Larry Romine, Et Al. V. Compuserve Corporation, Et Al. 96-CV-717-First

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PM/ UNITED STATES DISTRICT COttt - SOUTHERN DISTRICT OF OHIO EASTERN DIVISION

L..e. LARRY ROMINE, at al., on behalf : Ca P.,::.C2.-i.9.5.t7.1-Zu3. of themselves and all others e KinnearY) similarly situated, (Mag. Judge Xing) Plaintiffs, V. coMPUSERVE CORPORATION, et al., (Jury Trial Demanded) Defendants.

FIRST AMENDED AND CONSOUDATED CLASS ACTION_COMPLAINT Plaintiffs, by their attorneys, allege the following upon information and belief (based, inter alia, upon a review and analysis of documents filed with the Securities and Exchange commission, press releases, reports of securities analysts, news reports, and the investigation conducted by and. through Plaintiffs' counsel), except as to the allegations specifically pertaining to p laintiffs and their counsel. Plaintiffs believe that further substantial evidentiary support for the allegations set forth below will be available after a reasonable opportunity for discovery,

NATURE OF ACTION

1. This is a securities class action arising in connection with an initial public offering of common stock (the "Initial Public Offering" or "IPO"), by CompuServe Corporation ("CompuServe" or the "Company") at $30,00 per share pursuant to a registration

(1(2 statement (the "Registration Statement") and a prospectus (the "Prospectus") that were filed with the Securities and Exchange Commission (the "SEC") and became effective on or about April 18, 1996. The IPO raised $552,000,000 from the sale of 18,400,000 shares of CompuServe common stock at $30 per share. 2. Formerly a wholly-owned subsidiary of H&R Block, Inc. ("H&R Block"), CompuServe provides computer-based interactive services and data communications and is involved in the development of consumer on-line and Internet access services. The Company operates primarily through two divisions: "Interactive Services" which offers worldwide on-line and Internet access services for consumers; and ',Network Services" which provides worldwide network access, management and applications, and Internet services to businesses. (Prospectus at 3) 3. The Registration statement and Prospectus was false and/or misleading in at least the following respects. The Prospectus glowingly described CompuServe's proprietary software as its cornerstone. But, shortly after selling over 18 million shares of stock to the public at $30 per share, CompuServe announced a fundamental shift in its core business to becoming an Internet service provider using standard software protocols as opposed to its proprietary software. Consistent with this change, which was not disclosed until after the Offering, CompuServe recently announced the discontinuance of one of its showcase software services and an associated after-tax charge of $4.9 million.

-2- 4. Defendants failed in the Prospectus to inform investors that, contrary to the impressive statements in the Prospectus, the Company had experienced serious adverse business trends which were likely to materially impact its continuing operations. Defendants failed to disclose that increasing levels of cancellations and declining enrollment of now subscribers had and would likely continue to erode the Company's subscriber base; that the Company was under severe competitive pressure due to increasing use of cheaper direct access Internet services; and that there were serious problems, including design flaws, with the Company's new online service, WOWIsm 5. Defendants failed to disclose that CompuServe intended to substantially abandon its core business as an online proprietary content provider to become an open technology service provider to the world Wide Web (the "Red Dog Plan"). CompuServe was about to embark upon a strategy whereby access to its content would be open to Internet users, who did not even have to pay CompuServe, thus compounding CompuServe's business decline in the months preceding the Initial Public Offering and ensuring the business would continue to suffer as CompuServe went head to head with many, many competitors on the World Wide Web. such a significant change in the nature of its business was not something that could be developed in a month. Rather, while the industry has developed rapidly, such a drastic change in direction would have taken substantially longer to plan and initiate and thus was known to Defendants at the time of the IPO.

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_ • 6. As the truth about CompuServe's business became known to the marketplace, the price of the Company's stock fell precipitous- ly, and the Plaintiff and the other members of the investing public suffered damages. CompuServe shares now trade for about one third of the IPO price of $30.00, an aggregate market loss of over $350 million.

aURISDICTION_AND VENUE 7. The claims asserted herein arise under and pursuant to Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the ', securities Act") [15 U.S.C. 5577k, 77(a)(2) and 7703. 8. This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C. §51331 and 1337 and Section 22 of the Securities Act [15 U.S.C. 577v]. 9. Venue is proper in this District pursuant to Section 22 of the Securities Act, 28 u.s.c. 51391(b). Defendant CompuServe, the issuer, maintains its principal place of business in this District and the acts complained of in this action, including the preparation, issuance and dissemination of materially false and misleading information to the investing public, occurred in substantial part in this District. 10. In connection with the acts alleged in this Complaint, Defendants, directly or indirectly, used the mails and the means and instrumentalities of interstate commerce, including telephonic communications.

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_ _ PARTIES

Plaintiffs 11. Plaintiff Larry Romine purchased 200 shares of CompuServe common stock on April 19, 1996 at $30.00 per share and has been

damaged thereby.

12. Plaintiff Elaine F. Mason, as Executrix for the Estate of Allan Mason, purchased 1,000 shares of CompuServe common stock on

April 19, 1996 at $35.25 share and has been damaged thereby.

13. Plaintiffs Steven P. Ewing and Connie S. Ewing jointly purchased 300 shares of CompuServe common stock on April 19, 1996

at $35 per share and have been damaged thereby. 14. Plaintiffs Jere Settle and Linda Settle, joint tenants, purchased 100 shares of CompuServe common stock on April 18, 1996 at $30 per share and have been damaged thereby.

15. Plaintiff Dori Newell purchased 300 shares of CompuServe common stock on May 28, 1996 at $25,50 per share and has been

damaged thereby.

