PRECEDENTIAL Before: ROTH, MCKEE and UNITED STATES COURT OF CUDAHY* , Circuit Judges APPEALS FOR THE THIRD CIRCUIT (Opinion filed May 17, 2004) ______Howard J. Kaplan, Esquire (Argued) No: 03-2347 Stanley S. Arkin, Esquire ______590 Madison Avenue 35th Floor GSC PARTNERS CDO FUND; New York, NY 10022 GSC PARTNERS CDO FUND II, LTD; GSC RECOVERY II, L.P., Bruce H. Snyder, Esquire Sheppard A. Guryan, Esquire Appellants Lasser Hochman 75 Eisenhower Parkway v. Roseland, NJ 07068

DENNIS R. WASHINGTON; Counsel for Appellants STEVEN G. HANKS; THOMAS H. ZARGES; Shannon M. Kasley, Esquire ANTHONY S. CLEBERG; DAVID H. Beth Heiftz, Esquire (Argued) BATCHELDER; Adrian Wager-Zito, Esquire LEONARD R. JUDD; ROBERT S. Megyn M. Kendall, Esquire MILLER, JR.; Jones Day DORN PARKINSON; TERRY W. 51 Louisiana Avenue, N.W. PAYNE; Washington, D.C. 20001 JOHN D. ROACH; CREDIT SUISSE FIRST Robinson B. Lacy, Esquire (Argued) BOSTON CORPORATION; JOHN Sullivan & Cromwell LLP DOES I THROUGH X 125 Broad Street New York, New York 10004

Appeal from the United States District Anthony J. Marchetta Court Pitney, Hardin, Kipp & Szuch LLP for the District of New Jersey P.O. Box 1945 (D.C. Civil Action No.01-CV-04905) Morristown, New Jersey 07962 District Judge: Honorable Anne E. Thompson ______

______*The Hon.Richard D. Cudahy, Circuit Judge for the United States Court of Argued on December 19, 2003 Appeals for the Seventh Circuit, sitting by designation. Christopher J. Carey, Esquire Partners CDO Fund, Ltd., GSC Partners David Blackwell, Esquire CDO Fund, Ltd. II, LTD., and GSC Graham, Curtin & Sheridan Recovery II, L.P. (the plaintiffs) appeal the Four Headquarters Plaza, P.O. Box 1991 district court’s dismissal of their action Morristown, New Jersey 07962-1991 against individual officers and directors of Washington Group International, Inc. George T. Manning, Esquire (Washington) and Credit Suisse First Jones Day Boston Corporation (CSFB). The 1420 Peachtree Street, N.E. plaintiffs filed this action under section Atlanta, Georgia 30309-3053 10(b), Rule 10b-5 of the Securities Exchange Act of 1934 (the Act), alleging Counsel for Appellees that their purchase from CSFB of $48.8 million in notes, which Washington used to finance its acquisition of Raytheon Engineers & Constructors International, Inc. (REC), was carried out pursuant to O P I N I O N defendants’ allegedly false and misleading offering circular. Because the plaintiffs failed to meet the heightened pleading CUDAHY, Circuit Judge requirements of the Act, we affirm the district court’s grant of defendants’ motion The background of this case is the to dismiss. classic corporate love story. Company A I. meets Company B. They are attracted to Washington is an international each other and after a brief courtship, they engineering and construction firm that, in merge. Investor C, hoping that the two 2000, employed approximately 39,000 companies will be fruitful and multiply, workers and brought in approximately $5 agrees to pay $50 million for the wedding. billion in annual revenue.1 App. at 41, 77. Nine months later, however, things begin Defendants Dennis R. Washington, Hanks, to fall apart and the combined entity Zarges, Cleberg, Batchelder, Judd, Miller, declares bankruptcy. Investor C feels Parkinson, Payne, and Roach were officers misled. He believes that Company A and/or directors of Washington during the knew that there were problems with acquisition process. App. at 38-9 (Cplt. ¶ Company B but that it made the oft 14-23). repeated mistake of thinking that it would Washington representatives be able to change Company B for the better. Investor C files suit in the district 1 Washington was known as Morrison court and after his complaint is dismissed, Knudsen Corporation (sometimes referred to we find ourselves here. It is an old story as MK) before the note offering. App. at 41. but it never fails to elicit a tear. The company filed for bankruptcy In this case, appellants GSC protection in May 2001, and was not named as a defendant in this action.

