On April 20, 2018, the Ninth Circuit in Varjabedian v. Emulex, No. 16-55088 (9th Cir. Apr. 20, 2018), split from five of its sister circuits, holding that plaintiffs seeking to recover under § 14(e) of the Securities Exchange Act (“Exchange Act”) for alleged material misstatements or omissions in tender-offer filings need only plead (and prove) negligence, not scienter. The circuit split threatens to invite forum shopping and make the Ninth Circuit a magnet for § 14(e) actions, and sets up a potential Supreme Court resolution. The Varjabedian opinion is available here.
On February 25, 2015, Avago Technologies Wireless Manufacturing, Inc. (“Avago”) and Emulex Corp. (“Emulex”) issued a joint press release announcing a merger agreement under which Avago would offer to pay $8.00 per share of Emulex stock, reflecting a 26.4% premium over Emulex’s closing stock price at the time. After Avago initiated the tender offer, Emulex filed with the SEC a 48-page Recommendation Statement in support of the offer, which included a nine-factor analysis and a summary of Goldman Sachs’s fairness opinion. Emulex omitted, however, Goldman Sachs’s one-page “Premium Analysis,” showing that while Emulex’s 26.4% premium fell within the normal range of merger premiums in comparable transactions, it was also below the average.
Shortly after Emulex and Avago completed the merger, a class of former Emulex shareholders filed a putative class action complaint alleging that the $8.00 share price was too low in light of Emulex’s growth before the tender offer. Plaintiffs later amended their complaint to allege that defendants had violated § 14(e) by failing in the Recommendation Statement to summarize the Premium Analysis and to disclose that the 26.4% premium was below the average of premiums in similar mergers.
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), aff’d in part, rev’d in part and remanded, No. 16-55088, 2018 WL 1882905 (9th Cir. Apr. 20, 2018). Citing the “obvious” parallels between Rule 10b-5 and § 14(e), the district court reasoned that Rule 10b-5’s scienter requirement should also apply to § 14(e) claims. Id. at 1232. The court also emphasized that numerous other courts have “unanimously [held] that § 14(e) claims require proof of scienter.” Id.
In reversing the district court’s ruling, the Ninth Circuit began by noting that § 14(e) contains two separate clauses, “each proscribing different conduct”—i.e., (1) making or omitting an untrue statement of material fact, and (2) engaging in fraudulent, deceptive, or manipulative acts or practices.1 Varjabedian v. Emulex Corp., No. 16-55088 (9th Cir. Apr. 20, 2018) (Slip op. at 10). The Ninth Circuit reasoned that the first clause, on its face, does not include a scienter requirement. Id.
The Ninth Circuit acknowledged that five other circuits (the Second, Third, Fifth, Sixth, and Eleventh) had held that § 14(e) requires that plaintiffs plead scienter, but was “persuaded that the rationale underpinning those decisions” should not actually apply to the first clause of §14(e). Id. at 11. According to the Ninth Circuit, those other circuits ignored or misread Supreme Court precedent in relying on the “similarities between Rule 10b-5 and § 14(e)” to import Rule 10b-5’s scienter requirement to § 14(e) claims.2 Id. That is because the Supreme Court in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), made clear that adding “scienter [a]s an element of Rule 10b-5(b) had nothing to do with the text of Rule 10b-5.” Id. at 12. To the contrary, the Court in Hochfelder “acknowledged that the wording of Rule 10b-5(b) could reasonably be read as imposing a scienter or a negligence standard.” Id. (emphasis in original). It, nonetheless found, that “Rule 10b-5 requires a showing of scienter because 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],’” which necessarily entails scienter. Id. at 13 (emphasis in original). In other words, Rule 10b-5 requires a showing of scienter because of the authorizing statute, not based on the Rule’s language. According to the Ninth Circuit, “[t]his rationale regarding Rule 10b-5 does not apply to Section 14(e), which is a statute, not an SEC rule.” Id. at 14.
