I confess that I haven’t spent a lot of time on the SEC’s rule proposal on M&A financial statement requirements, but I thought that there might be a few potential bombshells lurking in there. Sure enough, it looks like Wachtell Lipton found a big one. Here’s an excerpt from the firm’s recent memo:
Article 11 of Regulation S-X currently precludes inclusion of pro forma adjustments for the potential effects of post-acquisition actions expected to be taken by management. As explained in the SEC Division of Corporation Finance’s Financial Reporting Manual, “highly judgmental estimates of how historical management practices and operating decisions may or may not have changed as a result of that transaction” are “considered a projection and not an objective of S-X Article 11.”
The proposed amendments would replace the existing pro forma adjustment criteria with, among other things, “Management’s Adjustments” that would include “synergies and other effects of the transaction, such as closing facilities, discontinuing product lines, terminating employees, and executing new or modifying existing agreements, that are both reasonably estimable and have occurred or are reasonably expected to occur.” The proposed rules would require, for each Management’s Adjustment, “a description, including the material uncertainties, of the synergy or other transaction effects; disclosure of the underlying material assumptions, the method of calculation, and the estimated time frame for completion; qualitative information necessary to give a fair and balanced presentation of the pro forma financial information; and to the extent known, the reportable segments, products, services, and processes involved; the material resources required, if any; and the anticipated timing.”
For synergies and other transaction effects that are not reasonably estimable and will not be included in Management’s Adjustments, the proposed rules would require “that qualitative information necessary for a fair and balanced presentation of the pro forma financial information also be provided.”
What is it with everybody’s obsession with synergies these days? First the Delaware Supreme Court deducts them in appraisals and now the SEC wants them filed with your pro formas. The thing is, well, there’s usually a big problem with synergies, as another excerpt from Wachtell’s memo explains:
“Pro formas are an imperfect vehicle for communicating synergy predictions for many reasons, including the timing disconnect, the fact that synergies are not always a material element of transactions, and the practical reality that synergy targets identified upon transaction announcements are inherently uncertain and based on limited information exchanged during due diligence.”
In other words, even the best synergy estimates often include a fair amount of wishful thinking. That’s not a good place to be if the information in question is going to be included or incorporated by reference in a proxy statement or a 1933 Act filing.
– John Jenkins