Keyspan Corporation Securities Litigation 01-CV-05852-Amended

Case 1:01-cv-05852-ARR-MDG Document 64 Filed 04/07/2003 Page 1 of 97 UNITED STATES DISTRICT COURT EASTERN DISTRICT OF NEW YORK ------------------------------------------------------X In re: KEYSPAN CORPORATION CV 2001-5852 (ARR) (MDG) SECURITIES LITIGATION ------------------------------------------------------X AMENDED CLASS ACTION COMPLAINT 1. Lead Plaintiffs Donald Kassan and Peter E. Hubbard (“Lead Plaintiffs”), for their amended complaint against defendants, allege the following based upon the investigation of counsel, which included, inter alia, a review of U.S. Securities and Exchange Commission (“SEC”) filings, press releases and other public statements issued by KeySpan Corporation (“KeySpan” or the “Company”), securities analysts' reports and advisories by or about the Company, media and third party reports about the Company, and a review of the case file and certain discovery in the litigation styled KeySpan Services Inc. et al. v. LeRoy Kay et al., Docket No. MON-C-95-01, pending in the Chancery Court Division of the Superior Court of New Jersey, Monmouth County (the “Monmouth County litigation”). Lead Plaintiffs in good faith believe that substantial additional evidentiary support will exist for the allegations set forth herein after a reasonable opportunity for discovery. 2. This amendment addresses the deficiencies found by the Court in its Opinion and Order dated March 18, 2003. Plaintiffs expressly reserve their right to appeal said Order. INTRODUCTION 3. This is a federal class action under the Securities Exchange Act of 1934 (the “Exchange Act” or “1934 Act”) on behalf of purchasers of KeySpan securities between March 24, 2000, and July 17, 2001 inclusive (the “Class Period”). As more fully set forth herein, the defendants have admitted that financial and operational improprieties had not been disclosed. Case 1:01-cv-05852-ARR-MDG Document 64 Filed 04/07/2003 Page 2 of 97 Moreover, the SEC is conducting a formal investigation into insider trading and the truthfulness of disclosures by KeySpan and its directors. 4. In fiscal year 1999, KeySpan stock lost almost 24% of its market value. This decline reflected the uncertainty and turbulence of deregulation in the energy sector and, equally, the misfortunes deriving from KeySpan’s merger with the Long Island Lighting Co. (“LILCO”). Since its merger with LILCO on May 29, 1998, KeySpan’s market value dropped a whopping 40%, its stock declining from $33.8125 per share on June 1, 1998, the first day of trading after the merger, to $20.3125 per share on March 1, 2000, an all time low, shortly before the commencement of the Class Period. The turbulence responsible for this diminution in KeySpan’s value, however, consolidated defendant Robert Catell’s control over the Company’s leadership. 5. Indeed, symptomatic of the difficulties plaguing KeySpan during the pre-Class Period time frame, on August 18, 1999, KeySpan was rated only "hold" by analyst William Hyler at CIBC World Markets Inc. 6. On December 18, 1999, in an article entitled "KeySpan to make Acquisitions, Sign New Customers to Boost Stock," Bloomberg News summarized the events plaguing KeySpan's stock price, and reported on the Company's efforts to rehabilitate itself and Wall Street's assessment of the rehabilitation. According to the article, CEO Robert Catell sought to reverse the Company's misfortunes by joining the merger trend sweeping the U.S. utility industry and agreeing to buy Eastern Enterprises (“Eastern”), owner of Boston's natural gas utility, for $2.5 billion. In addressing Catell's conviction "to prove KeySpan can rebound from a rocky 1998 merger with LILCO," the article continued: 2 Case 1:01-cv-05852-ARR-MDG Document 64 Filed 04/07/2003 Page 3 of 97 “KeySpan has very good prospects, but it needs to show it can consistently cut costs and increase earnings more than its peers,” said Gregory Phelps, a fund manager at John Hancock Advisors Inc., which owns about 300,000 KeySpan shares. One of Catell's immediate goals is to boost KeySpan's stock price, which has fallen 24 percent this year and 31 percent since the LILCO merger. In 1998, the company had a loss of $196 million after charges and payment of preferred dividends, on revenue of $1.7 billion. Its shares fell 5/16 to 23 1/8 in trading Friday on the New York Stock Exchange. * * * The past two years haven't been easy. KeySpan combined with LILCO in May 1998 as part of an agreement with New York state officials to lower electricity rates on Long Island. The Long Island Power Authority, a state agency, took over LILCO's electric lines. KeySpan acquired LILCO's power plants that provide electricity to about 1 million customers. The KeySpan gas-service area expanded to 1,417 square miles. LILCO's Chief Executive, William