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In at least four Circuit Courts of Appeals, there are also decisions that reject the Trump-like per se application of bespeaks caution. The most instructive may be the decision of the Sixth Circuit in Mayer v. Midol.[1] The court re-examined the earlier decision of the Sixth Circuit in Sinay v. Lamson & Sessions Co.,[2] concluding that although decided shortly after the Supreme Court’s decision in Virginia Bankshares,[3] Sinay had not taken Virginia Bankshares into account as evidenced by the court’s failure to cite it. The court first noted that in Sinay:[4] “[t]his court held that beliefs about future earnings which turn out to be incorrect are not actionable under Section 10(b) if the statements contain sufficient cautionary language.”[5] The court in Mayer then said:[6]

Sinay is not entirely consistent with Virginia Bankshares. The court in Virginia Bankshares noted, “publishing accurate facts in a proxy statement can render a misleading proposition too unimportant to ground liability,” which is similar to the Sinay court’s statement that predictions are not actionable if accompanied by words of caution. . . . However, the court in Virginia Bankshares went on to say “But not every mixture with the true will neutralize the deceptive. If it would take a financial analyst to spot the tension between the one and the other, whatever is misleading will remain materially so, and liability should follow.” . . . Therefore, the central point of Sinay, that a claim is insufficient as a matter of law if optimistic opinions are coupled with cautionary statements, partially conflicts with Virginia Bankshares because Virginia Bankshares contemplates a weighing of the true with the untrue statements in an announcement for liability to result.

The court reversed the district court, which had granted defendant’s motion to dismiss in reliance on Sinay. It may be pertinent to note that Judge Souter in discussing the weighing process in Virginia Bankshares also said that the offsetting statement must “discredit the other one [the misleading statement] so obviously that the risk of real deception drops to nil.”[7]

Worlds of Wonder is one of three cases[8] involving Section 11 decided by the Ninth Circuit in a period of less than 35 days. The three panels consisted of eight different judges (one of whom was sitting by designation from the Eighth Circuit); only Judge Cynthia Hall who wrote the opinion in Worlds of Wonder and Software Toolworks[9] participated in more than one of the panels. In Toolworks, Judge Hall agreed with the district court, which granted defendants’ motion for summary judgment, that the underwriter, as to most of the alleged misrepresentations, made a reasonable investigation and had no grounds to believe that the statements were false or misleading. The registrant, with the concurrence of its accountants, had been following (a familiar refrain) aggressive accounting principles in recognizing revenues. These practices surfaced shortly before the registration statement became effective with a story in Barron’s to that effect. The story triggered an inquiry by the Commission’s staff relating specifically to the financial results for the first quarter of the current fiscal year, which were not included in the prospectus. The company responded to the SEC’s inquiry with a letter, which had been drafted with the assistance of the underwriter and the accountants, stating, among other things, that preliminary results for the quarter were not yet available. The company, however, predicted that revenues for the quarter would be as great as their projections without disclosing that a significant portion of those revenues consisted of consignment contracts, which subsequently resulted in returned merchandise and a reduction in revenues of $7 million. The court concluded that to recognize such revenues would make the financial information misleading and that such misrepresentation would be material.[10] In terms of the responsibility of the underwriter and the accounting firm, the court concluded in view of their participation in drafting the response to the SEC that summary judgment was not appropriate since such participation raised a disputed issue as to what they knew or should have known concerning such contracts.[11]

None of the Worlds of Wonder panel of judges were on the panel that approximately four weeks later decided Kaplan v. Rose.[12] The company prior to going public in June of 1984 was engaged in developing and marketing a system, referred to as lithotripsy, that treated kidney stones by disintegrating the stones with soundwaves, thus avoiding invasive surgery. In January of 1988, the company received permission from the FDA to commence clinical trials using its system for the treatment of gallstones. This was a significant development since lithotripsy was fairly well established for treating kidney stones, but at the time was experimental for treating gallstones. The first to develop lithotripsy that was successful in treating both would have a significant competitive advantage.

