Federal courts have increasingly used the "bespeaks caution" doctrine to dismiss securities fraud cases at the outset. The doctrine holds that optimistic forecasts or projections in a prospectus are not fraudulent when accompanied by specific disclaimers or warnings of the risks associated with the investment. Recently, courts have expanded the doctrine beyond forecasts or projections to render a variety of alleged misrepresentations or omissions non-actionable where investors received suitable risk disclosures or cautionary language. The doctrine also is no longer limited to prospectuses or offering memoranda, but has been applied to press releases, interviews, speeches, annual reports and other disclosures that suitably warn investors of potential risks. Given the high stakes in securities litigation, particularly once burdensome and expansive discovery begins, the "bespeaks caution" doctrine has become an important weapon in securities defendants' arsenals.

The bespeaks caution doctrine is rooted in the requirement that an alleged misrepresentation or omission must be material to be actionable under Section 10(b) of the Securities Exchange Act of 1934, Section 12(2) of the Securities Act of 1933, and similar statutes. In Basic v. Levinson, 485 U.S. 224 (1988), for example, the Supreme Court reasoned that certain information could well be of "dubious significance" to the reasonable investor, and that to hold a defendant liable for securities fraud, the misrepresented or omitted information must be of the kind that "would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available."

Courts for years have recognized that where an investor is fully informed of the material risks of an investment, he assumes the risk and cannot later claim fraud if those disclosed risks materialize. E.g., Luce v. Edelstein. 802 F.2d 49 (2d Cir. 1986). Early applications of the bespeaks caution doctrine simply extended this principle to forward looking statements about the investment, but only after protracted discovery and expensive motion practice. In In re Worlds of Wonder Securities Litigation, 814 F. Supp. 850 (N.D. Cal. 1993), aff'd, 35 F.3d 1407 (9th Cir. (1994), for example, the parties had produced numerous documents and deposed many witnesses before the district court finally granted summary judgment for defendants on the basis of the risk disclosures in the offering materials.

Over the past two years, however, courts have applied the bespeaks caution doctrine to grant motions to dismiss complaints pursuant to Fed. R. Civ. P. 12(b)(6). These courts appropriately considered the offering documents at the outset of the litigation, on the theory that they were incorporated by reference into the complaint or under the evidentiary "doctrine of completeness". Thus, courts will now evaluate the materiality of an alleged representation or omission early in the litigation in the context of the "total mix" of information available to the reasonable investor.

That "total mix" invariably includes the offering documents drafted by the issuer and issuer's counsel and reviewed by the SEC. Courts reason that if a plaintiff receive the prospectus or other offering material, he is assumed to have read it in its entirety, and cannot selectively rely on optimistic language to the exclusion of other, cautionary statements. The warnings must be specific and tailored to the particular risks of the investment; however, boilerplate warnings about the riskiness of investing are not sufficient to counter allegations of misleading projections. See Rubinstein v. Collins, 20 F.3d 160 (5th Cir. 1994).

In one of the leading bespeaks caution cases, In re Donald J. Trump Casino Securities Litigation, 7 F.3d 357 (3d Cir. 1993), cert. denied, 114 S. Ct. 1219 (1994), for example, the United States Court of Appeals for the Third Circuit affirmed dismissal of a suit alleging that a prospectus for an issue of junk bonds misled investors by not adequately disclosing the risks involved in financing the Taj Mahal Casino in Atlantic City. Plaintiffs challenged a statement in the prospectus that "[t]he Partnership believes that funds generated from the operations of the Taj Mahal will be sufficient to cover all of its debt service (interest and principal.)" The prospectus for the offering, expressly warned investors that the Partnership might not be able to service its debt and that a foreclosure on the Taj Mahal would preclude payment of the principal and accrued interest on the bonds. After a careful reading of these and other risk disclosures included in the prospectus, the court concluded that a reasonable investor was well aware of the specific risks of the investment, and that, in this context, managements' optimistic projections failed to state a claim for securities fraud.

The bespeaks caution has been particularly useful in the mutual fund context, where disgruntled investors have sued for securities fraud when their funds did not perform as anticipated. In Tabankin v. Kemper Short-Term Global Income Fund, No. 93-C5231, 1994 U.S. Dist. LEXIS 965 (N.D. Ill. Feb. 1, 1994) and 1994 U.S. Dist. LEXIS 8498 (N.D. Ill. June 22, 1994), the court dismissed securities fraud claims against a short-term global bond fund and its advisers because the fund's prospectus specifically warned about the risk of a decline in investment value resulting from currency devaluation. Similarly, in In re Hyperion Securities Litigation, 1995 WL 422480 (S.D.N.Y. July 12, 1995), the court held that the offering documents for a mortgage-backed securities fund provided investors with "enough information to discern" the risks of an investment because the prospectuses warned investors that "[n]o assurance can be given that the Trust will achieve its investment objectives" and "[c]hanges in interest rates will also lead to changes in the Trust's net asset value." And, in Krouner v. American Heritage Fund, Inc., 1995 WL 548501 (S.D.N.Y. Sept. 11, 1995), the court dismissed claims that a mutual fund failed to disclose its intention to invest in certain risky securities, where the prospectus stated that the fund would invest in securities of bankrupt companies and entailed "greater than average risks." The court explained:

In our view, plaintiff's ... claims have as much merit as a claim made by an Atlantic City gambler who had lost some money at a black jack table that the casino owner had defrauded him by not specifically mentioning in its promotional literature that the casino maintained that particular gambling device.

Although the bespeaks caution doctrine has its origins in cases involving warnings in offering documents, courts have applied it to other kinds of statements as well. See, e.g., Raab v. General Physics Corp., 4 F.3d 286 (4th Cir. 1994) (affirming dismissal of a complaint where the company disclosed risks of a slowdown in government contracts in a press release); Rand v. Starter Corp., 1995 WL 322024 (S.D.N.Y. May 30, 1995) (cautionary statements in press release); Pache v. Wallace, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) " 98,643 (E.D. Pa. Mar. 20, 1995) (cautionary disclosures in a Form 10-K and three Form 10-Qs); In re Seagate II Sec. Litig., [1994-1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) " 98,530, at 91,587 (N.D. Cal. Feb. 8, 1995) (speech by CEO); In re Philip Morris Sec. Litig., 872 F. Supp. 97, 101 (S.D.N.Y. 1995) (annual report, press releases, and press interviews).

A prospectus or other document that contains specific cautionary language also may defeat claims of misleading oral statements or deceptive sales practices. Where the prospectus "bespeaks caution" about an investment, and contradicts "oral assurances by brokers," the "total mix" of information available is deemed accurate, and alleged misrepresentations in oral statements or sales brochures have been found nonactionable. E.g., In re Hyperion Securities Litigation, 1995 WL 422480 (S.D.N.Y. July 12, 1995); Eckstein v. Balcor Film Investors, Fed. Sec. L. Rep. (CCH) " 97,712 (7th Cir. 1993), cert. denied 114 S. Ct. 883 (1994).

In sum, the message of the bespeaks caution doctrine is that carefully drafted disclosure documents that specifically describe the risks of an investment may be an insurance policy against securities fraud claims brought by plaintiffs if that investment - with the benefit of hindsight - proves unfavorable. The likelihood that plaintiffs can extract strike suit settlements is greatly reduced when the federal courts are willing to consider at the pleading stage the extensive array of warnings and disclaimers contained in those disclosures.

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