A forward looking statement describes future events or results. When made by a company, these statements can trigger shareholder lawsuits, so safe harbor provisions are now used to mitigate a company's risk.
For many years, it was very risky for a publicly-held company to make any type of statement about the financial results that it expected to see in the future. Whenever the price of a stock declined, shareholders could attempt to link the decline with anything said about future plans, and use that as the basis for a securities fraud lawsuit. The result was a multitude of lawsuits, which companies had the choice of either fighting (at a substantial legal cost) or of settling out of court (for an equally substantial sum).
Congress alleviated the litigation situation by passing the Private Securities Litigation Reform Act (PSLRA) in 1995. In general, the Act was designed to reduce the number of frivolous securities lawsuits. The Act does so by increasing the amount of evidence that a plaintiff must have before filing a lawsuit. In particular, the following three concepts apply (with text taken from the Act):
The complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.
The complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind. (Author’s note: This means the defendant knew a statement was false at the time it was made, or was reckless in not recognizing that it was false)
The plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this chapter (of the Act) caused the loss for which the plaintiff seeks to recover damages.
All of these concepts were designed to place a considerable burden of proof on the plaintiff, requiring the presentation of substantial evidence before a judge would accept a case.
The Act also contains the following provisions, which make it less likely that a lawsuit will be converted into a class action lawsuit:
- The judge determines who is the most adequate plaintiff for a class action, which may not be the plaintiff that originally filed suit
- Investors must receive full disclosure of the terms of proposed settlements
- Favored plaintiffs cannot receive bonus payments
In short, the Act makes it more difficult for a plaintiff to file suit, for it is necessary to have evidence of fraudulent behavior without the discovery process (which is only allowed after the plaintiff has presented proof of fraud).
In addition to the provisions of the PSLRA that were noted in the last section, it also contained a safe harbor provision. This provision states that an entity issuing forward-looking statements is protected from liability as long as:
The forward-looking statement is 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.
However, the safe harbor provision does not apply in certain circumstances, including:
- An offering of securities by a blank check company
- A penny stock issuance
- Rollup transactions
- Going private transactions
In the Act, a forward-looking statement is defined as:
A. 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;
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, including any such statement contained in a discussion and analysis of financial condition by the management or in the results of operations included pursuant to the rules and regulations of the Commission;
D. Any statement of the assumptions underlying or relating to any statement described in subparagraph (A), (B), or (C);
E. Any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a forward-looking statement made by the issuer; or
F. A statement containing a projection or estimate of such other items as may be specified by rule or regulation of the Commission.
The Act does not require a company to continue to update forward-looking statements, even if the information contained in the last such statement becomes obsolete.