I 4,7 UNITED STATES DISTRICT COURT FEB 09 SOUTHERN DISTRICT OF NEW YORK Li liSDI IN RE ADVANCED HEALTH CORPORATION : Master File ' vd.' — - - SECURITIES LITIGATION • 98 Civ. 4647 (BDP) THIS FILING RELATES TO: CONSOLIDATED CLASS ALL CLASS ACTIONS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS JURY TRIAL DEMANDED Plaintiffs, individually and on behalf of all others similarly situated, by and through their undersigned attorneys, make the following allegations upon information and belief, except as to allegations specifically pertaining to plaintiffs and their counsel which are based upon personal knowledge. Plaintiffs' information and belief is based on, among other things, the investigation made by and through plaintiffs' attorneys, which includes, among other things, a review and analysis of the public filings of Advanced Health Corporation ("Advanced Health" or the "Company"), as well as press releases, reports, and articles issued by or about Advanced Health. Plaintiffs believe that further substantial evidentiary support will exist for the allegations set forth herein after a reasonable opportunity for discovery. NATURE OF THE ACTION 1. This is a federal securities class action on behalf of all persons, other than defendants and their affiliates, who
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I 4,7
UNITED STATES DISTRICT COURT FEB
09SOUTHERN DISTRICT OF NEW YORK
Li
liSDIIN RE ADVANCED HEALTH CORPORATION : Master File ' vd.'—- -SECURITIES LITIGATION
•98 Civ. 4647 (BDP)
THIS FILING RELATES TO: CONSOLIDATED CLASSALL CLASS ACTIONS ACTION COMPLAINT FOR
VIOLATIONS OFFEDERAL SECURITIES LAWS
JURY TRIAL DEMANDED
Plaintiffs, individually and on behalf of all others
similarly situated, by and through their undersigned attorneys,
make the following allegations upon information and belief,
except as to allegations specifically pertaining to plaintiffs
and their counsel which are based upon personal knowledge.
Plaintiffs' information and belief is based on, among other
things, the investigation made by and through plaintiffs'
attorneys, which includes, among other things, a review and
analysis of the public filings of Advanced Health Corporation
("Advanced Health" or the "Company"), as well as press releases,
reports, and articles issued by or about Advanced Health.
Plaintiffs believe that further substantial evidentiary support
will exist for the allegations set forth herein after a
reasonable opportunity for discovery.
NATURE OF THE ACTION
1. This is a federal securities class action on behalf of
all persons, other than defendants and their affiliates, who
PP
purchased or acquired the common stock of Advanced Health during
the period from May 7, 1997 through August 5, 1993, inclusive
(the "Class Period"), and sustained damages as a result of those
1 transactions (the "Class") seeking to pursue remedies under the
Securities Exchange Act of 1934 (Lhe "Exchange Act"). During the
Class Period, defendants issued to the investing public a series
of materially false and misleading financial statements, press
releases, and other statements concerning, among other things,
Advanced Health's operations, performance, and financial
condition. As a result, the price of Advanced Health common
stock was artificially inflated throughout the Class Period,
thereby damaging plaintiffs and other purchasers of such stock.
2. As hereinafter alleged, during the Class Period,
Advanced Health and the Individual Defendants, as identified
below in paragraph 16, who were senior executive officers and
directors, major shareholders, and controlling persons of
Advanced Health, knowingly or recklessly, dratted, reviewed,
approved and/or disseminated materially false and misleading
statements, press releases, reports, and other public
representations of and about Advanced Health. Among other
things, defendants concealed from the investing public that
certain of the Company's accounting practices were improper and
in violation of Generally Accepted Accounting Principles
("GAAP"), and that, as a result, the Company's reported financial
results were materially misstated.
3. For example, in violation of GAAP, Advanced Health (a)
improperly recorded at least $2.5 million in revenue in the first
2
1p-
quarter of fiscal 1997 in connection with a software license
agreement, prior to completion of the earnings process with
respect to the software; (b) improperly permitted $3.6 million of
forgiven accounts receivable to be recorded as revenue in the
second quarter of fiscal 1997; (c) improperly recorded $3.5
million in revenue in the fourth quarter of fiscal 1997 from a
purported "sale" to a sham entity ; and (d) improperly recorded
$2.5 million in revenue in the fourth quarter of fiscal 1997
which was actually the return of an investment made by the
Company. The effect of these and other deceptive practices was
to overstate the Company's operating results reported during the
Class Period. in particular, among other things, defendants
overstated the Company's reported revenue for fiscal 1997 by a
total of at least $11.6 million -- almost 20% of the reported
revenue for the fiscal year.
4. In addition, during the Class Period, defendants sought
to profit by using almost $9,000,000 in shares of artificially
inflated Advanced Health stock as consideration for the
acquisition of two other companies. Defendants also profited
from the artificial inflation of the Company's stock price
through the secondary public offering of 2,500,000 shares of
Advanced Health common stock by the Company and certain selling
shareholders in October 1997_ Advanced Health and the selling
shareholders reaped total proceeds of approximately $5b million
from this offering.
S. The Individual Defendants also reaped significant
personal financial windfalls through lucrative insider sales of
3
more than 337,000 shares, at prices ranging from $12.54 to $21.25
per share, yielding total proceeds of more than $6.6 million.
The Individual Defendants' insider sales were particularly
suspicious because they were well-coordinated, as two or more of
the Individual Defendants typically sold stock on the same day.
By virtue of their insider sales of Advanced Health's stock at
artificially inflated prices, defendants had a duty to
disseminate promptly truthful information that would be material
to investors in compliance with the integrated disclosure
provisions of the SEC as embodied in SRC Regulation S-X (17
C.F.R. Sections 210.01 et seq.) and S-K (17 C.F.R. Sections
229.10 et seq.) and other SEC regulations, including accurate and
truthful information with respect to the Company's operations,
financial condition and earnings so that the market price of the
Company's common stock would be based on truthful, complete and
accurate information.
6. As a result of defendants' successful efforts to
obscure and conceal the truth concerning Advanced Health's
financial performance, the Company was able to keep its true
financial condition hidden from investors throughout the Class
Period. On June 30, 1998, the Company suddenly announced that it
anticipated an operating loss of $3-4 million -- in contrast to
the previous five quarters of the Class Period, during each of
which the Company had reported increasing profits. The Company
also reported that it anticipated one-time charges totalling
approximately $8 million (on a pre-tax basis), which included,
among other things, the write-off of approximately $5 million in
4
certain accounts receivable for sales prior to 1998. Defendants
still failed to disclose, however, the true extent to which the
Company's financial performance had been misrepresented.
7. Finally, on August 6, 1998, the Company announced that
revenues for the second quarter of 1998 were only $16.8 million,
that the Company had experienced an operating loss of $16.3
million, and that one-time charges for the quarter were $9.6
million.
8. Market reaction to these revelations, which
contradicted defendants' previous representations during the
Class Period of continued revenue growth and increasing
profitability, was immediate and devastating. On June 30, 1998,
the closing price of Advanced Health common stock fell more than
40%, from $9.25 per share (the previous day's closing price) to
$5.50 per share. By August 6, 1998, the stock had fallen even
further to just $2.50 per share -- a decline of more than 90%
from the Class Period high of $27.375 per share (on October 16,
1997). Advanced Health common stock currently trades in the
range of $2-$3 per share.
