AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS 1996 TWENTY-FOURTH ANNUAL NATIONAL CONFERENCE ON CURRENT SEC DEVELOPMENTS December 10, 1996 Remarks by Douglas Tanner* Associate Chief Accountant Division of Corporation Finance U.S. Securities and Exchange Commission (c) Copyright 1996. All rights reserved. * The SEC, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author, and do not necessarily represent the views of the Commission or the author's colleagues on the staff. A. Streamlining Disclosure Requirements Relating to Significant Business Acquisitions On October 8, 1996, the Commission adopted amendments to Rule 3-05 of Regulation S-X and Item 310 of Regulation S-B (Securities Act Release No. 7355). The amendments streamline the requirements for financial statements of significant businesses acquired or to be acquired in two fundamental ways. First, the amendments changed the thresholds for determining when an acquisition is significant to the registrant. Second, they generally allow an issuer to provide information about significant business acquisitions in Securities Act registration statements on the same time schedule as for Exchange Act reporting. As amended, Rule 3-05 requires one year of audited financial statements for acquisitions significant at the 20% to 40% level, two years of audited financial statements for acquisitions significant at the 40% to 50% level, and three years of audited financial statements for acquisitions significant at the over 50% level. Under the old rules, the thresholds were formerly 10%, 20% and 40% for one year, two years and three years of financial statements. As was the case before the amendments, unaudited interim financial statements of the acquired business are required whenever audited financial statements of the acquired business are presented. With respect to the second fundamental change, under the old rules, if a significant acquisition was consummated or was probable, an issuer was required to include in any Securities Act registration statement filed after the acquisition becomes probable, audited financial statements of the acquired or to be acquired business. The amendments, however, changed a number of items. First, with respect to consummated acquisitions, if the significance of the acquisition is under 50%, the issuer may proceed with a registered offering without the financial statements of the acquired business until 75 days after the acquisition is consummated. A time schedule which generally conforms the updating requirements for acquired businesses under the Securities Act to that of the due date of the registrant's Form 8-K/A filed under the Exchange Act in connection with the acquisition. Second, with respect to probable acquisitions, financial statements of probable acquisitions are now required in registration statements only if the acquisition exceeds the 50% level of significance. However, there are some exceptions to the above rules. The amendments do not change the requirements of Form S-4, Form F-4, and Item 14 of Schedule 14A of the proxy rules. These forms and schedules already provide for certain accommodations with respect to acquired businesses that were not already reporting companies under the Exchange Act and, accordingly, these rules were not amended to change the financial statement requirements for the registrant and the company being acquired. Accordingly, financial statements of the target company continue to be required in registration statements on Forms S-4 and F-4 when securities are being registered in connection with the acquisition of the business and in proxy statements delivered to shareholders in connection with the solicitation of their approval of the acquisition transaction. With respect to individually insignificant businesses acquired since the date of the most recent audited balance sheet, under the old rules, financial statements of the majority of the individually insignificant businesses were required in registration statements if the aggregate impact of such businesses exceeded 20%. Under the amendments, financial statements of individually insignificant businesses are now required to be furnished only if, in the aggregate, the individually insignificant businesses (consummated and probable) exceed the 50% level. If financial statements of individually insignificant businesses are required to be presented, they should be furnished for the most recent fiscal year and the latest interim period preceding the acquisition. The new rules provide that pro forma information relating to a business acquisition is required under Article 11 of Regulation S-X only if audited financial statements of the acquired business are furnished. In addition, the new rules provide that pro forma financial statements are not required for individually insignificant businesses unless they are significant in the aggregate at over the 50% level. However, if a registrant presents the financial statements of an individually insignificant business, the staff would encourage registrants to also include Article 11 pro forma financial information in the filing. Conforming changes were also made to Form 8-K. Although registrants may elect to disclose the fact that they have acquired a business which is significant at the 10% to 20% level pursuant to Item 5 of Form 8-K, as amended, an Item 2 Form 8-K is not required for a "business acquisition" unless the acquisition is significant at the 20% or greater level. However, an Item 2 Form 8-K continues to be required for all other asset acquisitions, and all dispositions, that exceed the 10% level in significance. Before moving on to my five most frequently asked questions regarding the new rules, let me cover one last point. The amendments do not change the requirements of Rule 3-14 of Regulation S-X relating to the financial statements of acquired real estate operating properties. Now, I would like to take a few minutes and discuss the five frequently asked questions regarding the new Rules. 1.The amendments do not change the methods of evaluating significance. The old asset, investment, and income test remain the same. However, for purposes of evaluating the level of significance of a group of acquired businesses, under the new rules businesses are deemed to be related, and evaluated as a single acquisition, if they are under common control or common management, or the acquisitions are dependent on each other or a single common event or condition. 