Case 1:05-cv-01563-EWN-BNB Document 87 Filed 02/28/2006 Page 1 of 81 IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO Judge Edward W. Nottingham Civil Action No. 05-cv-01563-EWN-BNB (Consolidated with Baird v. Red Robin Gourmet Burgers. Inc., 05-cv-01903; and consolidated for pretrial proceedings with Wilster v. Snyder, 05-cv-01707) ANDRE ANDROPOLIS, on behalf of himself and all others similarly situated, Plaintiff, v. RED ROBIN GOURMET BURGERS, INC., MICHAEL J. SNYDER, JAMES P. McCLOSKEY, LISA A. DAHL, KATHERINE L. SCHERPING, and DENNIS B . MULLEN, Defendants. CONSOLIDATED COMPLAINT 1. Lead Plaintiff, the City of Philadelphia Board of Pensions and Retirement, by its attorneys alleges the following facts, except as to allegations about itself or its counsel, based upon counsel's investigation, which included: analysis of publicly-available news articles and reports, press releases, transcripts of investor conference calls, analyst reports, and public filings with the Securities and Exchange Commission ("SEC"), review of other matters of public record, and interviews of certain former employees of Red Robin Gourmet Burgers, Inc. ("Red Robin" and the "Company"). The former Red Robin employees who provided information set forth in this complaint requested that their names not be revealed in the pleading but permitted counsel to identify Case 1:05-cv-01563-EWN-BNB Document 87 Filed 02/28/2006 Page 2 of 81 the general time period during which they were employed by Red Robin along with a general description of their positions and responsibilities: Confidential witness number 1("CW 1 ") is a former Red Robin staffaccountant who worked at the Company' s Greenwood Village, Colorado headquarters from 2001 until 2003. CW 1's responsibilities included, among other things, (i) processing travel and entertainment expenses for Red Robin ' s management and executive team, (ii) the accounts payable and accounts receivable functions for 22 company-owned restaurants, and (iii) the preparation of financial packets provided to the executive team and board of directors. Confidential witness number 2 ("CW2") is a former Red Robin staffaccountant who worked at the Company's headquarters from 2004 to 2005. CW2's responsibilities included, among other things, (i) processing travel and entertainment expenses for Red Robin's management and executive team, and (ii) the accounts payable function for 20 company-owned restaurants. CW2 explained that Red Robin's bookkeeping operations are on the first floor ofthe building that houses the Company's headquarters, and that the executives' offices are located on the second floor ofthe building. The former employee further explained that staff accountants work in cubicles as distinguished from enclosed offices. • Confidential witness number 3 ("CW3") is a former Red Robin senior officer who worked at the Company ' s headquarters prior to the Class Period. • Confidential witness number 4 ("CW4") is a former Red Robin senior executive who worked at the Company ' s headquarters prior to the Class Period. • Confidential witness number 5 ("CW5") is a former accounts payable specialist who worked at Red Robin ' s headquarters from 2004 until 2005. CW5 was responsible for accounts payables for 20 Red Robin restaurants. • Confidential witness number 6 ("CW6") is a former accounts receivable specialist who worked at Red Robin ' s headquarters prior to the Class Period. INTRODUCTION AND OVERVIEW 2. This is a securities class action on behalf of all persons who purchased the common stock of Red Robin between August 13, 2004 and January 9, 2006, inclusive (the "Class Period"), and asserts claims under Sections 10(b), 14 and 2 0(a) ofthe Securities Exchange Act (the "Exchange Act"), 15 U.S.C. §§78j, 78n and 78t(a), and the rules and regulations promulgated thereunder by the -2- Case 1:05-cv-01563-EWN-BNB Document 87 Filed 02/28/2006 Page 3 of 81 SEC, including Rules IOb-5, 14a-3 and 14a-9 (17 C.F.R. §240.10b-5, .14a-3 and . 14a-9). 3. Mike Snyder -Red Robin's Chairman, Chief Executive Officer ("CEO") and President- transformed Red Robin from a small, stagnant restaurant chain into a fast-growing chain of gourmet burger restaurants with a wholesome image. 4. Red Robin's wholesome brand image and gourmet burgers became a hit with diners and eventually Wall Street as well. In fact, between the Company's July 2002 initial public offering and early August 2005, the value ofRed Robin's stock price increased five-fold -from $12 per share to more than $60 per share. 5. From 2003 through 2005, Red Robin added forty-eight (48) company-owned restaurants , increasing its total to 163, and supported the opening of thirty-three (33) franchised restaurants, increasing its total to 136. 