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In Re Dynacq International_ Inc. Securities Litigation 02-CV

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                                                                            United States Courts
s         t                                                              Souther District of Texas
                                                                                  FILED

                                                                       W SEP 16 2002

                                                                          Michael N. Milby, Clerk
                               IN THE UNITED STATES DISTRICT COURT
                               FOR THE SOUTHERN DISTRICT OF TEXAS
                                        HOUSTON DIVISION


         CEDRIC C. JIMERSON and JACK D.              Master File No. H-02-0377
         HAMILTON, On Behalf of Themselves and All
         Others Similarly Situated,                  CLASS ACTION

                                     Plaintiffs,

               vs.

         DYNACQ INTERNATIONAL, INC., CHIU
         MOON CHAN, ELLA CHAN and PHILIP S
         CHAN,                                                     ORIGINAL                          0
                                     Defendants


         In re DYNACQ INTERNATIONAL, INC.
         SECURITIES LITIGATION


         This Document Relates To:

               ALL ACTIONS.
                                                     DEMAND FOR JURY TRIAL




                         CONSOLIDATED COMPLAINT FOR VIOLATION OF
                            THE SECURITIES EXCHANGE ACT OF 1934




                                                                      269
                                         INTRODUCTION

           1.   This is a class action on behalf of all persons who purchased the common stock of

Dynacq International, Inc. ("Dynacq" or the "Company") between November 30, 2000 and

January 16, 2002 (the "Class Period"), against Dynacq and its CEO, CFO and controlling shareholder

for violations of §§10(b), 20(a) and 20A of the Securities Exchange Act of 1934 (" 1934 Act").

           2.   Dynacq owns and operates an integrated healthcare delivery system that includes

outpatient surgical centers, hospital, physician management services , and home infusion therapy.

During the Class Period , defendants misrepresented that Dynacq's favorable financial results were

due to its commitment to quality and cost- effective care , stating that Dynacq's financials were strong

and attributing the Company's stellar bottom line to its " state-of-the-art" facilities and "high-quality

patient care ." Defendants also misrepresented that Dynacq's publicly reported financial statements

and financial results were true and correct and in compliance with Generally Accepted Accounting

Principles ("GAAP").

           3.   Defendants' false and misleading statements propelled Dynacq common stock from

below $5 per share to an all-time and Class Period high of $29.25 per share. While Dynacq stock

traded at artificially inflated levels, Dynacq's top insiders engaged in a massive insider trading

bailout. Dynacq's CEO, defendant Chiu Moon Chan and his wife, defendant Ella Chan - Dynacq's

largest individual shareholder - sold 281,874 shares of the Dynacq common stock that they actually

owned for unlawful insider trading proceeds of $5.7 million, while Dynacq's CFO, defendant Philip

S. Chan, sold 24,850 shares of the Dynacq common stock that he actually owned for unlawful insider

trading proceeds of $394,306. These stock sales were both suspicious in timing and amount as they

were defendants' largest sales ever, coincided with Dynacq's announcements of "record" earnings

results, and occurred at or near Dynacq's all-time highest stock prices. Chiu Chan and Ella Chan's

insider stock sales were also especially suspicious because they immediately preceded the disclosure

of adverse, material non-public information about Dynacq's hospital and surgical centers.            For

example, after learning on October 4, 2001, that the U.S. Department of Health and Human Services

had found Dynacq's hospital to be in violation of federal regulations, Chiu and Ella Chan sold 23,000

shares of stock on October 4 and 5, 2001, for over $450,000 in unlawful insider trading proceeds.

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Chiu and Ella Chan then stepped-up their sales over the next three months to exceed $3.1 million

and 143,874 shares, all prior to the public disclosure of the U.S. Department of Health and Human
Services' findings after the end of the Class Period.

           4.     Dynacq's common stock continued to trade at artificially inflated levels until mid-

January 2002. However, defendants could no longer conceal their fraudulent scheme to artificially

inflate Dynacq's stock price and insider bailout forever.          On January 16, 2002, Dynacq stock

collapsed by over 50% to as low as $12.26 per share when TheStreef.com published an article

exposing defendants' misconduct entitled "Dynacq's Doubtful Accounts Sends Distress Signals."

                     When it comes to red flags, so many are flying over Dynacq International...
           that it's hard to count. Dynacq owns and manages an acute care hospital in Pasadena,
           Texas, where it manages three physician practices. It also operates two outpatient
           surgical facilities and a medical office complex.

                    The only analyst covering the company, Gary Weber of Taglich Brothers,
           rates it a buy. That Dynacq pays Taglich for that coverage is reason enough to
           warrant caution: The disclosure is right there in the fine print of the analyst's report.

                   But in recent quarters there have been numerous other issues that, by
           themselves, would warrant a mention here. For example, Dynacq's allowance for
           doubtful accounts - something every CFO should know like the back of his or her
           hand - has been hovering around the I% range, which is far below the level used by
           such rivals as HCA, ... Tenet ... and Universal. Yet when asked about the amount of
           the allowance on the company's bizarre conference call Tuesday, CFO Philip Chan
           couldn't answer the question.

                   The dialogue is worth the price of admission.

                          Caller: Could you give us where allowance for doubtful
                   accounts stands right now, please?

                          CFO: Are you asking the provision for uncollectible accounts
                   of $41,673 on the income statement ? Or are you talking about ...

                           Caller: I'm talking about the reserve - the allowance for
                   doubtful accounts that would be against your gross receivables so that
                   you have - you report net accounts receivable. What is your
                   allowance for doubtful accounts? What's your reserve that's been
                   built up over time?

                           CFO: The way we present our [unintelligible] and net
                   revenue and that is the gross revenue minus, I believe, what you are
                   talking about the reserve for uncollectible portion from insurance
                   company or third party.

                          Caller: Uh, either one. Let me, maybe if I can contrast it
                   where it was in the 10-K. ... Anyway, it's a standard nomenclature.


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                  It's called allowance for doubtful accounts . ... It was $193,000 in
                  August. Do you know what it is now, please?

                          CFO: Let me turn my page on the same page that you are
                  saying ... a minute.

                         Caller: All right, let me - maybe I can go on while he's
                  searching that. If I could ask another question here ...

                  And so it was! The entire call was pretty much like that.

                  Take the same caller's question about the company's revenue per hospital bed,
           which appears to be much higher than the average for the acute care hospital industry.

                          Caller: You have 37 beds and in the hospital you had
                  revenues in here ofjust under $9 million, and that equates somewhere
                  to about a quarter-million dollars revenue per bed.           That is
                  substantially higher than industry averages. Why is that?

                          CEO Chiu Chan (who, according to the 10-K is not related to
                  the CFO): We are not general acute hospital. We are surgical
                  hospital.

                   Not an acute care hospital?! The company itself says in its 10-K, filed
           Nov. 27, that it is engaged in "the ownership and management of an acute care
           hospital."

                   The caller continues, saying that revenue at Dynacq's clinic and outpatient
           surgical center, which had been a key driver of Dynacq's growth, was "down about
           7% year over year. At the same time, the hospital revenues just skyrocketed here.
           They were up 160% or something."

                           CEO Chan: Well, as you can see, we are aligning our
                   company towards - we are now saying that Dynacq is a surgical
                   hospital company . We are a surgical hospital company. That is the
                   direction which we are going . So, right now all the focus is, the
                   management focus is a surgical hospital company.

                    Chan later added: "The reason why we are trying to do this is because we
           listen to a lot of the research analysts or those brokers about a single focus company
           enhance our shareholder value a lot better than getting more - all this kind of other
           business. ... So, the other thing which is not surgical hospital business is going to go
           gradually - scale down."

                   But last March Dynacq purchased a second ambulatory or outpatient surgery
           center. Now it's saying that that part of the business will no longer be a focus?!
                   The conference call continued. A different caller noted that the company had
           "very impressive" 12% revenue growth in the fourth quarter from the third quarter.
           "But it appears net income may have declined slightly quarter to quarter. Is that the
           case?"

                            CEO: Net income? No. I don't think so. Net income actually
                   go up.


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                                                                                264
                         Caller No. 2: I backed out that the fourth quarter net income
                  was about $3,490,000.... I have this quarter at about $3,378,000. So,
                  maybe a 3% or so decline in net income, and you had 12% sequential
                  revenue growth. I'm just curious where ...

                   The CEO then started talking about how earnings per share of 23 cents were
           higher than the prior quarter's 22 cents, then injected:
                          CFO: Your math ... could be very well correct . The thing that
                  may confuse a little bit during the fourth quarter is where we have the
                  annual audit come in and make all the adjustments. There's no
                  significant adjustment that we made . You may be able to look at the
                  income tax provision for the fourth quarter, which kind of declined
                  pretty significantly from the periods before . That is the time that the
                  auditor come in and look our annual income tax situation.

                          Caller No. 2: OK ... the real question I'm driving at ... it
                  appears that your profit margins came down quite a bit from quarter
                  to quarter [net profit margin was down nearly 4 percentage points
                  from the fourth quarter to the first quarter] ... and I'm just wondering
                  if you could comment a little bit on why the profit margins ...
                  contracted, and again, is this something we should expect going
                  forward?

                          CEO: If you look at the number for the whole fiscal year last
                  year, our profit margin is ... 25.3. Therefore our net margin is 24.7 or
                  24.6. So we are talking about a decimal point percentage difference,
                  and I don't think it's something of anybody's concern.

                   Year over year, maybe, but quarter to quarter it's nearly 4 percentage points.
           That's certainly somebody's concern. But I digress, as the call returned to the subject
           of the allowance for doubtful accounts.

                          Caller No. 1: I wondered if you' d had a chance to find that
                  answer on the allowance for doubtful accounts on accounts
                  receivable?

                          CFO: I tried to find out the real question - all on income
                  statement, the only provision for uncollectible account is - for this
                  quarter is $41,670 ... before talk about $137,000 - 1 don't know what
                  number you have been looking at.

                          Caller No. 1: $193,000 is what it was in August.

                          CFO: In August $193,000?

                          Caller No. 1: August of'01.

                          CFO: Hold on.

           5.      On January 23, 2002, The Wall Street Journal exposed defendants ' massive insider

bailout, reporting that Dynacq's top insiders sold shares in advance of the stock's fall, but failed to

disclose those sales properly. The Wall Street Journal also revealed that the U. S. Department of

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                                                                           1-    265
Health and Human Services had issued a report to Dynacq in October 2001, finding that Dynacq's

flagship Vista Medical Center Hospital was maintained in unsafe conditions, including black mold

contamination in operating rooms. On this news, Dynacq's stock price declined to $10 per share on

January 29, 2002, and to $6 per share on February 4, 2002. As a result of defendants' misconduct,

Lead Plaintiffs and the Class suffered tens of millions in damages.

