August 28, 2008

SEC Approves “Potential” IFRS Roadmap: D-Day Six Years Hence

Yesterday, the SEC adopted a proposed roadmap for the potential transition by US companies from US GAAP to IFRS at an open Commission meeting. The roadmap provides that the voluntary transition to IFRS for a limited category of US companies could start with reports filed for fiscal periods ending on – or after – December 15, 2009. To be allowed to do that, a company would have to be among the 20 largest companies within its industry in the world – and a large number of its competitors would have to already be using IFRS. The SEC estimates that about 110 companies would qualify for this voluntary movement.

The roapmap entails possibly mandating IFRS for large US companies for their 2014 financial statements, with somewhat smaller ones required to make the move in 2015 and then the smallest companies forced to use IFRS in 2016. The final decision on whether to implement this timetable would be made in 2011.

Here are the related SEC documents:

Press Release
Opening Remarks by Chief Accountant
Videotaped Remarks from Chair Chris Cox
Speech from Commissioner Elisse Walter

We’ll provide more coverage of this big development over the next few weeks. Note that the Big 4 auditors and others will soon be holding webcasts – I’ve already seen announcements – so there will be “all you can handle” coverage of this topic. Here’s more coverage from FEI’s “Financial Reporting Blog.”

SEC Adopts Tighter Form 20-F Deadline

At its open Commission meeting, the SEC also adopted amendments to the rules applicable to foreign private issuers that file reports with the SEC (here are opening remarks from the Corp Fin Staff; here is the press release). Here are extensive notes from Cleary Gottlieb:

The most important amendment is to accelerate the deadline for filing an annual report on Form 20-F to four months after the end of the fiscal year, an improvement compared to the 90-day deadline the SEC originally proposed for large issuers. Based on the discussion at the open meeting, the final rule will otherwise implement the amendments substantially as proposed in March 2008, with one exception (the full text of the release is not yet available).

Deadline for Filing Form 20-F

Currently an issuer’s annual report on Form 20-F is due six months after the end of each fiscal year. The SEC shortened the deadline to four months for all FPIs. It had proposed 90 days for accelerated filers and 120 days for other filers. The change will take effect for fiscal years ending on or after December 15, 2011 – so for a calendar-year issuer, it will take effect for the 2011 annual report filed in 2012.

To justify the shorter deadline, the SEC pointed out that filing deadlines in other countries are generally not longer than four months and that a four-month deadline will ensure more timely disclosure for investors. The SEC apparently rejected the arguments of many commentators that an accelerated deadline will be burdensome for FPIs since their 20-F reports must include more and different information than the home-country report and are often prepared after the home-country report is substantially complete.

The accelerated deadline is particularly significant for FPIs that must reconcile their financial statements to U.S. generally accepted accounting principles, a complex and lengthy process that may be hard to complete within the new deadline. Companies that prepare financial statements under IFRS (as issued by the International Accounting Standards Board) are exempt from this requirement, and the tighter deadline may cause some companies to switch to IFRS, especially if they can use IFRS for home-country reporting. One reason for the three-year delay in effectiveness is to allow time for foreign issuers and regulators to adopt IFRS.

Other Changes Relating to Form 20-F

Most of the changes concern the disclosure requirements of Form 20-F, which FPIs use to file annual reports with the SEC and which forms the basis of the disclosures required for registered offerings.

– An FPI that must reconcile its financial statements to U.S. GAAP will no longer have the option to use the less demanding presentation under Item 17 of Form 20-F. Financial statements of a company other than the issuer – e.g., an acquired company or an equity-method investee – may still be prepared under Item 17.

– Form 20-F will require disclosure of significant differences between the issuer’s corporate governance practices and the requirements of U.S. securities exchanges. The rules of the U.S. exchanges already require essentially the same information but permit it to be published on the website instead.

– Form 20-F will require disclosures about any fees and charges relating to an issuer’s ADR programs, including payments made by a depositary to the issuer in connection with the programs.

– Form 20-F will require disclosures regarding changes in and disagreements with the issuer’s auditors. The disclosures are substantially the same as those that apply to U.S. issuers under Form 8-K, except that under Form 20-F they will only be required annually.

The SEC specified that the change described in the first bullet above will take effect for fiscal years ending on or after December 15, 2011. It did not address the effectiveness of the other amendments, which will apparently be earlier.

The SEC did not adopt one related proposal, under which an annual report on Form 20-F would have had to include target financial statements and pro forma financial information for some large completed acquisitions. The proposal would have affected only a few companies each year, but the burden would have been significant, so the decision not to adopt this requirement provides significant relief.

