Financial Statement Disclosure Relief Under Rule 3-13

Rule 3-13 of Regulation S-X allows a company to request relief from the SEC from the financial statement disclosure requirements if they believe that the financial information is burdensome and would result in disclosure of information that goes beyond what is material to investors. Consistent with the ongoing message of open communication and cooperation, the current SEC regime has been actively encouraging companies to avail themselves of this relief and has updated the CorpFin Financial Reporting Manual to include contact information for staff members that can assist.

As part of its ongoing disclosure effectiveness initiative, the SEC is also considering amendments to the financial statement disclosure process and the publication of further staff guidance. In addition to advancing disclosure changes, allowing for relief from financial statement requirements could help encourage smaller companies to access public markets, an ongoing goal of the SEC and other financial regulators. For a review of the October 2017 Treasury Department report to President Trump, including discussions related to the need to promote public markets, see HERE. For a review of Nasdaq’s publication “The Promise of Market Reform: Reigniting American’s Economic Engine,” see HERE.

In fact, the SEC, under Chair Jay Clayton, has used current rules and staff prerogative to implement changes over the past two years for the direct purpose of removing barriers to capital formation and making the U.S public markets more attractive. For example, In June 2017 the SEC announced that the Division of Corporation Finance will permit all companies to submit draft registration statements, on a confidential basis. For more information see HERE.

Rule 3-13 of Regulation S-X

Rule 3-13 of Regulation S-X reads in total:

The Commission may, upon the informal written request of the registrant, and where consistent with the protection of investors, permit the omission of one or more of the financial statements herein required or the filing in substitution therefor of appropriate statements of comparable character. The Commission may also by informal written notice require the filing of other financial statements in addition to, or in substitution for, the statements herein required in any case where such statements are necessary or appropriate for an adequate presentation of the financial condition of any person whose financial statements are required, or whose statements are otherwise necessary for the protection of investors.

That is, the Rule gives the SEC the authority to modify or waive financial statement requirements under Regulation S-X as long as the modification is consistent with investor protections. The SEC has delegated the authority to the Division of Corporation Finance. Rule 3-13 applies to all financial statement requirements under Regulation S-X including financial information that a company may have to provide from other entities such as acquired businesses, subsidiaries, tenants with triple net lease arrangements that comprise a concentration of assets, certain related parties and others. For more information on financial statement requirements for entities other than the registrant, see HERE.

Although the requirement that relief be consistent with investor protections is not defined by any rules, the SEC uses the concept of materiality as guidance. Materiality requires a facts-and-circumstances analysis. In TSC Industries, Inc. v. Northway, Inc., the U.S. Supreme Court defined materiality as information that would have a substantial likelihood of being viewed by a reasonable investor as having significantly altered the total mix of information available.

The Financial Accounting Standards Board (FASB) has also published guidance on the utilization of the materiality standard in financial reporting. In September 2015, FASB published two concept papers recommending changes to the rules and analysis related to determining materiality. The changes would have given companies more flexibility in determining materiality. FASB’s proposed changes met with opposition from investor groups.  After two years of a back-and-forth process, in November 2017, FASB abandoned its proposed changes and reverted to an earlier materiality standard.

FASB now defines materiality in the context of “the magnitude of an omission or misstatement of accounting information that, in light of the surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information, would have been changed or influenced by the omission or misstatement.” The FASB materiality analysis is primarily quantitative although circumstances, such as whether a particular matter is outside the ordinary course of business or could have an impact on larger contractual obligations, must also be considered.

This definition is consistent with the standard used by the SEC, the PCAOB and the AICPA. The old and now new again materiality standard is set forth in FASB’s Statement of Financial Accounting Concepts No. 2 Qualitative Characteristics of Accounting Information.

A materiality analysis must also take into account the relevance of the information. That is, information may be material based on pure magnitude but it may lack relevance. Relevance is generally information that would make a difference to a decision maker such as in making predictions about outcomes of past, present, and future events or to confirm or correct prior expectations.  By its very nature, relevant information is timely. If information is not available when it is needed or becomes available so long after the reported events that it has no value for future action, it lacks relevance and is of little or no use.

How to Seek Relief

As with all communications with the SEC, the company should ensure it is prepared prior to seeking relief. Being prepared includes conducting research to see if the SEC has issued guidance on a particular topic or provided relief, such as no-action relief, to other companies in similar circumstances. The SEC’s Financial Reporting Manual (FRM) should always be reviewed.

The FRM may even provide for self-executing relief from certain requirements, especially where the SEC has granted similar relief on a regular basis. For example, the FRM now allows a company to file a “super 10-K” to catch up delinquent reports, without seeking relief from the SEC prior to doing so. As another example, companies may provide abbreviated financial statements for certain oil and gas properties without first seeking SEC relief.  Furthermore, the FRM provides guidance on seeking relief in certain circumstances, including the criteria the staff will consider.

As indicated in the rule, a request for relief should be in writing to the appropriate staff member(s). However, under the new regime, the SEC encourages companies to engage in conversations with the SEC staff prior to submitting the written request. The company can discuss any items they believe are relevant to the determination, why they believe a particular disclosure is not necessary for that company’s investors and how and why preparation of the rule-mandated financial statements would be overly burdensome. To avoid unnecessary logjam, the SEC staff cautions against providing unnecessary background or peripheral information.

Further 

Background on SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes.

In December 2017, the American Bar Association (“ABA”) submitted its fourth comment letter to the SEC related to the financial and business disclosure requirements in Regulation S-K.  The comment letter focused on disclosures related to materiality, known trends or uncertainties, critical accounting estimates, strategy, intellectual property rights, sustainability, litigation and risk factors.  For a review of the comment letter, see HERE.

In October, 2017 the U.S. Department of the Treasury issued a report to President Trump entitled “A Financial System That Creates Economic Opportunities; Capital Markets” (the “Treasury Report”). The Treasury Report made specific recommendations for change to the disclosure rules and regulations, including those related to special interest and social issues and duplicative disclosures. See more on the Treasury Report HERE.

On October 11, 2017, the SEC published proposed rule amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The proposed rule amendments implement a mandate under the Fixing America’s Surface Transportation Act (“FAST Act”).  The proposed amendments would: (i) revise forms to update, streamline and improve disclosures including eliminating risk-factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks. See my blog HERE.

On March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The new Rule goes into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018. See my blog HERE on the Item 601 rule changes and HERE related to SEC guidance on same.

On November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K as required by Section 72003 of the FAST Act. A summary of the report can be read HERE.

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. This proposal is slated for action in this year’s SEC regulatory agenda.

That proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.

As part of the same initiative, on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE. Both of these items are slated for action in this year’s SEC regulatory agenda.

As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the reporting requirements in general, see my blog HERE.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog HERE. These items are all included in this year’s SEC regulatory agenda.

The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
LAnthony@AnthonyPLLC.com

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service.  The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

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