August 2000


By Ann Morales, René Sacasas, and Paul Munter

Over the past few years, forward-looking information has become an increasingly important part of financial reporting.

Forward-looking information is probably most evident in the management’s discussion and analysis (MD&A) that is included with any SEC filing containing a financial statement. In MD&A, companies discuss information currently known to management that could materially impact key trends embodied in the company’s financial statements. Clearly, this requirement calls upon management to make forward-looking projections. Additionally, the SEC’s expanded disclosure requirements calling for increased quantitative and qualitative information about market risk (Item 7A of an annual 10-K filing or Item 3A of a quarterly 10-Q filing) call for companies to include forward-looking information about their market-risk sensitive financial instruments and derivatives.

Because the U.S. market is a litigious environment, companies have been reluctant to provide forward-looking information beyond the minimum required by securities laws. Consequently, investors do not always have access to important information known to management that could impact investors’ and creditors’ decisions.

To address the legal liability concerns of companies and their auditors, Congress (overriding a presidential veto) enacted the Private Securities Litigation Reform Act of 1995 (the Reform Act). The Reform Act came about for two reasons. First, it was a reaction to the increase in so-called strike suits: vexatious, often meritless, class action lawsuits filed in response to a drop in a stock’s value and alleging that some disclosure (or failure to make disclosure) by an issuer of the security was either false or misleading. Defendants in these suits frequently include the issuers’ auditors.

To address these types of abuses, the Reform Act includes procedural and substantive provisions aimed at discouraging strike suits and, for those suits that are filed, disposing of them quickly and inexpensively at an early stage in the litigation (in particular, the ability to have suits dismissed on summary judgment prior to discovery).

The second objective of the Reform Act was to promote disclosure to the investing public by issuers of securities. This was to be accomplished by immunizing certain types of predictive statements made by issuers. The argument was that if certain “safe harbors” were provided to management, then management could be expected to provide more of the forward-looking information that interests investors.

The Safe Harbor

The Reform Act’s most significant component, referred to as the safe harbor, protects that subset of soft information known as “forward-looking statements.” Forward-looking statements include—

  • financial projections
  • future management plans and objectives
  • statements of future economic performance, including certain statements required in SEC filings
  • any statement of assumptions that are key to understanding these types of statements.

Because these types of statements are inherently predictive, they can be particularly vulnerable to “Monday-morning quarterbacking” or the so-called fraud-by-hindsight lawsuits that have plagued issuers, underwriters, and accountants alike.

To immunize companies against these types of lawsuits, issuers disclosing forward-looking information are relieved of legal liability when—

  • a disclosure is identified as forward-looking and is accompanied by “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement”;
  • a forward-looking statement is deemed to be “immaterial”; or
  • a forward-looking statement is material but either not specifically identified as forward-looking or not accompanied by the required cautionary statements, and the plaintiff is unable to prove actual knowledge of falsity on the part of the issuer making the statement.

Although the safe harbor can apply to both oral and written forward-looking disclosures, the Reform Act takes a flexible approach to exempting oral forward-looking statements from liability. To fall within the safe harbor, oral statements need not include the required “meaningful cautionary language.” Rather, the speaker may simply refer to specific cautionary language that satisfies the statute but is contained in a “readily available written document.”

In order to minimize an auditor’s exposure to legal liability, the safe harbor protects “any reports issued by an outside reviewer retained by an issuer which address a forward-looking statement by the issuer.” In this context, an outside reviewer includes the independent auditor reporting on the company’s financial statements.

Exclusions from Protection by the Safe Harbor

The safe harbor does not protect all forward-looking statements or all issuers. The statute exempts disclosures contained in the financial statements prepared in conformity with GAAP, as well as statements made in connection with certain inherently risky transactions, including initial public offerings, tender offers, going-private transactions, and the issuance of penny stocks.

The safe harbor also expressly excludes disclosures made by issuers that—

  • do not file reports with the SEC under sections 13(a) or 15(d) of the 1934 Act;
  • have violated antifraud provisions of the securities laws within three years of the statement; and
  • are not otherwise in compliance with SEC filing and reporting requirements.

