Weil, Gotshal & Manges LLP
A Few Courts Try to Make Waves in the PSLRA's "Safe Harbor" - Part I
(July 2001, Metropolitan Corporate Counsel)
By Joseph S. Allerhand Robert F.
Carengelo Anthony J. Albanese
In December 1995, Congress enacted the Private Securities Litigation Reform
Act of 1995 (the "PSLRA") in order to combat abuses in the securities
litigation process.1 A widespread abuse that Congress sought to prevent
was the "routine" filing of lawsuits against companies "based
on nothing more than a company's announcement of bad news[,]" "without
regard to any underlying culpability . . . and with only faint hope that
the discovery process might lead eventually to some plausible cause of
action."2 Prior to passage of the PSLRA, whenever a company's management
made optimistic statements concerning future prospects or earnings, and
the prospects or earnings failed to materialize, the inevitable lawsuit
followed with the allegation that, in light of subsequent events, the initial
projections or predictions "must have" been fraudulent when made.
In enacting the PSLRA, Congress specifically intended to encourage companies
to make forward-looking statements concerning, for example, projections
of revenues, plans and objectives for future products and services, and
future economic performance.3 Congress did not want corporate officers
to be inhibited "from fully explaining their outlooks" relating
to such matters because such outlooks are essential to investors' investment
decisions.4 Therefore, "in order to loosen 'effect' of potential liability
for forward-looking statements, which often kept investors in the dark
about what management foresaw for the company," Congress enacted various
safe harbor provisions in the PSLRA which insulate forward-looking statements
that later turn out to be false from liability under Section 10(b).5
Specifically, the PSLRA provides that a complaint attacking forward-looking
statements, as defined in the statute, must be dismissed if (1) the statements
were accompanied by meaningful cautionary language identifying important
factors that could cause results to differ materially from those in the
statements or (2) the plaintiff fails to plead with particularity facts
giving rise to a strong inference that the defendants had "actual
knowledge" of the falsity of their statements when made.6
A few recent decisions, however, have made waves in the safe harbor by
straying from the plain language of the statute and creating a judicial
exception to the safe harbor provision. These courts have concluded that
"'allegations based upon omissions of existing facts or circumstances
do not constitute forward looking statements protected by the safe harbor
of the Securities Act.'"7 Under this judicially created exception,
a plaintiff can easily survive a motion to dismiss by merely alleging that
forward-looking statement omitted some existing fact. As such, even a classic
forward-looking statement which Congress intended to protect, such as a
projection of earnings, would not be considered forward-looking if the
plaintiff also alleged the omission of some purported existing negative
fact. These decisions, deviate from the plain language of the PSLRA as
well as a plethora of case law, jeopardizing the safety of the safe harbor
and Congress' goal to encourage companies to make "forward-looking"
statements. A recent decision, however, has rejected the exception created
by these decisions.8
The PSLRA Defines "Forward-Looking" Statements
In determining whether the PSLRA provides a safe harbor from liability
for a "forward-looking" statement, the court must resolve a "threshold
question:" does the statement constitute a "forward-looking"
statement as defined by the PSLRA.9
The PSLRA defines a "forward-looking statement" to include "(A)
a statement containing a projection of revenues . . .; (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; [and] (D) any statement
of the assumptions underlying or relating to any statement described in
subparagraph (A), (B), or (C).10 The statute does not provide for any exceptions
- if a statement falls within this definition it constitutes a "forward-looking"
statement under the PSLRA and courts must then determine whether one of
the statute's two alternative safe harbors applies to protect the statement.
In determining whether a statement falls within the statutory definition
of a "forward-looking" statement, there are three analytical
steps for courts to apply.
First, the PSLRA requires that courts specifically examine each of the
challenged statements to determine whether or not each particular statement
falls with the statute's definition of "forward-looking."11 As
the Eleventh Circuit explained, allegedly misleading forward-looking statements
cannot be treated with a "broad brush;" rather, the "legislative
history implies piecemeal examination of the statements found in a company
communication."12 Any other approach, the court concluded, would not
"comport with the Act's demand of articulate pleading: The PSLRA closes
the universe of supposedly false statements under scrutiny to those 'specif[ied]'
in the complaint."13 As such, any approach that would deny a statement
safe harbor protection without analyzing the statement under the statute's
definition would be contrary to the
plain language of the PSLRA. Second, each statement at issue must not be
read in isolation, but in the context of the entire document.14 In fact,
even though a statement does not appear on its face to be "forward-looking,"
it may be considered forward-looking when read in context. For example,
even a "mixed statement," i.e., a statement which contains forward-looking
and non-forward-looking factors, must be treated as forward-looking.15
As the Eleventh Circuit explained, "were we to banish from the safe
harbor lists that contain both factual and forward-looking factors, we
would inhibit corporate officers from fully explaining their outlooks.
