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EXHIBIT 99.5
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION
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)
THOMAS W. BROWN, ADMINISTRATOR, ) NO. 1 96-CV 2904
THOMAS W. BROWN PROFIT SHARING )
PLAN, Derivatively on Behalf of ) FIRST AMENDED VERIFIED
MEDAPHIS CORPORATION, ) DERIVATIVE COMPLAINT
)
Plaintiff, ) PLAINTIFF DEMANDS A
vs. )
RANDOLPH G. BROWN, ROBERT C. BELLAS, ) TRIAL BY JURY
JR., DAVID R. HOLBROOKE, RICHARD H. )
STOWE, JOHN A. DOWNER, DAVID E. )
McDOWELL, DENNIS A. PRYOR, STEVEN G. )
PAPERMASTER, MICHAEL L. DOUGLAS, )
MICHAEL R. COTE and JAMES S. )
DOUGLASS, )
)
Defendants, )
and )
)
MEDAPHIS CORPORATION, )
)
Nominal Defendant. )
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Plaintiff, through his attorneys, for his First Amended Derivative
Complaint ("Complaint") alleges, as of November 1, 1996, the date of the
original filing of Plaintiff's derivative complaint, upon information and
belief, except as to the allegations contained in paragraph 2, which are alleged
upon personal knowledge, as follows:
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INTRODUCTION
1. This is a shareholders' derivative action brought on behalf of
Medaphis Corporation (hereinafter "Medaphis" or "the Company"), a Delaware
corporation whose headquarters and principal place of business are in Atlanta,
Georgia. Medaphis' shares are publicly traded on the NASDAQ market, with at
least hundreds of record shareholders and many thousands of beneficial
shareholders. In this action, plaintiff, on behalf of Medaphis, alleges that
defendants have damaged Medaphis by deliberately, in bad faith or recklessly (I)
engaging in violations of federal securities laws, (ii) implementing a sham
system of internal controls completely inadequate to ensure timely and proper
accounting and reserves to account for receivables, (iii) engaging in fraud and
securities fraud, and (iv) by damaging the Company's reputation. As alleged
herein, defendants' actions and omissions were deliberate, undertaken in bad
faith, fraudulent, and constituted breaches of their fiduciary duties of loyalty
and due care. The acts and omissions alleged herein occurred during the period
from February 29, 1996 through October 22, 1996 (the "Relevant Period").
Defendants were motivated by the desire to wrongfully obtain the resources
Medaphis needed to succeed in its existing commitments, which it could not meet,
at a nominal cost, and thereby secure their continued lucrative employments as
officers and directors of Medaphis and its subsidiaries. Defendants knew that if
Medaphis' true financial and operational condition became known, Medaphis would
be unable to continue to grow using its stock as currency for acquisitions, to
gain expertise and manpower to perform under existing Medaphis contracts which
Medaphis lacked the resources to perform, as set forth below. Defendants knew
that if the truth about Medaphis became public, Medaphis would be forced to
restructure and eliminate or divest itself of subsidiaries of which certain
defendants are
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officers and founders, and otherwise renegotiate the Company's major contracts
and credit resources, to the personal detriment of defendants.
THE PARTIES
2. Plaintiff Thomas W. Brown, Administrator, Thomas W. Brown
Profit Sharing Plan, resides in Carnegie, Pennsylvania. Plaintiff purchased
1,260 shares of Medaphis common stock on June 21, 1995 and has been a
shareholder of the Company continuously since that date.
3. Nominal Defendant Medaphis is a provider of outsourced
billing, accounts receivable and business management systems and services to the
health care industry. As of August 12, 1996, there were more than 71 million
shares of Medaphis common stock outstanding. During the Relevant Period, the
Company's common stock was actively traded on the NASDAQ National Market System.
4. Defendant Randolph G. Brown ("Brown") was at all times
relevant the President, Chief Executive Officer and a Director of Medaphis. He
joined the Company in July 1987 as Executive Vice President and Chief Financial
Officer and was named President, Chief Executive Officer and Director in April
1988, and Chairman in January 1991. Defendant Brown received $1,508,396 in total
cash compensation in 1995, which included a $1 million signing bonus received as
part of a five-year employment agreement he entered into in March 1995. Also in
1995, defendant Brown received options to purchase 200,000 shares of Medaphis
common stock at an exercise price of $22.8150 per share. As of March 12, 1996,
defendant Brown beneficially owned a total of 500,750 shares of the Company's
common stock. Brown executed the Company's Annual Report on Form 10-K filed with
the Securities and Exchange Commission
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("SEC") on April 1, 1996. Brown was still a director of the Company on November
1, 1996, when this derivative action was first filed.
5. Defendant Robert C. Bellas, Jr. ("Bellas") has been a director
of Medaphis since 1987, and is a member of the Audit and Compensation Committees
of the Board of Directors. Bellas serves as Chairman of the Compensation
Committee. Bellas signed the Company's Annual Report on Form 10-K filed with the
SEC on April 1, 1996. As of April 3, 1996, Bellas beneficially owned 8,115
shares of the Company's common stock, including shares issuable upon the
exercise of stock options. Bellas signed Medaphis' registration statement on
Form S-3 filed with the SEC on July 12, 1996.
6. Defendant David R. Holbrooke ("Holbrooke") has been a
director of Medaphis since 1994, and is a member of the Audit Committee of the
Board of Directors. Holbrooke signed the Company' s Annual Report on Form 10-K
filed with the SEC on April 1, 1996. As of April 3, 1996, Holbrooke beneficially
owned 33,900 shares of the Company's common stock, including shares issuable
upon the exercise of stock options. Holbrooke signed Medaphis' registration
statement on Form S-3 filed with the SEC on July 12, 1996.
7. Defendant Richard H. Stowe ("Stowe") was a director of
Medaphis from 1988 until approximately May 16, 1996, and was a member of the
Audit and Compensation Committees of the Board of Directors. Stowe chaired the
Company's Audit Committee. Stowe signed the Company's Annual Report on Form 10-K
filed with the SEC on April 1, 1996. As of April 3, 1996, Stowe beneficially
owned 13,762 shares of the Company's common stock, including shares issuable
upon the exercise of stock options.
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8. Defendant John A. Downer ("Downer") was a director of Medaphis
from 1989 until approximately May 16, 1996. Downer signed the Company's Annual
Report on Form 10-K filed with the SEC on April 1, 1996.
9. Defendant David E. McDowell ("McDowell") has since
approximately May 16, 1996, served as a director of Medaphis. Since
approximately October 31, 1996, McDowell has served as Chairman and Chief
Executive Officer of Medaphis, assuming these positions following Brown's
resignation of these positions. McDowell signed Medaphis' registration statement
on Form S-3 filed with the SEC on July 12, 1996.
10. Defendant Dennis A. Pryor ("Pryor") has since 1992 served as
a director of Medaphis. Pryor served as Chairman of Medaphis subsidiary CompMed,
acquired by merger in 1992. Pryor signed Medaphis' registration statement on
Form S-3 filed with the SEC on July 12, 1996.
11. Defendant Steven G. Papermaster ("Papermaster") has, since
approximately May 16, 1996, served as a director of Medaphis. Papermaster is
Chairman and CEO of Medaphis subsidiary BSG Corp., acquired by merger on May 6,
1996. Papermaster signed Medaphis' registration statement on Form S-3 filed with
the SEC on July 12, 1996.
12. Defendant Michael L. Douglas ("Douglas") from approximately
June 26, 1996 to approximately February 5, 1997, served as a director, Vice
Chairman and Chief Operating Officer of Medaphis. Although represented by
Medaphis to be a director at the time, Douglas did not sign the registration
statement on Form S-3 filed with the SEC on July 12, 1996.
13. Defendant Michael R. Cote ("Cote") is and was, at all relevant
times, Senior Vice President-Finance and Chief Financial Officer of the Company.
Press releases issued by
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defendants during the Relevant Period consistently identified Cote as the
contact person at the Company for purposes of communications with the investment
community. Cote signed all periodic reports and registration statements filed
with the SEC during the Relevant Period.
14. Defendant James S. Douglass ("Douglass") is and was, at all
relevant times, Vice President, Corporate Controller, and Chief Accounting
Officer of the Company.
15. Brown, Bellas, Holbrooke, Stowe, Downer, McDowell, Pryor,
Papermaster and Douglas, are collectively hereinafter sometimes referred to as
the "Director Defendants".
16. Brown, Bellas, Holbrooke, Stowe, Downer, McDowell, Pryor,
Papermaster, Douglas, Cote and Douglass are collectively hereinafter sometimes
referred to as the "Individual Defendants".
JURISDICTION AND VENUE
17. This court has subject matter jurisdiction over this action
pursuant to 28 U.S.C. ss.ss. 1332(a) (1) and 1367(a). Venue is proper pursuant
to 28 U.S.C. ss. 1391(a)(2) because a substantial part of the events or
omissions giving rise to the claims set forth herein occurred in this judicial
district.
SUBSTANTIVE ALLEGATIONS
MEDAPHIS' BUSINESS OPERATIONS AND METEORIC
GROWTH THROUGH ACQUISITIONS
18. Medaphis has consistently described itself as a leading
provider of business management systems and services to the healthcare industry.
The Company's original and core business consists of billing, collection, and
other outsourced financial services designed to assist its physician clients
with the business management functions associated with providing medical
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services. Medaphis also provides subrogation and related recovery services
primarily to healthcare payers, scheduling and information management systems to
hospitals and emerging integrated healthcare delivery systems, and systems
integration and work flow engineering systems and services.
19. Medaphis reportedly provides business management systems and
services to over 19,000 physicians and over 2,000 hospitals across the United
States, subrogation and services to healthcare plans covering in excess of 23
million people nationwide, and systems integration and work flow engineering
systems and services in the United States and abroad. The Company's operations
are organized into two principal operating units: Medaphis Services Corporation,
which includes all doctor and hospital transaction processing companies,
including MPSC; and Medaphis Systems Corporation, which includes all of
Medaphis' technology companies, including its systems integration businesses
(such as Imonics) and its healthcare information businesses (such as Atwork) .
20. Over the past several years, a key component of Medaphis'
stated business strategy involved growth through acquisitions of other
businesses, using its stock as currency. Indeed, Medaphis built its reputation
in the investment community by representing itself as a fast-growing company
with an aggressive acquisition program and a successful history of integrating
those acquisitions smoothly into its overall business operations. Such
representations - which, as will be shown herein, were demonstrably false and
misleading - convinced the investment community that the Company's strategy was
successful and poised Medaphis for future earnings growth. For example:
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Analysts liked the flawless way Medaphis assimilated these firms [it
acquired], which formed the core of the company's 40-plus acquisitions
over eight years. As revenue grew fivefold, Medaphis gained Wall Street
stardom. The Atlanta Journal and Constitution, September 8, 1996.
21. The Company's rising stock price financed Medaphis' growth
strategy. Because Medaphis paid for most of its acquisitions with stock, the
higher the price of the stock, the fewer shares the Company had to issue to
acquire target businesses.
22. Prior to and during the Relevant Period, defendants left no
doubt that Imonics -- a company acquired by Medaphis in late 1994 -- was one of
the keys to the Company's success, and enabled the Company to continue its
strategy of growth through acquisitions. Medaphis consistently represented that
the Imonics acquisition allowed it to diversify its operations from primarily
billing and accounts receivable management and enabled the Company to offer
integration services to various health care providers and other businesses.
