Saturday, January 12, 2019
The Supreme Court just agreed to hear Emulex Corp. v. Varjabedian, which presents something of a puzzle for merger law and policy.
In brief, Emulex agreed to be acquired by Avago in a friendly tender offer under DGCL 251(h). When Emulex issued its Schedule 14D-9 recommending that shareholders tender their shares, it failed to mention that its bankers found the premium was on the low side as compared to similar deals. The plaintiffs sued, alleging that the omission rendered Emulex’s recommendations misleading in violation of Exchange Act Section 14(e), which prohibits false statements in connection with tender offers. In the courts below, the defendants argued, among other things, that the plaintiffs failed to plead that any misleading statements were made with scienter. On appeal, the Ninth Circuit broke with other circuits and held that scienter is not a required element of a Section 14(e) violation.
When the defendants petitioned for certiorari, here’s how they phrased the Question Presented:
Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.
Note the precise wording here – because we’re going to come back to that.
The dispute begins with the language of Section 14(e):
It shall be 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, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation.
The basic difficulty is that the phrase “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” is very similar to that used in Section 11 of the Securities Act, which prohibits misstatements in registration statements, and does not require a showing of scienter. It’s also nearly identical to that used in Rule 14a-9 of the Exchange Act, which prohibits misstatements in proxy materials, and also has generally been interpreted not to require scienter. And it’s pretty much word-for-word the language in Section 17(a)(2) of the Securities Act, which is enforceable only by the SEC and prohibits obtaining money or property by means of untrue statements about securities, and also - you guessed it - does not require a showing of scienter.*
But the phrase “fraudulent, deceptive, or manipulative acts or practices” is very similar to the prohibitions in Section 10(b) of the Exchange Act, which does require a showing of scienter.
14(e) has both! Oh no! Which is it?
Now the interesting thing is, until now, it wasn’t that much of an issue. But then the situation changed.
First, in around 2009 or 2010, you had the great merger litigation explosion; suddenly almost every sizeable merger was being challenged under state law, at least partly (most say) because the collapse of Milberg Weiss left a lot of plaintiffs’ firms hungry for work. Delaware eventually got sick of it and started making it harder to bring state law claims with cases like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and In re Trulia, 129 A.3d 884 (Del. Ch. 2016). Plaintiffs responded by bringing claims under federal law instead. (The stats are documented in The Shifting Tides of Merger Litigation, by Matthew Cain, Jill Fisch, Steven Davidoff Solomon, and Randall Thomas).
Second, in 2013, Delaware enacted 251(h), which created the so-called “intermediate form” merger by making it much easier to structure a friendly acquisition as a tender offer without holding a shareholder vote (a few other states followed suit). Suddenly, the number of deals structured as tender offers spiked.
All of which means that Section 14(e) has been getting more of a workout than it has in the past, leading to new questions about the proper interpretation of the statute.
But here’s where we get back to that Question Presented. It’s really two questions: first, what is the state of mind element under Section 14(e), and second is there a private right of action at all? The implication of the defendants’ petition for cert is, well, no, there isn’t, and the amicus brief filed by the Chamber of Commerce makes that argument explicitly.
So what the defendants are really angling for is a declaration that plaintiffs cannot bring claims under 14(e) at all, with a fallback position of, if they can, they have to show intent. (Well, actually, I think the defendants are after something else - but we’ll get there.) And here’s where the rubber meets the road:
When an acquisition is structured as a merger, it will require a shareholder vote, which means the target corporation must circulate a proxy statement. And it was established way back in 1964 that private plaintiffs can bring actions for false statements in corporate proxy materials under Rule 14a-9. See J.I. Case Co. v. Borak, 377 U.S. 426 (1964). As I mentioned, at this point it’s reasonably well established that 14a-9 does not require a showing of scienter.
