David J. Bershad (DB-9981) Max W. Berger (MB-5010) Jerome M. Congress (JC-2060) Daniel L. Berger (DB-7748) Patrick L. Rocco (PR-8621) Steven B. Singer (SS-5212) Elaine S. Kusel (EK-2753) Jeffrey N. Leibell (JL-1356) Mary Lynne Calkins (MC-5949) Javier Bleichmar (JB-0435) MILBERG WEISS BERSHAD HYNES BERNSTEIN LITOWITZ BERGER & & LERACH LLP GROSSMANN LLP One Pennsylvania Plaza 1285 Avenue of the Americas New York, NY 10119-0165 New York, NY 10019 (212) 594-5300 (212) 554-1400
Seth R. Lesser (SL-5560) BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP A New York Limited Liability Partnership One University Place Suite 516 Hackensack, NJ 07601 (201) 487-9700 Co-Lead Counsel for the Class
UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY ______) IN RE LUCENT TECHNOLOGIES, INC. ) Civil Action No. 00-621 (AJL) SECURITIES LITIGATION ) ______)
FIFTH CONSOLIDATED AND AMENDED CLASS ACTION COMPLAINT
Plaintiffs, Teamsters Locals 175 & 505 D&P Pension Trust
Fund (the “Pension Trust Fund”), whose address is 4815 Maccorkle
Avenue SE, Charleston, West Virginia 25304, and The Parnassus
Fund and Parnassus Income Trust/Equity Income Fund, whose address is One Market Street Tower, Suite 1600, San Francisco, California
1 94105,(“Parnassus,” and together with the Pension Trust Fund,
“Lead Plaintiffs”), allege the following against defendants.
NATURE OF THE ACTION
1. This is a class action on behalf of all purchasers of the common stock of Lucent Technologies, Inc. (“Lucent” or the
“Company”) between October 26, 1999, and December 21, 2000, inclusive (the "Class Period"), seeking to pursue remedies under the Securities Exchange Act of 1934 (the "Exchange Act").
2. This case arises from defendants’ efforts to conceal from the investing public the fact that Lucent was experiencing pervasive and material difficulties which were adversely impacting its revenues and profits, as well as its relationships with clients and customers.
3. Lucent was spun off from AT&T in 1996 and endowed at its inception with a dominant position in the market for telecommunications equipment. However, by mid-1999, Lucent had squandered that advantage. As the telecommunications industry shifted from transmission of voice to data, new technologies and products developed and new entrants into the market place began to compete with Lucent. Lucent represented that it was at the forefront of competition in these new arenas and publicly projected continuing dramatic growth, but the true circumstances at Lucent belied defendants' representations.
2 4. By the beginning of the Class Period, the Company was confronting severe problems. First, Lucent had fallen seriously behind in developing optical networking products capable of running at "OC-192" speed, which had become the product of choice for Lucent's potential customers. Lucent also was experiencing wide-spread problems with a broad range of its other optical networking products. The difficulties with optical networking negatively impacted Lucent’s sales and revenues. Second, problems of product design, reliability and timeliness of deliveries were widespread throughout Lucent's product lines including among others, optical networking, wireless, switching and software, causing customer dissatisfaction and withdrawal of orders, especially for Lucent’s WaveStar and wireless products.
Third, problems had developed with AT&T, Lucent’s largest and most important customer, stemming from Lucent's unwillingness to manufacture to AT&T's specifications, AT&T's desire to diversify its sources of supply, and Lucent's inability to adequately develop products which met AT&T’s requirements.
5. By the fall of 1999, Lucent had met or exceeded analysts' published expectations for Lucent’s revenue and earnings(which were premised on the "guidance" Lucent’s management regularly provided to analysts) for fourteen straight quarters. However, by the beginning of the Class Period,
Lucent's management acknowledged in internal emails discussing
3 the problems that the Company’s optical networking group was in
“serious disrepair” and, as a result, Lucent was "up against a revenue wall."
6. Indeed, by October 1999, as reported by The Wall Street
Journal in an October 24, 2000 article entitled “Lucent Ousts
McGinn as CEO and Chairman”, Lucent senior executives had informed defendant McGinn, Lucent's President, Chief Executive
Officer and Chairman, that Lucent needed to drastically reduce its public projections of revenue and earnings because necessary new products were not ready for sale and sales of older products were in decline. McGinn refused to heed this instruction, and
Lucent failed to cut back its aggressive public guidance to reflect the reality of its declining business.
7. Instead, defendants took various steps to conceal its true financial situation from the investing public. Among other things, defendants misrepresented the demand for the Company's optical networking products without disclosing that demand had shifted dramatically away from the optical networking products
Lucent was then able to deploy because the Company’s products were slower than their rivals and beset by persistent technological problems. Defendants knew that, as a result, potential customers were deserting Lucent and buying from companies (such as Nortel) that were already successfully deploying newer OC-192 capable products.
4 8. Faced with declining demand for the only optical networking products it could reliably deliver and for its other products, defendants decided to artificially inflate reported sales by shipping products that were not yet ready.
Specifically, in September 1999, Lucent's optical networking head
Harry Bosco told the Company's directors at a meeting in
Nuremberg, Germany that Lucent's strategy was to ship optical networking products notwithstanding design and technical problems, and to solve those problems later. Although that decision was designed to increase reported sales, it exacerbated the existing problem of poor product quality, which had a further adverse impact on customer acceptance and sales.
9. Documents obtained since the filing of the Fourth
Amended Complaint establish that Lucent’s most senior officers knew throughout the Class Period that: (1) Lucent’s accounting practices violated generally accepted accounting principles
(“GAAP”); (2) Lucent had improperly booked hundreds of millions of dollars of revenue on sales to customers in situations where the customers had not ordered the product; (3) Lucent had improperly booked hundreds of millions of dollars of revenue on shipments to distributors even though Lucent’s senior officers had specifically granted those distributors the right to return the products if they were ultimately not sold; (4) Lucent sales people were routinely entering into “side deals” with
5 distributors to allow them to return the product while improperly reporting these deals as current sales; and (5) Lucent was
“stuffing” its distributors with product they did not want or need (and in many instances had not even ordered). These documents establish that Lucent’s accounting improprieties began during the first quarter of fiscal 2000 (ended December 31, 1999) and continued throughout the Class Period.
10. Despite defendants' accounting machinations, on
January 6, 2000 Lucent was forced to announce that the Company would miss analysts’ earnings estimates for the first quarter of fiscal 2000. Rather than disclose the true reasons for the disappointing results, McGinn assured the market that demand for the Company's optical networking products was strong and that the principal causes of the shortfall were manufacturing constraints that limited the Company's ability to meet that demand and changes in timing (rather than cancellation) of customer orders.
These statements were false.
11. Thereafter, throughout the spring and summer of 2000,
McGinn and Lucent reassured the investing public that the demand for the Company's products was very strong and that the Company was still a leader in all areas. In truth, however, during this time Lucent lost all of the business for its newest optical networking products with its largest customer, AT&T, and had internally declared a "sales crisis." By no later than the end
6 of Lucent’s fiscal 2000 second quarter (ended March 31, 1999),
Lucent’s most senior officers had explicitly recognized that
“[a]s the first half of 2000 comes to a close, it is clear that we cannot continue with the current operational model -- it just doesn’t work.” Nevertheless, by engaging in a variety of improper accounting practices and fraudulent revenue recognition,
Lucent was able to report results for the March quarter which met expectations. On the strength of Lucent’s false assurances,
Lucent's share price rebounded to $62 99/256 on July 17, 2000.
12. On July 20, 2000, Lucent announced results for the third fiscal quarter of 2000 ended June 30, 2000, which were below expectations. In the Company’s press release announcing those results, McGinn sought to assure investors that Lucent’s business remained strong, and stated that Lucent’s pro forma revenues from continuing operations would grow about 15% for the fourth fiscal quarter of 2000, and that pro forma earnings per share would be roughly in line with revenue growth. As was ultimately revealed, however, McGinn’s July 20 guidance was knowingly false. According to a complaint filed against Lucent in December 2000 by Nina M. Aversano, Lucent’s former President,
North America - Service Provider Networks, in July 2000, shortly before McGinn provided his guidance, Aversano and Patricia Russo, the Chief Executive Officer of the SPN segment (which accounted for approximately 80% of Lucent’s annual revenues), specifically
7 told McGinn that the revenue and earnings projections for the fourth quarter that he intended to include in Lucent’s press release were unattainable and needed to be reduced. Despite this information, McGinn issued the press release with the materially inflated fourth quarter expectations. Shortly thereafter, McGinn terminated Ms. Russo’s employment.
13. On October 10, 2000, Lucent disclosed information enabling analysts to determine that its optical networking business had actually declined 15% for the quarter, and that it was increasing its reserve for uncollectible accounts receivable by a material amount. The market reaction to these disclosures was severe: On October 11, 2000, Lucent's share price fell more than $10 per share to close at $21 3/16 -- less than a third of the average price of Lucent shares during the Class Period.
14. In an effort to stem the dramatic decline in Lucent's share price, defendants falsely reassured the market about the strength of Lucent's business by announcing, on October 23, 2000, fourth quarter revenues of $9.4 billion, and pro forma earnings of $0.18 per share, which were in line with analysts' revenue expectations. The October 23, 2000 announcement had the desired effect. Lucent's share price rebounded to trade at approximately
$24 per share by November 11, 2000 and analysts concluded that
Lucent had begun to take a "step in the right direction."
8 15. However, on November 21, 2000, Defendants revealed that the fiscal year 2000 fourth quarter results reported on October
23, 2000 materially overstated the Company's results and, accordingly, the Company in fact had not met analysts expectations for the quarter. Specifically, the Company stated that an unspecified "revenue recognition problem" had impacted approximately $125 million of reported quarterly revenue. As a result, the Company announced that it would restate its fiscal fourth quarter revenues, and that earnings per share for the quarter and the year would be reduced by approximately two cents per share. The market reaction to the November 21, 2000 disclosure was severe: Lucent shares fell $3.31 to $17.63.
16. Finally, on December 21, 2000, Lucent disclosed that its November 21, 2000 announcement of a $125 million revenue recognition problem itself materially understated the depth of the problems at the Company. In a December 21, 2000 announcement and conference call with analysts, the Company revealed that it was again restating its fiscal fourth quarter revenues, this time reducing revenue for the quarter by $679 million to $8.7 billion
-- a figure $700 million less than the quarterly revenues initially reported, and more than $400 million greater than the restatement amount announced on November 21. The Company also revised its earnings per share for the quarter from $0.18 per share to $0.10 per share. In addition, the Company revealed that
9 it would take a $1 billion restructuring charge in late January
2001.
17. The December 21, 2000 announcement revealed that sales practices at the company were responsible for, among other things, the inappropriate recognition of hundreds of millions of dollars in revenue for sales of products which were later returned pursuant to prior agreement, and for sales of products which had been incompletely shipped.
18. Lucent's December 21, 2000 announcement had a devastating effect on the Company's share price. Following this announcement, Moody's Investor Services downgraded Lucent's credit rating and Lucent shares plummeted to trade as low as
$12.19 per share – $72 or 86% less that its Class Period high of
$84.19.
JURISDICTION AND VENUE
19. The claims asserted herein arise under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. §§ 78j(b) and 78t(a), and Rule 10b-5 promulgated thereunder by the Securities and
Exchange Commission ("SEC"), 17 C.F.R. § 240.10b-5.
20. This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C. §§ 1331 and 1337 and Section 27 of the Exchange Act, 15 U.S.C. § 78aa.
21. Venue is proper in this district pursuant to Section 27 of the Exchange Act and 28 U.S.C. § 1391(b). Many of the acts
10 charged herein, including the preparation and dissemination of materially false and misleading information, occurred in this district. Additionally, defendants maintain their chief executive offices and principal place of business within this district.
22. In connection with the acts alleged in this complaint, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including the mails, interstate telephone communications and the facilities of the national securities markets.
PARTIES
23. By order of the Court dated April 26, 2000, the Pension
Trust Fund was provisionally appointed Lead Plaintiff. By Order of the Court dated April 17, 2001, Parnassus was appointed as Co-
Lead Plaintiff and the non-provisional status of the Pension
Trust Fund was confirmed. As reflected in Schedule A annexed hereto, Lead Plaintiffs purchased the common stock of Lucent during the Class Period and have been damaged thereby. The Lead
Plaintiffs have previously filed certifications with the Court authorizing their participation in this action as mandated by
Section 21D(a)(2)(A) of the Exchange Act.
24. The Pension Trust Fund is a multi-employer pension trust organized in West Virginia and created pursuant to collective bargaining agreements between a number of employers
11 and Teamsters Local Nos. 175 and 505. The Pension Trust Fund is administered by trustees nominated by both employers and the union. The trustees of the Pension Trust Fund believe that the investments of the Fund must be diversified. Further, it is the policy of the Pension Trust Fund's trustees to invest the assets of the fund with care in those vehicles that should preserve the principal while recognizing the need for income and appreciation with minimal risk.
25. Parnassus is a group of mutual funds founded in 1984 and located in San Francisco, whose principal investment objective is long-term growth of capital. Parnassus only invests in companies that practice corporate social responsibility. In general, Parnassus looks for companies that respect the environment, treat their employees well, have effective equal employment opportunity policies, good community relations and ethical business dealings. Parnassus does not invest in companies that manufacture alcohol, tobacco or weapons.
26. The persons and entities listed on Schedule B annexed hereto are additional plaintiffs in this action. During the
Class Period, each acquired Lucent common stock and suffered damages as a result of defendants’ violations of law.
27. Defendant Lucent is a Delaware corporation with its principal place of business and chief executive offices located at 600 Mountain Avenue, Murray Hill, New Jersey 07974. Lucent
12 designs, builds and installs a wide range of public and private networks, communications systems, data networking systems, business telephone systems and microelectronics components, and manufactures integrated circuits and optoelectronic components for the computer and telecommunications industries.
28. The following defendants (together, the “Individual
Defendants”) served in the capacities listed below at all times relevant to this action:
(a) Defendant Richard A. McGinn (“McGinn”) was
Lucent's President, Chief Executive Officer and Chairman of its
Board of Directors from February, 1996 until he was fired by the
Company's Board of Directors on October 22, 2000. McGinn signed the Company's 1999 Annual Report on Form 10-K (the “1999 10-K”).
During the Class Period, McGinn was quoted frequently in the news media and in press releases and other publicly disseminated materials.
(b) Defendant Donald K. Peterson (“Peterson”) was
Lucent’s Chief Financial Officer and Executive Vice President until March 1, 2000. Peterson signed the 1999 Form 10-K.
(c) Defendant Deborah C. Hopkins (“Hopkins”) joined
Lucent on April 24, 2000 as Chief Financial Officer. Hopkins was responsible for executive management and oversight of all financial operations for the Company. As set forth herein,
13 Hopkins directly issued many of the statements alleged to be misleading.
CLASS ACTION ALLEGATIONS
29. Lead Plaintiffs bring this action as a class action pursuant to Federal Rule of Civil Procedure 23(a) and (b)(3) on behalf of a class (the “Class”) consisting of all persons who purchased Lucent common stock between October 26, 1999, and
December 21, 2000, inclusive (the "Class Period") and who were damaged thereby. Excluded from the Class are: (i) defendants;
(ii) members of the immediate family of each individual defendant; (iii) any entity in which any defendant has a controlling interest; (iv) any person who was an officer or a director of Lucent (or of any Lucent subsidiary or affiliate) during the Class Period; and (v) the legal representatives, heirs, successors or assigns of any such excluded party.
30. The members of the Class are so numerous that joinder of all members is impracticable. Throughout the Class Period,
Lucent common shares were actively traded on the NYSE. As of
October 10, 2000, there were approximately 3,071,784,797 shares of Lucent common stock issued and outstanding. While the exact number of Class members is unknown to plaintiffs at this time, plaintiffs believe that there are thousands of members in the proposed Class. Record owners and other members of the Class may be identified from records maintained by Lucent or its transfer
14 agent and may be notified of the pendency of this action by mail, using the form of notice similar to that customarily used in securities class actions.
31. Lead Plaintiffs' claims are typical of the claims of the members of the Class as all members of the Class have been similarly affected by defendants' wrongful conduct in violation of federal law that is complained of herein.
32. Lead Plaintiffs will fairly and adequately protect the interests of the members of the Class and have retained counsel competent and experienced in class and securities litigation.
33. Common questions of law and fact exist as to all members of the Class and predominate over any questions solely affecting individual members of the Class. Among the questions of law and fact common to the Class are:
(a) whether the federal securities laws were violated by defendants' acts as alleged herein;
(b) whether statements made by defendants to the investing public during the Class Period misrepresented material facts about the business, operations, financial statements of
Lucent;
(c) whether the Company's financial statements violated GAAP; and
(d) to what extent the members of the Class have sustained damages and the proper measure of damages.
15 34. A class action is superior to all other available methods for the fair and efficient adjudication of this controversy since joinder of all members is impracticable.
Furthermore, as the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation make it impossible for members of the Class to individually redress the wrongs done to them. There will be no difficulty in the management of this action as a class action.
FACTS
A. BACKGROUND
1. Lucent's Operating Structure
35. Lucent's business consists of the design and manufacture of telecommunications systems and software, data networking systems and microelectronic components. Lucent conducts its research and development activities through Bell
Laboratories. The Company or its predecessors have supplied products to virtually every local and long distance telephone company in the United States.
36. During the Class Period, the Company classified its business into three segments or divisions: Service Provider
Networks ("SPN"); Enterprise Networks; and Microelectronics and
Communications Technologies ("MCT").
37. The SPN segment included the product groups responsible for Lucent's optical networking, switching solutions, wireless
16 networking and software solutions. It also included Lucent's data networking business for service provider customers. During the Class Period, in the first quarter of 2000, the Company transferred its optic components business from its MCT segment to its Service Provider Networks segment.
38. The Enterprise Networks segment included the Company's
Business and Communication Systems ("BCS") division. BCS developed, sold and installed telephone and data networks for business customers. On October 2, 2000, Lucent spun off BCS as a separate company, named Avaya Communications, ("Avaya").
39. During the Class Period, Lucent's MCT division designed and manufactured high performance integrated circuits, power systems and optical components. On July 21, 2000, Lucent announced that it intended to spin-off the MCT division as a separate public company in the first quarter of 2001. As part of this plan, shares of that company, called Agere Systems Inc.
("Agere"), were offered to the public on March 21, 2001. Lucent is now the majority shareholder of Agere, owning approximately
58% of Agere’s stock.
40. During the Class Period, Lucent operated using a fiscal year that ended on September 30 of each calendar year. Quarters ending on September 30 were designated as the fiscal fourth quarter and quarters ending on December 31 were designated as the fiscal first quarter.
17 2. The Formation of Lucent
41. Prior to 1996, Lucent’s telecommunications equipment businesses were a part of AT&T. Specifically, AT&T’s Western
Electric subsidiary conducted the equipment manufacturing business and AT&T’s Bell Labs subsidiary conducted the research and development. Until 1984, these Lucent predecessors were sister organizations of AT&T’s wholly owned local telephone service providers collectively known as the Bell Operating
Companies (“BOCs”). The BOCs purchased substantially all of their telecommunications equipment from Western Electric and other Lucent predecessors.
42. On September 30, 1996, AT&T completed the spin-off of its telecommunications equipment business as Lucent.
Historically, this business had been based on copper wireline technology and switches which carried voice and data using electric currents. By the time of the Lucent spin-off, the telecommunications equipment business was poised to undergo a sea change, as new wireless and optical technologies were emerging which would eventually make Lucent's near monopoly power in the old electrical technology far less important. Thus, if Lucent were to maintain its market share, Lucent would have to develop and market products using the new technology by the time that customers began to demand them.
18 43. For nearly two years following Lucent’s 1996 IPO, the
Company was able to continue to generate strong sales to its traditional customers, based on the flow of business inherited from AT&T. The Company became an investor favorite and was the most widely-held stock in the United States. Lucent was followed by numerous analysts who favorably commented on the Company’s potential.
44. However, behind the positive numbers, there were significant problems growing at Lucent which threatened the
Company’s ability to compete.
45. By 1998, Lucent's traditional customers -- the Regional
Bell Operating Companies ("the RBOCs") – were facing competition from start-up telecommunications service providers commonly called Competitive Local Exchange Carriers ("CLECs"). The CLECs were creating wireless and optical networks which could be built without Lucent's wireline based technology and which were far faster and more efficient. As a result of this new competition, the RBOCs demanded the most technologically advanced products available.
46. According to counterclaims filed by individuals who were employed at Lucent's North Andover optical manufacturing facility (¶¶100-04), by the fall of 1999, Lucent’s Bell Labs development unit had fallen behind in developing new telecommunications technology. These problems were so pervasive
19 and intractable that, in September 1999, Lucent’s senior management told the Company’s directors that Lucent would follow a policy of shipping products with known design flaws first (so that Lucent could record revenue), and then attempt to fix the problems later. Furthermore, it was widely recognized within
Lucent that the Company had continual production problems with its products, and that the Company's products were much more expensive than those of their competitors.
47. Thus, as of the end of its 1999 fiscal year, Lucent was facing increasing demand for advanced technology just as it realized that it lacked the ability to develop such technology in a timely or effective manner.
3. Problems With Lucent's Optical Networking Products
a. Nature of the Optical Networking Business
48. Optical networking products are designed to increase capacity into Internet portals by using pulses of light to transmit millions of phone connections simultaneously through thin optical fibers, rather than the old generation copper wire infrastructure.
49. Optical networking technology is in demand because customers want faster connections and because the volume of information flowing through public networks has nearly tripled in the past three years. The demand for optical networking products is inversely related to the demand for Lucent's conventional
20 large scale switching products. As regional telephone companies transition to optical networking, they necessarily require less conventional copper wire electrical equipment. Thus, increasing sales of optical networking products negatively impacts Lucent, unless Lucent were to be the provider of the new technology.
50. The transmission capacity or bandwidth in optical networking technology has increased exponentially since the technology was introduced in 1995. Advances in optical networking technology have impacted two aspects of the product, speed and capacity.
51. OC-192 is the fastest class of available fiberoptic networking technology and enables users to transmit 10 gigabits of data per second. OC-192 was developed by Nortel Networks in the mid-1990s. Before Nortel's development of OC-192, the standard of technology was OC-48, which transferred data at only
2.5 gigabits per second. OC-192 products are 400% faster and have 16 times the network capacity of 2.5 gigabit products.
During the summer and fall of 1999, Lucent had a 2.5 gigabit product line but was seriously behind in developing a viable
OC-192 product.
b. Lucent’s Optical Networking Products
52. Lucent’s optical networking products were manufactured in its North Andover, Massachusetts facility, which was also referred to internally at Lucent as the Merrimac Valley facility.
21 During the Class Period, these products consisted of the WaveStar family of products.
53. During the relevant time, Lucent's optical business was a material portion of Lucent's overall business, accounting for approximately 25% of Lucent's reported sales, according to research reports issued by SG Cowen on October 8, 1999 and JP
Morgan, dated July 21, 2000.
54. Analysts covering the Company viewed Lucent's optical networking business as a very important part of Lucent's future.
For example, in an analyst report issued in November 1999,
Credit Suisse First Boston described the Optical Networking
Division as one of Lucent's "key top-line catalysts" for fiscal year 2000.
55. Lucent’s Optical Networking Group (ONG) was responsible for the Company’s optical production and was a part of the
Service Provider Network segment. ONG’s business consisted of four product lines: (1) DWDM (e.g., WaveStar 400G); (2) Cross
Connect (e.g., Bandwidth Manager); (3) Multiplexers; and (4)
Software. Each product line had a product management team, e.g., the WaveStar 400 product team, the OLS 40G product team. Sales teams at ONG are divided by customer. They represent all of the current Lucent (excluding Microelectronics and what is now Avaya) products for a particular customer.
22 56. The DWDM segment was based in North Andover and produced the WaveStar products. The OC-192 DWDM product was the
Wave Star 400G -- a product that transports data over very long distances. Wave Star 400G is a fiber optic transmission product and it does nothing with the data except transport it. The pre-
OC-192 older series DWDM product line was OLS 40G, sometimes known as the 80G, and was a 16-wave length product with much lower capacity operating at a 2.5 gigabits per wave length.
57. Lucent’s Cross Connect segment was also based in North
Andover and produced the Bandwidth Manager product. Bandwidth
Manager takes the data from the 400G, breaks it down into pieces and routes those pieces in different directions and then in some cases "manages the bandwidth" (meaning, taking one slice out of a big data stream and filling up that space with another slice from somewhere else and then sending the results in a particular direction). The pre-OC-192 (older) Cross Connect product was the
DACS series of products.
58. The Multiplexing segment was based in Nuremberg,
Germany. Most of the OC-192 deployment was not in the multiplexer product group. The multiplexers are designed for the edge of the network where capacity levels are lower. In general, the Cross-Connects and the DWDM systems make up the network between the central offices and the networks. In all probability, a central office would also have a multiplexer, and
23 the job of the multiplexer was to take the traffic that was destined for that geographical area and break it down into even smaller pieces.
59. The fourth ONG segment was software. The software unit was located in Holmdel and Red Hill, New Jersey. The principal
OC-192 software was the WaveStar Element Manager ("WEM") and other variations of Element Management System product. The software unit did not become a segment of ONG until late 1999.
This change was brought about by Harry Bosco, the head of
Lucent’s Optical Networking Group, in an attempt to cure delays in producing the WEM software. The delays were due in part to software problems involving interoperability of ONG products
(specifically, the products, which were designed to operate together in a system, could not talk to each other).
60. Software was an integral part of DWDM systems. The only Lucent customers who developed their own software were extremely large ones, such as AT&T and Sprint. However, 75% to
80% of customers bought Lucent’s Element Management Software to help manage their optical networks. The WEM connected the pieces in a local optical networking system or segment, the SNMS
(Network Management Software) ran the entire network.
61. While the Optical Networking Group produced a number of different products, they were generally sold together. To build an optical network, a customer would require a Bandwidth Manager
24 in every office and DWDM systems, specifically WaveStar 400Gs (or other speed) products to connect those offices with fiber. Each of those product groups would be designed to manage, in addition, older products of the same type which operated at slower than OC-
192 speed.
62. Thus, ONG was very dependent on selling the entire group of products. The "product" itself was either OC-192 or the slower older product. During the Class Period, Lucent could install pieces in isolated places but, as described below, potential big sales were lost because Lucent could not install the entire OC-192 network. Thus, the failure to market an OC-192 system affected every line of the optical networking business.
