The most frequent question I’ve been asked about the SEC’s proposed SPAC rules concerns the provision that would make unavailable the Private Securities Litigation Reform Act’s safe harbor for forward-looking statements with respect to de-SPAC transactions: would this change increase the risk that SPACs and de-SPACs face in securities litigation?
Not much. Public companies understandably believe that the Reform Act’s safe harbor protects them from liability for their guidance and projections if they simply follow the statute’s requirements. But, as a practical matter, the safe harbor is not so safe; some judges think the Reform Act goes too far, so they go to great lengths to avoid the statute’s plain language. This is one significant reason why we always have advocated an approach to defending forward-looking statements that does not depend solely on the safe harbor, even when the statute’s plain language would indicate that it applies. Thus, while SPACs and de-SPACs are certainly better off with the safe harbor than without it, its loss should not be as consequential as some may think.
The safe harbor was a key component of the Private Securities Litigation Reform Act. 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 straightforwardly says that a forward-looking statement is not actionable if it (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 immaterial, “or” (3) is made without actual knowledge of its falsity. 15 U.S.C. § 77z-2(c)(1); 15 U.S.C. § 78u-5(c)(1) (emphasis added).
Yet courts’ application of the safe harbor has been anything but straightforward. Indeed, courts have committed some basic legal errors in their attempts to nullify it. Foremost among these is the tendency to collapse the three prongs—essentially reading “or” to mean “and”—and to hold that actual knowledge that the forward-looking statement is false means that the cautionary language can’t be meaningful. Courts also engage in other types of legal gymnastics, such as straining to convert forward-looking statements into present-tense declarations, in order to take statements out of the safe harbor.
Beyond prominent instances of judicial error, judges frequently evade the safe harbor by simply avoiding defendants’ safe harbor arguments, choosing either to treat the safe harbor as a secondary issue or to avoid dealing with it altogether. 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 companies come to realize that they cannot rely on the clear safe harbor protection Congress meant to provide, they will make fewer and/or less meaningful forward-looking statements, to the detriment of investors.
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 making false forward-looking statements. Indeed, 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). This judicial antipathy for the safe harbor won’t change until the Supreme Court establishes a standard that resonates with lower-court judges. (In an article on the Quality Systems case and our amicus brief on behalf of Washington Legal Foundation in support of Quality Systems’ cert petition, we explained these problems (and our suggested solution) in more detail.)
For these reasons, we take a dual approach to defending forward-looking statements.
- A forward-looking statement is also an opinion under the Supreme Court’s decision in Omnicare, Inc. v. Laborers Dist. Council Const. Industry Pension Fund, 135 S. Ct. 1318 (2015), so we start by arguing that the forward-looking statement is not false in the first place. Omnicare held that a statement of opinion is false under the federal securities laws only if the speaker does not genuinely believe it, and it is misleading only if it omits information that, in context, would cause the statement to mislead a reasonable investor. See generally “Omnicare, Five Years Later: Strategies for Securities Defense Lawyers’ More Effective Use of the Decision.”
Lack of falsity defeats the claim regardless of the safe harbor’s application, but we have found that judges who believe that the forward-looking statements are not false (and are thus assured that they were not knowingly dishonest) also are more comfortable applying the safe harbor.
- We then argue the safe harbor as an additional basis for dismissal and use that discussion 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; risk factors that don’t change from 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. We can help convince judges of the defendants’ candor and good faith, as well as the applicability of the safe harbor, by demonstrating the thoughtful evolution of tailored risk factors over time.
Ultimately, the least effective arguments are those that rest on the literal terms of the safe harbor, which create the impression that defendants are trying to skate on a technicality. It is these types of arguments—lacking sophisticated supporting analysis of either the context of the challenged forward-looking statements or the thoughtfulness of the cautionary language—that cause courts to try to evade what they see as the unjust application of the safe harbor. Effective defense counsel should appreciate that safe harbor “law” includes not only the statute and decisions interpreting it but also the skepticism with which many judges evaluate safe harbor arguments.
So, while SPACs and de-SPACs would be better off with the safe harbor, effective use of Omnicare is the primary protection for forward-looking statements anyway.