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“Open for Business” Mantra Takes Hold – And SEC Streamlines

Summary

  • Recent developments demonstrate that the SEC Staff is taking to heart the “Open for Business” mantra propagated by political appointees from the recent change in administrations.
  • The most significant development is the dramatic shift in receptiveness for waivers for audited financial statements where the production may be burdensome but not clearly material to investors. Such waivers are being granted specifically with respect to financial statements in cases of marginal significance tests or where fully audited financials would involve significant cost but not necessarily provide substantial incremental useful information.
  • In addition, the Staff continue to emphasize eligibility for all filers (and not just “emerging growth companies” under the JOBS Act) to take advantage of confidential preliminary registration statements for IPOs as well as follow-on offerings occurring within one year of IPO.
  • The number of Staff comments issued upon review of registration statements have declined significantly, in an effort toward a speedier path to encourage use of public markets.
  • In a relative revolution in customer service, registrants are encouraged to call the Staff early in a process to potentially be granted relief without a labored, sclerotic timeline.

New Administration, New Focus

A change in administration has brought with it a new focus by the SEC to lessen regulatory burden on public companies. This comes as large private companies in recent years have increasingly eschewed the public markets. Such avoidance may have been for various reasons wholly unrelated to SEC regulation, and also may have been transient, given the advent of late of unicorns such as Uber that are openly espousing the benefits of public ownership. However, the SEC, to its credit, appears committed to ensuring that the Commission is not considered part of the problem – and “Open for Business” has become an overarching mantra at all levels.

Pain Relief for Accounting Waivers on Both M&A and Equity Markets

Accounting treatment can send chills through transaction participants. Two circumstances in particular have historically required fully audited financial statements – including potentially the painful need to recast prior year financials – even though their substantive worth was arguable. In recent public remarks, senior SEC accounting staff have highlighted two specific areas that in particular are the beneficiaries of increased relief in the form of accounting waivers, referred to as Section 313 waivers.

The first situation surrounds significance testing, which focuses on three tests: income, balance sheet and earnings. If any of these tests breaches the relevant significance threshold (beginning at 20% – a summary is available on our M&A checklist here), then various periods of audited financials are required. The tests are more complex than they necessarily appear on their face, involving look-back periods and twists and turns if a filer has been loss-making instead of income-recognizing. A common “foot fault” in significance testing is when a Buyer has marginal earnings per share (either negative or positive). In the situation where significance testing is not triggered with respect to the balance sheet or income tests, a relatively small and arguably immaterial transaction may trigger the earnings-per-share significance test due to rounding error. For example, if a Buyer with $0.01 EPS acquires a Target and rounding error pushes the Buyer to break-even (0) EPS, then even though the Buyer may have income and a strong balance sheet that dwarfs that of the target company, the Buyer could be required to file full financials, as the change in the EPS number on a relative basis is quantitatively material. The Staff have been explicit that in this situation they are open to discussions on the actual qualitative materiality and facts and circumstances of the transaction, and have been granting waivers for precisely this situation.

The second scenario involves where a Buyer may purchase a carved-out business from a Target, but the business was not previously held separate by the Target and thus fully audited carve-out financials are burdensome in cost and time. While the Staff may still (reasonably) request a high-level summary of the financial impact of the transaction, such as aggregate assets purchased and liabilities assumed, they may waive requiring fully broken-out financial statements with various sub-categories that would entail substantial upfront accounting judgments and work, but would thus conform completely with GAAP.

Equity Registration – Greater Availability, Easing of Comments

Further, the Staff has reinforced its relatively recently changed rule that confidential preliminary filings are available to all IPO candidates, as well as for follow-on offerings that occur within one year of IPO. While “emerging growth companies” under the JOBS Act were already eligible for this, expanding it to large enterprises means that the large unicorns that may be considering going public will also be able to avail themselves of starting the process in private.

Moreover, practice in the past year has indicated a substantial reduction in the sheer volume of Staff comments on registration statements relative to historical norms. During the technology IPO boom of the late 1990s, it was not unusual to receive a first Staff review comment letter with well over 100 comments. In recent months, that number may have fallen dramatically in a given offering – to the magnitude of 25 or so.

Call Them Early

As part of an overall initiative to encourage interaction with the regulator, the SEC is explicitly inviting early discussion of waiver requests or other areas of particular concern. SEC officials have noted that in more than one case, a Buyer could have avoided the cost and time delay of a lengthy treatise letter from outside counsel by simply calling the Staff first. Moreover, the Staff  publishing the telephone numbers for key waiver request areas in the Commission’s Financial Reporting Manual.

These tweaks are cumulatively important – and at the same time, the Staff appears to continue with its statutory duties to protect investors, lately and most notably including its growing levels of concern on the increasingly frothy and grey-operating world of initial coin offerings. With respect to bread and butter regulation of equity offerings, clearly the Commission is focused on tweaking the regulatory formula to grease the wheels of offerings, with the intended effect of stimulating what has been a relatively lackluster crop of offerings in recent years.