if:
    (i) They are under common control or management;
    (ii) The acquisition of one business is conditional on the 
acquisition of each other business; or
    (iii) Each acquisition is conditioned on a single common event.
    (4) This section does not apply to a real estate operation subject 
to Sec.  210.3-14 or a business which is totally held by the registrant 
prior to consummation of the transaction.
    (b) Periods to be presented. (1) If registering an offering of 
securities to the security holders of the business to be acquired, then 
the financial statements specified in Sec. Sec.  210.3-01 and 210.3-02 
must be filed for the business to be acquired, except as provided 
otherwise for filings on Form N-14, S-4, or F-4 (Sec.  239.23, Sec.  
239.25, or Sec.  239.34 of this chapter). The financial statements 
covering fiscal years must be audited except as provided in Item 14 of 
Schedule 14A (Sec.  240.14a-101 of this chapter) with respect to 
certain proxy statements or in registration statements filed on Forms 
N-14, S-4, or F-4 (Sec.  239.23, Sec.  239.25, or Sec.  239.34 of this 
chapter).
    (2) In all cases not specified in paragraph (b)(1) of this section, 
financial statements of the business acquired or to be acquired must be 
filed for the periods specified in this paragraph (b)(2) or such 
shorter period as the business has been in existence. Determine the 
periods for which such financial statements are to be filed using the 
conditions specified in the definition of significant subsidiary in 
Sec.  210.1-02(w), using the lower of the total revenue component or 
income or loss from continuing operations component for evaluating the 
income test condition, as follows:
    (i) If none of the conditions exceeds 20 percent, financial 
statements are not required.

[[Page 54061]]

    (ii) If any of the conditions exceeds 20 percent, but none exceed 
40 percent, financial statements must be filed for at least the most 
recent fiscal year and the most recent interim period specified in 
Sec. Sec.  210.3-01 and 210.3-02.
    (iii) If any of the conditions exceeds 40 percent, financial 
statements must be filed for at least the two most recent fiscal years 
and any interim periods specified in Sec. Sec.  210.3-01 and 210.3-02.
    (iv) If the aggregate impact of businesses acquired or to be 
acquired since the date of the most recent audited balance sheet filed 
for the registrant, for which financial statements are either not 
required by paragraph (b)(2)(i) of this section or are not yet required 
based on paragraph (b)(4)(i) of this section, exceeds 50 percent for 
any condition, the registrant must provide the disclosure specified in 
paragraphs (b)(2)(iv)(A) and (B) of this section, however in 
determining the aggregate impact of the investment test condition also 
include the aggregate impact calculated in accordance with Sec.  210.3-
14(b)(2)(ii) of any acquired or to be acquired real estate operations 
specified in Sec.  210.3-14(b)(2)(i)(C). In determining whether the 
income test condition (i.e. both the revenue component and the income 
or loss from continuing operations component) exceeds 50 percent, the 
businesses specified in this paragraph (b)(2)(iv) reporting losses must 
be aggregated separately from those reporting income. If either group 
exceeds 50 percent, paragraphs (b)(2)(iv)(A) and (B) of this section 
will apply to all of the businesses specified in this paragraph 
(b)(2)(iv) and will not be limited to either the businesses with losses 
or those with income.
    (A) Pro forma financial information pursuant to Sec. Sec.  210.11-
01 through 210.11-02 that depicts the aggregate impact of these 
acquired or to be acquired businesses and real estate operations, in 
all material respects; and
    (B) Financial statements covering at least the most recent fiscal 
year and the most recent interim period specified in Sec. Sec.  210.3-
01 and 210.3-02 for any acquired or to be acquired business or real 
estate operation for which financial statements are not yet required 
based on paragraph (b)(4)(i) of this section or Sec.  210.3-
14(b)(3)(i).
    (3) The determination must be made using Sec.  210.11-01(b)(3) and 
(4).
    (4) Financial statements required for the periods specified in 
paragraph (b)(2) of this section may be omitted to the extent specified 
as follows:
    (i) Registration statements not subject to the provisions of Sec.  
230.419 of this chapter and proxy statements need not include separate 
financial statements of an acquired or to be acquired business if 
neither the business nor the aggregate impact specified in paragraph 
(b)(2)(iv) of this section exceeds any of the conditions of 
significance in the definition of significant subsidiary in Sec.  
210.1-02 at the 50 percent level computed in accordance with paragraph 
(b)(3) of this section, and either:
    (A) The consummation of the acquisition has not yet occurred; or
    (B) The date of the final prospectus or prospectus supplement 
relating to an offering as filed with the Commission pursuant to Sec.  
230.424(b) of this chapter, or mailing date in the case of a proxy 
statement, is no more than 74 days after consummation of the business 
acquisition, and the financial statements have not previously been 
filed by the registrant.
    (ii) A registrant, other than a foreign private issuer required to 
file reports on Form 6-K (Sec.  249.306 of this chapter), that omits 
from its initial registration statement financial statements of a 
recently consummated business acquisition pursuant to paragraph 
(b)(4)(i) of this section must file those financial statements and any 
pro forma information specified by Sec. Sec.  210.11-01 through 210.11-
03 (Article 11) under cover of Form 8-K (Sec.  249.308 of this chapter) 
no later than 75 days after consummation of the acquisition.
    (iii) Separate financial statements of the acquired business 
specified in paragraph (b)(2)(ii) of this section need not be presented 
once the operating results of the acquired business have been reflected 
in the audited consolidated financial statements of the registrant for 
at least nine months. Separate financial statements of the acquired 
business specified in paragraph (b)(2)(iii) of this section need not be 
presented once the operating results of the acquired business have been 
reflected in the audited consolidated financial statements of the 
registrant for a complete fiscal year.
    (iv) A separate audited balance sheet of the acquired business is 
not required when the registrant's most recent audited balance sheet 
required by Sec.  210.3-01 is for a date after the date the acquisition 
was consummated.
    (c) Financial statements of a foreign business. Financial 
statements of an acquired or to be acquired foreign business (as 
defined in Sec.  210.1-02(l)) meeting the requirements of Item 17 of 
Form 20-F (Sec.  249.220f of this chapter) will satisfy this section. 
Such financial statements may be reconciled to U.S. Generally Accepted 
Accounting Principles (U.S. GAAP) or International Financial Reporting 
Standards as issued by the International Accounting Standards Board 
(IFRS-IASB) if the registrant is a foreign private issuer that prepares 
its financial statements in accordance with IFRS-IASB. This 
reconciliation must generally follow the form and content requirements 
in Item 17(c) of Form 20-F; however, accommodations in Item 17(c)(2) of 
Form 20-F that would be inconsistent with IFRS-IASB may not be applied, 
and IFRS 1, First-time Adoption of International Financial Reporting 
Standards, may be applied.
    (d) Financial statements of an acquired or to be acquired business 
that would be a foreign private issuer if it were a registrant. 
Financial statements of an acquired or to be acquired business that is 
not a foreign business (as defined in Sec.  210.1-02(l)), but would 
qualify as a foreign private issuer (as defined in Sec. Sec.  230.405 
and 240.3b-4 of this chapter) if it were a registrant may be prepared 
in accordance with IFRS-IASB without reconciliation to U.S. GAAP or, if 
the registrant is a foreign private issuer that prepares its financial 
statements in accordance with IFRS-IASB, may be prepared according to a 
comprehensive basis of accounting principles other than U.S. GAAP or 
IFRS-IASB and must be reconciled to IFRS-IASB or to U.S. GAAP. This 
reconciliation must generally follow the form and content requirements 
in Item 17(c) of Form 20-F; however, accommodations in Item 17(c)(2) of 
Form 20-F that would be inconsistent with IFRS-IASB may not be applied, 
and IFRS 1, First-time Adoption of International Financial Reporting 
Standards, may be applied.
    (e) Financial statements for net assets that constitute a business. 
For an acquisition of net assets that constitutes a business (e.g., an 
acquired or to be acquired product line), the financial statements 
prepared and audited in accordance with Regulation S-X may be 
abbreviated financial statements prepared in accordance with paragraph 
(e)(2) of this section if the business meets all of the qualifying 
conditions in paragraph (e)(1) of this section.
    (1) Qualifying conditions. (i) The total assets and total revenues 
(both after intercompany eliminations) of the acquired or to be 
acquired business constitute 20 percent or less of such corresponding 
amounts of the seller and its subsidiaries consolidated as of and for 
the most recently completed fiscal year.
    (ii) Separate financial statements for the business have not 
previously been prepared;
    (iii) The acquired business was not a separate entity, subsidiary, 
operating segment (as defined in U.S. GAAP or

[[Page 54062]]

IFRS-IASB, as applicable) or division during the periods for which the 
acquired business financial statements would be required; and
    (iv) The seller has not maintained the distinct and separate 
accounts necessary to present financial statements that, absent this 
paragraph (e), would satisfy the requirements of this section and it is 
impracticable to prepare such financial statements.
    (2) Presentation requirements. (i) The balance sheet may be a 
statement of assets acquired and liabilities assumed;
    (ii) The statement of comprehensive income must include expenses 
incurred by or on behalf of the acquired business during the pre-
acquisition financial statement periods to be presented including, but 
not limited to, costs of sales or services, selling, distribution, 
marketing, general and administrative, depreciation and amortization, 
and research and development, but may otherwise omit corporate overhead 
expense, interest expense for debt that will not be assumed by the 
registrant or its subsidiaries consolidated, and income tax expense. 
The title of the statement of comprehensive income must be 
appropriately modified to indicate it omits certain expenses; and
    (iii) The notes to the financial statements must include:
    (A) A description of the type of omitted expenses and the reason(s) 
why they are excluded from the financial statements.
    (B) An explanation of the impracticability of preparing financial 
statements that include the omitted expenses.
    (C) A description of how the financial statements presented are not 
indicative of the financial condition or results of operations of the 
acquired business going forward because of the omitted expenses.
    (D) Information about the business's operating, investing and 
financing cash flows, to the extent available.
    (f) Financial statements of a business that includes oil and gas 
producing activities. (1) Disclosures about oil and gas producing 
activities must be provided for each full year of operations presented 
for an acquired or to be acquired business that includes significant 
oil- and gas-producing activities (as defined in the FASB ASC Master 
Glossary). The financial statements may present the disclosures in FASB 
ASC Topic 932 Extractive Activities--Oil and Gas, 932-235-50-3 through 
50-11 and 932-235-50-29 through 50-36 as unaudited supplemental 
information. If prior year reserve studies were not made, they may be 
computed using only production and new discovery quantities and 
valuation, in which case there will be no ``revision of prior 
estimates'' amounts. Registrants may develop these disclosures based on 
a reserve study for the most recent year, computing the changes 
backward. The method of computation must be disclosed in a footnote.
    (2) The financial statements prepared and audited in accordance 
with Regulation S-X may consist of only statements of revenues and 
expenses that exclude expenses not comparable to the proposed future 
operations such as depreciation, depletion and amortization, corporate 
overhead, income taxes, and interest for debt that will not be assumed 
by the registrant or its subsidiaries consolidated if:
    (i) The acquisition generates substantially all of its revenues 
from oil and gas producing activities (as defined in Sec.  210.4-
10(a)(16)); and
    (ii) The qualifying conditions specified in paragraph (e)(1) of 
this section are met.
    (3) If the financial statements are presented in accordance with 
paragraph (f)(2) of this section, the disclosures specified in 
paragraph (e)(2)(iii) of this section must be provided.

