On January 4, 2019, the U.S. Supreme Court granted cert in a case that will determine what a plaintiff must plead in order to state a claim for false statements or omissions in connection with a tender offer under Section 14(e) of the Securities Exchange Act of 1934. The Ninth Circuit held in the case at issue that a plaintiff needs only plead negligence, differing on the issue from at least five different federal circuit courts that had previously held that in order to establish a claim a plaintiff must plead that the defendants acted with scienter. The U.S. Supreme Court’s ruling in the case could have a significant impact on merger objection lawsuits filed in connection with tender offers. The Supreme Court’s January 4, 2019 order in Emulex Corporation v. Varjabedien can be found here.
This case arises out of the merger of two technology companies, Emulex Corporation and Avago Technologies Wireless. On February 25, 2015, the companies jointly announced that they had agreed to merge. Under the terms of the agreement, a subsidiary of Avago offered to pay $8.00 for every outstanding share of Emulex stock. Emulex filed a statement recommending the merger with the SEC.
On April 8, 2018, a plaintiff shareholder filed a lawsuit in the Central District of California against, Emulex, Avago, Avago’s merger sub, and the Emulex board of directors, seeking to enjoin the transaction and damages. In an amended complaint in the action, the plaintiff alleged that in materials associated with Emulex’s recommendation statement misleadingly created the impression that the premium the Emulex shareholders were to receive in the transaction was significant. The defendants filed a motion to dismiss the plaintiff’s complaint.
The District Court’s Ruling
In a January 13, 2016 order (here), Central District of California Judge Cormac J. Carney granted the defendants’ motion to dismiss. Judge Carney held, relying on case law from five different federal appellate courts, that in order to plead a viable claim for misrepresentation in connection with a tender offer under Section 14(e), a plaintiff must plead that the defendants acted with scienter. Judge Carney rejected the plaintiff’s argument that “only negligence” is required.
Judge Carney evaluated the plaintiff’s allegations in light of the scienter requirements, and concluded that the plaintiff’s allegations failed to meet these requirements, and accordingly dismissed the plaintiff’s complaint. The plaintiff appealed.
The Ninth Circuit’s Opinion
In an April 20, 2018 opinion written by Judge Mary Murguia for a unanimous three-judge panel of the Ninth Circuit (here), the Ninth Circuit reversed in relevant part Judge Carney’s ruling with respect to requirements to plead a claim under Section 14(e).
The Ninth Circuit said, among other things, that “because the text of the first clause of Section 14(e) is devoid of any suggestion that scienter is required, we conclude that the first clause of Section 14(e) requires a showing of only negligence, not scienter.” The Ninth Circuit expressly declined to follow the Second, Third, Fifth, Sixth and Eleventh Circuits in holding that allegations that the defendants acted with scienter are required in order to state a claim under Section 14(e).
The other appellate courts had held that scienter was required based on the similarity of the language between Rule 10b-5 and Section 14(e). The Ninth Circuit rejected this analysis saying that the U.S. Supreme Court in the Ernst & Ernst v. Hochfelder case in 1976 had inferred the scienter requirement for Rule 10b-5 actions not based on the language of Rule 10b-5 but based on the meaning and requirements of Section 10(b), on which Rule 10b-5 is based. The Ninth Circuit concluded that the rationale for the U.S. Supreme Court’s rulings regarding the requirements for pleading scienter in actions under Rule 10b-5 did not apply to actions under Section 14(e). The Ninth Circuit said that there are “important distinctions” between Rule 10b-5 and Section 14(e), “distinctions that strongly militate against importing the scienter requirement” from the context of Rule 10b-5 to Section 14(e).
The Cert Petition
The defendants filed a petition for writ of certiorari with the U.S. Supreme Court. In their petition (here), the defendants identified the question presented as whether the Ninth Circuit erred in holding “in disagreement with five other courts of appeals” that Section 14(e) “supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.” In its January 4, 2019 order, the U.S. Supreme Court granted the defendants’ petition.
Given the clear split in the Circuits, it is not a surprise that the U.S. Supreme Court granted the petition. It is hardly an appropriate state of affairs for there to be such a clear disagreement between the circuits on what is required in order for a plaintiff to be able to state a claim for statutory relief.
Indeed, when the Ninth Circuit issued its opinion in the Emulex case, commentators warned that the ruling, easing the standard for pleading a cause of action under Section 14 (e) in connection with a tender officer, would encourage plaintiffs to file these kinds of lawsuits in the Ninth Circuit as obvious result of forum shopping.
Beyond just the forum shopping potential that the Ninth Circuit’s ruling presents, there is a larger consideration that makes the U.S. Supreme Court’s grant of certiorari in this case significant. As readers of this blog well know, one of the most significant securities litigation phenomena in recent years has been the rising tide of federal court merger objection litigation. As I noted earlier in the week, the wave of merger objection lawsuits has been a significant factor in the near record level of federal court securities class action lawsuit filings in recent years, including during 2018. The U.S. Supreme Court’s consideration of the issues involved in this case provides a significant opportunity for the high Court to weigh in on a class of litigation that has become a very important part of the business and corporate litigation landscape.
