Invited by a federal appeals court to give
its view on the scope of the Private Securities
Litigation Reform Act safe harbor for forward-looking
statements, the SEC said that statements in the MD&A
section of a Form 10-Q were within the scope of the safe
harbor since the MD&A is separate and distinct from the
financial statements in the 10-Q. In its amicus brief,
the Commission also opined that it is not a meaningful
cautionary statement to warn of a potential
deterioration in yields when you are aware that such a
deterioration is actually occurring.
The SEC said that a forward-looking
statement need not be included in a special section or
specifically labeled as a forward-looking statement to
be identified as such. It also said that, under the safe
harbor, a person has actual knowledge that a statement
of projection is misleading if the person knows that he
or she has no reasonable basis upon which to make the
statement.
The 2nd Circuit Court of Appeals invited
the SEC’s views of the safe harbor for forward-looking
statements in the case of Slayton v. American Express
Co., which is on appeal from a district court’s
dismissal of allegations regarding a company’s statement
in its Form 10-Q that losses on high-yield investments
for the remainder of 2001 are expected to be
substantially lower than in the first quarter.
Section 21E(b)(2)(A) of the Exchange Act
excludes from the safe harbor forward-looking statements
that are included in a financial statement prepared in
accordance with GAAP. Since the forward-looking
statement here was included in the MD&A , the court
asked the SEC if it came within the exclusion. In the
SEC’s view, the challenged statement is not excluded
from the statutory safe harbor, since the MD&A section
is separate and distinct from the financial statements
of a Form 10-Q. The SEC has consistently believed that
the MD&A section should provide a discussion and
analysis of a company’s business as seen through the
eyes of its managers, and should not be a recitation of
financial statements in narrative form.
Section 21E(c)(1)(A)(i) requires that in
order to receive safe-harbor protection a statement must
be identified as a forward-looking statement. There is
no bright line rule on this element, according to the
SEC. Rather, the facts and circumstances of the language
used in a particular registration statement or report
will determine whether or not a forward-looking
statement is sufficiently identified to receive
safe-harbor protection.
In general, the SEC does not believe that
to sufficiently identify forward-looking statements a
company must include all forward-looking statements in a
separate section or label each forward-looking statement
as such. According to the SEC, a forward-looking
statement can be adequately identified, as the company
did in this case in its Form 10-Q, by including an
explanatory note indicating that the use of certain
forward-looking words is intended to identify a
forward-looking statement. The use of linguistic cues
like "we expect" or
"we believe," when combined
with an explanatory description of the company’s
intention to thereby designate a statement as
forward-looking generally should be sufficient to put
the reader on notice that the company is making a
forward-looking statement.
Section 21E(c)(1)(A)(i) also provides that
a forward-looking statement that is accompanied by
meaningful cautionary statements identifying important
factors that could cause actual results to differ
materially from those in the forward-looking statement
is protected under the safe harbor. In the SEC’s view,
the company’s statement that potential deterioration in
the high-yield sector could result in further losses in
the investment portfolio was not meaningful under the
safe harbor provision because, according to the
allegations, it misleadingly warned of a potential
deterioration in the high yield sector when management
was aware that it was actually occurring at the time.
The SEC cautioned that safe harbor
coverage does not apply when the cautionary statement is
itself misleading. In adopting the safe harbor in the
PSLRA, the Commission reasoned, Congress did not intend
to deviate from the well-established proposition that
misleading cautionary language does not render
inactionable a misleading forward-looking statement. The
conference committee expressly recognized that a company
could not rely upon a cautionary statement that
misstates historical facts.
Finally, Section 21E(c)(1)(B) states that
a person is not liable with respect to a forward-looking
statement if the plaintiff fails to prove that the
statement was made with actual knowledge that the
statement was false or misleading. In the Commission’s
view, a forward-looking statement is made with actual
knowledge that it is misleading if the speaker makes the
statement with the knowledge that he or she had no
reasonable basis, or no basis at all, upon which to make
it.
A statement of prediction or expectation,
like the company’s statement here that losses are
expected to be substantially lower, contains at least
the implicit factual assertion that the statement is
reasonably genuinely believed and the speaker is not
aware of any undisclosed facts undermining its accuracy.
A speaker has actual knowledge that a forward-looking
statement is misleading if the speaker actually knows
that these implicit factual representations are not
true.
This standard is distinct from, and
requires more than, a showing that a speaker acted
recklessly in making a misleading forward-looking
statement. Although the PSLRA’s legislative history is
not illuminating on the matter, the SEC noted, the plain
language of the provision requiring actual knowledge
indicates that, to avoid the safe harbor, a plaintiff
needs to show more than that a defendant acted
recklessly.
Thus, to remove a forward-looking
statement from the protection of the safe harbor, it
must be shown that the company actually knew that the
statement was misleading. In other words, to survive a
motion to dismiss, an investor must plead facts
sufficient to establish that company management was
subjectively aware that one of the implicit factual
assertions underlying its forward-looking statement was
false when the statement was made.