United States: Supreme Court Will Hear Case Raising Whether A Private Action May Be Brought For Alleged Misrepresentations In Connection With A Tender Offer Under Section 14(E) Of The Exchange Act, Based Only On A Showing Of Negligence, Not Scienter

On January 4, 2019, the United States Supreme Court granted a petition for writ of certiorari concerning whether Section 14(e) of the Securities Exchange Act of 1934 includes an implied private right of action for negligent misrepresentation or omission made in connection with a tender offer.  Emulex Corporation, et al. v. Varjabedian, No. 18-459 (Jan. 4, 2019).

Ever since the Delaware Chancery Court's decision in In re Trulia, Inc. Stockholder Litig., 129 A.3d 885 (Del. Ch. 2016), which raised the bar for the approval of disclosure-only settlements in M&A litigation, stockholders have increasingly opted to instead challenge M&A transactions in federal court under Section 14 of the Exchange Act.  According to the Securities Industry and Financial Markets Association ("SIFMA"), which filed an amicus brief in support of the petition in this case, such filings have doubled since 2016.

In language substantially similar to Section 10(b) of the Exchange Act, Section 14(e) of the Exchange Act provides that "it shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation."  15 U.S.C. § 78n(e).  The Supreme Court has previously noted that Section 14(e), which post-dated the enactment of Section 10(b) by decades, was "modeled on the antifraud provisions of § 10(b) of the Act and Rule 10b-5."  Schreiber v. Burlington N., Inc., 472 U.S. 1, 10 (1985).  Like Section 10(b), Section 14(e) includes no express private right of action for investors to pursue damages, and the Supreme Court has not yet considered whether such an implied private right of action exists, as has been found with respect to Section 10(b).  However, all courts of appeal that have addressed the issue prior to the Ninth Circuit have determined that an implied private right of action exists under Section 14(e), just as it does under Section 10(b).  In particular, the Second, Third, Fifth, Sixth and Eleventh circuits have emphasized that Section 14(e) is modeled on Section 10(b) and virtually identical to Rule 10b-5, and held that Section 14(e) requires the same elements as 10(b) and 10b-5, including the requirement that a plaintiff plead and prove scienter (i.e. knowledge of falsity or recklessness severe enough to be tantamount to fraudulent intent) rather than simple negligence.

In the case now before the Supreme Court, however, the Ninth Circuit disagreed, finding that only negligence, rather than scienter, need be shown under Section 14(e).  There, a former shareholder of Emulex filed a putative securities class action for alleged violations of Section 14(e) in connection with Emulex's merger with Avago Technologies Wireless (USA) Manufacturing and Emulex's recommendation to shareholders that they accept the tender offer initiated by a subsidiary of Avago.  That recommendation was based in part on financial analyses and a fairness opinion rendered by Emulex's financial advisor, which opined that the transaction was fair from a financial point of view to Emulex's shareholders.  Among the analyses performed by the financial advisor was a "premium analysis," which allegedly showed that the premium to be received by Emulex shareholders was within the range of transaction premiums identified in unrelated transactions but below the mean and median of those premiums, and which was not disclosed to the shareholders.  Plaintiff alleged that Defendants (Emulex, its board of directors, and Avago and its subsidiary) violated federal securities laws, specifically Section 14(e) of the Exchange Act, by failing to summarize this "premium analysis" in the recommendation statement for the tender offer.  The district court dismissed the complaint with prejudice, holding that Section 14(e) requires a showing of scienter and that plaintiff had failed to meet that standard. 

