The Securities and Exchange Commission is prodding companies to provide more information about the risks they face.
The regulator wants companies to give more details about potential problems in annual and quarterly financial statements, as well as proxies. Among the subjects they'd like to see addressed in more detail are risks tied to credit and liquidity, goodwill impairments, and compensation.
Christine Davine, national director of SEC services at Deloitte & Touche, notes that the emphasis today is on specifics. 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."
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 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."
Most often, says Davine, companies can simply promise to do better next time and don't have to revise already submitted filings. 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.
In July, SEC chair Mary Schapiro said the commission planned to issue a recommendation for changing the regulator's risk-disclosure requirements. Schapiro did not give a timeline or provide specifics, and the demands of the recently passed financial-reform bill may delay the project.
Nonetheless, 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, investor-relations, and finance departments meet quarterly to discuss risks, their potential impact, and whether that impact warrants disclosure.
The SEC's Top 10 Risks
Over the past two years, the SEC has most frequently questioned the following issues in its comments on companies' risk factors.
1. Inadequate disclosure issues
2. Market for products and services
3. Reliance on suppliers, customers, governments
4. Going concern
5. Effects of regulatory changes
6. Legal exposures and reliance on legal positions
7. Ineffective internal or disclosure controls
8. Reliance on certain employees
9. Conflicts of interest/related party issues
10. History of operating losses
List based on SEC comment letters on U.S. companies' annual and quarterly filings dated between January 1, 2009, and July 1, 2010. Data based on CFO's analysis of Audit Analytics's comment-letter database as of July 28, 2010.