The company’s initial public offering was made in June of 1988. The prospectus stated: “The Company believes the Medstone System compares favorably with other lithotripters presently being offered by competitors with respect to the precision of its imaging system . . . and its success rate in treating patients.” The prospectus also included the following statement: “The Medstone [lithotripsy system] has been used successfully to treat kidney stone patients since October 1986 and gallstone patients since January 1988.” These representations were at the core of plaintiffs’ Section 11 claim. The court held, reversing the district court, that both of these statements raised disputed issues of fact that precluded granting defendant’s motion for summary judgment.

The foregoing representations were undermined by the fact that the company had received (and apparently based its representations on) a report of preliminary results from Baylor University. That report stated that five of 27 patients, or 17.5 percent, showed significant fragmentation of their gallstones (to fragments less than or equal to three millimeters) within 24 hours of treatment with the Medstone system. Those patients were classified as “successes.” The New England Journal of Medicine was reporting about the same time the results of a German company, which was the registrant’s main competitor, which showed that 139 of 175 patients, or almost 80 percent, had no stones or had significant fragmentation (also to fragments less than or equal to three millimeters) within 24 hours of treatment.

The “Risk Factors” section of the Prospectus stated: “To date the System has only been used at one hospital on a limited number of patients. No assurance can be given that the clinical trials for the use of this System in treating patients with gallstones under the IND/IDE [the FDA approval to conduct clinical trials] will be successful.” Judge Boochever speaking for the court acknowledged that the Ninth Circuit as a result of Worlds was now in the bespeaks caution camp. The doctrine, however, was not applicable to the alleged misrepresentations noted above. “While the statement that no assurance can be given that the clinical trials ultimately will be successful might ‘bespeak caution’ as to the future success of clinical trials . . . at least a jury question remains whether it neutralized Medstone’s statement that its system already had been used successfully and was thus competitive.”[13]

This is an appropriate application of Virginia Bankshares.[14] There were representations that a jury reasonably could conclude were misleading. Whether the cautionary statements neutralized the statements was also for the jury. Fortuitously for the plaintiffs, a competitor had achieved better results. Although the court took pains to distinguish Worlds, the ultimate question of success depended on the FDA granting approval of the company’s application, which ultimately was denied on October 20, 1989 because it lacked “reasonable assurance that the device is effective.”[15] This is why the company “failed” (and would have been just as true if the company had no competitors) and the investors were cautioned that the work done was preliminary and used on a limited number of patients and that there was no assurance that it would be successful in obtaining FDA approval. The claim that preliminary results were successful was important to an investor’s decision and if not true would have been as misleading whether or not there was a competing product being developed.

In Rubinstein v. Collins,[16] which is one of the cases the Statement of Managers’ Conference Report cites as adopting the bespeaks caution doctrine,[17] the district court dismissed a Rule 10b-5 claim alleging misrepresentations relating to estimates of oil and gas reserves, holding that economic forecasts and predictions are not actionable when such statements are couched in cautionary language. The Fifth Circuit reversed, as in its view the district court had applied the bespeaks caution doctrine as a per se bar to liability.[18] “[C]autionary language is not necessarily sufficient, in and of itself, to render predictive statements immaterial as a matter of law.”[19] Rather, “materiality is not judged in the abstract, but in light of the surrounding circumstances.”[20] Summary judgment was inappropriate in view of the allegations that the prediction of gas reserves and future revenues to be generated from such reserves resulting from discovery of a new field was misleading because of failure to disclose a drop in pressure that occurred shortly after production commenced that suggested the field might have significantly less reserves than predicted.[21]

