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[2]  Bespeaks Caution and the Uncovered Forward-Looking Statement

[a]    Introduction

The Conference Report suggests that the safe harbor does not replace the judicially crafted bespeaks caution doctrine, stating: “The Conference Committee does not intend for the safe harbor provisions to replace the judicial ‘bespeaks caution’ doctrine or to foreclose further development of that doctrine by the courts.”[1] It is unlikely, however, that forward-looking statements made by issuers within the scope of the PSLRA safe harbor, but fail to meet the safe harbor criteria, will be protected by bespeaks caution. Nonetheless, some issuers will contend that a particular forward-looking statement that fails to meet the important factors criterion of the safe harbor is protected by bespeaks caution, and some courts applying the per se version of bespeaks caution will agree with them. The focus of this section, however, is on forward-looking statements made by issuers in connection with offerings that are outside of the scope of the PSLRA safe harbor.

The Supreme Court has not specifically considered the “be­speaks caution” doctrine, nor has it used that term. Justice Souter’s opinion in Virginia Bankshares[2] is relevant, however, since it dealt with the issue of materiality as applied to a form of “soft-information.” Defendants had argued that statements of opinion as to “fair price” and “high value” were not actionable because they were statements of opinion and belief and the disclosure document included other information from which the readers could draw their own conclusion as to the accuracy of the opinion. Justice Souter turned the opinions into representations by noting that “conclusory terms in a commercial context are reasonably understood to rest on a factual basis that justifies them as accurate, the absence of which renders them misleading.”[3] This is the same predicate for finding that forward-looking statements generally include a representation that they have a reasonable basis. See § 1_05_2. What is particularly relevant to the bespeaks caution doctrine is what Justice Souter had to say relating to defendant’s contention that there was adequate accurate information included elsewhere in the proxy statement. The issue to Justice Souter was one of materiality. The inclusion of “accurate facts in a proxy statement,” he opined, “can render a misleading proposition too unimportant to ground liability.”[4] But he had preceded this statement with a measure of what is required, by stating: “While a misleading statement will not always lose its deceptive edge simply by joinder with others that are true, the true statements may discredit the other one so obviously that the risk of real deception drops to nil.” The misleading statements, he also noted, remain misleading “[i]f it would take a financial analyst to spot the tension between the one and the other. . . . The point of a proxy statement, after all, should be to inform, not to challenge the reader’s critical wits.”[5]

Disclosure documents relating to an offering of securities necessarily contain a number of forward-looking statements, particularly with respect to a startup company. A company seeking to raise money necessarily must disclose what it plans to do in the future. Registrants filing on Form S-1 (or on Form 10 under the Exchange Act), which are not reporting companies and which have not received revenues from operations in each of the preceding three fiscal years, must include a description of their plan of operations, including a statement of registrant’s opinion as to the period of time that the proceeds from the offering will satisfy its cash requirements and whether it will be necessary in the next six months to raise additional funds.[6] In the case of natural resource companies, there are estimates of reserves which, in effect, are predictions as to the amount of the mineral that can be recovered at a profit.[7] In the case of limited partnership offerings relating to real estate projects and other activities limited to a single property or single activity, there are invariably projections of expected distributions to the partners over the life of the project, reflecting not only cash flow but the value of tax benefits, and a projected rate of return. In most Securities Act registration statement, management’s discussion and analysis has to be in­cluded, and it must discuss trends and uncertainties that may impact future liquidity, resources and results.[8] In a debt offering, there will be statements relating to the company’s ability to make the interest and principal payments. The typical disclosure document contains a number of cautionary statements vis-à-vis all of the above. No self-respecting securities practitioner would not have on his or her computer risk factors to cover such situations. The disclosure of risk factors is necessary in a registration statement not only because Item 503 (c) of Regulation S-K requires such disclosure, but to keep many of the forward-looking statements from being misleading. Although frequently commingled with a discussion of “bespeaks caution,” on one thing there is no disagreement. If the plaintiff contends that a forward-looking statement is misleading because of failure to disclose certain risks, and those risks are adequately disclosed, the statement is not actionable not because the prospectus bespeaks caution, but because the statement is not misleading.[9] The “bespeaks caution” doctrine, on the other hand, assumes that even if a forward-looking statement(s) is misleading it is not material because in the light of the cautionary statements investors would not have regarded it as important. The bespeaks caution situations are similar to Virginia Bankshares where the court acknowledged that a misleading statement of belief arguably if read together with other statements may render a “misleading proposition too unimportant to ground liability,” which is a materiality issue. To the extent it is an issue of materiality, in concept at least, the issue is the same whether it arises under Rule 10b-5, Section 11, or Section 12(2).

[b]    Bespeaks Caution and Reasonable Basis

Two Circuit Court of Appeals cases define some of the terms and purport to frame some of the issues relating to the bespeaks caution doctrine. The Third Circuit Court of Appeals in Trump Securities Litigation[10] defined soft information as “statements of subjective analysis or extrapolation, such as opinions, motives, and intentions, or forward-looking statements, such as pro­jec­tions, estimates, and forecasts.”[11] This appears to be an appropriate working definition modified to read forward-looking statements and statements of opinion and belief, although the latter may be redundant as opinions and belief typically have a forward-looking element.[12] The court in Trump defined bespeaks caution as follows:[13] “[W]hen an offering document’s forecasts, opinions or projections are ac­com­panied by meaningful cautionary statements, the forward-looking statements will not form the basis for a securities fraud claim if those statements did not affect the ‘total mix’ of information the document provided investors. In other words, cautionary language, if sufficient, renders the alleged omissions or misrepresentations immaterial as a matter of law.” The Ninth Circuit in In re Worlds of Wonder adopted the following definition of bespeaks caution:[14] “The doctrine holds that economic projections, estimates of future performance, and similar optimistic statements in a prospectus are not actionable when precise cautionary language elsewhere in the document adequately discloses the risks involved.”