-2- commenced negotiations during the Power Producer (IPP) market,” as well as summer of 1999 for the acquisition of in the rail, power, chemicals, metals REC, the engineering and construction pharmaceutical, pulp and paper, chemical division of Raytheon Company. App. at demilitarization, refinery and heavy 42 (Cplt. ¶ 37). After conducting an initial maintenance markets. App. at 320. The examination of REC’s financial team also noted that the personnel it information, Washington submitted a non- worked with had been “cooperative and binding offer of between $775 and $875 forthcoming.” Id. at 317. million for the business operations of REC, subject to its findings in due The due diligence team expressed diligence. App. at 42 (Cplt. ¶ 39). some concerns as well. It cited as among Raytheon accepted this offer in September REC’s general weaknesses its 1999. Id. at ¶ 41. Before finalizing the “aggressive” and “optimistic” plans for deal, Washington began its due diligence sales volume and profit growth in certain process, which entailed thorough scrutiny businesses, the volatility of the company’s of REC’s financial statements and working capital, the possible lack of projections. Id. In this process, it received accounting integrity of its unaudited assistance from Arthur Andersen, L.L.P. financial statements and its “[u]nderstated Id. at ¶ 41. Meanwhile, the parties began or undisclosed liabilities.” Id. at 319. In negotiating a definitive agreement for the particular, the team calculated that the acquisition. Id. at ¶ 40. To augment this profit projections for some of the process, Washington employed defendant construction projects were inaccurate. For CSFB to act as its financial advisor for the example, the team revised estimated profit REC purchase. Id. at ¶ 40. CSFB projections for the “Pine Bluff” project conducted its own due diligence and had from $20.2 million to $3.1 million, for the access to all of Washington’s due “SADAF” project from $4.2 million to diligence findings as well. Id. at ¶ 43. $0.8 million and for the Hudson Bergen Throughout the due diligence process, the project from $61.1 million to $46.9 two companies communicated their million. Id. at 326. At the same time, findings and concerns to each other. Id. however, Washington noted, that “[w]ider leverage of proprietary technology” could On October 27, 1999, after one improve some of the projects’ month of interviews, document reviews deteriorating margins, and that and project site visits, Washington’s “[o]perational synergies offer [an] upside management reported to the Washington to a combined new company.” Id. at 346. Board its findings regarding the accuracy of REC’s financial information. App. at On November 3, defendant Zarges 44 (Cplt. ¶ 46), 317. The team was sent a memorandum to other members of impressed with the “[s]trong, capable the Washington management, elaborating management team in place” and with on some of the perceived inaccuracies in REC’s “solid position in [the] Independent the project profit estimates but projecting

-3- that if the acquisition went through, even bring them into compliance with Generally taking into account the risks, the combined Accepted Accounting Principles (GAAP). entity could perform well in the Id. Hanks stipulated that in order to engineering and construction industry. remedy the discrepancies, it would be App. at 362. Zarges first emphasized that necessary to arrange for an increase in the findings in the October 27 Board liabilities assumed by Raytheon of up to presentation were not conclusive. Id. He $100 million. Id. wrote that, although the Umatilla and Pine Bluff projects had been presented as The Washington Board met on breakeven projects through 2001, they March 14, 2000 to consider the progress of were at the time of the memo in “loss the due diligence team. App. at 548-88. positions with deteriorating performance The team again reported some concerns trends.” App. at 364. The memorandum about REC’s financial health, but also reiterated concerns about Raytheon’s expressed confidence that a partnership aggressive plans and optimistic positions with Washington would improve REC’s on most projects, reporting inconsistencies position, “having actually experienced and shaky performance history. Id. at 365- what it takes to turn a company around.” 66. Zarges concluded, however, that the App. at 420, 422. The team reported risks projected operating fee (i.e. profit) in 2000 involved in the acquisition of REC, citing could, taking into account Washington’s historical performance that was adjustments to REC’s calculations, characterized by large loss projects. Id. at “provide an industry-leading margin of 554. The team revised the projected profit 3.8% on adjusted revenues.” App. at 362. for the Umatilla project downward to He added, “This . . . represents quite an “22M loss, best case,” an adjustment of improvement over recent performance $38 million from REC’s estimate. App. at histories . . . [and] is no easy task.” Id. 559. It also adjusted the projected profit for the Pine Bluff project from breakeven A month later, on December 2, to a $20 million loss. Id. REC had 1999, defendant Hanks sent a “[p]oor financial controls/accounting memorandum to the Board on the progress practices,” and the team suspected that of the due diligence team. App. at 362. there may have been inadequate He reported that in order to address restructuring reserves in The Hague and in Washington’s concerns about the accuracy Houston. Id. at 554. The due diligence of REC’s financial statements, Washington team also revised REC’s projected had hired PricewaterhouseCoopers L.L.P., EBITDA (earnings before interest, independent accountants, to audit the taxes, depreciation and amortization) for financial statements for 1996, 1997, and the year 2000, from $143 million to $115 1998, and to “review” the financial million, assuming that the combined statement for 1999. App. at 207, 367. company would be indemnified by These audited financial statements Raytheon against any downside from required $350 million of adjustments to Umatilla and Pine Bluff and that it “would

-4- incur 50% of the $60 million of Design and build services in the vulnerabilities identified in the due infrastructure market today.” Id. at 422. diligence report.” Id. at 420-21, 567. In addition, “[t]he combination of MK’s industrial process unit with Raytheon’s In addition, the due diligence team industrial unit affords synergetic had encountered practical difficulties in opportunities … and a greatly improved completing the due diligence. Defendant client base.” Id. at 422-23. He reported Hanks recorded in his notes and reported that the due diligence team was not in to the board that “the due diligence and complete agreement as to the value of negotiation process has been a difficult REC. Id. at 423. He highlighted some one- Raytheon’s procedural rules limited points on which they all agreed, however, our opportunities for open and candid including that “[t]he strengths of MK – discussions with management, limited our and the strengths of Raytheon are ability to see company offices and projects complementary” and that “the Markets that … and Raytheon has not been cooperative the combined MK/Raytheon will serve with Washington Group’s attempts to going forward are the fastest growing reconcile the [discrepancies between segments of the industry.” Id. at 424. His financial and operational reports and other notes concluded by suggesting that comparative data].” App. at 418, 552. Washington should pursue the acquisition. These limitations led Hanks to suspect that Id. Raytheon was “hiding serious business issues and problems.” Id. The same Zarges’ April 3 memorandum was concern had been recorded in the more positive about the team’s access to November 3 memorandum, which noted