Third Circuit disposition — 03-1055

PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
__________
Case No: 03-1055
IN RE: DIGITAL ISLAND
SECURITIES LITIGATION
WILLIAM BLAIR MASSEY, Lead
Plaintiff
as representative of a class consisting
of all holders of the common stock of
Digital Island, Inc.,
Appellant
__________
On Appeal From The
United States District Court For The
District of Delaware
(Civil Action No. 02-cv-00057)
The Honorable Gregory M. Sleet,
District Judge
__________
Argued November 4, 2003
__________
Before: MCKEE, SMITH, and WEIS,
Circuit Judges
(Opinion Filed February 6, 2004)
Jeffrey G. Smith
Robert Abrams [Argued]
Wolf, Haldenstein, Adler, Freeman & Herz
270 Madison Avenue
New York, NY 10016
Pamela S. Tikellis
Chimicles & Tikellis
One Rodney Square
P.O. Box 1035, Suite 500
Wilmington, DE 19899
Counsel for Appellants
Jerrold J. Ganzfried [Argued]
Mark D. Wegener
Howrey, Simon, Arnold & White
1299 Pennsylvania Avenue, N.W.
Washington, DC 20004
Philip A. Rovner
Potter, Anderson & Corroon
1313 North Market Street
6th Floor, P.O. Box 951
Wilmington, DE 19801
Counsel for Appellees
_________
OPINION
____________
SMITH, Circuit Judge
This securities class action lawsuit
arises out of the acquisition of Digital
Island, Inc. by Cable & Wireless, PLC
(“C&W”). Pursuant to a May 14, 2001
Merger Agreement between Digital Island
and C&W, Dali Acquisition Corp.
(“Dali”), a wholly-owned subsidiary of
C&W, made a cash tender offer to
shareholders of Digital Island under which
it acquired 80 percent of the shares of
Digital Island. Dali was thereafter merged
into Digital Island, which survived as a
wholly-owned subsidiary of C&W.
Plaintiffs filed a Consolidated
Amended Class Action Complaint (the

-- 1 of 20 --

“Complaint”) on May 15, 2002. Plaintiffs
in this case represent a class comprised of
all persons, other than the named
defendants and certain related parties, who
owned Digital Island common stock
during the relevant period and who
received the tender offer.1 Defendants are
Digital Island, members of Digital Island’s
Board of Directors during the relevant
time period, including Digital Island’s
CEO, Ruann Ernst (the “Directors”),2
C&W, C&W’s CEO, Graham Wallace,3
and Dali. Plaintiffs allege that, in
connection with the tender offer,
Defendants made misleading statements
and failed to disclose material information
in violation of Section 14(e) of the
Securities and Exchange Act of 1934 (the
“‘34 Act”), as amended by the W illiams
Act of 1968. 15 U.S.C. § 78n(e).
Plaintiffs further allege that the Directors
received “extra consideration” for their
shares in violation of Section 14(d)(7) of
the ‘34 Act, 15 U.S.C. § 78n(d)(7), and
Securities and Exchange Commission
(“SEC”) Rule 14d-10, the so-called “Best
Price Rule,” 17 C.F.R. § 240.14d-10(a).
Plaintiffs allege both individual violations
by Defendants of these provisions, as well
as “control person liability” under Section
20(a) of the ‘34 Act. 15 U.S.C. § 78t(a).
The District Court dismissed
Plaintif fs’ c o n s o l id a t e d a m e n d ed
complaint, with prejudice, for failure to
state a claim pursuant to Fed. R. Civ. P.
12(b)(6) and the Private Securities
Litigation Reform Act of 1995 (the
“PSLRA”), 15 U.S.C. § 78u-4. In re
Digital Island Sec. Litig., 223 F. Supp. 2d
546 (D. Del. 2002). By a subsequent
order, the District Court denied Plaintiffs’
motion, pursuant to Fed. R. Civ. P. 59(e),
which sought to alter the court’s judgment
and to permit Plaintiffs to file an amended
complaint under Fed. R. Civ. P. 15(a).
Because we conclude that Plaintiffs’
proposed Second Consolidated Amended
Class Action Complaint (the “proposed
amended Complaint”) does not articulate
a viable theory of fraud, we will affirm
both orders of the District Court.
I.
The following facts are drawn from
the proposed amended Complaint and
from Digital Island’s Securities and
Exchange Commission (“SEC”) Form
14D-9, which is referenced in the proposed
amended Complaint and included in the
1 Individual complaints were filed by
shareholders of Digital Island in late
January and early February of 2002. On
April 16, 2002, the District Court granted
Plaintiffs’ Joint Motion for Consolidation,
Appointment of Lead Plaintiff and
Appointment of Lead Counsel.
2 The other Directors are: Charlie Bass,
Christos Cotsakos, Mary Cirillo-Goldberg,
G. Bradford Jones, Robert Marbut, Shahan
Soghikian, Don Reed, Mike McTighe,
Robert Drolet, Avery Duff, and Marc
Lefar.
3 Defendant Wallace also served as a
member of Digital Island’s board
beginning on July 16, 2001.