0
4. Revise Sec.  210.3-06 to read as follows:


Sec.  210.3-06  Financial statements covering a period of nine to 
twelve months.

    (a) Except with respect to registered investment companies, the 
filing of financial statements covering a period of 9 to 12 months will 
be deemed to satisfy a requirement for filing financial statements for 
a period of 1 year where:
    (1) The issuer has changed its fiscal year;
    (2) The issuer has made a significant business acquisition for 
which financial statements are required under Sec.  210.3-05, Sec.  
210.3-14, Sec.  210.8-04, or Sec.  210.8-06 and the financial 
statements covering the interim period pertain to the business being 
acquired; or
    (3) The Commission so permits pursuant to Sec.  210.3-13 or Sec.  
210.8-01(e).
    (b) Where there is a requirement for filing financial statements 
for a time period exceeding one year but not exceeding three 
consecutive years (with not more than 12 months included in any period 
reported upon), the filing of financial statements covering a period of 
9 to 12 months will satisfy a filing requirement of financial 
statements for one year of that time period only if the conditions 
described in paragraph (a)(1), (2), or (3) of this section exist and 
financial statements are filed that cover the full fiscal year or years 
for all other years in the time period.

0
5. Amend Sec.  210.3-09 by revising paragraph (a) to read as follows:


Sec.  210.3-09  Separate financial statements of subsidiaries not 
consolidated and 50 percent or less owned persons.

    (a) If any of the conditions set forth in Sec.  210.1-02(w), 
substituting 20 percent for 10 percent in the tests used therein to 
determine a significant subsidiary, are met for a majority-owned 
subsidiary not consolidated by the registrant or by a subsidiary of the 
registrant, separate financial statements of such subsidiary must be 
filed. Similarly, if either the first or third condition set forth in 
Sec.  210.1-02(w)(1), substituting 20 percent for 10 percent, is met by 
a 50 percent or less owned person accounted for by the equity method 
either by the registrant or a subsidiary of the registrant, separate 
financial statements of such 50 percent or less owned person must be 
filed.
* * * * *

0
6. Revise Sec.  210.3-14 to read as follows:


Sec.  210.3-14  Special instructions for financial statements of real 
estate operations acquired or to be acquired.

    (a) Financial statements required. (1) Financial statements (except 
the related schedules specified in Sec.  210.12) prepared and audited 
in accordance with Regulation S-X (including the independence standards 
in Sec.  210.2-01 or, alternatively if the real estate operation is not 
a registrant, the applicable independence standards) for the periods 
specified in paragraph (b) of this section and the supplemental 
information specified in paragraph (f) of this section must be filed if 
any of the following conditions exist:
    (i) During the most recent fiscal year or subsequent interim period 
for which a balance sheet is required by Sec.  210.3-01, an acquisition 
of a real estate operation has occurred; or
    (ii) After the date of the most recent balance sheet filed pursuant 
to Sec.  210.3-01, consummation of an acquisition of a real estate 
operation has occurred or is probable.
    (2) For purposes of determining whether the provisions of this 
section apply:
    (i) The term real estate operation means a business (as set forth 
in Sec.  210.11-01(d)) that generates substantially all of its revenues 
through the leasing of real property.
    (ii) The acquisition of a real estate operation encompasses the 
acquisition of an interest in a real estate operation accounted for by 
the registrant under the equity method or, in lieu of the equity 
method, the fair value option.

[[Page 54063]]

    (3) Acquisitions of a group of related real estate operations that 
are probable or that have occurred subsequent to the latest fiscal 
year-end for which audited financial statements of the registrant have 
been filed will be treated under this section as if they are a single 
acquisition. The required financial statements may be presented on a 
combined basis for any periods they are under common control or 
management. For purposes of this section, acquisitions will be deemed 
to be related if:
    (i) They are under common control or management;
    (ii) The acquisition of one real estate operation is conditional on 
the acquisition of each other real estate operation; or
    (iii) Each acquisition is conditioned on a single common event.
    (4) This section does not apply to a real estate operation that is 
totally held by the registrant prior to consummation of the 
transaction.
    (b) Periods to be presented. (1) If registering an offering of 
securities to the security holders of the real estate operation to be 
acquired, then the financial statements specified in paragraph (c) of 
this section and the supplemental information specified in paragraph 
(f) of this section must be filed for the real estate operation to be 
acquired for the periods specified in Sec. Sec.  210.3-01 and 210.3-02, 
except as provided otherwise for filings on Form S-4 or F-4 (Sec.  
239.25 or Sec.  239.34 of this chapter). The financial statements 
covering fiscal years must be audited except as provided in Item 14 of 
Schedule 14A (Sec.  240.14a-101 of this chapter) with respect to 
certain proxy statements or in registration statements filed on Form S-
4 or F-4 (Sec.  239.25 or Sec.  239.34 of this chapter).
    (2) In all cases not specified in paragraph (b)(1) of this section, 
financial statements of the real estate operation acquired or to be 
acquired must be filed for the periods specified in this paragraph 
(b)(2) or such shorter period as the real estate operation has been in 
existence. The periods for which such financial statements are to be 
filed must be determined using the investment test condition specified 
in the definition of significant subsidiary in Sec.  210.1-02(w)(1)(i) 
modified as follows:
    (i)(A) If the condition does not exceed 20 percent, financial 
statements are not required.
    (B) If the condition exceeds 20 percent, financial statements of 
the real estate operation for at least the most recent fiscal year and 
the most recent interim period specified in Sec. Sec.  210.3-01 and 
210.3-02 must be filed.
    (C) If the aggregate impact of acquired or to be acquired real 
estate operations since the date of the most recent audited balance 
sheet filed for the registrant, for which financial statements are 
either not required by paragraph (b)(2)(i)(A) of this section or are 
not yet required based on paragraph (b)(3)(i) of this section, exceeds 
50 percent, the registrant must provide the disclosures specified in 
paragraphs (b)(2)(i)(C)(1) and (b)(2)(i)(C)(2) of this section. If 
there are also businesses acquired or to be acquired as described in 
Sec.  210.3-05(b)(2)(iv), the requirements in Sec.  210.3-05(b)(2)(iv) 
will apply instead.
    (1) Pro forma financial information pursuant to Sec. Sec.  210.11-
01 through 210.11-02 that depicts the aggregate impact of these 
acquired or to be acquired real estate operations in all material 
respects; and
    (2) Financial statements covering at least the most recent fiscal 
year and the most recent interim period specified in Sec. Sec.  210.3-
01 and 210.3-02 for any acquired or to be acquired real estate 
operation for which financial statements are not yet required based on 
paragraph (b)(3)(i) of this section.
    (ii) When the investment test is based on the total assets of the 
registrant and its subsidiaries consolidated, include any assumed debt 
secured by the real properties in the ``investments in'' the tested 
real estate operation.
    (iii) The determination must be made using Sec.  210.11-01(b)(3) 
and (4).
    (3) Financial statements required for the periods specified in 
paragraph (b)(2) of this section may be omitted to the extent specified 
as follows:
    (i) Registration statements not subject to the provisions of Sec.  
230.419 of this chapter and proxy statements need not include separate 
financial statements of the acquired or to be acquired real estate 
operation if neither the real estate operation nor the aggregate impact 
specified in paragraph (b)(2)(i)(C) of this section exceeds the 
condition of significance in the definition of significant subsidiary 
in Sec.  210.1-02(w)(1)(i), as modified by paragraphs (b)(2)(ii) and 
(iii) of this section, at the 50 percent level computed in accordance 
with paragraph (b)(2) of this section, and either:
    (A) The consummation of the acquisition has not yet occurred; or
    (B) The date of the final prospectus or prospectus supplement 
relating to an offering as filed with the Commission pursuant to Sec.  
230.424(b) of this chapter, or mailing date in the case of a proxy 
statement, is no more than 74 days after consummation of the 
acquisition of the real estate operation, and the financial statements 
have not previously been filed by the registrant.
    (ii) A registrant, other than a foreign private issuer required to 
file reports on Form 6-K (Sec.  249.306 of this chapter), that omits 
from its initial registration statement financial statements of a 
recently consummated acquisition of a real estate operation pursuant to 
paragraph (b)(3)(i) of this section must file those financial 
statements and any pro forma information specified by Sec. Sec.  
210.11-01 through 210.11-03 (Article 11) under cover of Form 8-K (Sec.  
249.308 of this chapter) no later than 75 days after consummation of 
the acquisition.
    (iii) Separate financial statements of the acquired real estate 
operation specified in paragraph (b)(2)(i)(B) of this section need not 
be presented once the operating results of the acquired real estate 
operation have been reflected in the audited consolidated financial 
statements of the registrant for at least nine months.
    (c) Presentation of the financial statements. (1) The financial 
statements prepared and audited in accordance with Regulation S-X may 
be only statements of revenues and expenses excluding expenses not 
comparable to the proposed future operations such as mortgage interest, 
leasehold rental, depreciation, amortization, corporate overhead and 
income taxes.
    (2) The notes to the financial statements must include the 
following disclosures:
    (i) The type of omitted expenses and the reason(s) why they are 
excluded from the financial statements;
    (ii) A description of how the financial statements presented are 
not indicative of the results of operations of the acquired real estate 
operation going forward because of the omitted expenses; and
    (iii) Information about the real estate operation's operating, 
investing and financing cash flows, to the extent available.
    (d) Financial statements of a foreign real estate operation. 
Financial statements of an acquired or to be acquired foreign business 
(as defined in Sec.  210.1-02(l)) that is a real estate operation, 
specified in paragraph (c) of this section and meeting the requirements 
of Item 17 of Form 20-F (Sec.  249.220f of this chapter), will satisfy 
this section. Such financial statements may be reconciled to U.S. 
Generally Accepted Accounting Principles (U.S. GAAP) or International 
Financial Reporting Standards as issued by the International Accounting 
Standards Board (IFRS-IASB) if the registrant is a foreign private 
issuer that prepares its financial statements in accordance with

