The SEC has long recognized that smaller issuers should be subject to somewhat less stringent disclosure standards than larger companies. The SEC has referred to this as “scaled disclosure” and has embodied the idea in a series of rules for smaller reporting companies, or SRCs. The SEC has adopted final rules to expand the availability of scaled disclosure requirements for a company qualifying as an SRC by allowing companies with a public float of less than $250 million to qualify as an SRC, as compared to the $75 million threshold under the prior definition. In addition, companies that do not have a public float are now permitted to provide scaled disclosures if annual revenues are less than $100 million, as compared to the prior threshold of less than $50 million in annual revenues.
The adopting release for the change to the SRC definition discusses other important topics as well. For instance, the Commission did not raise the accelerated filer public float threshold or otherwise modify the Section 404(b) requirements (which include mandatory auditor attestation of internal controls) for registrants with a public float between $75 million and $250 million in this release, choosing instead to defer such potential relief to future rulemaking. So public companies with a float of $75 million to less than $250 million can take advantage of scaled disclosures, but since accelerated filer status does not change, the deadline for filing reports stays constant. In addition, unless an issuer is an emerging growth company it will need to continue to provide auditor attestation of internal controls.
While not required under the new rules, issuers planning to avail themselves of the newly-available thresholds for SRCs should consider providing advance notice to the investing public that future filings will include scaled disclosures commensurate with requirements applicable to SRCs under Regulation S-K. This could be done in the upcoming second quarter 10-Q.
The SEC also adopted final rules mandating issuers use Inline XBRL. Inline XBRL embeds most of the XBRL data in the text of the SEC filing rather than an exhibit to the SEC filing. The SEC believes this makes the XBRL data more useful and easier to prepare, thereby reducing errors. While portions of the rule will be effective shortly, mandatory use of Inline XBRL is subject to an extended transition period. The Inline XBRL requirements for financial statement information will apply to all operating company filers, including SRCs, emerging growth companies and foreign private issuers.
SEC Reduces Thresholds for Smaller Reporting Company Definition
The Securities and Exchange Commission voted to approve modifications to the SRC definition under Rule 12b-2 of the Exchange Act increasing the population of companies that may provide scaled disclosure in public filings pursuant to the requirements for SRCs under Regulation S-K. The Commissioners were unanimous in their approval of the technical changes to the SRC definition despite debating the significance of the changes and their impact on compliance costs and capital formation.
The final rules enable a company with public float of less than $250 million to provide scaled disclosures as an SRC, as compared to the $75 million threshold under the prior definition. In addition, companies that do not have a public float are now permitted to provide scaled disclosures if annual revenues are less than $100 million, as compared to the prior threshold of less than $50 million in annual revenues.
As under the prior rules, once a company exceeds either of the thresholds, it will not qualify as a smaller reporting company again until public float or revenues decrease below a lower threshold set at 80% of the initial threshold. Under the final rules, a company would re-qualify as an SRC only if its public float is less than $200 million or, if it has no public float, its annual revenues are less than $80 million.
The impact of the changes will be felt by a number of companies for which scaled disclosure will now be available. In her comments on the rulemaking, Commissioner Kara Stein cited data indicating that nearly a thousand public companies will become eligible to provide scaled disclosure as new SRCs upon adoption of the rules.
An issuer’s status as an SRC is determined on an annual basis. For issuers required to file public reports under section 13(a) or 15(d), the applicable public float is measured on the last day of the issuer’s most recently completed second fiscal quarter, while annual revenues are tested as of the most recently completed fiscal year for which audited financial statements are available. Issuers must reflect their determination of SRC status in quarterly reports for the first fiscal year of the next year and in subsequent filings. The final rules will become effective 60 days following their publication in the Federal Register. Practically speaking, this means that that for calendar year filers the new rules will be available for Forms 10-Q filed for the third quarter in 2018.
Issuers should also keep in mind that the new rules include conforming amendments to the cover pages for registration statements (Forms S-1, S-3, S-4, S-8, S-11, Form 10) and periodic reports (Forms 10-K and 10-Q) and will need to re-evaluate the appropriate boxes to check.
We would also advise any issuers planning to avail themselves of the newly-available thresholds for SRCs to consider providing advanced notice to the investing public that future filings will include scaled disclosures commensurate with requirements applicable to SRCs under Regulation S-K. This could be done in the upcoming second quarter 10-Q.
Rule 3-05 of Regulation S-X
The final rules also revise the financial statement requirements for business acquisitions under Regulation S-X. In its prior formulation, paragraph (b)(2)(iv) of Rule 3-05 of Regulation S-X allowed registrants to omit financial statements for the earliest of three fiscal years required if the net revenues of the business to be acquired are less than $50 million (following the revenue threshold under the SRC definition). The newly-adopted rules make corresponding changes to Rule 3-05 to permit the omission of the financial statements of acquired business falling under $100 million in annual revenues.
