Acquisitions and Regulation S-X Rule 3-10(g)
We’ve spent the last few weeks considering whether So-Crates, Inc. will be required under Reg S-X Rule 3-05 to include separate financials for its recently acquired subsidiary in its new registration statement. We’ve also considered the requirements to include pro forma financial information under S-X Article 11.
Just as you’re about to wrap up the conference call with the company’s GC, Bill S. Preston, Esq., and its CFO, “Ted” Theodore Logan, who repeatedly extol your “most excellent” job of conveying your ace analysis, Ted (not known for extraordinarily high attention to detail, or “ATD,” as we call it) mentions that the newly acquired subsidiary might guarantee the notes. Will that affect the analysis? Yes it will — keep reading to avoid heinously bogus outcomes, dude.
Requirements for financial statements of guarantors -- background
S-X Rule 3-10 sets forth the requirements for including financial statements of guarantors in a registration statement. Remember, a guarantee of a security is itself a security whose issuance requires registration under the 1933 Act, absent an available exemption. As a result, under S-X Rule 3-10(a), the general rule is that guarantors must present the same financial statements as the issuer of the guaranteed securities.
Fortunately, paragraphs (b) through (f) of S-X Rules 3-10 contain important exceptions that permit issuers of debt instruments to disclose financial information about parent or subsidiary guarantors in a condensed format using a footnote to the issuer’s own consolidated financial statements. Paragraphs (c), (e) and (f) of S-X Rule 3-10 go even further, dispensing with any additional information requirement for guarantors in the case of a parent company or subsidiary issuer where the parent company does not have independent assets or operations of its own and all of the non-guarantor subsidiaries are “minor” (generally, less than three percent of the consolidated parent) and each guarantee is full and unconditional.
Financial statements for recently acquired guarantors – S-X Rule 3-10(g)
Paragraph (g) of S-X Rule 3-10 provides that separate financial statements for a newly acquired subsidiary guarantor must be included if (i) the subsidiary has not been included in the audited consolidated results of the parent company for at least nine months of the most recent fiscal year; and (ii) the greater of the purchase price or net book value (as of the most recent fiscal year prior to the acquisition) of the subsidiary is 20 percent or more of the principal amount of the securities being registered. If a subsidiary guarantor meets the Rule 3-10(g) requirements, audited financial statements for the subsidiary’s most recent fiscal year prior to the acquisition, as well as unaudited financial statements for any required interim periods, must be included in the registration statement.
The key here is that these requirements apply even if the recently acquired subsidiary would otherwise be eligible for the use of condensed consolidating footnote presentation provided by Rules 3-10(b)-(f) or S-X Rule 3-05 would not otherwise require financial statements. This means that the requirement to include financial statement of a recently acquired subsidiary that guarantees the notes must be analyzed separately under both Rule 3-10(g) and Rule 3-05. The same analysis applies if the newly acquired subsidiary will be the issuer of the securities.
In addition, note that the auditors of the recently acquired subsidiary must be PCAOB registered and the audit report must refer to PCAOB standards, even in the case of a newly acquired entity that is not an SEC reporting company (i.e., where S-X Rule 3-05 would otherwise permit use of a non-PCAOB registered auditor). See Financial Reporting Manual, Topic 4110.5
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