Courts in Recent Decisions Consider Applicability of Safe Harbor Protection to Statements Known to be False

Article Date: Thursday, November 03, 2011

Written By: Heather Adams

The Private Securities Litigation Reform Act ("PSLRA"), enacted in 1995, significantly changed public companies' potential exposure for forward-looking statements. The PSLRA safe harbor provides that, under certain circumstances, a person or entity shall not be liable with respect to written or oral forward-looking statements. See 15 U.S.C. §78u-5(c) (1)-(2).

A "forward-looking statement" is defined under the statute to include "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," as well as "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," and "a statement of future economic performance." 15 U.S.C. § 77z-2(i)(1); 15 U.S.C. § 78u-5(i)(1).

Failure to achieve a predicted target may mean that the issuer is faced with a securities fraud lawsuit. However, under the PSLRA safe harbor, a person or entity shall not be liable with respect to any forward-looking statement if:

(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 … was made with actual knowledge … that the statement was false or misleading.

15 U.S.C. §78u-5(c)(1).

Courts in recent decisions have considered whether, under sub-section (A), the safe harbor provision is available when a forward-looking statement is identified as such and accompanied by meaningful cautionary language, but the issuer allegedly knew the statement to be false at the time it was made.


In re Cutera Securities Litigation
The Ninth Circuit recently considered whether a material forward-looking statement, which is accompanied by sufficient cautionary statements, can nonetheless subject the issuer to liability if the plaintiffs allege that the issuer knew the forward-looking statement was false.

The defendant company, Cutera, sold lasers and other light-based aesthetic systems to medical professionals, primarily through its direct sales force. In late 2005, the company implemented an expansion plan to market a lower-priced laser through junior sales representatives. In a Jan. 31, 2007 conference call with analysts and a press release on the same date, the company stated that it was realigning its sale organization and explained that, although its senior sales force had generally been successful, the junior sales force had not been as productive. The company warned that its ability to compete and perform in the future depended on its sale force and that failure to attract and retain sales and marketing personnel would materially harm its ability to compete and grow. Nonetheless, the company projected first quarter and year-end revenues in 2007 of $26 million and $126 million respectively, a growth of 25% from the previous year. The following day, the company's stock value went from $28.62 to $33.38.

Three months later, Cutera announced that it had failed to meet its first-quarter revenue projections. The company explained that the shortfall was caused in part by the unsuccessful implementation of a sales program and unusually high turnover among its sales force. In re Cutera Sec. Litig., 610 F.3d 1103, 1107 (9th Cir. 2010).

Investors filed a securities fraud lawsuit, claiming that the company did not adequately disclose the poor performance of the junior sales force, leading to artificially inflated stock prices. When Cutera moved to dismiss, claiming protection under the safe harbor, the plaintiffs introduced evidence that Cutera had been aware of problems with the sales force in January 2007, i.e., at the time of the conference call and press release. The plaintiffs argued for a conjunctive reading of the safe harbor provision, under which a sufficiently strong inference of actual knowledge would overcome a claim of safe harbor protection even for statements identified as forward-looking and accompanied by meaningful cautionary language. Plaintiffs introduced the testimony of a confidential witness who said that "senior management had already effectively given the group its walking papers" at the time of the press release and conference call. Id. at 1110.

The district court determined that the plaintiffs' proposed construction of the safe harbor provision was inconsistent with the statutory language, and the Ninth Circuit affirmed on appeal. Because the defendant had used sufficient cautionary language, the court determined that the case could be decided under the first prong of the safe harbor test, and the defendant's state of mind was irrelevant. Accordingly, the Ninth Circuit affirmed dismissal of the claims. Id. at 1113.


