ORIGINAL " 1 WOLF HALDENSTEIN ADLER FREEMAN & HERZ, LLP 2 FRANCIS M. GREGOREK (144785) • 0 V T3J1. 11. 2j ti4 FRANCIS A. BOTTINI, JR. (175783) 3 Symphony Towers ._.•. 750 2 Street, Suite 2770 4 San Diego, CA 92101 Telephone 619/239-4599 5 WEISS & YOURMAN 6 JORDAN L. LURIE (130013) SCHOENGOLD & SPORN, P.C. LEIGH A. PARKER (170565) SAMUEL P. SPORN 7 10940 Wilshire Blvd., CHRISTOPHER LOMETTI 24 th Floor 233 Broadway 8 Los Angeles, CA 90024 New York, NY 10279 Telephone: 310/208-2800 Telephone: 212/964-0046 9 Attorneys for Plaintiffs 10 [Additional Counsel Appear on Signature Page] 11 12 UNITED STATES DISTRICT COURT 13 SOUTHERN DISTRICT OF CALIFORNIA 14 In re USA TALKS.COM , INC.) Master File No. 99 CV 0162fK(JAH) SECURITIES LITIGATION ) 15 ) CLASS ACTION ) 16 This Document Relates to: ) CONSOLIDATED AMENDED COMPLAINT ) FOR VIOLATION OF THE SECURITIES 17 ALL ACTIONS. ) EXCHANGE ACT OF 1934 ) 18 19 20 21 22 23 24 25 26 27 '-' 28
Transcript
ORIGINAL"
1 WOLF HALDENSTEIN ADLERFREEMAN & HERZ, LLP
2 FRANCIS M. GREGOREK (144785)• 0 V
T3J1.11. 2j ti4FRANCIS A. BOTTINI, JR. (175783)
3 Symphony Towers ._.•.750 2 Street, Suite 2770
4 San Diego, CA 92101Telephone 619/239-4599
5WEISS & YOURMAN
6 JORDAN L. LURIE (130013) SCHOENGOLD & SPORN, P.C.LEIGH A. PARKER (170565) SAMUEL P. SPORN
7 10940 Wilshire Blvd., CHRISTOPHER LOMETTI24 th Floor 233 Broadway
8 Los Angeles, CA 90024 New York, NY 10279Telephone: 310/208-2800 Telephone: 212/964-0046
9Attorneys for Plaintiffs
10[Additional Counsel Appear on Signature Page]
11
12 UNITED STATES DISTRICT COURT
13 SOUTHERN DISTRICT OF CALIFORNIA
14 In re USA TALKS.COM , INC.) Master File No. 99 CV 0162fK(JAH)SECURITIES LITIGATION )
15 ) CLASS ACTION)
16 This Document Relates to: ) CONSOLIDATED AMENDED COMPLAINT
) FOR VIOLATION OF THE SECURITIES17 ALL ACTIONS. ) EXCHANGE ACT OF 1934 )
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1 SUMMARY AND OVERVIEW
2 1. This is a securities class action on behalf of all
3 purchasers of the common stock of USA Talks.com , Inc. ("USAT" or
4 the "Company") between November 24, 1998 and January 28, 1999 (the
5 "Class Period"), against USAT and its top officers for violations
6 of the Securities Exchange Act of 1934 (the "1934 Act").
7 2. USAT represented that it was building the first national
8 internet-based long distance telephone service to offer unlimited
9 use for a monthly flat fee, and that USAT had proprietary
10 technologies which allowed telephone-to-telephone calls using a
11 simple, fast call placement. The Company stated that it intended
12 to offer unlimited long distance service for $20 to $60 per month.
13 3. USAT was formed in July 1998 through the reorganization
14 of two businesses and, as of September 30, 1999, reported total
15 assets of only $86,088, of which $39,303 was furniture and
16 equipment. During the Class Period, the Company and officers
17 represented that USAT was able to move ahead on an accelerated
18 program to provide national coverage, that the Company already had
19 all necessary funds in place for national installation by January
20 1, 1999, that its network offered "toll" quality, and that it had
21 successfully implemented its network in California which was a
22 "clear sign" that USAT had the ability for successful nationwide
23 implementation.
24 4. In fact, the defendants knew that USAT would not be in a
25 position to implement its system in California, and certainly not
26 nationwide, due to extremely poor quality of its system and lack of
27 funding. Mr. Portnoy and Mr. Ervine also failed to disclose
28 material information about their backgrounds, such as the fact that
-2- Master File No. 99 CV 0162 K(JAH)
1 both had filed for bankruptcy twice this decade. USAT also failed
2 to disclose that one of its main marketing contractors, Trendmark,
3 was not only being investigated by the FTC for making
4 unsubstantiated statements with regard to products it was
5 marketing, but also was not signing up anywhere near the number of
6 persons to use USAT's phone network as expected by USAT. Due to
7 these problems, which USAT knew to exist, USAT fired Trendmark on
8 February 1, 1999.
9 5. During the Class Period defendants had actual knowledge
10 that their network, contrary to USAT's representations, did not
11 provide "toll quality" calls and that USAT's network was frequently
12 down and was completely unreliable. Defendants knew these adverse
13 facts because defendants Portnoy, Ervine, and Alexander were three
14 of USAT's only four full-time employees during the Class Period.
15 In addition, defendants Portnoy, Ervine, and Alexander all received
16 internal memos from part-time USAT employees who specifically
17 described these problems. One memo from Maggie Yates, director of
18 marketing for USAT and wife of Mr. Ervine, stated: "The system is
19 not producing calls with appropriate network reliability. System
20 unreliability has plagued the network for the past two weeks. San
21 Diego was down for a period of three days during the past week."
22 Ms. Yates was fired from her job at USAT because she provided her
23 memo to the San Diego Union-Tribune.
