Eye-Opening Study on the Use of Boilerplate in IPO Prospectuses Highlights the Real Costs to Issuers and Investors

The Vanderbilt Law Review recently published an interesting and slightly quirky article “Boilerplate and the Impact of Disclosure in Securities Dealmaking” by Jeremy McClane, a professor at the University of Illinois College of Law (see 72 Vand. L. Rev. 191 (2019)).  Prof. McClane studied the impact of boilerplate – defined as language that is copied from one deal to the next – contained in SEC initial public offering filings on issuers, investors, bankers and lawyers during the period from 1996 to 2015.  His quantitative analysis through computerized language processing techniques found that the overall level of boilerplate in the typical IPO registration statement was considerable.  On average, the prospectuses across the entire time period shared approximately 47% identical content to other recent industry deals and, as to individual sections within the prospectuses, they shared approximately 32% identical content for risk factors, 34% for management’s discussion and analysis, 23% for use of proceeds and 15% for the business description.  And, over this time period, the level of boilerplate grew steadily, despite some pullback following the SEC’s plain English rules in 1998, but only to rise again in 2003 following the enactment of new disclosure requirements under the Sarbanes-Oxley Act of 2002.

For IPO issuers, the expected impact from the use of boilerplate in terms of lower advisory costs (i.e., legal fees, underwriters’ discount and auditing fees), quicker timing of deal completion and fewer number of SEC comments proved not to be at all certain.  While the data supported the assumption that higher levels of boilerplate were associated with lower legal fees (it was found that each additional 10% of boilerplate in a document was associated with legal fees that were lower by approximately $46,000 to $84,000), there was no statistically significant association between boilerplate and auditor fees, or the underwriters’ discount, even though auditors and underwriters might also contribute to boilerplate use either directly through participation in drafting or indirectly by engaging in less due diligence and necessitating less modification of precedent.  Interestingly, according to the study, the data showed that the quality and experience of the issuer’s law firm (as well as the managing underwriter) was apparently not associated with the amount of boilerplate used.   

The data also found no statistically significant association between the use of boilerplate and the speed at which a deal was completed (from the time the issuer filed the registration statement and the effective date of the offering), despite the assumption that “cutting and pasting” is faster than drafting and editing nonstandard disclosure language. The data also revealed a lack of any discernable relationship between the number or extent of amendments to the prospectus and the amount of boilerplate used.  Further, despite the fact that the SEC flags boilerplate language for comments, the overall amount of boilerplate in a prospectus bore no statistically significant relationship to the number of comment letters or comments given by the SEC.  

For investors, Prof. McClane associated boilerplate with “information asymmetry,” suggesting that boilerplate tends to hinder investors from becoming informed about issuers or that its mere presence signals lower quality information about an issuer, making it harder for investors or the market to determine the “true” value of a company’s shares.  As a result, Prof. McClane identifies an implicit issuer/investor “bargaining” relationship between boilerplate disclosure in the preliminary prospectus and the final pricing of an offering, noting:

An issuer (and perhaps more importantly, its underwriters) can invest in conducting due diligence and set the price accordingly, or it can simply set a low price and effectively pay off the initial investors to do their own research on the company. Less due diligence would result in less specific disclosure and more boilerplate borrowed from other deals, while reliance on book building would be marked by more price revision as the issuer and its investment banks set the intial price low to induce initial investors to do their own research.

Greater use of generic boilerplate disclosures may also fail to protect issuers, and in some cases their underwriter and auditors, from liability if they are too generic to be considered meaningful (see Dingee v. Wayfair Inc., No. 15cv6941 (DLC), 2016 WL 3017401 (S.D.N.Y. May 24, 2016).  According to the study, the data indicated that more boilerplate in certain sections of the prospectus, such as risk factors, use of proceeds and management’s discussion and analysis, generally related to more litigation.  The analysis showed that a 10% greater level of boilerplate was associated with between a 1.5% and 4% increase in the liklihood that an issuer will be subject to IPO-related class action securities litigation.

Due to the underpricing of offerings below what the market would have borne and the higher litigation risks and related legal fees and settlement costs, as noted above, Prof. McClane associated boilerplate with higher costs to issuers by as much as $5 to $6 million in the market on average for each additional 10% of their disclosure that consists of rote recitations.

For lawyers and bankers who draft IPO disclosure, the results of Prof. McClane’s study are a bit unsettling.  Typically, issuer’s counsel begins preparing the offering prospectus with recent deals from within the same industry or that have been underwritten by the same underwriter and, in some generic sections, frequently tailors the language only in relatively minor ways (such as in the risk factors section, for example, which is commonly perceived anyway as “lawyers’ boilerplate”).  For smaller issuers, counsel may wish to be more efficient in order to conserve on legal fees which are often capped by liberal use of boilerplate disclosure that has already passed SEC scrutiny, has been tested on the market and utilizes keywords to comply with the SEC’s broad and complex disclosure rules, instead of “reinventing the wheel.” 

As Prof. McClane suggests, however, the expansive use of boilerplate may simply cover up a lack of careful due diligence of the company by its lawyers and underwriters by passing on boilerplate disclosure without critical revision, or reflect reticence to disclose harmful information, and ultimately prove to be a poor value proposition for the issuer.  Prof. McClane also posits that there is a human tendency to gravitate toward the status quo and precedent, as dealmakers may fear straying from the template provided by other successful deals.  With this analysis, lawyers will be better able to recognize the unintended consequences and tradeoffs from the overuse of boilerplate disclosure, and the SEC will be better able to identify areas for disclosure reform.  

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