Imagine arriving at the hospital by ambulance with your father, who is experiencing severe shortness of breath. As paramedics speed him into the emergency room, you try to make sense of highly technical medical jargon. Paramedics, nurses, and doctors communicate in “code,” using precise terms to swap information vital to your father’s quick treatment. Once that treatment begins, your father’s primary-care physician fills you in on what is happening in layman’s terms.
Nobody questions the need for medical specialists to communicate in technical terminology to help patients in crisis. In fact, were they to take time for “plain English” for the benefit of relatives, they could lose patients through unclear, incomplete, or imprecise communication. Similarly, the Securities and Exchange Commission, by passing its new Plain English Rule for corporate and mutual fund prospectuses, is placing corporations at significant risk through misplaced advocacy for layman investors.
The Plain English Rule requires the cover sheet, summary, and risk-factor sections of prospectuses to be written in plain English, using the active voice, everyday language, tabular and bullet-point summaries, and so on. In theory, the rule benefits investors by reducing the apparent gobbledygook in investment documents. But it is founded on the fallacy that investors read these documents.
CFOs know that financial analysts, investment publications, bankers, and attorneys are the professionals that take time to comb through prospectuses. In fact, investors depend on these primary readers to evaluate corporate or mutual fund performance on several measures and pass along their judgments. There is a genuine danger that prospectus writers, in moving from language structured with hair-splitting precision to plain language, will confuse these primary readers with misstatements or omissions, leading to invalid investment recommendations and higher numbers of investor lawsuits.
How can the SEC help its primary readers analyze prospectuses more quickly and accurately? It can do so in three ways:
- * Allow corporations to shorten the risk-factors section of their prospectuses. Since many risk factors are standard within certain industries, universal code numbers can cover most of them. Corporations could then mention the appropriate codes in prospectuses.
- * Encourage a commitment to plain English to percolate throughout its staff, and not just among those reviewing the sections to which plain English now applies. Corporations generally try to provide the SEC with first drafts of prospectuses that are effective and internally consistent. Yet when reviewers return the prospectuses, they frequently ask for changes that lead to increased redundancy or less clarity. In a rush to issue a final prospectus, corporations will follow these edits to the letter.
- * Recognize that attorneys helping to draft prospectuses must heed legal precedents as conscientiously as they comply with SEC regulations. Attorneys have developed certain complex sentences for prospectuses because of court rulings that less-complex language was insufficient. Responsible legal advisers will not move toward plainer English when they have full knowledge of these judicial milestones. It is incumbent upon them to err on the side of caution. Certainly, there is room for more clarity in the typical prospectus. Adopting an active voice and using charts and tables for clarification would assist the analysts charged with evaluating multiple prospectuses. A senior banker, an attorney, or an adviser known for outstanding speaking skills should take charge of the drafting. Senior-level writers have the skill and experience to move toward plain English without losing precision. As the Plain English Rule takes full effect in October, the need for such precision will rise considerably. Organizations should also limit the number of co-writers to two or three, even if the committee overseeing the drafting has many more members.
The fallacy of the Plain English Rule is the phantom investor readership that it benefits. Fixing sections of a prospectus that investors do not read is like giving CPR to a man who is merely short of breath. Both initiatives are well intentioned, but they have the potential to cause new problems rather than solving existing ones.
Attorney Gabor Garai is a managing partner of the Boston office of Epstein Becker & Green, P.C.
