1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 ORIGINA L Kevin J . Yourman Vahn Alexander Jennifer R . Liakos WEISS & YOURMAN 10?40 Wilshire Boulevard 24 , Floor Los An eles CA 90024 Tel : (3 m ) 2d8-2800 Nadeem Faru q i Shane T . Rowley Antonio Vozzol o FARUQI &ARUQI, LLP 320 East 39 Stree t New York, NY 10016 Tel : (212 ) 983-933 0 Co-Lead Counsel for the Clas s William H . Stoddard G . Mark Alb ri gh t C . Adam Buc k A BRIGHI STODDARD , WARNICK 801 S . Rancho Driv e Quail Park Suite D-4 Las Veg as , NV 89106 Tel : (7 (T 2 ) 384-711 1 Liaison Counsel for the Class ~rC~LVED FILFI] "'"~ SERIF-~ ~ ~ ~p{ D NSElIPAR 4~ ES Of RECOR D AP B CLERK RI 1SiR CEPL1 ~ UNITED STATES DISTRICT COUR T DISTRICT OF NEVAD A In Re PURCHASEPRO .COM, IN C SECURITIES LITIGATIO N THIS DOCUMENT RELATES TO : Master File No . : CV-S-0I-0483-JLQ CLASS ACTIO N SECOND AMENDED CONSOLIDATED CLASS ACTION COMPLAINT Plaintiffs Demand A Trial By Turn 213
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ORIGINALKevin J . YourmanVahn AlexanderJennifer R. LiakosWEISS & YOURMAN10?40 Wilshire Boulevard24 , FloorLos An eles CA 90024Tel: (3 m ) 2d8-2800
Nadeem Faruq iShane T . RowleyAntonio Vozzol oFARUQI &ARUQI, LLP320 East 39 StreetNew York, NY 10016Tel: (212 ) 983-9330
Co-Lead Counselfor the Class
William H . StoddardG . Mark AlbrightC . Adam Buck
A BRIGHI STODDARD, WARNICK
801 S. Rancho DriveQuail Park Suite D-4Las Vegas , NV 89106Tel : (7 (T2) 384-711 1
Moskal and Anderson are collectively referred to in this Complaint as the
"PurchasePro Defendants" and were at all relevant times during the Class Period
controlling persons of PurchasePro within the meaning of §20(a) of the Exchange
Act. By reason of their stock ownership, management positions, and/or membership
on PurchasePro's Board, the PurchasePro Defendants were controlling persons o f
PurchasePro ar;d had the power and influence, and exercised the same, to cause it t o
engage in the it egal conduct complained of herein . The PurchasePro Defendants are
liable for the false statements pled herein, as those statements were each "group
published" infarmation, the result of the collective action of the PurchasePro
Defendants .
39 . A ; officers, directors and/or controlling persons of a Company
registered with the SEC under the federal securities laws, whose securities are traded
on the NASDAQ, and governed by the provisions of the federal securities laws, the
PurchasePro Defendants each had a duty to : disseminate truthful information
promptly and accurately with respect to the Company's operations, products,
markets, management, earnings and business prospects ; to correct any previously
issued statements that had become materially misleading or untrue ; and to disclose
any trends thc, :.t would materially affect earnings and the financial results of
PurchasePro, so that the market price of the Company's publicly traded securities
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I would be based upon truthful and accurate information .
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40. U,ider rules and regulations promulgated by the SEC under the
Exchange Act ; the PurchasePro Defendants also had a duty to report all trends,
demands or uncertainties that were likely to influence : (a) PurchasePro's liquidity ;
(b) PurchasePro's net sales, revenues and/or income ; and (c) previously reported
financial infori nation such that it would not be indicative of operating results . The
PurchasePro Defendants' representations during the Class Period violated these
specific requirements and obligations .
41 . The PurchasePro Defendants, because of their positions with th e
I Company, controlled and/or possessed the power and authority to control the
contents of ParchasePro's quarterly and annual reports, press releases and
presentations to securities analysts, which information was conveyed through th e
analysts to the =.nvesting public . Each of the PurchasePro Defendants was provided
with copies of the Company's reports and press releases alleged herein to be
misleading prier to or shortly after their issuance and had the ability and opportunity
to prevent their issuance or cause them to be corrected .
42 . In fact, these defendants have repeatedly admitted in numerous filings
with the SEC that they exercised control not only over the activities of the Company
but also over each other. For example, the Company stated in a document filed with
the SEC on or about March 7, 2000, that PurchasePro's directors and executive
officers as a group owned 23,778,399 shares or 18 .7% of the outstanding common
stock of the Company. As a result, these defendants were able to exercise significant
influence over r,ll matters requiring shareholder approval, including the election o f
directors and approval of significant corporate transactions .
43 . Because of their positions and. access to material non-public information
available to then but not to the public, each of the PurchasePro Defendants knew ,
or with conscious or deliberate recklessness disregarded, that the adverse facts
specified herein had not been disclosed to, and were being concealed from the
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public, and that the positive representations which were being made were the n
materially false and misleading .
44 . It is also appropriate to treat the PurchasePro Defendants as a group fo r
pleading purpoases under the federal securities laws, and the Federal Rules of Civil
Procedure , and to presume that the false and misleading information complained of
herein was disseminated through the collective actions of these defendants. The
PurchasePro Defendants were involved in the drafting, producing, reviewing, and/or
disseminating of the false and misleading information detailed herein, and knew, or
with conscious or deliberate recklessness disregarded, that such materially
misleading statements were being issued by the Company, and/or approved or
ratified these statements in violation of the federal securities laws . The PurchasePro
Defendants' false and misleading statements and omissions of fact consequently had
the effect of, both on their own and in the aggregate, artificially inflating the price
of the securities of PurchasePro at all times during the Class Period .
45 . Defendants AOL Time Warner, Inc ., and America On-Line, Inc . are
Delaware corporations with headquarters in New York, New York, and Dulles,
Virginia, respectively. AOL Time Warner, Inc . was formed in connection with the
merger of Time Warner, Inc ., and America On-Line, Inc ., on January 11, 2001 (the
"Merger") and is the successor in interest to all of the liabilities and wrongdoings o f
America On-Line, Inc., as is the current Time Warner, Inc . Prior to the Merger,
America On-Lne, Inc . was an independent publicly traded company, but after the
Merger it became a wholly owned subsidiary of AOL Time Warner, Inc. On
September 18, 2003 , the Board of Directors of AOL Time Warner, Inc . voted to drop
AOL from the AOL Time Warner, Inc . name , and on October 16, 2003 , AOL Time
Warner, Inc . was officially renamed and began operating as Time Warner, Inc .
46 . Defendant Robert W. Pittman ("Pittman") was AOL' s President and
Chief Operating Officer during the Class Period . By his own admission, he
reviewed and approved the sham transactions between PurchasePro and AOL which
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are the subject of this complaint . Moreover, Pittman made and/or controlled the
sham transactions and manipulations of PurchasePro's revenues as well as AOL's
public statements, including the joint statements of PurchasePro and AOL alleged
herein .
47 . Defendant David Colburn ("Colburn") was Senior Vice President o f
Business Affairs for AOL during the Class Period . He also reported directly to
defendant Pittman . Following the Merger, Colburn was named Executive Vice
President of Business Affairs and Development for AOL, and continued to report
directly to Pittman . Colburn was AOL's chief deal maker and was ultimately
terminated by AOL in mid-2002 when he was identified as the target of SEC and
DOJ investigations regarding certain transactions between AOL and PurchasePro .
Colburn not only structured, but also controlled and executed the fraudulent
transactions between AOL and PurchasePro alleged herein .
48 . Defendant Eric Keller ("Keller") was a Senior Executive Vice Presiden t
of Business Affairs at AOL during the Class Period and reported directly to
defendant Colburn. Following the Merger, Keller was named Executive Vice
President of Business Affairs and Development for AOL, and continued to report
directly to Colhurn . Keller was AOL's number two deal maker and is also under
investigation by the SEC and DOJ regarding certain transactions between AOL and
PurchasePro . In June of 2002, Keller was placed on administrative leave and then
ousted or fired two months later in August of 2002 . After Keller left AOL, Senior
AOL executive Ted Leonsis hired Keller as a consultant . Leonsis later ended his ties
with Keller on the advice of an AOL attorney . Keller and Colburn.j ointly structured,
controlled, and executed the fraudulent transactions between AOL and PurchasePro
which are alleged herein .
49 . Di:'fendant Myer Berlow ("Berlow") was Vice President for Nationa l
~ Accounts for 2!AOL during the Class Period and also became President of AOL' s
Interactive Marketing Division in the Business Affairs Department during that tim e
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frame . Follow,_ng the Merger , in August 2001, Berlow became President of Global
Marketing Solutions Group. In September, 2002, Berlow became a senior advise r
to AOL .
50. Defendants AOL, Pittman, Colburn, Keller and Berlow , i .e., the "AOL
Defendants," are each primarily liable as individual participants in a fraudulent
scheme and course of conduct that operated as a fraud and/or deceit upon the Class .
Because of the r access to the adverse, non-public information about the business,
finances and business prospects ofPurchasePro, and their ability to conspire with the
PurchasePro Defendants to effectuate the fraudulent transactions described herein,
these defendants acted to misrepresent, misstate or conceal such information from
plaintiffs and the investing public and are primarily liable under the federal securities
laws for their ti ansgressions .
IV. PURCHASEPRO'S FRAUDULEN T
RECOGNITION OF REVENUE
51 . PurchasePro purported to be one of the largest B2B e-commerc e
software comp, .nies in the world . According to PurchasePro, it operated the Global
Marketplace, a form of electronic "Yellow Pages," interconnecting more than
140,000 businesses and powering hundreds of private and public marketplaces wit h
its highly scalable, hosted e-commerce software . The Global Marketplace allegedly
enabled PurchasePro's customers to compete more effectively by enhancing sale s
opportunities, r:nducing procurement costs, and increasing employee productivity .
52 . Specifically, PurchasePro claimed to allow trading partners to procur e
goods and services, advertise their services throughout the network, post and
respond to purchase orders and requests for quotes, and display their product
catalogs for customers . As noted in PurchasePro's internal Company manuals o r
policies, the Company 's stated goal was to "create the standard platform where
businesses of all sizes can transact business seamlessly and efficiently . "
53 . However, in order to accomplish that goal, the Company needed to
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achieve "critic ::tl mass," or the appearance of a marketplace large enough and with
a significant <<mount of trading partners necessary to attract or entice other
companies to 'Darticipate or contract with PurchasePro . As noted by a former
employee of PCrchasePro, one of the key metrics or indicators of success in the B2B
industry, in addition to revenue, was the number of users on the system . Moreover,
as defendant Johnson noted throughout the Class Period, "critical to the growth of
PurchasePro is member adoption ."
54 . PurchasePro grouped its revenue into four categories : (1) marketplac e
software licens°s ; (2) network access and service fees ; (3) advertising ; and (4) other .
Software licenses were licenses for marketplaces sold by PurchasePro . According
to the Company, network access and service fees included subscription fees and
transaction fees charged to individual subscribers for PurchasePro's Global
Marketplace, al)plication service fees for labeled marketplaces that were powered for
its customers, . maintenance fees for on-going marketplace software license
maintenance, hosting fees for those customers who had licensed PurchasePro's
software products and had contracted its hosting capabilities, services for setting up
marketplaces and PurchasePro's share of subscription fees . Advertising fees
included fees f:)r advertising on PurchasePro's Global Marketplace .
55 . Throughout the Class Period, Defendants, caused PurchasePro t o
misrepresent is key metrics by inflating its number of users and engaging in
improper accounting practices with respect to its sources of revenue . This had the
effect of inflating the Company's reported revenues and growth rate, diminishing the
losses that the C Company reported and inflating the price of the Company's securities .
56 . These improper accounting practices included : (i) the improper
recognition of revenue from sham transactions ; (ii) the improper recognition of
revenue from round trip transactions, wherein PurchasePro essentially bought
revenue by ", ;elling" marketplace software licenses in exchange for secret
undisclosed ag-•eements requiring PurchasePro and/or AOL to, among other things :
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(a) buy an equivalent or greater amount of products from license purchasers, (b)
provide on line advertising to licensee purchasers, and (c) invest in license
purchases, and otherwise make the license purchasers whole in the future for the cost
of the marketplace license purchasers (collectively "side agreements") ; (iii) the
improper recognition of revenue attributable to non-monetary barter, or "Barney,"
exchange transactions wherein PurchasePro recorded revenue far in excess of the
value received in exchange ; (iv) the premature and improper recognition of revenue
that should have been deferred to later periods for the delivery of software products
that required substantial additional production, modification or customization in
order to work ; (v) the improper recognition of revenue from customers through the
overstatement of subscription revenues ; (vi) the improper recording of accounts
receivable without the consideration of an adequate reserve for doubtful accounts
where they knew the accounts would never be collected ; and (vii) improperly
recognizing reti enue by backdating and forging contractual documents that were not
executed prior .:o the period being reported .
A. False And Misleading Revenue Recognized From Sham Transactions
1 . Warrant-For-Revenue Transaction s
57 . Throughout the Class Period, PurchasePro improperly recognize d
revenue generated by payments made to PurchasePro by customers, which payments
were in fact and substance payments for warrants to purchase PurchasePro stock that
PurchasePro had granted to those customers in order to gain their business . The SEC
has ruled that such payments cannot properly be classified as revenues, because they
are not paymen's for the company's goods or services but rather for the company's
warrants .
58 . Spylcifically, PurchasePro' s fi nancial results during the Class Perio d
I were in large part subsidized and distorted by PurchasePro's warrants-for-revenue s
business model , which included transactions with AOL, Advanstar, Office Depot ,
Gateway, Springy., and Computer Associates .
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2 . Warrant Agreement With AOL
59 . O i or about March 15, 2000, PurchasePro and AOL entered into an
Interactive Marketing Agreement ("IMA"), Technology Development Agreement
("TDA") and a Warrant Agreement . Pursuant to the original terms of the IMA,
PurchasePro was required to pay AOL $50 million in cash -- $25 upon the signing
of the IMA and $3 .57 million a quarter for seven quarters, ending December 2001 .
In exchange, AOL would allow PurchasePro to be AOL's "strategic partner" and co-
develop a busness-to-business global marketplace on AOL's Internet platform
called the Netbusiness Marketplace ("Netbusiness") . In addition, the original terms
of the TDA r quired PurchasePro to pay AOL a total of $20 million in equal
quarterly payments of $2 .5 million for each of 8 quarters beginning in August 2000 .
60 . However, Netbusiness was never fully implemented because it lacke d
much of the functionality promised by PurchasePro . In fact, it was virtually
abandoned and: the business arrangement quickly deteriorated to the point that it
became nothing more than a shell used by both companies to falsify their reported
revenue and financial statements .
61 . A.; a result, the remaining focal point ofPurchasePro's relationship wit h
AOL was the Warrant Agreement . The original terms of the Warrant Agreement
provided that AOL was granted warrants to buy PurchasePro stock based on how
much business 'it "referred" to PurchasePro. In other words, in order for AOL to be
credited with referred business, the marketplace licenses or subscription agreements
would actually have to be sold to third parties . The original Warrant Agreement
granted to AOL as many as 4 million warrants for PurchasePro stock, adjusted fo r
stock splits, with an exercise price of $63 .26 per share. Because such a strike price
soon became i :iconceivable due to a decline in PurchasePro's stock price, these
warrants became worthless and gave AOL no incentive to refer business t o
27 II PurchasePro .
28 62 . Fi..rthermore, in or around October 2000, AOL was facing the effect s
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of an industry wide downturn in revenues that could be generated from online
Internet advert0 sing . In fact , on October 18, 2000, defendant Pittman and other AOL
executives were informed at a meeting at Dulles headqua rters that AOL faced the
risk of losing more than $140 mi llion in ad revenue the following year . While such
a decline would represent only 5 % of AOL' s proceeds from advertising and
commerce , giN en the tenuousness of the Tender Offer AOL was attempting to
consummate with Time Warner, Inc., any such decline in revenues raised great
concern among AOL executives, including the AOL Individual Defendants named
herein .
63 . Furthermore, certain AOL executives had begun internally questioning
the validity of riany of the deals whereby AOL was recognizing advertising revenue .
For example, James Patti ("Patti"), a senior manager in AOL's Business Affairs
Department, ht aded by defendants Colburn and Keller, stated that by October 2000,
"[t]he bubble had clearly burst, but senior management was under enormous
pressure to hit the [financial] numbers and close the Time Warner transaction, which
would diversif- ' the revenue base and lower the risk profile of the company ." Patti
also told senior executives that he was uncomfortable with some of the transactions
pushed by his unit . Patti further reported that "I had been asked to paper many of
these questionable deals and was unwilling to cooperate, making my concerns
known to management ." Then, one week after expressing these concerns, and
shortly after re ;eiving a merit promotion, Patti was terminated in 2001, a move he
said he believe .3 was directly related to his refusal to participate .
64 . Likewise, Robert O'Connor ("O'Connor"), then Vice President o f
Finance for AOL's advertising division, outlined his concerns in a series of meetings
in late 2000 and early 2001 with defendants Pittman and Colburn, along with J .
Michael Kelly. Chief Operating Officer of the Online Division , and other high-
ranking company executives . Based upon O'Connor's review of AOL's internal
financial documents , he has stated: "Clearly, a lot of what [the AOL Defendants ]
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were living on was revenue that was not of the highest quality . . .1 don't know if
they're still in denial, but there were some pretty big business issues they were not
willing to face . . For nine months, [ tried to get these guys out of denial . I tried to take
the perfume off the pig ." However, rather than listen to such warnings, the AOL
Defendants engaged in the sham transactions discussed herein and replaced
O'Connor.
65 . These internal warnings also came when investors were highly alert t o
any weakness :.n online advertising and also shortly before the Tender Offer was
scheduled to be completed. Thus , by the end of October 2000 , defendant Pittman
was seeking to allay investors conce rns . When asked by Wall Street analysts and the
media about the industry -wide downtu rn in advert ising revenues, defendant Pittman
offered a resounding answer : "I don't see it, and I don't buy it ." Interestingly, just
a week before Pittman's public statements , shares of AOL' s key competitor, Yahoo
Inc., plunged 21 % after the company reported strong ad g rowth but acknowledged
that the pace could not be sustained . A day before Pittman spoke , AOL shares also
dropped 17% on what analysts described as similar worries .
66 . In addition, internal company projections raised caution about on e
particular secto r : dot-com's . Failu re s were accelerating among those Inte rnet start -
ups, which represented a significant amount of the company ' s ad business . In such
an atmosphere , and with its takeover of Time Warner, Inc . imminent, it became more
important then ever for AOL to maintain its breakneck growth in advertising and
commerce revenue .
67 . As such, PurchasePro was one source by which the AOL Defendants
could attain the r goals . However, AOL no longer had an incentive to refer business
to PurchasePro since the warrants it had been granted in the Warrant Agreement
were out of tht! money -- i .e., it cost far more to exercise the warrants than to
purchase the shares on the open market. In addition, against the back drop of
internal wamin ;s concerning declining advertising revenue, and just when AO L
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needed all of its available revenue in order to complete the Tender Offer, defendan t
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I Johnson threati -Ined to withhold payments due to AOL under the IMA and the TDA
for AOL' s fail -, ire to refer substantial business to PurchasePro .
68 . In response to Johnson's threats, on or about November 18, 2000 ,
PurchasePro a :id AOL amended the Warrant Agreement, decreasing the exercise
price of the warrants by over 99%, from $63 .26 to $0.01, in order to motivate AOL
to promote Pw:chasePro and "refer" business to the Company . Under the revised
Warrant Agreement, AOL earned a $3 credit for each $1 of revenue it referred to
PurchasePro. AOL and PurchasePro valued the warrants issued under the amended
Warrant Agreement at $30 million, requiring AOL to refer only $10 million in third
party business to receive the maximum number of warrants granted under the
Agreement . In exchange for the amendments to the Warrant Agreement, AOL
agreed to assist PurchasePro in reaching its revenue targets in future quarters through
coerced sales and round trip transactions with suppliers, partners and customers, as
more fully described below. Moreover, to assure that it would be able to "earn" the
maximum $30 million in PurchasePro warrants, AOL bought $10 million worth of
bulk subscription agreements and marketplace licenses with the declared intent to
distribute them to its suppliers, partners, customers, subscribers, and/or vendors .
69 . Defendant Anderson has admitted under oath that following th e
amendment to the Warrant Agreement , PurchasePro ' s auditors questioned whether
PurchasePro could recognize revenue from AOL's bulk purchase of subscription
agreements ant. marketplace licenses which had not yet been sold to third parties and
whether AOL could vest or "earn" $30 million in warrants without the referral or
actual sale of tt e licenses to third parties . Such concerns by PurchasePro ' s auditors
would have n°cessarily been expressed to the PurchasePro Defendants, and
especially Johr.,son, an admittedly hands -on CEO , and defendant Miller .
70. Defendant Anderson, who at that time reported directly to defendan t
McGhee, has also disclosed that he discussed these matters with "co-conspirator s
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within PurchasePro," i.e., senior management , who devised the fraudulent scheme
to falsely credit AOL with the referral of $10 .5 million in business by third parties
during the fouxth quarter , even though they knew that AOL "had referred less than
half that amount ." To perpetrate the scheme , defendant Anderson has further
admitted that "at the direction of a senior officer of PurchasePro, Anderson wa s
responsible for the creation of false business records prepared at Anderson's
direction by his subordinate that he knew would be used to falsely credit [AOL] with
referral revenue that he knew [AOL] had not generated for PurchasePro in the fourth
quarter of 2000." These records were also transmitted to and relied upon by the
Company's auditors in approving the revenues recognized by PurchasePro in the
fourth quarter of 2000 .
71 . Thus, not only did the PurchasePro Defendants engage in a questionable
warrant-for-revenue arrangement with AOL, they fraudulently credited AOL with
the referral of approximately $5 .5 million in third party "purchases," in order to
enable the Company to record $10 .5 million in revenues . This in turn allowed AOL
to "earn" its full $30 million in warrants . In addition, it allowed the AOL
Defendants to record the $20 million gain on the warrants as advertising revenue,
which artificially inflated AOL's revenues on the eve of closing the Merger wit h
Time Warner, Inc .
3 . Warrant Agreement With Gatewa
72 . The pleadings and discovery materials in an action currently pending
between Pro-After and Gateway have also revealed that on or about September 29,
2000, defendant Carton - on behalf of PurchasePro - entered into a Training and
Marketing Ag{-eement with Gateway in exchange for warrants valued by
PurchasePro and Gateway at $38 .2 million under the Black Scholes method . The
agreement called for Gateway to install the PurchasePro icon and an imbedded dem o
on 3,000 ,000 Gi teway computers . PurchasePro and Gateway allocated $9 millio n
as the value for these icons. The agreement also called for Gateway to provid e
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training in their company stores on the usage of PurchasePro's software and
marketplace, and to include PurchasePro in Gateway's website, catalogues and
various marketing materials . Based upon this contract, PurchasePro recognized $9
million in advertising revenue and continued to carry the "asset" represented by the
3,000,000 Gateway icons on its books throughout the Class Period . However,, the
PurchasePro icon appeared on only 22,800 computers, PurchasePro received little
or no training from Gateway, and PurchasePro failed to appear in Gateway's
catalogues and marketing materials . Thus, throughout the Class Period, the
PurchasePro Defendants knew that the Company's revenue and financial statements
were overstated by carrying the value of this worthless asset which was falsely
created through its warrant arrangement with Gateway .
4. Importance of Warrant-For-Revenue Transactions
73 . To note the magnitude of such warrants-for-revenue transactions, in th e
first quarter of 2001, payments derived from PurchasePro's partnership with AOL
accounted for f 5% of PurchasePro's revenues (according to the figures reported by
the Company c n April 26, 2001). PurchasePro had, at prior times during the Class
Period, also entered into warrants-for-revenues contracts with Gateway (as described
above) Office Depot, and Sprint . Thus, the PurchasePro Defendants, together with
the AOL Defendants, engaged in an ongoing pattern of improperly generating
"revenue" through the issuance of warrants .
74. The upshot of such warrants-for-revenue transactions is that : (i)
PurchasePro generated artificial "revenue" by issuing warrants to business partners
that offered the partner much more in warrant profits than the partner paid to
PurchasePro ; (i) such "revenue" continued only so long as the warrants did, and
once the warrants were "earned" there was no incentive for referrals or payments to
the Company tr F continue (because, at such point, the payments actually became real
payments rather than a game in which one receives $3 for every $1 one pays) . Thus,
as the SEC has held, calling such payments revenues is materially misleadin g
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services nor indicate anything about the market demand for, or acceptance of, th e
company's goods or services . Such payments are not payments for the company's
goods or services but for its warrants .
75 . Wedbush Morgan Securities analyst George Santana , in an analyst
report published on April 27, 2001, summarized the issue as follows :
PPRO: 1 Earnings Fiasco, Reiterate Sell - STILL BELIEVEREVEN~JES ARE BING DRIVEN BY AGGRESSIVE WARRANTSFOR REVENUES DEAL S
We believe PurchasePro has failed to address our main point ofcriticism . We contend that PurchasePro ' s revenues are being driven byaggressive warrants for revenues deals that raise serious questionsa gout the long -term sustainabi lity of PurchasePro's revenues . Webelieve investors should take zero comfo rt in PurchasePro'srelationship with AOL . True, the AOL pa rtnership accounted for 65%of PurchasePro ' s revenues in the first q uarter 2001 . We believe a hi hrevenue concentration is to be expected in the very near term , preciselybecause AOL is ea rnin warrants at a rapid clip as it refers business toPurchase.Pro . Specifically AOL is earning $3 worth of warrants (at anexercise ` price of 0 .01 5 for every $1 of revenue referred toPurchasePro . We believe that the current warrant agreement for AOLencourages a very sho rt-term revenue benefit for PurchasePro and verylittle long-term benef t . When AOL earns and exercises its warrantsand sell s its PurchasePro shares, we believe the referral of business toPurchasePro will drop sharply .
In addition to the referral of license fees, PurchasePro is benefittinfrom significant nonrecurring revenues from AOL that are an offshootwe believe , of the same warrant award to AOL . These revenues helpedPurchasePro's fourth quarter, as AOL paid $4 .9 million for 100,000one-month promotional subscriptions to PurchasePro ' s network for themonth of December 2000 . In the first quarter 2001 , PurchaseProrecognized $9 mi llion of revenues from AOL for subscriptions to thePurchasePro network and an additional $3 .7 million of revenues fromAOL for `integration services ' that weren't very well exp ~la~ ined . Webelieve this type ofrevenue will prove to be short-lived . We could bewrong but we believe it less than coincidental that these revenues fromAOL began after PurchasePro re-priced the warrants to AOL, inNovember 2000 from the original strike price of $63 . 26 to the newstrike price of $d.01 .
Overall , it is our belief that AOL has every incentive to refer businessto Purch-isePro as quickly as possible to earn i ts warrants as quickly aspossible We contend AOL will exercise these warrants and sell itsPurchasf .Pro shares sooner rather than later . We believe that once AOLearns its. warrants and sells its PurchasePro shares it will have littleincentive; to refer additional business to PurchasePro and will scaledown resources devoted to the relationship , leaving PurchasePro witha sharply reduced revenue outlook .
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76 . A.- a result of these warrant transactions , PurchasePro recognized
significant amounts of revenue from certain entities, that was in fact , merely the
return of monks that PurchasePro had previously given these entities . For example,
during the Class Period , AOL received $48,707,000 in cash from PurchasePro while
AOL remitted )ack only $19 ,063,000 to the Company during the same time frame .
All of the $ 19,063,000 was treated as operating revenues by PurchasePro during the
Class Period .
77 . According to GAAP, APB 29, ¶21, the exchange transaction is not the
culmination of an earning process if the transaction involves the exchange of a
productive asset not held for sale in the ordinary course of business for a similar
productive asset not held for sale. Many of these transactions were based upon,
among other things, the exchange of customer lists . They were also supplemented
with supposed payments for marketing rights, shared sales and website design sales .
78 . TI e SEC has said that the simultaneous exchange of non-monetary
assets along w!th equal amounts of cash consideration between the parties to an
exchange woul 1 raise significant substance over "form" questions .
5 . The Ad Swap
79 . In another deal arranged between PurchasePro and AOL towards the
end of the first quarter 2001, the parties agreed to exchange "advertising" of little or
no value to either company in order to generate sham revenues . Under this deal,
according to an internal AOL document dated March 21, 2001, PurchasePro would
receive $1 .8 million worth of advertising on the AOL service . In return, AOL would
receive $1 .8 million worth of promotions that mentioned its Netscape brand when
PurchasePro ran television ads on CNN and Headline News, which were now part
of the merged company, AOL Time Warner, Inc .
80 . In reality, PurchasePro got little value from the ads it ran on the AOL
service, accorc:ing to inte rnal AOL documents, since AOL controlled where
PurchasePro's .ds would run. For example, the "carriage plan" for the PurchasePro
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I ads showed that many of the PurchasePro ads would run on AOL's ICQ instant-
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messaging service . Instant messages allow users to converse by text in real time
over the Internet . The ICQ service targets a largely teenage and international
audience who would have little use for PurchasePro 's business -to-business software .
The ads appearing on ICQ's application also had "almost no click through,"
according to AOL inside sources, meaning that few users actually clicked on the ad s
to find out more about the product being touted . PurchasePro ' s ads were also run
on Winamp , AOL's music software player, another service that did not target
PurchasePro ' s business clientele . Of course , the success of the advertising was o f
little interest to AOL or PurchasePro . Each company was more interested in
boosting its ad revenue .
81 . Consequently, there was no reasonable justification for the swap of
advertising, since neither party received any material benefit from the transaction .
This swap was designed solely for the purpose of generating sham revenue to
artificially inflate the revenues and financial results of both companies .
6. The Statement Of Work Between AOL And PurchasePr o
82 . Near the end of the first quarter 2001, PurchasePro was far fro m
reaching its projected and publicly forecast revenue goals . Therefore, defendant
Johnson traveled to AOL headquarters in New York, New York, and threatened to
once again withhold payments for commissions that AOL had "earned" for the sale
of PurchasePro software if AOL did not live up to its agreement to help PurchasePro
reach its revenue forecasts through the coercive round trip transactions as promised,
and through the payment of nearly $5 million to PurchasePro in promotional
expenses for AOL giving 100,000 of its subscribers a free one month subscription
to the PurchasePro global marketplace .
83 . In response, the parties further agreed to enter into a fraudulent
"Statement of \-Vork" so that PurchasePro could reach its goals . Defendant Anderson
has admitted under oath that to generate the necessary revenues, "Anderson an d
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I certain of his c-o-conspirators ," at PurchasePro and AOL, "devised a scheme to
I fraudulently recognize approximately $3 .65 million in additional revenue fo r
I PurchasePro ." Pursuant to the scheme, a Statement of Work was entered int o
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between PurchasePro and AOL wherein AOL agreed to pay PurchasePro
approximately $3 .65 million for the integration of auction functionality into AOL's
Internet marketplace for small businesses . Moreover, Pro-After, PurchasePro's
debtor in posse ;sion, has also determined that this Statement of Work was negotiated
by defendant Johnson in New York, during the week of April 9, 2001, but that the
document was backdated to February 5, 2001, so that revenue could be recognized
in PurchasePro's first quarter of 2001 .
84 . Knowing that no work had been performed under the Statement of
Work, which made it fraudulent to recognize any revenue therefrom, Anderson has
also admitted that he and "other co-conspirators within PurchasePro caused th e
$3,65 million associated with the Statement of Work to be improperly recorded as
revenue for PurchasePro in the first quarter of 2001 and to be submitted t o
PurchasePro's ~juditors as revenue, without informing PurchasePro's auditors that
no work or virtually no work had been performed under the contract," Importantly,
such fraudulert transactions would have necessarily been approved by the
PurchasePro .D( fendants, and specifically defendants Johnson, Miller, and McGhee,
Anderson's immediate supervisor . Furthermore, defendant Chiles, as a member of
the Audit and Compensation Committees, would have had the responsibility of
confirming such a material amount of revenue which implicates his knowledge o f
such a fraudulent transaction as well .
B. False And Misleading Revenue Recognition
On Round Trip Transactions In The Sale O f
PurchasePro ' s Marketplace Software License s
85 . By June of2000, the PurchasePro Defendants realized that they needed
to change the Company's business model in order to maintain the illusion of revenu e
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growth . Consequently, they shifted PurchasePro's focus from its operation of
"Global Marki tplaces," which allowed the Company to recognize incremental
revenue over time, to the licensing of software . In this manner, according to internal
e-mails, the PurchasePro Defendants "discovered new opportunities for revenue
recognition" w ;-iereby they could immediately recognize "up-front" revenue upon the
alleged sale of a particular license .
86 . However, defendant Anderson has revealed under oath that PurchasePro
experienced significant difficulties in selling its software and/or marketplace licenses
since third party customers were unlikely to make their purchases based solely on
the value of the license . Therefore, Defendants devised a scheme for round trip
transactions wiereby PurchasePro and/or AOL would essentially buy revenue by
entering into secret side agreements with third parties . The agreements provided that
if the third party would buy a marketplace license, PurchasePro and/or AOL would
invest a similar or greater amount in the third party, or would buy goods and services
from the third /party in the same or greater amount. Thus, through these secret side
agreements, PurchasePro and/or AOL essentially sustained the Company by buying
revenue .
87 . Furthermore, defendant Anderson has stated that these side agreements
and round trip transactions were never disclosed to PurchasePro's auditors . In fact,
Defendants took active steps to conceal these secret agreements from the Company's
auditors . Importantly, since the Company did not have an extensive staff of senior
management, such secret side agreements necessarily would have required the
knowledge, approval and/or acquiescence, at a minimum, of Anderson's direct
supervisor(s), i e., the remaining PurchasePro Defendants . Moreover, not only did
Defendants mi :lead the investing public and the Company's auditors by overstating
PurchasePro's revenues with regard to the following transactions, but as set forth
below, they issued false and misleading press releases which claimed that the
Company demonstrated widespread acceptance of the PurchasePro platform an d
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AOL's Netbusness Marketplace for B2B transactions .
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1 . Third Quarter 2000 Round Trip Transactions
a. The I-Storm Transaction
88 . Pro-After, PurchasePro's debtor in possession, has determined that in
June 2000, dependant Carton, acting on behalf of PurchasePro, entered into an
agreement with I-Storm, a start-up company with a history of losses since its
inception. Through this agreement, PurchasePro invested $1,000,000 in the
fledgling company in exchange for an agreement that I-Storm would purchase a
marketplace software license from PurchasePro for $720,000 in September 2000 .
At the time that this agreement was entered into, the PurchasePro Defendants knew
that I-Storm would have been unwilling and unable to buy the PurchasePro
marketplace software license absent the side agreement .
b . The LawCommerce Transactio n
89 . Pro-After has determined that in September 2000, defendant Anderson ,
acting on behalf of PurchasePro, entered into a secret side agreement with
LawCommerce, a start up Internet legal research firm . The agreement provided that
PurchasePro would buy a $1 million convertible note from LawCommerce, in
exchange for LawCommerce's agreement to buy a PurchasePro marketplace
software license for $510,000 . At the time that this agreement was entered into, the
PurchasePro Defendants knew that LawCommerce would have been unwilling an d
unable to buy the PurchasePro marketplace software license absent the sid e
agreement .
c . The Computer Associates Transactio n
90 . Pi o-After has determined that towards the end of the third quarter 2000,
PurchasePro entered into an agreement with Computer Associates whereb y
Computer Associates agreed to buy a marketplace software license from
PurchasePro fcr $2,000,000 in exchange for $6,400,000 in Computer Associates
software . Nevertheless, PurchasePro fraudulently recognized $2,000,000 in revenu e
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based upon this transaction . At the time that this agreement was entered into, the
PurchasePro Defendants knew that Computer Associates would have been unwilling
to buy the PurchasePro marketplace software license absent the side agreement .
d. The Working Woman Transaction
91 . Pro-After has determined that during the third quarter of 2000,
PurchasePro entered into an agreement with Working Woman whereby Working
Woman purchased a marketplace software license from PurchasePro for $400,000 .
However, this purchase was conditioned upon a secret side agreement whereby
PurchasePro agreed to invest $3,000,000 in Working Woman resulting in ownership
of 7% of the outstanding shares of Working Woman. At the time of the
"investment," Working Woman was forecasting a net loss for 2001 . At the time that
this agreement was entered into, the PurchasePro Defendants knew that Working
Woman would-have been unwilling and unable to buy the PurchasePro marketplac e
software license absent the side agreement .
e . The InsureZone Transaction (Part 1)
92 . In;ureZone entered into a Preferred Supplier Agreement with
PurchasePro on August 25, 2000, which was executed by defendant Anderson .
Additionally, Dale Boeth, Vice president of strategic development at PurchasePro,
outlined the engagement model between PurchasePro and InsureZone in March of
2000 .3 Pursuant to this agreement, InsureZone agreed to pay PPRO $100,00 0
annually for th right to be a preferred supplier preferred supplier of insurance
products and services on the PurchasePro global marketplace . Under the preferred
supplier agreement, InsureZone would receive additional exposure in PurchasePro's
global marketp'.ace and would be the Company's preferred supplier of insurance
products . IntetnaI e-mails, both within InsureZone and PurchasePro, reveal that
Both Dale Boeth and defendant Anderson worked together asexecutives at Sprint . In fact they negotiated the warrant arrangement betweenPurchasePro and Sprint while working as executives for Sprint .
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PurchasePro was unable to ever modify its Internet platform to make the links to
InsureZone as a default preferred supplier or products and services or of any other
future marketplaces ; (ii) promote InsureZone pursuant to the terms of the Preferred
Supplier Agreement; (iii) provide home page banner rotation ; (iv) promote
InsureZone in connection with the banner ad-on category page, preferred listing in
category, and placing InsureZone's logo on PurchasePro's partners page; (v) include
lnsureZone in all sales and marketing materials that promote preferred suppliers ; (vi)
enable the XML, punchout from PurchasePro networks to InsureZone's site ; and (vii)
provide up to 24 hours of telephone consulting services . In fact PPRO did not
perform, and had no intentions of performing, the obligations under the terms and
conditions of the Preferred Supplier Agreement . As a result, InsureZone made the
first two monthly payments, of $8,333 .33, and refused to make further payments
until the platform was made operational .
93 . Thus, it is apparent that this was a ploy to improperly and prematurel y
generate revenue without making good on its alleged technology . For example, in
a letter from Bob McCintyre ("McCintyre" ), Project Manager of PurchasePro, to
Mr. James Rusty Reid ("Reid"), dated September 27, 2000, regarding the
acceptance of the of the preferred supplier designation, McCintyre urged Reid to
sign the letter in order for PurchasePro's auditors to recognize a portion of the
revenues generated under the Preferred Supplier Agreement for the then current
quarter. On the very same day McCintyre requested Reid to sign the letter, in an e-
mail from Scott McClure 4 to David Newton of InsureZone, cc'd to Rusty Reid o f
Scott PalcClure, Director of Business Development was the principalnegotiator of the Preferred Supplier Agreement . David Newton of InsureZonealso negotiated the terms of supplier agreement on behalf of InsureZone .McClure left Purchasepro in July of 2002 to work for Z3 Marketing, a subsidiaryof NEXX, a company run by defendants Johnson and Carton .
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InsureZone on September 27, 2000, McClure notes that :
A ain I want to emphasize that the le tter is not tied to any futurede1ivera)les on our side. It is for our auditors and allows PPRO torecognize a po rtion of the revenue from our agreement this quarter .
However as of `ieptember 27, 2000, PurchasePro failed to fulfill its obligations unde r
I the Preferred Supplier Agreement .
94 . The improper or "roundtrip" transactions identified above constitute d
a material portion of PurchasePro's revenues in the third quarter 2000 . PurchasePro
reported total revenue of $17 .3 million in the third quarter of 2000. The total
revenue recognized by the Company with regard to the I-Storm, LawCommerce,
Computer Associates and Working Woman transactions alone was $3 .63 million .
Therefore, these round trip transactions constituted 21 % of the Company's total
revenues forth :,- quarter . Moreover, during the third quarter of 2000, PurchasePro
reported a net loss of $4 .7 million, but incurred costs and/or expenses of $11 .3
million to "purchase" this revenue, representing nearly three times the Company's
total net loss fcr the quarter .
2 . Fourth Quarter 2000 Round Trip Transaction s
a. The Broad Vision Transactio n
95. Pro-After has determined that towards the end of the fourth quarte r
2000, Purchas.Pro entered into an agreement with BroadVision whereby
BroadVision agreed to buy a marketplace software license from PurchasePro for
$5,000,000 in e -,change for PurchasePro's purchase of $11,200,000 in BroadVisio n
software which was unneeded. Nevertheless, PurchasePro recognized $5,000,000
in revenue based upon the transaction . At the time that this agreement was entered
into, the Purcha :;ePro Defendants knew that Broadvision would have been unwilling
to buy the PurciiasePro marketplace software license absent the side agreement .
b . The Thread.com Transaction
96. Defendant Anderson has admitted under oath that "at the direction o f
a senior officer ofPurchasePro," he personally participated in negotiations whereby
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The Thread .comn agreed to purchase a marketplace license for $720,000 in exchange
for a secret sid:.- agreement whereby PurchasePro agreed to invest $250,000 in The
Thread .com's :text round of financing . At the time that the secret side agreement
was negotiates°, The Thread .com was unable to obtain financing from any other
source . Anderson further admitted that this secret side agreement was concealed
from PurchasePro's auditors, even when The Thread .com failed to pay the full
amount due under the license . The PurchasePro Defendants knew at the time that
the secret side agreement was entered into that The Thread .com would have been
unwilling and unable to buy the PurchasePro marketplace software license absent the
side agreement .
c. The ProfatScape. com Transaction
97 . D;-fendant Anderson has admitted under oath that in PurchasePro' s
fourth quarter of 2000, ProfitScape .com agreed to buy two marketplace licenses for
$1,100,000 ea--h. Anderson further admitted that he knew at the time of the
transaction that ProfitScape .com only agreed to purchase the second marketplace
license in exc':~ange for a secret side agreement whereby PurchasePro would
simultaneously loan $1 million to ProfitScape.com. Not only was this secret side
agreement not disclosed to the Company's auditors, but Anderson has admitted that
senior officers ,3f PurchasePro "had made financial commitments to an outside party
in order to get t'iat outside party to substitute for PurchasePro" under the note for the
$1 million loan "so that PurchasePro's auditors would approve of PurchasePro's
revenue recognition from its marketplace license sales to [ProfitScape .com] ." Such
a secret side a i eement and the negotiation of a substitute payee under the $1 million
loan could not lave been negotiated without, at a minimum, the knowledge, approval
and/or acquiescence of the PurchasePro Defendants . At the time that this agreement
was entered in' :o, the PurchasePro Defendants knew that ProfitScape,com would
have been unwilling and unable to buy the PurchasePro marketplace software
licenses at issue absent the side agreement .
