Monday, 5 October 2009

I cannot predict the future accurately !

The United States is well known for the excesses of its lawyers. Citizens of other nations, while marveling at the upholding of the law in the US, are left scratching their heads in bewilderment at the famous McDonald’s case or the Washington DC laundry case. Cases like this have resulted in some labeling gems such as “Contents Hot” on a cup of coffee or “Remove the baby before folding the pram”. This post covers such an impact on the glamorous world of accounting.

When lawsuits against companies began mounting in the late eighties and early nineties, companies started to become extremely careful in disclosing any information at all, other than the statutory minimum, for fear of being sued. Best to say nothing ; say your name ( presumably safe) and say nothing more. The powers that be, in the US, realized that disclosure of more information , especially plans and strategies would be good for investors . In order to encourage companies to do so, some protection against being sued had to be given. The Private Securities Litigation Reform Act was thus passed in 1995.

This Act offered protection from being sued for companies making “forward looking statements”. The framers of the Act were oblivious to grammar - statements can neither look forward nor backward, not possessing any eyes, but we shall pass lightly over. If they had left it at that, we would have had some very interesting company announcements on the following lines – this is a forward looking statement ; my name is Ramesh. This is a forward looking statement; I may or may not post on my blog tomorrow. This is a forward looking statement. The blog may or may not be up tomorrow …..

So they very kindly stated that you do not have to preface every statement with a declaration that it is a forward looking statement and instead statements that contain words like “expect,” “anticipate,” “intend,” “plan,” believe,” “seek,” , “will”, etc may be deemed to be forward looking and that the company cannot get sued if such statements ultimately don’t turn out to be right. So if you say we expect to grow our market share and one year later it has fallen, you cannot be sued for having made a false statement.

This has hence resulted in the famous disclaimer that now precedes every company’s accounts, every earnings call, every filing, every anything. Its called by various names – simply disclaimer, or safe harbor statement, or whatever. It says that the company may be making some statements about the future, can’t guarantee that they will come true, and isn’t endowed with godlike powers to predict the future accurately. Of course, not in those words, but to that effect. If you are seriously interested in exactly what is said in wonderful legal language, click here for an example.

This is one of those useless statements nobody reads or pays the slightest attention to. As if anybody needs to be told that you can’t predict the future. But the absence of this statement would be fatal for a company, as some lawyer will then sue the pants off it. So they dutifully make it – page 1 of any filing, slide 1 of any presentation, first words (after Good Morning) of any speech.

What a waste.

Disclaimer – This post may contain certain forward looking statements, blah blah ..

15 comments:

  1. Ramesh ..you have hit the nail on the head ... this needs me to do a post on personal experience .... bravo ... on your gamut of knowledge about areas that is very heard of !!!

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  2. What I meant was unheard of ....by common people except when it hits the news stands.

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  3. Sandhya Sriram5/10/09

    Read this recently:

    Charlotte, North Carolina. A lawyer purchased a box of very rare and expensive cigars, then insured them against, among other things, fire. Within a month, having smoked his entire stockpile of these great cigars and without yet having made even his first premium payment on the policy the lawyer filed a claim against the insurance company. In his claim, the lawyer stated the cigars were lost "in a series of small fires." The insurance company refused to pay, citing the obvious reason, that the man had consumed the cigars in the normal fashion.

    The lawyer sued.. and WON!

    Delivering the ruling, the judge agreed with the insurance company that the claim was frivolous.
    The judge stated nevertheless, that the lawyer held a policy from the company, which it had warranted that the cigars were insurable and also guaranteed that it would insure them against fire, without defining what is considered to be unacceptable fire" and was obligated to pay the claim. Rather than endure lengthy and costly appeal process, the insurance company accepted the ruling and paid $15,000 to the lawyer for his loss of the cigars lost in the "fires". After the lawyer cashed the check, the insurance company had him arrested on 24 counts of ARSON (Arson is the crime of deliberately and maliciously setting fire to structures or wildland areas.) With his own insurance claim and testimony from the previous case being used against him, the lawyer was convicted of intentionally burning his insured property and was sentenced to 24 months in jail and a $24,000 fine.

    I am told This is a true story and was the First Place winner in the recent
    Criminal Lawyers Award Contest.

    ONLY IN America!

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  4. :) Resort to escapism, with a disclaimer! McDonald's case sounded funny!! Thanks for the sharing this in your tone!!

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  5. First, the safe harbor statement, I expect this comment to be rambling and incoherent. True or otherwise, I like irony in Sandhya Sriram's story. I think PSLRA is at least one attempt to keep the excesses of the legal system in check. But lawyers then reduce it to a trivial sham. As an aside (I warned you...), in psychological experiments, apparently when people have the chance to include a caveat, it becomes a licence for them to exaggerate their claims and interestingly when the listener is faced with the caveat, it seems more credible and he believes the statement even more. So with all of this safe harbor stuff, I wonder if in the balance, investors are better off or not... which is, at least in my mind, related to your earlier post on earnings guidance... Well, at least I delivered on my forecast.

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  6. Gaurav Jain5/10/09

    Well they call it Stella awards in the US.It is awarded to the most insensible lawsuits in the US every year.I suppose all the reaers should have a look at this
    http://www.snopes.com/legal/lawsuits.asp
    they say that US has two major probems 1) MBAs and 2) lawyers
    now I think they are quite right.

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  7. @blogueur - Can't wait for your post. Wait - I better get prepared for sides aching with laughter.

    @sandhya - hee ho ha - Unbelievable. Only in America indeed.

    @athivas - I don't want to get sued :-)

    @DA - Lawyers are only partly responsible. Judges and juries who come to such ridiculous decisions equally deserve to be kicked. You are right - sometimes these caveats lend credibility. On alance investors are more screwed by misreporting of the past than by tall claims of the future , I think.

    @Gaurav - Thanks. Snopes.com is a superb site - can get addictive reading all those stories there.

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  8. //On balance investors are more screwed by misreporting of the past than by tall claims of the future//

    I agree wholeheartedly. I would also add that some of that "history" in the actual earnings is distorted to keep up with the previous tall claims of the future...

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  9. kiwibloke5/10/09

    Boss
    God bless the forward looking statements - My entire business is predicated on the wonderful things brought out by the SEC
    cheers

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  10. Is the small printed disclaimers for credit card and other mutual funds/shares are forward looking statements as well ?

    The Mcd case is funny! the pants case is hard on the dry cleaning owners though. That was so un fair! I thought people generally sue wealthy firms.

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  11. @DA - Yes; they cook the past because the gourmet dish they promised came out in reality a dud. (horribly mixed metaphors, but ...)

    @kiwi - Of course, the SEC is your raison d'ĂȘtre , but I thought you were strictly a "past" man and had nothing to do withe future ??

    @Sri - No that fine print is just to arm themselves to bash you up if you don't pay (called in polite language as credit collections) !

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