Adecision this month by a federal court in Boston, and the U.S. Supreme Court’s recent refusal to hear an appeal of a case from Chicago, underscore the importance of drafting forward-looking statements to make sure they will be protected by the “safe harbor” provision in the Private Securities Litigation Reform Act of 1996.
Under the PSLRA, companies can avoid liability for inaccurate forward-looking statements as long as the statement is identified as forward-looking and is accompanied by “meaningful cautionary statements” warning investors about factors that could cause actual results to change.
In the case from the 1st Circuit in Boston, the court rejected a trial judge’s conclusion that a statement that dealt with a company’s present financial ability to deal with future needs could not form the basis of a securities fraud suit. Such a “mixed” statement had to be carefully scrutinized to determine if the alleged fraud dealt with the reference to present financial ability or to future needs. If the former, the safe harbor provision did not apply.
The case from the Chicago-based 7th Circuit interpreted whether cautionary language accompanying a forward-looking statement was “meaningful.” Although courts have generally dismissed securities fraud suits at an early stage of litigation under the safe harbor provision where cautionary statements were specific and detailed, the 7th Circuit said that it was impossible to determine whether the statements in question were meaningful without looking into all the major risks the company faced at the time the statements were made. The Supreme Court refused to hear the company’s appeal in June.
Best Practices
Douglas Clark, a lawyer with Wilson Sonsini Goodrich & Rosati, tells Compliance Week that companies can help ensure that the safe harbor provision will apply if they adhere to some best practices:
Identify with specificity the real risks that could cause results to differ materially.
Use the “magic words” in the statute that refer to “important factors that could cause actual results to differ materially from those in the forward-looking statement.”
Be particular when identifying the forward looking statement.
Include the safe harbor language immediately following the text of the release, before a description of the company and in a font that is at least as large as the text size of the release itself.
Clark
“The key here is avoiding boilerplate,” says Clark, who practices in Palo Alto, Calif. “That means no one-size-fits-all safe harbor statement on any release. Risks will always be different.”
Clark notes that many companies include the safe-harbor language in releases that don’t include forward-looking statements. “Where there are no forward-looking statements, there need be no safe harbor language," says Clark. Though he adds that there may be little harm in including safe harbor language when it isn’t needed, "over time it diminishes the effectiveness of your safe harbor program—it does reduce it to boilerplate.”
Forward-Looking Aspects
The plaintiffs in the 1st Circuit case filed a purported class action suit under the Securities Exchange Act of 1934 against Stone & Webster Inc., a construction, engineering and consulting firm. Also named as defendants were the company’s CEO, its CFO and its auditor. Because of Stone & Webster’s bankruptcy filing, the claims against the company were stayed, but the action proceeded against the executives and the auditor.
The plaintiffs alleged that S&W issued fraudulent financial statements and press releases that were designed to conceal a rapidly worsening financial condition. One of the main allegations was that S&W made public statements concealing and misrepresenting its shortage of liquid reserves and its impending bankruptcy.
A federal judge dismissed all the claims, finding that the complaint failed to satisfy the heightened pleading requirement imposed by the PSLRA. The judge also ruled that the claims were bared by the PSLRA’s “safe harbor” provision.
On appeal, the 1st Circuit first found that some of the statements relied upon by the plaintiffs could serve as the basis for claims of misleading statements relating to the company’s liquidity and financial condition.
“While the exact wording of these statements varied slightly, they effectively asserted that the company ‘has on hand and has access to sufficient sources of funds to meet its anticipated operating, dividend and capital expenditure needs,’” the court noted, disagreeing with the trial judge’s conclusion that the statement is protected by the safe harbor rule.
Because the statement in question included a reference to anticipated future needs for funds, the trial judge “found it to be ‘forward-looking,’ apparently concluding that the statement came within the protection granted for ‘a projection of . . . capital expenditures, dividends, . . . or other financial items.’ We think that the meaning of this curious statute, which grants (within limits) a license to defraud, must be somewhat more complex and restricted,” the 1st Circuit said.
In order to determine whether a statement falls within the safe harbor, a court “must examine which aspects of the statement are alleged to be false,” the 1st Circuit said. “The mere fact that a statement contains some reference to a projection of future events cannot sensibly bring the statement within the safe harbor if the allegation of falsehood relates to non-forward-looking aspects of the statement. The safe harbor, we believe, is intended to apply only to allegations of falsehood as to the forward-looking aspects of the statement.”
According to Clark of Wilson Sonsini, the 1st Circuit ruled correctly. “The court was correct to focus on the fact that part of the statement in question wasn’t forward-looking,” he says. According to Clark, the case “underscores the point that, if you want protection for a forward-looking statement, make it forward looking. Be clear when you’re going to make projections.”
Were Statements ‘Meaningful’?
The case from the 7th Circuit involved a suit filed by shareholders of Baxter International, a manufacturer of medical products. The claims arose out of the company’s 2002 release of projections that revenues would grow in the mid-teens compared to the prior year, that earnings-per-share would experience similar growth and that operational cash flow would be at least $500 million. The projections turned out to be overly optimistic, causing the share price of stock to drop by nearly 25 percent.
The plaintiffs claimed that Baxter’s projections were materially false because, among other things, one of its major divisions had apparently not met its internal budget in many years and the company had closed two plants that had been the principal source of low-cost dialysis products. But a judge dismissed the suit, finding that the statements underlying the claims were forward-looking ones protected by the safe-harbor provision.
On appeal, the 7th Circuit disagreed with the plaintiffs’ claim that Baxter’s cautionary statements were boilerplate but still concluded that the company’s statements may not have been sufficient to be meaningful. “For all we can tell, the major risks Baxter objectively faced when it made its forecasts were exactly those that, according to the complaint, came to pass, yet the cautionary statement mentioned none of them,” the court said.
Wilson Sonsini’s Clark tells Compliance Week that the court’s ruling in the Baxter case weakens the safe harbor protection and requires companies to be more cautious.
“[The decision] would deprive companies of the protection that Congress intended to grant them for making forward-looking statements,” he says, noting that the “in-depth examination of whether statements were ‘meaningful’ crosses the line into an examination of intent.”
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