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EXHIBIT 99.1
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF TEXAS
HOUSTON DIVISION
In re: SERVICE CORPORATION INTERNATIONAL Civil Action No. H-99-280
JURY DEMANDED
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CONSOLIDATED CLASS ACTION COMPLAINT
Plaintiffs sue individually and on behalf of all those similarly
situated. Their allegations are upon personal knowledge as to their own acts.
Other matters are alleged based upon the investigation conducted by counsel as
detailed below.
This class action against Service Corporation International ("SCI" or
the "Company") and certain of its present and former officers and directors is
prosecuted on behalf of all members of the class certified by the Court on
August 25, 1999 (the "Class") who were damaged by defendants' violations of the
federal securities laws.
JURISDICTION AND VENUE
1. This action arises under Sections 11,12(a)(2) and 15 of the
Securities Act of 1933 (the "Securities Act"), 15 U.S.C. Sections 77(k),
77(l)(2) and 77(o); Sections 10(b), 20(a) and 20A of the Securities Exchange Act
of 1934 (the "Exchange Act"), 15 U.S.C. Sections 78j(b), 78t(a) and 78t-1, and
the rules and regulations promulgated thereunder, including Securities and
Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. 240.10b-5.
2. Jurisdiction exists under 15 U.S.C. Section 77v, 15 U.S.C. Section
78aa; and 28 U.S.C. Section 1331.
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3. Venue is proper in this district under 28 U.S.C. Sections 1391 (b)
and (c) as acts, transactions and wrongful conduct alleged herein, including the
dissemination to the investing public of the materially false and misleading
statements at issue, occurred in substantial part in this District. In
addition, the principal offices of SCI are located in this District.
4. Defendants, directly or indirectly, used the mails and
instrumentalities of interstate commerce in connection with the acts and conduct
alleged in the Complaint.
THE PARTIES
5. Rujira Srisythep, Carl Helwig, and Allan Lisse were appointed as
Lead Plaintiffs by this Court's order dated June, 9, 1999. On August 25, 1999,
the Court certified them as Class representatives. Each Lead Plaintiff purchased
SCI common stock during the Class Period (July 17, 1998 through January 26,
1999) and was damaged thereby.
6. Defendant SCI is a corporation organized and existing under the laws
of the State of Texas. Its principal executive offices are at 1929 Allen
Parkway, Houston, Texas. SCI purports to be the world's largest provider of
death care services. At December 31, 1998, SCI operated 3,442 funeral service
locations, 433 cemeteries, and 191 crematoria located in 20 countries on five
continents.
7. At all relevant times, defendant R.L. Waltrip ("Waltrip") was SCI's
Chairman of the Board and Chief Executive Officer. Waltrip signed the materially
false and misleading Amendment No. 1 to Form S-4 Registration Statement
containing a Proxy Statement/Prospectus, filed with the SEC on or about November
19, 1998 (the "Registration Statement/Prospectus"). The Registration
Statement/Prospectus was declared effective on November 20, 1998. Waltrip
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also made numerous materially false and misleading statements to the public via
media reports and press releases issued by the Company during the Class Period
as alleged herein.
8. At all relevant times, defendant George R. Champagne ("Champagne")
was SCI's Senior Vice President and Chief Financial Officer. Champagne signed
the materially false and misleading: (i) Form 10-Q Quarterly Report Pursuant to
Section 13 or 15(D) of the Securities Exchange Act of 1934 for the Quarterly
Period Ended June 10, 1998, filed with the SEC on August 14, 1998 (the "1998 Q2
10-Q"); (ii) Form 10-Q Quarterly Report pursuant to Section 13 or 15 (D) of the
Securities Exchange Act of 1934 for the Quarterly Period Ended September 30,
1998, filed with the SEC on November 16, 1998 (the "1998 Q3 10-Q"); and
Registration Statement/Prospectus. Champagne also made numerous materially false
and misleading statements to the public via media reports and press releases
issued by the Company during the Class Period as alleged herein.
9. At all relevant times, defendant L. William Heiligbrodt
("Heiligbrodt") was SCI's President and Chief Operating Officer. Heiligbrodt
signed the materially false and misleading Registration Statement/Prospectus.
Heiligbrodt also made numerous materially false and misleading statements to the
public via media reports and press releases issued by the Company during the
Class Period as alleged herein. Heiligbrodt left the employment of the Company
shorty after the disclosure of the adverse information alleged herein.
10. Defendants Waltrip, Champagne and Helligbrodt are sometimes
collectively referred to as the "Individual Defendants."
11. The Individual Defendants, by reason of their stock ownership,
management positions, and/or membership on the Company's Board of Directors and
committees thereof, had
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control over the operations of the Company and had the power and/or ability to
control each of the wrongful acts and practices complained of herein. The
Individual Defendants exercised such power and control to commit the wrongful
acts complained of herein, including making materially false and misleading
statements and material omissions in statements to the media, the Company's
press releases, quarterly SEC filings, and the Registration
Statement/Prospectus. The Individual Defendants were, "control persons" of SCI
within the meaning of Section 15 of the Securities Act and Section 20(a) of the
Exchange Act.
12. As a result of their positions with SCI, the Individual Defendants
had access to undisclosed adverse information throughout the Class Period about
SCI's multi-million dollar backlog of unprofitable preneed funeral business and
the impact this backlog had, and would continue to have, on SCI's profitability.
They had access to such information through: (a) internal corporate documents;
(b) corporate profit/loss information conveyed directly to corporate
headquarters from each of the Company's domestic funeral homes on a next-day
basis, via, the Company's proprietary "Falcon" computer system; (c)
conversations and communications with other corporate officers and employees;
(d) attendance at management and/or meetings of the Board and committees
thereof; and (e) daily, weekly and monthly reports such as SCI's "Call In
Reports" which provided them with profit and loss information on each of SCI's
domestic funeral homes, and other information provided in connection therewith.
13. It is appropriate to treat the Individual Defendants as a group for
pleading purposes and to presume that the materially false, misleading and
incomplete information conveyed in the company's public filings, press releases
and other publications as alleged herein are the collective actions of the
Individual Defendants identified above.
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14. The Individual Defendants made and were involved in drafting,
reviewing and/or disseminating the materially false and misleading statements
and information alleged herein. Each of the Individual Defendants was provided
with copies of the documents alleged herein to be misleading prior to their
issuance and or had the ability and/or opportunity to prevent their issuance or
cause them to be corrected. Accordingly, each of the Individual Defendants is
responsible for the accuracy of the public reports, press releases, and
statements detailed herein and is therefore primarily liable for the materially
false representations and omissions contained therein.
15. As officers and/or directors and controlling persons of a public
company whose securities were registered with the SEC and governed by the
federal securities laws, the Individual Defendants each had a duty to
disseminate promptly accurate and truthful information with respect to the
Company's business, operations, financial condition, management, earnings, and
present and future business prospects, and to correct any previously issued
statements that had become materially false and misleading so that the market
price of the Company's publicly traded securities would be based upon truthful,
accurate and complete information. The Individual Defendants' material
misrepresentations and omissions, and failures to correct, during the Class
Period violated these specific requirements and obligations as alleged below.
SUBSTANTIVE ALLEGATIONS
SCI'S FUNERAL HOME CONSOLIDATOR BUSINESS MODEL
16. Throughout the 1990s, thousands of locally-owned family operated
independent funeral homes have been acquired by major corporations known in the
funeral industry as "funeral home consolidators." The three largest publicly
traded funeral home consolidators are SCI,
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Loewen Group Inc. ("Loewen"), and Metarie, Louisiana-based Stewart Enterprises
Inc. ("Stewart").
17. All funeral home consolidators employ a relatively standard
business model. SCI's model consists of acquiring several independently owned
and locally managed funeral homes in one geographic area and then sharing labor
and equipment among this "cluster" to cut costs. As reported in SCI's Form 10-K
for the fiscal year ended December 31, 1998, filed with the SEC on March 31,
1999 (the "SCI 1998 Form 10-K"):
the majority of the Company's funeral service locations and cemeteries
are managed in groups called clusters. Clusters are established
primarily in metropolitan areas to take advantage of operational
efficiencies, including the sharing of [operating expenses such as]
service personnel, vehicles, preparation services, clerical staff and
certain building facility costs.
18. Once SCI acquires a funeral home, the public often is unaware of
any change in ownership. By SCI's own design, the original family owners and
employees usually remain and continue to operate the SCI-acquired funeral home
under the original family name. This semblance of continuity is essential to SCI
retaining the goodwill and future business of a client base largely loyal to the
funeral homes' original family owners.
SCI ACQUIRES THOUSANDS OF INDEPENDENT FUNERAL HOMES
19. According to SCI's 1998 Form 10-K, "[SCI] is the largest provider
of death care services in the world. At December 31, 1998, the Company operated
3,442 funeral service locations, 433 cemeteries and 191 crematoria located in 20
countries on five continents." However, SCI was not always this large.
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20. SCI's funeral empire is a creature of an acquisition campaign SCI
has waged since the early 1990s. The following table illustrates the annual
growth in the number of funeral homes owned by SCI throughout the 1990s:
NUMBER OF FUNERAL HOMES
YEAR ACQUIRED
1990 45
1991 164
1992 54
1993 124
1994 674
1995 1,263
1996 210
1997 294
1998 308
Total 2,873
21. In acquiring a funeral home, SCI typically acquires all assets and
assumes all liabilities of the acquired funeral home while paying the funeral
home owner in cash, SCI securities, or some combination thereof.
PRE-NEED FUNERAL SERVICES
22. The assets purchased by SCI in a typical funeral home acquisition
transaction included "preneed" or "guaranteed price" funeral contracts entered
into by the independent funeral homes during the years those homes were
independently operated. Preneed funeral contracts generally govern an
arrangement where individuals purchase their funeral arrangements prior to their
death, and funeral homes agree to perform the funeral service in the future for
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payment of a fixed sum that is paid at the time the contract is entered into, or
over time pursuant to an installment payment schedule. The contractual
obligation to perform these guaranteed price funerals in the future was
typically reflected as a liability on the books of the independent funeral homes
prior to their acquisition by SCI. Once acquired SCI assumed this future
liability.
23. In connection with each acquisition, SCI also acquired the mortuary
trust assets that eventually are used to pay for the preneed funerals. At the
time the preneed funeral contracts were sold to prospective clients, the
independent funeral homes typically established mortuary trusts, funded with
payments from the prospective clients. The total funds, or trust principal,
generally were less than the then-current cost of providing the funeral service
because preneed funeral services were often sold at a discount. The trust
principal was routinely invested in a certificate of deposit issued by a bank
and redeemable only upon the death of the prospective client. To the extent that
the principal and income generated by the trust equals or exceeds the ultimate
cost of performing the funeral service, the funeral home will either break-even
or realize a profit. If, on the other hand, the mortuary trust assets do not
grow to equal or exceed the future cost of performing the service, then the
funeral service will be performed at the contractually agreed upon price,
resulting in a loss for the funeral home performing the service.
24. The practice of selling preneed funeral contracts began to gain
increasing acceptance in the late 1980s. At this time and throughout the 1990s,
the vast majority of the nation's funeral homes were independently owned and
operated and lacked the financial sophistication to perform any meaningful
analysis aimed at determining whether the assets invested in the mortuary trusts
would generate a real rate of return in excess of the amount necessary to cover
future increases in the cost of providing a price guaranteed funeral service. As
a result, the
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funds invested in these mortuary trusts were often not actively managed - if
they were managed at all - and the answer to whether such funds would grow
sufficiently to equal or exceed the cost of providing a price guaranteed funeral
service at some future date was left to happenstance. Industry sources have
confirmed that the financial management of these mortuary trust assets often
consisted of little more than opening a certificate of deposit at a local bank
and then throwing the preneed contract into a drawer where it remained
essentially untouched until the prospective client passed away.
25. While the financial impact of such a laissez-faire approach to
mortuary trust asset management may have been relatively insignificant during
periods of high prevailing interest rates and relatively low funeral home cost
inflation, these practices have had a severely negative impact on funeral home
profit margins during the protracted period of declining interest rates and
escalating funeral home costs, such as those experienced throughout the 1990s.
26. By way of example, interest rates on 24 month certificates of
deposit stood as high as 8.21% in 1990, however, by 1998 they had fallen to as
low as 4.22%. Conversely, the costs associated with providing funeral services
increased at an average annual rate of 8.5% during this same time period. As a
result, funeral homes that entered into guaranteed price funeral contracts, but
failed to actively manage their mortuary trust assets during this time period,
amassed multi-million dollar preneed funeral backlogs that would eventually be
performed at break-even - or a loss - resulting in a drastic, negative impact on
profit margins.
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SCI FAILS TO DISCLOSE THAT IT HAS AMASSED A MULTI-MILLION DOLLAR BACKLOG OF
UNPROFITABLE PRENEED FUNERALS BY ACQUIRING THOUSANDS OF INDEPENDENT FUNERAL
HOMES THAT FAILED TO MANAGE THESE PRENEED FUNDS
27. It is well known in the death services industry that the failure to
actively manage preneed contract trust funds can have disastrous effects on a
company's financial position. As one industry analyst recognized as early as
March 1997:
You see there is one basic problem with preneed - the money. Regardless
of how you finance prearranged funerals - trusts, insurance or some
combination - the amount of the funeral at-need and the amount
available to finance it will never be exactly the same. Sometimes the
difference may be only a few dollars or it could be several hundred
dollars. Trusts and insurance will naturally grow at a different rate
than funeral prices. Therefore, there will always be only two
possibilities. Either there will be too little money to finance the
service at current prices, or there will be an overage.
If there is a shortfall, it is the funeral home that must absorb that
shortage. No trust or insurance company will be willing to make up the
difference. We can rationalize it in any number of ways, but a shortage
is a shortage and must be accounted for somewhere, either through an
increase of at-need prices or decreased profit. BUT WHAT WOULD HAPPEN
TO YOUR FUNERAL HOME IF EVERY FUNERAL YOU DID THIS YEAR HAD BEEN FUNDED
10 YEARS AGO? THERE IS NO WAY TO RECOVER THE SHORTAGES. HOW WOULD YOU
SURVIVE? While it may be unrealistic to think that someday all funerals
will be prefunded, isn't that the direction we are encouraging through
our preneed marketing efforts? [Emphasis added].
Curtis Rostad, Preneed: Here Today, Gone Tomorrow, The Director (March 1997).
