Public companies around the country labor under a misunderstanding: that the Private Securities Litigation Reform Act’s Safe Harbor protects them from liability for their guidance and projections if they simply follow the statute’s requirements. But the Safe Harbor is not so safe – because they think it goes too far, many judges go to great lengths to avoid the statute’s plain language. Companies and their securities litigation defense counsel can usually work around this judicial attitude and take advantage of the statute’s protections, however, with the right approach to preparing and defending the company’s disclosures.
The Safe Harbor was a key component of the 1995 reforms of securities class action litigation. Congress sought “to encourage issuers to disseminate relevant information to the market without fear of open-ended liability.” H. R. Rep. No. 104-369, at 32 (1995), as reprinted in 1995 U.S.C.C.A.N. 730, 731. The Safe Harbor, by its plain terms, is straightforward. A material forward-looking statement is not actionable if it either (1) 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 (2) is made without actual knowledge of its falsity. 15 U.S.C. § 77z-2(c)(1); 15 U.S.C. § 78u-5(c)(1).
Yet courts’ application of the Safe Harbor has been anything but straightforward. Indeed, courts have committed some really basic legal errors in their attempts to nullify the Safe Harbor. Foremost among them is the tendency to collapse the two prongs – thus essentially reading “or” to mean “and” – to hold that actual knowledge that the forward-looking statement is false means that the cautionary language can’t be meaningful. See, e.g., In re SeeBeyond Techs. Corp. Sec. Litig., 266 F. Supp. 2d 1150, 1163-67 (C.D. Cal. 2003); In re Nash Finch Co. Sec. Litig., 502 F. Supp. 2d 861, 873 (D. Minn. 2007); Freeland v. Iridium World Commc’ns, Ltd., 545 F. Supp. 2d 59, 74 (D.D.C. 2008); Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 193-94 (S.D.N.Y. 2010). Courts also engage in other types of legal gymnastics to take the statements out of the Safe Harbor, such as straining to convert forward-looking statements into present-tense declarations. The court in City of Providence v. Aeropostale, Inc., No. 11 Civ. 7132, 2013 WL 1197755 (S.D.N.Y. Mar. 25, 2013), recently did so, characterizing a number of statements related to the company’s earnings guidance to be statements of present fact outside the Safe Harbor’s protection – and thereby essentially taking the guidance out of the Safe Harbor as well. Even worse, the court articulated an incorrect rule of law: “the safe harbor does not apply to material omissions.” Id. at *12. But, of course, all forward-looking statements rely on, and necessarily omit, myriad facts – a prediction is, by definition, the bottom line of analysis.
The most notorious erroneous Safe Harbor decision was written by one of the country’s most renowned judges, Judge Frank Easterbrook. In Asher v. Baxter, 377 F.3d 727 (7th Cir. 2004), Judge Easterbrook read into the Safe Harbor the word “the” before “important” in the phrase “identifying important factors,” to then hold that discovery was required to determine whether the company’s cautionary language contained “the (or any of the) ‘important sources of variance’” between the forecast and the actual results. Id. at 734. The statute only requires a company to identify “important factors,” not the important factors. Judge Easterbrook’s mis-reading of the statute injected a subjective component into an objective inquiry; it purported to require courts to evaluate the company’s disclosure decisions – what the company thought were “the” important factors. This error led the court to permit discovery on what the company thought was “important” – a procedure directly contrary to Congress’s clear intent that courts apply the Safe Harbor on a motion to dismiss and “not  provide an opportunity for plaintiff counsel to conduct discovery on what factors were known to the issuer at the time the forward-looking statement was made.” H.R. Rep. No. 104-369, at 44 (1995), as reprinted in 1995 U.S.C.C.A.N. 730, 743.