Indeed, liability conscious
officers would be relegated to citing only the factors that could individually
be called forward-looking. That would hamper the communication that Congress
sought to foster."16
Third, neither grammar nor particular words control the inquiry. The Eleventh
Circuit rejected a "purely grammatical argument . . . that a present-tense
statement cannot predict the future."17 The court held that "[t]he
chairman and CEO's hopeful conclusion that conditions are better because
of two anticipated improvements in business conditions is a prediction
of economic performance, however couched."18 The rationale is that
any "statement about the state of a company whose truth or falsity
is discernible only after it is made necessarily refers only to future
performance" and thus qualifies for safe harbor protection.19 Therefore,
the existence of a historical or present fact in the statement will not
preclude the statement from being characterized as "forward-looking."
For example, a statement that "we are building a new widget machine
that will improve efficiency as well as the company's future earnings,"
is a forward-looking statement despite reference to an existing fact that
"we are building a widget machine."
If after engaging in the appropriate analysis a court determines that the
statement constitutes a forward-looking statement as defined in the PSLRA
then the court must move to the "next step," which is to determine
whether either of the statute's safe harbors apply.20
The PSLRA Creates Two Alternative Safe Harbors For Forward-Looking Statements
The PSLRA creates two alternative
safe harbors for forward-looking statements, the application of either
of which will immunize a forward-looking statement from attack under Section
10(b) even if the statement later proves to be incorrect.21 The PSLRA provides
that a forward-looking statement, whether written or oral, is protected
where (A) "the forward-looking statement is (i) 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; or (ii) immaterial; or (B)
the plaintiff fails to prove that the forward-looking statement - (i) if
made by a natural person, was made with actual knowledge by that person
that the statement was false or misleading; or (ii) if made by a business
entity; was (I) made by or with the approval of an executive officer of
that entity, and (II) made or approved by such officer with actual knowledgeby that officer that the statement was false or misleading.22
Courts have analyzed each safe harbor in turn. In the first safe harbor,
state of mind is irrelevant. It provides that there shall be no liability
with respect to any "forward-looking statement" that proves false
if the statement is "accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those in the forward-looking statement."23 The Eleventh
Circuit has found that cautionary language is sufficient to satisfy the
first safe harbor provision even where the defendants' various warnings
do not explicitly refer to the risk which ultimately came to pass.24 The
reasoning is that "[w]hen an investor has been
warned of risks of a significance similar to that actually realized, 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."25
If a court determines that the forward-looking statements were accompanied
by meaningful cautionary language, the analysis ends there and the statements
are protected under the PSLRA. If, however, a court concludes that the
forward-looking statements were not accompanied by the requisite cautionary
language, the statements are still protected if the "alternative"
second safe harbor applies.26
Unlike the first safe harbor, state of mind is relevant under the second
safe harbor. The second safe harbor provides that there is no liability
unless the plaintiff proves that the defendant made the statement with
"actual knowledge" that it was "false or misleading."27
"Instead of examining the forward looking and cautionary statements,
this prong of the safe harbor focuses on the state of mind of the person
making the forward-looking statement."28 The applicable state of mind
is not recklessness (or even severe recklessness) when dealing with the
second prong of the safe harbor - the required state of mind is actual
knowledge. Furthermore, the heightened pleading standard of the PSLRA is
applicable - not only must a plaintiff plead "actual knowledge"
to overcome the second prong of the PSLRA safe harbor for forward-looking
plaintiff must do so through particularized facts "giving rise to
a strong inference that the defendant acted with the required state of
In short, the safe harbor protection for forward-looking statements applies
to statements that fall within the statute's definition if (1) meaningful
cautionary language accompanies the forward-looking statements, or (2)
plaintiffs fail to allege that the defendants had "actual knowledge"
of the falsity of their forward-looking statements without cautionary language
when such statements were made. The two prongs of the test are alternative
prongs and as such provide forward-looking statements with the protection
with which Congress intended to afford them. Not all courts, however, have
applied this standard in a way that preserves Congress' intended protection.
