On June 15, 2017, the Securities and Exchange Commission (the “SEC”) entered an order (the “Order”) instituting cease-and-desist proceedings against the former CEO and CFO (the “Respondents”) of UTi Worldwide Inc. (the “Company”)^[1]. The Respondents each agreed to pay a civil money penalty of $40,000 to settle the proceeding, which found that they caused the Company to violate Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), by failing to comply with the requirement of Regulation S-K Item 303 that it disclose “any known trends 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.”^[2]

The Company was a freight forwarding and logistics company whose business model required cash outlays in connection with transportation costs that the company paid in advance and subsequently invoiced for reimbursement. In connection with a new operating system, the Company experienced challenges in issuing invoices in a timely manner, leading to higher than usual “unbilled” receivables and cash shortages. The Company was also struggling to comply with its debt covenants on an ongoing basis, and while its lenders agreed to amend these covenants for prior periods, they eventually made it clear they would not grant any further amendments. When the Company filed its 10-Q covering the relevant period, there was no discussion of the billing issues and how these had contributed to changes in cash flows, and only a very generic discussion of seasonal fluctuations in liquidity. When, in the following quarter, the Company disclosed that it was unable to meet its debt covenants due to the ongoing liquidity issues resulting from the billing challenges, the Company’s stock fell almost 30%.

Regulation S-K Item 303 requires the “disclosure of a trend, demand, commitment, event or uncertainty…unless a company is able to conclude either that it is not reasonably likely that the trend, uncertainty or other event will occur or come to fruition, or that a material effect on the company’s liquidity, capital resources or results of operations is not reasonably likely to occur.”^[3] As the SEC noted in the Order, the “reasonably likely” standard is a lower standard than “more likely than not.”^[4] What the SEC did not discuss, but what is equally important for companies that need to comply with the disclosure requirements to understand, is the probability floor for when this forward-looking disclosure is required. The good news is that the “reasonably likely” standard is a higher probability threshold than if a material effect is “reasonably possible” (which is the standard for the disclosure of contingent liabilities under Accounting Standards Codification 450, Contingencies, and which would require disclosure in the event the likelihood of a “material effect is higher than remote”^[5].  The SEC noted, in an analogous context,^[6] that a “reasonably likely” standard reduces the possibility that investors will be “overwhelmed by voluminous disclosure of insignificant and possibly unnecessarily speculative information” that could be produced under the lower probability threshold.^[7]

In addition to the Order, the trend (and similar, forward-looking) disclosure requirements of Regulation S-K Item 303 have recently been thrust into the spotlight by a Second Circuit case that held that companies could face expansive liability under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder for omitting “trends” and “uncertainties” required under Item 303.^[8] The Supreme Court recently granted certiorari and will hear the case in the fall. While we believe the Supreme Court should reverse the Second Circuit and hold, in line with other circuits, that there is no private liability under Section 10(b) for the omission of trend disclosure required by Item 303, if the ruling holds the pressure on reporting companies to correctly assess the threshold for Item 303 disclosure will increase substantially.

[1] In the Matter of Eric W. Kirchner and Richard G. Rodick (File No. 3-18024).

[2] The Order also found that the Respondents caused the Company to violate the requirements of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder that companies subject to the SEC’s reporting requirements make the required filings and that periodic reports contain any additional “material information as may be necessary to make the required statements not misleading.”

[3] Order, citing SEC Release No. 33-8350 (Dec. 19, 2003).

[4] Order, citing SEC Release No. 33-8056 (Jan. 25, 2002).

[5] See SEC Release No. 33-8144 (Nov. 4, 2002).

[6] The appropriate standard for the disclosure of off-balance sheet arrangements under Regulation S-K Item 303. See SEC Release No. 33-8182 (Jan. 28, 2003).

[7] See Id.

[8] Indiana Public Retirement System v. SAIC, Inc., 818 F.3d 85 (2d Cir. 2016).