A corporation that doesn’t properly inform its shareholders about likely future risks to its business can become liable to shareholders if their stock holdings lose value. Since nobody can be sure exactly what the future holds, corporations tend to err on the side of caution when listing risks in their SEC filings.

In Red Hat’s 2009 SEC form 10-K,1 the “risk factors” section lists the company’s estimated risk factors under almost 80 different headings.2

We think such long listings of risks provide questionable value to investors. Investors are looking to figure out what is likely to happen, not the worst that could possibly happen. But once something bad does happen, investors look for somebody to blame.3 Anticipating that, company management tries to make sure that it can later point to its SEC filings and show that it did, in fact, warn these investors of the risks.

Any investor who actually bases his4 investment decisions on these risk factor listings in SEC filings will likely end up putting his money under a mattress. Smart investors know how the game is played, and they know what these risk factors are intended to do—protect the company management from liability.

But give a blogger5 an opportunity to get a few more hits, and common sense goes out the window. Instead of recognizing these risk factors for what they are—essentially CYA for company management—bloggers get all hyperactive instead.

In Red Hat’s filing, we see this risk:

We are subject to risks of currency fluctuations and related hedging operations.

Does this mean that Red Hat management is shivering from a fear of currency fluctuations? Spending sleepless nights keeping a gun by its side in case ruthless related hedging operations try to break in and burglarize the Red Hat headquarters?

No, it just means Red Hat has cautious management that wants to cut off shareholder lawsuits and SEC action at the border so far as possible.

It’s like those sun protection covers that warn you not to drive with the cover on the windshield. A person sufficiently lacking in sense to drive with the cover on isn’t going to be bothered by the warning, but it may protect the manufacturer from liability later on.

Microsoft’s stock has not been growing much lately. In anticipation of future shareholder lawsuits, Microsoft management is doing the smart thing—thinking of every possible accusation that could be made against it in a future shareholder lawsuit, and making sure it covers itself by listing every possible risk in its SEC filings now, under 20 different headings.6 This is not fear, it’s caution and self-defense.

But throwing Linux in front of a blogger can sometimes be like throwing a ball of wool in front of a cat. Cat instincts take over and, for all practical purposes, at least until the cat gets bored, the wool is a fleeing rat.

It all began (this time around) when Blogger 1 happened to note7 that “Microsoft’s latest 10-K … adds Canonical, distributor of Ubuntu Linux, to the list of acknowledged competitors for Microsoft’s Client division, which makes Windows for PCs. Also notable is the addition of Linux distributor Red Hat to the list of Client division rivals. Previously, Red Hat was mentioned only as a competitor for the Microsoft Business and Server & Tools divisions.”

Give that man a cigar—straightforward and factual reporting like this is unfortunately rare in the blogosphere.

Blogger 2 took the simple and straightforward quote above and made the following headline out of this: “Microsoft says it’s fighting on two fronts against netbook Linux, browsers”. And then proceeded to claim that Blogger 1 “[N]oted that Microsoft—the company which European regulators continue to allege abuses its dominant position in multiple markets for even greater gains—paints a picture of itself facing significantly greater threats from stronger competitors in two key market areas: the “UX” brands of operating systems, including Linux and Unix; and netbooks, whose rise in popularity has opened up a toehold for Windows’ rivals.”8

Blogger 1 does nothing of the sort, so far as we can tell. How do you go from “list of acknowledged competitors” to “fighting on two fronts” and “significantly greater threats”, unless you have an overactive imagination?

We know, of course, that Microsoft has been often described as trying to keep margins up on netbooks. But we have read that elsewhere. We can’t find that anywhere in Blogger 1′s article or in Microsoft’s SEC filing.

What we see Blogger 2 doing is essentially giving his own opinion, and making it seem authoritative by citing another blogger and Microsoft’s SEC filing.

Microsoft’s filing mentions “strong competition” from Apple, Canonical, and Red Hat. And also from Google, Mozilla, and Opera Software Company.

And Microsoft also concludes that section by saying: “Our operating system products compete effectively by delivering innovative software, giving customers choice and flexibility, a familiar, easy-to-use interface, compatibility with a broad range of hardware and software applications, and the largest support network for any operating system.”

