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Investors in a bankrupt digital subscriber line (DSL) company that was supposed to merge with New York based-Verizon Communications have failed in a bid to recover damages after Verizon pulled out of the deal. In a 37-page decision, U.S. Southern District Judge William C. Conner granted Verizon’s motion to dismiss the complaint filed by the purchasers of publicly traded notes issued by San Francisco-based NorthPoint Communications Group, Inc. The Aug. 3 decision, Faulkner v. Verizon Communications Inc., also blocked the plaintiffs’ efforts to conduct additional discovery. Business analysts had been highly critical of Verizon’s agreement to merge with NorthPoint, an organization formed in 1997 to provide high-speed, local data-network services that use digital subscriber line technology to transport data over telephone lines. Verizon, the resulting entity of a merger between Bell Atlantic Corporation and GTE Corporation, is the largest provider of telephone and wireless communications in the United States. Verizon is also the second largest provider of DSL services. NorthPoint, on the other hand, had experienced massive economic troubles with net losses for 1999 of $440 million. Nevertheless, Verizon had agreed to contribute $800 million in cash and more than $500 million in assets in exchange for a 55 percent equity interest in NorthPoint. Verizon also promised to provide $200 million in interim financing and to buy $150 million of certain nonvoting stock in NorthPoint. SECURITIES FRAUD CLAIM The deal fell through after NorthPoint modified its third-quarter loss statements last year. On Oct. 26, 2000, NorthPoint filed forms with the Securities and Exchange Commission which indicated the company had experienced third-quarter operating losses of $106 million and net losses of $125 million on revenues of just $30 million. Two weeks later, NorthPoint apparently informed Verizon that it was revising its results. Operating losses were estimated to be $118 million, and net losses reached $136 million. Forms that Verizon filed with the SEC last November indicated that the company still intended to go through with the merger. Nevertheless, by the end of the month, Verizon had pulled out of the deal. Under the terms of the merger agreement, Verizon could cancel it if a material adverse effect on the business or financial condition of NorthPoint occurred. After Verizon withdrew from the merger, NorthPoint reduced its personnel and, in January 2001, filed for bankruptcy under Chapter 11 of the Bankruptcy Code. Purchasers of publicly traded notes issued by NorthPoint then brought a securities fraud claim against Verizon. The plaintiffs claimed that Verizon made fraudulent misrepresentations in connection with its contemplated merger with NorthPoint. According to the plaintiffs, Verizon used NorthPoint’s revised third-quarter results as a mere pretext for canceling the deal. The plaintiffs maintained that Verizon actually withdrew to avoid a huge funding commitment and to avoid a lowering of near-term prices by negative analyst reports. Verizon moved to dismiss the complaint. STATE OF MIND Under the relevant provisions of the Securities Exchange Act, a plaintiff must show that, with respect to the purchase or sale of securities, the defendant knowingly made a false material misrepresentation or failed to disclose material information that the plaintiff relied on and that ultimately caused injury to the plaintiff. In an effort to deter suits of dubious merit, the Securities Exchange Act was amended in 1995 by the Private Securities Litigation Reform Act, which placed stringent procedural requirements on plaintiffs who bring private securities fraud claims. The law now requires plaintiffs to state with particularity the facts giving rise to a strong inference that the defendant acted with the requisite state of mind. The plaintiffs maintained that Verizon knew about NorthPoint’s revised third-quarter results before NorthPoint publicly announced the shifts. Under the plaintiffs’ theory, Verizon just waited until the public announcement as a means to bolster its claim that a material adverse effect had occurred, allowing its withdrawal from the deal. Verizon argued that the plaintiffs failed to sufficiently allege any fraudulent intent, and the court agreed. “We cannot perceive any concrete benefits Verizon could realize by deceiving NorthPoint’s investors into believing that the merger was expected to proceed,” Judge Conner wrote. In fact, Verizon’s statements that it had planned to go ahead with the deal had the effect of substantially depressing its own stock prices, the court observed. “It is simply illogical to conclude that if Verizon really had non-public knowledge of the revision of NorthPoint’s third-quarter earnings and had decided to withdraw from the merger, it would have deliberately concealed that decision until the public announcement of the revision,” the court explained. In any event, Judge Conner concluded that Verizon’s right to back out of the deal did not depend on the timing of NorthPoint’s public disclosures, and he granted Verizon’s motion to dismiss the complaint. DELAYED DISCOVERY The court also declined the plaintiffs’ motion to lift a stay on discovery. The plaintiffs had sought to obtain information about the merger from NorthPoint’s lawyers, who are representing the company in its lawsuit brought in California Superior Court against Verizon. In that litigation, NorthPoint claimed that Verizon had no basis to cancel the merger. The effort of the Faulkner plaintiffs to obtain certain documents produced in the California litigation was stayed when Verizon moved to dismiss the Faulkner complaint. Under �21D(b)(3)(B) of the Private Securities Litigation Reform Act, discovery is stayed during the pendency of any motion to dismiss in any private action unless the court finds that discovery is necessary to preserve evidence or to prevent undue prejudice. The Faulkner plaintiffs only claimed that discovery should be lifted to prevent undue prejudice. The court, however, considered the effort to be a fishing expedition. “Essentially, plaintiffs seek to lift the stay for the sole purpose of uncovering facts to support the fraud allegations in the complaint,” Judge Conner wrote. Moreover, NorthPoint objected to the requested discovery because the same information the plaintiffs sought could have been obtained directly from Verizon. The court observed that “it would be unfair to require NorthPoint, a non-party to this action, to expend its time and money while Verizon stands idly by.” Ultimately, the court concluded that the plaintiffs would not experience undue prejudice if they could not get the materials from NorthPoint’s lawyers. The plaintiffs “could have waited to determine what allegations were proven in the NorthPoint California litigation rather than filing first and using the action to discover whether they have a viable securities fraud claim,” wrote Judge Conner, who denied the plaintiffs’ motion to lift the stay of discovery. The court did, however, grant the plaintiffs leave to amend their complaint, and also granted Verizon the opportunity to move to dismiss the amended complaint. The plaintiffs were represented by Stephen Lowey, David C. Harrison, Michelle Rago and Stacey Blaustein of Lowey Dannenberg Bemporad & Selinger PC in White Plains, N.Y. Verizon was represented by William H. Pratt, Frank Holozubiec, Peter D. Doyle and Eric Hecker of Kirkland & Ellis in New York City.

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