“Emulex Will Likely Dictate Venue For Merger Shareholder Suits,” Law360, February 20, 2019.

Extracted from Law360

On Jan. 4, 2019, the U.S. Supreme Court granted certiorari and agreed to hear a challenge by Emulex Corp. to a 2018 U.S. Court of Appeals for the Ninth Circuit ruling on the pleading standard for a claim alleging a misleading tender offer document brought under Section 14(e) of the Securities Exchange Act of 1934.[1] The Supreme Court’s decision could have a significant impact on the viability of merger-related shareholder suits in federal court.

District Court Proceedings

In February 2015, Emulex announced that it had entered into a merger agreement with Avago Technologies Ltd., another technology company, in which Avago offered to pay $8 per share of outstanding Emulex stock. Emulex retained an investment bank to advise on the transaction, and the banker determined that the proposal was fair to shareholders. Emulex then filed a statement with the Securities and Exchange Commission recommending that shareholders tender their shares for the price offered. The tender offer expired several months later, the requisite number of shares were tendered, and Avago and Emulex merged.

One day after the recommendation statement was published, a shareholder plaintiff filed suit in federal court, alleging that Emulex and the individual defendants had violated, among other things, Section 14(e) of the Securities Exchange Act of 1934, which generally prohibits untrue statements and fraudulent, deceptive and manipulative acts in connection with a tender offer. The plaintiff alleged that the defendants violated Section 14(e) by failing to disclose certain information about the investment bank’s fairness opinion.

The defendants moved to dismiss on the basis that Section 14(e) claims require a showing of scienter, or intent to defraud, which the plaintiff had failed to adequately plead. The plaintiff contended, on the other hand, that a Section 14(e) claim requires only a showing of negligence. After thorough analysis of the statutory language and citation to prior decisions from several courts of appeals, the district court held that scienter was a required element of the plaintiff’s Section 14(e) claim and granted the defendants’ motion to dismiss on the grounds that scienter had not been adequately pled.[2]

The Ninth Circuit Reverses

The plaintiff appealed the district court’s dismissal to the Ninth Circuit. In April 2018, the Ninth Circuit issued its decision in which it largely reversed the dismissal and held that mere negligence is all that is required for a Section 14(e) claim.[3]

The Ninth Circuit recognized that its ruling conflicted with those of five other courts of appeals, which, in a series of decisions dating back to 1973, had held that scienter was a required element of a Section 14(e) claim. Two of those decisions, from the U.S. Court of Appeals for the Second and Fifth Circuits, simply looked to Rule 10b-5 and held that because Rule 10b-5 required a showing of scienter, Section 14(e) did as well.

The Ninth Circuit noted that two subsequent Supreme Court decisions, Ernst & Ernst v. Hochfelder[4] and Aaron v. SEC,[5] cast doubt on the rationale of the Second and Fifth Circuits’ prior rulings. And, although three other courts of appeals following the Supreme Court’s rulings similarly held that Section 14(e) claims require a showing of scienter, the Ninth Circuit disagreed with those rulings on the basis that, like those before them, they improperly likened Section 14(e) with Rule 10b-5 claims. Accordingly, the Ninth Circuit stated that it was “persuaded that the rationale underpinning those decisions does not apply to Section 14(e) of the Exchange Act,” noting “important distinctions” between Section 14(e) and Rule 10b-5 that “strongly militate[d] against importing the scienter requirement from the context of Rule 10b-5 to Section 14(e).”

Finally, the Ninth Circuit relied heavily on the fact that the first clause of Section 14(e), the proscription against making an untrue statement of material fact or making a material omission, does not contain a scienter requirement. The Ninth Circuit reversed the lower court’s dismissal of the Section 14(e) claim and remanded to the district court with instruction to reconsider the motion to dismiss under a negligence standard.

Certiorari Petition and Amicus Briefing

Emulex filed its petition for a writ of certiorari in October 2018. Emulex initially stressed the “acknowledged circuit conflict concerning an undeniably important question.” It noted that the Supreme Court has often granted certiorari to resolve circuit conflicts concerning the federal securities laws and cautioned that the Ninth Circuit’s decision — which Emulex argued is incorrect — could have adverse consequences on the number of Section 14(e) filings both in federal court generally and in the Ninth Circuit in particular, where a disproportionately large number of cases are already filed.

Two parties filed amicus briefs urging the court to grant certiorari — the Securities Industry and Financial Markets Association, or SIFMA, and the U.S. Chamber of Commerce. The Chamber of Commerce stressed that private securities class action litigation, including litigation under Section 14(e), imposes a significant burden on its members and adversely affects their access to capital markets, including the market for mergers and acquisitions. By holding that private claims under Section 14(e) may be pleaded and proven by meeting only a negligence standard instead of a scienter standard, the Ninth Circuit’s decision threatens to increase the litigation burdens faced by the Chamber’s members. Similarly, SIFMA argued that the Ninth Circuit’s decision would result in an increase in frivolous merger challenge lawsuits that are designed only to extract a settlement.

Following briefing, the Supreme Court granted the petition, likely to resolve the circuit split created between the Ninth Circuit on the one hand and the Second, Third, Fifth, Sixth and Eleventh Circuits on the other.

Impact on M&A Litigation

The Supreme Court’s ruling could have a profound impact on M&A litigation because it could resolve the current split of authority and determine definitively whether Section 14(e) claims require intent to defraud. Assuming that the Supreme Court sides conclusively with one of the two competing views, its ruling is likely to either increase the number of Section 14(e) lawsuits or serve as a warning to plaintiffs that reflexive, strike-suit Section 14(e) claims will be dismissed unless there is intent to defraud.

The case is also important from a jurisdictional perspective. The plaintiffs-side securities class action bar routinely files lawsuits challenging the vast majority of U.S. public company merger transactions. These suits frequently focus on the financial advice provided to the seller’s board of directors — stockholders allege that the financial advisors’ analyses were flawed and accompanied by inadequate or incomplete disclosures. Until recently, stockholders filed most merger objection class actions in state court under theories based on state law, including disclosure obligations. Since early 2016, however, in response to developments in state law that made these suits harder to pursue in state court, plaintiffs-side lawyers have changed strategies and now are filing merger objection cases in federal court invoking Section 14(e) rather than state disclosure law. The Supreme Court’s review of the Ninth Circuit’s decision could push the plaintiffs bar back toward state court. Regardless of the outcome, it is likely to have an enormous impact on the mergers and acquisitions industry.