28. The "direction" that Mr. Rostad found the industry "encouraging"
is precisely the direction taken by SCI during the 1990s. Significantly, by
1998, SCI had acquired ownership of more than 2,873 independent funeral homes
during the preceding eight years. In doing so, SCI amassed a multi-billion
dollar backlog of preneed funeral contracts. Indeed, between 1992 and 1998, in
just a six-year period, SCI's prearranged funeral contract backlog increased
three-fold, from $1.2 billion to $3.7 billion. The chart that follows depicts
the explosive growth in the dollar
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value of prearranged funeral contracts acquired and sold by SCI, as well as
SCI's preneed funeral contract backlog between 1992 and 1998:
Value of
Prearranged
Prearranged Funeral Prearranged Funeral
Year Contracts Acquired Funeral Contracts Backlog
Services-Sold
12/31/92 $ 24 million $119 million $1.2 billion
12/31/93 $ 60 million $159 million $1.3 billion
12/31/94 $127 million S245 million $1.5 billion
12/31/95 $656 million $371 million $2.3 billion
12/31/96 $ 72 million $512 million $2.7 billion
12/31/97 $102 million $529 million $3.3 billion
12/31/98 $138 million $490 million $3.7 billion
TOTAL $1.179 billion $2.425 billion --
29. Undisclosed to the Class was the fact that a material number of
independent funeral homes acquired by SCI throughout the 1990s were among those
that had failed to actively manage their mortuary trust assets to insure that
such assets would equal or exceed the cost of providing the guaranteed price
funerals in the future. As a result, each time SCI acquired ownership of another
independent funeral home, SCI had, unbeknownst to the Class, also acquired
countless numbers of unprofitable guaranteed price funeral contracts that had
long-ago been entered into by the independent funeral homes. Significantly, all
of these unprofitable funerals would eventually have to be performed by SCI.
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30. Also undisclosed to the Class throughout the Class Period was the
fact that SCI failed to establish any means of actively managing the mortuary
trust assets that would eventually be used to pay for these acquired preneed
funeral contracts. Defendants never disclosed that SCI's failure to take such
measures had already caused, and would continue to cause, SCI to perform a
material number of these prearranged funerals unprofitably, and that this
ultimately would have a severe adverse impact on SCI's profit margins.
DEFENDANTS CONCEAL THE RESULTS OF THE PRENEED STUDY
31. During 1995 alone, SCI purchased 1,263 independent funeral homes
and acquired a staggering $656 million in preneed funeral contracts in
connection with these purchases. These purchases resulted in SCI increasing its
preneed funeral backlog by more than 40% in a single year and created an
unprecedented need to determine the projected profitability - or lack thereof -
of these preneed funeral contracts.
32. During 1996, SCI undertook what it termed "a review of the
prearranged trust investment process which included an asset/liability study"
(the "Preneed Study"). The results of the Preneed Study confirmed that SCI had
amassed ownership of a material number of independent funeral homes with
significant preneed contract inventories throughout the 1990s. The Preneed Study
also confirmed for the defendants that a significant number of the independent
funeral homes acquired by SCI had failed to actively manage their mortuary trust
assets. As a result, a material number of SCI's funeral services had been, and
would continue to be, performed at significant losses.
33. Although defendants publicly disclosed the fact that the Preneed
Study had been conducted in the Company's Form 10-K for the fiscal year ended
December 31, 1996 filed with
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the SEC on March 28, 1997 (the "SCI 1996 Form 10-K"), they never disclosed the
clearly material factual findings of the Preneed Study to Class members. In this
vein, the SCI 1996 Form 10-K reported only that:
THE COMPANY HAS RECENTLY COMPLETED A REVIEW OF THE PREARRANGED TRUST
INVESTMENT PROCESS WHICH INCLUDED AN ASSET/LIABILITY STUDY. This has
resulted in a NEW INVESTMENT PROGRAM which entails the consolidation of
multiple trustees, the use of institutional managers with differing
investing styles and consolidated performance monitoring and tracking.
THIS NEW PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT
NECESSARY TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE
GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. THIS IS
ACCOMPLISHED BY ALLOCATING THE PORTFOLIO MIX TO THE APPROPRIATE
INVESTMENTS THAT MORE ACCURATELY MATCH THE ANTICIPATED MATURITY OF THE
POLICIES. THIS HAS RESULTED IN A NEW ASSET ALLOCATION POLICY OF
APPROXIMATELY 65% EQUITY AND 35% FIXED INCOME WHICH THE COMPANY INTENDS
TO IMPLEMENT IN THE FIRST HALF OF 1997. [Emphasis added].
34. Defendants again referred to the Preneed Study in the Company's
Form 10-K for the fiscal year ended December 31, 1997 filed with the SEC on
March 30, 1998 (the "SCI 1997 Form 10-K"). Defendants again failed to disclose
the results of the study and instead stated only that:
During 1997, the Company completed a review of the prearranged trust
investment process which included an asset/liability study. THIS HAS
RESULTED IN A NEW INVESTMENT PROGRAM WHICH ENTAILS THE CONSOLIDATION
OF MULTIPLE TRUSTEES, THE USE OF INSTITUTIONAL MANAGERS WITH DIFFERING
INVESTMENT STYLES AND CONSOLIDATED PERFORMANCE MONITORING AND
TRACKING. THIS NEW PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE
AMOUNT NECESSARY TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A
PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. This is
accomplished by allocating the portfolio mix to the appropriate
investments that more accurately match the anticipated maturity of the
policies. The Company is currently reallocating the portfolio to
achieve a new asset allocation of approximately 65% equity and 35%
fixed income. [Emphasis added.]
35. While SCI, and the Individual Defendants disclosed the fact that
the Preneed Study had been conducted and boasted of the "new [preneed]
investment program" that was to be implemented, they misled investors by failing
to disclose the material information they had learned
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as a result of the Preneed Study - namely that a significant number of
independent funeral homes acquired by SCI had failed to actively manage their
mortuary trust assets and, as a result, a material number of SCI's funeral
services had been, and would continue to be, performed at significant losses to
SCI.
36. Equally misleading was SCI's disclosure concerning the steps the
Company was purportedly taking in connection with the implementation of its "new
investment program." While the Company's public filings proclaim that this
program "targets a real rate of return in excess of the amount necessary to
cover future increases in the cost of providing a price guaranteed funeral
service as well as any selling costs," the filings did not disclose that this
"new investment program" would only be utilized to manage preneed assets
acquired by SCI in the future. Nor did defendants disclose the absence of any
effective program to manage the assets associated with the previously acquired
preneed funeral service contracts. Significantly, the vast majority of the
preneed assets that SCI had previously acquired in connection with its purchases
of independent funeral homes were not, and would not be, invested in accordance
with the terms of the "new investment program." This clearly material fact, as
well as the reasons why this was so, were not publicly disclosed. By 1998, SCI's
failure to actively manage its mortuary trust assets was having an increasingly
negative impact on SCI's profit margin as reflected in the following graph:
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FUNERAL SERVICE GROSS MARGIN FY 19
[GRAPH]
37. Rather than disclose the fact that SCI's funeral margins had been,
and would continue to be, severely negatively impacted as a result of SCI
continually having to perform the non-profitable preneed funerals in its
backlog, defendants misled the Class by instead blaming the margin contraction
throughout 1998 on a number of other factors including "increased costs," "lower
funeral service volume," and "higher personnel and facility costs." Defendants
did so in hopes that they could execute their plan to conceal the true cause of
the margin squeeze by "burying" the impact of these non-profitable funerals in a
"one time charge" as discussed in detail below.
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SCI'S NEED TO SECRET ITS IDENTITY RESTRICTS THE COMPANY'S
ABILITY TO ACTIVELY MANAGE THE PRENEED ASSETS SCI ACQUIRED
WHEN IT PURCHASED THOUSANDS OF INDEPENDENT FUNERAL HOMES
38. In order to profit from the goodwill and long standing reputations
of the family-owned independent funeral homes, it was necessary for SCI to
refrain from advertising its acquisitions to the public. As an article in the
August 28, 1995 edition of The Boston Globe reported, large funeral operators,
like SCI, were so successful in hiding their ownership of the formerly
independent family-run funeral homes from the public that most consumers failed
to notice a change in ownership. The August 28 article stated, "chains prefer to
keep the owners on, usually with good pay and benefits, to preserve the
operation's family image... Most consumers would never even notice that their
local funeral home is now owned by an outside firm."
39. The December 8, 1996 edition of The Boston Globe reported that,
although SCI handled roughly one in every 10 funeral arrangements in the United
States at this time, its expanding presence had generally gone unnoticed by the
public. "When it buys a funeral home, SCI keeps the same name and usually the
same management in place. What changes are the backroom operations; vehicle
fleets, embalming operations, casket purchases and management are all
centralized. " While a December 11, 1996 Seattle Times article entitled, "Big
Corporations Shove Aside Mom and Pop" reported
SCI and Loewen have been accused of hiding local buyouts hoping to cash
in on the good feelings that a locally owned funeral business has
accumulated through the years. Thus, with the old name still on the
building, family portraits of the founders still in the lobby and the
old manager still in his post, many customers won't know they're
dealing with a chain.
40. Negative press on the aggressive sales practices engaged in by SCI
provided further impetus to conceal SCI's ownership from the local clientele.
For example, the July 6, 1996
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edition of The Ledger (Lakeland, FL) reported on the abuse of the elderly by an
SCI-owned funeral home. According to this report, two months after performing
the funeral service for Mr. Russell Carriere, a salesman from the SCI-operated
Glen Abbey Memorial Gardens ("Glen Abbey") repeatedly approached Mr. Carriere's
81-year-old widow and cajoled her into purchasing her own prepaid funeral for an
astonishing $132,439, which included a $39,000 casket, and a $52,000 mausoleum.
As Mrs. Carriere's niece stated, "They truly preyed on a lonely, weak old
woman." A civil suit against SCI and Glen Abbey was filed on behalf of Mrs.
Carriere, charging them with coercing Mrs. Carriere, who had been disabled by a
stroke, into buying burial services she did not want.
41. Included among the myriad examples of negative publicity were:
a. A report in The Arizona Daily Star on January 14, 1996
stated that SCI was singled out by consumers as "providing for minimum disposal
without regard for the emotional needs of the family." The report also quoted a
source as saying, "Some of the policies put in place locally by SCI decrease the
amount of service while maintaining a status quo on cost."
b. In a story in the February 15, 1996 Las Vegas Review
Journal, it was reported that an SCI-owned funeral home attempted to bury a
prominent local businessman in the mausoleum of an unrelated family because,
although there was insufficient space for the businessman to have his own
mausoleum, the funeral home operator wanted the publicity of having the
prominent businessman buried on the premises.
c. The Chicago Sun Times reported on April 28, 1996 that two
SCI-owned funeral homes employed sales personnel who attempted to persuade
bereaved consumers
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to buy more expensive caskets by describing more affordable caskets as "public
aid" caskets, instead of providing the consumer a price list, as required by
law. The reference by the salesperson to "public aid" was designed to create the
image that only persons with limited or no assets were buried in the public aid
caskets and induce the purchase of a higher-priced casket. According to the
report, "Psychology plays an important role in choices made by survivors. Many
buyers would feel guilty purchasing a less expensive casket."
d. An August 6, 1998 report in The Fort Worth Star Telegram
stated that the Texas Funeral Service Commission would consider a recommendation
that SCI be fined $450,000 for allowing unsupervised trainees to embalm bodies
and failing to advise consumers that the price being charged for embalming was
higher than the cost to the funeral home.
42. Because of such criticisms, and SCI's fear of losing clients who
learned that the local funeral home was no longer locally owned, SCI's ability
to actively manage the preneed trust assets it had acquired was severely
hampered. The Company was hampered because it would have been required to
disclose its ownership of the funeral homes and control of the preneed trust
assets it acquired to future clients in order to advise these clients that these
assets would now be actively managed. Doing so meant risking the loss of
millions of dollars worth of potentially profitable preneed funeral business.
43. Defendants feared that undertaking such a process would lead to
countless contract terminations when customers realized that an organization
tarnished by allegations of the outrageous conduct described above was
responsible for something as highly sensitive as the customers' future burial
services. Moreover, an admission by defendants that customers' funds had long
been inactively managed by the local funeral home would serve to criticize the
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independent funeral home operators who were well regarded by their clients and
thus could lead to even more contract cancellations and loss of business.
SCI Attempts To Conceal its Plunging Profit Margins
44. The undisclosed results of the Preneed Study confirmed for the
defendants that a significant number of the independent funeral homes acquired
by SCI had failed to actively manage their mortuary trust assets and, as a
result, a material number of SCI's future funeral services had been, and would
continue to be, performed at significant losses, severely cutting into SCI
profit margins.
45. Rather than disclosing this clearly material adverse information,
defendants embarked upon a campaign to conceal the truth about increasing number
of unprofitable prearranged funerals SCI was performing, the Company's growing
backlog of inadequately funded acquired preneed funeral contracts, and the
increasingly adverse impact these factors were having, and would continue to
have, on SCI's profit margins and earnings. The first step in this campaign was
the public dissemination of materially misleading and incomplete information
falsely representing that SCI was actively managing its preneed mortuary trust
assets to ensure sufficient funds to cover or exceed costs for performing
contractually prearranged funerals. In fact, there was no active management by
SCI of the vast majority of the preneed trust assets it had amassed through its
aggressive acquisitions of funeral homes over the last decade.
46. As part of its scheme to conceal the true facts about the adverse
impact of SCI's multi-billion dollar backlog of preneed funeral contracts on
SCI profit margins, the defendants misleadingly touted the implementation of
their so-called "new investment program," described in detail above, without
disclosing that the "new investment program" did not address the
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enormous and growing backlog of preneed mortuary trust assets acquired in SCI's
purchases of funeral private homes, which were laying virtually dormant in CD's,
unable to grow sufficiently to cover the costs to SCI of providing the
associated contractually prearranged funeral services.
47. Defendants' false and misleading representations that SCI was, in
fact, actively managing its backlog of acquired preneed trust assets was
reinforced when, at the beginning of the Class Period in July, 1998, the
defendants publicly announced the creation of SCI Financial Services, Inc., a
subsidiary which would purportedly actively manage SCI's preneed trust assets.
48. Because defendants could not afford the time and expense involved
in building this new subsidiary from the ground up, SCI sought quickly to
establish this new organization and did so by purchasing two operating
businesses, each of which had extensive experience in preneed asset management.
The first acquisition involved SCI's purchase of American Memorial Life
Insurance Company ("AML" or "American Memorial") and the second acquisition
involved the purchase of Equity Corporation International ("ECI").
49. The purchase of these two organizations provided SCI for the first
time with an organizational infrastructure for managing the Company's preneed
business.
50. The purchase of ECI is of particular significance because ECI,
unlike SCI, already had established, and fully disclosed the existence of, a
financial management system which ensured that its customers' preneed
investments, or the funeral insurance coverage obtained, would be sufficient to
cover adequately the costs of prearranged funeral services. In its Form 10-K for
the fiscal year ending December 31, 1997 filed with the SEC on or about March
30, 1998 (the "ECI 1997 Form 10-K"), ECI reported:
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Insurance policies intended to fund preneed funeral contracts cover the
original contract price AND GENERALLY INCLUDE BUILT-IN ESCALATION
CLAUSES DESIGNED TO OFFSET FUTURE INFLATIONARY COST INCREASES.
[Emphasis added.]
