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Published: 2008-03-26

Application Of The Safe Harbor For Forward-Looking Statements



This summer, two United States courts of appeals interpreted the safe harbor for forward-looking statements enacted as part of the Private Securities Litigation Reform Act of 1995 ("PSLRA" or "Reform Act").1 In June 1999, the U.S. Court of Appeals for the Third Circuit, in In re Advanta Corporation Securities Litigation,2 held that forward-looking statements made by a corporate spokesperson were not actionable absent specific allegations that the speaker had actual knowledge of the falsity of the statements. Then, in July 1999, the U.S. Court of Appeals for the Eleventh Circuit held, in Harris v. Ivax Corporation,3 that a company's forward-looking statements in press releases were protected from liability as long as they were accompanied by sufficiently "cautionary statements." In Ivax, the court found that disclosures containing a mixture of both forward-looking statements and historical fact, when read together, qualify for protection under the safe harbor, and also that the defendant is not required to identify the specific risk that ultimately occurs, but need only identify significant risks of a similar nature.

History Of Forward-Looking Statements

Forward-looking or "soft" information refers to projections, forecasts or other predictive statements, such as earnings projections, asset appraisals, new product developments and statements as to management's reasoning or beliefs.4 Although the Securities and Exchange Commission (the "SEC") had at one time excluded forward-looking information from SEC filings, beginning in the early 1970's, the SEC adopted policies encouraging issuers to disclose voluntarily forward-looking information both in their public filings and in public statements generally.5 In so doing, the SEC recognized that management projections concerning future economic performance were "of significant importance" to informed investor decision-making. As time has gone by, the SEC has gradually required the disclosure of forward-looking information in certain circumstances, most notably in Management's Discussion and Analysis of Financial Condition and Results of Operations as required by Item 303 of Regulation S-K ("MD&A").6

By 1979, the SEC had adopted safe harbor rules in the form of Rule 175, with respect to the Securities Act of 1933 (the "Securities Act"),7 and its twin, Rule 3b-6, with respect to the Securities Exchange Act of 1934 (the "Exchange Act").8 Under these rules, forward-looking information included statements concerning projections of certain financial information, management's plans for future operations and statements of future economic performance contained in the issuer's MD&A. These safe harbors provided that statements of forward-looking information would not be considered fraudulent unless it was shown that the statements lacked a reasonable basis or were not made in good faith; however, these rules applied only to statements made in reports filed with the SEC or to related statements reaffirmed in subsequent filings.

Notwithstanding the view that forward-looking disclosure is useful to investor decisions and market efficiency, issuers remained reluctant to make such disclosures beyond those necessary to comply with SEC reporting requirements. The primary basis for this reluctance had been attributed to the significant litigation risks imposed on the company, and possibly its directors and officers, as a result of predictive disclosures that later turned out to be incorrect. This perception was heightened by the concern that the company would have difficulty in successfully exiting litigation at an early enough stage to avoid expensive discovery and the possibility of a large settlement.9

Moreover, numerous commentators observed that the 1979 safe harbor rules were ineffective largely because they failed to protect companies from being sued over projections and did not protect oral statements.10 Indeed, both courts (with the notable exception of the U.S. Court of Appeals for the Seventh Circuit)11 and defendants rarely relied on the 1979 safe harbor rules. Instead, litigation concerning forward-looking statements focused on the requirement of F.R.C.P. 9(b), that a complaint set forth allegations of fraud with particularity or common law doctrines. The most significant common law doctrine providing protection for defendants seeking to avoid liability based on forward-looking statements became known as the "bespeaks caution" doctrine.

The Bespeaks Caution Doctrine

The bespeaks caution doctrine generally protects an issuer or affiliate from liability based on forward-looking statements if the statements are tempered by the inclusion of cautionary language. This protection is not guaranteed and one court has noted that the "'bespeaks caution' doctrine reflects nothing more than 'the unremarkable proposition that statements must be analyzed in context.'"12 The doctrine is significant, however, in that it has been used to terminate securities fraud litigation on pre-trial motions to dismiss or for summary judgment.13

Virtually all of the circuit courts of appeals have adopted the bespeaks caution doctrine in some form.14 Some courts have described the doctrine as addressing the materiality element of a securities fraud claim, while other courts have concluded that the presence of the requisite cautionary language negates the plaintiff's ability to establish reasonable reliance on the alleged misrepresentation.15 For example, in In re Donald J. Trump Casino Securities Litigation,16 the U.S. Court of Appeals for the Third Circuit affirmed the dismissal of a complaint by treating the bespeaks caution doctrine as essentially a question of materiality. According to the Trump court, the doctrine is "shorthand for the well-established principle that a statement or omission must be considered in context, so that the accompanying statements may render it immaterial as a matter of law." In that case, the court concluded, "the prospectus at issue contained an abundance of warnings and cautionary language which bore directly on the prospective financial success of [the business venture] and on the partnership's ability to repay" the subject debt.

