Date: 6 May 1999

The Duty to Disclose Intra-Quarter Financial Results

By Jared L. Kopel, Ignacio E. Salceda, and Scott L. Adkins

In every public offering of securities, the issuer and underwriters face a difficult question: Because companies report their results every quarter, and because it takes anywhere from three to six weeks after the end of every quarter to close the quarter, and make all of the needed accounting adjustments, any offering necessarily takes place during a period for which there is usually no financial information available. Securities issuers face a dilemma because if their results are disappointing for the quarter during which they sell securities, they may face a shareholder lawsuit claiming that the company should have warned about the factors which led to the financial disappointment. Underwriters, who must conduct due diligence to satisfy their securities obligations and to price the offering properly, could also face such liability. Given that the potential liability under Sections 11 and 12(b) of the Securities Act of 1933 is extremely broad and does not require any intent to deceive, the prospect of being held liable for a failure to make a statement about an ongoing period is chilling.

Traditionally, the answer to this kind of lawsuit would be straightforward: companies are under no obligation to predict the future; they must only disclose accurate historical facts. So long as the statements in the registration statement are accurate and comply with SEC regulations, there can be no liability. In recent years, however, a number of courts have held that plaintiffs in such cases may be able to state a claim for violations of the federal securities laws where the issuer did not disclose material information about an ongoing period -- even where that period is not complete and the issuer has at most sketchy information about how it will turn out.

This article first examines a dispute that has arisen among the courts concerning a company's duty to disclose facts concerning an ongoing quarter. There are two broad lines of authority concerning whether a company has violated Section 11 or 12(2) by not disclosing intra-quarter financial data. One line of authority strongly favors companies because it generally imposes no duty to disclose such data. Another school of judicial thought says companies should disclose intra-quarter data when that data indicates the current quarter will be substantially different from market expectations. The reader should note an important difference between the first two schools of thought: the first generally assumes that companies cannot reasonably conclude based on incomplete quarterly financial data that an on-going quarter will be disastrous. The second concedes that such conclusions are reasonable and possible.

We shall review each line of authority in detail and conclude that while the first approach is more intellectually defensible, issuers cannot now be sure that a court will hold that there is no duty under the federal securities laws to disclose financial results for a quarter in progress. Subsequently, we will provide some suggestions for issuers and underwriters in the midst of due diligence for a public offering facing this uncertainty in the law. Because it is becoming increasingly clear that the Private Securities Litigation Reform Act passed by Congress in 1995 has not reduced the incidence of securities cases against public companies, issuers and underwriters must assume that they will be sued if a company does not meet expectations for the quarter in which an offering is made. The continued prevalence of securities class actions and the uncertainty in the law may in some instances counsel in favor of liberal disclosure of intra-quarter financial data and heavy reliance on the certain "defensive disclosure practices, especially use of the safe harbor for forward-looking statements available under the Reform Act and reliance on the judicially-created bespeaks caution doctrine.

With the right disclosure practices (backed with extensive due diligence efforts discussed below) issuers and underwriters may reduce the risk that they will be targets in a class action lawsuit claiming that the company should have foretold about an adverse future, as well as improve their likelihood of success should such a suit be filed. First, we turn to a discussion of the various lines of judicial authority concerning the disclosure of intra-quarter financial results.

I. Cases Holding There Is No Duty to Issue Intra-Quarter Results

The first line of authority which clearly states that companies are under no duty to disclose intra-quarter financial data rests on two decisions: In re Worlds of Wonder Securities Litigation1 and Zucker v. Quasha.2 In Worlds of Wonder, a toy company sold $80 million of high yield "junk" bonds on June 4, 1987. On July 27, 1987, the company announced a loss of $10 million for the quarter ending June 30. In early August 1987, the company announced a fifteen percent domestic workforce reduction. In December, the company defaulted on the first interest payment on the bonds and filed for bankruptcy before the end of the year.3

Several purchasers of the bonds filed a class action. Among other things, the plaintiffs argued that the prospectus for the bond offering was misleading because the company failed to disclose that performance for quarter in which the offering occurred would be substantially lower than the same quarter of the preceding year. Notably, plaintiffs did not allege that the prospectus inaccurately disclosed intra-quarter financial data. Rather, plaintiffs argued that the prospectus was misleading because it omitted such data altogether. After the federal district court granted summary judgment for the defendants, the Ninth Circuit Court of Appeals affirmed on this issue. The Court of Appeals rejected plaintiffs' argument and held the company was not required to disclose financial data for a quarter that was on-going at the time of the offering.4

The decision is helpful to issuers for several reasons.

First, and most clearly, the court held that there is no absolute requirement that companies disclose intra-quarter financial data when issuing securities. Second, as will be discussed more fully later, the decision gives companies a roadmap to avoid potential liability when they omit intra-quarter financial data from their registration statements. One interpretation of Worlds of Wonder is that a company need not disclose anything about an ongoing quarter where it warns of the possibility that its future results will be disappointing or where disclosure of completed fiscal quarters reveals the trend that the plaintiffs complain was concealed by the omission of intra-quarter data.

The court reached a similar result in Zucher v. Quasha, a case involving a public offering of a mail-order catalog retailer. In that case, plaintiffs claimed that company's follow-on offering registration statement was false and materially misleading because the it did not disclose that merchandise return rates were higher during the on-going quarter than for the same quarter during the previous fiscal year. In addition, the plaintiffs claimed that the registration statement should have disclosed that catalog response rates were lower during the on-going quarter than for the same quarter in the previous fiscal year.

