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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 1 of 106
UNITED STATES DISTRICT COURTNORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION
IN RE FIRST HORIZONPHARMACEUTICAL CORPORATIONSECURITIES LITIGATION
CIVIL ACTION NO:1:02-CV-2332-JOF
PLAINTIFFS' SECOND CONSOLIDATED AMENDED CLASS ACTIONCOMPLAINT
Lead Plaintiffs, based upon personal knowledge as to themselves, their own
acts and the acts of their counsel, and the investigation undertaken by Plaintiffs'
counsel, allege the following facts. Plaintiffs' counsel's investigation included,
inter alia, a review and analysis of: (i) publicly available news articles and reports
concerning First Horizon Pharmaceutical Corporation ("First Horizon" or the
"Company") (n/k/a Sciele Pharmaceutical, Inc.), and its industry; (ii) securities
analyst reports issued by brokerage firms covering First Horizon and its industry;
(iii) First Horizon filings with the Securities and Exchange Commission ("SEC");
and (iv) press releases and other public statements issued by the Company.
Plaintiffs' counsel's investigation also included consultation with experts and
interviews of persons knowledgeable about the Company and its industry.
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 2 of 106
NATURE OF THE ACTION
Plaintiffs bring this class action on behalf of all persons or entities (the
"Class") who purchased or otherwise acquired the securities of First Horizon from
April 24, 2002, to April 29, 2003, inclusive (the "Class Period"), including a
subclass consisting of all persons or entities who purchased First Horizon common
stock in a secondary offering , dated April 24, 2002, pursuant to or traceable to a
Registration Statement/Prospectus (the "Registration Statement") filed with the
SEC on or about March 5, 2002, and amended on or about March 26, 2002, April
17, 2002, and April 19, 2002 (the "Offering" and the "Offering Subclass")
2. Prior to, and continuing throughout the Class Period, Defendants
issued a series of false and misleading statements to investors, first inflating First
Horizon's revenues artificially, and then, when the inflation of such revenues could
no longer be maintained, disguising the reasons for the subsequent revenue decline.
3. More specifically, beginning in or about July 2001, Defendants
learned that a First Horizon competitor intended to introduce generic versions of
the Company's best selling product, Tanafed.
4. This occurred at the same time that First Horizon was negotiating the
purchase of the antihypertension medication, Sular. The Company intended to
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 3 of 106
finance the purchase of Sular by means of the sale of First Horizon common stock
pursuant to a secondary offering.
5. In order to further the two-fold goal of: (a) flooding the wholesale
market with Tanafed to block the entrance into the market of anticipated generic
competitors, and (b) ensuring the success of the secondary offering at as a high a
price as possible, Defendants contrived a plan to improve artificially First
Horizon's financial performance by stuffing the wholesale distribution pipeline
with certain of its products, offering wholesalers unusual discounts, liberal return
policies, and/or extended payment terms as inducement to take additional product
above normal order quantities.
6. However, Defendants misled the marketplace about the reasons for
the Company's resulting growth and failed to disclose that the consequence of their
stuffing channels was the loss of future sales revenue that would materially reduce
net income and earnings in future quarters after the Offering had been completed.
7. By the second quarter 2002, after the Offering was completed, the
fallout from Defendants' efforts to stuff the wholesale channel began to appear in
the form of lost sales revenue from those products previously stuffed into the
wholesale pipeline. This was despite continued efforts to stuff wholesalers'
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 4 of 106
inventory with additional product in the first half of 2002 and beyond, including
Sular.
8. Rather than reveal the true reasons for this lost revenue, Defendants
represented , in a July 2, 2002 announcement reducing earnings guidance, that
declines in revenue and earnings were due to a reduction in Tanafed and Prenate
sales as a result of substitution by knock-off products . This representation was
misleading and only partially true; while generic substitutes posed a greater threat
to the sale of Tanafed and Prenate, the real reason for the decline in revenues was
the oversupply of those products stuffed into the marketplace in anticipation of
such threat.
9. In response to the Company's July 2, 2002 announcement reducing
earnings guidance, First Horizon's stock dropped 81 % from over $14 per share to
$3.51 on volumes of 16.4 million shares traded, more than 30 times the daily
average. Analysts downgraded the stock, "blindsided by the magnitude of the
preannouncement" and management ' s "loss of credibility." See, 7/02/02 analyst
report issued by J.P. Morgan.
10. In order to maintain artificially the stock price of First Horizon, and to
disguise the reason for the decline in revenues, First Horizon reverted to its
practice of deliberately overselling its products to its wholesalers. In particular, the
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 5 of 106
Company sold excess amounts of Tanafed and Prenate while knowing that the
Company was developing a replacement version that would render the product sold
obsolete and, thus, subject to return. In addition, the Company sold excess
amounts of Sular, so that trade inventory amounts increased to three times normal.
During this entire period, without disclosure to shareholders, First Horizon
materially changed its return policy, making it substantially easier for customers to
return the unwanted product that they had purchased.
11. On February 27, 2003, First Horizon announced that it was reducing
its earnings guidance due to depressed sales of Sular, Tanafed and other products,
higher than "anticipated" trade inventories, and increased product returns. In
response, First Horizon's stock dropped over 64% in a single day - - trading at only
$2.06 on February 28, 2003. The impact of Defendants' fraud on First Horizon's
stock price is depicted in the chart below:
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 6 of 106
ti ^r
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announcing a further reduction in earnings guidance for first quarter 2003. In the
press release, the Company admitted that a significant contribution to the decline in
net revenue "was the Company's reductions of shipments of those products
(including Sular) for which the Company seeks to reduce the levels of trade
inventories and the Company's current decision to withdraw Tanafed Suspension
from the market earlier than planned...."
13. Following the April 29 disclosure, the price of First Horizon's stock
fell another 20% from a closing price of $3.39 per share on April 28, 2003, to close
at $2.70 per share on April 29, 2003. As a result of Defendants ' false and
misleading statements during the Class Period, Plaintiffs have incurred tremendous
losses.
JURISDICTION AND VENUE
14. Plaintiffs bring this action pursuant to Sections 11, 12(a)(2), and 15 of
the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. §§ 77(k), 77(l)(2) and
77(o), and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the
"Exchange Act"), 15. U.S.C. §§ 78j (b), 78(n) and 78t(a), and Rule lOb-5
promulgated thereunder by the SEC.
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pursuant to Section 22 of the Securities Act, and 15 U.S.C. ' 77v, Section 27 of the
Exchange Act, 15 U.S.C. '78aa, and 28 U.S.C. ' 1331, as amended.
16. Venue is proper in this District pursuant to Section 22 of the
Securities Act and Section 27 of the Exchange Act, 15 U.S.C. § 77v and 15 U.S.C.
§ 78aa. Many of the acts and transactions giving rise to the violations of law
complained of herein, including the preparation and dissemination to the investing
public of false and misleading information, occurred in this District. Further, First
Horizon has its principal place of business in this District at 6195 Shiloh Road,
Alpharetta, Georgia 30005. In connection with the acts, conduct and other wrongs
complained of herein, Defendants, directly or indirectly, used the means and
instrumentalities of interstate commerce, including the United States mails and
interstate telephone communications , and the facilities of the NASDAQ National
Market ("NASDAQ"), a national securities exchange.
THE PARTIES
A. The Plaintiffs
17. Lead Plaintiff Thomas Sheahan purchased the securities of First
Horizon during the Class Period, as set forth in his certification already on file with
the Court.
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Horizon during the Class Period as set forth in his certification already on file with
the Court.
19. Lead Plaintiff Roy LaTourette, Jr. purchased the common stock of
First Horizon pursuant to the Registration Statement as set forth in his certification
already filed with the Court.
B. The Defendants
20. First Horizon is a specialty pharmaceutical company that markets and
sells brand name prescription products. The Company focuses on the treatment of
cardiovascular, obstetrical and gynecological, pediatric and gastroenterological
conditions and disorders. First Horizon's strategy is to acquire or license
pharmaceutical products that other companies do not actively market and that the
Company believes have high sales growth potential, are promotion-sensitive and
compliment existing products. In addition, the Company seeks to develop new
patentable formulations, use new delivery methods and seek new uses for existing
drugs. First Horizon also acquires businesses with complimentary products or
develop pipelines as well as late-stage development products consistent with the
Company's therapeutic focus.
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Board, Chief Executive Officer and President of First Horizon throughout the
entire Class Period. Defendants Shah left the Company under puzzling
circumstances shortly after the close of the Class Period. Just before the close of
business on February 12, 2003, Shah signed a new employment agreement with the
Company pursuant to which he was to receive $300,000 in annual salary.
However, On May 19, 2003, the Company issued a press release announcing the
resignation of Shah as Chairman of the Board, Chief Executive Officer and
President of First Horizon.
22. Defendant Shah was a signatory to the Company's Registration
Statement, the Company's Form 10-Qs during each quarter of 2002 and the
Company's 2002 Form 10-K. Shah also executed written certifications attesting to
the accuracy of the Company's Form 10-Qs for the second and third quarters of
2002, and the Company's 2002 Form 10-K.
23. Defendant Balaji Venkataraman ("Venkataraman") acted as Executive
Vice-President and Chief Operating Officer of First Horizon during the Class
Period until his resignation from the Company was announced on March 5, 2003,
near the end of the Class Period. Venkataraman resigned from the Company under
circumstances that were even stranger than the circumstances surrounding Shah's
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Case 1:02-cv-02332 -J F Document 114 Filed 04/20/2007 Page 11 of 106
resignation. On February 12, 2003, Venkataraman signed a new employment
agreement with the Company pursuant to which he was to receive $193,000 in
annual salary. Just three weeks later, the Company issued a press release
announcing the resignation of Venkataraman as Executive Vice-President and
Chief Operating Officer, effective immediately. Pursuant to the terms of his
severance agreement with the Company, Venkataraman received his $193,000
salary for one year and a lump sum payment of $28,000. In addition to his salary
and the lump sum payment, the Company also agreed to pay Venkataraman
$75,000 upon his termination.
24. Defendant Venkataraman entered into an agreement with the
Company, which was undisclosed to the investing public until the Company issued
its Proxy Statement on April 14, 2003, in which he agreed to perform at least 80
hours of consulting services for the Company for the period following his
resignation up to and including April 30, 2003. During this period, while in
possession of material adverse non-public information, Venkataraman sold 51,190
shares of his First Horizon stock on April 16, 2003, for proceeds of $51,190 and
sold 150 ,000 shares of his First Horizon stock on April 21, 2003, for proceeds of
$450,000. The sale of 201,190 shares of First Horizon stock represented almost
one-third of his entire holdings, including exercisable stock options.
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Registration Statement and the Company's Form 10-Qs for each quarter in 2002.
Venkataraman also executed written certifications attesting to the accuracy of the
Company's Form 10-Qs for the second and third quarters of 2002.
26. Defendant Darrell Borne ("Borne") has been the Chief Financial
Officer of the Company since December 2002, and Treasurer and Secretary of the
Company since January 2003, and Executive Vice President since March 2006.
On February 12, 2003, Borne signed a new employment agreement with First
Horizon in which he was to receive $140,000 in annual salary. Borne is a
signatory to the Company's 2002 Form 10-K and the severance agreements entered
into between the Company and Shah and Venkataraman.
27. Defendant John N. Kapoor ("Kapoor") was a Director of First
Horizon from 1996 until his resignation in December 2006, and a signatory to the
Company's Registration Statement . On May 19, 2003, Kapoor became the non-
executive Chairman of the Board for First Horizon. Kapoor is the founder of
Kapoor-Pharma Investments , L.P., ("Kapoor-Phanna") the Company 's largest
shareholder with approximately 15% of First Horizon's outstanding common
stock. The managing general partner of Kapoor-Pharma is EJ Financial
Enterprises, Inc., where Kapoor serves as the President and sole stockholder. Shah
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 13 of 106
and Venkataraman also served as officers of EJ Financial Enterprises , Inc. prior to
the Class Period. According to Kapoor-Pharma's 2003 Proxy Statement, Kapoor
has the authority to vote and dispose of the shares owned by Kapoor-Pharma
Investments, and is therefore deemed the beneficial owner of those shares. As
Kapoor-Pharma admitted in its Form 10-K for the year ended December 31, 2002,
filed with the SEC on or about March 18, 2003, "Kapoor-Pharma Investments
holds significant control or influence over [First Horizon's] policies and acts."
28. Kapoor, and companies that he controls, have shown a consistent
disregard for compliance with securities laws and regulations . For example,
Kapoor is the controlling shareholder of another publicly traded pharmaceutical
company, beneficially owning over 38% of the stock of Akorn, Inc. ("Akorn")
Kapoor served as Akorn's Chief Executive Officer from March 2001 until his
resignation in December 2002, and has been the Chairman of the Board of Akorn
from May 1995 through the present. In April 2002, during Kapoor's tenure as
Chief Executive Officer, the SEC conducted an investigation of Akorn's financial
statements. As a result of the investigation, Akorn agreed to restate its financial
statements for 2000 and 2001 and entered into a proposed consent order with the
SEC, which found that Akorn violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B)
of the Exchange Act and Rules 12b-20, 13 a-1 and 13 a-13 promulgated thereunder.
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 14 of 106
Additionally, Akorn restated its financial statements for the first two quarters of
2002 because of a transaction Akorn entered into with Kapoor in which Akorn
failed to recognize a $1.5 million beneficial conversion feature embedded in the
terms and conditions of convertible notes issued to Kapoor in 2001. Ultimately,
Akorn was delisted from NASDAQ for filing unaudited financial statements with
the SEC as well as being subject to SEC enforcement proceedings and FDA
investigations and fines.
29. Kapoor was also previously the Chairman and President of Lyphomed
Inc. ("Lyphomed"), a publicly traded company in which he owned more than 10%
of the stock. During his tenure as Chairman and President of Lyphomed, Kapoor
was sued in a class action alleging securities fraud in violation of the Exchange Act
that ultimately settled for $10.4 million. Subsequently, Fujisawa Pharmaceutical
Co. Ltd. also sued Kapoor for separate securities fraud and RICO violations that
was also settled, but the terms are not public and are subject to a confidentiality
agreement.
