357 F.3d 322 | 3rd Cir. | 2004
District Judge SMITH, Circuit Judge __________
This securities class action lawsuit Argued November 4, 2003 arises out of the acquisition of Digital __________ Island, Inc. by Cable & Wireless, PLC (“C&W”). Pursuant to a May 14, 2001
Before: MCKEE, SMITH, and WEIS, Merger Agreement between Digital Island Circuit Judges and C&W , Dali Acquisition Corp. (“Dali”), a wholly-owned subsidiary of
(Opinion Filed February 6, 2004) C&W, made a cash tender offer to shareholders of Digital Island under which Jeffrey G. Smith Robert Abrams [Argued] it acquired 80 percent of the shares of Wolf, Haldenstein, Adler, Freeman & Herz Digital Island. Dali was thereafter merged 270 Madison Avenue
into Digital Island, which survived as a New York, NY 10016 wholly-owned subsidiary of C&W. Pamela S. Tikellis Plaintiffs filed a Consolidated Chimicles & Tikellis Amended Class Action Complaint (the “Complaint”) on May 15, 2002. Plaintiffs received “extra consideration” for their in this case represent a class comprised of shares in violation of Section 14(d)(7) of all persons, other than the named the ‘34 Act, 15 U.S.C. § 78n(d)(7), and defendants and certain related parties, who Securities and Exchange Commission owned Digital Island common stock (“SEC”) Rule 14d-10, the so-called “Best during the relevant period and who Price Rule,” 17 C.F.R. § 240.14d-10(a). received the tender offer. [1] Defendants are Plaintiffs allege both individual violations Digital Island, members of Digital Island’s by Defendants of these provisions, as well Board of Directors during the relevant as “control person liability” under Section time period, including Digital Island’s 20(a) of the ‘34 Act. 15 U.S.C. § 78t(a). CEO, Ruann Ernst (the “Directors”), [2] C&W, C&W ’s CEO, Graham Wallace, [3] The District Court dismissed and Dali. Plaintiffs allege that, in Plaintif f s’ c o n s o l id a t e d a m e n d ed connection with the tender offer, complaint, with prejudice, for failure to Defendants made misleading statements state a claim pursuant to Fed. R. Civ. P. and failed to disclose material information 12(b)(6) and the Private Securities in violation of Section 14(e) of the Litigation Reform Act of 1995 (the Securities and Exchange Act of 1934 (the “PSLRA”), 15 U.S.C. § 78u-4. In re “‘34 Act”), as amended by the W illiams Digital Island Sec. Litig. , 223 F. Supp. 2d Act of 1968. 15 U.S.C. § 78n(e). 546 (D. Del. 2002). By a subsequent Plaintiffs further allege that the Directors order, the District Court denied Plaintiffs’
motion, pursuant to Fed. R. Civ. P. 59(e), which sought to alter the court’s judgment [1] Individual complaints were filed by and to permit Plaintiffs to file an amended shareholders of Digital Island in late complaint under Fed. R. Civ. P. 15(a). January and early February of 2002. On Because we conclude that Plaintiffs’ April 16, 2002, the District Court granted proposed Second Consolidated Amended Plaintiffs’ Joint Motion for Consolidation, Class Action Complaint (the “proposed amended Complaint”) does not articulate Appointment of Lead Plaintiff and Appointment of Lead Counsel. a viable theory of fraud, we will affirm
both orders of the District Court. [2] The other Directors are: Charlie Bass, Christos Cotsakos, Mary Cirillo-Goldberg,
I.
G. Bradford Jones, Robert Marbut, Shahan Soghikian, Don Reed, Mike McTighe,
The following facts are drawn from Robert Drolet, Avery Duff, and Marc the proposed amended Complaint and Lefar. from Digital Island’s Securities and Exchange Commission (“SEC”) Form [3] Defendant Wallace also served as a 14D-9, which is referenced in the proposed member of Digital Island’s board amended Complaint and included in the beginning on July 16, 2001. $3.40 per share. [4] Digital Island made a Joint Appendix. See Oran v. Stafford , 226 F.3d 275, 289 (3d Cir. 2000) (taking counter-proposal of $4.10 per share, which judicial notice of documents required by was rejected by C&W . On May 13, 2001, law to be filed with the SEC). Digital the Digital Island board met and voted Island provides a global e-business unanimously to approve the execution of delivery network and suite of services for the Merger Agreement with a per share enterprises that use the internet to deploy tender offer price of $3.40 and to business applications and conduct e- recommend to the shareholders that they commerce. Digital Island began searching accept the tender offer. for a potential acquirer in August of 2000, at which time representatives of Digital On May 14, 2001, Digital Island Island contacted representatives of C&W and C&W executed the Merger to gauge C& W’s interest in a strategic Agreement, which contemplated a first partnership with Digital Island. In March step tender offer followed by a second step of 2001, C&W indicated that it was merger. Under the tender offer, interested in a potential business shareholders who tendered their shares combination with Digital Island. In April were to receive $3.40 per share. Under the of 2001, C&W delivered an initial draft of merger, all remaining shares of Digital the Merger Agreement and made an initial I sland wo uld be c a nce le d , and offer to purchase Digital Island for $2.25 shareholders would receive $3.40 per a share. After considering the offer and share. The tender offer period expired on meeting with its financial advisors, Digital June 18, 2001, and on June 19, 2001, Island advised C&W that it was prepared D i g i t a l I s l a n d a n n o u n c e d t h a t to begin negotiations, provided that the appro xima tely 80 percent of it s offer price was increased to at least $3.25. outstanding stock had been tendered.
