Private Securities Litigation Reform Act of 1995: safe harbor for the innocent or modern day Port of Tortuga for the buccaneers of Wall Street?

• Author: Lasker, Cory A.

1. Introduction II. Background A. Development of the Private Securities Litigation Reform Act of 1995 (PSLRA) B. Forward-Looking Statements and the Safe Harbor 1. Basis for the Safe Harbor i. The "Bespeaks Caution " Doctrine ii. SEC Rule 175 2. Functionality of the Safe Harbor 3. Inconsistencies in the Application of the PSLRA's Safe Harbor Have Not Led to the Desired Result III. ANALYSIS A. Confusion Has Led to Varying Interpretations B. Knowledge Does Not Render Cautionary Language Meaningless C. Cautionary Language Is Not Meaningful If Defendant Is Aware That the Forward-Looking Statement Is Misleading 1. Meaningfulness Defined from the Defendant's Point of View 2. Meaningful Cautionary Language Does Not Necessarily Render Forward-Looking Statements Immaterial 3. Knowledge Can Indicate that Some Statements Are Not Actually Forward-Looking IV. Recommendation A. Policy Objectives Are Accomplished by Finding Intentionally Misleading Projections to Not Be Forward-Looking B. The Statutory Objectives of the Safe Harbor Are Secondary to Those of Rule 10b-5 C. Finding Intentionally Misleading Projections to Not Be Forward-Looking Does Not Ignore Legislative History and Statutory Construction V. Conclusion I. INTRODUCTION

   For much of the 1600s the Port of Tortuga was an infamous pirate safe harbor. (1) At the time, French and English colonial rule divided the Island of Tortuga, which consequently allowed pirates to use it as base port. (2) The popular Walt Disney film Pirates of the Caribbean: The Curse of the Black Pearl once again brought the island notoriety. (3) Like the notorious Port of Tortuga, pockets of unartfully drafted regulation exist where the buccaneers of Wall Street find refuge. (4)

   Undoubtedly, securities play a key role in American life. (5) They represent financial rights and the power to control entities that comprise a large segment of our economy. (6) They also represent the financial hopes of business enterprises and millions of Americans. (7) However, the term "security" should not be taken literally. Securities have no distinct intrinsic value; their value rests in the business prospects they represent. (8)

   Securities' inherent uncertainty has led to instances where unscrupulous individuals deceive unsuspecting investors for profit. (9) To combat this practice, Congress has enacted legislation prohibiting deliberately misleading financial information, (10) and the Supreme Court has created a civil remedy for losses resulting from such deceit. (11) While federal securities laws and regulations have protected investors from fraud, they also have created an environment discouraging companies from disclosing all information relevant to investment decisions. (12) Although investors may benefit when management discloses its projections, the fear that liability will result if the projections prove to be false has chilled predictive disclosures. (13) While this information's value is disputable, a system that results in withholding pertinent information from investors can be harmful. (14)

   In an effort to prevent fraud while encouraging more expansive disclosure practices, Congress enacted the Private Securities Litigation Reform Act of 1995 (PSLRA). (15) While Congress intended the PSLRA to limit securities litigation, its vagueness has proven problematic. This Note addresses one PSLRA provision that courts have inconsistently applied: the safe harbor for forward-looking statements. (16)

   Part II begins by explaining the safe harbor's development and its varying interpretations. It discusses the legislative and historical context in which the Act developed. Additionally, it examines the different existing legal frameworks that Congress used in creating the safe harbor. Finally, it addresses the safe harbor's functionality by explaining how and when courts may apply it.

   Part III examines the inconsistent interpretations of the safe harbor. First, it discusses the circumstances from which the inconsistencies arise. Next, it analyzes the traditional approach to the safe harbor's cautionary language prong. It also analyzes alternative approaches to the safe harbor. Finally, it examines supporting legislative history, statutory construction, and policy considerations.

   Part IV recommends an interpretation of the PSLRA's safe harbor that is consistent with policy concerns, the 1933 and 1934 Securities Acts' objectives, and the statutory framework and legislative history. ultimately, the desired approach must encourage both market integrity as well as market efficiency.

