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§ 1.07  Forward-Looking Statements Outside the PSLRA Safe Harbor

[1]  The Commission’s Safe Harbor Rules

The Commission has adopted safe harbor rules relating to projections and certain other forward-looking information included in documents filed under the Securities Acts.[1] The safe harbor rules encompass the several fraud provisions of the Securities Acts notwithstanding differences in their precise language and scienter requirements and the Supreme Court’s prior emphasis on these differences. See § 1_04_2. The adoption of the PSLRA safe harbor for forward-looking statements does not displace completely the Commission’s safe harbor, but diminishes its significance. The rules function by providing that a forward-looking statement made in compliance with the rules is not deemed to be a “fraudulent statement” under any relevant provision of the Securities Acts. The safe har­bor rules require that information to be protected by the rule have a reasonable basis and be disclosed in good faith. The rules require the plaintiff to carry the burden of proof on these issues; that is, the plaintiff must establish that the projections or other forward-look­ing information do not have a reasonable basis or were not dis­closed in good faith. The information covered by the financial forecasts rule includes, in addition to projections of revenues and earnings (losses), projections of capital expenditures, dividends, capital structure and other financial items; statements of manage­ment’s plans and objectives; certain aspects of management’s dis­cussion and analysis of the summary of earnings; and disclosed as­sumptions underlying or relating to any of the foregoing. The latter provision relating to assumptions is intended to encourage the dis­closure of assumptions, notwithstanding the fact that the guidelines relating to financial projections do not mandate their disclosure. Providing a safe harbor for management’s plan is particularly important to first-time registrants since such disclosure and re­lated estimates of the period of time for which the proceeds of the offering will satisfy cash needs are mandatory.[2]

The financial forecasts safe harbor rule extends to reporting companies (other than invest­ment companies) provided they are (1) current in the filing of their last an­nual report on Form 10‑K and (2) the forward-looking infor­mation appears in a document filed with the Commission or in an annual report to shareholders meeting the requirements of the proxy rules. It also extends to covered forward-look­ing statements made outside of filed documents provided such statements previously appeared in any of the foregoing or were subsequently reaffirmed in a filed document or annual report made publicly available within a reasonable time after the making of the forward-looking statement. This provision en­courages issuers to include their publicized projections in a current Form 8‑K. The rules are also applicable to forward‑looking state­ments made by a nonreporting company in a registration statement filed under the Securities Act of 1933 and offering circulars filed pursuant to Regulation A. It is not applicable, how­ever, to forward-looking state­ments by a nonreporting com­pany which appear in a Regulation D offering memorandum. The rule protects only forecasts made by the issuer or an outside reviewer retained by the issuer. The rule would not, for example, protect projections of analysts.

Rule 175 is specifically applicable to certain information furnished by oil and gas producers either voluntarily or pursuant to Item 302 of Regulation S-K.^[3] The information covered includes the value of proved oil and gas reserves, including the standardized measure of discounted future net cash flows relating to such reserves as set forth in SFAS No. 69. The rule is an outgrowth of the Commission’s experimentation with reserve recognition accounting for oil and gas produc­ers. It applies to the unaudited supplementary information which is required to accom­pany the financial statements of oil and gas producers. See § 5.08[6]. Rule 3b-6 of the Exchange Act does not include this specific coverage, but the failure to do so appears to be of no moment, since Rule 3b-6 is essentially redundant. It is not entirely clear whether the PSLRA safe harbor is applicable to estimates of oil and gas or other mineral reserves. See § 1.06[4]. For companies within the PSLRA safe harbor, the SEC’s safe harbor presumably is pre-empted for the most part as it is difficult to comprehend how it could apply protection not available under the PSLRA. See § 1.06[3]. The SEC’s safe harbor is applicable, however, to a number of issuers and a number of offerings to which the PSLRA is not. See § 1.06[2], [4]. Probably the most significant in this regard is an initial public offering registered under the Securities Act.[4]

The Commission in October of 1994 published a concept release in which it sought comment on how the safe harbor for forward-looking information could be revised to broaden the scope of its coverage and in February of 1995 held a public hearing on the issue, but failed to adopt revisions to the safe harbor rules.[5] The adoption of the PSLRA safe harbor turned this into an academic exercise. See § 1.06. The Commission, however, does have authority under the PSLRA to add by rule a safe harbor (exemption from liability) for other forward-looking statements.[6]

