cHP\RL0TTE '4.
Ff iOOü' UNITED STATES DISTRICT COURT 0STRCT COURT WESTERN DISTRICT OF NORTH CAROLINAj. S. CHARLOTTE DIVISION 'N. 01ST. OF N. C. 3 :99CV237-MCK
IN RE: THE FIRST UNION CORP. SECURITIES LITIGATION
CONSOLIDATED AND AMENDED CLASS ACTION COMPLAINT
Plaintiffs, by and through their attorneys, allege the following based upon, among other things, the investigation of their attorneys, which included: (a) review and analysis of public filings made by First Union Corporation ("First Union" or the "Company'), with the
Securities and Exchange Commission (the "SEC"); (b) interviews with former employees of First
Union; (c) review and analysis of securities analysts' reports concerning First Union; (d) review and analysis of First Union press releases and reports and articles about First Union and/or the individual defendants in the financial and general press; (e) review and analysis of other publicly available information about First Union; (0 review and analysis of First Union financial statements and reports; and (g) consultation with certified public accountants. Plaintiffs believe that further substantial evidentiary support for the allegations will be uncovered after a reasonable opportunity for discovery. Many additional detailed facts supporting the allegations contained herein are known only to defendants or are within their exclusive possession and control.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 1 of 64 NATURE OF THE CASE
1. This is a class action on behalf of purchasers of the common stock of First
Union, a nationwide banking and financial services provider, between August 14, 1998, and May
24, 1999, inclusive (the "Class Period"). Plaintiffs' claims arise under Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934 (the "Exchange Act") and SEC Rule lOb-5.
2. During the Class Period, the individual defendants made statements, and
caused First Union to make statements in public filings and press releases, trumpeting the
success of the Company's massive acquisition program, in particular the $20 billion acquisition of CoreStates Financial Corporation ("CoreStates") and over $2 billion acquisition of The Money
Store, Inc. ("The Money Store"). According to these defendants - who were the top officers and managers of the Company - First Union had successfully implemented the "integration" of the acquired businesses and operations of CoreStates and The Money Store into First Union's existing operations, resulting in substantial operating savings and increased efficiencies that were and would continue to result in increased earnings and profitability.
3. In fact, as defendants knew or recklessly disregarded, the acquisition program was a debacle. First Union was experiencing severe and costly problems in virtually every area of its day-to-day business operations in connection with integrating and consolidating its acquisitions, including the loss of hundreds of thousands of customers. These undisclosed problems included: credit card discrepancies, computer crashes, incorrect billing statements, failure to complete corporate customers' payrolls, losing checks, wiring currency transfers in incorrect amounts, losing information about customer accounts, assigning incorrect numbers to customer accounts, and depriving customers access to their accounts electronically.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 2 of 64 4. These integration problems were more than simply a headache for First
Union. According to an August 16, 1999, article in The Morning Call, First Union lost 400,000,
or 20%, of CoreStates' 2 million customers due to service-related issues resulting from the merger. Similarly, the costs resulting from these integration and conversion problems had a material adverse effect on the Company's profitability.
Defendants' also engaged in accounting manipulations to inflate reported pretax earnings in violation of generally accepted accounting principles ("GAAP"). In particular, defendants failed to properly adjust on First Union's 1998 financial statements the value of certain securitized interests in portfolios of siibprirne home equity loans originating from The
Money Store. As a result, 1998 pretax earnings were overstated by at least $79 million.
6. In order to inflate and maintain the market price of First Union's common stock, the defendants not only failed to disclose the major logistic and financial obstacles First
Union was encountering in integrating its acquisitions and the material impact of those obstacles on its bottom line earnings and profitability, but also falsely represented that the acquisitions were, and would continue to add to First Union's earnings and profitability. Among other fraudulently misleading representations, defendants:
(a) repeatedly misrepresented the progress and success of the integration of the acquired companies;
(b) publicly touted a 1999 earnings per share ("EPS") estimate of
$4.00, without having any reasonable basis;
(c) falsely represented First Union's acquisition of The Money Store as
"immediately accretive to earnings";
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 3 of 64 (d) boasted of First Union's strong customer retention rates while the
Company was, in fact, losing customers in droves; and
(e) touted cost cutting programs such as the "Future Bank" initiative as
successful means to streamline operations and enhance profits and earnings, while at the same
time knowing that the Company's massive layoffs, combined with the severe problems
integrating its multi-billion dollar acquisitions were creating chaotic, not improved or
streamlined, customer services and operations.
7. Despite defendants' repeated representations to the contrary, the
Company's merger with CoreStates, in particular, was ridden with significant and material obstacles. For example:
(a) The Company was experiencing major problems integrating the
CoreStates' computer systems into First Union's systems, because, as one former senior executive in the Company's Commercial Card division stated, "the Company wanted to complete what should have been a two-year job in six months." After First Union signed the merger agreement with CoreStates, it quickly discovered that the two computer systems were not compatible, and that a system conversion was not going to work. In April of 1998, First Union learned that the treasury management systems were also incompatible.
(b) The integration of CoreStates' data into the First Union computer system led to a multitude of repeated errors in customer accounts. From August to September of
1998, overdraft processing was substantially delayed because of failures of the First Union computer system caused by the integration process and failures of the automated check sorting system.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 4 of 64 (c) Resources were being wasted because of the chaotic conditions
surrounding the integration with CoreStates. For example, the Company incurred thousands of
dollars a month in unnecessary losses as a result of active computer network access jacks that
were not being used despite paying monthly fees for each activated jack.
(d) A frequent computer error alienating customers involved double-
billing customers who used debit cards for payment. A former First Union overdraft processor
experienced the problem firsthand when he purchased a suit with his debit card on his employee
account and discovered he was billed twice for the clothing. He was informed that First Union
was experiencing "computer errors."
(e) For at least six months after the merger, First Union took an extra
two to three days to credit deposits that customers made to their checking accounts. If a check
was deposited in a non-First Union ATM machine, First Union would automatically debit the
customer account for the ATM fee, but not credit the account for the check that had been
deposited, leading to numerous customer complaints.
(f) When customers complained about the frequency of improperly bounced checks and overdraft fees, First Union employees were told to tell customers that First
Union was 'having computer system problems." After First Union eliminated CoreStates' customer service department as part of its "cost-cutting" initiatives, CoreStates' overdraft processors took on customer service duties, including handling customer calls and complaints, which they were not equipped to handle.
(g) As a result of First Union's sale of certain CoreStates branches and customer accounts to Sovereign Bank, numerous former customers had problems with balances
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 5 of 64 that were transferred over from CoreStates to Sovereign. Even though the accounts were sold,
customers' checks were still coming to First Union rather than Sovereign. For two or three
months after the merger, temporary employees were brought into First Union's overdraft
department to sort through First Union's incoming checks by hand to determine if any Sovereign
customer checks were in the group. Every time this happened, check processing for First Union
customers was substantially delayed.
(h) The e-commerce area system conversion, which covers cash
management, cash management account reconcilement, control disbursement and the lock box
system, was also adversely impacted from the merger. Between October, 1998 and June, 1999.
First Union lost "batches" of work, customers did not receive credit for lock box deposits, and
First Union lost payments. According to a former executive in the Company's corporate banking
department, these problems resulted because of incompatible wire and lock box systems at
CoreStates.
(1) In November of 1998, First Union's electronic billing system, which backed procurement cards (corporate credit cards which corporate clients gave their employees to buy business-related products) regularly crashed, causing major problems for corporate clients. The system crashes affected major corporations and about 340 schools that used the procurement cards. The customers could not reconcile any of their monthly books for more than six months. First Union lost bills, never sent bills, lost payments and double-billed procurement card clients. As late as March of 1999, some customers could not do accounting related to these cards;
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 6 of 64
(j) Prior to the merger, CoreStates' customers, especially corporate
customers, colleges and universities, could pay their credit card bills by wiring money to a
special account CoreStates set up, which would then be credited to the particular customer's
credit card accounts. In January, 1999, First Union changed the system, customer account
numbers, wire instructions and the destination of the wire transfers to an account in Florida.
First Union, however, did not notify its customers or the CoreStates employees of the new
account numbers or the new wiring instructions, and clients were not instructed how to pay their
bills under the "new" system. As a result, although customers were still wiring payments, their
credit would "max out" because First Union did not credit their cards, and the customers were
denied access to their credit lines.
(k) As a result of the problems, First Union lost 50% of its education
customers, including the Common Fund, a fund which managed the money of 1,600 universities
and colleges, and had $7 billion in assets, $3 billion of which was at CorcStates. CoreStates
managed the Common Fund's operating endowment, and sold treasury management systems,
including the ACH and Lock Box systems, to these institutions. First Union lost profits of
$1 million a year - - a lucrative account lost in the integration havoc.
(1) Due to the massive layoffs after the merger, there were long lines
at branch locations, with sometimes 50 or 60 people waiting in line for one teller.
(m) The process to convert CoreStates' electronic bulletin board
service, which was used for clients to dial in for credit card account updates, to First Union's
format was scheduled to take two business days. Because of First Union's integration problems,
the board was inoperable for 120 days. As a result, the credit card division had to service calls
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 7 of 64 for customers who regularly used the board and, according to a former executive, could "barely
keep afloat."
(n) First Union did not send customers their credit card bills, or sent
the bills three or four months late. As a result, the Company had to grant liberal payment
extensions to customers who had not received any credit card statements in months. In addition,
First Union had to create new credit card numbers for customers whose accounts incorrectly
were coded as "unpaid" or "delinquent."
(o) CoreStates produced customized VISA credit cards with logos for
its clients. When the credit card system was converted, all the CoreStates cards had to be
duplicated. During the conversion in October through December of 1998, the wrong logos were
printed on some cards, some cards were the wrong color, and others were sent to customers who
had already canceled their accounts. For example, First Union sent MIT credit cards with the
name of a different college imprinted on the cards, which had to be sent back at First Union's
expense. So many cards were returned that employees had to sort the cards by hand to make sure the cards were sent to the correct clients; which was a time-consuming process since some clients had as many as 5,000 cards.
(p) As a result of the problems in the credit card division, customer complaints skyrocketed from 25 calls per day to 40, 50, and over 60 calls per day. Since First
Union had laid off the entire CoreStates credit card department with the exception of two employees in March 1999, there were not enough representatives to handle the huge volumes of calls. Just prior to the merger, CoreStates had recruited two new clients, the County of Dane,
Wisconsin, and the County of Milwaukee. The banks' relationship with those clients was
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 8 of 64 destroyed "right away" because of these problems. According to a former credit-division
employee, the problems were so severe that in one two-hour period on February 26, 1999, four of
the division's biggest customers threatened to withdraw their business.
