In re Global Crossing, Ltd. Securities Litigation

322 F.Supp.2d 319

In re GLOBAL CROSSING, LTD. SECURITIES LITIGATION

No. 02 Civ. 910GEL.

United States District Court, S.D. New York.

March 23, 2004.

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Jay W. Eisenhofer, Sidney S. Liebesman, Michael J. Barry, Lauren E. Wagner, and Marlon Q. Paz, Grant & Eisenhofer, P.A., Wilmington, DE, for Lead Plaintiffs Public Employees Retirement System of Ohio and State Teachers Retirement System of Ohio.

Peter Fleming Jr., Eliot Lauer, Jacques Semmelman, Jonathan Harris, Curtis, Mallet-Prevost, Colt & Mosle LLP, New York, NY, for Defendants Arthur Andersen LLP and the Individual Andersen Defendants.

OPINION AND ORDER

LYNCH, District Judge.

This consolidated class action arises from alleged accounting improprieties at the telecommunications firm Global Crossing, Ltd. ("GC"), during the period between February 1, 1999, and January 28, 2002, the "class period," that artificially inflated the company's stock price. According to the Consolidated Class Action Complaint, "[d]uring the Class Period, insiders sold over $1.5 billion in artificially inflated Global Crossing stock while in possession of material, non-public information and the outside advisor defendants reaped hundreds of millions of dollars in fees and profits. But the Company and its purported multi-billion dollar revenues and strong, substantial cash flow were a complete sham." (Compl.¶ 1.) In addition to suing GC, its individual directors and officers, and numerous financial institutions,¹ plaintiffs have named as defendants Arthur Andersen LLP ("Andersen"),² GC's outside auditor, as well as several of its officers, board members, and employees ("the individual Andersen defendants").³ Plaintiffs later amended their Complaint to assert claims against a GC subsidiary, Asia Global Crossing, Ltd. ("AGC"), and against Andersen in its role as AGC's outside auditor.⁴ Plaintiffs assert these claims under sections 11 and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k, 77o, and sections 10(b), 14, and 20(a) of the Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78n, 78t-1(a), as well as Rule 10b-5 promulgated thereunder by the Securities Exchange Commission ("SEC"), 17 C.F.R. § 240.10b-5.

On April 4, 2003, Andersen and the individual Andersen defendants moved to dismiss all claims asserted against them in the original Complaint; on October 10, 2003, they further moved to dismiss all claims relating to AGC. Because both motions implicate similar legal issues, they will be decided together. For the reasons set forth below, Andersen's motions will be granted in part and denied in part.

BACKGROUND

The facts underlying the Complaint in this case were briefly set forth in this Court's December 18 Opinion, but will be outlined in more detail here. The claims against Andersen in particular center around allegedly fraudulent misstatements of GC's and AGC's assets, obligations, and cash revenues, arising from the manner in which the two companies accounted for certain transactions involving "indefeasible rights of use" ("IRUs"). In its role as independent auditor for both GC and AGC ("the Companies"), Andersen is alleged to have perpetrated a fraud on investors by dictating incorrect and misleading accounting systems for these transactions and by structuring them so as to inflate the Companies' reported earnings, in violation of Generally Accepted Accounting Practices ("GAAP") and Generally Accepted Accounting Standards ("GAAS").⁵

An IRU is the "right to use a specified capacity, or bandwidth, over a designated communications cable owned by a telecommunications company for a set period of time." (¶ 150.) Income from IRU transactions represented a large portion of the Companies' revenues during the class periods and therefore played a substantial role in determining the market value of their shares. Plaintiffs claim that the Companies, in order to meet performance expectations and thereby boost the value of their securities, (1) reported as immediate cash revenue income that should have been booked over the 25-year term of each IRU, while amortizing the related costs over the entire term; and (2) similarly reported income from unneeded reciprocal "swaps" with other carriers of such capacity, notwithstanding that, where cash actually changed hands, it was "round-tripped" in the return half of the swap, thereby yielding no actual revenue. They further assert that the Companies overstated the value of their assets by failing to mark down the value of the IRUs received in the swaps, which had been booked at or above their "fair market value," even as the market price for capacity plummeted due to the glut on the market. (¶ 718.)