JURISDICTION AND VENUE
9. This Court has jurisdiction over the subject matter of
this action pursuant to 28 U.S.C. §§ 1331 and 1337 and Section 27
of the Exchange Act [15 U.S.C. § 78aa].
10. The claims asserted herein arise under and pursuant to
Sections 10(b) and 20(a) of the Exchange Act [15 U.S.C. §§ 78j(b)
and 78t(a)1 and Rule 10b-5 promulgated thereunder [17 C.F.R. §
240.10b-5].
5
11. Venue is proper in this District pursuant to Section 27
of the Exchange Act [15 U.S.C. 78aa1 and 28 U.S.C. § 1391(b)
and (c). The acts charged herein, including the preparation and
dissemination of materially false and misleading information,
occurred in substantial part in this District and Advanced Health
maintains its principal executive offices in this District.
12. In connection with the acts, conduct, and other wrongs
complained of herein, defendants, directly or indirectly, used
the means and instrumentalities of interstate commerce,
including, but not limited to, the United States mails,
interstate telephone communications, and the facilities of the
national securities markets.
PARTIES
The Plaintiffs
13. The representative plaintiffs listed below, who
ourchascd Advanced Health stock during Lhe Class Period, seek
appointment as Lead Plaintiffs in this consolidated action. A
proposed Order desi gnating the following plainLiffs as
representative plaintiffs has been submitted to the Court for its
approval:
(a) Plaintiff Donald Aboussclman made the following
purchases of Advanced Health common stock during The Class Period
at prices that were artificially inflated by defendants'
wrongdoing, and has been damaged thereby:
No. of Shares Date Price Per Share
1,000 06/01/98 $12.625
1,000 06/15/98 $12.000
500 07/01/98 $5.375
6
(b) Plaintiff Michael R. Angel purchased 1,500 shares
of Advanced Health common stock on or about May 15, 1998 at a
price of $15.25 per share, which was artificially inflated by
defendants' wrongdoing, and has been damaged thereby.
(c) Plaintiff David Bookstaber purchased 200 shares of
Advanced Health common stock on or about May 15, 1998 ar_ a price
of $18.00 per share, which was artificially inflated by
defendants' wrongdoing, and has been damaged thereby.
(d) Plaintiff Andrew Feldman purchased 400 shares of
Advanced Health common stock on or about October 7, 1997 at a
price of $22.75 per share, which was artificially inflated by
defendants' wrongdoing, and has been damaged thereby.
(e) Plaintiff Ross Feldman purchased 300 shares of
Advanced Health common stock on or about October 7, 1997 at a
price of $22.75 per share, which was artificially inflated by
defendants' wrongdoing, and has been damaged thereby.
(f) Plaintiff Leonard GutfleLsch made the following
purchases of Advanced Health common stock during the Class Perio
at prices that were artificially inflated by defendants'
wrongdoing, and has been damaged thereby:
No. of Shares Date Price Per Share
100 10/30/97 $18.206100 11/12/97 $15,78
(g) Plaintiff Jason Handwerker made the following
purchases of Advanced Health common stock during the Class Period
at prices that were artificially inflated by defendants'
condition, operations, and the true value of Advanced Health
common stock; and (ii) caused plaintiffs and other members of the
Class to purchase Advanced Health common stock at artificially
inflated prices that did not reflect its true value.
BACKGROUND
2. Advanced Health was, at all relevant times, a health
care management company which provides physician oriented
products and services through its two wholly-owned subsidiaries,
Advanced Health Management (AHM) and Advanced Health Med-E
Systems (AHMES). AHM primarily provides physician practice and
network management services. AHMES is a clinical information
systems provider. At all relevant times, the Company represented
that it managed several physician group practices comprised ot
hundreds ot physicians in the New York metropolitan area and
multiple physician networks with thousands of affiliated
physicians and network enrollees in the New York, Philadelphia,
and A=lanta metropolitan areas.
20
24. According to the Company's Form 10-K for the year ended
December 31, 1997, anproximately 80% of the Company's operating
revenues were generated from fees for non-medical and
administrative services that the Company provided to member
physician group practices and physician networks. The remainder
of the Company's revenues were generated from licensing fees for
the Company's information systems and network management services
rendered to non-member third-parties.
The Synetic Agreement
25. On or about March 31, 1997, Advanced Health and
Synetic, Inc. ("Svnetic") executed a Software License Agreement
(the "Agreement") for the provision of certain existing software
(mainly, The Company's Med-E-Practice 3.1 software) and certain
software that was then under development (including amon g others,
the Company's Internet Script Writer). The Agreement obligated
Advanced Health to license, deliver, install, test, and interface
the existing software "promptly after the execution of this
Agreement." The Agreement provided that Synetic would pay the
Company $2.5 million only after successful deliver y of the
existing software and completion of Advanced Health's obligations
with respect to the installation thereof. However, as detailed
herein, prior to delivery and installation of the existing
software, and in direct violation of the Company's stated policy
for recording such software licensing fees and GAAP, defendants
improperly recognized as revenue the full $2.5 million.
26. Further, the Agreement provided that upon completion of
Internet Script Writer, the Company would deliver and install it
21
at •ynetic's premises. The Agreement provided that Synetic would
pay the Company an additional $1 million upon "Installation and
Acceptance of Internet Script Writer ..., provided, however, that
such amount shall be reduced $100,000 for every month or portion
thereof past July 1, 1997 that Internet Script Writer remains
undelivered or unsuccessfully installed." Notwithstanding the
foregoing, as detailed herein, and in contravention ot the
Company's stated Policy for recording such software licensing
fees and GAAP, defendants recognized as revenue the full $1
million on or before June 30, 1997, even though the Company had
failed to meet its contractual obligations regarding Internet
Script Writer.
27. Synetic received incomplete and operationally flawed
portions of the Internet Script Writer in July and August 1997.
Because of the software's failure to conform to the requirements
of the Agreement, Synetic was, under the terms of the Agreement,
excused from any obligation to pay for it, and gave Advanced
Health prompt not:ice of its failure.
28. Thereafter, in September 1997, the Company iniilated an
action against Synetic in the Supreme Court of the State of New
York. in support of certain counterclaims asserted by Synetic,
Synetic submitted the affidavit of Anthony Vuolo, its Chief
Financial Officer, which included the following assertions
relating to defendants' premature recognition of revenue:
"[Advanced Health] also reported income from the firstdeliverable product under the agreement known as Med-E-Practice 3.1. Med-E-Practice 3.1 was delivered to Synetic in the beginning of April 1997, and payment was made by Synetio for this software on April 8, 1997.
22
Althouch delivery and payment occurred in the quarterended June 30, 1997, it appears that revenues and the related profits from such delivery were recorded in [Advanced Health's] financial statements for the quarter ended March 31, 1997. This conclusion isreached based upon a review of revenues reported by[Advanced Health] for its clinical information businessfor applicable quarters." [Emphasis added.]
29. According to a press release dated January 14, 1999,
the Company and Synetic have agreed to settle the litigation.
