On February 29, 2016, the Supreme Court denied certification in Harman International Industries Inc. et al. v. Arkansas Public Employees Retirement System et al., thereby leaving unanswered a number of questions related to the Safe Harbor provision of the Private Securities Litigation Reform Act (PSLRA).  The petitioners, defendant Harman International Industries Inc. (“Harman” or “the Company”) and related individual defendants, argued that the D.C. Circuit Court of Appeals erred when it reversed the district court’s decision granting Harman’s motion to dismiss.  In declining to hear the case, the Supreme Court failed to resolve a circuit split concerning the relevance of state of mind to the efficacy of cautionary language.

The case stems from a securities class action based on statements made around the time that Harman was considering “going private” following substantial changes in the market for Harman’s Personal Navigation Devices (“PNDs”).  Harman announced a possible going-private deal in April 2007, the same day that Harman’s CEO predicted PND sales in Europe would grow.  Harman’s stock price rose steadily following those announcements until September 2007, when Harman announced the going-private deal was no longer on the horizon.  The stock price then fell – initially dropping 24% on the news of the abandonment of the going private deal; then dropping 40% when Harman lowered its earnings per share forecast, blaming poor PND sales; and finally dropping 15% following the announcement of earnings for Q2 of FY2008, which showed that PND sales had fallen substantially compared to the same period in FY 2007.

The consolidated complaint identified several allegedly false or misleading statements, including 1) the CEO’s prediction that sales of PNDs in Europe were “not as margin challenged” and that revised forecasts included unit sales of 618,000, an increase over initial forecasts; 2) a statement in the Company’s 10-K for FY2007, filed in August 2007, that “sales of aftermarket products, particularly PNDs, were very strong during fiscal 2007”; and 3) a statement by the CFO during a September 2007 call that Harman had forecast first quarter FY2008 sales to be up 15% compared to the same quarter the prior year, and noting that the PND business was continuing to grow “primarily in Europe.”

The district court rejected the Arkansas Public Employees Retirement System’s (“APERS”) argument that Harman allegedly “knew” facts undermining certain statements made in connection with the Company’s announcement of annual sales results.  APERS argued that this knowledge deprived those statements of protection under the safe harbor for forward-looking statements.

The D.C. Circuit acknowledged that “the circuits are split as to whether there is room to consider the issuer’s state of mind in determining whether cautionary language is sufficiently meaningful under the safe harbor.”  The Third, Seventh, and Eleventh circuits have held that the issuer’s state of mind is irrelevant to the analysis of whether the cautionary language is meaningful.  In contrast, the Second Circuit noted that the safe harbor rule “may ‘require an inquiry into what the defendants knew because in order to determine what risks the defendants faced [a court] must ask of what risks they were aware.’”

The D.C. Circuit looked primarily at Harman’s 10-K because the cautionary statements made in connection with some of the allegedly misleading statements were “cursory,” as is typical, but referred to the 10-K for reference.  The appeals court noted that the more detailed risk factors set forth in the 10-K were themselves misleading in light of certain historical facts alleged in the complaint.  The 10-K warned, among other things, that inventory was growing and sales could suffer if the Company failed to “develop, introduce, and achieve market acceptance of new and enhanced products” and that the Company had to “maintain and improve existing products, while successfully developing and introducing new products.”  The court found that the cautionary language was insufficient for in light of two allegations of fact made in the complaint: (1) the inventory was already obsolete when the cautionary statements were made; and, (2) sales had been weak in 2006 and there was no reason to think that obsolete models from 2006 would sell any better in 2007.  The court further noted that the cautionary language was too general and largely boilerplate, and was re-used by the company in the subsequent 10-K, despite continued declining PND sales.

In their petition, the defendants argued that the D.C. Circuit’s decision exacerbated the circuit split “over the role of falsity in the safe harbor analysis.”  They argued that other circuits have correctly noted that “a safe harbor matters only when the firm’s disclosures . . . are false or misleadingly incomplete” and that otherwise “the safe harbor loses its function.”  By denying certification, the Supreme Court leaves this conflict in place along with the attendant uncertainty in Circuits that have not directly addressed the question.  For those defendants mounting safe harbor defenses in the Third, Seventh, and Eleventh Circuits, no news is good news as misleading statements may still be protected. For defendants in the Second and D.C. Circuits, the safe harbor may not be so safe after all.