Last year Cleary Gottlieb published a blog post and an alert memorandum highlighting the SEC staff’s renewed focus on whether the use of non-GAAP financial measures (NGFMs) by domestic registrants complies with the requirements of Regulation G.  Recently, a number of plaintiff-stockholders of target companies in M&A transactions have brought purported class actions in federal court alleging that the “Forecasts” section in M&A disclosure documents violates Regulation G.  In support of these M&A disclosure related claims, plaintiffs have been citing our post and memo about these SEC staff initiatives, which relate to earnings releases and periodic reports, even though our prior publications did not address the application of Regulation G to M&A disclosure documents.

It is true that the projections in the “Forecasts” section of M&A disclosure documents include projections that are not GAAP.  Indeed, projected unlevered free cash flows are a central input into any discounted cash flow analysis.  But in our view the contention that these projections are subject to Regulation G is incorrect.  The provision of a GAAP reconciliation for these forecasts would not serve the purpose for which Regulation G was adopted – namely, to prevent a company from misleading investors by providing NGFMs that obscure its GAAP results and guidance.  No such concern applies to the “Forecasts” section of M&A disclosure documents, where the data are being provided solely to enable shareholders to understand the specific, projected financial metrics that the company’s financial advisor used in its financial analyses to support a fairness opinion.  The standard introduction to these projections in every M&A disclosure document states that these forward-looking data are not intended to provide reliable guidance about historical or future financial performance of the company, but are disclosed because they were used by the financial advisors in their fairness opinion analyses.  Indeed, for this reason, Regulation G contains a special exemption (Rule 100(d)) for all communications made pursuant to Item 1015(b)(6) of Regulation M-A, which provides for disclosure of a summary of “the bases for and methods of arriving at” a fairness opinion.[1]

To understand the relationship between the “Forecasts” section and the Item 1015(b)(6) exemption from Regulation G, it is important to understand the genealogy of the “Forecasts” section in M&A disclosure documents.  The SEC rules applicable to disclosure about fairness opinions differ depending on whether the transaction is structured as a merger (where the fairness opinion disclosure is typically in a proxy statement and governed by Regulation 14A) or as a tender offer or exchange offer (where the fairness opinion disclosure is typically in a recommendation statement governed by Regulation 14D).  In a merger proxy statement, if it references the receipt by the target board of an opinion that the transaction is fair to the target shareholders, Item 14(b)(6) of Schedule 14A requires that the disclosure include a long-form summary of the financial analyses underlying the fairness opinion.  Prior to 2002, however, proxy statements rarely, if ever, included a “Forecasts” section to accompany the summary of the financial analyses.  Moreover, in a tender offer recommendation statement, there has never been a line-item requirement to include a summary of the financial analyses underlying a fairness opinion.

Then, with its 2002 decision in In re Pure Resources,[2] the Delaware Chancery Court kicked off several years of opinions focused on disclosure requirements in connection with M&A transactions.  Then Vice Chancellor (now Chief Justice) Leo Strine observed that disclosure of a banker’s fairness opinion, without more, was insufficient, and that a “fair summary” of the analyses was required.[3]  This reasoning was based on a straightforward interpretation of the case law about what is “material” to investors and echoed the rationale for the SEC rule that requires disclosure of a summary of the financial analyses in merger proxy statements:

[I]nvestment bankers’ analyses … usually address the most important issue to stockholders – the sufficiency of the consideration being offered to them for their shares in a merger or tender offer. … [C]ourts must be candid in acknowledging that the disclosure of the banker’s “fairness opinion” alone and without more, provides stockholders with nothing other than a conclusion….[4]

Prior to Pure Resources, the Delaware courts had, in their own words, been reluctant to mandate disclosure requirements in proxy statements and tender offer documents due to “[f]ear [of] stepping on the SEC’s toes.”[5] But, beginning with Pure Resources, the Delaware judiciary has regularly opined on what disclosure is (and is not) required for a “fair summary” of the analyses underlying the fairness opinion in M&A disclosure documents (whether they are proxy statements or tender offer recommendation statements).

Eventually the Court of Chancery, prompted by a plaintiffs’ bar energized by disclosure claims, began to focus on the extent to which, when a fairness opinion is disclosed to the target shareholders, the key projections used in the financial analyses underlying the opinion should also be disclosed.  Citing Pure Resources, the Court held that a fair summary should include, in some instances and subject to a number of facts and circumstances, not just a summary of the underlying financial analyses but also the key financial projections underlying those analyses:

Once a board broaches a topic in its disclosures, a duty attaches to provide information that is “materially complete and unbiased by the omission of material facts.”  For this reason, when a banker’s endorsement [in a fairness opinion] of the fairness of a transaction is touted to shareholders, the valuation methods used to arrive at that opinion as well as the key inputs … must also be fairly disclosed.[6]

Meanwhile, just as this Delaware-driven evolution of disclosure requirements in M&A disclosure documents was getting going – in fact a mere three months after the Pure Resources decision – in January 2003 the SEC adopted Regulation G.  In response to strong arguments in comment letters on the proposed rule from the M&A community, the SEC included the special exemption for all communications made pursuant to Item 1015 of Regulation M-A.[7]  However, there are two potential misunderstandings that might cast doubt on whether the projections really are part of the summary of what underlies the fairness opinion and therefore exempt from Regulation G due to their being disclosed pursuant to Item 1015.

