UNITED STATES DISTRICT COURT WESTERN DISTRICT OF NORTH CAROLINA CHARLOTTE DIVISION 3 :99CV237-MC K Clerk, U. S. Dist. Court W. Dist of N. C. IN RE: THE FIRST UNION CORP. ) SECURITIES LITIGATION ) THIRD CONSOLIDATED AND AMENDED CLASS ACTION COMPLAINT TABLE OF CONTENTS Page NATURE OF THE CASE . 2 JURISDICTION AND VENUE . 6 PARTIES . 7 PARTICIPATION OF INDIVIDUAL DEFENDANTS . 9 CONFIDENTIAL SOURCES . 1 0 SUBSTANTIVE ALLEGATIONS . 1 3 A. DEFENDANTS RECKLESSLY IGNORED THE FRAUDULENT PRACTICES AT THE MONEY STORE . 1 3 1 . Defendants Performed Virtually No Due Diligence . 1 3 B. THE "BARCELONA WEEKEND": FIRST UNION EXECUTIVES DISCUSS THE MONEY STORE' S TRUE FINANCIAL CONDITION . 1 6 C . A 1998 INTERNAL AUDIT AT THE MONEY STORE REVEALS ENORMOUS ERROR RATE S IN THE MONEY STORE'S LOAN PORTFOLIO . 1 8 1 . The Results of The Money Store Audit Are Given to First Union . 19 2 . The Money Store's Fraudulent Practices are Detaile d In Written Reports Provided to First Union . 20 D . First Union Is Directly Confronted With The Money Store's Fraud . 22 1 . Concerned Money Store Employees Confront First Union Senior Management . 22 2. Defendants Take No Action to Remedy the Fraudulent Practices . 2 3 E. The Impact of the Money Store's Fraud on First Union . 3 0 1 . The Magnitude of The Money Store's Problems . 3 0 i 2. The August 1998 KPMG Audit . 3 1 3 . The Elimination of Gain-On-Sale Accounting . 33 4. Defendants Receive Documents Describin g Massive Losses at The Money Store . 34 5 . A Written Manual Prepared by First Unio n Details The Money Store's Fraud . 36 6. First Union Continues to Ignore Serious And Illegal Practices at The Money Store . 37 F. THE NEED FOR OCC COMPLIANCE FURTHER FLAGGED THE MONEY STORE'S PROBLEMS . 42 1 . The Conditional Approval Order . 42 2. OCC Inspectors Arrive at The Money Stor e for an In-Depth Examination . 44 3. The Project Book - - Written Evidence of Defendants ' Fraud . 45 4. Defendants' Fraud Violated GAAP . 47 DEFENDANTS' FALSE AND MISLEADING STATEMENT S AND RELEVANT EVENTS DURING THE CLASS PERIOD . 5 1 Defendants Announce the Acquisition . 5 1 Defendants' Statements In The March 4, 199 8 Press Release Were False and Misleading . 5 3 Defendants Close The Acquisition Of The Money Store . 5 5 First Union's False And Misleading Form I0-Q For The Quarter Ending June 30, 1998 . 56 Defendants' Statements in the Third Quarter of 1998 . 59 Defendants Issue False Statements at Year End 1998 . 62 Defendants' Year-End 1998 Statements Were Materiall y False and Misleading . 65 Defendants' Fraud Continues During Fiscal Year 1999 . 67 Defendants Failed to Disclose The Magnitude of The Problems at The Money Store in The First Quarter of Fiscal 1999 . 70 ii DEFENDANTS CONTINUE TO ISSUE INFLATE D FINANCIAL REPORTS AFTER THE CLASS PERIOD . 7 1 Defendants' Statements After The Class Perio d Continued to Mislead Investors . 74 Defendants' False Statements During Fiscal Year 2000 . 77 THE FULL TRUTH ABOUT THE MONEY STORE IS REVEALED . 80 ADDITIONAL SCIENTER ALLEGATIONS . 8 1 A. First Union Uses Inflated Stock as Currency . 1 . 8 1 B . Defendants and Other Insiders Sell Millions at Artificially Inflated Prices . 82 C. Defendants' Actual Knowledge of The Fraud . 85 NO SAFE HARBOR . 8 8 RELIANCE ALLEGATION S FRAUD-ON-THE-MARKET DOCTRINE . 89 INDIVIDUAL DEFENDANTS' DUTY TO REPORT TRENDS , DEMANDS OR UNCERTAINTIES . 90 CLASS ACTION ALLEGATIONS . 9 1 FIRST CLAIM FOR RELIEF FOR VIOLATION O F SECTION 10(b) OF THE EXCHANGE ACT AND SEC RULE I Ob-5 . 93 SECOND CLAIM FOR RELIEF FOR VIOLATIO N OF SECTION 20(a) OF THE EXCHANGE ACT . 94 JURY TRIAL DEMANDED . _ . 96 III Lead Plaintiffs ("Plaintiffs"), by and through their attorneys, allege the followin g based upon the investigation of their attorneys, which included: (a) review and analysis of publi c filings made by First Union Corporation ("First Union" or the "Company"), with the Securitie s and Exchange Commission (the "SEC"); (b) interviews with confidential witnesses who are former employees of First Union and The Money Store Inc. ("The Money Store" or "Mone y Store"); (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 th e individual defendants in the financial and general press ; (e) review and analysis of other publicly available information about First Union; (f) 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 . Plaintiffs further believe that there are many additional detailed facts supporting the allegations contained herein which are known only to defendants or are within defendants' exclusive possession and control . The Court dismissed certain claims in Plaintiffs' Second Consolidated and Amended Complaint (the "Second Amended Complaint") . See