In Varjabedian v. Emulex Corp.,[1] the Ninth Circuit held that claims under Section 14(e) of the Securities Exchange Act of 1934 only require a showing of negligence rather than scienter. Section 14(e) makes it unlawful for any person: “[1] 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 the light of the circumstances under which they are made, not misleading, or [2] to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer . . . .”

Grounding its analysis on Supreme Court cases establishing pleading standards for claims brought under Exchange Act Section 10(b), Securities Act Section 17(a)(2), and the language of Securities and Exchange Commission Rule 10b-5, the Ninth Circuit held that nothing in the text of Section 14(e) requires a showing of scienter.[2] In contrast, courts of appeals from the five other circuits that have addressed this issue uniformly held that claims under Section 14(e), like claims under Section 10(b) and its interpretive rule, Rule 10b-5, require an allegation of scienter.[3] By lowering the bar and recognizing that a claim under Section 14(e) can be based on mere negligence, the Ninth Circuit broke new ground and now stands alone among the circuits in allowing such claims.

The Merger, Premium Analysis, and Resulting Lawsuit

In 2015, Emulex Corp. (“Emulex”) and Avago Technologies Wireless Manufacturing, Inc. (“Avago”) announced they had entered into a merger agreement, whereby Avago offered to pay $8.00 for every share of outstanding Emulex stock. The $8.00 tender offer price was a 26.4% premium over Emulex’s stock price. After consulting with its investment bank for a fairness opinion, Emulex filed a Recommendation Statement with the SEC, encouraging Emulex shareholders to tender their shares. In its Recommendation Statement, Emulex pointed out that: (1) the value received would be “greater than could be reasonably expected” in the future; (2) other alternatives were less favorable; (3) shareholders would receive a premium on their stock; (4) the investment bank thought the merger was fair; (5) shareholders were certain to receive cash consideration; (6) Emulex could back out of the agreement if a better offer arrived; (7) Emulex could modify its recommendation; (8) the termination fee would not preclude other offers; and (9) the closing conditions were appropriate.

In its Recommendation Statement, Emulex included a summary of its investment bank’s fairness opinion that did not include a “Premium Analysis” that compared the premium of the Avago tender offer to seventeen similar transactions. The Premium Analysis indicated that the 26.4% premium was within the normal range of semiconductor company premiums, but it was below average. Despite the lower than average premium, the investment bank still determined the offer was fair. Even though the merger was ultimately consummated, certain shareholders objected and brought a class action against Emulex, Avago (and its subsidiary), and Emulex’s Board of Directors, claiming that Emulex’s failure to include the Premium Analysis violated Sections 14(e) and 14(d)(4) of the Exchange Act. Ultimately, the district court dismissed the complaint with prejudice, holding that Section 14(e) requires a showing of scienter and that there is no private right of action under Section 14(d)(4).

The Ninth Circuit Relies on Landmark Supreme Court Decisions to Find that Section 14(e) only Requires an Allegation of Negligence

The Ninth Circuit affirmed in part and reversed in part the district court’s dismissal, holding that, although Section 14(d)(4) does not contain a private right of action, claims under Section 14(e) require only an allegation of negligence.

The Ninth Circuit disagreed with the district court, which had relied on decisions from five other circuits in holding that Section 14(e) requires scienter. Previously, the Second, Third, and Fifth Circuits had each held that claims under Section 14(e) require a pleading of scienter because of the similarity of the Section’s language to Rule 10b-5, which has a well-established scienter requirement applied to claims made under Section 10(b).[4] The Eleventh Circuit, while less detailed in its reasoning, also stated that claims under Section 14(e), Section 10(b), and their accompanying rules all require proof of scienter.[5] The Sixth Circuit established a scienter requirement based on the fact that Section 14(e) uses the words “fraudulent,” “deceptive,” and “manipulative.”[6]

First, the Ninth Circuit looked to principles of statutory interpretation. The court noted that the conjunction “or” divided Section 14(e) into two distinct clauses, each of which describes a distinct offense the statute was intended to proscribe. While the second clause prohibiting “any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer” would likely prohibit only actions done with scienter, it is not as clear that scienter is necessary to state a violation of the first clause, which prohibits “any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.”

Second, the Ninth Circuit pointed to the Supreme Court’s decision in Ernst & Ernst v. Hochfelder,[7] which analyzed whether claims under Section 10(b) and Rule 10b-5 require an allegation of scienter. The Ninth Circuit acknowledged that the language of Rule 10b-5—“[1]t shall be unlawful . . . [t]o make any untrue statement of a material fact or omit to state any material fact,”—was largely identical to the first clause of Section 14(e). In Ernst & Ernst, the Supreme Court noted that “[5]iewed in isolation the language of [Rule 10b-5(b)] . . . could be read as proscribing, respectively, any type of material misstatement or omission . . . whether the wrongdoing was intentional or not.”[8] As a result, the plain language of Rule 10b-5 could reasonably be interpreted as imposing either a scienter or a negligence standard. However, the Supreme Court ultimately held in Ernst & Ernst that the authorizing legislation of Section 10(b), which regulates only “manipulative or deceptive device[s],” requires scienter. In light of the Supreme Court’s analysis in Ernst & Ernst, the Ninth Circuit held that there is nothing in the text of either Rule 10b-5 or Section 14(e) that requires a showing of scienter.

Third, the Ninth Circuit analogized to the Supreme Court’s decision in Aaron v. SEC,[9] which held that claims under Section 17(a)(2) of the Securities Act of 1933 do not require a showing of scienter. According to the court, this was important because, although Section 17(a)(2) of the Securities Act and Section 14(e) of the Exchange Act occur in different statutes, they deal with similar subjects and have nearly identical language and therefore “should be interpreted harmoniously.”[10] Despite the fact that five other circuits rely on Rule 10b-5 to conclude that Section 14(e) requires scienter, the Ninth Circuit drew parallels between Exchange Act and Securities Act Section 17(a)(2) and held the opposite.

Fourth, after applying the standard laid out in Cort v. Ash, the Ninth Circuit agreed with the district court that Exchange Act Section 14(d)(4) does not provide a private right of action.[11]

Conclusion and Key Takeaways

In Emulex Corp., the Ninth Circuit’s departure substantially diminished plaintiffs’ initial burden in pleading claims related to tender offers under Exchange Act Section 14(e). Companies engaging in tender offers—and their boards of directors—should take note.

Specifically, companies should be aware that claims under Section 14(e) may be much more difficult to dismiss at the pleading stage in the Ninth Circuit than in other circuits. Moreover, companies should take particular care in advocating a tender offer to shareholders, since Emulex now permits plaintiffs to bring claims for even negligent misstatements and omissions. Given that the Ninth Circuit erected a much lower standard than its sister circuits for bringing claims under Section 14(e), plaintiffs may now be incentivized to forum shop. In particular, Emulex provides plaintiffs with a reason to bring their cases in the Ninth Circuit. While Emulex did limit claims brought under Section 14(d)(4), the lowered standard for claims under Section 14(e) may make claims based on tender offers more numerous and difficult to defend, especially in the Ninth Circuit.

Additionally, given that the Ninth Circuit in Emulex parted with the great weight of contrary authority among other circuits, this split may be primed for Supreme Court review. That the circuit split involves something as fundamental as the pleading standard for Section 14(e) claims could militate in favor of a grant of certiorari. While the Ninth Circuit ultimately remanded the case to the district court to determine whether the allegedly omitted “Premium Analysis” was material, Emulex’s ultimate fate may indeed rest with a much higher Court.