Case 2:07-cv-00177-DAK Document 41 Filed 12/03/2007 Page 1 of 30 Daniel B. Scotti (admitted pro hac vice) DREIER LLP 499 Park Avenue New York, New York 10022 Telephone: (212) 328-6100 Facsimile: (212) 328-6101 [email protected] Lead Counsel for Plaintiffs Jan Graham (01231) GRAHAM LAW OFFICES Ambassador Plaza 150 South 600 East Suites 5A & 5B Salt Lake City, UT 84102 Telephone: (801) 596-9199 [email protected] Associated Local Counsel for Plaintiffs IN THE UNITED STATES DISTRICT COURT DISTRICT OF UTAH, CENTRAL DIVISION ASHOK KAPUR, Individually and On Behalf of All Others Similarly Situated, CIVIL ACTION NO. 2:07cvl77 DAK Plaintiffs, (Consolidated:2:07cv214TS; 2:07cv280BSJ) V. USANA HEALTH SCIENCES, INC., : PROPOSED CLASS ACTION MYRON W. WENTZ, DAVID A. WENTZ, GILBERT A. FULLER DEMAND FOR JURY TRIAL Defendants. AMENDED CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS Lead Plaintiff Irina Sech, individually and on behalf of all others similarly situated, alleges the following upon personal knowledge as to herself and her own acts, and as to all other Case 2:07-cv-00177-DAK Document 41 Filed 12/03/2007 Page 2 of 30 matters, based upon an investigation by plaintiffs counsel, which included, among other things, interviews of former associates and employees of USANA Health Sciences, Inc. ("USANA" or the "Company") (including employees who worked in accounting, finance, customer service and data management), and review and analysis of. (i) the public filings of USANA, including its filings with the United States Securities and Exchange Commission (the "SEC"); (ii) news articles, press releases, analyst conference calls and securities analyst reports by or relating to USANA; (iii) pleadings and other court documents in the action captioned Johnson v. USANA Health Sciences, Inc., Case No. 37-2007-00053808-CU-BT-NC (Cal. Super. Ct.); (iv) reports by, and other materials from, the Fraud Discovery Institute'; (v) legal precedents and statutes concerning illegal pyramid schemes; (vi) SEC filings of certain of USANA's competitors; and (vii) additional information readily available on the Internet. Lead Plaintiff believes that further evidentiary support for the allegations set forth below will exist after a reasonable opportunity for discovery. NATURE OF THE ACTION 1. Lead Plaintiff brings this action as a class action on behalf of a class of purchasers of USANA common stock between July 18, 2006 and continuing through and including March The Fraud Discovery Institute's reports on USANA were the culmination of three years of investigative research. According to the Fraud Discovery Institute, that investigation included: (i) interviewing numerous witnesses; (ii) reviewing and analyzing court records and financials statements; (iii) attending a business opportunity presentation at USANA's corporate headquarters (and secretly taping the presentation); (iv) commissioning Jon M. Taylor, Ph.D, President of the Consumer Awareness Institute, to analyze USANA's multi-level marketing system for similarities to an unlawful pyramid scheme (for his report, Dr. Taylor conducted an extensive investigation of USANA, including interviews with numerous current and former Company insiders); (v) commissioning Robert Fitzpatrick, President of Pyramid Scheme Alert, Inc. (a non-profit, all-volunteer entity that describes itself as "the first consumer organization to confront the abuses and trickery of pyramid scheme perpetrators") to investigate USANA and opine on whether the entity constitutes a pyramid scheme; (vi) commissioning Covance Laboratories, Inc., an independent laboratory, to perform chemical analyses on USANA's products; and (vii) hiring private investigators Expol Limited to investigate the background of Myron Wentz. 2 Case 2:07-cv-00177-DAK Document 41 Filed 12/03/2007 Page 3 of 30 14, 2007 (the "Class Period"), to recover damages caused by defendants' violations of the anti- fraud provisions of the federal securities laws. 2. USANA develops and manufactures nutritional, personal care and weight management products. To distribute and "sell" the Company's products, throughout the Class Period, USANA utilized a multi-level marketing system -- a chain of vertically-organized, independent distributors, who were referred to as "Associates." 3. Unlike legitimate multi-level marketing companies, USANA operated very much like an unlawful, unsustainable pyramid scheme. As alleged below, USANA was almost entirely recruitment focused and there was very little real demand for the Company's products. USANA Associates were lured to join the scheme through high-pressure recruiting tactics that promised financial freedom. They joined USANA because they hoped to make money, not because they were interested in using the Company's products. Associates were trained to focus on recruiting new members rather than on selling the Company's products, were forced to make large up-front payments for "training" materials, and were required to make minimum purchases of USANA products on a monthly basis. It was those required purchases that constituted the vast majority of the Company's reported sales. 