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d. The V-Twin Holdings Transaction
98 . Defendant Anderson has admitted that in PurchasePro's fourth quarte r
of 2000, he negotiated an agreement with V-Twin Holdings, Inc ., whereby V-Twin
agreed to buy two PurchasePro marketplace licences for $1,100,000 in exchange for
a secret side agreement by a PurchasePro senior officer to invest in V-Twin . At the
time Anderson negotiated the agreements with V-Twin he knew that it was a
relatively new venture that had always operated at a substantial loss and that it would
not be able to pay for the marketplace license absent the investment by Anderson's
co-conspirator. In addition, at the time that this agreement was entered into, the
PurchasePro Defendants knew that V-Twin would have been unwilling and unable
to buy the Purc,hasePro marketplace software licenses absent the side agreement .
e. The Woosh! Transaction
99 . Pro-After has determined that in December. 2000, defendants Anderson
and Johnson entered into an agreement with a company called Woosh!, whereby
Woosh i agreed to purchase a marketplace license from PurchasePro for $900,000 in
exchange for a secret side agreement wherein Johnson and Anderson agreed that
PurchasePro would invest $1 million in series C convertible notes issued by Woosh!,
constituting a 20% interest in the company . At the time that this agreement was
entered into, the PurchasePro Defendants knew that Woosh! would have been
unwilling and unable to buy the PurchasePro marketplace software license absent the
side agreement .
100 . The "roundtrip" transactions identified above constituted a materia l
portion of Puri.hasePro's total revenues in the fourth quarter 2000 . PurchasePro
reported total '-evenue of $33 .6 million in the fourth quarter of 2000 . The total
revenue recognized by the Company with regard to the BroadVision, The
Thread .com, ProfitScape .com, V-Twin Holdings, and Woosh! transactions was
$8 .35 million . Therefore, these round trip transactions constituted 25% of the
Company's total revenues for the quarter . Moreover, when combined with the $5 . 5
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million in revenue recognized from the fraudulently recorded AOL business referrals
used to allow AOL to "earn" its $30 million in warrants , set forth above, thes e
f combined share transactions resulted in $13 .85 million, or 41% of PurchasePro' s
total revenue f or fourth quarter 2000.
3 . First Quarter 2001 Round Trip Transaction s
101 . Pursuant to the agreements between Defendants , as noted above, AO L
promised to assist PurchasePro in reaching its forecasted revenue projections . As
such, AOL ag.•eed to enter into secret agreements with certain of its suppliers,
partners and customers whereby AOL agreed that, in exchange for the purchase of
a PurchasePro marketplace or software license, AOL would spend an equal or
greater amount on goods and services with the supplier, partner or customer . AOL
also informed t'iese suppliers, partners or customers that they could only do business
with AOL if they purchased a software or marketplace license from PurchasePro ,
even though many of such suppliers, partners or customers had no use whatsoever
for the Purchas=,Pro product or services . Thus, during the first quarter of 2001, AOL
played a primay role in PurchasePro's fraudulent round trip transactions .
a. The Chinadotcorn Transaction
102 . Wring the Class Period, AOL was a shareholder ofChinadotcom Corp .
million to AO-_ for Internet advertising services . In the first quarter of 2001,
Chinadotcom was forced to buy a PurchasePro marketplace software license for
$5,000,000 . Chinadotcom also paid AOL directly for computer software from
PurchasePro . In exchange, AOL agreed to continue doing business with
Chinadotcom and agreed to buy an equal or greater amount of goods and services
from Chinadotuom. A former sales representative of PurchasePro who was in a
position to ha .,re first-hand knowledge of these transactions, has stated that
Chinadotcom n±;ver wanted the software and that the software was never operational,
but that Chinadijtcom only bought the software due to the secret side agreement with
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AOL. Chinadotcom wrote off virtually its entire purchase of the marketplace
software licenie in the first quarter of 2002 since it was never operational .
Chinadotcom took this impairment charge a year later as a result of a re-assessment
and re-evaluation of the software . Defendants knew, at the time that the secret side
agreement was'entered into, that Chinadotcom would have been unwilling to buy the
PurchasePro marketplace software license absent the side agreement .
b. The Bigstep, Inc Transactio n
103 . During the first quarter 2001, Defendants also secured an agreemen t
with Bigstep, Inc ., ("Bigstep") whereby Bigstep agreed to buy a PurchasePro
marketplace license for $1,100,000 in exchange for a secret side agreement with
PurchasePro and AOL to buy $1,100,000 in goods and services . Defendants knew
at the time that'the secret side agreement was entered into that Bigstep would have
been unwilling and unable to buy the PurchasePro marketplace software license
absent the side agreement .
c. The Future Media Products Transaction
104. Pro-After has determined that during the first quarter 2001, AOL
strong-armed Future Media Products, a major supplier to AOL, into buying a
PurchasePro marketplace software license for $1,000,000 by an agreement dated
March 30, 2001, in exchange for a secret side agreement that AOL would buy
additional goods and services from Future media products to offset the expenditure .
To justify recognizing the revenue, Defendants caused PurchasePro to ship a non-
functioning "skin" without modification, to Future Media Products on March 31,
2001 . Defendants knew at the time the secret side agreement was entered into that
Future Media Products would have been unwilling to buy the PurchasePro
marketplace software license absent the side agreement . Ultimately, Future Media
Products refusf ..d to pay for the marketplace software license, but Defendants caused
PurchasePro to recognize the revenue from the transaction and continued to carry the
purchase price on its accounts receivable . Pro-After has filed suit against Future
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Media Products in an attempt to collect this amount .
d. The InsureZone Transaction (Part 2)
105 . Towards the end of the first quarter 2001, after InsureZone had withhel d
payments for approximately 4 months, Defendants recognized this as an opportunity
to convert the preferred supplier relationship into a marketplace software license so
they could immediately recognize additional revenue . Defendants convinced
InsureZone to purchase a marketplace software license by persuading them that this
would allow InsureZone to avail itself of PurchasePro ' s strategic alliance with AOL,
through InsureZone ' s Vertical Foundation Agreement with AOL . Defendant
Anderson adm"tted under oath , that after discussing the matter with one or more
senior officers at PurchasePro , PurchasePro secretly converted InsureZone's existing
contractual obligation to pay PurchasePro $ 180,000 pursuant to the preferred
supplier agreement that was entered into on August 25, 2000 (InsureZone Part 1)
into the price for a marketplace license .
106 . PurchasePro' s sales representative McClure, with the knowledge an d
approval of PutchasePro's senior officers, i .e., the PurchasePro Defendants, orally
informed InsurcZone that they would not be required to make any further payments
under the Preferred Supplier Agreement, but could retain all of the benefits through
a separate Vertical Foundation Agreement with AOL. Therefore, on March 30,
2001, Purchase P'ro and InsureZone signed an agreement whereby InsureZone would
pay $180,000, the same amount as the balance remaining on the Preferred Supplier
Agreement, for a marketplace software license . Defendant Anderson admitted under
oath that, in effect, PurchasePro gave away the marketplace license to InsureZone
for $180,000, the amount that InsureZone already owed PurchasePro, so that the
$180,000 would falsely appear to be a new marketplace license sale .
107 . Morever, when told to do so by a co-conspirator within PurchasePro ,
Anderson signed a PurchasePro internal confirmation letter backdated by Anderso n
to March 30, 2C01, the last day of the first quarter . In that letter, Anderson admit s
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that he lied to, and otherwise deceived, PurchasePro's auditors when he stated that
PurchasePro had not made any other unidentified or undisclosed oral agreements,
written obligati ons to deliver future services to InsureZone that were related to the
sale of the marketplace license . Regardless, the software that was shipped to
InsureZone w _as a non-operational skin that was never made functional, and
InsureZone never made any further payments under the agreement .
108 . However, as revealed by internal e-mails dated March 30, 2001 ,
between Todd Lehtonen, PurchasePro's general counsel, McClure, Miller and
Anderson., the marketplace software license agreement did not specify that the
remaining payments were no longer due and owing under the Preferred Supplier
Agreement . Consequently, even though the contract had already been signed so
PurchasePro could recognize the revenue in the first quarter of 2001, throughout
early April, and after the close of the first quarter, Anderson, Miller and McClure
continued to negotiate with InsureZone regarding additional language to be included
in an addendum to extinguish InsureZone's duty to pay the remaining balance under
the Preferred Supplier Agreement .
109 . For example , in an e-mail from Lehtonen to Anderson and McClure ,
dated March 30, 2001, concerns are expressed about the emphasis that PurchasePr o
placed on being able to recognize the revenue from such secret end of the quarte r
transactions and the manner in which Defendants reviewed and structured the deals :
Given Scott Miller's concerns . . letting PPRO and InsureZoneterminat ;~ the Preferred Supplier deal may be problematic . Its sic] onething if ill we risk is not being able to recognize $180k . low I'mconcernf,d we might be deemed to have given away a MarketplaceLicense Agreement for 0$ which might have more wide rangingnegative accounting impact .
110 . In subsequent e-mails between the same parties dated April 9 and 11 ,
2001, it becomes clear that PurchasePro still attempted to insert the agreement to
extinguish InsureZone's obligations under the Preferred Supplier Agreement into an
addendum to InsureZone's Vertical Foundation Agreement with AOL . Yet despit e
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the execution of the marketplace software license agreement, PurchasePro failed to
ever provide InsureZone with either operable software or the modifications required
to make InsureZone's preferred supplier arrangement operational . Consequently,
InsureZone ref used to make any further payments to PurchasePro under either the
Preferred Supplier Agreement or the marketplace license agreement . Nevertheless,
Defendants recognized the full amount of the marketplace license agreement as
revenue for the first quarter 2001 and continued to carry the balance due under th e
Preferred Supplier Agreement on the Company's accounts receivable . In fact Pro-
After, as debtor in possession for PurchasePro , has recently filed suit agains t
InsureZone seeking payment of the balance due under both the Preferred Supplier
Agreement, and the marketplace software license agreement, even though
PurchasePro failed to fulfill its obligations to make either the software or the Internet
platform for In ;ureZone's preferred supplier status functional ,
e. The Homestore.com Transactio n
111 . During the first quarter 2001, AOL also strong-armed Homestore .com
into purchasing for $1,000,000 from PurchasePro a marketplace software license that
was not operational, not wanted by Homestore .com, and was never made functional .
In exchange, AOL entered into a secret side agreement with Homestore .com in
which AOL promised that it would give Homestore .com the same or a greater
amount in advertising and placement on its website . The PurchasePro software
provided no benefit to Homestore.com and was never used by the company .
Defendants knew at the time the secret side agreement was entered into tha t
Homestore.com would have been unwilling to buy the PurchasePro marketplac e
software licens :, absent the side agreement .
112 . By September 2002, the SEC and the DOJ had commenced
investigations into the accounting irregularities posed by this round trip transaction .
These investigations, in part, led to three Homestore .com executives pleading guilty
to charges of securities fraud .
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f. The BizPro Link.com Transactions
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113 . Based upon information provided by BizProLink.com, Inc ., and its
successor in interest, BizProLink, LLC (together "BizProLink"), in March 2001,
AOL executives contacted BizProLink seeking to establish a "global partnership"
whereby BizProLink would create industry tailored small business content for
AOL's Netbusiness venture . AOL entered into this Netbusiness Integration
Agreement with BizProLink on April 11, 2001, whereby BizProLink would provide
these services and receive the right to place advertisements and banners on the AOL
network. However, in conjunction with BizProLink's agreement with AOL, it was
required to enter into a preferred supplier agreement with PurchasePro . Specifically,
BizProLink was informed by AOL Senior Account Executive Glenn Caruso that "in
order to enter into this relationship with AOL, BizProLink must sign a contract with
PurchasePro ." This is confirmed by an internal e-mail from G . Caruso to Steve
Sponder, President and CEO of BizProLink, on April 10, 2001, 3 :13 PM, inquiring
about the payment status . Glenn Caruso asks :
"Just wanted to confirm that you've wired the $130k for theNetbusiness agreement to our American Online bank account (you'rersicl S l Ok hold check applies to the $140k initial payment forNetbusiness) .
And, I' m assuming , a check went out with the signed PurchaseProagreement ?
Please confirm, Thanks, Glen .
114. Moreover, the PurchasePro marketplace software license agreemen t
entered into between Robert Layne, SVP Sales and Strategic Development of
PurchasePro, and Steve Sponder, President and CEO of BizProLink, on April 9,
2001, was subsequently sent to Colburn, President of Business Affairs and
Development at AOL to confirm this request. Thereafter, on April 11, 2001, a check
in the amount of $220,000 for a preferred supplier and marketplace software licens e
agreement was sent by Kevin Goch, EVP Operations of BizProLink, to Sheila Stuey,
who was in the Accounts Receivable Department at PurchasePro . Based solely upo n
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the secret side agreements , including promises of future business and advertising on
the AOL network , BizProLink entered into a preferred supplier agreement and a
marketplace software license with Defendants, paying PurchasePro $220,000 in th e
11 process .
115 . In reality, the PurchasePro software provided no benefit to BizProLin k
11 and was never .used by the company. Defendants knew at the time the secret sid e
agreement was entered into that BizProLink would have been unwilling to procure
the software license from PurchasePro absent the side agreement. Based upon Rule
26 Statements filed by BizProLink and AOL in pending litigation between the
parties, defendants Miller, Anderson and McGhee, at a minimum, knew of th e
relationship between the parties and the terms of the secret side agreement.
116 . The "roundtrip " transactions identi fied above constituted a material
portion of PurchasePro's total revenue in the first quarter of 2001 . The total revenue
recognized by the Company with regard to the Chinadotcom , Bigstep , Future Media
Products , Homestore . com, InsureZone and BizProLink transactions was $8 . 5
million, which was ultimately a significant and material amount of the Company's
first quarter revenues .
C. False And Misleading Revenue Recognition
Through The Overstatement Of Subscription Revenue s
117 . PurchasePro's subscriber revenues consisted of recurring payments
made by subscribers to access its supposed Global Marketplace . During the Class
Period, these fees varied from $39 to $99 dollars per month based upon the
individual contract. It was common for "subscribers" to enroll in the service through
a promotional reduced enrollment fee and be billed thereafter on a monthly basis .
Promotional enrollments usually varied from a period of three to six months, but in
some instances would extend to one year . The terms of the enrollment required the
subscriber to commit to payment for the entire promotional period in advance,
whether it was three months or one year. According to former employees ,
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PurchasePro would then recognize all of the revenue from the promotional period
upon receipt as opposed to properly allocating the revenue over the period of service
in accordance with GAAP .
118. It was a common occurrence, according to former employees, for a
majority of the customers to enroll through a promotional offer, such as those
purportedly purchased by AOL to assure AOL's ability to recognize the maximum
amount of revenue under the Warrant Agreement, but to never access or use the
service and to never pay any additional monthly subscriber fees once the
promotional periods expired. Nevertheless, PurchasePro maintained such non-
paying customers on their roster of members and continued to record their monthly
subscription revenues and related accounts receivable . In fact, some of the most
prominent customers that the Company boasted as using their marketplace --
including the Phoenix Suns, the Arizona Diamondbacks, Carnival Cruise Lines,
Bank One Ballpark, America West Arena and ILX Resorts -- publicly admitted that
they never "actually purchased anything" because executives were not convinced it
would recoup the cost of membership .
119 . Through these inflated membership numbers, at various times
throughout the Class Period, defendant Johnson publicly boasted that PurchasePro's
number of paying subscribers was growing . However, according to former
employees of the Company in the finance and IT departments, the actual number of
"true users" on the PurchasePro system varied from 1%-9% of the overall numbers
being reported to the investing community . The remainder of PurchasePro's
"subscribers" that were maintained on the Company's roster were non-paying and
non-participating customers that, as stated by one company, "were just kicking the
tires ." These non-users were retained on the Company's roster after they ceased
making payments, materially adding to the reported amounts of the Company's
accounts receivable .
120. The number of non-users carried on the accounts receivable was furthe r
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exacerbated when PurchasePro entered into "joint development " deals with AOL.
There was a glitch in the software programming that linked AOL subscribers to the
registration forms for PurchasePro such that each time an AOL subscriber began to
register for the PurchasePro Global Marketplace, whether or not the registration
procedure was completed, a new account was established in PurchasePro's account s
f receivable . Former data entry personnel estimate that this glitch alone wa s
responsible for creating over 100,000 non-paying accounts for AOL subscribers who
did not even know they had accessed the PurchasePro system . Thus, several of the
non-paying AOL subscribers had multiple accounts, none of which were ever paid
or used . According to former data entry personnel, this ultimately led to the creation
of over 500,000 accounts, none of which were paying .
121 . Furthermore, according to former employees, PurchasePro never
I conducted credit checks on any new customers during the Class Period . Moreover ,
despite the fact that the Company's accounts receivable skyrocketed during the Class
Period, PurchasePro did not have adequate collection procedures in place to collect
these receivables . Instead, the Company hired one contract employee to handle
collection of all outstanding accounts receivable . Thus, throughout the Class Period,
the Company had no reasonable expectation that it would actually be able to collec t
these fees . Nevertheless, the Company continued to record these subscriptio n
transactions as receivables and related revenue throughout the Class Period .
122. These factors, which include continued non-payment of monthl y
subscription revenue, lack of any assessment of customer creditworthiness, lack of
adequate collection and data processing departments and erroneous processing of
fictitious customer accounts clearly resulted in PurchasePro improperly recognizing
significant revenue without persuasive evidence of an arrangement and without
adequate assessment of creditworthiness . See ARB 43, Chapter IA, and Accounting
Principles Board ("APB") 10, ¶12 .
123 . Defendants, and in particular the PurchasePro Defendants, were aware
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of these operating issues, the fact that many of PurchasePro's monthly subscribers
were not paying and that the Company's customer database was inaccurate, but they
still chose to materially overstate recorded subscription revenues in order to support
their claims of continued revenue growth . They did so even though they knew that
recorded revenues and receivables were not fairly presented in accordance wit h
II GAAP .
D. Understatement Of Required Allowance For Doubtful Account s
124. As discussed herein, PurchasePro did not perform any form of credit
approval during the Class Period and had insufficient personnel staffing to follow-up
on collections. Further, the Company's collections significantly trailed the amount
of revenue being recorded which should have caused great concern among the
PurchasePro Defendants given the significant amount of supposed monthly
subscription revenue that the Company was reporting . In addition, accounts
receivable for PurchasePro at the end of fiscal year 1999 was approximately
$1,950,000, compared to over $23,000,000 for the end of fiscal year 2000 . At the
same time, the reserve for such amounts for the end of fiscal 2000 wa s
approximately $2,500,000 . Since the receivables of the Company were not truly
collectible, the reserve for such amounts was materially understated and improper .
125 . The Company's receivables were increasing proportionately more then
its revenues . The Company, as a result of these collection issues, should have
further increased its allowance for doubtful accounts receivable . The Company's
collections, as a percentage of its revenues on a quarterly basis, were materially less
than 100% throughout the Class Period .
126 . Under GAAP, the Company is required to record timely reserves to
adjust the carrying amount of its accounts receivable to the amount expected to be
collected. See Financial Accounting Standards Board ("FASB") 6, ¶34, and FASB
5, ¶¶3 and 8 . An estimated loss should be accrued by a charge to income, if both of
the following conditions are met :
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a . Information available prior to issuance of the financial
statements indicates that it is probable that an asset had been
impaired at the date of the financial statements .
b . The amount of loss can be reasonably estimated .
127. The PurchasePro Defendants , were aware of PurchasePro ' s accounts
receivable/collection issues and failed to timely and accurately provide for a reserve
for doubtful accounts . This resulted in material understatements of the Company's
general and administrative expenses and its net losses during the Class Period . FASB
No. 5, ¶ 22 .
E. False And Misleadin Revenue
Recognition Through Back Dating Of Key Contracts
128 . Throughout the Class Period, PurchasePro improperly recognized
recorded revenues from contractual agreements that had not been fully executed . In
fact, as stated above, and according to former employees of the Company,
PurchasePro recognized revenue from contracts that were fraudulently back-dated
so that the revenue from those contracts could be immediately recognized .
129 . It was PurchasePro's customary business practice to reflect the terms
of its arrangements providing for the sale of its marketplace software licenses an d
related services in written contracts. GAAP is unequivocal in requiring that before
any revenue can be recognized from such arrangements, "evidence of the
arrangement is provided only by a contract signed by both parties ." SOP 97-2 .
130 . A former key financial employee has said that at the end of eac h
quarter, management would analyze the recorded revenue, versus the publically
projected revenue, and for each quarter the Company would be short of its financial
goal. Company management would discuss pending large contracts that may have
existed at the end of the quarter . The former employee was then instructed by
PurchasePro management, and in particular defendant Miller, to "go find the
revenue" necessary to make the revenue goal for the quarter . This former employee
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would then contact the sales people involved in pending large contract deals . If
signatures were not available until after the quarter closed, the date on the contrac t
11 was changed by the sales person involved to falsely reflect that the contract was
executed in the previous quarter .
131 . This has been confirmed by defendant Anderson, who admitted under
oath that he signed a PurchasePro Internal Confirmation Letter backdated by
Anderson to March 30, 2001, the last day of the first quarter . In 'the letter, Anderson
admitted that he lied to and otherwise deceived PurchasePro's auditors when h e
stated that PurchasePro had not made any other unidentified or undisclosed oral
agreements, written agreements or obligations to deliver future services to
InsureZone that were related to the sale of the marketplace software license .
132 . This former employee stated that these contracts were for amounts
ranging from $50,000 to millions of dollars . The contracts typically were to engage
PurchasePro to build marketplaces for the customer involved. Certain former
employees have said that all of the revenue from these transactions was recognized
immediately even though actual work on these marketplaces did not start for two to
three months later, if ever .
133 . SOP 97-2, ¶74, mandates that companies use "contract accounting" if
the sale involves "an arrangement to deliver software or a software system either
alone or together with other products or services, which requires significant
production, modification or customization of software ." PurchasePro's transaction s
met this criteria . In applying contract accounting, PurchasePro was required to use
either the percentage -of-completion method or the completed contract method . See,
SOP 97-2, ¶¶74-75 . As long as the Company had "reasonably dependable" cost
estimates, it could use the percentage-of-completion method . However, this would
have required PurchasePro to defer the majority of revenue to future periods on
properly executed contracts . These contracts were not even executed prior to the
quarter end , so therefore no revenue should have been recorded in connection wit h
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134 . Thus, Defendants , and particularly the PurchasePro Defendants ,
knowingly violated GAAP by recognizing revenues from software licensing
arrangements prior to their bi-lateral execution . The Company also recognized all
respective revenues from these un-executed contracts even though substantially all
work associated with delivery of a working product was not to be performed until
several months later, thereby requiring deferral of the majority of the revenue
associated with a properly executed contract . As a result, not only were
PurchasePro's revenues inflated, and net losses materially understated, but the
Company's representations of conformance with SOP 97-2 and GAAP were false
and misleading .
F. False And-Misleading Revenue
Recognition On Future Maintenance And Hosti n
135 . PurchasePro also charged recurring maintenance and hosting fees to
third party licensees. During the Class Period, defendant Johnson claimed and
represented to investors that such hosting and maintenance fees, over the life of th e
contract, would approximate 50% of the cost of the license in recurring maintenance
and hosting revenue .
136. These maintenance and hosting fees, however, did not commence until
the program was fully functional and the third party marketplace was operational .
Therefore, such revenues would not commence for a period of six weeks to eighteen
months from the actual signing of the contract .
137. Moreover, as set forth above, during the Class Period, PurchasePro and
AOL entered into round trip transactions with various third parties where the
PurchasePro marketplace software licenses were only purchased due to secret side
agreements of promised investments by or sales of goods and services to
PurchasePro, PurchasePro senior officers or AOL . According to former PurchasePro
employees, the customers themselves and the admitted testimony of defendan t
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Anderson, many of these third parties were unaware of the purpose and function of
the license and as such never implemented the software . This resulted in no
maintenance or hosting revenue whatsoever for PurchasePro .
138 . Asa result of these factors, PurchasePro was never able to generate the
recurring maintenance and hosting revenue that it represented would naturally follow
the execution of the marketplace software license .
G. False And Misleading Revenue
Recognition On Marketplace Software
Licenses For Non -Functional Softwar e
139. According to SOP 97-2, ¶7, for software arrangements, in addition to
the delivery of software or a software system, which require significant production,
modification or customization of software, the entire arrangement should be
accounted for in conformity with Accounting Research Bulletin ("ARB") No . 45,
Long-Term Construction-Type Contracts and SOP 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts, The
proper accounting for these types of contracts is one of two generally accepted
accounting methods : the percentage of completion method or the completed contract
method, which would require full deferral of revenue and profit until the contract i s
completed .
140. According to SOP 81-1, ¶23, the percentage of completion method is
preferable as an accounting policy in circumstances in which reasonably dependable
estimates can be made and in which all of the following conditions exist :
1 . Contracts executed by the parties normally include provisions
that clearly specify the enforceable rights regarding goods or
services to be provided and received by the parties, the
consideration to be exchanged and the manner and terms of
settlement ;
2 . The buyer can be expected to satisfy his obligations under th e
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contract ; and
3 . The contractor can be expected to perform his contractual
obligation .
141 . According to reports received. from several key financial an d
operational former employees of PurchasePro , a high percentage of these
transactions ( 60-80%) for the delivery of software licenses and marketplace designs
were done at the end of the quarter when little time and effo rt was expended on the
customization of the product . These transactions were for anywhere from $50,000
to millions of dollars and , according to former employees , substantially all revenue
was improperly recognized "up front," i .e., at the time of the delivery of the non-
working and non-customized product . Proper revenue recognition under GAAP
would require the respective revenue from these transactions to be recorded in
accordance with the time, effort and cost that was involved with getting the product
to work, most of which would occur later at the time of customization .
142 . To conceal the fact that this software was not yet operational , plaintiffs '
investigation, together with testimony provided by former employees, has revealed
that Defendants utilized a scheme which included sham transactions whereby
PurchasePro would ship a non-functioning "skin" to the customer . In many
instances, such as the round trip transactions identified above, the customer was only
purchasing the marketplace software license to obtain investments or additional sales
in exchange and no further work was ever performed and the software was neve r
made operational .
143 . As such, PurchasePro knowingly violated GAAP by recognizing all of
the revenue up front on these licensing revenue transactions in order to meet or
exceed Wall Street expectations and maintain the illusion of consistent revenue
growth and a reduction of its net loss .
144 . As a result, not only were PurchasePro's revenues materially inflated
during the Class Period, but PurchasePro's representation of conformance with SO P
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97-2 and GAAP were false and misleading . Thus, the financial results detaile d
below, that were issued by the Company during the Class Period, were materially
false and misleading when disseminated due to Defendants' fraudulent activities .
V. INFORMATION PROVIDED BY FORME R
EMPLOYEES OF PURCHASEPRO
145 . During the course of plaintiffs' investigation, numerous former
f employees of the Company have been contacted and interviewed . Plaintiffs also
further corroborated the information provided by these employees through the
evaluation of discovery in third party actions to which these former employees were
not parties, including the review of deposition transcripts of certain of these forme r
employees. The former employees listed below held managerial and executive
positions in accounting, operations, finance, business development, corporate
development, data entry, accounts receivable and contract administration during the
Class Period. For the purpose of reference, the following allegations are a
compilation of the information provided by these former employees of the Company .
These individuals had first-hand knowledge of PurchasePro's true state of affairs ,
prior to, during and after the Class Period .
146 . Former Employee 1 ("Employee I") was employed by PurchasePr o
from September 1997, until August 1999, as an Accounting Manager and was
responsible for Accounts Payable and Accounts Receivable . Employee 1 was hired
by and reported to Brian Cole originally, and then later to defendant Miller .
Employee I also confirmed that Brian Cole and defendant Miller both reported
directly to defendant Johnson. The information provided by Employee 1 . is
important because it provides some background as to the Company's state of affairs
just prior to the beginning of the Class Period s
(a) When Employee I joined the Company, Brian Cole was the onl y
' For the purpose of this complaint, all former employees of the Companywill be referred to in the masculine, regardless of their true gender .
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person in accounting . Employee I described the accounting department and
financial software that was used by the Company . PurchasePro was using Excel
spreadsheets for all accounting records . Later, the system was converted to MAS 90 .
11 After that, and prior to the Class Period, records were moved from MAS 90 to Oracl e
f j Financials and after that, to Erogo software .
(b) Employee 1 stated that prior to the Class Period, PurchasePr o
improperly reported revenue by booking the prepaid portion of new contracts
immediately, rather than allocating the revenue over the number of months that th e
service was actually provided. Further, Employee I said that the terms and
conditions in sales contracts were so inconsistent that it made bookkeeping not only
incredibly difficult, but prone to error. Moreover, virtually no effort was put into
collections and PurchasePro management, including defendant Miller, refused to let
this former employee write off bad debts which caused accounts receivable to grow
dramatically .
(c) On the issue of "customer creditworthiness," Employee 1 said tha t
the creditworthiness of customers was not confirmed prior to the Class Period .
Employee I stated that when a copy of a contract was received, it was immediately
entered into the system for billing purposes . A contract would typically list the
billing information, the method of payment, the name of the software package that
was being purchased, what it included, the price on a monthly basis, and any other
terms and conditions . This former employee stated that packages over $9 9
sometimes went to defendant Johnson, or defendant Carton, for approval . This
former employee had been directed to assume that all contracts were "okay" and to
immediately book them as revenue. In other words, because upper management
wanted people using the system, PurchasePro would "pretty much" let anyone use
the software if they would sign a contract, regardless of their creditworthiness . This
information i~ important because throughout the Class Period, defendants ha d
unequivocally stated that the credit of all customers was not only checked, but
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approved by the Company's auditors .
(d) Employee l also stated that PurchasePro' s "accounting controls "
were seriously deficient during this time frame . In fact, Employee I expressed great
frustration with the lack of accounting controls at PurchasePro prior to the Class
Period. For example, Employee 1 said that one of the major "rules" in Company
contracts was that the client had to pay the first three months in advance and that
many times that "rule" was waived . In other words, even though this requirement
was not stricken from the contract, the salesperson would get the client to sign the
contract and at the same time, not make them pay the balance due . Employee 1 said
that this type o verbal agreement (the true nature of the deal) was repeatedly being
made with clients and superseded written agreements . Employee I felt that the
waiver of such fees in itself would lead to the artificial inflation of revenue since th e
contracts were not modified accordingly . The lack of Company accounting control s
is not only one of plaintiffs' primary allegations, it was the subject of an
investigation by the SEC . Further, the investigation resulted in the Company being
enjoined from violating the Exchange Act . Thus, not only is this information highly
relevant, it directly supports plaintiffs' allegations .
(e) Employee 1 also described the booking of revenue at the Company
during his tenure . When an advance payment on a contract was made, the entire
amount of the payment would be booked as one -time revenue, whether the payment
was for three months or for one year, depending on a particular deal . Any other part
of the revenue that was part of the contract was considered recurring and was
accounted for on a monthly basis . For example, Employee I said that one off-site
sales representative, Barbara Cohen, was selling one year contracts for
approximately .$2,000 each to buyers. All of these contracts were booked as one-
time revenue and no accruals were done . This would make the Company's
financials look very good when a great number of these contracts were sold in one
month .
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(f ) Employee 1 also indicated that growth in "accounts receivable" wa s
misleading because it did not represent a strong demand for PurchasePro's products,
but rather, the lack of payment by its customers . Employee 1 explained that
PurchasePro marketed to both buyers (which included large and small retail
businesses) and sellers (such as Gateway and AOL) . However, Employee 1 said that
the focus of PurchasePro's business was on sellers . By way of example, many of
PurchasePro's customers were in the hospitality industry . So a buyer might get on
the "system" and enter information indicating a need for towels . The software woul d
search for all sellers of towels and would send a request for a bid to each of them .
Because the Company's software was promoting sales to both large businesses, as
well as smaller. companies, the bigger companies were competing head to head with
the smaller ones . As such, Employee I stated that many of the smaller businesses
would give up and not pay their PurchasePro invoices because they had not won any
bids. However, Employee 1 said that while this would cause the size of account s
receivable to increase, it was not representative of the true number of paying
customers . Further, since PurchasePro did not have anyone that was actively
pursuing collections, these receivables were not being written off. In fact, just
months before the beginning of the Class Period, Employee 1 requested permission
from management, specifically defendant Miller, to write-off these uncollectible
receivables . However, Employee 1 said that these requests were refused . Moreover,
Employee 1 was not even allowed to place a hold on delinquent accounts which
would have prevented these customers from using PurchasePro software .
(g) Internal Company documentation confirms the misconduct allege d
by this formes' employee and other farmer employees contacted by plaintiffs .
Further, the documentation shows that the misconduct continued throughout the
Class Period. Specifically, in an e-mail written on September 27, 2000, from Joe
Macy to Tracy Teague entitled "Duplicate Accounts are an Increasing Problem,"
Macy notes that :
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Multiple accounts for a single Supplier company are quickly becominga serious problem. In many cases, the problem is unwanted duplicateaccounts which we have no way to prevent, track, or eliminate atpresent . . .
Where multiple accounts for a single Supplier company are desired, weneed to enable means of account identification beyond what wecurrently possess . For example : we have at least 67 accounts for SyscoFood Service currently in the system (and there are many more to comeas we move ahead in our project and interface with them) .
Additionally, in an e-mail written on September 1, 2000, from Jeannie Caruso
to Randy Gabe and defendant Miller, entitled "Trial Accounts on PPRO," Carus o
notes :
Randy ~ Scott - Please let me know as well what your thoughts are onthis. We probably need to define what are the best steps to take in theinterim, and what is the long term solution . Pulling these accounts offwill of course affect the numbers of users we have reported to have tothe public , but the fact remains, we can never track the use of users ortrue revenue generated per user with the information collected currentlyin our databases . . .
147 . This foregoing information shows how PurchasePro was being ru n
before and during the Class Period . Moreover, this has been confirmed by
PurchasePro ' s former accountants , Andersen , LLP. In a management letter dated
May 30 , 20006 (two months after the start of the Class Period), and addressed to the
"Management . nd the Board of Directors ofPurchasePro . com, Inc .," Andersen, LLP
stated, in part , that (i) the Company does not have written policies and procedures
for most accounting practices ; (ii) sales personnel or senior management have
historically negotiated contracts without adequately involving the finance and
accounting functions to ensure that any potential accounting issues are reviewed and
resolved before the contract is finalized; and (iii ) management changed its reserve
methodology several times during 1999 which leads to the loss of integrity in th e
b While the letter referred to fiscal 1999, the fact that the letter was datedMay 30, 2000, suggests that none of these problems had been corrected by thatdate . See plaintiffs' Request for Judicial Notice, Exhibit A .
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system. Unfortunately for the investing community, things only changed for th e
worse in the upcoming months .
148 . Former Employee 2 ("Employee 2") was employed by PurchasePro
from November 1999 until October 2001 . During his entire tenure, he worked in th e
finance department and was responsible for making revenue and expense
projections . Fe was also responsible for making credit recommendations to the
credit committee. Employee 2 primarily reported to defendant Miller during the
Class Period . He provided plaintiffs with important information concerning ho w
Company revenue was recognized and by whom .
(a) Employee 2 stated that throughout the Class Period, projections of
both expenses and revenues were generated for upper management's review .
Further, the model of revenue projections was based on the following sources of
information which included : (i) deals in progress (provided by the sales team) ; (ii)
"additional" sales information provided directly by the CEO, defendant Johnson ;
(iii) information on existing contracts ; and (iv) information from the existing
customer base .
(b) In addition to the foregoing, Employee 2 said that revenue was
derived from the following sources : (i) selling licenses for Company software so that
customers could set up a marketplace (non-recurring revenue) ; (ii) hosting and
maintenance fees for the licenses (recurring revenue) ; (iii) Internet advertising
revenue from "banners" or "pop-ups" on PurchasePro's own marketplace (recurring
revenue) ; and (b.v) subscription revenues (derived from PurchasePro's use of its own
marketplace"" . Each marketplace would have its own subscribers . Each subscriber
would be a business that would pay a fee between $19-$100 per month . In theory,
by logging into a marketplace, an individual or business would have access to
millions of new customers (recurring revenue) . Employee 2 also noted that if a
company was not creditworthy, it was usually pretty obvious .
(c) According to Employee 2, defendant Johnson was very activel y
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involved with sales, and the controller of the Company played a part in the
classification of revenues . This is important because it confirms Johnson's
knowledge of the Company's true financial condition, including revenue
1 1 recognition, throughout the Class Period .
(d) Employee 2 also explained that "license" revenue and revenue s
i from the "sale of several marketplaces" were considered to be one and the same .
Employee 2 further confirmed that PurchasePro sells "marketplace software" and
that each time it sells a marketplace, that is equivalent to selling a license to run th e
PurchasePro Software .
149 . Former Employee 3 ("Employee 3) was employed by PurchasePro
from November 1999, until Ap ril 2002 as Director of Business Development . He
was primarily responsible for getting large customers that would potentially add a
significant number of new users of PurchasePro ' s system. He repo rted to Jim
Scholes ("Scholes" - VP of Business Development) who reported to defendant
Anderson (VP of Strategic Development ) who in turn reported to defendant Johnson .
The information provided by this employee confirms that PurchasePro had a trac k
record of misrepresenting the true number of paying customers to the public, and the
lack of demand and effectiveness of PurchasePro's product, both during and after the
end of the Class Period .
(a) Employee 3 stated that in July of 2001, he met with a senio r
financial analyst for PurchasePro, Dave Clark ("Clark") . During that conversation,
Employee 3 noted to Clark that, during analyst conference calls, Employee 3 had
heard defendant Johnson state that the Company had 350,000 customers . Moreover,
when Employee 3 inquired of Clark why PurchasePro did not have more cash if the
Company had so many customers, the response by Clark was that "a lot of the
information that PurchasePro told the public was not true ." Clark also stated that the
Company might only have 20,000 paying customers (this is months after the end of
the Class Period) and that many of PurchasePro's transactions were nothing mor e
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II then handshake deals which didn't involve cash .
(b) Employee 3 also stated that as pa rt of the PurchasePro training
program for the AOL sales force , he witnessed other employees of PurchasePro lying
to AOL salespeople in January 2001 (during the Class Period) when PurchasePro's
sales people set expectations regarding the speed of PurchasePro's sales .
Specifically , Employee 3 said that PurchasePro lied to AOL employees by stating
that each salesperson would be able to close two large deals a quarter worth between
$250,000 to $1,000 ,000 each . Employee 3 knew this to be untrue , but refrained from
saying anything at the time for fear of losing his job. After working for several
months with the AOL sales team , Employee 3 ultimately admitted to AOL
employees that it had taken him approximately 18 months to sell just one
PurchasePro license . This information supports the lack of desirability for
PurchasePro's products and the need to enter into the side agreements set fo rth
herein in order to sell marketplace software licenses .
(c) Employee 3 also stated that, along with other salespeople, they
knew that PurehasePro was selling what they ca ll ed "vaporware" (non-functional
software ) to tht- business community . Employee 3 was directed by superiors, such
as Scholes , to promise customers anything to make them sign a contract . Employee
3 said that customers were told that they would get new features which they had
requested within 30 days , even though it was known that the features would never
be delivered . One example of a promised feature that was made to every customer
was the ability of a marketplace owner to collect a percentage of each sale that was
sold through the use of their "marketplace" (software they bought from
PurchasePro) . However, Employee 3 said that the Company didn't have a method
for tracking the transactions which would be required to calculate percentages that
were due . In fact , even as late as March of 2001, Employee 3 said that when an
individual named Sushil Garg of Erogo was brought in and placed in charge of the
entire PurchasePro product to implement this feature , it still didn 't work.
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(d) Employee 3 further stated that the way the Company 's sales people
were told to sell the product was unethical because PurchasePro didn't have the
technology it was trying to sell, Employee 3 said that he almost had a sense of relief
when customers like Allstate Insurance saw through the Company pitch and told
PurchasePro's salespeople to come back when the features they wanted were
actually available .
(e) As for defendant Johnson's sales involvement, Employee 3 state d
I that Johnson closed most of the large deals and that no deals were made without hi s
being involved. This confirms what other employees have stated which supports
Johnson's knowledge of PurchasePro's true financial condition .
(f) Finally, Employee 3 stated that defendant Johnson told Compan y
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employees that anyone selling their PurchasePro stock options was committing an
act of disloyalty and that they were "leaving money on the table ." In light of all the
foregoing, Employee 3 left the Company because he felt that Johnson had no
business sense or business ethics .
150 . Former Employee 4 ("Employee 4") was employed by PurchasePr o
as Vice President of Corporate Development from February 2000 until October
2000 . His primary responsibilities included eliminating those portions of
PurchasePro that did not make money and structuring new deals with potential
customers . He reported directly to defendant Johnson . As with the other
information provided in this section, Employee 4's revelations are very important
because they directly support plaintiffs' allegations . For example, Employee 4
revealed that Johnson wrongfully provided information to analysts, misled analysts,
was personally, motivated to increase PurchasePro's stock price and that Johnson
"very aggressively" recognized revenue which included making nonsensical deals,
including the AOL deal, to achieve his goals .
(a) Employee 4 stated that on many occasions prior to, and after ,
joining PurchasePro, Employee 4 heard Johnson provide financial information t o
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analysts that was not publicly available, in violation of SEC regulations . For
example, during the Class Period, Employee 4 heard Johnson tell analysts about
"large deals" that were about to close, including the Stratton and Warren acquisition .
Employee 4 was surprised by Johnson's behavior because analysts were only
supposed to receive publicly available information . Employee 4 confronted Johnson
about the inappropriateness of these disclosures and the two of them had many
heated discussions on this topic . This information is relevant because, according to
Employee 4, Johnson made these disclosures in order to win favor with analysts s o
that more of them would cover PurchasePro .