Imonics was also put in charge of re-engineering the physician billing business
of Medaphis, which falls under MPSC, the Company's largest operating unit, which
reportedly accounts for approximately 60% of the Company's total services
revenues.
23. With the acquisition of Imonics, Medaphis began a
much-publicized project to re- engineer the paper and labor intensive business
of MPSC in order to significantly reduce personnel-related costs, upgrade the
Company's systems to the level of other service industries, and provide for
economies of scale. Defendants have referred to this project as the
"Re-Engineering Project".
24. The Re-Engineering Project was designed to allow for the
consolidation of the processing operations of MPSC that had previously been
conducted in over 300 local physician
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backoffice operations into fewer than 10 large regional data processing centers.
The Re-Engineering Project involved designing and installing software through
Imonics to automate the Company's billing process and reduce the quantity of
paper processed.
FALSE AND MISLEADING STATEMENTS DURING THE
RELEVANT PERIOD
1. DEFENDANTS' MOTIVATION AND METHODOLOGIES
25. The defendants were aware that in order for Medaphis to
preserve its status as a Wall Street "star," it would have to continue
aggressively acquiring high-profit technology companies to generate revenues
sufficient to maintain its growth and cover the high costs of its Re-Engineering
Project. Moreover, to continue its acquisition strategy, Medaphis would have to
use it stock as currency. To this end, beginning at the end of 1995, defendants
set out to increase the price of Medaphis stock and thereby ensure that the
Company's acquisition pipeline remained robust by issuing a series of materially
false and misleading public statements. Specifically, defendants knew that, but
for Medaphis continuing its acquisition strategy, Medaphis would be unable to
meet its obligations under existing contracts, and would be forced to eliminate,
divest or otherwise restructure its operations to the detriment of defendants'
positions with Medaphis and the Medaphis subsidiaries of which defendants were
founders and employees.
26. The materially false and misleading public statements issued
by defendants related in large part to reported financial results and financial
statements that did not comply with Generally Accepted Accounting Principles
("GAAP"). GAAP encompasses the rules, conventions and practices recognized and
employed by the accounting profession for the preparation financial statements.
Statements of Financial Accounting Standards are promulgated by the profession's
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Financial Accounting Standards Board, and are considered the highest authority
of GAAP. SEC Regulation S-X (17 C.F.R. ss.210.4-01(a)(1)) provides that
financial statements filed with the SEC which are not prepared in compliance
with GAAP are presumed to be misleading and inaccurate.
27. Defendants' false and misleading statements also related to
narrative misrepresentations concerning: Medaphis' business operations and the
Re-Engineering Project; Medaphis' earnings growth; the operating performance,
condition and prospects of Imonics; and Medaphis' acquisition and integration of
several companies into the operations of Imonics.
28. Defendants issued these statements directly, through press
releases, SEC filings, and annual and quarterly reports to shareholders.
Defendants also provided guidance to securities analysts and used them as
conduits to provide false and misleading information to the investment
community.
29. In writing their reports, several of which are referred to
herein at paragraphs 32, 33, 34, 63, 67, and 86-88 securities analysts relied in
substantial part upon information provided to them privately by the Company.
Indeed, it was the Company' s practice to have key members of its management
team, including defendants Brown and Cote, communicate with securities analysts
on a regular basis to discuss the Company's business, operations, performance
and prospects. Defendants knew that by disseminating information to the
investment community, investors would rely and act upon such information and
that such information would have in effect on the market price of the Company's
Stock.
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2. FEBRUARY 6, 1996 PRESS RELEASE ANNOUNCING FOURTH QUARTER
AND YEAR-END 1995 RESULTS AND RELATED ANALYSTS REPORTS
30. On February 6, 1996, defendants issued a press release
announcing the Company's results for the fourth quarter and year ended December
31, 1995. The Company reported fourth quarter earnings of $11.4 million or $0.22
per share before one-time merger and other charges. These results, which were in
line with analysts' estimates, represented a more than 50% increase over
reported earnings of $0.14 per share in the fourth quarter of 1994. For the full
year of 1995, Medaphis reported operating earnings of $41.9 million or $0.82 per
share before charges, representing an increase of approximately 80% over
reported operating earnings for the full year of 1994. The Company also reported
in the February 6, 1996 release that operating revenues grew 29% in the fourth
quarter, to $122.5 million, also in line with analysts' projections. Revenue for
the year ended December 31, 1995 was reportedly $467.8 million, up 47% from
$319.1 million in the same period in 1994.
31. In this press release, defendant Brown noted that the
Re-Engineering Project was progressing well and had achieved "significant
milestones", and that the Company's technology division (which includes Imonics
and Atwork) "continued to grow rapidly and show positive operating results
outperforming our expectations in the second half of 1995" and was "effectively
offsetting the margin pressure and results" being experienced by MPSC.
32. Securities analysts following Medaphis, while taking note of
the margin pressures at MPSC, recommended the purchase of Medaphis stock based
on defendants' representations and other information provided by the Company.
For example, on February 7, 1996, one day
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after the quarterly and annual operating results were issued, Donaldson, Lufkin
& Jenrette issued a research report which stated:
Medaphis reported Q4 and year end 1995 results from continuing
operations of $0.22 and $0.82, respectively.... Based on the results...
it is becoming clear that the higher-growth technology businesses (such
as Imonics, Atwork and Consort) are more than offsetting the margin
pressures at MPSC. As MEDA essentially hit our EPS projections, we
remain comfortable with our $1.07 EPS estimate for this year and a
range of $1.40 - 1.50 for 1997.
33. In a similar vein, a research report issued by Hambrecht &
Quist on February 7, 1996, again prepared on the basis of information provided
by the Company and/or its senior management stated:
Management indicates that, in addition to the technology units, several
of the recent acquisitions are experiencing growth that is well-above
the corporate average. Overall, the company 's internal growth has
largely been moderated by a lack of growth in the MPSC unit. Looking
forward, this unit should see better growth as the re-engineering
effort winds down. MPSC's growth, when combined with the other units,
should accelerate Medaphis' internal growth rate.... The company
continues to progress on the re-engineering front.... To reiterate,
while Medaphis' re-engineering is modestly depressing margins in the
near-term, we believe the long term efficiencies gained will more than
offset any pricing pressure in the core billing and receivables market
and fuel significant EBITDA margin expansion in 1997.
34. Likewise, a report issued by the firm of Morgan Stanley on
February 6, 1996, on the basis of information provided by the Company and/or its
senior management, stated in relevant part:
MEDA's overall fundamentals continue to be buoyed by its strong
technology divisions. We estimate that the companies Atwork, Imonics,
and recently acquired Consort divisions will be the driving force to
margins. We estimate that these divisions are on the order of 1-2 times
more profitable than MEDA's core A/R, billing business. As evidence of
MEDA's conviction here, it has significantly added to staff at the
Imonics subsidiary, increasing headcount from 80 to 300 in 1995.
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The February 6, 1996 press release announcing operating results for the fourth
quarter and full year, 1995, and the information provided by defendants to the
market through the analysts' reports referred to in paragraphs 30-34 were
materially false and misleading in at least the following respects:
(a) The financial results incorporated and discussed
therein were false and had been achieved only through the use of improper
accounting practices in violation of GAAP. As was ultimately disclosed at the
close of the Relevant Period, the operating results reported for this period
were improperly and materially overstated by at least $5 million as a result of
the reporting of revenues and profits under software license agreements entered
into by Imonics, which is permissible under GAAP only where customers are
unconditionally obligated to perform under the agreements. In fact, unknown to
the general public, in order to create the illusion that more customers had
signed such license agreements than was actually the case, the Company had
aggressively enlisted one or more major customers but then provided them with
secret side letters, enabling the customer(s) to avoid paying all of the fees
payable under the agreements. This was improper under GAAP, in the following
respects:
Accounting Research Bulletin ("ARB") 43, Chapter 1, Section A: Profit
is deemed to be realized when a sale in the ordinary course of business
is effected, unless the circumstances are such that the collection of
the sale price is not reasonably assured. (Emphasis added.)
Financial Accounting Standards Board ("FASB") Statement of Concepts
("CON"), paragraph 83 (a): Revenues and gains are generally not
recognized until realized or realizable. Revenues and gains are
realized when products (goods or services), merchandise, or other
assets are exchanged for cash or claims to cash. Revenues and gains are
realizable when related assets received or held are readily convertible
to known amounts of cash or claims to cash. (Emphasis added).
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FASB Statement of Standards No. 5, paragraph 27: Contingencies that
might result in gains usually are not reflected in the accounts since
to do so might be to recognize revenue prior to its realization.
FASB Statement of Standards No. 48 ("FAS48"), paragraph 6: If an
enterprise sells its product but gives the buyer the right to return
the product, revenue from the sales transaction shall be recognized at
time of sale only if all of the following conditions are met: (1) The
seller's price to the buyer is substantially fixed or determinable at
the date of sale; (2) The buyer has paid the seller, or the buyer is
obligated to pay the seller and the obligation is not contingent on
resale of the product; (3) The buyer's obligation to the seller would
not be changed in the event of theft or physical destruction or damage
of the product; (4) The buyer acquiring the product for resale has
economic substance apart from that provided by the seller; (5) The
seller does not have significant obligations for future performance to
directly bring about resale of the product by the buyer; and the amount
of future returns can be reasonably estimated.
Where resolution of a significant contingency is part of a license agreement,
then "a sale in the ordinary course of business" has not been "effected." (ARB
43). Additionally, if the contingency is not resolved, then "related assets
received or held are [not] readily convertible to known amounts of cash or
claims to cash." (FASB CON 5). Further, if the non-satisfaction of the
contingency results in the "return" of the product or the absence of any
obligation of the buyer to pay for the license fee, then the buyer is not
"obligated to pay the seller" and revenue may not permissibly be recognized
under the license agreement. (FAS48). As detailed in paragraphs 107- 108, the
falsification of reported revenue in the fourth quarter of 1995 ultimately
required the Company, at the end of the Relevant Period, to restate the results
to reduce reported net income by $5.1 million, resulting in a net loss of $1.1
million rather than the previously reported net income of $4 million for the
quarter, and a net loss of $8.5 million for 1995, over double the previously
reported net loss of $3.4 million for the year.
(b) In addition, the representations that the technology
division (consisting primarily of Imonics and Atwork) was "effectively
offsetting" the margin pressures and results at
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MPSC were materially false and misleading when made in that the technology
division was not able to offset revenue, growth and margin pressures affecting
MPSC because: (i) Imonics was experiencing severe operational problems
including, among other things, excessive staffing, inadequate cost controls, and
poor operating performance so severe that they negated Imonics' ability to
perform as represented; and (ii) Atwork's sales pipeline had been in decline
since September of 1995 and there were significant operating flaws, or "bugs,"
in certain of the Atwork division's software products introduced at year end
1995.
3. PUBLIC STATEMENTS RELATING TO THE RAPID SYSTEMS AND
BSG MERGERS
35. Having disseminated its materially false and misleading press
release of February 6, 1996, which included false financial results showing
increasing net income rather than true losses the Company was actually
suffering, Medaphis implemented its scheme to use its stock (the price of which
was artificially inflated as a result of defendants' misstatements) as currency
for additional acquisitions.
