Publications & Presentations
June 11, 2020

On May 21, 2020, the United States Securities and Exchange Commission (“SEC”) announced that it has significantly revised its disclosure rules for public companies in connection with the acquisition or disposition of businesses, including for real estate operations and investment funds. The amendments are designed to facilitate access to capital by reducing the complexity and costs to prepare the disclosure for registrants and to improve for investors the financial information about acquired or disposed businesses. The amendments, which result from the SEC’s ongoing, comprehensive evaluation of disclosure requirements for public companies, will update SEC rules that have not been comprehensively addressed since their adoption, over 30 years ago.

The amendments, codified as part of Regulation S-X and related rules and forms, will be effective beginning January 1, 2021, with voluntary early compliance permitted. The complete text of the amendments to Regulation S-X can be found here.

Overview of Amendments

Below are a few of the noteworthy changes resulting from the amendments:

Testing for Significance

  • Amending the significance tests in Rule 1-02(w) of Regulation S-X and other applicable rules by:
    • Revising the investment test to compare the company’s investments in and advances to the acquired or disposed business to the company’s aggregate worldwide market value of its common equity, if available, instead of its total assets;
    • Revising the income test by adding a revenue component, when applicable;
    • Expanding the use of pro forma financial information in measuring significance; and
    • Raising the significance threshold for disclosure of pro forma financial information of a disposition from 10% to 20% 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.

Required Disclosure 

  • Amending Rule 3-05 of Regulation S-X (financial statements of business acquired or to be acquired) to require the audited financial statements of the acquired business to cover no more than the two most recent fiscal years (reduced from three);
  • Modifying and enhancing the required disclosure for the aggregate effect of insignificant acquisitions for which financial statements are not required by eliminating the requirement for historical financial statements for such businesses, but expanding the pro forma information required to be disclosed;
  • Permitting the use of, or reconciliation to, International Financial Reporting Standards in certain circumstances;
  • No longer requiring separate financial statements of an acquired business once the financial information about the business has been included in the acquirer’s post-acquisition financial statements for nine months or more, depending on the level of significance;
  • Amending the pro forma disclosure requirements to permit “management’s adjustments” depicting expected synergies and dis-synergies of the acquisition or disposition if certain conditions are met, and requiring disclosure of other adjustments; and
  • Making corresponding changes to the requirements applicable to smaller reporting companies and issuers relying on Regulation A.

Real Estate Companies

  • Formalizing the definition of “real estate operations” for purposes of required financial disclosure;
  • Aligning Rule 3-14 of Regulation S-X (which sets forth the requirements pursuant to which the financial statements of significant real property or properties acquired or to be acquired must be presented) with Rule 3-05 where practical; and
  • Clarifying the application of rules for acquired real estate operations regarding, among others:
    • The determination of significance; and
    • The need for interim statements.

Investment Companies

  • Adding a definition of significant subsidiary that is specific to investment companies; and
  • Making changes to address financial reporting for fund acquisitions by investment companies and business development companies.


When a company acquires a significant business or if a significant business acquisition becomes probable, Rule 3-05 of Regulation S-X generally requires that company to provide separate audited annual and unaudited interim pre-acquisition financial statements of that business. These financial statements are typically filed in a current report on Form 8-K following the acquisition and, where applicable, included in a registration statement or proxy statement. The number of years of required financial statements depends on the relative significance of the acquisition to the acquirer. Similarly, Rule 3-14 of Regulation S-X addresses the unique nature of real estate operations and requires a company that has acquired or proposes to acquire a significant real estate operation to file financial statements with respect to such acquired operation.

Article 11 of Regulation S-X also requires the company to file unaudited pro forma financial information showing the effect of the acquisition or disposition on the company’s financial condition and results of operations. The pro forma financial information is based on the historical financial statements of the public company and the acquired or disposed business, with adjustments to show how the acquisition or disposition might affect the company’s operations.

Changes to the Significance Tests

Prior to the amendments, companies were required to measure the significance of an acquired business under Regulation S-X 3-05 and Regulation S-X 8-04 (for smaller reporting companies) using three tests with reference to Rule 1.02(w), the: (1) investment test, (2) asset test, and (3) income test. Under current rules, the investment test requires a company to compare the total GAAP purchase price of the acquired business (the investment in the acquired business) to the company’s total consolidated assets. The income test requires a company to compare its equity in the acquired business’s income or loss from continuing operations to that of the company. The asset test, which was not changed by the amendments, requires a company to compare its share of the acquired business’s total assets to its consolidated total assets. 