Additional Courts Finding That State of Mind is Irrelevant
Other courts have likewise declined to consider the issuer's state of mind where meaningful cautionary language accompanies the forward-looking statement. See Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., 594 F.3d 783, 795 (11th Cir. 2010) ("[A]n allegation of actual knowledge of falsity will not deprive a defendant of protection by the statutory safe harbor if the forward-looking statements are accompanied by meaningful cautionary language); Miller v. Champion Enters., Inc., 346 F.3d 660, 672 (6th Cir. 2003) ("[F]or 'forward-looking statements' that are accompanied by meaningful cautionary language, [subsection (A)(i)] makes the state of mind irrelevant.").

The Middle District of North Carolina has followed this approach, stating that where forward-looking statements are accompanied by meaningful cautionary language, the court need not consider allegations that the defendants made the statements with actual knowledge of falsity. In re Laboratory Corporation of America Holdings Sec. Litig., 2006 WL 1367428 (M.D.N.C. May 18, 2006). The court in In re Laboratory Corporation reiterated that, in order to be meaningful, cautionary language must include "substantive information about factors that realistically could cause results to differ materially from those projected in the forward-looking statements, such as, for example, information about the issuer's business." Id. (citing In re Humphrey Hospitality Trust., Inc. Sec. Litig., 219 F.Supp.2d 675, 683-84 (D. Md. 2002)).

See also Johnson v. Pozen Inc., 2009 WL 426235 (M.D.N.C. Feb. 19, 2009) (stating that forward-looking statements are immunized from liability if they contain meaningful cautionary language, and even if a forward-looking statement is not accompanied by meaningful cautionary language, liability attaches only if the speaker had actual knowledge of falsity at the time the statement was made).


Courts Finding that Actual Knowledge of Falsity Defeats Protection
There is some case law holding that actual knowledge of falsity will defeat safe harbor protection, even where meaningful cautionary language is included. For example, in Freeland v. Iridium World Communications Ltd., 545 F.Supp.2d 59 (D.D.C. 2008), the court found that the cautionary statements at issue could not be "meaningful" if defendants knew the forward-looking statements were false and misleading at the time they were made. See also In re Nash Finch Co., 502 F.Supp.2d 861, 873 (D. Minn. 2007) ("[C]autionary language cannot be 'meaningful' when defendants know that the potential risks they have identified have in fact already occurred, and that the positive statements they are making are false.").

In Lormand v. US Unwired, Inc., the plaintiff investor alleged that a telecommunications company made material misrepresentations about the company.  On appeal, the Fifth Circuit reversed the district court's decision that the safe harbor applied to the alleged misrepresentations. Lormand v. US Unwired, Inc., 565 F.3d 228, 244 (5th Cir. 2009). The court held that where "plaintiff adequately alleges that the defendants actually knew that their statements were misleading at the time they were made, the safe harbor provision is inapplicable to all [the] alleged misrepresentations." Id.
These courts are in the distinct minority.


Other Case Law
The Second Circuit has declined to decide the issue, but invited Congress to "give further direction." See Slayton v. American Express Co., 604 F.3d 758, 772 (2d Cir. 2010).
Even where statutory protection under the PSLRA may not be available, the "bespeaks caution doctrine" may immunize forward-looking statements. Case law under this doctrine is likewise unsettled as to whether the issuer's knowledge of falsity is relevant.


Conclusion
Litigants are likely to continue arguing about whether an issuer's alleged knowledge of falsity renders PSLRA safe harbor protection unavailable. Most courts that have considered the issue thus far have concluded that the PSLRA safe harbor protection is available regardless of the issuer's state of mind. At least at this time, it does not appear likely that Congress will amend the PSLRA safe harbor provision to clear up the issue. The Supreme Court may end up resolving the split. In the meantime, the PSLRA safe harbor continues to provide strong protections for companies making forward-looking statements.•


Heather Adams is counsel to the Litigation and Trial Practice Group at Alston & Bird LLP. Resident in the firm's Research Triangle Park office, she handles securities, employment, financial services, and antitrust litigation, with an emphasis on class action defense.

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