data, reporting that the recent site visits that the “team has been concerned about were “more informative.” App. at 433. the abrupt limits of the due diligence Having been given more access to data, process and data. With 2 ½ weeks to the team had been able to update its evaluate data, the diligence was restricted calculations about profit from operations. to selected high-impact projects and Its findings did confirm some losses. In issues.” App. at 365. large part due to the lower profitability of the Damshead Creek and San Roque Hanks also recorded in his projects, the team reduced its estimate of presentation notes some high points REC’s 2000 operating fee from $63 disclosed by the due diligence process. He million to $45 million. Id. at 433, 653, wrote, “Raytheon’s Power Group is poised 655. A further memorandum dated July 6 to benefit greatly from the surge in disclosed that for certain projects, the demand for new power,” and expressed “total MAC [material adverse changes] confidence that “[t]he combination of estimate – project MK’s contractors unit with Raytheon’s deterioration/understated liabilities” was Infrastructure business would create the $73.5 million. App. at 657. most experienced and powerful provider of It appears that throughout the due

-5- diligence process, the due diligence team of $22 million. See Supp. App. (discussed and the Washington Board communicated supra at n.1). regularly and frankly about their assessment of REC’s strengths and On July 7, 2000, Washington’s weaknesses. At no point in this process acquisition of REC closed. App. at 52 did the Washington management express (Cplt. ¶ 82). The acquisition was primarily the conviction that the acquisition would financed through the $300 million note prove a failure. In fact, the management offering, sold pursuant to a confidential team took steps to remedy the weaknesses offering circular dated June 28, 2000. Id. it pinpointed by renegotiating the purchase at ¶¶ 86-7. The offering circular included so as to avoid acquisition of liabilities and certain audited financial statements as well risky projects. App. at 81. as unaudited financial statements for the first quarter of 1999 and the first quarter of On April 14, 2000, Washington 2000. App. 286-96. Defendant CSFB was entered into a Stock Purchase Agreement one of the lead underwriters and initial with Raytheon and REC. Id. The purchasers of the notes. App. at 53 (Cplt. agreement specified that the purchase ¶ 88). It purchased $225 million in price, which was to be based on the April principal amount of the notes, then offered 30, 2000 balance sheet, would be and resold some of those notes to the approximately $510 million—between petitioners, who purchased $48.8 million $265 and $365 million less than face amount of notes. Id. (Cplt. ¶ 93). Washington’s initial offer. Id. Washington would acquire the On October 23, 2000, Washington’s engineering, design, procurement, Form 10-Q filing announced that as a construction, operation and maintenance result of “a comprehensive review” of business of REC, as well as the capital REC’s existing contracts, Washington stock of certain REC subsidiaries. App. at “reduced [REC’s] net assets relating to 51 (Cplt. ¶ 78). The purchase price long-term contracts in the preliminary reflected the exclusion of the four most purchase price by approximately $325 significant REC loss projects, for which [million] . . . [and] had made reductions in Raytheon had agreed to retain liability. Id. net contract assets in the preliminary at 51 (Cplt. ¶ 77), 81. Raytheon also purchase price allocation of approximately agreed to “retain specified assets” of REC $225 [million].” App. at 58-59 (Cplt. ¶ and to indemnify Washington for 105). Washington also disclosed that it “specified liabilities of REC and its had to record approximately $1.2 billion in subsidiaries.” App. at 81. Later, goodwill. Id. In a press release dated Washington was able to get Raytheon to March 2, 2001, Washington disclosed that retain partial liability for the Umatilla “[s]everal [REC] projects had serious project as well, which Washington had undisclosed problems and were in trouble” predicted was in a position to show a loss before it acquired REC. App. at 59 (Cplt. ¶ 110). It noted that as of September 1,

-6- 2000, Washington had reduced REC’s Broselow v. Fisher, 319 F.3d 605, 607 (3d assets and increased its liabilities by Cir. 2003). We also exercise plenary approximately $700 million from the review over the district court’s amounts originally estimated. App. at 60 interpretation of federal securities laws. (Cplt. ¶ 111). On March 8, 2001, See Oran v. Stafford, 226 F.3d 275, 281 Washington’s Form 8-K filing indicated n.2 (3d Cir. 2000); In re Westinghouse that REC’s financial statements referred to Sec. Litig., 90 F.3d 696, 706 (3d Cir. in the circular should not be relied upon. 1996). We accept all allegations in the Id. at ¶ 112. plaintiffs’ complaint as true and draw all reasonable inferences in favor of the non- On May 14, 2001, Washington and moving party. See Oran, 226 F.3d at 279. some of its subsidiaries filed petitions in A court may look beyond the complaint to bankruptcy in the Bankruptcy Court in extrinsic documents when the plaintiffs’ Nevada for relief pursuant to Chapter 11 of claims are based on those documents. See the Bankruptcy Code. Id. at 61 (Cplt. ¶ In re Burlington Coat Factory Sec. Litig., 117). Washington also filed a complaint 114 F.3d 1410, 1426 (3d Cir. 1997). A in a Idaho state court against Raytheon court may not dismiss the complaint unless alleging fraudulent inducement, fraud and it appears beyond doubt that the plaintiffs misrepresentation, requesting rescission or can prove no set of facts in support of their specific performance. App. at 455-81. claims that would entitle them to relief. That suit was apparently settled in See In re Rockefeller Ctr. Props., Inc. Sec. November 2001, and is under a Litig., 311 F.3d 198, 215-16 (3d Cir. confidentiality restriction. Pl. Br. at 17 2002). n.4. Plaintiffs commenced this action alleging violation of federal and state The plaintiffs allege a violation securities laws. Id. at 37-8. In January under Section 10(b) of the 1934 Securities 2002, the defendants filed a motion to Exchange Act and Rule 10b-5 under it. In dismiss plaintiffs’ amended complaint. order to state a claim under Rule 10b-5, Although no formal discovery had taken plaintiffs must allege “with particularity” place in the civil action, the plaintiffs were that defendants (1) made a misstatement or able to obtain access through omission of material fact (2) with scienter Washington’s bankruptcy to documents (3) in connection with the purchase or the discussed in the instant opinion. The sale of a security (4) upon which the district court granted the defendants’ plaintiffs reasonably relied and (5) the motion, holding that the complaint failed plaintiffs’ reliance was the proximate to state a cause of action for securities cause of their injury. Semerenko v. Cedant fraud. App. at 1. This appeal followed. Corp., 223 F.3d 165, 174 (3d. Cir. 2000); II. see also In re Westinghouse, 90 F.3d at We exercise plenary review over 710. the district court’s decision to grant the The plaintiffs’ securities fraud defendants’ motions to dismiss. See claim is also subject to heightened

