Supreme Court to Resolve Recent Circuit Split Over Whether Section 14(e) of the Exchange Act Requires Proof of Scienter

Kramer Levin Naftalis & Frankel LLP

On Jan. 4, 2019, the Supreme Court granted certiorari in Emulex Corporation, et al., v. Varjabedian, a case teeing up the question of whether scienter is required to state a claim under Section 14(e) of the Securities Exchange Act of 1934, prohibiting misrepresentations and omissions in tender offers.

In the underlying case, plaintiffs, a putative class of former Emulex shareholders, brought claims under Section 14(e) against Emulex and related entities, in the District Court for the Central District of California, alleging that Emulex made a material omission in its Recommendation Statement supporting a purchaser’s tender offer for the company. According to plaintiffs, Emulex should have disclosed a “Premium Analysis” chart that showed the share price being offered by the purchaser was at a premium that fell below that of comparable transactions. Defendants moved to dismiss, arguing that plaintiffs failed to allege that defendants intentionally omitted the chart, and a Section 14(e) claim cannot be based on an allegation of mere negligent conduct.

The district court dismissed the case for failure to adequately allege scienter. The shareholders then appealed to the United States Court of Appeals for the Ninth Circuit. In its decision on appeal, the Ninth Circuit declined to follow five other circuits and instead held that Section 14(e) requires only a showing of negligence. The Ninth Circuit analyzed the first clause of Section 14(e), which 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[.]” The panel argued that the first clause in Section 14(e) is “devoid of any suggestion that scienter is required” and therefore “Section 14(e) requires a showing of only negligence, not scienter.” The Ninth Circuit thus rejected the decisions of other circuits that had held that Section 14(e) should be interpreted as consistent with Rule 10b-5, which does require scienter. 

The issue now before the Supreme Court could have significant ramifications for defendants in merger class actions. Following the Delaware Court of Chancery decision in In re Trulia, Inc. Stockholder Litig., 129 A.3d 884, 891 (Del. Ch. 2016), making Delaware less hospitable to disclosure-only settlements in merger cases, merger suits have tended to migrate to the federal courts. If plaintiffs need only plead negligence – at least in tender offer transactions – such filings would likely accelerate.

The Securities Industry and Financial Markets Association (SIFMA) and the Chamber of Commerce submitted amicus briefs in support of certiorari. The Chamber of Commerce brief urged the question of whether a private right of action under Section 14(e) should exist to start with. The Supreme Court has not specifically spoken to whether a private right of action should be inferred under Section 14(e). Petitioners wrote that the Supreme Court could decide courts have erred when inferring a private right of action under Section 14(e) but that the Supreme Court need not go that far.   

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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