-- 2 of 20 --

Joint Appendix. See Oran v. Stafford, 226
F.3d 275, 289 (3d Cir. 2000) (taking
judicial notice of documents required by
law to be filed with the SEC). Digital
Island provides a global e-business
delivery network and suite of services for
enterprises that use the internet to deploy
business applications and conduct e-
commerce. Digital Island began searching
for a potential acquirer in August of 2000,
at which time representatives of Digital
Island contacted representatives of C&W
to gauge C&W’s interest in a strategic
partnership with Digital Island. In March
of 2001, C&W indicated that it was
interested in a potential business
combination with Digital Island. In April
of 2001, C&W delivered an initial draft of
the Merger Agreement and made an initial
offer to purchase Digital Island for $2.25
a share. After considering the offer and
meeting with its financial advisors, Digital
Island advised C&W that it was prepared
to begin negotiations, provided that the
offer price was increased to at least $3.25.
Negotiations between Digital Island
and C&W continued through April and
into May, but C&W would not agree to
raise its offer to $3.25 per share. On May
10, 2001, Digital Island announced an
agreement to provide certain business
services to Microsoft Corporation. The
price of Digital Island’s stock rose that day
from $2.00 per share to $3.69 per share.
On May 11, 2001, representatives of C&W
indicated that C&W’s board of directors
had preliminarily approved an offer of
$3.40 per share.4 Digital Island made a
counter-proposal of $4.10 per share, which
was rejected by C&W. On May 13, 2001,
the Digital Island board met and voted
unanimously to approve the execution of
the Merger Agreement with a per share
tender offer price of $3.40 and to
recommend to the shareholders that they
accept the tender offer.
On May 14, 2001, Digital Island
and C&W executed the Merger
Agreement, which contemplated a first
step tender offer followed by a second step
merger. Under the tender offer,
shareholders who tendered their shares
were to receive $3.40 per share. Under the
merger, all remaining shares of Digital
Island would be cancele d , and
shareholders would receive $3.40 per
share. The tender offer period expired on
June 18, 2001, and on June 19, 2001,
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
appro xima tely 80 percent of it s
outstanding stock had been tendered.
Plaintiffs’ Section 14(e) claim is
based on two significant business deals
that were announced immediately after the
expiration of the tender offer. On June 20,
2001, Digital Island announced a major
business agreement with Bloomberg LP,
and on July 2, 2001, Digital Island
announced anoth er major business
agreement with Major League Baseball
4 According to information submitted in
the Joint Appendix, Digital Island’s stock
dropped to $3.13 at the close of trading on
May 11.

-- 3 of 20 --

(“MLB”). According to Plaintiffs, both
the Bloomberg and MLB deals had
substantial value to Digital Island, and, if
disclosed, would have substantially
influenced the shareholders’ decision to
tender their shares.5
Plaintiffs allege that Defendants
knew of the Bloomberg and MLB deals
prior to expiration of the tender offer, but
deliberately or recklessly failed to disclose
the deals until after the expiration of the
tender offer. Plaintiffs argue that
Defendants had an affirmative duty to
disclose the Bloomberg and MLB deals,
or, alternatively, that Defendants’ failure
to mention those deals in the tender offer
and the Schedule 14D-9 rendered those
docu men ts mate rially misleading.
Plaintiffs allege that Defendants were
motivated to suppress the Bloomberg and
MLB deals because the success of the
tender offer and resulting merger created a
windfall for Defendants that was not
enjoyed by Digital Island’s other
shareholders. Specifically, Plaintiffs
allege that, pursuant to the merger, the
Directors received substantial cash
payments for outstanding options to
purchase Digital Island common stock, as
well as for their shares of restricted
common stock. Additionally, Plaintiffs
allege that CEO Ernst had executed a
lucrative contract for employment to serve
as President and CEO of the surviving
entity.6
Such extra consideration was given
to Digital Island officers and
directors in order to induce them to
support the Offer to Purchase at the
$3.40 price per share and to
withhold the announcement of the
Bloomberg and Major League
Baseball deals until after the
expiration of the Offer to Purchase
in order to preclude the need for
C&W to increase the consideration
in the Offer to Purchase.
5 Plaintiffs’ prediction is based on the
increase in value of Digital Island stock
that occurred after announcement of the
Microsoft deal. The actual disclosure of
the Bloomberg and MLB deals does not
appear to have affected the price of Digital
Island stock. Plaintiffs explain that the
success of the tender offer on June 19
effectively froze Digital Island’s share
price at $3.40 per share because, under the
merger agreement, all outstanding shares
of Digital Island were to be automatically
cashed out at that price. Nevertheless,
Plaintiffs allege very few facts from which
any meaningful comparison can be drawn
between the Microsoft deal on the one
hand, and the Bloomberg and MLB deals
on the other.
6 The proposed amended Complaint
alleges that “five of the officers of Digital
Island, including Ms. Ernst, received
lucrative employment contracts in
connection with the merger which entitled
them to generous salary and option
packages.” Defendants point out that,
according to the Schedule 14D-9
referenced in the Complaint, only one
named Defendant, CEO Ernst, received
such a contract. Plaintiffs did not respond.

-- 4 of 20 --

App. at 338. According to Plaintiffs,
disclosure of the Bloomberg and MLB
deals threatened to derail the merger with
C&W:
If the announcement induced more
than 50 percent of Digital Island
stockholders not to tender their
shares, the Merger would not be
consummated and the Digital Island
officers would lose their lucrative
employment agreements, as well as
the extra consideration for their
shares. Thus, any announcement
concerning the Bloomberg or
Major League Baseball Deals
carried with it the threat of
u n d e r m i n i n g t h e M e r g e r
Agreement.
App. at 352.
In addition to their Section 14(e)
claim, Plaintiffs allege that, by virtue of
these cash payments and the Ernst
employment agreement, the Directors
received “extra consideration” for their
shares in violation of Section 14(d)(7) of
the ‘34 Act and the SEC’s Best Price Rule.
Plaintiffs allege individual violations by
Defendants of Sections 14(e) and the Best
Price Rule, as well as “control person
liability” under Section 20(a) of the ‘34
Act.7
The District Court dismissed the
Complaint on September 10, 2002, for
failure to state a claim. The District Court
held that Plaintiffs’ Section 14(e) claim
failed to meet the heightened pleading
requirements of the PSLRA in two
respects: (1) the Complaint did not
identify with specificity the statements that
were allegedly misleading, and (2) the
Complaint did not plead facts giving rise
to a strong inference of scienter. 15
U.S.C. § 78u-4(b). The District Court
further held that Plaintiffs failed to state a
claim for violation of the Best Price Rule
because that provision applies only to
payments made during a tender offer, and
the extra consideration alleged by
Plaintiffs was received pursuant to
agreements executed prior to the tender
offer. Finally, the District Court dismissed
Plaintiffs’ “control person liability” claim
because (1) the predicate violations on
which that claim was based (i.e., the
Section 14(e) and Best Price Rule claims)
were dismissed, and (2) because Plaintiffs
failed to allege facts sufficient to establish
control and/or culpable participation.
Plaintiffs filed a Motion to Alter
Judgment and For Leave to File An
Amended Complaint under Fed. R. Civ. P.
59(e) and 15(a). The District Court denied
Plaintiffs’ motion on November 25, 2002.
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
amend until after judgment had been
entered on the motion to dismiss.
7 The Complaint also alleges that
Defendants issued a false and misleading
proxy statement in violation of Section
14(a) of the ‘34 Act. Plaintiffs do not
appeal dismissal of this claim.