30. Defendants Shah, Venkataraman, Borne and Kapoor are hereinafter
referred to collectively as the "Individual Defendants." The Company and the
Individual Defendants are sometimes referred to collectively as the "Defendants."
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 15 of 106
31. Defendant Jerry N. Ellis ("Ellis") has been a Director of First Horizon
since November 2000 and was a signatory to the Company's Registration
Statement. Ellis was a partner at Arthur Andersen and has also been a Director of
Akorn since 2001, during which time Akorn restated its financial results for 2000,
2001 and the first two quarters of 2002, and was delisted by the NASDAQ stock
market in June 2002 for filing unaudited financial statements with the SEC, as well
as being subject to SEC enforcement proceedings and FDA investigations and
fines, as detailed above.
32. Defendant Jon S. Saxe ("Saxe") has been a Director of First Horizon
since January 2000 and was a signatory to the Company's Registration Statement.
Saxe was President, Chief Executive Officer and a Director of Synergen, Inc.
("Synergen") from October 1989 to April 1993. During his tenure at Synergen, he
was a named party defendant in a class action alleging securities fraud under the
Exchange Act, which ultimately settled for $28 million.
33. Defendant Patrick J. Zenner ("Zenner") has been a Director of First
Horizon since May 2002 and was a signatory to the Company's Registration
Statement.
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Horizon since April 2000 and was a signatory to the Company's Registration
Statement. Lapalme is the Company's current Chairman of the Board of Directors.
35. Defendants Ellis, Saxe, Zenner and Lapalme are hereinafter referred
to collectively as the "Director Defendants."
36. Defendant Deutsche Bank Securities, Inc.; Banc of America
Securities , LLC; J. P. Morgan Securities , Inc.; Thomas Weisel Partners , LLC and
LaSalle Capital Markets (collectively, the "Underwriter Defendants") are full
service investment firms and sold First Horizon's stock presented in the Offering
on a firm commitment basis, a contractual agreement under which they agreed to
purchase 6.5 million shares offered for sale in the Offering for resale to the
investing public. In addition, the Underwriter Defendants exercised an option to
purchase an additional 975,000 shares in the Offering for resale to the investing
public.
37. By reason of their management positions and/or their membership on
the Company's Board of Directors, their ability to make public statements in the
name of the Company, and their stock ownership, the Individual Defendants were
controlling persons of the Company and had the power and influence, which they
exercised, to cause the Company to engage in the unlawful conduct alleged herein.
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 17 of 106
In fact, the Company admitted in its 2002 Form 10-K that Kapoor-Pharma,
controlled by Kapoor, holds significant control or influence over First Horizon's
policies and acts.
38. Each Individual Defendant had access to the adverse non-public
information about the Company's business, finances, products, markets and
present and future business prospects, as particularized herein, by means of internal
corporate documents, conversations or connections with corporate officers or
employees, attendance at Company management and/or Board of Directors
meetings and committees thereof, and/or reports and other information provided to
each in connection therewith. Because of this access, each of these Defendants
actually knew or recklessly disregarded the adverse facts specified herein that were
being concealed.
CLASS ACTION ALLEGATIONS
39. Plaintiffs bring this action as a class action pursuant to Rules 23(a)
and (b)(3) of the Federal Rules of Civil Procedure on behalf of the Class, which
consists of all persons or entities who purchased First Horizon securities during the
Class Period, and on behalf of the Offering Subclass. Excluded from the Class and
Offering Subclass are Defendants, members of the immediate family of each of the
Individual Defendants, the Director Defendants, the Underwriter Defendants, any
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 18 of 106
entity in which any Defendant has a controlling interest, and the legal affiliates,
representatives, heirs, controlling persons, successors, and predecessors in interest
or assigns of any such excluded party.
40. Because more than 34 million shares of the Company's common stock
were outstanding, and because the Company's common stock was actively traded
on the NASDAQ during the Class Period, the members of the Class are so
numerous that joinder of all members is impracticable. While the exact number of
Class members can only be determined by appropriate discovery, Plaintiffs believe
that Class members number at least in the hundreds or thousands and that they are
geographically dispersed.
41. Pursuant to the Registration Statement, the Company issued
approximately 7.475 million shares of its common stock in connection with the
Offering. Plaintiffs believe that there are thousands of Offering Subclass members
comprised of persons and entities that are geographically dispersed. This makes
joinder of each member of the Offering Subclass impracticable.
42. Plaintiffs' claims are typical of the claims of the members of the Class
and Offering Subclass, because Plaintiffs and all of the members of the Class and
Offering Subclass sustained damages arising out of Defendants' wrongful conduct
as alleged herein.
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members of the Class and Offering Subclass. Plaintiffs have retained counsel who
are experienced and competent in class action and securities litigation. Plaintiffs
have no interest that is contrary to or in conflict with those of the members of the
Class and Offering Subclass that they seek to represent.
44. A class action is superior to all other available methods for the fair
and efficient adjudication of this controversy, since joinder of all Class and
Offering Subclass members is impracticable. Furthermore, as the damages
suffered by individual members of the Class and Offering Subclass may be
relatively small, the expense and burden of individual litigation make it impossible
for the members of the Class and Offering Subclass individually to redress the
wrongs done to them. There will be no difficulty in the management of this action
as a class action.
45. Questions of law and fact common to the members of the Class and
Offering Subclass predominate over any questions that may affect only individual
members, in that Defendants have acted on grounds generally applicable to the
entire Class and Offering Subclass. Among the questions of law and fact common
to the Class and Offering Subclass are:
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alleged herein;
(b) Whether the Company's publicly disseminated releases and
statements during the Class Period omitted and/or misrepresented material facts,
and whether Defendants breached any duty to convey material facts or to correct
material facts previously disseminated;
(c) Whether Defendants participated in and pursued the common
course of conduct complained of,
(d) Whether Defendants acted knowingly or severely recklessly in
omitting and/or misrepresenting material facts;
(e) Whether the market prices of First Horizon's securities during
the Class Period were artificially inflated due to the material nondisclosures and/or
misrepresentations complained of herein; and
(f) Whether the members of the Class and Offering Subclass have
sustained damages and, if so, what is the appropriate measure of damages.
THE MANNER IN WHICH FIRST HORIZON PERPETRATED ITSFRAUD
46. First Horizon is a specialty pharmaceutical company that markets and
sells brand name prescription products. The Company sells its products to
pharmaceutical wholesalers (who in turn distribute to pharmacies), chain drug
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 21 of 106
stores, other retail merchandisers and, on a limited basis, directly to pharmacies.
First Horizon' s sales to three major pharmaceutical wholesalers, McKesson
Corporation ("McKesson"), Cardinal Health, Inc. (and one of its divisions, Bindley
Western Industries) ("Cardinal"), and ArnerisourceBergen ("Am erisource")
(collectively the "Big Three" distributors) account for approximately 80% of the
Company's total sales revenues.
47. The Company focuses on four major product areas : (i) cardiovascular;
(ii) obstetrical and gynecological; (iii) pediatric; and (iv) gastroenterological. First
Horizon promotes and markets its products through the Company's nationwide
sales and marketing force that targets high-prescribing cardiologists, obstetricians
and gynecologists, and select primary care physicians. The Company's sales and
marketing force creates demand for the Company's products by targeting the
medical community that prescribes them . This demand generally is met, in the
first instance, from the inventories of pharmacies filling these prescriptions and
then, as needed, from the inventories of wholesalers that directly purchase and
stock First Horizon's products.
48. Depending upon the size of the wholesalers' inventories of particular
First Horizon products, measured in months on hand, there can be a substantial
disconnect between demand for the product, measured by the numbers of
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 22 of 106
prescriptions written and actually filled for the product, and First Horizon's
revenues, which are primarily generated through sales to wholesalers. When
wholesaler inventory is dramatically inflated for a particular product, there may be
no sales by First Horizon for that product despite an increase in the rates by which
the product is prescribed and those prescriptions are filled.
49. Of equal, if not greater importance, the number of prescriptions
written does not bear a direct correlation to the amount of drugs that First Horizon
may sell, since customers have the option of filling such prescription with a
generic version of the product manufactured by a competitor.
50. With this information in hand, and as described in more detail below,
Defendants stuffed the wholesale inventory channels with product in order to meet
analyst earnings estimates and enhance the Company's ability to complete
successfully its Offering on April 24, 2002 (the first day of the Class Period).
Defendants' use of improper channel stuffing activities in order to meet publicly
announced sales estimates began prior to the Class Period.
51. According to a former Vice President of Marketing ("Marketing
V.P."), employed by First Horizon from May 2001 to May 2003, and a former
Vice President of Sales ("Sales V.P."), employed by First Horizon from May 2000
until December 2002, a strategic plan was devised starting in July 2001, during the
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 23 of 106
Weekly Operating Committee meetings, by the "whole executive team" to stuff the
wholesale distribution pipeline with Tanafed as a part of an "anti-competitive"
strategy to stem the substitution rate of generic competitors to Tanafed. In order to
accomplish this goal, First Horizon would either give a discount to wholesalers of
up to 10%, or engage in "invoice dating," which would extend payment terms from
30 days to 60 days. At the time First Horizon began to stuff Tanafed into the
wholesale channel, the Company also started to develop Tanafed DP and DMX to
block shelf space of generic competitors, and thus knew that the Tanafed that it
was selling would become obsolete.
52. Specifically, the First Horizon executive team learned from various
sources in July and August 2001 that a generic substitute for Tanafed would be
hitting the market in the near future from "one of [its] distributors" in Puerto Rico
- Deliz Pharmaceuticals ("Deliz"). The Marketing V.P. stated that Deliz faxed a
"flier" promoting the Tanafed generic substitute to either Venkataraman or
Christopher Offen ("Offen"), First Horizon's Chief Commercial Officer, who then
presented the flier as a discussion point during the Company's Weekly Operating
Committee Meeting. Once the information came from Deliz, Kathy Lang
("Lang"), the Company's Director of Trade Relations, started contacting wholesale
distributors in an effort to seek out additional information. The Marketing V.P.
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 24 of 106
said that, by September 2001, "we knew for sure the generics were going to hit the
market when we got a pricing sheet from Puerto Rico." A former Product
Manager ("Product Manager I") of First Horizon, employed by the Company from
January 2002 to July 2003, stated that around September 2001, the wholesale
pipeline report on Tanafed showed a supply of approximately 10 months, five
times the normal inventory of two months. Thus, First Horizon increased sales
during a period when wholesale inventories far exceeded their normal levels.
53. During this same time period, First Horizon was engaged in
negotiations with AstraZeneca UK Limited ("AstraZeneca") for the purchase of
the antihypertensive prescription medication Sular. The purchase of Sular
represented the most significant and expensive product acquisition in the
Company's history. In order to ensure that the Company would receive the private
financing required for the acquisition of Sular and to ensure the highest stock price
per share as possible to successfully complete the Offering, Defendants took
measures to meet and exceed analyst earnings expectations in both the fourth
quarter of 2001 and the first quarter of 2002, the anticipated closing date of the
Sular acquisition. First, as noted above, Defendants stuffed the wholesaler
channels with product during the second half of 2001. Second, according to the
Sales V.P. and another former Product Manager ("Product Manager II"), employed
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 25 of 106
by First Horizon from January 2002 until July 2003, because First Horizon had met
its estimated earnings for the fourth quarter of 2001 by early December 2001, the
Company improperly shifted sales of Robinul that the Company had made in the
fourth quarter of 2001, transferring the revenue into the first quarter of 2002.
Third, according to Product Manager II, First Horizon stuffed the wholesale
channel during the first quarter of 2002, including its Prenate and Tanafed
products, so as to present the Company in a positive light immediately prior to the
Offering. Product Manager II said that the Company would not have met its
projections for this period had it not engaged in channel stuffing. These activities
ensured that First Horizon made its estimated earnings for the third and fourth
quarters of 2001 and, more importantly, for the first quarter of 2002.
54. On February 13, 2002, , Defendants issued a press release announcing
an agreement to purchase the Sular product line. The press release stated that First
Horizon obtained private financing to complete the acquisition:
In order to finance the acquisition, the Company intends to use itsavailable cash and has received a commitment for a six-month $152million senior secured credit facility, arranged through Deutsche BancAlex. Brown Inc., which also acted as financial advisor to FirstHorizon in connection with this transaction.
55. On April 19, 2002, First Horizon announced that it priced the offering
of 6,500,000 shares of its common stock at $21.75 per share for gross proceeds of
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 26 of 106
$141,375,000 in order to repay the privately financed debt incurred in connection
with the Sular acquisition. In addition, the Underwriter Defendants were granted
the right to purchase an additional 975,000 shares to cover potential over-
allotments. The common stock was sold pursuant to the Registration Statement.
The Underwriter Defendants exercised their right to purchase these additional
975,000 shares.
FALSE AND MISLEADING STATEMENTS ISSUED AT THE TIME OFTHE PUBLIC OFFERING
56. The Class Period begins on April 24, 2002, the date of First Horizon's
Offering pursuant to the Registration Statement of 6,500,000 shares of common
stock, not including an underwriters over-allotment allocation of 975,000
additional shares. The Offering was priced at $21.75 per share.
57. Explaining the Company's $32.6 million increase in net revenues in
2001 as compared to 2000, which resulted in a total of $69.3 million in revenues
for 2001, the Registration Statement's Results of Operations section stated:
The increase in sales for the year ended December 31, 2001 was
primarily due to increased unit sales of our key products Tanafed,
Robinul, Nitrolingual Pumpspray and Ponstel. According to IMS
Health's National Prescription Audit Plus data, total prescriptions of
Tanafed, Robinul and Robinul Forte and Ponstel increased 41.9%,
51.9% and 47.0%, respectively.