The Commission’s safe harbors for forward-looking statements, much maligned as inadequate, is being used by some courts post-PSLRA to dismiss allegations of fraud based on forward-looking statements included in filed documents. Plaintiffs must allege with particularity why such statements do not have a reasonable basis and this may be no easy matter. Defendant company’s representations that a product under development would attain $30 to $40 million in sales when introduced in the European market and predicting a specific launch date were forward-looking statements. Although neither prediction proved to be correct, plaintiffs had failed to allege with particularity any facts other than such failure demonstrating that the prediction had no reasonable basis.[7] Similarly, the representation by a sporting goods manufacturer in a Form 10-K that the 1994 major league baseball strike would not significantly affect its non-major league baseball sales was a forward-looking statement and conclusory allegations that such representations did not have a reasonable basis are not adequate.[8]

A decision of the Eighth Circuit is very interesting.[9] Plaintiff alleged that certain forward-looking statements in an IPO prospectus “were false and had no reasonable basis because [the defendants] knew that there were no valid assumptions underlying the projections.” The court earlier in the opinion held that claims asserted pursuant to Section 11 or 12(2) do not sound in fraud and, therefore, Rule 9(b) is not applicable to such claims. See § 11.09. The court held that these allegations were sufficient to plead the lack of a reasonable basis both for purposes of a Section 11 and Section 12(2) claim. Such “claims do not involve fraud, and the plaintiffs did not have to plead specific facts to avoid the safeharbor rule.”[10] On the other hand, since Rule 9(b) is applicable to Rule 10b-5 claims, the court held that the pleading of the same allegations relating to the same representations as inadequate to satisfy Rule 3b-6,[11] the Exchange Act counterpart to Rule 175. “While these statements are ‘short and plain’ enough for Federal Rule 8(a), and therefore are sufficient to avoid the safeharbor rule for the §§ 11 and 12(2) claims, they do not include enough particular facts to show management’s allegedly fraudulent statements lacked a reasonable basis.” The court’s conclusion as to the adequacy of the pleading in the light of plaintiff’s burden of proof under Rule 175 contrasts with the holding of courts that as to the Section 13 statute of limitations. In that context courts have held that because the plaintiff has the burden of proof on this issue the complaint must set forth sufficient facts from which it may be inferred that the one-year period since discovery of the fraud has not elapsed. See § 11.18[5].

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SECTION 4
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[1]  The Commission’s Safe Harbor Rules

The Commission has adopted safe harbor rules relating to projections and certain other forward-looking information included in documents filed under the Securities Acts.[1] The safe harbor rules encompass the several fraud provisions of the Securities Acts notwithstanding differences in their precise language and scienter requirements and the Supreme Court’s prior emphasis on these differences. See § 1.04[2]. The adoption of the PSLRA safe harbor for forward-looking statements does not displace completely the Commission’s safe harbor, but diminishes its significance. The rules function by providing that a forward-looking statement made in compliance with the rules is not deemed to be a “fraudulent statement” under any relevant provision of the Securities Acts. The safe har­bor rules require that information to be protected by the rule have a reasonable basis and be disclosed in good faith. The rules require the plaintiff to carry the burden of proof on these issues; that is, the plaintiff must establish that the projections or other forward-look­ing information do not have a reasonable basis or were not dis­closed in good faith. The information covered by the financial forecasts rule includes, in addition to projections of revenues and earnings (losses), projections of capital expenditures, dividends, capital structure and other financial items; statements of manage­ment’s plans and objectives; certain aspects of management’s dis­cussion and analysis of the summary of earnings; and disclosed as­sumptions underlying or relating to any of the foregoing. The latter provision relating to assumptions is intended to encourage the dis­closure of assumptions, notwithstanding the fact that the guidelines relating to financial projections do not mandate their disclosure. Providing a safe harbor for management’s plan is particularly important to first-time registrants since such disclosure and re­lated estimates of the period of time for which the proceeds of the offering will satisfy cash needs are mandatory.[2]

The financial forecasts safe harbor rule extends to reporting companies (other than invest­ment companies) provided they are (1) current in the filing of their last an­nual report on Form 10‑K and (2) the forward-looking infor­mation appears in a document filed with the Commission or in an annual report to shareholders meeting the requirements of the proxy rules. It also extends to covered forward-look­ing statements made outside of filed documents provided such statements previously appeared in any of the foregoing or were subsequently reaffirmed in a filed document or annual report made publicly available within a reasonable time after the making of the forward-looking statement. This provision en­courages issuers to include their publicized projections in a current Form 8‑K. The rules are also applicable to forward‑looking state­ments made by a nonreporting company in a registration statement filed under the Securities Act of 1933 and offering circulars filed pursuant to Regulation A. It is not applicable, how­ever, to forward-looking state­ments by a nonreporting com­pany which appear in a Regulation D offering memorandum. The rule protects only forecasts made by the issuer or an outside reviewer retained by the issuer. The rule would not, for example, protect projections of analysts.

