On January 30, 2023, the SEC’s Division of Corporation Finance updated its Financial Reporting Manual (“Manual”). The latest update is dated as of December 31, 2022. Although we attorneys like to leave the accounting to the accountants, the Financial Reporting Manual is a go to resource for all practitioners and is generally one of the many resources always open on my desktop.
As the preamble to the Manual states, it was originally created as internal guidance to the SEC staff. In 2008, in an effort to increase transparency of informal staff interpretations, the SEC posted a version of the Manual to its website. The SEC continues with its usual disclaimers that the manual is not formal guidance and that they can change their interpretations or views at any time, etc. Regardless, we all use it as a resource and in my years of experience, have never had the SEC take a counter-position to the Manual’s guidance unless there has been a subsequent rule change.
In that regard, the SEC notes that the newest edition of the Manual has not been updated for changes resulting from the amendments to the financial disclosures about acquired and disposed businesses (see HERE); qualifications of accountants including auditor independence requirements (see HERE); or Regulation S-K amendments to management, discussion and analysis disclosure, selected financial data, and supplementary financial information (see HERE).
In addition to updating some basic contact information such as the phone number for the Division of Corporation Finance’s Office of Chief Accountant and providing a link to the new online submission for financial statement waiver or substitution requests, the updated Manual has made numerous substantive changes.
Overview of the Manual
The Manual is broken down by sections with hyperlinks in the table of contents for quick navigation. Although the entire manual is a lengthy 368 pages, each section is direct and pointed generally laid out in bullet points and easy-to-follow charts. For attorneys, several of the sections are extremely helpful in advising clients and engaging in “smart” conversations with their accounting teams. Below is a very brief summary of the provisions I find the most useful. It is not a complete list of the sections in the Manual, but rather only those topics that we tend to use most often.
Registrant’s Financial Statements
The first section is a discussion of financial statement requirements in registration statements, proxy statements and periodic reporting. We all generally know that financial statements for domestic issuers go stale after 135 days, but the chart breaks down each statement (balance sheet, income statement, changes in stockholders equity and cash flows) by type of company (smaller reporting company and others with EGCs having their own section). The chart not only shows the periods required and the age of statements, but contains quick nuance reference notes on presentation. Separate charts are provided for audited and interim unaudited financial statements.
The discussion also includes information on, for example, due dates, extensions, the effect of weekends and holidays, entering and exiting accelerated filing status (see HERE), changing fiscal year ends, adopting new accounting standards and again, nuanced information that reflects SEC policy beyond the rules. For example, the Manual lets us know although the SEC will allow a delinquent filer to catch up with a comprehensive 10-K (“Super 10-K”) that includes all material information that would have been included in the delinquent filings, that company would still not be considered “current” for purposes of Regulation S, Rule 144, or Form S-8 registration statements. Also, the company would not be eligible to use Form S-3 until it establishes a sufficient history of making timely filings (see HERE).
In very short, easy-to-look-up subheadings, the Manual reminds us of quick reference facts such as that that the first Form 10-Q after an effective registration statement is not due until the later of 45 days after the effective date or the date the Form 10-Q would otherwise be due and the more complex due date calculation for the first 10-K. In particular, if an initial registration statement has an effective date within 45 days (90 days for a smaller reporting company) after the fiscal year-end, but does not include the audited statements of the just recently completed year, then the 10-K requirements depend on whether the company is registered under the Exchange Act of 1934 (a Form 10 or 8-A) or became subject to the Exchange Act reporting requirements because of the filing of a registration statement under the Securities Act of 1933 (i.e., a 15(d) reporting company).
If the company is registered under the Exchange Act, a full annual report on Form 10-K is due within 90 days after its fiscal year-end. If the company is a 15(d) reporting company, it can file a “special report” on Form 10-K within 90 days of effectiveness containing audited financial statements, but need not file a full 10-K until the following year. A “special report” does not need to include MD&A or other narrative disclosures ordinarily required in a Form 10-K. For more on Exchange Act registration and 15(d), see HERE and HERE.
Other nuggets that are helpful when drafting registration statements include such things as when selected financial data is not required (i.e., in an IPO when the company is not already registered under the Exchange Act) or for a target in an S-4.
Other Financial Statements Required
The second topic which is also very helpful, especially for us firms that have a robust mergers and acquisitions practice, relates to when financial statements must be included for other companies, such as businesses acquired or to be acquired, disposed of businesses, significant real estate tenants, guarantors of securities and general partners in a limited partnership.
As noted above, the Manual is not completely up to date on the rules related to financial statements for businesses acquired or to be acquired (see HERE), but is still extremely helpful. In addition to the basics related to shell company and change in shell company status, the Manual delves into both determination of a business and significance tests.
Significance is used to determine whether full separate financial statements are required for a business that is acquired or to be acquired or whether the financial statements can just be consolidated with the rest of the company on a going forward basis. The level of significance also determines when separate financial statements must be presented, such as, for example, in a registration statement or proxy statement and/or a separate Form 8-K. For a current discussion on the significance test rules, see HERE).