-7- pleading requirements. Under Federal Rule Advanta Corp. Sec. Litig., 180 F.3d 525, of Civil Procedure 9(b), “[i]n all averments 531 n.5 (3d Cir. 1999)). of fraud . . . , the circumstances constituting fraud . . .shall be stated with The plaintiffs may establish a particularity. Malice, intent, knowledge, “strong inference” that the defendants and other condition of mind of a person acted with “scienter” “either (a) by may be averred generally.” Fed. R. Civ. P. alleging facts to show that defendants had 9(b). This particularity requirement is both motive and opportunity to commit “rigorously applied in securities fraud fraud, or (b) by alleging facts that cases.” Burlington, 114 F.3d at 1417. The constitute strong circumstantial evidence Private Securities Litigation Reform Act of conscious misbehavior or recklessness.” (PSLRA), 15 U.S.C. § 78u, “imposes In re Burlington, 114 F.3d at 1418 another layer of factual particularity to (quoting Acito v. IMCERA Group, Inc., 47 allegations of securities fraud.” In re F.3d 47, 53 (2d Cir. 1995)); see also In re Rockefeller, 311 F.3d at 217. If a Advanta, 180 F.3d at 534-35; Oran, 226 complaint fails to comply with the F.3d at 288-89. PSLRA’s pleading requirements, dismissal A. Motive and opportunity is mandatory. 15 U.S.C. § 78u-4(b)(3)(A). Motive must be supported by facts The PSLRA requires the complaint to stated “with particularity,” and must give specify “each statement alleged to have rise to a “strong inference” of scienter. In been misleading, the reason or reasons re Advanta, 180 F.3d at 535; 15 U.S.C. § why the statement is misleading, and, if an 78u-4(b)(2). “Blanket assertions of motive allegation regarding the statement or and opportunity” will not suffice, and omission is made on information and “catch-all allegations that defendants stood belief, the complaint shall state with to benefit from wrongdoing and had the particularity all facts on which that belief opportunity to implement a fraudulent is formed.” 15 U.S.C. § 78u-4(b)(1). scheme are no longer sufficient, because they do not state facts with particularity or With regard to the “scienter” give rise to a strong inference of scienter.” component of the 10b-5 claim, the critical In re Advanta, 180 F.3d at 535. Moreover, issue before this Court, the PSLRA further “[m]otives that are generally possessed by requires the plaintiffs, “with respect to most corporate directors and officers do each act or omission,” to “state with not suffice; instead, plaintiffs must assert particularity facts giving rise to a strong a concrete and personal benefit to the inference that the defendant acted with the individual defendants resulting from this required state of mind.” 15 U.S.C. § 78u- fraud.” Kalnit v. Eichler, 264 F.3d 131, 4(b)(2). This particularity requirement 139 (2d Cir. 2001) (citation omitted). supersedes Rule 9(b)’s provision allowing state of mind to be averred generally. See In their amended complaint, the In re NAHC, Inc. Sec. Litig., 306 F.3d plaintiffs allege that the defendants’ 1314, 1328 (3d Cir. 2002) (citing In re motive to commit fraud was that

-8- Washington “would not have been able to Morris Cos., 75 F.3d 801, 813-14 (2d Cir. acquire REC without the successful 1996) (finding that a “company's desire to issuance of the Notes,” and would not maintain a high bond or credit rating” have been able to sell any of the notes at or insufficient motive for fraud because such near the price sought “had the true motive could be imputed to any company); financial condition of the REC been Tuchman v. DSC Communications Corp., revealed in the Circular.” Pl. Br. at 32; 14 F.3d 1061, 1068 (5th Cir. 1994) App. at 37, 53 (Cplt. ¶¶ 7, 86, 89). (“[I]ncentive compensation can hardly be Further, the complaint suggests that the basis on which an allegation of fraud is because defendant Dennis Washington predicated.”) (citation omitted); Herzog v. received stock options in 1999 after GT Interactive Software Corp., 98 Civ. Washington acquired Westinghouse, it can 0085, 1999 WL 1072500, at *9 (S.D.N.Y. be inferred that he would receive stock Nov. 29, 1999) (holding that a defendant's options after the present merger. See App. “‘desire to consummate [a] corporate at 41, (Cplt. ¶ 36). Plaintiffs argue that transaction does not constitute a motive for these alleged stock options provided securities fraud’”); Leventhal v. Tow, 48 Washington with an additional motive to F. Supp. 2d 104, 115 (D. Conn. 1999) commit fraud. These allegations are (“[T]he allegation that the defendants insufficient. artificially inflated Citizens’ stock price in order to ‘protect and enhance their In every corporate transaction, the executive positions’ and ‘negotiate as corporation and its officers have a desire to favorable a deal as possible’ on a pending complete the transaction, and officers will employment contract also fail[s] to give usually reap financial benefits from a rise to a strong inference of scienter. This successful transaction. Such allegations motive has been rejected routinely.”); alone cannot give rise to a “strong Thacker v. Medaphis Corp., 97 Civ. 2849, inference” of fraudulent intent. See In re 1998 WL 684595, at *3 (S.D.N.Y. Sept. Burlington, 114 F.3d at 1424; see also 30, 1998) (finding plaintiff’s claim that Phillips v. LCI Int'l, Inc., 190 F.3d 609, defendant was motivated by a desire to 623 (4th Cir. 1999) (“Similar situations eliminate competitors and to acquire arise in every merger; thus, allowing a related companies insufficient to plead plaintiff to prove a motive to defraud by scienter because such motive could be simply alleging a corporate defendant's imputed to any corporate officer). desire to retain his position with its attendant salary, or realize gains on Although the allegation is not company stock, would force the directors apparent from the complaint, plaintiffs of virtually every company to defend now argue that CSFB had a motive to securities fraud actions every time that commit fraud because it stood to receive company effected a merger or underwriting and financial advisory fees. acquisition.”); San Leandro Emergency This allegation is undoubtedly true but Med. Group Profit Sharing Plan v. Philip equally unavailing. See Melder v. Morris,

-9- 27 F.3d 1097, 1104 (5th Cir. 1994) (quoting Beck v. Mfrs. Hanover Trust Co., (declining to find scienter where plaintiffs 820 F.2d 46, 50 (2d Cir. 1987)). alleged that underwriters’ motive in participating in fraud was to collect fees); A reckless statement is a material Schnell v. Conseco, Inc., 43 F. Supp. 2d misrepresentation or omission “‘involving 438, 449 (S.D.N.Y. 1999) (“[A]n not merely simple, or even inexcusable underwriter's alleged motive to earn its negligence, but an extreme departure from underwriting fees is not alone sufficient to the standards of ordinary care, and which sustain a strong inference of fraudulent presents a danger of misleading buyers or intent. If it were, every underwriter, law sellers that is either known to the firm, accountant, and investment advisor defendant or is so obvious that the actor whose compensation or commission must have been aware of it.’” In re depended on the completion of an initial Advanta, 180 F.3d at 535 (quoting McLean public offering would have a motive to v. Alexander, 599 F.2d 1190, 1197 (3d Cir. commit fraud, which would make Rule 1979)). 