UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
_________________________________________
)
CHANI HERZOG, individually and on behalf ) Case No. [98-CV-85]
of all others similarly situated, ) [filed Jan. 7, 1998]
)
)
Plaintiff, ) CLASS ACTION COMPLAINT
) FOR VIOLATION OF THE
v. ) FEDERAL SECURITIES LAWS
)
GT INTERACTIVE SOFTWARE CORPORATION, )
RONALD CHAIMOWITZ, and JOSEPH J. CAYRE, ) JURY TRIAL DEMANDED
)
Defendants. )
)
_________________________________________)
Plaintiff, by her attorneys, for her Class Action
Complaint (the "Complaint") alleges the following upon personal
knowledge as to herself and her own acts, and upon information
and belief based upon the investigation of plaintiff's attorneys
as to all other matters. The investigation includes the thorough
review and analysis of public statements, publicly-filed
documents of GT Interactive Software ("GT" or the "Company"),
press releases, news articles and the review and analysis of
accounting rules and related literature. Plaintiff believes that
further substantial evidentiary support will exist for the
allegations set forth below after a reasonable opportunity for
discovery.
SUMMARY OF ACTION
I. This is a securities class action on behalf of public
investors who purchased securities of GT during the period from
August 1, 1996 through December 12, 1997 (the "Class Period").
During the Class Period, GT's financial results, as reported by
defendants, were materially misleading and materially inflated
the Company's true financial position and results of operations.
1. GT, a Delaware corporation whose headquarters are
in New York, New York, publishes and merchandises interactive
entertainment, edutainment (presumably an amalgam of "education"
and "entertainment") and value-priced consumer software for a
variety of platforms on a world-wide basis. Throughout the Class
Period, GT reported artificially inflated earnings by failing
properly to expense research and development costs. Moreover,
during the Class Period, defendants issued public statements
which fraudulently created the false impression that the
Company's accounting practices were proper.
2. On December 12, 1997, after BancAmerica, Robertson
Stephens downgraded GT due to possible accounting improprieties,
GT's stock price fell more than 17%. This downgrade considered
the impact of GT's writing off of some, if not all, of the $87.5
million in prepaid royalties that GT had previously improperly
capitalized.
JURISDICTION AND VENUE
3. This Court has jurisdiction over this action
pursuant to Section 27 of the Securities Exchange Act of 1934
(the "1934 Act"), 28 U.S.C. §§ 1331 and 1337. The claims
asserted herein arise under, Sections 10(b) and 20(a) of the 1934
Act, 15 U.S.C. §§78j(b), 78(n), and 78t(a), and Rule 10b-5, 17
C.F.R. §240.10b-5, promulgated thereunder by the SEC.
4. Venue is proper in this District pursuant to
Section 27 of the 1934 Act, 15 U.S.C. §78aa, and 28 U.S.C.
§1391(b). Many of the defendants reside in this District. Many
of the acts giving rise to the violations complained of,
including the dissemination of false and misleading public
statements and financial information, occurred in this District.
5. In connection with the wrongs alleged herein,
defendants used the instrumentalities of interstate commerce,
including the United States mails, interstate wire and telephone
facilities, and the facilities of the national securities
markets.
THE PARTIES
6. Plaintiff purchased shares of GT common stock
during the Class Period and was damaged thereby, as set forth in
the Certification filed with this Complaint.
7. a. GT, incorporated in Delaware in 1992, creates,
publishes and merchandises interactive entertainment, edutainment
and value-priced consumer software for a variety of platforms on
a world-wide basis. PC Data reported that in 1996 the Company
achieved the video-gaming industry's second highest market share
in number of units sold in the personal computer ("PC") software
game category and the industry's highest market share in number
of units sold in the PC software budget/value-priced category.
The Company claims to have expanded its line of published front-
line titles from five titles it released in 1994 to 24 titles it
released in 1995. In 1996, it released 67 titles.
b. The Company currently claims to be the
largest distributor of consumer software to mass merchants in the
United States. The Company claims to be the primary supplier of
its own, as well as third party consumer software, to
approximately 2,320 Wal-Mart stores, approximately 2,150 Kmart
stores, and approximately 760 Target stores. In addition, the
Company boasts of direct selling relationships for its own
published software with a variety of major retailers, including
among others, Sam's Club, Price-Costco, CompUSA, Best Buy,
Egghead and Computer City.
c. In December 1995, following the Company's
initial public offering, the Company's Common Stock was listed on
the Nasdaq National Market under the symbol "GTIS".