16. Plaintiff Vincent Scorese purchased 500 shares of CompuServe common stock on June 4, 1996 at $27.25 per share and has been damaged thereby.

17. Plaintiff Heather Kennedy purchased 100 shares of

CompuServe common stock on June 5, 1996 at $26,375 per share and has been damaged thereby.

18. Plaintiff Electa N. Savage purchased 200 shares of

CompuServe common stock on May 9, 1996 at $26,75 per share and 300

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_ shares of Compuserve common stock on May 24, 1996 at $23,25 per

share and has been damaged thereby. 19. Plaintiff Harry Savage purchased 500 shares of CompuServe common stock on May 8, 1996 at $26.00 per share, 300 shares of . CompuServe common stock on May 24, 1996 at $23.50 per share and 300 shares of CompuServe common stock at $23.375 per share and has been damaged thereby. 20, Plaintiff Allan Hepp per purchased 500 shares of CompuServe common stock on May 21, 1996 at $27.25 per share and has

been damaged thereby. 21. Plaintiff Guido sodige purchased 1,000 shares of

CompuServe common stock on May 7, 1996 at $27.50 per share and has

been damaged thereby.

22. Plaintiff James A. Acker purchased 400 shares of CompuServe common stock on may 31 7 1996 at $24.00 per share and 500

shares of compuServe common stock on June 5, 1996 at $24.125 per

share and was damaged thereby. 23. Plaintiff cyndi Scott purchased 400 shares of CompuServe common stock on April 19, 1996 at $34.25 per share and was damaged thereby.

24. Plaintiff Jeffrey Lynn purchased 2,000 shares of CompuServe common stock on April 19, 1996 at $34.50 per share and was damaged thereby. 25. Plaintiff Hunt McKenzie purchased 75 shares of compuserve common stock on May 8, 1996 at $26 1/4 per share and was damaged thereby.

-6- 26. Plaintiff Scott Dinhofer purchased 100 shares of compuServe common stock on April 19, 1996 at $34 1/4 per share and was damaged thereby. 27. plaintiff Paul McCormack purchased 200 *hares of CompuServe common stock on April 19, 1996 at $35 1/4 per share and was damaged thereby. 28. Plaintiff Rosemary Mize purchased 300 shares of CompuServe common stock on April 19, 1996 at $35 1/8 per share and was damaged thereby. 29. Plaintiff James Schwartz purchased 900 shares of

Compuserve common stock on April 19, 1996 at $30 per share, 1,000 shares of CompuServe common stock on May 22, 1996 at $25 5/8, and 600 shares of CompuServe common stock on May 28, 1996 at $23 per share, and was damaged thereby. 30. Plaintiff 1070125 Ontario, Ltd. purchased 2,800 shares of CompuServe common stock on April 19, 1996 at $35.00 per share and was damaged thereby. 31. Plaintiff Philip Silverglate purchased 2,000 shares of

compuServe common stock on June 6, 1996 at $25 1/8 per share and

2,000 shares of CompuServe common stock on June 7, 1996 at $27 3/8 and was damaged thereby. 32. Plaintiff Aimee P. Katz purchased 200 shares of CompuServe common stock on April 19, 1996 at $35.00 per share and was damaged thereby.

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33. Plaintiff Tishrei Trading purchased 100 shares of CompuServe common stock on June 11, 1996 at $25.50 per share and was damaged thereby. 34. Plaintiff Brian McCormack purchased 100 shares of compuserve common stock on April 19, 1996 at $34 5/8 per share and was damaged thereby. 35. Plaintiff Judy Szak purchased 500 shares of CompuServe common stock on July 3, 1996 at $21.50 per share and was damaged thereby. 36. Each of the Plaintiffs (identified in paragraphs 11-35) and other members of the Class acquired shares of CompuServe common stock pursuant to or traceable to the Registration Statement and Prospectus and the IPO.

Defendants 37. Defendant CompuServe is incorporated under the laws of the state of Delaware and maintains its executive offices at 500 Arlington Centre Boulevard, Columbus, Ohio 43220. CompuServe shares trade on the Nasdaq Stock Market under the symbol "CSRV." 38. (a) Each of the Individual Defendants (the "Individual Defendants") served, at times relevant to the claims set forth herein, as a director and/or as a senior executive officer of CompuServe as set forth below:

L.ame Position Richard H. Brown Chairman of the Board of Directors Robert J. Massey President, chief Executive Officer, Director

-8- Herbert J. Kahn Executive Vice President, Administration (Principal Financial Officer) Kenneth M. Marinik Treasurer and Corporate Controller (Principal Accounting Officer) Henry F. Frigon Director Roger W. Hale Director Morton I. Sosland Director

(b) Each of the Individual Defendants, individually or through an attorney-in-fact, signed the Registration Statement. (0) According to the Prospectus, all of the Company's current directors are "designees n of H&R Block. In addition, Richard Brown is the President and Chief Executive Officer and a director of H&R Block. Defendants Frigon, Hale, and Sosland also are directors of H&R Block. 39. Defendant H&R Block is a corporation organized under the laws of the State of Missouri. Its principal executive offices are located at 4410 Main Street, Kansas City, Miseouri. Prior to the consummatien of the IPO, H&R Block was the beneficial owner, through its wholly-owned subsidiary H&R Block Groep, of all of the shares of common stock of CompuServe. Upon completion of the IPO, H&R Block continued to own beneficially more than 80 of the outstanding common stock of Compuserve and, according to the Prospectus, "continue[d] to control the Company." 40. Defendant H&R Block Group, Inc. ( IIII&R Block Group"), a Delaware corporation, is a wholly-owned subsidiary of H&R Block. Prior to the consummation of the ipo, H&R Block Group was the record owner of all of the shares of common stock of CompuServe.

