§ 5_13                   

When is a Forward-Looking Statement False or Misleading?

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If plaintiff overcomes the first and second prong (e.g., no cautionary statements and forward-looking statement setting forth projection of current quarter earnings is deemed material), leaving aside for the moment the question of who must know, the second prong of the safe harbor requires plaintiff to allege and prove that the appropriate person(s) have “actual knowledge . . . that the [forward-looking] statement was false or misleading.” The first prong (adequate cautionary statements) may or may not delve into the issue of whether the statement is false or misleading. See § 5_7 to 5_11. The second prong, however assumes that the forward-looking statement is false or misleading; if it is not, there is no need to consider materiality or its falsity.  The second prong specifically refers to forward-looking statements that are false or misleading. Forward-looking statements, however, by their nature cannot be false,[1] except in the limited sense that the maker may expressly or impliedly represent that s/he believes the statement when s/he does not. The situation in which they are misleading invokes the third prong of Apple Computer — a failure to disclose existing facts that seriously undermine the statement. Does it also invoke the first prong of Apple Computer that such statements imply that they have a reasonable basis?[2] It is apparent that the focus of the first prong of the safe harbor is on the adequacy of the cautionary statements and not on reasonable basis as the purpose of the first prong of the safe harbor is to permit a court to dismiss the complaint on a motion to dismiss if there are adequate cautionary statements. See § 5_9. The Statement of Managers of the Conference Committee alluded to Rule 175 (which, in order to make the safe harbor unavailable, requires proof of lack of a reasonable basis OR that it was not made in good faith) as not providing “companies meaningful protection from litigation.”[3] Arguably, the meaningful cautionary statement prong of the safe harbor is intended to overcome this aspect of what was wrong with the safe harbor, but lack of a reasonable basis and defendants’ knowledge concerning such lack remains an aspect of the actual knowledge prong. This does not contribute to the objective of providing a basis for early dismissal, but the second prong generally does not contribute to that objective. The basis for early dismissal under the second prong is found in the enhanced pleading requirement relating to state of mind generally (see § 3.02) and the requirement of actual knowledge as distinguished from recklessness. In the real world, lack of reasonable basis and undermining facts are likely to overlap. Because of pleading difficulties, if the second prong of the safe harbor is reached, it is likely to be on the basis of failure to disclose known existing facts that seriously undermine the forward-looking statement.

None of the above as to what can be false or misleading about a forward-looking statement, however, can be said with assurance. In Virginia Bankshares, Justice Souter stated that “proof of mere disbelief or belief undisclosed should not suffice for liability.”[4] His reason for doing so was that to base a case solely “on psychological inquiry alone would threaten just the sort of strike suits and attrition by discovery that Blue Chip Stamps [Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 734-35 (1975)] sought to discourage.”[5] Justice Scalia noted that this analysis was contrary to the common law which allowed a claim to be asserted based on proof that the party stating a belief did not in fact have such belief. That was all right with Justice Scalia (i.e., Justice Souter’s view that it was not actionable) since the claim was an implied claim never authorized by Congress: “I have no problem with departing from modern tort law in this regard, because I think the federal cause of action at issue here was never enacted by Congress, . . . and hence the more narrow we make it (within the bounds of rationality) the more faithful we are to our task.”[6] But Congress appears here to put the question of belief in issue, having taken care of its concerns about strike suits in the first prong and of discovery in other provisions of the Act.[7] See § 4.01]. Justice Souter also held, referring to a representation that shareholders in connection with a proposed merger were being given the opportunity to “achieve a high value for their shares,” 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.”[8] This appears to be saying that the absence of a reasonable basis makes such statements false or misleading. In addition to the Statement of Managers, Senators expressed concern[9] about a “reasonable basis” safe harbor requirement and it is not entirely clear whether availability of the first prong dispels with those concerns.

The proponents of the safe harbor, in their repeated assertion that the safe harbor is not a license to lie, repeatedly referred to the actual knowledge prong, but generally in terms that suggest whether forward-looking statements are false or misleading is self definable. Mrs. Feinstein did state, and Senator Dodd concurred,[10] that “the safe harbor does not apply if the statement is made with ‘actual knowledge’ that the statement was ‘an untrue statement of a material fact or omission of a material fact necessary to make the statement not misleading.’” Senator Reid, refuting an editorial in Money Magazine, said, “[e]xecutives who deliberately lie about their company’s prospects would be liable under the compromise.”[11] These statements as a minimum appear to embrace the third prong of Apple Computer that a forward-looking statement is misleading if there is a failure to disclose known facts that seriously undermine the statement. But even that is not clear; Senator Bennett in defending the safe harbor gave an example as what should be protected and was not under the prior law that is close to what was involved in Apple Computer,[12] referring to a chief executive who receives conflicting advice from his engineers as to how close the product is to being ready for market and fails to disclose the negative opinion of the one engineer, stating: “And, there you are, you have made a false statement. And, ‘If you did not know the product was defective, you should have known the product was defective.’”[13] The real issue here appears to be whether the CEO in the light of the conflicting advice at worse has made an error of judgment or knew that when the marketability date was so uncertain that it was misleading to predict an optimistic date.

If the legislative history had not been made so explicit by the President’s veto and emphasis on the Statement of Managers with respect to the first prong, the language itself is not inconsistent with the third prong of Apple Computer that it is misleading and fraudulent to make a forward-looking statement without disclosing facts that the defendants know seriously undermine the statement. This is particularly true if generic boilerplate disclosure is not adequate for this purpose. On the surface, the requirement that “meaningful cautionary statements identifying important factors” be set forth lends itself to the construction that they are not meaningful if facts that seriously undermine the statement are not disclosed. This does not entail determining the maker’s state of mind, but the second prong comes into play and requires that the maker have actual knowledge of the undermining facts. One would have to ignore the Statement of Managers to reach this conclusion, however, and/or place an undue emphasis on the repeated statements of the proponents that the safe harbor does not permit one to knowingly make false or misleading statements. See § 5_8.