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Failed Deals, Bankruptcy and Class Action Securities Fraud in Global Outsourcing: In re Alcatel Securities Litigation
In a pre-Sarbanes-Oxley time, the hypergrowth Dot.Com era disintegrated into “Dot.bomb” implosions. Reciprocal deal-making in speculative ventures was almost the norm, particularly in telecommunications transport. The litigation aftermath of failed deals, bankruptcy and class actions for securities fraud is reaching resolution. This short case study provides a synopsis of some key points of failure in reciprocal transactions, with a focus on telecom.
Alcatel is a French technology corporation. On October 20, 2000, the company issued a U.S. initial public offering (IPO) for its Class O shares. This class was 100% owned by Alcatel, but served as a “tracking” stock for the company’s Optronics Division. The IPO raised approximately $1.2 Billion and created additional shares that could be used as currency in mergers and acquisitions.
Soon after the IPO, Alcatel announced that it had invested $700 million in its customer, 360networks Corporation. In turn, the customer agreed to purchase over $1 billion in equipment from Alcatel to create a proposed trans-Pacific fiber-optic network.
When Alcatel’s proposed merger with Lucent fell through, Alcatel issued an unexpected announcement to investors that warned of a projected $2.6 billion loss for the second quarter of 2001. The loss included charges associated with a write-down of goodwill for two acquisitions (Xylan and Packet Engines), a full write-down of the $700 million invested in 360networks and various inventory write-downs. Allegedly, the announcement downgraded its Optronics Division in light of that unit’s “high exposure to the submarine market and the increased lack of visibility and potential delays in large projects, as well as inventory build-ups.” In re Alcatel Sec. Litig, __ F.3d __, NYLJ Mar. 11, 2005, p. 23, cols. 1-4, p. 24, cols. 1-4, at p. 24, col. 3 (S.D.N.Y. Mar. 11, 2005) (Judge Casey) [“In Re Alcatel Sec. Litig.”].
The Alcatel investors claimed securities fraud. Most of the claims were dismissed because of late filing. The case is a cautionary tale and reminds us of the interests of investors as key stakeholders in outsourcing, whether as shareholders in global enterprises or as shareholders or bondholders in service providers.
The story of Romeo and Juliet brings to mind the aphorism “‘T’is better to have lived and loved than to never loved at all.”
In securities fraud litigation, the love has turned to hate. So we posit the modern aphorism, “‘T’is better to have solicited investment and warned than to have never solicited investment at all.”
In short, participants in outsourcing should each refocus on the specificity of their warnings surrounding the risks of outsourcing and other strategic relationships, the nature and risks of the issuing company’s supply chain of suppliers and customers, and the particular risks in the industry. The generic warnings might not be sufficient, so constant updating may be appropriate, even without considering the special certification, audit and control issues presented under the Sarbanes-Oxley Act of 2002.
Reciprocal Dealings and Joint Ventures Pose Special Securities Risks.
Typically, the service provider’s investors are the ones with a securities fraud claim. To be put on notice to inquire further, the service provider’s investors need to receive a storm warning of the seriousness of a material problem that could affect an ordinary investor’s decision to buy, sell or hold the securities of the service provider. In the case of reciprocal business dealings and joint ventures between service providers and their enterprise customers, the standards of disclosure are heightened because the materiality is heightened: a bankruptcy by the enterprise customer (as in the case of WorldCom for EDS or in the case of 360networks for Alcatel).
Service providers should therefore consider the following prudent business practices:
Enterprise customers face questions, as securities issuers, surrounding the viability of their key suppliers. Best practices to avoid securities fraud claims should be considered.
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