NATURE OF THE CASE
This is a class action on behalf of all purchasers of the securities of 2TheMart.Com Inc., ("2TheMart" or the "Company") between January 19, 1999 and August 26, 1999 inclusive (the "Class Period"), seeking remedies under the Securities Exchange Act of 1934 (the "Exchange Act"). Defendants include 2TheMart, Steven W. Rebeil, and Dominic J. Magliarditi.
2TheMart was conceived in January 1999 through a reverse merger with an unrelated Oklahoma corporation. Its proclaimed business strategy was to launch an E-commerce auction web site that would provide a dynamic person to person auction environment, in direct competition to those established by eBay, Onsale Inc., Excite Inc. and Ubid Inc.
From its inception, 2TheMart represented that the web site, which was the core of its business, was "currently in final development" and was expected to be running before the end of the second quarter 1999. Defendants said the site would then offer direct, meaningful, competition with established sites such as eBay. These representations were made continuously throughout the Class Period and caused the Company's stock price to soar as high as $50.00.
Throughout the Class Period, defendants assured the investing community that the web site was on schedule and that it would prove to be worthy competition to larger and better funded companies that already had or were developing similar sites.
Notwithstanding their positive statements to the investing community, defendants knew the following information which belied their representations:
a. The management of 2TheMart did not include a "full team of operational, finance, marketing and technical personnel." Rather it consisted of two men, Rebeil, and Magliarditi, who had a long checkered history of real estate dealings in Nevada. Most of 2TheMart's support came through contractual dealings with third parties.
b. The website, which is the mainstay of the 2TheMart, was not currently in "final development" and, in truth, had not yet been started. The Company's August 26, 1999 public filing on Form 10 reveals that: (a) a basic IBM Customer Agreement had not been entered into until February 3, 1999; (b) it would not be until February 2, 1999 that IBM would agree to take the preliminary steps of identifying 2TheMart's business, technical and design requirements; (c) The preliminary plan consisting of a high level application design, a budget planning estimate and schedule for the implementation had not even been delivered to 2TheMart until April 30, 1999; and (d) IBM and 2TheMart would not sign a contract for IBM to "[d]esign, build, and test the 2TheMart.com Web Site" until June 1, 1999. This was almost five months after 2TheMart began touting that its web site was in "final development."
c. The Form 10 also revealed that 2TheMart had not signed an IBM Customer Agreement until February 3, 1999. The Agreement was for a Phase 0 Solution Design which amounted to no more than an analysis and proposal for a Web Site. The contract which was signed by Magliarditi stated that this project would take an estimated "eight weeks" from the initial "three day Joint Requirements Definition" session which happened sometime after February 3, 1999. The proposal resulting from the Phase 0 Solution Design were delivered by IBM to 2TheMart on April 30, 1999. Not until June 1, 1999 was a contract entered into parties for the actual "development of an online auction web site." The final agreement gave a 6 month production plan for the completion of the site. In light of these facts, defendants representations throughout the Class Period that the web site was in "final development" or that it would be "active by the second quarter 1999" were patently false when made.
d. "2TheMart expects competition to intensify further in the future. Barriers to entry are relatively low, and current and new competitors can launch new sites at a relatively low cost using commercially available software." The Form 10 goes on to identify eBay, Amazon.com, Auction Universe, Yahoo Auctions, Excite, uBid, First Auction, Surplus Auction as competitors concluding that, "[m]any of the Company's current and potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources. Competitive pressures created by any one of these companies, or by the Company's competitors collectively, could have a material adverse effect on the Company's business, results of operations and financial condition."
e. 2TheMart's principals had already been determined to be not of good character, honesty and integrity and not suitable to act as officers or directors of public companies.
i. Magliarditi and Rebeil have been business associates for more than six years. On Feb. 19, 1997, the Nevada Gaming Commission denied their applications for a casino license. The commission found both men "not of good character, honesty and integrity. " It also found that both lied to investigators for the State Gaming Control Board, and thus each "failed to meet the burden of proving his qualifications and suitability as an officer, director or controlling shareholder of a publicly traded corporation."
ii. According to a transcript of testimony before the Gaming Control Board in 1997, investigators for the agency also discovered that Magliarditi, an attorney who previously practiced tax law, under reported his income by about $70,000 in 1994. "The board felt this wasn't an honest mistake, but purposeful underreporting," Steve DuCharme, chairman of the Nevada Gaming Control Board, said in an interview. Magliarditi testified that he owed the IRS an additional $24,000 after he amended his federal tax return to include the previously unreported income.
iii. Furthermore Magliarditi admitted that he altered K-1 tax schedules reporting Rebeil's partnership income after they were prepared and signed by the accounting firm of Arthur Andersen LLC. Magliarditi said the adjustments he made, at Rebeil's request, lowered Rebeil's 1994 income tax bill. "I think they were whited out and then the numbers were inserted," Magliarditi testified. He said more than a year passed before the accounting firm received a copy of the altered document.
iv. Separately, in December 1998, Magliarditi was fined $4,000, publicly reprimanded and placed on one-year probation by the Nevada State Bar Association. That followed his conditional guilty plea to allegations he had a conflict of interest when he represented clients on both sides of an issue.
v. Control Board investigators also found that Rebeil diverted "millions of dollars" from a homebuilding company in which he was a partner to finance construction of his personal residence. Rebeil allegedly directed subcontractors to overcharge the builder and use the excess payments as credits toward work on his house. Magliarditi testified that there "could possibly be" criminal wrongdoing by Rebeil in connection with the diversion. Frank Schreck, Rebeil's former attorney, testified that at first he believed Rebeil's denials about the skimming. However, after interviewing a concrete subcontractor, he said he became "100 percent" certain that Rebeil was lying when he denied the skimming. At that point, he said, he resigned as his attorney. The Control Board alleged that Magliarditi told its investigators Rebeil's actions were a "complete surprise" to him, even after he'd been alerted to the activity by Rebeil's business partner and by subcontractors.
f. The Company had not "secured funding" for the "final development" of the website. The Form 10, filed on August 26, 1999 demonstrates that the Company will need millions of dollars more to complete the web site. Moreover, "[A]fter the launch of the Company's Web site, there can be no assurance that the Company will generate positive cash flow and there can be no assurances as to the level of revenues, if any, the Company may actually achieve from its web operations."
g. Defendants knew that its public accountant, Deloitte & Touche, LLP ("Deloitte"), had serious concerns over the financial representations to be included in the Company's upcoming public filing, which ultimately resulted in their withdrawal from the 2TheMart account. Although defendants also knew that Deloitte withdrew from the audit because of these issues, they purposefully hid this fact from the investing community. Defendants did not reveal the material loss of Deloitte & Touche, LLP until they had secured another auditor and still have not acknowledged the reasons Deloitte left.
h. The Company was suffering huge losses and was no where near releasing its web site -- its only source of revenue. As a result, the continued viability of the Company was in serious doubt -- a fact confirmed by 2TheAmrt's outside auditors, Grant Thorton LLP. "The Company is not yet generating revenues and, as shown in the financial statements, has incurred losses in its development stage. Also. . .the Company has incurred substantial obligations and will need to raise capital to complete its development activities. These factors, among others. . .raise substantial doubt about the Company's ability to continue as a going concern."
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