First, these financial projections typically appear in a separate section titled “Forecasts,” rather than the section titled “Opinion of the Financial Advisor”, which is more obviously a summary of what underlies the fairness opinion and therefore more clearly made pursuant to Item 1015(b)(6).  The reason for the appearance of the projections in a separate “Forecasts” section is to emphasize that the management of the target company, rather than the financial advisor, prepared the projections; but the rationale for including the “Forecasts” section, and therefore the availability of the exemption from Regulation G, is unaffected and falls squarely within Item 1015(b)(6) – to summarize what underlies the fairness opinion.

The second misunderstanding is that, while Item 1015(b)(6) is cross-referenced in the form for a proxy statement on Schedule 14A, there is no express reference to Item 1015(b)(6) in the form for a tender offer statement on Schedule TO or a tender offer recommendation statement on Schedule 14D-9.  As a result, it could be argued that the Rule 100(d) exemption from Regulation G does not extend to the “Forecasts” section in a tender offer disclosure document.  However, the SEC staff has explicitly recognized the applicability of the Rule 100(d) exemption to tender offer documents in the SEC’s Compliance and Disclosure Interpretations (C&DIs) on NGFMs.[8]  In addition, Pure Resources and its progeny filled this gap in Schedule 14D-9, so for tender offer recommendation statements we have a regime where target boards, by mandate of the Delaware courts, effectively comply with Item 1015(b)(6) when preparing Schedule 14D-9.

In commenting on M&A disclosure documents, the SEC staff has from time to time raised the GAAP reconciliation requirement of Regulation G in the context of the disclosure of management projections used by financial advisors in their fairness analyses.  In response to these comments, several companies and their outside counsel have argued that the reconciliation exemption in Rule 100(d) of Regulation G applies to these forecasts consistent with our analysis above.  The SEC staff has sometimes challenged such arguments, leading some companies to ultimately include a GAAP reconciliation of the financial forecasts in order to end the comment process, but a number of companies have mailed the disclosure documents to the target’s shareholders without such a reconciliation and without further comment from the staff.[9]

In sum, in our view Regulation G does not require that the management projections used by financial advisors to opine on the financial fairness of merger consideration be reconciled to GAAP.  This information is not the type of information that Regulation G was adopted to police and should be considered exempt from the reconciliation requirements of Regulation G pursuant to the exemption for disclosures of data underlying the fairness opinion as described in Item 1015(b)(6) of Regulation M-A.

We would urge the SEC staff to provide guidance confirming the applicability of the exemption from Regulation G to disclosure of projections underlying a fairness opinion in M&A disclosure documents.  That would increase certainty on the applicability of the exemption.  More important, it would put an end to an absurd practice: companies unnecessarily preparing a GAAP reconciliation of M&A-related financial forecasts – and paying mootness fees to plaintiffs’ lawyers – to dispose of meritless Regulation G challenges to mergers and tender offers.

[1] The projections included in the “Forecasts” section of M&A disclosure documents are similarly exempt from Item 10(e) of Regulation S-K, which also includes an exemption for disclosure contained in communications made pursuant to Item 1015 of Regulation M-A.  In addition, Item 10(e) includes an exemption for financial measures “required to be disclosed by … [SEC] rules, or a system of regulation of a government or governmental authority … that is applicable to the registrant,” which would apply to the projections to the extent they are included in a M&A disclosure document in order to satisfy Rule 12b-20 or state law requirements such as the requirements stemming from Delaware case law described below.

[2] In re Pure Res., Inc., S’holders Litig., 808 A.2d 421 (Del. Ch. 2002).

[3] Id. at 448-450.

[4] Id. at 449.

[5] Id.

[6] In re Netsmart Techs., Inc. S’holders Litig., 924 A.2d 171, 203-204 (Del. Ch. 2007) (emphasis added). See also Maric Capital Master Fund, Ltd. V. Plato Learning, Inc., 11 A.3d 1175 (Del. Ch. 2010); Transcript Ruling on Motion for Expedited Proceedings, In re S1 Corp. S’holders Litig., Consolidated C.A. No. 6771-VCP (Del. Ch. 2011).  The Court has never adopted a bright line rule that forecasts are always required to be disclosed and has always deferred to the general standard of materiality, which takes account of the specific facts and circumstances.

[7] See SEC, Final Rule: Conditions for Use of Non-GAAP Financial Measures (Release No. 33-8176; 34-47226), Section II.A.1.c., available at

[8] Non-GAAP Financial Measures, Compliance and Disclosure Interpretations, Question 101.01 (Jan. 11, 2010), available at

[9] See, e.g., Oracle Corp., Response to SEC Comment Letter, Oct. 4, 2016 (in respect of projections included in a combined Tender Offer Statement/Rule 13e-3 Transaction Statement on Schedule TO); Brocade Communications Systems, Inc., Response to SEC Comment Letter, May 19, 2016 (in respect of projections included in a registration statement on Form S-4 pertaining to an exchange offer); Symmetry Surgical, Inc., Response to SEC Comment Letter, Oct. 8, 2014 (in respect of projections included in a registration statement on Form S-4). But see Apollo Commercial Real Estate Finance, Inc., SEC Comment Letter, June 3, 2016 (suggesting the disclosure of projections is not required by Item 1015 as it relates to Form S-4 or Schedule 13E-3); HomeAway, Inc., SEC Comment Letter, December 2, 2015 (suggesting the disclosure of projections is not required by Item 1015 as it relates to Schedule 14D-9).