SEC changes M&A rules for first time in 30 years

The new rules will reduce audit and financial reporting requirements for both registrants and target companies in an effort to streamline the process, improve access to capital, make “more meaningful determinations of whether a subsidiary or an acquired or disposed business is significant, ” and remove “the complexity and costs to prepare the disclosure,” according to the SEC.

The changes will also provide clarification on the applicability of some financial reporting requirements on certain types of registrants.

“This action, which is designed to enhance the quality of information that investors receive while eliminating unnecessary costs and burdens, will benefit investors, registrants and the market more generally,” said Chairman Jay Clayton in a May 21 statement announcing the changes.

Some critics, including SEC Commissioner Allison Herren Lee, say the new rules reduce transparency for investors. She argues the new rules could also lead to economic concentration, as larger companies, in a better position to weather economic turbulence, swallow up weakened competitors.

One update reduces the requirement for financial disclosures for some target companies from three years to two. In her dissenting opinion, Lee said if one of those two years was impacted by significant events like the coronavirus pandemic or climate change, it “may create anomalies as sudden and severe shocks to financial results are absorbed.”

The new rules do not properly examine the potential effects on competition, she said, “particularly in the present economic climate where the risks that arise from overly concentrated markets are heightened.”

The new rules officially take effect Jan. 1, 2021, but companies can apply them to M&A transactions this year, the SEC said.

The changes affect several groups of rules for M&As. One is how to measure the significance of the target company relative to the company buying it to determine how much financial information must be provided. The SEC measures significance by an investment test, an asset test, and an income test.

“Under the current rules, the investment test compares the registrant’s investment in the target company, based on the fair value of the purchase consideration, to the registrant’s total assets as reported on its latest audited balance sheet. The asset test compares the total assets of the target against the total assets of the acquirer. The income test compares the pre-tax income from continuing operations of the target and registrant,” according to a blog post from international law firm King & Spalding.

In the past, the way those tests have been administered have sometimes created “false positives requiring enhanced disclosures for transactions that, in reality, are relatively insignificant to the registrant,” notes the King & Spalding blog post.

Significantly, the new rules promote the use of the registrant’s market capitalization in place of total assets for the investment test; expand situations where the registrant can use pro forma financial information in place of historical financial information; and increase the significance threshold for business acquisitions from 10 percent to 20 percent.

Current rules say target businesses must provide three years of audited financial statements if the significance is over 50 percent. The new rules require only two, and the significance is lowered to 40 percent.

A rule requiring target businesses to file unaudited pro forma financial information is being relaxed, so businesses instead report transaction accounting adjustments and management’s adjustments.