PLAINTIFFS' CLASS ACTION ALAgonoNs. 41. Plaintiffs bring this action as a class action pursuant to Rules 23(a) and (b)(3) of the Federal Rules of Civil Procedure, on behalf of themselves and a class (the "Class") of all persons who purchased shares of CompuServe common stock pursuant to or traceable to the Registration Statement and Prospectus dated April 18, 1996 and prior to July 16, 1996 (when the Company announced a projected loss for the quarter ended July 31, 1996 due, at least in part, to "flat subscriber growth" and a corporate restructuring). Excluded from the Class are Defendants herein; members of the immediate family of each of the Individual Defendants; the directors, officers, affiliates, subsidiaries and parents of Defendants CompuServe, HEAR Block, and H&R Block Group; any person in which any excluded person has a controlling interest; and the legal representatives, agents, heirs, successors-in-interest or assigns of any excluded person.

42. The members of the class are so numerous that joinder of all members is impracticable. CompuServe sold approXimately 1 18,400,000 shares of common stock to members of the investing

public pursuant to the IPO. The precise number of Class Irimbers is unknown to Plaintiffs at this time but Class members are believed to number in the hundreds, if not the thousands. In addition, the -10- ,

names and addresses of the Class members can be ascertained from the books and records of CompuServe and its underwriters in the IP0. 43. Plaintiffs will fairly and adequately represent and protect the interests of the members of the Class. Plaintiffs have retained competent counsel experienced in class action litigation

under the federal securities laws to further ensure such protection and intend to prosecute this action vigorously. 44. Plaintiffs , claims are typical of the claims of the other members of the Class. The damages suffered by Plaintiffs and all other Class members arise from and were caused by the same false and misleading representations and omissions made by or chargeable to Defendants. Plaintiffs do not have interests antagonistic to, or in conflict with, the Class.

45. A class action is superior to other available methods for the fair and efficient adjudication of this controversy. Since the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation Make it virtually impossible for individual Class members to seek redress for the wrongful conduct alleged. Plaintiffs know of no difficulty which will be encountered in the management of this litigation that would preclude its maintenance as a class action. 46. 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:

-11- (a) Whether the federal securities laws were violated by Defendants' acts as alleged herein; (b) whether the Registration Statement and Prospectus disseminated to the investing public in connection with the sale of CompuServe common stock in the Initial Public Offering omitted and/or misrepresented material facts about the Company; (c) Whether, at the time of the IPO of trends, events existed which were reasonably likely to have an impact on CompuServe's continuing operations; (d) Whether, at the time of the TPO, CompuServe and the Individual Defendants intended to abandon CompuServe's proprietary information network structure for a web-based open architecture; and (e) The extent of injuries sustained by members of the Class and the appropriate measure of damages. 47. The names and addresses of the record purchasers of CompuServe common stock pursuant to the IPO are available from CompuServe, its agents, and the underwriters who distributed CompuServe stock in the IPO. Notice can be provided to Class members by a combination of published notice and first-class mail using techniques and forms of notice similar to those customarily used in class actions arising under the federal securities laws.

FACTUAL ALLEGATIONS Events Prior To The Class Period and the Offering 48. On February 20, 1996, the Board of Directors of Defendant H&R Block unanimously voted to separate CompuServe from H&R Block. -12- ' . • .

Defendant Brownstated: The sepa ration of CompuServe will unlock the value we have created through both of these strong franchises and will better position each entity to aggressively pursue the significant growth opportunities in their respective markets." 49. On March 13, 1996 CompuServe introduced W0W1 814 , a supposedly powerful new consumer on-line service created specifically for at-home use. WOWOm is a proprietary content provider built by CompuServe from the ground up specifically for the at-home consumer market place. Defendant Massey had stated that WOW!"...is ideally positioned to gain an increasing share of the market." The introduction of Wowl sm and Massey's comments demonstrated to investors and the market that CompuServe was focused on growing as a proprietary software service provider.

The Inj.ial Public Offering

50.. Approximately 18,400,000 shares of CompuServe common stock were sold in the IPO pursuant to the Registration Statement

and Prospectus (including approximately 2.4 million shares sold pursuant to an over-allotment agreement with the underwriters) for $30.00 per share, yielding total proceeds of $552,000,000. The IPO was consummated on or about April 18, 1996. 51. $200,000,000 of the net proceeds of the IPO was to be Used to repay intercompany indebtedness owed by the Company to

another subsidiary of H&R Block. The Prospectus also stated that H&R Block had advised the Company that after the TPO H&R Block would no longer provide financing to CompuServe.

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52. Upon completion of the TPO, H&R Block continued to own approximately 80.1% of CompuServe's outstanding common stock. According to the Prospectus, H&R Block intended to distribute these shares to H&R Block's stockholders within approximately twelve months after the TPO.

Misrepresentations In and Omissions From The Prospectus Relating To CompuServe's New Business and Customer RICItion 53. In the section entitled "Managements's Discussion and Analysis of Financial Condition and Results of Operations: "Overview," the Prospectus states that: The Company's revenues have increased significantly over the last three years primarily because of the growth in subscriber count driven by the rapidly expanding narket for consumer on-lino and Internet Services, and because of Network Services revenue growth due to market and market share increases. (Prospectus at 16)(emphasis added)

54. The Prospectus states with respect to the Company's subscriber base: The Company has experienced rapid growth in its subscriber base. During 1995, the net number of the Company's and its licensee's subscribers grew by an average of 84,000 per month, and through the first nine months of 1996, at an average of 176,000 per month. One of the key components of increased subscriber growth is the extent to which those who try an online service remain customers. (Prospectus at 17)(emphasis added) 55. The Prospectus discusses subscriber retention levels as of January 31, 1996:

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1 I . At January 31, 1995, the Company has retained• approximately seven out of ten customers that had subscribed In the previous 90 days, six out of ten customers that had subscribed in the previous year, five out of ten customers that had subscribed in the previous two years and four out of ten customers that had subscribed in the previous three and four years. . (Prospectus at 17)(emphasis added) 56. The Prospectus states that the Company would improve its customer service to guard against customer attrition: To complement its expanded marketing efforts, CompuServe is investing in customer service to improve customer retention. During 1996, the Company is more than doubling its customer service personnel worldwide to over 1,500 representatives... These efforts are intended to reduce busy signals when customers call for assistance and enhance response time to customer questions. (Prospectus at 31) (emphasis added) 57. Tn the section of the Prospectus entitled "Subscriber Acquisition and Retention," the Company highlights its goal of promoting subscriber acquisition:

. . CompuServe employs a number of approaches to • position and strengthen the CompuServe brand in the consumer market place. The goal of these programs is to promote subscriber acgui- 1 sition, and build long term loyalty and in- • creased usage by providing the right combination of content and utility, customer support, • and pricing for the targeted market segments.. • (Prospectus at 30)(emphasis added) 58. Also, in the Management's Discussion under a section called "Crowth in Subscriber ease and Subscriber Retention," the Prospectus touts a new marketing effort in order to increase its

-15- subscribers to its proprietary online services and thus increase their profitability: The Company has recently begun a major new marketing and distribution effort to capital- ise on the growing-interest in online services and the Internet, budgeting nearly $180 million in 1996 for marketing and distribution, an increase of five fold over 1995. Major aspects of the new programs include substantial increases in distribution of trial software disks through direct mail and publication inserts. New CIS subscribers receive ten free hours of access in their first month. The Company believes that this industry-wide practice has been a significant factor in encouraging new signups. (Prospectus at 17)(emphasis added) 59. Each portion of the Prospectus referenced in TT 53-58 above, individually and when taken together, are materially false and misleading for at least the following reasons: (a) Defendants failed and omitted to disclose that since at least January 1996, the Company had been experiencing a significant reduction in subscriber retention rates that more than offset new subscriptions; that this trend was continuing; and could reasonably be expected to have a material adverse impact sales, revenues and income from continuing operations; (b) Defendants failed and omitted to disclose that competitive pressure from cheaper direct Internet access providers had eroded CompuServe's subscriber base; was continuing to erode CompuServe's subscriber base; and would likely have a material adverse impact sales, revenue or income from continuing operations; and

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(0) Defendants misrepresented that marketing efforts and additional capital commitments were necessary to help expand CompuServe's subscriber base when, in fact, due to severe competitive pressure, the increased marketing efforts were actually needed to stop the continuing erosion in CompuServe's undisclosed declining subscriber base. 60. CompuServe's Form 10-K for the fiscal year ended April 30, 1996, which was only twelve days after the date of the IFO, confirms these non-disclosures and misrepresentations. The Form 10-K, which Defendants caused to be filed with the SEC and publicly disseminated on or about ,luly 31, 1996, reveals that between the end of January and the end of April, 1996, CompuServe's 90 day retention rate had dropped more than 14% from 70% to 60%. The one year retention rate also dropped, falling from 60% to 50%. The difference between the reported and actual retention rates would have been material to an investor when evaluating whether or not,to invest in CompuServe. The materiality of Defendants' failure to

disclose CompuServe's eroding subscriber base is confirmed by the fact that by the quarter ended September 30, 1996, CompuServe's 90- day retention rate had continued to fall further to 55% and its one-year rate had plunged to 36%.

Misrepresentations In and Omissions From The Prospectus Relating To ^pmuServe',s Core Business Plan 61. In the Prospectus summary (at page 3), under a section called "The Company-overview," CompuServe is describes itself as a worldwide leader in the rapidly growing market for computer-based -17- 1

interactive services and data communications and is pioneering the development of consumer online and Internet access services . ." 62. The prospectus Summary represents that CompuServe believes its online proprietary services to be preferred by customers over an Internet access only service: The CompuServe Information Service ("CIS"), the Company's flagship product, offers tradi- tional online services and integrated Internet access. Through SPRYNETsm, the Company also offers a stand-alone Internet access-only service. Management believes consumer online services are a preferred access vehicle to the Internet for the average user due to the ability of the online services to focus and aggregate content and provide centralized billing and support. Management also believes the CompuServe's business networking experi- ence and infrastructure position it to be a leader in the commercialization of the Inter- , net. (prospectus at 3) (emphasis added). 63. At page 4, in the section captioned "strategy," the prospectus explicitly states that CompuServe's intent was to expand upon its core business as an on-line content provider: The Company's goal is to continue to lead in the development and implementation of personal and commercial applications with computer- based interactive technology. The Company baseintends for consumerto aggressively on-line growand Xnterriet its subscriber services, to expand its market position in the corporate networking sector and continue to seek opportun,iti'es to increase the value or the nev medium of computer-based interactive technology to individuals and businesses. (Prospectus at 4) (emphasis added) 64. The prospectus emphasizes the importance of CompuServe's proprietary software in a section entitled, "Rapidly Changing

