Second Circuit Cautions Issuers to Provide “Meaningful” Forward-Looking Statement Disclaimers
The May 18, 2010 Second Circuit Court of Appeals decision in Slayton v. American Express Company et al. No. 08-5442-cv (2d Cir. 2010) fires a warning across the bow of any issuer that routinely replicates its forward-looking statement disclaimer. At issue in Slayton was a statement made by American Express in its May 2001 Form 10-Q that, although it had incurred a $182 million loss from its high-yield debt investments in the first quarter of 2001, “[t]otal losses on these investments for the remainder of 2001 are expected to be substantially lower than in the first quarter.”1 A few pages later, the Form 10-Q included a customary forward-looking statement disclaimer setting forth factors which could cause the statements to differ materially, including “potential deterioration in the high-yield sector, which could result in further losses in [its] investment portfolio . . . .”2 Following a July 2001 press release by American Express announcing an $826 million loss associated with its high-yield debt portfolio, including a $403 million loss related to investment-grade collateralized debt obligations (CDOs), plaintiff-shareholders filed a securities fraud action alleging that American Express had misled investors as to the extent of the anticipated losses associated with American Express’ over-investment in high-yield debt securities. American Express sought the protection of the safe harbor provisions of the Private Securities Litigation Reform Act (PSLRA) for its forward-looking statement regarding these losses.
The PSLRA exempts an issuer from liability in a private action based upon an untrue statement of a material fact or the omission of a material fact necessary to make the statement not misleading, to the extent:
- the statement is identified as forward-looking and “is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement”; or
- if the plaintiff in an action fails to prove that the forward-looking statement was made or approved by an officer “with actual knowledge by that officer that the statement was false or misleading.”3
In applying this statute, the Court determined that the statement at issue in Slayton was exempt from liability under the second prong of the safe harbor because the statement was not made with “actual knowledge” that it was false or misleading. To meet their burden of proof, the Court required the plaintiff-shareholders to plead with particularity facts evidencing scienter, i.e. an intention by the defendant “to deceive, manipulate, or defraud.”4 In determining whether the plead facts supported a strong inference of scienter that was “at least as compelling as any opposing inference of nonfraudulent intent,”5 the Court considered the record as a whole and was persuaded by, among other things, the absence of any personal financial gain or other motive associated with the alleged misstatement, American Express’ prompt investigation into the condition of the investment-grade CDOs and American Express’ “prudent” application of conservative assumptions in its investigation.6 The Court found that the plaintiffs were unable to meet their heightened burden of proof because the defendants had engaged in a “good-faith process to inform themselves and the public of the risks.”7
Although the statements were held to be protected by the PSLRA for the reasons cited above, the Court held that American Express’ forward-looking statement failed to be accompanied by “meaningful cautionary statements that identify important factors” and accordingly did not qualify for the first prong of the safe harbor. In reaching its conclusions, the Court noted that adequate cautionary language must be “substantive” and “tailored to the specific future projections.”8 The Court found American Express’ reference in its Form 10-Q to “deterioration in the high-yield sector” to be “too vague” and to verge “on the mere boilerplate,” particularly in the face of plead facts that the defendants knew of a specific risk relating to “rising defaults on the bonds underlying [its] investment-grade CDOs.”9 The Court also focused on the fact that American Express’ cautionary language had remained the same in prior as well as later public filings, even though the situation had changed over time (i.e., the same cautionary language appeared in American Express’ filings as early as January 2001 and continued to appear after the $182 million loss was reported in May 2001), which proved that the statement at issue was not modified to fit the particular projection at issue.
The Court also took the opportunity to address any lingering concerns as to whether under the PSLRA forward-looking statements need to be segregated or specifically labeled in an issuer’s disclosure. The Court clarified that the commonly found references to “expect,” “believe,” etc. in a single disclosure section is, in fact, sufficient to identify the inclusion of forward-looking statements throughout an issuer’s disclosure.
Although American Express was fortunate to withstand the scrutiny of the Court’s scienter analysis, the interesting implication of the Court’s decision in Slayton is its guidance on drafting adequate cautionary language, which can avoid this scrutiny altogether. The Second Circuit has reminded us all that in the crunch of earnings releases and compliance deadlines, it behooves issuers and their securities counsel to remember that the often-overlooked forward-looking statement disclaimer may very well be one of the most important disclosures you make.
1 Slayton v. American Express Co., No. 08-5442-cv, 2010 WL 1960019, at *2 (2d. Cir., May 18, 2010) (internal quotation marks omitted).
2 Id. at *3 (emphasis added).
3 15 U.S.C. § 78u-5(c) (emphasis added).
4 Slayton at *12 (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007) (internal quotation marks omitted)).
5 Id. (quoting Tellabs at 314 (internal quotation marks omitted)).
6 Id. (internal citation and quotation marks omitted).
7 Id. at *15.
8 Id. at *11 (internal citation and quotation marks omitted).
9 Id.
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