INTRODUCTION AND BACKGROUND II. THE PSLRA STATUTORY SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS III. THE LEGISLATIVE HISTORY OF THE PSLRA SAFE HARBOR A. Criteria for Considering Legislative History B. The PSLRA Conference Report C. Legislative History of the PSLRA Prior to the Conference Report D. Legislative History of the PSLRA After the Conference Report E. The President's Veto and the Override F. Conclusion--The Reliance by Congress on Bespeaks Caution in Fashioning the First Prong of the Statutory Safe Harbor IV. JUDICIAL INTERPRETATIONS OF THE SAFE HARBOR A. Many Cases Treat the Second (Actual Knowledge) Prong as Irrelevant if the First Prong Is Satisfied B. Some Cases Treat the Second Prong as Pertinent Even if the First Prong Has Been, or May Be, Satisfied C. Some Cases Find that Actual Knowledge of the Falsity of the Forward-Looking Statement Precludes a Finding that Meaningful Cautionary Statements Were Made Within the Meaning of the First Prong of the Safe Harbor D. Summary of the Case Law V. THE VIEWS OF COMMENTATORS AND THE SEC A. Many Commentators Treat the Second (Actual Knowledge) Prong as Irrelevant if the First Prong Is Satisfied B. Some Commentators Urge That Actual Knowledge of the Falsity of the Forward-Looking Statement Be Taken into Account in Determining Whether the First Prong of the Safe Harbor Applies C. The SEC Urges that Application of the First Prong Take into Account Knowledge of Historical Facts Bearing on the Forward-Looking Statement VI. THE FIRST PRONG OF THE SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS PROVIDES A COMPLETE DEFENSE THAT CANNOT BE OVERRIDDEN BY ALLEGATIONS OF ACTUAL KNOWLEDGE OF THE FALSITY OF A PROJECTION VII. CONCLUSION Many public companies disclose earnings projections and make other statements about their future. Those companies are sometimes sued when the projection is not borne out. This Article addresses action by Congress to afford a safe harbor to public companies that make projections that are not accurate. Based on an analysis of the statute, its legislative history, judicial decisions, and commentary regarding the interaction of the multiple prongs of the safe harbor, this Article proposes a definitive resolution of the extent to which the prongs overlap--that the prongs are independent and, in particular, actual knowledge of the weaknesses in a projection, including lack of a good faith belief in the projection, is not relevant to reliance on the meaningful cautionary statement safe harbor.
Introduction And Background
The Securities and Exchange Commission (SEC) once frowned upon--indeed, "generally prohibited"--public company (1) disclosure of earnings projections. (2) The SEC relented, (3) and in some cases now mandates disclosure of information with a forward looking element. (4) Making projections sometimes comes with a cost, however, as investors may seek damages when the projection does not come true, claiming that they were misled into buying or selling a security in reliance on an incorrect projection. (5)
In a private damage action based on a violation of section 10(b) of the Exchange Act (6) and SEC Rule 10b-5, (7) the most common basis for a private damage claim under the federal securities laws, (8) there is liability for an incorrect projection only if the defendant stated the projection with scienter, an intent to deceive. (9) "Scienter" is generally understood to encompass reckless conduct, although the Supreme Court has not addressed that issue. (10) If a materially incorrect projection is made in an effective registration statement for a public offering of securities, however, the issuer could be liable under section 11 of the Securities Act of 1933 (11) irrespective of any culpability. (12) Directors and officers of the issuer can defend a section 11 claim by showing that after reasonable investigation the person had reasonable ground to believe that the projection was sound. (13)
In 1979 the SEC adopted two rules to provide safe harbors for certain forward-looking statements. (14) Under these rules, if certain criteria are satisfied the statements are deemed not "fraudulent" and thus not the subject of any claim for wrongful conduct. (15) These rules proved to have limited utility in providing a defense, most notably because a court is able to determine that the criteria for protection are satisfied only after inquiring into the facts, including the good faith of the person who made the statement. Adding these safe harbors to a public company's arsenal of defense tools thus did little to remove the litigation exposure for making an incorrect projection even in the utmost good faith. (16)