[[Page 54064]]

IFRS-IASB. This reconciliation must generally follow the form and 
content requirements in Item 17(c) of Form 20-F; however, 
accommodations in Item 17(c)(2) of Form 20-F that would be inconsistent 
with IFRS-IASB may not be applied, and IFRS 1, First-time Adoption of 
International Financial Reporting Standards, may be applied.
    (e) Financial statements of an acquired or to be acquired real 
estate operation that would be a foreign private issuer if it were a 
registrant. Financial statements of an acquired or to be acquired real 
estate operation that is not a foreign business (as defined in Sec.  
210.1-02(l)), but would qualify as a foreign private issuer (as defined 
in Sec. Sec.  230.405 and 240.3b-4 of this chapter) if it were a 
registrant, may be prepared in accordance with IFRS-IASB without 
reconciliation to U.S. GAAP or, if the registrant is a foreign private 
issuer that prepares its financial statements in accordance with IFRS-
IASB, may be prepared according to a comprehensive basis of accounting 
principles other than U.S. GAAP or IFRS-IASB and must be reconciled to 
IFRS-IASB or to U.S. GAAP. This reconciliation must generally follow 
the form and content requirements in Item 17(c) of Form 20-F; however, 
accommodations in Item 17(c)(2) of Form 20-F that would be inconsistent 
with IFRS-IASB may not be applied, and IFRS 1, First-time Adoption of 
International Financial Reporting Standards, may be applied.
    (f) Supplemental information. For each real estate operation for 
which financial statements are required to be filed by paragraphs 
(b)(2)(i)(B) and (b)(2)(i)(C)(2) of this section, material factors 
considered by the registrant in assessing the real estate operation 
must be described with specificity in the filing, including sources of 
revenue (including, but not limited to, competition in the rental 
market, comparative rents, and occupancy rates) and expense (including, 
but not limited to, utility rates, property tax rates, maintenance 
expenses, and capital improvements anticipated). The disclosure must 
also indicate that the registrant is not aware of any other material 
factors relating to the specific real estate operation that would cause 
the reported financial statements not to be indicative of future 
operating results.
    Instruction 1 to paragraph (f): When the financial statements are 
presented in Form S-11 (Sec.  239.18 of this chapter), the discussion 
of material factors considered should supplement the disclosures 
required by Item 15 of Form S-11.


Sec.  210.3-18  [Amended]

0
7. Amend Sec.  210.3-18(d) by removing the text ``Sec. Sec.  210.6-01 
to 210.6-10'' and adding in its place ``Sec. Sec.  210.6-01 through 
210.6-11''.


Sec.  210.5-01  [Amended]

0
8. Amend Sec.  210.5-01(a) by removing the text ``Sec. Sec.  210.6-01 
to 210.6-10'' and adding in its place ``Sec. Sec.  210.6-01 through 
210.6-11''.


Sec.  210.6-01  [Amended]

0
9. Amend Sec.  210.6-01 by removing the text ``210.6-01 to 210.6-10'' 
everywhere it appears and adding in its place ``210.6-01 through 210.6-
11''.


Sec.  210.6-02  [Amended]

0
10. Amend Sec.  210.6-02(b) and (c) by removing the text ``Sec. Sec.  
210.6-01 to 210.6-10'' and adding in its place ``Sec. Sec.  210.6-01 
through 210.6-11''.


Sec.  210.6-03  [Amended]

0
11. Amend Sec.  210.6-03 by removing the text ``Sec. Sec.  210.6-01 to 
210.6-10'' in the introductory text and paragraph (a) and adding in its 
place ``Sec. Sec.  210.6-01 through 210.6-11''.

0
12. Add Sec.  210.6-11 to read as follows:


Sec.  210.6-11   Financial statements of funds acquired or to be 
acquired.

    (a) Financial statements required. (1) Financial statements 
described in Sec. Sec.  210.3-01 and 210.3-02, or Sec.  210.3-18, as 
applicable, including the schedules specified in Sec. Sec.  210.12-01 
through 210.12-29 (Article 12), prepared and audited in accordance with 
Regulation S-X (including the independence standards in Sec.  210.2-01 
or, alternatively if the fund is not a registrant, the applicable 
independence standards) for the periods specified in paragraph (b) of 
this section and the supplemental information specified in paragraph 
(d) of this section must be filed if any of the following conditions 
exist:
    (i) During the most recent fiscal year or subsequent interim period 
for which a balance sheet is required by Sec.  210.3-01 or Sec.  210.3-
18, a fund acquisition has occurred; or
    (ii) After the date of the most recent balance sheet filed pursuant 
to Sec.  210.3-01 or Sec.  210.3-18 or, if no relevant balance sheet 
has been filed in connection with a post-effective amendment for a new 
series submitted pursuant to Sec.  230.485(a)(2) of this chapter (Rule 
485(a)(2) under the Securities Act), the filing of such amendment, 
consummation of a fund acquisition has occurred or is probable.
    (2) For purposes of this section:
    (i) The term fund includes any investment company as defined in 
section 3(a) of the Investment Company Act of 1940, including a 
business development company, or any company that would be an 
investment company but for the exclusions provided by sections 3(c)(1) 
or 3(c)(7) of that Act, or any private account managed by an investment 
adviser.
    (ii) The determination of whether a fund has been acquired or will 
be acquired should be evaluated in light of the facts and circumstances 
involved. Among the facts and circumstances which should be considered 
in evaluating whether a fund acquisition has occurred or will occur are 
whether it will result in the acquisition by the registrant of all or 
substantially all of the portfolio investments held by another fund.
    (3) Acquisitions of a group of related funds that are probable or 
that have occurred subsequent to the latest fiscal year-end for which 
audited financial statements of the registrant have been filed will be 
treated under this section as if they are a single acquisition. For 
purposes of this section, funds will be deemed to be related if:
    (i) They are under common control or management;
    (ii) The acquisition of one fund is conditional on the acquisition 
of each other fund; or
    (iii) Each acquisition is conditioned on a single common event.
    (4) This section does not apply to a fund which is totally held by 
the registrant prior to consummation of the transaction.
    (b) Periods to be presented. (1) If securities are being registered 
to be offered to the security holders of the fund to be acquired, the 
financial statements specified in Sec. Sec.  210.3-01 and 210.3-02 or 
Sec.  210.3-18 for the fund to be acquired and the supplemental 
information specified in paragraph (d) of this section must be filed, 
except as provided otherwise for filings on Form N-14 (Sec.  239.23 of 
this chapter). The financial statements covering the fiscal year must 
be audited except as provided in Item 14 of Schedule 14A (Sec.  
240.14a-101 of this chapter) with respect to certain proxy statements 
or in registration statements filed on Form N-14 (Sec.  239.23 of this 
chapter).
    (2) In all cases not specified in paragraph (b)(1) of this section, 
financial statements of the fund acquired or to be acquired for the 
periods specified in this paragraph (b)(2) or such shorter period as 
the fund has been in existence and the supplemental information 
specified in paragraph (d) of this section must be filed. Whether such 
financial statements

[[Page 54065]]

and supplemental information are to be filed must be determined using 
the conditions specified in the definition of significant subsidiary in 
Sec.  210.1-02(w)(2)(i) and (w)(2)(ii)(B) as follows:
    (i) If none of the conditions set forth in Sec.  210.1-02(w)(2)(i) 
and (w)(2)(ii)(B), substituting 20 percent for 10 percent each place it 
appears therein, are satisfied, the financial statements and 
supplemental financial information in paragraph (d) of this section are 
not required.
    (ii) If any of the conditions set forth in Sec.  210.1-02(w)(2)(i) 
and (w)(2)(ii)(B), substituting 20 percent for 10 percent each place it 
appears therein, are satisfied, the financial statements of the 
acquired fund must be filed. If the acquired fund is subject to Sec.  
210.3-18, then the financial statements for the periods described 
therein must be filed. For all other acquired funds, the financial 
statements for the most recent fiscal year and the most recent interim 
period must be filed. The registrant must also provide the supplemental 
financial information in paragraph (d) of this section.
    (iii) If the aggregate impact of funds acquired or to be acquired 
since the date of the most recent audited balance sheet filed for the 
registrant, for which financial statements are not required by 
paragraph (b)(2)(i) of this section, satisfies any of the conditions 
set forth in Sec.  210.1-02(w)(2)(i) and (w)(2)(ii)(B), substituting 50 
percent for 10 percent each place it appears therein, the registrant 
must provide financial statements for any fund acquired or to be 
acquired for which financial statements are not yet required by 
paragraph (b)(2)(i) of this section. If any of the acquired funds are 
subject to Sec.  210.3-18, then the financial statements for the 
periods described therein must be filed. For any other acquired funds, 
the financial statements for the most recent fiscal year and the most 
recent interim period must be filed. The registrant must also provide 
the supplemental financial information in paragraph (d) of this section 
for such funds.
    (3) The determination must be made by comparing the most recent 
annual financial statement of each such fund, or for acquisitions each 
group of related funds on a combined basis, to the registrant's most 
recent annual financial statements filed at or prior to the date of 
acquisition. However, the determination may be made by using pro forma 
amounts as calculated by the registrant for the periods specified in 
Sec.  210.1-02(w)(2) that only give effect to an acquisition 
consummated after the latest fiscal year-end for which the registrant's 
financial statements are required to be filed when the registrant has 
filed audited financial statements of such acquired fund and provided 
the supplemental financial information for the periods required by this 
section.
    (4) Separate financial statements of the acquired fund and the 
supplemental information specified in paragraph (d) of this section 
need only to be filed once and not included in any subsequent filing or 
shareholder report.
    (c) Acquisitions involving private funds or private accounts. If 
the fund acquired or to be acquired would be an investment company 
under the Investment Company Act but for the exclusion provided from 
that definition by either sections 3(c)(1) or 3(c)(7) of that Act, then 
the required financial statements may comply with U.S. Generally 
Accepted Accounting Principles and only Article 12. In situations of 
any private account managed by an investment adviser provide the 
schedules specified in Article 12 for the assets acquired or to be 
acquired.
    (d) Supplemental financial information. (1) Supplemental financial 
information must consist of:
    (i) A table showing the current fees for the registrant and the 
acquired fund and pro forma fees, if different, for the registrant 
after giving effect to the acquisition using the format prescribed in 
the appropriate registration statement under the Investment Company 
Act;
    (ii) If the transaction will result in a material change in the 
acquired fund's investment portfolio due to investment restrictions, a 
schedule of investments of the acquired fund modified to reflect such 
change and accompanied by narrative disclosure describing the change; 
and
    (iii) Narrative disclosure about material differences in accounting 
policies of the acquired fund when compared to the registrant.
    (2) With respect to any fund acquisition, registered investment 
companies and business development companies must provide the 
supplemental financial information required in this section in lieu of 
any pro forma financial information required by Sec. Sec.  210.11-01 
through 210.11-03.

