APPLYING THE BESPEAKS CAUTION DOCTRINE

The Second Circuit clarified the application of the bespeaks caution doctrine, drawing a line between statements which might invite an inference of reducing risk in the future and characterizations which communicate a present or historical fact. Iowa Public Employees’ Retirement System v. MF Global, Ltd., Docket No. 09-3919-cv (2nd Cir. Sept. 14, 2010).

Plaintiffs claim that MF Global, Ltd. made material misstatements and omissions in its IPO prospectus and registration statement. The complaint asserts claims under Securities Act Sections 11, 12(a)(2) and 15. MF Global was the brokerage arm of Man Group, Plc., a hedge fund. The complaint names as defendants MF Global, Man Group, the IPO underwriters and various MF Global officers and directors.

The factual claims focus on allegations that on February 27, 2008, a broker at MF Global lost $141.5 million speculating in wheat futures. The losses resulted when the broker took positions vastly in excess of the firm’s trading limits and collateral requirements. MF Global was responsible for settling the broker’s trades and absorbing the losses. When the news of the losses reached the markets the next day, MF Global’s stock price fell 28%. The next day it declined another 17% for a total two-day market capitalization loss of over $1.1 billion. The revelation of the loss informed the market that MF Global’s internal risk controls had not been applied to brokers trading for their own account. A class action followed centered on claims that this omission and others rendered the offering documents false and misleading.

The district court dismissed the claim based on the bespeaks caution doctrine. The court concluded that “Plaintiffs’ objections to misrepresentations about specific or general shortcomings in MF Global’s risk management system that existed at the time the prospectus was issued are, in fact, objections to Defendants’ alleged failure to disclose the possibility that the risk management system might be unable to prevent future negative outcomes.”

The Second Circuit remanded the case for reconsideration. To prevail, plaintiff must show that the relevant communication either misstated or omitted a material fact the court noted. The bespeaks-caution doctrine is a corollary of the long-established principle that a statement or omission must be considered in context.

A forward looking statement accompanied by sufficient cautionary language is not actionable because a reasonable investor could not have found the statement materially misleading. Stated differently, projections about the future cannot be assumed to be settled facts by any reasonable investor. The bespeaks caution doctrine is one of the rules developed to deal with forward-looking statements.

It is settled that the doctrine only applies to projections about the future and those of optimism concerning future performance, but has no application to existing and past facts. While the principle appears straightforward, its application can be difficult.

Here, the question is whether it applies to statement in the prospectus about MF Global’s risk management system. Plaintiffs claim that the prospectus omitted the fact that it did not apply to company employees. This claim relates to an ascertainable fact when the challenged statements were made. It is error to apply the bespeaks caution doctrine to such a statement.

The court went on to note, however, that a statement specifying the risk of default is distinct from a statement of present or historical financial instability. At the same time, a statement of confidence in a firm’s operations may be forward looking and thus insulated by the bespeaks caution doctrine.

In this case “characterizations of MF Global’s risk-management system – that the system was ‘robust,’ for example – invite the inference that the it will reduce the firm’s risk. However, bespeaks caution does not apply insofar as those characterizations communicate present or historical fact … .” The case was remanded to the district court to apply these principles to the statements here.

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