8. Defendant Ronald Chaimowitz ("Chaimowitz") is and
was at all relevant times President and Chief Executive Officer
and Director of GT. By virtue of his position as President and
Chief Executive Officer and Director of the Company, Chaimowitz
had the authority and ability to and, in fact, controlled the
contents of the Company's annual and quarterly reports filed with
the SEC, and press releases. Further, his actions during the
Class Period caused the material mis-statement of the Company's
financial condition and results as alleged herein. He was aware
of the contents of the Company's publicly disseminated reports
and press releases alleged herein to be misleading and had the
ability and opportunity to prevent their issuance or cause them
to be corrected, but failed to do so.
9. Defendant Joseph J. Cayre ("Cayre") is and was at
all relevant times Chairman of the Board of Directors of GT. By
virtue of his position as Chairman of the Board of Directors of
the Company, Cayre had the authority and ability to and, in fact,
controlled the contents of the Company's annual and quarterly
reports filed with the SEC, and press releases. Further, his
actions during the Class Period caused the material misstatement
of the Company's financial condition and results as alleged
herein. He was aware of the contents of the Company's publicly
disseminated reports and press releases alleged herein to be
misleading and had the ability and opportunity to prevent their
issuance or cause them to be corrected, but failed to do so.
CLASS ACTION ALLEGATIONS
10. Plaintiff brings this action as a class action
pursuant to Rules 23(a) and 23(b)(3) of the Federal Rules of
Civil Procedure, individually and on behalf of all other persons
or entities who purchased or acquired GT during the Class Period
and were damaged thereby, excluding the defendants herein, their
affiliates and any officers or directors of GT or its affiliates,
and any members of immediate families and their heirs, successors
and assigns (the "Class").
11. The Class is so numerous that joinder of all the
members of the Class is impracticable. Plaintiff believes there
are at least hundreds of record holders of the Company's common
stock located throughout the United States.
12. Plaintiff's claims are typical of the claims of
absent Class members. Members of the Class have sustained
damages arising out of defendants' wrongful conduct in violation
of the federal securities laws in the same way as the plaintiff
sustained damages from the unlawful conduct.
13. Plaintiff will fairly and adequately protect the
interests of the Class. She has retained counsel competent and
experienced in class and securities litigation.
14. A class action is superior to other available
methods for the fair and efficient adjudication of the
controversy. The Class is numerous and geographically dispersed.
It would be impracticable for each member of the Class to bring a
separate action. The individual damages of any member of the
Class may be relatively small when measured against the potential
costs of bringing this action, and thus make the expense and
burden of this litigation unjustifiable for individual actions.
In this class action, the Court can determine the rights of all
members of the Class with judicial economy. Plaintiff does not
anticipate any difficulty in the management of this suit as a
class action.
15. Common questions of law and fact exist as to all
members of the Class and predominate over any questions affecting
solely individual members of the Class. These questions include,
but are not limited to, the following:
a. whether defendants' conduct as alleged herein
violated the federal securities laws;
b. whether the SEC filings, press releases and
statements disseminated to the investing public during the Class
Period misrepresented GT's financial condition and results;
c. whether defendants acted knowingly or
recklessly in omitting and/or misrepresenting material facts;
d. whether the market price of GT common stock
during the Class Period was artificially inflated; and
e. whether the members of the Class have been
damaged, and if so, what is the proper measure of damages.
FACTUAL BACKGROUND
16. GT's financial statements and results, which
defendants publicly disseminated during the Class Period, were
materially false and misleading because GT's financial statements
failed to expense GT's research and development expenses and
royalty payments for projects that were discontinued or for which
"technological feasibility" had not yet been achieved. As set
forth below, pursuant to generally accepted accounting
principals, research and development expenses and royalty
payments must be expensed under such circumstances. During the
Class Period, defendants materially overstated GT's net income
and net assets.
17. In each quarter during the Class Period, the
Company reported its royalties paid to software developers as
cost of goods sold, capitalizing this amount rather than
expensing it. The Company's financial statements were false and
misleading in that they materially overstated GT's net income and
net assets, and were not reported in accordance with general
accepted accounting principles, specifically, FASB Statement No.
86.
