What you need to know
- ASIC has modified Regulatory Guide 228 Prospectuses: Effective disclosure for retail investors (RG228) to clarify its expectations for the quality and quantity of historical financial information that should be disclosed in prospectuses.
- The modified RG 228 adopts most of ASIC's proposals in Consultation Paper 257 (CP257) released in May 2016 and introduces a threshold for determining whether a business acquired in the previous 12 months or around or contingent on the offer is significant with the consequence that, if so, audited historical financial information for the three most recent financial years(or two years of audited financial information and a half year of reviewed information) in respect of the acquired business will need to be included in the prospectus.
Background
ASIC has noted that there have been continuing issues with the disclosure of historical financial information in prospectuses (both as to quality and quantity) and that the standard of historical financial disclosures by some issuers falls below legal requirements. ASIC does not consider that risk disclosure can be used as a substitute for adequate financial disclosure.
ASIC considers that information about an issuer's financial position, performance and prospects is often the most important consideration for investors. As a result ASIC has modified RG 228 to clarify its expectations in relation to the disclosure of historical financial information to assist issuer's in complying with section 710 of the Corporations Act. ASIC has made it clear that a failure to comply with RG 228 will materially increase the risk of ASIC taking regulatory action. We have summarised the main modifications to RG 228 below.
Following are the clarifications and explanations regarding this modification:
Audited historical financial statements for two-and-a-half or three years should be disclosed
Issuers who own or are acquiring a business should provide audited historical financial information for at least the three most recent financial years (or two years of audited information and-a-half year of reviewed information) regardless of the corporate form used previously for the issuer's business or historical financial reporting requirements.
So, for instance, if the IPO is being used to fund a material acquisition, audited historical financial information about the company being acquired would need to be included in the prospectus notwithstanding that the target company may not have been subject to a statutory requirement to be audited. This means that in carrying out due diligence, the issuer will need to have obtained access to the underlying financial records to enable it to compile the relevant financial historical information to include in the prospectus.
Even in a roll-up listing, notwithstanding that the businesses to be acquired may not be individually material and there are no historically compiled financial statements, ASIC considers that issuers should compile and audit historical financial information, (subject to the thresholds noted below), for inclusion in the prospectus. ASIC has reservations as to whether historical metrics in these circumstances are a suitable substitute for full income statements.
In a backdoor listing, where a listed shell buys another company, the listed shell company should provide a pro forma balance sheet based on the most recent audited full year or reviewed half year showing the effect of the acquisition and audited financial statements for the prior two years for the company being acquired.
Preparation for an IPO will accordingly need to take into consideration the work and the negotiations that need to occur for a company to be able to fulfil these disclosure requirements.
When is the disclosure of less than two-and-a-half years to three years of audited historical information consistent with section 710?
ASIC has provided more specific guidance as to when disclosure of two-and-a-half or three years of audited (or reviewed for the half year) historical financial information may not be necessary, namely where:
It is not relevant to the investment decision being made, for example:
- the company's main business has changed significantly in the historical period and has no relationship to current business activities
- the company is a vehicle for a back door listing and is effectively a shell without material assets or liabilities. Only the incoming business's trading history, along with opening pro-forma balance sheet, are likely to be relevant for disclosure
It is not reasonable for investors and their advisers to expect it, for example:
- the company acquired the business before the prospectus fundraising and has already consolidated the acquisition for a substantial part of its disclosed financial history and prior financial records are of limited reliability
- three years of historical financial information has been prepared but the issuer is unable to obtain an audit opinion for the oldest financial year if the subsequent periods are audited, the financial information in totality may still be sufficient
- the company acquired a business in the 12 months before the lodgement of the prospectus or will do so around the time of lodgement or is contingent on the offer which although material is not significant (see below for guidance on the meaning of significant)
- the company acquires a business where there are no reliable historical financial records and the acquisition is neither material or significant
- the company is planning a roll-up listing (it plans to acquire many immaterial businesses without audited financial statements in the same sector). Given the practical difficulties in compiling and auditing information for each of these entities it may only be reasonable to expect that a minimum of 75% of historical financial information is audited for no less than one year
In these circumstances the provision of either unaudited information, audited information with a modified audit opinion or less than two-and-a-half to three years of historical financial information may be consistent with investors receiving sufficient information for the purposes of section 710. An explanation of the reasons for doing this should however be included in the prospectus.
Significant business acquisitions made less than 12 months before lodgement
An issuer needs to include in its prospectus audited financial information on any significant business it has acquired in the 12 months before lodgement or will acquire around lodgement or contingent on the offer.
An acquisition is significant if it accounts for more than 25% of consolidated:
- annual revenue (or where an entity is not earning material revenue, annual expenditure);
- annual income;
- total assets; or
- total equity.
This assessment should be based on pro-forma historical financial information for the last 12 months proposed to be presented in the prospectus.
Where an acquisition is significant, the financial information used to compile the prospectus should be audited for at least two full financial years before the lodgement. Less than two full financial years of audited financial information may be appropriate where the acquisition itself has undergone major change.
Where an acquisition is not significant but is material at a minimum the underlying financial information included in the prospectus should be reviewed as part of the independent accountant's review procedures.
Multiple insignificant acquisitions
Where issuers' have in the 12 months before prospectus lodgement have made (or propose to make) multiple insignificant acquisitions that collectively exceed 25% of the above thresholds, then the issuer may choose the entities to have audited so that less than 25% remains unaudited
Asset acquisitions which are in substance the acquisition of a business
Where an asset is being (or has been) acquired rather than a business, the basis for the acquisition price should be explained and the acquisitions disclosed in the balance sheet or the pro forma balance sheet. If the asset is in substance a business, historical income statements should be disclosed.
ASIC will use the guidance in Appendix B of AASB 3 to determine whether a business rather than a collection of assets has been acquired.
Historical financial information should be audited (or reviewed in the case of half year financial statements)
The audit or review of historical financial statements should be conducted for businesses and entities in Australia in compliance with Chapter 2M of the Corporations Act and for businesses and entities from foreign countries in substantial equivalence to Chapter 2M of the Corporations Act.
Where an audit opinion has a qualification or modification which indicates that the opinion is materially compromised so that it provides limited independent assurance for investors, ASIC is likely to treat the financial information as unaudited and is likely to conclude that the prospectus does not comply with the Corporations Act.
An emphasis of matter (for example, due to uncertainty about whether the company can continue as a going concern in circumstances where a successful fundraising will enable the company to continue its operations) or opening balance qualifications and, subject to materiality, qualifications relating to the ability to inspect inventory (for example, where a company has been audited for the first time) will ordinarily be acceptable.
Where underlying financial information has not been complied in contemplation of a public offering, it is generally acceptable for the financial information in the prospectus to be derived from financial statements prepared on a special purpose basis that have complied with applicable measurement and recognition standards.
Financial information must be current
Issuers should include in a prospectus:
- the most recent full-year audited financial statements (where the prospectus is lodged with ASIC less than 75 days after half-year end); or
- the most recent half-year audited or reviewed financial statements (where the prospectus is lodged with ASIC less than three months after year end)
If the business has substantially changed since the last audited balance-date or where more recent reports are subject to material qualifications more up-to-date audited financial statements should be prepared and included in the prospectus.
Cash flow statements
Historical cash flow statements showing at a minimum operating and investing cash flows for three (or two and a half) financial years should be included in a prospectus.
Authors: Sarah Dulhunty, Stuart Dullard, Ellen Zhang, Zac Thorneycroft
