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SEC Wants Quality, Not Quantity, in Risk Factor Disclosure

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Here’s all you really need to know about this blog post: In a new rule change, the SEC will require public companies to disclose only those risk factors that qualify as “material,” and also make the presentation of risk factors in disclosure documents more readable.

If you appreciated getting that bottom line up front, you’ll be a fan of the SEC’s changes to Reg S-K, at least as they relate to risk factors. (On Tuesday, we discussed how those changes impacted the separate subject of human capital disclosure.) One of the three big amendments to the risk factor disclosure rules, after all, is a requirement that public companies provide a summary of their risk factors if they exceed 15 pages.

The SEC says that 40% of filers will be affected by this change, which offers a sense of how bloated risk factor discussions often get. If the new rule works, that means no more wading through page after page of generic warnings that apply to every business. Instead, issuers must provide the summary—which is to be included at the front of the report or prospectus, limited to two pages, and bulleted or numbered for easy reading.

Likewise, the new rule requires issuers to group their risk factors under headings, in addition to using descriptive subcaptions that were already required (like “General Risk Factors,” for generic risks). Many issuers already do this.

The third and perhaps most significant change in the new rule, however, is the introduction of the “materiality” concept. Previously, issuers had to identify their “most significant” risks. Under the amended rule, they only have to disclose risks that are “material.” As the Journal noted, “The move is part of a wider regulatory shift from strict guidance toward principles-based disclosure that aims to simplify information for companies and investors.”

Chairman Clayton has stated that these are the first significant amendments to Reg S-K in more than 30 years. (Prior chairs might disagree.) The new risk factor materiality standard, in particular, may leave issuers questioning exactly which risks will survive the paradigm shift—not to mention create understandable uncertainty over how to present them in the summary. On both fronts, they may find some guidance from industry peers in the “risk factors summaries” that are sometimes tucked into prospectus overviews. We searched the Intelligize platform and spotted some benchmarking opportunities.

In the tech industry, we found multiple examples of companies pointing, in admirably plain language, to their history of losses. In an S-1 last month, Unity Software said “We have a history of losses and may not achieve or sustain profitability in the future.” Sumo Logic, Inc. used virtually the same verbiage. Meanwhile, the headline-grabbing Palantir Technologies Inc. (which we wrote about recently) said “We have incurred losses each year since our inception, we expect our operating expenses to increase, and we may not become profitable in the future.”

Life sciences companies have highlighted the hurdles they face in a highly regulated industry. In a recent S-1, Archerdx Inc. warned that it might not get regulatory clearance for its products, Vaxcyte warned that the FDA might not take a streamlined approach to approving its vaccines, and Acell warned about settlement agreements it has in place with the federal and state governments.

Meanwhile, manufacturers and other companies with supply chains are concerned about the pandemic. Vital Farms, the pasture-raised egg brand that went public in August, said it this way: “The COVID-19 pandemic could have a material adverse impact on our business, results of operations and financial condition.”

These are big changes, but don’t expect the SEC to wait another 30 years before it updates Regulation S-K again. In fact, later this year it plans to vote on another set of proposed changes, dealing with the disclosure of key performance indicators and off-balance-sheet arrangements.

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