The release of information to the investing public used to be fraught with peril, because legislation dating from the 1930s allowed investors to initiate class action lawsuits whenever a company’s stock price dropped, due to alleged malfeasance by the company. In the face of the potentially massive awards arising from these lawsuits, companies were inclined not to reveal any information beyond those items required by law. The situation changed when new, protective legislation was passed in 1995.
The Private Securities Litigation Reform Act (PSLRA) was that new law. The objective of the lawmakers who created the PSLRA was to reduce the routine filing of lawsuits against public companies whenever there was a significant change in their stock price.
The PSLRA requires that plaintiffs identify three items in their filed complaints, which are as follows:
- Each company statement alleged to have been misleading, the reasons why the statement is misleading, and all facts on which that belief is formed.
- Itemize the facts giving rise to a strong inference that the defendant knew the challenged statement was false at the time it was made, or was reckless in not recognizing that the statement was false.
- Prove that the defendant’s acts or omissions have caused the plaintiff’s loss.
These three requirements force plaintiffs to present a stronger up-front case, which defense attorneys have a better chance of arguing against in obtaining a dismissal of the case. Further, the PSLRA requires the court to dismiss the complaint if the first two requirements are not met.
The key protective aspect of the PSLRA is Section 102, “Safe Harbor for Forward-Looking Statements.” Section 102 provides companies with a safe harbor from liability for forward-looking statements to the extent that such statements are identified as forward-looking statements, and are accompanied by “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.” Further, if a company wishes to obtain protection for an oral statement under the provisions of the PSLRA, then it must include in the oral statement a “statement that additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statement is contained in a readily available written document” (such as a document filed with the SEC), and that “the information contained in that written document is a cautionary document.” However, a company making such statements will still be liable if the plaintiff can prove that the written or oral statements were made with actual knowledge that the information being provided was false or misleading.
A forward-looking statement is defined in the PSLRA as follows:
- 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;
- A statement of the plans or objectives of management for future operations, including plans or objectives relating to the products or services of the issuer;
- 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;
- Any statement of the assumptions underling or relating to any statement described in subparagraph (A), (B), or (C);
- 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; and
- A statement containing a projection or estimate of such other items as may be specified by rule or regulation of the Commission.”
Several types of information are not covered by the safe harbor provisions of the PSLRA. Section 102 of the Act includes a lengthy list of exclusions, such as roll-up transactions, going-private transactions, tender offers, initial public offerings, investment company registration statements, and financial statements prepared in accordance with GAAP.
In order to be in compliance with the protections offered by Section 102, the CFO must include a statement in all corporate communications that identify statements made as being forward looking, and adding cautionary statements identifying those factors that could cause actual results to differ from projections. Here are three sample statements that can be used for different forms of investor relations communications:
- Safe harbor statement for a conference call. “As we begin our review of the company’s quarterly results, let me remind you that some of the statements made during this call may disclose certain subjects that contain forward-looking statements, as that term is described in the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations, and involve risk and uncertainty and may cause results to differ materially from those set forth in the statement. The forward-looking statements may include statements regarding product development, product potential, or financial performance, and no forward-looking statement can be guaranteed, and actual results may differ materially from those projected. Forward-looking statements in this call should be evaluated together with the many uncertainties that affect the company’s business, particularly those mentioned in the risk factors and cautionary statements set forth in the company’s Form 10-K for the year ending December 31, ___, and in its periodic reports of Form 10-Q and 8-K, which the company incorporates by reference and which are posted on our website.”
- Safe harbor statement for an oral presentation. “This presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and are subject to the safe harbors created thereby. Actual results could differ materially from those projected in the forward-looking statements as a result of risk factors discussed in the company’s reports that are on file with the SEC.”
- Safe harbor statement for a written document. “In accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, the company notes that some statements in this news release look forward in time, and involve risks and uncertainties that may affect the company’s actual results of operations. The following important factors, among others that are discussed in company filings with the SEC, could cause actual results to differ materially from those set forth in the forward-looking statements:
- Competition may cause us to lose projects or result in decreased revenues.
- We may be unable to hire qualified technical personnel.
- Acquisitions involve significant risks, including difficulties in operational integration, management diversion from normal daily operations of the business, and the potential loss of key employees of acquired companies.”
Is there any legal liability associated with forward-looking statements that were made in the past, and which have not been subsequently updated? The PSLRA specifically states that “nothing in this section shall impose upon any person a duty to update a forward-looking statement.” Despite the protection offered by this section of the PSLRA, the CFO should update forward-looking statements, simply because it is a good investor relations practice to keep investors informed of any material changes in a company’s operations.