One variable that issuers, their officers and directors, and underwriters can affect before a securities lawsuit has been filed is the contents of the statements made to the investing public. One potential source for writing better public statements is the Safe Harbor for forward-looking statements. The Safe Harbor is approaching its twenty-fifth anniversary, yet skepticism persists about its value because courts do not always apply it. In reality, courts frequently apply the Safe Harbor as intended and it should be embraced, not downplayed. The best way to do this is to draw lessons from court decisions on how to write public statements that conform with the Safe Harbor. This article sets forth top-level lessons; more detailed, technical guidance (including arguments lawyers should raise once a lawsuit has been filed) will be presented in the forthcoming Advanced Guide To The Safe Harbor.

What is The Safe Harbor?

The Safe Harbor is codified in Section 22E of the Securities Exchange Act of 1934 (which covers federal securities fraud claims brought under Exchange Act Section 10(b) and SEC Rule 10b-5) and Section 27A of the Securities Act of 1933 (which covers false statement claims under Securities Act Sections 11 and 12(a)(2)). These statutes were enacted as part of the Private Securities Litigation Reform Act of 1995.

The Safe Harbor applies to "forward-looking statements." The statutes define this phrase by five examples, the first and most important being "a statement containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items" - i.e., traditional financial forecasts or guidance. Courts have developed other tests to identify forward-looking statements (e.g., that a statement whose validity cannot be determined until the future is forward-looking).

The crux of the Safe Harbor is that a person who makes a forward-looking statement cannot be liable in a private securities fraud case if either: (1) the statement is accompanied by "meaningful cautionary disclosures"; or (2) the statement is immaterial; or (3) plaintiff fails to prove that the statement was made with actual knowledge that it was false. The prongs are disjunctive (a fact some courts fail to recognize) and hence liability does not exist if any prong applies.

The first prong of the Safe Harbor is important because if it applies, private securities liability cannot exist without any further consideration of the case. This, in turn, focuses an issuer on writing what courts will find to be "meaningful cautionary disclosures," meaning ones that identify "important factors" (often called "risk factors") "that could cause actual results to differ materially from those in the forward-looking statement." Risk factors are most often written into periodic filings, and also may be found in press releases that include forward-looking statements. For oral forward-looking statements (e.g., on quarterly earnings release calls or at investor conferences), the risk factors in written documents can be invoked by a statement directing investors to look at those documents and disclosures.

The third prong of the Safe Harbor is important because liability can exist for non-forward looking statements under state of mind standards less culpable than actual knowledge of falsity. Thus, requiring a plaintiff to plead and prove actual knowledge of falsity for a forward-looking statement makes it more difficult to file and win a securities case that challenges such a statement. The second prong of the Safe Harbor is not as important because immaterial statements never give rise to liability.

The Safe Harbor is not always available. It does not apply to statements made in connection with an initial public offerings or a tender offer, or if issuer has entered into a consent decree with the SEC involving a violation of the antifraud provisions of the federal securities laws in the previous three years. It also does not apply to financial statements, even though some parts of financial statements (such as reserves) depend on judgmental assessments about the future.

Why The Safe Harbor Is Important

The Conference Committee responsible for the Reform Act explained why Congress created the Safe Harbor. Forward-looking information from issuers is valuable to investors, but forward-looking statements are by their nature susceptible of proving to be wrong; simply put, it's difficult to predict the future. The fear of securities law liability for making forward-looking statements that proved to be wrong had discouraged issuers from making such statements.

Thus, the Safe Harbor eliminates liability if its provisions apply so as to incentivize issuers to make forward-looking statements for the benefit of investors. The corollary is that if an issuer chooses to make forward-looking statements, it should write its disclosures in a manner that qualifies for Safe Harbor protection from liability.

Writing Cautionary Disclosures To Rebut The Challenge That A Risk Already Had Materialized: If/Could And Actual Adversities

The most common challenge to the application of the Safe Harbor is the argument that a factor characterized as a risk already had materialized as of the time of a statement challenged in a securities complaint. Plaintiffs will contend that such a risk disclosure is not a "meaningful cautionary disclosure" because it characterized an actual adverse fact as merely a hypothetical, not yet occurring risk. Plaintiffs also may contend that such a risk disclosure is itself misleading and gives rise to liability because it signaled to investors that an adverse fact did not yet exist.

While some pre-Reform Act case law supports this line of attack, there are strong reasons to reject it as applied to the Safe Harbor (which will be presented in the Advanced Guide). In practice, the success of these arguments usually depends on whether the complaint pleads with factual particularity that the risk already had materialized. This means that the efficacy of a risk disclosure as against this type of challenge in large part depends on what happens in court once a case has been filed, not on how the issuer had written its risk disclosures in the first place.

That being said, there are two ways to write risk disclosures more likely to stand up to this type of argument. On way is to systematically search the risk disclosures sections of periodic filings, registration statements, and press releases for the words "if" and "could." The predicate of plaintiff's argument is that when a statement couples either of these words with a discrete event that in theory may or may not occur, the statement implies that the event has not yet occurred. For example, if an issuer says "there is a risk our financial performance will suffer if we lose our contract with our largest customer," plaintiffs (and courts) may interpret the statement to imply that the company had not lost its contract with its largest customer as of the date of the statement. An issuer certainly may choose to make this statement in order to provide meaningful cautionary disclosures as the Safe Harbor intends, but it should do so only if, in fact, it has not lost its contract as of the date of the statement. An issuer's deliberate scrutiny of its risk disclosures to identify the instances in which this if/could factor may apply will reduce the probability of error in disclosure.