Therefore, the safe harbor does not provide immunity for bad accounting. Ultimately, management is responsible for issuing financial statements that comply with GAAP. Failure to do so is still a basis for legal action by investors. Likewise, auditors are responsible for auditing financial statements in accordance with GAAS. Thus, although the safe harbor protects auditors that participate in preparing forward-looking statements set forth in the MD&A and other investor-targeted documents and SEC filings, it does not immunize an auditor against a substandard audit.

Applying the Safe Harbor

Two questions are at the crux of the Reform Act’s safe harbor analysis:

  • What language actually qualifies as a forward-looking statement?
  • What constitutes the required “meaningful cautionary” language?

Qualifying language. The statute lists the types of predictions that qualify for safe harbor protection. Judicial interpretation to date has filled in some gaps in the statute.

Cautionary language. The statute gives little guidance about what will qualify as “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.” While relatively few courts have addressed the issue under the Reform Act, recent opinions and the still viable “bespeaks caution” doctrine provide some general guidelines. Specifically, courts applying the doctrine use two familiar securities law rationales:

  • Materiality: Courts hold that appropriate cautionary language renders forward-looking statements immaterial as a matter of law.
  • Reliance: The reliance approach results in a finding, as a matter of law, that in light of cautionary language no reasonable investor would have relied on the forward-looking statements.

Under the “bespeaks caution” doctrine, the required cautionary language must be substantive and tailored to the specific future projections, estimates, or opinions in the disclosure document under question as recent case law indicates.

Qualifying as a Forward-Looking Statement

The leading case that interprets what will and will not qualify as forward-looking is Harris v. IVAX Corp. [182 F.3d 799 (11th Cir. July 27, 1999)]. In Harris, the circuit court affirmed the district court’s dismissal of the plaintiff’s securities fraud complaint, finding that each statement that was the basis of the plaintiff’s complaint was forward-looking and therefore within the boundaries of the safe harbor.

The Harris opinion is particularly instructive because it considered various forms of forward-looking statements. For example, according to Harris, language of expectation, such as “reorders are expected to improve as customer inventories are depleted,” will fall squarely within the safe harbor. The court found that this type of information is a “statement of assumptions upon which a statement of future economic performance was based,” one of the four expressly articulated categories of forward-looking information in the Reform Act.

Another type of statement considered in Harris was “the challenges unique to this period in our history are now behind us,” which uses the present tense to convey an anticipatory message. This type of statement also receives safe harbor protection, notwithstanding “purely grammatical argument[s] to the contrary.” Stated differently, even statements made in the present tense can be deemed to be forward-looking and, thus, available for safe harboring. In holding that hopeful statements couched in the present tense are forward-looking, the court said that any statement about the state of a company “whose truth or falsity is discernible only after it is made necessarily refers only to future performance.”

The Harris court also analyzed what it called a laundry list or mixed statement and held that “when the factors underlying a projection or economic forecast include both assumptions [underlying a forward-looking statement] and statements of known fact, and a plaintiff alleges that a material factor is missing, the entire list of factors is treated as a forward-looking statement.” In particular, a company press release contained a list of factors relating to IVAX’s business that would influence the upcoming quarter’s results. Three of the listed factors were clearly statements of historical fact, and two others were not. The plaintiffs alleged that the list was misleading because it failed to forecast the possibility of a large goodwill reduction in the immediate future. (The company did, in fact, take such a write-off shortly after issuing the public statements.) Because the argument was that the list itself was misleading by omission, for purposes of safe harbor analysis the list as a whole had to be either forward-looking or not. The Harris court held that the list was a “unit” for liability purposes.

The existing case law leads to several conclusions:

  • The use of language of expectation is deemed to be forward-looking;
  • Regardless of the tense of the verbs chosen, statements that cannot be verified until after they are made are generally forward-looking; and
  • Mixed lists, where an omission is alleged, may be treated as a unit for purposes of safe harbor determination—the list as a whole will either qualify as forward-looking or not.