36. Thus, on February 29, 1996, defendants caused Medaphis to file
with the SEC a Form S-4 Registration Statement (the "February 1996 Registration
Statement"), which was signed by defendants Brown, Bellas, Holbrooke, Pryor,
Stowe, Downer, Cote and Douglass. Defendants filed the February, 1996
Registration Statement in order to issue 2 million shares of Medaphis common
stock which the Company reported "may be offered by Medaphis from time to time
in connection with acquisitions of other businesses or properties."
37. On March 13, 1996, the defendants issued a press release
announcing that Medaphis had signed a definitive agreement to acquire all of the
outstanding capital stock of
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Rapid Systems Solutions, Inc. ("Rapid Systems") (a closely-held, Columbia,
Maryland based computer systems integration company) in exchange for 1,135,000
shares of Medaphis common stock, worth approximately $43 million (the "Rapid
Systems Merger"). Defendant Brown stated that Rapid Systems was acquired
specifically because it complemented "the work Imonics is doing on the Medaphis
re-engineering project."
38. Two days later, on March 15, 1996, defendants issued a press
release announcing yet another acquisition, this time reporting that Medaphis
had executed a definitive agreement to acquire all of the outstanding capital
stock of BSG Corporation ("BSG") for approximately $350 million in stock,
including 7.5 million shares of Medaphis common stock, and assumption by
Medaphis of BSG stock options and stock rights representing an additional 2.66
million shares of Medaphis common stock (the "BSG Merger"). This transaction
represented the largest acquisition yet for Medaphis. According to the March 15
announcement, the Company's "existing systems integration and information
technology (IT) services companies - including Imonics Corporation and Rapid
Systems Solutions, Inc. - will come under the BSG umbrella, thereby creating the
industry's largest IT services company focused purely on client/server
technology and applications.
39. Significantly, defendant Brown, in emphasizing the
importance of the BSG Merger, assured investors that BSG had the necessary
infrastructure to manage successfully the integration of both Imonics and Rapid
Systems to create successfully the largest client/server technology services
company in the country:
The merger with BSG is a major milestone in increasing our technology
capabilities. Working with Imonics and Rapid Systems Solutions, BSG
will lead our systems
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integration efforts and we believe will accelerate transformation of
the way transaction processing in performed in the healthcare industry.
We are excited about our newly acquired capabilities in client/server
consulting and systems integration. Imonics and Rapid Systems Solutions
combined with BSG have created, we believe, the largest pure
client/server technology services company in the country. (Emphasis
added.)
40. A March 18, 1996 Wall Street Journal article reported in
connection with the planned BSG Merger that:
[t]he company said it decided to make a bigger push into systems
integration following the successful 1994 acquisition of Imonics, which
has seen its profit double since the purchase and its employees
increase, according to Michael Cote, Medaphis' chief financial officer.
41. As a result of the foregoing positive announcements, on
March 20, 1996, Medaphis shares hit a 52-week high of $53.25, a 40% increase
over the stock's March 12, 1996 close of $37.50.
42. The statements concerning the synergies and efficiencies of
the Rapid Systems and BSG Mergers, and the Company's integration of the
operations of Rapid Systems and BSG into its overall business identified in
paragraphs 36-40 above were materially false and misleading. Among other
reasons, because of the severe operational problems at Imonics summarized at
paragraphs 34(b) and 47 hereof, there was no reasonable basis for the
representations concerning the synergies offered by the merger of Imonics and
Rapid Systems with BSG's operations. Defendant Cote's representations concerning
the supposed profitability of Imonics were false and misleading for the same
reason, as well as for the added reason that, as set forth in greater detail at
paragraph 34(a) above, Medaphis' publicly reported profits were materially false
and misleading as a result of improper revenue recognition practices relating
specifically to improprieties at Imonics.
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43. On April 3, 1996, in connection with the BSG Merger, Medaphis
filed with the SEC a Registration Statement on Form S-4 (The "BSG Registration
Statement") and a Proxy Statement/Prospectus (the "BSG Prospectus"). The BSG
Registration Statement was signed by defendants Brown, Bellas, Holbrooke, Pryor,
Stowe, Downer, Cote and Douglass.
44. The BSG Prospectus, which was included as part of the BSG
Registration Statement filed with the SEC, incorporated by reference Medaphis'
Annual Report on Form 10-K for the fiscal year ended December 31, 1995,
including the audited financial statements incorporated by reference therein,
(discussed at paragraphs 47-57 herein), and incorporated the false and
misleading statements of the Company's year-end and fourth quarter 1995 results
as reported in the February 6, 1996 press release referred to at paragraph 30
above. These documents represent that the financial results presented therein
"include all adjustments . . . that are necessary for a fair presentation of the
financial position and results of operations for such periods."
45. In addition, the BSG Prospectus repeated defendants'
misleading statements regarding the successful consolidation of Imonics, BSG and
Rapid Systems, stating that the merger "will position Medaphis as the leading
client/server systems integration and workflow engineering company in the United
States." The BSG Prospectus also falsely stated that:
Finally, management believes that BSG, Rapid Systems and Imonics
complement each other and that the combination of these three
organizations within Medaphis should produce synergies.... Imonics
possesses extremely talented object oriented programming expertise, an
existing library of object codes and proprietary pricing methodologies.
Management of Medaphis believes that each of the foregoing attributes
of BSG, Rapid Systems and Imonics are complimentary [sic] in nature and
together position Medaphis to take advantage of systems integration and
workflow engineering projects within and outside the healthcare
industry.
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46. The BSG Prospectus also provided the following highly positive
description of the Re-Engineering Project:
In order to increase efficiency and position Medaphis to take advantage
of the opportunities being created by ongoing changes in the healthcare
industry, Medaphis has commenced a re-engineering project which will
involve, among other things, the consolidation of the billing and
accounts receivable processing function of its billing and accounts
receivable management business, which is currently operated out of
approximately 300 local business offices around the country, into
approximately 10 remote processing centers. In addition to the
consolidation of processing operations, the re-engineering project will
involve the establishment of advanced client/server computing at the
local sales and service offices and at remote processing centers. This
computing infrastructure will be designed to significantly reduce paper
handling and greatly increase the speed of record recovery while
permitting communication over a wide-area network and across geographic
markets and linking together all of Medaphis' operating divisions . . .
47. The BSG Prospectus continued:
Medaphis believes the re-engineering project will provide its customers
and employees with the full information processing and communications
power of an advanced distributed computing system. The re-engineering
project is designed to enable Medaphis to continue to grow and achieve
economies of scale in several areas, including training, client
service, patient and payer relations, transaction processing operations
and electronic data interchange capabilities. The project is expected
to be substantially completed during 1997. Although the re-engineering
project will involve consolidation of the processing functions of its
billing and accounts receivable management services, Medaphis intends
to continue to maintain and place increased emphasis on the sales and
customer service functions of this business on a local basis. (Emphasis
added)
(a) The representations contained in the BSG Registration
Statement and Prospectus, which incorporated Medaphis' operating results for the
fourth quarter and full year 1995 by reference, as well as the May 7, 1996 press
release, were materially false and misleading in the manner and for the reasons
specified in paragraph 34(a) above.
(b) In addition, defendants' representations regarding
the progress, positive results, and expected completion date of the Re-
Engineering Project were materially false and
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misleading and lacked a reasonable basis when made, in that they misrepresented
and/or failed to disclose that: (I) progress of the Re-Engineering Project was
being impeded by, among other things, the serious management, operational, and
other problems being experienced by Imonics, set forth above, and the Company's
inability to successfully integrate and coordinate the acquisitions of BSG and
Rapid Systems; (ii) the software designed to automate the billing process at
MPSC was not appropriate for large volume processing, thus requiring further
software development and causing a deferral of the office consolidation element
of the Re-Engineering Project; and (iii) in light of these problems, the
Re-Engineering Project was not likely to be completed until late 1997, if not
1998, contrary to defendants' representations.
(c) Further, defendants' statements regarding the
synergies to be derived from the BSG and Rapid Systems mergers, and the ability
of Medaphis and Imonics to successfully integrate and coordinate these
acquisitions, were materially false and misleading in that they misrepresented
and/or failed to disclose: (I) the adverse facts regarding Imonics, identified
above at paragraph 34(b); and (ii) that the integration of Imonics' operations
with BSG and Rapid Systems was not proceeding well in view of Imonics distressed
condition, and could not be accomplished without a complete reorganization of
Imonics.
(d) Moreover, defendants' representation that the Company
would "continue to maintain and place increased emphasis on the sales and
customer service functions" of the Company s MPSC division was false and
misleading. As defendants knew or recklessly disregarded: the Company's focus on
the Re-Engineering Project at MPSC was done at the expense of customer service
and customer retention, which was leading to significant revenue declines and
reductions in profitability for Medaphis.
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(e) In addition, the increasing staff levels at Imonics,
cited by analysts as a positive growth factor based on defendants'
representations, were, in reality, excessive, as evidenced by the October 22,
1996 disclosure that the Company had terminated 430 employees, including the
entire Imonics senior management team.
4. REPRESENTATIONS CONTAINED IN THE 1995 10-K AND
ANNUAL REPORT
48. On or about April 1, 1996, Medaphis filed with the SEC its
Form 10-K for the fiscal year ended December 31, 1995 (the "1995 10-K"). The
1995 10-K was signed by defendants Brown, Bellas, Holbrooke, Pryor, Stowe,
Downer, Cote and Douglass.
49. The 1995 10-K incorporated, at page 19, the same reported
financial results for the fourth quarter and full year of 1995 as were announced
on February 6, 1996 as set forth in paragraph 30 herein. The 1995 10-K also
incorporated by reference the financial presentations set forth in the Company's
1995 Annual Report, which is discussed in greater detail in paragraphs 53- 59
hereof. The 1995 10-K further stated, in relevant part, that such financial
presentations therein "include all adjustments that are necessary for a fair
presentation of the financial position and results of operations for such
periods."
50. The 1995 10-K boasted of the "core competencies in the systems
integration and work flow engineering fields," and went on to state that
although MPSC was experiencing some "revenue and margins pressures", these
pressures were being "offset" by growth in Medaphis' information management and
systems integration services business (for which Imonics was responsible), and
that the Re-Engineering Project was easing such pressures.
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51. The 1995 l0-K also contained a description of the Re-
Engineering Project virtually identical to that set forth in the BSG Prospectus
quoted at paragraphs 44-46 above.
52. With respect to the Company's revenue recognition policy, the
1995 10-K stated:
REVENUE RECOGNITION. . . .
Revenue from software licenses is generally recognized upon shipment of
the products and when no significant contractual obligations remain
outstanding. When the Company receives payment prior to shipment or
fulfillment of significant vendor obligations, such payments are
recorded as deferred revenue and are recognized as revenue upon
shipment or fulfillment of significant vendor obligations. The license
agreements typically provide for partial payments subsequent to
shipment; such terms result in an unbilled receivable at the date the
revenue is recognized. Costs related to insignificant vendor
obligations are accrued upon recognition of the license revenue.
Software maintenance revenue is deferred and recognized ratably over
the term of the maintenance agreement, which is typically one year.
Revenues from systems integration contracts are recorded on the
percentage of completion method of accounting. (Emphasis added).