The court rejected the plaintiffs' claims because it held that the company had no obligation to disclose financial data that was incomplete. Even thought the offering closed less than three days before the end of the quarter, the court held that there was no duty to disclose the financial data for a quarter in progress.5 Zucker noted, however, that if the quarter had been complete and the disclosure in the registration statement inaccurate, it might have reached a different result. The court dismissed the complaint with prejudice, and the decision was later affirmed by the appellate court. In sum, a fair reading of the Worlds of Wonder-Zucker line of decisions indicates that there is no absolute requirement that companies disclose incomplete intra-quarter financial data. If a court were to follow this line of authority, the omission intra-quarter financial data will seldom be the precipitant for liability under the federal securities laws.

Nevertheless, the caveat contained in the Zucker decision is important to keep in mind. As a general matter, courts have been unreceptive to the argument that there is no duty to disclose the results of a completed quarter for which the company has yet to prepare final financial statements. Although an issuer may not be obligated to include such data in a registration statement under SEC rules, several courts have held that a failure to disclose the results of a very recently completed quarter is misleading if those results differ from market expectations.6

Finally, issuers must keep in mind the elusive question of whether there is a duty to update prior statements. While courts generally recognize a duty to correct statements that were false when made, there is disagreement as to whether a duty exists to update statements that were true when made but which later become misleading in light of intervening events. The duty to correct and the duty to update are often confused. The duty to correct applies when a company makes a statement that the company believed was true, but which it later learns was not. A duty to update might arise in a situation where a company makes a projection that was reasonable and honestly believed at the time, but which was changed due to subsequent events.

Courts have differed on whether there exists a duty to update projections. A number of cases have held that if a forward-looking statement was true when made, the company is under no obligation to update the market if or when that statement later becomes inaccurate.7 These cases have held that imposing a duty to update not only runs counter to the language of Rule 10b-5, but also puts companies in the untenable position of having to continually apprise the market concerning new developments. Other cases hold that if a corporation voluntarily makes a public statement that is correct when issued, it has a duty to update that statement if it becomes materially misleading in light of subsequent events.8 Because the duty to update is a difficult and often debated question, an issuer should examine what, if anything, it has said about the quarter in progress and whether that information is still accurate.

II.Cases Finding a Duty to Disclose Intra-Quarter Financial Results

The second strain of caselaw can gleaned from a review of two appellate court decisions involving Digital Equipment, a major computer company, and Hart Brewing, a maker of specialty beers. As a practical matter, these cases require disclosure of operating results for an on-going quarter where the results are materially differing from known trends about the issuer. As even these courts recognize, however, materiality is a very flexible standard which courts are often reluctant to determine before discovery. Accordingly, issuers can only speculate how a court will view the materiality of the intra-quarter information that they did not disclose. That uncertainty is, pragmatically, the real factor that mandates disclosure of incomplete intra-quarter financial data because the almost absolute liability of an issuer to shareholders in an offering understandably makes companies reluctant to depend on a potential defense that has not been universally recognized by the courts.

In Shaw v. Digital Equipment Corp.9, the plaintiffs lodged a panoply of securities claims against the company, various of its officers, and the underwriters of a public offering. The issue of interest here is plaintiffs' charge that Digital violated the federal securities laws when it omitted operating results for the quarter that was in progress and which would conclude four days after the offering. The plaintiffs claimed that when Digital commenced the offering, the company possessed data about the on-going quarter which indicated that the quarter would be the worst one the company had suffered in over a year, and one that "bucked the positive trend of reduced losses under the company's new management."10 For purposes of resolving defendants' motion to dismiss, the court assumed that the company possessed the data that plaintiffs claimed. Thus, the only issue for the court was whether, given that the offering closed four days before the end of the quarter and the quarter turned out to be the worst in over a year, the data on hand before the close of the quarter indicated a material change in Digital's business and whether Digital was required to disclose it. The court concluded it was reasonable to infer that such might have been the case, and that the federal securities laws required disclosure of whatever data Digital possessed concerning the on-going quarter. The court also declined to adopt any bright line rule concerning the disclosure of intra-quarter data. Instead, the court said that "[t]he question of whether such present information must be disclosed (assuming the existence of a duty), poses a classic materiality issue[.]"11

Although an offering with only four days left in a quarter may have made this an easy case for the court, the implications of the decision are potentially problematic for securities issuers. Putting the matter of whether a company must disclose intra-quarterly data as a "classic materiality question," Shaw leaves companies guessing whether to disclose intra-quarter financial data in all but the most extreme cases, i.e., when, as Shaw put it, "the issuer is in possession of nonpublic information indicating that the quarter in progress at the time of the public offering will be an extreme departure from the range of results which could be anticipated" based on information currently available to the investing public.12 Phrased differently, Shaw held that when the quarter is nearly complete and the data in hand indicates that the quarter will be an unmitigated disaster, the company should disclose that data. Shaw was careful, however, to note that when disclosing the data, i.e., hard numbers, for the quarter in progress, the company is not required to make any projections about the data.13 But it is not clear what commentary, if any, must accompany the disclosure of data for an on-going quarter.