The Ninth Circuit reversed, based on a novel holding that a negligence standard applies to private claims under Section 14(e), rather than the scienter requirement adopted by all other courts of appeals to date.  The court found that Section 14(e) is divided into two clauses, separated by an "or," and each proscribing different conduct.  The court stated that, although the second clause prohibits "fraudulent, deceptive, or manipulative acts" (and accordingly requires scienter), the first clause prohibits the making of any "untrue statement of a material fact or omit[ting] to state any material fact," with no reference to state of mind.  The Ninth Circuit rejected the reasoning of the Second, Third, Fifth, Sixth, and Eleventh Circuit, which have all held that Section 14(e) requires a showing of scienter.  The Ninth Circuit concluded that, despite the "shared text found in both Rule 10b-5 and Section 14(e) . . . important distinctions exist" between the two provisions, which "strongly militate against importing the scienter requirement from the context of Rule 10b-5 to Section 14(e)."  Varjabedian v. Emulex Corp., 888 F.3d 399, 405 (9th Cir. 2018).  First, the Ninth Circuit focused on language in the Supreme Court's decision in  Ernst & Ernst, 425 U.S. 185 (1976), which the Ninth Circuit interpreted as suggesting that the wording of Rule 10b-5(b)—and accordingly the virtually identical wording of Section 14(e)—"could reasonably be read as imposing a scienter or a negligence standard."  Id. (emphasis in original).  Under the Ninth Circuit's interpretation, the Supreme Court's conclusion in Ernst & Ernst that Section 10(b) and Rule 10b-5 promulgated thereunder require a showing of scienter is based not on the wording of the Rule but on the fact that "it is a regulation promulgated under Section 10(b) of the Exchange Act, which allows the SEC to regulate only 'manipulative or deceptive device[s],'" and "[t]his rationale regarding Rule 10b-5 does not apply to Section 14(e), which is a statute, not an SEC Rule."  Id. at 406.  Second, the Ninth Circuit looked to the Supreme Court's decision in Aaron v. SEC, 446 U.S. 680 (1980), which addresses a different provision, Section 17(a) of the Securities Act of 1933.  Section 17(a)(2) provides for an express cause of action for the SEC (but has not been found to provide a private cause of action) and concerns public offerings.  In Aaron, the Supreme Court held that the SEC may seek injunctive relief under Section 17(a)(2) for negligence.  The Ninth Circuit noted that Section 17(a)(2) and the "first clause" of Section 14(e) contain nearly identical wording, and that, because Aaron held that Section 17(a)(2) does not require a showing of scienter, neither does Section 14(e).  Emulex, 888 F.3d at 406.  Finally, the Ninth Circuit found that the legislative history and purpose of the Williams Act provided "some support" for a finding that the negligence standard applies to Section 14(e), because that Act "places more emphasis on the quality of the information shareholders receive in a tender offer than on the state of the mind harbored by those issuing a tender offer."  Id. at 408.

Defendants submitted a petition for writ of certiorari to the Supreme Court of the United States.  Defendants pointed out that the Ninth Circuit's decision departs from established law from five other circuit courts, which have held that negligence is insufficient to support a private cause of action for damages under Section 14(e).  Defendants argued that the Ninth Circuit erroneously interpreted and relied on statements from the Supreme Court in Ernst & Ernst and Aaron, and that the Ninth Circuit's decision is inconsistent with Supreme Court jurisprudence.  Defendants further argued that the question presented by this case is highly important, and that the Ninth Circuit's creation of a negligence-based private cause of action for damages under Section 14(e) would drastically increase frivolous securities litigation. 

The potential implications were further sketched out by SIFMA and the United States Chamber of Commerce, both of which filed amici briefs in support of defendants' petition.  Of particular note, these amici argue that the Ninth Circuit's decision, if upheld, would surely increase the trend of plaintiffs bringing "merger objection" suits in federal court, based on Section 14, since Trulia, and could potentially exacerbate the threat of abuse and unfair settlement pressures created by securities class actions, even where the complaint has little chance of success at trial. 

Reversal of the Ninth Circuit's decision would confirm that Section 14(e) typically will not be a viable alternative to pursuing merger disclosure complaints with respect to tender offers under state law (typically Delaware law).  Whether plaintiffs continue to try, however, is a matter of conjecture, but scienter is hard to plead in federal court and harder to prove.  Affirmance, of course, would likely amplify greatly the post-Trulia trend of pursuing such cases in federal court, and in particular with respect to tender offers.  We will continue to closely follow this case, including when the Court hears oral argument.

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