==========================================START OF PAGE 1====== Remarks Of Isaac C. Hunt, Jr. Commissioner* U.S. Securities and Exchange Commission Washington, D.C. "Toward Better Disclosure" American Society of Corporate Secretaries 50th National Conference Seattle, Washington June 26, 1996 ______________ * The views expressed herein are those of Commissioner Hunt and do not necessarily represent those of the Commission, other Commissioners or the staff. U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 ==========================================START OF PAGE 2====== "Toward Better Disclosure" Thank you for that kind introduction, Mr. Bankston, and good evening ladies and gentlemen. I am delighted to be here to help you celebrate the 50th anniversary of the American Society of Corporate Secretaries. When Chairman Levitt informed me that he unfortunately would not be able to attend this event, and asked if I would like to speak before you in his place, I enthusiastically accepted his invitation. Not just because I would be able to visit the beautiful city of Seattle, but because I would have the opportunity to address your group, which, around the Commission, is regarded as being one of the most helpful sources of input on corporate governance and securities regulatory matters. The Commission has long benefited from the incisive comments made by members of your Society who, over the course of several decades, have taken the time to participate actively in numerous rule-makings that have spanned a wide range of issues. We at the Commission appreciate your input, and we look forward to continuing to receive the benefits of your thinking as we strive in the months and years ahead to increase the efficiency of our federal securities regulatory regime without diminishing the high degree of investor protection afforded by it. These are indeed exciting times to work in the securities arena, whether as a corporate secretary or as a government regulator. The rapid growth and transformation of U.S. securities markets, which has occurred over the last decade, has challenged both the Commission and Congress to re-evaluate fundamental principles concerning how we regulate in this area. If this "rethinking" is to be effective, it requires your ongoing participation as well. Tonight I intend to focus primarily on one aspect of this re-evaluation process, the achievement of which Chairman Levitt has deemed a high priority -- the need for "plain English" disclosure to investors. But first, I would like briefly to mention some of the other recent, on-going legislative and regulatory initiatives that are an outgrowth of this re- evaluation of our federal securities laws. You will undoubtedly hear more about these initiatives over the next couple of days. Therefore, consider my remarks to be a preview of "coming attractions." In a nutshell, these initiatives strive to: (1) streamline and more efficiently coordinate securities regulatory efforts on the federal and state levels; (2) promote the capital formation of U.S. businesses; and (3) simplify and improve federal securities disclosure requirements, all while maintaining an effective level of investor protection, and investor confidence, which have been crucial keys to the success of our securities markets. ==========================================START OF PAGE 3====== The first initiative is a legislative one--the so-called "Fields" Bill. The Commission supports the most recent version of this bill, known as the "Securities Act Amendments of 1996," which was approved by the House just last week. If this bill is eventually enacted into law, then several major changes to our securities regulatory regime would occur. Perhaps the most dramatic change would be the redefining of the states' role in regulating securities offerings. The Commission has long been aware that the current dual system of registration, which compels an issuer to meet both federal disclosure and state "blue sky" requirements, is both administratively onerous and unnecessarily costly. The bill would address this problem by preempting state blue-sky regulation of offerings of certain "covered securities." No longer would an issuer of "covered securities" have to meet state law registration requirements in addition to federal ones. The Act would also grant the Commission broad authority to provide exemptions from any provision of the Securities Act or of the Exchange Act. This would give the Commission much needed flexibility to adapt its rules to the demands of evolving securities markets and practices. A third major change wrought by passage of the Fields Bill would be the modernization of the Investment Company Act, which has not been significantly revised in over twenty-five years. So this bill could effect significant improvements to the present securities regulatory regime. And I'm sure you are following its developments as it makes its way through Congress. The other initiatives that I wish to bring to your attention are Commission-sponsored ones. In recent years, under the leadership of Chairman Levitt, the Commission has launched a series of initiatives to make our federal securities regulatory framework more efficient without sacrificing investor protection. For instance, there is the Advisory Committee on the Capital Formation and Regulatory Processes, which is being chaired by my colleague, Commissioner Steven Wallman. The Committee is developing a proposal to implement a "company-focused" registration and reporting system, which, if successful, could eventually replace our current "transaction-oriented" system. Simply put, under this company registration system, a company would initially register with the Commission and file periodic reports. Thereafter, the company could consummate routine securities issuances and certain other transactions without having to undertake additional significant registration procedures. The Advisory Committee is expected to issue its Report soon, which will provide in much greater detail its