Featured Expert Contributor, Corporate Governance/Securities Law
Stephen M. Bainbridge, William D. Warren Distinguished Professor of Law, UCLA School of Law.
In the wake of the Delaware Chancery Court’s pathbreaking decision in the Trulia case,1 which sharply increased the scrutiny given settlements of cases challenging mergers and other takeovers, there has been a dramatic shift of M&A litigation to federal courts.2 How receptive federal courts will be to this flood of new claims will be determined in part by Emulex Corporation, et al., v. Varjabedian, which is currently pending before the U.S. Supreme Court. Emulex turns on whether scienter is an element of the private-party cause of action under § 14(e) of the Securities Exchange Act of 1934. Section 14(e) prohibits fraud in connection with tender offers and thus will be a key provision in assessing the survivability of these new M&A lawsuits.3
Emulex was the target of a tender offer by what was then Avago Technologies Ltd. (subsequently merged into and becoming BroadCom Corporation). Emulex issued a favorable Recommendation Statement,4 which plaintiffs—purporting to represent a class of Emulex shareholders—claimed omitted an analysis of comparable transactions that would have shown the premium offered by Avago was below the premia offered in those comparable deals.
Defendants moved to dismiss on grounds that plaintiffs had failed to show that defendants had intentionally omitted the analysis. The District Court agreed, dismissing the case for failure to state a claim,5 but the Ninth Circuit reversed.6 The circuit court acknowledged that five other circuits had held that scienter7 is required to state a claim under § 14(e), but the court disagreed with those decisions, holding that a showing of negligence suffices.8
Nothing in the Exchange Act explicitly creates a private right of action against alleged violators of § 14(e), but the existence of an implied private right of action thereunder has long been accepted.9 The courts have thus been faced with the oft-contentious task of dividing what elements Congress would have wanted included in a remedy Congress never contemplated.
In this context, analysis must begin with the Supreme Court’s holding that Congress modeled the wording of § 14(e) “on the antifraud provisions of § 10(b) of the Act and Rule 10b–5.”10 As a result, the two provisions are generally construed in pari materia by courts.”11 Accordingly, it is not surprising that courts long have held that the same elements must be proven to sustain a Rule 14e-3 private cause of action as must be proven in a Rule 10b-5 case.12
Apropos of which, the Court has held that scienter is a necessary element of the implied private right of action under Exchange Act § 10(b) and, accordingly, Rule 10b-5 thereunder. In Ernst & Ernst v. Hochfelder,13 the Court opined that the “words ‘manipulative or deceptive’ used in conjunction with ‘device or contrivance’ [in the statute] strongly suggest that § 10(b) was intended to proscribe knowing or intentional misconduct.”14
Use of the word ‘manipulative’ is especially significant. It is and was virtually a term of art when used in connection with securities markets. It connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.15
The Court later held that scienter was also required in civil actions brought by the SEC.16
Section 14(e) similarly uses the words “fraudulent, deceptive, or manipulative acts or practices,” which has been deemed sufficiently similar to justify requiring scienter in private party cases arising under Rule 14e-3.17 To be sure, the language is not an exact match, but the Supreme Court has noted that:
For the purpose of interpreting the term ‘manipulative,’ the most significant changes from the language of § 10(b) were the addition of the term ‘fraudulent,’ and the reference to ‘acts’ rather than ‘devices.’ Neither change bears in any obvious way on the meaning to be given to ‘manipulative.’ 18
In response, the Ninth Circuit made essentially two arguments. First, the Ninth Circuit relied on the Supreme Court’s decision in United States v. O’Hagan,19 which held “under § 14(e), the [SEC] may prohibit acts not themselves fraudulent under the common law or § 10(b), if the prohibition is ‘reasonably designed to prevent … acts and practices [that] are fraudulent.’”20 The difficulty with that argument is that O’Hagan simply upheld the SEC’s authority to adopt Rule 14e-3. The SEC has never defined the state of mind necessary to support a private cause of action under the rule. Even if the SEC attempted to, moreover, it would have to show that such a prophylactic measure “reasonably designed to prevent … acts and practices [that] are fraudulent,” which means they must be reasonably designed to prevent conduct motivated by an intent to deceive.
Second, and much more plausibly, the Ninth Circuit embraced an argument made by the plaintiffs 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  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  to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer.21
Only the second clause contains the pertinent language from § 10(b). To the contrary, as the plaintiffs successfully argued to the Ninth Circuit, the first clause is modeled on the language of Exchange Act § 17(a)(2), which the Supreme Court had held does not require scienter.22
This is a novel and interesting argument. The District Court rejected it on grounds that “no federal court has held that § 14(e) requires only a showing of negligence.”23 Accordingly, relying on “the wealth of persuasive case law to the contrary,” the court concluded “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.”24
My research turned up one case, Pryor v. U.S. Steel Corp.,25 a Southern District of New York decision from 1984, which discussed the issue at length in a footnote. The court’s analysis is quite sympathetic to the argument subsequently made in Emulex, but the SDNY declined to adopt it in light of the “clear Second Circuit authority” generally holding §§ 14(e) and 10(b) to have the same elements.26
Resolving that argument will require the Supreme Court to dip toes into some of the most incoherent bodies of law in securities regulation, ranging from the validity of implied private rights of action to the methods used to interpret the elements of such rights of action. The Court may find things a little easier if they look back to Justice Kennedy’s majority opinion in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.27 What makes Stoneridge instructive for our purposes is not the specific legal issues or the holding, but rather explicit reliance on policy considerations and the content of those considerations:
The practical consequences of an expansion [of Rule 10b-5 liability] … provide a further reason to reject petitioner’s approach. In Blue Chip, the Court noted that extensive discovery and the potential for uncertainty and disruption in a lawsuit allow plaintiffs with weak claims to extort settlements from innocent companies. Adoption of petitioner’s approach would expose a new class of defendants to these risks. As noted in Central Bank, contracting parties might find it necessary to protect against these threats, raising the costs of doing business. Overseas firms with no other exposure to our securities laws could be deterred from doing business here. This, in turn, may raise the cost of being a publicly traded company under our law and shift securities offerings away from domestic capital markets. 28
Given the surge in federal cases following Trulia, these policy concerns seem pertinent once again.
