368 F.3d 228 (3rd Cir. 2004), 03-2347, GSC Partners CDO Fund v. Washington

Docket Nº:03-2347
Citation:368 F.3d 228
Party Name:GSC Partners CDO Fund v. Washington
Case Date:May 17, 2004
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit

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368 F.3d 228 (3rd Cir. 2004)

GSC PARTNERS CDO FUND; GSC Partners CDO Fund II, Ltd; GSC Recovery II, L.P., Appellants


Dennis R. WASHINGTON; Steven G. Hanks; Thomas H. Zarges; Anthony S. Cleberg; David H. Batchelder; Leonard R. Judd; Robert S. Miller, Jr.; Dorn Parkinson; Terry W. Payne; John D. Roach; Credit Suisse First Boston Corporation; John Does I Through X.

No. 03-2347.

United States Court of Appeals, Third Circuit

May 17, 2004

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Howard J. Kaplan, (Argued), Stanley S. Arkin, New York, Bruce H. Snyder, Sheppard A. Guryan, Lasser Hochman, Roseland, for Appellants.

Shannon M. Kasley, Beth Heiftz, (Argued), Adrian Wager-Zito, Megyn M. Kendall, Jones Day, Washington, Robinson B. Lacy, (Argued), Sullivan & Cromwell LLP, New York, Anthony J. Marchetta, Pitney, Hardin, Kipp & Szuch LLP, Morristown, Christopher J. Carey, David Blackwell, Graham, Curtin & Sheridan, Morristown, George T. Manning, Jones Day, Atlanta, for Appellees.

Before ROTH, McKEE and CUDAHY, [*] Circuit Judges.

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CUDAHY, Circuit Judge.

The background of this case is the classic corporate love story. Company A meets Company B. They are attracted to each other and after a brief courtship, they merge. Investor C, hoping that the two companies will be fruitful and multiply, agrees to pay $50 million for the wedding. Nine months later, however, things begin to fall apart and the combined entity declares bankruptcy. Investor C feels misled. He believes that Company A knew that there were problems with Company B but that it made the oft repeated mistake of thinking that it would be able to change Company B for the better. Investor C files suit in the district court and after his complaint is dismissed, we find ourselves here. It is an old story but it never fails to elicit a tear.

In this case, appellants GSC Partners CDO Fund, Ltd., GSC Partners CDO Fund, Ltd. II, LTD., and GSC Recovery II, L.P. (the plaintiffs) appeal the district court's dismissal of their action against individual officers and directors of Washington Group International, Inc. (Washington) and Credit Suisse First Boston Corporation (CSFB). The plaintiffs filed this action under section 10(b), Rule 10b-5 of the Securities Exchange Act of 1934 (the Act), alleging 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 defendants' allegedly false and misleading offering circular. Because the plaintiffs failed to meet the heightened pleading requirements of the Act, we affirm the district court's grant of defendants' motion to dismiss.


Washington is an international engineering and construction firm that, in 2000, employed approximately 39,000 workers and brought in approximately $5 billion in annual revenue. 1 App. at 41, 77. Defendants Dennis R. Washington, Hanks, Zarges, Cleberg, Batchelder, Judd, Miller, Parkinson, Payne, and Roach were officers and/or directors of Washington during the acquisition process. App. at 38-9 (Cplt.¶ 14-23).

Washington representatives commenced negotiations during the summer of 1999 for the acquisition of REC, the engineering and construction division of Raytheon Company. App. at 42 (Cplt.¶ 37). After conducting an initial examination of REC's financial information, Washington submitted a non-binding offer of between $775 and $875 million for the business operations of REC, subject to its findings in due diligence. App. at 42 (Cplt.¶ 39). Raytheon accepted this offer in September 1999. Id. at ¶ 41. Before finalizing the deal, Washington began its due diligence process, which entailed thorough scrutiny of REC's financial statements and projections. Id. In this process, it received assistance from Arthur Andersen, L.L.P. Id. at ¶ 41. Meanwhile, the parties began negotiating a definitive agreement for the acquisition. Id. at ¶ 40. To augment this process, Washington employed defendant CSFB to act as its financial advisor for the REC purchase. Id. at ¶ 40. CSFB conducted its own due diligence and had access to all of Washington's due diligence findings as well. Id. at ¶ 43. Throughout the due diligence process, the two companies communicated their findings and concerns to each other. Id.

