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August 3, 2001


The opinion of the court was delivered by: William C. Conner, Senior District Judge.


Plaintiffs John Faulkner, William Campaigne, Harry Haidet, and Coolidge C. Elder, trustee on behalf of the Coolidge C. and Hildegard N. Elder Revocable Trust, purchasers of publicly traded notes issued by NorthPoint Communications Group, Inc. ("NorthPoint"), bring this action against defendant Verizon Communications, Inc. ("Verizon") pursuant to § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. ¶¶ 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, for alleged fraudulent misrepresentations in connection with a contemplated merger with NorthPoint. Verizon now moves to dismiss the Complaint pursuant to FED. R. Civ. P. 12(b)(6) and 9(b). Plaintiffs cross-move to lift the automatic stay of discovery imposed by the Private Securities Litigation Reform Act of 1995 ("PSLRA") when a motion to dismiss is pending.

For the reasons stated hereinafter, Verizon's motion to dismiss is granted. However, plaintiffs are granted leave to amend the Complaint pursuant to FED. R. Civ. P. 15. Plaintiffs' cross-motion to lift the PSLRA stay is denied.


I. Merger Between NorthPoint and Verizon

Unless stated otherwise, the following facts are gleaned from the Complaint.

This suit is based on the anticipated merger between Verizon and NorthPoint, agreed to by the corporations in 2000 and scheduled to close in 2001.

Plaintiffs, individually and on behalf of the represented Class, purchased 12 7/8% Senior Notes issued by NorthPoint (the "Notes"), between November 14, 2000 and November 29, 2000 (the "Class Period"). (¶ 1.) Plaintiffs purchased the Notes at prices between 0.9275 and 0.9850 times their face value. (¶ 12.) The Notes contained a "change of control" feature which obligated NorthPoint to offer to purchase the Notes at 101% of the aggregate principal amount of the Notes plus accrued and unpaid interest if the consummation of a transaction, e.g., a merger, resulted in another entity owning more than 50% of the total voting stock or total common equity of the company. (¶¶ 20-21.)

Verizon, the resulting entity of a merger between Bell Atlantic Corporation and GTE Corporation, is the largest provider of wireline and wireless communications and the second largest provider of digital subscriber line ("DSL") services in the United States. (¶ 13.) It operates in 40 countries, has approximately 2.7 billion shares of outstanding common stock and, in 1999, generated approximately $60 billion in revenues. (¶¶ 13-14.)

NorthPoint, formed in 1997, was a national provider of highspeed, local data network services which use DSL technology to transport data over telephone company copper lines 25 times faster than common dial-up modems. (¶¶ 15-16.) As a start-up DSL service provider, it incurred massive losses and negative cash flow. In 1999, it reported net losses of $440 million. (¶ 25.) In its Form 10-Qs, it reported negative cash flow from operations and investing activities in the amount of $406 million for the six-month period ending June 30, 2000, which increased to $595 million by September 30, 2000. (Id.) Indeed, NorthPoint reported increasing net losses of $80 million, $112 million and $136 million, for the first, second and third quarters of the 2000 fiscal year. (¶ 24.) Moreover, in accordance with the securities laws, it repeatedly advised its investors that it expected its operating expenses and losses to increase in the future. (¶¶ 22-23.)

On August 7, 2000, NorthPoint and Verizon entered into a Merger Agreement. (¶ 29.) Pursuant to the Merger Agreement and the accompanying Funding Agreement, Verizon agreed to contribute $800 million in cash ($450 million to fund NorthPoint's capital expenditures and operations and $350 million to be paid to NorthPoint's shareholders) and more than $500 million of Verizon DSL assets in exchange for a 55% equity interest in NorthPoint. (¶ 27.) Verizon also agreed to provide interim financing of $200 million by January 1, 2001 and to purchase $150 million of NorthPoint nonvoting 9% convertible preferred stock. (¶ 28.)