MATERIALLY FALSE AND MISLEADING STATEMENTSMADE BY DEFENDANTS DURING THE CLASS PERIOD
30. The Class Period begins on May 7, 1997. On that date,
Advanced Health issued a press release, published on Business
Wire, announcing purportedly record positive results for the
first quarter of 1997, the period ending March 31, 1997. The
Company reported net revenues of $10.0 million and net income of
$0.66 million, or $0.08 per share, compared to net revenues of
$3.7 million and a net loss of $1.2 million, or a less of $0.27
per share, for the same period in 1996. Defendant Edelson
commented on the results as follows:
We are very pleased with cur performance and theresults that we achieved. These results reflect the growing momentum of our practice and network management contracts as well as the market penetration of ourclinical information tools for physicians. OUragreemenLs with Physicians' Online, Synetic, Inc., andRush-Presbyterian-St. Luke's Medical Center areextremely important in that they provide furthervalidation of our clinical applications. [Emphasesadded.]
31. The May 7, 1997 report of first quarter earnings and
defendants' comments sent the price of Advanced Health common
stock up $.75 per share to close at $18.75 per share on May 7,
23
1997, an increase ot more than 4% from the previous day's closing
price of S18.00 per share.
32. Market analysts following Advanced Health stock quickly
responded with favorable reports on the Company. For example:
(a) On or about May 7, 1997, following the Company's
maintaining the firm's "STRONG BUY u rating for Advanced Health
common stock and extolling the Company's growth potential. As
the Cowen report noted:
The growth potential is enormous.... New practice andnework affiliations, along with strategic HCISalliances (like the recent Synetic deal) will enhanceinvestor confidence in the strong earnings prospects.[Emphasis added.]
(b) Smilarly, on May 8, 1997, Hambrecht & Quist
analyst Ken R. Laudan issued a report heralding Advanced Health's
"szrong" March quarter results, reiterating the firm's "BUY"
rating for Advanced Health common stock, and raising the firm's
earnings per share estimates for the fiscal years 1997 and 1998,
$0.04 and $0.05 respectively. As the Hambrecht & Quist report
also noted:
Advanced Health continues to successfully execute insstated business strategy. The company is building itsphysician base nicely, both with groups and networks,and is signing significant software licensingagreements which validate its information technology inthe marketplace.
33. The results announced by the Company on May 7, 1997
were repeated in the Company's quarterly report on Form 10-Q, for
the quarterly period ended March 31, 1997 the "First Quarter
1997 10- 1 ), which was signed by defendants Edelson and Masarek
24
and filed with the SEC on or about May 15, 1997_ The Notes To
Condensed Consolidated Financial Statements, contained in the
First Quarter 1997 10-Q, stated with res-oecL to the interim
financial statements:
In the opinion of Management, the interim unauditedfinancial statements included herein reflect alladjustments necessary, consisting of normal recurringadjustments, for a fair presentation of such data on abasis consistent with that of the audited datapresented therein.
34. Included in "Management's Discussion and Analysis of
Financial Condition and Results of Operations"in the First
Quarter 1997 10-Q were the following statements relating to fees
purportedly earned by the Company from licensing agreements:
The Company earned fees for the use and support of itsclinical information systems, including the recognitionof license revenues and software training revenues, ofapproximately $3.4 million for the three months endedMarch 31, 1997, as compared to $0.8 million in thecomparable period ended March 31, 1996.
35. In truth and in fact, the reported financial results
and other representations referred to in 30, 33 and 34 above
were materially false and misleading, in that, among other
things:
(a) The Company's software licensing revenues for the
first quarter of 1997 were materially overstated by at least $2.5
million -- more than 73% of licensing revenue and more than 25%
of total revenues reported for the quarter -- which the Company
improperly recorded as revenue under the Agreement with Synetic
described in 1 41 25 through 28 above;
(b) The Company's revenues for the first quarter of
fiscal 1997 were also inflated because of a deceptive
25
transaction, which was not disclosed, pursuant to which the
Company advanced or purported to "loan" $2,000,000 to Madison
Medical - The Private Practice Group of New York, L.L.P.
("Madison"), a physician practice group that supposedly accounted
for 46k of Advanced Health's revenues during 1996_ The loan
proceeds were then used by Madison to pay the Company's
management fees which were then improperly recognized as revenue
by the Company, when they were really a return of loan proceeds.
Without the loan, Madison never could have paid those fees, and
the Company never could have expected to have been paid.
Defendants also failed to disclose that, in addition to the loan,
the Company had provided Madison with a $1.7 million letter of
credit by depositing restricted cash with a lending institution.
Recently. on January 15, 1999, the Company issued a press release
announcing that it had terminated its contract with Madison due
to Madison's failure to pay to Advanced Health 'contractually
obligated management fees"; and
(c) For the reasons set forth herein the Company's
financial statements violated GAAP and the Company's financial
statements failed Lo contain all necessary adjustments for a fair
presentation of the Company's operating results, as defendants
represented.
36. On or about August 7, 1997, Advanced Health issued a
press release, published on Business Wire, announcing purportedly
record results for the second quarter ended June 30, 1997. The
Company reoorted net revenues of $13.0 million and net income of
$1.2 million, or $0.14 per share, compared to net revenues of
26
$3.9 crillion and a net loss of $655,000, or a loss of $0.15 per
share, for the same period the prior year. Commenting on the
results, defendant Edelson stated:
We are extremely pleased with the tremendous growthAdvanced Health experienced during the quarter whichreflects the successful implementation of ourstrategy.... We continue to build up new physicianpractice and network management contracts and furtherpenetrate the untapped East Coast health caremarketplace. This growth reflects increasedrecognition of Advanced Health's strategy to partnerwith physician practices rather than purchase them.
Defendant Masarek, attributed the increase in revenue and
earnings to:
[Lhe Company's] continued growth in practice managementaffiliations and software sales in our Advanced HealthMed-E-Systems clinical information services subsidiary.
The August, 7, 1997 press release also highlighted a new softwaxe
product named H Med-E-Practice Intake", stating:
Product development announcements include theinstallaLion of Med-E-Practice intake, (TM) a newelectronic too] that aids physicians in monitoring andevaluating patients' risks and health status throughsurveys and on-line systems.
37. Market analysts once again reacted favorably. For
example, Hambrecht & Quist analyst Richard Lee issued a report
reiterating the firm's previously-issued "STRONG BUY" rating for
Advanced Health common stock. According to the report, "the
information technology business sill contributed $3 million to
revenues, mostly from existing contracts with Synetic and Rush
Presbyterian."
38. The results announced on August 7, 1997 were repeated
in the Company's quarterly report on Form 10-Q for the quarterly
period ended June 30, 1997 (the "Second Quarter 1997 10-Qn),
27
which was signed by defendants Edelson and Masarek and filed with
the SEC on or about August 14, 1997. The Notes To Condensed
Consolidated Financial Statemenus contained in the Second Quarter
1997 10-0 stated with respect to the financial statements:
Reference is made to the Notes to ConsolidatedFinancial Statements contained in the Company'sDecember 31, 1996 audited consolidated financialstatements as filed with the Securities and ExchangeComm*ssion on Form 10-K. In the opinion of Management,the interim unaudited financial statements includedherein reflect all adjustments necessary, consisting ofnormal recurring adjustments, for a fair presentationof such data on a basis consistent with that of theaudited data presented therein. ... Amounts advanced to an affiliate during the current period have been classified as an investment in such affiliate andincluded in other assets in the accompanying balance sheet at June 30, 1997 under the terms and conditions of the applicable agreement. {Emphasis added.]
