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From Securities Regulation Daily, April 20, 2018

Appellate panel holds that negligence, not scienter, embodies Exchange Act Section 14(e)

By Jay Fishman, J.D.

The United States Court of Appeals for the Ninth Circuit departed from five other circuits by declaring that Exchange Act Section 14(e), which prohibits fraud in tender offers, requires proof of negligence, not scienter. The appellate court remanded the case to California’s Central District Court to apply a negligence standard rather than a scienter standard to the tender offer claim. Similarly, the appellate court mandated the district court to review the plaintiff shareholders’ Exchange Act Section 20(a) claim. The appellate court, however, affirmed the lower court’s dismissal of the plaintiffs’ Section 14(d)(4) claim and affirmed the elimination of one of the defendants from the case (Varjabedian v. Emulex Corp., April 20, 2018, Murguia, M.).

Tender offer. The case involved a 2015 tender offer that was made part of a merger. While the defendant corporation hired Goldman Sachs to determine the tender offer’s potential value for shareholders, and Goldman Sachs did, in fact, provide the shareholders with a detailed recommendation statement, the statement failed to summarize a "premium analysis" which would have shown that the 26.4 percent premium offered to the shareholders was below average compared to similar mergers.

Lawsuit. The shareholders brought a class action against the two merging corporations and related defendants under Exchange Act Sections 14(e), 14(d)(4) and 20(a). The shareholders argued that Section 14(e) required them to prove that the defendants were negligent in not including the premium analysis—not that the defendants intentionally excluded the premium analysis to mislead them. As the Ninth Circuit had never ruled on the appropriate standard to apply in a Section 14(e) tender offer fraud case, the district court had no Ninth Circuit precedent to follow, and so abided by Second, Third, Fifth, Sixth and Eleventh Circuit holdings requiring proof of scienter.

Section 14(e) requires a negligence standard of proof. The appellate court acknowledged the Second and Fifth Circuit as the first two circuits to require proof of scienter for Section 14(e) claims, and how the Third, Sixth, and Eleventh Circuits had later based their respective decisions on the Second and Fifth Circuits’ rationale. But in analyzing that rationale, the Ninth Circuit court discovered that the other circuits may have mistakenly applied the typical scienter standard used for Exchange Act Rule 10b-5 claims to Section 14(e) claims.

The court specifically remarked upon two cases the U.S. Supreme Court decided in the intervening years between the Second and Fifth Circuit decisions and the later Third, Sixth and Eleventh Circuit decisions. The Supreme Court in those two cases, read the Rule 10b-5 language, and by extension the Section 14(e) language (particularly 14(e)’s first clause), to reasonably impose either a scienter or a negligence standard on the fraud they address. The appellate court, therefore, determined that since the Ninth Circuit was deciding this issue for the first time and that the two U.S. Supreme Court cases—Ernst & Ernst v. Hochfelder from 1976 and Aaron v. SEC from 1980—had cast doubt on the other circuits’ Section 14(e) decisions, the panel reversed the district court’s decision and held that Section 14(e) required proof of a negligence standard for the lower court to consider on remand.

Similarly, the court held that the shareholders’ Section 20(a) claim survived on remand since a Section 20(a) claim depends on a Section 14(e) claim, which also survived.

Section 14(d)(4) does not confer private right of action. But the appellate court affirmed the district court’s Section 14(d)(4)’s dismissal by reiterating from the 1975 United States Supreme Court case Cort v. Ashthat Section 14(d)(4) focuses on the person regulated, i.e., the company that issues a solicitation or recommendation to accept or reject a tender offer, and not on individual shareholders. Therefore, said the court, Section 14(d)(4) and statutes like it do not implicitly confer private rights on any particular class of persons.

Post-merger nonexistent defendant dismissed. The court also agreed with the lower court’s dismissal of a corporate defendant from the case because it ceased to exist after the merger occurred.

The case is No. 16-55088.

Attorneys: David E. Bower (Bower Law Group PC) for Gary Varjabedian. Travis Biffar (Jones Day) for Emulex Corp. Patrick Edward Gibbs (Cooley LLP) for Avago Technologies Wireless [USA] Manufacturing, Inc. and Emerald Merger Sub, Inc.

Companies: Emulex Corp.; Avago Technologies Wireless [USA] Manufacturing, Inc.; Emerald Merger Sub, Inc.

MainStory: TopStory FraudManipulation MergersAcquisitions AlaskaNews ArizonaNews CaliforniaNews HawaiiNews IdahoNews MontanaNews NevadaNews OregonNews WashingtonNews

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