Regulation S-K Item 503(c) requires disclosure of the most significant factors that make an offering speculative or risky. Recently, and seemingly in response to the new requirement that these disclosures be made on an annual basis in the Form 10-K (Item 1A), the practice of disclosing as a ‘risk factor’ that financial statements may have to be changed or restated has become more common.
At first blush, this kind of disclosure doesn’t make a lot of sense, except as boilerplate against the possiblity of getting sued for having made a material misstatement. Risk of investment loss is from the occurence of future events that could negatively affect the amount, timing or uncertainty of future cash flows. Having to correct debits and credits, in and of itself, is not one of those events.
Thus, the SEC staff has fittingly expressed its concern that such disclosures are generally inappropriate, and notwithstanding, lacking the specificity required by Item 503(c). (In other words, boilerplate generic rick factors are verboten; but that hasn’t stopped a lot of companies from trying.) However, the staff noted that, as part of its review of a specific filing, it will evaluate specific risk factors based on a registrant’s specific facts and circumstances. The SEC did not elaborate on the facts and circumstances that could justify disclosure of a potential accounting misstatement as a risk factor; but I suppose it may be theoretically possible.
For example, if a company represents and warrants that its financial statements are accurate, and if they are not, another contracting party would suffer a loss, for which the company is liable. I suppose that disclosure of an accounting error as a risk factor might be appropriate, but the real risk is not related to a future event, but management’s failure to act satisfactorily represent and warrant. Nonetheless, the SEC seems to be indicating that boilerplate would not be sufficient, and that language tailored to the facts and circumstances would be required.
The Staff made its views known in its quarterly presentation to the SEC Regulations Committee of the AICPA. A summary of the meeting has been published by the AICPA as CAQ Alert #2007-39. The document also contains links to separate documents related to the application of the following rules: S-X, 4-08(g) for less-than-significant equity investees (see my earlier post on this); S-X, 3-05 for financial statements of acquired companies in the registration statement of a secondary offering; and, S-K, 402 for reporting equity compensation that is deferred in the Summary Compensation Table.