The Securities and Exchange Commission has proposed rule amendments to simplify and streamline the financial disclosure requirements applicable to registered debt offerings for guarantors and issuers of guaranteed securities, as well as for affiliates whose securities collateralize a registrant’s securities.
“Companies have a number of options to raise capital,” explained Commissioner Kara Stein. “Some raise capital through the sale of stock, some through the sale of debt, and others choose to do both.”
Even within these broad categories, there are numerous options. One method, for example, is for a parent company to issue debt that is guaranteed by one or more of its subsidiaries. Another method is for the parent company to guarantee debt issued by one or more of its subsidiaries. Such arrangements can occur in the private markets or the public markets.
“When publicly issuing guaranteed debt, current Commission rules require a company to provide investors with detailed information about the nature and extent of the guarantees by requiring disclosure of both financial and non-financial information about the guaranteeing entities,” Stein said. “This is like having a co-signer on a vehicle loan. The dealership providing the financing wants information about both the borrower and the co-signer because the likelihood of the loan getting repaid is dependent upon both parties. Like the dealership, investors in corporate debt need to understand the financial position of both the issuer and the guarantor in order to understand the likelihood of repayment.”
Both Rules 3-10 and 3-16 of Regulation S-X affect disclosures made in connection with registered debt offerings and subsequent periodic reporting. The proposed amendments would focus disclosures on information that is material to investors, make the disclosures easier to understand, and reduce the costs and burdens for registrants.
“By reducing compliance burdens, the proposed amendments should further encourage issuers to register debt offerings, and thus provide investors with additional protections that are not present in unregistered offerings,” the Commission said in a statement.
“I have seen firsthand instances in which an issuer did not pursue SEC registration of a debt offering that included a subsidiary guarantee or pledge of affiliate securities as collateral because of the costs and, in particular, time burdens of these rules,” Chairman Jay Clayton said. “The proposed rules are intended to make the disclosures easier for investors to understand and to encourage these offerings to be conducted on a SEC-registered basis.”
The proposed changes are intended to:
Focus disclosures on the information that is material given the specific facts and circumstances;
Make the disclosures easier to understand;
Reduce the cost of compliance for registrants and encourage potential issuers to offer guaranteed or collateralized securities on a registered basis, thereby affording investors protections they may not be provided in offerings conducted on an unregistered basis; and
Facilitate, through lower costs and burdens of compliance, issuers’ flexibility to include guarantees or pledges of affiliate securities as collateral when they structure debt offerings, which may increase the number of registered offerings that include these credit enhancements and could result in a lower cost of capital and an increased level of investor protection.
The proposal will have a 60-day public comment period following its publication in the Federal Register.
In 2000, the Commission simplified its rules related to guaranteed debt, allowing companies to present condensed consolidating financial information rather than separate financial statements of the subsidiary guarantors.
Stein questioned the rationale behind the proposed changes. “The proposal centers on the idea that some of the current disclosures may not be necessary for investors,” she said. “For example, the proposal notes that the Commission’s current rules ‘require unnecessary detail, thereby shifting investor focus away’ from important information. Reducing the information provided to investors on the basis that such information may be too much for investors to handle is a precarious road to walk down.”
“Even more concerning is the proposal’s attempt to provide ‘increased flexibility’ by allowing certain material information to be removed from the audited financial statements,” she added. “I’m gravely concerned that the Commission is embarking on a slippery slope that might inadvertently result in threatening the strength and credibility of the bedrock of our markets—high quality financial reporting.”
For years, investors have struggled to understand financial statements with alternative metrics that do not conform to agreed-upon standards, such as U.S. GAAP or IFRS, as supplements to their audited financial reports, Stein explained. “In view of this, why is the Commission embarking down this path? The release states that it is intended to save costs, but does not provide adequate data in support,” she said. “To move away from investor and market accountability, without having a full understanding of the reasons behind doing so, is troubling. Indeed, this type of argument can support the removal of virtually any single footnote currently required in the financial statements.”