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September 28, 2000


The opinion of the court was delivered by: Cedarbaum, District Judge.


Plaintiffs in these consolidated class action suits assert claims against defendants under §§ 10(b) & 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) & 78t(a), and under Rule 10b-5. The essence of plaintiffs' complaint is that defendants, who were officers of Northern Telecom Ltd. ("Nortel") during the class period, made misleading statements over a period of time concerning the company's business and financial health that artificially inflated the price of Nortel's stock. Extensive discovery has been completed, and defendants move for summary judgment on all claims. For the reasons discussed below, the motion is granted in its entirety.


The following facts are undisputed unless otherwise noted.*fn1

I. The Parties

Plaintiffs Max Fecht, Stephen R. Raab, Guidance Components Corp., and Leon Shapiro together purchased 650 shares of Nortel stock from May 19, 1993 through June 24, 1993. Plaintiffs Boston International Partners, L.P. and Irwin Sternberg collectively bought 35 call options on June 18 and June 28, respectively. The class excludes foreign subjects or citizens who purchased Nortel securities outside the United States. The class period runs from January 26, 1993 through July 20, 1993 (the "Class Period").

Nortel is a Canadian corporation. During the Class Period, its principal place of business was located in Mississauga, Ontario, Canada. The company's common stock is traded on the Toronto, Montreal, New York, Vancouver, London, and Tokyo exchanges. Nortel is a major producer of a variety of communications products, including telephone switching systems.

All of the individual defendants were officers of Nortel during all or part of the Class Period. Jean C. Monty was President and a Director of Nortel and became Chief Executive Officer on March 1, 1993. Martin G. Mand was Nortel's Chief Financial Officer. Edward E. Lucente served as Nortel's Executive Vice President for marketing from 1992 until March 15, 1993. Roy G. Merrills served as a Vice President of Nortel, as Chairman of Nortel's United States subsidiary, Northern Telecom Inc. ("NTI"), and, as of July 1, 1993, in a new position entitled "Executive Vice President of the Americas." Alan G. Lutz was a Senior Vice President and President, Switching Networks, of Nortel until July 1, 1993. Desmond F. Hudson was Senior Vice President of Nortel and President of Northern Telecom Europe. Frank A. Dunn was a Vice President and Nortel's Deputy Controller and later Controller. The complaint alleges that all of the individual defendants are controlling persons under § 20(a) of the Securities Exchange Act of 1934.

II. Events Preceding the Class Period

During the three years preceding the Class Period, Nortel reported revenues of $6.8 billion in 1990, $8.2 billion in 1991, and $8.4 billion in 1992, respectively. Nortel reported research and development investments of $773.7 million, $948.3 million, and $930.5 million during each of those respective years. Nortel reported earnings per share growth from $1.80 to $2.03 in 1991 and to $2.17 in 1992.

As of 1993, Nortel produced a number of products, including central office digital switching and transmission equipment. A central office switch is essentially a large computer used to direct telephone operations. Nortel's switching software was customized for each customer and provided telephone companies with a variety of features, such as call waiting, call forwarding, and voice recognition. Transmission equipment is necessary to carry highspeed transmission of data and voice over optical fiber networks. In 1992 and 1993, Nortel was awarded substantial contracts by a number of Canadian and United States telephone companies to supply equipment for their networks.

In 1992, revenues from the United States accounted for $4.5 billion, or approximately 54% of Nortel's total revenues. Central office switching revenues worldwide accounted for approximately $4.24 billion, or 50%, of total revenues.

Nortel internally estimated its United States market share in switching equipment, excluding AT & T's own internal equipment purchases and including MCI and Sprint, at 51% in 1991 and 53% in 1992. At all relevant times, Nortel's principal competitors included AT & T (now Lucent Technologies), Ericsson, Nokia, and Alcatel.

In 1991-93, the largest telephone companies spent billions of dollars upgrading their networks through what Nortel terms "megadeals." Nortel obtained a number of these contracts. In 1991, for example, Nortel won 75% of a $1 billion contract with Ameritech to upgrade Ameritech's analog switching systems. By 1993, Nortel had captured 53% of BellSouth's switching market share. In 1992, Pacific Bell chose Nortel switches in a multi-million dollar contract to replace its remaining analog switches. Also in 1992, MCI awarded Nortel a $225 million network upgrade supply agreement. On January 25, 1993, the day before the Class Period began, Pacific Bell awarded Nortel almost half of a $1 billion contract to upgrade its analog switches.

In 1993, the only major switching deal was NYNEX's replacement of millions of lines of analog switches. Nortel won over half of that contract.

Unlike AT & T, Nortel's closest competitor in the United States digital switching market, Nortel did not compete with RBOCs for telephone customers.

Nortel solicited customer feedback from the RBOCs. Customers were encouraged to evaluate Nortel through regular surveys and Nortel crafted Customer Satisfaction Improvement Plans and Strategic Plans for Customer Satisfaction and Quality to address customers' concerns.

