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From Securities Regulation Daily, February 21, 2019

Emulex brief argues for reversal of Ninth Circuit's ruling on Section 14(e) standard

By Rodney F. Tonkovic, J.D.

A petitioner brief submitted to the Supreme Court says that the Ninth Circuit got it wrong in concluding that Section 14(e) requires a showing of negligence, rather than scienter.

Emulex Corporation's petitioner brief before the Supreme Court argues that the Ninth Circuit wrongly expanded the inferred private remedy under Section 14(e) to reach conduct taken without scienter. According to Emulex, the Ninth Circuit expressly split from five other circuits by declaring that Section 14(e), which prohibits fraud in tender offers, supplies an inferred private cause of action based on mere negligence, not scienter. This stance is incorrect, the brief argues, because even if one accepts the existence of an inferred private right of action under Section 14(e), there is no basis for expanding that cause of action to reach negligent conduct (Emulex Corporation v. Varjabedian, February 19, 2019).

Only negligence? The case arose from the 2015 merger of Emulex with another technology company. The respondent shareholders alleged that a recommendation statement that Emulex filed with the SEC left out a "premium analysis" and thus created a materially misleading impression in violation of Section 14(e). The district court dismissed the complaint with prejudice, holding that Section 14(e) requires showing a strong inference of scienter and rejecting the shareholder's argument that only proof that the defendants were negligent was required. The Ninth Circuit reversed and required the district court to reconsider under a negligence standard.

Emulex then filed a petition for certiorari asking whether the Ninth Circuit correctly held that Section 14(e) supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer. The Second, Third, Fifth, Sixth, and Eleventh Circuits all require proof of scienter. The court granted certiorari on January 4, 2019, and the case is set for oral argument on Monday, April 15, 2019.

Petitioner brief. Emulex's brief argues that the Ninth Circuit's error demands reversal. First, private rights of action must be created by Congress, and, in recent years, the Court has consistently refused to create new inferred private rights of action or to extend the scope of private rights that had been previously inferred. Even if there is an inferred private right of action under Section 14(e), the brief argues further, that inferred remedy should not be extended to mere negligence.

In its brief, Emulex notes that Section 14(e) was modeled in Rule 10b-5, which requires a showing of scienter. The brief points out that Congress wrote robust procedural protections when it authorized private negligence actions under the securities laws, and Section 14(e), which says nothing about negligence in the first place, has none of these protections against abuse. The language of Section 14(e) (e.g., "fraudulent," "deceptive," and "manipulative") is "unmistakably linked with intentional conduct," the brief contends, in contrast to concepts linked with a negligence regime, such as "reasonable care." The brief argues that the Ninth Circuit erred in looking at clauses of Section 14(e) in isolation instead of as a whole.

Moreover, allowing recovery based on negligence under Section 14(e) would circumvent Section 18's express cause of action authorizing suit against makers of false statements in SEC filings. The brief observes that the respondents could have sued under Section 18, but opted instead to sue under the inferred cause of action that the Ninth Circuit had derived from Section 14(e). Emulex notes that Section 18 claims are subject to procedural protections not found in Section 14(e) and, importantly, that Section 18 expressly forecloses liability based on negligence.

Emulex also takes issue with the Ninth Circuit's reliance on the Court's decision in Aaron v. SEC (1980) in finding an inferred private right. Aaron, the brief explains, concluded that scienter was not required under all subparagraphs of Securities Act Section 17(a). Emulex asserts that the language and historical context of Section 17(a) and Section 14(e) differ in ways that suggest that scienter is required under Section 14(e). The brief also suggests that Aaron is inapposite because Section 14(e) was modeled on Rule 10b-5, not Section 17(a).

Finally, the brief maintains that even if Section 14(e) proscribed negligent conduct, it would not be privately enforceable. First, if Aaron's treatment of Section 17(a) is used as a model, most appellate courts have held that there is no inferred right of action under Section 17(a) at all. In addition, Section 14(e) does not meet the requirements the Court has looked to in deciding whether Congress intended to create a private right of action. First, the Court looks for "rights creating" language, but Section 14(e) is a general prohibition and lacks language focusing on a particular class. And, Section 14(e) explicitly gives the SEC and enforcement role and nowhere alludes to a private remedy.

The petition is No. 18-459.

Attorneys: Gregory George Garre (Latham & Watkins) for Emulex Corp. Daniel L. Geyser (Geyser PC) for Gary Varjabedian and Jerry Mutza.

Companies: Emulex Corp.

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