The Minority Report: When Should Publicly Traded Corporations Be Required to Disclose Material Information to Its Shareholders Under Item 303?

Authors

• Alicia Mayo

Document Type

Note

Abstract

(Excerpt)

Due to the social distancing mandate during the COVID-19 pandemic, the demand for cloud-based platforms conducting virtual meetings grew drastically. ON24, a cloud-based digital platform that provides interactive webinars, virtual events, and multimedia content experiences, was one of the companies that experienced “explosive growth.” ON24’s customers increased from 760 customers to 1,900 from December 31, 2015 to September 30, 2020, and its revenue increased by fifty-nine percent from the previous year. ON24’s annual recurring revenue is driven by the company’s ability to acquire new customers while maintaining and expanding its existing client relationships. On February 3, 2021, ON24 commenced its initial public offering (“IPO”), selling 8,560,930 shares of common stock for fifty dollars per share.

However, three quarters prior to the IPO, ON24 changed its business model, enrolling new “atypical” customers to act as “quick fixes” for declining demand while preparing to go public. Shortly after its IPO, ON24’s common share price fell from $50 to $12.05. ON24’s CEO stated that churn had been one of its biggest issues, especially with the “first time renewal cohort.” Because ON24 did not disclose such information, shareholders sued ON24 in In re ON24, Inc. Sec. Litig. (2023). Shareholders alleged that ON24 violated Item 303.

Item 303 requires a corporation to “[d]escribe any known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” Misaligning from statutory text, the court did not explicitly explore if the churn after the February 2021 IPO was reasonably likely by calculating probability. Instead, the court seemed to transform the consideration of whether a trend or uncertainty was reasonably likely to have material impact into a review of corporate management’s ability to reasonably predict or expect the occurrence of a material event. The court’s interpretation likely derives from the Securities and Exchange Commission’s 1989 SEC Release, which states the standards for Item 303. Yet, the 1989 SEC Release also imposes probability requirements on Item 303.

So, why does the court in In re ON24, Inc. Sec. Litig. fail to calculate probability or require both parties to have competing probability calculations? The answer may be that probability calculations are inherently difficult and flawed. This Note argues that the SEC should refine the standards for Item 303 by substituting its reliance on probability with company-specific facts establishing knowledge and materiality. This change would give more guidance to courts on how they should apply Item 303 standards and to registrants on when their duty to disclose is triggered.