24 6. On January 29, 1999, the Securities and Exchange
25 Commission suspended trading in USAT stock due to "questions that
26 have been raised about the accuracy and adequacy of publicly
27 disseminated information concerning, among other things, the status
28 and extent of [USAT's] business operations." The SEC imposed a 10-
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1 day trading halt on USAT's stock. On February 12, 1999, less than
2 12 hours after the SEC's 10-day trading halt on USAT shares was
3 lifted, the Company's stock plunged an additional 161% to $5.00.'
4 The stock has never recovered and currently trades on the pink
5 sheets. The SEC is still investigating the Company.
6 JURISDICTION AND VENUE
7 7. Jurisdiction is conferred by §27 of the 1934 Act. The
8 claims asserted herein arise under §§10(b) and 20(a) of the 1934
9 Act and Rule 10b-5.
20 8. Venue is proper in this District pursuant to §27 of the
11 1934 Act. Many of the false and misleading statements were made in
12 or issued from this District.
13 9. The Company's operational headquarters are in San Diego,
14 California, at 4180 La Jolla Village Dr., #570, where the day-to-
15 day operations of the Company are directed and managed.
16 THE PARTIES
17 10. Lead Plaintiffs Pat Vitucci, Linda Vitucci, Ronald H.
18 Symanski, Sean Rassas, Matilda L. Hoover, Mike Carella, and Joyce
19 M. Doty purchased shares of USAT common stock as described in their
20 certifications filed with the Court in support of plaintiffs'
21 Motion for Lead Plaintiff and formally lodged with this Court on
22 May 26, 1999, and were damaged thereby.
23 11. Defendant USAT purports to be building the first national
24 internet-based long distance telephone service to offer unlimited
25 use for a monthly flat fee. During the Class Period, USAT's common
26 stock traded in an efficient market on the NASDAQ National Market
27Price reflects a four-for-one stock split effective February
28 1, 1999.
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1 System.
2 12. (a) Defendant Allen J. Portnoy ("Portnoy") is Chief
3 Executive Officer and a director of the Company.
4 (b) Defendant William H. Ervine, Jr. ("Ervine") is
5 President of USAT and a director of the Company.
6 (c) Defendant Jack C. Alexander ("Alexander") is Chief
7 Financial Officer of the Company.
8 ACTUAL KNOWLEDGE
9 13. The individuals named as defendants above are referred to
10 herein as the "Individual Defendants." The Individual Defendants
11 constituted three of only four full-time employees at USAT and thus
12 controlled every decision at USAT, including the contents of USAT's
13 SEC filings and press releases. Each defendant either personally
14 authored or was provided with copies of the Company's reports and
15 press releases alleged herein to be misleading prior to or shortly
16 after their issuance and had the ability and opportunity to prevent
17 their issuance or cause them to be corrected. Because of their
18 positions and access to material non-public information available
19 to them but not to the public, and because the Individual
20 Defendants constituted three of USAT's four full-time employees,
21 each of these defendants had actual knowledge that the adverse
22 facts specified herein had not been disclosed to and were being
23 concealed from the public and that the positive representations
24 which were being made were then materially false and misleading.
25 Each of the Individual Defendants personally received a copy of
26 Maggie Yates' memo, described infra at 1135-36, which directly
27 contradicted USAT's public statements. The Individual Defendants
28 are liable for the false statements pleaded herein at 1125-31 and
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1 38 as those statements were each "group-published" information, the
2 result of the collective action of the Individual Defendants.
3 MOTIVE AND OPPORTUNITY
4 14. In addition to having actual knowledge of the falsity of
5 their statements, defendants USAT, Portnoy, Ervine, and Alexander
6 had the motive and the opportunity to make the false statements and
7 perpetrate the scheme described herein.
8 MOTIVE
9 15. The defendants were motivated to artificially inflate
10 USAT's stock price because;
11 (a) The individual defendants' compensation structure
12 was completely tied to their USAT stock and option holdings.
13 Portnoy, Ervine, and Alexander were being paid very low salaries
14 for their positions and owned inordinately large stakes in USAT and
15 could only capitalize on these stakes by increasing USAT's share
16 price, In 1997, Portnoy received a salary of only $33,310;
17 Ervine's 1997 salary was only $22,500, as was Alexander's. In
18 1998, Portnoy and Ervine increased their salaries to $111,000 and
19 increased Alexander's to $86,000. Nonetheless, these salaries are
20 off the scale on the low end for officers of publicly-held
21 companies. In contrast, the individual defendants own huge chunks
22 of USAT stock, much more than officers at other public companies.
23 Disregarding their huge option holdings, Portnoy owns 5,537,710
24 shares, or 8.89%, of USAT; Ervine owns 3,003,153 shares, or 4.82%;
25 Alexander owns 92,880, or 0.15%. The defendants control much more
26 of USAT when their options are taken into account.
27 (b) Because he had founded and run several public
28 companies in his career, including Permaneer Corporation and
-6- Master File No. 99 CV 0162 K(JAH)
1 Spartech, Inc., Portnoy knew that the way to make "real" money in
2 this bull market was to load up on stock and stock options. Ervine
3 and Alexander were also aware of this recipe for becoming multi -
4 millionaires because of their previous roles as partner in a law
5 firm specializing in civil litigation and partner at an accounting
6 firm, respectively. Ervine also had been president of Compression
7 Technologies, Inc. for five years and president of Alfine before it
8 merged with USAT in 1998. All three individual defendants thus
9 were highly motivated to make money primarily through their USAT
10 stock and options and in order to facilitate this goal agreed to
11 accept extremely low salaries.
12 fc) Before the Class Period began, USAT's stock was
13 trading at around $4, making Portnoy's stock worth about $22
14 million; Ervine's stock was worth about $12 million and Alexander's
15 stock was worth about $371,000. However, as the Class Period began
16 and defendants' scheme of issuing false and misleading statements
17 to increase USAT's stock price successfully drove USAT's stock
18 price to in excess of $50, the value of Portnoy's stock holdings
19 increased exponentially to upwards of $276 million; Ervine's
20 holdings increased in value to $150 million; and Alexander's
21 holdings increased in value to over $4.6 million.
