In re Stone & Webster, Inc., Securities Litigation

• Decision Date: 28 March 2003
• Docket Number: No. CIV.A. 00-10874-RCL.,CIV.A. 00-10874-RCL.
• Citation: 253 F.Supp.2d 102
• Court: U.S. District Court — District of Massachusetts
• Parties: In re: STONE & WEBSTER, INC., SECURITIES LITIGATION

253 F.Supp.2d 102

In re: STONE & WEBSTER, INC., SECURITIES LITIGATION

No. CIV.A. 00-10874-RCL.

United States District Court, D. Massachusetts.

March 28, 2003.

COPYRIGHT MATERIAL OMITTED

Norman Berman, Jeffrey C Block, Alicia M. Duff, Berman DeValerio Pease Tabacco, Burt & Pucillo, Boston, MA, for Adele Brody, Albert A. Blank, David B. Everson, Fanny Mandelbaum, Mark Hanson, SG Cowen Asset Management, Inc., John Grady, Elena Hanley.

Edward J. Barshak, Sugarman, Rogers, Barshak & Cohen, Boston, MA, Jay W. Eisenhofer, Sidney S. Liebesman, Adria Benner, Grant & Eisenhofer, P.A., Wilmingotm, DE, Jay W. Eisenhofer, Sidney S. Liebesman, Adria Benner, Grant & Eisenhofer, P.A. Wilmington, DE, for Ram Trust Services, Inc., Lens Investment Management, LLC.

Steven G. Schulman, Milberg, Weiss Bershad Hynes & Lerach, LLP, New York City, Marc A. Topaz, Schiffrin & Barroway, LLP, Bala Cynwyd, PA, Paul J. Geller, Samuel H. Rudman, Cauley & Geller, LLP, Boca Raton, FL, Stephen Moulton Nancy F. Gans, Moulton & Gans, PC, Boston, MA, for Fred DuBois, Jr.

Thomas J. Dougherty, Skadden, Arps, Slate, Meagher & Flom, Boston, MA, Janet L. Goetz, Skadden, Arps, Slate, Meagher & Flom LLP, Washington, DC, for Stone & Webster, Inc.

William G. Meserve, Ropes & Gray, Boston, MA, Jordan D. Hershman, Thomas C. Frongillo, Inez H. Friedman-Boyce, Testa, Hurwitz & Thibeault, LLP, Boston, MA, for H. Kerner Smith, Thomas Langford.

Christian M. Hoffman, Peter M. Casey, Jack W. Pirozzolo, Kevin C Conroy, Foley Hoag LLP, Boston, MA, for Pricewaterhousecoopers, LLP.

MEMORANDUM AND ORDER ON DEFENDANTS' MOTIONS TO DISMISS

LINDSAY, District Judge.

I. Introduction

This is a consolidated securities fraud class action in which the lead plaintiffs are Ram Trust Services, Inc. and Lens Investment Management, LLC ("the plaintiffs"). The lead plaintiffs propose a class of all purchasers of Stone & Webster, Inc. ("S & W" or the "Company") securities between January 22, 1998, and May 8, 2000.¹ The defendants are S & W; H. Kerner Smith ("Smith"), S & W's former Chief Executive Officer ("CEO"); Thomas Langford ("Langford"), S & W's former Chief Financial Officer ("CFO"); and PricewaterhouseCoopers, LLP ("PwC"), S & W's auditors.

The Consolidated and Amended Class Action Complaint ("Amended Complaint") is in three counts. Count one alleges violations by all the defendants of section 10(b) of the Securities Exchange Act of 1934 ("the Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder by the Securities and Exchange Commission ("SEC"). Count two alleges that Smith and Langford violated section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). Count three alleges violations of section 18 of the Exchange Act, 15 U.S.C. § 78r, by all of the defendants.

All proceedings against S & W itself were stayed on July 25, 2000, upon its filing of a suggestion of bankruptcy. The other defendants have filed motions to dismiss the Amended Complaint under Fed. R.Civ.P. 12(b)(6), arguing that the plaintiffs have failed to satisfy the strict pleading requirements of the Private Securities Litigation Reform Act ("PSLRA"), Pub L. No. 104-67 (1995) (codified at 15 U.S.C. § 78u-4 & -5), and Fed.R.Civ.P. 9(b). For the reasons stated below, I GRANT these motions in part and DENY them in part.

II. Factual Allegations

The facts recited here, unless otherwise noted, are drawn from the Amended Complaint.

S & W was founded in 1889 by two graduates of the Massachusetts Institute of Technology. Am. Compl. ¶ 28. Originally an engineering services firm, S & W expanded into a construction, engineering, and consulting firm that executed projects around the world. Id. Over the years, it has been a major builder of urban transit systems, public utilities, and nuclear power plants. Id. 129. By the 1990s, however, S & W's business was stagnating: net income, which had been $49 million in 1987, dropped to $1.9 million in 1993. Id. ¶ 30.

