Division of Corporation Finance and Office of Chief Accountant:
Frequently Requested Interpretations of
Rules for Business Combinations Accounted
For as Pooling-of-Interests
Prepared by Accounting Staff Members in the Division of Corporation Finance and the Office of Chief Accountant, U.S. Securities and Exchange Commission, Washington, D.C.
November 8, 2000
The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any of its employees. This outline was prepared by members of the staffs of the Division of Corporation Finance and the Office of Chief Accountant, and does not necessarily reflect the views of the Commission, the Commissioners, or other
members of the staff.
Guidance About Treasury Stock Rules
Overview of Rules
Obligations to purchase treasury stock
Corporate authorizations to purchase treasury stock
The effect of treasury stock transactions on multiple poolings
Tainted treasury shares in a leveraged recapitalization
Trading and market making activities by a subsidiary
Other Accounting Guidance
Gain or loss on asset sales subsequent to a pooling
Personal Holding Companies
AICPA White Paper
Guidance About Financial Statement Requirements
Combining different fiscal years
Requirement for retroactive restatement
C. Supplemental Financial Statements
I. Guidance About Treasury Stock Rules
A. Overview of Rules
One condition for pooling of interests accounting, specified by paragraph 47(b)1 of APB 162, is that the issuing company must offer and exchange only its stock for at least 90% of the combining company's voting common stock outstanding immediately prior to consummation. Under paragraph 47d of APB 16, shares of a combining company acquired in exchange for recently acquired treasury shares may not be counted toward the 90% threshold because the cash paid for the treasury shares is imputed as consideration for the other company's shares. AIN-APB 16 # 20 provides that, absent persuasive evidence to the contrary, all treasury stock purchased in the two years before initiation of a combination and between initiation and its consummation is "tainted" by the presumption that it was purchased for re-issuance to effect the business combination. Tainted shares, combined with other violations of paragraph 47(b), may not exceed 10% of the shares issued in the combination.
Paragraph 47d of APB 16 and AIN-APB 16 # 20, as interpreted by ASR 146 and ASR 146-A, treats shares purchased in the two years before initiation and between initiation and consummation of a business combination as tainted shares unless there is a reasonable expectation that the shares will be re-issued pursuant to an existing compensation plan, or to settle contractual obligations, or in similar objective and nondiscretionary circumstances. Paragraph 48a, as interpreted by ASR 146-A and SAB 963, treats shares repurchased within six months following a business combination as tainted shares because the repurchases presumptively were planned as part of the previous business combination. An interpretation included in SAB 96 also treats shares contemplated by stock repurchase plans announced before and within six months after a business combination as tainted in the same circumstances as shares purchased in that period. However, repurchased shares are not tainted with respect to any business combination if they are acquired closely following a combination accounted for as a purchase to reduce dilution from the shares issued in that transaction.
The Business Combinations Task Force of the AICPA published a White Paper titled "Elements of a Systematic Pattern of Treasury Share Acquisitions", which provides additional interpretations of these provisions of APB 16. The White Paper is available at the Congressional and Federal Affairs section of the AICPA web site: www.aicpa.org.
B. Obligations to purchase treasury stock
ASR 146-A discussed circumstances where a company is "obliged by contract" to reacquire specific shares or must reacquire specific shares to settle outstanding claims. Shares reacquired in these circumstances are not tainted, despite the fact that there is no specific intent to reissue the shares, unless it appears that the rights or obligations are contrived to circumvent the pooling requirements. Among other examples, ASR 146 stated that shares repurchased to "settle a claim or lawsuit involving alleged misrepresentation or other acts relating to the original issuance of stock" would not be tainted.
In a situation addressed by the staff, a registrant and one of its principal shareholders disagreed about whether that shareholder had been promised anti-dilutive rights with respect to future share issuances promised to certain key employees. The principal shareholder vetoed each attempt to issue shares to those employees because the registrant would not preserve the shareholder's proportionate interest. The employees sued to compel the registrant to issue the promised stock. The dispute was settled when the registrant repurchased most of the principal shareholder's equity interest, enabling the registrant to issue the shares promised to the employees without interference.
Six months later, the registrant entered into a business combination that it desired to account for as a pooling of interests. The registrant believed the shares purchased from the principal shareholder were not tainted because they could be characterized as acquired in settlement of a claim of misrepresentation relating to whether the shares had been issued with anti-dilutive rights. Also, the registrant observed that the shares were repurchased in connection with litigation that was unrelated to the business combination. The registrant believed that the examples in ASR 146-A did not encompass all situations where persuasive evidence could overcome the presumption that treasury shares were repurchased in contemplation of a business combination.
