In Varjabedian v. Emulex Corp., No. 16-55088, 2018 U.S. App. LEXIS 10000 (9th Cir. Apr. 20, 2018), the United States Court of Appeals for the Ninth Circuit split from the Second, Third, Fifth, Sixth and Eleventh Circuits to hold that the liability standard for challenging alleged misstatements or omissions in connection with a tender offer under Section 14(e) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. § 78n(e), is mere negligence, not fraudulent intent or scienter. The district court had granted defendants’ motion to dismiss plaintiff’s Section 14(e) claim for failure to plead facts showing scienter. The Ninth Circuit, however, reversed and remanded to allow the district court to consider the sufficiency of the complaint under a negligence standard. This is the first instance in which a Court has allowed a Section 14(e) claim to proceed without a showing of scienter.

Pursuant to a merger agreement, Avago Technologies Wireless Manufacturing, Inc. (“Avago”) initiated a tender offer for the outstanding stock of Emulex Corp. (“Emulex”), a semiconductor firm. The offered price reflected a 26.4% premium over the stock’s pre-announcement trading price. In support, Emulex filed a Recommendation Statement with the Securities and Exchange Commission(the “SEC”). It contained a summary of Emulex’s financial advisor’s fairness opinion, including a description of various analyses the financial advisor performed in reaching its opinion. Avago’s tender offer succeeded and resulted in Emulex’s acquisition.

Plaintiff, an Emulex shareholder, brought a putative class action against Emulex (and others) challenging, under Section 14(e), Emulex’s failure to include in the Recommendation Statement an analysis by its financial advisor showing the 26.4% premium fell below the average premium for semiconductor industry acquisitions. On defendants’ motion to dismiss, the district court, after noting the Ninth Circuit had yet to decide whether Section 14(e) imposes a scienter standard, followed unanimous out-of-Circuit authority and dismissed the complaint based on plaintiff’s failure to plead facts showing scienter.

On appeal, the Ninth Circuit panel observed that other Circuit courts had read a scienter requirement into Section 14(e) identical to that under SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, because of their “shared text.” That text makes it “unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.” In rejecting a “shared text” approach, the panel noted that Section 14(e) also includes a second clause (“or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer”) that, unlike its first clause, expressly uses scienter-based language and, under rules of statutory construction, must reference conduct different from that proscribed by the first clause.

The Ninth Circuit also held that, since the time the “shared text” approach first appeared, two United States Supreme Court cases had undermined it. One, Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), held that Rule 10b-5 requires a showing of scienter not because it uses language suggestive of intentional wrongdoing but because its authorizing legislation, Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), permits the SEC to regulate only scienter-based conduct. The other, Aaron v. Securities & Exchange Comm’n, 446 U.S. 680 (1980), examined Section 17(a)(2) of the Securities Act of 1933, 15 U.S.C. § 77q(a)(2), a statute with wording “nearly identical to” Section 14(e)’s first clause, and held that the language did not require a scienter showing. The Ninth Circuit stated that “with the benefit of Ernst & Ernst and Aaron, the most compelling argument is that the first clause of Section 14(e) requires a showing of negligence, not scienter.” Although the panel found some support for its decision in Section 14(e)’s legislative history, in the end it stated, “Ultimately, because the text of Section 14(e) is devoid of any suggestion that scienter is required, we conclude that the first clause of Section 14(e) requires a showing of only negligence, not scienter.”

The Ninth Circuit’s reliance on a pure textual analysis to reach its conclusion is somewhat odd given that Section 14(e) creates no express private right of action and its first clause contains no language indicating any liability standard whatsoever — scienter, negligence or even strict liability. Also, even though the panel rejected the other Circuits’ “shared text” approach to allow Rule 10b-5 precedents to supply Rule 14(e)’s liability standard, it still assumed some liability standard applies, and appears to have applied a negligence standard by default. This assumption no doubt owes itself to a long-standing Rule 10b-5 principle rejecting the notion that Rule 10b-5 imposes liability on even non-negligent conduct. In future Section 14(e) cases, courts in the Ninth Circuit may find it necessary to determine and explain the precise extent to which Section 14(e)’s first clause is untethered from established Rule 10b-5 principles — unless and until the Supreme Court decides to resolve the split among the Circuits regarding this important issue of federal securities law.