United States: Financial Statement Triggers

Requirements for New or Updated Financial Statements Can Affect Access to Capital Markets and M&A

Financial statement requirements can surprise US public companies seeking to access the capital markets or to register shares in connection with acquisitions. Fully compliant 10-K, 10-Q and 8-K reporting can be inadequate. Before the company can register or offer securities, it may have to file new or updated financial statements. The relevant rules and market conventions are quite technical and not always intuitive, but understanding them is critical for successfully planning and executing transactions. We explore some of these triggers in a series of brief publications. In this first installment, we provide an overview.

Overview

SEC financial statement requirements can create periods when a company, despite being completely up to date with its 10-K, 10-Q and 8-K filings, is effectively blocked from accessing the capital markets or registering shares issued to target shareholders in an acquisition. This is true even for large public companies that qualify as so-called "well-known seasoned issuers," or WKSIs, and therefore do not require SEC review for their shelf registration statements. Market conventions in securities offerings can have similar effects. As discussed below, key factors that can trigger financial statement issues include: (1) the time of the fiscal year when the transaction takes place, (2) pending or completed acquisitions, (3) pending or completed dispositions, (4) changes in reporting segments or accounting principles, (5) changes in guarantors, and (6) significant equity investees that are not subsidiaries.

Registration vs. Offering

As a practical matter, in an offering of securities under an existing shelf registration statement, market participants generally apply the same financial statement rules that would apply to the filing of a new registration statement. Also offering documents for Rule 144A placements, although unregistered, typically include the same financial information that would be required in a registration statement. This market practice reflects the view that the financial statements required in a registration statement provide a benchmark for the financial information that investors will expect or that should be provided to them to avoid claims that the offering document omitted material information. This practice exists even though most of the SEC's financial statement requirements technically apply only when a registration statement is filed or becomes effective. In most cases, compliance does not need to be tested again at the time of a subsequent offering, and updates are only required to reflect a "fundamental change."

This distinction between registration and offering can become critical for planning and executing transactions. The rule of thumb is that the prospectus supplement for an offering should contain the same financial information that would be required in a newly filed registration statement. However, it may sometimes be possible for the company and the underwriting banks to conclude that certain financial information that would be required if the company were filing a new registration statement is not, in fact, material to investors, and can therefore be omitted.

Market practice accords different weights to the various SEC requirements. For example, it is fairly well established in Rule 144A bond offerings that the detailed consolidating guarantor financial information required by Rule 3-10 of Regulation S-X is not material to investors. Instead, investors receive information about the percentage of the consolidated group represented by the guarantors under certain financial metrics, and the amount of debt and other liabilities at the non-guarantor group. For other purposes, such as separate target and pro forma financial statements in connection with significant acquisitions, which are discussed below, the market tends to follow the SEC's requirements more closely, and in certain respects goes beyond them. The convention for significant acquisitions is to include target and pro forma financial statements even if those would not yet be required under SEC rules because the acquisition has not yet closed, or closed only recently. Getting comfortable with deviation from market convention is a judgment call that is based on the facts and circumstances of the particular situation.

In registered offerings, there is only room for such flexibility and judgment calls, however, if the company already has an effective registration statement on file at the time of the offering. Without an existing effective registration statement, the company must strictly comply with all applicable SEC financial statement requirements because it needs to file a new registration statement for the offering—or issue securities in the Rule 144A or private placement market instead. The same is generally true when the registration statement has to be amended for purposes of the offering, for example, in order to add a new class of securities. That is because for financial statement purposes the amendment of a registration statement is treated like a new filing if it amends the prospectus.

Financial Statement Triggers

Many different factors can trigger a requirement for new or updated financial statements or limit available auditor comfort in connection with the registration or offering of securities, including the following:

  • Time of Year. Registering or offering securities can be more difficult at certain times of the company's fiscal year. Public companies often observe quarterly blackout periods during which they will not issue securities. Sometimes these blackouts can be overcome through appropriate diligence or disclosure. However, there may also be issues of a more technical nature that are less susceptible to creative solutions. For example, a company will not be able to file a registration statement after February 14 (in the case of calendar-year filers) but before the filing of its 10-K if the company expects to report a loss for its just completed fiscal year or reported a loss for its previous two fiscal years. Offerings after February 11 and before the filing of the 10-K may not be eligible for full "negative assurance" level auditor comfort. More generally, offerings at any time after the end of the fiscal year but before the filing of the 10-K may face so-called "white paper" issues that limit the auditors' ability to provide comfort with respect to fourth quarter results. Offering securities after the earnings release but before the corresponding 10-Q or 10-K can also be challenging for comfort and other reasons.
  • Significant Acquisitions. The SEC has specific rules that govern when a company is required to file separate target financial statements and pro forma financial statements in connection with a significant acquisition. An acquisition is deemed "significant" if it exceeds 20% on any one of three specified significance tests based on the target's assets and pre-tax income and on the purchase price being paid in the acquisition. Target financial statements need to cover one to three years, depending on significance. Pro forma financial statements giving effect to the acquisition need to cover the most recent year. Both must also cover the most recent interim period.
  • Companies normally have approximately 75 days from the closing of the acquisition to prepare and file those financial statements on an 8-K. Absent a registration statement or offering, no target financial statements or pro forma financial statements are required to be filed before an acquisition has closed, even if an acquisition agreement has already been signed. However, if the acquiring company wants to offer securities after a significant acquisition has become probable, it may have to provide both target financial statements and pro forma financial statements at the time of the offering, even if the 75-day period has not yet expired. Where SEC rules would not require this, market convention usually does.