4. In light of the fact that USANA's products were highly overpriced and there was very little demand by actual end users, most Associates failed within the first few months. As a result, the Company experienced an exceedingly high Associate attrition rate and, therefore, had to constantly recruit tens of thousands of new Associates each year to replace those who had left the Company. Despite the Company's high-pressure recruiting tactics, as the pool of prospective Associates became saturated, it became increasingly more difficult to recruit new members into 3 Case 2:07-cv-00177-DAK Document 41 Filed 12/03/2007 Page 4 of 30 the scheme. Thus, the sustainability of USANA's business model for the long term was highly questionable. 5. Despite this harsh reality, throughout the Class Period, defendants issued a number of material misstatements and omissions that were designed to and did conceal the true nature of the Company's business and long-term business prospects. For example, defendants concealed the Company's extraordinarily high attrition rate, materially manipulated the reported average income per Associate and falsely represented that sales growth was the result of great "enthusiasm" for the Company's products when, in fact, the bulk of the Company's revenues represented mandatory purchases of products that Associates had no desire to use personally and little hope of reselling. Significantly, USANA's Associate attrition rate was the topic of regular reports distributed to, and weekly meetings amongst, the Company's most senior management; nevertheless, defendants chose not to share this material information with the investing public. 6. Defendants further concealed that the Company's business model and practices shared many characteristics that are often associated with unlawful pyramid schemes, including that: (i) there was very little retail demand for the Company's products by end users; (ii) the Company was recruitment focused, not product focused; (iii) Associates were required to pay large entry fees; (iv) Associates were required to make minimum purchases of product on a monthly basis; (v) Associates were rewarded for recruiting new members into the chain; (vi) the vast majority of associates failed and only a handful of people at the very top of the pyramid were profitable; and (vii) the Company employed high pressure recruiting tactics that promised enormous financial success. 4 Case 2:07-cv-00177-DAK Document 41 Filed 12/03/2007 Page 5 of 30 7. As a result of these false statements and material omissions, USANA common stock traded at artificially inflated or distorted prices throughout the Class Period, trading as high as $61.80 on February 21, 2007. 8. The Individual Defendants took advantage of the artificial inflation in the price of USANA's shares -- and the effectiveness of their materially false statements and omissions -- by selling tens of thousands of shares of their privately-held USANA stock, for total proceeds in excess of $7.6 million. Defendant Myron Wentz's reported sale of 85,000 shares (for proceeds of more than $5.1 million) was particularly suspicious because of its proximity to the Company's materially false and misleading February 6, 2007 press release and the five-year high in the Company's stock price. Moreover, as further evidence of defendants' fraudulent scheme and illegal course of conduct, at no time during the Class Period did any off the defendants purchase any USANA stock on the open market. 9. On March 15, 2007 an article in the Wall Street Journal revealed that the Fraud Discovery Institute had issued a shocking report that raised many serious concerns about USANA. The report (which was forwarded to government regulators) exposed, among other things, that: (i) the Company's business model was untenable because the vast majority of the Company's reported sales were made to distributors who were not end users of the products; (ii) the Company's long-term growth prospects were unsustainable because growth was almost entirely dependent upon recruitment, rather than upon an increase in retail demand for the Company's products; (iii) at least 85% of the Company's distributors, who accounted for 86% of the Company's revenues, were losing money; (iv) at least 74% of distributors were failing within the first year; (v) only the top 3% of distributors were receiving 70% of Company-paid