Which are you going to believe—the “strong competition” part, or the “compete effectively” part?

We recommend: Neither.

Blogger 2 also claims: “[T]he battle lines [Microsoft] draws for the SEC in its theoretical market map is that of a fortress defending itself from strong, simultaneous attacks on two sides.” Microsoft does nothing of the sort. This colorful description comes from Blogger 2, not from Microsoft. Remember, Microsoft listed 20 different types of risks, which included not only competition from Linux, but also: “We depend on our key personnel that we employ,” “Our quarterly operating results may not be a reliable indicator of our future operating results,” and “We may be subject to greater tax liabilities.” This is just a standard disclaimer.9 whose intended audience is a future jury or judge in a future lawsuit.

Blogger 3 chimes in with the headline: “Microsoft admits that it feels threatened by Linux”.10 Where did “admits” and “feels” come from?

Blogger 4 has a similar headline: “Microsoft admits to SEC: We fear Linux, Ubuntu, and Red Hat”.11

Blogger 5 concludes, “[I]t seems that Microsoft is preoccupied with open source as a threat, rather than as an opportunity. That’s unfortunate.”12 But if that is true, then isn’t Microsoft also preoccupied with security and privacy breaches? (“Security and privacy breaches may expose us to liability and cause us to lose customers.”) With contract problems? (“If we fail to comply with our customer contracts or government contracting regulations, our business could suffer.”) With its own quarterly results? (“Our quarterly operating results may not be a reliable indicator of our future operating results”.)

Could Microsoft also be preoccupied with Global Warming, tsunamis, meteorite strikes, explosions, wars, and assassinations? (“A disruption or failure of our systems or operations in the event of a major earthquake, weather event, cyber-attack, terrorist attack, or other catastrophic event could cause delays in completing sales, providing services, or performing other mission-critical functions.”)13

Blogger 6 claims, “Microsoft is feeling the heat of Linux competition.”14

Either Microsoft management is shuddering in fear of being attacked from twenty directions (if you take the 20 risk factors seriously) or they are simply anticipating arguments that could be made in shareholder lawsuits and inserting all the appropriate warnings into the SEC filings. Our money is on the latter.

We recommend taking it all with skepticism, because it’s all a game.

Legislators play the game, by making laws that make people feel like they are being taken care of.

The SEC plays the game, by making rules—thousands of them—and designing forms to be filled out.

Corporations play the game, by listing every possible risk that could ever occur.

And finally, bloggers play the game, by desperately grasping at every possible straw and trying to make breaking news out of it.

