IN THE UNITED STATES DISTRICT COURTFOR THE WESTERN DISTRICT OF MISSOURI
WESTERN DIVISION
IN RE AMERICAN ITALIAN PASTACOMPANY SECURITIES LITIGATION
ConsolidatedCivil Action No. 05-CV-0725-W-ODSJury Trial Demanded
AMENDED COMPLAINTFOR CLASS AND DERIVATIVE CLAIMS
Dated: January 19, 2006
TABLE OF CONTENTSPage
SUMMARY OF THE ACTION ...................................................... 1..............................................JURISDICTION AND VENUE .................................................................................................... 5THE PARTIES ............................................................................................................................... 6
Lead Plaintiff ...................................................................................................................... 6Additional Plaintiffs in the Class Action ........................................................................... 6
.........................................Derivative Plaintiffs .................................................................. 6Class Defendants ................................................................................................................ 6
AIPC's Officers and Board Chairman ................................................................... 6AIPC's Audit Committee Defendants .................................................................... 9AIPC's Outside Auditors ...................................................................... 9
Derivative Defendants ...................................................................................
SUBSTANTIVE ALLEGATIONS .............................................................................................. 11
Overview of the Fraudulent Scheme ............................................................................... 11Background .................................................................................... 12
THE FRAUDULENT SCHEME ................................................................................................. 13
AIPC' s Blatant Improper Capitalization of Overhead Costs ........................................... 13Impairment of Brand Names ............................................................ ...... 16Improper Timing of Revenue Recognition ...................... ........................ 20Excess and Unsold Inventory ............................................................................ 22
Lights-out Warehousing ....................................................................................... 23Unsafe Warehousing ............................................................................................ 23Repackaging of Excess Inventory ........................................................................ 24
Other Examples ................................................................................................................ 24
Improper Accrual of Allowances for Product Promotions .............................................. 26Defendants' Direct Participation in and Knowledge of the Fraud ................................... 29
AIPC .................................................................................................................... 29The Individual Defendants Collectively .............................................................. 30Webster ................................................................................................................ 30Schmidgall ........................................................................................................... 31Schroeder ............................................................................................................. 32The Audit Committee Defendants ....................................................................... 32Other Individual Defendants ................................................ ............... .. 33Ernst .................................................................................. ......................... 34
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TABLE OF CONTENTS, continuedPaae
THE FRAUDULENT STATEMENTS ISSUED DURING THE CLASS PERIOD .................. 34
1 Q02 ................................................................................................................................. 342Q02 ................................................................................................................................. 353Q02 ................................................................................................................................. 364Q02 and Fiscal 02 .......................................................................................................... 36
1 Q03 ................................................................................................................................. 392Q03 ................................................................................................................................. 403Q03 ................................................................................................................................. 414Q03 and Fiscal 03 .......................................................................................................... 42
1 Q04 ................................................................................................................................. 442Q04 ................................................................................................................................. 463Q04 ................................................................................................................................. 484Q04 and Fiscal 04 .......................................................................................................... 49
1 Q05 ................................................................................................................................. 512Q05 ................................................................................................................................. 52
The Full Revelations ........................................................................................................ 53
LEAD PLAINTIFF'S RULE 23 ALLEGATIONS ....................................................................... 57
CLASS CLAIMS FOR RELIEF .................................................................................................. 60CLASS COUNT IVIOLATION OF § 10(b) OF THE EXCHANGE ACTAGAINST AIPC AND THE CORPORATE OFFICER DEFENDANTS ...................... 60
CLASS COUNT IlVIOLATION OF § 10(B ) OF THE EXCHANGE ACTAGAINST THE AUDIT COMMITTEE DEFENDANTS .......................... 63....................
AIPC CORPORATION AUDIT COMMITTEE CHARTER .......................... 64...........................
Membership ..................................................................................................................... 64Responsibilities, Powers and Duties ................................................................................ 64General ............................................................................................................................. 65
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TABLE OF CONTENTS, continuedPage
CLASS COUNT IIIVIOLATION OF § 20(a) OF THE EXCHANGE ACTAGAINST THE CORPORATE OFFICERAND AUDIT COMMITTEE DEFENDANTS ................................................................ 66
CLASS COUNT IV ......................................................................................................... 66VIOLATIONS OF § 10(b) OF THE EXCHANGE ACTAND RULE I Ob-5 PROMULGATED THEREUNDERAGAINST ERNST & YOUNG ....................................................................................... 67
DERIVATIVE CLAIMS .............................................................................................................. 73
SUMMATION OF DERIVATIVE CLAIMS .............................................................................. 73
DEMAND WOULD BE FUTILE ................................................................................................ 75Additional Likelihood of Substantial Liability for Directors Schroeder and Webster .... 75Additional Likelihood of Substantial Liability of the Audit Committee Defendants ...... 77Additional Likelihood of Substantial Liability of Other Board Members ....................... 78Derivative Defendants Heeter , Thompson and Baum Otherwise Lack Independence .... 78
DERIVATIVE COUNT IAgainst the Individual Derivative Defendants For Breach of Fiduciary Duties ............. 80
DERIVATIVE COUNT IIAgainst the Individual Derivative Defendants for Unjust Enrichment ............................ 81
DERIVATIVE COUNT IIIAgainst Derivative Defendants Webster , Schmidgall and Shadid ................................... 81
DERIVATIVE COUNT IVProfessional Negligence and Accounting Malpractice Against Defendant Ernst ............ 82
DERIVATIVE COUNT VAgainst Defendant Ernst for Aiding and Abetting the Breaches of Dutyby the Individual Defendants ........................................................................................... 83
PRAYERS FOR RELIEF ............................................................................................................ 83FOR CLASS CLAIMS .................................................................................................... 83FOR DERIVATIVE CLAIMS .......................................................................... .. 84
JURY DEMANDS ....................................................................................................................... 85
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Lead Plaintiff alleges the following class and derivative claims upon personal knowledge
as to its own acts, and otherwise upon information and belief based on the investigation conducted
by its attorneys, which included, inter alia: interviews of former employees of Defendant American
Italian Pasta Company ("AIPC" or the "Company"); review of correspondence sent by an
anonymous whistle blower to AIPC' s outside auditors , Defendant Ernst and Young LLP ("Ernst"),
during the Class Period relevant to the claims asserted herein; review of public filings with the
United States Securities and Exchange Commission (the "SEC"); press releases; publicly available
trading information; articles in the general press, the financial press, and on wire services as follows;
SUMMARY OF THE ACTION
1. This is a class action brought on behalf ofinvestors who purchased the common stock
and call options of AIPC between January 23 , 2002 and August 17, 2005, inclusive (the "Class
Period") for violations of the federal securities laws. Named as Class Defendants are AIPC, its
senior officers (Timothy S. Webster, Horst W. Schroeder, George D. Shadid, Warren B. Schmidgall,
Walter George, Jerry Dear and David Potter); members of its Audit Committee (James E. Heeter,
William R. Patterson, and Jonathan E. Baum); and Ernst.
2. Consolidated herewith are also derivative claims brought on behalf ofAIPC against
certain of its officers, directors and Ernst for breach of their fiduciary duty of care, unjust
enrichment, accounting malpractice and other matters. Named as Derivative Defendants are all of
the foregoing Individual Defendants , Ernst , and other directors of AIPC during the Class Period
(Robert H. Niehaus, Terence C. O'Brien, Tim Pollak, Mark C. Demetree, Richard C. Thompson,
and John P. O'Brian).
3. AIPC is headquartered in Kansas City, Missouri . It manufactures and markets dry
pasta. Throughout the 1990's, AIPC portrayed itself as a booming company, with a steady growth
in revenues and earnings. The Company continually boasted that it was the industry's "low cost"
producer, which enamored analysts.
4. However, as the 90's boom came to end, so did the Company's good fortune. As the
"low-carb" craze began to pervade the market , AIPC 's sales growth declined . Efforts to stem the
fall by branching into "name brand" pastas, and by introducing "low carb" pasta , were abysmal
failures. Defendants therefore decided that the only way to maintain AIPC's upbeat image was to
"cook the books." Defendants engaged in a systemic fraudulent scheme designed to artificially boost
the Company's reported financial results, principally by improperly deferring accounting for
expenses , including those for marketing promotion, overhead and obsolete inventory , as well as
premature revenue recognition . AIPC also failed to timely recognize that its named brands were
performing poorly, thereby requiring a significant writedown of their "book value."
5. Defendant Ernst was alerted to many of these fraudulent practices by a series of over
25 letters that were sent by an anonymous whistle blower from September, 2002 through January,
2005. These letters were sent to Brenda Stasiulis, Ernst's Audit Manager; Steve Clifford, Ernst's
Managing Partner; and John Wilgers , Ernst's Audit Partner , all in the Kansas City, Missouri Office.
As detailed herein , the letters described specific problems with AIPC's (1) improper accounting for
costs during the "construction phase" of AIPC's new pasta manufacturing plants; (2) improper
repackaging (after expiration dates) of old and unsellable pasta, or simply burying it in warehouses,
to avoid inventory writeoffs; (3) failure to take timely charges against AIPC's impaired asset values
due to the significant revenue declines for its acquired "brand name" licenses; and (4) premature
recognition of revenue. These letters also specifically identified individuals who were
knowledgeable about these problems. Nonetheless, Ernst continued to certify AIPC's year end
statements as conforming with Generally Accepted Accounting Principals ("GAAP")
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6. As a result of these fraudulent accounting practices , AIPC's reported earnings were
materially overstated, and its stock price materially inflated, throughout the Class Period.
7. Defendants engaged in this multi-purpose scheme for two purposes: to "meet the
numbers" that Wall Street projected for the Company's performance; and to enable certain
Individual Defendants to dump nearly $10 million worth of AIPC shares at inflated prices.
Defendants Webster and Schroeder (CEO and Chairman ofAIPC} sold over $4.5 million shares in
February 2005, their only sales during the Class.
8. The scheme came to a crashing halt on August 9, 2005, just six months after those
huge insider sales. At that time, AIPC announced that its Audit Committee was investigating the
Company's accounting going back to fiscal year 2000. The Company also disclosed that it would
be taking $60 million in charges for impaired asset values, improper accounting for promotional
allowances, and other accounting i ssues. This charge offrepresented an astonishing 66% ofthe net
income that AIPC had reportedfor the entire Class Period.
9. AIPC also stated it would delay filing its financial statements, but that it expected to
report a loss for the third quarter and entire fiscal year 2005. The Company also disclosed that the
SEC was reviewing some of the accounting issues that were subject to the Audit Committee
investigation.
10. Following these revelations , AIPC's stock price collapsed , closing at $13.28 per
share, a 37% decline from the day before, with robust volume of 4.7 million shares (in contrast to
the average daily volume of less than 250,000 shares).
11. On August 17, 2005, the last day of the Class Period, the Associated Press reported
that Defendant Schroeder had resigned as Board Chairman . AIPC' s stock immediately declined
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another 6.1%, closing at $11.16, 47% below the pre-revelation closing price of $20.94 on August
9, 2005.
12. The impact of Defendants ' fraudulent scheme became more apparent when, on
October 27, 2005, AIPC announced that its financial statements for the prior 3%z years "should no
longer be relied upon," and that it expected to "prepare restated financial statement for the periods
in question." (Emphasis Supplied). AIPC admitted that the need to restate all the Class Period
financial statements, including those audited by Defendant Ernst, arose from, among other things,
the improper "accrual of allowances for product promotions and capitalization of certain overhead
costs." The Company also advised that the Audit Committee's investigation was still ongoing.
13. On December 4, 2005, Defendant Webster was fired as AIPC's Chief Executive
Officer, and his membership on the Board of Directors was terminated.
14. Despite the Company's assurance in October that it would file restated financials "as
soon as practicable," it has still not done so as of the date of this pleading. Nor has AIPC filed its
report for the third quarter of fiscal 2005 which was due on August 10, 2005, over 5 months ago.
By January 15, 2006, AIPC's stock price had fallen to $6.65 per share.
15. The foregoing misconduct has resulted in damage not only to shareholders who
overpaid for their AIPC stock , but to the Company itself by the loss of its market capitalization,
damages it will have to pay to injured investors, and costs incurred in connection with its
investigation. In addition, the Company has overpaid officers who received excess performance
bonuses that were based on inflated results; and has paid substantial fees to Defendant Ernst for
audits that were improperly performed. This action is therefore also brought derivatively against the
Derivative Defendants for violations of fiduciary duties owed to the Company for which AIPC is
entitled to money damages and injunctive relief.
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JURISDICTION AND VENUE
16. This Court has jurisdiction over the subject matter of the Class Claims pursuant to
§27 of the Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §78aa , and 28 U.S.C. §1331. This
Court has original jurisdiction over the Derivative Claims pursuant to 28 U.S.C. § 1331, and has
supplemental jurisdiction pursuant to 28 U.S.C. §1367(a).
17. The Class Claims asserted herein arise under §§ 10(b), and 20(a) ofthe Exchange Act,
15 U.S.C. §§78j(b) and 78t(a), and Rule 10b-5 promulgated thereunder by the Securities and
Exchange Commission (the "SEC"), 17 C.F.R. 240.10b-5. The Derivative Claims asserted herein
arise under common law and Rule 23.1 of the Federal Rules of Civil Procedure. This is not a
collusive action designed to confer jurisdiction on a court of the United States which it would not
otherwise have.
18. Venue is proper in this District pursuant to §27 of the Exchange Act and 28 U.S.C.
§§105(b)(1), and 1391(b) and (c). AIPC's corporate headquarters are located in this District, and
many of the acts charged herein, including preparation and dissemination of materially false and
misleading information occurred in substantial part in this District. Moreover, each defendant has
extensive contact with this State and this District, including Individual Defendants Dear and Shadid,
who live here.
19. In connection with the acts, conduct and other wrongs alleged herein, Defendants,
directly and indirectly, used the means and instrumentalities of interstate commerce, including the
United States mails, interstate telephone and electronic communications, and national securities
markets.
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THE PARTIES
Lead Plaintiff
20. Lead Plaintiff, Iron Workers Local 40, 361 & 417 Union Security Funds, purchased
shares of AIPC common stock during the Class Period, as set forth in its previously filed
Certification, and was damaged thereby.
Additional Plaintiffs in the Class Action
21. Additional plaintiffs Michael Stengle, Matt Brody, George Clark, and Thomas
Mayer, filed Certifications with their initial complaints that are consolidated herewith pursuant to
the Court's December 19, 2005 Order. Each purchased AIPC common stock and/or call options
during the Class Period and were damaged thereby.
Derivative Plaintiffs
22. Derivative Plaintiffs are Rolf Fasth, Ronald Corallo, and Michael Haag, each of
whom previously filed verified derivative complaints. In addition, Fasth and Corallo have verified
this complaint.
Class Defendants
AIPC 's Officers and Board Chairman
23. Defendant American Italian Pasta Company is a corporation organized under the
laws ofDelaware, authorized to do business in Missouri, with its principal executive offices located
at 4100 N . Mulberry Drive, Suite 200 , Kansas City, Jackson County, Missouri , 64116.
24. Defendant Timothy S. Webster ("Webster") was at all relevant times , the President,
Chief Executive Officer and a member of the Board of Directors.
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a. Webster received $777,588, $730,368 and $600,900, respectively in salary,
bonus , restricted stock awards , and other compensation for fiscal years 2002, 2003 and 2004,
including stock options totaling 125,000 (in 2002) and 100,000 (in 2003).
b. On February 3 and 4, 2005, Webster sold 111,000 AIPC shares at $26 per
share , reaping $2,884,314. This represented 58.57% ofhis AIPC holdings at the time. His last stock
sales prior to February 2005 were in 2001.
c. Webster "stepped down" from his position on December 4, 2005. At that time,
it was agreed that he would receive only $287,000 in additional severance compensation,
conditioned on his cooperation with the Audit Committee investigation. This was far less than the
$1.2 million to which Webster would have been entitled had he resigned for "good reason" or had
been terminated without cause.
25. Defendant Warren B. Schmidgall ("Schmidgall") was, from 2000 to August 2004,
the Executive Vice President and Chief Financial Officer and, from August 2004 to May 2005,
Executive Vice President ofInformation Technology, Human Resources and Treasury. He received
$321,913, $315,465 and $258,491, respectively in salary, bonus, restricted stock awards, and other
compensation for fiscal years 2002, 2003 and 2004. In fiscal 2002-2003, he was granted 40,000 and
11,484 stock options, respectively. He is a CPA and achieved the Gold Medal award for achieving
the highest CPA score in Kansas.
26. Defendant George D. Shadid ("Shadid") has been, since August 2004, the Executive
Vice President and Chief Financial Officer of AIPC. From May 2004 to August 2004, Shadid was
a consultant to the Company. He received a base salary of $250,000, and in 2004, he was granted
20,000 options at $28.90 per share, and was issued 10,000 shares of restricted stock.
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27. Defendant Horst W. Schroeder ("Schroeder") was, until August 17, 2005,
Chairman of AIPC's Board. He received $259,021, $370,634 and $265,142, respectively in salary,
bonus, restricted stock awards, and other compensation for fiscal years 2002, 2003 and 2004. In
fiscal 2003, he was granted 90,000 stock options. Schroeder reaped $1.625 million by selling 62,500
shares of AIPC on February 4, 2005 at $26 per share . This represented 29.4% of his AIPC holdings
at the time. Schroeder's last stock sale prior to this sale was in 2001.
28. Defendant Walter N. George ("George") was, since January 2003, Executive Vice-
President of Operations and Supply Chain. Prior to that time, George was Senior Vice-President
of Supply Chain & Logistics. He received $285,929, $306,749, and $676,910, respectively, in
salary, bonus, restricted stock awards, and other compensation for fiscal years 2002, 2003 and 2004.
He also received 35,000, 19,500 and 30,000 stock options in 2002, 2003 and 2004, respectively.
George sold $43,723 worth ofAIPC stock in November 2004 at $19.01 per share. This was his only
stock sale during his entire tenure at AIPC, and represented 12.18% of this AIPC holdings.
29. Defendant David B. Potter ("Potter") was, until March 2004, Executive Vice-
President of AIPC, after which he left the Company. Potter reaped over $4 .2 million in sales of
AIPC stock during the Class Period (2/7/02 - 8, 000 shares for $334,6009 ; 12/03 - 25,726 shares for
$1,049,878; 9/16/03 - 47,300 shares for $1,925,347; 2/4/04 - 5,000 shares for $194,000; 2/5/04 -
5,000 shares for $195,250; 2/6/04 -11,054 shares for $430,277; 2/6/04 - 2,000 shares for $77,800).