In addition, defendants commented on the Company's investing
activities as follows:
Net cash provided by (used in) investing activities was($7.9) million for the six months ended June 30, 1997compared with ($.2) million for the comparable periodended June 30, 1996, primarily relating to a minorityinvestment in Caresoft, a developer of diseasemanagement tools, advances to, and investments in, affiliates and purchases of fixed assets. [Emphasisadded.]
39. In truth and in fact, the reported financial results and
other representations referred to in 36 and 38 above were
materially false and misleading in that, among other things:
(a) Defendants failed to disclose that Synetic had
advised the Company that its Internet Script Writer was plagued
with defects and required substantial reformulation and
reconfiguration in order to cure these problems and that, in
accordance with the terms of the Agreement, Synetic was
28
withholding payment of $1 million until the problems were
resolved. As a result, the Company's software licensing revenues
for the second quarter and six months ended June 30, 1997 were
materially overstated by at least $1.0 million which the Company
recorded as revenue under the Agreement with Synetic;
(b) During June 1997, the Company forgave $3.6 million
in receivables due from its largest customer, Madison, which
previously were recorded by the Company as revenue. Rather than
reversing the previously recorded revenue as required by GAAP,
defendants capitalized as an intangible asset, $3.6 million, the
face amount of the receivables, thereby overstating revenue, net
income, and assets for the second quarter as follows:
Reported Second Second QuarterQuarter Results Results (Not(Including Madison including Madison PercentageRevenue) Revenue) Overs[atement Overstatement
Revenue $13,021,000 $9,421,000 $3,600,000 27.6%
Intan g ible 55,259,000 51,659,000 $3,600,000 68.5%Assets
Net Income 51,151,000 (52,419,000) 53,570,000 310%
EPS $0.14 ($0,29) 50,43 307%
Thus, instead of reporting net income of over $1 million for the
second quarter, the Company should have reported a not loss of
more than $2.4 million;
(c) The Med-E-Practice program was defective, did not
work properly, and was being used in a limited fashion by only a
small number of physicians. Moreover, defendant Masarek admitted
29
to Advanced Health employees thaL Med-F.-Practice was not ready
tor market;
(d) Advanced Health falsely claimed that its Ned E-
Practice program included "NOQA data collection". In fact, in an
e-mail dated January 21, 1998, defendant Alger stated, "we don't
have a NCQA reporting module anywhere that I know of ... so we
should not claim this"; and
(e) For the reasons set forth herein, the Company's
financial statements for the second quarter and six months ended
June 30, 1997 did not comply with GAAP, and did not contain all
necessary adjustments for a fair presentation of the Company's
operating results, as defendants affirmatively represented.
40. On or about September 8, 1997, the Company filed with
The SEC a registration statement (the "Registration Statement")
which incorporated a prospectus (the "Prospectus") relating to a
secondary public offering of 2,500,000 shares of its common
stock, of which 2,000,000 were being offered by the Company and
500,000 by selling shareholders. The Registraion Statement was
signed by, among others, defendants Edelson, Hochberg, and
Masarek. The Registration Statement was declared effective on or
about October 8, 1.997 and Advanced Health and the selling
shareholders successfully sold 2.5 million shares of Advanced
Health common stock, at a price of $22.25 per share, yielding
total proceeds of more than $55 million.
41. The Prospectus, under the sections entitled "Summary
Consolidated Financial Data" and "Selected Consolidated Financial
Data", incorporated the information from the consolidated
30
financial statements contained in the Second Quarter 10-Q for the
six months ended June 30, 1997.
42. The Prospectus, under the section entitled
"Management's Discussion and Analysis of Financial Condition and
Results of Operations", confirmed that the Company had recognized
as revenue in the quarter ended June 30, 1997, the $1 million due
from Synetic under the Agreement. The Prospectus further stated
that, in September 1997, the Company had commenced an action
against Synetic to collect the $1 million, which never had been
paid, and that Synetic had answered and counterclaimed.
43. The "Notes To Consolidated Financial Statements"
included in the Prospectus purported to describe the Company's
policy regarding revenue recognition and compliance with
accounting standards:
The Company recognizes revenue from the sale of itsinformation systems and services (upon installation andacceptance), and from the licensing of its software tothird parties (upon delivery)._ The Company's revenuerecognition policy is in compliance with the provisionsof [SOP 91-1]. [Emphases added.]
44. The "Notes To Consolidated Financial Statements
included in the Prospectus further represent:
The unaudited consolidated financial informationincluded herein for the six months ended June :=30, 1996and 1997 has been prepared in accordance with generallyaccepted accounting principles for interim financialinformation_ In the opinion of the Company, theseunaudited consolidated financial statements reflect alladjustments necessary, consisting of normal recurringadjustments, for a fair presentation of such data on abasis consistent with that of the audited datapresented herein.
45. In truth and in fact, the reported financial results and
other representations in the Prospectus referred to in 41-44
31
above were materially false and misleading in that, among other
things:
(a) Contrary to defendants' representations that the
Company recognized revenue from The sale at its information
systems and services upon installation and acceptance, and from
the licensing of its software to third parties upon delivery, it
was defendants' policy and practice to recognize revenue upon the
signing of a contract; and
(b) For the reasons set forth in 11 39 above, the
Company's financial statements were not prepared in accordance
with GAAP and it was not true that the financial statements
reflected all necessary adjustments for a fair presentation of
such data.
46. On September 18, 199?, Advanced Health issued a press
release, published on Business Wire, announcino. its acquisition
of Bukstel & Halfpenny Incorporated, a computer software company
that creates and markets products allowing doctors and healthcare
organizations to exchange individual patients' healthcare
information with other healthcare providers via computer. The
total consideration for the acquisition was over $4,500,000,
comprised of $1,444,000 in shares of Advanced Health common
stock, $250,000 in non qualified options for the purchase of
Advanced Health common stock, $2,500,000 in additional shares of
Advanced Health common stock, contingent upon the achievement of
certain performance goals, and $306,000 in cash. The share
amounts were each calculated based on the average daily closing
price of Advanced Health common stock for the thirty days
32
preceding September 17, 1997 (the date of the merger agreement),
which was $21.8125. The wrongdoing described herein enabled
defendants to use artificially inflated shares of Advanced Health
stock as consideration for this and other acquisitions. Bukstel
& Halfpenny has since commenced an action in the Supreme Court of
The State of New York against the Com'oany and the Individual
Defendants seeking damages tor, among other things, fraud and
breach of contract.
47. On or about October 7, 1997, defendants Hochberg and
Edelson sold 65,000 and 10,000 shares, respectively, of Advanced
Health common stock for $20.97 per share.
48.. On or about October 24, 1997, a Bloomberg News Service
article reported that The Company had defended its forgiveness of
the Madison receivables discussed in 1 39(b) above_
Specifically, the Bloomberg article quoLed defendant Masarek, who
stated:
We simply made an investment in the account and inexchange for that investment, we got a very significantextension of the term of our contract as well as asignificant increase in our management fees.
The article further reported that the Company "expects to meet
earnings estimates for this year and next".
49. Defendant Masarek's statement in the Bloomberg article
was materially false and misleading in that the Company's
revenues remained overstated due to the failure to reverse the
revenue relating to the forgiven Madison receivables as described
in 11 39(b) above.