                                 JURISDICTION AND VENUE

           6.   This Court has jurisdiction over the subject matter of this action under §27 of the

1934 Act, 15 U.S.C. §78aa, and 28 U.S.C. §§1331 and 1337. The claims alleged herein arise under

§§l0(b), 20(a) and 20A of the 1934 Act, 15 U.S.C. §§78j(b), 78t(a) and 78t-1, and Rule lOb-5

promulgated thereunder by the Securities and Exchange Commission ("SEC").

                                          THE PARTIES

Plaintiffs

           7.   (a)    Lead Plaintiff Cedric C. Jimerson purchased 7,300 shares of Dynacq

common stock and suffered damages as a result of the violations alleged herein.

                (b)    Lead PlaintiffJack D. Hamilton purchased 6,000 shares ofDynacq common

stock and suffered damages as a result of the violations alleged herein.

                (c)    The factual allegations of the Complaint are based on information obtained

by plaintiffs' counsel from current and former employees, supervisors and managers of Dynacq

responsible for the Company's accounting, billings and collections, financial reporting, patient care

and maintenance functions.

Defendants

           8.   Defendant Dynacq International , Inc., a Nevada corporation, is headquartered at

10304 Interstate 10 East, Suite 369, Houston, Texas , 77029. Dynacq's common stock trades in an

efficient market on the NASDAQ National Market System.

           9.   (a)    Defendant Chiu Moon Chan ("Chiu Chan") was, during the Class Period,

CEO and Chairman of the Board of the Company, as well as a member of Dynacq' s leadership team,

the small, insular group of senior officers who personally guided Dynacq's business affairs on a daily

basis. Chiu Chan sold 281,874 shares of Dynacq stock that he actually owned during the Class

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Period for prices as high as $28.65 per share, reaping proceeds of $5.7 million from insider trading

activity. These sales were unusual in timing and amount in that they came on the heels of Dynacq's

positive earnings announcements, reporting "record" results, and while Dynacq stock traded at prices

approaching its all-time and Class Period high of $29.25 per share. These suspicious sales are

depicted graphically in Exhibit A.

                 (b)   Defendant Ella Chan ("Ella Chan") was, during the Class Period, a

controlling shareholder of Dynacq by virtue of her direct or indirect ownership of more than 65%

of the Company's outstanding common stock. Ella Chan is also the wife of Dynacq's Chairman and

CEO, defendant Chiu Chan. Ella Chan sold 281,874 shares of the Dynacq stock that she actually

owned during the Class Period for prices as high as $28.65 per share, reaping proceeds of $5.7

million from insider trading activity. These sales were unusual in timing and amount in that they

came on the heels of Dynacq's positive earnings announcements, reporting "record" results, and

while Dynacq stock traded at prices approaching its all-time and Class Period high of $29.25 per

share. These suspicious sales are depicted graphically in Exhibit A.

                 (c)    Defendant Philip S. Chan ("Philip Chan") was, during the Class Period,

CFO, Vice President of Finance and Treasurer of the Company, as well as a member of Dynacq's

leadership team, the small, insular group of senior officers who personally guided Dynacq's business

affairs on a daily basis. Philip Chan sold 24,850 shares of Dynacq stock that he actually owned

during the Class Period for prices as high as $28 per share, reaping proceeds of $394,306 from

insider trading activity. These sales were unusual in timing and amount in that they came on the

heels of Dynacq's positive earnings announcements, reporting "record" results, and while Dynacq

stock traded at prices approaching its all-time and Class Period high of $29.25 per share. These

suspicious stock sales are depicted graphically in Exhibit A.

           10.   Chiu Chan (CEO) and Philip Chan (CFO) were the top two executives of Dynacq and

members of its leadership team, and, Ella Chan, at all relevant times, was Dynacq's controlling

shareholder. Together, they ran Dynacq as "hands-on" managers, dealing with important issues

facing Dynacq's business and representing to the investing public that they were successfully

implementing Dynacq's operating strategy of becoming a leading operator of ultra-efficient, high-

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•   volume speciality surgical hospitals and ambulatory surgery centers, thereby enabling the Company

    to continue to report rapid earnings and revenue growth in 2000, 2001, 2002 and beyond. According

    to colleagues, Chiu Chan's involvement in every facet of Dynacq' s business was manifest.

    According to one knowledgeable source in Dynacq's nursing department, " nothing happened without

    Chiu Chan" because he had to "approve everything."

               11.    A key factor in the Dynacq "story" was its ability to expand rapidly by opening new

    and expanding its existing hospital and surgical facilities, while sequentially reporting strong

    earnings growth. Thus, defendants closely monitored every material aspect of Dynacq's healthcare

    business, including accounts receivables, and actually knew, from the outset of the Class Period, that

    Dynacq's business was not performing nearly as well as defendants had told the market and misled

    investors to expect. Nevertheless, at every opportunity during the Class Period, defendants flooded

    the market with false positive statements about Dynacq's financial condition and their ability to grow

    the Company's revenues and earnings via Dynacq's "state-of-the-art" hospitals and surgical centers.

               12.   - Each defendant is liable for making false statements or for failing to disclose adverse

    material facts while selling Dynacq common stock, or for participating in a fraudulent scheme which

    operated as a fraud or deceit on purchasers and acquirers of Dynacq common stock. They are also

    liable for the false statements pled in ¶124, 34-35, 37, 39, 41-43, 47, 49, 51, 55-56, 58, 60-61, as

    those statements were each " group-published " information for which defendants were collectively

    responsible as officers and/or directors of the Company, as well as for the false statements pled in

    ¶¶38, 45, 52, 62, as those statements were made by defendants to securities analysts for the purpose

    of artificially inflating Dynacq's stock price during the Class Period.

               13.     In addition to knowing or recklessly disregarding that their Class Period statements

    were false or misleading when made, defendants also had the motive and opportunity to perpetrate

    the fraudulent scheme and course of conduct alleged herein. Specifically, by artificially inflating

    Dynacq's common stock price by making it appear that Dynacq was a fast growing company with

    sustainable growth, Dynacq insiders were able to sell 306,724 shares of their personal Dynacq

    common stock during the Class Period, pocketing over $6.1 million in unlawful insider trading



    00047514                                              7
proceeds, while Dynacq was able to acquire other healthcare companies cheaply in exchange, in

whole or in part, for artificially inflated Dynacq common stock.

                                            SCIENTER

Defendants Knew or Recklessly Disregarded
Dynacq's Overstated Accounts Receivable

           14.   Defendants were personally familiar with the quality of the Company's accounts

receivables and revenues because they monitored Dynacq's sales, closely monitoring the performance

of Dynacq's operations via Monthly Accounts Receivable Reports and other reports from Dynacq's

Finance Department, which were generated and provided to Chiu Chan, Ella Chan and Philip Chan

on a regular basis. The reports summarized the amounts billed, collected and outstanding accounts

receivable at the end of the prior month/beginning of the current month.        As a result of their

monitoring, defendants were aware that Dynacq would be unable to meet its projected results, and

that its receivables were grossly overstated.

           15.   Indeed, according to a former Dynacq collections staff member, on the first

Wednesday of every month, Philip Chan, Chiu Chan, J.L. Flotte, Sarah Garvin and Jean Wincher

(head of billings and collections) met to discuss the Monthly Accounts Receivable Report. This

report was created by Jean Wincher, and detailed totals for the amounts billed, collected, and

outstanding accounts receivable at the end of the prior/beginning of the current month. Further,

Philip Chan also received summary versions of the Monthly Accounts Receivable Report.

Defendants Knew or Recklessly Disregarded
the Deficient Quality of Dynacq ' s Healthcare Services

           16.   Throughout the Class Period, defendants repeatedly asserted that Dynacq's impressive

results were the result of the Company's unique and efficient model for running their state-of-the-art

facilities - thus, enabling Dynacq to attract top doctors and provide quality service. This, according

to defendants, resulted in growing revenues and increased income. However, Dynacq's facilities

were not state-of-the-art and its doctors and services were not top quality. Indeed, the Company's

poor health services were noted to at least defendants Chiu Chan and Philip Chan by Dynacq's nurses

and other employees.



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                                                                             261
           17.    Defendants knew or recklessly disregarded that the doctors under its employ were not

the "top" or "premier" surgeons they had represented them to be because, among other things, they

did extensive background checks on each doctor. As The Pasadena Citizen wrote after interviewing

Dynacq's Senior Vice President Don Holt:

                   Before granting privileges to physicians and surgeons, Vista Medical Center
           Hospital verifies a degree and date of issuance from the school, Texas license and
           standing, liability insurance, past claim history, post graduate courses, personal
           references and hospital references.

                  [Don Holt, senior vice president for Vista Medical Center,] said the hospital
           conducts extensive background checks.

           18.    With respect to the quality of Dynacq's health care services , defendants knowingly

or recklessly disregarded the veracity of their statements to the market. On numerous occasions,

senior staff persons at Dynacq provided defendants with written notification of their concerns about

patient care issues. For example, a Dynacq Director ofNursing, who left the Company in early 2001

because of "patient care issues," sent defendant Chiu Chan two certified letters, which concerned the

hospital's improper staffing and unsafe conditions.

           19.    Defendants were also fully aware of the deplorable conditions of Dynacq's facilities,

and the risks those poor conditions posed to patients. The U.S. Department of Health and Human

Services' surveyor discussed the Department's adverse findings concerning mold and other problems

at Vista Medical Center Hospital with Dynacq on October 4, 2001 - months before the end of the

Class Period. Thereafter, Dynacq's CEO, defendant Chiu Chan, and his wife, defendant Ella Chan,

sold 23,000 shares of stock on October 4 and 5, 2001 for over $450,000 - and stepped-up their

insider sales over the next three months to exceed $3.1 million and 143,874 shares, all prior to the

public disclosure of the U. S. Department of Health and Human Services' adverse findings.

           20.    Chiu Chan, however, knew of the problems at the heart of the Department of Health

and Human Services' findings long before the government discovered the problems at Dynacq's

facilities. For example, as detailed in ¶28 below, a Dynacq maintenance supervisor witnessed the

significant mold problem that was cited by the Department of Health and Human Services, and

personally informed Chiu Chan as to the conditions and the import of this problem earlier in the

Class Period.

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                                                                     r     260
Defendants Had Both Motive and Opportunity to
Artificially Inflate Dynacq ' s Stock Price

            21.    During the Class Period, Chiu Chan, Ella Chan and Philip Chan owned significant

amounts of Dynacq common stock. This large equity stake gave these defendants a very strong

motive to do everything they could to keep Dynacq's stock price up, including making false and

misleading statements to public investors about the actual state of the Company's business and

affairs.