(b) Employee 4 also remembered hearing Johnson state the number o f
PurchasePro "users," and while Employee 4 did not know the exact number of
paying users, Employee 4 knew that it was much smaller than defendant Johnso n
had stated . As such, Employee 4 confirmed what other employees have stated, that
Johnson's statements were misleading to analysts and to the public .
(c) Employee 4 also stated that in the middle of 2000, under Johnson' s
direction, PurchasePro created a new way of recognizing revenue . Employee 4 said
that a salesperson would make a deal, and enter into a contract, and a softwar e
engineer would quickly put together a "skin" of software that would "appear" to be
functional . This "skin" would be put together by PurchasePro developers in about
5 hours and delivered to the customer . Once this software was available, Employee
4 said that accounting would recognize all the revenue from the deal . In other
words, the real product that would meet the customer's expectations was not
complete and it would take anywhere from weeks to months to finish, if ever . Not
only did Employee 4 characterize this as "very aggressive" revenue recognition, he
argued with Johnson on this issue repeatedly . Employee 4 stated that between 60%
and 80% of all. sales were completed at the end of the quarter under this scenario .
(c) Employee 4 also said that the way Johnson was putting deals
together didn't make any sense . Employee 4 told Johnson this and explained to him
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why it was wrong. Employee 4 said he was eventually fired because of disagreement
with Johnson on this point . As for which deals did not make sense , Employee 4
referred to the "warrant swaps" with companies such as Gateway, Computer
Associates and AOL, and also stated that PurchasePro and AOL "sold" custome r
I lists to one another .
(e) Finally, Employee 4 stated that Johnson was trying to achieve
growth that paralleled that of Ariba and CommerceOne . This goes directly to
Johnson's state of mind, i .e., scienter. Employee 4 said that in order to achieve suc h
high growth, PurchasePro needed to receive a larger portion of revenue up front (at
the time of delivery) . Employee 4 stated that PurchasePro sold all it could sell in the
way of subscriptions . Then, when the Company couldn't get the growth Johnso n
wanted (in the middle of year 2000), a different model was used wherein the
Company would sell software to outside companies that would then sell
subscriptions . This temporarily achieved the growth desired . However, when that
didn't work anymore, Johnson started pulling "tricks" that included the warrant-
swapping and "aggressive" recognition of revenues -- which included the use o f
skins.
(f) Finally, Employee 4 said that keeping a high stock price was
important to Johnson because he had borrowed money against his stock options and
bought more PurchasePro stock . This confirms numerous articles which have bee n
discovered by plaintiffs and are discussed in more detail below . Moreover,
Employee 4 stated that other executives in the Company had purchased expensive
houses by borrowing against their options as well . Hence, Employee 4 said that if
the stock price fell, options would significantly lose value and their loans would
have been called by their lenders . This goes directly to PurchasePro Defendants '
scienter and helps to explain why they would have engaged in such fraud .
151 . Former Employee 5 ("Employee 5") was employed by PurchasePro
from June of 1099 until May of 2001 . Employee 5 was initially a Financial Analys t
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at the Company and was then promoted to Assistant Controller . Thereafter, in
October 2000, Employee 5 was moved to special projects in customer support and
had the title of Applications Analyst until the end of his tenure . During the entire
time that this former employee worked in the finance department, he reported to Je ff
Ramsey ("Ramsey") who reported to defendant Miller . The information provided
by him is very important because it offers exceptional evidence of fraud . Employee
5 said that during the Class Period., PurchasePro repeatedly and falsely recognized
revenue that belonged in later quarters so that management could "make their
numbers" for the current quarter. Moreover, the Company recorded revenues when
in fact, no money had been received. Employee 5 also confirmed what other former
employees ha""e disclosed, that PurchasePro did not perform credit checks o n
customers, even when a large contract was involved .
(a) Employee 5 directly dealt with defendants, specifically defendan t
Miller . Employee 5 stated that each quarter, upper management had a revenue goal
they had to reach . Employee 5 would prepare a financial report a few days before
the end of each quarter . Each quarter the report showed that management had not
met its goal . T .iere would then be a meeting that included, among others, Employee
5, Ramsey, and defendant Miller . Ramsey and Miller would discuss pending large
contracts that were about to close . They then instructed Employee 5 to "go find the
revenue" necessary to obtain management's goals . In order to " fi nd revenue,"
Employee 5 would contact each salesperson who was involved in large contract
deals describe .] by Ramsey and defendant Miller, and the exact status of the dea l
would be obtained. In some cases, if signatures would not be available until after th e
quarter closed, Employee 5 said the date on the contract would be back-dated by the
salesperson tc falsely reflect the contract closing in the earlier quarter so that
PurchasePro c,)uld book the revenue immediately. For each of these large pending
deals, PurchasePro would immediately recognize all of the revenue from the deal .
Employee 5 stated that many of these large contracts were written for $50,000 t o
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millions of dollars, and were allegedly paid so that PurchasePro would build
websites for the company that signed the contract . Employee 5 further stated that
PurchasePro would receive some payment up front, while the actual work done by
the Company for these websites would not start for at least two to three months .
(b) Employee 5 also stated that PurchasePro and AOL had a deal
i whereby each would place a "value" on their customer lists . They would then
exchange lists . Employee 5 stated that PurchasePro would then book the "value" o f
the AOL list(s) as revenue . Impo rtantly , Employee 5 knew at the time that no real
revenue was being earned, but he recorded the transactions as instructed .
(c) On the issue of "creditworthiness," Employee 5 confirmed wha t
other former employees have revealed, that no credit checks were made during the
Class Period .
152 . Former Employee 6 ("Employee 6") was employed by PurchasePro
as a Data Entry Manager from August 1997 until July 2002. Employee 6's primary
responsibilities included managing the entering of customer lists and sales leads into
the Company's databases . At one time, this former employee had as many as 15
temporary employees and 12 regular employees reporting to him . Furthermore,
Employee 6 reported to, among others, defendant Moskal, Richard Applebaum,
Mark McNally, Gary Bennett, Stephen Dawahare, Jeannie Caruso, Dave Rives, and
Matt Sorenson. Employee 6 confirmed what other employees have stated, that on
multiple occasions, PurchasePro -- through Johnson -- made false public statements
regarding the number ofPurchasePro's paying customers . Employee 6 also said that
documents were made public (and were never corrected) containing the same false
statements regarding the number of PurchasePro's paying customers . This type of
information goes directly to the demand for the Company's products and the
financial outlook of the Company at the time these representations were made .
(a) When Employee 6 was asked about statements that Johnson made
during year 2000, regarding the number of "paying customers" in the Company' s
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database, Employee 6 (who handled all of the customer lists) indicated that report s
would go out all the time which stated that all of the people in the system were
paying customers . Employee 6 said that this "flat out, was not true ."
(b) Internal documentation confirms the misconduct alleged by thi s
former employee. For example, in an e-mail written by Tracy Teague, Managing
Director of Information Systems, to Ralph Ray, Leah Thomas and Justin Carlson,
on July 24, 2000, Teague noted his concerns about the free 30 day trial accounts
being counted or given to the street as paying customers in the system . Accordingly,
in an e-mail he notes that :
We currently have 19,535 desktops on the production system. Thebiggest problem I have with this is that they do not pay, for any of theirac ivity . . . Our only way to control both of these issues is to move themto a demo environment where they can play all they want - but do nothave the potential for damaging our data integrity . . . .
(c) Moreover, in a series of e-mail exchanges between August 9 and 10 ,
2000, between John Devlin, Justin Carlson, Leah Thomas, Ramsey, Bryan Gage an d
Jason Sadow, entitled "Trial accounts vs Closed accounts," John Devlin noted :
We still have TRIAL accounts in production. These accounts have nopayment or promise of payment in their foreseeable future toPurchasePro . We need to Close those trial accounts where we have T& C's that have a payment stream promised (besides ZERO). All otherTrial accounts needto stay on production and stay on TRIAL statusuntil they can be contacted for conversion in a methodical fashion .These TAL accounts still need to have the ability to createtransactions on our network , We report number of accounts on ournetwork and that number has included "TRIAL" accounts. If wechange that method our accounts will go from approximately 25k to10k. . . . . . .TOTALLY UNACCEPTABLE . In our cleanup of TRIALaccounts , if they are in the CLOSED status they will show ourcancellation rates to skyrocket merely as a byproduct of maintenance .ALSO UNACCEPTABLE .
[In a response by Leah Thomas, she noted : ]
YOU ARE CORRECT>>>JR JOHNSON has put the numbers out thereand we cant take the large number of trial accounts off at this point .We are widdling away of them by closing them as contracts come in .
(d) Employee 6 also saw documents on several occasions that wer e
about to be released to the public that included the number of "paying" customers .
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On these occasyons, Employee 6 went directly to defendant Benyo, who was Senior
Vice President of Marketing, and told Benyo that the statements were not true
because the number of paying customers was not that big . However, Benyo refused
to change the documents to show the correct numbers .
(e E According to Employee 6, the correct way to calculate the number
of paying customers was to only look at the accounts in which a signed contract was
in place and where the status was "billable ." Accounts that had a status of "closed,"
"trial," or "canceled," should not have been counted . Instead of using only the
"billable" accounts, the documentation that was produced used the total number of
accounts in the: system . For example, Employee 6 said that activities with AOL
during and after the Class Period had resulted in over 500,000 accounts being in the
system, but no-►e of them were paying accounts, Although AOL had a contract in
place with Pun hasePro, and was considered "billable," all of the accounts that were
created via ACL were either "closed" or "trial . "
(f) In addition , Employee 6 stated that many of AOL's customers were
not even aware that they had accounts with PurchasePro . Apparently, the customers
had signed up for some type of service provided by AOL and as a result their names
were sent over to the Company . Employee 6 said that people would go to AOL or
Netscape and would think that they were signing up for small business services,
including purchasing services . PurchasePro was the software behind that interface .
The customer would provide their information such as company name, contact,
address, etc. This information was instantly sent to PurchasePro where a new
account would be automatically created . However, Employee 6 said that despite the
foregoing, not, e of these "customers" paid PurchasePro for these services and were
not even aware; that they were using PurchasePro software . Employee 6 also said
that while the plan was to eventually contact these people and convert them to
paying customers, that never happened . Employee 6 said that upper management,
and defendant'Johnson in particular, was telling the public that all of these account s
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were paying cvstomers .
(g) Employee 6 also constantly battled with management to remove th e
dead accounts from the system . In fact, Employee 6 said that Benyo was "running
games" to push the numbers up . Moreover, even after the deal with AOL was dead,
defendant Benyo told Employee 6 to keep the dead accounts on the system because
it would make the year-end numbers look better for 2001 and 2002.
(h) Employee 6 also described Company employee meetings held by
PurchasePro wherein defendant Johnson would make comments concerning the
number of "paying" customers that were made to the public . Employee 6 said that
in conjunction with several other employees, they would all shake their heads in
disagreement . According to Employee 6, these types of statements to PurchasePro
employees were made on a series of occasions from July 2000 through May 2001 .
(i) According to Employee 6, there was also a serious flaw in a certai n
software interface which led to the artificial creation of accounts from AOL . Every
time information was received via the interface, even if the information was
incomplete, the software would automatically create a new account in the
PurchasePro system for the new "customer ." Employee 6 stated that it was caused
by end-users on the AOL site terminating part of the way through the process to
"sign-up" for PurchasePro . However, despite this termination procedure, Employee
6 estimated that about 100,000 of the accounts in the PurchasePro system were
artificially created as a result of this error. Moreover, Employee 6 stated that upper
management was aware of this error, but refused to fix it . The importance of this
information is obvious . It supports plaintiffs' allegations that the "partnership" with
AOL was little`more then a sham . Further, the warrants being "earned" by AOL for
their referral of "customers" was for nothing more then the creation of "artificial
revenue."
(j) When asked what benefit could be derived from exaggerating th e
number of paying customers, Employee 6 stated that it was so PurchasePr o
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salespeople would be able to convince businesses to join the system . This supports
plaintiffs' allegations . By creating artificial demand for the Company's products,
it would not only create an air of success in the financial community, it would also
inspire others to try the product . However, Employee 6 said this tactic did not
always work because certain businesses were quickly discovering that they could not
practically use the system . By way of example, Employee 6 said that a business
would want to buy some mattresses and it would put out a request to 50 different
companies that were in the system and sold mattresses . After a couple of weeks, the
customer would have only received 2 proposals . This was because most of th e
companies that were in the system didn't even realize they had a PurchasePro
account. Employee 6 said that these problems were well known within PurchasePr o
and were the subject of many meetings .
(k) This account given by Employee 6 is also confirmed by an internal
memorandum obtained pursuant to plaintiffs' investigation . In an e-mail dated
September 1, 2000, from Leah Thomas to defendant Carton and Randy Gabe,
entitled "Trial Accounts on PPRO," Thomas states :
I am referring Frances Richards to you regarding 8000 accounts shewants loaded on the system on a trial basis .
As you both are aware by doing this we are increasing our number ofusers, but decreasing our revenue per user .
Blair and I have been working very hard to stop this kind of activity outof sales because we already have a high number of users we do not getrevenue from because of these diversity initiatives of loading largenumber of accounts on a trial basis . It is dangerous for us to take themoff because our numbers for canceled accounts then rises .
(1 .) Moreover, in another e-mail from Leah Thomas to Jeannie Caruso ,
dated September 1, 2000, concerning the same subject, Thomas notes that : "FYI-
Tracy Teague suggested that I send her to Chris and Randy for approval on this . I
am very uncomfortable with loading that number of trial accounts ." Then in a
response from Jeannie Caruso to Randy Gabe and defendant Miller, dated September
1, 2000, regarding the same subject matter, she notes that :
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Please let me know what your thoughts are on this . We probably needto define what are the best steps to Take in the interim, and what is thelong term solution . Pul ling these accounts off will of course affect thenumbers of users we have proported to have to the public , but the factremains, we can never track the use of the users or the true revenuegenerated per user with the information collected currently in ourdatabases .
(ni) Finally, while Employee 6 said that he didn't have any detaile d
information regarding how revenues were recognized by accounting , he said that it
was a running joke in the accounting department that instead of the Company
following "GA-AP" ("Generally Accepted Accounting Principles "), PurchasePro was
using "JAAP" ("Junior's Accepted Accounting Principles"). In support of such a
statement , Employee 6 said that there were many times when defendant Johnson was
told by other executives within the Company that "you can't do this" and he would
say, "I don't care, do it ."
153 . Former Employee 7 ("Employee 7") was employed by PurchasePro
from September 2000, until January 2001, primarily in Accounts Receivable . His
duties included customer service, sending out collection letters, new account data
entry, researching customer accounts, updating customer accounts with paymen t
information ard assisting with collections . Former Employee 7 was hired b y
.Emmeline Plummer and Patty Smith, and his immediate supervisor was Mary
O'hara . Through this former employee, plaintiffs were able to confirm that the
Company had only one person responsible for all "collections" and that this person
was "inundated" with work . This is significant because, as noted above, it created
an artificially high level of accounts receivable which was not the result of high
demand for PurchasePro's products and services .
(a) Employee 7 stated that Sandra Engleheart was in collections and
that she was "swamped" with work. Employee 7 also said that when he finished
with his own work, he would try and help Engleheart since she was so overloaded .
However, even with Employee 7's help, Engleheart could not keep up with
collections on PurchasePro's non-paying customers .
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(b) Thus, growth in the Company' s receivables was not attributable to
I high demand for PurchasePro's product, but rather, an unwillingness of its customer s
I to pay .
154. Former Employee 8 ("Employee 8") was employed by PurchasePr o
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from August 1997 until May 2001 . During this time he worked as a Contract
Administrator . His primary responsibility was to review contracts and make sure
that all of the forms were correctly completed . Employee 8 also reviewed contracts
in order to prevent inconsistencies in business arrangements . He initially reported
to Kevin Liske, Vice President of Operations, and Mark McNally, Manager of
Customer Support, Inside Sales, and Data Warehousing . Later, Employee 8 reported
directly to Jeff Ramsey and the majority of his interactions were with the legal
department of PurchasePro which consisted of Nick Perrino and Scott Wiegand,
among others . Employee 8 revealed that improper classification of revenues was a
constant theme at the Company . Further, Employee 8 said that PurchasePro engaged
in questionable barter transactions that had subjective valuations for the services
provided by the Company. Employee 8 also said that PurchasePro improperly
continued to show non-paying customers as collectable revenue throughout the Class
Period. Consequently, this former employee confirmed what other employees have
stated, that the size of accounts receivable appeared to be larger than it actually was .
(a) Employee 8 stated that PurchasePro had three types of contracts : (i )
subscription contracts which cost about $49 per month and were for smaller
customers; (ii) "big fish contracts" with customers like AOL, Computer Associates,
and Gateway. Employee 8 would work closely with inside sales and national sales
on "big fish contracts" to ensure that there were no conflicts . Employee 8 said that
the PurchasePro people involved with the AOL transactions included Mark McNally
and Chris Hammond ; and (iii) so-called "Barney" contracts, a term coined by
PurchasePro employees which referred to barter transactions . By way of example,
Employee 8 described a Barney transaction that happened around December 2000 .
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PurchasePro approached Gateway and told them that PurchasePro would build them
a website and valued the website at approximately $500,000 (Employee 8 was no t
sure of the exact amount) . Employee 8 stated that the full amount was placed on the
books as incoming cash revenue and that Gateway was told that instead of paying
$500,000 cash, PurchasePro would accept $500,000 worth of computers . Employee
8 remembered .a trailer full of computers showing up at PurchasePro as "payment"
for PurchasePro's services. This former employee stated that the Company had
approximately a dozen of these types of "Barney" contracts . The obvious problem
with such barter transactions is that valuation can be highly subjective and therefore
misrepresent the true revenue received by the Company .
(b) Employee 8 further stated that improper classification of revenue s
was a constant theme at PurchasePro and that defendants Miller and Johnson were
among the people at PurchasePro that knew how revenue was recognized . Employee
8 said that many employees fought with defendant Johnson on revenue recognitio n
issues . Moreover, this former employee said that for three quarters he answered
questions posed by the auditors at Andersen, LLP.
(c) Employee 8 also participated in meetings with Andersen, LLP
personnel, the Company's auditors, and PurchasePro's financial staff regardin g
contracts . Employee 8 said that at each of these meetings, there were usually three
or four Andersen, LLP auditors, defendant Miller, Jeff Ramsey (risk management),
Randy Gabe VP of finance), Donna Lauger (assistant controller) and other
PurchasePro financial analysts . Each quarter, Employee 8 overheard comment s
about improper classification of revenues .
(d) On the issue of "creditworthiness," Employee 8 confirmed that a
large number of PurchasePro's customers didn't pay their invoices. Employee 8
elaborated by saying that many contracts had been setup so that PurchasePro woul d
automatically receive a monthly draft from the customers' business checking
account . However, there was an issue because a number of these companies wer e
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"fly by night operations ," and PurchasePro was not able to collect their fees . The
remarks of this individual are consistent with statements made by other former
PurchasePro employees con firming that PurchasePro would "pretty much" let
anyone use the software if they would sign a contract .
(e) Employee 8 also explained that many of the smaller contracts wer e
written for 3 years, at $49 per month , and that accounting would project the money
out for three years . However, Employee 8 said that quite often, after a few months,
the smaller customers would not see the value of using PurchasePro software . Thus,
they would stop using the software and stop paying their invoices . Nevertheless,
Employee 8 stated that accounting would still show this revenue as ongoing even
though it was r_ot .
(f; While Employee 8 was not directly involved in any of the legal
issues surrounding transactions with AOL, he stated that defendant Johnson, in one
of the many Company employee meetings that Johnson held, explained that even
though Purcha: ePro would eventually pay AOL $3 for each $1 it received, defendant
Johnson saw this as a "good deal" because PurchasePro would get instant revenue .
Johnson explained to his employees that the warrants were paid over a matter of
years, but by then PurchasePro would be well positioned to pay the money .
155 . Former Employee 9 ("Employee 9") was employed by PurchasePro
from March 1999, until March 2001, as an Assistant Controller, Controller, and
finally Risk Manager. His duties included managing Accounts Receivable,
Accounts Payable, and Payroll . During his entire employment, he reported to
defendant Mi11,r . According to this former employee, during the third and fourth
quarters of fiscal year 2000, defendant Johnson repeatedly battled with Andersen,
LLP auditors over accounting interpretations on Statement of Position ("SOP") 97-2 .
Moreover, PurchasePro improperly booked revenue based on Johnson's
interpretations . While Employee 9 feared for his job, and did what he was told,
Employee 9 eventually quit because of these issues .
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(a) In the third and fourth quarters of 2000, near the end of eac h
quarter, meetings were held in defendant Johnson's office . In attendance were
defendants Johnson and Miller and the Andersen, LLP auditors . The purpose of
each meeting was to go over revenue numbers and make sure that SOP 97-2 was
followed . Defendant Miller told Employee 9 that during each meeting, the auditors
would come prepared with a list of transactions that included revenue that the auditor
stated should not be recognized in the immediate quarter. In each of the meetings,
Johnson took a hard line that all of the revenue should be recognized . Defendant
Miller told Employee 9 that during these meetings, Johnson yelled and screamed at
the auditors and was very intimidating. Miller also told Employee 9 that in most
cases, Johnson prevailed because the auditors were careful to state that they weren't
signing off on Johnson's approach . According to Employee 9, Miller would come
out of these meetings and brief Employee 9 on all that had transpired during each
meeting. Employee 9 further stated that defendant Johnson was ultimately able to
get rid of this set of auditors and obtain a different set of auditors from Andersen,
LLP . While he wasn't sure of the date, Employee 9 believed that the first set of
Andersen, LLP auditors was replaced after the fourth quarter of 2000 .
(b) Employee 9 also said that PurchasePro was booking non-existen t
revenue . As other former employees have stated, AOL and PurchasePro were
exchanging "customer lists" and claiming revenue in exchange . Employee 9 was
personally aware that PurchasePro's accounting department recorded approximately
$4 million in, revenue for such an exchange, revenue that was never actually
received . Employee 9 believes that this transaction occurred in the fourth quarter of
2000 and also stated that there was a similar non-cash deal with Gateway, but didn't
recall the specific details of the Gateway transaction .
(C) When asked about the growth of accounts receivable, Employee 9
further confirmed that many customers would stop using and paying for PurchasePro
software in the first few months when they had no success with the product .
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I However, PurchasePro continued to bill them because no one was following up to
2 see if customers were using the software .
3 (d) On the issue of "creditworthiness," Employee 9 also confirmed the
4 information provided by other former employees . Specifically, from March 1999
5 until January 2001, PurchasePro did not take any steps to check creditworthiness of
6 any customers .
7 (e) Employee 9 also confirmed that PurchasePro was drastically
8 overstating the number of PurchasePro paying users, which has been reiterated by
9 numerous other employees of the Company .
10 (t) Finally, when asked about "non-cash deals," such as the Barney
11 contracts described by other former employees of the Company, Employee 9
12 confirmed that PurchasePro's agreement with Gateway computers was not a cash
13 deal and provided the following additional details . Employee 9 revealed that
14 Gateway received software which was a marketplace "skin" that had their logo on
15 it. Further, PurchasePro recognized this non-cash revenue as though it were cash
16 and accounted for it as advertising revenue . Employee 9 said that the computers
17 received should have been capitalized because they were fixed assets .
18 156. Former Employee 1.0 ("Employee 10") was employed by PurchasePro
19 as a Senior Financial Analyst and Budget Manager from May 2000 until November
20 2001 . He was responsible for the budget and variance reporting system, which
21 involved expenses and revenue forecasts . Employee 10 reported to Randy Gabe,
22 Vice President of Finance, who then reported to defendant Miller. As such, he was
23 directly involved in revenue recognition issues . Employee 10 confirmed that
24 Johnson exercised direct, personal control over the revenue forecasting process .
25 This goes directly to Johnson's knowledge of Company affairs during the Class
26 Period. Employee 10 also said that PurchasePro changed. its business model during
27 the Class Period which resulted in a new revenue recognition rule .
28 (a', Employee 10 said that while he was responsible for the entire
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budget, his focus was on Company expenses . This is because Employee 10 received
essentially all r--venue information directly from defendant Johnson . Occasionally,
Employee 10 would also receive Johnson's forecast numbers from defendant Miller
or Randy Gabe. After Johnson left the Company, revenue information came directly
from Richard Clemmer, the new CEO . Neither Employee 1.0, nor his immediate
supervisor, did anything to change revenue forecasts made by Johnson or Clenuner .
Moreover, Employee 10, and his superior, were frustrated by upper management
controlling so much of the revenue forecasting and not allowing them to participat e
in that process .
(b) When asked about the reclassification of $2 .3 million of recurrin g
revenue into one-time income, Employee 10 explained that PurchasePro had
changed its bu::iness model to being a software supplier . This is important because
under a software supplier model, PurchasePro would recognize more revenue up
front, instead of over the course of the life of a contract . Employee 10 stated that
before switching to this model, PurchasePro was supposed to recognize revenue ove r
the life of the ceal (e.g., if an agreement was in place for 4 years, each month only
1/48 of the rev.mnue would be recognized) . Thus, when PurchasePro switched to a
software mode l'., all sales would instantly be recognized .
(c) Employee 10 also stated that Johnson would project huge quarters
and that almost all of the projected revenue would usually be booked in the last week
of each quarter . When asked for specifics, Employee 10 stated that 85% to 95% o f
all revenue arrived in the last week of each quarter, and most of PurchasePro' s
revenue arrived on the last day of the quarter . Further, Employee 10 said that
PurchasePro 's revenue was p rimarily derived from large contracts which included
AOL, Gateway, and. Computer Associates . This former employee also claimed that
PurchasePro was "living and breathing" based on large contracts . Small contracts
($49/month subscriptions) were only generating a few hundred thousand per mont h
in revenues .
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157 . Former Employee 11 ("Employee I I") was employed by PurchasePro
from 1997, until August 2001, in Management Information Services ("MIS") . He
was hired by defendant Carton and was initially responsible for network support ,
technical support, and building computers . Later, he was given the title of Account
Manager and his duties included installing and setting up computers with
PurchasePro software for local customers, such as hotels . Employee 11 stated that
I a series of reports were produced that showed the number of users on th e
PurchasePro system, reports which were ultimately given to the public . Employee
11. also provided some technical information by stating that the PurchasePro
software used Oracle as a back-end database and an off-the-shelf software
application called "Crystal Reports" as a front-end tool to actually create the reports .
(a) Employee I 1 said that reports were generated at the end of eac h
quarter and distributed to individuals in finance such as Randy Gabe, Vice President
of Finance, and to John Devlin, Director of Database Marketing . According to
Employee 11, Devlin had the responsibility of ensuring that the numbers showed
consistent growth based on previous quarters . These reports were also distributed
to upper management . All of the reports were archived on the PurchasePro server
in the Crystal Reports directory .
(b) Employee 11 said that the number of PurchasePro users shown o n
the quarterly reports was greatly overstated . The reason for the overstatement was
explained as follows . Employee l 1 said that the database being used was "dirty"
(i.e., inaccurate), because it contained : (i) duplicates; (ii) test data developed and
used by PurchasePro Quality Assurance ; (iii) special demonstration accounts set up
by sales people ; and (iv) erroneously entered data. According to Employee 11, at
one point, there were over 100,000 accounts that were not valid during his tenure .
(c) To the best of his knowledge, the bad data was never removed fro m
the database . Employee 11 also confirmed statements made by other former
employees that many discussions were held between MIS and accounting about th e
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"dirty" database and that staff wanted to "clean up" the database by removing the
invalid entries. However, Employee I I was told by his peers that defendant Benyo
was not happy because the number of accounts in the database was too low and
Benyo had asked if there were other "rules" that could be used to increase the
numbers .
(d) When asked what "rules" were used to produce the reports ,
Employee 11 stated that the definitions were handed to him by management, but that
the person drafting the definitions was defendant Johnson . Employee 11 said that
he used Johnson's definitions to run queries in order to produce the quarterly reports .
Employee 11 also stated that management did everything it could to keep the number
of accounts reported at an artificially high level . As an example, Employee 11 said
that management was particularly upset on one occasion when someone in
accounting had accidentally charged the credit card of every PurchasePro account .
Management had a system whereby customers were sent invoices . However ,
management's fear was that customers would cancel their subscriptions if they were
actually charged for the software and this would consequently lower the number of
accounts on the system .
(e) It was also an ongoing joke inside the MIS and accounting
departments that the Company used the PurchasePro-dot-free model
("Purchase Pro . free") because nearly all of the Company's customers used
PurchasePro software for free .
(f) Employee 11 also said that many of the deals that PurchasePro
closed didn't rake sense because they would cost more in labor than any income
that would be received. As an example, Employee 1 I remembered a deal whereby
an employee, Mike Ermi, entered into a transaction that required a tremendous
amount of development and website support even though it was obvious that
PurchasePro would lose money on the transaction .
(g) As for whether or not defendant Johnson ever made misleadin g
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statements, Employee 11 stated that the MIS and accounting departments hated it
every time Johnson spoke to the employees . This was because Johnson would lie
using the numbers in the MIS reports . In particular, Employee 11 said that Johnson
would repeatedly use the number which was calculated as the number of "users "
(which was overstated), and state or imply that this number represented the number
of "paying" customers . Employee 11 also stated that on multiple occasions, people
in accounting had stated that Junior was sharing too much information with analysts .
158 . Former Employee 12 ("Employee 12") was employed by PurchasePro
from April 1999, until June 2001, in the MIS department . His duties included the
management of the Goldmine sales contact database as well as creating custom
reports from both the Goldmine and the PurchasePro database . For a short time
during the Class Period, he also worked on a CRM (Customer Relationshi p
Management) software project where he configured the Oracle database . Employee
12 stated that the MIS reports were not representative of the actual business that was
being performed on the PurchasePro system .
(a) Employee 12 stated that, during his employment at PurchasePro, he
and Blair Turner produced a series of reports -- which included quarterly reports
concerning the number of customer accounts -- based on information in the
PurchasePro database .
(I) When Employee 12 was asked if PurchasePro reports seemed
inconsistent w,.th his understanding of the Company's true financial condition and
product demand, Employee 12 said that the criteria that was used to create th e
reports was not representative of the actual business being conducted on
PurchasePro's system . Employee 12 further explained that requests were made only
for reports thai showed the total number of accounts that were on the PurchasePro
system . Employee 12 was never asked for the number of actual users on the
PurchasePro system. This information is pertinent to plaintiffs' allegations because
the number of accounts on PurchasePro's system was significantly larger then th e
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actual number of paying users ofthe system . Thus, by using the former number,
rather then the latter, the PurchasePro Defendants could portray to the investing
community that the paying user base was growing at a rapid rate, when in fact it wa s
not .
(c) Employee 12 said that if an account had never logged into the
system, nor performed a transaction, it should not have been counted as a
PurchasePro user. Employee 12 also said that for more than six months, he assisted
in the loading of 10,000 to 30,000 accounts onto the PurchasePro database eac h
month. These were accounts that were received from AOL. This volume of
information was created because any person that possessed an AOL business account
was being automatically registered for a PurchasePro account as part of an
agreement between PurchasePro, .and AOL. Moreover, these accounts were added
to the system -- and counted as active users -- regardless of whether or not th e
individual customer knew it had a PurchasePro account or had ever used th e
PurchasePro system .
(d) Employee 12 also said that the foregoing "customer" information
was input, by design, over a se ries of months so that PurchasePro could show tha t
it had a constantly growing user base . According to this former employee, in the
beginning, the Company needed to look like a successful startup . Employee 12 said
that when PurchasePro was going public, one of the key indicators of success in
PurchasePro's industry was the number of users on the system . Thus, the goal at that
time was to show significant increases in the customer database . However, eve n
after PurchaseFro went public, Employee 12 stated that this goal was carried forward
throughout the, Class Period . Moreover, when PurchasePro entered into a n
agreement with AOL, it was obvious to this former employee that the reason for
spreading the new accounts over a series of months was for PurchasePro to appea r
to have a constantly growing user base .
(e..) Employee 12 stated that he specifically remembered the larg e
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number of AOL accounts because the data entry group could not manage all of the
data at once during the first few months . This was because a $250,000 application
called Trillium was not up and running . Employee 12 stated that AOL eventually
accounted for between 200,000 and 300,000 accounts on the PurchasePro system .
(f) When Employee 12 was asked how many people actually used the
PurchasePro system , he said that approximately 2% - 9% of all accounts on the
system ever logged in or used the PurchasePro system at least one time . Employee
12 said that he knew this because he created (without direction) a series of reports .
One of these reports showed the number of people that had logged in at least once
to the system. Thus, at least 90% of the accounts that were being counted, and
reported as system users by the PurchasePro Defendants to the financial community ,
never used the PurchasePro software .
(g) According to Employee 12, PurchasePro was nothing but "smok e
and mirrors ." Employee 12 confirmed what other former employees have stated,
that it was well known that the database was "dirty ." Employee 12 said that he tried
to build into the reports some level of error correction (that reduced the number of
accounts reported), but he was "shot down" by management and the reports
continued to show over-inflated numbers .
(h) Employee 12 also confirmed that the only reason that PurchasePro
changed its model of doing business from selling subscriptions to selling software
was to immediately recognize revenue . When the change was announced, Employee
12 asked Randy Gabe, a former Vice President of Finance, why the change had
occurred. It was explained to him that PurchasePro needed to recognize revenue
immediately. Further, he was told that the fact that PurchasePro was shipping a CD
would not hurt PurchasePro. It didn't matter what was on the CD because the people
getting the software would not be able to run the software without building a "multi-
million dollar infrastructure" to make it work . Thus, Employee 12 confirmed that
customers were buying "software" with "no physical way" of actually running th e
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software that was on the CD . This information is important because it supports
statements made by other employees that PurchasePro was shipping "skins" an d
I immediately recognizing revenue on products that were non-functional .
(i) Employee 12 stated that the information that Johnson was providing
to analysts via the conference calls, and to the media, was unfounded . Employee 12
said that the statements were misleading and false . With access to inside
information for the Company, Employee 1.2 said that PurchasePro ' s business model
was not working, PurchasePro was not making money and that it was never goin g
to make money . According to this former employee, sales were decreasing ,
profitability w,~s decreasing, and the number of new users was almost non-existent ,
while the nurrber of transactions on the PurchasePro system was only mildly
increasing . Wren asked how he knew this information, Employee 12 stated that
anyone looking at PurchasePro's financial numbers would be able to see this . In
addition, he had access to all of the numbers in the PurchasePro system, and he ran
his own reports on the system to answer these questions for himsel f
(j' Finally, Employee 12 stated that Benyo was one of the people at
PurchasePro that would put a positive "spin" on the numbers that were presented t o
the public .
159 . Former Employee 13 ("Employee 13") was employed by PurchasePro
from October 1998, until June 2001, as a PurchasePro Senior Database Analyst .
During his entire employment at PurchasePro, Employee 13 worked in the MIS
department . H , reported to Blair Turner who reported to Tracy Teague . This former
employee said that he was one of a few people that were responsible for all of the
Company reporting . His duties included all data analysis, all of the sales reports, and
all of the financials for PurchasePro's management . As discussed in more detai l
below, Employee 13 described a meeting three or four days before the end of the
first quarter in 2001, where defendants Johnson and Carton were asked to decide
how the numb,-Ir of "users" on the PurchasePro system should be counted . In that
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I meeting, Employee 13 and his colleague, Blair Turner, were directed by defendan t
Johnson to use a report that showed a fraudulently high number of users and level
of activity for the PurchasePro system . Employee 13 also said that these fraudulent
numbers were released to the public . Employee 13 described why the numbers were
wrong, how they were wrong, the motivation that caused the fraudulent numbers to
be produced, and the motivation that caused the numbers not be changed after th e
fraud was detected .
(a) Employee 13 confirmed that many of the accounts on th e
PurchasePro system were not actively using the system and should have never been
counted as users. Employee 13 knew this because he ran reports which showed that
most of the "users" had never logged in or used the PurchasePro system . Employee
13 stated that only I% of the "accounts" were active users of the system .
(b) Employee 13 said that many of the contracts that were signed
allowed companies to use the system for six months at no charge . Once a company
signed on, accounts would be created for every employee in the company, even if
only a handful of employees would have needed or used the system. Thus, if a small
business signed up to use the PurchasePro system, and had 30 employees, this would
result in the sales team reporting 30 new "users," even though only one or two
people might be using the system .
(c) Employee 13 also stated that the reports showing the number of
users were wrong because some users were counted more than once . Users were
classified as buyers or suppliers . However, a number of users were both buyers an d
suppliers . Reports were prepared in such a way that the number of buyers was added
to the number of suppliers to produce the total number of users . Thus, the users that
were both buyers and suppliers were double counted .
(d) Employee 13 revealed that as a part of demonstrating th e
PurchasePro system to potential clients, sales people would create a "catalog" ( a
website showing products), and then create a series of fictitious purchase order s
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("P.O .'s") and fictitious bids . Employee 13 said that during his tenure, these P .O.'s
and bids were not removed from the system. Employee 13's group made efforts to
find these false P.O.'s and update their report filters so that the final numbers were
closer to accurate . Employee 13 also said that over 30 separate filters were used to
try and clean the data .
(e) Employee 13 learned directly from PurchasePro sales people tha t
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they were paid large bonuses based on how many new clients they had in a quarter
and how much business the client was doing in the PurchasePro system . Employee
13 knew this because sales people would contact him directly, ask for custom
reports, and then brag about their bonuses .
(f) Employee 13 stated that as a result of producing trend analysis
reports, which showed activity per account over time, he learned that in order to
maximize the. 'r bonuses, PurchasePro sales people were logging in to their
"customers' accounts" and creating fraudulent activity in the way of P .O .'s and bids .
Employee 13 spoke directly with the sales people, who apparently denied this
activity. However, Employee 13 said that the ability to monitor PurchasePro usage
from the back-end was more sophisticated than the sales people were aware . Thus,
Employee 13 was able to definitively track down the creation of the false data to
individual sales people . Employee 13 said that Mike Ermi and Mike Bump, among
others, were the worst offenders . Employee 13 explained that it was fairly easy to
see fraudulent transactions . For example, a buyer might normally place a P.O. for
pencils for a few hundred dollars . However, Employee 13 uncovered P.O.'s valued
between $10,000 to $20,000 for pencils that were supposedly issued by the same
buyer .
(g) Employee 13 informed the sales people that these transaction s
would be filtered out of the final reports . During these conversations , Employee 1 3
explained to the sales people that these transactions were obviously fraudulen t
because they were so large . Employee 13 stated that rather than stop the creation o f
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false data, the sales people started creating fraudulent P .O .'s ranging from $1,000
to $2,000. These were harder to detect .
(h) Employee 13 stated that creating this type of false data was easy fo r
the sales peopl. since they had been trained on how to use the PurchasePro system
and they already had the necessary user identification codes and passwords . Once
the false information was in the system, the sales people could then generate a
personal report from the system showing how much "business" they had "created"
and turn this report into their management chain . Employee 13 believed that
management used these individually generated reports to compensate the sales force .
(i) Employee 13 stated that the reports that were generated to show the
amount of activ ity on the PurchasePro system didn't reflect PurchasePro's true state
of affairs . Employee 13 recalled creating special reports to show the overstated
activity and that the amount of the overstated activity varied each quarter from
$200,000 to $10 million .
(j; Employee 13 said that management (which would have included th e
PurchasePro Defendants) was aware of the fraudulent activity . Employee 1 3
recalled that three or four days before the end of the first quarter of 2001, he and
Blair Turner were working late to prepare reports for Wall Street . Both of them were
having a difficult time coming up with accurate numbers due to the fraudulent dat a
in the system. They decided to involve management . They prepared two different
reports that showed the number of PurchasePro users and the amount of activity on
the system. The first report showed all "users" without filtering out the fraudulent
number of users or account activity. They called this the "bloated" report . The
second report was filtered and Employee 13 regarded this report as being fairly
accurate . Both documents contained lists ofP .O .'s, the responsible sales people, the
number of users, and the total dollar value of the activity for each account . They had
printed hard copies of both documents and used highlighting to show the accounts
and P .O .'s that were fraudulent . Employee 13 and Blair Turner also provided tren d
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analysis information which showed that the P .O .'s in question were inconsistent with
a particular client's history of activity . They also provided supplemental data that
proved the P .O.'s in question had been created by PurchasePro salesmen . At
approximately 6 :30 p .m., Employee 13 and Blair Turner walked to the management
offices . They knocked on defendant Johnson's door and a discussion ensued with
defendants Johnson and Carton . They presented all of the reports to defendants
Johnson and Carton and explained that the first report was truly inaccurate because
of the fraudulent number of users and activity . They also showed examples of the
fictitious P.O.'s, including dates and times . Johnson directed them to use the first
report, the "bloated" report, which was artificially inflated . Johnson flatly stated that
he didn't care if the data was incorrect, that all he cared about was the bottom line
and that he wanted to present the larger numbers to Wall Street . Employee 13 stated
that the difference in activity for this particular quarter was $4 million . Employee
13 and Blair Turner returned to their offices and completed their work some time
between 9 :30 and 10 :00 p.m. that evening .
(k) When asked why Mike Ermi had been demoted, Employee 13 sai d
that Ermi reported directly to Johnson and that Johnson demoted Ermi when he
became too aggressive and greedy and had sought too much money for himself in
the way of bonuses . Employee 13 also said that it was a running joke between his
group and accounting that PurchasePro was not making any money . Employee 13
stated that without the big hotels, PurchasePro would have had to close down .
VI . DEFENDANTS' FALSE AND MISLEADING STATEMENT S
160 . Throughout the Class Period, Defendants made numerous statement s
concerning the financial strength of the Company, as well as the effectiveness of the
PurchasePro business model . However, these statements were not only false and
misleading, they were designed to artificially inflate the value of PurchasePro's
securities for their own personal benefit. Moreover, it is now evident that only
through Defendants' scheme were they able to maintain investor interest in the
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Company . If Defendants had honestly represented PurchasePro's business from the
outset, the Company would have ceased to exist as a going concern long ago . In
fact, not long after the true financial condition of the Company was revealed,
PurchasePro filed for bankruptcy on or about September 11, 2002, just three years
after the Company went public .
