A Signal for Honest Management Forecasts: Expanding the PSLA Safe Harbor to IPO Issuers with Extended Lockup Periods

John L. Orcutt

ABSTRACT

This article seeks to address one of the initial public offering (“IPO”) market’s most intractable problems: how to reduce the information asymmetry between IPO issuers and potential investors regarding the firm’s future financial performance. Valuing IPO stock fundamentally requires projecting the IPO issuer’s future performance, yet IPO issuers almost never voluntarily publish their internal financial forecasts (“management forecasts”) in their IPO disclosure documents due to liability concerns. Federal law could reduce those liability concerns by immunizing IPO issuers’ management forecasts from private litigation.

The Private Securities Litigation Reform Act (the “PSLRA”) already provides such immunization for seasoned public companies through a forward-looking statements safe harbor (the “PSLRA Safe Harbor”), but the safe harbor expressly excludes IPOs from its protections. Immunizing IPO issuers from management-forecast liability is not problem free. It could encourage IPO issuers to publish exaggerated forecasts that would exacerbate, rather than reduce, information asymmetries. Thus, the PSLRA Safe Harbor should only be expanded to protect IPO issuers if such expansion can be designed in a way that allows investors to easily distinguish honest management forecasts from dishonest ones.

This article provides such a solution and argues for expanding the PSLRA Safe Harbor’s protections to IPO issuers that submit to extended lockups. Lockups are private contracts between the underwriters and the IPO issuer’s most important stockholders (“Insiders”) that prevent the Insiders from selling their shares for a period following the IPO. Applying signaling theory, this article explains how properly designed extended lockups signal that an IPO issuer is an honest forecaster that produces conservative forecasts. Such honest-forecasting IPO issuers are worthy of the PSLRA Safe Harbor’s immunity protections, which would allow them to reduce their information asymmetries and improve the overall efficiency of the U.S. IPO market