-26-
Company's realigned sales force, correlating it to growth in its key products
through increased prescriptions:
We recently realigned our sales force into three specialty groups tooptimize productivity. We now have 68 professionals marketing toprimary care physicians and cardiologists, 99 professionals marketingto obstetricians and gynecologists, pediatricians andgastroenterologists and 11 professionals marketing to physicians atteaching hospitals. Prescription growth for our Robinul and RobinulForte, Tanafed and Ponstel products supports the effectiveness of ourpromotional strategy, as prescriptions of these products grew 51.9%,41.9% and 47.0%, respectively, from 2000 to 2001 according to IMSHealth's National Prescription Audit Plus data.
[Emphasis added].
59. The Registration Statement also disclosed that Tanafed had increased
from 22.3% of First Horizon's total sales in 2000 to 28.5% in 2001.
60. The Registration Statement was false and misleading for the following
reasons:
a. the Registration Statement failed to disclose that First Horizon, in
the fourth quarter of 2001, engaged in channel stuffing with respect to, inter alia,
its Tanafed line of drugs, and that there existed an oversupply among wholesalers
that was more than five times greater than normal;
b. the Registration Statement attributed the increase in sales to an
increase in the number of Tanafed prescriptions, even though the number of
-27-
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 28 of 106
prescriptions bore only an indirect relationship to First Horizon's actual sales,
since prescriptions could be filled by generic competitors, and the increase in sales
was due to First Horizon's channel stuffing activities;
c. the Registration Statement did not disclose that that the sales force
realignment to which it referred would remove sales personnel from existing
products so that First Horizon could concentrate on sales of its new Sular product.
According to Product Manager I, First Horizon was "spending so much energy on
Sular, all other drug sales suffered;"
d. the Registration Statement failed to disclose that, on January 1,
2002, the Company had changed its product return policy from a twelve month
window (i.e., from six months prior to expiration date of the product to six months
subsequent to the expiration date of the product) to an eighteen month window
(i.e., from six months prior to the expiration date of the product to twelve months
subsequent to the expiration date of the product);
e. the Registration Statement failed to disclose that much of the sales
of Tanafed and Prenate consisted of product that would be obsolete when the
Company introduced new versions of that drug, which it intended to do, and that
such obsolete product would be returned to First Horizon; and
-28-
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 29 of 106
f. the Registration Statement failed to disclose that the Company had
shifted sales of its Robinul product from the fourth quarter of 2001 to the first
quarter of 2002.
61. On May 6, 2002, the Company issued a press release announcing first
quarter 2001 earnings. The press release correlated the Company's increased
revenues to growth in the number of prescriptions for the Company's key products,
stating in relevant part:
Prescription growth of our key products continues to drive revenue . ... Total prescriptions of Ponstel®, Robinul® and Robinul® Forte, andthe Tanafed ® line increased 46%, 28% and 4%, respectively, fromthe first quarter of 2001 to the first quarter of 2002. (Source: IMSHealth's National Prescription Audit P1usTM data.)
[Emphasis added].
62. On the following day, May 7, 2002, the Company filed its Form 10-Q
for the period ending March 31, 2002 (the "March 31, 2002 Form 10-Q") with the
SEC. As to net income, the March 31, 2002 Form 10-Q essentially repeated the
financial results for the first quarter of 2002 as disclosed in the May 6 press release
and during the conference call on the same day. In conjunction with its discussion
of quarterly financial results, the March 31, 2002 Form 10-Q also correlated the
increased revenue to increases in prescription growth for the Company's key
products:
-29-
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 30 of 106
Net Revenues. Net revenues increased $14.7 million or 118%, overthe quarter ended March 31, 2001, to $27.1 million for the quarterended March 31, 2002. Sales of continuing products (includingTanafed DM which we added to our Tanafed line in January 2002) forthe quarter ended March 31, 2002 increased 45% compared to thequarter ended March 31, 2001. The increase in sales of continuingproducts for the quarter ended March 31, 2002 compared to thequarter ended March 31, 2001 was primarily due to prescriptiongrowth in Robinul, Tanafed and Ponstel in 2002 . According to IMSHealth's National Prescription Audit Plus data, total prescriptions ofour Ponstel product increased 46%, Robinul and Robinul Forteproducts increased 28% and our Tanafed products increased 4%.
[Emphasis added].
63. The March 31, 2002 Form 10-Q was false and misleading for the
following reasons:
a. Defendants failed to disclose that First Horizon, in the first quarter
of 2002, engaged in channel stuffing with respect to, inter alia, its Tanafed line of
drugs, and that there existed an oversupply among wholesalers that was at least
five times greater than normal;
b. Defendants attributed the increase in sales to an increase in the
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
-30-
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
d. Defendants failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon;
e. Defendants failed to disclose that the Company had shifted sales of
its Robinul product from the fourth quarter of 2001 to the first quarter of 2002; and
f. Defendants did not disclose that the Company had removed sales
personnel from existing products so that First Horizon could concentrate on sales
of its new Sular product.
64. On July 2, 2002, First Horizon issued a press release announcing the
reduction in its expected earnings for the second quarter 2002 and the reduction in
its earnings guidance for the remainder of the year. According to the press release,
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Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 32 of 106
there were two reasons for the decline in the Company's expected revenue, income
and earnings:
First Horizon reported that the primary contributing factor for theshortfall resulted from greater than expected erosion of sales in thesecond quarter of its Tanafed Suspension (pediatric liquid cold &allergy product) and Prenate GT (prescription prenatal vitamin)products to knock-off products . Another contributing factor for theshortfall was the distraction arising out of the realignment of the salesforce , which was completed in the second quarter of 2002.
[Emphasis added].
65. The market' s reaction to First Horizon 's announcement was quick and
significant . First Horizon' s stock price plummeted by 81% or by $14.74 to $3.51,
on volume of 16.4 million shares, about 30 times the daily average.
66. During an earnings conference call that same day, July 2, Shah stated,
among other things, that "[t]wo major factors" contributed to First Horizon's
earnings shortfalls in the second quarter. According to Shah:
The primary contributor was significant erosion of sales in the secondquarter of Tanafed Suspension and Prenate GT, due to substitution byknock-offs of these products .... The knockoffs had margin of impactuntil the second quarter ....
The second contributing factor was the distraction that rose due to therealignment of our sales force , which was completed in the secondquarter of 2002.... This distraction is over, and our sales force arefocused on building the company's key products.... [A]s we havediscussed in the past, the realignment is an integral part of our growthplan. These temporary distractions are behind us now, and our salesforce has completely familiarized themselves with their territories and
-32-
Venkataraman reiterated:
The shortfall is primarily due to the erosion of Tanafed and PrenateGT sales, involving the knock-off issues addressed by Mahendra[Shah]. Our second half guidance incorporates a lowering of revenuefor these two products.
[Emphasis added].
67. Later in the conference call, another questioner asks about the $14
million reduction in expected revenues for the second half of the year, seeking
confirmation that "the 14 million is just Tanafed and [Prenate] GT."
Venkataraman agrees, "Right."
68. When Venkataraman was asked what had changed in the second
quarter of 2002, "because the products [Tanafed and Prenate] were going so well,
right up until th[at] quarter," Venkataraman states that no new competitors had
entered into the market. Rather, the Company "did not see the erosion kicking up .
.. in terms of weekly prescriptions . That's what we did not see in terms of the
trends going into the second quarter." Responding to a follow-up question
regarding whether the revenue decline was really due to erosion from knock-offs
or "just a lack of attention by your sales force to these products, given the
realignment," Venkataraman stated:
- 33 -
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 34 of 106
All of the products that we had in our portfolio have continued togrow through the realignment . So if the question was did we continueto grow Prenate GT week over week through the realignment, we did.So to respond to your question, the substitution rates increased moreat the pharmacy level than our ability to grow the product, because wehave shown that, as in the example of Prenate GT, we have grown theproducts all the way through April and May.
[Emphasis added.]
69. These statements were false and misleading for the following reasons:
a. Defendants failed to disclose that First Horizon, in the first quarter
of 2002, engaged in channel stuffing with respect to, inter alia, its Tanafed line of
drugs, and that there existed an oversupply among wholesalers that was at least
five times greater than normal;
b. Defendants attributed the increase in sales to an increase in the
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
c. Defendants failed to disclose that, on January 1, 2002, the
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
-34-
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 35 of 106
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
d. Defendants failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon;
e. Defendants failed to disclose that the Company had shifted sales of
its Robinul product from the fourth quarter of 2001 to the first quarter of 2002; and
f. Defendants did not disclose that the Company had removed sales
personnel from existing products so that First Horizon could concentrate on sales
of its new Sular product.
70. In addition, these statements were false because First Horizon knew
that at least one new competitor had entered the market; indeed, the entry of such
competitor was so significant that it was one of the primary catalysts for First
Horizon 's channel stuffing.
71. Also, during the July 2 earnings conference call, Venkataraman raised
the issue of a possible write-off of Tanafed inventory in conjunction with the
Company's earnings guidance for the second half of 2002:
The guidance for the second half of 2002 is as follows. Revenuesbetween $60 and $65 million, EPS between 20 and 22 cents. This
-35-
exten si on .
[Emphasis added].
72. In follow-up, a questioner asked about the $5 million charge for the
"new formulation of Tanafed," Venkataraman responds:
We currently have Tanafed in our warehouse and in the trade. If welaunch a product that is going to replace it, in order to maximize thelaunch of that line extension, we may write off the inventory in thetrade and we may write off the inventory on hand. So that is thereason we have a one-time $5 million charge, up to $5 million.We've estimated those numbers based on the data we have, and that'show we've provided that. And it says, if we launch it, we may takethat write off up to $5 million.
73. Venkataraman was asked again about the Company's inventory
adjustments relating to Tanafed. The Q & A highlights Venkataraman ' s attempt to
deflect the issue in furtherance of Defendants' scheme:
ROBERT OLE (ph), FRANKLIN STREET PARTNERS: Thank you.I just needed a little bit more clarification on the inventory . It lookslike at the end of Q1, your total inventory was 11 . 4 million, and thenabout -- I don ' t know, some big chunk of that was Sular , so if youtake away Sular , it gives you about 5 . 2 million inventory for thenon-Sular inventory , and you 're talking about writing down $5million worth . And at your 15 percent cost of goods, $5 million writedown would imply sales of $30 to $35. So some of this doesn'tconnect to me ...
BALAJI VENKATARAMAN: Robert (ph).
-36-
BALAJI VENKATARAMAN: Robert (ph), when you buy back,when you impair inventory , when you buy back inventory fromwholesalers , you're not buying back at the cost of goods sold , you'rebuying back at ...
ROBERT OLE (ph): Their cost, right . Got you. So then ...
BALAJI VENKATARAMAN: So what we did is ...
ROBERT OLE (ph): If they hold -- so still, if they hold two months
of inventory, which is normal, then you're saying that -- I mean, they
think that's a $30 million a year product, and that doesn't make senseeither.
BALAJI VENKATARAMAN: What we did is we took the inventorythat we currently have on hand for samples and product . And we tookan estimated value -- we took a fairly conservative estimated value ofwhat we thought would be inventory at the wholesalers , and thenessentially combined the two, and arriving at the $ 5 million.
MAHENDRA SHAH: We said up to $5 million.
BALAJI VENKATARAMAN: Up to $ 5 million.
MAHENDRA SHAH: And it depends upon the launch time. When
we launch the new product.
ROBERT OLE (ph): So theoretically , they'll be ordering none now.
BALAJI VENKATARAMAN: That is correct.
[Emphasis added.]
-37-
given for the earnings shortfall. Indeed, a July 2, 2002 analyst report issued by
Corey Davis at J. P. Morgan explained "wholesaler inventory stocking" in the first
quarter that was "now being taken out of subsequent quarters" was a likely reason
for the Company's enormous "disconnect" between promised and actual financial
results. The J. P. Morgan analyst report downgraded the stock and revealed that
they did not see "any appreciation [in First Horizon's stock price] soon due to the
loss of [management 's] credibility."
75. Nevertheless, First Horizon continued to disguise the true reasons for
its second quarter results . On August 5, 2002, First Horizon announced in a press
release that its second quarter results were in line with its previously revised
earnings guidance. Commenting on the results, Shah stated:
The Company reported greater than expected erosion of sales in thesecond quarter of its Tanafed Suspension and Prenate GT productsdue to increased competition from knock-off products resulting inpharmacists substituting such knock-off products for the Company'sproducts. Another factor that contributed to the shortfall was thedistraction arising from the realignment of the sales force that wascompleted in the second quarter .
[Emphasis added].
76. In an earnings conference call that same day, August 5, Shah again
misrepresented the nature of First Horizon's faltering revenues:
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Case 1:02-cv-02332-J F Document 114 Filed 04/20/2007 Page 39 of 106
The primary contributing factor for revenues and earnings in the
second quarter was due to the greater than expected erosion of salessupport of suspension in Prenate projects due to increased substitutionby pharmacies of knockoff products .
[Emphasis added].
77. On August 16, 2002, the Company filed its Form 10-Q/A for the
period ending June 30, 2002 (the "June 30, 2002 Form 10-Q") with the SEC.
Addressing the Company's Results of Operations, the June 30, 2002 Form 10-Q
stated, in part, that:
The Company experienced erosion of sales of its Tanafed and Prenateproducts during the quarter ended June 30, 2002 due to increasedcompetition from knock-off products resulting_ fromrom pharmacists'substituting such knock-off products for the Company's products . Netrevenues for the 2002 quarter were also adversely affected bydistraction arising from the realignment of the Company's sales forcethat was completed during the second quarter. The Company expectsto experience continued erosion of sales of Tanafed and Prenate dueto competition from knock-off products . Subject to completion of theCompany's development project for Tanafed, the Company plans tolaunch a line extension of Tanafed later during 2002 to seek tomitigate future pharmacists' substitutions for Tanafed. In addition, theCompany is implementing a strategic education program to mitigatepharmacists' substitutions for Prenate.
[Emphasis added].