9(b) wholly meaningless.”) (quoting Fisher v. Offerman & Co., Inc., No. 95 The plaintiffs argue that they Civ. 2566, 1996 WL 563141 at *6 “alleged specific information transmitted (S.D.N.Y. Oct. 2, 1996)). Therefore, to Defendants prior to issuance of the plaintiffs have failed to meet the scienter Offering Circular and sale of the Notes requirement by pleading motive and that contradicted representations made in opportunity to commit fraud on the part of the Circular, identifying who any of the defendants. communicated them to whom, when, and how.” Pl. Br. at 23. In other words, it is B. Recklessness or conscious the plaintiffs’ position that the defendants misbehavior had actual knowledge of the falsity of their statements in the circular at the time they Because the plaintiffs have not were made. It is certainly true that “in a adequately pleaded that the defendants had non-disclosure situation, any required both motive and opportunity to commit element of scienter is satisfied where . . . fraud, their complaint will survive the the defendant had actual knowledge of the motion to dismiss only if they allege material information.” Fenstermacher v. specific facts that constitute “strong Phila. Nat’l Bank, 493 F.2d 333, 340 (3d circumstantial evidence of conscious Cir. 1974); see also In re Advanta, 180 misbehavior or recklessness.” Oran, 226 F.3d at 535. F.3d at 288-289; Kalnit, 264 F.3d at 142 (“Where motive is not apparent, it is still Of course, it is not enough for possible to plead scienter by identifying plaintiffs to merely allege that defendants circumstances indicating conscious “knew” their statements were fraudulent or behavior by the defendant, though the that defendants “must have known” their strength of the circumstantial allegations statements were false. See In re Digital must be correspondingly greater.”) Island Sec. Litig., 357 F.3d 322, 328-29 -10- (3d Cir. 2004); Rombach v. Chang, 355 The plaintiffs allege a number of F.3d 164, 176 (2d Cir. 2004) (finding no different affirmative misstatements that scienter where plaintiffs did “not allege form the basis of their 10b-5 claim. First, facts and circumstances that would support the plaintiffs argue that the circular was an inference that defendants knew of misleading in including REC’s financials specific facts that are contrary to their for the 2000 stub period which indicated public statements”); Bovee v. Coopers & “that as of April 2, 2000, REC had Lybrand C.P.A., 272 F.3d 356, 361 (6th liabilities of $1,279,333.” Reply Br. at 6; Cir. 2001) (“Plaintiffs may not simply rely Pl. Br. at 26-7; App. at 288. To establish on the proposition that Defendants must that Washington had actual knowledge to have known or should have known of, and the contrary, plaintiffs refer to a comment participated in, the fraud.”). Plaintiffs in Washington’s October 27, 1999 must plead allegations of scienter with presentation which indicated that REC had particularity. See 15 U.S.C. § 78u-4(b)(2). “understated or undisclosed liabilities.” They must support their allegations with See App. at 44 (Cplt. ¶ 48), App. at 319. the essential factual background that However, this comment could not have would accompany “the first paragraph of been made in reference to the financial any newspaper story”—that is, the “who, statements for the stub period between what, when, where and how” of the events January and April 2000, since those at issue. In re Burlington, 114 F.3d at statements would not have been available 1422 (citing DiLeo v. Ernst & Young, 901 in October of 1999. See App. at 47 (Cplt. F.2d 624, 627 (7th Cir.1990)). ¶ 59-60) (noting that as of December 2, 1999 “Washington Group had ‘requested Although the plaintiffs argue that “audited” financials for RE&C for years they have demonstrated that the defendants 1996, 1997, and 1998 and “reviewed” had “actual knowledge” that their public financial statements for the stub period statements were false and misleading at from January 1 to September 30, 1999.’”). the time in which they were made, the Moreover, in the October 27th plaintiffs have failed to plead with presentation, Washington was referring to particularity facts that so demonstrate. understated liabilities in REC’s unaudited The plaintiffs point to many statements financial statements. App. at 319 that the individual defendants made during (referring to “[a]ccounting integrity of the due diligence period as evidence that financial statements (unaudited) provided they had actual knowledge that their to date”). These statements were later circular statements were false and audited and adjusted to comply with misleading. However, these statements GAAP before they were incorporated into made during the due diligence period the circular. App. at 367. Plaintiffs cannot be connected directly to any present no evidence that Washington had misleading statement in the offering actual knowledge that the audited circular. statements were inaccurate during the 1. Liabilities relevant time period.

-11- Plaintiffs also rely on their Washington indicated its belief that several complaint allegation that “[a]s of January of REC’s many contracts were overvalued. 4, 2000, Washington Group and Id. (citing App. 45-51 (Cplt. ¶¶ 50, 54, 72- Defendants knew that REC’s financial 76)). Again, in some of these documents, statements of September 30, 1999 Washington was referring to REC's overstated assets by approximately $275 unaudited statements which were later million and understated liabilities by $145 audited before inclusion in the circular and million.” Reply Br. at 6; App. at 47-48 the other documents focused on projects (Cplt. ¶ 62). The plaintiffs, however, do for which Washington was later not provide any source to connect this indemnified.2 Moreover, there is no accusation to record evidence. In other words, plaintiffs have failed to plead with 2 Appellees filed a Motion for Leave particularity. See In re Party City Sec. to File a Supplemental Appendix Litig., 147 F. Supp. 2d 282, 300 (D.N.J. containing an Ancillary Letter 2001) (“Simply referring to a series of Agreement revealing that Washington public statements and then alleging, in a was partially indemnified against loss general and conclusory manner, that those regarding one of REC’s projects. disclosures were false or misleading is Appellants oppose this motion. “We insufficient.”). Plaintiffs do not even decide on a case-by-case basis whether mention whether, in this paragraph, they an appellate record should be are referring to REC’s audited or supplemented. Even when the added unaudited statements. Moreover, any material will not conclusively resolve an knowledge Washington may have had issue on appeal, we may allow regarding the accuracy of the 1999 supplementation in the aid of making an financial statements is of little relevance in informed decision.” Schwartz v. Million determining whether Washington had Air, Inc., 341 F.3d 1220, 1225 n.4 (11th actual knowledge that the statements from Cir. 2003). The Ancillary Letter the later stub period were inaccurate. Agreement, while not crucial to the instant decision, helps explain 2.Contracts in progress Washington’s motive for not discussing its concerns with respect to this particular Similarly, the plaintiffs argue that project in the circular. Therefore, we the circular was misleading in that REC’s find that the agreement will aid the Court unaudited financials for the 2000 stub in making an informed decision. period indicated “that as of April 2, 2000, Appellants do not question the validity or REC’s ‘contracts in process’ had a value authenticity of the agreement nor do they of $638,881,000.” Reply Br. at 6; GSC argue that they would be prejudiced in Br. at 26; App. at 288. To show that any way by our consideration of the Washington knew this statement was agreement. Appellants do not even argue misleading, plaintiffs refer us to various that they are unfamiliar with the documents Washington produced during agreement. See, e.g., Kalimian v. Liberty its due diligence period, in which Mutual Fire Ins. Co., 300 F.2d 547, 549 -12- indication that any of Washington’s 3.Four projects deviate documents referred to the April 2000 stub significantly period or to any other value appearing in The plaintiffs also take issue with a the circular, and in none of these statement in the circular indicating that documents does Washington provide an four projects for which REC retained estimate of the total value of REC’s liability “deviate significantly and are not contracts in progress. For both of these representative of other contracts being reasons, there is no way to know whether acquired.” Pl. Br. at 29, quoting App. at Washington would have disagreed with 126. Plaintiffs argue that this statement REC’s April valuation at the time the was misleading because