On July 24, 2018, the Securities and Exchange Commission (SEC) proposed rule amendments that would simplify the financial disclosure requirements applicable to registered debt offerings for guarantors and issuers of guaranteed securities, as well for affiliates whose securities collateralize a registrant’s securities. The proposed changes are part of the SEC’s ongoing efforts to ease disclosure and capital formation burdens for public companies while continuing to ensure that investors have access to material information.
The proposed changes would amend Rules 3-10 and 3-16 of Regulation S-X and relocate part of Rule 3-10 and all of Rule 3-16 to new Article 13 in Regulation S-X, which would comprise proposed Rules 13-01 and 13-02. Below is a brief summary of existing Rule 3-10 and Rule 3-16 and the most prominent proposed changes to such rules. Also included herein is a helpful table, excerpted from the SEC release, that includes side-by-side comparisons of the main features of the existing and proposed rules.
Under Rule 3-10, each issuer and guarantor of registered debt securities (which effectively includes securities issued in Rule 144A private placements with registration rights) must file its own audited annual and unaudited interim financial statements. However, Rule 3-10 contains five exceptions that conditionally allow a parent company to provide abbreviated disclosures in its own financial statements to cover a subsidiary issuer or guarantor. All five exceptions require that (1) each subsidiary issuer and guarantor be “100 percent owned” by the parent company; (2) each guarantee be “full and unconditional”; and (3) the parent company provide certain disclosures in its consolidated financial statements (the Alternative Disclosures).
The form and content of the Alternative Disclosures are determined based on the facts and circumstances of the issuer and guarantor structure and can range from brief narrative disclosures to, more commonly, highly detailed condensed consolidating financial information (Consolidating Information). Preparation of the Consolidating Information, while less costly than full financial statements, is often challenging and time-consuming, and can be costly, as many registrants do not typically design their accounting systems to capture the required information for each individual issuer or guarantor.
Subsidiary issuers and guarantors that are permitted to omit their separate financial statements under Rule 3-10 are automatically exempt from the public-company reporting provisions under the Exchange Act via Rule 12h-5. The parent company, however, must continue to provide the Alternative Disclosures in its annual and quarterly reports for as long as the guaranteed securities are outstanding, even if the subsidiary issuer or guarantor otherwise could suspend its reporting obligation by operation of Exchange Act Section 15(d)(1) or compliance with Rule 12h-3.
Recently acquired subsidiary issuers and guarantors are addressed separately, and less favorably, under Rule 3-10. A parent company registration statement covering the issuance of guaranteed debt securities must include one year of audited, and, if applicable, unaudited interim pre-acquisition financial statements for recently acquired subsidiary issuers and guarantors that are significant and have not been reflected in the parent company’s audited results for at least nine months of the most recent fiscal year.1
Rule 3-16 requires separate audited and interim financial statements for an issuer’s affiliate if the securities of that affiliate are pledged as collateral for a registered offering and those securities constitute a “substantial portion” of the collateral for the securities being registered. Securities of the affiliate are deemed to constitute a “substantial portion” of the collateral if the aggregate principal amount, par value or book value of the pledged securities (as carried by the issuer), or the market value of the pledged securities, whichever is the greatest, equals 20 percent or more of the principal amount of the securities that are being secured. If this test is met, the issuer must file full financial statements of each qualifying affiliate. Subsequent to the registered offering, the issuer must continue to provide full audited financial statements of each such affiliate in its annual reports but need not provide any interim financial statements in its quarterly reports.
Proposed Rule 3-10
The proposed amendments to Rule 3-10 would make it easier to omit separate financial statements as well as reduce the required alternative supplemental financial and nonfinancial disclosure about the subsidiary issuers and/or guarantors and the guarantees. The proposed amendments to Rule 3-10 would:
Proposed Rule 3-16
The proposed amendments to Rule 3-16, which reflect the view of the SEC that separate financial statements of affiliates whose securities are pledged as collateral “are not material in most situations,” would:
In our experience, the costs and challenges of complying with the rules currently applicable to guaranteed and collateralized securities are significant and continue to increase. This has caused many debt issuers to avoid registered public offerings in favor of Rule 144A private offerings, where the existing rules do not apply.
If adopted substantially as proposed, we believe the amendments may cause many debt issuers, especially those with issuer and guarantor or collateral support structures that currently do not comply with existing rules, to take a fresh look at whether to access the markets via a registered offering. Additionally, many parent companies will welcome the long overdue change that would permit them to cease providing the required financial disclosures for subsidiary issuers or guarantors if the obligation of the subsidiary issuer/guarantors to file periodic reports under Section 15(d) otherwise would have been suspended.
Comments on the proposed amendments are due 60 days after the publication of the proposing release in the Federal Register and may be submitted on the SEC’s website. Any final amendments to the SEC rules based on these proposed changes will require further action by the SEC and, as a result, likely will not be in effect until closer to the end of 2018, at the earliest. Additional information is available in the proposing release and the SEC’s press release.
Set forth below is a table summarizing the main features of existing Rules 3-10 and 3-16 and the proposed rules, which has been excerpted from the SEC proposing release. It is only a summary of certain requirements contained in the current SEC rules and regulations, as well as a summary of the proposed rules; it is not a substitute for the rules and regulations or for the proposed rules. Defined terms used below have the same meaning as in the SEC proposing release.
*Associate Rachel H. Berlage assisted in the preparation of this alert.
1 The requirements to provide separate pre-acquisition financial statements of recently acquired guarantors applies only to Securities Act registration statements and can require more extensive disclosure than Exchange Act periodic reports and acquired business financial statements under Rule 3-05 of Regulation S-X. Furthermore, the significance test for recently acquired guarantors, which compares the net book value or purchase price of the subsidiary to the principal amount of the securities registered, is different from and stricter than the usual significance test for acquiree financial statements.
2 Summarized financial information as understood by Rule 1-02(bb) includes current and noncurrent assets, current and noncurrent liabilities, preferred stock, noncontrolling interests, net sales or gross revenues, gross profit, income/loss from continuing operations, net income/loss and net income/loss attributable to the entity.