A second way to write better risk disclosures is to state that an adverse factor actually has occurred in the past or predict it will occur in the future. For example, assume that a risk to a company's revenue forecast is the decline in the average selling prices of its key products. A thoughtful issuer will disclose not only that declining prices as a risk factor; if prices have declined in recent years, the issuer will disclose that fact too; and if the issuer expects prices to decline in the upcoming time period covered by the forward-looking statement, it will disclose that expectation as well. If an issuer makes such disclosures and is sued, it can credibly argue (and probably at the earliest stage of the case) that it did not characterize a risk as a mere contingency and hence that the risk factors are meaningful cautionary disclosures.

Separate Forward-Looking Statements From Present Tense Statements

Some courts have found difficulties in identifying whether statements are "forward-looking" in particular contexts. One such context is when an issuer mixes statements that describe the past or present state of affairs with references to the future.

For example, assume a CEO says at an investor conference that her company (1) has completed the development of a new product (2) that contains new features not offered by competitors, and (3) expects sales of the new product to contribute positively to the upcoming quarter's revenues. A court may characterize the entire statement as present-tense, not forward-looking, even though clause (3) refers to the future. Other courts may characterize clause (3) as forward-looking, but read it in conjunction with clauses (1) and (2) and reject the application of the Safe Harbor if a complaint alleges that the CEO knew that clauses (1) and (2) were false at the time of her statement. (This is what the Ninth Circuit did in a recent decision.)

Now assume that the same company provides largely the same information, but separates and generalizes the forward-looking information from the rest of the disclosures. This time, the form of the disclosure is a quarterly press release. The main part of the release describes the financial results and achievements from the recently concluded quarter, which may or may not include the information about the new product with its unique features. The press release then includes a separate section providing revenue guidance for the upcoming quarter, which naturally would include revenue from sales of the new product (although the press release probably will not state this explicitly). The press release identifies this guidance as a forward-looking statement and discloses factors that may cause actual results to differ, including that customers may not find the features of the products sold by the company compelling or superior.

Under this alternative scenario, if the company fails to achieve the guidance in the press release and is sued on that basis, a court may find that the guidance is forward-looking and was accompanied by meaningful cautionary disclosures, and hence protected by the Safe Harbor. (This is how the same Ninth Circuit decision referenced above ruled.) This outcome is better for the issuer and better for investors, who can focus on the forward-looking statement and the risks to achieve it from the fact that the forward-lookingstatement was made in relative isolation.

Avoid Using "On Track" Unless You Intend To Given An Interim Progress Report

Another context in which courts have found difficulties in identifying whether statements are "forward-looking" is for statements using the phrase "on track."

Most often, "on track" is used with reference to an explicit forward-looking statement, such as "we are on track with our previously announced earnings forecast for the year." The best way to read this statement is: "as of today, the day of this statement, our earnings forecast for the year is the same number we announced earlier." Had the issuer not made a previous forecast, there would be no question that the on track statement was forward-looking.

An alternative reading of the statement, however, is that there is a plan, schedule, timeline, or series of expectations-a "track"-to the achievement of the yearly forecast which posits a particular level of progress towards that end of the date of the statement. Read this way, "on track" is a representation about the progress as of the date of the statement as compared to the schedule or timeline, which is closer to a present-tense statement that does not qualify for Safe Harbor protection.

There is nothing wrong with making a statement that progress towards an ultimate goal is as was planned, schedules, or expected as of a particular date. Given the ambiguity explained above, an issuer should use "on track" only if it wants to make such a statement. If the purpose of a disclosure is to remind investors of a previous forecast, an issuer should not use "on track" so as not to give an unintended impression about progress as against expectations. In particular, many issuers disclaim a duty to update or provide interim reports when they issue a forecast in the first place. If an issuer has that policy, it should not undermine it by using "on track."

Acknowledge The Limits Of Predictability

There is a natural tendency of corporate officials to be optimistic; after all, there's no point in working so hard in a business (or indeed any endeavor) that one thinks is going to fail. There is nothing wrong with such optimism; in fact, courts have recognized this phenomenon and reasoned that investors expect it. Moreover, the Safe Harbor dovetails well with this factor, as it encourages issuers to caution investors about the factors that may cause actual results to vary from whatever optimistic scenario the issuer and its executives present.

There is a danger, however, in equating optimism about the future with the predictability of a favorable outcome. To address this risk, issuers should identify the level of uncertainty of the accuracy of the information that flows into the company's business model and thereby influences forward-looking assessments. For example, a company may be particularly vulnerable to competitors or regulatory opinions, or particularly dependent on obtaining information from its supply chain. Then, the greater the dependency on less-than-controllable information, the less certainty the issuer should express in its forward-looking statements. For example, a company in an industry with rapid change may limit the time horizon of its forecasts to one quarter at a time. The market will not penalize such realistic humility in the face of uncertainty, and the issuer will be in better position if it fails to achieve its forecast and is sued.

Be Deliberate And Process Matters

The final recommendation naturally flows from what is presented above: an issuer should be thoughtful and deliberate in providing forward-looking statements and risk disclosures in order to use the Safe Harbor as intended and for its benefits. Whenever the goal is being deliberate, process matters, and three helpful elements of the process come to mind:

• Most companies already have a process to identify their business model and its risks and dependencies. The same information should be incorporated into the risk disclosures.

• The process of writing risk disclosures should start from the previous quarter's risk factors and systematically ask whether there has been any change in the underlying facts referenced by those disclosures (as well as any new risks); courts have declined to apply the Safe Harbor when a securities complaint alleges that the facts have changed but the risks disclosures stayed the same.

• Issuers would be well advised to have their outside counsel (including litigation counsel) review their risk disclosures so as to identify their vulnerabilities under Safe Harbor case law.