63. Because the universe of potential customers for DWDM systems is relatively small, numbering in the hundreds at most, the first company to market with a successful product captures a large number of customers. The importance of being first to market is underscored by the fact that, in optical networking systems a "footprint" is incredibly important; that is, getting the first piece of a system installed into a customer’s network.
This is because each manufacturer’s system has unique characteristics that make it easier to integrate with other units of the same manufacturer, but more difficult to integrate with another manufacturer’s system. For example, if Nortel has part of a network installed, all of Nortel's products operate well
25 with each other, so the customer can easily install another
Nortel product; however, installing a Lucent product in a Nortel network would be difficult, making Lucent's products relatively unattractive.
c. Problems in Lucent’s Optical Networking Group
64. By mid 1997, Nortel Networks had installed its first
OC-192 and was experiencing increasingly strong demand for the product. In response, Lucent made a strategic decision to postpone development of an OC-192 product. Specifically, according to an October 8, 2000 article in The Morning Call
(Allentown) entitled “Lucent Vies to Win Back Customers”, in
August 1997, defendant McGinn convened a secret 10-day long meeting in Red Bank, New Jersey to discuss strategy for optical networking development. Thereafter, Lucent's senior management, including McGinn, decided to cut spending on development of faster optical equipment in favor of developing a product with more capacity but far less speed than OC-192. Hoping that its customers would continue to purchase the Company's 2.5 gigabit product until the Company’s OC-192 product was ready was a dangerous strategy in light of the fact that Nortel was already shipping OC-192 and Nortel's orders for OC-192 were significant.
65. By the Fall of 1999, according to Witness 4 (a former
Director of Lucent’s Advance Technology Department within ONG from October 1999 until August 2000 who was involved in the
26 development of Lucent’s WDM products),1 although two years had passed since Nortel had introduced its OC-192 product, Lucent's
OC-192 capable product was lagging in development and the Company was having problems with its other optical networking products.
At the time of its original decision not to press ahead vigorously with OC-192, Lucent misread the market and did not anticipate that customers, intent on keeping ahead of their competitors, would quickly shift their demand from the older 2.5 gigabit technology to OC-192 capable products. They were disabused of this notion, however. For example, in November 1997
Lucent lost a $200 million contract to supply optical networking gear to Qwest because Lucent lacked OC-192 capability. NA00304.
Instead, Qwest ordered $150 million in networking gear from
Nortel in 1997, and $600 million more in June of 1999. Id. By the beginning of the Class Period, Lucent knew that it had made a major misjudgment, because demand for its 2.5 gigabit product had significantly diminished as the demand for OC-192 capability skyrocketed and Lucent was losing business to its competitors who could successfully deploy OC-192 systems.
1 Each of the witnesses referred to in this Complaint requested anonymity as a condition of speaking with Lead Plaintiffs’ Counsel. Accordingly, each such witness is identified by a unique designation, “Witness 1, Witness 2,” etc. A list identifying the name of each such witness is set forth in Schedule C.
27 66. According to Witness 5, a former member of Lucent’s technical staff at the North Andover facility from January 1996 until December 1999, Witness 6, a former process analyst at the
North Andover facility from November 1976 to May 2001, and
Witness 7, and a former regional training manager at the North
Andover facility from October 1997 to December 2000, at least from the summer of 1999 on, production at Lucent's optical networking facility was very slow because of the lack of work and machines often lay idle as employees sat on the production floor reading magazines. According to Witness 6, during late 1999 and early 2000, the North Andover facility’s production team for OC-
192 “kept building and building [the OC-192 product] boards and when they stockpiled, I guess, the thing fell through. They couldn’t sell the stuff.”
67. As reflected in ¶¶120, 126, 127 of the Tymann Answer
(as defined in ¶70, infra), by the Summer of 1999, Lucent management was well aware that the Company was seriously behind in the development of an OC-192 product and that potential customers were either going elsewhere to buy OC-192 or withholding purchases from Lucent until its OC-192 product was ready. According to Witness 9, (a former quality assurance auditor at the North Andover facility from August 1998 until June
2000 who worked in the quality and engineering assurance group and whose job was to find defects in products before shipment),
28 and Witnesses 4 and 7, during and after the Summer of 1999, these facts were openly discussed by optical networking personnel, including in meetings with Lucent senior management such as Harry
Bosco. As a result of the problems, demand for Lucent’s optical networking products had declined significantly throughout 1999.
68. Lucent’s problems in developing optical networking products were not limited to the OC-192 product. Since as early as the fourth quarter of fiscal 1999, Lucent was experiencing on- going systemic problems with its other newest optical networking products, including its BandWidth Manager, its OLS Wavestar
40/80G and its Wavestar OLS 400G.
B. THE FRAUD
69. Lead Plaintiffs have obtained documents and other information establishing that, by the start of the Class Period,
Lucent’s senior officers, including defendant McGinn, knew that the Company’s optical networking business was in “serious disrepair” (as stated in the November 1, 1999 SPN 2000 Operations
Plan) and that Lucent was experiencing significant difficulties marketing its optical networking products. These documents also establish that Lucent could not achieve its earnings and revenue targets through legitimate means. As a result, beginning no later than the first quarter of fiscal 2000 (the quarter ended
December 31, 1999), Lucent engaged in a variety of improper accounting practices designed to artificially inflate Lucent’s
29 publicly reported financial results, including booking hundreds of millions of dollars of revenue from phony sales in which the customers had neither ordered nor agreed to accept the products.
70. The principal sources for the facts pled below are: (i) internal Lucent emails and other documents produced by Nina
Aversano (“Aversano”) pursuant to subpoena (documents produced by
Aversano are cite to herein as “NA__”); (ii) documents produced by third parties, including Anixter International, Inc.
(“Anixter”) and Graybar Electric Company, Inc. (“Graybar”), who were large Lucent distributors during the Class Period; (iii) the facts pled by Aversano in a complaint she filed against Lucent in the Superior Court of New Jersey, Middlesex County, on December
11, 2000 (the “Aversano Complaint”); (iv) the facts pled by
Daniel B. Tymann and nine other former senior Lucent employees
(the “Tymann Defendants”) in the Answer and counterclaims they filed on July 20, 2000 in an action against them commenced by
Lucent in the United States District Court for the District of
Massachusetts (the “Tymann Answer”); (v) statements by former
Lucent employees interviewed by Lead Counsel (each one specifically identified where relied upon herein); (vi) public information related to the relevant time period, including SEC filings by Lucent, press releases, news articles, media reports
(including those disseminated in print and by electronic media),
30 and reports by securities analysts and investor advisory services.
71. Aversano was a senior executive at Lucent during the
Class Period. At all relevant times until May 2000, Aversano was
President of the Emerging Services Providers (“ESP”) Group in
North America, a division of SPN. On May 9, 2000, Lucent promoted Aversano to the position of President, Service Provider
Networks – North America. In both positions, Aversano reported directly to Patricia Russo, Executive Vice President and Chief
Executive Officer of SPN, who in turn reported directly to defendant McGinn. After McGinn fired Russo in early August 2000,
Aversano reported directly to McGinn. In October 2000, McGinn told Aversano that her employment would be terminated effective at year-end. In her complaint, Aversano states that she was fired because she refused to “support the use of . . . misleading financial targets” and because she told McGinn that his revenue targets were “hopelessly unrealistic.”
72. As President of SPN, North America, Aversano was responsible for approximately $20 billion of Lucent’s 1999 revenues, or 77% of SPN’s total 1999 revenues of about $26 billion. Lucent’s total revenues for 1999 were $33 billion, so
Aversano was in charge of 60% of Lucent’s business. Of the three segments that comprised Lucent’s operations in 2000, Service
Provider Networks was by far the most important, accounting for
31 nearly 80% of Lucent’s annual revenues. Lucent has since spun- off the other two operating segments – MCT and Enterprise
Networks.
1. Internal Lucent Documents And Interviews with Former Lucent Employees Demonstrate That Defendants Knew That Lucent’s ONG Business Was Performing Poorly
73. In the months leading up to the start of the Class
Period, Lucent had experienced substantial difficulty manufacturing and marketing ONG products. Thus, on July 27,
1999, Aversano sent a memorandum to Gerald J. Butters, ONG Group
President. [NA006438]. In the July 27, 1999 memo, Aversano states that Lucent was facing “a significant challenge in reaching our 4Q and FY 99 revenue objectives for the North
American Region,” and that ONG was expected to generate only $1 billion in revenues in fiscal 1999, which was more than “$700
[million] below the ONG plan of $1.73 billion.” The July 27 memorandum further stated that approximately $280 million of the
$700 million “gap” between the projected and actual revenues for
ONG was attributable to shortfalls from three key products:
Bandwidth Manager, OLS 40/80G and the OLS 400G. Aversano concluded that, in fiscal 2000, Lucent needed a “renewed commitment to identify and resolve the core issues that have impacted our 1999 performance,” including the problems associated with ONG. [NA006438].
32 74. The problems Aversano identified in her July 27 memorandum continued and intensified during the Class Period. On
November 1, 1999 (only five days after the start of the Class
Period), Aversano and Russo conducted an internal presentation concerning SPN North America’s prospects for 2000 and in connection therewith used a document entitled “Service Provider
Networks North America 2000 Operations Plan.” [NA003514-3631].
Defendant McGinn received a copy of this document. According to the 2000 Operations Plan, “Lucent is Up Against A Revenue Wall” and the document acknowledges that Lucent had led investors to expect “continued double-digit growth.” However, “NAR legacy products alone, no longer support that level of growth,” and
“Lucent’s [market] share is lowest in highest growth areas
(Packet Software, Access Services).”
75. The 2000 Operations Plan specifically described numerous optical networking products which Lucent was unable to deliver to many of its largest and most important customers.
With respect to Southwestern Bell, the Plan stated that “400G lab pitfalls cast doubt on LU ability to deliver.” The Plan also provided that Lucent would lose $148 million in optical networking business that it had projected in its 2000 fiscal plan because of “R&D Program Slips” with WaveStar 400G DWDM, WaveStar
AllMetro DWDM and WaveStar Bandwidth Manager. Similarly, with respect to Bell Atlantic, Lucent had lost a substantial amount of
33 optical networking market share because Lucent’s “performance in migrating to new platform was unsatisfactory” and Lucent “could not adequately help BA with missed service dates situation.” The
2000 Operations Plan further stated that, among the “major contributors to the loss” of Bell Atlantic’s business was the fact that Lucent’s “legacy products (with ten year old technology) do not meet BA’s modern day needs” and that, as a result, “Lucent lost credibility” with the customer.
76. The 2000 Operations Plan concluded that Lucent’s customers were “running out of patience” with the Company’s continued inability to market ONG products, that ONG was in
“serious disrepair,” and that Lucent’s sales expectations for
2000 were “unrealistic.” The document expressly concluded:
Conclusions
! Customers are Running Out of Patience w/Lucent ! Established Competitors “Smell the Blood” and are Going for the Kill ! New, Nimble Competitors Pose Unsubstantiated Threat ! The Sales Teams are Running Out of Ideas to Hold Markets w/Legacy Products - Even mortgaging the future does not help the unrealistic sales expectations ! Business Processes in ONG are in Serious Disrepair ! Lucent’s New Product Announcements Add Insult to Injury While we can NOT Deliver on Product Announced 3 Years Ago [NA003575]
77. By late December 1999 and early January 2000, demand for Lucent products was so poor that Lucent’s sales force was forced to resort to granting customers extended payment terms to induce them to accept products. The practice was so prevalent
34 that, in January 2000, Lucent adopted a corporate policy concerning extended payment terms. In an email dated January 18,
2000, James Cocito, who was the Chief Operating Officer of SPN
North America, wrote that “[e]ffective immediately, the Customer
Team CFOs must sign-off on all extensions of payment terms beyond net 30 days or the terms as documented in the customer’s current contract.” [NA005538].
78. On February 9, 2000, SPN North America conducted a formal internal review of its operations in 2000 to date.
[NA004100-89]. A document entitled “NAR Operations Review
2/9/00" was used in connection with the meeting and Russo,
Aversano, Cocito and others received copies. The Operations
Review shows that Lucent was experiencing significant difficulty marketing ONG products. For example, the Review noted that MCI had “zero confidence” in BandWidth Manager and that Lucent was
“wrestling in lab against [its competitor] Alcatel, underscoring our shortcomings” with ONG products. Similarly, “continued product slippage has resulted in a jeopardy [sic] in maintaining
SONET market share in Bell Atlantic,” and “at present, no Lucent
ONG products are certified in GTE.” [NA004169].
79. The Operations Review made clear that Lucent’s ONG product deficiencies were having a material impact on the
Company, and that NAR “must improve perception of Lucent products, features and functionality or risk losing all market
35 share.” All told, ONG was in “crisis” and the Review identified a number of reasons why Lucent had “lost transport business” in a variety of ONG markets: “product capacity limitations”, “price and feature/functionality deficiencies” and “inadequate account coverage and support.” [NA004107, NA004125, NA004169]. Finally, notwithstanding these difficulties, the “pressure is on to meet
2Q commitments.”
80. On April 4, 2000, Aversano sent an email to Russo,
Michael Chan (Vice President, Global Product Marketing
Development, Optical Networking Group), Kenan Sahin (Vice
President of Software Technology at Bell Labs) and others, regarding a proposed realignment of the Software Sales and
Marketing Team. In her email, Aversano summed up the difficulties experienced by Lucent during the first half of fiscal 2000:
As the first half of fiscal 2000 comes to a close, it is clear that we cannot continue with the current operational model – it just doesn’t work. [NA002005-06].
Aversano further wrote that if “we were to continue ‘business as usual,’ we stand to fall short of our North America target by
$200M or 28% ... Simply put, this business is in crisis and immediate and decisive action is required if we are to recover the year.” In the April 4, 2000 email, Aversano attributed
Lucent’s problems to, among other things, “customer dissatisfaction (i.e., BellSouth, Cablevision, MCI),” “fractured
36 accountability,” and “working at cross-purposes on the same account.” Aversano concluded that Lucent’s current business model was “fundamentally flawed” and was taking its toll on
Lucent’s employees: “[i]n addition to the obvious process flaws, the inherent inflexibility of the model has fostered an unhealthy environment fraught with hostility and frustration.” [NA002005-
6].
81. The foregoing internal Lucent documents demonstrate that Lucent had significant problems with its optical networking products beginning in the fourth quarter of 1999 and continuing through the Class Period, including: (1) the inability of the products to communicate and operate as a unit; and (2) individual quality problems with the products themselves. These facts are supported by the reports of percipient witnesses who were in a position to know about Lucent’s product difficulties.
82. According to Witness 4, who was Director of Lucent’s
Advance Technology Department at ONG from October 1999 until
August 2000, and who was involved in the development of Lucent’s
WDM products, Lucent faced serious problems with its optical products. Witness 4 states that the Company had difficulty getting its products to interface and work together, specifically its DWDM and Bandwidth Manager. This problem was due to deficiencies in the software which often surfaced during deployment. Deployment consisted of taking product from the
37 factory and installing it at the customer's premises and ensuring that the units talk to one another and that the system can carry the services that the customer wants.
83. In addition, Witness 4 states that Lucent had a second serious problem with all optical networking products due to design and manufacturing flaws. These problems would be addressed by changing circuit packs, and specifically changing the firmware, or software on those circuit packs. Circuit packs are a part of each type of ONG equipment (e.g. OC-192, DACS , OLS
40G). The majority of the circuit packs were made internally by
Lucent.
84. When circuit packs were flawed, Witness 4 stated, the requisite product development team created a replacement configuration. Replacement circuit packs were then manufactured in a rush, a process exacerbated by shortages of component parts.
Then, replacement circuit packs were shipped to the field, where a deployment team installed the new packs into the boards of the system. The board was then brought back on line.
85. Despite the fact that ONG used the parts on the faulty circuit pack to make a new one, according to Witness 4, the replacement process was very expensive to Lucent. The deployment organization used extensive plans because it could not replace packs at the same time across the whole network. Rather, circuit packs had to be replaced in pieces. Thus, changing circuit packs
38 was a very onerous task, requiring extensive effort and expense.
As a result, customers became dissatisfied with Lucent’s ability to deliver optical products as promised.
86. According to Witness 11 (former Senior Manager for
Quality Assurance from September 1990 to September 2000 at the
Breinisville, Pennsylvania facility) by the end of calendar year
1999, Lucent still did not have a workable design in place for
OC-192 standard equipment. As a result, Lucent was promising equipment for delivery when the company had not yet completed the technology design. Witness 11 stated that Lucent's inability to market a OC-192 product was "not capacity driven, [it was] technology driven."
87. Another former employee confirms that Lucent shipped
OC-192 before it was fully operational. According to Witness 12, who was a member of Lucent's technical staff at the North Andover facility from the Company's inception until December 1999, Lucent shipped its first OC-192 product in the fall of 1999, and had a celebration attended by senior management of the facility with the employees who worked on the project. Thereafter, senior management instructed the employees to get back to work designing the OC-192 product notwithstanding the fact that it was supposedly already designed, built and ready for commercial use, and had already been shipped. Management explained to the employees that they expected to have the software necessary to
39 make the system work ready at a later date and would thereafter ship it to the customers who had already bought the product.
88. In addition, Witness 8 (a test engineer in Lucent’s
North Andover plant from July 1985 to December 1999 who worked on
Bandwidth Manager and 2.5 optical products) and Witness 13 (a
Senior Technical Writer at the North Andover facility, who worked in Lucent’s Customer Training and Information Products (CTIP) division from November 1999 until February 2000), stated that prior to and throughout the Class Period, Lucent had great difficulty meeting production and delivery schedules so as to satisfy even the diminished demand for its older generation DWDM
WaveStar products. For example, as alleged in ¶¶64-68 below,
Lucent encountered problems with manufacturing its 2.5 gigabit products and had begun outsourcing some of its optical components requirements, but Lucent did not have procedures in place to inspect the quality of the fiber optic components that were outsourced. As a result, Lucent experienced significant quality control problems and the 2.5 gigabit products that it manufactured often failed to work properly.
89. As a result, according to Witnesses 8 and 13, even with decreased demand, the Company was unable to meet its own timetable for producing and shipping its optical products. For example, according to an article in Fortune magazine on February
5, 2001, Qwest Communications had placed an order for Lucent
40 optical data networking product in July of 1999. However, by
January of 2000, Qwest had ripped out the Lucent product because some components of the product came late and others did not work at all. The employees involved in Lucent's optical networking
WaveStar project (including Witnesses 4 and 9) openly discussed the fact that the 10G WaveStar product was not working properly and that deadlines were going to be delayed. This problem persisted far into the Class Period. For example, according to
Witness 4, British Telecom had ordered a WaveStar product for
December 1999, which was not shipped as scheduled.
90. Witness 4 further stated that a key problem with the
Qwest installation was that the software which was supposed to connect the DWDM system and BandWidth Manager product, did not function properly, so that the two products could not interact together. The software was incomplete in many ways and prevented the Qwest network from functioning.
91. According to Witness 6, the poor quality of optical networking products manufactured at the North Andover Facility led to a tremendous amount of product returns in April and May
2000. According to Witness 6 there were:
truck after truck after truck. Trailer truck loads in the plant. They had at least forty truck loads of returns. It sat out in the trailer out in the parking lot. Millions of dollars worth of stuff -just sat out there - millions! All OC-192.
41 92. The weak demand for the North Andover facility's products is confirmed by Witness 10 (a former Senior Product
Manager at Lucent's Mesquite Texas facility from Lucent's inception until January 2001): Beginning in at least January
2000, trailer loads full of product from the North Andover facility consisting of inventory were being placed on trucks and being shipped either back to other Lucent facilities such as
Mesquite or being left in the North Andover facility parking lot.
93. An email from Lucent employee "Salma" to SPN President
Patricia Russo and others dated July 24, 2000 confirms the undisclosed widespread problems that Lucent was experiencing with its products. This email recounts a Lucent customer’s comments
(Advanced TelCom Group Inc. (“ATG”)) regarding “systemic issues that have been plaguing [Lucent] for quite some time.” It notes that the issues raised by ATG are ‘identical to those voiced by
Bell Atlantic, Bell South, BT, Level 3, NTT, and SBC” — five other Lucent customers. It lists extensive product and support problems such as "poor communication, confusion, poor quality,
[and] delays. It quotes ATG’s CEO as saying "'Lucent seems to be repeating mistakes time and time again’.” The email further notes that “this is a difficult time for the Company, but
Lucent’s customers worldwide are making the same statement.”
[NA001442-43].
42 94. Further, because Lucent failed to implement an adequate quality control procedure for component outsourcing at least until March of 2000, Lucent did not evaluate the quality of the component parts it did receive, according to Witness 16 (an
Operations Manager at a Lucent Netcare Knowledge Center in
Aurora, Colorado from November 1996 until April 2000). As
Witness 14 and 15 confirmed (a quality assurance source inspector consultant at the North Andover facility who worked at Lucent in
March 2000 and a former Quality Assurance Engineer at the North
Andover facility for Lucent since its inception until July 2000), the Company often accepted components of substandard non-production grade and quality. Further, Witness 14 stated that with respect to optical networking components, they were often dirty, or out of geometric tune, and therefore would not function properly. According to Witness 9 a quality assurance auditor for Lucent’s North Andover facility, who worked at Lucent from August 1998 until June 2000 in the quality and engineering assurance group and whose job was to find defects in products before shipment, because of the increasing pressure to ship product during the Class Period, the Company nevertheless installed substandard components and shipped such products to customers.
43 2. Lucent’s Problems With AT&T
95. The extensive problems with Lucent’s products impacted
Lucent’s relationship with its largest customer, AT&T. AT&T was
Lucent's most important single customer, accounting for 12% of
Lucent's business during fiscal 1999.
96. By the beginning of the Class Period, Lucent had lost important contracts with AT&T. Specifically, Lucent had lost a significant AT&T contract for telecommunications switches called
5ESS (Lucent's main product during 1999) to Nortel because AT&T wanted to expand its base of suppliers, according to Witness 1, a former marketing manager in Lucent’s Power Systems Division from
1998 until 2000. In addition, prior to the Class Period, Lucent was in discussions with AT&T concerning an anticipated $1 billion contract under which Lucent would provide AT&T with 80-channel
DWDM fiber optic systems. By early or mid-November 1999, according to Witnesses 1 and 2, that contract had been lost for reasons which included the fact that Lucent's management had made a publicly undisclosed strategic decision to stop manufacturing to meet AT&T requirements which exceeded or differed from the marketplace generally. AT&T’s requirements for that particular product included a network management system that was important to AT&T but which was not required by other customers. Lucent determined that it would no longer meet that requirement of AT&T,
44 and AT&T went to another supplier that would meet that requirement.
97. In addition, according to Witness 4, Lucent lost a potential $1 billion in business with AT&T to NEC because NEC managed to qualify its 400G series product for production for
AT&T, and Lucent had difficulty qualifying its 400 series product in time to meet AT&T's schedule.
98. According to Witness 4, in the Spring of 2000, AT&T representatives informed Lucent that AT&T would not purchase any of Lucent’s next generation optical networking products because of various problems with those products. Specifically, in March or April 2000, Dennis Morgan (a former Lucent employee who was then working in AT&T's procurement arm) made a direct presentation to the Optical Networking Group -- first to Lucent's
Senior Management including Harry Bosco, and then to the entire leadership team of the Optical Networking Group at the Oyster
Point Hotel in Red Bank. The presentation described, in very great detail, the reasons that AT&T would no longer be buying
Lucent's ONG products, and outlined the few small areas where
AT&T would consider Lucent products in the near future.
99. The veracity of the statements by Witnesses 1, 2 and 4 concerning AT&T’s rejection of Lucent’s new optical networking products is confirmed by internal Lucent e-mails. Thus, an email dated July 5, 2000 from Jay Carter, the President of Lucent’s
45 AT&T Customer Team, to Bosco, Russo, and others, reports that
Lucent’s competitor, NEC, had announced that AT&T had selected
NEC to be AT&T's first vendor to supply terabit DWDM optical networking systems for AT&T's next generation network. [NA
00990]. Carter’s July 5 email then notes that Lucent had unsuccessfully bid on this project and lost it "primarily due to availability time frame ... and price.” On July 7, 2000 Carter sent another email to Aversano and Bosco, which recognized the long-term negative impact on Lucent of the loss of AT&T's optical networking business:
right now AT&T has told us they will not deploy any 400G in their core network other than the 80M we sold last quarter. Their rationale is simple “why would I deploy a system that can at best reach 400Gbit when I can deploy another system that will allow me to do in- service upgrades to >1Tbit and whose price per bit is ½ that of the 400G?” ... We are clearly out of the market for DWDM with AT&T until 2002 at best. An even bigger concern is what does this portend for our other customers?
[NA000987 (emphasis added)].
3. The Tymann Answer
100. In June 2000, Lucent filed a lawsuit in the United
States District Court for the District of Massachusetts against the Tymann defendants alleging breach of contract. Until March
2000, Daniel Tymann was the director of Optical Networking
Engineering and Manufacturing at Lucent’s optical network manufacturing facility in North Andover, Massachusetts. The
North Andover Facility was responsible for the testing,
46 manufacture and distribution of Lucent’s DWDM and 10G lines of optical networking products, including OC-192, which was manufactured only at the North Andover Facility. As Lucent admits in the complaint it filed against the Tymann Defendants,
Tymann was “involved in all aspects of the manufacturing and supply of 10G and DWDM systems for Lucent ... including design modifications, prototyping, testing and evaluation, and discussions with Lucent’s suppliers concerning component availability, specifications and costs.” ¶41 of Tymann
Complaint. Tymann was also “heavily involved in the testing and refinement of Lucent’s 10G and DWDM products” and had “complete knowledge of Lucent’s technological roadmap – i.e., where the products are going to be improved in the next two to three years” and the “reliability of Lucent’s products.” ¶¶42-43 of Tymann
Complaint.
101. The other Tymann Defendants, all of whom were employed at the North Andover Facility until the spring or summer of 2000, were David B. Ashley, Manufacturing Director; Karen M. Ashley,
Senior Manager in Product Management; Vimalkumar J. Patel, Test
Development Engineer; Meredith A. Hatten, 10G Project Manager;
Molly A. Broadly, Project Manager; Brenda A. Conkel, Material
Allocation and Prioritization Manager; Michael A. Hickey,
Technical Staff; and James F. Wholley and Nathan J. Tymann, both of whom were Buyers. ¶¶4-12 of Tymann Answer.