The U.S. Court of Appeals for the Fifth Circuit similarly focused on the materiality of the alleged misrepresentations or omissions in Rubinstein v. Collins.17 The Collins court noted that the bespeaks caution doctrine was developed to treat situations in which favorable predictions are coupled with cautionary language to affect the reasonable reliance and the materiality of those projections. The court cautioned, however, that cautionary language, in and of itself, is not necessarily sufficient to render such projections automatically immaterial. In applying a reasonableness test, the court inquired as to whether, "under all the circumstances, the omitted fact or the prediction without a reasonable basis 'is one [that] a reasonable investor would consider significant in [making] the decision to invest, such that it alters the total mix of information available about the proposed investment.'" The court then reversed the dismissal of a complaint, concluding that despite the cautionary language in a prospectus, the plaintiff's allegations that the defendants did not disclose adverse information until after completing an insider trading scheme rendered the asserted omissions and misrepresentations "presumptively material at this juncture."

The New Safe Harbor Under The PSLRA

Based on the perception of significant abuse in private securities lawsuits,18 largely in the form of unmeritorious class action litigation, Congress enacted amendments to the Securities and the Exchange Acts with the passage of the PSLRA in 1995. Included in the PSLRA amendments was the adoption of a safe harbor for forward-looking statements designed to have broader application than the existing SEC safe harbor rules. Significantly, the PSLRA's legislative history expressly states that the bespeaks caution doctrine is not to be replaced by the Reform Act's safe harbor, nor is the judicial development of that doctrine to be halted.19

For purposes of the statute, a forward-looking statement includes statements containing projections of financial matters, plans and objectives for future operations or future economic performance (such as statements contained in the issuer's MD&A), as well as the assumptions underlying or relating to such statements. Forward-looking statements made in connection with tender offers, going private transactions, initial public offerings and financial statements made in accordance with Generally Accepted Accounting Principles, however, are not covered by the PSLRA's safe harbor.

The safe harbor itself consists of two prongs.20 The first, a variant of the "bespeaks caution" doctrine,21 precludes liability for an oral or written forward-looking statement if the statement is identified as forward-looking and is accompanied by "meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those" in the statement or is otherwise immaterial. Alternatively, the second prong precludes liability where the plaintiff fails to establish that the statement was made with the actual knowledge that the statement was false or misleading. A final, but important, additional feature of the PSLRA's safe harbor provision is that oral forward-looking statements qualified by an oral reference to cautionary language contained in SEC filings or other materials which are "generally disseminated" are deemed "readily available" and eligible to be considered by the court on a motion to dismiss.22 Numerous companies, in public filings, press releases and other materials, have sought to invoke the protections of the safe harbor by including in such materials a "safe harbor statement" that includes a disclaimer specifically identifying "forward-looking" information and the risks and assumptions attendant to those statements.

Advanta And Ivax

A few federal district courts have applied the PSLRA safe harbor, with results generally turning on whether the statement was, in fact, forward-looking,23 or the cautionary language was sufficient.24 One court of appeals, the Third Circuit in In re Advanta Corporation Securities Litigation,25 rejected claims brought under Section 10(b) of the Exchange Act based on the PSLRA safe harbor. In Advanta, however, the court characterized certain public statements by a corporate spokesperson as purely forward-looking for purposes of the PSLRA and applied the second prong of the safe harbor in the absence of factual allegations in the complaint supporting an inference that anyone affiliated with the issuer had actual knowledge of the falsity of the challenged disclosure. In that regard, the court did not address the issue of cautionary statements.

In Harris v. Ivax Corporation,26 however, the Eleventh Circuit applied the first prong of the PSLRA safe harbor. In that case, Ivax Corporation, a manufacturer of generic pharmaceutical products, was profitable in 1995, but posted a loss in the second quarter of 1996. On August 2, 1996, the company issued a press release announcing and explaining the second quarter results and suggesting that the company was taking steps to remedy the causes of the loss. On September 30, the company announced that it expected a $43 million loss for the third quarter. Then, on November 11, Ivax announced a $179 million loss for the third quarter, $104 million of which was attributable to a reduction in the carrying value of goodwill attributed to several of the company's businesses. Neither the August 2 nor the September 30 press releases mentioned the potential for the goodwill charge for the third quarter results.