This represented all of his AIPC holdings.
30. Defendant, Jerry H. Dear ("Dear") was at all relevant times, Executive Vice-
President , Special Channels and Private Labels, of AIPC. Dear reaped over $ 1.2 million dollars in
proceeds from AIPC stock sales during the Class Period. (2/5/02 - 18,066 shares for $728,0609; 4/03
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- 5000 shares for $208,855; 9/5/03 - 5,906 shares for $245,247) This represented 93.34% of his
AIPC holdings.
AIPC's Audit Committee Defendants
31. Defendant William R. Patterson ("Patterson") was at all relevant times a member
of AIPC' s Board of Directors and the Chairman of its Audit Committee. He was a partner at the
accounting firm of Arthur Andersen LLP from 1976-1995. Patterson became AIPC's Chairman of
the Board on October 17, 2005.
32. Defendant James A. Fleeter ("Heeter") was at all relevant times a member of
AIPC's Board of Directors and Audit Committee.
33. Defendant Jonathan E. Baum ("Baum") was at all relevant times a member of
AIPC's Board of Directors and Audit Committee.
34. Defendants Patterson, Heeter and Baum are collectively referred to herein as the
Audit Committee Defendants.
AIPC' s Outside Auditors
35. Defendant Ernst & Young, LLP is an accounting firm that at all relevant times
provided accounting services to AIPC. Ernst audited AIPC 's books and records, and rendered
opinion letters stating that its annual financial statements filed with the SEC conformed with GAAP;
and that Ernst's audits thereof were conducted in conformance with Generally Accepted Auditing
Standards ("GAAS")
36. Ernst enjoyed a lucrative , long-standing business relationship with AIPC's
management, for which it received millions of dollars in fees. In 2002, Ernst earned $1,340,000 in
tax ($1.04 million) and audit related fees ($298,000); in 2003, Ernst earned $970,000 in tax
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($642,000) and audit related fees ($328,000); and in 2004, Ernst earned $933,000 in tax ($607,000)
and audit fees ($326,000).
Derivative Defendants
37. AIPC is a nominal Derivative Defendant. Each of the foregoing Class Defendants
are also Derivative Defendants. The following are additional Derivative Defendants:
38. Defendant Robert H. Niehaus has been a director of the Company since 1992 and
during the relevant period was chairman of the Compensation Committee.
39. Defendant Terence C. O'Brien has been a director of the Company since 2003.
40. Defendant Tim Pollak has been a director of the Company since 2001.
41. Defendant Mark C. Demetree has been a director and member ofthe Compensation
Committee since 1998.
42. Defendant Richard C. Thompson , a founder of AIPC, was a director of the
Company from 1986 until August 11, 2005.
43. Defendant John P. O'Brien was a director of the Company from 1997 through
October 2002.
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SUBSTANTIVE ALLEGATIONS
Overview of the Fraudulent Scheme
44. Throughout the Class Period, AIPC;
- Materially underreported market promotion allowances paid to distributorsand others to promote the sale of AIPC' s products through advertisements,circulars , and supermarket shelf placement;
- Improperly capitalized personnel and other costs that should have beenexpensed;
- Improperly capitalized or deferred costs associated with the "start up" ofcertain manufacturing facilities that should have been expensed;
- Failed to timely writeoff obsolete and excess inventory, and insteadrepackaged products whose expiration dates had passed, or simply dumpedthe goods in warehouses in order to defer their timely writeoff;
- Failed to timely writeoff the portions of the price that AIPC paid for severalbrand name products (including Golden Grain and R&F) when sales ofthoseproducts significantly declined;
Improperly accelerated revenues at the end of quarters to make up shortfallsby, among other things, scanning in receipts for customers even though theyhad not ordered the goods; treating products that were moved to loadingplatforms, but were not placed in delivery trucks, as "shipped" ; and dumpinggoods on certain large customers like Sysco and General Mills well in excessof the amount ordered by such customers;
Misrepresented its status as a "low cost" producer when in fact, thisappearance was due entirely to the foregoing manipulations of inventory andother costs;
Misrepresented the adequacy of AIPC's internal controls;
In the aggregate, materially overstated revenues and earnings, and materiallyunderstated expenses, throughout the Class Period by at least 66%.
45. AIPC has admitted that all of its financial statements issued during the Class Period
can "no longer be relied upon" and that they will be restated.
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46. As a result of the overstatement of its financial results, AIPC' s stock price was
materially inflated throughout the Class Period. When the Company revealed its prior misconduct,
AIPC's stock price cumulatively fell nearly 50% in value.
Background
47. Defendant AIPC produces and markets dry pasta, principally in North America. It
sells approximately 3,500 items, including long goods (such as spaghetti, linguine, fettuccine, angel
hair and lasagna); and short goods (such as elbow macaroni, rigatoni, rotini, ziti, and egg noodles).
The Company markets its products through food brokers and distributors in the United States,
Canada, and Mexico.
48. During the Class Period , AIPC was headquartered in Kansas City, Missouri, where
all statements issued to investors were prepared and disseminated.
49. AIPC portrayed itself as a leader in pasta manufacturing , with steady revenue and
volume growth. Stock market analysts were particularly attracted by the Company's status as the
"number one low cost producer."
50. In order to achieve this coveted status, AIPC ran its plants at full capacity (in order
to keep unit costs low), and embarked on a campaign to acquire "named brand pasta" licenses which
it could also manufacture and sell . This business plan though encountered significant problems as
the demand for pasta products precipitously declined with the advent of the "low-carb" diet craze
at the outset ofthe Class Period . AIPC' s efforts to adapt to changes by introducing "low carb pasta"
products required significant start up investments, and was met with mediocre results. As a result,
the Company began accumulating significant excess inventory that was unmarketable and whose
write-off required expenses to be charged against earnings.
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THE FRAUDULENT SCHEME
51. The roots of the fraudulent scheme pre-date the Class Period, as indicated by the
Audit Committee's investigation which went all the way back to 2000. After the Company went
public in October 1997, former AIPC employees reported witnessing many changes in the
Company's operations and financial reporting structure. While the Company initially continued to
report revenue and earnings growth, concerns about slippage caused senior officers of the Company
to pressure AIPC employees to meet Wall Street ' s numbers . According to a former Executive Vice-
President of Operations ("EVP Informant"), even before the Class Period, Defendant Webster had
instructed subordinates to "do whatever was necessary to make their numbers."
52. AIPC' s ability to legitimately meet Wall Street ' s "numbers" reached a crisis point
at least by the first quarter of fiscal 2002, if not earlier. To avoid any adverse impact from the
apparent decline in the pasta market, Defendants resorted to a time-tested recipe - cooking the
books. As discussed below, the separate ingredients of this scheme varied, but their cumulative
impact caused AIPC's reported results to be materially bloated.
AIPC' s Blatant Improper Capitalization of Overhead Costs
53. GAAP requires that most costs of personnel (i.e. "overhead") be expensed in the
period incurred.
FAS No. 151, ¶5A, which amends ARB 43, states;
Unallocated overheads are recognized as an expense in the period inwhich they are incurred.
FASCON 5 , ¶85 describes the concept of consumption of benefits;
Many expenses such as selling and administrative salaries arerecognized during the period in which cash is spent or liabilities areincurred for goods and services that are used up either simultaneouslywith acquisition or soon after.
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54. During the Class Period , Defendants routinely violated this GAAP requirement by
capitalizing such overhead costs over an extended period of time. Since the Company's recognized
expenses were thereby artificially lowered, its reported profits were artificially inflated. According
to a confidential informant who served as an operations manager at AIPC and who reported to
Defendant George throughout the Class Period ("Operations Manager Informant"), insiders joked
that "if sales were down, just capitalize it."
55. This fraudulent device was often employed at AIPC in connection with construction
or acquisition of new manufacturing facilities . GAAP permitted certain of these costs to be
capitalized as "start up costs." FAS No. 67 states:
Project costs clearly associated with the acquisition , development,and construction of a real estate project shall be capitalized as a costof the project .... Indirect costs that do not clearly relate to projectsunder development or construction , including general andadministrative expenses , shall be charged to expense as incurred.(FAS No. 67, ¶7)
56. AIPC sought to exploit this capitalization loophole by simply reclassifying a wide
range of costs , including personnel (and sometimes inventory), as "start up" related costs. By way
of example,
a. Starting in or about 2002, AIPC began constructing a new manufacturing
plant in Tolleson, Arizona. During the "construction" phase, the Company fraudulently capitalized
over $5,000,000 of operating expenses . By way of example, operations at the Tolleson facility
actually began in fiscal third quarter of 2002, and production was fully ramped up by the following
quarter. According to the anonymous whistle blower, AIPC improperly delayed the official
"commissioning" ofthe plant until six months later. By doing so, the Company improperly deferred
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$750,000 of depreciation expense on the plant, and capitalized (rather than expensed) $500,000 in
interest associated with plant construction.
b. The improper accounting continued after the plant became operational.
Accounting personnel in Tolleson were routinely instructed at the end of each month by corporate
headquarters to reclassify costs or make up names of employees for improper capitalization, solely
to "meet the numbers." By way of example, according to the Operations Manager Informant, in late
2003, Kerri Winter (an Operations Controller at AIPC' s corporate office) reportedly relayed to AIPC
employees in the Operations Department that the Company was having trouble making its numbers
for the quarter, and instructed these employees to re-classify approximately $250,000 of the
Tolleson employees' payroll costs as a "capital expenditure for contracting and machinery costs."
57. The foregoing fraudulent capitalization issues at the Tolleson facility were brought
to the attention of Steve Clifford, the Managing Partner at Ernst, as well as James Hassett, Ernst's
Global Vice Chairman in the Assurance & Advisory Business Services Department, by letters from
the anonymous whistle blower dated April 15 2003; July 12, 2004 and November 30, 2004. Ernst
failed to take the appropriate GAAS procedures in response to such notification, and fraudulently
issued unqualified audit opinions . In so doing Ernst failed to comply with the "Objectives" and
"Standards " which guide their work as auditors . For example , FAS No. 1, ¶16 states:
The function of financial reporting is to provide information that isuseful to those who make economic decisions about business enter-prises and about investments in or loans to business enterprises.Independent auditors commonly examine or review financial state-ments and perhaps other information, and both those who provideand those who use that information often view an independentauditor's opinion as enhancing the reliability or credibility of theinformation.
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58. This misconduct was standard operating procedure at AIPC, even before the Class
Period. According to EVP Informant, Webster demanded that Operations personnel improperly
capitalize certain operating costs for projects . This was consistent with Webster's demand that
personnel "do whatever was necessary to make their numbers." Webster typically approached
accounting personnel during the last week of the month and informed them that the Company
needed to show better numbers.
59. Defendant Schmidgall gave similar orders to the EVP Informant telephonically. The
practice of misappropriating costs became such a common practice that Schmidgall would call the
EVP Informant and say, "Its that time again," which meant that the EVP Informant was supposed
to fraudulently capitalize items. The EVP Informant quit the Company in 2000 due to these
improper demands.
60. AIPC has now admitted that it will have to restate its reported financial results for
the period 2002-05, due, in part, to improper "capitalization of overhead costs."
Impairment of Brand Names
61. A significant portion of AIPC' s revenue growth prior to and during the Class Period
was fueled by purchases of other named brand pastas, including Muellers, Golden Grain, Borden
and R&F. In most instances, AIPC acquired only the license for the name brand and inventory, since
AIPC already had ample manufacturing capacity (In some instances , AIPC had been producing the
pasta for the prior license owner before acquiring the license itself.). The cost of the acquisitions
were recorded as "assets" on AIPC's books.
62. Analysts initially viewed these acquisitions positively. For example, SunTrust
Robinson Humphrey issued a report on October 3, 2002, entitled "PLB: Positive Effect from Brand
Acquisitions." In rating AIPC a "Buy," the analyst noted: "We believe yesterday's acquisitions are
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small, involve no incremental capacity and seem completely in line with management's strategy of
buying brands with regional value (Omaha, Nebraska and Kansas City, Missouri and Europe) to
realize greater benefits from its low cost infrastructure."
63. However, many ofthese acquisitions turned out to be ill-timed and overpaid, as their
product sales significantly declined particularly by the end of 2003. This sales decline exacerbated
a problem inherent in the acquisition strategy. The purchases of certain brand name pastas placed
the Company in direct competition with other "private label" customers for whom it also
manufactured pasta products.
64. By way of example , AIPC had a longstanding manufacturing relationship with
Pepsico, Inc., the owner of the Golden Grain license prior to the Class Period. In January 2003,
AIPC bought the Golden Grain license and inventory for $48 million, all ofwhich was then recorded
on AIPC's books as an "asset ." Indicative ofthe premium it was willing to pay for the license, AIPC
outbid its nearest competitor by over 50%.
65. Undisclosed to investors was that AIPC's willingness to pay such a premium for
Golden Grain's license was not driven by the brand name's economic prospects. It was driven by
the fact that , in its zeal to be the "number one low cost producer," AIPC had built up a significant
amount of excess inventory of Golden Grain pasta (15 million pounds according to the whistle
blower's letter to Defendant Ernst dated August 3, 2004), which, if not purchased by Pepsico or its
distributors , would require AIPC to "eat" this excess and charge it against earnings . Acquiring the
license enabled AIPC to postpone the day of reckoning.
66. In any event, the purchase proved to be a poor investment. According to data
published in December 2003 in AC Nielsen Brand and Segment Reports (based on "SKU" scanner
code data compiled from supermarkets), by the end of 2003, Golden Grain sales had fallen 20%
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from the prior year, to only $28.4 million. This trend continued throughout the balance of the Class
Period, with Golden Grain' s sales falling to only $16 million by 2005.
67. Under GAAP, the fair market value of food licenses is generally the capitalized value
of the royalty the licensee would pay (generally 2-3% of annual sales over the license period). A
risky brand would generally be capitalized at 22% of annualized sales.
68. Given the sales trends and acquisition costs, it was more than apparent by the end of
2003 that the value of Golden Grain on AIPC' s books was materially overstated, and needed to be
written down, particularly since its book value exceeded annual sales by 100%. Nonetheless, in
reckless indifference to the truth, AIPC continued to book the license at its overstated value.
69. The unrecognized impairment of AIPC 's brand names was not limited to Golden
Grain. As of the end of June 2004, sales of R&F (another brand name license), had fallen 17% in
just six months from the beginning ofthe year. Impairment charges were further warranted because
at that time , AIPC had shut down 20% of its total capacity and had terminated 14% of its employees,
as part of a "Rightsizing Campaign" intended to address the general decline in the pasta industry.
70. The inflation of AIPC's brand name asset values was further apparent from the fact
that as of the end of 2003, the company had booked $186 million for such assets, when the sales for
such assets , for the year, totaled only $192.4 million. Just on its face, the book value for the assets,
using standard valuation techniques, would have resulted in a valuation estimate of 50% lower.
71. Under these circumstances , GAAP required that AIPC reflect an impairment of its
assets associated with these brand names . In particular , FAS 142 states:
An intangible asset that is not subject to amortization shall be testedfor impairment annually or more frequently if events or changes incircumstances indicate that the asset might be impaired.
Furthermore, SFAS No. 121 states, regarding recording impairment, as follows:
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... [I]f the sum of the expected future cash flows (undiscounted andwithout interest charges) is less than the carrying amount of the asset,the entity shall recognize an impairment loss... (¶ 6)
72. AIPC violated its own policy , as well , as stated in its Form 10-K filed with the SEC
for the period ending 2003:
These trademarks and brands are reviewed at least annually forimpairment by comparing the Company's best estimate of fair valuewith the carrying amount of the tangible asset.
73. Steve Clifford of Ernst was specifically advised of the foregoing facts regarding
Golden Grain and R&F by whistle blower letters dated January 8, 2004 and July 26, 2004.
Moreover, in letters dated January 8, 2004, July 26, 2004, August 3, 2004, November 9, 2004,
November 30, 2004 and January 19, 2005, the need to writeoff a portion of these assets was raised
in letters sent to Steve Clifford, James Hassett and Jo Marie Dancik (Area Managing Partner of
Ernst). However, no writedowns were demanded by the auditors.
74. It was not until August 9, 2005, that AIPC belatedly disclosed that it would take a
$35 million asset impairment charge related to its name brands:
Certain of the Company's pasta brands have experienced declines insales volume and related revenues over recent months resulting incorresponding declines in market share and profitability (primarilythe Golden Grain-Mission and R&F brands). The recent operatingtrends and the currently forecasted future performance for thesebrands differ significantly from the Company's earlier expectations.In accordance with SFAS No. 142 - "Goodwill and Other IntangibleAssets", the recoverability of these intangible assets has beenevaluated and the Company has determined that impairments nowexist. Accordingly, pre-tax impairment charges of $35.1 million willbe recorded in the third quarter.
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75. These charges are being taken directly against earnings , and thus contributed to the
Company's acknowlegment that it will report a significant loss for the third quarter and full year of
fiscal 2005.
Improper Timing of Revenue Recognition
76. AIPC also routinely inflated its reported revenues by prematurely recognizing sales
before the product was actually shipped to the customer:
a. The Operations Manager Informant stated that AIPC booked sales on
merchandise that was loaded onto the shipping docks at the end of the quarter, even though the
product was not shipped often until a week later, when it was finally placed on a delivery truck.
b. The Operations Manager Informant stated that typically, on the Friday night
before each end of a quarter, AIPC personnel pre-scanned receipt tickets before the product was
even ready for placement on the loading docks. This created the appearance that the products were
sold and ready for shipment before midnight of the respective Friday quarter-end, so they could be
included in the reported results.
c. According to a former assistant in Operations, another means of accelerating
revenues was to simply overship product to one of AIPC' s large distributors , Sysco Corporation,
even though the additional amounts had not been ordered. This required Sysco to return the
unwanted goods, the likelihood of which should have been reserved for by AIPC.
d. General Mills ("GM") was a private - label customer which had a long-term
supply agreement with AIPC for pasta products. According to the Operations Manager Informant,
as well as an a employee in the Logistics and Production Department who reported to Gerry
Willenbrink, former Vice President of Logistics ("Logistics Employee Informant"), Defendant
George, the Executive Vice-President of Operations, routinely instructed employees in the
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operations department to pull GM's orders forward, which meant that the Company would begin
to manufacture products in anticipation of GM's orders. Shifting anticipated future sales forward
into the current quarter became such a common practice that insiders often joked that entire months
of GM 's orders would "disappear" from calendars , effectively "stuffing the channel " for sales of
such products and thereby distorting the results. This practice occurred throughout the entire Class
Period.
