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Christian v. BT Group PLC

United States District Court, D. New Jersey

August 1, 2018

JAMES CHRISTIAN, individually and on behalf of all others similarly situated, et al., Plaintiffs,



         Plaintiffs bring a putative securities class action against BT Group PLC and three high-ranking individuals associated with that company. Plaintiffs allege that defendants were knowledgeable-or reckless in their ignorance of- fraudulent practices in one of BT Group PLC's many subsidiaries, BT Italy. According to plaintiffs, defendants made materially false or misleading statements; plaintiffs relied on those statements when investing in BT Group securities; and plaintiffs allegedly were damaged as a result. Now before the court is defendants' motion to dismiss the complaint for failure to state a claim. See Fed. R. Civ. P. 12(b)(6). Defendants argue that plaintiffs have failed to plead scienter. For the reasons stated below, the defendants' motion to dismiss the complaint is granted.

         I. BACKGROUND[1]

         The lead plaintiffs, Plumbing & Mechanical Contractors Association of Hawaii-United Association ("PAMCAH-UA") Local 675 Pension Fund, Gary Classen, Alice Korenblat, Robert Korenblat, and Pierre-S. Lefebvre (collectively, "plaintiffs") pursue a putative securities class action against BT Group PLC ("BT Group") and individuals associated with BT Group. (AC UK 1, 18-24). The individual defendants are Ian Livingston, the CEO and a member of the Board from 2008 until September 2013; Gavin E. Patterson, the CEO and a member of the Board from September 2013 to the present; and Tony Chanmugam, the Group Finance Director and a member of the Board from 2008 until July 2016. (AC Tin 20-22, 24).

         Plaintiffs purchased BT Group American Depositary Receipts ("ADRs")- i.e., certificates issued by a U.S. bank representing a specified number of shares in a foreign stock traded on a U.S. exchange. (AC K 17).[2] Plaintiffs argue that defendants engaged in securities fraud from May 10, 2013 to January 23, 2017, inclusive (the "Class Period"). (AC ¶ 1). They pursue claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (die "Exchange Act") and Rule 10b-5. (AC ¶ 1).

         A. BT Group and BT Italy

         Defendant BT Group, formerly known as British Telecom, is a provider of communication services and solutions serving customers in 180 countries. (AC K 37). BT Group has six customer-facing business lines; one of them is BT Global Services. (AC % 38). BT Global Services provides technology consulting, outsourcing, and communications systems for more than 10, 000 organizations and governments worldwide. (AC H 38). Defendant Alvarez became CEO of BT Global Services in 2012. (AC 38). Corrado Sciolla was President of BT Global Services in Continental Europe, which includes BT Italy. (AC ¶ 38).

         Plaintiffs allege that defendants knew that BT Group's operations in Italy suffered from control problems at least from the beginning of the Class Period-i.e., May 10, 2013. (AC ¶ 40). Since fiscal year 2013, which ended on March 30, 2013, BT Group's Audit 8& Risk Committee ("Audit Committee") had been assessing die "control environment" in Italy. (AC ¶ 40). Plaintiffs claim that defendants Livingston, Patterson, and Chanmugam certified the efficacy of BT Group's internal controls despite rampant fraud at BT Italy. (AC ¶ 40).

         Plaintiffs allege that BT Group's annual reports evince defendants' knowledge of control problems at BT Italy. The Audit Committee stated in BT Group's 2014 annual report that, "This year the Audit 8b Risk Committee paid special attention to several overseas locations that are important to BT Global Services, including Italy and Brazil .... We have received detailed presentations from key personnel in each of these areas and reviewed management's mitigation plans." (AC ¶ 42). Nick Rose, Chairman of die Audit Committee, noted, "I reported last year that the committee had given particular focus to BT's operations in Italy. We have continued to monitor the position there and significant progress has been made to improve the control environment." (AC ¶ 43). Rose made a similar statement in the 2015 annual report. (AC ¶ 44). The 2015 annual report also stated that the Audit Committee "asked management to provide us with greater detail on the governance and control in relation to ... operations in Italy." (AC ¶ 45). BT Group's 2016 annual report stated that the Audit Committee has "continued to monitor our operations in Italy and progress has been made to improve the control environment." (AC ¶ 47). HSBC Global Research noted that the Audit Committee had an unusual, "sustained" level of review regarding BT Group's control environment in Italy. (AC ¶ 48).

         B. Disclosures in 2016 and 2017

         BT Group reported on October 26, 2016 that it had to take a write-down of £145 million (approximately $191 million) due to "certain historical accounting errors" at its BT Italy division. (AC m 49-50). BT Group's press release stated, "Following allegations of inappropriate management behaviour in our BT Italia operations, we have conducted an initial internal investigation [and ...] identified certain historical accounting errors and reassessed certain areas of management judgment." (AC ¶ 50). On October 27, 2016, the price of BT Group ADRs fell $0.57, or 2.4%, to close at $23.25 per ADR. (AC ¶ 51).

