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Case 1:04-cv-03530 Document 77 Filed 01/03/2006 Page 1 of 137
Case 1:04-cv-03530 Document 77 Filed 01/03/2006 Page 2 of 137
TABLE OF CONTENTS
SUMMARY AND OVERVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
JURISDICTION AND VENUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
PARTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
CLASS ACTION ALLEGATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
MATERIALLY FALSE AND MISLEADING CLASS PERIOD STATEMENTS . . . . . . . . . . 13
THE TRUTH BEGINS TO EMERGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
POST-CLASS PERIOD DISCLOSURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
BALLY’S FINANCIAL STATEMENTS WERE MATERIALLY FALSE AND
MISLEADING WHEN MADE BECAUSE THEY VIOLATED GAAP . . . . . . . . . . . . 41
Accounting For Membership Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Accounting For Membership Acquisition Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Accounting For Recoveries Of Unpaid Dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Accounting For Acquired Payment Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Accounting For Sales Of Future Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Accounting For Prepaid Personal Training Services . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Accounting For Multiple Element Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Accounting For Self-Insurance Liabilities And Insurance Expense . . . . . . . . . . . . . . . . 50
Accounting For Costs Incurred To Develop Internal-Use Computer Software . . . . . . . . 51
Accounting For The Valuation Of Goodwill And For Separately Identifiable Intangible
Assets Apart From Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Accounting For The Amortization Of Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Accounting For Fixed Asset Impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
Accounting For Escheatment Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Accounting For Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Accounting For Maintenance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Accounting For Start-Up ("Presale") Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Accounting For Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
Accounting For Accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Accounting For Foreign Exchange Gains And Losses . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Accounting For Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
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Accounting For Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
RESTATEMENT SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
DEFENDANTS’ SARBANES-OXLEY CERTIFICATIONS AND OTHER ATTESTATIONS
TO THE EFFICACY OF INTERNAL CONTROLS WERE ALSO MATERIALLY
FALSE AND MISLEADING WHEN MADE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
ADDITIONAL SEC VIOLATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
E&Y’S AUDIT OPINIONS WERE MATERIALLY FALSE AND MISLEADING WHEN
MADE BECAUSE BALLY’S FINANCIAL STATEMENTS DID NOT CONFORM TO
GAAP AND E&Y’S AUDITS DID NOT CONFORM TO GAAS . . . . . . . . . . . . . . . . 74
ADDITIONAL SCIENTER ALLEGATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
UNDISCLOSED ADVERSE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
LOSS CAUSATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
APPLICABILITY OF PRESUMPTION OF RELIANCE:
FRAUD-ON-THE-MARKET DOCTRINE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
NO SAFE HARBOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
FIRST CLAIM
VIOLATION OF SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5
PROMULGATED THEREUNDER AGAINST ALL DEFENDANTS . . . . . . . . . . . . 126
SECOND CLAIM
VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT AGAINST THE
INDIVIDUAL DEFENDANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
JURY TRIAL DEMANDED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
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SUMMARY AND OVERVIEW
1. This is a securities class action on behalf of all purchasers of the publicly traded
securities of Bally Total Fitness Holding Corporation (“Bally” or the “Company”) between August
3, 1999 and April 28, 2004, inclusive (the “Class Period”), against Bally, certain of its current and
former officers and directors, and its then external auditor, Ernst & Young LLP (“E&Y”), for
violations of the Securities Exchange Act of 1934 (the “1934 Act”).
2. Bally describes itself as the largest commercial operator of fitness centers in North
America in terms of revenues, members, and the square footage of its facilities. Bally’s fitness
centers are concentrated in major metropolitan areas in the United States and Canada.
3. As alleged herein, during the Class Period, defendants falsely reported inflated
operating results to the market in publicly disseminated press releases and Securities and Exchange
Commission (“SEC”) filings. In addition, defendants repeatedly represented that the Company’s
financial statements, which were included in its SEC filings and press releases during the Class
Period, were reliable in that they were prepared in accordance with generally accepted accounting
principles (“GAAP”), and defendants further certified that the Company’s internal controls were
effective and reliable.
4. Unbeknownst to investors, however, the Company’s seeming success was not real.
Rather, the Company created the illusion of a healthy and growing business through wholly improper
accounting machinations. Subsequent to the Class Period, an independent review determined that
the Company’s improperly reported results were attributable to ineffective internal controls, multiple
accounting errors, and a “culture of aggressive accounting” that falsely inflated Bally’s reported
results.
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5. Throughout the Class Period, defendants employed a wide variety of techniques to
manipulate Bally's reported financial results, as set forth in detail below. While the manipulations
were often inconsistent and varied across many areas and many time frames, two themes remained
constant: (1) Bally was improperly recognizing revenue prematurely; and (2) Bally was improperly
delaying the recordation of expenses. These two related fraudulent techniques pervaded Bally's
publicly reported financial results, resulting in falsely inflated earnings and an artificial increase in
Bally' stock price throughout the Class Period.
6. The defendants, including Bally and E&Y, knew or were reckless in not knowing that
the accounting machinations were improper and violated GAAP (as well as certain of the company’s
own accounting policies). Indeed, each of the Individual Defendants (defined below) was, in
addition to being a high level officer of the Company, a certified public accountant (“CPA”) in his
own right.
7. Bally took advantage of the fraud by using its artificially inflated stock, in lieu of or
in combination with cash, to perform acquisitions, including the Planet Fitness and Crunch
acquisitions during the Class Period. Bally also did a secondary offering of its common stock, while
artificially inflated, to raise proceeds of $50 million for the Company, and otherwise used its
fraudulently reported financial statements to restructure debt on more favorable terms.
8. The truth concerning the Company’s chronic accounting improprieties began to
emerge on April 28, 2004. On that date, after the close of ordinary trading, the Company announced
that its Chief Financial Officer (“CFO”), defendant Dwyer, had resigned amid an SEC investigation
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into the Company’s April 2, 2004 initial restatement of previously reported 2003 financial results.1
In a press release, the Company stated as follows in relevant part:
Bally Total Fitness Holding Corporation (NYSE:BFT) announced today that,
effective immediately, John W. Dwyer, 51, has resigned as Chief Financial Officer
and as a Director of the Company pursuant to the terms of a separation agreement
* * *
Separately, the Company announced that the Division of Enforcement of the
Securities and Exchange Commission has commenced an investigation in connection
with the Company’s recent restatement regarding the timing of recognition of prepaid
dues. The Company is cooperating fully with the SEC on this matter.
9. This announcement stunned the investment community. Having just completed a
significant change in accounting principle and the initial restatement of 2003 results within the past
month, the market had every expectation that Bally’s financial statements were accurate and reliable.
Accordingly, the April 28, 2004 press release first disclosing the CFO’s resignation amid an SEC
investigation cast serious doubt on the accuracy and reliability of Bally’s financial statements, and,
significantly, on the integrity of Bally’s management.
10. In response to this announcement, the price of Bally common stock fell sharply, from
$5.40 per share on April 28, 2004, to $4.50 per share on April 29th, a one day drop of 16.6% on
unusually heavy trading volume. As the truth about Bally’s accounting was revealed to and absorbed
by the market, Bally stock continued to languish, reaching a mean trading price of $4.56 for the 90
trading-day period following the April 28, 2004 disclosure.
1
The April 2, 2004 initial restatement of previously reported 2003 financial results –
first prominently disclosed in the April 28, 2004 press release – was a precursor to the ultimate
restatement of November 30, 2005, when the Company comprehensively restated results for 2000,
2001, 2002, and 2003, and first reported results for 2004 and the first three quarters of 2005.
However, the initial restatement was misleading and continued to conceal the massive accounting
fraud during the Class Period. See ¶¶ 106-119.
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11. As set forth in an analyst report by Jefferies & Co., Inc. on April 30, 2004:
Investment Opinion: Hold rating maintained. Targeted price range changed to $4.40
- $5.60 from $5.00 - $6.50. The stock came under severe pressure on Thursday in
response to an announcement that the company’s CFO had resigned and that the SEC
was investigating the recent change in the company’s accounting practices . . .
12. Simultaneous with the SEC’s April 2004 investigation, Bally itself initiated an
internal investigation, spearheaded by its Audit Committee. That investigation ultimately uncovered
a fraud of massive proportions.
13. On November 15, 2004, Bally announced that its Audit Committee had concluded,
based on its internal investigation, that the Company’s financial statements for the years ended
December 31, 2000 through December 31, 2003 (including the initial restatement of 2003, first
reported in March 2004) and the first quarter of 2004 should be restated and could no longer be
relied upon. Also on November 15, 2004, Bally announced that it would be unable to issue any
financial statements for the remainder of 2004 or 2005 until it had completed the restatements which
were expected in July 2005 (but were actually completed much later, in November 2005).
14. On February 10, 2005, Bally announced that it was suspending severance pay to
defendants Hillman and Dwyer, the former CEO and CFO respectively, who were responsible “for
multiple accounting errors and creating a culture within the accounting and finance groups that
encouraged aggressive accounting.”
15. Also on February 10, 2005, Bally announced that it had identified deficiencies in its
internal controls over financial reporting that, either individually or in the aggregate, constituted
material weaknesses. They included a lack of clear, acceptable policies on financial reporting,
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ineffective delegation of authority and responsibility, insufficient instruction regarding accurate and
responsible assumptions and judgments, and insufficiently experienced and trained staff.
16. According to an analyst report by Jefferies & Co, Inc. from that same day, the key
findings of the Audit Committee investigation were:
* Multiple accounting errors.
* Bally’s former CEO, Lee Hillman, and former CFO, John Dwyer, engaged
in improper conduct, and were responsible for multiple accounting errors and
for a creating a culture of aggressive accounting. Mr. Dwyer also misled the
SEC.
* Improper conduct on the part of the current Vice President and Controller,
Ted Noncek (from 2001 to 2005) and current Vice President and Treasurer
Geoff Scheitlin (former Controller from 1997 to 2001) was also found. As
a result, both have been terminated. Mr. Noncek was offered the opportunity
to consult with the company on a short-term basis in order to facilitate timely
completion of the ongoing audits.
* The company had and currently has material weaknesses in internal controls
over financial reporting.
* Prior auditors Ernst & Young are currently being evaluated given BFT’s
belief that the auditors made several errors in the course of their work for
Bally.
* BFT’s current auditor, KPMG, will likely issue a qualified opinion in the
company’s 2004 10K and annual report as a result of the material weaknesses
in financial controls that were not remediated by December 31, 2004.
17. On November 30, 2005 – a full 19 months after the first incomplete and misleading
disclosure of problems – Bally was finally able to quantify the full impact of the restatement and
announce its financial results for the year ended December 31, 2004, and also for the first three
quarters of 2005. Bally’s November 30, 2005 SEC filings completed the restatement of financial
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results for the first quarter of 2004 and for the years ended December 31, 2000, 2001, 2002, and
2003, and are referred to collectively herein as the “Restatement”.
18. The Restatement adjustments resulted in an increase in previously reported net loss
of approximately $96.4 million for the year ended December 31, 2002, and a decrease of $540
million in net loss for the year ended December 31, 2003. The decrease in 2003 reported net loss
includes the reversal of the cumulative effect of a change in accounting previously reported in 2003
of $583 million. Bally also increased the January 1, 2002 opening accumulated stockholders’
deficit by $1.7 billion to recognize the effects of corrections in financial statements prior to
2002.
19. As admitted by Bally itself, and as set forth in the Restatement, each of Bally’s
financial statements, earnings related press releases, and Sarbanes-Oxley certifications issued during
the Class Period were materially false and misleading when made. The true facts, which were
concealed from the investing public during the Class Period, are set forth in ¶¶ 127-179, below.
JURISDICTION AND VENUE
20. 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)], and Rule 10b-5 promulgated thereunder by the
SEC [17 C.F.R. § 240.10b-5].
21. 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].
22. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and 28
U.S.C. § 1391(b). Many of the acts charged herein, including the preparation and dissemination of
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materially false and misleading information, occurred in substantial part in this District.
Additionally, defendants maintain their principal place of business within this District.
23. In connection with the acts alleged in this complaint, defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not limited
to, the mails, interstate telephone communications and the facilities of the national securities
markets.
PARTIES
24. Lead Plaintiff, Cosmos Investment Co., LLC (“Cosmos”) is an investment vehicle
through which Dr. Lokesh Sharma makes investments on behalf of himself, his wife, and his parents.
Cosmos is managed by Cosmos Capital Group, Inc., which in turn is managed by Dr. Sharma.
Cosmos, as set forth in the Certification previously filed with the Court, purchased the common
stock of Bally during the Class Period, and has sustained damages therefrom.
25. Defendant Bally Total Fitness Holding Corporation (“Bally”) is a Delaware company
with offices located in this District at 8700 West Bryn Mawr Avenue, Chicago, Illinois 60631. As
of February 29, 2004, Bally operated 418 fitness centers and had approximately 4 million members.
Its fitness centers are located in 29 states, Mexico, Canada, Asia, and the Caribbean. Bally fitness
centers feature a variety of cardiovascular and strength equipment, and offer personal training,
weight management, and group fitness training programs. In addition, the company’s fitness centers
include pools, racquet courts, spinning rooms, or other athletic facilities. Bally’s fitness centers
operate under the service mark ‘Bally Total Fitness’ ‘Bally Sports Clubs’, ‘Crunch Fitness’, ‘The
Sports Clubs of Canada’, ‘Pinnacle Fitness’, and ‘Gorilla Sports’.
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26. Defendant Lee S. Hillman (“Hillman”) served as Bally’s Chief Executive Officer, and
President from the beginning of the Class Period until December 11, 2002. Hillman also served as
Chairman of the Board of Directors from December 2000 until December 11, 2002. In 2002,
Hillman received $638,654 in salary, $1,641,750 worth of restricted stock awards and $4,863,600
in cash payments pursuant to a separation agreement with Bally, which included $926,100 for
vesting of restricted stock. Hillman was a CPA at all relevant times.
27. Defendant Paul A. Toback (“Toback”) was named Chairman of the Board of
Directors in May 2003 and has served as a Director since March 2003 and as President and Chief
Executive Officer since December 2002. He was Executive Vice President from February 2002 to
December 2002, Chief Operating Officer from June 2001 to December 2002, Senior Vice President,
Corporate Development from March 1998 to June 2001 and a Vice President from November 1997
to March 1998. In 2003, Toback was paid $775,00 in salary and bonus compensation, $1,206,000
in restricted stock awards and $200,000 in stock options granted by Bally. Toback was a CPA at all
relevant times.
28. Defendant John W. Dwyer (“Dwyer”) served as Bally’s Chief Financial Officer and
Executive Vice President throughout the Class Period. Dwyer resigned his positions as CFO and
Director on April 28, 2004, in connection with the SEC investigation into Bally’s accounting
practices. In 2003, Dwyer received a salary of $375,000, $603,000 in restricted stock options and
$160,000 in securities underlying stock options. Dwyer was a CPA at all relevant times.
29. Defendants Hillman, Toback and Dwyer are collectively referred to herein as the
“Individual Defendants”. Defendants Bally, Hillman, Toback and Dwyer are collectively referred
to herein as the "Bally Defendants".
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30. Defendant Ernst & Young, LLP (“E&Y”) served as Bally’s external auditor
throughout the Class Period until it resigned the engagement, effective March 31, 2004. E&Y issued
unqualified audit opinions on Bally’s year-end financial statements for the years ended December
31, 1999, 2000, 2001, 2002, and 2003. E&Y opined that the financial statements were presented in
accordance with GAAP and that its audits were conducted in accordance with generally accepted
auditing standards (“GAAS”). E&Y received substantial fees from Bally for its audit opinions,
including, e.g., $1,844,000 in audit fees for 2003.
31. The Individual Defendants, because of their positions with the Company (CEO and
CFO), possessed the power and authority to control the contents of Bally’s quarterly and year-end
reports, press releases and presentations to securities analysts, money and portfolio managers and
institutional investors, i.e., the market. Each defendant was provided with copies of the SEC filings
and press releases 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 corrected. Accordingly,
each of the Individual Defendants is responsible for the accuracy of the public reports and releases
detailed herein and is therefore primarily liable for the representations contained therein.
32. Because of their positions and access to material non-public information, each of the
Individual Defendants knew or recklessly disregarded that Bally’s positive representations which
were being made were materially false and misleading.
33. It is appropriate to treat the Individual Defendants as a group for pleading purposes
and to presume that the false, misleading and incomplete information conveyed in the Company’s
public filings, press releases and other publications as alleged herein are the collective actions of the
narrowly defined group of defendants identified above. Each of the above officers of Bally, by virtue
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of their high-level positions with the Company (CEO and CFO), directly participated in the
management of the Company, was directly involved in the day-to-day operations of the Company
at the highest levels and was privy to confidential proprietary information concerning the Company
and its business, operations, products, growth, financial statements, and financial condition, as
alleged herein.
34. The Individual Defendants were involved in drafting, producing, reviewing and/or
disseminating the false and misleading financial statements, press releases, and Sarbanes-Oxley
certifications. Each was aware or recklessly disregarded that false and misleading statements were
being issued regarding the Company, and approved or ratified these statements, in violation of the
federal securities laws.
35. As officers and controlling persons of a publicly-held company whose common stock
was, and is, registered with the SEC pursuant to the Exchange Act, traded on the New York Stock
Exchange (“NYSE”) during the Class Period, and governed by the provisions of the federal securities
laws, the Individual Defendants each had a duty to disseminate promptly, accurate and truthful
information with respect to the Company’s financial condition and performance, growth, operations,
financial statements, business, products, markets, management, earnings and present and future
business prospects, and to correct any previously-issued statements that had become materially
misleading or untrue, so that the market price of the Company’s publicly-traded securities would be
based upon truthful and accurate information. The Individual Defendants’ misrepresentations and
omissions during the Class Period violated these specific requirements and obligations.
36. Each of the defendants is liable as a participant in a fraudulent scheme and course of
business that operated as a fraud or deceit on purchasers of Bally securities by disseminating
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materially false and misleading statements and/or concealing material adverse facts. The scheme:
(i) deceived the investing public regarding Bally’s business, finances, internal controls, financial
statements and the intrinsic value of Bally securities; and (ii) caused Lead Plaintiff and other
members of the Class to purchase Bally securities at artificially inflated prices.
CLASS ACTION ALLEGATIONS
37. Lead Plaintiff brings this action as a class action pursuant to Federal Rule of Civil
Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased or otherwise
acquired the securities of Bally between August 3, 1999 and April 28, 2004, inclusive, and who were
damaged thereby. Excluded from the Class are defendants, the officers and directors of the
Company at all relevant times, members of their immediate families and their legal representatives,
heirs, successors or assigns and any entity in which defendants have or had a controlling interest.
38. The members of the Class are so numerous that joinder of all members is
impracticable. Throughout the Class Period, Bally had approximately 38 million shares of common
stock outstanding that were actively traded on the NYSE. While the exact number of Class members
is unknown to Lead Plaintiff at this time and can only be ascertained through appropriate discovery,
Lead Plaintiff believes that there are hundreds or thousands of members in the proposed Class.
Record owners and other members of the Class may be identified from records maintained by Bally
or its transfer agent and may be notified of the pendency of this action by mail, using the form of
notice similar to that customarily used in securities class actions.
39. Lead Plaintiff’s claims are typical of the claims of the members of the Class as all
members of the Class are similarly affected by defendants’ wrongful conduct in violation of federal
law that is complained of herein.
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40. Lead Plaintiff will fairly and adequately protect the interests of the members of the
Class and has retained counsel competent and experienced in class and securities litigation.
41. There is a well-defined community of interest in the questions of law and fact
involved in this case. Questions of law and fact common to the members of the Class which
predominate over questions which may affect individual Class members include:
a. whether the 1934 Act was violated by defendants;
b. whether defendants omitted and/or misrepresented material facts;
c. whether defendants’ statements omitted material facts necessary to make the
statements made, in light of the circumstances under which they were made, not misleading;
d. whether defendants knew or deliberately disregarded that their statements
were false and misleading;
e. whether the prices of Bally publicly traded securities were artificially inflated;
and
f. the extent of damages sustained by Class members and the appropriate
measure of damages.
42. A class action is superior to all other available methods for the fair and efficient
adjudication of this controversy since joinder of all members is impracticable. Furthermore, as the
damages suffered by individual Class members may be relatively small, the expense and burden of
individual litigation make it impossible for members of the Class to individually redress the wrongs
done to them. There will be no difficulty in the management of this action as a class action.
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MATERIALLY FALSE AND MISLEADING CLASS PERIOD STATEMENTS
43. The Class Period begins on August 3, 1999, when Bally announced its results for the
second quarter of 1999, which, as reported, represented marked growth over the Company’s
performance in the previous year’s second quarter. In a press release, the Company reported as
follows:
Bally Total Fitness Holding Corporation (NYSE:BFT) today announced second
quarter 1999 results -- with fully diluted earnings per share of $.34 versus $.08 in the
prior year and operating income of $21.1 million -- an improvement of 82% over the
1998 quarter. Earnings before interest, taxes, depreciation and amortization for the
1999 quarter grew to $33.8 million, a 44% improvement over the 1998 quarter, and
the positive trend of growth in operating cash flows continued.
Commenting on achievement of another strong quarter, Lee Hillman, President and
Chief Executive Officer of Bally Total Fitness, said, “Bally continued to demonstrate
success and gain momentum as evidenced by the growth in earnings and positive
trends in cash flows. By implementing the plan we presented two years ago, we are
continuing to invest in programs that achieve results with rapid returns. Our
aggressive program of facility upgrades, new product and service offerings and club
expansion efforts are demonstrating their value. We have now added 26 new fitness
centers during 1999, including our recent acquisition of The Sports Clubs of Canada,
a profitable, upscale 10-center group in Toronto. Also, as we had expected, second
quarter new member joins grew 9% over prior year levels while seasonal attrition
was 5% lower than prior year trends.” Mr. Hillman concluded, “A significant driver
of our business success, member satisfaction, is improving dramatically, as seen by
these trends. And our focus is to make the member experience still better by
continuing to execute those initiatives.”
44. On August 16, 1999, Bally filed its quarterly report for the second quarter of 1999
on Form 10-Q with the SEC. The report was signed by defendants Dwyer and Hillman and
represented that “[t]he accompanying condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles.” The second quarter 1999
Form 10-Q reiterated the financial results set forth in Bally’s August 3, 1999 press release.
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45. The August 3, 1999 press release and the August 16, 1999 10-Q were materially false
and misleading, because Bally’s growth was not attributable to the implementation of management’s
plan, but rather to an undisclosed accounting fraud, and for the reasons set forth in ¶¶ 127-175,
below.
46. On October 26, 1999 Bally filed a Form 8-K with the SEC, signed by defendant
Dwyer, attaching a press release thereto as an exhibit. The press release stated, in relevant part:
Bally Total Fitness Holding Corporation today announced third quarter 1999 results
– with fully diluted earnings per share of $.45 versus $.16 in the prior year and
operating income of $25.1 million – an improvement of 82% over the 1998 quarter.
Earnings before interest, taxes, depreciation and amortization for the 1999 quarter
grew to $38.4 million, a 49% improvement over the 1998 quarter. The strong,
positive trend of growth in operating cash flows continued with a $15.8 million
increase in cash flow from operations compared to the same quarter a year ago.
47. On November 15, 1999, the Company filed its quarterly report for the third quarter
of 1999 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented
that “[t]he accompanying condensed consolidated financial statements have been prepared in
conformity with generally accepted accounting principles.” In relevant part, the Company reiterated
the results set forth in the October 26, 1999 press release, reporting:
Operating income for the third quarter of 1999 was $25.1 million compared to $13.8
million in 1998. The increase of $11.3 million (82%) was due to a $29.2 million
(15%) increase in revenues offset by a $17.9 million (10%) increase in operating
costs and expenses. The operating margin before depreciation and amortization
increased to 17% from 14% in the prior year period.
48. The October 26, 1999 press release and the November 15, 1999 10-Q were materially
false and misleading, for the reasons set forth in ¶¶ 127-175, below.
49. On February 9, 2000, Bally announced its results for the fourth quarter and year ended
December 31, 1999. In its press release, Bally reported in relevant part that:
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Bally Total Fitness Holding Corporation (NYSE: BFT) today announced results for
the fourth quarter and year ended December 31,1999 with diluted earnings per share
for the quarter of $.53, compared to $.19 for the prior year's quarter. Operating
income for the quarter was $28.8 million - up 87% over the prior year period while
operating income before depreciation and amortization ("EBITDA") improved 59%
to $43.3 million. Strong growth in operating cash flow continued with cash flow
from operations growing $17.6 million versus the prior year's quarter.
For the full year, diluted earnings per share, before the cumulative effect of
a change in accounting principle, was $1.56 compared to $.51 per share in 1998.
Operating income for 1999 was $93.3 million, an improvement of 77% over the prior
year, and EBITDA grew 45% to $146.2 million. Cash flow from operations increased
$71.1 million over 1998. During the first quarter of 1999, the Company, as required
by AICPA Statement of Position 98-5, Reporting Costs of Start-up Activities, wrote
off the net book value of start-up costs, reducing basic and diluted earnings per share
$.01.
Lee Hillman, President and Chief Executive Officer of Bally Total Fitness,
noted, "We are very pleased with our quarterly and full-year results and, in particular,
that we have continued to deliver on our plans for improving earnings and cash
flows. Since 1996, when the Company lost more than $2.00 per share, we have
executed against our business plan with earnings per share now at $1.56.