77. All the foregoing practices whereby AIPC prematurely recognized revenues violated
FAS 48, ¶ 6, which provides that:
[I]f an enterprise sells product but gives the buyer the right to returnthe product, revenue from the sales transaction shall be recognized attime of sales only if all of the following conditions are met:
a. The seller's price to the buyer is substantially fixed ordeterminable at the date of sale.
b. The buyer has paid the seller, or the buyer is obligatedto pay the seller and the obligation is not contingenton resale of the product.
c. The buyer's obligation to the seller would not bechanged in the event of theft or physical destructionor damage of the product.
d. The buyer acquiring the product for resale haseconomic substance apart from that provided by theseller.
e. The seller does not have significant obligations forfuture performance to directly bring about resale ofthe product by the buyer.
f. The amount of future returns can be reasonablyestimated.
78. Additionally, the SEC issued Staff Accounting Bulletin ("SAB") No. 101 - Revenue
Recognition in Financial Statements in December 1999, which stated , in relevant part, as follows:
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The staff believes that revenue generally is realized orrealizable and earned when all of the following criteria aremet:
- Persuasive evidence of an arrangement exists,
- Delivery has occurred or services have been rendered,
- The seller's price to the buyer is fixed or determinable, and
- Collectibility is reasonably assured.
79. Additionally, the Company violated its own pre-fiscal 2004 revenue recognition
policy that revenue not be recognized until final shipment of the goods . As of fiscal 2004, the
Company tightened its revenue recognition policy, stating that "the Company will recognize revenue
in the period received." Nonetheless, this policy was violated as well.
80. Defendant Ernst was made aware ofthe Company's premature recognition ofrevenue
as early as July 16, 2004, by a letter sent by the whistle blower to Steve Clifford and James Hassett
("The Company has front loaded revenue from Sysco Corporation for product that has not been
delivered.").
Excess and Unsold Inventory
81. During the Class Period, Defendants were faced with massive amounts ofunsold and
aged pasta that was only marketable to farmers for pig feed. This excess inventory was the result
of (i) the decline in demand for pasta products generally (despite the Company's efforts to market
"flavored" and "low carb" pastas); and (ii ) AIPC 's policy to run its plants at full capacity , regardless
of whether the product was required. This "full capacity" practice was intended to give the
appearance that AIPC's manufacturing costs were relatively low compared to more inventory
conscious competitors. Indeed, according to the Operations Manager Informant, at quarterly
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management meetings at corporate headquarters, Defendant Webster instructed operational
personnel to "keep the presses running, no matter what."
82. There were a myriad of examples of excess inventory build-up during the Class
Period , none of which was properly accounted for:
Lights-out Warehousing
a. During the "low-carb" fad, which began in 2002 , AIPC over-produced a series
of low carb pastas, which sold poorly. According to the Operations Manager Informant, in 2003
Defendants disguised the lower sales and inventory build-up by renting an abandoned warehouse
near their Excelsior Springs, MO plant, packing the warehouse with unsold product, and "shutting
off the lights" with no intent of selling the product. It was not until August 9, 2005, over two years
later , that AIPC wrote off this and other "low carb" pasta inventory, belatedly taking a charge of
$5 million.
Unsafe Warehousing
b. According to the Operations Manager and Logistics Employee Informants,
in December 2003, Defendant George instructed employees in the Operations Department to "pull
GM orders forward," which meant that the Company would begin to manufacture products in
anticipation of GM' s orders. However, GM never placed the orders , and AIPC' s inventory began
swelling. Instead of writing the excess inventory off, AIPC moved 5 million pounds of pasta (with
a market value of over $1 million) into boxes and stored it at an AIPC facility that federal health
authorities had not certified as safe for food product storage. Thus, the product could not be sold to
the public. Nonetheless, AIPC continued to carry excess inventory on its books.
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Repackaging of Excess Inventory
c. During the Class Period , AIPC was faced with millions of pounds of
inventory that was unsold past the year expiration date that appeared on its packaging. Significant
amounts of this inventory had been manufactured in anticipation of orders from customers that
failed to materialize , or which simply stopped sourcing their products from AIPC. To avoid writing
off the aged pasta, Defendants simply repackaged the products with a later expiration date, and
continued to carry it on its books. This practice was witnessed with increasing frequency during the
Class Period by the Operations Manager and Logistics Employee Informants.
Other Examples
d. According to the whistle blower:
(1) as of August 2004 , AIPC had "6-8 million pounds of worthlessMueller ' s inventory , sitting in a warehouse in South Carolina thatwas packaged three years ago when the Company made an abortedattempt to add the Pasta La Bella name to the Mueller ' s box," (perletter to Ernst dated August 6, 2004).
(2) there were 40 million pounds of inventory at the Tolleson facility,when 10 million pounds was sufficient; (at least 10 million poundsof this product was the aforementioned excess that had beenmanufactured for General Mills, which was scrapped in December2003)(Id.; May 26, 2004 letter);
(3) as of August 2004, there were $3-4 million of worthless inventory ofdry pasta that was 5-7 years old , stashed away in a warehouse leasedfrom Kansas City Distribution Service Co.(August 6, 2004);
(4) as of May 2004, there were 20 million pounds of excess product ina Total Warehousing facility in Phoenix (per May 26, 2004 letter);
e. Furthermore, 40 days of inventory of finished goods is the norm for the food
industry; however , from October, 2002 through at least June , 2004 , AIPC had 80 days of finished
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goods (per October 4, 2004 letter). If AIPC had written this excess off, its pre-tax income would
have been cut nearly in half from the $86 million that was reported during that time-frame.
83. Under GAAP, this excess inventory should have been written off and expensed
against current period income. According to Accounting Research Bulletin (ARB) 43, Chapter 4,
A departure from the cost basis of pricing the inventory isrequired when the utility of the goods is no longer as great as its cost.If the utility of goods is impaired by damage, deterioration,obsolescence, changes in price levels, or other causes, a loss [shall]be reflected as a charge against revenues of the period in which itoccurs. The measurement of such losses shall be accomplished byapplying the rule of pricing inventories at cost or market, whicheveris lower. (ARB43, Ch. 4, ¶8) (Emphasis supplied).
84. Moreover, FAS No. 151 "... amends ARB 43, Chapter 4, to clarify that abnormal
amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be
recognized as current-period charges."
85. Even AIPC's own accounting policies acknowledged the need for such write offs:
Inventories - Inventories are carried at standard costs adjusted forcapitalized variances, which approximate the lower of cost,determined on a first-in, first-out (FIFO) basis, or market. TheCompany periodically reviews its inventory for slow-moving,damaged or discontinued items and provides reserves to reduce suchitems identified to their recoverable amount. (2004 10-K, filedDecember 15, 2004.)
86. AIPC failed to write off or reserve for this obsolete and excess inventory in a timely
fashion. Instead, AIPC engaged in the various artifices described above to disguise the true nature
of the inventory problem, including repackaging and parking the product in warehouses.
87. Defendant Ernst was alerted to the above fraudulent inventory practices as early as
September 5, 2003 through a letter by the whistle blower sent to its managing partner, Steve
Clifford, and its Global Vice-Chairman, James Hassett. Subsequent letters regarding inventory
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problems were sent by the whistle blower to Ernst dated January 8, 2004; May 26, 2004; June 23,
2004; July16, 2004; July 21, 2004; August 3, 2004; August 6, 2004; October 4, 2004; and October
26, 2004.
88. Nonetheless, Ernst, with reckless indifference to the truth, failed to take the
appropriate measures under GAAS to enhance its audit procedures , for their "Reports of
Independent Registered Public Accounting Firm" to the AIPC Board ofDirectors for the fiscal years
2002-04, which would have resulted in detection of this fraud in a timely fashion.
Improper Accrual of Allowances for Product Promotions
89. AIPC' s promotional allowances were intended to boost sales to supermarkets and
food distributors through promotions such as "buy one get one free" or "two for one," which would
thereby induce end-use customers to purchase the goods. The allowances were also intended to
defray the supermarkets ' related advertising and circular costs.
90. Generally, AIPC billed its customer for the entire amount of the product shipped. The
customer then deducted the amount of expenses it actually incurred in connection with the
promotion before paying the invoice . ( Sometimes there were rebates that AIPC offset from the
amount due as well).
91. Promotional allowances had to be pre-approved by AIPC sales personnel. When the
customer deducted the amount expended from the invoice, it usually provided AIPC with
documentation which was reviewed by Company personnel to validate the amounts deducted.
92. GAAP required AIPC to accrue the amount of promotional allowances it could
expect would be deducted by its customers at the time it booked the revenuefrom the goods shipped.
The AICPA' s Statement of Position (SOP) 93-7, "Reporting on Advertising Costs," states:
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In most cases, the costs of advertising [i.e., Allowances for ProductPromotion] should be expensed as incurred or the first time theadvertising appears. There are two exceptions to this general rule.
First, entities are to capitalize certain direct-response advertising[coupons, coded forms].
Second, expenditures for advertising costs that are made subsequentto the recognition of revenues related to those costs are to becapitalized and charged to expense when the related revenues arerecognized. For example, some entities enter into an arrangementwhereby they are responsible for reimbursing some or all of theircustomers' advertising costs. In most cases, revenues related to thetransactions creating these obligations are earned before thereimbursements are made. The entity responsible for reimbursingadvertising expenditures would recognize a liability and the relatedadvertising expense concurrently with the recognition of revenue.
93. By failing to record adequate amounts to cover these kinds of commitments, AIPC
overstated its revenue and/or understated its expenses.
94. In order to track promotional costs, AIPC used an accounting system called "Vista"
which calculated the amount of allowances to be accrued for every shipment invoice based on the
particular agreement with the customer; the type of product (e.g. long or short pasta); the
classification ofthe customer (distributor, warehouse, supermarket) and the pounds shipped. Noelle
Markar was responsible for computing such accruals during the period 2002-04. She reported to
Daniel Rennell.
95. The Vista system though only estimated the amount of market promotion expenses
to be accrued. It was necessary to compare these estimated expenses to the amounts actually
incurred and validated. That task fell to Darren Oellien ("Ollien"), a financial analyst at AIPC's
headquarters who reported to Thomas Olive, the former Vice President of Finance, who in turn
reported to Defendant Schmidgall. Each month Oellien prepared a report entitled "Trade Accrual
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Adequacy Reports" which determined the amount, if any, that the Company was under accruing for
marketing promotions costs.
96. According to Oellien, AIPC under accrued market promotion allowances by $1.6
million for fiscal 2002. This amount exponentially increased to $8.7 million by July 2003. The
gargantuan size of the under accrual (which, if taken, would have wiped out 2/3 of the quarterly
income) prompted a meeting attended by Oellien and Defendant Schmidgall, along with Tom Olive,
Dan Rennell, and Keith Conrad. Instead of expensing this amount, Schmidgall directed Company
personnel to retrieve from storage 25 bankers boxes of documentation supporting the deductions
made by customers from 2000-2003, in order to, after the fact, review the validity of the prior
deductions, and to challenge any questionable deductions. He also ordered that the amounts that
should have been deducted be reclassified as "account receivables" due from the customers, thereby
further delaying the timing of any expense. This tactic, which was designed to avoid taking timely
and proper charges against earnings, prompted Oellien to resign the next month.
97. Defendant Ernst was alerted to abuses in AIPC's market promotion accounting
practices by a letter from the whistle blower dated October 11, 2002 that was sent to Brenda
Stasiulis, Ernst's Audit Manager, and John Wilgers, Ernst's Audit Partner, which complained about
handling of "$2 million in sales and marketing expenses" which were "capitalized in violation of
[GAAP and] accounted for greater than 10% of [AIPC's] operating income for the June 2002
quarter." This red flag should have caused Ernst to institute additional audit procedures to
investigate the allegation as required under SAS No. 99, and was contemplated under an AICPA
Exposure Draft published in February 2002. In failing to increase its audit scope, Ernst improperly
performed its year end audit in violation ofGAAS. But for such misconduct , AICP would have been
unable to report inflated results.
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98. In August 2005, AIPC acknowledged that it would have to take a total charge of$6.6
million to account for its under accrual ofmarket promotion costs ($3.7 million) and related account
receivables now admitted to be uncollectible ($2.9 million). Moreover, when AIPC announced on
October 27, 2005, that it would be restating its financial results for the prior 3 V2 years, it cited
"accrual of promotional allowances" as a reason for the restatement.
Defendants' Direct Participation in and Knowledge of the Fraud
99. AIPC
a. By acknowledging the need to restate its financial results for the last 3 '/z
years, AIPC has admitted that its accounting failures were due to knowing or reckless indifference
to the truth. Under Accounting Principles Board Opinion ("APB") 20, such restatement (as opposed
to a subsequent period charge-off) must occur where the facts which rendered the prior statements
materially false and misleading were available at the time the inflated results were originally
reported . APB No. 20, ¶ 13, requires , in part:
errors in financial statements [that] result frommathematical mistakes , mistakes in the application ofaccounting principles , or oversight or misuse of factsthat existed at the time the financial statements wereprepared. [Emphasis supplied],
b. APB ¶ 38 requires a company to restate its prior results "[i]f a change or
correction has a material effect on income before extraordinary items or on net income ...," or "if
a change or correction has a material effect on the trend of earnings." [Emphasis supplied.]
c. By restating its financial results for 3 '/2 years in addition to writing off
significant amounts , AIPC and each of the Defendants have admitted that the restatement here was
due to "misuse of facts" that existed at the time the statements were issued.
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d. Moreover, the misconduct particularized in the foregoing paragraphs amply
demonstrates the active participation in, and knowledge of, the fraudulent scheme by the Company's
senior officers.
100. The Individual Defendants collectively
a. The Individual Defendants were aware of, or recklessly disregarded, the
fraudulent scheme by virtue of their positions as senior operating and financial personnel in the
Company. Each either directed the scheme, carried out those directives, or were otherwise regularly
informed regarding the results thereof by virtue of their positions as officer, Chairman, and Board
and Audit Committee members.
b. Moreover, indicative of their knowledge that shareholder lawsuits for
accounting fraud were likely and imminent, AIPC's Board members (all of whom are Class and/or
Derivative Defendants herein) adopted expanded indemnification provisions on February 2, 2005.
Within a month, Defendant Schmidgall, who had continued to serve as an Investor Relations
executive after his removal as CFO, was told he would be terminated at the expiration ofhis contract
in September, 2005. Within six months of adoption of the expanded indemnification provisions,
AIPC formally announced the Audit Committee's ongoing investigation.
101. Webster
a. As detailed above, Defendant Webster, AIPC's CEO, issued directives to
Company personnel to ensure that Wall Street estimates were met. This practice started well before
the start of the Class Period, going all the way back to when the Company became public in 1997.
The practice intensified following the Mueller's acquisition in 2000, and became rampant as the
Company experienced significant declines in its sales growth during the Class Period.
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b. Webster also signed each of the Company's quarterly and annual financial
statements , and certified pursuant to the Sarbanes-Oxley Act of2002 that he had familiarized himself
with the Company's controls, books and records, and thereby could attest to the accuracy of those
statements, all of which are now being restated because of facts that "existed" and, but for reckless
disregard of the truth, were knowable to Webster at the time they were issued.
c. Webster was more than familiar with the requisites ofGAAP accounting, and
thus capable of determining the accuracy of AIPC' s financial statements . Prior to coming to the
Company, he had been an accountant at Defendant Ernst.
d. Indicative of his knowledge of the likelihood of shareholder suits, Webster
sold 111,000 AIPC shares at approximately $26 per share, netting over $2.8 million within two days
ofthe Board ' s adoption of an enhanced indemnification agreement covering executives in the event
of shareholder lawsuits, well before the market learned about the fraud. He had made no prior sales
during the Class Period.
e. Because of his misconduct, Webster's employment with the Company was
severed on December 4, 2005.
102. Schmidgall
a. As CFO ofAIPC through mid-2004, Schmidgall was directly responsible for
preparing AIPC's quarterly and annual financial statements that are now being restated. He also
signed these reports and certified pursuant to the Sarbanes-Oxley Act of 2002 that he had
familiarized himself with the Company's controls, books and records, and thereby could attest to
the accuracy of those statements.
b. Schmidgall attended the July 2004 meeting to address the $8.7 million under
accrual of marketing promotion expenses at the time, and directed the strategy of re-reviewing 25
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boxes of documentation (that AIPC personnel had previously reviewed in validating deductions),
and reclassifying much of those expenses as account receivables due from the customers (a
substantial portion of which is now being charged off or restated).
C. Schmidgall participated in Oellien's exit interview in August 2003 following
the latter's decision to quit after the July 2003 meeting. At the exit interview, Oellien made
expressly clear to Schmidgall that he was, as he characterized it, "uncomfortable" with the
accounting problems at AIPC, besides being disturbed by senior executives "greedy behavior."
(Oellien was more blunt with another colleague at the Company, Pam Fraley, to whom he confided
that he was working with a "bunch of crooks" who were "messing with the financials.")
d. Schmidgall was relieved of his CFO duties in the summer of 2004 , and was
told he was otherwise being terminated in March 2005, one month after the Board adopted increased
indemnification protections, when Webster and Schroeder dumped $4.5 million of their AIPC
shares.
103. Schroeder
a. Schroeder consistently touted AIPC's inflated results in press release
statements issued during the Class Period. The day after the Company adopted the enhanced
indemnification provisions in February 2005, he sold 62,500 shares of AIPC at $26 per share,
netting $1.65 million. He had made no prior sales during the Class Period.
b. Schroeder was ousted as Board Chairman on August 17, 2005, one week after
the announcement of the Audit Committee investigation.