-- 5 of 20 --

Plaintiffs timely appealed both
orders on December 23, 2002.8 The
District Court had subject matter
jurisdiction under 28 U.S.C. § 1331 and 15
U.S.C. § 78aa. This Court has jurisdiction
over the District Court’s order dismissing
Plaintiffs’ Complaint under 28 U.S.C. §
1291 because the Complaint was
dismissed with prejudice. Manze v. State
Farm Ins. Co., 817 F.2d 1062, 1064 (3d
Cir. 1987). This Court also has
jurisdiction under section 1291 over the
District Court’s denial of Plaintiffs’ post-
judgment motion for leave to amend. See
Foman v. Davis, 371 U.S. 178 (1962); N.
River Ins. Co. v. CIGNA Reinsurance Co.,
52 F.3d 1194, 1203 (3d Cir. 1995). We
review de novo a District Court’s
dismissal of a complaint for failure to state
a claim under Fed. R. Civ. P. 12(b)(6).
Ramsgate Court Townhome Ass’n v. West
Chester Borough, 313 F.3d 157, 158 (3d
Cir. 2002).
On December 8, 2003, after oral
argument in this case, the successor entity
to the merger of Digital Island and Dali
filed for Chapter 11 Bankruptcy in the
District of Delaware. Under 11 U.S.C. §
362(a), this filing operates to stay all
proceedings against Digital Island and
Dali. Digital Island is a defendant in
Plaintiffs’ Section 14(e) claim, and Dali is
a defendant in Plaintiffs’ Best Price Rule
Claim. Although the stay of proceedings
against Digital Island and Dali does not
affect our reasoning, it does mean that our
decision today does not reach either entity.
II.
Section 14(e) of the ‘34 Act
provides, in pertinent part:
It shall be unlawful for any person
to make any untrue statement of a
material fact or omit to state any
material fact necessary in order to
make the statements made, in the
light of the circumstances under
which they are made, not
misleading, or to engage in any
f r a u d u l e n t , d e c e p t i v e , o r
manipulative acts or practices, in
connection with any tender offer . .
. .
15 U.S.C. § 78n(e). The District Court
held that Section 14(e) requires proof of
scienter, i.e., “a mental state embracing
intent to deceive, manipulate, or defraud.”
Ernst & Ernst v. Hochfelder, 425 U.S. 185,
193 n.12 (1976). Both parties appear to
agree.9
Section 14(e) is “modeled on the
antifraud provisions of § 10(b) of the [‘34]
Act and Rule 10b-5,” Schreiber v.
8 A timely Rule 59(e) motion suspends
the time in which to appeal, which then
begins to run, pursuant to Fed. R. App. P.
4(a)(4), upon the entry of an order granting
or denying the motion.
9 Plaintiffs cite Clearfield Bank & Trust
Co. v. Omega Fin. Corp., 65 F. Supp. 2d
325, 340, 342-43 (W.D. Pa. 1999), in
support of the proposition that Section
14(e) requires proof of scienter.

-- 6 of 20 --

Burlington Northern, Inc., 472 U.S. 1, 10
(1985), which require proof of scienter,
Ernst & Ernst, 425 U.S. at 193. Because
of the similarity in the language and scope
of Section 14(e) and Rule 10b-5, we have
in the past construed the two consistently.
E.g., Flynn v. Bass Bros. Enters., Inc., 744
F.2d 978, 984-85 (3d Cir. 1984) (adopting
the same test of materiality for both
Section 14(e) and Rule 10b-5). We
therefore join those circuits that hold that
scienter is an element of a Section 14(e)
claim. See, e.g., Conn. Nat’l Bank v. Fluor
Corp., 808 F.2d 957, 961 (2d Cir. 1987);
Smallwood v. Pearl Brewing Co., 489 F.2d
579, 605 (5th Cir. 1974) (“Congress
adopted in Section 14(e) the substantive
language of the second paragraph of Rule
10b-5 and in so doing accepted the
precedential baggage those words have
carried over the years.”).
The PSLRA establishes a
heightened pleading requirement for
certain securities fraud cases. The PSLRA
requires plaintiffs to “state with
particularity facts giving rise to a strong
inference that the defendant acted with the
required state of mind.” 15 U.S.C. § 78u-
4(b)(2). In requiring a “strong inference”
of scienter, the PSLRA alters the normal
operation of inferences under Fed. R. Civ.
P. 12(b)(6). In re Rockefeller Ctr. Props.,
Inc. Sec. Litig., 311 F.3d 198, 224 (3d Cir.
2002) (“[U]nless plaintiffs in securities
fraud actions allege facts . . . with the
requisite particularity . . . they may not
benefit from inferences flowing from
vague or unspecific allegations—
inferences that may arguably have been
justified under a traditional Rule 12(b)(6)
analysis.”); see also Greebel v. FTP
Software, Inc., 194 F.3d 185, 196 (1st Cir.
1999) (“A mere reasonable inference is
insufficient to survive a motion to
dismiss.”). For purposes of the PSLRA,
Plaintiffs may plead scienter by alleging
facts that (1) establish a motive and an
opportunity to commit fraud, or (2)
constitute circumstantial evidence of either
reckless or conscious behavior. In re
Advanta Corp. Sec. Litig., 180 F.3d 525,
534-35 (3d Cir. 1999). Either way,
plaintiffs must plead facts “w ith
particularity,” and these facts must give
rise to a “strong inference” of a knowing
or reckless misstatement. Id. at 535.
A.
Plaintiffs’ theory of the case is that
the Directors and CEO Wallace suppressed
the Bloomberg and MLB deals to ensure
the success of the tender offer and the
subsequent merger.10 When the tender
10 We agree with the District Court that,
absent a duty to correct or update
misleading statements, Plaintiffs failed to
identify an affirmative duty to disclose the
Bloomberg and MLB deals. Oran, 226
F.3d at 285-86 (“Such a duty to disclose
may arise when there is insider trading, a
statute requiring disclosure, or an
inaccurate, incomplete or misleading prior
disclosure.”); In re Burlington Coat
Factory Sec. Litig., 114 F.3d 1410, 1432
(3d Cir. 1997) (“Except for specific
periodic reporting requirements . . . there
is no general duty on the part of a company