53. At or about the time that it filed the 1995 l0-K, the Company
also issued its 1995 Annual Report. Like the 1995 10-K, the 1995 Annual Report
incorporated the same reported financial results for the fourth quarter and full
year of 1995 as were announced on February 6, 1996. The 1995 Annual Report
represented that the financial statements set forth therein:
present fairly, in all material respects, the financial position of
Medaphis Corporation and subsidiaries at December 31, 1995 and 1994 and
the results of their operations and cash flows for each of the three
years in the period ended December 31, 1995 in conformity with
generally accepted accounting principles.
54. In the 1995 Annual Report, the defendants again touted the
benefits and "positive results" of the Re-Engineering Project, and set forth a
description thereof virtually identical to that set forth in the BSG Prospectus
(see paragraphs 44-46 herein), and in the 1995 10-K (see paragraphs 48-52
herein). The 1995 Annual Report also represented that:
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The positive results of this progressive effort are already in
evidence. Today, Medaphis is a leading provider of information
management systems and systems integration and work flow engineering
systems and services to the healthcare industry and other industries.
55. The 1995 Annual Report also emphasized the positive
contributions that Imonics had made to the Company's business, stating that,
because of Imonics, the Company had gained an "immense competitive advantage"
and had "re-engineered its future." Defendants assured investors that Imonics
would allow the Company to recognize efficiencies that "will dramatically change
the way business done." The following excerpt appeared in the 1995 Annual
Report:
IMONICS: A LEADER IN BUSINESS PROCESS RE-
ENGINEERING AND SYSTEMS INTEGRATION.
With the 1994 acquisition of Imonics, Medaphis re-engineered its
future. A leader in business process re-engineering and systems
integration, Imonics will enable Medaphis to create internal
efficiencies while being able to offer the same cost -effective
solutions to others throughout the healthcare industry, and in other
industries. For Medaphis, or for any other customer service or business
operation that processes large volumes of paper, fax and phone calls,
Imonics' software solutions provide an immense competitive advantage.
The first signs of these increased efficiencies are already in evidence
in our Pittsburgh office. And as they are applied to an even greater
extent in the coming months, our belief is that they will dramatically
change the way business is done throughout our transaction processing
operations and, hopefully, our entire industry. (Emphasis added.)
56. The Annual Report also stated that the progress of the Re-
Engineering project "has been nothing short of remarkable," and that "[t]he
impact on customer service is immeasurable."
57. The 1995 Annual Report also praised the Company's 1995
acquisition of Atwork, which was described as "the leading provider of
information systems that schedule the activities of patients and employees in
healthcare." The 1995 Annual Report offered a highly upbeat assessment of
Atwork:
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Atwork solves complex scheduling problems in healthcare management, and
they have historically enjoyed a high level of client satisfaction.
Atwork markets four leading products to healthcare providers. The
first, ANSOS, automates nurse staffing and scheduling, and, as the
market leader, is the most widely used system of its kind. The second,
ORSOS used for operating room scheduling and inventory management, is
the market leader as well. The third product, One-Call, is used for
enterprise-wide patient scheduling. And finally, One-Staff is used to
schedule and manage all employees throughout the healthcare enterprise.
58. The letter to stockholders, included in the 1995 Annual Report
and signed by defendant Brown, stated, among other things, that:
Medaphis has embarked on an aggressive technology initiative to
increase its own internal efficiencies, as well as those of its
clients.
The positive results of this progressive effort are already in
evidence. Today, Medaphis is a leading provider of information
management systems and systems integration and work flow engineering
systems and services to the healthcare industry and other industries.
***
In the course of solving our own technology problems, we have
discovered a major business opportunity -the lack of next generation
distributed processing platforms and user-oriented applications to
solve business and information processing needs of industry in general,
particularly healthcare.
59. The representations contained in the 1995 10-K and Annual
Report and the documents incorporated therein by reference, incorporating
Medaphis' operating results for the fourth quarter and full year of 1995, and
Medaphis' revenue recognition policies, were materially false and misleading in
the manner and for the reasons set forth in paragraph 34(a) above. The
representations concerning the finances and operations of Imonics, the progress
of the Re-Engineering Project at MPSC, and the ability of Medaphis and Imonics
to successfully integrate and coordinate the acquisitions of BSG and Atwork were
materially false and misleading for failing to disclose the adverse material
facts concerning Imonics and Atwork specified at
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paragraphs 34(b) and 68 above. The false and misleading representations in the
1995 10-K were incorporated by reference into the July 12, 1995 Registration
Statement on Form S-3 signed by Defendants Brown, Cote, Douglass, Bellas,
McDowell, Holbrooke, Pryor and Papermaster.
5. REPRESENTATIONS CONCERNING THE BERTELSMANN JOINT VENTURE
AND MEDAPHIS' RESULTS FOR THE FIRST QUARTER OF 1996 ENDED
MARCH 30, 1996
60. In February 1996, Medaphis, through Imonics, entered into a
Joint Venture with a subsidiary of Bertelsmann AG, a German corporation.
According to the Company, the Joint Venture was formed to pursue custom software
development and systems integration projects for customer service systems in
Europe, primarily in Germany, over a multi-year period, with each partner
holding a 50% interest in the Joint Venture. The Joint partnership agreement was
signed on March 13, 1996, eighteen days before the close of the Company's fiscal
1996 first quarter.
61. On or about March 31, 1996, the last day of the first quarter
of fiscal 1996, the Joint Venture concluded an agreement with a German
telecommunications entity to provide systems integration and work flow
engineering systems and services (the "Systems Integration Contact").
Immediately upon entering into the Systems Integration Contract on March 31,
1996, the Company recognized $12.5 million of Joint venture net earnings,
thereby dramatically improving reported revenues and net earnings for the first
quarter of 1996.
62. On April 23, 1996, Medaphis issued a press release to announce
its first quarter results, which included the premature and decidedly optimistic
report of $12.5 million in net earnings recognized in connection with the
Systems Integration Contract into which the Company had rushed at the close of
first quarter. The Company reported that revenues had increased by 24.l% over
results for the first quarter of 1995, from $110.1 million to $136.6 million,
and that
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reported net income had increased from a reported loss of over $8.2 million for
the quarter ended March 31, 1995, to a reported profit of $13.2 million for the
first quarter of 1996. Commenting on these reported results, defendant Brown
noted that Medaphis was "pleased with the first quarter," adding:
The "performance of our client/server IT services business was
excellent and included formation of a joint-venture with a subsidiary
of Bertelsmann A.G. in Germany. The joint venture signed a large
contract with a telecommunications company during the quarter.
63. The market recognized the Joint Venture and the new Systems
Integration Contract as an important step for Medaphis, adding significantly to
the Company's value to an investor. In an April 30, 1996 Smith Barney report,
for example, which was prepared based on information provided by defendants, the
Joint Venture was specifically cited as an example of one of the areas in which
Medaphis had "displayed strong growth":
Imonics announced a joint venture with Bertelsmann, AG to provide
systems integration services overseas. Bertelsmann's BMG Music Club has
been a client of Imonics for several years. In the same announcement,
the JV disclosed a major, multi-year contract with a foreign
telecommunications company. Although Imonics is performing most of the
work on [Medaphis'] re-engineering, its headcount has grown to over 400
to also staff the growth in its outside business.
64. On May 14, 1996, defendants caused Medaphis to file its first
quarter Form 10-Q with the SEC (the "First Quarter 10-Q"), which was signed by
defendants Cote and Douglass, in which it incorporated and provided additional
details concerning first quarter 1996 financial results for the quarter
previously announced on April 23, 1996 (see paragraph 62 herein).
65. The First Quarter 10-Q represented that the financial
information contained therein was "prepared in accordance with the Company's
customary accounting policies and practices."
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66. In addition, the First Quarter 10-Q expressly incorporated the
representations contained in the 1995 10-K, including the representation that
"[r]evenues from systems integration contracts are recorded on the percentage of
completion method of accounting," and also contained management's representation
that the financial statements included therein reflect "all adjustments . . .
necessary for a fair presentation of the results of operations of the interim
period."
67. At or about the time defendants Publicly announced Medaphis'
first quarter 1996 operating results and filed the First Quarter l0-Q, several
bullish reports were issued by securities analysts based on information provided
by the Company:
(a) "Over the next several quarters, we expect the re-engineering
program in its core Medaphis Physician Services Corporation to begin to
have an impact while the growth in its technology businesses continues
[sic] to accelerate." (May 16, 1996 report by Donaldson, Lufkin &
Jenrette Securities Corporation);
(b) "Near-term, we have confidence in our quarterly estimates as well
as our $1.05 - $1.10 estimate for the full year." (May 16, 1996 report
by Donaldson, Lufkin & Jenrette Securities Corporation); and
(c) "Based on our conversation with management yesterday, our comfort
level on near-term earnings prospects have increased. While management
did not endorse a specific estimate, it appears as though there have
been some fundamental positive changes. While there remains
consolidation challenges, we believe that these are the early signs
that the large software development project is beginning to pay off.
(June 4, 1996 report by Donaldson, Lufkin & Jenrette Securities
Corporation).
68. The representations contained in Medaphis' announcements
concerning the Bertelsmann Joint Venture and the Company s financial results for
the quarter ended March 31, 1996, as set forth in paragraphs 60-68 herein, were
materially false and misleading in that the financial results set forth therein
were falsified and had been achieved only through the use of improper accounting
practices which violated GAAP.
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69. The reported net income for this period of $13.2 million was
improperly and materially overstated by virtue of the recognition of $12.5
million in profits from the Systems Integration Contract immediately upon the
execution of the contract in violation of relevant accounting principles,
including GAAP. Defendants knew or recklessly disregarded, at the time the
contract was entered into, that; (I) Imonics was experiencing serious problems,
including over-staffing poor management, inadequate cost controls and poor
operational performance (as detailed in paragraphs 34(b) and 47 hereof); and
(ii) that, as is also detailed at paragraphs 34(b) and 47 hereof, Imonics was
unable to perform its obligations under the Systems Integration Contract and the
Joint Venture. Under such circumstances, the recognition of $12.5 million in
Joint Venture net earnings was improper. ARB 43 provides that "profit is deemed
to be realized when a sale in the ordinary course of business is effected,
unless the circumstances are such that the collection of the sale price is not
reasonably assured." Additionally, the Company could not in good faith consider
the Systems Integration Contract to result in "actual or expected cash flow ...
that ha[s] accrued or will eventuate as a result of the entity's ongoing mayor
Or central operations," if, at the time the contract was entered into,
defendants were aware that there was no basis for the belief that Imonics could
fulfill its obligations under the Contract as proscribed by paragraph 78 of FASB
CON 6.
70. Recognition of the revenues from the contract under such
circumstances was improper under FASB CON 5, paragraph 83, which provides:
Revenues are not recognized until earned. An entity's revenue earning
activity involves delivering or producing goods, rendering services, or
activities that constitute its major or central operations, and
revenues are considered to have been earned when the entity has
substantially accomplished what it must do to be entitled to the
benefits represented by the revenues.
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Accordingly, in recognizing $12.5 million in Joint Venture net earnings in March
of 1996, the Company violated these provisions of GAAP.
71. Second, defendants improperly recognized $12.5 million in
Joint Venture net earnings in the first quarter because if these revenues could
have been properly recognized at all, they should have been recognized ratably
over the period the services were performed under the Systems Integration
Contract in accordance with the percentage-of-completion method of accounting.
As noted above, FASB CON 5, paragraph 83, provides that "revenues are not
earned," and therefore should not be recognized, until an "entity has
substantially accomplished what it must do to be entitled to the benefits
represented by the revenues." (Emphasis added).
