Your client requests that you prepare a forecast or projection for a real estat partnership he or she is forming. A favorable forecast or projection placed in an attractive prospectus will aid in the sale of partnership units to investors Or, your client is a corporation in need of a forecast or projection to help secure a bank loan. Either scenario, given the inherently unreliable nature of forecasts and projections, should be cause for concern. If the forecast or projection does not materialize, and your client or investors or lenders consequently sustain financial loss, you may find yourself in court. There has been an increasing number of lawsuits filed by persons claiming financial loss as a result of investment or business decisions made in reliance on a forecast or projection reported on by an independent accountant.

Presently there are various standards courts use to define the scope of an accountant's liability for providing inaccurate information. The most common are:

1. An accountant is liable to persons with whom he or she is in privity, i.e., the client who engaged him or her;

2. An accountant is liable to persons with whom he or she is in privity or whos relationship with the accountant sufficiently approaches privity;

3. An accountant is liable to persons with whom he or she is in privity and to persons or members of a limited group of persons for whose benefit and guidance the accountant intends to supply the information or knows that the recipient of the information intends to supply it; and

4. An account is liable to persons with whom he or she is in privity and to persons who reasonably can be foreseen to rely on the information.

Depending on the jurisdiction in which you practice, one of these standards likely defines the group of persons to whom you may be held liable for providin a report on an inaccurate forecast or projection. The problem is determining ho to protect yourself from unnecessary or unreasonable liability to those persons

The AICPA Guide

The AICPA's Guide for Prospective Financial Information (1993) (AICPA Guide) notes that "the disclosure of significant assumptions is essential to the reader's understanding of the financial forecast. Thus "the responsible party should disclose those assumptions deemed to be significant to the statements." The assumptions disclosed should include:

a. Assumptions about which there is a reasonable possibility of the occurrence of a variation that may significantly affect the prospective results;

b. Assumptions about anticipated conditions that are expected to be significantly different from current conditions, which are not otherwise reasonably apparent; and

c. Other matters deemed important to the prospective information or its interpretation.

A projection should also disclose the above assumptions. In addition, a projection should disclose "which assumptions in the projection are hypothetical," and "if the hypothetical assumptions are improbable, the disclosure should indicate that."

The AICPA Guide also states that the introduction to a forecast "should include a caveat that the prospective results may not be attained." The introduction should be similar to the following:

This financial forecast presents, to the best of management's knowledge and belief, the company's expected financial position, results of operations, and cash flows for the forecast period. Accordingly, the forecast reflects its judgment as of (date), the date of this forecast, of the expected conditions an its expected course of action. The assumptions disclosed herein are those that management believes are significant to the forecast. There will usually be differences between the forecasted and actual results, because events and circumstances frequently do not occur as expected, and those differences may be material.

The introduction to a projection should, in addition, "clearly explain any special purpose and limitation of the usefulness of the statements."

The AICPA Guide's advice on disclosure of assumptions and use of cautionary language is sound. Court decisions indicate that when accountants adequately disclose assumptions and include specific and extensive warnings and disclaimers, they stand a good chance of winning when sued for inaccuracies in forecasts or projections they have reported on.

Warnings, Disclaimers, and the Courts

In a number of cases, the courts ruled in favor of accountants because legally sufficient warnings and disclaimers had been included in the forecasts or projections. The courts based their rulings on the "bespeaks caution" doctrine, which states that cautionary language is not actionable. The doctrine originate in the case of Polin v. Conductron Corp., where the defendant corporation's annual report contained information about "anticipated" losses, "expected" improvement, and the "possibility" of breaking even. The court held that this language was not actionable:

The terms . . . employed bespeak caution in outlook and fall far short of the assurances required for a finding of falsity and fraud. Language of expectation of anticipation, and of possibilities recognizes the imponderable influences of complex variable in a fast-changing field.

According to the Polin court, therefore, the legal theory behind the "bespeaks caution" doctrine is that cautionary language falls short of a representation.

In Nichols v. Merrill Lynch, Pierce, Penner & Smith, the court applied the doctrine to shield an accounting firm from liability. The developer of a condominium hotel had retained the accounting firm to prepare financial projections for the hotel, which were then placed in a private placement memorandum distributed to investors. With respect to the projected room rates, the accountants warned:

The projected inflated average room rates could be materially different if significantly higher or lower rates of inflation are actually experienced. Sinc the actual rates of inflation cannot be predicted with any degree of certainty, no assurance is given that the projected average room rates will not vary materially from those shown above.

