Merger and acquisition lawyers were not certain what to expect when the Securities and Exchange Commission began applying its plain English rules to registration statements on Form S-4. Some practitioners believed that the rules were relatively benign and would improve the quality of disclosure. Others took a much darker view, fearing that the SEC staff would apply the new rules rigidly and that plaintiffs' lawyers would create a new set of plain English liability theories.
The rules have now been in effect for approximately six months, and the staff has commented on a large number of plain English S-4s filed in connection with mergers and other transactions. All practitioners, whether they were optimistic or pessimistic when the rules first went into effect, have been surprised at just how energetically the staff has taken on its new role as grammar police. Before the plain English rules were adopted, the typical comment letter for a proxy statement/prospectus might include 50 or 60 comments. Now, many of the letters include more than 100 comments, 50 or 60 of which relate to plain English.
The comments are not only high in number, but aggressive in tone. The SEC reviewers sometimes argue that the draftspersons made an inadequate effort to comply with the plain English rules. In these circumstances, as the SEC promised when it promulgated the rules, the reviewers do not undertake to rewrite the disclosure themselves. Instead, they ask the registrant to return to the drafting table and revise the document in its entirety. Even when the reviewers are not so critical, they make very detailed suggestions on how language should be revised.
Many of the comments seem picky in extreme. For example, the staff aggressively criticizes the use of the passive voice.even though most writers would agree that there are circumstances where the passive voice is very useful. Similarly, the staff has taken a particular dislike to the use of the word "certain" on the grounds that a more specific modifier will almost always be preferable. Phrases such as "certain tax consequences," "certain risks" or "certain exceptions" are now strictly forbidden.
The staff is taking the position that the entire document should be drafted in plain English, even though the rules make a distinction between the cover pages, the summary and the risk factors, on the one hand, and the main body of the prospectus, on the other. Rule 421(b) of Regulation C sets forth specific drafting rules for the cover pages, summary and risk factors; by contrast, Rule 421(d) states only that the main body must be clear and concise. The staff nonetheless makes the same type of comments about the main body as it makes about the forepart of the prospectus.
The plain English review process has been very time consuming. After the rules were first adopted in October 1998, the average initial review time for registration statements on Forms S-1 and S-4 was six weeks rather than the traditional 30 days. Because the comments demanded significant revisions, preparing responses was also very time-consuming. To make matters worse, the staff often delivered extensive plain English comments in the second or third round of comments. As a result, registrants and their advisors found that it was taking much longer to complete deals.
A number of lawyers have complained to the staff of the Division of Corporation Finance about what they view as overzealous and unduly rigid enforcement efforts. In informal conversations with the staff, members of the securities bar have argued that many of the comment letter positions are unreasonable. They have also complained that the review process has become too slow and costly.
Although the staff remains committed to aggressive application of the rules, it has made an effort to solve the timing problem. Until recently, a small handful of Division of Corporation Finance staff members were responsible for all plain English reviews. The result was a serious traffic jam. Over the past several months, however, these reviewers have become more proficient and other staff members have received training. In addition, issuers are getting better at preparing plain English documents that satisfy the SEC. As a consequence, initial review times have dropped to between 35 and 40 days. The staff has indicated that review times are not likely to drop much further in the near future because of the volume of filings, the accounting practices initiative and other special projects undertaken by the Division of Corporation Finance.
The staff is taking the position that the entire document should be drafted in plain English, even though the rules make a distinction between the cover pages, the summary and the risk factors, on the one hand, and the main body of the prospectus, on the other.
The SEC's zeal may seem excessive. But if the staff had not engaged in a vigorous enforcement effort, securities professionals probably never would have taken the plain English rules seriously. It is hard to deny that the staff's comments have resulted in better, more readable disclosure documents. A stockholder who reviews a proxy statement/prospectus prepared in the last few months will likely find that the document is much more user-friendly than an equivalent document drafted before the plain English rules went into effect.
The SEC staff plans to publish in the near future a Staff Legal Bulletin that will list typical plain English comments and provide additional drafting guidance. In the meantime, lawyers responsible for preparing registration statements on Form S-4 should review plain English comments from other deals. These comments, samples of which are set forth below, offer a wealth of information.
General Comments Regarding Presentation
Description of Drafting Goals
Many of the staff's letters include general comments regarding the quality of the plain English disclosure. These comments remind the registrant of the purpose of the rules.
Comment: You must revise your document significantly to comply with the plain English rules. We have raised a number of comments to assist you in making these revisions. However, we have not commented on every section of your document. We may have a number of additional comments on your first amendment.
