Open FutureXSafe Harbor
Open FutureXSafe Harbor
Abstract and Keywords
The U.S. Securities and Exchange Commission (SEC) provides a wealth of information on genomic companies and other corporations, and is the place where the “self-regulating” securities industry that undergirds the U.S. capital markets is, in fact, regulated. An important part of those securities regulations changed, however, with the passage of the Private Securities Litigation Reform Act of 1995. The change concerned how “forward-looking information” would be read by the courts, and how it should be read by someone sometimes called “the sophisticated investor” and other times called the more modest “reasonable investor.” This is the regulatory framework that shaped the genomic companies. Companies such as deCODE Genetics, Celera Genomics, Millennium Pharmaceuticals, and Human Genome Sciences Inc. have existed almost entirely in a historically specific regulatory framework of corporate disclosure; a framework that sanctions and encourages the promissory quality of the “forward-looking information” which has proven vital to these life-science corporations. In late 1994, the SEC issued a “concept release” calling for comments on proposed changes to the “safe harbor” provisions of federal securities law.
Keywords: Securities and Exchange, genomic companies, securities industry, Private Securities Litigation, forward-looking information, reasonable investor, deCODE Genetics, corporate disclosure, concept release, safe harbor
Forward-looking information occupies a vital role in the United States’ securities markets.
U.S. Securities and Exchange Commission, “Concept Release and Notice of Hearing: Safe Harbor for Forward-Looking Statements”
Maybe it’s not simply information that animates markets in today’s “information society.” The U.S. Securities and Exchange Commission, that regulatory body most concerned with enforcing the disclosure of corporate information, here names the “vital” force as forward-looking information. Just what kind of force is in play here, when forward-looking information plays its role? Or: what is the place in the network, in the so-called information economy, that forward-looking information occupies? What kinds of reading practices does forward-looking information demand, and from whom? In a territory of forward-looking information, how does one decide between fact, speculation, puffery, hype, straight dope, and bald-faced lies? Most succinctly: how are promises to be made and taken?
I have developed an abiding interest in the workings of the U.S. Securities and Exchange Commission, based on ethnographic work with Kim Fortun on how the SEC understands and works on important abstractions—information, disclosure, truth telling, transparency, due diligence—in the pragmatic context of globalizing capital markets.1 The SEC is an imperfect but important and interesting site for studying capital and its corporate entities. It provides a wealth of information on genomic (p.184) companies and other corporations and is the place where the “self-regulating” securities industry that undergirds the U.S. capital markets is, in fact, regulated.
An important part of those securities regulations changed, however, with the passage of the Private Securities Litigation Reform Act of 1995 (the PSLRA). The change concerned how “forward-looking information” would be read by the courts, and how it should be read by someone sometimes called “the sophisticated investor” and other times called the more modest “reasonable investor.” This is the regulatory framework that shaped the genomic companies. Companies like deCODE Genetics, Celera Genomics, Millennium Pharmaceuticals, and Human Genome Sciences Inc. have existed almost entirely in a historically specific regulatory framework of corporate disclosure—a framework that sanctions and encourages the promissory quality of the “forward-looking information” that has proven vital to these life-science corporations.
In late 1994, the SEC issued a “concept release” calling for comments on proposed changes to the “safe harbor” provisions of federal securities law. The SEC asked “whether the safe harbor provisions for forward-looking statements…are effective in encouraging disclosure of voluntary forward-looking information and protecting investors.” What is forward-looking information? The 1994 concept release made this distinction: “Required disclosure is based on currently known trends, events, and uncertainties that are reasonably expected to have material effects, such as: a reduction in the registrant’s product prices; erosion in the registrant’s market share; changes in insurance coverage; or the likely non-renewal of a material contract. In contrast, optional forward-looking disclosure involves anticipating a future trend or event or anticipating a less predictable impact of a known event, trend or uncertainty.”2
Since its establishment in 1933 as part of the New Deal, the SEC had prohibited disclosure of forward-looking statements. With the 1929 crash fresh in its institutional memory, the SEC regarded such forward-looking statements as “inherently unreliable,” the kind of speculative activity that had bubbled and burst the economy; in its role as protector of investors and preserver of trust in capital and its markets, the SEC worried that “unsophisticated investors would place undue emphasis on the information in making investment decisions.” This philosophy prevailed for thirty years.
(p.185) But in the mid-1960s the SEC formed the Wheat Commission to reconsider these matters and to speculate once again on the question of speculative statements. Despite the fact that, according to the SEC’s 1994 concept release, the Wheat Commission’s 1969 report found that “most investment decisions are based essentially on estimates of future earnings”—that is, “based on” something that was, at least in part, spectral or speculative—the commission did not recommend changing disclosure requirements, apparently because that was how things had been done for thirty years: “[The] commission stated that its decision not to mandate disclosure of forward-looking statements was based on its desire not to deviate too far from its historical position of prohibiting such disclosure.”
