Published in the October 1999 issue of the Public Company Advocate. Broadening the Protections for Forward-Looking Statements by C. William Phillips and Kevin A. Fisher The ground-breaking Private Securities Litigation Reform Act ( PSLRA ), enacted over presidential veto in 1995, continues to wind its way through the courts. Since March of this year, there have been no fewer than six pronouncements by federal appellate courts on the standards for intent under the PSLRA, including the hot topic of whether the PSLRA altered recklessness liability under the federal securities laws. Phillips v. LCI Int l Inc., 1999 U.S. App. LEXIS 22347 (4th Cir., Sept. 15, 1999); Bryant v. Avado Brands, Inc., 1999 U.S. App. LEXIS 21051 (11th Cir., Sept. 3, 1999); In re Comshare, Inc. Sec. Litig., 183 F.3d 542 (6th Cir. 1999); In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999); In re Advanta Corp. Sec. Litig., 180 F.3d 970 (3d Cir. 1999); Press v. Chemical Inv. Serv. Corp., 166 F.3d 529 (2d Cir. 1999). While these often conflicting circuit courts seem destined for Supreme Court review, a recent Eleventh Circuit Court of Appeals case, Harris v. Ivax Corporation, 182 F.3d 799 (11th Cir. 1999), which interprets the scope of the forward-looking statement provisions that the PSLRA made part of both the 1933 and 1934 acts, may prove to be more significant than any future clarification of the standards for intent under the PSLRA. Apart from In re Advanta Corp. Sec. Litig., 180 F.3d 970 (3d Cir. 1999), which deals with discrete issue of scienter pleading requirements for forward-looking statements without cautionary language, Harris is the first Circuit Court opinion to deal with the application of the safe harbor for forward-looking statements. The Harris case establishes an important framework for companies seeking to utilize the safe harbor for forward-looking statements, and for that reason may aid companies in avoiding, not just dismissing, litigation. What is a Forward-Looking Statement? The PSLRA established a safe harbor for certain forward-looking statements. PSLRA eliminated liability for any untrue statement of material fact or omission of a material fact based on any forward-looking statement,
- 2 - which is 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. Section 27A(c) of the Securities Act; Section 21E(c) of the Securities Exchange Act. A forward-looking statement is defined under the PSLRA to be : (A) (B) (C) (D) (E) (F) 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; 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; 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; any statement of the assumptions underlying or relating to any statement described in subparagraph (A), (B), or (C); 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 a statement containing a projection or estimate of such items as may be specified by rule or regulation of the Commission. Taking this definition, and the intention of Congress to encourage companies to provide investors with predictions, the Eleventh Circuit in Harris v. Ivax Corporation, 182 F.3d 799 (11th Cir. 1999), held that the safe harbor applies to any statement about a company whose truth or falsity is discernible only after it is made. As a result, Harris sweeps a variety of statements within the protective wing of the PSLRA safe harbor provisions. The Harris case involved the aftermath of yet another post disclosure stock plunge in a volatile industry, this time the manufacturing of generic drugs. The company, Ivax Corporation, after a profitable 1995, suffered a lost in its 1996 second quarter. When an August 1996 company release acknowledged problems,
- 3 - but exhibited optimism, the share price rose. The company reported a $43 million loss at the end of its third quarter, and announced another $179 million dollar loss in November of 1996, including a $104 million reduction in the carrying value of goodwill. The stock plummeted. The Harris plaintiffs alleged that the loss associated with the write-down of goodwill should have been disclosed earlier. In particular, the plaintiffs focused on seven statements taken from the company s August and September 1996 press releases which they claimed were false or misleading and not forward-looking statements, and therefore not protected by the PSLRA safe harbor. These statements included descriptions of past problems at the company accompanied by the statement from Ivax s chairman that the challenges unique to this period in our history are now behind us. Plaintiffs challenged the last statement as misleading in light of the expected write-off of good will. The Court of Appeals found that the statement was a hopeful conclusion that conditions are better because of two anticipated improvements in business conditions and therefore constituted a prediction of economic performance, however couched. The Court rejected that plaintiff s grammatical argument that a statement in the present tense cannot predict the future, because whether