33
50. On or about November 10, 1997, Advanced Health issued a
press release, published on Business Wire, announcing puportedly
record results for the third quarter ended September 30, 1997.
The Company reported net revenues of $16.7 million and net income
of $1.8 million, or $0.21 per share compared to net revenues of
$4.6 million and a net loss of $1.0 million, or a loss of $0.20
per share tor the same period the previous year Defendant
Edelson commented on the results, stating:
We are very pleased with the results for the quarter.Revenues are up 28 95 and earnings are up 50 aver theprevious auarter. Our current strategy continues toprovide value to our physicians both through ourpractice management services and informationtechnology.
51. The resulLs announced by the Company on November 10,
1997 were repeated in the Company's quarterly report on Form 10-0
for the quarterly period ended September 30, 1997 (the "Third
Quarter 1997 10-Q"), which was signed by defendants Edelson and
Masarek and filed with the SEC an or about November 14, 1997.
The Notes To Consolidated Financial Statements, contained in the
Third Quarter 1997 10-Q, stated:
Reference is made to the Notes to ConsolidatedFinancial Statements contained in the Company'sDecember 31, 1996 audited consolidated financialstatements as filed with the Securities and ExchangeCommission on Form 10-K. In the opinion of Management,the interim unaudited financial statements includedherein reflect all adjustments necessary, consisting ofnormal recurring adjustments, for a fair presentationof such data on a basis consistent with that of theaudited data presented therein....
52. In truth and in fact, the reported financial results and
other representations referred to in ¶T and 51 above were
materially false and misleading, in that, among other things:
34
(a) The Company's revenues and net income for the nine
months ended September 30, 1997 were mauerially overstated for
the reasons set forth in 1 39 above;
(h) Defendants violated GAP by improperly recognizing
revenue of $2 million in the third quarter of fiscal year 1997 in
connection with a purported 'sale ° of software to Horizon Family
Medical Group, P.C. ;"HorLzon"), a physician practice group. The
recognition of revenue in connection with this transaction was
improper because the delivery of the software did not occur until
after the end of the third quarter. Thus, the Company's revenue
for the third quarter of fiscal year 1997 and nine months ended
September 30, 1997 was overstaI:ed by at least $2 million; and
(c) For the reasons set forth herein, the Company's
financial statements violated GAAP and the Company's financial
statements failed to contain all necessary adjustments for a fair
presentation of the Company's operating results as defendants
represented.
53. On or about December 4, 1997, defendant d& son made a
presentation at the Robertson Stephens 1997 Medical Conference at
the Pierre Hotel in New York City. Seeking to reassure
investors, defendant Edelson stated, among other things:
Synetic is a company with whom Advanced Health has asoftware contract. The rumors circulating with regardto Synetic are that non-payment by Synetic through thecontract is going to impact company revenues andearnings going forward.
And the fact that this contract has concluded -- it wasa tour phase software contract, the last phase has beensuccessfully completed, and this contract has no impacton future earnings.
35
The second rumor that's been circulating regardingSynetic has been raising questions about the softwarefunctionality. The essence of the issue is thatSynetic didn't pay us, and the question arose in themarket place. . . does Advanced Health software notwork? And there could be nothing further from the truth. In fact, our software works, we use it ourselves , we have many users who use it today and are very satisfied.... And in fact, sales are growing at anunprecedented pace within the Company with nationalcustomers who have looked nationally for the sorts ofsolutions that we offer, and have gone on to select us.[Emphasis added.]
54. In truth and in fact, defendant Ecelson's statements
were materially false and :lisleading as the Internet Script
Writer software, for which Synetic refused to pay, was
operationally flawed and incomplete, and, in fact, the "last"
phase had not been successfully completed.
55. Further, on December 5, 1997, in an interview on an
MSNBC Business Video, defendant Edelson responded to concerns
about the recent decline in the Company's stock price by statin:
There were some specific things that are in play Ithink with our stock and unfortunately none of them hadto do with the fundamentals of the company. If youlook at the company's growth and I know you've reviewedit, we basically have had the increasing revenues andprofits for each quarter since we went public and infact we've meet [sicl or exceeded analystsexpectations. We've been profitable now for fourquarters and have a tremendous pipeline of business.
Yet nonetheless of course companies that do aswell as ours are oftentimes [sic] declared shortsellers, short sellers as you know circulate rumors, inthis case unfounded, about the company which has oflate depressed the stock. But we believe to get thefundamentals of the performance we seem to be verycomfortable with our numbers, we feel very comfortableof the pipeline and we expect very exciting things tohappen in the near future....
36
56. In truth and in tact, defendant Edelson's statements
were ma:._erially false and misleading for the reasons set forth in
52 above.
57. On March 10, 1998, Advanced Health issued a press
release, published on Business Wire, announcing its financial
results for the year ended December 31, 1997. The Company
reported net income of $7.2 million, as compared to a loss of
$1.5 million reported in the nrior year. Commenting on the
results, defendant Edelson stated:
1997 ended on a very strong note across the board,demonstrating the sustained value of our services tophysicians and propelling our company into 1998 withgood top and bottom line momen'Lum. Trends are in ourfavor as market forces are compelling physicians toseek professional management services. Increasingly,as well, physicians and hospitals are recognizing howcriLical information management is to managing thehealth care cycle that begins in a physician's officeand often extends in7io the hospital. Our latestresults validate our strategy ot integrating thephysician management and physician informationtechnology businesses hy demonstrating marketing,operational, and financial synergies between ourbusiness units.
The March 10 press release quoted defendant Masarek as follows:
We signed up a record number of new providers a.7_ multi-specialty practices. Physicians are signing up for ourmanagement services because they recognize we possessthe resources and know-how to meaningfully improve theoperations and growth trajectory of their practices.We stand out in our industry not only for the value wecreate for these practices bur also for our uniquemodel of preserving physician independence, which ishighly appealing to the many physicians who wish tomaintain au,:.onomy.
"We have determined," Mr. Masarek added, than thelarger, higher volume practices have betteropportunities for success than do certain smaller ones.As such, we are focusing on bringing our services to
37
larger physician groups where we receive optmalreturns for our investment of t.me and effort."
Defendant Rogers also commented on the year-end results as
follows:
Overall for the fourth quarter, Advanced Health'sprofits were up substantially and operating cash flowwas positive. In addition to the growth in ourpractice management business, our Advanced HealthTechnologies ;ACT) division signed a record number ofsoftware license agreements during the fourth quarter,in 1998, ... [T]he growth of ACT will be enhanced bythe expanded product offerings and distributionchannels we added through our previously announcedacquisition of Bukstel SL Halfpenny and our recentinvestment in Patient Care Dynamics.
58. The following day, March 11, 1998, Bloomberg News
Service reported that the Company's stock "rose 13 percent after
the physician management company met earnings expectations for
the fourth quarter and said it's confident it will match 1998
esLimaLes as well." In fact, from the close of trading on March
9, 1998 to the close of trading on March 12, 1998, the market
price of Advanced Health common stock rose $3.5625 per share to
$18.125 uer share, or almost 25 percent, as a result of the March
10, 1998 earnings report_ This was the highest the stock price
had been in over four months.