Negotiations between Digital Island Plaintiffs’ Section 14(e) claim is and C&W continued through April and based on two significant business deals into May, but C&W would not agree to that were announced immediately after the raise its offer to $3.25 per share. On May expiration of the tender offer. On June 20, 10, 2001, Digital Island announced an 2001, Digital Island announced a major agreement to provide certain business business agreement with Bloomberg LP, services to Microsoft Corporation. The and on July 2, 2001, Digital Island price of Digital Island’s stock rose that day announced anoth er major business from $2.00 per share to $3.69 per share. agreement with Major League Baseball On May 11, 2001, representatives of C&W indicated that C&W’s board of directors [4] According to information submitted in had preliminarily approved an offer of the Joint Appendix, Digital Island’s stock dropped to $3.13 at the close of trading on May 11.
(“MLB”). According to Plaintiffs, both MLB deals because the success of the the Bloomberg and MLB deals had tender offer and resulting merger created a substantial value to Digital Island, and, if windfall for Defendants that was not disclosed, would have substantially enjoyed by Digital Island’s other influenced the shareholders’ decision to shareholders. Specifically, Plaintiffs tender their shares. [5] allege that, pursuant to the merger, the
Directors received substantial cash Plaintiffs allege that Defendants payments for outstanding options to knew of the Bloomberg and MLB deals purchase Digital Island common stock, as prior to expiration of the tender offer, but well as for their shares of restricted deliberately or recklessly failed to disclose common stock. Additionally, Plaintiffs the deals until after the expiration of the allege that CEO Ernst had executed a tender offer. Plaintiffs argue that lucrative contract for employment to serve Defendants had an affirmative duty to as President and CEO of the surviving entity. [6] disclose the Bloomberg and MLB deals, or, alternatively, that Defendants’ failure to mention those deals in the tender offer Such extra consideration was given and the Schedule 14D-9 rendered those to Digital Island officers and docu men ts mate rially m isleadin g. directors in order to induce them to Plaintiffs allege that Defendants were support the Offer to Purchase at the motivated to suppress the Bloomberg and $3.40 price per share and to
withhold the announcement of the Bloomberg and Major League [5] Plaintiffs’ prediction is based on the Baseball deals until after the increase in value of Digital Island stock expiration of the Offer to Purchase that occurred after announcement of the in order to preclude the need for Microsoft deal. The actual disclosure of C&W to increase the consideration the Bloomberg and MLB deals does not in the Offer to Purchase. appear to have affected the price of Digital Island stock. Plaintiffs explain that the App. at 338. According to Plaintiffs, The District Court dismissed the disclosure of the Bloomberg and MLB Complaint on September 10, 2002, for deals threatened to derail the merger with failure to state a claim. The District Court C&W: held that Plaintiffs’ Section 14(e) claim
failed to meet the heightened pleading If the announcement induced more requirements of the PSLRA in two than 50 percent of Digital Island respects: (1) the Complaint did not stockholders not to tender their identify with specificity the statements that shares, the Merger would not be were allegedly misleading, and (2) the consummated and the Digital Island Complaint did not plead facts giving rise officers would lose their lucrative to a strong inference of scienter. 15 employment agreements, as well as U.S.C. § 78u-4(b). The District Court the extra consideration for their further held that Plaintiffs failed to state a shares. Thus, any announcement claim for violation of the Best Price Rule concerning the Bloomberg or because that provision applies only to Major League Baseball Deals payments made during a tender offer, and carried with it the threat of the extra consideration alleged by u n d e r m i n i n g t h e M e r g e r Plaintiffs was received pursuant to Agreement. agreements executed prior to the tender
offer. Finally, the District Court dismissed App. at 352. Plaintiffs’ “control person liability” claim because (1) the predicate violations on In addition to their Section 14(e) which that claim was based ( i.e ., the claim, Plaintiffs allege that, by virtue of Section 14(e) and Best Price Rule claims) these cash payments and the Ernst were dismissed, and (2) because Plaintiffs employment agreement, the Directors failed to allege facts sufficient to establish received “extra consideration” for their control and/or culpable participation. shares in violation of Section 14(d)(7) of the ‘34 Act and the SEC’s Best Price Rule. Plaintiffs filed a Motion to Alter Plaintiffs allege individual violations by Judgment and For Leave to File An Defendants of Sections 14(e) and the Best Amended Complaint under Fed. R. Civ. P. Price Rule, as well as “control person 59(e) and 15(a). The District Court denied liability” under Section 20(a) of the ‘34 Plaintiffs’ motion on November 25, 2002. Act. [7] The District Court concluded that
P l a in t i f fs h a d d e l i b e r a t e l y a n d unreasonably delayed seeking leave to [7] The Complaint also alleges that amend until after judgment had been Defendants issued a false and misleading entered on the motion to dismiss. proxy statement in violation of Section 14(a) of the ‘34 Act. Plaintiffs do not appeal dismissal of this claim.
Plaintiffs timely appealed both Claim. Although the stay of proceedings orders on December 23, 2002. [8] The against Digital Island and Dali does not District Court had subject matter affect our reasoning, it does mean that our jurisdiction under 28 U.S.C. § 1331 and 15 decision today does not reach either entity. U.S.C. § 78aa. This Court has jurisdiction over the District Court’s order dismissing II. Plaintiffs’ Complaint under 28 U.S.C. § 1291 because the Complaint was Section 14(e) of the ‘34 Act dismissed with prejudice. Manze v. State provides, in pertinent part: Farm Ins. Co. , 817 F.2d 1062, 1064 (3d Cir. 1987). This Court also has It shall be unlawful for any person jurisdiction under section 1291 over the to make any untrue statement of a District Court’s denial of Plaintiffs’ post- material fact or omit to state any judgment motion for leave to amend. See material fact necessary in order to Foman v. Davis , 371 U.S. 178 (1962); N. make the statements made, in the River Ins. Co. v. CIGNA Reinsurance Co. , light of the circumstances under 52 F.3d 1194, 1203 (3d Cir. 1995). We which they are made, not review de novo a District Court’s misleading, or to engage in any dismissal of a complaint for failure to state f r a u d u l e n t , d e c e p t i v e , o r a claim under Fed. R. Civ. P. 12(b)(6). manipulative acts or practices, in Ramsgate Court Townhome Ass’n v. West connection with any tender offer . . Chester Borough , 313 F.3d 157, 158 (3d . . Cir. 2002).