Another panel of the Third Circuit, subsequent to Trump, held (2-1) that the bespeaks caution doctrine did not entitle an attorney to summary judgment in connection with a Rule 10b-5 action alleging that his opinion relating to the tax treatment of losses incurred in connection with a commodities trading program being sold by his client was false and misleading.[22] The cautionary statements included the assumption that the facts set forth therein were correct (including the critical assumption that the transactions engaged in “will be for the purpose, and with a reasonable expectation, of economic gain”) and that the Internal Revenue Service might disagree with his conclusion and assess a tax.[23] The majority started with the premise that “[t]his court has generally recognized securities fraud claims based on allegations of misrepresentations in opinion letters. We have held that an opinion or projection, like any other representation, will be deemed untrue for purposes of the federal securities laws if it is issued without reasonable genuine belief or if it has no basis.”[24] The cautionary statements were not effective in light of the plaintiffs’ allegations, which the court construed to be to the effect that defendant implicitly represented that the assumed facts were true. The court analogized the situation to one of which the Southern District of New York had said:[25] “Plaintiffs . . . challenge more than just the future forecasts and predictions in the offering materials. They argue that the underlying assumptions of the PPMs, tax opinions and projections were designed to mislead the investors into believing that the partnership investments offered them the opportunity to achieve a profit and a tax benefit from their investment, when in reality defendants knew that these possibilities did not exist.” The dissent, however, argued that “[i]t stands to reason that where opinion letters regarding a potential investment — even those prepared with scienter — ‘bespeak caution,’ reasonable investors should not rely on the representations in them.”[26] The majority had, as the dissent pointed out, acknowledged that the doctrine would have been applicable if the plaintiffs had relied solely on the tax conclusion,[27] but plaintiffs also relied on the implicit statement that the assumed facts were accurate. The majority said in this regard that “for the doctrine [bespeaks caution] to even conceivably preclude plaintiffs’ claims in this case it would be necessary for the letters to have included a disclaimer stating, in essence, that there was a possibility that Arvey did know otherwise and that the opinion letter was a sham commissioned to construct a facade of legitimacy for a trading program that both First Western and Arvey knew was a farce.”[28] To which, the dissent says the majority confused scienter with reasonable reliance and it was not reasonable for the investors to rely on the attorney’s representations, implicit or otherwise, in this regard.[29] This type of difference of opinion is relevant because the claim was based on Rule 10b-5 and the view of some courts that plaintiffs cannot assert a Rule 10b-5 claim if they failed to exercise appropriate care.[30]

One week before the Conference Committee reported, a Ninth Circuit panel reversed a holding of a district court judge for the Northern District of California that applied bespeaks caution to dismiss a Rule 10b-5 claim pursuant to Rules 9(b) and 12(b)(6) without leave to amend.[31] The Ninth Circuit panel held:[32] “The cautionary statements cited by the district court, when considered against the backdrop of the allegations set forth in Paragraph 59 of the Complaint (‘Price Company’s Undisclosed Adverse Information’) — allegations which at this stage we must accept as true, — do not ‘so obviously’ render the challenged public documents not misleading as to permit the adequacy of the disclosure to be determined as a matter of law.”

The Price Company’s stock declined from $45 per share to $32 a share immediately after it announced lower net income for the first quarter of 1992 compared with the same quarter for the prior year; this was the first decline in earnings in the company’s history. The complaint was filed on the day following the announcement, but by the time the case was decided on the motion to dismiss the plaintiff had filed its second amended complaint. That complaint alleged that defendants in a series of public statements, including those filed in ’34 Act reports, shareholder reports, newspaper interviews, guidance given to analysts represented that the company was successfully expanding its retail warehouse operations, stating among things, that the company “anticipates a continuation of its accelerated expansion program” and predicting “an overall improvement in the sales trend due [in part] to a large number (24) of new Price Clubs.” The first statement in the view of the court “could reasonably be interpreted as conveying a level of confidence in the continued viability of the expansion program.”[33] The plaintiffs alleged these representations were misleading for failure to disclose the company was experiencing consistent losses in almost all of the new stores; initial sales volumes were below expectations and the level necessary to achieve profitable operations; the expansion program was seriously impacting the company’s profitability, and there was no reasonable basis for the forecasts concerning the expansion program.[34]