Comment: The four primary goals of a plain English document are to organize the information from your shareholders' perspectives, eliminate redundancy, write the text so it is clear on the first reading, and design the document to be visually appealing. Review your document with these four goals in mind.
Comment: Your document will communicate most effectively when it is tailored to meet the needs of its readers. Consider the following questions when you draft your document. What information in the filing is most important to your shareholders? Why is this information important to them? How should they be using this information? How can you organize this document so it highlights the most important information?
The staff warns against repetition in almost every comment letter.
Comment: You repeat much of the same information in the cover letter, the Q&A section and the summary. For example, you repeat several times the benefits of the merger. You also repeat the issues on which the shareholders will vote, the time of the special meeting and what shareholders will receive if the merger closes. An important objective of a plain English document is to say it once, say it well and organize information from the shareholders' perspectives. Accordingly, eliminate the unnecessary repetition from the forepart of your document and organize the remaining information so it flows logically from shareholders' perspectives.
The staff's focus on eliminating repetition may give some practitioners heartburn.the old habit of repeating deal information on the cover page, in the summary and in the main body of the proxy statement/prospectus will die hard. To a certain extent, this habit was the product of the "bespeaks caution" doctrine and other cases emphasizing the prominence of warnings delivered to investors. But if the warnings are clearly stated, the fact that they are not repeated several times should not affect a court's willingness to recognize the availability of the bespeaks caution defense.
Avoid the Use of Defined Terms
Lawyers almost instinctively use defined terms in their SEC filings. According to the staff, this practice must change.
Comment: Your document makes excessive use of defined terms throughout. Rule 421(b) requires you to avoid relying on defined terms as the primary means of disclosing information. Revise your document so that the general disclosure concepts are clear from context. Limit the use of defined terms to industry and proprietary terms only. Further, it is unnecessary and distracting to define such commonly understood terms as the Internal Revenue Service, the Securities and Exchange Commission and the New York Stock Exchange. Eliminate the definitions for commonly understood terms.
The four primary goals of a plain English document are to organize the information from your shareholders' perspectives, eliminate redundancy, write the text so it is clear on the first reading, and design the document to be visually appealing.
Comment: Avoid the use of defined terms. The meaning of all terms you use must be clear from the context. For instance, you do not need to define a shortened version of the registrant's name. If you first use the entity's full name, thereafter it will be clear what you are referring to each time you use the shortened version.
Avoid Parenthetical Phrases
The staff takes the view that parenthetical phrases are legalistic and the product of lazy writing.
Comment: You use many parenthetical phrases that disrupt the flow of information and make the sentences very long. As a result, investors have to read them several times to understand what you are disclosing. Eliminate the parenthetical phrases throughout your filing. If the information is important enough to disclose, then include it in an actual sentence rather than set it off in parenthesis.
Avoid the Word "Certain"
The staff wants to eliminate the word "certain" from the vocabularies of all securities professionals.
Comment: Avoid the use of phrases involving the word "certain." These phrases district the readers' attention from the main points of the sentence, and raise more questions than they answer.
Do Not Use the Term "Company"
A registrant should use the name of the company or the pronoun "we" rather than the term "Company" to refer to itself.
Comment: The term "Company" is a vague, abstract term. Rather than use plain vanilla Company to refer to your company, use your actual company name or a shortened version of it throughout your document.
Avoid the Word "Such" and Other Legalese
The staff believes that the word "such" is legalese. It also cautions against using other legalistic terms.
Comment: The term "such" is legalese for "this," "these," or "the." Please replace this term throughout your prospectus with a concrete, everyday word that means the same thing. Also, replace other legalistic terms that appear in your document with plain English synonyms. For example, these legalistic terms include: "hereof," "pursuant to," "thereof" and "subject to."
Comment: Avoid using overly legal, Latin phrases like "pari passu" here and throughout the document.
Comment: In this section you use the phrase "as amended." This phrase is legalese and you should eliminate it from the document.
Not surprisingly, the staff is making an effort to eliminate jargon.
Comment: Your document contains a lot of jargon, technical terms, and legalese. You have not used words for their common meanings. Eliminate the legalese and jargon from your documents. Instead, explain these concepts in concrete, everyday language. Further, place any proprietary terms you use in context so those potential investors who do not work in your industry can understand the disclosure.
Complying with this instruction may not be easy, particularly when the document relates to high-tech businesses. The staff takes a surprisingly broad view of what constitutes jargon. For example, the comment letters have criticized phrases business people commonly use to describe the benefits of a merger, such as "synergies," "brand leverage," "acquisition opportunities" and "operating efficiencies." Eliminating language that is likely to baffle the typical reader is one thing.insisting on the deletion of phrases that are part of common business parlance is another.