defendants knew circular was issued. “that numerous other projects were also misestimated, likely to incur costly In any case, Washington made it overruns that were uncollectible and were plain in the circular that REC’s accounting losing money.” Id. First, a fair reading of for these contracts was aggressive, when it this excerpt from the circular is that these warned that “REC revenue recognition four projects deviated significantly policies are significantly different from because of (a) the extent of loss already those used by MK on certain contracts incurred on each project; (b) “the reversal where significant components are procured of previously-recognized profit”; and (c) in advance of installation. . . . REC’s “the establishment of reserves for future revenue recognition policy on such losses.” Id.; In re Burlington, 114 F.3d at contracts generally result in more revenue 1426 (noting that if plaintiffs rely on recognition in the early stages of a extrinsic documents in their complaint, the contract.” App. at 126. It also suggested documents must be understood in their that this difference could be critical when entirety). Plaintiffs have failed to identify it noted that "[t]he loss of one or more any evidence suggesting that Washington major contracts, or our inability to perform believed that other contracts equally met profitably under one or more major these three criteria. To the contrary, contracts . . . could have a material adverse plaintiffs concede in their complaint that effect on our businesses, financial these projects are distinguishable, referring condition, results of operation and cash to them as “the four most significant loss flows." App. at 94. projects.” App. at 51 (Cplt. ¶ 77). Finally, because Raytheon ultimately retained liability for at least one additional project that plaintiffs allege “deviate[d] (2d Cir. 1962) (“[T]his court is free to significantly,” any misleading statements consider facts which have been admitted based on that project is immaterial as a in argument and in the briefs on appeal . . matter of law. See In re NAHC, Inc. Sec. . .”). To the contrary, appellants argue Litig., 306 F.3d 1314, 1330 (3d Cir. 2002) that the agreement actually supports their (“If the disclosure of certain information case. Reply Br. at 5-6. For these has no effect on stock prices, it follows reasons, we grant appellees’ motion to file their supplemental appendix. -13- that the information disclosed was difficult to predict the extent of the loss”). immaterial as a matter of law.”). On top of this, the circular 4.Collection is probable statement was qualified through the use of the word “probable” and was accompanied The plaintiffs also argue that the by cautionary language, which indicated circular was misleading in stating that that “[t]he settlement of these amounts “[u]napproved change orders and claims . depends on individual circumstances and . . are included in contracts in process at negotiations with the counterparty; their estimated realizable value. [REC] accordingly, the timing of the collection has a contractual or legal basis for will vary and approximately $235 million pursuing recovery of these unapproved of collections are expected to extend change orders and claims and has beyond one year.” App. at 277. Any determined that collection is probable.” reasonable reading of this statement, Pl. Br. at 28 (quoting App. at 277, 293); would make one skeptical about the see also Pl. Br. at 7. Plaintiffs suggests recovery of the full $235 million. that Washington knew this statement was Similarly, as noted supra, the circular false, because in a March 27, 2000 emphasized that REC took an aggressive memorandum it indicated that it believed approach to revenue recognition. App. at the recovery percentage for one particular 126. When viewed in this context, we do project would be “poor” and that not believe that the plaintiffs have attempted recovery could result in a loss of adequately alleged that any knowing between $22 and $60 million. App. at misstatement Washington may have made 429. It should be noted, however, that the in print here was material. This is circular refers to a total of $581 million especially true given that Washington was worth of change orders and claims. App. at least partially indemnified by Raytheon at 276. Therefore, plaintiffs’ argument for losses associated with the very project comes down to the fact that Washington discussed in the March 27th memorandum. actually believed that between 3.8 and 10 See Supp. App. percent of these contracts were not In any case, because the statement recoverable. As far as we know, about collectability is a prediction of the Washington believed collection was likelihood of collection on change orders probable for at least 90-96 percent of these and claims, it is a classic forward-looking change orders. Moreover, far from having statement. See 15 U.S.C. 78u- actual knowledge that between $22 and 5c(4)(I)(1)(A) (defining a forward-looking $60 million of change orders would be statement, in part, as “a statement uncollectible, the March 27th containing a projection of revenues, memorandum suggests a lack of certainty income (including income loss), earnings or confidence in Washington’s predictions. (including earnings loss) per share, capital App. at 428 (“[P]rojects results are expenditures, dividends, capital structure, difficult to quantify”); Id. at 429 (“[I]t is or other financial items”); see also In re Kindred Healthcare, Inc. Sec. Litig., No. -14- 02CV-600-H, 2004 WL 77850 at *9 (W.D. Therefore, this statement is Ky. 2004) (“The amount Kindred keeps in reserves to cover liability claims is protected by the statutory safe- necessarily a prediction about its future harbor. See 15 U.S.C. 78u-5c. claims experience . . . [which] could only be verified when liability claims were 5.Goodwill actually filed, litigated to conclusion, or settled. It would seem rather beyond Plaintiffs also raise the statement in argument that such projections . . . are the circular that: “[a]djustments to the forward-looking within the meaning of the purchase price . . . are expected to have no PSLRA.”); In re Smith-Gardner Sec. effect on goodwill.” Pl. Br. at 28; App. at Litig., 214 F. Supp. 2d 1291, 1296 (S.D. 111. Plaintiffs argue that this statement is Fla. 2002) (finding that defendant’s false because “[d]efendants already knew statement was protected as forward- that the true value of REC was looking where “[p]laintiffs . . . allege[d] significantly lower than the purchase price, that Defendants either knew or were which would require further allocation of severely reckless in disregarding that goodwill.” Id. Regardless of this alleged Smith Gardner would not receive full knowledge, however, the circular payment from [a customer], based on the statement would only be false or unpaid receivable balance of $1.5 misleading if Washington knew at the time million.”). Moreover, we find the accompanying cautionary language to be the safe harbor provision, protects sufficient in this case. See EP forward-looking statements that are Medsystems, Inc. v. EchoCath, Inc., 235 accompanied by meaningful cautionary F.3d 865, 873 (3d Cir. 2000) statements from liability). Cautionary ("[C]autionary language, if sufficient, language must be “extensive and renders the alleged omissions or specific.” Semerenko v. Cendant Corp., misrepresentations immaterial as a matter 223 F.3d 165, 182 (3d Cir. 2000) of law.") (quoting In re Donald J. Trump (quoting In re Trump, 7 F.3d at 369. Casino Sec. Litig., 7 F.3d 357, 371 (3d Cir. This Court in In re Trump explained: 1993)).3 “[A] vague or blanket (boilerplate) 3 The PSLRA requires forward-looking disclaimer which merely warns the statements to be accompanied by reader that the investment has risks will “meaningful cautionary statements” in