Following the November 11 announcement, Ivax stock plummeted, and Ivax shareholders commenced litigation in the United States District Court for the Southern District of Florida alleging violations of Section 10(b) of the Exchange Act. Plaintiffs asserted two theories of liability: (1) the company's projections were materially false and misleading and (2) Ivax's disclosure of factors affecting its predictions misled the plaintiffs by omitting the possibility of a goodwill writedown. The defendants moved to dismiss, based on the PSLRA safe harbor and the PSLRA's requirements with respect to the pleading of scienter. The district court granted the motion to dismiss, holding that the allegedly fraudulent statements were forward-looking and were accompanied by meaningful cautionary language. In addition, the district court held that the complaint failed to allege sufficient facts to support a strong inference that the statements were made with actual knowledge of their falsity.27

On appeal, the plaintiffs contended that (1) the allegedly fraudulent statements were either not forward-looking or were lacking sufficient cautionary language and (2) the amended complaint adequately alleged scienter by a showing of reckless indifference to the falsity of the disclosures. The plaintiffs argued in the alternative that even if the current complaint did not adequately allege scienter, the district court should have allowed them to amend their complaint to do so. The Eleventh Circuit rejected plaintiffs' arguments, holding that the statements at issue were forward-looking and were accompanied by "meaningful cautionary language." In declining to decide the issue of the PSLRA's pleading requirements for scienter, the court held that if a forward-looking statement is made accompanied by "meaningful cautionary language," the defendant's state of mind is irrelevant.28

The court began its analysis by resolving whether the August 2 and September 30 press releases were in fact forward-looking statements. In so doing, the court identified two core theories being advanced by the plaintiffs: (1) that Ivax's optimistic outlooks allegedly hid an intent to take a goodwill charge of $104 million in the third quarter of 1996 and (2) that the disclosure of a purportedly limited list of negative business factor risks deliberately omitted the risk of a goodwill writedown. The court noted that there was no question under the PSLRA that a material and misleading omission can fall within the protections of the safe harbor provision.29

The August 2 press release contained three statements challenged by plaintiffs. First, the press release stated that "Reorders are expected to improve as customer inventories are depleted." The court found that the arrangement of the text made it apparent that an expected increase in reorders was the foundation of the optimism. Accordingly, the court held that this statement fell into one of the categories of forward-looking statements defined in PSLRA, namely, a "statement of the assumptions underlying . . . future economic performance.30 The August 2 press releases also announced that "the challenges unique to this period in our history are now behind us" and further that the "fundamental business and its underlying strategies remain intact . . . . Ivax is very well positioned." The plaintiffs characterized these disclosures as present-tense statements which cannot be deemed to predict the future. The court disagreed, concluding that whether Ivax had, indeed, weathered the storm with its business and strategies intact were claims verifiable only in the future. Therefore, the statements were held to be forward-looking within the meaning of the PSLRA safe harbor.

The court then addressed the September 30, 1996 press release, which predicted third quarter results and featured a list of factors that would influence actual results. The five factors included high customer inventory levels and low orders; declining prices; "shelf stock adjustments" for existing customers; higher reserves for returns; and the bankruptcy of a major customer who owed Ivax $16 million. Acknowledging that certain of these factors, when viewed in isolation, were not forward-looking statements, the court faced the question of whether the safe harbor benefits the entire statement or only those portions which are purely forward-looking. Here, because the plaintiffs alleged that the list, in its entirety, was materially false and misleading in light of the failure to include the expectation of the goodwill charge, the court held that it made no sense to analyze the list in separate parts: the list was either forward-looking or not in its entirety.

The court observed that while the statute is silent on mixed statements of future and historical events, congressional intent on the issue points strongly toward treating the entire list as forward-looking. According to the court, the elimination of statements containing both factual and forward-looking information from safe harbor protection would stifle the public dissemination of useful company information that Congress sought to encourage with the passage of the Reform Act.31 Recognizing that treating mixed disclosures as forward-looking might create a loophole for misleading omissions, the court alerted potential investors to two important safeguards: (1) a disclosure of mixed factual and forward-looking statements will only qualify for protection if it contains assumptions essential to the statements and (2) a defendant can benefit fully from the safe harbor provision only when it has disclosed risk factors in a warning appended to the forward-looking statements.