22 (d) USAT's growth and success depended upon the
23 successful acquisition of other companies. However, since USAT had
24 no cash (as of September 30, 1998 it listed cash of $29,900), its
25 stock was the only currency which the Company had to acquire other
26 companies. A high stock price was essential to the ability of USAT
27 to acquire other companies because USAT had a limited amount of
28 stock with which to acquire other companies and because the
-7- Master File No. 99 CV 0162 K(JAH)
1 individual defendants did not want their large shareholdings to be
2 diluted. A high stock price would mean that USAT could acquire
3 another company by issuing much fewer shares. The day before the
4 SEC halted trading in USAT's stock, the Company's shares closed at
5 $52.25, giving the Company a market value of $1.3 billion.
6 (e) In September 1998, USAT began discussions to acquire
7 Trendmark, a company that was important to USAT's growth because of
8 its ability to market USAT's flat-rate telephone service and thus
9 generate essential cash and revenues. However, in September 1998
10 USAT's stock was only trading at around $4, meaning that USAT would
11 have to issue a significant number of its shares to acquire
12 Trendmark. Defendants' goal was to increase USAT's stock price by
13 the end of the year so that USAT could acquire Trendmark with fewer
14 shares and thus preserve USAT stock to be used as currency for
15 subsequent transactions and to pay USAT's vendors and consultants.
16 (f) During the Class Period, USAT also began
17 negotiations to purchase TriServe Communications, Inc. The cost to
18 buy TriServe was a direct factor of the market value of USAT
19 shares, since negotiations contemplated USAT shares to be received
20 by TriServe. Thus, defendants were motivated to increase USAT's
21 share price.
22 (g) During the Class Period, USAT was in negotiations to
23 buy Compression Technologies. Mr. Portnoy had served as
24 Compression's Chairman from 1990 to 1996 and owned 13% of
25 Compression's shares. The discussions between USAT and Compression
26 called for USAT to pay for Compression with USAT shares.
27 (h) During the Class Period, USAT had no cash (as of
28 September 30, 1998 it listed cash of $29,900) and thus used its
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1 stock as its sole currency. During the Class Period, USAT issued
2 over $20 million of stock in private transactions with individuals
3 and institutions to fund its operations.
4 (i) During the Class Period, USAT issued warrants
5 covering over 1.5 million shares to consultants as compensation for
6 services. The defendants were motivated to increase USAT i s stock
7 price because these warrants only had value to the consultants
8 insofar as they could exercise their warrants and buy USAT stock
9 and then resell it for a big profit.
10 (j) Because of the extreme degree of risk that the
11 consultants faced in accepting warrants, instead of cash, from a
12 start-up company like USAT with no revenues, the consultants
13 insisted that the warrants would have to have a big pay-off.
14 Moreover, if the warrants did not pay off in a big way, the
15 consultants would not work for USAT in the future and thus USAT,
16 which had no cash, would not be able to procure services from any
17 consultants. Portnoy, Ervine, and Alexander assured the
18 consultants that USAT stock was going to take off and that the
19 warrants would be worth a lot of money.
20 (k) As reported by the Wall Street Journal on February
21 1, 1999, one of the consultants to whom USAT issued 15,500 warrants
22 was Richard Langley, who is currently a defendant in a federal
23 criminal stock-fraud case in New York.
24 (1) The Company's 10-Q for the quarter ended March 30,
25 1999 states that USAT received $170,150 in cash during the quarter
26 ended March 30, 1999 for the exercise of Warrants resulting in the
27 issuance of 7,022,000 shares (as adjusted for the four-for-one
28 stock split). USAT also issued 67,267 shares and committed to
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1 issue 400,000 shares to three persons in exchange for consulting
2 services valued at $300,715.
3 (m) During the Class Period, defendants used USAT's
4 stock as consideration for paying Robert M. Beaton & Associates
5 ("Beaton"), a consulting firm hired by USAT to help inflate its
6 stock price. The formal consulting agreement between USAT and
7 Beaton stated that Beaton's job was to "assist [USAT] in developing
8 a professional business plan and corporate profile to further
9 [USAT's] business plans and its relationships with the securities
10 industry." In exchange for this assistance in carrying out its
11 fraudulent scheme, USAT issued Beaton warrants to purchase 750,000
12 USAT shares. These warrants were formally registered with the SEC
13 on January 11, 1999, although the consulting agreement itself was
14 dated October 13, 1998.
15 OPPORTUNITY
16 16. During the Class Period, USAT only had four full-time
17 employees. Defendants Portnoy, Ervine, and Alexander constituted
18 three of these four employees, and thus were intimately involved
19 with every decision which was made at USAT. Every press release
20 and public filing issued by USAT was personally reviewed by
21 Portnoy, as CEO, by Ervine, who is not only USAT's president but
22 also an attorney by training and thus reviewed USAT's documents for
23 legal compliance, and by Alexander, a CPA and USAT's CFO, for
24 accounting issues. As USAT did not have any other employees, the
25 individual defendants not only reviewed USAT's press releases and
26 SEC filings but actually drafted them.
27 17. According to the Company's June 1998 Form 10-K, USAT
28 management's plans were to raise additional equity capital and look
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1 for merger and acquisition candidates. These merger candidates are
2 specified supra at ¶15(e)-(g). Both of these goals necessitated
3 that USAT achieve a high share price and that USAT's business and
4 prospects be viewed favorably. The higher the share price, the
5 fewer number of shares would be required to be issued either in
6 equity offerings or in stock-for-stock acquisitions, making such
7 offerings or acquisitions less dilutive to USAT's earnings and to
8 the Individual Defendants' holdings.
9 FRAUDULENT SCHEME AND COURSE OF BUSINESS
10 18. Each of the defendants is liable for (i) making false
11 statements, or (ii) failing to disclose adverse facts known to them
12 about USAT. Defendants' fraudulent scheme and course of business
13 that operated as a fraud or deceit on purchasers of USAT stock was
14 a success, as it (i) deceived the investing public regarding USAT's
15 prospects and business; (ii) artificially inflated the price of
16 USAT's stock and publicly traded options; and (iii) caused
17 plaintiff and other members of the Class to purchase USAT stock and
18 options at inflated prices.
