Lucescu et al v. Zafirovski et al
OPINION AND ORDER....Defendants' October 6, 2017 motion to dismiss the Amended Complaint is granted. The Clerk of Court shall enter final judgment for the defendants and close the case. (Signed by Judge Denise L. Cote on 4/11/2018) (gr)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
DAVID LUCESCU, Individually and On
Behalf of All Others Similarly
MIKE ZAFIROVSKI and PAVI BINNING,
OPINION AND ORDER
For the plaintiffs:
Samuel H. Rudman
David A. Rosenfeld
Erin W. Boardman
Alan I. Ellman
Robbins Geller Rudman & Dowd LLP
58 South Service Road, Suite 200
Melville, NY 11747
For the defendants:
Joel C. Haims
Jamie A. Levitt
James J. Beha II
Steven T. Rappoport
Christina L. Golden
Morrison & Foerster LLP
250 West 55th Street
New York, NY 10019
DENISE COTE, District Judge:
In early 2009, during the world financial crisis, Nortel
Networks Corporation (“Nortel”) filed for bankruptcy protection.
Nortel emerged from bankruptcy and the bankruptcy stay was
lifted in 2017.
Accordingly, this securities fraud class action
lawsuit, which was filed in 2009 and asserts claims against two
Nortel executives for activities in 2008, is once again active.
For the following reasons, the defendants’ motion to dismiss the
action is now granted.
The following facts are primarily drawn from the first
amended complaint (“FAC”) and documents it incorporates by
They are taken in the light most favorable to the
Nortel was a supplier of end-to-end networking
Its principal place of business was in Toronto,
Its stock traded on the Toronto Stock Exchange and the
New York Stock Exchange.
In 2004, an accounting fraud came to light at Nortel.
led to the restatement of billions of dollars in revenue.
Defendant Mike Zafirovski was brought in as Nortel’s CEO in
November 2004 to revitalize the company.
In late 2005, under
While the FAC selectively quotes from numerous documents,
including filings with the SEC, the plaintiffs did not attach
any of the documents to the FAC. Those documents, however, are
“incorporated in it by reference.” Nicosia v. Amazon.com, Inc.,
834 F.3d 220, 230 (2d Cir. 2016) (citation omitted). Moreover,
“[w]here a document is not incorporated by reference, the court
may neverless consider it where the complaint relies heavily
upon its terms and effect, thereby rendering the document
integral to the complaint.” DiFolco v. MSNBC Cable L.L.C., 622
F.3d 104, 111 (2d Cir. 2010) (citation omitted). Defendants
attached many of the documents as exhibits to their brief in
support of their motion to dismiss.
Zafirovski’s guidance, Nortel commenced a Business
Transformation Plan that was designed to return Nortel to
Pavi Binning served as Nortel’s Chief Financial
Officer (“CFO”) from November 12, 2007 to March 2, 2009, and is
named as the second defendant in this action.
The class period
runs from May 2, 2008 and January 13, 2009 (the “Class Period”).2
The FAC, filed on September 21, 2017, asserts that the two
individual defendants made materially false statements in 2008
about Nortel’s relationship with key customers and failed to
timely write down over $2.3 billion of goodwill, which they knew
was impaired as of May 2, 2008.3
According to the FAC, the
defendants were motivated to delay writing down the goodwill so
that Nortel could conduct a private placement.
The FAC places
emphasis on the following events.
The original complaint asserted a Class Period running from May
2, 2008 to September 17, 2008. The FAC extends the Class Period
to January 13, 2009.
In broad terms, goodwill is a measurement of the value of a
company's intangible assets over and above the fair market value
of identifiable assets and liabilities. See Aswath
Damodaran, Damodaran on Valuation 423 (2d ed. 2006) (“The most
charitable interpretation of goodwill is that it measures the
estimated value of growth assets in the target company; growth
assets are investments that the target company is expected to
make in the future.”).
First Quarter Results
On May 2, 2008, the first day of the Class Period, Nortel
announced its results for the first quarter of 2008.
quarter Form 10-Q, dated May 2, 2008, was signed by Binning.
The Form 10-Q represented that Nortel’s financial results were
presented in conformity with Generally Accepted Accounting
The Form 10-Q reported that Nortel had
goodwill valued at $2.58 billion.
The Form 10-Q also disclosed
Nortel’s process for testing goodwill for possible impairment.
Nortel’s first quarter Form 10-Q stated in part:
We test goodwill for possible impairment on an annual basis
as of October 1 of each year and at any other time if an
event occurs or circumstances change that would more likely
than not reduce the fair value of a reporting unit below
its carrying amount. Circumstances that could trigger an
impairment test between annual tests include, but are not
limited to: a significant adverse change in the business
climate or legal factors an adverse action or assessment
by a regulator unanticipated competition loss of key
personnel the likelihood that a reporting unit or a
significant portion of a reporting unit will be sold or
disposed of a change in reportable segments results of
testing for recoverability of a significant asset group
within a reporting unit and recognition of a goodwill
impairment loss in the financial statements of a subsidiary
that is a component of a reporting unit.
Nortel held a conference call with investors and issued a
press release on May 2.
The press release confirmed Nortel’s
previously announced forward-looking guidance for the full
The release noted that the company was making
solid progress in repairing and turning around the company.
noted that the company expected to “achieve [its] full year
guidance and . . . continue to make solid progress against the
strategy to turn around the company.”
