In re Digital Island Securities Litigation

• Decision Date: 10 September 2002
• Docket Number: Civil Action No. 02-57-GMS.
• Citation: 223 F.Supp.2d 546
• Parties: In re DIGITAL ISLAND SECURITIES LITIGATION
• Court: U.S. District Court — District of Delaware

223 F.Supp.2d 546

In re DIGITAL ISLAND SECURITIES LITIGATION

Civil Action No. 02-57-GMS.

United States District Court, D. Delaware.

September 10, 2002.

Pamela S. Tikellis and Robert J. Kriner, Jr. of Chimicles & Tikellis LLP, Wilmington, DE, Jeffery G. Smith and Robert Abrams of Wolf Haldenstein Adler Freeman & Herz LLP, New York City, of counsel, for plaintiffs.

Robert K. Payson, Philip A. Rovner, and Kevin R. Shannon of Potter Anderson & Corroon LLP, Wilmington, DE, Mark D. Wegener, Edward B. Schwartz and Martin F. Cunniff of Howrey Simon Arnold & White, LLP, Washington, DC, of counsel, for defendants.

MEMORANDUM OPINION

SLEET, District Judge.

I. INTRODUCTION

This securities class action suit arises from Cable & Wireless plc's acquisition of Digital Island, Inc. Individual plaintiffs filed complaints on January 22, 2002, January 31, 2002, and February 22, 2002. The plaintiffs filed a joint motion for consolidation, appointment of lead plaintiff, and appointment of lead counsel on March 25, 2002. The court granted that motion on April 16, 2002. On May 15, 2002, the plaintiffs filed their Consolidated Amended Class Action Complaint. In this complaint, the plaintiffs contend that the defendants defrauded the Digital Island shareholders into approving the sale of the company to Cable & Wireless for less than fair value.¹

Presently before the court is the defendants' motion to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (the "PSLRA"). For the following reasons, the court will grant this motion.

II. BACKGROUND

A. The Tender Offer

Before it was acquired and merged into Cable & Wireless, Digital Island provided various e-Business services used for online marketing and sales, customer service, fulfillment, software, document, and multimedia distribution. Digital Island provided these services through a managed Internet infrastructure that integrated content delivery, hosting, intelligent networking, and applications services.

Ernst was the CEO, President, and a director of Digital Island at all relevant times. Bass, Cotsakos, Cirillo-Goldberg, Jones, Marbut, and Soghikian were directors of Digital Island as of May 14, 2001. Wallace, Reed, McTighe, Drolet, Duff, and Lefar became directors of Digital Island on July 16, 2001 when Cotsakos, Cirillo-Goldberg, and Marbut resigned from the Board of Directors (the "Board").

In 2000 and 2001, Digital Island lost a large amount of its market capitalization, falling from a high of $150 per share in December 1999 to a low of $1.50 in the spring of 2001. Because of its own financial problems related to the economic conditions at that time, Digital Island and its financial advisor Credit Suisse First Boston ("CSFB") began to contact potential acquirers, including Cable & Wireless. However, Digital Island stated in its Form 10Q for the quarter ended March 31, 2001 that "the deteriorating market conditions stalled most discussions in the preliminary stages." Nevertheless, Cable & Wireless made an initial offer to purchase Digital Island's stock for $2.25 per share. After considering the offer and meeting with its financial advisors, Digital Island advised Cable & Wireless that it was prepared to begin negotiations, provided that the offer price was increased to at least $3.25.

On May 10, 2001, Digital Island issued a press release announcing its prior agreement to provide certain services to Microsoft Corporation. The price of the stock rose that day from $2.00 per share to $3.69 per share. The stock dropped to $3.13 at the close of trading the following day.

On May 11, 2001, Cable & Wireless representatives indicated that the company was prepared to offer $3.40 per share for the stock.² Digital Island made a counteroffer of $4.10 per share. Cable & Wireless subsequently advised that its offering price remained at $3.40.

On May 13, 2001, the Digital Island seven-member Board met to evaluate the company's strategic options, including the pending Cable & Wireless offer. In particular, the Board, together with the executive management and representatives of CSFB, examined whether the company could stay independent "in an industry environment marked by waning and uncertain economic conditions which has made it difficult to raise the necessary capital [it] need[ed]." The Board's review also included an assessment of "the scarcity of potential suitors, suitable strategic partners and financial investors" and "the likelihood of consummation of such comparable and alternative transactions. . . ."