            22.    As set forth graphically in Exhibit A, while defendants were making false and

misleading statements about Dynacq which artificially inflated the price of Dynacq common stock

from below $5 per share to over $29 per share, Dynacq's top insiders, and particularly Chiu Chan,

Ella Chan and Philip Chan, were engaged in a massive insider bailout. Collectively, defendants sold

306,724 shares of the Dynacq common stock that they actually owned at prices as high as $28.65 per

share, pocketing over $6.1 million in unlawful insider trading proceeds. Defendants' stock sales

were highly suspicious, as The Wall Street Journal noted in an article published on January 23, 2002,

exposing Dynacq's insider trading bailout:

                    Insiders at Dynacq International Inc., shares of which have almost halved in
            the past week amid questions about the company's accounting, took advantage of the
            stock's prior strong run by selling shares.

                    Executives, their wives and other employees at the Houston health-care
            services provider said they planned to sell about 150,000 company shares since
            October. Dynacq stock traded at $12.69, down $1.41, or 10%, yesterday in 4 p.m.
            Nasdaq Stock Market trading, having peaked at $29.25 earlier this month.

                    Chief Financial Officer Philip Chan and his wife, Stella Shek, sold 2,800 and
            4,200 shares, respectively, in November, when the stock was trading at about $24 a
            share, said Mr. Chan. Ella Chan, wife of Chief Executive Chiu Chan - no relation
            to Philip Chan - has sold 42,801 shares since October.



                    But disclosure of the trades has been spotty. Philip Chan reported his
            intention to sell the shares in October, but by mid-January had not reported the actual
            sale. Insiders are required to file details of a completed stock sale or purchase by the
            10th day of the month following the trade. "We overlooked that," says Mr. Chan, and
            the company says disclosure of the trade has now been filed.

                    Chiu Chan made no disclosure about a change in holdings following the sale
            of shares by his wife. As of Nov. 13, Chiu Chan reported an 8.9-million-share stake,
            valued at about $260 million at the stock's peak, which does include shares held by
            Chiu Chan's wife, the company says. Typically, securities lawyers say, an executive

0001'7514                                              10                '

                                                                             r-   259
           will disclose any changes in those reported holdings, even if the shares being sold are
           being held under the spouse's name. Dynacq says that Ella Chan - who has sold
           281,874 shares valued at $5.7 million since the beginning of 2001 - owns the shares
           sold in her name and that they are her personal property."

           23.     Defendants were also motivated to artificially inflate Dynacq's stock price so that they

could use Dynacq's stock, in whole or in part, as currency to make acquisitions more cheaply.

                   DEFENDANTS' FALSE AND MISLEADING STATEMENTS

           24.     Dynacq owns and manages an acute care hospital, two outpatient surgical facilities,

a medical office complex, and a physician practices management business providing home infusion

healthcare services to patients in their homes. Throughout the Class Period, defendants described

Dynacq's healthcare delivery model in very favorable terms on the Company's website, emphasizing

the quality of Dynacq's hospital and surgical centers, the qualifications and professional standing of

its doctors, and efficiency and professionalism of its support staff.         For example, in describing

Dynacq's flagship facility, the Vista Medical Center Hospital, defendants stated:

                    This is the flagship of the Dynacq system.        Designed and built by
           management, VMCH is the model of surgical efficiency and patient care on which
           Dynacq's future facilities will be based. This compact prototype offers large,
           well-equipped operating rooms utilized by top surgeons and experienced staff, and
           is a healthful patient environment where personal attention is the order of the day.

                   VMCH focuses on specialized surgical procedures without the stress and
           disruptions of large general hospitals. This atmosphere fosters patient well-being and
           fast recovery, as well as optimal use of expensive facilities and surgeons' valuable
           time. The hospital is part of Dynacq's central campus, which is also home to Vista
           Ambulatory Surgical Center and a professional building housing physicians, ancillary
           services and corporate headquarters.

           25.     The statements in ¶24 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq did not provide

high-quality nor efficient patient care. Further, the quality of medical services provided by Dynacq

and its doctors was highly suspect. Indeed, numerous Dynacq nurses and employees complained to

defendants about Dynacq's inadequate patient care and facilities. For example, according to a former

Dynacq nurse, Dynacq fired its entire Emergency Room physician staff in the summer of 1999 as

a cost-cutting step - and never hired sufficient replacements. This witness refused to continue

working for defendants, telling them that she "wasn't going to risk somebody's life" and that "there

is no way you can safely practice in an emergency room like that." The witness subsequently left

00047514
                                                                          r      2 5 S
the Company because ofthese concerns. Further, a former Director ofthe Emergency Room at Vista

Hospital provided the same account ofthe firing ofthe E.R. physicians. Providing greater detail, this

witness explained that after Dynacq fired its E.R. staff (the Schumacher Group), the E.R. was run

by borrowing doctors from the Vista Surgical Center during the day, but without any on-site doctors

during the night. This, in itself, was dangerous. Furthermore, at night, the E.R. was staffed only by

nurses - who admittedly worried about the propriety of doing so and, increasingly, refused to work

the night shift for fear of being ill-equipped and ill-supported when an emergency occurred. The

nurses further worried that their continued employment under these conditions could cause them to

lose their licenses. Thus, the E.R. was oftentimes not even adequately staffed with nurses, leaving

it incapable of providing adequate care to its patients.

           26.   These issues were brought to the attention of defendants in a letter and a

memorandum to Dynacq senior staff persons, Glenn Rodriguez (Administrator of Vista Medical

Center Hospital) on July 30, 1999 and Janice Goad (Director of Nursing) on August 3, 1999.

Mr. Rodriguez reported these adverse facts to his superior, defendant Chiu Chan. A follow-up

memorandum was sent to Chiu Chan, Joyce Bossett and Glenn Rodriguez on September 13, 1999

raising concerns of "potential liability" from "continued incidents." Again, on October 4, 1999, a

memorandum sent to Glenn Rodriguez reiterated concerns that the emergency room was not properly

staffed, and summed-up defendants' disregard for following proper procedure, as the memorandum

stated with respect to the Company: "As you have explained, as long as the operating room does not

generate revenues the rest of the hospital areas are secondary."

           27.   These safety and quality of care issues in the emergency room of Vista Medical

Center continued into and through the Class Period. According to a former Director of Emergency

Room Nursing Services, between mid-2000 and the end of October 2001, there was never enough

money to run the emergency room properly.          Indeed, the E.R. (and the Intensive Care Unit)

constantly ran out of supplies and did not have enough equipment. Supplies were hard to get, as

suppliers (fed-up with the Company's repeated failures to pay bills promptly) would only ship goods

on a cash basis. Further, at least two of the doctors who saw patients in the E.R. did not have

training or experience in dealing with emergency room trauma patients.

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           28.   Dynacq's Vista Medical Center Hospital was not "the model of surgical efficiency and

patient care." On the contrary, the hospital, at all relevant times, had dangerous black mold growing

in its walls, the result of a humidity and poor-air conditioning problem. Consequently, conditions

in the hospital's operating rooms were dangerous, and patients' rooms and bathrooms were in

violation of federal and state law. This was known to defendants because, among other things, a

former Dynacq maintenance supervisor witnessed these conditions and personally informed

defendant Chiu Chan as to the conditions. Indeed, according to this individual, the air conditioning

problem that caused the mold growth was the result of a modification to the hospital's ventilation

system that defendant Chiu Chan had personally insisted upon. The builder who installed the central

air conditioning unit causing the mold problem specifically told Chiu Chan that doing so would

likely cause problems, but Chiu Chan disregarded the builder's opinion. The mold problem later

became the subject of a federal government report, as was reported by The Wall Street Journal just

after the end of the Class Period on January 23, 2002: "[A] Department of Health and Human

Services inspection revealed [that Dynacq's] flagship hospital was in less than peak condition. 'The

hospital's environment had not been maintained in a manner that the safety and well-being of patients

was assured,' according to the report."

           29.   Because Dynacq's hospitals and surgical centers were not top notch facilities with

state-of-the-art services, the Company was forced to hire some doctors with disreputable histories,

who were the subject of official inquiry, reprimand and litigation, and which posed a great risk of

liability to the hospital. Thus, defendants' statements that "top surgeons" worked at or with Dynacq

were also false and misleading because, rather than providing "high-quality" care, Dynacq's business

model included hiring some doctors whose credentials might be considered highly suspect. Each

of these doctors was employed at Dynacq's facilities, and their reputations were such that defendants

either knew or recklessly disregarded the truth of their statements to the market.

           30.   For example, Dynacq did not hire "top surgeons," but employed doctors such as Eric

Scheffey. Scheffey performed major surgeries for Dynacq even though, in the past, his medical

license had been "severely restricted" by state officials.     The Texas State Board of Medical

Examiners found that Scheffey has performed unnecessary operations and overcharged customers

00047514                                          13

-                                                                     r      256
(i.'e., patients) for those services. Furthermore, Scheffey admitted to state officials that he has settled

between 20 and 30 medical malpractice claims - which, according to Dr. Martin Barrash (a well

respected neurosurgeon and past President of the Texas Association ofNeurological Surgeons), may

be more medical malpractice claims than any other doctor in the entire United States. Indeed, Ken

Wood, a recent Scheffey patient, was told by a Houston area pharmacy that the pharmacy refused

to fill any prescription written by Scheffey and, furthermore, the pharmacy did not believe that

anyone in the Houston area would fill a prescription written by Scheffey.

           31.    Scheffey also topped list of doctors who have paid the most to settle malpractice

claims and have large numbers of entries in the National Practitioner Data Bank - 40 in his case.

                   To create the list, The Courani focused on doctors with 25 or more data bank
           entries, including at least one state regulatory action, and at least $3 million in
           malpractice payments . Eight physicians fit those criteria ; half of them are still
           practicing.

                   Few cases illustrate the controversy over licensing problem doctors, and the
           secrecy surrounding their backgrounds, like that of Scheffey, a wealthy Ferrari
           collector whose nickname among medical residents at one Houston hospital was
           "Eric the Red." That catchy moniker came not from the color of his sports cars, but
           from hospital gossip that his patients tended to bleed heavily during surgeries.

                    Despite his legal troubles, Scheffey - who flunked orthopedic board
           certification three times - still runs a thriving practice in Houston, where he lives in
           a gated, $3 million estate with his collections of art and expensive automobiles. He
           did not respond to messages left at his home, office and lawyer's office, nor to a
           certified letter seeking comment.

                   Because federal law prohibits anyone other than hospitals, HMOs and
           licensing boards from checking the data bank, Freeman and other patients of
           Scheffey's probably never heard of Pete Dunstan, Bobby Hall, Augustine Collins,
           Charles Caldwell, Craig Watson, Donald Taylor, Ronnie Armstead and John Ingram.

