SEC Amends Financial Disclosure Requirements for Registered Debt Offerings

On March 2, 2020, the Securities and Exchange Commission (SEC) adopted amendments to financial disclosure requirements applicable to registered debt offerings for subsidiary issuers and guarantors contained in Rule 3-10 of Regulation S-X and for affiliates whose securities are pledged as collateral contained in Rule 3-16 of Regulation S-X. In the press release, SEC Chairman Clayton stated that the changes “are intended to both improve the quality of disclosure and increase the likelihood that issuers will conduct debt offerings on a registered basis.” In the adopting release, which is available here, the SEC also noted that the changes “are intended to provide investors with material information given the specific facts and circumstances, make the disclosures easier to understand, and reduce the costs and burdens to registrants.” The amendments are largely as proposed in July 2018, with certain modifications in response to comments received by the SEC

The final rules are effective January 4, 2021, but earlier compliance is permitted. In addition, the SEC noted that under existing Rule 3-16, registrants often structure debt agreements to release affiliate securities pledged as collateral if Rule 3-16 is triggered. As a transitional matter, so as not to change the amount of collateral available to previously issued debt securities, the final amendments do not eliminate existing Rule 3-16, which will continue to apply to registered collateralized securities with collateral release provisions issued and outstanding as of the effective date. New Rule 13-02 applies to collateralized debt securities issued on or after January 4, 2021 and to each registered security issued and outstanding before the effective date for which the registrant has previously been required to provide separate Rule 3-16 financial statements.

The final rules are summarized below and a comparison of the current requirements and the new amendments are provided in more detail in Appendix A for registered debt securities with guarantees and Appendix B for registered debt securities with affiliate securities pledged as collateral.

Registered Debt Securities with Guarantees (Amended Rule 3-10 and New Rule 13-01 of Regulation S-X)

Under current Rule 3-10 of Regulation S-X, separate financial statements must be filed for subsidiary issuers and guarantors of registered debt¹, unless the issuer and guarantor structure fits within one of five exceptions provided in Rule 3-10 and the conditions specified in the applicable exception are met (see Appendix A). Each of the current five exceptions include as conditions that (i) each subsidiary issuer and guarantor must be “100%-owned” by the parent company and (ii) each guarantee must be “full and unconditional.” If one of the five exceptions is met, the parent company can include alternative disclosures to the separate financial statements for subsidiary issuers and guarantors, which alternative disclosures can range from a brief narrative to detailed condensed consolidating financial information in a footnote to the parent’s financial statements. The parent company is currently required to provide the separate subsidiary financial statements or any alternative disclosures as long as the guaranteed securities are outstanding. The final rules amend certain eligibility requirements for the exception to providing separate subsidiary financial statements, which remain in Rule 3-10, and revise the alternative disclosure requirements, which are now relocated to newly created Rule 13-01 in Regulation S-X. Among other things, the amendments:

• replace the current condition that a subsidiary issuer or guarantor be 100%-owned by the parent company with a condition that the subsidiary be consolidated in the parent company’s financial statements;
• replace the current five exceptions of eligible issuer and guarantor structures with a broader two-category framework that focuses on the parent company’s role as issuer, co-issuer or guarantor with respect to the guaranteed security, rather than the status of the subsidiary guarantor (the amendments no longer require the subsidiary guarantee to be full and unconditional, but if the parent is a guarantor of a subsidiary issuer, the parent guarantee must be full and unconditional);
• replace consolidating financial information with summarized financial information (as defined in Rule 1-02(bb)(1) of Regulation S-X) and reduce the number of periods required to be presented to the most recently ended fiscal year and most recent interim period, if applicable;
• permit the summarized financial information to be presented on a combined basis for the parent company and all subsidiary guarantors and issuers and eliminate the requirement to provide financial information for any non-guarantor or non-issuer subsidiaries;
• expand the required qualitative disclosures to include certain disclosures about the issuers and guarantors, the terms and conditions of the guarantees, and how the issuer and guarantor structure and other factors may affect payments to holders of the guaranteed securities;
• provide companies the option to include the revised alternative disclosures outside the financial statements, thereby avoiding the need for such revised alternative disclosures to be audited;
• eliminate the requirement to provide pre-acquisition financial statements of a recently acquired subsidiary issuer or guarantor and only require pre-acquisition summarized financial information of a recently acquired subsidiary issuer or guarantor if it is a “significant business” as defined by Regulation S-X; and
• require the summarized financial information and/or other disclosures required by new Rule 13-01 to be provided with respect to any subsidiary issuers or guarantors only as long as the Exchange Act reporting obligations continue to apply with respect to such debt securities instead of for as long as such debt securities are outstanding². For most registered debt offerings where the debt securities are not listed on a stock exchange, the Exchange Act reporting obligations for subsidiary issuers and guarantors will be suspended and the summarized financial information and/or other disclosures will not be required for any year other than the year in which the relevant registration statement became effective³.