The staff did not believe this registrant's share repurchase fell within the exception cited by ASR 146-A. The staff believed that a distinguishing characteristic of all the examples in that guidance is that a registrant has no discretion as to whether the shares will be repurchased. In this case, the reacquisition was part of a negotiated settlement. No party to the dispute argued that the repurchase of shares was required pursuant to a preexisting contractual obligation. The settlement of the dispute could have taken alternative forms. Since the registrant was not obligated to repurchase the shares, any shares repurchased were subject to a test of their intended subsequent reissuance. As a result, all the shares repurchased by the registrant from the principal shareholder were presumed tainted.
C. Corporate authorizations to purchase treasury stock
As indicated in SAB 96, corporate or board authorizations of stock repurchases within two years prior to consummation of a pooling provide evidence of a planned transaction. The staff expressed the view that the maximum number of shares that could be repurchased pursuant to an announced share repurchase program should be treated as tainted.
One registrant's board authorized it to repurchase up to 100,000 shares either for general purposes or in connection with its systematic pattern of reacquisitions. Because the staff was unable to distinguish between plans to purchase tainted and untainted treasury shares, it concluded that the entire 100,000 shares should be included in the 90% test.
Another registrant's board authorized the repurchase of "up to 10% of the amount of shares ... issued in" a pooling which occurred two months earlier. The authorization contained no reference to the effect on the authorized amount of the registrant's acquiring fractional shares of the combining company for cash, or of other APB 16, paragraph 47(b) violations. Management subsequently developed a more detailed repurchase plan indicating that the number of shares to be repurchased were 10% of the shares issued in the prior pooling reduced by fractional shares acquired for cash.
The registrant asserted that the intention always had been to repurchase only the maximum number of shares permissible under the pooling rules. However, because the authorization was silent with regard to other paragraph 47(b) violations, the staff concluded that the authorization was for 10% of the shares issued. The board's authorization for 10% of the shares issued in the prior pooling combined with the fractional shares actually acquired for cash in the transaction caused the registrant to fail the 90% test.
Another registrant realized that its recent board authorization must be modified or rescinded because its terms could cause it to fail the 90% test for pooling of interests. The staff advised the registrant that any revisions to the plan should (1) be disclosed with a level of prominence equal to the original corporate communication of the company's authorized treasury stock purchase program; (2) specify the number of shares authorized for repurchase; and (3) specify the period of time when the repurchases are authorized to occur.
D. The effect of treasury stock transactions on multiple poolings
A registrant consummated more than 15 business combinations during an 18 month period through the exchange of voting common stock. The registrant purchased treasury stock before, or within 90 days after, the completion of each combination. Board resolutions or other documentation stated management's intention to purchase slightly less than 10% of the stock to be issued in each specifically contemplated business combination in order to minimize dilution without disqualifying the transaction from pooling of interests accounting.
As stated in SAB 96, the staff believed that, in addition to tainted shares purchased before the business consummation, all shares purchased within six months following its consummation and all share purchases contemplated by announcements during that period of intentions to acquire treasury stock, should be treated as tainted shares with respect to that business combination unless the repurchases satisfied the narrow criteria demonstrating their probable reissuance for purposes other than a business combination or were closely associated with a prior business combination accounted for as a purchase. As a result, a repurchased share could count toward the disqualification of more than one business combination from pooling of interests accounting if that repurchase occurred within six months following the consummation of multiple combinations. Based on the staff's position, the registrant revised its financial statements to account for most of the business combinations during the 18 month period using the purchase method.
E. Tainted treasury shares in a leveraged recapitalization
A change in control can be effected through a series of equity transactions, a transaction structure often referred to as a leveraged recapitalization. Certain steps taken in a leveraged recapitalization transaction may affect the computation of tainted treasury shares for a subsequent business combination.
A typical leveraged recapitalization transaction generally is effected through two or three integrated steps. In the first step, new investors exchange cash for common and preferred shares of the company. In some transactions there is an intermediate step where additional cash is obtained from debt financing. In the final step, the cash proceeds from the first two steps are used to purchase a portion of the company's shares from existing shareholders. However, because the transaction is not effected as a leveraged buyout where a Newco acquires 100% of Oldco as described in EITF Issue 88-16, that guidance does not apply. Instead, the transaction is accounted for as a series of equity transactions and generally, there is no change in the accounting basis of the company's recorded assets and liabilities.