Although the Shaw court attempted to give companies some comfort by stating that it did not "mean to imply . . . that nondisclosure claims similar to those asserted by plaintiffs here can never be disposed of as a matter of law,"14 it gave little guidance as to how a company can gauge whether it has a duty to disclose intra-quarter results or, if it might have such a duty, how it should go about meeting it. For example, although the court held that the company need only give hard numbers (such as results for the quarter-to-date), there was no obligation to predict how the quarter would ultimately turn out. Yet, by its very nature, the inquiry a company must perform involves making a forecast about how the current period will compare with expectations or prior statements, and then disclosing that information along with the results for the quarter to date. A more recent decision analyzing this problem was the Ninth Circuit's decision in Steckman v. Hart Brewing.15 In that case, a maker of specialty beers conducted its initial public offering in December of 1995, less than three weeks before the end of the company's fourth quarter. Up to that point, Hart Brewing's business had grown exponentially since the company's inception in 1990. The registration statement for the offering disclosed that even though capacity was increasing rapidly, the amount of beer actually produced was growing at a slower rate than was capacity. Moreover, even though operating income increased at an annual rate of 200% from 1990 through 1994, income for the first three quarters of 1995 was only 83% higher than for the same period in 1994.

Less than two months after Hart Brewing went public, it announced results for the fourth quarter of 1995, the quarter in progress during the IPO. The results for the quarter were essentially flat compared to the results for the previous fourth quarter. Although the company's stock price rose after this announcement, plaintiffs nevertheless filed a securities fraud class action, claiming that the company should have disclosed that its fourth quarter results would be disappointing.

After the district court dismissed with prejudice, the court of appeals affirmed in a short and cryptic opinion. The court analyzed the question of whether Hart Brewing had a duty to disclose that its ongoing fourth quarter would be flat compared to the previous year by considering the provisions of Item 303 of SEC Regulation S-K. The court suggested that if the data available to the company at the time of the offering fit the parameters of Item 303, then a failure to disclose that data was a violation of the federal securities laws. Reduced to three elements applicable here, Item 303 requires an issuer to make the following analysis: (1) does the issuer know of a trend; (2) does the issuer reasonably expect the trend to come to fruition; and (3) has management determined that the trend is not reasonably likely to have a material effect on the company's financial condition.16 The court in Steckman considered these factors and applied them to the facts of the case. It first held that "[a] slowdown after a period of growth might be a trend" and that it was reasonable to believe that the company "knew or could have reasonably expected the slowdown in the middle of [the fourth quarter of 1995,] the IPO quarter."17

Nevertheless, the court concluded that it "management could not under any imaginable standard have reasonably expected that the slowdown was anything more than a regular fourth quarter slowdown or that it would have a material impact on net sales, revenues, or income." 18 The court noted that the company's prior fourth quarters had also been flat, that is that there had been no growth, year over year, from the fourth quarter of 1993 to the fourth quarter of 1994. In addition, the company warned in its registration statements that its results were often cyclical. In light of these facts, the court concluded that the dip was immaterial as a matter of law and, therefore, the intra-quarter data need not be disclosed, because net sales decreased only 4% and operating income decreased only 2% for the IPO quarter.

Does the result in Steckman mean that the Ninth Circuit followed the First Circuit's lead in Shaw and applied Shaw's "extreme departure"19 standard? No. Steckman expressly "decline[d] to pass on the validity of an 'extreme departure' threshold" and stated that the court did not have to decide "just how bad a trend must be before management might reasonably expect it to have material effects."20 Indeed, Steckman referred to the "extreme departure" standard as "enigmatic" and instead focused its inquiry on the language in Item 303: "known trends 'reasonably expected to have material effects.'"21

What does Steckman mean for public companies? The decision is very difficult to apply generally, as the court's ruling was based on very narrow, fact-specific issues. In addition, the holding is peculiar because the court's interpretation of Item 303 is difficult to square with the well-established principle that public companies need not disclose their internal projections.22 Quoting an SEC release about Item 303, Steckman stated that "[d]isclosure is then required unless management determines that a material effect on the registrant's financial condition or results of operations is not reasonably likely to occur."23 An issuer cannot comply with this standard unless it takes data for the on-going quarter and makes some internal forecast, projection, or estimate about what the data means and then decides either to disclose or omit the results of the internal forecast. So, although the internal projections need not be disclosed, they must, under Steckman, be done. Finally, Steckman is also very hard to harmonize with Worlds of Wonder, which was also issued by the Ninth Circuit Court of Appeals. In light of this, it is not surprising that other courts have largely ignored Steckman's holding.

The Shaw and Steckman decisions, although they came out differently, suggest that there is a possibility that a court would hold that an issuer had a duty to disclose financial results for a quarter in progress. In one respect, comparing Shaw and Steckman may be like comparing apples and oranges. Shaw was driven by bad facts, Steckman by good ones. So, it becomes difficult to talk about what Steckman might mean in a case with facts akin to Shaw and visa versa. Nevertheless, the doctrinal bases of the decisions and the paucity of guidance to issuer makes this area uncertain and potentially dangerous for any company in the process of conducting a public offering.

This uncertainty is especially acute for close cases, where the facts available to the company suggest that there might be some problems but that they do not suggest a disastrous result for the quarter. In practice, it is here that most companies will find themselves. Under the holding of Shaw, where in this vast gray area does a problem become sufficiently material or sufficiently certain that there arises a duty to disclose the intra-quarter data? No one is sure, least of all the courts. The only thing courts applying the Shaw-Steckman standard seem sure of is the cases on either end of the spectrum are easy. That is, there is a duty to disclose in a case like Shaw, where fiscal Armageddon looms a few days hence, and no duty in cases like Steckman, where business is generally good but there is a slight decrease in operating results similar to previous cyclical downturns.24

Confronted with this uncertainty in the law, companies can take certain measures to reduce the possibility of a securities suit (as well as improving their likelihood of success should such a suit be filed). These fall into two broad categories which will be discussed in turn. First, companies, as well as their underwriters, can structure their due diligence efforts to take into account this uncertainty. Second, and following from the first, issuers should consider whether making forward-looking disclosures, utilizing the newly enacted safe harbor for such statements, will protect them should future results turn out to be disappointing.