Exchanges of capacity were common in the telecommunications industry from its inception. However, "[u]ntil the late 1990s ... telecom companies did not treat these exchanges as sales and usually did not record revenue from the trades." (¶ 210.) GC alone among these companies booked immediate revenue from these sales. (¶ 211.) Plaintiffs allege that the practice of booking IRU revenue up front violated Financial Accounting Standards Board ("FASB") Statement No. 13, which restricts the circumstances under which a company may report as immediate revenue the total lease payments due under a multiyear lease agreement. Indeed, effective July 1, 1999, the FASB issued "FASB Interpretation No. 43" ("FIN 43"), a clarification of FASB 13 that clearly prevented GC from continuing to book the IRU payments as immediate cash income. Following the issuance of FIN 43, GC changed its accounting to come into compliance with its requirements, although AGC continued to book revenue for leases of subsea (as opposed to terrestrial) cable as immediate revenue until mid-2000. (¶ 157.)

Following the issuance of FIN 43, GC announced that compliance with its terms "would not have a material impact on the Company's financial position or results of operations." (¶ 220 (quoting unattributed source).) But plaintiffs allege that compliance with FIN 43 would, in fact, have been devastating had GC not found a new source of illusory revenue: reciprocal "swap" transactions with other telecommunications companies. According to the Complaint, Joseph Perrone, a senior partner in Andersen's media and communications practice, devised a "roadmap" whereby telecom companies, and GC in particular, could structure trades of capacity to create the appearance of revenue, with the purpose of avoiding the strictures of GAAP. (¶¶ 216-224.) In particular, the transactions were structured to circumvent Accounting Principles Board Opinion No. 29 ("APB 29"), "Accounting for Nonmonetary Transactions," which specifies that no revenue or expense should be recorded for transactions that involve an exchange of like assets. Andersen's scheme, which was embodied in a document that came to be known as the "White Paper," advised that telecom clients could book revenue from IRU sales between companies if the transactions had separate contracts and separate cash settlements, and if the contracts were at least sixty days apart. (¶ 217.) Thereafter, the Companies followed these guidelines to structure their exchanges of capacity such that they could book revenue from the transactions.

When revenue from IRU sales could no longer be reported immediately as cash revenue under GAAP, GC claimed that its own measures of revenue, styled by GC as "pro forma disclosures," "Earnings Before Interest, Taxes, Depreciation, and Amortization" ("EBIDTA"), and "Adjusted EBIDTA," were better measures of its financial health than financial statements according to GAAP. These financial statements, which were publicly disseminated to investors, reported as immediate revenue what they termed the "cash portion" of "deferred revenue": in effect, these disclosures allowed GC to further circumvent the requirements of FIN 43 and APB 29, and to continue to represent as immediate revenue the up-front payments they received for IRU sales. Additionally, AGC created the terms "Proportionate Cash Revenue" and "Proportionate Adjusted EBITDA," which purportedly reflected "the sum of our ownership percentage" of cash revenue and adjusted EBITDA of various GC affiliates with whom ACG participated in joint ventures. (¶¶ 240, 241.) The Companies' tactics succeeded, plaintiffs claim, in inflating the value of their stock, resulting in steep losses for shareholders in 2002 when the house of cards collapsed and the Companies inevitably went bankrupt.

Plaintiffs allege that Andersen, as independent auditor for both GC and AGC, played a central role in devising and implementing the accounting schemes in question. According to the Complaint, Andersen "created a web of interrelated transactions between [its] clients that had no economic substance but which were used to fool investors into believing that the industry and these companies were growing much faster than the reality." (¶ 146.) In addition to issuing clean audit opinions on the Companies' annual 10-K reports filed with the SEC, Andersen allegedly also had direct knowledge of the Companies' unaudited pro forma reports (¶ 732(h)), and was responsible through defendants Perrone and, later, Mark Fagan, Andersen's senior partner in charge of the GC account after Perrone was hired by GC, for overseeing all of GC's public statements (¶ 77.) Plaintiffs accordingly seek to hold Andersen liable under section 10(b) and Rule 10b-5 for the financial statements it audited for GC in 1998, 1999, and 2000, and for AGC in 2000, claiming that they included materially false or misleading information in their treatment of IRUs and swap transactions. They also seek to hold Andersen liable for GC's and AGC's unaudited press releases and "pro forma" disclosures, which included falsely optimistic statements of income and misleading statements of "EBIDTA." (Counts I, XIX.) As a corollary to the allegations of false...