When J.C. Penney stated in investor communications that “supplier relationships remain as strong as ever” was the company being hopeful or factual? Further, could that kind of statement get a company in trouble? According to U.S. Magistrate Judge K. Nicole Mitchell in a recent proposed class action against J.C. Penney, it certainly may.[1]

People who run companies tend to be optimistic about the future of their businesses. Generally, the courts have allowed managers to be confident about their stewardship, holding that “up to a point, companies must be permitted to operate with a hopeful outlook.” However, the next time you are tempted to insert an enthusiastic proclamation about your company into your communications with investors, I would suggest that you think twice.

Statements that are optimistic, general, broad or vague, such as “the bidding process for our company’s stock is going very well/very smoothly” or “we had a solid year”, are called puffery statements. Generally, puffery statements are shielded from liability in the context of Section 10b-5 of the Securities and Exchange Act of 1934 and Section 11 of the Securities Act of 1933, even if these statements turn out to be inaccurate. The courts’ rational for the puffery defense is that these kinds of statements do not cause a reasonable investor to rely on them, and hence are not actionable. Puffery statements are thus deemed immaterial as a matter of law, and are shielded from liability at a preliminary stage without jury.

The courts’ assumption that investors do not rely on puffery statements has recently been challenged by scholars. Their criticism is backed by the rich literature in behavioral economics that shows that language and framing affect people’s decision making. A recent experiment that I conducted finds, however, that these concerns are not warranted. In fact, in most cases, investors’ investment decisions are not affected by puffery statements.  

Not only do puffery statements not affect investors’ decision making, they may also expose the company and its officers to civil and even criminal liability if the statements are untrue. Although the puffery defense has been widely accepted by the federal courts in recent years, there is always the possibility that a court would reject such a defense. In fact, out of 233 cases between 2009 and 2013 that I surveyed, the puffery defense was rejected in 27% of those cases. 

Based on these findings, my suggestion for companies’ executives would be as follows: 

  • Don’t load your communications to investors with puffery statements. They don’t really affect investors’ decision making, and much worse – they can expose you to civil and even criminal liability.
  • If you do use puffery statements, it would be safer to frame them as opinions. For example, instead of saying: “the bidding is going very well”, say: “we believe that the bidding process is going very well”. A recent Supreme Court case, Omnicare Inc. v. Laborers District Council Construction,[2]made it clear that Section 11 exposes companies to liability only for “untrue statement[s] of… fact”, and that establishing liability with respect to statements of opinion would be more difficult. If a court rejects the puffery defense, the plaintiff would still have to prove that the opinion was not sincerely held for the defendant to be liable. 
  • When using statements of opinion, always make sure that you have back-up for these statements. According to Omnicare, since every statement of opinion affirms the fact that the speaker actually holds the stated belief, if the opinion is not sincerely held it will be actionable.