Case 1:00-cv-00767 Document 180 Filed 10/17/2002 Page 1 of 117
IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION
In re BANK ONE SECURITIES ) Civil Action No. 00-CV-0767 LITIGATION Judge Wayne R. Andersen First Chicago Shareholder Claims ) Magistrate Judge Morton Denlow
FILED
OCT 1 7 2002
MICHAEL W. CLERK, u. S. DOB8INS DISTRICT CoURr
FIRST CHICAGO NBD PLAINTIFFS' FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT
„e'1;1
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TABLE OF CONTENTS
Pa e
1. NATURE OF THE ACTION ...... 1
H. JURISDICTION AND VENUE ...... 8
III. THE PARTIES ...... 9
A. Lead Plaintiff ...... 9
B. Defendants ...... 9
IV. CLASS ACTION ALLEGATIONS ...... 13
V. NO STATUTORY SAFE I-IARBOR ...... 15
VI. SUBSTANTIVE ALLEGATIONS ...... 16
A. The Banc One/First Chicago Merger ...... 16
B. The Registration Statement And Prospectus Were Materially Misleading And Omitted Material Facts, Trends And Risks Related To First USA's Operations, Earnings And Prospects For Continued Growth ..... 22
1. The Changing Credit Card Environment And Banc One's Acquisition Of First USA ...... 22
2. First USA Quietly Changes Its Business Strategy In Response To The Changing Market ...... 23
3. The Change In Pricing Strategy Exacerbates An Undisclosed Attrition Problem And Breakdown in Customer Service At First USA ...... 26
4. First USA's Elimination Of Grace Periods On Its Credit Card Accounts Compounds The Undisclosed Attrition And Customer Service Problems At First USA ...... 28
5. The Undisclosed "Portfolio Collapse" At First USA And Ensuing Class Action Lawsuits ...... 29
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C. The Undisclosed Effort To Maintain The Appearance Of Earnings And Portfolio Growth At First USA Prior To The Merger ...... 31
1. The Pressure From Banc One To Earn More ...... 31
2. First USA's Efforts To "Manage" The Returns On Its Credit Card Portfolio To Earn Additional Short Term Profits ...... 33
3. First USA Purportedly "Comes Clean" To Banc One About The True Extent Of The Problems At First USA ...... 39
4. The Instruction From Banc One To "Earn More" To Complete The Merger Regardless Of The Cost ...... 41
5. First USA's Reaction to Slowing Growth: The "Portfolio Acquisition Blitz" ...... 44
6. First USA' s Aggressive Pursuit Of New Affinity Relationships To Bring In New Accounts ...... 45
D. Banc One ' s Inadequate Disclosure Of Accounting Practices At First USA That Materially Affected Banc One's Reported Results ...... 48
1. Banc One's Failure To Adequately Disclose That First USA Was Continuing To Capitalize And Defer Marketing Expenses Up To The Date Of The Merger ...... 49
2. Banc One ' s Failure To Adequately Disclose That First USA Was Capitalizing And Deferring Expenses Associated With Its Affinity Programs ...... 51
3. Banc One's Failure to Adequately Disclose First USA's Securitization and Gain On Sale Accounting Practices ...... 53
E. The Flurry Of Merger Activity ...... 57
1. The Retention Of A New Auditor ...... 57
2. The Efforts To Conform First USA's And First Card' s Divergent Accounting Policies ...... 58
a. The Internal Debate Over How To End First USA's Expense Capitalization Practices ...... 58
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b. The Undisclosed Accounting Implications Of Not Changing First USA's Bankruptcy Notification Charge-Off Policy At the Time of the Merger ...... 63
3. The Individual Defendants ' Supposed "Due Diligence " Efforts ...... 64
F. The Failure To Address The Undisclosed Problems At First USA Leads To Increased Regulatory Scrutiny ...... 66
G. The New Bank One ...... 69
1. Arthur Andersen's Audit Of Bank One's Combined 1998 Results ..... 69
2. The Post-Merger Efforts To Try To Resolve Some Of The Undisclosed Problems And Negative Trends At First USA ...... 73
3. The Unresolved Problems At First USA Ultimately Threaten The Safety And Soundness Of The Bank ...... 76
171. The Truth Begins To Emerge Only Ten Months AfterThe Merger ...... 78
1. Bank One Concludes That The Problems At First USA Are Beyond Easy Repair And Contracts To Take Out $320 Million Of Additional Insurance Coverage To Mitigate Defendants' Exposure .... 79
2. Bank One's August 24, 1999 Announcement Attributes The Earnings Revision "Entirely" To Problems At First USA ...... 80
3. The October 19, 1999 Resignation Of Richard Vague And Appointment of William Boardman As CEO of First USA ...... 84
4. The November 10, 1999 Announcement , Revising Earnings Projections For A Second Time Due To Problems At First USA ...... 85
5. Arthur Andersen's December 1999 Reassignment Of The Bank One Engagement To "Maximum Risk" ...... 87
6. The December 21, 1999 Resignation Of Bank One's CEO, John McCoy ...... 88
7. The January 11, 2000 Announcement And Revision of First USA's Business Plans ...... 89
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Bank One's Restructuring Of First USA's Balance Sheet In 1999 And Early 2000 Confirms That The Financial Statements Incorporated Into The Registration Statement Were Materially False And Misleading ...... 91
1. Bank One's Special $725 Million Fourth Quarter 1999 Charge ...... 91
2. The SEC's Challenge Of Bank One's Special Charge ...... 92
3. Bank One's Additional $1.91 Billion Charge In 2000 ...... 94
J. Conclusion And Summary ...... 95
K. Defendants Violated SEC Reporting Rules ...... 97
L. Defendants Violated Basic Tenets Of GAAP ...... 100
M. Defendants Violated OCC Regulations ...... 102
VII. INCORPORATION OF PRIOR ALLEGATIONS ...... 103
COUNT I: Against Bank One for Violations of Section 11 of the Securities Act ...... 103
COUNT 11: Against the Individual Defendants for Violations of Section 11 of the Securities Act ...... 105
COUNT III: Against Bank One for Violations of Section 12(a)(2) of the Securities Act ...... 106
COUNT IV: Against The Individual Defendants Under Section 15 of the Securities Act ...... 108
COUNT V: Against All Defendants for Violations of Section 14(a) of the Exchange Act and Rule 14a-9 Promulgated Thereunder ...... 109
COUNT VI: Against the Individual Defendants Under Section 20 of the Exchange Act ...... 110
PRAYER FOR RELIEF ...... 110
JURY DEMAND ...... III
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FIRST CHICAGO NBD PLAINTIFFS' FIRST AMENDED CONSOLIDATED CLASS ACTION COMPLAINT
Lead Plaintiff for the former First Chicago NBD ("First Chicago") shareholders, on behalf of itself and all other persons similarly situated, brings this class action complaint, upon personal knowledge as to itself, and upon information and belief as to other matters obtained through the
ongoing investigation by counsel ofthe following: (a) the Registration Statement dated July 31, 1998
(the "Registration Statement") issued in connection with the October 2, 1998 merger of First
Chicago into Bank One Corporation (the "Merger"); (b) the Joint Proxy Statement/Prospectus
included within the Registration Statement (the "Prospectus"); (c) financial statements and other
documents incorporated by reference into the Registration Statement; (d) materials obtained through
ongoing discovery in this action; and (e) other public filings, documents and press releases of Bank
One Corporation ("Bank One" or the "Company") and its predecessor, Banc One Corporation ("Banc
One").' Lead Plaintiff, by and through its attorneys, complains against Defendants, as follows:
1. NATURE OF THE ACTION
7. Lead Plaintiff brings this class action on behalf of itselfand the class (defined below),
who, in exchange for their shares of First Chicago common stock, purchased shares of Bank One
common stock in connection with the Merger and pursuant to the Registration Statement and
Prospectus. In connection with the Merger, First Chicago stockholders received 1.62 shares of Bank
One common stock in exchange for each share of First Chicago common stock.
8. The Merger between Banc One and First Chicago was first announced to the public
on April 10, 1998. At that time, and throughout the period leading up to the completion of the
' Where appropriate , the terms " Bank One" and the "Company " include Banc One, Bank One and First USA Bank, N.A. Case 1:00-cv-00767 Document 180 Filed 10/17/2002 Page 7 of 117
Merger on October 2, 1998, one of the represented strengths of Banc One's operations and business was the purportedly tremendous growth at Banc One's credit card division, First USA Bank, N.A.
("First USA"), then the third largest credit card issuer in the country. In documents incorporated by reference into the Registration Statement and Prospectus, Banc One repeatedly highlighted that the generation of new credit card accounts remained "very strong" at First USA, increasing at an average rate of two million new credit card accounts per quarter. The Registration Statement also included
Banc One's financial statements, which reflected enormous growth in First USA's credit card business for the recent fiscal year (1997) and the two most recent fiscal quarters (the first and second quarters of 1998). Indeed, the market viewed the First USA credit card business as a major asset and strength of Banc One, as the represented growth in First USA's credit card accounts generated increased income for Banc One through, inter (ilia, charges and fees earned on credit card loans with very positive margins, and gains associated with securitizations of credit card loans.
9. Contrary to the representations in the Registration Statement and Prospectus, First
USA was not the growth engine that it was represented to be. Rather, as detailed infra, much of the reported "earnings" and "growth" at First USA in the periods leading up to the Merger was misrepresented, illusory and/or achieved through undisclosed operating, earnings and accounting practices that placed the Company's immediate and foreseeable financial future at risk.
10. In fact, by the time the Merger was publicly announced in April 1998, through the
date of the Merger in October 1998, First USA was experiencing an alarming, undisclosed increase
in customer attrition and loss of account balances, which was negatively affecting almost every
aspect of First USA's business, including its ability to keep pace with its historical and forecasted
earnings and growth rates. This attrition problem was largely the result of an undisclosed and
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unsuccessful change in First USA's pricing strategy adopted in late 1997, coupled with undisclosed payment processing and customer service problems at First USA, which caused the posting of customer payments to often be significantly delayed. While such posting delays were not the fault of First USA' s customers, these processing errors nonetheless " triggered" penalty rates and increased late lee obligations that First USA had recently put in place, which, in turn, resulted in, and exacerbated, a growing customer backlash against First USA. A market research poll performed by
First USA in August and September 1998, just before the Merger was completed, revealed how First
USA's customers actually felt at the time:
A startling number of people, independently across this research, mentioned major concerns about late posting and payment policies as the immediate impetus to their account closing. Customers in different sessions repeatedly related the identical story: they mailed their payment to First USA 7-10 days before the closing date and the payment was posted one day past the closing. For being one day late, customers perceive that they were assessed a double penalty; late fees and a dramatic increase in their interest rate.
Importantly, cardholders repeatedly and independently characterized this late payment problem as a `scam operation' that is unique to First USA 's credit card operations . (Emphasis added).
l I . A report prepared by the Mitchell Madison Group in connection with a customer retention effort that First USA tried to implement just after the Merger reveals the scale of the attrition problem that First USA was facing in late 1997 and in 1998. The report details that, from
November 1997 to October 1998, First USA lost approximately $17.5 billion in credit card account balances and that the rate of gross attrition at First USA -- the pure loss of account balances , without an offset for balances brought in with new accounts or increased portfolio utilization -- had risen from First USA's historical levels of between 10-12%, to 28% in 1997, to 47% in 1998, and then had begun to stabilize by year end 1998 to a level of approximately 50%. This was a significant
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undisclosed trend , particularly since at the time of the Merger, First USA' s entire credit card portfolio consisted of only about $41 billion worth of credit card accounts, and this included more than $8 billion of credit card accounts that First USA had "purchased" from other issuers in the second and third quarters of 1998 to help perpetuate the appearance that First USA's operations and portfolio were continuing to grow.
12. Rather than disclosing the balance and customer attrition problem, the related payment processing and customer service issues , and the customer fallout that eventually ensued, and to ensure that the Merger would be approved at the previously agreed exchange rate, First USA
(at Banc One's urging) implemented abattery of additional, undisclosed pricing changes in early and mid 1998 to earn more from First USA' s existing accounts -- all with little regard to the impact that such changes were going to have on First USA's customers or First USA's alarming attrition rate.
As an internal communication entitled "finding money" stated:
As you heard this morning, we're trying to get back to George [Hubley, First USA's CFOJ by Thursday with our list of "what could we possibly do to bring money into 1998 regardless ofthe effect on 99 and on 98 growth ?" Please take a shot at sizing what's in your areas ....
13. In addition to putting the squeeze on customers to help make up for the undisclosed earnings shortfalls First USA was experiencing leading up to the Merger, First USA also was able to "find money" by stepping up use of other undisclosed earnings and accounting techniques which
First USA had been using since the time of its merger with Banc One in July 1997 to "manage" Bane
One's reported results. One of the more noteworthy practices employed by First USA -- reminiscent of both the recent Enron and WorldCom debacles -- was the formation and use of an affiliated shell company (internally referred to as the "LLC") through which First USA capitalized and deferred
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recognition of hundreds of millions of dollars of marketing expenses up to the time of the Merger.
First USA also was capitalizing and deferring tens of millions of dollars of account acquisition expenses related to its touted credit card affinity programs, and was accelerating and manipulating the reported gains and loan loss reserves associated with its securitization of credit card accounts.
These practices , along with other tactics -- euphemistically termed " earnings opportunities " by First
USA's management -- were utilized by First USA to increase Banc One's reported earnings, including the results reported in Banc One's 1997 Form 10-K and Forms 10-Q for the first and second quarters of 1998, all of which were incorporated into the Registration Statement and
Prospectus.
14. By August 1999, however, only ten months after the Merger, the undisclosed
"earnings at any cost" business approach employed by First USA before the Merger, along with Bank
One's undisclosed decision to end, as ofthe date ofthe Merger, several accounting practices that had been responsible for much of Banc One's reported pre-Merger results, were adversely impacting
Bank One as a whole. Thus, on August 24, 1999, Defendants began a series of public disclosures that would begin to belatedly reveal the existence (but not the true cause or extent) of the continuing problems at First USA.
15. On August 24, 1999, Bank One issued a press release announcing preliminary earnings estimates for the third quarter and full fiscal year of 1999. The press release reported that, based on "revised outlooks," anticipated full-year 1999 operating earnings per share would likely be down 7% to 8% from the then-current market estimates. According to Bank One, the revised earnings outlook was "entirely the result" of changes in the growth and margin prospects for First
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USA -- all of which, as detailed herein, were the results of the undisclosed issues, problems and trends that had existed at First USA since well before the Merger.
16. Even though these disclosures were incomplete, the market nonetheless found the negative news material. On August 25, 1999, the price of Bank One's common stock plunged
22.7%, or $12.625 per share, from the previous day's closing price of $55.625 per share, to close at
a 52 week low of $43 per share. This decline came on volume of 39,887,000 shares, more than
fifteen times the daily average trading volume for the previous 52-week period.
17. Bank One had anticipated that there would be a severe market reaction to the August
24, 1999 announcement regarding First USA ("I would think that the First Chicago NBD directors
and employees may be scratching their heads wondering if they got suckered in?"), and already had
retained special counsel to begin investigating the events that had transpired at First USA. To
mitigate Defendants ' potential financial exposure , Bank One contracted to take out $320 million of
directors and officers ' liability insurance coverage on the same day as the August 24`h announcement,
specifically to provide retroactive coverage relating back to the date of the Merger.
18. On November 10, 1999, the Company announced that Bank One ' s earnings for 1999
would likely be as much as 15% less than analysts' revised estimates. The Company again attributed
the earnings "shortfall" to the problems and conduct of First USA, including specific matters that
stemmed directly from First USA's pre-Merger activities, such as "negative cardholder reaction to
high late fees, a slow down in marketing, and processing problems." The market, shocked again,
sent the price of Bank One's common stock down to $34.625 per share in heavy trading volume,
down another $4.50 per share, or 11.5%, from the previous day's close of $39.125 per share. Thus,
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Bank One's share price had dropped more than $21 per share, or 37 . 7%, from the closing price on
August 23, 1999 (the day prior to Bank One's first revised earnings announcement).
19. To compound matters, on December 16, 1999, the Office of the Comptroller of the
Currency (the "OCC") issued a formal " Safety and Soundness Notice of Deficiency" to Bank One's
Board of Directors citing First USA, and later fining First USA $1 million, for continuous violations of Regulation Z of the Truth in Lending Act ("TILA ") since before the Merger, and for having failed to accurately and timely post customer payments since as far back as the " beginning of 1998."
20. By the time of the Merger, First USA also had already been named in at least four
separate class action lawsuits related to its pricing practices and for charging late fees to customers
for payments that had actually been made on time -- none of which was disclosed in the Registration
Statement. Ultimately, more than twenty class action lawsuits were filed against First USA related
to First USA's pre-Merger pricing practices and payment posting delays, and First USA was
eventually ordered by the OCC to refund tens of millions of dollars to customers for late fees that
had been illegally collected.
21. Finally, on January 11, 2000, Bank One announced that earnings for 1999 would be
as much as 18 percent less than analysts had been led to believe in November 1999, and that profits
for 2000 would drop sharply as a result of the practices at First USA. At a presentation made to
analysts the same day, Bank One again belatedly acknowledged that it had been facing increased
customer dissatisfaction and customer attrition since 1997 and throughout 1998, attributable to First
USA's previously undisclosed customer service and credit card pricing practices. What was not
publicly disclosed at that time was that all of the problems and issues at First USA, as detailed
herein, had existed prior to shareholders' approval of the Merger and could largely have been
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prevented, but for management's quest to increase Bane One's reported 1998 results and drive the
Merger through.
22. By not disclosing material facts which would have allowed shareholders to meaningfully understand and assess the magnitude of the issues, problems, trends and risks that existed at First USA in the period leading up to the Merger, and by engaging in earnings management that rendered Bane One's financial statements materially false and misleading,
Defendants violated Sections 11, 12(a)(2) and 15 ofthe Securities Act of 1933 (the "Securities Act"),
15 U.S.C. §§77k, 771(a)(2) and 77(o); and Sections 14(a) and 20 ofthe Securities and Exchange Act of 1934 (the "Exchange Act"), 15 U. S.C. §§78n(a) and 78t(a); and Rule 14a-9 promulgated thereunder , 17 C.E.R. § 240.14a-9.
II. JURISDICTION AND VENUE
23. This Court has jurisdiction over the subject matter of this action under Section 22 of the Securities Act, 15 U.S.C. §77v, and Section 27 of the Exchange Act, 14 U. S.C. §78aa.
24. Venue is proper in this District pursuant to Section 22 of the Securities Act and 28
U.S.C. §§1391(b) and 1391(c). Bank One's executive offices are located in this District. Many of the acts giving rise to the violations complained of herein, including the dissemination of false and misleading information, occurred and had their primary effects in this District.
25. In connection with the acts, transactions and conduct alleged herein, Defendants used the means and instrumentalities of interstate commerce, including the United States mails, interstate telephone communications and the facilities of national securities exchanges.
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III. THE PARTIES
A. Lead Plaintiff
26. Lead PlaintiffNaomi Borwell Trust held shares of First Chicago common stock that were exchanged for shares of Bank One common stock in connection with the Merger and pursuant to the Registration Statement and Prospectus.
B. Defendants
27. Defendant Bank One is a multibank holding company that provides domestic retail banking services, financial services and other services to customers, as well as credit card services offered through its First USA subsidiary. Bank One was formed as the result of a two-step merger.
In the first step, Bank One was formed as a new company and its predecessor, Banc One, was merged into the new Bank One in a transaction in which each share of Banc One common stock was converted into one new share of Bank One common stock. In the second step, First Chicago was merged into, and with, Bank One pursuant to the Merger effectuated on or about October 2, 1998.
28. Bank One provides corporate and institutional banking services, and trust and investment management services. Bank One maintains a web site at www.bankone.com , where it disseminates to investors: earnings releases; information regarding analyst conference calls; and its annual reports , with links to SEC filings. The Company' s common stock trades on the New York
Stock Exchange under the symbol "ONE." On October 31, 1999, Bank One had 1,146,880,315 shares of common stock outstanding. Bank One's wholly-owned subsidiary, First USA, a national banking association that maintains its principal place of business in Wilmington, Delaware, was acquired by Banc One on or about June 27, 1997. First USA has been a wholly-owned subsidiary of Banc One and/or its successor corporation, Bank One, since that date.
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29. Defendant John B. McCoy ("McCoy") was Chief Executive Officer and a director of Bank One from the date of the Merger until his resignation on or about December 21, 1999.
McCoy also served as President of Bank One from the date of the Merger until October 19, 1999, when Bank One announced that Verne Istock would be taking over the position of President and that
McCoy would be assuming Istock's role as Chairman of the Board. From approximately 1987 until the date of the Merger, McCoy served as Chairman and CEO of Banc One and, prior to that, McCoy was the President of Banc One. Because of McCoy's positions with Bank One (and its predecessor
Banc One), he had access to adverse, non-public information about the Company's credit card businesses, finances, products, markets, and present and future business prospects. McCoy signed the Registration Statement and Prospectus, and Banc One's annual report on Form 10-K for the year
ending December 31, 1997 (the "1997 Form 10-K").
30. Defendant Richard J. Lehmann ("Lehmann") was Vice Chairman of the Board of
Bank One from the date of the Merger until his resignation from the Company effective year-end
1999. Lehmann served as President and Chief Operating Officer of Banc One from approximately
1995 until the date of the Merger. Lehmann also was responsible for overseeing Bank One's credit
card line of business until about July 26, 1999, when the Company announced that McCoy would
be directly assuming those responsibilities. Because of Lehmann's positions with Bank One (and
its predecessor Banc One), he had access to adverse, non-public information about the Company's
credit card businesses, finances, products, markets, and present and future business prospects.
Lehmann signed the Registration Statement and Prospectus, and the 1997 Form 10-K.
31. Defendant Michael J. McMennamin ("McMennamin") was, at relevant times, Vice
President and the Principal Financial and Accounting Officer of Bank One. Because of
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McMennamin's positions with Bank One, he had access to adverse, non-public information about the Company's credit card businesses , finances, products, markets and present and future business prospects. McMennamin signed the Registration Statement and Prospectus, and Bank One's 1997
Form 10-K.
