The Effect of SEC Comment Letters on M&A Outcomes

Recent research on the effectiveness of the SEC’s filing review and comment letter process has focused almost exclusively on reviews of Forms 10-K and other periodic filings. Reviews of filings involving transactions such as mergers and acquisitions (M&A) have received little attention, even though (1) they are a top priority of the SEC and the executives and officers of the filing companies and (2) the SEC scrutinizes every transactional filing of this nature, in contrast to periodic filings, which are reviewed selectively. In our paper, SEC Comment Letters and M&A Outcomes, we examine the impact of one transaction-specific type of SEC comment letter, Form S-4 reviews, on short- and long-term M&A outcomes.

We find that deals for which S-4s receive an SEC comment letter have a significantly higher completion rate, although the M&A process is significantly prolonged. These results provide evidence on the immediate costs and benefits of the SEC’s S-4 filing review process on M&A outcomes. We also find that S-4s that receive an SEC comment letter are less likely to have a goodwill impairment or a restatement in the year after the deal is completed. These results suggest that the SEC’s S-4 filing review process improves the accounting quality of the entities involved in M&A deals. In cross-sectional tests, we find that the main results are stronger for S-4 comment letters with higher word counts and M&A specific comments. Our findings have important implications for regulators and others involved in the U.S. M&A market, as they provide evidence on the costs and benefits of the SEC’s disclosure regulation of M&A.

When a deal involves the combination of two public entities and when at least some stock is exchanged as consideration, the newly issued securities of the combined entity are required to be registered with the SEC on Form S-4, which is subject to mandatory review. As part of its review, the SEC may issue a comment letter if it finds potential deficiencies in the firms’ accounting choices, non-compliance with the S-4 disclosure requirements, or disclosures that could be clarified or improved.

The SEC staff screens all registration statements related to M&A for potential issues that would require further review. This mandatory review process is distinct from the periodic filing review process, which is done selectively. Since the SEC reviews only certain periodic filings and  issues a comment letter only when it finds issues with a company’s accounting and disclosure choices, absent a comment letter, researchers are unable to distinguish between periodic filings that are reviewed but do not receive comments and periodic filings that are not reviewed. As a result, it is difficult to cleanly isolate the effect of SEC comment letters. In contrast, since all S-4 filings are required to be reviewed, if the filing does not receive a comment letter, we can infer that the filing underwent SEC scrutiny without any issues being raised. Consequently, we can cleanly isolate the effect of SEC comment letters without the confounding effect of whether or not there was a review.

The Form S-4 review and comment process are particularly important in our setting, as the Form S-4 acts as both a registration statement and a proxy filing. The newly issued securities for the combined firm are required to be registered with the SEC to comply with Section 5 of the Securities Act, similar to those in an IPO, as the stock consideration offered in the M&A deal is considered a public offering. The filing also must comply with the rules regarding soliciting proxies to approve an action that requires shareholder approval. Both sets of shareholders involved in the deal are typically required to vote on it. Therefore, the S-4 is intended to provide a comprehensive set of disclosures for all acquirer and target shareholders prior to voting on whether to approve the merger.

To examine the short- and long-term consequences of S-4 comment letters on M&A outcomes, we first explore how the completion rate of deals differs between those that do and those do not receive an SEC comment. If the comment letter process delays the S-4 from being declared effective, it could also slow completion of the deal or even kill it. Alternatively, SEC comment letters could improve the transparency of the S-4 disclosures, allowing the legacy target and acquirer investors to more clearly value the deal, leading to a higher likelihood of completion.

Next, for completed deals, we examine the influence of S-4 comment letters on the duration of the M&A process from initial announcement to completion. This is an important issue because any benefits from the comment letter process may be accompanied by additional time or other obstacles to getting the deal done. It also sheds light on the sometimes competing missions of the SEC to protect investors and facilitate capital formation.

With regard to long-term consequences of SEC comment letters, we examine two measures of accounting quality related to the M&A deal: goodwill impairments and restatements. The SEC’s aims to help the company remedy any potential disclosure deficiencies at the time the S-4 is registered to avoid future issues regarding accounting quality. If the S-4 review process is effective, it should alleviate mispricing of goodwill and resolve accounting or estimation issues before they rise to the level of a restatement. This would predict a negative association between the receipt of a comment letter and the likelihood of future goodwill impairment and restatements. However, the receipt of a comment letter alone could signal poor accounting quality that could have a persistent effect. This would predict a positive association between the receipt of a comment letter and the likelihood of future goodwill impairment and restatements.

Using all S-4 filings between August 1, 2004 and December 31, 2015, we find that S-4s that receive an SEC comment letter have a significantly higher completion rate (4.3 percent more likely to be completed), but that the M&A process is significantly prolonged (20.4 percent or 34 days longer on  average between the initial announcement and completion date). These results provide evidence on the immediate costs and benefits of the SEC’s S-4 filing review process on M&A outcomes. Regarding long-term accounting quality, we find that S-4s that receive an SEC comment letter are less likely to have a goodwill impairment or a restatement in the year after the deal is completed. These results suggest that the SEC’s S-4 filing review process is effective in improving the accounting quality of the entities involved in M&A.

Finally, we examine the nature and extent of S-4 comment letters to shed light on the regulatory mechanisms that contribute to the M&A outcomes. We look at how the overall effects vary with the number and complexity of S-4 comments, for which we use as a proxy the average word count of the SEC comment letters. We also test what types of comments contribute to the overall effects, particularly goodwill, pro forma financial statements, and other M&A-specific comments. We find that the documented effects (higher completion and duration and lower goodwill impairments and restatements) are stronger for S-4 comment letters with higher word counts and M&A specific comments (i.e. comments on goodwill, pro forma financial statements, or other M&A-specific comments). These cross-sectional results help to make our main findings clearer and more credible.

Our study contributes to the academic literature on the effectiveness of the SEC’s filing review process. Our findings have implications for regulators and others involved in the U.S. M&A market, as they provide important evidence on the costs and benefits of the SEC’s disclosure regulation of M&A. Another practical implication is that investors can view an S-4 comment letter as a positive sign that the deal is more likely to be completed and have better future accounting quality.

This post comes to us from Professor Bret A. Johnson at George Mason University, Professor Ling Lei Lisic at Virginia Tech, Joon Seok Moon, who is a doctoral student at George Washington University, and Mengmeng Wang, who is a doctoral student at SUNY Buffalo. It is based on their recent paper, “SEC Comment Letters and M&A Outcomes,” available here.

Leave a Reply

Your email address will not be published. Required fields are marked *