                   Those are some of the people who have quietly settled malpractice cases
           against Scheffey over the years. Others , like Mary Tywater, never had a chance to
           sue.

                   Shortly before Memorial Day in 1985, Tywater, a 43-year-old housewife from
           Daisetta, died during a back operation by Scheffey. Scheffey went home and kicked
           off a long holiday weekend that ended in his arrest for cocaine possession, when he
           was found wandering in a Montgomery Ward's dressed in surgical garb and muttering
           incoherently, according to court records.

                   Scheffey's medical license was put on probation for 10 years, but he was
           allowed to keep practicing. It was left to Tywater's grieving family to press a claim
           against Scheffey that she bled to death because of his negligence. His insurance
           company settled the case for $1 million, but Scheffey denied he was negligent.


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                                                                             255
                   Although glimpses of Scheffey's legal problems occasionally appeared in the
           news, none of his patients or even the trial lawyers suing him was able to fully check
           his background. Lawyers familiar with Scheffey's legal history say the $8.5 million
           recorded in the data bank does not include another $1 million in payments made by
           Scheffey's insurance companies in the late 1980s - before the data bank began
           recording information in September 1990.



           [I]n 1994, the Texas State Board of Medical Examiners held an emergency hearing
           to consider suspending Scheffey's license.

                   "It is my opinion that Dr. Scheffey is a continuing threat and an imminent
           threat to the public with his type of practice of medicine," Dr. Bruce Cameron, a
           Houston orthopedic surgeon, wrote in a statement to the board. He added that he
           thought Freeman's surgery had been unnecessary.

                  [This investigation] happened to coincide with the release of a lengthy report
           by an administrative law judge, who examined four cases involving Scheffey and
           concluded that he performed unwarranted surgeries and then over-charged for them.
           That inquiry began in 1989, when the state medical board questioned Scheffey's
           handling of 21 case[s]; it later narrowed the list to just the four.

                    While noting that Scheffey appeared to have overcome the drug problem that
           afflicted him in the 1980s, Judge Cathleen Parsley nevertheless recommended that
           Scheffey lose his license.

                   "The pattern of conduct in this case is too egregious not to be sanctioned
           heavily," wrote Parsley. "Did this doctor over-treat and overcharge these four
           patients to the extent that revocation of his license is warranted? The answer is
           simple: yes."

                   But the medical board didn't find it so simple.

                    In 1995, it rejected both the petition for an emergency suspension and
           Parsley's revocation recommendation, and instead put Scheffey's license on probation
           for five years. The board vote against revocation was 5-3, with five doctor members
           overruling three public, non-doctor members. One doctor abstained.



                  Scheffey continues to practice, although, as part of his probation, he cannot
           perform operations without another surgeon present. The restrictions do not seem
           to have dampened his business - a reporter who called his office recently was told
           Scheffey didn't have time to talk "because he has a very, very high-volume practice."



                    "I've seen over 100 former patients of his over the years, and it's the most
           frustrating experience," Barrash said in an interview. "By the time they get here,
           there's very little I can do for them."

           32.     Dynacq also employed Dr. Maurice S. Conte during 2000. State medical records

show that the Texas State Board of Medical Examiners placed Conte on a five year probation in

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                                                                                   254
1990. After a finding that Conte failed to perform "adequate examinations" of two patients and did

not provide proper care to a pregnant patient, he was required to take a Special Purpose Examination

to keep his license; he failed twice. Thus, in 1993, Conte had his license suspended. Conte's license

was reinstated in 1995.

           33.    Other doctors employed by Dynacq are presently in litigation over the quality oftheir

performance, with Dynacq having been named in at least two lawsuits active during the Class Period.

The allegations in ScottRamirez v. Vista Heath Care, Inc., No. 2000-0295 8 (Harris County District

Court, Texas), and Butler v. Vista Health Care, Inc., No. 2001-618 86 (Harris County District Court,

Texas), are substantial, are known to defendants, and run contrary to Dynacq's claims that it runs an

efficient model for providing health care without jeopardizing quality. Defendants were fully aware

of the quality and caliber of the doctors to whom Vista Medical Center gave privileges to operate

at its facilities, because, as Dynacq Senior Vice President Don Holt confirmed in The Pasadena

Citizen on July 22, 2001, the Vista Medical Center Hospital "conducts extensive background

checks. "                                                               -

           34.    On November 30, 2000, Dynacq announced its year-end 2000 results, reporting net

income of $5,858,406, or $.022 per share, on a 61% increase in revenues to $26,032,411. In the

Company's press release, Chiu Chan, with Ella Chan and Philip Chan's approval, attributed Dynacq's

strong financial results to the Company's high quality, cost-effective and personalized healthcare

services:

           "It gives me great pleasure to report the results of our financial condition. Twelve
           consecutive record quarters attest to our commitment. Much of our success is not
           only providing care with compassion and understanding, but also allowing our
           service areas access to high quality, cost-effective and personalized care. [Our]
           management team is dedicated to these principals and to having positive relations
           with our medical staff."

                  Management is actively pursuing plans to replicate this successful concept in
           both Texas as well as the national markets.

           35.    On the same date, Dynacq filed with the SEC its 2000 Report on Form 10-K. The

Form 10-K was signed by Chiu Chan and Philip Chan and highlighted the Company's compliance

with applicable healthcare laws, rules and regulations for operators of hospitals and surgical

facilities, stating: "The healthcare industry is highly regulated at the federal and state levels. The

00047514                                            16

                                                                                253
Company believes its business is in material compliance with applicable law." Dynacq's stock price

advanced to higher levels based on these false and misleading statements.
           36.   The statements in ¶134-35 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's financial condition

was not strong because Dynacq's earnings were materially overstated because defendants did not

provide a sufficient allowance for doubtful accounts to comply with generally accepted accounting

principles as required by Accounting Research Bulletin No. 43, Financial Accounting Standards

Board No. 5 and the AICPA Audit and Accounting Guide for Health Care Organizations. For the

year ending August 31, 2000, Dynacq's accounts receivable grew to $8,419,608 - which was

purported to be net of the allowance for doubtful accounts. However, this put Dynacq's DSO at

approximately 90 days, substantially higher than that of most hospitals and much higher than is likely

in Texas, where state law mandates payments by insurance carriers within 45 days.            Further,

according to a former Dynacq Director of Nursing who worked at Dynacq prior to and during the

Class Period, Dynacq's financial performance in fiscal 2000 was manipulated by fraudulent

overcharges to patients covered by Workers Compensation. For example, Dynacq charged Workers

Compensation clients a mark-up of 300% for "cages" (i. e., implants used in back surgeries), whereas

patients were only normally charged a 10% mark-up. As each cage cost the hospital $1,600, but was

fraudulently billed out at $6,400, and between 6-10 cages were necessary for most surgeries - this

resulted in inflating the cost of each such surgery between $32,000 and $48,000. Given that Dynacq

performed many back surgeries, this resulted in significant inflation to Dynacq's revenues during

fiscal 2000.     In addition, Dynacq overcharged these patients for per-hour fees.        Defendants

specifically overcharged Workers Compensation patients because of their belief that Workers

Compensation did not audit or check bills. Moreover, Dynacq's facilities were not "in material

compliance with applicable law."     Defendants knew that, among other things, Dynacq's hospital

suffered from a terrible mold problem causing the hospital to violate regulatory codes and that it did

not maintain nurses' records as required by law. Dynacq's management was not "dedicated" to

providing medical services that were "high-quality" or which provided "personalized care."



00047514                                          17

                                              -                        1     2 5 `'
Defendants knew that their facilities were understaffed and employed highly questionable doctors,

as detailed in ¶¶25-33.

           37.    On December 20, 2000, Dynacq announced a deal to acquire Surgi+Group, Inc., an

ambulatory surgery center located in Houston, Texas. Commenting on the letter ofintent, Chiu Chan

with Ella Chan and Philip Chan's approval, stated:

           "Surgi+Group has the corporate development and operating expertise with for-profit
           surgery centers to fast-track Dynacq's ambitious expansion plans. The pipeline of
           high-quality, surgery center acquisition and start-up leads gained as a result of this
           merger will significantly expedite Dynacq's expansion into other markets."

           38.    On January 5, 2001, Taglich Brothers, Inc. issued an analyst report, written by Gary

Weber, based on conversations with Chiu Chan and Philip Chan, recommending the purchase of

Dynacq stock as "Speculative Buy," and noting that "Dynacq is undervalued relative to the

companies in the Hospital Industry within the Healthcare sector.... In our view , a fair valuation for

these shares should emerge as the Company leverages their resources by creating new integrated

medical facilities."

           39.     On January 16, 2001, Dynacq announced its results for the first quarter of 2001,

reporting net income of $2,372,119, or $0.09 per share, on revenue of $8,904,528. In the Company's

press release, Chiu Chan, with Ella Chan and Philip Chan's approval, attributed the Company's

strong results to Dynacq's "remarkable" healthcare delivery model:

           "Once again, for the 13th consecutive quarter, our management has demonstrated the
           phenomenal success of this remarkable model for the delivery of affordable
           healthcare. No one should be surprised at this report. With the extraordinary
           cooperation of our medical staff and the confidence of our patients, we continue to
           meet the challenge of providing exemplary care with compassion and understanding.
           We have unquestionably proven, again, the significance of our model for the delivery
           of cost effective, high quality, personalized medical care."



                   Dynacq International Inc., specializes in creating quality and efficient
           community-based, one stop healthcare resource centers designed to meet the needs
           of physicians and their patients.

           40.     The statements in ¶¶37-39 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's purportedly strong

results were the result of accounting manipulations and cost-cutting measures that rendered Dynacq's


00047514                                             18

                                                                               2 i
facilities non-compliant with state and federal health regulations, as detailed in ¶125-28, 66. Further,

Dynacq did not provide "high-quality" or "exemplary care," because it hired doctors with dubious

qualifications and its facilities were not adequately staffed or in compliance with health regulations,

as detailed in ¶¶28-33. Moreover, Dynacq's earnings were materially overstated because defendants

did not provide a sufficient allowance for doubtful accounts to comply with generally accepted

accounting principles as required by Accounting Research Bulletin No. 43, Financial Accounting

Standards Board No. 5 and the AICPA Audit and Accounting Guide for Health Care Organizations.

For the quarter ending November 30, 2000, Dynacq's accounts receivable grew to $10,159,706 -

which was purported to be net of the allowance for doubtful accounts. However, this put Dynacq's

DSO at approximately 95 days, substantially higher than that of most hospitals and much higher than

is likely in Texas, where state law mandates payments by insurance carriers within 45 days.