Meanwhile, acquisitions structured as friendly tender offers (easy to do now under 251(h)) do not require shareholder votes, and thus do not involve proxy statements; the only federal prohibition on false statements comes from 14(e). (And, well, Section 10(b)).
So if the defendants prevail in Emulex - and depending on how they prevail - it could create very different liability schemes for deals structured as mergers rather than tender offers – a difference that is just now mattering a whole lot because of the changes in Delaware law.
Now, the defendants are correct that these days, the Supreme Court finds implied rights of action far less easily than it used to, and when the Court interpreted 14a-9 in 1964, implied rights of action were at their heyday. But unless we’re going to revisit Borak – and literally a 50-plus year understanding of the liability scheme for proxies – it makes no sense to say that plaintiffs are prohibited from suing for misrepresentations in tender offers under 14(e) while still permitting claims for false proxy statements under 14a-9. There are enough artificial distinctions between mergers and tender offers without adding more incentives for deal planners to game out a kind of regulatory arbitrage; indeed, Delaware recently amended the DGCL to create more, not less, similarity between long form and intermediate form mergers. And reaffirming that 14(e) requires scienter while 14a-9 does not may not be as dramatic a move, but it still creates an unnecessary discontinuity.
In any event, if Emulex prevails, I can totally see all kinds of weird results. Like, there are many states that don’t allow intermediate-form mergers, meaning that if you acquire a majority of shares via tender offer, unless you manage to get all the way to 90% or so, you’ll either have to get some kind of top-up or – if you can’t – you’ll have to hold a shareholder vote anyway to complete the deal. In those states, it may make more sense to simply hold a shareholder vote from the outset and skip the tender offer. But if there’s more liability for proxy materials than tender offer materials, acquirers may be tempted to choose a two-step structure anyway: they’ll make the tender offer, obtain enough shares to swing the merger vote, and hold a vote on the back end. That way, they may be insulated from liability for the initial tender offer materials, and – after Virginia Bankshares, Inc. v. Sandberg (1991) – there’s no cause of action for false statements in proxy materials where the outcome is fait accompli.
Or say you need a shareholder vote on the acquirer side – like, to issue more shares. It’s common to just distribute a joint proxy and have both target and acquirer shareholders vote. But if there’s a greater liability risk for proxy materials than tender offer materials, acquirers could intentionally break up the steps and hold a vote of their own shareholders, and then commence the tender offer.
Obviously, all this would be unwieldy and expensive, and if there isn’t another business justification, the choice to avoid issuing proxy statements might function as a confession of intent to commit fraud, but my broader point is simply this: Whatever the rule is going to be, it shouldn’t turn on whether the deal is structured as a merger or a tender offer.
Now, true, we haven’t seen a rash of gaming under the current regime, which - until the Ninth Circuit’s decision - already had different scienter requirements for 14(e) and 14a-9. That said, it must be recalled that Delaware didn’t start pushing these cases into federal court until 2015-ish; we may not have fully experienced the effects of divergent standards. In that sense, then, what Emulex is really doing is making the distinction more salient.
And what about this issue of private rights of action? Kevin LaCroix doubts the Court will eliminate the private right of action under 14(e) entirely, especially since no circuit court has even hinted at that possibility. But here’s the payoff: the Supreme Court doesn’t have to go all the way to holding that 14(e) provides no right of action to make an impact; all it has to do is say “We reserve for another day the question whether a private right of action exists under 14(e),” and we are off to the races. Expect a bunch of test cases, and a concerted, coordinated build of precedent in the lower courts, now more populated with Republican judges inclined to be skeptical of private claims. And that, I suspect, is really what the defendants, and the Chamber of Commerce, consider endgame.
*yes, yes, the phrase about “mak[ing] any untrue statement[s]” is also similar to the language of Rule 10b-5(b), which requires a showing of scienter, but that interpretation of 10b-5(b) is entirely due to the fact that 10b-5’s authorizing statute, Section 10(b), requires scienter; it’s not a standalone interpretation of the language of the rule.