32. Defendant William P. Boardman ("Boardman") was, at relevant times , Vice President and a director of Bank One. Prior to the Merger, Boardman was Senior Executive Vice President of Bane One. Boardman was identified in the Registration Statement and Prospectus as the person responsible for "acquisitions" for Bank One. He was named "Head of Acquisitions" for Bank One in October of 1998, and Vice President in December of 1998. Boardman also was appointed to head up the Company's credit card and consumer lending businesses following the resignation of Richard
Vague on October 19, 1999. Because of Boardman's positions with Bank One (and its predecessor
Banc One), he had access to adverse, non-public information about the Company's credit card businesses, finances, products, markets and present and future business prospects. Boardman signed the Registration Statement and Prospectus.
33. Defendant David J. Vitale ("Vitale") was Vice Chairman of First Chicago before the
Merger. Following the Merger, Defendant Vitale was Vice Chairman of Bank One. In July 1999,
Vitale announced that he would resign from the Company, effective November 1, 1999. Because of Vitale's positions with First Chicago and Bank One, he had access to adverse, non-public information about the Company's credit card businesses, finances, products, markets, and present and future business prospects. Vitale consented to being named in the Registration Statement and
Prospectus as a person about to become a director of Bank One.
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34. Defendant Verne G. Istock ("Istock") was President and Chief Executive Officer and
Chairman of First Chicago and became a director ofBank One upon the Merger. Because ofIstock's positions with First Chicago and Bank One, he had access to adverse, non-public information about the Company's credit card businesses, finances, products, markets, and present and future business prospects. Istock consented to being named in the Registration Statement and Prospectus as a person about to become a director of Bank One.
35. The Defendants listed in paragraphs 23 through 28 are herein collectively referred to as the "Individual Defendants."
36. Each Defendant is liable as a direct participant in the wrongs complained of herein.
The Individual Defendants each signed, and/or consented to being named a director of Bank One in, the Registration Statement and Prospectus, pursuant to which Bank One issued securities in connection with the Merger.
37. The Individual Defendants participated in the drafting, preparation , and/or approval of various false and misleading statements contained in the Registration Statement and Prospectus filed by the Company with the SEC in connection with the Merger between First Chicago and Bank
One, which are complained of herein. Because of their board memberships, and executive and managerial positions, each of the Individual Defendants was responsible for ensuring the truth and accuracy ofthe various statements contained in the Registration Statement and Prospectus, including the truth of the reported operational and financial results ofFirst USA, and other filings incorporated by reference therein.
38. Each of the Individual Defendants had a duty to promptly disseminate accurate and truthful information with respect to the Company's true operational and financial condition and to
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promptly correct any previously disseminated information that as false and/or materially misleading.
As a result of their failure to do so in connection with the preparation and filing of the Registration
Statement and Prospectus, First Chicago shareholders voted to approve the Merger and exchanged their shares at the predetermined exchange ratio, injuring Lead Plaintiff and other members of the class defined herein.
39. The Individual Defendants, because oftheir management positions and memberships on the boards of Bank One, Banc One and/or First Chicago, had the power to influence and direct the management and activities of Bank One (and its predecessor Banc One), and its employees, and to cause Bank One to engage in the unlawful conduct complained of herein. Accordingly, the
Individual Defendants were able to, and did, control the contents of the Registration Statement and
Prospectus, including documents incorporated by reference therein. Each Individual Defendant was provided with copies of the filings alleged herein to be false and materially misleading prior to, or
shortly after their issuance, and had the ability and opportunity to stop their issuance, and/or to cause
them to be corrected, but failed to do so.
IV. CLASS ACTION ALLEGATIONS
40. Lead Plaintiff brings this action on its own behalf, and as a class action pursuant to
Rule 23(a) and Rule 23(b)(3) of the Federal Rules of Civil Procedure on behalf of a class (the
"Class") consisting of all persons and entities who exchanged their First Chicago common stock for
shares of Bank One common stock, pursuant to the Registration Statement and Prospectus, in
connection with the Merger. Excluded from the Class are: (a) Defendants; (b) members of the
Individual Defendants' families; (c) any entity in which any Defendant has a controlling interest or
is a part or subsidiary of, or is controlled by, the Company; and (d) the officers, directors, affiliates,
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legal representatives, heirs, predecessors, successors and assigns ofany ofthe Defendants. Pursuant to a Memorandum, Opinion and Order dated May 9, 2002, the Court certified the Class. However, the Court excluded from the Class all former First Chicago shareholders who acquired Bank One common stock pursuant to the Merger to the extent they sold such stock prior to August 30, 1999.
41. The members of the Class are so numerous and geographically dispersed that joinder of all members is impracticable . While the exact number of Class members is unknown to Lead
Plaintiff at this time and can only be ascertained through appropriate discovery, Lead Plaintiff believes there are thousands of members of the Class who exchanged their First Chicago common stock for Bank One common stock in connection with the Merger. Pursuant to the Registration
Statement, the Company issued approximately 470 million shares of Bank One common stock to
First Chicago shareholders in connection with the Merger.
42. Common questions of law and fact exist as to all members of the Class and predominate over any questions affecting solely individual members of the Class. Among the questions of law and fact common to the Class are whether:
a. Defendants violated Sections 11, 12(a)(2), and/or 15 of the Securities Act, and/or Sections 14(a) and 20 of the Exchange Act, as alleged herein;
b. the Registration Statement and Prospectus, and documents incorporated by reference therein, contained materially false and misleading statements of fact;
c. the Registration Statement and Prospectus, and documents incorporated by reference therein, omitted material facts necessary so that the statements made (in the circumstances in which they were made) were not misleading; and
d. the members of the Class sustained damages and, if so, the proper measure thereof.
43. Lead Plaintiff's claims are typical of the claims of the members of the Class. The claims of Lead Plaintiff and the members of the Class are based on the same legal theories, and each
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sustained damages in the same manner as a result of Defendants' wrongful conduct in violation of federal law, as complained of herein.
44. Lead Plaintiff will fairly and adequately protect the interests of the members of the
Class and has retained counsel competent and experienced in class action securities litigation. Lead
Plaintiff has no interests antagonistic to, or in conflict with, those of the Class.
45. A class action is superior to other available methods for the fair and efficient adjudication of the controversy, since joinder of all members of the Class is impracticable.
Furthermore, because the damages suffered by individual Class members are relatively small, the expense and burden of individual litigation makes it impracticable for Class members individually to redress the wrongs done to them. Lead Plaintiff anticipates no difficulty in managing this action as a class action.
V. NO STATUTORY SAFE HARBOR
46. The statutory safe harbor provided for forward- looking statements (under certain circumstances) does not apply to any ofthe materially false and misleading statements and omissions alleged in this complaint. The statements alleged to be materially false and misleading all relate to then-existing facts, conditions, trends and risks. In addition: (a) Defendants did not identify any of the statements alleged herein as "forward- looking statements" when they were made; and (b)
Defendants did not include, or identify, any meaningful cautionary language or information which would allow investors to conclude that actual results could differ materially from those stated. To the extent any statements alleged herein are deemed to be forward-looking, and to which the statutory safe harbor applies, Defendants nonetheless are liable for issuing false forward-looking
15 Case 1:00-cv-00767 Document 180 Filed 10/17/2002 Page 21 of 117
statements because, at the time each statement was made, the statements were authorized and/or approved by an executive officer of Bank One.
VI. SUBSTANTIVE ALLEGATIONS
A. The Banc One/First Chicago Merger
47. Before the Merger, Bane One operated as a multi-bank holding company out of
Columbus, Ohio, with banking offices in Arizona, Colorado, Illinois, Indiana, Kentucky, Louisiana,
Ohio, Oklahoma, Texas, Utah, West Virginia and Wisconsin. Banc One also owned non-bank subsidiaries that engaged in, among other things, credit card and merchant processing, consumer finance, mortgage banking, insurance, venture capital, investment and merchant banking, equipment leasing, and data processing.
48. On or about June 27, 1997, Banc One merged with First USA, which became a wholly owned subsidiary of Banc One . At the time of its merger with Bane One, First USA was a state-chartered Delaware bank that maintained its principal place of business in Wilmington,
Delaware. Industry sources reported a dramatic rise in First USA's fee income in 1998 . Banc One reported over $1.25 billion in fee income for First USA through the third quarter of 1998, despite an actual decline in its asset base . This represented an increase of more than $ 312 million (or approximately 33%) over the same period in 1997.
49. Prior to the Merger, First Chicago, like Bane One, also operated as a multi-bank holding company with its principal offices based in Chicago, Illinois. First Chicago engaged primarily in four lines of business: regional banking, corporate banking, corporate investment, and credit card operations.
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50. In February 1998, Verne Istock, Chairman, President and CEO of First Chicago, met with John McCoy, Chairman and CEO of Banc One , to discuss the possibility of a strategic combination of Banc One and First Chicago.
51. As represented in the Registration Statement and Prospectus for the Merger,
Defendants Istock and McCoy determined that:
such a combination could be beneficial for Banc One and FCN [First Chicago] and their respective shareholders in view of the characteristics of the companies' businesses and franchises (including each company's strong banking and credit card franch ises), the accelerating trend toward consolidation in Banc One's and FCN's businesses and in the financial services industry generally and the larger and more diversified institution that would be created. (Emphasis added).
52. Shortly thereafter, Bank One and First Chicago entered into an Agreement and Plan of Reorganization, dated April 10, 1998, and publicly announced the supposed "merger of equals" on the same date. Though disfavored by the SEC, the Merger agreement specified that the Merger nonetheless would be treated as a pooling-of-interests for accounting purposes (rather than a
purchase transaction). Pooling treatment obviated the need for the new Bank One to record any
"goodwill" in connection with the Merger transaction, freeing Bank One from the negative drain on
future earnings that would otherwise have resulted from having to amortize the significant amount
of goodwill associated with First Chicago's business. Additionally, treating the Merger as a pooling
transaction allowed Bank One to avoid having to evaluate, and potentially write down, hundreds of
millions of dollars of First USA's assets that were overstated and/or impaired at the time of the
Merger.
53. In connection with the Merger, Bank One set up and utilized a $1.25 billion Merger
"reserve," which Banc One later took advantage of to quietly change and discontinue use of several
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of First USA's highly questionable accounting policies . While these changes in accounting policy were both quantitatively and qualitatively material, as detailed more fully below, the risks and foreseeable consequences ofchanging and conforming First USA's accounting policies in connection with the Merger were not discussed in the Registration Statement or Prospectus, nor adequately explained or disclosed to investors.
54. On or about July 31, 1998, Defendants issued the Registration Statement and
Prospectus which, inter alia, solicited First Chicago shareholder votes needed to approve the Merger.
There, Defendants touted the historical operating results of First USA and Bane One and played up the strength and economies of the combined credit card business that would result from the Merger:
The Boards of Directors of Banc One Corporation and First Chicago NBD Corporation have agreed on a merger of Bank One and First Chicago NBD. This proposed transaction is a merger of equals that will create one of the strongest financial institutions in the nation. The combined company will be an effective competitor on many fronts, with a powerful consumer and commercial banking presence spanning West Virginia to Arizona, great strength in corporate banking and one of the largest credit card businesses in the country.
55. The Registration Statement and Prospectus incorporated by reference Banc One's financial results, as reported on Form 10-K for the year ended December 31, 1997 and on Forms 10-
Q for the first and second quarters of 1998. The 1997 Form 10-K repeatedly highlighted the strength and growth of Bane One's credit card operations, reporting among other things:
At December 31, 1997 First USA had approximately 40.5 million card members and $40.8 billion in managed credit card receivables and was the third largest issuer of bank credit cards in the United States.
The generation of new credit card business during 1997 remained very strong... . In the partnership areas, a number ofpremier names were signed including New York Life, Country Wide Home Loans, PGA Tour, American Medical Association and the
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Los Angeles Dodgers. This activity contributed to a record of 8.1 million new credit card accounts during the year, exceeding the previous record of 6.2 million new accounts set last year.
56. First USA comprised 36% of Banc One's managed loan portfolio (far and away the largest component) and was a vital element of Banc One's earnings and growth. Indeed, in 1997,
Banc One's average managed loan portfolio reportedly increased 12.7%, to $108.9 billion, largely as a result of a 17.2% growth in average managed credit card loans. Managed net interest margins also increased dramatically in 1997 to 6.27%, primarily as a result of new credit card loans.
57. Banc One's Form 10-Q for the first quarter ended March 31, 1998, incorporated into
the Registration Statement and Prospectus, continued to highlight the accelerating growth of First
USA's credit card business, and reported that credit card income had increased a stunning $203.6
million, to $491.6 million (or 70.7%), for the first quarter of 1998. The 10-Q also reported another
double-digit increase in Banc One's average managed loan portfolio "due primarily to a 15% growth
in average credit card loans." The Form 10-Q also highlighted that the "generation of new credit
card business remained very strong ... with 2 million new credit card accounts being opened," up
62% from the previous year's comparable quarter. Further, Banc One emphasized new credit card
affinity relationships between First USA and the Detroit Tigers, the San Diego Padres, YAHOO,
ExCite, Geo Cites, the University of Washington and the American Institute of Certified Public
Accountants. An affinity relationship occurs when a credit card issuer pays a "popular" third party
for the right to use its name or logo on the card and in marketing the card.
58. In its Form 10-Q for the second quarter ending June 30, 1998, also incorporated into
the Registration Statement and Prospectus, Banc One reported earnings that indicated a continuation
of very strong growth in First USA's credit card business. Banc One represented that credit card
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income was up $83.3 million, to $442.4 million (or 23.2%), from the previous year's comparable quarter. For the first six months of 1998, credit card income reportedly was up almost $300 million compared to the same period in 1997. The 10-Q also reported that: (a) for the "fifth consecutive quarter," First USA's affinity partnership programs continued to achieve success ; and (b) due primarily to "double digit growth" in average credit card loans, Bane One's average managed loan portfolio had increased to $122.2 billion for the quarter ending June 30, 1998. Bane One also touted
First USA's newest affinity relationships.
59. Besides incorporating Bane One's financial statements for 1997 and the first two
quarters of 1998 into the Registration Statement and Prospectus, Defendants also reiterated therein
that "such financial statements, in the opinion of Banc One management, contain the adjustments,
all of which are normal and recurring in nature, necessary to fairly present Banc One's consolidated
financial position, results of operations, and change in cash flows."
60. Defendants also represented and warranted in the Registration Statement and
Prospectus that, among other things:
1. since December 31,1997, no event had occurred which, individually or in the aggregate, had had a material adverse effect on Banc One and/or First Chicago;
2. there were no undisclosed liabilities and the financial statements contained in, or incorporated into, the Registration Statement and Prospectus complied with Generally Accepted Accounting Principles (GAAP); and
3. each party was in compliance with applicable laws and regulations.
61. Defendants unanimously recommended that Banc One and First Chicago shareholders
approve the Merger, and stated in the Registration Statement and Prospectus that "the consummation
of the Merger presents a unique opportunity to create a premier national financial services company,
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as well as one of the largest banking institutions in the United States and the strongest banking institution in the Midwest Region of the United States."
62. In making this recommendation, Defendants and the Registration Statement and
Prospectus highlighted:
[t]he competitive advantage that the combined company would have as a credit card issuer through the combination of two of the country's largest card operations and strongest card brands into a single franchise that is expected to be the second largest in the United States, with over $60 billion in managed assets and approximately 56 million customers,
63. Through these public filings, Defendants led First Chicago shareholders and the investment community to believe that First USA's purportedly strong credit card operations would provide a growth engine for Bank One because, in addition to cross-selling opportunities offered by
First USA's credit card accounts, new credit card accounts had significantly increased Banc One's:
(a) interest and fee income; (b) overall return on loans outstanding as a result of the high interest rates on First USA's revolving credit card accounts; and (c) gains recognized by First USA's frequent securitization of credit card accounts.
64. Pursuant to the representations made in the Registration Statement and Prospectus
(and the financial statements incorporated therein), First Chicago shareholders voted to approve the
Merger of Banc One and First Chicago at a special shareholders meeting held on September 15,
1998. The Merger became effective on October 2, 1998, and each share of First Chicago common stock outstanding at the time of the Merger was sold and exchanged for 1.62 shares of Bank One common stock.
65. As detailed herein, statements contained in the Registration Statement and Prospectus
(including the documents incorporated by reference therein): (a) were materially false and
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misleading; and/or (b) omitted material facts necessary to make the statements made, in light of the circumstances in which they were made, not misleading.
B. The Registration Statement And Prospectus Were Materially Misleading And Omitted Material Facts, Trends And Risks Related To First USA' s Operations , Earnings And Prosp ects For Continued Growth
1. The Changing Credit Card Environment And Bane One's Ac q uisition Of First USA
66. By year end 1996, if not earlier, First USA's management had determined, but not publicly disclosed, that, due to increased competition and the saturation and maturation of the credit card market , among other factors, First USA would no longer be able to compete and/or achieve any significant growth merely by offering competitive interest rates to prospective new accounts. First
USA's management decided to meet these changing market conditions , and attempted to maintain
First USA 's historical 20% growth rate , by changing First USA's marketing and pricing strategies.
67. In January 1997, First USA and Banc One discussed these strategic and competitive imperatives as part of their contemplated merger. Customer attrition at First USA already was on the rise. Among other things, Banc One's management was concerned that, if First USA did not get its then rising (12%) attrition under control, the "game could be lost here." Banc One also was concerned in early 1997 by what it termed the "rising losses" at First USA -- a concern that ultimately proved to be well-founded. Indeed, by the end of 1997, First USA already was forecasting significant earnings shortfalls for 1998: "4" quarter [of 1997] looks good ($10 million better than target) ... is' quarter is much worse ($57 million worse, as follows)."
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68. Banc One's due diligence materials from its merger with First USA also reflect concern over certain of First USA's accounting policies, which were going to have to be changed if the merger were going to go through, because they were contrary to GAAP:
There area number of accounting differences that were noted with the risks identified if First USA adopted our policy and the opportunities if we adopted First USA policies. The capitalization of marketing expenses was noted as being a significant risk of up to 5140 million and fairly clear cut from a GAAP perspective. Their current policy of capitalizing all marketing costs and amortizing over 12 months is not allowed under current GAAP. (Emphasis added).
69. On January 21, 1997, Banc One publicly announced the merger with First USA.
Approximately three months later, on April 24, 1997, Banc One announced that First USA had ceased its practice of capitalizing marketing expenses in order to conform with Banc One's practice, and that First USA's financial statements were going to be formally restated for the first and second quarters of 1997, to adjust for this change in First USA' s accounting practice . Two months later, on June 27, 1997, Banc One completed its merger with First USA.
2. First USA Quietly Changes Its Business Strategy In Response To The Changing Market
70. Following the merger with Banc One, First USA continued to consider ways to improve its operating results in light of changing market conditions. First USA recognized that, in the increasingly competitive market it was facing, it could not realistically increase annual percentage rates ("APRs") on its credit card accounts without losing more business to competitors.
Indeed, even though First USA prided itself on being able to offer some of the lowest rates in the industry, internal reports show that response rates for First USA's new account offerings had been declining steadily since early 1996.
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71. To try to attract and retain customers in the face of this increasingly competitive
environment, First USA began offering new accounts with even lower APRs. In or about July 1997,
First USA "tested" a credit card offer with a new low introductory "teaser" rate of 5.9%, and an
unprecedented fixed "go to" rate of 9.99%. While these introductory and fixed APRs were
approximately 200 to 400 basis points (or more) below what First USA and other credit card issuers
were offering at the time, and obviously more limiting to First USA's profit plan than First USA's
previous variable rate programs, First USA's Marketing Department envisioned (albeit, without the
support. of any marketing research or financial analysis) that the loss of finance charge income
associated with these lower APR's could be more than made up by charging and collecting additional
fees and penalties from customers that "broke the rules." As discussed below, a variety of new rules
and increased fees and penalties were eventually added to First USA's new account offers and,
ultimately, to First USA's existing accounts in 1998 to boost First USA's deteriorating operating
results. Collectively, this broad spectrum of new rules, fee increases and APR changes would come
to be know as "rules based pricing."
72. The early results of First USA's July 1997 test campaign appeared promising, as
customers flocked to First USA's new low fixed rates . What still was unclear was whether First
USA could actually make money by offering these sorts of fixed rate, fee-laden accounts, which, in turn, depended largely on how customers reacted when they learned that First USA had included all sorts of additional and increased fees and penalties in the fine print ofthese new account agreements,
("Rules based [pricing] has never been tested . . . . Full `98 financial impact needs to be dimensioned").
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73. Without waiting to see how customers would actually respond to the new rules based pricing approach, First USA decided in November 1997, under pressure from Bane One, to extend rules-based pricing to the bulk of its existing credit card accounts as well . An internal First USA e- mail from October 1997 explains the change in First USA's pricing strategy as follows:
Score Based Repricing Background. Score based repricing was the process of evaluating all of our accounts once every two months, and raising the APRs of accounts that were deemed more risky than their current pricing suggests. The riskiness and therefore appropriate price of each account was determined by algorithms using the combination of credit bureau score and an internal behavior score. We notified people 60 days in advance of when they'd see the new rate on their statement, and if they didn't call to close their account before the 60 days was up, they went to the higher rate.
Rules Based Repricing Background . Rules based repricing has a direct correlation between a cardmembers actions and the price they are at. They are notified in advance of these rules. If a cardmember goes 30 days delinquent twice in 6 months, or 60 days delinquent once, their next statement will be at a higher `penalty' rate. If you behave yourself (stay current) for 6 months in a row, you are said to `cure', and you go to a lower rate than your penalty price. We are repricing a very large portion of our current portfolio to this rules based system by January. All new account acquisitions will also be using the system. The `good behavior' price of repriced accounts on the books today will remain unchanged. It is only if an account `breaks the rules' that a higher rate will apply. For new account acquisitions, the current pricing strategy per segment remains in tact for good behavior, but they will once again flip to the penalty price if the [sic] break the rules. (Emphasis added).
74. Despite the obvious risk that First USA's best customers (those with high balances and good credit histories) might just transfer their balances to other issuers, rather than paying First
USA's additional and increased penalties and fees, F irst USA implemented this significant change in its business strategy without publicly disclosing the reasons for the change, the change itself, or any of the attendant risks.