  1. Red Hat’s SEC filings can be found at http://investors.redhat.com/financials.cfm visited 2009-08-05. Try the “Form 10-K” link or go directly to http://investors.redhat.com/secfiling.cfm?filingID=1193125-09-91983. Note: That’s a big web page that caused Firefox to slow down a lot. We had much better luck with Opera. ↩
  2. The following are the almost 80 headings in the “risk factors” section of Red Hat’s 2009 form 10-K. These are just the headings. In the original filing, each is followed by one or more paragraphs of text.
    • Unfavorable economic and market conditions could adversely affect our business, financial condition and results of operations.
    • If we fail to continue to establish and maintain strategic distribution and other collaborative relationships with industry-leading companies, we may not be able to attract and retain a larger customer base.
    • We have entered into and may continue to enter into or seek to enter into business combinations and acquisitions, which may be difficult to complete and integrate, disrupt our business, divert management’s attention, adversely effect our financial condition or results of operations and dilute stockholder value.
    • If we fail to effectively manage our growth, our operations and financial results could be adversely affected.
    • We rely, to a significant degree, on an indirect sales channel for distribution of our products and services, and disruption of any part of this channel could adversely affect the sales of our products.
    • We rely on software licensed from other parties, the loss of which could increase our costs and delay software shipments.
    • We may not be able to continue to attract and retain capable management personnel.
    • We depend on our key personnel that we employ.
    • Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture, and our business may be harmed.
    • Our subscription-based contract model may encounter customer resistance or we may experience a decline in the demand for our products.
    • If our current and future customers do not renew their subscription agreements with us, our operating results may be adversely impacted.
    • If open source software programmers, most of whom we do not employ, do not continue to develop and enhance open source technologies, we may be unable to develop new products, adequately enhance our existing products or meet customer requirements for innovation, quality and price.
    • If third-party enterprise hardware and software providers do not continue to make offerings compatible with our offerings, our software will cease to be competitive.
    • We may be unable to predict the future course of open source technology development, which could reduce the market appeal of our products and damage our reputation.
    • Because of the characteristics of open source software, there are few technology barriers to entry in the open source market by new competitors and it may be relatively easy for new competitors with greater resources than we have to enter our markets and compete with us.
    • Industry consolidation may lead to increased competition and may harm our operating results.
    • Our continued success depends on our ability to adapt to a rapidly changing industry as well as maintaining a strong brand. Investment in new business strategies and initiatives could disrupt our ongoing business and may present risks not originally contemplated.
    • We must effectively develop, deliver and stimulate demand for new products and technologies in order to remain competitive.
    • Security and privacy breaches may expose us to liability and cause us to lose customers.
    • We are vulnerable to system failures, which could harm our reputation and business.
    • If we fail to comply with our customer contracts or government contracting regulations, our business could suffer.
    • If our products are found or alleged to infringe third-party intellectual property rights, we could be required to redesign our products, replace components of our products, enter into license agreements with third parties and provide infringement indemnification.
    • We are vulnerable to claims that our products infringe third-party intellectual property rights because our products are comprised of software components, many of which are developed by numerous independent parties, and an adverse legal decision affecting our intellectual property could materially harm our business.
    • We could be prevented from selling or developing our software if the GNU General Public License and similar licenses under which our products are developed and licensed are not enforceable or are modified so as to become incompatible with other open source licenses.
    • Our products may contain defects that may be costly to correct, delay market acceptance of our products and expose us to claims and litigation.
    • Our efforts to protect our trademarks may not be adequate to prevent third-parties from misappropriating our intellectual property rights in our trademarks.
    • Efforts to assert intellectual property ownership rights in our products could impact our standing in the open source community, which could limit our product innovation capabilities and adversely affect our business.
    • We are, and may become, involved in disputes and lawsuits that could have a material adverse affect on our performance or stock price.
    • Our business is subject to a variety of U.S. and international laws regarding data protection.
    • Our quarterly operating results may not be a reliable indicator of our future operating results.
    • Our stock price has been volatile historically and may continue to be volatile. Further, the sale of our common stock by significant stockholders may cause the price of our common stock to decrease.
    • We may lack the financial and operational resources needed to increase our market share and compete effectively.
    • We may not be able to meet the financial and operational challenges that we will encounter as our international operations, which represented approximately 40.9% of our total revenue for the fiscal year ended February 28, 2009, continue to expand.
    • We may be subject to greater tax liabilities.
    • Because we recognize revenue from subscriptions for our service over the term of the subscription, downturns or upturns in sales may not be immediately reflected in our operating results.
    • If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings.
    • We may be exposed to potential risks if we do not have an effective system of disclosure controls or internal controls or fail on an ongoing basis to properly address Section 404 of the Sarbanes-Oxley Act of 2002.
    • Our investment portfolio is subject to credit and illiquidity risks and fluctuations in the market value of our investments and interest rates. These risks may result in an impairment in or the loss of all or portion of the value of our investments, an inability to sell our investments and a decline in interest income.
    • We are subject to risks of currency fluctuations and related hedging operations.