50. On March 31, 2000, the Company filed its annual report for the year 1999 with the
SEC on Form 10-K, reiterating the results set forth in the February 9, 2000 press release. The report
was signed by defendants Hillman and Dwyer, and represented that “[t]he accompanying
consolidated financial statements have been prepared in conformity with generally accepted
accounting principles.”
51. Also reassuring investors was a report from the Company’s auditors, E&Y, included
in the Form 10-K, representing that:
[i]n our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Bally Total
Fitness Holding Corporation at December 31, 1999 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States.
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E&Y further stated that “[w]e conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.”
52. The February 9, 2000 press release and the 1999 Form 10-K were materially false
and misleading, because Bally was not delivering on plans for improving earnings and cash flows,
but rather, achieving results through an undisclosed accounting fraud, and for the reasons set forth
in ¶¶ 127-175, 183-262, below.
53. On May 3, 2000 Bally filed a Form 8-K with the SEC, signed by defendant Dwyer,
attaching a press release thereto as an exhibit. The press release stated, in relevant part:
Bally Total Fitness Holding Corporation today reported its financial results for the
first quarter of 2000, with diluted earnings per share for the quarter of $.56, more
than double the $.25 earnings per share reported in the prior year quarter. Operating
income grew 63% to $29.8 million and operating income before depreciation and
amortization (“EBITDA”) improved 47% to $45.1 million. Net revenues for the
period reached $249.3 million, a 20% increase over the prior year quarter. Cash
provided by operating activities increased to $18.0 million for the quarter.
54. On May 15, 2000, the Company filed its quarterly report for the first quarter of 2000
on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that “[t]he
accompanying condensed consolidated financial statements have been prepared in conformity with
generally accepted accounting principles.” In relevant part, the Company reiterated the results set
forth in the May 3, 2000 press release, reporting:
Operating income for the first quarter of 2000 was $29.8 million compared to $18.3
million in 1999. The increase of $11.5 million (63%) was due to a $40.8 million
(20%) increase in net revenue, offset, in part, by an increase in operating costs and
expenses of $26.4 million (15%) and a $2.9 million increase in depreciation and
amortization. The operating margin before depreciation and amortization increased
to 18% from 15% for the 1999 quarter.
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55. The May 3, 2000 press release and the May 15, 2000 Form 10-Q were materially false
and misleading, for the reasons set forth in ¶¶ 127-175, below.
56. On August 3, 2000 Bally filed a Form 8-K with the SEC, signed by defendant Dwyer,
attaching a press release thereto as an exhibit. The press release stated, in relevant part:
Bally Total Fitness Holding Corporation today reported its financial results for the
second quarter of 2000, with diluted earnings per share up more than 70% to $.58.
Operating income for the quarter of $31.7 million was up 50% over the prior year.
Earnings before interest, taxes, depreciation and amortization (EBITDA) grew to
$47.3 million, a 40% improvement.
57. On August 14, 2000, the Company filed its quarterly report for the second quarter of
2000 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that
“[t]he accompanying condensed consolidated financial statements have been prepared in conformity
with generally accepted accounting principles.” In relevant part, the Company reiterated the results
set forth in the August 3, 2000 press release, reporting:
Operating income for the second quarter of 2000 was $31.7 million compared to
$21.1 million in 1999. The increase of $10.6 million (50%) was due to a $41.4
million (20%) increase in net revenue, offset, in part, by an increase in operating
costs and expenses of $27.8 million (16%) and a $3.0 million increase in depreciation
and amortization. The operating margin before depreciation and amortization
increased to 19% from 16% in the prior year quarter.
58. The August 3, 2000 press release and the August 14, 2000 Form 10-Q were materially
false and misleading, for the reasons set forth in ¶¶ 127-175, below.
59. On November 7, 2000, Bally issued a press release reporting its earnings for the third
quarter of 2000. The release stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported third quarter
2000 results - with diluted earnings per share of $.58 (before the effects of a $20
million, $.72 per diluted share, benefit from the reduction of tax valuation
allowances) versus $.45 in the prior year quarter. Net income, inclusive of the effect
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of this tax benefit totaled $35.9 million, $1.30 per diluted share, for the current
quarter.
Operating income for the quarter improved 29% to $32.4 million in the current
quarter from $25.1 million in the 1999 quarter. Earnings before interest, taxes,
depreciation and amortization (EBITDA) grew to $49.3 million, a 29% improvement
over the prior year quarter - while the Company's EBITDA margin continued to
expand to over 19% for the quarter. Cash flows from operations continued to build
as well, with a net improvement in operating cash flow of $12.4 million over the year
ago quarter. Other liquidity measures continue to be positive as well - with key
receivable portfolio measures of quality continuing to strengthen year over year.
In accordance with Financial Accounting Standard No. 109, Accounting for
Income Taxes, the Company reviewed the likelihood of realizing the future benefit
of tax loss carryforwards. Based upon consistent and growing profitability over the
past three years and reasonably expected continuation of these trends, the Company
reduced its tax valuation allowance against net operating losses realized in prior
periods by $20 million. Valuation allowances totaling over $100 million remain and
may be reversed in future periods.
Lee Hillman, Chairman of the Board of Directors, CEO and President of
Bally Total Fitness, noted that "Our third quarter results demonstrate yet again the
power of our business model. We are pleased with the growth and margin expansion
we continue to achieve, and believe the investments we have been making in our
business will lead to further improvements in operating results going forward." Mr.
Hillman continued, "We are pleased to have reached another key objective during the
quarter - generating free cash flow while at the same time continuing to expand and
grow our operations."
60. On November 14, 2000, the Company filed its quarterly report for the third quarter
of 2000 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented
that “[t]he accompanying condensed consolidated financial statements have been prepared in
conformity with generally accepted accounting principles.” In relevant part, the Company reiterated
the results set forth in the November 7, 2000 press release, reporting:
Operating income for the third quarter of 2000 was $32.4 million compared to $25.1
million in 1999. The increase of $7.3 million (29%) was due to a $35.8 million
(16%) increase in net revenue, offset, in part, by an increase in operating costs and
expenses of $24.8 million (14%) and a $3.7 million increase in depreciation and
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amortization. The operating margin before depreciation and amortization increased
to 19% from 18% in the prior year quarter.
61. The November 7, 2000 press release and the November 14, 2000 Form 10-Q were
materially false and misleading, because results did not demonstrate the power of Bally’s business
model, but rather, were attributable to an undisclosed accounting fraud, and for the reasons set forth
in ¶¶ 127-175, below.
62. The Company reported another year of impressive top and bottom line growth the
following year. On February 14, 2001 Bally filed a Form 8-K with the SEC, signed by defendant
Dwyer, attaching a press release thereto as an exhibit. The press release stated, in relevant part:
Bally Total Fitness Holding Corporation today announced results for the year and
quarter ended December 31, 2000 with diluted earnings per share for the year of
$2.35 (before the net benefit of unusual items of $13.5 million, $0.49 per diluted
share) versus $1.56 in the prior year. Net income, inclusive of the effect of unusual
items totaled $78.6 million, $2.84 per diluted share for the year. Revenues exceeded
$1.0 billion annually, for the first time, an increase of 17% over the prior year.
Operating income for the year improved 35% to $126.4 million from $93.3 million
in the prior year while earnings before taxes, depreciation and amortization
(EBITDA) grew to $192.0 million, a 31% improvement over the prior year. The
Company’s EBITDA margin continued to expand to over 19% for the year from 17%
in the prior year. Cash flows from operation continued to build as well, with a net
improvement in operating cash flow of $18.7 million over the prior year, before the
effect of retail inventory growth of $8.6 million to support a 54% growth in retail
outlets.
For the quarter, net income before the effects of a non-cash unusual item totaled
$18.0 million, an increase of 25% over the prior year quarter. Operating income for
the fourth quarter improved 13% to $32.5 million from $28.8 million in the prior year
quarter while EBITDA grew to $50.2 million, a 16% improvement over the prior
year quarter.
63. On March 9, 2001, Bally filed its annual report for the year 2000 on Form 10-K with
the SEC, reiterating the results set forth in the February 14, 2001 press release. The report was
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signed by defendants Hillman and Dwyer, and represented that “[t]he accompanying consolidated
financial statements have been prepared in conformity with generally accepted accounting
principles.”
64. Further reassuring investors was the report of the Company’s auditors, E&Y, included
in the Form 10-K, representing that:
[i]n our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Bally Total
Fitness Holding Corporation at December 31, 2000 and 1999, and the consolidated
results of its operations and its cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States.
E&Y further stated that “[w]e conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.”
65. The February 14, 2001 press release and the 2000 Form 10-K were materially false
and misleading, for the reasons set forth in ¶¶ 127-175, 183-262, below.
66. On May 8, 2001 Bally filed a Form 8-K with the SEC, signed by defendant Dwyer,
attaching a press release thereto as an exhibit. The press release stated, in relevant part:
Bally Total Fitness Holding Corporation today reported its financial results for the
first quarter of 2001, with diluted earnings per share for the quarter of $.65, up 16%
over the $.56 per share reported in the prior year quarter. Operating income grew
16% to $34.7 million and operating income before depreciation and amortization
(“EBITDA”) improved 17% to $52.6 million. Net revenues for the period grew to
$280.3 million, a 12% increase over the prior year quarter.
67. On May 15, 2001, the Company filed its quarterly report for the first quarter of 2001
on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that “[t]he
accompanying condensed consolidated financial statements have been prepared in conformity with
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generally accepted accounting principles.” In relevant part, the Company reiterated the results set
forth in the May 8, 2001 press release, reporting:
Operating income for the first quarter of 2001 was $34.7 million compared to $29.8
million in 2000. The increase of $4.9 million (16%) was due to a $30.5 million
(12%) increase in net revenue, offset, in part, by an increase in operating costs and
expenses of $23.0 million (11%) and a $2.6 million increase in depreciation and
amortization. The operating margin before depreciation and amortization increased
to 19% from 18% for the 2000 quarter.
68. The May 8, 2001 press release and the May 15, 2001 Form 10-Q were materially false
and misleading, for the reasons set forth in ¶¶ 127-175, below.
69. On August 7, 2001, Bally reported its earnings for the second quarter of 2001. Bally
reported, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the second quarter of 2001, with net income of $19.2 million, up 21% over
the prior year quarter, and diluted earnings per share for the quarter of $.63. Net
revenues increased 11% to $281.3 million, while operating income for the quarter
was up 8% over the prior year to $34.1 million. Earnings before interest, taxes,
depreciation and amortization (EBITDA) for the 2001 quarter grew to $52.1 million,
a 10% improvement over 2000.
Lee Hillman, Chairman of the Board, President and CEO of Bally Total
Fitness, stated "Our second quarter results are further demonstration of the strength
of our business model. We have grown revenues and profits despite challenging
economic conditions. Our balance sheet has continued to improve, attrition has
remained at its low level and our portfolio of membership receivables has remained
strong.
70. On August 14, 2001, the Company filed its quarterly report for the second quarter of
2001 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that
“[t]he accompanying condensed consolidated financial statements have been prepared in conformity
with generally accepted accounting principles.” In relevant part, the Company reiterated the results
set forth in the August 7, 2001 press release, reporting:
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Operating income for the second quarter of 2001 was $34.1 million compared to
$31.7 million in 2000. The increase of $2.4 million (8%) was due to a $28.5 million
(11%) increase in net revenue, offset, in part, by an increase in operating costs and
expenses of $23.8 million (12%) and a $2.3 million increase in depreciation and
amortization. The operating margin before depreciation and amortization was 19%
in each period.
71. The August 7, 2001 press release and the August 14, 2001 Form 10-Q were materially
false and misleading, because results were not demonstrative of the strength of Bally’s business
model, but rather, attributable to an undisclosed accounting fraud, and for the reasons set forth in ¶¶
127-175, below.
72. On November 6, 2001, Bally reported its earnings for the third quarter of 2001.
Bally’s press release stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the third quarter of 2001, with net income of $18.2 million, up 14% over
the prior year quarter, and diluted earnings per share for the quarter of $.61, before
the net benefit of unusual items of $8.3 million ($.27 per diluted share). Net revenues
increased 5% to $209.9 million, while operating income, exclusive of special charges
for the quarter, was up 6% over the prior year to $16.1 million. Earnings before
interest, taxes, depreciation and amortization, including finance charges earned
("EBITDA") for the 2001 quarter, exclusive of the impact of $6.7 million of special
charges, was $52.2 million, a 6% improvement over 2000.
"The third quarter was a uniquely challenging period for business," said Lee
Hillman, chairman of the board, president and CEO of Bally Total Fitness. "While
a number of obvious factors made this period one of the most difficult, Bally
remained strong and resilient. Continued revenue and profit growth in our core
operations and continued strength of our contracts receivable portfolio highlighted
Bally's performance this quarter. In October, new membership sales rebounded to
levels above those experienced for the same month a year ago and personal training
revenues reached an all time high. Our products and services businesses have
continued to grow despite disruptions during September."
"During this quarter, we also made progress on our goal to monetize our more
than $500 million receivables portfolio, completing another bulk sale and reducing
debt. In 2001, we have reduced debt by 15%, nearly $105 million, strengthening our
financial position. We also made significant progress toward our long-term goal with
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a pending new agreement to replace our existing securitization facility. This new
facility is expected to be completed in the coming weeks," Hillman added.
"Also, in October, we announced a merger agreement with Crunch Fitness,
the preeminent fitness brand serving the very important and fast-growing young,
upscale, urban market segment. Crunch will give us terrific new positioning in
exceptionally visible, high-growth markets, including New York, Los Angeles,
Chicago, Atlanta, Miami and San Francisco. All in all, we have made a lot of
progress in difficult times," Hillman concluded.
73. On November 14, 2001, the Company filed its quarterly report for the third quarter
of 2001 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented
that “[t]he accompanying condensed consolidated financial statements have been prepared in
conformity with generally accepted accounting principles.” In relevant part, the Company reiterated
the results set forth in the November 6, 2001 press release, reporting:
Operating income for the third quarter of 2001, excluding special charges of $6.7
million, was $16.1 million compared to $15.1 million in 2000. The increase of $1.0
million (6%) was due to an $11.0 million (6%) increase in net revenue, offset, in part,
by an increase in operating costs and expenses of $10.0 million (5%), including a
$2.2 million increase in depreciation and amortization. The special charges related
to cancelled or reformatted marketing events and other direct or indirect costs from
disruptions and shutdowns of various club operations and programs resulting from
the September 11th terrorist events and a one-time markdown of retail apparel in
connection with management's strategic repositioning of in-club retail stores, adding
juice bars to replace slow moving, lower margin fashion apparel. Earnings before
interest, taxes, depreciation and amortization, including finance charges earned
("EBITDA"), exclusive of the impact of the special charges, was $52.2 million versus
$49.3 for the last year quarter, a 6% increase.
74. The November 6, 2001 press release and the November 14, 2001 Form 10-Q were
materially false and misleading, because Bally had not made progress in difficult times, but rather
created the illusion of progress through an undisclosed accounting fraud, and for the reasons set forth
in ¶¶ 127-175, below.
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75. On February 13, 2002, Bally reported its fourth quarter and year end results for 2001.
In its press release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the year ended December 31, 2001, with net income of $72.4 million, an
increase of 11% over the prior year, and diluted earnings per share of $2.43, up 3%
from 2000, before the net benefit of unusual items of $8.3 million ($0.27 per diluted
share) in 2001, and $13.5 million ($0.49 per diluted share) in 2000.
The average number of diluted shares increased 8%. Net revenues increased
8% to $852.0 million, while operating income increased 11% to $64.5 million, before
special charges of $6.7 million and $6.5 million, in 2001 and 2000, respectively.
Earnings before interest, taxes, depreciation and amortization, including finance
charges earned (EBITDA), was $205.0 million before special charges, a 7%
improvement over 2000. Pretax income rose 12% to $67.0 million.
Net income for the fourth quarter was $16.3 million ($0.54 per diluted share)
compared with $11.5 million ($0.41 per diluted share) in the prior year quarter.
Excluding the special charge, net income in fourth quarter 2000 was $18.0 million
($0.65 per diluted share). Net revenues increased 5% during the quarter to $211.8
million compared to $201.6 million.
"Despite the many challenges of 2001, Bally had considerable success and
made progress toward our long-term objectives," said Lee Hillman, Chairman and
CEO, Bally Total Fitness Holding Corporation. "In a difficult economy, we were able
to increase revenues, with products and services growing very well, and margins
holding steady for the year. We exceeded our cash flow expectations, finishing the
year cash flow positive, exclusive of our year-end acquisition of Crunch Fitness. In
addition, we've worked hard to improve our sales processes and services for our
members, and believe the progress we're making is having an impact."
"Our 2001 results have enabled us to continue to improve our already strong
balance sheet, a primary objective over the past three years, reducing debt by nearly
$30 million. Clearly, this business model has been confirmed through the successful
completion of new bank and asset-backed facilities during the quarter, as well as the
recent credit upgrade by Moody's," said Hillman.
76. On March 27, 2002, Bally filed its 2001 annual report with the SEC on Form 10-K.
The report reiterated the results set forth in the February 13, 2002 press release, was signed by
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defendants Hillman and Dwyer and represented that “[t]he accompanying consolidated financial
statements have been prepared in conformity with generally accepted accounting principles.”
77. In addition, the annual report contained a report of Bally’s auditors, E&Y,
representing that:
In our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 2001 and 2000, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted in
the United States.
E&Y further stated that “We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.”
78. The February 13, 2002 press release and the 2001 Form 10-K were materially false
and misleading, because Bally had not had considerable success nor made progress toward long-term
objectives, but rather, created that illusion through an undisclosed accounting fraud, and for the
reasons set forth in ¶¶ 127-175, 183-262, below.
79. On May 2, 2002, Bally reported its earnings for the first quarter of 2002. In its press
release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the three months ended March 31, 2002, with net income of $19.4 million,
an increase of 4% over the prior year quarter, and diluted earnings per share of $0.59
versus $0.65 in the prior year quarter on a 15% increase in average diluted shares.
Net revenues increased 12% to $240.4 million inclusive of 8% attributable to recently
acquired Crunch Fitness. Cash flows from operations on a comparable basis
improved 84% over the prior year quarter.
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80. On May 15, 2002, the Company filed its quarterly report for the first quarter of 2002
on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that “[t]he
accompanying condensed consolidated financial statements have been prepared in conformity with
generally accepted accounting principles.” In relevant part, the Company reiterated the results set
forth in the May 2, 2002 press release, reporting:
Operating income for the first quarter of 2002 of $16.8 million was unchanged from
the prior year period. Net revenues increased $26.6 million (12%) for the first quarter
of 2002, offset by a $27.1 million (15%) increase in operating costs and expenses,
and depreciation and amortization decreased by $.5 million. Earnings before interest,
taxes, depreciation and amortization, including finance charges earned ("EBITDA")
was $51.9 million versus $52.6 million for the last year quarter, a 1% decrease. The
EBITDA margin was 22% in the 2002 quarter compared to 25% in the 2001 period.
81. The May 2, 2002 press release and the May 15, 2002 Form 10-Q were materially false
and misleading, for the reasons set forth in ¶¶ 127-175, below.
82. On August 6, 2002, Bally reported its earnings for the second quarter of 2002. In its
press release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the second quarter of 2002, with net revenues up 14%, net income of $16.1
million ($.48 per diluted share), and pretax income of $21.2 million, up 8%.
Assuming comparable tax rates for both periods, second quarter 2002 net income
grew $1.2 million (8%). Income tax provisions are not comparable between periods,
due to an increase in the Company's effective tax rate during the quarter, which
resulted in a $4.2 million non-cash deferred income tax charge in the second quarter
of 2002. Diluted earnings per share were $.63 in the prior year quarter on net income
of $19.2 million. Net revenues increased 14% to $246.4 million inclusive of $18.3
million attributable to Crunch Fitness centers acquired at the end of 2001. Cash flows
from operations, on a comparable basis, increased $4.0 million, more than doubling
from the prior year quarter. Earnings before interest, taxes, depreciation and
amortization, including finance charges earned ("EBITDA"), was $53.6 million
during the quarter, an increase of 3% over the prior year.
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83. On August 14, 2002, the Company filed its quarterly report for the second quarter of
2002 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that
“[t]he accompanying condensed consolidated financial statements have been prepared in conformity
with generally accepted accounting principles.” In relevant part, the Company reiterated the results
set forth in the August 6, 2002 press release, reporting:
Operating income for the second quarter of 2002 was $17.2 million compared to
$16.8 million in 2001. Net revenues increased $29.9 million (14%) for the second
quarter of 2002, offset by a $28.5 million (16%) increase in operating costs and
expenses, and an increase in depreciation and amortization of $1.0 million. Earnings
before interest, taxes, depreciation and amortization, including finance charges
earned ("EBITDA") was $53.6 million versus $52.1 million for the last year quarter,
a 3% increase. The EBITDA margin was 20% in the 2002 quarter compared to 22%
in the 2001 period.
84. The August 6, 2002 press release and the August 14, 2002 Form 10-Q were materially
false and misleading, for the reasons set forth in ¶¶ 127-175, below.
85. On November 12, 2002 Bally reported its earnings for the third quarter of 2002. In
its press release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the third quarter of 2002, with net revenues up 16% over the prior year
period to $243.1 million. During the quarter, comparable club revenue grew 4%,
driven primarily by increases in monthly membership dues and products and services.
Net income before the effect of a special charge was $12.2 million, $.37 per diluted
share, within the range estimated in the Company's business outlook announced
October 4, 2002. Pretax income, inclusive of the special charge, was $9.5 million,
down 20%. Assuming comparable tax rates for both the 2002 and 2001 periods, third
quarter 2002 net income declined $1.8 million to $7.2 million. The income tax
provisions are not comparable between periods due to an increase in the Company's
effective tax rate during 2002, which resulted in a $2.3 million non-cash deferred
income tax charge in the third quarter of 2002, compared to a $14.6 million non-cash
deferred income tax benefit in the 2001 quarter.
Net revenues increased 16% including 8% attributable to Crunch Fitness
acquired at the end of 2001. Cash flows from operations, on a comparable basis, were
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$18.7 million in the quarter versus $21.8 million in the prior year period. Earnings
before interest, taxes, depreciation and amortization, including finance charges
earned ("EBITDA") before special charges were $49.9 million during the quarter, a
4% decrease from the prior year.
86. On November 14, 2002, the Company filed its quarterly report for the third quarter
of 2002 on Form 10-Q with the SEC. The report was signed by defendants Dwyer and Hillman, and
represented that “[t]he accompanying condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles.” In relevant part, the
Company reiterated the results set forth in the November 12, 2002 press release, reporting:
Operating income for the third quarter of 2002, excluding special charges, was $13.5
million compared to $16.1 million in 2001. Net revenues increased $33.3 million
(16%) for the third quarter of 2002, offset by a $35.4 million (20%) increase in
operating costs and expenses, excluding special charges, and an increase in
depreciation and amortization of $.4 million. In the third quarter of 2002, we
recorded a non-recurring charge of $6.5 million ($.15 per diluted share on an after tax
basis) to settle a class action lawsuit arising in the early 1990's. In the prior year
quarter, we recorded a non-recurring charge of $6.7 million ($.21 per diluted share
on an after tax basis) related to costs from disruptions and shutdowns of various club
operations resulting from the September 11th terrorist attacks and a one-time
inventory markdown related to our repositioning of in-club retail stores. Earnings
before interest, taxes, depreciation and amortization, including finance charges
earned ("EBITDA"), exclusive of special charges, were $49.9 million versus $52.2
million for the last year quarter, a 4% decrease. The EBITDA margin, before special
charges, was 19% in the third quarter of 2002 compared to 23% in the 2001 period.
87. Moreover, the November 14, 2002 Form 10-Q contained Sarbanes-Oxley
certifications from both defendants Dwyer and Hillman attesting to the accuracy of the reported
results and the efficacy of the Company’s internal controls. Specifically, in the Form 10-Q, both
Hillman and Dwyer represented that:
1. I have reviewed this quarterly report on Form 10-Q of Bally Total Fitness
Holding Corporation;
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2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this quarterly report
(the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's auditors
any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
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most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
88. The November 12, 2002 press release and the November 14, 2002 Form 10-Q were
materially false and misleading, for the reasons set forth in ¶¶ 127-179, below.
89. On February 12, 2003, Bally issued a press release reporting its results for the fourth
quarter and full year ended December 31, 2002. In its release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the year ended December 31, 2002, with net income before special charges
of $58.4 million or $1.77 per diluted share, versus net income before the net benefit
of unusual items of $72.4 million in 2001, or $2.43 per diluted share. Including
special charges of $72.2 million for 2002 ($1.66 per diluted share), net income was
$3.5 million ($.11 per diluted share), versus $80.7 million ($2.70 per diluted share)
in 2001 which included the net benefit of unusual items of $8.3 million ($.27 per
diluted share). Net revenues increased 14% to $968.1 million during 2002 from
$852.0 million in the prior year, including 9% attributable to the Crunch Fitness
acquisition completed at the end of 2001. Same club net revenues grew 3%, driven
by increases in monthly membership dues and products and services, offset by a
decline in new member initiation fees. Earnings before interest, taxes, depreciation
and amortization, including finance charges earned ("EBITDA") before special
charges were $201.7 million for 2002, a decline of 2% from the prior year. Cash
flows from operations, on a comparable basis, were $88.2 million in 2002, compared
to $57.7 million in the prior year, a 53% increase.
