The SEC has a history of scrutinizing the classification of liabilities and equity in financial statements. This has resulted in the issuance of a standard that clarifies this classification. Certain financial instruments that were previously classified as “mezzanine” in the balance sheet may now be required to be classified as a liability. Particular attention should be paid to warrants and preferred stock. One area that could provide for complex transition issues between private and public companies is in the area of mandatorily redeemable shares.
 
The definition of mandatorily redeemable securities has historically been found only in SEC rules. However, recent guidance issued by the FinancialAccounting Standards Board (“FASB”) provided a new definition of the term “mandatorily redeemable” and requires that any securities meeting that definition be reported as liabilities in financial statements. FASB’s definition of mandatorily redeemable differs from that of the SEC’s. Accordingly, a mandatorily redeemable security that does not require liability classification under FASB’s rules guidance may require separate classification and accounting under the SEC’s rules. The rules can be complex and the rules can vary significantly based on the preferred stock redemption provisions.