Moreover, the ECI 1997 Form 10-K stated:
Earnings on trust funds increase the amount of cash to be received by
the Company at the time the funeral service is performed AND
HISTORICALLY HAVE ALLOWED THE COMPANY TO ADEQUATELY COVER THE
INFLATIONARY INCREASE IN COSTS OF FUNERAL SERVICES. [Emphasis added.]
51. ECI also recognized the high financial risk posed by the preneed
funeral business and took protective measures accordingly. In its Form 10-K for
fiscal year ending December 31, 1996, filed with the SEC on or about March 27,
1997 (the "ECI 1996 Form 10-K"), ECI succinctly recognized the risk of
overextending preneed funeral sales absent careful financial management of the
mortuary trusts:
Aggressive preneed funeral sales are frequently associated with highly
competitive market areas or are utilized to rapidly build market share
and generally require that funeral contracts be sold at a discount to
at need sales prices.
52. In response to the risks, ECI employed independent financial
institutions to manage this risk. Both the ECI 1996 Form 10-K and ECI's Form
10-K for fiscal year ending December 31, 1995, filed with the SEC on or about
March 25, 1996 (the "ECI 1995 Form 10-K") stated that ECI had:
...established a variety of trusts in connection with its funeral home
and cemetery operations as required under applicable state law. Such
trusts include (i) preneed funeral trusts, (ii) preneed cemetery
merchandise trusts and (iii) perpetual care trusts. These trusts are
typically administered by independent financial institutions selected
by the Company. The Company also uses independent professional managers
to advise the Company on investment matters.
53. The lack of disclosure regarding the Preneed Study in SCI's public
filings is striking when compared to the disclosures made by ECI. While ECI
disclosed that its insurance
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policies included "built-in escalation clauses" and that earnings on its trust
funds "have allowed [it] to adequately cover the inflationary increase in costs
of funeral services," SCI remained silent on these points. The reason for SCI's
omissions is clear: the Preneed Study confirmed that SCI's trust funds had not
been managed to grow at a rate equal to or greater than the increase in the
costs of funeral services.
54. Neither the establishment of SCI Financial Services, Inc. nor the
so-called "new investment program," however, addressed SCI's multi-million
dollar backlog of unprofitable preneed funeral contracts whose related mortuary
trust assets lay virtually dormant in certificates of deposit, and other
under-performing investments unable to grow sufficiently to cover the costs of
performing funeral services in the future.
55. Defendants had been able to deceive the Class as to the primary -
and continuing - reason for SCI's funeral service gross margin contraction
during the first three quarters of 1998 by pointing to declining death rates in
North America, higher costs and lower volumes of funerals throughout the
industry. In addition, defendants were able to carefully "manage" SCI's reported
1998 second and third quarter earnings by, inter alia, their aggressive
acquisition program which provided SCI fresh sources of revenue, including, for
example, the purchase of American Memorial Life Insurance in the third quarter
of 1998. However, defendants knew that SCI's deteriorating funeral service
profit margins would inevitably impact reported earnings, the all important
indicia of SCI's financial condition for the investing public; and that SCI's
fiscal year end would soon bring about a day of reckoning. Accordingly,
defendants desperately needed to find and a new way to conceal the impact that
the continued performance of these unprofitable funerals was having on the
Company's profitability.
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23
56. According to knowledgeable former employees, by November 1998, the
Individual Defendants knew that SCI's fourth quarter 1998 earnings would fall at
least between $.08 to $.10 below analysts' estimates. The Individual Defendants
were also aware, by virtue of their receipt of daily, weekly and monthly
profit/loss reports via the Company's "Falcon" system from each of the Company's
domestic funeral homes, that this shortfall resulted from SCI's performance of a
material number of unprofitable preneed funerals, as well as undisclosed changes
in SCI's costs. Other senior executives were also aware of this impending
shortfall and the reasons for it, and openly discussed how to hide the shortfall
from investors and how they and the Individual Defendants planned to "bury" this
shortfall in a one-time charge that SCI planned to take in connection with its
acquisition of ECI. All were well aware that the success of their plan hinged
on their ability to close the ECI acquisition during the fourth quarter of 1998
so that SCI could take this one-time charge in the fourth quarter and close the
ECI transaction without having to disclose the true reasons for the Company's
earnings shortfall.
57. Defendants' scheme was foiled, however, when the United States
Federal Trade Commission (the "FTC"), which was required to approve SCI's
purchase of ECI, refused to allow SCI to close the ECI transaction until SCI had
divested itself of certain funeral homes in numerous locations around the
country.
58. In particular, the FTC conditioned its approval on SCI's sale of
19 funeral homes and cemetery properties located in 14 markets, primarily in
the southern, western and mid-western parts of the United States, to Carriage
Service Inc., another Texas-based funeral home consolidator. Under the consent
agreement reached with the FTC, SCI would be permitted to acquire ECI, but only
after divesting specified properties within seven days of the FTC's order.
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59. SCI was unable to divest itself of these properties in time to
obtain FTC approval to close the ECI transaction in the fourth quarter of 1998.
As a result, SCI was unable to "bury" the earnings shortfall, which by the end
of the fourth quarter had nearly doubled to $.19 to $.20 per share, in an
acquisition charge as defendants had planned because the Merger did not close
until after the end of the fourth quarter.
60. Evidencing the degree of scienter with which defendants acted,
defendants nonetheless proceeded to close the ECI transaction without ever
disclosing to ECI or the Class that SCI would report a drastic shortfall in its
1998 fourth quarter earnings.
61. Defendants did so despite the fact that the Agreement and Plan of
Merger By and Among Service Corporation International, SCI Delaware Funeral
Services, Inc. and Equity Corporation International, dated August 6, 1998 (the
"Merger Agreement") required SCI to disclose to ECI its poor performance during
the fourth quarter of 1998 at any time at which it could reasonably be
anticipated that such poor performance could have an adverse financial impact on
SCI. Under the Merger Agreement, ECI would have had the right to terminate the
Merger Agreement if SCI's poor fourth quarter results had been disclosed prior
to the closing of the Merger. The fourth quarter results constituted material
adverse information known to defendants which defendants had a duty to disclose
in connection with the Merger.
62. The Registration Statement/Prospectus SCI filed with the SEC
incorporated the entire executed Merger Agreement. The Registration
Statement/Prospectus at page 6 stated: "The Merger Agreement is attached hereto
as Appendix A and incorporated herein by reference."
63. Article IV of the Merger Agreement is entitled "Representations and
Warranties of Parent and Merger Sub." Section 4.7 of Article IV is entitled
"Absence of Certain Changes
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Or Events" and provides, with respect to SCI, that "there has not been any
event, occurrence, development or state of circumstances or facts which has had,
or could reasonably be anticipated to have, individually or in the aggregate, a
Material Adverse Effect."
64. Section 10.10 of the Merger Agreement, entitled "Certain
Definitions," defines Material Adverse Effect as:
any event, occurrence, fact, condition, change, development or effect
that is or could reasonably be anticipated to be materially adverse to
the business, assets (including intangible assets), liabilities,
financial condition, results of operations, properties (including
intangible properties) or business prospects of the Company and all of
its Subsidiaries or the Parent and all of its Subsidiaries, as
applicable, taken as a whole....
65. Section 8.2 of the Merger Agreement, entitled "Conditions To
Obligation Of [ECI] To Effect The Merger," establishes as a condition for
consummating the Merger that the representations and warranties made by SCI in
the Merger Agreement shall continue to be true up to and including the day on
which SCI's shares are exchanged for ECI's shares. Section 8.2(a) provides:
the representations and warranties of [SCI] and Merger Sub contained in
this Agreement shall be true and correct in all material respects (or
in all respects in the case of any representation or warranty
containing any materiality qualification) on and as of the date made
and on and as of the Closing Date as if made at and as of such date,
and the Company shall have received a certificate executed on behalf of
Parent by the President or a Vice President of Parent and on behalf of
Merger Sub by the President and Chief Executive Officer or a Vice
President of Merger Sub to that effect.
66. Under the terms of the Merger Agreement, ECI had the right to
terminate the Merger Agreement at any time prior to January 19, 1999 if a
Material Adverse Event existed at SCI. Article IX of the Merger Agreement,
entitled "Termination, Amendment And Waiver," provides:
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[t]his Agreement may be terminated at any time prior to the Effective
Time, whether before or after approval by the stockholders of the
Company...if the representations and warranties of Parent and Merger
Sub shall fail to be true and correct in all material respects (or in
all respects in the case of any representation or warranty containing
any materiality qualification) on and as of the date made or, except in
the case of any such representations and warranties made as of a
specified date, on and as of any subsequent date as if made at and as
of subsequent date and such failure shall not have been cured in all
material respects (or in all respects in the case of any representation
or warranty containing any materiality qualification) within 30 days
after written notice of such failure is given to [SCI] by [ECI].
67. Defendants were well aware that disclosure of the adverse financial
conditions at SCI related to its unprofitable preneed business would lead to the
termination of the Merger by ECI or to a renegotiation of the transaction so
that SCI would potentially have to double the number of shares issued in order
to acquire ECI. This was a risk the defendants were not willing to take.
68. Under the terms of the Merger Agreement, SCI would acquire all of
ECI's common stock through a stock-for-stock transaction that would result in
ECI shareholders receiving $27 per share in SCI common stock. The number of
shares of SCI stock to be issued to ECI shareholders was to be determined based
on the average trading price of SCI common stock for the ten day trading period
ending on the third day prior to the closing of the Merger, provided that such
price was not less than $34 and not more than $41.50 per share. The Merger
Agreement provided that if the average trading price of SCI's common stock was
less than $34 per share, then 0.79412 shares of SCI common stock would be
exchanged for each share of ECI common stock. The Merger Agreement provided that
if the average trading price of SCI's common stock was greater than $41.50 per
share, then 0.65050 shares of SCI common stock would be exchanged for each share
of ECI stock declined, provided, however, that if SCI's common stock was trading
at
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a price above or below the price "collar" identified in the Merger Agreement
SCI shares would be exchanged for the outstanding ECI shares at fixed floor and
ceiling ratios.
69. The original Merger Agreement provided that if the average trading
price for a share of SCI common stock fell below $34, then SCI would exchange
0.79412 SCI shares for each ECI share. In exchange for raising the asset
divestiture limit, SCI required an amendment to the Merger Agreement that
provided that if the average trading price for a share of SCI stock prior to the
closing was below $38 per share, then SCI would exchange 0.71053 SCI shares for
each ECI share. This reduced the maximum number of SCI shares payable to ECI
shareholders from 17,298,472 to 15,477,614.
70. Defendants' audacity, however, is perhaps best highlighted by the
fact that, at some point after the FTC began its review of the Merger,
representatives from SCI started to discuss raising the Merger Agreement's limit
on assets that SCI would be required to divest as a condition for the Merger.
SCI used this opportunity to negotiate for a lower purchase price to be paid to
ECI in exchange for agreeing to divest assets having aggregate 1997 revenue of
up to $20 million, by demanding that ECI agree to lower the maximum number of
SCI shares to be exchanged for ECI's outstanding shares.
71. On December 14, 1998, SCI and ECI amended the Merger Agreement to
raise the asset divestiture revenue limit to $20 million and to reduce the
maximum SCI shares exchangeable for ECI shares. When the Merger closed on
January 19, 1999, the average trading price of a share of SCI was below $38,
triggering the re-negotiated maximum exchange ratio. Remarkably, defendants
renegotiated the consideration to be received by ECI shareholders with knowledge
of SCI's impending earnings shortfall and never disclosed it, despite having
warranted that there had
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been no such adverse development at the Company. Indeed, December 14 was only 12
business days prior to the end of SCI's fourth quarter for 1998, by which time
the Individual Defendants were well aware that SCI's preneed business would lead
to a material earnings shortfall for the fourth quarter. They were made aware,
in part, by the SCI proprietary computer systems known as the "Falcon" system,
which provided profit and loss information for every domestic funeral home owned
by SCI directly to SCI corporate headquarters electronically on a next-day
basis. However, this information was never disclosed to ECI shareholders and the
Class until after the Merger was completed.
DEFENDANTS' MATERIALLY FALSE AND MISLEADING STATEMENTS AND MATERIAL OMISSIONS
DURING THE CLASS PERIOD
72. Throughout the Class Period, defendants acted negligently,
recklessly or intentionally by omitting to disclose material information
concerning SCI and by issuing a series of materially false and misleading
statements concerning the Company's financial condition and preneed funeral
business. Defendants' misconduct caused the price of the Company's securities to
become and remain artificially inflated (artificially depressed in the case of
put options) throughout the Class Period, and ultimately resulted in millions of
dollars in damages being incurred by Class members. Defendants' materially false
and misleading statements, and the reasons why such statements were materially
false and misleading, are set forth below.
73. On July 17, 1998, SCI issued a materially false and misleading
press release that bore the headline, Service Corporation International Buys
Pre-need Insurance Division of American Annuity Group and Forms New Financial
Services Subsidiary. Defendant Champagne was listed as the "contact" person for
the press release. The release stated in relevant part:
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29
Service Corporation International (NYSE: SRV) ("SCI"), the world's
largest funeral and cemetery company, announced today that it will
acquire the pre-need funeral services division of American Annuity
Group Inc. (NYSE: AAG) ("AAG") of Cincinnati, Ohio for $164 million
cash.
* * *
SCI HAS FORMED A NEW FINANCIAL SERVICES SUBSIDIARY, SCI FINANCIAL
SERVICES, INC., TO FACILITATE THE EXPANSION OF SCI'S PRE-NEED
BUSINESSES AND FINANCIAL ACTIVITIES WORLDWIDE. The new company's
operations will include prearranged funeral marketing, funeral and
cemetery trust administration, investment management, life insurance
operations and the lending activities of Provident Services, Inc., an
existing SCI subsidiary which provides capital financing for
independent funeral home and cemetery operations.
SCI FINANCIAL SERVICES WILL COORDINATE THE INVESTMENT OF OVER $3
BILLION OF PRE-NEED FUNERAL TRUST AND INSURANCE ASSETS AND OVER $1
BILLION IN CEMETERY TRUST ASSETS, DIRECT THE MARKETING FOR OVER $700
MILLION IN ANNUAL FACE AMOUNTS OF PREARRANGED FUNERAL SALES, ADMINISTER
OVER ONE MILLION PRE-NEED FUNERAL TRUST AND INSURANCE CONTRACTS AND
OVERSEE A FINANCE OPERATION WITH A LOAN PORTFOLIO IN EXCESS OF $250
MILLION. [Emphasis added.]
