In an effort to promote capital formation and reduce compliance costs, the U.S. Securities and Exchange Commission has amended its rules to expand the number of public companies that qualify for scaled disclosure accommodations that traditionally have been available only to companies with very small public floats. Companies that previously did not qualify as “smaller reporting companies” — or SRCs — will be able to take advantage of some notable reduced disclosure requirements.
New SEC Rules
The SEC on June 28, 2018 adopted amendments to expand the number of companies that qualify as SRCs. The rules are effective 60 days after publication in the Federal Register, which occurred on July 10, 2018. Accordingly, the expected effective date of the new rules is September 10, 2018. The rules are effective 60 days after publication in the Federal Register. The new rules amend the SRC definition to include companies with a public float of less than $250 million, as well as companies with annual revenues of less than $100 million for the previous year and a public float of less than $700 million. Public float is calculated by multiplying the aggregate number of shares of outstanding common stock held by non-affiliates (i.e., stockholders that are not directors, executive officers or controlling stockholders) by a company’s stock price. SRCs were previously defined as companies with less than $75 million in public float or less than $50 million of annual revenues and no public float.
The following table summarizes the amendments to the SRC definition:
Initial Qualification Thresholds
Previous SRC Definition
New SRC Definition
Public float of less than $75 million
Public float of less than $250 million
Less than $50 million of annual revenues and no public float
Less than $100 million of annual revenues and public float of less than $700 million
For already public companies that previously did not qualify as a SRC under the previous definition, the new rules provide that for purposes of the first fiscal year ending after effectiveness of the amendments, a company will qualify as a SRC if it meets one of the initial qualification thresholds noted above as of the date that it is required to measure its public float or revenues. Public float is measured as of the last business day of a company’s most recently completed second fiscal quarter and revenue is measured based on a company’s most recently completed fiscal year for which audited financial statements are available. For example, a company with a December 31 fiscal year-end that had a public float of $200 million as of June 30, 2018, would not have previously qualified as a SRC because it had over $75 million in public float but will now qualify under the new rules for the fiscal year ending December 31, 2018, because it has less than $250 million in public float as of June 30, 2018.
In order to avoid situations in which companies enter and exit SRC status due to small fluctuations in public float and revenue, the release provides that if a company does not meet the initial qualification thresholds noted above, it will remain unqualified for SRC status until it determines that it meets one or more lower qualification thresholds, which are set at 80% of the initial qualification thresholds. Accordingly, (i) for the public float test, once a company exceeds $250 million as of its most recently completed second fiscal quarter, it will not qualify as a SRC under the public float test until it has public float of less than $200 million; and (ii) for the revenue test, once a company exceeds either or both of the $100 million annual revenue and $700 million public float thresholds, it will not qualify under the revenue test until it meets a lower threshold for the criteria on which it previously failed to qualify ($80 million of annual revenues and $560 million of public float).
For example, for the revenue test, if a company with a December 31 fiscal year-end had a public float of $800 million as of June 30, 2018, and revenues of $120 million for the fiscal year ended December 31, 2017, it will not qualify as a SRC until it falls below $80 million of annual revenues and a public float of less than $560 million. However, if the same company’s public float as of June 30, 2018, was $600 million (instead of $800 million) and it had revenues of $120 million for the fiscal year ended December 31, 2017, it will not qualify until it falls below $80 million of annual revenues.
The following table summarizes these subsequent qualification thresholds:
Subsequent Qualification Thresholds
Previous SRC Definition
New SRC Definition
Public float of less than $50 million
Public float of less than $200 million
Less than $40 million of annual revenues and no public float
Less than $80 million of annual revenues (if it previously had $100 million or more of annual revenues) and public float of less than $560 million (if it previously had $700 million or more of public float)
Impact on Smaller Technology and Life Sciences Companies
The SEC’s release estimates that approximately 1,000 additional companies will be eligible for SRC status in the first year under the new definition. Smaller technology and life sciences companies that previously did not qualify as SRCs will now be able to take advantage of reduced disclosure requirements. Some of the notable reduced requirements that SRCs can take advantage of include:
- Executive Compensation: SRCs are only required to provide detailed compensation information for three instead of five named executive officers. They are also not required to include a Compensation Discussion and Analysis and are not required to include certain tabular compensation information, including the grants of plan-based awards table and the option exercises and stock vested table. In addition, SRCs are not required to provide CEO pay ratio disclosure.
- Stock Performance Graph: SRCs are not required to include a stock performance graph.
- Financial Statements: SRCs can disclose two years of statements of operations, cash flows, and stockholders’ equity instead of three years. They also need to provide two years of balance sheets. SRCs also can take advantage of less stringent age of financial statement requirements and only need to provide a maximum of two years of acquiree financial statements rather than three years.
- MD&A: SRCs can compare two years rather than three years of financial results in MD&A. They are also not required to make tabular disclosures of contractual obligations.
There are a number of additional scaled disclosure accommodations noted in the adopting release, including with respect to related party transactions and corporate governance.
Newly qualified SRCs will need to determine whether providing additional information, even where scaled disclosure is available, will be useful. Moreover, in determining whether to take advantage of reduced disclosure, companies should also be mindful of institutional investor and proxy advisory firm sentiment, especially where the company had previously been reporting — and has the necessary internal processes and procedures in order to report — the information. With respect to certain disclosures, such as historical financial statements, the ability to reduce disclosure may not be particularly beneficial for newly qualified SRCs because these companies have already previously disclosed this information in their public filings and incurred the costs in compiling this information. Companies exiting emerging growth company status should also keep in mind that they still will be required to hold say-on-pay and say-on-frequency votes even if they qualify as a SRC.
In addition to amending the SRC definition, the new rules preserve the application of the current thresholds contained in the definition of “accelerated filer” or “large accelerated filer” and provide that SRCs are no longer excluded from being an accelerated or large accelerated filer. Previously, SRCs were excluded from being an “accelerated filer” or “large accelerated filer.” Accordingly, while SRCs are able to take advantage of reduced disclosure obligations, because the new rules no longer exclude SRCs from being an accelerated filer, SRCs with a public float of $75 million or more must still comply with the requirements applicable to accelerated filers. Accordingly, SRCs that qualify as accelerated filers will still be subject to accelerated periodic report filing deadlines and also would still be subject to Section 404(b) of the Sarbanes-Oxley Act, which requires a company’s auditor to attest to management’s assessment of its internal controls. Despite this, the SEC did note in the release that it is evaluating possible changes to reduce the number of companies that qualify as accelerated filers and therefore new rules that further relax the requirements on smaller public technology and life sciences companies may be on the horizon.
Finally, consistent with the amendments, the SEC is adopting technical revisions to certain Securities Act Forms, including Forms S-1, S-3, and S-8, and Exchange Act Forms 10-Q and 10-K, to remove the parenthetical next to the “non-accelerated filer” definition that states “(Do not check if a smaller reporting company).” Accordingly, once the rules are in effect, companies should modify their cover page for upcoming Securities Act and Exchange Act filings. After these amendments, a company should check all applicable boxes on the cover page addressing, among other things, non-accelerated, accelerated, and large accelerated filer status, SRC status and emerging growth company status.
For more information regarding the new rules, please see the SEC’s adopting release.