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Tellium Lawsuits Allege Rigged IPO

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News Analysis
Light Reading

Another law firm announced today that it has filed a class action lawsuit against optical switch maker Tellium Inc. (Nasdaq: TELM) on behalf of investors (see Tellium Sued for the Nth Time).

New York City-based Faruqi & Faruqi, LLP today announced that it has filed suit in New Jersey against the company, its executives, and Morgan Stanley Dean Witter & Co., the company’s lead underwriter when it went public in May 2001. The firm is asking for anyone who purchased Tellium stock between May 17, 2001 and February 1, 2002 to join the suit.

This is the fifth class action shareholder lawsuit that has been announced against the company in the past two weeks (see Shareholders Sue Tellium, Tellium Slapped With Class Action, Tellium Sued Some More, and Tellium Sued Yet Again).

While shareholder lawsuits are a dime a dozen these days, the Tellium suits are interesting in that they all paint the same picture of share-price manipulation and raise legitimate issues about the wheeling and dealing behind the company's 2001 IPO.

One major component in this case is motive. All five of the suits allege that executives from Qwest Communications International Inc. (NYSE: Q) received pre-IPO shares in Tellium in exchange for announcing a bogus $300 million contract in September 2000 (see Is Tellium Ready for an IPO?). The plaintiffs assert that Qwest officials -- including Joseph Nacchio, Marc Weisberg, and James Becker, who had received special “friends and family” stock options from Tellium prior to its IPO -- agreed to the contract in order to help the company gain the support it needed to go public. Qwest had never intended to purchase that much of the company’s gear, the suits assert.

According to the Faruqi & Faruqi suit filed today:

    “Defendants knew that the IPO had largely been based on the Qwest agreement supposedly for a minimum of $300 million in Tellium switches. Defendants also knew that was not a real commitment and Qwest did not use or want that many Tellium switches but had permitted the agreement because executives of Qwest received Tellium shares in the IPO.”

The suits claim that the original contract with Qwest was far too aggressive and that Tellium executives -- including Harry Carr, chairman of the board and CEO, Michael Losch, CFO, and Richard Barcus, former president and COO -- were aware of this. Lawyers involved in the case estimate that Qwest would have needed to purchase roughly 200 switches to fulfill the $300 million requirement. Some analysts covering the optical switch market note that those estimates were high.

The suits allege that these executives knew throughout 2001 that Qwest would not generate the revenue it had promised in the contract and that other customer prospects were hurting as well, and yet they continued to provide positive guidance throughout 2001 (see Tellium Confirms Guidance). The contract with Qwest was renegotiated in December of 2001, essentially freeing Qwest from most of its purchase obligation (see Qwest and Tellium Revise Contract).

“I’m sure under some scenarios, they could have been able to justify such a large order over a three-year period,” says Mark Lutkowitz, vice president of optical networking research at Communications Industry Researchers Inc.. “But I think that both parties knew that this was disingenuous, given that the Tellium switch lacked STS-1 grooming.”

Lutkowitz adds that there are fewer places in the network where switches like Tellium's are needed, because they only groom to the OC48 (2.5-Mbit/s) level.

While investors may look back now and say that they were deceived, there were plenty of critics -- including Light Reading's own subscription research service, Optical Oracle, and CIR’s Lutkowitz -- noting doubts about the company early on (see Tellium Bids for $250 Million IPO). Lutkowitz published a research note in the spring of 2001 (before Tellium’s IPO), predicting that the company would be forced to exit the optical switching market within six months to a year, due to a lack of carrier demand.

Also, plenty of investors knew about Qwest’s relationship with Tellium. The information regarding the pre-IPO shares had been disclosed in the company’s S-1 filed with the Securities and Exchange Commission (SEC). One sell-side analyst, who didn’t want to be named in this article, says that when Tellium pitched its IPO to institutional investors, many expressed concern about the potential conflict of interest.

What’s more, other companies had already been exposed for their “friends and family” IPO deals prior to the Tellium IPO, heightening awareness throughout the investor community to the potential abuses. For example: Matt Bross, former CTO of Williams Communications (now called WilTel Communications Group Inc. [OTC: WTELV]), was slammed by the press for his stake in startups like ONI Systems (see Williams' CTO Profits From His Position ).

There is also the argument that the telecom industry changed drastically from the time the deal was announced until it was revised in December 2001, and that Tellium executives had no idea that Qwest would not purchase what they had promised. Qwest had announced a large reduction in spending just a few weeks prior to Tellium’s announcement that the deal had been modified (see What's Behind Qwest's Numbers?). Other carriers were also announcing similar capital spending reductions.