recommendations for implementing such a system. We at the Commission eagerly await this Report, which should be of great interest to you and your companies as well. Of course, the ==========================================START OF PAGE 4====== Commission could not implement such a company registration system until it had considered the Advisory Committee's Report in full, and conducted extensive rule-making on the subject. During this rule-making, you would have the opportunity to comment on the proposed company registration system. Another recent Commission-sponsored initiative has been the work of the Task Force on Disclosure Simplification. The Task Force was charged with the mission of reviewing every rule and form pertaining to capital formation in order to streamline the overall disclosure structure without compromising important investor safeguards. In its Report, issued last March, the Task Force outlined its recommendations for eliminating 81 rules and 22 forms and modifying dozens of others. In the words of Chairman Levitt, the Report constitutes a "regulatory blueprint for corporate finance in the years ahead." The Commission has already completed "Phase One" of its plan to implement the Task Force's recommendations, by which it has eliminated 44 rules and four forms that the Commission has determined are no longer necessary or appropriate for the protection of investors. In addition, the Commission has recently launched "Phase Two" of this plan with additional proposals to streamline the registration process. A number of additional Task Force-inspired proposals are planned for the coming months. One major "theme" in recent Commission initiatives has been the need to continue modernizing the securities regulatory scheme to keep apace with technological developments--in particular, the use of electronic media to satisfy the "full disclosure" obligations under the federal securities laws. The EDGAR electronic filing and dissemination system, which became mandatory for all domestic companies as of May 6 of this year, has resulted in widespread dissemination to the marketplace of information about even the smallest companies. EDGAR filings are available from many sources, including the Commission's own Internet Web site. Companies have demonstrated rapidly increasing interest in using electronic media to communicate with their shareholders, to offer securities, and to satisfy various disclosure requirements. The Commission has issued two interpretive releases providing guidance in this area, and we continue to address issues as they arise. No discussion of recent Commission initiatives would be complete without mentioning the fact that, less than a month ago, we adopted long-awaited amendments to the rules under Section 16 of the Exchange Act. Among other things, the new rules provide a streamlined exemption for transactions between an issuer and its officers and directors. I know that the Society takes an active interest in the Section 16 rules, and you'll be hearing more about them from Brian Lane in his "SEC Update" panel discussion ==========================================START OF PAGE 5====== Saturday morning. Now let me turn your attention to a matter that Chairman Levitt has proclaimed to be of the highest priority--the need to draft all securities documents filed with the Commission in "plain English." As all of you in this audience know, the key to the success of the United States securities markets-the largest, most transparent and most respected in the world - is that, by and large, we have held investor protection supreme. Without confidence in the integrity, transparency, and stability of a market investors will not participate. And without investors, of course, there can be no market. Moreover, much of the success of our securities markets may be attributed to our successful regulatory system. Again, as all of you know, our regulatory system is premised on a simple, straightforward formula - full disclosure to investors. We protect investors by insuring that, when companies come to our markets, they fully disclose their financial and other information so that investors can make informed choices. From the investor's perspective, of course, disclosure may not be effective unless it is understandable, complete, and timely. The basic disclosure document used in our market to sell securities in public offerings is of course the prospectus, which contains information about the issuer, including its business, its management and financial condition, which information enables market participants to make informed judgements about a company and its prospects. The prospectus also contains information specific to the particular offering, such as risk factors, use of proceeds, the terms of the securities and the underwriting arrangements. The availability of this information has played a significant role in the success of the United States capital markets and in maintaining investors' confidence in the integrity of these markets. As a particular matter, however, prospectuses often are far more useful to the professional investor than to most retail investors. While of necessity prospectuses contain certain complex material often relating to the description of securities, our Task Force on Disclosure Simplification stated, in its report, that "even basic information about an issuer's business is written in a way that has been described as "turgid," "opaque," and "unreadable." Drafters claim that this dense writing style stems in part from an effort to meet the high standards of diligence under the Securities Act of 1933 imposed on companies, management, and underwriters with respect to the adequacy and accuracy of disclosure provided to investors. The Task Force went on to state that "issuers, underwriters and their lawyers produce defensively written documents that put a premium on legal jargon and over-inclusive disclosures." In the eyes of many, stated the Task Force, today's prospectus has become a ==========================================START OF PAGE 6====== legal document to shield against liability, rather than a useful and informative disclosure document, as contemplated by the Commission's current "plain English" rule, Rule 421 of Regulation C under the Securities Act, and applicable case law. As Chairman Levitt has observed, "our passion for full disclosure has created fact-blotted reports and prospectuses that are more redundant than revealing." The debate over what is good or adequate disclosure to investors, or indeed whether disclosure to investors is a good or useful thing, predates the passage of the Federal Securities Acts and has continued up until recent times. Professor Louis Loss reports in his Fundamentals of Securities Regulation that Louis Brandeis, in Other People's Money, published in 1914, made the famous observation that: . Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman. On the other hand, Justice Brandeis' eventual successor on the Supreme Court, William O. Douglas, writing in the Yale Law Review in 1934, stated that "the glaring light of publicity" on which the Securities Act is based was not enough because: . those needing investment guidance will receive small comfort from the balance sheets, contracts, or compilation of other data revealed in the registration statement. They either lack the training or intelligence to assimilate them and find them useful, or are so concerned with a speculative profit as to consider them irrelevant. As recently as 1969 the Report of the Disclosure Policy Study, chaired by Commissioner Francis M. Wheat, mentioned the Commission's long standing awareness of the problem created by prospectuses which are so long or complex that the average investors cannot readily understand them, although that Report also mentioned that Professor Loss had seen some improvement in the problem of the "unreadable prospectus" between the time of the publication of the first edition of his securities regulation treatise in 1951 and the 1961 second edition. So the Commission has not been unmindful of the problem of the unreadablity of the documents we review and over the years has made attempts to give issuers, underwriters and others some guidelines as to the degree of clarity we would like to see in such documents. For example, Rule 421 states, among other things, that information required in a prospectus "shall not...be set forth in such fashion as to obscure any of the required information," and that information should be set forth in "a ==========================================START OF PAGE 7====== clear, concise, and understandable fashion." (emphasis added) Similarly, in a 1991 release setting forth its views concerning existing disclosure requirements applicable to limited partnership roll-up transactions, and initial public offerings of limited partnership units and similar securities, the Commission identified the universal problems of overly complex, and therefore non-understandable, disclosure documents. The Commission stated that because of the complexity of these and similar transactions and the risks of limited partnership investments, generally, registrants should take particular care to assure that investors were provided with "clear, concise and understandable disclosure as required by the rules of the Commission" and particularly Rule 421. The Commission further stated then that "legalistic, overly complex presentation" and "inattention to understandability" often make the substance of the disclosure difficult to understand. The Commission further stated that while these problems are troublesome in connection with any disclosure document, they are "particular acute" in offerings directed primarily towards retail investors. Registrants were advised that where partnership and roll-up transaction documents were filed and the registrants have not undertaken to present the required information in a clear, comprehensible manner, the staff would advise the registrant that the documents could not be processed until they had been so written. The Commission recently received a document which I regard as the antithesis of "clear, concise and understandable" disclosure: In a draft Notice of Annual Meeting Filed in May, the drafters of that document described the single "transaction" to be voted upon at that upcoming meeting in a sentence of over 440 words! So, the Commission has long been concerned that documents in the securities industry should be more readable. We believe that this goal could be accomplished, in large part, if those documents were written in what we call "plain English." As many of you know, in 1994 Chairman Levitt began a project on what was called the Profile Prospectus. This project was designed to help mutual fund investors through development of a more concise and useful disclosure document. I will have more to say about that project and how it has progressed a little later. The important point to be made with respect to that project here is that out of it grew a movement at the Commission to encourage all of our registrants to use plain English in all of their documents filed with us, and most particularly in those documents intended to be distributed to the investing public. Members of the staff engaged in this project inform that me that they often encounter great resistance to this initiative from professionals in the securities industry. The typical initial response of these professionals, according to the staff, is that the Commission wishes the industry to "dumb down" their documents. If they do ==========================================START OF PAGE 8====== what the Commission staff is asking, say the professionals, the prospectus and other documents might be readable by the "average Joe," but the sophisticated financial analysts and other professionals will be without the information that they must have in order to exercise their professional judgements on behalf of their clients. We believe that nothing could be further from the truth, as in our view the use of plain English should