47 102. In the Tymann Answer, the Tymann defendants averred that “[b]eginning at least as early as the last quarter of 1998,
Lucent embarked upon end-of-quarter pushes to meet its earnings estimates by a variety of tactics designed to achieve quarterly earnings by whatever means necessary, often at the sacrifice of longer-term business objectives, reputation, product reliability and customer satisfaction. These pushes became a regular practice in 1999.” ¶118 of Tymann Answer (emphasis added). In addition, the Tymann defendants stated that they were under enormous “pressure” to achieve “unrealistic production goals.”
When they failed to achieve these goals, they were “routinely berated and embarrassed ... both publicly and privately” by the
Senior Manager of the North Andover Facility. ¶35 of Tymann
Answer.
103. The Tymann Defendants had direct personal knowledge of the development of Lucent’s optical networking products. In their Answer, they averred that, by the fall of 1999, Lucent had
“mistakenly put its investment in the slower 2.5 gigabit product and stumbled badly in the [optical networking] market.” ¶120 of
Tymann Answer. As a result, inventory of 2.5 gigabit products significantly increased. ¶120. Moreover, Lucent’s newer, 10- gigabit product was “inadequately designed.” Id. These problems exacerbated Lucent’s “deteriorating manufacturing outlook.” Id.
48 104. As a result, to attempt to recapture market share, by the start of the Class Period, Lucent determined to sell products which it knew had design and reliability problems, and attempt to fix the problems later:
In September 1999, Lucent confirmed its overall strategy to grab back market share. At a meeting in Nuremberg, Germany, Lucent senior management told the company’s directors that its new strategy was to sell products to customers as quickly as possible (despite design and reliability issues), and fix such problems later. (Tymann Answer, ¶121)
105. These allegations are further supported by independent witnesses. For example, according to Witnesses 9, 15 and 16 (a former quality assurance auditor at North Andover Facility from
August 1998 until June 2000, a former quality assurance engineer at the North Andover facility who was a Lucent employee from
Lucent’s inception until July 2000, and an Operations Manager for
Netcare Knowledge Center in Aurora, Colorado from November 1996 until April 2000), on several occasions during 1999, division directors ordered that product be shipped despite the existence of major flaws in the circuit pack portion of the product.
According to Witness 16, during the last fiscal quarter of 1999 or the first fiscal quarter of 2000, Lucent sold a WaveStar DWDM which was powered by circuit packs that were still in the test phase. Thereafter, the production packs failed and an employee had to replace all the circuit packs. Similarly, according to
49 Witness 17 (a Technical Support Representative for Network
Reliability Center in Denver from December 1996 until November
2000) by the end of 1999 or beginning of 2000, Lucent began shipping its Pathstar switching product even though it did not work properly. Pathstar's problems arose from the fact that the product was shipped as it was still being tested and designed.
When Lucent's technicians were unable to get the product to work to the customer's satisfaction, according to Witness 17 Lucent replaced the product with another switching product which was far more expensive, but without increasing the price. According to this witness, other customers who complained about Pathstar's performance were also offered more expensive products as an even exchange replacement.
106. Also, according to Witness 9 and Witness 15 quality assurance auditors at the North Andover facility were instructed to ship product which had failed to meet Lucent's quality assurance standards. Product that was identified as having a defect, for example, a product which failed to meet ANSIJ standards for soldering, were marked with red tags by quality assurance auditors. During the Class Period, according to
Witness 9 and Witness 18, a former analyst at the North Andover facility, management with increasing frequency directed quality assurance auditors to remove the red tags, rip them up and ship
50 the defective product unchanged, so that the Company could meet its numbers.
107. The policy of directing employees to ship defective products was implemented at other facilities besides the North
Andover facility. For example, according to Witness 11, a former
Senior Manager for Quality Assurance from September 1990 to
September 2000 at the Breinissville, Pennsylvania facility, which was a part of Lucent's microelectronics division which produced, outsourced and sold optical components, senior management also ordered quality control employees to "ship the shit", meaning knowingly ship defective product. Witness 9 said the same thing about the North Andover facility: quality assurance personnel in that location were instructed by Lucent Management to “ship the shit,” i.e., ship the product known to be defective. Among the destinations for the components shipped from this Lucent facility was Lucent's North Andover facility where such components were used for WaveStar products including OC-192 products.
108. Interviews with former employees confirm that Lucent's problems meeting expectations were not limited to the optical group. By at least mid-1999, and extending through the Class
Period, the Company was having a great deal of difficulty meeting forecasts and sales projections with respect to its wireless products. For example, according to Witness 19, a former
Development Manager for Lucent in Silicon Valley from October
51 1998 until April of 1999 employees recognized that Lucent "fell flat on their face" with the product they were working on, the
"Wireless Broadband." This is a product Lucent management had claimed would be a big seller. The Wireless Broadband product which Lucent developed in-house was poorly received in the marketplace because, like its fateful decision regarding OC-192, the Company had made a strategic mistake in developing a product that did not have the features that customers were demanding. The problems with customer acceptance of Lucent's Wireless products is confirmed by Witness 20, the former Director, Business
Development for Lucent in Milpitas, California (from April 1998 through November 1999). According to this witness, Lucent was having a great deal of difficulty meeting forecasts and sales projections for the Company's wireless local loop product.
109. Problems also existed with Lucent's switching products.
At least by the Fall of 1999, the Data Networking Division was also experiencing both production and demand problems. According to Witnesses 8, 16, 17, and 21, a former Production Support
Representative in Lucent’s Consumer Products Division and BCS from March 1997 to June 1999, the Company was missing shipment and release dates for products sold within that division. One cause of that problem was the fact that Lucent's sales representatives were selling products which were still in the design phase. For example, according to an article entitled,
52 "Lucent Vies to Win Back Customers,” The Morning Call,
(Allentown) October 8, 2000, in April, 1999, Lucent sales representatives were selling customers like GT Group Telecom a
7R/E voice switch which was still being designed. Although GT
Group Telecom was a recipient of Lucent financing, it was free to buy its products from anywhere, and the company eventually decided to buy from another supplier which had product ready to ship. Also, according to Witness 22, a former Account Executive in Lucent's Data Networking Systems Division in the GTE Customer
Business Unit from July 1998 to October 1999, at least as of
October 1999, shipment and release dates for products sold within the Data Networking Division were falling behind schedule, negatively impacting sales. For example, Lucent was losing business to Nortel including an “Internet Working Contract” with
GTE valued at approximately $200 million, as a result of its inability to effectuate timely delivery of product.
110. According to Witness 23, a Senior Telecomm Engineer with Saudi Telecomm who has held that position from February 1999 until the present, at least by the fourth quarter of 1999, Lucent senior management was aware that the Company was going to lose the bidding for a $6 billion contract called TEP-8 which was a telephone expansion project for Saudi Telecomm. As a result, in anticipation of the fact that the Company would lose the TEP-8 contract, Lucent laid off a quarter of its staff in Saudi Arabia
53 during that quarter. The contract loss was in part due to
Lucent's failure to complete an earlier version of the project also a multi-billion dollar contract, called, TEP-6, which was supposed to provide 1.5 million phone lines in Saudi Arabia.
Lucent missed deadlines, experienced cost overruns and failed to complete the project which the Saudi government later offered to other vendors.
111. In addition, according to Witnesses 1 and 2 (a former employee of the Network Professional Services Department from
October 1996 to July 2000, by the fourth quarter of fiscal 1999,
Lucent's Octel division (the voice messaging group) had lost to
Ericcson a significant contract from the Saudi Arabian government. Lucent had secured the contract in the first or second quarter of 1999. The initial portion of the contract was valued at $600 million, but the entire value of the activity contemplated -- and lost – was $6 billion. Another former employee, Witness 3, a former field engineer with Lucent in Saudi
Arabia from November 1996 to March 2000 confirmed this account and stated that the contract lost to Ericcson was a GSM (mobile unit) contract.
112. The weakening of Lucent's wireless and data networking businesses is also confirmed by an internal Lucent document entitled Value Analysis - Portfolio Valuation, dated April 13,
2000, which notes that Lucent has the "smallest mix of planned
54 revenues in three critical growth businesses (wireless, optical, data).” [NA 004216].
4. Internal Lucent Documents And Interviews with Former Employees Establish That, Beginning No Later Than The First Quarter of Fiscal 2000, Defendants Engaged In Accounting Fraud
113. To conceal the waning demand for the Company’s products, defendants engaged in a variety of practices during the
Class Period designed to misrepresent the true state of Lucent’s business. The facts which demonstrate these improper practices are set forth below.
a. Phony Sales to Customers
114. By no later than the first quarter of fiscal 2000,
Lucent’s senior executives were directing that the Company recognize hundreds of millions of dollars of revenue from transactions where customers had not agreed to purchase the product. For example, Witness 24, a senior manager in Lucent’s
Consumer Product Division from March 1997 to October 1999 stated that "we would ship stuff out to make our number and then take it back." Witness 1 also confirms that such manipulations occurred routinely at the end of each quarter.
115. On February 15, 2000, Leslie Rogers, PFO director of
SPN North America, sent an email to Cocito, Aversano and Orlando, which shows that, during the first fiscal quarter of 2000 ended
December 31, 1999, Lucent had improperly accounted for 37 deals and had fraudulently booked nearly $300 million in revenue:
55 I sent to Nina via Jim C’s [James Cocito] fax a list of the 37 deals with issues and the amounts outstanding thereunder. There is about $295 million outstanding under those deals which need to have documents signed, certificates of acceptance [signed by customers], etc. Revenue has been recognized on a great portion of the $295 MM. The worry is that it will be REVERSED if we don’t get the paperwork signed. Mark Wilson [Vice President, North America] has committed to get Pete Gladding’s team to personally go to the customers and get the documents. With the documents properly signed, these customers will be able to draw down on the remaining commitments and therefore be able to order more Lucent products. [NA000834].
116. That same day, in a separate email to Wilson, Aversano and Cocito, Rogers wrote that “[t]his means that there is almost
$300 million at risk. Obviously it is very important to get people out to these companies and resolve the product issues to make the companies sign the leases, certificates of acceptance, etc.” [NA000842].
117. Despite Lucent’s after-the-fact efforts to get the customers to agree to the sales, the customers did not agree to accept the products. On February 23, 2000, Aversano sent an email to the North America “Team” including, among others, Wilson and Cocito, stating that GE Capital, which financed the purchases, had been attempting unsuccessfully for several months to get the deals completed. Aversano gave the recipients of the email a deadline: unless the customers signed the deals by March
56 15, Lucent would have to reverse more than $100 million in fictitious revenue:
As you are aware, GE Capital has been struggling for the past couple of months in getting customers to return lease documentation from deals closed, shipped, and billed last quarter. This must be cleaned up by March 15, 2000 at the latest, to avoid revenue and commission reversal associated with over $100M of shipments and billings.
Jim Cocito will send out to you tomorrow a reminder of the specific customers and documentation requirements owed to GE.
This is a critical situation which requires your immediate personal attention. [NA005486].
118. These emails demonstrate that almost $300 million in revenue recorded in the first quarter violated GAAP and should never have been booked. Indeed, even if all these deals had been approved by the customers by March 15, 2000 (2½ months after the fiscal 2000 first quarter had ended) Lucent violated GAAP by recognizing the revenue during the first 2000 quarter.
119. In fact, Lucent did not even obtain customer approval for these deals by March 15, 2000. But rather than reverse the revenue, Lucent merely extended the deadline. On March 15, 2000, the North American Team held a conference call to discuss the fact that Lucent still had been unable to get its customers to agree to these sales. On March 16, 2000, Cocito sent the following email, marked “URGENT MESSAGE”, in which he emphasized the “criticality” of this issue:
57 Despite hard work by all, we have not made sufficient progress to date in collecting lease documents from last quarter. You will recall that Nina had asked that we clear this up by March 15, 2000. On our call yesterday, we all agreed that we would make significant progress over the next couple of days, which will be reflected on Monday’s report [March 20, 2000].
The criticality of this issue cannot be understated. For documents not returned, Lucent will risk a significant reversal of revenue, the magnitude of which will negatively impact our quarter ...
I really need your help here. This is an absolute crisis for the quarter. [NA005487].
120. Once again, however, Lucent was unable to complete the deals, as its customers refused to agree to accept these products for which Lucent had already booked hundreds of millions of dollars of revenue. On March 22, 2000, beyond the point when
Lucent was supposed to have made “significant progress” getting customers to agree to the deals, Aversano sent the following email to Michael Ward and Mark Wilson:
[I]n spite of all the hard work, efforts have fallen short of our commitments and a significant numbers [sic] of documents remain outstanding. Without your unrelenting personal engagement and leadership, and that of the other ESP Executives, Lucent faces a potential shortfall in excess of $100M in revenue reversals. Clearly a miss of this magnitude would be devastating to Lucent. As well, the team will be adversely impacted by reversal of related sales commissions. Therefore, I am asking for one more big push to collect all outstanding Certificates of Acceptance. I request that you personally call each customer who has yet to sign their
58 certificate, and get them to authorize the required documents. [NA000681-82].
121. Additional “phony” sales are confirmed by documents produced by Lucent’s customers. For example, on February 22,
2000, Tom Kaminsky of Anixter sent an email to certain other
Anixter employees regarding a “Lucent opportunity” that had come
Anixter’s way. According to the email, in the first quarter of fiscal 2000, Lucent recorded a $45 million sale to a company called ICG Communications, Inc. However, ICG would not “take ownership” to the product until later in 2000, and refused to pay for the product until it actually took ownership. As a result,
Lucent was having “accounting issues”, for which they needed
Anixter’s help to resolve. Although Lucent knew that the ICG sale should not have been booked during the prior quarter, rather than reverse the sale, Lucent asked Anixter to purchase the ICG products from Lucent in the March quarter, and then sell them to
ICG later in 2000:
I wanted to bring you up to speed on a Lucent opportunity that has come our way. Lucent today sells products to a CLEC called ICG. (Lucent helps fund ICG as well). In their zest to generate revenue, Lucent has sold about $45mil of this product to ICG in late 1999 that ICG will not be taking ownership to until various times throughout 2000. (March- September). ICG does not wish to pay for this product until the “turnover date” and as such, Lucent is having accounting issues with their revenue recognition. (Duh!)
59 So we have been called to play. We are being asked to buy $72 mil in product today, and then sell it to ICG per the turnover dates.
122. Witnesses confirm that, during the fall of 1999 and the spring of 2000, Lucent regularly booked revenue from transactions where the customer had not ordered the product. According to
Witness 25, a Product Manager/Sales Support employee in the China
Business Unit who worked at Lucent from June 1995 to October 1999 and who had responsibilities for communications equipment sales to China, in August or September 1999, Lucent's China Business
Unit falsely recognized revenue on WaveStar product which was never sold. The circumstances of this false WaveStar "sale" were discussed on a conference call which included, among others, Ron
Smith, an executive in the division, and other Lucent employees based in Shanghai. The order for approximately $66 million was placed "just to book revenue" and the product, which was an obsolete model, was supposed to be stored in a warehouse near JFK rather than be shipped to the joint venture "customer" who did not want to be saddled with the product.
123. Witnesses 26 (a former sales support representative in
Lucent’s Tuscon Customer Care Center from September 1997 until
November 30, 1999), 27 (a former employee at the Tuscon Customer
Care Center until the center closed at the end of 1999 with responsibility for accounts receivable for Global Accounts) and
28 (a former accounts receivables specialist in the Tuscon
60 Customer Care Center from mid 1997 until late 1999) stated that employees routinely culled invoices associated with transactions where the customer had not committed to purchase product to prevent the invoices from being mailed to the unsuspecting customers. After the end of the quarter, the supposed "order" often would be reversed, and Lucent employees would later re-invoice the customers when they actually agreed to make the purchase.
124. In other instances, according to Witness 26 a "dummy" invoice would be manually generated when Lucent's customers actually agreed to purchase the order. For example, in this manner, Lucent billed Hilton Hotels for two separate orders worth approximately $300,000 each prematurely, and subsequently billed
Hilton for the same orders. Also, according to Witness 26, another customer who was double billed was Time Warner. The entire contract was “closed out” early, and then it was “adjusted off” and rebilled later. The "dummy" invoice was generated so that it could be issued to Lucent's customers without the transaction being reflected in Lucent's accounting system, because the invoice for the order had previously been generated and revenue from the order had already been recorded. This process was known as "closing out" an order among Lucent's sales force. As a result, when Lucent's customer first received the
61 manual invoice, in many instances, Lucent's system already reflected the customer receivable as being "past due."
125. According to Witness 24 (a former senior product manager in Lucent’s Consumer Products Division from March 1997 to
October 1999), Witness 29 (a former area Vice President in the
BCS division responsible for small business accounts in Southern
California and Nevada from at least the beginning of 1999 until
March 2000), Witness 30 (a former National Account Manager in BCS
Division from July 1998 until March 1999), and Witness 26 (a
Sales Support Representative in Lucent’s Tuscon Customer Care
Center from September 1997 until November 30, 1999), the recognition of revenue on "orders" which had not yet occurred was a widespread practice throughout the Company, including but not limited to those divisions. According to these witnesses,
Lucent's sales force engaged in such conduct because Lucent paid sales commissions when it recognized revenue, regardless of whether the customer actually ordered or paid for the product.
126. Another tactic employed by Lucent to prematurely recognize revenue was referred to as "CNRing" an order, according to Witness 26 and Witness 28. “CNR” stood for “Customer Not
Ready.” This technique allowed the Company to invoice an order when the product had been shipped, but not yet installed.
Although Lucent attempted to divide these "sales" into two components, equipment and installation, so that it could
62 recognize revenue related to shipped equipment prior to its installation, in practice, it was difficult to allocate the billing among equipment and installation. As a result, Lucent generally billed 100% of the order at the time the product was shipped. Lucent's recognition of revenue on "CNRing" transactions was improper as the installation of Lucent's equipment was a significant obligation essential to the functionality of the delivered equipment which remained unperformed at the time revenue was recognized. As such, revenue was not earned and the collectability of the sales price was not reasonably assured on such transactions when revenue was recognized by Lucent. Often sixty days or more elapsed from the date of shipment before installation occurred. By virtue of the foregoing, the accounts receivables, as reported in Lucent’s financial statements issued throughout the Class Period, were materially inflated to the extent consistent with improper revenue recognition from these transactions.
b. Channel Stuffing And “Side Deals”
127. Lucent stuffed its distribution channels with products that distributors and resellers could not sell. Indeed, stuffing the distribution channel was such an accepted practice at Lucent that employees used the very term -- “stuffing” -- in their emails, as reflected in the March 8 and March 9 emails referred to in ¶¶128 and 129 below. To induce distributors to accept
63 products Lucent wished to “stuff”, Lucent sales people cut side deals to allow these distributors to return the product after a quarter had ended and Lucent had recognized the revenue sale.
Lucent also improperly recognized revenues on sales to poor credit risks and even though customers had not agreed to buy or pay for the product.
128. On March 8, 2000, numerous Lucent employees were sent an email by Jeanne-Castro Schmidt of the Ascend division (Lucent purchased Ascend in January 1999) entitled “Real Problems Here,” which stated that a Lucent distributor named ClearData.Net “was
‘stuffed’ with over $5 million of equipment they didn’t want nor expect to keep at the end of last quarter [ended December 31,
1999].” The email noted that Lucent had recognized revenue on this sale, but that “the sales person sent a letter on Lucent letterhead to the customer saying we would agree to exchange the equipment with other equipment whenever requested by ClearData.”
As a result, ClearData believed that “whenever they order a shipment of new ‘exchange’ equipment, they can simply cancel out the old equipment on the December lease.” The email concluded by stating that Lucent would have to allow ClearData to return the equipment. [NA000764].
129. On March 9, 2000, James Orlando, the Assistant
Treasurer of Lucent’s Global Customer Finance unit, sent an email to James Cocito, the Chief Operating Officer of the SPN division,
64 Aversano and Frank Manzi, the Chief Financial Officer of SPN, regarding the ClearData situation. That email made clear that the “side deal” with ClearData was not an isolated occurrence, but such side deals were commonplace throughout and, in many instances, were authorized by senior Lucent employees. In fact,
Orlando wrote that Lucent’s sales force was agreeing to so many
“side deals” that Lucent needed to change its commissions policy to make sure that the Company was not paying commissions for sales that were not real:
My understanding was that this was escalated last year but no action was taken by Pat Russo. We stuffed the company and then made a side deal, without finance knowledge, which is causing this situation. This sounds similar to AMC which was another deal that was created by sales people who we knew were leaving the company. I do not know the answer here but my opinion is that we should not pay out any commissions until we know that we have clean business to people who are leaving next quarter. There is just no way to know what side deals are being cut and the sales teams have demonstrated themselves to leave no stone unturned in enriching themselves while leaving Lucent holding the bag. [NA000770].
130. Former Lucent employees confirm that Lucent regularly stuffed distributors with product they did not want or need. To induce these distributors to accept the products, Lucent would generally agree to allow the distributors to return the product after the quarter had ended. According to Witness 1 (a Marketing
Manager in the Power Systems Group under the Network Products
65 Division in Dallas, Texas from 1998 until 2000), during the fourth quarter of 1999, the director of Lucent's Powers Systems
Division loaded Lucent's distributors with product they did not require so that Lucent could report the sales. These Lucent distributors were instructed to warehouse the product, until such time as Lucent bought it back. Lucent's recognition of revenue on these shipments was improper because the distributors had not agreed to purchase or accept the risks and rewards of ownership of such products when they were shipped. To the contrary, Lucent agreed that such products could be returned at a later date.
Accordingly, an exchange for purposes of revenue recognition did not occur at the time Lucent recognized and reported revenue on such product shipments, thereby resulting in improper revenue recognition. Witness 10 also stated that Lucent shipped product with an understanding that it could be returned in order to “make the numbers.” Specifically, beginning at least by the fall of
1999, the Mesquite facility would ship to Lucent facilities in
Oklahoma City and Columbus, and then take back the product later.
131. Similarly, according to Witness 31, a Senior Account
Representative in Lucent’s Internet Service Provider Division from December 1998 until August 1999, Lucent's Internet Service
Provider Division "strong-armed" re-sellers to take products. By this method, the Internet Service Provider Division "sold" $59 million worth of product to Westcon, Inc. on the last day of
66 Lucent's 1999 fourth quarter, so that revenues from that sale could falsely be recognized during that quarter.
132. Interviews with former employees of Lucent's largest distributors also confirm that Lucent stuffed their distributors with excess and unwanted product. Specifically, Witness 32, a former Graybar Corporate Purchasing Analyst Assistant: Lucent
Special Projects Group, from August 1999 until April 2001, stated that, at the end of each quarter, Lucent threatened to dissolve its relationship with Graybar unless Graybar found room for additional Lucent product. These threats were delivered by
Lucent management to Virginia Williams, Graybar's Lucent Special
Projects Supervisor. As a result, at the end of Lucent's fiscal quarter, Graybar employees worked round the clock to try to take in as much Lucent product as possible. By April 2000, Graybar's
Northborough warehouse, in addition to being completely full, had
35 trailers full of Lucent products from Consolidated
Freightways, RPS, UPS, and Federal Express sitting in its parking lot. This congestion caused the local fire chief to order
Graybar's personnel to clear the extraordinary inventory because it posed a fire hazard.
133. Witness 33 (a former Vice President of Purchasing and
Inventory Management: Public Networks and Integrated Supply
Group, at Anixter from May 2000 until June 4, 2001) confirmed that Lucent stuffed the channel to Anixter from the fourth
67 quarter of 1999 until at least the third quarter of 2000. Lucent offered inducements to Anixter to get the distributor to accept the merchandise. The product was accepted on a consignment basis. Lucent was careful not to commit to documenting in writing contingent nature of the sale; such fact was instead generally communicated orally. Witness 33 specifically explained one such transaction in September 2000. That deal was for approximately $108 million and was completed on Friday night,
September 30th (the last day of Lucent's fiscal year), and the product was immediately shipped. Lucent management orally agreed that Anixter did not have to pay for the products unless and until Anixter ultimately sold the products. All of the material was eventually returned to Lucent.
134. Documents obtained by Lead Plaintiffs from Anixter also confirm these improper revenue-generating practices. On December
30, 1999, Bill Standish of Anixter International, Inc., one of
Lucent’s largest distributors, sent an email to other Anixter employees which set forth the transactions that Anixter and
Lucent had negotiated that day. (December 30, 1999 was the last day of Lucent’s fiscal 2000 first quarter). The email reported that, to induce Anixter to accept Lucent products during that quarter, Lucent’s senior management – including Russo, the Chief
Executive Officer of SPN – had expressly granted Anixter the right to return the product if it could not be sold:
68 2. Lucent - 400G $50mil of ONG product. Most expected to sell to Argent/Att at margin of 12.8%. Shipments throughout 2000. 90 day payment terms to Lucent. Minimum of 12.8% margin if sold to Global Crossing or other customers. Per Leslie [Dorn, Lucent Vice President of Channel Sales] we have assurances from Jay Carter and Pat Russo that product will move or we can return.
3. Winstar - $10 mil of radio’s [sic] to be sold to Wannet (sp)? at a margin of 7% if sold within 90 days 2% per month additional beyond 90 days. We will return after 6 months. 90 day payment terms. If little or no sales after 90 days we will not pay Winstar and have option to return the product. Lucent will guarantee we will collect and they will guarantee return of the product. Discussion with Leslie [Dorn] and Jim Cassido (sp?) [actually referring to Jim Cocito] Nina Aversano’s COO. Leslie confirmed terms with Nina. [ANX000467 (emphasis added)].
c. Internal Audits Conducted By Lucent Senior Management Confirm Lucent’s Improper Revenue Recognition Practices
135. According to Witness 34, an Internal Audit Manager for
Lucent’s Caribbean and Latin American Region (CALA) from June
1998 to December 1999, in the fall of 1999, Lucent senior management rejected an internal auditor's recommendations in order to avoid taking write-offs in the quarter. An internal audit conducted during September/October 1999, revealed that accounts receivable were overstated in an international division.
The audit team determined that the proper course would be to take an immediate write-off. However, in November/December of 1999,
69 the division's management team reversed the audit team's recommendation stating that the division "could not afford to do so at th[e] time." The decision in this regard was made at the top level of Lucent management, and specifically involved
Lucent's head of internal audits.