15 U.S.C. § 78n(e). The District Court On December 8, 2003, after oral held that Section 14(e) requires proof of argument in this case, the successor entity scienter, i.e. , “a mental state embracing to the merger of Digital Island and Dali intent to deceive, manipulate, or defraud.” filed for Chapter 11 Bankruptcy in the Ernst & Ernst v. Hochfelder , 425 U.S. 185, District of Delaware. Under 11 U.S.C. § 193 n.12 (1976). Both parties appear to agree. [9] 362(a), this filing operates to stay all proceedings against Digital Island and Dali. Digital Island is a defendant in Section 14(e) is “modeled on the Plaintiffs’ Section 14(e) claim, and Dali is antifraud provisions of § 10(b) of the [‘34] a defendant in Plaintiffs’ Best Price Rule Act and Rule 10b-5,” Schreiber v. Burlington Northern, Inc. , 472 U.S. 1, 10 justified under a traditional Rule 12(b)(6) (1985), which require proof of scienter, analysis.”); see also Greebel v. FTP Ernst & Ernst , 425 U.S. at 193. Because Software, Inc. , 194 F.3d 185, 196 (1st Cir. of the similarity in the language and scope 1999) (“A mere reasonable inference is of Section 14(e) and Rule 10b-5, we have insufficient to survive a motion to in the past construed the two consistently. dismiss.”). For purposes of the PSLRA, E.g., Flynn v. Bass Bros. Enters., Inc. , 744 Plaintiffs may plead scienter by alleging F.2d 978, 984-85 (3d Cir. 1984) (adopting facts that (1) establish a motive and an the same test of materiality for both opportunity to commit fraud, or (2) Section 14(e) and Rule 10b-5). We constitute circumstantial evidence of either therefore join those circuits that hold that reckless or conscious behavior. In re scienter is an element of a Section 14(e) Advanta Corp. Sec. Litig ., 180 F.3d 525, claim. See, e.g., Conn. Nat’l Bank v. Fluor 534-35 (3d Cir. 1999). Either way, Corp. , 808 F.2d 957, 961 (2d Cir. 1987); plaintiffs must plead f acts “w ith Smallwood v. Pearl Brewing Co. , 489 F.2d particularity,” and these facts must give 579, 605 (5th Cir. 1974) (“Congress rise to a “strong inference” of a knowing adopted in Section 14(e) the substantive or reckless misstatement. Id. at 535. language of the second paragraph of Rule 10b-5 and in so doing accepted the A. precedential baggage those words have carried over the years.”). Plaintiffs’ theory of the case is that
the Directors and CEO Wallace suppressed The PS LR A establishes a the Bloomberg and MLB deals to ensure heightened pleading requirement for the success of the tender offer and the subsequent merger. [10] When the tender certain securities fraud cases. The PSLRA requires plaintiffs to “state with particularity facts giving rise to a strong [10] We agree with the District Court that, inference that the defendant acted with the absent a duty to correct or update required state of mind.” 15 U.S.C. § 78u- misleading statements, Plaintiffs failed to 4(b)(2). In requiring a “strong inference” identify an affirmative duty to disclose the of scienter, the PSLRA alters the normal Bloomberg and MLB deals. Oran , 226 operation of inferences under Fed. R. Civ. F.3d at 285-86 (“Such a duty to disclose P. 12(b)(6). In re Rockefeller Ctr. Props., may arise when there is insider trading, a Inc. Sec. Litig. , 311 F.3d 198, 224 (3d Cir. statute requiring disclosure, or an 2002) (“[U]nless plaintiffs in securities inaccurate, incomplete or misleading prior fraud actions allege facts . . . with the disclosure.”); In re Burlington Coat requisite particularity . . . they may not Factory Sec. Litig. , 114 F.3d 1410, 1432 benefit from inferences flowing from (3d Cir. 1997) (“Except for specific vague or unspecific allegations— periodic reporting requirements . . . there inferences that may arguably have been is no general duty on the part of a company offer succeeded, the merger cashed out various options to purchase shares of common stock as well as shares of restricted common stock held by the
to provide the public with all material Directors. According to Plaintiffs, the information.”). Because we conclude that prospect of cashing out these holdings Plaintiffs have failed to adequately plead induced the Directors to suppress scienter, we do not decide whether the information that would have raised the proposed amended Complaint adequately value of Digital Island’s shares. Such an specifies the statements alleged to be increase, Plaintiffs allege, would have misleading and the reason why those jeopardized the Merger Agreement statements are misleading, or whether the because shareholders would not have proposed amended Complaint properly tendered at $3.40 and C&W would not attributes those statements to any of the have increased the consideration offered. Defendants in this case. See Rockefeller , CEO Ernst’s lucrative employment 311 F.3d at 217-18 (discussing the contract with the surviving entity provided pleading requirements of the PSLRA and her with a further inducement. Fed. R. Civ. P. 9(b)). Setting aside the Ernst employment The District Court further dismissed agreement, the Directors stood to gain the Section 14(e) claim as to C&W , Dali, from any increase in Digital Island’s share and Wallace, because those defendants price in the same manner as any other were not affiliated with Digital Island and Digital Island shareholder, that is, by therefore owed no duty to Digital Island’s tendering their shares into the offer or by shareholders to disclose the Bloomberg having their shares cashed out in the and IBM deals. Plaintiffs make no merger. Moreover, our reading of the argument in their briefs that dismissal was proposed amended Complaint compels the erroneous as to C&W and Dali and have same conclusion reached by the District therefore abandoned these issues. Kost v. Court: “As a result of the tender offer and Kozakiewicz , 1 F.3d 176, 182 (3d Cir. merger, each [Director] was paid the face 1993). Plaintiffs do maintain that value of the options, i.e. , the difference, if Defendant Wallace violated Section 14(e) any between the option price and $3.40.” by failing to disclose the two deals. Digital Island , 223 F. Supp. 2d at 550. Plaintiffs make no argum ent that Nevertheless, Plaintiffs argue that the Defendant Wallace owed a duty to correct success of the tender offer created a or update statements that he did not make windfall for the Directors because it and over which he had no control. allowed them to unload their holdings all Accordingly, we will affirm the District Court’s dismissal of the Section 14(e) claim as to Wallace on the grounds that he was under no duty to disclose the Bloomberg and MLB deals. at once, at a guaranteed price of $3.40 a Granting that some value might share. [11]
attach to the avoidance of future risk, or that only so many shares can be unloaded on the open market without depressing the [11] The allegations in the proposed share price, Plaintiffs’ theory is amended complaint emphasize the fact that nevertheless a weak inference teetering on the merger cashed out both vested and an unfounded assumption. Kalnit v. unvested options and restricted stock: Eichler , 264 F.3d 131, 139-40 (2d Cir. 2001) (“Sufficient motive allegations
