Eleventh Circuit Dismisses Complaint Under 1995 Safe Harbor Provision
|The United States Court of Appeals for the Eleventh Circuit in Harris v. IVAX Corp., 1999 U.S. App. LEXIS 17725, 1999 WL 542319 (11th Cir. July 27, 1999), recently became the first Court of Appeals to construe the safe harbor provision for forward-looking statements enacted in the Private Securities Litigation Reform Act of 1995 (the "PSLRA").|
The court's construction of the safe harbor is broad: The court looked at the challenged statements as a whole, and rejected the "purely grammatical argument" that particular phrases written in the present tense cannot be forward-looking statements. The court also held that when a plaintiff contends that a list of cautionary factors - some of which are forward-looking and some of which are not forward-looking - is challenged as a whole on the ground that the list omits a particular factor, the list should be treated as a single unit that is a forward-looking statement.
The Safe Harbor
The safe harbor adopted by the PSLRA has two prongs. First, there is no liability under the federal securities laws for forward-looking statements that prove false if the statement is "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." 15 U.S.C. ' 78u-5(c)(1)(A)(i). Second, even if the forward-looking statement is not accompanied by cautionary language, the plaintiff must prove that each defendant in the case made the statement with "actual knowledge" that the statement was "false or misleading." Id. ' 78u-5(c)(1)(B)(i).
The IVAX case arose out of a press release issued on August 2, 1996 by IVAX Corporation, a manufacturer of generic drugs. This press release, "while acknowledging business problems, also showed some optimism." On September 30, 1996, IVAX issued another press release, this one announcing that the corporation anticipated a $43 million loss for the third quarter, which ended that day. On November 11, 1996, IVAX issued a third press release. This press release announced a $179 million loss for the third quarter, $104 million of which was a reduction in the carrying value of the goodwill ascribed to certain of IVAX's businesses. Neither of the earlier press releases had mentioned the possibility of this goodwill writedown based on third quarter results.
IVAX shareholders commenced a class action on behalf of all purchasers of IVAX stock between August 2, 1996 and November 11, 1996 against IVAX, its chairman and chief executive officer, and its chief financial officer. Violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder were asserted based upon two theories: (1) IVAX's projections allegedly were fraudulent, and (2) IVAX's disclosure of factors affecting its projections misleadingly omitted the possibility of a goodwill writedown. The United States District Court for the Southern District of Florida dismissed the case pursuant to the 1995 Act's safe harbor for forward-looking statements, and the Eleventh Circuit affirmed.
The Eleventh Circuit's decision focused upon the first prong of the safe harbor, asking the two questions required under that prong by the statute: (1) were the challenged statements forward-looking statements?, and (2) were the challenged statements "accompanied by meaningful cautionary statements"? The court held that "[a]ll of the statements that the plaintiffs claim to be false or misleading are forward-looking" and were accompanied by "meaningful cautionary language." The Eleventh Circuit therefore did not reach the second prong of the safe harbor or "enter the thicket of the PSLRA's new pleading requirements for scienter." The court emphasized that if a forward-looking statement "is accompanied by 'meaningful cautionary language,' the defendants' state of mind is irrelevant."
Were the Challenged Statements Forward-Looking Statements?
The court examined each of the statements alleged to be false or misleading in the August 2 and September 30 press releases to determine whether the statements were forward-looking statements. The court looked at each statement in light of the following definition of "forward-looking statement" in the statute:
(A) a statement containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items;
(B) a statement of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer;
(C) a statement of future economic performance, including any such statement contained in a discussion and analysis of financial condition by the management or in the results of operations included pursuant to the rules and regulations of the Commission;
(D) any statement of the assumptions underlying or relating to any statement described in subparagraph (A), (B), or (C);
(E) any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a forward-looking statement made by the issuer; or
(F) a statement containing a projection or estimate of such other items as may be specified by rule or regulation of the Commission.
15 U.S.C. ' 78u-5(i)(1).
The first sentence plaintiffs challenged appeared in the August 2, 1996 press release and stated that "[r]eorders are expected to improve as customer inventories are depleted." The court explained that this statement preceded "a general outlook for the third quarter" and fell "squarely in the middle" of section (D) of the statutory definition of a forward-looking statement: "it is 'a statement of the assumptions underlying' 'a statement of future economic performance.'" The court stated that "[t]he arrangement of the text makes clear that an expected increase in reorders was one of the bases of the optimism" stated in the press release.
The second sentence plaintiffs challenged in the August 2, 1996 press release quoted a statement by IVAX's chairman and chief executive officer stating that "the challenges unique to this period in our history are now behind us." The court explained that this statement followed two paragraphs that described two problems that contributed to a loss in the second quarter: excessive customer inventories that reduced new orders, and a technical default in a revolving credit facility. The press release stated that both of these problems were being resolved: inventories were becoming depleted, and a bank syndicate was expected to waive the default.
The court held that the statement that "the challenges unique to this period are now behind us" was "a statement of future economic performance" and included by Section (C) of the statutory definition of forward-looking statement. According to the court, the "hopeful conclusion that conditions are better because of two anticipated improvements in business conditions is a prediction of economic performance, however couched." The court rejected plaintiffs' "purely grammatical argument . . . that a present tense statement cannot predict the future." The court reasoned that "[w]hether the worst of IVAX's challenges were behind it was a matter verifiable only after the chairman so declared," and "a statement about the state of a company whose truth or falsity is discernible only after it is made necessarily refers only to future performance."
