It has been almost a year since a congressional override of a presidential veto breathed life into the safe harbor for forward-looking statements embodied in the Private Securities Litigation Reform Act of 1995. Prior to the act's passage, former Securities and Exchange Commission chairman Richard Breeden testified before the Senate Securities Subcommittee that "[u]nderstanding a company's own assessment of its future potential would be among the most valuable information shareholders and potential investors could have about a firm." Based on this belief, the safe harbor was designed to encourage public companies to provide investors with insight into their expectations regarding future performance -- historically the riskiest of all public disclosures -- without the fear of a securities class action suit should these expectations not materialize.
Unfortunately, the protections afforded under the safe harbor have not generally resulted in improved disclosure to the capital markets.
Concerns over how the courts will interpret certain provisions of both the safe harbor and the procedural reforms under the act, and therefore their efficacy in protecting companies from abusive securities fraud suits, have kept companies cautious about providing forward-looking information. More significantly, in response to the act and a less receptive federal judiciary, plaintiffs lawyers have recently resorted to filing securities suits in state court -- rendering the reforms under the act and the safe harbor provision essentially moot.
In addition, the mere prospect of the passage of California's Proposition 211, a plaintiff securities litigator's wish list, recently caused Intel Corp., previously a trendsetter in terms of forward-looking disclosures, to take the drastic step of canceling discussions with securities analysts over liability concerns. Notwithstanding the resounding defeat of Prop 211, securities class action suits are not going to disappear. Until the threat of abusive securities litigation in state court is addressed, the safe harbor is unlikely to achieve its primary goal of enhancing market efficiency by adequately protecting, and therefore encouraging, forward-looking disclosures.
While the safe harbor may not have yet achieved its full promise, it has had an impact on the practice of securities law, and early experiences from the small number of cases to date suggest that the act's reforms can be effective in defending securities suits filed in federal court.
WHERE'S THE HARBOR?
Registration statements and, increasingly, periodic reports now commonly include safe harbor language. Forward-looking disclosures found in these documents are usually prophylactic: warnings regarding potential risks, and compliance with the requirement to disclose certain known trends and uncertainties required in the Management's Discussion and Analysis of Financial Condition and Results of Operations sections of registration statements and annual and quarterly SEC reports.
However, even these formal securities lawyer-scrutinized public disclosures often include forward-looking statements that could later take center stage in a securities class action complaint. Statements regarding a pending product transition, the expected adequacy of available capital for a period of time, or expectations regarding gross margin trends, by their nature, carry a forward-looking connotation and therefore greater risk, but may still be necessary from a marketing and/or disclosure standpoint. In each of these situations, the safe harbor can be invoked by complying with the specific requirements of the act as follows: (i) the forward-looking statement is identified as such, and (ii) the statement is accompanied by meaningful cautionary language identifying important factors that could cause actual results to vary.
Under an alternative test, the safe harbor protects a forward-looking statement unless a plaintiff can prove that it was made with actual knowledge that the statement was misleading. The protections of the safe harbor are unavailable for, among others, forward-looking statements made in connection with initial public offering registration statements.
A likely area of focus in litigation involving the safe harbor will be whether cautionary language that accompanied an optimistic, forward-looking disclosure was "meaningful." The legislative history of the act cautions that boilerplate warnings will not suffice and that the cautionary statements must convey substantive information. However, the act does not require company officials to be prescient: The conference report accompanying the act provides that the factors disclosed need not necessarily include the very factor that ultimately caused results which differed from the forward-looking statement, as long as they satisfied the meaningful standard.
Because the question of whether risk factors were meaningful will be judged with the benefit of hindsight, risk factors tailored to the specific forward-looking disclosure in question are less likely to result in test cases under the act. Nevertheless, today many companies attempt to rely on the safe harbor by referencing an entire risk factor section, which discusses numerous risks, many of which may have no relationship to the forward-looking statement to be protected. The practice of citing very general and seldom-updated business risks seemingly relevant to almost every company is also a questionable strategy.
Securities lawyers and company officials charged with preparing cautionary language should not ignore board-of-director informational materials and reports among members of management as a source of identifying potential business risks -- they are unlikely to be ignored by the securities plaintiff bar. Risk factors described in these materials can be discoverable in litigation. Forward-looking public statements that exclude risks disclosed internally are more likely to be challenged, particularly if the undisclosed but apparently known risk actually ends up causing the stock drop preceding the plaintiff's suit. While beyond the scope of this article, the foregoing scenario also highlights the importance of educating those who prepare even informal corporate informational materials regarding the securities litigation environment.
Forward-looking disclosures in financial statements also present challenges for securities lawyers. Because the safe harbor is not available to protect forward-looking information in financial statements prepared in accordance with generally accepted accounting principles, such disclosures carry greater risk.
