On April 20, 2018, the Ninth Circuit in Varjabedian v. Emulex, 888 F.3d 399 (2018), held that plaintiffs seeking to recover under § 14(e) of the Securities Exchange Act (Exchange Act) for material misstatements or omissions in tender-offer filings need plead (and prove) only negligence, not scienter. In so holding, the Ninth Circuit split from five of its sister circuits, instantly making California and other Ninth Circuit courts plaintiff-friendly forums for tender-offer litigation. Given the circuit split on this important aspect of tender-offer disclosure and litigation, we predicted last year that the US Supreme Court would grant certiorari to review the Ninth Circuit’s decision.
The Supreme Court did just that on January 4, 2019. Below is a brief overview of the Ninth Circuit’s decision and an analysis of the key issues the Supreme Court will consider.
On February 25, 2015, Avago Technologies Wireless Manufacturing, Inc. (Avago) and Emulex Corp. (Emulex) announced a merger agreement under which Avago would initiate a tender offer and pay $8.00 per share of Emulex stock. Shortly after the merger closed, former Emulex shareholders filed a putative class action complaint alleging, among other things, that Emulex, its directors, and Avago had violated § 14(e) by omitting certain information in the Recommendation Statement filed with the SEC in support of the offer.
On January 13, 2016, the district court dismissed the § 14(e) claim for failure to plead that the misstatement or omission was made “intentionally or with deliberate recklessness.” Varjabedian v. Emulex Corp., 152 F. Supp. 3d 1226, 1233 (C.D. Cal. 2016). Citing the “obvious” parallels between Rule 10b-5 and § 14(e) and the unanimous holdings of other courts (the Second, Third, Fifth, Sixth, and Eleventh Circuits), the district court ruled that Rule 10b-5’s scienter requirement should also apply to § 14(e) claims. Id. at 1232.
The Ninth Circuit reversed based on the language and structure of the statute. The court noted that § 14(e) contains two separate clauses, “each proscribing different conduct”: (i) making or omitting an untrue statement of material fact, and (ii) engaging in fraudulent, deceptive, or manipulative acts or practices. Varjabedian, 888 F.3d at 404. The court reasoned that while the conduct prescribed by the second clause necessarily incorporates a scienter element, the same could not be said for the conduct that the first clause addresses. Id.
The court disagreed with the other circuits for two principal reasons. First, the court deemed it inappropriate to rely on the “similarities between Rule 10b-5 and § 14(e)” to import Rule 10b-5’s scienter requirement to § 14(e) claims. That is because the Supreme Court in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), implied a scienter requirement for Rule 10b-5 claims by reference to the language of Rule 10b-5’s authorizing statute, Section 10(b) of the Securities Exchange Act of 1934, whereas § 14(e) is itself a statute, not a rule. 888 F.3d at 406. Second, the court relied on the Supreme Court’s decision in Aaron v. SEC, 446 U.S. 680 (1980), that § 17(a)(2) of the Securities Act of 1933—which has similar language as § 14(e)—“does not require a showing of scienter.” Id.
The Supreme Court's Tast
The Supreme Court will address “[w]hether the U.S. Court of Appeals for the Ninth Circuit correctly held, in express disagreement with five other courts of appeals that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on the negligent misstatement or omission made in connection with a tender offer.”
In making that determination, the Supreme Court will have to choose between two ways of construing § 14(e): (i) dividing its text into two separate clauses, as the Ninth Circuit did, each of which prohibits a distinct category of conduct; or (ii) reading both clauses as an integrated whole that addresses fraudulent conduct. The former approach is more conducive to a no scienter determination because the first clause, read in isolation, does not suggest a scienter requirement. The latter approach, in contrast, entails reading § 14(e) as a single sentence that proscribes various kinds of fraudulent and deceptive acts. Viewed from that perspective, Congress’s use in the sentence’s latter half of words connoting intentional or willful conduct—“fraudulent,” “deceptive,” and “manipulative”—suggests that the entire sentence is concerned with purposeful conduct.
The Supreme Court will also need to reconcile Congress’s use in § 14(e) of language similar to both Rule 10b-5, which has a scienter requirement, and § 17(a)(2), which does not. The Court will determine which provision offers a better analogue.
Rule 10b-5 served as the model for § 14(e), Schreiber v. Burlington N., Inc., 472 U.S. 1, 10 (1985), weighing in favor of importing Rule 10b-5’s scienter requirement to § 14(e). And the private rights of action for damages in both § 14(e) and Rule 10b-5 are judicially created. The Supreme Court in Hochfelder refused to read Rule 10b-5’s implied cause of action to cover unintentional misconduct absent the procedural restrictions that Congress has imposed for express causes of actions covering mere negligent conduct. 435 U.S. at 209-211. That reasoning should also apply to the implied right of action in § 14(e) because it, too, does not have any of those procedural safeguards. Moreover, unlike § 14(e), § 17(a)(2) is enforced by the SEC through an express cause of action, and there is no private right of action—implied or explicit—to enforce § 17(a)(2). Thus, it arguably should not be relevant in interpreting an implied private right of action for damages that the SEC need not prove scienter in seeking the more limited congressionally mandated injunctive remedy under § 17(a)(2).
The rationale for looking instead to § 17(a)(2), as the Ninth Circuit did, is that it is a statutory provision, not a rule, like Rule 10b-5, that implements a statutory provision directed at fraudulent conduct. The same can be said of § 14(e). And according to the Court in Hochfelder, absent the relationship between Rule 10b-5 and its authorizing legislation, Rule 10b-5(b)’s parallel text “could encompass both intentional and negligent behavior.” 425 U.S. at 212.
We will monitor developments and provide further updates as the Supreme Court proceedings unfold.