On April 15, 2019, the Supreme Court heard argument in a closely-watched case asking whether mere negligence is sufficient to plead and prove a claim under Section 14(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) in connection with a tender offer and – perhaps – whether a private right of action exists under Section 14(e) at all. Emulex Corporation, et al. v. Varjabedian, No. 18-459 (Apr. 15, 2019). The argument was particularly lively, with the Justices posing numerous questions about both a defendant’s required mental state, as well as whether an implied right of action ought to be recognized – although it remains unclear whether the Court will actually decide the latter question.
As previously discussed in this newsletter, the backdrop to Emulex is the sharp and sustained spike in the number of investor cases in federal court under Section 14 attacking disclosures in connection with merger and acquisition transactions. This trend emerged as a direct consequence of the Delaware Chancery Court’s decision in In re Trulia, Inc. Stockholder Litig., 129 A.3d 885 (Del. Ch. 2016), which made it much more difficult for plaintiffs to pursue successfully the quick settlement of disclosure-based merger challenges. A majority of the cases of this nature filed in federal court have been under Section 14(a) – which addresses proxy solicitations, and regarding which the Supreme Court has previously concluded an implied private right of action exists – rather than under Section 14(e), which addresses tender offers. The Supreme Court has never addressed whether mere negligence, as opposed to scienter, is sufficient to plead and prove a claim under either subsection (a) or (e), nor has it addressed whether an implied private right action exists under Section 14(e), unlike Section 10(b), where an implied right of action has been repeatedly recognized.
The Supreme Court has previously observed that Section 14(e) was “modeled on the antifraud provisions of Section 10(b) of the [Exchange] Act and Rule 10b-5.” Schreiber v. Burlington N., Inc., 472 U.S. 1, 10 (1985). Section 14(e) 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). Like Section 10(b), Section 14(e) includes no express private right of action for investors to pursue damages, but all courts of appeals that have considered the issue have found or assumed that a private right of action exists under Section 14(e). Further, all of those courts other than the Ninth Circuit – whose decision is on appeal in this case – have held that Section 14(e) requires that, as with Section 10(b) and Rule 10b-5, 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.
On appeal to the Supreme Court, Emulex argued that the Court should reject the Ninth Circuit’s holding that a negligence standard applies to private rights claims under Section 14(e). Emulex also went further and argued that a private right of action should not be inferred at all under Section 14(e).
At oral argument, several Justices (including Justices Ginsburg, Breyer, Kagan, and Sotomayor) appeared skeptical of Emulex’s attempt to raise the broader question of whether an implied private right of action exists under 14(e) – which Emulex did not expressly argue before the Ninth Circuit and did not raise as a separate “question presented” to the Court. The fact that Justice Alito’s only question at the argument also raised why it would be appropriate for the Court to reach the issue of whether there is a private right of action could potentially suggest that a majority of the Court would find that the issue is not properly before the Court. Chief Justice Roberts did note, however, that resolving the question of what standard applies under 14(e) might be a “waste of time” if no right of private action actually exists under that provision. Emulex argued that it had not conceded the point that an implied right of action exists, and pointed to the Supreme Court’s prior decision in Central Bank as demonstrating that the Court has discretion to reach this broader issue, as, there, the Court itself raised and resolved a question about whether there was an implied private right for aiding and abetting under Section 10(b). Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994).
Leaving aside whether the issue is properly before the Court, several Justices appeared to express concern about the argument that there is no private right of action under Section 14(e). Justice Kagan’s questions, along with those of Justices Ginsburg, Breyer, and Sotomayor, could be understood to outline the following bases for finding a private right of action: (i) Section 14(a), concerning proxy solicitations, has been held to have a private right of action and Congress gave no indication that it wanted Section 14(e), concerning tender offers, to be treated differently, and (ii) Congress modeled Section 14(e) on Section 10(b) and Rule 10b-5 after courts had decided that 10(b) and 10b-5 create a private right of action. Justice Sotomayor also noted that if Congress disagreed with courts’ recognition of an implied private right of action for Section 14(e), then it could have taken steps to amend the statute, but did not do so. Emulex, for its part, argued that the language of 14(a) and 14(e) differs, and that although 14(e) tracks language from Rule 10b-5, the implied right of action for securities fraud comes from Section 10(b), not Rule 10b-5.
Of the other Justices, Chief Justice Roberts raised most expressly a potential position in favor of finding no implied right of action – raising a concern that courts are engaging in improper “law-making” if they read a private cause of action into statutory language, and further noting that if the Court’s view on private rights of action have changed, it should not replicate its past mistakes. This appeared to pick up on Emulex’s argument that, although the Court inferred a private right to sue under Section 14(a) of the Exchange Act under a prior decision, J.I. Case Co. v. Borak, 377 U.S. 426 (1964), the Court had subsequently “disavowed” that approach in Alexander v. Sandoval, 532 U.S. 275, 287 (2001) (stating that the Court had “abandoned [Borak’s] understanding” and that “private rights of action to enforce federal law must be created by Congress”).
The practical implications of finding that an implied right of action does or does not exist for Section 14(e) appeared to interest both Justices Breyer and Kavanaugh. Justice Kavanaugh asked the attorney representing the Office of the Solicitor General (which appeared as amicus curiae in support of neither party) whether courts’ prior recognition of a private right of action has “caused real-world problems.” The government argued that, in its view, the main problem was that this had led to a scienter standard being applied to the SEC, almost as an unintended consequence. Justice Kavanaugh also asked plaintiffs how they would assess, in terms of deterrence, SEC enforcement alone with a negligence standard as opposed to the status quo – and suggested himself, logically, that an entity faced with the SEC enforcing a negligence standard under Section 14(e) would be “very concerned about their actions.” Justice Breyer noted that the government had suggested that the SEC could handle any issues related to misrepresentations in connection with tender offers, if private actions could not be pursued under Section 14(e) – but he seemed concerned about the potential impact on 14(a) of finding no private right of action under 14(e) for tender offers, and whether the SEC could cover on its own the much larger number of potential cases involving proxy solicitations. Emulex stated it was not seeking to change the regime under 14(a).
Although the majority of the argument focused on whether there is a private right of action under Section 14(e), the Justices also asked questions, more briefly, about the issue of the applicable standard. The questions focused on two potential opposing approaches – proceeding by analogy to 10b-5, which has substantively similar language to 14(e) and has been held to require scienter, or looking for consistency with 14(a), for which most circuits have concluded that negligence is the appropriate standard. Justice Sotomayor asked the government – which took the position that Section 14(e) allows a negligence standard but not private actions – why, since 14(e) borrows the language of 10-5, which has consistently been interpreted to require scienter, the Court should not require the same standard for 14(e). Justice Gorsuch made a similar point, although he also separately suggested that courts may have “rachet[ed] up the mens rea to scienter” to “counter what they perceive as abuses” in private actions. Justice Breyer appeared more focused on consistency of interpretation with Section 14(a).
Although outcomes are always difficult to predict from oral argument, it appears possible that a majority of the Court may have procedural concerns about deciding the question of whether an implied private right of action exists under Section 14(e) on the existing record. On the scienter versus negligence question, the totality of the questions suggested, consistent with the majority view among circuits, that scienter will continue to apply to Section 14(e) claims so long as an implied private right of action continues to be recognized. Ultimately, the Court’s ruling as to 14(e) will have a more limited impact on the trend of federal actions challenging mergers than would a potential re-examination of these questions in connection with 14(a) concerning proxy statements, unless the decision is so sweeping as to have direct implication for Section 14(a) claims, too.