104. The Audit Committee Defendants
a. As detailed in ¶ 239 , infra, pursuant to AICP' s own Audit Committee Charter
(adopted at the end of 2003), as well as the Sarbanes-Oxley Act, Defendants Patterson , Baum and
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Heeter , were duty bound to be fully informed regarding the adequacy of AIPC' s accounting and
operating controls, as well as the integrity of its financial results. This was particularly true for
AIPC's fiscal year end financial statements that were contained in the Company ' s Form 10-K's,
which the Audit Committee members signed.
b. Consistent with these duties, the Committee regularly met with Ernst and
senior management, and thus was fully informed of the Company's financial condition and
accounting controls.
c. Moreover, consistent with the Committee's Charter, the Audit Committee
Defendants were professionally trained and experienced in financial matters. The Chairman of the
Committee, Defendant Patterson, had been an accountant at Arthur Anderson for almost 20 years,
d. The Committee was also duty bound to investigate any potential wrongdoing.
It recklessly failed to take appropriate steps in a timely fashion regarding the foregoing accounting
machinations. Only belatedly did the Committee undertake to investigate the other Defendants'
misconduct.
The Other Individual Defendants
105. Defendant George, AIPC's Executive Vice President, directed that all ofhis managers
ensure that sales were pulled forward at the end of the quarters . This practice was intended to create
the appearance that the Company's sales were growing. Defendant George put tremendous pressure
on his entire division to make their numbers, and to engage in fraudulent practices as described in
¶¶_76-88, supra.
106. Defendant Shadid succeeded Schmidgall as CFO, and thus certified that he had fully
examined the Company's books and records prior to the release of all financial results.
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107, The Individual Defendants were motivated to inflate AIPC's results in order to recoup
substantial sums upon the sale of their personal shares, as detailed in ¶¶24-30.
Ernst
108. Defendant Ernst was made aware of all of the fraudulent practices as they were
occurring, by virtue of the whistle blower letters sent throughout the Class Period, as described in
¶¶5, 57, 73, 80,82(a)-(e), 87, 97, supra. Additional facts that reflect Defendant Ernst's reckless
disregard for the truth are set forth in ¶¶ 250 a-k, 235-53.
THE FRAUDULENT STATEMENTS ISSUED DURING THE CLASS PERIOD
First Quarter of 2002 ("1002")
109. At the outset of the Class Period , on January 23, 2002, AIPC issued a press release
announcing its financial results for 1Q02 (ended December 28, 2001). The Company reported
"record" quarterly earnings per share ("EPS") of $0. 48 (on a diluted share basis), a 30% increase over
the prior year's results. Quarterly revenues had risen 39% to $92.0 million (in part boosted by the
acquisition of brands from Borden Foods).
110. On February 8, 2002, AIPC filed with the SEC its Form 10-Q for 1 Q02, consistent
with the financial results announced on January 23, 2002. The Company also reported net income
of $8,852,000, compared to $5,249,000 in 1 Q01. The Form 10-Q was signed by defendants Webster
and Schmidgall. The Company stated in this and each other quarterly report cited below that "[t]he
accompanying unaudited consolidated financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X."
111. Indicative of analysts ' skewed perception of AIPC, on February 20, 2002 , Janney
Montgomery Scott issued a "Buy" recommendation, noting that (based on AIPC's presentation
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before the Consumer Analyst Group ofNew York), it believed that the Company' s "[s]tate-of-the-art
facilities and low cost production ... will continue to drive margin expansion and earnings visibility."
112. The foregoing statements regarding 1 Q02 were materially false and misleading for
the reasons set forth in ¶¶ 44, 51-98, supra,
Second Ouarter of 2002 ("2002")
113. On April 24, 2002, AIPC announced record results for fiscal 2Q02 (ended March 29,
2002). Revenues for the quarter increased 26% to $ 94.8 million. Gross margin expanded to 35.6%,
up from 31.2% a year ago "primarily as a result of increased operating efficiencies and the higher
margins associated with the recent brand acquisitions." Net income increased 31% to $10. 1 million,
or $0.54 per diluted share. The results beat the average of analysts forecasts (known as the "First Call
Consensus ") of $0.53. The day after the release of the Company's financial results, Stifel, Nicolaus
& Company, Inc. issued a "Buy" recommendation, noting that AIPC "continues to be the number one
producer of dry pasta" and "[as] the low cost producer it makes it very difficult for the competition
to compete on pricing."
114. Defendants Webster and Schroeder made statements quoted in the press release
praising these results. As Defendant Schroeder stated:
I'm looking forward to continued momentum with our managementteam over the balance of the year.
115. On May 8, 2002, AIPC filed with the SEC its Form 10-Q for fiscal 2Q02 consistent
with the foregoing results, which was signed by defendants Webster and Schmidgall. Net income of
$ 10.1 million was also reported. Conformance with GAAP was reiterated by the Company.
116. By mid 2002, AIPC's stock was trading above $50 per share.
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117. The foregoing statements regarding 2Q04 were materially false and misleading for
the reasons set forth in ¶¶ 44, 51-98, supra.
Third Ouarter of 2002 ("3002")
118. On July 24, 2002, AIPC announced "record" results for fiscal 3Q02 ended June 28,
2002. Revenues rose 19% to $91.8 million. Gross margin expanded to 35.4%, up from 32.7% the
prior year "primarily as a result of lower unit costs and the higher margins associated with the
branded acquisitions ofJuly 2001." Net income increased 30% to $11.0 million, or $0.59 per diluted
share, which was in line with the First Call Consensus. Statements by Defendant Webster reinforced
the positive image reflected by these results.
119. On August 8, 2002, AIPC filed with the SEC its Form 10-Q for fiscal 3Q02 consistent
with the foregoing results, which was signed by defendants Webster and Schmidgall, and which
reiterated conformance with GAAP . In addition , defendants Webster and Schmidgall signed
certifications pursuant to §906 of the Sarbanes-Oxley Act of2002, representing that:
The information contained in the Report fairly presents, in all materialrespects, the financial condition and results of operations of theCompany.
120. The foregoing statements regarding fiscal 3Q02 were materially false and misleading
for the reasons set forth in ¶¶ 44, 51-98, supra.
Fourth Quarter of 2002 ("4002") and Fiscal 2002
121. On October 30, 2002, the Company issued a press release announcing results for 4Q02
and fiscal year ended September 27, 2002. For 4Q02, revenues increased 11.0% to $102 . 2 million.
Net income increased to $11.4 million, up 28.3%. Diluted earnings per share increased 27.1% to
$0.61. These results were in line with the First Call Consensus.
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122. For the entire fiscal year 2002, revenues increased by 22.5% to $380 .8 million ; diluted
EPS increased 27.7% to $2.21; and net income increased to $41,299,000.
123. Applauding these results, Defendant Webster stated, among things:
Our plants operated at high levels of capacity and efficiency, and asthe industry's low cost producer we continued to improve our per unitcosts... inventories were reduced by almost $7 million.
Defendant Schroeder added "Tim and I have always set highly ambitious targets for AIPC. The
results of the most recent quarter and fiscal 2002 bear that out."
124. Analysts were please with these results. Janney Montgomery Scott reiterated its Buy
recommendation, noting that:
Inventories declined sequentially to $49.7 million from $56.7 millionin the third quarter. Inventories are up 12% on a year over year basis,which essentially matches the growth of the overall business.Inventories should not be an issue anymore.
125. On December 20, 2002, AIPC filed its annual report with the SEC on Form 10-K for
the fiscal year-ended September 27, 2002, consistent with the foregoing results . This was signed by
Defendants Schroeder, Webster, Schmidgall, Patterson, Heeter and Baum. Further, in addition to the
previous § 906 Sarbanes-Oxley Certification , Defendants Webster and Schmidgall certified the
financial results pursuant to §302 of Sarbanes-Oxley, as follows:
I have reviewed this quarterly report on Form 10-Q of AmericanItalian Pasta Company;
2. Based on my knowledge, this quarterly report does not contain anyuntrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstancesunder which such statements were made, not misleading with respectto the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financialinformation included in this quarterly report, fairly present in allmaterial respects the financial condition, results ofoperations and cash
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flows of the registrant as of, and for, the periods presented in thisquarterly report;
4. The registrant's other certifying officers and I are responsible forestablishing and maintaining disclosure controls and procedures (asdefined in Exchange Act Rules 13a-14 and 15d-14) for the registrantand we have:
a) designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this quarterly report isbeing prepared;
b) evaluated the effectiveness of the registrant's disclosure controlsand procedures as of a date within 90 days prior to the filing date ofthis quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;
The registrant's other certifying officers and I have disclosed, based onour most recent evaluation, to the registrant's auditors and the auditcommittee of registrant's board of directors (or persons performing theequivalent function):
a) all significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant's ability to record,process, summarize and report financial data and have identified forthe registrant's auditors any material weaknesses in internal controls;and
b) any fraud, whether or not material, that involved management orother employees who have a significant role in the registrant's internalcontrols; and
6. The registrant's other certifying officers and I have indicated in thisquarterly report whether or not there were significant changes ininternal controls or in other factors that could significantly affectinternal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficienciesand material weaknesses.
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126. Furthermore, in the 2002 Form 10-K, Defendant Ernst represented that its audit of
AIPC' s financial statements for fiscal 2002 conformed with GAAS, and expressed its opinion that:
In our opinion, the financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of American Italian Pasta Company atSeptember 30, 2002 and 2001, and the consolidated results of its operations and itscash flows for each of the three years in the period ended September 30, 2002, inconformity with accounting principles generally accepted in the United States.
127. Furthermore, the Company's Proxy Statement for 2002, filed with the SEC on
December 20, 2002, stated as follows:
Based on the Audit Committee's review of the financial statements and theindependent auditors' report thereon, discussion with management and theindependent auditors, discussion with the independent auditors regarding SAS 61, andthe written materials provided by the independent auditors under ISB Standard No.1 and the related discussion with the independent auditors of their independence, theCommittee has recommended to the Board of Directors that the audited financialstatements of the Company be included in its Annual Report on Form 10-K for thefiscal year ended October 3, 2003, for filing with the Securities and ExchangeCommission.
128. The foregoing statements regarding 4Q02 and fiscal year 2002 were materially false
and misleading for the reasons set forth in ¶¶ 44, 51-98, supra.
First Quarter of 2003 ("1003")
129. On January 29, 2003, the Company announced results for fiscal 1 Q03 ended January
3, 2003. Revenues increased 16.3% to $107. 0 million ; diluted EPS increased 12.5% to $0.54
(excluding acquisition and plant start-up charges of $0.05 per share). These results were a penny
higher than the First Call Consensus. Laudatory statements by Defendants Webster and Schroeder
were included in the press release.
130. On February 18, 2003, AIPC filed with the SEC its Form 10-Q for fiscal 1 Q03
consistent with the foregoing and signed by defendants Webster and Schmidgall. In addition, AIPC
reported quarterly net income of $8,923,000, slightly higher than $8,852,000 reported for 1Q02.
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Conformance with GAAP was reiterated . Defendants Webster and Schmidgall also signed §§ 302
and 906 Sarbanes-Oxley Certifications . The 10-Q incorporated the results disclosed on January 29,
2003.
131. The foregoing statements regarding the 1 Q03 were materially false and misleading
for the reasons set forth in ¶¶ 44, 51-98, supra.
Second Quarter of 2003 ("2Q03")
132. On April 30, 2003, AIPC announced results for the fiscal 2Q03 ended March 31, 2003.
Revenues increased 17% to $110.7 million. Diluted EPS were $0.48, a decline of 12%. While the
quarterly results were lower than the prior year, they were in line with the First Call Consensus.
133. Moreover, AIPC also forecasted that for the entire fiscal year 2003, EPS would range
from $2.50 - $2.56, before plant start-up and acquisition-related charges, a 14% rise from the prior
year.
134. These results led Legg Mason to reiterate its Buy recommendation noting:
In our opinion, American Italian Pasta remains one of the mostcompelling, reasonably valued growth stocks in the food sector. Withthe lowest cost structure in the pasta industry and leading regionalbrands, American is poised to continue to gain market share andconsolidate its leadership in the industry.
135. On May 16, 2003, AIPC filed with the SEC its Form 10-Q for fiscal 2Q03, consistent
with the foregoing results and signed by Defendants Webster and Schmidgall, who also executed
§§302 and 906 Sarbanes-Oxley Certifications. The Company reported total net income of $8.87
million compared to $10.1 million in 2Q02. The Form 10-Q represented the results were in
conformance with GAAP.
136. The foregoing statements regarding 2Q03 were materially false and misleading for
the reasons set forth in 1144, 51-98, supra.
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137. Indicative of the market being misled about AIPC's purported "low cost" structure
and its ability to weather the weakness in the pasta market, Avondale Partners initiated coverage of
AIPC on July 1, 2003, stating that the Company was undervalued, and rated it as Market Outperform,
commenting that one of the main reasons it "liked the stock" was because AIPC had "a low cost,
vertically integrated production and distribution structure," adding that "[t]he company has achieved
a low cost structure through its efficient production facilities and well-trained work force."
Third Quarter of 2003 ("3003")
138. On July 30, 2003, AIPC announced results for fiscal 3Q03 ended July 4, 2003.
Revenues increased 14% to $104.3 million. Diluted EPS increased 10% to $0.65. These results were
a penny below the First Call Consensus. However, looking ahead to the fourth quarter, the Company
projected revenue growth of 15-20%, and EPS growth of 10% - 18%.
139. Reflective of analysts' favorable response to this announcement, Stifel, Nicolaus
issued a report on the same day iterating its "Buy" recommendation and noting "that [AIPC] remains
the low-cost producer, and its unique ability to deliver private label, branded, and imported pasta
should continue to provide a competitive advantage as retailers look to deal with a smaller of
suppliers." On August 14, 2003, Wachovia Securities initiated coverage with an "Outperform"
rating, stating that "AIPC's outlook is bright , based on its low-cost infrastructure and the potential
for more business wins."
140. On August 18, 2003, AIPC filed with the SEC its Form l0-Q for fiscal 3Q03,
consistent with the foregoing results, which was signed and certified as conforming to §§ 302 and
906 of the Sarbanes-Oxley by defendants Webster and Schmidgall . Reported earnings were
$12,034,000 compared to $11,007,000 for 3Q02. The Forml0-Q also stated that the results
conformed with GAAP.
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141. The foregoing statements regarding fiscal 3Q03 results were materially false and
misleading for the reasons set forth in ¶¶ 44, 51-98, supra .
142. Analyst reports issued in the months following release of the 3Q03 results reinforced
the upbeat , albeit false , impression provided to the market. Legg Mason added AIPC to its "select
list" as a "Buy" rated company, noting:
with the lowest manufacturing costs in the industry, broad productportfolio and strong distribution, we believe that American ItalianPasta is positioned to continue to take market share and strengthen itsposition in the dry pasta industry in the United States.
Fourth Quarter of 2003 (114003") and Fiscal 2003
143. On November 5, 2003, AIPC announced "record" results for the fourth quarter and
fiscal year ended October 3, 2003. Revenues for fiscal 4Q03 increased 14% to $116.9 million.
Diluted EPS increased 13% to $0.69. These results were within a penny of the First Call Consensus.
144. For the entire fiscal year 2003, revenues increased 15% to $438. 8 million and diluted
EPS for the year was $2. 3 1, compared to the prior year's $2.21. Excluding acquisition related and
plant start-up charges of $4.9 million ($0.18 per share) in fiscal 2003, diluted EPS increased 13% to
$2.49.
145. Defendant Webster reinforced the upbeat nature of these results;
AIPC's quarterly business performance was excellent with double digit revenue andprofit growth, a notable achievement when compared with recent food industry andcategory trends. We again profitably took market share in our Retail, Institutional andInternational operations. Retail revenues benefitted from another strong quarter inprivate label, branded acquisitions, and our new specialty business with productadditions including whole-wheat, organic and Atkins' reduced carb products.Institutional revenues were driven by strong growth in our Ingredient business,including our expanded supply agreement with General Mills.
146. Defendants Horst W. Schroeder added,
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Fiscal 2003 was a very successful year, with strong financial results, a significantincrease in cash generated from operations, and the construction of the Arizonafacility. We saw demonstrable success from our New Balance Strategy, increasingretail pasta market share, and are poised to continue creating profitable growth andincreasing shareholder value....
147. Aware that Wall Street was carefully watching its inventory, Defendants continued
to mislead analysts by insisting that it was modifying its manufacturing protocol to avoid any excess
build-up. Thus, in reiterating its "Aggressive Buy" rating on December 1, 2003, McDonald
Investment noted that AIPC represented that it;
would produce but not package short goods until it is ready to fill specific orders.This reduces inventory by packaging to order rather than warehousing essentially thesame finished goods which differ only by their package labels.... Further, [AIPC]will work more closely with all of its customers to improve its production planning.This will shorten the supply chain and further reduce inventories. Managementemphasizes that it not compromise its superior level of service to retailers whoconsistently praise the Company for its ability to promptly ship complete orders.
148. On December 30, 2003, AIPC filed with the SEC its Form 10-K for the fiscal year-
ended October 3, 2003, consistent with the foregoing results, which was signed by Defendants
Schroeder, Webster, Schmidgall, Baum, Heeter and Patterson. Defendants Webster and Schmidgall
certified the reports as conforming with the Sarbanes-Oxley Act. The Company reported earnings
of $42,623,000 for the entire fiscal 2003, compared to the prior year's $41,299,000. For the fiscal
4Q03, AIPC reported net income of $11,381,000 compared to $11,007,000 for the prior year. Ernst
signed the Report of Independent Auditors attesting that AIPC's financial statements conformed to
GAAP.
149. Furthermore, the Company's Proxy Statement for 2003, filed with the SEC stated that
the Audit Committee recommended that the financial statements be included in AIPC's Annual
Report on Form 10-K, identical to ¶ 127, supra.
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150, The foregoing statements regarding 4Q03 and fiscal year 2003 results were materially
false and misleading for the reasons set forth in ¶¶ 44, 51-98, supra.
First Ouarter of 2004 ("1004")
151. On January 12, 2004, AIPC announced that it would release its fiscal IQ04 earnings
report later in the month. In reaction to this announcement and further discussions with management,
several analysts issued pasta industry earnings "previews ," Piper Jaffray, Keybanc' s McDonald
Investments , and Bear Stearns commented that AIPC needed to demonstrate market acceptance of
its "low carb" products. The analysts all either recommended the Company as a "hold," or
downgraded their ratings.
152. In reaction to this news, on January 13, 2004, the stock dropped 10%, falling $4.17
to $37.15 per share. However, all of this loss was recovered in the following weeks as AIPC
fraudulently led investors to believe that the Company was poised to outperform the market.
