Adding Meaning to “Meaningful Cautionary Statements”: Protecting Investors with a Narrow Reading of the PSLRA’s Safe Harbor for Forward-Looking Statements
Volume 84, No. 2, Winter 2012
By Matthew Brinker

Although injured investors typically have a private right to sue when a publicly traded company makes a fraudulent statement regarding its business, many courts and commentators find an exception to this general rule with the statutory safe harbor for forward-looking statements in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). The PSLRA’s safe harbor provides that a qualifying public company shall not be liable for a false or misleading forward-looking statement as long as it was not made with actual knowledge of falsity, was immaterial, or was made with “meaningful” caution. Many courts and commentators have given this last provision broad protective power. They plainly read the PSLRA’s safe harbor to state that even if a defendant issuer had actual knowledge that its forward-looking statement was false or misleading—thus, defrauding investors—there is no private securities fraud action if the defendant company identified its statement as forward-looking and accompanied it with “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.” In evaluating “important factors” on a motion to dismiss, these courts and commentators state that a defendant’s actual knowledge of falsity is irrelevant to the analysis of whether a defendant’s caution was “meaningful,” and so a fraudulent forward-looking statement disclosing seemingly “important” risk factors is not actionable as a matter of law. In short, if there is caution, there is never fraud.

This Comment rejects such a proposition. The majority’s interpretation of the PSLRA’s safe harbor, which deliberately ignores the investor-protecting quality of the word “meaningful” in the phrase “meaningful cautionary statements,” is not only inapposite to traditional securities regulation but is also not the only suitable reading of the statutory safe harbor. This Comment proposes a reading of the PSLRA’s safe harbor for forward-looking statements that closes the gap where fraudulent forward-looking statements can find protection under the majority’s interpretation. Actual knowledge of falsity should always be relevant to a court’s analysis of a materially false or misleading forward-looking statement. In line with the history and purpose of securities regulation and in light of other recent PSLRA procedural developments, this Comment presents a reading of the PSLRA’s safe harbor that allows for facts producing a strong inference of actual knowledge of falsity to be submitted to a court on a motion to dismiss to show that the cautionary language accompanying a fraudulent forward-looking statement should not be considered “meaningful.”

Part II.A introduces forward-looking statements and the legal line that divides actionable fraudulent forward-looking statements from non-actionable statements that happen to turn out false. Part II.B details the development of legal protection for innocently false forward-looking statements embodied in the Securities and Exchange Commission’s (SEC) safe harbor rules and the judicially created bespeaks caution doctrine. Part II.C discusses the history and origins of private securities litigation and the movement for reform leading up to the 1995 passage of the PSLRA and its statutory safe harbor for forward-looking statements. Though it has been nearly fifteen years since Congress enacted the PSLRA, courts are still wrestling with how to apply the safe harbor. Part II.D provides an overview of the differing judicial interpretations of the PSLRA’s “meaningful” caution subprong—from an approach where cautionary language trumps evidence of actual knowledge to an approach that incorporates the qualitative aspects of knowledge into a determination of “meaningfulness.”

This Comment argues that quality of cautionary language is just as important as quantity and that Congress agreed with this principle when it passed the PSLRA. Part III.A supports an approach to the statutory safe harbor that incorporates evidence of scienter into a court’s meaningful caution analysis. Part III.A.1 discusses the importance of scienter as an element of securities fraud, and Part III.A.2 analyzes the text and legislative history of the PSLRA’s safe harbor to show that evidence of scienter can appropriately be submitted on a motion to dismiss to overcome any claims of “meaningful” caution. Part III.B critiques the majority interpretation, which stops short of a qualitative reading of the safe harbor by focusing entirely on the disjunctive nature of the statute’s text. Parts III.C and III.D, respectively, discuss the negative policy implications of the majority’s approach and how current pleading standards provide more-than-sufficient protection for issuers wishing to make forward-looking statements. This Comment concludes by proposing a reading of the PSLRA’s safe harbor that not only provides issuers with an opportunity to protect themselves with cautionary language, but also provides investors with meaningful protection from issuers who aim to use the safe harbor as a refuge from actionable securities fraud. Part III.E proposes a rule for courts evaluating a defendant’s motion to dismiss based on the PSLRA’s safe harbor: cautionary statements are meaningful (and thus preclude drawing a strong inference of scienter) only if they are substantive, firm specific, and tailored to a forward-looking statement and reasonably reveal any knowledge held by the defendant issuer that such a statement is or will be false or misleading.

Read Comment…