The release also
projected "low single digit" revenue growth for the year.
During the May 2 conference call, Zafirovski focused on
Nortel’s customer relationships, stating that Nortel was
continuing to “build market and customer momentum,” but
cautioned that the company was operating in a “tough macro
environment” and a “very uncertain environment.”
he and the company continued to have an optimistic outlook on
the remainder of the year.
The press release, and Zafirovski on
the call, signaled that the statements made were forward-looking
and assumed stable growth in customers’ capital expenditures.
On the call, Zafirovski warned that the company’s success was
“ultimately based on the customers embracing [the company’s]
In response to a question about wireless demand from
customers, Zafirovski answered that the demand was “pretty
Less than a week later, on May 7, Nortel held its annual
There, again, Zafirovski focused on
Nortel’s “growing momentum” with its customers.
simultaneously published press release, authored by Zafirovski,
emphasized that Nortel was still engaging in a massive turn-
around effort: although optimistic, the press release conceded
that Nortel was still in a “remaking” process and undergoing a
“business transformation plan.”
In addressing the company’s
effort to “rebuild,” the release noted that Nortel was
experiencing “improved employee and customer satisfaction.”
May Note Offering
Later, on May 21, 2008, Nortel issued another press
release, confirming its 2008 outlook.
Nortel also announced on
May 21 that its principal direct operating subsidiary, Nortel
Networks Limited, would commence a $500 million note offering.
The offering closed on May 28.
It raised $675 million.
proposed class does not include any debt holders from that
Second Quarter Results
On August 1, 2008, Nortel announced its results for the
second quarter of 2008.
It filed its second quarter Form 10-Q
on August 1, again signed by Binning.
The Form 10-Q represented
that Nortel’s financial results were presented in conformity
The Form 10-Q reported that Nortel had goodwill
valued at $2.57 billion.
The Form 10-Q reiterated Nortel’s
process for testing goodwill for possible impairment.
Also on August 1, Nortel held a conference call with
investors and issued a press release.
Nortel announced that its
second quarter results were consistent with its overall outlook
for the fiscal year, but Zafirovski admitted on the conference
call that one of its Carrier Network customers had “shut the
door on short-term capital expenditures.”
cautioned that “there is not much visibility [with] what is
going to happen in the next 3, 6, 9 months.”
also participated on the August 1 conference call, stating that
he anticipated “future growth” from investments the company had
made in “key programs.”
Like with its announcement in May,
Nortel cautioned that it was operating in a challenging business
It specifically noted potential losses from “key”
North American customers.
Nortel also filed a Form 8-K and accompanying press release
on August 1, 2008.
The press release stated: “Nortel’s
financial performance in the first half of 2008 has been
consistent and disciplined.
We have achieved our objectives and
are on track to meet our targets for the year.”
respect to earnings for the second quarter, the release noted:
The Company reported a net loss in the second quarter of
2008 of $113 million, or $0.23 per common share on a basic
and diluted basis, compared to a net loss of $37 million,
or $0.07 per common share on a basic and diluted basis, in
the second quarter of 2007 and a net loss of $138 million,
or $0.28 per common share on a diluted basis, in the first
quarter of 2008.
While confirming its full year outlook, the press release warned
“Nortel faces a challenging business environment with increasing
risk. . . .”
The price of Nortel’s common stock declined from a
closing price of $7.64 per share on July 31 to close at $6.52
per share on August 1.
Third Quarter Results
On September 15, Lehman Brothers filed for bankruptcy.
September 17, 2008, Nortel pre-announced its third quarter
In that announcement, Nortel lowered its full-year
2008 outlook, which it had confirmed as recently as August 1.
Specifically, it announced that its revenue would decline, its
gross margin was lower than previously announced, and its
operating margin would increase less than half the number of
basis points than previously projected.
Nortel explained that
there were both localized and broad reasons for this change in
outlook: Nortel’s customers were cutting back their capital
expenditures and the company was operating in a difficult
Nortel’s stock tumbled after this
At that same time, the global stock market fell
November 2008 Impairment Announcement
On November 10, 2008, Nortel filed a Form 8-K and
accompanying press release in conjunction with its third quarter
Nortel announced that it had written down the value of
its goodwill after the drop in its share price following its
It recorded a goodwill impairment
charge of $1.142 billion, representing the entire amount of the
reported goodwill associated with two of its business segments:
Enterprise and MEN.
The press release explained:
Goodwill is tested for possible impairment on an annual
basis and any time an event occurs or circumstances change
that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. Such an event
occurred with the Company’s market capitalization being
less than book value for a sustained period combined with
the continuation of challenging market conditions.
The November 10, 2008 Form 8-K press release announced that this
charge against Nortel’s goodwill took place sometime during the
“third quarter of 2008.”
Nortel's common stock price, which had
closed at $1.17 per share on November 7, 2008, closed at $0.95
per share on November 10, 2008.
In its 2008 Form 10-K, signed by both defendants and filed
on March 2, 2009, after Nortel had filed for bankruptcy, see
infra, Nortel revealed more information about its goodwill
impairment charge during the third quarter of 2008.5
The Financial Accounting Standards Board's Statement of
Financial Accounting Standards No. 142, titled Goodwill and
Other Intangible Assets (“SFAS 142”), issued in June 2001,
provides that the value of goodwill should be tested for
impairment at least annually, and “more frequently if events and
circumstances indicate that the assets might be impaired.” FASB
No. 142, June 2001, 12.