161 . In light of the magnitude of the sham and round trip transactions se t
forth above, and the information provided by former employees, it is implausible
that Defendants were not aware of the true financial condition of the Company . As
high ranking officers and directors of PurchasePro and AOL, they undoubtedly had
knowledge of these facts while the following statements were being made to the
investing community . Moreover, a number of employees have described many
instances where PurchasePro Defendants were directly confronted with the problems
described above . However, these problems were never disclosed to the investing
community .
162 . Thus, in light ofthe true state of affairs of PurchasePro during the Clas s
Period as alleged herein, the falseness of Defendants' following representations i s
quite apparent .
163 . Beginning on March 23, 2000, the first day of the Class Period, the
Company issued a press release announcing that PurchasePro expected to exceed
previously-stated financial expectations for the quarter . The March 23, 2000 press
release quoted defendant Johnson as follows :
PurchasePro.com Anticipates Record First Quarter
LAS VEGAS (March 23, 2000) -- PurchasePro .com, a leader inbrowser-based business-to-business electronic commerce, todayannounced that it believes its results for the quarter ended March 3I,2000 , will exceed published expectations .
"We're looking at a record quarter," said Charles E . Johnson Jr .,Chairman and CEO of PurchasePro .com. "Our revenues are trackingsignificantly ahead of Wall Street's forecasts, with a high recurringcomponent and very high gross profit margins . Further, we have anextremely healthy balance sheet with more than $140 mullion in cashon hand and no long term debt .'
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PurchasePro.com's browser-based solution has gained broadacce tance by companies of all sizes . The company has more than.20,000 members on its public and private networks and powers morethan 100 private marketplaces .
"Our strategy of partnering with leaders in a variety of vertical andhorizontal communities, combined with our geographical reach, willenable us to reach the desktops of the critical mass of businesses andenhance our leadership position in business-to-business e-commerce,"said Johnson .
164 . Johnson' s statements , including those concerning "revenue" and a
"healthy balance sheet," were far from true . As numerous former employees have
indicated, Purc hasePro was a financial mess . Accounts receivable were greatly
overstated because of non-paying customers . Collections were virtually non-
existent . Moreover, the majority ofPurchasePro's accounts (as many as 99%) were
either fraudulently created by PurchasePro salespeople, accounts of non-paying
customers or ac.counts created without customer knowledge . Thus, there was not a
great demand for PurchasePro's product as Johnson depicted .
165 . For these same reasons, the statements by Johnson in the following
article, disseminated on or about April 11, 2000, were similarly false and misleading .
Contrary to Johnson's statements, PurchasePro was not enjoying the substantial
growth which was being presented to the public . The article quoted Johnson, stating
in pertinent part :
PurchasePro.com Adds Record Number of New Businesses to ItsUnivers'.l Exchange -- New Customers to Pay Transaction and NetworkAccess fees 122 Percent Quarter-over-Quarter Growth
PurchascPro .com (Nasdaq: PPRO), a leader in browser-based, business-to-business electronic commerce, today announced strong quarter-over-quarter customer growth for its universal exchange .
"The 122 percent quarter-over-quarter growth we experienced in thefirst quarter reinforces the growth potential of our business model,"said Charles E. Johnson, Jr ., Chairman and CEO of PurchasePro .com."The fact that more than 25 percent of this record growth occurredthrough online registration accelerates our business plan of gaining acritical mass of businesses across all industries . "
The recurring revenue streams , combined with 90 percent gross profitmargins and Tess than one percent attrition rate , create long term profi t
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"Our business model of leveragin g both off-line and online channelpartners in the leading universal exchange enables PurchasePro .com tocapitalize on both the new and old economies ," said Johnson .
PurchasePro .com will formally announce its complete first quarterresults after market close on Wednesda Ap ril 19 , 2000 . The call-innumber for that announcement wi ll be 800/266-2145 .
166. In addition to Johnson's other statements, the "less then one percen t
attrition rate" claimed by Johnson was particularly misleading . PurchasePro's
alleged attrition rate was not so low because the Company's customers were satisfied
with the business model . On the contrary, the PurchasePro Defendants refused to
write-off the Company's bad debt, i .e., non-paying customers . These "users" were
staying on the books so that the PurchasePro Defendants, including Johnson, could
portray the Company as strong and growing, quarter over quarter
167 . Thereafter, on April 18, 2000, PurchasePro issued another press releas e
announcing PurchasePro's "record" and better-than-expected financial results for the
first quarter of 2000. The April 18, 2000 press release stated :
PurchasePro.com, Inc. Reports Record Financial Results for the FirstQuarter of 2000
Revenues Increase 71 Percent Over Most Recent Quarter; Gross ProfitMargins Grow to 93 Percent
LAS VEGAS (April 18, 2000) -- PurchasePro .com, Inc . (Nasdaq :PPRO) a business -to-business e-commerce solutions leader, todayannounced financial results for the first qua rter ended March 31, 2000 .
Purchase Pro.com reported record revenues of $4 .5 million for the firstquarter of 2000 with gross p rofit margin of 93% a 575% increase overrevenues of $6'14 ,00(J for the first Quarter of 19 9 , and an increase of71 % over revenues of $2 .7 million for the fou rth quarter of 1999 . Thenet loss for the quarter , excluding charges for stock-basedcompensation, was $8 .3 million , or $0 .28 per diluted share, comparedto a net loss of $6 .1 million , or $0 .22 per diluted share for the fou rthquarter )f 1999 .
"Our oi :.tstanding financial results illustrate that our network andmarketplace exchanges are reaching critical mass and gaining traction,"said Charles E . Johnson , Jr., chairman and chief executive officer ofPurchasePro .com. "We successfully completed a secondary offeringduring the quarter and from a balance sheet perspective,Purchas°Pro . com is extremely strong with more than $136 million in
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cash and cash equivalents . . Our growth strategy is to partner with thedominant players in a vaety or ve rtical and horizon al sectors andalign our interests with our partners by reaching out to their customersno competing with their suppliers . Our current reach of over 21,006companies pa rticipating in over 150 public and private marketplacesshows the broad acceptance of our solution and technology platform ."
"Our business model is clicking on all cylinders `we are generatin grecurring revenue , we increased our already healthy gross profitmargins while reducing our attrition rate to approximately one percent,and we increased customer growth nearly 120 percentquarter-over-q uarter . It is impo rtant to note that all of our growth wasorganic , and that approximately 25 percent of our new business for thequarter came through online registration, without the use of a sales call,illustrating the vibrant, viral nature of our solution ," concluded Mr .Johnson
"With direct expe rtise in strategic planning, operations , equitymanagefnent , mergers and acquisitions , marketing and purchasing, ourexpanded team is integral to cha rting the company's. future growthplans through ent ry into new vertical markets, expansion of strategicpartnerships and alliances , creation of new strategic initiatives andgrowth of sits increasingly diversified customer base ," concluded Mr .Johnson .
168 . As with the foregoing statements concerning PurchasePro ' s user base ,
and the financial growth and stability of the Company, Johnson's statements
contained in this press release were also false and misleading . Moreover, as with the
Company's SEC filings listed below, and contrary to Defendants' overal l
representations, the financial condition of the Company was not being fairly
represented to the public . As discussed in great detail above, Defendants wer e
manipulating every revenue stream of the Company so that PurchasePro could report
record quarter over quarter growth in violation of GAAP . See §§IV-V .
169. On the same day, the following press release was disseminated which
noted that defendants Johnson and Carton would be forgoing any compensation until
PurchasePro w,-is profitable . The article stated :
PurchasePro .com (PPRO . Nasdaq ) Chairman and CEO Charles JohnsonJr. said Tuesday that neither he nor COO Christopher Carton wouldtake cash or stock compensation until the company becomes profitableon an earnings-per -share basis .
After Tuesday' s close, the company repo rted a first-quarter earningsloss of 28 cents a share , a penny better than the seven -analyst First
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Call/Thomson Financial estimate and up from a 22-cent loss in thefourth quarter of 1999 .
"We are comm itted to the profitability of this compan y long-term andwe are committed to what we are doing ," Johnson said .
"We've taken a very positive twist on this , and we think it's the bestopportunity for us to differentiate ourselves from the softwarecompanies that are alluding that they are true B2B, Internet-basedcompanies ," Johnson said . We feel that the terms `market lace' and`exchange technology ' have been overused and misunderstood . Weconsider a marketplace to be a self-contained group of businesses,defined by whomever the marketplace owner is .
Companies that provide exchange software, on the other hand,generally encourage their customers to bring other buyers and sellersinto the network , something B2B insiders consider a "viral" -- andhence very profitable -- strategy .
Chris Vroom, an analyst for Credit Suisse First Boston who ratesPurchasePro .com a strong buy, said Johnson ' s decision not to et paidis good news from an investment standpoint . But he acknowledged themarket 's attraction to software providers versus browser-basedenablers . First Boston recently underwrote a secondary offering forPurchasePro meaning that it likely would profit from any rise inPurchase.Pro3s stock .
"Certainly , from a valuation standpoint , the companies that havedeveloped software solutions are being more richly valued in themarket . That re fl ects that they've been around a lttle lon ger andthey 're well known through their affiliations with these large industri alconsortiums ," Vroom said . "But over time, the market will recognizethat this is a huge business opportunity, and a viable solution thatcomes at a much lower price and is easier to train on . Then, investorswill recognize its true place in the world . "
170 . While it is important to note that PurchasePro could hardly b e
considered a true B2B Internet-based company as Johnson suggested, this article is
also important because it addresses the scienter of defendants Johnson and Carton .
By agreeing not to take compensation until the Company was "profitable," they had
even more incentive to reach that perceived goal as quickly as possible and by any
means necessary. Moreover, it failed to disclose to investors that defendants
Johnson and Carton had already obtained lines of credit through pledges of their
PurchasePro stock as collateral .
171 . On or about May 15, 2000, the Company filed with the SEC its For m
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I 0-Q for the first quarter of 2000. Signed by defendant Clough, and dated May 12 ,
1 2000, the Form 10-Q reiterated (and expanded upon) the financial results issued on
C April 18, 2000 . Further , the 10-Q stated :
The unaudited condensed interim consolidated financial statements ofPurchasePro . com, Inc . and its subsidiary , Hospitality PurchasingSystems (collectivel y the "Company") for the three months endedMarch 31, 1999 and 2000 , included herein, have been prepared by theCompany, without audit , pursuant to the rules and regulations of theSEC . Certain information and footnote disclosures normally includedin fi nancial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omi tted pursuant to suchrules and regulations relating to interim fnancial statements . In theopinion of management , the accompanying unaudited condensedconsolidated financial statements reflect all adjustments , consistingonly of normal recurrin g adjustments , necessary to present fairl theresults of the Company s operations and its cash flows for the threemonths ended March 31, 1999 and 2000 . The accompanying unauditedcondensed consolidated fi nancial statements are not necessarilyindicative of full year results . Certain reclassifications have been madeto prior period financial statements to conform with the 2000presentation , which have no effect on previously repo rted net income .
172 . Of course, contrary to these representations, PurchasePro's financial
statements were not being presented pursuant to the rules and regulations of the
SEC, or in accordance with GAAP . In fact, as discussed above, Defendants were
manipulating every revenue stream of the Company so that PurchasePro could
falsely report record quarter over quarter growth . See HIV-V.
173 . Moreover, these representations were false and misleading becaus e
PurchasePro was in accounting disarray according to former employees of the
Company . This has also been confirmed by PurchasePro's former auditors,
Andersen, LLP . In a management letter dated May 30, 2000, which was addressed
to the "Management and the Board of Directors of PurchasePro .com, Inc .," i .e ., all
PurchasePro Defendants, Andersen, LLP stated in part that : (a) the Company does
not have written policies and procedures for most accounting practices ; (b) sales
personnel or senior management have historically negotiated contracts without
adequately involving the finance and accounting functions to ensure that any
potential accounting issues are reviewed and resolved before the contract i s
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finalized; and (c) management changed its reserve methodology several times during
1999 which leads to the loss of integrity in the system .
174 . Amidst these misrepresentations to the investing community, on July
11, 2000, at 6 :56 PM, defendant Benyo circulated an internal e-mail to defendant s
Clough and Miller, as well as PurchasePro employees Randy Gabe , Anthony
Timmons, Ray Carpenter , Barry Joyce and Edward Kim, which contained a sta rtling
I revelation concerning a draft press release which was to accompany the
announcement . of PurchasePro's second quarter financial results . In this e-mail ,
Benyo states :
Well I wasn't happy with much of what I was seeing in the release soI took a stab. Included in this are my attempts at language around therevenue recognition piece.
Brooke and Michelle : Wanted to get with you guys today but ran outof time . We can talk tomorrow. im not concerned about reaction tothis, because I believe we have a good story. I do want to be prepared,however .
Randy- Looking forward to getting those numbers .
John- Working with Randy we have got to get 1/4ly subscribersnumbers nailed I'm getting worried .
Finally, : :he number of "web" sign-ups needs to be nailed .
Please wake comments on the language . I want to get this to Jr . andcompany ASAP .
Chris BenyoSr. VP, Marketing
175 . In addition , in the draft press release that accompanied the e-mail ,
language was included that candidly discussed the Company's revenue recognition
as a result of the change in PurchasePro's business model stating :
"During our design and rollout of these new marketplace products wediscovered new opportunities for revenue recognition " said Clough ."Customers were already paying us thousands of dolcars up-front toquickly implement marketplaces . With this change we can nowrecognize some of the revenue up-front rather than over the course ofthe contract ."
Clough emphasized that the accounting change does not diminishPurchasf;Pro's emphasis on recurring. revenue . In fact, continuinmarketp?ace sales increase substanally the company's base o
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recurring revenues from hosting, maintenance, subscriber andtransaction fees .176 . However, since the majority of PurchasePro's software license sale s
were nothing more than sham transactions, and since it was in Defendants' bes t
interest not to attract attention to these arrangements, this language was omitted from
the actual press release . Instead, misrepresentations simply continued regarding the
strength and financial condition of the Company on July 19, 2000, when
PurchasePro fcrlnally announced "record financial results" for the second quarter
ended June 30, 2000 . In that press release, defendants Johnson and Clough were
specifically quoted as follows :
PurchasePro .com, Inc . (Nasdaq: PPRO), the leader in browser-basedbusiness - to-business e-commerce solutions, today announced recordfinancial results for the second quarter ended June 30, exceedinganalyst consensus estimates by eight cents per share . The companyposted record revenue of $9 .5 mi llion for the quarter with a gross prat tmargin of 93 percent an 846 percent increase over revenues of $1 .0million for the second quarter of 1999 and an increase of $5 .0 mi ll ionor 109 percent , over revenues of $4, million for the first quarter of2000 . the net loss for the quarter , excluding charges for stock-basedcompensation, was $7 . 1 million , or $0 .22 per diluted share comparedto a net loss of $8 . 3 million , or $0 .28 per diluted share for the firstquarter of 2000 .
"This quarter we have shown our recurring revenue business model'sstrength in delivering top line revenue with only moderate expensegrowth," said Charles E . Johnson, Jr ., chairman and chief executiveofficer of PurchasePro .com. "With our continued high growth, lowattrition rates, and excellent cash position of $120 mi llion , we are wellpositioned to achieve profitability in the second quarter of 2001,significantly earlier than the market ' s expectations ."
"We are now the dominant player in the ` exchange to exchange ' space,linkin g all our marketplaces into a universal platform to deliver acritical mass of businesses ," he added. "At the same time we aredelivering a liquid marketplace where these companies can pa rticipateas both huyersand suppliers , bringing maximum value to both . Muchof our growth is attributable to the network effect surrounding bu yersand suppliers . As we move forward, growth will be enhanced bypro rams with key channel partners . As we expand these relationshipsand cortinue our strategy of partnering with dominant players in amultitude of vertical and horizontal sectors , we, expect to see ourcurrent high growth continue into future quarters . "
"A port on of the company's healthy revenue growth is attributable tothe second quarter release of PurchasePro .com's new suite of privatelabel e-inarketplace solutions ," said James P . Clough , senior executivevice president and chief financial officer of PurchasePro .com. "Ourcontinuing success in selling this suite of solutions will add
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substantially to our recurring revenue mix, with revenue contributioncoming from monthly hosting and maintenance, as well as subscriber,transaction and advertising es . "
177 . Defendants' statements were false and misleading for the following
reasons, in addition to those stated above . PurchasePro was not enjoying a strong
recurring revenue model as these defendants suggested . In fact, the recurring
revenue model of the Company was so unprofitable that a new method of artificially
inflating revenue for the Company had been implemented which was based on the
use of "skins ." As described by numerous former employees of the Company, skins
were non-functional software that were being shipped to "customers" so that
PurchasePro could prematurely and improperly recognize revenue from these
transactions in violation of GAAP . See §V . Moreover, as admitted under oath by
defendant Anderson, PurchasePro's senior officers and management knew that the
sale of marketplace software licenses had met with significant resistance . Thus,
Defendants were beginning to engage in the round trip and sham transactions
described above to generate the appearance of growing revenues through the sale of
such licenses .
178 . The next day, on July 20, 2000, the following article was released
entitled "A Percentage Game: PurchasePro .com Bests Ariba by Focusing on an Area
Where There's Not Much Competition ." The article noted :
PurchasePro . com (PPRO : Nasdaq) was able to do what Commerce One(CMRC : Nasdaq) couldn 't -- best the second-quarter sequential revenuegrowth of Ariba (ARBA : Nasdaq ) . Among B2B stocks this earningsseason , that's all that matters .
Investors were rewarding it accordingly Thursday, sending the stock up16%, or 7, to 49 %2 . But in some ways it's regaining the midteenpercentage loss it suffered Wednesday before its earnings wereannounced .
Wednesday , PurchasePro reported second-qua rter revenue of $9 .5million, an increase of 109% over the previous qua rter to ping Ariba's101% increase . It's a lot less revenue than the S62pmillion thatCommerce One handed in on Tuesday , but sequentially Commerce Oneincreased revenue only 79% . And in the B2B game, it's thatpercentage gain that matters .
"PurchasePro's results underscore the opportunity that exists in th e
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middle market ," says Chris Vroom , a Credit Suisse First Boston analystwho rates PurchasePro a strong buy . (His firm has performed bankingservices for the company .) "It s a distinct o pportunity from what Aribaand Commerce One are focusing on, and in an area where there'srelatively little competition . "
PurchasePro, which posted a net loss . of $7 .1 million, or 22 cents ashare compared with the consensus estimate of a 30 cents-a-share loss,builds exchanges andprivate market places for comp anies with revenuebetween $3 million and $20 million annually. Charles Johnson Jr .,PurchasePro's founder and chief executive, says he wants to expand hiscompan'f's target customers to those with less than $50 million inannual revenue, which includes about a half million U .S. businesses .
Ariba and Commerce One, on the other hand, have been targetin glarger , Fortune 500-tie businesses, to build mega -exchanges andprocurernent platforms for industries ike autos aerospace and energy .Those deals offer potentially lucrative payoffs down the road andmultimillion dollar1icensing fees up front .
Purchase-Pro gets its bread and butter from the monthly subscriptionfees - - on average about $75 -- it charges its customers . Those feesamounted to $7 .2 million in the latest quarter. And because those feesare recurring revenue -- PurchasePro has had customer attrition rates ofless than 5° -- the company says it is already assured of getting at least$8 million in revenue in the third qua rter without signing any newcustomers .
Analyst, had pegged third-quarter estimates at around $10 .5 millionthough those are sure to rise in the wake of this quarter's results . AndPurchasePro now says it'll turn profitable in the second quarter of 200 1,two quarters ahead of expectations .
"I feel like the winners in the niches are starting to be defined,"Johnson said in an interview. "And in the market, we're staring to Beseen as the middle-market niche player ."
179 . This article is important because it highlights one of the reasons fo r
Johnson to engage in the fraud . For Johnson , it was a personal goal not only to
compete with , but be bigger then, Ariba and Commerce One . This has been
confirmed by former employees of the Company . See §V (statements by Employee
4) .
180. Ay a result of the foregoing misrepresentations , concerning the financial
stability, growth and potential for the Company, the stock closed at $20 .25 per share .
Shortly thereafter, Chris Vroom, an analyst with Credit Suisse First Boston -- th e
same company that had extended to defendant Johnson a $100 million line of credit
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"strong buy . "
181 . Over the next couple of months, based on several positive
announcement's concerning PurchasePro's present and future prospects, th e
Company's stock price began to rise . In July alone, there were ten separate press
releases by the Company announcing partnerships that were being formed, the
addition of new Board of Director appointees, and the opening of a new technology
center built to prepare for the "rapid growth" the Company was about to undergo .
Simultaneously, PurchasePro announced the launch of its co-developed
business-to-bu .yiness destination with AOL .
182. Then , on or about August 15, 2000 , the Purchase Pro Defendants caused
the Company to file with the SEC PurchasePro's Form 10-Q for the second quarter
of 2000 . Signed by defendant Clough, and dated August 14 , 2000, the Form 10-Q
reiterated (and expanded upon) the financial results issued on July 19 , 2000 . These
results, as the Company would later admit when it filed an amended Form 10-Q with
restated financial results for the period , were materially incorrect when issued and
were materially false and misleading due to the PurchasePro Defendants ' improper
recognition of revenue . Moreover, the 10-Q speci fically stated :
The una'.1dited condensed interim consolidated financial statements ofPurchasePro .com, Inc . and its subsidiary , Hospitality PurchasingSystems- (collectively , the "Company") for the three months and sixmonths ended June -30, 1999 and 2000 included herein , have beenprepared by the Company, without audit, pursuant to the rules andregulations of the SEC . Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withgenerallaccepted accounting principles have been condensed oromitted pursuant to such rules and regulations relating to inte rimfinancial statements . In the opinion of management, the accompany ingunaudited condensed consolidated financial statements reflect alladjustments , consisting only of normal recurring adjustmentsnecessary to present fairly the results of the Company's operations andits cash { lows for the three months and six months ended Tune 30, 1999and 2000 . The accompanying unaudited condensed consolidatedfinancial statements are not necessarily indicative of full year results .Certain, reclassi fi cations have been made to prior p eriod financialstatements to conform to the 2000 presentation , which have no effecton previously reported revenue or net income .
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183 . Of course, contrary to these representations, PurchasePro's financial
statements were not being presented pursuant to the rules and regulations of the
SEC, or in accordance with GAAP . In fact, as discussed above , Defendants were
manipulating every revenue stream of the Company so that PurchasePro could
falsely report record quarter over qua rter growth . See §IV-V.
184 . As a result of the foregoing misleading statements , on August 25, 2000,
Prudential analyst Tim Getz ("Getz") gave PurchasePro a boost by stating that the
stock was undervalued . In the same article , which was based on and repeated
information provided by Defendants , specifica lly Johnson (Employees 4 and 12
stated that Johnson improperly provided analysts with inside information), Getz
stated that he expected the Company to have a strong third-quarter with a
"potentially significant upside " from his $ 13 .7 million revenue estimate . He also
reiterated his "strong buy" rating on the Company .
185 . Moreover , on August 31, 2000 , Patrick Walravens ("Walravens"), a
Lehman Brothers analyst , also called the Company "woefully undervalued," In fact,
Walravens noted that at 14 times earnings, PurchasePro was trading at a significant
discount to B213 players Ariba (at 80 times earnings ) Commerce One (at 32 times
earnings) and Freemarkets (at 25 times earnings ) . Moreover, in his report , which
was similarly based on and repeated information provided by defendant Johnson,
Walravens highlighted that the online marketplace that PurchasePro ha d
co-developed with AOL should deliver 4 million new impressions , or visits, a day
to PurchasePro ' s online marketplace .
186 . Thus, these unfounded positive statements had their effect . By
September 8, 2000, PurchasePro's stock had been artificially increased to $32 .875
which was up '70% from its closing price of $18 .50 on August 15, 2000 . Further,
Keith Jensen, Director of Investor Relations at PurchasePro, stated that the Company
was "`very comfortable' with Wall Street's expectations for the quarter ending
September 30 .'He added that there were only "a couple of week's [sic] left in th e
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187 . On September 26, 2000, Leah Thomas of PurchasePro attempted to
correct a serious problem regarding the number of alleged users disclosed to the
street. Specifically, various sales representatives were doing live demonstrations of
PurchasePro's product that created transactions that were being reported as valid
customers. In m e-mail from Thomas to Tracy Teague, Jeannie Caruso, John Goetz
and Blair Turner, cc'd defendant Anderson, Mary Alyce Smith, Denis Campbell,
Chris Odom, Jim Jensen, defendant Benyo, John Devlin, Mike Ermi, Richard
Appelbaum, Thomas stated :
As I said. last night I will move ahead with this when I have receivedconfirmation that Executive Mana gement understands that with thisinitiative- I can't be responsible for data integrity and someone steps upto the plate to take responsibility for the problems this could cause withour report ing .
Chris ,[Benyo] and Jeff [Anderson] please speak with John Goetz andJeannie Caruso concerning this . I need to have their approval to changeour policy regarding demos on production, as they are who I report to !
I also want to see signed document from sales rep before creating.account: for them . What are they agreeing too? Therefore , we can tmeet a deadline to create accounts prior to signed letters coming in!Accounts will not be created until the document is returned . In additionthe request for the account should go through the help desk as allinternal account requests are tracked through helpdesk . The marketingadmin can request The account by sending an e-mail to the helpdeskalong with a copy of the signed documents, or they must be heldresponsible for requesting an account that we have not gotten a signeddocument for . Blair nees to be included in this as he is responsible forthe repo , ting end.
While rrm.y roup can monitor the creation of additional accounts andviolation there, Blair needs to monitor the creation of bids, po's andreel's that are outside what is agreed to .
I am inc luding my Directors and VP as they seem to have been left outof this whole process . When I have received the directive from themto move ahead I will be happy to do so .
188. A3 a result of this e-mail, Thomas was warned about possibl e
repercussions .' On September 26, 2000, John Devlin stated :
Leah ,
As a friend, just want to make sure you know that Jeff Anderson an d
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Chris Benyo (Both Senior VPs ) both gave us direction to make thishappen . In other words they get it and understand the risks . Chri s
enyo ] has been a huge advocate of yours, but y~o~u might want to duckT s one. You have indirectly said that either -Wendy of Chris don'tknow what they are talkin about . You might get back more than youbargained for! Just a friendly note. Do what you want with the advice .
189 . On September 29, 2000, in an interview with Allan Gould o f
+ Line56.com, defendant Johnson continued to misrepresent the Company' s
I relationships with its customers and purported partners by describing them as tru e
"partnerships ." The following is an extract from that interview :
The value of these relationships comes from the value of our product,our product offering . And the ability of us to make money for thesepartners . When we do a deal, we set it up so where our success mirrorstheir success - so they are truly pa rtnerships , versus a vendor deal, orselling someone an e-commerce solution .
190 . Defendant Johnson' s statements on September 29, 2000, were false and
misleading because he knew that these relationships were unprofitable warrants-for-
revenue and round trip transactions that had nothing to do with the "value of
[PurchasePro's] product ." They simply offered the supposed "partner" much more
in warrant profits, investments or future business than the partner paid to
PurchasePro .
191 . On October 8, 2000, the Lexington Herald released an article which
highlighted defendant Johnson's background from his youth. The article is
interesting because it portrays Johnson as an individual who would do anything to
succeed, whether in sports or business . Moreover, the article described Johnson's
lavish lifestyle and how PurchasePro came about . The article stated in part :
Since he hasn't sold a single share of PurchasePro stock, Johnson'swealth is still all on paper. It could disappear, or double, tomorrow .But that hasn't stopped The mile-a-minute talker from living the flashylife he loves.
After PurchasePro went public he put up 2 .5 million shares of his stockas security for a $100 million line of personal credit . He's spent $44million so far .
Johnson now has his own 10-seat 'et, more Armani suits than mostpeople have socks, a fitness room that rivals any Gold's Gym and a
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backyard swimming pool that overlooks the Las Vegas golf coursewhere Tiger Woods won his second PGA tournament .
Last November, he flew several Lexington friends to a multi-milliondollar IPO party in Las Vegas.
Lexington Catholic High School Athletic Director Danny Haney whoattended the party, said that at the bash, Johnson gave away 15 Rolexwatches and a vacation to Hawaii , among other favors .
** *
Johnson still stays up after most people are snoozing . He sleeps aboutfour hours a night , devoting his long waking hours to Purchase-Pro. Heattribute ., his never -ending energy to attention deficit hyperactivitydisorder .
"You might say I get a lot of miles per gallon ," he said. "I was alwayswilling to do what it took to win . "
By the end of 1997, every PurchasePro executive had poured his lifesavings into the company, including at least $2 .5 million from Johnson."There was not one red cent that I could get that I have not put intothis ," Jo-,lnson said. "I sold my video stores . I started selling otherbusinesses . I borrowed against my life insurance . I took every pennythat I had ."
Unlike m-fiany dot-corn startups, PurchasePro wasn't attracting venturecapital from Silicon Valley . And who could blame the money men fortheir disinterest? Everything about this venture was screaming failure .
The com p any~'s CEO used to run video stores and fitness centers . Hetalks with a Kentucky twang and sometimes uses bad grammar . Healso takes a daily dose of Dexedrine to heI control attention deficithyperactivity disorder . And don ' t forget that the company's chiefoperating oficer was a country -club manager before faking on e-commerce .
But this odd bunch persevered . While the big shots on the coastsignored .} ohnson, there were plenty of folks in Kentucky and Las Vegaswilling to pony up for PurchasePro . The company raised $6.15 mi ll ionin its first round of financing in June 1998, A year later, it brought inanother 5 1 1 .55 million.
Even with that support Johnson would sometimes find himself hoursaway from pa roll with no money in the bank . So he headed for theblackjack tablye. "I did what I had to do and we met payroll," saidJohnson "Most people are fearful to task about it, but hey, what astory .
Business: is like a sport to Johnson, and he knew the company's $5 0
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million )PO was only the first pitch in a long ball game . "To me thegame had just begun , and I still think we 're in the early innings, ;' hesaid .
By Friday of the IPO week Johnson was back in Las Vegas pre paringfor a meeting with Keith I.rach, CEO of Ariba , considered to be theleading business-to-business e-commerce company .
As Dawahare recalled , it did not go smoothly : "Krach looks at Juniorand says, `Would you be interested in selling ?' He says `No, but wemight be interested in buying you.' The look on Krach s lace was verymemoraole . The idea was preposterous, of course , since Ariba had amarket cap of about $10 billion at the time, compared to PurchasePro's$700 million .
But Johnson didn't care. "We're not here to play second to anyone,"he said. "'We plan on winning this game . "
192 . Hence, the article highlights an incentive for defendants, and
specifically Johnson, to perpetrate their scheme. The PurchasePro Defendants had
put everything into the Company, and if it failed, they would lose it all . Thus, this
was not like the typical "dot .com" venture which was backed by venture capitalists .
This endeavor . consisted primarily of the PurchasePro Defendants' own money,
"every red cent." Moreover, the AOL Defendants were inspired to keep PurchasePro
afloat so that they could profit from the sham transactions and warrant-for-revenue
arrangements as well .
193 . As the PurchasePro Defendants were successfully implementing thei r
scheme, they continued to inundate the market with unfounded statements
concerning the Company's financial condition . For example, on October 17, 2000,
PurchasePro announced its third quarter results, which also quoted Johnson as
follows :
PurchascePro Inc. (Nasdaq : PPRO ), a leading enabler ofbusiness - to-business e-commerce and exchange -to-exchangetechnolcy~y for companies of all sizes , today announced record financialresults of $17 .3 million in revenue for the third quarter endedSeptember 30 , 2000 - an increase of $7 .8 million or 82% over theprevious quarter . The net loss for the quarter , excluding non-cashcharges, was $4 .7 mi llion or $0 .07 per diluted . share , an improvementover a net loss of $7 .1 million or $0 .11 per diluted share for the secondquarter .
"The company' s continuing trend of record financial results further
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positions PurchasePro as a leading provider of e-commerce solutions,"said Charles E . Johnson, Jr ., chairman and chief executive officer ofPurchasePro ." "As a result of our tremendous business efficiencies,Purchase'Pro's gross margins were above 90 percent for the fourthquarter in a row . "
"Because of our recurring revenue model, we will begin the fou rthq uarter with a significant percentage of the revenue generated in thethird quarter," said Johnson. "As a result , we are advancing ourprofitability estimate to the fourth quarter . "
194 . Unfortunately for the investing community, as with the statement s
above, the claims made by defendant Johnson were equally misleading . Among
other things, Defendants had commenced the round trip transactions described above
to create and maintain the illusion that there was demand for PurchasePro's software .
The Company was also a financial disaster with virtually no accounting controls i n
place. Moreover, salespeople were falsifying customer accounts and activity so they
could collect larger bonuses . The number of customers was being greatly overstated
and management was refusing to correct the problem . Contracts were also being
backdated so that PurchasePro could prematurely recognize revenue . Hence, as
stated above, every revenue stream was being artificially inflated in violation o f
GAAP. PurchasePro should not have been repo rt ing "record" results and defendant
Johnson had no business stating that the Company had exceptional "business
efficiencies" when the exact opposite was true .
195 . Then, on October 18, 2000 , defendant Johnson was inte rviewed on
CNBC . Through this interview , Johnson continued making unfounded statements
to the financial community about PurchasePro . The following is an extract from that
interview :
MARK HAINES, CNBC ANCHOR, SQUAWK BOX :PurchasePro .com making the connection . The compan y beat the Streetthird quarter results . The net loss was $0 . 10 narrower than expected at$0.07 a share, better than last year's $0 .12 loss, but discountin g anincrease in the number of shares net loss actually grew to $4 .7 millionfrom last year ' s $3 .7 million . Revenue up a whopping 900 percent at$17 million . PurchasePro helps connect companies on electronicmarketplaces . It says it expects to break even next quarter, instead of
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in 2001, as previously forecast . So, what's going to happen here? Thestock down about 40 percent year to date, ends at about $40 .25 onTuesday . And any moment now we will see - no we ' re not going tosee the stock . Okay . Let's go online and get a closer look .
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HAINES : In fact, you would have had a profit this quarter, would younot, if you hadn't deferred about $5 million in revenue?
JOHNSON : We have $5 .3 million that was done through resellers withno future deliverables or no obligation . But we elected to take anextreme conservative view of our accounting and to defer the revenue .
HAINES : What is bringing you to profitability somewhat ahead ofschedule ?
JOHNSON: Well, we' ve tracked well . There is a hue demand. Wehave huge resellers - Computer Associates , AOL, gateway Sprint,Office ITepot . And our product sits in the middle of the mid-marketand there s such a demand on the offline companies and we'vemanaged the business where we have not scaled our employees over thelast three quarter while our revenue continues to grow more that 100percent , our expenses are only growing at about 25 percent .
HAINES : I would assume these are primarily small businesses youserve since the big businesses tend to get in and do this themselves ?
JOHNSON : Well, actually , we go from the small all the way up to thelarger market and the ones that do it themselves, they still need aplatform where they can place their actual suppliers and their actualcustomers . So we built a platform where they can take their customersand their suppliers and not only use it for the inte rnal benefit, but theycan take their suppliers and customers and link them with everyoneelse's suppliers and customers . They can monetize as they previously,their database of both buyers and suppliers, that previously theyweren 't able to do .
LOUIS NAVELLIER : I notice the current ratio about current assetsversus liabilities was starting to deteriorate a bit but it is still, you arestill very positive . I mean is that going to improve?
JOHNSON : Well, the liability you see on the actual balance sheet is afuture obligation we have with AOL, which is tied to four millionimpressions a day, which will obviously be tied to an increasingrevenue . So our cash position is well over $100 million . If you add inthe $5 .3 million operationally including amortization we wereprofitable this quarter . So that is not a conce rn at all .
HAINES : And once gaining profitability , will you stay in profitability?
JOHNSON : Oh, absolutely . We are scaling very, very fast . As I saidbefore , we built this company from day one to make money. Weweren t a traditional dot .com with venture money . The bulk of"moneythat capitalized the company came from myself and the othershareholders . We went through a secondary and lockup that 's been off
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five months and we ' ve had no executive sell the single first share .
196 . Defendant Johnson's statements concerning "strong demand" for th e
Company's products were obviously false for the reasons already discussed .
However, this interview with Johnson is particularly disturbing because he
affirmatively represented that the Company was taking an "extremely conservative
view of accounting" when nothing could be further from the truth . In fact, on many
occasions throughout the Class Period, a number of defendants, including Johnson ,
Benyo and Miller, were approached by Company employees concerning
PurchasePro's accounting deficiencies and improper revenue recognition . However,
these defendants affirmatively refused to correct the problems . Moreover, the
Company was the target of an SEC investigation which addressed one of these
issues, a lack of accounting controls within the Company . This ultimately led to a
settlement with the SEC enjoining the Company from violating the Exchange Act .
In fact , one employee even stated that PurchasePro was not following GAAP during
the Class Period, but rather JAAP, which stood for "Junior ' s Accepted Accounting
Principles ." See information provided by Employee 6, §V .
197. On the same day , October 18, 2000 , the Company disseminated th e
following press release which was entitled, "PurchasePro Sees Profit by End of Year
After Better 3rd Quarter." The release stated :
PurchasePro . com announced a third-quarter net loss that wasn 't nearlyas bad as analysts ' pre dictions and said the company will reachprofitability by year's end .
The Las Vegas-based Internet company with Kentucky roots posted anet loss of $4 . 7 million, or 7 cents per share well below the 17 centsanalysts had predicted . PurchasePro lost $~.7 million , or 12 cents ashare , in the year-ago quarter .
The company had revenues of $17 .34 million for the third quarter, a938 percent increase over revenues of $1 .67 million in the third quarterof 1999 .
PurchasePro's revenue increased 82 percent from $9 .5 million in theprevious quarter .
Chairman and CEO Charles "Junior" Johnson, a Lexington native, sai d
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the company was increasing its pre-earnings estimates for the fourthquarter based on strong sales of marketplace software .
"We are overwhelmed with the success of the quarter ," Johnson said ona conference call to analysts . "We are speci fically targetingp rofitability in the fou rth quarter of this year . We have a zero cashburn rate . "
Businesses pay PurchasePro a monthly fee of about $75 to list a catalogof products on PurchasePro's Web site . Other PurchasePro membersthen buy from those electronic catalogs .
Johnson said. PurchasePro added 5,311 small and medium-sizebusinesses to its customer base during the quarter, raising the total tomore than 30,000 .
The company also sold 49 private-label marketplaces during thequarter. Nearly two-thirds of PurchasePro's revenues came fromsoftware licensing fees on those private marketplaces.
Johnson said transactions on the network durin the third quarter wereup 50 percent over the second quarter , with more than 16,000companies using the system .
198 . Johnson's statements concerning "strong sales of marketplace software"
were false and misleading because revenue and sales were being artificially inflated
with the use of "skins" and round trip transactions . The statements concerning the
number of users and orders being executed on PurchasePro's system were also false
and misleading. As numerous employees have indicated, these numbers were
materially overinflated and did not represent the true number of users on the
Company's system. In fact, certain former employees from the MIS department
calculated that PurchasePro's actual user base was no greater than 1%-9% of the
numbers being reported by the Company, and in this instance, defendant Johnson .
199 . Further, despite Johnson's prior statements to the public concerning the
lack of insider sales at PurchasePro, only days later, on or about October 23, 2000,
defendants Chiles and Clough took advantage of the inflated price of PurchasePro's
securities . With their insider knowledge that the Company would be "re-releasing"
its prior second quarter results later in the week reclassifying Company income, they
sold uncharacteristic amounts of their stock . Defendant Chiles sold a fourth of hi s
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direct shares and almost ten percent of his indirect shares totaling $5 .5 million .
Defendant Clough sold $4 .7 million of his direct shares . Plaintiffs are unaware of
either defendant selling any quantities of their PurchasePro securities prior to this
time .
200 . On October 23, 2000, PurchasePro announced that it had agreed t o
acquire Stratton Warren Inc . using a combination of cash and PurchasePro's stock .
The acquisition was completed on January 17, 2001, for a total price of $14 .5
million . Of this amount, approximately $5 .5 million was paid in cash, with the
remaining $9 .0 million paid with PurchasePro's artificially-inflated shares . As such,
the PurchasePro Defendants were motivated to maintain the Company's stock at an
artificially inflated level to facilitate the Stratton Warren Inc . acquisition.
201 . Also on the same day, PurchasePro posted a press release entitled ,
"PurchasePro Posts Answers to FAQs and Details Business and Financial Model on
its Website ." Defendants, specifically Johnson and Carton, made statements that
were patently false in light of the information provided by numerous insiders of the
Company . For example, the release stated :
"We believe that postin these items on our Web site will allow allinvestors to become bet er informed about the viability and growthprospects of PurchasePro," said Christopher P . Carton, president andchief operating officer for PurchasePro .
"The company's focus on multiple recurring revenue streams cansometimes seem complicated to the average investor . We have workedto develop explanations to demonstrate to investors and others thestrength and long-term profitability of our model . "
The site is operational and available immediately . If investors havespecific questions , they should send an e-mail toInvestor@ PurchasePro .com. The company will continually update thisWeb site with new questions and answers as they are received .
About PurchasePro Inc . - PurchasePro Inc . (Nasdaq : PPRO), is aleading enabler of business -to-business e-commerce for companies ofall sizes and powers approximately 200 private -labeled marketplacesencompassing more than 30,000 businesses . With the fastest e-marketplace products in the industry , such as e-Procurement, v-Distributor and e-MarketMaker the company takes private labeledmarketplaces operational in 45 days or less .
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We have several types of revenue that makes our model work . You cansee these in our financial statements . a) Network Access Fees : This iswhere you'll see much of the recurring po rtion of our revenue . b)License Fees : As a practical matter, this is the up front fee amarketplace owner pays to control ingress and egress from itsmarketplace . This fee gives them ownership of their marketplace andprovides the catalyst for the creation of recurring revenue . Over thefirst year, each marketplace owner pays approximately 50% of the costof the market lace license in recurring revenue in equal monthlyinstallments . c) Advert ising : This can take the form of "impressions '(typical advertising model) slotting (i .e. placement in a particular spoton the network), preferred (ownership of a particular category .) orclassi fi eds (a place for special pricing for oversfocks and clearances andnew product introductions) .
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There' s a great way to understand the long-term recurrin revenuestructure that our business model facilitates. Typically, 5(3% of thevalue of a license fee moves into recurring revenue on an ongoingbasis . We believe the typical marketplace will retu rn 100-125% in yeartwo in recurring revenue through various fees . This translates intolong-term revenue with very little cost basis .