(q) A Philadelphia physician, Steven Fischer, moved his practice's $2
million deposit account, his personal trust, and bill paying services to competitor Commerce
Bank after being driven to "screaming fits" by the time and aggravation of settling disputes over loan closing dates and misfiled account slips. First Union also lost the accounts of the
Philadelphia Daily News and the Philadelphia Inquirer after it lost hundreds of subscribers' checks and took weeks to locate them. Another corporate customer lost was Broudy Precision
Equipment Co., of West Conshohocken, PA, a climate control supply company and 20 year customer of CoreStates. Broudy withdrew their business because First Union mistakenly closed one of the company's accounts and lost three or four days of the Company's deposits.
(r) The integration process also resulted in problems with the electronic banking system. Sometimes the system would show that a payment had been made, when it in fact had not. On other occasions, customers would authorize a specific amount of funds to be paid to a credit card bill, and First Union would credit the wrong amount to the account.
(s) From October to December of 1998, there were thousands of computer-related problems with account numbers as a result of the merger. Many account numbers were deleted or duplicated. When converting old CoreStates account numbers, First
Union added about six extra digits, which resulted in invalid numbers. Often, changed account
S
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 9 of 64 numbers would duplicate existing First Union customer account numbers, which created so many
problems that First Union put together a task force to fix the problem.
(t) The Company had problems with payroll operations as a result of
the merger as well. For example, First Union handled Campbell Soup Corporations
("Campbell") cash management, including payroll operations. After Thanksgiving of 1998,
direct deposits for Campbell's employees were not posted to employee accounts because First
Union had not processed or could not process the statements to pay Campbell's employees and brokers.
(u) Campbell also had significant problems transferring electronic data to First Union. Campbell sends data to First Union with payment amounts to its food brokers and distributors, in which point First Union debits Campbell's accounts and sends payments to the brokers and distributors. As a result of conversion problems with First Union's electronic data systems, the Company lost or failed to apply payments to the payees on time.
(v) First Union's Automatic Clearing House (ACH) system, the
Company's electric payment and banking system, could not handle the volume of activity it encountered, and the system kept failing. As a result, employees of Swathmore College, a significant customer, did not receive their direct-deposit paychecks on time. When First Union tried to merge its system with CoreStates ACH system, it repeatedly crashed. The crashes were so costly and time consuming, that the Company tried running the systems in tandem rather than merging them.
(w) The integration involved combining the back-office operations of the two companies, such as accounting for loans and billing for loans. There were problems with
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 10 of 64 demand deposits and cash management accounts - - resulting in errors which affected as much
as fifty percent of the corporate banking business.
(x) After the merger with CoreStates, the Company discovered that the
cost and time needed for changing over the CoreStates records to the First Union computer
system for its real estate records was 'grossly underestimated." According to a former manager
in the corporate real estate section of the finance department at First Union, although figures
were missing from the records and there were gaps in the budgets for the properties that
CoreStates owned, "word came down to make the bottom line appear to be good. Nobody knew
what happened and nobody had time to find out,"
(y) Shortly after the merger, unpaid bills for utilities and security
systems at CoreStates properties started showing up at First Union headquarters, in addition to
uncollected rents. The department was in disarray.
(z) In addition, CoreStates had significantly underestimated what the expenses would be to upgrade its properties. Specifically, the costs to upgrade the MBO
Building, a high-rise in Philadelphia, Pennsylvania, were much higher than CoreStates' reported figures. These unanticipated costs were widely known and openly discussed within the corporate real estate section shortly after the merger.
(aa) According to a former employee in the Company's Castor Avenue,
Philadelphia, consumer bank support call center (CBS Center), the Company monitored and kept track of how many calls came in and how many minutes each call took to resolve. This report was generated on a daily basis. After the merger, the number of calls skyrocketed.
-Il -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 11 of 64 8. In late January 1999, defendants partially disclosed the problems the
Company was encountering, resulting in an immediate stock price decline of over 9%. Finally,
on May 25, 1999, the Company issued a press release that alerted the market to the full truth
about the deteriorating financial and business condition at First Union as a result of acquisition
related delays and costs and the impact on First Union's profitability and earnings. The
Company disclosed that problems integrating the Company's numerous acquisitions, especially
the CoreStates acquisition -- which accounted for one-third of its banking franchise -- would
have a material and negative impact on earnings. Rather than earning $4.00 per share as the
Company had boasted earlier in the Class Period, the Company would in fact only earn $3.40 -
$150 per share, an earnings shortfall of over $450 million. In response, the market price of
First Union common stock plummeted 8.6% to 45 1/8 per share, on unusually large volumes of
16,786,600, more than seven times the normal trading volume. This represented a 32% drop from the Company's 52-week high.
9. First Union investors saw the value of their holdings plummet by approximately 30%, from a Class Period high on January 8, 19992 of over $65 a share. On July
30, 1999, the Company announced that defendant Georgius, the principal architect of the
CoreStates/Future Bank initiative had resigned to "pursue other interests." A few days after,
William Templeton, President of The Money Store, resigned "without comment." The market for First Union stock has not recovered. On February 14, 2000, First Union stock closed at $29 per share.
-
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 12 of 64 JURISDICTION AND VENUE
10, The claims herein arise under 15 U.S.C. § 78aa and 28 U.S.C. § 1331.
Plaintiffs' claims arise under 15 U.S.C. §§ 780)(b) and 78(t)(a) of the Securities and Exchange
Act of 1934 (the "Exchange Act") and Rule lOb-5 promulgated thereunder (17 C.F.R. § 240.1Ob-
5).
11. This Court has subject matter jurisdiction of this action pursuant to 15
U.S.C. § 78u.
12. Venue is proper in this District pursuant to Section 27 of the Exchange Act
and 28 U.S.C. § 1391(b). Many violations of law complained of herein occurred in substantial part in this district, including the preparation and dissemination of materially false and misleading statements and the omission of material information complained of herein.
13. In connection with the conduct complained of herein, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including the mails and interstate telephone communications, and the facilities of a national securities exchange.
PARTIES
14. Lead Plaintiffs James R. Allen, Vincent Russo, Forest E.R. Gordon, and the Hotel Trades Council and Hotel Association of New York City, Inc. purchased shares of First
Union common stock during the Class Period at market prices artificially inflated by defendants' fraud and were damaged thereby.
15. Defendant First Union Corporation maintains its principal place of business at One First Union Center, Charlotte, North Carolina, with about 2,400 locations in 12 states and Washington D.C. In addition to retail banking, the Company provides investment
- 13 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 13 of 64 products, advice, corporate finance, home equity lending (through its Money Store unit), and
insurance products (with Hartford Financial),
16, Defendant Edward E. Crutchfield ("Crutchfield") was at all times relevant
hereto the Chairman and Chief Executive Officer of First Union, and issued several of the false
and misleading statements at issue, and signed several of the Company's SEC filings.
Crutchfield either knew, or recklessly disregarded, the truth about First Union's business and
financial condition and about the chaotic problems the Company was having integrating the
CoreState acquisition. In the early fall of 1998, Donald Brown, a stock analyst with Donaldson,
Lufkin & Jenrette, publicly criticized Crutchfield's acquisition of CoreStates and the adverse
effect the Company's recent acquisitions would have on the Company's earnings and financial
growth, calling Crutchfield a "serial dilutor.". In response, Crutchfield banned Brown from any
further analyst conferences, a reaction consistent with Crutchfield's knowing or reckless indifference to the mounting costs and obstacles of integrating the CoreStates acquisition into
First Union's existing operations and the resulting drain on First Union's earnings.
17. Defendant John R. Georgius ("Georgius") was at all times relevant hereto the President of First Union. Georgius issued several of the false and misleading statements at issue, and signed many of the Company's SEC filings, In addition, Georgius was a "hands-on" manager who headed the integration process, was well aware of the importance to First Union's stock price of the acquisitions being perceived by the market as successfully integrated. To that end, Georgius not only failed to reveal the Company's merger difficulties and the resulting impact on earnings and profitability, but continued to push the unworkable integration plan on already overwhelmed bank employees, who, according to a former CoreStates manager, were
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 14 of 64
told "If you don't reach your goals, you get fired." Georgius, aware of the major logistic and
financial obstacles the Company was encountering in the integration process and the effect of
those problems on First Union's bottom line, sold over $8,000,000 worth of his First Union stock
holdings before the investing public learned the truth about the Company's declining profitability
and drove down the market price of its stock. Similarly, other First Union insiders, also privy to
undisclosed inside information about the difficulties with the CoreStates merger, sold thousands
of shares of their stock during the Class Period, generating proceeds of over $48,000,000.
18. Defendant James H. Hatch ("Hatch") was at all times relevant hereto the
Senior Vice-President and Corporate Controller of First Union and signed each and every SEC
filing cited herein. Hatch, as the Company's controller, also had first hand inside knowledge
of its financial results, statements and accounting practices, and the Company's reports and
evaluations about the progress and costs associated with its acquisition and integration activities.
19. Defendants Crutchfield, Georgius and Hatch are collectively referred to
herein as the Individual Defendants.
PARTICIPATION OF INDIVIDUAL DEFENDANTS
20. The Individual Defendants participated in the drafting and preparation of
the various public filings and other communications complained of herein and were aware of the
misstatements contained therein and omissions therefrom, and were aware of their materially
misleading nature. Because of their Board membership and/or executive and managerial
positions with First Union, the Individual Defendants had access to the adverse non-public
information about First Union's business prospects and financial condition. The Individual
Defendants, by reason of their stock ownership, management positions, and/or membership on
- 15 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 15 of 64 First Union's Board of Directors, were controlling persons of First Union and had the power and
influence, and exercised it, to cause First Union to engage in the illegal practices complained of
herein.
21. It is appropriate to treat the Individual Defendants as a group for pleading
purposes and to presume that the materially false and misleading information conveyed in the
Company's public filings, press releases and other publications as alleged herein are the
collective actions of the narrowly defined group of defendants identified above. Each of the
above officers of First Union, by virtue of his high-level position with the Company, directly
participated in the management of the Company, was directly involved in the day-to-day
operations of the Company at the highest level and was privy to confidential proprietary information concerning the Company and its business, operations and business prospects as alleged herein. The Individual Defendants were involved or participated in the drafting, producing, reviewing and/or disseminating the false and misleading statements alleged herein.
The Individual Defendants were thus aware that these false and misleading statements were being issued regarding the Company and approved or ratified these statements, in violation of the federal securities laws.
CLASS ACTION ALLEGATIONS
22. Plaintiffs bring this action as a class action, pursuant to Fed. R. Civ. P.
23(a) and (b)(3), on behalf of a class consisting of all persons who purchased First Union common stock between August 14, 1998 and May 24, 1999, inclusive, and who were damaged thereby (the "Class"). Excluded from the Class are defendants, the officers and directors of First
-
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 16 of 64 Union, members of the immediate families of such officers and directors and subsidiaries and
affiliates of defendants and their officers and directors.