III. Avoiding the Pitfalls of a Potential Duty to Disclose Intra-Quarterly Financial Results

A. Due Diligence Efforts: The Law

In light of the uncertainty in the law concerning the disclosure of intra-quarter financial information, issuers and underwriters should consider dedicating part of their due diligence efforts for an offering to this issue. "Due diligence" has various meanings and it is important to distinguish between them. In regular business parlance, due diligence is the process by which a third party examines the books and records of another. In the context of public offerings, underwriters typically engage in such due diligence activities as investigating the nature of the issuer's business, interviewing its management, reviewing key contracts and calling the company's major business partners. Sometimes, it is also said, somewhat loosely, that the issuer itself is engaged in undertaking due diligence. That principally means that the issuer is participating in the preparation of the offering documents, verifying that their contents of these documents are accurate and complete, and supplying the underwriters with the information they need to conduct their due diligence.

Underwriters engage in due diligence in order to have a better understanding of a company's business and financial condition, to verify that the contents of a registration statement are accurate and complete, and to be able to explain the company to potential purchasers of the securities. Apart from these business considerations, there is an important legal reason for conducting due diligence. Although Sections 11 and 12 of the Securities Act of 1933 imposes virtually strict liability on an issuer of securities for material misstatements in a prospectus, Congress imposed a lesser requirement on underwriters. Section 11(b)(3)(A) of the Securities Act absolves an underwriter from liability if, "after reasonable investigation, [it had] reasonable ground to believe and did believe" that the registration statement was true. This has become known as the "due diligence" defense.25 This defense is also available to the issuer's officers and directors.

There have been a handful of cases where underwriters have been able to establish this defense and these decisions are helpful in understanding what is and is not sufficient. First, courts are aware of the fact that underwriters "cannot, of course, be expected to possess the intimate knowledge of corporate affairs of inside directors, and their duty to investigate should be considered in light of their more limited access."26 Nevertheless, courts expect that underwriters will not blindly rely solely on the representations of management, especially where there are "red flags" suggesting that these representations are inaccurate or that there is some significant undisclosed problem. Second, the courts expect that underwriters will conduct a reasonable investigation into the issuer's business. The more extensive the investigation, the more likely that the court will find that it satisfies the due diligence defense. Thus, where the underwriters had met with company personnel; contacted the company's suppliers, customers, and distributors; reviewed company documents; attempted to ascertain industry and market trends; inspected the company's facilities; and received written representations from the company and selling stockholders that the prospectus was accurate, courts have found that the investigation was sufficient.27

Finally, the courts generally evaluate the underwriters' overall investigation and determine whether it was reasonable under the circumstances. Thus, a failure in one portion of the diligence may not be fatal to the defense if, on the whole, the court concludes that the due diligence efforts were generally appropriate.28

B.Due Diligence on Intra-Quarter Financial Results

In light of this legal context, how can issuers and underwriters best perform due diligence into intra-quarter financial results? There are a couple of straightforward practices which have been developed over the years to reduce the potential securities liability exposure. The first is to understand the expectations of Wall Street analysts concerning the ongoing quarter and how those expectations compare with internal company projections. Wall Street does not like negative surprises. To the extent that a company's internal forecasts are substantially lower than those of analysts, the company should consider whether it should attempt to lower those expectations.

A second approach is to analyze what risks the company fares which could lead to a disappointment in the current quarter. Has a competitor recently introduced a new product or cut its prices? Is the issuer in the midst of a product transition? Are the company's partial results for the quarter substantially below where they normally are at this point in the quarter? Is the company depending upon a handful of large transactions in order to achieve its forecasts? The answers to those questions can give a better understanding of the risks and how they should be disclosed in the registration statement. The importance of disclosing such risks should not be underestimated. As noted above, those courts which held that the issuer was under no duty to disclose its intra-quarter financial performance relied heavily on the fact that the company had warned of the risks which eventually materialized. Thus, in Worlds of Wonder, the prospectus clearly warned that WOW expected lower net sales in the near future.29 Similarly, in Steckman, the defendants warned that the fourth quarter was traditionally weak.30

Finally, it is important for issuers and underwriters to understand that due diligence should be an ongoing process that continues up until the date of the offering. Where an offering does not go effective until weeks after a preliminary registration statement is filed, the due diligence should be updated before the effective date of the offering. This is often done through a conference call a day or two before the offering. During this call, sometimes dubbed the "bring down call," the working group of an offering reviews the registration statement to verify it is still accurate and also determines whether there has been a material change in the business.

C. Inclusion of Forward-Looking Statements About the Current Quarter in the Registration Statement Using Safe Harbor for Forward-Looking Statements and the Bespeaks Caution Doctrine.

For many years, companies avoided including forecasts in their SEC filings, including registration statements. Apart from the fact that companies were not required to make forward-looking statements, the SEC actively discouraged such disclosure during the 1970s. Although the Commission's stance evolved into half-hearted encouragement, most companies maintained their reluctance to include forecasts in their offering documents. One reason for this was the likelihood that a faulty forecast would open up the possibility of being the target of a class action lawsuit alleging that the company issued the forecast in order to mislead investors. In light of recent developments, however, companies should consider including forward-looking information in their registration statement, especially if they are concerned about a potential suit should they fail to meet expectations in the ongoing quarter. Below is a summary of the current law regarding forecasts, followed by suggestions on how issuers can use these provisions to issue forecasts.