The plaintiffs do not quote the 2008 Form 10-K in the FAC, nor
is it attached as an exhibit to the FAC or the plaintiffs’
10-K explained that Nortel conducted an interim period goodwill
impairment test on September 30, 2008.
Nortel performed the
interim impairment test because events and circumstances “had
changed that required it to perform” such a test.
The Form 10-K
referred to “significant pressure resulting from the expanding
economic downturn”, foreign exchange fluctuations, “challenging
market conditions, particularly in the U.S.,” and a loss in
market value, among other things.
The Form 10-K explained that
Nortel “perform[ed] an additional interim period goodwill
impairment test” on December 31, 2008 because the company
“observed further deterioration in industry conditions, [and in]
global economic and credit conditions.”
The total goodwill
impairment charge after the second test was nearly $2.4 billion.
On December 10, 2008, the Wall Street Journal reported that
Nortel was exploring bankruptcy.
The price of Nortel’s common
stock closed at $0.40 per share on December 10, compared to a
closing price of $0.52 per share on December 9.
On January 14,
2009, Nortel announced that it would seek bankruptcy protection
in Canada, the United Kingdom, and the United States.
announcement, the price of Nortel’s common stock fell by more
opposition to this motion. The plaintiffs quote from it at
length, however, in their opposition brief.
than 65%, to a closing price of $0.11 per share on January 14,
On January 14, 2009, the Ontario Superior Court issued an
Initial Order in Nortel’s Canadian Companies’ Creditors
Arrangement Act (“CCAA”) proceeding.
That Initial Order stayed
all proceedings against Nortel and its current and former
officers and directors.
On February 27, 2009, a United States
Bankruptcy Court recognized Nortel’s CCAA proceeding as a
“foreign main proceeding” and stayed all proceedings against
Nortel and its officers and directors.
In re Nortel Networks
Corp., 2013 WL 6053845, at *1 (D. Del. Nov. 15, 2013).
David Lucescu filed the complaint in this action in this
district on May 18, 2009.
The Honorable Shira Scheindlin placed
the case on the suspense docket on November 9, 2010.
2017, the Ontario Superior Court approved Nortel’s plan of
reorganization and lifted the CCAA stay on May 15.
On June 23,
2017, the United States Bankruptcy Court for the District of
Delaware recognized the Ontario Superior Court’s May 15 order.
This lawsuit was reassigned to this Court on July 11, 2017,
and was reopened on July 17.
At an initial conference with the
parties on August 4, 2017, the Court granted the plaintiff leave
to file an amended complaint and set a briefing schedule for a
motion to dismiss.
On August 14, the Court allowed the case to
continue with two lead plaintiffs, Moreno Minto and Kien Chen.6
Plaintiffs filed the FAC on September 21, 2017.
extends the Class Period to January 14, 2009 and adds
allegations concerning the first and second quarter 2008 Form
10-Q filings and the second quarter 2008 earnings release.
FAC also adds allegations from thirteen confidential witnesses
("CWs"), none of whom is alleged to have had any direct contact
with either defendant and only one of whom is alleged to have
worked in Nortel's headquarters.
Defendants moved to dismiss the FAC on October 6, 2017.
The motion became fully submitted on November 10.
additional allegations in the FAC do not overcome the
deficiencies in the pleading, it is unnecessary to address
whether these allegations are barred by the Exchange Act’s
statute of repose.
When deciding a motion to dismiss under Rule 12(b)(6), Fed.
R. Civ. P., a court must accept as true all allegations in the
complaint and draw all reasonable inferences in the plaintiff’s
On August 14, 2017, the Court appointed Robbins Geller Rudman &
Dowd LLP as lead counsel. David Lucescu, who was named as a
plaintiff in the original complaint in this action, is not named
in the FAC.
Loginovskaya v. Batratchenko, 764 F.3d 266, 269-70 (2d
A claim has facial plausibility when “the factual
content” of the complaint “allows the court to draw the
reasonable inference that the defendant is liable for the
Tongue v. Sanofi, 816 F.3d 199, 209 (2d
Cir. 2016) (citation omitted).
In the context of a securities
class action, a court may consider not only the complaint
itself, but also “any written instrument attached to the
complaint, statements or documents incorporated into the
complaint by reference, legally required public disclosure
documents filed with the SEC, and documents possessed by or
known to the plaintiff and upon which it relied in bringing the
Id. (citation omitted).
Any complaint alleging securities fraud must satisfy the
heightened pleading requirements of the Private Securities
Litigation Reform Act (“PSLRA”) and Fed. R. Civ. P. 9(b) by
“stating with particularity the circumstances constituting
Employees’ Ret. Sys. of Gov’t of the Virgin Islands v.
Blanford, 794 F.3d 297, 304 (2d Cir. 2015) (citation omitted).
The PSLRA “builds on Rule 9’s particularity requirement,
dictating the pleading standard for claims brought under the
To satisfy the pleading standard for a
misleading statement or omission under Rule 9(b), a complaint
must “(1) specify the statements that the plaintiff contends
were fraudulent, (2) identify the speaker, (3) state where and
when the statements were made, and (4) explain why the
statements were fraudulent.”