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3. The Change In Pricing Strategy Exacerbates An Undisclosed Attrition Problem And Breakdown in Customer Service At First USA
75. At the same time that First USA adopted its rules based pricing plan, and largely because it adopted the plan, First USA discovered that its customer payment processor, National
Processing Corporation ("NPC"), had been having trouble meeting the demands imposed by First
USA's increased marketing efforts and Banc One's aggressive merger and acquisition campaigns.
By the end of 1997, the posting of customer payments had become increasingly delayed, sometimes by as much as several days.
76. While this delay had never been of much consequence under First USA' s prior "score based" pricing strategy, due, primarily, to First USA's customary five-day grace period and its willingness to waive late fees for customers who called into complain, the change to rules based pricing meant that every dollar of fees had to be collected to ensure that the strategy would succeed.
Thus, besides increasing the amount of the late fees it charged (e.g., from $10 to $25, and later to
$35 and $39), First USA instructed its customer service representatives that late fees could no longer be waived as a matter of course.
77. Even though payments delayed by the payment processing problems at NPC were not really "late," these delayed payments nonetheless caused the billing system at First USA to post late fees to customer accounts. The posting of these erroneous late fees, in turn, caused hundreds of thousands of customer payments to be misreported as "late " to the national credit reporting bureaus.
In effect, First USA' s change to rules based pricing made visible the latent processing problems at
NPC that had existed for quite some time.
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78. The customer reaction to First USA' s erroneous late fee postings was immediate and severe. First USA's understaffed Customer Service Department , which had been created under the assumption that all it needed to do was keep "happy" customers "happy," was overwhelmed and completely unprepared to deal with the onslaught of irate customer complaints. In fact, the problem had arisen so suddenly and unexpectedly that customer service representatives at First USA had not been briefed about the existence of the payment processing problems and posting errors, and thus, customers who called in to complain were being told (just as First USA had instructed its customer service representatives only a few weeks before) that the late fees and penalties were part of First
USA's new rules based account terms, and could be avoided in the future only if customer's "started paying their bills on time." This naturally infuriated customers who had sent in their payments on time, many of whom, after paying First USA's $ 25 late fee , proceeded to cancel their accounts.
79. Additionally, many customers were learning for the first time as a result of these payment processing errors that their accounts were actually subject to being converted to much higher "penalty rates ." Under First USA' s new rules-based pricing strategy, late payments were triggering events that caused customer's accounts to automatically (electronically) be changed to penalty rates, typically ranging from 19.99% to 22.99%. When customers' supposedly "fixed" rate accounts were abruptly switched to these much higher penalty rates through no apparent fault of their own, customers naturally felt that they had been deceived.
80. By the end of December 1997, less than one month after thefirst rules basedpricing changes were made, First USA's CFO, George Hubley, was already referring to the unexplained rash of lost customers and account balances as a "portfolio collapse."
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4. First USA's Elimination Of Grace Periods On Its Credit Card Accounts Compounds The Undisclosed Attrition And Customer Service Problems At First USA
81. To make matters worse, in January 1998, First USA began implementing of the
"rules" phase of its rules based pricing campaign and eliminated the grace periods on almost all of its credit card accounts. While this change was expected to bring in an additional $273 million earnings "benefit" to 1998, the abrupt elimination of grace periods only exacerbated the customer service and attrition problems at First USA, as a large percentage of customers who had previously made their payments late in the billing cycle to take advantage ofFirst USA's grace period (so-called
"transactors") were now unexpectedly being charged significant rules based late fees and penalties.
82. This, in turn, resulted in a new phenomenon that First USA was utterly unprepared to cope with or prevent -- so-called "silent balance attrition" -- where customers paid down their balances (often with balance transfer checks from other issuers) and stopped using their First USA accounts, but never formally closed their accounts. By February 1998, less than one month after these grace period changes went into effect, First USA's statistical reports already were showing that, in contrast to the historical attrition rates at First USA that had averaged between 10% and 12%, the more recent "97-1 and 97-2 vintages" which had been changed to rules based pricing, were experiencing combined customer and balance related attrition of "20% and 24% respectively."
83. These significant undisclosed attrition rates, coupled with the rash of account closures that First USA was experiencing, eventually propelled First USA's attrition rate to upwards of 47% by the time of the Merger, resulting in the loss of literally billions of dollars worth of credit card accounts. At these high rates of attrition, First USA needed to book three to five billion worth of new receivables each quarter, just to stay even. Despite the obvious risks this posed to First
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USA's and Banc One's businesses and prospects for future growth -- including, a substantial loss of pre-Merger revenues and fees -- Banc One failed to disclose these negative trends to shareholders in the Registration Statement and Prospectus. Rather, as detailed below, First USA and Banc One used virtually every means available to manage their earnings and maintain the appearance of growth.
84. Additionally, Banc One failed to disclose that, through a process known as "backend adverse selection," First USA's credit card portfolio had become substantially more risky by the time of the Merger. As more and more of First USA's best customers were leaving (i. e., those with high credit scores and high balances), First USA's portfolio became more heavily weighted down with
the accounts of customers who, because of their poor credit or payment histories, had nowhere else to go. Thus, by the time of the Merger, as detailed more fully below, the number of insolvent and
bankrupt accounts had increased so much that First USA and Banc One were actively searching for
ways to improve First USA's "net credit loss" scores.
5. The Undisclosed " Portfolio Collapse" At First USA And Ensuing Class Action Lawsuits
85. Worried about the financial impact that the undisclosed account closures and lost
balances were going to have on First USA' s bottom line, First USA formed a cross-departmental
committee in January 1998, termed the "Payment Mad Dog Team," to begin addressing the so-called
"service delivery failures" at First USA. The Payment Mad Dog Team, along with Banc One's
Internal Audit Department, performed on-site audits of several NPC facilities in early 1998 and
found, just as customers had been indicating, that payments were not being "processed within
contractual timeframes." The Payment Mad Dog Team also eventually concluded that "controls
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should be improved" at both First USA and NPC, and that the mail receipt cutoff times in First
USA's contract with NPC (6:00 a.m.) needed to be changed to conform to the binding, contractual cutoff times (8:00 a.m.) specified in First USA's cardholder agreements.
86. These findings were reported to Banc One's Audit Committee on April 15, 1998, only days after the Merger was publically announced:
First USA recently experienced a significant increase in customer inquiries regarding the status of their payments. Due to ongoing portfolio growth, the third party remittance processor, NCS [sic], was unable to keep up with the volume. As a result, customers experienced delinquencies and late charges because their payments were not being processed timely.
87. Banc One's General Counsel also alerted the Audit Committee that four class action lawsuits had been filed against First USA at the end of 1997: the Navarro-Rice v. First USA action
in Oregon; (b) the Rosted v. First USA action in Washington; (c) the Grasso v. First USA Bank
action in Delaware; and (d) the Watkins v. First USA Bank action in Texas -- all of which "allege[d]
breach of contract, breach of the duty of good faith and fair dealing, fraud and violation of state
consumer protection laws arising out of the repricing of credit card accounts that are initially
established through a very low introductory rate followed by a higher `go to' rate."
88. On April 21, 1998, only two weeks after the Merger was announced, Banc One
released its earnings for the first quarter of 1998. On the subject of First USA's growth, Banc One's
quarterly report and press release indicated only that "First USA continued its excellent performance
and opened approximately 2 million new accounts." Since the attrition problem at First USA had
not been publicly revealed, Banc One instructed its Investor Relations Department that there should
be "no discussion of data related to receivables at introductory ratepricing, introductory rate loans
repricing schedule, or attrition levels ." (Emphasis added). In fact, no meaningful public disclosure
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of any of these issues, or the related class action lawsuits, would be made until late 1999, almost a year after the Merger had been approved.
89. Following Banc One's first quarter release, First USA began quietly issuing some refunds to a limited group of customers , later referred to as " disadvantaged customers", who had been the victims of First USA's improper posting of late fees and penalties . As detailed below, however, no real inroads into the payment processing and customer service issues, nor any systemic remediation effort, would be made by First USA until at least July 1999, when the OCC threatened to bring a formal enforcement proceeding against First USA if things did not immediately improve.
C. The Undisclosed Effort To Maintain The Appearance Of Earnings And Portfolio Growth At First USA Prior To The Merger
1. The Pressure From Banc One To Earn More
90. Following Banc One's merger with First USA in July 1997, Banc One began pressuring First USA's management to maintain First USA's historically high earnings and growth rates. Banc One expected earnings and portfolio growth from First USA of approximately 20% per year, which Banc One thought could, and should, be achieved by increasing the interest rates (APRs) on First USA's portfolio, and through use of an extensive (nearly $1 billion) annual marketing budget. Internal documents from the time reflect that there was "a lot of pressure on Dick Vague
[First USA's CEO] to maintain this growth for another 3-5 years."
91. On top ofthis general pressure to perform, Banc One started making specific demands for additional earnings once the Merger had been agreed to, to help offset some of the undisclosed earnings troubles that Banc One was experiencing. In the first quarter of 1998, for example, Banc
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One specifically asked First USA to "earn $20 million extra" for the quarter -- which was no small task given First USA's already aggressive business plan.
92. By March 1998, Banc One's earnings demands were becoming almost impossible for
First USA to fulfill, as First USA's own bottom line was being squeezed by the effects of First
USA's rising attrition rate. Indeed, while First USA already was anticipating that its first quarter results were going to be millions of dollars short of its revised budget (as detailed more fully below),
Bane One was, in the words of First USA 's management, still "looking for more !" In fact, Banc One instructed First USA 's management that, if they could not deliver the additional operating results, then they should try to "trade" some profits with the second quarter.
93. First USA's CFO, George Hubley, and First USA's CEO, Richard Vague discussed this additional earnings demand in a series of internal e-mails in mid March 1998, as follows:
Hubley: Following is an update on the Quarter:
Corp. is looking for more earnings ($10-$25 million).
1. We think we could earn between $2 and $12 million more than target -- $12 million if [Kevin Murphy] can do his sale [of bankrupt accounts] ... he's being squeezed on price and would prefer to defer to second quarter ... however, we may need the earnings and would like the benefit to [net credit losses] (10 bp).
The Corp. is looking for our ability/willingness to earn more . Please give us your thoughts
Vague: This is above our target? Do they understand it will be a reduction to our second quarter?
Hubley: Yes, above our target. Regarding the 2"d quarter, we haven't really discussed it (I don't think they're thinking about the 2"d quarter yet) ... we'll make sure they
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understand. Also, the number [we're reporting for the first quarter] is a little softer than we thought .. .
Vague: Do what you can -- as long as they understand the second quarter implications!
94. Despite the difficulty that First USA was having meeting even the objectives of its own internal business plan at the time, Banc One's demands for additional earnings did not let up.
Banc One demanded at least $20 to $ 25 million of additional earnings from First USA for the second quarter, and at least that much more again for the third quarter of 1998.
95. The pressure to meet Banc One's earnings expectations and demands was paramount to the management team at First USA. In fact, John McCoy, former CEO of Banc One and later
CEO of Bank One, candidly explained to Arthur Andersen just after the Merger was announced in
April 1998 that Banc One was essentially run on a "pass/fail" basis. A failure to meet expectations, in McCoy's words, was "career threatening."
2. First USA's Efforts To "Manage" The Returns On Its Credit Card Portfolio To Earn Additional Short Term Profits
96. The demands Banc One placed on First USA throughout the first three quarters of
1998 caused First USA's management to use every means possible to increase reported earnings.
Indeed, by March 1998, First USA already had implemented such a raft of rules based pricing
changes -- all designed to eke out incremental revenue from First USA's portfolio -- that
management despaired at finding anything else to do ("can't keep going back to the same well").
97. Among the changes that First USA had made to its credit card portfolio in late 1997
and early 1998 to boost First USA' s short term results were: (a) the changes to rules based pricing
in July and November 1997 (discussed supra); (b) the shortening of grace periods in January 1998,
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along with increases in late fees (from $25 to $28) and increases in cash advance fees, balance transfer fees and returned check fees; and (c) increases in rules based penalty rates from 19.99% to
22.99% in March 1998, as well as further increases in late fees (from X28 to $29) and over limit fees
(to X25). These pricing changes, along with several extensive "portfolio utilization programs" (e.g., marketing campaigns to try to get existing customers to use their cards more), were forecasted to, and did, bring in additional profits into 1998. Indeed, Banc One's first quarter earnings announcement issued on April 21, 1998, reported "record earnings" at First USA, up 36% based on strong revenue growth. Yet, as William Boardman explained after being appointed to clean up the problems at First USA after the resignation of Richard Vague in late 1999, these pre-Merger pricing initiatives (termed "balance desperation" by Boardman) were "front loaded" and only encouraged
First USA's worst/riskiest customers to build up higher balances. Once these customers had built up significant balances, moreover, they had no real choice but to remain at First USA until the balances were paid off (or written off by First USA), which, in turn, only "built in" the impacts of
the problems that First USA was experiencing. In effect, First USA traded its earnings problems in
early 1998 for the effects of inevitable attrition in late 1998 and 1999.
98. Notwithstanding this tradeoff, in May 1998, after reviewing April's actual results,
First USA's management concluded that they needed to be even more "bold" and "aggressive" in
their pricing initiatives to help make up for First USA's still straggling results. First USA's portfolio
statistics for May 1998 reveal that the "revolve rate" (an index which First USA used to track the rate
at which customer's revolving credit card balances were built up and paid down) had been declining
for over eight quarters in a row, from 96.07% in April 1996, to 92.15% in April 1998, including a
significant (115 basis point) fall during the first four months of 1998. While this material trend in
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customer prepayment rates (a direct function of First USA's increasing attrition rate) was not publicly disclosed, it was vitally important to First USA and Banc One at the time, because every
100 basis point (1%) decline in the portfolio revolve rate cost First USA and Banc One approximately $60 million in annual profits.
99. The decline in the portfolio revolve rate, coupled with tens of millions of dollars that
First USA was having to refund to customers each month, led First USA's Finance Department to conclude in May 1998 that First USA' s earnings for the second quarter of 1998 would be at least
$100 million less than had been forecasted, and that the earnings for the whole of 1998 might be as much as $289 million short.
100. Although First USA's management understood that making changes (and especially
repeated changes) to cardholder's accounts was going to cause further attrition ("problem will
intensify with late fee policy changes and pricing policy changes!"), by the end of May 1998, First
USA's Marketing Department already had begun work on several further repricing initiatives in the
hope of being able to bring an additional $58 million benefit into 1998 ("July notification/September
benefit"). These repricing measures included "tiered" increases in late fees, cash advance fees and
penalty rates for additional First USA accounts, as well as, similar changes for some of the accounts
of Banc One.
101. While First USA's management unanimously "voted" to approve these further
changes to customers' accounts, First USA still needed to obtain legal approval to make the changes,
as this was thefourth major reprice in five months and, therefore, many of these same accounts had
already had the terms of their accounts changed at least once before. Notwithstanding the further
loss of accounts that these additional pricing changes were projected to generate, First USA
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implemented these tiered repricings in June 1998 (and others approved in July and August 1998, discussed below) to boost Banc One's reported second quarter results.
102. Even with these additional pricing changes, however, First USA was still well short of its earnings target for the second quarter of 1998. So much so, in fact, that First USA's management sent around an e-mail to First USA's various departments on June 14, 1998 asking for lists of ideas to bring additional earnings into 1998:
Subject: Finding Money
As you heard this morning, we're trying to get back to George [Hubley] by Thursday with our list of "what could we possibly do to bring money into 1998 regardless of the effect on 99 and on 98 growth? " Please take a shot at sizing what's in your areas , including but not limited to:
Repricing - Repricing all populations (High Risk partners, Bank One etc) - Retros to non-rules based folks - $35 late fee across the board? - Other ?
PUP - Incremental mailbase? or Less mailbase? (i. e., is PUP a positive [pretax profit] in 98? if so do more, if not do less) - Lower PUP to 3.9? or raise it to 6.9? (again, same basic question, which is better for 98?) - Charge fees on PUP (which we're already doing right? any opportunity for more?) - Shorter promo period? - Other?
NIKE [account retention program] What is left to spend? Could we stop in our tracks, would that help 98? - Any opportunities on the accruals? - Others?
[Revenue Services] - Assess the CAP fee based on average daily balance but on ending balance - Others?
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Appreciate your creativity here! For all we need to put on the page not only the 98 benefit, but the 99 impact [on pretax profits] and the [effect these items will have on our 1998 year end level of outstandings]. (Emphasis added).
103. The following week, on June 18, 1998, First USA's management team met to see what the various departments had come up with. The Marketing Department, for example, proposed numerous additional small repricing measures for various parts of the portfolio (e.g., "Brand Teller
Cash to 3%/$15" and "50% of Partner accounts to Rules", etc.), as well as several additional short term revenue opportunities (e.g., "Checks in Statements $5.2MM") and added deferrals of expenses
(e.g., "More LLC Stuff $5.OMM"). The Marketing Department also recommended canceling First
USA's recently approved project "NIKE" account retention program to conserve expenses.
104. The NIKE program had been created to "increase profitable retained accounts and balances by 50% within 90 days," which the Customer Service Department believed could be accomplished by the hiring of about 200 additional account representatives to try to save customers who called in to close their accounts. While First USA already was committed to paying more than
$8.3 million for the work that had been done on the NIKE project so far, management was so desperate for additional short term results that they chose to stop the NIKE program in its tracks in order to save a projected $9.1 million of current expenses. The decision to suspend development of the program (until after the Merger) was a substantial blow to First USA, as the NIKE project had been expected to save hundreds ofmillions of dollars ofaccount balances, including savings ofmore than $217 million worth of balances in the remaining few months of 1998 alone.
105. By the end of the second quarter , First USA's strained customer relations and its repeated efforts to manufacture additional results were starting to take a significant toll on First
USA's business . For example , an internal " Service Delivery Failure Review" from early July 1998
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reports that account closures had increased 3% from May to June to "an all-time high" of 358,562 accounts -- more than three times the number of account closures than First USA had experienced
June of 1997.
106. Despite that it was now losing customers en masse, First USA's management team met again on July 6, 1998 to see if they could find "one more `Big Idea"' worth $40 to $50 million to help close the second quarter earnings gap. While the Finance Department was now forecasting a second quarter earnings shortfall of $146 million, by the time of the July 6" meeting, First USA's management already had found a way to make up nearly half of this amount: "Trying to find $100" -
"Got $75."
107. In order make up the difference, albeit recognizing that any pricing changes made so late in the year would have only a limited benefit for the last few months of 1998, management proposed the following: (a) a 22.99% penalty pricing increase on one-fourth of First USA's partnership accounts; (b) an increase in annual fees to $29 on the riskiest one million accounts; and
(c) a $39 annual fee on the least profitable three million accounts. Collectively, this three-pronged repricing initiative (thefifth significant repricing in less than a calendar year) was internally termed the "worst customer strategy" by First USA, and was expected to have a further adverse impact on
First USA's attrition rate ("What can we do to build [pretax profits] in 1998 regardless of [impact on outstandings] and 99 [pretax profits]?")
108. While the management team viewed this worst customer strategy as "insensitive," they nonetheless approved these further changes to customers ' accounts, as, by this point, there were virtually no other earnings opportunities to be found. In fact, Richard Vague (First USA's CEO)
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expressly admonished the management team that they needed to get to "$100 million by Friday"
(July 10, 1998), and that he was "counting on" each of the items "unless notified."
3. First USA Purportedly "Comes Clean" To Banc One About The True Extent Of The Problems At First USA
109. By the end of June 1998, as detailed above , First USA was finding it almost
impossible to achieve its budgeted operating results due to the effects of rampant attrition. About
this same time, First USA received a revised mid year plan from Banc One, spelling out what Banc
One needed from First USA for the remainder of the year, the primary "task" being to make the
previously budgeted results, while maintaining First USA's historically low level of charged off
accounts . The management team at First USA recognized that these objectives were going to be a
real stretch ("not real comfortable with this" -- " numbers appear aggressive")
110. Concluding that further pricing changes were going to have to be made to achieve
these goals, but also aware that repricing customer accounts was driving up First USA's rate of
attrition ("of 127 accounts polled, 60 (or 47%) were closed due to having `received penalty pricing
in November 1997 "'), George Hubley (First USA's CFO) advised the Finance Department that the
"key to success" for this forecast revision was going to be the accurate "modeling of [the] rules based
reprice attrition." Thus, on July 13, 1998, less than three months before the Merger would close,
First USA's Finance Department presented the first of a series of new volume forecasts to First
USA's management , which explained and expounded on the attrition problem at First USA, as
follows:
[S]ince November 1997 we have delivered 20 million on-time-promises [a notice in cardholder statements promising to process customer payments on time] and 39 million other change-in-terms notifications. While notifications show little or no
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impact on account attrition, the attrition impact ofAPR reprices [on First USA's credit card accounts] since July of1997 will be $I. 7 billion in calendar year 1998.
The higher attrition on the November Retro population has lead to short falls in the Finance Charge Forecast.
While hit rates are in line with original forecast, the effects of [eliminating grace periods] are yet to be seen. (Emphasis added).
111. Alerted by this news, First USA's senior management met with Richard Lehmann
(Vice Chairman and COO of Banc One) on July 15, 1998 -- only two weeks before Lehmann signed the Registration Statement -- to explain that First USA' s financial forecasts up to that point had been significantly overstated ("Mike Finn never had attrition in at all and added [it in] July for the first time"). First USA also reported that, for the second quarter of 1998, there had been a "[s]ignificant reduction to [the] late fee forecast due to some softening on due date late fees and higher refunds."
112. On July 17, 1998, two days after the meeting with Lehmann, Richard Vague (CEO of First USA) met with John McCoy (CEO of Banc One) -- who also signed the Registration
Statement -- to explain further, that, while the "current forecast corrects for optimistic revolve rate assumptions in [the] prior forecast," there was still an "additional risk" to First USA's earnings for the last half of 1998 of $30 or more million, "if [the] revolve rate continued to decline at the near current slope...."
113. Rather than disclosing that First USA's earnings were going to be less than had been expected for the last half of 1998, and potentially jeopardizing the Merger, Banc One released its second quarter results on July 21, 1998, publicly conveying a rosy picture: "Banc One Announces
Strong Second Quarter Earnings ." As for the prospects at First USA, Banc One touted First USA's
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opening of "2 million" new accounts and expressed, contrary to every internal report and assessment, that there was going to be "acceleration " in First USA' s earnings for the second half of 1998 due to higher credit card earnings.