19 BACKGROUND TO THE CLASS PERIOD
20 19. In July 1998 USAT (at the time called Alfine Corp.) went
21 public through the "back door" by merging into a public shell
22 corporation -- SBB, Inc. The name of the company was then changed
23 to USA Talks.com , Inc. and stock was sold to the public the next
24 month at $7.50 per share. Alfine's merger with a public shell
25 company was an intentional act done to avoid the scrutiny of the
26 SEC and enable the defendants to immediately begin selling their
27 stock to the public.
28 20. Alfine was a development-stage company formed in 1991,
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1 which owned the exclusive worldwide licensing and marketing rights
2 for its audio compression and speaker identification and speaker
3 verification technologies. Effective July 28, 1998, the Company
4 issued 12,350,000 shares over 90%) for all the assets of Alfine.
5 Effective July 31, 1998, the Company filed an S-8 Registration
6 Statement reporting issuance of 453,323 shares in connection with
7 the Company's Stock Bonus Agreement, which increased the total
8 shares of common stock issued and outstanding to 13,000,000 as of
9 July 31, 1998.
10 21. Effective August 3, 1998, the Company changed its name to
11 USA Talks.com , Inc. USAT markets its long distance service through
12 Trendmark, Inc., a direct marketing company based in Tennessee,
13 through Unlimited Long Distance, Inc., based in Nevada, and through
14 USAT's wholesale and reseller divisions located in San Diego. On
15 February 1, 1999, USAT announced that it was terminating its
16 contractual relationship with Trendmark due to a FTC investigation.
17 22. USAT stated that it intended to offer long distance
18 telephone service over the Internet using an unlimited-use flat
19 rate per month payment plan. USAT stated that the long distance
20 service would be telephone-to-telephone without the need for a
21 computer and that the service would have "toll-quality" voice
22 clarity. The Company stated that the service would use voice
23 recognition to prevent unauthorized use and be available in most
24 large U.S. cities by October 1998. On October 20, 1998, USAT
25 announced installation of its service test site in California,
26 representing that it was the first step toward a national
27 installation, and, on November 9, 1998, announced that the
28 California installation was successful ("USA Talks.com today
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1 announced the success of its installation of their long distance
2 internet telephone service test site throughout the State of
3 California with a call volume of over 3,000 per day and 'toll
4 quality' service.").
5 23. In October 1998, USAT implemented a system of "red
6 alerts" and "yellow alerts" as a means to monitor its systems. A
7 "red alert" meant that the system was completely down while a
8 "yellow alert" meant that there were jam-ups and busy signals.
9 Portnoy, Ervine, and Alexander each received daily reports of
10 yellow and red alerts beginning on or before October 20, 1998 and
11 thus had actual knowledge of significant technical problems with
12 USAT's network that directly contradicted the statements made by
13 USAT during the Class Period.
14 24. Mr. Portnoy and Mr. Ervine have been sued previously as
15 defendants in a class action lawsuit by shareholders of Alfine,
16 USAT's predecessor. The suit was settled in December 1997 with
17 Alfine agreeing to purchase all 585,000 shares owned by the
18 plaintiffs for $360,000.
19 FALSE AND MISLEADING STATEMENTS
20 25. On November 23,1998, USAT filed a Form 8-K with the SEC.
21 This filing was incorporated by reference into the press releases
22 and other public statements made by USAT during the Class Period.
23 The Form 8-K described the merger of Alfine Corp. and SBB, Inc. and
24 the subsequent change of the resulting company's name to USAT. The
25 filing admitted that USAT purposely created, and then merged into,
26 a Nevada corporation in the second quarter of 1998. The sole
27 purpose of this merger was to obtain the more favorable protection
28 of Nevada law which defendants hoped would protect them to the
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1 greatest extent permitted in the U.S. (even greater than Delaware
2 law) for the fraud they intended to commit later in 1998 and into
3 1999. The Form 8-K was materially misleading because it omitted to
4 disclose the backgrounds of Portnoy and Ervine, who had both filed
5 for bankruptcy protection twice this decade. It further failed to
6 reveal that Portnoy had been associated with Digitech, as described
7 below in ¶42(b).
8 26. On November 24, 1998, USAT issued a press release which
9 stated:
10 USA Talks.com , Inc. announced the receipt ofover $1.5 million in capital financing and
11 over $6 million in commitments for systemexpansion and equipment purchase.
12
13 William H. Ervine, President of USA Talks.comstates, "This capital infusion enables USA
14 Talks.com to move ahead on an acceleratedprogram to provide national coverage and to
15 expand into limited international markets."
16 USA Talks offer a flat rate, "all you cantalk", telephone-to-telephone, "toll-quality"
17 long distance service with a variety ofservice and pricing plans from $20 to $60 per
18 month. The long distance service is designedto meet the needs of residential and small to
19 medium size business target markets. Last month, USA Talks began operation of its long-
20 distance Internet telephone service test site in California and has been receiving over 3000
21 calls per day. The initial success of the test program is evidence of the long-term
22 market acceptance and demand for flat rate, "all you can talk" service worldwide.
23
24 27. On December 1, 1998, USAT issued a press release which
25 stated in part:
26 USA Talks.com , Inc. announced the receipt of all necessary funds for the first phase of the
27 equipment installation scheduled by January 1, 1999. This equipment installation includes
28 five additional super points of presence and
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1 will enable the USA Talks.com network to reach90% of the U.S. population by year-end.
2
3 Allen Portnoy, Chief Executive Officer,commented, "The receipt of these funds is a
4 green light for the Company in its scheduledinstallation and national network coverage.
5 We are excited about the positive responsefrom our investors in making USA Talks.com's
6 flat rate long distance network a reality."