-18- Markets and Technology," in which Defendants state at p.9, that, "[a]n integral part of the company's technology is its proprietary software." 65. With regard to the Company's new consumer online service, "WOW! sm", which CompuServe introduced in March 1996 as a crucial part of its effort to attract new subscribers, the Prospectus again reinforces the theme that CompuServe's main business focus was its proprietary online software and services: The on-line services market is expanding rapidly-to include an increasingly large group of inexperienced and occasional home PC users who, management believes, do not desire or need the breadth, depth or sophistication of the CIS service. In March 1996, the Company launched the WOW! service ("WOW!") , a new consumer on-line service targeted to the home market. WOW! employs a unique navigation structure to organize proprietary and Internet content in an intuitive, easy to understand manner that makes the underlying technology transparent to the user- The Company has applied for a patent on the WOW! navigation structure. ( prospectus at 25)(emphasis added) 66. The Company's strategy and plans for increasing profitability through developing proprietary software and online services is repeated throughout the Prospectus. "or instance, in Manag- ement's Discussion, under a section called "Pricing," the Prospec- tus states: In September 1995, CompuServe introduced a new pricing schedule intended to encourage subscribers to explore more features of the service and stay on the service longer, and to increase cIS's price competitiveness with the other major consumer online services. The new pricing schedule has reduced revenue per

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1 subscriber but has contributed to significant increases in subscriber acguisitions and usage • which management believes will support long-- term customer loyalty, (Prospectus at 16) (emphasis added) 67. In the main section of the Prospectus, at pages 24-30, the Company, in further detail, sets forth an overview of substantially the same issue addressed in the Summary, i.e., the Company's operations, services, products and strategy. In particular, the Prospectus touts the Company's software, CIM, WOW! sm and Sprynet", a proprietary software to access the company's information and other services, which are current and were supposed to be periodi- cally upgraded. 68. The Prospectus, at pages 28-29, discusses CompuServe's products and services and positively projects the future potential - for its proprietary online services and their technology: Online services and the Internet are revolu- tionizing communication by linking together individuals around the globe at modest cost through e-mail, electronic bulletin boards and online discussions. These communication applications are the single greatest use of the CIS service, an area which management believes has significant potential for expan- sion through creative deployment of technolo, gY- (emphasis added) 69. The Prospectus then, under the heading "Information," discusses the advantages of CIS and the Company's role as a propriety online service provider: CompuServe makes available to the mass market a vast universe of information on CIS and Internet. Because of the medium's unique

-20- characteristics, online information is capable of being updated and expanded on a teal-time basis. Management believes that Cis offers the broadest and deepest array of content In the consumer online industry, which is now augmented by information available on the Internet which may be accessed through either ciS or SPRYNET. CIS provides subscribers local and worldwide news, sports and financial information, North American and international newspapers and periodicals and, via gateways to hundreds of other data bases, extensive reference resources. Management believes CIS is the preferred source for computing' information and support among online and Internet users. The Company provides extensive data- bases of computer oriented information and offers the largest number of support areas dealing with computer hardware and software of any online service. * *

The company views its role as a content aggre- gator to be one of its principal value-added functions. In this role, the Company not only identifies information of interest to subscribers, but also develops software applications to facilitate manipulation of that information and communication applications that facilitate the exchange and understanding of information. (Prospectus at 29) (emphasis added). 70. The Prospectus, at page 32, states that with respect to one of CompuServe's proprietary online services, ". • the Company expects to introduce CIM 3.0 which will have an easier to use graphical interface, integrated Internet access . . and upgrade- able modules." (Emphasis added). 71. The Prospectus, at page 36, in the Company's discussion about competition, states: The Company believes that its extensive existing network infrastructure and reliability, breadth and depth of content for CIS, brand

-21- name recognition and large user base have been its competitive advantages in the consumer online services industry. Recent changes to the Company's pricing- structure, the introduction of woorin and CIM 3. 0, and cngtomer care initiatives are intended to enhance the COMpa- fly's position as a leader in the consumer online industry... (Emphasis added) 72. The Prospectus, under the section entitled "Risk Factors," with respect to WOWI sm also states that: The Company has invested, and will continue to invest, substantial amounts of capital in the research, development, marketing, distribution and support of wOwi (Prospectus at 9) 73. Each portion of the Registration Statement and Prospectus and the statements therefrom, referenced in 55 61-72 above, individually and taken together, are materially false and/or misleading for at least the following reasons: (a) Defendants failed and omitted to disclose that increasing subscriber defections to the World Wide Web and decreasing new subscriptions were having a material adverse affect on CompuServe and would negatively impact the Company's sales, revenues and profitability from continuing operations. (b) Defendants failed and omitted to disclose that cheaper alternative direct access Internet-based providers had eroded CompuServe's customer base; were continuing to erode CompuServe's subscriber base; and would likely negatively impact the Company's sales, revenues and income from continuing operations.

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. . (0) Defendants failed and omitted to disclose that existing design flaws in WOWOm jeopardized market acceptance of CompuServe's new service and would negatively impact related sales and revenues. (d) Defendants failed and omitted to disclose that CompuServe was already planning to abandon its core proprietary content provider business and move to an unproven, highly risky open Internet-based system, which was reasonably foreseen to have a material adverse impact on CompuServe's sales, revenues and income from continuing operations. (e) Defendants failed and omitted to disclose that the increased costs associated with the implementation of the Company's planned but undisclosed Internet software services would have a materially adverse impact on CompuServe's income from continuing operations.