the company s problems were indeed behind it was a matter verifiable only after the chairman so declared. Mixed Statements of Historical and Future Events The Court also addressed whether statements that contain both historical and forward-looking statements fall within the safe harbor for forward-looking statements. In a September 1996 press release, Ivax had set forth a list of five factors that would influence its third-quarter results. Some of these factors for example, that prices have continued to decline are neither assumptions nor forward-looking, but are statements of conditions already observed. Other statements in the list for example, lower prices... will increase shelf stock adjustments contain assumptions that are by their nature forward-looking. In its analysis of how to treat mixed statements, the Court of Appeals broadened the scope of forward-looking statements to include conclusions based upon both historical observations and assumptions about future events. Because the plaintiffs had alleged that the list as a whole was misleading by omitting information about the expected write-down of goodwill, the Court rejected plaintiffs attempt to examine each sentence on the list separately. If the
- 4 - allegation is that the whole list is misleading... the list becomes a statement in the statutory sense, and a basis of liability, as a unit. It must therefore be either forward-looking or not forward-looking in its entirety. The Court thus refused to banish from the safe harbor lists that contain both factual and forward-looking factors. This holding was necessary to achieve Congress intent to loosen the muzzling effect of potential liability for forwardlooking statements, which often kept investors in the dark about what management foresaw for the company. Any other conclusion would inhibit corporate officers from fully explaining their outlooks and hamper the communication that Congress sought to foster. The Scope of Cautionary Language The Court of Appeals also broadened the parameters of the safe harbor in its examination of the scope of protection afforded by cautionary language. The Harris plaintiffs had argued Ivax s cautionary language was mere boilerplate. In addition, the plaintiffs argued that since Ivax s statements had not specifically mentioned the possibility of the good will write off, its cautionary language could not insulate the company from liability for failure to inform investors about the impact of the write-off. The Court of Appeals rejected these arguments, noting the company s language was detailed and informative of the kind of misfortunes the company could face and their possible effects. The Court further held that the statute does not require a listing of all factors that may affect a company s performance. Indeed, the conference report accompanying the passage of the PSLRA specified that a failure to include a particular factor does not remove the safe harbor protections. The test is whether the investor has been warned of risks of a significance similar to that actually realized [such that] she is sufficiently on notice of the danger of the investment to make an intelligent decision about it according to her own preferences for risk and reward. Ivax s statement met this burden. Forward-looking Statements After Harris Harris greatest significance may be that it elevates the forward-looking statement safe harbor to a more viable defense. The defense is distinct from the more stringent bespeaks caution defense and the maligned corporate puffery defense. Both of these defenses effectively require a showing that an investor
- 5 - could not have relied upon the statements at issue, either because of strong specific cautionary language (the bespeaks caution defense) or the vagueness of the statement ( corporate puffery ). Under Harris, the investor s reliance is not an important factor. Instead, the Court of Appeals assumed that the inherent instability of predictive statements, together with generally relevant cautionary language, serve to warn the reasonable investor. The significance of the Harris decision has yet to be felt. A company facing a securities law action based upon statements that are predictive in nature, or referring to assumptions that could affect the future performance of the company, may be able to defeat claims based upon the safe harbor alone. By this defense defendant companies may be able to sidestep the thicket of PSLRA scienter pleading requirements altogether: as the Court of Appeals noted in Harris, where forward-looking statements include meaningful cautionary language, the defendant s state of mind is irrelevant. The Harris case leads the way among the Circuit Courts, but it remains to be seen whether its reasoning will become law of the land by being adopted by the Supreme Court. It is, nevertheless, at present a solitary and persuasive authority in an area of vital importance to reporting companies. 1999 C. William Phillips and Kevin A. Fisher. All rights reserved.