The court then turned to whether the cautionary language accompanying Ivax's forward-looking statements was sufficient for purposes of the safe harbor. Plaintiffs argued that the company's cautionary statements attached to the press releases were mere boilerplate. The court rejected this allegation, finding that not only were the risk disclosures in both press releases italicized, detailed and informative, they specifically stated the variety of misfortunes that might befall the company and the potential effect of these pitfalls on the company. Significantly, the court also rejected plaintiffs' contention that Ivax committed fraud because the press releases failed to mention the $104 million goodwill charge. In that regard, the court concluded that "meaningful" cautionary language under the safe harbor need not contain an explicit disclosure of the risk factor that ultimately contradicts a forward-looking statement. In support of its conclusion, the court observed that the safe harbor requires the risk disclosure to mention only "important factors that could cause actual results to differ materially from those in the forward-looking statement."32 The court also pointed to the legislative history accompanying the PSLRA which stated that "[f]ailure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor."33 Accordingly, the court held that when an investor has been warned of risks similar to those actually realized, he is on adequate notice of the precariousness of the investment.

Finally, while the plaintiffs argued that the proposed amended complaint properly alleged scienter, they did not contend that such amendments would prevent Ivax from taking advantage of the safe harbor. In a footnote, the court stated that the "statutory definition of 'forward-looking statement' does not refer at all to the defendants' knowledge of the truth or falsity of the statement; however, such knowledge is relevant only to liability in the safe harbor, and even there only when there is inadequate cautionary language."34 For these reasons, the court denied plaintiffs' leave to amend and affirmed the district court's dismissal of the complaint.

Conclusion

The first prong of the PSLRA's safe harbor protects a written or oral forward looking statement that is identified as such and that is accompanied by meaningful cautionary language identifying important factors that could belie the forward-looking statement. Ivax makes clear that mixed statements, containing both historical facts and forward-looking statements, may qualify for the safe harbor. Ivax provides further protection to issuer disclosures of forward-looking information by permitting issuers to satisfy the requirement that "important factors [exist] that could cause actual results to differ materially from those in the forward-looking statement" without having to expressly identify the risk factor that ultimately contradicts that statement.

The second prong of the safe harbor centers on the state of mind of the person or entity making the forward-looking statement. In Advanta, the complaint was dismissed because of the absence of allegations showing that the defendants had knowledge of the falsity of the forward-looking statements. In Ivax, the court remarked, in dictum, that "[e]ven if the forward-looking statement has no accompanying cautionary language, the plaintiff must prove that the defendant made the statement with 'actual knowledge' that it was 'false or misleading.'"35 The question remains, therefore, whether the safe harbor requires allegations that the defendant literally knew that the forward-looking statements were false or whether the courts will interpret that provision of the safe harbor to be overcome by pleadings akin to the "recklessness" standard of scienter adopted by several courts.36 *

Todd J. Frye, an associate at the Firm, participated in the preparation of this article.