Catacosinos, became KeySpan's chief executive after the merger, with Catell taking the job of president. Controversy soon erupted when reports surfaced that Catacosinos and 20 other former LILCO executives had been paid $67 million in bonuses. After Catacosinos resigned under pressure, taking his $42 million bonus with him, Catell succeeded him and demanded the other executives either return their bonuses or resign. Eleven kept their bonuses and left. Ten gave theirs back and stayed. * * * Investors will be attracted, [Catell] hopes, by the Eastern Enterprises acquisition. The combined company will have 2.4 million natural-gas customers, making KeySpan the largest gas distribution company in the Northeast. KeySpan estimates the purchase will dilute earnings by 5 cents a share in 2001 and add 4 cents in 2002. New England and Long Island, Catell said, are ripe for growth. Forty percent of homes in Eastern's territory in Massachusetts and New Hampshire use natural-gas furnaces, compared with the national average of 54 percent. About 28 percent of Long Island households use gas. KeySpan's goal is to sign up 17,000 new gas customers a year in New England, 9,000 in Long Island and 3,000 in New York. 3 Case 1:01-cv-05852-ARR-MDG Document 64 Filed 04/07/2003 Page 4 of 97 "We are going to aggressively expand the KeySpan brand," Catell said. Catell plans to use the same marketing techniques that helped the company boost gas usage in its New York City service area to 80 percent of households, up from 30 percent in the 1950s. 7. But Bloomberg News also reported analysts' skepticism of Catell's plans for a turnaround. Those analysts said that they were worried that even Catell's ambitious plans for adding customers wouldn't achieve rapid profit growth. “Increasing market share is a very slow process that could take 40 years," said Michael Heim, an analyst at A.G. Edwards & Sons Inc., who has a "maintain position" rating on KeySpan's shares. 8. Bloomberg News reported an alternative growth strategy being advocated by analyst Edward Tirello of Deutsche Banc Alex Brown: namely, the making of more acquisitions. If KeySpan doesn't expand even more, other companies will be substantially larger and could attack its customer base," said Tirello, who rates KeySpan's shares "market perform." 9. Indeed, KeySpan saw increased growth opportunity arising from increased demand for natural gas in the Northeast, fueled by residential and commercial oil-to-gas conversions and the need to power cleaner burning electric generation. To advance this goal, the Company had started its energy services business in 1997. This startup unit allowed KeySpan to provide unregulated energy solutions to homes and businesses throughout its growing territory that were otherwise prohibited to the Company’s regulated entities. Initially focused on providing appliance service contracts, the division grew to derive half of its revenues from the installation of gas equipment, such as boilers, furnaces, central air conditioners and water heaters. Although it took a few years to contribute to the Company’s bottom line, by 1999 the unit had sufficiently developed to be considered a viable growth business. Indeed, by that time the energy 4 Case 1:01-cv-05852-ARR-MDG Document 64 Filed 04/07/2003 Page 5 of 97 services business included unregulated, subsidiary companies that designed and/or operated energy systems for commercial and industrial customers, provided energy-related services to clients, provided and serviced various appliance, heating, ventilation and air conditioning service contracts to the Company’s customers, and marketed gas and electricity to retail customers. Many of the subsidiary companies in the energy services unit were only acquired in 1998-1999. In fact, in the latter half of 1999, KeySpan accelerated its acquisition plan and negotiated the purchase of Roy Kay, Inc. (“Roy Kay”), a contracting company headquartered in Freehold, New Jersey, which KeySpan represented was a major energy contracting company. 10. However, notwithstanding defendants’ contemporaneous priming of the public investment community with representations that the Roy Kay acquisition advanced KeySpan’s stated strategy of expanding while maintaining revenue and profit growth, defendants concealed material facts that became known to or recklessly disregarded by them concerning substantial and material segments of the acquired Roy Kay which were incompatible with KeySpan’s growth and profit plans because, in truth: (i) Roy Kay lacked proper accounting controls and had incurred but not properly recorded substantial contract liabilities; and (ii) KeySpan would belatedly take two special charges against Roy Kay’s earnings that caused KeySpan to report consolidated losses for the second and third

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