Id. at 305 (citation omitted).
The PSLRA’s requirements are similar, stating that the complaint
specify each statement alleged to have been
misleading, the reason or reasons why the statement
is misleading, and, if an allegation regarding the
statement or omission is made on information and
belief, the complaint shall state with particularity
all facts on which that belief is formed.
15 U.S.C. § 78u–4(b)(1).
Thus, plaintiffs asserting claims
under the PSLRA “must do more than say that the statements were
false and misleading; they must demonstrate with specificity why
and how that is so.”
Carpenters Pension Trust Fund of St. Louis
v. Barclays PLC, 750 F.3d 227, 236 (2d Cir. 2014) (citation
I. Section 10(b) Legal Standard
The FAC alleges that defendants violated § 10(b) of the
Section 10(b) and its implementing SEC Rule 10b-5
make it unlawful to “make any untrue statement of a material
fact or to omit to state a material fact necessary in order to
make the statements made, in light of the circumstances under
which they were made, not misleading . . . in connection with
the purchase or sale of any security.”
5(b); see also 15 U.S.C. § 78j(b).
17 C.F.R. § 240.10b–
To state a claim under Rule 10b–5 for misrepresentations, a
plaintiff must allege that the defendant (1) made
misstatements or omissions of material fact, (2) with
scienter, (3) in connection with the purchase or sale of
securities, (4) upon which the plaintiff relied, and (5)
that the plaintiff’s reliance was the proximate cause of
Blanford, 794 F.3d at 305 (citation omitted).
a. Misstatements or Omissions of Material Fact
“Rule 10b–5 expressly requires an actual statement, one
that is either untrue outright or misleading by virtue of what
it omits to state.”
In re Vivendi, S.A. Securities Litigation,
838 F.3d 223, 239 (2d Cir. 2016) (citation omitted).
omission is actionable under the securities laws only when the
corporation is subject to a duty to disclose the omitted facts.”
Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 101 (2d Cir.
2015) (citation omitted).
“Such a duty may arise when there is
a corporate insider trading on confidential information, a
statute or regulation requiring disclosure, or a corporate
statement that would otherwise be inaccurate, incomplete, or
Id. (citation omitted).
“[E]xpressions of puffery and corporate optimism do not
give rise to securities violations” because “[p]eople in charge
of an enterprise are not required to take a gloomy, fearful or
defeatist view of the future; subject to what current data
indicates, they can be expected to be confident about their
stewardship and the prospects of the business that they manage.”
Rombach v. Chang, 355 F.3d 164, 174 (2d Cir. 2004) (citation
“To succeed” on a securities fraud claim, “plaintiffs
must do more than say that the statements in . . . press
releases were false and misleading; they must demonstrate with
specificity why and how that is so.”
On the other hand, a
defendant’s “[c]autionary words about future risk cannot
insulate from liability the failure to disclose that the risk
Id. at 173.
When statements of opinion are the basis for alleging a
violation of securities laws,
[t]he investor must identify particular (and
material) facts going to the basis for the issuer’s
opinion -- facts about the inquiry the issuer did or
did not conduct or the knowledge it did or did not
have -- whose omission makes the opinion statement
at issue misleading to a reasonable person reading
the statement fairly and in context.
Tongue, 816 F.3d at 209 (quoting Omnicare, Inc. v. Laborers
Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318, 1332
Liability for making a false statement of opinion may
lie if either “the speaker did not hold the belief she professed
or the supporting facts she supplied were untrue.”
F.3d at 210 (citation omitted).
But “opinions, though sincerely
held and otherwise true as a matter of fact, may nonetheless be
actionable if the speaker omits information whose omission makes
the statement misleading to a reasonable investor.”
Upon hearing a statement of opinion from an issuer, a
reasonable investor “expects not just that the issuer believes
the opinion (however irrationally), but that it fairly aligns
with the information in the issuer’s possession at a time.”
But, reasonable investors “understand that
opinions sometimes rest on a weighing of competing facts,” and
do “not expect that every fact known to an issuer supports its
Id. (citation omitted).
A statement of
opinion “is not necessarily misleading when an issuer knows, but
fails to disclose, some fact cutting the other way.”
Accordingly, meeting the Omnicare standard
“is no small task for an investor.”
Id. (citation omitted).
With respect to financial statements, such statements must
be reported in accordance with Generally Accepted Accounting
Principles, or GAAP.
The Financial Accounting Standards Board
(“FASB”), an independent private sector organization, is the
“designated organization in the private sector for establishing
standards of financial accounting and reporting” and promulgates
See S.E.C. v. Escala Group, Inc., 09cv2646 (DLC), 2009 WL
2365548, at *7 (S.D.N.Y. July 31, 2009).
While there are “19
different GAAP sources,” standards issued by FASB sit at the top
of the hierarchy of GAAP sources.
Hosp., 514 U.S. 87, 101 (1995).
Shalala v. Guernsey Mem'l
FASB's standards have been
recognized by the SEC as authoritative.
See Statement of Policy
on the Establishment and Improvement of Accounting Principles
and Standards, SEC Release No. AS–150, 1973 WL 149263, at *1
(Dec. 20, 1973).
The goal of financial reporting is to “provide information
that is useful to present and potential investors and creditors
and other users in making rational investment, credit, and
FASB Statement of Financial Accounting
Concepts No. 1, 11 (1978); see also Statement of Financial
Accounting Standards No. 168, Appendix A (June 2009).
