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United States Supreme Court Grants Certiorari in Tender Offer Case Over the Appropriate Standard of Conduct to Apply Under Section 14(e) of the Exchange Act

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  • Posted on: Jan 14 2019

On January 4, 2019, the United States Supreme Court granted the petition for a writ of certiorari (here) filed by, among others, Emulex Corporation (“Emulex”), a Delaware corporation, that merged with Avago Technologies Wireless (USA) Manufacturing Inc. (“Avago”) (“Petitioners”). Emulex Corp. v. Varjabedian, 18-459. The question presented by the petition concerned whether “Section 14(e) of the Securities Exchange Act of 1934 [“Exchange Act”] supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.”

The case comes to the U.S. Supreme Court because of a split among the circuits over the appropriate standard of conduct to apply to a claim under Section 14(e). On April 20, 2018, the U.S. Court of Appeals for the Ninth Circuit held that a plaintiff bringing an action under Section 14(e) of the Exchange Act need only plead and prove negligence, rather than scienter, or an intent to deceive. Varjabedian v. Emulex Corp., 888 F.3d 339 (9th Cir. 2018) (here). That decision admittedly “part[ed] ways” with the decisions of the Second, Third, Fifth, Sixth and Eleventh Circuits, which have held that Section 14(e), like Section 10(b) of the Exchange Act and Rule 10b-5, promulgated thereunder, requires a showing of an intent to deceive or scienter.  Petitioners sought review “to establish a uniform, national rule” governing the standard of conduct to apply in a Section 14(e) tender offer litigation.

The Facts and Procedural History

[Ed. Note: The factual discussion below comes from the petition for a writ of certiorari. SeePet. Br. at 6-11.]

Emulexarose from the 2015 merger of Emulex and Avago.

On February 25, 2015, Emulex and Avago announced that they had agreed to merge pursuant to a tender offer. On April 7, 2015, Emerald Merger Sub, Inc., a subsidiary of Avago, offered to pay $8.00 for every share of outstanding Emulex stock. The $8.00 offering price reflected a 26.4% premium on Emulex’s stock price the day before the merger was announced.

On the same day that the tender offer was initiated, Emulex filed with the SEC, on Schedule 14D-9, a statement recommending the merger of the two companies (the “Recommendation Statement”). The Recommendation Statement identified nine reasons for approving the merger, including that Emulex shareholders would receive a premium for their shares. The Recommendation Statement also provided a five-page summary of a “fairness opinion” that Emulex had received from its financial advisor, Goldman Sachs, which found that the $8.00 offering price was fair to Emulex shareholders.

The day after Emulex filed its Recommendation Statement with the SEC, Gary Varjabedian (“Varjabedian”), an Emulex shareholder, filed a putative securities class action in the U.S. District Court for the Central District of California on behalf of himself and all others similarly situated, seeking to enjoin the merger. The district court later appointed Jerry Mutza (“Mutza”) lead plaintiff of the action pursuant to the Private Securities Litigation Reform Act of 1995 (“PSLRA”) (collectively, Mutza and Varjabedian are referred to as “Respondents”). Thereafter, Emulex voluntarily provided Respondents with a core set of documents, including the so-called “Board Book,” that Goldman Sachs had compiled in reaching its fairness opinion. The last page of the Board Book contained a chart, entitled “Selected Semiconductor Transactions,” which listed the premiums received in 17 transactions over a four-year period involving semiconductor companies.

The chart, also known as the “Premium Analysis,” did not contain an assessment of the transactions listed and did not compare the transactions with Avago’s tender offer. According to Petitioners, it simply showed that the 26.4% premium Emulex shareholders would receive in the tender offer was within the range of premiums identified in those listed transactions.

After receiving the information (and failing to enjoin the merger), Respondents amended the complaint to allege that, by failing to include the Selected Semiconductor Transactions chart in the Recommendation Statement, Petitioners violated Section 14(e) of the Exchange Act. According to Respondents, the omission of the chart “create[d] the materially misleading impression that the premium Emulex’s shareholders received was significant, or at the very least in line with premiums obtained in similar transactions.”

Respondents sought damages as well as an order rescinding the transaction.