23. During the Class Period, there were over 967.9 million shares of First
Union common stock outstanding held by thousands of shareholders. First Union common stock
was actively traded on the New York Stock Exchange under the symbol flFTU,I! an open and
efficient market, during the Class Period. Because persons who purchased First Union shares
during the Class Period number at least in the hundreds and are believed to be located throughout
the country, joinder of all such class members is impracticable.
24. There are questions of law and fact common to all class members which
predominate over any questions affecting only individual class members, including:
(a) Whether the federal securities laws were violated by def endants! acts as alleged herein;
(b) Whether documents, releases and/or statements disseminated to the investing public and First Union shareholders during the Class Period omitted and/or misrepresented material facts about the business and financial condition of the Company;
(c) Whether defendants made materially misleading statements during the Class Period about the business and financial condition of the Company;
(d) Whether the defendants acted knowingly and/or recklessly in making materially false statements and omitting material facts about the business and financial condition of the Company;
17-.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 17 of 64 (c) Whether the market price of the Company's common stock was
artificially inflated during the Class Period due to the non-disclosures and/or material
misrepresentations complained of herein; and
(f) Whether the members of the Class have suffered damages and, if
so, what is the proper measure of damages.
25. Plaintiffs' claims are typical of all class members' claims. Plaintiffs have
selected counsel experienced in class and securities litigation and will fairly and adequately
protect the interests of the Class. Plaintiffs have no interests antagonistic to those of the Class.
26. 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 members of the Class individually to seek redress for the wrongful
conduct alleged.
27. Plaintiffs know of no difficulty which will be encountered in the management of this litigation which would preclude its maintenance as a class action.
BACKGROUND TO THE CLASS PERIOD
28. In November 1997, First Union formally announced plans to acquire
Philadelphia-based CoreStates Financial in a deal valued at $19.8 billion. The deal was scheduled to be consummated by April 30, 1998. The combination of the two organizations would create the leading financial institution on the East Coast, with assets of approximately
$206 billion. Defendant Crutchfield spoke enthusiastically about the deal in a February 27, 1998 press release published in PR Newswire:
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 18 of 64 I am very enthusiastic about the expanded ability to serve customers that this merger between First Union and CoreStates generates, . . Our combined company will have the resources and the dedication to improve the economic growth of the communities and neighborhoods we serve,"
29. In January, 1998, market analysts reported to the investing public, based
on statements made by Company officials, that First Union expected the merger to be
immediately accretive to CoreStates' earnings, and that First Union expected in 1999 to reduce
CoreStates expenses by 45% and increase its revenues by 21%.
30. On March 4, 1998, First Union announced that a definitive merger
agreement had been signed between First Union and The Money Store. (The Money Store
acquisition closed on or about June 30, 1998). The deal created the nation's number one coast-to-
coast provider of home equity loans, small business loans and the number three provider of
student loans. Under the agreement, First Union agreed to pay $34 per share in First Union common stock for each share of The Money Store common stock. The Company stated that it also expected The Money Store acquisition to add to its earnings immediately.
31. First Union assured investors that it could handle the integration process for these aggressive acquisitions without a coincident loss of customers or business. Ralph
Perry, senior vice-president and head of corporate marketing at First Union stated in a March,
1998 Bank Marketing International article:
Most of the mergers we've done have been something of a hometown bank. We've always had good success. For the most part the customers arc interested in the quality of service they are getting. There clearly is an initial reaction sometimes, but customers don't seem to leave us for that reason.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 19 of 64
The article reported that the merger would be consummated in the next few months, including
conversion of the computer systems, ATM machines and checking services. As defendant
Crutchfield later admitted, however, the bank had "too much on its plate.' But in order to
maintain the Company's artificially inflated stock price, it was crucial that defendants keep up
First Union's problem-free appearance.
32. On July 2, 1998, Morgan Stanley, Dean Witter, after a meeting with
defendant Crutchfield in which Crutchfield outlined the Company's "new acquisition strategy,"
issued a "STRONG BUY" rating for First Union. The new strategy involved merging only with
similarly sized banks rather than smaller banks, "a future merger of equals."
33, On July 16, 1998, based in part from statements issued by the Company,
Merrill Lynch Capital Markets issued an "ACCUMULATE" rating for First Union, stating:
• Regardless of how one "slices and dices" it was a strong "out-of- the-shoots" showing post First-Union's finalization of its acquisition of CoreStates--with 2Q EPS of $0.92 (excluding $0.66 of merger charges) $0.02 above our consensus-like $0.90 estimate.
• Our sense is that the Money Store's estimated contribution will be above management's original projection-as it is already providing syncrgies. For example, in July, First Union will close on $30 million of "A" paper from Money Store customers.
34. Thus, at the start of the Class Period, First Union appeared to be
successfully implementing a viable business strategy as the Company expanded into new
financial product lines, customer bases, and especially, its "merger of equals" acquisition plan.
In order to maintain the Company's stock price, strong growth rate and ability to make
acquisitions in a banking industry known for its recent "mega-mergers," it was essential that the
Company's integration of its completed acquisitions be perceived by the market as trouble-free.
- 20 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 20 of 64 In addition, defendant Georgius, who personally oversaw the integration process, and therefore
knew or recklessly disregarded the significant problems involved with the integration, kept the
truth from the market so he could sell over $8,000,000 worth of his First Union holdings before
the truth surfaced.
DEFENDANTS' FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD
35. On August 14, 1998, the Company filed a quarterly report on Form l0-Q
for its second 1998 fiscal quarter ending June 30, 1998 (the "Second Quarter 10-Q"). The
Second Quarter 10-Q was signed by defendant Hatch. The Second Quarter 10-Q reported that
operating earnings in the first half of 1998 increased 19 percent to $1.7 billion from $1.4 billion
in the first half of 1997. On a diluted per share basis, such earnings increased 20 percent to $1.75
in the first half of 1998 from $1.46 in the first half of 1997. Operating earnings were reported as
"a record" $883 million, or 92 cents, in the second quarter of 1998, compared with $719 million, or 74 cents, in the second quarter of 1997. After merger-related and restructuring charges in the first half of 1997 of $37 million, earnings were $1.0 billion in the first half of 1998 compared with $1.4 billion in the first half of 1997. On a diluted per share basis, such earnings were $1.07 in the first half of 1998 compared with $1.42 in the first half of 1997.
36. In the Second Quarter 1 0-Q, defendants also purported to describe material facts regarding the Company's recent acquisitions. The Second Quarter 10-Q stated, in relevant part, that
We are very pleased with our progress in integrating recent acquisitions and with the growth prospects stemming from these transactions. We believe 1998 will continue to be a very active year as we work to develop new markets and business strategies
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 21 of 64 into revenue growth. In addition to revenue growth, we expect further improvements in efficiency as we begin to benefit from the consolidation of our recent acquisitions.
37. With respect to the process of integrating First Union's newly acquired
companies, the Second Quarter 1O-Q stated:
With our previously pending acquisitions now completed, our primary attention is focused on developing our existing business base as we continue to invest in new technology and fee income- generating lines of business.
The acquisition of CoreStates, of Philadelphia, will create new opportunities to leverage our crowing Capital Management and Capital Markets businesses in states that generate 36 percent of the nation's gross state product and in attractive consumer markets where the per capita income is 12 percent above the national average. In addition, in the second quarter of 1998, we completed the purchase accounting acquisitions of Bowles Hollowell Conner & Co., an investment banking firm, and The Money Store, a nationally recognized consumer finance compapy.
38. The market reacted almost immediately to the false and misleading positive statements about the Company's acquisitions. The price of First Union common stock, which was $52.875 per share on August 14, 1998, increased over a dollar a share to $53.93 on
August 18, 1998 after the lO-Q was disseminated to the marketplace.
39. The Second Quarter 1O-Q falsely stated that First Union's growth potential, efficiency and retail market position had been fortified by its acquisitions. It also misleadingly described the Company's acquisitions without disclosing in any way that First
Union was experiencing severe problems in integrating the newly-acquired companies into its existing operations or that the process was taking longer and consuming substantially more
-22 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 22 of 64 resources than anticipated. In fact, when these positive representations were made, the Company
was struggling to assimilate its multi-billion dollar acquisitions, while dissatisfied customers
were leaving due to delays and mix-ups with their accounts caused by wide-spread merger-
related layoffs.
40. First Union's 1998 Second Quarter 10-Q was materially false and
misleading for the following reasons:
(a) It concealed the true situation at First Union, namely, as alleged in
17 above, that various integration activities had already had a materially adverse impact on
efficiency, and would continue to do so, causing material earnings shortfalls due to the
increasingly severe problems integrating the numerous acquisitions, including the Core-States
acquisition -- an acquisition that represented one-third of First Union's banking franchise;
(b) There had been no "consolidation of [the] recent acquisitions," nor had the Company "completed" the pending acquisitions. In fact, First Union was in the midst of numerous severe integration difficulties including loss of employee morale in the midst of the thousands of layoffs necessary for the Company to meet its acquisition related earnings goals, and loss of customers; and
(c) Defendants also deceptively described the impact of the various integrations by stating that First Union was in the process of developing "new markets" for revenue growth, and would soon benefit from the "consolidation" of the recent acquisitions. This characterization falsely portrayed the Company as having successfully absorbed the acquisitions and, as a result, achieved cost savings from the "consolidation" of the recent acquisitions. The integration of the largest acquisition, CoreStates, was, as defendants knew, far from completed
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 23 of 64 and CoreStates' operations had not "consolidated" with First Union's existing businesses.
To the contrary, First Union had by August 14, 1998, already experienced, and was continuing to
experience, significant problems converting CoreStates systems, as detailed in ¶IJ 7(a) through 7(aa), above.
41. The importance of integrating CoreS tates and the Money Store was noted
in a August 25, 1998 report issued by Argus Research Corp., which issued a "BUY rating for
the stock. Argus estimated, after discussions with First Union management, 1999 operating
earnings per share to increase by 20% to $4.49, contingent on successful integration of the
CoreStates and Money Store acquisitions. The report emphasized that the long-term competitive
position of First Union was in large part dependent upon continued successful expansion through
acquisitions.