As phone companies spent billions of dollars on new digital networks, Nortel switches became a substantial component of the phone companies' "embedded base." RBOCs expected central office switches to last from ten to twenty years. Nevertheless, central office switches required constant additions and modifications over that period.

III. The DMS Evolution

Software was the greatest cause of dissatisfaction among Nortel's customers in the years leading up to the Class Period. The "BCS" software which operated Nortel's digital switches contained over 20 million lines of code. Nortel's customers demanded a high level of reliability in the switching software. One set of performance benchmarks, called the Local Switching Systems Generic Requirements ("LSSGR") standards, provided that there should be no more than one incident per switch every three years or three minutes of switch downtime per system per year. In 1992, Nortel's software releases had approximately one incident per year and 6.54 minutes of downtime per year. Nortel planned improvements to meet the LSSGR standards and exceed them by 1995.

Starting in mid to late 1992, Nortel's switching unit began the process of changing the architecture of its software, a project referred to as the "DMS Evolution." The objective of the project was to create a core layer of software with semi-customized features layered on top. With such a structure, future development could concentrate on the outer layers, which would simplify and accelerate the development process. In 1992, Nortel committed hundreds of software engineers to this effort. The project cost for 1993 was estimated at $71 million of a total research and development budget approximating $1 billion. The DMS Evolution included consultation with Nortel's customers to discuss software problems and how they could be corrected.

IV. The 1993 Budget

Nortel does not publicly disclose its annual or quarterly budgets. In 1992, when the 1993 budget was created, Nortel's senior management developed a set of corporate objectives which were distributed to the business units. Senior management demanded greater budgetary objectives from the business units. One reason the business units resisted committing to higher targets was that incentive compensation depended on meeting yearly budget forecasts. This was true for senior management as well. Management "had a personal incentive to get the board to accept the lowest possible earnings per share budget, because the budget earnings per share became the center of their matrix for their added compensation." (Butler Dep. at 245.) Yearly performance, and not quarterly performance, was used to calculate whether goals had been met. For the fifteen years spanning 1978-92, Nortel achieved its internal budget forecasts in all but three years.

Once the 1993 budget was created by management, it was presented to and approved by Nortel's Board of Directors in December 1992, although it was amended in some respects in January 1993. Management then broke the yearly numbers into quarters. The practice of breaking down the budget by quarters was employed because historically Nortel's revenues, as is common in the telecommunications industry, exhibited a so-called "hockey stick" effect such that revenues were heavily weighted toward the final quarter, when the RBOCs spent the bulk of their capital budgets as approved by public utility commissions.

The approved budget for 1993 forecast a record year for 1993 in all respects: revenues of $9.4 billion, up 12%; orders of $9.7 billion, up 6%; and earnings per share of $2.35, up from $2.17 in 1992. In the U.S., a similar record was forecast in revenue, including switching.

V. The Class Period

A. Statement One

On January 26, 1993, Nortel issued a seven-page news release reporting results for 1992, including record orders, revenues, and earnings. The first of the six challenged statements ("Statement One") is an excerpt from the first sentence of a paragraph on page six which reads, "[o]ur product lines have never been stronger. . . ." Following this release, Nortel's share price rose $2.50 per share to $44.75. Neither the financial press nor analysts' reports ever referred to Statement One.

Two days after the statement, Paul Stern announced that he would step down as CEO effective March 1, and would become non-executive chairman. Jean Monty, then President and COO, became the new CEO.

B. Statement Two

On March 9, 1993, Nortel issued a four-page news release announcing several internal management changes in marketing and sales. The second challenged statement ("Statement Two") is an excerpt from a quotation on page three from Dennis Matteucci, NTI's new Vice President for sales, that "we will continue to deliver the best of new technologies. . . ." Nortel's share price declined after this news release was issued. Neither the financial press nor analysts' reports ever referred to Statement Two.

C. Statements Three and Four

Four appeared in some analysts' reports.

D. Statement Five

By February 1993, Nortel's internal flash reports showed that there was a risk of variance from budgeted projections for the first quarter. Nortel's management practice, referred to as assigning "taskings," is to commit the executives in the field to work harder to make up such a shortfall. In February and March, taskings were assigned. However, notwithstanding the taskings, before the quarter's end, it appeared likely that Nortel would fall short of its internal forecasts.

Nortel's Board of Directors met on March 25, 1993. Management made a presentation to the board explaining that performance for the first quarter was likely to be disappointing. On that same afternoon, Nortel issued a two-page news release warning in the first sentence that "earnings for the first quarter of 1993 will be below 1992's record performance and analysts' expectations." The reasons cited for the cautious earnings estimate included increased strategic R & D and international market development expenditures, lower software revenues, and lower pricing in central office switching in North America. The report quotes Monty, then Nortel's president and CEO, on the outlook for 1993: "Although we are not satisfied with expected first quarter results, ...

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