“[F]inancial statements filed with the [SEC] which are not
prepared in accordance with generally accepted accounting
principles will be presumed to be misleading or inaccurate.”
re Fannie Mae 2008 Sec. Litig., 742 F. Supp. 2d 382, 408
(S.D.N.Y. 2010) (quoting 17 C.F.R. § 210.4–01(a)(1)).
As noted above, FASB’s Statement of Financial Accounting
Standards No. 142, titled Goodwill and Other Intangible Assets
(“SFAS 142”), provides that the value of goodwill should be
tested for impairment at least annually, and “more frequently if
events and circumstances indicate that the assets might be
The Second Circuit has held that “[e]stimates of
goodwill . . . are not matters of objective fact.”
Regions Fin. Corp, 655 F.3d 105, 110 (2d Cir. 2011).
of goodwill depend on management's determination of the fair
value of the assets acquired and liabilities assumed, which are
not matters of objective fact.”
A plaintiff arguing that a
defendant failed to properly record an impairment charge must
“point to objective standard[s] such as market price” that the
plaintiff claims defendant “should have but failed to use in
determining the value” of the company’ assets.
such a standard, an estimate of the fair value of those assets
will vary depending on the particular methodology and
Id. at 111.
Under §§ 10(b) and 20(a) of the
Exchange Act, a plaintiff “must plausibly allege that defendants
did not believe the statements regarding goodwill at the time
they made them to plead a material misstatement or omission.”
City of Omaha, Neb. Civilian Employee’s Retirement System v. CBS
Corp., 679 F.3d 64, 67 (2d Cir. 2012) (emphasis added).
Interim goodwill impairment testing is required only where
“events or changes in circumstances indicate that it is more
likely than not that the book value of a reporting unit exceeds
its fair value.”
Id. at 68 (citation omitted).
if [a plaintiff’s] complaint . . .
plausibly plead[s] that
defendants were aware of facts that should have led them to
begin interim impairment testing earlier, such pleading alone
would not suffice to state a securities fraud claim.”
To meet the scienter requirement in a Rule 10b–5 action
under the PSLRA, a plaintiff must “state with particularity
facts giving rise to a strong inference that the defendant acted
with the required state of mind.”
15 U.S.C. § 78u–4(b)(2)(A).
This “state of mind” requires a showing “of intent to deceive,
manipulate, or defraud, or recklessness.”
305 (citation omitted).
Blanford, 794 F.3d at
The PSLRA’s “strong inference”
requirement involves “taking into account plausible opposing
inferences and considering plausible, nonculpable explanations
for the defendant’s conduct, as well as inferences favoring the
Id. (citation omitted).
It is “not enough to set
out facts from which, if true, a reasonable person could infer
that the defendant acted with the required intent.”
Advanced Battery Techs., Inc., 781 F.3d 638, 644 (2d Cir. 2015)
Rather, “[t]he inference of scienter must
be cogent and at least as compelling as any opposing inference
one could draw from the facts alleged.”
Id. (citation omitted).
In making this judgment, a court “must assess the complaint in
its entirety, and not scrutinize each allegation.”
794 F.3d at 305.
“Allegations of a violation of GAAP provisions . . .
without corresponding fraudulent intent, are not sufficient to
state a securities fraud claim.”
Stevelman v. Alias Research
Co., 174 F.3d 79, 84 (2d Cir. 1999) (citation omitted).
Further, a company’s “subsequent revelation of its accounting
policy change and retroactive announcement of lowered earnings”
are not “probative of conscious misbehavior or recklessness.”
“Mere allegations that statements in one report should
have been made in earlier reports do not make out a claim of
Id. (citation omitted).
“The requisite scienter can be established by alleging
facts to show either (1) that defendants had the motive and
opportunity to commit fraud, or (2) strong circumstantial
evidence of conscious misbehavior or recklessness.”
134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co.,
553 F.3d 187, 198 (2d Cir. 2009) (citation omitted).
taken to maintain the appearance of corporate profitability, or
of the success of an investment does not entail concrete
benefits sufficient to demonstrate motive.”
Rombach, 355 F.3d
at 177 (citation omitted).
Although circumstantial evidence of conscious misbehavior
or recklessness may support a strong inference of scienter, “the
strength of the circumstantial allegations must be
correspondingly greater if there is no motive.”
at 199 (citation omitted).
ECA, 533 F.3d
To determine whether the complaint
raises a “strong inference” of scienter, courts must “take into
account plausible opposing inferences” to determine whether the
inference of scienter is “cogent and at least as compelling as
any opposing inference one could draw from the facts alleged.”
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 323,
In the securities fraud context, recklessness “must be
conduct that is highly unreasonable, representing an extreme
departure from the standards of ordinary care, not merely a
heightened form of negligence.”
In re Advanced Battery Techs.,
Inc., 781 F.3d at 644 (citation omitted).
An “allegation that
defendants behaved recklessly is weakened by their disclosure of
certain financial problems prior to the deadline to file its
Rombach, 355 F.3d at 176.
“[m]ere allegations of GAAP violations or accounting
irregularities or even a lack of due diligence will not state a
securities fraud claim absent evidence of corresponding
In re Advanced Battery Techs., Inc., 781
F.3d at 644 (citation omitted).
