"Amended" Class Action Lawsuit: PART FIVE
The full public document titled "First Consolidated and Amended Complaint for Violation of the Federal Securities Laws," was filed on May 9, 2002 with the U.S. District Court. A PDF copy can be downloaded from: hagens-berman.com
Below are some selected excerpts which are only a small fraction of the 101-page filing. Please refer to the entire document for the complete context, chronology, details, and the full allegations contained in the filing.
Excerpts below taken from Pages 66-81:
(bold added for emphasis)
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VIII. INFOSPACE'S FALSE AND MISLEADING FINANCIAL STATEMENTS
193. In order to improperly inflate InfoSpace's revenues, earnings and assets during the Class Period, Defendants undertook a scheme whereby they improperly booked as revenue sales which they were not entitled to claim as revenue because the revenues had been "purchased" by the Company, and failed to recognize expenses that had accrued.
194. These improper accounting practices and manipulations were in direct violation of InfoSpace's stated revenue recognition policies, GAAP and SEC rules, as described below, and resulted in materially overstated revenues from product sales, total revenues, net income and net assets for the quarter and year ended December 31, 1999, the quarters ended March 31, 2000, June 30, 2000, September 30, 2000 and the quarter and year ended December 31, 2000.
198. During the Class Period, InfoSpace (through the InfoSpace Venture Capital Fund) made significant investments in numerous start-up companies. These start-up companies were required to spend between 50-80% of the proceeds of these "investments" in services purchased from InfoSpace. In Essence, InfoSpace was "purchasing" this revenue stream in violation of GAAP and SEC Regulations, and specifically FAC 5.
199. Further, InfoSpace was aware that many of these start-up companies were in extreme financial difficulty at the time the investments were made, and that the InfoSpace Venture Capital Fund would almost certainly take significant losses from these "revenue purchasing" or "Lazy Susan" transactions.
200. Ultimately, InfoSpace was forced to "bail out" the InfoSpace Venture Capital Fund at significant cost to the Company, further confirming the fact that the revenues from these "Lazy Susan" transactions were recognized in violation of GAAP.
201. In order to inflate the price of InfoSpace securities, defendants caused the Company to falsely report its results through improper revenue recognition for the quarter and year ended December 31, 1999, each of the first three quarters of 2000, and the quarter and year ended December 31, 2000. Defendants improperly recognized revenue (I) by recording revenue on "tradeout" deals where InfoSpace would merely swap check payments with another company without any exchange of goods/services; (ii) by recording revenue on transactions with subsidiaries and other related parties where InfoSpace gave the parties the funds to pay for the product or service; and (iii) by artificially inflating revenue from barter transactions in which InfoSpace inflated the value of the non-monetary assets. These improper accounting practices and manipulations were in direct violation of GAAP and SEC rules.
203. Contrary to GAAP and SEC rules, during the class period InfoSpace improperly recognized revenue by merely swapping checks with other companies. For example, InfoSpace entered into "trade out" deals whereby it would receive monthly checks from companies and within days after the cash receipt, InfoSpace would issue a check back to the company for the same dollar amount. These sham transactions were structured and entered into for no other reason than to give the false appearance that InfoSpace had made sales to legitimate paying customers. InfoSpace improperly recorded advertising revenues on these deals despite the fact that no such advertising had been sold and thus no revenue had actually been earned.
204. On some occasions where InfoSpace may have engaged in an advertising "barter" whereby it actually traded advertising with a partner or customer, InfoSpace improperly over valued the revenue figure of the advertising placed with it by the partner. Specifically EITF 99-17, Accounting for Advertising Transactions states the dollar amount reflected on checks swapped between two companies in an advertising barter transaction does not evidence the value of the revenue to be recorded. EITF 99-17 in pertinent part states:
An exchange between the parties to a barter transaction of offsetting monetary consideration, such as a swap of checks for equal amounts, does not evidence the fair value of the transaction."