    • Unfavorable economic and market conditions could adversely affect our business, financial condition and results of operations.
    • If we fail to continue to establish and maintain strategic distribution and other collaborative relationships with industry-leading companies, we may not be able to attract and retain a larger customer base.
    • We have entered into and may continue to enter into or seek to enter into business combinations and acquisitions, which may be difficult to complete and integrate, disrupt our business, divert management’s attention, adversely effect our financial condition or results of operations and dilute stockholder value.
    • If we fail to effectively manage our growth, our operations and financial results could be adversely affected.
    • We rely, to a significant degree, on an indirect sales channel for distribution of our products and services, and disruption of any part of this channel could adversely affect the sales of our products.
    • We rely on software licensed from other parties, the loss of which could increase our costs and delay software shipments.
    • We may not be able to continue to attract and retain capable management personnel.
    • We depend on our key personnel that we employ.
    • Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture, and our business may be harmed.
    • Our subscription-based contract model may encounter customer resistance or we may experience a decline in the demand for our products.
    • If our current and future customers do not renew their subscription agreements with us, our operating results may be adversely impacted.
    • If open source software programmers, most of whom we do not employ, do not continue to develop and enhance open source technologies, we may be unable to develop new products, adequately enhance our existing products or meet customer requirements for innovation, quality and price.
    • If third-party enterprise hardware and software providers do not continue to make offerings compatible with our offerings, our software will cease to be competitive.
    • We may be unable to predict the future course of open source technology development, which could reduce the market appeal of our products and damage our reputation.
    • Because of the characteristics of open source software, there are few technology barriers to entry in the open source market by new competitors and it may be relatively easy for new competitors with greater resources than we have to enter our markets and compete with us.
    • Industry consolidation may lead to increased competition and may harm our operating results.
    • Our continued success depends on our ability to adapt to a rapidly changing industry as well as maintaining a strong brand. Investment in new business strategies and initiatives could disrupt our ongoing business and may present risks not originally contemplated.
    • We must effectively develop, deliver and stimulate demand for new products and technologies in order to remain competitive.
    • Security and privacy breaches may expose us to liability and cause us to lose customers.
    • We are vulnerable to system failures, which could harm our reputation and business.
    • If we fail to comply with our customer contracts or government contracting regulations, our business could suffer.
    • If our products are found or alleged to infringe third-party intellectual property rights, we could be required to redesign our products, replace components of our products, enter into license agreements with third parties and provide infringement indemnification.
    • We are vulnerable to claims that our products infringe third-party intellectual property rights because our products are comprised of software components, many of which are developed by numerous independent parties, and an adverse legal decision affecting our intellectual property could materially harm our business.
    • We could be prevented from selling or developing our software if the GNU General Public License and similar licenses under which our products are developed and licensed are not enforceable or are modified so as to become incompatible with other open source licenses.
    • Our products may contain defects that may be costly to correct, delay market acceptance of our products and expose us to claims and litigation.
    • Our efforts to protect our trademarks may not be adequate to prevent third-parties from misappropriating our intellectual property rights in our trademarks.
    • Efforts to assert intellectual property ownership rights in our products could impact our standing in the open source community, which could limit our product innovation capabilities and adversely affect our business.
    • We are, and may become, involved in disputes and lawsuits that could have a material adverse affect on our performance or stock price.
    • Our business is subject to a variety of U.S. and international laws regarding data protection.
    • Our quarterly operating results may not be a reliable indicator of our future operating results.
    • Our stock price has been volatile historically and may continue to be volatile. Further, the sale of our common stock by significant stockholders may cause the price of our common stock to decrease.
    • We may lack the financial and operational resources needed to increase our market share and compete effectively.
    • During fiscal 2007, several of our largest competitors made announcements relevant to markets in which we operate, including an announcement by Oracle to offer Linux support services and an announcement by Novell regarding an agreement with Microsoft to collaborate on technology, a cross covenant not to sue the other party’s customers for patent infringement and an agreement by Microsoft to purchase and distribute coupons for SUSE Linux maintenance and support. Microsoft and Novell announced an extension of their partnership and the purchase and distribution of an additional $100 million in coupons for SUSE Linux by Microsoft in August 2008.
    • We may not be able to meet the financial and operational challenges that we will encounter as our international operations, which represented approximately 40.9% of our total revenue for the fiscal year ended February 28, 2009, continue to expand.
    • We may be subject to greater tax liabilities.
    • Because we recognize revenue from subscriptions for our service over the term of the subscription, downturns or upturns in sales may not be immediately reflected in our operating results.
    • If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings.
    • We may be exposed to potential risks if we do not have an effective system of disclosure controls or internal controls or fail on an ongoing basis to properly address Section 404 of the Sarbanes-Oxley Act of 2002.
    • Our investment portfolio is subject to credit and illiquidity risks and fluctuations in the market value of our investments and interest rates. These risks may result in an impairment in or the loss of all or portion of the value of our investments, an inability to sell our investments and a decline in interest income.
    • We are subject to risks of currency fluctuations and related hedging operations.

