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Oklahoma Law Enforcement Retirement System v. Telefonaktiebolaget Lm Ericsson

United States District Court, S.D. New York

January 10, 2020

OKLAHOMA LAW ENFORCEMENT RETIREMENT SYSTEM et al., Plaintiffs,
v.
TELEFONAKTIEBOLAGET LM ERICSSON et al., Defendants.

          OPINION AND ORDER

          JESSE M. FURMAN, UNITED STATES DISTRICT JUDGE.

         Defendant Telefonaktiebolaget LM Ericsson (“Ericsson”) is a Swedish company that provides hardware and services for telecommunications networks. In this putative securities fraud class action, investors allege that Ericsson and several of its senior executive officers and directors made false and misleading statements and omissions about the company's financial performance, accounting practices, internal controls, and policies related to certain long-term service contracts. Defendants now move, pursuant to Rules 9(b), 12(b)(2), and 12(b)(6) of the Federal Rules of Civil Procedure, to dismiss the Second Amended Complaint. For the reasons that follow, Defendants' motion pursuant to Rules 9(b) and 12(b)(6) is GRANTED.

         BACKGROUND

         The following facts are taken from the Second Amended Complaint (the “Complaint”), documents it incorporates by reference, and matters of which the Court may take judicial notice, including public disclosure documents that Ericsson was required to file by law. See, e.g., Silsby v. Icahn, 17 F.Supp.3d 348, 354 (S.D.N.Y. 2014).

         Ericsson is a public company, incorporated and headquartered in Sweden and traded on the NASDAQ, that “provides networking hardware and services to telecommunications companies, like cellular phone providers, around the world.” ECF No. 52 (“SAC”), ¶ 2. At least two-thirds of its business “involves providing services to customers through large, multi-year contracts.” Id. Ericsson's services include “designing, building, and operating” communications networks, collectively referred to as “Managed Services.” Id. ¶ 4. During the Class Period - from April 24, 2013, to July 17, 2017 - Ericsson maintained more than three hundred Managed Services contracts, accounting for roughly 12% of its net sales in 2017. Id. ¶¶ 1, 4.

         In connection with its long-term service contracts, Ericsson allegedly engaged in four business and accounting practices relevant here. First, Ericsson entered into long-term “loss-leading contracts” - contracts that “Ericsson entered into with the understanding that they were going to lose money, ” but undertook anyway “to gain market share.” Id. ¶ 137. A former employee who served as the Chief Operating Officer of Managed Services during the Class Period knew of at least twenty-four such long-term service contracts. Id. ¶ 8. Loss-leading contracts were encouraged by an internal policy begun in 2016 known as “Feed the Gorilla, ” which “prioritized signing contracts at any cost above prudent risk management and scoping, ” without “worry[ing] about” whether project costs ultimately exceeded revenues. Id. ¶¶ 17-18, 129, 269. Loss-leading contracts were also incentivized through commissions paid upfront to sales employees. Id. ¶ 118.

         Second, Ericsson underestimated - or “under-scoped” - the costs of long-term service contracts in order to win project bids. Id. ¶¶ 9-11. Ericsson did this by accepting “open-ended commitment[s]” to fulfill any service needs that arose and failing to accurately estimate such costs. Id. ¶ 9. For example, in 2012, Ericsson estimated that its costs for a project at Grand Central Terminal would be $5-6 million, when in fact the costs grew to $157 million by March 2018. Id. ¶ 11. Ericsson's initial estimate failed to account for service needs such as “install[ing] different antennas, and finally an entire ‘new line.'” Id. ¶ 115. Ericsson was forced to shoulder the additional costs without compensation. Id. Ericsson allegedly encouraged its employees to scope contracts “as ‘slim and lean' as possible” through a “corporation-wide initiative” called “Bare Bone Tender Scoping.” Id. ¶ 151. The program continued “at least into 2014.” Id.

         Third, the Complaint alleges that Ericsson delayed recognizing costs that it incurred by “pushing” them onto the accounting books for later financial quarters. Id. ¶ 13. Account Vice Presidents advocated for this practice, and it was common, for example, in service contracts with Verizon and AT&T. Id. ¶ 114. One former project manager at Ericsson explained that “Ericsson would bill AT&T for projects in advance but wait until the project was completed before recognizing the costs.” Id. ¶ 123. According to another former employee, the practice was known to “top management, ” including Ericsson's U.S. Chief Executive Officer and Chief Financial Officer (neither of whom is named as a Defendant here). Id. ¶ 114. Publicly, however, Ericsson represented that “losses” were accounted for as they arose. Id. ¶¶ 6, 97-98, 123.[1]

         Fourth, Plaintiffs assert that Ericsson prematurely recognized revenues in its accounting. For example, pursuant to a service contract with AT&T, Ericsson was required to reach certain completion milestones, but Ericsson “would get AT&T to sign off on a milestone - prior to actually reaching the milestone - in order to internally record the revenue.” Id. ¶ 155. A former project finance manager also reported that Ericsson would recognize revenue before Ericsson had sent an invoice to other customer. Id. ¶ 154. Publicly, however, Ericsson represented that revenues were recognized “when the services have been provided, generally pro rata over the contract period.” Id. ¶ 104.