153. On January 22, 2004, Piper Jaffray issued a report stating that while fiscal I Q04
results would reflect a decline from the prior year, AIPC had increased its full year revenue
guidance of 6%-14% to 11%-18% based on "accelerating sales growth rates in the final three
quarters of fiscal 2004." AIPC attributed the heightened guidance to "increased account penetration,
coupled with the introduction of new low-carbohydrate pasta products ." Following release of this
report, AIPC stock rose 5%, from $37.75 to $39.35.
154. AIPC' s projected sales growth (which was conveyed through Piper Jaffray) was false,
misleading and without reasonable basis, and could be achieved only by the fraudulent manipulation
of shipments and inventory that AIPC had been engaged in, as detailed in ¶¶ 76(a)-(d), 81, 82(a)-(e),
supra.
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155. On January 28, 2004, AIPC announced results for fiscal 1 Q04 which ended February
2, 2004. Revenues for the quarter (13 weeks) were $101.6 million, down 5.1 %. Diluted EPS
declined 10% to $0.44. These results were within a penny of First Call consensus.
156. AIPC acknowledged for the first time that the low carb diet craze was impacting
results;
Finally, revenues were affected by declining category sales due in part to the currentreduced carbohydrate awareness trends in the American diet. The Company estimatesthat total retail pasta sales declined 3% to 4% over the last 90 days, which was morethan anticipated.
However, despite this downturn, AIPC remained upbeat about the future. As Defendant Schroeder
stated;
I am pleased with the results of the quarter given some of the environmentalchallenges we experienced. We grew our category market share, added new business,strengthened our competitive position, and prepared to launch our new reduced carbproducts. This progress positions us well for excellent growth over the balance of2004, and into 2005.
Consistent with this upbeat outlook, AIPC reiterated its recent earnings guidance for fiscal 2004:
Sales - $490 - $520 (+11-18% versus 2003)
EPS - $2.55 - $2.70 (+10-17% versus reported 2003)
157. On February 17, 2004 , AIPC filed with the SEC its Form 10-Q for fiscal 1 Q04,
consistent with the foregoing results, which was signed and certified as conforming to §§ 302 and
906 of the Sarbanes-Oxley Act by Defendants Webster and Schmidgall. The Company reported net
income of $8,127,000 for the quarter, compared to $8,923,000 in 1Q03. The Form 10-Q also stated
that the results conformed with GAAP.
158. The foregoing statements regarding the 1Q04 were materially false and misleading
for the reasons set forth in ¶¶ 44, 51-98, supra.
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Second Quarter of 2004 ("2004")
159. On April 12, 2004, AIPC announced "preliminary" results for fiscal 2Q04 ended April
2, 2004. AIPC stated that it expected to report net revenues of approximately $113 million,
representing 2% growth. Net income was expected to be $7.5-$7.8 million or $.40-$.42 per share
(approximately $9.2-$9.5 million and $.49-$.51/share excluding the Provision for New Product
Development and Start-up Costs). This was a decline from the $8.9 million and $.48 per share
reported in the prior year. However, the results were in line with the First Call Consensus.
160. At the same time, AIPC explained that these projected results, which were below
"internal targets ," were due to a sales slowdown that AIPC attributed to "consumer diet changes,
exacerbated by labor strikes and changes in [the Company's] category pricing and margin strategies."
The Company is very pleased with our progress to date on this complex and far-reaching project. The product development, manufacturing and operational start-uphave created products generating very favorable feedback in our consumer research.The new products are formulated with patented ingredients that are exclusivelyavailable to AIPC in the pasta category. The ingredients are much more costly thanour standard raw materials, currently in high demand and more challenging to workwith. While these characteristics generated significant upfront development costs, webelieve we have created superior products with meaningful barriers to replication.
... Net revenues generated from the low and reduced carb pastas totaled approximately$8 million for the quarter, up from $2.7 million in the first quarter, and drove strongoverall revenue growth from our Brands and Specialty business.
Defendant Webster added:
We are also proactively evaluating the alignment of our factories for new andtraditional pasta products and examining our current and targeted inventory levels tobetter align them with expected market demand. At this point in time, we anticipatereducing production schedules in our plants during the summer to modify some ofourprocesses for more efficient and broader geographic manufacturing of our newreduced carb products and to reduce inventory levels without affecting our excellentcustomer service performance. The necessary adjustments will increase per unitmanufacturing costs in the short term increasing near term profit challenges, but betterposition us for the future.
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161. AIPC also lowered its net income and EPS guidance for the balance of fiscal 2003
to $42.6 million and $2.31.
162. In reaction to this news, the stock dropped from a close of $37. 98 on the last trading
day prior, to $34.37 on April 12, 2004, a decline of 9.5%, but continued to trade at artificially inflated
levels as Defendants continued to fraudulently manipulate AIPC's reported results.
163. On April 28, 2004, the Company announced actual results for fiscal 2Q04. Revenues
grew to $113.3 million. Net income was $7.6 million and diluted EPS was $.41, compared to $8.9
million and $.48 in prior year. Webster acknowledged that, " Earnings were impacted significantly
by the new product costs, higher per unit manufacturing costs, and pricing reductions and
promotional support increases targeting volume and market share gains in our base business."
164. These disclosures caused AIPC stock to fall from $33.95 on April 27, 2004 to $31.30
on April 28, 2004, a drop of 7.8%. However, on the next day, several analysts expressed the belief
that AIPC would rebound . For example , Legg Mason attributed its continued "hold" recommendation
to statements by the Company that its higher inventory was due to a higher value in products as
opposed to a higher volume of products.
165. Within two weeks , analysts were upgrading the Company's ratings . For instance, on
May 10, 2004, D.A. Davidson upgraded AIPC to Buy from Neutral , noting that weak sales were due
to the drawing down of inventories.
166. On May 14, 2004, AIPC filed with the SEC its Form I 0-Q for fiscal 2Q02, consistent
with the foregoing results, which was signed and certified as conforming to §§302 and 906 of the
Sarbanes-Oxley Act by defendants Webster and Schmidgall. The Forml0-Q also stated that the
results conformed with GAAP.
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1 67. The foregoing statements issued directly by Defendants , and otherwise conveyed
through analysts regarding the 2Q04, were materially false and misleading for the reasons set forth
in ¶¶ 44, 51-98, supra.
168. On June 23, 2004, the Company announced a "Restructuring and Rightsizing
Program" which included suspending operations at its Kenosha, Wisconsin facility, reducing
personnel and temporarily halting production at two other facilities for 2-4 weeks.
169. The Company anticipated taking charges of $10-12 million over the balance of the
year for these changes of which only $3-4 million related to inventory costs. This amount was well
below the amounts that should have been charged off give the matters set forth in ¶¶ 76(a)-(d), 81,
82(a)-(e ), supra . As a result , analysts were very receptive to the June 24, 2004 announcement. Legg
Mason expressed the view that the "announced measures adequately align [AIPC] for the future,"
adding that the Company's "very high utilization rate" would enable it "to be most efficient and
profitable with the pounds it produces, a highly desirable outcome."
170. The failure to properly account for all the accounting wrongdoing at the Company
at the time buffered the impact of these adverse developments. While AIPC stock fell $1.19 on June
23, 2004 (or 3.8%) it had fully recovered by mid-July.
Third Quarter of 2004 ("3004")
171. On July 28, 2004, AIPC announced results for fiscal 3Q02, which ended July 2, 2004.
The Company reported a net loss of $500,000 or $.03 per diluted share. Several extraordinary
charges associated with the Restructuring and Rightsizing Program contributed to the loss, including
$945,000 in restructuring expenses; $5.5 million related to the inventory reduction strategy; and $3.5
million of new product introduction costs (including marketing expenses of $2.2 million). But for
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these charges , net income would have been $6 million , or $32 per diluted share. However, these
charges caused the results to be well below the First Call Consensus.
172. Despite this decline, Defendants remained upbeat about the future. Defendant
Webster stated:
We are encouraged, however, by our ability as an industry leader to gain market shareby delivering sales performance that outpaced the continued category declines.
173. Analysts were again beguiled by these results . On July 29, 2004, PiperJaffray rated
AIPC "Outperform" citing its "vastly superior cost structure relative to its competitors."
174. On August 2, 2004, AIPC filed with the SEC its Form 10-Q for 3Q04 for the period
ended July 2, 2004, consistent with the foregoing results, which was signed by Defendants Webster
and Shadid , who also certified the financials pursuant to §§302 and 906 of the Sarbanes-Oxley Act.
The Form 10-Q stated that the results were in conformance with GAAP.
175. Analysts continued to be misled by Defendants. An August 4, 2004 a Wachovia
Securities research report stated, "While AIPC has many problems, we believe they have mainly been
caused by weak consumer trends and damaged industry competitive dynamics - not primarily bad
management."
176. The foregoing statements regarding the 3Q04 were materially false and misleading
for the reasons set forth in ¶¶ 44, 51-98, supra.
Fourth Quarter of 2004 ("4Q04") and Fiscal 2004
177. On November 10, 2004, AIPC announced results for 4Q04 and full fiscal year 2004,
which ended October 1, 2004. The Company reported a net loss for the fourth quarter of $12.2
million , or $.67 per diluted share, which was in line with prior expectations. The loss included $1.9
million in restructuring expenses; $8.6 million of costs related to inventory reduction strategy; and
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$3.9 million of new product marketing costs. These results were in line with the First Call
Consensus.
178. Reported net income for the full 2004 fiscal year was $3.0 million, or $0.16 per diluted
share, compared to $42.6 million or $2.31 per diluted share for Fiscal 2003. A significant portion of
the decline was attributed to costs incurred from the "inventory reduction" strategy ($14.1 million);
and new product introduction and marketing costs ($9.9 million).
179. While expressing disappointment with the results, Defendants still misled investors
regarding the severity of the financial problems facing the Company. Defendant, Webster, stated:
The operational and profit impacts of the restructuring were much greater thanexpected; however, we believe our operations will improve over the next twoquarters. We accomplished our primary restructuring goals of capacity, inventory andcost structure reductions. Our inventories are approximately $24 million lower thanat the beginning of the quarter, we generated $18.5 million in cash and reduced debtby approximately $20 million during the quarter.
180. The cumulative effect of these announcements regarding "inventory reduction," was
that AIPC's stock price, which had been $37.98 per share on April 8, 2004, had fallen to less than
$21 per share by November 11, 2004, in part driven by the much larger size of the "inventory"
reduction than the original $3-4 million guidance given by the Company.
181. Consistent with the fraudulent scheme, AIPC sought to halt the downward slide ofthe
stock by issuing very favorable "targets" for fiscal 2005, including:
-- Net revenues $370 - 400 million
-- Net income $15 - 18 million
-- Earnings per share $0.80 - $1.00 per share
182. On December 15, 2004, AIPC filed with the SEC its Form 10-K for the fiscal quarter
and year-ended October 1, 2004, consistent with the foregoing results, which was signed by
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Defendants Schroeder, Webster, Shadid, Baum, Heeter and Patterson. Defendants Webster and
Shadid certified the results pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act.
Additionally, Ernst signed the Report ofIndependent Auditors attesting to the financials conformance
with GAAP.
183. Furthermore, the Company's Proxy Statement for 2004 filed with the SEC, stated that
the Audit Committee recommended that the financial statements be included in AIPC's Annual
Report on Form 10-K, identical to ¶ 127, supra.
184. The foregoing statements regarding 4Q04 and fiscal year 2004 were materially false
and misleading for the reasons set forth in ¶¶ 44, 51-98, supra.
First Quarter of 2005 ("1005")
185. On January 26, 2005, the Company announced results for 1Q05 ended December 31,
2004. The Company reported net earnings of $2.1 million , or $.11 per diluted share, generally in line
with the Company' s internal expectations , compared to $8.1 million , or $.44 per diluted share of
1 Q04. These results were a penny above the First Call Consensus.
186. Defendants remained upbeat about the Company's prospects. Defendant Webster
commented:
We continue to feel positive about the outlook for our performanceduring the remainder of fiscal 2005. The improving pasta industrymarket conditions and indications of strengthening sales demand,combined with our initial success in the implementation of our pricingstrategy, improvements in customer service, and the recentimprovements in our production and manufacturing cost efficiencies,all give us confidence in our ability to achieve our business plan thisyear.
The Company reaffirmed its key financial targets for the 2005 fiscal year, as set forth in the releases
dated October 28, 2004 and November 10, 2004.
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187. In reaction to the news, the stock sky-rocketed 17%, gaining $4.50 and closing at
$25.45 . Reflecting the rebounding sentiment for AIPC, Bear Stearns issued a report on January 27,
2005 rating the stock "Peer Perform" based on discussions with AIPC management that led it to
believe, incorrectly, that the restructuring program "appears to be near or at the finishing point, and
as a result, excess capacity has largely been removed from production. Low cart pastas, as we
anticipated, did notfactor heavily into inventory despite poor sales." [Emphasis supplied] By April
13, 2005, the stock was as high as $29.85.
188. On February 2, 2005 , AIPC' s Board met and approved an indemnification plan that
enhanced the protections afforded to the Company's officers and directors from shareholder lawsuits.
These enhanced protections were not announced though until June, 2005. Significantly, over the two
days following Board approval of these enhanced protections, Defendants Schroeder and Webster
locked in their AIPC stock profits by selling over $4.5 million of AIPC stock at prices they knew
were inflated.
189. On February 9, 2005, AIPC filed with the SEC its Form l 0-Q for fiscal 1 Q05,
consistent with the foregoing results, which was signed and certified as conforming to §§ 302 and
906 of the Sarbanes-Oxley Act by defendants Webster and Shadid . The Form 10-Q also stated that
the results conformed with GAAP.
190. The foregoing statements regarding the 1 Q05 were materially false and misleading
for the reasons set forth in ¶¶ 44, 51-98, supra.
Second Quarter of 2005 (112Q05")
191. On April 27, 2005 AIPC announced results for 2Q05 ended April 1, 2005. The
Company reported net income for the second quarter of $2.4 million, or $0.13 per diluted share,
compared with net income of $7.6 million, or $0.41 per diluted share, in Q204. Total revenues were
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$100.1 million, an 11.7% decrease from the prior year. Indicative of the pending unraveling of the
fraudulent scheme, these results were well below the First Call Consensus.
192. Defendant Webster, continuing to deceive investors, commented on the results:
Fundamental improvements were accomplished in customer servicelevels, production efficiency and manufacturing costs following ourrestructuring program late in the 2004 fiscal year. In that regard, bythe end of the quarter, service levels had again reached the Company'soverall historical standards. The improvements in productionefficiency during the first half of the year should allow us to reach ourdesired levels of production efficiency over the remainder of the year,and incremental operating costs incurred subsequent to therestructuring should be back in line in the third quarter.
193. The Company maintained a positive image, stating that it expected operating profit
margin and net earnings improvements for the rest of fiscal 2005, "primarily as a result of the full
impact ofthe recent price increases , the impact ofimproved production efficiency and manufacturing
costs , and reduced amortization of slotting costs relating to last year's reduced carb introduction."
194. On May 11, 2005, AIPC filed with the SEC its Form 10-Q for 2Q05 ended April 1,
2005, consistant with the foregoing results, signed and certified as conforming to §§ 302 and 906 of
the Sarbanes-OxleyAct by defendants Webster and Shadid . The Form 10-Q also stated that the results
conformed with GAAP.
195. The foregoing statements regarding 2Q05 were materially false and misleading for
the reasons set forth in ¶¶ 44, 51-98 supra.
The Full Revelations
196. On August 9, 2005 , after the close oftrading , AIPC shocked the market by disclosing
that its Audit Committee was "conducting an internal investigation of certain accounting procedures
and practices" including transactions "occurring as early as the Company's 2000 fiscal year." As a
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result , filing of the Company 's financial results for the fiscal third quarter of 2005 ("3Q05 ") ended
July 1, 2005, would be delayed.
197. AIPC further disclosed that it would have to incur $60.7 million of accounting related
charges in connection with the 3Q05 results . These charges were detailed as follows:
Impairment charges $36.7Low and reduced carb inventory write -downs $5.2Other financial statement adjustments 18.8
Total $60.7
198. The amount of these charges was astounding. They represented 66% of the net
income previously reported by AIPC during the entire Class Period.
199. The "Impairment Charges" were attributable to the charge-offofasset values for name
brand products, particularly, Golden Grain-Mission and R&F.
200. The Company also acknowledged the need to write down $5.2 million of inventory
related to low carb products due to lower "sales trends." This was in addition to increasing its
reserves for "slow moving, damaged and discontinued inventories" by $4.1 million.
201. The Company further admitted for the first time that it had improperly accounted for
"promotional allowances and related customer deduction receivables" totaling $6.6 million. Of this
amount, $3.7 million involved promotional allowances (resulting from updated estimates of prior
period promotional expenses incurred but not yet paid), and $2.9 million related to customer
receivables determined to be uncollectible . Given the ongoing nature of the Audit Committee's
investigation, and AICP's subsequent admission that it will have to restate 3 '/2 years of its financial
reports, it is very likely that these amounts will increase.
202. As a result of elimination of the foregoing improper accounting practices, the
Company revised its forecasts for future results. As it noted,
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Combined with the charges outlined below, the Company expects to record asignificant net loss for the third quarter ended July 1, 2005, leading to a net loss forthe 2005 fiscal year.
203. Finally, the Company acknowledged for the first time that a prior inquiry by the SEC
into trading activity in AIPC stock in late 2004 and early 2005 by "persons outside the company" had
ripened into "discussions" with the SEC relating to"certain of the [accounting] subjects" discussed
above.
204. As a result of these August 9, 2005 revelations, AIPC's stock price, which closed on
$20.94 that day, fell the next day to $13.28, a 37% decline, on volume of an astounding 4.7 million
shares (in contrast to the average daily volume for the period of less than 250,000 shares).
205. Many analysts immediately downgraded the Company. Indeed, on August 10, 2005,
Bear Stearns withdrew its coverage, stating: "Without any understanding of the company's recent
and expected performances, and absent a timetable for increased clarity, we find our visibility into
earnings, dividends, and cash flows insufficient."
206. On August 16, 2005, AIPC disclosed for the first time that in March 2005, five months
earlier , Defendant Schmidgall had been notified that he was being "terminated," and that his contract
would not be renewed when it expired on September 30, 2005.
207. The Company also disclosed on this date that AIPC's founder and Director, Defendant
Richard Thompson , was resigning , effective immediately.