42. On October 27, 1998, an analyst report was issued by A.G. Edwards &
Son, Inc., based in part on information obtained from the Company. The report commented favorably on First Union's progress with its recent acquisitions, and issued a "BUY" rating for the stock. Specifically, the report stated:
Money Store acquisition is in full swing. This was the first full quarter of results for the Money Store under FTU ownership as the deal closed on June 30, 1998. The Money Store contributed $163 million in revenues ($117 million in securitization gains and $46 million in net interest income) and $156 million in direct operating expenses for the quarter. FTU expects the Money Store to add about $0.04 to the bottom line in 1998 and roughly $0.08 in 1999. Despite the uncertainty in the asset-backed markets this quarter, FTU securitized $2.3 billion in Money Store loans. Home Equity production from the Money Store amounted to about $1.8 billion for the quarter.
-24 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 24 of 64 CoreStates conversion is expected to proceed smoothly. FTU revealed that it expects continued smooth integration of the CoreStates franchise. Almost 75% of major systems conversions had been completed by quarter end. All systems conversions are scheduled to be completed by early November,
43. The Company's representations, as communicated to the investing public
through the statements in the analyst report alleged in [ 42 above, were materially false and
misleading because, as defendants well knew, the Money Store acquisition was not then
accretive to earnings nor could it reasonable be anticipated to be so in the forseeable future.
44. As defendants knew or recklessly disregarded, the CoreStates
"conversion" was not proceeding smoothly, the Company was then experiencing severe problems
integrating the two banking systems and customer accounts, and knew that achievement of any
economies of scale from the CoreStates acquisition were, at best, highly speculative and far in the future, if not completely unattainable. Defendants failed to disclose the extent of the burden imposed by task of integrating CoreStates banking business with that of First Union's. As later disclosed, throughout the Class Period the Company was struggling with loss of customers due to merger-related staffing problems and lagging earnings for the newly acquired companies. As defendant Crutchfield admitted after the Class Period in a May 26, 1999 Wall Street Journal article, the Company was "crumbling under its own weight."
45. Similarly, defendants knew or recklessly disregarded that 75% of
CoreStates' major systems had not been converted, or if they had been converted, defendants failed to disclose the problems the Company was then experiencing as a result of the conversion.
Specifically:
- 25 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 25 of 64 (a) Defendants learned as far back as April of 1998 that the treasury
management systems were incompatible;
(b) The merger of CoreStates' data into the First Union computer
system led to a multitude of repeated errors in customer accounts. From August to September of
1998, overdraft processing was delayed for long periods of time because the First Union
computer system would crash or the automated check sorter system did not work;
(c) According to a former employee in the credit card division, the
conversion of CoreStates' to First Union credit cards was a 'disaster";
(d) CoreStates electronic bulletin board service which was used for
clients to dial in for credit card account updates was required to be converted to First Union's format. The conversion process was scheduled to take two business days, but due to First
Union's integration problems, the board was inoperable for 120 days. As a result, the credit card division had to service calls for customers who regularly used the board, and could "barely keep afloat";
(c) During the conversion of the CoreStates credit card system in
October through December of 1998, there was a system corruption that affected the client records and the printing of new cards. The wrong logos were printed on some cards, some cards were the wrong color, and others were sent to customers who had already canceled their accounts. So many cards were returned that employees had to sort the cards by hand to make sure the cards were sent to the correct clients; which was a time-consuming process since some clients had as many as 5,000 cards;
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 26 of 64 (f) the integration process also resulted in problems with the electronic
banking system. Sometimes the system would show that a payment had been made, when it in
fact had not. On other occasions, customers would authorize a specific amount of funds to be
paid to a credit card bill, and First Union would credit the wrong amount to the account; and
(g) the conversion also resulted in significant problems with payroll
operations for corporate customers, whose employees were not paid on time as a result.
46. On November 5, 1998, an article in the Morning call, a stock market
analysts' report, described the integration of CoreStates by First Union. Despite the problems it was facing after acquiring CoreStates, Scott Fainor, First Union's regional president, commenting on behalf of the Company, represented the integration process as working "smoothly," with procedures in place to immediately address issues as they may arise:
• JTIhc problems associated with the CoreStates merger will be minimal. There are thousands of Deople working to make sure that this integration will work smoothly, if there are issues, we're set up to tackle them. immediately,
Referring to the integration process, Fainor stated:
We're set up to grow, we want to put this behind us and move forward.
47. The above statement was materially false and misleading in that it implied any problems with CoreStates were minimal, and that First Union could easily dispose of any problems that might arise. First Union, however, was at the time experiencing serious difficulties with the CoreStates acquisition, as alleged in 17 above. The Company's statements were intended to convey the false impression that the integration process was proceeding without a hitch.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 27 of 64 48. In fact, as Defendant Crutchfield later admitted in a May 26, 1999 article
in the Charlotte Observer "the bank simply had too much on its plate." Contrary to the
defendants' numerous statements depicting the Company's success with the numerous
integrations, defendant Crutchfield admitted in a May 26, 1999 article in the American Banker that the Company was unable to handle the mergers while simultaneously producing revenue growth, stating "when you triple an organization in three to three and a half years, that in itself is a complex management chore," In addition, in marked contrast to the statement that problems with the merger "will be minimal," defendant Georgius admitted after the Class Period, that
"nobody ever said it was going to be easy." In fact, the Company on numerous occasions conveyed the message not only that it "was going to be" easy, but that it was easy.
49. On November 17, 1998, Merrill Lynch Capital Markets issued a "BUY" rating for First Union common stock. The report was released following an investor/analyst meeting with First Union management at the Company's Charlotte, North Carolina headquarters.
After direct consultation with First Union management, the report included as an investment highlight a bullet point indicating one of the major reasons for the "BUY" rating:
CoreStates' integration completed—successfully.
50. A November 18, 1998 article in the American Banker, entitled "First
Union Completes CoreStates Conversion", reported First Union as representing it had "wrapped up its conversion of the former CoreStates Financial Corporation last weekend." Defendants were reported to have said:
"This is a historic conversion because it was the largest and most complex we've ever done."
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 28 of 64 The article continued:
"Still, First Union officials don't deny there werea few bumps in the road. Customers faced long lines at many branches during the 10-day conversion, and at one point the entire First Union branch network had to deal with a 45 minute computer glitch that forced tellers to work off line.
The Company then stated, "its now business as usual."
51. The statements detailed in IT 49 and 50, above were materially false and
misleading because they implied that the integration work of the Company had been successfully accomplished with the exception of some minor "bumps in the road" which had been overcome, when in reality the Company was experiencing severe obstacles, as alleged in ¶ 7 above, to the successful integration of the acquired companies which would negatively impact 1999 results.
The statement that it was now "business as usual" at First Union was intended to, and did convey a false and misleading message to the public that any integration problems were over. In fact,
First Union was continuing to experience the loss of customers due to customer service problems as a result of the merger including computer errors resulting in serious mix-ups for customers; long teller lines and account confusion; layoffs and reallocation of resources to help solve merger-related issues arising from the Money Store acquisition and unexpected credit quality issues.
52. On November 30, 1998, the Company filed with the SEC its Form 10-Q for its 1998 third fiscal quarter ending September 30, 1998 (the "Third Quarter 10-Q"), signed by defendant Hatch. The Company reported that operating earnings in the first nine months of 1998 increased 25% to $2.7 billion from $2.2 billion in the first nine months of 1997. On a diluted per share basis, operating earnings in the first nine months of 1998 increased 24% to $2.77 from
- 29 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 29 of 64 $2.24 in the first nine months of 1997. Operating earnings were $1.0 billion, or $1.02 per share
in the third quarter of 1998, compared with $748 million or $0.78 in the third quarter of 1997.
53. With respect to the CoreStates acquisition the Company stated in the Third
Quarter 10-Q:
We have completed the integration of CoreStates. Customers sales and retention strategies are well underway, as well as efforts to achieve expense efficiency targets by the end of 1998. As such we are very pleased with our prospects for revenue growth and expense reductions stemming from this and other recently consolidated acquisitions.
54. The Company's statements in ¶j 52 and 53, above were materially false
and misleading for the reasons set forth in ¶ 7, above, and, in addition, because defendants knew
or recklessly disregarded that: (a) the "integration of CoreStates' was not "completed,"
(b) customer "sales and retention' strategies were not working, to the contrary, as revealed after the Class Period, the merger resulted in a loss of 400,000 CoreStates' customers as well as significant numbers of First Union customers, and (c) the Company had no basis to be pleased with prospects for "expense reductions" stemming from the recent acquisitions, as Crutchfield revealed after the Class Period, the CoreStates merger was in fact "crumbling under its own weight."
55. On December 16, 1998, defendants issued a press release announcing a
"Joint Initiative" between First Union's Capital Management Group and it's International
Division. The collaboration was designed to market the Company's Evergreen mutual funds and other investment products and services to customers in Japan and around the world. The first
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 30 of 64
initiative, Evergreen, Japan, was scheduled to have a Tokyo-based sales and service operation
beginning in January, 1999.
56, The Press Release emphasized the success of First Union's banking and
investment products throughout the world, stating:
The international Division serves more than 1,400 correspondent bank account relationships in more than 130 countries, through 5 foreign branches and 29 representative offices abroad. Through its acquisition of CoreStates Bank, First Union has maintained a presence in Japan since 1975.
57. The defendants' statements regarding its International Division were
materially false and misleading because defendants' statements failed to disclose any of the
multitude of problems the Company was then experiencing with its international operations:
(a) a former corporate trader in the foreign exchange marketing
department of CoreStates revealed that the process of converting CoreStates' International
Department's computer systems to First Union's was riddled with major problems;
(b) defendants discovered that the systems, including CoreStates'
international wiring and trade payment systems, were not compatible. Defendants lacked
experience in the area of international banking and did not understand CoreStates' international
department's systems;
(c) First Union's system was significantly smaller than CoreStates'
resulting in repeated and costly system "crashes" each time defendants tried the conversion;
(d) numerous international corporate clients outsourced their employee
payroll functions to First Union. As a result of the merger difficulties, clients regularly
complained that First Union was not issuing paychecks for their employees on time;
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 31 of 64 (e) in the Fall of 1998, First Union experienced numerous problems
with its international wiring system as a result of the conversion. As a result, no international
wires went out or came in from international corporate clients; and
(f) many international clients left after the merger due to customer
service issues. Prior to the merger, CoreStates assigned one customer service agent per client.
Subsequent to the merger, First Union gave out 1-800 numbers to their international corporate
customers, who had no background in international banking and could not address international
customers' complaints.
58. Despite upheaval in its international division, defendants touted new
profit-generating international "initiatives," knowing or recklessly disregarding the fundamental
operating deficiencies the international division was then facing.
59. On January 14, 1999, defendants issued a Press Release announcing First
Union earnings for the fourth quarter of its fiscal year 1998, ending December 31, 1998. The
Company reported earnings of $857 million, or 87 cents per diluted shares, for three months ending December 31, 1998 - - up from $576 million or 60 cents a share in the previous year. The
Company reported a 34% increase in operating earnings, to $993 million, or $I a share.
