Pulitzer Prize-winning journalist and author David Cay Johnston has posted an opinion piece on Reuters providing some advice on “How to avoid a securities class action.” He notes that research by Jonathan Rogers, Sarah Zechman, and Andrew Van Buskirk (available here) has shown that the risk of getting sued for stock price declines increases when the price drop is preceded by unusually optimistic statements about future earnings that is paired with insider selling.
While this may seem somewhat obvious, Johnston notes that Gregory Roussel, who coaches executives on “how to talk up their companies without inviting litigation,” finds that certain executives are simply reluctant to tone down their enthusiasm. Johnston goes on to note that overly enthusiastic executives may nonetheless find a reprieve by way of the “puffery” defense, which allows those accused of securities fraud to argue their misstatements were immaterial because they were essentially akin to a used car salesman telling a prospective buyer that the car at issue is “great.” (For more on the puffery defense, you might want to check out David Hoffman’s “The Best Puffery Article Ever.” David is also quoted by Johnston in his opinion piece.)
However, Johnston cites my paper “Is Puffery Material to Investors? Maybe We Should Ask Them” for the proposition that judges are perverting the definition of materiality, which turns on what a reasonable investor would consider important, when they extend this doctrine to securities transactions too frequently. In the paper, I argue that courts should survey investors before concluding as a matter of law that no reasonable investor would consider the alleged puffery material. My own survey findings, which I discuss in the paper, suggested that judges are prone to doing a very bad job of predicting what actual investors would consider material. Courts are already familiar with using surveys this way, as it is relatively common in Lanham Act cases.
Regardless, Johnston ultimately concludes that:
[C]ompanies should make their insiders put proceeds from stock sales into escrow for some period of time — 90 days ought to do it — after upbeat executive statements. If the price drops during that time, make them take the lower price or wait until the price recovers.