In Q3, PurchasePro had $11 .7 million in license revenue . Of this, 50%will move into recurring revenue over future quarters . On average, weforecast participation in marketplaces at about 200 member companiesper marketplace, though many Iarger ones will have more . We don'texpect to consistently begin receiving revenue from marketplacemembers for up to three quarters after a marketplace begins operation.Once in operation , we estimate that the average customer willgenerate$100 per month in recurring revenue fees . These come froma combination of membership, advertising , maintenance and transactionfees . )
PurchasePro has focused tirelessly on cost containment and top linerevenue growth. Expenses the last two quarters grew approximately25% each quarter including amortization while we averaged nearly100% revenue growth . We did this while maintaining 90% plus Tossprofit margins and less than 1% attrition . At this rate, we believePurchasePro will be profitable in the fourth quarter of fiscal year 2000 .
** *
Why do you use warrants? - First , a warrant is an ag reement thatallows someone to buy stock from the company at a pre-determinedprice .
We have issued warrants based on our partner ' s ability to create longterm recurring revenue and other significant values for PurchasePro .We want our strategic partners to invest in us through performance-based warrants rather than purchasing shares . We believe that a pa rtnerthat achieves earned equity in our company will enable the relationshipto build long term economic benefit for both companies because of the
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aligned interest. The companies with warrants currently are OfficeDepot, Sprint Corporation, America Online and Gateway Computer.
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"We founded PurchasePro with the philosophy that our equity willalways have supreme value because the original investors are thefounders," said chairman and chief executive officer Charles E .Johnson, Jr . "We purposely avoided bringin in high priced outsideventure money so we could protect our equity for all shareholders andemployees . We have an overwhelming percentage of the company andcan use equity to motivate our partners through earned opportunitiesthat create long-term revenue and value for every shareholder .
"Nonetheless , we believe that in the aggre gate,, the total share count andownership of our shares still remains predominately in the people whoeither produce revenue directly or indirectly which ultimately resultsin a larger return to all shareholders ," Johnson continued . "I carefullymanage this process because my personal equity stake in the companyis by far the largest and I do not want to take any dilution that doesn tyield a substantial return that exceeds the cost of the equity dilution . "
An example of a performance -based warrant is AOL . They earn onewarrant for every $80 in recurrin revenue generated through theirmarketplace . If AOL can produce 10 million per month in revenue,they will earn the right to receive shares of PurchasePro stock . If youtake the amount of revenue the warrant produces , multiplied by areasonable Wall Street multi le of 35 times earnings , and assume thatour gross profit margin is at 93 percent , you can determine the value ofthe revenue produced to earn the warrant, excluding- the exercise priceof the warrant (typically set at market price on the day of issue) .
Under our agreement with AOL, they receive $ 50 million dollars overa two-year period . For this, AOL is to deliver 1 .4 billion or moremarketing opportunities throughout all AOL prope rties to drive AOLbusiness users to the AOL/Netscape marketplace . In return for thecash , PurchasePro is entitled to the first $ 100 million in collectedrevenue through the Netscape market-place . For every business enteringthe marketplace PurchasePro and AOL share ownership of the customerand revenue into perpetuity .
AOL and PurchasePro are also jointly develo p ing a next generation ofe-commerce software . This version will contain proprietary elementsfrom both AOL and PurchasePro . AOL must dedicate programmingpersonnel to the relationship . For all these bene fits , PurchaseProbelieves it would have been required to spend a similar amountirrespective of its relationship with AOL .
Other warrants give us value like training for mass users ofPurchasePro marketplaces, training development, marketing materialsaimed at potential marketplace users and sales incentives for partners .In short, we've used equity as a carrot to motivate large partners to helpgrow our business at an astounding rate .
Why have your receivables (DSOs) grown so fast? - Over the past twoquarters, PurchasePro has grown at 1109% and 82°/% respectively . Muchof the growth has come in the form of license fees for marketplaces .
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Traditionally, PurchasePro's revenue came in the form of electronicallytransferred membership fees . With these there was virtually nooutstanding collectible. As we've sold higher ticket license fees,receivables were bound to go up with the typical licensee paying theiroutstanding balance in a net 30 days . These balances will continue torise in the sort term because license fees are accelerating quarter overquarter. Over time as the recurring portion of revenue kicks in,receivables will level out . In conjunction with our auditors, we strictlevaluate the creditworthiness and ability to pay of all customers . Werecognize no revenue from a licensee customer unless our auditors areconvinced this revenue is collectible . Additionally, we have set asidea reasonable portion of the receivables for bad debt in our reserves .
** *
What falls under deferred revenue and why do you have it? -- InPurchasePro ' s business model , these dollars would typically be bookedas revenue . During the quarter , the company began an aggressivereseller program . Thee accounting literature states a company must havehisto rical evidence that it will not take returns on licenses sold .Obviously this history is built over time . It is PurchasePro ' s belief thatwe wi ll never take a return of a license fee, either now or in the future .During the quarter we de livered marketplaces associated with thisrevenue with no expectation of future deliverables on the part of themarketplace owners . However, in consultation with our auditors, weelected to defer this revenue until future qua rters . At September 30,2000 we had $5 . 3 mil lion booked as deferred revenue under ourreseller program . It will be collected as licenses are place on behalf ofPurchasePro . The balance is advertising revenue that will be bookedas it is realized . We do not expect this line item to increase because wedo not recognize revenue until we have delivered the product andservice in its entirety . Our goal is to focus on never ending recurringrevenue rather than finite revenue that falls in the deferred category .
attrition and the overall financial strength of the Company were false and misleading
for the numerous reasons previously discussed . However, the statements concerning
the creditworthiness of PurchasePro's customers and its receivables deserv e
particular attention . As noted by numerous former employees, the collections
department was virtually non-existent at the Company . Further, PurchasePro was
not conducting any credit checks on its customers throughout the Class Period. In
fact, management was even preventing employees from charging customer accounts
for fear that they would cancel their membership . Thus, the growth in receivables
for the Company was not due to strong demand. On the contrary, it was due to
management's refusal to accurately report the true number of users on th e
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PurchasePro system .
203 . This is supported by an internal Company e-mail dated October 24 ,
2000, which was sent at 1 :39 PM, from Justin Carlson ("Carlson"), a PurchasePro
employee, to fellow employees Mary Ellen Ohara, Donna Lauger, Leah Thomas an d
I John Devlin . In that e-mail, Carlson notes :
Leah is correct , when she stated we will need Inside Sales involvementin getting contracts for those companies that used the Office DepotWeb enrollment process six months ago .
The Terms and Conditions for the ODP clients stated they wouldreceive 6 months of PurchasePro for free . The six months is up , andnow A/R must invoice these clients . Here is where the problem isexposed. The Off ce Depof web enrollment allows accounts to hecreated before credit card information is entered. The Majorit y, oftheOf ace Depot web enrollment accounts do not contain credit cardinformation, so therefore A/R can not invoice.
A/R now requires a paper contract to be si gned and returned in orderfor the clients to be successfully invoiced . If the clients do not wish topass along billing information , their accounts should be de -activated .
204 . Interestingly, defendant McGhee previously ran Office Depot's Nort h
American operations and was responsible for Office Depot ' s 950 stores and 35,000
employees . Moreover, as of November 29, 2000, Office Depot was PurchasePro' s
largest customer .
205 . Further, while the Company website touted the relationships it ha d
created by using the warrants-for-revenue model, the website did not indicate that
the AOL Warrant Agreement was in the process of being modified . The new
agreement would provide AOL with $3 for every $1 of revenue generated for the
Company. As discussed above, these types of relationships, as well as the sham
transactions, were far from beneficial for the Company . PurchasePro was simply
taking money out of one pocket only to receive it later in another pocket, thereafter
claiming it to be "revenue . "
206 . Days later, on or about October 27, 2000, the Company re-released its
second quarter results . The new results reflected that PurchasePro would be
"reclassifying" 82 .3 million, nearly 25% of its total profit for the second quarter, int o
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"other," one-time, income . That money had previously been classified as recurring
income . On October 27, 2000, PurchasePro filed with the SEC an amended For m
10-Q for the second quarter of 2000, signed by defendant Clough, that contained th e
I new and restated results . The 10-Q also stated that :
The unaudited condensed interim consolidated financial statements ofPurchasePro . com, Inc . and its subsidiary, Hospitality PurchasingSystems (collectively, the "Company") for the three months and sixmonths ended June 30, 1999 and 2000 included herein, have beenprepared by the Company ,without audit, pursuant to the rules andregulations of the SEC . Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withgenera lly accepted accounting principles have been condensed oromitted pursuant to such rules and regulations relating to inte rimfinancial statements . In the opinion of management , the accompany inunaudited condensed consolidated financial statements reflect a&adjustments , consisting only of normal recurring adjustmentsnecessary to present fairly the results of the Company's operations andits cash flows for the three months and six months ended June 30, 1999and 2000 . The accompanying unaudited condensed consolidatedfi nancial statements are not necessarily indicative of full year results .Certain reclassi fications have been made to prior period financialstatements to conform to the 2000 presentation, which have no effecton previously reported revenue or net income .
207 . Even through this restatement, the PurchasePro Defendants refused t o
disclose the true financial condition of the Company to the investing community .
In fact, while the market voiced certain concerns regarding this "reclassification" of
income, they continued to assure the investing community that all was well with
PurchasePro . This was done in furtherance of their scheme and in an effort to thwart
a decline in the value of the Company's securities .
208. In the upcoming months, it became more important than ever fo r
Defendants to continue perpetrating their fraud, especially when confronted by
analysts and financial columnists who were beginning to express doubts about
PurchasePro's financial results and accounting . For example, the PurchasePro
Defendants countered by saturating the investing community with more unfounded
positive news concerning the Company's growth and financial stability .
209. For instance, in a pair of articles that appeared in TheStreet.com on
November 3, 2000 ( "Doubters Question PurchasePro's Results, as its Stock Pric e
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Dives") and November 8, 2000 (" PurchasePro Pounded Over Deferred Revenue
Issue; CEO Unfazed"), analysts stated doubts and concerns about PurchasePro's
financial results , its accounting and what appeared to be a slow down in
PurchasePro's overall business . Further, the November 3, 2000 article specifically
noted that :
But concerns over PurchasePro's numbers don't end there. Thecompany beat third quarter estimates by a dime because it didn't recorda sales and marketing payment that analysts were looking for .
Under a March agreement with AOL for technology developmentPurchas { Pro has to ay $20 million over the next two years in equal~ uarterl -y installments (in total , it has agreed to pay AOL $ 70 millionthrough ✓various deals ) . But it only paid 9 1 .1 million of the $ 7 .1 millionit was expected to pay during the third quarter, a result of a "timingissue," t;ie company says.
210 . Nevertheless, these criticisms were actively countered . In fact ,
defendant Benyo offered the following statements which appeared in the November
3rd article :
Purchase;Pro blames the stock's decline on the overall market anddisputes critics' contentions about its recent results . "Business from arevenue perspective and from customer interest is white-hot right now,"says Chris Benyo, PurchasePro's marketing chief.
PurchasePro ' s Benyo says the company is on track . "We've said wewould be profitable in Q4, so that means we expect revenues to coverthat initial AOL expense,' he says .
211 . In addition, defendant Johnson offered the following statements on the
deferral of revenue issue which appeared in the November 8th article :
"That revenue will get recognized some day because it has to be, andit's the auditor ' s determination to decide when that happens," saysJohnson , "But we won ' t take retu rns . As Ion as I'm at PurchasePro,there will be no retu rns . I know that for sure . They [the auditors] maynot know that for sure , but I do . Who else do you think can make thatdecision?"
And Joh:zson says it ultimately doesn't matter to him whether he ever
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gets to recognize the $2 million in revenue . Certain] , at least, hecontends it won't kee his company from making its fourth-quarterrevenue projections ofp$30 million to $32 million -- and also turning aprofit .
"First and foremost, it doesn't matter, it's not going to make or breakmy quarter " Johnson said . "It's a gnat, in terms of significance . Let'ssay the deferred revenue stayed the same and I don't recognize any ofit . We've still got the cash in the bank and I smoke the quarter, so whatdifference does it make?"
Johnson said PurchasePro wasn't doing anything unusual with itsnumbers . Instead, the company was being conservative in itsaccounting, he said .
"I'm 99% sure that I get to recognize that revenue this quarter, but I'mnot courting on it . It's no~t~ goin to make a difference whether wemake our numbers or not . We're taking the high road and going withthe conservative accounting approach .
212. The statements by Benyo and Johnson were calculated to counter an y
criticisms being made about PurchasePro . Moreover, they had no basis to make
these statements because they knew the Company was doing worse as the Class
Period commenced and they were not following "conservative accounting . "
However, it still was not enough . Another tactic was needed to artificially boost
PurchasePro's revenue . As a result, during November 2000, Defendants modifie d
the warrant deal between the Company and AOL by reducing the strike price of
AOL's warrants to $0 .01 per warrant. In this manner, for every $1 worth of
"revenue" generated by AOL for PurchasePro, AOL would receive $3 worth of
warrants .
213 . A~ the Class Pe riod continued , on November 14, 2000 , in an art icle
entitled "PurchasePro Named to the Standard 100 Powered by Epoch Partners"
defendant Ben-,,,o misrepresented the member base of PurchasePro, which he kne w
to be false, as follows :
Inclusion in the Standard 100 is an honor for our company said ChrisBenyo , senior vice president of marketing for PurchasePro . We believeour recurring revenue business model , industry leading member baseof more than 30,000 businesses and impressive list of strategic pa rtnerspositions us as one of the most influential companies shaping today' s
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214. On or about the same day, the Company filed with the SE C
PurchasePro's Form 10-Q for the third quarter of 2000 . Signed by defendant
Clough, and dated November 13, 2000, the Form 10-Q reiterated and expanded upon
the third quarter financial results released on October 17, 2000. Further, the 10-Q
11 stated that :
The unaudited condensed interim consolidated financial statements ofPurchasePro .corn , Inc . and its subsidiary, Hospitality PurchasingSystems. (collectively , the Company) for the three months and ninemonths ended September 30, 1999 .and 2000 , included herein, havebeen prepared by the Company, without audit , pursuant to the rules andregulations of the SEC . Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withgeneraly accepted accounting p ri nciples have been condensed oromitted pursuant to such rules and regulations relating to interimfinancial statements . In the opinion of management , the accompan inunaudited condensed consolidated financial statements reflect aadjustments, consistin g only of normal recurring adjustmentsnecessary to present fairly the results of the Company ' s operations andits cash flows for the three months and nine months ended September30, 1999 and 2000 . The accompanying unaudited condensedconsolidated financial statements are not necessarily indicative of fullyear results . Certain reclassifications have been made to p rior periodfinancial statements to conform to the 2000 presentation , which haveno effect on previously reported revenue or net income.
215 . As noted with other 10-Q' s filed by the Company, that were also signed
by defendant Clough, and contrary to the foregoing representations, PurchasePro's
financial statements were not being presented pursuant to the rules and regulations
of the SEC, or in accordance with GAAP. In fact, as discussed above, Defendant s
were manipulating every revenue stream of the Company so that they could falsely
report record quarter over quarter growth . In addition, Defendants had modified the
warrant-for-revenue deal with AOL and falsified financial records to fraudulently
credit AOL with the referral of $10 .5 million in revenue, as an additional means to
artificially inflate the revenue of the Company. See §§1V-V.
216 . Days later, on November 20, 2000, an article was released concern ing
the AOL and PurchasePro relationship . In that article, defendant Benyo further
touted the resu`ts from the relationship. Specifically, Benyo stated :
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Some 1 00 , 000 small businesses have already registered to use theservice , said Chris Benyo , PurchasePro ' s senior vice president ofmarketing . Benyo said with the new site, those businesses will be ableto significantly add to their presence , tapping PurchasePro capabilitiesthat range from e- procurement to listing online catalogs .
217 . 0- course, these statements were also false and misleading . As
numerous employees have stated, the majority of "customers" that "registered" with
PurchasePro as a result of the Company's relationship with AOL did not even know
they had opened a PurchasePro account . Hence, as described in great detail by the
former employ°es of PurchasePro, these accounts were not true user accounts and
only contributei to artificially inflating the number of "members" of the PurchasePro
system . See th:, information provided by Employees 3-6, 9 and 12 in §V above .
218 . On November 29, 2000, TheStreet .com published an article discussin g
the hiring of defendant McGhee, who had previously run Office Depot's North
American operations . When questioned about issues concerning PurchasePro's big
rise in the Com pany's accounts receivable, a flattening of its recurring revenue, and
$5 .3 million in deferred revenues, McGhee noted that before accepting the job, he
spent days with the Company's top executives, grilled the Company's lawyers an d
even probed its auditors . Specifically, McGhee stated :
The questions I put to the auditors were whether the issues aresomethir..g that ' s specific to PurchasePro or a challenge within theindustry , . . . [the response I got back was that these are industry-typechallenges that are in the web industry . They said they don't see anissue wit :.1 PurchasePro or its management team . Obvious~ly when youlook at the volume of pronouncements out of the SEC: lately, it'sobvious that they 're trying to move the accounting issues along to catchup with what' s happening in the industry .
219. Of course, these statements are false and misleading because if McGhe e
had conducted the investigation he claims to have made, the problems with
PurchasePro would have been apparent . The accounting issues were indeed
Company -spec :.fic and not industry-wide .
220 . While Defendants were touting the AOL-PurchasePro relationship t o
investors, on December 21, 2000, defendant Colburn addressed about 100 employee s
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assembled in the Seriff Auditorium at AOL headquarters in Dulles for the monthly
all-hands meeting of his unit . The purpose of the meeting was to hand out the
Bammy Awards, a takeoff on television's Emmy Awards . The Bammys were given
to the best performers in Colburn's division, a group of aggressive deal maker s
skilled in extracting maximum dollars from a prospective client .
221 . Bvisiness affairs -- "BA," as it was known at AOL -- was in the middl e
of many of the company's biggest and most complicated deals, which helped AOL
reach or exceed its financial targets . On this day, Colburn bestowed the Bammy's
gold-star plaque on Kent Wakeford ("Wakeford") and Jason Witt ("Witt"), who had
put together the amendment to the PurchasePro/AOL Warrant Agreement .
According to several people at the meeting, Colburn praised the two men for wha t
he called a "science fiction" deal to generate revenue . Wakeford and Witt joined
Colburn on sto.ge and accepted the plaque . In his acceptance speech, Wakeford
thanked someone who was not in attendance -- "Junior," i .e ., defendant Johnson .
The crowd roared with laughter over the tongue-in-cheek remarks .
222 . Approximately one week later, on or about December 28, 2000,
defendant Johnson was interviewed by CNBC. Defendant Johnson used this
interview as yet another platform to further allay concerns and criticisms o f
PurchasePro. The following is an extract from the interview :
JOHNSON : Well, I think that we had a great year . We will be cashEPS positive this quarter . I think last year at this time we did $2 .7million for the quarter . We were caught in the whirlwind of theNASDAQ ,and now we will survive the 11ushing out of the dot .coms .We are going to be cash EPS positive. We will do as much revenuethis quarter as we ' ve done the last three quarters combined .
MARIA : You last week announced an alliance with BroadVision . Tellus about that . What does that do for your company ?
JOHNSON : Well, our alliance with BroadVision , Computer Associates,Gateway , AOL, they're all similar in the fact that we will be theirplatform .for their B to B strategy and by doing so it allows us to get toa mass market at a much faster pace and will help us create multiplestreams of revenue as well as deliver the personalization of softwarethat BroadVision has and offer our business base a wide range of goodsand serv ;ces
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GEROLD KLAUER : Mr. Johnson this is Gerry Klauer . I'm impressedwith what you just said in light ot the fact through the nine months Ithink you reported revenues of over $30 million and that the fourthquarter you just said would be as much as what you did in the first ninemonths. Can you tell our viewers how you derive your revenues ?
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JOHNSON : We derive it from multi ple streams. First is people pay anaccess fee to access universal network and the way that we've built oursolution is we have e-market services where people can market theirgoods and services to the entire universal network as well as each
Frivate marketplace that we have . We've really built this business fromhe ground up . We weren ' t incubated to be a dot . com, So we are
happy, that this business model is beginning to flush out and we think1 0 T will be a coming out party of the winners and losers and we feel wewill be on the winning side .
KLAUER : Just a quick follow on. Do you get a percentage of thetransactions that occur between companies?
JOHNSON : We are actually etting anywhere from a half percent to aone percent transaction fee . We get access fees . We get license fees .We get about eight or 10 different types of fee structures . So we haveno one fee structure that we are dependent upon and because of thatour customer base is very bul lish . The demand is very very high andwe hear about those soft landings and hard landings and we have yet tosee any effect at all on our space at all ,
MARIA, That all sounds great , Mr. Johnson, but I was just looking atyour customer base and you 've got Computer Associates and Sprintand Gateway and Office Depot all of whom have already said thatthings are slowing down, Are you not feeling that slowdown ?
JOHNSON : That ' s actually to our advantage because they ' ve now triedto create new streams of revenue and we are that stream of revenue .We are an alternative source of revenue where they can now take theirbusiness customers and monetize them in a different way by linkingthem in this universal database . Each one of these customers now hasa chance not only to buy those art icular company ' s goods and se rvice,but we enable them to sell Their goods and services to the othercustome,- of these companies . So we actually look at that as anopportur .ity and actually it will be a bene fit to us this year ,
MARIA : All ri ht, what exactly specifically do you need to do toenhance shareholder value?
JOHNSON : I think that really we're not ping to have to do much . Ithink the numbers wi ll speak for themselves . I think that up to thispoint , al . these stocks were valued on ho p e and hype based on theirpress releases and we are lookin g forward to `01 because we think atthe end c>f the day the companies that make the most mone y will be thewinners . And now that we are all be inning to be cash EPS positive,we feel like the numbers will speak for themselve s
GEROL] KLAUER : Mr. Johnson , the fourth quarter, I'm still ve ryimpressed. Congratulations . Is that any seasonal effect in the fou rth
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quarter?
JOHNSON: No it is a ramping effect of our recurring revenue and weare going to do from $ 17 million in Q3 to over $ 30 milion in cash EPSpositive, Ifyou . look at each quarter , we have grown anywhere from 80to 100 percent in revenue while our expenses have onl y grown at 25percent . We have gross mar ins at near 94 percent . I ftpnk it comesdown to [how] the market will recognize who the real winners in thisspace will be and because our to p line was not as great as some of theother players in the s pace , I think we were discounted heavily. But Ithink now people see now scalable the model is, but more importantlyhow profitable the model is .
MARIA : I'm just readin a report from Lehman Brothers on yourcompamr and the analyst here is say ing that he thinks that the programwith AOL is going extremely well but he was looking for revenuesfrom your alliance with AOL to come in the first quarter, but in fact itis kicking in earlier than people expected . Is that correct?
JOHNSON : Yes. Our alliance with AOL has actually been it'sexceeded even my expectations . AOL has nine million differentbusiness users and three million different business and we are theplatform and strategy that they are taking to market . And we've had inthe Net business registrations near a million businesses alreadyregistered . So we feel like the success of this actual program willexceed I think, everyone's expectations .223 . .fohnson s statements , and the image he po rtrayed of the Company
throughout this interview , were false and misleading . While Johnson knew abou t
everything that was wrong with the Company, and was aware of all the differen t
methodologies that were being employed to artificially boost Company revenue,
including the 1round trip and sham transactions, he still touted PurchasePro .
Throughout thus interview, he claimed that the Company would be a "dot .com
winner," that h,.- was bullish on his customer base, that demand was high and that
PurchasePro was both scalable and profitable . There was no basis for Johnson to
make any of these representations. Furthermore, when directly asked about the
effects of the general slowdown in the economy on the Company, Johnson countered
that PurchaseR-o was not being affected and that it would ultimately be good for
business . In fact, business was far from good and it was only going to get worse .
224 . On the next day, December 29, 2000, defendant Johnson was
interviewed by .CNN . Once again , as with the foregoing interview , Johnson made
false and misle ,-, ding statements concerning the Company ' s present condition and it s
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financial outlook. Moreover, he knew that his statements were false and misleading
for the reasons stated in the foregoing paragraph. The following is an extract from
the interview :
CHARLES MOLINEAUX, CNNfn ANCHOR : . . . Do you think thatyour company is now ready to tu rn around and move into 2001 ?
CHARLE S JOHNSON , CEO PURCHASEPRO . COM: We've reallybeen ready the whole year . This quarter will be the first quarter thatwe're cash EPS positive . So we really feel like that the winners andlosers will flush themselves out with the results .
[AMANDA] LANG[CNNfn ANCHOR] : What differentiates you fromsome of 'the other players in the B to B space? The names that come upAriba, Commerce one. How is Purchaseone [sic] any different ?
JOHNSON : Most of the other companies targeted going after a fewcustomers that would pay a lot of money . We've gone after a lot ofcustome rs that would pay a little bit of money but a gregately our grossmargins are near 94 percent and with the scalability ot`our model, ouroperating margins will approach 50 to 60 percent upon maturation ofthe modLal .
MOLINEAUX : Now a couple of conce rns with that model though .Your target is a mid-size company . Usually they are less the leadingedge adapters and adopters . Doesn't that put you at risk for a slowerpace of adoption?
JOHNSON: Well I think that's been a hypothesis that everybodystarted with but we found in reality that's not the case . We're olngafter this market through AOL , through Gateway, through Sgprinf,through Computer Associates and by not having to go through thetraditional route these people are very quick to adapt because its theirmoney and any money that they save or any marketing costs that theycan reduce to increase their sales, they're real quick to adapt .
LANG : Te ll us about your management team. There are some concernsabout th , ;re being some holes in it . Are you out vigorously recruiting.
JOHNSON : Holes , I'm actually kind of surprised . We,ust brought inthe former president of Office Depot Shawn McGhee . We have seniorlevel ma.na ement from Sprint, Sell South . Our legal comes fromPillsbury' Madison & Sutro , a big law firm . Obviously we'll continueto, as the company grows, to grow our management team but at thispoint in time we think we have a top tier management team that'ssecond to none and I think its reflective on our results of being cashEPS positive this quarter .
MOLINEAUX : We've seen a dramatic change in the business tobusiness world this year . Instead of independent market places andexchang°s being set up, there are a lot of them now being set up by theindustries and players with the industries that they are supposed toserve . Where do you fit into that?
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JOHNSON : We actually have a universal platform that allows all theindustries and a ll the individual companies that want to build a marketplace to build and have complete ,interoptibility (ph) . So instead jot]building individual silo's, we built it where both private and publicmarketplaces can come together and every business in the marketplacehas the ability to both buy and sell which is unique and its kind ofunique cause we started our platform from day one that way andbecause of that we have the greatest amount of liquidity and thegreatest amount of scalability because of already instant liquidity for anew market place .
225 . During this time frame, the PurchasePro Defendants also participate d
in a conference call to review the fou rth quarter and year ended December 31, 2000 .
Once again , thccy used this as a platform to continue touting the financial strength
and growth of the Company . In fact, during that conference call, defendants
Johnson, Benyo and Clough made nume rous misrepresentations regarding the
Company .
226 . Defendant Clough made the following statements conce rning "customer
I creditworthines s" and "accounts receivable." During the conference call, Clough
stated :
it's important to note, the hi h quality of receivables , as demonstratedby our r6cent license sales fo high quality names such as Hone ywelland BroadVision . Our reserve for doubtful accounts is $2 .5 million .We believe we have limited exposure to the dotcom world and ourreserves are sufficient to cover any exposure . We do not anticipate anycollection issues, noted by the si gnificant decline in DSOs . And webelieve that we have prudently added to our reserve .
227. These statements were false and misleading . The Company had a grea t
deal of exposure on these matters . PurchasePro's collection department was
virtually non-existent, which was an issue in and of itself . As noted by numerous
former employees of the Company, accounts receivable were overinflated . Most of
PurchasePro's ('~ustomers had completely abandoned paying the Company for their
accounts and many did not even know they had accounts with the Company, which
lead to the same. result, non-payment .
228 . During the same conference call, defendant Benyo made the followin g
misrepresentati~':)ns . In an effort to facilitate the appearance of an ever growin g
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During the fou rth quarter , our customers received more than 18,000purchase orders, 45 percent more than in the third quarter. To give youan idea of how transactions are ram pint we've already done as manypurchase orders this quarter as we did the entire fou rth quarter. Therewere also more than 110 ,000 bids and bid recipients in the fourthqparter . During the qua rter we added 100 ,000 business fromNetbusiness and more than 10,600 from our other marketplaces .
I think the other factor to put in there is the 100 000 businesses fromthe AOL relationship that have really only joined the network and arestill going through their adoption curve . So, we see the addition of lotsof buyers, lots of suppliers and back-end integration in drivingtransaction volumes in the near term and the long term .
229 . These statements were similarly false and misleading because most o f
PurchasePro's .ustomer base was non-existent . According to former employees of
the Company, the "true" number of paying users of the PurchasePro system
amounted to little more then 1 %-9% of the numbers being reported by the Company .
Further, the accounts being received from AOL were nothing more than a charade
at best .
230 . Thousands of those accounts were created without the customer' s
knowledge anc, did not generate revenue for the Company. Further, Benyo had
direct knowled,e throughout the Class Period that the database was "dirty," i .e., the
database was materially inflated due to fraud within the Company, accounts created
through error, 2nd non-paying accounts . Nevertheless, Benyo instructed employees
of PurchasePrc not to clean the database so that he could represent higher number s
to the public .
231 . Johnson's statements to the investing community during the conference
were equally misleading for the reasons stated immediately above . During the
conference, Johnson stated :
Going forward , we anticipate putting the primary focus on continuinto ramp to our recurring revenue . And we feel like the quality of thatrevenue and the margins that it creates long term is going, to bring thebiggest return to everyone . But, at the same time we have a deeppipeline and demand for these marketplaces , much different than what
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I think the public markets perceive .
As far as giving speci fic revenue from specific partners, Ian, each ofthese partners , know that we're getting into the maturation of theserelationships, we are actually limited on what we can say , which is whywe've aggregated it . I can tell you that it's signi ficant on a referralbasis . Cane thing that's impo rtant to point out is that the revenues thatwe received were not from AOL, but through AOL and through ourdirect contact with its business development depa rtment and its externalsales force .
So, a ai n I think it gets back to the model of PurchasePro notdepending on any single partner . So, we really want to keep the focusaway from individual partners because what p eople need to understandis that it is the partners, it's not the money they re spending with us .
232 . Johnson's statements were misleading because Defendants knew at th e
time that greater than one-half of the revenues referred to by Johnson had com e
directly from AOL. Defendants, including Johnson, also knew that they had
fraudulently falsified PurchasePro's accounting records to make it appear that the
revenues came from third parties referred to the Company by AOL . In reality,
PurchasePro had become totally dependent on falsified revenues de rived from its
agreements wig h AOL and the other companies listed above in order to sustain a n
appearance of :revenue growth .
233 . Ina release entitled "PurchasePro to Expand Time Warner Relationshi p
with Multi-Million Dollar Advertising and Promotional Agreement," on or about
January 31, 200 1, defendant McGhee also touted the Company's relationship with
AOL . While the release stated that the agreement with AOL represented an
expansion of ,he strategic alliance between PurchasePro and AOL, defendant
McGhee also s-)ecifically stated :
As we began to look to national branding and sales campaigns for ourmarketp ace solutions, we knew we wanted a pa rtner that bothunderstood our business priorities and could help us market across awide variety of platforms and media . Our plan is to bringindustry leading e-commerce marketplace solutions to even morebusiness 's across the world . Our strategic relationship with AOL TimeWarner provides a marketing reach that is unduplicated and provide s
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us with a valued partner to help drive our growth .
234. A:; noted with similar statements made by Johnson and Benyo,
immediately above, these statements concerning the "strategic relationship" with
AOL were false and misleading . But for the Warrant Agreement and PurchasePro's
agreement to falsify its accounting records to enable AOL to recognize the maximum
amount of warrant revenue therefrom, it is unlikely that AOL would have ever
entered into any agreements with the Company or to "encourage" customers,
subscribers and vendors to enter into any business relationship with PurchasePro .
235 . Not long thereafter, the February 5, 2001 edition of Barron 's (released
several days before February 5, 2001) published an article on PurchasePro which
highlighted certain concerns regarding the Company's accounting. The following
is an extract from the article :
Factors more specific to PurchasePro are definitely worth ponderin ,too . Among them: Its liberal accounting procedures and the lack of achief financial officer; its inexperienced management team fu ll ofbuddies ; its inability to retain some hi gh-profile artnerships , includingthose with troubled retailer Office De of andpSprint ; and its heavyreliance on a single source , Hilton Hotels , for transaction revenues . Abig question remains as to whether the small and mid-size companiesPurchasePro is targeting stand to reap the kind of bene fits from B2Bexchanges that win induce them to stay on as subscribers .
Notewor '-hy, too : Top PurchasePro officials often make a point inpresentations to investors and to the media that they have not sold anyof their sgares . What they don't disclose in their discussions , but haveacknowledged privately to investors , is they ' ve borrowed against theirshares , t}:e nexbest thing to selling shares since the stock is pledgedas collateral . Johnson, for one, secured a $100 million personal loan .Also insider selling has picked up of late .
"They need a CFO ," says Chris McHugh , of Turner InvestmentsPartners , who bought PurchasePro shares at the 16-17 level for hissmall-cap and 13213-funds .
Indeed , s :)me accounting issues have cropped up . In the third qua rterthe company refiled its second-quarter results to reclassify $2 .3~million of revenues . Also in the third quarter , CEO Johnson signaledto the Street that revenues would be in the $22 million range ; the-Iigurecame in at $17 million and Johnson admitted to investors $ 5 millionhad not been sold through yet to end users and he was advised to deferthe revenue . In addition , accounts receivable spiked up dramatica lly in
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the third. quarter - to $22 .6 million from $1 .73 million - and theprovision for "doubtful" (or uncollectible) accounts bulged by nearl y
2 million, versus $351 000 a year earlier . Days sales outstanding orDSOs, jumped to 123 Lays in the third quarter . Company officialsroutinelly characte rize PurchasePro as having tu rned cash flow-positivein the third qua rter , but then explained this is only possible if ordersbooked through resellers are accounted for immediately .
The more common practice is to wait until products or services are soldto the end users before recognizing revenues . "There are issues aboutcontrol and the business rocess and who is minding the store when itcomes to general accounting practices " says a New York hedge-fundmanager who was long the stock in the past as a momentum play, butno longer holds a position.
In his call to Barron ' s, Johnson said that the CFO post is the only onehe's filled with employees age 50 or older, something that helpedsatisfy investment bankers . One, Richard St. Peter-whose eight- earstint as former CFO of Petco Animal Sup plies ended in 1998, aftYer aseries of earnings shortfalls - lasted less than a year. Johnson, whonoted St : Peter did real real well in one year ," leaving with 50 000vested PurchasePro stock o ptions; says that the former CFO was toldschool" n his approach and didn t have confidence in PurchasePro'sbusiness model .
236 . Among other things, the Barron's article highlighted how defendant
Johnson was pi ofiting from this scheme to artificially inflate the Company's stock
price by using the inflated stock as collateral for a $100 million personal loan .
Johnson's use cof stock as collateral provided him with further motive to maintain th e
Company's stock price at its artificially inflated level .
237 . The Barron's article also quoted defendant Johnson as stating that :
"We're on the cutting edge of everything. We're on the cutting edge of technology,
the cutting edge of accounting ." By the end of the Class Period it became clear wha t
defendant Johnson meant by "cutting edge accounting" and it was not within the
boundaries of "GAAP," but rather of "JAAP," as described by former employees of
the Company.
238 . Ori February 4, 2001, in an effort to maintain Defendants ' scheme, the
Company issued a press release rebutting the Barron 's article entitled, "PurchasePro
Responds to Misleading Barron's Article ." The relevant portion of that releas e
specifically qunted defendant Johnson as follows :
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PurchasrPro today said that an art icle pub lished in Barron's February5, 2001, edition that discussed the company was riddled withinaccuracies and innuendo .
The company said that althou gh it is reluctant to give credence to thearticle with a response, it feels that its shareholders and analysts shouldbe assured that statements made in the article are without factual basis .
The company said, "Barron ' s continues to publish inaccurate,unverifif d information about PurchasePro . These refe rences beganalmost a year ago when the publication stated the company would beout of ca,'th in three quarters . PurchasePro , at the end of the most recentquarter , had in excess of a hundred million dollars in cash and cashequivalents . "
Charles E . Johnson Jr ., chairman and chief executive officer ofPurchasePro , pointed out that the article is "rife with inaccuracies ."According to Johnson, "Writing an article of this magnitude withoutconfirming the facts with the company violates a basic tenet ofreporting . Had the author simply called company representatives,identified herself, and asked to check facts, she m~ ht have had theopporturity to write a fresh, credible and powertul story about acompany that holds a signi ficant leadership position in e-commerce .We were eager for an interview with Barron ' s but wanted to wait untilafter our fourth quarter earnings announcements to do so . "
In terms of inaccuracies, Johnson specifically cited the following :
* PurchasePro's financial statements are prepared in accordance withenerall' accepted accounting principles . The company discloses its
financial condition in all material respects .
* PurchasePro has a chief financial officer. The company's CFO isJames P Clough . He has held the position since April18 2000 .Clough ii a former partner in the law firm Pillsbury Madison & SutroLLP and is the second to serve as CFO since before the company wentPublic in September 1999 . Additionally , the company has had a singleChief Accounting Officer Scott Miller, a former A rthur AndersenCPA, for the past three and a half years .
Barron ' s asserts that the company has an "inexperienced managementteam ." 't. his is not bo rne out by the facts . Johnson believes fhat thecompany has created a top-tier management team . AdditionallyJohnson , President Chris Carton, and Executive Vice President Geoff'Layne an each five-year veterans of an industry that is only five yearsold. Each has strong management experience and is recognized as apioneer la e-commerce . Together with the senior management team,PurchasePro is positioned to continue its rapid growth .
Other inF ccuracies in the Barron's profile include, but are not limitedto, the fo :lowing :
* Entrepreneur Steve Wynn did not pay off any notes for Johnson or
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PurchasePro . His total capital contribution to the company wasinsi nifcant, comprisin $50,000 . His equity position was repurchasedin tl e first quarter of 1998 .
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* PurchtisePro has not changed its business model . The company'sfocus has always been on developing multiple streams of recurringrevenue .. The addition of license revenue is a revenue stream thecompany is able to charge as a result of the instant liquidity in itsinteroperable platform. is new fee triggers an additional recurrinrevenue :stream "hosting and maintenance that equals almost 50% ofthe initial license fee on an annual basis . Other fees includingsubscription, transaction and commerce services are expected toincrease, in value due to the evolution of the model . Average licenserevenue -ias increased every quarter, contrary to the repo rter's assertionof competitive pricing pressure .
* In terms of metrics , usage on the PurchasePro global marketplacegrew 52% last quarter. The company expects that growth will continuefo accelerate .
* The company has no "handshake" deals and its a reements with itsmajor partners are available for review at the Securities and Exchan &eCommission ' s website at http :/www .sec .gov. Relationships with suchpartners remain strong . As is normal in the business cycle , certainagreeme .its with partners have expired . This expiration does not meancomp anies have left the network or have ceased to do business withPurchase. Pro . Office Depot for example, recently mailed more than300,000'catalogs prominently featuring the PurchasePro e-commercesolution . The company ' s relationship with Sprint is ongoing .
* Additii►nally , Barron's failed to mention that the company has signedother si gnificant- partners including Gateway, Honeywell, ComputerAssociates , and kJroadVision .
* AOL was not given four million warrants . AOL does have theopportunity to earn warrants as it meets certain revenue objectives .Additionally, PurchasePro and AOL have a revenue sharing agreementon monies received as a result of the partnership .
* Johnson did secure a line of credit using his PurchasePro stock ascollateral . This amount used on the line of credit does not approach$100 mil lion . In fact , Johnson has used more than $20 million from thecredit lime to acquire additional PurchasePro shares . Additionally,Johnson and several senior members of the management team continueto take no salary or other form of compensation~rom the company .
* Many of the non-financial metrics in the article have never beenreleased by PurchasePro and are grossly inaccurate . PurchasePro doesnot release transaction metrics on a marketplace -by-marketplace basisbecause ,-Iach is individually owned.
* PurchasePro is a browser-based software application . It is not a merewebsite , or simply an electronic "yellow pages" as described in theBarron ' s article . The product suite is the first to be fully browser-basedand wireess in the 132B sector . This product enables companies of al l
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sizes to eliminate the need to integrate, update, and incur 1arAeimplementation costs when becoming a member of the company sglobal marketplace .
"Overall," Johnson pointed out, "Barron ' s apparent misunderstandingof Purc '~ iasePro's business model and strategy is evident by thedepiction of the company 's partnerships . PurchasePro ' s model is tooverlap business databases through numerous partnerships .Purchasr,Pro recognized early that partnerships and relationships wi llvary in :heir success rates. Speed to market is key . We created astrategy that wouldn 't force the company to depend on any relationshipfor its success . "
Johnson concluded by saying, "A final egregious error in the article isrelative . o the mention or a supposed "Superbowl" party. If Barron'swould hive made its diligence calls, they would have learned that onJanuary twenty - sixth, PurchasePro had an employee appreciationgathering; to reward its employees for their continued loyalty andsupport .
"In cone usion I think every PurchasePro marketplace owner, memberand investor should take a personal affront to Barron ' s depiction ofPurchasePro in this article. Their style discredits the thousands ofmembers; our global marketplace who have made our solution pa rt oftheir day-to-day operations, as well as our strategic partners who havechosen t s as their e-commerce platform and B2B strategy .
"Although the company will not comment on financial results prior toits earnir gs on February 12, Johnson invites Barron's readers to reviewthe investor relations page of the company ' s websitewww.Durchasepro .com including the "ereq_uently Ask Questions"
pertaining to most o arron 's comments on the company 's businessand financial practices .
Johnson invited Barron's readers to access the company's earningswebcast .nd press release during the week of February 12 for a detailedanalysis Df its financial results and business prospects . Details relatingto this cE1l are forthcoming .