CoreStat&s assets amounted to $237 billion at the end of 1998. For the year, the bank reported earnings of $2.89 billion, or $2.95 a share, a 7 percent gain over the previous year's earnings.
60. Commenting on the Company's financial reports, defendants stated:
Our record 1998 performance clearly underscores our progress in building a new kind of financial services company. We move into 1999 having successfully executed several key initiatives: increased partnerships among our lines of business, the
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 32 of 64 implementation of our new retail Future Bank and the completed integration of CoreStates and five other acquisitions.
61. A January 15, 1999 article in the New York Times entitled "First Union
Posts 49% Increase in Profit," which cited the Company's financial statements and reports from
analysts, noted that "[tjhere has been some concern among analysts about how easily First Union
would digest the operations of CoreStates, how well it would be able to retain CoreStates
customers and how quickly it would be able to make that pricey acquisition profitable. After
First Union's January 13, 1999, earnings announcement attributing its strong financial
performance to, among other, the recent acquisitions, the article noted that '[First Union] was
well on its way to making the purchase of CoreStates pay off."
62. In response to the misleading reports on January 14 and 15, 1999, First
Union stock traded at artificially inflated levels, reaching $60.1 25 on January 15, 1999, as any concerns the market had regarding the success of the enormous CoreStates integration, its costs, and its effect on the Company's earnings and profitability were allayed.
63. The statements detailed in 11159-61, above were materially false and misleading for the reasons alleged in 17, above and, in addition, because: (a) First Union had not successfully implemented its key initiatives, nor had it successfully "completed [the] integration of CoreStates" or The Money Store. Indeed, only ten business days later, defendants partially disclosed some of the problems First Union had encountered, and was continuing to encounter with respect to the integration of CoreStates, and the materially adverse impact those problems had on its earnings. When defendants made the misleading statements on January 14 and 15,
1999, they knew or recklessly disregarded the severe problems and costs First Union had
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 33 of 64 encountered and were continuing to encounter in combining the operations of its acquisitions
with First Union's existing operations, problems encompassing virtually every area of the daily
operations, from electronic banking to losing checks and customer accounts, as alleged in IT 7
and 57, above.
Defendants Partially Disclose The Problems First Union Was Experiencing
64, On January 26, 1999, defendants filed a report on Form 8-K with the SEC,
disclosing that it would eliminate its use of gain-on-sale accounting (a method which allows
lenders to record profits on loan securitization before the loans are actually sold) when its
securitizes subprime loans. The Company announced that dropping the gain-on-sale method would cut 1999 earnings by 8 to 12 cents per share.
65. Two days later, on January 28, 1999, the Company announced that after nine months of 'cost-cutting", it had failed to meet its savings target in connection with the
CoreStates acquisition. According to defendant Crutchfield, First Union had missed its 1998 after-tax expenses cost-cutting goal by $50 million. A spokeswoman for the Company described the CoreStates shortfall as not resulting from "any single item", but from " a series of decisions, such as the plan to temporarily increase staffing when CoreStates was consolidated into First
Union" The Company declined to give further details.
66. The statements detailed in IT 64 and 65, above were materially false and misleading, and failed to reveal the magnitude and severity of the problems the Company was experiencing with the integration, such as the problems detailed in 117 and 57, above. As a result, investors were lulled into believing that the problems would result in marginally smaller
- 34 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 34 of 64 cost savings and earnings, but not the materially decreased earnings defendants knew were
coming.
67. In response to the news which only partially revealed the depth of the
severe problems and costs First Union had encountered, and was continuing to encounter in
integrating its acquisitions, the stock dropped $4.88 from its price of $52. 19 prior to the
Company's January 27, 1999 disclosure. Had investors known the entire truth regarding the
effect of the integration process on First Union's earnings and profitability, the price of First
Union stock would have dropped even further.
Defendants Continue To Make Misleading Statements
68. On March 16, 1999, the Company filed its annual report on Form 10-K for the year ended December 31, 1998 (the "1998 1 0-K"), signed by defendants Crutchfield and
Hatch. The 1998 10-K reported $3.7 billion in operating earnings, a 27% increase from $2.9 billion in 1997. On a per share basis, operating earnings increased 25% to $3.77 in 1998 from
$3.01 in 1997.
69. With respect to acquisitions, under a section titled "Highlights", the report stated:
Four 1998 acquisitions expanded our product line and added scale for our products and services. . . . We provided a full range of prc!ducts to the former CoreS tates customer base, leveragiflg CoreStates' expertise in global trade finance with First Unions broader geographic coverage and Capital Markets capabilities.
70. Defendants falsely characterized the integration process as "completed", stating:
- 35 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 35 of 64 We completed the CoreStates conversion in November 1998. Customer sales and retention strategies are well underway, as well as efforts to realize expense efficiencies. As such, we are encouraged with our prospects for revenue growth and for expense reductions in 1999 stemming from this and other recently consolidated acquisitions.
71. Commenting on the Money Store acquisition, the report stated:
The 1998 addition of The Money Store establishes our position as the nation's top home equity lender and the nation's sixth largest student Joan originator,..
72. On March 19, 1999, defendants issued a press release in the PR Newswire
that "reaffirmed" First Union's earlier $4.00 per share "earnings outlook for 1999." The press
release confirmed that First Union expected earnings of approximately $4.00 per share for 1999,
excluding merger-related and restructuring charges and non-recurring gains. It also stated that
pre-tax cost savings after restructuring were expected to be approximately $400 million for 1999.
Operating earnings were expected to be in the range of $.99 to $1.01 per share in the first quarter, excluding merger-related and restructuring charges. Management stated that earnings per share for subsequent quarters of the year were expected to be significantly stronger than in the first quarter.
73. The statements in the 1998 10-K, and in the March 19, 1999 press release, were deceptively false and misleading when made. It was not true that First Union "provided a full range of products" to CoreState's customers; to the contrary, the failure to service CoreState customers, as alleged in detail above, led to the Toss of large numbers of those customers. First
Union was also experiencing severe problems integrating CoreState's foreign operations. The
CoreStates "conversion" was not complete, and there was no reasonable basis to expect "expense
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 36 of 64 reductions in 1999. These statements were also false and misleading because of defendants'
failure to disclose that earnings were and would continue to be adversely and negatively
impacted by the serious integration problems including: (a) a significant loss of customers;
(b) higher expenses and costs associated with the size and complexity of the $20 billion
CoreStates merger; (c) inadequate internal controls, (d) low employee morale; and
(e) disappointing results from The Money Store acquisition.
74. Nevertheless, in March 1999, defendant Georgius, as reported in a May
28, 1999 Wall Street Journal article, told analysts, "I'm feeling good about where CoreStates is."
75. On April 15, 1999, defendants issued a press release with First Union's
reported earnings per share of $1 .00 for the first quarter of 1999, including a 12 cent per share
after-tax gain on the sale of First Union's interest in Electronic Payment Systems. Operating
earnings were $965 million in the first quarter of 1999 compared with $809 million in the first quarter of 1998. After merger-related and restructuring charges of $398 million pretax in the first quarter of 1999, net income was $706 million, or 73 cents per share. Commenting on the results, defendant Crutchfield stated:
"We were pleased in the first Quarter with the disciplined way our company focused on reducing our cost structure. We are confident that revenue momentum will continue to be strong, led by our growing Capital Markets and Capital Management businesses. Although we view 1999 as a challenging year, we continue to invest in areas that promise higher revenue growth.
76. Crutchfield's statement was materially false and misleading, in that he failed to disclose in any manner the serious problems and costs the Company continued to face with respect to the integration of its newly acquired companies, especially CoreStates, and the
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 37 of 64 severe difficulties the Company was facing in reducing costs and increasing earnings, all of
which are detailed in 117 and 57, above.
77. On May 5, 1999, defendants filed with the SEC its 1999 First Quarter
Form 10-Q for the period ending March 31, 1999 (the "1999 First Quarter I0-Q"). In the
paragraph entitled "merger and consolidation activity", the 1999 First Quarter 10-Q stated that
First Union "continued to evaluate acquisition opportunities that we believe would provide
access to customers and markets that complement our long-term, goals." There was no
discussion, however, about the severe problems First Union had integrating CoreState
operations, the dramatic loss of customers or the Company's deteriorating profitability.
78. The 1999 First Quarter 10-Q also failed to disclose any of the severe problems associated with integrating the CoreStates acquisition, all of which are detailed in ¶ 7 above, which defendants knew, or recklessly disregarded, would have a severely adverse impact on 1999 earnings.
79. On May 5, First Union stock was trading at $54.687 per share, on volumes of nearly 2 million shares.
THE TRUTH EMERGES
80. On May 25, 1999, following a telephone conference call the day before between Crutchfield and analysts, defendants shocked the market by announcing that the
Company would not meet consensus revenue and earnings estimates for 1999. Defendants disclosed that following "a strategic review and analysis," it expected earnings for 1999 to be in the range of $33 billion to $3.4 billion, or $3.40 to $3.50 per share. The "new" forecast fell far short of defendants previous forecast of $4.00 per share.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 38 of 64 81. Defendants announced that they expected earnings for the second quarter
to fall in the range of $770 million to $800 million, or 80 cents to 83 cents per share. A
consensus of analysts' estimates of earnings (based on information from defendants), however,
was 97 cents per share in the second quarter. The Company itself had stated that earnings in the
first quarter would be between 99 cents to $1.01 per share, and that earnings for the subsequent
quarters would be substantially higher.
82. In a press release, the Company, through defendant Crutchfield, sought to
explain the shortfall as follows:
"In 1999, the Company's fundamental operations are strong, as evidenced by an estimated 20 percent return on shareholders equity. However, in 1999, we are faced with overcoming the impact of substantial, 1998 unusual non-core earnings items, major acquisition integration and acceleration of spending for major new strategic initiatives as we deploy a new business model."
"This is an important transition year as we strategically reposition our company for the future", he added. "We are compressing a number of initiatives and acquisition consolidation into a short time frame. In addition, with the developing roles of Capital Markets and Capital Management, Future Bank and now the expansion of the Internet channel, we are deploying a new business model that no longer includes bank acquisitions as a fundamental part of our strategy."
83. The Company listed as the number one contributing factor for the revised earnings outlook problems with the CoreStates integration, stating "revenue growth in the former
CoreStates territory lags original expectations due to acquisition integration and the concurrent implementation of the Future Bank."
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 39 of 64 84. Defendants also revealed that the Company has taken $25 million in
securities gains in 1999, but did not plan to take the additional securities gains in 1999
contemplated in the Company's "previous outlook".