-- 7 of 20 --

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
Directors. According to Plaintiffs, the
prospect of cashing out these holdings
induced the Directors to suppress
information that would have raised the
value of Digital Island’s shares. Such an
increase, Plaintiffs allege, would have
jeopardized the Merger Agreement
because shareholders would not have
tendered at $3.40 and C&W would not
have increased the consideration offered.
CEO Ernst’s lucrative employment
contract with the surviving entity provided
her with a further inducement.
Setting aside the Ernst employment
agreement, the Directors stood to gain
from any increase in Digital Island’s share
price in the same manner as any other
Digital Island shareholder, that is, by
tendering their shares into the offer or by
having their shares cashed out in the
merger. Moreover, our reading of the
proposed amended Complaint compels the
same conclusion reached by the District
Court: “As a result of the tender offer and
merger, each [Director] was paid the face
value of the options, i.e., the difference, if
any between the option price and $3.40.”
Digital Island, 223 F. Supp. 2d at 550.
Nevertheless, Plaintiffs argue that the
success of the tender offer created a
windfall for the Directors because it
allowed them to unload their holdings all
to provide the public with all material
information.”). Because we conclude that
Plaintiffs have failed to adequately plead
scienter, we do not decide whether the
proposed amended Complaint adequately
specifies the statements alleged to be
misleading and the reason why those
statements are misleading, or whether the
proposed amended Complaint properly
attributes those statements to any of the
Defendants in this case. See Rockefeller,
311 F.3d at 217-18 (discussing the
pleading requirements of the PSLRA and
Fed. R. Civ. P. 9(b)).
The District Court further dismissed
the Section 14(e) claim as to C&W , Dali,
and Wallace, because those defendants
were not affiliated with Digital Island and
therefore owed no duty to Digital Island’s
shareholders to disclose the Bloomberg
and IBM deals. Plaintiffs make no
argument in their briefs that dismissal was
erroneous as to C&W and Dali and have
therefore abandoned these issues. Kost v.
Kozakiewicz, 1 F.3d 176, 182 (3d Cir.
1993). Plaintiffs do maintain that
Defendant Wallace violated Section 14(e)
by failing to disclose the two deals.
Plaintiffs make no argum ent that
Defendant Wallace owed a duty to correct
or update statements that he did not make
and over which he had no control.
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.

-- 8 of 20 --

at once, at a guaranteed price of $3.40 a
share.11
Granting that some value might
attach to the avoidance of future risk, or
that only so many shares can be unloaded
on the open market without depressing the
share price, Plaintiffs’ theory is
nevertheless a weak inference teetering on
an unfounded assumption. Kalnit v.
Eichler, 264 F.3d 131, 139-40 (2d Cir.
2001) (“Sufficient motive allegations
‘entail concrete benefits that could be
realized by one or more of the false
statements and wrongful nondisclosures
alleged.’” (quoting Shields v. Citytrust
Bancorp., Inc., 25 F.3d 1124, 1130 (2d
Cir. 1994)). The inference is that the
Directors feared that C&W would abandon
its efforts to acquire Digital Island if the
share price increased. Plaintiffs argue that
this fear can be inferred from C&W’s
rejection of Digital Island’s $4.10 counter-
proposal, and from the fact that the merger
agreement was hastily executed within
days of the disclosure of the Microsoft
deal. Whether or not this inference is
reasonable under Rule 12(b)(6), the
PSLRA requires a strong—as opposed to
merely reasonable—inference to survive a
motion to dismiss. See Rockefeller, 311
F.3d at 224. The inference urged by
Plaintiffs is not strong, because the far
11 The allegations in the proposed
amended complaint emphasize the fact that
the merger cashed out both vested and
unvested options and restricted stock:
First, the Digital Island officers and
directors were to receive substantial
cash payments in connection with
the Merger for their in-the-money
options to purchase Digital Island
common stock. This applied to
both vested and unvested options.
In addition, the officers of Digital
Island were to receive cash in
connection with the Merger in
return for certain restricted
common stock which they had been
granted in April 2001, several
weeks prior to the Merger
announcement, in return for their
out-of-the money options.
App. at 351. Plaintiffs do not allege that
the Directors received any sort of
accelerated payment for their holdings,
i.e., that any payment was made prior to
their vesting. Nor are there any allegations
regarding the circumstances or purpose of
the April 2001 option exchange program.
Instead, our reading of the proposed
amended Complaint leads us to the same
conclusion as the District Court: the
Directors received the face value of their
options and restricted stock pursuant to a
merger in which all outstanding securities
of Digital Island were cancelled. More
fundamentally, the value of these options
and restricted stock, whether vested or
unvested, was necessarily tied to the
market value of Digital Island’s common
stock. While other eventualities might
have decreased Digital Island’s share price
before these holdings vested, such open-
ended speculation is entirely insufficient to
support a strong inference of motive under
the PSLRA. Rockefeller, 311 F.3d at 222.

