In April of 2018, the Ninth Circuit split with five other circuits in finding 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. The panel reversed the district court’s dismissal and recognized its departure from previous jurisprudence, holding that the first clause of § 14(e) requires only a showing of negligence rather than scienter. The Supreme Court granted certiorari in January and is scheduled to hear arguments in April of 2019.
Emulex Corp. v. Varjabedian
In February of 2015, Avago Technologies Limited (Avago), a computer software provider, announced it had entered into a merger agreement with Emulex Corporation (Emulex). Under the agreement, Avago would acquire all outstanding shares of Emulex’s common stock at $8 dollars per share, which was a 26.4% premium over the price at which the shares were trading. Accordingly, a subsidiary of Avago initiated the tender offer in April of that year.
Before submitting a recommendation to its shareholders, Emulex retained Goldman Sachs to evaluate the fairness of the merger. Goldman ultimately supported the tender offer, but found that the 26.4% premium Emulex shareholders would receive was below average when compared with seventeen similar transactions between semiconductor companies in the same industry over the past five years. Goldman reported this finding in a one-page “Premium Analysis.” Emulex then filed a 48-page Recommendation Statement to its shareholders urging them to tender their shares in part because they would be receiving a premium for their shares, however the Recommendation Statement failed to include the Premium Analysis. Ultimately the tender was successful as 60.58% of shareholders offered up their shares.
Unhappy with the $8 offer price, a group of shareholders brought suit in California district court, claiming defendants’ omission of the Premium Analysis violated § 14(e) of the Securities Exchange Act.
The District Court dismissed the case, finding that the plaintiffs had not pled a “strong inference of scienter” as required “unanimously” by other courts. While noting plaintiffs’ argument—that only the second clause of § 14(e) requires scienter while the first clause requires only negligence—was not “entirely without merit,” the court aligned itself with other districts who inferred a scienter requirement. The court’s analysis relied primarily on the similarities between §14(e) and Rule 10b–5, which undisputedly requires a scienter showing.
Noting that the district court relied on out-of-circuit precedence, the 9th Circuit reviewed the statutory interpretation of § 14(e) de novo. The Court broke down the provision into two clauses:
15 U.S.C § 78n(e) (emphasis added) – § 14(e)
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 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 . . . .
The Court decided that while Rule 10b–5 requires scienter, it is derived from Section 10(b) of the Exchange Act, whereas § 14(e) is a statute and not an SEC rule, and is “authorized to regulate a broader array of conduct than under Section 10(b).” Rather, the Court emphasized the similar wording in the first clause of § 14(e) and § 17(a)(2) of the Securities Act of 1933, which requires only a showing of negligence. Further, the court found the legislative history of the Williams Act, which included § 14(e), focused more on the information shareholders received rather than the state of mind of the issuer. Ultimately, “because the test of the first clause of Section 14(e) is devoid of any suggestion that scienter is required,” the 9th Circuit reversed the circuit court’s decision.
Why It Matters
First, this decision must be read in the context of the rise of merger objection class action lawsuits. These lawsuits are typically brought by dissatisfied shareholders of an acquired company against their company’s board of directors in response to a public merger. Often these cases are resolved quickly in what are known as “disclosure-only settlements,” the real winner usually being the plaintiffs’ attorneys, who often reap large attorneys fees. From 2008 to 2013, the percentage of M&A deals valued over $100 million that were challenged by lawsuits rose from 54% to 94%. In that time frame, over 70% of those cases were resolved before the deal was finalized.
In 2016, the Delaware Chancery Court responded to this epidemic in In Re Trulia, Inc., announcing that it would heighten its scrutiny of disclosure claims. Following Trulia, the percentage of M&A deals that were challenged by lawsuits dropped by 18%, and the average number of lawsuits per deal dropped by 32%. However, one of the largest impacts of Trulia was driving objection litigation into the federal courts. In 2017, the number of M&A deals litigated in federal courts rose by 20%.
In response to Emulex’s petition for a writ of certiorari, the Chamber of Commerce of the United States (USCC) and the Securities Industry and Financial Markets Association (SIFMA) both filed briefs outlining why the Supreme Court should grant cert. Among their chief concerns with the 9thCircuit’s ruling was that lowering the threshold of § 14(e) from scienter to negligence would open the floodgates for merger objection litigation, essentially creating a litigation tax on mergers and acquisitions, and causing undue economic harm on corporate defendants. Further, the ruling would promote “over-disclosure” – erring on the side of disclosing all possible relevant information to shareholders – therefore making disclosure statements so lengthy and complex to the point they lose their informative value. Finally, because of broad venue granted under the Securities and Exchange act – “Any suit or action…may be brought in any such district or in the district wherein the defendant is found or is an inhabitant or transacts business” – the 9th Circuit’s ruling will promote forum shopping and essentially create a nationwide negligence standard.
Respondents Gary Varjabedian, et al. filed a brief in response, arguing rather that the negligence standard would properly hold corporate actors responsible for failing to disclose essential information, and merger objection litigation in fact keeps corporations honest as the SEC cannot properly monitor every disclosure statement. As an example in the present case, they argue that if Goldman Sachs considered the Premium Analysis important enough to include in its report to the board, then the shareholders should have been entitled to it as well.
The Supreme Court’s decision will not only clear up confusion between the circuit courts, but it will have an enormous impact on federal dockets, the scope SEC enforcement, and the future of private securities litigation. A win for Emulex would mean increased protection for corporate actors and a lowering of the “merger tax,” while win for Varjabedian could force a change in disclosure practices and/or an increase in settlement disclosures. The Supreme Court is expected to deliver its ruling in June of 2019.