The Substantive Limits of Liability for Inaccurate Predictions

• Published date: 01 March 2007
• DOI: http://doi.org/10.1111/j.1744-1714.2007.00033.x
• Date: 01 March 2007
• Author: Hugh C. Beck

The Substantive Limits of Liability for

Inaccurate Predictions

Hugh C. Beck

1

I. INTRODUCTION

Courts have always had to negotiate a slippery uphill course to evaluate

liability for inaccurate business forecasts, but during the past fifteen years,

judges have found it particularly difficult to get their footing on this slope.

In 1995 the Private Securities Litigation Reform Act

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established the

landscape’s only statutory guidepost in the form of a forward-looking

statement safe harbor. The safe harbor protects an issuer from liability for

an inaccurate ‘‘forward-looking statement’’

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if the statement was ‘‘accom-

panied by meaningful cautionary statements identifying important factors

r2007, Hugh C. Beck

Journal compilation r2007, Academy of Legal Studies in Business

161

American Business Law Journal

Volume 44, Issue 1, 161–205, Spring 2007

1

Staff Attorney, Division of Enforcement, U.S. Securities and Exchange Commission (‘‘SEC’’

or ‘‘Commission’’). The SEC disclaims responsibility for any private publication of statements

of any of its employees. The views expressed herein are those of the author and do not

necessarily reflect the views of the Commission.

2

Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified

as amended in scattered sections and subsections of 15 U.S.C. §§ 77–78) [hereinafter PSLRA

or Reform Act].

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The PSLRA defines ‘‘forward-looking statement’’ as: ‘‘(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 projectionor estimate of

such other items as may be specified by rule or regulation of the Commission.’’ 15 U.S.C. §§

77z-2(i) (2000).

that could cause actual results to differ materially from those [predicted].’’

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Commentators recognized the ambiguities in this statutory language when

the act was passed, but most predicted the courts would quickly resolve any

uncertainty over the provision’s meaning by holding that it codified the

‘‘bespeaks caution doctrine,’’ a judicial doctrine under which properly

crafted cautionary statements render an incorrect prediction nonaction-

able.

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Ten years of case law interpreting the PSLRA safe harbor, however,

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15 U.S.C. § 78u-5(c)(1)(A)(i) (2000). The safe harbor also protects an issuer from liability for

an ‘‘immaterial’’ forward-looking statement or if the speaker who made the forward-looking

statement did not have ‘‘actual knowledge’’ that the statement was false or misleading. Id. The

safe harbor provisions are codified at 15 U.S.C. § 77z-2 (Section 27A of the Securities Act of

1933 [hereinafter Securities Act]) and 15 U.S.C. § 78u-5 (Section 21E of the Securities

Exchange Act of 1934 [hereinafter Exchange Act]). Recent commentary regarding the PSLRA

safe harbor has focused on the stage of litigation at which courts ought to apply the safe harbor

provisions rather than on the substantive limits of liability for inaccurate forward-looking

statements. This controversy over judicial timing was sparked by the Seventh Circuit’s

decision in Asher v. Baxter Int’l, Inc., 377 F.3d 727 (7th Cir. 2004), to reverse the dismissal of

a complaint alleging fraudulent projections after finding that the availability of the safe harbor

could not be determined without discovery.See, e.g., Joseph De Simone et al., Asher to Asher and

Dust to Dust: The Demise of the PSLRA Safe Harbor?, 1 N.Y.U. J.L. & BUS.799, 799 (2005); Joseph

De Simone et al., High Court Should Review Ruling on Securities Fraud ‘‘Safe Harbor’’,WASH.

LEGAL FOUND., Dec. 3, 2004, www.wlf.org/upload/120304LOLDeSimone.pdf; Sarah S. Gold

et al., The Not-So-Safe Harbor, N.Y.L.J., Oct. 13, 2004, at 3; Allan Horwich, Is There a Breach in the

Breakwater of the Statutory Safe Harbor for Forward-Looking Statements?,W

ALL ST.LAWYER, Sept.

2004, http://www.realcorporatelawyer.com/wsl/wsl0904.html; O’Melveny & Myers LLP, Seventh

Circuit Limits Applicability of PSLRA Safe Harbor for Forward-Looking Statements, Aug. 6, 2004,

http://www.omm.com/webdata/content/publications/client_alert_securities_2004_08_06.htm.