The investors eventually sued the accounting firm for Federal securities fraud, alleging that the firm's projections of rental income never materialized. Pointing to the accountants' warning, the court held:

For anyone who can read, this seems a clear warning that the forecast of rental income was highly speculative and in some measure contingent upon uncontrollabl future events. To say nothing more, it certainly "bespeaks caution" . . ., and this is enough to insulate defendant (accounting firm) from liability.

In Stevens v. Equidyne Exractive Indus., an accounting firm prepared financial projections for a partnership. The cover letter accompanying the projections included the following warnings and disclaimers:

You have asked us to use the set of assumptions attached hereto . . . These assumptions were provided solely by you and were not evaluated or audited by us . . . There is no implication or inference, by the accountants, that the result of the (projections) can or will be achieved.

The benefits set forth . . . could be significantly affected by adverse determinations by the Internal Revenue Service with respect to the deductibilit of certain expenditures and the appropriate periods in which these expenditures may be deductible.

Accordingly, we are not in a position to express any opinion on the aforementioned statements and do not express any opinion on them or the achievability of the results shown therein.

An investor in the partnership later sued the accounting firm for Federal securities fraud, alleging misrepresentations in the financial projections. Pointing to the accountant's warnings and disclaimers, the court dismissed the lawsuit:

These statements "bespeak caution" . . . Not only do they set forth that they are based on supplied facts, but they additionally state that there is no implication that the results predicted can or will be achieved. Thus, (the accounting firm) cannot be held liable . . .

A Different Legal Theory

The Stevens court, however, invoked a different legal theory behind the "bespeaks caution" doctrine. According to the court, the investor's reliance on "such speculative projections" was "unreasonable." Thus there are two theories behind the doctrine: 1) cautionary language falls short of a representation and 2) cautionary language precludes justifiable reliance.

In Friedman v. Arizona World Nurseries Ltd., the court applied both legal theories. An accounting firm had prepared a tax opinion and financial projections for inclusion in a partnership offering memorandum. The tax opinion stated:

The tax analysis with which we concur is not binding on the Internal Revenue Service and there can be no assurance that the Service will not take a position contrary to any of the opinions expressed therein or that if the Service took such a position, it would not be sustained by the courts. In addition, prospective investors are urged to seek the advice of their personal tax advisors.

As to the expected tax benefits, the offering memorandum stated:

There can be no assurance that some of the deductions and credits claimed by th partnership will not be challenged by the Service . . . A prospective investor should obtain professional guidance from his own tax advisor in evaluating the tax risks involved.

The financial projections specified that they were "based upon assumptions made by (the partnership) of the income and expenses and cash flow from the operations of the nursery." They further stated:

|The projections were generated based on these assumptions and upon appraisals of the nursery items as well as the sales of the nursery items. Some assumption may not materialize, and unanticipated events and circumstances may occur subsequent to the date of the projections. Accordingly, the actual results achieved during this projection period may vary from the projections and the variations may be substantial.

The cover letter accompanying the projections explained that they "are based on appraisals, assumptions and estimates which were made by the representatives of (the partnership)," and that the accounting firm's sole undertaking with respec to the projections was to satisfy itself "as to the mathematical accuracy of th projections and that they fairly reflect the estimates and assumptions containe therein." The letter concluded with the following warnings and disclaimers:

The selection of estimates and assumptions requires the exercise of judgment an is subject to uncertainties relating to the effect that changes in legislation or economic or other circumstances may have on future events. There can be no assurance that the assumptions or data upon which they are based are accurate. Variations of such assumptions could significantly affect the projections. To the extent that the assumed events do not occur, the outcome may vary significantly from that projected. Accordingly, we express no opinion on the achievability of the results presented in the projections, and no representatio to the contrary may be made or implied.

When investors in the partnership sued the accounting firm for Federal securities fraud, alleging that their investments had been induced by the inaccurate tax opinion and inaccurate financial projections, the court dismisse their claims, explaining:

(G)iven all of the cautionary language, (the accounting firm's) tax opinion cannot be read to mean that (it) undertook to make representations of any kind . . Furthermore, . . . to the extent that (the investors) relied on the tax opinion letter as representing otherwise, such reliance was not reasonable . . The warnings and disclaimers discussed above clearly limited the degree to whic an investor could reasonably rely on these documents as a forecast of the future.

But What If You Knew?