1See 1933 Act, 15 U.S.C.
77z-1; 1934 Act, 15 U.S.C.
78u-4; H.R. Conf. Rep. No. 104-369 (1995), reprinted in 1995 U.S.C.C.A.N.
In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 548-49 (6th Cir. 1999).
No. 104-98 (1995), reprinted in 1995 U.S.C.C.A.N. 679, 690; H.R. Conf.
104-369 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 818. 3See 15 U.S.C.
78u-5(i)(1). 4Harris v. Ivax Corp., 182 F.3d 799, 806 (11th Cir. 1999),
denied, 209 F.3d 1275 (2000). 5Harris, 182 F.3d at 806: see In re Splash
Holdings, Inc. Sec. Litig., 2000 WL 1727377, at *5 (*N.D. Cal. Sept. 29,
78u-5(c)(1)(B)(ii)(II); Harris, 182 F.3d at 803. 7See In re MobileMedia
Litig., 28 F. Supp. 2d 901, 930 (D.N.J. 1998); see also In re Cell Pathways,
Inc. Sec. Litig., 2000 WL 805221, at *11 (E.D. Pa. June 20, 2000); In re
ValuJet, Inc. Sec. Litig., 984 F. Supp. 1472, 1479 (N.D. Ga. 1997). 8See
Columbia Labs., Inc. Sec. Litig., 2001 WL 527155 (S.D. Fla. May 9, 2001).
Ehlert v. Singer, 245 F.3d 1313, 1316 (11th Cir. 2001). 1015 U.S.C.
78u-5(i)(1). 11 See 5 U.S.C.
78u-5(e). 12See Harris, 182 F.3d at 804. 13Id. 14Id. at 805; see also In
Technical Chems. Sec. Litig., 2000 WL 1222025, at *8 (S.D. Fla. July 3,
(granting leave to file second amended complaint) ("Technical Chems.
I"); In re
Technical Chems. Sec. Litig., 2001 U.S. Dist. LEXIS 4851, at *25-26 (S.D.
Mar. 20, 2001) ("Technical Chems. II") (dismissing second amended
15See Harris, 182 F.3d at 806. 16Id. at 806-07. 17Id. at 805. 18Id. 19Id.;
In re Splash Tech. Holdings, Inc., 2000 WL 1727377. 20See Ehlert, 245 F.3d
1318. 21See 15 U.S.C.
78u-5(c)(1)(A) and (B); Harris, 182 F.3d at 803; Technical Chems. I, 2000
1222025, at *8; Technical Chems. II, 2001 U.S. Dist. LEXIS 4851, at *23.
78u-5(c)(1) (emphasis added). 23See 15 U.S.C.
78u-5(c)(1)(A)(i); Harris, 182 F.3d at 803; Technical Chems. I, 2000 WL
1222025, at *8. 24Harris, 182 F.3d at 807. 25Id. 26See H. R. Conf. Rep.
104-369, at 44 (1995), reprinted in 1995 U.S.C.C.A.N. 730, 743; Harris,
at 803; see also In re Columbia Labs., Inc. Sec. Litig., 2001 WL 527155
In re Republic Servs., Inc. Sec. Litig., 134 F. Supp. 2d 1355, 1363 (S.D.
2001). In re Splash Tech. Holdings, Inc., 2000 WL 1727377, at *5. 27 See
78u-5(c)(1)(B)(i), see also Harris, 182 F.3d at 803; Technical Chems. I,
WL 1222025, at *8. 28H. R. Conf. Rep. No. 104-369, at 44 (1995), reprinted
1995 U.S.C.C.A.N. 730, 743. 2915 U.S.C.
78u-4(b)(2) (emphasis added); see Harris v. Ivax Corp., 998 F. Supp. 1449,
1454-55 (S.D. Fla. 1998), aff'd on other grounds, 182 F.3d 799 (11th Cir.
Technical Chems. I, 2000 WL 1222025, at *8 n.11; see also In re Comshare,
F.3d at 549-50 n.5; In re Advanta Corp. Sec. Litig., 180 F.3d 525, 536-37
Cir. 1999) (same).