85. Defendants admitted in the press release that the integration of CoreStates,
which constituted one-third of the Company's revenue -- was causing serious problems, and
causing significant expense, contrary to defendants' numerous statements during the Class Period
that the integration had been successfully completed, the effects of the integration process were
"minimal", and the Company was well equipped to handle any problems.
86. The reaction of the market to the news was swift and severe. On the same day, First Union stock tumbled 8.6% or 4 13/16 to 45 1/8, on trading of 16,786,600 shares, more than seven times the normal trading volume. The drop constituted First Union's biggest drop in eight years, and well below the stock's 52-week high of 65.9375 per share.
87. The same day, numerous analysts including Friedman Billings, Prudential,
AG Edwards, JP Morgan, Montgomery Scott, and Salomon Smith Barney slashed First Union's ratings and earnings estimates, citing First Union's problems "digesting a slew of acquisitions."
88. On May 26, 1999, in a conference call with investors and analysts, defendant Crutchfield admitted that revenues from a string of recent acquisitions, notably CoreStates, had not measured up. In a May 26, 1999 report issued by First Call,
Michael Granger, an analyst with Fox-Pitt Kelton Inc., stated:
"Obviously they were overconfident about the ability to transfer CoreStates into a revenue growth story. CoreStates is a third of First Union's banking franchise. So, if you have a third of the franchise not working, you've got a big hole,"
- 40 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 40 of 64 89. In the report, Crutchfield indicated that the Company's strategy would be
changing to an Internet strategy and would seek to expand First Union's customer base by
attracting individuals who wanted to do their banking via the Internet -- a complete reversal in
First Union's acquisition strategy.
90. The same day, defendant Crutchfield admitted in an article in the
Charlotte Observer, "the bank's problem is that it simply has had too much on its plate."
DEFENDANTS' FRAUDULENT ACCOUNTING AND FINANCIAL STATEMENTS DURING THE CLASS PERIOD
91. Defendants fraud during the Class Period also included accounting
manipulations and the public issuance of materially inflated financial results. The accounting
fraud was part and parcel of defendants' overall scheme to conceal and misrepresent materially adverse financial and business conditions at First Union in order to maintain the market price of its common stock at artificially inflated levels.
92. The 1998 Second Quarter 10-Q, filed on August 14, 1998, the beginning of the Class Period, stated that "First Union is a major participant in the . . . sub-prime market for securitization or sale of residential real estate loans." "Securitization" of real estate loans
(i.e.,mortgages) is explained in the1998 Second Quarter Form 10-Q:
In a securitization transaction, a pool of loans is generally transferred to a trust, which simultaneously issues interests in the underlying cash flows of the pool to third-party investors. First Union typically. . . retains interest-only and residual certificates as
an investment. .. I
A substantially identical representation appeared in the 1998 Third Quarter 10-Q and the 1998 10-K.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 41 of 64 In other words, "securitization" entails creating an interest-paying security (represented by a
certificate) that is backed, or collateralized, by a "pool," or portfolio, of loans - in First Union's
case, by a pool of real estate loans consisting in significant part of sub-prime home equity loans.
First Union's securitized interests (the "interest-only and residual certificates" referred to in the
excerpt above) can be sold to third parties or retained as investments.
93. The importance and magnitude of First Union's securitization of sub-prime
real estate loans increased substantially in June 1998 as a result of its acquisition of The Money
Store, a company that specialized in home loans to sub-prime borrowers. As First Union
explained in its 1998 10-K, the "June 1998 acquisition of The Money Store establish[ed] [its]
position as the top home equity lender."
94. Beginning shortly after the commencement of the Class Period, defendants
fraudulently accounted for First Union's securitizcd interests in real estate loans (hereinafter
"Mortgage Securities"), as part of their overall scheme to misrepresent the financial and business condition of First Union to the investing public. As a result of defendants' accounting manipulations and violations of generally accepted accounting principles ("GAAP"), defendants concealed no less than $79 million of 1998 holding losses attributable to the devaluation of First
Union's holdings of Mortgage Securities, and thereby also overstated First Union's 1998 pre-tax earnings by no less than $79 million.
95. GAAP are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. SEC Regulation S-X (17 C.F.R. § 210.4-0I(a)(I) states that financial statements filed with the SEC which are not prepared in compliance with GAAP are presumed to be misleading and
- 42 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 42 of 64 inaccurate, despite footnote or other disclosure. Regulation S-X requires that interim financial
statements must also comply with GAAP, with the exception that interim financial statements
need not include disclosure which would be duplicative of disclosures accompanying annual
financial statements. 17 C.F.R. § 210.10-01(a).
96. During 1998, GAAP, and in particular Financial Accounting Standards
Board ("FASB") Statement No. 115, required that First Union's financial statements reflect any
devaluation in First Union's Mortgage Securities, or holding losses," by adjusting the value of
those securities on First Union's balance sheet, an adjustment that would also result in an
equivalent reduction in First Union's reported pre-tax earnings. GAAP also required that the
amount of the holding losses be measured as the difference between First Union's carrying value
for the Mortgage Securities, and their current fair market value.
97. During the summer of 1998, severe financial dislocations abroad, particularly in Russia and Asia, created unusual volatility in capital markets throughout the world. One of the key events, if not the key event, marking these disruptions in the capital markets was Russia's devaluation of the Ruble and declaration of a debt moratorium on August
17, 1998, only three days after the commencement of the Class Period. In the following months, investors in the financial and capital markets worldwide became increasingly risk averse, strongly increasing the demand for securities like U.S. Treasuries and decreasing the demand for relatively higher risk investments, such as Mortgage Securities. The phenomenon was so pervasive and dramatic that the financial press coined the expression "the flight to quality" to describe it. This phenomenon resulted not only in a dramatically decreasing demand for
- 43 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 43 of 64 securities like First Union's Mortgage Securities, but also a concomitant dramatic decrease in the
value of those securities.
98. Defendants, however, failed to report the holding losses in First Union's
portfolio of Mortgage Securities that occurred as a result of their loss of value - losses that
ultimately totaled at least $79 million by the end of 1998.
99. Instead, the defendants deceptively represented to the investing public that
First Union was properly and prudently valuing its Mortgage Securities and thus that its financial
statements appropriately reflected any holding losses attributable to those securities. For
example, the First Union Form 1998 Second Quarter 10-Q stated:
First Union maintains a disciplined valuation process whereby on a monthly basis a risk management committee reviews actual cash flows and the factors that affect the amounts and timing of the cash flows from each of the underlying static pools relative to the assumptions used in estimating fair value. Based on this analysis, assumptions are validated or revised as necessary, and the amounts and timing of cash flows are estimated and fair value is determined.
100. A substantially identical representation appeared in the First Union 1998
Third Quarter 10-Q, filed with the SEC on or about November 13, 1998. Similarly, the First
Union 1998 10-K, filed on March 16, 1999, stated:
Servicing assets, interest-only certificates, residual certificates and other interests retained are periodically evaluated for impairment based on the fair value of those assets.
101. Each of the foregoing representations, and the related discussions in First
Union's 1998 Second Quarter 10-Q, 1998 Third Quarter l0-Q and 1998 10-K, falsely and misleadingly lulled the investment community into believing that defendants had fairly presented
- 44 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 44 of 64 and appropriately recognized holding losses on First Union's Mortgage Securities when this was
not the case. To the contrary, the book (carrying) value, , the purported fair market value, of
the Mortgage Securities were, in fact, overstated by no less than $79 million in First Union's
financial statements for 1998 and First Union's pre-tax earnings were therefore overstated by the
same amount.
102. Moreover, the defendants' public representations that First Union's
valuation process was "disciplined" and based on reasonable "assumptions" that were "validated
or revised" on a monthly basis were belied by defendants' apparently haphazard variations in
"fair value adjustments" related to Mortgage Securities issued by The Money Store. For
example, the defendants valued the same Mortgage Securities issued by The Money Store at
$185 million in First Union's 1998 Second Quarter 1O-Q (filed August 14, 1998); $237 million in the 1998 Third Quarter l0-Q (filed November 30, 1998); and $207 million in the 1998 10-K
(filed March 16, 1999). These huge swings indicate a near-whimsical valuation process not grounded in reasonably objective or verifiable assumptions.
103. In addition to the devaluation caused by the widespread "flight to quality," the Company's Mortgage Equity portfolio was also subject to devaluation pressures caused by an increased rate of prepayments of existing loans that the entire subprime home equity loan market was experiencing in 1998 as a result of markedly declining interest rates. The failure to appropriately adjust the value of First Union's Mortgage Securities to account for the increased risk of prepayment was also contrary to GAAP.
104, Having effectively concealed the fraudulent non-recognition of at least
$79 million through the end of 1998 by issuing materially misleading disclosures and by
- 45 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 45 of 64 violating GAAP requirements, defendants then reclassified these 'trading" securities, at their
inflated values, to a new category of securities ("available for sale" securities) in furtherance of
their overall scheme to conceal the deteriorating financial and business condition of First Union.
105. Prior to January 1, 1999, First Union was required by GAAP (FASB
Statement No. 65, as amended by FASB Statement No 115 and No. 125), to, and did, classify its
portfolio of Mortgage Securities as "trading" securities. Under FASB Statement No. 115,
holding losses in trading securities must be recognized as a balance sheet fair market value
adjustment, which also results in a charge to pre-tax earnings in the amount of the adjustment.
FASB Statement No. 115 also provides that holding losses associated with "available for sale"
securities, in contrast to "trading" securities, are not to be recognized and therefore do not result in decreased earnings. Holding losses for "available for sale" securities are only recognized in financial statements upon (a) the sale or disposition of the securities, or (b) if the value of the securities are impaired other than temporarily.
106. As of January 1, 1999, First Union reclassified its Mortgage Securities as
"available for sale" securities under a new GAAP provision issued in 1998, FASB Statement No.
134, pursuant to which, as disclosed in First Union's First Quarter March 31, 1999 Form 10-Q:
• . retained interests resulting from the securitization of mortgage loans held for sale [Mortgage Securities] are classified either [as] securities available for sale or [as] trading account assets based on intent [to sell or hold those investments]. (Emphasis added.)
107. Prior to January 1, 1999, financial institutions like First Union were not permitted under GAAP to use the "available for sale" classification, or the accompanying accounting treatment for holding losses incurred in retained Mortgage Securities. However,
- 46 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 46 of 64 while FASB Statement No. 134 permitted the reclassification of Mortgage Securities from
"trading" to "available for sale" securities from January 1, 1999 forward, it did not govern the
classification of Mortgage Securities in 1998, which under GAAP provisions effective for 1998,
were required to be classified as "trading" securities. Defendants violated GAAP by ignoring the
holding losses incurred by the devaluation of its Mortgage Securities in 1998, as it did.