205. InfoSpace also undertook a separate scheme to inflate its revenue during the class period whereby it purchased its own revenue from certain affiliated parties. Internally, InfoSpace referred to these transactions as "lazy Susan" or "roundtrip" deals. InfoSpace's "lazy Susan" investment scheme involved conditional cash investments made by InfoSpace (or InfoSpace Venture Capital Fund) in exchange for that companies business. These deals were entered into with Freeinet, Savishopper, Netgenshopper, ChinaBig.com; AmEx and Knight Ridder. The cash investments made by InfoSpace to the undercapitalized companies were made under the condition that the subsequent related party investee would use the investment proceeds as payment for sales transactions with InfoSpace. InfoSpace1s "Lazy Susan" scheme was a sham and violated the fundamental financial reporting assumptions that financial statements reflect the economic substance of a transaction and arm's length bargaining between independent parties. The bogus sales transactions InfoSpace used to falsely generate revenue through its "Lazy Susan" deals had no economic substance, and as such, should not have been recognized as revenue. [Footnote: In determining whether a transaction is recorded in accordance with GAAP, Statement of Auditing Standard ("SAS") No. 82, Consideration of Fraud in a Financial Statement Audit, requires the auditor to specifically assess the risk of material misstatement due to fraud and provides examples of fraud risk factors relating to operating characteristics and financial stability. SAS 82 specifically lists "significant, unusual, or highly complex transactions, especially those close to year end, that pose difficult 'substance over form' questions as one such example of a fraud risk factor." See AU § 316.17(c).] Further, InfoSpace's "lazy Susan" deals violated GAAP in that the buyer acquiring the product did not have economic substance apart from that provided by InfoSpace. InfoSpace's improper accounting for the "lazy Susan" deals resulted in drastically overstated revenues and net income during the class period.
206. Notwithstanding the improper recognition of revenue on the above transactions, InfoSpace also failed to adequately disclose the extent of the existence of the "lazy Susan" deals as related party transactions in any of its Form 10-Qs and Form 10-Ks filed with the SEC during the class period. In accordance with Statement Financial Accounting Standard ("SFAS") 57 financial statement disclosures of material related party transactions shall include:
The nature of the relationship(s) involved
A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed...
The dollar amounts of transactions...
Amounts due from or to related parties... and if not apparent, the terms and manner of settlement. See SFAS 57 (paragraph) 2.
207. This lack of disclosure on the "Lazy Susan" deals also violated SEC Regulation S-K Item 303(a)(3)(ii) which requires management to disclose any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on revenues.
208. The undisclosed barter transactions identified above also violated APB Opinion No. 29. (Footnote: APB Opinion #29, Accounting For Nonmonetary Transactions, Accounting Principles Board, May 1973). APB 29 provides that revenue on barter transactions may not be recognized until the earnings process has culminated. If the Company has done everything it needs to do to have claim to the revenues from barter transactions, the revenues may be recognized, but only at the fair market value of the bartered item given to the other company, except that if the fair market value of the item given cannot be determined, the fair market value of the items received must be used. If the fair value of neither can be determined, the gain or revenue may only be recognized to the extent of the book value of the items given up. In the current case, InfoSpace recognized revenues from barter transactions based on trumped-up calculations of the value of the advertising it was giving or receiving, neither of which had any reasonable basis in the true fair market value of these services. Accordingly, this improperly recognized barter income served to materially overstate InfoSpace's revenues during the Class Period.
209. InfoSpace further violated the disclosure requirements of APB 29, which require a company to include a description of the nature of the nonmonetary transactions, as well as the accounting basis used for the transferred assets. Because InfoSpace failed to make this disclosure, the market was unaware of the true nature of the barter transactions.
213. The bogus revenues InfoSpace recorded associated with the "trade out" transactions, and the "Lazy Susan" transactions described above could not be recognized under SOP 97-2 as no product or service had been delivered and/or collectability was not assured as the customer would not pay unless InfoSpace gave them the resources by which to do so.
234. Defendant Jain used both his inside knowledge of the actual conditions at InfoSpace and his ability to mask those conditions to the investing public to unload more than 3 million shares of InfoSpace stock during the Class Period, reaping illegal insider trading proceeds of more than $192 million.
235. According to documents he filed with the SEC, defendant Jain had never sold InfoSpace shares to the market prior to his selling binge during the Class Period.
236. Defendant Jain's scienter is also established by his efforts to manipulate Blodget and Merrill Lynch to write favorable reports, including the withholding of a fee until they did so.
237. Defendant Jain's scienter can also be inferred by the comments of his co-wrongdoers at Merrill Lynch, who noted Jain had engaged in "hyperbole" (Wall Street jargon for untrue or misleading statements) and was a "sleazebag."
238. Defendant Jain's scienter can also be inferred from his desire to turn InfoSpace into a trillion dollar company, in part to surpass his old boss Bill Gates who Jain had grown tired of "making billions for." Jain knew that in order to do so, he would have to grow InfoSpace by acquiring companies that had the technology he needed. These acquisitions could only be accomplished by using InfoSpace stock.
239. Scienter can also be inferred from Jain's overt statements made to keep the price of InfoSpace stock spiraling up, as evidenced by this pre-class period statement, when the stock was trading at $135:
BARTIROMO: Very quickly, sir, your stock has had quite a run. Do you think it's gotten ahead of itself?
JAIN: Actually, if you look at the stock, the stock is very undervalued, relat-relatively very undervalued, given the performance that we have had and the continued ex-execution that we have had. |