First, the Digital Island officers and ‘entail concrete benefits that could be directors were to receive substantial realized by one or more of the false cash payments in connection with statements and wrongful nondisclosures the Merger for their in-the-money alleged.’” (quoting Shields v. Citytrust options to purchase Digital Island Bancorp., Inc. , 25 F.3d 1124, 1130 (2d common stock. This applied to Cir. 1994)). The inference is that the both vested and unvested options. Directors feared that C&W would abandon In addition, the officers of Digital its efforts to acquire Digital Island if the Island were to receive cash in share price increased. Plaintiffs argue that connection with the Merger in this fear can be inferred from C&W’s return for certain re stricted rejection of Digital Island’s $4.10 counter- common stock which they had been proposal, and from the fact that the merger granted in April 2001, several agreement was hastily executed within weeks prior to the Merger days of the disclosure of the Microsoft announcement, in return for their deal. Whether or not this inference is out-of-the money options. reasonable under Rule 12(b)(6), the PSLRA requires a strong—as opposed to
App. at 351. Plaintiffs do not allege that merely reasonable—inference to survive a the Directors received any sort of motion to dismiss. See Rockefeller , 311 accelerated payment for their holdings, F.3d at 224. The inference urged by i.e. , that any payment was made prior to Plaintiffs is not strong, because the far their vesting. Nor are there any allegations regarding the circumstances or purpose of the April 2001 option exchange program. and restricted stock, whether vested or Instead, our reading of the proposed unvested, was necessarily tied to the amended Complaint leads us to the same market value of Digital Island’s common conclusion as the District Court: the stock. While other eventualities might Directors received the face value of their have decreased Digital Island’s share price options and restricted stock pursuant to a before these holdings vested, such open- merger in which all outstanding securities ended speculation is entirely insufficient to of Digital Island were cancelled. More support a strong inference of motive under fundamentally, the value of these options the PSLRA. Rockefeller , 311 F.3d at 222. more compelling inference is that the Regardless of the strength of this Directors bargained aggressively with inference, it rests on an assumption, C&W, motivated solely by a desire to devo id of any fac tual alle gation exploit the surge in Digital Island’s stock whatsoever, that the Directors would be price that followed the announcement of worse off if C&W withdrew its offer. Yet the Microsoft deal. If the Directors were Plaintiffs’ theory of the case necessarily confident of the Bloomberg and MLB requires that disclosure of the MLB and deals before the merger agreement was Bloomberg Deals would have increased finalized, they would certainly have the market value of Digital Island stock disclosed those deals to support their absent the merger. Accordingly, to counter-offer. [12] If instead, the Bloomberg establish a strong inference of motive, and MLB deals were finalized after Plaintiffs were obliged to allege some facts execution of the merger agreement, tending to show how the Directors could C&W’s rejection of the counter-offer have hoped to make out better by could have no bearing on how C&W unloading their options and restricted stock would react to the deals. Rather, C&W’s than by realizing the impact of the decision to increase the tender offer price Bloomberg and MLB deals on their shares, following the Microsoft deal would either in the market or in a merger with indicate that C&W might respond another suitor. See Advanta , 180 F.3d at favorably to the Bloomberg and MLB 540-41 (no strong inference of scienter deals. where detailed allegations revealed that
allegedly improper profits were small in comparison to defendants’ stock holdings); Burlington Coat Factory , 114 F.3d at 1423 (noting that plaintiffs had failed to plead [12] Plaintiffs equivocate on when the facts showing that allegedly improper Bloomberg and MLB deals became profits were substantial in comparison to sufficiently certain to merit disclosure. defendants’ overall stock holdings and Plaintiffs generally allege that the deals compensation). [13] Considering all the were close to completion sometime during allegations in Plaintiffs’ proposed the tender offer period. Plaintiffs, amended Complaint, we agree with the however, imply that the deals were District Court that “plaintiffs’ theory sufficiently final sometime prior to execution of the merger agreement, insofar makes little economic sense because the The rationale underlying these directors’ own stock options would have holdings is straightforward. Similar been devalued if they tried to sell the situations arise in every merger; company for less than full price.” Digital thus, allowing a plaintiff to prove a Island , 223 F. Supp. 2d at 555. The motive to defraud by simply proposed amended Complaint therefore alleging a corporate defendant’s does not allege facts giving rise to a strong desire to retain his position with its inference that the Directors acted with attendant salary . . . would force the scienter in not disclosing the Bloomberg directors of virtually every and MLB deals in their statements company to defend securities fraud regarding the tender offer. actions, every time that company
effected a merger or acquisition. The Ernst employment agreement does little to strengthen the inference of Accord Kalnit , 264 F.3d at 139-40 (“[A]n motive that can be drawn from Plaintiffs’ allegation that defendants were motivated allegations. As with the Directors’ stock by a desire to maintain or increase holdings, Plaintiffs allege no facts from executive compensation is insufficient which it can be inferred that the because such a desire can be imputed to all employment agreement actually created a corporate officers.”). Because Plaintiffs’ windfall to Ernst beyond what she would a l l eg a t i o n s r e g a r d in g t h e E r n st otherwise realize by an increase in the employment agreement do nothing to value of her shares. More fundamentally, distinguish her motivations from those the fact that CEO Ernst had executed an surrounding countless other mergers and employment agreement with the acquirer acquisitions, the proposed amended cannot, in and of itself, establish a strong Complaint fails to create a strong inference inference of motive. As the Fourth Circuit of scienter as required by the PSLRA. explained in Phillips v. LCI Int’l, Inc. , 190 F.3d 609, 622-23 (4th Cir. 1999): B.
