September 18, 2014

Corp Fin’s Comment Letters: WSJ Peeks Under the Hood

It was bound to happen. I just thought it would happen much sooner. It’s been just over a decade since Corp Fin began posting its comment letters (and the related responses) – but yet there has been scant mass media attention paid to them other than high profile IPOs. Some of us in the industry have tracked comment letter trends (see these memos in our “SEC Comment Process” Practice Area) – but the mass media has left this area alone for the most part. That’s why I was a little surprised to see this WSJ article entitled “To Be Clear, SEC Reviewers Want Filings in Plain English, Period”:

After combing through a 19,974-word filing for a securities offering, Securities and Exchange Commission senior counsel Catherine Gordon had some guidance for the company that drafted it. “In the second paragraph, add a comma,” she wrote to an attorney for the trust, sponsored by Incapital LLC, in December, “to improve readability.” Meet the stock market’s punctuation police. Corporate securities filings are plagued by some of the world’s most impenetrable prose, but it isn’t for lack of effort. Every year, SEC lawyers and accountants review several thousand of the more than half-million documents that companies file with the agency. And while they are primarily on the prowl for accounting inconsistencies and breaches of securities regulations, they also chase down typos, sentence fragments, jargon, puffery and sloppy punctuation.

Making sure corporate disclosures pass muster falls to the SEC’s 350-member Corporation Finance division—Corp Fin in the trade—which reviews every public company’s primary filings at least once every three years. Last year alone, the securities industry’s style police sent nearly 8,800 letters to more than 4,600 companies, according to LogixData, which analyzes SEC filings. The letters, which eventually become public, contained more than 66,000 questions, most seeking fuller disclosure or better adherence to accounting rules. But many would have been right at home in freshman English.

SEC staffers asked a brewer to provide the volume of a barrel, a wedding organizer to define “marriage-seeking profiles,” racing companies to describe their horses with complete sentences, a biopharmaceutical maker to explain aplastic anemia and an annuity company to punctuate the end of a sentence. In reply, they received nearly 8,700 letters containing more than 67,000 answers and proposed revisions. Incapital added the comma and agreed to additional changes prompted by 19 other queries in the letter from Ms. Gordon and her colleagues, including requests for more detail about investment practices and references to the “economic environment.” The SEC declined to comment on specific letters or to make staffers who sent them available for comment.

“Please use a readable type size throughout,” senior staff attorney Kathryn McHale wrote First Internet Bancorp in October after it filed to sell shares. “The summary selected financial data beginning on page 6 is too small.” The bank promised to increase the font size, though subsequent filings continued to use 8-point type for the numbers. Most of the rest of the text appears in 13-point type. First Internet said it used small type to fit figures for seven financial periods in the table. The company uses larger type where possible, and online filings mean readers can zoom in, spokeswoman Nicole Lorch said. “It was not our intention to obfuscate financial data,” she said.

Some inquiries get technical. Pamela Long, one of Corp Fin’s assistant directors, questioned Technology Applications International Corp. , a marketer of water purifiers and cosmetics based in Aventura, Fla., about this phrase: “rotatable perfused time varying electromagnetic force bioreactor.” She asked the company to explain what exactly it was, along with “how this enhances the product, if at all.” Technology Applications proposed a revision: “In use, the rotatable perfused time varying electromagnetic force bioreactor supplies a time varying electromagnetic force to the rotatable perfusable culture chamber of the rotatable perfused time varying electromagnetic force bioreactor to expand cells contained therein.”

Ms. Long wasn’t satisfied. “The revised disclosure uses a number of terms that are unclear to the reader and appear to be industry jargon,” she wrote, asking the company to revise. The company’s next revision—with a color illustration—mostly passed muster: The device is designed to grow more-natural cell cultures. But Ms. Long remained concerned by language saying the device was “sponsored” or “managed” by the National Aeronautics and Space Administration. “As currently drafted, the disclosure suggests that NASA is actively involved in the process of making the cosmetics,” she wrote in January 2013. The company now says in its filings that the device was “developed and patented” by NASA and a private firm. John Stickler, vice president at Technology Applications, said the company expected some back and forth with the SEC over its share registration, though the extent came as a bit of a surprise. “The process got a little old after a while when you kept reiterating this is how it works, this is how it works,” said Mr. Stickler.