Changes to “Going Private” Rules

The SEC amended its “going private” rules under Exchange Act Rule 13e-3 to cover share repurchases, tender offers and proxy solicitations that are intended, or would be reasonably likely, to render an FPI eligible to deregister its securities.

Changes to Determination of FPI Status

Under the new rules, an issuer will be required to determine its FPI status under the SEC’s rules once a year on the last day of its second fiscal quarter, and the amendments will provide a transition period for a company that loses FPI status. Under current rules, a company must test its status continually and start reporting as a U.S. company immediately upon the loss of FPI status.

SEC Overhauls Registration Exemption for Foreign Companies

At the open Commission meeting, the SEC also voted to adopt amendments to Rule 12g3-2(b), which exempts certain foreign private issuers from registration with the SEC (here are opening remarks from the Corp Fin Staff; here is the press release). Here are extensive notes from Cleary Gottlieb:

Based on the SEC staff’s comments at the open meeting, the SEC has accepted the most widely made comment on its original proposal, by eliminating the proposed 20% cap on U.S. trading volume. The final rule will otherwise be adopted substantially in the form proposed in the SEC’s February 2008 proposing release (the full text of the release is not yet available).

Under Section 12(g) of the Securities Exchange Act of 1934 and related rules, a foreign private issuer (as defined under the Exchange Act) that has 300 or more U.S. resident holders of a class of equity securities at the end of its most recently completed fiscal year, and 500 or more worldwide holders of record (plus US$10 million or more in total assets), must register that class under the Exchange Act unless an exemption is available. Exchange Act registration requires a company to comply with SEC reporting requirements, and with the Sarbanes-Oxley Act of 2002.

Registration under Section 12(g) is theoretically required even if a company does not list or publicly offer its securities in the United States. However, an exemption is available under Rule 12g3-2(b). Rule 12g3-2(b) currently allows an FPI that has not listed or publicly offered securities in the United States to avoid registration by making an application under the Rule and furnishing the SEC with English-language versions of certain material information that the issuer makes public or is required to file in its home country. For most companies, the information must be submitted to the SEC in paper form.

The amendments will make the exemption automatically available to eligible FPIs, which will no longer have to make an application to the SEC. Under the amendments, in order to maintain the exemption, a company must publish electronically (either on its website or on a publicly available electronic system) English translations of certain key documents, such as annual and interim reports and financial statements, material press releases and certain other significant documents. Paper submission will no longer be required.

The amendments will include two eligibility requirements that an FPI must meet to benefit from the exemption:

– The issuer has no active Exchange Act reporting obligations under Section 13(a) or 15(d) (this means essentially that the issuer has not listed or publicly offered securities in the United States).

– The issuer maintains a listing of the subject securities on one or more non-U.S. exchanges that are its primary trading market (meaning one or two markets that represent at least 55% of its worldwide trading volume, at least one of which must have greater trading volume than the United States).

The amendments do not include the most controversial eligibility requirement from the SEC’s February proposal, which would have made companies ineligible if trading in the United States represented more than 20% of the issuer’s worldwide trading volume in the most recently completed year. In the open meeting, the SEC’s staff indicated that most commenters had opposed the 20% trading volume test, in particular due to the dampening effect it could have had on sponsored ADR facilities and the inclusion of U.S. investors in exempt offerings such as private placements. As the issuer must still meet the primary trading market requirement described above in order to benefit from the exemption, U.S. trading must in any case represent no more than 45% of an issuer’s worldwide trading volume.

The result of these amendments is that vast numbers of non-U.S. companies that regularly publish English-language documents will automatically become exempt, without any action (or even any knowledge of the exemption). As a result, their shares will become eligible for unsponsored ADR facilities and Rule 144A resales to qualified institutional buyers. At the same time, some companies, such as unlisted funds or acquisition targets that have delisted but have remaining U.S. shareholders, may be ineligible for the exemption.

It is also uncertain whether the amended Rule will require that issuers publish full English translations of documents or whether English versions that cover all material information will be sufficient. We had noted in our comment letter that many companies include information in their home country reports (due either to local regulations or to local practices) that is not of interest for U.S. investors, and that some of these companies omit this information from the English versions of these reports.

The amendments will provide for a three-year transition period for FPIs that lose their Rule 12g3-2(b) exemption because they are unable to meet the Rule’s new substantive requirements. In addition, the Rule will include a three-month transition period following effectiveness to enable issuers to comply with the Rule’s substantive requirements, in particular the electronic publication of English-language documents.

– Broc Romanek