Endnotes

  1. Private Securities Litigation Reform Act of 1995, Pub. L. 104-67, 109 Stat. 737 (1995).
  2. 180 F.3d 525 (3d Cir. 1999).
  3. 182 F.3d 799, 807-08 (11th Cir. 1999).
  4. See Dennis J. Block & Jonathan M. Hoff, "Forward-Looking Statements: Reducing Litigation Risks," New York Law Journal, Aug. 25, 1994.
  5. See Guides for Disclosure of Projections of Future Economic Performance, Securities Act Release No. 5992 [1978 Transfer Binder] Fed. Sec. L. Rep. (CCH) 681,756, at 81,037 (Nov. 7, 1978).
  6. See Block and Hoff, supra note 4.
  7. 17 C.F.R. § 230.175 (1995).
  8. 17 C.F.R. § 240.3b-6 (1995).
  9. See Remarks by Barbara B. Kennelly, in the House of Representatives, 126 Cong. Rec. E826 (daily ed. May 3, 1994).
  10. See "[Former Commissioner] Beese Suggests New Safe Harbor as a Step Toward Securities Litigation Reform," The SEC Today (SEC, Washington, D.C.), June 13, 1994, at 1; John M. Olivieri, "Liability for Forward-Looking Statements: The Securities and Exchange Commission's Ambiguous Stance," 1993 Col. Bus. L. Rev. 221, 221-22 (1993).
  11. See, e.g., Arazie v. Mullane, 2 F.3d 1456 (7th Cir. 1993); Roots Partnership v. Lands' End Inc., 965 F.2d 1411 (7th Cir. 1992); Wielgos v. Commonwealth Edison Co., 892 F.2d 509 (7th Cir. 1989).
  12. Fecht v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995) (citation omitted), cert. denied, 517 U.S. 1422 (1996).
  13. See Dennis J. Block & Jonathan M. Hoff, "Court Defines Scope of Bespeaks Caution Doctrine," New York Law Journal, Nov. 18, 1993.
  14. See generally In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994); Kline v. First Western Gov't Sec., Inc., 24 F.3d 480 (3d Cir. 1994); Rubinstein v. Collins, 20 F.3d 160 (5th Cir. 1994); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993), cert. denied, 510 U.S. 1178 (1994); Sinay v. Lamson & Sessions Co., 948 F.2d 1037 (6th Cir. 1991); I Meyer Pincus & Assocs. v. Oppenheimer & Co., Inc., 936 F.2d 759 (2d Cir. 1991); Romani v. Shearson Lehman Hutton, 929 F.2d 875 (1st Cir. 1991).
  15. The Second Circuit, for instance, has addressed the bespeaks caution doctrine both as an issue of materiality and of reliance. Compare I. Meyer Pincus & Assoc. v. Oppenheimer & Co., 936 F.2d 759, 763 (2d Cir. 1991) (focusing on materiality), with Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1031 (2d Cir. 1993) (dismissing a complaint based on lack of justifiable reliance) and Griffin v. McNiff, 744 F. Supp. 1237, 1253 (S.D.N.Y. 1990) (basing its holding on a reliance analysis).
  16. 7 F.3d 357 (3d Cir. 1993), cert. denied, 510 U.S. 1178 (1994).
  17. 20 F.3d 160 (5th Cir. 1994).
  18. See Testimony of Arthur Levitt, Hearings on H.R. 10, the Common Sense Legal Reform Act of 1995, Subcommittee on Telecommunications and Finance, House Commerce Committee, February 10, 1995; see also Janet Cooper Alexander, "Do the Merits Matter? A Study of Settlements in Securities Class Actions," 43 Stan. L. Rev. 497, 511-13 (1991).
  19. H.R. Conf. Rep. No. 104-369, at 46 reprinted in 1995 U.S.C.C.A.N. 730, 745.
  20. 15 U.S.C. §§ 77z-2(c)(1)(B) & 78u-5(c)(1)(B) (Supp. 1997); see also Dennis J. Block & Jonathan M. Hoff, "Securities Litigation Reform Law," New York Law Journal, Dec. 21, 1995.
  21. H.R. Conf. Rep. No. 104-369, at 46, reprinted in 1995 U.S.C.C.A.N. 730, 745.
  22. 15 U.S.C. §§ 77z-2(c)(3) & 78u-5(c)(3) (Supp. 1997).
  23. In re Oxford Health Plans, Inc. Sec. Litig., 187 F.R.D. 133, 141-42 (S.D.N.Y. 1999); In re Aetna Sec. Litig., 34 F. Supp. 2d 935, 947 (E.D. Pa. 1999).
  24. Ruskin v. TIG Holdings, Inc., 98 Civ. 1068 (LLS) (S.D.N.Y. Sept. 23, 1999); In re Cendant Corp. Litig., 1999 WL 549015, at *18-19 (D.N.J. July 27, 1999); Karacand v. Edwards, 53 F. Supp.2d 1236, 1248-49 (D. Utah 1999).
  25. 180 F.3d 525 (3d Cir. 1999).
  26. 182 F.3d 799 (11th Cir. 1999).
  27. Harris v. Ivax Corp., 998 F. Supp. 1449, 1453-54 (S.D. Fla. 1998).
  28. See H.R. Conf. Rep. 104-369, at 44 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 743 (stating that courts should not examine the state of mind of the person making the cautionary statement).
  29. See 15 U.S.C. § 78u-5(c)(1) (Supp. 1997).
  30. See 15 U.S.C. § 78u-5(i)(1)(D), (C) (Supp. 1997).
  31. H.R. Conf. Rep. 104-369, at 42 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 741.
  32. 15 U.S.C. § 78u-5(c)(1)(A)(i) (Supp. 1997).
  33. H.R. Conf. Rep. 104-369, at 44 (1995), reprinted at 1995 U.S.C.C.A.N. 730, 743.
  34. Harris, 182 F.3d at 807-08 (citing 15 U.S.C. § 78u-5(c), (i) (Supp. 1997)).
  35. See 15 U.S.C. § 78u-5(c)(1)(B) (Supp. 1997).
  36. Compare In re Silicon Graphics Sec. Litig., 183 F.3d 970, 991-92 (9th Cir. 1999) (holding "that allegations either of recklessness . . . or of motive and opportunity to commit fraud are no longer sufficient to avoid dismissal") with Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 537-38 (2d Cir. 1999) (stating that claims of recklessness or motive and opportunity are sufficient to satisfy the PSLRA's "strong inference" standard) and Williams v. WMX Techs., Inc., 112 F.3d 175, 178 (5th Cir. 1997) (same).