Summary
On October 6, 2011, the staff of the Securities and Exchange Commission’s Division of Corporation Finance published a new edition of the Division’s Financial Reporting Manual (FRM). The inside cover lists a summary of the paragraphs that were updated. For the most part, the updates provide clarification or make housekeeping changes. However, two of the updates are noteworthy and are discussed below.
Details
2005.8 — Reporting requirements when an acquisition or disposition is made by a consolidated variable interest entity
When a registrant becomes required to consolidate or deconsolidate a variable interest entity, this is an event that may require reporting pursuant to Rule 3-05 and/or Article 11 of Regulation S-X and/or Items 2.01 and 9.01 of Form 8-K. The staff has added guidance in paragraph 2005.8 of the FRM that clarifies that the need to consider these reporting requirements in Regulation S-X and Form 8-K also applies to acquisitions and dispositions made by consolidated VIEs.
While the need to consider these requirements is clear, the approach for computing significance and the date by which such an event needs to be reported are not always clear. In these cases, registrants should consider consulting with the staff.
2510.5 — Subsidiary guarantee release provisions
As a general rule, every issuer and guarantor of a registered security is required to file the financial statements that would be required of a registrant under Regulation S-X. For example, if a parent registers debt instruments that are guaranteed by its subsidiaries, separate financial statements of the subsidiaries would generally be required. However, Rule 3-10 of Regulation S-X allows a registrant to present condensed consolidating financial information in a footnote in lieu of separate financial statements if certain criteria are met. To qualify for this relief, among other conditions, the guarantees must be full and unconditional.
For several months, the SEC staff has been discussing the full and unconditional requirement in speeches, communicating the point that whether a guarantee is full and unconditional should not be assessed solely in terms of the extent of a guarantee. Rather, the assessment must also consider a guarantee’s duration. The staff believes that if a guarantee will not be in place continuously throughout the life of the registered security (e.g., if a guarantor can “opt out” of the guarantee during the term of the debt), the guarantee is not full and unconditional.
We understand that the staff has recently determined that contracts covering high yield notes frequently allow the release of subsidiary guarantees before the notes are extinguished, and many of the contract provisions are so common that the staff considers them to be “customary.” The staff believes that such guarantees do not meet the definition of “full and unconditional” in Rule 3-10(h)(2) of Regulation S-X. However, if the conditions under which a subsidiary may be released from a guarantee are limited to those the staff considers to be customary, the staff has concluded that it does not need to require registrants to provide the full separate guarantor financial statements required by Rule 3-10. Instead, condensed consolidating financial information is sufficient.
This view is reflected in revised paragraph 2510.5 of the FRM, and that paragraph now contains a list of customary release provisions. Paragraph 2510.5 now reads as follows:
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Subsidiary Guarantee Release Provisions – A subsidiary that guarantees its parent’s debt securities pursuant to an indenture that provides for the subsidiary’s guarantee to be released automatically under customary circumstances may rely on S-X 3-10, provided the other requirements of S-X 3-10 are met. These customary circumstances include, for example, when:
- The subsidiary is sold or sells all of its assets;
- The subsidiary is declared “unrestricted” for covenant purposes;
- The subsidiary’s guarantee of other indebtedness is terminated or released;
- The requirements for legal defeasance or covenant defeasance or to discharge the indenture have been satisfied;
- The rating on the parent’s debt securities is changed to investment grade; or
- The parent’s debt securities are converted or exchanged into equity securities.
Registrants with questions about these and other types of customary circumstances in which S-X 3-10 may be available notwithstanding the existence of arrangements that provide for the release of subsidiary guarantees should contact CF-OCC. (Last updated: 6/30/2011)
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In applying this new guidance, the following should be noted:
- Deciding whether a release provision is customary will require judgment and may require consultation with legal counsel and the SEC staff.
- If some subsidiary guarantees are full and unconditional and others are not, then in its condensed consolidating financial information a registrant should present separate columns for the subsidiaries whose guarantees are full and unconditional and those whose guarantees are not. The new guidance does not provide relief from this aspect of Rule 3-10(i)(6).
- If customary release provisions are present, a registrant cannot state in its disclosure that all guarantees are full and unconditional. (Rule 3-10(i)(8)(ii) requires a statement to this effect if it is true.)
- We expect that disclosure of the release provisions will typically be considered necessary to comply with Rule 3-10(i)(11).
- We understand that the SEC staff believes that a provision allowing a guarantor to “opt out” of a guarantee at will (vs. pursuant to specified conditions) is not a customary release provision. A registrant with such a provision is required to fully comply with Rule 3-10.
- The relief provided by this guidance is available only to subsidiary guarantors. It is not available when a conditional guarantee is provided by a parent guarantor.