In recent years, public companies have been the target of numerous class actions alleging a variety of disclosure sins under federal securities laws.
In high-tech cases, one standard sin was putting out positive publicity about a new product that turned out to be a dud. In bank cases, a typical sin was boilerplate language in annual reports and Securities and Exchange Commission documents stating that the loan portfolio was "adequately reserved" or that loan underwriting was done "conservatively."
None of the celebrated class actions involved a company directly telling its shareholders how much it expected to earn and then failing to meet the projection.
The reason may be that, until passage of the Private Securities Litigation Reform Act of 1995, most companies shared their earnings estimates only with securities analysts, not directly with their shareholders or the general public.
Forward-looking statements have always been the medium of exchange in the dialogue between company officers and securities analysts, and earnings estimates are the most recognizable form of exchange.
Recently there has been a marked increase in the volume of forward- looking statements exchanged between companies and analysts.
Among banking companies, First Union Corp., in its July 1995 out-of- market acquisition of First Fidelity Bancorp., announced its earnings estimates for the remainder of 1995 and 1996 in a conference with analysts when the deal was announced. It then took the previously unusual step of following that with inclusion of the information in the joint proxy statement in connection with the merger.
The prediction in the proxy statement was a unique show of fair play to noninstitutional shareholders and investors.
Chase Manhattan-Chemical Bank faced similar issues with respect to one- time charges and future earnings in their joint proxy statement-prospectus. But Chase-Chemical "outlined" only "performance goals" and did not give earnings estimates.
Congress' primary goal in passing the Reform Act was to redress abuses in class actions based upon federal securities laws.
As part of that, Congress fashioned the reform to encourage public companies to give their individual shareholders the same explicitly forward-looking information they have historically given to institutional investors - and to insulate companies when they do so.
Congress did the latter by creating a "safe harbor" for forward-looking statements in the Reform Act.
Activists on both sides of the issue have complained about this. Consumer activist Ralph Nader has proclaimed that the Reform Act is a license to lie because the safe harbor theoretically immunizes companies that tell falsehoods if the company includes an appropriate cautionary statement.
Lawyers for companies subject to the safe-harbor provision find fault with the new law's clarity and caution their clients that the safe harbor leaves interpretive issues to judges who, if so inclined, could make companies liable for off-target predictions.
In the safe-harbor section of the Reform Act, Congress gave a broad definition of "forward-looking statements." The term includes projections of revenues, income or loss, earnings or loss per share, dividends, capital expenditures, or "other financial items."
It also includes statements of the plans or objectives of management for operations, including plans or objectives relating to products or services, as well as statements of expected economic performance contained in the management discussion sections of SEC reports.
Thus the definition appears to include both what anyone would call a projection and statements that may amount merely to opinion or perhaps puffery.
Congress also created a safe harbor in which sued companies could, before any expensive discovery takes place, dismiss claims arising from forward-looking statements on two independent grounds.
Under the "cautionary" ground, a defendant can get a claim dismissed summarily if, when made, the forward-looking statement was identified as such, was accompanied by "meaningful cautionary statements" identifying important factors underpinning the statement, and was clear that such factors could cause "results to differ materially" from those predicted.
Even if a defendant cannot meet this cautionary standard, it is not liable for the forward-looking statement unless the latter was made with "actual knowledge that it was false or misleading."
Since many courts have held that a defendant may be liable for a statement made with reckless disregard for the truth, the "actual knowledge" standard affords more protection than is available for misstatements regarding historical facts.
The safe harbor for the forward-looking statement is available to any public company required to file certain reports with the SEC, as well as to financial institutions that file such reports with the bank regulatory agencies. It is not available to a company that is not publicly traded.
The Reform Act does not offer an answer to a recurring and puzzling question about forward-looking statements: In the course of subsequent events, when does a company have a duty to update a forward-looking statement?
If a company predicts that its earnings will be $2 a share, for example, must it update the prediction when it learns that its results are likely to be a few cents above or below $2? Must it do so even though the statement clearly specified that actual results may differ? What if something completely unforeseen happens and the results will turn out to be just $1?
More specifically, circumspect attorneys also will advise their public companies to appreciate the risks posed by state securities laws that offer paths for plaintiffs' lawyers and which lack a safe harbor like the Reform Act's. If a forward-looking statement is the heart of a complaint, plaintiffs' lawyers may sue under state law as well as federal law and may even forgo federal claims altogether.
The politically powerful plaintiffs' lawyers groups have contributed heavily to insure that state laws undo the safe harbor and remain viable economic boons for them. California has Proposition 211 on its ballot this fall, the effect of which would be to undo the safe harbor and to allow a state class action to proceed even if the defendant company has only a single California shareholder with one share.
State judges who are told that Ralph Nader says the Reform Act is a license to lie may see themselves and their interpretations of state securities laws as the final bulwark against fraud.
Notwithstanding these risks, forward-looking statements will be just as much a part of the future as cybercash. So companies, understanding the risks, must be prepared.
A few words of advice:
*First, know and understand the Reform Act's rules on forward-looking statements, as well as comparable state laws at least in your home state.
*Second, issue a forward-looking statement only after you have thought it through and researched the facts. If time does not allow a complete review of all facts in advance (for example, as it does not in the context of disclosing one-time charges in connection with the merger announcement), then recheck your facts and update your forward-looking statement after the time for haste has passed. Never rely on your lack of actual knowledge about whether the forward-looking statement is misleading.
Whenever you make an oral presentation to analysts or your shareholders, give the necessary precautionary statement and have a Form 8-K or Form 10-Q filed that you can point to for more information.
And if you make a substantial prediction, keep reviewing it in the context of your results and your disclosure posture to see if it would be fair or necessary to prepare an update. If you find yourself repeating the forward-looking statement or incorporating it into other filings, you should consider updating it each time.
Do not use the safe harbor as a cover for employing unjustifiable superlatives or for adopting puffery as an approach to disclosure. Remain upbeat but prudent.
Recognize when you are making forward-looking statements. Use the forward-looking-statement format whenever it appears appropriate.
It will not impress anyone to use the standard precautionary language in documents that include no forward-looking statements. But it will benefit you to know when you are making forward-looking statements and to make them carefully.
Mr. Janis is a partner in Pitney Hardin, a law firm active in financial institution acquisitions and securities law. He was assisted on this article by his partner Michael W. Zelenty.