Many comment letters ask registrants not to use acronyms.
Comment: If you want to use a shortened name or acronym, its meaning must be clear from the context. Investors should be able to tell what the shortened name or acronym is referring to without the need for the parenthetical definition.
Avoid Embedded Lists of Information
The plain English reviewers almost always include a comment criticizing the use of lists of information embedded in a paragraph. This comment seems unduly rigid. It may be true that paragraphs with dozens of items in list form are hard to read, but when the list is relatively short, this may be the most efficient way to make the disclosure.
Comment: Many sentences throughout your document are too long to understand on the first reading because you have embedded lists of information in paragraph form. Rather than include these lists in the paragraph, break them out into bullet points, with one bullet point for each list item. Also use bullet points, regular numbers, or letters instead of small roman numerals in parentheses.
Avoid Long Sentences
The staff criticizes some documents simply on the grounds that they contain sentences that are too long.
Comment: Numerous sentences throughout your document are too long, complex, and legalistic to be understandable on the first reading. Rewrite your sentences so they are clear, concise, and understandable.
Avoid the Use of the Passive Voice
The staff also takes seriously its campaign against use of the passive voice. It will often identify a number of places in the proxy statement/prospectus where the registrant has used the passive voice and ask that it revise the language.
Comment: Throughout the document your use of the passive voice makes the disclosure difficult to understand.
Avoid Excessive Capitalization
In the past, lawyers have used capitalized terms throughout their documents. For example, they may capitalize "Joint Proxy Statement" or "Merger Consideration." The staff is asking registrants to change this practice.
Comment: You capitalize terms you are using for their common meanings. Please revise.
Avoid Cross-References to or Duplication of the Merger Agreement
In the past, lawyers would often refer to the merger agreement rather than defining complex terms in the body of the proxy statement/prospectus. They also describe key provisions of the merger agreement by lifting sections more or less wholesale from the agreement. According to the SEC, these practices are not consistent with plain English principles.
Comment: You use "as defined in the merger agreement" which makes it difficult for the reader to understand the disclosure on the first reading. Revise your disclosure so that the general concepts are clear from the context.
Comment: It appears that some language in the body of the prospectus was taken directly from other documents, specifically the merger agreement. Rule 421(b) permits you to copy this language provided you present it clearly and explain what it means to investors. There does not appear to be any explanation as to what the disclosure means to investors, particularly for the merger agreement. Please revise.
Cover Page, Summary and Q&A Section
Prepare a Focused Cover Page
The comment letters provide guidance on how to prepare plain English cover pages. In the past, the parties to a merger transaction would prepare a cover for the proxy statement/prospectus that included a detailed description of the transaction extending for several pages. In addition, each company's chairman would prepare a letter to his shareholders describing the deal. The staff is now insisting that the cover, including communications from the chairmen, must be only one page long and must convey only the information most important to shareholders.
Comment: Your cover page cannot exceed one page. Revise your document to have either a joint chairmen's letter or a cover page.
Comment: Your cover page should focus shareholders on the information that is key to their investment decision. The technical description of the transaction obscures this key information. Reorganize the information contained in the letters to highlight the information that is key to your shareholders' investment decision.
Comment: Your cover page should focus shareholders on the information that is key to their investment decision. The technical description of the transaction obscures this key information. For example, before you tell shareholders what they will receive in the merger, you introduce the merger subsidiary that exists solely to effect the merger. Reorganize the presentation to highlight the information that is key to your shareholders' investment decision. Also, move the information that is not required by Item 501 of Regulation S-K and is not key to an investment decision off the cover page.
Keep the Summary Brief
The staff will insist that the summary be brief.
Comment: Your summary is lengthy and repetitive. Please revise so that the summary briefly highlights the information important to investors.
Present the Most Important Information First
The S-4 comment letters advise registrants to organize their summary disclosure so that the information most important to shareholders is provided first.
Comment: The information about book-entry does not appear as important as possible tax consequences of the merger, the issuance of dividends and what the company's stockholders may receive as a result of the merger. You appear to provide information about how to vote before you provide information on the consequences of voting. Please organize the Q&A section from a shareholder's perspective.
Description of Termination Rights and Fees
In some deals, the staff has criticized the summary's description of termination rights and termination fees on the grounds that it is overly technical.
Comment: The discussions of termination fees are complicated and difficult to follow. This is because they present the information in the format of a merger agreement. Revise the disclosure to present the key points from a shareholder's perspective in a clear and concise way. Use concrete everyday language and short sentences. Consider the word "complete" rather than "consummate."