The district court “dismissed” Respondents’ “claims … with prejudice.” Varjabedian v. Emulex Corp., 152 F. Supp. 3d 1226, 1243 (C.D. Cal. 2016) (here). The court rejected Respondents’ argument that “only negligence” is required, finding instead that Section 14(e) requires a showing of scienter. Id. at 1233. The court explained that “no federal court has held that § 14(e) requires only a showing of negligence,” and that “the better view is that the similarities between Rule 10b-5 and § 14(e) require a plaintiff bringing a cause of action under § 14(e) to allege scienter,” i.e., that “‘defendants made false or misleading statements either intentionally or with deliberate recklessness.’” Id. (citation omitted).

The Ninth Circuit reversed. The court focused on the language of Section 14(e), framing the question as whether the statute requires “proof of scienter, as the district court held, or mere negligence.” Id. at 404. In doing so, the court found that “[a] plain reading of Section 14(e) readily divides the section into two clauses, each proscribing different conduct:

It shall be unlawful for any person [1] 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 [2] to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer….

15 U.S.C. § 78n(e) (emphasis added).” The court reasoned that “[t]he use of the word ‘or’ separating the two clauses in Section 14(e) shows that there are two different offenses that the statute proscribes; to construe the statute otherwise would render it ‘hopelessly redundant’ and would mean ‘one or the other phrase is surplusage.’” Id. at 404 (citing Hart v. McLucas, 535 F.2d 516, 519 (9th Cir. 1976)).

Based upon the foregoing, the court chose to “part[] ways from [its] colleagues in [the] five other circuits” that have required plaintiffs to plead and prove scienter (id. at 409) and held that Section 14(e) requires a showing of “only negligence….” Id. at 408.

The court concluded that the other circuits incorrectly focused on the “the shared text found in both Rule 10b-5 and Section 14(e)” (id. at 405), text which focuses on fraud. As such, the Ninth Circuit remanded the matter for the district court to “reconsider Defendant’s motion to dismiss under a negligence standard.” Id. at 410.

On October 11, 2018, Petitioners filed the petition for certiorari.

The Parties’ Briefs

Petitioners

Petitioners argued that the Ninth Circuit’s decision should be reversed because it “upsets the statutory scheme enacted by Congress.” Pet. Br. at 15. In this regard, Petitioners claimed that the Ninth Circuit improperly considered the constituent components of Section 14(e) individually instead of as a whole, a reading that it argued was inconsistent with the Supreme Court’s prior rulings. Pet. Br. at 17 (citing United States v. Morton, 467 U.S 822, 828 (1984) (“Indeed, as this Court has repeatedly explained, courts should not ‘construe statutory phrases in isolation,’ but rather must ‘read statutes as a whole.’”). By properly reading the first sentence of the statute – which pertains to “fraudulent,” “deceptive,” and “manipulative” conduct – together with the second sentence of the statute – which “authorized the SEC to promulgate rules and regulations ‘reasonably designed to prevent[] such acts and practices as are fraudulent, deceptive, or manipulative’” – the only conclusion to be drawn, said Petitioners, is that “Section 14(e) is concerned with purposeful misrepresentations and omissions, not merely negligent ones.” Id. at 17-18.

This reasoning, explained Petitioners, is consistent with the courts that have “inferred a private right of action under Section 14(e) for intentional violations.” Pet. Br. at 20. Noting that the Supreme Court had not “previously recognized a private right of action under Section 14(e),” Petitioners argued that the “lower courts [which] have created one by inference,” recognized that they “have a special responsibility to consider the consequences of their rulings and to mold liability fairly to reflect the circumstances of the parties.” Id. at 18 (quoting Adams v. Standard Knitting Mills, Inc., 623 F.2d 422, 428 (6th Cir. 1980)). Petitioners concluded that “[u]ntil the Ninth Circuit’s decision in this case, every court to exercise that ‘special responsibility’ had refused to extend the inferred private right of action to negligent conduct.” Id. at 19.

Notably, Petitioners argued that the Supreme Court could decide the matter without re-examining whether there is a private right of action under Section 14(e). It did so “on the assumption that the lower courts have properly inferred a private right of action under Section 14(e) for intentional violations.” Pet. at 20. However, Petitioners invited the high court to “reexamine” whether there is a private right of action if “it believes that any inferred cause of action that exists under Section 14(e) may be applied to negligent behavior as well ….” Id.