136. On June 21, 2000, Lucent’s Internal Audit Division completed an investigation into Emerging Service Provider, or
ESP, product returns in the Company’s North American Region. In that report, which evaluated product returns during the first and second quarters of fiscal 2000, the Company’s product return process was given the next to lowest possible rating because, at
Lucent, “[a]n inadequate system of internal control exist[ed] and substantial process weaknesses were disclosed upon audit.” As part of their product return audit, Lucent’s internal auditors also evaluated the “root causes” for the high amount of returns
Lucent experienced, which were 50% higher than industry standards. The audit determined that returns of Lucent products were “often related to product performance and the ESP sales practices.” Specifically, the report disclosed that almost one- half of products were returned because of “product performance issues,” almost 20% of the returns were caused by product obsolescence and the Company’s failure to cooperate with its distributors, and another 7% of the products were returned because Lucent’s customers did not need them. Significantly, the
70 Audit Report determined that, in many instances during the first and second quarters of 2000 Lucent had booked revenue and shipped products even where customers had not ordered the product and before Lucent had received purchase orders or other necessary documents evidencing a real sale. Accordingly, the report recommended that, “ESP sales practices should be tightened to avoid product shipments prior to receiving purchase orders, signed orders, signed loan agreements, and signed lease agreements.” This internal audit report was distributed to several senior Lucent employees, including defendants McGinn and
Hopkins, and unequivocally stated that “[m]anagement is aware of these issues.” [NA005548-50].
137. On August 15, 2000, Hopkins sent an email to, among others, Aversano and Cocito, regarding the issues detailed in the
Audit Report. The email leaves no doubt that Hopkins knew that
Lucent was improperly recording revenue. Hopkins wrote: “I understand that we have cases where equipment was authorized to be sent to the customers without contracts being in place, [and] we've agreed to bridge loans to someone who is not even a customer outside of delegation of authorities.” Hopkins informed
Aversano that she wanted a “total accounting of these situations” and to know “what has gone on and why.” Later that day, Aversano responded by telling Hopkins that it would be in Lucent’s “best interests” to “perform a comprehensive audit across the entire
71 North America portfolio.” Aversano also wrote that “[w]ith regard to bridge loans - more have been used than any of us would have liked. Unfortunately, severe product problems and non- performance (most notably voip and softswitch), at times have left little option for Lucent.” [NA005318].
d. Sales to Poor Credit Risks
138. Lucent also booked hundreds of millions of dollars of revenue on sales to customers whom Lucent knew could not pay for the products. In many instances, Lucent agreed to provide financing to these customers to enable them to purchase Lucent products even though, without Lucent’s financing, these customers would have gone bankrupt. For example, according to an email dated February 10, 2000, one of Lucent’s customers, Virtual
Networks, had called that day regarding $500,000 of working capital that Lucent was supposed to provide. The email stated that Virtual Network’s CEO had requested that Lucent approve the financing “asap” and, if it could not, “he wants to know if
Lucent can at least just wire $100k today, as they are about to go into default!!” The email further provided that “this is a very dangerous situation” and that Lucent had spent “too much time and effort getting their network ready, getting them to sign the legal release, to now be in a situation where we have not executed on Lucent’s commitment for the working capital.”
[NA000838].
72 139. Later that same day, Lucent agreed to provide Virtual
Networks with $500,000 in working capital, and further agreed to allow Virtual Networks to defer any payments on the financing for six months. In return, Virtual Networks agreed to purchase a
Lucent product called NetCare.
140. Similarly, on March 10, 2000, Aversano, Michael
Lambert, the Chief Financial Officer and Vice President of the
Data Networking Division and Cocito, among others, were notified by email that Lucent was “working on cleaning up problem leases with our funding source, Varilease, so that we can restore
Varilease’s capacity to fund new leases this quarter.” That email also discussed two other transactions where Lucent had shipped products to customers who did not need the products, and could not afford to pay for them. The first involved a product which Lucent had shipped in February and March 1999 to a company called ISPTEL. The customer had asked for a working capital loan of $500,000, and “[s]ales had suggested that, in order to obtain a loan of that size, the customer should consider taking more equipment than was actually needed at the time.” However, the equipment did not work (the customer claimed it was “useless”), and the customer had been “requesting to return the equipment since July of last year [1999], but they were ignored due to turnover on the account and turmoil in the customer finance area.” The email further stated that “failing to do so [take
73 back the product] will force the customer into bankruptcy.”
Accordingly, the email asked for permission to allow the customer to return the product, and for Lucent to make the customer’s interest payments to the leasing company. [NA000707-14]. By email dated March 12, 2000, Lambert approved this proposal.
[NA000717].
141. The email also discussed a transaction with Waller
Creek, where “the company wants to return approximately $10 million in product that is still in unopened boxes.” According to the email, “the product was shipped in June of last year
[1999], in part due to heavy sales pressure prior to the Ascend-
Lucent merger,” and the customer wanted to “replace it with new
Stinger product over a four-six month time frame.” The email stated that “the products are not of much value to Lucent given their age.” Further, the email provided that “the company needs equity, and a return of this unneeded product will assist them in raising it ... If we choose not to accept the return, then Waller will cease making future payments on their lease.” If that occurred, then Lucent’s financing source, Varilease, would sue
Lucent because of “their current delinquency experience on the pools [of loans] we’ve sold them.” On March 12, 2000, Lambert authorized the return of the products. [NA000717].
142. In addition, according to Witness 35 (a former employee in both the BCS Division and the Consumer Products Division from
74 March 1997 until September 1999) prior to and during the Class
Period, customers with credit problems often were released from
"credit hold" status near the end of fiscal quarters so that revenue could be recognized on their orders. This practice, according to this same witness, which enabled Lucent to meet quarterly analyst revenue estimates, violated Lucent's policy that mandated that Lucent would not accept orders from customers on credit hold. For example, Patagonica, a South American company, had a $5 million receivable outstanding for more than 90 days but was nevertheless released from credit hold and allowed to place new orders for $1 to $2 million.
143. Lucent’s senior executives were well aware that Lucent was doing “bad financing deals” in an effort to generate revenues. On March 30, 2000, Orlando sent an email to Aversano and Cocito which discussed Lucent’s financing practices:
Jim, I have 3 former employees at Cisco. My former people laugh at what we allow our sales people to do in financing and the lack of focus we have on credit risk. I also have direct information from people who talk to the guy that runs Cisco Capital. Here’s the quote: “Lucent and Nortel are spoiling the marketplace by doing so much [off market] financing which we have to match.” Clearly, Cisco is not as desperate as we are to do bad financing deals but they will do it to win in some cases. [NA000662].
144. Similarly, on March 29, 2000, Aversano and Orlando received an email from Linda Fiore, a representative of G.E.
Capital. G.E. Capital had financed many of Lucent’s sales, and
75 Lucent had guaranteed the loans. The email stated that Lucent’s internal delinquency forecast report for March 2000 showed a
“high level of delinquency ($93 MM)” that was attributable to
“equipment issues.” The email further stated that many of these accounts were long overdue:
Many of these accounts are over 90 days past due or will be in April. As you know, per the Operating Agreement, at 90 days, GE has the right to issue a Default Notice to Lucent requesting that Lucent (unless the delinquency has been cured by Lucent or the customer) repurchase these accounts. We would much rather work with Lucent to understand if these delinquencies are truly equipment related, and restructure or make joint proposals to these delinquent customers. [NA000667].
145. Further, Lucent employees often reclassified the age of accounts receivables in a process that was condoned and encouraged by Lucent management. This practice served two purposes: (1) it helped mask Lucent's improper revenue recognition; and (2) it purportedly reduced the need to reserve for an impairment in the value receivables that remained uncollected for an extended period of time. These practices helped maintain the appearance that the Company's financial growth was continuing at historic levels when, in fact, it was not.
146. Significant problems also existed in the financial reporting, internal control and information systems in Lucent's operations in Europe. According to Witness 36 (a Senior
76 Consultant at Lucent from 1998 until December 1999 who also worked as an outside Consultant for Lucent in February and March
2000), in September 1999, a Price Waterhouse consultant to Lucent who was trying to clean up Lucent's European billings expressed concern because nothing was online, the books were a mess, and he was "appalled" at how disorganized things were.
e. By The Start Of The Fiscal 2000 Fourth Quarter, Lucent’s ONG Business Is In “Crisis” And The Fourth Quarter Targets Are Unattainable
147. By the start of Lucent’s fiscal 2000 fourth quarter,
McGinn, Hopkins, Russo and Aversano each was aware of the legion of problems plaguing Lucent’s products. These problems were severe and intractable – quite simply, Lucent could not provide its customers with the products they needed on a timely basis.
As a result, by the start of the fourth quarter, Lucent’s largest customers were cancelling orders and telling the Company that they would no longer accept Lucent’s products.
148. On July 5, 2000, Jay W. Carter, the President of
Lucent’s AT&T Customer Business Unit, sent an email to Aversano,
Russo, Bosco and others in which he reported that AT&T had selected NEC over Lucent to supply optical networking systems for its next generation network. As Carter’s email stated, Lucent had bid on the project but was not selected because Lucent was at least six months behind NEC in terms of developing the system
AT&T needed. AT&T was Lucent’s largest customer. [NA000990].
77 149. By email dated July 6, Aversano asked Carter to quantify the “financial implication of their loss,” and stated
“Advise please so I [c]an review with McGinn and Russo on July
11.” [NA000988]. By return email dated July 7, 2000 addressed to Aversano (with copies to Bosco and Michael Chan), Carter wrote that the loss of the AT&T contract “will cost us a minimum of $50 million [in revenue] this year and $400 million next year.”
Carter’s email also noted that AT&T had informed Lucent that it would “not deploy” any of Lucent’s 400G optical networking equipment in the future, because NEC’s system was twice as fast as Lucent’s and cost half as much. Carter concluded that the loss of AT&T as a customer for optical networking could go beyond
AT&T: “We are clearly out of the market for DWDM with AT&T until
2002 at best. An even bigger concern is what does this portend for our other customers?” [NA000987].
150. On July 6, 2000, Russo sent an email to, among others,
Aversano and Michael Butcher, President of Lucent’s International
Service Provider Networks, asking “[h]ow can we ramp up the
Optical sales?” Russo emphasized that Aversano and Butcher needed to put a “gameplan” in place for the fourth quarter to improve optical networking sales, and that Lucent “must build the funnels and close the business that will help us close the gap with [Nortel].” [NA002304].
78 151. On July 7, 2000, Rod Randall, Chief Marketing Officer for Service Provider Networks, asked Aversano in an email if
Lucent needed to offer incentives and “special promotions” or
“special packages” to entice customers to purchase Lucent products. Aversano responded that same day by saying “simply put: yes.” [NA002298].
152. In late June and early July 2000, Aversano and the senior officers of Lucent’s SPN-North America business began to review their objectives and projections for the fourth quarter of
2000. By email dated June 29, 2000, Aversano and Cocito informed the senior officers responsible for customer accounts of the revenue targets for each customer, that the assumptions used to derive the targets and that the overall revenue for SPN-North
America had to be $7 billion “to ensure that our commitment for the year is met.” The $7 billion was premised on a target of
$1.6 billion in revenue from AT&T. [NA000986].
153. In response to the $7 billion target, on July 7, 2000,
Carter (the VP in charge of the AT&T business) informed Aversano that the $7 billion target was not achievable. Carter’s July 7,
2000 email stated that “if you are counting on the $1.6 billion to reach the NAR target of $7 billion, I think it is highly unlikely.” Carter reported that even “if everything was to come in perfectly we would hit” only $1.25 billion, or nearly $400 million below target. Carter made it clear that even achieving
79 this reduced target was highly doubtful, noting that
“unfortunately, we never close all of the opportunities and many of those that we do close get reduced in size in the final deal making.” Carter’s email also noted that Lucent’s distribution channels were stuffed with excess product, with the AT&T alone having more than half-a-billion dollars in excess inventory. As a result, according to Carter, even $1.2 billion would be an
“extreme reach given the past three quarters actuals, what AT&T is telling us, the $530 million [of inventory] we have on distributors’ shelves that AT&T is committed to use, the credits we owe, and the size of the funnel.” [NA000986 (Emphasis added)].
154. On July 11, 2000, Carole Spurrier, Vice President of
Emerging Service Providers for Lucent’s North American Region, sent an email to Aversano and Stan Holcomb, Vice President of
Market Management, regarding a “VERY CRITICAL” situation with an optical networking product (the 2.5G) that Lucent was supposed to deliver to Verizon. Spurrier, who reported directly to Aversano, emphasized that Lucent was in jeopardy of losing the deal because it could not deliver older products to Verizon which had been promised months before. Spurrier noted that “not only will this effect [sic] this quarter’s revenue but it will put our selection for new products in question.” Holcomb responded the next day by noting that, in addition to the problems with Verizon, Lucent’s
80 “Bell South and Bell Atlantic teams have run into a $30 million
(potentially growing to $90 million shortfall)” on the same products. [NA002595-96].
155. According to a July 18, 2000 Daily Status Report entitled “Critical 10G Customer Shipments Status,” which was sent to Russo and Bosco, Lucent was far behind its target in shipments of critical 10G optical networking equipment. According to that report, as of July 17, 2000, Lucent had shipped only 625 10G modules – only approximately 20% of the July 2000 target of 3000 modules – and the month was more than half over. The report provided that Lucent had only shipped (to date) an average of 36 modules per day in July, and that Lucent needed to ship an average of 170 modules per day for the rest of the month to meet its July target. That report further provided that Lucent was
“nearly done moving August hard orders, with either contracts or
POs, into July” and that “we are lacking sufficient hard orders –
WE NEED ORDERS!!” [NA002276].
156. As reflected in Cocito’s June 29, 2000 email, a formal review of Lucent’s fourth quarter was scheduled to take place on
July 19, 2000. [NA000986]. As Aversano stated in her complaint against Lucent, before McGinn gave the investment community
Lucent’s July 20 guidance, Aversano and Russo “were convinced that [Lucent] would be unable to make the guidance for the fourth quarter of fiscal 2000" (Aversano Complaint ¶36). Russo told
81 McGinn that the revenue and earnings projections for the fourth quarter that he intended to include in Lucent’s press release announcing the third quarter results were unattainable and insisted that the “guidance” be reduced. ¶37. Despite this advice, McGinn went ahead and issued the press release with the materially inflated fourth quarter expectations. Shortly thereafter, McGinn terminated Ms. Russo’s employment.
157. On July 21, 2000, Aversano conducted a North America
Gap Closure Call, in which McGinn participated. On the call,
Aversano discussed the fact that, according to a report prepared on July 20, 2000 (the same day McGinn issued the false fourth quarter guidance), quarter-to-date billing for the North American region was only $441 million, or 7.7% of the $6.6 billion target.
For the month of July, revenue to date was only at 27% of the
$1.65 billion July target. [NA005984].
158. An email to Russo, Aversano and others dated July 24,
2000 confirmed the undisclosed widespread problems that Lucent was experiencing with its products. This email recounts the comments of the CEO of ATG, a Lucent customer, regarding
“systemic issues that have been plaguing [Lucent] for quite some time.” It notes that the issues raised by the customer were
“identical to those voiced by Bell Atlantic, Bell South, BT,
Level 3, NTT and SBS.” The email also listed extensive product and support problems such as “poor communication, confusion, poor
82 quality, [and] delays.” It quoted the CEO as stating that
“Lucent seems to be repeating mistakes time and time again.”
[NA001442-43].
159. On July 24, 2000, Michael Chan and Harry Bosco sent
Aversano strongly worded emails, telling her not to let “the ONG commitment from your teams for this quarter to drop further from the current $879 [million estimated revenues].” Chan wrote that
“this is key for Lucent, otherwise we are talking about going down in revenue (globally for the ONG) relative to the same quarter a year ago.” [NA002271].
160. On July 25, 2000, Russo sent an email to, among others,
Aversano and Butcher, regarding optical sales. Russo left no doubt that the critically important ONG business was in a
“crisis” situation:
we need to think of the issue with optical sales as a crisis. We must ramp up our coverage, customer contacts and sales in this space. I ask both of you to work this issue as if it is the crisis it is. That means, in my mind, all hands on deck, swat teams, tracking contacts, proposals and results ... We have got to change the momentum going in this arena immediately. I know there is a lot going on but I am concerned it is not enough to change the course. [NA002271].
161. On July 26, 2000 – only one day after Russo sent her email – John Pellegrini, the Vice President of Lucent’s Bell
Atlantic/GTE Customer Team, sent an email to Spurrier with copies to Russo and Aversano. The email was entitled “ONG Delivery
83 Issues – HELP.” In that email, Pellegrini wrote that Lucent had a “major problem” with respect to Bell Atlantic, one of Lucent’s largest customers:
BA has called me to complain that there are 14,000 FT and DDM plugs on backorder. BA says that our delivery plan is unacceptable and they are now denying service ... As a matter of fact they need 50 plug-ins desperately today that we can’t deliver until Monday. We also have a $30 million PICs deal on the table that is in jeopardy. BA is in the process of escalating the delivery problem internally. They have also stated that our 2.5G press release [announcing a large order of ONG equipment] is now at risk, as tied to our performance on plug delivery.
The deliver [sic] problem appears to be the worst that we have seen in some time. We need help now! There doesn’t appear to be an acceptable recovery plan coming from ONG.
[NA002263-64].
162. On August 4, 2000, Mary Duncan sent an email to Russo,
Aversano and Spurrier, among others, regarding serious problems with BellSouth, another large customer. According to the email,
“BellSouth Executives have been expressing serious concerns regarding Lucent’s overall quality and product performance.” The email noted that these concerns had been raised with Pat Russo by senior BellSouth employees, including Charlie Coe, President -
Network Services, and Bill Smith, BellSouth’s Chief Technical
Officer. As a result, Lucent had scheduled a senior executive meeting for August 24, 2000 to address these issues.
84 163. On August 14, 2000, Aversano and McGinn held the weekly
North America Gap Closure Call. On the call, these senior executives discussed the fact that fourth quarter revenue to date for the North American Region was only $1.1 billion, or roughly
17% of target. For July 2000, revenue had been only $825 million
– or 50% less than the target. According to a March 29, 2001 article in The Wall Street Journal, during that call, Aversano stated that fiscal fourth quarter 2000 revenue would be even lower than what she had expected revenue to be on July 20.
Indeed, Aversano stated that fourth quarter revenues for NAR would be at least $500 million less than the quarterly target.
McGinn became extremely agitated and angry, and told Aversano that she was going to take down the whole business if she didn’t
“make the numbers.”
164. That same day, Marc Schweig, the Chief Financial
Officer of the AT&T account, who was on the Gap Closure Call, sent an email to his boss, Carter (with a copy to Aversano).
Schweig’s email reported McGinn’s reaction to Aversano’s information:
In case you were wondering, Rich [McGinn] was on the Monday morning call and it was very painful for Nina and all of us. He went ballistic over the NAR CWV [Current Working View of anticipated fourth quarter revenue for the North American Region]. No surprise. We need to redouble our efforts at any possible deals...no holds barred. . . that can improve the top line. [NA000967 (emphasis added)].
85 165. Further, by August 2000, Lucent was attempting to defer costs that should have been incurred during the fourth quarter to subsequent periods, so that those costs would not impact fourth quarter results. Thus, in April 2000, Lucent acquired a company called Ignitus, a company focused on developing high-speed optical communications technology according to a lawsuit filed by
Mahesh Ganmukhi against Lucent on September 27, 2000 in the
United States District Court District of Massachusetts (00-11987
MLW) (Ganmukhi Complaint ¶6). When Lucent made this acquisition, it appointed Mahesh Ganmukhi, the President and CEO of Ignitus, a
Vice President and General Manager of Lucent. Mr. Ganmukhi’s employment agreement provided for him to receive a cash payment of $20,250,000 immediately in the event that his responsibilities and duties as an employee of Lucent changed materially and adversely. (Ganmukhi Complaint ¶8). In early August 2000,
Lucent reorganized its optical networking business by, among other things, cancelling the Ignitus Project. Lucent informed
Mr. Ganmukhi of the termination of Ignitus on August 15, 2000, and announced the cancellation to all Ignitus employees on August
16, 2000. (Ganmukhi Complaint ¶15).
166. Accordingly, pursuant to the terms of his employment agreement, Mr. Ganmukhi was entitled to receive $20.25 million immediately. Robert Barron, the President of Lucent’s
Metropolitan Optical Networking business and a Lucent officer,
86 acknowledged this fact in an email to Mr. Ganmukhi dated August
20, 2000. Indeed, on or about August 20, Lucent informed Mr.
Ganmukhi that it would pay him the money it owed him on September
1, 2000, and even drafted an agreement pursuant to which Lucent would pay Mr. Ganmukhi the full $20.25 million it owed him on
September 1, 2000. (Ganmukhi Complaint ¶17).
167. However, on August 31, 2000, just one day before Mr.
Ganmukhi was to be paid, Lucent informed Mr. Ganmukhi that it would not pay him on September 1. Instead, Lucent stated that it wanted him to “work with them” and wait until early October 2000 to be paid – after the end of the fiscal 2000 fourth quarter.
The excuse Lucent gave Mr. Ganmukhi for failing to pay him as promised on September 1, 2000 was “accounting and financial reporting considerations.” (Ganmukhi Complaint ¶22). In other words, Lucent deliberately sought to defer this $20.25 million payment until after the fourth quarter ended so that it would not reduce fourth quarter profits. Eventually, on September 27,
2000, Mr. Ganmukhi filed suit against Lucent, and the action was resolved shortly thereafter – but after the fiscal 2000 fourth quarter had ended.
168. On August 30, 2000, Aversano sent an email to, among others, Cocito, Spurrier and Holcomb, which aptly summarized
Lucent’s inability to meet its targets. In that email, Aversano wrote that “I think we would all agree that our sales funnel is
87 inadequate to support our revenue growth objectives.”
[NA001882].
f. Lucent’s Operational Difficulties Led to Accounting Improprieties to Meet Revenue and Earnings Expectations
169. With the knowledge that Lucent’s ONG products did not work and were being rejected by its customers, and that the
Company’s other products were rapidly becoming obsolete and would not sell, once again Lucent turned to non-customary sales terms and fraudulent accounting practices to achieve the financial results Lucent had promised investors.
170. In its November 21, 2000 press release, Lucent announced that it had identified a “revenue recognition issue” impacting approximately $125 million in revenue during its fiscal
2000 fourth quarter. As a result, Lucent announced that fourth quarter earnings per share would be reduced by more than 11%.
Lucent further announced that it had informed the Securities and
Exchange Commission of this issue, and that Lucent would conduct an internal investigation of its accounting practices. One month later, the Company’s December 21, 2000 press release disclosed that, as a result of accounting improprieties that occurred during Lucent’s fourth quarter, the Company’s previously reported fiscal 2000 fourth quarter results would be reduced by a total of
$679 million – $554 million more than had been previously disclosed. All told, in the restatement, Lucent’s fiscal 2000
88 fourth quarter revenues were reduced from $9.4 billion to approximately $8.7 billion, and fourth quarter earnings were cut nearly in half, from $0.18 per share to $0.10 per share.
171. The restatement was required to correct improper revenue recognition from several schemes used to generate phony revenue prior to year-end: (i) $125 million of revenue was improperly recognized on the sale of software to Winstar
Communications, Inc. (“Winstar”), even though Winstar simultaneously was granted credits in the same amount to be used in fiscal 2001 and, in any event, was financially incapable of paying for the product; (ii) $74 million of revenue was improperly recognized on the sales of software, even though the customers, BellSouth and AT&T Wireless, simultaneously were granted credits in the same amounts to be used in fiscal 2001;
(iii) $452 million of revenue was improperly recognized on inventory sent to distributors, including Anixter and Graybar, that were consignment sales, i.e., Lucent agreed not to bill these distributors until they sold the product to an end user and also agreed that the distributors could return the product to
Lucent if they were unable to sell it; and (iv) $28 million of revenue was recognized on the sale of a system to Allegiance
Telecom, even though the system had only been partially shipped.
The details of Lucent’s accounting improprieties in the fourth quarter are as follows:
89 g. The $125 Million Fraudulent Winstar Transaction
172. Lucent fraudulently recognized $125 million from a software license sold to Winstar during the last week of Lucent’s fourth quarter. At the time, Lucent and Winstar had a long- standing vendor financing relationship, which required Lucent to provide up to $2 billion in financing to Winstar so that Winstar could purchase Lucent products. This arrangement allowed Lucent to bolster its own revenues by selling equipment to Winstar, even though Winstar was paying for the product with Lucent’s money.
173. Lucent’s relationship with Winstar was extraordinary, particularly when judged by the standards of vendor financing deals Lucent and its competitors ordinarily entered into with their customers. In most such arrangements, Lucent would lend a customer an amount equal to the cost of the equipment Lucent was selling. However, Lucent typically loaned Winstar as much as 30% more than the cost of Lucent’s equipment. In addition, Lucent would routinely finance Winstar’s purchases from other companies.
In sum, Lucent was Winstar’s primary source of financing, and
Lucent acted more like an aggressive bank than an equipment seller in its dealings with Winstar. By the start of Lucent’s fiscal 2000 fourth quarter, Winstar owed Lucent approximately
$700 million.
174. McGinn and Hopkins were informed that Lucent was engaging in fraudulent transactions with Winstar in an anonymous
90 letter dated August 8, 2000 addressed to defendant Hopkins, which defendant McGinn received on August 14, 2000:
Dear Ms. Hopkins:
I am writing to inform you of some Lucent accounting irregularities that I suspect are illegal. Please excuse me for writing anonymously.
About a year ago I started hearing rumors of completely fabricated revenue, for both Lucent and its customers. Now I have friends (at very low levels of management) that complain of being forced to take part in such schemes.
Here’s the way it works: a small customer (non-RBOC) contracts for a network to be provided (EF&I) by Lucent. As the quarter comes to a close, the customer adds $35M to the purchase for some special professional services. Lucent decides to outsource the services, so it hires the customer as its sub-contractor, for the price of $35M. The customer and Lucent exchange invoices and payments a day or so before the quarter ends, so both can recognize revenue immediately. No additional services are actually provided by either party. The purpose of the exchange, according to those involved, is to help the customer cook its books, though it obviously also inflates Lucent’s revenues.
In a case I personally know of, the $35M of over-stated revenue represents over a third of the customer’s quarterly revenue publicly reported. How will it look when this company fails and the SEC finds out that Lucent conspired to inflate its numbers?
