On 4 January 2019, the U.S. Supreme Court agreed to consider whether negligence or scienter is the appropriate mental state standard for misstatements or omissions made in connection with a tender offer. The case is Emulex Corp. v. Varjabedian. The decision from the Ninth Circuit below held, in express conflict with five other circuit court decisions, that mere negligence suffices to support a private right of action arising under Section 14(e) of the Exchange Act. The Second, Third, Fifth, Sixth and Eleventh Circuits have held that 14(e) claims require a higher showing of scienter, or intent to defraud.
The Ninth Circuit's decision stems from the 2015 acquisition of Emulex by Avago Technologies Wireless Manufacturing pursuant to an all-cash tender offer. After the closing, investors filed a class action alleging that Emulex had failed to disclose in its recommendation statement on Schedule 14D-9 one of six financial analyses performed by Emulex's financial advisor in delivering its fairness opinion to the Emulex board. The omitted analysis found that the merger premium was fair and within the normal range, but fell below the average for comparable transactions in the industry. After private plaintiffs brought putative class action claims arising under Section 14(e), the district court dismissed the complaint for failure to adequately plead a strong inference of scienter.
On appeal, a Ninth Circuit panel reversed the dismissal and remanded for reconsideration under a negligence standard. The Ninth Circuit noted that Section 14(e) prohibits (1) making untrue statements or omissions of material fact, or (2) engaging in fraudulent or deceptive acts. By focusing on the use of the word "or," the court found that the two components of Section 14(e) created two different offenses. Because the former does not contain the words "fraudulent," "deceptive," or "manipulative," which have been held to support a scienter standard, the Ninth Circuit concluded that misstatement liability could be proven based upon a showing of mere negligence.
The five other circuits that have considered this issue have held that claims under Section 14(e) require a finding of scienter because of its "shared text" with SEC Rule 10b-5 (the primary basis for federal securities fraud liability, which has a well-established scienter requirement. As the petition notes, because words are known by the company they keep (Yates v. U.S., 135 S. Ct. 1074, 1085 (2015)), it makes sense to read meaning into words like "deceptive" and "manipulative" by applying them to the entire statute, not reading them out because of the word "or." The Ninth Circuit rejected this rationale and found that standards of Rule 10b-5 do not apply to Section 14(e) because one is an SEC rule, and the other is a statute.
The Ninth Circuit's decision is an outlier and, if left undisturbed, would make Ninth Circuit lower courts a magnet for this type of litigation. While the Court could limit its decision to the narrow issue of scienter versus negligence for 14(e) claims, it also could use Emulex as a vehicle to opine on the standards for Section 14 claims as a whole (which also include claims based on false statements in proxy solicitations). Indeed, an amicus brief filed in support of the petitioner by the U.S. Chamber of Commerce argues that the Court should address the threshold issue of whether a private right of action exists under Section 14 at all (despite the fact that many lower courts have found that it does). Briefs will be filed in Emulex in the coming months, and oral argument likely will be held in Spring 2019.
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