[A]ssertions that a corporate officer A reckless statement is one or director committed fraud in “involving not merely simple, or even order to retain an executive inexcusable negligence, but an extreme position, or retain such a position departure from the standards of ordinary with the merged company, simply care, and which presents a danger of do not, in themselves, adequately misleading buyers or sellers that is either plead motive. . . . known to defendant or is so obvious that
the actor must have been aware of it.” Advanta , 180 F.3d at 535. Allowing Plaintiffs to plead recklessness is intended to “discourage[] deliberate ignorance and
prevent[] defendants from escaping Where any person varies the terms liability solely because of the difficulty of of a tender offer . . . before the proving conscious intent to commit fraud.” expiration thereof by increasing the Id. Scienter therefore requires “a consideration offered to holders of misrepresentation so recklessly made that such securities, such person shall the culpability attaching to such reckless pay the increased consideration to conduct closely approaches that which each security holder whose attaches to conscious dec eptio n.’” securities are taken up and paid for McLean v. Alexander , 599 F.2d 1190, pursuant to the tender offer . . . . 1197 (3d Cir. 1979) (quoting Coleco 15 U.S.C. § 78n(d)(7). [14] SEC Rule Indus., Inc. v. Berman , 567 F.2d 569, 574 (3d Cir. 1977) (per curiam)). Recklessness 14d-10(a)(2), the “Best Price Rule,” is not intended to encompass “claims implements Section 14(d)(7) and provides: essen tially grounded on corporate “No bidder shall make a tender offer mismanagement.” Advanta , 180 F.3d at unless . . . [t]he consideration paid to any 540. security holder pursuant to the tender offer
is the highest consideration paid to any We agree with the District Court other security holder during such tender that Plaintiffs’ allegations fail to create a offer.” 17 C.F.R. § 240.14d-10(a). strong inference of recklessness. Because Plaintiffs allege that the Directors received Plaintiffs’ allegations show that “extra consideration” for their shares when Defendants’ interests were at all times tied their options and restricted stock were to the value of their shares, we have no cashed out in the merger pursuant to the basis to infer the sort of conscious disregard and deliberate ignorance required to plead scienter. At most, Plaintiffs’ allegations show that the [14] Plaintiffs do not appeal dismissal of Directors failed to exploit the potential that this claim as to Digital Island or any of the the Bloomberg and MLB deals had to individual defendants other than Wallace. increase the value of Digital Island shares, As the District Court recognized, the Best whether through the tender offer price paid Price Rule, by its terms, only applies to by C&W or on the open market. Such bidders. Digital Island , 223 F. Supp. 2d at alleged mismanagement does not fall 556. On appeal, Plaintiffs offer no within the anti-fraud prohibitions of explanation why Defendant Wallace Section 14(e). should be considered a bidder. We therefore will affirm the District Court’s
IV.
dismissal of the Best Price Rule claim with respect to Defendant Wallace on the
Section 14(d)(7) of the ‘34 Act ground that Defendant W allace is not a provides, in pertinent part: bidder within the meaning of the rule. Merger Agreement. [15] In addition, C.F.R. § 240.14d-10(a). The District Plaintiffs allege that the employment Court and Defendants rely heavily on agreement between C&W and CEO Ernst Lerro v. Quaker Oats Co. , 84 F.3d 239, further constituted a premium for her 245 (7th Cir. 1996), in which the Seventh shares. There is no dispute that both the Circuit held that “transactions before or Merger Agreement and the Ernst after a tender offer are outside the scope of Employment agreement were executed Rule 14d-10.” The plaintiff in Lerro prior to the tender offer. alleged that a controlling shareholder had
received extra compensation for his shares The District Court adopted, and in the form of an exclusive distribution Defendants urge this Court to adopt, a agreement executed by the tender offeror “bright-line rule” that payments arising out and the controlling shareholder prior to the of an agreement executed prior to a tender tender offer. Id. at 240. The agreement offer do not state a claim under the Best was to commence upon consummation of Price Rule, which expressly applies only to the offer. Id. The court held that the value payments made “during a tender offer.” 17 of the distribution agreement did not
constitute extra compensation in violation of the Best Price Rule because the [15] The proposed amended Complaint agreement was signed before the offer alleges that this consideration exceeds that began. Id . at 244. The court reasoned: received by other Digital Island shareholders, although Plaintiffs make no
Before the offer is not “during” the allegation that Digital Island’s outstanding offer. . . . The difference between options and restricted stock were held “during” and “before” (or “after”) exclusively by the Directors. is not just linguistic. It is essential to permit everyone to participate in
Curiously, Plaintiffs argue in their the markets near the time of a brief that we should read the proposed tender offer. Bidders are forbidden amended Complaint to allege that the extra to buy or sell on the open market or payment was made when the Directors via negotiated transactions during tendered their shares. If that is the case, an offer, but they are free to we do not understand how the Directors transact until an offer begins, or could h a v e r e c e iv e d the ex tra immediately after it ends. consideration alleged by Plaintiffs, which is premised on the allegation that those
Id . at 243; see also Katt v. Titan options were partially unvested at the time Acquisitions, Inc. , 244 F. Supp. 2d 841, of the merger. If the Directors did indeed 850 (M.D. Tenn. 2003) (stating that Rule exercise their options, to the extent vested, 14d-10 “is, on its face, ‘aimed at conduct they were simply paid the tender price for during the pendency of the tender offer’” each share tendered like every other (quoting Walker v. Shield Acquisition shareholder. Corp. , 145 F. Supp. 2d 1360, 1375 (N.D. after it accepted all of the tendered Ga. 2001))). shares before paying the favored