7 28. On January 11, 1999, Business Wire ran a story based on
8 a conversation with the defendants and with Maggie Yates, Marketing
9 Director of USAT. The story was entitled, "Customers Chat Nonstop
10 Over the Internet for $20." The article stated in part:
11 The Company is on the brink of throwing itscompetitors for a jolt on long distance rates.
12 USA Talks.com is testing its Californianetwork installation, which has provided
13 service to more than 60,000 calls in the last30 days. USA Talks.com will complete testing
14 in the next week and plans to offer nationwide services by Feb. 1. In its favor the company
15 has $8.2 million in financial backing.
16 The infusion, rounded up by private investors,is allowing the service provider to speed up
17 equipment installation for its nationwide service.
18
19 Maggie Yates, a spokeswoman for USA Talks.com , says tests in California have been a success.
20
21 29. On January 6, 1999, USAT issued a press release which
22 stated in part:
23 USA Talks.com, Inc. (OTC Bulletin) announcedthe receipt of over $8.2 million in financing
24 to complete the nationwide installation of theUSA Talks.com's [sic] flat rate long distance
25 service. This equipment installation includespoints of presence across the United States,
26 which will enable [the] USA Talks.com network to reach the entire US population by the end
27 of the first quarter 1999.
28
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1 "The completion of this round of financingallows the Company to open its doors as the
2 first provider of flat rate long distanceservices," commented William Ervine,
3 President. "We are pleased by the responsefrom our investors in making USA Talks.com's
4 flat rate long distance network a reality."
5 30. On January 20, 1999, Portnoy was quoted in an article
6 published by Businesswire in which he stated:
7 Since the introduction of our Flat Rate LongDistance service, our business has really
8 taken off. The Tempest has receivedconsistent praise for its voice quality and
9 ease of installation from our people.
10 We at USAT are extremely pleased to have California up and running on schedule. We
11 expect to enjoy a long, prosperousrelationship with Franklin as we expand
12 throughout the world.
13 31. On January 27, 1999 ! USAT issued a press release which
14 stated in part:
15 USA Talks.com , Inc. today announced the successful installation of its flat rate "all
16 you can talk" toll quality, long distance Internet telephone service throughout the
17 state of California. The newly installed andtested USA Talks' California network allows
18 its California subscribers to dial a local USATalks' access number and place calls
19 nationwide.
20 Allen Portnoy, Chief Executive Officer,commented, "USA Talks' California network is
21 performing beautifully. The 'toll auality' service of our California network is a clear
22 signal of our ability to create a successful nationwide installation, which is projected to
23 be operational by February 10 th . California isnot only a major accomplishment for the
24 company, but also a win for the consumer."
25 32. During the Class Period, as its stock price began to
26 soar, USAT used many opportunities to plug the fact that it had won
27 the telecommunications Most Innovative New Product Award from
28 University of California at San Diego Connect at a gala luncheon on
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1 December 16, 1998. Although it told potential investors that it
2 had won this award, USAT failed to disclose the significant
3 technical problems identified herein at ¶T35-36, 42.
4 33. The positive representations and forecasts made about
5 USAT during the Class Period were false. During the Class Period,
6 defendants knowingly or recklessly failed to disclose that USAT's
7 California operations were not performing as well as represented
8 and that USAT did not have the ability to install a nationwide
9 program in the near future.
10 34. USAT had implemented a system to monitor its telephone
11 network in October 1998. The system involved "yellow alerts" and
12 "red alerts." A red alert signified that USAT's system was
13 completely down, while a yellow alert signified that there were
14 jam-ups and busy signals. Portnoy, Ervine, and Alexander received
15 daily reports from USAT's part-time employees of yellow and red
16 alerts beginning in October 1998 and continuing throughout the
17 Class Period. The defendants thus had actual knowledge that USAT's
18 system was not functioning and that quality issues were inherent to
19 its system- These facts were not disclosed to the public and
20 directly contradicted defendants' statements such as "We at USAT
21 are extremely pleased to have California up and running on
22 schedule," made by Portnoy on January 20, 1999, and "USA Talks'
23 California network is performing beautifully," made by Portnoy on
24 January 27, 1999.
25 35. In fact, just two weeks after these statements were
26 published to the public, Portnoy, Ervine, and Alexander received an
27 internal memo from Maggie Yates, director of Marketing for USAT,
28 which notified the defendants that USAT's network was plagued with
-17- Master File No. 99 CV 0162 K(JAH)
1 problems. The memo was typical of other memos and reports which
2 the defendants had previously received. The memo stated:
3 System unreliability has plagued the networkfor the past two weeks. San Diego was down
4 for a period of three days during the past week. On Thursday, Feb. 11, there were red
5 alerts in San Diego and San Jose. There was also a yellow alert in Irvine. . . On Thursday
6 and Friday, Feb. 11-12, I placed approximately15 calls during the day. Only three of these
7 calls were near toll quality. The remainderhad noticeable echoes, clipping and latency.
8
9 36. The existence of this internal report was publicly
10 reported by Don Bauder in the San Diego Union-Tribune on February
11 18, 1999 in an article entitled "Memo faults USATalks' Long
12 Distance Services." Mr. Bauder obtained the memo directly from Ms.
13 Yates. In a February 19, 1999 article entitled, "S.D. Stocks
14 Reflect the Market's Bad Breath," Don Bauder of the San Diego Union
15 Tribune reported that he had spoken with USAT officials and that
16 they confirmed the existence and veracity of Ms. Yates' memo. USAT
17 subsequently fired Yates for disclosing the memo. The Union-
18 Tribune article stated in part:
19 USATalks.com yesterday conceded that it hasexperienced the technical problems described
20 in an internal company memo that was revealedin this column yesterday. The company also
21 acknowledged that the memo to the board by thecompany's director of marketing was genuine.