result in documents which are clearer, but not documents which are simpler. It is our belief that through the use of plain English the description of even the most complex transactions in our industry can be made clear or, at the very least, clearer, than is the case with most of the descriptions of such transactions at the present time. It is true that legal writers must aim for precision. But plain language is an ally in that cause, in my judgement, not an enemy. One law professor active in the plain English movement in the legal academy, in addressing this point, made the following observations: "Plain language lays bare the ambiguities and uncertainties and conflicts that traditional style tends to hide. At the same time, the process of revising into plain language will often reveal all kinds of unnecessary detail." As to the necessity of using technical terms or terms of art, practices also often cited by the professionals in their conversations with the Commission's staff, of course we recognize that the use of technical terms and terms of art is sometimes necessary in this field, but this same professor cited one study showing that such terms constitute less than three percent of most legal documents. While Chairman Levitt may have reinvigorated the Commission's efforts towards urging utilization of plain English in securities industry documents, the so called Plain English Movement with respect to all legal documents has been well recognized not only in legal education but in parts of the practicing legal profession as well for some time. The movement either began or gained force as part of the consumer movement in the 1970's, and the symbolic birthday of this movement is given either as 1974, when NationWide Mutual Insurance Company simplified two of its insurance policies, or 1975, when Citibank introduced a promissory note for use with its consumer customers reduced in content, simplified in language, and redesigned in appearance. Citibank's action prompted New York to pass the first state statute requiring plain English in consumer contracts. From the mid 70's to the mid 1980's, seven more states passed plain English statutes applicable to consumer contracts (generally leases, loans, and other contracts for personal, family, or household purposes). As of 1986 half of the states had plain English statutes that applied to insurance ==========================================START OF PAGE 9====== contracts, and nine federal statutes relating to this matter are on the books as well. Scholars of this movement also report that other countries are also becoming more and more active in the plain English movement. The Canadian Bar Association, in the earlier 1990's, passed a resolution in favor of plain language, with specific recommendations concerning the legal profession, Canadian banks, all governments in Canada, and a proposed "Canadian coalition for Plain Legal Language." Canada also has a Plain Language Centre in Toronto and a Plain Language Institute in Vancouver. In England there exists a government wide effort to simplify forms, and an organization of lawyers called Clarity, and in Australia there has existed for several years a Centre for Plain Legal Language created by the Law Foundation of New South Wales and the University of Sydney. So it is clear that the effort to increase the use of plain English in legal documents does not begin and end with Arthur Levitt or within the walls of the Securities and Exchange Commission's building. I think it is obvious to all in this room that of course better disclosure is synonymous with comprehensible disclosure. There are reported studies from around the world that indicate that the increased use of plain English in legal documents of all kinds improves the readers' comprehension of those documents, whether those readers be lay persons or judges, lawyers and law students. These studies have involved analyses of jury instructions, given both orally and in writing, studies showing an increase in the comprehension of medical consent forms and a decrease in the response time required to answer more questions on such forms correctly, studies showing that lawyers and law students took between half and a third of the mean time to comprehend the plain language versions of legislation as compared with original versions, and studies showing that law graduates improve their comprehension of the terms of a mortgage from 66% to 76% when the mortgages are written in more plain English as compared to the original or traditional versions, among many other studies cited in the literature. I know of no study on the efficacy of the use of plain English in documents prepared for submission to the Commission and for use in the securities industry. However, in 1994 the then chair of the Business Law section of the State Bar of California, and advisor from the ABA's Section of Business Law to the UCC Section 9 Drafting Committee, published an article in the Loyola of Los Angeles Law Review which set forth what he thought would be the benefits of the drafting of documents relating to transactions governed by the Uniform Commercial Code in plain English. Among those benefits, this author posited, would be the following: . reduce the disputes among parties to agreements ==========================================START OF PAGE 10====== governed by the UCC; . produce results in accordance with the expectation of the parties; . resolve business disputes at the time of the business transaction, not at the time a dispute about performance arises; . assist the courts in reaching results that conform to the UCC; . improve attorney-client relations, as clients will not be put off by density of contract provisions; . force the lawyer preparing the agreement to think about what is being written. As I mentioned, the writer of this article is a practicing lawyer. Nevertheless, he espouses the same techniques of plain language writing as are set forth in the academic literature on the subject: use of the active voice; use of lists