Public companies should consider the impact of new sanctions on Russia in assessing risk factor disclosure for upcoming annual reports on Form 10-K and quarterly reports on Form 10-Q.
In late 2020, as part of the Securities and Exchange Commission’s (SEC) efforts to modernize, simplify, and enhance public company disclosure, the SEC revised Item 105 of Regulation S-K, a principles-based requirement that public companies disclose the material factors that make an investment in the company speculative or risky.[1] While the requirement to provide risk factor disclosure was not new,[2] the revisions were intended to codify and incorporate the staff’s longstanding approach to risk factor disclosure.[3]
In this respect, risk factor disclosure should be registrant-specific, concise, organized logically, and rooted in materiality. Effective risk factor disclosure provides investors with an appropriate amount of information to adequately understand and appreciate the context and magnitude of the risk being presented as it relates specifically to the company.
Against the backdrop of rising tensions between the United States and Russia, particularly as it relates to Russia’s actions in Ukraine, and the new sanctions announced on February 22 by President Joseph Biden and several European leaders against Russia, public companies should review their risk factor disclosure to ensure that it appropriately addresses the risks associated with these events as they relate to their business, results of operations, and financial condition.
For example, if a company’s business depends on exports or imports to or from Russia, its disclosure should appropriately convey the potential effect of bans, sanction programs, additional licensing requirements, and/or boycotts on its business, including supply chain disruptions and other restrictions, to reflect the uncertainty surrounding the escalating conflict as it is unfolding in real time.
Additionally, a company that materially depends on third parties for its operations should consider whether those third parties may be impacted by the events in Russia and Ukraine. For example, third party contractors may have staff, material operations, financial transactions, research and development facilities, equipment, or other properties located in Russia or Ukraine that could be directly impacted by the conflict, which, in turn, could result in material implications for the company’s operations.
Similarly, a public company may have a material customer base located in Russia or Ukraine whereby both the economic and security conditions could limit the company’s ability to provide its services or products to such customers, as well as limit its ability to receive payments, resulting in a potential loss of revenues.
The examples provided are not exhaustive but present a starting point for evaluating the manner in which any updated disclosure may be needed. Public company clients should take a holistic and detailed approach to their review and evaluation of risk factor disclosure and carefully consider whether additional or revised disclosure, either qualitative or quantitative, is necessary. As is true of all risk factor disclosure, no one disclosure works for every company and the details of how the company conducts business will matter substantively. In this respect, the SEC has consistently emphasized that generic or boilerplate disclosure is discouraged.[4]
Any disclosure provided regarding the tensions between the United States and Russia, including sanctions, and the ongoing conflict in Ukraine should be timely in light of the rapidly evolving situation, meaningful, and appropriately tailored to the specific risks that a company faces.
Morgan Lewis continues to monitor the latest developments and will be providing updates as necessary.
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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Washington, DC
Erin E. Martin
Giovanna M. Cinelli
Kenneth J. Nunnenkamp
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Carl A. Valenstein
Pittsburgh
Celia A. Soehner
[1] Modernization of Regulation S-K Items 101, 103, and 105, Securities Act Release No. 33-10825 (Nov. 9, 2020).
[2] Prior to adopting Item 105, risk factor disclosure was required via Item 503(c) of Regulation S-K. See, e.g., FAST Act Modernization and Simplification of Regulation S-K, Securities Act Release No. 10618 (May 2, 2019).
[3] Id.
[4] For example, both current Item 105 and prior Item 503(c) explicitly discourage generic risk factor disclosure (i.e., risks that could apply to any issuer or offering).