Predictions, Projections, and Precautions: Conveying Cautionary Warnings in Corporate Forward-Looking Statements

Abstract

This article discusses the problems that are created when corporate insiders make public predictions about the future prospects of their business. Investors crave these types of forward-looking corporate disclosures because investors use them to make judgments about the future profitability of companies. Corporations, however, are often reluctant to make predictions and projections because sometimes the predictions fail to come true, and investors may then sue corporations for misleading the market. Congress enacted a controversial statutory safe harbor designed to encourage corporations to make forward-looking statements. The safe harbor immunizes corporations from liability so long as they include meaningful cautionary warnings disclosing the risks that could cause actual results to differ from the insiders' predictions.

Recent large-scale corporate scandals have caused investors to question whether it is appropriate to have a statutory safe harbor that allows a corporate executive to publicly paint a rosy picture of the company while knowing the business is in serious jeopardy. Because no clear standards exist for determining what constitutes a truly meaningful warning, it has become increasingly problematic to allow corporations to rely on cautionary warnings to protect corporations from liability. This article addresses this problem and discusses the nature of effective risk communication in the corporate context. Professor Ripken draws on insights from the "duty to warn" doctrine in tort law to develop a richer understanding of risk communication in consumer and securities markets. Professor Ripken ties these concepts into a more fundamental debate over the efficacy of warning law and the ability of financial markets to incorporate risk statements efficiently in the pricing of securities. Using the psychological research on cognitive and motivational constraints, biases, and heuristics, the article proposes guidelines for constructing warning statements that are more meaningful and instructive.

Keywords: Corporations, Forward-Looking Statements, Financial Projections, Soft Information, Safe Harbor, Private Securities Litigation Reform Act, Meaningful Cautionary Statements, Bespeaks Caution, Duty to Warn, Disclosure, Securities Regulation, Rational Choice, Efficient Capital Markets

JEL Classification: K2, K22, K4, K41