4. The Instruction From Banc One To "Earn More" To Complete The Merger Regardless Of The Cost
114. Following the close of the second quarter, management of First USA and Banc One immediately turned their attention to the third quarter of 1998, which did not look any better. If the
Merger was not approved and/or finalized before Banc One had to report its third quarter results, then it was almost a certainty that the financial impacts of the problems plaguing First USA were going to be revealed . Additionally, in June 1997, the Financial Accounting Standards Board
("FASB") announced the adoption of SFAS 131, which required companies to begin separately detailing and discussing the operating results for each oftheir lines of business for periods beginning after December 15, 1997, which Banc One liberally interpreted, as follows:
The segment and other information disclosures [of SFAS 131] are required for the year ended December 31, 1998 with earlier adoption encouraged. Interim period disclosures in the initial year of adoption are not required .... This Statement will be initially adopted in the BANC ONE December 31, 1998 Annual Report. During the interim periods in 1998 BANC ONE willprovide limited segment disclosures in the Management's Discussion and Analysis section of the financial statements filed with the SEC. This approach provides additional flexibility during 1998 in finalizing key management decisions .... (Emphasis added).
Without the consolidated financial statements ofBanc One to hide behind, the problems at First USA might well be revealed.
115. Thus, by July 23, 1998, First USA's management already had approved a further 200 basis point increase of First USA' s ruled based penalty rates (from 22.99 % to 24. 99%), as well as several additional smaller changes to the portfolio, for an estimated pretax profit benefit of $32.8
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million for the last half of 1998 ("[t]he increase in revenue forecasted for the third and fourth quarters is attributed to heavy new account acquisition and substantial penalty price trips/fee repricing activities").
116. Given that further APR changes were only going to exacerbate First USA's already high attrition rate, First USA's management asked for an updated volumes forecast to try to gauge when, and how many, additional accounts were going to be lost:
looks like we are probably going to do this reprice! Need to assess volumes impact for 1998/1999.
117. The updated Repricing Analysis prepared for First USA's management on July 24,
1998, reported that, based on First USA's then current rate of attrition, the estimated loss of account balances would be at least an additional $205 million for the remaining few months of 1998, with a whopping $902 million additional loss of balances in 1999 -- and these attrition estimates were for that one single reprice, the sixth significant reprice in a year. In spite of the cost, this further "global" repricing was approved on July 24, 1998, because First USA "still need[ed] "$10-20MM more" for
the third quarter and, by this point, only one week before the Registration Statement and Prospectus
was scheduled to be filed and sent out to shareholders, management no longer cared about anything
but buying enough time to ensure that the Merger would be approved (it's the " wrong time not to
be making our numbers "). (Emphasis added).
118. Even with these further pricing changes in the works, however, by the middle of the
third quarter, First USA was still forecasting a significant $192 million earnings shortage for the
year. Perhaps recognizing that they were in over their heads ("[h]ow much is our `screw up"'), or
possibly because many ofthe accounting tactics that First USA had customarily used to help manage
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its results were now under attack (e.g., First USA's capitalization of marketing expenses, discussed below), Richard Vague (First USA's CEO) met with John McCoy (Banc One's CEO) on August 21,
1998, to discuss what were going to be First USA's dismal third quarter results.
119. Rather than publicly disclosing that First USA's earnings were going to be significantly short only weeks before shareholders were going to vote on the Merger, McCoy instructed Vague that First USA needed to do whatever was necessary to get as close to its earnings target as possible: "McCoy said `earn more 3Q and `try' to have halfstick.'' (Emphasis added).
120. By the following week, about August 28, 1998, the situation at First USA had gotten even worse, with the earnings shortfall now estimated to be $222 million for the year. To compound the problem, First USA was now issuing so many customer refunds that First USA's Finance
Department was reporting a "49% decrease" in the overall effectiveness of First USA's repricing initiatives. By this point, however, First USA's management was almost completely out of options to further enhance the bottom line. Although more repricing opportunities were again being examined, the internal view was that few, if any, could provide any sort of meaningful benefit in
1998, given that there were only a few weeks left in the year.
121. Management also considered the possibility of capitalizing some ofthe expenses from
the Banc One credit card portfolio, but George Hubley (First USA's CFO) recommended against
doing this, because (as discussed below) First USA' s expense deferral practices already were being
scrutinized . The only revenue "opportunity" First USA's management appear to have come up with
at all was to accelerate the sale from the fourth quarter of some of First USA' s insolvent accounts,
and even this was controversial : "[Kevin] Murph[y] stated he does not want to do", but " Dick's fine
[with the sale] ... commented just have losses continue to get better this week." Indeed , by this
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point, all the management team at First USA could do was stand by and watch the company bleed, and try to conserve expenses as much as possible:
re our expenses for the quarter (and the impact of some of these accounting items on our ability to make the target set by John McCoy) ... from Dick [Vague], our rule needs to be to (a) use the accounting treatment which favors us (unless it's cleared by him) and (b) do not close the books unless we've hit our expense target.
5. First USA's Reaction to Slowing Growth: The "Portfolio Acq uisition Blitz"
122. Having already lost billions of dollars of account balances due to attrition, by June
1998, First USA's management also was literally asking how it was going to meet First USA's budgeted 20% growth objective: "[h]ow are we going to grow from $38.8 billion to $46 billion from
June to December." To help achieve the achieve the goal established by Bane One, First USA began what was later termed a "portfolio acquisition blitz," during which Banc One paid significant undisclosed premiums (of 7 to 10 percent) to acquire new portfolios of credit card accounts. While this largely was new, uncharted territory for Banc One, which had previously relied on First USA's marketing skill and aggressive direct mailing campaigns to grow, Bane One did not disclose that these pre-Merger acquisitions were being made to help make up for First USA's slowing growth.
123. In June 1998 , First USA acquired First Commerce and took over its $1 billion credit card portfolio . In September 1998, First USA shocked banking industry analysts by acquiring the
$4.9 billion Chevy Chase credit card portfolio. Given the lackluster performance that Chevy Chase had achieved with the portfolio, analysts were questioning whether the acquisition was being made to cover "slowing growth," which Bane One denied. Then, GE announced that First USA had agreed to "trade" a stake in First USA's lucrative $1.6 billion private label (store charge account) business, in exchange for approximately $2.3 billion worth of GE's credit card accounts. As the American
44 Case 1 :00-cv-00767 Document 180 Filed 10/17/22 Page 50 of 117
Banker later reported in December 1998, following GE's announcement of the deal, the acquisition of a stake in First USA' s private label business was a good strategic move for GE as 1998 was "a watershed year" in the private label industry; yet it questioned why Bane One would have made such a deal in the first place: "[i]f there were all of these synergies and leverage opportunities, why would
Bank One want to shed its private-label business ...." Internal First USA documents from June
1998 reveal that First USA 's motivation for selling the private label business had been to record a
"$95 million gross gain " and that First USA needed to complete the sale quickly because the accounts in its private label portfolio were starting to be impacted by the problems at First USA as well (' [s]peed is very important as portfolio shows some signs of deterioration"). (Emphasis added).
124. Similar to First USA' s other short sighted practices before the Merger, these acquisitions ultimately proved very costly for Bank One. Besides adding to (and potentially placing
at risk) the already extensive and chaotic Merger, payment processing and "Y2K" integration efforts
underway at First USA, Bank One ultimately concluded that many of the accounts that First USA
had purchased in 1998 in order to bolster its credit card portfolio were not worth what First USA had
paid. In 1999 and early 2000 Bank One wrote off more than 7 million of these accounts
(approximately 17.5% of the accounts that First USA had had at the time of the Merger), at a cost
of more than $291 million.
6. First USA's Aggressive Pursuit Of New Affinity Relationships To Bring In New Accounts
125. In addition to acquiring new portfolios, First USA began relying increasingly on
affinity programs in the period leading up to the Merger to bring in new accounts . As First USA's
management explained to John McCoy (CEO of Bane One) and Richard Lehmann (President and
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COO ofBane One) on February 24,1998, increased emphasis on affinity relationships was necessary because response rates on First USA's new account offerings had been declining for the last "18 months" in a row, and because the preliminary results of First USA's November 1997 repricing, which had been made partially to counteract the trend in response rates, were coming in substantially lower than had been anticipated. As a result, First USA informed Banc One that it was going to rely even more heavily on acquiring affinity accounts with a plan to "add over three million new partner accounts, representing 40-45% of all new accounts" for 1998. Not only was this a substantial change in First USA's marketing direction, but the costs and risks associated with generating new accounts through affinity relationships, as discussed more fully below, were far different than those associated with First USA's past practice of generating accounts primarily through direct mail.
126. While Banc One publicized that First USA was entering into affinity relationships with high profile groups, Bane One did not disclose in its Form 10-K's or 10-Q's, or elsewhere, that
First USA was paying and capitalizing up-front payments of millions of dollars to enter into these
affinity arrangements, and guaranteeing to pay millions of dollars more over the lives of these
agreements, just for the "right" to market to these affinity groups' members. Between October 1997
and October 1998 (when industry demand for new affinity deals was at an all time high), First USA
entered into at least 31 separate affinity relationships which obligated First USA to make minimum
guaranteed payments of more than $173 million to various affinity partner groups over the next few
years.
127. What also was not disclosed was that First USA's affinity programs were entirely
dependent upon First USA's ability to spend money to generate new accounts. While this had never
been much of an issue in light of First USA's historically "unlimited" marketing budget, the
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marketing resources made available to First USA following the Merger were going to be substantially less than they had been under Banc One's control, because management of the new
Bank One, as detailed below, decided that, as of the date of the Merger, First USA was no longer going to be allowed to capitalize marketing expenses. Thus, to even meet historical levels of earnings, let alone exceed such results by 20%, First USA was going to have to spend several hundred million dollars a year less, rendering the affinity relationships that First USA paid at least
$173 million for in 1997 and 1998, all but worthless. Indeed, when First USA finally ran out of
money in early 1999, one large affinity partner even threatened to sue First USA for "failing to
market" to the program's members, alleging that the loss to the organization was between $37.5
million (the minimum amount that First USA had guaranteed to pay) and $300 million (the
anticipated revenue sharing amount that the organization expected it would have earned if First USA
had actually sent out the solicitations it had contracted for).
128. To further compound matters, by March 1999, only a few months after the Merger,
but still well before the first of Bank One's earnings revisions and charges would be made, Bank
One's internal auditors issued a "needs improvement" rating on the accounting controls for First
USA's affinity programs. Also, Arthur Andersen, which had identified First USA's affinity
programs as a "risk item" due to the growth and size of the asset balance, found that the method that
First USA had been using value its affinity contracts was not in compliance with GAAP. While
Arthur Andersen did not believe that the amount of the misstatement was quantitatively material,
Arthur Andersen recommended that Bank One begin maintaining a "quarterly watch list" of affinity
relationships close to impairment.
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129. Following Bank One' s earnings revision in late 1999, Bank One concluded that the value of First USA's affinity programs were substantially overstated and wrote off more than $181 million worth of First USA's "affinity marketing programs."
D. Bane One' s Inadequate Disclosure Of Accounting Practices At First USA That Materially Affected Banc One's Reported Results
130. In the period leading up to the Merger, as set forth above, First USA was spending tens of millions of dollars (and more) each month to purchase and/or generate new accounts to perpetuate the impression that it was still capable of achieving significant growth. To avoid having to report these enormous expenses in the period in which they were incurred, particularly now that much of First USA's earnings were due to late fees and penalties that would not be earned until sometime in the future, First USA stepped up use of several undisclosed accounting techniques through which First USA had been inappropriately capitalizing and deferring the bulk of its marketing and new account acquisition expenses since the time of the July 1997 merger with Banc
One. Additionally, First USA's change to rules based pricing had substantially altered the profit structure and revenue dynamics of First USA' s portfolio. To counteract the effect of these changes and to forestall the inevitable extension of First USA's earnings that followed, First USA began accelerating recognition of future revenues into current periods, accomplished primarily through complex securitization gain calculations.
131. First USA' s use of these accounting techniques to accelerate recognition of its revenues and to defer more and more expenses in the period leading up to the Merger, particularly when considered in the aggregate, materially diminished investors' ability of to understand First
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USA's operating results and rendered Banc One ' s financial statements for 1997 and the first and second quarters of 1998 false and materially misleading.
1. Banc One's Failure To Adequately Disclose That First USA Was Continuing To Cap italize And Defer Marketin g Expenses Up To The Date Of The Merger
132. As noted supra, in April 1997, in connection with its merger with First USA, Banc
One had publicly announced that First USA was going to end its prior practice of capitalizing and deferring marketing expenses because the practice did not comply with GAAP. However, less than one month after the Banc One/First USA merger was completed, First USA signed an agreement with Global Sourcing Services, LLC ("GSS") to form a company known as First Credit Card
Services USA, LLC (collectively, the "LLC"), which, at least in theory, would "allow" First USA
to again begin capitalizing and deferring expenses.
133. According to internal First USA documents, GSS was aj oint venture created by Banc
One's credit card processor, First Data Resources ("FDR"), and a company owned by the Mitchell
Madison Group (the consultant First USA hired to help develop the LLC concept), called
International Sourcing Services , Inc. ("ISS"). Since the ability to capitalize and defer marketing
expenses would provide GSS's customers with such a significant financial reporting advantage over
other credit card issuers who had to report their marketing expenses as incurred, First USA was
careful to make sure that the joint venture agreement between FDR and ISI contained clauses
preventing GSS from entering into similar arrangements with First USA's two principal competitors
-- Citibank and MBNA.
134. On October 31, 1997, FDR issued a press release announcing the formation of the
LLC:
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GSS is an umbrella company with independent subsidiaries that will provide a variety of marketing services, including execution of marketing campaigns and development of new accounts for individual bank clients.
First USA is the first client to take advantage of this new outsourcing from GSS. It will provide new account development services for First USA, including developing new accounts and providing production and processing activities prior to transferring new accounts to First USA.
As part of this agreement, a group of employees in First USA's Marketing and Credit Operations departments will join FCCSUSA on January 1, 1998 . FCCSUSA will be based in Wilmington, Delaware, with an office in Columbus, Ohio. (Emphasis added).
135, While the LLC admittedly would not be operational until at least some time in 1998,
First USA began deferring expenses through the relationship with the LLC, effective as of July 28,
1997. As Banc One's Form 10-K for 1997 (incorporated into the Registration Statement and
Prospectus) discussed:
BANC ONE contracted with an independent third party beginning in 1997 to originate a portion of its credit card portfolio. As a result of this agreement, and reflecting the benefit of increased specialization and economies of scale, both an increase in the number of accounts originated and a decrease in the origination costs is anticipated, with desired credit quality standards being retained. At December 31, 1997, $218 million in credit card relationships purchased from this third party were included in other assets. (Emphasis added).
136. What was not disclosed , and the reason such a statement was misleading , was that in reality, the LLC was just a vehicle for capitalizing and deferring marketing expenses . The LLC lacked "independent" business operations , and the LLC' s supposed "increased specialization" and
"economies of scale" were little more than First USA employees, using First USA systems and facilities , to direct and perform First USA' s marketing and account acquisition programs, just as they had always done in the past -- albeit without current recognition of all of the associated expense.
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First USA accomplished this sleight ofhand by executing two separate, undisclosed side agreements with the LLC (a "Transition Services Agreement " and a " Software Licensing Agreement"), which provided , in essence, that the LLC was hiring First USA to do all of the things that First USA had just hired the LLC to do. Through use of this legal fiction, First USA was able to conveniently extend its past practice of capitalizing and deferring expenses for the foreseeable future. As discussed more fully below, Banc One and Bank One ultimately went to some lengths to make sure that First USA's expense deferral practices were never publicly revealed.
2. Banc One's Failure To Adequately Disclose That First USA Was Cap italizin g And Deferring Exp enses Associated With Its Affini Programs
137. In addition to capitalizing and deferring marketing expenses , First USA also was capitalizing and deferring millions of dollars that First USA had been paying to enter into affinity relationships. As discussed supra, in 1998 alone, First USA entered into at least 31 separate affinity contracts with associated minimum payment guarantees of more than $173 million, and by the end of the third quarter of 1998, the "deferred asset" related to First USA's affinity programs exceeded
$400 million, rendering glowing, one-sided disclosures such as the following from Bank One's 1997
Form 10-K, materially misleading:
The generation of new credit card business in 1997 remained very strong, reflecting a decision in the second quarter to step up marketing and business development activities. First USA continued to refine and strengthen its strategic emphasis on segmentation. In the partnership area, a number of premier names were signed including New York Life, Countrywide Home Loans, PGA Tour, American Medical Association, and the Los Angeles Dodgers. This activity contributed to a record 8.1 million new credit card accounts opened during the year, exceeding the previous record of 6.2 million accounts set last year. At the end of 1997, cardmembers totaled 40.5 million, up 11.6% from the end of 1996.
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I 5
138. What made the capitalization of affinity program expenses so misleading was that most of the "value" of a given affinity relationship was in the initial solicitation and mailing, which
First USA generally made within weeks of having entered into the deals. Capitalizing and deferring the enormous up-front expenses and guarantees associated with these programs over the lives ofthe multi-year contracts , seriously mismatched First USA 's revenues and expenses and created the false and materially misleading impression that affinity relationships were a low cost means of generating new accounts.
139. Also unbeknownst to investors was the fact that First USA had previously entered into an exclusive affinity relationship development deal with a company known as Affinity Partners,
Inc. ("API"). First USA entered into this arrangement in January 1995, when the affinity marketing concept was just developing, and affinity programs were not yet a prominent part of First USA's (or other issuers') business plans. Essentially, the agreement provided that API, with a significant advance from First USA, would solicit different organizations and prepare affinity contracts for execution by First USA; First USA, in turn, would send solicitations to the different groups' members in the hope of being able to open new accounts, after which both API and the affinity group would share in some of the additional revenues.
140. Banc One was concerned about the arrangement with API at the time of its July 1997 merger with First USA, as the contract contained a long-term commitment, but no buy out provision.
This meant that, even though First USA was starting to rely increasingly on affinity relationships to generate new accounts (see discussion supra), it was going to cost First USA more in the long run to pursue such marketing strategy than it was going to cost First USA's competitors. By late 1997,
First USA had grown to dislike the expensive , one-sided arrangement with API, but was unable to
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get out of the deal; accordingly, First USA and Banc One threw huge undisclosed sums of money at the problem in exchange for slightly more preferential treatment from API:
First USA purchased API in 1997. This organization consists primarily of two principal consultants who are heavily involved with finding affinity groups and negotiating contracts under direction of FUSA management. They employ a large staff of sales people who `recruit' affinity groups for First USA. A purchase price of $102,000,000 was paid to purchase the company (primarily people). The renegotiated contract with API also provides for guaranteed minimum earnout of $37,500,000 generated by 25,000,000 new credit card accounts to be generated through 2011 (calculated as $1.5/account) for which API is entitled to payment.
API earns $1.5 on all new First USA partnership accounts regardless of who obtains the new account. This includes co-brand, affinity, purchased portfolios (i.e. Chevy and GE), and $35 on internet brand accounts where API has had material involvement.
141. That First USA was incurring and capitalizing expenses associated with its affinity
programs, and that its cost structure with respect to such programs was substantially altered, higher
and different than other issuers due to the presence of First USA 's undisclosed arrangement with
API, was not meaningfully disclosed in the Registration Statement or Prospectus.
3. Banc One's Failure to Adequately Disclose First USA's Securitization and Gain On Sale Accounting Practices
142. In addition to capitalizing and deferring all kinds of expenses, in late 1997 and
throughout 1998, First USA increasingly began relying on securitization gains to help make up for
dwindling operating results. First USA' s general practice of securitizing credit card accounts is
described in Bank One's 2001 Annual Report as follows:
In a credit card securitization, a designated pool of credit card receivables is removed from the balance sheet and transferred to a third-party special purpose entity (" SPE' or "Trust"), that in turn sells securities to investors entitling them to receive specified cash flows during the life of the security. The proceeds from the issuance are then distributed by the SPE to the Corporation as consideration for the loans transferred.
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Following a securitization, the Corporation receives: fees for servicing the receivables and any excess finance charges, yield-related fees, and interchange revenue on the receivables over and above the interest paid to investors, net credit losses and servicing fees (the "excess spread").
The Corporation's continuing involvement in the securitized assets includes the process of managing and servicing the transferred receivables, as well as maintaining an undivided, pro rata interest in all credit card receivables that have been securitized, referred to as the seller's interest, which is generally equal to the pool of assets included in the securitization less the investors' portion of those assets. The Corporation's seller's interest ranks pari-passu with the investors' interests in the Trusts. As the amount of the loans in the securitized pool fluctuates due to customer payments, purchases, cash advances, and credit losses, the carrying amount of the seller's interest will vary. However, the seller's interest is required to be maintained at a minimum level to ensure receivables are available for allocation to the investors' interest. This minimum level is generally between 4% and 7% ofthe SPE's principal receivables.
Investors in the beneficial interest of the securitized loans have no recourse against the Corporation if cash flows generated from the securitizations are inadequate to service the obligations of the SPE. To help ensure that adequate funds are available in the event of a shortfall, the Corporation is required to deposit funds into cash spread accounts if excess spread falls below certain minimum levels. Spread accounts are funded from excess spread that would normally be returned to the Corporation. In addition various forms of credit enhancements are provided to protect investor interests from loss.
143. While there was nothing improper with securitizing accounts per se, First USA was securitizing billions of dollars worth of accounts in the period leading up to the Merger for the undisclosed purpose of accelerating revenues and reporting overestimated gains. Banc One's first quarter 1998 Form 10-Q, issued in May 1998, reported that "credit card non-interest income" had increased due to securitization of "high-yield credit card loans." Bane One reported similarly in its second quarter Form 10-Q that:
Credit card servicing income increased $83.3 million, or 23.2%, and $293.6 million, or 44.8% for the quarter and year-to-date periods ended June 30, 1998, respectively, compared with the same 1997 periods. This was primarily due to an increase in the level of securitized loans [and] credit card servicing income, as well as an increase
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in the yield on these securitized loans. As a result, the net interest and fee income related to these securitized loans increased $172.6 million and $429.3 million for the first three and six months ended June 30, 1998, respectively, compared with [the] same 1997 periods.