0
13. Revise Sec.  210.8-01 to read as follows:


Sec.  210.8-01   General requirements for Article 8.

    Sections 210.8-01 through 210.8-08 (Article 8) shall be applicable 
to financial statements filed for smaller reporting companies. These 
sections are not applicable to financial statements prepared for the 
purposes of Item 17 or Item 18 of Form 20-F.
    (a) Financial statements of a smaller reporting company, as defined 
by Sec.  229.10(f)(1) of this chapter, its predecessors or any 
businesses to which the smaller reporting company is a successor shall 
be prepared in accordance with generally accepted accounting principles 
in the United States.
    (b) Smaller reporting companies electing to prepare their financial 
statements with the form and content required in Article 8 need not 
apply the other form and content requirements in Regulation S-X with 
the exception of the following:
    (1) The report and qualifications of the independent accountant 
shall comply with the requirements of Sec. Sec.  210.2-01 through 
210.2-07 (Article 2); and
    (2) The description of accounting policies shall comply with Sec.  
210.4-08(n); and
    (3) Smaller reporting companies engaged in oil and gas producing 
activities shall follow the financial accounting and reporting 
standards specified in Sec.  210.4-10 with respect to such activities.
    (c) Financial statements for a subsidiary of a smaller reporting 
company that issues securities guaranteed by the smaller reporting 
company or guarantees securities issued by the smaller reporting 
company must be presented as required by Sec.  210.3-10, except that 
the periods presented are those required by Sec.  210.8-02.
    (d) Financial statements for a smaller reporting company's 
affiliates whose securities constitute a substantial portion of the 
collateral for any class of securities registered or being registered 
must be presented as required by Sec.  210.3-16, except that the 
periods presented are those required by Sec.  210.8-02.
    (e) The Commission, where consistent with the protection of 
investors, may permit the omission of one or more of the financial 
statements or the substitution of appropriate statements of comparable 
character. The Commission by informal written notice may require the 
filing of other financial statements where necessary or appropriate.
    (f) Section 210.3-06 applies to the preparation of financial 
statements of smaller reporting companies.


Sec.  210.8-03  [Amended]

0
14. Remove and reserve Sec.  210.8-03(b)(4).

0
15. Revise Sec.  210.8-04 to read as follows:

[[Page 54066]]

Sec.  210.8-04   Financial statements of businesses acquired or to be 
acquired.

    Apply Sec.  210.3-05 substituting Sec. Sec.  210.8-02 and 210.8-03, 
as applicable, wherever Sec.  210.3-05 references Sec. Sec.  210.3-01 
and 210.3-02.

0
16. Revise Sec.  210.8-05 to read as follows:


Sec.  210.8-05   Pro forma financial information.

    (a) Pro forma financial information must be disclosed when any of 
the conditions in Sec.  210.11-01 exist.
    (b) The preparation, presentation, and disclosure of pro forma 
financial information must comply with Sec. Sec.  210.11-01 through 
210.11-03 (Article 11), except that the pro forma financial information 
may be condensed pursuant to Sec.  210.8-03(a).

0
17. Revise Sec.  210.8-06 to read as follows:


Sec.  210.8-06   Real estate operations acquired or to be acquired.

    Apply Sec.  210.3-14 substituting Sec. Sec.  210.8-02 and 210.8-03, 
as applicable, wherever Sec.  210.3-14 references Sec. Sec.  210.3-01 
and 210.3-02.

0
18. Amend Sec.  210.11-01 by:
0
a. Revising paragraphs (a) introductory text and (a)(1) and (2);
0
b. Removing and reserving (a)(5);
0
c. Revising paragraphs (a)(6) and (8), (b), and (c).
    The revisions read as follows:


Sec.  210.11-01   Presentation requirements.

    (a) Pro forma financial information must be filed when any of the 
following conditions exist:
    (1) During the most recent fiscal year or subsequent interim period 
for which a balance sheet is required by Sec.  210.3-01, a significant 
business acquisition has occurred (for purposes of this section, this 
encompasses the acquisition of an interest in a business accounted for 
by the equity method);
    (2) After the date of the most recent balance sheet filed pursuant 
to Sec.  210.3-01, consummation of a significant business acquisition 
or a combination of entities under common control has occurred or is 
probable;
* * * * *
    (6) Pro forma financial information required by Sec.  229.914 of 
this chapter is required to be provided in connection with a roll-up 
transaction as defined in Sec.  229.901(c) of this chapter;
* * * * *
    (8) Consummation of other transactions has occurred or is probable 
for which disclosure of pro forma financial information would be 
material to investors.
    (b) A business acquisition or disposition will be considered 
significant if:
    (1) The business acquisition meets:
    (i) The definition of a significant subsidiary in Sec.  210.1-
02(w)(1), substituting 20 percent for 10 percent each place it appears 
therein; or
    (ii) If the business is a real estate operation as defined in Sec.  
210.3-14(a)(2), the significant subsidiary condition in Sec.  210.1-
02(w)(1)(i) (i.e., the investment test condition), substituting 20 
percent for 10 percent, as modified by the guidance in Sec.  210.3-
14(b)(2)(ii).
    (2) The business disposition, including a business that is a real 
estate operation as defined in Sec.  210.3-14(a)(2), meets the 
definition of a significant subsidiary in Sec.  210.1-02(w)(1), 
substituting 20 percent for 10 percent each place it appears therein.
    (3) The determination must be made, except as noted in paragraph 
(b)(4) of this section for the continuous offerings described therein, 
by using:
    (i) For amounts derived from financial statements, the registrant's 
most recent annual consolidated financial statements required to be 
filed at or prior to the date of acquisition or disposition and the 
business's pre-acquisition or pre-disposition financial statements for 
the same fiscal year as the registrant or, if the fiscal years differ, 
the business's most recent fiscal year that would be required if the 
business had the same filer status as the registrant, however the 
determination may be made using:
    (A) The financial statements for the business described in Sec.  
210.3-05(e) or (f) if the business meets the conditions for presenting 
those financial statements.
    (B) Pro forma amounts for the registrant for the periods specified 
in Sec.  210.11-01(b)(3) that only depict significant business 
acquisitions and dispositions consummated after the latest fiscal year-
end for which the registrant's financial statements are required to be 
filed and only include Transaction Accounting Adjustments (see Sec.  
210.11-02(a)(6)(i)), provided that:
    (1) The registrant has filed audited financial statements for any 
such acquired business for the periods required by Sec.  210.3-05 or 
Sec.  210.3-14 and the pro forma financial information required by 
Sec. Sec.  210.11-01 through 210.11-02 for any such acquired or 
disposed business. The tests may not be made by ``annualizing'' data; 
and
    (2) If a registrant has used pro forma amounts to determine 
significance of an acquisition or disposition, it must continue to use 
pro forma amounts to determine significance of acquisitions and 
dispositions through the filing date of its next annual report on Form 
10-K (Sec.  249.310 of this chapter) or Form 20-F (Sec.  249.220f of 
this chapter); or
    (C) The registrant's annual consolidated financial statements, for 
the most recent fiscal year ended prior to the acquisition or 
disposition, that are included in the registrant's Form 10-K (Sec.  
249.310 of this chapter) filed after the date of acquisition or 
disposition, but before the date financial statements and pro forma 
financial information for the acquisition or disposition would be 
required to be filed on Form 8-K (Sec.  249.308 of this chapter).
    (ii) If the business is a related business (see Sec.  210.3-
05(a)(3)), combined pre-acquisition financial statements of the group 
of related businesses for the fiscal year specified in paragraph 
(b)(3)(i) of this section.
    (4) When a registrant, including a real estate investment trust, 
conducts a continuous offering over an extended period of time and 
applies the Item 20.D. Undertakings of Industry Guide 5, the income 
test condition does not apply, and the determination must be made for 
the investment test condition, when it is based on the total assets of 
the registrant and its subsidiaries consolidated, and the asset test 
condition, if applicable, using the following for the registrant:
    (i) During the distribution period, total assets as of the date of 
acquisition or disposition plus the proceeds (net of commissions) in 
good faith expected to be raised in the registered offering over the 
next 12 months, except that for acquisitions total assets must exclude 
the acquired business; and
    (ii) After the distribution period ends and until the next Form 10-
K is filed, total assets as of the date of acquisition or disposition, 
except that for acquisitions total assets must exclude the acquired 
business; and
    (iii) After that next Form 10-K is filed, the guidance in paragraph 
(b)(3).
    (c) The pro forma effects of a business acquisition need not be 
presented pursuant to this section if separate financial statements of 
the acquired business are not included in the filing, except where the 
aggregate impact of businesses acquired or to be acquired is 
significant as determined by Sec.  210.3-05(b)(2)(iv) or Sec.  210.3-
14(b)(2)(i)(C).
* * * * *

0
19. Revise Sec.  210.11-02 to read as follows:


Sec.  210.11-02   Preparation requirements.