74. The foregoing statements were intended to, and did, misrepresent to
the investing public the false and misleading information that the formation of
SCI Financial Services, Inc. would result in the active and effective investment
of SCI's existing and future pre-need funeral trust assets to ensure SCI's
revenues and earnings from its pre-need funeral business, which the statements
also falsely implied was financially healthy and profitable. The Company and the
Individual Defendants failed, however, to disclose the following facts, known to
or recklessly disregarded by the defendants when the press release was issued,
that rendered the statements in the press release materially false and
misleading when made:
(a) the Individual Defendants knew from the Preneed Study that a
material number of the independent funeral homes acquired by SCI throughout the
1990s had failed to actively manage their mortuary trust assets to ensure that
such assets would equal or exceed the
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cost of providing the prearranged guaranteed price funerals SCI was
contractually obligated to provide, and, as a result, a material number of SCI's
funeral services had been, and would continue to be, performed at significant
losses;
(b) SCI's funeral profit margins were being, and were going to
continue to be severely eroded as a result of having to perform prearranged
funeral services at costs not covered by the mortuary trust assets dedicated to
those funeral services as a result of the failure by SCI to establish any means
to actively or effectively invest its existing mortuary trust assets, including
those from funeral homes acquired by SCI, to improve the rates of return on or
growth of those assets, and, as a result, SCI had performed, and would continue
to perform, a material number of prearranged funeral services at significant
losses;
(c) far from establishing SCI Financial Services, Inc. "to
facilitate the expansion of SCI's pre-need business and financial activities
worldwide," as defendants claimed, the creation of this subsidiary marked the
first time in SCI's history that the Company had implemented any concrete steps
to actively manage at least a portion of its preneed trust assets. Prior to the
creation of this subsidiary, and notwithstanding defendants' earlier
representations about a "new investment program," no individual or organization
at SCI had been responsible for actively managing those assets;
(d) SCI Financial Services, Inc. would not be involved in
managing of the vast majority SCI's existing multi-billion dollar backlog of
preneed mortuary trust assets acquired in SCI's funeral home acquisitions, which
would continue to be invested in dormant, underperforming interest bearing
vehicles, such as bank CD's;
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(e) American Memorial was being acquired to provide SCI with a
vehicle to begin to actively manage preneed assets going forward, in order to
blunt the ongoing drastic adverse impact that the under-performance of SCI's
preexisting mortuary trust assets was having on SCI's profitability, but
(f) SCI's "new investment program," which was purportedly
implemented in 1997 in order to "target a real return in excess of the amount
necessary to cover future increases in the cost of providing a price guaranteed
funeral service as well as any selling costs," was not actively managing the
vast majority of the preneed trust assets SCI had acquired by purchasing
independent funeral homes. Indeed, SCI was unable to actively manage these
preneed trust assets because doing so would have required SCI to step out of the
shadows and identify itself as the true owner of thousands of funeral homes
across the country and internationally and would cause existing and future
customers to seek out other locally-owned funeral homes when they learned that
what they believed was a locally-owned funeral home was actually owned by SCI,
the world's largest funeral home conglomerate.
75. On July 18, 1998, the Houston Chronicle published an article
entitled, SCI To Get Into Funeral Insurance; Houston Giant To Buy 'Final
Expense' Business. This article discussed SCI's acquisition of American Memorial
and quoted defendant Waltrip as stating:
"SCI is a world leader in the provision of high-quality funeral and
cemetery services," said R.L. Waltrip, SCI chairman and chief executive
officer. "This acquisition enables SCI to directly respond to the
increased demand for alternative methods for paying for these
services."
* * *
"SCI's longstanding relationship with American Memorial makes them the
logical choice to drive our expansion into the preneed insurance
business," Waltrip said. The way SCI sees it, the acquisition is a way
for it to expand its profit
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base. Not only will it make money arranging funerals, but it will also
collect the insurance premiums people pay for final-expense insurance,
Heiligbrodt said. "Our goal is to pick up two profits," he said. "The
money we're spending is buying new profits and generating new future
profits."
"WE'RE ADDING ANOTHER DIMENSION TO MAKE SURE WE'RE PICKING UP ALL THE
VALUE WE CAN FOR OUR SHAREHOLDERS," Heiligbrodt said.
SCI sells about $700 million of prearranged funerals a year worldwide,
he said. [Emphasis added).
76. The foregoing statements were materially false and misleading at
the time they were made and were intended to, and did, convey to the investing
public the false impression that SCI was in the midst of a profitable "expansion
into the pre-need insurance business," and that SCI's acquisition of American
Memorial was undertaken to build on and increase the profitability of its
existing preneed "profit base." In fact, as defendant Waltrip knew, or
recklessly disregarded, SCI's profitability was being severely undercut by its
existing backlog of preneed funeral contracts, and the acquisition of American
Memorial and planned expansion into preneed insurance was not "a way to expand
[SCI's] profit base," nor an effort to "make sure we're picking up all the value
we can for our shareholders." Instead, the acquisition of American Memorial was
an attempt to obtain new sources of revenue to mask the growing reductions in
SCI's overall profit margins caused by having to provide unprofitable
prearranged funerals pursuant to SCI's existing and acquired preneed contracts,
and to ensure that going forward SCI would not be saddled with even more dormant
and underperforming mortuary trust assets that could not cover the costs of
prearranged funerals.
77. The foregoing statements by defendant Waltrip were also false and
misleading because of the failure to disclose the facts set forth in Paragraph
74(a)-(f) above, which were necessary to
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make the statements Waltrip made about SCI's acquisition of American Memorial
and expansion into the preneed insurance business not false and misleading.
78. On July 23, 1998, SCI issued a materially false and misleading
press release that bore the headline, Service Corporation International Reports
Net Income up 15% and EPS up 13% for Second Quarter. Defendant Champagne was
listed as the "contact" person on the press release. The release stated in
relevant part:
Service Corporation International (NYSE: SRV) ("SCI"), the world's
largest funeral and cemetery company, today reported record second
quarter revenues and earnings. For the three months ended June 30,
1998, the company reported revenues of $671.9 million, net income of
$90.9 million and diluted earnings per share of $.35 ($.36 basic). This
represents a 11.8 percent increase in revenues, a 15.4 percent increase
in net income and a 12.9 percent increase in diluted earnings per share
(9.1 percent basic) when compared to the second quarter of 1997.
"Strong North American cemetery results contributed impressively to our
quarterly earnings growth, MORE THAN OFFSETTING THE EFFECT ON THE
FUNERAL SEGMENT OF LOWER THAN EXPECTED NORTH AMERICAN MORTALITY RATES.
FUNERAL VOLUMES IMPROVED IN JUNE AFTER EXPERIENCING UNUSUALLY WEAK
VOLUMES IN APRIL AND MAY," said R. L. Waltrip, SCI's Chairman and Chief
Executive Officer.
***
Commenting on the results, L. William Heiligbrodt, SCI's President and
Chief Operating Officer said, "FLUCTUATIONS IN MORTALITY RATES PRESENT
OPERATIONAL CHALLENGES OVER CERTAIN TIME PERIODS; however, THE
FUNDAMENTALS OF THE FUNERAL SERVICE INDUSTRY REMAIN STRONG. Our
properties include MANY OF THE PREMIER FUNERAL BUSINESSES IN MAJOR
METROPOLITAN MARKETS around the world, providing excellent
opportunities for growth. OUR NEWLY FORMED FINANCIAL SERVICES GROUP AND
ITS ACQUISITION OF AMERICAN MEMORIAL LIFE INSURANCE COMPANY WILL
INCREASE OUR PREARRANGED FUNERAL MARKETING EFFORTS, PROVIDING FOR
FUTURE FUNERAL VOLUME TO MAINTAIN OUR CONSISTENT PERFORMANCE."
***
During the second quarter of 1998, sales of prearranged funeral
contracts were approximately $138.9 million, WHICH EXPANDED THE BACKLOG
OF PREARRANGED
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FUNERAL CONTRACTS TO BE SERVICED IN FUTURE PERIODS TO APPROXIMATELY
$3.3 BILLION. [Emphasis added.]
79. The foregoing statements were materially false and misleading at
the time they were made because, as defendants SCI, Waltrip, Heiligbrodt and
Champagne knew, or recklessly disregarded, and failed to disclose:
(a) the financial results of SCI's funeral segment was being
adversely effected by the increasing number of unprofitable prearranged funeral
services SCI was performing, not by "lower . . . mortality rates" or "weak
volumes;"
(b) the principal operational "challenge" facing SCI was not
"[f]luctuations in mortality rates," but the multi-million dollar backlog of
passive underperforming preneed mortuary trust assets;
(c) SCI's "newly formed financial services group [SCI
Financial Services, Inc.]" was not addressing the known and growing
deterioration in SCI's funeral services profit margins caused by its backlog of
preneed mortuary trust assets invested in passive, low return bank CDs and
similar investment vehicles; and
(d) SCI Financial Services, Inc. and the acquisition of
American Memorial were part of SCI's attempt to begin to actively manage the
investment of future preneed mortuary assets, not the "expanded ... backlog" of
existing preneed funeral contracts, nor was SCI in any manner seeking to
"maintain [the] consistent performance" of its multi-billion dollar backlog of
preneed funeral contracts, but, to the contrary, was actively concealing the
increasingly unprofitable performance of that segment of its business.
80. On August 6, 1998, SCI issued a materially false and misleading
press release that bore the headline, Service Corporation International
Announces Definitive Agreement for Merger
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With Equity Corporation International. Defendant Champagne was listed as a
"contact" person on the press release. The release stated in relevant part:
Service Corporation International (NYSE: SRV)("SCI"), the world's
largest funeral and cemetery company, announced today that it has
reached a definitive agreement with Equity Corporation International
(NYSE: EQU)("ECI") to form a business combination between the two
companies.
ECI, the nation's fourth largest publicly traded death care company,
based in Lufkin, Texas, currently owns and operates 326 funeral homes
and 81 cemeteries in 35 states and one Canadian province. The
combination would occur through a stock-for-stock transaction that
would result in ECI shareholders receiving $27 per share in SCI
stock. The actual number of shares of SCI stock to be issued to the ECI
shareholders will be determined based on the average SCI stock price
for the ten (10) consecutive trading days ending on the third trading
day prior to the closing of the merger. The average price of SCI stock
used in computing the exchange will not be less than $34.00 and no more
than $41.50 per share.
***
In explaining the transaction, Robert L. Waltrip, Chairman of the Board
and Chief Executive Officer of SCI said, "The merger will create a
combined North American operation with unparalleled resources servicing
both the metropolitan and rural markets throughout the country. The
addition of ECI and its exceptional revenue growth rate should further
enhance SCI's leading domestic market position."
***
L. William Heiligbrodt, President and Chief Operating Officer of SCI
noted, "The addition of ECI's properties opens SCI and its newly formed
financial services division to the North American rural market,
providing an expanded network and infrastructure through which we can
better service both out prearranged and at-need families. Additional
synergies should result from consolidating our operations and through
further leveraging our cost structure."
***
81. The foregoing statements were materially false and misleading at
the time they were made because defendants SCI, Waltrip and Heiligbrodt knew, or
were reckless in not knowing, and failed to disclose that:
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(a) the acquisition of ECI was part of SCI's attempt to
establish, belatedly, a means to actively manage its preneed mortuary trust
assets in order to ensure that its own future sales of preneed funeral contracts
would not result in the kind of unprofitable funeral services increasingly
generated by a substantial portion of SCI's existing multi-billion dollar
preneed backlog; and
(b) SCI's "leading domestic market position" was largely the
result of SCI's acquisition of private funeral homes, and of their poorly
invested preneed mortuary trust assets, which, at the time the statements were
made, were severely cutting into SCI's profit margins.
82. On August 7, 1999, the Houston Chronicle published an article
entitled, SCI Will Buy Rural-Market Equity Corp.; $588 Million Deal a Reunion
For The Two Firms. This article discussed SCI's acquisition of ECI, quoted
defendants Waltrip and Heiligbrodt, and stated in relevant part:
Service Corporation International, the world's largest funeral company
and one of the largest firms in Houston, is buying a Lufkin-based
company [ECI] specializing in buying and operating funeral homes in
rural areas and small cities.
***
"The merger will create a combined North American operation with
unparalleled resources servicing both the metropolitan and rural
markets throughout the country," Service Corp. Chairman Robert L.
Waltrip said in a written statement. "The addition of ECI and its
exceptional revenue growth rate SHOULD FURTHER ENHANCE SCI'S LEADING
DOMESTIC MARKET POSITION."
***
"THEY HAVE A VERY GOOD MANAGEMENT TEAM. THEY OPERATE THEIR BUSINESS
VERY WELL," Heiligbrodt said. "THEY SEE THINGS LIKE WE DO. THEIR
OPERATIONAL SYSTEMS ARE VERY SIMILAR TO OURS. WE KNOW EACH OTHER VERY
WELL. IT IS ONE OF THE SAFEST ACQUISITIONS A COMPANY LIKE SCI COULD
DO." [Emphasis added.]
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83. The foregoing statements were materially false and misleading at
the time they were made because defendants SCI, Waltrip and Heiligbrodt knew, or
were reckless in not knowing, and failed to disclose:
(a) the facts set forth in Paragraph 81(a) and (b), above; and
(b) that ECI's "operational systems" were fundamentally
different from SCI's systems in that ECI, unlike SCI, had an established program
to actively manage its preneed mortuary assets to ensure that the funds
available from those assets would cover or exceed the cost of providing
guaranteed price preneed funeral services in the future.
84. On August 11, 1998, a death care industry journal entitled Death
Care Business Advisor published an article entitled SCI Acquires American
Annuity Group, Moves Into Preneed Services. This article, which discussed SCI's
acquisition of American Memorial, contained extensive quotes from defendant
Champagne that echoed many of the false and misleading representations about
SCI's business and plans which began with the July 17, 1998 announcement of
SCI's acquisition of American Memorial. Defendant Champagne was quoted as
commenting on the American Memorial acquisition as follows:
"It's a new focus on our part," confirmed SCI Senior VP/CFO George
Champagne. He called the acquisition a "logical fit," citing SCI's
history in the prearranged funeral business. "WE'VE LONG BEEN THE
LEADERS IN THE PREARRANGED FUNERAL BUSINESS," he claimed.
SCI has been seeking ways, to increase its market share, according to
Champagne. "THE MOST COMPELLING WAY TO DO THAT IS TO INCREASE THE LEVEL
OF THE PREARRANGED FUNERAL BUSINESS," HE OFFERED. "THE ACQUISITION OF
AMERICAN MEMORIAL GIVES US THE ABILITY TO FUND OUR PREARRANGED
BUSINESS."
***
"YOU'RE EFFECTIVELY BUILDING YOUR BACKLOG OF FUNDING FOR PREARRANGED
FUNERALS," WHICH HAS THE EFFECT OF EXPANDING OR MAINTAINING SCI'S
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PREARRANGED FUNERAL BUSINESS, EXPLAINED CHAMPAGNE. "THAT IS A VERY
IMPORTANT ASPECT TO A COMPANY LIKE SCI. THERE IS A LOT OF COMPETITION
FOR PREARRANGED FUNERAL BUSINESS." Thus the acquisition of AAG's
funeral services division, he said, will allow SCI to better compete
for and serve customers. [Emphasis added.]