When the defendant is a corporate entity, this means that
the pleaded facts must create a strong inference that
someone whose intent could be imputed to the corporation
acted with the requisite scienter. In most cases, the most
straightforward way to raise such an inference for a
corporate defendant will be to plead it for an individual
Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital
Inc., 531 F.3d 190, 195 (2d Cir. 2008).
The Second Circuit has
not, however, held that the reverse is true: when a defendant is
an individual it is insufficient to allege that the corporation,
as a whole, acted with the requisite scienter and impute that
intent to an individual defendant.
A showing of corporate
scienter is inadequate to assign that scienter to individual
II. Section 20(a) Legal Standard
Section 20(a) of the Exchange Act imposes derivative
liability on persons that control others who violate the
In re Vivendi, 838 F.3d at 238 n.6.
(a) Joint and several liability; good faith defense
Every person who, directly or indirectly, controls any
person liable under any provision of this chapter or
of any rule or regulation thereunder shall also be
liable jointly and severally with and to the same
extent as such controlled person to any person to whom
such controlled person is liable (including to the
Commission in any action brought under paragraph (1)
or (3) of section 78u(d) of this title), unless the
controlling person acted in good faith and did not
directly or indirectly induce the act or acts
constituting the violation or cause of action.
15 U.S.C. § 78t(a) (emphasis supplied).
The statutory language identifies two components to a
control person claim: (1) a primary violation by a controlled
person and (2) direct or indirect control of the primary
violator by the defendant.
defense of good faith.
It also provides for an affirmative
The concept of “culpable participation,”
which is a regular fixture of the Second Circuit’s
jurisprudence, describes that degree of control which is
sufficient to render a person liable under § 20(a).
WorldCom, Inc. Sec. Litig., 02cv3288 (DLC) 294 F. Supp. 2d 392,
415 (S.D.N.Y. 2003); cf. Fed. Hous. Fin. Agency v. Nomura
Holding Am., Inc., 11cv6201 (DLC), 104 F. Supp. 3d 441, 575-78
(S.D.N.Y. 2015) (analyzing trial evidence of the nature of the
controlled entity, the status of the alleged controlling entity,
and the actions taken by the controlling entity on behalf of the
controlled entity) (Section 15 of the Securities Act).
is no required state of mind for a defendant’s culpable
participation in a Section 20(a) offense.”
In re WorldCom, Inc.
Sec. Litig., 294 F. Supp. 2d at 415; see In re WorldCom, Inc.
Sec. Litig., 02cv3288 (DLC), 2005 WL 638268, at *13 (S.D.N.Y.
Mar. 21, 2005).
Control over a primary violator may be established by
showing that the defendant possessed “the power to direct or
cause the direction of the management and policies of the
primary violators, whether through the ownership of voting
securities, by contract, or otherwise.”
In re Lehman Bros.
Mortg.-Backed Sec. Litig., 650 F.3d 167, 185 (2d Cir. 2011)
Once the plaintiff makes out a prima facie
case of liability under § 20(a), the burden shifts to the
defendant “to show that he acted in good faith, and that he did
not directly or indirectly induce the act or acts constituting
SEC v. First Jersey Sec., Inc., 101 F.3d 1450,
1473 (2d Cir. 1996) (citation omitted).
a. The Alleged Misstatements
In opposition to this motion to dismiss, the plaintiffs
rely on two sets of alleged misstatements.
First, they assert
that Zafirovski’s statements surrounding Nortel’s first and
second quarter results are misleading and false to the extent
that he did not discuss the reduction in capital investments by
certain Nortel customers.
Second, they assert that the
statements in Nortel's first and second quarter financial
reports -- the Forms 10-Q, signed by defendant Binning -- that
the company's financial results were reported in compliance with
GAAP were false.
Neither set of alleged misstatements supports
i. Statements Regarding Customers
The defendants moved to dismiss the FAC’s claims to the
extent they were premised on the defendants’ vague statements of
In opposition to this motion, the plaintiffs rely
exclusively on statements made in a May 7, 2008 press release,
which was issued on the heels of Nortel’s annual shareholder
The FAC refers to statements made the day the first quarter
results were announced –- May 2, 2008 -- as well as at the
annual shareholders meeting on May 7, 2008, and in an additional
press release published on May 21, 2008 in conjunction with a
debt offering. It also points to statements made in relation to
Nortel’s second quarter results: statements in the August 1,
2008 press release and conference call.
The plaintiffs contend that Zafirovski's statements in
that press release regarding Nortel's relationships with its
customers created a duty to disclose that Nortel was facing
problems with its most important customers.
The statements on which the plaintiffs rely include such
We see a big opportunity to step forward and become the
‘voice of the customer’ within communications and
technology markets by driving innovation in ways that
solves our customers’ biggest challenges . . . . We are
turning customer focus into a competitive advantage by
improving satisfaction . . . . Nortel is not only
addressing customer needs through innovation, but through
operational initiatives as well. . . . Nortel's growing
momentum with customers is evidence of progress against the
company's business transformation plan . . . . Our
customer engagements are proving our relevance and momentum
. . . . I believe, more than ever, that we are on the
right path today and are rebuilding our company in the
right way. We have improved employee and customer
satisfaction. We have made progress on our business
transformation plan and customers are coming on
board . . . .