22
23 "S.D. Stocks Reflect the Market's Bad Breath" by Don Bauder, the
24 San Diego Union-Tribune, February 19, 1999.
25 37. Moreover, the defendants knew that USAT's network was
26 experiencing these problems long before they received this memo
27 from Ms. Yates. Each of the defendants, as three out of USAT's
28 four full-time employees, personally tested USAT's system on a
-18- Master File No. 99 CV 0162 K(JAH)
1 weekly basis and received daily reports beginning at least in
2 October 1998 on red and yellow alerts and thus knew that the system
3 was plagued with the aforementioned problems. Thus, defendants
4 Portnoy, FrvIne, and Alexander had actual knowledge of these facts
5 at the same time that they made the false statements about USAT's
6 network.
7 38. On January 23, 1999, an article entitled "USATalks Has
8 Walked a Fine Line But Still Looks Ahead," appeared in the San
9 Diego Union Tribune. The article was written by Don Bauder after
10 he had a conversation with Portnoy. In the article, Portnoy was
11 quoted as stating that the California portion of USAT's network was
12 "up and running" and that, "The rest of the country is coming
13 online the first week of February."
14 39. This statement was false when made because Portnoy knew
15 about the technical problems with USAT's network and knew that
16 USAT's nationwide network would not be ready by the first week of
17 February for the reasons stated in 1 4135-36, 42. Portnoy made these
18 statements to Bauder with knowledge and intent that the statements
19 would be disseminated to the public in the newspaper article.
20 40. Back in August 1998, Portnoy had stated in a August 24,
21 1998 Business Wire story that:
22 We are on schedule to offer its long-distancephone service throughout the state of
23 California, its first service area, by the endof September 1998... .We expect to proceed
24 across the country and 'light up' at least 34 major metropolitan areas, including
25 approximately 60 area codes by the end of October 1998, giving us access to 75 percent
26 of the U.S. population....After the entirenation is covered, we will then move to
27 international markets in 1999.
28 41. Portnoy knew that these statements were false when made
-19- Master File No. 99 CV 0162 K(JAH)
1 because he knew that USAT did not have any resources to complete
2 this ambitious schedule. At the time, USAT did not have any
3 significant resources and did not have the funds necessary to
4 establish the points of presence (POPs) necessary to establish
5 nationwide service. The statements made by Portnoy in January 1999
6 were similarly false when made because of these same factors and
7 due to the factors identified in 11 41!35-36, 42. Portnoy's statements
8 had absolutely no basis in fact and were made solely for the
9 purpose of maintaining USAT's stock price and facilitating USAT's
10 acquisitions of other companies.
11 UNDISCLOSED FACTS
12 42. The statements listed above were all false and misleading
13 because they failed to disclose the following facts known to the
14 defendants:
15 (a) USAT's SEC filings failed to disclose that both
16 Portnoy and Ervine have filed for bankruptcy twice this decade.
17 Portnoy filed a Chapter 11 bankruptcy in San Diego in 1993 and a
18 Chapter 7 bankruptcy in San Diego in 1996. Ervine filed a Chapter
19 7 bankruptcy in 1990 in San Angelo, Texas and a Chapter 13
20 bankruptcy in 1993 in Houston, Texas. In addition, both Portnoy
21 and Ervine have been assessed with substantial tax liens in the
22 past.
23 (b) Portnoy was involved with Digitech, a company spun
24 off in the mid 1980s by Spartech, where Portnoy was president from
25 1979 to 1983. Digitech, like USAT, was a company formed to promote
26 and sell voice recognition technology. Under Portnoy's guidance,
27 Digitech's stock soared after the company issued numerous press
28 releases touting its voice recognition technology. After it was
-20- Master File No. 99 CV 0162 KCJAH)
1 revealed that the technology did not work, Digitech's stock crashed
2 and the company was liquidated. Spartech sued Portnoy in 1991 in
3 a dispute over stock.
4 (c) USAT did not have the ability to service any
5 customers that might sign up for its service. In fact, in its Form
6 10-Q for the quarter ended March 30, 1999, filed with the SEC on
7 May 17, 1999, USAT admitted that it still does not have the ability
8 to provide service to its customers and therefore has been unable
9 to recognize revenue:
10 As of March 31, 1999, as a result of ULD'stelesale activities, in excess of 9,000 new
11 customers have subscribed to the Company'slong distance service representing
12 approximately $1.1 million in gross revenues.However, due to the Company's inability to
13 provide full service to the new customers byMarch 31, 1999, management has not recognized
14 substantially all of this revenue as of March31, 1999. In view of the Company's delay in
15 completing its national network and providingsuch services, the Company has elected to re-
16 contact the customers to confirm theirinterest in the Company's long distance
17 service.
18 (d) The Company did not have an organizational and
19 operations plan to accommodate the rapid growth of its customer
20 base which would be associated with implementation of a national
21 plan. Operation of the Company's nationwide network required the
22 installation of specialized equipment to be strategically located
23 at sites selected to serve certain telephone markets. Such sites
24 are known as points of presence ("POPs"). Those POPs serving
25 broader geographical areas are referred to as "super POPs." During
26 the Class Period, USATalks.com announced that it was building its
27 own private IP network to implement its voice-over-internet
28 protocol ("VOIP"). The private network which USATalks.com
-21- Master File No. 99 CV 0162 K(JAH)
1 announced that it was building converts voice signals originating
2 locally by telephone into internet protocol ("IP") digital data
3 packets using a digital signal processor and ancillary software
4 located at each POP. The Company's network then compresses the
5 speech and converts it into digital message packets transmitted by
6 the Company's internet network and then directs the data to other
7 sites. During the Class Period, the Company failed to disclose
8 that its VOIP hardware devices were not compatible with the devices
9 and services of multiple vendors and thus placed a significant
10 limitation on the Company's ability to implement its nationwide
11 network and handle high-level calls. The Company still does not
12 have this ability and thus is not in a position to service the
13 large number of customers that would be associated with
14 implementation of a nationwide plan.
15 (e) There was a lag time of 10-15 seconds between the
16 time a caller placed a call to the Company's network and the time
17 the caller received a dial tone;
18 (f) The Company's network did not have "toll" quality,
19 as represented. Calls were characterized by significant noise and
20 "scratchy" sounds which plagued other Internet telephony companies.