Family members controlled a registrant immediately prior to its leveraged recapitalization. The parents controlled the majority of the shares and their adult children held the remaining shares. In the leveraged recapitalization, lenders and new equity investors provided the cash to the registrant enabling it to purchase all of the parents' interest and 95% of the children's interest. Because of the leverage in the new capital structure, the children's voting interest in the registrant remained approximately the same after the transactions as it was before the transactions.
The registrant believed that the cash payments to the family should be accounted for as a dividend to the extent each received a pro rata distribution. In other words, the registrant interpreted the transactions to consist of a distribution of 95% of each shareholders' interest, followed by a repurchase of the parents' remaining 5% interest in the company. Therefore, the company believed that only the 5% redemption of the parents' interest in the company gave rise to tainted treasury shares. In addition, the company argued that the shares issued to the new investors in the first step of the recapitalization transactions cured an equivalent number of tainted shares.
The staff objected to the company's treatment of any part of the cash payments to the family members as a substantive dividend. The staff noted that the cash payments were structured legally as stock redemptions, rather than dividends. As a result, the staff concluded that all of the cash payments to the family members gave rise to tainted treasury shares.
The staff also addressed whether the taint on any of those treasury shares was removed when shares were issued to new investors. The staff considered Interpretation 20 to Opinion 16 which provides that to the extent treasury shares reacquired during the restricted period "... have not been issued ... an equivalent number of shares of treasury stock may be sold prior to consummation to 'cure' the presumed violation of paragraphs 47c and 47d." The staff believes that an implicit principle in that guidance is that the issuance of shares cures taint on treasury shares only if tainted treasury shares exist at the time of reissuance. In the registrant's transaction, new money was raised first by the sale of shares, with the proceeds used to purchase treasury shares from the family members. As a result, the staff objected to the company's conclusion that the sale of shares to new investors cured the taint on the subsequent purchases of treasury shares.
F. Trading and market making activities by a subsidiary
A registrant that is a financial institution had subsidiaries and divisions that traded, made markets in, wrote derivative contracts on, or otherwise transacted in the registrant's own common shares. The staff advised the registrant that those transactions are considered to be treasury share transactions that must be evaluated under paragraphs 47d and 48a of APB 16 in connection with any business combination to be accounted for as a pooling of interests. The staff believed that shares of the registrant repurchased by those operations could not be distinguished in a sufficiently persuasive and objective manner to overcome the presumption that some or all were repurchased in contemplation of a business combination. Similarly, the staff believed that transactional activity occurring between the dates of initiation and consummation, or after consummation, could not be distinguished in a sufficiently persuasive and objective manner to overcome the presumption that some or all were repurchased pursuant to agreements or plans to reacquire shares issued in the business combination. The staff advised the registrant that all shares purchased by those operations were tainted and must be aggregated with all violations of 47(b) in applying the 10% limitation.
II. Other Accounting Guidance
A. Gain or loss on asset sales subsequent to a pooling
Paragraph 60 of APB 16 addresses the rare circumstance of a significant disposal of assets within two years after consummation of a business combination accounted for using the pooling-of-interests method. Paragraph 60 requires that material profit or loss resulting from that disposal be reported separately as an extraordinary item. Extraordinary treatment is warranted because, under paragraph 48c, the pooling-of-interests method would have been inappropriate if the combined company planned the disposal as part of the plan of combination.
In the fifth quarter following a business combination accounted for as a pooling of interests, a registrant decided to dispose of certain assets. The disposition was expected to occur within the next two quarters. The registrant asked whether paragraph 60 applies to the asset's impairment loss recognized under SFAS 121 in connection with the asset's write down to net realizable value and reclassification as held for sale. The staff concluded that impairment losses are similar to a loss on disposal and are within the scope of paragraph 60. As such, the impairment loss should be classified as an extraordinary item when the paragraph 60 conditions are met.
B. Escrow Share Arrangements
Paragraph 47(g) of APB Opinion No. 16, Business Combinations (Opinion 16), requires that the combination be resolved at the date the plan is consummated and no provisions to issue securities or other consideration remain pending. Paragraph 47(g) does allow for an agreement to revise the number of shares issued to effect a combination for the later settlement of a contingency known at the combination date at an amount different from that recorded by a combining company. AICPA Accounting Interpretations (AIN-APB 16) 30 of Opinion 16, Representations in a Pooling, clarifies that the most common type of contingency agreement not prohibited in a pooling by paragraph 47(g) is the "general management representation," and states that a portion of the shares issued to effect the combination may be placed with an escrow agent until the contingency is resolved. The staff has previously stated its view that placement of more than 10% of the shares issued to effect the combination in escrow for a "general management representation" clause would be deemed excessive and evidence of the broader type of contingency proscribed by paragraph 47(g).