The "bespeaks caution" doctrine allows courts a means of winnowing non-meritorious incorrect projection claims under the federal securities laws. (17) Under one line of bespeaks caution cases, a forward-looking statement that is sufficiently qualified by cautionary statements is not "material." (18) Because materiality is an essential element of a claim of deception under the federal securities laws, this doctrine afforded a defense to claims based on an incorrect projection. (19) In appropriate cases the bespeaks caution doctrine is raised on a motion to dismiss the complaint for failure to state a claim upon which relief can be granted under Rule 12(b)(6) of the Federal Rules of Civil Procedure. (20) In applying the bespeaks caution doctrine, courts may take into account an indisputably authentic disclosure document extant at the time of the alleged incorrect projection, whether or not the plaintiff included the cautionary disclosures in its complaint. (21)
In 1995, Congress enacted extensive reforms to securities litigation in the Private Securities Litigation Reform Act (PSLRA). (22) Reflecting a judgment that neither the bespeaks caution doctrine nor the SEC rule-based safe harbors afforded adequate protection for public companies that made forward-looking statements, (23) in the PSLRA Congress added safe harbors for certain forward-looking statements to both the Securities Act (new section 27A) and the Exchange Act (new section 21E). (24) One aspect of these safe harbors is the focus of this Article.
The PSLRA Statutory Safe harbor for Forward-looking Statements
What follows is an overview of the PSLRA safe harbor for forward-looking statements sufficient to provide a framework to address one aspect of the safe harbor that remains unsettled after 14 years. This Article does not include a comprehensive discussion of all aspects of the safe harbor. (25) The PSLRA safe harbor applies to certain statements made by public companies and specified other persons, such as a person acting on behalf of the company. (26) The safe harbor does not apply to statements made by persons who are subject to specified disqualifications or to statements made in connection with certain transactions. (27) The safe harbor defines the term "forward-looking statement" with the result that the safe harbor does not apply to all statements by public companies that speak to the future, but it surely covers the preponderance of the significant ones.28 The provision that affords the safe harbors states as follows:
[I]n any private action arising under [the Exchange Act] that is based on an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading, a person referred to in subsection (a) of this section shall not be liable with respect to any forward-looking statement, whether written or oral, if and to the extent that--
(A) the forward-looking statement is--
(i) identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement; or
(ii) immaterial; or
(B) the plaintiff fails to prove that the forward-looking statement--
(i) if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; or
(ii) if made by a business entity, was--
(I) made by or with the approval of an executive officer of that entity; and
(II) made or approved by such officer with actual knowledge by that officer that the statement was false or misleading. (29)
Before turning to an exegesis of this statutory language, several other aspects of the safe harbor should be noted. on any motion to dismiss based on the safe harbor, "the court shall consider any statement cited in the complaint and any cautionary statement accompanying the forward-looking statement, which are not subject to material dispute, cited by the defendant." (30) In other words, the defendant can move to dismiss based on cautionary statements in, most commonly, some document filed by the company with the SEC even if those statements are not contained in the complaint or even adverted to by the plaintiff. (31) If the defendant moves for summary judgment based on the safe harbor, the court will stay any discovery not "specifically directed to the applicability" of the safe harbor. (32) The availability of the safe harbor does not in and of itself "impose upon any person a duty to update a forward-looking statement." (33)
Returning to the core provision, the gist of the safe harbor is that in any private action (34) a person covered by the safe harbor is not liable for an incorrect projection if (I) the projection was identified as forward-looking and was accompanied by "meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those" in the projection, (Ia) the projection was "immaterial," or (II) the plaintiff fails to prove that the projection was made with actual knowledge of its falsity or misleading character. (35) These few words raise myriad issues of interpretation.
For example, on a first reading the inclusion of alternative Ia may seem to be superfluous, inasmuch as an "immaterial"...
Cleaning the murky safe harbor for forward-looking statements: an inquiry into whether actual knowledge of falsity precludes the meaningful cautionary statement defense.
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