The Ninth Circuit also found “compelling” the Supreme Court’s ruling in Aaron v. SEC, 446 U.S. 680, 696–97 (1980), that Section 17(a)(2) of the Securities Act of 1933—a provision that applies to initial public offerings and is worded similarly to the first clause of § 14(e)3—“does not require a showing of scienter.” Varjabedian v. Emulex Corp., No. 16-55088 (9th Cir. Apr. 20, 2018) (Slip op. at 14) (emphasis in original). Noting that “statutes dealing with similar subjects should be interpreted harmoniously,” id., the Ninth Circuit found that the first clause of Section 14(e), like Section 17(a)(2), “requires a showing of negligence, not scienter.” Id. at 16. The Ninth Circuit distinguished the contrary rulings in the five other circuits by noting that they were either decided before Ernst & Ernst and Aaron, or failed to follow the reasoning of those decisions and acknowledge the distinction between Rule 10b-5 and § 14(e). Id. at 15–16.
We see four things to note about Varjabedian.
First, the decision (assuming Emulex and Avago do not petition for and obtain en banc review) will likely incentivize plaintiffs pursuing § 14(e) claims to file in Ninth Circuit courts. Under § 27 of the Exchange Act, § 14(e) claims may be brought in “the district wherein any act or transaction constituting the violation occurred” or in the district “wherein the defendant is found or is an inhabitant or transacts business.” See 15 U.S.C. § 78aa; accord Bourassa v. Desrochers, 938 F.2d 1056, 1057 (9th Cir. 1991) (stating same). Thus, plaintiffs pursuing § 14(e) claims on behalf of a nationwide class of shareholders have some choice of jurisdictions in which to file suit—to the extent that potential defendants transact business in the Ninth Circuit or alleged violations occur there—and may attempt to use that flexibility to file in the Ninth Circuit.
Second, the circuit split created by Varjabedian substantially increases the likelihood of Supreme Court review. Even if the other circuits that already have addressed § 14(e) want to revisit the issue in light of Varjabedian, they could do so only through en banc proceedings or after a contrary Supreme Court decision. See, e.g., United States v. Sanchez, No. 17-11043, 2018 WL 1882961, at *1 (5th Cir. Apr. 19, 2018) (“One panel of this court may not overrule the decision of another absent a superseding en banc or Supreme Court decision.”).4 Moreover, it is not clear that those circuits would agree with the Ninth Circuit on the merits in any event. As the Fifth Circuit noted, “Congress adopted in [the first clause of] Section 14(e) the substantive language of the second paragraph of Rule 10b-5 and in so doing accepted the precedential baggage those words have carried over the years.” Smallwood v. Pearl Brewing Co., 489 F.2d 579, 605 (5th Cir. 1974). Thus, when Congress drafted the first clause of § 14(e), it arguably did so with the understanding that it was borrowing language (from Rule 10b-5) that included an implied scienter requirement. Because of those divergent interpretations, the Supreme Court could be persuaded to resolve the circuit split, perhaps even in response to a cert petition in Varjabedian.
Third, Varjabedian brings Ninth Circuit § 14(e) tender-offer claims in line with §14(a) proxy-statement claims, which the Ninth Circuit held in Knollenberg v. Harmonic, Inc., 152 F. App’x 674, 682–83 (9th Cir. 2005), do not require scienter. The Ninth Circuit’s reasoning in Knollenberg was similar to Varjabedian; the court distinguished § 14(a) from § 10(b) because the former lacked any reference to a “manipulative device or contrivance,” and on that basis held that § 14(a) did not include a scienter requirement. Id. at 682. There is also a circuit split as to the interpretation of Section 14(a), compare Adams v. Standard Knitting Mills, Inc., 623 F.2d 422, 431 (6th Cir. 1980) (“[A]n action under 14(a) requires proof of scienter.”), and the Supreme Court has reserved judgment on the issue, see Va. Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1090 n.5 (1991). This increases the chances of Supreme Court review.
Fourth, even under Varjabedian, defendants still have several avenues to challenge § 14(e) claims. Nothing in Varjabedian, for example, limits defendants’ ability to argue, as they often do in M&A cases, that the alleged misstatements or omissions are not material. The district court in Varjabedian did not reach the defendants’ argument that the Premium Analysis was not material, Varjabedian v. Emulex Corp., 152 F. Supp. 3d at 1232, and the Ninth Circuit noted that it will be “difficult to show that [the] omitted information was indeed material.” Varjabedian v. Emulex Corp., No. 16-55088 (9th Cir. Apr. 20, 2018) (Slip op. at 18).