78. These statements were false and misleading for the following reasons:
a. Defendants failed to disclose that First Horizon, in the first quarter
of 2002, engaged in channel stuffing with respect to, inter alia, its Tanafed line of
-39-
Case 1:02-cv-02332 -J F Document 114 Filed 04/20/2007 Page 40 of 106
drugs, and that there existed an oversupply among wholesalers that was at least
five times greater than normal;
b. Defendants attributed the increase in sales to an increase in the
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
c. Defendants failed to disclose that, on January 1, 2002, the
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
d. Defendants failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon;
e. Defendants failed to disclose that the Company had shifted sales of
its Robinul product from the fourth quarter of 2001 to the first quarter of 2002; and
-40-
personnel from existing products so that First Horizon could concentrate on sales
of its new Sular product.
79. With respect to the previously announced potential $5 million
Tanafed inventory write-off, the June 30, 2002 Form 10-Q reiterated that:
If the Company is successful in completing and introducing the lineextension to Tanafed which the Company currently has underdevelopment, the Company anticipates that it may incur a expenseestimated at $5 million associated with the launch of the Tanafed lineto buy back Tanafed products held for sale by wholesalers andpharmacists.
80. In a press release issued on September 23, 2002, announcing First
Horizon's line extensions of its Tanafed products, the Company stated, among
other things:
We believe that Tanafed DP(TM) and Tanafed DMX (TM) have the
potential to mitigate pharmacy substitution issues that impacted our
second quarter results . The timing of this launch is crucial, as we
were recently made aware of a knock off product to our Tanafed
DM(TM) entering the market.
[Emphasis added].
81. The statement set forth above was materially false for the following
reasons:
a. Defendants failed to disclose that First Horizon, in the first quarter
of 2002, engaged in channel stuffing with respect to, inter alia, its Tanafed line of
-41 -
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 42 of 106
drugs, and that there existed an oversupply among wholesalers that was at least
five times greater than normal;
b. Defendants attributed the increase in sales to an increase in the
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
c. Defendants failed to disclose that, on January 1, 2002, the
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
d. Defendants failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon;
e. Defendants failed to disclose that the Company had shifted sales of
its Robinul product from the fourth quarter of 2001 to the first quarter of 2002; and
-42-
personnel from existing products so that First Horizon could concentrate on sales
of its new Sular product.
82. First Horizon's September 23 press release also confirmed that its
"previously announced one-time charge of approximately $5 million related to the
discontinuance of Tanafed® and Tanafed DM(TM) [would] be recorded in the
third quarter."
DEFENDANTS' SUBSEQUENT FRAUD
83. First Horizon's problems did not cease with the second quarter.
Having invested so greatly in the success of Sular, the Company soon discovered
that the market for such product were far less than anticipated. Again, the
Company resorted to deliberately oversupplying the wholesale market to maintain
its revenue figures. Trade inventories for Sular increased from 3.6 months to 6
months by November 2002.
84. Nevertheless, on November 6, 2002, with regard to trade inventories
of Sular, Shah told the marketplace that "Sular had excess inventories when we
bought it and we're slowly pulling those inventories down ...."
85. On November 12, 2002, the Company filed its Form 10-Q for the
period ending September 30, 2002 (the "September 30, 2002 Form 10-Q") with the
- 43 -
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 44 of 106
SEC. Explaining the decline in net revenues through the third quarter 2002 over
the same period in 2001, the September 30, 2002 Form 10-Q stated that:
The Company has experienced erosion of sales of its Tanafed andPrenate products during the nine months ended September 30, 2002due to increased competition from knock-off products resulting frompharmacists' substituting such knock-off products for the Company'sproducts .
[Emphasis added].
86. The statements set forth in paragraphs 81 and 82 were false and
misleading. With respect to the first two quarters of 2002, the 10-Q was false and
misleading for the following reasons:
a. Defendants failed to disclose that First Horizon, in the first quarter
of 2002, engaged in channel stuffing with respect to, inter alia, its Tanafed line of
drugs, and that there existed an oversupply among wholesalers that was at least
five times greater than normal;
b. Defendants attributed the increase in sales to an increase in the
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
-44-
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
d. Defendants failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon;
e. Defendants failed to disclose that the Company had shifted sales of
its Robinul product from the fourth quarter of 2001 to the first quarter of 2002; and
f. Defendants did not disclose that the Company had removed sales
personnel from existing products so that First Horizon could concentrate on sales
of its new Sular product.
87. In addition , Defendants admitted , in a conference call on February 27,
2003, that Shah's statement that First Horizon was "pulling down" Sular
inventories was false in light of the fact that such inventories were actually
increasing.
-45-
Horizon issued a press release announcing its earnings guidance for the first two
quarters of 2003 and for full year 2003. In that release, the Company stated that,
for the first quarter of 2003, it expected earnings per share to be $.11 - $.12. The
Company stated that, for the year, earnings would be $.55 to $.60 per share.
89. With respect to Sular, Shah stated: "We believe we have stemmed the
Sular prescription decline and have stabilized the brand. We believe that new
prescription growth will be a good metric to measure our success." Shah went on
to state:
As a result of the sales force realignment into two focused specialty sales groupsand the sales force expansion in April 2002, we were able to accelerateprescription growth in the third quarter of 2002 for most of our key brands due toour increased focus on key products and targeted physicians. We expect thismomentum to continue in 2003.
90. This disclosure was false and misleading. The release failed to
disclose that any "stabilization" of the Sular "brand" was not due to increased
prescriptions but to First Horizon's deliberate oversupply of the drug to
wholesalers. The release failed to disclose that trade inventories for Sular
increased from 3.6 months to 6 months by November 2002.
91. Further, the release was false and misleading because:
-46-
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
b. The release failed failed to disclose that, on January 1, 2002, the
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
c. The release failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon; and
d. The release did not disclose that the the Company had removed
sales personnel from existing product's so that First Horizon could concentrate on
sales of its new Sular product.
-47-
Case 1:02-cv-02332- J F Document 114 Filed 04/20/2007 Page 48 of 106
92. On the February 27, 2003 conference call, Defendants announced that
the Company was revising its first quarter earnings guidance downward yet again
from that given on December 5, 2002 due to: (i) fewer than expected total
prescriptions of Sular compounded by higher than anticipated levels of trade
inventories; (ii) lower than expected performance of Tanafed DP in the first quarter
2003; and (iii) increased rates of decline in total prescriptions of the Company's
non-promoted products and increased returns of these products. The Company
stated that it expects net revenues to be between $20 million and $25 million and
earnings per share to range from a loss of $.03 per share to a profit of $.02 per
share, significantly below the figures announced in December 2002..
93. The market reacted swiftly. The Company's stock price dropped from
a close of $5.80 per share on February 27, 2003 to close at $2.06 on February 28,
2003, a drop of over 64% in a single day.
94. On February 28, 2003, Deutsche Bank issued an analyst report, stating
that it: continue[d] to be perplexed by [First Horizon's] disclosures, especially as it
relates to Sular inventory, as this is the third time in the past seven months that
management has suggested a significant imbalance between trade inventory and
end market demand for this product, while supposedly working down inventory.
-48-
and Offen resigned, effective immediately. The Company did not disclose to the
investing public until the Company issued its Proxy Statement on April 14, 2003,
that Venkataraman had agreed to perform at least 80 hours of consulting services
for the Company up to and including April 30, 2003. This is significant because
Venkataraman sold over 200,000 shares of his First Horizon stock (approximately
a third of his holdings including exercisable options) during April 2003, just prior
to the announcement on April 29, 2003 that the Company's earnings would be
substantially below its earnings guidance announced on February 27, 2003.
96. On March 18, 2003, the Company filed its Form 10-K for the annual
period ending December 31, 2002 (the "2002 Form 10-K") with the SEC. In the
"overview" section, the 2002 Form 10-K stated that, among other things, "during
2002, we experienced erosion of sales of our Prenate GT and Tanafed brands due
to competition from knock-off products." In the "Results from Operations"
section , the 2002 Form 10-K reiterated that statement:
We experienced erosion of sales of our Tanafed Suspension andTanafed DM line of products during 2002 due to increasedcompetition from knock-off products resulting from pharmacistssubstituting such knock-off products for prescriptions of our TanafedSuspension and Tanafed DM line of products....
We acquired the Prenate line in August 2001, introduced Prenate GTin September 2001 and experienced erosion of sales of the products
-49-
Case 1:02-cv-02332-J F Document 114 Filed 04/20/2007 Page 50 of 106
included in our Prenate line during 2002 due to increased competition
from knock-off products resulting in pharmacists substituting such
knock-off products for prescriptions of our Prenate line of products.
[Emphasis added].
97. These representations were repeated in the "Risks Related to Our
Business" section of the 2002 Form 10-K:
Sales of Prenate GT have been adversely affected by theintroduction of competitive products.Commencing during the second quarter of 2002, we experiencedsignificant erosion of Prenate GT sales due to increased substitution ofknock-off products by pharmacies filling prescriptions for PrenateGT. This substitution caused us to report lower than expected netrevenues and net income during the second quarter....
Sales of our Tanafed products have been adversely affected by theintroduction of competitive products.Commencing in the second quarter of 2002, we experiencedsignificant erosion of sales of Tanafed Suspension and Tanafed DMdue to increased substitution of knock-off products by pharmaciesfilling prescriptions for Tanafed Suspension and Tanafed DM. Thissubstitution caused us to report lower than expected net revenues andnet income during the second quarter ....
We face generic and other competition that could lower pricesand unit sales.Sular competes with products that are generic to other calciumchannel blockers. Nitrolingual Pumpspray competes with a generictablet product. Companies introduced knock-off products to ourPrenate GT product which has caused a significant sales erosionparticularly in the second quarter of 2002 , and in 2002, twocompanies introduced products that compete with Tanafed Suspensionand Tanafed DM which caused significant sales erosion primarily inthe second quarter of 2002 ....
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[Emphasis added].
98. These statements were false for the following reasons:
a. Defendants failed to disclose that First Horizon, in the first quarter
of 2002, engaged in channel stuffing with respect to, inter alia, its Tanafed line of
drugs, and that there existed an oversupply among wholesalers that was at least
five times greater than normal;
b. Defendants attributed the increase in sales to an increase in the
number of Tanafed prescriptions, even though the number of prescriptions bore
only an indirect relationship to First Horizon's actual sales, since prescriptions
could be filled by generic competitors, and the increase in sales was due to First
Horizon's channel stuffing activities;
c. Defendants failed to disclose that, on January 1, 2002, the
Company had changed its product return policy from a twelve month window (i.e.,
from six months prior to expiration date of the product to six months subsequent to
the expiration date of the product) to an eighteen month window (i.e., from six
months prior to the expiration date of the product to twelve months subsequent to
the expiration date of the product);
d. Defendants failed to disclose that much of the sales of Tanafed and
Prenate consisted of product that would be obsolete when the Company introduced
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new versions of that drug, which it intended to do, and that such obsolete product
would be returned to First Horizon;
e. Defendants failed to disclose that the Company had shifted sales of
its Robinul product from the fourth quarter of 2001 to the first quarter of 2002; and
f. Defendants did not disclose that the Company had removed sales
personnel from existing products so that First Horizon could concentrate on sales
of its new Sular product. set forth in paragraph 61.
99. Also in the section titled "Risks Related to Our Business," the 2002
Form 10-K stated, among other things:
Unexpected increases in 2002 year-end quantities of Sular onhand with wholesalers may adversely affect sales of Sular during2003.We learned in mid-December 2002 that wholesalers had increasedtrade levels of Sular significantly in October 2002 and November2002, presumably in anticipation of future price increases. Thisunexpected spike in the level of trade inventories and the lower thanexpected total prescription performance of Sular resulted in a higherlevel of trade inventories than targeted_ by us . We have developed aplan to manage the trade inventory level of Sular, we expect that thehigh level of Sular inventory in the trade will adversely affect ouroperating results in the first quarter of 2003 and possibly insubsequent periods.
A small number of customers account for a large portion of oursales and the loss of one of them, or changes in their purchasingpatterns, could result in reduced sales.We sell most of our products to a small number of wholesale drugdistributors. For the year ended December 31, 2002, sales toMcKesson Corporation, Cardinal Health Inc., (including the Bindley
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Western Division) and AmerisourceBergen Corporation represented23%, 23%, and 31% , respectively , of our total sales. The smallnumber of wholesale drug distributors , consolidation in this industryor financial difficulties of these distributors could result in thecombination or elimination of warehouses , which could temporarilyincrease returns of our products or, as a result of distributors reducinginventory levels, delay the purchase of our products .
[Emphasis added].
100. The Company also stated in its "Results of Operations" section in the
2002 10-K that:
We continue to manage the levels of trade inventories of Sular.Wholesalers who purchase our products increased the levels of tradeinventories significantly in October and November of 2002,presumably in anticipation of future price increases . We plan toreduce our shipments of Sular and thereby seek to reduce the levels oftrade inventories of Sular in the first quarter of 2003.
[Emphasis added].
101. This statement was false; trade inventories had risen to six months
by the beginning of November 2002. This rise was not due to unexpected events
in the fourth quarter of 2002, but to events that preceded such quarter.
102. On April 29, 2003 (the last day of the Class Period), the Company
announced estimated revenues of $11-13 million for the first quarter of 2003, well
below the $20-25 million Defendants had led investors to expect just two months
earlier. This time, according to the Company, the decline in net revenues was as a
result of the Company's plan to reduce inventories at the wholesaler level for a
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number of its products, the Company's decision to withdraw Tanafed Suspension
from the market earlier than expected, and the purportedly new decision to
withdraw Tanafed DM from the market. This reduced revenues by an estimated
$3.4 million in the first quarter of 2003 due to the associated increase in the
Company's estimate of future product returns. Again, the market reacted quickly.
First Horizon's stock price dropped from a close of $3.39 per share on April 28,
2003 to close at $2.70 per share on April 29, 2003, a loss of over 20%.