         Plaintiffs allege that, without disclosing these four practices, Ericsson regularly reported its financial results. Id. ¶¶ 186-87. Ericsson also made a variety of affirmative statements related to its contracts, accounting practices, and internal controls. For example, in its 2014 Annual Report, Ericsson represented that about 75% of its managed services contracts were in the “optimization phase, ” which had a “beneficial effect on earnings and cash flow.” Id. ¶ 215(d). As noted, Ericsson also repeatedly asserted that losses were accounted for when they became “probable” and that revenue was “recognized when services have been provided, generally pro rata over the contract period.” E.g., id. ¶¶ 95, 104.[2]

         On July 17, 2016, a Swedish newspaper called Svenska Dagbladet published an article reporting that Ericsson was using “aggressive accounting techniques, ” including prematurely recognizing revenue to the point that “revenue from existing contracts had been so fully recognized that these contracts are now virtually empty - i.e., that most of the long-term contracts had already been accounted for as sales.” Id. ¶ 156. Ericsson published an official denial of the article's allegations on July 18, 2016. Id. ¶ 21. Ericsson's Chief Financial Officer at the time, Defendant Jan Frykhammar, also denied the allegations during a conference call with investors on July 19, 2016. Id. ¶ 160. Nevertheless, Ericsson's stock price dropped from $7.77 on July 18, 2016, to $7.08 on July 19, 2016. Id. ¶ 159.

         On March 28, 2017, Ericsson announced that a “provision, ” or write-down of asset value, of between seven and nine billion Swedish krona (corresponding to between $900 million and $1.16 billion) was expected in its first quarter financial report. Id. ¶ 23. During a conference call on that date, Defendants Börje Ekholm (then Ericsson's President and Chief Executive Officer) and Carl Mellander (then Ericsson's Chief Financial Officer) explained to investors that a “few, ” “specific and certain” large contracts had encountered “negative developments, which could be lower [sic] expected revenues or higher costs to complete those projects . . . due to specific events during the first quarter.” Id. ¶¶ 23, 162-64. Ekholm insisted that the issues were “isolated.” Id. ¶ 163. Still, the Complaint alleges that “the market began to understand that these provisions were necessitated by Ericsson taking on unprofitable contracts and then letting those unprofitable contracts pile up on its books.” Id. ¶ 165. By the close of business on March 28, 2017, Ericsson's share price fell from $6.69 to $6.45. Id. ¶ 161.

         On April 25, 2017, Ericsson released its quarterly results for the first quarter of 2017, including a provision of 8.4 billion Swedish krona (about $1.08 billion). Id. ¶ 166. Ericsson explained that the provision was the result in part of “additional project costs . . . which due to recent negative developments are not expected to be covered by future project revenues.” Id. During conference calls that day, Ekholm further stated that “we have contracts today that are not profitable, ” and Mellander admitted that “some of those projects . . . could have been scoped in a better way.” Id. ¶¶ 167, 171. Finally, to the extent relevant here, on July 18, 2017, Ericsson released its results for the second quarter of 2017, and reported “continued declining sales and increasing losses.” Id. ¶ 174. Specifically, Ericsson disclosed that forty-two contracts accounting for $892 million in revenue in 2016 would have to be “exit[ed], renegotiate[d], or transform[ed].” Id. Ekholm again admitted during conference calls that “part of it is, of course, we could have scoped the contract better.” Id. ¶ 178(b). In addition, Ericsson warned that there was an “increased risk of further market and customer project adjustments, which would have a negative impact on results, estimated” at three to five billion Swedish krona. Id. ¶ 175. Ericsson's share price fell that day from $7.28 to $6.07. Id. ¶ 176.

         On April 5, 2018, Plaintiffs filed this lawsuit, alleging that Defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5.

         LEGAL STANDARDS

         In reviewing a motion to dismiss, the Court accepts all well-pleaded factual allegations in the Complaint as true and draws all reasonable inferences in favor of the nonmoving party. See Gamm v. Sanderson Farms, Inc., 944 F.3d 455, 462 (2d Cir. 2019). The Court will not dismiss any claims pursuant to Rule 12(b)(6) unless the plaintiff has failed to plead sufficient facts to state a claim to relief that is facially plausible, see Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007) - that is, a claim that contains “factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged, ” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). More specifically, a plaintiff must allege facts showing “more than a sheer possibility that a defendant has acted unlawfully.” Id. A complaint that offers only “labels and conclusions” or “a formulaic ...


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