A registrant proposed to issue 2 million of its common shares in exchange for the outstanding common stock of the target. In exchange for outstanding in-the-money options of the target, the registrant proposed to issue similar options to purchase 200,000 shares of the registrant's common stock. The merger agreement called for 220,000 common shares (10% of 2,200,000) to be placed in escrow. The registrant believed that the target's options should be considered equivalent to outstanding common shares when calculating the maximum number of shares available for escrow under the "general management representation" because they were deep in the money and their exercise was virtually assured. The staff did not concur with the registrant's conclusion. The staff believed that the maximum number of shares held in escrow should be limited to 10% of the common shares issued to effect the combination, without adjustment for securities deemed equivalent to common shares. In this fact pattern, the staff believed the maximum number of shares that could be placed in escrow was 200,000.
C. Personal Holding Companies
Paragraph 46(a) of Opinion 16 requires that each of the combining companies be autonomous and not have been a subsidiary or division of another corporation within the two-year period before a plan of combination is initiated in order for the combination to be accounted for as a pooling of interests. AICPA Accounting Interpretations (AIN-APB 16) 28 of Opinion 16, Pooling By Subsidiary of Personal Holding Company, allows an exception to a technical violation of paragraph 46(a) when the "parent" is a personal holding company established for federal income tax reasons and the owners operate the "subsidiaries" as if the personal holding company did not exist. The interpretation does note, however, that in many cases a parent-subsidiary relationship does in fact exist and should be considered as such in applying paragraph 46(a) if the personal holding company or any of its subsidiaries is involved in a business combination. The staff is often asked if and when an analogy can be made to this narrow interpretation in situations other than personal holding companies.
To determine whether a parent entity is similar to a personal holding company and meets the assertion that the entity is not substantive, the staff looks to all aspects of the holding company-investment relationship to determine whether it has substance beyond a mere tax convenience. In past inquiries, the staff has considered, among other things, (1) the number of holding company shareholders, (2) the number of holding company employees and their functions, (3) the assets and liabilities of the holding company other than its investment(s) in the subsidiary(s) involved in the instant pooling, and (4) the nature and amount of any transactions between the holding company and the subsidiary(s). The staff has not concurred with registrants' conclusions that pooling-of-interests accounting by a subsidiary(s) is appropriate when the shareholders of the holding company have numbered more than a few, or the holding company has provided services to the subsidiary(s) such as management, financial, legal, accounting or employee benefits activities. In addition, any assets or liabilities at the holding company level other than the investment in the subsidiary(s) involved in the pooling would be evidence that a substantive holding company does in fact exist which would preclude pooling-of-interests accounting by the subsidiary(s).
In the circumstance where a holding company was otherwise able to meet the personal holding company exemption except that the number of shareholders of the holding company was more than a few, the staff has not objected to pooling-of-interests accounting by the subsidiary(s) under certain circumstances. In those cases, registrants have liquidated the holding company contemporaneously with the consummation of the business combination such that the holding company's investment in the combined entity is immediately distributed to the holding company's shareholders. In addition, any minority interest previously outstanding in the subsidiary(s) was accounted for as the acquisition of minority interest in accordance with AICPA Accounting Interpretations (AIN-APB 16) 26 of Opinion 16, Acquisition of Minority Interest, and any basis difference between the holding company's investment in the subsidiary(s) and the underlying assets and liabilities recorded in the subsidiary's accounts has been considered by recording the holding company's basis in the combined financial statements. Such an approach was presented in the combined financial statements as if the holding company was the combining entity in the pooling-of- interests combination.
D. AICPA White Paper
The Business Combinations Task Force of the AICPA published a White Paper titled, "Pooling of Interests: Alterations of Equity Interests (47c) and Asset Dispositions (48c)," which provides additional interpretations of these provisions of APB 16. The White Paper is available at the Congressional and Federal Affairs section of the AICPA web site: www.aicpa.org.
III. Guidance About Financial Statement Requirements
A. Combining different fiscal years
Companies combining in a pooling of interests may have fiscal year ends that differ by greater than 93 days. Rule 3A-02(b) of Regulation S-X permits the financial statements of the constituents to be combined retroactively even if their respective fiscal periods do not end within 93 days, except that the financial statements for the fiscal year in which the merger is consummated must be recast to dates that do not differ by more than 93 days.
