Inherent in the investment decision is the ability to project the earnings potential of a company, and thereby to value its stock. The stock market is, after all, an auction market in which buyers and sellers buy and sell stock on the basis of their perceptions of a stock’s ability to appreciate in value. The stock market is a perfect example of an arena in which different people perceive the same information differently. Regulation guarantees that all buyers and sellers start with the same information at the same time.

But until 1995, shareholders, disappointed with the projections of management that weren’t met, would rush to sue. Ours is a litigious society, and when a corporation announced an expected earnings per share in the foreseeable future, and then failed to meet that projection, that corporation was often sued for that failure by disgruntled shareholders. The result of that growing tendency to litigate had been to inhibit corporate managers from forecasting legitimate and useful projections of performance. Recognizing this inhibition, Congress passed The Private Securities Litigation Reform Act of 1995—the Safe Harbor Act. The new law was developed to reduce frivolous law suits by raising the bar of evidence of fraudulent behavior, including routine filing of class action suits when stock price dropped precipitously.

The Act puts a greater burden on the plaintiff to prove a case of negligence in making profit projections. But more significantly, it clearly defines a forward-looking statement that, properly delineated, protects management from liability. Under the law, both written and oral statements must be identified as forward-looking, and accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. The law defines a forward-looking statement as

• A statement containing a projection of revenues, income (including loss), earnings (including loss) per share, capital expenditures, dividends, capital structure, or other financial items

• A statement of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer

• A statement of future economic performance, including any such statement contained in a discussion and analysis of financial condition by management, or in the results of operations included pursuant to the rules and regulations of the SEC

• Any statement underlying or relating to any statement described in the foregoing paragraphs

• Any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a forward-looking statement by the issuer

• A statement containing a projection or estimate of such other items as may be specified by rule or regulation of the SEC

As a result of this law, media releases and other communications to shareholders now routinely include a safe harbor disclaimer. Corporate management would be well advised to make the disclaimer universal and mandatory, and to include it in the annual report to shareholders.