1.The Legal Analysis of Forward-Looking Statements

Congress passed the Private Securities Litigation Reform Act of 199531 in response to growing complaints that public companies were being targeted by abusive shareholder lawsuits. Among the goals of the Reform Act was to encourage companies to make forward-looking statements. Congress concluded that "[u]nderstanding a company's own assessment of its future potential [is] among the most valuable information shareholders and potential investors could have about a firm."32 Congress found that the existing system of private securities litigation had a "muzzling effect" on "the willingness of corporate managers to disclose information to the marketplace," and harmed shareholders by creating a "chilling effect . . . on the robustness and candor of disclosure," because companies and their officers [were] subjected to potentially limitless liability if they disclose projections that later turn out to be inaccurate."33 In response to this problem, Congress created a statutory "safe harbor" for forward-looking statements, "to enhance market efficiency by encouraging companies to disclose forward-looking information" without fear of liability. The goal of the safe harbor is "to provide certainty that forward-looking statements will not be actionable by private parties . . . if they are accompanied by a meaningful cautionary statement."34 The safe harbor creates two new separate and independent defenses to liability for a forward-looking statement.

First, a defendant shall not be liable for a forward-looking statement if it is "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement."35 Second, a defendant shall not be liable unless plaintiff proves that the forward-looking statement "was made with actual knowledge" that it "was false or misleading."36

Under the first requirement, "cautionary statements" are considered "meaningful" if they "convey substantive information about factors that realistically could cause results to differ materially from those projected in the forward-looking statement, such as, for example, information about the issuer's business."37 A risk factor is "important" if it "could actually affect whether the forward-looking statement is realized."38 Congress did not intend to make it burdensome for a company to comply with the safe harbor. A company is not required to identify "all" factors or "caution against every conceivable factor that may cause results to differ."39 A company is not even required to include "the particular factor that ultimately cause[d] the forward-looking statement not to come true."40 In interpreting the safe harbor, courts have held that a company complies with the safe harbor if it identifies sufficiently important factors that could cause actual results to vary from the forward-looking statement.41

Although it is very broad, the safe harbor does not protect all forward-looking statements made by issuers. The safe harbor does not apply in certain situations such as statements made in connection with rollup and going private transactions, forecasts included in financial statements, and, most significantly, statements made in connection with tender offers or initial public offerings.

Nevertheless, it is not the case that forward-looking statements are without protection in such instances. Before the Reform Act, many courts had embraced the "bespeaks caution" doctrine. Under this doctrine, a projection is not actionable where it is accompanied by meaningful and specific cautionary disclosures concerning the subject matter of the alleged misrepresentation.42 In order for the doctrine to apply, the risk disclosure must relate to the subject of the alleged misrepresentation. Generalized, conclusory and boilerplate risk factors will not be protected under the doctrine.

The bespeaks caution doctrine remains viable even after the creation of the new safe harbor. In passing the Reform Act, Congress noted with approval that many Circuits had applied the bespeaks caution doctrine to dismiss cases and it expressly encouraged further development of the doctrine.43 As a result, even if the Reform Act's safe harbor is unavailable for forward-looking statements made in connection with an initial public offering, the availability of the bespeaks caution doctrine may immunize forward-looking statements should they turn out to be incorrect.

2. Using the Safe Harbor and the Bespeaks Caution Doctrine.

Although the law provides greater protection for forward-looking statements, including such statements in a registrations statement does have some risks. First, and most obviously, if a company's financial results do not turn out as forecasted, the company will be unable to take advantage of the line of cases discussed above which holds that there is no duty to issue such forecasts. Second, plaintiffs will undoubtedly challenge the forecast head on, arguing that it was not genuinely believed, that it lacked a reasonable basis, or that it was undermined by undisclosed information.

Nevertheless, despite these risks, it may make sense for issuers in some instances to disclose their expectations for the ongoing quarter and even for additional periods. First, even before the passage of the Reform Act in 1995, courts had become increasingly skeptical of claims based on a missed forecast, especially where the forecast was accompanied by a discussion of its assumptions and the risks that could lead the forecast to be missed. Second, if used properly, the safe harbor and the bespeaks caution doctrine are extremely powerful tools in defending a securities case. Third, it is a fact of life for many public companies that stock market investors are insistent on obtaining management's best guess as to the future. Even if companies have no legal duty to make forecasts, they often find themselves having to issue some form of forward-looking information to the market, whether directly or by giving "guidance" to analysts reporting on the company. Rather than using these back-door devices, with the danger that company guidance may be misread by analysts or the market, a company may in the appropriate circumstance want to issue forecasts directly and accompanied with the risk disclosures it believes are appropriate.

In order to make forward-looking disclosures, however, it is essential for companies to do it correctly. Although the Reform Act was passed over three years ago, there are few cases interpreting the safe harbor. Nevertheless, these cases as well as experience in dealing with companies attempting to use the safe harbor suggest a few tips on how best to invoke the protections of the new legislation.

1.Avoid boilerplate risk disclosures.

Although there have been few cases dealing with it, safe harbor has been shown to be effective when used correctly. The most common problems encountered by companies making forward-looking statements concern either the nonuse or misapplication of the safe harbor. The most significant is the use of boilerplate, repetitive or "generic" risk factors. Throughout the bespeaks caution cases, courts repeatedly stress that boilerplate risk disclosures are insufficient to insulate projections. Although the safe harbor does not expressly bar boilerplate, it does require that risk disclosures be "meaningful." We expect that courts will continue to require that risk disclosures be specific, and thus, it is essential that companies tailor their risk disclosures to their own situation.44

2.Identify forward-looking statements.