           41.    On February 1, 2001, Dynacq announced that it had obtained approval from the State

of Texas to expand its Ambulatory Surgical Care ("ASC") facility . In the Company's press release,

defendants stated:
                     Dynacq International Inc. ... reports the beginning of expansion construction
           of its Ambulatory Surgical Care ("ASC") facility. The State of Texas has approved
           the plans for expansion of the existing facilities , creating an additional Operating
           Room and recovery stations . This expansion will result in a 33% increase in the
           facility's surgical capacity and operating room availability.

                   After securing bids for the $500,000.00 project, the successful contractor has
           obtained all necessary building permits and estimates the project will be completed
           no later than May 1, 2001. This renovation is designed to enhance the company's
           commitment to the delivery of quality and efficient healthcare and exceeds the
           requirements of the Texas Department of Health for like facilities.

                   This project will not interfere with current operations. All construction costs
           will be paid out of existing earnings and no debt will be incurred.

                    Mr. Chiu M. Chan, president and CEO of Dynacq stated, "This is but the first
           of many steps we are taking towards implementing our plan to expand our ability to
           provide exemplary and cost efficient healthcare through controlled and well managed
           growth. The company is continuing its efforts to penetrate the area and national
           medical markets and propagate its very successful model for creating quality and
           efficient community-based, one stop healthcare resource centers designed to meet the
           needs of physicians and their patients."




00047514                                             19
                                                                           250
           42.    On February 27, 2001, Dynacq announced a stock split effected as a 100% stock

dividend on all issued common shares. Commenting on the stock split and the strength of Dynacq's

business , Chiu Chan, with Ella Chan and Philip Chan's approval, stated:

           "We are very excited by the tremendous success of the company. We have carefully
           planned our growth, and acquire only entities, like Piney Point, which are accretive
           to our bottom line. We believe this approach to be in the best interest or our
           company and its stockholders. The 100% stock dividend is a reward to our
           shareholders in appreciation of their trust and support. We are especially grateful to
           those dedicated employee shareholders who have brought great success to the
           company and made this event possible. We offer this as a demonstration of our
           intent to strengthen our commitment to increase stock value and encourage wider
           distribution of Dynacq stock."

           43.    On April 16, 2001, Dynacq announced its first half 2001 results, reporting a 111 %

increase in net income to $4,788,338, or $0.17 per share, on revenue of $18,691,939. In the press

release, Chiu Chan, with Ella Chan and Philip Chan's approval, attributed the Company's "record-

setting" financial results to Dynacq's "remarkable" model for delivery of healthcare:

           "Now, for the 15th consecutive quarter, our management team has met the
           formidable challenge placed before them. They have again demonstrated the success
           that comes from their commitment to working our plan of controlled growth while
           maintaining the integrity of our remarkable model for the delivery of affordable
           healthcare. The continued support from our medical staff and patients has been the
           catalyst for our recent acquisitions, all of which are structured to be accretive to our
           bottom line. Consequently, with the current expansion projects at both Vista Medical
           Center Hospital and Vista Healthcare's ASC, and future acquisitions now under
           serious consideration, we fully expect more earnings records to be broken in the near
           future."

           44.     The statements in ¶¶41-43 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's earnings were

materially overstated because defendants did not provide a sufficient allowance for doubtful accounts

to comply with generally accepted accounting principles as required by Accounting Research

Bulletin No. 43, Financial Accounting Standards Board No. 5 and the AICPA Audit and Accounting

Guide for Health Care Organizations.            For the first six months of fiscal-year 2001 (ending

February 28, 2001), Dynacq's accounts receivable grew to $11,562,278 - which was purported to

be net of the allowance for doubtful accounts. However, this put Dynacq's DSO at approximately

97 days, substantially higher than that of most hospitals and much higher than is likely in Texas,

where state law mandates payments by insurance carriers within 45 days. Consequently, Dynacq had


00047514                                             20

                                                                                 249                  -
not actually achieved a "record-setting income increase of 111% for the first six months of fiscal year
2001 ...." Further, Dynacq's "success" was not attributable to "maintaining the integrity of [its]

remarkable model," as - in reality - the Company's facilities suffered from cost-cutting measures that

rendered them non-compliant with state and federal health regulations, as detailed in ¶¶25-28, 66.
           45.    Following the release of the Company's first-half 2001 results, on May 1, 2001,

Taglich Brothers, Inc. issued an analyst report written by Gary Weber, based on conversations with

Chiu Chan and Philip Chan, recommending the purchase of Dynacq stock as a "Buy," stating:

           Dynacq has been operating very efficiently within the competitive healthcare
           marketplace, as evidenced by steadily increasing revenues and earnings over the past
           few years, and we expect the Company to remain successful despite any competitive
           challenges that it may face.



           Dynacq's steadily increasing revenues and earnings show that the Company has been
           managing its growth efficiently, and we expect to see further increases in revenues
           and earnings over the coming years.



           Even at current price levels, however, we believe that the Company's stock remains
           undervalued.... Dynacq still seems undervalued, especially given the earnings growth
           expected over the next few years.

           46.    After these announcements, Dynacq's stock price advanced from approximately $5

per share its then all-time and Class Period high of $20.57 per share. While Dynacq stock traded at

artificially inflated prices, defendants Chiu Chan, Ella Chan and Philip Chan sold 108,200 shares

of Dynacq common stock that they actually owned, for prices between $14.35 and $20 per share,

pocketing $1.8 million in unlawful insider trading proceeds at the expense of Dynacq's public

shareholders. The stock sales were both suspicious in amount and timing, as they were (i) Philip

Chan's largest sales ever; (ii) Chiu Chan and Ella Chan's largest sales to date; and (iii) coincided with

Dynacq's earning announcement of "record-setting" first-half of second quarter 2001 results.

           47.    On July 2, 2001, Dynacq announced that it had been ranked as one of the top

performing companies in the United States by Fortune Small Business Magazine. In the Company's

press release, Chiu Chan, with Ella Chan and Philip Chan's approval, attributed Dynacq's rapid

growth to the success of the Company's healthcare delivery model:


00047514                                            21              -


                                                                            24 S
           "We earned the third place in the FSB 100 list as a result of consistent growth in size,
           revenues and [ ] profitability through the successful model that delivers quality and
           cost efficient healthcare designed to meet the needs of both physicians and their
           patients. We are also very proud of being acknowledged as the leader in the
           healthcare industry in the group because we are the only healthcare company to earn
           a top spot in the FSB 100 listing. We are very grateful to accept the congratulations
           offered by FSB publisher, Kathleen H. Kayse, who said, '100 entrepreneurs who
           successfully took their companies public, and staying profitable is no easy feat, and
           they are on their way to becoming the next generation ofFORTUNE 500 companies.
           ... We hope their success will serve as inspiration for those of you who face this
           challenge now or are considering this path."'

           48.     The statements in ¶¶45-47 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq was not operating

very efficiently, nor was its operating efficiency evidenced by steadily increasing revenues and

earnings. Rather, Dynacq's results were created by defendants' accounting manipulations and cost

cutting measures that made the Company's facilities non-compliant with federal and state

regulations, as detailed in ¶¶25-28, 66. Further, Dynacq did not "earn [ ] the third place in the FSB

100 list as a result of consistent growth in size, revenues and [ ] profitability through the successful

model that delivers quality and cost efficient healthcare designed to meet the needs of both

physicians and their patients." Dynacq did not model its facilities to meet the needs of patients or

provide quality care. Rather, the Company's facilities suffered from cost-cutting measures that

rendered them non-compliant with state and federal health regulations, as detailed in ¶125-28, 66.

Moreover, Dynacq's hospitals were staffed by doctors with dubious qualifications, as detailed in

¶¶29-3 3.

           49.     On July 16, 2001, Dynacq announced its third quarter 2001 results, reporting a 70%

increase in net income to $2,782,617, or $0.20 per share, on revenue of $12,788,986.                  In the

Company's press release, Chiu Chan, with Ella Chan and Philip Chan's approval, again attributed

Dynacq's strong financial results to managements' successful implementation of the Company's

healthcare delivery model and state-of-the-art facilities:

           "Sixteen consecutive quarters ofcontinued earnings growth clearly demonstrates that
           our management team continues their excellent performance. We enjoy the success
           that comes from their implementation of our model for the delivery of affordable
           healthcare. As I predicted in April of this year, we have provided our shareholders
           with a new record in earnings and we are very excited about it. We fully intend to
           repeat this pattern."


00047514                                              22

                       -                                                         247
           50.    The statements made in ¶49 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's earnings were

materially overstated because defendants did not provide a sufficient allowance for doubtful accounts

to comply with generally accepted accounting principles as required by Accounting Research

Bulletin No. 43, Financial Accounting Standards Board No. 5 and the AICPA Audit and Accounting

Guide for Health Care Organizations. For the quarter ending May 31, 2001, Dynacq's accounts

receivable grew to $15,541,435 - which was purported to be net of the allowance for doubtful

accounts. However, this put Dynacq's DSO at approximately 98 days, substantially higher than that

of most hospitals and much higher than is likely in Texas, where state law mandates payments by

insurance carriers within 45 days. Further, as of July 22, 2001, according to The Pasadena Citizen,

the Houston division of the Federal Bureau of Investigation had "begun a preliminary investigation

on one of Dynacq's doctors, Eric Scheffey, regarding workmen compensation fraud."

           51.    On July 25, 2001, Dynacq announced its addition to the Russell 2000 and Russell

3000 Stock Indexes . In the Company s press release, Chiu Chan, with Ella Chan and Philip Chan's

approval, stated:

           "Our company's inclusion in the Russell 2000 and Russell 3000 again demonstrates
           the success that comes from management's commitment to our controlled growth
           plan while maintaining the integrity of our remarkable model for the delivery of
           affordable healthcare."

           52.    Following Dynacq's announcements , on July 31, 2001, Taglich Brothers , Inc. issued

an analyst report, written by Gary Weber, based on conversations with Chiu Chan and Philip Chan,

recommending Dynacq's stock as a "Buy":

           Dynacq has been operating very efficiently within the competitive healthcare
           marketplace, as evidenced by steadily increasing revenues and earnings over the past
           few years, and we expect the Company to remain successful despite any competitive
           challenges that it may face.



           Dynacq has been managing its growth efficiently, and has achieved steadily
           increasing revenues and earnings over the past few years. We fully expect that the
           Company will continue to manage its growth efficiently and will achieve further
           increases in revenues and earnings.




00047514                                           23


                                                                                  2 41   6
           Dynacq still seems undervalued, especially given the earnings growth expected over
           the new few years.