Many clients believe that they can avoid an audit by structuring transactions as asset purchases, but that is not necessarily the case. While leaving the final determination to the auditors, it is very helpful to focus the client in understanding the basic considerations as to when assets constitute a “business” for accounting purposes and thus would be subject to further analysis on accounting treatment. A “business” for purposes of Regulation S-X is identified by evaluating whether there is sufficient continuity of operations so that disclosure of prior financial information is material to an understanding of future operations. There is a presumption that a separate entity, subsidiary, or division is a business. A lesser component, such as a product line or separate assets, also may be considered a business. In evaluating whether a lesser component is a business, companies should consider (i) will the nature of the revenue producing activity generally remain the same?; and (ii) will the facilities, employee base, distribution system, sales force, customer base, operating rights, production techniques, or trade names remain after the acquisition?
Special considerations must also be given to partial business acquisitions, the age of financial statements under several different fact scenarios, where a foreign business is being acquired that had been using IFRS instead of U.S. GAAO or where the acquisition involves a hostile takeover. The Manual includes flow charts and easy-to-understand discussions. In this era of significant de-SPAC transactions, the Manual is a great reference for the financial statement requirements of target companies in Form S-4.
Guarantors and Issuers of Guaranteed Securities
The newest Manual updates discussions on the financial statement requirements for guarantors and issuers of guaranteed securities. Generally, a guarantee of a security is a separate security, and the issuer of a guarantee is subject to the reporting and registration requirements applicable to other issuers. Many exceptions are in place where the guarantor is a parent or subsidiary, especially where such parent or subsidiary is a separate reporting entity. For more on this topic, see HERE.
Another updated section of the Manual relates to affiliate securities pledged as collateral. If securities registered or being registered include a pledge of affiliate securities as collateral, the rules require a registrant to provide supplemental financial and non-financial disclosures about the affiliate and collateral arrangement.
Pro Forma Financial Information
The Manual provides an in-depth analysis of the circumstances requiring pro forma financial information including involving business combinations and dispositions. Pro forma financial information is intended to provide investors with information about the continuing impact of a transaction by showing how a specific transaction or group of transactions might have affected historical financial statements. Of special interest is a section on problems and issues in the preparation of pro forma financial information including combining companies with different fiscal year-ends, and prohibitions against including transaction specific financing or offering proceeds. Although projections and financial forecasts may be presented in lieu of pro forma financial statements, and the Manual discusses such projections, most companies choose not to do so due to the greater risk of future liability.
Independent Accountants
As mentioned, the Manual is not completely updated for the new rules on auditor independence (see HERE but it has updated some sections related to auditor involvement. Newly added is a chart outlining the application of certain PCAOB requirements in SEC filings, including breaking down entities for which an audit report must be included in SEC filings (for example, issuer, target in a de-SPAC, operating company after a reverse merger, co-issuers, etc.), whether the audit report must be issued by a PCAOB registered public accounting firm and whether the audit report itself must refer to PCAOB standards.
Other nuggets are helpful as well. For example, the Manual clearly spells out that financial statements previously audited by a firm whose registration has been revoked would generally need to be reaudited by a PCAOB registered firm prior to inclusion in future filings or if included in a registration statement that has not yet been declared effective – a question a few of my clients have unfortunately had to face over the years. Similarly, the Manual provides information on when a consent or updated consent must be obtained to use an audit report.
Another helpful section is unusual issues involving changes in accountants, including what to do when a prior auditor refuses to furnish its exhibit letter to the Form 8-K disclosing their termination or resignation. In that case, the company can simply state the fact of such refusal. The Manual addresses the need to include change in auditor information in a Form 8-K or Super 8-K involving a reverse merger. The Manual also provides great information on the contents of a Form 8-K for non-reliance on previously issued financial statements.
Smaller Reporting Companies
The Manual contains an entire section devoted to smaller reporting companies. A smaller reporting company is one with less than a $250 million public float or if a company does not have an ascertainable public float or has a public float of less than $700 million, a SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year. The Manual delves into the nuances of the definition including determining public float and revenue calculations. For more information on smaller reporting companies, see HERE.
The Manual provides quick reference for unique situations such as when a smaller reporting company acquires a company that is not smaller reporting entity and vice versa. In particular where a non-smaller reporting company acquires a smaller reporting company, the acquired business must follow the same standards as the non-smaller reporting company. Where a smaller reporting company acquires a business that does not qualify as a smaller reporting company, the target company and the acquiror can continue to rely on the smaller reporting company accommodations until the next determination date. In a reverse acquisition, the eligibility of the target company as a smaller reporting company, or not, will determine the financial statement requirements in the 8-K.
Foreign Private Issuers
The Manual contains a whole section on foreign private issuers. Both the Securities Act of 1933, as amended (“Securities Act”) and the Securities Exchange Act of 1934, as amended (“Exchange Act”) contain definitions of a “foreign private issuer.” Generally, if a company does not meet the definition of a foreign private issuer, it is subject to the same registration and reporting requirements as any U.S. company. For more on foreign private issuers, see HERE.