Comment: Detailed information concerning termination fees are more appropriately disclosed in the body of the document. You have included as much detail in the summary as you have in the body of the document. Please revise.
Comment: Please explain the terms of terminating the merger in every day words.
Identify Key Regulatory Approvals
The staff will insist that important regulatory approvals be identified in the summary.
Comment: Please provide a statement addressing whether any federal or state regulatory requirements must be complied with or approval must be obtained in connection with the transaction. If so, state the status of such compliance or approval.
Prepare a Focused Q&A Section
The staff's comment letters provide extensive guidance on the Q&A section of a proxy statement/prospectus.
Comment: Ideally, your Q&A section should function as a stand-alone piece and have one discrete purpose. For example, your Q&A's purpose should be to answer shareholders' most frequently asked questions. Your Q&A currently answers these questions, but includes detailed information about the company's structure after the transaction. This information would be better positioned in the summary. This would streamline the Q&A, narrow its purpose and give more context to the discussion in the summary.
Comment: If you provide a Q&A section, it should be limited to information that is purely technical or logistical in nature. For example, the exchange formula is not appropriate for the Q&A section. Please move the discussion of the exchange formula to the body of the summary.
Comment: Ideally, your question and answer section should function as a stand-alone piece and have one discrete purpose. For example, your Q&A's purpose could be to answer shareholders' most frequently asked questions or to discuss management.s' reasons for approving the transaction. Your Q&A currently answers these questions but also includes detailed information about the transaction that is repeated in the summary. You should narrow the focus of your Q&A section and remove information that you repeat in the summary. You should also remove the cross-references. This will streamline the Q&A, narrow the Q&A's purpose, and give more context to the discussion in the summary.
Comment: While the Q&A section is considered to be part of the summary, it should not be inserted in the middle of it. Move the Q&A section to either the beginning or the end of the summary.
Comment: Consider presenting the Q&A in a double column form to improve readability.
Putting the Q&A at the end of a summary section or opting in favor of double columns is relatively easy. But deciding what the focus of the Q&A discussion should be, and what subjects should not be addressed, is more difficult. The SEC does not provide much concrete guidance.
Summary and Selected Financial Data
Several comment letters warn against using too many footnotes in the summary and selected footnote data, or making the text too dense.
Comment: The use of so many footnotes is hard to follow. Please revise to include the information in the footnotes in the text preceding the tables. Additionally, the text in this section is too dense, making it difficult to read. Please revise.
The staff's plain English comments on risk factors range from the nitpicky to the substantive.
Draft Captions that Clearly Describe the Risk
The staff wants registrants to draft risk factor captions that describe the specific risk being discussed in a sentence.
Comment: Each risk factor should be described following a risk factor caption that adequately describes the risk. The risk factor headings should convey the nature and consequences of the risk presented to you and your investors. Revise the headings where necessary. Avoid using the phrases "risks related to" and "risks associated with."
Do Not Include Mitigating Factors
The staff does not want issuers to include mitigating factors in their risk factor discussions.
Comment: In some of your risk factor discussions you have included information which mitigates the risk being disclosed. Information that mitigates the risk is inappropriate for risk factor disclosure. Please revise.
Avoid Generic or Vague Risk Factors
The staff will complain if the risk factors are generic or too vague.
Comment: Many of your risks could apply to almost any company or to almost any offering. Revise your factors to explain how the risk affects you or the securities you are offering.
Comment: This risk factor is too vague. Please revise to clearly specify the risk.
What Is Plain English?
- Do not use the term "Company."
- Do not use the term "certain."
- Do not define commonly understood terms (like IPO).
- Do not use parenthetical phrases (like this one).
- Avoid use of the word "such."
- Do not use right justified margins.
- Write the entire prospectus in plain English.
- Defined terms: avoid in the front, minimize in the back.
- Breakup long paragraphs into bullet points.
- Use (l) Arabic numbers or (b) letters, not (iii) roman numbers.
- Avoid cryptic acronyms.
- Do not repeat information.
- Shorten the summary.
- Do not use "hereof," thereof" or other legalese.
- Do not use vague terminology like "strategic alternatives."
- Do not use industry jargon such as "synergy" or "leverage."
- Limit use of cross-references.
- Do not overuse footnotes in the summary/selected financials.
- Do not copy language from legal documents.
- Emphasize with italics or bold, not ALLCAPS.
- Do not use an unnecessary glossary.
- Use more descriptive headings.
- Do not capitalize every word of the captions.
- Do not use "Risks Associated With" in captions.
- Emphasize the risk early in the discussion.