           53.    The statements in ¶¶51-52 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's purported "steadily

increasing revenues and earnings" were the result of accounting manipulations and cost-cutting

measures that rendered Dynacq's facilities non-compliant with state and federal health regulations,

as detailed in ¶¶25-28, 66.        Further, Dynacq's "success" did not come from "'management's

commitment to ... maintaining the integrity of [its] remarkable model for the delivery of affordable

healthcare"' because it hired doctors with dubious qualifications and its facilities were not adequately

staffed or in compliance with health regulations, as detailed in ¶¶29-33.

           54.    On September 19, 2001, Dynacq announced a stock buy back program, stating that

"under the stock buyback program, purchases may be made from time-to-time, in the open market

or in privately negotiated transactions. The timing and the amount of the shares repurchased will

be determined by the company's management based on its evaluation of market conditions and other

factors ...."    In the Company's press release, defendants also confirmed guidance that Dynacq

expected to earn $0.19 per share in the fourth quarter of 2001.

           55.    On October 3, 2001, Dynacq announced that the Company had been favorably

recognized by the MotleyFool. com, an on- line investment publication - In the Company's press

release , defendants stated:

                   Dynacq International Inc. ... announced today that it has enjoyed recent
           favorable mention as one of the top seven small cap stock investing ideas in the
           Oct. 2, 2001, online publication of "The Motley Fool.com."

                    As an entry in their small cap investing idea contest, Dynacq International Inc.
           clearly met 7 out of 8 of the Foolish 8 criteria, and may very well have met all 8 of
           the criteria.

                  Dynacq International Inc. was recently ranked No. 3 among The Fortune
           Small Business Magazine's 100 fastest growing small public companies traded on
           major stock exchanges.

                  Dynacq International Inc. has also, in the recent past, been recognized by the
           Houston Chronicle newspaper as one ofthe top ten fastest growing public companies
           in Houston and by Wallstreet.com as one of the top 15% fastest growing public
           companies in America.



00047514                                              24
                                                                                  '     245
                    Mr. Chiu M. Chan, chairman, president and CEO of Dynacq International
           Inc., stated, "We are always pleased to find our company favorably recognized by the
           investment community. We see this as just one more reward for the success
           generated by all the hard work and effort put forth by our management team. We
           appreciate this well deserved recognition."

           56.    On October 18, 2001, Dynacq announced its retention of Schey Advertising/Public

Relations to promote Dynacq's stock. In the Company's press release, Chiu Chan, with Ella Chan

and Philip Chan's approval, stated: "Dynacq International develops, owns and manages

state-of-the-art surgical hospitals designed for greater efficiency and cost containment to meet the

needs of physicians and their patients." Shortly thereafter on October 31, 2001, Dynacq announced

the appointment of Sarah C. Garvin as Executive Vice President and Chief Operating Officer. In

that press release, defendants falsely stated: "Dynacq International Inc. specializes in developing,

owning and operating community-based surgical hospitals designed to meet the needs of premier

surgeons and their patients."

           57.    The statements in ¶¶55-56 were false and misleading when made. At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's surgical hospitals

were not "state-of-the-art" nor could they provide "greater efficiency and cost containment," as the

Company's facilities suffered from cost-cutting measures that rendered them non-compliant with

state and federal health regulations, as detailed in ¶¶25-28, 66. Further, Dynacq's hospitals were not

staffed by "premier surgeons"as the Company hired doctors with dubious qualifications, as detailed

in ¶¶29-33. Indeed, on the same date that defendants hailed their doctors as "premier surgeons," it

was reported that one of Dynacq's leading doctors, Eric Scheffey "was publicly reprimanded [] by

the Texas State Board of Medical Examiners after allegations that he failed to practice in an

acceptable professional manner consistent with the public health and welfare." In accordance with

Scheffey's "public reprimand," his practice was ordered to be "monitored by a licensed Texas

orthopedic surgeon" and is "also subject to on-site inspection of his medical practice no less than

every other month ...."

           58.    On November 8, 2001, Dynacq announced it had successfully doubled the surgical
capacity of its Vista Medical Center Hospital. In the Company's press release, Chiu Chan, with Ella

Chan and Philip Chan's approval, stated:

00047514                                           25

                                                                           P      24.1
                  Dynacq International Inc. ... has doubled the surgical capacity of its Vista
           Medical Center Hospital in nearby Pasadena, Texas ...

                   The new operating rooms, intensive care unit and pre-operative and recovery
           rooms have been surveyed and approved by the Texas Department of Health and
           placed into service today. Construction expenses were paid out of earnings with no
           debt incurred.

                     "Completion of this important construction project is further confirmation of
           our strong focus on same-store growth,"... "Inauguration of the new surgical
           facilities at our flagship surgical hospital in Pasadena completes the goal of doubling
           our surgical capacity in the Houston market - from five to ten operating rooms - in
           the past twelve months...."

                   "Selective regional expansion, as reflected by our previously announced
           hospital acquisition last month in Baton Route, La., also helps achieve our strategic
           growth goals. By associating Dynacq with premier surgeons and excellent patient
           care, we will achieve the full potential of each of our surgical hospitals, Chan said.



                   Dynacq International Inc. specializes in developing, owning and operating
           community-based surgical facilities designed to meet the needs of leading surgeons
           and their patients.

           59.     On November 27, 2001, following discussions with Chiu Chan, and Philip Chan,

Dow Jones wrote a favorable article on Dynacq entitled " Dynacq Intl Hits 52-Week High; Strong

4Q Profit Expected," stating:

                   Shares of Dynacq International Inc. ... hit a new 52-week high Tuesday, a
           move which some market participants attributed to investors' hopes for another solid
           quarterly report by the outpatient health-care provider, due out after the closing bell.

                   "The market is anticipating very strong earnings from Dynacq," said Mark
           Garfinkel, fund manager of STI Classic Small Cap Growth Stock Flex.

                   Garfinkel, whose $550 million fund owns 140,000 Dynacq shares, also
           attributed the stock's recent strong performance to a "technical breakout" after it
           broke resistance around $20.

                  Dynacq stock has been on a consistent upward trajectory since Nov. 19, when
           the Texan company said that it had closed its acquisition of Charis Hospital in Baton
           Rouge, La., for $3.4 million. Dynacq announced in October that it would buy the
           50,000-square-foot facility, its latest effort to expand through acquisitions.

                   "The company has been growing both its top line and bottom line through
           acquisitions as well as expanding its existing facilities," said Gary Weber, an analyst
           with Taglich Brothers Inc., a New York-based brokerage which is currently the only
           firm covering Dynacq.

                 Weber, who recommends investors to buy the stock, said he expects the
           company to report earnings of 18 cents a share for its fiscal fourth quarter ended in


00047514                                             26



                                     -                                                    243
           August, up from 11 cents a year earlier. For the full fiscal year, Weber's earnings
           estimate is 71 cents a share, up 73% from a year ago.

                   After taking into account Dynacq's latest acquisitions, Weber said he will
           likely push up his fiscal 2002 earnings projection from 89 cents a share.

                   If the current earnings momentum continues, he said, "the stock will be able
           to break through $30 within a year and a half."

                   The analyst said he likes Dynacq's focus on outpatient health care and its
           strategy ofrunning small-scale facilities as compared with traditional hospitals. Both
           allow the company to come up with "much less overhead per procedure," Weber said.

           60.    Later, after the close of the bell on the same date, Dynacq announced its 2001 year-

end results, reporting an 89% increase in net income to $11,060,808, or $0.76 per share, on revenues

of $43,803,619. In the Company's press release, Chiu Chan, with Ella Chan and Philip Chan's

approval, stated: "'It gives me great pleasure and pride to report the financial achievements of

Dynacq's most recent fiscal year .... It reflects management's successful strategy of same-store

growth and targeted expansion in developing our special niche in the healthcare sector."'

           61.     On November 27, 2001, Dynacq also filed with the SEC its 2001 Report on Form

I 0-K. The Form 10-K was signed by Chiu Chan and Philip Chan and highlighted the Company's

strong 2001 year-end results:

                   The Company recorded consolidated net income of $11,060 , 080 for the year
           ended August 31, 2001 , as compared to consolidated net income of $5,858,406 in
           fiscal 2000 and net income of $2,663 , 832 in fiscal 1999.... For the fiscal year ended
           August 31 , 2001 total consolidated net revenues net of contractual adjustments
           increased by $17,771 ,178 from $26,032,441 to $43, 803,619 , a 68% increase.

           62.     Following Dynacq's announcements, on December 11, 2001, Taglich Brothers, Inc.

issued an analyst report, written by Gary Weber, based on discussions with Chiu Chan and Philip

Chan, recommending the purchase of Dynacq common stock as a "Buy," stating:

                   Over the past year, Dynacq has grown significantly both by expansion and by
           acquisition. The Company has managed its growth wisely and has experienced
           notable increases in both revenues and earnings.... With a strong balance sheet,
           Dynacq is well poised to make further acquisitions.

                    Dynacq's recent growth has been     impressive .... Dynacq has been managing
           its growth efficiently, and has achieved     steadily increasing revenues and earnings
           over the past few years.... We believe       that Dynacq will continue to grow in an
           efficient manner that allows it to achieve   further increases in revenues and earnings.




00047514                                                27
                                                                                         242
           Dynacq has been operating very efficiently within the competitive healthcare
           marketplace, as evidence by steadily increasing revenues and earnings over the past
           few years, and we expect the Company to remain successful despite any competitive
           challenges that it may face.



                 Dynacq has been growing impressively over the past few years and has been
           managing its growth wisely, increasing its bottom line as well as its top line.

           63.    The statements in ¶¶58 -62 were false and misleading when made . At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's earnings were

materially overstated because defendants did not provide a sufficient allowance for doubtful accounts

to comply with generally accepted accounting principles as required by Accounting Research

Bulletin No. 43, Financial Accounting Standards Board No. 5 and the AICPA Audit and Accounting

Guide for Health Care Organizations. For the fiscal year ending August 31, 2001, Dynacq's accounts

receivable grew to $18,993,648 - which was purported to be net of the allowance for doubtful

accounts. However, this put Dynacq's DSO at approximately 114 days, substantially higher than that

of most hospitals and much higher than is likely in Texas, where state law mandates payments by

insurance carriers within 45 days. Further, defendants were not "'associating Dynacq with premier

surgeons and excellent patient care."' Dynacq hired some doctors with disreputable histories and

maintained unhealthy facilities in violation of the law as detailed in ¶¶29-33.

