August 06, 2004

In the early 1990s, any publicly-traded corporation that had a sizable drop in stock price found itself a defendant in a shareholder class action lawsuit with some concocted allegation that previous disclosures to the public were misleading. Corporations were hesitant to make public forecasts; if something went wrong, and the forecast was missed, they would be forced to prove that the erroneous forecast was a good-faith mistake rather than an attempt to defraud the public. Nuisance settlements to avoid expensive and time-consuming litigation were common. One of the important provisions of the Private Securities Litigation Reform Act of 1995 was the adoption of a safe harbor for forward-looking statements that are accompanied by "meaningful cautionary language."

A recent Seventh Circuit opinion, Asher v. Baxter International, Inc., has interpreted this safe harbor quite narrowly by holding that a court, in most circumstances, cannot determine whether cautionary language is "meaningful" in the procedural posture of a motion to dismiss. In the words of Lyle Roberts, "the safe harbor may just be a safe puddle." While the PSLRA continues to provide some limits on discovery, in courts that follow Asher, only plaintiffs unable to draft a complaint to fit within the Asher loophole will not be allowed to conduct "fishing expeditions" into defendants' documents--and the end result may well be a return to the pre-PSLRA equilibrium of nuisance settlements. If so, it would be a good example of the potential ineffectiveness of piecemeal reform.

David Furbush and I have a short article analyzing the case on the O'Melveny website. ("Court revives investors' lawsuit over Baxter financial projections", Bloomberg News, Jul. 30).