85. The foregoing statements made by Champagne were materially false
and misleading because they failed to disclose facts that Champagne knew or
recklessly disregarded, and that were necessary to make the statements accurate
and truthful when made, including that:
(a) the acquisition of American Memorial was part of
defendants' scheme to conceal the sharply adverse effects on SCI's profit
margins caused by the multi-million dollar backlog of inadequately funded
and/or dormant and underperforming mortuary trust assets;
(b) SCI's position as a "leader in the prearranged funeral
business" was gained through the acquisition of small, private funeral homes
that brought with them dormant and underperforming mortuary trust assets that
were, and continued to be, inadequate to cover the costs of the related
guaranteed price prearranged funerals SCI was obligated to provide;
(c) SCI's acquisition of American Memorial did not, and would
not give it "the ability to fund [its] prearranged business" because that
business included large numbers of preneed funeral contracts funded by
inadequate and/or dormant and underperforming mortuary trust assets; and
(d) SCI's "competition for prearranged funeral business," such
as ECI, had taken steps to actively manage their mortuary trust assets and were
thus not subject to the drastic decreases in profit margins plaguing SCI.
86. In that August 11, 1998 article, Champagne was also quoted as
stating:
Lastly, Champagne reminded that in the early 1980s SCI was in the
insurance business. "We owned Family Services Life Insurance
Company.... At the time," he continued, "SCI WAS A MUCH
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SMALLER COMPANY. WE DID NOT HAVE THE INFRASTRUCTURE OF FUNERAL HOMES
ACROSS THE COUNTRY."
Then, in 1989, SCI made "a strategic decision to exit that portion of
the business," said Champagne. "We couldn't support the insurance
organization that was predominantly selling insurance for independent
funeral homes." TODAY, THOUGH, AS THE DOMINANT FUNERAL SERVICES
PROVIDER IN THE INDUSTRY, "WE'VE GOT THE INFRASTRUCTURE ACROSS THE
COUNTRY," Champagne said.
***
Citing the company's record [1998] second-quarter earnings, with net
income reportedly up 15 percent and earnings per share up 13 percent,
CHAMPAGNE SAID SCI IS PLEASED WITH THE RESULTS "IN THE FACE OF WHAT
HAS COME TO BE WEAK FUNERAL VOLUMES CAUSED BY A LOWER DEATH RATE
SCENARIO IN NORTH AMERICA IN THE SECOND QUARTER." BUT THE COMPANY
DOESN'T EXPECT THAT TREND TO CONTINUE. "WE DON'T THINK IT'S A
CONTINUING PHENOMENON," CHAMPAGNE SAID. "THAT'S ONE THING ABOUT THE
FUNERAL BUSINESS. IT'S PREDICTABLE, CONSISTENT AND SUSTAINABLE OVER A
LONG PERIOD OF TIME. IN ANY THREE-MONTH PERIOD YOU'RE GOING TO HAVE
FLUCTUATIONS. THE CHALLENGE IS TO MANAGE THROUGH THOSE FLUCTUATIONS."
***
"OUR ACQUISITION ACTIVITY CONTINUES AT A VERY STRONG PACE RIGHT NOW,"
SAID CHAMPAGNE. "WE'RE ON TARGET TO ACQUIRE BETWEEN 280 MILLION AND 300
MILLION OF ANNUALIZED REVENUES, of which probably 50 percent to 60
percent of that will be from international sources." [Emphasis added.]
87. These additional statements were also materially false and
misleading at the time they were made because defendant Champagne, knew, or was
reckless in not knowing, and failed to disclose that:
(a) SCI's "infrastructure of funeral homes around the country"
included a material number of formerly privately owned funeral homes that
brought with them inadequately funded and/or dormant and underperforming
mortuary trust assets;
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40
(b) SCI's position as the "dominant funeral services provider"
was obtained through the acquisition of a material number of formerly private
funeral homes with inadequately funded and/or dormant and underperforming
mortuary trust assets;
(c) SCI's weakness in the second quarter was the result of the
unprofitability of prearranged guaranteed price funeral services performed
pursuant to inadequately funded and/or dormant and underperforming mortuary
trust assets, and not "weak volumes caused by a lower death rate scenario"; and
(d) SCI's acquisition activities were continuing "at a very
strong pace" because of the urgent need to "purchase" revenue to disguise the
fundamental and growing problems caused by the Company's enormous backlog of
inadequately funded and/or dormant and underperforming mortuary trust assets.
88. On August 14, 1998, SCI filed its Form 10-Q for the quarter ended
June 30, 1998 with the SEC (the "1998 Q2 Form 1O-Q"). The 1998 Q2 Form 10-Q was
also incorporated by reference into the Registration Statement/Prospectus for
SCI's acquisition of ECI, filed on November 19, 1998. The 1998 Q2 Form 10-Q was
signed by defendant Champagne and contained the following materially false and
misleading statements in Note 4 to the Consolidated Financial Statements:
Prearranged Funeral Activities
The Company sells price guaranteed prearranged funeral contracts
through various programs providing for future funeral services at
prices prevailing when the agreements are signed. Payments under these
contracts are generally placed in trust accounts (pursuant to
applicable law) or are used to pay premiums on life insurance policies
[issued by third party insurers] ... Trust earnings and increasing
insurance benefits are accrued and deferred until the service is
performed, at which time these funds are also recognized in funeral
revenues
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41
and are intended to cover future increases in the cost of providing a
price guaranteed funeral service.... [Emphasis added.]
1998 Q2 Form 10-Q at 7-8.
89. The foregoing statements were materially false and misleading when
made because SCI and the Individual Defendants knew, or were reckless or
negligent in not knowing, and failed to disclose that:
(a) SCI's backlog of prearranged funeral contracts included a
material number of contracts that were not sold "at prices prevailing when the
agreements [were] signed," but at discounts to those prices; and
(b) The funds from many of SCI'S mortuary trusts did not
"cover" or exceed the cost of their related price guaranteed funeral services,
and, as a result, SCI was and would continue to experience drastically
deteriorating profit margins in its funeral service business.
90. The 1998 Q2 Form 10-Q also stated in the Management's Discussion
and Analysis of Financial Condition ("MD&A") section, that:
Prearranged Funeral Services
The Company has a marketing program to sell prearranged funeral
contracts and the funds collected are generally held in trust or are
used to purchase life insurance or annuity contracts. The principal
amount of each such prearranged funeral contract will be received in
cash by a Company funeral service location at the time the funeral is
performed. EARNINGS ON TRUST FUNDS AND INCREASING BENEFITS UNDER
INSURANCE AND ANNUITY FUNDED CONTRACTS ALSO INCREASE THE AMOUNT OF CASH
TO BE RECEIVED UPON PERFORMANCE OF THE FUNERAL AND ARE INTENDED TO
COVER FUTURE INCREASES IN THE COST OR PROVIDING A PRICE GUARANTEED
FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. DURING 1997, THE COMPANY
COMPLETED A REVIEW OF THE PREARRANGED TRUST INVESTMENT PROCESS WHICH
INCLUDED AN ASSET/LIABILITY STUDY. THIS HAS RESULTED IN A NEW
INVESTMENT PROGRAM WHICH ENTAILS THE CONSOLIDATION OF MULTIPLE
TRUSTEES, THE USE OF INSTITUTIONAL MANAGERS WITH DIFFERING INVESTMENT
STYLES AND CONSOLIDATED PERFORMANCE MONITORING AND TRACKING. THIS NEW
PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT NECESSARY TO
COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED
FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. ...[Emphasis added.]
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1998 Q2 Form 10-Q at 19-20.
91. The foregoing statements were materially false and misleading at
the time they were made because SCI and the Individual Defendants knew, or were
reckless or negligent in not knowing, and failed to disclose that:
(a) SCI's backlog of prearranged funeral contracts included a
material number of contracts that were backed by mortuary trusts that were
inadequately funded and/or had assets that were not actively invested to ensure
growth adequate to cover "the cost of providing a price guaranteed funeral
service";
(b) The Preneed Study showed that a material number of funeral
homes acquired by SCI failed to actively manage their mortuary trust assets,
and, as a result, a material number of SCI's funeral services had been, and
would continue to be, performed at significant losses, resulting in an
increasingly sharp erosion in SCI's profit margins for funeral services; and
(c) SCI's "new investment program" was not actively managing
the vast majority of the preneed trust assets SCI had acquired by purchasing
independent private funeral homes, and was not obtaining "a real return in
excess of the amount necessary to cover" the costs to SCI of providing a
material number of prearranged guaranteed price funeral services.
92. On September 30, 1998, SCI issued a materially false and misleading
press release that bore the headline, Service Corporation International
Completes Strategic Acquisition of Pre-need Insurance Division of American
Annuity Group. The release stated in relevant part:
Service Corporation International (NYSE: SRV), the world's largest
funeral and cemetery company, announced today that it has completed its
previously announced acquisition of the pre-need funeral services
division of American Annuity Group Inc. (NYSE: AAG) of Cincinnati, Ohio
for $164 million cash.
* * *
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AMERICAN MEMORIAL WILL BE PART OF A NEW FINANCIAL SERVICES SUBSIDIARY,
SCI FINANCIAL SERVICES, INC., FORMED TO FACILITATE THE EXPANSION OF
SCI'S PRE-NEED BUSINESSES AND FINANCIAL ACTIVITIES WORLDWIDE. The new
company's operations include prearranged funeral marketing, funeral and
cemetery trust administration, investment management, life insurance
operations and the lending activities of Provident Services, Inc., an
existing SCI subsidiary which provides capital financing for
independent funeral home and cemetery operations. [Emphasis added.]
93. The foregoing statements were materially false and misleading at
the time they were made because SCI and the Individual Defendants knew, or were
reckless in not knowing, and failed to disclose that:
(a) the acquisition of American Memorial was an attempt by SCI
to conceal its deteriorating funeral service profit margins resulting from its
backlog of inadequately funded and/or dormant and underperforming preneed
mortuary trust assets; and
(b) SCI Financial Services, Inc. and SCI's acquisition of
American Memorial was part of SCI's attempt to begin to actively manage the
investments of future preneed mortuary assets, and did not and would not address
the continually more acute and drastic deterioration in profit margins caused by
the existing backlog of inadequately funded and/or dormant and underperforming
assets SCI acquired pursuant to its purchases of privately owned funeral homes.
94. On October 22, 1998, SCI issued a materially false and misleading
press release that bore the headline, Service Corporation International Reports
14.4% Increase in Net Income and 14.3% Increase in EPS for Third Quarter 1998.
Defendant Champagne was listed as a "contact" person for the press release. The
release stated in relevant part:
Strategic Highlights
-- Completed the acquisition of American Memorial Life Insurance
Company (AML) for $164 million.
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44
-- Announced the business combination with Equity Corporation
International for $830 million, including assumed
indebtedness.
-- Formed a new financial services subsidiary, SCI Financial
Services, Inc. to facilitate expansion of preneed businesses
and financial activities worldwide.
Commenting on the results, Robert Waltrip, Chairman and Chief Executive
Officer, said:
"I AM PLEASED TO REPORT ANOTHER QUARTER OF INCREASED PROFITABILITY FOR
SCI DESPITE THE WIDELY PUBLICIZED REDUCED NUMBER OF DEATHS REPORTED BY
OUR INDUSTRY. WHILE SCI WAS NOT INSULATED FROM THIS EXPERIENCE, THE
STRATEGIC ACQUISITIONS AND INITIATIVES ANNOUNCED THIS SUMMER WILL ADD
VALUE TO SCI TODAY AND LONG-TERM."
SCI's President and Chief Operating Officer, L. William Heiligbrodt,
added:
"SINCE 1990, SCI'S NORTH AMERICAN MARKET SHARE HAS NEARLY DOUBLED TO
APPROXIMATELY 11% TODAY, MAINLY THROUGH ACQUISITIONS, NEW CONSTRUCTION
AND PREARRANGED FUNERALS. SCI'S MARKET SHARE IS EXPECTED TO INCREASE AS
WE ACCELERATE THE SALES OF PREARRANGED FUNERALS. WE PLAN TO DOUBLE THE
ANNUAL SALES OF PREARRANGED FUNERALS WITHIN FIVE YEARS...."
Acquisition Activity
Effective July 1, 1998, SCI acquired AML, the pre-need funeral services
division of American Annuity Group Inc., for $164 million cash. AML
offers a variety of pre-need and final expense life insurance and
annuity products to finance prearranged funerals. TO FACILITATE THE
EXPANSION OF SCI'S PRE-NEED BUSINESSES AND FINANCIAL ACTIVITIES
WORLDWIDE, SCI FORMED A NEW FINANCIAL SERVICES SUBSIDIARY, SCI
FINANCIAL SERVICES, INC.
In August, SCI reached an agreement with Equity Corporation
International (ECI) to enter into a business combination between the
two companies. The combined company will have operations throughout
metropolitan and rural North America and will consist of approximately
3,600 funeral homes, 500 cemeteries and 200 crematoria worldwide, with
annualized revenues approaching $3 billion. [Emphasis added.]
95. The foregoing statements made by SCI and the Individual Defendants
were materially false and misleading at the time they were made because these
defendants knew, or were reckless in not knowing, and failed to disclose that:
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45
(a) the profitability of SCI's funeral services business was
and continued to deteriorate materially as a result of the increasing number of
unprofitable funeral services being performed pursuant to preneed funeral
service contracts backed by inadequately funded and/or dormant and
underperforming preneed mortuary trusts;
(b) SCI's nearly doubling of its market share since 1990
"mainly through acquisitions, new construction and prearranged funerals"
resulted in the accumulation of an enormous backlog of preneed contracts backed
by inadequately funded and/or dormant and underperforming mortuary trust assets,
resulting in drastically decreasing profits margins;
(c) far from establishing SCI Financial Services, Inc. "to
facilitate the expansion of SCI's pre-need business and financial activities
worldwide," as defendants claimed, the creation of this subsidiary marked the
first time in SCI's history that the Company had implemented any concrete steps
to manage actively at least a portion of its preneed trust assets. Prior to the
creation of this subsidiary, and notwithstanding defendants' earlier
representations about a "new investment program," no individual or organization
at SCI had been responsible for actively managing those assets;
(d) SCI's new investment management operations through the
establishment of SCI Financial Services, Inc. would not be involved in managing
of the vast majority of SCI's existing multi-billion dollar backlog of preneed
mortuary trust assets acquired in SCI's funeral home acquisitions, which would
continue to be invested in underperforming interest bearing vehicles, such as
bank CDs; and
(e) the acquisition of ECI was part of SCI's attempt to
establish, belatedly, a means to actively manage its preneed mortuary trust
assets in order to ensure that its future sales
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46
of preneed funeral contracts would not result in the kind of unprofitable
funeral services increasingly generated by a substantial portion of SCI's
existing multi-billion dollar preneed backlog.
96. On November 10, 1998, Death Care Business Advisor published an
article entitled SCI Reports 14 Percent Gains in Income, Share Earnings. This
article discussed SCI's third quarter 1998 financial results, quoted defendants
Waltrip and Champagne, and stated in relevant part:
A slowdown in the number of deaths in North America did not stop
Service Corporation International from racking up double-digit gains in
net income and earnings per share for the third quarter of 1998 (see
detailed results on p4). THE COMPANY USED ITS STRATEGY OF ACQUISITIONS
COMBINED WITH A CONSCIOUS EFFORT TO CUT COSTS TO, AS SCI CHAIRMAN
ROBERT WALTRIP SAID, "ADD VALUE TO SCI TODAY AND LONG TERM."