and bullets; use of short sentences, plain words and short paragraphs; and the use of captions or headings to separate portions of the document, principally among them. I am certain you could think of analogous benefits that would result from prospectuses and other documents in our industry being written in such manner that directors and officers of issuers, securities industry professionals, and ordinary investors would find them more, and more quickly, comprehensible. Another benefit to industry that most studies of writing documents in plain English show is a substantial reduction in the length of these documents, which obviously means that your companies could, in some cases, lower the printing costs for their documents relating to a public offering or other securities transaction. Of course if there are fewer disputes among parties to securities transactions because of comprehensible documents, and more resolution of what prospectuses or other documents should say at the time of the drafting of the documents rather than after the fact in suits based on Sections 11 or 12 of the 33 Act, or Section 10b of the '34 Act and Rule 10b-5, there may also be lower legal expenses in the securities industry, which the lawyers who represent your companies may or may not regard as a good thing. We at the Commission are convinced that the use of more plain English in the documents of our industry can lead to better disclosure and have as many salutary effects in our industry as the author of the article argued would result from the use of plain English in documents relating to transactions governed by the UCC. To that end, the Commission and staff are engaged in initiatives on several fronts to improve disclosure in the securities industry through the use of more plain English: . the Division of Corporation Finance is training its staff in plain English; ==========================================START OF PAGE 11====== . the Office of Investor Education and Assistance and the Division of Corporation Finance are working with issuers and representatives on workshops to draft plain English disclosure documents; and . the Office of Investor Education and Assistance is working on a manual to assist preparers of documents in drafting in plain English. As I mentioned earlier, in 1994 Chairman Levitt began a project to help mutual fund investors through the development of more concise and useful disclosure documents. In August 1995, the Commission approved an experimental version of the profile prospectus for use during a year-long trial period by participating fund groups. Eight mutual fund groups participated in the project, and on May 20th of this year those eight fund groups and the Investment Company Institute submitted their research findings and Institute recommendations concerning the use of the profile prospectus. The overall conclusion of the research of the Institute and fund complexes participating in the profile project provided strong evidence that the profile prospectus does "serve as a model for effective disclosure." According to this research, substantially more shareholders are likely to actually read the profile prospectus than the traditional prospectus because the profile provides the information they need more succinctly, in a way they can more readily understand, and in a formula they can more easily use. According to the Institute and the fund groups in the study "investors prefer the profile prospectus to the existing long form prospectus for its writing style, presentation, and usefulness for locating information, comparing mutual funds, and making investment decisions." Comparing funds from different complexes was made particularly easier during the trial period, as the fund complexes agreed to set forth eleven items of disclosure on important aspects of the funds in generally the same words and in the same order in each fund profile. The partnership of the eight mutual fund groups, the Investment Company Institute, and the Commission and its staff thus seems to be leading towards creative solutions to the problem of improving disclosure in the mutual fund industry. Issuers and representatives in other areas of our industry are aware of the problems of disclosure in their segments of the industry as well. We need to develop partnerships similar to the partnership between the Commission, the ICI and the fund groups in order to work on improving disclosure not just in the mutual fund industry but in all securities industry documents. I think that with good will on all sides these partnerships could lead to results as positive as the mutual fund pilot project seems to be headed towards. Of course there are examples of excellent plain English writing in some documents published in our industry at the ==========================================START OF PAGE 12====== present time. I would like to bring an example to your attention, from a publication of Berkshire Hathaway Inc. whose Chairman is Warren Buffett, arguably the most successful investor of his generation. The quotation is from Berkshire Hathaway's Form S-3 Registration Statement filed with the Commission on April 2, 1996: . Warren Buffett, as Berkshire's Chairman, and Charles Munger, as Berkshire's Vice Chairman, want you to know the following (and urge you to ignore anyone telling you that these statements are "Boilerplate" or Unimportant): . Mr. Buffett and Mr. Munger believe that Berkshire's Class A Common Stock is not undervalued at the market price stated above. Neither Mr. Buffett nor Mr. Munger would currently buy Berkshire shares at that price, nor would they recommend that their families or friends do so. I think this example illustrates that clear, understandable and even eloquent documents can be, and are being, produced by issuers for better communication with their shareholders. Again, many thanks for inviting me to join you for this 50th Anniversary celebration. I look forward to interacting with you on various issues during my tenure at the Commission. Thank you.