Everything, poet Alexander Smith wrote, is sweetened by risk.
That would make investing life’s bottomless sugar bowl.
Risk is inherent in investing, and the warnings are ubiquitous: Past performance is no guarantee of future results; corporate “forward-looking statements” involve certain risks, and in futures and options, investors can lose all or more than their original investments.
Behind the boilerplate, the stark reality of those risks has been driven home time and again of late, and investor advocates and regulators are pushing companies to improve the amount and quality of disclosure about their finances and prospects.
The result, experts said, is a boomlet in companies providing an expanded–and sometimes massive–discussion of broad risk factors in their corporate 10K filings with the Securities and Exchange Commission, essentially telling investors: Don’t say we didn’t warn you.
Heads up, members of the Shareholder Nation: It seems that poor quarterly results can affect a company’s stock price. Losing major customers hurts revenue. The economy is iffy. The competition is brutal. A hurricane could hit corporate headquarters. And, as one prison operator warned investors, more people might start obeying the law.
“More is not necessarily better,” said Louis Thompson Jr., president and chief executive of the National Investor Relations Institute and a prominent advocate of improved corporate disclosure. “The notion that you have to have a 10,000-word discussion of risk factors goes almost to the point of absurdity.”
“These statements … I don’t think are very informative,” said Thomas Lys, a professor in the accounting information and management department at Northwestern University’s Kellogg School of Management.
But, Lys said, they are part of a significant shift: Where companies once were not rewarded in the market for tough accounting standards and detailed disclosure, the recent string of scandals in Corporate America has turned that around.
“The view right now is, if you stay quiet, you have something to hide,” he said.
With that in mind, many companies are warning investors of no end to potential pitfalls–to the point that the casual reader may wonder how some companies possibly stay in business.
“Coach’s inability to respond to changes in consumer demands and fashion trends in a timely manner could adversely affect its sales,” the New York-based luxury goods retailer and Sara Lee Corp. spinoff warned in September.
“Consumers could pirate our service,” New York-based satellite radio operator Sirius Satellite Radio Inc. told investors in its March 10K, a slightly more polite version of the previous year’s warning: “Consumers may steal our service.”
Some are vaguely apocalyptic.
“The adequacy of our water supplies depends upon a variety of factors beyond our control,” warned American States Water Co., a San Dimas, Calif.-based utility holding company, in March.
Approaching 10,000 words
Others are notable for their heft: Alviso, Calif.-based TV commercial zapper TiVo Inc. provided investors with a 9,300-word discussion of risks this spring–including that tech-sector standby, “We may never achieve profitability”–up from nearly 7,500 words in 2001.
TiVo officials declined to discuss its disclosures, but this year’s offering is longer by 68 words than the first 13 chapters in the King James version of Genesis, which takes readers from “In the beginning God created the heaven and the earth,” past Adam and Eve, Noah and the flood, all the way to the destruction of Sodom and Gomorrah.
Many in Corporate America are reluctant to talk about their risk discussions, with Coach, Sirius, American States Water and others either declining to discuss filings or not responding to requests for comment.
But, experts say, much of the impetus comes from SEC Chairman Harvey Pitt’s push for firms to disclose more forward-looking information.
Current SEC rules have few mandates for 10K risk discussions, requiring companies to provide “such other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations.”
Finding middle ground
Mel Stephens, vice president of investor relations at automotive supplier Lear Corp. of Southfield, Mich.–which provided a longer but comparatively concise risk discussion in its 10K this year–said investors indeed want more disclosure, but that companies need to find a middle ground between too little information and too much, which can overwhelm the effectiveness.
“Investors are increasingly concerned … they’re looking for companies to be more forthright,” Stephens said. “We increased our disclosure in this area because we thought it was the right thing to do.”
The model for many of the current disclosures seems to be the prospectus, in which the SEC requires companies to provide, in plain English, a logical, concise and specific “discussion of the most significant factors that make the offering speculative or risky.”
Some companies, of course, take the bare-bones approach: In its last 10K, months before its bankruptcy filing, Enron Corp.’s discussion of broad risk factors was 252 words long.
Experts almost universally agree that investors benefit more from a fuller disclosure of crucial accounting policies, off-balance-sheet arrangements and other financial details, but many also see benefits in the expanded risk factor discussions.
“The investment community wants to know everything,” said Bryan Armstrong, executive vice president of Chicago-based Ashton Partners, which advises companies on investor relations and financial communications issues. “Proactively addressing issues that are already on investors’ minds, such as business model risks, can go a long way in establishing credibility with current and prospective shareholders.”
Cutting down on overload
Several experts have suggested ways to provide investors with an improved discussion of qualitative factors affecting the business in 10K filings while cutting down on the prospectus-style overload. Thompson of the National Investor Relations Institute, for example, has advocated a two-tier system, with a widely disseminated plain English executive summary of trends affecting financial performance, followed by a more detailed discussion in various SEC filings.
And, experts said, not only is the value of expanded warnings sometimes dubious, but they don’t necessarily provide added protection from lawsuits, either.
Thompson notes that courts have ruled that as long as companies warn investors about relevant risks, they aren’t liable for failing to note a specific risk that later hurts results.
“My impression is that it’s not a liability issue–it’s more, if you don’t do that, your stock price takes a dip,” Northwestern’s Lys said, adding that such disclosures “are more to look good on Wall Street than to look good in a courtroom.”