Net income before special charges for the fourth quarter of 2002 was $10.8 million,
or $.33 per diluted share. Including the special charges of $65.7 million, the
Company had a net loss in the fourth quarter of $39.2 million, or $1.21 loss per
diluted share. Net income in the fourth quarter of 2001 was $16.3 million or $.54 per
diluted share. Net revenues for the quarter increased 12%, including 8% attributable
to Crunch Fitness. Same club net revenues increased 2% during the quarter. EBITDA
before special charges were $46.3 million during the quarter, a 4% decrease from the
prior year fourth quarter.
90. On March 28, 2003, Bally filed its 2002 annual report with the SEC on Form 10-K/A.
The report reiterated the results set forth in the February 12, 2003 press release, was signed by
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defendants Toback and Dwyer and represented that “[t]he accompanying consolidated financial
statements have been prepared in conformity with generally accepted accounting principles.”
91. A report from the Company’s auditors, E&Y, included in the annual report,
represented that:
[i]n our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Bally Total
Fitness Holding Corporation at December 31, 2002 and 2001, and the consolidated
results of its operations and its cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States.
E&Y further stated that “[w]e conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.”
92. The March 28, 2003 Form 10-K/A also contained Sarbanes-Oxley certifications from
defendants Dwyer and Toback, in which each represented that:
1. I have reviewed this annual report on Form 10-K of Bally Total Fitness
Holding Corporation ("Registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Registrant as of, and
for, the periods presented in this annual report;
4. The Registrant's other certifying officer and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the Registrant, and we have:
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a. designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during
the period in which this annual report is being prepared;
b. evaluated the effectiveness of the Registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual report
(the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The Registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the Registrant's auditors and the audit committee of
Registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record, process,
summarize and report financial data and have identified for the Registrant's auditors
any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal controls; and
6. The Registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the date of our
most recent evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
93. The February 12, 2003 press release, and the March 28, 2003 Form 10-K/A were
materially false and misleading, for the reasons set forth in ¶¶ 127-262, below.
94. On May 7, 2003, Bally reported its earnings for the first quarter of 2003. In its press
release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the quarter ended March 31, 2003, with net income of $9.7 million ($.30
per diluted share), versus $19.4 million ($.59 per diluted share) in the prior year
quarter. Net revenues increased 5% to $253.1 million during the quarter. Cash flows
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from operations ($19.3 million) less cash used in investing activities ($9.8 million),
free cash flow, was $9.5 million.
95. On May 15, 2003, the Company filed its quarterly report for the first quarter of 2003
on Form 10-Q with the SEC. The report was signed by defendants Toback and Dwyer, and
represented that “[t]he accompanying condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles.” In relevant part, the
Company reiterated the results set forth in the May 7, 2003 press release, reporting:
Operating income for the first quarter of 2003 was $8.2 million compared to $16.8
million in 2002. Net revenues increased $12.7 million (5%) for the first quarter of
2003, offset by a $19.1 million (9%) increase in operating costs and expenses ($14.0
million of which is related to the growth in products and services revenues), and an
increase in depreciation and amortization of $2.1 million. Earnings before interest,
taxes, depreciation and amortization, including finance charges earned ("EBITDA"),
was $46.7 million, a decrease of $5.2 million from the prior year period. The
EBITDA margin was 17% in the first quarter of 2003, compared to 20% in the 2002
period.
96. The May 15, 2003 10-Q also reiterated Toback and Dwyer’s Sarbanes-Oxley
certifications with respect to the efficacy of internal controls, as set forth in ¶ 92 above.
97. The May 7, 2003 press release, and the May 15, 2003 Form 10-Q were materially
false and misleading, for the reasons set forth in ¶¶ 127-179, below.
98. On August 5, 2003, Bally reported its earnings for the second quarter of 2003. In its
press release, Bally stated, in relevant part:
Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financial
results for the quarter ended June 30, 2003. Second quarter net revenues totaled
$251.3 million, a $5.0 million increase over the prior year quarter (2%). Free cash
flow, defined as cash flow from operations ($12.1 million) less cash used in investing
activities ($10.8 million), was $1.3 million during the quarter bringing the year to
date total to $10.8 million compared to deficits during the prior year periods of $24.7
million and $33.9 million, respectively.
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99. On August 14, 2003, the Company filed its quarterly report for the second quarter of
2003 on Form 10-Q with the SEC. The report was signed by defendants Toback and Dwyer, and
represented that “[t]he accompanying condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles.” In relevant part, the
Company reiterated the results set forth in the August 5, 2003 press release, reporting:
Operating income for the second quarter of 2003 was $8.5 million compared to $17.6
million in 2002. Net revenues increased $5.0 million (2%) for the second quarter of
2003, offset by a $13.9 million (7%) increase in operating costs and expenses ($13.8
million of which is related to the growth in products and services revenues), and an
increase in depreciation and amortization of $.1 million. Earnings before interest,
taxes, depreciation and amortization, including finance charges earned ("EBITDA")
as adjusted, was $46.2 million, a decrease of $7.8 million from the prior year period.
The EBITDA margin was 17% in the second quarter of 2003, compared to 20% in
the 2002 period.
100. The August 14, 2003 10-Q also reiterated Toback and Dwyer’s Sarbanes-Oxley
certifications with respect to the efficacy of internal controls, as set forth in ¶ 92 above.
101. The August 5, 2003 press release, and the August 14, 2003 Form 10-Q were
materially false and misleading, for the reasons set forth in ¶¶ 127-179, below.
102. On October 28, 2003 Bally filed a Form 8-K with the SEC, signed by defendant
Dwyer, attaching a press release thereto as an exhibit. The press release stated, in relevant part:
Bally Total Fitness Holding Corporation today reported net revenues of $241.5
million for the quarter ended September 30, 2003. This compares to net revenues of
$243.1 million for the third quarter of 2002. Net income for the third quarter was
$4.7 million, or $.14 per diluted share, compared to $7.2 million, or $.22 per diluted
share, in the prior year quarter.
103. On November 12, 2003, the Company filed its quarterly report for the third quarter
of 2003 on Form 10-Q with the SEC. The report was signed by defendants Toback and Dwyer, and
represented that “[t]he accompanying condensed consolidated financial statements have been
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prepared in conformity with generally accepted accounting principles.” In relevant part, the
Company reiterated the results set forth in the October 28, 2003 press release, reporting:
Operating income for the third quarter of 2003 was $5.5 million compared to $7.6
million in 2002. Net revenues decreased $1.6 million (1%) and operating costs and
expenses increased $.8 million for the third quarter of 2003 offset by a decrease in
depreciation and amortization of $.3 million. Earnings before interest, taxes,
depreciation and amortization, loss from discontinued operations, including finance
charges earned ("EBITDA") as adjusted, was $44.4 million, a decrease of $6 million
from the prior year period. The EBITDA margin (as adjusted) was 17% in the third
quarter of 2003, compared to 19% in the 2002 period.
104. The November 12, 2003 10-Q also reiterated Toback and Dwyer’s Sarbanes-Oxley
certifications with respect to the efficacy of internal controls, as set forth in ¶ 92 above. The 10-Q
also represented that:
The Company's Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of the Company's disclosure controls and procedures (as such term
is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")) as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, the Company's disclosure
controls and procedures are effective in alerting them on a timely basis to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's reports filed or submitted under the
Exchange Act.
Since the Evaluation Date, there have not been any significant changes in the
Company's internal controls or in other factors that could significantly affect such
controls.
105. The October 28, 2003 press release and the November 12, 2003 Form 10-Q were
materially false and misleading, for the reasons set forth in ¶¶ 127-179, below.
106. On March 11, 2004, the Company issued a press release announcing its results for
the fourth quarter and year ended December 31, 2003, reporting increased revenues and free cash
flow:
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__ 2003 net revenues grew 5% over 2002 to $953.5 million.
__ Products and services rendered increased 18% over prior year to $192.3 million.
__ Company generated 2003 free cash flow of $15.7 million versus a deficit of $39.7
million in 2002.
__ Gross committed membership fees grew to record levels in December 2003 and
January and February 2004, up 14% in December, 18% in January and 30% in
February over the prior year.
__ The number of new members joining increased 3% during 2003 over the prior year.
107. In addition, the Company discussed a change in accounting method, from its prior
method of estimation-based deferral accounting to a modified cash basis of accounting for its
membership revenues, resulting in a $675 million charge. The Company represented as follows in
relevant part:
Importantly, effective with the 2003 period, the Company has elected to change from
its prior method of estimation-based deferral accounting to a preferable, modified
cash basis of accounting for its membership revenues. Under the modified cash basis
of accounting, revenue is recognized upon the later of when collected or earned and
costs associated with the sale of memberships are no longer deferred but are
recognized when incurred. This change, which is an extension of the guidance in
EITF 00-21 “Revenue Arrangements with Multiple Deliverables” pertaining to
revenues from products and services embedded in membership contracts, is fully
supported by the Company’s independent auditors. The Company’s independent
auditors will be providing the Company with a preferability letter supporting the
changes. In related actions, the Company also reduced the balance sheet carrying
value of its deferred tax assets and corrected an error in the recognition of prepaid
dues. The accounting change and these actions result in total non-cash charges of
$675 million . . .
108. The Company then listed components of the charge and other matters associated with
the so-called accounting change. The Company also disclosed that it would be restating results,
supposedly due to errors in calculating a portion of prepaid dues. In this regard, the Company stated
as follows:
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The accounting change and these actions result in total non-cash charges of $675
million consisting of:
__ Cumulative effect as of the beginning of 2003 of the changes in accounting principles
totaling $581 million.
__ $441 million to defer revenues previously recognized that will now be recognized
when the cash is collected.
__ $119 million from the elimination of deferred membership origination costs.
__ $21 million principally from a previously reported change in accounting for
recoveries on inactive memberships.
__ $51 million related to a special tax charge recorded effective the first quarter of 2003
to reduce the balance sheet carrying value of deferred tax assets.
__ $43 million as of December 31, 2002 resulting from the correction of an error related
to the prior calculation of prepaid dues. This change is reflected as a restatement of
prior periods and represents less than 2% of the reported revenues during each annual
restatement period.
109. The March 11, 2004 press release was materially false and misleading, for the reasons
set forth in ¶¶ 127-175, below.
110. On March 30, 2004 and April 2, 2004, the Company filed its 2003 annual report on
Forms 10-K and 10-K/A with the SEC. The 10-K/A stated:
Historical Analysis of Restated Prepaid Dues
As described in the “Changes in accounting principles” section above, in applying
the new accounting method for membership revenue we undertook an evaluation of
our methods and processes related to accounting for deferral of revenue for
prepayments of non-obligatory membership dues. In consultation with our
independent auditors, it was determined that our previous methodology resulted in
errors in calculating prepaid dues and accelerated dues recognition for certain
prepaying members. As a result, we have restated prior periods in accordance with
the requirements of APB No. 20, “Accounting Changes.”
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In relevant part, the Company included the following chart, which purportedly quantified the impact
of the initial restatement:
Income Statement Member Revenue
Balance Sheet Deferred Revenues Increase/(Decrease)
As Reported Prepaid Dues in Membership Revenue
Under- Over/
Period As As statement As As (Under)- Total Deferred Net
Ended Reported Restated Error Reported Restated Statement Assets Revenue Revenue
Dec. 31,
2002 $55.3 $98.3 $43.0 $0.2 $(7.9) $8.0 $1,771.9 $334.7 $912.9
Dec. 31,
2001 55.4 90.5 35.0 8.5 (2.2) 10.6 1.716.0 366.3 851.5
Dec. 31,
2000 63.9 88.3 24.4 (7.7) (3.7) (4.0) 1,560.6 389.2 785.9
Dec. 31,
1999 56.2 84.6 28.4 (5.0) (9.9) 4.9 1,348.6 373.3 663.0
Dec. 31,
1998 51.2 74.7 23.5 (0.8) (4.3) 3.5 1,128.8 361.8 573.8
Dec. 31,
1997 50.4 70.4 20.0 2.0 (8.8) 10.7 967.6 361.8 525.7
Dec. 31,
1996 52.4 61.7 9.3 893.3 363.5
111. The April 2, 2004 Form 10-K/A also contained assurances from E&Y that:
in our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 2003 and 2002, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted in
the United States.
E&Y further stated that “We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement.”
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112. The March 30, 2004 Form 10-K and the April 2, 2004 Form 10-K/A were materially
false and misleading, for the reasons set forth in ¶¶ 127-262, below.
THE TRUTH BEGINS TO EMERGE
113. The truth concerning the Company’s accounting improprieties was not known to the
market until April 28, 2004. On that date, after the close of ordinary trading, the Company
announced that defendant Dwyer had resigned as the Company’s CFO and that the SEC was
investigating the Company in connection with its initial restatement. In a press release, the Company
stated as follows in relevant part:
Bally Total Fitness Holding Corporation (NYSE:BFT) announced today that,
effective immediately, John W. Dwyer, 51, has resigned as Chief Financial Officer
and as a Director of the Company pursuant to the terms of a separation agreement. . .
Separately, the Company announced that the Division of Enforcement of the
Securities and Exchange Commission has commenced an investigation in connection
with the Company’s recent restatement regarding the timing of recognition of prepaid
dues. The Company is cooperating fully with the SEC on this matter.
Bally recently reported its results for 2003, which included a restatement to correct
errors in a portion of its revenues relating to non-obligatory prepaid membership
dues. The errors accelerated dues recognition for certain prepaying members. The
restated amounts aggregated approximately $43 million during the seven-year
restatement period. The Company’s amended Annual Report on Form 10-K for the
year ended December 31, 2003, which was filed on April 2, 2004, contains restated
financial statements audited by Ernst & Young LLP and describes the impact of
correcting the errors for each annual and quarterly period from January 1, 1997
through September 30, 2003. The amended Annual Report on Form 10-K also
discloses that the Company made changes to its systems and processes related to the
deferral of prepayments of non-obligatory dues and believes its current controls over
such systems and processes are effective.
114. In response to this announcement, the price of Bally common stock fell sharply, from
$5.40 per share on April 28, 2004, to $4.50 per share on April 29, a one day drop of 16.6% on
unusually heavy trading volume. As the truth about Bally’s accounting was revealed to and absorbed
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by the market, Bally stock continued to languish, reaching a mean trading price of $4.56 for the 90
trading-day period following the April 28, 2004 disclosure.
115. Simultaneous with the SEC’s investigation, Bally initiated its own internal
investigation, spearheaded by its Audit Committee, which ultimately uncovered a fraud of massive
proportions.
POST-CLASS PERIOD DISCLOSURES
116. On November 15, 2004, Bally announced that its Audit Committee had concluded,
based on its internal investigation, that the Company’s financial statements for the years ended
December 31, 2000 through December 31, 2003 and the first quarter of 2004 should be restated and
could no longer be relied upon. Also on November 15, 2004, Bally announced that it would be
unable to issue any financial statements for the remainder of 2004 or 2005 until it had completed the
restatements which were expected in July 2005 (but were actually completed over a year later, in
November 2005).
117. On February 10, 2005, Bally announced that it was suspending severance pay to
defendants Hillman and Dwyer, the former CEO and CFO respectively, who were responsible “for
multiple accounting errors and creating a culture within the accounting and finance groups that
encouraged aggressive accounting.” Also on February 10, 2005, Bally announced that it had
identified deficiencies in its internal controls over financial reporting that, either individually or in
the aggregate, constituted material weaknesses. They included a lack of clear, acceptable policies
on financial reporting, ineffective delegation of authority and responsibility, insufficient instruction
regarding accurate and responsible assumptions and judgments, and insufficiently experienced and
trained staff.
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118. On November 30, 2005, Bally finally announced its financial results for the year
ended December 31, 2004, and also for the first three quarters of 2005. Bally also completed the
ultimate Restatement of financial results for the first quarter of 2004 and for the years ended
December 31, 2000, 2001, 2002, and 2003.
119. The Restatement adjustments resulted in an increase in previously reported net loss
of approximately $96.4 million for the year ended December 31, 2002, and a decrease of $540
million in net loss for the year ended December 31, 2003. The decrease in 2003 reported net loss
includes the reversal of the cumulative effect of a change in accounting previously reported in 2003
of $583 million. Bally also increased the January 1, 2002 opening accumulated stockholders’
deficit by $1.7 billion to recognize the effects of corrections in financial statements prior to
2002.
120. As admitted by Bally itself, and as set forth in the Restatement, each of Bally’s
financial statements, earnings related press releases, and Sarbanes-Oxley certifications issued during
the Class Period were materially false and misleading when made. The true facts, which were
concealed from the investing public during the Class Period are set forth in ¶¶ 127-179.
BALLY’S FINANCIAL STATEMENTS WERE MATERIALLY FALSE AND
MISLEADING WHEN MADE BECAUSE THEY VIOLATED GAAP
121. At all relevant times during the Class Period, defendants represented that Bally’s
financial statements, when issued, were prepared in conformity with GAAP, which are recognized
by the accounting profession and the SEC as the uniform rules, conventions and procedures
necessary to define accepted accounting practices at a particular time.
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122. As set forth in Financial Accounting Standards Board (“FASB”) Statement of
Financial Accounting Concepts (“Concepts Statement”) No. 1, Objectives of Financial Reporting
by Business Enterprises (November 1978), one of the fundamental objectives of financial reporting
is that it provide accurate and reliable information concerning an entity’s financial performance
during the period being presented. Concepts Statement No. 1, paragraph 42, states:
Financial reporting should provide information about an enterprise’s financial
performance during a period. Investors and creditors often use information about the
past to help in assessing the prospects of an enterprise. Thus, although investment
and credit decisions reflect investors’ and creditors’ expectations about future
enterprise performance, those expectations are commonly based at least partly on
evaluations of past enterprise performance.
123. As set forth in SEC Rule 4-01(a) of SEC Regulation S-X, “[f]inancial statements filed
with the [SEC] which are not prepared in accordance with [GAAP] will be presumed to be
misleading or inaccurate,” despite footnote or other disclosure. 17 C.F.R. § 210.4-01(a)(1).
124. Management is responsible for preparing financial statements that conform to GAAP.
As noted by the American Institute of Certified Public Accountants (“AICPA”) Codification of
Statements on Auditing Standards § 110.03:
The financial statements are management’s responsibility . . . . Management is
responsible for adopting sound accounting policies and for establishing and
maintaining internal control that will, among other things, initiate, record, process,
and report transactions (as well as events and conditions) consistent with
management’s assertions embodied in the financial statements. The entity’s
transactions and the related assets, liabilities and equity are within the direct
knowledge and control of management . . . . Thus, the fair presentation of financial
statements in conformity with generally accepted accounting principles is an implicit
and integral part of management’s responsibility.
125. In view of “the potential dilution of public confidence in financial statements
resulting from restating the financial statements of prior periods,” according to GAAP, a retroactive
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restatement of financial statements is reserved for material accounting errors that existed at the time
the financial statements were prepared. APB Opinion No. 20, Accounting Changes, ¶¶ 18, 27, 34-38
(July 1971). This accounting mandate was reaffirmed through the issuance of FASB Statement No.
154 in May 2005. Since GAAP allows only for correction of errors that are “material,” by restating
its financial statements, Bally admitted the materiality of the errors in its previously issued financial
statements for fiscal years 2000 through 2003.
126. On January 31, 2002, the SEC, the ultimate authority regarding GAAP and matters
of financial reporting (SEC Accounting Series Release Nos. 4 and 150), submitted an Amicus Curiae
Brief (In Re: Sunbeam Securities Litigation, 98-8258-Civ - Middlebrooks, S.D. FL, Miami Div.) (the
“SEC Brief") which unequivocally stated its position with regard to restated financial statements
as follows:
. . . corrected financial statements are highly probative of at least two of the elements
of a private action under the federal securities laws: whether there was a
misstatement in the original financial statements and whether the misstatement was
material. See, e.g., In re Telxon Corp. Secs. Litig., 133 F. Supp. 2d 1010, 1025 (N.D.
Ohio 2000) (when ruling on defendants' motion to dismiss action under PSLRA,
court held that company defendant was not in a position to dispute that it misstated
material facts in its financial disclosures because company admitted its prior
disclosures were materially misstated when it issued the restatements which gave rise
to the litigation) (citing In re Peritus Software Servs., Inc. Secs. Litig., 52 F. Supp.
2d 211, 223 (D. Mass. 1999) ("after the fact accounting admissions may suffice to
show that material misstatements occurred")). Restated financial statements are
probative of these two issues because under GAAP and GAAS they cannot be
filed unless the original financial statements contained material errors as
defined in GAAP. See pages 11-12, above. Thus, under GAAP, restated financial
statements must constitute an admission of past errors. . . By filing restated
financial statements with the Commission, a company announces that it had
previously materially misstated its financial condition or its results of
operations. This exposes it to a high risk of civil and criminal investigations and
legal actions by the federal government . . ." (Emphasis added).
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There is no question that by filing restated financial statements with the SEC, Bally announced that
it had previously disseminated materially misstated financial statements to the investing public.
127. The Company used improper accounting practices in violation of GAAP and SEC
reporting requirements to falsely inflate Bally’s reported revenues, net income and earnings per share
in the interim quarters and fiscal years during the Class Period, as follows:
Accounting For Membership Revenue:
128. GAAP (SEC Staff Accounting Bulletin No. 101) addresses the appropriate accounting
for the recognition of membership revenue. It states:
Supply or service transactions may involve the charge of a nonrefundable initial fee
with subsequent periodic payments for future products or services. The initial fees
may, in substance, be wholly or partly an advance payment for future products or
services. In the examples above, the on-going rights or services being provided or
products being delivered are essential to the customers receiving the expected benefit
of the up-front payment. Therefore, the up-front fee and the continuing performance
obligation related to the services to be provided or products to be delivered are
assessed as an integrated package. In such circumstances, the staff believes that
up-front fees, even if nonrefundable, are earned as the products and/or services are
delivered and/or performed over the term of the arrangement or the expected period
of performance and generally should be deferred and recognized systematically over
the periods that the fees are earned. . . A systematic method would be on a
straight-line basis, unless evidence suggests that revenue is earned or obligations are
fulfilled in a different pattern, in which case that pattern should be followed.
129. Bally did not comply with the foregoing GAAP. Instead, Bally improperly recognized
membership revenue based upon a computed “average contractual life of twenty-two months.” As
a part of the Restatement, the Company changed its prior membership revenue recognition
methodology "such that membership revenue is earned on a straight-line basis over the longer of the
initial membership term or the estimated membership life" with membership life estimated at time
of contract execution based on historical trends of actual attrition, and with these estimates updated
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quarterly to reflect actual membership retention. In this regard, Bally revised its previous financial
reporting to reflect the proper amount of Bally's membership revenue in the appropriate time periods,
thus admitting that its previously issued financials statements were materially false and misleading.
Accounting For Membership Acquisition Expenses:
130. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) states that:
"Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of
both) from delivering or producing goods, rendering services, or carrying out other activities that
constitute the entity's ongoing major or central operations." Bally's expenditures which were
incurred in connection with obtaining customers (i.e., signing up members) were primary costs of
Bally's "ongoing major or central operations." Accordingly, these expenditures were required to
have been expensed as incurred, just as rent, utilities, payroll and other day to day primary costs of
doing business were required to have been expensed.
131. Bally did not comply with the foregoing GAAP. Instead of recognizing membership
acquisition expenses (substantially all of which were sales commissions) when incurred, Bally
improperly "deferred" costs incurred in signing up members ("the Company improperly accounted
for membership acquisition costs by improperly deferring certain costs in 2002 and prior"), thereby
reflecting the costs as an asset (FASB Statement Of Financial Accounting Concepts No. 6 defines
assets as "probable future economic benefits obtained or controlled by a particular entity as a result
of past transactions or events") and gradually expensed these deferred costs over the same period
used for revenue recognition (twenty-two months). As a part of the Restatement, the Company
changed its prior method of accounting for membership acquisition costs and properly expensed such
costs as incurred. In this regard, Bally revised its previous financial reporting to reflect the proper
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amount of Bally's membership acquisition expenses in the appropriate time periods, thus admitting
that its previously issued financials statements were materially false and misleading.
Accounting For Recoveries Of Unpaid Dues:
132. GAAP (Accounting Research Bulletin No. 43 and Accounting Principles Board
Opinion No. 10) states that "revenues should ordinarily be accounted for at the time a transaction is
completed, with appropriate provision for uncollectible accounts." The uncollectible accounts
should be written off and presented as a bad debt expense in accordance with Regulation S-X article
5-03 (b)(5). GAAP (Accounting Research Bulletin No. 43 and Accounting Principles Board Opinion
No. 10) also states where there is "no reasonable basis for estimating the degree of collectibility. . .
either the installment method or the cost recovery method of accounting may be used." It notes that:
"Under the cost recovery method, equal amounts of revenue and expense are recognized as
collections are made until all costs have been recovered, postponing any recognition of profit until
that time."
133. Bally did not comply with the foregoing GAAP. Instead, Bally established accruals
for unpaid dues on inactive membership contracts. As a part of the Restatement, the Company
appropriately changed its prior method of accounting for recoveries of unpaid dues to the cash basis
("the Company should have adopted the cash basis for recoveries of unpaid dues on inactive
memberships prior to 2003"). In this regard, Bally revised its previous financial reporting to reflect
the proper amount of Bally's unpaid dues recoveries associated with inactive memberships in the
appropriate time periods, thus admitting that its previously issued financials statements were
materially false and misleading.
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Accounting For Acquired Payment Obligations:
134. GAAP (Accounting Principles Board Opinion No. 16) states that upon acquisition
of a business, all liabilities (company obligations) should be accounted for and reflected "normally
equal to their fair values at date of acquisition."