18. The chart set forth below summarizes the
substantial increase in Royalty Advances that GT reported during
Fiscal 1996 and 1997, along with GT's quarterly income as
reported in its filings with the Securities and Exchange
Commission.
GT Interactive Software
1996 Reports
Date of
Date of Earnings Royalty Net
SEC Filing Announcement Advances Income
---------- ------------ -------- ------
Quarter 1 05/14/96 4/30/96 $21,280,000 $5,100,000
Quarter 2 08/14/96 8/1/96 $29,577,000 $2,140,000
Quarter 3 11/14/96 11/4/96 $57,357,000 $3,757,000
Quarter 4 03/31/97 2/10/97 $69,202,000 $4,393,000
1997 Reports
Date of
Date of Earnings Royalty Net
SEC Filing Announcement Advances Income
---------- ------------ -------- ------
Quarter 1 05/15/97 5/5/97 $70,344,000 $4,554,000
Quarter 2 08/14/97 8/7/97 $83,591,000 $4,469,000
Quarter 3 11/14/97 11/3/97 $87,542,000 $8,526,000
GT's net income was materially inflated by the failure of GT to
expense its prepaid royalties in violation of FASB Statement No.
86.
19. GT's failure to expense its prepaid royalties was
one of the contributing factors to Microprose, Inc.'s decision
not to proceed with a proposed merger with GT. Microprose and GT
had signed a definitive agreement for a merger on Oct 5, 1997.
The proposed merger of these two companies fell apart on or about
December 5, 1997 when Microprose withdrew.
20. FASB Statement No. 86, Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed,
requires that all research and development costs are to be
expensed until the "technology feasibility" of the computer
software product has been established. Royalties paid to
software developers for research and development of products
prior to establishing "technological feasibility" must be
expensed rather than capitalized. Furthermore, FASB Statement
No. 86 requires that the unamortized capitalized costs of each
software product shall be evaluated at each balance sheet date
and the amount by which the unamortized capitalized costs exceed
the net realizable value of that asset shall be written off.
Accordingly, during the Class Period, GT improperly capitalized
the royalties paid to software developers for research and
development of products which did not achieve "technological
feasibility" and/or failed to write off the unamortized
capitalized costs (royalties paid) of software that exceeded the
net realizable value of that software.
21. Illustrative of GT's failure to disclose material
information to investors and its improper accounting treatment of
software royalties was its "deal" with Scavenger, Inc.
22. On November 28, 1995, GT entered into an agreement
with Scavenger, Inc., to develop four software games: Into the
Shadows, 4X Frenzy, Vertigo and Amok. GT paid Scavenger advances
in the amount of $2.5 million under the foregoing agreement. The
contractual relationship between GT and Scavenger fell into
disarray over the failure of Scavenger adequately and timely to
produce the requested software, which was initially due on
August 1, 1996. GT contended that "Scavenger completely failed
to perform under the agreement; it has never to this day
delivered two of the games and the two games that were delivered
arrived late and failed to satisfy the requirements of the
agreement."
23. Scavenger filed a breach of contract lawsuit
against GT in the Supreme Court of the State of New York in
September of 1997. In the lawsuit, Scavenger claims that GT
deliberately withheld further payments in December of 1996 and
that, as a direct result, Scavenger ceased business operations in
January of 1997. GT's cross-complaint against Scavenger claims
that GT notified Scavenger on January 20, 1997 that Scavenger was
in breach of contract and failed to cure its breach. On March
12, 1997, GT notified Scavenger that the time period in which to
cure its breaches had expired and the agreement was terminated.
GT fraudulently inflated its financial results for the first and
second quarters of 1997 by failing to take a write off for the
Scavenger project.
24. Instead of timely disclosing the foregoing
difficulties with the Scavenger project, GT's 10-K filed on March
31, 1997 affirmatively and materially misrepresented the then-
current status of GT's relationship with Scavenger. GT's 10-K
discussed the retention of software developers such as Scavenger,
and discussed its current relationship with Scavenger: "designers
of Scorcher, Amok and Into the Shadows" even though Scavenger was
out of business in January, and GT, according to its own
allegations had terminated the contract on March 12, 1997.
Furthermore, GT never wrote off the monies it advanced to
Scavenger under the Scavenger agreement. The payments to
Scavenger should never have been capitalized. However, even if
such capitalization had been justified, the payments should have
been expensed when it became apparent, in 1996, that the
Company's relationship with Scavenger would terminate. If the
advances had been written down in the third or fourth quarter of
1996 or the first quarter of 1997, as required by FASB Statement
No. 86 they would have had a material impact on GT's reported
earnings (see ¶ 19, supra).