144. What was not disclosed was that First USA' s securitizations were no longer just an optional, occasional source of financing, but rather, were now a critical part of First USA's overall business strategy which carried with it several substantial undisclosed risks. First USA needed to do these securitizations and book the associated gains because, by changing its pricing strategy, First
USA had altered the profit structure and revenue recognition dynamics of its portfolio. First USA's increased reliance on low teaser rates meant that First USA was now increasingly having to wait for accounts to "flip" to higher "go to" rates before First USA earned any real incremental profit from new accounts. Similarly, the change of its portfolio to rules based pricing meant that First USA's
income had become largely dependent on fees and penalties which, if earned at all, were not going
to be realized until some time into the future. Together, these changes to First USA's revenue stream
substantially extended the time that it took for First USA to earn income from its credit card
accounts.
145. By securitizing credit card accounts, First USA could effectively " accelerate"
recognition of these unearned future fees and penalties back into current periods, boosting Banc
One's current results and offsetting some of the up front revenue loss associated with First USA's
use of teaser rates. First USA accomplished this by computing the present value of the expected
stream of future cash flows that First USA believed would be earned on the securitized accounts
(under numerous, dubious assumptions detailed below), and then securitizing these accounts at the
overestimated present value to recognize a gain ("FUSA has a very aggressive gain model for its
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credit card securitizations, as the gain is based on a total average yield, including all fees [including] arguably fees on future receivables"). Additionally, by securitizing (i.e., selling) credit card accounts , First USA could write off the associated loan loss reserves on its books for a modest additional benefit to current results (second quarter of 1998 is "currently $16 million short" but we
"still have $16mm LLR [loan loss reserve] issue")
146. What was particularly egregious about First USA's securitization accounting practices was that the gains and related asset carrying values that First USA was calculating and booking in the period leading up to the Merger were substantially overestimated. First USA's valuation model
(the so-called "True Blue" model) had been developed in the mid 1990's when the credit card market and First USA's business were still growing and, accordingly, the model did not adjust for numerous key factors, including, inter alia, First USA's increased attrition rate, the quicker overall repayment
rate on First USA's repriced accounts ( i. e., shorter duration) and reduced portfolio yields. Moreover,
one of the key assumptions of the model was that First USA actually was going to earn all of the late
fees and penalties that First USA was forecasting, when, in reality, approximately 14-16% of the late
fees and penalties First USA was collecting were being returned and refunded to customers on
account of the processing errors at NPC. These unrealistic and unsupportable assumptions, along
with several other highly questionable, subjective variables (e.g., use of an unrealistically low 8%
discount rate, use of an overly aggressive 150 basis point servicing fee, etc.), substantially overstated
the gains and associated seller's interest asset carrying values that First USA and Banc One booked.
147. While First USA considered updating the mechanics and core assumptions of the
True Blue model in July 1998 in connection with an effort to try to make First USA's financial
forecasts more useful and reliable, these changes were postponed until after the Merger to conserve
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expenses ("controls cost money!!!"). When Bank One's internal auditor's took up the cause again in late 1999 after the problems at First USA were revealed , Bank One wrote down hundreds of millions of dollars worth of First USA's securitization-related accounts , including a loss on First
USA's "interest only (I/O) strip" of more than $402 million..
E. The Flurry Of Merger Activity
1. The Retention Of A New Auditor
148. In mid May 1998, the senior accounting officers of Bane One and First Chicago were considering whether to retain Price Waterhouse Coopers (Bane One' s auditors) or Arthur Andersen
(First Chicago's auditors) as the continuing auditors for the combined Bank One after the Merger.
In meetings with Arthur Andersen' s engagement partner at the time , members of Bane One's
External Auditor Selection Committee expressed two primary concerns with regard to First USA, including (a) whether First USA's accounting practices were "legitimate," and (b) whether First
USA's accounting practices should be conformed to what the competition was doing to allow industry comparisons to be made. In addition, Robert O'Neill (Chief Auditor at Banc One) cautioned Arthur Andersen that there had been a " myopic focus" on short term results recently, largely due to the influence of John McCoy (Banc One 's CEO).
149. Arthur Andersen was selected to be the auditor for Bank One after the Merger and was formally retained in or about July 1998. Nevertheless , Arthur Andersen had little direct involvement with Bane One and/or First USA in the period leading up to the Merger, because (a)
Andersen still had continuing auditing obligations for First Chicago, and (b) the Registration
Statement, which already had been prepared by the time of Andersen's retention, included, for Bane
One at least, only the Price Waterhouse Cooper's audited 1997 financial statements, and Bane One's
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unaudited first and second quarter 1998 financial statements that had been prepared by management.
In effect, First Chicago was accepting Banc One's unaudited results at face value, for the critical period in 1998 leading up to the Merger -- the same time when the bulk of the problems and issues at First USA were coming to a head.
150. While the undisclosed problems and issues at First USA had already substantially eroded First USA's operating results by the end of the second quarter of 1998 (as detailed supra),
Banc One was able to substantially offset First USA' s extraordinary losses by year end through aggressive earnings management (also detailed supra) and through several "fortuitous" events, including the impact of several hundred million dollars worth of undisclosed changes in accounting policies (discussed infra). Indeed, while Banc One's combined credit card business purportedly wound up only $17 million short of target for 1998, the so-called "punchline", according to an internal First USA earnings reconciliation (prepared to support First USA's recommendation that full management bonuses should be approved for 1998), was that First USA had "used securitizations and [loan loss reserves]" - as well as a "$145 million change" in Chevy Chase's and
First Chicago's bankruptcy notification charge-off accounting policies -- "to get there."
2. The Efforts To Conform First USA's And First Card' s Divergent Accounting Policies
a. The Internal Debate Over How To End First USA' s Expense Capitalization Practices
151. In or about June 1998, almost a year after the LLC purportedly was formed -- and after hundreds of millions of dollars in marketing expenses had been capitalized and deferred through the LLC -- Banc One's internal audit staff reviewed the LLC. The internal auditors discovered that, contrary to management's previous representations, there were a variety of
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"independence -related" issues with the LLC which had never been addressed . They included: (a) the LLC's lack of expertise and personnel to perform its various marketing functions; (b) that "Event
Marketing/Take-One and Alternative Media programs have not been transitioned [from First USA to the LLC] even though the expenses are being recorded by the LLC"; (c) that many of First USA's marketing -related vendor contracts had not been reassigned to, or assumed by, the LLC; (d) that First
USA received many vendor invoices (some over $ 50 million in amount), even though the services were supposedly provided to the LLC; (e) that the LLC' s "purchase orders are originated by First
USA and sent to GSS"; (f) that First USA's Marketing Department controlled campaign planning and monitoring, and prepared most of the marketing and mail production schedules; (g) that First
USA developed the LLC 's yearly budget and its pricing and volume forecasts ; (h) that the LLC continued to rely on, and enjoy free access to , First USA' s confidential general ledger and accounts payable systems ; (i) that the LLC continued to rely on, use and access First USA' s proprietary
"Magnum" account underwriting system; and {j) that all requests for computer services, reports or computer programming were issued and performed by First USA' s staff. Banc One's internal auditors also noted that the LLC "shared information (i.e. solicitation costs) with First USA that was not appropriate nor in compliance with SFAS 91." In short, the auditors were concerned that the
LLC concept was being abused.
152. By the end of June 1998 , First USA 's use of the LLC also was under attack from
Robert Rosholt, the CFO at First Chicago at the time , who was slated to become the CFO for Bank
One after the Merger:
Bob Rosholt, CFO, would like to discontinue the use of the LLC to do marketing for the credit card business . Therefore , following the merger, all marketing expenses will be expensed directly as incurred.
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153. Banc One's internal view was that First USA should stop capitalizing and deferring expenses as of the date of the Merger, but that the nearly $500 million in already capitalized expenses should continue to be amortized over the last quarter of 1998 and first three quarters of
1999. Arthur Andersen's uncharacteristically objective view ofthe situation in June 1998, while still acting as the auditor for First Chicago, was that Banc One was "skirting on [the] issue of accounting error." Although Arthur Andersen ultimately agreed to go along with the approach posed by Banc
One, on the condition that the issue was adequately disclosed, Arthur Andersen nonetheless urged at the time (in June 1998) that First USA's capitalization practice should be ended immediately.
154. After analyzing the potential financial impacts of Arthur Andersen' s suggestion, management of Banc One (Richard Lehmann, President and COO, and William Leiter,
SVP/Controller) and First USA (Richard Vague, CEO) met on July 29,1998 to consider what should be done. Everyone agreed that Arthur Andersen's approach was "probably too expensive to consider," particularly since: (a) if First USA just stopped using the LLC, it would have a "$672 million earnings impact" in 1998 and 1999 (a so-called "negative run rate impact"); (b) the abrupt
change might result in an "earnings target adjustment" by industry analysts, which would have been
disastrous given the very public stage of the Merger; and (c) there was some possibility that the
change might require Banc One's prior period financial statements to be restated (just as First USA's
financial statements had been restated at the time of the First USA/Banc One merger a year before).
155. Thus, instead of discontinuing First USA' s use of the LLC at the end of the second
quarter of 1998, as Arthur Andersen had recommended, Banc One waited until October 2, 1998, the
date of the Merger and just after the end of the third quarter of 1998 (ending September 30, 1998),
to formally end First USA's capitalization of expenses. The additional delay alone allowed more
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than $318 million of additional marketing expenses to be deferred in the two or three months before the Merger, as First USA continued to attempt to make up for its earnings shortfalls.
156. To try to prevent the LLC issue from becoming a lightning rod for the new, post-
Merger Bank One, Bank One's management decided to "skirt the issue of accounting error" for a while longer and to go ahead and amortize (defer) the approximately $486 million in already capitalized expenses at the time of the Merger over the following year, rather than taking the highly
visible step of immediately expensing such costs so close to the Merger. Bank One also materially
"modified" (rather than extinguishing) First USA's contract with the LLC on the very day that the
Merger took place, October 2, 1998, so that the adverse impact of discontinuing the LLC could be
booked as a "merger related expense." That Bank One could unilaterally make such sweeping
changes to First USA's contract with the LLC at all -- let alone for little, or no, additional
consideration -- provides further proof that the LLC was not independent in the first place.
157. While these were obviously extremely material matters that went to the heart of First
USA's marketing-based business, there was no discussion of this change in accounting policy in the
Registration Statement or Prospectus, nor any explanation of how this change likely was going to
affect First USA's and Bank One's businesses and financial statements following the Merger. Only
months later, in Bank One's 1998 Form 10-K, did Defendants make any disclosures about these
issues at all, and even then the disclosures were far from specific:
Merger related costs of $348 million included $294 million related to the accounting consequences of changes in business practices. Of this total, $260 million resulted from the modification, in light of the Merger, of a contractual relationship to purchase credit card accounts. Previously capitalized costs under this account sourcing agreement will be amortized over a one-year period. On a going forward basis, such costs will be expensed as incurred.
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158. Moreover, even this limited disclosure was misleading, since it did not reveal : (a) that in addition to the $260 million taken in 1998, at least three more quarterly write offs were going to be made in 1999 before the nearly $486 million in expenses that were capitalized at the time of the
Merger were completely amortized (including $116 million in the first quarter of 1999; $76 million in the second quarter of 1999 and $34 million in the third quarter of 1999); and (b) that the so-called
"previously capitalized costs" were actually nothing more than First USA's pre-Merger marketing and account acquisition expenses. Indeed, the single largest item booked against the $1.25 billion
Banc One/First Chicago Merger reserve was the $ 486 million amortization of First USA's deferred marketing expenses, and since this substantial cost was not included when the initial Merger reserve was calculated, the Merger now was going to cost substantially more than had been estimated in the
Registration Statement and Prospectus.
159. All of this was material information that should have been disclosed to investors in
connection with the Merger. Had investors been informed that First USA had been capitalizing
expenses since mid 1997 and throughout 1998, and that these practices were being discontinued as
of the date of the Merger, investors would have been able to see the obvious fact that, following the
Merger, First USA was going to have to either start recognizing hundreds of millions of dollars of
marketing expenses each month as First USA continued to try to grow its portfolio (at a substantial
cost to Bank One's future results), or spend less, conserving expenses, but foregoing any real
prospect for future growth. This Hobson's choice, coupled with the rampant loss of accounts and
account balances due to the attrition problem at First USA, meant that it was only a matter of time
before things at First USA were going to get worse.
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b. The Undisclosed Accounting Implications Of Not Changing First USA's Bankruptcy Notification Charge-Off PolicyAt the Time of the Merger
160. In May 1998, to help boost First USA's second quarter results, First USA changed the bankruptcy notification charge-off accounting policy in its private label (store charge) credit card division to extend the date at which consumer credit card loans were charged off following notification of a bankruptcy. While the private label division had previously charged off bankrupt accounts at "notification"'(i.e., upon receipt of a notice that the customer had filed for bankruptcy protection), First USA extended the private label division's charge-off period out to "90" days after
notice to recognize an undisclosed accounting gain of $10 million in the second quarter of 1998. By
the time of the Merger, however, First USA (and the private label division) had built up and avoided
writing off so many bankrupt accounts that, instead of changing First USA's policy back to the more
reasonable "notification" policy used by First Card and Chevy Chase, First USA' s management
lobbied Bane One to have First Card's and Chevy Chase's policies conformed to First USA's. The
difference between these two approaches was substantial: if First Card's and Chevy Chase's policy
was adopted, the combined credit card division would have to record a charge for the change in
accounting principle at the time of the Merger of approximately $230 million . IfFirst USA 's policy
were adopted, however, the credit card division could book an additional $145 million gain, which
would help offset some of First USA's significant anticipated third quarter operating loss.
161. While Banc One opted to book the gain ("used $145 mm of Bk c/o policy change to
get there (Chevy = $45; First Card = $ 100)"), Bane One recognized internally that these short term
benefits were going to cost Bank One down the road. In particular, by the time of the Merger, the
Federal Financial Institutions Examination Council ("FFIEC"), already had announced that, effective
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June 30, 1999, all U.S. financial institutions would have to conform to an industry standard bankruptcy notification charge off policy, which Banc One internally believed would either be at
"notification" or at the outside, 30 or 60 days (since this was what most of the industry was doing).
Either way, Banc One reasoned internally, but did not disclose, that "when [the] regulators mandate
... our charge will be bigger than others." Nonetheless, Bank One decided that it was not going to disclose that it had chosen to book the gains ("would hide [it] if [we] do it"). By not disclosing the change and the gains Bank One had booked, investors were unable see the negative trend that had occurred in First USA's operating results, and were unable to assess the true extent of the FFEIC- related charges that Bank One was going have to take only months after the Merger.
3. The Individual Defendants' Supposed "Due Diligence " Efforts
162. The Merger was conceived at some time in early 1998. As McCoy later reported to
Arthur Andersen, McCoy and Verne Istock (First Chicago's CEO) met for two days and agreed how the new company would be run.
163. Following this initial meeting by the CEOs, it appears that the management of Banc
One and First Chicago met together only twice. The first of these meetings , on April 7th and 8",
1998, was held at the Chicago O'Hare Hilton. Most of the Individual Defendants, however, including John McCoy, Verne Istock and Richard Lehmann, did not attend. Two days after these meetings concluded, Banc One and First Chicago publicly announced the Merger.
164. Defendants' internal guidelines define the term "due diligence" as follows:
the process of verifying the actual existence and condition of assets and liabilities being purchased. This is usually accomplished by an onsite, physical audit of all assets and properties being purchased.
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Yet, despite the magnitude of the Merger, there is no record of any onsite due diligence evaluation of Banc One's or First Chicago 's businesses by the other party as a part of the Merger.
165. On July 2, 1998, approximately four weeks before the Registration Statement and
Prospectus was issued, a further "bringdown" conference call was convened to comply with the
SEC's July 19 , 1998 directive that Banc One and First Chicago needed to:
comply with the updating requirements of Rule 3-12 of Regulation S-X .... "If significant events or transactions have occurred and have not otherwise been reported, disclose the information in a Recent Developments Section of the filing."
166. Notes from the one half-hour conference call reveal that little was actually discussed.
Indeed, they suggest that the discussion centered predominately on the changes that were taking place at First Card, i. e., First Chicago's credit card business, whereas Banc One reported merely that it was (a) "right on target [with street] consensus," and (b) there were "no major surprises."
167. On July 31, 1998 , the Registration Statement and Prospectus were signed, filed with the SEC and distributed to First Chicago shareholders. The Registration Statement and Prospectus were materially false and misleading, inter alia, because they did not contain any disclosures regarding the material events which had occurred and were continuing at Banc One and First USA, as alleged herein.
168. Moreover, even though the management representations made in the Registration
Statement and Prospectus were stale as of October 2, 1998, the Merger appears to have been closed in such haste (third quarter results would soon need to be reported) that no new management assurances or representation letters were exchanged (e.g., letters containing assurances that no event had occurred which, individually or in the aggregate, has had a material adverse effect on Banc One and/or First Chicago). In fact, it appears that the only representation provided at all were several
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comfort letters that were issued to Arthur Andersen on October 6, 1998 , four days after the Merger was completed.
169. In the absence of any record of a real due diligence effort, the Individual Defendants lacked any reasonable basis to substantiate their recommendations and stated beliefs in the
Registration Statement and Prospectus that the Merger was in the best interests of First Chicago shareholders.
F. The Failure To Address The Undisclosed Problems At First USA Leads To Increased RegulatoLry Scrutiny
170. Prior to and at the time ofthe Merger, the pricing, payment processing and customer service problems at First USA were causing First USA to violate § 1637(b)(9) of TILA, as well as
§ 226.10 of Regulation Z and various similar state lending and consumer protection laws.
171. Chapter 2 of TILA regulates revolving charge accounts , credit cards , and other types of open-end credit. TILA mandates specific disclosures , both before the first use of the credit card, and also in each subsequent periodic (monthly) statement sent to the consumer.
172. The credit cards issued by First USA to its cardholders involve " open-end credit," as that term is defined and used in TILA.
173. The Federal Reserve Board' s Regulation Z (promulgated under the Consumer
Protection Act of 1968, as amended) requires payments to be credited on the date ofreceipt . Section
226.10 of Regulation Z states:
(a) General Rule . A creditor shall credit a payment to the consumer's account as of the date of receipt, except when a delay in crediting does not result in a finance or other charge or except as provided in paragraph (b) of this section.
(b) Specific requirements for payments . If a creditor specifies, on or with the periodic statement, requirements for the consumer to follow in making payments, but
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accepts a payment that does not conform to the requirements, the creditor shall credit the payment within 5 days of receipt.
(c) Adjustments of account. If a creditor fails to credit a payment, as required by paragraphs (a) and (b) of this section, in time to avoid the imposition of finance or other charges, the creditor shall adjust the consumer's account during the next billing cycle.
Regulation Z has the full force of law, just as TILA. Violations of Regulation Z give rise to civil liability and fines.
174. The official commentary to TILA, promulgated by the Federal Reserve Board, states that open-end creditors and credit card insurers are "required to credit payment[s] as of the date of receipt." The "date of receipt" is the date that the payment instrument or other means of completing the payment reaches the creditor." TILA Official Staff Commentary §226.10(a).
175. Credit providers (like First USA) also are required to make certain statutory disclosures in all periodic statements sent to consumers. If there is a period of time during which the consumer must pay the balance, or any portion thereof, to avoid finance charges (also known as a grace or "free ride" period), the periodic statement must disclose the date by which, or the time within which, payment must be made to avoid such finance charges. 15 U.S.C. §1637(b)(9).
176. While First USA' s violations of TILA and similar laws had been ongoing for some time -- indeed, the Payment Mad Dog Team' s internal "Scorecards " for NPC from late 1997 and throughout 1998 consistently gave NPC's payment processing performance failing grades (ranging from "D's" to "F's") -- it was not until the OCC gained a supervisory position over First USA, as a result of First USA's change to a national banking charter effective July 1, 1998, that any real effort was made by First USA to comply with the law. By the end of end of 1998, only three months after the Merger, the OCC had discovered and cited First USA for an increasing number of TILA
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violations, including violations of Regulation B (failing to process new account applications within
30 days) and Regulation Z (failing to make timely refunds, failing to properly report customer's payments on credit histories and failing to timely resolve customer disputes).
177. While the OCC appears to have taken some comfort in the fact that First USA was already issuing refunds to customers (mainly those customers whose payments were processed at
NPC's Phoenix, Arizona facility), the OCC believed that First USA needed to do even more, including providing refunds to customers whose payments were processed through NPC 's Louisville,
Dallas and Atlanta facilities, and taking steps to ensure that customer's credit histories were being reported correctly. By January 13, 1999, the OCC "threatened" to initiate a formal enforcement proceeding if First USA did not take steps to immediately restore all of the customer accounts that had been affected by the payment processing problems since January 1998.
178. Rather than the situation improving, however, the effects of the earnings trade-offs that First USA had made in 1998 started to accelerate. In the first half of 1999 alone, the OCC received 2,793 complaints about prior First USA's practices (while the next nine largest credit card banks combined received a total of only 2,536 complaints). Then, in April 1999, Senator Gramm, the Chairman of the U.S. Senate Banking Committee (which had received a number of complaints about First USA on its own), formally requested that the OCC begin an investigation into First
USA's credit card practices. The results of the OCC's investigation, discussed below, ultimately led the issuance a formal "Safety and Soundness Notice of Deficiency" to Bank One in December 1999.
Defendants did not disclose the existence or extent ofFirst USA 's violations of TILA and consumer credit laws at the time of the Merger, or the increased OCC scrutiny that it was facing as a result of those violations.
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G. The New Bank One
179. Unaware of the problems plaguing First USA and Banc One at the time, and misled by the glowing recommendations and disclosures in the Registration Statement and Prospectus, First
Chicago shareholders voted to approve the Merger on September 15, 1998. The Banc One/First
Chicago Merger was finalized on October 2, 1998, pursuant to the predetermined 1.62:1 exchange ratio.