135. Bally did not comply with the foregoing GAAP. Instead, upon its acquisition of a
business "in the late 1980s," the Company "improperly accounted for $22,000[,000] of face amount
repayment obligations due in 2015 or later." As a part of the Restatement, the Company changed
its prior method of accounting for repayment obligations at less than its fair value and recognized
a liability for this repayment obligation based upon fair value. In this regard, Bally revised its
previous financial reporting to reflect the proper amount of Bally's repayment obligation liabilities
and associated interest expense in the appropriate time periods, thus admitting that its previously
issued financials statements were materially false and misleading.
Accounting For Sales Of Future Receivables:
136. GAAP (EITF 88-18: Sales of Future Revenues) states that proceeds from the "sale"
of a future revenue stream are required to be classified as debt if the selling company "has
significant continuing involvement in the generation of the cash flows due the investor (for example,
active involvement in the generation of the operating revenues of a product line, subsidiary, or
business segment)." Furthermore, GAAP (FASB Statement No. 140) states: "If a transfer of financial
assets in exchange for cash or other consideration (other than beneficial interests in the transferred
assets) does not meet the criteria for a sale. . . the transferor and transferee shall account for the
transfer as a secured borrowing with pledge of collateral."
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137. Bally did not comply with the foregoing GAAP. Instead, Bally recorded a "sale" upon
the exchange of cash for "future member receivables" (a revenue stream that would only exist
through Bally's performance of services for its members) which could only come into existence
through Bally's active involvement in the generation of the operating revenues. As a part of the
Restatement, the Company changed its method of accounting for its surrender of "future member
receivables" to properly reflect such transactions as borrowings. In this regard, Bally revised its
previous financial reporting to reflect its exchanges of "future member receivables" for cash as
financings and to correct previously reported income and interest expense, thus admitting that its
previously issued financials statements were materially false and misleading.
Accounting For Prepaid Personal Training Services:
138. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) explains the
relationship between prepayments and deferrals, and the appropriate accounting for these items as
follows:
Deposits and prepayments received for goods or services to be provided--"unearned
revenues," such as subscriptions or rent collected in advance--. . . qualify as
liabilities. . . because an entity is required to provide goods or services to those who
have paid in advance.
*****
Deferral is concerned with past cash receipts and payments--with prepayments
received (often described as collected in advance) or paid: it is the accounting
process of recognizing a liability resulting from a current cash receipt (or the
equivalent) or an asset resulting from a current cash payment (or the equivalent) with
deferred recognition of revenues, expenses, gains, or losses. Their recognition is
deferred until the obligation underlying the liability is partly or wholly satisfied or
until the future economic benefit underlying the asset is partly or wholly used or lost.
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139. Bally received cash in advance of the performance of personal training services and,
in material part, recognized such proceeds as fees earned, and not as a liability (deferred revenue)
as required by GAAP ("we inappropriately estimated deferred revenue related to personal training
services that had been paid for but not yet earned"). As a part of the Restatement, the Company
changed its prior method of accounting for customers' prepayment of personal training services to
properly recognize a liability for the amounts prepaid and eliminate the improperly recognized
revenue. In this regard, Bally revised its previous financial reporting to reflect the proper amount
of Bally's personal training revenue and Bally's prepaid personal training liabilities in the appropriate
time periods, thus admitting that its previously issued financials statements were materially false and
misleading.
Accounting For Multiple Element Arrangements:
140. GAAP (EITF 00-21) states that, except in certain limited instances, "all deliverables
(that is, products, services, or rights to use assets) within contractually binding arrangements
(whether written, oral, or implied, and hereinafter referred to as `arrangements') in all industries
under which a vendor will perform multiple revenue-generating activities. . . should be divided into
separate units of accounting" and that: "Applicable revenue recognition criteria should be considered
separately for separate units of accounting."
141. Bally did not comply with the foregoing GAAP. The Company entered into bundled
contracts that included a combination of (i) health club services, (ii) personal training services, and
(iii) nutritional products, and it "improperly separated these multiple element arrangements into
multiple units of accounting resulting in premature recognition of early delivered nutritional products
and personal training services." As a part of the Restatement, the Company appropriately classified
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and recognized revenue for the three single components of revenue (health club services, personal
training services, and nutritional products), and recognized revenue for these arrangements on a
straight-line basis over the later of when collected or earned in the appropriate time periods.
Accounting For Self-Insurance Liabilities And Insurance Expense:
142. GAAP (FASB Statement of Financial Accounting Standards No. 5) states that an
estimated loss from a loss contingency shall be accrued by a charge to income if information
available prior to issuance of the financial statements indicates that it is probable that an asset had
been impaired or that a liability had been incurred at the date of the financial statements and the
amount of the loss can be reasonably estimated. When a company self-insures, additional GAAP
(FASB Statement of Financial Accounting Standards No. 60) specifies that the charge to income and
the related liability for unpaid claims "shall be based on the estimated ultimate cost of settling the
claims (including the effects of inflation and other societal and economic factors), using past
experience adjusted for current trends, and any other factors that would modify past experience" and
that "changes in estimates of claim costs resulting from the continuous review process and
differences between estimates and payments for claims shall be recognized in income of the period
in which the estimates are changed or payments are made." (Emphasis added).
143. Bally did not comply with the foregoing GAAP because it self-insured for workers'
compensation, health and life, and general liability claims and did not estimate the ultimate cost of
settling these claims (including the effects of inflation and other societal and economic factors) using
past experience adjusted for current trends, and other factors that would modify past experience, and
because it did not undertake to engage in a continuous review process. As a result, the Company
materially understated its liability for self-insured workers' compensation, health and life and general
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insurance claims ("We concluded that our previous methodologies for estimating our self-insured
workers' compensation, health and life and general insurance claims resulted in an understatement
of our self-insured liabilities."). As a part of the Restatement, the Company appropriately performed
the procedures described above and used "generally accepted actuarial reserving methods" to
compute reasonable estimates of "ultimate obligations for reported claims plus those incurred but
not reported," and established appropriate liabilities and charges to income in the appropriate time
periods.
Accounting For Costs Incurred To Develop Internal-Use Computer Software:
144. GAAP (Statement Of Position 98-1) states that the capitalization of costs to develop
internal-use computer software may only begin after the preliminary project stage has been
completed and management, with relevant authority, commits to funding the project and it is
probable that the project will be completed and the software will be used to perform the internal-use
function intended. It further provides that cost-capitalization shall cease when the software project
is substantially completed and the software is ready for its intended use.
145. Bally did not comply with the foregoing GAAP because it did not adhere to these
cost-capitalization requirements and it improperly capitalized costs that were required to have been
expensed ("We improperly deferred recognition of internal and external costs incurred to develop
internal-use computer software."). As a part of the Restatement, the Company appropriately
reviewed the internal and external costs which had been capitalized and expensed those costs which
had been improperly capitalized. In addition, as an integral part of this restatement adjustment, the
Company corrected depreciation which had been recorded on the costs which had been capitalized.
In this regard, Bally revised its previous financial reporting to appropriately reflect the proper
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carrying value of Bally's internal-use computer software and the proper software development
expenses in the appropriate time periods, thus admitting that its previously issued financials
statements were materially false and misleading.
Accounting For The Valuation Of Goodwill And For Separately Identifiable Intangible
Assets Apart From Goodwill:
146. GAAP (Accounting Principles Board Opinion No. 16) states that, in connection with
the acquisition of a business, "all identifiable assets acquired, either individually or by type, and
liabilities assumed in a business combination, whether or not shown in the financial statements of
the acquired company, should be assigned a portion of the cost of the acquired company, normally
equal to their fair values at date of acquisition."
147. Bally did not comply with the foregoing GAAP because it improperly failed to record
and assign a fair value to certain separately identifiable acquired intangible assets as follows:
a) "Membership Relations" which represent the fair market value of relationships with
existing members as of the acquisition date:
b) "Non-compete Agreements" which represent the fair market value of the
non-competition agreement with the seller of the company:
c) "Trade name" which represents the fair market value of the trade names associated
with the acquired operations, and;
d) "Leasehold Rights" which represent the estimate of the favorable and unfavorable
lease agreements in place as of the acquisition date.
148. As a part of the Restatement, the Company revisited its previous acquisitions,
identified all assets and liabilities acquired, assigned appropriate valuations to the acquired assets
(including the above specified intangible assets), and corrected the Company's previously issued
financial statements to reflect proper amounts for each such acquired asset ("We concluded that our
previous method of allocating purchase prices of acquired businesses resulted in an overstatement
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of goodwill. Specifically, in applying APB 16, Business Combinations, we should have allocated
a portion of the purchase price to certain separately identifiable intangible assets").
Accounting For The Amortization Of Goodwill:
149. GAAP (Accounting Principles Board Opinion No. 17) states that "the cost of each
type of intangible asset should be amortized by systematic charges to income over the period
estimated to be benefitted. The period of amortization should not, however, exceed forty years."
150. Bally did not comply with the foregoing GAAP because it established a practice of
amortizing goodwill over 40 years when this amortization period was inconsistent with the
maximum reasonable and likely duration of material benefit from the acquired goodwill ("We
concluded that our practice of amortizing goodwill over 40 years was inconsistent with the
maximum reasonably likely duration of material benefit from the acquired goodwill."). Moreover,
when it became apparent that the goodwill had become impaired, the Company did not properly
apply the guidance in FASB Statement No. 121 (as discussed in the paragraph below). As a part of
the Restatement, the Company revised its previously issued financial statements to properly reflect
appropriate amortization periods taking into account the "likely duration of material benefit from the
acquired goodwill" and to properly recognize apparent impairment losses. In this regard, Bally
revised its previous financial reporting to appropriately reflect the proper carrying value of the
amount of Bally's goodwill and the proper goodwill amortization expenses in the appropriate time
periods, thus admitting that its previously issued financials statements were materially false and
misleading.
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Accounting For Fixed Asset Impairment:
151. GAAP (FASB Statement No. 121 and FASB Statement No. 142) requires that
long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. It further provides that, in performing the review for recoverability,
the entity should estimate the future cash flows expected to result from the use of the asset and its
eventual disposition. If the sum of the expected future cash flows is less than the carrying amount
of the asset, an impairment loss is required to be recognized.
152. Bally did not comply with the foregoing GAAP because it ignored "trigger events"
and other existing conditions which, at various dates, indicated that the carrying amounts of fixed
assets were impaired, and it failed to perform any impairment analyses or recognized impairment
losses ("we determined that the Company did not properly apply the guidance in FASB Statement
No. 121, "Accounting for the Impairment of Long-Lived Assets and Assets to be Disposed Of" and
in FASB Statement No. 142, "Goodwill and Other Intangible Assets", to measure the amount of
impairment losses. In addition, we determined conditions at various dates which indicated the
carrying amounts of fixed assets were impaired, but determined that impairment analyses had not
been performed even though trigger events were present."). As a part of the Restatement, the
Company revised its previously issued financial statements to (i) properly reflect the carrying
amounts of fixed assets, equipment (including trade-in equipment: "We determined that the
Company's accounting for equipment trade-ins resulted in an overstatement of the cost basis of the
Company's investment in exercise equipment."), other long-lived assets and identifiable intangibles,
and to (ii) recognize obvious and discernable impairment losses in the appropriate time periods.
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Accounting For Escheatment Obligations:
153. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) defines a liability
as "probable future sacrifices of economic benefits arising from present obligations of a particular
entity to transfer assets. . . to other entities in the future as a result of past transactions or events."
Uncashed payroll and other checks (and any other items that may meet the definition of "unclaimed
property") may, through the operation of law, convert to escheatment obligations and, therefore, are
required to be reflected as liabilities in a company's financial statements.
154. Bally did not comply with the foregoing GAAP because it reported the dollar amount
of uncashed checks as income in its financial statements, not as escheatment liabilities as required
by GAAP ("We determined that the liability for the potential escheatment of certain payroll-related
and supplier-related checks was understated."). As a part of the Restatement, the Company revised
its previously issued financial statements to eliminate the improperly recognized income and to
properly reflect escheatment liabilities in the appropriate time periods.
Accounting For Advertising Expense:
155. GAAP (Statement of Position 93-7) states that "the costs of advertising should be
expensed either as incurred or the first time the advertising takes place" except in certain instances
of direct-response advertising (i.e., advertising that clearly reflects a measurable and direct
correlation between the cost of selling and the closing of a sale transaction, such as the relationship
which is often measurable in the telemarketing industry).
156. Bally did not comply with the foregoing GAAP because it capitalized advertising
costs, and amortized these costs as expenses over the estimated life of the advertising campaign
("We determined that our previous method of deferring recognition of production costs over the
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estimated life of the advertising resulted in an overstatement of capitalized advertising and that the
cost of advertising should be expensed no later than the first time the advertising takes place."). As
a part of the Restatement, the Company changed its prior method of accounting for advertising costs
to properly expense such costs as incurred, or in the case of television commercial productions, upon
the first airing. In this regard, Bally revised its previous financial reporting to reflect the proper
amount of Bally's deferred advertising costs and advertising expenses in the appropriate time periods,
thus admitting that its previously issued financials statements were materially false and misleading.
Accounting For Maintenance Expense:
157. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) states that:
"Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of
both) from delivering or producing goods, rendering services, or carrying out other activities that
constitute the entity's ongoing major or central operations." The costs which Bally incurred in
connection with maintaining its facilities were primary costs of Bally's "ongoing major or central
operations" as evidenced by the following:
a. "Most of our leases require us to pay real estate taxes, insurance, maintenance and,
in the case of shopping center and office building locations, common-area
maintenance fees." (2000 Form 10-K, 2001 Form 10-K, 2002 Form 10-K and 2003
Form 10-K)
b. "We implemented a comprehensive fitness equipment preventive maintenance
program that provides for regular service and replacement of high-wear equipment
components resulting in both an improvement in our members' workout experience,
and a reduction in the incidence and severity of liability claims by members injured
as a result of fitness equipment malfunctions." (2002 Form 10-K)
158. Accordingly, the Company's maintenance costs (described by the Company as
"internal compensation costs") were required to have been expensed as incurred, just as rent costs,
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utilities costs, payroll costs and other day to day primary costs of doing business were required to
have been expensed.
159. Bally did not comply with the foregoing GAAP because it added (capitalized)
maintenance costs to the cost of property and equipment, and then depreciated this improperly
established "asset" ("We improperly deferred recognition of internal compensation costs incurred
in conjunction with the remodeling and construction of various clubs. These payments should have
been recorded as expense when services were rendered, rather than deferred and recorded as an
expense in later periods."). As a part of the Restatement, the Company changed its prior method of
accounting for maintenance costs to properly expense such costs as incurred. In this regard, Bally
revised its previous financial reporting to reflect the proper amount of Bally's property and
equipment, depreciation, and maintenance expense in the appropriate time periods, thus admitting
that its previously issued financials statements were materially false and misleading.
160. Similarly, Bally improperly capitalized other costs which were required to have been
expensed ("We determined that other capitalized costs, none of which were individually significant,
should have been expensed as incurred.") and, as part of the Restatement, revised its previous
financial reporting to reflect the proper amount of Bally's other current assets, net property and
equipment, accounts payable and expenses.
Accounting For Start-Up ("Presale") Costs:
161. GAAP (Statement Of Position 98-5 defines "start-up activities" as "those one-time
activities related to opening a new facility, introducing a new product or service, conducting business
in a new territory, conducting business with a new class of customer or beneficiary, initiating a new
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process in an existing facility, or commencing some new operation." It states that: "Costs of start-up
activities, including organization costs, should be expensed as incurred."
162. Bally did not comply with the foregoing GAAP because it deferred (it did not
expense) costs associated with start-up activities (principally costs related to opening new facilities)
such as rent ("We determined that our previous method of deferring rent costs associated with club
leases during the construction period resulted in an overstatement of leasehold improvements and
that the rent costs during the construction period should be expensed as incurred."). As a part of the
Restatement, the Company changed its prior method of accounting for "costs associated with club
leases during the construction period" (alternatively referred to as "presale costs" by Bally) to
properly expense such costs as incurred. In this regard, Bally revised its previous financial reporting
to reflect the proper amount of Bally's operating costs and deferred costs in the appropriate time
periods, thus admitting that its previously issued financials statements were materially false and
misleading.
Accounting For Inventory:
163. GAAP (Accounting Research Bulletin No. 43) states: "Whenever the operation of a
business includes the ownership of a stock of goods, it is necessary for adequate financial accounting
purposes that inventories be properly compiled periodically and recorded in the accounts. Such
inventories are required both for the statement of financial position and for the periodic measurement
of income. . . In accounting for the goods in the inventory at any point of time, the major objective
is the matching of appropriate costs against revenues in order that there may be a proper
determination of the realized income. Thus, the inventory at any given date is the balance of costs
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applicable to goods on hand remaining after the matching of absorbed costs with concurrent
revenues."
164. Bally did not comply with the foregoing GAAP because it failed to (i) properly
compile and record inventory in the accounts of the Company on a periodic basis and because it
failed to (ii) match appropriate costs against revenues in order that there may be a proper
determination of the realized income ("We determined that the recorded value of retail inventories
were overstated, primarily as a result of differences in physical count and as a result of incorrect
accounting for cost of goods sold."). As a part of the Restatement, the Company changed its prior
method of accounting for inventory to reflect differences detected during physical counts and to
correct its prior incorrect accounting for inventory and cost of goods sold. In this regard, Bally
revised its previous financial reporting to reflect the proper amount of Bally's inventory and cost of
goods sold in the appropriate time periods, thus admitting that its previously issued financials
statements were materially false and misleading.
Accounting For Accruals:
165. GAAP (FASB Statement Of Financial Accounting Concepts No. 1) states: "Accrual
accounting attempts to record the financial effects on an enterprise of transactions and other events
and circumstances that have cash consequences for the enterprise in the periods in which those
transactions, events, and circumstances occur rather than only in the periods in which cash is
received or paid by the enterprise."
166. Bally did not comply with the foregoing GAAP because it failed to accrue obligations
as of the end of each accounting period although transactions and events giving rise to these
obligations arose during these accounting periods ("The Company identified obligations that were
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not properly accrued for as of the end of an accounting period."). In this regard, Bally revised its
previous financial reporting to recognize these obligations in the period in which the underlying
transactions giving rise to these obligations occurred, thus admitting that its previously issued
financials statements were materially false and misleading. As a result, Bally's Restatement adjusted
the reported amounts of current assets, property and equipment, other current assets, accounts
payable and accrued liabilities, membership services, advertising, and general and administrative
expense to reflect proper amounts in the appropriate time periods.
Accounting For Foreign Exchange Gains And Losses:
167. GAAP (FASB Statement No. 52) states: "The economic effects of an exchange rate
change on a foreign operation that is an extension of the parent's domestic operations relate to
individual assets and liabilities and impact the parent's cash flows directly. Accordingly, the
exchange gains and losses in such an operation are included in net income."
168. Bally did not comply with the foregoing GAAP because it failed to recognize gains
and losses from various foreign currency transactions which impacted individual assets (such as
management fees and foreign receivables), liabilities (such as foreign payables), and cash flows
("The Company determined that gains and losses from various foreign currency transactions, such
as those relating to management fees and. . . the settlement of foreign receivables or payables, were
not properly accounted for in prior periods."). Upon Restatement, Bally properly (in compliance with
FASB Statement No. 52) caused the foreign operations of non-U.S. subsidiaries whose functional
currency was not the U.S. Dollar to be translated into U.S. dollars with all assets, liabilities, and
minority interests translated at the period end exchange rates, stockholders' equity translated at
historical rates, and revenues and expenses translated at the average rates of exchange prevailing
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during the period. Translation adjustments were included in the accumulated other comprehensive
income component of stockholders' equity (deficit); gains and losses resulting from foreign currency
transactions were reflected in net earnings. In this regard, Bally revised its previous financial
reporting to recognize the impact of the recordation of the proper amount of these foreign exchange
translation adjustments and gains and losses on the Company's current assets, property and
equipment, net, goodwill, deferred income taxes, other assets, accounts payable, deferred income
taxes, accounts payable, current maturities of long term debt, long-term debt, other liabilities and
accumulated other comprehensive income in the appropriate time periods, thus admitting that its
previously issued financials statements were materially false and misleading.
Accounting For Leases:
169. GAAP (FASB Technical Bulletin No. 85-3) states: "The effects of. . . scheduled rent
increases, which are included in minimum lease payments. . . should be recognized by lessors and
lessees on a straight-line basis over the lease term unless another systematic and rational allocation
basis is more representative of the time pattern in which the leased property is physically employed."
In addition, GAAP (FASB Technical Bulletin No. 88-1) states:
a. "If rents escalate in contemplation of the lessee's physical use of the leased property,
including equipment, but the lessee takes possession of or controls the physical use
of the property at the beginning of the lease term, all rental payments, including the
escalated rents, should be recognized as rental expense or rental revenue on a
straight-line basis in accordance with paragraph 15 of Statement 13 and Technical
Bulletin 85-3 starting with the beginning of the lease term."
b. "Payments made to or on behalf of the lessee represent incentives that should be
considered reductions of rental expense by the lessee and reductions of rental revenue
by the lessor over the term of the new lease."
170. Bally did not recognize rent expense on club leases with escalating rental obligations
using the required straight-line rent method, and it did not reflect lease incentives as reductions of
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rental expense over the term of the lease. Moreover, Bally reflected tenant allowances as a reduction
to property and equipment and depreciated these amounts (and the related leasehold improvements)
over periods which exceeded either the useful life of the improvement or the lease term, or both
("The Company did not maintain effective policies and procedures related to its accounting for leases
and did not. . . document and review its accounting for leases to ensure that such accounting
complied with U.S. generally accepted accounting principles."). This accounting was improper and
in violation of GAAP (Accounting research Bulletin No. 43) which states:
The cost of a productive facility is one of the costs of the services it renders during
its useful economic life. Generally accepted accounting principles require that this
cost be spread over the expected useful life of the facility in such a way as to allocate
it as equitably as possible to the periods during which services are obtained from the
use of the facility. This procedure is known as depreciation accounting, a system of
accounting which aims to distribute the cost or other basic value of tangible capital
assets, less salvage (if any), over the estimated useful life of the unit (which may
be a group of assets) in a systematic and rational manner. It is a process of
allocation, not of valuation. (Emphasis added).
171. Through Restatement, Bally revised its previous financial reporting to (i) properly
reflect rent expense using the straight-line method over the lease term; to (ii) properly reflect lease
incentives (such as rent allowances) to be amortized as a reduction to rent expense; and to (iii)
depreciate leasehold improvements over the lesser of the assets economic life or the contractual term
of the lease, excluding all renewal options. In this regard, Bally revised its previous financial
reporting to recognize the impact of the foregoing changes, thereby effecting changes to reported
goodwill, deferred rent, accrued liabilities, long term liabilities, net property and equipment, long
term debt, interest expense, depreciation expense, and membership services expenses, thus admitting
that its previously issued financials statements were materially false and misleading.
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Accounting For Income Taxes:
172. GAAP (FASB Statement No. 109) states:
A deferred tax asset is recognized for temporary differences that will result in
deductible amounts in future years and for carryforwards. For example, a temporary
difference is created between the reported amount and the tax basis of a liability for
estimated expenses if, for tax purposes, those estimated expenses are not deductible
until a future year. Settlement of that liability will result in tax deductions in future
years, and a deferred tax asset is recognized in the current year for the reduction in
taxes payable in future years. A valuation allowance is recognized if, based on the
weight of available evidence, it is more likely than not that some portion or all of the
deferred tax asset will not be realized.
173. Bally did not comply with this GAAP because it caused its financial statements to
reflect deferred tax assets and valuation allowances thereon based upon improperly determined
taxable income and without having performed a realistic and objective assessment as to whether or
not it is more likely than not that some portion or all of the deferred tax asset will not be realized
("the Company reviewed the likelihood of realizing a future benefit from the related restatement
adjustments. As a result of this review, the Company increased its valuation allowance for the net
effect of the tax benefits resulting from the restatement adjustments and determined that the
valuation adjustment originally reversed in 2003 should be restated back to the period
recognized . . . In addition, the Company reviewed actual and contingent tax liabilities for the
restatement period and increased its contingency reserve accordingly."). (Emphasis added). In this
regard, Bally revised its previous financial reporting to properly reflect the amount of its reported
deferred tax and tax expense based upon a properly determined taxable income and a realistic and
objective assessment of the realizability of deferred taxes, thus admitting that its previously issued
financials statements were materially false and misleading.
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174. Each of the foregoing misapplications of accounting principles, set forth above in ¶¶
128-173, served to overstate reported earnings, either by overstating reported revenues or by
understating reported expenses.