-- 9 of 20 --

more compelling inference is that the
Directors bargained aggressively with
C&W, motivated solely by a desire to
exploit the surge in Digital Island’s stock
price that followed the announcement of
the Microsoft deal. If the Directors were
confident of the Bloomberg and MLB
deals before the merger agreement was
finalized, they would certainly have
disclosed those deals to support their
counter-offer.12 If instead, the Bloomberg
and MLB deals were finalized after
execution of the merger agreement,
C&W’s rejection of the counter-offer
could have no bearing on how C&W
would react to the deals. Rather, C&W’s
decision to increase the tender offer price
following the Microsoft deal would
indicate that C&W might respond
favorably to the Bloomberg and MLB
deals.
Regardless of the strength of this
inference, it rests on an assumption,
devo id of any fac tual allegation
whatsoever, that the Directors would be
worse off if C&W withdrew its offer. Yet
Plaintiffs’ theory of the case necessarily
requires that disclosure of the MLB and
Bloomberg Deals would have increased
the market value of Digital Island stock
absent the merger. Accordingly, to
establish a strong inference of motive,
Plaintiffs were obliged to allege some facts
tending to show how the Directors could
have hoped to make out better by
unloading their options and restricted stock
than by realizing the impact of the
Bloomberg and MLB deals on their shares,
either in the market or in a merger with
another suitor. See Advanta, 180 F.3d at
540-41 (no strong inference of scienter
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
facts showing that allegedly improper
profits were substantial in comparison to
defendants’ overall stock holdings and
compensation).13 Considering all the
allegations in Plaintiffs’ proposed
amended Complaint, we agree with the
District Court that “plaintiffs’ theory
12 Plaintiffs equivocate on when the
Bloomberg and MLB deals became
sufficiently certain to merit disclosure.
Plaintiffs generally allege that the deals
were close to completion sometime during
the tender offer period. Plaintiffs,
however, imply that the deals were
sufficiently final sometime prior to
execution of the merger agreement, insofar
as Plaintiffs allege that the disclosure of
the Microsoft deal was misleading because
it implied that no other deals were about to
be consummated. Plaintiffs also allege
that C&W generally became aware of the
deals by virtue of the due diligence
process.
13 The proposed amended Complaint
further assumes, without the support of
factual allegations, that other potential
acquirers would not have emerged on
terms comparable to those offered by
C&W, or at least that the Directors feared
that no other suitor would emerge.

-- 10 of 20 --

makes little economic sense because the
directors’ own stock options would have
been devalued if they tried to sell the
company for less than full price.” Digital
Island, 223 F. Supp. 2d at 555. The
proposed amended Complaint therefore
does not allege facts giving rise to a strong
inference that the Directors acted with
scienter in not disclosing the Bloomberg
and MLB deals in their statements
regarding the tender offer.
The Ernst employment agreement
does little to strengthen the inference of
motive that can be drawn from Plaintiffs’
allegations. As with the Directors’ stock
holdings, Plaintiffs allege no facts from
which it can be inferred that the
employment agreement actually created a
windfall to Ernst beyond what she would
otherwise realize by an increase in the
value of her shares. More fundamentally,
the fact that CEO Ernst had executed an
employment agreement with the acquirer
cannot, in and of itself, establish a strong
inference of motive. As the Fourth Circuit
explained in Phillips v. LCI Int’l, Inc., 190
F.3d 609, 622-23 (4th Cir. 1999):
[A]ssertions that a corporate officer
or director committed fraud in
order to retain an executive
position, or retain such a position
with the merged company, simply
do not, in themselves, adequately
plead motive. . . .
The rationale underlying these
holdings is straightforward. Similar
situations arise in every merger;
thus, allowing a plaintiff to prove a
motive to defraud by simply
alleging a corporate defendant’s
desire to retain his position with its
attendant salary . . . would force the
directors of virtually every
company to defend securities fraud
actions, every time that company
effected a merger or acquisition.
Accord Kalnit, 264 F.3d at 139-40 (“[A]n
allegation that defendants were motivated
by a desire to maintain or increase
executive compensation is insufficient
because such a desire can be imputed to all
corporate officers.”). Because Plaintiffs’
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
employment agreement do nothing to
distinguish her motivations from those
surrounding countless other mergers and
acquisitions, the proposed amended
Complaint fails to create a strong inference
of scienter as required by the PSLRA.
B.
A reckless statement is one
“involving not merely simple, or even
inexcusable negligence, but an extreme
departure from the standards of ordinary
care, and which presents a danger of
misleading buyers or sellers that is either
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

-- 11 of 20 --

prevent[] defendants from escaping
liability solely because of the difficulty of
proving conscious intent to commit fraud.”
Id. Scienter therefore requires “a
misrepresentation so recklessly made that
the culpability attaching to such reckless
conduct closely approaches that which
attaches to conscious deceptio n.’”
McLean v. Alexander, 599 F.2d 1190,
1197 (3d Cir. 1979) (quoting Coleco
Indus., Inc. v. Berman, 567 F.2d 569, 574
(3d Cir. 1977) (per curiam)). Recklessness
is not intended to encompass “claims
essen tially grounded on corporate
mismanagement.” Advanta, 180 F.3d at
540.
We agree with the District Court
that Plaintiffs’ allegations fail to create a
strong inference of recklessness. Because
Plaintiffs’ allegations show that
Defendants’ interests were at all times tied
to the value of their shares, we have no
basis to infer the sort of conscious
disregard and deliberate ignorance
required to plead scienter. At most,
Plaintiffs’ allegations show that the
Directors failed to exploit the potential that
the Bloomberg and MLB deals had to
increase the value of Digital Island shares,
whether through the tender offer price paid
by C&W or on the open market. Such
alleged mismanagement does not fall
within the anti-fraud prohibitions of
Section 14(e).
IV.
Section 14(d)(7) of the ‘34 Act
provides, in pertinent part:
Where any person varies the terms
of a tender offer . . . before the
expiration thereof by increasing the
consideration offered to holders of
such securities, such person shall
pay the increased consideration to
each security holder whose
securities are taken up and paid for
pursuant to the tender offer . . . .
15 U.S.C. § 78n(d)(7).14 SEC Rule
14d-10(a)(2), the “Best Price Rule,”
implements Section 14(d)(7) and provides:
“No bidder shall make a tender offer
unless . . . [t]he consideration paid to any
security holder pursuant to the tender offer
is the highest consideration paid to any
other security holder during such tender
offer.” 17 C.F.R. § 240.14d-10(a).
Plaintiffs allege that the Directors received
“extra consideration” for their shares when
their options and restricted stock were
cashed out in the merger pursuant to the
14 Plaintiffs do not appeal dismissal of
this claim as to Digital Island or any of the
individual defendants other than Wallace.
As the District Court recognized, the Best
Price Rule, by its terms, only applies to
bidders. Digital Island, 223 F. Supp. 2d at
556. On appeal, Plaintiffs offer no
explanation why Defendant Wallace
should be considered a bidder. We
therefore will affirm the District Court’s
dismissal of the Best Price Rule claim with
respect to Defendant Wallace on the
ground that Defendant W allace is not a
bidder within the meaning of the rule.