Both Trump and Wonders involved forward-looking statements made in a prospectus relating to large offerings of junk bonds. In Trump, the bonds were sold to finance the completion and operation of the Taj Mahal casino; in the case of Worlds of Wonder, to finance the growth and continued operation of a recent start-up toy company that had initial success in marketing two product lines of toys (animated toy bears and infrared toy weapons). The Trump prospectus included the following statement: “‘The Partnership believes that funds generated from the operation of the Taj Mahal will be sufficient to cover all of its debt service (interest and principal).’”[15] The June 6, 1997 prospectus of Worlds of Wonder stated as follows: “The Company anticipates that the proceeds of this offering, together with cash flow from operations, existing lines of credit and new bank credit facilities presently being negotiated, will provide sufficient funds to meet the Company’s capital needs through March 31, 1988.”[16] Worlds of Wonder included the perfunctory “its operations would be adversely affected” if the predictive statement did not prove to be true and both prospectuses included cautionary statements about the risks of the business that are standard prospectus fare for securities practitioners, making it clear that there was no assurance that the predictive statements would prove to be correct. The two cases differ to the extent that in Trump the Third Circuit applied bespeaks caution as a matter of law on a motion to dismiss without any opportunity for discovery or for plaintiff to show that the belief as to the company’s ability to meet principal and interest had no reasonable basis. In Worlds of Wonder, there had been extensive discovery and the court considered the alleged misrepresentations in the light of the record developed in applying the doctrine and in granting defendants’ motion for summary judgment. The court, however, could not resist noting that one of the things it liked about bespeaks caution is that the “doctrine helps ‘to minimize the chance that a plaintiff with a largely groundless claim will bring a suit and conduct extensive discovery in the hopes of obtaining an increased settlement.’”[17]

The bespeaks caution doctrine is founded on the concept of materiality and, to the extent it is applicable, it is just as applicable to actions (civil and administrative) initiated by the Commission and criminal prosecutions for securities fraud. When Justice Souter and the Supreme Court held that statements of belief can be actionable under the federal securities law, that aspect of Virginia Bankshares was hailed by the then General Counsel to the Commission.[18] The Commission basically has sat on the sideline without much comment as the courts quietly developed the bespeaks caution concept. The Commission in accepting the safe harbor of the PSLRA referred to “[t]he need of legitimate businesses to have a mechanism for early dismissal of frivolous lawsuits argues in favor of codification of the ‘bespeaks caution’ doctrine that has developed under the case law.”[19] This, presumably, is predicated on the limited scope of the safe harbor in terms of issuers and offerings to which it is applicable.

[c]    Where the Circuits Stand

Judge Conti for the District Court for the District of Northern California has discussed extensively the origin of “bespeaks caution” and the extent of its acceptance among the various circuits.[20] According to this account, the doctrine originated in the language of a 1977 decision of the Eighth Circuit.[21] The doctrine was “more firmly established” by the Second Circuit[22] refusing to find liability because of alleged misrepresentations, stating “we are not inclined to impose liability on the basis of statements that ‘bespeak caution.’” The doctrine was subsequently reinforced in the Eighth Circuit[23] and adopted by the First[24] and Sixth[25] Circuit Courts of Appeals. Trump put the Third Circuit squarely in the “bespeaks caution” camp.[26] “Though this doctrine had not yet been adopted expressly by the Ninth Circuit,” Judge Conti noted, “the trend in the recent cases heavily favors adopting this approach,”[27] and “the bespeaks caution doctrine is consistent with the Ninth Circuit’s approach to securities fraud claims.”[28] The Fifth Circuit also is generally included among the jurisdictions recognizing the bespeaks caution doctrine.[29]

Judge Conti correctly anticipated that the Ninth Circuit (or at least a panel thereof) would adopt the “bespeaks caution” doctrine. It did so affirming Judge Conti on this aspect of the case, adopting his general approach, stating: “[T]he doctrine, when properly construed, merely represents the pragmatic application of two fundamental concepts of the law of securities fraud: materiality and reliance.”[30] To the argument that the doctrine may be applicable to Rule 10b-5 claims, but is not applicable to Section 11 claims, the court responded that bespeaks caution is primarily an issue of “materiality” and “applies equally to both statutory provisions.”[31] In the Section 11 and 12(2) context, the questions of whether it is an issue or materiality or reliance (in reality, justifiable reliance) is a critical one since reliance, let alone justifiable reliance, is not an element of a claim under either section.

With the addition of the Ninth Circuit, there were at least seven Circuit Courts of Appeals that subscribed to the bespeaks caution doctrine before the adoption of the PSLRA. A Tenth Circuit panel post-PSLRA has adopted bespeaks caution.[32] There are other appellate court decisions that have taken a more cautious approach in applying bespeaks caution. Interestingly, four of the circuits that are said to have adopted bespeaks caution since doing so have decisions by other panels that temper the court’s view.[33] See § 1.07[2][f].