ordinarily be inadequate to prevent order for safe harbor protection to apply. misinformation. To suffice, the The cautionary language should be cautionary statements must be “directly related to the alleged substantive and tailored to the specific misrepresentations,” but it does not have future projections, estimates or opinions to “actually accompany the alleged in the prospectus which the plaintiffs misrepresentation.” EP Medsystems, Inc., challenge.” Id. at 182 (quoting In re 235 F.3d at 874 (referring to the Trump, 7 F.3d at 371-72). “bespeaks caution” doctrine which, like -15- it made the statement (a) that it was going “[d]efendants had already discovered to make adjustments to the purchase price significant additional liabilities.” Pl. Br. at in the future and (b) that those adjustments 28-29; App. at 93. This argument is would not track the value of REC. frivolous. First, this statement in the Plaintiffs have neither alleged nor have circular is included in a long discussion of they presented any evidence of such risks associated with the company, and in knowledge. Moreover, none of the that context, it is true and not misleading. documents relied upon by plaintiffs Moreover, none of the documents upon suggests that Washington even had actual which the plaintiffs rely suggests that knowledge that additional goodwill would Washington had actual knowledge that ultimately have to be recorded.4 The mere there were significant additional liabilities fact that the amount of additional goodwill which were not already reflected in the that later had to be recorded was circular, or for which Washington had not substantial is not enough, on its own, to been indemnified. App. at 93 (noting in infer either actual knowledge or the circular that Washington “generally recklessness. See Kushner v. Beverly seek[s] to minimize the impact of . . . Enters., 317 F.3d 820, 829 (8th Cir. 2003). liabilities by obtaining indemnities and Additionally, this is another forward- warranties from the seller.”) looking statement accompanied by meaningful cautionary language, and is 7.Due diligence therefore protected by the statutory safe- harbor. See, e.g., App. at 93 (warning that Finally, plaintiffs raise various acquisitions “may involve risk of omissions which fall within two undisclosed liabilities”). categories. First, plaintiffs allege that Washington failed to disclose that its due 6.Undiscovered liabilities diligence had been obstructed. While it is clear that REC initially obstructed The plaintiffs argue that the circular Washington’s due diligence, it seems that was misleading in stating that “[t]here may by the issuance of the circular, Washington be liabilities of acquired companies, believed, perhaps mistakenly, that it had including REC, that we fail or are unable been given adequate access. See, e.g., Due to discover during our due diligence Diligence Memorandum of April 3, 2000, investigation” because as plaintiffs allege, App. at 653 (noting that “[i]n most cases the first visits were not conclusive because site performance information was 4 Similarly, none of the documents relied restricted. The recent update visits were upon by plaintiffs suggest that more informative.”). Although we do not Washington had actual knowledge mean to suggest approval of the practice, contradicting its statement that “[t]he we note that it is not uncommon for a acquisition of REC will double target to be somewhat uncooperative with [Washington’s] size in terms of revenues respect to due diligence requests from a and backlog.” Pl. Br. at 27; App. at 117. potential acquirer. See, e.g., Larry -16- Schnapf, Cost Effective Due Diligence In unaudited financial statements for the first Corporate Mergers and Acquisitions, 15 quarter of 2000 should not be relied on.” Nat. Resources & Env't 80 at 83 (2000) Reply Br. at 7. First, we reiterate our (noting that even in a friendly takeover, earlier finding that plaintiffs have the target company may be reluctant to presented no evidence that Washington share information that may cause a party to had actual knowledge that the unaudited back out of a deal, renegotiate the price or financial statements for the 2000 stub that may end up having repercussions if period were unreliable. The plaintiffs’ the transaction collapses). Often this argument appears to be, however, that tendency towards secrecy relates to a Washington was reckless in disclosing concern, that if the deal falls through, the REC’s unaudited financial statements acquirer might use the target’s secrets to knowing that its earlier unaudited better compete with it, or that the target statements evidenced poor accounting. will be otherwise disadvantaged. Id. In This argument is not without some such situations, as here, the target will support. often become more cooperative and candid the closer the deal gets to becoming a In In re Lucent Tech., Inc. Sec. reality. We see no evidence in this case, Litig., 217 F. Supp. 2d 529 (D.N.J. 2002), however, that Washington believed its due the court found recklessness under similar diligence had been materially obstructed at circumstances. In Lucent, plaintiffs argued the time of the circular, nor do we believe that “Lucent management was already that Washington would have gone through aware that revenues had been inflated in with this acquisition had it believed this to previous quarters, and that they learned of be the case.5 There is simply nothing to these earlier accounting improprieties, at suggest that Washington was on a suicide the latest, during the third quarter.” Id. at mission in this acquisition. 554 (citations omitted). As here, plaintiffs in Lucent claimed that “Defendants would 8.Poor financial accounting have been at least reckless in reporting financial results for the third quarter Plaintiffs allege that Washington without first determining whether those “knew, but did not disclose, that Raytheon results were also inflated.” Id. The and REC had poor financial accounting, district court agreed, finding that “[i]f which necessarily entailed that the Defendants were aware that accounting manipulations occurred during the first two quarters of 2000, then, conceivably, 5 In fact, we doubt that we would be they may have been reckless in blindly able to uncover any offering circular reporting results for the following quarter, which cautioned that due diligence had and proof of recklessness is enough.” Id. been materially obstructed by the target and that this issue was still unresolved, While such a scenario may very given that it seems unlikely that any well constitute recklessness under the facts acquirer would proceed with an of Lucent, we do not believe that acquisition under such circumstances. -17- Washington’s conduct here rises to the substituted different financial statements. “extreme departure from the standards of At most, it could have included an ordinary care” which is required for a additional cautionary note. While the finding of recklessness. In re Advanta, inclusion of such a note may have been a 180 F.3d at 535 (quoting McLean, 599 good idea, we do not believe its omission F.2d at 1197). First, the circular contained rises to the level of recklessness required both audited and unaudited financial under the PSLRA. statements for some overlapping periods as well as for periods closely linked in time. In conclusion, plaintiffs have failed See, e.g., App. at 126, 288. Therefore, to to plead with particularity the required the extent that the unaudited statements element of scienter, either by were out of line with the audited demonstrating motive and opportunity, statements, this deviation could be conscious misbehavior or recklessness. deduced from the circular itself, obviating Therefore, the district court properly the need for a special note. granted Washington's motion to dismiss.