    ↩

  3. Remember all the people who were flipping houses hoping to make a killing? Today they are the victims. ↩
  4. We use “his” in its generic sense. See our glossary entry on He versus she. ↩
  5. Not every blogger, of course. You, dear reader, if a blogger, are obviously not one of those. But you are greatly outnumbered by the ones who are. Don’t fight it. ↩
  6. We found Microsoft’s 2009 10-K filing at http://www.sec.gov/Archives/edgar/data/789019/000119312509158735/d10k.htm visited 2009-08-05. It lists “risk factors” under 20 headings, which are:

    • Challenges to our business model may reduce our revenues and operating margins.
    • We face intense competition.
    • We may not be able to adequately protect our intellectual property rights.
    • Third parties may claim we infringe their intellectual property rights.
    • We may not be able to protect our source code from copying if there is an unauthorized disclosure of source code.
    • Security vulnerabilities in our products could lead to reduced revenues or to liability claims.
    • We are subject to government litigation and regulatory activity that affects how we design and market our products.
    • Our business depends on our ability to attract and retain talented employees.
    • Delays in product development schedules may adversely affect our revenues.
    • We make significant investments in new products and services that may not be profitable.
    • Adverse economic conditions may harm our business.
    • We have claims and lawsuits against us that may result in adverse outcomes.
    • We may have additional tax liabilities.
    • Our vertically-integrated hardware and software products may experience quality or supply problems.
    • If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings.
    • We operate a global business that exposes us to additional risks.
    • Catastrophic events or geo-political conditions may disrupt our business.
    • Acquisitions and joint ventures may have an adverse effect on our business.
    • Improper disclosure of personal data could result in liability and harm our reputation.
    • We may experience outages and disruptions of our online services if we fail to maintain an adequate operations infrastructure.

    ↩

  7. Article “Microsoft filing lists Canonical, Red Hat as PC Windows rivals” dated 2009-08-03 by Todd Bishop in blog “TechFlash” http://www.techflash.com/Microsoft_filing_lists_Canonical_Red_Hat_as_PC_Windows_rivals_52370627.html visited 2009-08-05. ↩
  8. Article “Microsoft says it’s fighting on two fronts against netbook Linux, browsers” dated 2009-08-05 by Scott M. Fulton, III in blog “betanews” http://www.betanews.com/article/Microsoft-says-its-fighting-on-two-fronts-against-netbook-Linux-browsers/1249483476 visited 2009-08-05. ↩
  9. Standard disclaimers can be found all over the net. Just do a web search for “standard disclaimer” or try this link: http://www.google.com/search?q=standard+disclaimer. ↩
  10. Article “Microsoft admits that it feels threatened by Linux” dated 2009-08-05 by Scott Merrill in blog “CrunchGear” http://www.crunchgear.com/2009/08/05/microsoft-admits-that-it-feels-threatened-by-linux/ visited 2009-08-05. ↩
  11. Article “Microsoft admits to SEC: We fear Linux, Ubuntu, and Red Hat” dated 2009-08-04 by Preston Gralla in blog “Computerworld Blogs” http://blogs.computerworld.com/microsoft_admits_to_sec_we_fear_linux_ubuntu_and_red_hat visited 2009-08-05. ↩
  12. Article “SpringSource, Canonical, and MySQL join Red Hat on Microsoft’s hit list” dated 2009-08-05 by Matt Asay in blog “cnet news; The Open Road” http://news.cnet.com/8301-13505_3-10302552-16.html visited 2009-08-05. ↩
  13. The same 10-K filing from Microsoft, under the subject heading “Catastrophic events or geo-political conditions may disrupt our business.” ↩
  14. Article “Linux is a threat to desktop business says Microsoft” dated 2009-08-05 by Elizabeth Montalbano in online periodical “Techworld” http://www.techworld.com/opsys/news/index.cfm?RSS&NewsID=120501 visited 2009-08-05. ↩