Supreme Court to Review Standard for Challenging Tender Offers Under the Securities Exchange Act
On January 4, 2019, the United States Supreme Court agreed to review the ruling in Varjabedian v. Emulex Corporation, 888 F.3d 399 (9th Cir. 2018), which held that shareholders are required to plead only negligence by a corporation when alleging that it misled shareholders in a tender offer. This case could settle whether, under the Securities Exchange Act of 1934 (the “Exchange Act”), shareholders are required to allege intentional wrongdoing or only negligence by companies when suing based on statements made by them during a merger and acquisition process.
To acquire Emulex Corporation, Avago Technologies Wireless Manufacturing paid nearly $610 million via an $8 per share tender offer and back-end merger. Emulex hired a prominent financial advisor to determine whether the tender offer price was fair from a financial point of view. The financial advisor rendered its opinion that the offer would be fair from a financial point of view and provided financial analysis to support its conclusion. Based in part on this opinion, Emulex filed a Schedule 14d-9 solicitation/recommendation statement with the SEC recommending that shareholders accept the offer and, if required, approve the second-step merger. After the merger was approved and consummated, Emulex shareholders brought a class action suit in the Central District of California, claiming they were misled by Emulex and Avago in violation of Section 14(e) of the Exchange Act, which prohibits false and misleading statements in connection with tender offers. Plaintiffs asserted that, among other things, Emulex did not summarize in its recommendation a one-page “premium analysis” chart drafted by the financial advisor that showed the 26.4% stock price premium offered was within the normal range of similar merger premiums but was below average.
The district court dismissed the complaint with prejudice. In doing so, the district court concluded that Section 14(e) of the Exchange Act requires a showing of scienter, meaning that defendants “made false or misleading statements either intentionally or with deliberate recklessness,” and that the plaintiffs failed to plead scienter in the complaint.
On appeal, the Ninth Circuit reversed the dismissal of the Section 14(e) claim and revived the class action. In requiring that a plaintiff plead only negligence to state a claim under Section 14(e), the Ninth Circuit took a different position from past rulings from the Second, Third, Fifth, Sixth, and Eleventh Circuits, all of which held that claims under Section 14(e) related to tender offers must allege scienter. The Ninth Circuit justified its departure from these earlier decisions based on its reading of two Supreme Court cases and the differences between SEC Rule 10b-5 and Section 14(e).
This case could have significant ramifications for plaintiffs seeking to challenge M&A transactions. For many years, almost every M&A transaction involving a public company on the sell side attracted shareholder lawsuits. Most of these suits were brought as class actions in the Delaware Court of Chancery, alleging that the target’s board breached its fiduciary duties. Many of these suits settled with the target making some supplemental disclosures before the shareholder vote, with a payment of fees to the plaintiff’s firm. In 2016, however, the Delaware Court of Chancery’s decision in In re Trulia, Inc. Stockholder Litigation, 129 A.3d 885 (Del. Ch. 2016), added heightened scrutiny to disclosure-only settlements of stockholder class action suits arising from the announcement of a merger or acquisition. Following that decision, shareholders have largely stopped filing merger-objection cases in Chancery Court and have opted instead to bring them as proxy claims in federal court under Section 14 of the Exchange Act—under Section 14(a) for transactions requiring a shareholder vote, and under Section 14(e) for tender offers. If the Supreme Court reverses the Ninth Circuit and holds that these claims require scienter, Section 14(e) claims in federal court will be much less appealing to plaintiffs, as scienter is difficult to plead and prove. Reversal of the Ninth Circuit in this case could have a similar effect on federal court cases challenging tender offers as Trulia had on Delaware court cases challenging M&A transactions, and could lead plaintiffs to redirect these suits back to fiduciary duty claims asserted in the state of the target’s headquarters or incorporation (if other than Delaware), or possibly opting not to bring these suits at all.
On the other hand, if the Court affirms the Ninth Circuit and holds that only negligence is required, then the trend begun by Trulia will likely continue. In that scenario, there will likely be an increase in the number of cases challenging tender offers in federal court under Section 14(e), particularly since before Emulex, all of the circuits to consider the issue had held that scienter is required.
The Supreme Court’s ruling could extend beyond just Section 14(e) and encompass a much broader range of merger challenges. Most suits challenging mergers are brought under Section 14(a), applicable to proxy votes, rather than Section 14(e), applicable to tender offers. Most courts have held that Section 14(a) claims require only negligence, but others have required scienter in certain cases. Although Emulex is a case regarding tender offers under Section 14(e), the Supreme Court’s ruling could have implications for Section 14(a) claims as well depending on the Court’s rationale.
Finally, it is possible that the Supreme Court could hold that Section 14(e) provides no private right of action whatsoever. If the Court were to hold that Section 14(e) provides no remedy for investors, they would be left with having to challenge tender offers either under Rule 10b-5 (which requires scienter) or under state law.
The Supreme Court is expected to issue a decision by the time it adjourns in June 2019.
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