The Securities and Exchange Commission has been prodding companies in recent reviews of regulatory filings to provide more information about the risks they face.
In annual and quarterly financial statements, as well as proxies, the regulator wants companies to give more details about potential problems, including risks tied to credit and liquidity, goodwill impairments, and compensation. These topics became hot-button issues during the financial crisis, so it makes sense that the SEC has focused on them in the comment letters that are just now trickling into the commission’s electronic filing system.
Christine Davine, national director of SEC services at Deloitte & Touche, reports seeing pushback from the SEC in recent months on these topics, as well as a demand for more-specific information. The commission doesn’t want companies to “present risks that apply to any issuer,” she says. “It’s really about making them specific to a company and its operations.” Davine has reviewed SEC comment letters received by Deloitte’s clients that have not yet been made public (the correspondence is publicly available within 45 days of when the SEC ends its review).
In one letter dated earlier this year that has been publicly released, the SEC questioned a risk factor in Eagle Materials’s 10-K for fiscal year 2009. The reviewer, SEC accounting branch chief Rufus Decker, said the building-materials provider’s brief note about the possibility of economic and market conditions affecting the fair value of its pension assets was “too broad and generic.” Decker further wrote: “It is not readily apparent why such risk would be unique to you and your business.”
In response, CFO D. Craig Kensler told the SEC in a letter that the company would disclose in future filings “in a direct and more specific manner how this risk affects our business.” Kensler did not respond to CFO‘s request for further comment.
Most often, says Davine, companies promise to do better next time and don’t have to revise their already submitted filings to address the SEC’s concerns. For Eagle Materials (which is not a Deloitte client), that meant explaining in its FY2010 10-K that economic conditions could affect the assumptions the company uses to calculate its obligations for its employee benefit plans, which in turn could affect the cost of running the programs and the results of its operations.
For its part, the SEC has warned companies about its renewed attention to risk disclosures. At a conference for certified public accountants in December, Meredith Cross, director of the SEC’s Division of Corporation Finance, said that while the commission was in the process of reviewing all of its disclosure rules as part of a larger project, risk disclosure was a particular area that “needs fixing.”
She expressed a desire to get companies away from “mind-numbing risk factors discourse to a more-targeted discussion of the principal risk facing the company.” She theorized such a change could entail combining the risks disclosed in the management discussion and analysis portion of companies’ financial reports with the discussions about risk factors and market risks.
And in July, SEC chairman Mary Schapiro said the commission’s staff is working on making a recommendation for changing the regulator’s risk-disclosure requirements. Schapiro did not give a time line or provide specifics, but the project will likely sit on the back burner as the commission tackles its mandates from the recently passed financial-reform bill, which has several deadlines for new regulations and studies.
Beyond the Ks and Qs, the SEC has also been questioning companies’ talk of risk in their proxy statements, based on rules passed just before the most recent proxy season began, says Davine. These inquiries concern whether companies have considered how incentives in their compensation programs are tied to risk, and explanations of the board’s role in overseeing risk.
As the SEC works on possibly issuing new guidelines for risk disclosures while also providing companies with feedback, observers say companies should avoid “copying and pasting” their risk disclosures every quarter. Katharine Martin, a partner at law firm Wilson Sonsini Goodrich & Rosati, suggests representatives from the legal, finance, and investor-relations departments meet once a quarter to specifically discuss the various risks affecting their company, their potential impact, and whether that impact warrants disclosure. (The SEC’s Regulation S-K requires companies to disclose “the most significant factors” that make a securities offering speculative or risky.)
However, it’s hard to kick the habit that the SEC has been trying to break through its comment process. Risk disclosures have become more generic, lengthy, and repetitive as companies have attempted to fend off potential scrutiny from securities plaintiffs. “When the SEC makes suggestions for preparing the 10-K, they are explicit in saying, don’t just take last year’s report and adjust it,” says Karen Nelson, an accounting professor at Rice University. “They want companies to start from scratch, but that’s not the way people think.”
Nelson’s research has shown that the risk-factor sections of companies’ filings tend to have more boilerplate language, or repeated phrases year after year, than the discussion of risk in MD&As.