Defining Issues. SEC Requests Comments on Financial Disclosures. October 2015, No Key Facts. Key Impacts

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1 Defining Issues October 2015, No SEC Requests Comments on Financial Disclosures The SEC recently asked for comments about the effectiveness of financial disclosure requirements that companies make about acquired businesses, subsidiaries not consolidated and 50 percent or less owned persons, guarantors and issuers of guaranteed securities, and affiliates whose securities collateralize registered securities. 1 Contents Background... 2 Regulation S-X... 2 Financial Statements of Acquired Companies... 3 Investments in Entities Qualifying for the Equity Method of Accounting Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.. 4 This request is part of the Division of Corporation Finance s review of public company disclosure requirements and initiative to identify ways to streamline and simplify disclosure requirements. Comments are due November 30. Key Facts The SEC wants to: Understand how the disclosure requirements currently help investors and find out how they use the disclosures to make investment and voting decisions; Find out what disclosure changes would enhance the information provided to investors; and Learn about challenges that companies face in preparing the required disclosures. Key Impacts While the SEC s request for comment does not immediately affect public company reporting, its reconsideration of disclosure requirements may have a significant future impact on all public companies. At this point, the SEC is not proposing any changes. Instead, it will review the comments before determining whether the disclosure requirements should be modified. Collateralizations... 5 Other Requirements SEC s Request for Comment on the Effectiveness of Financial Disclosures about Entities Other Than the Registrant, September 25, 2015, available at

2 Rule 3-05 has not been thoroughly reconsidered by the SEC since 1996, while Rules 3-09 and 3-16 have not been thoroughly reconsidered since However, Rule 3-10 was substantially revised in 2000, which included the separation of Rule 3-16 from the requirements of Rule There have been no changes to Rule 3-16 since Background Over many years the SEC has made rules that were designed to enhance financial and nonfinancial disclosure for investors and other users of the financial statements. In 2013, the SEC staff conducted a detailed study of the disclosure items in Regulation S-K, the SEC s industry guides, and related rules and forms, which is described in its Report on Review of Disclosure Requirements in Regulation S-K. 2 In that report, the SEC staff recommended that a plan be developed to systematically review the disclosure requirements in the SEC s rules and forms, including Regulation S-K and Regulation S-X, and related rules covering the presentation and delivery of information to investors. The SEC staff issued its review, which addresses the disclosure requirements found in Regulation S-K in December Currently, the SEC staff is focused on the business and financial information that is required by periodic and current reports, such as Forms 10-K, 10-Q, and 8-K, and registration statements. The SEC s request for comment is the first action related to the Disclosure Effectiveness Initiative that is specific to Regulation S-X. Regulation S-X Regulation S-X contains the disclosure requirements that dictate the form and content of financial statements to be included in filings with the SEC. It addresses both the financial statements of a company as well as financial disclosures for other companies (i.e., certain subsidiaries, guarantors, or affiliates). The SEC s request for comment is focused on the requirements for entities other than the company. Specifically, the SEC is seeking public comment on the following rules: Rule 3-05, Financial Statements of Businesses Acquired or to be Acquired, and Accompanying Article 11, Pro Forma Financial Information; Rule 3-09, Separate Financial Statements of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons, and related summarized financial information under Rule 4-08(g); Rule 3-10, Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered; and Rule 3-16, Financial Statements of Affiliates Whose Securities Collateralize an Issue Registered or Being Registered. 2 The SEC s study was mandated by Section 108 of the Jumpstart Our Business Startups Act (the JOBS Act), available at 3 KPMG s Defining Issues No. 14-1, SEC Releases Report on Regulation S-K, available at 2

3 The request for comment includes questions that are common to each rule. How do investors use the required disclosures? Are there changes or alternatives to the requirements that should be considered to further facilitate the disclosure of useful information to investors? Are there challenges in preparing and providing the required disclosures? Are there requirements that result in disclosures that investors do not consider useful? Should the percentage thresholds or the financial measures (e.g., investment, asset, and income) used to determine significance be changed, and should companies be able to use more judgment for that determination? Should smaller reporting companies, emerging growth companies, investment companies, or foreign entities be treated differently? Financial Statements of Acquired Companies Rule 3-05 requires companies to file pre-acquisition financial statements and pro forma financial information if an acquisition is significant under specific investment, asset, and income tests. The Article 11 rule about pro forma information includes adjustments to historical financial statements to show how an acquisition might have affected those financial statements if it occurred at an earlier date. Similarly, Rule 3-14, Special Instruction for Real Estate Operations to be Acquired, requires financial statements and pro forma financial information for acquired real estate properties. The SEC s inquiry included the following questions about acquisitions. Should there be fewer restrictions on adjustments to pro forma financial information that do not allow companies to reflect the significant changes expected to occur with an acquisition? Should the pro forma financial information be in comparative format, and should auditors have any involvement with the information? Should the amount of time companies have to provide disclosures be modified? Investments in Entities Qualifying for the Equity Method of Accounting Rule 3-09 requires companies to file financial statements of investees qualifying for accounting under the equity method of accounting if those entities are determined to be significant, based on investment and income tests. 4 Rule 4-08(g) requires summarized financial information for investees to be disclosed in the notes to the company s financial statements based on investment, asset, and income tests. 4 FASB ASC Topic 323, Investments Equity Method and Joint Ventures, available at requires disclosures if material in relation to the financial position or results of operations. 3