Coincidentally, recent accounting pronouncements, such as those in the American Institute of Certified Public Accountants Statement of Position 94-6 (Dec. 30, 1994), require greater forward-looking disclosures in financial statements. An estimate contained in the management's discussion-and-analysis section of a 10-K report, for example, could be protected using the safe harbor, while the same estimate made in the financial statement footnotes will be unprotected.
Similarly, a company's forward-looking disclosure as to the likely outcome and impact of pending litigation can be protected if disclosed outside of the financial statements, but not if it is in the financial statement footnotes -- where such disclosures are commonly found, and where no safe harbor protection is available.
Companies, their lawyers and accountants will all be better served by minimizing the risk of securities litigation, and therefore forward-looking disclosures in financial statements should be prepared conservatively. More optimistic forward-looking disclosures, such as estimates suggesting improvements in financial performance, are better placed outside the financial statements, where they can be protected by the safe harbor.
JUDGING BY THE ACCOMPANY YOU KEEP
For securities lawyers, one of the more important unresolved interpretive issues under the safe harbor is how to incorporate risk factor language so as to satisfy the "accompanied by" requirement. For example, when, if at all, is cross-referencing permissible, such as to an earlier cautionary disclosure in a "Risk Factor" section? While the answer to this question may be left to the courts, many practitioners believe that a clear cross-reference to another portion of the same document should prove sufficient accompaniment. From an investor's perspective, requiring risk factors to be repeated numerous times in a document each time a related forward-looking statement is made hardly seems to promote better disclosure. A cross-reference to another document, on the other hand, may not prove effective (absent SEC expansion of the safe harbor) because oral communications are specifically distinguished from the written kind in this regard.
The safe harbor is likely to accelerate the trend toward including cautionary language in public disclosures. In addition, whether or not the safe harbor applies, informing investors of potential risks tends to make a securities fraud case more difficult to prove, as evidenced by the adoption of the"bespeaks caution" doctrine (essentially, a judicially created safe harbor for forward-looking statements) in the Ninth Circuit U.S. Court of Appeals and most other federal circuit courts. Where once found exclusively in registration statements, today sections entitled "Risk Factors" (or sometimes "Trends and Uncertainties") are increasingly included in 10-K and 10-Q reports and annual reports to shareholders.
CASUAL DISCLOSURES
In the context of less formal public disclosures, such as information conveyed in press releases, on corporate World Wide Web sites and in discussions with securities analysts, disclosure practices among companies vary more widely, including the extent to which forward-looking statements are made, whether the safe harbor is relied on at all and, if so, the manner in which it is invoked.
In the case of oral communications, the safe harbor provides disclosers of information with more flexibility than is provided with respect to written information. Companies relying on the safe harbor for oral statements must still identify the statement as forward-looking, but may reference other "readily available" documents for the required disclosure of factors that could cause actual results to vary. This eliminates the need to take the awkward step of including lengthy oral risk factor recitations in every analyst conference call or offering road show.
Following the adoption of the Act, many company officials initially resisted utilizing the safe harbor for oral communications. However, securities lawyers and former securities class action defendants understand all too well that oral disclosures can be even riskier than written disclosures. Many company officials who would refrain from including optimistic predictions in SEC-filed documents (at least without substantial qualification) let their guard down in telephone conversations with analysts or at investor conferences.
Unfortunately, these unprotected, predictive statements are often repeated in analyst reports or in the press and, as a result, can easily find their way into securities class action complaints. Today, many well-counseled companies begin any oral public disclosures with the safe harbor language, which could take the following form: "This discussion may/will include forward-looking statements, and actual results could vary. For a discussion of factors that could cause actual results to vary from these forward-looking statements, see the following sections of the company's Annual Report on Form 10-K for fiscal year 1995 and its Quarterly Report on Form 10-Q for the quarter ended Sept. 30, 1996, on file with the Securities and Exchange Commission."
In addition to this preface, each forward-looking statement in the ensuing discussion should be specifically identified as such and, ideally, tied to the relevant factors cross-referenced earlier. According to the conference report, SEC-filed documents, annual reports and other widely disseminated materials, such as press releases, satisfy the "readily available" requirement. To the extent the referenced SEC-filed documents do not contain all of the relevant factors that could cause actual results to vary, or these factors are not current, they should be supplemented orally in the context of the forward-oriented statement.
Press releases, often the most fertile of hunting grounds for securities plaintiff lawyers, are perhaps also the most problematic disclosure area. Unlike oral disclosures, a company that wishes to rely on the safe harbor to protect, for example, a press release disclosure regarding the expected availability of a critical new product, must actually include risk factors with the release itself. The safe harbor does not permit written communications to reference other readily ascertainable documents containing the requisite cautionary language.