- Consider shortening the discussion.
- Move "Forward-looking Statements" after risk factors.
Financial Advisor Opinions
- Use tabular presentation.
- Discuss how specific analyses relate to the fairness opinion.
- Disclose projections.
Consider a Tabular or Bullet List Presentation
The staff will often suggest that risk factors be presented in tabular or bullet list form to improve the presentation.
Comment: This risk factor is very long. Please consider using a table detailing the risks discussed.
The Risk Should Be Described in the First Two or Three Sentences of the Risk Factor
The SEC wants registrants to provide an overview of the risk of the beginning of each risk factor, so that shareholders who do not intend to read all of a complicated risk factor discussion can quickly understand the problem.
Comment: In each risk factor, get to the risk as quickly as possible and provide just enough detail to place the risk in context. In some of your risk factors the actual risk you are trying to convey does not stand out from the extensive detail you provide. Therefore, revise your risk factors so that you are stating the risk in at least the second or third sentence. Where you repeat later in the document the details you currently include in your risk factors section, eliminate the extensive detail here. Instead, include a very brief overview to place the risk in context and provide a cross- reference to the more detailed discussion elsewhere in the document. Furthermore, the section you cross- reference should not be so long that investors have trouble finding the supporting detail for the risk.
Reasons for the Merger
The staff may ask the registrant to provide a more detailed analysis of why the board of directors of each company decided to approve a transaction. Registrants have often resisted this kind of detail in the past.
Comment: In the section identifying reasons for the merger recommendations of the boards of directors, clarify whether the factors supported or detracted from the fairness determination. Also explain how each factor affected the board's fairness determination. In other words, how did each factor lead to each company's board's determination that the merger is fair to and in the best interests of each company's shareholders?
Some registrants have responded to this comment by observing that the board did not assign specific priorities or weights to the various factors it considered.
Financial Adviser Opinions
Most S-4 plain English comment letters have included several comments on the description of the financial advisers. opinions. Some of these comments are not, strictly speaking, plain English comments. The staff seems to be using the advent of the new rules to toughen its stance on fairness opinion disclosures.
Many of the comments have suggested that when the advisers. analysis is complex, tabular presentation or bullet lists will make the material easier to understand.
Comment: Tabular presentations aid the understanding of complex information by providing an organized way to digest summarized items. Long and dense narrative disclosure alone, no matter how concise, is often less effective than carefully constructed tables accompanied by clear explanations. We encourage you to include tables for information like the analysts' presentations and the advisors' methodologies.
The substantive comments regarding fairness opinions and projections that the staff is making in conjunction with its plain English comments are more troubling. Responding to the requests for more information creates liability risk.
Provide a More Detailed Description of the Adviser's Analysis
Preparing tables and bullet lists is easy enough. But the comments go further, and ask the registrant to describe the weight that the advisers gave to various factors in reaching their fairness conclusions. These comments ask for much more than registrants and financial advisers want to give. Advisers are usually very reluctant to describe the weight given to different methodologies or explain how they reached their ultimate conclusion. They argue that this detail is inappropriate, since valuation is more of an art than a science, and since further disclosure may increase liability risk. As a result, if the staff continues to ask for more information, it should expect extensive discussions with issuers, investment banks and their counsel.
Comment: Discuss how each analysis is relevant to the fairness determination. Did each analysis support or weaken the financial advisor's determination, and if so how? Discuss the meaning of the multiples which are disclosed under each analysis.
Comment: With regard to each of the analyses performed, disclose the values derived and the conclusions drawn therefrom with regard to the fairness of the terms of the merger to the company and its stockholders.
Disclose the Issuer's Projections
The staff has been aggressive in asking issuers to disclose the projections on which the financial advisers relied. This comment is also likely to trigger an ongoing debate among issuers, financial advisers, their counsel and the SEC staff.
Comment: Disclose all material projections provided to [the financial advisers.] We note that the financial advisers relied on these projections for several of their analyses, including discounted cash flow analysis and for former merger analysis.
Comment: We note your response to our comment. We continue to believe that a summary of the financial projections and assumptions relied upon is material information needed by investors to evaluate the analyses performed by the financial advisers. Please revise.
The plain English review process has slowed down some recent deals and forced lawyers to do painful redrafting. At the end of the day, however, the optimists' view.that the rules are benign and will improve disclosure.may prevail. As everyone gains more experience with plain English drafting, and the supply of good model documents increases, the review process is likely to become much easier. The substantive comments regarding fairness opinions and projections that the staff is making in conjunction with its plain English comments are more troubling. Responding to the requests for more information creates liability risk.