, (f) Defendants failed and omitted to disclose that Comp- userve's information content providers were increasingly defecting to the World Wide Web and away from proprietary services such as CIS and that providers that had stayed with CompuServe were increasing prices significantly, and that this had and would likely continue to have a material adverse impact on CompuServe's profitability from continuing operations; and (g) Defendants failed and omitted to disclose that CompuServe had not committed to spend enough to properly support and ensure the successful introduction or ongoing viability of WOW! .31w

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, Events Subspapent To The_IEg 74. Events after the CompuServe IPO confirm the materiality of the facts concealed from investors by Defendants and support the conclusion that these facts were in existence at the time of the IPO. 75. Less than one week after the IPO, on or about April 23, 1996, CNET Inc., a closely watched computer industry news service published on the Internet, issued a review panning w0w1 8M , Compu- Serve's new on-line service. CNET cautioned consumers that: Judging from Wow's interface, its designers must think that average people spend their lives watching Nickelodeon. Large typefaces and a cartoonish feel may be comforting for those who don't yet clutch their mouse with confidence, but others will find Wow more condescending than accessible. A couple of design flaws may deter you from signing up for the service. First, when you navigate through Wow's service, you'll notice that the Back button jumps all over the place, which quickly becomes irritating. And the email software integrated into the Wow interface won't let you type in an email address--you must first enter the address into an address book through a lengthy, button-heavy process. [Emphasis added] 76. On or about May 15, 1996, less than 30 days after completion of the IPO, CompuServe announced the departure of its Chairman, Richard M. Brown; and admitted that it was abandoning a substantial part of its business positively described only one month earlier in its Prospectus. On May 21, 1996, the Associated Press reported that Compuserve would give up its customized operation and instead produce, sort and present information in the same manner as the World Wide Web, According to the Associated

-24- 1 Press report, future developments by CompuServe would be on software that is tightly integrated with the World Wide Web. 77. Peter Krasilovsky, senior analyst with Arlen Communica- tions, stated on or about May 21, 1996 that the change in Compu- Serve's business (which was not disclosed in the Prospectus) meant that "CompuServe [was] going to transform itself into a billing and collection agency" -- in essence, fundamentally transforming itself

into a completely different type of company than the one sold pursuant to the Prospectus to investors only one month earlier.

78. On May 22, 1996, an article in The Washington 'East stated: CompuServe Inc., the granddaddy of the consumer on-line industry, is trying again to bring back lost leadership; It announced yesterday that it will start moving away from its pri- vate service by year end and put material directly on Internet's World Wide Web. (Em- phasis added) 79. The stock market reacted sharply to these announcements. CompuServe's stock price fell $1.25 the following day and continued down to close at $20.75 per share on June 26, 1996, a drop of more than 30% from the Public Offering price of $30 per share only two months earlier. It is apparent that had Defendants disclosed in the Prospectus the adverse facts detailed herein, Defendants would not have been able to sell CompuServe stock in the Initial Public Offering for the $30 per share offering price.

80. An article in The Washington Post on May 22, 1996 reported comments that the drop in CompuServe's stock price was due to fears that the Company's move to the Web will be costly and that

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; "it won't he easy for CompuServe to maintain its proprietary service while making content available on the Web." 81. On or about June 18, 1996, CompuServe released results for the fourth quarter and fiscal year ended April 30, 1996. The Company reported a net loss for the quarter of $1.1 million, or $.02 per share. The Company stated that the number of its domestic cis subscribers was "relatively stable," but that it would "significantly step up marketing efforts for CIS within the next month."

Disclosures of the Major Shift in the Nature of CompuServe's Business and The Projected Losses of the Company 82. One month later, on or about July 16, 1996, CompuServe

finally admitted "that flat subscriber growth w..1.thin on-line services, coupled with continued investments in the introduction of wowl w and infrastructure improvements, will result in a projected loss from operations in the range of $.15 to .20 per share for the quarter ended July 31" (emphasis added). The Company acknowledged that new subscriber growth had stalled at 3.4 million customers from the end of April, when it went public, to the end of June 1996, and that CIS subscribers actually decreased "slightly more than one percent" during the two-month period. The Company acknowledged a higher level of cancellations from recent subscribers and that there were problems with respect to speed of service, difficulty in navigation, and a large number of users experimenting with on-line Internet services. The Company announced "major

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, ,

upgrades" to CIS and WOW! I" (which had been introduced only a few months earlier in March) to "simplify browsing CompuServe and the Internet and speed up user operations" and disclosed that it was taking a "number of actions" to reduce costs, eliminate under- performing assets, and improve profitability for the remainder of the year.

Disclosures Following the July 16th p_jIscostawe in CompuServe 83. In an article published the next day, July 17, 1996, The

WiLgitmLlat_ggErnol reported that the anticipated loss announced by CompuServe "stunned Wall Street, which had been expecting a moderate profit gain in the quarter ending July 31." According to The Wall Street aournal, CompuServe disclosed that an equal number of subscribers are dropping the service as are signing up and that the rate of subscribers dropping CompuServe rose to 34t in the most recent quarter from 29% in previous quarters. An analyst at Bear Stearns was quoted as stating: "1 was pretty stunned. That's a big surprise. That kind of churn rate is higher than expected." 84. The same day that CompuServe announced a projected loss of as much as $.20 per share for its first fiscal quarter as a public company, H&R Block separately announced that its 8oard of Directors had approved plans to proceed with the spin-off of HSER Block's remaining 80.1% interest in the Company to be completed on or about November 1, 1996_ 85. On August 20, 1996, CompuServe further jolted the investment community when it disclosed that a decline in subscriber

-27- growth, continued WOW! sm investment and infrastructure costs contributed to a first quarter loss of $.32 per share, including a one time charge of $.13 per share. These results were a reflection of a decline in total subscribers and decreased revenues per subscriber. CompuServe also disclosed that it anticipated a loss of $.10 to $.15 per share for the second quarter, ended October 31, 1996. 86. On August 21, 1996 in an article carried over the Reuters Financial Service, Adam Schoenfeld, Vice President of Jupiter Communications, reported that CompuServe's move of its services to the open architecture of the Internet was "... a strategic decision to abandon their profitable model and they are now paying a price for that." 87. The market price of CompuServe stock continued to drop steadily. On July 15, 1996, CompuServe shares closed at $15.50. After the August 20, 1996 announcement, the trading price of CompuServe stock fell a further $1 5/8 per share, on unusually high volume, to close at $11.875 per share -- down more than 60% from the $30 IPO price at which such shares were sold on the IPO just three months earlier. 88. On October 22, 1996, CompuServe announced that its second-quarter loss would be double the size it had originally estimated. The Company announced that it expected a loss of $.22 to .27 per share, compared with the previously announced loss of $.10 to .15 per share. This news sent CompuServe stock tumbling nearly 12 percent, down $1.25 to an all time low of $9.25,

