A Negligence Approach to Section 14(e) Violations

• Publication year: 2019

A Negligence Approach to Section 14(e) Violations

Jessica Pekins

A NEGLIGENCE APPROACH TO SECTION 14(E) VIOLATIONS

Abstract

The tender offer is a common method used by third parties to gain control of a company. Third parties will approach a company's shareholders with the opportunity to sell their shares at a fixed price, the result being a change in ownership and control. A company's top executives may be threatened by this change in ownership and want to recommend that the shareholders reject the offer. However, executives have a duty to act in accordance with the shareholders' best interests. This may lead to a conflict between the shareholders' interests and the executives' interests. Section 14(e) of the Securities Exchange Act of 1934 is designed to ensure that tender offers are not alienated by these conflicts of interests faced by company executives, and to ensure that shareholders are given all accurate information material to the decision of whether to accept or reject the tender offer.

This Comment analyzes and critiques how circuit courts have historically taken a scienter approach to Section 14(e) claims, largely due to the appealing comparison to Rule 10b-5 and its requirements. A scienter requirement forces plaintiffs to prove that defendants acted with sufficient culpability when violating Section 14(e). This Comment proposes that courts alternatively implement a negligence standard, requiring plaintiffs to prove that defendants acted negligently in connection with a tender offer when alleging a violation of Section 14(e). A negligence standard would make it easier for a plaintiff to prove a violation of Section 14(e), which would mean an increase in claims asserted against a company's top executives. Therefore, a negligence standard would increase executives' exposure to liability, which could create positive change toward executives focusing more on the shareholders' interests than on their own interests when evaluating tender offers.

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Introduction.............................................................................................521

I. The Development of Section 14(e) in the Law..........................523

A. History of Section 14(e) of the Securities Exchange Act of 1934 .......................................................................................... 524
B. Five Circuits Require Scienter for Section 14(e) Claims ......... 531
C. The Ninth Circuit's Negligence Standard................................. 541

1. The Plain Language of Section 14(e) ................................. 543
2. Differences Between Rule 10b-5 and Section 14(e) ........... 543
3. Similarities Between Section 17(a) of the Securities Act and Section 14(e)................................................................ 545
4. The Legislative History of the Williams Act ....................... 546

II. The Negligence Approach............................................................546

A. Textual Interpretation Through a Plain Reading of Section 14(e) Supports a Negligence Standard........................ 547
B. The Legislative History of the Williams Act Supports a Negligence Standard ................................................................ 550
C. Inappropriate Use of Section 10(b) and Rule 10b-5 to Interpret Section 14(e) ............................................................................. 555
D. A Comparison of Section 17(a) and Section 14(e) Supports a Negligence Standard ................................................................ 557

III. Implications of the Proposed Negligence Standard..............560

Conclusion.................................................................................................561

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Introduction

Imagine you own 1,000 shares of Time Warner Inc. at $40 per share for a market valuation of $40,000. One day, you are notified that AT&T has made a formal tender offer to buy your shares at $55 per share but that the deal will only close if 80% of the outstanding stock is tendered to AT&T by Time Warner's stockholders as part of the transaction. You have a couple of weeks to decide whether you will tender your shares. If you decide to accept and enough shares are tendered, the transaction is completed, and you'll see the 1,000 shares of Time Warner taken out of your account and a deposit of $55,000 cash put into it. If the tender offer fails because less than 80% of the shares were tendered to AT&T, the offer disappears and you don't sell your stock. You're left with your original 1,000 shares of Time Warner in your brokerage account.