108. Defendants used the reclassification of First Union's Mortgage Securities
portfolio - which First Union carried on its financial statements as of December 31, 1998 at a
value that was improperly overstated by at least $79 million - as a device to permit First Union
to report its 1998 holding losses incrementally during 1999 through strategically timed
announcements of "impairments" to the value of "certain" of its Mortgage Securities. In fact, however, the "impairments" to the value of First Union's Mortgage Securities had already occurred -- in 1998. Tellingly, defendants gave no public explanation about, nor did they identify, any unusual economic or market factor in 1999 that could account for the supposed
"discovery" of a $79 million impairment to the value of the First Union Mortgage Securities in
1999 - as opposed to 1998, when market disruptions did adversely impact the value of virtually all relatively high risk securities such as First Union's Equity Securities.
109. As part of defendants' scheme to incrementally disclose the decreased earnings defendants knew First Union would have to report in 1999, defendants caused First
Union to state in its 1998 10-K:
1999 has the potential to be a challenging year for the financial services industry, including First Union, as a result of continued uncertainty in the global markets. . . a change in the business strategy for funding subprime home equity loans (discussed in the Asset Securitization section), led us to announce in late January
- 47 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 47 of 64 1999 a modified goal for 1999 operating earnings per share growth on a percentage basis in the mid- to high-single digits. Our previously stated earnings growth financial performance guideline was 12 to 14 percent.
In 1998 securitization was the primary funding strategy for certain types of home equity loans. In these transactions, which were accounted for as sales, the loans were securitized and sold, and gains were recognized in current income. In early 1999, we reevaluated our business strategy for sub-prime home equity loan products and decided that we will utilize other strategies that do not result in gain recognition. Accordingly, we estimate that 1999 income per share may be reduced by eight to twelve cents.
110. These statements in the 1998 1 0-K, which were made to the investing
public on or about March 16, 1999, were materially false and misleading because they:
(a) Led the investment community to believe that the "modified goal
for 1999 operating earnings per share" were based upon a changed "business strategy for funding
subprime home equity loans! when, in fact, it was based upon the planned recognition during
1999 of no less than $79 million of 1998 holding losses on Mortgage Securities that were fraudulently not recognized in First Union's 1998 financial statements.
(b) Failed to disclose the fact that as of the March 16, 1999 date of filing of the 1998 Form I 0-K, the Company was about to report "a $19 million impairment loss on retained interests in certain securitizations of home improvement loans," L., Mortgage
Securities, for its 1999 First Quarter, which ended March 31, 1999 - only two weeks after the defendants filed the 1998 10-K.
(c) Failed to disclose that 1999 earnings per share was expected to be materially lower than forecast as a result of not only the severe undisclosed problems First Union
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 48 of 64 experienced throughout the Class Period in connection with integrating its newly acquired
CoreStates business and operations with its existing business and operations, but also because of
the imminent adjustment to the overstated value of the Company's Mortgage Securities portfolio.
Significantly, two months later, in the absence of any news of materially adverse developments,
the Company announced 'revised" earnings of $3.40 to $3.50 per share and stated that: "The new
outlook compares with the earnings goal of approximately $4.00 per share that the company had
communicated earlier this year."
111. On or about May 5, 1999, First Union filed its 1999 First Quarter Form
10-Q with the SEC ("the 1999 First Quarter 10-Q"). The 1999 First Quarter 10-Q disclosed a
$19 million "impairment" to the value of the company's Mortgage Equity portfolio that was
attributed to "the impact of revised loss assumptions on the valuation of the retained interests" in
"certain securitizations of home improvement loans." Again, there was no identification of any
event or condition in the financial market or the business experience of the Company that could account for the "impairment" becoming apparent to defendants during the three months ended
March 31, 1999, as opposed to during the second half of 1998, when there were extraordinary dislocations in the financial markets that dramatically impacted the value of relatively high risk securities such as the First Union Equity Securities.
112. In fact, the statements in the 1999 First Quarter l0-Q were materially false and misleading because they:
(a) Led the investment community to believe that the $19 million
Impairment loss occurred during the first quarter of 1999 when, in fact, this loss had been fraudulently deferred from 1998 to the first quarter of 1999.
-49 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 49 of 64 (b) Failed to recognize, via a charge to earnings, or to disclose to the
investing public that there remained no less than $60 million of additional fraudulently deferred
1998 holding losses associated with the Company's Mortgage Securities portfolio.
113. The 1999 First Quarter 10-Q was also materially false and misleading
because it failed to disclose that defendants had no reasonable basis for their previously
announced $4.00 per share "estimate" of 1999 income per share, and, in fact, knew or recklessly
disregarded that the 1999 income per share would be significantly lower than represented, and
that within three weeks, in the absence of news of any materially adverse developments, the
Company would be announcing a revised earnings forecast of $3.40 to $3.50 per share.
114. After the Class Period, on or about November 15, 1999, the Company
filed its 1999 Third Quarter Form 10-Q with the SEC ("the September 30, 1999 Form l0-Q")
This document stated:
In the first nine months of 1999, portfolio-related net securities losses were $55 million, which included a $79 million impairment loss on certain residual interests in securitizations. This write- down was the result of the impact of revised loss assumptions on the valuation of the residual interests.
In the third quarter of 1999, we transferred $744 million of mortgage-related residual interests and $8.7 billion of other mortgage-related securities to a trust in return for a new security representing substantially all of the interest in the assets transferred to the trust. Substantially all of the corporation's investment in mortgage-related residual interests was included in this transfer. The assets were transferred to the trust at their respective carrying values at the date of transfer, and the transfer did not result in recognition of any gain or loss. This new security is classified in Securities available for sale. Prior to the transfer, we recognized a $79 million impairment loss on certain residual interests.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 50 of 64 115. The additional $60 million of impairment losses recognized in the third
quarter of 1999, like the $i 9 million recognized in the 1999 first quarter, was attributed to "the
impact of revised loss assumptions on the valuation of the residual interests." All of these
impairment losses were, however, known or recklessly disregarded by defendants in 1998 during
the Class Period.
116. Due to these accounting improprieties, First Union's financial statements
violated the following fundamental GAAP accounting principles:
(a) The principle that financial reporting should provide information
that is useful to present and potential investors and creditors and other users in making rational
investment, credit and similar decisions (FASB Statement of Concepts No. 1, ¶34);
(b) The principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and effects of transactions, events and circumstances that change resources and claims to those resources
(FASB Statement of Concepts No. 1, 1140);
(c) The principle that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners
(stockholders) for the use of enterprise resources entrusted to it. To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general (FASB Statement of Concepts
No. 1 ,1J50);
(d) The principle that financial reporting should provide information about an enterprise's past financial performance. Investors and creditors often use information
-51 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 51 of 64 about the past to help in assessing the prospects of an enterprise. Thus, although investment and
credit decisions reflect investors' expectations about future enterprise performance, those
expectations are commonly based at least partly on evaluations of past enterprise performance
(FASB Statement of Concepts No. 1, ¶42);
(e) The principle that financial reporting should be reliable in that it
represents what it purports to represent was violated. That information should be reliable as well
as relevant is a notion that is central to accounting (FASB Statement of Concepts No. 2, ¶1158-
59);
(f) The principle of completeness, which means that nothing is left out
of the information that may be necessary to insure that it validly represents underlying events and
conditions was violated (FASB Statement of Concepts No. 2, 179); and
(g) The principle that conservatism be used as a prudent reaction to
uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent (FASB Statement of Concepts No. 2, J T95, 97).
ADDITIONAL SCIENTER ALLEGATIONS
117. The Individual Defendants acted with scienter to artificially inflate the price of First Union common stock in order to: (i) allow insiders to sell shares of First Union common stock at a substantial profit before the truth could be discovered; and (ii) enhance the ability of First Union to fund acquisitions by granting the acquired company shares of First
Union common stock. Specifically, First Unions inflated stock price enabled defendants to
- 52 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 52 of 64 acquire EVEREN Capital Corporation ("EVERENt), a full service brokerage based in Chicago,
Illinois, an all-stock transaction valued at $1.1 billion as announced May 5, 1999,
118. During the Class Period, defendant Georgius sold over 133,672 shares of
First Union common stock at prices ranging from $58.31 per share to $61.53 per share for
proceeds totaling $8,007,291.
119. Georgius stock sales were as follows:'
DATE NO. OF SHARES PRICE PER SHARE PROCEEDS
10/21/98 5,000 58.31 291,550
10/21/98 12,338 58.44 721,032
10/21/98 2,662 58.44 155,567
10/21/98 9,572 58.75 562,355
10/21/98 5,500 58.38 321,090
10/21/98 1,500 58.69 88,035
10/21/98 5,000 58.31 291,550
10/21/98 12,338 58.44 721,032
10/21/98 9,572 58.75 562,355
10/21/98 5,500 58.38 321,090
10/21/98 1,500 58.69 88,035
11/30/98 59,690 61.53 3,672,725
12/1/98 3,500 60.25 210,875
TOTAL 133,672 8,007,291
120, In addition to defendant Georgius' substantial sales of First Union stock, according to Insider Trader, defendant Crutchfield sold 26, 637 shares of his own First Union stock in a private sale" at prices ranging from $53.19 per share to $54.88 per share, between
2 Trades are as reported in First Call's Insider Trading Report.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 53 of 64 March 8, 1999 and April 21, 1999, shortly before the Company's devastating news was revealed
for total proceeds of over $1.46 million; and defendant Hatch sold over 3,000 shares at prices
ranging from $52.31 to $62.88 per share, generating proceeds of nearly $200,000.
121. Other First Union insiders, including highly ranked officers and directors,
sold shares of First Union stock at prices ranging from $52.31 to $65.38 per share, well above the
trading price of the stock after the May 25, 1999 news was finally disclosed, for total proceeds of
over $48 million.
122. Terrence Larsen, as the former Chairman of CoreStates and a director of
First Union, knew that defendants' statements regarding the "completion" of the integration
process and the Company's bright financial prospects had no basis, and that the Company would
face material earnings shortfalls due to the substantial problems First Union was already facing
integrating the companies' systems. According to a December 29, 1998 article in the
Philadelphia Inquirer, Larsen sold 250,000 shares, or nearly all of his First Union holdings, in
November of 1998, grossing more than $15 million.
