The Securities and Exchange Commission (SEC) recently approved amendments to the definition of “smaller reporting company” (SRC), which will allow more businesses to take advantage of scaled disclosure requirements in their public filings. Among other benefits, smaller reporting companies are permitted to include two years of audited financial statements (compared to three years for larger reporting companies), avoid pay ratio disclosure and may provide scaled disclosure on executive compensation. Scheduled to take effect on September 10, 2018, the final rule changes will increase the financial thresholds in the current definition by a considerable margin.  Significantly, however, the SEC did not make a corresponding increase in the financial threshold in the definition of “accelerated filer.” This divergence means that newly-eligible smaller reporting companies with more than $75 million in public float may remain subject to the requirements applicable to accelerated filers.

Whether a company qualifies for SRC treatment remains tied to the size of its public float and its revenues. Under the amended definition, smaller reporting companies generally are entities that meet one of the following tests:

• Public Float Test. Less than $250 million in public float as of the last business day of the most recently ended second fiscal quarter. (Currently, this threshold is set at $75 million.) OR
• Revenue Test. Annual revenues of less than $100 million for the most recently completed fiscal year for which audited financial statements are available and either no public float or less than $700 million in public float as of the last business day of the most recently ended second fiscal quarter. (The current revenue test applies to businesses with annual revenues of less than $50 million and no public float.)

Calendar year-end companies should apply the new SRC definition when assessing their eligibility for the fiscal year ending December 31, 2018. The public float prong will be evaluated as of June 29, 2018, and the revenue prong will be tested using the most recent audited financial statements. We expect that calendar year-end companies that are newly-eligible for SRC status based on the public float test will be permitted to provide scaled disclosures in their Forms 10-Q for the third quarter ended September 30, 2018 although the SEC has not issued official guidance on this question.

A registrant that determines it does not qualify as a SRC under the tests described above may qualify at a later date, but only if it meets certain lower qualification thresholds. The financial thresholds for subsequent testing are set at 80  percent of the initial levels, consistent with the existing SRC definition, and are designed to avoid the scenario in which a company frequently enters and exits SRC status due to small fluctuations in the level of its public float.

The amendments to the qualification thresholds in the SRC definition, for determinations made at the initial testing stage and thereafter, are summarized in the following table:

As noted above, the SEC did not propose to increase the $75 million threshold in the “accelerated filer” definition in conjunction with the SRC amendments. Instead, that threshold was preserved and the automatic exclusion for companies that are also smaller reporting companies was removed. As a result, following effectiveness of the new rules, a company with a public float between $75 million and $250 million could qualify as both a SRC and an accelerated filer. A registrant meeting these definitions would benefit from the scaled disclosure accommodations, but simultaneously would be required to comply with the filing requirements applicable to accelerated filers, which include, most notably, shorter deadlines for the filing of periodic reports and delivery of an outside auditor’s attestation of management’s assessment of internal control over financial reporting, as required by Section 404(b) of the Sarbanes-Oxley Act of 2002. While this overlap may lead to regulatory complexities and more onerous disclosure obligations for certain smaller reporting companies in the near term, SEC Chairman Jay Clayton directed the staff to review the “accelerated filer” definition and to propose additional changes that, if adopted, would reduce the number of companies that qualify as accelerated filers.

The SEC staff estimates that nearly 1,000 additional companies will be eligible for SRC status due to these amendments. As with the current rules, investment companies, asset-backed issuers and majority-owned subsidiaries of a parent that is not a SRC are not eligible for this classification.

Ahead of the effectiveness of the final rule changes, public companies should evaluate whether they qualify as smaller reporting companies under the revised framework and, if so, weigh the benefits and consequences of the scaled disclosure accommodations. Newly-eligible smaller reporting companies should also ensure they have a complete understanding of the few yet important disclosure requirements applicable to smaller reporting companies that are more stringent than the equivalent standard applicable to larger businesses, including Item 404(d) of Regulation S-K pertaining to transactions with related persons. Additionally, while the SEC may ultimately decide to restore the exemption from “accelerated filer” status for smaller reporting companies, for the time being it will be important for smaller reporting companies to pay special attention to whether they are subject to the additional requirements that apply to this class of registrants.