shareholders. Plaintiffs urge this Court to adopt a more flexible rule that focuses on whether Id . at 655. Epstein held that the proper the allegedly improper payment is an focus should be “whether the . . . integral part of the tender offer. For their transaction was an integral part of [the] tender offer.” Id . [17] part, Plaintiffs rely on Epstein v. MCA, Inc. , 50 F.3d 644 (9th Cir. 1995), in which the Ninth Circuit rejected the argument We agree with the Seventh Circuit that Rule 14d-10 turns on the timing of the and the District Court that the market payment. Epstein did not involve an requires a bright-line rule “to demark agreement executed prior to the tender clearly the periods during which the will enter into a wide variety of special Williams Act rules apply.” Lerro , agreements, including agreements with 84 F.3d at 243. W e also agree with shareholders, that are conditioned on the Epstein that tender offerors cannot be success of the tender offer. The Ernst permitted to evade the requirements of the employment agreement is a perfect Williams Act simply by delaying the actual example: An offeror who intends to payment, or by agreeing on the extra operate a company as a going concern payment beforehand. Indeed, Lerro itself after the acquisition may reasonably acknowledges that some payments made attempt to secure the services of outside of the tender offer period may be incumbent management. Only where the so transparently fraudulent as to require tender offeror deliberately inflates that them to be treated as made “during the compensation to provide a premium for the tender offer”: officer’s shares is there a violation of the
Best Price Rule. In such instances, the Doubtless there are limits to the use tender offeror has attempted to defraud the of a follow-up merger as a means to shareholders of the target company of the deliver extra com pe nsa tion. equal consideration to which they are Suppose [the acquirer] had entitled under the Williams Act and the promised [a shareholder] $14 for Best Price Rule. each share he tendered during the offer, plus another $6 for each of Accordingly, in order to base these shares one month later. Just recovery under the Best Price Rule on a as tax law requires “boot” to be transaction execute d prior to the treated as a gain received from the commencement of a tender offer, Plaintiffs sale of stock, securities law treats must comply with Fed. R. Civ. P. 9(b), “boot” as a payment during the which requires that “[i]n all averments of tender offer. fraud or mistake, the circumstances
constituting fraud or mistake shall be Lerro , 84 F.3d at 245. Nevertheless, the stated with particularity.” See Shapiro v. exception to the general rule is a narrow UJB Fin. Corp. , 964 F.2d 272, 287-89 (3d one, and Plaintiffs’ allegations do not fall Cir. 1992) (holding that Rule 9(b) applies within it. to claims under Sections 11 and 12(2) of
the Securities and Exchange Act of 1933, Where, as here, a plaintiff argues 15 U.S.C. §§ 77k, 77l, when those claims that the Best Price Rule has been violated are grounded in fraud). Rule 9(b)’s by a transaction executed prior to the particularity requirement, which “has been tender offer, the plaintiff necessarily rigorously applied in securities fraud alleges that the tender offeror has cases,” Burlington , 114 F.3d at 1417, fraudulently devised a scheme to requires plaintiffs to “accompany their circumvent the Rule. An offeror can and legal theory with factual allegations that make their theoretically viable claim mergers as distinct from tender plausible,” id. at 1418. Furthermore, offers. Statutory mergers are under the PSLRA, Plaintiffs must allege authorized and regulated by state facts giving rise to a strong inference that corporation codes, and federal C&W acted with fraudulent intent; that is, regulation of such mergers is found that C&W intended to provide a premium in federal regulations concerning to the Directors for their shares through the the solicitation of proxies. Finally, Merger Agreement and the Ernst the Williams Act contains, in employment agreement. 15 U.S.C. § 78u- addition to the “best price” 4(b)(2); see also Burlington , 114 F.3d at provision, time limits, disclosure 1418 (requiring, prior to passage of the requirements, pro rata acceptance PSLRA, allegations supporting a “‘strong r u l e s , a n d p r o v i s io n s f o r inference’ that the defendant possessed the withdrawal of tendered shares that requisite intent” to satisfy Rule 9(b)). make no sense whatsoever in the
merger context. [18] With respect to the Merger Agreement, Plaintiffs allege that the Accord Lerro , 84 F.3d at 244 (“ Kramer Directors received “extra compensation” rejects, rightly we think, any argument that to the extent that they were able to cash a follow-up merger should be integrated out all of their options and restricted stock with a tender offer. They are different at once. As a threshold matter, we transactions, under different bodies of law question whether the Best Price Rule . . . .”); Epstein , 50 F.3d at 659 n.21 should ever apply to payments made (distinguishing Kramer on the grounds that pursuant to a second-step merger. We find Kramer , unlike Epstein , involved a second-step statutory merger). [19] persuasive the Second Circuit’s reasoning in Kramer v. Time Warner Inc. , 937 F.2d 767, 779 (2d Cir. 1991): [18] In Kram er , the plaintiff claimed that certain officers received payments for