The transaction just described is known as a tender offer. A tender offer is a broad solicitation by a third party to purchase a substantial percentage of a company's shares for a limited period of time.¹ The offer is typically at a fixed price above the current market price and is contingent on shareholders tendering a fixed number of their shares.² In the 1960s, the tender offer became a common method used by third parties to gain control of corporations. To this day, the tender offer remains a topic of contention as courts have tried to navigate the elements of a claim made by stockholders regarding the possible mishandling of a tender offer by company executives. congress added provisions to the Securities Exchange Act of 1934 (Exchange Act) by way of the Williams Act of 1968 in response to the growing popularity of tender offers.³ The Williams Act regulates tender offers by requiring the offeror to disclose all material information relating to the tender offer and by ensuring that current shareholders have adequate time to consider the information provided before accepting or rejecting the tender offer.⁴

Section 14(e) of the Exchange Act was part of the Williams Act.⁵ The purpose of Section 14(e) is to regulate the conduct of the broad range of people who could influence the decision of company investors or the outcome of a

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tender offer.⁶ Thus, Section 14(e) is a broad anti-fraud provision requiring persons engaged in making or opposing tender offers to accurately disclose all material information in connection with the tender offer to the target company's shareholders.⁷

Section 14(e) generally prohibits two forms of conduct.⁸ First, the statute prohibits the making of any false statements of a material fact and the omission of any material fact necessary to make the statements made not misleading.⁹ Second, the statute prohibits "any fraudulent, deceptive, or manipulative acts or practices."¹⁰

Until 2018, when faced with the question of the correct burden of proof for Section 14(e) claims, five federal circuits had ruled that plaintiffs asserting a Section 14(e) claim were required to prove that the defendant acted with sufficient culpability, as opposed to mere negligence.¹¹ The concept of culpability is often referred to as scienter, which functions as a way of limiting the imposition of liability to persons whose conduct has been sufficiently culpable to justify the liability.¹² Each of these circuits pointed to the similar language in Rule 10b-5, which the Supreme court ruled requires proof of scienter,¹³ in support of its holding that Section 14(e) requires scienter as well.¹⁴ A scienter standard requires a showing of intent or knowledge of the nature of one's act or omission.¹⁵ In contrast, a mere negligence standard does not require a plaintiff to prove the defendant's intentional wrongdoing.¹⁶ Thus, a scienter requirement puts a heavier burden of proof on a plaintiff than does a negligence standard.

On April 20, 2018, the Ninth Circuit created a circuit split regarding whether claims asserting violations of Section 14(e) require a showing of negligence or scienter.¹⁷ In Varjabedian v. Emulex Corp., the Ninth Circuit held that a plaintiff

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alleging a Section 14(e) violation need only show negligence, rather than scienter.¹⁸ Because a scienter standard is a heavier burden of proof than a negligence standard, the Ninth Circuit's decision will make it easier for a plaintiff to claim a violation of Section 14(e). Additionally, the Ninth Circuit's holding potentially places a company's top executives—that is, the people who have influence over the decision to accept a tender offer—at a higher risk of these claims being asserted against them.

This Comment argues for the adoption of a negligence standard for claims asserting violations of Section 14(e), consistent with the Ninth Circuit's holding in Varjabedian. Part I discusses the background of Section 14(e) of the Exchange Act, the history of cases in which five circuits held that scienter was a necessary element for Section 14(e) claims, and the context of the Ninth Circuit's holding in Varjabedian that led to the current circuit split. Part II argues that a negligence standard under Section 14(e) is appropriate for four reasons: (1) the text of the statute suggests that it can be readily divided into two clauses, one requiring a showing of negligence and the other requiring proof of scienter; (2) the legislative history of the Williams Act evinces an intent to require less than an allegation of scienter; (3) the five circuits requiring proof of scienter inappropriately used Section 10(b) and Rule 10b-5 to interpret Section 14(e); and (4) the similarities between Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 14(e) warrant extrapolation of the case law under Section 17(a) as precedent for a negligence standard. Finally, Part III discusses the potential implications, from both a legal and policy perspective, that a negligence standard would have on the judicial system and company executives. Legally, a negligence standard would make it easier for a plaintiff to prove a violation of Section 14(e), which means an increase in claims asserted against a company's top executives. From a policy standpoint, a negligence standard would place a company's top executives at a higher risk of these...