From a policy standpoint, Petitioners argued that the Court should reverse the Ninth Circuit decision to address, what it considered to be inevitable, forum shopping for a more favorable venue to litigate Section 14(e) claims:

This Court has frequently intervened to resolve conflicts over the meaning of the federal securities laws, in part because the flexible venue rules applicable to such suits mean that the outlier position of one circuit can become a de facto national standard simply through forum shopping. Plaintiffs’ lawyers already file a disproportionately large number of securities class actions in the Ninth Circuit, and the Ninth Circuit’s creation here of a negligence-based claim for damages and other remedies that had been rejected in other circuits for decades will only make it more of a magnet for such actions. After all, given the choice, why would a plaintiff desiring to assert a private claim under Section 14(e)—along with, as here, a demand for damages—ever file anywhere else?

Pet. Br. at 3; seealsoid. at 22-26.

Respondents

Respondents opposed the grant of certiorari (here).

Respondents argued that “the Ninth Circuit’s decision [did] not implicate any direct circuit conflict.” Resp. Br. at 2. They maintained that Petitioners could not “identify a single appellate decision that squarely rejects the Ninth Circuit’s logic, much less in the relevant context (construing Section 14(e)’s first clause, not its second) and after this Court’s intervening guidance.”

None of the cases grapple with the Ninth Circuit’s rationale. Those cases rest on scant reasoning (or worse); some address the question in dicta (and thus held nothing); and at least one “decided” the issue when it was uncontested by both sides, leaving nothing to decide. Aside from a few errant statements and some superficial disagreement, there is no legitimate split. Further review is unwarranted.

Resp. Br. at 7.

Respondents concluded that “[o]nce the circuit decisions are reviewed in their proper context …, the circuit conflict is illusory.” Resp. Br. at 2.

Respondents contended that the Ninth Circuit’s analysis was correct making “Petitioners’ contrary view … incompatible with Section 14(e)’s plain text, statutory purpose, and legislative history.…” Resp. Br. at 14. Indeed, to Respondents, Petitioners’ reading of Section 14(e) was “irreconcilable with [the Supreme] Court’s interpretation of indistinguishable language in related securities provisions.” Id.

Respondents argued that the plain meaning of Section 14(e) controlled the Court’s analysis: “the Ninth Circuit correctly read Section 14(e)’s plain language to mean what it says.” Resp. Br. at 2. In this regard, Respondents argued that the two clauses “are set up as separate, independent bans on distinct wrongdoing.” Id.  Consequently, Petitioners’ contention that the Court must read the two clauses together was wrong and contrary to prior Supreme Court jurisprudence:

Petitioners insist that Section 14(e)’s separate clauses must be read together to impose a unitary scienter requirement. But this Court already rejected that proposition in Aaron, holding that no “uniform” treatment was required. It explained that provisions like this are properly read as targeting separate categories, each with their own independent requirements. This is confirmed by “the use of an infinitive to introduce each of [the] subsections, and the use of the conjunction ‘or’ at the end of the first two.” Had Congress wanted identical coverage under each clause, it would have used the same wording in each section. Instead, Congress outlined “distinct categor[ies] of misconduct” because “[e]ach succeeding prohibition is meant to cover additional kinds of illegalities—not to narrow the reach of the prior sections.”

Resp. Br. at 18-19 (citations omitted).

In addition, Respondents maintained that Petitioners’ reading of Section 14(e) would frustrate the objectives of the statute: disclosure of material information in a tender offer. Resp. Br. at 22. Respondents reasoned that “Congress expected corporate statements to be correct—which is why it declared it ‘unlawful’ to ‘make any untrue statement’ or ‘omi[ssion]’” in a tender offer. Id. at 23. “Requiring scienter,” urged Respondents, “undercuts Congress’s disclosure mandate.”

Finally, addressing the “flood gates” argument proffered by Petitioners, Respondents claimed that the “case lack[ed] … broader significance” and any concerns about a supposed “rash of reckless securities litigation … [was] unfounded.” Resp. Br. at 2.

