April 26, 2018

Tender Offers: 9th Cir. Says Negligence Enough for 14(e) Claims

This O’Melveny memo addresses the 9th Circuit’s recent decision in Varjabedian v. Emulex – in which the Court held that liability under Section 14(e) of the Exchange Act may be based upon negligence.  Section 14(e) is the Williams Act’s general anti-fraud provision, and prohibits misstatements or omissions in connection with tender offers.  As this excerpt notes, the 9th Circuit’s decision creates a split among the circuits on this issue:

The Ninth Circuit acknowledged that five other circuits (the Second, Third, Fifth, Sixth, and Eleventh) had held that § 14(e) requires that plaintiffs plead scienter, but was “persuaded that the rationale underpinning those decisions” should not actually apply to the first clause of §14(e). According to the Ninth Circuit, those other circuits ignored or misread Supreme Court precedent in relying on the “similarities between Rule 10b-5 and § 14(e)” to import Rule 10b-5’s scienter requirement to § 14(e) claims.

That is because the Supreme Court in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976), made clear that adding “scienter [a]s an element of Rule 10b-5(b) had nothing to do with the text of Rule 10b-5.”    To the contrary, the Court in Hochfelder “acknowledged that the wording of Rule 10b-5(b) could reasonably be read as imposing a scienter or a negligence standard.”  Id. (emphasis in original).

It nonetheless found that “Rule 10b-5 requires a showing of scienter because it is a regulation promulgated under Section 10(b) of the Exchange Act, which allows the SEC to regulate only ‘manipulative or deceptive device[s],’” which necessarily entails scienter.  Id. at 13 (emphasis in original).  In other words, Rule 10b-5 requires a showing of scienter because of the authorizing statute, not based on the Rule’s language.  According to the Ninth Circuit, “[t]his rationale regarding Rule 10b-5 does not apply to Section 14(e), which is a statute, not an SEC rule.”

The memo points out that the circuit split created by the decision increases the likelihood that the Supreme Court will take up the issue of whether scienter is required under Section 14(e).  Meanwhile, the decision is likely to provide incentives for plaintiffs in nationwide class actions to file their cases in the 9th Circuit.

John Jenkins