The Securities and Exchange Commission has adopted amendments to its “smaller reporting company” definition to expand the number of companies that qualify for scaled disclosure accommodations.
The new smaller reporting company definition enables a company with less than $250 million of public float (the portion of shares in the hands of public investors) to provide scaled public disclosures. The prior threshold was $75 million.
The final rules also expand the definition to include companies with less than $100 million in annual revenues if they also have either no public float or a public float that is less than $700 million. This reflects a change from the revenue test in the prior definition, which allowed companies to provide scaled disclosure only if they had no public float and less than $50 million in annual revenues.
The amendments are intended to promote capital formation and reduce compliance costs for smaller companies while maintaining appropriate investor protections.
The smaller reporting company category of companies was created in 2008 as an effort to provide general regulatory relief for smaller companies. SRCs may provide scaled disclosures under Regulation S-K and Regulation S-X.
Under the previous definition, SRCs generally were companies with less than $75 million in public float. Companies with no public float, because they have no public equity outstanding or no market price for their public equity, were considered SRCs if they had less than $50 million in annual revenues.
The rules and new thresholds, enacted on June 28, will become effective 60 days after publication in the Federal Register.
“Expanding the smaller reporting company definition recognizes that a one-size regulatory structure for public companies does not fit all,” Chairman Jay Clayton said in a statement late last month, prior to the vote. “These amendments to the existing SRC compliance structure bring that structure more in line with the size and scope of smaller companies while maintaining our longstanding approach to investor protection in our public capital markets.”
The amendments do not change the threshold in the “accelerated filer” definition that requires, among other things, that filers provide an auditor’s attestation of management’s assessment of internal control over financial reporting. SEC staff, however, is preparing recommendations to the Commission for additional changes to the “accelerated filer” definition to reduce the number of companies that qualify as accelerated filers in order to further reduce compliance costs for those companies.
The SEC estimates that 966 additional companies will be eligible for SRC status in the first year of the new definition.
These include: 779 companies with a public float of $75 million or more and less than $250 million; 161 companies with a public float of $250 million or more and less than $700 million and revenues of less than $100 million; and 26 companies with no public float and revenues of $50 million or more and less than $100 million.
“It is no secret that companies, in particular smaller companies, have been avoiding our public markets,” said Commissioner Hester Peirce. “There are good reasons for a company to opt for a private offering over a public one, and it makes sense for some companies to stay private indefinitely. When private offerings start to dwarf public offerings, however, it becomes our duty as regulators to ask whether we had a hand in this trend. Have we created a regulatory framework for public companies that comes with so many extraneous bells and whistles that neither the companies nor their investors deem the benefit of being public worth the cost?”
“We have not yet evaluated the full panoply of options available to us to achieve a balance in small company regulation that meets the needs of both issuers and investors,” Peirce added. “ We have not yet grappled with the most glaring burden on smaller issuers—Section 404(b) of Sarbanes-Oxley.”
She promised that “fresh efforts are underway to rethink the value of Section 404(b) for smaller issuers.”
“There is a deeper assumption behind today’s rule that I cannot accept: that the hidden secret to helping small companies go and stay public is simply cutting red tape,” Commissioner Robert Jackson said, voicing his objections. “As finance scholars like to say, there is no free lunch. Reducing disclosure requirements can lead to increased costs of capital. Investors are forced either to diligence the risk of fraud on their own or demand higher returns in light of that risk.”
Also, “our actual experience with the red-tape theory is hardly promising,” he added. “We've tried to roll back disclosure requirements in an effort to encourage small-company capital formation before, and the torrent of IPOs that commenters predicted at the time never materialized.”
Jackson also expressed concern that “rolling back disclosure requirements makes it harder” for retail investors to participate in small-company capital formation.
“Reducing compliance costs may be a benefit, but at what cost? Reducing disclosure may ultimately lead to greater indirect costs to smaller companies, such as a higher cost of capital,” Commissioner Kara Stein said.