Rule 175 is specifically applicable to certain information furnished by oil and gas producers either voluntarily or pursuant to Item 302 of Regulation S-K.^[3] The information covered includes the value of proved oil and gas reserves, including the standardized measure of discounted future net cash flows relating to such reserves as set forth in SFAS No. 69. The rule is an outgrowth of the Commission’s experimentation with reserve recognition accounting for oil and gas produc­ers. It applies to the unaudited supplementary information which is required to accom­pany the financial statements of oil and gas producers. See § 5.08[6]. Rule 3b-6 of the Exchange Act does not include this specific coverage, but the failure to do so appears to be of no moment, since Rule 3b-6 is essentially redundant. It is not entirely clear whether the PSLRA safe harbor is applicable to estimates of oil and gas or other mineral reserves. See § 1.06[4]. For companies within the PSLRA safe harbor, the SEC’s safe harbor presumably is pre-empted for the most part as it is difficult to comprehend how it could apply protection not available under the PSLRA. See § 1.06[3]. The SEC’s safe harbor is applicable, however, to a number of issuers and a number of offerings to which the PSLRA is not. See § 1.06[2], [4]. Probably the most significant in this regard is an initial public offering registered under the Securities Act.[4]

The Commission in October of 1994 published a concept release in which it sought comment on how the safe harbor for forward-looking information could be revised to broaden the scope of its coverage and in February of 1995 held a public hearing on the issue, but failed to adopt revisions to the safe harbor rules.[5] The adoption of the PSLRA safe harbor turned this into an academic exercise. See § 1.06. The Commission, however, does have authority under the PSLRA to add by rule a safe harbor (exemption from liability) for other forward-looking statements.[6]

The Commission’s safe harbors for forward-looking statements, much maligned as inadequate, is being used by some courts post-PSLRA to dismiss allegations of fraud based on forward-looking statements included in filed documents. Plaintiffs must allege with particularity why such statements do not have a reasonable basis and this may be no easy matter. Defendant company’s representations that a product under development would attain $30 to $40 million in sales when introduced in the European market and predicting a specific launch date were forward-looking statements. Although neither prediction proved to be correct, plaintiffs had failed to allege with particularity any facts other than such failure demonstrating that the prediction had no reasonable basis.[7] Similarly, the representation by a sporting goods manufacturer in a Form 10-K that the 1994 major league baseball strike would not significantly affect its non-major league baseball sales was a forward-looking statement and conclusory allegations that such representations did not have a reasonable basis are not adequate.[8]

A decision of the Eighth Circuit is very interesting.[9] Plaintiff alleged that certain forward-looking statements in an IPO prospectus “were false and had no reasonable basis because [the defendants] knew that there were no valid assumptions underlying the projections.” The court earlier in the opinion held that claims asserted pursuant to Section 11 or 12(2) do not sound in fraud and, therefore, Rule 9(b) is not applicable to such claims. See § 11.09. The court held that these allegations were sufficient to plead the lack of a reasonable basis both for purposes of a Section 11 and Section 12(2) claim. Such “claims do not involve fraud, and the plaintiffs did not have to plead specific facts to avoid the safeharbor rule.”[10] On the other hand, since Rule 9(b) is applicable to Rule 10b-5 claims, the court held that the pleading of the same allegations relating to the same representations as inadequate to satisfy Rule 3b-6,[11] the Exchange Act counterpart to Rule 175. “While these statements are ‘short and plain’ enough for Federal Rule 8(a), and therefore are sufficient to avoid the safeharbor rule for the §§ 11 and 12(2) claims, they do not include enough particular facts to show management’s allegedly fraudulent statements lacked a reasonable basis.” The court’s conclusion as to the adequacy of the pleading in the light of plaintiff’s burden of proof under Rule 175 contrasts with the holding of courts that as to the Section 13 statute of limitations. In that context courts have held that because the plaintiff has the burden of proof on this issue the complaint must set forth sufficient facts from which it may be inferred that the one-year period since discovery of the fraud has not elapsed. See § 11.18[5].