The Reform Act requires companies to identify forward-looking statements in order to avail themselves of the protections of the safe harbor. Since the Reform Act's adoption, securities lawyers have debated how far one has to go in identifying the forward-looking statements, how close in proximity the meaningful cautionary language must be, and how particularized this language must be in order to avoid it being construed as boilerplate. Fortunately, a recent decision held that the safe harbor may apply even where every single forward-looking statement is not specifically identified, so long as the company stated at the beginning of a conference call that it would be making forward looking statements. In that case, Wenger v. Lumisys Inc.,45 plaintiffs alleged that the defendants had made false statements about the company's business and prospects. Plaintiffs cited various statements in a company conference call with financial analysts and argued that the company's disclosure did not meet the requirements of the safe harbor, notwithstanding the following preface to the speech by the chief executive officer:

As in most presentations, the following discussion contains forward- looking statements, and our actual results may differ materially from those discussed here. Additional information concerning factors that could cause such a difference can be found in the report on Form 10-K for the year ended December 31, 1995.46

Plaintiffs argued that forward-looking statements made during the call did not meet the requirements of the safe harbor because each particular forecast was not identified as a forward-looking statement. The Court rejected plaintiffs' contention that each forecast must be identified as a forward-looking statement as being contrary to the way people communicate and not required under the statute. Citing the legislative history of the Reform Act, the Court held that Congress made clear that it did not intend to make the safe harbor cumbersome or difficult to use, and thus dismissed plaintiffs' claim. Although a speaker need only invoke the safe harbor at the start of a conference call or analyst presentation, a few companies still fail to do so. A more common problem is the failure to give the "Miranda warning" about forward-looking statements in one-on-one conversations with analysts or reporters. Executives of public companies should make it a habit to use the "Miranda warning" in every one of these conversations.

With regard to written statements, no court has yet ruled on how they are to be identified. Some companies have used asterisks or a different font to identify forward-looking statements.48 Others include a prominent notice that any sentence which includes words like "anticipates" and "expects" is forward-looking. Whichever method a company uses, it should do so consistently and ensure that the forward-looking statements are identified in some way. In addition, as discussed below, companies should segregate historical and forward-looking information.

3. Separate forward-looking statements from statements of historical fact.

In challenging forward-looking statements, one of the tactics plaintiffs have employed is to suggest that some forward looking statements are actually statements of present fact, and thus not subject to the protections of the safe harbor.49 In order to avoid this problem, it makes sense for companies to separate historical and forward-looking information into separate paragraphs. Otherwise, a court might find that what the company intended to be covered by the safe harbor was merely a statement of historical fact.

4. Do not cross-reference from one document to another.

Another problem, which is very common in press releases, is cross-referencing risk factors from one written document to another. Thus, it is common to see a press release containing a short statement at the end stating that there may be forward-looking statements contained in the press release and directing the reader to a recent SEC filing containing a description of the risks which may cause actual results to differ. Many securities lawyers believe that this is not enough as the statute requires that the risk disclosures "accompany" the forward-looking statements.50 Referencing risk factors for written documents to those in SEC-filed documents may not qualify forecasts in such documents for safe harbor protection. Thus, accompanying forward-looking statements in written documents with risk factors is the safest practice.

The reason many companies make such cross references is that they are applying the rules for oral communications, which allow the speaker to merely make a reference to a publicly available document containing a description of risks (e.g., SEC filings). Unfortunately, the rules are different for written and oral communications. This is especially important to keep in mind when converting oral forward-looking statements to a written format, such as in publishing on a company World Wide Web page a transcript of a conference call with analysts. If a company is going to do this (and most securities lawyers would counsel against the practice), it must make appropriate changes to conform to the now-written disclosure to the requirements for forward-looking statements in documents.51

An open question is whether companies may incorporate risk disclosures, by reference where they incorporate by reference one document into another per SEC regulations (e.g., in an S-3 registration statement). Although we believe that such incorporation in compliance with SEC regulations should be adequate under the safe harbor, this has not been tested in the courts. In order to be safe, companies should lay out the risk disclosures in full in their SEC filings, rather than incorporate them by reference.


As seen above, there is significant uncertainty about whether a company has a duty to disclose financial information for an ongoing period when they sell stock to the public. Because of this uncertainty, companies can take certain steps to reduce the likelihood that they will be sued should the company have disappointing results soon after the offering, and increase the likelihood of a favorable outcome in the event a suit is filed. Foremost among these is the disclosure of the risks the company faces and which, if they materialize, could prevent the company from meeting expectations. In addition, with the passage of the safe harbor for forward-looking statements and the ongoing vitality of the bespeaks caution doctrine, companies should consider making affirmative disclosures about their expectations for the current period. Finally, it behooves securities issuers (as well as their underwriters) to target part of their due diligence efforts to the question of how the company is performing in a quarter that will not be completed before the offering goes effective. By doing this, companies may be able to minimize their exposure to a securities class action lawsuit and increase their chance of prevailing should they be sued.