One of the defendant’s problems, perhaps, was that the statements the district court interpreted as cautionary statements were of a backhanded nature. Thus, the statement that the company “felt a little more optimistic about our near term future than we did at the end of the last quarter” was interpreted by the district court as an admission that the company was not too happy with what was going on and similarly the district court regarded the statement that “earnings may not increase at as high a rate as sales because of the . . . operating costs associated with opening new Price Clubs” as a cautionary statement. The Ninth Circuit panel concluded that “the mix of information contained in the public documents issued by the Company does not clearly preclude ‘reasonable minds’ from differing on the question of whether they included misleading statements.”[35]

It is not surprising in view of its conclusion that the court noted that “[i]nclusion of some cautionary language is not enough to support a determination as a matter of law that defendants’ statements were not misleading,” citing Virginia Bankshares.[36] Nor is it surprising that the court relied upon[37] the oft-quoted statement in TSC Industries that determination of whether an omission is material “requires delicate assessments of the inferences a ‘reasonable shareholder’ would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact.”[38] Similarly in Kaplan v. Rose,[39] the court observed materiality is a “fact-specific issue[ ] which should ordinarily be left to the trier of fact.”

The Seventh Circuit (or at least some panels of that Circuit) has been cautious about applying the bespeaks caution doctrine. The Seventh Circuit has declined in an action brought under Rule 10b-5 to hold that forward-looking statements were immaterial as a matter of law “merely because they bespoke caution.”[40] The Seventh Circuit subsequently said of this holding that “[w]e think that Roots Partnership is best read not as rejecting the bespeaks caution doctrine generally but as rejecting its application to the facts at hand.”[41] The court in the same case, however, said:[42] “Inclusion of cautionary language — along with disclosure of any firm-specific adverse facts or assumptions — is, of course, relevant to the materiality inquiry, for such inclusion or disclosure is part of the “total mix of information.” Nevertheless, cautionary language as such is not per se dispositive of this inquiry.” The case also is illustrative of the fact that it is not always easy to draw the line between a statement of an existing fact and a forward-looking statement. The defendant in a ’33 Act registration statement had said: “[I]f [the company’s] plans to restore profitability to its day-to-day operations are not successful, . . . the Company’s stockholder’s equity will continue to erode.” The company contended that “plans” related to its “future efforts”; the plaintiff contended, and the court agreed, that it referred to existing plans. Defendant also contended that it was misleading because the company did not have a plan. Since the court concluded that the reference was to an existing plan, the bespeaks caution doctrine would not apply in any event.[43]

Although not involving a forward-looking statement, a district court decision[44] post-adoption of the PSLRA emphasizes a point often important as well in applying bespeaks caution. The complaint alleged that the financial statements of the defendant corporation were false and misleading because of the premature (on shipment of the goods) recognition of revenue in violation of GAAP relating to a recently entered into transaction with newly organized distributor of the company’s one marketable product (a wrinkle remover cream) under which the distributor had 60 days to return any unsold merchandise and 90 days in which to pay for the merchandise. The complaint alleged that the premature recognition of revenue overstated the company’s revenues by 50 percent for the relevant fiscal year and by 90 percent for the fourth quarter of that year. The price of the stock collapsed after Barron’s publicly questioned the company’s accounting practices. The defendants argued that there was no misrepresentation because a Form 10-K filed after the stock took off but before the officer defendant sold any of her stock included the contract giving rise to the allegations relating to premature recognition of income. The contract, defendants argued, disclosed the distributor’s right to return merchandise and the extended payment period. The court, relying on cases holding inadequate disclosures that “would take a financial analyst to spot,”[45] or that required “the sensitive antennae of investment analysts” to pick-up,[46] concluded: “The Court is unable to find, therefore, that the material information was transmitted with a degree of ‘intensity and credibility’ sufficient to render defendants’ overstatement of revenues not misleading as a matter of law.”[47]