72. In addition, the First Quarter 10-Q, having incorporated by
reference the 1995 10-K (and derivatively the 1995 Annual Report), was
materially false and misleading for the same reasons, specified in paragraph 82
herein, as the 1995 10-K and Annual Report were false and misleading. The First
Quarter 10-Q expressly incorporated the additional representation contained in
the 1995 10-K that "[r]evenue from systems integration contracts are recorded on
the percentage-of-completion method of accounting." (Emphasis added). Thus, in
recognizing first quarter revenues from the Systems Integration Contract,
defendants violated the Company s own disclosed revenue recognition policy,
rendering this specific statement false.
6. ADDITIONAL PUBLIC STATEMENTS RELATING TO IMONICS AND
THE HDS MERGER
73. In April 1996, Medaphis officials attended a Robinson-Humphrey
Co. conference at which they touted the successes at Imonics, declaring that it
was "going like gangbusters."
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74. Seeking to continue its practice of acquiring companies
utilizing overvalued Medaphis stock, on or about May 24, 1996, Medaphis
announced its intention to acquire Health Data Sciences Corporation ("HDS") in
exchange for 6,125,000 Medaphis common shares and assumption or issuance by
Medaphis of stock options representing an additional 556,000 shares. Based on
May 24, 1996 closing price of Medaphis stock of $40.938, the HDS Merger was
valued at approximately $273.5 million.
75. HDS was a developer and supplier of health care information
systems to institutions, payers, health care networks, and providers. HDS' main
product offering was a line generally known as ULTICARE(R), an integrated
information system which allows doctors and hospitals in large health care
systems to enter, and access immediately thereafter, clinical information on
patients. The ULTICARE system can also schedule medical procedures, such as
surgery.
76. According to an article published in the Atlanta Journal and
Constitution on May 25, 1996, defendant Brown stated that, with the planned
acquisition of HDS, "I think we now have the pieces we need... This is where
we've been aiming with our business."
77. A definitive Merger Agreement was executed by Medaphis and HDS
on May 23, 1996 (the "HDS Merger"). Under the terms of the HDS Merger,
stockholders of HDS were entitled to receive .7912 of a share of Medaphis common
stock for each share of HDS common stock and HDS preferred stock. In connection
therewith, the defendants were specifically motivated to keep the price of
Medaphis stock artificially high in order to complete the acquisition of HDS.
This was because the Merger Agreement expressly provided that HDS could
unilaterally terminate the deal if the average closing price of Medaphis stock
dropped below $37 per share for
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a period of time. Thus, defendants knew that it was imperative that the Company
continue to tout its many "successes" while concealing the true facts about
Medaphis' business.
78. On May 31, 1996, in connection with the HDS Merger, Medaphis
filed an Amendment No. 1 to its Form S-4 Registration Statement with the SEC
(the "HDS Registration Statement"). The Registration Statement included a Proxy
Statement/Prospectus, also dated May 31, 1996, which was issued in connection
with a special meeting of HDS stockholders to be held on June 29, 1996 (the "HDS
Prospectus"). The HDS Registration Statement was signed by defendants Brown,
Bellas, Holbrooke, Pryor, McDowell, Papermaster, Cote and Douglass.
79. The HDS Prospectus included, inter alia, a detailed
description of the background of the HDS Merger, the reasons for the HDS Merger,
and the terms of the Merger. The HDS Prospectus also included an upbeat
description of Medaphis' Re-Engineering Project which was substantially similar
to the statements contained in the BSG Prospectus, the 1995 10-K and the 1995
Annual Report. The defendants again represented in the HDS Prospectus that
"[t]he [Re-Engineering] project is expected to be substantially completed during
1997."
80. As they had in the BSG Prospectus, the defendants also
continued to tout the benefits of the BSG and Rapid Systems mergers in the HDS
Prospectus, stating that:
Management believes that the acquisition of BSG, when combined with
Rapid Systems and Medaphis' existing systems integration and workflow
engineering operations, will position Medaphis as the leading
client/server systems integration and workflow engineering companies in
the United States.
81. The HDS Registration Statement and Prospectus expressly
incorporated by reference Medaphis' 1995 Annual Report, filed on April 1, 1996,
and its First Quarter l0-Q, filed on May 15, 1996, relevant excerpts of which
are set forth at length herein above. As such, the
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HDS Registration Statement and Prospectus was materially false and misleading
for the same reasons the 1995 Annual Report and First Quarter 10-K were
misleading, as specified above.
82. The additional representations in the HDS Prospectus, set
forth in paragraphs 79- 80, concerning the finances and operations of Imonics,
the progress of the Re-Engineering Project at MPSC, and the ability of Medaphis
and Imonics to successfully integrate the Company's various acquisitions were
materially false and misleading for failing to disclose the adverse material
facts concerning Imonics specified at paragraphs 34(b) and 47 hereof.
83. Had the full truth about Medaphis been disclosed at the time,
the Company never would have been able to complete the HDS Merger. Based on
recent trading prices of Medaphis stock (as low as $8.50 per share), the
acquisition of HDS, which cost the Company just over 6 million shares, would
have cost nearly five times that amount, or 28 million shares. Based recent
trading prices, defendants' fraudulent conduct enabled the Company to purchase
HDS -- a company valued at $230 - $260 million in the HDS Merger for stock now
worth just $53 million, costing HDS shareholders hundreds of millions of dollars
in losses. Consequently, Defendants have exposed the Company to at least $177
million securities fraud liability in connection with this transaction alone.
7. PUBLIC STATEMENTS RELATING TO SECOND QUARTER 1996 RESULTS
84. On July 23, 1996, defendants issued a press release announcing
Medaphis' financial results for the second quarter of 1996, ending on June 30,
1996. The Company reported that revenue for the three months ended June 30, 1996
was $175.2 million, up 24% from the $141.3 million in the year-earlier period,
and that, excluding merger and other one-time costs, net income was $18.7
million, up 159%, with earnings per share of $0.25, up 150%. For the six months
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ended June 30, 1996, Medaphis reported a 23% increase in revenues over the six
months ended June 30, 1995, from $274.4 million to $338.8 million, and an
increase in net income and earnings per share, from a loss of $4.6 million or
$.08 per share in 1995 to net income of $16.4 million or $.22 per share in 1996.
85. Defendant Brown continued to assure the investment community
that Medaphis' technology companies were "generat[ing] strong results," and he
explained that much of these "strong results" were attributable to the recent
acquisitions of HDS, Rapid Systems and BSG:
We are pleased with the second quarter and underlying results of our
technology and services businesses. The technology companies continue
to generate strong results, especially our latest additions: Health
Data Sciences Corporation ("HDS"), BEG Corporation and Rapid Systems
Solutions, Inc. I am thrilled with the recent addition of HDS to our
technology capabilities and am excited about the opportunities that it
affords us to offer patient-centered information technology in the
healthcare industry. Medaphis Physician Services Corporation continued
to adversely affect results of the Services Division in the second
quarter; however its operating results improved slightly over the first
Quarter of 1996. We continue to assess and evaluate the technology and
processes necessary to ensure our long-term success and remain
cautiously optimistic that the re- engineering project and related
management initiatives are positioning the Company for important
improvements in operating results. (Emphasis added).
86. The defendants' representations concerning the second quarter
of 1996 had their intended effect on the investment community. On July 24, 1996,
Bear Stearns issued a research report based on information provided by the
Company which stated, in relevant part, that:
Importantly, management is confident that the top line and cost
pressures in the physician billing business (which we estimate to be
25% - 30% of total revenue) may have bottomed. These pressures are
expected to continue to moderate over the third and fourth quarters of
1996 allowing for a stabilization of this business segment. During
1997, we expect to see the benefits of the re-engineering which we
believe will pave the way for earnings acceleration."
87. In a similar vein, a Cowen & Co. report dated July 23, 1996,
based on information provided by the Company, stated:
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Technology Strategy A Winner - Virtually all of the revenue growth was
derived from terrific performances in the technology companies (+82% at
$70MM). Strongest performers include Consort Technologies (radiology
information systems), Atwork (medical software), BEG, RSSI and Imonics
(client/server systems integration)."
88. Similarly, on July 24, 1996, Donaldson Lufkin & Jenrette
issued a research report based on information provided by the Company which
stated:
EPS for the next two quarters should be $0.28 and $0.30, respectively.
Management indicated comfort with street estimates for the third and
fourth Quarter of this year. This is in sharp contrast to previous
statements about the last few quarters when management consistently
hedged about its near-term operating results.
89. The representations contained in the July 23, 1996 press
release, which incorporated and reflected Medaphis' operating results for the
first quarter of 1996 (see paragraph 84 herein), were materially false and
misleading for the reasons set forth in paragraph 68-69 herein. The
representations concerning the finances and operations of Imonics, the progress
of the Re-Engineering Project at MPSC, and the ability of Medaphis and Imonics
to successfully integrate the Company's various acquisitions were materially
false and misleading for failing to disclose the adverse material facts
concerning Imonics specified at paragraphs 34(b) and 47 hereof. Moreover,
defendants' forecasts of $0.28 and $0.30 per share for the third and fourth
quarters of 1996, respectively, were contradicted by the adverse facts set forth
above in 34(b) and 47 and were issued by defendants, through analysts' reports
endorsed and adopted by the Company, without any reasonable basis.
THE TRUTH BEGINS TO EMERGE
1. THE AUGUST 14, 1996 DISCLOSURES
90. On August 14, 1996, after the close of trading, Medaphis
finally began to disclose the severe problems which it had been experiencing
with Imonics, as well as the difficulties being
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encountered with MPSC, Atwork, the BSG Merger and the Re-Engineering Project
during the Class Period. On that day, it issued a press release announcing that
it expected to report a loss in the range of $0.28 to $0.33 per share in the
third quarter of 1996, which would include substantial charges in the range of
$35 to $40 million. It also announced that it expected earnings per share in the
range of only $0.75 to $0.90 for fiscal 1997, compared with analysts'
expectations of earnings per share of $0.27 for the third quarter and $1.42 for
fiscal 1997. The press release stated:
The Company's near-term earnings will be impacted by continued weakness
in Medaphis Physician Services Corp.'s business and the reorganization
of Imonics. Medaphis' near-term outlook also has been affected by
slower than expected sales of some of the Company's enterprise-wide
scheduling products. The third quarter earnings estimate includes
charges in the range of $35 to $40 million relating primarily to the
reorganization of Imonics and the re-engineering and consolidation
program at MPSC.
91. A substantial portion of the Company's difficulties, and the
resulting third quarter charges, were reported to have arisen from the need to
reorganize its Imonics subsidiary and the Company's problems with the Systems
Integration Contract, so positively reported by Medaphis during the Relevant
Period. Explaining the situation, Medaphis reported:
Management has commenced the process of reorganizing the Imonics
systems integration business. This reorganization resulted from a
review by BSG of Imonics' overall operations and an assessment of
recent difficulties encountered by Imonics with a large systems
integration agreement entered into by its European joint venture.
The reorganization of Imonics will include efforts to more closely align
Imonics' business practices with those of BSG. The BSG model is structured to
manage client/server information technology projects with experienced project
management. It is currently anticipated that Imonics' European joint venture
will continue with its system integration project on terms and conditions
mutually satisfactory to the parties, but that the agreement relating to the
project will be restructured.