Commenting on future plans, SCI, which holds an 11 percent market
share in the funeral industry, has aggressive plans to grow its
business operations.
* * *
SCI Takes on More Preneed
RESPONDING TO CONCERNS THAT THE DEATH RATE WAS FALLING, SCI TOUTED THE
MOVES IT HAS MADE IN THE PRENEED FUNERAL MARKET, INCLUDING THE RECENT
ACQUISITION OF AMERICAN MEMORIAL LIFE, THE PRENEED INSURANCE DIVISION
OF AMERICAN ANNUITY GROUP, INC. ON JULY 1. THE COMPANY PAID 164
MILLION. TO FACILITATE SCI'S GROWTH IN THIS AREA, THE COMPANY FORMED A
NEW SUBSIDIARY, SCI FINANCIAL SERVICES INC. TO HANDLE PRENEED AND OTHER
COMPANY FINANCIAL ACTIVITIES.
IN THAT AREA, THE COMPANY SHOWED BOOMING GROWTH, WITH REVENUES GROWING
FROM 21.5 MILLION IN THE THIRD QUARTER OF 1997 TO 65.8 MILLION FOR THE
THIRD QUARTER OF 1998, INCORPORATING THE ACQUISITION OF AML INTO ITS
FINANCIAL RESULTS.
"IN 1997, DOMESTICALLY, JUST OVER 25 PERCENT OF THE ATNEED SERVICES WE
PROVIDED WERE THE CULMINATION OF A PRE-ARRANGED CONTRACT. THAT MEANS
ONE-QUARTER OF OUR FUNERALS CAME FROM THE BACKLOG, UP TWO PERCENTAGE
POINTS FROM 1996," SAID SCI CHIEF FINANCIAL OFFICER GEORGE CHAMPAGNE.
"FOR THE FIRST NINE MONTHS
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OF 1998, THAT PERCENTAGE IS JUST BELOW 27 PERCENT. PRENEED IS PROVIDING
AN INCREASING AMOUNT OF OUR ATNEED SERVICES, AND THERE IS POTENTIAL TO
EXPAND MARKET SHARE."
* * *
Expenses Drop in Quarter
DESPITE THE GROWTH THE COMPANY ACHIEVED THROUGH ACQUISITION, THE FLAT
DEATH RATE DOMESTICALLY CAUSED IT TO BECOME AGGRESSIVE IN THE AREA OF
EXPENSE REDUCTION. For the third quarter of 1998, general and
administrative expenses were 15.4 million, a decrease from the 16.7
million SCI spent last year.
Champagne said that SCI has made an effort to reduce those expenses,
but they should see a reasonable upswing in the fourth quarter as most
executive compensation and bonuses accrue during that time. Following
that, he said they can be expected to increase reasonably, as expected,
based on expansion and market conditions. [Emphasis added].
97. The foregoing statements made by defendants Waltrip and Champagne
were materially false and misleading at the time they were made because these
defendants knew, or were reckless in not knowing, and failed to disclose that:
(a) far from enjoying a unique advantage over its competitors
in addressing the slowdown in North American deaths by virtue of acquisition and
cost cutting, SCI was continuing to experience drastic deterioration in its
funeral services profit margins as a result of its backlog of inadequately
funded and/or dormant and underperforming preneed mortuary trust assets;
(b) the acquisition of American Memorial and the formation of
SCI Financial Services, Inc. did not address SCI's backlog of unprofitable
preneed funeral service contracts; and
(c) the "booming growth" and increased revenues from SCI's new
financial activities were part of SCI's scheme to mask its increasingly
deteriorating profit margins in its preneed funeral services business, and the
touted increase in the number of funerals "from the
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48
backlog" of preneed contracts was, in fact, fueling the profit margin
deterioration, and was not, as represented, a positive development for SCI.
98. On November 16, 1998, SCI filed its Form 10-Q for the quarter ended
September 30, 1998 with the SEC (the "1998 Q3 Form 10-Q"). The 1998 Q3 Form 10-Q
was also incorporated by reference into the Registration Statement/Prospectus
for SCI's acquisition of ECI, filed on November 19, 1998. The 1998 Q3 Form 10-Q
was signed by defendant Champagne and contained the following materially false
and misleading statements in Note 4 to the Consolidated Financial Statements:
Prearranged Funeral Activities
The Company sells price guaranteed prearranged funeral contracts
through various programs providing for future funeral services at
prices prevailing when the agreements are signed. Payments under these
contracts are placed in trust accounts (pursuant to applicable law) or
are used to pay premiums on life insurance policies. ... TRUST EARNINGS
AND INCREASING INSURANCE BENEFITS ARE ACCRUED AND DEFERRED UNTIL, THE
SERVICE IS PERFORMED, AT WHICH TIME THESE FUNDS ARE ALSO RECOGNIZED IN
FUNERAL REVENUES AND ARE INTENDED TO COVER FUTURE INCREASES IN THE COST
OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE.... The total value of
unperformed prearranged funerals at September 30, 1998 was $3,395,916
($3,163,357 at December 31, 1997). [Emphasis added.]
1998 Q3 Form 10-Q at 7-8
* * *
99. The foregoing statements were materially false and misleading when
made because SCI and the Individual Defendants knew, or were reckless or
negligent in not knowing, and failed to disclose that:
(a) SCI's backlog of prearranged funeral contracts included a
material number of contracts that were not sold "at prices prevailing when the
agreements were signed," but at discounts to those prices; and
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49
(b) The funds from many of SCI's mortuary trusts did not
"cover" or exceed the cost of their related "price guaranteed" funeral services,
and as a result, SCI was and would continue to experience drastically
deteriorating profit margins for its funeral service business.
100. The 1998 Q3 Form 10-Q also stated in the MD&A section, that:
Prearranged Funeral Services
The Company has a marketing program to sell prearranged funeral
contracts and the funds collected are generally held in trust or are
used to purchase life insurance or annuity contracts. The principal
amount of each such prearranged funeral contract will be received in
cash by a Company funeral service location at the time the funeral is
performed. EARNINGS ON TRUST FUNDS AND INCREASING BENEFITS UNDER
INSURANCE AND ANNUITY FUNDED CONTRACTS ALSO INCREASE THE AMOUNT OF CASH
TO BE RECEIVED UPON PERFORMANCE OF THE FUNERAL AND ARE INTENDED TO
COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED
FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. During 1997, the Company
completed a review of the prearranged trust investment process which
included an asset/liability study. THIS HAS RESULTED IN A NEW
INVESTMENT PROGRAM WHICH ENTAILS THE CONSOLIDATION OF MULTIPLE
TRUSTEES, THE USE OF INSTITUTIONAL MANAGERS WITH DIFFERING INVESTMENT
STYLES AND CONSOLIDATED PERFORMANCE MONITORING AND TRACKING. THIS NEW
PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT NECESSARY TO
COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED
FUNERAL SERVICE AS WELL AS ANY SELLING COSTS....
* * *
Prearranged funeral service sales afford the Company the opportunity to
both protect current market share and mix as well as expand market
share in certain markets. The Company believes this will stimulate
future revenue growth. Prearranged funeral services fulfilled as a
percent of the total North American funerals performed annually
approximates 25% and is expected to grow, thereby making the total
number of funerals performed more predictable. [Emphasis added.]
1998 Q3 Form 10-Q at 19-20.
101. The foregoing statements were materially false and misleading at
the time they were made because SCI and the Individual Defendants knew, or were
reckless or negligent in not knowing, and failed to disclose that:
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50
(a) SCI's backlog of prearranged funeral contracts included a
material number of contracts that were backed by mortuary trusts that were
inadequately funded and/or had assets that were not actively invested to ensure
growth adequate to cover "the cost of providing a price guaranteed funeral
service";
(b) The Preneed Study showed that a material number of funeral
homes acquired by SCI failed to actively manage their mortuary trust assets,
and, as a result, a material number of SCI's funeral services had been, and
would continue to be, performed at significant losses, resulting in an
increasingly sharp erosion in SCI's profit margins for funeral services;
(c) SCI's "new investment program" was not actively managing
the vast majority of the preneed trust assets SCI had acquired by purchasing
independent private funeral homes, and was not obtaining "a real return in
excess of the amount necessary to cover" the costs to SCI of providing a
material number of prearranged guaranteed price funeral services; and
(d) the increasing percentage of "at need" funerals
attributable to "prearranged funeral services fulfilled" was, far from being the
positive development represented in the 1988 Q3 Form 10-Q, a reflection of the
increasing number of unprofitable funeral services being performed pursuant to
preneed contracts backed by underfunded and/or dormant and underperforming
mortuary trust assets, which was fueling SCI's drastically deteriorating profit
margins.
102. On or about November 19, 1998, defendants Waltrip, Champagne and
Heiligbrodt, caused SCI to file the materially false and misleading Registration
Statement/Prospectus with the SEC in connection with SCI's acquisition of ECI.
The Registration Statement/Prospectus was
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signed by each of the foregoing defendants, declared effective by the SEC on
November 20, 1998, and incorporated SCI's 1998 Q2 Form 10-Q, and 1998 Q3 Form
1O-Q by reference.
103. The Registration Statement/Prospectus contained numerous
materially false and misleading statements and omitted to disclose numerous
material facts that were required to be disclosed in order to render the
statements made therein not materially misleading at the time it was declared
effective, including, by incorporation, the materially misleading statements
contained in SCI's 1998 Q2 Form 10-Q and in SCI's 1998 Q3 Form 10-Q, which are
set forth in detail above.
104. The Registration Statement/Prospectus at pages 40-41 also
contained the following materially false and misleading statements:
SCI's strategy is to:
o continue to expand through the acquisition and construction, both
domestically and internationally of funeral homes, cemeteries and
crematoria in areas with demographics that SCI believes to be
favorable;
o increase the operating margins of its existing and acquired
facilities by having those facilities share resources pursuant to
SCI's cluster strategy;
o increase revenue per location through the merchandising of a broad
line of funeral and cemetery products and services, both on a
preneed and at-need basis; and
o increase future volume and revenues through the sale of
prearranged funeral services.
105. The foregoing statements were materially false and misleading at
the time they were made because SCI and the Individual Defendants knew, or were
reckless or negligent in not knowing, and failed to disclose that:
(a) SCI had been, and would continue to, suffer from materially
deteriorating profit margins as a result of its enormous backlog of preneed
funeral service contracts that were backed by inadequately funded and/or dormant
and underperforming mortuary trust assets; and
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(b) those deteriorating profit margins and the material adverse
impact they had on SCI's overall profits and earnings would not be reversed by
SCI's touted strategies of: continued expansion through "acquisition and
construction"; having facilities "share resources pursuant to SCI's cluster
strategy"; increased "merchandising"; or increased sales of "prearranged funeral
services."
106. The Merger Agreement, which was made an exhibit to the
Registration Statement/Prospectus and incorporated therein by reference,
contained the following statement at pages A15-16, in the form of a
representation by SCI:
there has not been any event, occurrence, development or state of
circumstances or facts which has had, or could reasonably be
anticipated to have, individually or in the aggregate, a Material
Adverse Effect.
107. The Merger Agreement provided that this statement "shall be true
and correct in all material respects... as of the Closing Date" as a condition
to the consummation of the merger.
108. On January 19, 1999, the merger was consummated, and, as of that
date, SCI, by virtue of, inter alia, its increasingly deteriorating funeral
service profit margins, had suffered a Material Adverse Effect, as reflected by
its poor earnings per share in the fourth quarter of 1998, which ended almost
three weeks prior to the closing of the merger.
109. SCI and the Individual Defendants' failure to disclose the
existence of Material Adverse Effects which they knew, or were reckless or
negligent in not knowing, at the time that the Registration Statement/Prospectus
was filed with the SEC and declared effective and, as a result the Registration
Statement/Prospectus was materially false and misleading. Further, on or about
January 19, 1999, by announcing in a press release that the merger had been
completed, SCI
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and the Individual Defendants impliedly told investors that the representation
that there had been no material adverse changes was true as of the closing of
the merger when, in fact, they knew or recklessly disregarded the true and
undisclosed facts regarding the adverse earnings and causes thereof.
ADDITIONAL SCIENTER ALLEGATIONS
DEFENDANTS' MOTIVES TO MISREPRESENT SCI'S FINANCIAL CONDITION
110. Defendants were highly motivated to conceal the true reasons
behind SCI's funeral margin contraction and the negative impact that SCI's
unprofitable multi-million dollar preneed funeral backlog had already had, and
was continuing to have, on SCI's profit margins and earnings. By doing so,
defendants were able to cause the market price of SCI's to become and remain
materially artificially inflated (artificially depressed in the case of put
options) throughout the Class Period. Because the consideration paid by SCI to
ECI stockholders was SCI common stock, SCI was able to effectively purchase ECI
with "watered stock," thereby saving SCI millions.
111. As alleged above, the ECI acquisition was critical to the
Company's ability to turn around its unprofitable preneed business and therefore
represented significant motivation to defraud Class members.
112. Under Section 9.1 of the Merger Agreement, ECI had the right to
terminate the Merger Agreement "if the representations and warranties of [SCI]
shall fail to be true and correct in all material respects...." Thus, prior to
negotiating the deal with ECI, SCI was motivated to maintain SCI's stock price
in an effort to acquire ECI in a stock-for-stock transaction for less than ECI's
true value. After the Merger Agreement was executed, but before the deal closed,
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SCI was motivated to conceal the adverse developments from ECI to prevent ECI
from terminating the Merger Agreement. Disclosure of SCI's unprofitable preneed
business would have constituted a Material Adverse Effect, as contemplated by
the Merger Agreement. Had SCI admitted the existence of the Company's problems,
ECI would have been able to terminate the Merger Agreement under Section 9.1.
113. In addition, defendants were motivated to conceal the truth
concerning SCI's funeral margin contraction in order to obtain and maintain
favorable ratings on the debt securities that SCI had registered with the SEC
but not yet issued.
114. In particular, in a prospectus filed with the SEC on May 29, 1998,
SCI registered to sell up to $1 billion of debt, common stock and warrants to
the public from "time-to-time." Similarly, in a prospectus filed with the SEC on
October 15, 1998, SCI registered to sell an additional $500 million in SCI
preferred stock. The debt and equity securities were issued pursuant to shelf
registration statements that were declared effective by the SEC on June 10, 1998
and October 29, 1998, respectively. As a result of filing the shelf registration
statements, SCI was able to avail itself of much-needed funds to finance the
Company's acquisitions and operations.
115. The omissions concerning SCI's unprofitable preneed business
ensured that the debt securities would be priced as attractively as possible to
SCI upon issuance. Favorable pricing allowed SCI to save millions of dollars in
interest payments that would otherwise have been paid to bondholders had SCI's
debt instruments been assigned lower ratings by credit rating agencies such as
Standard & Poor's. Also, the omissions would ensure that SCI stock and
warrants would be sold to the investing public at the highest possible prices.