    (a) Form and content. (1) Pro forma financial information must 
consist of a pro forma condensed balance sheet, pro

[[Page 54067]]

forma condensed statements of comprehensive income, and accompanying 
explanatory notes. In certain circumstances (i.e., where a limited 
number of pro forma adjustments are required and those adjustments are 
easily understood), a narrative description of the pro forma effects of 
the transaction may be disclosed in lieu of the statements described in 
this paragraph (a)(1).
    (2) The pro forma financial information must be accompanied by an 
introductory paragraph which briefly sets forth a description of:
    (i) Each transaction for which pro forma effect is being given;
    (ii) The entities involved;
    (iii) The periods for which the pro forma financial information is 
presented; and
    (iv) An explanation of what the pro forma presentation shows.
    (3) The pro forma condensed financial information need only include 
major captions (i.e., the numbered captions) prescribed by the 
applicable sections of Regulation S-X. Where any major balance sheet 
caption is less than 10 percent of total assets, the caption may be 
combined with others. When any major statement of comprehensive income 
caption is less than 15 percent of average net income attributable to 
the registrant for the most recent three fiscal years, the caption may 
be combined with others. In calculating average net income attributable 
to the registrant, loss years should be excluded unless losses were 
incurred in each of the most recent three years, in which case the 
average loss must be used for purposes of this test. Notwithstanding 
these tests, de minimis amounts need not be shown separately.
    (4) Pro forma statements will ordinarily be in columnar form 
showing condensed historical statements, pro forma adjustments, and the 
pro forma results.
    (5) The pro forma condensed statement of comprehensive income must 
disclose income (loss) from continuing operations and income or loss 
from continuing operations attributable to the controlling interest.
    (6) The pro forma condensed balance sheet and pro forma condensed 
statements of comprehensive income must include, and be limited to, the 
following pro forma adjustments, except as noted in paragraph (a)(7) of 
this section:
    (i) Transaction Accounting Adjustments. (A) Adjustments that depict 
in the pro forma condensed balance sheet the accounting for the 
transaction required by U.S. Generally Accepted Accounting Principles 
(U.S. GAAP) or, as applicable, International Financial Reporting 
Standards as issued by the International Accounting Standards Board 
(IFRS-IASB). Calculate pro forma adjustments using the measurement date 
and method prescribed by the applicable accounting standards. For a 
probable transaction, calculate pro forma adjustments using, and 
disclose, the most recent practicable date prior to the effective date 
(for registration statements), qualification date (for offering 
statements under 17 CFR 230.251 through 230.263 (Regulation A)), or the 
mail date (for proxy statements).
    (B) Adjustments that depict in the pro forma condensed statements 
of comprehensive income the effects of the pro forma balance sheet 
adjustments in paragraph (a)(6)(i)(A) of this section assuming those 
adjustments were made as of the beginning of the fiscal year presented. 
Such adjustments must be made whether or not the pro forma balance 
sheet is presented pursuant to paragraph (c)(1) of this section. If the 
condition in Sec.  210.11-01(a) that is met does not have a balance 
sheet effect, then depict the accounting for the transaction required 
by U.S. GAAP or IFRS-IASB, as applicable.
    (ii) Autonomous Entity Adjustments. Adjustments that depict the 
registrant as an autonomous entity if the condition in Sec.  210.11-
01(a)(7) is met. Autonomous Entity Adjustments must be presented in a 
separate column from Transaction Accounting Adjustments.
    (7) Management's Adjustments depicting synergies and dis-synergies 
of the acquisitions and dispositions for which pro forma effect is 
being given may, in the registrant's discretion, be presented if in its 
management's opinion, such adjustments would enhance an understanding 
of the pro forma effects of the transaction and the following 
conditions are met:
    (i) Basis for Management's Adjustments. (A) There is a reasonable 
basis for each such adjustment.
    (B) The adjustments are limited to the effect of such synergies and 
dis-synergies on the historical financial statements that form the 
basis for the pro forma statement of comprehensive income as if the 
synergies and dis-synergies existed as of the beginning of the fiscal 
year presented. If such adjustments reduce expenses, the reduction must 
not exceed the amount of the related expense historically incurred 
during the pro forma period presented.
    (C) The pro forma financial information reflects all Management's 
Adjustments that are, in the opinion of management, necessary to a fair 
statement of the pro forma financial information presented and a 
statement to that effect is disclosed. When synergies are presented, 
any related dis-synergies must also be presented.
    (ii) Form of presentation. (A) If presented, Management's 
Adjustments must be presented in the explanatory notes to the pro forma 
financial information in the form of reconciliations of pro forma net 
income from continuing operations attributable to the controlling 
interest and the related pro forma earnings per share data specified in 
paragraph (a)(9) of this section to such amounts after giving effect to 
Management's Adjustments.
    (B) Management's Adjustments included or incorporated by reference 
into a registration statement, proxy statement, Regulation A offering 
statement, or Form 8-K should be as of the most recent practicable date 
prior to the effective date, mail date, qualification date, or filing 
date as applicable, which may require that they be updated if 
previously provided in a Form 8-K that is appropriately incorporated by 
reference.
    (C) If Management's Adjustments will change the number of shares or 
potential common shares, reflect the change within Management's 
Adjustments in accordance with U.S. GAAP or IFRS-IASB, as applicable, 
as if the common stock or potential common stock were outstanding as of 
the beginning of the period presented.
    (D) The explanatory notes must also include disclosure of the basis 
for and material limitations of each Management's Adjustment, including 
any material assumptions or uncertainties of such adjustment, an 
explanation of the method of the calculation of the adjustment, if 
material, and the estimated time frame for achieving the synergies and 
dis-synergies of such adjustment.
    Instruction 1 to paragraph (a)(7): Any forward-looking information 
supplied is expressly covered by the safe harbor rules under Sec. Sec.  
230.175 and 240.3b-6 of this chapter.
    (8) All pro forma adjustments should be referenced to notes that 
clearly explain the assumptions involved.
    (9)(i) Historical and pro forma basic and diluted per share amounts 
based on continuing operations attributable to the controlling 
interests and the number of shares used to calculate such per share 
amounts must be presented on the face of the pro forma condensed 
statement of comprehensive income and only give effect to Transaction 
Accounting Adjustments and Autonomous Entity Adjustments.

[[Page 54068]]

    (ii) The number of shares used in the calculation of the pro forma 
per share amounts must be based on the weighted average number of 
shares outstanding during the period adjusted to give effect to the 
number of shares issued or to be issued to consummate the transaction, 
or if applicable whose proceeds will be used to consummate the 
transaction as if the shares were outstanding as of the beginning of 
the period presented. Calculate the pro forma effect of potential 
common stock being issued in the transaction (e.g., a convertible 
security), or the proceeds of which will be used to consummate the 
transaction, on pro forma earnings per share in accordance with U.S. 
GAAP or IFRS-IASB, as applicable, as if the potential common stock were 
outstanding as of the beginning of the period presented.
    (10) If the transaction is structured in such a manner that 
significantly different results may occur, provide additional pro forma 
presentations which give effect to the range of possible results.
    (11) The accompanying explanatory notes must disclose:
    (i) Revenues, expenses, gains and losses and related tax effects 
which will not recur in the income of the registrant beyond 12 months 
after the transaction.
    (ii) For Transaction Accounting Adjustments:
    (A) A table showing the total consideration transferred or received 
including its components and how they were measured. If total 
consideration includes contingent consideration, describe the 
arrangement(s), the basis for determining the amount of payment(s) or 
receipt(s), and an estimate of the range of outcomes (undiscounted) or, 
if a range cannot be estimated, that fact and the reasons why; and
    (B) The following information when the accounting is incomplete: A 
prominent statement to this effect; the items for which the accounting 
depicted is incomplete; a description of the information that the 
registrant requires, including, if material, the uncertainties 
affecting the pro forma financial information and the possible 
consequences of their resolution; an indication of when the accounting 
is expected to be finalized; and other available information that will 
enable a reader to understand the magnitude of any potential 
adjustments to the measurements depicted.
    (iii) For each Autonomous Entity Adjustment, a description of the 
adjustment (including the material uncertainties), the material 
assumptions, the calculation of the adjustment, and additional 
qualitative information about the Autonomous Entity Adjustments, if 
any, necessary to give a fair and balanced presentation of the pro 
forma financial information.
    (12) A registrant must not:
    (i) Present pro forma financial information on the face of the 
registrant's historical financial statements or in the accompanying 
notes, except where such presentation is required by U.S. GAAP or IFRS-
IASB, as applicable.
    (ii) Present pro forma financial information, or summaries of such 
information, elsewhere in a filing that excludes material transactions 
for which pro forma effect is required to be given.
    (iii) Present the pro forma amounts in paragraph (a)(7) of this 
section elsewhere in a filing without also presenting with equal or 
greater prominence the amounts specified in paragraph (a)(7) of this 
section to which they are required to be reconciled and a cross-
reference to that reconciliation.
    (iv) Give pro forma effect to the registrant's adoption of an 
accounting standard in pro forma financial information required by 
Sec. Sec.  210.11-01 through 210.11-03.
    (b) Implementation guidance--(1) Historical statement of 
comprehensive income. The historical statement of comprehensive income 
used in the pro forma financial information must only be presented 
through income from continuing operations (or the appropriate 
modification thereof).
    (2) Business acquisitions. In some transactions, such as in 
financial institution acquisitions, measuring the acquired assets at 
their acquisition date fair value may result in significant discounts 
relative to the acquired business's historical cost of the acquired 
assets. When such discounts can result in a significant effect on 
earnings (losses) in periods immediately subsequent to the acquisition 
that will be progressively eliminated over a relatively short period, 
the effect of the discounts on reported results of operations for each 
of the next five years must be disclosed in a note.
    (3) Business dispositions. Transaction Accounting Adjustments 
giving effect to the disposition of a business must not decrease 
historically incurred compensation expense for employees who were not, 
or will not be, transferred or terminated as of the disposition date.
    (4) Multiple transactions. (i) When consummation of more than one 
transaction has occurred, or is probable, the pro forma financial 
information must present in separate columns each transaction for which 
pro forma presentation is required by Sec.  210.11-01.
    (ii) If the pro forma financial information is presented in a proxy 
or information statement for purposes of obtaining shareholder approval 
of one of the transactions, the effects of that transaction must be 
clearly set forth.
    (5) Tax effects. (i) Tax effects, if any, of pro forma adjustments 
normally should be calculated at the statutory rate in effect during 
the periods for which pro forma condensed statements of comprehensive 
income are presented and should be reflected as a separate pro forma 
adjustment.
    (ii) When the registrant's historical statements of comprehensive 
income do not reflect the tax provision on the separate return basis, 
pro forma statements of comprehensive income adjustments must reflect a 
tax provision calculated on the separate return basis.
    (c) Periods to be presented. (1) A pro forma condensed balance 
sheet as of the end of the most recent period for which a consolidated 
balance sheet of the registrant is required by Sec.  210.3-01 must be 
filed unless the transaction is already reflected in such balance 
sheet.
    (2)(i) Pro forma condensed statements of comprehensive income must 
be filed for only the most recent fiscal year, except as noted in 
paragraph (c)(2)(ii) of this section, and for the period from the most 
recent fiscal year end to the most recent interim date for which a 
balance sheet is required. A pro forma condensed statement of 
comprehensive income may be filed for the corresponding interim period 
of the preceding fiscal year. A pro forma condensed statement of 
comprehensive income must not be filed when the historical statement of 
comprehensive income reflects the transaction for the entire period.
    (ii) For transactions required to be accounted for under U.S. GAAP 
or, as applicable, IFRS-IASB by retrospectively revising the historical 
statements of comprehensive income (e.g., combination of entities under 
common control and discontinued operations), pro forma statements of 
comprehensive income must be filed for all periods for which historical 
financial statements of the registrant are required. Retrospective 
revisions stemming from the registrant's adoption of a new accounting 
principle must not be reflected in pro forma statements of 
comprehensive income until they are depicted in the registrant's 
historical financial statements.
    (3) Pro forma condensed statements of comprehensive income must be 
presented using the registrant's fiscal year end. If the most recent 
fiscal year end of any other entity involved in the transaction differs 
from the registrant's most recent fiscal year end by more than one 
fiscal quarter, the other entity's