    Once the acquisition has closed and the acquiring company has filed all required target and pro forma financial statements on the 8-K, it will often assume that no further financial information about the completed acquisition will be required. However, if the acquiring company subsequently registers or offers securities, it may find itself having to update the target or pro forma financial statements. This can be the case even after the acquiring company has filed a post-acquisition 10-K or 10-Q that includes the more limited pro forma financial information required by GAAP in the notes to the financial statements.

  • Dispositions. In relation to dispositions, there are two overlapping but separate regimes: GAAP standards for "discontinued operations" and the SEC's rules about pro forma financial statements for significant dispositions. Each regime has its own triggers and calls for different disclosure, so they need to be analyzed separately.
  • If a company has classified a business as "discontinued operations" under GAAP, it will start reporting that business separately in its financial statements for dates and periods subsequent to the classification. This classification can be triggered when management has committed to a plan for the sale of the business, an active program to locate a buyer has been initiated, it is probable that the sale will be completed within a year, and certain other criteria are met. The classification would only apply going forward and no revisions to prior years would be required until the next 10-K. But if the company then registers or offers securities, it first may have to recast its annual financial statements and MD&A to reflect this classification retroactively for all audited periods. This is the case even for discontinued operations that are not considered "significant" under the SEC's rules.

    Once a disposition that is significant under the SEC's rules has closed, the company must file an 8-K with pro forma financial statements reflecting the disposition unless the disposed business has already been classified as discontinued operations in the company's most recent 10-K. If they are required, these pro forma financial statements should generally cover all three fiscal years included in the 10-K, rather than just the most recent year required in the case of significant acquisitions. They also need to cover the most recent interim period, unless the corresponding 10-Q already reflected the disposition. In contrast to the 20% threshold for acquisitions, dispositions are considered significant when the disposed business exceeds 10% on any one of the three tests. Also, once a significant disposition has closed, the company has only four business days to file the 8-K with the pro forma financial statements, not 75 days as in the case of a significant acquisition. As in the acquisition context, however, the registration or offering of securities can accelerate the timing for the required pro forma financial statements. They may then need to be filed before the significant disposition has closed, merely on the basis that it has become probable.

  • Change in Reporting Segments or Accounting Principles. If a company changes its reporting segments during the first three quarters of the fiscal year, it will reflect the new segment structure in the first 10-Q that covers a period ended after the effectiveness of the change. The company would not be required to recast the segment reporting footnote in its annual financial statements or make corresponding changes to its annual MD&A until it files its next 10-K. However, similar to the effect that discontinued operations can have, a change in segment reporting may make it impossible for a company to register or offer securities until it has revised its annual financial statements and MD&A to reflect the new segment structure for all audited periods. The same applies to a change in accounting principles for which retrospective application is either required or elected.
  • Change in Guarantors. A company that has registered guaranteed debt securities includes in its 10-K and 10-Qs the guarantor financial information required by Rule 3-10 of Regulation S-X. When the guarantor structure changes—for example, a subsidiary that did not previously guarantee the debt securities becomes a guarantor— this would simply be reflected in the next 10-Q or 10-K. However, if the company would like to offer new debt securities in a registered offering that rank effectively equally with the existing ones, it may first have to update its financial statements to reflect the new guarantor structure. In addition, if a subsidiary guarantor has been acquired only recently, the company may have to provide separate financial statements for that subsidiary if its net book value or purchase price, whichever is greater, is 20% or more of the principal amount of the securities being registered. As a result of all of these issues, companies often decide to sell the new guaranteed debt securities not in a registered offering, but in a Rule 144A placement. If the Rule 144A placement includes registration rights, these issues may become relevant for the subsequent exchange offer registration statement.
  • Significant Equity Investees. Public companies are required to file separate annual financial statements for significant investments that are not consolidated as subsidiaries, but accounted for under the equity method. The relevant significance test is 20%, although more limited information may also be required for equity investees that are significant merely in excess of 10%. When separate investee financial statements are required in a 10-K, the reporting company has a grace period that permits it to file those financial statements later than the due date of its 10-K if the investee itself is a non-accelerated filer or a foreign business. These grace periods are not available if the separate financial statements are required in a registration statement. As part of its broader "disclosure effectiveness" initiative, the SEC is currently in the process of reviewing the requirements for target and pro forma financial statements as well as those for guarantor and equity investee financial information. It is possible that some of the rules may change as a result.

Financial Statement Requirements Can Affect M&A Transactions

Financial statement requirements that are triggered by registering securities can also have implications for mergers and acquisitions. In addition to specific target and pro forma financial statement requirements for the acquisition itself, the filing, amendment or effectiveness of the S-4 registration statement for a stock merger or exchange offer can trigger a need to file new or updated financial statements for the acquiror. In addition, financial statement requirements can affect an acquiror's ability to file a resale registration statement to register shares issued to owners of a private target company in a private placement. If the acquiring company is unable to file a registration statement and have it become effective at the closing of the acquisition or shortly thereafter due to the absence of required financial statements, this can affect its ability to use stock as an acquisition currency in the transaction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.