The Merger Agreement contained three relevant provisions. First, Verizon was required to (1) "use all commercially reasonable efforts to obtain in a timely manner all necessary waivers, consents and approvals and to effect all necessary registrations and filings" and (2) "use all commercially reasonable efforts to take, or cause to be taken, all other actions and to do, or cause to be done, all other things necessary, proper or advisable to consummate and make effective as promptly as practicable the transactions contemplated by this [Merger] Agreement." (¶ 29.) August 7, 2001 was the scheduled termination date. (Id.) Second, the parties agreed not to "issue any press release or public statement with respect to this [Merger] Agreement or the transactions contemplated hereby . . . without prior consent" of the other entity. (¶ 30.) Third, Verizon was given the right to terminate only in the case of a Material Adverse Effect, defined as "any fact, event, change or effect having, or which will have, a material adverse effect on the business, operations, properties . . ., financial condition, assets or liabilities of NorthPoint. . . ." (¶¶ 32-33.)

On August 8, 2000, Verizon and NorthPoint jointly announced the proposed merger. (I 35.) In this announcement, Verizon proclaimed, inter alia, that the merger was a "groundbreaking agreement to fundamentally change the dynamics of the broadband industry." (¶ 37.) Verizon Vice-Chairman, President and Chief Operating Officer Lawrence T. Babbio (¶¶ 37, 44) represented that "this deal combines complementary assets — Verizon's position in the consumer market and NorthPoint's presence with business customers — to provide the scale to fuel growth and deliver the full benefits of high speed connections." (1137.) Verizon CEO Ivan Seidenberg extolled the merger as one which "will take us a long way toward achieving national scale in our broadband operations and putting another `piece of the bundle in place.'" (¶ 39.)

From NorthPoint's perspective, the market reacted relatively well to the news of the merger. Following the August 8, 2000 announcement, the market price of the NorthPoint's $1,000 Notes increased from approximately $600 to approximately par, or $1,000. (¶ 36.) Conversely, the market value of Verizon's stock plummeted. For example, on August 7, 2000, 5 million Verizon shares were traded, closing at a price of $47 7/8 per share. On August 8, 2000, 33 million shares were traded, closing at a price of $42 1/2 per share. On August 9, 2000, 22 million shares were traded, closing at a price of $40 3/8 per share. (¶ 57.)

Moreover, the merger received negative reactions from analysts. On August 9, 2000, Paine Webber bluntly stated that it did not understand the transaction and remarked that "Verizon gave up too much to get too little." (¶ 58.) Similarly, on the same day, the New York Times described the merger as a "peculiar structure" and predicted that the merger will dilute "Verizon's per-share earnings growth by about 5 percent." (¶ 59.)

Nevertheless, in its Form 10-Q filed on August 14, 2000, for the period ending June 30, 2000, Verizon represented that the Merger was expected to be completed in mid-2001. (¶ 40.) On September 6, 2000, NorthPoint and Verizon issued a joint press release in which they announced that Verizon had funded $150 million through the purchase of preferred stock and that they "expect[ed] the deal to close by mid-2001." (¶ 43.) In the October 2000 edition of Telecommunications, Babbio stated that "the new strategy will expand broadband choice for customers by providing a superior alternative to cable." (¶ 44.) On October 26, 2000, NorthPoint Chief Executive Officer Liz Fetter stated in a conference call that "the merger with Verizon continues on schedule" and "[t]wo months after the announcement, we are even more excited by what the deal holds, not only for NorthPoint, but also for the future of the broadband industry. We continue to be on track for a closing in the first half of 2001 . . ." (¶ 45 (emphasis in original).)

On October 26, 2000, NorthPoint filed its Form 10-Q for its third fiscal quarter, reporting operating losses of $106 million and net losses of $125 million on revenues of approximately $30 million, but acknowledged it had opted not to recognize revenues for certain data industry customers in troubled financial condition. (¶¶ 46-47.) In any event, it confirmed, with Verizon's prior approval, that "[w]e continue to be on track with our prior expectation of doing the transaction in the first half of 2001." (¶ 46.)

Allegedly, during the next two weeks, NorthPoint's management advised Verizon's senior executives that it had decided to revise its previously disclosed thirdquarter results and recognize total operating losses in the amount of $118 million and net losses in the amount of $136 million. (¶ 48.) Verizon gave no indication that a Material Adverse Effect had occurred. (¶ 50.) Instead, on November 14, 2000, Verizon filed its own Form 10-Q for the period ending September 30, 2000, which stated:

During August 2000, we announced a merger with NorthPoint . . . We expect the Merger to close in 2001. . . . Upon completion of the Merger we will own 55% of NorthPoint and will consolidate its results. . . . In addition, we have agreed to make a cash investment in NorthPoint of $450 million. Up to $350 million of this investment will be in the form of financing prior to the closing.