208. On August 17, 2005, the last day ofthe Class Period, the Associated Press reported
that Defendant Schroeder "has stepped down from the company's board of directors, only days after
the company disclosed it is facing questions over its accounting." AIPC did not confirm this ouster
until October 19, 2005.
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209. On this same day, D.A. Davidson issued a report on AIPC entitled "The Accountants
Were MIA But the Lawyers Were Hard at Work." Noting the earlier departure of Schmidgall, the
enhanced indemnification of the remaining officers and directors , and the increased compensation
provided to the Chair of the Audit Committee, the report observed:
American Italian Pasta Company filed two 8-Ks today, which shed furtherlight on the tangled web. It becomes very clear that the board and executiveofficers have been preparing for a train wreck for some time.
210. Following this revelation , AIPC's stock fell to $ 11.16, a decline of 6.1% from the
prior day, and 47% from the pre-revelation closing price of $20.94 on August 9, 2005.
211. The enormous impact and longevity of the fraudulent scheme was confirmed when
AIPC announced on October 27, 2005 that its financial statements for the fiscal years 2002-04, and
the first two interim quarters of 2005, "should no longer be relied upon" and that it expected to
"prepare restated financial statements for the periods in question." Significantly, the Company
conceded that the need to restate arose, in part, from improper;
accrual of allowances for product promotions and capitalization of certain overheadcosts, when combined with certain uncorrected immaterial errors, had a materialimpact on the Company's historical financial statements.
212. The Company further stated that the Audit Committee' s investigation was ongoing,
and that the restatement would be made at its conclusion.
213. Analysts were swift to condemn the Company. In an article that appeared in the
Kansas City Star on October 28, 2005, reporter Jennifer Mann cited comments by a Janney
Montgomery Scott analyst, Mitch Pinheiro:
One issue that Pinheiro has long had with the company's accounting proceduresrelates to a long stretch, including the years that American Italian intends to restate,when the company was running its plants at near-capacity levels. That lowers the per-unit cost.
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[According to Pinheiro] " they weren't selling what they were making, but it madetheir per-share earnings look better... .Then in their restructuring the company took aone-time charge for inventory reductions. Investors don't care about one-time charges- - supposedly Wall Street ignores them - - but what that was, was a way of sayingprevious earnings were overstated."
The inventory reduction charge Pinheiro referred to was part of a "rightsizing"announced in June 2004. Initially projected to cost $3 million to $4 million, the costof the inventory reduction eventually ballooned to $8.6 million."
214. On December 5, 2005, AIPC announced that Defendant Webster had been fired.
215. As of the close of trading on January 15, 2005, AIPC shares were down to $6.65 per
share.
LEAD PLAINTIFF'S RULE 23 ALLEGATIONS
216. Lead Plaintiff brings this action as a class action pursuant to Rule 23(a) and (b)(3) of
the Federal Rules ofCivil Procedure on behalf of a class consisting of all persons and entities who
purchased common stock or call options of AIPC between January 23, 2002 and August 17, 2005
(both dates inclusive), and were damaged thereby ("the Class"). Excluded from the Class are
defendants herein , officers and directors of AIPC, members of their immediate families, and the
heirs, successors or assigns of any of the foregoing. Also excluded are any persons and entities that
purchased AIPC shares to cover short positions or uncovered options.
217. The members of the Class are so numerous that joinder of all members is
impracticable . While the exact number of Class members is unknown to Lead Plaintiff at this time
and can only be ascertained through appropriate discovery, Lead Plaintiff believes there are, at a
minimum, thousands of members of the Class who purchased AIPC common stock and call options
during the Class Period. The Company has approximately 20 million shares outstanding and trades
on the New York Stock Exchange (NYSE) under the symbol "PLB."
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218, Common questions of law and fact exist as to all members of the Class and
predominate over any questions affecting solely individual members of the Class. Among the
questions of law and fact common to the Class are:
a) whether the federal securities laws were violated by Defendants' acts asalleged herein;
b) whether AIPC issued false and misleading financial statements during theClass Period;
c) whether the Individual Defendants caused AIPC to issue false and misleadingfinancial statements during the Class Period;
d) whether Defendants acted knowingly or recklessly in issuing false andmisleading financial statements;
e) whether the market prices of AIPC securities during the Class Period wereartificially inflated because of the conduct complained of herein; and
f) whether the members of the Class have sustained damages and, if so, what isthe proper measure of damages.
219. Lead Plaintiffs claims are typical of the claims of the members of the Class as Lead
Plaintiff and members of the Class sustained damages arising out of Defendants' wrongful conduct
in violation of federal law as complained of herein.
220. Lead Plaintiff will fairly and adequately protect the interests of the members of the
Class and has retained counsel competent and experienced in class actions and securities litigation.
Lead Plaintiff has no interests antagonistic to or in conflict with those of the Class.
221. A class action is superior to other available methods for the fair and efficient
adjudication of the controversy since joinder of all members of the Class is impracticable.
Furthermore, because the damages suffered by the individual Class members may be relatively small,
the expense and burden of individual litigation makes it impracticable for the Class members
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individually to redress the wrongs done to them. There will be no difficulty in the management of
this action as a class action.
222. Lead Plaintiff will rely, in part , upon the presumption of reliance established by the
fraud-on-the-market doctrine in that:
a) Defendants made public misrepresentations or failed to disclose material factsduring the Class Period;
b) the omissions and/or misrepresentations were material;
c) the securities of the Company traded in an efficient market for the followingreasons:
(1) AIPC stock met the requirements for listing, and was listed andactively traded on the NYSE, a highly efficient market;
(2) As a regulated issuer, AIPC filed periodic public reports with the SECand the NYSE;
(3) AIPC regularly communicated with public investors via establishedmarket communication mechanisms , including through regulardisseminations of press releases on the national circuits of majornewswire services and through other wide-ranging public disclosures,such as communications with the financial press and other similarreporting services; and
(4) AIPC was followed by several securities analysts employed by majorbrokerage firms who wrote reports which were distributed to the salesforce and certain customers of their respective brokerage firms. Eachof these reports was publicly available and entered the publicmarketplace;
(5) AIPC call options traded in direct relationship to the price of itscommon stock.
d) the misrepresentations and omissions alleged would tend to induce areasonable investor to misjudge the value of the Company's securities; and
e) Lead Plaintiff and members of the Class purchased their AIPC stock and calloptions between the time the defendants failed to disclose or misrepresentedmaterial facts and the time the true facts were disclosed, without knowledgeof the omitted or misrepresented facts.
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223. Based upon the foregoing, Lead Plaintiff and the members of the Class are entitled
to a presumption of reliance upon the integrity of the market.
CLASS CLAIMS FOR RELIEF
CLASS COUNT I
VIOLATION OF §10(b) OF THE EXCHANGE ACT AGAINSTAIPC AND THE CORPORATE OFFICER DEFENDANTS
224. Lead Plaintiff repeats and realleges each and every allegation contained in the fore-
going paragraphs as if fully set forth herein.
225. This Count is asserted against Defendant AIPC and the Corporate Officer Defendants
(Webster, Schmidgall, Shadid, George, Schroeder, Potter and Dear) for violations of § 10(b) of the
Exchange Act, 15 U.S.C. §78j(b), and Rule I Ob-5 promulgated thereunder by the SEC.
226. During the Class Period, all Defendants engaged in a plan, scheme, conspiracy and
course of conduct, pursuant to which they knowingly or recklessly engaged in acts, transactions,
practices and courses of business which operated as a fraud and deceit upon Lead Plaintiff and the
other members of the Class; made various untrue statements of material facts and omitted to state
material facts necessary in order to make the statements, in light of the circumstances under which
they were made, not misleading; and employed devices, schemes and artifices to defraud in
connection with the purchase and sale of securities.
227. The scheme was intended to, and , throughout the Class Period , did: (a) fraudulently
misrepresent APIC's financial results ; (b) artificially inflate and maintain the market price of AIPC
common stock; (c) enable Company insiders to sell AIPC common stock at artificially inflated prices;
(d) cause Lead Plaintiff and the other members of the Class to purchase AIPC common stock at
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artificially inflated prices; and (e) cause Lead Plaintiff and other members of the Class to sustain
losses as a result of the fraud.
228. The statements set forth in ¶¶ 109-195, were false and misleading statements for the
reasons set forth ¶¶ 44, 51-98, supra.
229. The Corporate Officer Defendants directly participated in the fraudulent scheme.
Defendants Webster and Schroeder routinely made statements reflected in AIPC' s press releases
regarding the Company's quarterly and annual financial results. Defendants Webster and Schmidgall
(and later Shadid) signed each of the quarterly Form 10-Q Reports and annual Form 10-K reports
filed with the SEC, and certified their compliance with § § 302 and 906 of the Sarbanes-Oxley Act.
All the Corporate Officer Defendants , by virtue of their positions and as participants in the "control
group" at AIPC, participated in "making" the false and misleading statements under the "group
publication doctrine." As such, each of these Defendants violated Rule 1Ob-5(b) by making
materially misleading statements.
230. In addition, each of the Corporate Officer Defendants engaged in fraudulent acts
intended to enable AIPC to report inflated earnings , including but not limited to instructing personnel
to improperly (1) capitalize overhead and construction related costs; (2) engage in repackaging and
burying in warehouses excess inventory in order avoid writing it off; (3) defer recognition of
marketing promotion allowances; (4) prematurely recognizing revenues, and other fraudulent acts
set forth above. Each of the Corporate Officer defendants thereby violated Rule lOb-5(a) by
engaging in an "artifice to defraud"; and Rule I Ob-5(c) by engaging in a "course of business which
operates as a fraud or deceit upon any person."
231. AIPC and the Corporate Officer Defendants had actual knowledge ofthe facts making
the material statements false and misleading when made, or acted with reckless disregard for the truth
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in that they failed to ascertain and to disclose such facts, even though same were available to them
as set forth in 11100-108, supra. In addition:
As officers and controlling persons of a publicly held company whose common stock
is registered with the SEC under the Exchange Act and traded on the NYSE, the Corporate Officer
Defendants had a duty to promptly disseminate accurate and truthful information with respect to the
Company's operations, finances, financial conditions, and present and future business prospects, to
correct any previously issued statement from any source that had become untrue, and to disclose any
trends that would materially affect earnings and the present and future operating results of AIPC, so
that the market price of the Company's publicly traded securities would be based upon truthful and
accurate information.
b. During the Class Period, the Corporate Officer Defendants were senior executives and
directors of AIPC and were thereby privy to confidential and proprietary information concerning
AIPC, its operations, finances, financial condition, products, and present and future business
prospects via internal corporate documents, conversations and connections with other corporate
officers and employees, attendance at management and Board of Directors meetings and committees
thereof, and via reports and other information provided to them in connection therewith.
The Corporate Officer Defendants were personally motivated to make false statements
and omit material information necessary to make the statements not misleading in order to personally
benefit via the sale of nearly $10 million of AIPC common stock from their own portfolios.
232. In ignorance ofthe adverse facts concerning AIPC's business operations and earnings,
and in reliance on the integrity of the market, Lead Plaintiff and the members of the Class acquired
AIPC common stock and call options at artificially inflated prices and were damaged thereby.
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233, Had Lead Plaintiff and the members of the Class known of the materially adverse
information not disclosed by the Corporate Officer Defendants, they would not have purchased AIPC
common stock at all, or not at the inflated prices paid.
234. By virtue of the foregoing, AIPC and the Corporate Officer Defendants have violated
§ 10(b) of the Exchange Act and Rule 1 Ob-5 promulgated thereunder.
CLASS COUNT II
VIOLATION OF § 10(b) OF THE EXCHANGE ACTAGAINST THE AUDIT COMMITTEE DEFENDANTS
235. Lead Plaintiff repeats and realleges each and every allegation contained in the fore-
going paragraphs as if fully set forth herein.
236. This Count is asserted against the Audit Committee Defendants (Patterson, Heeter and
Baum) for violations of § 10(b) ofthe Exchange Act, 15 U.S.C. §78j(b), and Rule IOb-5 promulgated
thereunder by the SEC.
237. The Audit Committee members signed each of AIPC's Form 10-K's for fiscal years
2002-04, and are therefore liable for the misleading statements contained therein, as set forth in the
foregoing paragraphs.
238. As AIPC Audit Committee members , these defendants had a heightened duty of care
which they knowingly and/or with reckless indifference failed to exercise. This heightened duty is
set forth, in part by § 301 ofthe Sarbanes-Oxley Act, which requires , inter alia, that audit committees
be directly responsible for the appointment, compensation, and oversight ofthe work ofauditors, and
requires auditors to report directly to the audit committee . Pursuant to Sarbanes-Oxley, the purpose
of the audit committee is to oversee the accounting and financial reporting processes of the company
and audits of its financial statements.
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239. These heightened standards were reinforced by the Charter for AIPC's Audit
Committee (adopted in 2003), which provided, in pertinent part, as follows:
AIPC CORPORATION AUDIT COMMITTEE CHARTER
Membership
The committee will have three members, each of whom will meet the independencestandards of the NYSE and the Sarbanes-Oxley Act of 2002. Committee memberswill be financially literate and their backgrounds will include at least one of thefollowing key qualities:
- industry knowledge- financial reporting or auditing background- experience in business risk management- experience as an audit committee member with a publicly held company
At least one member of the committee will be an "audit committee financial expert", asdesignated by the Board of Directors.
Responsibilities, Powers and Duties
It will be the committee's responsibility to:
Assess auditors' performance and performance of the lead auditor;
The committee shall meet as it deems necessary to carry out its responsibilities, butat minimum shall meet as follows. One meeting shall be heldprior to commencementofexternal audit to discuss key business, financial and regulatory risk as well as thescope ofthe audit examination. Another meeting shall be held after completion oftheaudit examination, to review results ofthe audit. In addition, there shall be quarterlymeetings to review and discuss the following with management and the auditors: 1)financial statements, including MD & A, 2) earnings releases, 3) financial informationand guidance provided to analysts, and 4) results of the auditors' quarterly review,including GAAP alternatives preferred by the auditors (if any), and other issues thatarose during the audit. At least twice annually, the committee will meet with theauditors without management to facilitate open auditor communication.
Periodically receive and evaluate reports from senior management on processes foridentification and control of key business, financial and regulatory risks.
Periodically meet separately with management, with personnel responsible for theinternal audit function, and with the independent auditors.
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Monitor the procedures for insuring the integrity and quality ofannual and interimreporting to stakeholders.
Review and approve significant new or changed accounting and reporting practicesand policies.
Ensure that adequate procedures are in place to ensure the appropriate receipt,retention and treatment of complaints regarding accounting, internal accountingcontrols and auditing matters and the confidential, anonymous submission byemployees ofconcerns regarding accounting, auditing, and business ethics matters.
General
The committee will have access to the auditors and members of management as needed todischarge its responsibilities....
The committee will work with management to establish an Internal Audit functionand will receive annually from management an evaluation of the Company's InternalAudit function. Additionally the committee will receive annually from managementand external auditors an assessment of the effectiveness of internal controls relatedto financial reporting.
The committee will have the power to conduct or authorize investigations into anymatters within the committee's scope ofresponsibilities. The committee is empoweredto retain independent counsel, accountants, or others to assist in the conduct of anyinvestigation. (Emphasis Supplied).
240. Defendant Patterson was the financial expert on the Audit Committee, as defined by
§ 407 of the Sarbanes-Oxley Act . Defendant Patterson had a thorough understanding of GAAP and
experience in the preparation and auditing of financial statements , as a partner at Arthur Andersen
for almost 20 years. The other members were equally qualified to handle their responsibilities and
to appreciate the flaws in AIPC's internal controls and financial reporting by virtue of their
fulfillment of the criteria for membership on the committee.
241. The Audit Committee Defendants were continually debriefed by the Corporate Officer
Defendants and Defendant Ernst regarding AIPC' s operations , controls and results. They were
knowledgeable about the trends in the industry, and the pressure to meet analyst expectations, and,
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given their access to information and personal financial backgrounds, were in a position to realize,
among other things, that AIPC had not timely recognized the impairment of its brand name asset
values and that controls over the accounting for promotional allowances and capitalized items were
woefully inadequate and were being manipulated by the "bottom line" oriented by the Corporate
Officer Defendants.
242. For reasons stated above and in ¶¶ 104(a)-(d), the Audit Committee Defendants acted
with knowledge or reckless indifference to the truth in signing AIPC' s Form 10-K ' s which contained
the false and misleading statements set forth above. They are therefore liable for violations of § 10(b)
of the Exchange Act and Rule I Ob-5, to Lead Plaintiff and class members.
CLASS COUNT III
VIOLATION OF § 20(a) OF THE EXCHANGEACT AGAINST THE CORPORATE OFFICERAND AUDIT COMMITTEE DEFENDANTS
243. Lead Plaintiff repeats and realleges each and every allegation contained in the
paragraphs above as if fully set forth herein.
244. This count is asserted against the Corporate Officer Defendants and the Audit
Committee Defendants (collectively, the "Individual Defendants") for violations of §20(a) of the
Exchange Act.
245. The Individual Defendants, by virtue of their corporate offices, positions as Chairman
of the Board, members of the Audit Committee, and specific acts were, at the time of the wrongs
alleged herein , controlling persons of AIPC within the meaning of § 20(a) of the 1934 Act. The
Individual Defendants had the power and influence and exercised the same to cause AIPC to engage
in the illegal conduct and practices complained ofherein by causing the Company to disseminate the
false and misleading information referred to above.
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246. By virtue of the conduct alleged herein, the Individual Defendants are liable for the
aforesaid wrongful conduct and are liable to Lead Plaintiff and the Class for damages suffered.
CLASS COUNT IV
VIOLATIONS OF § 10(b) OF THE EXCHANGE ACTAND RULE 10b-5 PROMULGATED THEREUNDER
AGAINST ERNST & YOUNG
247. Lead Plaintiff incorporates by reference all of the foregoing paragraphs as ifrealleged
herein.
248. Defendant Ernst served as AIPC' s independent auditor throughout the Class Period.
In that capacity, it performed audits of AIPC's books, records, and financial statements for the
periods 2002, 2003, and 2004. Following such audits, Defendant Ernst issued opinion letters stating
that its audits of AIPC's financial statements had been conducted in conformance with GAAS, and
that the financial statements conformed with GAAP.