1. Arthur Andersen's Audit Of Bank One's Combined 1998 Results
180. In the last few months of 1998 and into early 1999, Arthur Andersen began gearing
up for its audit of Bank One's combined year end 1998 financial results. One of the first things
Andersen noted, in or about October 1998, was that the management of the new Bank One was
leaning more towards adopting the prior aggressive accounting policies of the old Banc One:
Since GAAP gives little guidance in terms of `how' certain things should be done, Bank One management's leaning is to generally adopt the legacy Banc One/First USA policies.
181. On or about October 16, 1998, Arthur Andersen met with Richard Lehmann to
discuss the new Bank One's combined third quarter 1998 results. About the only thing Lehmann
had to say on the issue of First USA was that "balance growth" at First USA is "weak." The
following week, on or about October 21, 1998, Bank One released its combined third quarter 1998
results . As McCoy stated to industry analysts the following day, the view that Bank One was trying
to portray was that "this is a terrific picture."
182. By the middle of November 1998, Arthur Andersen's audit team was starting to turn
its attention towards First USA. For example, on November 19, 1998, Arthur Andersen met with
Rick Taglione, who candidly described First USA's regular practice of managing results:
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After three weeks of actuals, and one week before close, senior management and Dick Vague meet to review the forecast of the current month's results. This is usually very close to the actuals as only one week is forecasted. Earnings are discussed and decisions can be made as to whether any action is needed to meet the earnings target. The task is for senior management to meet earnings. There are several actions management can take such as selling of a portfolio, selling charged off loans or doing a securitization to increase revenue. On the expense side, marketing can be cut back if necessary.
183. As part of its review, Arthur Andersen also interviewed the head of First Chicago's
First Card credit card division, who explained that comparisons between First USA's and First
Card's results of operations were very difficult, because stated simply: "First USA's accounting policy is to capitalize all account origination costs (marketing and plastics) and accelerate income recognition through FAS 125 gains on their securitized portfolio."
184. Following these, and several other similarly revealing meetings with the management team at First USA, Arthur Andersen documented what it believed was a significant accounting risk related to First USA:
Aggressive GAAP: Based on our SMART assessment, BPR reviews and Understanding the Business , we know that `aggressive GAAP ' (and application of GAAP) represents an area of significant risk for Bank One. This risk is heightened by the merger between First Chicago NBD and Bank One and the need to conform accounting policies and practices as well as valuation and risk management practices. Finance , Internal Audit and Risk Management are all focused on this issue. Bank One's accounting practices are more aggressive than FCNBD's. This, in part, was due to Banc One's acquisition in 1997 of FUSA, a large independent monoline credit card company, who followed a somewhat aggressive accounting practices in the areas of credit card solicitation costs (a cost deferral issue), purchase accounting , loan loss reserve and securitization accounting."
185. By this point in late 1998, Arthur Andersen was also becoming concerned about the potential financial reporting risk at Bank One -- a risk that Arthur Andersen's Fraud Risk Practice
Aid termed as someone "cooking the books." Arthur Andersen completed its firm's Fraud Risk
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Assessment Worksheet, which showed that there was indeed some cause for concern, including risk due to: (a) "aggressive accounting policies"; (b) "commitments made to analysts, creditors or shareholders"; (c) "overly complex corporate structure"; and (d) "unclear lines of authority."
186. The following week, Arthur Andersen began looking into the LLC. What Andersen found was that First USA had been capitalizing all kinds of expenses through the LCC, including
"internet marketing costs" which Andersen concluded were "not eligible for deferral," given the limited scope of First USA's contract with the LLC. Accordingly, on December 4, 1998, Arthur
Andersen asked to see Bank One's internal audit workpapers related to the LLC, and was given, among other things, Internal Audit's report from June 1998, discussed supra, which Andersen summarized in its workpapers as follows:
In order for First USA to defer and amortize marketing costs under SFAS 91, GSS must sell new accounts to FUSA individually, based on pre-determined price per account. The LLC must be an independent third party bearing all the risks and rewards of the marketing effort.
Issues were noted [by First USA's Internal Audit Department] where First USA performed procedures that really should have been performed by GSS.
Per review of IAD workpapers , AA noted the following procedures, within the marketing function , performed by FUSA that may not comply with SFAS 91: 1. Campaign planning and monitoring 2. Preparation of schedules , forecasts and matrices for direct mail promotion 3. GSS uses FUSA' s vendor training program design for event marketing 4. Develops yearly budget and volume forecast for pricing.
Within the invoice process , AA noted the following that may not comply with SFAS 91: 1. Invoices for campaigns are received by FUSA 2. Purchase orders are initiated by First USA and sent to GSS 3. FUSA issues all requests for services (RFS).
The workpapers also noted the acquisition process related to campaigns was far from complete, therefore IAD did not perform their planned campaign walkthroughs (determines accuracy of the flowcharts). GSS shared information (i.e., solicitation
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costs) with FUSA that was not appropriate nor in compliance with SFAS 91. Issues were noted with the shared information and compliance with contract terms (transition issues).
AA notes that by performing certain procedures or functions and having access to the LLC's cost information , FUSA may be exercising a certain element of control over the LLC.
187. After reviewing Internal Audit's workpapers, Arthur Andersen documented its concern that the reason for the LLC's existence was so that First USA could "... capture favorable accounting treatment under SFAS 91 and EITF 93-1 for it's $560mm acquisition spending to increase reported earnings ." (Emphasis added). Since this presented a risk to the 1998 audit, Arthur
Andersen added an entry related to the LLC to its Business Risk Control Matrix, to remind its auditors that "[i]ndependence issues exist during the period of 1/1/98 through 9/30/98."
188. As Arthur Andersen dug further into the LLC issue, it discovered that the contract with the LLC that was supposed to have been modified as of the date of the Merger, had never been formally amended. Indeed , as Arthur Andersen ' s file memo from January 13, 1999 indicates, this was such a significant issue -- as it undermined all possibility that the LLC had been operating as an independent entity -- that Andersen requested formal comfort letters from Bank One and the LLC to help attempt to limit Andersen's exposure after the fact:
BANK ONE and the LLC have not formally renegotiated their contract. This should be completed prior to the release of earnings. We are requesting representation letters from management and the LLC regarding certain aspects of the LLC's independence and risk.
189. Arthur Andersen was also starting to question Bank One's treatment of the LLC as a Merger-related expense:
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We support the one line item income statement disclosure of the merger restructure and merger related costs. However, increased SEC scrutiny could question both the presentation as well as whether certain items such as the amortization of costs paid to the LLC should be disclosed as a merger related expense. $91 million of prepaid marketing costs as of September 30, 1998 ("in transition") may be more appropriate as "marketing expense."
190. While the LLC issue was already a fait accompli, Andersen's audit team did recommend that "CdJeferred costs related to [First USA's] affinity contracts should be disclosed."
(Emphasis added). Notwithstanding Arthur Andersen ' s view, Bank One's 1998 Form 10-K contained only the following brief, uninformative discussion of First USA's capitalization of millions of dollars in affinity program expenses : " The increase in identified intangible assets relates to the credit card business, reflecting premiums associated with credit card portfolio acquisitions and credit card affinity arrangements."
2. The Post-Merger Efforts To Try To Resolve Some Of The Undisclosed Problems And Negative Trends At First USA
191. Following completion of the Merger on October 2, 1998, management of the new
Bank One set out to try to quietly resolve some of the problems and negative trends that existed at
First USA. It was important to Bank One to do this, because: (a) First USA was starting to come under increased regulatory scrutiny from the OCC; (b) additional class action lawsuits (12 to 15 of them) had been filed against First USA in different jurisdictions all across the country (in addition to 30-40 individual cardholder suits); and (c) the accounts that First USA repriced in July and
September 1998 were ready to "flip" to their higher go to rates, which was likely to cause a sharp additional upwards spike in First USA's attrition rate, if steps were not immediately taken to save these accounts.
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192. To deal with First USA's attrition problem, which by this point had become an extremely significant issue, Bank One retained the Mitchell Madison Group ("MMG") to develop a "turn key" customer and balance retention program for First USA. On December 22, 1998, MMG presented a preliminary " benchmarking " report to Carter Warren, the head of First USA' s Customer
Service Department, which summarized the kinds of account retention programs other credit card issuers had in place. MMG also reported that, based on its preliminary analysis, the rate of gross attrition at First USA -- the pure loss of account balances, without an offset for balances brought in with new accounts or increased portfolio utilization -- had exceeded $17.5 billion for the period from November 1997 to October 1998, and that First USA's attrition rate had risen from First
USA's historical levels of between 10-12%, to 28% in 1997, to 47% in 1998, and then had begun to stabilize by year end 1998 to a level of approximately 50%.
193. On January 26, 1999, MMG presented its "summary of findings" and proposed customer retention strategy for First USA. Among other things , MMG advised First USA that it could "produce a significant improvement in both program performance and operations productivity by making targeted investments in its retention related systems infrastructure." Essentially, MMG's view was that First USA needed gather more data and do more analysis into "why" customers had left, so that First USA could create more individually tailored retention and customer loyalty programs. MMG also recommended several structural improvements to First USA's customer service operation, which MMG thought might have some immediate benefit, such as hiring additional account representatives, improving account representatives' access to information about customers' accounts, etc.
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194. At First USA, several other "mad dog" teams were formed to start tackling specific problems at First USA. For example, a "Forecasting Mad Dog Team" was established in or about
November 1998 to help update and overhaul First USA's financial forecasting process; a "Service
Delivery Failure Mad Dog Team" was established to help improve the level ofcustomer service; and, by November 13, 1998, the list of issues for the newly formed Pricing Mad Dog Team were "too numerous to count." These Mad Dog Teams eventually turned up many pre-Merger problems that were never disclosed, including many of the matters discussed herein.
195. According to internal First USA documents, teams such as these were deployed by
First USA to quickly address significant problems:
Mad dog teams were created to address the customer focus. Mad dog teams are small project teams assigned to quickly address blatant product delivery failures. Over the last few years, mad dog teams were created to handle many problem areas within FUSA.
196. While efforts were being made following the Merger to try to fix some of the operational problems that existed at First USA, the underlying " earnings at any cost philosophy" that had existed at First USA and Banc One was not being addressed. For example, on January 26, 1999, on the same day that MMG presented its retention plan for First USA, the head of Bank One's
Investor Relations Department , Jay Gould, circulated a copy of a presentation that McCoy was going to make to analysts at a conference held by Salomon Smith Barney the following day. The transmittal letter from Gould admonished the senior management of First USA and Bank One that:
it is important that we continue to communicate to external audiences only the taraets outlined in the October presentation in NYC. As you know, some of the 1999 Plan targets are more aggressive or have changed from those previously communicated targets . But, Plan targets need to remain internal, as we do not want to be altering expectations at this time. (Emphasis in original).
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3. The Unresolved Problems At First USA Ultimately Threaten The Safety And Soundness Of The Bank
197. By April 1999 -- less than six months after the Merger -- the level of customer contempt for First USA was so high that First USA was becoming a topic of the nightly news.
Additionally, by this point, as discussed supra, the OCC had already made a demand for more refunds to be issued and had threatened to initiate a formal enforcement proceeding if things at First
USA did not immediately and dramatically improve.
198. Thus, on July 14, 1999, Robert A. O'Neill, Jr., the head of Bank One's Internal Audit
Department, reported to Bank One's Audit Committee that, at the OCC's direction, more customer refunds were going to be issued for late fees "which should not have been charged." O'Neill further reported that "[i]n many cases, the reimbursements may have exceeded the amount due customers because of the lack of an audit trail at NPC." (Emphasis added). By the time of the next Audit
Committee meeting on October 13, 1999, First USA had decided to move all of its processing "in house" (away from NPC). O'Neill reported to the Audit Committee that "this action was needed to respond to a crisis situation" as "the infrastructure supporting the settlement, and reconcilement processes were not adequate to handle the increasing volume and complexity." Bank One also approved a $10 million reserve for "repricing", and Bank One's General Counsel, Sherman
Goldberg, reported in a "regulators meeting" held on October 14, 1999, that a default judgment had been entered against First USA in a matter internally referred to as the "Lively case," for $250,000 in compensatory damages and "$10 million" in punitive damages.
199. During 1999, Bank One's contingent liability reports indicated that numerous other class action lawsuits were filed related at least in part to First USA's pre-Merger activities , including:
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i. a "First USA Late Fee Class Action" (filed April 8, 1999);
ii. a "First USA Repricing Class Action";
iii. Man one v. First USA, class action alleging failure to post payments on time;
iv. a "First USA Finance Charge Class Action" (filed June 3, 1999);
v. three "pricing/contract fraud" class actions in Washington, Oregon and Texas "that the organization is worried about";
vi. a "First USA Incorrect APR Class Action" (filed September 23, 1999);
vii. a "First USA Late Posting Class Action" (filed October 6, 1999);
viii. Davis v. First USA, class action alleging failure to post payments on time;
ix. the "FDIC Litigation" (filed October 21, 1999);
X. a "First USA Late Payment Class Action" (filed October 21, 1999);
xi. Whyns v. Bank One and First USA, class action alleging failure to post payments on time; and
xii. a "First USA Late Fee Class Action II and III" (filed December 6, 1999).
200. Similarly, while the OCC had expected to see the number of complaints being filed against First USA decline in the later half of 1999, the level of complaints almost tripled from the number received during the first half of 1999 -- to 6,213 separate complaints -- more than most of the rest of the industry combined. First USA's failure to address the problems that were causing this customer backlash for more than " 15 months," occasioned the OCC to conclude that "the root causes of complaints have not been adequately addressed," and left the OCC with little alternative but to take formal action.
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201. Thus, on December 13, 1999, the OCC sent First USA's and Bank One's management (and auditors) a memo citing First USA for its ongoing violations of the Truth in
Lending Act: "A violation of 12 C.F.R. Part 226,. 10, Regulation Z, is being cited for failure to promptly post payments to customer accounts." Given the magnitude of the problem, and the potential risk that the unresolved operational issues posed to the health of the Bank, the OCC also issued a formal "Safety and Soundness Notice of Deficiency" to Bank One's Board of Directors on
December 16, 1999:
The OCC has determined that the Bank has failed to satisfy the safety and soundness standards contained in the Interagency Guidelines Establishing Standardsfor Safety and Soundness set forth in Appendix A to 12 C. F.R. Part 30.
202. At the insistence of the OCC , Bank One eventually appointed a board-level committee to direct and oversee implementation of a remediation plan, and agreed to provide a bevy of additional refunds to affected First USA customers, going back as far as the "beginning of 1998."
H. The Truth Begins To Emerge Only Ten Months After The Merger
203. While the various problems, issues and negative trends at First USA were, and had
been, ongoing at First USA and Banc One since before the Merger, and continued at First USA and the new Bank One at the time of and after the Merger, the public (including First Chicago's
shareholders) were unaware ofthese material facts, risks and trends, which were not disclosed in the
Registration Statement or Prospectus , and would not begin to be disclosed until late 1999. When
Defendants ultimately began to make disclosures in late 1999, the market reacted swiftly, and
established that this information was material to determining the true value of the Merger and Bank
One's common stock.
1. Bank One Concludes That The Problems At First USA Are
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Beyond Easy Repair And Contracts To Take Out $320 Million Of Additional Insurance Coverage To Mitigate Defendants ' Exposure
204. The turning point at Bank One appears to have been in or about June 1999, when industry analysts began to press Jay Gould, the head of Bank One's Investor Relations Department, for an explanation of why Bank One's net interest margins were beginning to decline. Bank One, in turn, wrote to George Hubley (First USA's CFO) on June 5, 1999, asking for information to help explain the negative trend in First USA's results:
Both [Net Interest Income] and [Net Interest Margin] are included in our quarterly earnings release. These numbers are reported on a managed asset basis. The largest single component of the margin, and the component most frequently asked about, is Credit Card (26% of earning assets and 39% of NII).
Variances in margin are a focus of Investor Relations. This includes variance from prior quarter, prior year, and the trend in NIM vs. forecast. As with any reported numbers, trends must be forecasted and explained, and an unexpected change is problematic to explain. . . . (Italics in original).
205. Bank One investigated whether it might be able to reverse the net interest margin decline by returning some of First USA's repriced accounts to higher, more profitable rates.
However, Bank One found that it was effectively locked into First USA's pre-Merger pricing
changes for at least the foreseeable future ("only able to target ` reprice ' $ 16 [billion] of the $65
[billion] portfolio"), due to contractual restraints in First USA's affinity contracts -- not to mention
the public relations risk, and added attrition and regulatory risk that making further changes to
customer ' s accounts would present. ( "Ability to implement straight portfolio reprice compromised
by [public relations], attrition, [and] legal risks")
206. Only a few weeks later, the first of a series of public disclosures would be made that
would begin to reveal the truth about what had been happening at First USA. Before the
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announcements were made, however, Bank One retained counsel to advise the Bank regarding the likelihood that Bank One would be sued for securities violations and to help assess the potential magnitude of Defendants' exposure. Before making its public announcement, Bank One made arrangements to take out $320 million of additional "directors and officers" liability insurance coverage, specifically to provide coverage for management's conduct relating back to the date of the
Merger.
2. Bank One ' s August 24, 1999 Announcement Attributes The Earnings Revision "Entirely" To Problems At First USA
207. On August 24, 1999, Bank One announced that earnings for 1999 were going to be
substantially lower than had been expected, due "entirely" to problems that existed at First USA:
Bank One today announced that, based on a revised outlook for the second half, it anticipates full-year 1999 operating earnings per share to be between $3.60-$3.65. While down 7%-8% from current market estimates, this would be 11%-12% above 1998's operating earnings.
The revised earnings outlook is entirely the result of a recent change in the growth and margin prospects for First USA, the Corporation ' s credit card unit. The factors driving this change include:
Acceleration in underlying trends for credit cards, specifically slower industry growth and increased competition.
Selected First USA-specific factors including:
Lower relative marketing investment.
Higher than anticipated account attrition.
Specific pricing initiatives.
This revision represents a resetting of the Corporation' s base earnings level because of the lower credit card profit contribution now anticipated for the second half of 1999. The Corporation' s earnings growth rate today is less than 15% given the current business mix and related returns.
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"We are disappointed in this earnings estimate revision," said [McCoy], president and chief executive officer. "We believe we are taking appropriate actions to generate solid returns and growth in the credit card business model, and our card customers remains [sic] as strong as ever.
"In the recent past and continuing today," said [Vague], "we have witnessed a significant acceleration in competition, including increased mail solicitation volumes and more aggressive introductory rate programs. These issues, along with tightened underwriting standards and higher account attrition, have made it more difficult to grow outstandings at targeted levels."
208. On August 25, 1999, McCoy and Vague met with analysts to discuss Bank One's
August 24th announcement. Vague attempted to justify what First USA and Banc One had done in the period leading up to the Merger, but not told anyone about:
"What was the imperative to do all these repricing and late-fee moves all at one time? Didn't you run the risk of a train wreck?" one analyst asked at the meeting . Replied Vague: "We had an ambitious budget and earnings targets that ended up being high, and we were very anxious to deliver on those targets." (Emphasis added).
209. One of the industry analysts in attendance that day summarized Bank One's presentation, as follows:
First, Bank One did not try to portray the problems at First USA as primarily industry issues in this morning's remarks -- they made it abundantly clear that their problems were mostly unique to their credit card operation . The issue of attrition of the best and longest-term customers -- the so-called prime segment and the resultant remixing of credit card accounts which will push card margins down dramatically in the second half of the year. That attrition is due somewhat to competitive conditions in the industry -- industry mailings in the second quarter once again reached the high levels of 1995-1995 -- but mostly due to some monumental marketing miscalculations on the part of First USA management.
Simply put, the company tried to ram through too many pricing changes at once. They went for the "go to 9.9%" market segment, which is a prime segment, and went too far down in the profitability tranches, finding (too late) that those offerings had to be priced at at least 12% to be profitable. Secondly, they instituted a raft of changes (zero grace period, `rules-based pricing', etc.) And in the midst of all this
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change, experienced a giant processing snafu with their third-party processor, National Processing (of National City fame), which resulted in late postings of payments and resultant erroneous late fees, repricings , etc. Our big question -- which really didn't get answered this morning -- is why didn ' t their supposedly advanced predicative models (assumed to be among the industry ' s best) tell them that customers would simply get ticked off by too many changes seen as punitive, and would have a lot of places to go? (Emphasis added).
210. According to Kiplinger's magazine, Richard Vague also indicated that First USA was going to discontinue its previous undisclosed practice of "accelerating" revenues related to First
USA's repriced , rules based accounts:
Vague also told analysts that he expects credit card profit margins to drop this year because of the customer attrition, and an end to "Accelerating" late fees, and planned interest-rate concessions to customers designed to boost the issuer's retention rate. " "The impact will be in the area of $500 million over the next couple of quarters." (Emphasis added).
211. Bank One' s management understood how the market would likely view the news about the undisclosed problems at First USA. Indeed, by the time of the analyst meeting on August
25, 1999, Bank One had already prepared a series of "questions and answers" to assist Vague and
McCoy in responding to anticipated questions , such as: " I would think that the First Chicago NBD directors and employees may be scratching their heads wondering if they got suckered in?"
212. Although Bank One did not disclose the full truth about the problems and trends at
First USA, the disclosures regarding the decline in First USA's prospects caused the market to react swiftly and severely. On August 25, 1999, the price of the Company' s common stock plummeted
22.7%, or $12.625 per share, from the previous day's closing price of $55.625 per share, to close at a 52 week low of $43.00 per share. This decline was on volume of 39,887,000 shares, more than fifteen times the daily average trading volume for the previous 52-weeks.
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213. While Bank One tried to pin the earnings revision at First USA on increased industry competition, other banks and credit card issuers were quick to renounce any such notion. As reported by the American Banker on August 26, 1999:
MBNA Corp., which at $64.5 billion of receivables trails only Citigroup Inc. and First USA, was quick to distance itselffrom [Vague's competitive pressures] warning statement. It fired off a news release Wednesday to calm investors worried that First USA's woes were an indictment of a whole industry.
"Industry problems are not impacting us," said MBNA spokesman Brian Dalphon. "We are growing. Our losses are stable. We are only losing 3% of the customer relationships we want to keep."