(Id. (emphasis in original).)

On November 20, 2000, NorthPoint, after receiving Verizon's prior consent, issued a press release announcing its revised third-quarter results, but reassured its investors that "we continue to be on track with our prior expectation of closing the Verizon transaction in the first half of 2001." (¶ 51 (emphasis in original).) Finally, on November 29, 2000, Verizon announced that it was unilaterally terminating the Merger Agreement, on the basis that NorthPoint's revised third-quarter figures constituted a Material Adverse Effect under the Merger Agreement. (¶¶ 5, 52.)

The effects of Verizon's actions were fatal for NorthPoint. Soon after the termination, the market price of NorthPoint's notes plunged from $120 to $150 per Note, or 12-15% of their face value. (¶ 63.) By January 10, 2001, the Notes traded for less than 10% of their face value. (¶¶ 7, 67.) NorthPoint was force to reduce its workforce by 20%. (¶ 66.) Finally, on January 16, 2001, it filed for bankruptcy pursuant to Chapter 11 of the Bankruptcy Code. (¶ 68.) Conversely, the market price of Verizon's stock increased, and it received positive reactions from analysts. (¶ 62.)

Plaintiffs argue that Verizon's stated reasons for terminating the merger were a mere "pretext" for Verizon to avoid its financing obligations which had already had a negative impact on Verizon's near-term earnings. (¶¶ 5, 53.) Indeed, plaintiffs allege that no later than November 14, 2000, "Verizon was no longer using commercially reasonable efforts to consummate the Merger, but rather had soured on the deal and was exploring ways to justify terminating the Merger Agreement and its funding obligations" (¶ 56) of $200 million prior to January 1, 2001. (¶ 4.) This was allegedly a result of the negative reaction the merger received from analysts and its concomitant stock price decline. (¶ 56.) NorthPoint argues that Verizon had know of the revised third-quater results prior to the filing of its November 14, 2000 From 10-Q as well as its approval of NorthPoint's November 29, 2000 press release. "The truth is that increase in NorthPoint's reported losses and negative cash flow were not contrary to expectations." (¶ 5; see ¶¶ 49, 53.)

II. Lawsuits Commenced by Verizon and NorthPoint

On December 1, 2000, Verizon filed a lawsuit against NorthPoint in the Delaware Superior Court seeking a declaratory judgment that NorthPoint's financial difficulties constituted a Material Adverse Effect under the Merger Agreement. (¶ 64; see Verizon Communications, Inc. v. NorthPoint Communications Group, Inc., Civ. No. 00C-11-240 (Del.Super.Ct. Dec. 1, 2000.))

On December 8, 2000, NorthPoint commenced a lawsuit against Verizon in the California Superior Court, San Francisco County (the "NorthPoint California litigation"), asserting claims of breach of contract, fraud, negligent misrepresentation, and violation of CAL. BUS. & PROF. CODE § 17200. (¶ 65; see NorthPoint Communications Group, Inc. v. Verizon Communications, Inc., No. 317249 (Cal.Super.Ct. Dec. 8, 2000).)*fn1 It alleged that Verizon was without a basis to terminate that Merger Agreement and that its purported reasons were merely a pretext designed to free Verizon from its investment obligations and to lift its depressed stock prices. "In addition, Verizon and its management determined that Verizon could destroy NorthPoint's business by reneging on the merger and could then usurp the DSL business opportunities of NorthPoint in Verizon's monopoly territory." (NorthPoint Cal. Complt. ¶ 35.) On June 14, 2000, after holding oral argument in connection with the fraud claim, the California Superior Court granted Verizon's motion to dismiss the fraud claim because of lack of specificity. (Def Reply Mem. Supp. Mot. Dismiss at 3 n. 2.) The court granted NorthPoint 30 days leave to amend its Complaint. (Id.)

On July 12, 2001, NorthPoint filed its Amended Complaint and on July 25, 2001, plaintiffs' submitted a copy to this Court requesting leave to amend the Complaint in this action pursuant to FED. R. Civ. P. 15(a). It is obvious that the NorthPoint California Amended Complaint was neither incorporated by reference nor integrally related to the Complaint in this action. Although it is a public document, we decline to take judicial notice of unproven allegations therein. See infra n. 9 Therefore, those allegations will not be considered in connection with this motion to dismiss.


I. Applicable Law

A. Rule ...

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