239. The aggressive rebuttal of February 4, 2001 , was not only false an d
misleading on its face, but compounded and reinforced Defendants' other false an d
misleading Cla ;s Period statements . In fact, by this time, all Defendants were aware
that demand fo : PurchasePro's products and services was virtually non-existent and
totally dependant upon the secret side agreements with the very customers listed by
Johnson in Purc .hasePro's rebuttal. Defendants also knew that because the Company
was using warrants to manipulate its revenue, and that the "accounts" being created
by AOL were )ittle more then an outright fabrication, the Company's "revenues "
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were not indicative of underlying demand for the Company's products and services .
On the contrary, the Company's records were being intentionally falsified in order
to represent financial growth to the investing community . Thus, Defendants'
arrogant attempt to hide the truth from the investing community in this manner is
perhaps the most egregious example of Defendants' fraud throughout the Class
Period .
240. Then, on or about February 12,200 1, the Company announced "record "
year end results for PurchasePro . In this press release, defendant Johnson, as in
numerous other: releases, continued to make false and misleading statements to the
investing community concerning PurchasePro's financial condition . The press
release stated i;i pertinent part :
PurchasePro .com Inc . (Nasdaq: PPRO), a leading enabler ofbusiness-, .to-business e-commerce solutions for companies of all sizes,today re ported operating positive cash earnings per share of $0 .11 or$7 .6 minion of cash earnings, exclusive of non-cash charges and aone-time gain .
The com3any reported revenue of $33 .6 million for the fourth quarterended Dfcember 31, 2000 . Additionally during the fourth quarter thecompany posted a one-time net gain of $0 .04 per share from the sale ofan investment. The company's cash flow for the quarter was $10 .3million .
PurchasePro ' s revenues for the fourth quarter rose 94 percent from the$17 .3 million posted in the precedin quarter and increased 1,160percent U) a record $33 .6 mi llion , from $2 .7 million a year ago. For thel=ull year, PurchasePro recorded revenues of $65 . 0 million, an increaseof 953 percent versus last year's revenues .
The company also reported that it has significantly narrowed its totalcash loss to $12 .6 million , or $0 .20 per basic share for the year endedDecember 31, 2000 , from a cash loss of $0 .45 per basic share a yearearlier .
Including all charges, the company repo rted a total net loss p er share of$0.55 for the quarter compared to a ne loss per share of $1 .03 last year .For the year , the total net loss per share was $1 . 15 versus $2 .44 lastyear .
Charles E . Johnson Jr., chairman and chief executive officer , said, "Wethink our fourth quarter results confirm the strength of our businessmodel and validate without quali fi cation , our revenue model . This isfurther evidence of the leadership PurchasePro has established in thee-comme -ce industry ."
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"Critical to the growth ofPurchasePro is member adoption ," continuedJohnson . "Adoption by new members has continued to increase and weexpect that growth to be of even greater magnitude in the future .Simultaneously , the company 's purchase order volume rose by nearlyfifty percent during the fourth quarter . Posting record revenue whileeffectively managing company expenses enabled PurchasePro torecognize cash earnings per share of eleven cents , significantlyexceedirn.g consensus analyst estimates . "
241 . In this release, without any basis for his statements, Johnson continue d
to tout the PurchasePro "business" and "revenue" model, and the alleged increase
in adoption by new members . For all the reasons stated above, Johnson knew that
these statements were false, but continued to deceive the investing community
without regard for shareholder's investment in the Company .
242 . Yet despite the numerous false representations being made concerning
PurchasePro, some criticism of the Company continued in an article entitled "At
PurchasePro, Wondering What's Beyond the Numbers ." That article again
challenged the Company, and defendant Johnson , noting in part :
Purchasf :Pro's stock fell 42% last week a fter three pieces of bad news :A critical a rticle in Barron ' s questioned management's experience andthe company 's accounting practices ' the company ' s underwriterdowngraded the stock over concerns about growth ; and the companand its top executive [Johnson] were named in a racketeering lawsui ~
For its part, PurchasePro issued press releases refuting the article andthe claims in the lawsuit . But the company ' s denials shed little light onCEO Charles Johnson Jr .' s relationship with the failed businessman andconvicted money-launderer Russell Pike, who is now suing; him and thecompany from the confines of a federal prison camp near Area 51 in theNevada desert . As PurchasePro holds an earnin gs conference callMonday afternoon , investors and analysts are, likely to be askingwhether Johnson's role in a failed business venture with Pike wen
tbeyond that of investor and, if so, whether he should haveacknowledged it . The stock was rallying Monday, rising $1 .69, or
6 .19 .12%, to '06 .19 .
The Dispute - The lawsuit filed by the Las Vegas law firms ofCampbe'l & Williams and llarrison Kemp & Jones Feb . 6 in ClarkCounty District Court , alleges that Johnson and PurchasePro co-founder Ranel Erickson stole All Creative Technologies' business planbefore launching PurchasePro in 1996 . Pike is Tisted as the onlyco orate offi cer for All Creative . During that same period , Pike fi ledfor-Chapter 7 personal bankruptcy , according to court records . Johnsonsaid he invested in All Creative. A news repo rt pegged that investment
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at $250,000 . But beyond saying that Pike ' s lawsuit is without meritand that the company will defenditself vigorously , PurchasePro, whichsaid Johnson lost his investment in Pikes company , wouldn 't outlineJohnson's relationship with Pike or that relationship ' s genesis .
All Creative which is still incorporated but apparently is not active,published fti-ROM guides to hotel-industry vendors and theirproducts , according to a 1995 press release . PurchasePro , which got itsstart serving the hotel and casino industry in Las Vegas, has beendescribed as an "electronic yellow pages " for buyers and suppliers onthe Internet .
Johnson wouldn't comment for this story, other than to reiterate thecompany ' s line that the lawsuit is baseless . But in an interviewPurchasEePro ' s attorneys disputed the claim that PurchasePro stole AllCreative's business plan .
"One thing we can say is that PurchasePro was not the idea of RussellPike," said Brya~ n Williams, a partner at Las Vegas -based Sklar WarrenConway .. & Williams . ut according to Johnson 's hometownnewspaper, the Lexington (K,) Herald-Leader , Johnson said during aninterview last August that Ail Creative 's "concept and the idea it wasbased upon was still very interesting to me . I guess it ' s an example ofturning 1amons into lemonade ."
Pike went to prison after pleading guilty in fall 1998 to charges ofmoney aundering at another company he ran, Advanced" CartTechnology, which made casino floor carts . It is not clear whetherthere wai a connection between Advanced Cart Technology and AllCreative Technologies beyond Pike's involvement with each . Theindictment and plea agreement for that case said Pike inflated the firm'saccounts receivable, or money owed to the firm by its customers to useas collateral for more than $2 million in loans from PriMerit bank . Theindictment alleged Pike intended to use that money for gamblingactivities .
243. Nevertheless, on February 27, 2001 , defendant Moskal confirmed
PurchasePro 's growth to the investing community . In an article entitled
"PurchasePro Adds Thousands of Hotel Prope rties to Its Hospitality Marketplace ;
"The addition of ten industry -leading hotel entities to theProPurchasing hospitality marketplace is further proof ofPurchas ePro 'Sstrong position as a premier marketplace enabler ," said RichardMoskal , senior vice president of hospitality for PurchasePro . "We'veproven that our solution works to power the procurement needs ofhotels and hospitality establishments ."
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anything but a "premier marketplace enabler ." Most of PurchasePro's customers
were not using' the system and as many as 99% of its members weren't paying for
their "service ." PurchasePro was little more then a shell of a company, which wa s
sustained only by fraud and would ultimately end up in bankruptcy .
245 . Just over one week later, on March 6, 2001, the Company announced
that it had agreed to acquire BayBuilder, and would pay for this acquisition usin g
cash and PurchasePro stock.
246. The very next day, on or about March 7, 2001, a press release wa s
disseminated which reaffirmed the supposed financial solidity of the Company :
Responding to numerous investor and media inquiries following theannouncement of its acquisition of BayBuilder, PurchasePro todayannounced that the company is confident and on track to achieve theobjectives stated in its current financial guidance .
PurchasePro said it expects basic cash earnings per share for fiscal year2001 to 'be in excess of $0 .65, or $0 .59 diluted .
The company again stated that for the fiscal year' 2001 it anticipatesrevenue -will grow approximately 250 percent to more than 225million , bompared with $65 million in 2(100 . PurchasePro also said itbelieves that gross margin will .be in excess of 90 percent for the yearand that casli operating margins excluding non-cash charges, willcontinue to increase to as hi h as ~6 percent in the fourth quarter frommore than 24 percent in thelirst qua rter .
PurchasePro expects first quarter revenue of more than $42 million, a25 percent quarter-over-quarter increase . Basic cash earnings per shareare anticipated to be in excess of $0 .10 per share . With the inclusionof the anticipated impact of the diluted share count, which comprisesa port ior . of outstanding stock options and warrants , estimated dilutedcash earnings per share are calculated to be in excess of $0.09 per sharefor the f rst quarter and $0.59 for the fi scal year 2001 .
247 . The aforementioned March 7, 2001 press release was issued a t
defendant Johnlson' s insistence over the opposition of PurchasePro's in-hous e
counsel . This press release provided a grossly inflated revenue projection of $4 2
million for th€- first quarter of 2001, and resulted in PurchasePro's stock price
soaring by 14° o.
248 . During this time, defendants Johnson and Moskal sold 1,450,000 and
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50,000 shares of their stock, respectively, for prices as high as $11 .70 per share .
Defendant Johnson pocketed $15 .9 million and defendant Moskal reaped $584,000
in ill-gotten gains . In total, between March 6, 2001, and March 9, 2001, these
defendants unloaded 1 .5 million of their shares of PurchasePro stock for over $1 6
million in illegal insider proceeds .
249 . Days later, on March 12, 2001, the Company issued a press release
entitled, "PurchasePro Chairman Announces Stock Sale Plan ; Company Announces
First Founder Stock Sale Since Company IPO 18 Months Ago ." The press release
stated in part :
Purchase.Pro Inc., a leading enabler of business-to-business e-commerce solutions for companies of all sizes, today announced thatits founder, chairman and chief executive officer Charles E . JohnsonJr., has adopted a plan to begin selling shares under rule 10b5-1 .
Under this plan he will gradually liquidate a portion of his holdings inthe company.
The plan sets forth a predetermined amount of shares to be sold daily .Rule 1015-1 permits an implementation of a written plan for stockselling at times when insiders are not in possession of material non-public information and allows them to sell shares on a regular basis,regardle ;s of any subsequent non-public information they receive or theprice of *he stock at the time of the sale .
Johnson adopts the plan 18 months after the company's IPO and morethan a year after the company completed its secondary offering . He hadcommitted that he would not sell any shares until the compan y reachedprofitability . The company posted cash earnings per share in the fourthquarter of 2000 . Johnson has not received any cash compensation inthe form of salary or bonus for over a year and has not received anyoption giants since the company went public .
250 . Defendant Johnson had in fact sold $15.9 million worth of his
PurchasePro shares just days prior to this disclosure in order to pay down his line of
credit with CS :: irst Boston and maintain the margin requirements, or loan-to-value
ratio, under thE.t line of credit .
251 . In.-erestingly, on or about the same day, an article in the Lexington
Herald Leader revealed that Carton had "also pledged his PurchasePro stock a s
security on an $8 million loan when the Company went public ." As with Johnson ,
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this offered Carton the incentive to engage in the fraud described herein .
252 . Thereafter , on or about March 22, 2001, the following article was
released entitled "PurchasePro Stock is Downgraded for Second Time in Tw o
11 Months." In this article, a hint of the financial difficulties at PurchasePro began to
emerge. The article noted in pertinent part :
The financial firm that brought PurchasePro .com to Wall Streetdowngraded the stock yesterday for the second time in two months .Prudential Securities , which underwrote PurchasePro 's September 1999initial public offering lowered its rating on the shares to hold fromaccumulate, sending he stock to a new a-11-time low.
Shares of Las Vegas -based PurchasePro (PPRO : Nasdaq) closed at$5 .97, aster dropping $ 1 .56 or 20.75 percent . The stock is down 90p~rcent from a year ago, compared with a 61 percent drop in theNasdaq stock market .
Analyst Fim Getz said he is concerned PurchasePro is not convertingenough registered users of its electronic marketplaces into payingcustomer: s .
Although PurchasePro has signed up more than 100,000 businessesthrough its partnership with AL's Netscape Netbusiness po rtal, Getzthinks "conversion of these registered users to paying customers wasfar below expected minimal thresholds . "
He bases' that conclusion on conversations with about one third of thecompanies that use the Netbusiness portal to recruit customers, just asPurclzascPro does .
** *
Getz , who had a strong buy rating on PurchasePro until early February,lowered its price target for PurchasePro from $25 to $10 . He said thestock wi~l likely trade between $6 and $ 11 until more PurchaseProcustomers start paying for the service and the economy turns upward .
253 . Then, on March 28, 2001, defendants Benyo and Johnson made the
following statements to counter claims that B2B companies have been under the gun
in the slowing economy . The article stated in part :
Business -to-business companies have been under the gun lately, asanal ysts remain skeptical of their ability to bring in _profits in atightenin ; economy. But Chris Benyo, vice president at 1urchasePro,prefers to take a different view . With the economy slowing , he said,businesses are becoming interested in how they can save money. SincePurchasePro's solutions can be u~p and running in five or six weeks,they won't necessarily turn away from them in a downturn , Benyo said.
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The marketplaces can create additional revenue sources going forward,Johnson said . And recurring revenue sources that are important toevery business , especia ll y during tough economic times .
Beny o said having the 200 additional AOL salespeople behind thePurchasePro products will greatly expand the company s reach. Rightnow, PurchasePro employees about 50 sales represenatives , he said .
254 . Also on March 28, 2001, Defendants caused PurchasePro and AOL to
issue a joint press release heralding the effects of the three corner or round trip
transactions more fully described in the preceding paragraphs by stating :
AOL and PurchasePro have also joined with a broad range of industryleaders to create unique vertical marketplaces . Announced agreementsinclude BroadVision, Inc . (www .broadvision.com), a leading supplierof personalized e-business applications ; TheThread(www.trhethread .com), a leading provider of collaborative supply chainmanagement and e-purchasing solutions for the fashion industry ; PlantAmerica (www .p lantamerica .com), a key resource for the lawn andlandscape indusfry, Viva Magnetics Limited (www . viva.com .hk) theworld's largest CD -Rom replicator , also offering specialty 'CDpackaging services ; eFruit (www.efruitinternational.com), the globalelectronic marketplace for buyers and sellers of agriculturalcommodities; and' ProfitScape (www .profitscape.com ), a majorprovider of an automated payment solution -- eNLT30(tm) - whichfacilitates business -to-business online transactions through financialinstitutions such as GMAC B2B Credit .
By joining with leaders in their respective ve rtical, fields, theNetbusmess Marketplace provides the opportunity for small to mediumsized companies to create specialized industry - specific marketplaces,providing a convenient one-stop location for buyers and sellers toconduct business online .
In addition , AOL and PurchasePro announced today that currentNetbusiiiess partnerBigstep .com (www .bigstep .com ) , an on line servicecenter providing small businesses easy-to-use tools and services togrow and succeed on the Web, signed a separate Marketplaceagreement to provide increased functionality to the NetbusinessMarketplace .
255 . A,, the time that this press release was issued the AOL/PurchasePro
Netbusiness Marketplace was not yet functional and Defendants knew tha t
BroadVision, The Thread.com, ProfitScape .com, and BigStep .com, only purchased
marketplace software licenses from the Company in order to avail themselves of the
secret side agreements with AOL and PurchasePro, as is more fully described above .
256 . In another joint press release on the same day, Defendants further
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boasted of the supposed benefits concerning the Homestore .com transaction which
in part led to the conviction of three Homestore .com executives for securities fraud
due to revenue recognition irregularities . In that article, Defendants stated in
pertinent part :
America Online , Inc . and PurchasePro (Nasdaq : PPRO ), a leadingenabler of business -to-business e-commerce solutions for companiesof all sizes today announced 16 new strategic agreements , includingdeals wish 1ewlett-Packard Com p~any , Homestore .com and Spherion
tion to accelerate their T32B and e -commerce eCorpora fforts, andjointly-develop the Netscape Netbusiness Marketplace . TheNetbusir.,ess Marketplace is a one -stop global e-commerce network ofhundreds of communities and marketplaces that allows small , mediumand large businesses to buy, sell and interact online .
257 . In this release defendant Johnson went on to claim that these serie s
Charles E . Johnson Jr., chairman and chief executive officer ofPurchasePro said, "One of the keys to building a successful business-to-business network is interoperability . PurchasePro's capacity topower businesses of all sizes, and its ability to link hundreds ofmarketplaces - and millions of business users - in a completebuyside/sellside application, provides partners and members with abroader reach to a wider range of audiences . This `network effect' is adriving force in the success of the Marketplace, and an importantcatalyst in our expanding relationship with AOL.'~
258. Of course, as stated above, at the time that this press release was issue d
Defendants knew that the AOL/PurchasePro Netbusiness Marketplace was not yet
functional and tzat Homestore .com only purchased the marketplace software license
from PurchasePro to avail themselves of the secret side agreement with AOL as
described herei 'i .
259 . In light of the foregoing, on or about March 28,200 1, Lehman Brothers
Analyst Patrick Walravens noted that : "we believe this announcement only
represents a portion of the major deals that AOL and PurchasePro have jointly sold
and closed so far . We expect the balance to be announced in the coming weeks .
With 200 AOL sales people focusing on this business, we also think the number of
new deals will continue to increase . "
260 . Th', next day, on March 29, 2001, defendant McGhee touted th e
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Company's fir:ancial condition by making the following statements as part of a n
interview with Investor 's Business Daily ("IBD") . Defendant McGhee stated :
IBD: Is it frustrating to beat analysts' expectations but watch your stockdrop ?
McGhee : If we do our job ve well and are able to meet the guidancewe've put out to the Street in 2001, then we'll be very successTul in thefuture. We'll work on the first quarter , then the second and so on . Ifwe can consistently meet what (estimates ) we put out each quarter, thenthe critics ' noise will start to go away. We realize that thebest way tomeet the critics in the future is to run consistent numbers and do a verygood jot of taking care of our customers .
IBD: Cr tics also say PurchasePro doesn't have enough experiencedmanager s .
McGhee : We're always evaluatin our employees , including myself, tofigure out how we can improve . The experience of this team has beencriticized over and over again . We've still managed to consistentlybeat the Street ' s expectations . As long as we can continue to do that,at some point people wi ll start to understand a couple of things .
IBD : Sueh as?
McGhee: The fact that we know how to run a business. And that we'llbe able to do it profitably. It doesn't take a Harvard MBA or a Stanfordgrad to the able to do that .
IBD : Investors also have questioned the experience of Junior Johnson .
McGhee: Junior has been criticized for not being a Silicon Valleyindividual . He didn't use VCs - he bankrolled the company from dayone . We're based in Las Vegas . We've been successful against all ofthe odds We've said we'd be profitable in 2001 which is a lot betterthan a vast majority of the dot-corns out there. We're very proud ofthat, and we're going to keep working hard to make this an even moresuccessf.il business .
261 . These statements by McGhee were false and misleading for the detaile d
reasons above . In addition, these statements were false and misleading because days
before the end of the first quarter of 2001, Employee 13 specifically described how
he approached defendants Johnson and Carton concerning the rampant fraud being
committed by PurchasePro salespeople, as well as the dramatic overstatement of
"users" being conveyed to the public . Yet despite being presented with direct
evidence that the actual user base of PurchasePro was as little as I% of the numbers
being reported to the public, the PurchasePro Defendants continued to make th e
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foregoing statements and also filed their 10-K with the SEC, in violation of GAAP,
as described below .
262 . On or about April 2, 2001, the Company filed with the SEC its For m
10-K for fiscal year 2000 . Signed by defendants Johnson, Clough, Miller and
Chiles, among others, and dated March 29, 2001, the Form 10-K reiterated (and
expanded upon.) the financial results for the fourth quarter and provided full fiscal
year results for .the Company. In that filing, a comfort letter by Andersen, LLP was
also incorporated which stated :
To PurchasePro .com, Inc . :
We have, audited the accompanying consolidated balance sheets ofPurchasePro .com, Inc . (a Nevada corporation) and subsidiary as ofDecember 31 2000 and the related consolidated statements ofoperations redeemable convertible preferred stock and stockholders'equity (deficit) and cash flows for each of the two years in the periodended December 31 2000. These financial statements are theresponsi ility . of the Company 's management. Our responsibility is toexpress an opinion on these financial statements based on our audits .
We conducted our audits in accordance with auditing standardsgenerally accepted in the United States . Those standards require thatwe plan'-and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement . Anaudit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements . An audit alsoincludes assessing the accounting principles used and significantestimates made by management as well as evaluating . the overallfinancial statement presentation . We believe that our auts provide areasonable basis for our opinion .
In our opinion , the financial statements referred to above resent fairly,in all material respects , the financial position of Purchase-Pro .com, Inc .and subsidiary as of December 3 T, 2000 , and the results of theiroperations and their cash flows for each of the two years in the periodended December 31, 2000 in conformity with accounting principlesgenerally accepted in the United States .
Arthur Andersen LLP - Las Vegas , Nevada - February 1.2, 200 1
263 . The Company ' s 10-K was false and misleading . As stated in referenc e
to the prior 10-Q's which were filed by the Company, and contrary to defendants '
representations, PurchasePro's financial statements were not being presente d
pursuant to the'rules and regulations of the SEC, or in accordance with GAAP . As
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II discussed abo re, Defendants were manipulating every revenue stream of th e
Company so that they could report record quarter over quarter growth by engaging
in sham transactions and warrant-for-revenue arrangements, none of which had bee n
1 1 disclosed to thy, public .
264. Moreover, there is every reason to believe that each of these defendants,
all high rankin€ ; executive officers, were aware of the misrepresentations in the 10-K
concerning the Company's financial condition. Defendant Johnson was an activ e
CEO and was i,ivolved in all major deals concerning the Company. Miller, who has
pled guilty to oostruction for destroying documents also appears to have knowledge
of many of the fraudulent transactions. Defendant Clough served as interim CFO
during the Cli-.ss Period, and it is inconceivable that he was unaware of th e
Company's true condition . Finally, as a member of the Audit and Compensation
Committees, Chiles was responsible for conducting a thorough review of the
Company's fin .incials before signing its 10-K. Thus, he either knew that the 10-K
was false and misleading, or with conscious or deliberate recklessness represented
that the Company was fine when it was not .
265 . In addition, the letter by Andersen, LLP should have offered littl e
comfort to the investing community . As former employees have stated, ever y
quarter, defendant Johnson constantly fought with Andersen, LLP auditors
concerning revenue recognition issues. Further, every quarter, Andersen, LLP would
acquiesce to Jolnson on most of his demands . Thus, there is no reason to believe
that things werf any different with the filing of the Company's 10-K for fiscal year
2000 . On the contrary, things were worse then ever . Nevertheless, Defendants did
nothing to reveal the true condition of the Company .
266. Through this 10-K, Defendants also reported the change in their
relationship with AOL :
In November 2000, we entered into an amended and restated AOLwarrant a reement, amending the March 2000 warrant a reement. Forthe 3,00000 performance-based warrants that had not been earned as
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of the date of the amendment the strike price was adjusted to $0 .01 pershare . Ir exchange for the reduced strike price , the
adjustedrevenue for
which AOL can vest the performance -based warrants was expanded toinclude software licenses recognized by us that resulted from referralsfrom AOL. The formula for vestin g warrants on referral revenue is thatfor each $ 1 of revenue generated from the referrals du ring a fiscalquarter , AOL is able to earn a number of warrants calculated as threetimes the revenue recognized divided by the estimated fair value of ourcommor stock, as defined . The agreement limits the total recognizedrevenue allowed in the calculationTo $ 10 .0 million in the qua rter endedDecember 31, 2000, $ 15 .0 million in the quarter ending March 31,2001 and $20 . 0 million in the quarter ending June 30 , 2001 . For thequarter .,nded December 31, 2000 AOL earned approximately 1 .8million warrants under the amended agreement, andin January 2001 .AOL exercised the warrant with respecT to such shares . For the quarterended March 31 2001, AOL earnedthe remaining 1 .2 million warrantsunder th,ti amended agreement, and in April 2001, AOL exercised thewarrant with respect to such shares .
267 . A ': the time that Defendants caused these statements to be disclosed ,
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Johnson was jr default under the terms of his loan agreements with Bank One and
CS First Boston . This was because the trading price had fallen below the minimum
price necessan" to maintain the loan-to-value ratio under his loan agreements . In
fact, by February 15, 2001, and at all times thereafter, Johnson was in default under
the terms of hl'-) loan agreement with Bank One, since the trading price had fallen
below the minimum price necessary to maintain the loan-to-value ratio. Between
April 2, 2001,rnd April 30, 2001, Credit Suisse ended up foreclosing and selling
$16 .3 million of Johnson's PurchasePro stock .
268 . O:i April 3, 2001, Defendants again caused PurchasePro and AOL to
issue a joint pr.,ss release which boasted their relationship by stating :
America Online , Inc . and PurchasePro (Nasdaq : PPRO), a leadingenabler of business-to-business , e-commerce solutions for com~ p aniesof all si. : es today announced agreements with Information MarketsCorp . (IMd), InsureZone and Chinadotcom Corp . to establish_ private-labe_l marketplaces that will be interconnected with the NetscapeNetbusit ess Marketplace .
The Ne .business Marketplace, jointly developed by AOL andPurchasePro, is a global e-commerce network linking hundreds ofcommunities and marketplaces to allow small, medium and larg e
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businesses to buy , sell and interact online. These new agreementsdramatically expand the procurement and supplier communitiescurrently participating in the Netbusiness Marketplace , which alsoencompasses more than 140 , 000 businesses from PurchasePro'sextensive network of more than 290 private-label marketplaces .Netbusiness Marketplace also provides the opportunity for small tomedium-sized corppanies to create specialized industry - specificmarketplace s , providing a convenient one-stop location for buyers andsellers to conduct business online .
The announcement also demonstrates the growin momentum of thejoint sales, marketing and advanced product development operationsrecently , implemented by AOL and PurchasePro in support of theNetbusir ; ess Marketplace .
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Fred Singer, SVP of AOL Interactive Services and General Manager ofNetscape Netbusiness said , "We are delighted to announce the additionof IMC and InsureZone and Chinadotcom Corp . - all leaders in theirrespective fields - to the ever expanding online trading and informationcommunities available through The Netscape Netbusiness Marketplace .By further expanding the industry-specific and broad -based marketsavailable" to buyers and sellers from companies of all sizes, theeffectiveness and relevance of the Netbusiness Marketplace increasesexponen tially. We can help small businesses expand their growthopportunities and open entire new distribution and procurementchannels for our larger participants . "
Chris B'enyo , SVP of Marketing of PurchasePro , said, "Thecombina : ion ofPurchasePro 's industry -leading e-commerce technologywith ACL's vast consumer and small business customer base is apowerfui draw for companies lookin g to create branded e -marketplacesthat foster content , community , and commerce for the small to mid-sized bu< : iness market. These new partners illustrate the scalability ofour solut '. on to power businesses of all sizes and interconnect hundredsof branded marketplaces . "
Today ' s announcement includes agreements with industry leaders tocreate unique vertical marketplaces , including Information MarketsCorp . (w°wvw.infomarkets .com), the leading provider of fee-based onlinequestion . .nd answer marketplaces ; Insure/one (www.insurezone.com)a full-ser v ice, nationwide "Bricks and clicks" marketplace -- backed byan indept;ndent insurance agency that provides fast, easy access tocommercial insurance from highly rated carriers ; and ChinadotcornCorp . (www . corp . china .com) a leading integrated Internet companyoffering E;-business solutions, portal ande-marketin g services . The newagreements announced today follow on the heels often other strategicmarketplace deals announced last week , including those with Hewlett-Packard Com-pany, BroadVision , Inc . and Spherion Corporation, toaccelerat ., AOL's and PurchasePro's B2B and e -commerce efforts .
269 . Of. course, at the time that this press release was issued , Defendants
knew that the majority of agreements referred to were solely the result of fraudulen t
agreements . Th ° AOL/PurchasePro Netbusiness Marketplace was not yet functiona l
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and Defendants knew that InsureZone, Chinadotcom and BroadVision only
purchased mar'cetplace software licenses from PurchasePro to avail themselves o f
the secret side .greements with AOL and PurchasePro more fully described above .
For example , as previously discussed , the InsureZone agreement referenced above
was false and n'tisleading because the marketplace license bought from PurchasePro
for approximately $ 180,000 was in essence , a forgiveness of a $180,000 debt that
InsureZone al•eady owed to PurchasePro . In effect , Anderson and others at
PurchasePro agreed to reclassify InsureZone's old debt of $180,000 as a ne w
marketplace software license purchase, thereby improperly causing PurchasePro to
recognize$ 180 000 as revenue in Q 1 2001 .
270 . Besides the previously discussed admission of defendant Anderson
regarding the f.ilse and misleading nature of the InsureZone announcement, this is
fully supporter . by numerous confidential internal e-mail . For example, on March
20, 2001, McC lure e-mailed Carolyn Lusk of InsureZone and asked her to "revise
the InsureZone contract or license agreement to reflect a $100,00 license and
forward it to Dante Orsini and Jeff Stanley , at AOL, first thing Wednesday
Morn ing ." Hc`wever, as of March 20, 2001 , PurchasePro failed to perform its
obligations to InsureZone as set forth in the original Preferred Supplier Agreement
in August 2000 . Moreover , on March 30 , 2001, the last day of PurchasePro's firs t
quarter, Purcha.sePro's General Counsel, Todd Lehtonen ("Lehtonen"), sent an e-
mail to McClure at 2 :58 PM, cc'd to Scott Weigand, defendant Anderson and
defendant Miller regarding InsureZone . Lehtonen advised McClure that certain
language will l kely suffice to get InsureZone to execute the marketplace software
license agreem-Int to replace the preferred supplier agreement effect . This would
allow PurchastePro to reclassify InsureZone's old debt of $180,000 as a new
marketplace so .tware license purchase and thus allow PurchasePro to recognize this
$180,000 as revenue in Q1 2001 . Specifically Lehtonen states :
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The following language will likely suffice in order to get InsureZoneto execute the1Vlarketp1ace Software License A reement however, I dobe lieve that this construct may well result in rurchasePro not beingable to recognize the $180,000 from the Marketplace Software LicenseAgreement .
[T]he Preferred Supplier Fees paid to PurchasePro by InsureZone as ofMarch 30 , 2001 under the Preferred Supplier Agreement will fulfi llInsureZone ' s payment obli gations for the first 2 years (i .e . the InitialTerm) of Preferred Supplier Fees under the Preferred SupplierAgreement (approximately $ 180,000) . However both PurchasePro andInsureZone will mutually agree to terminate tfie Preferred SupplierAgreement if InsureZone ' s rights and benefits under the PreferredSupp lier Agreement are substantially delivered to InsureZone under theVertical Foundation Partner Agreement between AOL and InsureZone .
Todd
271 . In response to the previous March 30, 2001, e-mail from Lehtonen ,
defendant Miller responded via e-mail to Lehtonen on March 30, 2001, at 3 :05 PM :
I thought the concept on this one was that they would terminate thecontract and we would quit providing the preferred supplier agreement .I had not focused on the [fact tat the] discounted price on themarketpace was exactly the same as the marketplace fee . If so, thiswill look real funny . If we don't discount , and they terminate under thenormal terms then I think we can make an argument for recognition .This onc ! really pisses me off- i get 9uestions asked of me on twodifferent.' days and they put the two individuals questions together tocome up with this solution . thanks for the tip on this .
272 . In response to the previous March 30, 2001, e-mail from Lehtonen ,
defendant Anderson responded via e-mail to Lehtonen on March 30, 2001, at 3 :1 0
PM : "How can we change this to avoid accounting problems?" In response to the
previous Marci 30, 2001, e-mail from Lehtonen, McClure offered his solution t o
avoid the accounting problem . In an e-mail to defendant Anderson, Lehtonen,
defendant Miller, cc'd Scott Weigand on March 30, 2001, at 3 :11 PM, McClur e
states :
I think we got it . Jason Witt' agree[d] to put the ps preferred supplier]language , into his contract , with our permission . T'fils will allow us to
' Jason Witt is the star AOL employee whom defendant Colburn bestowedthe "Bammy's gold-star plaque" for putting together a complex transaction withPurchasePro .
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terminate the ps [preferred supplier] agreement upon execution of theaol vert _~ cal foundation . Tocdcf was on that call , 1ust after the emailbelow went out . [referring to Anderson 's March 30, 2001, 3 :10 PM,email regarding avoiding accounting problems ]
273 . In response to the March 30, 2001, e-mail from McClure, defendant
Anderson replied, via e-mail on March 30, 2001, 3 :12 PM, "Perfect ." McClure told
Scott Newton that InsureZone's obligation under the August 2000 supplier
agreement would be terminated once InsureZone signed the license agreement .
Moreover, McClure told Rusty Reid and David Newton of InsureZone that th e
license agreement executed on March 30, 2001, between PurchasePro and
InsureZone, would replace the Preferred Supplier Agreement executed in August of
2000.
274 . Then, on or about April 4, 2001, in reference to Johnson ' s bankers
selling his stoc c to cover his lines of credit, Johnson called PurchasePro's in-house
counsel, and asked : "what the f--- are you going to do to stop them from selling?"
He then follow -d with threats to quit and sue the Company if PurchasePro did not
buy him out of his Credit Suisse problem . Counsel explained that PurchasePro's
cash position made it difficult to bail Johnson out, and Johnson responded a s
follows:
Desperate people do desperate things and I'm desperate . . .if thecompany don't do the related transaction, they can get sued, remember,I'm the n other-f---ing biggest shareholder you allgot . . . I will bring thats--- dow i . . . . So you etter get-get them on the hone now . . . BecauseI'm not l ;oing to sit here and watch me get obliterated making all thecompan all this money , and the company can't help me? Are youkidding? And they'r e 're worried about a suit? They'll get sued . IGuaranty it ! Its me! And I am the largest shareholder .
275 . Tl- en, on or about April 19 , 2001, following the PurchasePro Board o f
Directors' discovery that Johnson's loan with Credit Suisse had become impaired,
and Johnson's repeated requests for a bail-out, defendant Chiles, Collins and
O'Brien, acting in their capacity as the Board of Directors, agreed to pay Johnson a
"retention bonus" of $2 million and an "expense reimbursement" of $1 million ,
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despite the lack of evidence documenting his expenses . Upon information and
belief, Johnson and Miller also instructed PurchasePro to wire Credit Suisse the $3
II million .
276. On April 23, 2001, PurchasePro completed the acquisition of
BayBuilder, paying $8 .5 million in cash and artificially-inflated PurchasePro stock.
The consummation of the BayBuilder transaction provided the PurchasePro
Defendants with further motivation to maintain the stock price at artificially inflated
levels .
277 . TI ten, only two days after having closed the BayBuilder acquisition, on
or about April 25, 2001, the true financial condition of PurchasePro began t o
emerge .
VII. PURCHASEPRO 'S TRUE FINANCIAL
CONDITION BEGINS TO EMERGE
278 . On April 25, 2001, PurchasePro stunned the financial community with
a surprise announcement that PurchasePro expected its first quarter results to be
below consensus estimates "primarily due to the deferred recognition of ce rtain
license revenue;" ( after having very clearly affirmed on March 7, 2000 that the
Company would not only meet, but exceed , its financial expectations) . The p rice of
PurchasePro stock fell from the previous day ' s close of $6 .22 to $4 .05, a 35% one
day drop on volume of 11 . 6 million shares .
279. On the same day , the Company announced that it would be hosting a
conference call to discuss PurchasePro 's results for its first fiscal quarter of 2001 .
However, the conference call was rescheduled at the last minute , without
explanation, to occur on the following day, April 26, 2001 .
280. On April 26, 2001, the Company disclosed the following :
For the 2001 first uarter PurchasePro's revenues totaled $29 .8 millioncompared with $33 .6 million posted in the fourth quarter of 2000 and,$4.6 milion posted in last year's first quarter .
Excludir'g non-cash charges of $16 .7 million for strategic marketingexpense, and amo rt ization of equity-based compensation and goodwill ,
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Purchas -Pro reported a cash operating loss for the first quarter . Netloss for The 2001 first quarter was $18 . 1 million , or $0.26 per share,compan-d to net loss of $36 .8 million, or $0 .55 per share , in The fou rthquarter of 2000 , and $15 .7 million , or $0.27 per share, in thecorrespc>nding year earlier quarter .
Charles E. Johnson , Jr. chairman and chief executive officer, said,"While we recognize that our results are below expectations, weachieved a number of milestones in the quarter that are broadening ourreach , strengthening our network and setting us u p for solid growth intothe future. Our focus continues to be on driving transactions, revenuesand growth to further our position as a leading business -to-businesse-comm, -,rce company . "
The company said that the difference between estimates and reportedrevenue; resulted rfrom deferral of revenues associated withthe sale of several' marketplaces .
281 . In other words, PurchasePro repo rted financial results for the first
quarter showirg a sequential revenue decline from the prior quarter, rather than
growth, The Company showed revenues that came in approximately 30% lower than
the Company had explicitly led the market to expect, numbers that it reaffirmed
during the quarter, and showing a net loss rather than the net profit the Company had
explicitly prorr ised .
282 . TF:e following report by The Street.com elaborated on the revelation s
by the Company and stated in pertinent part, on April 26, 2001 :
After pr,--announcing on the day of its scheduled earnings releaseWednesday, and then post postponing its results and conference call unti lthis morning , PurchasePro -badly missed the consensus estimate . Thecompany; posted a loss of 2 cents per share , compared with analysts'ex ions for a profit , on revenue reduced to $29.8 million becauseof accou sting concerns .
Analysts , expected the compan y would earn 8 cents a share on revenueof $41 million , according to Thomson Financial/First Call .On its conference call with financial analysts, the company. said it sawa total of about $43 million in "contract activity" but that its auditorswouldn't let it recognize all that revenue due to accounting rules .
Jim Clough, the company's interim CFO, said that $4 .1 million of thecompany s deals this quarter fell into the deferred revenue category,while the company didn't recognize another $3 .7 million because "wehad insuSfficient facts to determine whether the customer wascreditwo-thy ." In all, Clough said about $10 million of the company'spotential, revenue this quarter was affected by recognition issues .
Account., receivable, or the money owed to the company by itscustomers but not yet collected, shot up to $44 million from $2 3
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million n the fourth quarter of 2000. Days sales outstandiN41 or thelength of time it takes to collect that money jumped to days .Purchasf,Pro said the spike resulted from several large deals that closedtoward the end of the quarter and that it had already collected $23million of its accounts receivable so far in April .
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The delayed quarterly report and loss comes after PurchaseProreiterated its guidance in March , promising Wall Street that it wouldmake its, numbers despite the rough economy .
George Santana, an analyst at Wedbush Morgan Securities who ratesPurchasc;Pro a sell, found little to be happy about in the report .
"In 2001, you probably shouldn't be selling to or banking a largepercentage of your revenue to customers with credit conce rns, Santanasaid. "A lot of analysts had taken comfo rt that the economy had notsignificantly impacted their business because they adamantly reiteratedtheir guidance in March , and then here the company is with thismayhem: and the delay in releasing their results . Then they miss theirnumbers, and there 's no guidance going forward ." (Santana's firmhasn 't done underwriting for PurchasePro .com)
Charles Johnson, Jr., the company 's CEO, told investors to expectsimilar "business activity" and gross revenue in the company ' s secondquarter , and that PurchasePro would give further guidance in comingweeks. Currently consensus revenue estimates for the second qua rterstand at $47 .4 million . Analysts expect 11 cents per share in ea rnings,accordir-'g to Thompson Financial/First Call .
The company also said it was doing away with its controversial practiceof issuing warrants to business partners .
"That w~3s an early stage strategy," said Johnson . "We will not issueany new;-warrants, and now warrants will be repriced ."
In November , PurchasePro repriced to a penny per share 3 millionwarrants that it had granted to AOL Time Warner . While the companywon't mnt any new warrants , Wedbush Morgan's Santana pointed outthat AO. gets warrants it was already promised over time, as it helpssell PurchasePro ' s marketplaces . The company said that nearly two-thirds of its revenue during the first quarer came through itspartnersmlip with AOL .
How quickly AOL can exercise its warrants , however, is based on howmuch revenue it generates for PurchasePro - the more revenue it refersto the co npany , the faster its warrants are rewarded . Santana estimatedthat at it< ; current rate , AOL could earn all of its promised warrants bythis Jun(, ., .
"AOL i ; getting the warrants and exercising them immediately,"Santana says. If you go throw h and exercise all the warrants byJune, what's the incentive for AOL to keep pushing PurchasePro'smarketplaces after that?"
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The issues were taking a toll on PurchasePro's stock . After losing 35%Wednesday, it was trading off $1 .27, or 31 .4%, to $2 .78 in recenttrading . ,
The company also introduced its new CFO former Quantum executiveRichard Clemmer, on its conference call . He will succeed Clough, whowill remain at the company .
283 . After the market absorbed these disclosures, the stock was trading in th e
$3 range and continued to be artificially inflated during the remainder of the Clas s
I Period as Defendants concealed the full extent to which the Company ha d
misreported its financial condition in prior quarters .
284 . The accounting mayhem that was plainly in existence at the Company
was fu rther highlighted on April 27 , 2001, in an interview on CNNfn of Cory
Johnson , editor of The Industry Standard. In the interview, Cory Johnson stated a s
follows:
CORY JOHNSON: They don't know where their revenues are comingfrom . They don' t even know what to ca ll revenues . This is a companythat's been through at least four CFOs in about four years . The 1usthired their fifth O . They've been operating with an interim LFO .They come out in March -- the y came out in March 7 and said -- this isall detailed in my sto
ry Webut they come out and said, We're going to
make our guidance . We don ' t see an economic slowdown . We stillexpect to earn $42 million in the quarter .
This is in March, Bruce . This is well into the quarter. They shouldknow exactly what they're doing .
285 . On May 7, 2001, The Industry Standard, published the following art icl e
about PurchasePro :
There is 'an order to Wall Street , an expected procession of events thatfollow each other as dependably as summer follows spring . And in thisyear ' s ugly climate "pre-announcement season " - during which publiccompanies warn of poor results - is followed weeks later by "earnin gsseason . Last week, that order was upset : PurchasePro jumped straightfrom spring to fall and Wall Street punished the business -to-businessexchange as only Na ll Street can.