-- 12 of 20 --

Merger Agreement.15 In addition,
Plaintiffs allege that the employment
agreement between C&W and CEO Ernst
further constituted a premium for her
shares. There is no dispute that both the
Merger Agreement and the Ernst
Employment agreement were executed
prior to the tender offer.
The District Court adopted, and
Defendants urge this Court to adopt, a
“bright-line rule” that payments arising out
of an agreement executed prior to a tender
offer do not state a claim under the Best
Price Rule, which expressly applies only to
payments made “during a tender offer.” 17
C.F.R. § 240.14d-10(a). The District
Court and Defendants rely heavily on
Lerro v. Quaker Oats Co., 84 F.3d 239,
245 (7th Cir. 1996), in which the Seventh
Circuit held that “transactions before or
after a tender offer are outside the scope of
Rule 14d-10.” The plaintiff in Lerro
alleged that a controlling shareholder had
received extra compensation for his shares
in the form of an exclusive distribution
agreement executed by the tender offeror
and the controlling shareholder prior to the
tender offer. Id. at 240. The agreement
was to commence upon consummation of
the offer. Id. The court held that the value
of the distribution agreement did not
constitute extra compensation in violation
of the Best Price Rule because the
agreement was signed before the offer
began. Id. at 244. The court reasoned:
Before the offer is not “during” the
offer. . . . The difference between
“during” and “before” (or “after”)
is not just linguistic. It is essential
to permit everyone to participate in
the markets near the time of a
tender offer. Bidders are forbidden
to buy or sell on the open market or
via negotiated transactions during
an offer, but they are free to
transact until an offer begins, or
immediately after it ends.
Id. at 243; see also Katt v. Titan
Acquisitions, Inc., 244 F. Supp. 2d 841,
850 (M.D. Tenn. 2003) (stating that Rule
14d-10 “is, on its face, ‘aimed at conduct
during the pendency of the tender offer’”
(quoting Walker v. Shield Acquisition
15 The proposed amended Complaint
alleges that this consideration exceeds that
received by other Digital Island
shareholders, although Plaintiffs make no
allegation that Digital Island’s outstanding
options and restricted stock were held
exclusively by the Directors.
Curiously, Plaintiffs argue in their
brief that we should read the proposed
amended Complaint to allege that the extra
payment was made when the Directors
tendered their shares. If that is the case,
we do not understand how the Directors
could h a v e r e c e iv e d the ex tra
consideration alleged by Plaintiffs, which
is premised on the allegation that those
options were partially unvested at the time
of the merger. If the Directors did indeed
exercise their options, to the extent vested,
they were simply paid the tender price for
each share tendered like every other
shareholder.

-- 13 of 20 --

Corp., 145 F. Supp. 2d 1360, 1375 (N.D.
Ga. 2001))).
Plaintiffs urge this Court to adopt a
more flexible rule that focuses on whether
the allegedly improper payment is an
integral part of the tender offer. For their
part, Plaintiffs rely on Epstein v. MCA,
Inc., 50 F.3d 644 (9th Cir. 1995), in which
the Ninth Circuit rejected the argument
that Rule 14d-10 turns on the timing of the
payment. Epstein did not involve an
agreement executed prior to the tender
offer period.16 Instead, the issue in Epstein
was whether a payment made after the
tender offer expired could violate the Best
Price Rule. The Ninth Circuit held that
such a payment could establish a violation,
reasoning that to hold otherwise
would drain Rule 14d-10 of all its
force [since] even the most
blatantly discriminatory tender
offer—in which large shareholders
were paid twice as much as small
shareholders— would fall outside
Rule 14d-10’s prohibition, so long
as the bidder waited a few seconds
after it accepted all of the tendered
shares before paying the favored
shareholders.
Id. at 655. Epstein held that the proper
focus should be “whether the . . .
transaction was an integral part of [the]
tender offer.” Id.17
We agree with the Seventh Circuit
and the District Court that the market
requires a bright-line rule “to demark
16 The agreements in Epstein were
executed the same day on which the tender
offer was announced, thus occurring
during the tender offer under Rule 14d-
2(a), which provides that, for purposes of
Section 14(d), a tender offer commences
“at 12:01 a.m. on the date when the bidder
has first published, sent, or given the
means to tender to security holders.” 17
C.F.R. § 240.14d-2(a); see Epstein, 50
F.3d at 653, 655 & n.18, 657.
17 We regard Epstein as persuasive,
despite the fact that it was reversed on
other grounds by the Supreme Court.
Matsushita Elec. Indus. Co., Ltd. v.
Epstein, 516 U.S. 367 (1996). Epstein is
apparently regarded as precedential within
the Ninth Circuit, e.g., Harris v. Intel
Corp., No. 00-CV-1528, 2002 WL
1759817, at *5 (N.D. Cal. July 8, 2002),
and has been adopted by district courts in
other circuits, e.g., Katt v. Titan
Acquisitions, Inc., 133 F. Supp. 2d 632,
644 (M.D. Tenn. 2000). Epstein was also
cited with approval by the Second Circuit
in Gerber v. Computer Assocs. Int’l, Inc.,
303 F.3d 126 (2d Cir. 2002). Gerber
involved a non-compete agreement
between a bidder and a shareholder
executed during a tender offer. Gerber
held that it was immaterial that payment
was not made under the non-compete
agreement until after the expiration of the
tender offer. Quoting Epstein, the court
held that the Best Price Rule “cannot be so
easily circumvented” by simply delaying
payment until after the expiration date. Id.
at 135 (quoting Epstein, 50 F.3d at 655).

