On March 2, the Securities Exchange Commission (SEC) adopted amendments that, among other things, significantly reduce the subsidiary guarantor financial statement requirements in periodic reports for companies that have registered debt that is guaranteed by subsidiaries. These changes are part of the SEC’s ongoing efforts to modernize and ease disclosure burdens for public companies. The SEC hopes that these amendments will facilitate an increase in the number of registered (versus unregistered) debt offerings.

Although the amendments do not become effective until January 2021, in light of the relief offered, many companies are preparing to voluntarily comply with the amendments in advance of the effective date (which is expressly permitted by the SEC).

This alert briefly describes the changes to existing reporting requirements for subsidiary guarantors. The SEC’s press release announcing the changes and full text of the final rule can be found here.

Existing Requirements of Rule 3-10

Rule 3-10 of Regulation S-X currently requires each subsidiary guarantor of registered debt securities to file its own audited annual and unaudited interim financial statements, provided that a parent company may instead provide abbreviated alternative disclosures regarding subsidiary guarantors in its financial statements (and thus eliminate any separate filing requirement for a subsidiary guarantor) if certain conditions are met, including that guarantors be “100%-owned” by the parent company and that guarantees are “full and unconditional.”

The form and content of the alternative disclosures are determined based on the guarantor structure but most often require the inclusion of detailed condensed consolidating financial information, which can be challenging and time-consuming to prepare (in particular for companies with a large number of subsidiary guarantors). The parent company is required to continue to provide such alternative disclosures in its annual and quarterly reports for as long as the debt securities are outstanding.

Amendments to Rule 3-10

The amendments to Rule 3-10 are as follows:

• Make it easier to avoid filing separate full financial statements by replacing the condition that a subsidiary guarantor is 100%-owned by the parent company with a condition that it be consolidated in the parent company’s consolidated financial statements.
• Reduce the information that is required to be disclosed by replacing condensed consolidating financial information with certain new financial and non-financial disclosures. The amended financial disclosures will consist of summarized financial information of the issuers and guarantors, which may be presented on a combined basis, and the amendments reduce the number of periods presented but will expand the qualitative disclosures about the guarantees and the issuers and guarantors. Consistent with the existing rule, disclosure of additional information about each guarantor will be required if it would be material for investors to evaluate the sufficiency of the guarantee.
• Eliminate the need for the disclosures to be audited by permitting the amended disclosures to be provided outside the footnotes to the parent company’s audited annual and unaudited interim consolidated financial statements (such as in the MD&A), in all filings.
• Reduce the length of time the disclosures must be provided by only requiring the amended financial and non-financial disclosures for as long as any guarantor has an Exchange Act reporting obligation for the guaranteed securities, rather than for as long as the guaranteed securities are outstanding.

Overall, these amendments provide welcome relief in reducing the compliance burdens for issuers of guaranteed securities and may encourage more issuers to offer guaranteed securities on a registered basis.

Recommendations for Issuers in Light of the Amendments to Rule 3-10

We recommend that affected companies take the following actions:

1. Assess how the amendments will impact their disclosures.
2. Decide whether to go ahead and transition to the new requirements (as early as in the upcoming Quarterly Report on Form 10-Q to be filed for the period ended March 31, 2020), which we believe many public companies subject to these rules will elect to do.
3. At such time that the new disclosure requirements are followed, consider whether to continue to provide the required disclosure in financial statement footnotes (which are audited, on an annual basis) or to include the disclosure in the MD&A (which is unaudited). We expect that a significant number of companies who transition to the new disclosure requirements will take a wait-and-see approach and keep this disclosure in the financial statement footnotes for now.
4. Consider – potentially in consultation with underwriters – whether there are any capital markets implications with potential disclosure approaches taken in periodic reports. Remember that from a capital markets perspective, disclosures (including subsidiary guarantor disclosures) from periodic reports will be incorporated by reference into offering documents, and issuers and their underwriters will want to be able to move quickly in an offering context without needing to build out additional subsidiary guarantor disclosure in comparison to what is already included in an issuer’s periodic reports.