“Contract wins are meaningless,” says Lutkowitz. “Things can change drastically over a three- or five-year period. I think part of Tellium’s problem is that the market just went away. There will be a need for what they offer someday, but not right now.”

A Qwest spokesperson declined to comment on this story, and Tellium officials did not return phone calls.

Tellium is just one of many telecom companies getting sued by shareholders for supposedly deceiving investors. Shareholders are also filing suit against Avici Systems Inc. (Nasdaq: AVCI; Frankfurt: BVC7), BellSouth Corp. (NYSE: BLS), Broadwing Inc. (NYSE: BRW), Cable & Wireless (NYSE: CWP), JDS Uniphase Corp. (Nasdaq: JDSU; Toronto: JDU), Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA), and XO Communications Inc. (OTC: XOXO). Sell-side financial analysts are also taking the heat. Former Salomon Smith Barney telecom analyst Jack Grubman is facing several suits in connection with his research on service providers like Global Crossing Holdings Ltd., Level 3 Communications Inc. (Nasdaq: LVLT), and WorldCom Inc. (OTC: WCOEQ).

For more on this issue, see these stories:

  • C&W Slapped With Suit
  • Shareholders Sue Broadwing
  • Shareholders Sue BellSouth
  • XO Communications Faces Lawsuit
  • Avici Hit With Shareholder Suit
  • Shareholders Sue Tellabs
  • JDSU Sued (Again)
  • Grubman Gets Some New Suits

  • — Marguerite Reardon, Senior Editor, Light Reading

    Editor's Note: Light Reading is not affiliated with Oracle Corporation.
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    User Rank: Light Beer
    12/5/2012 | 12:56:24 AM
    re: Tellium Lawsuits Allege Rigged IPO
    Well, having been at Bellcore when the folks went to start Tellium, there's a lot I could say about this company that had such an illustrious beginning, and that has had some of the industries' absolute best folks. (And I still put Krishna Bala and the other CTO-group folks in that category...)

    But anyway, the critical issue here is...

    "But I think that both parties knew that this was disingenuous, given that the Tellium switch lacked STS-1 grooming."

    This is not necessarily true. STS-1-level grooming is a 'relic' of the circuit-switched era. If Qwest can show that they truly intended to build out a large "IP over Optical" network, then it could easily be argued that Qwest did intend to buy lot of the Tellium switches.

    Don't get me wrong...it's not like I don't believe there's all sorts of dirt on this relationship. Why these stock deals to carrier CEOs was ever allowed or legal I can't imagine...perhaps we believed the old lie about "letting the market sort out all the problems"...?

    But the Tellium switch was created precisely to sit in networks where circuit switching was on the way out. It was a good, focused pure-play that could have done well in another universe. I sincerely hope that it can survive in some form or another, and maintain the technical- and thought-leadership it has maintained until today.
    User Rank: Light Beer
    12/5/2012 | 12:56:13 AM
    re: Tellium Lawsuits Allege Rigged IPO
    The interesting thing is that none of the mentioned, or not mentioned for that matter, execs are currently still at Qwest. Not to metion that of the technical people at Qwest have spent the last two plus years trying to figure out where to put the Tellium switches into their network. They didn't need them then and they don't need them now. The idea of a planned IP based network has never been there. I do understand that the contract has been renegotiated. But that is the case with all of Qwest's vendors.

    I guess this helps explain why Notebart only wants to deploy equipment from vendors he already has stock in.

    User Rank: Light Beer
    12/5/2012 | 12:56:05 AM
    re: Tellium Lawsuits Allege Rigged IPO
    For all of the next generation Tellium companies with a reduced staff of less than 200, just missing the same IPO type of deal with Qwest, there is a second chance. There are many cities in the world requiring a next generation Golden Gate bridge which is more dense and compact and saves lots of money when economic analysis and creative capital recovery computations are presented. Wagging the dog never looked better. Still need to get the new-bridge (no pun intended) out of the labs however:

    User Rank: Light Beer
    12/5/2012 | 12:56:02 AM
    re: Tellium Lawsuits Allege Rigged IPO
    Read this post and the referenced one. This is what Bobby Max was trying to be but never could!

    Amusing posts, seeds-to-weeds. Kinda rings a bell...
    User Rank: Light Beer
    12/5/2012 | 12:55:27 AM
    re: Tellium Lawsuits Allege Rigged IPO
    The relationship between Nachio of Qwest and Tellium appears to be scandlous. Mr. Nachio should not have accepted Tellium stocks in exchange for his promise to buy Tellium. Any time an RBOC buys a product from a company, it considerably enhances the marketability of its products.

    This is so bizzare that a Grand Jury should investigate Mr. Nachio and Tellium.

    The number of lawsuits against Tellium are rather numerous. This is not very conducive to do business with other companies.
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