Is Negligence in a Tender Offer Enough for a Securities Act Violation?

The troublesome issue of scienter, as a necessary ingredient of various securities acts violations, remains in flux. In a decision that roiled the securities industry and those specializing in mergers and acquisitions, the Ninth Circuit held in Varjabedian v. Emulex that to prove a violation of Section 14(e) of the Securities Exchange Act of 1934, which governs tender offers, a plaintiff need only show negligence, not scienter. The Supreme court granted certiorari, but after oral argument in April dismissed the writ as improvidently granted.

The underlying facts are simple enough. A predecessor in whose shoes Emulex stood, made a tender offer for the stock of Emulex. Goldman Sachs, engaged by Emulex, opined that it was fair. Emulex, after summarizing this opinion, recommended that stockholders accept the tender offer. But Emulex did not include or refer to one specific page in the Goldman Sachs report—a chart comparing the merger premium of 26.4% over the Emulex share price on the day of the offer with the prevailing range of selected semiconductor quotations, within which the Emulex tender fell, but well below the 50.85% average. In their complaint plaintiffs alleged that defendants were negligent in failing to include this premium analysis, in violation 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….not misleading or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer….” The district court dismissed, holding that “the similarities between Rule 10b-5 (promulgated under the Securities Act of 1933) and Sec. 14(e) require a plaintiff bringing a cause of action under Sec. 14(e) to allege scienter or a strong inference of scienter,” as five Circuits had ruled. Rule 10b-5, in language almost identical to a portion of 14(e), prohibits “the use of manipulative and deceptive practices in connection with the purchase or sale of any security,” for the violation of which the Supreme Court has held a plaintiff must plead and prove scienter, i.e. a knowing or reckless violation of the statute.