In 1972 the SEC announced its “intention” to promulgate rules that would still not require the disclosure of forward-looking information, but that would encourage voluntary disclosure, and the SEC promised corporations some limited protections from antifraud litigation. The SEC never issued those rules, citing “opposition from commenters,” but deferred to the future, hoping that the issue would be taken up again by its newly formed Advisory Committee on Corporate Disclosure.
The courts, in the meantime, had begun to rule on similar questions revolving around “facts,” “intentionality,” and “prediction.” In the case with the almost allegorical title, Marx v. Computer Sciences Corporation, the ninth U.S. Circuit Court of Appeals addressed the question of whether “predictions or statements of opinion could ever be considered to be ‘facts’ which could be said to be false or misleading for purposes of liability under the securities laws.”3 The court found that “while predictions could properly be characterized as facts, the failure of a prediction to prove true was not in itself actionable. Instead, the court looked at the factual representations which it found were impliedly made in connection with the prediction; namely that, at the time the prediction was made, it was believed by its proponent and it had a valid basis.”4
In its 1994 concept release, the SEC noted new trends in capitalism that suggested the need for change in disclosure requirements; the networks were being rearticulated. There was “increasing interest” both by corporations and among analysts and investors in “enhanced disclosure of information that may affect corporate performance but is not readily susceptible [to] measurement in traditional, quantitative terms.”
Among such qualitative informational items are workforce training and development, product and process quality and customer satisfaction. A large registrant considers one such item—product quality—to be so important to its profitability (p.186) that it has chosen to make it a key determinant of executive compensation. Other companies are beginning to experiment with voluntary disclosure of the utilization of an intangible asset termed “intellectual capital,” or employee knowledge. In this connection, another federal agency has urged more corporate disclosure of the use of measures of “high performance work practices and other nontraditional measures” of corporate performance.5
At the same time, some corporations expressed concerns about the increased risk of securities antifraud class-action suits that such disclosures might encourage. “Recent surveys,” the SEC wrote, “suggest that this threat of mass shareholder litigation, whether real or perceived, has had a chilling effect on disclosure of forward-looking information.” (The fine-print footnote to this statement discloses the source of the surveys: the National Venture Capital Association, the National Investors Relations Institute, and the American Stock Exchange CEO Survey. This list of names suggests a certain slant, whether real or perceived, to the survey.)
The SEC also included in its concept release suggestions from legal scholars about how the speculative status of forward-looking statements might be recodified. Law professor John Coffee offered a “bespeaks caution” doctrine under which “a forward-looking statement would be protected so long as it were properly qualified and accompanied by ‘clear and specific’ cautionary language that explains in detail sufficient to inform a reasonable person of both the approximate level of risk associated with that statement and the basis therefor.” (The “reasonable” if not “sophisticated” investor returns as ideal assessor here, precisely when the sheer increase in the number of investors into the U.S. securities market might have called for some reconsideration of the security of these characterizations.) In addition, “the suggested safe harbor would not require that the forward-looking statement have a ‘reasonable basis’…because, according to Professor Cofee, this requirement often raises factual issues that cannot easily be resolved at the pre-trial stage.”6 These suggestions—in which the volatile and hence litigation-inviting concepts of “fact,” “reason,” and “basis” are devolatilized by a second cautionary statement that simply names them as volatile—would become part of the new disclosure landscape.
The concepts released in 1994 by the SEC were soon gathered and picked up. What would become the Private Securities Litigation Reform Act of 1995 was introduced into the U.S. Congress early that year, as part of the Newt Gingrich-led Republican Party Contract with America package of legislation. The reform act was supposed to have multiple effects, (p.187) the two most vital being a reduction in the number of “frivolous lawsuits” brought against corporations by their shareholders and the expansion of the safe harbor for forward-looking statements. The high-tech, infocentric corporations of Silicon Valley were a main force behind the act’s passage. As an editorial in the Washington Post reported on the day of the final congressional vote (that would override President Clinton’s previous veto of the bill): “When the price of a company’s stock drops sharply, the present law invites suits on the questionable grounds that the company’s past expressions of hope for its future misled innocent stockholders. This kind of suit has turned out to be a special danger to new companies, particularly high-technology ventures with volatile stock prices…. The bill would protect companies’ forecasts as long as they did not omit significant facts.”7 Money magazine spoke in the name of protecting “small investors like you,” and was more critical of the proposed legislation, characterizing it as “a license to defraud shareholders” by “help[ing] executives get away with lying.” “High-tech executives, particularly those in California’s Silicon Valley, have lobbied relentlessly for this broad protection. As one congressional source told Money’s Washington, DC, bureau chief Teresa Tritch: ‘High-tech execs want immunity from liability when they lie.’ Keep that point in mind the next time your broker calls pitching some high-tech stock based on the corporation’s optimistic prediction.”8
But with promises and other commissive speech acts, as we learned from J. L. Austin and others in “PromisesXPromises,” all one ever has is the volatile speech act itself; “one’s word is one’s bond,” as Austin says, because to try to gauge the promise by what the “high-tech exec” intends— making the difference between a lie and an optimistic prediction one of interior “profundity”—in fact only “paves the way for immorality” (see Ch X). An impossible situation, yet something had to be done.
