§ 5_15                   

Who is the Maker of the Forward-Looking Statement?

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The second prong (proof of actual knowledge) requires plaintiff to prove in order to make the safe harbor unavailable the following:[1]

(i) if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; or

(ii) if made by a business entity; was —

      (I) made by or with the approval of an executive officer of that entity, and

      (II) made or approved by such officer with actual knowledge by that officer that the statement was false or misleading.

This provision is confusing, notwithstanding that it follows closely the suggestion of the SEC in terms of referring to the knowledge of the person making the statement.[2] First, it appears to suggest an either/or approach — that forward-looking statements are made either by an individual acting on his/her own behalf or by a business entity, since it distinguishes between forward-looking statements made by a natural person and forward-looking statements made by a business entity.[3] Given the fact that individuals offer their own securities only under limited circumstances that are unlikely to otherwise be within the safe harbor, it is apparent that this provision relates to an individual making a forward-looking statement (e.g., an employee responsible for financial public relations) on behalf of the issuer with knowledge that it is misleading.[4] The corporate issuer, however, has liability only if the misleading forward-looking statement is made by or with approval of an executive officer and the executive officer who made or approved the statement had actual knowledge that it was misleading.[5] Aside from the issue of who is an executive officer, it is likely that forward-looking statements of an issuer are made with at least the tacit approval of an executive officer and with adequate discovery plaintiffs probably could establish the officer who authorized the statement and, possibly, that such officer had actual knowledge that it was false or misleading. But given the specificity required in pleading and limitations on discovery (see §§ 3.03, 4.01), it will be the unusual situation in which plaintiffs know which officer made or approved the statement and facts that establish that person’s knowledge that it was false or misleading. In the case of the underwriter entity, it would not be unusual as to a run of the mill underwriting by a major investment banking firm that no executive officer of the underwriter was directly involved in preparing or reviewing the registration statement and that no executive officer had knowledge that the forward-looking statement was false or misleading.

Second, the provision is susceptible to and may require the construction that only the persons making the forward-looking statement or approving it have liability; that liability does not extend to others (e.g., directors and other officers) who knew of the misrepresentation but did not make the statement. To this extent, this provision exacerbates problems associated with an already difficult area of distinguishing between primary and secondary violators, which is of increased significance because of the failure of Congress in the securities litigation reform legislation, notwithstanding the SEC’s request that it do so, to impose liability on aiders and abettors. It is difficult to understand why the Commission would recommend language that exacerbates that problem.

To limit liability for forward-looking statements to the natural persons who made the statement would be an unduly narrow construction, however, particularly in the context of a registration statement filed under the Securities Act. The statements made in the registration statement, including the prospectus, except for statement of experts, are not made by any individual, but are made by the company. The authorization by the executive officers of the company is apparent by the fact that the registration statement is signed by appropriate company officers on behalf of the company. The registration statement is also signed by certain specified officers and by a majority of the board of directors. All of the signatories plus the directors who do not sign the registration statement have liability under Section 11 for false or misleading representations in the registration statement. Unless Section 11 is to be completely subverted with respect to officer and director liability for forward-looking statements in the registration statement, it is necessary to conclude that the officers signing the registration statement and all the directors made the forward-looking statement. If that were not so, the actual knowledge part of this provision relating to individuals is redundant in this context. This provision requires that plaintiff prove as to each defendant that they intend to hold liable that they had actual knowledge that the forward-looking statement was false or misleading. In this respect, it overrides the provision of Section 11(b)(3) that requires defendants to carry the burden of proof that they had made a reasonable investigation as to the non-expertised portion of the registration statement and had reasonable grounds to believe the statements to be true and not misleading. See  § 1.02[7]. Similarly, if plaintiff fails to prove actual knowledge of the officer authorizing the forward-looking statement that it is false or misleading, the issuer avoids the absolute liability otherwise imposed on issuers for material false or misleading statements. See  § 1.02[5].

The more difficult issue is whether anyone other than the actual maker of the statement and the issuer, if the statement is authorized by an executive officer, have made forward-looking statements that appear outside of a Securities Act registration statement. The formal filings under the Exchange Act (Forms 8-K, 10-Q, and 10-K) are obviously statements of the issuer and authorized by the issuer. All are executed by the issuer and signed on its behalf by an officer of the company. Unlike the Securities Act, which sets forth in Section 6(a) by whom the registration statement is signed, the signature requirements relating to ’34 Act filings are found in the forms and the regulations. The Form 10-K is the most specific in this respect mimicking Section 6(a) of the Securities Act, except it refers to controller rather than comptroller, and in detailing the signatories other than the registrant refers to such signatures as being “on behalf of the registrant.”[6] When the Commission expanded the Form 10-K signature requirements beyond that of the registrant in 1980, it noted: “In the Commission’s view this added measure of discipline [for the signatories] is vital to the disclosure objectives of the federal securities laws, and outweighs the potential impact, if any, of the signature on legal liability.”[7] This provides some basis for asserting that all the signatories made the statement, but leaves the issue of whether the non-signing directors made the statements. Further, in determining the adequacy of pleading for purposes of Rule 9(b), the courts have been reluctant to assume that outside directors have responsibility for filed documents.[8] Some courts, as astounding as it may seem, absolve outside directors of responsibility, absent more, for “merely” signing group published documents.[9] The annual report is not signed by anyone, although it must include much of the same information as the Form 10-K. The annual report is likely to include a president’s letter, and this may be the source of many of the forward-looking statements. Who beyond the issuer and the president will be deemed to have made the statement is not clear; arguably, no one.

The requirement that the maker of the statement have actual knowledge and the issuer is responsible only for statements authorized by an executive officer with actual knowledge that it is false or misleading, although all embracing, seems to be directed primarily at and fits better situations in which forward-looking statements are made in unstructured disclosure outside of filed documents. If the CEO makes a forward-looking statement, for example, s/he and the company are not to be charged with the knowledge of some subordinate. If a non-executive officer employee makes a statement to an analyst and it is not authorized by an executive officer, the company is not responsible for the statement. If authorized, the company is responsible only if the authorizing officer knew it was false or misleading. Senator Domenici referring to this provision stated: “This will prevent the situation under current law which permits lawsuits to go forward based upon the existence of a memo or electronic mail by a low-level employee who disagrees with management’s projection.”[10] The Senator, presumably, was assuming that the executive officer who made or authorized the statement was not aware of the memo. This, of course, can be the situation with respect to forward-looking statements made in filed documents, but is more likely to be the situation in the case of unstructured disclosure.

It is interesting to note that the safe harbor is applicable to forward-looking statements made by a “person acting on behalf of the issuer” as well as statements made by the issuer.[11] That term (“person acting on behalf of an issuer”) is defined as “an officer, director, or employee of the issuer.”[12] On the assumption that employee refers to an authorized employee, such as an employee in charge of shareholder public relations, such employee may not be an executive officer. Further, the employee may routinely make public statements on behalf of the company without consulting an executive officer. Presumably, however, if the employee has general authority to make such statements, the employee is authorized to make the statement. By whom authorized, however, may vary from company to company, although one might assume that the CEO gave the general authorization. Plaintiffs, however, have to allege all of this with particularity and without the benefit of discovery, which may be no easy task. Further, the public relations employee may have made specific forward-looking statements without consulting the executive officer and may have unfavorable information not known to the executive officer. The company and the executive officer, but not the public relations employee, would appear to have the benefit of the second prong under these circumstances. There is a built-in disincentive for executive officers to be informed, although there are obviously other and usually more important reasons for executive officers to remain informed about the statements being made by its financial public relations employees, not the least of which is the company’s credibility.