SEC Amends Financial Reporting Rules for Investment Company Business Combination Transactions
On May 20, 2020, the SEC adopted amendments to the financial statement disclosure requirements under Regulation S-X related to acquisitions and dispositions involving investment companies.
First, the amendments streamline applicable significance tests under Regulation S-X to more closely align with significance tests under the Investment Company Act of 1940. Amended Rule 1-02(w)(2) of Regulation S-X creates a separate definition of “significant subsidiary” for investment companies using modified versions of the investment test and income test set forth in Rule 8b-2 under the Investment Company Act, as follows:
- Investment Test. Under the amended investment test, an acquisition will be significant if the value of a fund’s investment in and advances to the tested subsidiary (i.e., the acquired fund) exceed 10 percent of the value of the fund’s total investments as of the most recently completed fiscal year.
- Income Test. Under the amended income test, an acquisition would be significant if the total investment income of the tested subsidiary for the most recently completed pre-acquisition fiscal year is greater than either (1) 80 percent of the total consolidated change in net assets resulting from the acquiring fund’s operations for the most recently completed fiscal year or (2) 10 percent of the total change in net assets resulting from the acquiring fund’s operations for the most recently completed fiscal year, if the investment test condition also exceeds 5 percent. The amended income test includes income from dividends, interest, other income, net realized gains and losses on investments and the net change in unrealized gains and losses on investments.
- Asset Test. Pursuant to the amendments, the asset test under Rule 1-02(w) has been eliminated for investment companies.
The amendments also address the financial statements required for acquiring and acquired investment funds, including registered investment companies and private funds relying on Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. New Rule 6-11 of Regulation S-X applies a facts and circumstances evaluation to determine whether a fund acquisition has occurred. This facts and circumstances evaluation uses the significant subsidiary criteria of Rule 1-02(w)(2), as described above, modified to use the investment test at a 20 percent, rather than a 10 percent, significance threshold, and to exclude the 80 percent condition of the income test. If this significance test is met, one year of audited financial statements of an acquired fund would need to be provided. For private funds, the new rule allows financial statements to be filed in accordance with U.S. GAAP.
Additionally, the amendments eliminated the requirement for investment companies to provide pro forma financial statements in connection with business combination transactions. Instead, the amendments require investment companies to provide certain supplemental financial information about the combined fund post-acquisition, including, among other things, (1) a pro forma fee table; (2) a schedule of the acquired fund’s investments along with a related narrative discussion, if the acquisition causes material changes to the acquired fund’s investment portfolio resulting from applicable investment restrictions; and (3) narrative disclosure about material differences between the accounting policies of the acquired fund and those of the combined fund.
Lastly, the amendments modify certain financial disclosure requirements of Form N-14 to align those with the requirements of new Rule 6-11, as described above.
The SEC’s final rule is available here.