[[Page 54069]]

statement of comprehensive income must be brought up to within one 
fiscal quarter of the registrant's most recent fiscal year end, if 
practicable. This updating could be accomplished by adding subsequent 
interim period results to the most recent fiscal year end information 
and deducting the comparable preceding year interim period results. 
Disclosure must be made of the periods combined and of the sales or 
revenues and income for any periods which were excluded from or 
included more than once in the condensed pro forma statement of 
comprehensive income (e.g., an interim period that is included both as 
part of the fiscal year and the subsequent interim period).
    Instruction 1 to paragraph (c)(3): In circumstances where different 
fiscal year ends exist, Sec.  210.3-12 may require a registrant to 
include in the pro forma financial information an acquired or to be 
acquired foreign business historical period that would be more current 
than the periods included in the required historical financial 
statements of the foreign business.
    (4) Whenever unusual events enter into the determination of the 
results shown for the most recently completed fiscal year, the effect 
of such unusual events should be disclosed and consideration should be 
given to presenting a pro forma condensed statement of comprehensive 
income for the most recent twelve-month period in addition to those 
required in paragraph (c)(2)(i) of this section if the most recent 
twelve-month period is more representative of normal operations.


Sec.  210.11-03  [Amended]

0
20. Amend Sec.  210.11-03 by:
0
a. In paragraph (a) introductory text, removing ``Sec.  210.11-
02(b)(1)'' and adding in its place ``Sec.  210.11-02(a)(1)''; and
0
b. In paragraph (a)(2), removing ``Sec.  210.11-02(b)(3)'' and adding 
in its place ``Sec.  210.11-02(a)(3)''.
0
c. In paragraph (d), removing ``rule'' and ``generally accepted 
accounting principles'' and adding in their places ``section'' and 
``U.S. GAAP or IFRS-IASB,'' respectively.

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

0
21. The authority citation for part 230 continues to read, in part, as 
follows:

    Authority:  15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h, 
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Pub. L. 112-106, sec. 201(a), sec. 401, 126 
Stat. 313 (2012), unless otherwise noted.
* * * * *

0
22. Amend Sec.  230.405 by revising the definition of ``Significant 
subsidiary'' to read as follows:


Sec.  230.405   Definitions of terms.

* * * * *
    Significant subsidiary. The term significant subsidiary means a 
subsidiary, including its subsidiaries, which meets any of the 
conditions in paragraph (1), (2), or (3) of this definition; however, 
if the registrant is a registered investment company or a business 
development company, the tested subsidiary meets any of the conditions 
in paragraph (4) of this definition instead of any of the conditions in 
paragraph (1), (2), or (3) of this definition. A registrant that files 
its financial statements in accordance with or provides a 
reconciliation to U.S. Generally Accepted Accounting Principles (U.S. 
GAAP) must use amounts determined under U.S. GAAP. A foreign private 
issuer that files its financial statements in accordance with 
International Financial Reporting Standards as issued by the 
International Accounting Standards Board (IFRS-IASB) must use amounts 
determined under IFRS-IASB.
    (1) Investment test. (i) For acquisitions, other than those 
described in paragraph (1)(ii) of this definition, and dispositions 
this test is met when the registrant's and its other subsidiaries' 
investments in and advances to the tested subsidiary exceed 10 percent 
of the aggregate worldwide market value of the registrant's voting and 
non-voting common equity, or if the registrant has no such aggregate 
worldwide market value, the total assets of the registrant and its 
subsidiaries consolidated as of the end of the most recently completed 
fiscal year.
    (A) For acquisitions, the ``investments in'' the tested subsidiary 
is the consideration transferred, adjusted to exclude the registrant's 
and its subsidiaries' proportionate interest in the carrying value of 
assets transferred by the registrant and its subsidiaries consolidated 
to the tested subsidiary that will remain with the combined entity 
after the acquisition. It must include the fair value of contingent 
consideration if required to be recognized at fair value by the 
registrant at the acquisition date under U.S. GAAP or IFRS-IASB, as 
applicable; however if recognition at fair value is not required, it 
must include all contingent consideration, except contingent 
consideration for which the likelihood of payment is remote.
    (B) For dispositions, the ``investments in'' the tested subsidiary 
is the fair value of the consideration, including contingent 
consideration, for the disposed subsidiary when comparing to the 
aggregate worldwide market value of the registrant's voting and non-
voting common equity, or, when the registrant has no such aggregate 
worldwide market value, the carrying value of the disposed subsidiary 
when comparing to total assets of the registrant.
    (C) When determining the aggregate worldwide market value of the 
registrant's voting and non-voting common equity, use the average of 
such aggregate worldwide market value calculated daily for the last 
five trading days of the registrant's most recently completed month 
ending prior to the earlier of the registrant's announcement date or 
agreement date of the acquisition or disposition.
    (ii) For a combination between entities or businesses under common 
control, this test is met when either the net book value of the tested 
subsidiary exceeds 10 percent of the registrant's and its subsidiaries' 
consolidated total assets or the number of common shares exchanged or 
to be exchanged by the registrant exceeds 10 percent of its total 
common shares outstanding at the date the combination is initiated.
    (iii) In all other cases, this test is met when the registrant's 
and its other subsidiaries' investments in and advances to the tested 
subsidiary exceed 10 percent of the total assets of the registrant and 
its subsidiaries consolidated as of the end of the most recently 
completed fiscal year.
    (2) Asset test. This test is met when the registrant's and its 
other subsidiaries' proportionate share of the tested subsidiary's 
consolidated total assets (after intercompany eliminations) exceeds 10 
percent of such total assets of the registrant and its subsidiaries 
consolidated as of the end of the most recently completed fiscal year.
    (3) Income test. (i) This test is met when:
    (A) The absolute value of the registrant's and its other 
subsidiaries' equity in the tested subsidiary's consolidated income or 
loss from continuing operations before income taxes (after intercompany 
eliminations) attributable to the controlling interests exceeds 10 
percent of the absolute value of such income or loss of the registrant 
and its subsidiaries consolidated for the most recently completed 
fiscal year; and
    (B) The registrant's and its other subsidiaries' proportionate 
share of the tested subsidiary's consolidated total revenue from 
continuing operations (after intercompany eliminations)

[[Page 54070]]

exceeds 10 percent of such total revenue of the registrant and its 
subsidiaries consolidated for the most recently completed fiscal year. 
This paragraph (3)(i)(B) does not apply if either the registrant and 
its subsidiaries consolidated or the tested subsidiary did not have 
material revenue in each of the two most recently completed fiscal 
years.
    (ii) When determining the income component in paragraph (3)(i)(A) 
of this definition:
    (A) If a net loss from continuing operations before income taxes 
(after intercompany eliminations) attributable to the controlling 
interest has been incurred by either the registrant and its 
subsidiaries consolidated or the tested subsidiary, but not both, 
exclude the equity in the income or loss from continuing operations 
before income taxes (after intercompany eliminations) of the tested 
subsidiary attributable to the controlling interest from such income or 
loss of the registrant and its subsidiaries consolidated for purposes 
of the computation;
    (B) Compute the test using the average described in this paragraph 
(3)(ii)(B) if the revenue component in paragraph (3)(i)(B) in this 
definition does not apply and the absolute value of the registrant's 
and its subsidiaries' consolidated income or loss from continuing 
operations before income taxes (after intercompany eliminations) 
attributable to the controlling interests for the most recent fiscal 
year is at least 10 percent lower than the average of the absolute 
value of such amounts for each of its last five fiscal years; and
    (C) Entities reporting losses must not be aggregated with entities 
reporting income where the test involves combined entities, as in the 
case of determining whether summarized financial data must be presented 
or whether the aggregate impact specified in Sec. Sec.  210.3-
05(b)(2)(iv) and 210.3-14(b)(2)(i)(C) of this chapter is met, except 
when determining whether related businesses meet this test for purposes 
of Sec. Sec.  210.3-05 and 210.8-04 of this chapter.
    (4) Registered investment company or business development company. 
For a registrant that is a registered investment company or a business 
development company, the term significant subsidiary means a 
subsidiary, including its subsidiaries, which meets any of the 
following conditions using amounts determined under U.S. GAAP and, if 
applicable, section 2(a)(41) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(41)):
    (i) Investment test. The value of the registrant's and its other 
subsidiaries' investments in and advances to the tested subsidiary 
exceed 10 percent of the value of the total investments of the 
registrant and its subsidiaries consolidated as of the end of the most 
recently completed fiscal year; or
    (ii) Income test. The absolute value of the sum of combined 
investment income from dividends, interest, and other income, the net 
realized gains and losses on investments, and the net change in 
unrealized gains and losses on investments from the tested subsidiary 
(except, for purposes of Sec.  210.6-11 of this chapter, the absolute 
value of the change in net assets resulting from operations of the 
tested subsidiary), for the most recently completed fiscal year 
exceeds:
    (A) 80 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year; or
    (B) 10 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year and the 
investment test (paragraph (4)(i) of this definition) condition exceeds 
5 percent. However, if the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated is at least 10 percent lower than the average of the 
absolute value of such amounts for each of its last five fiscal years, 
then the registrant may compute both conditions of the income test 
using the average of the absolute value of such amounts for the 
registrant and its subsidiaries consolidated for each of its last five 
fiscal years.
* * * * *

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
23. The authority citation for part 239 continues to read, in part, as 
follows:

    Authority:  15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-
3, 77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 
78ll, 78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 
80a-26, 80a-29, 80a-30, and 80a-37; and sec. 107, Pub. L. 112-106, 
126 Stat. 312, unless otherwise noted.
* * * * *

0
24. Form S-11 (referenced in Sec.  239.18) is amended by revising Item 
9 to read as follows:

    Note: The text of Form S-11 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM S-11

* * * * *

Item 9. Selected Financial Data

    File the information required by Item 301 of Regulation S-K (Sec.  
229.301 of this chapter).