Defendants' False and Misleading Information
25. During the Class Period, defendants inflated the
price of GT securities by publicly issuing false and misleading
statements and omitting to disclose material facts necessary to
make defendants' statements, as set forth herein, not false and
misleading. Said statements and omissions were materially false
and misleading in that they failed to disclose material adverse
information and misrepresented the truth about the company.
26. GT's reported financial statements and reported
results for each quarter of the class period violated GAAP for
the following reasons, among others:
a. FASB Statement No. 86, Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed, was violated;
b. The principle of adequacy and fairness of
disclosure was violated;
c. The principle of materiality concerning
information that is significant enough to affect evaluation or
decisions was violated (FASB Statement of Concepts No. 1 and No.
2);
d. The principle that the financial information
presented should be complete was violated (FASB Statement of
Concepts No. 2);
e. The principle that the substance rather than
the form of a transaction should be reflected was violated (FASB
Statement of Concepts No. 2);
f. The principle that items included in the
financial statements be reliably corroborated by outside evidence
(verifiability) was violated (FASB Statement of Concepts No. 2);
g. The principle that the financial statement
should contain and disclose relevant, understandable and timely
information for the economic decisions of the user was violated
(FASB Statement of Concepts No. 2);
h. The principle that the financial statement
provide reliable financial information about the enterprise for
the economic decisions of the user was violated (FASB Statement
of Concepts No. 1 and No. 2);
i. The principle that estimated losses should be
accrued was violated (FASB Statement No. 5);
j. The principles governing interim reporting
was violated (Accounting Principles Board Opinion No. 28).
Defendants' Knowing or Reckless Disregard of the
False and Misleading Financial Statements
27. Defendants' false representations and material
omissions were made with scienter in that: defendants knew or
recklessly disregarded that the public documents and statements
issued or disseminated by GT were materially false and misleading
as described above; knew or were reckless in not knowing that the
false financial results would be issued or disseminated to the
investing public; and knowingly and substantially participated in
the preparation and/or issuance or dissemination of such
statements or documents. The following factors indicate that
defendants made the misrepresentations knowingly or with reckless
disregard for the truth:
a. GT's SEC filings referred to an existing and
ongoing relationship with Scavenger months after Scavenger had
gone out of business, and after GT informally had notified
Scavenger that Scavenger had breached the parties' agreement.
b. Throughout the Class Period, Defendant Cayre
sought to maintain the price of GT common stock so that he could
sell approximately 420,799 direct and 40,000 indirect shares at
artificially inflated prices for net proceeds of approximately $4
million.
28. Defendant Cayre is no stranger to exploiting and
manipulating the stock market for his own profit. The November
12, 1997 issue of the Wall Street Journal article - entitled "The
Spin Desk: Underwriters Set Aside IPO Stock for Officials Of
Potential Customers --- Coincidentally or Otherwise, Work
Frequently Follows For the Investment Bank --- Bribery, or Just
Business?" - contained Defendant Cayre's admission that he had
participated, and even insisted on, the "spinning" of initial
public offering (IPO) shares in "roughly 400" various new issues.
Various investment banks allocated him such shares through his
brokerage account upon trading of the new issue. This practice
resulted in significant profits to him. One such example, was
the $2 million profit that he took in 1995 on 100,000 shares that
Robertson, Stephens allocated to him for the Pilar Animation
Studies IPO. This practice, is at the very least, of
questionable legality. The Securities and Exchange Commission
and the National Association of Securities Dealers are currently
investigating the practice of "spinning" as a violation of the
recipient's disclosure obligations as well as the "corporate
opportunity" doctrine. Defendant Cayre boasted that "[e]very
banker has given me great IPOs."
Inapplicability of Statutory Safe Harbor
29. The statutory safe harbor provided for forward-
looking statements under certain circumstances does not apply to
any of the allegedly false statements pleaded in this complaint.