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116. The defendants' omissions about the unprofitable preneed business
had the desired effect on the public, particularly Standard & Poor's ("S&P"). On
October 27, 1998, shortly after defendants announced SCI's favorable third
quarter results which omitted from disclosure facts about the unprofitable
preneed business, S&P issued a press release praising SCI's "well-established
and diverse geographic market positions, and strong industry characteristics
[which] should enable the company to generate predictable cash flow." Most
importantly, S&P affirmed its triple-B plus corporate credit, unsecured debt,
and bank loan ratings as well as its triple B plus subordinated debt rating and
it's A-2 commercial paper rating on SCI. S&P also assigned its preliminary
triple B plus/triple B rating to the Company's debt registered pursuant to the
shelf registration statement.
117. Thus, SCI's ability to sustain growth through continued
acquisition activity was intimately tied to its ability to maintain favorable
credit ratings and also periodically issue equity for cash flow purposes. By
publicly making materially false and misleading statements and omitting from
disclosure material facts, defendants had been able to artificially increase and
maintain the inflated price of SCI common stock, maintain favorable credit
ratings, and increase SCI's shelf registration for a announcement of a combined
debt and equity offering of $1.5 billion.
THE INDIVIDUAL DEFENDANTS KNEW THE TRUE FINANCIAL CONDITION OF SCI
118. SCI's earnings shortfall for the fourth quarter 1998 was an
extraordinary event in the financial history of SCI. Prior to the fourth quarter
of 1998, SCI's management repeatedly forecasted current quarterly financial
performance with extraordinary accuracy.
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119. SCI's quarterly results are particularly easy for management to
estimate prior to a quarter's end because of a number of factors generally
applicable to companies in the death care field and because of certain factors
particularly applicable to SCI. Initially, death care providers have an
extremely high level of recurring, budgeted, fixed costs that generally do not
fluctuate greatly with demand for a company's services. Unlike companies in
other industries, death care providers cannot respond to increased demand by
delaying the period in which a service will be provided; obviously, a death care
provider cannot promise to fill an order "in a week or two" and still retain a
customer. The SCI 1998 Form 10-K explains, "[t]he funeral business has a high
fixed cost structure (approximately 80%-90% of funeral costs) that does not
easily lend itself to reduction during periods of slower revenue growth."
120. Additionally, demand for death services is steadier than almost
any other industry. Demand for death care services may fluctuate somewhat as a
result of disease patterns or seasonal changes, but demand is not affected by
changes in consumer taste or technological developments.
121. SCI is also able to accurately measure its current quarterly
performance because SCI's Falcon system reports North American cemetery and
funeral home sales on a daily basis. This enables SCI to determine accurately
the level of funeral and cemetery sales at any point during a quarter.
122. Further, it reasonably could have been anticipated that the
declining profitability caused by SCI's undisclosed backlog of inadequately
funded and/or dormant and underperforming preneed trust assets would continue
into the fourth quarter. Indeed, as a result of the increasingly deteriorating
profitability caused by inadequately funded preneed contracts, costs had been
steadily increasing as a percentage of revenue throughout the entire 1998 year.
In the first quarter 1998,
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SCI's costs were approximately 68% of revenue; in the second quarter 1998 costs
were approximately 72% of revenue; in the third quarter 1998 costs were
approximately 76% of revenue; and in the fourth quarter 1998 costs were
approximately 82% of revenue.
THE TRUTH IS REVEALED
123. On January 26, 1999, just five business days after SCI and ECI
jointly announced the completion of the Merger, SCI shocked the investment
community by issuing a press release which stated:
[SCI], the world's largest funeral and cemetery company, announced
today that it expects diluted earnings per share for the fourth
quarter of 1998 to be lower than current analyst expectations.
SCI's fourth quarter 1998 gross profits were $141,246,000. This represented a
19% decline from SCI's third quarter 1998 gross profits and a 24% decline from
SCI's fourth quarter 1997 gross profits. SCI's earnings per share for fourth
quarter 1998 were $.23. This was 28% below EPS for third quarter 1998; 36% below
SCI's EPS for the fourth quarter 1997; and 45% below the average forecast or
"consensus estimate" for fourth quarter EPS by analysts who followed SCI. These
"consensus estimates" were based on misleading information given directly by SCI
to professional market analysts. Defendants deceptively failed to disclose to
analysts, the market, or to ECI or its shareholders in connection with the
negotiation and closing of its acquisition of ECI, the grave and worsening
losses in its preneed funeral business.
124. The market's reaction to the January 26, 1999 disclosure was swift
and severe. The price of SCI common stock plunged from $34 7/16 on January 25 to
$19 1/8 on trading of over 36 million shares, a one-day decline of $15.3125 or
44%. This price decline also effectively cut the consideration paid for each
share of ECI common stock in the merger virtually in half.
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Pursuant to the Merger Agreement, ECI shareholders received SCI common stock
that was worth $25.53 when the deal closed, in exchange for each share of ECI
common stock they owned. Following SCI's January 26, 1999 disclosure, that same
SCI common stock was worth only $12.79, effectively reducing the total
consideration paid for ECI from $556 million to $278 million. As of September 1,
1999, SCI's common stock was trading at or about $14.00 per share.
125. On February 9, 1999, the Company issued a press release
purporting to explain the earnings shortfall. The primary reasons cited for the
shortfall were decreased revenues and increased costs. However, the true reason
for the earnings surprise was revealed later by defendant Heiligbrodt.
126. Indeed, the Company and defendant Heiligbrodt have admitted that
the earnings shortfalls reported for fiscal year 1998 resulted from losses on
SCI's preneed business which was information known to defendants throughout the
Class Period. A story published by the Death Care Business Advisor on February
23, 1999 stated in part:
Because the company said that it is now selling preneed at prices
which, combined with its investment strategy should lead to increased
at-need earnings, SCI is understandably bullish on preneed. Especially
when it estimates that only 30 percent of the people who buy preneed
through an SCI facility would be an SCI atneed customer.
For the time being, though, preneed is hurting company profit margins.
Because SCI does not count preneed funds in its earnings until services
are delivered, many of the 27 percent of SCI calls in 1998 that were
the result of a preneed sale were from policies sold 12-15 years ago.
According to SCI, many of those policies were sold by third parties,
such as companies later purchased by SCI. ACCORDING TO [DEFENDANT)
HEILIGBRODT, THE AT NEED VALUE OF MANY OF THE PRENEED PLANS SOLD IN THE
1980S IS ABOUT 20 PERCENT LESS THAN THE COMPANY PRESENTLY CHARGES FOR
ITS SERVICES. [Emphasis added.]
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127. Following up on its February 23, 1999 article, Death Care Business
Advisor published another story on August 12, 1999 entitled "SCI Looking For
Comeback In 2000; Company Results Miss Targets As Expected: Management Expects
Flat Earnings in 1999" stating, in part:
SCI has said in the past that it loses money on some of its preneed
services because the contract was sold at too low a price by a funeral
home or death care company later bought by SCI.
When pursuing preneed, it is worth considering that a large percentage
of the contracts still become at-need within 5 years of purchase, not
leaving a lot of time to make up the seller's commission and
inflationary price increases, to ensure the preneed seller of the same
profit ordinarily achieved from an atneed funeral.
While these numbers are not likely to slow the boom in the sale of
preneed funeral contract, they are worth looking over. Preneed sales
are supposed to ensure a successful future, not serve as a drain on
company profit.
PLAINTIFFS' INVESTIGATION
128. Plaintiffs' allegations set forth herein are based on a thorough
investigation conducted by and through their attorneys. Such investigation
included a review and analysis of:
a. SCI's filings with the SEC both prior to and throughout
the Class Period;
b. the Company's Annual Reports to shareholders both prior
to and during the Class Period;
c. The Company's press releases and other publicly
disseminated statements made by defendants prior to,
during, and following the Class Period;
d. reports, articles, and other written materials concerning
the Company and the subject matter of this complaint;
e. analyst reports and investor advisory service reports;
and
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f. consultations with forensic accountants, former company
employees and other individuals knowledgeable about the
Company's business, operations and services.
INAPPLICABILITY OF STATUTORY SAFE HARBOR
129. The statutory safe harbor provided for forward-looking statements
pursuant to 15 U.S.C. Section 78u-5 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 known to
defendants. In addition, to the extent that defendants may claim that certain
statements alleged to be false and misleading may be characterized as forward
looking, (i) such statements were not identified as "forward-looking statements"
when made; (ii) 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 (iii) 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 does
apply to any forward-looking statements pleaded 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 false, and/or the
forward-looking statement was authorized and/or approved by an executive officer
of SCI who knew that those statements were false when made.
FRAUD ON THE MARKET PRESUMPTION
130. At all relevant times, the market for SCI securities was an
efficient market for the following reasons, among others:
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a. SCI common stock met the requirements for listing,
and was listed and actively traded, on the New York
Stock Exchange (the "NYSE"), a highly efficient
market;
b. As a regulated issuer, SCI filed periodic public
reports with the SEC and the NYSE;
C. SCI was followed by securities analysts employed by
major brokerage firms who wrote reports which were
distributed to the sales force and customers of their
respective brokerage firms. Each of these reports was
publicly available and entered the public
marketplace. The securities firms that followed the
Company during the Class Period, included, inter
alia, Morgan Stanley Dean Witter, ABN AMRO; Merrill
Lynch; J.P. Morgan; Nations Banc Montgomery
Securities; Wasserstein Perella; and Bear, Stearns;
and
d. SCI regularly communicated with public investors by
means of established market communication mechanisms,
including through regular dissemination of press
releases on the national circuits of major newswire
services and through other wide-ranging public
disclosures, such as communications with the
financial press and other similar reporting services.
Each of these releases was publicly available and
entered the public marketplace.
As a result, the market for SCI common stock promptly digested current
information with respect to SCI from all publicly-available sources and all such
information was reflected in market prices
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of SCI common stock. Under these circumstances, all those who purchased or
otherwise acquired SCI securities during the Class Period suffered similar
injury through their acquisition of such securities at artificially inflated
prices and a presumption of reliance applies.
COUNT I
AGAINST ALL DEFENDANTS FOR VIOLATION OF SECTION 11 OF THE SECURITIES ACT
131. Plaintiffs incorporate each of the foregoing paragraphs as if
fully set forth herein, except to the extent such allegations charge the
defendants with intentional or reckless conduct. For the purposes of this Count,
plaintiffs expressly do not allege that any defendant acted with scienter or
fraudulent intent, which is not an element of a Section 11 claim.
132. This Count is asserted against all defendants for violations of
Section 11 of the Securities Act, 15 U.S.C. Section 77(k).
133. This count is brought on behalf of those Class members who
exchanged shares of ECI common stock for shares of SCI common stock in
connection with the Merger or held employee options to purchase ECI common stock
under a stock plan of ECI that became options to purchase SCI common stock as a
result of the Merger.
134. SCI is the issuer of the stock via the Registration
Statement/Prospectus filed with the SEC in connection with the Merger. The
Individual Defendants are signatories of the Registration Statement/Prospectus.
135. The Registration Statement/Prospectus contained untrue statements
of material fact and/or omitted to disclose material facts required to be stated
therein or necessary to make the statements made therein not misleading as
alleged herein.
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136. Defendants participated in the preparation of, issued, caused to
be issued and participated in the issuance of the materially false and
misleading Registration Statement/Prospectus, which was inaccurate and
misrepresented or failed to disclose, inter alia, material facts concerning
SCI's business and prospects, as set forth above.
137. The Individual Defendants as directors and/or officers of SCI and
as signatories of the Registration Statement/Prospectus that was filed with the
SEC were responsible for the preparation of the Registration
Statement/Prospectus and failed to make a reasonable investigation or possess
reasonable grounds for believing that the representations contained in the
Registration Statement/Prospectus, were true and that they disclosed all
material facts.
138. The Individual Defendants are primarily liable under Section 11 of
the Securities Act and are also secondarily liable as controlling persons of SCI
under Section 15 of the Securities Act.
139. As a direct and proximate result of the false and misleading
statements in the Registration Statement/Prospectus, plaintiffs and the Class
acquired SCI securities issued pursuant to the defective Registration
Statement/Prospectus.
140. Accordingly, plaintiffs and the Class have sustained damages as a
result of the violations of Section 11 of the Securities Act by defendants and
are entitled to recover damages therefore pursuant to Section 11(e) of the Act.
141. At the time they approved the Merger and acquired SCI common
stock, plaintiffs and the class were without knowledge of the untruths and
omissions alleged herein.
142. The action was brought within one year after the discovery of the
untrue statements and omissions and within three years after SCI stock was
offered to the public in the Merger.
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COUNT II
AGAINST SCI FOR VIOLATION OF SECTION 12(a)(2) OF THE SECURITIES ACT
143. Plaintiffs incorporate each of the foregoing allegations as if
fully set forth herein, except to the extent that such allegations charge the
defendants with intentional or reckless misconduct. For the purposes of this
Count, plaintiffs expressly do not allege that any defendant acted with scienter
or fraudulent intent, which is not an element of a Section 12(a)(2) claim.
144. This count is asserted against SCI for violation of Section
12(a)(2) of the Securities Act, 15 U.S.C. Section 771.
145. This count is brought on behalf of those Class members who
exchanged shares of ECI common stock for shares of SCI common stock in
connection with the Merger or held employee options to purchase ECI common stock
under a stock plan of ECI that became options to purchase SCI common stock as a
result of the Merger.
146. SCI was a seller, offeror, and/or solicitor of sales of the SCI
common stock for its financial benefit pursuant to the Registration
Statement/Prospectus in connection with the Merger.
147. The Registration Statement/Prospectus contained materially false
and misleading statements and omitted to state material facts necessary in order
to make the statements, in light of the circumstances under which they were
made, not misleading.
148. None of the defendants named in this Count made a reasonable
investigation or possessed reasonable grounds for the belief that the statements
contained in the Registration Statement/Prospectus were true, without omissions
of any material facts and were not misleading.
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149. Plaintiffs, individually and representatively, hereby elect to
rescind and tender to SCI those securities that plaintiffs and other members of
the Class continue to own, in return for the consideration paid for those
securities together with interest thereon.
150. Plaintiffs and members of the Class who have sold their SCI common
stock are entitled to recissory damages.
151. The action was brought within one year after the discovery of the
untrue statements and omissions and within three years after SCI common stock
was offered to the public.
COUNT III
AGAINST THE INDIVIDUAL DEFENDANTS FOR
VIOLATION OF SECTION 15 OF THE SECURITIES ACT
152. Plaintiffs repeat and reallege each and every allegation contained
above as if fully set forth herein, except to the extent that such allegations
charge the Individual Defendants with intentional or reckless conduct. For
purposes of this Count, plaintiffs do not allege than any Individual Defendant
acted with scienter or fraudulent intent, which is not an element of controlling
persons' liability under Section 15.
