If you find the title of this posting confusing, let me explain: On June 28, the SEC announced revisions to the definition of “smaller reporting company”that will significantly expand the number of companies that fit within that category (i.e., “smaller gets bigger”). As a result, more public companies will be able to reduce the disclosure they are required to provide under SEC rules (i.e., “which means less”). The new definition will go into effect 60 days after publication in the Federal Register.
The SEC adopted the reduced disclosure requirements applicable to smaller reporting companies, or SRCs, in 2007. These reduced requirements were intended to ease the costs and other burdens of disclosure for small companies. The reduced requirements enabled SRCs, among other things, to:
- present only two (rather than three) years of financial statements and the related management’s discussion and analysis;
- provide executive compensation for only three (rather than five) “named executive officers”;
- omit the compensation discussion and analysis in its entirety;
- present only two (vs. three) years of information in the summary compensation table; and
- omit other compensation tables, pay ratio disclosure, and narrative descriptions of various compensation matters.
In addition, SRCs that are not “accelerated filers” (companies that must file their Exchange Act reports on an accelerated basis) need not provide an audit attestation of management’s assessment of internal controls, required by the Sarbanes-Oxley Act. More on this below.
The New Definition of “SRC”
The following table, included in the SEC’s announcement of the new rules, summarizes the changes in the definition of “SRC”:
|Previous SRC Definition
|Revised SRC Definition
|Public float of less than $75 million
|Public float of less than $250 million
|Less than $50 million of annual revenues and no public float
Less than $100 million of annual revenues and
· no public float, or
· public float of less than $700 million
An SRC must determine each year whether it remains eligible for SRC status, based upon its public float. If a company loses its SRC status, it needs to requalify base on the following requalification standards (which are 80% of the initial standards):
|Previous SRC Definition
|Revised SRC Definition
|Public float of less than $50 million
|Public float of less than $200 million, if it previously had $250 million or more of public float
|Less than $40 million of annual revenues and no public float
Less than $80 million of annual revenues, if it previously had $100 million or more of annual revenues; and
Less than $560 million of public float, if it previously had $700 million or more of public float.
Note that the rule changes have triggered changes in the cover pages of many Exchange Act filings (including 10-Ks and 10-Qs), regardless of a company’s status as an SRC.
Who Will Benefit?
The SEC Staff estimates that nearly 1,000 additional companies will qualify for SRC status under the new definition in the first year. Also benefiting will be “emerging growth companies”, which also enjoy reduced disclosure requirements, that are approaching the end of their fifth year as such, when eligibility for that status expires.
Accelerated Filer Status
As noted above, SRCs that are accelerated filers do not get all the benefits of SRC status.
Specifically, 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 Sarbanes-Oxley. The SEC’s announcement states that Chairman Jay Clayton has directed the Staff, and the Staff has begun, to come up with changes to the “accelerated filer” definition that would reduce the number of companies that qualify as accelerated filers.
SEC Chairman Clayton and a number of his appointees have repeatedly stated that they want to reinvigorate IPOs (and our capital markets generally) by reducing compliance costs while maintaining appropriate investor protections. It’s too soon to tell whether the changes outlined above will help to achieve those objectives – much less whether those objectives are achievable at all. The IPO market seems to be doing well this year, but the number of public companies continues to drop. To the extent that fewer companies stay public, and to the extent that they go private because of disclosure burdens, it’s questionable whether these reforms will help. Anyone who’s had to explain to the conflict minerals rules to a fledgling public company knows that’s a tough sell.
So much for reducing compliance costs. Despite the SEC’s belief that the SRC changes maintain investor protections, a number of investors disagree. Even “disclosure effectiveness” initiatives, which do not necessarily reduce disclosures but rather are designed to make disclosures more accessible, are getting flak from some investors as well as our legislators (see my prior posting about a certain senator from Massachusetts). And, lest we forget, the plaintiffs’ bar may also have some thoughts on that.