(Article from Securities Law Alert, April 2018)
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On March 30, 2018, the Ninth Circuit held that the first clause of Rule 14(e), which prohibits material misstatements in connection with tender offers, requires only proof of negligence, rather than scienter.[1] Varjabedian v. Emulex Corp., 2018 WL 1882905 (9th Cir. 2018) (Marguia, J.). Five other circuits to consider this question have relied on similarities between the first clause of Rule 14(e) and Rule 10b-5(b)[2] to hold that a scienter requirement applies to Rule 14(e) claims. The Ninth Circuit departed from these decisions based on its determination that “important distinctions exist between Rule 10b-5 and Section 14(e)” that “strongly militate against importing the scienter requirement from the context of Rule 10b-5 to Section 14(e).”
The prevailing view that the first clause of Section 14(e) requires proof of scienter dates back to the Second Circuit’s decision in Chris-Craft Industries v. Piper Aircraft Corp., 480 F.2d 341 (2d Cir. 1973), in which the court stated that it would “follow the principles developed under Rule 10b-5 regarding the elements of [Section 14(e)] violations.” A year later, the Fifth Circuit agreed with the Second Circuit and held that the first clause of Rule 14(e), like Rule 10b-5, requires proof of scienter. Smallwood v. Pearl Brewing Co., 489 F.2d 579 (5th Cir. 1974). Three other circuits have since reached the same conclusion.[3]
The Ninth Circuit disagreed with Chris-Craft and Smallwood, and the rulings of other circuits following those decisions, for several reasons. First, the Ninth Circuit explained that Rule 10b-5(b)’s scienter requirement is based not on the text of the rule itself but on the language of Section 10(b), pursuant to which Rule 10b-5 was promulgated. The Ninth Circuit noted that in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), the Supreme Court “acknowledged that the wording of Rule 10b-5(b) could reasonably be read as imposing a scienter or a negligence standard.” Varjabedian, 2018 WL 1882905. However, as the Ninth Circuit explained, the Ernst & Ernst Court ultimately concluded that Rule 10b-5(b) “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].’” The Ninth Circuit found “[t]his rationale regarding Rule 10b-5 does not apply to Section 14(e), which is a statute, not an SEC Rule.”
The Ninth Circuit also explained that “Section 14(e) differs fundamentally from Section 10(b)” because the SEC may regulate non-fraudulent conduct under Section 14(e). The Ninth Circuit observed that “[i]f the SEC can prohibit acts themselves not fraudulent under Section 14(e), then it would be somewhat inconsistent to conclude that Section 14(e) itself reaches only fraudulent conduct requiring scienter.”
Second, the Ninth Circuit found it significant that in Aaron v. SEC, 446 U.S. 680 (1980), the Supreme Court held that Section 17(a)(2) of the Securities Act of 1933—which is nearly identical to the first clause of Rule 14(e) —does not require a showing of scienter.[4] The Ninth Circuit noted that the two provisions both “govern disclosures and statements made in connection with an offer of securities, albeit in different contexts: Section 17(a) applies to initial public offerings while Section 14(e) applies to tender offers.” The Ninth Circuit explained that “statutes dealing with similar subjects should be interpreted harmoniously.”
Finally, the Ninth Circuit found that the legislative history of the Williams Act, pursuant to which Section 14(e) was enacted, also “supports a negligence standard.” The court explained that “[t]he legislative history suggests that the Williams Act places more emphasis on the quality of information shareholders receive in a tender offer than on the state of mind harbored by those issuing a tender offer.”
The Ninth Circuit concluded that “because the text of the first clause of Section 14(e) is devoid of any suggestion that scienter is required, … the first clause of Section 14(e) requires a showing of only negligence, not scienter.”
[1] Rule 14(e), titled Untrue statement of material fact or omission of fact with respect to tender offer, provides:
It shall be unlawful for any person to make any untrue statement of a material fact or omit to state a 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.
15 U.S.C. §78n(e). Rule 14(e) was added as an amendment to the Securities Exchange Act of 1934 pursuant to the Williams Act.
[2] Rule 10b-5(b), titled Employment of manipulative and deceptive devices, provides in relevant part:
It shall be unlawful for any person, directly or indirectly … [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading … in connection with the purchase or sale of any security.
[3] See In re Digital Island Sec. Litig., 357 F.3d 322 (3d Cir. 2004); SEC v. Ginsburg, 362 F.3d 1292 (11th Cir. 2004); Adams v. Standard Knitting Mills, 623 F.2d 422 (6th Cir. 1980).
[4] Section 17(a)(2) provides in relevant part:
It shall be unlawful for any person in the offer or sale of any securities … to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
15 U.S.C. § 77q(a)(2).