SEC Amends Smaller Reporting Company Definition

On June 28, 2018, the SEC voted unanimously to adopt amendments to the “smaller reporting company” (SRC) definition to expand the number of smaller companies eligible to comply with certain scaled disclosure accommodations.¹ The final rule was adopted generally in the form in which it was proposed two years ago, except for several changes that are described below.

Although the final rule amendments did not change the applicable threshold in the “accelerated filer” definition (which carries with it the requirement to provide an outside auditor’s attestation of management’s assessment of internal control over financial reporting), Chairman Clayton has directed SEC staff to formulate recommendations to the SEC for possible, additional changes to the “accelerated filer” definition.

Background

The SEC established the SRC category of companies in 2008 in an effort to provide general regulatory relief for smaller companies. SRCs may provide certain scaled disclosures under SEC rules, including providing two, instead of three, years of audited financial statements and omitting certain disclosures relating to executive compensation and the CEO pay ratio. For a summary of scaled disclosure accommodations available to SRCs, please see Appendix A.

Under the previous definition, a company qualified as an SRC if (i) its public float was less than $75 million or (ii) it had no public float or no market price for its public equity and less than $50 million in annual revenues.

Amendments to the SRC Definition

Consistent with the 2016 proposal, the final rules increase the threshold for determining SRC status based on public float from $75 million to $250 million. In a change from the proposal, the SRC definition also includes companies that have annual revenues of less than $100 million and a public float of less than $700 million. SRC status is determined on an annual basis.

Thus, under the final rules, SRCs generally are companies with:

• a public float of less than $250 million; or
• annual revenues of less than $100 million and either no public float or a public float of less than $700 million.

Under the amended revenue test, companies with a large public float (i.e., equal to or greater than $250 million but less than $700 million) but with little to no revenues (i.e., less than $100 million in annual revenues) are eligible for SRC status. This change from the proposal, which had significant support in the biotech community, should permit additional companies to qualify as SRCs.

In addition, consistent with the previous definition, once a company determines that it does not qualify as an SRC under the initial qualification thresholds, it will remain unqualified unless and until it meets one or more lower qualification thresholds, which are set at 80% of the initial qualification thresholds. Under the final rules, a company that did not previously qualify as an SRC because its public float was $250 million or more would subsequently qualify as an SRC if its public float dropped below $200 million, regardless of its revenues. In addition, once a company determines that it does not qualify as an SRC because it exceeded either or both of the $100 million annual revenue and $700 million public float thresholds, it will remain unqualified unless and until it meets one or both thresholds that have been exceeded:

Prior Annual Revenues	Prior Public Float
	None or less than $700 million	$700 million or more
Less than $100 million	Neither threshold exceeded.	Public float Less than $560 million; and Revenues Less than $100 million.
$100 million or more	Public float None or less than $700 million; and Revenues Less than $80 million.	Public float Less than $560 million; and Revenues Less than $80 million.

By requiring that a company satisfy a separate, lower threshold to re-qualify for SRC status, the SEC has attempted to strike a balance between avoiding situations in which companies frequently enter and exit SRC status due to small fluctuations and not imposing an undue burden on companies seeking to qualify for SRC status.

Amendments to the Financial Statement Requirements of Acquired Businesses

When an SEC reporting company acquires a business, Rule 3-05 of Regulation S-X generally requires it to provide separate audited annual and unaudited interim pre-acquisition financial statements of the business if it is significant to the SEC reporting company, based on various investment, asset, and income tests. Previously, when at least one Rule 3-05 test was exceeded at the 50 percent level, a third year of financial statements was required unless net revenues of the acquired business were less than $50 million in its most recent fiscal year, a threshold that was based on the revenue threshold in the previous SRC definition.

In another change from the 2016 proposal, the SEC increased the net revenue threshold in Rule 3-05(b)(2)(iv) of Regulation S-X from $50 million to $100 million, which is consistent with the increase made to the revenue threshold in the revised SRC definition. As a result, companies may omit financial statements of businesses acquired or to be acquired for the earliest of the three fiscal years otherwise required by Rule 3-05 of Regulation S-X if the net revenues of that business are less than $100 million.

Amendments to Accelerated Filer and Large Accelerated Filer Definitions

The final rules preserve the application of the current thresholds contained in the “accelerated filer” and “large accelerated filer” definitions in Exchange Act Rule 12b-2. As a result, companies with $75 million or more of public float that qualify as SRCs will remain 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 control over financial reporting required by Section 404(b) of the Sarbanes-Oxley Act. However, Chairman Clayton has directed SEC staff, and the staff has begun, to formulate recommendations to the SEC for possible, additional changes to the “accelerated filer” definition.

Practical Considerations

The final rules will become effective 60 days after official publication in the Federal Register. The final rules also contain minor, technical revisions to the cover pages of Securities Act Forms S-1, S-3, S-4, S-8, and S-11 and Exchange Act Forms 10, 10-Q, and 10-K. Companies should ensure that these technical updates are reflected in such Forms (and check all applicable check boxes thereto) for filings made with the SEC once the final rules are effective.

Based on SEC staff estimates, 966 additional companies will become eligible for SRC status in the first year under the new SRC definition. Smaller public companies should begin to evaluate whether they may qualify as an SRC as of a relevant measurement date² and assess the potential impact(s) of transitioning to scaled disclosures. For purposes of the first fiscal year ending after effectiveness of the final rules, a company will qualify as an SRC if it meets one of the initial qualification thresholds in the revised definition as of the date it is required to measure its public float or revenues, even if such company previously did not qualify as an SRC. For example, a company with a December 31 fiscal year end that previously was not an SRC and that had a public float of $220 million as of June 29, 2018 (the last business day of its most recently completed second quarter) will qualify as an SRC for the fiscal year ending December 31, 2018.

Emerging growth companies (EGCs) are also eligible for a variety of accommodations, including scaled disclosure requirements. However, there are differences between the scaled disclosure requirements for an EGC versus an SRC. EGCs that may potentially exit EGC status and qualify for SRC status should seek to understand those differences to determine the impact on their required public disclosures.

In addition, since the final rule amendments did not change the applicable threshold in the “accelerated filer” definition, some companies may qualify as both SRCs and accelerated filers. As a result, SRCs will need to monitor whether they also become accelerated filers, which would subject those companies to the requirements that apply to accelerated filers, including the timing of the filing of periodic reports and the requirements of Section 404(b) of the Sarbanes-Oxley Act. These companies should also monitor any future SEC rulemaking on changes to the “accelerated filer” definition that would possibly reduce the number of SRCs that qualify as accelerated filers.

Please feel free to contact any member of Ropes & Gray’s securities & public companies practice group or your usual Ropes & Gray contact with any questions about this Alert.

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¹ At the Open Meeting on June 28, 2018, the SEC also adopted and proposed other rules concerning the mandatory use of Inline XBRL, a new approval process for certain exchange-traded funds, targeted changes to public liquidity risk management disclosure, and whistleblower rule amendments. We expect to discuss these other SEC rulemakings in one or more future Alerts.

² For companies that are required to file Exchange Act reports, (a) public float is measured as of the last business day of a company’s most recently completed second fiscal quarter; and (b) annual revenues are as of the most recently completed fiscal year for which audited financial statements are available.