Registered Debt Securities with Affiliate Securities Pledged as Collateral (New Rule 13-02 of Regulation S-X; Elimination of Rule 3-16 of Regulation S-X)

Under current Rule 3-16 of Regulation S-X, separate financial statements must be filed for each affiliate whose securities constitute a “substantial portion” of the collateral for any class of registered securities, as if the affiliate were a separate registrant. An affiliate’s portion of the collateral is a “substantial portion” if the highest amount among the aggregate principal amount, par value, book value, or market value of the affiliate’s securities equals or exceeds 20% of the principal amount of the registered securities. The final rules relocate the revised disclosure requirements to new Rule 13-02 of Regulation S-X. Among other things, the amendments:

• replace the current requirement for separate financial statements for each affiliate whose securities constitute a substantial portion of the collateral with a requirement to provide summarized financial information for each such affiliate;
• replace the requirement to provide disclosure only when the pledged securities meet the numerical threshold of a “substantial portion” of the collateral with a requirement to provide the financial and non-financial disclosures in all cases, unless immaterial;
• require certain non-financial disclosures about the securities pledged as collateral, each affiliate whose securities are pledged, the terms and conditions of the collateral arrangement, and whether a trading market exists for the pledged securities;
• provide companies the option to include the disclosures in the footnotes of the parent company’s financial statements or outside of the financial statements, thereby avoiding the need for such disclosures to be audited; and
• require pre-acquisition summarized financial information of a recently acquired affiliate if it is a “significant business” as defined in Regulation S-X.

New Exhibit Requirement

In addition, the amended rules also require a new exhibit in the relevant registration statement and the parent company’s periodic reports identifying (1) all entities and their roles as issuers or guarantors of the registered debt securities or (2) all affiliates whose securities have been pledged and identifying the pledged securities, as applicable.

¹ If required to provide separate financial statements of any subsidiary issuers and guarantors, those subsidiary issuers and guarantors would also be subject to the reporting requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 because the Rule 12h-5 exemption from those reporting requirements would not be available.

² Although not required, parent companies which anticipate issuing registered debt securities with a similar obligor group on a regular basis may wish to continue including the disclosures in their Exchange Act reports to provide greater flexibility and enable faster access to capital markets for future offerings.

³ Parent companies may also wish to consider whether to issue the registered debt securities through a separate standalone registration statement or using a shelf registration statement. Issuing registered debt securities through a shelf registration statement and, particularly, a universal shelf registration statement, may require the summarized financial information and/or other disclosures to be provided for a longer time period. If the relevant registration statement is a shelf registration statement which is required to be updated pursuant to Section 10(a)(3) of the Securities Act of 1933, the SEC deems the registration statement to have gone “effective” again upon the filing of the Form 10-K (since the SEC views the Form 10-K as a “post-effective amendment” to a shelf registration statement). This results in the automatic reporting suspension in Section 15(d)(1) of the Securities Exchange Act of 1934 being unavailable for any year in which a shelf registration statement is automatically updated by the filing of a Form 10-K. A registrant has to file a post-effective amendment deregistering any unsold securities under the shelf registration statement before the automatic reporting suspension under Section 15(d) is available, see SEC Exchange Act Sections Compliance and Disclosure Interpretation Question 153.01.