In re Northpoint Communications Group, Inc.

• Decision Date: 21 December 2001
• Docket Number: No. C01-01473 WHA.,C01-01473 WHA.
• Citation: 184 F.Supp.2d 991
• Court: U.S. District Court — Northern District of California
• Parties: In re NORTHPOINT COMMUNICATIONS GROUP, INC., SECURITIES LITIGATION And Consolidated Cases. This Document Relates To: All Actions.

184 F.Supp.2d 991

In re NORTHPOINT COMMUNICATIONS GROUP, INC., SECURITIES LITIGATION And Consolidated Cases This Document Relates To: All Actions.

No. C01-01473 WHA.

United States District Court, N.D. California.

December 21, 2001.

COPYRIGHT MATERIAL OMITTED

ORDER: (1) GRANTING INDIVIDUAL DEFENDANTS' MOTION TO DISMISS; AND (2) GRANTING PLAINTIFF LEAVE TO AMEND

ALSUP, District Judge.

INTRODUCTION

In this securities-fraud suit, the class-action complaint alleges that defendants made false and misleading statements concerning NorthPoint Communications Group, Inc., between August and November 2000. The complaint contends that defendants, inter alia, overstated NorthPoint's revenues, earnings and subscribers, mischaracterized its accounting practices, and made misleading statements concerning a pending merger with Verizon Communications. NorthPoint was ultimately forced to revise its revenues. The Verizon merger fell through. NorthPoint's stock dropped, the company went bankrupt, and this suit ensued. Because NorthPoint is now in bankruptcy, this action is stayed as to it. The four individual defendants in this case, however — former CEO and President Elizabeth A. Fetter; former Chief Development Officer Herman Bluestein; former CFO Michael Glinsky; and former chairman Michael Malaga — have moved to dismiss the complaint. This order grants their motion, with leave to amend. It concludes that plaintiff has not met its burden of pleading facts giving rise to a "strong inference" of scienter.

STATEMENT

NorthPoint Communications Group, Inc., was a provider of digital-subscriberline (DSL) technology services. Through DSL technology, data can be transported at high speeds over traditional telephone wires. As a DSL "wholesaler," NorthPoint owned digital-communications equipment, which was installed in telephone-company offices. It also leased copper telephone lines to connect this equipment with end users. It marketed its DSL services to customers including telephone companies, Internet service providers (ISPs) and data-service providers (collectively, "network service providers"), who in turn would sell DSL services to end users. If a user signed up through one of NorthPoint's customers, NorthPoint would arrange for the installation of a DSL connection. NorthPoint would bill its customers for the installation (a one-time charge) as well as a monthly service fee for the use of the line.

The complaint attacks statements made between August and November 2000. These statements, primarily press releases, related to NorthPoint's revenues, subscriber lines, accounting policies, general business condition, and a planned merger with Verizon Communications. The principal charge is that defendants were knowingly or with deliberate recklessness reporting revenue NorthPoint was not reasonably assured of collecting and leading investors to believe that NorthPoint's merger with Verizon would still take place notwithstanding a possible abort by Verizon.

On August 7, 2000, NorthPoint agreed to combine its DSL business with that of Verizon's. This would have created a new company, Verizon Ventures I, Inc., to which Verizon was to contribute $800 million and certain DSL assets in exchange for majority ownership. The merger agreement, disclosed in a 8-K report filed August 14, 2000, allowed Verizon to back out if a "Material Adverse Effect" occurred upon NorthPoint's business (Def. Exh. G at 69). The agreement defined a Material Adverse Effect as (id. at 77):

[I]n the case of NorthPoint or Parent, any fact, event, change or effect having, or which will have, a material adverse effect on the business, operations, properties (including intangible properties), financial condition, assets or liabilities of NorthPoint or Parent, as the case may be, and its Subsidiaries taken as a whole, but shall not include facts, events, changes or effects that are generally applicable to (A) the data industry, (B) the United States economy or (C) the United States securities markets generally ...¹ The alleged class period would begin on August 8, 2000. On that day, NorthPoint announced the Verizon merger in a press release saying, among other things, that "[t]he merger combines the DSL networks, product suites, customers and personnel of NorthPoint and Verizon to create the preeminent broadband leader dedicated to accelerating broadband service innovation and choice nationwide" (Compl.¶ 32). NorthPoint also revealed its 2Q 2000 financial results in the same release. NorthPoint reported quarterly revenue of $24.4 million, and EBITDA-positive performance in four markets (ibid).