On Wed:;esday morning , the day PurchasePro was to release earnings,the coml)any warned it would badly miss expectations . Then late in theafternoon PurchasePro said it wasn ' t ready to report earnings after all :Another day was needed to get the books organized. That was all theStreet needed ; the stock was sold off massively .
The nex~ morning, before the markets opened, the company revealedthe nature of the earnings shortfall in a conference call with investors .
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Purchase,Pro's CEO , Charles "Junior" Johnson , said that "complex"accounting had drawn the ire of the firm ' s outside auditors ArthurAndersen . Wall Street had been expecting revenue of $41 million forthe quarter , and PurchasePro threw in eve ry last item to come close tothat number . The accountants weren ' t having it and insisted thecompany defer some revenue into coming qua rters . In the end,PurchasePro came up with just $29 . 8 million in revenue . In two days,Wall Street clipped over half the company ' s value , and the stock wasdown to $3 a share .
It was a bi g step down for PurchasePro . Based in Las Vegas, the firmfamously boasted of its ability to be bigger than rivals Ariba andCommerce One, despite a management team that knew little about thesoftware business . The blond-haired muscle -bound Johnson ran somevideo stores and a gym in his native Louisville, Ky ., before launchingPurchasePro .
Johnson' s swagger is legendary . At Credit Suisse First Boston'stechnology conference last fall, Johnson wore a gold pinkie ring, goldRolex and black a lligator-skin boots . During{ his presentation, onehedge -fund manager eaned over to me to say , I d short the stock if Iwasn't a- raid Junior would come over here and kick my ass .
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Johnson's confidence didn't end with his wardrobe . In the face of theeconomic slowdown, PurchasePro reaffirmed its earnings guidance inearly March, forecasting $42 million in quarterly revenue . The stocksoared 14 percent after the announcement.
But just ; ive days later, Junior admitted he was going to sell massivequantities of stock . PurchasePro underwriters S First Boston hadgiven him a $ 100 million personal line of credit. Now Johnson saidthat CS First Boston was forcing him to sell stock to back the loan .Accordir. to InsiderScores .com, Junior sold $15 . 9 million inPurchasePro stock on March 6 and 7 alone .
This is the backdrop to the mess over PurchasePro ' s revenues .Anal ysts. say the company is overl y reliant on one customer , HiltonHotels , and on deals offered via AOL - deals they say, that are notlikely to be renewed. Some were done in exchange for PurchaseProwarrants . a once-valuable commodity but now vi rtually wo rthless .
More warning signs : Last year , the company refiled certain resultsbecause .)f revenue recognition problems . The company had beeno~ peratin€ without a chief financial officer after burning through fourUFOs in less than five years . (CFO No . 5 signed on last week
)Like Gat :way and Lucent, PurchasePro is suffering less from the sloweconomy, than from its own missteps . These are not the failures of thenew eco tom - these are the failures of weak management, baddecisionss. and shoddy accounting.
286 . In . an effort to stem the tide of negative news emerging about
PurchasePro, on May 8, 2001, Defendants caused a joint press release to be issue d
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by PurchasePm and AOL heralding the benefits of its agreement with BizProLink :
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"We are delighted to announce the addition of Travelocity® andBizProliink Network to the expanding online trading and informationcommunities available through the Netscape Netbusiness Marketplace .By fu rther expanding the industry -specific and broad -based marketsavailable to buyers and sellers from companies of all sizes , we haveincreased the effectiveness and relevance of the NetbusinessMarketplace . "
Additionally , BizProLink Network (www.bizprolink .com) with itscomplete range of business services , information and tools will provideextensive vertical industry and community information in theCommunities section within the Netbusiness Marketplace providingincreased functionality to the Marketplace .
287 . O' course, these statements concerning the benefits derived from
Defendants' agreement with BizProLink were false and misleading . As noted
herein, Defend,ints knew that but for the secret side agreement with BizProLink, that
company neve•w would have agreed to the business arrangements discussed above .
288 . On May 15, 2001, PurchasePro missed the deadline to file its Form 10-
Q for the first quarter, and instead notified the SEC that it would be late in filing its
first quarter results . No explanation was given by PurchasePro , voluntarily or when
explicitly asked , as to why the Company needed more time to file its financial
results, or as to what specific issues were involved .
289 . O-1 May 21, 2001, it was announced that after an emergency meeting
of the Board of Directors on the night of May 20, 2001, defendant Johnson had "left
the company and resigned his position on the board," thus ceasing all active roles in
PurchasePro .
290. Then, in an article entitled "PurchasePro 's Flashy CEO Resigns," the
following was noted :
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Last week , PurchasePro missed the deadline for filing its first -quarterreport with the Securities and Exchange Commission , the second timeit has blown SEC deadlines . There have been concerns about thecompany's accounting policies and whether it can meet rather headyrevenue . guidance numbers for the remainder of the year . And a lawsuitclaims that Johnson stole the business model for PurchasePro , a chargethe company denies . Add all that to a stock chart that showsPurchasePro s shares dropping more than 90% since February .
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"The las t bit of credibility with PurchasePro was worn away with theway they handled first-quarter earnings," says Wedbush Morgananalyst (Teorge Santana , who has a sell ratm~ on the company . "I feelbad for ~,he people who step into [Johnson s ] shoes because I don'tknow if his company makes it ." Santana ' s firm hasn ' t done bankingfor PurchasePro .
Santana was one of the first Wall Street analysts to raise questionsabout ,'urchasePro ' s accounting rocedures , especially thecontroversial practice of trading warrants to buy stock in the companyfor revenue . He believes Johnson ' s abrupt exit could be a signal thatnew CFO Clemmer and the entire board of directors are conce rnedabout a possible Securities and Exchange Commission investigation .
"The SEC has plenty of time on its hands to review things, and ifPurchasePro s practices are put under the microscope , I don t thinkthey stand up too well," he says .
Compan:Fes that use stock warrants to sweeten business deals havecome under SEC scrutiny ~lately . Nearly two weeks ago, business-to-business auctioneer FreeMarkets was forced to restate more than $10million in revenue after the SEC examined a warrants deal with itsbiggest customer , Visteon (VC : NYSE) . PurchasePro has a hu gewarrants deal with AOL, which was recently repriced so that the mediagiant could buy them for a penny a share .
SEC accounting probe or no , analysts have little insight into lust howmuch re ,, enue the company expects to~ generate this year . The Past timePurchasePro issued guidance was in March when the company said itexpected to post sales of $225 million in 206 1 . Monday's news throwsthat num)er out the window , but just how bad things get is anyone'sguess .
PurchasePro used to be known as Johnson's company in more waysthan one. He not only owned 20% of the company's stock but he filledboard seats and executive offices with his cronies including businesspals and n one case a first cousin . But the steep 111 in Purc asePro'sstock undermined J'ohnson's influence . In the past few months, hisownership stake in the company has dropped to 11 % because he wasforced to -sell shares to pay back a previous $100 million loan securedby his PurchasePro stock .
"Make no mistake, this was not an orderly transition," says Walravensof Johnsc n's sudden ouster after a Sunday night board meeting . "I justthink there were too many lawsuits and oo many mistakes ."
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291 . Then, at 4:00 a .m. on May 22, 2001, the very next day after defendant
Johnson resigned, PurchasePro issued a release which announced a further, and even
more drastic, revision of its first quarter 2001 financial results . The press release
11 noted in part :
PurchasePro Revises Reported First Quarter Results
LAS VEGAS, May 22, 2001 (PRIMEZONE) - PurchasePro®),(Nasdaq : PPRO - news ) today reported revised results for its firstquarter ended March 31, 2001 .
For the 2001 first quarter PurchasePro's revenues were $17 . 1 millioncompared with $33 .6 million posted in the fourth quarter of 2000 and$4 .6 million posted in first quarter a year earlier .
Excluding non-cash charges of $16 .7 million for strategic marketin gexpenses, and amortization of equity -based compensation andgoodwil , PurchasePro reported a cash operating loss for the firstquarter of $15 .9 million , or $0 .23 per share .
The net loss for the first quarter ended March 31, 2001 was $32 .4million or $0 .47 per share, compared with a net loss of $36 .8 million,or $0.5~'per share, in the fourth quarter of 2000, and $15 .7 million, or$0 .27 per share, in the corresponding year earlier quarter .
292 . In, other words, as opposed to the original revenue guidance of $43
million, and e rnings per share of approximately $0 .08 per share, PurchasePro's
financial results for the first quarter of 2001 looked shockingly different : revenue of
$17 .1 million (i .e., 60% less than the revenue previously claimed) and a loss of $0 .47
per share. Based on this latest revision to the Company's financial results,
PurchasePro stock fell to $2 .58 per share on May 22, 2001 .
293 . Unfortunately for the investing community, in ignorance of the advers e
facts concerning PurchasePro's business condition during the Class Period relating
to the Company's revenues, products and improper accounting practices, which were
concealed by Defendants throughout the Class Period, plaintiffs and the other
members of the Class purchased their PurchasePro securities at artificially high
prices, relying on the statements made and/or the integrity of the market and were
damaged there')y .
294 . Hid plaintiffs and the other members of the Class known of th e
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materially adverse information not disclosed by Defendants, they would not have
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purchased their PurchasePro securities at the artificially inflated prices that they did .
VIII. POST CLASS PERIOD NEWS
295 . On May 29, 2001, the PurchasePro Defendants caused the Company t o
announce yet another set of revised earnings. The following extract from th e
Lexington Herald-Leader, of May 30, 2001, detailed those revelations :
Like a mirage in the Nevada desert, PurchasePro .com's revenue for thefirst throe months of the year keeps disappearing . Yesterday, LasVegas-based PurchasePro revised its first-quarter financial resultsdownward for the second time in a week .
The late s t numbers, included in the company ' s long-overdue Form 10-q~uartcrly report to the Securities and Exchange Commission, are
slightly : ~e1ow results announced in a press release last Tuesday, anddramatic ally lower than the company's original estimates of April 26 .
Last week ' s revision came a day after Chairman and CEO Charles"Junior"Johnson a Lexington native, abruptly left the company he hadfounded in October 199 PurchasePro builds Web sites that letbusinesses buy and sell goods over the Inte rnet .
The company's first-quarter loss of $33 .47 million is 85 percent greaterthan the 18'08 million it announced in April and its revenue figuresdropped 46 percent, from $29 .78 million to $16 .03 million .
296. Thereafter, on or about May 31, 2001, Lynn E. Turner, Chief
Accountant for the SEC, noted in a speech how the use of warrants to generate
revenue can be misleading. In that speech, Ms . Turner stated in part :
Compan '_ es are increasingly entering into complex strategic alliances,joint ventures , cross licensing and cross ownership agreements . Thesearrangements often involve two parties , each providing goods orservices .o each other, and may also involve the issuance ofquity fromone pa rty to the other . These arrangements are commonly documentedin mul °.ple agreements that are negotiated and entered intocontemporaneously . As such , the agreements are complex, and it maybe diffic .jlt, if not impossible to distinguish and reliably measure thefair values of the separate elements of the contracts .
A simpl e example of this is a company that issues warrants to acustome; • at the same time the company and customer enter into asupply arrangement for the company ' s goods or services. Thesearrangements have become common recently . In some instances, thewarrants will only become exercisable if the customer makes a ce rtainlevel ofpurchases . In others , the warrants are fully vested when issuedbut the customer contractually commits to purchase some amount o1'goods or services from the issuer . The sfaff is conce rned when it
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appears Company A has taken $1 million out of its left pocket only toreceive that $1 million back in its right pocket , and wants to record theSi million received in revenue . For example , assume that Company Apays Company X $ 1 million to enter into the purchase and supplyarrangement under which Company A agrees to supply a product toCompany X and Company X agrees to purchase a specified minimumvolume of product from Company A. Company A gets the $1 millionthat it gave Company X back through Company X's guaranteed productpurchases . The staff questions how these types of "round-trip"arrangements result in revenue , and whether, in substance, they aresham transactions engineered solely to inflate the revenue line in theincome statement .
Companies and auditors must carefully evaluate the substance of thesearrangements to determine the proper accounting even in instanceswhere the accounting literature does not specifically address theaccounting for a transaction .
297 . On June 4 , 2001, the following article was released entitled "A Risky
B-to-B Bet in v. egas ." The article is noteworthy because it detailed how far-reaching
the fraud was revealing that many organizations, which PurchasePro claimed
were clients, h_ad never in fact been clients . The following are extracts from that
article :
Perhaps investors should have thought twice last year when Johnsontold other Internet executives that There is a fine line "between anentrepreneur and a pile of manure . "
Last Mo .iday Johnson ' s luck ran out . He was ousted as PurchasePro'schairman and CEO. After guiding the company throw h a spectacularIPO, he :3pent the last two months selling almost halt of his stock forabout $ 2 million . The day after Johnson ' s departure, PurchaseProrevised its first -quarter revenues downward nearly 45 percent to $17 .1million from $29 .8 million . Even worse , the company acknowled gesit will likely have to revise the figures again soon . Its stock has fallenfrom a h : h of $79 in December 1999 toless than $2 a share last week .At least `i7 class action lawsuits have been filed charging PurchaseProwith fraud .
Now it's clear that corporatepurchasing departments aren't flocking tothe Net, and it appears that PurchasePro overstated its business as itslosses mounted .
The cor_lpany's 1999 annual report, for instance , lists about 50organizations - including the state of Nevada and five casino companies- as users of its network that links corporate buyers with suppliers ofgoods rangin g from offic~ e~~paper to food. But at least a half dozen wereLust kicking the tires . "We never actually purchased anything," saysDave Mitchell, purchasing director for four of the customers onPurchasePro's list : the Phoenix Suns basketball team, the Arizona
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Diamondbacks baseball team and their respective stadiums, AmericaWest Arena and Bank One Ballpark .
One alleged customer, Carnival Cruise Lines says it tested the systembut never used it. Another, Phoenix-based IL 5Z Resorts, decided not tosign on -because executives weren't convinced it would recoup itsinvestment .
298 . About two weeks later, on June 19, 2001, The Washington Post
published the following article concerning the placement on administrative leave by
AOL of one of its executives who worked closely with PurchasePro . The following
is an excerpt from the article :
An America Online Inc . executive has been placed on administrativeleave pending an internal investigation of the Comp any ' s relationshipwith a corporate partner , according to sources familiar with the matter .
Eric Keller a senior vice president of business affairs at the InternetDivision of New York- based AOL Time Warner, is on leave for sixweeks while the compan looks into matters related to its partnershipwith financially troubledPurchasePro.com Inc ., sources said. At leastone other lower-level AOL employee also was put on administrativeleave, they said . "As a policy, we don't comment on employeematters," said Jim Whitney, a spokesman for the Dulles-based onlineunit which runs the world s largest Internet service . Whitney said thatKeifer was unavailable for comment .
299 . Ina conference call on August 7, 2001, Rick Clemmer, PurchasePro's
new President and Chief Executive Officer, made the telling admission that the
Company was :`working [with AOL] to restructure the relationship, so that there's
balance in the relationship ." This was a belated admission of PurchasePro' s
imbalanced relationship with AOL, an admission that directly contradicted defendant
Johnson's Class Period statements where he characterized the relationship with
AOL, as well a;, other clients, as "true partnerships ." As is alleged herein, these were
not true partnerships, but were instead artificial "relationships" with no genuine
benefits accruing to the Company .
300. Almost one month later, on October 4, 2001 , an article was released
which addressed Johnson's lawsuit against the lender that offered a line of credit
against his Pure,hasePro holdings . That article stated :
The founder and former CEO of PurchasePro .com has filed a lawsuitagainst the bank that he borrowed $2 .77 million from last year .
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Lexington native Charles "Junior" Johnson is claiming that heshouldn't have to repay the now-overdue loan from Bank One ofKentucky .
The loan, given on Oct . 28, 2000 was secured by 410,000 shares of LasVegas-based PurchasePro, which the bank sold between June 10 andJune 13 for $524,774 .39 .
But the loan has been in default since Feb . 15, when shares ofPurchasePro closed at $16 .87 on the NASDAQ. If the stock had beensold then, the bank would have collected $6 .9 million - enough to repaythe debt and leave at least a $4 million surplus for Johnson, the suitsays .
Johnson claims the bank now owes him the $4 million he would havegotten if the stock was sold Feb . 15, and has asked for punitivedamages of more than $ 12 million .
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301 . Thereafter, on November 29,200 1, the Company announced through an
8-K that the Company's auditors had resigned over revenue recognition dispute s
I with PurchasePro executives . The 8-K specifically stated :
CHANGES IN REGISTRANT ' S CERTIFYING ACCOUNTANT . OnNovember 21, 2001 Arthur Andersen LLP ("Andersen") notifiedPurchasePro .com, Inc . (the "Company") that Andersen resigned as theCompany 's independent ce rtifying accountant , effective immediately .The reports of Andersen with respect to the Company for fiscal years1999 and 2000 contained no adverse opinion or disclaimer of opinion andwere not quali fied or modified as to uncertainty , audit scope orapplication of accounting principles . During fiscal years 1999 and 2000and the subsequent interim period preceding the resignation of Andersen,there were no disagreements between the Company and Andersen on anymatter of accounting principles or practices , financial statementdisclosure , or auditing scope or procedure, which disagreements, if notresolved to the satisfaction of Andersen , would have caused Andersen tomake reference to the subject matter of the disagreements in its re port onthe financial statements for such years , except as follows : DuringAndersen ' s review of the Company ' s interim financial statements for thethree-month period ending September 30, 2000 , Andersen expresseddisagreerrient with prior members of the Company 's managementregarding proposed recognition of revenue derived from resellera reements between the Company and ce rtain of its business pa rtners .
isThis issue was the subject of discussion between Andersen and theCornpany ' s Audit Committee and was resolved to Andersen'ssatisfaction . During fiscal years 1999 and 2000 and the subsequentinterim period precedin the resignation of Andersen , there have been noreportable events (as defined by tem 304 of Regulation S-K ,except asfollows ; Andersen has noted what they considered to be de iciencies inthe design and operation of the Company's inte rnal controls . Theseissues were the subject of discussions between Andersen and theCompany 's Audit Committee . Through the implementation of newinternal control procedures and recent chan ges in management, theCompany believes it has adequately addressed Andersen ' s concerns . The
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Company has provided Andersen with a copy of this Form 8 -K and hasrequested that Andersen furnish to the Company a letter addressed to theSecurities and Exchan ge Commission stating whether it agrees with thestatements presented above . A copy of Andersen ' s response letter, datedNovember 29, 2001 , is filed as Exhibit 16 .1 to this Form 8-K .
302 . In response, Andersen, LLP submitted the following letter to the SE C
which stated :
Office of the Chief AccountantSecurities and Exchange Commission450 Fifth Street N .W.Washington , Di` 20549
November 29, 200 1
Dear Sir :
We have read the paragraphs of Item 4 included in the Form 8-K datedNovember 29, 2001 of PurchasePro .com Inc. to be filed with theSecurities and Exchange Commission and are in agreement with thestatements contained therein . With respect to paragraph 6 of Item 4, wecannot comment on the adequacy pf new internal control procedures andrecent changes in management in addressing the deficiencies in theinternal confrols which we previously noted .
Very truly yours,
Is/ Arthur. Andersen LLP
303 . On July 19, 2002, the following article was released by The Washingto n
Post entitled, "Unorthodox Partnership Produced Financial Gains ; Deals Allowed
AOL, PurchasePro.com to Boost Revenue." The article is relevant because it
describes, in great detail, the relationship between AOL and PurchasePro during the
Class Period . The article stated :
At the he;ght of the Internet boom, when America Online Inc . was kingof the heap, it found an unlikely business partner: a former video storeoperator who had a penchant for blackjack .
In the ear'y days of his Las Vegas start-up, Charles E. Johnson Jr. said hewould go down to the neon-bathed Strip , put big wads of money on thecasino tables and find a way to meet payroll .
"Junior ," as he liked to be called , played for the big payday. And for acouple of heady years , his company, PurchasePro . corn Inc ., was thearchetypz,l dot-com a software venture led bya swashbucklin g executivewho took it public during the Internet euphoria of 1999 , struck a big dealwith AOL a year later and hit it rich .
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AOL also profited from the pa rtnership . In one uno rthodox arrangement,AOL gave $9 .5 million in cash to PurchasePro for $30 million in stockwarrants in the firm , and AOL booked the difference -- $20 .5 million --as ad and commerce revenue . PurchasePro also bought advertising spacefrom AOL, and it paid AOL commissions for selling PurchaseProsoftware .
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AOL earned its warrants under a marketing deal that included distributingPurchasePro software . The warrants similar to stock options , gave AOLthe right to buy shares in PurchaseEro for a penny each, according tointernal company documents . AOL calculated the value of the warrantsand booked it as $20 .5 million in advertising and commerce revenue inits December 2000 quarter and another $7 million in the March 2001period .
The $28 million in PurchasePro deals represented just a fraction of AOL'soverall revenue . But the partnership illustrates how AOL did business atthe peak of the Internet bubble , using its corporate leverage to generateadvert ising and commerce revenue, a Key growth engine , from a dot-comfirm whose fortunes were tied to the online giant .
It wasn't-- long before such online business-to-business transactionsbecame the hot thing in 2000 . AOL, always on the lookout for newopportunities, struck a deal with Johnson's start-up in March 2000 .
AOL used PurchasePro's software to erect a small-business portal onAOL's N ;tscape site to which customers could subscribe for a monthlyfee . AOL also earned a commission when it sold PurchasePro's softwareto other companies, which could create their own online marketplaces tobuy and sell goods and services .
There was another way AOL made money : It earned $3 in performancewarrants for each dollar of revenue it generated for PurchasePro undertheir marl;cetin partnership . Under the agreement, the warrants gaveAOL the right to buy shares in PurchasePro for $63 each . But with dot-com shares in decline, the two companies agreed to revise the deal inDecember 2000, according to a confidential AOL summary circulated toexecutives for their signatures .
As part of the revised arrangement , PurchasePro agreed to reduce theexercise price for each share of PurchasePro stock an AOL warrant couldbuy from $63 to a~~~
Jpenny . AOL estimated it would earn $30 million in the
quarter ended in IJecember 2000 by exercising the warrants , accordin tointernal company documents . AOL would buy PurchasePro stock for apenny pel share and resell them at their market price .
The warrants were valuable to AOL because they were treated as ad andcommerce revenue .
"$30MM [million] of revenue from performance warrants vesting incalendar Q4 [the December quarter] will be treated as advertisingrevenue ," AOL stated in its executive summary of the deal .
For PurchasePro, a dot-com on the rise, the AOL partnership helped it t o
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generate revenue and sell its software service .
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Many cash -poor dot-corns paid for their online as by iving AOL equityin their high-flying stock . Often such deals legitimized corn panies in theeyes of Wall Street because of AOL's status at the vanguard of the techboom .
But the difference in this deal was that PurchasePro was not using, itsstock to buy ads to promote itself on AOL . Instead, AOL was earningwarrants from selling PurchasePro software . The revenue was booked ascommerce, which is reported in the same income line as advertising sales .AOL said it combines ad and commerce revenue because many of itsdeals are multifaceted and do not fall neatly in either of those categories .
In return for restructuring the agreement, which included reducing thewarrants ' exercise price , AOL agreed to give PurchasePro $10 million inrevenue , according to AOL's internal documents .
PurchasePro got its $ 10 million this way: AOL paid it $4 .9 million tocover the cost of giving 100 ,000 AOL customers a free month'ssubscription -- at $49 per user -- to PurchasePro ' s marketplace service,which was co-branded with AOL 's Netscape portal . AOL also agreed tobuy $4 .6 million worth of PurchasePro ' s software , which AOL woulddistribute to some of its business partners . AOL would come up withanother $ 500,000 by selling ad space on PurchasePro's onlinemarketplace .
The bottom line : AOL essentially paid $9 .5 million for $30 million inwarrants, netting $20.5 million .
The deal helped AOL boost its income from ad and commerce . Thoughthe category includes the two revenue streams, most Wall Street analystsgeneralry regard the total as an indicator of how AOL ' s ad business isloing. Such assumptions could be misleading , said Johnson , the formerPurchasPro chief executive .
"The warrants had nothing to do with ad revenue," Johnson said . "Theywere directly related to selling our marketplace software to ourcustomers, suppliers and partners . "
As the months went by, AOL and PurchasePro found other ways toprovide each other with quick infusions of revenue , often near the end ofa quarter
Under one small deal PurchasePro would receive $1 .8 million worth ofadvertising on the AOL service, according to an internal compandocument dated March 21, 2001 . In return AOL would receive $1 .million worth of promotions that mentioned its Netscape brand whenPurchasePro ran television ads on CNN and Headline News, which werenow partof the merged company, AOL Time Warner Inc .
Purchase.Pro got little value from the ads it ran on the AOL service,according to sources and internal AOL documents that lay out wherePurchasePro's ads would run .
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The "carr a e lan" showed that many of the PurchasePro ads would runon AOL's RQinstant -messaging service. Instant messages allow usersto converse by text in real time over the Internet . The ICC,service targetsa largely teenage and international audience who would have little use forPurchase Pro s business-to-business software . The ads appearing onICQ's application also had "almost no click through " an AOL sourcesaid, meaning that few users actually clicked on the ads to find out moreabout the product being touted.
PurchasePro 's ads also were to run on Winamp AOL's music softwareplayer, another service that did not tar et PurchasePro's businessclientele . A source familiar with PurcnasePro ' s thinking said thecompany did not care where the ads ran . Each side was more interestedin boostirsg its ad revenue, sources for both companies said .
Eventually, the partnership between AOL and PurchasePro fell apart . InMay 2001 , Johnson stepped down as PurchasePro ' s CEO after thecompany badly missed its financial targets . In November 2001, ArthurAndersen LLP resigned as PurchasePro s independent auditor after notinwhat it considered deficiencies in the design and operation o1PurchasePro ' s internal controls .
About a month after Johnson left PurchasePro, Eric Keller, an AOLsenior vice president, was placed on administrative leave pending aninternal investigation of the company's relationship with PurchasePro,sources said .
AOL has not publicly disclosed the internal inquiry, Keller's status or hissubsequent departure . Keller declined to comment .
AOL stopped reselling_ PurchasePro software in the first half of 2001,according to PurchasePro officials. AOL ceased using PurchasePro'stechnology as the backbone of AOL 's small -business po rtal around thisFebruary, PurchasePro said .
304. On August 2, 2002, in an article by The Associated Press entitled "AOL
Time Warner Shares Drop on Reports of PurchasePro Inquiry," it was furthe r
revealed that :
AOL Time Warner stock tumbled nearly 7 percent Friday on publishedreport s that the media con glomerate , whose accounting practices alreadyare bein ; investigated by federal regulators, may have used itsrelationship with a business software company to distort its financialperformance .
AOL Time Wa rner fell 71 cents on the New York Stock Exchange toclose at $10 . 30 following articles in The Wall Street Journal and TheWashington Post on Friday that authorities are looking into whether thecompany s AOL division booked tens of millions of dollars that itreceived from selling PurchasePro . com stock warrants as advertisingrevenue .
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Stock sales are usually considered gains, not revenue . PurchasePro fella penny to 32 cents .
An AOL spokesman declined to discuss the PurchasePro issuespecifically, but said the company is cooperating with the SECinvestigation that it had confirmed on July 24 . That disclosure followeda series of Washington Post articles questioning the company'saccounting practices .
"We have no independent knowledge of any of the companies that havebeen contacted by the SEC but it is completely in keeping with aninvestigation tha some would be contacted," said John Buckley,executive vice president of corporate communications at AOL .
A source with knowledge of the investigation said that two AOLexecutives , Myer Berlow and David Colburn, were deposed earlier thissummer by SEC investigators looking into PurchasePro ' s financialstatements .
PurchasePro declined to comment Friday, but the company confirmed tothe newspapers that it was speaking to the SEC about the AOLtransactions .
305 . On the same day, in an art icle on Info World Daily News, entitled "SE C
Scrutinizes AOL's Deal With PurchasePro ," the following was noted :
The U . S . Securities and Exchan ge Commission (SEC) has broadened itsprobe of AOL Time Warner 's (AOLTW) financial practices to examinehe company's relationship with Las Vegas software company
PurchasePro , according to a published report .
AOLTW is under investigation by both the SEC and the U.S . Departmentof Justice (DOJ) for alleged financial misdealin g such as improperlybooking -revenue from business partners like PurchasePro .AOLTW forged a deal with the business purchasing_ software companyin March of 2000 whereby it agreed to help PurchasePro sell its softwarein return for part of the revenue and warrants for PurchasePro ' s stock .
According- to a report in F riday's online edition of the Wall StreetJournal cOLTW is being investigated for cashing in $27 mil lion worthof PurchasePro stock and booking it as advertising revenue .
No one from AOLTW or PurchasePro was immediately available tocomment on the investigation Friday mo rn ing .
Authorities' investigation into AOLTW 's dealings with PurchasePro isjust part of a larger robe into the company' s financial practices, whichcame into question
pfollowing repo rts in the Washington Post last month
that the company made unusual deals in an effort to prop up its saggingAOL Internet unit. The SEC has declined to comment on theinvestigation .
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306 . The next day, on August 3, 2002, in a Los Angeles Times article entitled
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11 "Probes Weighing on AOL Shares ; The focus Apparently is $27 Million in Ad
11 Revenue from Transactions Between the America Online Unit and Software Firm
PurchasePro .com," the article noted in pertinent part :
Shares of AOL Time Warner Inc . sank for a third straight day Friday, asconcerns about twin federal investigations into the media giant'saccounting continued to weigh on the stock .
The Securities and Exchange Commission is investi gatingwhether thecompany ' s America Online unit wrongly booked $27 million inadvertising revenue in late 2000 and early 2 . 001 from transactions withsoftware company PurchasePro.com Inc ., the Washington Post and WallStreet Jou rnal reported Friday .
Las Vegas-based PurchasePro confirmed that it had been contacted by theSEC, tlge newspapers said . The SEC declined to comment on the case .
Shares of AOL Time Warner fell 71 cents, or 6 .5%, to close at $10 .30 onthe New York Stock Exchange .
AOL Time Warner Chief Executive Richard D . Parsons disclosed theSEC's "fact-finding inquiry" on July 24 . This week, the companyconfirmed an apparently related criminal investigation by the JusticeDepartment .
The probes reportedly were sparked by reports that America Online usedunorthodox accounting methods to boost reported ad revenue while itshuge merger with Time Warner was pending and it needed to persuadeWall Street that it was still growing strongly .
Parsons denied any accounting irre ularities, saying the transactions havetwice been approved by audiors Ernst & Young .
Purchasel ' ro is a former dot-com highflier in the business -to-businesssector whose shares closed at 32 cents Friday , down 1 cent in Nasdaqtrading . The company used to buy advertising on Ame rica Online andused the Internet giant to sell its software .
In one transaction, AOL reportedly paid $9 .5 million for $30 million inPurchase Pro stock warrants, then booked the $20 .5-million difference asadvertising and commerce revenue .
"AOL Time Warner has announced previously that the SEC is lookinginto a number of transactions . It should be no surprise that one of thetransactions is PurchasePro," AOL spokesman John Buckley toldReuters .
307 . Th,:Jn, on or about August 7, 2002, it became apparent that PurchasePro
was also being investigated by the SEC . In a Wall Street Journal article entitled
"PurchasePro is Subject of Investigation by SEC," the following was disclosed :
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PurchasePro .com Inc . said it is being investigated by the Securities andExchange Commission . The inquirybegan last year, said people familiarwith the situation .
The investigation came to light when The Wall Street Journal reportedlast week That two AOL Time Warner Inc. executives had' beeninterviewed by the SEC about AOL' s relationship with the Internetsoftware company.
AOL executives said the interviews were related to a prior investigationof PurchasePro and not the more recent inqui ry into AOL's accountingpractices . ; AOL disclosed last month that its accounting practices areunder investigation by the SEC fora series of unconventional adve rtisingtransactions that occurred in 2000 and 2001 .
At the time the article was published, PurchasePro didn ' t reveal theinvestigation. PurchasePro didn 't disclose the purpose of theinvestigation , but said it is cooperating fully. The SEC declined tocomment ;
People familiar with the inquiry say it likely focuses on a pe ri od last yearwhen Pur'chasePro announced disappointing quarterly sales in a newsrelease , then revised those sales downward in an SEC filing .
In 4 p.m . Nasdaq Stock Market trading Tuesday, PurchasePro shares felltwo cents to 27 cents .
308 . Wi~:hin a month, on or about September 11, 2002, PurchasePro file d
Chapter 11 bankruptcy and announced plans to sell all of its assets to Perfect
Commerce for $2 .638 million .
309 . On .or about the same day, the Company announced the following :
PurchasePro Announces Agreement in Principle to Sell Substantially Allits Assets to Perfect Commerce ; Files for Reorganization Under Chapter11 as Part of Pact -- PurchasePro (Nasdaq : PPRO) today announced thatit has signed a letter of intent pursuant to which it has agreed to sellsubstantially all its assets to Perfect Commerce, Inc . Perfect Commerceprovides Enterp ri se Supply Management (ESM) software, services andexpertise , including auction and c -sourcing solutions, that enable Global20U0 companies such as America West Airlines , Bechtel , HooverPrecision :. roducts Peabody Energ (NYSE : BTU), Smut-Stone (Nasdaq :SSCC), Unocal (NYSE : UCL)' and others to increase profits and improveproduct and service quality . Unlike companies offering only software orserv ices , Perfect Commerce provides a complete solution comprised ofsoftware 'systems and the deep expe rtise and services in strategicsourcing , six-sigma procurement processes , and business processmanagement needed to harness the power of Ente ri se Supp 1Management. Perfect Commerce is headquartered in Palo AltoCalifornia .
As part of the letter of intent, PurchasePro today filed a voluntary petitionunder Ch tpter 11 of the United States Bankruptcy Code in the Unite d
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States Bankruptc y Court for the District of Nevada . Pursuant to sections363 and 365 of the Bankruptcy Code , the sale and the definitive assetpurchase agreement will be placed before the Cou rt for its requiredapproval . -PurchasePro said that under its agreement with PerfectCommerce, it has the option , subject to conditions in the le tter, ofobtaining debtor in possession " financing up to $750 , 000 . Richard L .Clemmer, PurchasePro ' s president and chief executive officer, said, "Thecost of doing business as a public company has increased significantlyover the past year . After reviewing many of the options available as wellas the opportunity presented by Perfect Commerce , PurchaseProconcluded that the terms of the acquisition and subsequent filing werenecessary to preserve the assets and values of PurchasePro 's business andto protect the interest of the company . "
In Chapter 11 PurchasePro will continue operating as the "debtor-in-possession." Daily operations will continue as usual with our officesremaining open and performing transactions in the ordinary course ofbusinessjust as it did prior to our fi ling.
Separately , PurchasePro has reached an agreement in ~princDi le with theEnforcement Division of the SEC . The terms of which the vision .hasagreed to recommend to the Commission . The agreement in princi pleconcerns the settlement of proposed allegations that have been underinvestigation since the sp ring of 2001 . The proposed. agreement ca ll s forPurchasePro , without admitting or denyin the Commission ' s allegations,to consent to the entry of a permanent in unction enjoining it fromviolations of Sections 13(b)(2 )(A) & (B) of the Securities Exchange Actof 1934 ind is subject to approval by the Commission and the UnitedStates District Cou rt. There can be no assurance that the proposedagreement will be approved or, if it is not approved , that PurchasePro willsucceed n defending or settling any subsequent action that might bebrought against it by the Commission .
310 . On or about September 23, 2003, the SEC and DOJ filed accounting
fraud charges in the United States District Court for the Eastern District of Virgini a
against defendants Anderson and Miller . Both Anderson and Miller settled the
charges without admitting or denying the Commission' s allegations .
IX . DEFENDANTS' SCIENTE R
A . PurchasePro Defendants ' Scienter
311 . Through their efforts, the PurchasePro Defendants reaped numerou s
benefits by engaging in their scheme . These benefits, together with the facts
disclosed by numerous former employees of the Company, support a stron g
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inference of conscious or deliberate recklessness on the part of each of thes e
II defendants
312 . Th? most obvious benefit received was financial gain . As detailed
below, defendants Johnson, Moskal, Clough and Chiles realized over $43,000,000
in ill-gotten gains from insider trading .
313 . Moreover, defendants Johnson and Carton used their stock as collateral
for personal loans . Johnson used his stock for a personal line of credit for over
$100,000,000 (a line of credit from CS First Boston of $ 100 million and a separate
loan from Bank One in the amount $2,769,994 .76) and Carton used his stock for a
personal line of credit for $8 million . This money allowed these defendants, and in
particular Johnson, to maintain an extremely lavish lifestyle which was otherwise
unattainable . Plaintiffs believe that with the opportunity for discovery, it will
become appar':nt that other PurchasePro Defendants had used their stock as
collateral for similar lines of credit . For example, while not named as a defendant
in this action, plaintiffs are aware that another former executive and co-founder of
PurchasePro, Robert Geoff Layne, also used his stock as collateral for personal
loans . See also §V (information provided by Employee 4) .
314 . The artificial inflation of PurchasePro's stock price also allowed
PurchasePro to acquire two companies (Stratton Warren and BayBuilder) .
PurchasePro used artificially-inflated PurchasePro stock to provide the majority of
the $23 million aggregate purchase price for these companies . This is significant
because PurchasePro was barely functioning as a going concern . Thus, in order to
provide real revenue for the Company, there was motivation to acquire real
companies with real products .
315 . Further, the general economy was in a state of disarray and high tech
companies were failing at a surprising rate . Thus, in order to maintain interest in
PurchasePro by the financial community, the PurchasePro Defendants were unde r
enormous pressure to create the perception that the Company was strong an d
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growing . In fact, the PurchasePro Defendants had even raised investor expectations
by committing,the Company to profitability during the Class Period . This created
additional pressure to meet those expectations . Hence, if the PurchasePro
Defendants had not engaged in their scheme, the Company would have been doomed
to failure . In other words, these defendants did not engage in their scheme for the
more common .rewards enjoyed by other business executives, they were fighting t o
maintain the very viability of the Company .
316 . With these benefits in mind, together with the information provided by
former employees of the Company, plaintiffs further note that during the Class
Period, each of the PurchasePro Defendants were senior executives and/or directors
of PurchasePro and were privy to confidential and proprietary information
concerning PurchasePro, its operations' finances, financial condition, products and
business prospects, including terms of sales, customer returns, price protection
promotions, credit allowances, receivables and customer inventory levels . These
defendants also had access to and knew of, or were consciously or deliberately
reckless in not knowing of, material adverse non- public information concerning
PurchasePro's financial condition .
317. Each of the PurchasePro Defendants was also provided with copies of
management reports, press releases and SEC filings alleged herein to be misleading
prior to, or shortly after their issuance . As such, all of the PurchasePro Defendants
had the ability and opportunity to prevent their issuance or cause them to be
corrected . As a result, each of the PurchasePro Defendants is responsible for th e
accuracy of the public reports and releases detailed herein as "group published"
information and is therefore responsible and liable for the representations containe d
therein .
318 . Furthermore, during the Class Period, the PurchasePro Defendant s
directly and indirectly engaged and participated in a continuous course of conduct
to misrepresent the results of PurchasePro's operations and to conceal adverse
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material information regarding the finances, financial condition, and results of
operations of PurchasePro as specified herein . The PurchasePro Defendants
employed devices, schemes, and artifices to defraud, and engaged in acts, practices,
and a course of conduct as herein alleged in an effort to increase and maintain an
artificially high market price for the common stock of the Company . This included
the formulation, making, and/or participation in the making of untrue statements of
material facts, and the omission to state material facts necessary in order to make the
statements made, in light of the circumstances under which they were made, not
misleading, which operated as a fraud and deceit upon plaintiffs and the other
members of the Class .
319. Under these circumstances, the PurchasePro Defendants are liable ,
jointly and severally, as direct participants in the wrongs complained of herein .
They had a duty to promptly disseminate accurate and truthful information with
respect to PurchasePro's products, operations, financial condition and business
prospects or to cause and direct that such information be disseminated so that the
market price of PurchasePro stock would be based on truthful and accurate
information .
320. As officers, directors and/or controlling persons of a publicly hel d
company whose securities were registered with the SEC under the Exchange Act,
traded on the NASDAQ National Market System, and governed by the provisions
of the Exchange Act, the PurchasePro Defendants had a duty to promptly
disseminate accurate and truthful information with respect to the Company's
operations, business, products, markets, management, earnings and business
prospects, to correct any previously issued statements from any source that had
become untrue, and to disclose any trends that would materially affect earnings and
financial operating results of PurchasePro, so that the market price of the Company's
publicly traded securities would be based upon truthful and accurate information .
321 . Since the beginning of the Class Period, at the latest, the PurchasePr o
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Defendants were we ll aware of the existence of inadequate internal controls and/or
with conscious or deliberate recklessness disregarded their obligation to implement
adequate controls to ensure that revenues and accounts receivable were properly
recorded in compliance with GAAP . These defendants had a responsibility t o
maintain sufficient accounting controls to accurately report PurchasePro's financial
results . Moreover, the representations made by these defendants in PurchasePro's
financial statements and in other financial disclosures to the public were the
representations of PurchasePro's management. Contrary to the requirements of
GAAP and SEC.' rules, the PurchasePro Defendants failed to implement and maintain
an adequate internal accounting control system and engaged in improper accounting
practices as described herein .
322 . By virtue of their positions with PurchasePro and because of th e
significant repuAational and monetary benefits they stood to gain from a positive
public perception of PurchasePro, and as a result of artificially inflated stock prices,
the PurchasePro Defendants also had both the opportunity and motive to commit the
acts alleged he -ein . These defendants were aware of PurchasePro's true financial
condition and knew, or with conscious or deliberate recklessness disregarded, the
limitations of the Company . The air of accomplishment and success created as a
result of their material misrepresentations made PurchasePro more attractive to
potential investors, and served to maintain its stock price at artificial levels .
323 . Each of these defendants had the opportunity to commit and participate
in the fraud . The PurchasePro Defendants were senior officers and/or directors of
PurchasePro ar+d they controlled press releases, corporate reports, communications
with analysts, 15ublic filings, and the reporting of the Company's financials . Thus,
these defendants controlled the public dissemination of PurchasePro's false and
misleading statements to the investing public as alleged herein which artificially
inflated the price of PurchasePro's stock .