59. In an article released on March 15, 1998 (and dated
March 23, 1998), The New York Observer reported that agents from
the Federal Bureau of Investigation, the Internal Revenue
Service, and the Department of Health and Human Services were
investigating fraudulent billing and improper patient referral at
two medical group practices. The New York Observer article
further reported that Advanced health, which managed the billing
38
A
and administration of those practices, was also under
investigation.
60. On April 1, 1998, Advanced Health issued a press
release maintaining that neither it nor the physician groups it
managed were the targets of a federal investigation.
61. On April 4, 1998, Advanced Health filed its annual
report on Form 10-K for the year ended December 31, 1997, which
reiterated the previously announced results in the March 10, 1998
press release. The Form 10-K was signed by, among others,
deLeadants Edelson, Hochberg, Masarek, and Rogers.
62. The "Notes To Consolidated Financial Statements"
included in the Form 10-K represented with respect to the
Company's policy regarding revenue recognition and compliance
with current accounting standards that:
The Comoany recognizes revenue from the licensing ofits information systems and services (upon installationand acceptance), and from the licensing of its softwareto third parties (upon delivery)._ The Company'srevenue recognition policy is in compliance with theprovisions of [SOP 91-1]. [Emphases added.]
63. In truth and in fact, the reported financial results
and other representations referred to in 11 57, 61 and 62 above
were materially false and misleading in that, among other things:
(a) The Company's revenues and net income for fiscal
1997 were materially overstated for the reasons set forth in $1
39 and 52 above;
(b) In addition, the Company's financial statements
also violated GAAP, and the Company's own stated policy,
regarding revenue recognition, in that, among other things:
39
(i) Defendants recorded revenue of $3.5 million
from a transaction with ACRM, Inc. ("ACRM") in the fourth quarter
of fiscal year 1997, although ACRM was a sham entity that had no
offices, business cards, stationary, or other indicia of an
operating business. Recording revenue for the purported sale to
ACM violated GAAP because ACRM did not exist as a separate
entity and, thus, no true exchange had taken place between
Advanced Health and ACRM. Moreover, collection of the sales
price was impossible under the circurrstances. As a result of
improperly recording revenue from this transaction, the Company's
revenues were overstated by approximately $3.5 million tor the
fourth quarter of fiscal year 1997;
(ii) Defendants recorded a sale of approximately
$2.5 million at the end of fiscal year 1997 to Patienteare
Dynamics, LLC ("PCD"). In exchange for a $5 million investment
trom Advanced Health, PCD agreed to purchase $2.5 million of
software from Advanced Health. Recording PCD's "purchase" of
software as revenue violated GAAP because no r_rne exchange had
taken place and the collection of the sales price was not
reasonably assured_ The purported revenue was, in substance, a
return of Advanced Health's investment in PCD. As a result,
revenues were overstated by 82.5 million for the fourth quarter
of fiscal year 1997; and
(iii) Defendants recorded the sale of
approximately $1 million of software in late 1997 to the Mayo
Clinic in Rochester, Minnesota. Defendants shipped the software
to the Mayo Clinic, despite knowing that: (1) the software was
40
not functional, (2) did not perform properly, and (3) would be
rejected by the Mayo Clinic when it was found to be defective.
When an Advanced Health officer brought these facts to the
attention of defendant Masarek, the officer was told by defendant
Masarek that the only thing that mattered was the Federal Express
receipt, which could be used to prove a completed transaction in
order to permit booking of the revenue in 1997. The officer was
further told that the transaction would be hooked as $1 million
in revenue for the last quarter of 1.997 in spite of the fact that
the Mayo Clinic had never paid for the software. Recording
revenue under these circumstances violated GAAP because no true
exchange had taken place, the earnings process was not complete,
and collection of the sales price was impossible. Indeed, the
Mayo Clinic has never paid for the software; and
(c) Contrary to defendants' representations ;:hat the
Company recognized revenue from the sale of its information
systems and services upon installation and acceptance, and from
the licensing of its software to third parties upon delivery, in
truth and in fact, it was defendants' policy and practice to
recognize revenue upon the signing of a contract.
64. On May 12, 1998, Advanced Health issued a press
release, published on Business Wire, announcing its financial
results for the first quarter of 1998, the quarter ended March
31, 1998. The Company reported that revenues for the quarter
increased to $24.2 million, as compared to $10 million in the
first quarter of 1997. Net income grew to $2.4 million, or $0.21
per diluted share, as compared to net income of $660,000, or
41
$0.08 per diluted share, for the first quarter of 1997.
Defendant Rogers commented on he results as follows:
Advanced Health posted another strong quarter,bolstered by both our practice management andinformation technology segments. Market demand forphysician management services continues to grow on theEast Coast. As well, national demand for ourinformation technology services remains strong_
65. In that same press release, the Company also announced
the $6.6 million ($5 million in Advanced Health stock and the
remainder in cash) acquisition of Integrated Medical Management,
Inc. ("IMM"), a privately-held physician management company.
Concerning the acquisition, defendant Masarek stated: "We believe
• . . that this acquisition provides great synergy and long-term
strategic value to Advanced Health, especially given the number
of physicians under management and the platform IMM provides from
which our combined entities can success fully target the
marketplace." Defendants intentionaily overstated the Company's
revenues, to specifically inflate the trading price of Advanced
Health stock, in order, among other things, to use the stock as
consideration for this and other acquisitions.
66. The results reported in the May 12, 1998 press release,
were repeated in the Company's quarterly report on Form 10-Q for
the quarter ended March 31, 1998 (the "First Quarter 1998 10-Q"),
which was signed by defendants Edelson and Rogers and filed with
the SEC on or about May 15, 1998. The Company did not disclose
whether any of the monthly payments on account of the purported
$2,000,000 loan to Madison had been received. The Notes To
42
Consolidated Financial Statements, contained in the First Quarter
1998 10-Q, stated:
Reference is made to the Notes to ConsolidatedFinancial Statements contained in the Company'sDecember 31, 1997 audited consolidated financialstatements as filed with the Securities and ExchangeCommission on Form 10-K. In the opinion of Management,the interim unaudited financial statements includedherein reflect all adjustments necessary, consisting ofnormal recurring adjustments, for a fair presentationof such data on a basis consistent with that of theaudited data presented therein.
67. In truth and in fact, the reported financial results
and other representations referred to in 11 64 and 66 above we
materially false and misleading in that, among other things, for
the reasons set forth herein, the Company's financial statements
violated GAAP and it was not true that Advanced Health's
financial statements contained all necessary adjustments for a
fair presentation of the Company's operatlng results, as
defendants represented. Among other things, the First Quarter
1998 10-Q reoresented that accounts recelvatae as of March 31,
1998 totaled $16,468,000. However, the Company's accounts
receivable were materially misstated by approximately $7 million
because accounts receivable as of March 31, 1998 improperly
included the sales to ACRM, PCD, and the Mayo Clinic alleged in
$ 63 above. These amounts were not properly included as accounts
receivable as of March 31, 1998 because the related sales
resulted from either: (1) i=he shipping cf inoperable software to
customers (PCD and the Mayo Clinic), or (2) a transaction with a
sham entity (ACRM). Under these circumstances, collection of the
43
sales price was not reasonably assured, and the accounts
receivable should have been written off in accordance with GAAP.
