Strategies for defense attorneys to address Emulex demurral
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Published in May 2, 2019 Daily Journal
Used with permission
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On April 23, one week after oral argument, the United States Supreme Court dismissed as improvidently granted the certiorari petition in Emulex Corp. v. Varjabedian, 18-459. The petition challenged Varjabedian v. Emulex Corp., 888 F.3d 399 (9th Cir. April 20, 2018), which ruled that liability for false or misleading statements in connection with tender offers under Section 14(e) of the Securities Exchange Act of 1934 ("Section 14(e)") does not require proof of scienter, contrary to five other Circuits.
The Court likely dismissed the appeal because a key issue had been belatedly raised without being considered below: whether Section 14(e) allows an implied private right of action (as there is no express action). The certiorari petition argued that the Court could "decide this case-and reverse the decision below-on the assumption that the lower courts have properly inferred a private right of action under Section 14(e) for intentional violations," and that only if the Court believed negligence suffices should it "reexamine whether a private right of action can be inferred at all...." It was not until merits briefing that defendants and amici pressed the latter point in earnest. Plaintiffs responded that the issue was not before the Court because it had not been decided below, and this was the first question raised at oral argument.
The Court's demurral leaves intact the Ninth Circuit Varjabedian ruling and its resulting uncertainty. This article presents approaches securities defense attorneys may take to address this uncertainty-including an approach to reduce the probability of a viable Section 14(e) complaint being filed at all.
First, defense attorneys may raise the private right of action issue the Supreme Court left open. Even the Ninth Circuit may agree: Varjabedian itself held that other provisions governing proxy statements (Exchange Section 14(d)(4) and SEC Rule 14d-9) do not imply a private right of action. The court applied the modern approach to this issue from Cort v. Ash, 422 U.S. 68 (1975), which focuses on the statutory text and had been used to sweep aside the pre-existing implied private action for aiding and abetting securities fraud in Central Bank v. First Interstate Bank, 511 U.S. 164 (1995). The case against an implied right of action is stronger for Section 14(e) than Section 14(d)(4); Varjabedian set aside the Cort factor of whether the would-be cause of action traditionally was delegated to State law, and an issuer's communications to its shareholders underlying a Section 14(e) case traditionally are governed by State fiduciary duty law. That being said, the Supreme Court's questions reveal disagreement on this issue. The main question is whether Congress' enactment of Section 14(e) in 1968 incorporated the then-existing, since replaced jurisprudence on implied rights of action, which looked only at the utility of a private right of action rather than its statutory warrant.
Second, defense attorneys may maintain that scienter is required even if a Section 14(e) action exists. Varjabedian is not the law outside the Ninth Circuit and there are grounds to question it-including grounds not raised in the briefing of that case and thus perhaps available today, even in that court. One such ground is the Ninth Circuit's statement in Varjabedian that Section 14(e) differs from Securities Exchange Section 10(b) (which requires scienter) because it authorizes the SEC "to regulate a broader array of conduct than under Section 10(b)," including by prohibiting acts "not themselves fraudulent under the common law or §10(b)," through SEC rule-making authority that "has no parallel in Section 10(b)." The court's citation to United States v. O'Hagan, 521 U.S. 642, 673 (1997), reveals why that reasoning is wrong. O'Hagan allowed SEC Rule 14e-3(a), which prohibits trading on material nonpublic information even if it is not acquired in breach of a fiduciary or other duty of nondisclosure as required under Section 10(b) or the common law, "in the tender offer context." (That's why, in the movie Wall Street, Gordon Gekko buying Annacott Steel stock after learning of Sir Lawrence Wildman's tender offer thanks to Bud Fox's diligence was illegal; one could imagine Fox having obtained the information without any deception whatsoever, and there being no insider tipping or breach of duty.) This has nothing to do with the disclosures to shareholders challenged in a Section 14(e) private case and the SEC has not adopted any disclosure-to-shareholder regulation under its Section 14(e) authority other than Rule 14e-8, which merely prohibits illusory tender offer announcements.
Third, defense attorneys can move to dismiss for failure to state a claim-even in the Ninth Circuit. Varjabedian did not find that the complaint stated a Section 14(e) claim; it remanded to consider whether a recommendation statement had a "material omission" because it omitted a one-page chart from the company's financial advisers. The actual standard from the very statutory text on which Varjabedian relies is that liability requires an affirmative statement that is either false or rendered misleading by a material omission-any contention that a claim may be based solely on a naked "material omission" is legal fiction-and securities defense attorneys are well versed in challenging the pleading of falsity in Section 10(b) cases. Moreover, even if the required state of mind for liability is negligence rather than scienter, the Private Securities Litigation Reform Act applies and requires (i) particularized facts giving rise to a strong inference that each defendant was negligent in disclosure and (ii) courts to draw inferences against negligence arising from a complaint itself and matters of judicial notice. 15 U.S.C. §78u-4(b)(2), Tellabs Inc. v. Makor Issues & Rights Ltd., 551 U.S. 308 (2007). In other words, Section 14(e) is not a strict liability statute and it cannot suffice for plaintiffs to assert that a disclosure was false or missing.
Fourth-and related-securities litigation defense attorneys can try to reduce the probability of a successful Section 14(e) complaint being filed in the first place by helping our corporate colleagues draft the documents. There is substantial Delaware case law (and to some extent Section 14(e) case law) on the type and amount of information in typical tender offer recommendation statements that satisfy reasonable shareholder disclosure standards and/or provide value. One can even imagine a chart or table of the typical topics in a tender offer communication and the corresponding case law-approved disclosures on each topic. If a tender offer communication follows this chart or table, there can be no cognizable assertion that the defendants responsible for the communication were negligent.