0
25. Form N-14 (referenced in Sec.  239.23) is amended by revising Item 
14 to read as follows:

    Note:  The text of Form N-14 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM N-14

* * * * *

Item 14. Financial Statements

    The Statement of Additional Information must contain the financial 
statements, including the schedules thereto, and supplemental financial 
information of the acquiring company and the company to be acquired 
required by Regulation S-X [17 CFR 210] for the periods specified in 
Article 3 and Rule 6-11 of Regulation S-X, except:
    1. If the company to be acquired is an investment company or would 
be an investment company but for the exclusions provided by sections 
3(c)(1) or 3(c)(7) of the 1940 Act [15 U.S.C. 80a-3(c)(1) and (c)(7)] 
(a ``private fund''), the financial statements need only be filed for 
the most recent fiscal year and the most recent interim period, unless 
it is an investment company subject to Sec.  210.3-18 in which case the 
financial statements for the periods described therein must be filed;
    2. if the company to be acquired is a private fund, then the 
required financial statements may comply with U.S. Generally Accepted 
Accounting Principles and only Article 12 of Regulation S-X;
    3. the financial statements required by Regulation S-X for any 
subsidiary that is not a majority-owned subsidiary may be omitted from 
Part B and included in Part C; and
    4. the table showing the current fees and pro forma fees, if 
different, required by Rule 6-11 of Regulation S-X (which is required 
by Item 3 of this Form).
* * * * *

0
26. Amend Part F/S of Form 1-A (referenced in Sec.  239.90) by revising 
paragraph (b)(7)(iv) to read as follows:

    Note: The text of Form 1-A does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM 1-A

REGULATION A OFFERING STATEMENT UNDER THE SECURITIES ACT OF 1933

GENERAL INSTRUCTIONS

* * * * *

[[Page 54071]]

Part F/S

* * * * *
    (b) Financial Statements for Tier 1 Offerings * * *
    (7) * * *
    (iv) Pro Forma Financial Statements. File pro forma financial 
information as described in Rule 8-05 of Regulation S-X.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
27. The authority citation for part 240 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.; and 
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; 
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and Pub. L. 112-106, 
sec. 503 and 602, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *

0
28. Amend Sec.  240.12b-2 by revising the definition of ``Significant 
subsidiary'' to read as follows:


Sec.  240.12b-2  Definitions.

* * * * *
    Significant subsidiary. The term significant subsidiary means a 
subsidiary, including its subsidiaries, which meets any of the 
conditions in paragraph (1), (2), or (3) of this definition; however, 
if the registrant is a registered investment company or a business 
development company, the tested subsidiary meets any of the conditions 
in paragraph (4) of this definition instead of any of the conditions in 
paragraph (1), (2), or (3) of this definition. A registrant that files 
its financial statements in accordance with or provides a 
reconciliation to U.S. Generally Accepted Accounting Principles (U.S. 
GAAP) must use amounts determined under U.S. GAAP. A foreign private 
issuer that files its financial statements in accordance with 
International Financial Reporting Standards as issued by the 
International Accounting Standards Board (IFRS-IASB) must use amounts 
determined under IFRS-IASB.
    (1) Investment test. (i) For acquisitions, other than those 
described in paragraph (1)(ii) of this definition, and dispositions 
this test is met when the registrant's and its other subsidiaries' 
investments in and advances to the tested subsidiary exceed 10 percent 
of the aggregate worldwide market value of the registrant's voting and 
non-voting common equity, or if the registrant has no such aggregate 
worldwide market value, the total assets of the registrant and its 
subsidiaries consolidated as of the end of the most recently completed 
fiscal year.
    (A) For acquisitions, the ``investments in'' the tested subsidiary 
is the consideration transferred, adjusted to exclude the registrant's 
and its subsidiaries' proportionate interest in the carrying value of 
assets transferred by the registrant and its subsidiaries consolidated 
to the tested subsidiary that will remain with the combined entity 
after the acquisition. It must include the fair value of contingent 
consideration if required to be recognized at fair value by the 
registrant at the acquisition date under U.S. GAAP or IFRS-IASB, as 
applicable; however if recognition at fair value is not required, it 
must include all contingent consideration, except contingent 
consideration for which the likelihood of payment is remote.
    (B) For dispositions, the ``investments in'' the tested subsidiary 
is the fair value of the consideration, including contingent 
consideration, for the disposed subsidiary when comparing to the 
aggregate worldwide market value of the registrant's voting and non-
voting common equity, or, when the registrant has no such aggregate 
worldwide market value, the carrying value of the disposed subsidiary 
when comparing to total assets of the registrant.
    (C) When determining the aggregate worldwide market value of the 
registrant's voting and non-voting common equity, use the average of 
such aggregate worldwide market value calculated daily for the last 
five trading days of the registrant's most recently completed month 
ending prior to the earlier of the registrant's announcement date or 
agreement date of the acquisition or disposition.
    (ii) For a combination between entities or businesses under common 
control, this test is met when either the net book value of the tested 
subsidiary exceeds 10 percent of the registrant's and its subsidiaries' 
consolidated total assets or the number of common shares exchanged or 
to be exchanged by the registrant exceeds 10 percent of its total 
common shares outstanding at the date the combination is initiated.
    (iii) In all other cases, this test is met when the registrant's 
and its other subsidiaries' investments in and advances to the tested 
subsidiary exceed 10 percent of the total assets of the registrant and 
its subsidiaries consolidated as of the end of the most recently 
completed fiscal year.
    (2) Asset test. This test is met when the registrant's and its 
other subsidiaries' proportionate share of the tested subsidiary's 
consolidated total assets (after intercompany eliminations) exceeds 10 
percent of such total assets of the registrant and its subsidiaries 
consolidated as of the end of the most recently completed fiscal year.
    (3) Income test. (i) This test is met when:
    (A) The absolute value of the registrant's and its other 
subsidiaries' equity in the tested subsidiary's consolidated income or 
loss from continuing operations before income taxes (after intercompany 
eliminations) attributable to the controlling interests exceeds 10 
percent of the absolute value of such income or loss of the registrant 
and its subsidiaries consolidated for the most recently completed 
fiscal year; and
    (B) The registrant's and its other subsidiaries' proportionate 
share of the tested subsidiary's consolidated total revenue from 
continuing operations (after intercompany eliminations) exceeds 10 
percent of such total revenue of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year. This 
paragraph (3)(i)(B) does not apply if either the registrant and its 
subsidiaries consolidated or the tested subsidiary did not have 
material revenue in each of the two most recently completed fiscal 
years.
    (ii) When determining the income component in paragraph (3)(i)(A) 
of this definition:
    (A) If a net loss from continuing operations before income taxes 
(after intercompany eliminations) attributable to the controlling 
interest has been incurred by either the registrant and its 
subsidiaries consolidated or the tested subsidiary, but not both, 
exclude the equity in the income or loss from continuing operations 
before income taxes (after intercompany eliminations) of the tested 
subsidiary attributable to the controlling interest from such income or 
loss of the registrant and its subsidiaries consolidated for purposes 
of the computation;
    (B) Compute the test using the average described in this paragraph 
(3)(ii)(B) if the revenue component in paragraph (3)(i)(B) in this 
definition does not apply and the absolute value of the registrant's 
and its subsidiaries' consolidated income or loss from continuing 
operations before income taxes (after intercompany eliminations) 
attributable to the controlling interests for the most recent fiscal 
year is at least 10 percent lower than the average of the absolute

[[Page 54072]]

value of such amounts for each of its last five fiscal years; and
    (C) Entities reporting losses must not be aggregated with entities 
reporting income where the test involves combined entities, as in the 
case of determining whether summarized financial data must be presented 
or whether the aggregate impact specified in Sec. Sec.  210.3-
05(b)(2)(iv) and 210.3-14(b)(2)(i)(C) of this chapter is met, except 
when determining whether related businesses meet this test for purposes 
of Sec. Sec.  210.3-05 and 210.8-04 of this chapter.
    (4) Registered investment company or business development company. 
For a registrant that is a registered investment company or a business 
development company, the term significant subsidiary means a 
subsidiary, including its subsidiaries, which meets any of the 
following conditions using amounts determined under U.S. GAAP and, if 
applicable, section 2(a)(41) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(41)):
    (i) Investment test. The value of the registrant's and its other 
subsidiaries' investments in and advances to the tested subsidiary 
exceed 10 percent of the value of the total investments of the 
registrant and its subsidiaries consolidated as of the end of the most 
recently completed fiscal year; or
    (ii) Income test. The absolute value of the sum of combined 
investment income from dividends, interest, and other income, the net 
realized gains and losses on investments, and the net change in 
unrealized gains and losses on investments from the tested subsidiary 
(except, for purposes of Sec.  210.6-11 of this chapter, the absolute 
value of the change in net assets resulting from operations of the 
tested subsidiary), for the most recently completed fiscal year 
exceeds:
    (A) 80 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year; or
    (B) 10 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year and the 
investment test (paragraph (4)(i) of this definition) condition exceeds 
5 percent. However, if the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated is at least 10 percent lower than the average of the 
absolute value of such amounts for each of its last five fiscal years, 
then the registrant may compute both conditions of the income test 
using the average of the absolute value of such amounts for the 
registrant and its subsidiaries consolidated for each of its last five 
fiscal years.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
29. The authority citation for part 249 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C. 
5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111-203, 124 
Stat. 1904; Sec. 102(a)(3), Pub. L. 112-106, 126 Stat. 309 (2012); 
Sec. 107, Pub. L. 112-106, 126 Stat. 313 (2012), and Sec. 72001, 
Pub. L. 114-94, 129 Stat. 1312 (2015), unless otherwise noted.
* * * * *

0
30. Form 8-K (referenced in Sec.  249.308) is amended by revising the 
introductory text to Item 2.01, Instruction 4 to Item 2.01, and Item 
9.01 to read as follows:

    Note: The text of Form 8-K does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM 8-K