103. The Class Period ends on April 29, 2003, when First Horizon issued a
press release announcing reduced earnings for the first quarter of 2003. As
essentially admitted by the Company, the revenue reductions were primarily due to
reduced product shipments as a result of inflated wholesaler inventories:
The Company stated that it expects to report first quarter 2003 netrevenues of between $11 million and $13 million. Significantlycontributing to the decline in net revenues was the Company'sreductions of shipments of those products (including Sular) for whichthe Company seeks to reduce the levels of trade inventories and theCompany's current decision to withdraw Tanafed Suspension fromthe market earlier than previously planned and the new decision towithdraw Tanafed DM from the market. While the withdrawal ofthese Tanafed products reduces net revenues an estimated $3.4 millionin the first quarter of 2003 due to the associated increase in theCompany's estimate of future product returns , the Company believesthe withdrawal will in the long term improve the Company's ability tosell Tanafed DP and DMX....
[Emphasis added].
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104. As a result of the materially false and misleading financial statements
issued by First Horizon during the Class Period, Plaintiffs, the Class and the
Offering Subclass purchased their First Horizon securities at artificially inflated
prices and were damaged thereby.
GAAP VIOLATIONS
105. First Horizon violated GAAP through its aggressive and improper
accounting practices throughout the Class Period. Specifically, these manipulative
accounting devices involved improper revenue recognition practices and improper
valuation of the Company's inventory, resulting in the overstatement of reported
revenues, income and earnings throughout the Class Period as well as the inflation
of the price of its securities.
Revenue Recognition and Returns
106. On March 28, 2002, Defendants filed the Company's Form 10-K for
the year ended December 31, 2001 with the SEC ("the 2001 Form 10-K"), which
was incorporated by reference in the Registration Statement. The 2001 Form 10-K
reported net revenue and net income of $69,290,000 and $10,723,000,
respectively, for the year. As set forth in the 2001 Form 10-K, the Company
represented that its product return policy was as follows:
Product Returns. The Company's customers generally may returnproduct from six months prior to the expiration date of the product
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until six months after expiration . In accordance with Statement ofFinancial Accounting Standards ("SFAS") No. 48 , "RevenueRecognition When Right of Return Exists," a provision for theseestimated returns is recorded at the time of sale and is periodicallyadjusted to reflect actual experience. These costs are recorded as areduction to sales.
[Emphasis added].
107. The reported net revenue and net income of $69,290,000 and
$10,723,000, respectively, was materially false and misleading because it was
based upon the false inclusion of material sums of revenue derived through
channel stuffing that, as discussed herein, were not properly recognizable.
108. The 2001 Form 10-K was also materially false and misleading
because it concealed the fact that the Company had initiated a new liberalized
product return policy that was not publicly disclosed until November 12, 2002,
when First Horizon filed its Form 10-Q for the quarter ended September 30, 2002
with the SEC.
109. On November 12, 2002, First Horizon filed its Form 10-Q for the
quarterly period ended September 30, 2002 with the SEC ("the September 30,
2002 Form 10-Q"). This document, which revealed the truth regarding the
Company's return policy, stated:
Beginning January 1, 2002, the Company's return policy was revisedto allow product returns for products within an eighteen-monthwindow from six months prior to the expiration date and up to twelve
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[Emphasis added].
110. This liberalized return policy was concealed from the investing public
because disclosure of the fact that the Company had effected a 50% increase in the
time permitted to return products would have raised questions regarding the
necessity to materially increase the reserve for product returns, which according to
the Company's 2001 Form 10-K were "deducted from. . .gross sales to determine. .
net revenues."'
111. The change in the Company's return policy constituted a material
change in accounting principles that was required by GAAP to have been disclosed
in the notes to First Horizon's December 31, 2001 financial statements and First
Horizon 's March 31, 2002 financial statements.
112. The GAAP provision contained in FASB Statement No. 48 , Revenue
Recognition When Right of Return Exists ("FASB Statement No. 48") defines
"guaranteed sales" as "arrangements in which customers buy products for resale
with the right to return products." It provides (in paragraph 6):
1 "Management is required to estimate the level of sales which will ultimatelybe returned pursuant to our return policy, and record a related reserve at the time ofsale. These amounts are deducted from our gross sales to determine our netrevenues." (the 2001 Form 10-K)
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If an enterprise sells its product but gives the buyer the right to return
the product, revenue from the sales transaction shall be recognized attime of sale only if all of the following conditions are met:
a. The seller's price to the buyer is substantially fixedor determinable at the date of sale;
b. The buyer has paid the seller, or the buyer isobligated to pay the seller and the obligation is notcontingent on resale of the product;
c. The buyer's obligation to the seller would not bechanged in the event of theft or physicaldestruction or damage of the product;
d. The buyer acquiring the product for resale haseconomic substance apart from that provided bythe seller;
e. The seller does not have significant obligations forfuture performance to directly bring about resale ofthe product by the buyer; and
f. The amount of future returns can be reasonabestimated
(Emphasis added).
113. Elaborating on item "f' above, FASB Statement No. 48 states (in
paragraph 8) that:
The ability to make a reasonable estimate of the amount of futurereturns depends on many factors and circumstances that will varyfrom one case to the next. However, the following factors may impairthe ability to make a reasonable estimate:
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a. The susceptibility of the product to significantexternal factors, such as technologicalobsolescence or changes in demand,
b. Relatively long periods in which a particularproduct may be returned,
c. Absence of historical experience with similar typesof sales of similar products , or inability to applysuch experience because of changingcircumstances, for example, changes in the sellingenterprise's marketing policies or relationshipswith its customers; and
d. Absence of a large volume of relativelyhomogeneous transactions.
The existence of one or more of the above factors, in light of thesignificance of other factors, may not be sufficient to prevent makinga reasonable estimate; likewise, other factors may preclude areasonable estimate .
(Emphasis added).
114. On December 3, 1999, the SEC issued its Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements ("SAB 101"), setting forth
the SEC views concerning the "other factors" referred to above as follows:
Facts: Paragraph 8 of Statement 48 lists a number of factors that mayimpair the ability to make a reasonable estimate of product returns insales transactions when a right of return exists. The paragraphconcludes by stating "other factors may preclude a reasonableestimate."
Question: What "other factors," in addition to those listed inparagraph 8 of Statement 48, has the staff identified that may preclude
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Interpretive Response: The staff believes that the following additionalfactors, among others, may affect or preclude the ability to makereasonable and reliable estimates of product returns:
(1) significant increases in or excess levels of inventoryin a distribution channel (sometimes referred to as"channel stuffing"),
(2) lack of "visibility" into or the inability to determineor observe the levels of inventory in a distributionchannel and the current level of sales to end users,
(3) expected introductions of new products that mayresult in the technological obsolescence of and largerthan expected returns of current products ,
(4) the significance of a particular distributor to theregistrant's (or a reporting segment's) business, sales andmarketing,
(5) the newness of a product,
(6) the introduction of competitors' products withsuperior technology or greater expected marketacceptance, and other factors that affect market demandand changing trends in that demand for the registrant'sproducts. Registrants and their auditors should carefullyanalyze all factors, including trends in historical data,that may affect registrants' ability to make reasonableand reliable estimates of product returns.
The staff reminds registrants that if a transaction fails to meet all ofthe conditions of paragraphs 6 and 8 in Statement 48, no revenue maybe recognized until those conditions are subsequently met or thereturn privilege has substantially expired, whichever occurs first.
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not appropriate.
(Emphasis added).
115. Regulation S-X [17 C.F.R. § 210.4-01(a)( 1)] states that financial
statements filed with the SEC that are not prepared in conformity with GAAP are
presumed to be misleading and inaccurate. The failure to make disclosures that
were required to have been made rendered the Company's financial statements
non-compliant with GAAP and, therefore , presumptively misleading and
inaccurate.
116. As discussed above, First Horizon stuffed its distribution channel with
excess levels of inventory in connection with Tanafed and Prenate. Alternatively,
even if the Company was unaware that the channels were stuffed at the wholesaler
level, the amount of First Horizon's future returns could not be reasonably
estimated because Defendants were unable to accurately observe and assess the
current level of sales to end users and were unable to evaluate new product
introductions and competitors' activities that could adversely impact sales and
increase returns of its key products. Therefore, in observance of all of the above
specified GAAP provisions, from the onset of its channel stuffing that commenced
at the latest in September 2001, First Horizon was prohibited from recognizing
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revenue at the time of sale and was required to wait until the return privilege had
substantially expired to recognize revenue.
117. In contravention of GAAP, First Horizon sold material quantities of
products on a guaranteed sales basis and concomitantly recognized material
amounts of revenue on such sales despite the fact that, in all instances, the amount
of future returns could not be reasonably estimated by First Horizon.
118. First Horizon's financial statements that were disseminated to the
investing public during the Class Period were misleading, inaccurate and did not
provide accurate and reliable information concerning First Horizon's financial
performance because, as a result of the channel stuffing and liberalized return
policy as discussed above , they were not prepared in conformity with GAAP. In
this regard, the Company' s representations that the reported revenue and earnings
of First Horizon were in compliance with GAAP2 were materially false and
"These financial statements are the responsibility of the Company'smanagement....Management believes the Company's revenue recognition criteriaare consistent with the guidance provided by SAB No. 101." (the 2001 Form 10-K)
"The accompanying unaudited interim financial statements reflect alladjustments (consisting solely of normal recurring adjustments) whichmanagement considers necessary for fair presentation of the financial position,results of operations and cash flows of the Company for the interim periods."(September 30, 2001 Form 10-Q)
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misleading because such revenue and earnings included material amounts arising
from guaranteed sales that were not properly recognizable as revenue.
Overvaluation of Inventory
119. The 2001 Form 10-K represented the value of the Company's
inventory and samples as of December 31, 2001, to be $4,363,000 and $827,000,
respectively, while stating:
Inventories consist of purchased pharmaceutical products and arestated at the lower of cost or market. Cost is determined using thefirst-in, first-out method, and market is considered to be net realizablevalue.
...
Samples primarily consist of product samples used in the sales andmarketing efforts of the Company's products.
120. The GAAP provision set forth in Accounting Research Bulletin No.
43 ("ARB No. 43") provides that "[t]he primary basis of accounting for inventory
is cost." However, ARB No. 43 also provides that:
A departure from the cost basis of pricing the inventory is requiredwhen the utility of the goods is no longer as great as the cost. Wherethere is evidence that the utility of goods, in their disposal in theordinary course of business, will be less than cost, whether due tophysical deterioration, obsolescence, changes in price levels, or othercauses, the difference should be recognized as a loss of the currentperiod. This is generally accomplished by stating such goods at alower level commonly designated as market.
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compliance with this GAAP ("products and are stated at the lower of cost or
market") evidencing knowledge of the applicable accounting requirements.
Despite the fact that Defendants were aware of the planned obsolescence of the
Company's Tanafed and Prenate products, the imminent return of products from
the stuffed wholesale channels and the competition from generic and knock-off
products that rendered the Company's inventory of products substantially
unsaleable (and the Company's supply of samples substantially unusable), the
Individual Defendants failed to cause the Company's December 31, 2001 financial
statements to reflect an adequate reserve for these items.
122. The Company was ultimately compelled to recognize a portion of
these losses3 at the end of 2002. As disclosed in the 2002 Form 10-K that was
filed with the SEC on or about March 18, 2003:
Cost of revenues for 2002 were $24.0 million and was comprised ofcost of revenues from product sales of $22.1 million as increased byan allowance for obsolete inventory for existing Tanafed Suspensionand Prenate GT inventory totaling $1.9 million... Costs of revenues forthe year ended December 31, 2001 of $10.4 million do not include acomparable allowance for obsolete inventory.
3 "...at June 30, 2003, the Company had an allowance for excess and obsoleteinventory of $4.6 million compared to $2.8 million at December 31, 2002." SeeFirst Horizon's June 30, 2003 Form 10-Q filed with the SEC on August 13, 2003.
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2002 2001(In millions)
Cost of revenues fromproduct sales
Charge for Prenate GTobsolescence
Charge for TanafedSuspension obsolescence
$22.1 $10.4
7
1.2
Total cost of revenues
[Emphasis added].
$24.0 $10.4
123. On May 18, 1989, the SEC issued its Securities Act Release No. 6835
that stated, in relevant part:
The MD&A requirements are intended to provide, in one section of afiling, material historical and prospective textual disclosure enablinginvestors and other users to assess the financial condition and resultsof operations of the registrant, with particular emphasis on theregistrant's prospects for the future. As the Concept Release states:
The Commission has long recognized the need for a narrativeexplanation of the financial statements, because a numericalpresentation and brief accompanying footnotes alone may beinsufficient for an investor to judge the quality of earnings and thelikelihood that past performance is indicative of future performance.MD&A is intended to give the investor an opportunity to look at thecompany through the eyes of management by providing both a shortand long-term analysis of the business of the company. The Item asksmanagement to discuss the dynamics of the business and to analyzethe financials.
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As the Commission has stated, "[i]t is the responsibility ofmanagement to identify and address those key variables and otherqualitative and quantitative factors which are peculiar to andnecessary for an understanding and evaluation of the individualcompany."
124. SAB 101 reaffirmed these SEC mandates , noting that:
Management's Discussion and Analysis (MD&A) requires adiscussion of liquidity, capital resources, results of operations andother information necessary to an understanding of a registrant'sfinancial condition, changes in financial condition and results ofoperations. This includes unusual or infrequent transactions, knowntrends or uncertainties that have had, or might reasonably be expectedto have, a favorable or unfavorable material effect on revenue,operating income or net income and the relationship between revenueand the costs of the revenue. Changes in revenue should not beevaluated solely in terms of volume and price changes, but should alsoinclude an analysis of the reasons and factors contributing to theincrease or decrease. The Commission stated in Financial ReportingRelease (FRR) 36 that MD&A should "give investors an opportunityto look at the registrant through the eyes of management by providinga historical and prospective analysis of the registrant's financialcondition and results of operations, with a particular emphasis on theregistrant's prospects for the future." Examples of such revenuetransactions or events that the staff has asked to be disclosed anddiscussed in accordance with FRR 36 are. . .Changing trends in...asales channel or separate class of customer that could be expected tohave a significant effect on future sales or sales returns...
[Emphasis added].
125. The information that was required to be disclosed pursuant to the
mandates of GAAP and the SEC as particularized above were readily available
because this information was accumulated by the Company as detailed above.