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See, e.g., SEC.REG.COMMITTEE OF THE ASS’NOFTHEBAR OF THE CITY OF N.Y., FORWARD-LOOKING

STATEMENTS AND CAUTIONARY LANGUAGE AFTER THE 1995 PRIVATE SECURITIES LITIGATION REFORM

ACT:ASTUDY OF CURRENT PRACTICES (1998), 1084 PLI/Corp 795, 802 (‘‘The former concern

[regarding the absence of judicial guidance as to what constitutes ‘meaningful’ cautionary

language] may well be overstated; the intent of the statute in this area was largely to codify the

‘bespeaks caution’ doctrine, which has been adopted in principle by every circuit to consider

it . . . .’’); Ann M. Olazabal, Safe Harbor ForForward-Looking Statements Under the Private Securities

Litigation Reform Act of 1995: What’s Safe and What’s Not?, 105 DICK.L.REV.1, 12 (2000) (‘‘[W]e

are not completely without guidance as to how protected forward-looking statements will be

treated by the courts. This is true because long before the Reform Act was enacted, there was

already an expansive body of judge-made law holding that plaintiffs could not base securities

fraud claims on forward-looking statements if such statements were accompanied by language

that ‘bespeaks caution’ as to reliance thereupon.’’); Richard A. Rosen, The Statutory Safe Harbor

for Forward-Looking Statements After Two and a Half Years:Has it Changed the Law? Has it Achieved

What Congress Intended?,76W

ASH. U. L.Q. 645, 653 (1998) (stating, ‘‘Although the statute does

not define ‘meaningful cautionary statements,’ an abundance of case law exists on this issue . . . . It

should be evident, then, that in interpreting and applying [the ‘‘meaningful cautionary state-

ments’’ provision of the safe harbor], the key feature of pre-Act case law relevant to understanding

162 Vol. 44 / American Business Law Journal

have failed to yield uniform standards for evaluating allegedly fraudulent

forward-looking statements.

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Indeed, it is often impossible to discern the

substantive criteria applied by courts in individual forward-looking in-

formation cases, let alone trends in the case law.

This article argues that two characteristics of the pre-PSLRA devel-

opment of regulatory and judicial approaches to forward-looking informa-

tion are primarily responsible for the current confusion in this area of the

law. The first is a sharp, but heretofore unacknowledged, doctrinal shift in

the early 1990s marked by In re Donald J. Trump Casino Securities Litigation,

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a 1993 bespeaks caution case in which the Third Circuit held that

accompanying statements appropriately tailored to a prediction render

the prediction immaterial.

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The second is the pre-1993 proliferation of

distinct vocabularies that refer to identical concepts of liability for inaccu-

rate predictions but fail to adequately elucidate the judicial inquiries

entailed by those concepts. The article further argues that the flexible

language of the PSLRA safe harbor offers the SEC or the Supreme Court

the opportunity to eliminate both of these sources of confusion by steering

the lower courts into a single, clearly articulated framework for assessing

liability for inaccurate forward-looking statements.

Part II lays the foundation for these arguments by demonstrating

that all pre-1993 regulatory and judicial approaches to forward-looking

information (including the pre-1993 bespeaks caution doctrine) can be

reduced to a single doctrinal framework whose primary inquiry is whether

the prediction in question would have misled a reasonable investor. Pre-

1993 inconsistencies in judicial decisions and regulatory policy reflect

evolving conceptions of the reasonable investor rather than departures

from this framework.

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Part III explains how the Third Circuit, in its 1993

and predicting how the safe harbor will be applied is the ‘bespeaks caution’ doctrine, which has

been adopted in principle by every circuit to consider it . . . .’’).

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The first cases implicating the safe harbor were filed in 1997 because the PSLRA’s provisions

did not apply retroactively. Private Securities Litigation Reform Act of 1995, Pub. L. No.

104-67, 108, 109 Stat. 737, 758.

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7 F.3d 357 (3d Cir. 1993).

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Id. at 357.

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Tobe sure, many of the opinions in pre-1993 forward-looking information cases leave much

to be desired in terms of rhetorical precision and suggest that the judges who wrote the

opinions may not have fully grasped the framework’s structure. Many of the pre-1993

‘‘bespeaks caution’’opinions are particularly susceptible to this criticism; these opinions clearly

2007 / The Substantive Limits of Liability for Inaccurate Predictions 163