The irregularities I see may be common throughout Aversano’s organization. It is obvious to us that few of our sales people expect to be caught or punished.
91 I hope that you will investigate and put a stop to these practices soon.
Thanks for your consideration of this matter. [NA004371].
175. In a September 7, 2000 email to McGinn and Hopkins,
Aversano concludes that the anonymous letter referred to Lucent’s transactions with Winstar. [NA004369].
176. Lucent was willing to go to great lengths to appease
Winstar so that Winstar would continue to purchase products and software from Lucent and Lucent could continue to meet its quarterly numbers. Indeed, in a document entitled the
“Lucent/Winstar End of Quarter Deals, Fiscal Year 2000” Lucent sets forth that, for the first three quarter of fiscal 2000,
Lucent recognized $358.9 million of revenue as a result of the
Company’s end-of-quarter “deals” with Winstar, as follows:
$113.9 million in the first quarter, $115.0 in the second quarter and $130.0 in the third quarter. Among the concessions Lucent made to assure Winstar’s end-of-quarter cooperation was deferred billing. In other words, Lucent would defer billing Winstar for products Winstar supposedly purchased until subsequent financial periods. This allowed Winstar to improperly avoid recording the cost of these products until a later period. This created the illusion that Winstar’s financial condition was better than it actually was, and allowed Lucent to continue to book revenue on sales made to Winstar at the end of fiscal quarters. For
92 example, the “Winstar/Lucent 2000 Partnership Deal” description attached to a September 22, 2000 email from Deborah Harris provides that, in exchange for Winstar’s commitment to purchase
$187.8 million of products and services from Lucent, Lucent would defer $63.4 million of billing properly made during the quarter ended December 31, 2000 until January 2, 2001. [NA004425-30].
177. Lucent needed Winstar’s end-of-quarter help so much that the Company also regularly contributed to Winstar’s violation of federal securities laws by “passing through” to
Winstar fictitious revenue. Lucent’s participation in this fraudulent scheme was an integral part of the Lucent/Winstar relationship; without it, Winstar would not have provided Lucent with the end-of-quarter “assistance” Lucent needed. According to a September 18, 2000 email from Deborah K. Harris, Vice President in charge of Lucent’s Winstar Customer Team, to Aversano and
Cocito, among others, Lucent “pass[ed] through around $67M/Q of
[revenue to] Winstar Services. We have been told to stop this practice. We will be communicating our position to Winstar the week of 9/18 . . . We may want to delay this move for a quarter based on this EOQ [end-of-quarter] deal.” [NA004387-88].
178. In a September 22, 2000 letter to Nate Kantor,
President and Chief operating Officer, Harris informed Kantor that Lucent would no longer participate in the revenue creation scheme. Responding in a September 24, 2000 email to Aversano,
93 Kantor stated that if the Company went through with its decision to cease the $65 million per quarter of fraudulent “pass through” revenue to Winstar, Winstar would no longer help Lucent at quarter-end:
I am very surprised and disappointed with this – we’ve only discussed and agreed on this a million times. This doesn’t sit well with me and will have a major impact on our ability to help you this quarter.
You’ve got to get this fixed. [NA004434].
Winstar’s threat was effective: just three days later, in a
September 27, 2000 letter to Kantor from Aversano, Lucent agreed to continue the fraudulent revenue “pass through” to Winstar.
[NA004450-51].
179. As a result of their unique relationship, Lucent ordinarily was able to rely on Winstar to accept Lucent’s products whenever Lucent needed to generate sales. Most of these
“sales” consisted of product that Winstar did not need or want.
During the last week of the fiscal 2000 fourth quarter, when
Lucent was approximately $1 billion short of the fourth quarter revenue “guidance” McGinn had given on July 20, 2000, Lucent approached Winstar and asked for end of quarter help. On this occasion, however, Winstar informed Lucent that it did not need or want the software Lucent was offering. Indeed, Deborah
Harris’ September 18, 2000 email specifically stated that Winstar was “vehement that they are out of money and do not want to spend
94 money on product that they cannot immediately utilize. The deals of the past are haunting us . . . there’s $87M [of inventory] in their warehouse.” Accordingly, to induce Winstar to agree to the sale of the software license, Lucent agreed to provide Winstar with $125 million worth of “credits,” that would ostensibly be used by Winstar to purchase products from Lucent in 2001.
[NA004387-88].
180. Moreover, as Harris’ September 18 email makes clear,
Lucent knew that Winstar could not afford to pay for the software. Indeed, in June 2000, only three months earlier,
Lucent had engaged Donaldson, Lufkin & Jenrette and Bear Stearns to attempt to sell some of the loans it had extended to Winstar.
Indicating its lack of confidence in Winstar’s ability to pay,
Lucent took the extraordinary step of offering the loans at less than 90 cents on the dollar. The sale never occurred because
Winstar demanded that it be halted.
181. As explained in further detail below, under generally accepted accounting principles (“GAAP”), the $125 million worth of credits that Lucent granted Winstar – effectively, a discount from the sale price – should have been recorded during the fourth quarter of 2000 as a reduction to the revenue that Lucent recorded in connection with the sale of the software license.
However, in violation of GAAP, Lucent did not record the value of the credits it had provided to Winstar and instead booked the
95 entire sale. As a result, Lucent’s fourth quarter revenues and earnings were materially overstated.
182. Lucent has admitted the Winstar improprieties violated
GAAP. In its answer to the Aversano Complaint, Lucent states that Aversano had agreed to provide Winstar with the credits in exchange for Winstar’s agreement to purchase the software license, even though she “was aware that the customer did not want most of the software and was only agreeing to purchase the software because of the credits that [Aversano] had offered.”
Lucent states that it improperly recognized revenue in connection with the Winstar transaction “[i]n large part because of
[Aversano’s] actions in offering credits . . . and failing to inform Lucent senior management that she had done so.”
183. The fraudulent Winstar transaction was specifically authorized by senior executives at the Company, and the failure to account for the $125 million of special incentives was known at the highest levels of Lucent. As reported in The Wall Street
Journal on March 29, 2001, Aversano concedes that “[t]here were dozens of people at senior levels [of Lucent] who were fully aware of the facts and circumstances” of the fraudulent Winstar transaction. The emails to defendants McGinn and Hopkins, and the September 8, 2000 anonymous letter [NA004371] put McGinn and
Hopkins on notice of the Winstar deal. In fact, in emails dated
September 27 and 28, 2000 to defendant Hopkins and Robert C.
96 Holder, Executive Vice President of Lucent’s Corporate
Operations, Aversano stated that she was directed by defendant
McGinn to provide daily updates of pending North American region end-of-quarter deals, including the Winstar deal, and that she was “leaving voicemail updates for Rich [McGinn], given that he is out of pocket.” [NA005512].
184. Lucent’s accounting for the Winstar transaction violated GAAP. Under GAAP, revenue may be recognized only when it is realized or realizable and earned. SEC Staff Accounting
Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial
Statements, states that revenue is realized when all of the following criteria are met:
! Persuasive evidence of an arrangement exists;
! Delivery has occurred or services have been
rendered;
! The seller’s price to the buyer is fixed or
determinable; and
! Collectibility is reasonably assured.
When a sales transaction includes credits that the seller extends to the buyer that may be used only to reduce the cost of future purchases, the selling price on the initial transaction is not fixed because the credits must be taken into consideration for purposes of determining the true selling price on that transaction. In other words, only the net sales price (i.e., the
97 nominal sales price less the credits issued) is realizable in such a situation.
185. Lucent’s transactions with Winstar violated GAAP in another respect. In light of Winstar’s financial condition at the time of the transaction, Lucent should not have recorded any revenue from the sale of the software license. In order to record revenue from a sale, the collectibility of the sales price must be reasonably assured. SAB 101; see also American Institute of Certified Public Accountants, Statement of Position 97-2,
Software Revenue Recognition. In certain vendor financing relationships, the financing provided to the customer by the vendor is so material that the customer effectively has no economic substance apart from that provided by the vendor. Here,
Lucent had more than $700 million in loans outstanding to Winstar at the time of the fourth quarter sale and, as demonstrated by, inter alia, Lucent’s attempted “fire sale” of its Winstar receivables, Lucent knew that Winstar was experiencing financial difficulties and could not survive without Lucent’s continued financing. Indeed, Harris’ September 18, 2000 email stated that
Winstar was “vehement that they are out of money.” [NA004387-
88]. Lucent also knew that Winstar’s financial solvency depended on Winstar engaging in a series of accounting improprieties in which Lucent participated.
98 186. Winstar’s dependence on Lucent for its continued viability is demonstrated by Winstar’s reaction when Lucent finally pulled the plug. On March 31, 2001, Lucent refused to provide $75 million in financing to Winstar. Less than three weeks later, on April 18, 2001, Winstar filed for bankruptcy.
Accordingly, collectibility of any revenue from the Winstar transaction was not reasonably assured and should not have been booked.
h. The Fraudulent Software Pooling
187. Lucent improperly recognized $74 million of revenue in the fourth quarter on “software pooling” transactions with
BellSouth even though BellSouth had not even identified the specific software it intended to purchase. This revenue was recognized in contravention of GAAP.
188. In a September 21, 2000 email to defendants McGinn and
Hopkins, Carole Spurrier, Vice President of Emerging Service
Providers for Lucent’s North American Region, described a
$350 million deal for billing software (which would include a
$75 million “Arbor” software license fee) with BellSouth that was not likely to close by the end of the year. In order to recognize some revenue from BellSouth by September 30, 2000
(Lucent’s fiscal 2000 year-end), Spurrier suggested that
BellSouth “sign a software pooling agreement for the $75M (which would include the Arbor license) with the intention of
99 negotiating the billing deal ASAP.” Spurrier then explained the terms of a software pooling agreement:
A software pool lists a variety of software that the customer can chose from in the future. The customer gives us an irrevocable agreement to buy some dollar amount ($75M) and an agreement to pay within 12 months. The irrevocable agreement allows Lucent to book the revenue immediately and allows BS [BellSouth] to put off the decision on which software they want from the pool and therefore put off capitalization until they make their selection. My teams have done numerous software pools and we have not had trouble getting revenue recognition. [NA001030-31].
189. Pursuant to the software pools, Lucent would recognize revenue in a particular quarter even though the customer would not identify the specific software and Lucent would not deliver that software until as long as one year after the sale was booked. The customer would typically make a token payment to
Lucent of $1 million and Lucent would record the entire value of the sale ($75 million in the case of the BellSouth pool).
Spurrier recognized that when entering into the deals, Lucent knew that the customers’ failure to identify the specific software presented an accounting problem. Indeed, in a
September 25, 2000 email to Aversano, Spurrier specifically noted that: “[g]iven that the customer does not commit to the specific pieces, I am not sure how the corporation will book the revenue by business unit.” [NA006374].
100 190. These software pooling agreements pulled revenue from future quarters into the fourth quarter of 2000. Accordingly, in addition to violating GAAP, entering into this software pooling arrangement with BellSouth is probative of McGinn’s and Hopkins’ scienter, because using this mechanism distorted the true picture of Lucent’s business for the quarter and year. Spurrier’s
September 21 email states:
We have indicated, that Lucent could be flexible in what might go into the pool. This might include switching software or ONG software that they need to purchase in the future giving them security around the $75M commitment. Our intention would be to get the largest commitment to Arbor as possible and live to fight another day.
This flexibility would call into question if and how many of the incentives we would be willing to give them for a revised deal. Our intention was to both close billing this quarter and insure new revenue streams with BellSouth. Giving them the incentives for a $75M software pool which merely pulls forward software revenue from future quarters is neither good business or [sic] a good precedent to set. [NA 001030- 31].
Spurrier’s email concluded by noting that McGinn would call
BellSouth to negotiate the deal.
191. To induce BellSouth to enter into the deal, Lucent ultimately agreed to provide BellSouth with “significant incentives,” including $20 million in “product and service credits.” In a separate September 25, 2000 email to defendant
101 Hopkins, Spurrier stated that BellSouth intended to use the
$20 million in credits against the purchase of software from the software pool, even though that particular incentive was initially designed by Lucent to encourage other purchases: “It is our intent to make the pool for $95M to [sic] so when the $20M in credits that they are seeking are credited against the sale,
Lucent will net $75M.” Defendants McGinn and Hopkins, as well as other senior Lucent employees, were aware of this and other similar pooling transactions in which Lucent recognized revenue even though no actual sale had occurred. [NA005490].
192. Lucent’s fraudulent accounting for the software pooling transactions with BellSouth violated GAAP by improperly recognizing $75 million of revenue in its fiscal 2000 fourth quarter. Paragraph 8 of AICPA Statement of Position No. 97-2
(“SOP 97-2”), Software Revenue Recognition, states that revenue can be recognized in software transactions only if (a) persuasive evidence of an arrangement exists, (b) delivery has occurred,
(c) the vendor’s fee is fixed or determinable, and
(d) collectibility is probable. With respect to the sale of more than one software component, Paragraph 10 of SOP 97-2 states:
[I]f an arrangement includes multiple elements (e.g., multiple software products, upgrades, or services), the fee should be allocated to the various elements based on vendor-specific objective evidence of fair value [the price charged when the same element is sold separately], regardless of
102 any separate prices stated within the contract for each element.
Paragraph 12 of SOP 97-2 then states:
If sufficient vendor-specific objective evidence does not exist for the allocation of revenue to the various elements in the arrangement, all revenue from the arrangement should be deferred until the earlier of the point at which (a) such sufficient vendor- specific objective evidence does exist or (b) all elements of the arrangement have been delivered.
193. Given that at the time of execution of the arrangement,
BellSouth had not selected from the pool those specific software products that it would license, and given that BellSouth had up to a year to finalize its selections, Lucent did not have sufficient vendor-specific objective evidence of fair value by software product at the time the software pooling arrangement was executed. Therefore, the first criterion of SOP 97-2 for revenue recognition was not met. The software pool arrangement was nothing more than a purchase commitment by BellSouth; terms of the transaction failed to provide persuasive evidence as to which of the various software products were to become licensed to
BellSouth.
194. In addition, delivery could not have occurred prior to
BellSouth’s selection of the specific software products it intended to license. Therefore, the second criterion of SOP 97-2 also was not met. Accordingly, to be in compliance with SOP 97-
2, Lucent should have deferred revenue recognition until
103 sufficient vendor-specific objective evidence existed or all elements of the arrangement had been delivered.
195. Furthermore, with respect to the licensing of software,
SAB 101 states:
[T]he staff believes that delivery does not occur for revenue recognition purposes until the license term begins. Accordingly, if a licensed product or technology is physically delivered to the customer, but the license term has not yet begun, revenue should not be recognized prior to inception of the license term.
In the absence of BellSouth’s selection of the software products to be licensed, it is inconceivable that the license term could have begun.
196. As Spurrier’s September 21, 2000 email demonstrates,
Lucent did numerous software pooling agreements during the Class
Period. In February 2000, for example, Lucent offered BellSouth a $10 million software pooling agreement. Similarly, according to an email dated September 22, 2000 from Aversano to Len Lauer of Sprint Communications, Lucent proposed that Sprint agree to a
$37 million software pooling agreement which would close before the end of the fiscal 2000 fourth quarter. Pursuant to this arrangement, Sprint would pay Lucent $1 million during the fourth quarter, but Lucent would record $37 million in revenue. The proposal acknowledged that such an agreement would eliminate future software expenditures by Sprint on switching software and that “the aggressiveness of this proposal is grounded in the
104 specific value of receiving the order by the close of Lucent’s fiscal year.” [NA002516].
i. The $452 Million of Fraudulent Distributor Revenue
197. On December 21, 2000, Lucent announced it had reversed
$452 million in revenue that it had recorded in 2000 from supposed sales to distributors, including Graybar, Anixter,
Westcon, and CTDI, because they had the unconditional right to return the product and were only obligated to pay Lucent if they eventually sold the product to an end-user. Shortly after the fourth quarter ended, these distributors returned $452 million worth of products that the Company had previously recognized as sales. These sales actually were consignment sales and Lucent should not have recognized revenue until the distributors sold the product to an end-user and the distributors became obligated to pay Lucent for the product. These improper revenue recognition practices accounted for approximately two-thirds of the $679 million in fourth quarter revenue that Lucent reversed.
198. More than $200 million of the returns, or almost 50%, came from Anixter, one of Lucent’s largest distributors.
Documents obtained from Anixter pursuant to subpoena confirm
Lucent’s improper practices. On December 30, 1999, Bill Standish of Anixter sent an email to other Anixter employees which set forth the transactions that Anixter and Lucent had negotiated that day. (December 30, 1999 was the last day of Lucent’s fiscal
105 200 first quarter). The email provided that, to induce Anixter to accept Lucent products during that quarter, Lucent’s senior management – including the Chief Executive Officer of SPN – had expressly granted Anixter the right to return the product if it could not be sold:
2. Lucent - 400G $50mil of ONG product. Most expected to sell to Argent/Att at margin of 12.8%. Shipments throughout 2000. 90 day payment terms to Lucent. Minimum of 12.8% margin if sold to Global Crossing or other customers. Per Leslie [Dorn, Lucent Vice President of Channel Sales] we have assurances from Jay Carter and Pat Russo that product will move or we can return.
3. Winstar - $10 mil of radio’s [sic] to be sold to Wannet (sp)? at a margin of 7% if sold within 90 days 2% per month additional beyond 90 days. We will return after 6 months. 90 day payment terms. If little or no sales after 90 days we will not pay Winstar and have option to return the product. Lucent will guarantee we will collect and they will guarantee return of the product. Discussion with Leslie [Dorn] and Jim Cassido (sp?) [actually referring to Jim Cocito] Nina Aversano’s COO. Leslie confirmed terms with Nina. [ANX000467].
199. On January 31, 2000, Gary Conrad, another Anixter employee, wrote that “[i]f the inventory has not moved by the end of March, we can return the remainder to Lucent at the end of
March ... For now, the most important thing we can do is to make sure that at the end of each month we are quickly billing them for the inventory holding charges, monitoring inventory movement
106 and preparing for a return at the end of March if it does not move.” [ANX000003].
200. On February 22, 2000, Tom Kaminsky of Anixter sent an email to certain other Anixter employees regarding a “Lucent opportunity” that had come Anixter’s way. According to the email, in the first quarter of fiscal 2000, Lucent recorded a $45 million sale to ICG Communications, Inc. However, ICG would not
“take ownership” of the product until later in 2000, and refused to pay for the product until it actually took ownership of it.
As a result, Lucent was having “accounting issues” – issues which they needed Anixter’s help to resolve. Although Lucent knew that the ICG sale should not have been booked during the prior quarter, rather than reverse the sale, Lucent asked Anixter to purchase products from Lucent in the March quarter, and then sell them to ICG later in 2000.
I wanted to bring you up to speed on a Lucent opportunity that has come our way. Lucent today sells products to a CLEC called ICG. (Lucent helps fund ICG as well). In their zest to generate revenue, Lucent has sold about $45mil of this product to ICG in late 1999 that ICG will not be taking ownership to until various times throughout 2000. (March- September). ICG does not wish to pay for this product until the “turnover date” and as such, Lucent is having accounting issues with their revenue recognition. (Duh!)
So we have been called to play. We are being asked to buy $72 mil in product today, and then sell it to ICG per the turnover dates. [ANX000220].
107 201. On March 23, 2000, Tom Kaminsky of Anixter sent an email to Angela Haneklau of Lucent, which gave her an overview of
Anixter’s December 30, 1999 purchase of 400G product. The email stated that AT&T “had not made a full commitment to purchase the product” and that “[a]s of this date, we have sold no 400G product, and as such, will see no cash inflows in the first quarter.” The email further stated that Anixter had been given
“a personal guarantee from Jay Carter and Leslie Dorn that this product would be accepted for return if there was no or little sales movement.” [ANX000637].
202. On May 24, 2000, an internal Anixter email stated that
Lucent was looking “for a back up plan to support Lucent material in the event that Anixter will not take on additional inventory.”
The email also provided that Lucent’s 400G optical networking product was experiencing technical difficulties: “testing is being done on the 400G, and it has uncovered some problems with circuit packs and software revisions are needed. This does affect our current inventory and we will have to ship material back ... for testing before we can deploy the material.”
Further, with respect to Lucent’s back-up plan for generating revenue, “I think we both know that revenue recognition is driving a lot of this decision to send out an RFI. The magic number from Nina is somewhere in the neighborhood of $60mm for fiscal Q3 based on what I heard.” The email also made it clear
108 that there was no demand for Lucent’s optical networking products, and that significant amounts of inventory were simply sitting unsold and unwanted at the distributors:
My thoughts, we can rewrite the rules of engagement that include penalties on current inventory and any future inventory, possible margin concessions, or allowing Lucent to ship additional material with really extended terms to help them meed their objective. A stretch might be to ship back all of our 400G inventory and replace it with a larger order at much better terms due to problems with the current inventory. I don’t think they understand that revenue is only part of the problem, if the asset just sits at Anixter it doesn’t help us a whole lot.
It appears that Lucent is in desperate need of help to meet internal commitments and with Boots [Bagby, an employee of another Lucent distributor] dragging his feet it has put them in a position to look beyond Anixter for dollar commitments. [ANX000617-18].
203. On December 6, 2000, Tom Kaminsky of Anixter wrote two emails that stated that, during the third quarter of fiscal 2000
(ended June 30, 2000), Lucent had improperly shipped more than
$50 million of products to Anixter (and booked revenue on the
“sale”), even though the purported end-user of the products (a company called KMC) had not ordered the product. The vast majority of the product was now sitting in Anixter’s inventory, and would now have to be returned. As Kaminsky wrote, “[b]ecause of Lucent’s drive to recognize revenue in their 3rd quarter,
Lucent forced KMC to buy product ($52mil Big Buy) from them at least 6 or more months before they were ready for it ... As such,
109 Anixter got in the middle of the deal. KMC was not sure of what products they were even going to need. As a result, they now need something different than what we own.” Kaminsky further noted that “Lucent knowingly had “tagged” on some product, specifically switches, to the KMC “big buy” order that was not usable by KMC” and that “Anixter was informed about this situation only after we had received the product.” Kaminsky noted that Anixter would have to talk to Lucent about these issues, and pointedly noted that “We have concerns as to how long
Lucent [has] known about the problem of KMC cancelling or wanting to return significant portions of the ‘big buy’ order.”
[ANX000109-110].
204. In an August 4, 2000 email from Leslie Dorn, Vice
President of North American Channel Sales, to Cocito, among others, Dorn warned that $38 million of 400G inventory “sold” to
Anixter in the first quarter of fiscal 2000 “will be returned
THIS quarter if not sold . . . that is a substantial hit in quarter for ONG . . . and NA.”
205. Then, in an August 29, 2000 email sent to Aversano,
Cocito and others, Dorn noted that between $16 million and
$61 million (with $45 million from the third quarter) of ESP product Lucent had “sold” to Graybar had “a moderate risk for revenue reversal.” Dorn went on to explain that “Lucent committed that financing would be in place before we required
110 Graybar to pay us . . . and that the product would all move during this quarter. Neither of these things has occurred.”
Dorn then advised that the associated revenue would require reversal unless Lucent manipulated its books by changing the age of the receivable from Graybar: “[U]nless we ‘re-age’ the receivable (to 90 days), we need to reverse the revenue.” Dorn separately warned that there was “high risk” on $36 million of inventory at Anixter. [NA004737].
206. In a separate August 29, 2000 email sent to Cocito and others, Dorn stated that Graybar had roughly $118 million worth of Lucent products in inventory, all of which likely would have to be returned to Lucent. As Dorn explained, although Lucent had booked the $118 million in revenue from those shipments to
Graybar, Graybar was only obligated to pay Lucent if Graybar resold the products to Qwest, and Qwest did not want virtually any of these products. The inventory was “scheduled to be consumed [by Qwest] over a three to five month period beginning in July 2000. Less than one percent has been ordered to date.”
As a result, Dorn concluded that Lucent ‘cannot ask Graybar for payment until Qwest agrees to place the orders . . . and that all product will be consumed by December 1, 2000.” Dorn separately discussed the inventory of SSG, or Switching Solutions Group, products at Graybar, noting that this inventory was likely not what customers wanted to buy from Graybar: “We also need to
111 assess the type of SSG inventory that is there, and, as required, refresh to ensure that it is the right product. There may be a sizable (over 60%) change required . . . all via “refresh” . . . not incremental orders.” [NA004736].
207. On September 5, 2000, James Morris sent an email to
Dorn regarding the resolution of certain channel issues. Morris pointed out that approximately two-thirds of the $129 million of inventory at Graybar for Qwest would need to be “refreshed,” and that it was unlikely that the full $129 million would be consumed by December 2000. Morris went on to warn that Lucent would almost certainly have to reverse $110 million in sales that had been previously booked: “If a larger portion of the inventory can’t be moved this calendar year, we need to reverse sales.”
[NA004729-30].
208. The fact that Lucent would have to reverse revenue previously recognized on sales to Graybar was again discussed on
September 8, 2000 in an email sent from Dorn to Richard Neri at
SSG, among others:
This is my reaction to the current view of demand Vs [versus] inventory at Graybar. We will work with you to create the RMA [return merchandise authorization]. I know that we all want to avoid an SSG negative for this quarter for Lucent, but the sheer differential (inventory Vs full year requirement) forces a return this quarter. I cannot collect the outstanding A/R ($110M) when I know it cannot be sold and be off the shelf by 12/1/2000. [NA004720].
112 209. In a separate September 8, 2000 email to Jay Carter,
President of Lucent’s AT&T Customer Business Unit, Dorn foretold the return of inventory at Graybar: “I know that SSG and NA
[North America] do not want to return this in F4Q, but I cannot collect the A/R ($110M) on product that is not forecasted to be used, based on Qwest’s projected consumption for 2001, within a reasonable time frame.” [NA000092].
210. On September 12, 2000, Lucent executives met with Qwest in an attempt to get Qwest to purchase Graybar’s inventory so that Lucent would not have to reverse the revenue it had already recognized. Dorn discussed that meeting in a September 13, 2000 email sent to Cocito, Carter and Neri, among others, in which she highlighted the significant over-supply of inventory at Graybar that Qwest could not and would not purchase:
Customer purchased and installed about 8000 PRIs in F2000 . . . Qwest will purchase no additional PRIs this year . . . there is no budget for any additional product for calendar 2000. . . . If they could get budget $s, the most they would need is 2000-3000 PRIs. This is about 10% of the current inventory at Graybar. [NA000091].