249. Such opinion letters attesting to Ernst's performance ofits audits in conformance with
GAAS, and AIPC's financial statements conformance with GAAP, were materially false and
misleading . As noted above, AIPC:
a. improperly capitalized costs that clearly should have been expensed;
b. failed to write off or reserve for excess inventory;
c. prematurely recognized revenue;
d. failed to properly accrue material amounts of marketing promotional costs, and failedto write off as uncollectible significant amounts due from certain customers forpromotion allowance related payments; and
e. failed to timely charge off asset values of several name brands acquired by theCompany.
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As a result of the foregoing, AIPC's revenues were materially overstated; expenses were materially
understated, and earnings were materially overstated. Indeed, the Company has admitted that it will
have to restate each of the annual reports certified as GAAP compliant by Defendant Ernst during
the Class Period.
250. Defendant Ernst acted with knowledge and/or reckless indifference to the falsity of
AIPC's annual reports:
a. The Ernst audit team for the AIPC account were from the Kansas City, Missouri office
of Ernst & Young. The audit team was led by Managing partner, Steve Clifford and audit manager,
Brenda Stasiulis. Starting at least as early as September 2002, the whistle blower sent a series of
letters to the foregoing audit team members (as well as Area Managing Partner, Jo Marie Dancik and
James Hassett, Ernst's Global Vice Chairman in the Assurance & Advisory Business Services
Department) detailing numerous instances ofimproper accounting for, among other things, marketing
promotions (10/11/02); premature recognition of revenue (7/16/04); inventory (1/8/04; 5/26/04;
6/23/04; 7/16/04; 7/21/04; 8/3/04; 8/6/04; 10/4/04; 10/26/04); impairment ofbrand name asset values
(1/8/04;7/26/04; 8/3/04; 11/9/04; 11/30/04; 1/19/05); and improper capitalization of overhead
(4/15/03 ; 7/12/04 ; 11/30/04). In addition , these letters identified Company and other personnel who
were knowledgeable about these improper accounting practices, including Sheri Lauber,
b. Despite such detailed information and identification of potential informants,
Defendant Ernst knowingly and/or recklessly failed to appropriately increase the degree of scrutiny
of AIPC' s books and records, as it was obligated to do under GAAS.
c. Such auditing standards have been established by the American Institute of Certified
Public Accountants (AICPA), ofwhich Defendant Ernst is a member. The standards set the minimum
level ofperformance and quality that auditors are expected, by their clients and the public, to achieve.
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Under GAAS, the auditor has a responsibility to plan and perform the audit to obtain reasonable
assurance that the financial statements are free of material misstatement , whether caused by error or
fraud,
d. According to Statement of Auditing Standards (SAS) No, 1 (effective November
1972);
When the auditor becomes aware of information which relates to financial statementspreviously reported on by him, but which was not known to him on the date of hisreport, which is of such a nature and from such a source that he would haveinvestigated it had it come to his attention during the course of his audit, he should,as soon as practicable, undertake to determine whether the information is reliable andwhether the facts existed at the date of his report. In this connection, the auditorshould discuss the matter with his client at whatever managements levels he deemsappropriate, including the board of directors, and request cooperation in whateverinvestigation may be necessary.
e. Subsequently, for audits for periods beginning on or after January 1, 1989, GAAS was
amended by SAS No. 90 to further clarify regarding matters to be communicated with audit
committees, including:
(1) The auditor should determine that the audit committee is informedabout the initial selection of and changes in significant accounting policies ortheir application.
(2) The auditor should determine that the audit committee is informedabout the process used by management in formulating particularly sensitiveaccounting estimates and about the basis for the auditor's conclusionsregarding the reasonableness of those estimates.
(3) In connection with SEC engagement , the auditor should discuss withthe audit committee the auditor ' s judgments about the quality, not just theacceptability of the entity's accounting principles as applied in its financialreporting .... The discussion should be open and frank and generally shouldinclude such matters as the consistency of the entity's accounting policies andtheir application, and the clarity and completeness of the entity ' s financialstatements , which include related disclosures. The discussion should alsoinclude items that have a significant impact on the representationalfaithfulness , verifiability , and neutrality of the accounting informationincluded in the financial statements . (AU §380. 06-.11)
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f. Further Ernst should have been aware of the AICPA's recent work to establish
standards and provide guidance to auditors in fulfilling their responsibility as it relates to fraud in an
audit of financial statements conducted in accordance with GAAS;
( 1) In 1997 the Auditing Standards Board of the AICPA issued SAS No.82, "Consideration of Fraud in a Financial Statement Audit," with anobjective of enhancing auditor performance by providing auditors withadditional operational guidance on the consideration of material fraud in afinancial statement audit.
(2) In 1998, at the request of the SEC, the Public Oversight Boardappointed a Panel on Audit Effectiveness to examine the current audit model,including the way independent audits are performed regarding the auditor'sconsideration of fraud.
(3) Since the issuance ofSAS No. 82, the International Auditing PracticesCommittee (IAPC) of the International Federation of Accountants examinedthe auditor's responsibility to consider fraud and error, resulting in theissuance of a revised International Standard on Auditing (ISA 240) in thespring of 2001.
g. Furthermore, Ernst, beginning with their work on the AIPC audit for the fiscal year
ended September 27, 2002, would have been aware that the AICPA had published on February 28,
2002, an "Exposure Draft" for a proposed statement on auditing standards: "Consideration of Fraud
in a Financial Statement Audit," which was all part of a broader AICPA program to address the
growing concerns about fraudulent financial reporting. The requirements and guidance provided in
the Exposure Draft, if adopted, would result in an increased focus on professional skepticism during
an independent auditor's work. For example, the Exposure Draft recommended;
A requirement for the auditor to perform specified substantive tests, primarily inresponse to a risk of management override of controls that cannot easily be addressedthrough reliance on traditional controls. The auditing procedures proposed to addressthe risk of management override would include reviewing accounting estimates forbias, including a retrospective review of significant management estimates.
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h. The Exposure Draft also included a draft of a statement on auditing standards which
was to supersede previous standards . In October 2002, the AICPA issued SAS No. 99,
"Consideration of Fraud in a Financial Statement Audit," effective for audits of financial statements
for periods beginning on or after December 15, 2002. Both the Exposure Draft and SAS No. 99
included language similar to what is found in SAS No. 99, ¶68:
The auditor's assessment ofthe risks ofmaterial misstatement due to fraud should beongoing throughout the audit. Conditions may be identified during fieldwork thatchange or support a judgment regarding the assessment of the risks, such as thefollowing:
Discrepancies in the accounting records, including:
Tips or complaints to the auditor about alleged fraud . [Emphasis Supplied]
SAS No. 99, ¶79, states:
Whenever the auditor has determined that there is evidence that fraud may exist, thatmatter should be brought to the attention of an appropriate level of management....Fraud involving senior management and fraud (whether caused by senior managementor other employees) that causes a material misstatement of the financial statementsshould be reported directly to the audit committee.
i. Had Defendant Ernst taken the appropriate and necessary audit measures mandated
by GAAS, it would have detected AIPC' s improper accounting at the outset of the Class Period.
Indeed, as evident from the fact that AIPC is going to restate its annual financial reports for 2002-04,
all of the facts evidencing the fraud were "knowable" at the time those statements were issued. See
ABP Opinion No. 20.
By way of example, despite being given ample evidence of the significant erosion of
sales of brand name pastas acquired by AIPC (particularly Golden Grain) as early as January 2004,
it was not until the Audit Committee commenced its investigation in mid-2005 that AIPC finally
recognized the impaired nature of the brand name assets. This was despite red flags raised by the
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whistle blower, as well as independent data regarding super market sales of these brand name items
that was available from A.C. Nielsen's Weekly Scanner Data Reports. See ¶¶ 61-75, supra.
k. Defendant Ernst also recklessly ignored another red flag, AIPC's own production and
inventory management policy, which effectively required the Company to risk the build up of excess
inventory with the knowledge that it might not be ordered or accepted by customers, and therefore
would need to be written off. That policy, as set forth in the Company fiscal 2002 Annual Report, was
as follows:
We must manage our production and inventory levels in order to operate costeffectively.
Most of our customers use, to some extent, inventory management systems that tracksales of particular products and rely on reorders being rapidly filled by suppliers tomeet consumer demand rather than on large inventories being maintained by retailers.Although these systems reduce a retailer's investment in inventory, they increasepressure on suppliers like us to fill orders promptly and thereby shift a portion of theretailer's inventory management cost to the supplier. This results in our carrying extrainventory to meet customers demands. Our production of excess inventory to meetanticipated retailer demand could result in markdowns and increased inventorycarrying costs. In addition, if we underestimate the demand for our products, we maybe unable to provide adequate supplies of pasta products to retailers in a timelyfashion, and may consequently lose sales.
251. As a result of this policy, as noted above, at least by the end of 2003, AIPC's
inventory had bloated to 80 days worth of product, compared to the industry norm of 40 days.
Defendant Ernst was specifically alerted to this fact by the whistle blower's letter dated October 4,
2004.
252, Defendant Ernst failed to appropriately increase its audit scope, because to do so
would have required it either to charge significantly more audit fees, or to absorb the extra costs itself
lest AIPC decide to utilize a different auditing firm. Defendant Ernst's auditing fees for the work
performed for AIPC were relatively small, only about $300 ,000 per year . However, the account was
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very profitable for Ernst because it was able to charge AIPC 3-4 times that amount in "tax consulting
services" whose margins were far higher for the firm than ordinary auditing services.
DERIVATIVE CLAIMS
SUMMATION OF DERIVATIVE CLAIMS
253. These shareholder Derivative Claims are brought by the Derivative Plaintiffs on behalf
of AIPC against the Individual Derivative Defendants for violations of their fiduciary duties to
AIPC. During the Class Period, the Individual Derivative Defendants grossly mismanaged AIPC's
business and finances ; misrepresented AIPC's financial condition and the state of its internal
financial controls ; manipulated AIPC's reported financial results ; failed to establish adequate
financial controls; and as a result intentionally, recklessly and or negligently exposed AIPC to
potential liability to its shareholders for hundreds of millions of dollars. The Derivative Defendants
also awarded bonuses to themselves and to other senior executives based on these false financial
results and, even after it was determined that the results would be restated, took no action to recoup
any of them. Many Individual Derivative Defendants also profited from their own wrongdoing by
selling over 320,000 shares of AIPC stock at prices that were inflated by the false financial
information that these same Defendants had disseminated to the market.
254. The Individual Derivative Defendants concealed their misconduct from the market
until August 9, 2005, when AIPC publicly disclosed that its publicly reported financial results for
2002-2004, and for the first two quarters of 2005, could no longer be relied upon and would have to
be restated, and that the Company lacked sufficient internal controls to assure that the Company
reported accurate financial results.
255. One week later, on August 16, 2005 AIPC filed an 8-K with the SEC disclosing that
the its board had, on February 2, 2005, approved new indemnification agreements substantially
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strengthening and expanding Board member's rights, and the rights of various senior executives, to
indemnification for claims that might be asserted against them in their official capacities as officers
and/or directors of the Company . They did this knowing full well that a massive financial fraud was
about to be revealed which would subject them all to an avalanche of investor claims, both direct and
derivative in nature. This attempt to protect themselves from the consequences of their own
wrongdoing was an unfair self-dealing transaction and is void as a matter of law.
256. Moreover, knowing full well that disclosure, the writedowns and other changes
necessitated by their prior misconduct would cause AIPC's stock price to collapse, Derivative
Defendants Schroeder and Webster unloaded $4.5 million of their AIPC stock holdings within two
days of the adoption of these enhanced indemnification provisions.
257. This action also asserts claims for professional malpractice against Derivative
Defendant Ernst for certifying AIPC' s financial statements even though Ernst knew, or should have
known, that these statements were false and that AIPC 's financial controls were so inadequate that
it was impossible to determine what the Company's actual financial results had been. Not only did
Ernst not follow Generally Accepted Auditing Standards ("GAAS"), as it was required to do, in
auditing those financial statements, it actually received information from a whistle blower concerning
these accounting manipulations, which Ernst chose to ignore. Ernst knew, or should have known,
that, contrary to their certifications, those financial statements did not fairly present the financial
condition and results of AIPC in accordance with Generally Accepted Accounting Principles
("GAAP").
258. Ernst' s independence as an auditor and "gate keeper" of AIPC was further
compromised by its fee structure with the Company under which Ernst was paid a relatively small
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amount of "auditing fees," but earned 3-4 times that amount in additional consulting services the
firm provided to AIPC.
DEMAND WOULD BE FUTILE
259. Derivative Plaintiffs have not made a demand on AIPC's Board of Directors to bring
these causes of action because such a demand would be futile. At the time these derivative actions
were commenced, the Board of Directors consisted of eleven members : Webster (the CEO);
Schroeder (the Chairman); Baum , Patterson and Heeter (the three members ofthe Audit Committee);
Niehaus and Demetree (members of the Compensation Committee), Thompson, Terence O'Brien,
John O'Brien and Pollak. As detailed below, each ofthe directors are subject to substantial liability
on these derivative claims and are therefore in no position to render a disinterested judgment on
whether the Company should bring them, and/or lack sufficient independence with which to render
a disinterested decision on whether to pursue the Derivative Claims against the Derivative
Defendants.
260. All of these directors face a substantial likelihood of liability in this action because
of their failure, as directors, to assure that a reliable system of financial controls was in place and
functioning effectively. The dramatic breakdowns and gaps in those controls were so systemic that
the entire board faces substantial exposure to liability, under the Caremark doctrine, for the total
abrogation of their duty of oversight. These directors either knew or should have known that
violations of law were occurring and took no steps in a good faith effort to prevent or remedy that
situation, proximately causing hundreds of millions of dollars of losses for the Company.
Additional Likelihood of Substantial Liability for Directors Schroeder and Webster
261. In their respective roles as Chairman and CEO of AIPC, Defendants Schroeder and
Webster made many of the false statements themselves, and had direct responsibility for the
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Company's financial reports and controls. Moreover, as alleged in ¶ 101(a)-(e), 103(a)-(b) above,
they either knew or recklessly ignored facts indicating that the financial reports were misleading and
that the financial controls were inadequate.
262. Moreover, as CEO , Derivative Defendant Webster was required by §§302 and 906
of the Sarbanes-Oxley Act to certify in each AIPC annual or quarterly report that he had reviewed
the financial statments; that, based on his knowledge, the reports did not contain any untrue statement
of a material fact or omit any material fact; that the reports fairly present the financial condition and
results of AIPC 's operations ; that he had designed such internal controls to ensure that material
information was made known to him; that he evaluated the effectiveness of the Company 's internal
controls; that he had presented conclusions about the effectiveness ofthose internal controls; and that
all of the financial statements fairly presented in all material aspects the financial condition of the
Company. Thus, §§302 and 906 required Derivative Defendant Webster to be personally involved
in assuring the accuracy of AIPC's financial reports.
263. Derivative Defendant Webster executed such certifications during the Class Period.
Webster signed these certifications either knowing that they were false or without conducting the
appropriate examination that the Sarbanes-Oxley Act requires of him . In either case, his conduct
constituted a violation of the duty of care.
264. In addition , during the relevant period Webster sold 111,000 shares of AIPC stock,
for proceeds of close to $3 million , and Schroeder sold 62 , 500 shares of AIPC stock, for proceeds
of over $1.6 million. These sales were made at inflated prices based on non-public information, and
enabled these two defendants to profit personally from their own misconduct.
265. Such conduct is not protected by the business judgment rule and, accordingly,
Schroeder and Webster face a substantial prospect of liability on these claims.
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Additional Likelihood of Substantial Liability of the Audit Committee Defendants
266. Derivative Defendants Baum , Patterson and Heeter also had enhanced responsibilities
as members of the Company's Audit Committee. As alleged in ¶¶ 238-239 above, that Committee
was charged by §301 of the Sarbanes-Oxley Act with direct responsibility for the appointment,
compensation and oversight of the work of Ernst as outside auditors . The Audit Committee Charter
imposed a detailed set of responsibilities and powers in connection with financial reporting and
financial controls. Defendant Patterson , as a former partner in the accounting firm of Arthur
Andersen LLP, was the chairman of the Committee and was a "financial expert" as required by § 307
of the Sarbanes-Oxley Act. As a person of special knowledge and talents , Patterson had particular
responsibility to prevent and ferret out fraud and inadequate financial controls at the Company.
267. Given the size, scope, and blatancy of the accounting violations and misrepresenta-
tions described above, the Audit Committee members either knew of the financial manipulations or
turned a blind eye to them. Such conduct is also not protected by the business judgment rule and
exposes these three Individual Defendants to substantial threat of liability in this action.
268. Defendant Baum also carries additional exposure for his actions as a member of the
Compensation Committee.
269. Together, Defendants Schroeder, Webster, Patterson, Baum and Heeter constitute a
substantial portion of the board of directors. Moreover, they are all defendants on the Class Claims
and therefore have an inherent conflict of interest in deciding whether to pursue related causes of
action against themselves on behalf of the Company, because prosecution of such claims could
establish their own liability on the class action claims as well . In addition, should they decide to
bring claims against themselves, that would likely trigger an "insured vs. insured" exclusion which
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is typical for Director and Officer ("D&O") insurance policies , which would make D&O insurance
coverage unavailable to them.
Additional Likelihood of Substantial Liability of Other Board Members
270. The other Derivative Defendant directors (Demetree, Niehaus, Terence O'Brien, John
O'Brien and Thompson) are also exposed to substantial potential liability in this action because of
their complete failure to put appropriate financial and legal compliance controls in place to assure
the accuracy of financial information disclosed by the Company to the public.
271. In addition, Defendants Niehaus and Demetree (along with Baum) are further exposed
to liability because of their membership on the Compensation Committee. In those positions, they
approved compensation plans for senior executives and directors, pursuant to which millions of
dollars were paid out by the Company based on financial results that have now turned out be grossly
inflated . They have nonetheless failed to take any steps to recover any of these illegal and improper
bonus and incentive compensation payments, even though, in the case of the Defendants Webster,
Schmidgall and Shadid, as CEO and CFOs of the Company, they were required to recover such
payments pursuant to § 304 of the Sarbanes-Oxley Act.
272. Finally, during the relevant period, Derivative Defendant Demetree sold 11,500 shares
of AIPC stock at prices inflated by the fraudulent financial reports, reaping a total personal financial
benefit from these violations in the amount of $588,909.
