United States: IPO Prospectuses: Avoiding And Responding To Common SEC Comments

This practice note examines some of the issues most commonly raised in initial Securities and Exchange Commission (SEC) comment letters on registration statement filed for initial public offering (IPOs). It is intended to guide you, as counsel to an IPO company, in assisting your client in efficiently navigating the SEC comment and review process.

This practice note discusses comments that apply to IPO prospectuses generally, including comments on plain English principles and expert consent requirements, and comments on specific sections of a prospectus, including the risk factors, management's discussion and analysis of financial condition and results of operations, and others. It provides excerpts from, and links to, representative SEC comment letters, and offers drafting and other tips to help issuers avoid receiving these types of comments or, failing that, to respond effectively to the SEC's concerns.

This practice note does not provide a comprehensive list of the types of comments that the staff of the SEC's Division of Corporation Finance (SEC staff or staff) can issue, and does not address SEC staff comments on executive compensation disclosure, which has become less important since the Jumpstart Our Business Startups Act of 2012 (JOBS Act) enabled emerging growth company (EGCs) to provide less detailed executive compensation disclosures in their registration statements, which most EGCs undertaking IPOs have done. It also does not discuss financial statement and related accounting issues, which are typically addressed by the issuer's chief financial officer and its outside auditor. SEC staff comments can vary widely from offering to offering and depend on the issuer's industry sector, the stage of the issuer's business, and the issuer's financial condition. Accordingly, each issuer must draft its IPO prospectus disclosures to accurately reflect its own unique facts and circumstances.

For information about preparing the registration statement and prospectus for an IPO, see Registration Statement and Preliminary Prospectus Preparations for an IPO, Top 10 Practice Tips: Drafting a Registration Statement, and Form S-1 Registration Statements. For information about the IPO process, see Initial Public Offering Process. For information generally on responding to SEC comment letters and the SEC staff review process, see SEC Comment Letter Responses and Understanding the SEC Review Process.

SEC Review Process

After a company files a registration statement on Form S-1 (or Form F-1 for foreign private issuer), the SEC staff will perform a cover-to-cover review of the document to ensure compliance with the applicable disclosure and accounting requirements under the Securities Act of 1933, as amended (Securities Act). The SEC staff does not evaluate the merits of an investment in an IPO but rather focuses on whether the disclosures provided in the registration statement provide investors with enough information to make an informed investment decision.

The SEC Staff's Comment Letter

Virtually all IPO registration statements receive comments. The SEC staff will generally issue a comment letter within 30 days from the date the registration statement is filed (whether submitted confidentially or publicly on EDGAR). According to the SEC's Fiscal Year 2016 Annual Performance Report, available at https://www.sec.gov/ files/secfy18congbudgjust.pdf, in 2016 the SEC staff issued initial comments within an average of 25.5 days.

The SEC staff's comments will include a description of any deficiencies identified in their review and may also include requests for supplemental information from the company if the staff believes the disclosures do not comply with SEC disclosure requirements or omit information that may be material to investors. Each comment letter is unique to the filing and may include comments that require substantial revisions to the registration statement. The number of comments in the SEC staff's initial comment letter can range from just a few to 70 or more. There may be several rounds of letters from the SEC staff and responses from the company until the issues identified in the staff's review are resolved.

Responding to SEC Staff Comment Letters

You should work with your client, underwriters' counsel, the company's auditor, and the other members of the IPO working group to carefully address each SEC staff comment in the company's response letter and in any amended registration statement filed with it.

When responding to the SEC, it is important to be mindful of your responses as they will eventually be made publicly available. If you do not fully understand a specific comment, you should contact the SEC staff reviewer for clarification so you can provide an appropriate response. Thoughtful, well-written response letters are crucial to resolve SEC staff comments efficiently. Responses should focus on the SEC staff's specific questions and cite the SEC's rules, guidance, and other authoritative sources (especially for accounting comments) wherever possible. Although it is helpful to review other registrants' response letters, a company's response letter should address its unique facts and circumstances. If an amendment to the registration statement is being filed with the response letter, the responses should indicate specifically where the revisions have been made to address the SEC staff's comments.

You should not assume that receiving a comment means that the SEC staff reviewer disagrees with the company's approach or disclosure. Often comments seek additional information and clarification to better understand the company's position. You should not, however, respond to a comment by adding disclosures to the registration statement that you believe to be immaterial. If you believe that a comment concerns an immaterial matter, you should communicate that to the SEC staff reviewer (legal or accounting) responsible for the comment as early as possible in the review process to avoid causing any delays in resolving the comment. The response letter should thoroughly explain the judgments the company applied in drafting such disclosure to assist the SEC staff in understanding why additional disclosure is not material to investors or necessary to comply with the disclosure requirements.

Generally, SEC comment letters request responses within 10 business days. However, if you believe more time is needed to respond to the comments, you should discuss this with the appropriate SEC staff reviewer.

Once all the SEC staff's comments on its registration statement have been resolved, the company can request that the SEC declare the registration statement effective, which allows it to proceed with the IPO. The SEC staff will upload its comment letters and the company's responses to EDGAR within 20 days of declaring the registration statement effective.