[W]e perceive no basis in the their stock options in connection with a language, structure or legislative merger that exceeded the price paid to history of the Act for viewing a other shareholders pursuant to the merger. second-step statutory merger Id. at 778-79 & n.5. following a successful tender offer for 51 percent of a target’s shares [19] Plaintiffs allege that the payments as a continuation of the tender receiv ed by the Directors w ere offer. Such a merger lacks the consideration for options and restricted most salient characteristics of a stock that were held prior to the Merger tender offer—an offer to purchase, Ag reem ent. This gro und f urther tender and acceptance. Moreover, distinguishes Epstein , where the options state and federal law clearly treat themselves were alleged to be conditioned As discussed above, Plaintiffs fail allegation provides no basis on which to to cobble together a coherent theory as to infer the payment of a share premium in how these payments could have induced violation of the Best Price Rule. the Directors to suppress the Bloomberg and MLB deals and support the tender The facts alleged by Plaintiffs are offer. Conversely, we have difficulty therefore a far cry from Epstein . In that understanding how these payments could case, the tender offeror executed an give rise to an inference that they were agreement with one of the shareholders, intended by C&W as such an inducement. Sheinberg, under which Sheinberg would More fundamentally, the fact that the receive a lump sum payment if the tender merger cashed out certain unvested offer succeeded. Epstein , 50 F.3d at 657. holdings of the Directors, without more, Immediately after the execution of the cannot establish a strong inference of agreement— i.e. , that same day—the tender fraudulent intent. Plaintiffs do not allege offer was announced. Id . at 653, 657. The that these holdings were anything but pre- defendant in Epstein claimed that the existing, legitimate obligations of Digital payment was to induce Sheinberg to stay Island. The only inference we can take on as an officer and to cash out his stock from these allegations, then, is that C&W options under the merger. Id. at 657. chose to honor Digital Island’s existing Plaintiffs argued, however, that the options obligations. Plaintiffs provide no themselves were conditioned on the explanation for why this behavior should success of the tender offer. Id . at 658. raise suspicion, particularly where C&W With respect to Sheinberg’s “amended intended to operate Digital Island as a employment agreement,” Plaintiffs pointed going concern. out that the payment appeared to
correspond precisely to the value of his Nor have Plaintiffs alleged any options, i.e ., there was no compensation facts that would render the Ernst for services. Id. at 658-59. Epstein thus employment agreement suspect. Plaintiffs involved precisely the kind of allegations do not allege that Ernst’s employment of fraud that a bright line rule would agreement is a sham transaction designed exclude from Best Price Rule protection. to insulate an improper tender offer Further proceedings were therefore premium. They do not contend that the necessary to determine the purpose of the compensation package was excessive, or Sheinberg agreement, i.e. , whether the that it was out of line with amounts that lump sum payment “constitutes incentive similarly situated executives were paid. compensation that [the offeror] wanted to Instead, Plaintiffs simply characterize the give Sheinberg independently of the . . . agreement as “lucrative.” This conclusory deal, or a premium that [the offeror]
wanted to give Sheinberg as an inducement to support the tender offer and
on the success of the tender offer. 50 F.3d tender his own shares.” Id. at 659. at 658. To the extent that Epstein holds that Instead, when applying the Best the proper inquiry in such cases is whether Price Rule to a transaction that is executed the transaction “unconditionally obligated” outside of the tender offer period and that the offeror, we respectfully reject that nominally does not involve the purchase of holding. Id. at 656-57; see also id. at 656 securities, the “central issue” is whether a (concluding that an agreement was “an given payment constitutes “a premium that integral part of the offer and subject to [the offeror] wanted to give [the Rule 14d-10’s requirements” because the shareholder] as an inducement to support agreement was “conditioned on the tender the tender offer and tender his own offer’s success”). Whether the offeror was shares.” Epstein , 50 F.3d at 659; see, e.g ., unconditionally obligated would be Katt , 244 F. Supp. 2d at 857-58. This, of important if we were dealing with an course, requires an intent to defraud the outright purchase of securities. See 17 remaining shareholders of their entitlement C.F.R. § 240.14e-5(b)(7) (allowing to equal consideration under the tender purchases of securities during—but offer. Accordingly, when reviewing a “outside”—of a tender offer where complaint alleging a violation of Rule 14d- purchase is pursuant to an unconditional 10 based on a transaction executed prior to and binding contract entered into before the commencement of a tender offer, the public announcement of the tender offer); trial court should determine whether the Epstein , 50 F.3d at 656 (“Thus a bidder plaintiff has met the heightened pleading who purchases shares from a particular requirements of Rule 9(b) and the PSLRA. shareholder before a tender offer begins does not violate Rule 14d-10.”). But We conclude that Plaintiffs’ tender offerors routinely engage in allegations do not meet these heightened transactions not involving the purchase of pleading standards. The proposed securities that are conditioned on the a m e n d e d C o m p l a i n t a l l o w s n o success of the tender offer ( e.g. , if the reasonable—let alone strong—inference offer fails, the prospective “employer” that the Merger Agreement or the Ernst never comes into existence). Epstein’s employment agreement conceal a “unconditionally obligated” test should not fraudulent share premium in violation of subject all of these transactions to the Best Price Rule. We acknowledge that challenge under the Best Price Rule. See we are applying for the first time the also Lerro , 84 F.3d at 244-45 (warning pleading requirements of Rule 9(b) and the against a construction of the Best Price PSLRA to a Best Price Rule claim. Rule that “would imperil countless Nevertheless, we believe that allowing ordinary transactions [including] simple Plaintiffs an opportunity to amend this employment agreements under which the claim would be futile. Plaintiffs’ theory of surviving entity promises to employ fraud with respect to their Best Price Rule managers for stated terms or give claim mirrors the theory underpinning their severance pay”). Section 14(e) claim and we have rejected as implausible Plaintiffs’ most recent the District Court’s order denying iteration of this theory. We see no reason Plaintiffs leave to amend. to allow them a third opportunity under the Best Price Rule. VII.
