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Nortel Networks Corp. Securities Litigation
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IN RE NORTEL NETWORKS CORP SECURITIES
LITIGATION COMPLAINT SUMMARY
Overview
The Complaint alleges that, between October 24, 2000 and February 15, 2001 (the
"Class Period"), Nortel mislead investors as to the state of its business.
During the Class Period, the Complaint alleges that Nortel's public statements
failed to reflect its business conditions, and were based upon accounting
practices that were contrary to generally accepted accounting principles
("GAAP") and U.S. Securities and Exchange Commission ("SEC") rules. A summary
of the accounting and misrepresentation allegations is set out below.
Accounting Allegations
The Complaint alleges that Nortel improperly recorded and exaggerated its
revenues during the third and fourth quarters of 2000, and that this was
contrary to GAAP and SEC rules.
The Complaint alleges the following accounting improprieties:
(a) that Nortel financed 100% of the purchase price of its products to a number
of customers, including a number of uncreditworthy customers, and recorded
these vendor-financed sales as revenue even though it knew that these loans
would not be repaid;
(b) that Nortel improperly required its customers to purchase significant
quantities of additional product that the customers informed Nortel that they
neither needed nor wanted, and recorded such sales as revenue, notwithstanding
the significantly increased risk that these unneeded products would be returned
or not fully paid;
(c) that Nortel "pulled forward hundreds of millions, if not billions, of
dollars in revenues from future quarters into the third and fourth quarters of
2000", thus artificially inflating its revenues for the Class Period;
(d) that Nortel recognized revenues on the basis of non-binding "letters of
intent", rather than legally binding purchase orders, thus further inflating
its revenues;
(e) that where certain products were in short supply, Nortel shipped interim or
substitute products and booked revenue as though the final products had been
shipped, again with the effect of recognizing as revenue proceeds of the sales,
notwithstanding that the product on order had not been shipped;
(f) that Nortel recognized revenues on sales prior to the date by which its
customers were permitted to return the product, but maintained a very generous
returns policy, with the effect of improperly recognizing revenues prior to the
end of the return period and thereby inflating revenues;
(g) that Nortel failed to reflect the risks inherent in its revenue accounting
through appropriate reserves or charges against income; and
(h) that Nortel's third quarter 2000 reported financial results were also
materially overstated because they failed to recognize that the value of
Nortel's recent acquisitions had deteriorated significantly. Much of the value
of those acquisitions had been identified as long-term in nature, predominantly
as "goodwill", and the Complaint alleges that these assets were not written
down in a timely manner, thereby presenting a misleading picture of Nortel's
financial position.
Disclosure Allegations
The Complaint alleges that, as Nortel was beginning to experience the general
downturn that affected the telecommunication sector, and was involved in the
accounting practices set out above, it nevertheless issued public statements to
the effect that its growth remained strong, and that it expected to
substantially outperform its competitors.
Some of the relevant public statements are as follows:
(a) October 24, 2000
At the beginning of the Class Period, Nortel issued a press release referring
to its strong earnings growth for 2000 to 2001:
"We are extremely pleased with the strong growth in the quarter which reflected
our continued strength and leadership in the key growth areas of Optical
Internet, Wireless Internet, Local Internet and eBusiness Solutions… Carriers
and providers around the world continued the drive to provide a broad range of
wireless, Internet and eBusiness services to their customers. Leading the
growth again this quarter, revenues for our Optical Internet Solutions grew
nearly 90% in the quarter compared to the same period last year
Based on the momentum we have experienced during the first nine months and the
strong order backlog, we continue to expect that our percentage growth in 2000
over 1999 will be in the low 40's. Consistent with our overall expectations for
the year is an expectation that Optical Internet solutions revenues will exceed
U.S. $10 billion. We now expect however, that our percentage growth in EPS from
operations in 2000 compared with 1999 will also be in the low 40's, up from our
previously stated expectation which was in the high 30's
Looking forward to 2001, we expect the overall market to grow in excess of 20
percent. Given our strong market position and industry leading network
solutions, we expect to continue to grow significantly faster than the market,
with anticipated growth in revenues and EPS from operations in the 30 to 35
percent ranges."
(b) November 1, 2000
After its third quarter earnings shortfall, Nortel continued to express
optimism about its revenues going forward, making no reference to any of the
accounting or business practices described above:
"We continue to expect that our percentage growth in revenue and earnings per
share from operation sin 2000 over 1999 will be in the low 40's, said John
Roth, president and chief executive officer, Nortel Networks. 'In response to
specific requests for guidance on the fourth quarter of 2000, we expect our
revenue and earnings per share from operations in the fourth quarter of 2000
will be in the range of U.S. $8.5 million to U.S. $8.8 billion and U.S. $0.26
per share on a fully diluted basis, respectively. Overall, we expect continued
strong growth in Optical Internet, Wireless Internet, Local Internet and
eBusiness solutions. We continue to expect our optical Internet revenues to
grow in excess of 125 percent in 2000 over 1999, to exceed U.S. $10 billion.
Looking forward to 2001, we continue to expect the overall market to grow in
excess of 20 percent. Given our strong market position and leadership in high
performance Internet solutions, we continue to expect to grow significantly
faster than the market, with anticipated growth in revenues and earnings per
share from operations in the 30 to 35 percent range, said Roth. 'For the first
quarter of 2001, consistent with historical profile trends, we expect our
revenue and earnings per share from operations will be in the range of U.S.
$8.1 billion to U.S. $8.3 billion and U.S. $016 per share on a fully diluted
basis, respectively."
(c) February 15, 2001
Finally, on February 15, 2001, just after the close of trading, Nortel issued a
press release stating that the company was seeing a "faster and more severe
economic downturn in the United States" and "longer than expected delays in
spending by … U.S. customers as they continue to assess the impact of the
economic and market conditions on their business." Nortel also said:
"We now expect the U.S. Market slowdown to continue well into the fourth quarter
of 2001" and [we] now expect growth in revenues and earnings per share from
operations in 2001 over 2000 of 15 percent and 10 percent, respectively."
After the February 15, 2001 press release, which dramatically reduced the
company's guidance for 2001 growth in revenues and earnings per share, Nortel's
stock price plunged 34% from its $29.75 closing price on February 15, 2001 to
trade as low as $19.00 per share on February 16, 2001.
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