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89. While extolling the virtues and power of woW0 m, Defen- dants failed to disclose in the Prospectus that woWi sm 's information content was woefully sparse, containing nowhere near the depth of information available regularly on CompuServe, which significantly limited the potential market. In a press release issued November 21, 1996, CompuServe revealed that its W0141 814 service would be withdrawn from the market as of January 31, 1997. 90. on November 22, 1996, in an article in the Financial Times Defendant Hassey finally admitted: "Like others in the industry, we are bringing users in the front door and seeing many go out the bacX-"

91. The Hew York Times, on November 22, 1996, quoted Massey

• as saying that CompuServe no longer had any stomach for the "bloodbath of spending and churn" in the business. These are material facts, or reasonably foreseeable consequence of material facts, that were concealed by Defendants and omitted from the Prospectus. Had Defendants disclosed that the Company planned to shirt its strategy to direct competition on the World Wide web; that WOW! mq had design flaws; that subscriber churn rates were accelerating; that subscriber retention rates were declining; and/or that Defendants intended to fundamentally change the nature and manner in which CompuServe operated, individually or taken together, Defendants could not have sold shares pursuant to the IPO at $30.00 per share.

-29- COUNT I [Against CompuServe And The Individual Defendants or Violations of section 11 of The Securities Act] 92. Plaintiffs repeat and reallege each and every allegation contained above. 93. This Count is brought by Plaintiffs pursuant to Sec- tion 11 of the Securities Act, 15 U.S.C. §77k, on behalf of the Class against CompuServe and the Individual Defendants. 94. The Registration statement, which incorporated the Prospectus, was inaccurate and misleading, contained untrue statements of material facts, omitted material facts required to be stated therein and omitted other facts necessary to make the statements made not misleading. 95. CompuServe is the registrant for the shares sold to

• Plaintiffs and other members of the Class and as an issuer of the shares, CompuServe is strictly liable to Plaintiffs and the Class for the material misstatements or omissions attributed to the Registration Statement and Prospectus. 96. Each of the Individual Defendants, either personally or through an attorney-in-fact, signed the Registration Statement and

was a director and/or senior executive of CompuServe at the time of the IPO. 97. The Defendants named herein were responsible for the

contents and dissemination of the Registration Statement and the Prospectus. The Individual Defendants named herein failed to make a reasonable investigation of, or possessed reasonable grounds for

-30- believing that statements contained in the Registration statement and Prospectus were untrue or omitted material facts. 98. Plaintiffs a.cguired shares of CompuServe issued pursuant or traceable to the Registration Statement. 99. Plaintiffs and the Class have sustained damages. The market value of the Company's shares has declined substantially since Defendants' violations. 100. At the times they purchased the Company's shares, Plaintiffs and other members of the Class did not know of the wrongful conduct alleged herein and could not have reasonably discovered such facts.

COUNT II

[Against CompuServe, JUR Block And li&R Group For Violations Of Section 12 (a) (2) Of The Securities Act] 101. Plaintiffs repeat and reallege each and every allegation contained above.

102. This Count is brought by Plaintiffs pursuant to Sec- tion 12 (a) (2) of the securities Act, 15 t.T. S . C. §771 (a) (2 ) , behalf of the Class against Defendants CompuServe, ri&R Block and ll&R Block Group. 103. The statements referred to herein above were each made in a "prospectus', as that term is defined in Section 2()(10) of the Securities Act, contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading, and concealed and failed to disclose material facts. The actions of the Defendants named in this Count solicited

-31- 7 the sale of shares of CompuServe common stock in the Initial Public Offering for their personal financial gain. Those actions included participating in the preparation of the materially false and misleading Prospectus and other materials used in the sale of CompuServe common stock. 104. The Defendants owed to the purchasers of the company's shares, including Plaintiffs and other members of the Class, the duty to make a reasonable and diligent investigation of the statements contained in the Prospectus and other offering materials to insure that such statements were true and that there was no omission to state a material fact required to be stated in order to make the statements contained therein not materially misleading. 105. The Defendants named in this Count sold and/or solicited the sale of the Company's common stock offered pursuant to the Prospectus and Registration Statement for their individual financial gain, including the following: (a) The Company received proceeds of approximately $521,640,000 from the successful completion of the TPO, which, among other things, provided the company with needed capital to operate independently of H&R Block;

(b) Successful completion of the IPO enabled the Company to repay intercompany indebtedness of approximately $200,000,000 owed by the Company to another subsidiary of H&R Block; and (0) lig5iR Block obtained repayment of its $200,000,000 loan to CompuServe and, by facilitating the IPO and the subsequent

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spin-off of its remaining interest in CompuServe, eliminated the need to make further expenditures on CompuServe. 106. Plaintiffs and other members of the Class purchased or otherwise acquired the Company's common stock pursuant to and traceable to the Prospectus. Plaintiffs did not know, or in the exercise of reasonable diligence could not have known, of the untruths and omissions contained in or made in connection with the 1 Prospectus. 107. Plaintiffs and other members of the Class have sustained injury and suffered damages, 108. By reason of the conduct alleged herein, the Defendants named in this Count violated Section 12(a)(2) of the Securities Act. Accordingly, Plaintiffs and members of the Class who hold the Company's shares have the right to rescind and recover the consideration paid for the company's shares and hereby elect to rescind and tender their shares of the Company to the Defendants sued herein. Class members who have sold their shares of Compu- Serve are entitled to rescissory damages,

COUNT III [Against The Individual Defendants, H&R Block, And H&R Block Group Pursuant To section 15 Of The Securities Act] 109, Plaintiffs repeat and reallege each and every allegation contained above.