Derivative Defendants Heeter, Thompson and Baum Otherwise Lack Independence
273. In addition to his potential exposure in this litigation , Defendant Heeter is not in a
position to render an impartial decision on the prosecution of this action because of his financial
relationship to management. Defendant Heeter, an attorney, has been managing partner of the
Kansas City, Missouri office of the law firm, Sonnenschein Nath & Rosenthal ("SNR"), which has
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served as AIPC's general counsel since its inception. SNR represented the Company in connection
with its initial public offering ofcommon stock, major asset-based bank financings, long-term supply
contracts and major plant expansions. These services have generated significant revenues for
Defendant Heeter's firm, and renders him an interested director. He is beholden to management for
this lucrative financial relationship and would be unwilling to jeopardize it by bringing this action.
SNR also closely interfaced with Defendant Ernst and the Company concerning audit and disclosure
issues that are now at the center of this action. It is highly unlikely the Defendant Heeter would
authorize any action be taken against his law firm nor his law partners.
274. Defendant Baum also has lucrative financial relationships with the Company that he
would not be willing to jeopardize by bringing this action. He is Chairman and CEO of George K.
Baum Company, an investment banking firm. Since 1994, AIPC has paid substantial fees to George
K. Baum & Company's Investment Banking Division for investment banking and financial advisory
services , and has paid the Professional Investment Advisors Division of that firm substantial fees for
investment advice provided with respect to the AIPC 401(k) Plan . He is therefore beholden to
management for this lucrative financial relationship and would be unwilling to jeopardize it by
bringing this action.
275. In addition, Defendants Baum and Thompson are members of an investment group
with Defendants Schroeder, Webster and Potter, which further vitiates their independence. These
five individuals, together with Morgan Stanley, Citicorp, and other AIPC stockholders, have formed
a stockholder group . They have agreed amongst themselves , inter alia, that Morgan Stanley will have
the right to designate a board member and that all members vote jointly for director nominees
selected by the group.
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276. Derivative Defendant Thompson's company, Thompson's Nutritional Technologies,
Inc., purchases milling products from the Company, a fact which further undermines his
independence.
DERIVATIVE COUNT I
Against the Individual Derivative Defendants For Breach of Fiduciary Duties
277. Derivative Plaintiffs incorporate by reference all of the foregoing paragraphs.
278. Under applicable Delaware law, the Individual Derivative Defendants had fiduciary
duties to the Company of care, loyalty, candor and good faith. All of these Defendants violated these
duties because they knew, or recklessly disregarded, facts demonstrating that the financial
information being disseminated by the Company was false and misleading . They were all in a
position to control the contents of the Company's financial reports and other financial disclosures;
but they all either created these false reports themselves or failed to take steps to correct them. The
Director Defendants also failed in their duty to take reasonable steps to monitor the conduct of
management, and to create systems of financial and legal compliance controls, to assure that the
financial statements were accurate and that the Company was complying with the federal securities
laws and other applicable laws and regulations.
279. Each of the Individual Derivative Defendants breached his fiduciary duty of loyalty
and care by misrepresenting the Company's financial condition, results, and adequacy of financial
controls and/or by failing to prevent others from doing so, as alleged above. Each of these
Defendants knew, or recklessly turned a blind eye to the fact that financial results were far worse than
the Company was publicly reporting and that financial controls were inadequate.
280. As a result ofthese Defendants ' breaches of fiduciary duties, the Company is now the
subject of the class action claims in this action alleging violations of the federal securities laws.
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AIPC has expended and will continue to expend significant amounts of money investigating and
defending itself in all of these proceedings, and may well be found liable to the class for hundreds
of millions of dollars in damages, plus financial penalties that may be imposed by the SEC.
281. As a result of their breaches of fiduciary duties, the Company has been damaged.
DERIVATIVE COUNT II
Against the Individual Derivative Defendants for Unjust Enrichment
281 Derivative Plaintiffs incorporate by reference paragraphs 1-276, above.
283. As a result ofthe conduct described above, all ofthe Individual Derivative Defendants
will be and have been unjustly enriched at the expense of AIPC in the form of unjustified salaries,
benefits, bonuses, stock options and other benefits, as well as profits from illegal insider stock sales.
284. In addition to the insider sales for other Individual Derivative Defendants referenced
above , set forth in paragraphs 253, 256, 264, 272, above, David Potter , Executive Vice President of
the Company, sold 104,080 shares of Company stock during the relevant period, at prices inflated
by the false financial information released by the Company, reaping total proceeds of $4,207,152;
Jerry H. Dear, another Company Executive Vice President, sold a total of 28,972 shares, reaping total
proceeds of $1,182,162; and Walter George, another Company Executive Vice-President reaped
$43,723 in insider sales during the Class Period . All three of these defendants , because of their
positions, knew the true facts but nonetheless participated in the preparation and dissemination ofthe
false financial reports.
DERIVATIVE COUNT III
Against Derivative Defendants Webster, Schmidgall and Shadid
285. Pursuant to § 304 of the Sarbanes-Oxley Act, where , as here, the issuer has been
forced to restate its financial results as a result of misconduct, AIPC's Chief Executive Officer
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(Defendant Webster) and the Chief Financial Officer (Defendant Shadid and Schmidgall) are required
to return to the Company any bonus or other incentive-based compensation received during the 12
months following publication of the misleading reports, and any profits realized from the sale of
securities of the issuer during that 12-month period. These Defendants have failed to disgorge these
ill-gotten gains, and the other directors of the Company have taken no action to require them to do
so.
286. As a result of their breaches of fiduciary duty, the Company has been damaged.
DERIVATIVE COUNT IV
Professional Negligence and Accounting Malpractice Against Defendant Ernst
287. Derivative Plaintiffs incorporate by reference paragraphs 1-276, above.
288. AIPC retained Defendants Ernst to review and opine on the accuracy of its annual
financial reports and also to review its quarterly reports. Defendant Ernst issued unqualified opinions
certifying the 2002-04 annual financial statements of AIPC, stating that such statements were
presented in accordance with GAAP based on Ernst's audits, which were performed in accordance
with GAAS . In fact, the audit reports were misleading due to, among other things , Ernst ' s failure to
conduct the audits in accordance with GAAS and the fact that AIPC's 2002-2004 financial statements
were not prepared in conformity with GAAP. Ernst ' s reports therefore violated GAAS, GAAP and
SEC rules.
289. Ernst was aware of, or should have been aware of, facts demonstrating that the
financial statements of AIPC did not conform with GAAP but were, in fact, materially misleading.
Ernst negligently certified the 2002-04 financial statements, and its unqualified opinions were
therefore false and misleading.
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290. In performing the auditing and accounting services to AIPC in the negligent manner
alleged herein, Ernst failed to use such skill, care and diligence as other members of its profession
commonly exercised.
291. AIPC relied to its detriment on Ernst and was damaged thereby. Ernst is liable for all
the fees it was paid by AIPC for the work it negligently performed, as well as all ofthe consequential
damages to the Company resulting therefrom.
DERIVATIVE COUNT V
Against Defendant Ernst for Aiding and Abettingthe Breaches of Duty by the Individual Defendants
292. Derivative Plaintiffs incorporate by reference paragraphs 1-276, above.
293. Defendant Ernst knew that the Individual Defendants were disseminating false and
misleading financial information to the public, through misleading financial statements and reports,
and that many of them were profiting personally by doing so. Nonetheless, Ernst certified those
reports and failed to take any action to correct them. In so doing, Ernst aided and abetted the
Individual Defendants' breaches of fiduciary duty, as alleged in Derivative Counts I, II and III.
PRAYERS FOR RELIEF
FOR CLASS CLAIMS
WHEREFORE, Lead Plaintiffdemands judgment against the Class Defendants with respect
to the Class Claims as follows:
A. Determining that the instant action may be maintained as a class action under Rule
23, Federal Rules of Civil Procedure, and certifying the Lead Plaintiff as the Class representative;
B. Requiring Defendants to pay damages sustained by Lead Plaintiff and the Class by
reason of the acts and transactions alleged herein;
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C. Awarding Lead Plaintiff and the other members of the Class prejudgment and post-
judgment interest, as well as their reasonable attorneys' fees, expert fees and other costs; and
D. Awarding such other and further relief as this Court may deem just and proper.
FOR DERIVATIVE CLAIMS
WHEREFORE the Derivative Plaintiffs, on behalf of AIPC, demand judgment against
Derivative Defendants as follows:
A. Declaring that this action was properly commenced and maintained as a derivative
class action and that the Derivative Plaintiffs are adequate representatives of AIPC;
B. Awarding money damages against all Derivative Defendants, jointly and severally,
for all losses and damages suffered by AIPC as a result of the acts and transactions complained of
herein, and preventing the Derivative Defendants from sharing in any benefits flowing to the
Company from such an award;
C. Directing all Derivative Defendants to account for all profits, salaries, bonuses,
contractual payments and all other benefits they received while perpetrating the misconduct alleged
herein;
D. Directing Derivative Defendants Webster, Schroeder, Shadid and Schmidgall to return
all profits, bonuses and other benefits they reaped in violation of Section 304 of the Sarbanes-Oxley
Act;
E. Voiding all indemnity rights issued pursuant to the June 2005 indemnity agreements;
F. Awarding the costs and disbursements of this action, including reasonable attorneys',
experts' and accountants' fees; and
G. Granting such other and further relief as the Court may deem just and proper.
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JURY DEMANDS
Pursuant to Rule 38 ofthe Federal Rules ofCivil Procedure and Western District ofMissouri
Rule 38.1 Lead Plaintiff demands a trial by jury for all Class Claims. Derivative Plaintiffs demand
a trial by jury of all causes of action so triable.
Dated: January 19, 2005POMERANTZ HAUDEK BLOCK
GROSSMAN & GROSS, LLP
By: s/sMarc I. Gross, Admitted Pro Hac ViceStanley M. GrossmanShaheen RushdFei-Lu Qian
100 Park Avenue, 26th FloorNew York, New York 10017(212) 661-1100migross(pomlaw.com
Patrick V. DahlstromLeigh Handelman Smollar , Admitted Pro HacVicePOMERANTZ HAUDEK BLOCK
GROSSMAN & GROSS, LLPOne North LaSalle Street , Suite 2225Chicago, IL 60602(312) 377-1181pdahlstromgpomlaw.comIsmol [email protected]
Cheryl H. MackellPOMERANTZ HAUDEK BLOCK
GROSSMAN & GROSS, LLP1025 Connecticut Ave. N.W.Washington , DC 20036(202) 327-5420chmackell@pomlaw. com
Kent T. Perry (W.D. Mo. #24312)Gregory M. Dennis (W.D. Mo. #40263)KENT T. PERRY & CO.
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7300 West 110`h Street, Suite 260Overland Park, KS 66210-2387(913) [email protected]
Lead Counsel and Attorneys for Iron WorkersLocal 40, 361 & 417 Union Security Funds andthe Class
William B. FedermanW. Todd Ver WeireFEDERMAN & SHERWOOD120 N. Robinson, Suite 2720Oklahoma City, OK 73102(405) 235-1560wfederman aol.comtvwnfedermanlaw.com
Attorneys for Rolf Fasth (Derivative)
Marc A. TopazRichard A. ManiskasSCHIFFRIN & BARROWAY, LLP280 King of Prussia Rd.Radnor , PA 19087T: (610) 667-7706F: (610) 667-7056mtopazc@ sbclasslaw.comrmaniskas@,sbclasslaw.com
Avi JosefsonBERNSTEIN LITOWITZ BERGER &
GROSSMAN LLP1285 Avenue of the AmericasNew York, NY 10019T: (212) 554-1400Avigb1b 1aw.com
Attorneys for Michael Stengle (Class)
Janet Ivey BlauveltSUMMERS & BLAUVELT, LC4510 Belleview , Suite 202Kansas City, MO 64111-3538
-86-
(816) 561-2100jhlauvelt c,summersblauvelt.com
Attorneys for International Brotherhood ofElectrical Workers Local 98 Pension Fund(Class)
Kenneth E. NelsonNELSON LAW FIRM, P.C.2900 City Center Square1100 Main StreetKansas City, MO 64105(816) [email protected]
Frederic S. FoxJoel B . StraussDonald R. HallJeffrey P. CampisiKAPLAN FOX & KILSHEIMER LLP805 Third Avenue, 22"d Fl.New York, NY 10022T: (212) 687-1980F; (212) [email protected]@kaplanfox.comdhall(kaplanfox.comj campisi nkaplanfox. com
Attorneys for George Clark (Class)
R. Frederick WaltersWALTERS BENDER STOHBEHN &
VAUGHN, PC1100 Main Street2500 City Center SquareP.O. Box 26188Kansas City, MO 64196(816) 421-6620fwalters a,wbsvlaw.com
Attorneys for New Jersey Building Laborers
and
The City of Tulsa, Oklahoma MunicipalEmployees Retirement Plan (Class)
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Leslie R. SternJoseph MerschmanBERMAN DEVALERIO PEASE TABACCO
BURT & PUCILOOne Liberty SquareBoston , MA 02109T: (617) 542-8300F: (617) 542-1194[stern ,bermanesq.comimerschman(abermanesq.com
Attorneys for Louisiana Teachers RetirementPension Fund (Class)
John J. MillerLAW OFFICE OF JOHN J. MILLER, PC4770 N. Belleview, Suite 202Kansas City, MO 64116(816) 413-9075millerlaw a,prodigy.net
Attorneys for Ronald Corallo and Rolf Fasth(Derivative)
Evan J. SmithMarc L. AckermanBRODSKY & SMITH, LLCTwo Bala Plaza , Suite 602Bala-Cynwyd, PA 19004(610) 667-6200esmithnbrodsky-smith.com
Attorneys for Ronald Corallo (Derivative)
George G. BarrettDouglas S. Johnston, Jr.Timothy L. MilesGerald E. MartinBARRETT, JOHNSTON & PARSLEY217 Second Avenue NorthNashville , TN 37201bgarrettnbarret :tjohnston.comdi ohnstonn barretti ohnston.comtmiles (a),barrettjohnston.commgartin cr,barrettiohnston.com
-88-
Attorneys for Michael Haag (Derivative)
Don R. Lolli, Esq.DYSART TAYLOR LAY COTTER
& MCMONIGLE, P.C.4420 Madison AvenueKansas City , MO 64111(816) [email protected]
Attorneys for Matt Brody ; Michael Stengle andThomas Mayer (Wayne Hummer GrowthFund) (Class)
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VERIFICATION
I, Ronald F. Corallo, declare that I have reviewed the Amended Complaint,
including the derivative sections, (the "Complaint") prepared on behalf of American
Italian Pasta Company (NYSE: PLS). and 1 authorize its filing. I have reviewed the
allegations made in the Complaint, and to those allegations of which I have personal
knowledge , I believe those allegations to be true. As to those allegations of which I do
not have personal knowledge , I rely on my counsel and their investigation and for that
reason believe them to be true . I further declare that I am a current holder , and have
been a holder, of American Italian Pasta Company common stock during the time
period in which the wrongful conduct alleged and complained of in the Complaint was
occurring.
Date signature of Ronald F. Corallo
?'.A 'qmCCasese 4:05-cv-00725-ODS Document 82-2 Filed 01/19/2006 Page 11 of 11hrlni FNTNfl 1T1 4IFTRRbT.bgT. RF:G1L'J q IR7/) T,Tr
I v., -I '
VERIFICATION
I, Rolf Fasth, declare that I have reviewed the Amended Complaint, including the
derivative sections, (the "Complaint") prepared on behalf of American Italian Pasta
Company (NYSE: PLLB), and I authorize its filing. I have reviewed the allegations made
in the Complaint, and to those allegations of which I have personal knowledge, I believe
those allegations to be true. As to those allegations of which I do not have personal
knowledge, I rely on my counsel and their investigation and for that reason believe them
to be true. I further declare that I am a current holder, and have been a holder, of
American Italian Pasta Company common stock during the time period in which the
wrongful conduct alleged and complained of in the Complaint was occurring.
ate Signature of o Fasth
UNITED STATES DISTRICT COURTWESTERN DISTRICT OF MISSOURI
ConsolidatedIN RE AMERICAN ITALIAN PASTA Civil Action No. 05-CV-0725-W-ODSCOMPANY SECURITIES LITIGATION
CERTIFICATE OF SERVICE
Elaine Goodman hereby certifies that:
I am employed with the firm of Pomerantz Haudek Block Grossman & Gross LLP in the Countyof New York, State of New York, and am over the age of 18 and not a party to the action; mybusiness address is 100 Park Avenue , New York, New York 10017.
On January 19, 2006 , I caused the AMENDED COMPLAINT FOR CLASS ANDDERIVATIVE CLAIMS and VERIFICATIONS to be served via electronic filing service with theabove-captioned Court, with notice of case activity to be generated and sent electronically by theClerk of said Court, and a copy of the filing served to the parties listed below:
By U.S. Mail, postage prepaid:
Mary K. Blasy655 West BroadwaySuite 1900San Diego , CA 92101
Kenneth I. SchacterBingham McCutchen LLP399 Park AvenueNew York, NY 10022
John Michael ClearOne Metropolitan Square211 N. Broadway, Suite 3600St. Louis, MO 63102
Via electronic transmission
Frederic S. FoxJoel B. StraussDonald R. HallJeffrey P. CampisiKAPLAN FOX & KILSHEIMER LLP805 Third Avenue, 22"d Fl.New York, NY 10022ffoxnkaplanfox.comj [email protected] carkaplanfox.com
Gerald H. SilkAvi JosefsonBERNSTEIN LITOWITZ BERGER & GROSSMAN LLP1285 Avenue of the AmericasNew York, NY 10019avi(u1blbglaw.comjerryic ,blbglaw.com
Marc A. TopazSCHIFFRIN & BARROWAY, LLP280 King of Prussia Rd.Radnor, PA [email protected]
Brian J. RobbinsROBBINS UMEDA & FINK, LLP610 West Ash Street , Suite 1800San Diego , CA [email protected]
Jonathan C. BungeKirkland & Ellis LLP200 E. Randolph DriveChicago, IL 60601jbungegkirkland.com
Pete ElliottBeresch, Friedlander, Coplan & Aronoff LLP2300 BP Tower
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200 Public SquareCleveland, OH 44114pelliott abfca.com
Jean P. Bradshaw, IILathrop & Gage2345 Grand Blvd., Suite 2800Kansas City, MO 64108jpbradshawglathropga eg com
Elaine
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