324 . Each of the PurchasePro Defendants also had the motive to commit, and
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participate in the fraud, in order to achieve the benefits discussed above . The
continued receipt of salary and employment in the Company were significant
motives to inflate the Company's stock, as well as the avoidance of bankruptcy
which ultimately occurred on or about September 11, 2002 .
325 . Moreover, Anderson admitted, under oath, that he and certain of his co-
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conspirators within PurchasePro and AOL conspired to falsely inflate the revenue
reported by PutchasePro for a multitude of reasons, including, but not limited to, the
following : (i) to sustain PurchasePro's outward appearance as a growing and
successful Internet software company in late 2000 and early 2001 when Anderson
and certain of his co-conspirators knew that PurchasePro's revenue growth, such as
it was, resulted in large part from the systematic use of secret side agreements to sell
PurchasePro's revenue generating products ; (ii) to meet the revenue estimates for
PurchasePro as disseminated by Wall Street to the investing public ; and (iii) to profit
personally from the fraud by: (a) exercising options to buy PurchasePro stock if the
price rose above the strike price of his options and to sell that same PurchasePro
stock at a profit ; (b) keeping his job at PurchasePro and continuing to receive salary,
which Anderson admits he was able to do through November 2001 ; and (c)
preserving the possibility of obtaining profitable stock options in the future .
Anderson admitted, on or about April 2001, that he received stock options for about
75,000 shares of PurchasePro stock from the Company, which was approved by a
senior officer at PurchasePro.
326 . Finally, as a small Company with limited outside information and new s
concerning the Company, it is noteworthy that PurchasePro's stock price wa s
particularly sensitive to statements regarding PurchasePro's revenues, business an d
profits .
1 . PurchasePro Defendants' Insider Loan s
327 . Defendants Johnson and Carton used their stock as collateral for loans
in the amounts of $100,000,000 and $8,000,000, respectively. Plaintiffs are also
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aware of another executive with the Company, Johnson's long-time business
associate Robert Geoff Layne ("Layne"), who also used his stock as collateral fo r
I loans during the Class Period . Barron's financial publication has described these
types of transactions as the "next best thing to selling shares . "
328 . It is apparent that Johnson needed the loan and lines of credit because h e
put virtually every penny he had into the stock. According to an article published
in the Lexington Herald Leader (Kentucky), on October 8, 2000, "[t]here was not one
red cent that I could get that I have not put into this," Johnson said . "I sold my video
stores . I started selling other business . I borrowed against my life insurance . I took
every penny I had."
329. Further exacerbating the problem, and adding to Defendants' motive to
inflate the stock, was the fact that defendant Johnson and Carton, in mid April o f
2000, said that neither would take cash or stock compensation until the Company
became profitable on an earning-per-share basis . Thus, according to Johnson and
Carton's own statements, their only real source of income from PurchasePro wer e
the loans and lines of credit secured by these collateralized agreements .
330 . Specifically, Johnson pledged 12 .3 million shares of his PurchasePro
common stock holdings to secure a $100 million line of credit from CS First Boston .
The terms of this line of credit required Johnson to maintain a 25% loan-to-value
ratio between the collateral posted and the amounts drawn under the line of credit .
During the Class Period, Johnson had drawn over $40 million for the line of credit .
Throughout the Class Period, Johnson was also aware that he "would be in default
under the terms of the line of credit each time the trading price of PurchasePro
common stock -fell below $13 a share . Consequently, throughout the Class Period ,
Johnson made the misrepresentations set forth above in order to artificially maintain
the trading price above the minimum levels required under the CS First Boston lin e
of credit .
331 . Johnson and Layne also used their shares of PurchasePro common stoc k
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as collateral to secure loans from Bank One in Kentucky . On or about October 28,
2000, Johnson entered into a loan agreement with Bank One, whereby Johnson
borrowed $2,7(9,994 .76 from Bank One and pledged 410,000 shares ofPurchasePro
common stock as collateral . Pursuant to the loan agreement, Johnson was required
to maintain a 40% loan-to-value ratio, meaning that Johnson would be in default any
time the trading price of PurchasePro common stock fell below $16 .89 per share .
Additionally, pursuant to the terms and conditions of the note, defendant Johnson
indebted himself to the principal amount of $2,769,994 .76 (the "Loan") together
with interest thereon . Interest continues to accrue on the outstanding principal
balance due and owing under the Note at a rate of $311 .08 per day. Consequently,
throughout the Class Period, Johnson made the misrepresentations set forth above
in order to artificially maintain the trading price above the minimum Ievels required
under the Bank One loan agreement .
332 . When Johnson failed to elevate the stock in excess of the loan-to-valu e
ratio necessary to avoid a default of the loan, Bank One informed Johnson he was
in default and had to either pledge to Bank One additional property acceptable to the
bank or reduce the outstanding principal balance of the note in an amount sufficient
to cause such loan-to-value ratio to no longer exceed the default ratio . When
defendant Johnson failed to make the required payments to Bank One to cure such
default, Bank One exercised its rights against certain collateral for the loan and
applied the proceeds of such collateral to the balance of the note .
333 . When the proceeds of the sale of collateral for the loan were insufficien t
to cover the balance of the sums owed and due to Bank One, Bank One commenced
legal action, or or about October 9, 2001, against defendant Johnson for breach of
contract, unjus-~ enrichment and breach of implied covenant of good faith and fair
dealing . Bank One sought compensatory damages in the amount of $2,093,817 .18,
plus accrued interest, late charges, and fees thereon .
334 . On January 5, 2004, the Lexington Herald reported that Bank On e
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Kentucky, won a $2.26 million judgment against Johnson in July, As a result of the
Judgment, Bank One Kentucky was attempting to garnish Johnson's wages .
Moreover, Magistrate Judge James B . Todd ordered Johnson to release his bank
records from Red Rock Bank in Las Vegas, and Central Bank & Trust Co . in
Lexington, after the court learned that Johnson recently transferred his ownership
interest in Nexx, his new multi-level marketing venture co-founded with defendant
Carton.
335 . Moreover, at various dates between May 4, 2000, and December 12 ,
2000, Layne entered into loan agreements with Bank One whereby Layne borrowed
$3,250,000 from Bank One and pledged 482,142 shares of PurchasePro common
stock as collateral . Pursuant to the loan agreement, Layne was required to maintain
a 50% loan-to-value ratio, meaning that Layne would be in default any time the
trading price of PurchasePro common stock fell below $13 .48 per share .
336 . Similarly, in October 1999, defendant Carton obtained an $8,000,00 0
line of credit :':rom Prudential Securities Incorporated . As security for the loan,
Carton pledgee to Prudential Securities Incorporated 300,000 shares of PurchasePro
common stock . At the same time, Prudential Securities Incorporated also provided
a line of credit of up to $650,000 to other employees at prevailing interest rates, for
which such employees pledged an aggregate of 213,250 shares of Company stock .
337 . Therefore, throughout the Class Period, defendants Johnson, Carton, and
other borrowing PurchasePro employees, recognized that it was necessary to
maintain the trading price of PurchasePro common stock at levels sufficient to
maintain the loan-to-value ratios . Each of these loan agreements gave the lender the
right to sell the pledged shares of PurchasePro stock and provided recourse against
the personal assets of the borrower in the event the value of the pledged PurchasePro
stock fell behw the minimum loan-to-value ratio set forth in the respective
agreements .
338 . Throughout the Class Period, the PurchasePro Defendants and Compan y
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employees were also subject to a series of lock-up agreements whereby they had
agreed, in conjunction with the initial and secondary offerings, that their holdings
of PurchasePro stock could not be publicly traded . The foregoing loan agreements,
many of which were made with underwriters of PurchasePro's public offerings, were
entered into so that the borrowers could realize a gain from their holdings o f
PurchasePro stock without violating the lock-up agreements, without selling their
shares, and without publicly reporting the transactions .
2. PurchasePro Defendants ' Insider Trading
339 . Certain PurchasePro Defendants took advantage of their scheme t o
artificially inflate the Company's stock price by selling large portions of thei r
personal stock holdings for huge proceeds as detailed below :
340 . Many, if not all of the sales set forth above for defendant Johnson were
accomplished because he was in default under the CS First Boston line of credit an d
the Bank One loan agreement . Moreover, Johnson filed suit against Bank One
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alleging that Bank One breached the covenant of good faith and fair dealing by
failing to sell the pledged shares of PurchasePro common stock "in a timely and
reasonable ma,iner" -- i .e., when the shares were most inflated during the Class
II Period .
B. Scienter Of AOL Defendants
341 . Through their efforts, the AOL Defendants also reaped numerous
benefits by engaging in their scheme . These benefits, together with the other facts
recited herein, support a finding of strong circumstantial evidence of conscious or
deliberate recklessness on the part of each of the AOL Defendants .
342 . The AOL Defendants part icipated in the fraudulent scheme to overstate
PurchasePro' s revenues in order to obtain and record additional revenues for AO L
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and its successor in interest , AOL Time Warner, Inc . The artificial inflation of AOL
revenue allows d the company to complete its $112 billion all stock tender offer for
Time Warner, Inc . The AOL/Time Warner, Inc . Merger announcement contained
a term known as a "material adverse change" in control provision . As a result, AOL
and its officers and directors knew that its stock price and business prospects had to
be maintained at a high enough level to ensure the consummation of the Merger .
343 . Defendants Pittman, Colburn, Keller, and Berlow each received
substantial bonuses, stock options and incentive based compensation, based upon
AOL reaching its revenue targets . Moreover, when the Merger was completed, each
outstanding AOL stock option would be converted into an option to purchase share s
of America On-Line/Time Warner, Inc . common stock at an exercise price per share
equal to the e>.ercise price per share of AOL common stock subject to the optio n
before the conversion. In addition, each outstanding restricted share of AOL
common stock would be converted into one restricted share of AOL/Time Warner,
Inc. common stock . As a result of the completion of the Merger, substantially all
AOL employe,- stock options and shares of restricted stock outstanding on Januar y
10, 2000, by their terms, vested and became exercisable or free of restrictions, as th e
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case may be, upon the earliest of either their normal vesting date, the firs t
I anniversary of the completion of the Merger or approximately one year after th e
Merger .
344 . Moreover, on January 24, 2001, Forbes . com, repo rted the following :
As of June 30 , 2000, AOL had 356 million options outstanding. Sixtypercent was not vested and had a total exercise cost of 5 . 5 illion.That averages $25 .69 per unvested option --less than halt the current$54 value of AOL Time Warner stock . Unvested Time Warner optionsas of Dec . 31, 1999 were $1 .4 billion , with a merger- adjusted averageexercise price around $32 .55 .
At current prices , the total realizable profit on accelerated vesting forAOL's 15 ,1)00 employees , most of whom can participate in optionplans, would be $b billion --an average of $400 ,000 each . That's apowerful incentive to take advantage of accelerated vesting .
345 . As with the PurchasePro Defendants , the most obvious benefit receive d
by these defendants was financial gain . Between July 24, 2000 and August 30,
2000, prior to the completion of the Merger and after the onset the secret side
agreements, AOL insiders, including defendant Pittman sold approximately 1 .4
million shares for proceeds of over $82 million . More specifically, defendant
Pittman sold 394,745 shares for proceeds of $21,833,346 .00 .
346 . Moreover, between January 1, 2001 and November 30, 2002 ,
immediately prior to and after the completion of the Merger defendant Pittman and
Colburn sold substantial portions of their personal holdings of AOL and AOL/Time
Warner, Inc. stock. Specifically, Colburn sold 180,000 shares for proceeds of over
$9 million . Pittman during this time period sold 1 .5 million shares for proceeds of
over $72 million. The aforementioned sales by the individual AOL Defendants were
unusual in timing and amount .
347. Moreover, each defendant had the opportunity to commit and
participate in the fraud. The individual AOL Defendants were senior officers and/or
directors ofAOL and were actively involved in structuring the sham transactions and
round trip transactions identified above . Moreover, AOL had a highly elaborate
approval process for each of the transactions complained of which gave the AO L
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348 . In addition, each of the AOL Defendants controlled the joint pres s
releases with PurchasePro concerning its financial growth and condition which ar e
the subject of this action . Thus, these defendants controlled the public dissemination
of AOL's false and misleading statements to the investing public as alleged herein
which artificially inflated the price of PurchasePro's stock .
349 . Finally, each of the AOL Defendants had the motive to commit, an d
J participate in, the fraud in order to achieve the benefits discussed above . The
continued receipt of salary and employment with AOL, as well as the options
received within one year after the consummation of the Tender Offer, provided
significant motive to inflate PurchasePro 's stock price for their own benefit .
X. VIOLATIONS OF GAAP AND SEC REGULATION S
350 . During the Class Period, the Defendants publicly disseminated and/o r
filed with the SEC financial statements, earnings releases and financial information
which contained materially false and misleading financial information in violatio n
of GAAP and SEC Rules and Regulations . GAAP encompasses the rules,
conventions and practices recognized and employed in the preparation of financia l
statements for the fair presentation of the financial condition, results of operations
and cash flows of an enterprise . Financial statements that are filed with the SEC
must conform with GAAP and SEC Regulations .
351 . During the Class Period, Defendants materially misled the investin g
public, thereby inflating the price of PurchasePro securities, by publicly issuing false
and misleading statements and omitting to disclose material facts necessary to mak e
Defendants' statements, as set forth herein, not false and misleading. Said
statements and omissions were materially false and misleading in that they failed to
disclose material adverse information and misrepresented the truth about the
Company, its financial performance, accounting, reporting and condition, including :
a. During the Class Period, the Company reported revenues, incom e
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b . The Company's financial statements did not present, in al l
f material respects, the Company's true financial condition, and did not reflect al l
I adjustments which were necessary for a fair statement of the interim and full year
I period presented ; and
c . Interim financial statements reported by the Company were no t
presented in conformity with GAAP or principles of fair repo rt ing .
352. The SEC requires that publicly-traded companies present their financial
statements in accordance with GAAP. 17 C.F.R. §210.4-01(a)(1) . Moreover,
financial statements fled with the SEC which are not prepared in accordance with
GAAP "will be presumed to be misleading or inaccurate , despite footnote or other
disclosures , unless the Commission has otherwise provided ." 17 C.F.R. §210.4-
01(a)(1) . Although certain defendants stated in PurchasePro ' s financial statements
contained in their public filings throughout the Class Period that such statements
were prepared in accordance with GAAP , these defendants deviated from GAAP in
material and significant ways which violated GAAP, SEC rules and regulations and
federal securities laws .
353 . Interim financial statements must also comply with GAAP, with the
exception that interim financial statements need not include disclosures which would
be duplicative Of disclosures accompanying annual financial statements . 17 C.F.R.
§210 .10-01 (a). Further, "where material contingencies exist , disclosure of such
matters shall b, provided even though a significant change since year end may not
have occurred. "
354. A .3 set forth in APB Opinion No, 28 , "Interim Financial Reporting "
(part of GAAP), "[e]ach interim period shall be viewed primarily as an integral part
of an annual period . The results for each interim period shall be based on the
accounting principles and practices used by an enterprise in the preparation of it s
latest annual financial statements unless a change in an accounting practice orpolic y
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has been adopted in the current year ." Additionally, "[r]evenue from products sold
or services rendered shall be recognized as earned during an interim period on the
same basis as followed for the full year . "
355 . Importantly, management is responsible for preparing financial
statements that conform with GAAP . As noted by the American Institute of
Certified Public Accountants ("AICPA") professional standards [AU § 110.03
(1998)] :
[Financial statements are management's responsibility .[ lanagement is responsible for adopting sound accountin g policiesand for establishing and maintaining internal controls that will ,will, amongother things , record, process, summarize , and report transactions (aswell as events and conditions ) consistent with management's assertionsembodied in the financial statements . The entity's transactions and therelated assets , liabilities and equity are within the direct knowledge andcontrol of management . . . . Thus , the fair presentation of financialstatements in conformity with Generally Accepted AccountingPrinciples is an implicit and integral part of management'sresponsibility .
356 . Pursuant to GAAP , as described by FASB Statement of Concepts No .
5 ("Concepts No . 5"), revenue should not be recognized unless and until it is realized
or collectible . See Concepts No . 5, ¶1$3-84 .
357 . During the Class Pe riod , PurchasePro improperly recognized revenue
from the sale of'software licensing which did not conform with ARB 45 and SOP 81-
1 . Such revenue should have been recognized on the percentage of completion
method. SOP 81-1, ¶23 .
358. PurchasePro improperly recognized subscription revenues that were fo r
invalid customers or for customers that had stopped paying their monthly
subscriptions. ARB 43 Chapter IA and APB 10, ¶12 .
359 . Pt rchasePro failed to properly record an appropriate reserve for
doubtful accounts in accordance with GAAP on receivables that were not reasonabl y
expected to be collected . FASB No. 5, ¶22 .
360. Pi rchasePro recognized revenue on backdated contracts that were no t
properly executed prior to the respective quarter ended . SOP 81-1 and SOP 97-2 .
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361 . PurchasePro improperly recognized revenue, and improperly accounte d
for, non-monetary exchange transactions . APB 29, ¶21 .
362 . GAAP also requires the following :
a. GAAP requires the restatement of previously issued financial
statements for the correction of a material error in the financial statements of a prior
period. "Errors in financial statements result from . . . misuse of facts that existed
at the time the financial statements were prepared ." APB 20 . The same GAAP
standard requires restatement of previously repo rted financial statements if the
misuse of facts that existed at the time the financial statements were prepared caused
reported net income to be materially misstated ;
b . GAAP also required Defendants , and in particular the
PurchasePro Defendants , to disclose the existence of known trends , events or
uncertainties that would be reasonably expected to have a material unfavorabl e
impact on net revenues or income, or that were reasonably likely to result in the
Company's liquidity decreasing in a material way, in violation of Item 303 of
Regulation S-K under the federal securities laws (17 C .F .R. §229.303). That failure
to disclose these facts rendered the statements that were made during the Class
Period materially false and misleading ; and
c . By failing to file financial statements with the SEC whic h
conformed to the requirements of GAAP and SEC rules and regulations, such
financial statements were presumptively misleading and inaccurate pursuant to 17
C.F .R . §210 .4-01(a)(1) .
363 . As a result of its accounting improprieties and known restatements, the
Company's reported financial results also violated at least the following provisions
of GAAP for which Defendants are responsible :
a. The principle that financial reporting should provide information
that is useful _o present and potential investors and creditors and other users in
making rational investment, credit and similar decisions was violated (FASB
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Statement of Concepts No . 1, ¶34) ;
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b . The principle that financial reporting should provide informatio n
about the economic resources of an enterprise, the claims to those resources , and the
effects of transactions , events and circumstances that change resources and claim s
to those resources was violated (FASB Statement of Concepts No, 1, ¶40) ;
c. The principle that financial reporting should provide information
about an enterprise 's financial performance during a period was violated . Investors
and creditors often use information about the past to help in assessing the prospects
of an enterprise . Thus, although investment and credit decisions reflect investors'
expectations about future enterp rise performance , those expectations are commonly
based at least partly on evaluations of past enterprise performance (FASB Statement
of Concepts No . 1, ¶42) ;
d. The principle that financial reporting should provide informatio n
about how management of an enterprise has discharged its stewardship responsibility
to owners (stockholders) for use of enterprise resources entrusted to it was violated .
To the extent that management offers securities of the enterprise to the public, it
voluntarily accepts wider responsibilities for accountability to prospective investors
and to the public in general (FASB Statement of Concepts No . 1, ¶50) ;
e . The principle that financial reporting should be reliable in that i t
represents what it purports to represent was violated . That information should be
reliable as we ll as relevant is a notion that is central to accounting (FASB Statement
of Concepts No. 2, ¶¶58-59) ;
f. The principle of completeness , which means that nothing is left
out of the information that may be necessary to ensure that it validly represents
underlying events and conditions (FASB Statement of Concepts No . 2, ¶79); and
g. The principle that conservatism be used as a prudent reaction t o
uncertainty to ty to ensure that uncertainties and risks inherent in business situation s
are adequately considered was violated . The best way to avoid injury to investors
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I is to try to ensure that what is reported represents what it purports to represent
2 (FASB Statement of Concepts No . 2, ¶¶95, 97) .
3 XI. DEFENDANTS FAILED TO ACT IN ACCORDANC E
4 WITH GAAP AND RELATED ACCOUNTING GUIDELINE S
5 364. During the Class Period, PurchasePro's financial statements were
6 publicly issued and were claimed to be prepared in accordance with GAAP . In fact,
7 PurchasePro's financial statements during the Class Period did not fairly present or
8 report PurchasePro's financial condition, results of operations or changes in financial
9 position, and were not fairly presented in conformity with GAAP because of material
10 deficiencies in PurchasePro's financial reporting, which all Defendants either knew
11 of, or recklessly disregarded.
12 365. In order to make the Company appear successful, and to otherwise
13 artificially support PurchasePro's stock price, Defendants caused PurchasePro to
14 falsely report its financial results during the Class Period through improper revenue
15 recognition, sham transactions and by understating allowances for uncollectible
16 receivables . For example, Defendants engaged in improper revenue recognition, in
17 contravention of GAAP, by: (i) the premature and improper recognition of revenue
18 that should have been deferred to later periods ; (ii) the improper recognition of
19 revenue from customers when the Company had insufficient facts to determine
20 whether these customers were actually creditworthy; (iii) the improper recognition
21 of revenue when defendants were aware of facts which made collection of accounts
22 receivable doubtful, without the adequate establishment of a reserve for doubtful
23 accounts; and (v) throughout the Class Period, the improper recognition as revenue
24 of payments made to PurchasePro by a number of its customers, through fraudulent
25 transactions, as well as payments for warrants to purchase PurchasePro stock that the
26 Company had granted to customers in order to gain their business .
27 366. Thus, while Defendants publicly represented that the Company had a
28 bright financial future, they failed to disclose that PurchasePro was improperl y
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recognizing revenue and that millions of dollars in receivables were in jeopardy of
never being collected . Defendants were required , yet failed , to disclose these issues
to the public and the PurchasePro Defendants failed to book the appropriate reserves
pursuant to GAAP to account for such doubtful accounts .
367. The undisclosed adverse information concealed by Defendants durin g
the Class Period is the type of information which, because of SEC regulations,
regulations of national stock exchanges and customary business practice, is expecte d
by investors and securities analysts to be disclosed and is known by corporat e
officials and their legal and financial advisors to be the type of information which
is expected to be and must be disclosed .
368. The Company's financial statements during the Class Period whic h
were disseminated to the investing public were not presented in accordance with
GAAP in that such financial statements failed to disclose that there existed a material
overstatement of revenue, as well as the Company's problems associated with its
accounts receivable . Defendants allowed PurchasePro to book revenue from its
customers when they knew that this was not in fact revenue, but compensation i n
exchange for fraudulent side agreements and for warrants issued . By concealing
these transgressions , in contravention of GAAP and other accounting guideline s
compelling disclosure, Defendants disseminated false and misleading earnings
announcements and financial statements and press releases which were not a fai r
presentation of PurchasePro ' s financial condition and were presented in violation of
GAAP and SEC rules and regulations .
XII . CLASS ACTION ALLEGATION S
369 . Plaintiffs bring this action as a class action, pursuant to Federal Rules
of Civil Procedure 23(a) and (b)(3), on behalf of a class consisting of all persons
who purchased or otherwise acquired PurchasePro securities between March 23 ,
2000, and May 21, 2001, inclusive, and who were damaged thereby (the "Class") .
Excluded frorr! the Class are Defendants, the officers and directors of PurchasePr o
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and AOL, the members of their immediate families and entities in which they have
a controlling interest .
370 . During the Class Period, there were over 66 million shares of
PurchasePro common stock outstanding and held by thousands of shareholders . At
I all relevant times, PurchasePro common stock was actively traded on the NASDA Q
(under the ticker symbol "PPRO"), an open, well-developed and efficient market,
during the Class Period. There were numerous analysts following the stock an d
numerous market makers trading the stock . Because persons who purchased or
otherwise acquired PurchasePro shares during the Class Period number at least in the
thousands and are believed to be located throughout the country, j oinder of all such
Class members is impracticable .
371 . There are questions of law and fact common to all Class members
which predominate over any questions affecting only individual Class members,
including :
(a) Whether the federal securities laws were violated by Defendants '
acts as alleged herein ;
(b) Whether documents, releases and/or statements disseminated to the
investing public and PurchasePro shareholders during the Class Period omitte d
and/or misrepresented material facts about the business, financial condition an d
accounting practices of the Company ;
(c) Whether Defendants made materially misleading statements during
the Class Period about the business, financial condition and accounting practices o f
the Company ;
(d) Whether Defendants acted knowingly or with conscious or
deliberate recklessness in making materially false statements and omitting material
facts about the business, financial condition and accounting practices of th e
Company;
(e) Whether the market price of the Company 's securities was
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artificially inflated during the Class Period due to the non-disclosures and/or
material misrepresentations complained of herein ; an d
(f) Whether the members of the Class have suffered damages and, if so ,
I what is the proper measure of damages .
372 . Plaintiffs' claims are typical of all Class members' claims . Plaintiffs
I have selected counsel experienced in class and securities litigation and will fairl y
I and adequately protect the interests of the Class . Plaintiffs have no interest s
antagonistic to those of the Class.
373 . A class action is supe rior to other available methods for the fair an d
efficient adjudication of this controversy. Since the damages suffered by individual
Class members may be relatively small, the expense and burden of individual
litigation make it virtually impossible for members of the Class to individually seek
redress for the wrongful conduct alleged .
374 . Plaintiffs know of no difficulty which will be encountered in th e
~ management of this litigation which would preclude its maintenance as a clas s
action .
XIII . STATUTORY SAFE HARBOR
375 . The statutory safe harbor provided for forward -looking statements
under certain circumstances does not apply to any of the false statements pleaded in
this complaint The statements alleged to be false and misleading herein all relate
to then-existing facts and conditions . In addition, to the extent certain of the
statements alleged to be false may be characterized as forward-looking, they were
not identified as "forward-looking" when made, there was no statement made with
respect to any of those representations forming the basis of this complaint that actual
results "could differ materially from those projected," and there were no meaningful
cautionary statements identifying important factors that could cause actual results
to differ materially from those in the purportedly forward-looking statements .
Alternatively, to the extent that the statutory safe harbor is intended to apply to an y
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forward-looking statements pled herein, defendants are liable for those false
forward-looking statements because at the time each of those forward-looking
statements was made, the particular speaker had actual knowledge that the particular
forward-looking statement was materially false or misleading, and/or the
forward-looking statement was authorized and/or approved by an executive officer
of PurchasePro who knew that those statements were false when made .
XIV. RELIANCE ALLEGATIONS
FRAUD-ON-THE-MARKET DOCTRINE
376 . Plaintiffs will rely, in part, upon the presumption of reliance established
by the fraud-on-the-market doctrine in that, among other things :
(a) PurchasePro common stock met the requirements for listing, and
was listed, on the NASDAQ, a highly efficient market ;
(b) as a regulated issuer, the Company filed periodic public report s
with the SEC;
(c) the trading volume of the Company' s stock was substantial ,
reflecting numerous trades each day ;
(d) PurchasePro was followed by securities analysts who were
employed by several major brokerage firms and who wrote reports that were
distributed to the sales force and certain customers of such firms, and were available
to various automated data retrieval services ;
(e the misrepresentations and omissions alleged herein were
material and would tend to induce a reasonable investor to misjudge the value of
PurchasePro common stock; and
(f )! plaintiffs and the members of the Class purchased their common
stock during the Class Period without knowledge of the omitted or misrepresented
facts .
377 . Based upon the foregoing, plaintiffs and the other members of the Class
are entitled to a presumption of reliance upon the integrity of the market for th e
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purpose of class certification as well as for ultimate proof of their claims on th e
j merits . Plaintiffs will also rely, in part , upon the presumption of reliance establishe d
by material omissions and upon the actual reliance of the class members .
XV. COUNTS
Count I
Violations of §10 (b) Of The Exchange Ac t
And Rule 10b-5 Promulgated Thereunder
(Against All Defendants)
378. Plaintiffs repeat and reallege each and every allegation contained in the
I foregoing paragraphs as if fully set forth herein.
379. Al. all relevant times, Defendants , individually and in concert, directl y
and indirectly, by the use and means of instrumentalities of interstate commerce
and/or of the mails, engaged and participated in a continuous course of conduct
whereby they knowingly and/or recklessly made and/or failed to correct public
representations which were or had become materially false and misleading regarding
PurchasePro's financial results and operations . This continuous course of conduct
resulted in Defendants causing PurchasePro and AOL to publish public statements
which they knew, or were reckless in not knowing, were materially false and
misleading, in order to artificially inflate the market price of PurchasePro stock and
which operated as a fraud and deceit upon the members of the Class .
380. Defendant PurchasePro is a direct participant in the wrongs complained
of herein . The PurchasePro Defendants are liable as direct participants in and as
controlling persons of the wrongs complained of herein . By virtue of their positions
of control and authority as officers of PurchasePro, the PurchasePro Defendants were
able to and did, directly or indirectly, control the content of the aforesaid statements
relating to the Company, and/or the failure to correct those statements in timely
fashion once they knew or were reckless in not knowing that those statements were
no longer true or accurate . The PurchasePro Defendants and the AOL Defendant s
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also caused or controlled the preparation and/or issuance of public statements and
the failure to correct such public statements containing misstatements and omission s
I of material facts as alleged herein .
381 . Defendants had actual knowledge of the facts making the material
statements false and misleading, or acted with reckless disregard for the truth in that
they failed to ascertain and to disclose such facts, even though same were available
to them.
382 . In ignorance of the adverse facts concerning PurchasePro's business
operations and earnings, and in reliance on the integrity of the market, plaintiffs and
the members of the Class acquired PurchasePro common stock at artificially inflate d
prices and were damaged thereby .
383 . Had plaintiffs and the members of the Class known of the materially advers e
information not disclosed by Defendants, they would not have purchased
PurchasePro common stock at all or not at the inflated prices paid .
384 . By virtue of the foregoing, Defendants have violated § 10(b) of the 1934
Act and Rule I Ob-5 promulgated thereunder .
Count III
Violation Of §20(a) Of The Exchange Act
(Against The PurchasePro Defendants)
385 . Plaintiffs repeat and reallege each and every allegation contained in the
foregoing paragraphs as if fully set forth herein .
386. This count is asserted against the PurchasePro Defendants and is base d
upon §20(a) of the 1934 Act .
387. The PurchaseP ro Defendants , by virtue of their office , directorship ,
stock ownership and specific acts, at the time of the wrongs alleged herein and as set
forth in Count 1, were controlling persons of PurchasePro within the meaning of
§20(a) of the 1934 Act . The PurchasePro Defendants had the power and influence
and exercised the same to cause PurchasePro to engage in the illegal conduct an d
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practices complained of herein by causing the Company to disseminate the false and
misleading information referred to above .
388 . The PurchasePro Defendants' positions also made them privy to and
provided them,with actual knowledge of the material facts concealed from plaintiffs
and the Class . ,
389 . By virtue of the conduct alleged in Count I, the PurchasePro Defendants
are liable for the aforesaid wrongful conduct and are liable to plaintiffs and the Class
for damages suffered .
XVI PRAYER FOR RELIEF
WHEREFORE, plaintiffs demand judgment :
1 . Detennining that the instant action is a proper class action
maintainable under Rule 23 of the Federal Rules of Civil Procedure ;
2 . Awarding compensatory damages and/or rescission as
appropriate against Defendants, in favor of plaintiffs and all members of the Class
for damages sustained as a result of defendants' wrongdoing;
3 . Awarding plaintiffs and members of the Class the costs and
disbursements ofthis suit, including reasonable attorneys', accountants' and experts'
fees; and
4 . Awarding such other and further relief as the Court may deem
just and proper .
XVII. JURY DEMAND
Plaintiffs demand a trial by jury.
Dated : April 30, 2004
ABy :LIFar ng sq~
Wi ll iam . . Stod EC . Adam uck Esq .Albright, Stoddard, Warnick& A1ri ht801 S . Rancho DriveQuail Park , Suite D-4Las Vegas , NV 89106
Liaison Counsel for the Class
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1 Kevin J. YourmanVahn Alexander
2 Jennifer R. LiakosWEISS & YOURMAN
3 10940 Wilshire Blvd. 24`'' FloorLos Angeles , CA 90O 4
4Nadeem Faruq 1
R5 owleyShane T.Antonio Vozzol o
6 FARUQI & 1 ARUQI, LL Pt Street320 East 3 9
7 New York, NY 1001 6
8 Co-Lead Counsel for the Class
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PROOF OF SERVICE
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I STATE OF CALIFORNI A
COUNTY OF LOS ANGELESss . :
I am employed in the county of Los Angeles, State of California , I am overthe age of 18 and not a pa rty to the within action ; my business address is 10940Wilshire Boulevard , 24" Floor, Los Angeles , CA 90024.
On April 30, 2004 , I served the documents described as follows :
SECOND AMENDED CONSOLIDATED CLASS ACTION COMPLAINT
PROOF OF SERVIC E
by placing a true copy(ies) thereof enclosed in a sealed envelope (s) addressed asfolipows :
SEE ATTACHED SERVICE LIST
I served the above document(s) as follows:
X BY OVERNIGHT DELIVERY via Federal Express . I am familiar with thepractice at my place of business for collection and processing ofcorrespondence for overnight delivery by Federal Express. Suchcorrespondence will be deposited with a facility regularly maintained b yFederal Express for receipt on the same day in the ordinary course ofbusiness . Ipplaced the envelope ( s) for collection and delivery by FederalExpress with delivery fees paid or provided for in accordance with ordinarybusiness practices .
X BY MAIL as indicated above . I deposited such envelope (s) in the mail atLos Angeles California . The envelope was mailed with p ostage thereonfully prepaid . I am familiar with the firm 's practice of collection andprocessing correspondence for mailing Under that practice it would bedeposited with U . S . postal service on that same day with postage thereonfully prepaid at Los Angeles , California in the ordinary course of business . Iam aware that on motion of the party served, service is presumed invalid ifpostal cancellation date or postage meter date is more than one day after dateof deposit for mailing in an affidavit .
I declare that I an employed in the office of a member of the bar of thisCourt at whose direction the service was made .
Executed on April 30 , 2004, at Lc
LA DONNA R . MC DUFFIEType or Print acne
SERVICE LISTIn Re PURCHASEPRO.COM INC .
SECURITIES LITIGATION
SERVICE BY OVERNIGHT DELIVERY via Federal ExpressThe Honorable Justin L . QuackenbushSenior United States Distract Judge73-710 Fred Waring Drive , No . 2-10-APalm Desert , CA 92260
SERVICE BY MAI L
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Mark Gardy, Esq.Nancy Kaboolian, Es qABBEY GARDY & SQUITIERI, LLP212 East 39th Stree tNew York , New York 10016Attorneys for Hector Velazquez
Greg ory M . Nesp ole Esq .WOLF HALDENST IN ADLERFREEMAN & HERZ LLP270 Madison AvenueNew York , New York 10016AttorneU or Terry SherbondyandJ Hoggard
Eduard Korsinsky, Es q,BEATIE & OSBORN, LLP521 Fifth Avenu eNew York, New York 10175Attorneys for Hector Velasquez
Bruce G. Murphy Esq .LAW OFFICES OF
BRUCE G. MURPHY265 Lyl wds LaneVero Beach, Florida 32963Attorney for Terry Sherbondy
Marvin L. Frank, EsqJoseph V . McBride EsqR
~ABIN & PECKEI . LLP
275 Madison Avenue34th FloorNew York , New York 10016Attorneys for Stanley Myatt
Michael D . Braun, Esq .Patrice L . Bishop, Es q~STULL STULL & BRODY10940 Wilshire BoulevardSuite 230 0Los Angeles , California 90024Attorneys for Dash Limite d
William S . Lerach, Esq .Darren J . Robbins Esq .MILBERG WEISS ~ BESHAD
HYNES & LERACH LLP600 West Broadway, Suite 1800San Diego, California 92101Attorneys for Michael Green andLouis Martin, Jr .' Thomas H. Tallant;Leelon Jones and Hans Kapur ; andSamer Maani
Kenneth A . ElanLAW OFFICES O F
KENNETH A. ELAN217 BroadwaySuite 606New York, New York 10007Attorney for Stanley Myatt
Jules Brody Esq .STULL, STtJLL & BRODY6 East 45th StreetNew York, New York 10017Attorneys for Dash Limited
Alfred G. Yates Jr. Esq .LAW OFFICES OFALFRED G. YATES, JR.519 Allegheny Building429 Forbes Avenu ePittsburgh Pennsylvania 15219Attorney/ r Michael Green andLouis Martin, Jr .
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Christopher A . See er Esq .SEEGER WEISS LIP'One William Stree tNew York; New York 10004-2502Attorneys for Michael Green andLouis Martin, Jr .
Jonathan M . Stein Esq .CAULEYGELLR BWMAN &
COATES LL P2255 Glades RoadSuite 421 ABoca Raton , Florida 33431Attorneys for Christopher Colvi n
Marc A . Topaz, Esq .E RIN & BARROWAY LLP
Thomas G . Shapiro, Esq .SHAPIRO HA ER & URB MY LL P
Three Bala Plaza East Suite 400Bala Cynwyd Pennsylvania 19004
75 State Stree tBoston Massachusetts 0210 9
Attorney for ~'hristopher Colvin,
Attorneys for Anthony V. DemarcoRichard J . Vita P .C .LAW OFFICE. 6F'
Robert Finkel Esq .WOLF POPPER LLP
RICHARD J . VITA P.C. 845 Third Avenu e77 Franklin Street, Suite 300 New York, New York 1002 2Boston, Massachusetts 02110 Attorneys for Anthony V. DearcoAttorneys for Anthony V. Demarco
Betsy C . Manifold EsqWOLF HALDENS'TEIN ADLER
FREEMAN & HERZ LL PS mphony Towers, Suite 2770750 i StreetSan Diego, California 92101Attorneys for Joseph Villari
Nadeem Faruqi EsFARUQI & FAIR-06-1320 East 39th Stree tNew York, New York 10016Attorneys for Joseph Villari
Evan J . Smith, Esq . Brian Felgoise, Esq .BRODSKY & SMITH, L .L .C . LAW OFFICES OFTwo Bala Plaza Suite 602 BRIAN FELGOISEBala Cynwyd, Pennsylvania 19004 261 York Road, Suite 423Attorneys ;or Chris Grater Jenkintown, Pennsylvania 1904 6
Attorney for Chris GraterSandy A . Liebhard Esq .Michael S . Egan E's~a~BERNSTEIN LI~BHARD &
LIFSHITZ, LLP10 East 40th Stree tNew York , New York 10016Attorneys for Ezra Birnbaum
Joshua M. Lifshitz, Esq .BULL & LIFSHITZ, I L P18 East 41st Street 1 I ` FloorNew York, New York 10017Attorneys f or Hagop Wanesian
Marc S . Henzel Esc .LAW OFFICES OF
MARC S . IHENZEL273 Montgomery Square AvenueSuite 202Bala Cynwyd PA 19004Attorney for i. 0. Hoggard
Frederic S . Fox Esq .KAPLAN, KIBHEIMER & FOX LLP805 Third Avenue22nd FloorNew York, New York 10022Attorneys for Thomas H. Tallant
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Laurence D. King~ EsqKAPLAN , KILSHEIMER & FOX LLP555 Montgomery StreetSuite 150 1San Francisco CA 94111Attorneys for Thomas H. Tallant
Steven J. Toll, Esq .Andrew N Friedman, Esq .COHEN MILSTEIN , HAUSFELD
& TOLL,: P .L .L .C .i 100 New York Avenue N .W .Washington, D.C . 20005Attorneys for George Steil
Stanley M . Grossman, Esq.Marc 1 Gross Es q ~POMERANTL HAUDEK BLOCK
GROSSMAN & GROSS, LLP100 Park AvenueNew York, New York 10017Attorneys for Loretta Li n
Leo W . Desmond Esq .LAW OFFICES OF
LEO W. DESMOND2161 Wes : Palm Beach Lake Blvd.Suite 204West Palm Beach , Florida 33409Attorneys 'or Samer Maan i
Daniel J . Albre ts, Esq .DANIEL ALBREGTS LTD .601 S. Tenth Street Suite 202Las Vegas, Nevada 89101
Sherrie R. Savett, EsCarole A. Broderick Esq .Jacob A . Goldberg ~ LsgBERGER & MON FAGUE, P .C .1622 Locust StreetPhiladelphia, Pennsylvania 19103Attorn eys for Esteban Munne
Andrew M . Schatz, Esq .Jeffrey S . Nobel, Esq .Patrick A . Klin man Es q~.SCHATZ & NOBEL, P .C .330 Main Street , 2nd FloorHartford, Connecticut 06106-185 1Attorneys for Mazen Gharaibeh
Patrick V . Dahlstrom Es ~q .POMERANTZ HAUDEK BLOCK
GROSSMAN & GROSS, LLPOne North LaSalle Stree tSuite 22 5Chicago , Illinois 60602Attorneys for Loretta Lin
John W . MuI~) e ESgMUIJE & VAKRICCHIO302 East Carson AvenueSuite 55 0Las Vegas , Nevada 89101Attorneys for Teachers RetirementSystem of-Louisiana
SE RVICE BY OVERNIGHT DELIVERY via Federal Express2
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Kerry L. Early Esq .EARLY SAVAGE7251 W . Lake Mead #550Las Vegas, NV 8912 8Attorneys or Defendant Charles EJohnson, ar .
Joseph S . Kistler, Esq .Erika Pike Turner, Es
Garm GORDON &S LVERsq
3960 Howard Hughes Pkwy9` FloorLas Vegas , Nevada 89109Attorneys for Pro-Aer, Inc., f/k/aPurchase!'ro .com, inc.n
David S . Steuer, Esg ,WILSON, SONSINT, GOODRICH
& ROSAT I650 Page Mill RoadPalo Alto, California 94304-1050Attorneys for Defendant Charles E.Johnson, r.
Suvinder S . Ahluwalia E~sqSKLAR WARREN CONWAY &
WILLIAMS LLP221 North Buffalo Drive Suite ALas Vegas , Nevada 89145Attorneys for DefendantPurchasepro . com, Inc .
Christopher Mc Grath, Es q~PAUL HASTINGS JANOSKY
& WALKER3579 Valley Center DriveSan Diego ,CaliforniaCn92130Attorneysf or Defendants