Although perfectly understandable to securities lawyers, sales and marketing personnel often do not seem to appreciate risk factors in their product announcements. The options then become the following: (i) retain the optimistic predictions in the release and eliminate the risk factors -- which is dangerous and therefore the least advisable alternative; (ii) eliminate, or significantly tone down, the predictive language, thereby reducing the exposure and therefore the need to include risk factors -- the safe approach; or (iii) retain the predictive disclosures and include the risk factors. Practices vary significantly in this area depending upon a variety of factors, including how risk-averse a company is from a disclosure viewpoint (companies whose officers and directors have experienced securities litigation firsthand are among the most risk-averse), a company's internal controls regarding press release review prior to dissemination, and even the type of disclosure involved.
To enhance the efficacy and responsiveness to real-world conditions of the safe harbor, the SEC, pursuant to its rule-making authority explicitly granted under the act, should expand the safe harbor to specifically authorize cross-referencing in a press release to cautionary factors contained in a readily available document, similar to the flexibility afforded oral communications.
Companies should carefully examine their policies and procedures regarding the issuance of press releases. Ideally, all press releases, whether issued by the finance department or the sales and marketing staff, should be screened by counsel or another individual knowledgeable about the potential hazards of public disclosures. The designated individual should be charged with identifying forward-looking disclosures that create litigation exposure and determining, with the advice of securities counsel, the best approach for taking advantage of the safe harbor.
A TANGLED WEB
The growth of the Internet as a corporate disclosure and general informational vehicle has created additional challenges to using the safe harbor effectively. Web sites, hardly a bastion of conservatism regarding disclosure of company prospects, present the same technical challenges as do press releases with respect to reliance on the safe harbor. In addition, the posting of information on corporate Web sites is often less controlled than press releases due to the frequent absence of clear corporate policies and procedures.
For example, many different individuals within a given organization may have responsibility for providing and updating Web site information. Some of these individuals may be inexperienced with the risks of overly optimistic public disclosures. Web sites have not escaped the attention of plaintiffs lawyers, and information posted on corporate sites has been cited prominently in securities class action complaints.
Web sites also present other unique issues in relying on the safe harbor. Unlike press releases, which are issued as of a particular date, Web site information is often not dated and is, plaintiffs might argue, republished constantly. As a result, information on Web sites potentially creates a greater affirmative duty to update than might be the case with press releases.
On the positive side, forward-looking information posted on corporate Web sites can be linked directly to risk factors in a filed SEC report or elsewhere providing an investor with immediate access to the required meaningful cautionary language.
In October 1995, prior to the passage of the act, the SEC issued guidelines regarding investor communications on the Internet. In these guidelines, the SEC concluded that information delivered in paper under the federal securities laws may be delivered in electronic format. Presumably, documents available on the Internet would satisfy the "readily available" requirement for relying on the safe harbor with respect to oral communications, although the SEC should clarify this point explicitly. It is also unclear whether a direct link from a forward-looking statement to relevant risk factors located elsewhere satisfies the "accompanied by" requirement of the safe harbor applicable to written communications. Because information linked on Web sites is immediately available, the SEC should clarify the safe harbor such that forward-looking statements on Web sites can be linked to the requisite risk factor language elsewhere on the Web.
On a related issue, to the extent a corporate Web site references or links to an analyst's report containing forward-looking information, a risk exists that these links will be deemed by a court to be sufficient "entanglements" with the analyst's report to constitute adoption by the company -- a dangerous position should such predictions not materialize. Further, such "entangled" statements may not have been specifically prepared to take advantage of the safe harbor.
To reduce the level of exposure for information posted on corporate Web sites, do the following: (i) establish clear corporate procedures and policies regarding the posting of information on Web sites, similar to those described above for press releases; (ii) ensure that the individual designated to screen Web site disclosures also understands the importance of ensuring information, whether forward-looking or not, is updated in light of the possibility of an ongoing duty to update; (iii) date Web pages containing forward-looking statements, and specifically disclaim any duty to update; (iv) employ the safe harbor wherever possible to protect forward-looking information made available on corporate Web sites; and (v) avoid furnishing or referencing analysts' reports on Web sites or otherwise (or, at a minimum, include appropriate disclaimers and invoke the safe harbor).
The federal safe harbor represents a large step forward in terms of deterring abusive securities suits, notwithstanding the interpretive issues that remain. However, the filing of securities suits in state court is likely to continue, and the potential exists for legislative, judicial or other offspring of Prop 211. These possibilities have undermined, at least temporarily, the effectiveness of the safe harbor in meeting the goal of encouraging forward-looking disclosure. To accomplish this goal, corresponding reforms targeted at the state level, or federal preemption, must occur. Whether or not this happens, companies should put mechanisms in place now to identify forward-looking statements in all forms of public disclosures, and to employ the federal safe harbor in appropriate circumstances.
The views expressed in this article are those of the writer, and do not necessarily represent the views of the firm.
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