21 Thus, the Company's system did not provide a unique advantage and
22 "toll" quality. These problems caused numerous customers to demand
23 a refund from USAT, which the Company refused to do.
24 (g) The Company's network was not up and running as
25 promised. The lack of ability to place any calls caused many people
26 to demand a refund from USAT, which the Company refused to do.
27 USAT never publicly disclosed that its policy was not to issue
28 refunds to customers;
-22- Master File No. 99 CV 0162 K(JAH)
1 (h) USAT was not using a proprietary network, but was
2 relying on the public Internet to handle the routing of its calls.
3 The Internet works well for the transmission of data but not for
4 voice. Calls on USAT's system were plagued by not only very poor
5 quality but also significant delays, caused directly by USAT's
6 reliance on the Internet. USAT was aware of these problems but
7 could not yet pay for dedicated private Internet transmission due
8 to a lack of funds.
9 (i) USAT was having serious disagreements with its
10 accountants, Crouch, Bierwolf Chisolm, regarding whether USAT was
11 obligated under the federal securities laws to report the
12 undisclosed information alleged in this Complaint. USAT's
13 accountants told USAT that it was obligated under Item 303 of
14 Regulation SK to report these events. USAT insisted that it was
15 not obligated to disclose such events. An impasse developed and
16 USAT eventually fired Crouch, Bierwolf Chisolm effective March 1,
17 1999, a month before USAT was required to file its annual report
18 with the Securities and Exchange Commission. Source: USAT's Form
19 8-K filed with the SEC March 1, 1999.
20 (i) The marketing companies that USAT was using to
21 generate sales were net generating anywhere near the sales numbers
22 expected. One of USAT's main marketers, Trendmark, was performing
23 so poorly that USAT fired Trendmark on February 1, 1999. Maggie
24 Yates, USAT's marketing director, was quoted in a February 3, 1999
25 Bloomberg article as stating: "Their sales didn't meet our
26 expectations. We wanted tighter control of our sales process."
27 Defendants Portnoy, Ervine, and Alexander were aware of Trendmark's
28 extremely poor sales efforts during the Class Period since they
-23- Master File No. 99 CV 0162 K(JAH)
I constituted three of USAT's four full-time employees during the
2 Class Period and directly received weekly status reports from
3 Trendmark. USAT failed to disclose this material information to
4 the market.
5 (k) USAT was marketing its service by sending
6 unsolicited facsimile messages, in contravention of California law.
7 USAT has been sued in Los Angeles Superior Court for this conduct
8 - Case No. EC 199397, filed February 24, 1999.
9 (1) USAT also failed to disclose that Trendmark was a
10 multi-level marketing company which was subject to a consent decree
11 from the FTC for misleading marketing practices. Although USAT has
12 denied that it knew about the FTC consent decree, Trendmark's CEO,
13 Robert Gates was quoted in the February 3, 1999 Los Angeles Times
14 as stating, "USATalks.com knew about the FTC investigation. I told
15 them about it early on."
16 (m) Trendmark's CEO, Robert Gates, was previously
17 president of a Memphis company named Victory Investment that
18 declared bankruptcy in 1986. The state of Tennessee subsequently
19 issued a cease and desist order against Victory for acting as an
20 unregistered investment adviser.
21 (n) Another Trendmark executive, William F. McCormack,
22 was involved with a Kentucky multi-level marketing company named
23 Gold Unlimited. In 1996, its principals were convicted of multiple
24 counts of mail fraud and money laundering and sentenced to prison.
25 The individuals subsequently "skipped the country, are at large,"
26 according to Hopkinsville, KY attorney Daniel Kemp, the receiver
27 for Gold Unlimited. Although McCormack was not himself charged,
28 Portnoy admitted in a January 30, 1999 San Diego Union-Tribune
-24- Master File No. 99 CV 0162 K(JAH)
1 article that he was aware of McCormack's involvement with Gold
2 Unlimited and of the FTC investigation of Trendmark.
3 (a) USAT had significant competition, which it denied.
4 In fact, numerous other companies were developing identical
5 technology to that touted by USAT. For example, defendants knew,
6 but did not disclose, that GTC Telecom was offering identical
7 service which offered better quality than that offered by USAT.
8 GTC Telecom formally announced its service on January 28, 1999.
9 GTC Telecom's service is not only better than USAT's because its
10 quality is better (due to the private network backbone used by GTC)
11 but also because users do not need to dial an access number, as
12 USAT customers need to do.
13 43. On January 29, 1999, the Securities and Exchange
14 Commission suspended trading in USAT, issuing the following
15 release:
16 TRADING SUSPENSION ORDERED IN USA TALKS.COM ,INC.
17
18 The Commission announced the temporarysuspension, pursuant to Section 12(k) of the
19 Securities Exchange Act of 1934 (ExchangeAct), of over-the-counter trading of the
20 securities of USA Talks.com , Inc. (USA Talks),a Nevada corporation headquartered in San
21 Diego, California, for a ten business dayperiod commencing at 9:30 a.m. EST on January
22 29, 1999, and terminating at 11:59 p.m. EST onFebruary 11, 1999.
23
24 Trading has been suspended in view of questions that have been raised about the
25 accuracy and adecruacy of publicly disseminated information concerning, among other things,
26 the status and extent of USA Talks' business operations.
27
28
-25- Master File No. 99 CV 0162 K(JAH)
The Commission cautions broker-dealers,shareholders, and prospective purchasers thatthey should carefully consider the foregoinginformation along with all other currently
3 available information and any informationsubsequently issued by the company.
4
5 Any broker or dealer or other person who hasany information which may relate to this
6 matter should contract the Securities andExchange Commission's Pacific Regional Office
7 at (323)965-3998. (Rel. 34-41002)
8 44. The Securities and Exchange Commission was concerned
9 about significant information that was not included in USAT's
10 public documents including:
11 • USAT's California network was not "up andrunning" as represented and did not offer
12 "toll" quality.