The Private Securities and Litigation Reform Act of 1995 accomplished many things, but one of the most important was to adopt a strong form of John Coffee’s “bespeaks caution” doctrine, which expanded the safe harbor for forward-looking statements and protected corporations from shareholder lawsuits.9 The PSLRA also sanctioned both “oral forward-looking statements” (such as what is said during an IPO “road show” or an investors’ teleconference) and “written forward-looking statements” (such as ebullient press releases), as long as they were marked as forward-looking statements and as long as potential investors—”sophisticated” or not—were also directed to other, more “cautionary” texts, such as SEC filings.
(p.188) The full and final effects of the PSLRA remain unclear. Whether the legislation has reduced the number of lawsuits (and whether there were, as certain surveys “suggested,” so many of them in the first place), whether it has given CEOs “a license to lie,” and whether it has increased market volatility while parting the sophistication-challenged investor from his and her money—all this remains uncertain, unknowable, or at least open to debate.10 But some signs of this uncertain future are still worth reading and pondering.
In their delectably named article “Enter Yossarian,” Elliott Weiss and Janet Moser analyze the catch-22 set up by the PSLRA: plaintiffs in securities fraud cases need to show that a company knowingly misrepresented matters in forward-looking statements, but can do so only by being granted discovery, which they can’t get since they can’t file suit based on forward-looking information now protected by the expanded safe harbor.11 This fissure is also plumbed by Douglas Branson, who describes the effect as one of substituting “mere” words or ink for “due diligence”:
The PSLRA provision provides that if a statement is “accompanied by meaningful cautionary statements,” plaintiffs are denied discovery and the court must dismiss allegations as to the false or misleading nature of the statement….
The effect of the PSLRA provision, as with stronger forms of the judge-made bespeaks caution doctrine, is to substitute mere cautionary words for the due diligence traditionally associated with preparation of statements in disclosure documents. Rather than building a due diligence file that, through research, establishes more than plausible, and often alternative, bases for making the statements made in the documents, securities lawyers will plaster forward-looking statements with cautionary warnings…. No incentive now exists for hiring the traditional, classical securities lawyer who quarterbacked the research and other effort necessary to do the due diligence exercise. Instead, Congress has placed a premium on buying and using ink by the barrel.12
Richard Rosen, who is sympathetic to the PSLRA, has discussed the case of Parnes v. Gateway 2000, Inc., and suggests that “forward-looking” and “cautionary” statements can’t be considered on their own. Rather, they must be evaluated within the larger machine that enables them to function, a machine that includes the old reliable “reasonable investor”:
The plaintiffs claimed that the computer company misrepresented its obligations to pay sales taxes to states other than South Dakota. But the court pointed out that the prospectus warned investors that taxing authorities in other states had sought information regarding the sufficiency of Gateway’s contacts with the states, that the company had not established any reserves and that it might be required to pay income or franchise taxes in other states. The court found that “any reasonable (p.189) investor would be on notice that Gateway faced potential state tax liability for states other than South Dakota.”
Gateway also warned that because of volatility of the computer industry, the introduction of new products was a risky venture and there was no assurance of success. This more generalized risk disclosure was also found to be sufficient, even though it says little that is specific to a company or its products. Yet there is no question that some courts would have found the latter statement by Gateway to be too general to be “meaningful.”13
In “Yahoo!XFinance,” we’ll look more closely at how such reasoning about disclosure and the reading demands placed on “any reasonable investor” worked out in the world of genomics. The general pattern that is supposed to hold can be glimpsed here in the Gateway case, however: the reasonable investor does not watch TV news puff pieces, read press releases or the newspaper articles based on them, or surf a plethora of investment Web sites, but spends all his or her time wading through downloaded reams of SEC filings.