2. The amendments do not change the percentages or methods of evaluating significance for purposes of Staff Accounting Bulletin 80 (Topic I:J), although the staff is considering whether revisions to that guidance should be developed. 3.Some have erroneously read the new rules to require financial statements for the majority of the consummated and probable individually insignificant acquisitions when their aggregate impact exceeds 50%, while not requiring any financial statements for multiple individually significant acquisitions which have been consummated within 75 days of the offering, provided no single acquisition was significant at the greater than 50% level. However, this is not the case. The aggregate impact of all acquired and to be acquired businesses for which financial statements are required, but for which have not been included in the registration statement pursuant to Rule 3-05(b)(4)(i) of Regulation S-X, should not exceed 50%. If the registrant has individually significant and individually insignificant acquisitions, the aggregate impact of all such acquisitions should likewise not exceed 50%. 4.Although Forms S-2 and S-3 require restated financial statements if the registrant has consummated a business combination accounted for as a pooling of interest which is significant at the greater than 20% level, most registrants, in order to obtain a consent from their independent auditors, will likely be required to restate their financial statements for poolings which were significant at less than the 20% level when such financial statements are re-issued in connection with their inclusion in the Form S-2 or Form S-3. The staff notes that this restatement is required under GAAP when financial statements are re-issued after a material pooling of interest and that significance for purpose of Rule 3-05 is not the same, nor was it intended to be the same, as materiality under GAAP for the restatement of a registrant's own financial statements when it has consummated a material pooling of interest. As a general rule of thumb, remember, the only difference between the financial statements included in a Form S-1 and those in a Form S-3 should be the method of delivery to the investors. 5.And lastly, the new rules did not change Regulation A, nor any of its requirements with respect to financial statements of acquired businesses. B.Applicability of SAB 48 to Purchase Business Combinations; Identification of an Accounting Acquiror On July 31, 1996, the staff issued Staff Accounting Bulletin ("SAB") 97 setting forth the staff's views regarding two issues involving purchase business combinations: (a) the application of SAB 48, "Transfer of Nonmonetary Assets by Promoters or Shareholders," to purchase business combinations and (b) the identification of an accounting acquiror in a purchase business combination. SAB 97 states that SAB 48 was not intended to modify the requirements of APB Opinion 16. If a business combination fails to meet the conditions specified by APB 16 for the pooling-of- interests method of accounting, it should be accounted for at fair value using the purchase method pursuant to APB 16. The SAB also expresses the staff's view that an acquiring entity must be identified in all business combinations which do not meet the conditions specified in APB 16 for a pooling of interests. If no single former shareholder group of the combining companies obtains more than 50% of the outstanding stock of the new combined entity, the staff believes that the shareholder group receiving the largest ownership interest in the new combined entity should be presumed to be the accounting acquiror unless objective and verifiable evidence rebuts that presumption and supports the identification of a different shareholder group as the accounting acquiror. The SAB also indicates that financial statements of the accounting acquiror should not be presented on a basis combined with the pre-acquisition financial statements of the acquired companies, except to the extent pro forma financial information is presented pursuant to Article 11 of Regulation S-X. The amendments to Rule 3-05 discussed earlier support the general prohibition of presenting combined financial statements of unrelated entities and codify staff practice that financial statements of related businesses may be presented on a combined bases for the periods for which they are under common management or common control. We have received many inquires regarding SAB 97, some even erroneously asking if we have completely rescinded SAB 48. Let me point out that SAB 97 did not amend or rescind SAB 48. SAB 48 remains in effect for the transfer, just prior to or contemporaneously with an initial public offering, of nonmonetary assets in exchange for a registrant's common stock. SAB 97 clarifies that SAB 48 does not apply to business combinations. However, many questions remain with respect to SAB 48 and SAB 97. Questions such as: 1.When is an acquisition the acquisition of a business and when is an acquisition the purchase of a non- momentary asset? I understand that the EITF may take up this issue in a related matter regarding physician practice management companies. 2.If, just prior to the closing of an IPO, stock is given for non-momentary assets and an employment agreement (or an arrangement similar to an employment agreement) should there be an allocation of the shares to both the assets and the employment agreement and the amounts allocated to the employment agreement accounted for pursuant to SFAS 123? You would think so. 3.What level of objective and verifiable evidence is necessary to rebut the presumption that the shareholder group receiving the largest portion of the shares of the new entity is the accounting acquiror? This is hard to answer. It would be dependent upon the facts and circumstances. With these questions as food for thought, I will wind up my presentation. I will be happy to answer any question you may have during the question and answer section. Thank you.