13 • USAT did not have the funds or capability toimplement a nationwide network on the
14 timetable represented by USAT, if at all.
15 • Both Portnoy and Ervine had filed forbankruptcy at least twice this decade.
16
17 • Both Ervine and Portnoy had substantial taxliens.
18
19 ,• USAT's subsidiary TrendMark was a multi-levelmarketing operation that was required to enter
20 into a consent decree with the FTC due tomisleading marketing practices.
21
22 • One of USAT's principals was Robert Gates whowas president of a Tennessee company named
23 Victory Investment which had received a cease-and-desist order for acting as an unregistered
24 investment advisor.
25 • Portnoy had been involved in Digitech, atelecom company whose stock soared after
26 putting out news releases touting itstechnology (like USAT) which was ultimately
27 liquidated.
28
-26- Master File No. 99 CV 0162 K(JAH)
1 45. After trading in USAT stock was suspended by the SEC,
2 USAT issued a February 1, 1999 press release in which Portnoy
3 stated:
4 We understand that the SEC is rightfullyconcerned with companies which misrepresent
5 the existence and extent of Internet-basedbusinesses to stimulate trading in their
6 stock.
7 46. The SEC is still investigating the Company.
8 FIRST CLAIM FOR RELIEF
9 For Violation of §10(b) Of The 1934 ActAnd Rule 10b-5 Against All Defendants
10
11 47. Plaintiffs incorporate by reference each and every
12 paragraph above as though set forth in full herein.
13 48. During the Class Period, defendants disseminated or
14 approved the false statements specified above, which they knew or
15 recklessly disregarded were misleading in that they contained
16 misrepresentations and failed to disclose material facts necessary
17 in order to make the statement made, in light of the circumstances
18 under which they were made, not misleading.
19 49. Defendants violated §10(b) of the 1934 Act and Rule 10b-5
20 in that they:
21 (a) Employed devices, schemes, and artifices to defraud;
22 (b) Made untrue statements of material facts or omitted
23 to state material facts necessary in order to make statements made,
24 in light of the circumstances under which they were made, not
25 misleading; or
26 (c) Engaged in acts, practices, and a course of business
27 that operated as a fraud or deceit upon plaintiff and others
28 similarly situated in connection with their purchases of USAT's
-27- Master File No. 99 CV 0162 K(JAE)
1 common stock and publicly traded options during the Class Period.
2 50. Plaintiffs and the Class have suffered damages in that
3 in reliance on the integrity of the market, they paid artificially
4 inflated prices for USAT stock and options. Plaintiffs and the
5 Class would not have purchased USAT stock or options at the prices
6 they paid, or at all, if they had been aware that the market prices
7 had been artificially inflated by defendants' misleading
8 statements.
9 51. As a direct and proximate result of these defendants'
10 wrongful conduct, plaintiffs and the other members of the Class
11 suffered damages in connection with their purchases of USAT common
12 stock and its publicly traded options during the Class Period.
13 SECOND CLAIM FOR RELIEF
14 For Violation of §20(a) Of The1934 Act Against All Defendants
15
16 52. Plaintiffs incorporate each and every paragraph above by
17 reference.
18 53. Defendants Portnoy, Ervine, and Alexander acted as
19 controlling persons of USAT within the meaning of §20(a) of the
20 1934 Act. By reason of their positions as Chief Executive Officer,
21 President, and Chief Financial Officer and by virtue of Portnoy and
22 Ervine's positions as directors of USAT, and their ownership of
23 USAT stock, the Individual Defendants had the power and authority
24 to cause USAT to engage in the wrongful conduct complained of
25 herein. USAT controlled each of the Individual Defendants and all
26 of its employees. By reason of such conduct, the Individual
27 Defendants and USAT are liable pursuant to §20(a) of the 1934 Act.
28
-28- Master File No. 99 CV 0162 K(JAB)
1 CLASS ACTION ALLEGATIONS
2 54. Plaintiffs bring this action as a class action pursuant
3 to Rule 23 of the Federal Rules of Civil Procedure on behalf of all
4 persons who purchased USAT stock and options (the "Class") on the
5 open market during the Class Period, excluding defendants.
6 55. The members of the Class are so numerous that joinder of
7 all members is impracticable. The disposition of their claims in
8 a class action will provide substantial benefits to the parties and
9 the Court. USAT had more than 25 million shares of stock
10 outstanding owned by hundreds if not thousands of persons.
11 56. There is a well-defined community of interest in the
12 questions of law and fact involved in this case. Questions of law
13 and fact common to the members of the Class which predominate over
14 questions which may affect individual Class members include:
15 (a) Whether the 1934 Act was violated by defendants;
488 Madison Avenue, 8 . - FloorJordan L. Lurie New York, NY 10022Leigh A. Parker 212/935-7400WEISS & YOURMAN 212/753-3630 (fax)10940 Wilshire Blvd.24" Floor Michael D. BraunLos Angeles, CA 90024 Steven B. Chroman
310/208-2800 STULL, STULL & BRODY310/209-2348 10940 Wilshire Blvd., Suite 2300
Los Angeles, CA 90024Samuel P. Sporn 310/209-2468Christopher Lomettl 310/209-2087 (tax)SCHOENGOLD & SPORN, P.C.233 Broadway Andrew L. BarrowayNew York, NY 10279 SCHRIFEIN & BARROWAY, LLP
212/964-0046 Three Bala Plaza East, Suite 40212/267-8137 (fax) Bala Cynwyd, PA 19004
610/667-7706610/667-7056 (fax)
Bruce G. MurphyLAW OFFICES OF BRUCE G. MURPHY265 Llywds LaneVero Beach, FL 32963
561/231-4202561/231-4042 (fax)
USA TALKSService List -- March 30, 1999Page 2
COUNSEL FOR DEFENDANTS
*Robert BrownlieGRAY, CARY, WARE & FREIDENRICH401 B Street, Suite 1700San Diego, CA 92101-4297