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On October 27, 1999, after one month of interviews, document reviews and project site visits, Washington's management reported to the Washington Board its findings regarding the accuracy of REC's financial information. App. at 44 (Cplt.¶ 46), 317. The team was impressed with the "[s]trong, capable management team in place" and with REC's "solid position in [the] Independent Power Producer (IPP) market," as well as in the rail, power, chemicals, metals pharmaceutical, pulp and paper, chemical demilitarization, refinery and heavy maintenance markets. App. at 320. The team also noted that the personnel it worked with had been "cooperative and forthcoming." Id. at 317.

The due diligence team expressed some concerns as well. It cited as among REC's general weaknesses its "aggressive" and "optimistic" plans for sales volume and profit growth in certain businesses, the volatility of the company's working capital, the possible lack of accounting integrity of its unaudited financial statements and its "[u]nderstated or undisclosed liabilities." Id. at 319. In particular, the team calculated that the profit projections for some of the construction projects were inaccurate. For example, the team revised estimated profit projections for the "Pine Bluff" project from $20.2 million to $3.1 million, for the "SADAF" project from $4.2 million to $0.8 million and for the Hudson Bergen project from $61.1 million to $46.9 million. Id. at 326. At the same time, however, Washington noted, that "[w]ider leverage of proprietary technology" could improve some of the projects' deteriorating margins, and that "[o]perational synergies offer [an] upside to a combined new company." Id. at 346.

On November 3, defendant Zarges sent a memorandum to other members of the Washington management, elaborating on some of the perceived inaccuracies in the project profit estimates but projecting that if the acquisition went through, even taking into account the risks, the combined entity could perform well in the engineering and construction industry. App. at 362. Zarges first emphasized that the findings in the October 27 Board presentation were not conclusive. Id. He wrote that, although the Umatilla and Pine Bluff projects had been presented as breakeven projects through 2001, they were at the time of the memo in "loss positions with deteriorating performance trends." App. at 364. The memorandum reiterated concerns about Raytheon's aggressive plans and optimistic positions on most projects, reporting inconsistencies and shaky performance history. Id. at 365-66. Zarges concluded, however, that the projected operating fee (i.e.profit) in 2000 could, taking into account Washington's adjustments to REC's calculations, "provide an industry-leading margin of 3.8% on adjusted revenues." App. at 362. He added, "This ... represents quite an improvement over recent performance histories ... [and] is no easy task." Id.

A month later, on December 2, 1999, defendant Hanks sent a memorandum to the Board on the progress of the due diligence team. App. at 362. He reported that in order to address Washington's concerns about the accuracy of REC's financial statements, Washington had hired PricewaterhouseCoopers L.L.P., independent accountants, to audit the financial statements for 1996, 1997, and 1998, and to "review" the financial statement for 1999. App. at 207, 367. These audited financial statements required $350 million of adjustments to bring them into compliance with Generally Accepted Accounting Principles (GAAP). Id. Hanks stipulated that in order to remedy the discrepancies, it would be necessary to arrange for an increase in

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liabilities assumed by Raytheon of up to $100 million. Id.

The Washington Board met on March 14, 2000 to consider the progress of the due diligence team. App. at 548-88. The team again reported some concerns about REC's financial health, but also expressed confidence that a partnership with Washington would improve REC's position, "having actually experienced what it takes to turn a company around." App. at 420, 422. The team reported risks involved in the acquisition of REC, citing historical performance that was characterized by large loss projects. Id. at 554. The team revised the projected profit for the Umatilla project downward to "22M loss, best case," an adjustment of $38 million from REC's estimate. App. at 559. It also adjusted the projected profit for the Pine Bluff project from breakeven to a $20 million loss. Id. REC had "[p]oor financial controls/accounting practices," and the team suspected that there may have been inadequate restructuring reserves in The Hague and in Houston. Id. at 554. The due diligence team also revised REC's projected EBITDA (earnings before interest, taxes, depreciation and amortization) for the year 2000, from $143 million to $115 million, assuming that the combined company would be indemnified by Raytheon against any downside from Umatilla and Pine Bluff and that it "would incur 50% of the $60 million of vulnerabilities identified in the due diligence report." Id. at 420-21, 567.

In addition, the due diligence team had encountered practical difficulties in completing the due diligence. Defendant Hanks recorded in his notes and reported to the board that "the due diligence and negotiation process has been a difficult one--Raytheon's procedural rules limited our opportunities...

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