by T. GormanPosted on Posted in SECActions

A critical question in making forward looking statements is whether there is meaningful cautionary language. If there is, then the PSLRA provides a safe harbor from liability. If there is not, the speaker may be liable, but only upon proof of knowing falsity. A critical question then is what constitutes meaningful cautionary language under the PSLRA. In Slayton v. American Express Co., Case No. 08-5442-cv (2nd Cir. Decided May 18, 2010), the Second Circuit rejected defendants’ claim that their forward looking statements came within the safe harbor because the cautionary language was boilerplate. Nevertheless, the Court affirmed the dismissal of the action, concluding that plaintiffs had failed to adequately plead facts demonstrating knowing falsity.

The action is based on a statement made by American Express in its May 2001 10-Q regarding its portfolio of high-yield debts investments in the MD&A section of the filing. There, the company reported a loss of $182 million from those investments. It went on to state that the company expected substantially lower losses for the remainder of 2001. Plaintiffs claim that this statement is false. According to the second amended complaint, at the time of the quarterly filing, the company knew that the $182 million first quarter write down did not reflect the true magnitude of the deterioration of the portfolio. In fact, when the 10-Q was filed, senior management was investigating the question and later reported substantially larger losses totaling over $800 million.

The Form 10-Q also contained cautionary language which appeared several pages after the allegedly false statement. There, the report warned that it “contain[ed] forward-looking statements, which are subject to risks and uncertainties.” It also stated that “[f]actors that could cause actual results to differ materially from these forward-looking statements include . . . potential deterioration in the high-yield sector, which could result in further losses . . .”

First, the court concluded that the statement challenged by plaintiffs was clear a forward looking statement. The PSLRA has several definitions of forward looking statement. One provides that “a statement containing a projection of . . . income . . . or other financial items . . .” is a forward looking statement. Although projections included in financial statements are excluded from the safe harbor, here the statement was in the MD&A section of the 10-Q, not in the financial statements.

Second, the critical question is whether the projection is accompanied by meaningful cautionary language. The PSLRA only provides a safe harbor from liability if the statement is “identified as a forward-looking statement, 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 . . .” 15 U.S.C. § 78u-5(c)(1)(A)(i).

In this case, the Court concluded that the cautionary language was not sufficient. Nothing in the statute requires that the forward looking statement be contained in a separate section. Equally clear is the fact that cautionary language which is misleading in light of historical fact cannot be meaningful within the meaning of the statute. The difficulty in this case, the Court noted, is that the defendants knew of specific risks about the portfolio, but did not warn of them. At the same time however, Congress foreclosed any inquiry into a defendants’ state of mind in applying the safe harbor provision. This creates a difficult tension in applying the statute.

The Court resolved this problem by focusing on a provision in the Conference Report to the PSLRA which warns that the cautionary language may not be boilerplate. Rather, the warnings should be extensive and specific.

Here, the warning was boilerplate. The same cautionary language appeared in several other filings both before and after the one at issue here. The consistency of the language demonstrates it was not tailored to the specific situation. Clearly such language is not meaningful as required by the PSLRA. Accordingly, defendants could not rely on the safe harbor.

Nevertheless, plaintiffs’ complaint failed because it did not adequately plead facts demonstrating knowing falsity. In this case, the totality of the circumstances demonstrates that while there is an inference of scienter, the contrary inference is at least as strong. In addition, the fact that there was no motive to falsify the facts supports the conclusion that the complaint fails to adequately plead actual knowledge. Accordingly, the decision of the district court dismissing the complaint was affirmed.

by T. GormanPosted on Posted in SECActions

President Obama frequently cites the “twenty-four hour news cycle” which pounces on everything and often becomes a source of misinformation, rumors and distortions rather than news. This has become such a regular part of his speeches that the pundits are now commenting on his commentary on the news cycle.

Those claiming that the SEC is following the lead of the administration – such as some of the critics of the Goldman enforcement action – should review SEC Chairman Mary Schapiro’s latest speech. In her Remarks at CFA Institute 2010 Annual Conference delivered on May 18, 2010, the Chairman states that a number of myths have evolved regarding the SEC’s commitment to international accounting standards. These come not from the twenty-four hour news cycle of Mr. Obama’s speeches but the lack of news coverage Ms. Schapiro referred to as a “news void . . .”

The Chairman began her remarks by reviewing a number of recent Commission initiatives. Once is the “Dear CFO letters.” The first of what is going to become a periodically used tool of Corporation Finance was sent out in March 2010 to large financial institutions. The letter requested information about repurchase agreements, securities lending transactions and other arrangements involving the transfer of financial assets. The purpose is to gather information to assess the need for accounting and disclosure changes.

To fill the news void about the SEC’s commitment to the adoption of global accounting standards, Ms. Schapiro then addressed four myths which have evolved:

Myth 1: The SEC’s does not have a strong commitment to the project. Citing comments from the Commission’s Statement in Support of Convergence and Global Accounting Standards from February, the Chairman noted that this myth is simply wrong.

Myth 2: The U.S. is dragging its feet on the project. Wrong again says the Chairman. While the FASB and the IASB have worked diligently, key issues remain. These include accounting for financial assets – the type which were at the center of the financial crisis – as well as principles involving revenue recognition, consolidation and leases. In this regard, the Chairman stressed the importance of the process established by the FASB and IASB which is designed to ensure high-quality improvements to accounting standards.

Myth 3: The U.S. is fixated on process. This myth is also inaccurate. The Commission will not, however, accept shortcuts that could undermine the larger goals of ensuring high quality global standards. It is critical during this process that the IASB and the FASB be shielded from undue political or commercial pressures. While the IASB process of using a Monitoring Board to safeguard against outside pressures slows the process, it helps ensure that the standards are high quality.

Myth 4: The U.S. is protecting its parochial interests. Wrong again. The Commission is committed to ensuring that investors around the globe are protected and that all who participate in the U.S. markets “come under the SEC’s umbrella of protection.”

Dispelling all myths, and filling in the news coverage void, the Chairman concluded by reiterating the Commissions commitment to global accounting standards.