Let’s close out Rosen and this discussion of forward-looking information and its burdens with one last quote:
Of course, it would be wonderful to have a rule that allowed courts and litigators unfailingly to be able to discriminate among the cases and to allow discovery to proceed only in those in which there was some reason to believe that, notwithstanding adequate cautionary language, the company’s management really did know that the predictions were not likely to come true. But because no such rule could ever be constructed, any rule will either allow a few dishonest issuers to win motions to dismiss or will impose enormous costs on honest companies and their shareholders. Congress has struck the balance in favor of protecting companies and their shareholders—a balance which strikes me as absolutely correct. (657–58)
One might agree with Rosen insofar as it is indeed impossible to construct “unfailingly” discriminatory rules for calculating fissures, volatilities, and chiasma such as these opened up by forward-looking information. But it would be prudent and even reasonable to question the “balance” that he hyperbolizes as “absolutely correct,” since it in fact depends on a far-from-certain calculus of the fissure: how does one know that, in the chasm opened up by forward-looking information, there won’t be an “enormous” number of dishonest issuers and only a “few” costs to honest companies? Rosen’s unsubstantiated calculation is little more than a political endorsement of the balance that Congress indeed “struck”: a forceful cut that transfers many of the financial risks and the burdens of (p.190) proof, discovery, and due diligence from corporations to their presumably sophisticated shareholders.
The volatile conjunction of safe harbor (however expanded or restricted) and open future was certainly intensified by the PSLRA of 1995. But the chiasmus of safety and risk, secured closure and speculative future, has always been a feature of economies—a fissure that economists have diagrammed and mapped, but never paved over.
(1) . See Fortun and Fortun, “Due Diligence and the Pursuit of Transparency.”
(2) . U.S. Securities and Exchange Commission, “Concept Release and Notice of Hearing: Safe Harbor for Forward-Looking Statements.” The quotations immediately following are from this document unless otherwise indicated.
(3) . Marx v. Computer Sciences Corporation, 507 F.2d 485 (9th Cir. 1974).
(4) . U.S. Securities and Exchange Commission, “Concept Release and Notice (p.303) of Hearing: Safe Harbor for Forward-Looking Statements.” The SEC also noted “more extreme positions” taken by some courts, which ruled that “soft,” “pufy” statements “upon which no reasonable investor would rely” would not be actionable unless they were worded in the language of a guarantee.
(5) . Ibid. The footnote to this passage refers to two documents to substantiate the SEC’s historical argument: R. Eccles and S. Mavrinac, “Improving the Corporate Disclosure Process” (working paper, Harvard Business School, Boston, 1994) and “Your Company’s Most Important Asset: Intellectual Capital,” Fortune, October 3, 1994, p. 68.
(6) . U.S. Securities and Exchange Commission, “Concept Release and Notice of Hearing: Safe Harbor for Forward-Looking Statements.”
(7) . Washington Post, “Override the Securities Bill Veto,” A18. This editorial was inserted in the Congressional Record by advocates of the legislation.
(8) . Quoted in U.S. Securities and Exchange Commission, “Concept Release and Notice of Hearing: Safe Harbor for Forward-Looking Statements.” In another example of the mass media being aimed at the reading and citational practices of a few readers, this editorial too was included in the Congressional Record.
(9) . Protected corporations in federal courts, at least. One effect of the PSLRA was to create a rush to file suits in various state courts, a problem addressed by the Securities Litigation Uniform Standards Act of 1998, which preempts class-action suits being filed in state courts; see Lerach, “The Private Securities Litigation Reform Act of 1995–27 Months Later,” Lerach also states that “there is little doubt now that Congress legislated [the PSLRA] on the basis of erroneous data in 1995” (601). But that’s a different story.
(10) . See, for example, Perino, “What We Know and Don’t Know about the Private Securities Litigation Reform Act of 1995,” testimony before the Subcommittee on Finance and Hazardous Materials of the Committee on Commerce, U.S. House of Representatives, October 21, 1997, available from Stanford Law School, Securities Class Action Clearinghouse http://securities.stanford.edu/research reports/19971021.html (accessed July 2, 2000).
(11) . Weiss and Moser, “Enter Yossarian.”
(12) . Branson, “Securities Litigation in State Courts,” 518–19.
(13) . Rosen, “The Statutory Safe Harbor for Forward-Looking Statements,” 656–57. Rosen continues in this passage to rely on the reasonable investor: “I would submit that, however anomalous the result may seem on the facts of a particular case, this result is correct as a matter of policy as well. The theory of the Act—like that of much prior case law—is that no reasonable investor could rely on a forward-looking statement in light of specific attendant risk disclosures, so a prediction that is adequately hedged with concrete cautionary language simply is not material” (657).