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.