However, before anyone jumps to the conclusion that in the Emulex case the U.S. Supreme Court could drive a stake into the heart of the federal court merger objection lawsuit curse, due consideration should be given to the relatively limited nature of the question the Court likely will address. That is, the Court will be looking at the requirements applicable to pleading a cause of action under Section 14(e). Section 14(e) applies with respect to alleged misrepresentations or omissions in connection with tender offer transactions.
Although there are a significant number of merger transactions that involve tender offers, many of the transactions that are the subject of merger objection lawsuits do not involve tender offers, and the merger objection lawsuits filed in connection with those transactions do not allege violations of Section 14(e). Most federal court merger objection lawsuits allege violations not of Section 14(e), but rather allege violations of Section 14(a), relating to solicitation of proxies.
To put these generalizations into perspective, let’s take a look at the 2018 federal court merger objection lawsuits. There were 185 federal court merger objection lawsuits filed in 2018. Of those 185, 30 (or about 16%) were filed under Section 14(e). Almost all of the other federal court merger objection lawsuits alleged proxy misrepresentations in violation of Section 14 (a). In other words, the vast majority of federal court merger objection lawsuits do not involve allegations under Section 14(e).
As significant as it is that the Court has taken up a case that will consider the requirements for pleading a cause of action under Section 14(e), it is probable the Court’s decision will not have any impact on cases alleging violations of Section 14(a). In other words, the case is relatively unlikely to have any impact on the majority of federal court merger objection lawsuits.
It is also worth asking what the impact of the Emulex case could be on future actions under Section 14(e). From the defense perspective, the best outcome (on the pleading standard issue) is that the U.S. Supreme Court concludes that plaintiffs must plead that defendants acted with scienter in order to state a claim under Section 14(e). If the court were to reach that conclusion, it would be a good outcome from the defendants’ perspective, but it arguably would not change the state of play all that much, as pleading scienter has been required up to this point in five judicial circuits (and as far as I know, other than the Ninth Circuit in the Emulex case, in the rest of the country as well). So were the court to conclude that pleading scienter is required, it arguably might not change all that much from where we are now. However, if the Court were to conclude that pleading negligence is sufficient to state a Section 14(e), that could increase the likelihood that plaintiffs might pursue these kinds of claims.
There is at least one way that the Court’s ruling in the Emulex case could wind up having a very significant impact more broadly on all litigation under Section 14. In an amicus brief filed on behalf of the U.S. Chamber of Commerce in support of the defendants’ cert petition (here), counsel for the Chamber asserted that this case presents not just the question of the pleading standard under Section 14(e) but presents the “more fundamental issue” of whether a private right of action under Section 14(e) even exists at all.
Chamber’s counsel argued in its amicus brief that the courts of appeals have ignored the U.S. Supreme Court’s precedents on inferring statutory rights of action. The Chamber’s brief, in urging the Court to take up the case, contended that the case could provide the Court a chance to rule that the circuit courts improperly implied a right of action under Section 14(e) and could thereby eliminate a “complex, judicially-created liability scheme.”
In her November 14, 2018 post on her On the Case blog about the Chamber’s amicus brief (here), Alison Frankel quotes Stanford Law Professor Joseph Grundfest as predicting not only that the Court would take up the Emulex case, but that it would conclude that there is no private right to sue under Section 14. Interestingly, in making his comments, Grundfest does not seem to be limiting his prediction just to the private right of action under Section 14(e); rather he seems to be suggesting that the Court will conclude there is no private right of action at all under any part of Section 14. Obviously, if the Court were to go so far, then the Emulex decision would indeed have a very significant impact on federal court merger objection litigation.
There may be grounds to be skeptical of the likelihood that the Court would in fact go so far as to eliminate the private right of action under Section 14 altogether, or even with respect just to Section 14(e). In her article about the Chamber’s amicus brief, Frankel quotes counsel for Emulex as saying, first, that Congress has amended the securities laws numerous times since the courts recognized the private right of action under Section 14(e), and yet did not address the issue. In addition, Emulex’s counsel notes that the issue of whether there is a private right of action under Section 14 arguably was not fully addressed in the courts below, which would seem to eliminate the possibility that the Supreme Court would take up the issue for the first time in the case now. Indeed, the plaintiff in the Emulex case argued in his brief in opposition to the cert petition (here) that Emulex itself conceded in the lower courts that there is a private right of action under Section 14(e).
At least based on the arguments that the Chamber raised in its amicus brief, there is the possibility that the Emulex case could indeed prove to be quite interesting and even meaningful. However, the greater likelihood at this point seems to be that the Court’s ruling in the case will be limited to determining the appropriate standard for pleading a Section 14(e) claim; the case is unlikely to reach further, to affect claims plaintiffs may assert under Sections 14(a).
One further statistical observation about tender offer claims under Section 14(e). In looking at the 30 actions filed in 2018 in federal court alleging violations of Section 14(e), I though the data might show that there was an uptick in the number of Section 14(e) actions after the Ninth Circuit ruled in Emulex, particularly in California federal courts. Interestingly, the data doesn’t show this at all. There were roughly 2 to 3 Section 14(e) actions filed each month in 2018, both before and after the Ninth Circuit’s Emulex opinion. Of the 21 Section 14(e) actions filed after the Ninth Circuit’s opinion in Emulex, only four were filed in California (or other Ninth Circuit) federal courts. At least based on 2018 filings, there is little evidence to suggest that the Emulex decision is resulting in a flood of Section 14(e) filings in the Ninth Circuit.