David J. Petrini, executive vice president and chief financial officer of Providian Financial Corp., said: "I wouldn't call this an industry wide problem. The stock market represents a herd mentality."
"It's not surprising to me that rational consumers are leaving First USA," said Edward Mierzwinski, executive director of U.S. Public Interest Research Group in Washington. "The bank has been extremely arrogant in its charging of latefees to consumers who probably paid on time." (Emphasis added).
214. On October 18, 1999, the Company announced its results for the third quarter ending
September 30, 1999, reporting operating earnings of $1.014 billion, excluding Merger-related and restructuring costs, or $0.86 per diluted share. Net income for the third quarter was reported to be
$925 million, or $0.79 per share . The Company also reported a $1.115 billion managed provision for credit losses for the quarter, $10 million more than related net charge-offs. The Company stated that its results for the third quarter "were consistent with the expectations announced on August 24,
1999," and that "[a]ctions [were] being taken . . . to reduce customer attrition and stabilize returns at First USA in coming periods." Commenting on the results of operations, McCoy stated: "As expected, earnings from our credit card business declined ...."
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3. The October 19, 1.999 Resignation Of Richard Vague And Appointment of William Boardman As CEO of First USA
215. Near the end of the third quarter, at the September 21, 1999 meeting of Bank One's
Board of Directors, Robert Rosholt (Bank One 's CFO) explained that there had recently been some
"unexpected " expense bookings made by First USA:
[the negative earnings per share variance] was primarily attributable to lower-than- plan net interest income and higher-than-plan operating expense. He said that approximately one-half ofthe negative operating expense variance resulted from the timing of expenses, including credit card related expense.
Arthur Andersen's description of these "timing" discrepancies was not so forgiving, referring to the matter as a "Third Quarter overstatement of revenue of credit card income determined at last minute. " (Emphasis added).
216. Following these discoveries, Richard Vague and John McCoy discussed Vague's
"possible departure" from First USA and Bank One. According to a verified complaint filed by
Richard Vague in the Delaware Chancery Court on March 15, 2001 (where Vague is suing Bank One to enforce the terms of the various stock awards that had been made to him), McCoy and other officers of Bank One informed Vague in October 1998 that his separation would be treated as a
"resignation determined by the Corporation to be in the best interest ofthe Corporation" for purposes of Vague' s eligibility for benefits under Bank One's Executive Management Separation Plan.
Pursuant to this understanding , Vague tendered his letter of resignation to McCoy on October 19,
1999, and Bank One announced later that same day that Richard Vague had "resigned to pursue other interests." Bank One's October 19, 1999 press release also announced several management realignments at the Company, including William Boardman's appointment to the position of interim
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CEO for First USA, McCoy' s change of responsibilities from CEO of Bank One to Chairman and
CEO, and Verne Istock's switch (from Chairman) to President.
217. Immediately following Boardman's appointment as CEO at First USA, work began on a comprehensive "retention analysis" to study, break out and quantify the attrition impacts that
First USA's 1998 repricing initiatives had had on the different categories and segments of First
USA's portfolio (e.g., "First USA branded" accounts versus "Banc One branded" accounts and
"affinity" accounts, and by "APR tier" and credit score, etc.). The results of the analysis , completed
October 27, 1999, reflected that attrition rates at First USA had grown across "all credit line levels" from 1998 to 1999 and that attrition had "increased the most" with First USA 's best customers, those with high credit scores and high balances. The report also detailed an additional $5.22 billion of account balance run-off in 1999, bringing the total, gross attrition-related loss of accounts attributed to First USA's pre-Merger activities up to more than $22.5 billion.
4. The November 10, 1999 Announcement, Revising Earnings Projections For A Second Time Due To Problems At First USA
218. OnNovember 10, 1999, more of the story about the previously undisclosed problems at First USA came out, when the Company announced that 1999 earnings would be approximately
15% below analysts' revised expectations:
BANK ONE today announced a revised 1999 earnings outlook and the postponement of its November 15, 1999, investor update until no later than early January 2000.
Excluding merger and special charges, the Corporation's full-year 1999 operating earnings are now targeted at $3.45-$3.55 per share. The decrease in expectations principally reflects ongoing softness in earnings at First USA, Bank One's credit card and consumer lending company.
"In August we advised investors of the earnings pressure we were seeing at First USA," said [McCoy]. "Bill Boardman, newly appointed head of First USA, and his
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team have done an excellent job in examining and understanding the details necessary to evaluate the core trends of First USA's businesses. Part of this review's findings, as well as the continuation of the trends noted in August, have resulted in the lower 1999 fourth quarter earnings outlook."
The Corporation's commitment to investors was to come back in the fourth quarter with a full review on the company and the outlook for 2000. But completion of a current strategic review, which is well underway, is necessary before a full understanding of the Corporation's core trends, outlook for 2000 and long-term direction can be provided. The course and duration of the review has been impacted by the previously announced management changes at First USA.
219. In a recorded message on the same day, McCoy stated that "lower than expected profits" at First USA were "caused by negative cardholder reaction to high late fees, a slow down in marketing, and processing problems" -- the very problems that had existed since at least 1997.
According to an article in American Banker, McCoy blamed the revision on subordinates for providing earnings estimates that were "greatly exaggerated" and for acquiring "too much too fast" which only increased the chance of "blowing out the forecasts."
220. Once again the market reacted swiftly to this additional bad news about First USA.
The price of the Company's stock fell $4.50 per share, or 11.5%, from its previous day's close of
$39.125 per share, to close at $34.625 per share on heavy volume. At various points during the day, the New York Stock Exchange suspended trading in the Company ' s stock. The stock was now down
37.7% from $55.625 on August 23, 1999, when the Company first started to reveal the problems at
First USA.
5. Arthur Andersen's December 1999 Reassignment Of The Bank One Engagement To "Maximum Risk"
221. On the day ofBank One's August 24,1999 earnings announcement, Arthur Andersen updated its Fraud Risk Practice Aid and Checklist (designed to help detect any "cooking of the
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books") to include several items ofadditional concern which had, as detailed earlier, been the factors behind Bank One's problems at First USA:
Significant accounting estimates involve an unusual degree of subjective judgment by management;
Significant compensation plans (e.g., bonuses, stock options) contingent upon aggressive targets; and
Desire to maintain high earnings of stock values in anticipation of a merger.
222. On November 30, 1999, just after Bank One's release of a second earnings revision on November 10, 1999, Arthur Andersen met with William Boardman, the new CEO at First USA.
Arthur Andersen's December 7, 1999 file memo details the discussion with Boardman, who emphasized that not only had the new rules based pricing strategy not been disclosed to investors before the Merger, but that the untested strategy itself was somewhat nonsensical and, at best, ill timed:
Bill's first objective was to determine what happened at First USA to cause the decline in earnings and subsequent adjustments to the profit plan for 1999. He feels the largest driver was the 9.9% fixed campaign, which provided for rules-based pricing. The cardholder's rate remains fixed at 9.9% as long as they never miss a payment due date and incur a late fee (no grace period). If a late payment is received, the cardholder's rate goes to penalty pricing. With such a low fixed rate, the theory was that new cardholder's would be obtained and eventually go to a higher penalty- pricing structure. This program was not tested as extensively as prior programs and launched very quickly. The program backfired in that the profit plan was dependent on the cardholder "screwing up" and when that happened and the cardholder received notification of the higher rate, they transferred their balances to another issuer. Therefore First USA lost balances and never reaped the benefits of the higher rates on most of the accounts. Additionally, a large portion of the current portfolio was converted to this program, so they lost some long-term customers that were previously at higher rates. 75% of the attrition has been with cardholder's whose rates were 17% or higher. The payment processing problems magnified the negative impact of this program in that customers were erroneously converted to the higher rate in some instances, which led to overloads in customer service (which led to poor problem response rates and problem resolution) and widely publicized bad press. In
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addition to the 9.9% program, remittance problems and deficiencies in customers service, all of which affected the margin, operating expenses were escalating to very high levels. Money was being spent without the proper profitability analysis and approval. In summary, the dynamics of the industry changed, FUSA launched a bad product and was not executing any expense control.
223. Following the meeting with Boardman, Arthur Andersen upgraded its audit engagement to "maximum risk." In connection with the change, Andersen added the following information to its SMART audit risk database in or about December 1999:
Management is constantly under significant pressure to meet analysts' as well as shareholders ' expectations . This pressure has increased since the release of the two earnings reforecasts [sic] discussed above. Pressures to increase operating performance , stock price , and market share are paramount.
6. The December 21., 1999 Resignation Of Bank One's CEO, John McCoy
224. On December 21, 1999, three business days after the Company received the OCC's
Safety and Soundness Notice of Deficiency, the Management Committee of Bank One's Board of
Directors met to consider the Profit Plan for Bank One for the year 2000. That afternoon, Bank One announced that John McCoy had resigned effective immediately. As reported by the Detroit Free
Press , several other management changes were announced by the Bank as well:
shareholders celebrated a bittersweet victory Tuesday when the company's stock rose about 11 percent -- the highest one-day gain in at least four months -- following chairman and chief executive officer John McCoy's abrupt retirement. The retirement, effective immediately, was announced Tuesday afternoon after Bank One halted trading of its stock for an hour.
Shareholders and analysts blamed McCoy for the problems since he purchased the credit card division in 1997 while he was president and CEO of Banc One Corp. of Columbus, Ohio. Banc One merged with Chicago-based First Chicago NBD Corp. in 1998 to create Bank One.
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225. Three days later, on December 24, Arthur Andersen documented in a file memo that "there [we] re concerns over potentially unrecorded liabilities as of 12/21/99 [the date of
McCoy's resignation] due to earnings pressures."
7. The January 11, 2000 Announcement And Revision of First USA's Business Plans
226. Finally, on January 11, 2000, Bank One announced that its earnings for the fourth quarter of 1999 would be as much as 18 percent less than analysts had been led to believe in
November 1999, and that profits for 2000 would drop sharply as a result of the Company's previously undisclosed problems and practices at its First USA credit-card operations (which had been ongoing since well before the Merger). At an analyst conference held the same day in New
York City, Bank One's President, Verne Istock, announced that, going forward, First USA would
have reduced reliance on "late fees and repricing" and was going to focus more on retaining its
existing customers and accounts.
227. William Boardman, the new CEO of First USA, then discussed some of the reasons
why the prior business plan at First USA had failed. Among other things , Boardman indicated that
by having taken away the ability of customers to make payments within a reasonable time without
incurring penalties, "[w]e took actions that directly impacted, in an adverse way, the most important
item impacting cardholders." As for what had actually happened at First USA, Bank One's handout
to analysts on January 11, 2000 presented five "key issues" which had led to the earnings decline at
First USA: (1) the change to a "rules based pricing strategy " in 1997; (2) lack of "[a]ppreciation of
and respect for the customer" and related operational and service issues; (3) "net interest margin
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decline"; (4) increases in "operating expense"; and (5) disparate "organizational philosophies" between the management of First USA and that of Bank One.
228. Boardman discussed these key issues in some detail, explaining what had happened, why it had happened, and noting that the problems at First USA were all traceable back to 1997, before the Merger. For example, as to the change to a rules based pricing strategy, Boardman indicated that "52% of anticipated NPV ofthis product result from late fees and trips to penalty rate" and that "[a]ttrition relates to repricing triggers." Boardman further explained that "75% of this attrition [was] in [the] 19% APR bands" and that the effects of such attrition had been largely overlooked before, as First USA had made its "[d]etermination of profitability in marketing not finance." According to Boardman's presentation, every two and a half percent increase in First
USA's attrition rate had negatively impacted Bank One's return on outstandings by approximately nineteen basis points, or $125 million.
229. Analyst reports and news articles issued after the January 11 `" announcement reported
additionally that Boardman had "said [that] Vague's strategy was to focus on account growth to the
exclusion of other concerns, by using rates well below industry averages and then hitting customers
with late fees and penalty rates":
The difficulties began in May 1998, when First USA changed the date upon which penalties and late fees accrued from the billing cycle to the due date, which shortened the grace period by three to eight days, said William Boardman. Citing studies that show that consumers' deciding factor when choosing a credit card is the ability to make payments in a reasonable time frame without incurring penalties, Boardman said that "we took actions that directly affected in an adverse way what our customers valued most."
Boardman said 75% ofthe attrition was in the 19%-plus APR band and in most cases was the result of these rules-based pricing actions. We lost many of our best customers."
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At the analysts' conference, Boardman placed much of the blame for First USA's difficulties on the unit's freewheeling business culture, which resulted in lax oversight. "There was little direct accountability for the profitability for individual portfolios" once they were acquired.
230. In an interview with Credit Card Management in March 2000, Boardman reiterated what he had told analysts in January 2000, and added that "[w]e are now requiring a new financial discipline in all of our investments , including marketing expenses." (Emphasis added). As part of this new expense discipline, internal documents show that First USA's annual marketing budget had been slashed, from pre-Merger levels of approximately $1.2 billion, to $600 million.
1. Bank One' s Restructuring Of First USA's Balance Sheet In 1999 And Early 2000 Confirms That The Financial Statements Incorporated Into The Registration Statement Were Materially False And Misleading
1. Bank One's Special $725 Million Fourth Quarter 1999 Charge
231. As part of its earnings announcement on January 11, 1999, Bank One reported that it had taken a $725 million "special" charge in the fourth quarter 1999. Out of this $725 million charge, $185 million was for "the write-down ofcertain assets and other charges at First USA, Bank
One's credit card company ," and $183 million more was attributable to First USA' s "early adoption" ofFFIEC's industry-standard bankruptcy notification charge-off policy that B ank One had foreseen prior to the time of the Merger.
232. While Bank One stated that "[t]he projected earnings decline at First USA, including revised marketing plans" had led to the impairment of these assets, the reality was that these assets had been impaired since before the Merger. For example, while Bank One attributed some of the write downs to revisions in marketing plans, the only marketing related change that had taken place up to this point was the cessation ofFirst USA' s practice of capitalizing and deferring these expenses
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as of the date of the Merger. Similarly, the other accounts which Bank One was writing down -- including First USA' s "purchased credit card receivables," First USA's "affinity marketing programs" and First USA's "interest only strips" -- were all by-products of First USA's pre-Merger efforts to manage Bane One's earnings.
233. Now that the problems at First USA had been revealed, and a turnover in management had occurred, there was no longer any reason to maintain (and, in fact, there was now every reason to charge off) these (and other) inflated asset account balances that had been on the books since before the Merger. Also notable is what Bank One did not disclose about its fourth quarter "big bath" charge -- namely, that in addition to the asset writedowns, Bank One's $725 million charge included $25 million to cover the cost ofthe remediation program that had been ordered by the OCC, plus a charge of $23 million "related to credit card repricing class action litigation," plus a charge of $1 million for " anticipated fines and penalties [from the OCC] resulting from alleged violations of Regulation Z at First USA (i .e. untimely processing of customer payments)" -- all items that related specifically to the pre-Merger actions of First USA.
234. While Bank One believed that the $ 725 million charge would be "enough" to cover the cost of restructuring the Bank, analysts were speculating that it would more likely take $1 to $2 billion more to clean up the problems at First USA.
2. The SEC's Challenge Of Bank One's Special Charge
235. On January 14, 2000, three days after Bank One's announcement of the $725 million special charge, Bank One received a formal inquiry from the SEC, requesting, inter alia, a breakdown and explanation of the $187 million charge related to First USA. The SEC apparently was not buying Bank One's contrived explanation that the charge was necessitated by Bank One's
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second earnings revision (on November 11, 1999), when management purportedly "realized" that the decline in First USA earnings was not just an isolated adjustment , but the start of a sustaining trend. Even Arthur Andersen was questioning how Bank One's earnings announcement could be viewed as a any kind of special economic event ("How is this a triggering event?")
236. On January 17, 2000, Arthur Andersen advised Bank One what it could likely expect with regard to the SEC's investigation:
This will be a long drawn out process that will prevent public treasury activities... . The SEC will use the information provided to `audit ' the transactions under scrutiny.... Too much documentation should be avoided .... Due to the class action lawsuits , the attorneys working on the case should have a chance to review the letter.... In addition , the letter should be made privileged and confidential (consult with your counsel).... The SEC will look to an economic event (not some bullshit FFIEC policy) that occurred in the fourth quarter to support the [loan loss reserve] charges. In the absence of an economic event, reserve adequacy of previous period will be questioned... .
237. William Roberts, Bank One Controller and Principal Accounting Officer, responded to the SEC's letter of inquiry on January 25, 2000, explaining the Company's belief that the $725 million "special charge" was truly a one time event and was not "indicative of an ongoing run rate for the respective financial statement line items." As for the breakdown of the charge that had been requested by the SEC, Bank One' s initial response attempted to avoid the issue altogether , specifying that of the $ 187 million charge related to First USA, $108 million was classified to "non- interest income" and the remaining $79 million hit " other noninterest expense."
238. On February 1, 2000, Bank One received a reply and follow up letter from the SEC.
The internal Bank One transmittal memo distributing the copy of the SEC's letter to Bank One's senior management summarized the SEC's reply as follows:
Attached is an initial response from the SEC. It is not good news.
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they are challenging the characterization of the charges taken in the 4" quarter as special and indicating that we should not exclude them from presentations of operating earnings/net income in our 1999 Form 10-K filing. (Emphasis in original).
239. The SEC's attached February 1, 2000 reply letter went on to explain the SEC's view that:
Due to the nature of the items included in the charge, we do not agree that they are appropriately characterized as "special." We believe that exclusion of the charge from presentations ofoperating earnings or net income is not appropriate and should be avoided. Based on information available to us, the items apparently resultfrom your historical operations and changes in estimates. Therefore, they are indicative ofyour historical and ongoing run rate. (Emphasis added).
240. Arthur Andersen later documented its concerns with Bank One' s response to the SEC, expressing that Bank One had placed too much reliance and emphasis on the change in outlook for
First USA, and had not given enough credence to what actually had caused First USA's prospects to change -- "Economics drove ... (not willy nilly)." (Emphasis in original). Andersen also noted that, "in hindsight - tying [the loan loss reserve adjustments] to [the] FFIEC [policy change was] not good" and did not " score points" or help Bank One's "credibility" with the SEC.
3. Bank One's Additional $ 1.91 Billion Charge In 2000
241. In addition to approximately $162 million of asset write downs taken in the fourth quarter of 1999 (as part of the Bank's $725 million special charge), Bank One announced in July
2000 that additional charges of $ 1.91 billion were going to be taken in 2000 to restructure Bank One.
These charges were brought about by the hiring of a new CEO at Bank One, James Dimon, who according to the Wall Street Journal , took the charge "primarily to shore up the bank's balance sheet, which Dimon says had been opaque and inadequate." At the time Dimon was hired by the Bank in late March 2000, Dimon indicated to analysts that he intended to change the way Bank One
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approached its "accounting and earnings guidance" and, in April 2000, Bank One announced that
Robert Rosholt (Bank One's CFO) had resigned.
242. Included in Bank One' s $1.91 billion charge were an additional $750 million worth of asset write downs related to First USA -- bringing just the asset impairments related to First
USA's pre-Merger conduct up to approximately $912 million . According to Bank One's 2000 Form
10-K, $275 million of the impairment related to First USA's purchased credit card relationships
(which had already been written down by $21 million in 1999); $121 million related to First USA's marketing partnership agreements (already written down by $60 million); and $354 million related to First USA's interest only strips (already written down by $48 million). "These asset writedowns reduced the carrying value of identified intangible assets and will reduce the ongoing level ofrelated amortization expense."
243. Bank One's 2000 Form 10-K also disclosed the significant financial damage that First
USA's pre-Merger conduct had caused to Bank One: "First USA reported a net loss of $1 million in 2000, compared with net income of $1.135 billion in 1999." (Emphasis added). Moreover, Bank
One reported that the loss of account balances attributable to First USA's undisclosed "silent attrition" problem (i. e., customers paying off their balances with balance transfer checks from other issuers, but not closing their First USA accounts) was going to be permanent: " 7 million inactive accounts were purged during 2000," reducing the number of customer accounts by 24% from 64.2 million accounts at year end 1999, to 51.7 million at year end 2000. (Emphasis added).
J. Conclusion And Summary
244. As the foregoing discussion reflects, there were literally dozens of material issues, problems, trends and risks which were not disclosed in the Registration Statement or Prospectus.
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To summarize , the key undisclosed material facts , trends and risks , included, inter alia: (a) First
USA's November 1997 change to rules based pricing (essentially a strategy to earn more by penalizing customers); (b) First USA's inability and failure to address the payment processing problems, posting delays and errors and customer service problems related to its payment processor
NPC; (c) First USA's January 1998 elimination of grace periods on its credit card accounts ; (d) First
USA's increasing attrition rate, which rose from between 9% to 12% in 1996 , to over 47% by the
end of 1998, which resulted in a total loss of more than 7 million customers and between $17.5 to
$22.5 billion worth of account balances ; (e) increasing customer dissatisfaction and regulatory
scrutiny, which led to the filing of over 20 class action lawsuits (including at least four prior to the
Merger), and eventually resulted in millions of dollars being refunded to customers in 1998 and
1999, as well as the levy of fines and a formal Safety and Soundness Notice of Deficiency by the
OCC; (f) the declining rate of First USA's marketing success (spending more everywhere , e.g., First
USA's "portfolio acquisition blitz," affinity programs, etc., to get less); (g) increased regulatory and
legal risk associated with unresolved TILA violations and payment processing problems; (h)
increased accounting risk, related primarily to the change of several of First USA's accounting
policies at the time of the Merger, including, in particular, the discontinuation of First USA's
expense capitalization and deferral practices; (i) increased reputation risk, including a loss of
credibility with investors, market analysts, the OCC and the SEC; j) increased financial reporting
risk; (k) that much of First USA's revenues in the period leading up to the Merger were being
accelerated (e.g., gains on securitizations) and exaggerated (e.g., booking ofunearned future late fees
and penalties, and without adjusting for the millions of dollars of refunds that First USA was
making); (1) that much of its expenses were being deferred (i.e., through the LLC), rendering the
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financial statements incorporated into the Registration Statement and Prospectus materially false, misleading and inaccurate.