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92. Medaphis further disclosed that approximately $9 million of
charges would be made in the third quarter to account for the restructuring of
the Systems Integration Contract entered into by the Joint Venture with another
$15 million in charges relating to the reorganization of Imonics.
93. The Company revealed that, contrary to its July 23, 1996
representations, its MPSC unit was continuing to experience poor results, due in
part to delays in the Re-Engineering Project. The Company disclosed that as a
result of these problems, it would take a restructuring charge of approximately
$11 million, and "up to $5 million of other costs." The Company stated:
The Company expects to incur charges in the third quarter in the range
of $35 to $40 million. These charges are expected to consist of
approximately $9 million relating to the restructuring of a large
systems integration agreement entered into by Imonics' European joint
venture, approximately $15 million relating to reorganization of
Imonics, approximately $11 million relating to additional restructuring
costs associated with MPSC's re-engineering and consolidation program
and up to $5 million of other costs.
94. Defendant Brown was quoted as stating:
We are extremely disappointed with these developments. The problems
that we have identified at MPSC and Imonics are being addressed by a
new operating management team which possesses the process and
technology expertise and experience we need to execute our plan.
95. Moreover, in sharp contrast to defendants' previous statements
that Medaphis would continue to grow through acquisitions -- the key to its
success -- the Company announced that it had abandoned its acquisition strategy:
"We're focused on re-engineering MPSC's business for future growth, and not on
expanding the business through acquisitions in the near term," defendant
Douglass stated.
96. As reported in Bloomberg News on August 15, 1996, Bertelsmann
officials had called Medaphis in late July to, complain about the computer
integration project which Imonics
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was working on with the Joint Venture. In particular, Bertelsmann offered two
choices to Medaphis: quit or renegotiate the contract. According to Cowen &
Co. analyst Charles Trafton, the news of problems with Imonics came as "a
complete shocker" and "Imonics was not delivering."
97. On the same day it announced its anticipated losses for the
third quarter, Medaphis filed its Form 10-Q for the fiscal 1996 second quarter
(the "Second Quarter 10-Q"). In it, the Company disclosed for the first time
that the Joint Venture had begun discussions with its European Partner,
Bertelsmann, and the related customer on July 25, 1996 regarding difficulties
that had been encountered with certain aspects of the Systems Integration
Contract. As a result of these difficulties, which were not disclosed until
August 14, 1996, Medaphis reported that it had been forced to negotiate "the
restructuring of the operating relationships and economics underlying the
Contract," adding:
Although a restructured arrangement among the parties is subject to the
negotiation and execution of definitive agreements, the Company
anticipates that the contract will be amended and a restructured
arrangement will be executed that will position the Joint Venture to
move forward with the project and to pursue other opportunities and
projects on terms and conditions that are mutually beneficial to the
parties. The Company anticipates recording a loss related to the
restructured arrangement or approximately $9 million during the third
quarter of 1996.
98. With respect to the Imonics' restructuring, the Company
disclosed in the Second Quarter 10-Q that, contrary to previous statements to
the effect that the Company had the necessary infrastructure to create
tremendous business opportunities, the Company would need to take a charge of
$15 million to reorganize Imonics because of over-staffing, inadequate internal
cost controls and poor operating performance. The Second Quarter 10-Q stated:
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Many changes have and will continue to occur at Imonics Corporation
("Imonics") including: headcount reductions, increased focus on project
management, increased cost controls and implementation of the BSG
business model. In addition to the expected $9 million loss related to
the restructured arrangement noted above, the Company anticipates
recording losses in the third quarter of 1996 related primarily to the
reorganization of Imonics of approximately $15 million.
99. The market reacted sharply and dramatically to Medaphis'
August 14 announcement, with its share price plunging the following day,
decreasing the value of the Company by $1.6 billion. The stock price closed at
$14-1/4 per share, after dropping by $21-3/8, or approximately 60 percent. More
than 42 million shares of Medaphis stock changed hands during the day, making it
the most active U.S. issue on NASDAQ that day and representing the sixth-highest
single trading day in NASDAQ history, excluding penny stocks.
2. THE OCTOBER 22, 1996 DISCLOSURES
100. Despite the startling disclosures of August 14, 1996, and the
resulting drop in the price of Medaphis stock, defendants had not yet disclosed
the full extent of the Company' s problems known to, or recklessly disregarded
by, defendants at the time. Instead, defendants continued to mislead investors
about the current and future business prospects of Medaphis and represented that
all of the Company's problems had been identified and adequately reserved
against.
101. For example, after a meeting with Medaphis senior management
on August 21, 1996, an analyst with Bear, Stearns Co. ("Bear Stearns") reported
that:
[a]fter uncovering the problems at Imonics and MPSC, management
undertook a rigorous examination of all business units in order to
assess [the] possibility [of additional charges and a further reduction
in earnings expectations] and concluded that all of the potential
problems have been reserved against. (Emphasis added).
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102. Based largely on this positive meeting with Medaphis
management, Bear Stearns forecast third quarter earnings per share of $0.02
excluding charges of $35 - $40 million, and continued to give Medaphis stock an
"Attractive" rating. Other analysts issued similar cautiously optimistic reports
following the August 21, 1996 meeting, and, based on guidance from Medaphis
management, projected earnings per share of approximately $0.02 for the third
quarter, excluding charges, or a loss of about $0.27 per share including
charges.
103. On October 22, 1996, Medaphis shocked the market for the
second time in as many months, issuing a press release announcing third quarter
results that were far worse than analysts' diminished expectations and the
Company's previous projections. The Company also reduced its earnings
projections for 1997 even further, announced even larger charges associated with
the reorganization of Imonics, and revealed that due to improper revenue
recognition practices in the Imonics division, the Company would have to restate
its financial results for the fourth Quarter and year ended December 31, 1995.
104. In contrast to its August 16, 1996 forecast of losses in the
range of $.28 - $.33 per share, including charges; Medaphis reported a loss of
$.5l per share, or $36.4 million for the 1996 third quarter. These results
compared to a net loss per share of $0.05 in the year-ago quarter. The Company
reported that revenue fell 10% in the third quarter, to $126.7 million, from
$140.8 million the prior year.
105. The Company disclosed that rather than taking charges of
between $35 - $40 million, Medaphis reported total charges of approximately $50
million in the third quarter, relating primarily to the reorganization of
Imonics the write-off of revenues from the Systems Integration Contract. The
October 22, 1996 press release stated:
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The results for the three months ended September 30, 1996 include a
charge against revenue of $16.8 million relating primarily to the
reorganization of Imonics, including the renegotiation of a large
systems integration contract entered into by Imonics' European joint
venture in March 1996. In addition, approximately $8.5 million was
included in salaries and wages relating to employees and contractors,
who are no longer providing services to the Company, costs to complete
certain Imonics contracts and certain other nonrecurring items. In
addition, a $24.3 million restructuring charge was recorded during the
quarter relating to the reorganization of Imonics. The charge consists
of approximately $10.7 million relating to the write down of Imonics'
assets, $3.7 million of severance costs primarily for former Imonics
employees, $3.2 million in exit costs for lease terminations and $6.7
million of legal and other costs.
106. While Medaphis had stated in August that it expected 1997
earnings per share to fall between $0.75 and $0.90, defendant Brown lowered that
range to just $0.60 to $0.75 in connection with the October 22, 1996 press
release. At the same time, however, defendant Brown hinted that 1997 earnings
were likely to come in even lower still, stating: "I believe there are risks
inherent in the business which could cause us to fall short of that goal."
107. In yet another stunning disclosure, the Company announced in
the press release that it would restate 1995 results to reflect an actual loss
for the year ended December 31, 1995 $8.5 million, compared with a previously
reported loss of $3.4 million. For the 1995 fourth quarter, the Company said it
expected to post a loss of $1.1 million, compared with a previously reported
profit of $4 million.
108. Medaphis stated that the 1995 restatements were the result of
improper revenue recognition practices in the Company's Imonics division,
including the improper recognition of $5.1 million in earnings in the fourth
quarter of 1995. According to the Company, the Imonics unit had booked revenue
on a license agreement it had executed in December 1995 despite the existence of
"unauthorized correspondence" which improperly "created a contingency" under the
license agreement. The revenue recognized on this contract, "together with
previously deemed
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immaterial amounts," reduced net income for the quarter and year ended December
31, 1995 by $5.1 million. As disclosed in the press release:
The Company also announced that it intends to restate its financial
results for the year and three months ended December 31, 1995. This
restatement relates primarily to a license agreement entered into by
Imonics in December 1995 and unauthorized correspondence discovered in
connection with the Imonics reorganization which created a contingency
upon license fees payable under the agreement. The license fee revenue
payable under the agreement and recognized by the Company during the
fourth quarter of 1995, together with previously deemed immaterial
amounts, are expected to result in an aggregate reduction to net income
for the quarter and year ended December 31, 1995 of $5.1 million. After
appropriate adjustments for such items, it is currently anticipated
that the Company's restated results for year ended December 31, 1995
will be a net loss of $8.5 million as compared with previously reported
net loss of $3.4 million. In addition, it is anticipated that restated
results for the quarter ended December 31, 1995 will reflect a net loss
of $1.1 million, as compared with previously reported net income of
$4.0 million.
109. Continuing the stream of devastating disclosures that day,
Medaphis reported in the press release that during the third quarter it had laid
off 430 employees, including the entire senior management team at Imonics. This
was in stark contrast to defendants' prior statements portraying the growth in
the number of Imonics employees as a positive factor. The Company also announced
attempting to renegotiate its credit line from $250 million to $300 million.
110. In a lengthy statement accompanying the October 22, 1996 press
release, defendant Brown admitted that BSG had been "preoccupied with the
restructuring of Imonics, that the Company's strategic acquisition program had
"ended," and that "[w]e have no ongoing plans to make acquisitions at this
time."
111. The adverse disclosures of October 22, 1996 drove the
Company's stock down $6.375 or 38%, to close at just $10.375 per share, a
52-week low for the stock. The drop in the market capitalization of the Company
was approximately $450 million. The trading volume of Medaphis stock on October
22, 1996 was more than 13 million shares, making it the most actively
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traded stock in the United States that day. During the Relevant Period, Medaphis
shares, artificially inflated by defendants' wrongful conduct, had closed as
high as $52 1/2 per share (on March conduct, had closed as high as $52 1/2 per
share (on March 20, 1996).
112. On October 31, 1996, Medaphis announced that it had named
David E. McDowell the Company's new Chairman and Chief Executive, replacing
defendant Brown. According to the Company, defendant Brown had resigned for
"personal" reasons. However, Brown had not resigned his board of directors
position when Plaintiff's initial complaint herein was filed November 1, 1996.
DEFENDANTS' CONDUCT HAS DAMAGED MEDAPHIS
113. Each of the defendants, by reason of their management
positions, membership on Medaphis' Board of Directors or membership on the Audit
Committee, were, during the time they held such positions, "controlling persons"
of Medaphis within the meaning of ss. 20 of the Securities and Exchange Act of
1934. Said defendants had the power and influence, and exercised the same, to
cause Medaphis to engage in the illegal practices complained of herein.
114. Said defendants participated in the decisions to release the
false and misleading press releases and SEC filings complained of herein, and/or
were aware of, or recklessly disregarded, the misstatements contained therein
and omissions therefrom and were aware of their materially misleading nature.
