Risk factor disclosure frequently presents a conundrum in public reporting.  The SEC’s risk factor disclosure requirements focus on what makes an investment in a company’s securities “risky or speculative”.  Buy many companies present so many risk factors that questions arise about their relevance to investors.  This is one among a number of reasons the SEC included this disclosure in their March 20, 2019 Disclosure Modernization and Simplification rule.

As you likely have heard, most of the changes in this rule, including risk factor changes, are effective for filings after May 2, 2019.

To begin reviewing the changes in risk factor disclosures, Item 1A in Form 10-K previously read:

Item 1A. Risk Factors.

Set forth, under the caption “Risk Factors,” where appropriate, the risk factors described in Item 503(c) of Regulation S-K (§229.503(c) of this chapter) applicable to the registrant. Provide any discussion of risk factors in plain English in accordance with Rule 421(d) of the Securities Act of 1933 (§230.421(d) of this chapter). Smaller reporting companies are not required to provide the information required by this item.

Item 1A has been changed to now read:

Item 1A. Risk Factors.

Set forth, under the caption “Risk Factors,” where appropriate, the risk factors described in Item 105 of Regulation S-K (§ 229.105 of this chapter) applicable to the registrant.

The specific disclosure requirements surrounding risk factors have been moved to S-K Item 105 and out of Item 503. Since most of the disclosures in Part 500 of S-K deal with prospectus disclosures and risk factors are, since 2005, a regular ‘34 Act report disclosure requirement, this change makes sense.

In addition, as you will see below, the removal of the plain English language that was in the Item 1A instructions is not really a change as the requirement is now incorporated in new S-K Item 105.

The old text of Item 503(c), which has been removed, read:

 (c) Risk factors. Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make the offering speculative or risky. This discussion must be concise and organized logically. Do not present risks that could apply to any issuer or any offering. Explain how the risk affects the issuer or the securities being offered. Set forth each risk factor under a subcaption that adequately describes the risk. The risk factor discussion must immediately follow the summary section. If you do not include a summary section, the risk factor section must immediately follow the cover page of the prospectus or the pricing information section that immediately follows the cover page. Pricing information means price and price-related information that you may omit from the prospectus in an effective registration statement based on §230.430A(a) of this chapter. The risk factors may include, among other things, the following:

(1) Your lack of an operating history;

(2) Your lack of profitable operations in recent periods;

(3) Your financial position;

(4) Your business or proposed business; or

(5) The lack of a market for your common equity securities or securities convertible into or exercisable for common equity securities.

The new requirement in S-K Item 105 now reads:

229.105 (Item 105) Risk factors.

Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make an investment in the registrant or offeringspeculative or risky. This discussion must be concise and organized logically. Do not present risks that could apply generically to any registrant or any offering. Explain how the risk affects the registrant or the securities being offered. Set forth each risk factor under a subcaption that adequately describes the risk. If the risk factor discussion is included in a registration statement, it must immediately follow the summary section. If you do not include a summary section, the risk factor section must immediately follow the cover page of the prospectus or the pricing information section that immediately follows the cover page. Pricing information means price and price-related information that you may omit from the prospectus in an effective registration statement based on Rule 430A (§ 230.430A(a) of this chapter). The registrant must furnish this information in plain English. See § 230.421(d) of Regulation C of this chapter.

New S-K Item 105 has some subtle wording changes which are highlighted above.  The addition of the phrase “an investment in the registrant” makes the application of this disclosure clearer for ‘34 Act periodic reports.  And, the addition of the phrase “apply generically” helps clarify that the requirement should not be interpreted too broadly.

Also, the removal of the examples makes it clear that this is intended to be a registrant specific, principles-based requirement.  In the Final Rule Release the SEC included these comments:

The Commission also proposed amendments that would eliminate the specific risk factor examples that are currently enumerated in Item 503(c). Although Item 503(c) is principles based, and the Commission has eschewed “boiler plate” risk factors that are not tailored to the unique circumstances of each registrant, the …. examples of factors that may make an offering speculative or risky have remained unchanged since the Commission first published guidance on risk factor disclosure in 1964.

As discussed in the Proposing Release, the Commission’s principles-based approach to risk factor disclosure is not consonant with the item’s list of examples of material risks. These examples may not apply to all registrants and may not correspond to the material risks of any particular registrant. In addition, the inclusion of these examples could suggest that a registrant must address each one in its risk factor disclosures, regardless of the significance to its business. Finally, the Commission was concerned that the inclusion of any examples in Item 503(c), whether to illustrate the specific kinds of risks that should be disclosed or generic risks that should be avoided, could anchor or skew the registrant’s risk analysis in the direction of the examples.

 It will be interesting to watch and see how or if companies take advantage of this new requirement.

As always, your thoughts and comments are welcome!