           64.    After these announcements , Dynacq's stock price rocketed to its all-time and Class

Period high of $29.25 per share. While Dynacq stock traded at artificially inflated prices, defendants

Chiu Chan, Ella Chan and Philip Chan sold 198,524 shares of the Dynacq common stock that they

actually owned, for prices between $18.56 per share to $28.65 per share, pocketing more than $4.3

million in unlawful insider trading proceeds. Defendants' stock sales were both suspicious in amount

and timing as they were (i) Chiu Chan and Ella Chan's largest sales of Dynacq stock; (ii) occurred

immediately before public disclosure of the U.S. Department of Health and Human Services adverse

report finding Dynacq's flagship Vista Medical Hospital to be maintained in unsafe conditions; and

(iii) coinciding with Dynacq's positive earnings announcement of strong fourth quarter and year-end

2001 results.



00027514                                           28                             r
                                                                                      241
           65.    On January 14, 2002, Dynacq announced its first quarter 2002 results, reporting a

42% increase in net income of $3,377,615, or $0.23 per share, on revenues of $13,854,531. In the

Company's press release, Chiu Chan, with Ella Chan and Philip Chan's approval, stated: "'We are

growing the company and the facts speak for themselves .... We have also reduced our accounts

receivable collection time by more than 20%.'°

           66.    The statements in ¶65 were false and misleading when made.          At the time these

statements were made, defendants knew or recklessly disregarded that Dynacq's earnings were

materially overstated because defendants did not provide a sufficient allowance for doubtful accounts

to comply with generally accepted accounting principles as required by Accounting Research

Bulletin No. 43, Financial Accounting Standards Board No. 5 and the AICPA Audit and Accounting

Guide for Health Care Organizations. For the quarter ending November 30, 2001, Dynacq's accounts

receivable stood at 17,881,417 - which was purported to be net of the allowance for doubtful

accounts. However, this put Dynacq's DSO at approximately 121 days, substantially higher than that

of most hospitals and much higher than is likely in Texas, where state law mandates payments by

insurance carriers within 45 days. Further, the Company had repeatedly violated federal laws,

including 42 C.F.R. §482.22(c) (enforcing the hospital's own bylaws); 42 C.F.R. §482.23(b) (failing

to ensure that at least 14 of its 19 nurses had valid and current licenses); 42 C.F.R. §482.23(c)

(failing to properly administer drugs to patients); 42 C.F.R. §482.41(a) (failing to ensure the safety

of patients via the maintenance of the hospital, e.g., patient rooms were riddled with mold and rust);

42 C.F.R. §482.51(b) (failing to follow policies concerning "crash cart" contents).

           67.    Dynacq's common stock continued to be traded at artificially inflated levels until mid-

January 2002. However, defendants could not conceal their fraudulent scheme to artificially inflate

Dynacq's stock price and massive insider bailout forever. On January 16, 2002, Dynacq's stock price

collapsed when TheStreet. coni ran an article exposing defendants ' misconduct.

                  Dynacq's Doubtful Accounts Send Distress Signals

                     When it comes to red flags, so many are flying over Dynacq International ...
           that it's hard to count. Dynacq owns and manages an acute care hospital in Pasadena,
           Texas, where it manages three physician practices. It also operates two outpatient
           surgical facilities and a medical office complex.


00047514                                            29

                                                                             r   -   24 0
                    The only analyst covering the company, Gary Weber of Taglich Brothers,
           rates it a buy. That Dynacq pays Taglich for that coverage is reason enough to
           warrant caution: The disclosure is right there in the fine print of the analyst's report.

                   But in recent quarters there have been numerous other issues that, by
           themselves, would warrant a mention here. For example, Dynacq's allowance for
           doubtful accounts - something every CFO should know like the back of his or her
           hand - has been hovering around the 1% range, which is far below the level used by
           such rivals as HCA, ... Tenet ... and Universal. Yet when asked about the amount of
           the allowance on the company's bizarre conference call Tuesday, CFO Philip Chan
           couldn't answer the question.

                   The dialogue is worth the price of admission.

                          Caller: Could you give us where allowance for doubtful
                   accounts stands right now, please?

                          CFO: Are you asking the provision for uncollectible accounts
                   of $41,673 on the income statement? Or are you talking about ...

                           Caller: I'm talking about the 'reserve - the allowance for
                   doubtful accounts that would be against your gross receivables so that
                   you have - you report net accounts receivable. What is your
                   allowance for doubtful accounts? What's your reserve that's been
                   built up over time?

                           CFO: The way we present our [unintelligible] and net
                   revenue and that is the gross revenue minus, I believe, what you are
                   talking about the reserve for uncollectible portion from insurance
                   company or third party.

                            Caller: Uh, either one. Let me, maybe if I can contrast it
                   where it was in the 10-K. ... Anyway, it's a standard nomenclature.
                   It's called allowance for doubtful accounts. ... It was $193,000 in
                   August . Do you know what it is now, please?

                           CFO: Let me turn my page on the same page that you are
                   saying ... a minute.

                          Caller : All right, let me - maybe I can go on while he's
                   searching that . If I could ask another question here ...

                   And so it was! The entire call was pretty much like that.

                  Take the same caller's question about the company's revenue per hospital bed,
           which appears to be much higher than the average for the acute care hospital industry.

                           Caller: You have 37 beds and in the hospital you had
                   revenues in here ofjust under $9 million, and that equates somewhere
                   to about a quarter-million dollars revenue per bed.           That is
                   substantially higher than industry averages. Why is that?

                            CEO Chiu Chan (who, according to the 10-K is not related to
                   the CFO): We are not general acute hospital. We are surgical
                   hospital.

00047514                                              30
                                                                                        239
                   Not an acute care hospital?! The company itself says in its 10-K, filed
           Nov. 27, that it is engaged in "the ownership and management of an acute care
           hospital."

                   The caller continues, saying that revenue at Dynacq's clinic and outpatient
           surgical center, which had been a key driver of Dynacq's growth, was "down about
           7% year over year. At the same time, the hospital revenues just skyrocketed here.
           They were up 160% or something."

                          CEO Chan: Well, as you can see, we are aligning our
                  company towards - we are now saying that Dynacq is a surgical
                  hospital company. We are a surgical hospital company. That is the
                  direction which we are going. So, right now all the focus is, the
                  management focus is a surgical hospital company.

                    Chan later added: "The reason why we are trying to do this is because we
           listen to a lot of the research analysts or those brokers about a single focus company
           enhance our shareholder value a lot better than getting more - all this kind of other
           business. ... So, the other thing which is not surgical hospital business is going to go
           gradually - scale down."

                   But last March Dynacq purchased a second ambulatory or outpatient surgery
           center. Now it's saying that that part of the business will no longer be a focus?!

                   The conference call continued. A different caller noted that the company had
           "very impressive" 12% revenue growth in the fourth quarter from the third quarter.
           "But it appears net income may have declined slightly quarter to quarter. Is that the
           case?"

                            CEO: Net income? No. I don't think so. Net income actually
                   go up.

                         Caller No. 2: I backed out that the fourth quarter net income
                  was about $3,490,000.... I have this quarter at about $3,378,000. So,
                  maybe a 3% or so decline in net income, and you had 12% sequential
                  revenue growth. I'm just curious where...

                   The CEO then started talking about how earnings per share of 23 cents were
           higher than the prior quarter's 22 cents, then injected:

                           CFO: Your math ... could be very well correct. The thing that
                   may confuse a little bit during the fourth quarter is where we have the
                   annual audit come in and make all the adjustments. There's no
                   significant adjustment that we made. You may be able to look at the
                   income tax provision for the fourth quarter, which kind of declined
                   pretty significantly from the periods before. That is the time that the
                   auditor come in and look our annual income tax situation.

                          Caller No. 2: OK ... the real question I'm driving at ... it
                  appears that your profit margins came down quite a bit from quarter
                  to quarter [net profit margin was down nearly 4 percentage points
                  from the fourth quarter to the first quarter] ... and I'm just wondering
                  if you could comment a little bit on why the profit margins ...
                  contracted, and again, is this something we should expect going
                  forward?

00047514                                             31

                                                                                       238
                          CEO: If you look at the number for the whole fiscal year last
                  year, our profit margin is ... 25.3. Therefore our net margin is 24.7 or
                  24.6. So we are talking about a decimal point percentage difference,
                  and I don't think it's something of anybody's concern.

                   Year over year, maybe, but quarter to quarter it's nearly 4 percentage points.
           That's certainly somebody's concern. But I digress, as the call returned to the subject
           of the allowance for doubtful accounts.

                          Caller No. 1: I wondered if you'd had a chance to find that
                  answer on the allowance for doubtful accounts on accounts
                  receivable?

                          CFO: I tried to find out the real question - all on income
                  statement, the only provision for uncollectible account is - for this
                  quarter is $41,670 ... before talk about $137,000 - I don't know what
                  number you have been looking at.

                          Caller No. 1: $193,000 is what it was in August.

                          CFO: In August $193,000?

                          Caller No. 1: August of'01.

                          CFO: Hold on.

                   He never did answer the question.

           68.     On this news, Dynacq's stock price collapsed by over 50%, falling from $25.45 per

share on January 16, 2001 to as low as $12.26 per share on January 17, 2002, on extraordinarily

heavy volume of 2.6 million shares, wiping out tens of millions in shareholder equity-

           69.     On January 23, 2002, The Wall Street Journal exposed defendants ' insider trading

bailout, reporting that Dynacq's top insiders sold shares in advance of the stock's fall, but failed to

disclose those sales properly. In addition, The Wall Street Journal revealed the U.S. Department of

Health and Human Services' report that defendants received in October 2001, finding that Dynacq's

flagship Vista Medical Center Hospital "'had not been maintained in a manner that the safety and

well-being of patients was assured ...."' On this news, Dynacq's stock price declined again, falling

to $10 per share on January 29, 2002, and to $6 per share, on February 4, 2002. As a result of

defendants' misconduct, Lead Plaintiffs and the Class suffered tens of millions of dollars in damages.




00047514                                             32                    - `
                                                                             I- " 237
              DYNACQ'S FALSE AND MISLEADING FINANCIAL STATEMENTS

           70.   Lead Plaintiffs incorporate ¶¶1-69.

           71.   To overstate Dynacq's earnings during the Class Period, defendants violated GAAP

and SEC rules by failing to properly report its financial results for 2000, 2001 and the first quarter

of 2002.

           72.   These financial statements and the statements about them were false and misleading,

as such financial information was not prepared in conformity with GAAP, nor was the financial

information a fair presentation of the Company's operations due to the Company's improper

accounting for its revenues and receivables, in violation of GAAP and SEC rules .             Dynacq

manipulated financial statements and falsified the doubtful account allowance which artificially

inflated Dynacq 's revenue , income and receivables.

           73.   GAAP are those principles recognized by the accounting profession as the

conventions , rules and procedures necessary to define accepted accounting practices at a particular

time. Regulation S-X (17 C.F.R. §210. 4-01(a) (1)) states that financial statements filed with the SEC

which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate.