  • 1 In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994).
  • 2 Zucker v. Quasha, 891 F. Supp. 1010 (D. N.J. 1995), aff'd mem., 129 F.3d 310 (3d Cir. 1997).3 Worlds of Wonder, 35 F.3d at 1411-12.
  • 4 Id. at 1419-20.
  • 5 Zucker, 891 F. Supp. at 1015. See also In re Stokeley USA, Inc. Sec. Litig.,

No. 95-C-3, slip. op. at 23 (E.D. Wis. Mar. 21, 1996) ("[Plaintiff's] position seems to be that a company has a duty to continuously update its quarterly financial information if it wishes to sell stocks on the open market. ... It is simply not practical to expect a company to publicly update its financial performance on anything more than a quarterly basis."); Renz v. Shreiber, 832 F. Supp. 766, 781 (D. N.J. 1993) (holding that company was under no duty to update statement of historical fact regarding sales growth about an ongoing quarter); Klein v. Maverick Tube Corp., 790 F. Supp. 68 (S.D.N.Y. 1991) (dismissing complaint alleging that IPO prospectus should have disclosed decline in demand for the company's products in quarter ended twelve days after IPO), aff'd without opinion, 969 F.2d 1041 (2d Cir. 1992).

6 Slate v. Mitzner, [1995 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 98 707 (N.D. Ga. 1995) (denying motion to dismiss; offering conducted on January 25 did not disclose results for quarter ended December 31); cf. In re Software Toolworks, Inc., Sec. Litig., 50 F.3d 615, 625-26 (9th Cir. 1994) (holding that underwriters failed to satisfy due diligence defense with respect to financial results of recently concluded quarter which were not included in registration statement).

7 See, e.g., Eisenstadt v. Centel Corp., 113 F.3d 738, 748 (7th Cir. 1997); Grassi v. Information Resources, Inc., 63 F.3d 596, 599 (7th Cir. 1995); Stransky v. Cummins Engine Co., 51 F.3d 1329, 1331 (7th Cir. 1995).

8 E.g., Weiner v. Quaker Oats, Inc., 129 F.3d 310 (3d Cir. 1997); Greenfield v. Heublein Inc., 742 F.2d 751, 758 (3d Cir. 1984). See also In re Phillips Petroleum Sec. Litig., 881 F.2d 1236, 1245 (3d Cir. 1989); In re Goodyear Tire & Rubber Co. Sec. Litig.,No. 88-8633, 1993 U.S. Dist. LEXIS 5333, at *17-*18 (E.D. Pa.), aff'd mem. 16 F.3d 403 (3d Cir. 1993); In re Kulicke & Soffa Indus. Sec. Litig., 747 F. Supp. 1136, 1140 (E.D. Pa. 1990).

9 Shaw v. Digital Equipment Corp., 82 F.3d 1194 (1st Cir. 1996).

10 Id. at 1200.

11 Id. at 1210.

12 Id.

13 Id. at 1211 n.21.

14 Id. at 1210.

15 Steckman v. Hart Brewing, Inc., 143 F.3d 1293 (9th Cir. 1998).

16 Id. at 1297.

17 Id. In support of this conclusion, the court pointed out that the company had announced in the middle of the following quarter, the first quarter of 1996, that it would not meet Wall Street analysts expectations. Based on this, the court reasoned that it appeared that the company would have had enough information available during the fourth quarter to determine whether or not it would have "flat" results. Id.

18 Id. at 1298.

19 Shaw, 82 F.3d at 1210.

20 Steckman, 143 F.3d at 1298.

21 Id. at 1298 n.1.

22 See In re VeriFone Sec. Litig., 11 F.3d 865, 869 (9th Cir. 1993) (federal securities laws impose no obligation upon an issuer to disclose internal projections).

23 Steckman, 143 F.3d at 1297 (quoting Securities Act Rel. No. 6835 (May 18, 1989), Fed. Sec. L. Rep. (CCH) ¶ 72,436 at 62,143, reprinted at ¶ 73,193, at 62,842)) (emphasis in the original).

24 Although this analysis may be done using traditional concepts for the materiality of financial data, the SEC has recently hinted that it will bring enforcement actions where it believes there has been a violation of accounting rules, even if it is of doubtful materiality. For example, the SEC recently filed an enforcement action against a company which allegedly manipulated reserved decisions which had the effect of understating its earnings slightly for 1990 and 1991 and overstating them slightly from 1993 to 1995. SEC v. W.R. Grace & Co., No. 98-8942 (S.D. Fla.) (filed December 22, 1998). Whether the Commission will direct this broadened view of materiality toward financial projections is still to be seen.

25 Congress established as an affirmative defense to Section 12(2) liability that the defendant "did not know, and in the exercise of reasonable care could not have known," of any material misstatements or omissions. The standard of "reasonable care" under Section 12(2) is identical to the standard of "reasonable investigation" under Section 11. See, e.g., Sanders v. John Nuveen & Co., 619 F.2d 1222, 1228-29 (7th Cir. 1980); Weinberger v. Jackson, [1990-91 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,693, at 98,255 (N.D. Cal. 1990).

26 Feit v. Leasco Data Processing Equip. Corp., 332 F. Supp. 544, 582 (E.D.N.Y. 1971).

27 See In re Software Toolworks, Inc. Sec. Litig., 50 F.3d 615, 623 (9th Cir. 1994) (affirming summary judgment on part of the underwriters' due diligence); In re International Rectifier Sec. Litig., [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,469 (C.D. Cal. 1997); Weinberger v. Jackson, [1990-91 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,693, at 98,255 (N.D. Cal. 1990); Competitive Assocs., Inc. v. International Health Sciences, Inc., [1974-75 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 94,966, at 97,337 (S.D.N.Y. 1975); Feit, 332 F. Supp. at 582.

28 See In re International Rectifier Sec. Litig., [1997 Tr. Binder] at 97,139-40; Weinberger v. Jackson, [1990-91 Tr. Binder] at 98,255.

