The United States District Court for the Middle District of Florida in Ehlert v. Singer, 1999 U.S. Dist. LEXIS 20879, 1999 WL 1427735 (M.D. Fla. Dec. 16, 1999), dismissed claims under Sections 11 and 12(a)(2) of the Securities Act of 1933 and Sections 10(b) of the Securities Exchange Act of 1934 pursuant to the safe harbor for forward looking statements adopted in the Private Securities Litigation Reform Act of 1995 (the "PSLRA") and codified at 15 U.S.C. ' 77z-2 and 15 U.S.C. ' 78u-5. The decision, written by Judge Elizabeth A. Kovachevich, demonstrates the availability of the safe harbor in the context of a motion to dismiss before discovery or a trial and the need for plaintiffs asserting claims under Section 11 and 12(a)(2) of the 1933 Act, which ordinarily do not require allegations of scienter or actual knowledge, to allege facts that, if true, would demonstrate actual knowledge where claims under Sections 11 and 12(a)(2) are premised upon forward-looking statements.
The case involved a challenge by purchasers of Medical Manager Corporation ("MMC") common stock in a public offering of 2.5 million shares pursuant to a registration statement and prospectus dated April 23, 1999. The court began its analysis by quoting "the exact language contained in the prospectus" that plaintiffs challenged.
Risk of Product-Related Claims
Certain of the company's products provide applications that relate to financial records, patient medical records and treatment plans. Any failure of the Company's products to provide accurate, confidential and timely information, including failures which may be traceable to the Year 2000 issue, could result in product liability or breach of contract claims against the Company by its clients, their patients or others. . . . There can be no assurance that the Company will not be subject to product liability or breach of contract claims . . . .
Year 2000 Compliance
The Year 2000 issue relates to whether computer systems will properly recognize and process information relating to dates in and after the year 2000. These systems could fail or produce erroneous results if they cannot adequately process dates beyond the year 1999 and are not corrected. Significant uncertainty exists in the software industry concerning the potential consequences that may result from failure of software to adequately address the Year 2000 issue . . . .
Proprietary (External) Software
The Year 2000 issue also creates risk for the Company from problems that may be experienced by customers of it software. While the Company believes that Version 9 of The Medical Manager practice management system, which was commercially released in November 1997, is Year 2000 complaint, prior versions of the system are not. The Company has encouraged users of pre-Version 9 versions of the Medical Manager software to upgrade to Version 9 in order to become Year 2000 compliant. If these or other customers experience significant difficulties as a result of the Year 2000 issue, or if the Company encounters difficulties in responding in a timely manner to customer requests to upgrade to Version 9, there could be a material adverse impact on the Company's results of operations, financial condition or business.
These statements were false or misleading, plaintiffs alleged, because the prospectus did not disclose MMC's intention to render its Version 8 medical manager practice management system product and related services obsolete through its sale of Version 9, and falsely stated that its Version 9 was Year 2000 complaint when in fact it had a Year 2000 software defect. Plaintiffs alleged that on August 5, 1998 MMC announced its decision to "curtail" support for Version 8 and that MMC's stock price dropped from $26.75 per share to $20.375 per share.
The court stated that the challenged statements in MMC's prospectus were forward-looking statements concerning future economic performance and described the two prongs of the safe harbor for forward looking statements codified by the PSLRA.
- First, "corporations and individual defendants may avoid liability 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'" (quoting Harris v. Ivax Corp., 182 F.3d 799, 803 (11th Cir. 1999), 15 U.S.C. ' 77z-2 (c)(1)(A)(i) and 15 U.S.C. 78u-5(c)(1)(A)(i).
- Second, "[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'" (quoting Ivax, 182 F.3d at 803 (11th Cir. 1999), 15 U.S.C. ' 77z-2(c)(1)(B)(i) and 15 U.S.C. 78u-5(c)(1)(B)(i)).
Protection from liability can be achieved by means of either prong of the safe harbor.
First Prong of Safe Harbor
The court did not quote the cautionary language in the prospectus but held that it was "abundantly clear that the prospectus informed investors of the potential misfortune that could befall MMC" and thus that this requirement for the safe harbor protection from liability was satisfied. The court noted that "[t]he statute only requires cautionary language to mention 'important factors that could cause actual results to differ materially from those in the forward-looking statement'" (quoting 15 U.S.C. ' 77z-2(c)(1)(A)(i) and 15 U.S.C. ' 78u-5(c)(1)(A)(i)) and "does not require the prospectus to list all factors that may influence a company's financial future." Judged in this light, the court concluded that the prospectus contained adequate cautionary language and that "a reasonable investor had enough information to evaluate the risks associated with investing in MMC."
The court labeled the fact that the prospectus contained both factual and forward-looking factors "irrelevant" because "[w]ere 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. Indeed, liability-conscious officers would be relegated to citing only . . . forward-looking [factors]." That would hamper the communication that Congress sought to foster." Ivax, 182 F.3d at 806-07.
Second Prong of Safe Harbor
In the alternative, the court held that even if the prospectus did not contain adequate cautionary language, the prospectus still was protected by the PSLRA safe harbor because plaintiffs "did not allege facts sufficient to support a finding that any of the named Defendants actually knew that the statements were false at the time the forward-looking statements were made." The court explained that the PSLRA's heightened pleading standard requires that plaintiffs "may not simply allege scienter with nothing more, but must 'state with particularity facts giving rise to a strong inference that the [D]efendant[s] acted with the required state of mind'" (quoting 15 U.S.C. ' 78u-4(b)(2)).
The court quoted plaintiffs' allegation in support of its claim that defendants acted with the required state of mind:
Each of Individual Defendants' and MMC's primary liability, scienter and controlling person liability, arises from the following facts:
- the Individual Defendants were high level executives and/or directors of the Company during the Class Period;
- the Individual Defendants, by virtue of their positions as directors and/or officers of MMC were privy to and participated in the preparation and/or approval of the Company's Prospectus; and
- the Individual Defendants were aware of the Company's dissemination of information to the investing public which they knew or recklessly disregarded was material, false and misleading, as well as the Company's omission of material facts necessary in order to make the statements concerning MMC and its business operations and prospects, in light of the circumstances under which they were made, not misleading.
This pleading failed, the court stated, because "[r]ather than stating with particularity facts indicating that Defendants acted with the required state of mind," plaintiffs "merely raise the possibility of such conduct." The court stated that "[w]hile pleading in the alternative is a generally accepted practice, Plaintiffs do not sufficiently state facts as required by the PSLRA."
The court acknowledged that claims under Sections 11 and 12(a)(2) of the Securities Act normally do not require that plaintiffs allege or prove scienter. The court held, however, that "[t]he PSLRA applies to all forward-looking statements" in a prospectus and "'applies to all private actions arising under the Securities Act based upon an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading'" (quoting In re Stratosphere Corp. Securities Litigation, 1 F. Supp. 2d 1096, 1109 (D. Nev. 1998)).