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On Tuesday, Coinbase announced disappointing first quarter earnings. In the midst of a crypto crash, that would’ve been enough by itself to result in a big hit to the company’s stock price, but to make matters worse, the addition of new language to an existing risk factor prompted a firestorm of negative media reports about the company’s prospects. What caught the eye of many analysts was an updated version of a risk factor relating to issues associated with safeguarding client assets that appeared on p. 40 of its latest Form 10-K. The company’s first quarter Form 10-Q tacked on the following sentences to the first paragraph of that risk factor, which appears on p. 83 of the filing:

Moreover, because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors. This may result in customers finding our custodial services more risky and less attractive and any failure to increase our customer base, discontinuation or reduction in use of our platform and products by existing customers as a result could adversely impact our business, operating results, and financial condition.

That language was added in response to the SEC Accounting Staff’s issuance of SAB 121, which addressed accounting for safeguarded digital assets and noted that “disclosures regarding the significant risks and uncertainties associated with the entity holding crypto-assets for its platform users may also be required outside the financial statements under existing Commission rules, such as in the description of business, risk factors, or management’s discussion and analysis of financial condition and results of operation.”

My guess is that Coinbase probably viewed this disclosure as not being particularly material. It likely concluded that it was simply making explicit something that was implicit in its existing risk factor disclosure or at least widely known among crypto investors. But the market freaked out after media reports suggested that the new language implied that the company was facing the risk of bankruptcy. To make matters worse, some of those reports accused the company of hiding this allegedly apocalyptic disclosure. Ultimately, Coinbase’s CEO felt compelled to respond with a Twitter thread explaining the fact that the disclosure was prompted by the adoption of SAB 121.

I think there are a couple of takeaways from the Coinbase situation. First, sometimes a perfect storm of negative events surrounding a company and its industry can transform what a company thinks is a non-controversial risk factor update into a five-alarm fire – and the possibility of that kind of perfect storm needs to be kept in mind when drafting disclosure and considering its possible impact.

Second, as we point out in the discussion on p. 9-10 of our Risk Factors Disclosure Handbook, companies take different approaches to updating risk factors.  Some opt to simply set forth the risk factors that are being updated in the filing, while others, like Coinbase, include the entire set of risk factors that appeared in the 10-K.  We recommend that companies that repeat the entire section highlight the updated language in some fashion. Highlighting the new language might not stop an unexpected firestorm from happening, but it might help avoid accusations of attempting to bury the disclosure if one does break out.

– John Jenkins