Second, as noted earlier, C. Credit Suisse First Boston Washington disclosed in the circular that REC’s accounting was aggressive. App. at The plaintiffs allege that CSFB 126. This would give any reasonable conducted its own due diligence, had investor pause before relying on REC’s access to Washington’s due diligence and unaudited statements. Third, plaintiffs communicated with Washington about due have shown at most that Washington diligence findings. They further allege believed REC had “poor” accounting that, because CSFB had access to and practices. App. at 554 (March 14, 2000 shared information with Washington, presentation) (noting that REC had “[p]oor CSFB “knew and/or recklessly disregarded financial controls/accounting practices”). all of the information known by In contrast, in Lucent, plaintiffs alleged Washington Group and the other that before it reported its earnings for the Defendants.” App. at 43, 53 (Cplt. ¶¶ 43, fourth quarter, Lucent already knew that it 85). This a bare bones allegation, and the “had improperly booked hundreds of plaintiffs fail to specify which statements millions of dollars of revenue on sales to CSFB knew were false or misleading. customers in situations where customers Furthermore, as noted supra, an allegation had not ordered products”—clearly a more that CSFB “must have known,” because of egregious allegation. In re Lucent Tech., its relationship with Washington, that a 217 F. Supp. 2d at 538. Finally, in Lucent, statement was false or misleading, is the alleged manipulations were in the insufficient to raise a “strong inference” company’s own balance sheet, rather than that CSFB acted recklessly or with on the balance sheet of the company to be conscious misbehavior. See In re Advanta, acquired, as in this case. Therefore, unlike 180 F.3d at 539. The plaintiffs cannot Lucent, Washington realistically could not satisfy the scienter requirement by have revised REC’s financial statements or grouping CSFB with the Washington -18- defendants. Oran, 226 F.3d at 290; In re D. Dismissal with prejudice Advanta, 180 F.3d at 539 (“Generalized imputations of knowledge do not suffice . The plaintiffs ask that the case be . .”). Regardless, since the plaintiffs have remanded with instructions to allow them failed to show scienter with respect even to to replead, yet they “do not specify what Washington, the plaintiffs certainly cannot additional facts, if any, they would plead if establish scienter with respect to CSFB, given another opportunity to amend their since the plaintiffs have made no Complaint.” In re NAHC, 306 F.3d at 1332 allegation unique to CSFB. (holding that amendment of the complaint would be futile). One of Congress’ Finally, the plaintiffs have failed to objectives in enacting the PSLRA was “‘to attribute any false statement or omission to provide a filter at the earliest stage (the CSFB. The plaintiffs rely on Gabriel pleading stage) to screen out lawsuits that Capital, L.P. v. NatWest Fin., Inc., 94 F. have no factual basis.” Id. (quoting In re Supp. 2d 491 (S.D.N.Y. 2000), for their Champion Enters., Inc., Sec. Litig., 145 F. argument that CSFB can be held liable as Supp. 2d 871, 874 (E.D. Mich. 2001). an initial purchaser for a Rule 10b-5 This objective would be frustrated where violation. The district court correctly “there is a stark absence of any suggestion noted that Gabriel is distinguishable on its by the plaintiffs that they have developed facts. In Gabriel, the plaintiffs alleged that any facts since the action was commenced the defendants, in addition to being the which would, if true, cure the defects in initial purchasers, also drafted the offering the pleadings under the heightened memorandum as well as distributed it requirements of the PSLRA.” Id. at 1333. during sales pitches. Id. at 502. The Because the plaintiffs have offered no plaintiffs here do not allege that CSFB additional facts that would cure their drafted or distributed the circular. amended complaint, we decline the Therefore, the holding of Gabriel is not plaintiffs' request for permission to replead applicable here.6 and for the foregoing reasons, we affirm the district court's grant of defendants’ 6 Gabriel is distinguishable for motion to dismiss. another reason. In Gabriel, the disclaimer in the offering memorandum stated only that the initial purchasers made “no warranty” as to the statements contained therein. Id. Here, in contrast, the offering circular states that the initial circular is, or shall be relied upon as, a purchasers made “no representations” at promise or representation by the initial all. App. at 74 (“No representations or purchasers.”) While this subtle warranty, express or implied, is made by difference in language is hardly the initial purchasers as to the accuracy dispositive, it adds to our conclusion that or completeness of the information Gabriel does not apply and that CSFB contained in this offering circular. did not make any actionable statement. Nothing contained in this offering -19-