         In a press release on January 24, 2017, BT Group announced that it would increase the write-down regarding its Italian operations to £530 million (approximately $700 million)-a nearly four-fold increase. (AC ¶ 52). Additionally, BT Group stated it no longer expected revenue growth for the next two years. (AC ¶ 52). The company also estimated its 2016-2017 free cash flow at £2.5 billion, about £700 million lower than the original forecast. (AC ¶ 52).

         BT Group explained that its investigations had revealed that "the extent and complexity of inappropriate behaviour in the Italian business were far greater than previously identified" and had revealed "improper accounting practices and a complex set of improper sales, purchase, factoring and leasing transactions," resulting in the "overstatement of earnings in our Italian business over a number of years." (AC ¶ 53). BT Group suspended members of BT Italy's senior management team and appointed a new Chief Executive of BT Italy. (AC ¶ 53). The new Chief Executive was told to review the Italian management team and improve the governance, compliance, and financial safeguards of the Italian business. (AC ¶ 53).

         On a conference call around this time, Simon Lowth, the company's Group Finance Director, made the following statement:

The majority component [of unwinding the improper working capital transactions] was to repay essentially working capital loans to factoring companies where loans had been taken against receivables and, indeed, had been taken to pay suppliers. Those working capital loans [were] clearly improper and we are unwinding them, and that is overwhelmingly the most significant contributor to the onetime cash unwind in the 2016/2017.

(AC ¶ 55). Lowth also identified "additional smaller contributors" to BT Italy's woes, such as "sale and leaseback transactions." (AC ¶ 55).

         On January 24, 2017, media outlets reported that BT Group suspended a number of senior executives in Italy, including the BT Italy CEO. (AC ¶ 58). They also reported that Corrado Sciolla, the President of BT Global Services in Continental Europe, was expected to resign shortly. (AC ¶ 58). Sciolla had previously been the BT Italy CEO from 2006 until January 2013. (AC % 58). On January 24, 2017, the price of BT Group ADRs fell $5.05, or approximately 21%, to close at $19.38 per ADR. (AC ¶ 9). On January 28, 2017, a media outlet reported that a KPMG LLP investigation found that the misconduct had been ongoing at BT Italy for most of the past ten years. (AC ¶ 61).

         C. Report to BT Group Vice President in 2015

         On March 30, 2017, Reuters reported that, in November 2015, three BT Italy employees warned their Madrid-based supervisor Jacinto Cavestany about this potential fraud. (AC ¶ 62). Jacinto Cavestany was BT Global Services' Vice President of Iberia and Head of Sales in Europe and Latin America. (AC H 62). The source claimed that the BT Italy employees met with Cavestany on the sidelines of a Company gathering to express concern over the unit's financial results, bullying by local management, and intense pressure to meet difficult bonus targets. (AC ¶ 62). The source added that Cavestany had replied that the three BT Italy employees should help him steer Cimini, the then-BT Italy CEO, "in the right direction." (AC ¶ 62).

         BT Group claimed that it launched an internal investigation in January 2017-almost a year after the BT Italy employees met with Cavestany about the BT Italy fraud. (AC ¶ 63). According to Reuters, a network of people at BT Italy had exaggerated revenues from certain BT-installed phone lines, faked contract renewals and invoices, and invented bogus supplier transactions to meet bonus targets and disguise the unit's true financial performance. (AC U 65). These practices had allegedly been ongoing since at least 2013. (AC ¶ 65).

         For instance, BT Italy's purchasing office made fake purchase orders to suppliers with no intention of receiving goods; the office would cancel the order and ask the supplier to issue a credit note by way of refund, and the bogus credit notes were then sold to a factoring company for cash. (AC ¶ 68). BT Italy also had multiple internal-accounting systems that enabled staff to inflate revenues by entering duplicate invoices for die same client. (AC ¶ 69).

         D. Criminal Complaint, Italian Government Investigation

         On April 21, 2017, Reuters reported that BT Group filed a criminal complaint with Italian prosecutors on March 21, 2017 over the accounting scandal. (AC ¶ 72). BT Group accused several former BT Italy executives and other employees of breaking company rules and committing unlawful conduct. (AC ¶¶ 72-75).

         Additionally, BT Group is being investigated by the Guardia di Finanza, an Italian law-enforcement agency responsible for prosecuting financial crimes. (AC 1 76). The Guardia di Finanza has raided BT Italy offices, interviewed employees, and collected records. (AC ¶ 76-78).

         E. BT Group's ...

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