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Accordingly, Defendants knew or recklessly disregarded and failed to disclose the
fact that their channel stuffing could be expected to have a significant adverse
effect on both future sales and sales returns . Moreover, Defendants caused the
Company's December 31, 2001, financial statements to fraudulently:
a. recognize revenue on guaranteed "channel-stuffing" sales asdiscussed herein;
b. conceal the fact that the Company's product return policy hadbeen materially liberalized;
c. understate the reserve for product returns by no less than $7.2million;
d. understate the allowance for excess and obsolete inventory byno less than $4.6 million;
e. understate the allowance for obsolete sample inventory by noless than $0.6 million; and
f. conceal the fact that Defendants overstated intangible assets byno less than $2.7 million and concomitantly established a bogus$2.7 million reserve as detailed below.
Defendants Report Fictitious Revenue from a Bogus Reserve
126. The term "cookie jar reserves" refers to "inflated or wholly improper
reserves posted to provide a cushion against earnings shortfalls in later periods,
when those reserves can be drawn into income ." SEC Accounting and Auditing
Enforcement Release No. 1393 (May 15, 2001). As detailed below, the Company
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established a "cookie jar" reserve in connection with First Horizon's acquisition of
the drug Cognex in order to be able to utilize this reserve during the Class Period.
127. On August 10, 2000, the Company filed its Form 10-Q for the
quarterly period ended June 30, 2000 with the SEC ("the June 30, 2000 Form 10-
Q"). The June 30, 2000 Form 10-Q stated with regard to the Company's
acquisition of Cognex:
On June 22, 2000 the Company acquired exclusive rights to market,distribute and sell the drug Cognex and a new unapproved version ofCognex called Cognex CR, in the U.S. and other countries for$3,500,000 in cash.. .The purchase price was preliminarily allocatedamong the fair values of tangible and intangible assets and liabilitiesassumed, the majority of which is being amortized over 20 years...The Company purchased Cognex on June 22, 2000 for $3,500,000 incash and assumed liabilities for returned products shipped by theseller prior to the acquisition .
[Emphasis added].
128. On May 14, 2001, the Company's Form 10-Q for the quarterly period
ended March 31, 2001 was filed with the SEC ("the March 31, 2001 Form 10-Q").
The March 31, 2001 Form 10-Q contained comparative balance sheets that
reflected net intangible assets of $25,942,480 as of March 31, 2001, as compared
to net intangible assets of $23,150,025 as of December 31, 2000. No reason was
given for the $2.7 million increase in the Company's intangible assets.
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129. Unbeknownst to the investment community and as later revealed after
the end of the Class Period, the increase in intangible assets was due to the fact that
Defendants had altered the Company's original (June 2000) accounting for the
acquisition of Cognex, so that First Horizon's books and records falsely reflected
the acquisition of an additional $2.7 million of intangible assets and the assumption
of an additional $2.7 million of liabilities for the return of products shipped by the
seller prior to the acquisition . This inflated the Company's assets by $2.7 million
and concomitantly established a bogus reserve in the same amount.
130. Defendants utilized the reserve during the Class Period in the third
quarter of 2002 ending September 30, 2002. On November 12, 2002, First
Horizon filed its Form 10-Q for the quarterly period ended September 30, 2002
with the SEC ("the September 30, 2002 Form 10-Q"). The September 30, 2002
Form 10-Q stated : "During the quarter ended September 30, 2002 the Company
determined that the established reserves for Ponstel and Cognex were in excess of
the currently expected returns" and, therefore, "reduced the liability and increased
net revenues by $2.6 million. " [Emphasis added].
131. Because the reserve which the Company reduced by $2.6 million had
been created in March 2001 through an adjustment of the Company' s accounting
in connection with its acquisition of Cognex without any impact on earnings, the
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adjustment to reverse these reserves should have been similarly made without any
impact on earnings (i.e. through a $2.6 million reduction to intangible assets and a
corresponding $2.6 million reduction to the liability for the return of products).
132. By characterizing the excessive reserve as revenue instead of properly
reversing the improper journal entry that created the bogus reserve without any
impact on the Company's income statement, the Company improperly recognized
$2.6 million of revenue and overstated intangible assets (Cognex licensing rights)
by the same amount . The failure to write down the $2.6 million of overstated
intangible assets (Cognex licensing rights) served to improperly understate
expenses, thereby materially overstating reported earnings. The improper
accounting effectively overstated income for the quarter by $5.2 million by
overstating revenue by $2.6 million while at the same time understating expenses
by $2.6 million.
133. However, the write-off of the improperly inflated intangible assets
was improperly deferred until the second quarter of 2003, when the Company took
a charge to earnings, stating that:
The Company estimated the fair market value of the Cognex assetsand based on the estimated fair market value, it was determined thatthe carrying value of the Cognex licensing rights was in excess of thefair value, and an impairment charge of $4.2 million was recorded forthe second quarter of 2003.
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134. The fact that First Horizon paid $3.5 million for the "Cognex assets"
(which included inventory and other assets in addition to the license rights),
indicates that the Cognex license rights (which had been amortized each quarter
beginning in June 2000 and thereby reduced in value) could not have been valued
at $4.2 million as of June 30, 2003 in the absence of fraud.
SCIENTER ALLEGATIONS
135. Defendants acted with scienter in that Defendants knew or recklessly
disregarded that the public documents and statements issued or disseminated in the
name of the Company were materially false and misleading, knew or recklessly
disregarded that such statements or documents would be issued or disseminated to
the investing public, and knowingly or recklessly and substantially participated or
acquiesced in the issuance or dissemination of such documents or documents as
primary violators of the federal securities laws. Defendants, by virtue of their
receipt of information reflecting the facts regarding First Horizon, their control
over, and receipt of First Horizon's allegedly materially misleading misstatements,
and their associations with the Company that made them privy to confidential
proprietary information concerning First Horizon, participated in the fraud as
alleged herein.
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carefully monitors its marketing efforts, product sales and wholesaler inventories
on an ongoing basis. The Company receives information on how many total
prescriptions are written for each of its products, the number of new prescriptions
that are written for each of its products and, at the pharmacy level, the total number
of dispensed prescriptions for each of its products. In this way, the Company can
compare the total amount of prescriptions written with the total amount of
prescriptions dispensed to determine which and how much of its product were
being substituted by pharmacists with competitors' generic or knock-off products.
First Horizon also receives daily sales reports on how much of each of its products
have been purchased by wholesalers and, at least on a monthly basis, reports on the
amount of product in inventory at the wholesaler level.
137. A former First Horizon Vice President of Sales ("Sales V.P."),
employed by the Company from May 2000 until December 2002, stated that First
Horizon utilized an internal Daily Sales Recap that reported the products shipped
to wholesalers. This report listed the sales by product line, further broken down by
the strength of each product within the product line, in three categories: (1) today's
activity; (2) period to date; and (3) year to date. Each category listed the number
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of products shipped, sales and profit. According to the Sales V.P., this report was
circulated to all First Horizon senior executives - "the officers had `em every day."
138. The Company utilized MAS 90 Accounting Software to track daily
sales, among other things. According to the Sales V.P., "[a]ll sales were invoiced
daily. Every day, we could see what went out the back door to the wholesalers."
The existence of this software was confirmed by a Former Vice President of
Marketing ("Marketing V.P."), employed by First Horizon from May 2001 to May
2003. The Marketing V.P. reported to Offen, who in turn reported to
Venkataraman. Using the MAS 90 accounting software, the Marketing V.P. said
that sales could be tracked "hour by hour if you want."
139. The MAS 90 Accounting Software also was used by the Company's
finance department to monitor wholesaler returns. According to the Sales V.P.,
"the Daily Sales Sheet showed what went out and returns, by volume and product."
The Sales V.P. stated that Lang "handled returns from wholesalers." This was
confirmed by a former Regional Sales Manager ("Regional Sales Manager") for
First Horizon, employed by the Company from March 1998 to October 2002, who
stated that the key people who dealt with the wholesalers were Venkataraman,
Offen and Lang.
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products from IMS Health, an organization that collects and resells drug
wholesalers' inventory data and information from pharmacies regarding the
numbers of prescriptions filled for each drug as well as the number of prescriptions
written for each drug. A former District Sales Manager ("District Sales
Manager"), employed by First Horizon from August 2000 through February 2002,
explained that drug wholesalers and pharmacies sell their information to IMS
Health, who then sells it on a monthly, and possibly weekly, basis to drug
companies such as First Horizon.
141. First Horizon also tracked total prescriptions ("TRX") and new
prescriptions ("NRX") weekly from IMS Health, and compared those figures to its
"back-door sales," or shipments made to wholesalers. First Horizon also received
information reflecting the total amount of each of its products dispensed at the
pharmacy level. This information was received electronically from IMS Health
and distributed within First Horizon on an on-going basis, including to
Venkataraman and Offen.
142. As Venkataraman explained during a July 2, 2002 earnings
conference call, the Company tracked weekly prescriptions and pharmacy sales:
[T]he way we track our prescriptions of our product is not only- weget two separate audits from IMS. We get the provider audit, the
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provider prescription audits, which is what physicians write. It's anOK audit, it gives you fairly good idea of what the physician iswriting, and we track the IMS- the dispense audits, which is whatmost people get on a weekly basis. So that's how we track ourbusiness. We have both- we have both those audits to compare whatis being written relative to what is being dispensed. So we know ifwe're growing our brand and we're getting a larger percentage of itcannibalized or eroded by knockoffs, or we're not growing the brandand we're getting greater - and we're getting some erosion.
143. The Sales V.P. explained that these IMS reports were provided first to
him, and then to other senior level executives including the Individual Defendants.
Thus, First Horizon would get reports on the movement of all of First Horizon's
products as well as the generic drugs and knock-offs that competed with them.
The Company would then use that information in a number of ways. For example,
there was a "pipeline" report available to management that Lang would generate
monthly from the IMS Health inventory data supplied by First Horizon 's major
wholesalers, including the "Big Three" distributors.
144. The pipeline report listed the number of units of First Horizon's
products on hand at the wholesaler level at the end of a month, broken down by
product and wholesaler. The report also listed the wholesalers' average monthly
demand for each of the Company's products and the average number of months of
supply of each product in the wholesalers' inventory. The existence of the pipeline
report was confirmed by Product Manager I as well as the District Sales Manager.
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report, the Trade Relations Group, and more specifically Lang, would contact the
Big Three distributors on a more frequent basis to check on the amount of physical
inventory the distributors had of each First Horizon product. Thus, based on
Lang's discussions with wholesalers and the monthly pipeline report she generated,
First Horizon's product managers and executives knew precisely how much
inventory wholesalers possessed at any given time.
146. In addition to receiving these reports, the Marketing V.P. stated that
each week, the First Horizon "executive team" (consisting of all vice-president
level employees and above) met to discuss the ongoing business of the Company in
a Weekly Operating Committee meeting. The meeting took place in the
Company's board conference room at corporate headquarters. The Weekly
Operating Committee meetings were regularly attended by the Marketing V.P.,
Venkataraman, Shah, and Offen. Certain "director-level" employees were also
"permanent members," including Lang, Scott Wilson, the Director of Managed
Care, Alan Roberts, the Director of Business Regulation, and Ralph Jordan, the
Director of Legal Affairs. Other director-level employees also would attend the
meetings, depending on the topic. While the agenda for the meetings changed on a
weekly basis, and no specific reports were prepared for the meeting , a regular
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feature was Lang's distribution and presentation of the pipeline report at the first
meeting immediately after each report was generated. The numbers listed in the
pipeline report were then discussed. In this way, Defendants kept a constant watch
on the Company' s sales and marketing efforts at the wholesaler, pharmacy, and
physician levels, as well as the inventory levels of the Company's key wholesalers.
147. Based on these reports the Individual Defendants each actually knew,
or were reckless in not knowing, the exact amount of the Company's products that
were being demanded by physicians and/or patients and how that demand
compared with similar , generic or knock-off products , as well as the amount that
wholesalers had on hand in inventory. Facts critical to First Horizon's core
operations (such as the lagging sales, channel stuffing and a large increase in the
number of returned products) are so apparent that their knowledge may be
attributed to the Company and the Individual Defendants. Moreover, the fact that
the sales of certain products (such as Tanafed and Prenate) constituted a significant
source of income to First Horizon establishes a strong inference that the
Defendants knew or were reckless in not discovering additional facts available to
them that directly affected that source of income.
148. Furthermore, Defendants had the motive and opportunity to perpetrate
the fraudulent scheme and course of business described herein in order to raise
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additional capital from investors through the Offering which provided the
Company with proceeds in excess of $150 million, and allowed the Company to
retire over $130 million worth of debt.
149. Maintaining First Horizon's high stock price and the illusion of its
earnings and operations success was critical to Defendants' scheme to enable First
Horizon to grow itself through a program of acquisitions by procuring private
financing and tapping into the public marketplace to pay for these acquisitions,
such as the acquisition of the drug Sular, as discussed herein.
150. Furthermore, had Defendants revealed the truth about the Company's
financial condition, the Company would have fallen out of compliance with the
financial covenants of its senior bank credit agreement ("Credit Agreement")
Similarly, had Defendants disclosed the Company's true financial condition prior
to the Offering, the Company would not have been able to raise sufficient capital to
pay back the costly interim financing used to purchase Sular.
151. In addition to the Company's motive to pay off its debt, Company
executives also had an executive compensation program whereby First Horizon
executives were given the opportunity to earn annual incentive payments and long
term incentive compensation based upon the volume of sales, operating income
and the price of the Company 's securities.
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152. First Horizon ' s lucrative executive compensation structure during the
Class Period consisted of three primary components: (i) base salary; (ii) annual
incentives; and (iii) long-term incentives. Annual incentives were determined by
the following: the position held by the executive to whom the bonus was paid; total
compensation paid by comparable companies to similarly situated executives; the
performance of the executive; the development of the Company as measured by
the Company's growth in revenues, increases in doctors prescribing the
Company's products and increases in the number of sales representatives; and the
perceived increase in the value of the Company's business . Overall, annual
incentives, such as bonuses, payable in cash, were tied to the achievement of
performance goals established by the Board of Directors. Long-term incentives
comprised the largest portion of the total compensation package for executive
officers and included thirteen long-term stock-based incentive awards that
rewarded executive officers increased sales, net revenue earnings and, ultimately
high share prices.