For additional information about the SEC review process, see Understanding the SEC Review Process.

To minimize the number of SEC staff comments on your client's registration statement, you should review staff comment letters and company response letters from recently completed IPOs in the same industry to identify industry-specific issues that the SEC staff may have, as well as IPOs for companies that have adopted similar accounting principles to identify any accounting-specific issues that the SEC staff is focused on. Foreign private issuers should also review SEC comment letters and company response letters from recently completed IPOs for issuers with the same country of domicile. However, many comments tend to fall under the recurring themes discussed below.

Common SEC Comments on IPO Prospect uses

The following types of comments apply to prospectuses generally.

Plain English

Rule 421 under the Securities Act (17 CFR 230.421) requires companies to use plain English writing principles in their prospectuses. Here are some examples of comments received by issuers that failed to do so:

"Throughout the prospectus numerous statements in your disclosure are unclear because they are not written in plain English or the concept is not fully described. Please review your entire prospectus to ensure that your disclosure throughout is written in plain English and the concepts that you describe are fully explained. See Rule 421(b) of Regulation C." (SEC Comment Letter to Achison Inc. (Sept. 20, 2016), Comment #1).

To avoid this type of comment, you should write in short declarative sentences, use definite and concrete everyday language, use active voice, present complex information in tabular format, and avoid legal and industry jargon and double negatives. Descriptive headings and bullet lists are also recommended. If highly technical or legal jargon cannot be avoided, then you should include a glossary in the prospectus to facilitate the reader's understanding of the prospectus disclosure.

Eliminating Repetition

The SEC staff may comment if there is too much redundant information in the prospectus. The problem of repetitive disclosure most commonly arises in the summary section of the prospectus. Here is an example of this type of comment:

In preparing the summary section, you should avoid repeating too much information from the business section. The summary should highlight the most significant aspects of the company's business, with a lengthier description reserved for the business section. Item 503(a) of Regulation S-K (17 CFR 229.503) provides that the prospectus summary should be brief and provide an overview of the key aspects of the offering, and the SEC staff will object if it is too long. When drafting the summary, you and your client should consider and identify those aspects of the offering that are most significant and determine how to best highlight those points in clear, plain language.

Clarifying the Basis for the Issuer's Statements

Although the prospectus is, in part, a marketing tool, companies should avoid hyperbolic statements and marketing language. Statements of belief should be clearly labeled as such and be accompanied by an explanation of the basis for each belief. Companies should also be cognizant of potential liability under the federal securities laws for misstatements or omissions in the registration statement. Here are some examples of this type of comment:

To avoid comments on statements about a company's relative position in the industry, such as being a leader in a field, the company should disclose the relevant metric used for making the assertion, such as industrywide sales figures or, if possible, a third-party source. It should also be clear when a statement is made based on management's belief (i.e., "We believe that . . ."). Although phrasing a statement as a belief may weaken its impact, it can help companies avoid liability under federal securities laws for misstatements or omissions of material facts. If a company has a good faith basis for its belief or opinion, and does not omit any material facts necessary to make the statements not misleading, statements of belief and opinion should be insulated from liability under Section 11 of the Securities Act (15 U.S.C. § 77k). Additionally, a good faith belief can support a defense against claims asserted under Section 10(b) (15 U.S.C. § 78j) of the Securities Exchange Act of 1934, as amended (Exchange Act), and Rule 10b-5 thereunder (17 CFR 240.10b-5), which require proof of an intent to deceive, manipulate, or defraud to impose liability.

For more information about the liability under the federal securities laws of participants in IPOs, see Liability under the Federal Securities Laws for Securities Offerings and Liability for Securities Offerings Checklist.

The SEC staff may, nonetheless, ask for the company's basis for a statement of belief. When responding to such comments, the company should carefully review how the statement of belief is phrased and provide support where possible, as in this example:

SEC Comment:

Company response:

The SEC staff will also typically ask the company to provide copies of all sources cited in the prospectus:

To facilitate a timely response, you should prepare copies of all relevant third-party reports in advance and clearly highlight the relevant portions of the reports that support the statements included in the prospectus. Third-party reports and other supplemental information submitted in response to SEC staff comments are generally not filed on EDGAR and thus will not be made publicly available.

Experts' Consents

Rule 436 under the Securities Act (17 CFR 230.436) requires that the written consent of any expert (e.g., the issuer's independent auditor) or counsel whose report is quoted or summarized in the prospectus be filed as an exhibit to the registration statement. Here are some examples of this type of comment:

The SEC staff will not require a consent when the prospectus cites a publicly available report, but will require a consent when the report or other information was prepared by a third party at the company's request. Third parties may be reluctant to be deemed to be "experts" because experts are subject to liability under Section 11 of the Securities Act for any material misrepresentations in or omissions from their reports or other information included in the prospectus. Therefore, before filing your client's initial registration statement, you should determine whether any third-party information included in the prospectus will require a consent and whether the third party(ies) would be willing to deliver a consent.

If the company believes that an expert's consent is not required, it should explain its position in its response to the SEC:

SEC comment:

Company response:

In the example above, the company, through its outside counsel, responded to the SEC staff's comment citing the applicable rules to explain why an expert's consent was not needed.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2018. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.