68. On May 29, 1998, several of the Individual Defendants
sold significant amounts of Advanced Health common stock as
follows:
(a) Defendant Masarek sold 15,000 shares at $12.54 per
share, representing virtually all of his holdings (excluding
opt.ions(b) Defendant Edelson sold 20,000 shares at $12.54 per
share; and
(c) Defendant Alger sold 7,500 shares at $12.54 per
share.
THE TRUTH BEGINS TO EMERGE
69. On June 30, 1998, just one month after defendants'
insider sales, Advanced Health surprised the market by issuing a
press release announcing that iL anticipated a second-quarter
loss. The press release stated, m [biased on a preliminary
anal ysis of results in the second quarter and one-time special
charges, the Company will likely experience an operating loss of
approximately $3 million to $4 million on revenues of
approximately $17.5 million and one-time charges of approximately
$8 million pre-tax."
70. According defendants, the "one- 1:.ime charges" were
expected to include the write-off of approximately $5 million in
certain accounts receivable for sales prior to 1998.
44
71. In the same announcement, it was revealed that
defendant Rogers, Advanced Health's Chief Financial Officer, had
resigned from the Company "to pursue other interests".
72. ALLer the close of the market. on June 30, 1998,
Bloomberg News Service reported that Advanced Health's shares had
fallen 41 percent "after the company said its chief financial
officer quit and that weak sales of its medical-records software
will give it a second •quarter loss." Advanced Health shares :cell
3-3/4 from the previous day's closing price to close at 5-1/2 per
share, representing the biggest percentage decline on U.S.
markets for the day.
73. The June 30, 1998 press release was materially false
and misleading because defendants still failed to disclose, and
concealed, The true extent to which they previously had
misrepresented the Company's financial results.
74. On August 6, 1998 (one day after the end of the Class
Period), the Company announced its actual financial results for
the second quarter of 1998, the period ending June 30, 1998,
which revealed that the extent of the Company's problems was even
greater than the June 30, 1998 press release had led the market
to believe. Notwithstanding the previous announcement, the
Company now reported that revenues for the second quarter of 1998
were only $16.8 million, that the Company had experienced an
operating loss of $16.3 million, and that one-time charges for
the quarter were $9.6 million. The Company described the one-
time charges as follows:
45
$3.1 million for bad debts; - 52_1 million relating toprofessional fees; -- $1.5 million in non-capitalizablesoftware development costs; -- $800,000 for networkmanagement services; -- $800,0000 relating to thewrite-off of goodwill; -- $400,000 for previouslyterminated employees; and -- $900,000 for miscellaneousitems.
By the close of trading on August 6, 1998, the stock had fallen
even further to just $2.50 per share -- a decline of more than
90% tram the Class Period high of $27.375 per share (on October
16, 1997). Advanced Health common stock currently trades in the
range of $2-$3 per share.
75. On November 12, 1998, the Company issued a press
release announcing that it was caking yet another charge of $6.3
million relating to the write down of Med-E-Practice software
development assets, effectively admitting that the Med-E-Practice
products had failed.
76. On January 13, 1999, the Company issued a press release
announcing that it was changing its name to AHT Corporation, to
reflect its new focus on "healthcare e-commerce'. The press
release further announced that the Company was "seeking strategic
alternatives" for its practice management business, which
according to defendant Edelson was not "core" to the Company's
new healthcare e-commerce business.
77. During the Class Period, defendants materially misled
the investing public, thereby inflating the price of Advanced
Health stock, by publicly issuing materially false and misleading
statements and omitting to disclose material facts necessary to
make defendants' statements, as set forth herein, not false and
misleading. Said statements and omissions were materiall y false
45
and misleading when made in that they failed to disclose material
adverse information and misrepresented the truth about the
Company, its business, operations, performance, and financial
condition. Amona other things:
• a) Contrary to defendants' affirmative
representations, the Company's financial statements were not
prepared in accordance with GAAP and the federal securities laws
and SEC regulations concerning fair reporting as set forth below,
and it was not true that Advanced Health's financial statements
contained all necessary adjust-Tents for a fair presentation of
the Company's operating results;
(b) Defendants materially overstaed the Company's
reported revenues and net income due to their violations of GAAP
as set forth herein;
(c) Defendants materially overstated the Company's
assets due to their violations of GAAP as set forth herein;
(d) Contrary to defendants' representations that the
Company recognized revenue from the sale of its information
systems and services upon installation and acceptance, and from
the licensing of its software to third parties upon delivery, in
truth and in fact, it was defendants' policy and practice to
recognize revenue upon the scning of a contract;
(e Defendants falsely represented that the Company's
Internet Script Writer software worked, when in truth and in
fact, the software was flawed and incomplete; and
(f) The Company's public filings during the Class
Period failed to describe known trends and uncertainties that
47
had, and that the Company reasonably expected would continue to
have, a material unfavorable impact on net sales or revenues or
income from continuing operations as required by Item 303(a) and
(b) of Regulation S-K.
78. At all relevant times, the material misrepresentations
and omissions particularized in this Complaint directly or
proximately caused or were substantial contributing causes of the
damages sustained by plaintiffs and other members of the Class.
As detailed herein, during the Class Period, defendants made or
caused to be made a series of materially false and misleading
statements about Advanced Health which had the cause and effect
of creating in the market an unrealistically positive assessment
of Advanced Health and its busLness, performance and operations,
thus causing the Company's common stock to be overvalued and
artificially inflated at all relevant times. Defendants'
materially false and misleading statements during the Class
Period resulted in plaintiffs and other members of the class
purchasing the Company's common stock at artificially inflated
prices, that did not reflect the stock's true value, thus causing
the damages complained of herein.
DEFENDANTS' GAP VIOLATIONS
79. Although defendants represented that the Company's
financial statements issued during the Class Period were prepared
in accordance with GAAP and fairly presented on a basis
consistent with that of the audited data presented therein,
defendants violated GAAP and SEC regulations in material and
significant ways as described below_
48
80. GAAP incorporates the consensus among accountants at a
particular Lime concerning the economic resources and obligations
that should be recorded as assets and liabilities, which changes
in them should be recorded, when these changes should be
recorded, how the recorded asseLs and liabilities and changes in
them should be measured, what information should he reported, how
it should be disclosed, and which financial sUaLements should be
prepared.
81. The SEC requires that publicly-traded companies present
their financial statements in accordance with GAAP. 17 C,F.R. §
210.4-01(a)(1). Financial statements filed with the SEC that are
not_ prepared in accordance with GAAP "will be presumed to be
misleading or inaccurate, despite footnote or other disclosures,
unless the Commission has otherwise provided." 17 C.F.R. §
210.4-01(a)(1).
82. Moreover, under Item 303 of Regulation S-K, promulgated
by the SEC under the Exchange Act, there is a duty to disclose in
periodic reports filed with the SEC "known trends or any known
demands, commitments, events or uncertainties" that are
reasonably likely to have a material impact on a Company's sales
revenues, income or liquidity, or to cause previously reported
financial information not to be indicative of future operations
results. 17 C.F.R. 5 220.303a)(1)-(3) and Instruction 3. To
addition to the periodic reports required under the Exchange Act,
management of a public company has a duty "to make full and
prompt announcement of material facts regarding the Company's
83. Defendants intentionally or recklessly tailed to
disclose the existence of known trends, events or uncertainties
that they reasonably expected would have a material unfavorable
impact on Advanced Health's operating results or that were
reasonably likely to result in the Company's liquidity decreasing
in a material way, in violation of Item 303 of Regulation S-K
under the federal securities laws (17 C.F.R. § 229.303). Such
failure rendered the Company's Class Period financial statements
and Forms 10-K and 10-Q materially false and misleading.