RESTATEMENT SUMMARY
175. The effects of the initial restatement and the Restatement on the reported revenue and
earnings may be summarized as follows:
($ In Millions)
Quarter Ended 3/31/04
Net revenues:
Membership revenue 184.2
Products and services 55.7
Miscellaneous revenue 4.8
Net revenues as reported in 3/31/04 Form 10-Q 244.7
Net revenues as restated in 12/31/04 Form 10-K 259.0
Net loss as reported in 3/31/04 Form 10-Q (13.8)
Net loss as restated in 12/31/04 Form 10-K (15.8)
Year Ended 12/31/03
Net revenues:
Membership revenue 743.3
Products and services 192.3
Miscellaneous revenue 17.9
Net revenues as reported in 12/31/03 Form 10-K 953.5
Net revenues as restated in 12/31/04 Form 10-K 1,002.9
Net loss as reported in 12/31/03 Form 10-K (646.0)
Net loss as restated in 12/31/04 Form 10-K (106.0)
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Quarter Ended 9/30/03
Net revenues:
Membership revenue 165.6
Products and services 71.6
Miscellaneous revenue 4.3
Net revenues as reported in 9/30/03 Form 10-Q 241.5
Net revenues as restated in 12/31/03 Form 10-K 235.1
Net revenues as restated in 12/31/04 Form 10-K 250.0
Net income as reported in 9/30/03 Form 10-Q 4.7
Net loss as restated in 12/31/03 Form 10-K (2.8)
Net loss as restated in 12/31/04 Form 10-K (4.8)
Quarter Ended 6/30/03
Net revenues:
Membership revenue 172.2
Products and services 74.3
Miscellaneous revenue 4.8
Net revenues as reported in 6/30/03 Form 10-Q 251.3
Net revenues as restated in 12/31/03 Form 10-K 239.6
Net revenues as restated in 12/31/04 Form 10-K 256.1
Net income as reported in 6/30/03 Form 10-Q 6.7
Net loss as restated in 12/31/03 Form 10-K (0.1)
Net loss as restated in 12/31/04 Form 10-K (3.7)
Quarter Ended 3/31/03
Net revenues:
Membership revenue 173.1
Products and services 75.1
Miscellaneous revenue 4.9
Net revenues as reported in 3/31/03 Form 10-Q 253.1
Net revenues as restated in 12/31/03 Form 10-K 240.2
Net revenues as restated in 12/31/04 Form 10-K 247.6
Net income as reported in 3/31/03 Form 10-Q 9.7
Net loss as restated in 12/31/03 Form 10-K (635.2)
Net loss as restated in 12/31/04 Form 10-K (11.1)
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Year Ended 12/31/02
Net revenues:
Membership revenue 730.6
Products and services 217.6
Miscellaneous revenue 19.9
Special charge to receivable reserve (55.0)
Net revenues as reported in 12/31/02 Form 10-K 913.1
Net revenues as restated in 12/31/03 Form 10-K 904.9
Net revenues as restated in 12/31/04 Form 10-K 937.8
Net income as reported in 12/31/02 Form 10-K 3.5
Net loss as restated in 12/31/03 Form 10-K (4.5)
Net loss as restated in 12/31/04 Form 10-K (100.9)
Quarter Ended 9/30/02
Net revenues:
Membership revenue 180.5
Products and services 57.4
Miscellaneous revenue 5.2
Net revenues as reported in 9/30/02 Form 10-Q 243.1
Net revenues as restated in 12/31/03 Form 10-K 240.8
Net income as reported in 9/30/02 Form 10-Q 7.2
Net income as restated in 12/31/03 Form 10-K 5.4
Quarter Ended 6/30/02
Net revenues:
Membership revenue 188.4
Products and services 53.3
Miscellaneous revenue 4.7
Net revenues as reported in 6/30/02 Form 10-Q 246.4
Net revenues as restated in 12/31/03 Form 10-K 244.9
Net income as reported in 6/30/02 Form 10-Q 16.1
Net income as restated 4/04 14.9
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Quarter Ended 3/31/02
Net revenues:
Membership revenue 182.7
Products and services 52.4
Miscellaneous revenue 5.3
Net revenues as reported in 3/31/02 Form 10-Q 240.4
Net revenues as restated 4/04 in 12/31/03 Form 10-K 238.1
Net income as reported in 3/31/02 Form 10-Q 19.4
Net income as restated in 12/31/03 Form 10-K 17.6
Year Ended 12/31/01
Net revenues:
Membership revenue 689.5
Products and services 145.0
Miscellaneous revenue 17.5
Net revenues as reported in 12/31/01 Form 10-K 852.0
Net revenues as restated in 12/31/03 Form 10-K 840.9
Net revenues as restated in 12/31/04 Form 10-K 810.1
Net income as reported in 12/31/01 Form 10-K 80.7
Net income as restated in 12/31/03 Form 10-K 70.1
Net loss as restated in 12/31/04 Form 10-K (100.0)
Quarter Ended 9/30/01
Net revenues:
Membership revenue 168.7
Products and services 37.1
Miscellaneous revenue 4.1
Net revenues as reported in 9/30/01 Form 10-Q 209.9
Net revenues as restated in 12/31/03 Form 10-K 210.9
Net income as reported in 9/30/01 Form 10-Q 26.5
Net income as restated in 12/31/03 Form 10-K 27.7
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Quarter Ended 6/30/01
Net revenues:
Initial membership fees on financed
memberships originated 137.4
Initial membership fees on paid-in-full
memberships originated 5.8
Dues collected 72.8
Change in deferred revenues 5.7
Finance charges earned 17.3
Products and services 37.5
Miscellaneous revenue 4.8
Net revenues as reported in 6/30/01 Form 10-Q 281.3
Net revenues as restated in 12/31/03 Form 10-K 217.5
Net income as reported in 6/30/01 Form 10-Q 19.2
Net income as restated in 12/31/03 Form 10-K 20.3
Quarter Ended 3/31/01
Net revenues:
Initial membership fees on financed
memberships originated 146.2
Initial membership fees on paid-in-full
memberships originated 7.6
Dues collected 73.2
Change in deferred revenues (5.1)
Finance charges earned 17.8
Products and services 36.4
Miscellaneous revenue 4.2
Net revenues as reported in 3/31/01 Form 10-Q 280.3
Net revenues as restated in 12/31/03 Form 10-K 207.7
Net income as reported in 3/31/01 Form 10-Q 18.6
Net income as restated in 12/31/03 Form 10-K 12.6
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Year Ended 12/31/00
Net revenues:
Initial membership fees on financed
memberships originated 518.4
Initial membership fees on paid-in-full
memberships originated 24.6
Dues collected 281.5
Change in deferred revenues (12.4)
Finance charges earned 68.4
Products and services 111.0
Miscellaneous 15.6
Net revenues as reported in 12/31/00 Form 10-K 1,007.1
Net revenues as restated in 12/31/03 Form 10-K 789.9
Net revenues as restated in 12/31/04 Form 10-K 735.6
Net income as reported in 12/31/00 Form 10-K 78.6
Net income as restated in 12/31/03 Form 10-K 82.6
Net loss as restated in 12/31/04 Form 10-K (141.9)
Quarter Ended 9/30/00
Net revenues:
Initial membership fees on financed
memberships originated 133.0
Initial membership fees on paid-in-full
memberships originated 6.1
Dues collected 70.4
Change in deferred revenues (4.6)
Finance charges earned 17.3
Products and services 29.2
Miscellaneous revenue 3.4
Net revenues as reported in 9/30/00 Form 10-Q 254.8
Net revenues as restated in 12/31/03 Form 10-K 199.6
Net income as reported in 9/30/00 Form 10-Q 35.9
Net income as restated in 12/31/03 Form 10-K 36.7
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Quarter Ended 6/30/00
Net revenues:
Initial membership fees on financed
memberships originated 133.4
Initial membership fees on paid-in-full
memberships originated 5.6
Dues collected 71.1
Change in deferred revenues (5.9)
Finance charges earned 17.1
Products and services 26.8
Miscellaneous revenue 2.8
Net revenue as reported in 6/30/00 Form 10-Q 250.9
Net revenues as restated in 12/31/03 Form 10-K 194.9
Net income as reported in 6/30/00 Form 10-Q 15.9
Net income as restated in 12/31/03 Form 10-K 15.5
Quarter Ended 3/31/00
Net revenues:
Initial membership fees on financed
memberships originated 144.5
Initial membership fees on paid-in-full
memberships originated 6.7
Dues collected 67.4
Change in deferred revenues (16.3)
Finance charges earned 16.4
Products and services 26.6
Miscellaneous revenue 4.0
Net revenues as reported in 3/31/00 Form 10-Q 249.3
Net revenues as restated in 12/31/03 Form 10-K 189.0
Net income as reported in 3/31/00 Form 10-Q 15.3
Net income as restated in 12/31/03 Form 10-K 14.2
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Year Ended 12/31/99
Net revenues:
Initial membership fees on financed
memberships originated 465.4
Initial membership fees on paid-in-full
memberships originated 23.7
Dues collected 243.0
Change in deferred revenues (4.0)
Finance charges earned 59.4
Products and services 62.6
Fees and other 11.0
Net revenues as reported in 12/31/99 Form 10-K 861.1
Net revenues as restated in 12/31/03 Form 10-K 658.1
Net income as reported in 12/31/99 Form 10-K 42.2
Net income as restated in 12/31/03 Form 10-K 37.3
Quarter Ended 9/30/99
Net revenues:
Initial membership fees on financed
memberships originated 120.0
Initial membership fees on paid-in-full
memberships originated 5.6
Dues collected 58.9
Change in deferred revenues (0.3)
Finance charges earned 15.0
Products and services 20.3
Net revenues as reported in 9/30/99 Form 10-Q 219.5
Net revenues as restated in 12/31/03 Form 10-K/A 167.2
Net income as reported in 9/30/99 Form 10-Q 12.2
Net income as restated in 12/31/03 Form 10-K/A 11.2
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Quarter Ended 6/30/99
Net revenues:
Initial membership fees on financed
memberships originated 118.9
Initial membership fees on paid-in-full
memberships originated 5.4
Dues collected 55.4
Change in deferred revenues (0.8)
Finance charges earned 15.4
Fees and other 15.5
Net revenues as reported in 6/30/99 Form 10-Q 209.8
Net revenues as restated in 12/31/03 Form 10-K/A 158.7
Net income as reported in 6/30/99 Form 10-Q 9.1
Net income as restated in 12/31/03 Form 10-K/A 8.7
DEFENDANTS’ SARBANES-OXLEY CERTIFICATIONS AND OTHER
ATTESTATIONS TO THE EFFICACY OF INTERNAL CONTROLS WERE ALSO
MATERIALLY FALSE AND MISLEADING WHEN MADE
176. Section 13(b)(2) of the Exchange Act states, in pertinent part, that every reporting
company must: (A) make and keep books, records and accounts which, in reasonable detail,
accurately and fairly reflect the transactions and disposition of the assets of the issuer; and (B) devise
and maintain a system of internal controls sufficient to provide reasonable assurances that
transactions are recorded as necessary to permit the preparation of financial statements in conformity
with GAAP. These provisions require an issuer to employ and supervise reliable personnel, to
maintain reasonable assurances that transactions are executed as authorized, to properly record
transactions on an issuer’s books and, at reasonable intervals, to compare accounting records with
physical assets.
177. Bally violated Section 13(b)(2)(B) of the Exchange Act by failing to implement
procedures reasonably designed to prevent accounting irregularities. Bally failed to put into place
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proper reviews and checks to ensure that its management did not engage in accounting improprieties.
It failed to ensure that transactions were reported in accordance with GAAP.
178. Bally’s lack of adequate internal controls rendered the Company’s Class Period
financial reporting inherently unreliable and precluded the Company from preparing financial
statements that complied with GAAP. Nonetheless, during the Class Period, the Company regularly
issued quarterly and annual financial statements without ever disclosing the existence of the
significant and material deficiencies in its internal accounting controls and falsely asserted that its
financial statements complied with GAAP.
179. Each Sarbanes-Oxley certification issued during the Class Period, in which the
Individual Defendants specifically warranted that they had personally designed and implemented
internal control procedures to ensure the disclosure of “any fraud, whether or not material, that
involves management or other employees who have a significant role in the Registrant's internal
controls” were false and misleading when made for the reasons set forth above.
ADDITIONAL SEC VIOLATIONS
180. Item 7 of Form 10-K and Item 2 of Form 10-Q, Management’s Discussion and
Analysis of Financial Condition and Results of Operations (“MD&A”), require the issuer to furnish
information required by Item 303 of Regulation S-K [17 C.F.R. 229.303]. In discussing results of
operations, Item 303 of Regulation S-K requires the registrant to:
Describe any known trends or uncertainties that have had or that the registrant
reasonably expects will have a material favorable or unfavorable impact on net sales
or revenues or income from continuing operations.
The instructions to Paragraph 303(a) further state:
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The discussion and analysis shall focus specifically on material events and
uncertainties known to management that would cause reported financial information
not to be necessarily indicative of future operating results . . . .
181. In addition, the SEC, in its May 18, 1989 Interpretive Release No. 34-26831, has
indicated that registrants should employ the following two-step analysis in determining when a
known trend or uncertainty is required to be included in the MD&A disclosure pursuant to Item 303
of Regulation S-K:
A disclosure duty exists where a trend, demand, commitment, event or uncertainty
is both presently known to management and is reasonably likely to have a material
effect on the registrant’s financial condition or results of operations.
182. Nonetheless, Bally’s Class Period Forms 10-K and 10-Q failed to disclose the
Company’s improper accounting practices as noted above as well as its internal control system
deficiencies, all of which were reasonably likely to have a material adverse effect on Bally’s
operating results, and the disclosure of such was necessary for a proper understanding and evaluation
of the Company’s operating performance and an informed investment decision.
E&Y’S AUDIT OPINIONS WERE MATERIALLY FALSE AND MISLEADING WHEN
MADE BECAUSE BALLY’S FINANCIAL STATEMENTS DID NOT CONFORM TO
GAAP AND E&Y’S AUDITS DID NOT CONFORM TO GAAS
183. On or about February 9, 2000, E&Y issued its unqualified audit opinion on the
consolidated financial statements of Bally as of December 31, 1999 and 1998, and for each of the
three years in the period ended December 31, 1999. This audit opinion, which was contained in
E&Y's report as reproduced in the Company's Form 10-K for the year ended December 31, 1999
which was filed with the SEC on or about March 30, 2000 ("the 1999 Form 10-K") with the written
consent of E&Y (which was appended to the 1999 Form 10-K as exhibit 23), stated:
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REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Bally Total Fitness Holding Corporation
We have audited the accompanying consolidated balance sheets of Bally Total
Fitness Holding Corporation as of December 31, 1999 and 1998, and the related
consolidated statements of operations, stockholders’ equity and cash flows for each
of the three years in the period ended December 31, 1999. Our audits also included
the financial statement schedule listed in the Index at Item 14(a)2. These financial
statements and the schedule are the responsibility of the Company’s management.
Our responsibility is to express an opinion on these financial statements and the
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 1999 and 1998, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted in
the United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein. As discussed
in the Summary of Significant Accounting Policies footnote to the consolidated
financial statements, in 1999 the Company changed its method of accounting for
start-up costs. (Emphasis added).
184. The E&Y-referenced "Summary of Significant Accounting Policies footnote" which
discussed the "changed. . . method of accounting for start-up costs" stated:
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, Reporting the Costs of Start-up Activities, and
was effective beginning on January 1, 1999. SOP 98-5 required that start-up costs,
including organization costs capitalized prior to January 1, 1999, be written off
and any future start-up costs be expensed as incurred. (Emphasis added). The
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Company's unamortized start-up costs at January 1, 1999 were written off and
reported as a cumulative effect of a change in accounting principle, net of tax.
185. On or about February 13, 2001 (except for a subsequent events note, as to which the
date was March 7, 2001), E&Y issued its unqualified audit opinion on the consolidated financial
statements of Bally as of December 31, 2000 and 1999, and for each of the three years in the period
ended December 31, 2000. This audit opinion, which was contained in E&Y's report as reproduced
in the Company's Form 10-K for the year ended December 31, 2000 which was filed with the SEC
on or about March 9, 2001 ("the 2000 Form 10-K") with the written consent of E&Y (which was
appended to the 2000 Form 10-K as exhibit 23), stated:
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Bally Total Fitness Holding Corporation
We have audited the accompanying consolidated balance sheets of Bally Total
Fitness Holding Corporation as of December 31, 2000 and 1999, and the related
consolidated statements of income, stockholders' equity and cash flows for each of
the three years in the period ended December 31, 2000. Our audits also included the
financial statement schedule listed in the Index at Item 14(a)2. These financial
statements and the schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and the
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 2000 and 1999, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted in
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the United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in the Summary of Significant Accounting Policies footnote to the
consolidated financial statements, in 1999 the Company changed its method of
accounting for start-up costs. (Emphasis added).
186. The E&Y-referenced "Summary of Significant Accounting Policies footnote" which
discussed the "changed. . . method of accounting for start-up costs" stated:
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, Reporting the Costs of Start-up Activities, and
was effective beginning on January 1, 1999. SOP 98-5 required that start-up costs,
including organization costs capitalized prior to January 1, 1999, be written off
and any future start-up costs be expensed as incurred. The Company's
unamortized start-up costs at January 1, 1999 were written off and reported as a
cumulative effect of a change in accounting principle, net of tax. (Emphasis added).
187. On or about February 12, 2002, E&Y issued its unqualified audit opinion on the
consolidated financial statements of Bally as of December 31, 2001 and 2000, and for each of the
three years in the period ended December 31, 2001. This audit opinion, which was contained in
E&Y's report as reproduced in the Company's Form 10-K for the year ended December 31, 2001,
filed with the SEC on or about March 27, 2002 ("the 2001 Form 10-K") with the written consent of
E&Y (which was appended to the 2001 Form 10-K as exhibit 23), stated:
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Bally Total Fitness Holding Corporation
We have audited the accompanying consolidated balance sheets of Bally Total
Fitness Holding Corporation as of December 31, 2001 and 2000, and the related
consolidated statements of income, stockholders' equity and cash flows for each of
the three years in the period ended December 31, 2001. Our audits also included the
financial statement schedule listed in the Index at Item 14(a)2. These financial
statements and the schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and the
schedule based on our audits.
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We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 2001 and 2000, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted in
the United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in the Summary of Significant Accounting Policies footnote to the
consolidated financial statements, in 1999 the Company changed its method of
accounting for start-up costs. (Emphasis added).
188. The E&Y-referenced "Summary of Significant Accounting Policies footnote" which
discussed the "changed. . . method of accounting for start-up costs" contained language which was
substantially identical to the discussion which appeared in the 1999 and 2000 Form 10-K as
particularized above.
189. On or about February 12, 2003, E&Y issued its unqualified audit opinion on the
consolidated financial statements of Bally as of December 31, 2002 and 2001, and for each of the
three years in the period ended December 31, 2002. This audit opinion, which was contained in
E&Y's report as reproduced in the Company's Form 10-K for the year ended December 31, 2002
which was filed with the SEC on or about March 28, 2003 ("the 2002 Form 10-K") with the written
consent of E&Y (which was appended to the 2002 Form 10-K as exhibit 23), stated:
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REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Bally Total Fitness Holding Corporation
We have audited the accompanying consolidated balance sheets of Bally Total
Fitness Holding Corporation as of December 31, 2002 and 2001, and the related
consolidated statements of income, stockholders' equity and cash flows for each of
the three years in the period ended December 31, 2002. Our audits also included the
financial statement schedule listed in the Index at Item 15(a)2. These financial
statements and the schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and the
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 2002 and 2001, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted in
the United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in the Goodwill, trademarks and intangible assets note to the
consolidated financial statements, in 2002 the Company changed its method of
accounting for goodwill and intangible assets.
190. The E&Y-referenced "Goodwill, trademarks and intangible assets note to the
consolidated financial statements" stated:
Prior to the implementation in the first quarter of 2002 of Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No.
142), goodwill had been amortized on the straight-line method over periods ranging
up to 40 years from dates of acquisition. Amounts assigned to acquired operating
lease rights, are being amortized on the straight-line method over the remaining lease
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periods (six to 20 years). Also in 2000, we purchased certain marks, including the
"Bally Total Fitness" service mark, from their owner. Prior to this purchase, the
marks were used pursuant to a long-term trademark license agreement. At December
31, 2002, these trademarks had a net book value of $6,969. Prior to the
implementation of SFAS No. 142 the Company annually evaluated whether the
carrying value of goodwill warranted revision, generally considering
expectations of future profitability and cash flows (undiscounted and without
interest charges) on a consolidated basis. No revisions have been recorded. As
a result of the adoption of SFAS No. 142 the Company ceased amortization of
goodwill and indefinite lived trademarks in 2002 in accordance with the
provisions of this standard. Upon adoption, the Company determined that the
value of recorded goodwill was not impaired. Based on the decline in the
Company's common stock price below book value per share, the Company
performed an assessment of business valuation and concluded that no
impairment of goodwill has occurred based on current projections of future
cash flows. (Emphasis added).
191. On or about March 11, 2004, E&Y issued its unqualified audit opinion on the
consolidated financial statements of Bally as of December 31, 2003 and, as restated, 2002 and 2001,
and for each of the three years in the period ended December 31, 2003. This audit opinion, which
was contained in E&Y's report as reproduced in the Company's Form 10-K for the year ended
December 31, 2003 which was filed with the SEC on or about March 30, 2004 ("the 2003 Form 10-
K") with the written consent of E&Y (which was appended to the 2003 Form 10-K as exhibit 23),
stated:
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Bally Total Fitness Holding Corporation
We have audited the accompanying consolidated balance sheets of Bally Total
Fitness Holding Corporation as of December 31, 2003 and, as restated, 2002, and the
related consolidated statements of operations, stockholders' equity (deficit) and cash
flows for the years ended December 31, 2003 and, as restated, 2002 and 2001. Our
audits also included the financial statement schedule listed in the Index at Item
15(a)2. These financial statements and the schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the schedule based on our audits.
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We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Bally Total Fitness
Holding Corporation at December 31, 2003 and 2002, and the consolidated results
of its operations and its cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted in
the United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in the Changes in accounting Note to the consolidated financial
statements, in 2003, the Company changed its methods of accounting for recognition
of revenue from membership contracts, membership origination costs, and asset
retirement obligations and, as discussed in the Goodwill, trademarks and intangible
assets Note, in 2002, the Company changed its method of accounting for goodwill
and intangible assets.
192. The E&Y-referenced "Note to the consolidated financial statements" which described
the changes in Bally's methods of accounting for recognition of revenue from membership contracts,
membership origination costs, and asset retirement obligations stated:
In 2003, we changed our accounting for the recognition of financed initial
membership fees from our prior 22-month pool deferral method to a preferable
modified cash method of recognition and implemented EITF 00-21 "Revenue
Arrangements with Multiple Deliverables." We also changed our accounting for the
recognition of recoveries of unpaid dues on inactive membership contracts from
accrual-based estimations to a preferable cash basis of recognition. Concurrently with
the change in accounting for membership fees, we also changed our method of
accounting in 2003 for initial membership origination costs from our prior method
where such costs were deferred and recognized over the same period used for
revenue recognition to a preferable method of expensing such costs as incurred.
These accounting changes were all implemented as of the beginning of 2003 as a
cumulative effect of changes in accounting and as a result we recorded non-cash
charges of $441 million related to the change to the modified cash basis of
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accounting for membership fees and adoption of EITF 00-21, $21 million related to
the change regarding unpaid dues on inactive membership contracts and $119 million
related to the change in accounting for initial membership fee origination costs.
As a result of the accounting changes described in the preceding paragraph and the
lower level of proforma historical earnings under the new revenue recognition
policies, we additionally recorded a special tax provision of $50.5 million in 2003 to
reduce previously recognized deferred tax assets.
In applying the new accounting for membership revenues as described above, it was
determined in consultation with our independent auditors that our previous
methodology of accounting for the deferral of prepayments of non-obligatory
dues resulted in errors in calculating deferred revenue related to prepaid dues.
As a result the Company has restated prior periods in accordance with the
requirements of Accounting Principles Board Opinion No. 20 "Accounting Changes."
The impact of the correction to previously reported net revenues and net income was
a reduction of $8.0 million ($.25 per diluted share), $10.6 million ($.36 per diluted
share), and $4.9 million ($.18 per diluted share) in each of the years 2002, 2001 and
1999, respectively, and an increase in reported net revenues and net income in 2000
of $4.0 million ($.14 per diluted share). The impact of the correction to previously
reported deferred revenue and stockholders' equity was an increase in deferred
revenue and a decrease in stockholders' equity of $43.0 million, $35.0 million, $24.4
million and $28.4 million at the end of each of the years 2002 through 1999,
respectively.
*****
We elected to change our accounting methods effective January 1, 2003 related to the
recognition of revenue from membership contracts, initial membership origination
costs, and asset retirement obligations. The cumulative effect as of January 1, 2003
of these changes in accounting principles has been charged to the 2003 statement of
operations. These charges are discussed below.
As required, we adopted the provisions of EITF 00-21 "Revenue Arrangements with
Multiple Deliverables" as it relates to revenues included in initial membership
contracts. Under the previously acceptable method, revenues allocated to products
and services included in initial membership contracts, including financed contracts,
were recognized upon delivery to the member. The new pronouncement limits the
amount of revenue we can recognize upon delivery of the products and services to
cash collected upon membership origination. Limiting early recognition to cash
collected resulted in a reversal of amounts previously recognized upon membership
sale, and an increase in amounts deferred to be recognized during future periods.
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Concurrent with the adoption of EITF 00-21, we elected to adopt a modified cash
basis of accounting for the recognition of membership fees effective January 1, 2003.
Under the new method, membership revenue is recognized as income at the later of
when it is collected, or in the case of paid-in-full memberships or accelerated receipts
from financed memberships, when earned. This changes the pre-2003 22-month pool
deferral method that amortized revenues from financed initial membership fees on
the straight-line basis, after application of estimated uncollectible amounts. The use
of the modified cash basis, which is viewed by us and by our independent
auditors as a preferable accounting method, recognizes membership revenue
over a longer period than the previous method. We have also applied the modified
cash basis of recognition to our accounting for non-obligatory membership dues.
Since monthly dues are collected in arrears, prior to 2003 we included in other assets
a receivable for uncollected dues at the end of each period. Under the modified cash
basis, the recognition of membership dues revenue has been changed to the later of
either collected or earned consistent with our new policy for membership fees. As a
result, the receivable for earned but uncollected dues has been reversed and is
included as a component of the cumulative effect adjustment.
