TAKEAWAYS

  • Section 14(e) ruling creates circuit split, increasing odds of Supreme Court review.
  • Section 14(e) ruling lowers pleading standard for attacking tender offer documents.
  • Section 14(e) ruling largely moots the benefit for defendants of the ruling that Section 14(d)(4) does not provide a private right of action.

Background

For decades, every circuit of the United States Court of Appeals that has considered the issue has ruled that a plaintiff must allege scienter when attacking tender offer documents under Section 14(e) of the Securities Exchange Act of 1934. But now, the Ninth Circuit has reached the opposite conclusion, holding that negligence suffices. Varjabedian v. Emulex Corp., No. 16-55088 (9th Cir. Apr. 20, 2018). The opinion also holds that Section 14(d)(4)—which regulates what a tender offer solicitation or recommendation must contain—does not provide a private right of action.

Added by the Williams Act in 1968, Section 14(e) makes it “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 the 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.”

From the Second Circuit in 1973 to the Fifth Circuit in 2009, five circuits of the United States Court of Appeals have held that to state a claim under Section 14(e), one must allege that the defendant acted with scienter—which, though never precisely defined, means something more than negligence or recklessness, but (perhaps) something less than intent. Most of these courts have done so by noting the textual similarities between Rule 10b-5—which the Supreme Court held in 1976 requires scienter—and Section 14(e). But in Varjabedian, a panel of the Ninth Circuit held that the better analogy is between the first part of Section 14(e) and the “nearly identical text” of Section 17(a)(2) of the Securities Act of 1933. That’s significant because back in 1980, the Supreme Court held that Section 17(a)(2) does not require a showing of scienter.

Other circuits had relied on the Supreme Court’s ruling in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) that a claim for violation of Rule 10b-5(b) requires a showing of scienter and the similarity between that rule and the language of Section 14(e). But the Ninth Circuit observed that the ruling in Hochfelder was based not on the language of Rule 10b-5(b) but rather on the ground that the rule requires a showing of scienter because it is promulgated under Section 10(b) of the Exchange Act, which allows the SEC to regulate only manipulative or deceptive devices.

The Varjabedian Case

Since the Delaware Court of Chancery disapproved of disclosure-only settlements in 2016, the plaintiffs’ securities bar that challenges mergers has been flocking to federal court to bring disclosure claims. When the merger involves a proxy and shareholder vote, the claims typically are asserted under Section 14(a) and its related rules; where the merger involves a tender offer, the claims typically are asserted under Sections 14(e) and 14(d)(4) and their related rules.

Varjabedian is in many ways a typical tender offer case involving two tech companies. Avago, through a subsidiary, sought to acquire Emulex. The subsidiary made a tender offer; Emulex asked its banker whether the proposed terms were fair from a financial point of view to its stockholders and, upon receiving the thumbs-up, filed with the SEC a 48-page statement recommending that its stockholders accept the tender offer and listing nine reasons why. The statement summarized the banker’s fairness opinion and described in some detail the processes and financial analyses employed to reach that opinion. But—said the plaintiff—the summary did not cover one specific page from the banker’s slide deck: a chart comparing the merger premium to that of selected semiconductor transaction and showing that the premium on this deal (allegedly 26.4 percent), while within the range, was below the average (allegedly 50.8 percent).

Plaintiff sued, asserting claims under sections 14(e), 14(d)(4) and 20(a) of the Exchange Act. Defendants move to dismiss, arguing that the omitted information was publicly available and immaterial, and that plaintiff had not pleaded scienter. The district court dismissed the 14(e) claim on the ground that plaintiffs were required to plead scienter but had not. The court dismissed the 14(d)(4) claim on the ground that 14(d)(4) does not provide a private right of action. The Ninth Circuit affirmed as to the 14(d)(4) claim but reversed as to the 14(e) claim, holding that scienter was not required and not reaching defendants’ alternative argument that the chart was immaterial.

Consequences

The net effect of Varjabedian is to make it easier for plaintiffs to challenge tender offer disclosures. Already plaintiffs were using 14(d)(4) in an attempt to avoid having to plead scienter, but that was an uncertain work-around, as many district courts had held that 14(d)(4) does not provide a private right of action. From a plaintiff’s point of view, having a negligence claim under 14(e) is more than an even trade for losing the opportunity to claim under 14(d)(4).

But the consequences should not be overstated. Many courts, the Ninth Circuit included, already had held that a plaintiff need not plead scienter under 14(a) to challenge a proxy statement. The ruling here could be seen as harmonizing the two standards—for merger-by-tender-offer and merger-by-proxy—although this is not a point the Ninth Circuit discussed. It will be interesting to see whether courts in other circuits accept the Ninth Circuit’s reasoning. In any event, the circuit split created by Varjabedian makes review by the Supreme Court a definite possibility.