V. Because Plaintiffs failed to allege facts giving rise to a strong inference that Section 20(a) provides, in pertinent Defendants acted with scienter in regard to part: “Every person who, directly or their statements and/or silence concerning indirectly, controls any person liable under the Bloomberg and MLB deals, we will any provision of this chapter or of any rule affirm the District Court’s dismissal of or regulation thereunder shall also be their Section 14(e) claim. Likewise, we liable jointly and severally with and to the will affirm dismissal of Plaintiffs’ Best same extent as such controlled person . . . Price Rule claim because it depends on the .” 15 U.S.C. § 78t(a). Liability under same implausible theory of fraud as their Section 20(a) is derivative and must be Section 14(e) claim. Moreover, dismissal predicated upon an independent violation of these claims compels dismissal of of the ‘34 Act. Advanta , 180 F.3d at 541. Plaintiffs’ Section 20(a) claims, which are Accordingly, because we will affirm the derivative of the Section 14(e) and Best District Court’s dismissal of Plaintiffs’ Price Rule claims. Finally, our analysis fraud and Best Price Rule claims for has taken into consideration the additional failure to state a claim, the proposed allegations in Plaintiffs’ proposed amended Complaint necessarily fails to amended Complaint. We therefore will state a claim under Section 20(a). affirm the District Court’s denial of leave
to amend on the basis of futility.
VI.
Finally, we address the District Court’s denial of Plaintiffs’ motion under Rules 59(e) and 15(a) to alter the judgment and to obtain leave to file an amended complaint. We have determined that Plaintiffs’ proposed amended Complaint fails to state a claim under Rule 12(b)(6) and the PSLRA and that leave to amend would therefore be futile. Foman v. Davis , 371 U.S. 178, 182 (1962); In re NAHC, Inc. Sec. Litig. , 306 F.3d 1314, 1332 (3d Cir. 2002). Accordingly, we will affirm
NOTES
[6] The proposed amended Complaint success of the tender offer on June 19 effectively froze Digital Island’s share alleges that “five of the officers of Digital price at $3.40 per share because, under the Island, including Ms. Ernst, received merger agreement, all outstanding shares lucrative employment contracts in of Digital Island were to be automatically connection with the merger which entitled cashed out at that price. Nevertheless, them to generous salary and option Plaintiffs allege very few facts from which packages.” Defendants point out that, any meaningful comparison can be drawn according to the Schedule 14D-9 between the Microsoft deal on the one referenced in the Complaint, only one hand, and the Bloomberg and MLB deals named Defendant, CEO Ernst, received on the other. such a contract. Plaintiffs did not respond.
[8] A timely Rule 59(e) motion suspends
[9] Plaintiffs cite Clearfield Bank & Trust the time in which to appeal, which then Co. v. Omega Fin. Corp. , 65 F. Supp. 2d begins to run, pursuant to Fed. R. App. P. 325, 340, 342-43 (W.D. Pa. 1999), in 4(a)(4), upon the entry of an order granting support of the proposition that Section or denying the motion. 14(e) requires proof of scienter.
[13] The proposed amended Complaint as Plaintiffs allege that the disclosure of the Microsoft deal was misleading because further assumes, without the support of it implied that no other deals were about to factual allegations, that other potential be consummated. Plaintiffs also allege acquirers would not have emerged on that C&W generally became aware of the terms comparable to those offered by deals by virtue of the due diligence C&W, or at least that the Directors feared process. that no other suitor would emerge. offer period.
[16] Instead, the issue in Epstein
[17] We regard Epstein as persuasive, was whether a payment made after the despite the fact that it was reversed on tender offer expired could violate the Best other grounds by the Supreme Court. Price Rule. The Ninth Circuit held that Matsushita Elec. Indus. Co., Ltd. v. such a payment could establish a violation, Epstein , 516 U.S. 367 (1996). Epstein is reasoning that to hold otherwise apparently regarded as precedential within the Ninth Circuit, e.g. , Harris v. Intel would drain Rule 14d-10 of all its Corp. , No. 00-CV-1528, 2002 WL force [since] even the most 1759817, at *5 (N.D. Cal. July 8, 2002), blatantly discriminatory tender and has been adopted by district courts in offer—in which large shareholders other circuits, e.g. , Katt v. Titan were paid twice as much as small Acquisitions, Inc. , 133 F. Supp. 2d 632, shareholders— would fall outside 644 (M.D. Tenn. 2000). Epstein was also Rule 14d-10’s prohibition, so long cited with approval by the Second Circuit as the bidder waited a few seconds in Gerber v. Computer Assocs. Int’l, Inc. , 303 F.3d 126 (2d Cir. 2002). Gerber
[16] The agreements in Epstein were involved a non-compete agreement executed the same day on which the tender between a bidder and a shareholder offer was announced, thus occurring executed during a tender offer. Gerber during the tender offer under Rule 14d- held that it was immaterial that payment 2(a), which provides that, for purposes of was not made under the non-compete Section 14(d), a tender offer commences agreement until after the expiration of the “at 12:01 a.m. on the date when the bidder tender offer. Quoting Epstein , the court has first published, sent, or given the held that the Best Price Rule “cannot be so means to tender to security holders.” 17 easily circumvented” by simply delaying C.F.R. § 240.14d-2(a); see Epstein , 50 payment until after the expiration date. Id. F.3d at 653, 655 & n.18, 657. at 135 (quoting Epstein , 50 F.3d at 655).