Concurrent with our change to the modified cash basis of revenue recognition as
described above, in 2003 we additionally changed our accounting principle for initial
membership origination costs from the pre-2003 method whereby such costs were
deferred and recognized over the same period used for revenue recognition to
expensing such costs as incurred. This change has also been determined to be a
preferable method when considered along with the modified cash basis adopted for
membership fee recognition.
In the second quarter of 2003, we changed our accounting for the recognition of
recoveries of unpaid dues on inactive membership contracts from accrual-based
estimations to a cash basis of recognition, which was considered a preferable method
of accounting for such past due amounts.
We believe these changes in accounting to recognize membership revenues at the
later of when collected or earned and to expense membership origination costs as
incurred will result in financial reporting that is more understandable to the reader.
The new methods also reduce the impact of estimations in the financial reporting
process by eliminating the need to estimate the amount and timing of future member
collections for purposes of revenue and expense recognition.
We also implemented the provisions of Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations," in the first quarter of 2003.
It requires that we recognize the fair value of a liability for an asset retirement
obligation in the period in which it is incurred if a reasonable estimate of fair value
can be made. The associated asset retirement costs are then capitalized as part of the
carrying amount of the long-lived asset. As a result, a non-cash cumulative
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adjustment of $.2 million was recorded to provide for estimated future restoration
obligations on our leaseholds. (Emphasis added).
193. The 2003 Form 10-K contained the following management disclosure: "As of March
25, 2004, Ernst & Young LLP resigned as independent auditors for the Company effective no later
than the filing with the Commission of the Company's Quarterly Report on Form 10-Q for the
quarter ending March 31, 2004."
194. E&Y's unqualified audit opinions on the financial statements of the Company as of
and for the years ended December 31, 1999, December 31, 2000, December 31, 2001, December 31,
2002, and December 31, 2003, were materially false and misleading because these financial
statements were not presented in accordance with GAAP nor were they audited in accordance with
GAAS.
195. GAAS, as set forth in AICPA Professional Standards Volume 1, U.S. Auditing
Standards ("AU"), in section AU 411, describes "The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles in the Auditor's Report." It states:
The auditor's opinion that financial statements present fairly an entity's financial
position, results of operations, and cash flows in conformity with generally accepted
accounting principles should be based on his judgement as to whether (a) the
accounting principles selected and applied have general acceptance; (b) the
accounting principles are appropriate in the circumstances; (c) the financial
statements, including the related notes, are informative of matters that may affect
their use, understanding, and interpretation. . . ; (d) the information presented in the
financial statements is classified and summarized in a reasonable manner, that is,
neither too detailed nor too condensed. . . ; and (e) the financial statements reflect the
underlying events and transactions in a manner that presents the financial position,
results of operations, and cash flows within a range of acceptable limits, that is, limits
that are reasonable and practicable to attain in financial statements.
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196. During the Class Period, the audited financial statements of the Company, which were
publicly disseminated, were not presented "fairly in conformity with generally accepted accounting
principles" because as subsequently admitted through Restatement, the:
a. Accounting principles selected and applied did not have general acceptance.
b. Accounting principles were not appropriate in the circumstances.
c. Financial statements, including the related notes, were not informative of matters that
affected their use, understanding, and interpretation.
d. Financial statements did not reflect the underlying events and transactions in a
manner that presented the financial position and the results of operations within a
range of acceptable limits that were reasonable and practicable to attain in financial
statements.
197. E&Y knew it was required to adhere to standards and principles of GAAS, including
the requirement that the financial statements comply in all material respects with GAAP. E&Y, in
issuing its unqualified audit opinions, as alleged herein, knew that by doing so it was engaging in
a gross departure from GAAS, or issued such certification with reckless disregard for whether or not
GAAS was being complied with.
198. In the introductory portion of Accounting Series Release 173, the SEC made the
following comments pertaining to economic substance:
Another problem. . . is the need for emphasizing the importance of substance over
form in determining accounting principles to be applied to particular transactions and
situations. In addition to considering substance over form in particular transactions,
it is important that the overall impression created by the financial statements be
consistent with the business realities of the company's financial position and
operations.
We believe that the auditor must stand back from his resolution of particular
accounting issues and assess the aggregate impact of the particular issues upon a
reasonable investor's perception of the economic substance of the enterprise for
which the financial statements are being presented.
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199. In opining on the fairness of the financial statements of the Company, E&Y failed to
assess the propriety of the accounting principles used by the Company and it failed to consider the
importance of substance over form in determining accounting principles to be applied.
200. As noted by the SEC in its Accounting And Auditing Enforcement Release No. 817
(September 19, 1996) "In the Matter of Cypress Bioscience Inc. and Alex P. De Soto, CPA": "It is
a well-established tenet of GAAP that transactions must be accounted for in accordance with their
substance rather than their form."
201. Due to the failure of the Company to account for transactions in accordance with their
substance rather than their form, the overall impression created by the financial statements was
inconsistent with the business realities of the Company's financial position and operations, and as
a result they were deceptive and materially misleading.
202. E&Y knew and recklessly disregarded, or was reckless in not knowing, the facts set
forth herein concerning the non-GAAP accounting and the materially false and misleading
disclosures which were contained in the Company's filings with the SEC during the Class Period.
E&Y further knew and disregarded, or was reckless in not knowing, that such non-GAAP accounting
and the materially false and misleading disclosures resulted in material misstatements of the
Company's financial position and results of operation.
203. E&Y's unqualified audit opinions, insofar as they state that E&Y's audits of the
Company's financial statements were conducted in accordance with GAAS, were false and
misleading because the following GAAS (AU 150) were knowingly or recklessly violated:
a. General Standard No. 1 was violated, which standard requires that the examination
is to be performed by a person or persons having adequate technical training and
proficiency as an auditor.
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b. General Standard No. 3 was violated, which standard requires that due professional
care is to be exercised in the performance of the examination and in the preparation
of the report.
c. Standard Of Field Work No. 1 was violated, which standard requires that the work
is to be adequately planned and assistants, if any, are to be properly supervised.
d. Standard Of Field Work No. 2 was violated, which standard requires that a sufficient
understanding of the internal control structure is to be obtained to plan the audit and
to determine the nature, timing and extent of tests to be performed.
e. Standard Of Field Work No. 3 was violated, which standard requires that sufficient
competent evidential matter is to be obtained through inspection, observation,
inquiries, and confirmations to afford a reasonable basis for an opinion regarding the
financial statements under examination.
f. Standard Of Reporting No. 1 was violated, which standard requires that the report
shall state whether the financial statements are presented in accordance with
generally accepted accounting principles.
g. Standard Of Reporting No. 3 was violated, which standard requires that informative
disclosures in the financial statements are to be regarded as reasonably adequate
unless otherwise stated in the report.
204. Bally restated its previously issued financial statements to correct its prior accounting.
As discussed above, these corrections were, in significant part, required to rectify improper
accounting for:
a. Membership Revenue
b. Membership Acquisition Expenses
c. Recoveries Of Unpaid Dues
d. Acquired Payment Obligations
e. Sales Of Future Receivables
f. Prepaid Personal Training Services
g. Multiple Element Arrangements
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h. Self-Insurance Liabilities
i. Costs Incurred To Develop Internal-Use Computer Software
j. The Valuation Of Goodwill And Separately Identifiable Assets Apart From Goodwill
k. The Amortization Of Goodwill
l. Fixed Asset Impairment
m. Escheatment Obligations
n. Advertising Costs
o. Maintenance Costs
p. Start-Up Costs
q. Inventory
r. Accruals
s. Foreign Exchange Gains And Losses
t. Leases
u. Income Taxes
205. Although each of the above listed accounting issues was material to Bally's financial
statements, Bally's accounting policy with respect to certain of these issues was not disclosed during
the Class Period. For example, prior to effecting changes to Bally's previously issued financial
statements, Bally never disclosed the fact that it:
a. self-insured against risks arising from workers' compensation claims, health and life
insurance claims, and general liability claims.
b. capitalized all costs associated with endeavors to develop computer software,
irrespective of whether such costs were properly capitalizable.
c. capitalized all advertising costs, irrespective of whether such costs were properly
capitalizable, and allocated these costs over the estimated life of the advertising.
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d. recognized revenue by billing inactive members for dues, although such dues were
not paid by the inactive members.
e. did not account for foreign currency gains and losses.
f. did not account for escheatment obligations.
g. did not record all assets obtained and all liabilities assumed in business
combinations.
206. Non-disclosure of the foregoing accounting policies violated GAAP (APB Opinion
No. 22) which states:
Disclosure of accounting policies should identify and describe the accounting
principles followed by the reporting entity and the methods of applying those
principles that materially affect the determination of financial position, changes in
financial position, or results of operations. In general, the disclosure should
encompass important judgments as to appropriateness of principles relating to
recognition of revenue and allocation of asset costs to current and future periods. . .
Examples of disclosures by a business entity commonly required with respect to
accounting policies would include, among others, those relating to basis of
consolidation, depreciation methods, amortization of intangibles, inventory pricing,
accounting for research and development costs (including basis for amortization),
translation of foreign currencies, recognition of profit on long-term construction-type
contracts, and recognition of revenue from franchising and leasing operations. This
list of examples is not all-inclusive.
(Emphasis added).
207. Although the foregoing accounting policies (including the "required" disclosure of
accounting policies governing translation of foreign currencies) were not disclosed, throughout the
Class Period E&Y falsely led the investment community to believe that all accounting policies which
materially affected the determination of Bally's financial position and results of operations had been
disclosed in notes to Bally's financial statements by issuing unqualified audit opinions which stated
that:
a. E&Y's "audit includes examining, on a test basis, evidence supporting the. . .
disclosures in the financial statements"
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b. "the consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Bally Total Fitness Holding
Corporation. . . and the consolidated results of its operations"
208. As noted above, E&Y's February 9, 2000 unqualified audit opinion, E&Y's February
13, 2001 (except for a subsequent events note as to which the date was March 7, 2001) unqualified
audit opinion and E&Y's February 12, 2002 unqualified audit opinion each emphasized (in a separate
paragraph -- AU Section 508) the fact that (i) Bally had "changed its method of accounting for
start-up costs" and (ii) referred to a note to Bally's financial statements which stated that "beginning
on January 1, 1999" GAAP "required that start-up costs. . . be written off and any future start-up
costs be expensed as incurred." Accordingly, there is no question that both E&Y and the Bally
defendants understood the appropriate accounting for start-up costs.
209. Despite this fact, during the Class Period, the Bally defendants caused start-up costs
(particularly rental charges on new club facilities which were being readied for their grand opening)
to be capitalized, and E&Y failed to qualify its Class Period audit opinions as a result of this flagrant
violation of GAAP as required by GAAS (AU Section 508).
210. Upon Restatement, the Company admitted (in the 2004 Form 10-K) that correction
of the improper accounting required a $7,937,000 adjustment "as of January 1, 2002."
211. As noted above E&Y's February 12, 2003 unqualified audit opinion and E&Y's March
11, 2004 unqualified audit opinion each emphasized (in a separate paragraph -- AU Section 508) the
fact that (i) Bally had "changed its method of accounting for goodwill and intangible assets" and (ii)
referred to a note to Bally's financial statements which stated: "Prior to the implementation in the
first quarter of 2002. . . the Company annually evaluated whether the carrying value of goodwill
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warranted revision" and determined that no revisions were required; that "no impairment of goodwill
has occurred."
212. Various narrative disclosures, including notes to the financial statements which
appeared in the 2002 Form 10-K and the 2003 Form 10-K, made it very clear that both E&Y and the
Bally defendants understood the determinants of goodwill impairment and the appropriate
accounting for such impairments.
213. Despite this fact, during the Class Period, the Bally defendants failed to recognize
obvious impairment charges for accounting purposes, and E&Y failed to qualify its Class Period
audit opinions as a result of this flagrant violation of GAAP as required by GAAS (AU Section 508).
214. Upon Restatement, the Company's financial statements (as reflected in the 2004
Form 10-K) reflected goodwill impairment charges of $54.5 million and $1.6 million in 2003 and
2002, respectively, and other impairment charges for periods prior thereto.
215. The "Goodwill, trademarks and intangible assets" note, which E&Y's February 12,
2003 audit opinion referred to, also stated: "Amounts assigned to acquired operating lease rights,
are being amortized on the straight-line method over the remaining lease periods (six to 20 years)."
(Emphasis added).
216. Accordingly, there is no question that both E&Y and the Bally defendants understood
that "acquired operating lease rights" were intangible assets that were required to be assigned a
value and recognized for accounting purposes.
217. Despite this fact, and despite the fact that both E&Y and the Bally defendants had
unrestricted access to one of the finest accounting research tools in the nation ("Other fees paid to
Ernst & Young LLP for 2003 included $2,500 for a subscription to EY On-line, an accounting
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research tool." -- June 10, 2004 Form 14A), during the Class Period, the Bally defendants failed to
recognize "acquired operating lease rights" for accounting purposes, and E&Y failed to qualify its
Class Period audit opinions as a result of this flagrant violation of GAAP as required by GAAS (AU
Section 508). The admission of wrongdoing is unequivocal. Upon Restatement, the Company
stated:
. . . in applying APB 16, Business Combinations, we should have allocated a portion
of the purchase price to certain separately identifiable intangible assets: a) "Membership
Relations" which represents the fair market value of relationships with existing members as
of the acquisition date: b) "Non-compete Agreements" which represents the fair market value
of the non-competition agreement with the seller of the acquired company: c) "Trade name"
which represents the fair value of the trade names associated with the acquired operations,
and; d) "Leasehold Rights" which represents the estimate of the favorable and
unfavorable lease agreements in place as of the acquisition date. The impact of this
correction resulted in a decrease of goodwill and non-compete agreements and an increase
in membership relations, trade name and leasehold rights of $14,651, $29, $5,943, $1,600
and $7,138, respectively, as of January 1, 2000. The impact of this correction resulted in a
decrease in goodwill of $91,581 as of January 1, 2002. In addition, for the year ended
December 31, 2003 and 2002, this correction resulted in an increase in depreciation and
amortization of $6,404 and $8,435, respectively. (Emphasis added)
218. Other flagrant violations of GAAP during the Class Period, which were corrected
through Restatement, are discussed at paragraphs 128 through 173 above.
219. None of the Restatement adjustments was predicated upon judgmental determinations
which were subject to interpretative differences. Each adjustment was required to rectify
unquestionably wrong accounting as determined by PricewaterhouseCoopers LLP and KPMG LLP,
two of the nationally recognized "big four" accounting firms. Accordingly, the 2004 Form 10-K set
forth a plethora of accounting corrections and, in addition, contained the following representations
in addition to others discussed above:
In November 2004, the Audit Committee announced that based on the results of the
investigation led by independent legal counsel at Bingham McCutchen LLP
("Bingham") who consulted with accounting experts PricewaterhouseCoopers LLP
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("PwC") and Marshall Wallace, both retained by Bingham, and in consultation with
KPMG, it had determined that:
o following the 1999 promulgation of Staff Accounting Bulletin No.
101, "Revenue Recognition," beginning in the year ended December
31, 2000, the Company should have changed its revenue recognition
policy for membership initiation fees. The Audit Committee
determined that the Company should have recognized all membership
fees over the longer of the contractual life or the period over which
services are expected to be provided, and concluded that the deferred
pool method used by the Company did not meet this standard of
recognition as the recognition period was in most cases shorter than
the contract life. Additionally, the Audit Committee determined that
the 2003 adoption of the modified cash basis method of accounting
for revenue recognition failed to defer initial membership fee revenue
beyond the initial contract period for certain members who are
expected to maintain their membership beyond the initial period of
membership (36 months in most markets) and therefore required
changes to extend recognition over such renewal periods;
o prior to the second quarter of 2003, the Company's recognition of
revenue associated with recoveries of unpaid dues on inactive
member contracts was in error (See Restatement - 2003 Changes in
Accounting and Restatement);
o Bally's allowance for doubtful accounts was inadequate for years
prior to and including 2003; and
o a liability related to repayment obligations of approximately $22
million due in 2015 or later with respect to membership contracts
sold by a subsidiary before Bally acquired it in the late 1980s had not
been reflected in the Company's financial statements since 1995.
*****
The Board of Directors and Stockholders
Bally Total Fitness Holding Corporation:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting (Item 9A(b)),
that Bally Total Fitness Holding Corporation (the Company) did not maintain
effective internal control over financial reporting as of December 31, 2004, because
of the effects of material weaknesses identified in management's assessment, based
on criteria established in Internal Control - Integrated Framework issued by the
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Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Bally Total Fitness Holding Corporation's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to
express an opinion on management's assessment and an opinion on the effectiveness
of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective internal
control over financial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company's internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements
in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies,
that results in more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or detected. The
following material weaknesses have been identified and included in management's
assessment as of December 31, 2004:
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1. Deficiencies in the Company's control environment. The Company did not
maintain an effective control environment as defined in the Internal
Control-Integrated Framework published by the Committee of Sponsoring
Organizations of the Treadway Commission. Specifically, the following control
deficiencies were identified:
o The Company's finance and accounting resources were insufficient in
number, insufficiently trained, and authority and responsibility were
not properly delegated as of December 31, 2004. Accordingly, in
certain circumstances, accounting control activities were not
performed consistently, accurately, and timely, and an effective
review of technical accounting matters was not performed;
o Management did not have acceptable and clearly communicated
policies reflecting an appropriate management attitude towards
financial reporting and the financial reporting function and did not
have sufficient controls in place to ensure the appropriate selection of
and modifications to accounting policies;
o The Company did not establish effective controls to address the risk
of management override in the financial reporting process; and
o Management did not have effective processes to ensure that relevant
information was communicated in a timely manner from the
Company's regional service center, property management department,
information technology group, human resources, sales and marketing,
and legal department to the Company's corporate accounting
department.
These deficiencies resulted in a more than remote likelihood that a material
misstatement of the Company's annual or interim financial statements would not be
prevented or detected, and contributed to the development of other material
weaknesses described below.
2. Deficiencies in end-user computing controls. The Company did not maintain
adequate controls over end-user computing. Specifically, controls over the access to,
and completeness, accuracy, validity, and review of, certain spreadsheet information
that supports the financial reporting process were either not designed appropriately
or did not operate as designed.
This deficiency resulted in material errors in accounting, which required restatement
of the Company's consolidated financial statements as of and for the years ended
December 31, 2003 and 2002, and for interim periods in 2003 and the first quarter
of 2004, to reflect the correction of these errors in accounting. These deficiencies also
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resulted in material errors in accounting that required correction in the Company's
consolidated financial statements as of and for the year ended December 31, 2004
prior to their issuance.
3. Inadequate controls associated with accounting for revenue. The Company
did not maintain effective policies and procedures related to its accounting for
revenue and did not employ personnel with the appropriate level of technical
knowledge and experience to prepare, document and review its accounting for
revenue to ensure that such accounting complied with U.S. generally accepted
accounting principles. This lack of effective policies and procedures and lack of
knowledge and experience contributed to the Company's failure to:
o Select and implement membership revenue accounting policies in
accordance with U.S. generally accepted accounting principles;
o Effectively perform and document a periodic evaluation of the
reasonableness of assumptions with respect to the deferral of revenue
associated with personal training services;
o Establish procedures to identify and periodically assess promotional
offers to ensure that they were accounted for in accordance with U.S.
generally accepted accounting principles;
o Establish procedures to identify and periodically assess changes to the
Company's principal member offers to ensure that they were
accounted for in accordance with U.S. generally accepted accounting
principles; and
o Execute policies and procedures to ensure that the financial reporting
and disclosure obligations related to revenue recognition were
appropriately understood and considered.
These deficiencies resulted in material errors in accounting, which required
restatement of the Company's consolidated financial statements as of and for the
years ended December 31, 2003 and 2002, and for interim periods in 2003 and the
first quarter of 2004, to reflect the correction of these errors in accounting. These
deficiencies also resulted in material errors in accounting that required correction in
the Company's consolidated financial statements as of and for the year ended
December 31, 2004 prior to their issuance.
4. Inadequate controls associated with accounting for fixed assets. The Company
did not maintain effective policies and procedures related to its accounting for fixed
assets and did not employ personnel with the appropriate level of knowledge and
experience to prepare, document and review its accounting for fixed assets to ensure
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that such accounting complied with U.S. generally accepted accounting principles.
This lack of effective policies and procedures and lack of knowledge and experience
contributed to the Company's failure to:
o Select and implement fixed asset accounting policies in accordance
with U.S. generally accepted accounting principles;
o Effectively perform and document procedures to periodically review
the valuation of capitalized costs incurred prior to the opening of a
fitness center;
o Effectively perform and document a review of fixed asset
depreciation;
o Effectively perform and document procedures to review capitalizable
labor costs;
o Effectively reconcile the subsidiary fixed asset ledger to consolidated
fixed asset information; and
o Execute policies and procedures to ensure that the financial reporting
and disclosure obligations related to fixed assets were appropriately
understood and considered.
These deficiencies resulted in material errors in accounting, which required
restatement of the Company's consolidated financial statements as of and for the
years ended December 31, 2003 and 2002, and for interim periods in 2003 and the
first quarter of 2004, to reflect the correction of these errors in accounting. These
deficiencies also resulted in material errors in accounting that required correction in
the Company's consolidated financial statements as of and for the year ended
December 31, 2004 prior to their issuance.
5. Inadequate controls associated with accounting for goodwill and other
intangible assets. The Company did not maintain effective policies and procedures
related to its accounting for goodwill and other intangible assets and did not employ
personnel with the appropriate level of knowledge and experience to prepare,
document and review its accounting for goodwill and other intangible assets to
ensure that such accounting complied with U.S. generally accepted accounting
principles. This lack of effective policies and procedures and lack of knowledge and
experience contributed to the Company's failure to:
o Select and implement accounting policies in accordance with U.S.
generally accepted accounting principles;
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o Effectively identify, and allocate an appropriate portion of the cost of
an acquisition to, identifiable intangible assets in conjunction with its
purchase business combinations;
o Effectively perform and document procedures to periodically reassess
the valuation of goodwill; and
o Execute policies and procedures to ensure that the financial reporting
and disclosure obligations related to goodwill and other intangible
assets were appropriately understood and considered.
These deficiencies resulted in material errors in accounting, which required
restatement of the Company's consolidated financial statements as of and for the
years ended December 31, 2003 and 2002, and for interim periods in 2003 and the
first quarter of 2004, to reflect the correction of these errors in accounting. These
deficiencies also resulted in material errors in accounting that required correction in
the Company's consolidated financial statements as of and for the year ended
December 31, 2004 prior to their issuance.
6. Inadequate controls associated with accounting for leases. The Company did
not maintain effective policies and procedures related to its accounting for leases and
did not employ personnel with the appropriate level of knowledge and experience to
prepare, document and review its accounting for leases to ensure that such accounting
complied with U.S. generally accepted accounting principles.
This lack of effective policies and procedures and lack of knowledge and experience
contributed to the Company's failure to:
o Perform and document procedures to record rent expense on a
straight-line basis over the lease term, when appropriate, and to
record a related deferred rent obligation, in accordance with U.S.
generally accepted accounting principles;
o Perform and document procedures to ensure that leasehold
improvements were properly depreciated over the lesser of the
economic useful life or the lease term;
o Perform and document procedures to ensure leases were appropriately
accounted for as capital or operating leases;
o Perform procedures to periodically review the accounting for landlord
incentives; and
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o Execute policies and procedures to ensure that the financial reporting
and disclosure obligations related to leases were appropriately
understood and considered.
These deficiencies resulted in material errors in accounting, which required
restatement of the Company's consolidated financial statements as of and for the
years ended December 31, 2003 and 2002, and for interim periods in 2003 and the
first quarter of 2004, to reflect the correction of these errors in accounting. These
deficiencies also resulted in material errors in accounting that required correction in
the Company's consolidated financial statements as of and for the year ended
December 31, 2004 prior to their issuance.
7. Inadequate controls associated with accounting for accrued liabilities. The
Company did not maintain effective policies and procedures related to its accounting
for accrued liabilities and did not employ personnel with the appropriate level of
knowledge and experience to prepare, document and review its accounting for
accrued liabilities to ensure that such accounting complied with U.S. generally
accepted accounting principles. This lack of effective policies and procedures and
lack of knowledge and experience contributed to the Company's failure to:
o Effectively perform and document procedures to periodically evaluate
the reasonableness of assumptions used to estimate liabilities
associated with workers compensation, health care, and other insured
arrangements with retained risk exposures;
o Perform and document procedures to periodically evaluate items that
may meet the definition of unclaimed property, in order to properly
value the Company's escheatment liability;
o Perform and document procedures to periodically evaluate liabilities
related to the Company's obligation to former members to refund
initial member fees in a future period;
o Perform and document a periodic assessment of the Company's risk
sharing obligation associated with its transfers of obligatory member
payments to third parties;
o Effectively perform and document procedures to reconcile
commission and other payroll related liabilities to supporting detail;
o Effectively perform and document a review of expenses incurred in
one period and paid in subsequent periods to ensure that the related
accounting is reflected in the appropriate period; and
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o Execute policies and procedures to ensure that the financial reporting
and disclosure obligations related to accrued liabilities were
appropriately understood and considered.
These deficiencies resulted in material errors in accounting, which required
restatement of the Company's consolidated financial statements as of and for the
years ended December 31, 2003 and 2002, and for interim periods in 2003 and the
first quarter of 2004, to reflect the correction of these errors in accounting. These
deficiencies also resulted in material errors in accounting that required correction in
the Company's consolidated financial statements as of and for the year ended
December 31, 2004 prior to their issuance.