The amendments modify the investment test and the income test as follows:

  • Investment Test. As amended, the investment test will require a company to compare its investments in and advances to the acquired business (generally, the purchase or sales price) to the aggregate worldwide market value of the company’s voting and non-voting common equity, when available. This change is designed to correct a measurement mismatch, eliminating what previously was a comparison of fair value (current investment) to book value (total assets). (For acquirers without a reported worldwide market value of common equity, such as an issuer of public debt or a pre-IPO company, the current investment test will be retained.)
  • Income Test. As amended, the income test will include a revenue component, which will require the company to compare its and its subsidiaries’ proportionate share of the acquired business’s consolidated total revenues to the company’s consolidated total revenues for the most recently completed fiscal year. For the target’s financial statements to be required to be presented under the amended test, the acquisition will be required to meet the revenue component, if applicable, in addition to the net income component, and the acquirer may use the lower of the two significance tests to determine the number of periods for which financial statements of the target are required. This change is designed to reduce or eliminate anomalies that have resulted under the current version of the income test when acquirers that have nominal income or losses have acquired smaller entities with reported income. The amendments also formalize the requirement to use the absolute value of the income or loss when one entity reports net income and the other a net loss.

In addition to the foregoing changes, the amendments also expand the circumstances under which pro forma financial information may be used to test significance.

Reduction of Financial Statement Requirements from Three to Two Years

Under the current rules, depending on the relative significance of the acquired business, Rule 3-05 financial statements may be required for up to three years. If any of the Rule 3-05 significance tests exceed 20% but none exceed 40%, audited financial statements for the most recent fiscal year and any required interim periods are required. If a significance test exceeds 40% but none exceed 50%, two years are required. A third year is required if any significance test exceeds 50%.

Pursuant to the amendments, where a significance test exceeds 20%, but none exceeds 40%, the registrant will be required to provide one year of audited statements and financial statements for only the “most recent” interim period, rather than for “any” interim period. This change has the effect of eliminating the requirement to provide comparative interim statements for the prior year. Moreover, audited financial statements will need to be provided for a maximum of two years, rather than three. The SEC believes that the third year of Rule 3-05 financial statements are less likely to be indicative of current financial condition and operations of the acquired business and require the registrant to incur a significant incremental cost and time to prepare.

Abbreviated Financial Statements

Companies often acquire a component of an entity that is a business as defined in SEC rules but which does not constitute a separate entity, subsidiary or division of the seller and which business does not have historical financial statements or separate sets of accounts for that business. These acquisitions may include a distinct product line or a line of business contained in more than one subsidiary of the selling entity. Due to the absence of historical financial statements and the difficulty in allocating corporate overhead, interest and taxes to these components, the staff of the SEC has allowed acquirers in these circumstances to file abbreviated audited financial statements in the form of statements of assets acquired and liabilities assumed and statements of revenues and expenses (“Abbreviated Financial Statements”). Historically, requests to substitute Abbreviated Financial Statements had to be submitted to the staff for approval. The staff of the SEC has also provided informal guidance on this issue in the Division of Corporation Finance’s Financial Reporting Manual.

Under the amendments, acquirers are expressly permitted to provide Abbreviated Financial Statements if certain conditions are met, including the following:

  • The total assets and total revenues of the acquired or to be acquired business constitute 20% or less of the corresponding amounts of the seller for the most recently completed fiscal year;
  • The acquired business was not a separate entity, subsidiary, operating segment or division of the seller during the periods for which financial statements would be required;
  • Separate financial statements of the business have not previously been prepared; and
  • The seller has not maintained separate accounts necessary to present financial statements that include the allocable overhead expenses of the business and it is impractical to prepare those financial statements.

As before the amendments, the use of “carve-out” financial statements will remain subject to the staff consultation process.

The amendments also adopt new rules specific to acquisitions of significant oil and gas producing activities, codifying prior reporting practices for that industry and allowing for modified abbreviated financial statements when certain conditions exist.

As always, the attorneys in Polsinelli’s Securities and Corporate Finance Practice are available to answer any questions and assist clients in applying these new rules.

The information provided above does not, and is not intended to, constitute legal advice; instead, all information and content above is for general informational purposes only. The information above may not constitute the most up-to-date legal or other information. Readers should contact their attorney to obtain advice with respect to any particular legal matter.