Relying on secret disclosures from eight "confidential witnesses" as well as other alleged facts, plaintiff claims that the second-quarter financial announcement was false and misleading. At that time, it is alleged, NorthPoint's customers were in such financial disarray and NorthPoint was so delinquent in providing services that much of the company's revenue was not reasonably assured of collectibility. In turn, the undisclosed matters purportedly posed a time bomb for the Verizon merger.

For similar reasons, the complaint also characterizes as misleading two press releases issued in September and a statement by defendant Liz Fetter, NorthPoint's CEO, in an October media article. All concerned the merger. The first press release, issued on September 6, 2000, quoted Fetter as saying, "Verizon's equity investment and debt financing will help NorthPoint maintain strong momentum as we move toward the close of our merger agreement," and, "We will use our greater financial strength to expand our network, scale our business and enhance the broadband customer experience. We look forward to the completion of the merger and to delivering its many benefits to American consumers and businesses" (Compl.¶ 34). The second release, issued September 20, 2000, said that "the deal accelerates NorthPoint's ability to scale and innovate, and makes NorthPoint a more formidable competitor against cable service providers" (Compl.¶ 36). The September 20 release also quoted Fetter as saying, "Our agreement with Verizon enables NorthPoint, already one of the most nationwide of all DSL service providers, to double its network and dramatically expands the availability of fast, reliable and affordable connections to the Internet" (ibid). Then, on October 20, 2000, a media article quoted Fetter as saying, "The road is littered with companies that have been unsuccessful at raising capital.... That's a worry off the table" (Compl.¶ 38).

* * * * * *

The main issue concerns 3Q 2000. In a press release issued on October 26, 2000, NorthPoint announced its 3Q 2000 financial results. Third-quarter revenues were reported to be $30.1 million, with an EBITDA loss of minus $79.2 million (Compl.¶ 40(c)). Significantly, the revenue excluded, for the first time, billings made to certain failing customers. The press release addressed this issue in the following manner (Compl.¶ 40(d)):

NorthPoint has consistently applied what it believes is a conservative revenue recognition policy. During the past several months there has been a considerable change in the financing environment and it may be that a few of NorthPoint's customers will have difficulty raising the capital required to continue to grow their businesses.

Given the consistent application of its revenue recognition policies and the financing challenges faced by a few of its customers, NorthPoint has chosen to recognize revenue for lines installed for these few customers only when the customers' financial outlook improves or when cash is received by NorthPoint.

The press release did not say how much revenue NorthPoint did not recognize in the results released October 26. In a conference call with industry analysts held on or about that day, however, it was revealed that the company excluded $2.8 million in revenue for the quarter (Compl.¶ 42). In other words, given the downward spiral of the Internet industry at that time, a revenue allowance of $2.8 million was taken to more realistically state revenue.

NorthPoint's October 26 press release also reported that the company had 87,300 installed lines as of September 30, 2000. It additionally included several statements pertaining to the Verizon merger, including quoting Fetter as saying, "We continue to be on track with our prior expectation of closing the transaction in the first half of 2001" (Compl.¶ 40(d)).

On or about the same day, NorthPoint officers held a conference call with industry analysts, as stated. Pursuant to the call, one analyst then reported that "the company has indicated that it is comfortable with revenue estimates for the fourth quarter and full year 2000" (Compl.¶ 42). A few weeks later, on November 13, 2000, Fetter was quoted in a NorthPoint press release as saying, "NorthPoint ... continues to be successful among the most formidable names in leading companies this century," and that the company was nearing the end of a "landmark year" (Compl.¶ 45). Then, on November 15, 2000, on a form NT-10-Q filed with the SEC, NorthPoint remarked on its "rapid growth since September 30, 1999" (Compl.¶ 52).

* * * * * *

On November 20, 2000, NorthPoint announced that it was revising its 3Q 2000 revenues. The press release said that NorthPoint had received "additional facts after the October 26, 2000, third-quarter press release that indicated some of its privately-held, consumer focused network service provider customers did not have sufficient long-term financial resources to assure the Company that they would be able to make timely payment for the Company's services" (Def.Exh. M). Revenues were revised downward from $30 million to $24 million. The release also quoted Fetter as saying, "These recent events confirm the validity of our decision to find a strategic partner like Verizon," and "We continue to be on track with our prior expectation of closing the Verizon transaction in the first...