123. As alleged herein, defendants acted with scienter in that (i) defendants knew or recklessly disregarded the severe and persistent problems and costs that First Union was encountering in the process of integrating CoreStates operations with the Company's existing operation; (ii) defendants knew or recklessly disregarded that the public documents and statements issued and disseminated in the name of First Union were materially false and misleading; (iii) defendants knew or recklessly disregarded that such statements or documents would be issued or disseminated to the investing public; and (iv) defendants knowingly or recklessly substantially participated or acquiesced in the issuance or dissemination of such
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 54 of 64 statements or documents as primary violators of the federal securities laws. As set forth herein in
detail, defendants, by virtue of their receipt of information reflecting the true adverse facts
regarding First Union, its experience with both the CoreStates and The Money Store acquisitions,
their control over, and/or receipt and/or modification of First Union's materially misleading
misstatements and/or their associations with First Union that made them privy to confidential
proprietary information concerning First Union, participated in the fraudulent scheme alleged
herein.
124. The defendants' motive to engage in the conduct alleged herein also
included an effort to manipulate and artificially inflate the price of First Union stock to cover up
and conceal the severe problems the Company was encountering in integrating the businesses
and operations of CoreStates, thus protecting and enhancing their executive positions and
substantial compensation and prestige they obtained thereby.
125. Defendants were also the top managers and executives of First Union, and thus could not, absent a severely reckless disregard of the truth, have been ignorant of the pervasive problems with First Union's over $20 billion acquisitions of CoreStatcs and The
Money Store, problems that were materially impacting the Company's fundamental, day-to-day operations and no secret at the Company, involved over a third of its banking franchise, and directly bore on the Company's most widely publicized activities. In sum, the individual defendants cannot now credibly distance themselves from knowledge of the true deteriorating earnings and profitability at the Company during the Class Periods.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 55 of 64 NO SAFE HARBOR
126. The statutory safe harbor provided for forward looking statements under
certain circumstances does not apply to any of the allegedly false statements pleaded in this
complaint. The statements alleged to be false and misleading herein all relate to then-existing
facts and conditions. In addition, to the extent certain of the statements alleged to be false may
be characterized as forward looking, they were not identified as "forward looking" when made,
there was no statement made with respect to any of those representations forming the basis of
this complaint that actual results "could differ materially from those projected," and there were
no meaningful cautionary statements identifying important factors that could cause actual results
to differ materially from those in the purportedly forward-looking statements. Alternatively, to the extent that the statutory safe harbor is intended to apply to any forward-looking statements pled herein, defendants are liable for those false forward-looking statements because at the time each of those forward-looking statements was made, the particular speaker had actual knowledge that the particular forward-looking statement was materially false or misleading, and/or the forward-looking statement was authorized and/or approved by an executive officer of First Union who knew that those statements were false when made.
RELIANCE ALLEGATIONS FRAUD-ON-THE-MARKET DOCTRINE
127. Plaintiffs will rely, in part, upon the presumption of reliance established by the fraud-on-the-market doctrine in that, among other things:
(a) First Union common stock met the requirements for listing, and was listed, on the New York Stock Exchange, a highly efficient market;
- 56 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 56 of 64 (b) as a regulated issuer, the Company filed periodic public reports
with the SEC;
(c) the trading volume of the Company's stock was substantial,
reflecting numerous trades each day;
(d) First Union was followed by securities analysts employed by
several major brokerage firms who wrote reports which were distributed to the sales force and
certain customers of such firms and which were available to various automated data retrieval
services;
(e) the misrepresentations and omissions alleged herein were material
and would tend to induce a reasonable investor to misjudge the value of First Union common
stock; and
(f) plaintiffs and the members of the Class purchased their common stock during the Class Period without knowledge of the omitted or misrepresented facts.
128. Based upon the foregoing, plaintiffs and the other members of the Class are entitled to a presumption of reliance upon the integrity of the market for the purpose of class certification as well as for ultimate proof of their claims on the merits. Plaintiffs will also rely, in part, upon the presumption of reliance established by material omissions and upon the actual reliance of the class members.
INDIVIDUAL DEFENDANTS' DUTY TO REPORT TRENDS, DEMANDS OR UNCERTAINTIES
129. Under the rules and regulations promulgated by the SEC under the
Exchange Act, specifically Item 303 of Regulation S-K, the Individual Defendants also had a
- 57 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 57 of 64 duty to report all trends, demands or uncertainties that were reasonably likely to impact First
Union's:
(a) liquidity;
(b) net sales, revenue and/or income; and/or
(c) previously reported financial information such that it would not be
indicative of future operating results.
130. As set forth in detail above, the Individual Defendants' representations
during the Class Period violated their duty to report all trends, demands or uncertainties
reasonably likely to impact upon First Union's net sales, revenue, income, and previously
reported financial information such that it would not be indicative of future operating results.
FIRST CLAIM FOR RELIEF FOR VIOLATION OF SECTION 10(b) OF THE EXCHANGE ACT AND SEC RULE lOb-5
131. Plaintiffs repeat and reallege each and every allegation contained in the paragraphs above as if fully set forth herein.
132. During the Class Period, the defendants engaged in a course of conduct, described above, pursuant to which they knowingly or recklessly engaged in acts, transactions, practices, and a course of business which operated as a fraud upon plaintiffs and the other members of the Class; made various untrue statements of material facts and omitted to state material facts necessary to make statements made, in light of the circumstances under which they were made, not misleading to plaintiffs and the other Class members; and employed manipulative and deceptive devices and contrivances in connection with the purchase of First
Union common stock.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 58 of 64 133. The purpose and effect of the defendants' plan, scheme, conspiracy and
course of conduct was to artificially inflate the price of First Union common stock and artificially
to maintain the market price of the stock.
134. The Individual Defendants, through their positions as officers and/or a
director, had actual knowledge of the material omissions and/or the falsity of the statements set
forth above, and intended to deceive plaintiffs and the other members of the Class or, in the
alternative, acted with reckless disregard for the truth when they failed or refused to ascertain and
disclose in the aforementioned documents the true facts to plaintiffs and the other members of
the Class.
135. The defendants had actual knowledge of the material omissions and/or the
falsity of the statements set forth above, and intended to deceive plaintiffs and the other members
of the Class or, in the alternative, acted with reckless disregard for the truth when they failed or refused to ascertain and disclose in the aforementioned documents the true facts to plaintiffs and the other members of the Class.
136. As a result of the foregoing, the market price of First Union stock was artificially inflated during the Class Period. In ignorance of the materially false and misleading nature of the misrepresentations, described above, made by defendants and the deceptive and manipulative devices and contrivances employed by the defendants, plaintiffs and the other members of the Class relied, to their detriment, on the integrity of the market price of the stock in purchasing First Union stock. Had plaintiffs and the other members of the Class known of the material adverse information not disclosed by the defendants, they would not have purchased
First Union stock at the artificially inflated prices that they did.
- 59 -
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 59 of 64 137. Plaintiffs and the other members of the Class have suffered substantial
damages as a result of the wrongs alleged herein.
138. By reason of the foregoing, defendants have violated Section 10(b) of the
Exchange Act and Rule lOb-5 promulgated thereunder, in that they: (a) employed devices,
schemes and artifices to defraud; (b) made untrue statements of material fact or omitted to state
material facts necessary to make the statements made not misleading; and (c) engaged in acts,
practices and a course of business which operated as a fraud or deceit upon plaintiffs and the
other members of the Class in connection with their purchases of First Union stock during the
Class Period.
SECOND CLAIM FOR RELIEF FOR VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT
139. Plaintiffs repeat and reallege each and every allegation set forth in the paragraphs above, as if set forth fully herein.
140. The Individual Defendants, by virtue of their offices, directorship, and specific acts were, at the time of the wrongs alleged herein, controlling persons of First Union within the meaning of Section 20(a) of the Exchange Act. The Individual Defendants had the power and influence and exercised the same to cause First Union to engage in the illegal conduct and practices complained of herein by causing the Company to disseminate to the public, or through analysts, the materially false and misleading information referred to above.
141. The Individual Defendants' positions made them privy to, and provided them with, actual knowledge of the material facts concealed from plaintiffs and the Class by First
Union during the Class Period.
Weitz
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 60 of 64 142. By reason of the conduct alleged in the First Claim for Relief, the
Individual Defendants are liable for the aforesaid wrongful conduct and liable to the plaintiffs
and the other members of the Class for the substantial damages which they suffered in
connection with their purchases of First Union common stock during the Class Period.
WHEREFORE, plaintiffs on their own behalf, and on behalf of the other
members of the Class, prays for judgment as follows:
A. Declaring this action to be a proper class action, and certifying the
Lead Plaintiffs as Class representatives;
B. Declaring and determining that the defendants violated the federal
securities laws by reason of their conduct as alleged herein;
C. Awarding money damages against the defendants, jointly and
severally, in favor of the plaintiffs and the other members of the Class for all losses and injuries suffered as a result of the acts and transactions complained of herein, together with prejudgment interest on all of the aforesaid damages which the Court shall award from the date of said wrongs to the date of judgment herein at a rate the Court shall fix;
D. Awarding plaintiffs their costs and expenses incurred in this action, including reasonable attorneys', accountants' and experts' fees; and
E. Awarding such other relief as may be just and proper.
Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 61 of 64 JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury pursuant to Rule 38(b) of the Federal Rules of Civil Procedure,
Dated: February 22, 2000 LESESNE & CONNETTE
By:
Louis 4L.~ 1001 Elizabeth Avenue Suite 1-D Charlotte, NC 28204-2234 (704) 372-5700 BROWN & ASSOCIATES Donald Brown 7400 Cannel Executive Park Suite 120 Charlotte, NC 28226 Tel: (704) 542-2525 Fax: (704) 541-4751 Co-Liaison Counsel MILBERC WEISS BERSHAD HYNES & LERACH LLP Abraham Rappaport Maya Saxena The Plaza, Suite 900 5355 Town Center Road Boca Raton, Florida 33486 Tel: (561) 361-5000 Fax: (561) 367-8400 - 62 - Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 62 of 64 SCHOENGOLD & SPORN, P.C. Samuel P. Sporn Christopher Lometti Jay P. Saltzman 233 Broadway New York, NY 10279 (212) 964-0046 SCHIFFRJN & BARRO WAY, LLP Andrew L. Barroway Marc A. Topaz Three Bala Plaza East Suite 400 Bala Cynwyd, PA 19004 (610) 667-7706 Co-Lead Counsel Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 63 of 64 CERTIFICATE OF SERVICE I HEREBY CERTIFY that a true and correct copy of the foregoing has been forwarded via regular U.S. mail to all counsel of record listed below this 22nd day of February, 2000. JAMES, McELROY & DIEHL KIRKPATRICK & LOCKHART, LLP Edward T. Hinson Richard J. Morviflo Ann L. Hester Jeffrey B. Maletta 600 South College Street 1800 Massachusetts Ave., N.W. Charlotte, NC 28202 Suite 200 Washington, D.C. 20036 Case 3:99-cv-00237-CH Document 47 Filed 02/22/00 Page 64 of 64