- In re Trulia, Inc. Stockholder Litig., 129 A.3d 884 (Del. Ch. 2016).
- See generally Ryan Lewis, What Happens in Delaware Need Not Stay in Delaware: How Trulia Can Strengthen Private Enforcement of the Federal Securities Laws, 2017 B.Y.U. L. Rev. 715, 740 (2017) (discussing the impact of Trulia on state versus federal filings).
- The statute provides:
It shall be 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, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation. The Commission shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative.
15 U.S. Code § 78n(e).
- Emulex filed a Schedule 14d-9 as per Rule 14d-9. 17 CFR § 240.14d-9.
- Varjabedian v. Emulex Corp., 152 F. Supp. 3d 1226 (C.D. Cal. 2016), aff’d in part, rev’d in part and remanded, 888 F.3d 399 (9th Cir. 2018), cert. granted, 2019 WL 98542 (U.S. Jan. 4, 2019).
- Varjabedian v. Emulex Corp., 888 F.3d 399, 406 (9th Cir. 2018), cert. granted, 2019 WL 98542 (U.S. Jan. 4, 2019).
- The Supreme Court has defined scienter in the securities law context as “mental state embracing intent to deceive, manipulate, or defraud.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). The Supreme Court has reserved the question of “whether, under some circumstances, scienter may also include reckless behavior.” Aaron v. Securities and Exch. Commn., 446 U.S. 680, 686 n.5 (1980). Every circuit court to have considered the question has determined that recklessness can satisfy the scienter requirement, although the circuits have disagreed as to degree of recklessness necessary. See Rubinstein v. Gonzalez, 241 F. Supp. 3d 841, 855 (N.D. Ill. 2017) (discussing status of scienter requirement under Exchange Act § 10(b)).
- Varjabedian, 888 F.3d at 407. The Ninth Circuit agreed with the District Court that there is no implied private right of action under Rule 14d-9 and therefore dismissed plaintiffs’ claims purporting to sound thereunder. Id. at 409. That ruling is not before the Supreme Court.
- See, e.g., Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 55 (1977) (Stevens, J., dissenting) (“No one seriously questions the premise that Congress implicitly created a private right of action when it enacted § 14(e) in 1968.”); Liberty Nat. Ins. Holding Co. v. Charter Co., CV82-H-233-S, 1982 WL 1304, at *5 (N.D. Ala. Apr. 27, 1982), aff’d, 734 F.2d 545 (11th Cir. 1984) (noting “the now well established principle that a private right of action does exist under Section 14(e)”).
- Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 10, (1985).
- Am. Carriers, Inc. v. Baytree Inv’rs, Inc., 685 F. Supp. 800, 808 (D. Kan. 1988) (“Since section 14(e) and rule 10b–5 are coextensive in their anti-fraud prohibitions, they are construed in pari materia by courts.”).
- See, e.g., Smallwood v. Pearl Brewing Co., 489 F.2d 579, 605 (5th Cir. 1974) (holding that “the same elements must be proved to establish a violation of either [statute]”); Chris–Craft Indus. Inc., v. Piper Aircraft Corp., 480 F.2d 341, 362 (2d Cir. 1973) (holding that “we shall follow the principles developed under Rule 10b-5 regarding the elements of [Section 14(e)] violations”).
- 425 U.S. 185 (1976).
- Id. at 198.
- Id. at 199.
- Aaron v. Securities and Exch. Commn., 446 U.S. 680 (1980).
- See, e.g., Securities and Exch. Commn. v. Texas Intern. Co., 498 F. Supp. 1231, 1252 (N.D. Ill. 1980).
- Schreiber, 472 U.S. at 10 n.10.
- 521 U.S. 642 (1997).
- Id. at 673.
- Varjabedian v. Emulex Corp., 888 F.3d 399, 404 (9th Cir. 2018), cert. granted, 18-459, 2019 WL 98542 (U.S. Jan. 4, 2019).
- See Aaron v. SEC, 446 U.S. 680, 701 (1980) (discussing § 17(a)(2)).
- Varjabedian v. Emulex Corp., 152 F. Supp. 3d 1226, 1233 (C.D. Cal. 2016) (emphasis in original), aff’d in part, rev’d in part and remanded, 888 F.3d 399 (9th Cir. 2018).
- Pryor v. U.S. Steel Corp., 591 F. Supp. 942 (S.D.N.Y. 1984), aff’d in part, rev’d in part, 794 F.2d 52 (2d Cir. 1986).
- Id. at 19.
- 552 U.S. 148 (2008).
- Id. at 163-64 (citations omitted).