A U.S. District Court for the Southern District of New York recently found that a company that had provided lower earnings guidance in its statements to the public than its results from the previous year was not protected by the safe harbor for forward-looking projections provided by the Private Securities Litigation Reform Act (PSLRA) because the company failed to provide sufficient cautionary language and the "safe harbor does not apply to material omissions."

The case centered on the projected sales of a clothing retailer that changed the design of its women's fashion line. The new designs and styles sold poorly and the company failed to meet its projected sales. The plaintiffs filed a securities fraud class action suit alleging that the company had made false and misleading statements about its projected sales. The company claimed that its projections and sales guidance fell squarely within the PSLRA's safe harbor. The court disagreed and refused to grant the company's motion to dismiss.

The PSLRA provides a safe harbor for forward-looking statements that shield corporate defendants from liability when the company fails to meet projected sales or figures. To overcome the safe harbor, plaintiffs must demonstrate that (1) the guidance was not accompanied by "meaningful cautionary statements," and (2) the company had "actual knowledge" of the falsity of those statements.

Despite the company having accompanied its projections with disclosed risks of varying consumer spending patterns, the unpredictability of consumer fashion preferences and potential inventory management problems, the court found the company had not provided "meaningful cautionary statements" under the statute because it failed to disclose that these risks were extended over a larger period of time, as the new clothing styles would continue to be sold and remained in inventory. The court said that even though there was "no question that the forward-looking statements . . . were specifically identified as 'forward looking' and were accompanied by cautionary language," they failed to provide adequate cautionary language as they included statements that the court admitted were "technically true," but were nonetheless misleading. Particularly, the court referenced the company's failure to disclose that it had already ordered the same styled clothing for the upcoming quarter. The court stated that this was a material omission because it made the aforementioned risks greater in magnitude.

Second and perhaps most troubling, the Southern District of New York court held that the "safe harbor does not apply to material omissions," and as such, defendants need not possess actual knowledge of the falsity of their statements to lose safe harbor protections. This interpretation is interesting because the PSLRA specifically states that its safe harbor covers "omissions of material fact." The court's broad language seems to suggest that the safe harbor, then, does not apply to forward-looking statements made by corporate defendants that plaintiffs claim were misleading because of the omission of a fact that is now known to be material, but was not clearly so at the time the statement was made.

The court's seemingly narrow interpretation of the PSLRA safe harbor would considerably limit the provision's ability to shield corporate defendants from liability. Plaintiffs could engage in Monday morning quarterbacking, determining which facts turned out to be a material omission when the forward-looking statement was made after the fact, which is particularly what the safe harbor was enacted to prevent.

The opinion is City of Providence v. Aeropostale, Inc., No. 11 Civ. 7132(CM)(THK) (S.D.N.Y. Mar. 25, 2013) and may be found at:

http://securities.stanford.edu/1047/ARO00_01/2013325_r01o_11CV07132.pdf