Accelerated and Large Accelerated Filer Definitions
The final rules also revise the “accelerated filer” or “large accelerated filer” definitions to remove provisions specifically excluding from the definitions issuers eligible to use rely on the scaled disclosure for their annual and quarterly reports. As a result, the final rules preserve the prior thresholds contained in the accelerated filer and large accelerated filer definitions but, as expected, do not include commensurate amendments to the public float thresholds for when a registrant would qualify as an accelerated filer or large accelerated filer in coordination with the increased SRC thresholds. As a result, companies with $75 million or more of public float that qualify as smaller reporting companies under the new rules will also be subject to the requirements that apply to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002.
As expected, the approved rules did not revise the accelerated filer definition to provide relief from the auditor attestation requirements under Section 404(b) in coordination with the changes to the SRC thresholds. The staff was, however, left with a mandate from Chairman Jay Clayton to formulate recommendations for possible additional changes to the accelerated filer definition that, if adopted, would have the effect of reducing the number of registrants that qualify as accelerated filers (thereby reducing the number of issuers required to comply with auditor attestation requirements). Nonetheless, while the Commissioners were in agreement on the adoption of the SRC modifications, each of the Commissioners also indicated that any future rulemaking with respect to the more significant issues surrounding application of Section 404(b) would be a more contentious subject. In particular, both Commissioners Stein and Jackson cited significant reservations on removing this requirement for any number of issuers while Commissioners Piwowar (in his final open meeting) and Peirce expressed strong support for reducing the regulatory costs associated with auditor attestation. Any future modifications to the applicability of Section 404(b) will surely be marked by heavy debate and as these comments made clear, achieving a clear consensus amongst the commissioners on the issue seems unlikely.
SEC Requires Use of Inline XBRL
The SEC also adopted final rules to require the use of Inline XBRL. Currently, data in XBRL format is attached as an exhibit to SEC filings. Inline XBRL allows filers to embed XBRL data directly into the body of the SEC filing, eliminating most of the need to tag a copy of the information in a separate XBRL exhibit. Inline XBRL will still require exhibits to be used with and the exhibits will contain contextual information about the XBRL tags embedded in the filing. Inline XBRL would be both human-readable and machine-readable for purposes of validation, aggregation and analysis.
The rules will be effective 30 days after publication in the Federal Register. However, the rules apply the following phase in period for required use of Inline XBRL:
- June 15, 2019–large accelerated filers that prepare their financial statements in accordance with U.S. GAAP;
- June 15, 2020—accelerated filers that prepare their financial statements in accordance with U.S. GAAP; and
- June 15, 2021—all other filers.
Domestic form filers will be required to comply beginning with their first Form 10-Q for a fiscal period ending on or after the applicable compliance date, as opposed to the first filing for a fiscal period ending on or after that date, to enable filers to gain experience with Inline XBRL through less complex filings.
Officer Certifications and Auditor Assurance
Inline XBRL does not change any requirements with respect to officer certification or auditor assurance. The changes relate only to the manner of submitting interactive data and not the data comprising the data files. Currently, the financial statement information included in interactive data files is excluded from the officer certification requirements under Rules 13a-14(f) and 15d-14(f) of the Exchange Act. Furthermore, auditors are not required to apply AS 2710 (Other Information in Documents Containing Audited Financial Statements), AS 4101 (Responsibilities Regarding Filings Under Federal Securities Statutes), or AS 4105 (Reviews of Interim Financial Information) to the interactive data files submitted with a company’s reports or registration statements. However, the SEC has previously stated that XBRL is part of an issuer’s disclosure controls and procedures. However, consistent with the existing XBRL requirements, issuers would not be prohibited from indicating in the financial statements (such as in a footnote) the degree (or lack thereof) of auditor involvement related to the financial statement information XBRL data.
The Inline XBRL requirements for financial statement information will apply to all operating company filers, including SRCs, emerging growth companies and foreign private issuers.
Elimination of Website Posting Requirements
Currently the rules require XBRL files be posted on the filer’s website, if any, on the earlier of the calendar day that the filer submitted or was required to submit the XBRL files. The new rules eliminate this requirement. This requirement is not subject to the phase in period and will be effective 30 days after the rules are published in the Federal Register.
Changes to SEC Forms
The new rules include conforming amendments to the cover pages for certain periodic reports, including Forms 10-K and 10-Q. The change to the cover pages eliminates reference to compliance with the website posting requirement. Like the elimination of the website posting requirements, these form changes are not subject to the phase in period.