4 The SEC s questions specific to investee disclosures include the following topics. Could the usefulness of summarized financial information be improved by adding a requirement to present separately each significant investee or reconcile the disclosures to the amounts presented in the company s financial statements? Are unaudited Rule 3-09 financial statements and summarized financial information for fiscal years during which an investee was not significant useful to investors? Guarantors and Issuers of Guaranteed Securities Registered or Being Registered Companies that issue registered securities that are guaranteed and guarantors of registered securities must file financial statements under Rule The rule permits companies to provide more limited disclosure under certain conditions, such as when the subsidiary issuer and guarantor is 100 percent-owned by the parent company and the guarantees are full and unconditional, which is referred to as the Alternative Disclosure (usually in the form of condensed consolidating financial information). The SEC s questions specific to Rule 3-10 include: Do the conditions allowing the Alternative Disclosure influence the structure of guarantee relationships? Could the usefulness of the consolidating financial information be improved by revising the content requirements? Should the disclosure requirement for interim periods focus only on significant changes? Should parent companies be allowed to provide the Alternative Disclosure if subsidiary issuers and guarantors are not 100 percent-owned and the guarantee does not meet the definition of full and unconditional? Should the conditions that must be satisfied to qualify for the abbreviated narrative disclosure be revised? KPMG Observations The consolidating information that is required when a company qualifies for the Alternative Disclosure is a columnar footnote presentation of each category of the parent and subsidiaries as the issuer, guarantor, or nonguarantor. Rule 3-10 requires that all captions of the balance sheet, income statement, and cash flow statement required under Article 10 of Regulation S-X be presented separately in the consolidating information. 5 5 Regulation S-X, Article 10, Interim Financial Statements, available at 4

5 The SEC wants to know whether it should permit or require companies to provide summary information, along with more detailed information, to enable investors to review the disclosures at a level that they choose. For the purposes of distinguishing the assets, liabilities, operations, and cash flows of the companies that are legally obligated to make payments under the guarantees from those that are not, the columnar format must show (1) a parent company s investments in all consolidated subsidiaries based upon its proportionate share of the net assets; and (2) subsidiary issuer/guarantor investments in certain consolidated subsidiaries using the equity method. The presentation required by Rule 3-10 is purposely unique and designed to ensure that a subsidiary does not consolidate, within this presentation, its own non-guarantor subsidiary. The disclosure requirements provide financial statement preparers with significant challenges. This occurs because the required disclosures are not typically captured in the companies books and records, which makes preparing disclosures time consuming and tedious. Collateralizations Rule 3-16 requires companies to provide separate financial statements for each affiliate whose securities represent a substantial portion of the collateral for any class of securities, as if the affiliate were a separate issuer. Separately, Rule 4-08(b) requires a company to disclose in the notes to its annual financial statements the amounts of assets mortgaged, pledged, or otherwise subject to lien. The SEC s questions specific to securitizations follow. Do the Rule 3-16 requirements influence the structure of collateral arrangements? How can the usefulness of the footnote disclosure be improved? Could the usefulness be improved by adding a requirement to disclose additional details about the affiliates? Other Requirements Currently, the financial disclosures related to entities other than the company are filed in XBRL format only to the extent that the financial disclosures are part of a company s financial statements. Other disclosures, such as the separate financial statements of separate entities other than the company and pro forma financial Information are not required to be presented in XBRL. The SEC is interested in understanding ways to use technology to facilitate the disclosure of useful information to investors and wants to address any challenges faced by investors and companies. 5

6 Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Melanie F. Dolan and Timothy M. Phelps Earlier editions are available at: Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the potential rule or any other potential or applicable requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP. 6