Most of Corp Fin’s inquiries tackle tougher topics. But simplifying language to be better understood by investors is also a serious goal. Former SEC Chairman Arthur Levitt made clarity a career mission, prompting the agency in 1998 to publish an 83-page “Plain English Handbook” that still circulates today. “What we are getting to is clear and concise disclosure that people can understand,” said Shelley Parratt, Corp Fin’s deputy director for disclosure operations. One pitfall for corporate filers: forgetting that filings are primarily legal documents, not marketing material. Restaurant chain Zoe’s Kitchen Inc., which blends Southern and Greek dining, bills itself as providing “flavorful, Mediterranean, naturally healthful meals prepared fresh each day.”

Similar language didn’t fly when Zoe’s registered shares for sale to the public. “We note that 17% of your total cost of sales was chicken; 7%, beef; and 4%, feta cheese and that your menu includes soft drinks and potato chips. Do you believe this is a reflection of traditional Mediterranean cuisine a 100 years ago?We suggest revising your descriptions,” wrote Max Webb, then assistant director of Corp Fin for transportation and leisure and a law-school lecturer. “Are the potato chips prepared from scratch daily? The soft drinks?” Zoe’s replied: “The Company respectfully advises the staff that chicken, beef and feta are significant contributors to the Company’s cost of sales, and the Company’s traditional Mediterranean menu includes a majority of ingredients that reflect cuisine from 100 years ago.”

Mr. Webb also highlighted redundancies. “We note…that on pages 1 and 2 you mention that your food is ‘fresh’ five times. The same two pages inform the reader that your offerings are prepared ‘from scratch’ four times,” he wrote. “In the four sentence paragraph under Overview on page 56 you use ‘fresh’ and/or ‘freshly-prepared’ three times.” Zoe’s agreed to most of the requested changes, although references to “traditional Mediterranean cuisine” made it into the final prospectus. The company’s shares have roughly doubled since their April 11 initial public offering.

Conflict Minerals: NAM Argues Against En Banc Rehearing 

Here’s a blog from Steve Quinlivan (and here’s a related one from Ning Chiu):

Earlier, the United States Court of Appeals for the District of Columbia Circuit ordered the appellants in the conflict minerals case, NAM et al, to file a response to the SEC’s and Amnesty International’s petition for an en banc rehearing.

The response has now been filed. NAM says there is no need for a rehearing. According to NAM the standard for a rehearing isn’t met because the case presents no conflict in the DC Circuit’s decisions or with decisions of the Supreme Court or other Courts of Appeals.

Maybe it’s not surprising so far because the court essentially ruled in favor of NAM. Then NAM says what it really wants – the appellate panel should amend its decision in light of the American Meat case to clarify that the compelled statement is not eligible for Zauderer rational basis review. The reason Zauderer doesn’t apply is the conflict minerals disclosure does not constitute “purely factual and uncontroversial information.”

According to NAM, doing anything else would break dangerous new ground: “Appellants are aware of no case permitting the government to require a company to adopt an ideological slogan written by the government that attacks the company and its products, and neither the SEC nor Amnesty has cited any such case. If such requirements were deemed permissible, the temptation for Congress and state legislatures to require similar self-shaming measures across a range of controversial issues could be irresistible.”

The response also includes predictable references to the “scarlet letter,” issuers with “blood on their hands” and like rhetoric that has become familiar in this case.

House Passes JOBS Act-Related Bill 

As noted by MoFo’s Anna Pinedo in this blog: The House of Representatives voted 320 to 102 to pass H.R. 5405 (Promoting Job Creation and Reducing Small Business Burdens Act) that contains a number of JOBS Act related measures that previously were the subject of individual bill proposals. For example, the bill addresses the JOBS Act inadvertent failure to address the Exchange Act threshold as to savings and loan holding companies; a pilot tick-size pilot program for emerging growth companies; a grace period for transitioning from EGC status; and an exemption from xBRL requirements for EGCs.

– Broc Romanek