2. BACKGROUND

   1. Development of the Private Securities Litigation Reform Act of 1995 (PSLRA)

      In the aftermath of the 1929 stock market crash, Congress enacted the Securities Act of 1933 (17) and the Securities Exchange Act of 1934. (18) Congress intended these acts to protect investors from fraud by imposing various reporting requirements on publicly held companies. (19) While neither act explicitly created a civil remedy for violations or fraudulent acts, the Supreme Court allowed investors a private cause of action. (20)

      In the securities fraud litigation realm, section 10(b) (21) of the 1934 Act and Rule 10b-5 (22) are two of the most significant anti-fraud provisions. (23) They prohibit companies from making "untrue statement[s] of material fact" or "omit[ing] material fact[s]" that would "make the statements made ... not misleading." (24) Although Rule 10b-5 and the other provisions arising from the two Acts offer greater assurances against fraud, (25) some have argued that they created an environment in which plaintiffs file frivolous claims, not because of losses they have suffered, but because of a settlement's potential monetary value. (26)

      The majority of these claims arise from relatively simple circumstances. Typically a company makes an announcement disclosing negative information that results in a sudden decline in the company's stock price. (27) Shortly thereafter, plaintiffs file claims asserting that optimistic statements the company made earlier constituted fraud. (28) Due to extortionate litigation costs, "potentially crippling liability," (29) and potential reputational harm, (30) most defendants settle regardless of the claims' merits. (31) Often the settlement value of these claims does not necessarily correspond to the damages plaintiffs suffered, but rather, corresponds more directly the to defendants' insurance coverage. (32)

      While the fear of litigation encourages companies to improve the accuracy and objectivity of the information they communicate to the public, this system harms current shareholders to the benefit of former ones. (33) Ultimately current shareholders bear the costs of these strike suits. (34) The costs of abuse are not limited to the monetary value of companies defending or settling frivolous claims; 10b-5 abuses may also deter them from providing investors with beneficial information, such as predictive disclosures. (35) This reluctance to disclose relevant information inhibits investors from making informed investment decisions because pertinent information is not available. (36)

      Reacting to these concerns, Congress enacted the PSLRA. (37) The PSLRA's primary objective was to limit "abuses in private securities litigation." (38) Congress sought to remedy these abuse problems by imposing various procedural and pleading requirements on federal securities claims. (39)

   2. Forward-Looking Statements and the Safe Harbor

      Within the PSLRA is a controversial provision40 creating a safe harbor for forward-looking statements. (41) This safe harbor is designed to encourage corporations to disclose their prospects. (42) Congress included the safe harbor because of the value it found in a company's "assessment of its future potential." (43) Congress found that companies were reluctant to disclose forward-looking information due to the litigation risks stemming from inaccurate projections. (44)

      1. Basis for the Safe Harbor

         Congress based its safe harbor provision "on two existing legal approaches" to securities fraud litigation.45 First, Congress used the "bespeaks caution" doctrine--a judicially created principle--as a basis for its safe harbor. (46) Congress also used the SEC's Rule 175 to guide its formation of the PSLRA's safe harbor. (47)

         i. The "Bespeaks Caution" Doctrine

         First, Congress based the safe harbor on the existing "bespeaks caution" doctrine, which renders a forward-looking statement immaterial if meaningful cautionary statements accompany it. (48) While courts have differed on the requirements for rendering predictive statements immaterial, (49) they agree on the legal significance of immateriality (50)--immaterial forward-looking statements are not actionable at law. (51)

         Pre-PSLRA, some federal circuits used the "bespeaks caution" doctrine to allow Rule 12(b)(6) motions. (52) They found that accompanying cautionary language negated a forward-looking statement's materiality to the point that it was not actionable at law. (53) one commentator articulated two approaches courts used to arrive at this conclusion. (54) First, some courts reasoned that cautionary language deteriorated the potency of projections to the point that reasonable investors would not rely on them as definitive. (55) other courts chose to ignore whether the forward-looking statements were actually optimistic and suggested that cautionary language prevents plaintiffs from relying on projections, regardless of the optimism they convey. (56) Regardless of the applied approach, courts uniformly determined materiality by focusing on how a reasonable investor would react to the projections. (57)

         Additionally, courts do not consider ambiguous "boilerplate"58 disclaimers to be meaningful. (59) To meet the requirements of the "bespeaks caution" doctrine, disclaimers need to be "substantive and tailored to the specific future projections, estimates or opinions." (60) This doctrine applies not only to documents filed with...