Meaningful Cautionary Statements

Once a particular disclosure is determined to be a forward-looking statement, the next major question in determining whether the safe harbor applies is whether “meaningful cautionary language” accompanies the forward-looking statement. The Reform Act provides no guidance as to what will suffice as meaningful cautionary language. However, the Reform Act’s legislative history shows that a discussion of key risk factors is critical to having the forward-looking statement protected by the safe harbor. The original House bill required only a recitation that actual results could differ from those predicted in the forward-looking statement. The statute eventually enacted is intended to avoid the kind of boilerplate warnings that often accompany forward-looking statements. This notion of avoiding boilerplate language is consistent with existing case law under the “bespeaks caution” doctrine. On the other hand, Congress also rejected an SEC proposal to require the identity of those factors “most likely to cause actual results to differ” in favor of the identification of only “important factors.”

While the intention to avoid boilerplate wording is clear, what will qualify as “important factors” is not. The Congressional Statement of Managers preceding the Reform Act warned that “cautionary statements must convey substantive information about factors that realistically could cause results to differ ... such as information about the issuer’s business.”

Case law thus far decided under the Reform Act shows that a registrant is not required to identify all of the factors that might materially affect the forward-looking disclosures. According to the relevant judicial opinions and the statute’s legislative history, “failure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor.”


The safe harbor also shields from liability forward-looking statements that are “immaterial,” whether or not they are accompanied by cautionary language. Therefore, arguably, a projection is immaterial if it is a vague or a general statement of optimism. So, statements such as, “We’re the leader in a rapidly growing market” are unlikely to be actionable.

While a corporation can use the claim of immateriality as a basis for safe harbor protection, the SEC has recently moved, in effect, to reduce materiality thresholds through Staff Accounting Bulletin No. 99, Materiality. Companies and their auditors should exercise extreme caution in relying on a lack of materiality as a basis for invoking the safe harbor defense.

Consequences for Management and Auditors

Properly used, the safe harbor provisions can be a powerful tool for securities fraud defendants in fighting off threats of litigation. However, as with most benefits, there is a related cost or consequence.

The Reform Act provides safe harbor protection for forward-looking statements but does not provide protection for either information included in the financial statements or failure to meet the disclosure requirements of the securities laws. The SEC’s rules on MD&A call for management to discuss information currently known to management that could significantly affect trends embodied in the financial statements. Consequently, while many companies are reluctant to provide forward-looking information in their SEC filings, in certain circumstances it is required. Examples include known capacity constraints, the need to obtain additional financing, dependence on key customers or suppliers, and other information known to management.

These and other situations would require management to make forward-looking statements in MD&A. To the extent that forward-looking statements are needed, management should ensure that MD&A includes the appropriate risk information to qualify the disclosures for protection under the Reform Act’s safe harbor provisions.

Additionally, although the auditor is not expressing an opinion on information outside the financial statements, the auditor is required to read all of the information in the document containing the financial statements and consider whether the other information contains any known misrepresentations or omissions. Thus, the auditor has a responsibility to work with management in ensuring that the statements include all appropriate disclosures—regardless of whether the information is needed in the financial statements or in other parts of the filing. Furthermore, the auditor should carefully consider whether all the disclosures (including the financial statement notes, MD&A, president’s letter, and discussion of business and other information in the forepart of the filing) are consistent throughout the document.

Both management and auditors should consider relevant information in evaluating the appropriateness of the disclosures provided to the public. Exhibit 1 lists the information management and auditors should review in evaluating the appropriateness of the disclosures. Exhibit 2 summarizes the requirements for forward-looking information to receive protection under the Reform Act’s safe harbor provisions. q

Ann Morales, JD, and René Sacasas, JD, are assistant professors of business law, and Paul Munter, PhD, CPA, is KPMG Professor of Accounting, all at the School of Business Administration, University of Miami, Fla.

Dan L. Goldwasser, Esq.
Vedder, Price, Kaufman & Kammholz

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