At the end of April, following briefing and oral argument, the Supreme Court abruptly reversed course and declined to answer the question Emulex Corporation presented to it regarding whether a negligent misstatement or omission made in connection with a tender offer supports a shareholder’s private right of action under the federal law that governs tender offers, Section 14(e) of the Securities Exchange Act of 1934 (Exchange Act). Embedded in Emulex’s appeal were actually two inquiries: a broad question of whether shareholders have a right to sue over allegedly deficient tender offer disclosures, and a narrow question of whether shareholders have to show fraudulent intent or mere negligence in class actions involving tender offer disclosures. The Court punted on both issues, dismissing the matter with a one-sentence order stating that the appeal was improvidently granted.
The immediate implication of the Supreme Court’s order is that it leaves in place the Ninth Circuit’s ruling that investors need only show that a company acted negligently, rather than intentionally, when alleging that shareholders were misled in a tender offer merger. And at least for now, investors maintain their right to bring these Section 14(e) suits.
Before delving into the long-term implications, some background. Emulex Corp. v. Varjabedian arises from a 2015 merger of two technology companies—Emulex Corporation and Avago Wireless Technology. In February 2015, Emulex and Avago jointly announced that they had agreed to merge by way of an accepted tender offer (a tender offer is a type of takeover bid in which the offeror (in this case, Avago) publicly offers to purchase a specified amount of stock from a target company (Emulex), usually at a price higher than market value). The merger agreement provided that Avago would pay $8.00 for every share of outstanding Emulex stock. This price was 26.4% higher than the value of Emulex stock the day before the merger was announced. In accordance with the agreement, the tender offer was initiated in April 2015. That same day, Emulex filed a Recommendation Statement with the Securities and Exchange Commission (SEC) listing nine reasons for approving the merger, including that shareholders would receive a premium on their stock, and attaching a fairness opinion from Emulex’s financial advisor, Goldman Sachs, that determined the $8.00 offer price was fair.
Questioning the deal’s purported fairness, Gary Varjabedian, an Emulex shareholder, filed a putative class action against Emulex, its board, and Avago in the U.S. District Court for the Central District of California for violating federal securities laws. The case alleged, among other things, that the Recommendation Statement omitted and/or misrepresented material information in violation of Section 14(e) of the Exchange Act because it omitted a premium analysis of similar transactions that revealed the Emulex premium was below average. The omitted information was alleged to be material to Emulex shareholders’ decision whether or not to tender their shares and/or whether to seek appraisal for their shares. The district court dismissed the matter finding that fraudulent intent (i.e., scienter) was required to prove a Section 14(e) violation, which had not been adequately alleged.
The shareholder appealed and the Ninth Circuit reversed the district court, finding 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 distinguished its opinion from the Second, Third, Fifth, Sixth, and Eleventh Circuits that hold fraudulent intent is required to maintain a claim under Section 14(e).
With an established circuit split on whether Section 14(e) requires shareholders to show fraudulent intent or mere negligence, Emulex Corp. v. Varjabedian was well-suited to be taken up by the Supreme Court to resolve the differing interpretations of the pleading standard. Emulex presented that issue, but also inserted a more fundamental one in its appeal to the Supreme Court: do investors even have a private right of action to bring Section 14(e) claims? Shareholders attempted to swiftly do away with that question by highlighting the fact that Emulex conceded in the Ninth Circuit that there was a private right of action, thereby waiving the issue on appeal.
Nonetheless, the private right of action issue intrigued the government and friends of the court who submitted amicus briefs in the matter. In addition to Emulex, the U.S Chamber of Commerce and the SEC argued that modern precedent frowns on courts inferring private rights of action in statutes that do not specify them and the Supreme Court should clarify that shareholders cannot sue over tender offer disclosures. The Solicitor General also argued that Section 14(e) does not create a private right of action, but noted that the proper pleading standard is negligence and not fraud.
The issue also dominated the April 15, 2019 oral argument. However, Justices Ginsburg, Kagan, Breyer, Sotomayor, Alito, and Roberts asked questions indicating concern that the private right of action issue had not been properly presented to the lower courts and therefore was not ripe for the Supreme Court’s consideration. Those questions proved prescient, as one week later the case was dismissed without a substantive opinion. Although the pleading standard in tender offer suits under Section 14(e) was properly before the Court, the Court may not have wanted to decide that narrow issue about negligence versus fraudulent intent without first deciding the broader topic of whether such suits could be brought by shareholders in the first place, which was not properly before the Court.
Emulex is headed back to the district court to consider the negligence standard under Section 14(e), and the company may not have another opportunity to raise its private right of action argument. Indeed, few defendant-companies in merger and acquisition shareholder suits raise the issue as most cases are resolved prior to filing motions to dismiss because companies simply make additional disclosures to resolve the issue. But the Emulex matter may embolden future defendants faced with Section 14(e) claims to litigate motions to dismiss and argue whether investors have a right to even bring the action. Eventually, the issue will wind its way through the district and appellate courts to find its way back to the Supreme Court.
In the meantime, when investors in the Ninth Circuit believe a tender offer merger has gone sideways, they only need to plead negligence to assert their claims under Section 14(e), while investors in most of the other parts of the country will need to allege fraudulent intent. This inconsistency may lead to some forum shopping favoring the West, but it should not have a huge impact on the majority of merger objection lawsuits filed in federal court because most suits (approximately 84% in 2018) allege proxy misrepresentations in violation of Section 14(a) rather than tender offer violations under Section 14(e).