8. Inadequate controls associated with accounting for computer software. The
Company did not maintain adequate policies and procedures or employ sufficiently
knowledgeable and experienced personnel to ensure appropriate application of
Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. This lack of effective policies and
procedures and lack of knowledge and experience contributed to the Company's
failure to select and implement software accounting policies in accordance with U.S.
generally accepted accounting principles, and effectively perform and document
procedures to periodically reassess their valuation.
This deficiency resulted in material errors in accounting, which required restatement
of the Company's consolidated financial statements as of and for the years ended
December 31, 2003 and 2002, and for interim periods in 2003 and the first quarter
of 2004, to reflect the correction of these errors in accounting. These deficiencies also
resulted in material errors in accounting that required correction in the Company's
consolidated financial statements as of and for the year ended December 31, 2004
prior to their issuance.
9. Inadequate financial statement preparation and review procedures. The
Company did not maintain effective policies and procedures related to its financial
statement preparation and review procedures and did not employ personnel with the
appropriate level of knowledge and experience to ensure that accurate and reliable
interim and annual consolidated financial statements were prepared and reviewed on
a timely basis. Specifically, the Company did not have:
o Effective reconciliation of significant balance sheet accounts;
o Effective reconciliation of subsidiaries' accounts to consolidating
financial information;
o Effective reconciliation and conversion of foreign financial
statements to consolidated financial information;
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o Policies and procedures relating to the origination and maintenance
of contemporaneous documentation to support key judgments made
in connection with the selection of significant accounting policies or
the application of judgments within its financial reporting process;
o Policies and procedures related to the identification and disclosure of
subsequent events;
o Policies and procedures related to the review of complex or unusual
transactions;
o Adequate policies and procedures related to the review and approval
of accounting entries;
o Sufficient retention policies with respect to historical documentation
that formed the basis of prior accounting judgments that have
continuing relevance; and
o Effective review of financial statement information, and related
presentation and disclosure requirements.
These deficiencies resulted in material errors in accounting, which required
restatement of the Company's consolidated financial statements as of and for the
years ended December 31, 2003 and 2002, and for interim periods in 2003 and the
first quarter of 2004, to reflect the correction of these errors in accounting. These
deficiencies also resulted in material errors in accounting that required correction in
the Company's consolidated financial statements as of and for the year ended
December 31, 2004 prior to their issuance.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of Bally
Total Fitness Holding Corporation and subsidiaries as of December 31, 2004 and
2003, and the related consolidated statements of operations, stockholders' equity
(deficit) and comprehensive income, and cash flows for each of the years in the
three-year period ended December 31, 2004. The aforementioned material
weaknesses were considered in determining the nature, timing, and extent of audit
tests applied in our audit of the 2004 consolidated financial statements, and this
report does not affect our report dated November 29, 2005, which expressed an
unqualified opinion on those consolidated financial statements.
In our opinion, management's assessment that Bally Total Fitness Holding
Corporation did not maintain effective internal control over financial reporting as of
December 31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee of
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Sponsoring Organizations of the Treadway Commission (COSO). Also, in our
opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, Bally Total Fitness Holding
Corporation has not maintained effective internal control over financial reporting as
of December 31, 2004, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
/s/ KPMG LLP
Chicago, Illinois
November 29, 2005
220. Each and every audit opinion which E&Y expressed during the Class Period stated
that its audit "includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion." This representation was materially false and
misleading because E&Y either failed to assess the propriety of the accounting principles used by
the Company and to consider the Company's use of non-GAAP accounting as specified above, or
did so in an egregiously reckless manner.
221. In auditing Bally's financial statements as of and for the years ending December 31,
1999, December 31, 2000, December 31, 2001, December 31, 2002, and December 31, 2003, E&Y
either identified and ignored, or recklessly failed to investigate extremely questionable transactions,
and made audit judgments that no reasonable auditor would have made if confronted with the same
facts. Accordingly, E&Y's audits were so deficient that they amounted to no audit at all.
222. Had E&Y undertaken the performance of those audit procedures which were required
by GAAS, and with the due professional care which was required by GAAS, it would have known
that the Company's 1999, 2000, 2001, 2002, and 2003 financial statements were materially false and
misleading because these financial statements were not presented in accordance with GAAP.
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223. Given the woefully deficient state of Bally's internal controls, E&Y was required by
GAAS (AU Section 312) to expand the scope of its substantive audit procedures and use more
experienced staff:
Whenever the auditor has concluded that there is significant risk of material
misstatement of the financial statements, the auditor should consider this conclusion
in determining the nature, timing, or extent of procedures; assigning staff; or
requiring appropriate levels of supervision. The knowledge, skill, and ability of
personnel assigned significant engagement responsibilities should be commensurate
with the auditor's assessment of the level of risk for the engagement. Ordinarily,
higher risk requires more experienced personnel or more extensive supervision by the
auditor with final responsibility for the engagement during both the planning and the
conduct of the engagement. Higher risk may cause the auditor to expand the extent
of procedures applied, apply procedures closer to or as of year end, particularly in
critical audit areas, or modify the nature of procedures to obtain more persuasive
evidence.
224. Indeed, E&Y represented that it had complied with the foregoing GAAS. In a May
10, 2004 letter to the SEC (Exhibit 16 to Bally's March 31, 2004 Form 10-Q), E&Y stated:
"Regarding the registrant's statement concerning the material weakness in internal accounting control
related to accounting for the deferral of revenue related to prepayments of non-obligatory dues
revenue, included in the fourth paragraph of Item 5, we had considered such matter in determining
the nature, timing and extent of procedures performed in our audit of the registrant's financial
statements for each of the three years in the period ended December 31, 2003."
225. Accordingly, E&Y either expanded its substantive audit procedures to determine
whether Bally's accounting for membership revenue, membership acquisition expense, recoveries
of unpaid dues and bad debts, acquired payment obligations, sales of future receivables, prepaid
personal training services, multiple element arrangements, self-insurance, development of
internal-use computer software, goodwill and other intangibles, amortization, asset impairment,
escheatment obligations, advertising costs, maintenance costs, start-up costs, inventory, accruals,
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foreign exchange gains and losses, leases, and income taxes was appropriate or E&Y failed to
expand substantive audit procedures of Bally's financial data and audited them in a manner which
was so deficient that it amounted to no audit at all, while making audit judgments that no reasonable
auditor would have made if confronted with the same facts.
226. E&Y knew and ignored or recklessly failed to know the facts which indicated that the
Company's financial statements were materially false and misleading and were presented in a manner
which violated the principles of fair financial reporting and the GAAP specified herein.
227. As particularized above, E&Y failed to comply with GAAS in that it failed to perform
its audits of the Company's financial statements with a proper degree of professional skepticism (AU
Section 316). In this regard, E&Y either identified and ignored evidence that the Company's
financial statements were materially misstated via fraudulent accounting or recklessly failed to
identify such fraudulent accounting.
228. Further, as particularized herein, E&Y either identified and ignored, or recklessly
failed to investigate extremely questionable transactions, and made audit judgments that no
reasonable auditor would have made if confronted with the same facts. Accordingly, E&Y audits
were so deficient that they amounted to no audit at all.
229. Had E&Y undertaken the performance of those audit procedures which were required
by GAAS, and with the due professional care which was required by GAAS, it would have known
that the Company's financial statements were materially false and misleading because these financial
statements were not presented in accordance with GAAP. In reckless disregard of professional
standards, E&Y failed to audit the Company's financial statements in conformity with GAAS.
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230. As particularized herein, E&Y either knew and ignored, or recklessly failed to know
that the Company's audited financial statements which were disseminated to the investing public
during the Class Period improperly reported revenues, expenses, earnings, assets, liabilities and
shareholders' equity, and failed to disclose material facts that were necessary in order to make these
financial statements, in light of the circumstances, not misleading.
231. GAAS (AU Section 311) states that:
The auditor should obtain a level of knowledge of the entity's business that will
enable him to plan and perform his audit in accordance with generally accepted
auditing standards. That level of knowledge should enable him to obtain an
understanding of the events, transactions, and practices that, in his judgment, may
have a significant effect on the financial statements. . .Knowledge of the entity's
business helps the auditor in:
a. Identifying areas that may need special consideration.
b. Assessing conditions under which accounting data are produced, processed,
reviewed, and accumulated within the organization.
c. Evaluating the reasonableness of estimates.
d. Evaluating the reasonableness of management representations.
e. Making judgments about the appropriateness of the accounting principles applied and
the adequacy of disclosures.
232. E&Y audited the Company's financial statements prior to the Class Period and,
therefore, it had a thorough knowledge of the Company's financial history, accounting practices,
internal controls, and business operations. Accordingly, E&Y either failed to:
a. Identify areas that needed special consideration (such as the Company's accounting
for membership revenue, membership acquisition expense, recoveries of unpaid dues
and bad debts, acquired payment obligations, sales of future receivables, prepaid
personal training services, multiple element arrangements, self-insurance,
development of internal-use computer software, goodwill and other intangibles,
amortization, asset impairment, escheatment obligations, advertising costs,
maintenance costs, start-up costs, inventory, accruals, foreign exchange gains and
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losses, leases, and income taxes) or identified such areas and audited them in a
manner which was so deficient that it amounted to no audit at all, while making audit
judgements that no reasonable auditor would have made if confronted with the same
facts.
b. Assess the conditions under which accounting data (such as accounting data related
to membership revenue, membership acquisition expense, recoveries of unpaid dues
and bad debts, acquired payment obligations, sales of future receivables, prepaid
personal training services, multiple element arrangements, self-insurance,
development of internal-use computer software, goodwill and other intangibles,
amortization, asset impairment, escheatment obligations, advertising costs,
maintenance costs, start-up costs, inventory, accruals, foreign exchange gains and
losses, leases, and income taxes) was produced, processed, reviewed, and
accumulated within the organization or assessed such conditions and made audit
judgements based upon said assessment that no reasonable auditor would have made
if confronted with the same facts.
c. Evaluate the reasonableness of management's representations (such as its
representations regarding the recovery of the carrying value of goodwill through
future operations, or the fact that Bally was "subject to minimal foreign exchange and
commodity risk" ) or evaluated them in a manner which was so deficient that it
amounted to no evaluation at all.
d. Judge the appropriateness of the accounting principles applied (such as the principle
that disclosure of accounting policies should identify and describe the accounting
principles followed by the reporting entity and the methods of applying those
principles that materially affect the financial statements) and the adequacy of
disclosures in the Company's financial statements (such as disclosure of the fact that
there existed retained risk exposures associated with workers compensation, health
care, and other self-insurance arrangements), or did so and arrived at judgements that
no reasonable auditor would have arrived at if confronted with the same facts.
233. GAAS (AU Section 331) states that the observation of inventories is a generally
accepted auditing procedure, and that an auditor who issues an opinion without having observed
inventory "has the burden of justifying the opinion expressed." Accordingly, E&Y observed the
inventories in conjunction with each of its audits. In connection therewith, E&Y learned that there
were differences between the inventory that was reflected in the Company's ledger and the inventory
that physically existed and was counted. These shrinkage shortfalls were required to have been
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recorded as an expense in the period of loss (in compliance with GAAP (Accounting Research
Bulletin No. 43)).
234. E&Y either knew and ignored, or recklessly failed to know that the shrinkage losses
which it had identified and documented in its working papers (AU Section 339) were required to
have been recorded as an expense in the period of loss, and E&Y failed to issue a qualified opinion
and disclose the material facts (regarding the Company's non-recognition of shrinkage losses) that
were necessary in order to make these financial statements, in light of the circumstances, not
misleading. The Company, not E&Y, ultimately disclosed in the Form 10-K what E&Y was
required to have disclosed during the Class Period:
. . . the recorded value of retail inventories were overstated, primarily as a result of
differences in physical count and as a result of incorrect accounting for cost of goods
sold. The impact of these adjustments is an increase in accumulated deficit and a
decrease in other current assets of $2,231 as of January 1, 2002. In addition, these
adjustments resulted in an increase in retail products expenses of $594 for the year
ended December 31, 2003, and a decrease in retail products expenses of $538 for the
year ended December 31, 2002.
235. Similarly, during its audits, E&Y either knew and ignored, or recklessly failed to
know that the Company's accounting for and disclosures concerning membership revenue,
membership acquisition expense, recoveries of unpaid dues and bad debts, acquired payment
obligations, sales of future receivables, prepaid personal training services, multiple element
arrangements, self-insurance, development of internal-use computer software, goodwill and other
intangibles, amortization, asset impairment, escheatment obligations, advertising costs, maintenance
costs, start-up costs, inventory, accruals, foreign exchange gains and losses, leases, and income taxes
was woefully deficient and E&Y failed to issue a qualified opinion and disclose the material facts
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that were necessary in order to make these financial statements, in light of the circumstances, not
misleading.
236. The Company, not E&Y, ultimately disclosed what E&Y was required to have
disclosed regarding the Company's accounting for and disclosures concerning membership revenue,
membership acquisition expense, recoveries of unpaid dues and bad debts, acquired payment
obligations, sales of future receivables, prepaid personal training services, multiple element
arrangements, self-insurance, development of internal-use computer software, goodwill and other
intangibles, amortization, asset impairment, escheatment obligations, advertising costs, maintenance
costs, start-up costs, inventory, accruals, foreign exchange gains and losses, leases, and income taxes,
as particularized above.
237. It was no secret that Bally's growth was predicated upon the acquisition of existing
clubs from third parties and the opening of new clubs by Bally. Each of Bally's Forms 10-K which
were filed with the SEC during the Class Period discussed Bally's "expansion and acquisition"
history and strategy. Accordingly, during its audits, E&Y reviewed numerous acquisition
agreements which required Bally to pay for specified assets (including Membership Relations,
Non-compete Agreements, Trade names, and Leasehold Rights) and numerous agreements
associated with the leasing of new facilities and the developments of new clubs.
238. During its audits, E&Y either knew and ignored, or recklessly failed to know of the
Company's acquisition and non-recordation of Membership Relations, Non-compete Agreements,
Trade names, and Leasehold Rights, and E&Y failed to issue a qualified opinion and disclose the
material facts (regarding the Company's non-recordations) that were necessary in order to make these
financial statements, in light of the circumstances, not misleading. The Company, not E&Y,
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ultimately disclosed what E&Y was required to have disclosed during the Class Period as specified
above.
239. During its audits, E&Y either knew and ignored, or recklessly failed to know of the
Company's acquisition of new facility sites through the assumption of existing leases or through the
signing of new leases, and E&Y failed to issue a qualified opinion and disclose the material facts
(regarding the Company's improper accounting for acquired operating lease rights and lease rentals
associated with start-up operations) that were necessary in order to make these financial statements,
in light of the circumstances, not misleading. The Company, not E&Y, ultimately disclosed what
E&Y was required to have disclosed during the Class Period as specified above.
240. In order to assure itself that significant risks and uncertainties were properly disclosed
(Statement Of Position 94-6), and that contingencies were properly accounted for in Bally's financial
statements (FASB Statement No.5), E&Y was required to determine whether Bally was materially
uninsured. Accordingly, during its audits, E&Y either examined the nature and extent of Bally's
insurance coverage and knew and ignored that Bally self-insured for numerous risks and that its
financial statements materially understated expenses and liabilities arising from its self-insurance,
or E&Y failed to examine the nature and extent of Bally's insurance coverage and recklessly failed
to know.
241. As a result, during the Class Period, the Bally defendants failed to disclose the fact
that Bally self-insured against certain risks and that Bally's financial statements materially
understated expenses associated with Bally's self-insurance, and E&Y failed to qualify its Class
Period audit opinions as a result of this flagrant violation of GAAP as required by GAAS (AU
Section 508).
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242. Upon Restatement, the Bally defendants stated: "We concluded that our previous
methodologies for estimating our self-insured workers' compensation, health and life and general
insurance claims resulted in an understatement of our self-insured liabilities. The impact of this
adjustment was a decrease in accrued liabilities of $3,365 and increase in other inabilities and
accumulated deficit of $4,312 and $947, respectively, as of January 1, 2002."
243. Similarly, there were repayment obligations associated with certain membership
contracts sold. E&Y never audited these obligations. Accordingly, E&Y never knew that Bally's
liabilities were materially understated. This financial reporting deficiency was cured when the
Company's "Audit Committee identified that the Company had improperly accounted for $22,000
[,000] of face amount repayment obligations due in 2015 or later on membership contracts sold by
a subsidiary before its acquisition in the late 1980s" and caused corrections to be made to Bally's
previously issued financial statements ("The impact of this correction resulted in an increase in
accumulated deficit and other liabilities of $4,335[,000] as of January 1, 2002 and an increase in
interest expense of $589[,000] and $526[,000] for the years ended December 31, 2003 and 2002,
respectively." -- 2004 Form 10-K).
244. E&Y addressed several of the accounting issues discussed in paragraphs 128 through
173 above during its audit of Bally's 2003 financial statements as evidenced by notes to these
financial statements which stated:
We elected to change our accounting methods effective January 1, 2003 related to the
recognition of revenue from membership contracts, initial membership origination
costs, and asset retirement obligations. The cumulative effect as of January 1, 2003
of these changes in accounting principles has been charged to the 2003 statement of
operations. These charges are discussed below.
As required, we adopted the provisions of EITF 00-21 "Revenue Arrangements with
Multiple Deliverables" as it relates to revenues included in initial membership
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contracts. Under the previously acceptable method, revenues allocated to products
and services included in initial membership contracts, including financed contracts,
were recognized upon delivery to the member. The new pronouncement limits the
amount of revenue we can recognize upon delivery of the products and services to
cash collected upon membership origination. Limiting early recognition to cash
collected resulted in a reversal of amounts previously recognized upon membership
sale, and an increase in amounts deferred to be recognized during future periods.
Concurrent with the adoption of EITF 00-21, we elected to adopt a modified cash
basis of accounting for the recognition of membership fees effective January 1, 2003.
Under the new method, membership revenue is recognized as income at the later of
when it is collected, or in the case of paid-in-full memberships or accelerated receipts
from financed memberships, when earned. This changes the pre-2003 22-month pool
deferral method that amortized revenues from financed initial membership fees on
the straight-line basis, after application of estimated uncollectible amounts. The use
of the modified cash basis, which is viewed by us and by our independent auditors
as a preferable accounting method, recognizes membership revenue over a longer
period than the previous method. We have also applied the modified cash basis of
recognition to our accounting for non-obligatory membership dues. Since monthly
dues are collected in arrears, prior to 2003 we included in other assets a receivable
for uncollected dues at the end of each period. Under the modified cash basis, the
recognition of membership dues revenue has been changed to the later of either
collected or earned consistent with our new policy for membership fees. As a result,
the receivable for earned but uncollected dues has been reversed and is included as
a component of the cumulative effect adjustment.
Concurrent with our change to the modified cash basis of revenue recognition as
described above, in 2003 we additionally changed our accounting principle for initial
membership origination costs from the pre-2003 method whereby such costs were
deferred and recognized over the same period used for revenue recognition to
expensing such costs as incurred. This change has also been determined to be a
preferable method when considered along with the modified cash basis adopted for
membership fee recognition.
In the second quarter of 2003, we changed our accounting for the recognition of
recoveries of unpaid dues on inactive membership contracts from accrual-based
estimations to a cash basis of recognition, which was considered a preferable method
of accounting for such past due amounts.
We believe these changes in accounting to recognize membership revenues at the
later of when collected or earned and to expense membership origination costs as
incurred will result in financial reporting that is more understandable to the reader.
The new methods also reduce the impact of estimations in the financial reporting
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process by eliminating the need to estimate the amount and timing of future member
collections for purposes of revenue and expense recognition.
245. Given the nature and magnitude of the audit issues, E&Y would have been required
to have significantly expanded the scope of its audit and the nature of its procedures in observance
of GAAS (AU Section 311).
246. Having specifically addressed the foregoing issues during its 2003 audit, it is
remarkable that the 2004 Form 10-K, which contained restated 2003 financial statements, attested
to the deficiency in E&Y's audit by stating that, after investigation, the Company's Audit Committee
determined that the Company:
a. "improperly applied Staff Accounting Bulletin No. 101 ("SAB 101") in a prior
period. Specifically, after the Company's adoption of SAB 101, revenue was
recognized over the average contractual life of twenty-two months. As a part of this
restatement, the Company has modified its membership revenue recognition
methodology such that membership revenue is earned on a straight-line basis over
the longer of the initial membership term or the estimated membership life. The
impact of this correction resulted in an increase in deferred revenue and an increase
in accumulated deficit of $997,837 as of January 1, 2002, a decrease in installment
accounts receivable, net of $493,236 and $522,605 for the years ended December 31,
2003 and 2002, respectively, and an increase in membership services revenue of
$9,269 and $54,233 for the years ended December 31, 2003 and 2002, respectively."
b. "improperly accounted for membership acquisition costs by improperly deferring
certain costs in 2002 and prior. The impact of this correction resulted in an increase
in accumulated deficit and a decrease in deferred membership origination costs of
$113,959 as of January 1, 2002 and a decrease in membership services expenses and
cumulative effect of changes in accounting principle of $1,000 and $119,484,
respectively, for the year ended December 31, 2003 and an increase in membership
services expense of $6,525 in the year ended December 31, 2002."
c. "should have adopted the cash basis for recoveries of unpaid dues on inactive
memberships prior to 2003. The impact of this correction resulted in an increase in
accumulated deficit and a decrease in accounts receivable of $21,821 as of January
1, 2002, and a decrease in cumulative effect of change in accounting principle of
$20,335 for the year ended December 31, 2003."
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d. "improperly separated. . . multiple element arrangements into multiple units of
accounting resulting in premature recognition of early delivered nutritional products
and personal training services. As a part of this restatement, the Company has
modified its membership revenue recognition policy to treat these arrangements as
single units of accounting and recognize revenue for these arrangements on a
straight-line basis over the later of when collected or earned. The impact of this
change resulted in an increase in deferred revenue and an increase in accumulated
deficit of $105,467 as of January 1, 2002, and a decrease in membership services
revenue of $33,013 and $86,499 for the years ended December 31, 2003 and 2002,
respectively."
247. GAAS (AU Section 230) states that "Auditors should be assigned to tasks and
supervised commensurate with their level of knowledge, skill, and ability so that they can evaluate
the audit evidence they are examining. The auditor with final responsibility for the engagement. . .
should be knowledgeable about the client"
248. E&Y either possessed the requisite level of knowledge to understand and evaluate
the above discussed accounting changes and knew and ignored that they were inappropriately
applied, or E&Y failed to possess the requisite level of knowledge and understanding and failed to
know this fact.
249. GAAS (AU Section 326) notes that underlying accounting data and all corroborating
information available to the auditor (including books of original entry, the general and subsidiary
ledgers, related accounting manuals, and records such as work sheets and spreadsheets supporting
cost allocations, computations, checks, purchase orders, bills of lading, invoices, records of
electronic fund transfers, invoices, contracts, minutes of meetings, and reconciliations) constitute
evidence that should be subjected to inquiry, observation, inspection, confirmation, and physical
examination. It is inconceivable that E&Y could have inquired about, observed, inspected,
confirmed and physically examined the available documentation and failed to detect Bally's improper
accounting for membership revenue, membership acquisition expense, recoveries of unpaid dues and
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bad debts, acquired payment obligations, sales of future receivables, prepaid personal training
services, multiple element arrangements, self-insurance, development of internal-use computer
software, goodwill and other intangibles, amortization, asset impairment, escheatment obligations,
advertising costs, maintenance costs, start-up costs, inventory, accruals, foreign exchange gains and
losses, leases, and income taxes. Accordingly, E&Y either performed audits which were so deficient
that they amounted to no audit at all, or it identified and ignored, or recklessly failed to investigate
extremely questionable transactions, and made audit judgments that no reasonable auditor would
have made if confronted with the same facts.
250. For example, in this regard, notes to the audited financial statements which appeared
in the 1999 Form 10-K, the 2000 Form 10-K, the 2001 Form 10-K, the 2002 Form 10-K, and the
2003 Form 10-K each articulated Bally's leasehold improvement amortization accounting policy as
follows: "Amortization of leasehold improvements is provided on the straight-line method over the
lesser of the estimated useful lives of the improvements or the lease periods." This statement was,
at all relevant times, wholly false.
251. As admitted by the Bally defendants after the Class Period, throughout the Class
Period, Bally violated not only GAAP in accounting for amortization of leasehold improvements,
it violated its own stated accounting policy.
Historically, we depreciated leasehold improvements over the contractual term
of the lease. We also depreciated leasehold improvements acquired subsequent
to store opening, such as remodels, over the contractual term of the lease. In
both instances, optional renewal periods were included in the contractual term
of the lease. We have concluded that such leasehold improvements should be
depreciated over the lesser of the asset's economic life, with a maximum of
fifteen years, or the contractual term of the lease, excluding all renewal options.
The Company's club leases generally have a term of ten to fifteen years and provide
options to renew for between five to fifteen additional years." (2004 Form 10-K)
(Emphasis added).
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252. Had E&Y performed even the most perfunctory audit of Bally's amortization of
leasehold improvements, it could not have avoided knowing that in contravention of GAAP Bally
amortized leasehold improvements over "extended" lease periods which assumed the exercise of
lease options (thereby significantly decreasing reported amortization expense); not over the lesser
of the estimated useful lives of the improvements or the lease periods as stated in Bally's financial
statements.
253. E&Y either examined Bally's accounting for the amortization of leasehold
improvements and knew and ignored that Bally's accounting violated GAAP and Bally's own stated
accounting policy, or E&Y failed to examine Bally's accounting for the amortization of leasehold
improvements and recklessly failed to know. Accordingly, E&Y performed audits which were so
deficient that they amounted to no audit at all.
