Ninth Circuit Holds That Safe Harbor Provision Of The Reform Act Applies To Forward-Looking Statements Accompanied By Cautionary Language And Forward-Looking Statements Made Without Actual Knowledge Of Falsity
In In re Cutera Securities Litigation, 2010 WL 2595281 (9th Cir. June 30, 2010), the United States Court of Appeals for the Ninth Circuit concluded that the Private Securities Litigation Reform Act’s (“Reform Act”) safe harbor provision, 15 U.S.C. § 78u-5, protects forward-looking statements accompanied by meaningful cautionary language” andforward-looking statements in the absence of meaningful cautionary language not made with “actualknowledge” that the statement was false or materially misleading when made. This decision greatly clarifies the law in the Ninth Circuit. Previously, in dicta, a Ninth Circuit court had suggested that if plaintiffs could prove a sufficiently strong inference that a forward-looking statement made with actual knowledge of its falsity, such a statement would not protected by the safe harbor provision of the Reform Act even if accompanied by meaningful cautionary language. In re Cutera puts this notion to rest. A forward-looking statement that is either accompanied by meaningful cautionary language or is made without actual knowledge of its falsity may not form the basis for a federal securities fraud claim.
Defendant Cutera, Inc. (“Cutera”) sold lasers and other light base aesthetic systems to medical professional for use in cosmetic procedures. Initially Cutera was successful and, in light of that success, embarked on an expansion effort. As part of that expansion effort, Cutera hired a number of junior sales representatives to market a lower priced laser to medical professionals. Cutera completed its hiring in May 2006. At that time, Cutera projected it would take two quarters for the junior sales force to reach productivity. In a January 31, 2007 conference call with analysts, Cutera’s CEO and CFO claimed that turnover among the junior sales force was “normal” and that Cutera’s relationship with its junior sales force was good. In addition, on that call and in a subsequent press release, Cutera projected first quarter and year end revenues showing growth of 25% over the previous year. Cutera’s stock price rose almost 20% on the strength of those projections.
On April 5, 2007, Cutera revised its revenue projections downward, projecting a lower rate of growth, and blaming the shortfall on the productivity of the junior sales force. Cutera’s stock price fell more than 30% on this news. When Cutera announced its revenue for the preceding quarter in May, 2007 that reflected this lower revenue projection, its stock price fell more than 18% from the previous day’s price.
Plaintiffs, who had purchased Cutera stock between January 31, 2007 and May 7, 2007, asserted claims under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, alleging that management had provided “false and misleading revenue projections and failed to disclose material information about the shortcomings of Cutera’s sales staff.” Plaintiffs alleged two principle misleading statements. First, class plaintiffs alleged that “Cutera omitted material information about the weakness of its junior sales force in its statements of January 31, 2007.” Second, class plaintiffs alleged that “Cutera made faulty earnings projections.” Cutera moved to dismiss. The United States District Court for the Northern District of California granted the motion, finding there was no material difference between Cutera’s January 31 disclosures, and that Cutera’s earnings projections were protected by the Reform Act’s safe harbor provision for forward-looking statements.
On appeal, the Ninth Circuit first turned to the January 31, 2007 statement. The Court held that plaintiffs, through the use of confidential witnesses, pleaded enough facts to suggest that “Cutera knew about the weakness of its junior sales force by January 31, 2007.” The Ninth Circuit, however, concluded that there was “no material difference between what Cutera disclosed in January and what it disclosed in later reports and conference calls” because plaintiffs had “not raised a plausible claim that stock prices fluctuated with disclosures about the sales staff.”
The Ninth Circuit then turned to the more problematic question of whether Cutera’s earnings projections were actionable under Section 10(b) and Rule 10b-5. The Court started its analysis by noting that Cutera’s January 31 earnings projection was “by definition a forward-looking statement.” Under the Reform Act, forward-looking statements are provided a “safe harbor” (i.e., protected from liability) when (1) “they were identified as forward-looking statements and accompanied by meaningful cautionary language” or (2) the investors failed to “prove the projections were made with actual knowledge that they were materially false or misleading.” 15 U.S.C. § 78u-5(i)(A)(i)-(B).
The Court held that Cutera adequately identified its earnings projections as “forward-looking” and included “meaningful cautionary language.” Plaintiffs pushed “for a conjunctive reading of the safe harbor provision, under which a sufficiently strong inference of actual knowledge would overcome a claim of safe harbor protection even for statements identified as forward-looking and accompanied by meaningful cautionary language.” In other words, under plaintiffs’ reading of the statute, if a defendant had actual knowledge that a statement was false, no amount of cautionary language would protect such a statement under the safe harbor provision of the Reform Act. For support, plaintiffs pointed to the Ninth Circuit’s comment in No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920, 937 n.15 (9th Cir. 2003), that a “strong inference of actual knowledge” could except forward-looking statements from the safe harbor rule.”
The Court in Cutera rejected plaintiffs’ argument for three principle reasons. First, the Court noted that a “logical reading of the statute” required the court to “take it as written,” i.e., that each subsection “offer[ed] safe harbors for different categories of forward-looking statements.” “It would be anomalous indeed,” the Court found, “if a false but misleading statement would fall outside the safe harbor.”
Second, the Court noted that plaintiffs’ conjunctive interpretation was “not only inconsistent with the statutory language, but has been rejected by all of our sister circuits to consider the question.” The court then pointed to decisions in the Fifth, Sixth and Eleventh Circuits, and stated that the Ninth Circuit joined with these Circuits’ “reasoned interpretation.”
Third, the Court held that the comment in America West relied upon by plaintiffs was a “passing reference” which offered “no statutory analysis or discussion of the safe harbor itself” and could “only be characterized as obiter dicta.” On that ground, the Cutera Court advised its holding “should clear up the issue for the handful of district courts that have embraced” America West’s “passing reference as a holding from this court.”
Cutera thus greatly clarifies the law in the Ninth Circuit regarding the Reform Act’s safe harbor provision. Under Cutera, a defendant need only show that the challenged forward-looking statement was accompanied by a meaningful cautionary statement or that plaintiffs fail to plead sufficient facts giving rise to a strong inference of actual knowledge of the falsity of such a statement to be protected from liability by the Reform Act’s safe harbor provision.