Because of their Board Membership, Audit Committee membership and/or executive
and managerial positions with Medaphis, each of the defendants had access to the
adverse non-public information about Medaphis' financial performance and
condition, as particularized herein. Each of the defendants knew that those
adverse facts rendered misleading the positive statements made by and about
Medaphis in the press releases and SEC filings.
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115. Said defendants, because of their positions of control and
authority as officers and/or directors of the Company and/or as members of the
Audit Committee, were able to and did control the contents of the SEC filings
and press releases pertaining to the Company. Each of said defendants was
provided with copies of Medaphis' public statements and SEC filings alleged
herein to be misleading prior to or shortly after their issuance and had the
ability and opportunity to prevent their issuance or cause them to be promptly
corrected.
116. Each of the defendants engaged in a course of conduct which
was designed to and did (I) deceive the investing public regarding Medaphis'
financial reporting and business prospects; (ii) artificially inflate the market
price of Medaphis' securities; (iii) enable Medaphis to make acquisitions paid
for with Medaphis stock based on the inflated value of that stock; (iv) cause
members of the public to purchase or otherwise acquire Medaphis securities at
inflated prices, including, without limitation, shareholders of HDS, BSG and
other companies acquired for Medaphis stock; and (v) make the stock and options
of some of the defendants more valuable. Defendants undertook this scheme to
prolong the appearance of good fortune at Medaphis in a desperate gamble to gain
the resources and expertise necessary to attempt to meet Medaphis' contractual
commitments, and to avoid the otherwise inevitable consequences including
eliminating, divesting or reorganizing Medaphis and certain of its subsidiaries
in which defendants held managerial positions and which certain defendants had
founded. In furtherance of this course of conduct, defendants took the actions
as set forth herein.
117. Defendants engaged in a conspiracy and common course of
conduct, commencing at least by February 29, 1996, the purpose and effect of
which was, inter alia, to cause Medaphis to deceptively present the Company's
financial reporting, financial performance and business
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prospects. Defendants did this so that they could inflate the price of the
Company's stock in order to: (I) protect and enhance their executive positions
and the substantial compensation and prestige they obtained thereby; (ii)
enhance the value of their Medaphis stock holdings and their options to buy
Medaphis stock; and (iii) conceal their previous fraudulent conduct.
118. As set forth above, Defendants accomplished their conspiracy
and common course of conduct through the issuance of the interrelated and
interdependent deceptive and misleading press releases to the public, as well as
by filing the false and misleading SEC filings, all of which misrepresented
Medaphis' financial condition, financial performance and business prospects,
thereby creating a deceptive and misleading impression of continued growth and
future profitability.
119. Each of the defendants aided and abetted and rendered
substantial assistance in the wrongs complained of herein. In taking the actions
to substantially assist the commission of the fraud complained of, each
defendant acted with knowledge of the primary wrongdoing, substantially assisted
the accomplishment of that fraud, and was aware of his overall contribution to
and furtherance of the fraud.
120. Defendants either knew or recklessly disregarded the fact that
the illegal acts and practices and misleading statements and omissions described
herein would adversely affect the integrity of the market for Medaphis
securities and would artificially inflate the prices of those securities.
Defendants, by acting as herein described, knowingly and/or recklessly exposed
Medaphis to liability under the federal securities laws for violations thereof.
121. As a result of the dissemination of the false and misleading
statements described herein, the market price of Medaphis stock was artificially
inflated. That has resulted in the
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Company being subjected to at least 18 class action lawsuits brought on behalf
of purchasers of Medaphis securities during the time the Company was
disseminating the above quoted false information ("the Class Actions").
122. Medaphis has been damaged by its exposure to multi-million
dollar damages claims by the members of the classes in the Class Actions, as
well as to the substantial legal expenses to be incurred in connection with the
Class Actions. In addition, the Company's reputation in the securities markets
has been severely damaged, thereby hampering the Company's ability to secure
future business partners and financing.
123. In particular, Medaphis announced on October 22, 1996, that
it was curtailing a program of expansion which had enabled the Company to
acquire 46 targets in eight years.
124. Medaphis' reputation, and specifically its ability to retain
its significant joint venture partners on favorable terms was damaged: On August
14, 1996, Medaphis announced that it would be forced to renegotiate its major
Joint Venture agreement in Europe.
DERIVATIVE ACTION ALLEGATIONS
125. Plaintiff brings this action, pursuant to Rule 23.1, Federal
Rules of Civil Procedure, on behalf of Medaphis to enforce claims of Medaphis
against defendants which may properly be asserted by Medaphis and which Medaphis
has failed to enforce.
126. The wrongs complained of herein began following plaintiff's
purchase of stock of Medaphis in June, 1995, and were not consummated until
October 22, 1996. Hence, plaintiff has standing to bring this derivative action
on behalf of Medaphis to recover damages for all of the conduct described in
this complaint.
DEMAND IS EXCUSED FOR FUTILITY
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127. Demand on Medaphis to bring this action has not been made and
is not necessary because such demand would be futile. Medaphis is controlled by
its Board of Directors, and, as described herein, each of the Directors, were
involved in and approved the transactions and misstatements complained of
herein, knew or should have known that Medaphis did not have an adequate system
of internal controls in place to account for "accounts receivable, unbilled",
and/or were responsible for the unlawful and improper conduct of Medaphis which
has damaged the company, and hence are named as defendants herein. The Director
Defendants were not in a position to exercise independent business judgment with
respect to the claims alleged herein due to their individual and collective
approval of, participation in and responsibility for this unlawful and wrongful
conduct. Hence, the Director Defendants were not disinterested and could not
have exercised independent business judgment on the issue of whether Medaphis
should prosecute this action. Under the factual circumstances described herein,
the directors of Medaphis were more interested in protecting themselves than
they were in protecting one company by prosecuting this action. Therefore demand
on Medaphis and its Board of Directors was futile and is excused. In particular:
(a) Demand on defendants Brown, Pryor, and Papermaster
would have been futile, and is therefore excused, because they were actively
involved in the day-to-day management of Medaphis and its major subsidiaries,
including BSG which directly managed Imonics, and were directly responsible for
the acts and omissions, including the false statements and omissions, complained
of herein. Brown in particular made many of the false statements alleged herein;
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(b) Demand on defendants Holbrooke, Bellas and McDowell
would have been futile, and is therefore excused, because Holbrooke, Bellas and
McDowell served on the Audit Committee of the Board of Directors, and were
charged with "meeting with the Company's auditors at least annually to review
the Company's financial statements and internal accounting controls. The Audit
Committee is also responsible for submitting recommendations to the Board
regarding the Company's internal accounting controls. Medaphis 1996 Proxy
Statement at 3.
(i) Medaphis is required to have an Audit
Committee by the NASDAQ National Market System listing of Medaphis' securities.
National Association of Securities Dealers, Inc. Bylaws, Schedule D, Part III,
P. 6, ss. (d) provides that "[e]ach Nasdaq National Market issuer shall
establish and maintain an Audit Committee, a majority of the members of which
shall be independent directors."
(ii) Among other things, as members of the Audit
Committee, McDowell, Holbrooke and Bellas had the duty to:
- - Recommend the firm to be employed as the corporation's external auditor
and review the proposed discharge of such firm.
- - Review the external auditor's compensation, the proposed terms of its
engagement and its independence.
- - Review the appointment and replacement of the senior internal auditing
executive.
- - Serve as the channel of communication between the external auditor and
the board and between the senior internal auditing executive and the
board.
- - Review the results of each external audit of the corporation, the
report of the audit, any related management letter, management's
responses to recommendations made by the
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external audit in connection with the audit and reports of the internal
auditing department, that are material to the corporation as a whole
and management's responses to those reports.
- - Review the corporation's annual financial statements; any
certification, report, opinion or review rendered by the external
auditor in connection with those financial statements; and any
significant disputes between management and the external auditor that
arose in connection with the preparation of those financial statements.
- - Consider, in consultation with the external auditor and the senior
internal auditing executive, the adequacy of the corporation's internal
controls.
- - Consider major changes and other major questions of choice respecting
the appropriate auditing and accounting principles and practices to be
used in preparation of the corporation's financial statements when
presented by the external auditor, principal senior executive or
otherwise.
(iii) The Audit Committee should properly have
been the keystone of Medaphis' corporate finance governance. Instead, Holbrooke,
Bellas and McDowell perpetrated a sham, and utterly failed to ensure that
Medaphis' Audit Committee was an informed, vigilant and effective overseer of
the Company's financial reporting process and its internal control system.
(iv) Despite claiming to have met four times
during the 1996 fiscal year, Holbrooke, Bellas and McDowell through utter and
complete abdication of their duties to Medaphis, failed to implement and
maintain an adequate system of internal controls to account for receivables.
Holbrooke, Bellas and McDowell either knew or should have known that Medaphis
lacked an adequate system of internal controls. Their service on the Audit
Committee was a
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sham, in that they took no action whatsoever to assure that such a system of
internal controls was in place. The absence of such controls directly
contributed to the false financial statements and violations of GAAP alleged
herein, and was the proximate cause of Medaphis' disastrous restatement and
consequent exposure to massive liability for violation of the federal securities
laws;
(c) Medaphis was controlled by its Board of Directors,
and, as described herein, all the members of the Board of Directors of Medaphis
were involved in and approved the false or misleading SEC filings complained of
herein. Furthermore, Defendant Brown is responsible in damages for the unlawful
and improper conduct of Medaphis which has damaged the Company. None of the
Director Defendants serving on November 1, 1996, was in position to exercise
independent business judgment with respect to the claims alleged herein due to
their individual and collective approval of, participation in and responsibility
for Medaphis' unlawful and wrongful conduct, which has damaged and will continue
to damage Medaphis severely. Hence, the Director Defendants serving on November
1, 1996, were and are not disinterested and could not have exercised independent
business judgment on the issue of whether Medaphis should prosecute this action.
Under the factual circumstances described herein, the Director Defendants
serving on November 1, 1996, were more interested in protecting themselves than
they were in protecting the Company by prosecuting this action. Therefore,
demand on Medaphis and its Board of Directors would have been futile and is
excused;
(d) Further, demand would have been futile and, in turn,
legally excused, because the Director Defendants serving on November 1, 1996,
had and have irreconcilable conflicts of interest because of their
responsibility for and control of the related class action
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securities litigation arising out of their acts of wrongdoing alleged herein,
which are themselves also a basis for liability herein. Although the class
action complaint herein, which alleges that Medaphis and other defendants
violated federal securities laws, only explicitly names Defendant Brown, the
statute of limitations has not, and will not run until August for the remaining
directors not yet named in the class action. These directors signed the false or
misleading SEC filings herein complained of and each is exposed to liability for
violation of the securities laws. Such a conflict renders each of the Medaphis
directors incapable of disinterestedly deciding to prosecute this action. Each
of said directors signed the SEC false or misleading SEC filings listed after
their name:
Brown: February 29, 1996 Registration Statement on Form S-4
(registration of stock to acquire Rapid Systems); April 3, 1996, Registration
Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form
l0-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement
on Form S-3;
Bellas: February 29, 1996 Registration Statement on Form S-4
(registration of stock to acquire Rapid Systems); April 3, 1996, Registration
Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form
10-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement
on Form S-3;
Holbrooke: February 29, 1996 Registration Statement on Form
S-4 (registration of stock to acquire Rapid Systems); April 3, 1996,
Registration Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual
Report on Form 10-K For The Year Ended December 31, 1995; July 12, 1995
Registration Statement on Form S-3;
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Pryor: February 29, 1996 Registration Statement on Form S-4
(registration of stock to acquire Rapid Systems); April 3, 1996, Registration
Statement on Form S-4 (the BSG Prospectus); April 1, 1996, Annual Report on Form
l0-K For The Year Ended December 31, 1995; July 12, 1995 Registration Statement
on Form S-3;
McDowell: July 12, 1995 Registration Statement on Form S-3;
Papermaster: July 12, 1995 Registration Statement on Form
S-3; Douglas: None.