29 Worlds of Wonder, 35 F.3d at 1419.

30 Steckman, 143 F.3d at 1298.

31 Pub. L. No. 104-67, 109 Stat. 445 (1995).

32 H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 43 (1995) ("Conf. Rep."). The Conference Committee Report which accompanied the Reform Act is essential reading for anyone interested in understanding the background and purpose of the legislation. A copy of the Report, as well as the statute and some of the leading cases interpreting it, is available at the Stanford Law School Securities Class Action Clearinghouse ( Indeed, a central aspect of some of the judicial debates surrounding the interpretation of the Reform Act is the meaning of some of the statements in the Conference Committee Report. See, e.g., In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746 (N.D. Cal. 1997) (discussing Conference Report in the context of interpreting the Reform Act's heightened pleading standards for scienter).

33 Conf. Rep. at 42-43. The Conference Report also noted that one study found that over two thirds of venture-capital-backed public companies were reluctant to disclose forward-looking information for fear of lawsuits. Id. at 43.

34 Conf. Rep. at 43-44. Congress defined a "forward-looking statement" as one that projects financial items, describes management's plans and objectives for future operations or economic performance, or any statement of the assumptions underlying the foregoing. Section 27A(c)(1)(A) of the Securities Act of 1933; 17 U.S.C. § 77z-2 (c)(1)(A); Section 21E(i)(1)of the Securities Exchange Act of 1934, 17 U.S.C. § 78v-5(i)(1).

35 Section 27A(c)(1)(A) of the Securities Act of 1933; 17 U.S.C. § 77z-2(c)(1)(A); Section 21E(c)(1)(A)I of the Securities Exchange Act of 1934, 17 U.S.C. § 78v-5(c)(1)(A).

36Section 27A(c)(1)(B) of the Securities Act of 1933, 17 U.S.C. § 77z-2(c)(1)(B); Section 21E(c)(1)(B) of the Securities Exchange Act of 1934, 17 U.S.C. § 78v-5(c)(1)(B).

37 Conf. Rep. at 43.

38 Id. at 43-44.

39 Id. at 44.

40 Id. at 44.

41 Rasheedi v. Cree Research, Inc., [1997 Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 99,566, at 97,818 (M.D.N.C. 1997) ("Defendants do not have to caution against every conceivable factor that may cause actual results to differ. Certainly if Congress did not see fit to impose such a stringent standard, neither can Plaintiffs nor the Court."); Harris v. IVAX Corp., 998 F. Supp. 1449, 1454 (S.D. Fla. 1998) ("The Court will not, looking in hindsight, hold the Defendants to the impossible burden of having to warn of every factor that ultimately causes the forward-looking statement not to come true. Such an approach was not the intent of Congress and would effectively eviscerate the safe harbor. It is sufficient that the cautionary statements identify meaningful and important factors that could affect future performance.").

42 See, e.g., Grossman v. Novell, Inc., 120 F.3d 1112, 1121-23 (10th Cir. 1997) (cautionary statements in registration statement required dismissal); Saltzberg v. TM Sterling/Austin Assocs. Ltd., 45 F.3d 399, 400 (11th Cir. 1995) (cautionary language in private placement memorandum); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 364-65 (3d Cir. 1993) (prospectus "took considerable care to convey to potential investors the extreme risks inherent in the venture while simultaneously carefully alerting the investors to a variety of obstacles the [casino] would face"); Romani v. Shearson Lehman Hutton, 929 F.2d 875, 879 (1st Cir. 1991) (documents that "clearly 'bespeak caution' are not the stuff of which securities fraud claims are made") (citation omitted); Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 949 F.2d 243, 245-46 (8th Cir. 1991) (no claim based on any matter "addressed by the repeated, specific warnings of significant risk factors and the disclosures of underlying factual assumpt ons"); Sinay v. Lamson & Sessions Co., 948 F.2d 1037, 1040 (6th Cir. 1991) (court must consider whether "prediction suggested reliability, bespoke caution, was made in good faith, or had a sound factual or historical basis") (citations omitted).

43 See Conf. Rep. at 46 ("The Conference Committee does not intend for the safe harbor provisions to replace the judicial 'bespeaks caution' doctrine or to foreclose further development of that doctrine by the courts").

44 For example, in In re Boeing Securities Litigation, [Current Tr. Binder] Fed. Sec. L. Rep. (CCH) ¶ 90,285, at 91,319-20 (W.D. Wash. 1998), the court held that optimistic forward-looking statements were accompanied by generic and boilerplate warnings not tailored to the forward-looking disclosure, and thus they did not qualify for safe harbor protection.

45 2 F. Supp. 2d 1231 (N.D. Cal. 1998).

46 Id. at 1241.

47 Id. at 1242. The court quoted the Senate Banking Committee Report on the legislation which stated: "In the case of oral statements, the Committee expects that the notice will be provided at the outset of any general discussion of future events and that further notice will not be necessary during the course of the discussion." Id. (quoting Senate Report No. 104-98, 1995 U.S.C.C.A.N. (109 Stat. 737) 679, 696)).

48 Given that most company SEC filings and press releases go out over the Internet, use of a different typeface may not be the most effective practice as most Internet formats do not differentiate between typefaces.

49 See, e.g., Harris v. Ivax, 998 F. Supp. at 1453; In re Boeing Sec. Litig., [Current Tr. Binder] at 91,319-20.

50 For example, see the discussion in Steven E. Bochner & Anita S. Presser, An Outlook on Forward-Looking Statements,, November 1998, at 1.

51 To reduce this risk, a company that decides to post transcripts of conference calls or speeches on the Internet should consider inserting into the transcripts direct links to the written cautionary disclosures referenced in the previously oral communication.