* * * * *

Item 2.01. Completion of Acquisition or Disposition of Assets

    If the registrant or any of its subsidiaries consolidated has 
completed the acquisition or disposition of a significant amount of 
assets, otherwise than in the ordinary course of business, or the 
acquisition or disposition of a significant amount of assets that 
constitute a real estate operation as defined in Sec.  210.3-14(a)(2) 
disclose the following information:
* * * * *
    Instructions. * * *
    4. An acquisition or disposition will be deemed to involve a 
significant amount of assets:
    (i) If the registrant's and its other subsidiaries' equity in the 
net book value of such assets or the amount paid or received for the 
assets upon such acquisition or disposition exceeded 10 percent of the 
total assets of the registrant and its consolidated subsidiaries;
    (ii) if it involved a business (see 17 CFR 210.11-01(d)) that is 
significant (see 17 CFR 210.11-01(b)). The acquisition of a business 
encompasses the acquisition of an interest in a business accounted for 
by the registrant under the equity method or, in lieu of the equity 
method, the fair value option; or
    (iii) in the case of a business development company, if the amount 
paid for such assets exceeded 10 percent of the value of the total 
investments of the registrant and its consolidated subsidiaries.
    The aggregate impact of acquired businesses are not required to be 
reported pursuant to this Item 2.01 unless they are related businesses 
(see 17 CFR 210.3-05(a)(3)), related real estate operations (see 17 CFR 
210.3-14(a)(3)), or related funds (see 17 CFR 210.6-11(a)(3)), and are 
significant in the aggregate.
    5. Attention is directed to the requirements in Item 9.01 
(Financial Statements and Exhibits) with respect to the filing of:
    (i) Financial statements of businesses or funds acquired;
* * * * *

Item 9.01. Financial Statements and Exhibits

    List below the financial statements, pro forma financial 
information and exhibits, if any, filed as a part of this report.
    (a) Financial statements of businesses or funds acquired.
    (1) For any business acquisition or fund acquisition required to be 
described in answer to Item 2.01 of this form, file financial 
statements and any applicable supplemental information, of the business 
acquired specified in Rules 3-05 or 3-14 of Regulation S-X (17 CFR 
210.3-05 and 210.3-14), or Rules 8-04 or 8-06 of Regulation S-X (17 CFR 
210.8-04 and 210.8-06) for smaller reporting companies, or of the fund 
acquired specified in Rule 6-11 of Regulation S-X (17 CFR 210.6-11).
    (2) The financial statements must be prepared pursuant to 
Regulation S-X except that supporting schedules need not be filed 
unless required by Rule 6-11 of Regulation S-X (17 CFR 210.6-11). A 
manually signed accountant's report should be provided pursuant to Rule 
2-02 of Regulation S-X (17 CFR 210.2-02).
    (3) Financial statements required by this item may be filed with 
the initial report, or by amendment not later than 71 calendar days 
after the date that the initial report on Form 8-K must be filed. If 
the financial statements are not included in the initial report, the 
registrant should so indicate in the Form 8-K report and state when the 
required financial statements will be filed. The registrant may, at its 
option, include unaudited financial statements in the initial report on 
Form 8-K.
    (b) Pro forma financial information.
    (1) For any transaction required to be described in answer to Item 
2.01 of this form, file any pro forma financial information that would 
be required pursuant to Article 11 of Regulation S-

[[Page 54073]]

X (17 CFR 210) or Rule 8-05 of Regulation S-X (17 CFR 210.8-05) for 
smaller reporting companies unless it involves the acquisition of a 
fund subject to Rule 6-11 of Regulation S-X (17 CFR 210.6-11).
    (2) The provisions of paragraph (a)(3) of this Item 9.01 must also 
apply to pro forma financial information relative to the acquired 
business.
    (c) Shell company transactions. The provisions of paragraph (a)(3) 
and (b)(2) of this Item do not apply to the financial statements or pro 
forma financial information required to be filed under this Item with 
regard to any transaction required to be described in answer to Item 
2.01 of this Form by a registrant that was a shell company, other than 
a business combination related shell company, as those terms are 
defined in Rule 12b-2 under the Exchange Act (17 CFR 240.12b-2), 
immediately before that transaction. Accordingly, with regard to any 
transaction required to be described in answer to Item 2.01 of this 
Form by a registrant that was a shell company, other than a business 
combination related shell company, immediately before that transaction, 
the financial statements and pro forma financial information required 
by this Item must be filed in the initial report. Notwithstanding 
General Instruction B.3. to Form 8-K, if any financial statement or any 
financial information required to be filed in the initial report by 
this Item 9.01(c) is previously reported, as that term is defined in 
Rule 12b-2 under the Exchange Act (17 CFR 240.12b-2), the registrant 
may identify the filing in which that disclosure is included instead of 
including that disclosure in the initial report.
    (d) Exhibits. * * *
    Instruction.
    During the period after a registrant has reported an acquisition 
pursuant to Item 2.01 of this form, until the date on which the 
financial statements specified by this Item 9.01 must be filed, the 
registrant will be deemed current for purposes of its reporting 
obligations under Section 13(a) or 15(d) of the Exchange Act (15 U.S.C. 
78m or 78o(d)). With respect to filings under the Securities Act, 
however, registration statements will not be declared effective and 
post-effective amendments to registration statements will not be 
declared effective unless financial statements meeting the requirements 
of Rule 3-05, Rule 3-14, Rule 6-11, Rule 8-04, and Rule 8-06 of 
Regulation S-X (17 CFR 210.3-05, 210.3-14, 210.6-11, 210.8-04, and 
210.8-06), as applicable, are provided. In addition, offerings should 
not be made pursuant to effective registration statements, or pursuant 
to Rule 506 of Regulation D (17 CFR 230.506) where any purchasers are 
not accredited investors under Rule 501(a) of that Regulation, until 
the audited financial statements required by Rule 3-05, Rule 3-14, Rule 
6-11, Rule 8-04, and Rule 8-06 of Regulation S-X (17 CFR 210.3-05, 
210.3-14, 210.6-11, 210.8-04, and 210.8-06), as applicable, are filed; 
provided, however, that the following offerings or sales of securities 
may proceed notwithstanding that financial statements of the acquired 
business have not been filed:
    (a) Offerings or sales of securities upon the conversion of 
outstanding convertible securities or upon the exercise of outstanding 
warrants or rights;
    (b) dividend or interest reinvestment plans;
    (c) employee benefit plans;
    (d) transactions involving secondary offerings; or
    (e) sales of securities pursuant to Rule 144 (17 CFR 230.144).
* * * * *

0
31. Form 10-K (referenced in Sec.  249.310) is amended by revising Item 
8.(a) of PART II to read as follows:

    Note: The text of Form 10-K does not, and this amendment will 
not, appear in the Code of Federal Regulations.

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
EXCHANGE ACT OF 1934

GENERAL INSTRUCTIONS

* * * * *

PART II. * * *

Item 8. Financial Statements and Supplementary Data

    (a) File financial statements meeting the requirements of 
Regulation S-X (Sec.  210 of this chapter), except Sec.  210.3-05, 
Sec.  210.3-14, Sec.  210.6-11, Sec.  210.8-04, Sec.  210.8-05, Sec.  
210.8-06 and Article 11 thereof, and the supplementary financial 
information required by Item 302 of Regulation S-K (Sec.  229.302 of 
this chapter). Financial statements of the registrant and its 
subsidiaries consolidated (as required by Rule 14a-3(b)) must be filed 
under this item. Other financial statements and schedules required 
under Regulation S-X may be filed as ``Financial Statement Schedules'' 
pursuant to Item 15, Exhibits, Financial Statement Schedules, and 
Reports on Form 8-K, of this form.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
32. The general authority citation for part 270 continues to read as 
follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless 
otherwise noted.
* * * * *

0
33. Amend Sec.  270.8b-2 by revising paragraph (k) to read as follows:


Sec.  270.8b-2  Definitions.

* * * * *
    (k) Significant subsidiary. The term ``significant subsidiary'' 
means a subsidiary, including its subsidiaries, which meets any of the 
following conditions, using amounts determined under U.S. Generally 
Accepted Accounting Principles and, if applicable, section 2(a)(41) of 
the Act:
    (1) Investment test. The value of the registrant's and its other 
subsidiaries' investments in and advances to the tested subsidiary 
exceed 10 percent of the value of the total investments of the 
registrant and its subsidiaries consolidated as of the end of the most 
recently completed fiscal year; or
    (2) Income test. The absolute value of the sum of combined 
investment income from dividends, interest, and other income, the net 
realized gains and losses on investments, and the net change in 
unrealized gains and losses on investments from the tested subsidiary, 
for the most recently completed fiscal year exceeds:
    (i) 80 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year; or
    (ii) 10 percent of the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated for the most recently completed fiscal year and the 
investment test (paragraph (k)(1) of this section) condition exceeds 5 
percent. However, if the absolute value of the change in net assets 
resulting from operations of the registrant and its subsidiaries 
consolidated is at least 10 percent lower than the average of the 
absolute value of such amounts for each of its last five fiscal years, 
then the registrant may compute both conditions of the income test 
using the average of the absolute value of such amounts for the 
registrant and its subsidiaries consolidated for each of its last five 
fiscal years.
* * * * *

[[Page 54074]]

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

0
34. The general authority citation for part 274 continues to read as 
follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, 80a-26, 80a-29, and Pub. L. 111-203, 
sec. 939A, 124 Stat. 1376 (2010), unless otherwise noted.
* * * * *

0
35. Amend Form N-2 (referenced in Sec. Sec.  239.14 and 274.11a-1) as 
follows:
0
a. Revise Item 8.6, paragraph (a) to Instruction 1 by removing the 
phrase ``Sections 210.6-01 through 210.6-10 of Regulation S-X [17 CFR 
210.6-01 through 210.6-10]'' and adding in its place ``Article 6 of 
Regulation S-X [17 CFR 210.6-01 et seq.]''.
0
b. Revise Item 24, paragraph (a) to Instruction 1 by removing the 
phrase ``Sections 210.6-01 through 210.6-10 of Regulation S-X [17 CFR 
210.6-01 through 210.6-10]'' and adding in its place ``Article 6 of 
Regulation S-X [17 CFR 210.6-01 et seq.]''.

    Note:  The text of Form N-2 does not, and this amendment will 
not, appear in the Code of Federal Regulations.


    By the Commission.

    Dated: May 20, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020-11479 Filed 8-28-20; 8:45 am]
BILLING CODE 8011-01-P