In February 1996, S & W's then CEO resigned and was replaced by Smith. Id. ¶ 31. In June 1997, Langford became an Executive Vice President and CFO. Id. ¶ 32. By the end of that year, S & W represented that a corporate restructuring program directed by Smith and Langford had turned the Company around, and the Company reported net income of $33.5 million. Id. The Company's stock reached $55 per share. Id.

The plaintiffs allege, however, that this turn-around and profitability "was a mirage." Id. ¶ 33. They allege that: "Smith and Langford had employment contracts providing for lucrative payments should a `change of control' occur. Therefore, from the outset, their strategy was to make the Company look good in the short-run to position it for a sale." Id. To achieve this goal,

S & W distorted and misrepresented its results throughout the Class Period by failing to book known losses on its income statement, by failing to reduce its net assets to account for its money-losing projects and by booking phantom revenue and receivables from a suspended job, long after there was no hope the job would be revived.

Id. ¶ 50.

The plaintiffs allege that Smith and Langford made false and misleading statements about S & W's financial condition in press releases, SEC filings, and other public documents. Id. ¶ 20. Moreover, the plaintiffs claim, S & W's auditors, PwC, knew of or recklessly disregarded false statements in S & W's financial statements and issued false or misleading opinions with respect to those financial statements. Id. ¶ 24-25.

A. Allegations Against Smith and Langford

As noted above, much of S & W's work consisted of large construction projects. Such contracts usually took one of two forms: cost-plus or fixed-price. Am. Compl. ¶ 37. In a cost-plus contract, the contractor is paid its cost to complete the project plus an agreed-upon percentage of the total cost as profit. Id. By contrast, in a fixed-price contract, the contractor receives a fixed sum for performing the contract, no matter what the cost eventually proves to be. Id. Thus, under a fixedprice contract, as distinguished from a cost-plus contract, the contractor bears the risk of cost overruns on the project. Id.

1. The Underbidding Policy

According to the plaintiffs, Smith and Langford established a policy of "underbidding" on projects in 1997. Id. ¶ 52.

This strategy was an effort to increase the number and dollar magnitude of projects on S & W's books, create the perception of growth in S & W's business and tout an ever-increasing project backlog. Smith and Langford did this even though they knew that S & W's backlog figures would then represent money losing projects.

Id. The "backlog" is "the accumulated amount of the Company's committed, but unexpended, contractual work." Id. ¶ 38. Investors watch a contractor's backlog "because backlog represents the best indication of a company's future growth." Id. Underbidding meant that Smith, often over the objections of his own project teams, was dictating project terms so that S & W was selling fixed-price jobs either at a loss or with such small margin for error that the slightest adverse change in a project's economics would cause S & W to lose money on the job. Id. ¶ 53.

The plaintiffs quote or paraphrase several S & W employees about the underbidding policy: "According to a confidential source who worked for S & W as an assistant controller before and during the Class Period (`CS-1'), Smith was warned by senior management that this policy would result in long-term disaster for the Company." Id. ¶ 54. "Roger LeFavor, Vice President of Strategic Planning, regularly challenged Smith and told Smith numerous projects could not be done for the bid price, but Smith overruled his objections." Id. ¶ 55.

The significance of this policy to the plaintiffs' legal claims is that, according to the plaintiffs, Generally Accepted Accounting Principles ("GAAP") required S & W to recognize the prospective losses from underbid projects in the period that S & W was first obliged to perform the contract. Id. ¶ ¶ 39-46. S & W's failure to do so, and its retention of the underbid projects in its backlog, the plaintiffs allege, rendered fraudulent all of S & W's financial statements issued during the Class Period.

The plaintiffs list ten projects which, according to several named and unnamed S & W employees, "were all bid at a loss pursuant to Smith and Langford's undisclosed policy" of underbidding. Id. ¶ 58. S & W allegedly underbid these projects by 10-40%; on one project, S & W's bid was approximately $70-80 million, whereas the bid of a competitor, Raytheon, for the same work was $120 million. Id. ¶¶ 60-61.

2. The TPPI Project

In 1996, S & W joined a consortium of contractors to construct an integrated ethylene and olefins complex in Indonesia for Trans Pacific Petrochemical Indotama ("TPPI"). Id. ¶¶ 62-63. In late 1997, "TPPI suspended work on the project because it had exhausted its funding for the project." Id, ¶ 65. As a result, in 1998 S & W incurred numerous expenses from the project— including payments to vendors for equipment shipped to Indonesia— but received no corresponding payments. Id. ¶¶ 65-67. "CS-1 said that TPPI suggested to S & W that it try to get out of its contracts with its vendors due to the suspension. Based upon this suggestion, S & W knew in late 1997 that the project was dead even though they had not received an official termination notice." Id. ¶ 65. The plaintiff further alleges that

According to CS-1, ... beginning with the first quarter of 1998, S & W created phantom revenue and receivables from the TPPI project to cover S & W's project related costs by recording revenue equal to the amount of those costs. The purpose of recording this revenue was to avoid showing a loss from the project on S & W's financial statements.

Id. ¶ 67. Again according to CS-1, S & W booked $86.9 million in revenues from TPPI in 1998 and $53 million in 1999. Id. ¶ 68.

According to CS-1, [Daniel] Marti...