Dorn, after noting that Qwest was forecasting a “need/budget” for
8500 PRIs for 2001, then continued, “We currently have over
25,000 PRIs at Graybar for Qwest deployment by 12/1/000 . . . total inventory is valued at about $128-129M . . . about $110M shipped in the last week of June, 2000 . . . none can be installed this year.” She then noted another problem with the
113 inventory that assured its return and should have prevented
Lucent’s recognition of revenue on its sale to Graybar: “Also, it appears that the product models that were shipped (non-EMC) are not the right product models for deployment at Qwest.” Dorn then wrote, “We have an overdue A/R balance that will be negated by the return of this product.” She concluded by stating that
“[w]e believe that there is only one viable alternative at this time . . . and that is to immediately [allow Graybar to] return all product shipped in June 2000.”
211. Lucent’s problems in getting its inventory at distributors sold were exacerbated by Lucent’s own direct sales teams. Lucent was supposed to help its distributors sell the equipment, but was instead effectively competing with them by selling the same equipment directly to these customers. Lucent did so even though it knew that any sales to these customers would effectively render Lucent’s sales to Anixter, Graybar and other distributors “null and void,” because it ensured that those distributors would not be able to sell the equipment and would instead return it to Lucent. As described in a September 14,
2000 email sent to, among others, Carter and Stan Holcomb, Vice
President of Market Management, Dorn rebukes the sales teams for competing with her late September push to sell the inventory at
Anixter and Graybar so that Lucent would not have to take it back and reverse the revenue it had improperly recognized:
114 [T]here is NO reason this cannot be sold by Anixter and billed by Anixter. I do not consider your response acceptable. I also am aware that ONG is preparing to do a “special” on the 400G inventory that is at MV [Merrimack Valley, North Andover Facility]. If any of this product overlaps with our stock at Anixter . . . and Graybar (and I am sure that it must) . . . the inventory at our distributors must be used prior to a new direct sale. I find it odd that you did not think of a “special” incentive before to drive sales off the shelves. Everyone at ONG was very happy to get the revenue (and recognized it at 100%) when it went to our partners . . . but have not been 100% supportive in moving it off the shelves. Let’s really team on this issue. It is time for our actions to match our words. [NA004704].
212. A September 27, 2000 email from Robert Vrij, Vice
President of Lucent’s Qwest Customer Team, to Dorn, makes clear that Qwest had never actually ordered the products Lucent shipped to Graybar, even though Lucent had recognized $110 million in revenue from this sale during the fiscal 2000 third quarter. As
Vrij wrote, the $110 million worth of PRI switches that was now sitting at Graybar and which Qwest was supposed to consume by
December 2000, was more than three times Qwest’s annual consumption of this product: “The question I know you were trying to answer is: Could Qwest logically consume 3 TIMES annual consumption in 3 months? ANSWER: clearly no.” Vrij’s email demonstrated that Lucent’s recognition of revenue from the sale of this inventory to Graybar was improper because Qwest had
115 never ordered the product, and, in fact, it was simply impossible for Qwest to have agreed to this deal:
Your next question to be answered: Was there any written commitment or verbal acknowledgment of Qwest’s willingness to do this deal? ANSWER: There are not written commitments or P.O.’s, and Clay van Doom [VP of Qwest] has stated that to his knowledge there were never any verbal commitments . . . Clay’s view is that 25,000 PRI would never be feasible and represents 3 year’s of inventory. [NA004639].
213. In an October 18, 2000 “Inventory at Risk” email from
Dorn to Aversano, Cocito and Frank Manzi, Chief Financial Officer of Lucent’s North American Region, Dorn notes that any inventory identified as a “high” risk “will probably be returned unless we can find a viable customer to support with the partner.” The
“Inventory at Risk” schedule attached to this email reflects
$308 million of at risk inventory where the risk is assessed as
“high,” including $195 million at Graybar, $67 million at
Anixter, and $16 million at Westcon. [NA004592]
214. Lucent’s premature recognition of revenue in these circumstances was a blatant violation of GAAP and, in particular,
FASB’s Statement of Financial Accounting Standards No. 48
(“SFAS 48”), Revenue Recognition When Right of Return Exists.
SFAS 48 specifically provides that revenue may not be recorded where a buyer has been granted the right to return the product and the obligation of the buyer to pay the seller is “contingent on resale of the product.” Similarly, with respect to
116 consignments, the Handbook of Accounting and Auditing (Second
Edition; Robert S. Kay and D. Gerald Searfoss; Warren, Gorham &
Lamont; Boston Massachusetts; 1989), Chapter 13, page 31, states:
Consignments. Merchandise shipped on a consignment or trial basis should not be considered as a sale and a receivable, because the consignee is not obligated until he has resold the merchandise or otherwise accepted it. The legal title still rests with the consignor, who has merely relinquished possession of the merchandise. For accounting purposes, the merchandise should remain classified as inventory, separately delineated if the amount if large.
215. The SEC staff provides the same guidance in SAB 101,
Question 2, which states:
Products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue until a sale occurs. The staff believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee.
j. $28 Million of Fraudulent Partial Shipment Revenue
216. During the fiscal 2000 fourth quarter, Lucent improperly booked millions of dollars in revenue on sale of a system sold to Allegiance Telecom, Inc. that had not been completely shipped. The FASB’s Statement of Financial Accounting
Concepts No. 5, Recognition and Measurement in Financial
Statements of Business Enterprises, in paragraph 84, states that revenue may ordinarily be recognized when the product or merchandise is delivered or services are rendered to customers.
117 However, in situations such as this one, which involve a system, delivery of the product is only one step in the earnings process, because the seller has significant obligations to the customer after delivery. Transactions involving a system are usually subject to agreements that require the seller to install the system and enable the customer to test and accept or reject the system as meeting or failing to meet specifications. SAB 101,
Question 3, addresses revenue recognition is such a situation:
After delivery of a product or performance of a service, if uncertainty exists about customer acceptance, revenue should not be recognized until acceptance occurs. Customer acceptance provisions may be included in a contract, among other reasons, to enforce a customer’s rights to (1) test the delivered product, (2) require the seller to perform additional services subsequent to delivery of an initial product or performance of an initial service (e.g., a seller is required to install or activate delivered equipment), or (3) identify other work necessary to be done before accepting the product. The staff presumes that such contractual customer acceptance provisions are substantive, bargained-for terms of an arrangement. Accordingly, when such contractual customer acceptance provisions exist, the staff generally believes that the seller should not recognize revenue until customer acceptance occurs or the acceptance provisions lapse.
A seller should substantially complete or fulfill the terms specified in the arrangement in order for delivery or performance to have occurred. When applying the substantially complete notion, the staff believes that only inconsequential or perfunctory actions may remain incomplete such that the failure to complete the actions would not result in the customer receiving a
118 refund or rejecting the delivered products or services performed to date. In addition, the seller should have a demonstrated history of completing the remaining tasks in a timely manner and reliably estimating the remaining costs. If revenue is recognized upon substantial completion of the arrangement, all remaining costs of performance or delivery should be accrued.
Accordingly, Lucent should not have recorded revenues from this partial shipment.
C. LUCENT'S "GUIDANCE" TO MARKET ANALYSTS
217. Throughout the Class Period, Lucent regularly disseminated material information about its businesses through the conduit of securities analysts employed by Wall Street investment banks. Specifically, Lucent managed investors’ expectations for earnings by providing "guidance" to analysts.
Defendant McGinn participated in regular conference calls with analysts on the Bloomberg Forum, during which he issued guidance on Lucent's business, results and future earnings. These analysts communicated that guidance to the marketplace, which in turn then influenced investors buying decisions and the Company's share price. As a result, Lucent was under pressure to meet analysts' earnings projections in order to continue to grow market capitalization and increase the value of the company's stock.
119 D. FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD
218. On October 26, 1999, the first day of the Class Period,
Lucent issued a press release to announce the Company’s fourth quarter operating results. In describing those results, Lucent made the following statements, which included statements from defendant McGinn:
“Our ability to provide customers with the systems, software, silicon and services they need to build end-to-end next-generation networks continues to win Lucent new business and strengthen our relationships with existing customers,” said McGinn. In fiscal 1999, Lucent announced more than $11 billion in contract wins, including more than $2 billion in September alone. McGinn noted that Lucent’s growth in the fourth quarter was again driven by the company’s focus on hot growth areas like optical networking, wireless networking and professional services.
McGinn’s and Lucent’s statements that the Company’s products and services were “continu[ing] to win Lucent new business and strengthen our relationships with existing customers,” and that
Lucent’s growth was "driven by the Company's focus on hot growth areas like optical networking, wireless networking and professional services," were materially false and misleading because:
(a) Instead of growing as a result of “hot growth areas,” the Company was desperately playing catch up in optical networking, and had serious manufacturing, supply, cost, and quality assurance problems that impaired its ability to produce
120 and perform. Demand had shifted dramatically away from Lucent's existing optical networking product to OC-192 (¶64). Customers were shifting their purchases to companies like Nortel, which could already sell OC-192 product, or were deferring purchases from Lucent until Lucent would be able to sell OC-192 (¶¶64-68).
Demand also had significantly diminished for the OC-48 optical networking product that Lucent was presently able to sell (¶¶65-
66). According to an article published in The Wall Street
Journal on October 24, 2000, as early as October of 1999, senior
Lucent Executives had told McGinn that Lucent needed to drastically cut its financial projections because the Company’s newest products weren't ready for sale, and sales of older ones were going to decline.
(b) Lucent's ONG products were not directed at “hot growth areas.” With regard to product speed, for example, Lucent was focused on slower data speed products, such as the OC-48, rather than the faster OC-192 (¶¶64-68). The difference in focus related to more than data speed, however; it related to all the features of the product.
(c) Lucent's relationships with existing customers were not being strengthened, but were weakening. For example, according to Witness 1 and Witness 2 and, Lucent lost two major
AT&T contracts, including an important power supply contract and
121 a 5ESS switching contract worth hundreds of millions of dollars
(¶¶95-99).
(d) As stated in the Tymann Answer, Lucent’s optical networking products did not work. In fact, the Company had adopted a policy of selling its products to customers as quickly as possible, despite design and reliability issues, and fixing those problems later (¶¶100-04).
(e) Lucent could not "provide customers with the systems, software, silicon and services . . . which were continuing to win Lucent new business.” Rather, the Company was facing declining demand across its divisions and was losing market share to competitors. For example, Lucent was experiencing problems with meeting forecasts and sales projections for wireless products, in part because the Company's new products were not living up to their expectations. (¶¶73-
87). In addition, Lucent's data networking division was experiencing production and demand problems, and the Company was missing shipment and release dates for Lucent's switching products (¶¶88-112). Further, sales of switching products, previously the backbone of Lucent's sales revenues, were impacted both by the overall decline in the switching business as a result of the advent of optical and wireless products, and by the fact that Lucent could not get its newest switching product, the
122 7 R/E, to operate properly, though Lucent's sales representatives were selling the product (¶109); and
(f) Certain of the "contracts wins" Lucent touted actually were losses. According to Witness 22, a former Account
Executive in Lucent’s Data Networking Systems Division from July
1998 to October 1999 who worked in the GTE Business Unit, by the fall of 1999, the Company had lost a $200 million internet working contract to Nortel (¶65); according to Witness 1 and
Witness 2, Lucent lost two major AT&T contracts, including an important power supply contract and a 5ESS switching contract worth hundreds of millions of dollars (¶¶96-99); and according to
Witness 2, the Company's wireless division had lost a significant contract with the government of Saudi Arabia, worth approximately
$6 billion.
(g) As described in the June 21, 2000 Internal Audit
Department report that examined the causes for returns during
Lucent’s first and second quarters of 2000 (¶36), in the February and March 2000 internal Lucent emails that warned of reversals of revenue recognized in the first quarter because customers had not approved the deals (¶¶115-19), and in interviews with former
Lucent employees (¶¶122-26), Lucent, in order to report revenue at levels the Company previously told the market to expect, recognized hundreds of millions of dollars of revenue in the first quarter on products that had not yet been sold.
123 219. During a Bloomberg Forum conference call with analysts on October 26, 1999 to discuss Lucent's results, McGinn stated to analysts: "We are experiencing exceptionally strong growth in data networking for service providers, in wireless networks,
[and] in optical networking ..." McGinn was asked "whether optical networking was growing - you know people are saying the market is growing at 40 to 50% a year, are you in that range?"
In response, McGinn stated: "I can tell you that you're right, that Optical is growing 40 to 50% and we're exactly the same range even though we are the leader." McGinn’s statements were materially false and misleading when they were made for the reasons set forth in ¶218 above and because:
(a) Lucent could not grow its optical business in the range of 40-50%. As reflected in the November 1, 1999 “Service
Provider Networks North America 2000 Operations Plan" (¶¶74-76),
Lucent was "Up Against a Revenue Wall" [NA 00352] and facing serious technical and developmental problems throughout its newest optical networking line of products, which problems were negatively impacting its market growth with these products.
[NA003514-631]. In this Plan, Lucent evaluated its optical business with respect to several key customers. In assessing one of those customers, SBC, Lucent predicted that Lucent would lose
$148 million in fiscal 2000 revenues because of research and development "slips" with regard to its Wavestar 400G DWDM,
124 Wavestar AllMetro DWDM and Wavestar Bandwith Manager products.
[NA003557]. The Plan also noted that Lucent had "lost market share" for its optical products with another major customer, BA
(Bell Atlantic), because of similar research and development problems with other Lucent Wavestar optical products. [NA003568,
NA003571]. The Plan notes further that all of Lucent's newest
WaveStar optical networking products "are slipping," placing
Lucent's BA "SONET Contract in Jeopardy" because Lucent failed consistently in developing its optical networking products for timely delivery to BA. [NA003573]. The November 1, 2000 Plan concludes, among other things, that "Business Processes in ONG
[Optical Networking Group] are in Serious Disrepair."
[NA003575].
(b) At this time, Lucent was not “the leader” in optical networking, but was a quickly eroding second to Nortel, which had developed the OC-192 product in 1997 (¶¶64-68); and
(c) Lucent's optical networking business was not growing 40 to 50%, but was in decline, as customers rejected
Lucent's older generation 2.5 gigabit products and Lucent was unable to market and successfully deploy its newer optical networking products, including an OC-192 product (¶¶64-68).
220. In response to these materially false and misleading statements, shares of Lucent rose from a market price of $59.00 per share immediately prior to the Company’s October 26
125 announcement to over $80.62 per share by November 18, 1999.
Thereafter, based significantly on the guidance provided by the
Company, the price of Lucent stock continued to rise, reaching a
high of over $84.00 per share on December 9, 1999.
221. On November 11, 1999, Lucent held its annual meeting
with market analysts covering the Company. According to a
November 12, 1999 Legg Mason Wood Walker Inc. report, the message at the meeting was “decisively bullish, as has become characteristic of the company.” Further, according to the report, “management reiterated its 2000 guidance of 17% to 19% top line growth and earnings growth in excess of that rate.”
Also according to the report, management stated that optical networking was an “area in which Lucent has the leadership position in a market and that have growth rates of at least 20%.”
Similarly, on November 16, 1999, Morgan Stanley Dean Witter issued an analyst report that stated that “optical’s not good, it’s great.”
222. Lucent's management's November 11, 1999 guidance to analysts, as reported by Legg Mason, specifically the statements regarding 17 to 19% top line growth, earnings growth in excess of that rate, and a market growth rate of 20% in optical networking were false. In fact, as reported in The Wall Street Journal on
October 24, 2000, McGinn had been informed by Lucent senior
executives that Lucent needed to drastically cut financial
126 projections because its newest products weren't ready yet and sales of older products were going to decline. They knew, as asserted in the Tymann Answer, for example, of the optical networking problems (¶¶100-04), including the fact that very little demand existed for the optical networking product Lucent was actually able to sell. And they knew, as reported in the
November 1, 1999 Operations Plan (¶74), Lucent was "Up Against a
Revenue Wall" [NA 003514-3631] and facing serious technical and developmental problems throughout its newest optical networking line of products, which problems were negatively impacting its market growth with these products. Also, Lucent senior management knew that Lucent's recorded revenues were materially overstated sales because the Company engaged in a widespread practice of recording revenue before sales were completed (¶¶114-
37).
223. On January 6, 2000, only weeks after the Company assured analysts and investors that the Company was poised to meet foreseeable earnings and revenue expectations, Lucent issued a press release, published on PR Newswire, in which it announced that results for the first fiscal quarter of 2000 would fall materially short of analysts' expectations. According to the press release, the Company announced that it only would report quarterly and yearly earnings of between $0.36 to $0.39 per share and $1.44 to $1.50 per share, respectively, compared with
127 analysts’ fiscal first quarter and full fiscal year 2000 estimates of approximately $0.54 per share and $1.53, respectively. The Company attributed these surprising results to several factors, including:
- - Faster than anticipated shifts in customers’ purchases to Lucent’s newest 80-channel DWDM optical product line and greater than expected demand for OC-192 capability on the 80-channel systems, which resulted in near-term manufacturing capacity and deployment constraints;
- - Changes in implementation plans by a number of customers inside and outside the United States, which led to delays in network deployments by enterprises and service providers;
- - Lower software revenues, reflecting an acceleration in the continuing trend by service providers to acquire software more evenly throughout the year. In the past, these purchases occurred primarily in the quarter ending December 31; and
- - Preliminary results show lower than anticipated gross margins this quarter from ramp-up costs associated with introducing and implementing new products and lower software revenues.
While the January 6, 2000 announcement disclosed Lucent's disappointing failure to meet prior projections, the statements explaining the reasons for the shortfall were false and misleading at the time they were made because:
(a) It was materially false and misleading to say that the shift in customer demand to OC-192 was "faster" or "greater" than anticipated because Lucent was seriously behind the
128 competition in this area, and that potential customers were refusing to buy 2.5 gigabit products and shifting their purchases to competitors who were selling OC-192 (¶¶64-68);
(b) Lucent's former customers were not shifting their purchases to Lucent’s new DWDM OC-192 product, but instead were buying products from Lucent's competitors, including Nortel, NEC,
Ciena and Cisco, because, among other reasons, the launch of
Lucent's OC-192 product continued to be delayed and the product was still being tested (¶¶64-68);
(c) Lucent was not experiencing "near-term manufacturing capacity and deployment constraints." To the contrary, the Tymann Answer states that “nothing could have been further from the truth.” According to them, “there was little demand [for Lucent products], because Lucent was attempting to sell older or lesser products to customers who were waiting for the next release or who, like AT&T and others, had given up on
Lucent and gone elsewhere for their telecommunications equipment needs.” Indeed, the Tymann Answer alleges that the decline in customer demand for Lucent's existing optical products was in part the result of customers' responses to poor product quality
(¶¶100-04), in part the result of a shift in demand to the newer
OC-192 product that Lucent was not yet even ready to manufacture, and in part due to Lucent’s continued inability to adequately design and deploy its earlier generation optical networking
129 products. The Tymann Answer also discloses that Lucent’s senior managers were advised in January 2000 that Lucent intended to change its manufacturing model and would either sell or close the
North Andover Facility – where Lucent manufactured optical networking equipment – which frequently laid dormant as employees played card games or read magazines;
(d) Lucent's lower revenues were in part the result of
Lucent's sales representatives having previously stuffed the channels with unwanted merchandise, as described in the March 8 and 9, 2000 “side deal” emails (¶¶128-29) and in interviews with former Lucent Employees (¶¶130-33), reducing Lucent's ability to perform currently at the levels wrongfully projected by management;
(e) Many of the sales of optical networking products that Lucent recorded should not have been recognized because they were the result of Lucent aggressively offering discounts and loans to potential customers of questionable creditworthiness who could not pay (¶¶138-46), including $113.9 million of improperly recognized revenue from end-of-quarter deals with Winstar (¶¶172-
86);
(f) Lucent failed to obtain expected revenues from the lost contracts and certain divisions described above, including
(1) the Saudi contract, which Lucent knew was lost before the
Class Period began (¶110); (2) weakening ties with AT&T and the
130 $1 billion AT&T contract lost to Nortel (¶96); and (3) mounting problems with wireless products such as the Wireless Broadband
(¶108).
224. On a January 7, 2000 conference call with analysts hosted by Bloomberg News reporter Eric Schatker, McGinn again sought to reassure the market about the underlying strength of demand for Lucent products by characterizing Lucent's Optical production problems as due to demand being "not fully anticipated by us." McGinn also stated that "it is an execution issue for us." Later in the call, he reiterated that the optical problems were due to Lucent not "hav[ing] the capacity to meet that need."
These statements were false and misleading at the time they were made for the reasons stated in ¶223.
225. On January 30, 2000, Lucent issued a press release announcing the Company’s first quarter financial results, including revenue of $9.9 billion and net income per share of
$0.38. These financial results were materially false and misleading for the following reasons:
(a) As described in the June 21, 2000 Internal Audit
Department report that examined the causes for returns during
Lucent’s first and second quarters of 2000 (¶136), and in the
February and March 2000 internal Lucent emails that warned of reversals of revenue recognized in the first quarter because customers had not approved the deals (¶¶115-19), Lucent
131 improperly recognized almost $300 million of revenue in the first quarter on products that had not yet been sold;
(b) Lucent improperly recognized millions of dollars of revenue even though the Company’s sales representatives made
“side deals” to permit customers and distributors to return the product in a later period if it was not sold, according to
March 8 and 9 emails (¶¶128-29), including the $60 million in deals made with Anixter on December 31, 1999, the last day of the first quarter (¶134); and
(c) Lucent improperly recognized many millions of dollars of revenue where collections were questionable as a result of aggressively offering discounts and loans to potential customers of questionable creditworthiness who could not pay
(¶¶138-46), including $113.9 million of improperly recognized revenue from end-of-quarter deals with Winstar (¶¶177-86).
226. On or about February 11, 2000, Lucent filed with the
SEC the Company’s quarterly report on Form 10-Q for the first quarter of 2000. In that 10-Q, Lucent reported, among other things, that its revenues were $9.9 billion and its net earnings per share were $0.38. In addition, in Note 1, entitled “Basis of
Presentation,” to the consolidated financial statements, the
Company stated that
The accompanying unaudited consolidated financial statements have been prepared . . . pursuant to the rules and regulations of the Securities and Exchange Commission and, in
132 the opinion of management, include all adjustments necessary for a fair presentation of the results of operations, financial position and cash flows for each period shown.
As described in paragraph 225 above, the financial results were materially false and misleading when made. As a result, the
“Basis of Presentation” representation also was materially false.
227. On February 17, 2000, The New Jersey Star Ledger reported that, at Lucent's annual shareholder meeting, McGinn again characterized the Company's optical problems as having been caused by Lucent’s failure to anticipate a rapid shift by its customers to the newest generation of fiber optic products.
According to the report, in a meeting with reporters after the meeting, McGinn stated that Lucent's first quarter problems were not indicative of a slowdown in demand, which he said, "remained robust and w[ould] enable Lucent to regain its momentum swiftly."
McGinn reiterated his previously voiced forecast that Lucent would post full year revenue gains of 17% and per-share earnings growth of 20-25%. These statements that Lucent's first quarter problems were not indicative of a slow down in demand were false and misleading because, as set forth in ¶¶64-65, Lucent had in fact experienced a slow down in demand in the Company’s optical networking products due to product failure.
228. McGinn also had, at the time he made them, actual knowledge of the falsity of his statements forecasting fall
133 revenue gains of 17% and per share earnings of 20-25%, because
McGinn knew that Lucent was experiencing severe problems throughout its optical networking, wireless, switching and software product lines, as set forth in ¶¶74, 64-68, 96, 100-04,
108, 110, 128-29, 130-33, which made it impossible for Lucent to achieve McGinn’s forecasted earnings.
229. On April 19, 2000, Lucent issued a press release, carried over PR Newswire, announcing financial results for its second fiscal quarter of 2000, including revenues of
$10.3 billion and net income per share of $0.23. In addition,
McGinn stated that “Lucent is regaining its momentum this quarter with strong growth in wireless, Internet infrastructure – including optical and data networking systems and optical fiber – professional services and optoelectronics.” McGinn also noted that revenues for both wireless and service provider Internet infrastructure increased by more than 50 percent. These financial results and other statements were materially false when made for the following reasons:
(a) As described in the June 21, 2000 Internal Audit
Department report that examined the causes for returns during
Lucent’s first and second quarters of 2000 (¶136), Lucent improperly recognized hundreds of millions of dollars of revenue in the second quarter on products that had not yet been sold;
134 (b) Lucent improperly recognized many millions of dollars of revenue even though the Company’s sales representatives made “side deals” to permit customers and distributors to return the product in a later period if it was not sold by then, according to March 8 and 9 emails (¶¶128-29), including the $72 million deal made with Anixter (¶¶121);
(c) Lucent improperly recognized millions of dollars of revenue where collections were questionable as a result both of aggressively offering discounts and loans to potential customers of questionable creditworthiness who could not pay
(¶¶138-46), including $115 million of improperly recognized revenue from end-of-quarter deals with Winstar (¶172), and of offering unusually long extended payment terms (¶176); and
(d) Lucent improperly recognized millions of dollars of revenue on software pools, like the $10 million deal made with
BellSouth (¶196), under which Lucent currently recognized revenue for the full amount of the pool even though customers made only a token payment at that time and do not select the actual software purchased from the pool or pay the balance until later periods.
230. On or about May 10, 2000, Lucent filed with the SEC the
Company’s quarterly report on Form 10-Q for the second quarter of
2000. In that 10-Q, Lucent reported, among other things, that its revenues were $10.3 billion and its net earnings per share were $0.23. In addition, in Note 1, entitled “Basis of
135 Presentation,” to the consolidated financial statements, the
Company stated that
The accompanying unaudited consolidated financial statements have been prepared . . . pursuant to the rules and regulations of the Securities and Exchange Commission and, in the opinion of management, include all adjustments necessary for a fair presentation of the results of operations, financial position and cash flows for each period shown.
As described in paragraph 229 above, the financial results were materially false and misleading when made. As a result, the
“Basis of Presentation” representation also was materially false.
231. On May 15, 2000, an article carried on the Multichannel
News Service of Cahners Publishing Company reported that Lucent announced it would sell $6 billion of optical networking gear in
2000, up from $4 billion in 1999. Further, the report stated that optical division head Kathy Szelag stated that the demand for Lucent’s optical products was “unprecedented.” She further stated that snags that hit the unit in its first fiscal quarter – component shortages and a lack of deployment personnel – had been ironed out. These statements were materially false and misleading at the time of their publication because, as Lucent recognized internally at this time, the demand for its optical networking products was declining due to the systemic problems it was having in developing and deploying a working optical networking system capable of running at OC-192 speed (¶¶64-68).