84. The realization principle requires generally that
revenue be earned before it is recognized. Under GAAP, revenue
is recognized when the earnings process is complete and a true
exchange has taken place (Statement of Financial Accounting
Concepts ('FAC") D. 5, Recognition and Measurement in Financial
Statements of Business Enterprises, V[ 83, 84). Paragraph 83(b)
of PAC No. 5 states:
Revenues are not recognized until earned. Anentity's revenue-earning activities involvedelivering or producing goods, renderingservices, or other activities that constituteits ongoing major or central operations, andrevenues are considered to have been earnedwhen the entity has substantiallyaccomplished what it must do to be entitledto the benefits reoresented by the revenues.[Footnote omitted.]
Moreover, the earnings process is not complete until collection
of the sales price is reasonably assured (Id.).
50
85. During all relevant times, the authoritative accounting
pronouncement was the American Institute Of Certified Public
Accountants Statement of Position 91-1 (ACC-SOP 91-1) issued on
December 12, 1991. The criteria for determining the timing of
software license revenue recognition is discussed at ACC-SOP 91-
1,034, "Software Licenses With Other Significant Vendor
Obligations," which states in pertinent part:
If, in addition to the obligation to deliver thesoftware, the sales or licensing agreement includesother significant vendor obligations, the agreementshould first be examined to determine if it should beaccounted for using contract accounting or as a servicetransaction. For agreements with significant vendorobligations beyond the delivery of the software thatare not accounted for using contract accounting or asservice transactions, revenue should not be recognizeduntil all of the following conditions are met:
a. Delivery has occurred.b. Other remaining vendor obligations are no longersignificant.c. Collectibility is probable. [Emphasis added.]
86. As set forth above, the Company violated the foregoing
GAAP principles, and its own publicly-stated revenue recognition
principles, in connection with major software transactions with,
at least, Synetic (see 25-28, 35(a) and 39(a)), Horizon • (see 11
b1(b)), ACRM (see 63(b)(i)), PCD (see 11 63(b)(ii)), and the
Mayo Clinic (see 1 63(b) (iii)).
87. Accounting Research Bulletin No. 43 and FASB No. 5,
Accounting for Contingencies provide that entities report
accounts receivable at net realizable value." By reclassifyiny
accounts receivable due from Madison Medical as intangible assets
as described in 11 39(b) above, defendants avoided immediately
writing off the receivables down to "net realizable value" (under
51
the circumstances, zero) and instead sought to write the
receivables off over thirty years the length of the corc.:ract
between Advanced Health and Madison Through this improper
practice, the Company recognized the revenue immediately, while
deferrng charges to net income for thirty years Thus, the
Company's revenues and net income were overstated by
ap'oroximately $3.6 million for the second quarter of fiscal year
1997.
38. Moreover, by capitalizing the forgiven receivables, the
Company was able to present a far more favorable cash flow from
operations, even though no cash was collected from the sale to
Madison. Indeed, the Company's cash flow from operations was
negative for the quarters ending December 31, 1996 and March 31,
1997.
89. In addition to the accounting violations noted above,
the Company presented its financial statements tr. a manner which
also violated at least the following provisions of GAAP:
(a) The principle that a conservative approach betaken providing early recognition ofunfavorable events and minimizing the amountof income recorted (See Statement No. 4 ofthe Accounting Principles Board ("AEG Nos")at 1$ 28, 35, 171);
(b) The principle that the financial informationpresented should be complete. (See APB No.4, 11 28, 35, 83 171);
(c) The principle of fair presentation ("presentsfairly"). (See APB No. 4, 9 4[ 109, 138, 189);
(d) The principle of adequacy and fairness ofdisclosure. (See APB No. 4, $1 81, 106, 189,199);
52
(e) The principle of materiality concerninginformation that is significant enough toaffect evaluations or decisions. (Sec APBNo. 4, 4 1 25, 128),
(f) The principle that the substance oftransactions rather than form should bereflected. (See APB No. 4, '01 25, 35, 127);
(q) The principle tha7 informed judgment based onbackground and knowledge should be applied.(See APB No. 4, Vfi 25, 35, 124, 173, :74);
(h) The principle that items included in thefinancial statements be reliably corroboratedby outside evidence (verifiability). (See APBNo. 4, 11 23, 35, 90);
(i) The principle that the financial statementscontain and disclose relevant,understandable, and timely information forthe economic decisions of the user. (See APBNo. 4, 23, 88, 89, 92);
(j) The principle that the financial statementsprovide reliable financial information aboutthe enterprise for the economic decisions ofthe user. (See APB No. 4, 77, 73, 107,108); and
(k) The principle that accounts receivable mustbe reported in the financial statements atnet realizable value (See, e.q., ARB-43,Chapter 3A; FASB No. 5, Accounting for Contingencies.)
ADDITIONAL SCIENTER ALLEGATIONS
90. As alleged herein, defendants acted with scienter in
that defendants knew that the public documents and statements
issued or disseminated in The name of the Company during the
Class Period were materially false and misleading; knew that such
statements or documents would be issued or disseminated to the
investing public; and knowingly and substantially participated or
acquiesced in the issuance or dissemination of such szatements or
documents as primary violations of the federal securities laws.
As set forth elsewhere herein in detail, defendants, by virtue of
their receipt of information reflecting the true facts regarding
Advanced Health, :heir control over, and/cr receipt and/or
modification of Advanced Health's allegedly materially misleading
misstatements and/or their associations with the Company which
made them privy to confidential proprietary information
concerniny Advanced Health, participated in the fraudulent scheme
alleged herein.
91. Defendants were motivated to conceal the true state of
affairs at the Company in order to enable the Company and certain
selling shareholders to sell 2.5 million shares of Advanced
Health common stock at $22.75 per share, raising $55 million,
Defendants also sought to profit by using shares of artificially
inflated Advanced Health stock as consideration for the
acquisition of two other companies.
92. Moreover, defendants' insider selling is high4
probative of defendants' scienter and is part of defendants'
scheme, artifice to defraud, and acts, pracLices and course of
business in violation of Section 10(b) and Rule lob-5. As set
forth above, while defendants were issuing false favorable
statements about_ the Company's business and concealing or
obscuring negative information, the Individual Defendants who had
access to confidential inforation and were aware of the truth
about the Company and its operations, were benefitting from the
unlawful scheme complained of herein by selling shares of the
Advanced Health common stock owned by Lhem at artificially
inflated prices without disclosing the material adverse facts
54
about the Company to which they were privy. Such sales were
unusual in their amount and in their timing. Among other things,
detendant Masarck sold virtually all of the shares of Advanced
Health common stock that were owned by him (excluding options)
and the sales by the different defendants were coordinated in
that two or more defendants sold stock on the exact same date on
four separate occasions during the Class Period. The following
table shows the insider selling of certain of the Individual
Defendants during the Class Period:
SHARES PRICEDEFENDANT DATE SOLD PER SHARE PROCEEDS
Jonathan 08/12/97 30,000 $21.25 $637,500Edelson 08/20/97 15,000 $19.88 $298,200