The determination of foreign private issuer status is not just dependent on the country of domicile, though a U.S. company can never qualify regardless of the location of its operations, assets, management and subsidiaries. There are generally two tests of qualification as a foreign private issuer, as follows: (i) relative degree of U.S. share ownership; and (ii) level of U.S. business contacts.
As with many securities law definitions, the overall definition of foreign private issuer starts with an all-encompassing “any foreign issuer” and then carves out exceptions from there. In particular, a foreign private issuer is any foreign issuer, except one that meets the following as of the last day of its second fiscal quarter:
(i) a foreign government;
(ii) more than 50% of its voting securities are directly or indirectly held by U.S. residents; and any of the following: (a) the majority of the executive officers or directors are U.S. citizens or residents; (b) more than 50% of the assets are in the U.S.; or (c) the principal business is in the U.S. Principal business location is determined by considering the company’s principal business segments or operations, its board and shareholder meetings, its headquarters, and its most influential key executives.
That is, if less than 50% of a foreign company’s shareholders are located in the U.S., it qualifies as a foreign private issuer. If more than 50% of the record shareholders are in the U.S., the company must further consider the location of its officers and directors, assets and business operations.
In addition to going over the basic rules related to foreign private issuers, including the age and requirements for financial statements, the newest edition of the Manual updated many sections on this subject. Many of the updates are helpful with the slew of recent de-SPAC transactions, including determining financial statement requirements of foreign businesses acquired by either a foreign or domestic company, S-4 financial statement requirements, requirements for reconciliation to U.S. GAAP, and the treatment of foreign equity investees.
Use of Non-GAAP Financial Information
Another entire chapter of the Manual that I find useful relates to the use of non-GAAP financial information, including in press releases, periodic reports, proxy and registration statements. I’ve written on this topic several times – see HERE. Once again, the Manual has charts to help guide when reconciliations to GAAP are required, the basic requirements of Regulation G and Item 10(e) of Regulation S-K, and importantly, prohibited practices.
Management’s Discussion and Analysis of Financial Position and Results of Operations (MD&A)
Although MD&A is included in the body of periodic reports, and not in the financial statements, it directly relates to financial performance and is the subject of its own section in the Manual. For the most recent discussion of SEC rules on MD&A, see HERE As a practitioner it is incredibly helpful to direct internal CFO’s and management to this section of the Manual for an easy to read and understand discussion of what should be included in MD&A and how to focus the contents.
Emerging Growth Companies (EGC)
Just like smaller reporting companies, emerging growth companies have their own section in the Manual. An EGC is defined as a company with total annual gross revenues of less than $1,235,000,000 during its most recently completed fiscal year that first sells equity in a registered offering after December 8, 2011. An EGC loses its EGC status on the earlier of (i) the last day of the fiscal year in which it exceeds $1,235,000,000 in revenues; (ii) the last day of the fiscal year following the fifth year after its IPO (for example, if the issuer has a December 31 fiscal year-end and sells equity securities pursuant to an effective registration statement on November 2, 2012, it will cease to be an EGC on December 31, 2017); (iii) the date on which it has issued more than $1,235,000,000 in non-convertible debt during the prior three-year period; or (iv) the date it becomes a large accelerated filer (i.e., its non-affiliated public float is valued at $700 million or more).
The revenue and debt thresholds for an EGC are adjusted for inflation, with the most recent adjustment moving the number from $1,070,000,000 to $1,235,000,000. The Manual is updated for this change as well and includes thorough discussions on determining the various threshold figures. For more on EGC’s, including their scaled disclosure accommodations, see HERE.
Reverse Acquisitions and Reverse Recapitalizations
The acquisition of a private operating company by a non-operating public shell corporation typically results in the owners and management of the private company having actual or effective voting and operating control of the combined company. The SEC considers a public shell reverse acquisition to be a capital transaction in substance, rather than a business combination. That is, the transaction is a reverse recapitalization, equivalent to the issuance of stock by the private company for the net monetary assets of the shell corporation accompanied by a recapitalization. The accounting is similar to that resulting from a reverse acquisition, except that no goodwill or other intangible assets should be recorded.
The Manual explains when acquisition versus reverse acquisition accounting is appropriate. Where a reverse acquisition is completed there are several items to be considered such as change of auditor, change in fiscal year-ends and super 8-K Form 10 information requirements.
Subsequent Events
Certain events that occur after the end of a fiscal year will require retrospective revision of that year’s financial statements (the “pre-event financial statements”) if they are reissued after financial statements covering the period during which the event occurred have been filed. Such events include reporting a discontinued operation, a change in reportable segments, or a change in accounting principle for which retrospective application is either required or elected. I am often asked about the impact of various transactions and whether such proposed transactions should be delayed. Again, we leave the accounting to the accountants but the Manual provides useful discussion points when talking to clients, and the auditors, on the impacts these transactions could have.
The Author
Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm
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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