Companies ordinarily may select among a number of different ways to conform historical periods of a combined company. Parts of the conforming company's fiscal year may be either excluded from or double counted in the combined income statement. The most preferable presentation usually will combine twelve sequential months of the conforming company's results while minimizing the number of days that are omitted or counted twice. The staff will object to methods of retroactively combining the financial statements that do not result in a fair representation of historical results of the combined entities.
Disclosure should be made of the periods combined and of the revenues, net income before extraordinary items and net income of any interim periods excluded from, or included more than once in, the results of operations as a result of such recasting. Disclosure should also be made on the face of the statement of cash flows, or in the notes to the financial statements, of the operating, investing and financing cash flows of any interim period excluded from the recast combined financial statements. Additional quantitative and narrative disclosure about gross profit, selling and marketing expenses, operating income may be necessary to inform readers about the effects of unusual charges or adjustments in the omitted or double counted period.
B. Requirement for retroactive restatement
If a business combination is otherwise properly accounted for as a pooling of interests, a failure to retroactively restate results on a combined basis is a departure from GAAP. The staff will request restatement if the effect on any line item reported in the financial statements for any year presented would be materially different. While registrants may expect the staff to challenge a failure to retroactively restate if the effect on any line item exceeds 3%, they should be aware that effects smaller than 3% could be material to investors in some circumstances.
C. Supplemental Financial Statements
In some cases, registrants elect to present as promptly as possible their historical financial statements on a basis that reflects consummation of a post-balance sheet merger accounted for as a pooling of interests. In addition, Item 11(b) of Form S-3 requires "restated financial statements prepared in accordance with Regulation S-X" in registration statements filed or amended after the date of a business combination accounted for as a pooling of interests. The staff believes the guidance in Form S-3 is applicable to any registration statement or proxy following a pooling of interests except Form S-8.
However, paragraph 61 of APB Opinion No. 16 provides that until the financial statements for the period encompassing consummation of the combination have been issued, "the financial statements issued should be those of the combining company and not those of the resulting combined corporation." Paragraph 61 also requires that each combining company "disclose as supplemental information in notes to financial statements or otherwise, the substance of a combination consummated before financial statements are issued and the effects of the combination on reported financial position and results of operations."
The form of the financial statements of the registrant to be furnished in Commission filings depends on whether financial statements for a post-consummation period have been published. The post-merger reporting requirement of paragraph 61 of APB 16 can be satisfied by the release of summary financial information [S-X 1-02(bb)] in a Form 8-K for a post-combination period of not less than one month.
If post-consummation period results have not been published:
1. Financial statements giving effect to the pooling should be presented in transactional filings or in voluntary supplemental filings as "supplemental financial statements."
2. If the financial statements are required to be furnished in connection with an Exchange Act or Securities Act filing, the supplemental financial statements should:
· be audited,
· comply with Regulation S-X, and
· include an audit report dated subsequent to the consummation of the transaction but prior to publication of post-combination results.
3. Typically supplemental financial statements are filed on an Item 5 Form 8-K. If the restated financial statements are furnished pursuant to the requirements of a registration statement or proxy, MD&A and applicable industry guide information should also be restated or expanded to provide necessary information about the combined entity.
4. Any registration statement made effective or proxy materials mailed prior to publication of post-combination financial information must include the audited historical financial statements of the registrant, without giving effect to the business combination. Presentation of audited supplemental financial statements restated for the pooling-of-interests does not satisfy the requirement to furnish the registrant's financial statements.
If post-consummation period results have been published:
1. The financial statements required in registration statements and proxies are the complete set of audited restated financial statements (not supplemental) giving retroactive effect to the pooling.
2. A Form 10-K reporting on the year ending prior to the consummation date of the pooling must include the registrant's historical financial statements without giving effect to the pooling, even if post-combination operating results have been published prior to filing the Form 10-K. Inclusion of audited supplemental financial statements in the Form 10-K is encouraged, but not required.
3. Interim reports on Form 10-Q and other interim financial statements filed for periods ending after consummation should be presented on a basis that retroactively reflects the pooling of interests for all periods presented. Prior Exchange Act filings reporting on periods ending before consummation of the merger should not be amended, although the registrant may elect to furnish restated information for earlier periods in accordance with the guidance in this section.
1 Accounting Principles Board Opinion No. 16, Business Combinations (APB 16) paragraph 47(b) common-stock-for-common-stock condition.
2 As interpreted by EITF Issue 87-16, Whether the 90 Percent Test for a Pooling of Interests is Applied Separately to Each Company or on a Combined Basis.
3 Staff Accounting Bulletin No. 96, Treasury Stock Acquisitions Following a Business Combination Accounted for as a Pooling-of-Interest.