136 232. On July 20, 2000, Lucent issued a press release carried on the PR Newswire, announcing its third fiscal quarter results.
The release's headline touted that "Revenues from Lucent's pro forma continuing operations [were] up 20% and pro forma earnings per share rose 30%." Lucent also stated that its OC-192 optical systems had seen “strong customer acceptance.” However, the
Company stated that its reported results for the quarter were a net loss of $301 million, or $.09 a share, but attributed the loss to charges as a result of recent acquisitions. These financial results and other statements were materially false when made for the following reasons:
(a) Lucent improperly recognized hundreds of millions of dollars of revenue even though the Company’s sales representatives made “side deals” to permit customers and distributors, including Anixter and Graybar, to return the product in a later period if it was not sold (¶¶127-37);
(b) Lucent improperly recognized millions of dollars of revenue where collections were questionable as a result both of aggressively offering discounts and loans to potential customers of questionable creditworthiness who could not pay
(¶¶138-46), including $130 million of improperly recognized revenue from end-of-quarter deals with Winstar (¶¶172-86), and of offering unusually long extended payment terms (¶176); and
137 (c) Lucent improperly recognized millions of dollars of revenue on software pools, like the $10 million deal made with
BellSouth (¶196).
(d) Lucent’s OC-192 optical systems were not seeing
“strong customer acceptance”: (i) as disclosed in Jay Carter’s
July 5, 2000 email to Aversano and others (¶99), AT&T had selected NEC over Lucent to supply optical networking systems for its next generation network; (ii) as disclosed in the July 18,
2000 Daily Status Report (¶155), Lucent had shipped only 625 10G modules, which was only approximately 20% of the July 2000 target of 3000 modules, and that, according to the Daily Status Report,
Lucent was “lacking sufficient hard orders – WE NEED ORDERS!!”;
(iii) confirmation, as described in the July 24, 2000 email to
Russo, of the undisclosed widespread problems that Lucent was experiencing with its products; (iv) as described in Russo’s
July 25, 2000 email to, among others, Aversano and Butcher
(¶160), the critically important ONG business was in a “crisis” situation; (v) the “major problem” Lucent had with Bell Atlantic, one of its largest customers (¶161), as described in John
Pellegrini’s July 26, 2000 email to Spurrier (with copies to
Russo and Aversano); (vi) the serious problems with BellSouth, which had expressed “serious concerns regarding Lucent’s overall quality and product performance” (¶162), as described in an
August 4, 2000 email circulated to Russo, Aversano and Spurrier,
138 among others; (vii) the circumstances that caused Aversano to send her August 30, 2000 email to, among others, James Cocito,
Chief Operating Officer of the North America Region, Spurrier and
Holcomb (¶168), that included Aversano’s view that “we would all agree that our sales funnel is inadequate to support our revenue growth objectives”; and (viii) the fact, as alleged by the Tymann
Defendants, that the North Andover facility was largely idle.
233. The July 20, 2000 release also announced guidance for the fourth fiscal quarter of 2000: “McGinn said Lucent expects that pro forma revenues from continuing operations will grow about 15% for the fourth fiscal quarter of 2000, which ends Sept.
30, 2000, and pro forma earnings per share from continuing operations will be roughly in line with revenue growth.” That guidance was false. To the extent McGinn’s statements were
“forward-looking” statements, they were not accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. The July 20 press release only contained the following, boiler-plate disclaimer at its end:
This news release contains forward-looking statements based on current expectations, forecasts and assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially. These risks and uncertainties include price and product competition, dependence on new product development, reliance on major customers, customer demand for our products and services, the ability to successfully
139 integrate acquired companies, the timely completion of the spin-off of the enterprise networks business and final costs of the spin-off, control of costs and expenses, international growth, general industry and market conditions and growth rates and general domestic and international economic conditions including interest rate and currency exchange rate fluctuations. For a further list and description of such risks and uncertainties, see the reports filed by Lucent with the Securities and Exchange Commission. Lucent disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
This disclaimer merely lists generalized risks applicable to any business venture. It does not discuss risks specific to Lucent’s particular business, and, more importantly, it does not discuss risks specifically tailored to McGinn’s fourth quarter revenue and earnings predictions. Lucent’s disclaimer does not warn of risks of similar significance to the risk actually realized, and it does not reference any particular publicly-filed document that does disclose such risks.
234. Further, the statements concerning Lucent’s fourth quarter revenues and earnings contained in the Company’s July 20,
2000 press release were made by and with the approval of McGinn,
Lucent’s Chief Executive Officer, with actual knowledge that they were false. McGinn knew that Lucent’s business during the fourth quarter was continuing to deteriorate, and that the fourth quarter revenue guidance was unattainable. In addition to the
140 knowledge he possessed as described in paragraphs 232-33 above concerning Lucent’s optical networking problems and the Company’s fraudulent recognition of revenue, McGinn also possessed the following knowledge at the time he issued the July 20 guidance:
(i) as alleged in Aversano’s complaint, Aversano and Russo specifically told McGinn that the revenue and earnings projections for the fourth quarter that he intended to include in
Lucent’s press release announcing the third quarter results were unattainable and needed to be reduced (¶156); (ii) as disclosed in Jay Carter’s July 5, 2000 email to Aversano and others (¶99),
AT&T had selected NEC over Lucent to supply optical networking systems for its next generation network; (iii) as disclosed in
Carter’s July 7, 2000 email to Aversano and others (¶¶99), the
North American Region would not make its plan for the fourth quarter by hundreds of millions of dollars; (iv) as disclosed in the July 18, 2000 Daily Status Report (¶¶155), Lucent had shipped only 625 10G modules, which was only approximately 20% of the
July 2000 target of 3000 modules, and that, according to the
Daily Status Report, Lucent was “lacking sufficient hard orders –
WE NEED ORDERS!!”; (v) as disclosed on the July 21, 2000 “gap” closure call (¶155), fourth quarter-to-date billing for the North
American region was only $441 million, or 7.7% of the
$6.6 billion target; (vi) confirmation, as described in the
July 24, 2000 email to Russo (¶93), of the undisclosed widespread
141 problems that Lucent was experiencing with its products; (vii) as described in Russo’s July 25, 2000 email to, among others,
Aversano and Butcher (¶158), the critically important ONG business was in a “crisis” situation; (viii) the “major problem”
Lucent had with Bell Atlantic, one of its largest customers
(¶161), as described in John Pellegrini’s July 26, 2000 email to
Spurrier (with copies to Russo and Aversano); (ix) the serious problems with BellSouth, which had expressed “serious concerns regarding Lucent’s overall quality and product performance”
(¶162), as described in an August 4, 2000 email circulated to
Russo, Aversano and Spurrier, among others; (x) as described on the August 14, 2000 weekly North America “gap” closure call
(¶163), senior executives discussed the fact that fourth quarter revenue to date for the North American Region was only
$1.1 billion, or roughly 17% of target; (xi) the circumstances that caused Aversano to send her August 30, 2000 email to, among others, James Cocito, Chief Operating Officer of the North
America Region, Spurrier and Holcomb (¶168), that included
Aversano’s view that “we would all agree that our sales funnel is inadequate to support our revenue growth objectives”; and
(xii) the fact, as alleged by the Tymann Defendants, that the
North Andover facility was largely idle.
235. In addition, Lucent’s statement in its July 20, 2000
Press Release that the Company’s OC-192 optical systems had seen
142 “strong customer acceptance” was false and misleading at the time it was made because customers were rejecting Lucent's OC-192 products in part because they had already given their orders to
Lucent's competitors that were far ahead of Lucent in ability to ship those systems, and in part because they failed to perform as promised. Indeed, AT&T had already told Lucent that it would go elsewhere for optical networking products (¶98). Lucent knew by
July 5, 2000 that AT&T had rejected all of Lucent’s next generation optical DWDM systems, and by July 7, 2000 that AT&T would “not deploy any 400G in their core network other than the
80M [Lucent] sold last quarter”; therefore, Lucent knew that it was “clearly out of the market for DWDM with AT&T until 2002 at best” (¶99). [NA000987].
236. On a July 20, 2000 conference call with analysts,
Defendant McGinn reiterated his guidance to the market:
We expect to have top line growth with the current quarter ending September 30th at 15% with bottom line growth roughly in line with that.
Further, during the call, McGinn stated:
Deb Hopkins and I personally did a comprehensive operations review of each of our businesses and we are confident in the [numbers] we are giving you today. When we did this review we found [it] [sic] fundamentals to the business are solid. The market is strong and there is tremendous customer acceptance of our products and our services. In fact, we have a [sic] demand of exceeded capacity of broad band access
143 products in 10G optical systems, fiber optics and other electronic devices.
* * *
As we said we would we shipped to 250 million dollars plus [of the 10G optical product] during the 3rd fiscal quarter just ended. And, as we have advised we expect to triple that ramp up to 750 million dollars in Q4. We are confirming that - that ramp continues but by definition, we have had to sell this to our customers at market prices before full volume production has been achieved. . .despite tripling the manufacturing capacity and optical component shortages and lengthy customer certification process [sic] has spread the ramp up to full volume over the next two quarters but customer acceptance is very, very, good.
237. On the July 20, 2000 conference call, Deborah Hopkins made the following statement:
Today we reported that pro forma net income from continuing operations for the 3rd fiscal quarter rose 3.4 % to 30 cents a share. . . We had strong revenue growth in key areas. Leading the way our data networking for service providers grew nearly 60% quarter over quarter with particularly strong sales of our access products. Our optical business, including the optical fiber business that will stay [with Lucent] grew 27%. . . The good news is that increasingly our revenues are coming from newer products and high growth markets such as broad band.
Hopkins also specifically addressed Lucent's customer financing:
Since coming on board, I have been studying Lucent's customer financing program in detail. As with any program or process service there are some areas that could be improved.. .I must tell you that I am finding and it has been verified by independent sources that Lucent's programs do not vary
144 significantly from our competitors [check this word] from the types of risks we take and the way we structure our transactions.
238. The guidance issued by McGinn and Hopkins during the
July 20, 2000 conference call was false and misleading at the time it was made for the reasons set forth in (¶¶232-33).
239. McGinn's statements on the July 20, 2000 conference call that the "fundamentals to [Lucent's] business are solid.
The market is strong and there is tremendous customer acceptance of our products and our services. In fact, we have a [sic] demand of exceeded capacity of broad band access products in 10G optical systems, fiber optics and other electronic devices" was false and misleading when made for the reasons set forth in
¶¶232-33.
240. McGinn's statements on the July 20, 2000 conference call that Lucent shipped "250 million dollars plus [of the 10G optical product] during the 3rd fiscal quarter . .[and] we expect to triple that ramp up to 750 million dollars in Q4. We are confirming that - that ramp continues but by definition, we have had to sell this to our customers at market prices before full volume production has been achieved . . . despite tripling the manufacturing capacity and optical component shortages and lengthy customer certification process [sic] has spread the ramp up to full volume over the next two quarters but customer
145 acceptance is very, very, good." was false for the reasons set forth in ¶¶232-33 above.
241. Hopkins statement during the July 20, 2000 conference call that it had been verified by independent sources that Lucent credit programs did not vary significantly from those of its competitors was false and misleading for as set forth in (¶¶232-
33) and because Hopkins knew that an independent source had determined that Lucent's credit policies were "unacceptable"
(¶¶232-33).
242. According to a July 21, 2000 article in The New Jersey
Star Ledger regarding the July 20, 2000 announcement, Hopkins vowed that the surprises were over: "My credibility is the most precious asset I own ... It's not going to happen a third time."
243. On or about August 4, 2000, Lucent filed with the SEC the Company’s quarterly report on Form 10-Q for the third quarter of 2000. In that 10-Q, Lucent reported, among other things, that its revenues were $8.7 billion and its net earnings per share were $0.09. In addition, in Note 1, entitled “Basis of
Presentation,” to the consolidated financial statements, the
Company stated that
The accompanying unaudited consolidated financial statements have been prepared . . . pursuant to the rules and regulations of the Securities and Exchange Commission and, in the opinion of management, include all adjustments necessary for a fair presentation of the results of operations, financial
146 position and cash flows for each period shown.
As described in paragraph 232-33 above, the financial results were materially false and misleading when made. As a result, the
“Basis of Presentation” representation also was materially false.
244. On October 10, 2000, Lucent issued a press release entitled “Lucent Technologies Comments On Expectations For Fourth
Fiscal Quarter 2000 Earnings.” In that press release, Lucent informed the market that it expected fourth quarter earnings to be lower than the previously reduced financial results announced on July 20 because of:
-- Less than expected revenues and gross margins in the company's optical systems business;
-- Credit concerns in the emerging service provider market that led to increasing reserves for bad debt;
-- Greater than anticipated decline in circuit switching sales and margins.
On a conference call following the release of the results, McGinn reiterated that
[the] earnings shortfall resulted from 3 primary factors, all roughly equivalent. First, we saw less than expected revenues in gross margins in our optical business. Then again we saw credit concerns about the ability of emerging service providers to meet their financial obligations. While the market looks good for the long term, the risk in the current environment led us to increase reserves for bad debt. Third, we saw a greater than anticipated decline in circuit
147 switching sale and margins. As a result our gross margins will be about 39% to 40% for this quarter....
Notwithstanding this disclosure, Lucent still had not disclosed that its previously reported financial results for the first three quarters, as well as those the Company anticipated for its fourth quarter, were materially overstated as a result of such accounting devices as granting unusually long extended payment terms and entering into aggressive financing arrangements with customers that were poor credit risks (¶¶138-46); using software pools (¶¶1887-96); stuffing product into the distribution channels (¶¶127-37, 197-215); and making side deals through which customers and distributors were given the right to return product, in order to persuade customers to take Lucent’s products
(¶¶127-37, 197-215).
245. After digesting almost a year of false statements from the Defendants, by October 11, 2000, the market had grown weary of Lucent's explanations for disappointing results in its optical networking business. J.P. Morgan's October 11, 2000 analyst report pointedly noted, "we are especially surprised by the deteriorating fundamentals in the optical systems business for the quarter. If we assume that fiber is growing 25%, then optical systems revenues experienced a decline of 15% in the quarter, a performance that stands in stark contrast to management's previous guidance” (emphasis added). More
148 specifically, in a Lehman Brothers analyst report issued after the McGinn’s October 10 call, analyst Steve Levy pointed out that
McGinn had changed his story yet again about why optical was lagging:
Over the last few quarters, Lucent management has suggested that many factors such as production constraints, lack of qualified installation employees, and aggressive pricing by competitors limited optical system sales and profitability. The Company's management is now saying that the gating factor is customer acceptance.
(Emphasis added). And in an October 12, 2000 article in
Investors Business Daily, Lehman Brothers' analyst Steve Levy was quoted as stating that "Lucent had above average exposure to data carriers who [are having solvency problems]. This is what happens when you're stretching credit to take up the slack in sales" (emphasis added).
246. Lucent’s own executives concede that the Company’s problems with OC-192 are a principal cause of Lucent’s declining earnings. In an interview with The New York Times, published on
October 16, 2000, William O’Shea, a Lucent Executive Vice
President, characterized the cause of Lucent’s problems this way:
“It all boils down to kind of one fundamental thing, . . . [a]nd that is, we made a decision around OC-192 and 10 gigabit optical systems that, frankly, we’re still living with . . . If we had made a different decision and had shown an optical business this
149 year and this quarter the size of Nortel’s, we wouldn’t even notice the other things we’ve talked about.”
247. Lucent’s October 10, 2000 press release was followed quickly by the Company’s filing of a Form 8-K on October 23,
2000. As disclosed in that Form 8-K, pro forma revenues for the fourth fiscal quarter ended September 30, 2000 increased 14.6% to
$9.4 billion, while earnings per share from continuing operations for the quarter were $0.18 per share or $600 million. Further, the Form 8-K reported that Lucent Executive Deborah Hopkins had issued guidance that pro forma earnings per share from continuing operations would break even for the first fiscal quarter of 2001.
According to the report, the Company also said it expected results from operations to improve each quarter for the rest of the fiscal year. The financial results included in the Form 8-K were materially false and misleading at the time it was issued because of Lucent's longstanding practice of, among other things, recognizing revenue on sales that were not final (¶¶127-37, 197-
215) in an effort to meet overly unrealistic corporate earnings projections, which artificially inflated sales as alleged above, and resulted in quarterly revenue being overstated by at least
$679 million, and earnings per share overstated by $0.08.
248. On November 21, 2000, Lucent conceded the October 23, forecast was inaccurate by filing with the SEC a Form 8-K that announced that the Company had identified a "revenue issue"
150 involving approximately $125 million of revenue in its fourth fiscal quarter ended September 2000. At that time, Lucent also disclosed it could no longer confirm its guidance for the first quarter of fiscal 2001, ended December 31, 2000.
249. The falseness of the results reported in the
October 23, 2000 Form 8-K was further confirmed by Lucent's
December 21, 2000 announcement that it was restating – for the second time – its results for the fourth quarter of 2000, reducing reported earnings for the quarter by $679 million.
Further, on December 21, 2000, Lucent specifically acknowledged the fact that the Company's results had been inflated because
Lucent had recognized revenue on sales that were not yet final.
F. Applicability Of Presumption Of Reliance: Fraud-On-The-Market Doctrine
250. At all relevant times, the market for Lucent’s stock was an efficient market for the following reasons, among others:
(a) Lucent’s stock met the requirements for listing, and was listed and actively traded on the New York Stock
Exchange, a highly efficient and automated market;
(b) As a regulated issuer, Lucent filed periodic public reports with the SEC and the NYSE;
(c) Lucent regularly communicated with public investors via established market communication mechanisms, including through regular disseminations of press releases on the national circuits of major newswire services and through other
151 wide-ranging public disclosures, such as communications with the financial press and other similar reporting services; and
(d) Lucent was followed by numerous securities analysts employed by major brokerage firms who wrote reports which were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace.
251. As a result of the foregoing, the market for Lucent’s stock promptly digested current information regarding Lucent from all publicly available sources and reflected such information in
Lucent’s stock price. Under these circumstances, all purchasers of Lucent’s common stock during the Class Period suffered similar injury through their purchase of Lucent’s common stock at artificially inflated prices and a presumption of reliance therefore applies.
CLAIMS FOR RELIEF
COUNT I
Against All Defendants for Violations of Section 10(b) of the Exchange Act and Rule 10b-5 Promulgated Thereunder
252. Lead Plaintiffs repeat and reallege each of the allegations set forth above as if fully set forth herein. This
Claim is asserted against defendants Lucent, McGinn, Peterson and
Hopkins for violations of Section 10(b) of the Exchange Act, 15
U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, on behalf of all Class members.
152 253. During the Class Period, Lucent and the Individual
Defendants, individually and in concert, directly and indirectly, by the use and means of instrumentalities of interstate commerce and the U.S. mails, engaged and participated in a scheme to defraud investors and the public markets. This scheme included conduct that inflated Lucent’s financial results and concealed
Lucent’s true financial condition and operating results. As specified in ¶¶218-251 above, the Company and the Individual
Defendants made false statements of material fact that caused the prices of Lucent common stock to be artificially inflated.
254. Defendants Lucent and McGinn are liable for the following specific statements:
a. The false and misleading statements in Forms 10-Q for the quarters ended December 31, 1999, March 31, 2000, and
June 30, 2000, as set forth in ¶¶226, 230, 243, above;
b. The false and misleading statements in the October
26, 1999 Press Release, as set forth in ¶218 above;
c. The false and misleading statements made by McGinn on the October 26, 1999 conference call on Bloomberg Forum, as set forth in ¶219 above;
d. The false and misleading statements made on
November 11, 1999 by Lucent’s management giving guidance to Wall
Street analysts, as set forth in ¶222 above;
153 e. The false and misleading statements in the January
6, 2000 Press Release, as set forth in ¶223 above;
f. The false and misleading statements made by McGinn on the January 7, 2000 conference call on Bloomberg Forum, as set forth in ¶224 above;
g. The false and misleading statements in the January
30, 2000 Press Release, as set forth above in ¶225 above;
h. The false and misleading statements made by McGinn on February 17, 2000 to The New Jersey Star Ledger, as set forth in ¶227 above;
i. The false and misleading statements in the April
19, 2000 Press Release, as set forth in ¶229 above;
j. The false and misleading statements made on May
15, 2000 in an article carried on the Multichannel News Service of Cahners Publishing Company, as set forth in ¶231 above;
k. The false and misleading statements in the July
20, 2000 Press Release, as set forth in ¶¶232-35 above;
l. The false and misleading statements in the July
20, 2000 conference call, as set forth in ¶¶236-41 above;
m. The false and misleading statements in the October
10, 2000 Press Release, as set forth in ¶244 above; and
n. The false and misleading statements in the October
23, 2000 Press Release, as set forth in ¶247 above.
154 255. Defendant Peterson is liable for the following specific statements:
a. The false and misleading statements in Form 10-Q for the quarter ended December 31, 1999, as set forth in ¶226, above;
b. The false and misleading statements in the October
26, 1999 Press Release, as set forth in ¶218 above;
c. The false and misleading statements in the January
6, 2000 Press Release, as set forth in ¶223 above;
d. The false and misleading statements in the January
30, 2000 Press Release, as set forth above in ¶225 above;
256. Defendant Hopkins is liable for the following specific statements:
a. The false and misleading statements in Form 10-Q for the quarter ended June 30, 2000, as set forth in ¶230, above;
b. The false and misleading statements in the July
20, 2000 Press Release, as set forth in ¶¶232-35 above;
c. The false and misleading statements in the July
20, 2000 conference call, as set forth in ¶236-41 above;
d. The false and misleading statements in the October
10, 2000 Press Release, as set forth in ¶244 above; and
e. The false and misleading statements in the October
23, 2000 Press Release, as set forth in ¶247 above.
155 257. Each Defendant acted with scienter with respect to each of the false statements for which he or she is charged with liability. The following facts give rise to a strong inference, if not demonstrate, that each defendant acted with scienter, the state of mind required for liability under §10(b) and Rule 10b-5:
a. With respect to the October 26, 1999 Press
Release:
(1) According to an article published in The Wall
Street Journal on October 24, 2000, as early as October of 1999, senior Lucent Executives had told McGinn that Lucent needed to drastically cut its financial projections because the Company’s newest products were not ready for sale, and sales of older ones were going to decline (¶6);
(2) Lucent was “up against a revenue wall” as a result of share losses and product failures in the optical networking market, as set forth above in the presentation entitled “Service Provider Networks North America 2000 Operations
Plan” (¶74). The presentation stated that:
• “Business processes at ONG are in serious disrepair,” • “Even mortgaging the future does not help unrealistic sales expectations;” and • “Customers are running out of patience with Lucent.”
This presentation was conducted by Aversano and Russo who reported directly to McGinn. McGinn received a copy of the 2000
Operations Plan. The presentation further described how Lucent
156 was unable to deliver numerous optical networking products resulting in a substantial loss of optical networking market share with key customers, such as Bell Atlantic and Southwestern
Bell (¶75);
(3) According to individuals formerly employed at
Lucent, by the fall of 1999, the Company had lost a $200 million internet working contract to Nortel; lost two major AT&T contracts, including an important power supply contract and a
5ESS switching contract worth hundreds of millions of dollars; and the Company’s wireless division had lost a significant contract with the government of Saudi Arabia, worth approximately
$6 billion according to a former employee (¶¶65, 96-97, 110-11).
AT&T was Lucent’s largest and most important customer and McGinn and Petersen were informed of the loss of the AT&T contracts at the time they occurred.
(4) According to Witness 4 during the Class
Period, defendants McGinn and Russo received regular presentations with regard to the problems facing the Optical
Networking Group, created by an internal ONG organization called the Portfolio Review Board (the "PRB") – an internal ONG group whose job is to evaluate the competitiveness of ONG's product portfolio. These presentations described the Optical Networking
Group's weak competitive position, including sales and growth forecasts (relative to Nortel and other competitors). During
157 the Class Period, the PRB compiled reports which described the fact that Lucent was losing market share because customers were rejecting Lucent's products for the faster, newer products of the
Company's competitors and that Lucent was experiencing systemic technical problems in bringing its products to market such that the Company missed planned release dates, and was unable to deploy product as promised. The PRB compiled the growth rates expected in different product lines and made recommendations about where ONG should focus investment. The PRB "viewgraph" presentations were very explicit and included quantitative reviews about ONG's competitive position, about the investments that had been made, and about corrective actions necessary to retain a competitive position. These PRB viewgraph presentations were created for the express purpose of their use by Harry Bosco in presentations to Russo and McGinn. Furthermore the PRB viewgraph presentations were regularly delivered to Bosco for this purpose.
(5) Also, the most senior levels of Lucent management were aware that Lucent was attempting to inflate their sales by a practice which involved shipping products to customers which had serious design or reliability problems and were not yet out of the testing phase. That policy was discussed at a meeting between Lucent senior management and the Company's directors in
Nuremberg, Germany in September 1999.
158 (6) According to Witness 2, by September 1999,
Defendants were well aware that the Company was seriously behind in the development of newer generation optical networking products, and this fact was discussed by optical networking personnel with members of Lucent senior management. Defendants knew that customers were going elsewhere for optical networking products, and recognized the lack of any meaningful demand for the optical networking systems that Lucent was actually able to sell, in the fall of 1999.
b. With respect to McGinn’s statements at Bloomberg
Forum on October 26, 1999, stating that Lucent “was experiencing exceptionally strong growth . . . in optical networking,” and with respect to the “decisively bullish” guidance McGinn provided on November 11, 1999 to analysts, McGinn had the knowledge specified in the immediately preceding 6 sub-paragraphs.
c. With respect to Lucent’s January 6, 2000 and
January 30, 2000 Press Releases:
(1) Lucent was not experiencing manufacturing constraints in optical products, but rather did not have sufficient customer orders. The Tymann Defendants specifically averred in their Answer that McGinn’s January 6 statement was false, and that “nothing could be further from the truth.”