The plaintiffs do not assert that any of these statements
They do assert, however, that they created a duty to
add information about existing problems that Nortel had with
certain customers to avoid being misleading.
To support that
assertion they rely on the following information provided by
The plaintiffs’ opposition to this portion of the defendants’
motion refers only to paragraphs 111 to 112 of the FAC.
Nortel had experienced a significant decline in
revenue from its largest customer between 2006 and 2008, and
that decline was apparent by early 2008.
Two other large
customers had already announced that they were reducing their
forecasted capital expenditures for 2008 or were not ordering
any additional equipment from Nortel in 2008.
Canadian customers had selected Nortel competitors to provide
them with high speed wireless equipment.10
For several reasons, the plaintiffs have not pleaded a
claim that Zafirovski was required to discuss specific customers
to correct or complete his statements regarding customer
momentum and other customer-related statements.
Zafirovski’s statements were general statements about the goals
and progress of the company in providing service to its
Each of these statements was forward-facing and a
broad description of the company’s goals.
The statements were
not made in the context of discussions of specific customers or
The opposition brief points to information provided by CWs 2,
3, 4, 12 and 13.
The FAC does not indicate whether the selection of competitors
to provide high speed wireless equipment was already known to
Second, Nortel had already disclosed and emphasized that
its own fortunes were dependent on the capital investments its
customers would be making, and that that investment was
uncertain given the overall financial climate.
For instance in
the May 2 press release, Nortel signaled that the statements
made were forward-looking and took into account certain
assumptions, like stable growth in customers’ capital
expenditures and that the company’s success was “ultimately
based on the customers embracing [the company’s] strategy.”
the May 2 conference call, in response to a question about
wireless demand from customers, Zafirovski answered that the
demand was “pretty flattish overall.”
He reminded shareholders
and analysts that Nortel was operating in a “tough macro
environment” and a “very uncertain environment.”
Third, the public was aware that some Nortel customers had
cut back business with Nortel or were generally reducing their
By May, at least two customers to which
the CWs refer had already made public disclosures of those
decisions; Nortel had no obligation to remind investors of
information that was already publicly disclosed.
Zafirovski admitted on August 1 that one significant North
American customer had “shut the door” on short term capital
expenditures, the plaintiffs do not allege that any shareholder
or analyst followed up on that statement and asked for more
The plaintiffs also allege that
revenue from one customer declined significantly because Nortel
failed to win the customer’s “LTE” business.
But the FAC
acknowledges that this failure became clear at “the end of
2008,” after the allegedly misleading statements at issue were
In sum, the plaintiffs have not pleaded a claim that
defendants made misleading statements with respect to customer
ii. Goodwill Impairment
The defendants also move to dismiss the claims premised on
Nortel’s assertion of its compliance with GAAP, specifically in
connection with the valuation of Nortel’s goodwill in the first
and second quarter Forms 10-Q signed by defendant Binning.
contend that the plaintiffs’ claim amounts to nothing more than
a disagreement about Nortel’s subjective accounting judgments.
The plaintiffs allege that the estimate of Nortel’s
goodwill of almost $2.6 billion in the Forms 10-Q for the first
and second quarters of 2008 was materially false and misleading
because the two documents failed to disclose that Nortel was
delaying recognizing an impairment charge.
that GAAP, specifically SFAS 142, required Nortel to perform an
interim impairment test no later than May 2008, rather than in
September 2008, when it took an impairment charge of $1.142
Because estimates of goodwill are not matters of objective
fact, plaintiffs must allege that defendant Binning did not
believe the statements regarding goodwill made in the Form 10-Q
Plaintiffs argue that Binning could not have plausibly
believed that an impairment charge was not necessary in May 2008
and therefore the statements in the first and second quarter
Form 10-Qs were misstatements of material fact.
In opposition to this motion, the plaintiffs rely on
essentially three facts to support their assertion of falsity.
In May 2008, defendants reported that the value of Nortel’s
goodwill was $2.57 billion as of March 21, 2008, while the
market valued all of Nortel at $2.93 billion.
This meant that
Nortel’s non-goodwill assets were valued at a total of only $360
Second, plaintiffs assert that Nortel had experienced
“financial losses” for the five previous quarters and was losing
They argue that this reflects a sustained
decline that made an interim impairment analysis of goodwill
Finally, they contend that the “same circumstances”
that led to the September impairment existed in May.
As noted above, estimates of goodwill are not matters of
They are statements of opinion, and understood
as such by investors.
To be actionable as a false statement,
the FAC must adequately plead that Binning did not believe the
statements regarding Nortel’s goodwill.
None of plaintiffs’
contentions actually speak to defendant Binning’s state of mind
when making statements about Nortel’s goodwill in the Forms 10Q, and so fail to state a claim against him for securities
Even if he knew of facts that cut against the
representations of Nortel’s goodwill, that does not make the
statements, which are statements of opinion, false or
As explained in more detail below when the scienter
allegations are discussed, in the very particular circumstances
of this company and the economic climate of 2008, these
allegations are insufficient to state a claim that the
assurances that Nortel complied with GAAP were false.
b. Defendants’ Scienter
Even if the plaintiffs had adequately pled that either
defendant made a misstatement or omission of material fact, they
have not adequately pled that either defendant acted with
The plaintiffs do not assert in opposition to this
motion that either defendant was motivated to engage in fraud
because of a “concrete and personal” benefit he would receive
from the fraud.11
Instead, plaintiffs contend that the FAC
pleads conscious or reckless misbehavior.
