On May 3, the Securities and Exchange Commission (the SEC) proposed amendments to its rules governing financial disclosures relating to acquisitions and dispositions of businesses. If adopted, these proposed amendments will have a significant impact on financial disclosures in high-yield bond offering materials, both in the case of public offerings and back-end exchange offers that are registered under the Securities Act of 1933, as amended (the Securities Act), and in the more common "Rule 144A-for-life" private offerings, as market participants typically seek to comply in all material respects with the disclosure requirements applicable to offerings registered under the Securities Act. The 60-day comment period for the proposed amendments will run through mid-July 2019.
A discussion of the proposed amendments most relevant to high-yield bond offerings is set forth below.
Liberalization of Income Statement Pro Forma Adjustments
Under current SEC rules, a pro forma income statement can only include adjustments to historical results that are directly attributable to the relevant transaction, expected to have a continuing impact and factually supportable.
Under the proposed amendments, a pro forma income statement can include adjustments that give effect to reasonably estimable synergies and other transaction effects, such as closing facilities, discontinuing product lines, terminating employees and executing new or modifying existing agreements that have occurred or are reasonably expected to occur.
The most significant differences in these standards are:
- The elimination of the "directly attributable" requirement.
- The effective change from a "factually supportable" standard to a "reasonably expected to occur" standard.
- Explicit endorsement of the inclusion of "synergies" in "reasonably estimable" adjustment amounts.
- An open-ended definition of includable synergies that explicitly allows for giving effect to "new agreements" that are "reasonably expected" to be entered into.
The exact contours of permissible income statement synergy adjustments under the proposed amendments, if adopted, would be established over time through the consultative and review processes of the staff of the SEC and, as a practical matter, the policies of the accounting firms in providing comfort. Nonetheless, it is safe to say that if adopted, the proposed amendments will result in the inclusion of many synergy adjustments that are currently included in loan syndication materials but not in high-yield bond offering memoranda.
Modification of the "Investment Test" and the "Income Test"
Under current SEC rules, the requirement for an issuer to present audited financial statements for a business that has been or is likely to be acquired is based upon whether the acquired business meets at least a 20% significance level under any of the investment, income or asset tests provided in the "significant subsidiary" definition in Rule 1-02(w) under Regulation S-X (one year of audited financial statements if a 20% level under any test is met, two years if a 40% level is met and three years if a 50% level is met). Under the current investment test, the issuer's investment or proposed investment in the acquired business is compared to the issuer's total assets. Under the proposed amendments, if the issuer has publicly traded equity, such investment would be compared to the aggregate market value of all classes of the issuer's common equity. Under the current income test, the acquired business's income from continuing operations before taxes, extraordinary items and cumulative effect of changes in accounting principles is compared to that of the issuer. Under the proposed amendments, an alternative revenue test would be added (comparing the acquired business's revenue to that of the issuer), with the lower percentage of the two tests determining whether or how many years of audited financial statements of the acquired business must be presented. The proposed amendments would also change the income test to be an after income tax calculation rather than before income tax calculation.
Elimination of Third Year of Audited Statements of Acquired Businesses
Under current SEC rules, if an issuer has acquired or is likely to acquire a business that exceeds the 50% significance level under any of the investment, income or asset tests, it must include three years of audited financial statements for the acquired business. Under the proposed amendments, only two years of audited financial statements would be required.
Omission of Acquired Business Financial Statements
Under current SEC rules, an acquired business's financial statements must be presented even after the acquired business has been reflected in the issuer's financial statements for a complete fiscal year if the acquired business is of "major significance" (i.e., significant at the 80% level) or the financial statements have not been previously filed with the SEC. Under the proposed amendments, an acquired business's financial statements would no longer have to be presented after the acquired business has been reflected in the issuer's financial statements for a full fiscal year.
Elimination of Carve-Out Acquisition Allocations
Under current SEC rules, in carve-out acquisitions, financial statements for the acquired business typically require an allocation of the seller's corporate overhead, interest and income tax expenses. Under the proposed amendments, issuers may prepare audited financial statements that exclude allocations of corporate overhead, interest and income tax expenses if certain conditions are met.
Modification of Treatment of Individually Insignificant Acquisitions
Under current SEC rules, if the aggregate significance of individually insignificant businesses exceeds or would exceed 50%, issuers must present audited financial statements covering at least the mathematical majority under the relevant triggered tests of the acquired businesses. Under the proposed amendments, audited financial statements would be required only for acquired businesses with individual significance that exceeds 20%. However, the proposed amendments would expand the pro forma financial statement requirement to reflect the aggregate effects of all such acquired businesses regardless of significance, rather than represent those that represent such mathematical majority.
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