On May 3, 2019, the Securities and Exchange Commission (SEC) issued a release (release) proposing amendments to the financial disclosure requirements for financial statements of businesses acquired (including real estate acquisitions) or to be acquired and for business dispositions. See, Securities Act Release 33-10635; 84 Fed. Reg. 24,600 (May 28, 2019). The release changes are intended to improve the information investors receive regarding acquired or disposed businesses, reduce complexity and costs of preparing the required disclosures, and facilitate timely access to capital. Among the changes, the release includes changes to improve the disclosure requirements for (1) acquired or to be acquired businesses in Rule 3-05 of Regulation S-X; and (2) real estate operations in Rule 3-14 of Regulation S-X.

Financial Statement Requirements for Acquired Businesses

Rule 3-05. Rule 3-05 of Regulation S-X generally requires the inclusion of financial statements of an acquired business when the acquired business is significant to the registrant. Whether an acquisition is significant under Rule 3-05 is determined by applying an investment, asset and income test. Currently, Rule 3-05 requires separate audited annual and unaudited interim pre-acquisition financial statements of the business if any of the investment, asset or income tests exceeds the 20% significance threshold. The periods for which financial statements are required also depends on the relative significance of the business acquired or to be acquired.

The release proposes amendments to the investment and income tests intended to more accurately reflect the relative significance of the acquired business to the registrant and to reduce unusual results in the application of the current significant subsidiary definition.

General Rules Relating to Required Periods for Financial Statements. Under current rules, financial statements must be provided based on the significance of the acquired or to be acquired business. Currently, the rules are: (i) 20% to less than 40% significance requires the most recent fiscal year (audited) and any interim periods (unaudited); (ii) 40% to less than 50% significance requires the two most recent fiscal years (audited) and any interim periods (unaudited); or 50% or more significance requires the three most recent fiscal years (audited) and any interim periods (unaudited).

Financial statements for interim periods may be unaudited but must be prepared in comparative form to include the comparative period for the prior fiscal year. Once the operating results of the acquired business have been reflected in the audited consolidated financial statements for a complete fiscal year, financial statements are no longer required unless the financial statements have not been previously filed or the acquisition is deemed to be of major significance.

The release eliminates the requirement to provide three years of financial statements where the relative significance of the business exceeds 50% and revises the requirement to provide financial statements for any required interim period under the 20% to 40% relative significance band with a requirement to provide financial statements for the most recent interim period. This eliminates the requirement for the registrant to present a comparative interim period of financial statements.

The release results in the financial statement requirements: (i) at 20% to 40% significance, the most recent fiscal year (audited) and most recent interim period only (unaudited); and (ii) at more than 40% significance, the two most recent fiscal years (audited) and any interim periods (unaudited).

Financial Statements for Real Estate Operations

Alignment of Rule 3-14 to Proposed Changes to Rule 3-05. Rule 3-14 of Regulation S-X generally requires the filing of abbreviated financial statements with respect to significant acquisitions of real estate operations. Rule 3-14 financial statements are abbreviated (in comparison to Rule 3-05) in order to exclude certain historical items that are not comparable to the proposed future operations of the real estate operation, such as mortgage interest, leasehold rental, depreciation, corporate expenses and income taxes. Additionally, Rule 3-14 generally requires one year of financial statements, in comparison to Rule 3-05's requirement to potentially require up to three years of financial statements.

Although Rule 3-14 has historically differed from Rule 3-05, the SEC staff indicated in the release that there are no unique industry considerations that justified treating real estate acquirees differently from others. Therefore, the release includes a number of changes to substantially align Rule 3-14 with Rule 3-05 in an effort to reduce complexity while retaining certain industry-specific disclosures.

The release proposes a number of amendments to Rule 3-14 to conform Rule 3-14 with the proposed amendments to Rule 3-05 and is intended to streamline the ability of REITs and other registrants to raise capital and reduce transaction and audit costs.

The release's proposed amendments that affect real estate are:

• increasing the significance threshold for individual acquisitions from 10% of total assets  to 20% of common equity market capitalization;
• aligning the Rule 3-14 significance threshold for the aggregate impact of (i) acquisitions for which financial statements are not required due to insignificance or are significant but not yet required to be filed and (ii) individual probable acquisitions, to those in excess of the 50% level for registration statements and proxy statements;
• eliminating the requirement to provide three years of financial statements for a real estate operation acquired from a related party (only one year of financial statements would be required);
• permitting the filing of financial statements covering a period of nine to 12 months to satisfy the requirement for filing financial statements for a period of one year for an acquired or to be acquired real estate operation;
• amending Rule 3-14 to align the significance and timing of filing requirements in registration statements and proxy statements with Rule 3-05;
• clarifying existing SEC staff guidance on Rule 3-14 financial statements;
• permitting the omission of Rule 3-14 financial statements in registration statements and proxy statements once the acquired real estate operation has been reflected in the Registrant's filed post-acquisition financial statements for a complete fiscal year;
• amending Form 8-K to increase the significance threshold for dispositions of a "business" (including real estate operations) to 20% under all of the significance tests.

Peter M. Fass is a partner at Proskauer Rose.