110. This Count is brought by Plaintiffs pursuant to Sec- tion 15 of the Securities Act, 15 U.S.C. §77o, on behalf of the

-33- Class against H&R Block, H&R Block Group, and the Individual Defendants. 111. CompuServe is liable as an issuer under Section 11 of the Securities Act and as a seller under Section 12(a)(2) of the Securities Act as set forth in Counts T and IT herein. 112. Each of the Individual Defendants was a control person of the company with respect to the TPO by virtue of his position as a senior executive officer and/or director of the Company. 113. H&R Block and H&R Block Group were control persons of the Company with respect to the IPO by virtue of their ownership at the time of the Initial Public Offering of a majority of the outstanding common shares of the Company and their control of the Company's Board of Directors. In addition, H&R Block was a control person of H&R Block Group by virtue of its ownership of all of the outstanding shares of H&R Block Group. 114. As a result, the Defendants named in this Count are liable under Section 13 of the Securities Act for CompuServe's primary violations of Sections 11 and 12(a)(2) of the Securities Act. In addition, H&R Block is liable under Section 15 of the Securities Act for H&R Block Group's primary violations of Section 12(a)(2) of the securities Act.

JURY DEMAND Plaintiffs hereby demand a trial by jury.

-34- : PRAYER FOR RELIEF WHEREFORE, Plaintiffs pray for judgment as follows: 1. Declaring this action to be a plaintiff class action properly maintained pursuant to Rule 23 of the Federal Rules of Civil Procedure and certifying Plaintiffs as class representatives and their counsel as Class counsel; 2. Awarding Plaintiffs and the Class damages in accordance with Section 11 of the Securities Act on Count I and count III; 3. Awarding Plaintiffs and the Class rescission and damages in accordance with Section 12(a)(2) of the Securities Act on Count II and Count III; 4. Awarding Plaintiffs and the class interest and the costs and expenses of this litigation, including reasonable attorneys' fees, and experts' fees, and other costs and disbursements; and

5. Awarding Plaintiffs and other members of the Class such other and further relief as may be just and proper under the circumstances.

Dated: February çt1997

STRAUS & TROY

By: fr I Richard e . W-1The (0022390) William K. Flynn (0029536) Allan Jefferson Fossett (0042014) 2100 PNC Center 201 East Fifth Street Cincinnati, OH 45202 (513) 621-2120

-35- David J. Bershad Richard H. Weiss Joseph Opper MILBERG WEISS BERSHAD HYNES & LERAcH LLP One Pennsylvania Plaza, 49th Fl. New York, NY 10119-0165 (212) 594-5300 David A. P. Brower Shane T. Rowley WOLF, HALDENSTEIN, ADLER, FREEMAN & HERZ 270 Madison Avenue New York, NY 10016 (212) 545-4600 CO-LEAD COUNSEL FOR PLAINTIFFS Steven E. Cauley STEVEN E. CAULEY, P.A. 400 West Capitol Suite 1700 Little Rock, AR 72201 (501) 375-1200 Robert S. Schachter Joseph Lipof sky ZWERLING, SCHACHTER & ZWERLING, LLP 767 Third Avenue New York, NY 1001/-2023 (212) 223-3900 Peter Lagorio GILLMAN & PASTOR 28th Floor One Boston Place Boston, MA 02108 (617) 589-3730 Glen DeValerio BERMAN, DEVALERIO & PEASE One Liberty Square Boston, MA 02109 (617) 542-8300

-36- Sandy A. Liebhard BERNSTEIN LIEBHARD & LIFSHITZ 274 Madison Avenue New York, NY 10016 (212) 779-1414 John Hinton, IV APPEL, CHTTWOOD & HARLEY 1400 Resurgens Plaza 945 E. Paces Ferry Road Atlanta, GA 30326 (404) 266-1650 Jonathan M. Plasse GOOOKIND LABATON RUDOFF & SUCHAROW 100 Park Avenue New York, NY 10017-5563 (212) 907-0700 Deborah R- Gross LAW OFFICES OF BERNARD M. GROSS, P.C. 1500 Walnut Street - Sixth Floor Philadelphia, PA 19102 (215) 561-3600 James E. Tullman WEISS & YOURMAN 10940 Wihshire Blvd., 24th Floor Los Angeles, CA 90024 (310) 208-2800 Curtis V- Trinko LAW OFFICES OF cURTIS V. TRIM, LLP Suite 1401 310 Madison Avenue New York, NY 10017 (212) 490-9550 Jeffrey R. Xrinsk JEFFREY R. KRINSK, APLc 501 West Broadway, Suite 1250 San Diego, CA 92101 (619) 238-1564 ATTORNEYS FOR PLAINTIFFS

45.688.1122W1W2

-37- , ,CERTIFICATE OT.JEgME

hereby certify that a true and correct copy of the foregoing First Amended and Consolidated Class Action Complaint was served by telecopy and Federal Express ."' upon the following counsel this 6- day of February, 1997: Frances Floriano Goins, Esq. SQUIRE, SANDERS & DEMPSEY 4900 Society Center 127 Public Square Cleveland, Ohio 44114-1304

Michael P. Colley, Esq. MICHAEL F. COLLEY CO. L.P.A. Hoster & High Building 536 South High Street Columbus, Ohio 43215-5674

, I : 7 Ile'r 04.4 Richard S. ityne

45688$9.2.18170412

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