6. However, Red Robin did not align its internal controls with the rapid growth of its operations. Section 13(b)(2)(B) ofthe Exchange Act requires registrants, like Red Robin, to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that: • transactions are executed in accordance with management's general or specific authorization; • transactions are recorded as necessary (i) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (ii) to maintain accountability for assets; • access to assets is permitted only in accordance with management's general or specific authorization; and • the recorded accountability for assets is compared with the existing assets at -3- Case 1:05-cv-01563-EWN-BNB Document 87 Filed 02/28/2006 Page 4 of 81 reasonable intervals and appropriate action is taken with respect to any differences. Representations in Red Robin's quarterly and annual financial statements filed with the SEC throughout the Class Period, led investors to believe that the Company had adequate and effective internal controls in place. More specifically, Red Robin represented to investors that: (i) management conducted evaluations, under the supervision and with the participation ofthe CEO and chief financial officer ("CFO"), of the effectiveness of the Company's disclosure controls and procedures as of the end of each reporting period; (ii) based upon each evaluation, management concluded that disclosure controls and procedures were effective; and (iii) there were no changes during the reporting periods that materially affected internal controls over financial reporting. 7. Investors first became aware of cracks in internal controls in early 2005 when the Company acknowledged that deficient internal controls led to improper lease accounting that made earnings appear higher than they actually were. As a result, Red Robin was forced to restate its financial results for fiscal years 2002 and 2003. 8. As investors later learned through two major disclosures offraudon August 11, 2005 and January 10, 2006, Red Robin's internal control deficiencies ran much deeper than just lease accounting. Red Robin's concealment ofthese deficiencies and the resulting diversion of corporate funds and issuance of materially false and misleading earnings and revenue forecasts caused Red Robin's common stock to trade at artificially inflated prices during the Class Period. 9. The first major disclosure of fraud came after the market closed on August 11, 2005 when investors learned that Chairman/CEO Mike Snyder had been treating the Company as his own personal fiefdom by diverting corporate and shareholder assets to pay for personal travel and non- -4- Case 1:05-cv-01563-EWN-BNB Document 87 Filed 02/28/2006 Page 5 of 81 business related expenses . The Company explained that the improper transactions were uncovered during an internal investigation initiated by the Company' s Board of Directors at the conclusion of which Mr. Snyder retired and the Company' s longtime CFO, Jim McCloskey, resigned. Red Robin no longer appeared so wholesome, as shareholders and Wall Street questioned the Company's integrity and credibility. 10. In reaction to the August 11, 2005 disclosure, Red Robin's common stock plummeted 24% on August 12, 2005, closing at $45.55 per share, down significantly from the prior day closing price of $59.79. Red Robin subsequently acknowledged in its second quarter of 2005 Form 10-Q that inadequate controls enabled Mr. Snyder to disregard company policy and spend approximately $1.25 million of corporate and shareholder funds on personal expenses since 2001 . The SEC has launched a formal investigation of Red Robin. 11. Red Robin initiated its internal investigation of Mr. Snyder after members of the Board read an article published in the Wall Street Journal discussing how corporate executives may bill shareholders for their own pleasure trips and that many companies conceal the abuse. On the same day that the Wall Street Journal article was published, Messrs. Snyder andMcCloskey foresaw scrutiny and disclosure oftheir improper practices and, thus, made arrangements to lock in gains and unload a sizable amount oftheir personal holdings ofRed Robin stock. Mr. McCloskey sold 10,000 shares at approximately $55.00 per share reaping proceeds in excess of $550,000. Mr. Snyder entered into two pre-paid variable share forward contracts through which he was paid a total of $14,086,341 in exchange for agreeing to deliver 150,000 shares on November 17, 2006 and another 150,000 shares on May 25, 2007. 12. Red Robin director, Denny Mullen, replaced Mike Snyder as Chairman ofthe Board -5- Case 1:05-cv-01563-EWN-BNB Document 87 Filed 02/28/2006 Page 6 of 81 and CEO. Katie Scherping took over as CFO in June 2005 after Mr. McCloskey was quietly reassigned. Contributing to the sharp erosion in credibility was the replacement executives' vague explanation of the internal investigation and the sugar-coating oftheir former boss' and the former CFO's departures from the Company. Mr. Mullen and Ms.