(Reuters) - Over the past couple of years, as shareholder challenges to M&A transactions have migrated from Delaware Chancery Court to federal courts, judges have begun squirming about the legitimacy of these class actions. Just last month, for example, I told you about a decision in which U.S. District Judge Thomas Durkin of Chicago said he has the inherent power to police mootness fees defendants have agreed to pay shareholders’ lawyers – even when those shareholders’ lawyers voluntarily dismiss prospective class actions. Both the 5th and 7th U.S. Circuit Courts of Appeal, meanwhile, have balked at fee awards for plaintiffs’ lawyers who file M&A class actions in federal court and obtain only additional deal disclosures.
Federal courts, it would seem, aren’t thrilled that they have become the chosen venue for what used to be called “deal-tax” litigation: shareholder class actions routinely filed after major deal announcements, challenging the adequacy of corporate disclosures about deals. Decisions like Judge Durkin’s are a warning that federal judges are on the lookout for potential abuse of class action leverage.
But what if it turns out that the securities statute that plaintiffs’ lawyers cite to bring cases in federal court doesn’t countenance private suits at all?
That’s the rather startling argument posited by Emulex Corporation in a newly-filed petition for U.S. Supreme Court review of a 9th Circuit decision that revived a shareholder class action challenging Avago Technologies’ $610 million acquisition of Emulex in 2015. The petition contends that although courts have long construed the statute governing deal disclosures, Section 14 of the Securities and Exchange Act of 1934, to imply that shareholders have a right to bring private actions for disclosure deficiencies, there’s nothing in the statute to justify that inference.
“Viewed under the rigorous standard that this court applies today, there is no basis for inferring any private right of action under Section 14(e),” wrote Emulex’s counsel of record Gregory Garre of Latham & Watkins, in what seems to be a nod to the Supreme Court’s textualists. And in case you’re thinking that the argument seems impossibly far-fetched, the petition includes a reminder that in 1977’s Piper v. Chris-Craft Industries, Inc (97 S.Ct. 926), the Supreme Court said that Section 14 “makes no provision whatever for a private cause of action, such as those explicitly provided in other sections of the 1933 and 1934 Acts.”
Granted, Emulex’s bid to deprive federal courts of jurisdiction over private shareholder suits over proxy disclosures is a looooong shot: In a 1964 case mentioned in the company’s petition, J.I. Case Co. v. Borak, 377 U.S. 426, the Supreme Court itself said it “appears clear that private parties have a right … to bring suit” for violations of Section 14.” That precedent leaves some room to argue to the contrary, but not much.
First, of course, Emulex has to persuade the justices to hear its case. Its lawyers make a strong argument for Supreme Court review. The 9th Circuit held that shareholders suing under Section 14 for proxy disclosure violations need only show the alleged misrepresentations were negligent – not that the defendant acted with fraudulent intent. That reasoning is at odds with precedent from no fewer than five other federal circuits, all of which have said shareholders much allege scienter in Section 14 class actions.
The 9th Circuit decision “blew up that consensus” on the pleading standard for M&A shareholder class actions at the very moment these suits are exploding through federal courts, Emulex said. Venue rules will make it possible for plaintiffs’ lawyers to opt for trial courts in the 9th Circuit, where they will benefit from the looser pleading standard. Defendants, in turn, won’t be able to dispose of the class actions via early-state dismissal motions. The result of the circuit split, according to Emulex, will be disproportionate filings in 9th Circuit courts, warping the balance of power between shareholders and corporations and ultimately hurting investors.
“The 9th Circuit’s adoption of a negligence standard for private damages claims — potentially applicable to every merger or acquisition of a publicly traded company (no matter where it is listed, incorporated, or headquartered) — fundamentally shifts the balance struck by Congress,” the Emulex petition said. “Companies and their directors (who, like the individual petitioners here, face piggyback claims under Section 20 of the Exchange Act) will now be exposed to a much greater threat of abusive litigation and will have to grapple with whether any corrective disclosures will be read as admissions of negligence that subject them to backward-looking liability — likely restricting the flow of information into the market. That is precisely the opposite of what Section 14(e) was intended to accomplish.”
As Emulex says in the petition, the Supreme Court can certainly take up and decide the appropriate pleading standard for Section 14 claims without ever getting to the big question of whether there’s even a private right of action under the statute. On the other hand, that’s why it’s so intriguing that the company and its very experienced lawyers – including, in addition to Garre and his Latham team, Supreme Court veteran Shay Dvoretzky of Jones Day – chose to raise doubts at this very early stage about the very legitimacy, under the statutory text, of M&A shareholder class actions.
If the newly entrenched conservative majority wants to erect protections for business interests, this case would sure be a start.
The views expressed in this article are not those of Reuters News.