Determining the Materiality of Earnings Forecasts under the Private Securities Litigation Reform Act in Helwig V. Vencor

I. INTRODUCTION Congress included safe harbor provisions for forward-looking statements in the 1995 Private Securities Litigation Reform Act ("PSLRA" or "Reform Act")1 to "enhance market efficiency by encouraging companies to disclose forward-looking information."2 The second of these safe harbors provides that a defendant "shall not be liable with respect to any forward-looking statement, whether written or oral, if ... the forward-looking statement is ... immaterial."3 Prior to the enactment of the PSLRA, lower courts applied a variety of materiality standards to forward-looking statements. Many courts applied the standard endorsed by the Supreme Court in Basic Inc. v. Levinson4 (a case involving non-predictive statements), under which a statement's materiality turns on whether "`there is a substantial likeIMAGE FORMULA3 lihood that a reasonable shareholder would consider it important.'"5 Other courts found the direct application of the Basic test inappropriate in the forward-looking statement context and, therefore, applied various proxy "bright-line" materiality tests instead. Because the PSLRA does not express an explicit preference for the standard endorsed in Basic or for any of the bright-line materiality tests, post-PSLRA courts must decide which standard is most consistent with the overall legislative scheme of the Act to determine whether the second safe harbor immunizes a given forward-looking statement from liability. This Note argues that the use of bright-line materiality tests rather than the standard endorsed in Basic was unjustified before the enactment of the PSLRA and remains unjustified after the Act's passage. This Note, therefore, concludes that post-- PSLRA courts should not use these bright-line tests to give content to the second PSLRA safe harbor. Part II of this Note briefly describes the Securities Exchange Commission's ("SEC" or "Commission") regulatory approach to forward-looking statements prior to the PSLRA and then summarizes the PSLRA safe harbor provisions. Part III discusses the disagreement in Helwig v. Vencor Inc.,6 the principal case of this Note, between the Sixth Circuit en banc majority and dissent over the applicability of the PSLRA's "immateriality" safe harbor to optimistic earnings forecasts made by the defendant that proved inaccurate. The majority cited the materiality standard endorsed in Basic, but then, in a puzzling turn, found that the Sixth Circuit's bright-line "substantial certainty" test, if appropriately qualified, was consistent with that standard. Applying this qualified substantial certainty test to the defendants' earnings forecasts, the majority found that the forecasts could not "be deemed 'immaterial' within the meaning of the PLSRA."7 The dissent argued that Basic does not require courts to assess the materiality of forward-looking information by applying the materiality standard endorsed by the Supreme Court in that case. The dissent, therefore, applied the substantial certainty test without IMAGE FORMULA6 any qualification and found the forecasts immaterial as a matter of law. Part IV of this Note identifies several important aspects of the Supreme Court's treatment of the issue of materiality and then, with the help of that background, analyzes the Helwig dissent's use of the substantial certainty test. Part V describes some of the other bright-- line materiality tests that pre-PSLRA circuit and district courts have applied to find projections and other forward-looking information immaterial as a matter of law. The Fourth Circuit has often achieved this result by applying a "guarantee" test, under which a projection is material only if its presentation suggests to investors that the results it projects are guaranteed. The Fourth Circuit's justification for applying this test, rather than the materiality test endorsed in Basic, is based on the assumption that accuracy-based protection8 is not available with respect to forward-looking statements because such statements almost always prove wrong in hindsight. …