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CALIFORNIA CORPORATE & SECURITIES LAW

There’s No Dressing This Up – Item 303(a)(1) Of Regulation S-K Is Unreasonable

In less than a month, the United States Supreme Court will hear oral argument in Leidos, Inc. v. Indiana Public Retirement System (Docket No. 16-581).  The question presented in Leidos is:

Whether the Second Circuit erred in holding – in direct conflict with the decisions of the Third and Ninth Circuits – that Item 303 of SEC Regulation S-K creates a duty to disclose that is actionable under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.

Item 303 specifies what a registrant must include in its Management’s Discussion and Analysis.  Whether one agrees with the Second Circuit or not, it should be beyond peradventure that the disclosure standard established by Item 303(a)(1) is nonsensical.  Item 303(a)(1) requires a registrant to:

 Identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.

But what does it mean to say that something is “reasonably likely”?  The likelihood of anything is a determination of its probability.  The probability that a fair coin will land heads or tails is .50.  This .50 probability is neither reasonable nor unreasonable – it just is.  It is simply nonsense to call a .50 probability of the coin landing heads reasonably likely.

Suppose a registrant determines with absolute accuracy (I don’t know how) that there is a .15 probability that a certain event will decrease liquidity in a material amount.  If you believe that this makes the “reasonably likely”, what makes it so?

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