On The Case

Justices seem split on whether to consider private right to sue over tender offers

(Reuters) - At oral arguments Monday at the U.S. Supreme Court in Emulex v. Varjabedian, the big question was whether the justices will use the case to decide if private investors have a right to sue over allegedly misleading tender offer disclosures. Will the court consider the big issue? Or will the justices hew to the much narrower question of the proper pleading standard for shareholder claims?

If you’ve been following along since Emulex filed its petition for Supreme Court review last fall, you know that both questions are up for grabs. Technically, Emulex’s petition presented the question of whether the 9th U.S. Circuit Court of Appeals erroneously applied a negligence standard, rather than requiring evidence of fraudulent intent, when it revived a class action alleging that Emulex misled shareholders in tender offer disclosures about its 2015 acquisition by Avago Technologies. (Emulex, a network connectivity business, denies the allegations.)

Want more On the Case? Listen to the On the Case podcast.

But Emulex Supreme Court counsel Greg Garre of Latham & Watkins hinted in the company’s petition for certiorari that the real issue was statutory: Congress, he said, never specified that shareholders can sue over tender offer disclosures.

Garre’s argument that courts have wrongly inferred a private right of action picked up momentum when the U.S. Chamber of Commerce filed an amicus brief urging the Supreme Court to grant review of the Emulex case to shut down class actions with no statutory grounding. And after the Supreme Court granted review, the Justice Department and the Securities and Exchange Commission threw their considerable weight behind Emulex’s macro-argument that shareholders can’t sue over tender offer disclosures. In an amicus brief, the government said the Supreme Court should clarify that there’s no private right of action in the statute governing tender offers. (DOJ's brief also said that when the SEC brings enforcement actions claiming inadequate disclosures, it should only be required to plead negligence. But that's another story.)

There was a major snag in Emulex's theory, though. As shareholders’ counsel Daniel Geyser argued in his side’s merits brief, Emulex did not challenge shareholders’ right to sue when the case was at the 9th Circuit. In fact, Geyser said, Emulex actually conceded the point in the appeals court. According to shareholders, Emulex had waived the right to ask the Supreme Court – a court of final review – a question that neither the 9th nor any other circuit has had a chance to decide.

The subtext for the Emulex case – and the reason why it has caught the attention of the business lobby – is the rise in federal-court shareholder class actions challenging M&A transactions. Most of those suits allege that defendants misled shareholders in proxy materials, citing Section 14(a) of the Securities and Exchange Act. The Supreme Court held back in 1964’s J.I. Case v. Borak that shareholders can sue over misleading proxies, and even the U.S. Chamber has not called on the justices to reconsider that precedent.

But when deals are structured as tender offers, shareholders often bring claims under Section 14(e), not 14(a). The Supreme Court has not previously ruled on whether shareholders can sue under that provision, though shareholders argue that Congress and the federal circuits have operated for decades on the assumption that 14(e), like 14(a), implies a private right to sue.

On Monday, the Supreme Court’s four left-leaning justices peppered Emulex lawyer Garre with questions almost as soon as he opened his mouth. Justice Ruth Bader Ginsburg led off by echoing shareholders’ argument that the Supreme Court shouldn’t be the first court to decide if the statute permits private suits. Justices Elena Kagan and Stephen Breyer pressed Garre on whether his client had conceded private enforcement when the case was at the 9th Circuit. Justice Sonia Sotomayor wanted to know if the court would be sending the wrong message to litigators if it took up an issue beyond the question Emulex presented in its petition.

“Aren’t we rewarding you - rewarding you for not raising it adequately below, rewarding you for mentioning it in two sentences in your cert petition and not asking us to take it as a separate question presented?” Justice Sotomayor said. “Where should we draw the line as to when we stop rewarding counsel for changing or moving the ball on cert grounds?”

Garre had a well-prepared answer for the liberal justices: In 1994, when the Supreme Court held in Central Bank of Denver v. First Interstate Bank that shareholders cannot sue defendants for allegedly aiding and abetting securities fraud, the justices ventured far afield from the question that was presented to them, ruling on an issue that had not been addressed in lower-court decisions.

In the Central Bank case, “this court confronted the exact same situation, except we’re actually in a much stronger position here,” Garre said. “The cert petition (in Central Bank) didn’t raise any question about whether there was an underlying implied private right for aiding and abetting. This court itself raised and added that question. It granted certiorari, and it resolved the case on that ground. Now we are in a much stronger position than Central Bank because, first of all, it’s undisputed that we raised this at the cert stage. The broader issue (is) within the question presented.”

The only Republican-appointed justice to question Garre during his initial argument was Justice Brett Kavanaugh, who asked the Emulex lawyer to address the Supreme Court’s 2001 ruling in Alexander v. Sandoval, which expressly repudiated the court’s “ancient regime” of inferring private causes of action based on the justices’ perception of congressional intent.

But when DOJ’s Morgan Ratner began arguing on behalf of the Solicitor General and the SEC, Justice Samuel Alito asked her nearly the same question that Justice Sotomayor posed to Garre: “Could you explain why you think it’s appropriate for us to reach the question whether there’s a private right of action?”

Ratner, like Garre, said that the technical question posed in Emulex’s petition – whether courts should apply a negligence or scienter standard to allegations of misleading tender offer documents – was subsumed by the broader question of who can sue to enforce adequate tender offer disclosures. And like Garre, the DOJ lawyer pointed out that when the Supreme Court faced a parallel situation in the Central Bank case, the justices opted to confront the broad issue instead of confining themselves to a side question.

Chief Justice John Roberts asked shareholder lawyer Geyser about Emulex’s contention that 9th Circuit precedent precluded the company from arguing there’s no private right of action in the statute or SEC regulation governing tender offer disclosures. Geyser emphasized that even when it was before a three-judge appellate panel, Emulex could have reserved a challenge to shareholders’ right to sue or at least questioned that right in a footnote. Instead, Geyser argued, the company expressly conceded at the 9th Circuit that shareholders have a right to sue. And that fact, he said, distinguishes the Emulex case from the Central Bank situation.

Justice Kagan asked Geyser whether plaintiffs’ lawyers were abusing the private right to sue that courts have inferred them to possess. “This court, Mr. Geyser, has sometimes indicated real concern with abuse of private suits and particularly with the opportunity for strike litigation,” she said. “Do you have an answer to that?” Geyser said Congress has imposed all kinds of checks on abusive securities class actions. It would be a mistake, he said, for the justices to “throw the baby out with the bath water.”

Both Geyser and Garre declined my requests for comment on Monday’s arguments. If I had to guess, which is always a risky business based on oral arguments, I’d predict that the court’s conservative majority concludes shareholders don’t have a private right of action, over a dissent from liberal justices who argue the court should not have reached the question. We’ll find out sometime in the next two months.