According to the Tymann Defendants “ there was little demand [for
Lucent products], because Lucent was attempting to sell older or
159 lesser products to customers who were waiting for the next release or who, like AT&T and other, had given up on Lucent and gone elsewhere for their telecommunications equipment needs;”
(2) Lucent was “up against a revenue wall” resulting from optical networking market share losses and product failures, as made clear in the November 1, 1999 “Service Provider
Networks North America 2000 Operation Plan” (¶74);
(3) Lucent had fraudulently recognized $300 million in revenue on “sales” that were not approved by customers before the end of the first fiscal quarter of 2000, as set forth above in ¶115. Specifically, On February 15, 2000, Leslie Rogers sent an email to Aversano, Cocito and Orlando, which provided that, during the first fiscal quarter of 2000 [ended December 31,
1999], Lucent had improperly accounted for 37 deals and had fraudulently booked nearly $300 million in revenue; and
(4) Lucent had fraudulently “stuffed the channels.” A March 8, 2000 internal Lucent email that was received by Lucent's President of North American Sales, Nina
Aversano (¶128), among others, states that:
ClearData.Net was “stuffed” with over $5 million of equipment they didn’t want nor expect to keep at the end of last quarter. This equipment is on lease with Varilease, and was irrevocably accepted by ClearData last December and revenue was recognized ... the sales person sent a letter on Lucent letterhead to the customer saying we would agree to exchange the equipment with other equipment whenever requested by ClearData ... they can simply cancel out the old equipment on the December lease and write a new lease
160 with a new deferral period staring from the date the new equipment is shipped.” [NA000771, NA000764 (emphasis added)].
On the same date another internal Lucent email referred to
“stuffed” Varilease equipment, noting “when will this ever end.
This is the reason why I cannot make any forward progress on cleaning up Varilease. I am disgusted with this whole business.”
[NA000764]. On the following day, another Lucent internal email dated March 9, 2000 openly discussed channel stuffing and noted that the issue was raised at the highest level of Lucent management (¶129). [NA00770]. The email further noted that the issues discussed had been escalated all the way up to President
Pat Russo. An earlier Lucent internal e-mail dated March 8, 2000 regarding channel stuffing further demonstrates the pervasiveness of channel stuffing at Lucent, stating: “My problem is in thinking through how to get someone in the space of doing the right things for the business rather than creating a continual push to ship without any concern for revenue getting paid, getting documents, etc., etc.” [NA000746] Another internal
Lucent e-mail in March 10, 2000 sent to Nina Aversano acknowledged that product was shipped in June of 1999 under
“heavy sales pressure” which was now in March of 2000 generating a customer’s return of $10 million in Lucent products that were still in unopened boxes” and that would “come back fully obsolete.” These emails also discussed a Lucent practice in 1999
161 wherein sales personnel suggested that “in order to obtain a loan of that size, the customer should consider taking more equipment than was actually needed at the time.” [NA000707-14].
(5) Lucent booked revenue and shipped products even where customers had not ordered the product and before Lucent had received purchase orders or other necessary documents evidencing a real sale, as documented by an internal audit dated June 21,
2000, in the first two fiscal quarters of 2000 (¶136). This internal audit report was distributed to several senior Lucent employees, including defendants McGinn and Hopkins, and unequivocally stated that “[m]anagement is aware of these issues.”
d. With respect to the financial results included in
Lucent’s Form 10-Q for the quarter ended December 31, 1999:
(1) Lucent had fraudulently recognized $300 million in revenue on “sales” that were not approved by customers before the end of the first fiscal quarter of 2000, as set forth above in ¶115. Specifically, On February 15, 2000, Leslie Rogers sent an email to Aversano, Cocito and Orlando, which provided that, during the first fiscal quarter of 2000 [ended December 31,
1999], Lucent had improperly accounted for 37 deals and had fraudulently booked nearly $300 million in revenue (¶115).
(2) Accounts receivables were overstated in an international division in the fall of 1999, as determined by an
162 internal audit conducted at that time that was rejected by senior management. While the audit team had determined that the proper course would be to take an immediate write-off, the division’s management team reversed the audit team’s recommendation stating that the division “could not afford to do so at th[e] time”
(¶135).
(3) Lucent had fraudulently “stuffed the channels,” as set forth above in ¶¶127-37.
(4) Lucent booked revenue and shipped products even where customers had not ordered the product and before
Lucent had received purchase orders or other necessary documents evidencing a real sale, as documented by an internal audit dated
June 21, 2000, in the first two fiscal quarters of 2000 (¶136).
This internal audit report was distributed to several senior
Lucent employees, including defendants McGinn and Hopkins, and unequivocally stated that “[m]anagement is aware of these issues.”
e. With respect to McGinn’s statements on February
17, 2000 made to The New Jersey Star Ledger that Lucent’s problems were not indicative of a slowdown in demand, as set forth above in ¶64-112:
(1) On February 9, 2000 the North American Region conducted a formal operations Review that documented Lucent’s
“crisis” in its Optical Network Group’s product, including its
163 deficiencies and the impact on the Company. The operations review made clear that Lucent’s ONG product deficiencies were having a material impact on the Company, and that the North
American Region “must improve perception of Lucent products, features and functionality or risk losing market share” (¶78).
(2) The Tymann Defendants explicitly aver in their answer that as early as January 6, 2000 the problems with the optical networks products were the result of poor product quality, resulting in loss of customers and sales by Lucent
(¶100-04).
(3) Lucent’s optical networking products were so bad that, by January 2000, Qwest had ripped out Lucent product it had purchased in July 1999 because some of the components failed to work at all, while others were shipped much too late (¶89).
f. With respect to Lucent’s April 19, 2000 Press
Release, and the financial results included in its Form 10-Q for the quarter ended March 31, 2000, Lucent had resorted to extreme measures, including (i) granting extended payment terms (¶¶127-
37) and entering into aggressive financing arrangements with customers that were poor credit risks (¶¶138-46), both of which cast significant doubt on collectability; (ii) using software pools (¶¶187-96), under which customers did not pay or select the actual software purchased until later periods; (iii) forcing product into the distribution channels (¶¶127-37), which reduce
164 the Company’s revenues in future periods; and (iv) making “side deals” (¶¶127-37), through which customers and distributors were given the right to return product, in order to persuade customers to take Lucent’s products. Moreover, according to Witness 4, throughout the Class Period, Lucent senior management, including
McGinn, had contemporaneous knowledge of the serious but undisclosed problems with Lucent's product portfolio, including, inter alia, the Company's Optical Networking Group's weakening competitive position in the optical networking system market.
According to this witness, the Competitive Analysis Group ("CAG") tracked and communicated to senior Lucent management the inability of ONG to manufacture and deliver products that provided the same functions as those of their competitors and
ONG's corresponding inability to sell product. The sole function of the CAG was to explicitly review the announcements of competitors and evaluate them, that is, to identify the features that competitors’ products had that ONG's lacked. The CAG went into great detail, examining every feature of comparable products on a head to head basis. The regular reports of the CAG were created for the benefit of, and were provided to, Lucent senior management.
g. With respect to Lucent’s July 20, 2000 Press
Release, the July 20, 2000 conference call and the financial results included in its Form 10-Q for the quarter ended June 30,
165 2000, Lucent was recognizing revenues on sales even though, among other things, products were not ordered or approved by customers and products did not work, as set forth above in ¶115. In addition, (i) as disclosed in Jay Carter’s July 5, 2000 email to
Aversano and others (¶99), AT&T had selected NEC over Lucent to supply optical networking systems for its next generation network; (ii) as disclosed in Carter’s July 7, 2000 email to
Aversano and others (¶¶99), the North American Region would not make its plan for the fourth quarter by hundreds of millions of dollars; (iii) as disclosed in the July 18, 2000 Daily Status
Report (¶155), Lucent had shipped only 625 10G modules, which was only approximately 20% of the July 2000 target of 3000 modules;
(iv) as alleged in Aversano’s complaint, Aversano and Russo specifically told McGinn that the revenue and earnings projections for the fourth quarter that he intended to include in
Lucent’s press release announcing the third quarter results were unattainable and needed to be reduced (¶156); and (v) during the
July 20, 2000 conference call, McGinn declared that he and
Hopkins had conducted a comprehensive operations review of
Lucent's entire business and were familiar with the
"fundamentals" of those businesses.
h. With respect to Lucent’s October 10, 2000, and
October 23, 2000 Press Releases:
166 (1) McGinn and Hopkins had been informed by an anonymous letter dated August 8, 2000, that Lucent and Winstar were “cooking the books” by engaging in certain improper deals, which in fact Lucent engaged in during the fiscal fourth quarter of 2000. McGinn had instructed the principal executive executing the fraudulent deal at the end of the quarter, Nina Aversano, to leave him daily voicemail updates regarding these end of the quarter transactions (¶174).
(2) McGinn and Hopkins were involved in the negotiation of improper software pooling agreements with
BellSouth during the fourth fiscal quarter of 2000, which resulted in millions of dollars of revenue reversals because the recognition of revenue pursuant to those agreements violated GAAP
(¶191).
(3) Lucent still had not disclosed that its previously reported financial results for the first three quarters, as well as those the Company anticipated for its fourth quarter, were materially overstated as a result of such accounting devices as granting extended payment terms and entering into aggressive financing arrangements with customers that were poor credit risks; using software pools; stuffing product into the distribution channels; and making “side deals” through which customers and distributors were given the right to
167 return product, in order to persuade customers to take Lucent’s products (¶127-46, 187-96).
(4) The Company had a pervasive practice of recording sales prematurely or falsely at the end of each quarter to assure that the projections given to Wall Street analysts would be met, and of other steps in this regard, such as
"stuffing the channels,” and fraudulently “recategorizing” overdue receivables so that they would no longer appear to be uncollectible (¶¶127, 137, 145).
258. The Individual Defendants were among the senior officers of Lucent, and, as such, are liable for the false financial statements issued by Lucent and for the other false public statements they and Lucent made. Through their positions of control and authority as officers of Lucent, these defendants were able to and did control the content of the public statements disseminated by Lucent.
259. As a result of the deceptive practices and false and misleading statements and omissions described above, the market prices of Lucent’s common stock were artificially inflated throughout the Class Period. In ignorance of the false and misleading nature of the representations and omissions described above and the deceptive and manipulative devices employed by defendants, Lead Plaintiffs and the other members of the Class, in reliance either on the integrity of the market or directly on
168 the statements and reports of those defendants, purchased Lucent at artificially inflated prices and were damaged thereby.
260. Had Lead Plaintiffs and the other members of the Class known of the material adverse information not disclosed by defendants, or been aware of the truth behind those defendants’ material misstatements, they would not have purchased Lucent publicly traded securities at artificially inflated prices, if at all.
261. By virtue of the foregoing, Lucent and the Individual
Defendants have violated 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.
COUNT II
Against McGinn, Peterson and Hopkins For Violations of Section 20(a) of the Exchange Act
262. This Claim is asserted against McGinn, Peterson and
Hopkins for violations of Section 20(a) of the Exchange Act, 15
U.S.C. § 78t(a), on behalf of all Class members who purchased or otherwise acquired Lucent common stock during the Class Period, who were damaged thereby.
263. From October 26, 1999 until October 22, 2000, McGinn, was a controlling person of Lucent within the meaning of Section
20(a) of the Exchange Act. From October 26, 1999 until March 1,
2000, Peterson was a controlling person of Lucent within the meaning of section 20(a) of the Exchange Act. From April 24, 2000
169 until the end of the Class Period, Hopkins was a controlling person of Lucent within the meaning of Section 20(a) of the
Exchange Act. At the time the false and misleading statements that are the bases of this Claim were made, McGinn, Hopkins and
Peterson had the power and authority, and exercised such power and authority, to cause Lucent to engage in the wrongful conduct complained of herein by reason of the following:
a. McGinn had the power and authority to cause, and did cause, Lucent to engage in the wrongful conduct complained of herein by virtue of his positions as Lucent’s Chairman and Chief
Executive Officer from the beginning of the Class Period until
October 22, 2000.
b. Hopkins had the power and authority to cause, and did cause, Lucent to engage in the wrongful conduct complaint of herein by virtue of her position as Lucent’s Chief Financial
Officer from her appointment on April 24, 2000 until the end of the Class Period.
c. Peterson had the power and authority to cause, and did cause, Lucent to engage in the wrongful conduct complaint of herein by virtue of his position as Lucent’s Chief Financial
Officer from the beginning of the Class Period until March 1,
2000.
264. During the relevant periods specified in the preceding paragraph, McGinn, Hopkins and Peterson were designated as
170 executive officers of Lucent, distinguishing them from other
Lucent corporate officers.
265. By reason of their positions of control of Lucent, as alleged herein, McGinn, Hopkins and Peterson are individually liable under Section 20(a) of the Exchange Act, and to the same extent as Lucent, are liable under Section 10(b) of the Exchange
Act to Lead Plaintiffs and the other members of the Class, as a result of the wrongful conduct alleged herein.
PRAYER FOR RELIEF
WHEREFORE, Lead Plaintiffs, on behalf of themselves and the other members of the Class, pray for judgment as follows:
A. Declaring this action to be a proper class action maintainable pursuant to Rule 23 of the Federal Rules of Civil
Procedure and declaring Lead Plaintiffs to be proper Class representatives;
B. Awarding Lead Plaintiffs and the other members of the
Class compensatory damages as a result of the wrongs alleged in the Complaint;
C. Awarding Lead Plaintiffs and the other members of the
Class their costs and expenses in this litigation, including reasonable attorneys’ fees and experts’ fees and other costs and disbursements; and
171 D. Awarding Lead Plaintiffs and the other members of the
Class such other and further relief as the Court may deem just
and proper.
JURY TRIAL DEMANDED
Lead Plaintiffs demand a jury trial of all issues so triable.
Dated: July 10, 2001
MILBERG WEISS BERSHAD BERNSTEIN LITOWITZ BERGER HYNES & LERACH LLP & GROSSSMANN LLP
By______By______David J. Bershad (DB-9981) Max W. Berger (MB-5010) Jerome M. Congress (JC-2060) Daniel L. Berger (DB-7748) Patrick L. Rocco (Pr-8621) Steven B. Singer (SS-5212) Elaine S. Kusel (EK-2753) Jeffrey N. Leibell (JL-1356) Mary Lynne Calkins (MC-5949) Javier Bleichmar (JB-0435) One Pennsylvania Plaza 1285 Avenue of the Americas 49th Floor 33rd floor New York, New York 10119-0165 New York, New York 10019 (212) 594-5300 (212) 554-1400
BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP A New York Limited Liability Partnership
By______Seth R. Lesser (SL-5560) One University Place Suite 516 Hackensack, NJ 07601 (201) 487-9700
Co-Lead Counsel for Plaintiffs and the Class
172 Robert A. Hoffman, Esq. Samuel R. Simon, Esq. Barrack, Rodos & Bacine 14 Kings Highway West, 3rd Floor Haddonfield, NJ 08033
Daniel E. Bacine, Esq. Barrack, Rodos & Bacine 330 Two Commerce Square 2001 Market Street Philadelphia, PA 19103
Steven J. Toll, Esq. Andrew Friedman, Esq. Dan Somers, Esq. Josh Devore, Esq. Cohen, Milstein Hausfield & Toll PLLC 1100 New York Avenue NW Suite 500 West Tower Washington DC 20005
Ann D. White, Esq. Michael J. Kane, Esq. Mager & White, P.C. The Pavilion, 261 Old York Road, Suite 810 Jenkintown, Pennsylvania 19046
Sandy Liebhard, Esq. Bernstein, Liebhard & Lifshitz, LLP 10 East 40th Street New York, NY 10016
Robert Berg, Esq. Mel E. Lifshitz, Esq. Bernstein, Liebhard & Lifshitz 2050 Center Avenue, Suite 200 Fort Lee, NJ 07024
Robert N. Cappucci, Esq. Entwistle & Cappucci LLP 400 Park Avenue New York, NY 10022
Leo W. Desmond, Esq. 29 Fairway Trail Sparta, NJ 07871
173 Lisa J. Rodriguez, Esq. Rodriguez & Richards LLC 3 Kings Highway East Haddonfield, NJ 08033
Brian Felgoise, Esq. Law Offices of Brian Felgoise 1420 Walnut Street, Suite 605 Philadelphia, PA 19102
Peter Fishbein, Esq. Law Offices of Peter Fishbein 777 Terrace Avenue Hasbrouk Heights, NJ 07604
Gary S. Graifman, Esq. Kantrowitz, Goldhamer & Graifman 210 Summit Avenue Montvale, NJ 07645
Harvey Greenfield, Esq. Law Offices of Harvey Greenfield 60 East 42nd Street, Suite 2001 New York, NY 10165
Andrew R. Jacobs, Esq. Epstein, Fitzsimmons, Brown, Ringle, Gioia & Jacobs, P.C. 245 Green Village Road PO Box 901 Chatham Township, NJ 07928-0901
Allyn Z. Lite. Esq. Joseph J. DePalma, Esq. Lite, DePalma, Greenberg & Rivas, LLC Two Gateway Center, 12th Floor Newark, NJ 07102
Charles J. Piven, Esq. Law Offices of Charles J. Piven World Trade Center-Baltimore 401 East Pratt Street, Suite 2525 Baltimore, MD 21202
174 Joseph E. Saul, Esq. Gellerstein & Saul 1485 Teaneck Road, Suite 300 Teaneck, NJ 07666
Stuart Wechsler, Esq. Samuel K. Rosen, Esq. Wechsler, Harwood, Halebian & Feffer 488 Madison Avenue New York, NY 10022
Fred T. Isquith, Esq. Michael Jaffe, Esq. Wolf, Haldenstein, Adler, Freeman & Herz 270 Madison Avenue New York, NY 10016
Andrew M. Schatz, Esq. Jeffrey S. Nobel, Esq. Schatz & Nobel, P.C. 330 Main Street Hartford, CT 06106-1851
Jack G. Fruchter, Esq. Fruchter & Twersky 60 East 42nd Street, 47th Floor New York, NY 10165
Paul Geller, Esq. Jonathan M. Stein, Esq. Shepherd & Geller 7200 West Camino Real, Suite 203 Boca Raton, FL 33433
Marc Henzel, Esq. Law Offices of Marc Henzel 210 West Washington Square, 3rd Floor Philadelphia, PA 19106
James V. Bashian, Esq. Law Offices of James V. Bashian 500 Fifth Avenue, Suite 2100 New York, NY 10110
175 Mark Topaz, Esq. Schiffrin & Barroway, Ltd. Three Bala Cynwyd Plaza East, Suite 400 Bala Cynwyd, PA 19004
Frederic S. Fox, Esq. Kaplan, Kilsheimer & Fox 850 Third Avenue New York, NY 10022
William J. Pinilis, Esq. Kaplan, Kilsheimer & Fox, LLP 237 South Street Morristown, NJ 07962
David B. Kahn, Esq. David B. Kahn & Associates One Northfield Plaza, Suite 100 Northfield, IL 60093
Marvin L. Frank, Esq. Rabin & Peckel 275 Madison Avenue New York, NY 10016
Barbara A. Podell, Esq. Savett, Frutkin, Podell & Ryan 32S Chestnut Street Philadelphia, PA 19106
Curtis V. Trinko, Esq. Law Offices of Curtis V. Trinko, LLP 16 West 46th Street, 7th Floor New York, NY 10036
Robert Susser, Esq. Law Offices of Robert Susser, P.C. 6 East 43rd Street, Suite 1900 New York, NY 10017
Brian Barry, Esq. Law Offices of Brian Barry 8284-A Santa Monica Blvd. Los Angeles, CA 90069
176 Jules Brody, Esq. Stull, Stull & Brody 6 East 45th Street New York, NY 10017
Peter D. Bull, Esq. Joshua M. Lifshitz, Esq. Bull & Lifshitz, LLP 246 West 38th Street New York, NY 10018
Joseph H. Weiss, Esq. Weiss & Yourman 551 Fifth Avenue, Suite 1600 New York, NY 10176
Peter S. Pearlman, Esq. Cohn Lifland Pearlman Herrman & Knopf LLP Park 80 Plaza West One Saddlebrook, NJ 07663
Dennis J. Johnson, Esq. Law Offices of Dennis J. Johnson 1690 Williston Road So. Burlington, VT 05403
Jeffrey H. Squire, Esq. Kirby McInerney & Squire LLP 830 Third Avenue New York, NY 10022
Deborah Gross, Esq. Law Office of Bernard M. Gross, P.C. 1500 Walnut Street, 6th Fl. Philadelphia, PA 19102
Ellen M. McDowell, Esq. Whittlesey McDowell & Riga 46 West Main Street Maple Shade, NJ 08052
Francis J. Farina, Esq. 577 Gregory Lane Devon, PA 19333
177 Michael J. Kane Mager & White, PC 338 Haddon Avenue Westmont NJ, 08108
Lisa J. Rodriguez. Esq. Rodriguez & Richards, LLC 3 Kings Highway East Haddonfield, NJ 08033
Andrew G. Tolan Pomerantz, Haudek, Block, Grossman & Gross, LLP 100 Park Avenue New York, NY 10017-5516
Glen DeValerio, Esq. Jeffrey C. Block, Esq. Berman, Devalerio & Pease LLP One Liberty Square Boston, MA 02109
Robert S. Kitchenoff, Esq. Weinstein Kitchenoff Scarlato & Goldman Ltd. 1608 Walnut Street, Suite 1400 Philadelphia, PA 19103
Robert M. Roseman, Esq. Spector, Roseman & Kodroff, P.C. 1818 Market Street Suite 2500 Philadelphia PA 19103
Jeffrey H. Squire Kirby Mcinery & Squire LLP 830 Third Avenue New York, New York 10022
Thomas G. Shapiro Shapiro Haber & Urmy, LLP 75 State Street Boston, Massachusetts 02109
John T. Bennett Law Offices, Ltd. P.O. Box 775 Marksville, LA 71351
178 Thomas A.Dubbs, Esq. Goodkind Labaton Rudoff & Sucharow LLP 100 Park Avenue New York, NY 10017
Counsel for Plaintiffs in the Actions Consolidated by the Court's Orders of February 25, 2000 and December 26, 2000
179 SCHEDULE A
PENSION TRUST FUND ACQUISITIONS Security Transaction Date Price Per Share Common Stock Acquired 11,500 Shares 11/10/99 $66.68 Common Stock Acquired 8,000 Shares 10/27/00 $20.615 Common Stock Acquired 7,485 Shares 11/06/00 $24.723 Common Stock Acquired 800 Shares 12/20/00 $13.00
PENSION TRUST FUND SALES Common Stock Sold 400 Shares 11/30/99 $74.56 Common Stock Sold 300 Shares 03/06/00 $66.875 Common Stock Sold 100 Shares 05/12/00 $58.00 Common Stock Sold 19,700 Shares 06/07/00 $62.008
THE PARNASSUS FUND ACQUISITIONS Security Transaction Date Price Per Share Common Stock Acquired 50,000 Shares 09/20/00 $35.56 Common Stock Acquired 50,000 Shares 09/21/00 $33.56 Common Stock Acquired 50,000 Shares 09/22/00 $32.19 Common Stock Acquired 100,000 Shares 12/13/00 $20.25 Common Stock Acquired 25,000 Shares 12/19/00 $18.12
THE PARNASSUS FUND SALES Common Stock Sold 150,000 Shares 11/01/00 $22.76 PARNASSUS INCOME TRUST EQUITY INCOME FUND ACQUISITIONS Security Transaction Date Price Per Share Common Stock Acquired 3,000 Shares 01/07/00 $52.94 Common Stock Acquired 1,000 Shares 01/25/00 $55.50 Common Stock Acquired 1,000 Shares 02/08/00 $54.44 Common Stock Acquired 1,000 Shares 02/09/00 $53.06 Common Stock Acquired 2,000 Shares 02/23/00 $52.81 Common Stock Acquired 3,000 Shares 08/11/00 $40.12 Common Stock Acquired 10,000 Shares 09/20/00 $35.56 Common Stock Acquired 5,000 Shares 09/22/00 $31.94 Common Stock Acquired 10,000 Shares 10/27/00 $21.00 Common Stock Acquired 20,000 Shares 12/13/00 $20.25 Common Stock Acquired 5,000 Shares 12/19/00 $18.12
PARNASSUS INCOME TRUST EQUITY INCOME FUND SALES Common Stock Sold 36,000 Shares 11/09/00 $23.13 SCHEDULE B Additional Plaintiffs - LUCENT TECHNOLOGIES INC. Susan Kaufman, Robert Elan, John M. Razzano, Zipora Baron Weber, Oren Giskan, Bernice Seiden, John P. Clifford, Jr., Stephen Schoeman, James V. Biglan, FMWL Enterprises, Inc., Rachel Stern, James Courtright, Miriam Sarnoff, Peter S. Powers, Elliot Mayerhoff, David Plotkin, Jeffrey Schwartz, Steven Fairlie, Thomas Pearlman, Tom Chaplinski, Dominie Morelli, Charles Edward Norrell, New England Health Care Employees Pension Fund, Perry Mermelstein, George Carter, Jonathan Brod, Timothy Phelan, Jeffrey Marks, Donald Press, Dennis Pasparage, Jacqueline Bragin, Ralph Stone, Daniel Murphy, Howard Davis, John J. Wizbicki, Naomi Raphael, Milton Abowitz, Wayne E. Meyer, David M. Feder, Richard Sakkal, Riddle and Bennett Corp. SCHEDULE C Witness Number Witness Name 1 L. Hunter Rose 2 Phil Henry 3 Abdullah Mayouf Al-Qahtani 4 Charlie Roxlo 5 Warren Monroe 6 Alan Demain2 7 Malene Bassett 8 Joseph McManus 9 Rebecca Daniel 10 William Roberts 11 Robert Ricco3 12 Daniel Hutson 13 John Parks 14 John Smith 15 Donald Maurier 16 Dale Ash 17 Dan Bissey 18 John Koslow 19 Kelly Joyce 20 Gary Labelle 21 Tyrone Griffin 22 Gary Woltal
2Because of a transcribing error, this witness’s first name was inadvertently omitted in the schedule C initially served on the Court on July 10, 2001.
3Because of a transcribing error, this witness’s first name was inadvertently omitted in the schedule C initially served on the Court on July 10, 2001. 23 Ernesto Camaya 24 Barbara Clarke 25 Milton Tannis4 26 Grant Hopkins 27 Stephen Hammel 28 Jason Miles 29 Patricia Cain-Stanley 30 Keith Sharp 31 Daniel Greenstein 32 Bobbi Jo Blue 33 Stu Figenholtz 34 Antonio Llizo 35 George King 36 Joan Slepian
4Because of a transcribing error, this witness’s first name was inadvertently misspelled in the schedule C initially served on the Court on July 10, 2001.