245. These material misrepresentations and omissions , including Banc One's "opaque and inadequate" financial statements, to quote Bank One's present CEO, did not allow investors to see that First USA and Banc One had essentially traded any remaining prospect for future growth at First
USA, in exchange for short term profits needed to complete the Merger. When the effects of these decisions caught up to Bank One in the months immediately after the Merger, as surely they would, the financial statement impact to Bank One was more than one and a half billion dollars, including, inter alia::
amortization charges of more than $486 million related to First USA's pre- Merger capitalization of marketing expenses through the LLC;
asset write downs totaling more than $874 million, including:
a. $291 million related to First USA's purchased credit card relationships;
b. $181 million related to First USA's marketing partnership affinity agreements; and
c. $402 million related to First USA's interest only strips; and
a $183 million charge related to the adoption of the FFIEC's standardized bankruptcy charge-off notification policy.
K. Defendants Violated SEC Reporting Rules
246. At the time of the Merger, Defendants: (a) inflated the price of Bank One securities by publicly issuing materially false and misleading statements and/or failing to disclose material facts necessary to insure Defendants' statements were not misleading; and (b) materially misled First
Chicago shareholders in connection with the Merger. Defendants' statements and/or omissions were
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materially false and misleading because Defendants: (a) did not disclose material adverse information; and (b) misrepresented the truth about Bank One and its predecessor Banc One and their operational and financial performance, accounting, reporting, and financial condition, thereby violating SEC reporting rules and the federal securities laws.
247. SEC Rule 12b-20 and SEC Staff Accounting Bulletins 99, 100 and 101 require that periodic reports filed with the SEC contain information necessary to make the required statements, in light of the circumstances under which they are made, not misleading. In addition, and particularly since the recent highly publicized reporting scandals at companies such as Sunbeam,
Tyco, Waste Management, Enron and WorldCom, the SEC has been outspoken in condemning the practice of earnings management. A speech given by SEC Chairman Levitt in December 1998 identified eight separate financial reporting concerns that the SEC believed were undermining the
U.S. capital markets -- many or all of which were being employed by First USA and Banc One to manage Banc One's reported financial results in the period leading up to the Merger:
• Accelerating Recognition of Revenues (e.g., gains on securitizations)
• Adjusting of Timing of Operations (e.g., the numerous repricings)
• Use of Special Purpose Entities (e.g., the LLC and API)
• Capitalization Practices (e.g., deferral of marketing and affinity program expenses)
• Taking of Omnibus "Big Bath" Charges (e.g., booking the LLC as a Merger related expense and the 1999 fourth quarter charge)
• Aggressive Merger Practices (e.g., pooling of interest rather than purchase accounting treatment for the Merger)
• Booking of "Cookie Jar" Reserves (e.g., establishment of loan loss reserve cushions)
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• Use ofAccounting Materiality Thresholds to Ignore Qualitative Events (e.g., failure to disclose TILA class actions, the existence of customer refunds and increased scrutiny by the OCC)
248. Through use of the foregoing earnings management techniques, among others, First
USA and Bane One were able to create the continued appearance of earnings and growth at First
USA, misleading First Chicago shareholders into approving the Merger.
249. In addition, Item 303 of Regulation S-K (17 CFR §229.303(a)(3)(ii)) requires that, for interim periods, the Management's Discussion and Analysis ('MD&A") section of a prospectus must include, among other things, a discussion of any material changes in the registrant's results of operations with respect to the most recent fiscal year-to-date period for which an income statement is provided. Instructions to Item 303 require that the discussion identify any significant elements of the registrant's income or loss from continuing operations that do not arise from or are not necessarily representative ofthe registrant's ongoing business. Item 303(a)(2)(ii) to Regulation S-K requires the following discussion in the MD&A section of a company's publicly filed reports with the SEC:
Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in relationship shall be disclosed.
Paragraph 3 of the Instructions to Item 303 states in relevant part:
The discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition. This would include descriptions and amounts of (A) matters that would have an impact on future operations and have not had an impact in the past ... .
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250. Defendants violated the foregoing SEC disclosure rules by failing to disclose the existence of known trends, events and uncertainties regarding Bane One's and/or First USA's credit card operations and financial results that they reasonably should have expected would have a material, unfavorable impact on net revenues or income, or that were reasonably likely to result in the Company's liquidity decreasing in a material way. Defendants' failure to disclose known trends
(e.g., increasing attrition rates), events (e.g., change to rules based pricing) and uncertainties (e.g., payment processing overload and resultant contingent legal and regulatory liability) rendered the statements that were made in the Registration Statement and Prospectus materially false and misleading.
251. Additionally, Defendants failed to comply with SEC Rule 3-12 of Regulation S-X which required Defendants to discuss in the Registration Statement and Prospects any significant events or transactions that occurred between the time the Merger was announced (April 10, 1998), and the time that the Merger closed (October 10, 1998).
252. Had the truth about Bank One's critical credit card business and operations been disclosed, First Chicago shareholders would not have voted to approve the Merger at the specified exchange rate, if at all.
L. Defendants Violated Basic Tenets Of GAAP
253. GAAP consists of the principles , conventions , rules, and procedures which define accepted accounting practices at the particular time. Regulation S-X, to which the Company is subject as a registrant under the Exchange Act, 17 C.F.R. § 210 .4-01(a)(1), provides that, while compliance with GAAP is not a "safe harbor," financial statements filed with the SEC that are not prepared in compliance with GAAP are presumed to be misleading and inaccurate . SEC Rule 13a- 13
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requires issuers to file quarterly reports. SEC Rule 12b-20 requires that periodic reports contain information necessary to make the required statements, in light of the circumstances under which they are made, not misleading.
254. Defendants' SEC filings in connection with the Merger, including the Registration
Statement, the Prospectus, and the Forms 10-K and 10-Q (and other documents) incorporated therein by reference, stated the following in the Notes to the financial statements:
The consolidated financial statements for [Bank One], including its subsidiaries, have been prepared in conformity with generally accepted accounting principles.
255. Defendants' representations that these financial statements were prepared in accordance with GAAP were materially false and misleading for the reasons herein, and failed to conform to, inter alia, the following principles:
a. the principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events and circumstances that change resources and claims to those resources; Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Concepts ("SFAC") No. 1;
b. the principle that financial reporting should provide accurate information about an enterprise ' s financial performance during a period; SFAC No. 1, ¶42;
C. the principle that financial reporting should be reliable in that it represents what it purports to represent; SFAC No. 2, ¶¶58-59;
d. the principle of completeness ; SFAC No . 2, ¶¶79-80; and
e. the principle of conservatism . SFAC No. 2, ¶¶95, 97.
256. In addition, Banc One's SEC filings issued in connection with the Merger departed from generally accepted accounting principles requiring recognition of revenues and expenses and the matching of revenues with expenses, including the provisions of Accounting Principles Board
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Opinion No. 28, SFAC No. 5 (including, ¶¶55, 63-77, 83(a)-(b)) and SFAC No. 6 (including, ¶¶78-
79).
M. Defendants Violated 4CC Regulations
257. OCC Bulletin 98-3 provides safety and soundness guidance on how national banks
such as First USA should identify, measure, monitor and control risk associated with the use of
technology. OCC Bulletin 98-3 discusses how a national bank's use oftechnology related products,
services, delivery channels and processes exposes the bank to various risks, particularly transaction
risk, strategic risk, reputation risk and compliance risk, and requires national banks to ensure that they have an adequate internal control environment and systems in place to monitor and mitigate
these risks . The key controls required by OCC Bulletin 98-3 include adoption of formal internal
control guidelines, adoption of formal technology-related policies and procedures, appropriate
expertise and training of management information systems ("MIS") and other involved personnel,
a system of periodic testing of the internal control environment, adoption of a contingency and
business continuity plan, a clearly defined process and system of oversight for all outsourced processing, an internal audit system and some measure of quality control.
258. OCC Bulletin 98-3 also mandates that "banks must establish clearly defined
measurement objectives and conduct periodic reviews to ensure that goals and standards established by bank management are met." The Bulletin also cautions that technology concerns are "a particular concern" in any significant merger with other institutions or acquisition of other businesses, such as
Bane One's successive mergers with First USA, First Commerce and First Chicago. As the
allegations regarding First USA's payment processing problems going back to at least late 1997
demonstrate , Defendants violated numerous provisions of OCC Bulletin 98-3.
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259. In addition, Defendants violated OCC Bulletin 93-16 requiring banks to perform periodic reviews and valuations of their assets and write down any discovered impairment. The
Instructions to Schedule RC-M of the OCC Bulletin 93-16 provide that, "if unanticipated acceleration or deceleration of cardholder payments, account attrition, changes in fees or finance
charges, or other events occur that reduce the amount of expected future cash flows, a writedown of the book value of the purchased credit card relationships shall be made to the extent that the
discounted amount of estimated future net cash flows is less than the asset's carrying amount." By
not performing periodic valuations and reviews of its assets and by not promptly writing down the
value of First USA's assets when the attrition problem at First USA was first discovered and as it
continued through the date of the Merger, Bank One violated this OCC rule.
VII. INCORPORATION OF PRIOR ALLEGATIONS
260. While Lead Plaintiff has endeavored to include all of the allegations and claims in
this First Amended Consolidated Complaint that the Court previously upheld, Lead Plaintiff, in the
interest of being thorough, hereby adopts and incorporates by reference herein, each of the
paragraphs, allegations and counts set forth in the First Chicago NBD Plaintiffs' Consolidated Class
Action Complaint dated May 30, 2001. Furthermore, to the extent that anything in this First
Amended Consolidated Complaint could be deemed to expand the legal bases and scope of Lead
Plaintiff's claims, Lead Plaintiff hereby expressly limits its legal claims to those violations of the
securities laws previously upheld by the Court. Lead Plaintiff's intention in preparing this First
Amended Consolidated Complaint is to provide additional substantive support for the claims
previously pled, both to put Defendants on notice of Lead Plaintiff's factual theory of the case, and
to clarify the scope of relevant discovery.
103 Case 1 : 00-cv-00767 Document 180 Filed 10/17/2002 Page 109 of 117
COUNT I
Against Bank One for Violations of Section 11 of the Securities Act
261. Lead Plaintiff repeats and realleges each of the allegations set forth in the foregoing and subsequent paragraphs , as if fully set forth herein.
262. This Count is asserted against Bank One for violations of Section 11 ofthe Securities
Act, 15 U.S.C. § 77k.
263. The Registration Statement and Prospectus , and those documents and disclosures
incorporated by reference therein: were materially false and misleading; contained untrue statements
of material facts; omitted to state material facts necessary to make the statements made in the
Registration Statement and Prospectus, under the circumstances in which they were made, not
misleading; and/or failed to adequately disclose material facts. As detailed herein, the material
misrepresentations contained in, and/or the material facts omitted from, the Registration Statement
and Prospectus included, but were not limited to. (a) the overstatement and misrepresentation of
earnings at Banc One's credit card division; (b) the failure to disclose material information relating
to the purported growth of Banc One's credit card operations and the basis on which such growth
was achieved; and (c) the failure to disclose material risks associated with the billing, marketing,
pricing, accounting, securitization, and revenue and expense recognition and financial reporting
practices employed at First USA.
264. Bank One is the registrant for the shares issued pursuant to the Merger, and filed the
Registration Statement as the issuer of its common stock, as defined in Section 11(a)(5) of the
Securities Act.
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265. Bank One is the issuer of the common stock issued pursuant to the Registration
Statement. As issuer of such common stock, Bank One is liable to Lead Plaintiff and the members of the Class who exchanged First Chicago common stock for Bank One common stock in connection with the Merger, and pursuant to the Registration Statement and Prospectus.
266. Lead Plaintiff and the members of the Class each acquired, or purchased, Bank One common stock issued pursuant to the Registration Statement and Prospectus.
267. This action was brought within one year after the discovery of the untrue statements and/or omissions and within three years after Lead Plaintiff and the Class members acquired Bank One common stock in connection with the Merger.
268. By reason of the foregoing, Bank One violated Section 11 of the Securities Act and
is liable to Lead Plaintiff and the members of the Class, each of whom is entitled to relief and has
been damaged by reason of such violation.
COUNT II
Against the Individual Defendants for Violations of Section 11 of the Securities Act
269. Lead Plaintiff repeats and realleges each of the allegations set forth in the foregoing
and subsequent paragraphs as if fully set forth herein.
270. This Count is asserted against the Individual Defendants for violations of Section I 1
of the Securities Act, 15 U.S.C. § 77k.
271. The Registration Statement and Prospectus, and those documents and disclosures
incorporated therein by reference: were materially false and misleading; contained untrue statements
of material facts; omitted to state material facts necessary to make the statements made in the
105 Case 1:00-cv-00767 Document 180 Filed 10/17/2002 Page 111 of 117
Registration Statement and Prospectus, under the circumstances in which they were made, not misleading; and/or failed to adequately disclose material facts. As detailed herein, the material misrepresentations contained in, and/or the material facts omitted from, the Registration Statement and Prospectus included, but were not limited to: (a) the overstatement and misrepresentation of earnings at Banc One's credit card division; (b) the failure to disclose material information relating to the purported growth of Banc One's credit card operations and the basis on which such growth was achieved; and (c) the failure to disclose material risks associated with the billing, marketing, pricing, accounting, securitization, and revenue and expense recognition and financial reporting practices employed at First USA.
272. The Individual Defendants signed the Registration Statement and/or Prospectus, consented to being named therein as directors of Bank One, and caused them to be prepared, filed with the SEC and circulated to the public, including Lead Plaintiff and the members of the Class.
273. Lead Plaintiff and the members of the Class each acquired, or purchased, Bank One common stock issued pursuant to the Registration Statement and Prospectus.
274. This action was brought within one year after the discovery of the untrue statements and/or omissions, and within three years after Lead Plaintiff and the Class member acquired Bank
One common stock in connection with the Merger.
275. By reason of the foregoing, the Individual Defendants violated Section 11 of the
Securities Act and are liable to Lead Plaintiff and the members ofthe Class, each of whom is entitled to relief and has been damaged by reason of such violation.
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COUNT III
Against Bank One for Violations of Section 12(a)(2) of the Securities Act
276. Lead Plaintiff repeats and realleges each of the allegations set forth in the foregoing and subsequent paragraphs, as if fully set forth herein.
277. This Count is asserted against Bank One for violations of Section 12(a)(2) of the
Securities Act, 15 U.S.C. § 771(a)(2).
278. As set forth in the Registration Statement and Prospectus Statement, First Chicago shareholders received 1.62 shares of Bank One common stock for each share of First Chicago common stock they sold pursuant to the Merger. Bank One, acting through employees and others, including, but not limited to, the Individual Defendants, solicited such exchanges through the preparation and dissemination of the Registration Statement and Prospectus, and is a seller of securities.
279. The Registration Statement and Prospectus contained untrue statements of material facts, and concealed and failed to disclose material facts, as detailed above. Bank One, and its predecessor Banc One, its employees and agents, owed Lead Plaintiff and the other members of the
Class the duty to make a reasonable and diligent investigation of the statements contained in the
Registration Statement and Prospectus to ensure that such statements were true and did not omit material facts necessary to make the statements contained therein not misleading. Bank One, and its predecessor Banc One, in the exercise of reasonable care by its employees and agents, should have known of the misstatements and omissions contained in the Registration Statement and
Prospectus, as set forth above.
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280. By reason of the conduct alleged herein, Bank One violated Section 12(a)(2)of the
Securities Act. As a direct and proximate result of such violations , Lead Plaintiff and the members of the Class are entitled to relief and were damaged in connection with their exchange of First
Chicago common stock for shares of Bank One common stock, and hereby tender their securities or seek damages to the extent permitted by law.
COUNT IV
Against The Individual Defendants Under Section 15 of the Securities Act
281. Lead Plaintiff repeats and realleges each of the allegations set forth in the foregoing and subsequent paragraphs, as if fully set forth herein.
282. This Count is asserted against the Individual Defendants pursuant to Section 15 of the Securities Act.
283. Each of the Individual Defendants was a controlling person of the Company within the meaning of the Securities Act at the time of the Merger. At the time First Chicago was merged with and into Bank One and the Registration Statement and Prospectus were filed with the SEC, each of the Individual Defendants had the power and authority to cause the Company to engage in the wrongful conduct complained of herein, including the issuance of the false and misleading
Registration Statement and Prospectus.
284. None of the Individual Defendants made a reasonable investigation or possessed reasonable grounds to believe the statements contained in the Registration Statement and Prospectus were true and devoid of any omissions of material fact. Therefore, by reason of their positions of control over Bank One, as alleged herein, each of the Individual Defendants is jointly and severally
108 Case 1:00-cv-00767 Document 180 Filed 10/17/2002 Page 114 of 117
liable with, and to the same extent as, Bank One to Lead Plaintiff and the members of the Class as a result of the wrongful conduct alleged herein, and directly participated in and influenced same.
COUNT V
Against All Defendants for Violations of Section 14(a) of the Exchange Act and Rule 14a-9 Promulgated Thereunder
285. Lead Plaintiff repeats and realleges each of the allegations set forth in the foregoing and subsequent paragraphs, as if fully set forth herein.
286. This Count is brought pursuant to Section 14(a) ofthe Exchange Act, and Rule 14a-9 promulgated thereunder by the SEC.
287. Defendants violated Section 14(a) of the Exchange Act and Rule 14a-9 thereunder in that Defendants solicited proxies from Lead Plaintiff and the members of the Class by means of the Prospectus that contained statements which, at the time and in the light of the circumstances under which they were made, were false and misleading with respect to material facts, and omitted material facts necessary to make the statements therein not false or misleading.
288. As a result, Lead Plaintiff and the members of the Class were denied the opportunity to make an informed decision in voting on the Merger, and received a smaller stake in the combined
Company than they otherwise would have had Defendants disclosed the information.
289. Lead Plaintiff and the members of the Class are entitled to relief and have suffered damages as a result of the Merger, which was approved through use of a proxy in violation of
Section 14(a) of the Exchange Act and Rule 14a-9 thereunder.
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COUNT VI
Against the Individual Defendants Under Section 20 of the Exchange Act
290. Lead Plaintiff repeats and reallege each of the allegations set forth in the foregoing and subsequent paragraphs, as if fully set forth here.
291. This Count is brought pursuant to Section 20 of the Exchange Act.
292. Each of the Individual Defendants was a controlling person of the Company within the meaning of Section 20 of the Exchange Act at the time of the Merger. At the time First Chicago was merged with and into Bank One, and the Registration Statement and Prospectus were filed with the SEC, each of the Individual Defendants had the power and authority to cause the Company to engage in the wrongful conduct complained of herein, and directly participated in and influenced same, including the issuance of the false and misleading Registration Statement and Prospectus.
293. None of the Individual Defendants made a reasonable investigation or possessed reasonable grounds to believe that the statements contained in the Registration Statement and
Prospectus were true and devoid of any omissions of material fact. Therefore, by reason of their positions of control over Bank One, as alleged herein, each of the Individual Defendants is jointly and severally liable with, and to the same extent as, Bank One to Lead Plaintiff and the members of the Class as a result of the wrongful conduct alleged herein.
PRAYER FOR RELIEF
WHEREFORE, Lead Plaintiff, on its own behalf and on behalf of the Class, prays for judgment as follows:
110 Case 1:00-cv-00767 Document 180 Filed 10/17/2002 Page 116 of 117 1.
Confirming this action is a proper class action and confirming Lead Plaintiff as class representative under Rule 23 of the Federal Rules of Civil Procedure;
2. Awarding damages in favor of Lead Plaintiff and the members of the Class against all Defendants for the damages to which the Class is entitled as a result of Defendants' wrongdoing, together with interest thereon;
3. Awarding Lead Plaintiff the fees and expenses incurred in this action, including reasonable allowance for attorney and expert fees; and
4. Granting such other and further relief as the Court may deem just and proper.
JURY DEMAND
Pursuant to Fed.R.Civ.P. Rule 37(b), Lead Plaintiff demands a trial by jury,
Dated: October 17, 2002
-6 --<: :L- Lead Counsel for Plaintiffs
Elwood S. Simon, Esq. Arthur T. Susman, Esq. John P. Zuccarini, Esq. Charles R. Watkins, Esq. Michael G. Wassmann, Esq. John Wylie, Esq. Lance C. Young, Esq. Matt Heffner, Esq. ELWOOD S. SIMON & ASSOC., P.C SUSMAN & WATKINS 355 South Old Woodward Ave. Two First National Plaza Suite 250 20 South Clark Street, Suite 600 Birmingham, MI 48009 Chicago, Illinois 60603 Ph: (248) 646-9730 Ph: (312) 346-3466 Fx: (248) 258-2335 Fx: (312) 346-2829
111 Case 1 :00-cv-00767 Document 180 Filed 10/17/290 Page 117 of 117
Robert D. Allison, Esq. Marvin A. Miller, Esq. ROBERT D. ALLISON & ASSOCIATES Jennifer Winter Sprengel, Esq. 122 South Michigan Avenue, Suite 1850 MILLER FAUCHER & CAFFERTY, LLP Chicago, IL 60603 30 North LaSalle Street, Suite 3200 Ph: (312) 427-7600 Chicago, IL 60602 Fx: (312) 427-1850 Ph: (312) 782-4880 Fx: (312) 782-4485
Andrew M. Schatz, Esq. Edward Mills, Esq. SCHATZ & NOBEL, PC STULL, STULL & BRODY 330 Main Street 6 East 45th Street Hartford, CT 06106-1851 New York, NY 10017 Ph: (860) 493-6292 Ph: (212) 687-7230 Fx: (860) 493-6290 Fx: (212) 490-2022
Clinton A . Krislov, Esq. Scott W. Fisher, Esq. KRISLOV & ASSOCIATES, LTD. Brett Cebulash, Esq. Civic Opera Building, Suite 1350 Kevin Landau, Esq. 20 North Wacker Drive GARWIN, BRONZAFT, GERSTEIN & Chicago, IL 60606 FISHER, LLP Ph: (312) 606-0500 1501 Broadway, Suite 1416 Fx: (312) 606-0207 New York, New York 10036 Ph: (212) 398-0055 Fx: (212) 764-6620
Michael B . Susman, Esq. SPITZER ADDIS SUSMAN & KRULL 100 W. Monroe Street, Suite 1500 Chicago , IL 60603 Ph: (312) 372-0550 Fx: (312) 372-1789
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