153. In 2001, Shah received $247,917 in salary, $250,000 in bonus
compensation and was granted stock options to purchase 472,500 shares of the
Company's common stock. In 2002, Shah received $278,750 in salary and
$42,000 in bonus compensation.
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154. In 2001, Venkataraman received $148,787 in salary, $75,000 in bonus
compensation and was granted stock options to purchase 262,500 shares of the
Company's common stock. In 2002, Venkataraman received $183,542 in salary
and $28,000 in bonus compensation.
155. Accordingly, Shah , Venkataraman and Borne were under tremendous
pressure to keep reported sales, overall financial results and the Company's stock
price as high as possible in order to receive their executive compensation. The
possibility of not receiving such compensation provided ample motive to inflate
the Company's volume growth and financial results and to engage in numerous
GAAP violations.
156. Furthermore, Shah and Venkataraman entered into severance
agreements when resigning from the Company, which contained the following
provision:
Employee hereby covenants and agrees that he will no voluntarily
assist, support, or cooperate with, directly or indirectly, any entity or
person alleging or pursuing any claim, administrative charge, or cause
of action against the Company, including without limitation, by
providing testimony or other information, audio or video recordings,
or documents, except under compulsion of law.
157. This provision reflects the Company's attempt to prevent any person
with knowledge about its illegal activities from revealing so to the investing public.
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The inclusion of such a provision during the pendency of this litigation raises a
strong inference that Defendants acted with the requisite scienter.
158. In addition, according to Product Manager II, the Company kept two
sets of financial records, a clear indication that Defendants knew or were severely
reckless in not knowing that the financial results reported to the public were false
and misleading when issued.
159. Furthermore, had Defendants revealed the truth about the Company's
financial condition, the Company would have falled out of compliance with the
financial covenants of its senior bank credit agreement ("Credit Agreement").
Similarly, had Defendants disclosed the Company's true financial condition prior to
the Offering, the Company would not have been able to raise sufficient capital to
pay back the costly interim financing used to purchase Sular.
160. In addition to the Company's motive to pay off its debt, Company
executives also had a unique executive compensation program that gave its
executives the opportunity to earn annual incentive payments and long term
incentive compensation that encouraged executives to increase the volume of sales,
operating income and the price of the Company's securities at all costs. This
unusual compensation scheme gave First Horizon's executives - including Shah,
Venkataraman and Borne - a lucrative and direct economic motivation to
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manipulate First Horizon's 2002 and 2003 sales performance and reported profits
and to artificially inflate the Company's stock price during 2002 and 2003.
161. First Horizon's lucrative executive compensation structure during the
Class Period consisted of three primary components: (i) base salary; (ii) annual
incentives; and (iii) long-term incentives. Annual incentives were determined by
the position held by the executive to whom the bonus was paid, total compensation
paid by comparable companies to similarly situated executives, the performance of
the executive, the development of the Company as measured by the Company's
growth in revenues, increases in doctors prescribing the Company's products and
increases in the number of sales representatives, and the perceived increase in the
value of the Company's business . Overall, annual incentives , such as bonuses,
payable in cash, were tied to the achievement of performance goals established by
the Board of Directors. Long-term incentives comprised the largest portion of the
total compensation package for executive officers and included thirteen long-term
stock-based incentive awards that rewarded executive officers increased sales, net
revenue earnings and, ultimately high share prices.
162. Thus, during the Class Period, had Defendants told the truth about
First Horizon's financial performance, the Company's executives faced a real threat
of receiving no annual incentive or long-term incentive compensation.
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pressure to keep reported sales up, to keep reported financial results up, and to
prop up First Horizon's share price, or receive only paltry compensation in 2002.
This tremendous threat provided ample motive to these Defendants to keep volume
growth and financial results up, to improperly recognize revenue and to prop up
First Horizon's share price.
164. The Company' s severance agreements entered into with Shah,
Venkataraman, Offen and William Campbell (another member of the Company's
senior management) also raise a strong inference of scienter.
165. Shah, Venkataraman and Offen signed new employment agreements
with the Company on February 12, 2003. Similarly, Campbell signed a new
employment agreement with the Company on February 13, 2003.
166. Three weeks later , on March 3, 2003, Campbell resigned . Two days
later, on March 5, 2003, Offen and Venkataraman resigned. Each received
substantial compensation pursuant to the severance agreements signed with the
Company. Campbell received half his annual salary of $115,000 and a lump sum
payment of $19,000. Offen received his annual salary of $177,000 and a lump sum
payment of $2,000. Venkataraman received his annual salary of $193,000 and a
lump sum payment of $28,000, along with an additional $75,000.
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167. On May 19, 2003, Shah resigned from the Company . Pursuant to his
severance agreement with the Company, Shah received twice his annual salary of
$300,0000, or $600,000 and a lump sum payment of $84,000.
168. Each of the severance agreements signed by Shah, Venkataraman,
Offen and Campbell was signed by Borne and contained the same following
provision: Employee hereby covenants and agrees that he will no voluntarily assist,
support, or cooperate with, directly or indirectly, any entity or person alleging or
pursuing any claim, administrative charge, or cause of action against the Company,
including without limitation, by providing testimony or other information, audio or
video recordings, or documents, except under compulsion of law.
169. This provision clearly indicates that the Company had something to
conceal and the inclusion of such a provision during the pendency of this litigation
raises a strong inference that Defendants acted with the requisite scienter.
170. In addition, according to Product Manager II, the Company kept two
sets of financial records, a clear indication that Defendants acted with scienter.
APPLICABILITY OF THE FRAUD ON THE MARKET DOCTRINE ANDTHE PRESUMPTION OF RELIANCE
171. Plaintiffs will rely, in part, upon the presumption of reliance
established by the fraud-on-the-market doctrine in that, among other things:
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(a) Defendants made public misrepresentations or failed to disclose
facts during the Class Period;
(b) The omissions and misrepresentations were material;
(c) First Horizon securities traded in an efficient market;
(d) The misrepresentations alleged would tend to induce a
reasonable investor to misjudge the value of the Company' s securities; and
(e) Plaintiffs and the other members of the Class purchased First
Horizon securities between the time Defendants misrepresented or failed to
disclose material facts and the time the true facts were disclosed, without
knowledge of the misrepresented or omitted facts.
172. At all relevant times, the market for First Horizon securities was an
efficient market for the following reasons, among others:
(a) First Horizon securities were listed and actively traded during
the Class Period on the NASDAQ exchange, an open , highly efficient and
automated market. The average daily volume of the First Horizon's common stock
during the Class Period was 775,686 shares based on information from the Yahoo
Finance website. The total number of shares traded during the Class Period was
196,248,600 shares.
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filings, including its Forms 10-K, Forms 10-Q and related press releases, with the
SEC. Additionally, First Horizon met the eligibility requirements for filing a SEC
Form S-1 Registration Statement and in fact filed such a statement on March 5,
2003.
(c) First Horizon was followed by analysts from major brokerages
including Deutsche Bank, J.P. Morgan, Leerink Swann & Co., Thomas Weisel
Partners, UBS Warburg and Lazard Freres. The reports of these analysts were
redistributed to the brokerages' sales force, their customers, and the public at large;
and
(d) First Horizon regularly communicated with public investors via
established market communication mechanisms, including the Company's website,
regular disseminations of press releases on the major news wire services, and other
wide-ranging public disclosures, such as communications with the financial press
and other similar reporting services.
173. As a result, the markets for First Horizon securities digested current
information regarding the Company from the publicly available sources described
above and reflected such information in the prices of First Horizon's securities. As
would be expected where a security is traded in an efficient market, material news
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concerning First Horizon's business had an immediate effect on the market price of
First Horizon's securities, as evidenced by the rapid decline in the market price in
the immediate aftermath of First Horizon's corrective disclosures as described
herein. Under these circumstances , all purchasers of First Horizon' s securities
during the Class Period suffered similar injury due to the fact that the price of First
Horizon securities was artificially inflated throughout the Class Period. At the
times they purchased or otherwise acquired First Horizon's securities, Plaintiffs
and other members of the Class were without knowledge of the facts concerning
the wrongful conduct alleged herein and could not reasonably have discovered
those facts. As a result, the presumption of reliance applies. Plaintiffs will also
rely, in part, upon the presumption of reliance established by a material omission.
LOSS CAUSATION/ECONOMIC LOSS
174. During the Class Period, as detailed herein, Defendants engaged in a
scheme to deceive the market and a course of conduct that artificially inflated First
Horizon's stock price and operated as a fraud or deceit on Class Period purchasers
or acquirers of First Horizon stock.
175. During the Class Period, as detailed herein, Defendants engaged in a
scheme to deceive the market and a course of conduct that artificially inflated First
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Horizon's stock price and operated as a fraud or deceit on Class Period purchasers
or acquirers of First Horizon stock.
176. Defendants failed to disclose to the marketplace that, in order to
achieve First Horizon's reported financial performance and meet analyst earnings
and revenue expectations during the Class Period, Defendants inflated the
Company's results by a variety of means, including the wide-spread practice of
channel stuffing.
177. Defendants' conduct created the short-term illusion that demand
during the Class Period was higher than it actually was. The effect of Defendants'
conduct was to increase revenues and earnings in quarters during the class period
to levels that were unsustainable, to the detriment of subsequent quarters.
178. Defendants' conduct caused and maintained the artificial inflation in
First Horizon's stock price throughout the Class Period and until the truth was
revealed to the market. Defendants' false and misleading statements had the
intended effect and caused First Horizon stock to trade at artificially inflated levels,
first for the period during which First Horizon engaged in its public offering, and
then again during the latter part of the Class Period.
179. With respect to the first part of the Class Period, by the end of the
second quarter of 2002, First Horizon was no longer to sustain the volume levels
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that it had achieved as a result of its improper activities. In the second quarter of
2002, its operating income declined, and it was unable to meet its prior earnings
guidance . This decline in financial performance was not merely connected to
Defendants' prior oversupply of products, but was the direct and proximate result
thereof. Given the excess supply inventoried by First Horizon's customers,
Defendants could not maintain First Horizon's prior financial performance.
180. On July 2, 2002, Defendants disclosed that the Company's operating
income had declined, and that First Horizon would not meet its previously
estimated earnings guidance for 2002..
181. Asa result of its partial revelation of the truth, First Horizon's stock
dropped 81% during a single day on record trading volume of 16,445,100 shares.
At the close of business on July 1, 2002, First Horizon's stock price was $18.24
per share . At the close of business on July 2, 2002, one day after Defendants'
disclosures, First Horizon's stock price fell to $3.51.
182. The 81% decline in First Horizon's stock price on July 2, 2002 was a
direct result of the nature and extent of Defendants' fraud being partially revealed
to investors and the market. The timing and magnitude of First Horizon's stock
price declines negate any inference that the loss suffered by Lead Plaintiffs and
other Class members was caused by changed market conditions, macroeconomic or
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industry factors or Company-specific facts unrelated to Defendants' fraudulent
conduct.
183. The economic loss, i.e., damages, suffered by Lead Plaintiffs and
other Class members was a direct result of Defendants' fraudulent scheme to
inflate artificially First Horizon's stock price. The subsequent significant decline
in the value of First Horizon's stock was a direct and proximate result of
Defendants' disclosure that demand for First Horizon products had declined from
the inflated levels during the Class Period, and that prior revenue and earnings
levels were unsustainable and would be lower in the future. This decline was the
direct and proximate result of Defendants fraudulent activities, the effect of which
was to inflate earnings and revenue in prior periods at the expense of subsequent
periods.
184. The full extent of Defendants' conduct was not revealed until April
29, 2003. On that day, the Company announced estimated revenues of $11-13
million for the first quarter of 2003, well below the $20-25 million Defendants had
led investors to expect just two months earlier as a result of the Company's plan to
reduce inventories at the wholesaler level for a number of its products, the
Company's decision to withdraw Tanafed Suspension from the market earlier than
expected, and the purportedly new decision to withdraw Tanafed DM from the
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April 28, 2003 to close at $2.70 per share on April 29, 2003, a loss of over 20%.
185. The 20% decline in First Horizon's stock price on April 29, 2004 was
a direct result of the nature and extent of Defendants' fraud being revealed to
investors and the market. The timing and magnitude of First Horizon's stock price
declines negate any inference that the loss suffered by Lead Plaintiffs and other
Class members was caused by changed market conditions, macroeconomic or
industry factors or Company-specific facts unrelated to Defendants' fraudulent
conduct.
186. As a result of their purchases of First Horizon stock during the Class
Period, Lead Plaintiffs and other members of the Class suffered economic loss, i.e.,
damages under the federal securities laws.
NO SAFE HARBOR
187. The statutory safe harbor provided for forward-looking statements
under certain circumstances does not apply to any of the allegedly false statements
pleaded in this complaint. The specific statements pleaded herein were not
identified as "forward-looking statements" when made. Nor was it stated with
respect to any of the statements forming the basis of this complaint that actual
results "could differ materially from those projected." To the extent there were
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any forward-looking statements, there were no meaningful cautionary statements
identifying important factors that could cause actual results to differ materially
from those in the purportedly forward-looking statements.
188. Alternatively, to the extent that the statutory safe harbor does apply to
any forward-looking statements pleaded herein, Defendants are liable for those
false forward-looking statements because at the time each of those forward-looking
was made the particular speaker knew that the particular forward-looking
statement was false, and/or the forward-looking statement was authorized and/or
approved by an executive officer of First Horizon who knew that those statements
were false when made.
COUNT I
[Against Defendant First Horizon, Individual Defendants, DirectorDefendants and Underwriter Defendants For Violations of Section 11 of the
Securities Act]
189. This Count is brought pursuant to Section 11 of the Securities Act, 15
U.S.C. § 77k, on behalf of the Offering Subclass, against all Defendants (other
than Defendant Borne) and is being brought by Plaintiff Roy LaTourette, Jr.