With regard to the Cable & Wireless offer, CSFB informed Digital Island that it was of the opinion that the $3.40 offer was "fair from a financial point of view to our stockholders." The Board considered the fact that the $3.40 offer price represented an 8% premium over the closing price of the stock that day. It also represented a 51% premium over the average trading price of $2.25 for the immediately preceding twenty trading days, and a 68.5% premium over the immediately preceding thirty trading days. It also represented a 4.6% premium over the $3.25 per share price that Digital Island had indicated it would accept just weeks before.

Finally, the Board considered several other factors, including the fact that "Cable & Wireless was in a strong strategic position ... and would likely be willing to pay more for our company than any other suitor." Based upon these, and other, considerations, the Board voted unanimously to approve the execution of the Merger Agreement and related documents, and to recommend to the shareholders that they accept the offer. Under the Offer to Purchase (the "Offer"), those Digital Island shareholders who tendered their shares by midnight on June 18, 2001 would receive $3.40 per share. For those who did not tender, their shares would be canceled following the merger and also exchanged for $3.40 per share. Furthermore, under the Offer, no appraisal rights were available in connection with the Offer. The Offer did indicate, however, that shareholders might have appraisal rights in connection with the merger.

The Offer further provided for the possibility of a subsequent offering period during which Digital Island shareholders who had not tendered their shares during the initial offering period could do so at that time. Those shareholders who had tendered their shares during the initial offering period would have been allowed to withdraw their tenders during the initial offering period. They would, however, not be able to withdraw their tenders during the subsequent offering period. The first tender offer was completed on June 19, 2001, with the purchase of approximately 80% of Digital Island's total issued and outstanding common stock.

B. The Bloomberg and MLB Deals

Despite the serious financial issues that it was facing, Digital Island had been very successful in developing an impressive roster of customers. Indeed, as of May 31, 2001, Digital Island had contracts with 881 customers, including America Online, Charles Schwab, CNBC.com, E*TRADE, Hewlett-Packard, JP Morgan Chase, Microsoft, Reuters, Sony, and Universal Music Group. On June 20, 2001, Digital Island announced an agreement to provide certain services to a new customer, Bloomberg, L.P. ("Bloomberg"). The plaintiffs contend that this agreement had not previously been disclosed either in Digital Island's 14D-9, or in Cable & Wireless' Offer. On July 2, 2001, Digital Island further announced an agreement with Major League Baseball Advanced Media, L.P. ("MLB") to provide certain services. The plaintiffs contend that this agreement had also not been previously disclosed in Digital Island's 14D-9, in Cable & Wireless' Offer, or in any other publication.

The plaintiffs also contend that, since these two deals were announced only after the June 18 date on which the tender offer terminated, Digital Island shareholders who tendered their shares could not withdraw their tenders. Moreover, the plaintiffs argue that, even without such a prohibition, there would be no incentive for any individual shareholder to withdraw, because once Cable & Wireless announced on June 18, 2001 that it had acquired 80% of Digital Island stock, there could be no certainty that a sufficient number of other shareholders would also withdraw their tenders to preclude Digital Island's takeover at the $3.40 price.

C. Executive Compensation and Retention

The "executive compensation" packages and other compensation to be paid by Cable & Wireless after the acquisition are summarized in Digital Island's Schedule 14D-9. With the exception of Ernst, each of the individual defendants held stock options pursuant to the Digital Island Stock Incentive Plans instituted in 1999 and 2000. As a result of the tender offer and merger, each was paid the face value of the options, i.e., the difference, if any, between option price and $3.40. For these defendants, the compensation ranged from $19,000 to $57,000 in connection with the payment for their in-the-money options, whether vested or unvested. The plaintiffs contend that no other shareholders received such extra consideration for their stock. The defendants maintain, however, that all executive compensation and retention issues were fully negotiated before the commencement of the tender offer.

Finally, the plaintiffs contend that five of the Digital Island officers, including Ernst, received lucrative employment contracts in connection with the merger. These contracts entitled them to generous salary and options packages as described in Cable & Wireless' Offer and Digital Island's SEC Form 14D-9. The plaintiffs thus claim that these agreements constituted extra compensation for the Digital Island common stock held by Digital Island officers. Moreover, the plaintiffs argue that the employment agreements were integral to the Merger Agreement because, if the merger were...