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Trends in Early Adoptions of New SEC Rules Relating to Guarantors and Issuers of Guaranteed Securities

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On March 2, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments to Rules 3-10 and 3-16 of Regulation S-X, largely contained in new Rules 13-01 and 13-02, respectively. The new rules significantly streamline and simplify the disclosure requirements with respect to subsidiary guarantees and collateral supporting registered debt securities. The new rules are intended to reduce disclosure burdens on reporting companies, as well as make the relevant disclosure more useful and intelligible for investors. Our prior alert on the adoption of the amendments can be found here.

Amended Rule 3-10 expands the conditions under which a reporting company may omit separate financial statements for subsidiary guarantors or issuers of registered debt, and new Rule 13-01 specifies the new disclosure requirements for such subsidiaries. Similarly, for any affiliate the securities of which constitute collateral of the reporting company’s registered securities, amended Rule 3-16 permits the reporting company to omit separate financial statements for such affiliate in lieu of the new, reduced disclosure requirements of new Rule 13-02.

The new disclosure requirements under Rules 13-01 and 13-02 include, among other things:

  • financial disclosure consisting of the summarized financial information described in Rule 1-02(bb) of Regulation S-X and

  • material non-financial disclosure about any relevant guarantors, issuers or guarantees, in the case of Rule 13-01, and material non-financial disclosure about the securities pledged as collateral and the associated affiliates, in the case of Rule 13-02.

Reporting companies may even in certain instances omit summarized financial information if the information presented is not materially different from the corresponding amounts reported in the company’s consolidated financial statements.  Further, these new rules and amendments allow reporting companies the flexibility to present the new disclosure in either a footnote to the consolidated financial statements or in MD&A.

In conjunction with the new non-financial disclosure requirements, the SEC also adopted amendments to Item 601(a) and new Item 601(b)(22) of Regulation S-K. These amendments require a new Exhibit 22 to be filed with a reporting company’s annual reports on Form 10-K and quarterly reports on Form 10-Q, among others, that lists each of the subsidiaries or affiliates of the reporting company that are covered by new Rules 13-01 and 13-02. Under new Item 601(b)(22), Exhibit 22 must identify each such subsidiary or affiliate and the associated securities.

These new rules and amendments will not be effective until January 4, 2021, but they allow for voluntary adoption and compliance, and many reporting companies have opted to early adopt these new disclosure rules.

We surveyed 39 companies that have early adopted the amended Rule 3-10 and new Rule 13-01 through May 19, 2020, we note the following trends1:

  • Disclosure: Six of the 39 surveyed companies determined under the new rules to omit summarized financial information of their subsidiary issuers or guarantors, finding that their combined financial statements were not materially different from the corresponding amounts reported in the company’s consolidated financial statements, and that providing summarized financial information for the subsidiaries would be repetitive and not useful to investors. The remaining 33 surveyed companies provided summarized financial information in accordance with Rule 1-02(bb) in the form of line item presentation that tracked the requirements of the rule.

  • Location: 35 of the 39 reporting companies that early adopted the new rules opted to include their non-financial disclosure in MD&A, while only four included it in a footnote to the consolidated financial statements. Most of the discussions were fairly comparable, with brief descriptions of the new rules in addition to discussions of the subsidiary guarantors or issuers and associated securities to which the new rules applied.2

  • Sufficiency of the Guarantees: Most of the reporting companies included some description of the sufficiency of the guarantees at issue in their non-financial disclosure pursuant to Rule 13-01(a)(6) of Regulation S-X.3 Among other things, such descriptions included: the conditions under which such guarantees might terminate; the circumstances under which the rights of holders against the issuer may become limited due to, for example, the U.S. Bankruptcy Code or state fraudulent transfer or conveyance law; and the possibility that payments to holders may be affected by relationships between a parent and its non-guarantor subsidiaries or affiliates.

  • Exhibit 22: Of the 39 surveyed reporting companies that early adopted the new rules, 28 included an Exhibit 22. The format of and information included in these exhibits varied considerably. Some companies opted to use narrative style disclosure, while others provided tabular disclosure; and some companies included only the name of the subsidiary or affiliate and the associated security, while others provided such subsidiary’s or affiliate’s jurisdiction of incorporation and the nature of the guarantee (e.g., as joint and several, conditional or unconditional).

Finally, in addition to the amendments to Rules 3-10 and 3-16 and the additions of Rules 13-01 and 13-02 described above, the SEC has eliminated the portion of Rule 3-10(a) that required parent companies to continue providing modified financial information described by Rule 3-10(b) through (f) relating to subsidiary issuers or guarantors. If the subsidiary issuer’s or guarantor’s reporting obligation under Section 15(d) is suspended by operation of Section 15(d)(1) or compliance with Rule 12h-3, the SEC’s recent amendment of Rule 3-10(a) also permits the parent to cease providing the relevant disclosure. It remains to be seen whether reporting parent companies will take advantage of this change or whether registrants will continue to produce the more streamlined information to preserve the ability to offer guaranteed or collateralized securities on a registered basis.

1We found one example of a company early adopting Amended Rule 3-16 and Rule 13-02, but the company provided no summarized financial information for its affiliates thereunder. Due to the prior version of Rule 3-16’s reporting obligations, among other reasons, secured bonds were rarely offered in SEC-registered transactions. 

2Additionally, although not expressly required by the new rules, 6 of the 25 reporting companies which included their non-financial disclosure in MD&A also included a brief discussion of their early adoption of the new rules in a footnote to their financial statements devoted to new accounting policies or recent accounting pronouncements.

3Rule 13-01(a)(6) requires reporting companies to include in their subsidiary-guarantor disclosure “[a]ny financial and narrative information about each guarantor if the information would be material for investors to evaluate the sufficiency of the guarantee.”  SEC Release No. 33-10762 provides as an example of such information a scenario in which substantially all of a subsidiary guarantor’s non-current assets consisted of goodwill, in which case goodwill would need to be presented separately from other non-current assets in order to allow investors to evaluate the sufficiency of such guarantee.

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