153. Count III is brought pursuant to Section 15 of the Securities Act,
15 U.S.C. Section 77o, against the Individual Defendants. SCI is liable to
plaintiffs and the Class as an issuer under Section 11 and as a seller under
Section 12(a)(2) of the Securities Act, as previously set forth in Counts I and
II above.
154. This count is brought on behalf of those Class members who
exchanged shares of ECI common stock for shares of SCI common stock in
connection with the Merger or held employee options to purchase ECI common stock
under a stock plan of ECI that became options to purchase SCI common stock as a
result of the Merger.
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155. The Individual Defendants were controlling persons of SCI by
virtue of their positions as senior officers and directors of the Company. As a
result, the Individual Defendants are jointly and severably liable with and to
the same extent as SCI under Section 15 of the Securities Act for SCI's primary
violations of Sections 11 and 12(2)(a) of the Securities Act.
COUNT IV
AGAINST ALL DEFENDANTS FOR
VIOLATIONS OF SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5
156. Plaintiffs incorporate the foregoing allegations as if fully set
forth herein. This claim is asserted against SCI and the Individual Defendants.
157. These defendants, and each of them, carried out a plan, scheme
and course of conduct which was intended to and did: (i) deceive the investing
public, including plaintiffs and other Class members, as alleged herein; and
(ii) artificially inflate (artificially deflate in the case of put options) and
maintain the market price of SCI securities. In furtherance of this unlawful
scheme, plan and course of conduct, these defendants, and each of them, took the
actions set forth herein.
158. Defendants employed devices, schemes, and artifices to defraud;
made untrue statements of material fact and/or omitted to state material facts
necessary to make the statements made not misleading; and engaged in acts,
practices and a course of business which operated as a fraud and deceit upon
Class members in an effort to maintain artificially high market prices for SCI's
common stock in violation of Section 10(b) of the Exchange Act and Rule 10b-5
promulgated thereunder. These defendants are sued either as primary participants
in the wrongful and illegal conduct charged herein or as controlling persons.
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159. In addition to the duties of full disclosure imposed on defendants
as a result of their making of affirmative statements and reports, or
participation in the making of affirmative statements and reports to the
investing public, the defendants had a duty to promptly disseminate truthful
information that would be material to investors so that the market prices of the
Company's publicly traded common stock would be based on truthful, complete and
accurate information.
160. Defendants, individually and in concert, directly and indirectly,
by the use of means and instrumentalities of interstate commerce and/or of the
mails, engaged and participated in a continuous course of conduct to conceal
adverse material information about the Company's financial results, business,
operations, and future outlook as specified herein. These defendants employed
devices, schemes and artifices to defraud, while in possession of material
adverse non-public information and engaged in acts, practices, and a course of
conduct as alleged herein in an effort to mislead purchasers of SCI's securities
concerning the Company's business prospects and financial condition, which
included the making of, or the participation in the making of, untrue statements
of material facts and omitting to state material facts necessary in order to
make the statements made about the Company's financial and business operations
in the light of the circumstances under which they were made, not misleading, as
set forth more particularly herein, and engaged in transactions, practices and a
course of business which operated as a fraud and deceit upon Class members.
161. Defendants had actual knowledge of the misrepresentation and
omissions of material facts set forth herein, or acted with reckless disregard
for the truth in that they failed to ascertain and to disclose such facts, even
though such facts were available to them. Defendants' material
misrepresentations and/or omissions were done knowingly or recklessly and for
the purpose and
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effect of concealing SCI's operations and business affairs from the investing
public and supporting the artificially inflated price of its securities.
162. As a result of the dissemination of the materially false and
misleading information and failure to disclose material facts, as set forth
above, the market price of SCI securities was artificially inflated
(artificially deflated in the case of put options) throughout the Class Period.
In ignorance of the fact that the market price of SCI's securities were
artificially inflated, and relying directly or indirectly on the false and
misleading statements made by defendants, or upon the integrity of the market in
which the securities trade, and the truth of any representations made to
appropriate agencies as the investing public, at the times at which any
statements were made, and/or on the absence of material adverse information that
was known to or recklessly disregarded by defendants but not disclosed in public
statements by defendants, plaintiffs and the other members of the Class
purchased SCI's securities at artificially high prices and were damaged thereby.
163. At the time of said misrepresentations and omissions, plaintiffs
and the other members of the Class were ignorant of their falsity, and believed
them to be true. Had plaintiffs and the other member of the Class and the
marketplace known of the true nature of the operations of the Company and the
noncompliance with federal law, which were not disclosed by defendants,
plaintiffs and the other members of the Class would not have acquired their SCI
securities, or, if they had acquired such securities, they would not have done
so at the artificially inflated (artificially deflated in the case of put
options) prices which they paid.
164. By virtue of the foregoing, defendants have violated Section 10(b)
of the Exchange Act, and Rule 10b-5 promulgated there under.
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165. As a direct and proximate result of these defendants' wrongful
conduct, plaintiffs and the other members of the Class suffered damages in
connection with their purchases of SCI securities.
COUNT V
AGAINST THE INDIVIDUAL DEFENDANTS FOR
VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT
166. Plaintiffs incorporate the foregoing allegations as if fully set
forth herein. This claim is asserted against the Individual Defendants.
167. The Individual Defendants acted as controlling persons of SCI
within the meaning of Section 20(a) of the Exchange Act as alleged herein. By
virtue of their stock ownership, executive positions and Board membership, as
alleged above, the Individual Defendants had the power to influence and control
and did influence and control, directly or indirectly, the operations of the
Company, and possessed the power and/or ability to control each of the wrongful
acts and practices complained of herein, including the content and dissemination
of the various statements which plaintiffs contend are false and misleading. The
Individual Defendants were provided with or had unlimited access to copies of
the Company's internal reports, press releases, public filings and other
statements alleged by plaintiffs to be misleading prior to and/or shortly after
these statements were issued and had the ability to prevent the issuance of the
statements or cause the statements to be corrected.
168. In particular, the Individual Defendants had direct involvement in
the day-to-day operations of the Company and therefore, are presumed to have had
the power to control or influence the particular transactions giving rise to the
securities violations as alleged herein, and exercised the same.
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169. As set forth above, SCI violated Section 10(b) and Rule l0b-5 by
its acts and omissions as alleged in this Complaint. By virtue of their
positions as controlling persons of SCI, the Individual Defendants are liable
pursuant to Section 20(a) of the Exchange Act. As a direct and proximate result
of defendants' wrongful conduct, plaintiffs and the other members of the Class
suffered damages in connection with their purchases of SCI securities.
COUNT VI
AGAINST SCI FOR VIOLATIONS
OF SECTION 20A OF THE EXCHANGE ACT
170. Plaintiffs incorporate the foregoing allegations as if fully set
forth herein. This claim is asserted against SCI. This count is brought on
behalf of those Class members who exchanged shares of ECI common stock for
shares of SCI common stock in connection with the Merger or held employee
options to purchase ECI common stock under a stock plan of ECI that became
options to purchase SCI common stock as a result of the Merger.
171. The exchange of SCI stock for ECI stock pursuant to the Merger
Agreement constituted a sale of securities within the meaning of Section 20A of
the Exchange Act. 15 U.S.C. Section 78t-1. At the time of the exchange of SCI
stock for ECI stock, SCI was in possession of material, non-public information
concerning the financial condition of SCI. As a result of SCI's failure to
disclose the material, non-public information in its possession, SCI was able to
negotiate a higher ratio of exchange of SCI stock for ECI stock.
172. By virtue of the foregoing, SCI has violated Section 20A of the
Exchange Act.
173. As a direct and proximate result of SCI's wrongful conduct,
members of the Class suffered damages in connection with their exchange of ECI
stock and ECI options for SCI stock and SCI options.
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PRAYER FOR RELIEF
WHEREFORE, plaintiffs, on their own behalf and on behalf of the other
members of the Class. respectfully request that this Court enter judgment in
their favor and against defendants as follows:
(a) Awarding plaintiffs and the other members of the Class rescission
of their shares and/or the appropriate measure of damages;
(b) Awarding plaintiffs and the other members of the Class prejudgment
and post-judgment interest, as well as their reasonable attorneys' fees, expert
witness fees and other costs and expenses; and
(c) Awarding such other relief as this Court may deem just and proper.
JURY DEMAND
Plaintiffs demand a trial by jury.
DATED: September 3, 1999
Respectfully submitted,
By:
--------------------------------
ROGER B. GREENBERG
Attorney-in-Charge
State Bar No. 08390000
12 Greenway Plaza, 10th Fl.
Houston, TX 77046
(713) 627-2720
(713) 627-7057 Fax
Lead Counsel for Plaintiffs
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OF COUNSEL:
GREENBERG, PEDEN, SIEGMYER & OSHMAN, P.C.
David E. Sharp
Tenth Floor, 12 Greenway Plaza
Houston, TX 77046
(713) 627-2720
(713) 627-7057 Fax
WOLF POPPER LLP
Robert M. Kornreich
Paul O. Paradis
Peter Safirstein
Catherine E. Anderson
845 Third Avenue
New York, NY 10022
BERMAN, DEVALERIO & PEASE LLP
Glen DeValerio
Michael T. Matraia
One Liberty Square
Boston, MA 02109
BERNSTEIN LITOWITZ BERGER
& GROSSMANN, LLP
Douglas M. McKeige
1285 Avenue of the Americas
33rd Floor
New York, NY 10019
LAW OFFICES OF STEVEN E. CAULEY, PA
Steven E. Cauley
Suite 218, Cypress Plaza
Little Rock, AK 72212
COHEN, MILSTEIN, HAUSFELD & TOLL, PLLC
Steven J. Toll
999 Third Avenue, Suite 3600
Seattle, WA 98104
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MILBERG WEISS BERSHAD
HYNES & LERACH LLP
Abraham Rappaport
Maya Saxena
5355 Town Center Road
Suite 900
Boca Raton, FL 33486
ABBEY, GARDY & SQUITIERI LLP
Mark S. Gardy
212 East 39th Street
New York, NY 10016
BARRACK, RODOS & BACINE
2001 Market Street
33rd Floor
Philadephia, PA 19103
BERGER & MONTAGUE, PC
Todd S. Collins
Michael L. Block
1622 Locust Street
Philadelphia, PA 19103
BOIES & SCHILLER, LLP
Richard Drubel
26 South Main Street
Hanover, New Hampshire 03755
BRUCE G. MURPHY
265 Llywyd's Lane
Veto Beach, Florida 32963
CHANDLER LAW OFFICES
George Chandler
P.O. Box 3400
Lufkin, TX 75901
CLAXTON & HILL, PLLC
Roger F. Claxton
Robert J. Hill
3131 McKinney Avenue - LB 103
700 McKinney Place
Dallas, Texas 75204-2471
74
CONSTANT & VELA
Anthony Constant
802 North Caranachua
Suite 1570
Corpus Christi, TX 78401
CRUSE, SCOTT, HENDERSON & ALLEN, LLP
Sam W. Cruse
600 Travis Street, Suite 3900
Houston, TX 77002-2910
FARUQI & FARUQI
Nadeem Farqui
415 Madison Avenue
New York, NY 10017
FINKELSTEIN & KRINSK
Howard D. Finkelstein
Jeffrey R. Krinsk
501 West Broadway, Suite 1250
San Diego, CA 92101-3579
FRANK & ROSEN
Alan L. Frank
David T. Shulick,
1835 Market Street, Suite 320
Philadelphia, PA 19103
HOEFFNER, BILEK & EIDMAN
Thomas E. Bilek
720 Lyric Office Center
440 Louisiana, Suite 720
Houston, TX 77002
JAROSLAWICZ & JAROS
David Jaroslawicz
150 William Street
New York, NY 10038
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KAPLAN, KILSHEIMER & FOX LLP
Robert N. Kaplan
Peter A. Lennon
Janine R. Azriliant
685 Third Avenue, 26th Floor
New York, NY 10017
KENNETH A. ELAN
217 Broadway, Suite 404
New York, NY 10007
KIRBY MCINERNEY SQUIRE
Jeffrey H. Squire
Ira M. Press
830 Third Avenue, 10th Floor
New York, NY 10022
LAW OFFICES OF CLAYTON E. DARK, JR.
Clayton E. Dark, Jr.
P.O. Box 2207
Lufkin, TX 75902-2207
LAW OFFICES OF DENNIS J. JOHNSON
Dennis J. Johnson
1690 Williston Road
South Burlington, VT 05403
LOCKRIDGE, GRINDAL, NAUEN & HOSTEIN, PLLP
Richard A. Lockridge
Karen M. Hanson
100 Washington Avenue South, Suite 2200
Minneapolis, MN 55401
LOWEY DANNENBERG BEMPORAD
& SELINGER PC
Richard Bemporad
David C. Harrison
The Gateway - 11th Floor
One North Lexington Avenue
White Plains, NY 10601-1714
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LYNN STODGHIIL MELCHIMER
AND TILLOTSON, LLP
Thomas M. McIsheimer
M. Brett Johnson
750 N. Pearl Street, Suite 1400
Dallas, TX 75201
RABIN & PECKEL LLP
Marvin L. Frank
Joseph V. McBride
275 Madison Avenue, 34th Floor
New York, NY 10016
SCHIFFRIN & BARROWAY, LLP
Andrew L. Barroway
David Kessler
Three Bala Plaza East, Suite 400
Bala Cynwyd, Penn. 19004
SCOTT & SCOTT
Neil Rothstein
108 Norwich Avenue
P.O. Box 192
Cochester, CT 06415
SCOTT, DOUGLASS & MCCONNICO, LLP
Stephen E. McConnico
600 Congress Avenue, 15th Floor
Austin, TX 78701-2334
SPECTOR & ROSEMAN, PC
Eugen A. Spector
Jeffrey L. Kodroff
1818 Market Street, Suite 2500
Philadelphia, PA 19103
STULL STULL & BRODY
Jules Brody
Aaron Brody
6 East 45th Street
New York, NY 10017
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SUSMAN GODFREY LLP
Kenneth S. Marks
5100 First Interstate Bank Plaza
1000 Louisiana
Houston, TX 77002-5096
THE OLSEN LAW FIRM
Kurt Olsen
2121 K. Street, N.W. Suite 800
Washington, D.C. 20037
WEISS & YOURMAN
Joseph H. Weiss
551 Fifth Avenue, Suite 1600
New York, NY 10176
WHITTINGTON, VONSTERNBERG, EMERSON
& WILSHER, LLP
John G. Emerson, Jr.
2600 South Gessner, Suite 600
Houston, TX 77063
WOLF, HALDENSTEIN, ADLER, FREEMAN
& HERZ, LLP
Fred T. Isquith
Robert Abrams
270 Madison Avenue
New York, NY 10016
ATTORNEYS FOR PLAINTIFFS
Certificate of Service
This document was served on defendants' counsel of
record on September 3, 1999 pursuant to the Federal
Rules of Civil Procedure.
/s/ David E. Sharp
------------------
David E. Sharp
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