Respondents claimed that the heightened pleading requirements of the PSLRA mitigated any concerns about the flood gates opening if the Court denied the writ. Resp. Br. at 25 (“Plaintiffs must cross multiple thresholds to survive a motion to dismiss, including the PSLRA’s other heightened-pleading requirements. 15 U.S.C. 78u-4(b)(1)(A)- (B). That Section 14(e)’s first clause does not require scienter does not mean weak claims get a free pass.”).

Similarly, the many considerations that motivate venue decisions, said Respondents, protect against the forum shopping about which Petitioners expressed concern.  Resp. Br. at 25. Plaintiffs consider many factors in choosing where to file a case. Consequently, Respondents argued, “[i]t is the rare case where a plaintiff feels he can satisfy everything except scienter and sues in an unnatural location for that reason alone.”  Id.

The Amici Briefs

The Securities Industry and Financial Markets Association (“SIFMA”)

SIFMA filed an amicus brief (here) in which it argued that it was important for the Supreme Court to grant certiorari to address the increase in “merger objection” litigation in the wake of the Delaware Chancery Court’s decision in In re Trulia, Inc. Stockholder Litig., 129 A.3d 885 (Del. Ch. 2016). SIFMA Br. at 4. In Trulia, the court “severely limited the ability of stockholders” to bring “merger objection” litigation by objecting to disclosure only settlements. Id. [This Blog discussed Truliahere.] To SIFMA, “‘[m]erger objection’ litigation has become a federal court and federal law problem that likely will be exacerbated by the Ninth Circuit’s decision allowing stockholder plaintiffs to bring § 14(e) claims on a showing of mere negligence.”Id.

SIFMA also argued that left unreviewed, the Ninth Circuit’s “decision risks establishing a de facto national standard in § 14(e) cases.” Such a standard, argued SIFMA, would encourage forum shopping, a problem that is exacerbated by the fact that “most public companies transact business and conduct tender offers across all 50 states.” SIFMA Br. at 4.

The risk of “over-disclosure” was also cited as a reason for urging the Court to grant the petition. Id. In particular, SIFMA contended that “merger participants will err on the side of even more voluminous disclosure, making it more difficult for stockholders to make well-informed investment decisions,” “[i]f participants in multi-billion dollar merger transactions can be held liable for damages under § 14(e) for inadvertently failing to include some disclosure item that a court determines in hindsight to be material.…” SIFMA Br. at 5.

Finally, like Petitioners, SIFMA argued that the “the Ninth Circuit’s decision [was] wrong on the merits.” SIFMA Br. at 5.

The Chamber of Commerce of the United States of America (“Chamber”)

The Chamber also filed an amicus brief (here) in which it primarily argued that the Supreme Court should consider whether there is a private right of action to bring a claim under Section 14(e) of the Exchange Act. Chamber Br. at 3 (“Subsumed within that question [i.e., “what state of mind is required to plead and prove a private claim for damages under Section 14(e)”], however, is an even more fundamental issue that the Court should grant certiorari to address: whether a private right of action under Section 14(e) even exists at all.”) (Orig’l emphasis.) Under the Court’s prior “precedents,” said the Chamber, “recognition of a private right under Section 14(e)” should be “foreclose[d].” Chamber Br. at 3.

Takeaway

The issue before the Court – i.e., the state of mind required to plead and prove a violation of Section 14(e) of the Exchange Act – is a limited one. The policy considerations that may have driven the petition – i.e., forum shopping, the increase in “merger objection” litigation in the federal courts, and the over-disclosure of information – while important, are secondary to the required state of mind necessary to withstand a challenge by defendants.

The broader issue, however, alluded to by Petitioners and advanced by the Chamber, is whether there is a private right of action under Section 14(e) at all. Chamber Br. at 3 (orig’l emphasis). As the Chamber notes, this issue is a “threshold” one. Chamber Br. at 16. While it is always difficult to know which way the Court will rule, if the Court takes up the Chamber’s argument and rules that there is no private right of action, plaintiffs will have to find other avenues to challenge tender offers, such as Section 10(b) and Section 14(a) of the Exchange Act – avenues that are already available to them.

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