Some courts will not apply the "bespeaks caution" doctrine to shield an accountant from liability if at the time of reporting on a forecast or projection the accountant knew it would not materialize. One court, however, did.

In Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, an accounting firm prepared a financial feasibility study for a proposed residential retirement center. The study, which was placed in the offering memorandum for the municipa bonds used to finance construction of the center, favorably analyzed the future economic viability of the project. It was based on certain financial and marketing assumptions, and contained the following warnings and disclaimers:

We believe that the underlying assumptions provide a reasonable basis for management's forecast. However, some assumptions inevitably will not materializ and unanticipated events and circumstances may occur; therefore, the actual results achieved during the forecast periods will vary from the forecast and th variations may be material.

The accompanying financial forecast indicates that sufficient funds will be generated to meet (the retirement center's) operating expenses, working capital needs and other financial requirements, including the debt service requirements associated with the proposed . . . (b)ond issue, during the forecast periods. However, the achievement of any financial forecast is dependent upon future events, the occurrence of which cannot be assured.

No representations or assurances can be made that sufficient revenues will be realized by the (retirement center) in amounts sufficient to pay maturing principal and interest on (the bonds). Future economic and other conditions, including demand for the (retirement center's) services, the residents' ability to meet their financial obligations under the residency agreement, the economic developments in (the center's geographical area), competitive facilities, third party reimbursement and government regulations, may adversely affect revenues and, consequently, payment of principal and interest.

Factors such as increasing maintenance fees, which would affect occupancy, in construction delays of the facility, differences in interest rates from those expected, employee strife disrupting operations, construction costs and the sustained employment of professional management of the facility are all items t which the forecast financial statements are highly sensitive.

When the retirement center went into bankruptcy, purchasers of the municipal bonds sued the accounting firm for Federal securities fraud, alleging that the accounting firm reported on the feasibility study knowing of its inaccuracy. Sidestepping the purchasers' argument that there was evidence of the accountants' knowledge, the court, citing Polin and other "bespeaks caution" cases, held that the specific and extensive warnings and disclaimers in the study as a matter of law shielded the accountants from liability for any fraud:

We . . . hold that (the purchasers) could not base a Federal securities fraud claim on any misrepresentation or omission in the feasibility study which was addressed by the repeated, specific warnings of significant risk factors and th disclosures of underlying factual assumptions also contained therein.

The Moorhead court's decision to apply the "bespeaks caution" doctrine to shiel the accountants from liability for their knowingly inaccurate forecast may seem inequitable. In a subsequent decision, In re Donald J. Trump Casino Securities Litigation, however, the court agreed with Moorhead, reasoning that adequate cautionary language--

answers in a dispositive way a misrepresentation claim. The "bespeaks caution" analysis subsumes the misrepresentation analysis. No reasonable inference can b drawn in favor of a plaintiff that a document or statement which bespeaks caution as to future forecasts contains actionable misrepresentations.

The Trump court noted the "troubling possibility" that this "will encourage management to conceal deliberate misrepresentations beneath the mantle of broad cautionary language." It is for this reason, the court stated, that the doctrin will shield knowingly inaccurate forecasts or projections only if they contain "precise cautionary language" which "directly addresses" the forecasts or projections. The Trump decision was recently affirmed by the U.S. Court of Appeals.

The Actual Results Will Vary

Specific and extensive warnings and disclaimers as to the accuracy of a forecas or projection should protect an accountant from liability in the event the forecast or projection does not materialize. The cautionary language recommende in the AICPA Guide should adequately warn of the inherently unreliable nature o forecasts and projections. While familiarity with and observance of the AICPA Guide is essential, it is worth noting the successful cautionary language used by the accountants in the above cases. In Moorhead, for instance, the accountin firm unequivocally stated that "the actual results . . . will vary." You may wish to consider using similar language the next time you report on a forecast or projection.

|Editor's note: Several of the cases discussed indicate that an accountant was shielded from liability by the use of cautionary language even though the accountant may have known of inaccuracies in a forecast. In a somewhat related case, however, Virginia Bankshares, Inc. v. Doris I. Sandberg et al, the U.S. Supreme Court ruled that a statement by directors in a proxy solicitation of their opinion that the value of shares as stated in the proxy material was high when they knew the value was significantly higher may be actionable as a misstatement of fact under Federal securities law. While it is true there was n cautionary language present about the value of the shares, Bankshares is a warning about potential liability when statements are made and the persons making the statements know of inaccuracies.