-- 14 of 20 --

clearly the periods during which the
special Williams Act rules apply.” Lerro,
84 F.3d at 243. W e also agree with
Epstein that tender offerors cannot be
permitted to evade the requirements of the
Williams Act simply by delaying the actual
payment, or by agreeing on the extra
payment beforehand. Indeed, Lerro itself
acknowledges that some payments made
outside of the tender offer period may be
so transparently fraudulent as to require
them to be treated as made “during the
tender offer”:
Doubtless there are limits to the use
of a follow-up merger as a means to
deliver extra compensation.
Suppose [the acquirer] had
promised [a shareholder] $14 for
each share he tendered during the
offer, plus another $6 for each of
these shares one month later. Just
as tax law requires “boot” to be
treated as a gain received from the
sale of stock, securities law treats
“boot” as a payment during the
tender offer.
Lerro, 84 F.3d at 245. Nevertheless, the
exception to the general rule is a narrow
one, and Plaintiffs’ allegations do not fall
within it.
Where, as here, a plaintiff argues
that the Best Price Rule has been violated
by a transaction executed prior to the
tender offer, the plaintiff necessarily
alleges that the tender offeror has
fraudulently devised a scheme to
circumvent the Rule. An offeror can and
will enter into a wide variety of
agreements, including agreements with
shareholders, that are conditioned on the
success of the tender offer. The Ernst
employment agreement is a perfect
example: An offeror who intends to
operate a company as a going concern
after the acquisition may reasonably
attempt to secure the services of
incumbent management. Only where the
tender offeror deliberately inflates that
compensation to provide a premium for the
officer’s shares is there a violation of the
Best Price Rule. In such instances, the
tender offeror has attempted to defraud the
shareholders of the target company of the
equal consideration to which they are
entitled under the Williams Act and the
Best Price Rule.
Accordingly, in order to base
recovery under the Best Price Rule on a
transaction executed prior to the
commencement of a tender offer, Plaintiffs
must comply with Fed. R. Civ. P. 9(b),
which requires that “[i]n all averments of
fraud or mistake, the circumstances
constituting fraud or mistake shall be
stated with particularity.” See Shapiro v.
UJB Fin. Corp., 964 F.2d 272, 287-89 (3d
Cir. 1992) (holding that Rule 9(b) applies
to claims under Sections 11 and 12(2) of
the Securities and Exchange Act of 1933,
15 U.S.C. §§ 77k, 77l, when those claims
are grounded in fraud). Rule 9(b)’s
particularity requirement, which “has been
rigorously applied in securities fraud
cases,” Burlington, 114 F.3d at 1417,
requires plaintiffs to “accompany their
legal theory with factual allegations that

-- 15 of 20 --

make their theoretically viable claim
plausible,” id. at 1418. Furthermore,
under the PSLRA, Plaintiffs must allege
facts giving rise to a strong inference that
C&W acted with fraudulent intent; that is,
that C&W intended to provide a premium
to the Directors for their shares through the
Merger Agreement and the Ernst
employment agreement. 15 U.S.C. § 78u-
4(b)(2); see also Burlington, 114 F.3d at
1418 (requiring, prior to passage of the
PSLRA, allegations supporting a “‘strong
inference’ that the defendant possessed the
requisite intent” to satisfy Rule 9(b)).
With respect to the Merger
Agreement, Plaintiffs allege that the
Directors received “extra compensation”
to the extent that they were able to cash
out all of their options and restricted stock
at once. As a threshold matter, we
question whether the Best Price Rule
should ever apply to payments made
pursuant to a second-step merger. We find
persuasive the Second Circuit’s reasoning
in Kramer v. Time Warner Inc., 937 F.2d
767, 779 (2d Cir. 1991):
[W]e perceive no basis in the
language, structure or legislative
history of the Act for viewing a
second-step statutory merger
following a successful tender offer
for 51 percent of a target’s shares
as a continuation of the tender
offer. Such a merger lacks the
most salient characteristics of a
tender offer—an offer to purchase,
tender and acceptance. Moreover,
state and federal law clearly treat
mergers as distinct from tender
offers. Statutory mergers are
authorized and regulated by state
corporation codes, and federal
regulation of such mergers is found
in federal regulations concerning
the solicitation of proxies. Finally,
the Williams Act contains, in
addition to the “best price”
provision, time limits, disclosure
requirements, pro rata acceptance
r u l e s , a n d p r o v i s io n s f o r
withdrawal of tendered shares that
make no sense whatsoever in the
merger context.18
Accord Lerro, 84 F.3d at 244 (“Kramer
rejects, rightly we think, any argument that
a follow-up merger should be integrated
with a tender offer. They are different
transactions, under different bodies of law
. . . .”); Epstein, 50 F.3d at 659 n.21
(distinguishing Kramer on the grounds that
Kramer, unlike Epstein, involved a
second-step statutory merger).19
18 In Kram er, the plaintiff claimed
that certain officers received payments for
their stock options in connection with a
merger that exceeded the price paid to
other shareholders pursuant to the merger.
Id. at 778-79 & n.5.
19 Plaintiffs allege that the payments
receiv ed by the Directors w ere
consideration for options and restricted
stock that were held prior to the Merger
Ag reem ent. This ground f urther
distinguishes Epstein, where the options
themselves were alleged to be conditioned