(e) Medaphis has agreed to indemnify its directors and
officers against liability for acts and omissions occurring in the performance
of their duties as directors and maintains insurance policies to cover the costs
of such indemnification. Under the terms of those insurance policies, however,
claims against directors which are brought by the Company or other directors are
excluded from coverage. Therefore, Medaphis' Board of Directors, or any
committee thereof, was effectively disabled from complying with any demand that
would cause the Company to bring suit against the Defendants because to do so
would result in the loss of insurance coverage;
(f) In order to bring this action for bad faith breaches
of fiduciary duty, the members of Medaphis' Board of Directors would have had to
sue themselves and/or their fellow directors and allies in the top ranks of the
corporation. They, therefore, would not initiate litigation nor be able to
prosecute any such action.
128. Each and every member of the Board of Directors was incapable
of exercising independent business judgment in connection with a shareholder
demand in this case. Brown was still on the board November 1, 1996, when this
action was first filed. He is an insider and primary actor in the underlying
securities fraud, having made many of the untrue statements to the press.
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He signed all of the periodic reports and registration statements complained of
herein. Bellas, Holbrooke and McDowell, in addition to deliberately making a
sham of the Audit Committee also signed some or all of the registration
statements complained of herein and are primarily liable under the federal
securities laws. Papermaster and Pryor, in addition to signing some or all of
the registration statements herein, also were insiders in direct control of
major Medaphis subsidiaries, with intimate working knowledge of the day to day
affairs of Medaphis. Papermaster, in particular, was charged with supervising
and ameliorating Imonics. Medaphis acquired BSG, of which Papermaster was CEO,
to integrate the operations of Imonics and Rapid Systems. BSG allegedly
possessed large processing volume software expertise which Imonics in fact
lacked, and which it needed to meet its commitments under the Bertelsmann
contracts, and on the MPSC Re- Engineering Project. In essence, Papermaster was
hired to straighten out the mess at Imonics. He knew from his first day on the
job that Imonics lacked the capacity to perform under the Bertelsmann contract
and on the MPSC Re-Engineering Project. Finally, Douglas, the 'mystery
director', was never elected by the shareholders, who came and went before any
shareholder ever had the opportunity to vote for him, constituted the
unauthorized seventh member of the board in violation of the Company's By-Laws.
Douglas failed to execute the Company's registration statements, despite being
required to do so by SEC regulations. Each member of this group lacked the
independence required to evaluate a shareholder demand, for all the reasons set
forth above.
129. No demand has been made on the shareholders of Medaphis to
cause Medaphis to bring this action against defendants on behalf of the Company
because such an effort would be futile. The shareholders of Medaphis do not have
the power to collectively act on behalf of the
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company. All any shareholder or group of shareholders can do is, as plaintiff
does here, bring a derivative action, on behalf of Medaphis, pursuant to Rule
23.1 of the Federal Rules of Civil Procedure.
130. Plaintiff will fairly and adequately protect the interests of
Medaphis and its shareholders in enforcing the rights of Medaphis against the
Defendants. Plaintiff's attorneys are experienced in this type of litigation and
will prosecute this action diligently on behalf of Medaphis to enforce the
rights of the company against the Defendants. Plaintiff has no interest adverse
to Medaphis.
COUNT I
BAD FAITH BREACH OF FIDUCIARY DUTY AGAINST ALL DEFENDANTS
131. Plaintiff incorporates by reference the allegations set forth
in paragraphs 1 through 130 above.
132. Each of the Defendants, as directors and/or officers of
Medaphis, owed fiduciary duties to the company.
133. By engaging in conduct described above, and by their actions
or omissions causing or permitting Medaphis to engage in unlawful conduct
described above, each of Defendants deliberately and in bad faith breached his
fiduciary duties to the company. Defendants' violation of their fiduciary duties
to Medaphis was willful and knowing and made in bad faith.
134. Medaphis has been damaged by Defendants' breach of their
fiduciary duties.
COUNT II
VIOLATION OF LAW
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135. Plaintiff incorporates by reference the allegations set forth
in Paragraphs 1 through 130 above.
136. Defendants deliberately violated the federal securities laws
and have damaged Medaphis thereby.
137. Each of the defendants owes a fiduciary duty of care to
Medaphis.
138. Each of the defendants has breached his fiduciary duty of care
to Medaphis by violating the federal securities laws, as set forth above.
COUNT III
GROSS NEGLIGENCE AGAINST ALL DEFENDANTS
139. Plaintiff incorporates by reference the allegations set forth
in Paragraphs 1 through 130 above.
140. Each of the Defendants, as directors and/or officers of
Medaphis, owed to Medaphis a duty to act with reasonable care.
141. Each of the Defendants, by their conduct and omissions
described herein, breached his duty to act with reasonable care.
142. The breach by Defendants of their duty to act with reasonable
care was grossly negligent and reckless.
143. Medaphis has been damaged by the gross negligence and reckless
disregard by defendants of their duties.
COUNT IV
BREACH OF CONTRACT AGAINST THE ALL DEFENDANTS
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144. Plaintiff repeats, realleges and incorporates the allegations
set forth in Paragraphs 1 to 130 above.
145. In consideration of the substantial compensation and
professional enhancement and prestige which each of the Defendants received, as
directors and/or officers of Medaphis, each of those defendants contracted with
Medaphis to act in the best interests of Medaphis and to cause Medaphis to
operate lawfully and properly. Specifically, Brown, Pryor, McDowell,
Papermaster, Douglas, Cote and Douglass all had written employment contracts
with Medaphis, which they breached by their actions, as set forth herein. Each
of the Director Defendants also had an express agreement to serve as a director
of the corporation in exchange for compensation, which each Director Defendant
breached by their actions herein.
146. By their actions and omissions set forth herein, those
defendants breached their contractual obligations and commitments to Medaphis by
not acting in the best interests of Medaphis and by causing or permitting
Medaphis to act in unlawful and improper ways.
147. Medaphis has been damaged by Defendants' breaches of their
contracts with Medaphis.
PRAYERS FOR RELIEF
WHEREFORE, Plaintiff, on behalf of Medaphis, demands judgment against
defendants, and each of them jointly and severally, as follows:
A. Determining that this suit is a proper derivative action and
certifying plaintiff as appropriate representative of Medaphis for said action
pursuant to Rule 23.1 of the Federal Rules of Civil Procedure;
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B. Declaring that each of the defendants breached his fiduciary
duty to Medaphis in bad faith, and breached his contract with Medaphis as
alleged herein;
C. Declaring that each of the Director Defendants breached his
duty of care to Medaphis and that this conduct constituted gross negligence;
D. Determining and awarding Medaphis the damages sustained by it
as a result of the violations set forth in each count of this complaint from
each of the defendants named in each count, jointly and severally, with interest
thereon;
F. Awarding plaintiff the costs and disbursements of this action,
including reasonable fees and costs to plaintiff's attorneys, accountants, and
experts;
G. Granting such other further relief as the Court may deem just
and proper.
JURY DEMAND
Plaintiff demands a trial by jury.
(Signatures appear on the following page.)
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Dated: February ll, 1997 Respectfully submitted,
/s/
-----------------------------------
ROBERT C. SCHUBERT, ESQ.
/s/
-----------------------------------
JUDEN JUSTICE REED, ESQ.
SCHUBERT & REED LLP
Two Embarcadero Center,
Suite 1050
San Francisco, CA 94111
Telephone: 415-788-4220
Telecopier: 415-788-0161
/s/
-----------------------------------
ALFRED G. YATES, JR., ESQ.
ALFRED G. YATES, JR. &
ASSOCIATES
519 Allegheny Building
429 Forbes Avenue
Pittsburgh, Pennsylvania 15219
Telephone: 412-391-5164
Telecopier: 412-471-1033
BIRD, BALLARD & STILL
/s/
-----------------------------------
WILLIAM Q. BIRD, ESQ.
14 Seventeenth Street,
Suite 5
Atlanta, GA 30309
Telephone: 404-873-4696
Telecopier: 404-872-3745
ATTORNEYS FOR DERIVATIVE PLAINTIFF
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VERIFICATION
I, Thomas W. Brown, hereby declare:
1. I am the administrator for the Thomas W. Brown Profit Sharing
Plan, plaintiff in the captioned matter.
2. I have read the foregoing First Amended Verified Derivative
Complaint and know its contents. I am informed and believe and on that ground
allege that the matters stated therein are true and correct
Executed this ____ day of February, 1997 in Pittsburgh, Pennsylvania. I
declare under penalty of perjury that the foregoing is true and
correct.
/s/
-----------------------------------
Thomas W. Brown
59
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF GEORGIA
ATLANTA DIVISION
- ------------------------------------------
)
THOMAS W. BROWN, ADMINISTRATOR, ) NO. 1 96-CV 2904
THOMAS W. BROWN PROFIT SHARING )
PLAN, Derivatively on Behalf of )
MEDAPHIS CORPORATION, )
)
Plaintiff, )
vs. )
RANDOLPH G. BROWN, ROBERT C. BELLAS, )
JR., DAVID R. HOLBROOKE, RICHARD H. )
STOWE, JOHN A. DOWNER, DAVID E. )
McDOWELL, DENNIS A. PRYOR, STEVEN G. )
PAPERMASTER, MICHAEL L. DOUGLAS, )
MICHAEL R. COTE and JAMES S. )
DOUGLASS, )
)
Defendants, )
and )
)
MEDAPHIS CORPORATION, )
)
Nominal Defendant. )
- ------------------------------------------)
CERTIFICATE OF SERVICE
THIS IS TO CERTIFY that I have this day served a copy of the within and
foregoing First Amended Verified Derivative Complaint upon all parties in this
action by depositing same in the United States mail, in a properly addressed
envelope with adequate postage thereon, to the following:
60
M. Robert Thornton, Esq.
Robert A. Ambler, Jr., Esq.
Leisa L. Bernardin, Esq.
King & Spalding
191 Peachtree Street
Atlanta, GA 30303-1763
Henry P. Wasserstein, Esq.
Skadden, Arps, Slate, Meagher & Floam
919 Third Avenue
New York, NY 10022
J. Marbury Rainer, Esq.
Parker, Hudson, Rainer & Dobbs
1500 Marquis Two Tower
285 Peachtree Center Ave.
Atlanta, GA 30303
Jack J. Dalton, Esq.
John M. Bowler, Esq.
Troutman Sanders
NationsBank Plaza, Suite 5200
600 Peachtree Street, NE
Atlanta, GA 30308-2216
This _______ day of February, 1997.
/s/
-------------------------------------
William Q. Bird
Georgia State Bar No. 057900
BIRD, BALLARD & STILL
14 Seventeenth Street, Suite 5
Post Office Box 7009
Atlanta, Georgia 30357
404/873-4696
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