Order, dated September 16, 2002, granting in part defendants' motion to dismiss the Second Amended Complaint on procedural grounds (the "Order"). The Order did not dismiss claims "relating to" misstatements alleged in Paragraphs 101, 122, 133, 134, 137, 138 (in part), 141 and 143-147 of the Second Amended Complaint. Order at 11-12 . Plaintiffs attach hereto Exhibit A, which alleges the original Paragraphs 101-204 of the Second Amended Complaint . Exhibit A is made part of this Third Amended Complaint for the purpose of preserving the record for any potential appeal of the Order and Plaintiffs' ability and rights to make such an appeal after final judgment . See In re Trimble Navigation Securities Litigation, 1997 U .S. Dist. LEXIS 21138, at * 10-* 12 (N .D. Cal. Dec . 10, 1997) (denying defendants' motion to strike allegations included in third amended complaint that had been dismissed with prejudice from a second amended complaint, to preserve plaintiffs' appellate rights under Ninth Circuit law). Incorporating Exhibit A into this Third Amended Complaint, as in In re Trimble Navig. Sec. Litig., is warranted given that Plaintiffs have found no Fourth Circuit decision holding appellate rights are waived, as in the Ninth NATURE OF THE CASE 1 . This is a class action on behalf of purchasers of the common stock of Firs t Union, a nationwide banking and financial services provider, between March 4, 1998 and Ma y 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 I Ob-5 . 2. During the Class Period, defendants made a series of materially false statements regarding the Company's $2 .1 billion acquisition of The Money Store Inc ., a New Jersey-based sub-prime mortgage lender. The deal was touted as being "immediately" accretive to earnings, and a conduit to an entire new customer base, borrowers with "B" credit who could not qualify for traditional loans through First Union. In connection with the acquisition, defendants recorded an astonishing $1 .9 billion of goodwill- - or over 90% of the purchase price of The Money Store . 3 . The deal was crucial for First Union . In a decade of unprecedented bank consolidation involving regular "mega-mergers" between multi-billion dollar financial institutions, First Union was a company in the midst of an acquisition spree . In November 1997, First Union formally announced plans to acquire Philadelphia-based CoreStates Financial Bank 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 biggest financial institution on the East Coast, with assets of approximately $206 billion . 4 . The CoreStates acquisition, however, was not yielding the benefit s promised to investors, due to a variety of problems integrating the operations of the two banks . As defendant Crutchfield admitted in a May 26, 1999 Wall Street Journal article, First Unio n Circuit, or not waived, by the failure to reallege claims dismissed with prejudice in a subsequent amendment. Consistent with In re Trimble Navig. Sec. Litig., except for purposes of a subsequent appeal of the Order, Plaintiffs' operative pleading consists only of the allegations and claims set forth in the body of this Third Amended Complaint . 2 was "crumbling under its own weight." 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 were having a material adverse effect on the Company's profitability. As a result, First Union looked to The Money Store as a quick fix to provide the immediate earnings boost the Company needed to avoid reporting massive losses to investors . Indeed, defendants were in such haste to announce the acquisition, that they rushed through a minimal off-site due diligence, and, either intentionally or with extreme recklessness, ignored warnings to the First Union due diligence team about The Money Store's improper practices, and the massive losses in The Money Store's mortgage portfolio . First Union began, almost immediately after its acquisition of The Mone y Store, to suffer from The Money Store's dismal financial condition. As a former Money Store Head of Delinquency described The Money Store operations, "the Wizard of Oz couldn't have done anything to fix that company ." For years, The Money Store had regularly engaged in fraudulent practices . These practices included: deliberately understating delinquency rates ; failing to properly account for uncollectible receivables (including unpaid loans from long- deceased customers); improper revenue recognition through double-counting customer payments ; improperly "curing" or bringing up-to-date late accounts ; and granting loans to unqualified customers to increase quarter-end revenues through what employees referred to as the "[expletive deleted] it, fund it" policy.