254. Notes to Bally's audited 2003 financial statements articulated its accounting policy
with regard to the impairment of long-lived assets as follows:
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of long-lived assets held for use are assessed by a comparison of the
carrying amount of the asset to the estimated future undiscounted net cash flows
expected to be generated by the asset. If estimated future undiscounted net cash flows
are less than the carrying amount of the asset, the asset is considered impaired and
expense is recorded in an amount required to reduce the carrying amount of the asset
to its fair value.
255. As admitted by the Bally defendants after the Class Period, Bally violated not only
GAAP in accounting for the impairment of long-lived assets, it violated its own stated accounting
policy.
. . . we determined conditions at various dates which indicated the carrying
amounts of fixed assets were impaired, but determined that impairment
analyses had not been performed even though trigger events were present. As
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a result, we performed the impairment analyses not previously completed for the
periods being restated and recorded impairment adjustments as applicable. . . We
determined that the Company did not properly apply the guidance in FASB Statement
No. 121 and in FASB Statement No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", to either identify the existence of relevant triggering
events or to measure the related impairment charges. As a result, we performed the
impairment analyses and recorded impairment charges as applicable. . . The
Company recorded impairment losses of $14,772, $19,605, and $18,258 in the years
ended December 31, 2004, 2003, and 2002, respectively.
The 2004 and 2003 charges related to club locations with operating performance that
deteriorated subsequent to the 2001 review or which had additions during the
subsequent period that were found to additionally be impaired. The 2003 charge
related primarily to the Crunch Fitness International acquisition in 2001, which was
found to perform at a level below expectations during 2002 and 2003. The
impairment charges in 2004, 2003, and 2002 related primarily to the carrying values
of land, buildings and leasehold improvements that will, with the possible exception
of Crunch (See Note 21 of Notes to Consolidated Financial Statements), continue to
be operated by the Company. (2004 Form 10-K) (Emphasis added).
256. Had E&Y performed even the most perfunctory audit of long-lived asset impairment
it could not have avoided knowing that, in contravention of GAAP and the Company's own stated
accounting policy, Bally failed to account for obvious impairments of long-lived assets.
257. E&Y either audited Bally's accounting for long-lived asset impairment and knew and
ignored that Bally's accounting violated GAAP and Bally's own stated accounting policy, or E&Y
failed to audit Bally's accounting for long-lived asset impairment and recklessly failed to know.
Accordingly, E&Y performed audits which were so deficient that they amounted to no audit at all.
258. The Bally defendants were required to cause the Company to disclose, in its financial
statements, the existence of the material facts described herein and to appropriately recognize and
report revenues and expenses in conformity with GAAP. The Company failed to make such
disclosures and to account for and to report revenue and expenses in conformity with GAAP.
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259. Due to the pervasive mosaic of non-disclosures, deceptive disclosures and improper
accounting, the Company's financial statements which were disseminated to the investing public
during the Class Period (including those which were audited by E&Y as specified above) were
materially false and misleading.
260. The defendants knew and ignored, or were reckless in not knowing, the facts which
indicated that the Company's financial statements (and the various press releases and public
statements which referred to them which were disseminated to the investing public during the Class
Period (including those which were audited by E&Y as specified above) were materially false and
misleading for the reasons set forth herein above.
261. SEC Regulations require that financial statements filed with the SEC conform with
GAAP. Financial statements filed with the SEC which are not prepared in conformity with GAAP
are presumed to be misleading or inaccurate, despite footnote or other disclosure [17 C.F.R.
§210.401 (a)(1)]. The Company's financial statements referred to above were false and misleading
for the reasons alleged herein and because they constituted an extreme departure from GAAP as
particularized herein above.
262. Pursuant to GAAS, E&Y was required to express a qualified opinion on the
Company's 1999, 2000, 2001, 2002, and 2003 financial statements (AU Section 508) because they
were not prepared in conformity with GAAP. In so doing, E&Y was required (AU Section 508) to
disclose to the investing public the nature and extent of the Company's false and misleading
accounting and to provide those disclosures which the Company's financial statements failed to
provide. E&Y either knew and ignored or recklessly failed to know these facts and, therefore, failed
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to express a qualified opinion on the Company's financial statements and make those required
disclosures. As a result, Lead Plaintiff and members of the Class sustained damages.
ADDITIONAL SCIENTER ALLEGATIONS
263. In addition to the allegations set forth above, all defendants acted with scienter in that
defendants knew or recklessly disregarded that the public documents and statements issued or
disseminated in the name of the Company were materially false and misleading; knew or recklessly
disregarded 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 statements 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 Bally, their control over, and/or receipt and/or modification of Bally’s allegedly
materially misleading misstatements and/or their associations with the Company which made them
privy to confidential proprietary information concerning Bally, participated in the fraudulent scheme
alleged herein.
264. As alleged herein, the Company and the Individual Defendants disseminated to the
investing public false and misleading press releases and filed false and misleading quarterly and
annual reports with the SEC. The statements made in these documents described Bally's positive
financial performance, but failed to disclose and/or misrepresented adverse material facts.
265. Furthermore, as illustrated by the Individual Defendants' positions with the Company,
they had and used their influence and control to further the scheme alleged herein. The Individual
Defendants had broad responsibilities that included communicating with the financial markets and
providing the markets with financial results. The Individual Defendants were privy to and directed
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the making of financial projections and results. By making the misleading statements contained
herein, the Individual Defendants knew that they would artificially inflate the value of the Company's
securities. Defendants' actions in doing so resulted in damage to Lead Plaintiff and the Class.
266. As Chief Financial Officer of Bally, defendant Dwyer, in conjunction with his direct
supervisors, defendants Toback and Hillman, were responsible for the preparation of Bally's financial
statements and for ensuring that the periodic reports filed with the SEC containing such financial
statements complied fully with the disclosure requirements of the federal securities laws. The
Individual Defendants signed and/or reviewed Bally's SEC filings containing the Company's falsely
reported financial results, as alleged herein, were the persons responsible for the preparation and
filing of Bally's financial statements, and had the responsibility to verify the underlying facts of any
publicly released financial statements.
267. In addition, given the fact that certain of the accounting irregularities involved
accounting for the revenues of the Company's core business – club memberships – the Individual
Defendants as senior executive officers and directors of the Company, approved, knew of, or
recklessly ignored the improper conduct complained of herein.
268. Moreover, each of the Individual Defendants was a CPA – each having worked for
E&Y prior to joining Bally – such that they knew or should have known that the improper and
aggressive accounting techniques being employed at Bally did not comply with GAAP.
269. Defendant Dwyer, as CFO, should have known of the basic principles of revenue and
expense recognition. Defendants Toback and Hillman, as experienced executives, also should have
known that revenue should not be recognized before it was earned and realized or realizable, and that
expenses were required to be recognized when incurred. Said defendants were involved in drafting,
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producing, reviewing and/or disseminating the false and misleading statements and information
alleged herein, were aware, or recklessly disregarded, that the false and misleading statements were
being issued regarding the Company, and approved or ratified these statements.
270. Defendants were motivated, in part, to materially misrepresent Bally's results in order
to cause and maintain artificial inflation in the price of Bally common stock, in order to secure for
themselves lucrative performance-based bonuses from the Company, pursuant to their employment
agreements with the Company, in addition to substantial stock awards pursuant to incentive plans.
271. For instance, in 2003, Toback was paid $775,00 in salary and bonus compensation,
$1,206,000 in restricted stock awards and $200,000 in stock options. That same year, Dwyer
received a salary of $375,000, $603,000 in restricted stock options and $160,000 in securities
underlying stock options. In 2002, Hillman received $638,654 in salary, $1,641,750 worth of
restricted stock awards and $4,863,600 in cash payments pursuant to a separation agreement with
Bally, which included $926,100 for vesting of restricted stock previously awarded to Hillman.
272. Defendants were further motivated to materially misrepresent Bally's results in order
to cause and maintain artificial inflation in the price of Bally common stock. Defendants took
advantage of that artificial inflation by raising additional cash proceeds for the Company during the
Class Period through a secondary offering of common stock. Defendants also took advantage of the
Company's false financial results and inflated stock price to obtain financing, refinance outstanding
debt, and effect acquisitions using inflated Bally stock as partial payment, as follows:
a. On February 7, 2001, defendants took advantage of the Company's inflated stock
price and made a public offering of 4,000,000 shares of its common stock, of which
the proceeds from 1,408,821 shares went directly to Bally, for approximate proceeds
of $50.6 million.
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b. On October 15, 2001, Bally announced via press release that it had signed a merger
agreement with Crunch Fitness. The companies reached an agreement whereby Bally
would acquire Crunch, a privately-held concern of 19 health clubs in five states, in
a cash and stock-for-stock merger. The terms of the agreement required Bally to issue
approximately three million shares of its common stock, plus a payment of cash and
other consideration. The total purchase price was valued at approximately $90
million.
c. On April 23, 2002, Bally issued a press release announcing that it had expanded its
presence in the New England area with the acquisition of seven health clubs operated
by Planet Fitness. The agreement included the payment of 383,000 shares of Bally's
common stock.
d. On June 27, 2003, Bally announced that it had priced $200 million of senior notes
due 2011 at 10.5 percent in a private offering to qualified institutional buyers under
Rule 144A and Regulation S under the Securities Act of 1933, as amended.
e. On June 27, 2003, Bally also announced that it intended to enter into a new $90
million dollar senior secured revolving credit facility with its existing group of banks
concurrently with the closing of the note offering. Bally planned to use the net
proceeds from the issuance of the senior notes, and, if required, borrowings under the
new credit facility to repay all outstanding borrowings under its existing credit
facility.
f. On June 27, 2003, Bally further announced that it had completed the refinancing of
$100 million of its outstanding $155 million Securitization Series 2001-1, which had
been scheduled to start amortizing in December 2003. The refinancing extended the
maturity of the $100 million of the Securitization Series to July 2005, and required
that the remaining balance begin amortizing in October 2003.
g. On July 15, 2003, Bally announced that it had secured an additional $35 million in
a private offering to institutional buyers. The additional senior notes were priced at
101% plus accrued interest from July 2, 2003.
273. In sum, all defendants acted with scienter in that they knew or recklessly disregarded
that the public documents and statements issued or disseminated in the name of the Company were
materially false and misleading when made; knew or recklessly disregarded that such statements or
documents would be issued or disseminated to the investing public; and knowingly or recklessly and
substantially participated or acquiesced in the issuance or dissemination of such statements or
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documents as primary violations of the federal securities laws. As set forth herein, defendants acted
with a knowing or reckless disregard for the falsity of Bally's financial statements.
UNDISCLOSED ADVERSE INFORMATION
274. The market for Bally’s securities was open, well-developed and efficient at all
relevant times. As a result of these materially false and misleading statements and failures to
disclose, Bally’s securities traded at artificially inflated prices during the Class Period. The artificial
inflation continued until at least April 28, 2004. Lead Plaintiff and other members of the Class
purchased or otherwise acquired Bally securities relying upon the integrity of the market price of
Bally’s securities and market information relating to Bally, and have been damaged by the disclosure
of the truth.
275. During the Class Period, defendants materially misled the investing public, thereby
inflating the price of Bally’s securities, by publicly issuing 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 materially false and misleading in that
they failed to disclose material adverse information and misrepresented the truth about the Company,
its business and operations, including, inter alia:
(a) that the Company’s financial statements were not prepared in accordance with GAAP
and/or in accordance with the federal securities laws and SEC regulations concerning fair reporting;
and
(b) that the Company’s seeming growth was, in material part, the result of improper
accounting.
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276. At all relevant times, the material misrepresentations and omissions particularized
in this Complaint directly or proximately caused or were a substantial contributing cause of the
damages sustained by Lead Plaintiff and other members of the Class. As described herein, during
the Class Period, defendants made or caused to be made a series of materially false or misleading
statements about Bally’s business, prospects and operations. These material misstatements and
omissions had the cause and effect of creating in the market an unrealistically positive assessment
of Bally and its business, prospects and operations, thus causing the Company’s securities to be
overvalued and artificially inflated at all relevant times. Defendants’ materially false and misleading
statements during the Class Period resulted in Lead Plaintiff and other members of the Class
purchasing the Company’s securities at artificially inflated prices, causing the damages complained
of herein upon disclosure of the truth.
LOSS CAUSATION
277. During the Class Period, as detailed herein, defendants engaged in a scheme to
deceive the market and a course of conduct that artificially inflated the price of Bally’s securities and
operated as a fraud or deceit on Class Period purchasers of Bally securities by misrepresenting the
Company’s financial results, business success and future business prospects. Defendants achieved
this facade of success, growth and strong future business prospects via improper accounting
(prematurely recognizing revenue and delaying the recordation of expenses) in violation of GAAP.
278. The false financial statements caused and maintained the artificial inflation in Bally’s
stock price throughout the Class Period.
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279. Defendants’ false and misleading statements had the intended effect and caused Bally
securities to trade at artificially inflated levels throughout the Class Period, reaching as high as $34
per share.
280. Over at least four and 1/2 years, defendants improperly inflated Bally’s reported
earnings. On April 28, 2004, however, when defendants’ prior misrepresentations and fraudulent
conduct were first disclosed and became apparent to the market, Bally stock fell precipitously as the
prior artificial inflation came out of Bally’s stock price. As a result of their purchases of Bally
securities during the Class Period, and the diminution in value attributable to disclosure of the truth,
Lead Plaintiff and other members of the Class suffered economic loss, i.e., damages under the federal
securities laws.
281. As a direct result of defendants’ admissions (later set forth with detail in the
Restatement) and the public revelations regarding the truth about Bally’s previously reported
financial results and its actual business prospects going forward, Bally’s stock price plummeted from
$5.40 on April 28, 2004 to $4.50 per share the following day, or over 16%. This drop removed the
inflation from Bally’s stock price, causing real economic loss to investors who had purchased the
stock during the Class Period. In sum, as the truth about defendants’ fraud and Bally’s business
performance was revealed, the Company’s stock price plummeted, the artificial inflation came out
of the stock and Lead Plaintiff and other members of the Class were damaged.
282. The timing and magnitude of Bally’s stock price decline negates any inference that
the loss suffered by Lead Plaintiff and other Class members was caused by changed market
conditions, macroeconomic or industry factors or Company-specific facts unrelated to the
defendants’ fraudulent conduct. During the same period in which Bally’s stock price fell
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approximately 16.6%, the Standard & Poor’s 500 securities index was down less than 1%. The
economic loss, i.e., damages, suffered by Lead Plaintiff and other members of the Class was a direct
result of and was proximately caused by defendants’ fraudulent scheme to artificially inflate Bally’s
stock price and the subsequent significant decline in the price of Bally’s stock when defendants’
prior misrepresentations and other fraudulent conduct were revealed.
APPLICABILITY OF PRESUMPTION OF RELIANCE:
FRAUD-ON-THE-MARKET DOCTRINE
283. At all relevant times, the market for Bally’s securities was an efficient market for the
following reasons, among others:
(a) Bally’s stock met the requirements for listing, and was listed and actively traded on
the NYSE, a highly efficient and automated market;
(b) As a regulated issuer, Bally filed periodic public reports with the SEC and the NYSE;
(c) Bally regularly communicated with public investors via established market
communication mechanisms, including through regular disseminations of press releases on the
national circuits of major newswire services and through other wide-ranging public disclosures, such
as communications with the financial press and other similar reporting services; and
(d) Bally was followed by several securities analysts employed by major brokerage firms
who wrote reports which were distributed to the sales force and certain customers of their respective
brokerage firms. Each of these reports was publicly available and entered the public marketplace.
284. As a result of the foregoing, the market for Bally’s securities promptly digested
current information regarding Bally from all publicly available sources and reflected such
information in Bally’s stock price. Under these circumstances, all purchasers of Bally’s securities
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during the Class Period suffered similar injury through their purchase of Bally’s securities at
artificially inflated prices and a presumption of reliance applies.
NO SAFE HARBOR
285. The statutory safe harbor provided for forward-looking statements under certain
circumstances does not apply to the false statements pleaded in this complaint, which consist
primarily of materially false and misleading statements of Bally’s historical performance. Moreover,
many of the specific statements pleaded herein were not identified as “forward-looking statements”
when made. To the extent there were any forward-looking statements, there was no meaningful
cautionary statement identifying important factors that could cause actual results to differ materially
from those in the purportedly forward-looking statements. Alternatively, to the extent that the
statutory safe harbor does apply to any forward-looking statements pleaded herein, defendants are
liable for those false forward-looking statements because at the time each of those forward-looking
statements was made, the particular speaker knew that the particular forward-looking statement was
false, and/or the forward-looking statement was authorized and/or approved by an executive officer
of Bally who knew that those statements were false when made.
FIRST CLAIM
VIOLATION OF SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5
PROMULGATED THEREUNDER AGAINST ALL DEFENDANTS
286. Lead Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein.
287. During the Class Period, Bally, E&Y, and the Individual Defendants, and each of
them, carried out a plan, scheme and course of conduct which was intended to and, throughout the
Class Period, did: (i) deceive the investing public, including Lead Plaintiff and other Class members,
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as alleged herein; (ii) artificially inflate and maintain the market price of Bally’s securities; and (iii)
cause Lead Plaintiff and other members of the Class to purchase Bally’s securities at artificially
inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, defendants, and
each of them, took the actions set forth herein.
288. Defendants (i) employed devices, schemes, and artifices to defraud; (ii) made untrue
statements of material fact and/or omitted to state material facts necessary to make the statements
not misleading; and (iii) engaged in acts, practices, and a course of business which operated as a
fraud and deceit upon the purchasers of the Company’s securities in an effort to maintain artificially
high market prices for Bally’s securities in violation of Section 10(b) of the Exchange Act and Rule
10b-5. All defendants are sued as primary participants in the wrongful and illegal conduct charged
herein.
289. In addition to the duties of full disclosure imposed on defendants as a result of their
making of affirmative statements and reports, or participation in the making of affirmative
statements and reports to the investing public, defendants had a duty to promptly disseminate truthful
information that would be material to investors in compliance with the integrated disclosure
provisions of the SEC as embodied in SEC Regulation S-X (17 C.F.R. Sections 210.01 et seq.) and
Regulation 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 securities would be based on truthful, complete and
accurate information.
290. Bally, E&Y, and the Individual Defendants, individually and in concert, directly and
indirectly, by the use, means or instrumentalities of interstate commerce and/or of the mails, engaged
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and participated in a continuous course of conduct to conceal adverse material information about the
business, operations and future prospects of Bally as specified herein.
291. These defendants employed devices, schemes and artifices to defraud, while in
possession of material adverse non-public information and engaged in acts, practices, and a course
of conduct as alleged herein in an effort to assure investors of Bally’s value and performance and
continued substantial growth, which included the making of, or the participation in the making of,
untrue statements of material facts and omitting to state material facts necessary in order to make the
statements made about Bally and its business operations and future prospects in the light of the
circumstances under which they were made, not misleading, as set forth more particularly herein,
and engaged in transactions, practices and a course of business which operated as a fraud and deceit
upon the purchasers of Bally’s securities during the Class Period.
292. Each of the Individual Defendants’ primary liability, and controlling person liability,
arises from the following facts: (i) the Individual Defendants were high-level executives (CEOs and
CFO) and directors at the Company during the Class Period and members of the Company’s
management team and had control thereof; (ii) each of these defendants, by virtue of his
responsibilities and activities as a senior officer and director of the Company was privy to and
participated in the creation, development and reporting of the Company’s internal budgets, plans,
projections and/or reports; (iii) each of these defendants enjoyed significant personal contact and
familiarity with the other defendants and was advised of and had access to other members of the
Company’s management team, internal reports and other data and information about the Company’s
finances, operations, sales, and internal controls at all relevant times; and (iv) each of these
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defendants was aware of the Company’s dissemination of information to the investing public which
they knew or recklessly disregarded was materially false and misleading.
293. The defendants had actual knowledge of the misrepresentations and omissions of
material facts set forth herein, or acted with reckless disregard for the truth in that they failed to
ascertain and to disclose such facts, even though such facts were available to them. Such defendants’
material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose
and effect of concealing Bally’s operating condition and future business prospects from the investing
public and supporting the artificially inflated prices of its securities. As demonstrated by defendants’
overstatements and misstatements of the Company’s business, operations and earnings throughout
the Class Period, defendants, if they did not have actual knowledge of the misrepresentations and
omissions alleged, were reckless in failing to obtain such knowledge by deliberately refraining from
taking those steps necessary to discover whether those statements were false or misleading.
294. As a result of the dissemination of the materially false and misleading information
and failure to disclose material facts, as set forth above, the market price of Bally’s securities was
artificially inflated during the Class Period. In ignorance of the fact that market prices of Bally’s
publicly-traded securities were artificially inflated, and relying directly or indirectly on the false and
misleading statements made by defendants, or upon the integrity of the market in which the securities
trade, and/or on the absence of material adverse information that was known to or recklessly
disregarded by defendants but not disclosed in public statements by defendants during the Class
Period, Lead Plaintiff and the other members of the Class acquired Bally securities during the Class
Period at artificially high prices and were damaged by disclosure of the truth.
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295. At the time of said misrepresentations and omissions, Lead Plaintiff and other
members of the Class were ignorant of their falsity, and believed them to be true. Had Lead Plaintiff
and the other members of the Class and the marketplace known of the true financial condition and
business prospects of Bally, which were not disclosed by defendants, Lead Plaintiff and other
members of the Class would not have purchased or otherwise acquired their Bally securities, or, if
they had acquired such securities during the Class Period, they would not have done so at the
artificially inflated prices which they paid.
296. By virtue of the foregoing, defendants have violated Section 10(b) of the Exchange
Act, and Rule 10b-5 promulgated thereunder.
297. As a direct and proximate result of defendants’ wrongful conduct, Lead Plaintiff and
the other members of the Class suffered damages in connection with their respective purchases and
sales of the Company’s securities during the Class Period.
SECOND CLAIM
VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT AGAINST THE
INDIVIDUAL DEFENDANTS
298. Lead Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein.
299. The Individual Defendants acted as controlling persons of Bally within the meaning
of Section 20(a) of the Exchange Act as alleged herein. By virtue of their high-level positions, and
their ownership and contractual rights, participation in and/or awareness of the Company’s
operations and/or intimate knowledge of the false financial statements filed by the Company with
the SEC and disseminated to the investing public, the Individual Defendants had the power to
influence and control and did influence and control, directly or indirectly, the decision-making of
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the Company, including the content and dissemination of the various statements which Lead Plaintiff
contends are false and misleading. The Individual Defendants were provided with and/or had
unlimited access to copies of the Company’s reports, press releases, public filings and other
statements alleged by plaintiff to be misleading prior to and/or shortly after these statements were
issued and had the ability to prevent the issuance of the statements or cause the statements to be
corrected.
300. In particular, each of these defendants had direct and supervisory involvement in the
day-to-day operations of the Company and, therefore, is presumed to have had the power to control
or influence the particular transactions giving rise to the securities violations as alleged herein, and
exercised the same.
301. As set forth above, Bally and the Individual Defendants each violated Section 10(b)
and Rule 10b-5 by their acts and omissions as alleged in this Complaint. By virtue of their positions
as controlling persons, the Individual Defendants are liable pursuant to Section 20(a) of the
Exchange Act. As a direct and proximate result of defendants’ wrongful conduct, Lead Plaintiff and
other members of the Class suffered damages in connection with their purchases of the Company’s
securities during the Class Period.
WHEREFORE, Lead Plaintiff prays for relief and judgment, as follows:
(a) Determining that this action is a proper class action under Rule 23 of
the Federal Rules of Civil Procedure;
(b) Awarding compensatory damages in favor of Lead Plaintiff and the
other Class members against all defendants, jointly and severally, for all damages sustained as a
result of defendants’ wrongdoing, in an amount to be proven at trial, including interest thereon;
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CERTIFICATE OF SERVICE
I, Carol V.Gilden, an attorney, certify that on December 30, 2005, I served the
Consolidated Class Action Complaint on the parties set forth on the Service List below through
the CM/ECF system.
/s/ Carol V. Gilden
Carol V.Gilden
SERVICE LIST
Sherrie R. Savett
Douglas M. Risen
Berger & Montague
1622 Locust Street
Philadelphia, PA 19103
Tel: (215) 875-3000
Fax: (215) 875-4604
Erin S. Shaw
Amanda Jean Hollis
Robert Brian Tanner
Robert Walter Tarun
Latham & Watkins LLP
233 South Wacker Drive
5800 Sear Tower
Chicago, IL 60606
Tel: (312) 876-7700
Fax: (312) 993-9767
Laurie B. Smilan
Latham & Watkins, LLP
TwoFreedom Square
11955 Freedom Drive
Reston, VA 20190
Tel: (703) 456-1000
Case 1:04-cv-03530 Document 77 Filed 01/03/2006 Page 137 of 137
Howard S. Suskin
Ross M. Rosenberg
Shyni R. Varghese
William D. Heinz
Jenner & Block, LLP
One IBM Plaza
330 N. Wabash
Chicago, IL 60611
Tel: (312) 222-9350
Fax: (312) 840-7604
Gregory A. Markel
Gregory G. Ballard
Cadwalader Wickersham & Taft, LLP
One World Financial Center
New York, NY 10281
Tel: (212) 504-6000
Steven Bashwiner
Mary Ellen Hennessy
Dawn M. Canty
Katten Muchin Zavis Rosenman
525 W. Monroe
Chicago, IL 60661
Tel: (312) 902-5200
Fax: (312) 902-1061