190. The Registration Statement for the Offering was inaccurate and
misleading, contained untrue statements of material facts, omitted to state other
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facts necessary to make the statements made not misleading, and concealed and
failed adequately to disclose material facts as described above.
191. First Horizon is the registrant for the Offering. All Defendants named
herein were responsible for the contents and dissemination of the Registration
Statement and the Prospectus.
192. As issuer of the shares , First Horizon is strictly liable to Plaintiff and
the Offering Subclass for the misstatements and omissions.
193. None of the Defendants named herein made a reasonable investigation
or possessed reasonable grounds for the belief that the statements contained in the
Registration Statement were true and without omissions of any material facts and
were not misleading.
194. Defendants issued, caused to be issued and participated in the
issuance of materially false and misleading written statements to the investing
public that were contained in the Registration Statement, which misrepresented or
failed to disclose, inter alia, the facts set forth above. By reasons of the conduct
herein alleged, each Defendant violated, and/or controlled a person who violated,
Section 11 of the Securities Act.
195. Plaintiff acquired First Horizon shares pursuant to or traceable to the
Registration Statement.
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value of First Horizon shares has declined substantially subsequent to and due to
Defendants' violations.
197. At the times they purchased First Horizon shares, Plaintiff and other
members of the Offering Subclass were without knowledge of the facts concerning
the wrongful conduct alleged herein and could not have reasonably discovered
those facts prior to April 24, 2002. Less than two years elapsed from the time that
Plaintiff discovered or reasonably could have discovered the facts upon which this
action is based to the time that Plaintiff filed this action. Less than five years
elapsed between the time that the securities upon which this Count is brought were
bona fide offered to the public and the time Plaintiff filed this action.
COUNT II[Against Defendant First Horizon For Violations Of
Section 12(a)(2) Of The Securities Act]
198. This Count is brought by Plaintiff Roy LaTourette, Jr. against
Defendant First Horizon pursuant to Section 12(a)(2) of the Securities Act on
behalf of all members of the Offering Subclass that purchased First Horizon shares
pursuant to the Offering.
199. First Horizon was a seller and an offeror of the shares offered
pursuant to the Registration Statement.
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facts, omitted to state other facts necessary to make the statements made not
misleading, and concealed and failed to disclose material facts. Defendants'
actions of solicitation included participating in the preparation of the false and
misleading Registration Statement.
201. First Horizon owed to the purchasers of First Horizon shares,
including Plaintiff and other Offering Subclass members, the duty to make a
reasonable and diligent investigation of the statements contained in the
Registration Statement, ensure that such statements were true and ensure that there
was no omission of material fact required to be stated in order to make the
statements contained therein not misleading.
202. Plaintiff and other members of the Offering Subclass purchased or
otherwise acquired First Horizon shares pursuant to the defective Registration
Statement. Plaintiff did not know, or in the exercise of reasonable diligence could
not have known, of the untruths and omissions contained in the Registration
Statement.
203. Plaintiff, individually and representatively, hereby offers to tender to
Defendant those securities which Plaintiff and other Offering Subclass members
continue to own, on behalf of all members of the Offering Subclass who continue
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to own such securities, in return for the consideration paid for those securities
together with interest thereon. Offering Subclass members who have sold their
First Horizon shares are entitled to rescissory damages.
204. By reason of the conduct alleged herein, First Horizon violated,
and/or controlled a person who violated, Section 12(a)(2) of the Securities Act.
Accordingly, Plaintiff and members of the Offering Subclass who hold First
Horizon shares purchased in the Offering have the right to rescind and recover the
consideration paid for their First Horizon shares and hereby elect to rescind and
tender their First Horizon shares to First Horizon sued herein. Plaintiff and the
Offering Subclass members who have sold their First Horizon shares are entitled to
rescissory damages.
205. Less than five years elapsed between the time that the securities upon
which this Count is brought were sold to the public and the time of the filing of this
action. Less than two years elapsed from the time when Plaintiff discovered or
reasonably could have discovered the facts upon which this Count is based to the
time of the filing of this action.
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COUNT III[Against the Individual Defendants (Other Than Defendant Borne) For
Violations of Section 15 of the Securities Act]
206. This Count is brought pursuant to Section 15 of the Securities Act
against the Individual Defendants (other than Defendant Borne) by Plaintiff Roy
LaTourette, Jr.
207. Each of these Defendants was a control person of First Horizon by
virtue of their position as directors and/or senior officers of First Horizon. These
Defendants each had a series of direct and/or indirect business and/or personal
relationships with other directors and/or officers and/or major shareholders of First
Horizon.
208. Each of these Defendants was a culpable participant in the violations
of Sections 11 and 12(a)(2) of the Securities Act alleged in Counts I and II above,
based on their having signed the Registration Statement and having otherwise
participated in the process that allowed the Offering to be successfully completed.
COUNT IVFor Violations Of Section 10(b) Of The
Exchange Act And Rule 10b-5 Promulgated ThereunderAgainst Defendants First Horizon and the Individual Defendants
209. Plaintiffs repeat and reallege the allegations set forth above as though
fully set forth herein.
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210. During the Class Period, First Horizon and the Individual Defendants,
and each of them, carried out a plan, scheme and course of conduct that was
intended to and, throughout the Class Period, did: (i) deceive the investing public,
including Plaintiffs and other Class members, as alleged herein ; (ii) artificially
inflate and maintain the market price of First Horizon securities; and (iii) cause
Plaintiffs and other members of the Class to purchase First Horizon securities at
artificially inflated prices. In furtherance of this unlawful scheme, plan and course
of conduct, Defendants took the actions set forth herein.
211. These Defendants: (a) employed devices, schemes, and artifices to
defraud; (b) made untrue statements of material fact and/or omitted to state
material facts necessary to make the statements not misleading; and (c) engaged in
acts, practices and a course of business that operated as a fraud and deceit upon the
purchasers of the Company' s securities in an effort to maintain artificially high
market prices for First Horizon securities in violation of Section 10(b) of the
Exchange Act and Rule IOb-5. These Defendants are sued as primary participants
in the wrongful and illegal conduct charged herein.
212. In addition to the duties of full disclosure imposed on these
Defendants as a result of their making of affirmative statements and reports, or
participation in the making of affirmative statements and reports to the investing
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public, they each had a duty to disseminate truthful information promptly that
would be material to investors in compliance with the integrated disclosure
provisions of the SEC as embodied in SEC Regulation S-X (17 C.F.R. § 210.01 et
seq.) and S-K (17 C.F.R. § 229.10 et seq.) and other SEC regulations, including
accurate and truthful information with respect to the Company's operations,
financial condition and performance so that the market prices of the Company's
publicly traded securities would be based on truthful, complete and accurate
information.
213. First Horizon and these Defendants, individually and in concert,
directly and indirectly, by the use of the mails or other means or instrumentalities
of interstate commerce, engaged and participated in a continuous course of conduct
to conceal adverse material information about the business, business practices,
performance, operations and future prospects of First Horizon as specified herein.
These Defendants employed devices, schemes and artifices to defraud while in
possession of material adverse non-public information and engaged in acts,
practices, and a course of conduct as alleged herein in an effort to assure investors
of First Horizon's value and performance and substantial growth. This included
the making of, or the participation in the making of, untrue statements of material
facts and omitting to state material facts necessary in order to make the statements
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made about First Horizon and its business, operations and future prospects in the
light of the circumstances under which they were made, not misleading, as set forth
more particularly herein, and engaging in transactions, practices and a course of
business that operated as a fraud and deceit upon the purchasers of First Horizon
securities during the Class Period.
214. The Individual Defendants' primary liability, and controlling person
liability, arises from the following facts: (i) each of the Individual Defendants was
a high-level executive and/or Director at the Company during the Class Period; (ii)
each of the Individual Defendants, by virtue of his responsibilities and activities as
a senior executive officer and/or Director of the Company, was privy to and
participated in the creation, development and reporting of the Company's internal
budgets, plans, projections and/or reports; (iii) these Defendants enjoyed
significant personal contact and familiarity with each other and were advised of
and had access to other members of the Company's management team, internal
reports, and other data and information about the Company's financial condition
and performance at all relevant times; and (iv) these Defendants were aware of the
Company's dissemination of information to the investing public that they knew or
recklessly disregarded was materially false and misleading.
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omissions of material facts set forth herein, or acted with reckless disregard for the
truth in that they failed to ascertain and to disclose such facts, even though such
facts were readily available to them. Such Defendants' material misrepresentations
and/or omissions were done knowingly or recklessly and for the purpose and effect
of concealing First Horizon's operating condition, business practices and future
business prospects from the investing public and supporting the artificially inflated
price of its securities. As demonstrated by their overstatements and misstatements
of the Company's financial condition and performance throughout the Class
Period, these Defendants, if they did not have actual knowledge of the
misrepresentations and omissions alleged, were reckless in failing to obtain such
knowledge by deliberately refraining from taking those steps necessary to discover
whether those statements were false or misleading.
216. As a result of the dissemination of the materially false and misleading
information and failure to disclose material facts, as set forth above, the market
price of First Horizon's securities was artificially inflated during the Class Period.
Unaware of the fact that the market price of First Horizon's shares was artificially
inflated, and relying directly or indirectly on the false and misleading statements
made by these Defendants, or upon the integrity of the market in which the
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 102 of 106
securities trade, and/or on the absence of material adverse information that was
known to or recklessly disregarded by these Defendants but not disclosed in public
statements during the Class Period, Plaintiffs and the other members of the Class
acquired First Horizon securities during the Class Period at artificially high prices
and were damaged thereby.
217. At the time of said misrepresentations and omissions , Plaintiffs and
other members of the Class were unaware of their falsity, and believed them to be
true. Had Plaintiffs and the other members of the Class known of the true
performance, business practices, future prospects and intrinsic value of First
Horizon, which were not disclosed by these Defendants, Plaintiffs and other
members of the Class would not have purchased or otherwise acquired their First
Horizon securities during the Class Period, or, if they had acquired such securities
during the Class Period, they would not have done so at the artificially inflated
prices that they paid.
218. By virtue of the foregoing, these Defendants each violated Section
10(b) of the Exchange Act and Rule IOb-5 promulgated thereunder.
219. As a direct and proximate result of Defendants ' wrongful conduct,
Plaintiffs and the other members of the Class suffered damages in connection with
their purchases of the Company's securities during the Class Period.
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220. Plaintiffs repeat and reallege the allegations set forth above as if set
forth fully herein.
221. The Individual Defendants were and acted as controlling persons of
First Horizon within the meaning of Section 20(a) of the Exchange Act as alleged
herein. By virtue of their high-level positions with the Company, participation in
and/or awareness of the Company's operations and/or intimate knowledge of the
Company's actual performance, and/or stock holdings, these Defendants had the
power to influence and control and did influence and control, directly or indirectly,
the decision-making of the Company, including the content and dissemination of
the various statements that Plaintiffs contend are false and misleading. Each of
these Defendants was provided with or had access to copies of the Company's
reports, press releases, public filings and other statements alleged by Plaintiffs to
be misleading prior to and/or shortly after these statements were issued and had the
ability to prevent the issuance of the statements or cause the statements to be
corrected.
222. In addition, each of the Individual Defendants had direct involvement
in the day-to-day operations of the Company and, therefore, is presumed to have
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 104 of 106
had the power to control or influence the particular transactions giving rise to the
securities violations as alleged herein, and exercised the same.
223. As set forth above, First Horizon and these Defendants each violated
Section 10 (b) and Rule I Ob-5 by their acts and omissions as alleged in this
Complaint. By virtue of their controlling positions, the Individual Defendants are
liable pursuant to Section 20(a) of the Exchange Act. As a direct and proximate
result of these Defendants' wrongful conduct, Plaintiffs and other members of the
Class suffered damages in connection with their purchases of the Company's
securities during the Class Period.
PRAYER FOR RELIEF
WHEREFORE, Plaintiffs , on behalf of themselves , the Class, and the
Offering Subclass pray for judgment as follows:
A. declaring this action to be a class action pursuant to Rule 23(a) and
(b)(3) of the Federal Rules of Civil Procedure;
B. awarding Plaintiffs, members of the Class and members of the
Offering Subclass damages together with interest thereon;
C. awarding Plaintiffs and the Offering Subclass rescission on Count II
to the extent they still hold First Horizon shares, or if sold, awarding
rescissory damages in accordance with Section 12(a)(2) of the
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 105 of 106
Securities Act;
D. awarding Plaintiff, members of the Class and members of the Offering
Subclass their costs and expenses of this litigation, including
reasonable attorneys' fees, accountants' fees and experts' fees and
other costs and disbursements; and
E. awarding Plaintiffs, members of the Class and members of the
Offering Subclass such other and further relief as may be just and
proper under the circumstances.
JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury.
Respectfully submitted this 20th day of April, 2007.
CHITWOOD HARLEY HARNES LLP
/s/ Martin D . ChitwoodMartin D. ChitwoodGeorgia Bar No. 124950
John F. Harnes
Admittedpro hac vice
Meryl W. Edelstein
Georgia Bar No. 238919
2300 Promenade II
1230 Peachtree Street, N.E.Atlanta, GA 30309Tel: (404 ) 873-3900Fax: (404) 876-4476
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Case 1-02-cv-02332-JOF Document 114 Filed 04/20/2007 Page 106 of 106
CERTIFICATE OF SERVICE
I hereby certify that I have served a copy of the foregoing "Second Amended
Complaint" upon the following counsel of record via the Court's electronic filing
system:
Scott Hilsenscott [email protected] & BIRD, LLP1201 W. Peachtree StreetOne Atlantic CenterAtlanta , GA 30309
John P . Brumbaughpbrumbaugh@kslaw. comKING & SPALDING, LLP1280 Peachtree StreetAtlanta , GA 30309
This 20th day of April 2007.
/s/ Martin D. ChitwoodMartin D. Chitwood (Ga. State Bar No. 124950)Chitwood Harley Harnes [email protected]
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