-- 16 of 20 --

As discussed above, Plaintiffs fail
to cobble together a coherent theory as to
how these payments could have induced
the Directors to suppress the Bloomberg
and MLB deals and support the tender
offer. Conversely, we have difficulty
understanding how these payments could
give rise to an inference that they were
intended by C&W as such an inducement.
More fundamentally, the fact that the
merger cashed out certain unvested
holdings of the Directors, without more,
cannot establish a strong inference of
fraudulent intent. Plaintiffs do not allege
that these holdings were anything but pre-
existing, legitimate obligations of Digital
Island. The only inference we can take
from these allegations, then, is that C&W
chose to honor Digital Island’s existing
obligations. Plaintiffs provide no
explanation for why this behavior should
raise suspicion, particularly where C&W
intended to operate Digital Island as a
going concern.
Nor have Plaintiffs alleged any
facts that would render the Ernst
employment agreement suspect. Plaintiffs
do not allege that Ernst’s employment
agreement is a sham transaction designed
to insulate an improper tender offer
premium. They do not contend that the
compensation package was excessive, or
that it was out of line with amounts that
similarly situated executives were paid.
Instead, Plaintiffs simply characterize the
agreement as “lucrative.” This conclusory
allegation provides no basis on which to
infer the payment of a share premium in
violation of the Best Price Rule.
The facts alleged by Plaintiffs are
therefore a far cry from Epstein. In that
case, the tender offeror executed an
agreement with one of the shareholders,
Sheinberg, under which Sheinberg would
receive a lump sum payment if the tender
offer succeeded. Epstein, 50 F.3d at 657.
Immediately after the execution of the
agreement—i.e., that same day—the tender
offer was announced. Id. at 653, 657. The
defendant in Epstein claimed that the
payment was to induce Sheinberg to stay
on as an officer and to cash out his stock
options under the merger. Id. at 657.
Plaintiffs argued, however, that the options
themselves were conditioned on the
success of the tender offer. Id. at 658.
With respect to Sheinberg’s “amended
employment agreement,” Plaintiffs pointed
out that the payment appeared to
correspond precisely to the value of his
options, i.e., there was no compensation
for services. Id. at 658-59. Epstein thus
involved precisely the kind of allegations
of fraud that a bright line rule would
exclude from Best Price Rule protection.
Further proceedings were therefore
necessary to determine the purpose of the
Sheinberg agreement, i.e., whether the
lump sum payment “constitutes incentive
compensation that [the offeror] wanted to
give Sheinberg independently of the . . .
deal, or a premium that [the offeror]
wanted to give Sheinberg as an
inducement to support the tender offer and
tender his own shares.” Id. at 659.
on the success of the tender offer. 50 F.3d
at 658.

-- 17 of 20 --

To the extent that Epstein holds that
the proper inquiry in such cases is whether
the transaction “unconditionally obligated”
the offeror, we respectfully reject that
holding. Id. at 656-57; see also id. at 656
(concluding that an agreement was “an
integral part of the offer and subject to
Rule 14d-10’s requirements” because the
agreement was “conditioned on the tender
offer’s success”). Whether the offeror was
unconditionally obligated would be
important if we were dealing with an
outright purchase of securities. See 17
C.F.R. § 240.14e-5(b)(7) (allowing
purchases of securities during—but
“outside”—of a tender offer where
purchase is pursuant to an unconditional
and binding contract entered into before
public announcement of the tender offer);
Epstein, 50 F.3d at 656 (“Thus a bidder
who purchases shares from a particular
shareholder before a tender offer begins
does not violate Rule 14d-10.”). But
tender offerors routinely engage in
transactions not involving the purchase of
securities that are conditioned on the
success of the tender offer (e.g., if the
offer fails, the prospective “employer”
never comes into existence). Epstein’s
“unconditionally obligated” test should not
subject all of these transactions to
challenge under the Best Price Rule. See
also Lerro, 84 F.3d at 244-45 (warning
against a construction of the Best Price
Rule that “would imperil countless
ordinary transactions [including] simple
employment agreements under which the
surviving entity promises to employ
managers for stated terms or give
severance pay”).
Instead, when applying the Best
Price Rule to a transaction that is executed
outside of the tender offer period and that
nominally does not involve the purchase of
securities, the “central issue” is whether a
given payment constitutes “a premium that
[the offeror] wanted to give [the
shareholder] as an inducement to support
the tender offer and tender his own
shares.” Epstein, 50 F.3d at 659; see, e.g.,
Katt, 244 F. Supp. 2d at 857-58. This, of
course, requires an intent to defraud the
remaining shareholders of their entitlement
to equal consideration under the tender
offer. Accordingly, when reviewing a
complaint alleging a violation of Rule 14d-
10 based on a transaction executed prior to
the commencement of a tender offer, the
trial court should determine whether the
plaintiff has met the heightened pleading
requirements of Rule 9(b) and the PSLRA.
We conclude that Plaintiffs’
allegations do not meet these heightened
pleading standards. The proposed
a m e n d e d C o m p l a i n t a l l o w s n o
reasonable—let alone strong—inference
that the Merger Agreement or the Ernst
employment agreement conceal a
fraudulent share premium in violation of
the Best Price Rule. We acknowledge that
we are applying for the first time the
pleading requirements of Rule 9(b) and the
PSLRA to a Best Price Rule claim.
Nevertheless, we believe that allowing
Plaintiffs an opportunity to amend this
claim would be futile. Plaintiffs’ theory of
fraud with respect to their Best Price Rule
claim mirrors the theory underpinning their
Section 14(e) claim and we have rejected

-- 18 of 20 --

as implausible Plaintiffs’ most recent
iteration of this theory. We see no reason
to allow them a third opportunity under the
Best Price Rule.
V.
Section 20(a) provides, in pertinent
part: “Every person who, directly or
indirectly, controls any person liable under
any provision of this chapter or of any rule
or regulation thereunder shall also be
liable jointly and severally with and to the
same extent as such controlled person . . .
.” 15 U.S.C. § 78t(a). Liability under
Section 20(a) is derivative and must be
predicated upon an independent violation
of the ‘34 Act. Advanta, 180 F.3d at 541.
Accordingly, because we will affirm the
District Court’s dismissal of Plaintiffs’
fraud and Best Price Rule claims for
failure to state a claim, the proposed
amended Complaint necessarily fails to
state a claim under Section 20(a).
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
the District Court’s order denying
Plaintiffs leave to amend.
VII.
Because Plaintiffs failed to allege
facts giving rise to a strong inference that
Defendants acted with scienter in regard to
their statements and/or silence concerning
the Bloomberg and MLB deals, we will
affirm the District Court’s dismissal of
their Section 14(e) claim. Likewise, we
will affirm dismissal of Plaintiffs’ Best
Price Rule claim because it depends on the
same implausible theory of fraud as their
Section 14(e) claim. Moreover, dismissal
of these claims compels dismissal of
Plaintiffs’ Section 20(a) claims, which are
derivative of the Section 14(e) and Best
Price Rule claims. Finally, our analysis
has taken into consideration the additional
allegations in Plaintiffs’ proposed
amended Complaint. We therefore will
affirm the District Court’s denial of leave
to amend on the basis of futility.

-- 19 of 20 --

-- 20 of 20 --