SEC Amends Financial Disclosures about Acquired and Disposed Businesses – Impact on Investment companies and BDCs

As noted in SEC Flash Report 2020-12, on May 21, 2020, the SEC issued final rules that amend the financial disclosure requirements of Regulation S-X for acquired and disposed businesses. The SEC also amended the significance tests for a “significant subsidiary” in certain SEC rules. The changes included the addition of new S-X Rule 6‐11, and amendments to certain forms, including Form N‐14 for financial reporting of acquisitions involving investment companies and business development companies (“BDCs”). The amendments to the rules and Form N-14 are intended to assist investment company and BDC registrants in making more meaningful determinations as to whether a subsidiary or an acquired or disposed entity is significant and improve the financial disclosure requirements applicable to acquisitions and dispositions of investment companies and BDCs. The amendments are effective for a registrant’s fiscal year beginning after December 31, 2020. However, early application is permitted if the amendments are applied in their entirety.

For a high-level summary of the SEC’s financial statement requirements for significant business acquisitions view our Snapshot, Financial Statements of Acquired Businesses.

Some of the significant amendments that impact investment companies, including BDCs, compared to the current requirements are as follows:

 

Topic	New Guidance (Investment companies and BDCs)	Current Guidance (Investment companies and BDCs)
Significant subsidiary tests under S-X Rule 1-02(w)(2)	Revised the Investment Test A subsidiary is significant if the value of the registrant’s and its other subsidiaries investment in and advances to the tested subsidiary exceeds 10% of the value1 of the registrant’s consolidated total investments as of the end of the most recently completed fiscal year.	The Investment Test determines significance by evaluating whether the value of the registrant’s investments in, and advances to, the tested subsidiary exceeds 10% of the registrant’s consolidated total assets as of the end of the most recently completed fiscal year.
Significant subsidiary tests under S-X Rule 1-02(w)(2) (continued)	Revised the Income Test: A subsidiary is significant if the absolute value of the sum of its combined investment‐related income (i.e., dividends, interest, other income, realized and net change in unrealized gains and losses) for the most recently completed fiscal year (the numerator) exceeds: 80% of the absolute value of the change in net assets from operations of the registrant and its consolidated subsidiaries for the most recently completed fiscal year (the denominator) (the “primary income test”); or 10% of the absolute value of the change in net assets from operations of the registrant and its consolidated subsidiaries for the most recently completed fiscal year and the Investment Test is greater than 5% (the “alternate income test”)   If the absolute value of the consolidated change in net assets from operations of the registrant and its consolidated subsidiaries for the most recently completed fiscal year is at least 10% lower than the average of the absolute value of the change in net assets from operations for the past five fiscal years, the registrant may compute both the primary income test and the alternate income test using the average for the denominator.	The Income Test compares the registrant’s and its consolidated subsidiaries’ equity in the income from continuing operations before income taxes of the tested subsidiary exclusive of amounts attributable to any noncontrolling interests to the consolidated income of the registrant and its consolidated subsidiaries for the most recently completed fiscal year.
	Eliminated the Asset Test as a measure of a significance.	The Asset Test compared the registrant’s and its consolidated subsidiaries’ proportionate share of the total assets (after intercompany eliminations) of the tested subsidiary to the total assets of the registrant and its consolidated subsidiaries as of the end of the most recently completed fiscal year.
Financial statements and supplemental financial information of funds acquired or to be acquired under new S-X Rule 6-11	Use “significant subsidiary” definition in S-X Rule 1-02(w)(2) above to determine if financial statements for the acquired fund must be filed as follows: Investment Test, but substitute 20% for 10%; Use alternative income test, but calculate using the absolute value of the change in net assets resulting from operations of the tested subsidiary rather than the absolute value of the sum of the combined investment-related income as discussed above; The primary income test is not used to determine significance   For acquired funds that are not subject to S-X Rule 3-182, such as private funds, S-X Rule 6-11 requires that only the audited financial statements for the most recent fiscal year and the financial statements for the most recent interim period need to be filed. Such financial statements can be prepared in accordance with U.S GAAP (i.e., ASC 9463), except for the schedule of investments which must be prepared in accordance with S-X Rule 12.	No rules or requirements specific for investment companies and BDCs. Investment companies and BDCs apply the general requirements of S-X Rule 3-05 and the pro forma financial information requirements in S-X Rule 11, although it is often unclear how to apply these reporting requirements in the context of acquired funds.

The final amendments also eliminate certain pro forma financial information requirements for investment company and BDC registrants in connection with fund acquisitions and require instead supplemental information about the newly, combined entities that include:
 
(1) a pro forma fee table that includes the post‐transaction fee structure of the combined entity;
(2) a schedule of investments of the acquired fund modified to show the effects of the change in the portfolio to reflect the investment restrictions of the registrant accompanied by a narrative disclosure describing the change, if the change will result in a material change in the acquired fund’s investment portfolio due to the restrictions; and
(3) narrative disclosure about material differences in accounting policies of the acquired fund when compared to the acquiring fund.
 
The changes to the “significant subsidiary” definition based on new S-X Rule 1-02(w)(2) will also have effects on an investment company’s and BDC’s application of S-X Rule 3-09 regarding separate financial statements for significant subsidiaries and S-X Rule 4-08(g) regarding summarized financial information of subsidiaries not consolidated. In applying S-X Rule 3-09, investment company and BDC registrants will substitute 20% for where 10% is used in S-X Rule 1-02(w)(2), i.e. under the Investment Test and the alternate income test only.