The third sentence plaintiffs challenged in the August 2, 1996 press release was the following additional hopeful outlook by IVAX's chairman and chief executive officer: "Our fundamental business and its underlying strategies remain intact . . . . Only a limited number of companies are positioned to meaningfully participate in this rapidly growing market and, among them, IVAX is certainly very well positioned."
The court held that "[l]ike the previous statement, this one is a prediction 'of future economic performance'" and thus included in Section (C) of the statutory definition of forward-looking statement. The court acknowledged that "the state of IVAX's 'fundamental business' and 'underlying strategies' is a question of present condition," but reasoned that "whether they are intact is a fact only verifiable by seeing how they hold up in the future." Likewise, the court continued, "whether IVAX is 'well positioned'" is a forward-looking statement because its "truth can only be known after seeing how IVAX's future plays out."
Plaintiffs also challenged the following list of factors in the September 30, 1996 press release "relating to [IVAX's] generic drug business [that] will influence [IVAX's] third quarter results": "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." Plaintiffs alleged that this list of factors was false as a whole because it omitted any expectation of a goodwill writedown.
The court described this list of factors as a "mixed bag, with some sentences that are forward-looking and some that are not." The court explained that three of the factors already had been observed: "'customer re-orders remain depressed'; 'prices have continued to decline'; and 'a wholesaler customer who owed us approximately $16 million filed a Chapter 11 bankruptcy petition.'" The court stated that "[o]bserved facts of this kind are not 'assumptions,' and they are not any kind of prediction, either, that would put them within the definition of a forward-looking statement." Two other factors, the court continued, however, were "worded as assumptions about future events: 'we expect reserves for returns and inventory writeoffs to be well above typical quarters' and 'lower prices . . . will increase shelf stock adjustments.'" The court stated that "[a]s 'assumptions underlying' the predictions elsewhere in the press release" these sentences were forward-looking statements within Section (D) of the statutory definition.
The court then focused upon "the question whether the safe harbor benefits the entire statement or only parts of it" where it is the list as a whole that allegedly misled plaintiffs concerning IVAX's projections. The court acknowledged that "[o]f course, if any of the individual sentences describing known facts (such as the customer's bankruptcy) were allegedly false, we could easily conclude that the smaller, non-forward-looking statement falls outside the safe harbor." Here, however, where the allegation is that "the list as a whole misleads anyone reading it," "it makes no sense to slice the list into separate sentences." Rather, "the list becomes a 'statement' in the statutory sense, and a basis of liability, as a unit" that is "either forward-looking or not forward-looking in its entirety."
The court stated that "extrinsic sources of congressional intent" also "point strongly toward treating the entire list as forward-looking." The court explained that "Congress enacted the safe-harbor provision in order to loosen the 'muzzling effect' of potential liability for forward-looking statements, which often kept investors in the dark about what management foresaw for the company" (citing H.R. Conf. Rep. 104-369, at 42 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 741). The court also pointed to the fact that forward-looking statements "often rest both on historical observations and assumptions about future events" and "[t]hus, were we to banish from the safe harbor lists that contain both factual and forward-looking factors, we would inhibit corporate officers from fully explaining their outlooks." As a result, "liability-conscious officers would be relegated to citing only the factors that could individually be called forward-looking" and in the process "hamper the communication that Congress sought to foster."
The court recognized that "[t]reating mixed lists as forward-looking may open a loophole for misleading omissions" but concluded that "two circumstances . . . should put investors on guard, anyway." First, "a list or explanation will only qualify for this treatment if it contains assumptions underlying a forward-looking statement." The court stated that "[i]nvestors should know, under the current statutory scheme, that relying on assumptions is dangerous" because "there will often be no legal recourse even if the assumption is false." Second, "a defendant can fully benefit from the safe harbor's shelter only when it has disclosed risk factors in a warning accompanying the forward-looking statement." The court stated that this disclosure "should warn investors against blind reliance on mixed lists."
For all of these reasons, the court held that "when the factors underlying a projection or economic forecast include both assumptions and statements of known fact, and a plaintiff alleges that a material factor is missing, the entire list is treated as a forward-looking statement."
Were the Challenged Statements Accompanied by Meaningful Cautionary Language?
The court held that italicized warnings that IVAX included at the end of its August 2, 1996 and September 30, 1996 press releases - these statements are reproduced in the box accompanying this article - were "detailed and informative" and told the reader "in detail what kind of misfortunes could befall the company and what the effect could be." The court rejected "out of hand" the plaintiffs' contention that the cautionary statements were "mere boilerplate."
The court also held that the lack of any reference in the cautionary statements to the possibility of a large goodwill writedown was not dispositive. To be meaningful, the court held, cautionary language is not required to "explicitly mention the factor that ultimately belies a forward-looking statement."
The court reasoned that "[t]he statute requires the warning only to mention 'important factors that could cause actual results to differ materially from those in the forward-looking statement" (quoting 15 U.S.C ' 78u-5(c)(1)(A)(i)). The statute, the court continued, "does not require a listing of all factors." The court also relied upon legislative history stating 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" (quoting H.R. Conf. Rep. 104-369, at 44 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 743).
In sum, the court concluded, "when an investor has been warned of risks of a significance similar to that actually realized," the investor "is sufficiently on notice of the danger of the investment to make a intelligent decision about it" according to the investor's "own preferences for risk and reward." The cautionary language in IVAX's August 2, 1996 and September 30, 1996 press releases, the court held, accordingly "satisfies IVAX's burden to warn under the statute" and "excuses IVAX from liability."
The Eleventh Circuit's decision was written by Circuit Judge Emmett R. Cox and was joined by Circuit Judge Frank Mays Hull and District Judge Maurice B. Cohill of the United States District Court for the Western District of Pennsylvania, sitting by designation.