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In prior blogs, Liz and Dave touched on risk factor and MD&A disclosure issues arising out of President Trump’s tariff-related actions.  However, I wanted to address those issues again, because if you’re preparing your first quarter Form 10-Q, the timing of the President’s actions and the potential for another shoe to drop in less than 90 days create almost perfect conditions for companies to stumble into traps for the unwary when addressing these line-item disclosure requirements.

“Liberation Day” occurred on April 2nd, shortly after calendar year companies completed their first fiscal quarter. As a result, the financial statements for the first quarter that will appear in Form 10-Q filings typically won’t reflect the impact of the current tariff regime or the one that may be in place in 90 days.  However, it’s pretty clear that most companies are already experiencing the impact of the change in tariff policy on their business – and that’s where the potential traps for the unwary start to unfold.

Under Item 105 of Regulation S-K, the fact that tariffs only began to impact a company’s business after the end of the quarter means that drafters should be particularly conscious of the “hypothetical” risk factor issue when updating risk factor disclosure.  With events unfolding so rapidly, today’s risk may be tomorrow’s reality, and those responsible for drafting the 10-Q need to pay even closer attention to developments in the business than they have for previous filings.

There’s reason to think that in its current configuration, the SEC may be less enthusiastic about hypothetical risk factors as a basis for enforcement actions, but the same probably can’t be said for the plaintiffs’ bar. Since that’s the case, in updating risk factor disclosure companies should remember the Fifth Circuit’s admonition that “[t]o warn that the untoward may occur when the event is contingent is prudent; to caution that it is only possible for the unfavorable events to happen when they have already occurred is deceit.” Huddleston v. Herman & MacLean, 640 F. 2d 534, 544 (5th Cir. 1981). If you make disclosure in a risk factor, you need to be very clear about events that have occurred and those that may occur – otherwise you’re likely only digging a deeper hole.

Second, events that are currently impacting a company’s business but that are not reflected in the financial statements included in a periodic report are precisely what Item 303’s “known trends” disclosure requirement is intended to capture.  What’s more, companies aren’t just dealing with the current tariff regime, but the more draconian one that may be in place a few months from now. That future tariff regime is a contingency, and when it comes to contingencies, the SEC’s position is that known trends disclosure under Item 303 is triggered by any contingent event that is “reasonably likely” to occur and would be material if it did. Here’s how the SEC characterized its standard in its 2020 MD&A Release:

[W]hen applying the “reasonably likely” threshold, registrants should consider whether a known trend, demand, commitment, event, or uncertainty is likely to come to fruition. If such known trend, demand, commitment, event or uncertainty would reasonably be likely to have a material effect on the registrant’s future results or financial condition, disclosure is required.

Known trends, demands, commitments, events, or uncertainties that are not remote or where management cannot make an assessment as to the likelihood that they will come to fruition, and that would be reasonably likely to have a material effect on the registrant’s future results or financial condition, were they to come to fruition, should be disclosed if a reasonable investor would consider omission of the information as significantly altering the mix of information made available in the registrant’s disclosures.

The TL;DR version of this standard is that if a contingent event likely would be material if it occurred and management can’t conclude that it isn’t reasonably likely to occur, then the MD&A discussion must address the consequences of that event assuming that it occurred.  So, when assessing their MD&A disclosure obligations, companies should consider the implications of the current tariff regime and, unless they conclude that it’s not reasonably likely to be implemented, the more draconian one that may come into effect in a few months.

– John Jenkins