Frequently, courts simply avoid defendants’ Safe Harbor arguments, choosing either to treat the Safe Harbor as a secondary issue or to avoid dealing with it at all. The Safe Harbor was meant to create a clear disclosure system: if companies have meaningful risk disclosures, they can make projections without fear of liability. When judges avoid the Safe Harbor, companies’ projections are judged by legal rules and pleading requirements that result in less certain and less protective outcomes, even if judges get to the right result on other grounds. And if they come to realize that they do not have the clear Safe Harbor protection Congress meant to provide, companies will make fewer and/or less meaningful forward-looking statements.
The root of these problems is that many judges don’t like the idea that the Safe Harbor allows companies to escape liability for knowingly false forward-looking statements. Some courts have explicitly questioned the Safe Harbor’s effect. For example, in In re Stone & Webster, Inc. Securities Litigation, the First Circuit called the Safe Harbor a “curious statute, which grants (within limits) a license to defraud.” 414 F.3d 187, 212 (1st Cir. 2005). And the Second Circuit, in its first decision analyzing the Safe Harbor – 15 years after the Reform Act was enacted, illustrating the degree of judicial avoidance – correctly interpreted “or” to mean “or,” but stated that “Congress may wish to give further direction on …. the reference point by which we should judge whether an issuer has identified the factors that realistically could cause results to differ from projections. May an issuer be protected by the meaningful cautionary language prong of the safe harbor even where his cautionary statement omitted a major risk that he knew about at the time he made the statement?” Slayton v. American Express Co., 604 F.3d 758, 772 (2d Cir. 2010). (Soon after the Second Circuit decided American Express, the Ninth Circuit also interpreted “or” to mean “or.” In re Cutera, Inc. Sec. Litig., 610 F.3d 1103, 1112-13 (9th Cir. 2010).)
This judicial antipathy for the Safe Harbor won’t change. So it is up to companies to draft cautionary statements that will be effective in the face of this skepticism, and for securities defense counsel to make Safe Harbor arguments that resonate with dubious judges.
I have had success in obtaining dismissal under the Safe Harbor when I am able to demonstrate that the company’s Safe Harbor cautionary statements show that it really did its best to warn of the risks it faced. Judges can tell if a company’s risk factors aren’t thoughtful and customized. Too often, the risk factors become part of the SEC-filing boilerplate, and don’t receive careful thought with each new disclosure. But risk factors that don’t change period to period, especially when it’s apparent that the risks have changed, are less likely to be found meaningful. And even though many risks don’t fundamentally change every quarter, facets of those risks often do, or there might be another, more specific risk that could be added.
Companies can help to inoculate themselves from lawsuits – or lay the groundwork for an effective defense – if they simply spend time thinking about their risk factors each quarter, and regularly supplement and adjust those factors. There are situations in which competitive harm or other considerations will outweigh the benefit of making negative elective risk disclosures. But companies should at least evaluate and balance the relevant considerations, so that they maximize their Safe Harbor protection without harming their business and shareholders.
I have also had success with Safe Harbor arguments that defend the honesty of the challenged forward-looking statements. For example, the complaint, along with incorporated and judicially noticeable facts, often allow defense counsel to support the reasonableness of challenged earnings guidance. Some defense lawyers avoid this approach because it is fact-intensive, which they worry may cause judges to believe that dismissal isn’t appropriate. I have found, however, that judges who believe that the forward-looking statements have a reasonable basis (and are thus assured that they were not knowingly dishonest) are more comfortable applying the Safe Harbor, or granting the motion on another basis, such as lack of falsity.
On the other hand, I believe the least effective arguments are those that rest on the literal terms on the Safe Harbor, which create the impression that defendants are trying to skate on a technicality. It is these types of arguments – lacking in a sophisticated supporting analysis of the context of the challenged forward-looking statements and of the thoughtfulness of the cautionary language – that cause the courts to try to evade what they see as the unjust application of the Safe Harbor. Defense counsel need to appreciate that Safe Harbor “law” includes not just the statute and decisions interpreting it, but also the skepticism with which Safe Harbor arguments are evaluated by many judges.