Regulation S-X requires that interim financial statements must also comply with GAAP, with the

exception that interim financial statements need not include disclosure which would be duplicative

of disclosures accompanying annual financial statements . 17 C.F.R. §210.10-01(a).

           74.   Due to these accounting improprieties, the Company presented its financial results

and statements in a manner which violated GAAP, including the following fundamental accounting

principles:

                 (a)    The principle that accounts receivables should be effectively stated as the

amount of cash estimated as realizable (APB 43, No. 3, ¶9; FASB 5, Appendix A, ¶122 and 23;

AICPA AAG-HCO 517);

                 (b)    The principle that interim financial reporting should be based upon the same

accounting principles and practices used to prepare annual financial statements was violated (APB

No. 28, ¶10);



00047514                                          33

                                                                        r      23-6
               (c)     The principle that financial reporting should provide information that is useful

to present and potential investors and creditors and other users in making rational investment, credit

and similar decisions was violated (FASB Statement of Concepts No. 1, ¶34);

               (d)     The principle that financial reporting should provide information about the

economic resources of an enterprise, the claims to those resources, and effects oftransactions, events

and circumstances that change resources and claims to those resources was violated (FASB
Statement of Concepts No. 1, ¶40);

               (e)     The principle that financial reporting should provide information about how

management of an enterprise has discharged its stewardship responsibility to owners (stockholders)

for the use of enterprise resources entrusted to it was violated. To the extent that management offers

securities of the enterprise to the public, it voluntarily accepts wider responsibilities for

accountability to prospective investors and to the public in general (FASB Statement of Concepts

No. 1, ¶50);

                (f)    The principle that financial reporting should provide information about an

enterprise's financial performance during a reporting period was violated. 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' expectations about future enterprise

performance, those expectations are commonly based at least partly on evaluations ofpast enterprise

performance (FASB Statement of Concepts No. 1, ¶42);

                (g)    The principle that financial reporting should be reliable in that it represents

what it purports to represent was violated. That information should be reliable as well as relevant

is a notion that is central to accounting (FASB Statement of Concepts No. 2, ¶¶58-59);

                (h)     The principle of completeness, which means that nothing is left out of the

information that may be necessary to insure that it validly represents underlying events and

conditions was violated (FASB Statement of Concepts No. 2, ¶79); and

                (i)     The principle that conservatism be used as a prudent reaction to uncertainty

to try to ensure that uncertainties and risks inherent in business situations are adequately considered



00047514                                          34

                                            -                                     235
was violated. The best way to avoid injury to investors is to try to ensure that what is reported

represents what it purports to represent (FASB Statement of Concepts No. 2, ¶¶95, 97).

                                CLASS ACTION ALLEGATIONS

           75.   This is a class action on behalf of all persons who purchased Dynacq common stock

between November 30, 2000 and January 16, 2002 (the "Class"). Excluded from the Class are
defendants and officers and directors of the Company, as well as their families. Class members are

so numerous that joinder of them is impracticable.

           76.   Common questions of law and fact predominate and include whether defendants:
(i) violated § § 10(b), 20(a) and/or 20A of the 1934 Act; (ii) omitted and/or misrepresented material

facts; (iii) knew or recklessly disregarded that their statements were false and/or misleading when

made; and (iv) artificially inflated the prices of Dynacq 's common stock and the extent of and

appropriate measure of damages.

           77.   Lead Plaintiffs' claims are typical of those of the Class. Prosecution of individual

actions would create a risk of inconsistent adjudications. Lead Plaintiffs will adequately protect the

interests of the Class. A class action is superior to other available methods for the fair and efficient

adjudication of this controversy.

                                      CLAIMS FOR RELIEF

                                    FIRST CLAIM FOR RELIEF

                          (Against All Defendants for Violations of §10(b)
                    of the 1934 Act and Rule 10b-5 Promulgated Thereunder)

           78.   Lead Plaintiffs incorporate ¶¶1-77.

           79.   Defendants violated § 10(b) and Rule I Ob-5 by: (i) employing devices, schemes and

artifices to defraud; (ii) making untrue statements of material fact and omitting to state material facts

necessary in order to make the statements made, in light of the circumstances under which they were

made, not misleading; and (iii) engaging in acts, practices and a course of business that operated as

a fraud or deceit upon the Class in connection with their purchases or acquisitions of Dynacq

common stock.




00047514                                           35

                                            -                               r      234
           80.   The undisclosed adverse information concealed by defendants during the Class Period

is the type of information which, because of SEC regulations, regulations of the national stock

exchanges and customary business practice, is expected by investors and securities analysts to be

disclosed and is known by corporate officials and their legal and financial advisors to be the type of

information which is expected to be and must be disclosed.

           81.   Lead Plaintiffs and the Class have suffered damages in that, in reliance on the

integrity of the market, they paid artificially inflated prices for Dynacq common stock.          Lead

Plaintiffs and the Class would not have purchased Dynacq common stock at the prices they paid, or

at all, if they had been aware that the market price had been artificially inflated by defendants' false

and misleading statements detailed herein.

                                 SECOND CLAIM FOR RELIEF

                               (Against All Defendants for Violations
                                     of §20(a) of the 1934 Act)

           82.   Lead Plaintiffs incorporate $1 1-81.

           83.   Defendants Chiu Chan, Ella Chan and Philip Chan acted as control persons of Dynacq

within the meaning of §20(a) of the 1934 Act.           By virtue of their executive positions, Board

membership, and/or stock ownership, Chiu Chan, Ella Chan and Philip Chan had the power to

influence and control, and did influence and control, directly or indirectly, the decision making of

the Company, including the content and dissemination of the various statements which Lead

Plaintiffs contend are false and misleading. They each were provided with and had unlimited access

to Dynacq's press releases, public filings and other statements alleged by Lead Plaintiffs and the

Class to be false 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.

           84.   In particular, Chiu Chan (CEO) and Philip Chan (CFO) were Dynacq's top two
executive officers and had direct involvement in the day-to-day operations of the Company and,

therefore, are 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. By virtue of her

majority ownership interest in Dynacq, Ella Chan directed and controlled Dynacq's business and


00047514                                           36                        -       -


                                     _                                           r       233
1       _




    '   affairs at all times relevant to this lawsuit. Dynacq controlled each of its officers, directors and

        employees.

                      85.   By reason of such wrongful conduct, Chiu Chan, Ella Chan, Philip Chan and Dynacq

        are liable under §20(a) of the 1934 Act. As a direct and proximate result of these defendants'

        wrongful conduct, Lead Plaintiffs and the Class suffered damages in connection with their purchases

        of Dynacq's common stock during the Class Period.

                                             THIRD CLAIM FOR RELIEF

                                    (Against Defendants Chin Chan, Ella Chan and
                                  Philip Chan for Violations of §20A of the 1934 Act)

                      86.   Lead Plaintiffs incorporate ¶¶1-77.

                      87.   Defendants Chiu Chan, Ella Chan and Philip Chan violated §20A ofthe 1934 Act by

        selling Dynacq common stock at artificially inflated prices during the Class Period, while in

        possession of adverse material non-public information.

                      88.   Lead Plaintiff Cedric C. Jimerson, who purchased 2,800 shares of Dynacq common

        stock on October 8, 2001, and other members of the Class, traded contemporaneously with Chiu

        Chan and Ella Chan who sold Dynacq common stock at artificially inflated prices on October 5,

        2001, and were damaged thereby.

                      89.   Lead Plaintiff Jack D. Hamilton, who purchased 4,000 shares of Dynacq common

        stock on January 4, 2002, and other members of the Class, traded contemporaneously with Chiu

        Chan and Ella Chan who sold Dynacq common stock at artificially inflated prices on January 4,

        2002, and were damaged thereby.

                      90.   Lead Plaintiff Cedric C. Jimerson, who purchased 400 shares of Dynacq common

            stock on January 9, 2002, and other members of the Class, traded contemporaneously with Philip

            Chan who sold Dynacq common stock at artificially inflated prices on January 9, 2002, and were

            damaged thereby.

                      91.   Lead Plaintiffs and all other members of the Class who purchased Dynacq common

            stock contemporaneously with the sale of Dynacq common stock by Chiu Chan, Ella Chan and/or

            Philip Chan have suffered damages in that they paid artificially inflated prices for their Dynacq


            00 ^s^a                                          37
                                                                                   r     232
shares. They would not have purchased Dynacq stock at the prices they paid, or at all, if they had

been aware that the market price had been artificially inflated by defendants' false and misleading

statements detailed herein.

                                        PRAYER FOR RELIEF
           WHEREFORE, Lead Plaintiffs pray for judgment as follows:(i) declaring this action to be

a proper class action; (ii) awarding damages, including interest and reasonable attorneys' fees; and

(iii) such other relief as the Court may deem just and proper.

                                            JURY DEMAND

           Lead Plaintiffs demand a trial by jury.

DATED: September 16, 2002                            Respectfully submitted,




                                                     ROGER B. REENBERG
                                                     State Bar No. 08390000
                                                     Federal I.D. No. 3932
                                                     SCHWARTZ, JUNELL, CAMPBELL
                                                      & OATHOUT, LLP
                                                     Two Houston Center
                                                     909 Fannin, Suite 2000
                                                     Houston, TX 77010
                                                     Telephone: 713/752-0017
                                                     713/752-0327 (fax)

                                                     Liaison Counsel

Co-Lead Counsel for Lead Plaintiffs:

MILBERG WEISS BERSHAD
 HYNES & LERACH LLP
WILLIAM S. LERACH
TRAVIS E. DOWNS, III
A. RICK ATWOOD, JR.
MATTHEW P. SIBEN
401 B Street, Suite 1700
San Diego, CA 92101
Telephone: 619/231-1058
619/231-7423 (fax)




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        CAULEY, GELLER, BOWMAN
         & COATES, LLP
        STEVEN E. CAULEY
        J. ALLEN CARNEY
        RANDALL K. PULLIAM
        P.O. Box 25438
        Little Rock, AR 72221-543 8
        Telephone : 501/312-8500
        501/312-8505 (fax)

        Attorneys for Plaintiffs:

        BARLEY, SNYDER, SENFT & COHEN, LLC
        MICHAEL P. GILES
        501 Washington Street
        Reading, PA 19603
        Telephone: 610/376-6651
        610/376-5243 (fax)




                                        CERTIFICATE OF SERVICE

                I hereby certify that a true and correct copy of the foregoing Consolidated Complaint for
        Violations ofthe Securities Exchange Act of 1934 was sent to all counsel of record on the attached
        service list by hand-delivery and/or U.S. mail on this 16"' day of September, 2002.

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                                                    Roger B. eenberg                              U




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