This is the fourth in a series of blog posts delving into the practical aspects of implementing the Regulation S-K changes in the SEC’s August 26, 2020 Final Rule that modernizes and updates three disclosure areas in Regulation S-K:

Item 101 – Description of business

Item 103 – Legal proceedings

Item 105 – Risk factors

The Final Rule was published in the Federal Register on October 8, 2020 and is effective for filings made on or after November 9, 2020, regardless of the accounting period-end of the financial statements included in a filing.

This post focuses on the risk factor disclosures required by S-K Item 105.  You can read discussions of the description of business and legal proceedings disclosure changes in the first, second and third posts in this series.  The changes discussed in this post for risk factor disclosures are effective for 10-Q’s and 10-K’s filed on or after November 9, 2020.

The overall theme of all these changes is to make disclosure requirements less prescriptive and more principles based with a focus on information that is material.  It has been over 30 years since there were any significant changes in these disclosure requirements, and it would be fair to say that the world and businesses have changed a lot over these 30 years.  It makes sense that these disclosures could stand some “modernization.

The Final Rule makes a number of changes in risk factor disclosures:

1. In the first sentence of S-K Item 105 the word significant is changed to material.

Old version

Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make an investment in the registrant or offering speculative or risky.

New version

Where appropriate, provide under the caption “Risk Factors” a discussion of the material factors that make an investment in the registrant or offering speculative or risky.

This change is consistent with the overall goal of disclosure modernization to make requirements more principles based and to focus on material information.

2. The disclosure reorganizes and slightly changes the details about presentation of risk factors.

Old version

This discussion must be concise and organized logically. ….. 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.

New version

This discussion must be organized logically with relevant headings and each risk factor should be set forth under a subcaption that adequately describes the risk. …… Concisely explain how each risk affects the registrant or the securities being offered

3. The new disclosure requirements acknowledge that companies frequently present “generic” risk factors, and requires that they be disclosed at the end of the risk factor section and include a specific heading.

Old version

Do not present risks that could apply generically to any registrant or any offering.

New version

The presentation of risks that could apply generically to any registrant or any offering is discouraged, but to the extent generic risk factors are presented, disclose them at the end of the risk factor section under the caption “General Risk Factors.”

4. The new rule includes provisions for a “summary” if your risk factors are over 15 pages.

(b) Concisely explain how each risk affects the registrant or the securities being offered. If the discussion is longer than 15 pages, include in the forepart of the prospectus or annual report, as applicable, a series of concise, bulleted or numbered statements that is no more than two pages summarizing the principal factors that make an investment in the registrant or offering speculative or risky.

Here is an example of a risk factor summary from a KLA Corporation’s Form 10-Q for the quarter ended September 30, 2020:

ITEM 1A.    RISK FACTORS

A description of factors that could materially affect our business, financial condition or operating results is provided below.

Risk Factor Summary

The following summarizes the most material risks that make an investment in our securities risky or speculative. If any of the following risks occur or persist, our business, financial condition and results of operations could be materially harmed and the price of our common stock could significantly decline.

COVID-19 Pandemic Risks

• our supply chain may be disrupted, customer demand for our products may decline or customer purchases may be pushed out if the COVID-19 pandemic persists;
• we may not be able to meet customer demand and keep our workforce healthy if an outbreak should occur at one of our facilities and we are unable to contain it;
• we may be unable to provide service to our customers in a timely manner or at all if travel restrictions persist, common carrier routes are canceled or quarantines are imposed; and
• our facilities could be shut down for an extended period of time if an outbreak occurs in any of the jurisdictions where we manufacture our products.

General Commercial, Financial and Regulatory Risks

• laws, regulations or other orders may limit our ability to sell our products to certain customers or to provide service on products previously sold to those customers;
• we may be exposed to tariffs or similar trade impairments;
• international sales may expose us to longer payment cycles or collection difficulties;
• intellectual property disputes can be expensive and could result in an inability to sell our products in certain jurisdictions;
• we may be unable to attract or retain key personnel;
• reliance on third party service providers could result in disruptions if such third parties cannot perform services for us in a timely manner;
• cybersecurity incidents could result in the loss of valuable information or assets or subject us to costly litigation;
• we may face disruptions if we cannot access critical information in a timely manner due to system failures;
• we may fail to successfully integrate our acquisitions;
• natural disasters, acts of war or other catastrophic events could significantly disrupt our operations for lengthy periods of time;
• we may fail to successfully hedge our exposure to currency and interest rate fluctuations;
• we are subject to exposure from tax and regulatory compliance audits;
• economic, political or other conditions in the jurisdictions where we earn profits can impact the tax laws and taxes we pay in those jurisdictions, subsequently impacting our effective tax rate, cash flows and results of operations; and
• changes in accounting pronouncements and laws could have unforeseen effects.

Industry Risks

• we may not be able to keep pace with technological changes in the industries in which we operate;
• we have a highly concentrated customer base; and
• prevailing local and global economic conditions may negatively affect the purchasing decisions of our customers.

Business Model and Capital Structure

• we may not be able to maintain our technology advantage or protect our proprietary rights;
• we may not be able to compete with new products introduced by our competitors;
• we may not receive components necessary to build our products in a timely manner;
• we may fail to operate our business in a manner consistent with our business plan;
• we may not have sufficient financial resources to repay our indebtedness when it becomes due;
• we may fail to comply with the covenants in our revolving credit facility, which could impair our ability to borrow needed funds under the facility, or require us to repay it sooner than we planned;
• if our products fail to operate properly or contain defects or our customers are sued by third parties due to our products, we may be liable under indemnification provisions with our customers; and
• we may incur significant restructuring charges or other asset impairment charges or inventory write-offs.

For a more complete discussion of the material risks facing our business, see below.

As always, your thoughts and comments are welcome!

For your reference, here is the new language of S-K Item 105 risk factors with the changes bolded:

(a) Where appropriate, provide under the caption “Risk Factors” a discussion of the material factors that make an investment in the registrant or offering speculative or risky. This discussion must be organized logically with relevant headings and each risk factor should be set forth under a subcaption that adequately describes the risk. The presentation of risks that could apply generically to any registrant or any offering is discouraged, but to the extent generic risk factors are presented, disclose them at the end of the risk factor section under the caption “General Risk Factors.”

(b) Concisely explain how each risk affects the registrant or the securities being offered. If the discussion is longer than 15 pages, include in the forepart of the prospectus or annual report, as applicable, a series of concise, bulleted or numbered statements that is no more than two pages summarizing the principal factors that make an investment in the registrant or offering speculative or risky. If the risk factor discussion is included in a registration statement, it must immediately follow the summary section required by § 229.503 (Item 503 of Regulation S-K). 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 of this chapter). The registrant must furnish this information in plain English. See § 230.421(d) of Regulation C of this chapter.