Both defendants had acquired a substantial number of Nortel
shares before the Class Period. Zafirovski did not sell any of
his shares during the class period. Binning sold about 5% of
i. Customer-Related Statements and Financial Guidance
Plaintiffs' contention that they have alleged scienter by
demonstrating Zafirovski’s conscious misbehavior or recklessness
with respect to his customer-related statements and forwardlooking financial guidance is unavailing.
Relying heavily on
information provided by the CWs, plaintiffs contend that they
have adequately alleged that Zafirovski either knew or should
have known in May 2008 that Nortel was in financial distress
because of a dwindling and dissatisfied customer base.
Zafirovski had access, the plaintiffs argue, to non-public
information regarding Nortel’s customers and chose to conceal
In opposing this motion to dismiss, as noted above, the
plaintiffs have identified Zafirovski’s May 7, 2008 statements
as the statements that were false and misleading.
forward-looking statements of general optimism regarding
Nortel’s progress as it worked to emerge from its troubled past,
cabined by cautionary warnings.
They were statements of
The plaintiffs have not pleaded facts that plausibly
allege that Zafirovski made these statements with the requisite
This is true with respect to any particular statement
that he made on May 7 and also true with respect to the May 7th
statements taken as a whole and considered in context.
The information provided by the CWs does not alter this
None of the CWs asserts that he or she reported to
Zafirovski or had any discussions with him, including on the
issues he discussed on May 7.
While the apparent absence of
such direct access to Zafirovski is not controlling, the lack of
such access underscores the paucity of the FAC’s allegations
regarding Zafirovski’s scienter.
Moreover, nothing that Zafirovski said on May 7 created a
duty to discuss any particular Nortel customer or to have a more
detailed discussion about Nortel customers generally.
result, no fair inference can be drawn from Zafirovski’s failure
to make more pointed comments about customers on that occasion.
Without more, the allegations in the FAC fail to demonstrate
that Zafirovski recklessly disregarded information about Nortel
customers and misled the public with his statements.
fails to give rise to a strong inference of his intent to
deceive, manipulate or defraud investors or of his recklessness.
ii. Interim Impairment
In their discussion of scienter in opposition to this
motion to dismiss, the plaintiffs principally discuss scienter
in the context of their allegation that Nortel improperly
delayed taking an impairment to goodwill.
As already explained,
the plaintiffs have not plausibly alleged that Binning did not
believe the statements regarding Nortel’s compliance with GAAP
or Nortel’s goodwill in Nortel’s first and second quarter Forms
10-Q for 2008.
Because estimates of goodwill are based on
management’s determination of the value of the company, they are
inherently matters of judgment and subjective.
To recap, plaintiffs contend that Nortel should have taken
an impairment charge by May 2008, the beginning of the Class
Nortel conducted an initial interim test of impairment
to its goodwill in September 2008, four months after plaintiffs
argue it should have done so.
Ultimately, the plaintiffs and
defendants simply disagree on the timing for an impairment
On September 17, amidst a global economic crisis,
Nortel pre-announced its third quarter results, explaining the
significant financial stress the company was under.
the FAC alleges that statements that Nortel made in one report
should have been made in an earlier report.
In its 2008 Form 10-K, filed in March 2009, Nortel listed
factors that caused it to perform an interim period goodwill
impairment test in September 2008.
The FAC does not suggest
that there was any misrepresentation or omission in that
Unsurprisingly, those factors were substantially
tied to the extraordinary market events that occurred in the
Plaintiffs allege that the May 2008 debt offering was only
possible by fraudulently delaying an impairment charge.
Fall of 2008 and that had a profound impact on many companies,
not just Nortel, and on the world’s economy.
Nor do the other facts on which the FAC relies to plead
that the May 2008 report of goodwill was false plausibly plead
Nortel’s history of financial losses and
the relatively low value of its non-goodwill assets were
unremarkable in the context of the company’s troubled history.
An expectation that Nortel’s new management would be able to
rebuild the company’s fortunes does not constitute an intent to
deceive or defraud investors.
Without plausible allegations of
fraudulent intent or an extreme departure from the standards of
ordinary care, there is no adequate pleading that Binning acted
with the requisite scienter.
In sum, the FAC fails to give rise to a strong inference of
Because the plaintiffs do not adequately allege that
defendants made an actionable misstatement or material omission,
or that that they did so with scienter, the FAC fails to state a
legally sufficient claim under § 10(b) of the Exchange Act.13
c. Section 20(a) Claims
Plaintiffs allege control person liability under § 20(a) of
the Exchange Act.
Their failure to state a claim under § 10(b),
Because the FAC fails to allege both falsity and scienter it
is unnecessary to reach the defendants’ remaining arguments
regarding the deficiencies in the plaintiffs’ § 10(b) claims.
however, precludes relief under § 20(a).
See SEC v. First
Jersey Sec., Inc., 101 F.3d 1450, 1472 (2d Cir. 1996).
Dismissal of the § 20(a) claim is therefore warranted.
Defendants' October 6, 2017 motion to dismiss the Amended
Complaint is granted.
The Clerk of Court shall enter final
judgment for the defendants and close the case.
New York, New York
April 11, 2018
United States District Judge
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