Many of the statements pleaded herein were not specifically
identified as "forward-looking statements" when made. To the
extent there were any forward looking statements, there were no
meaningful cautionary statements identifying the important then-
present factors that could and did cause actual results to differ
materially from those in the purportedly forward-looking
statements. Alternatively, to the extent that the statutory safe
harbor does apply to any forward-looking statements pleaded
herein, defendants are liable for those false forward-looking
statements because at the time each of those forward-looking
statements was made, the particular speaker knew that the
particular forward-looking statement was false or misleading,
and/or the forward-looking statement was authorized and/or
approved by an executive officer of GT who knew that those
statements were false when made.
30. Any warnings contained in the press releases and
the financial statements quoted herein were generic statements of
the kind of risks that affect any high-tech computer company and
misleadingly contained no specific factual disclosure of any of
the looming problems with GT which placed GT's profitability and
growth at risk.
AS AND FOR A FIRST CAUSE OF ACTION
VIOLATIONS OF SECTION 10(b) OF THE EXCHANGE ACT
AND RULE 10b-5 PROMULGATED THEREUNDER
AGAINST ALL DEFENDANTS
31. Plaintiff repeats and realleges each and every
allegation contained in the foregoing paragraphs as if fully set
forth herein.
32. At all relevant times, the defendants,
individually and in concert, directly and indirectly, by the use
and means of instrumentalities of interstate commerce and/or of
the mails, engaged and participated in a continuous course of
conduct whereby they knowingly and/or recklessly made and/or
failed to correct public representations which were or had become
materially false and misleading regarding GT's financial results
and operations. This continuous course of conduct resulted in
the defendants causing GT to publish public statements which they
knew, or were reckless in not knowing, were materially false and
misleading, in order to artificially inflate the market price of
GT stock and which operated as a fraud and deceit upon the
members of the Class.
33. Defendant GT is a direct participant in the wrongs
complained of herein. The Individual Defendants are liable as
direct participants in and as controlling persons of the wrongs
complained of herein. By virtue of their positions of control
and authority as officers and directors of GT, the Individual
Defendants were able to and did, directly or indirectly, control
the content of the aforesaid statements relating to the Company,
and/or the failure to correct those statements in timely fashion
once they knew or were reckless in not knowing that those
statements were no longer true or accurate. The Individual
Defendants caused or controlled the preparation and/or issuance
of public statements and the failure to correct such public
statements containing misstatements and omissions of material
facts as alleged herein.
34. The Individual Defendants had actual knowledge of
the facts making the material statements false and misleading, or
acted with reckless disregard for the truth in that they failed
to ascertain and to disclose such facts, even though same were
available to them.
35. In ignorance of the adverse facts concerning GT's
business operations and earnings, and in reliance on the
integrity of the market, plaintiff and the members of the Class
acquired GT common stock at artificially inflated prices and were
damaged thereby.
36. Had plaintiff and the members of the Class known
of the materially adverse information not disclosed by the
defendants, they would not have purchased GT common stock at all
or not at the inflated prices paid.
37. By virtue of the foregoing, defendants have
violated Section 10(b) of the 1934 Act and Rule 10b-5 promulgated
thereunder.
AS AND FOR A SECOND CAUSE OF ACTION
VIOLATION OF SECTION 20(a) OF THE EXCHANGE
ACT AGAINST THE INDIVIDUAL DEFENDANTS
38. Plaintiff repeats and realleges each and every
allegation contained in the foregoing paragraphs as if fully set
forth herein.
39. This count is asserted against the Individual
Defendants and is based upon Section 20(a) of the 1934 Act.
40. The Individual Defendants, by virtue of their
office, directorship, stock ownership and specific acts were, at
the time of the wrongs alleged herein and as set forth in Count
I, controlling persons of GT within the meaning of Section 20(a)
of the 1934 Act. The Individual Defendants had the power and
influence and exercised the same to cause GT to engage in the
illegal conduct and practices complained of herein by causing the
Company to disseminate the false and misleading information
referred to above. Moreover, the Individual Defendants owned or
controlled substantial amounts of the Company's stock.
41. The Individual Defendants positions made them
privy to and provided him with actual knowledge of the material
facts concealed from plaintiff and the Class.
42. By virtue of the conduct alleged in Count I, the
Individual Defendants are liable for the aforesaid wrongful
conduct and are liable to plaintiff and the Class for damages
suffered.
PRAYER FOR RELIEF
WHEREFORE, plaintiff demands judgment:
1. Determining that the instant action is a proper
class action maintainable under Rule 23 of the Federal Rules of
Civil Procedure;
2. Awarding compensatory damages as appropriate against
defendants, in favor of plaintiff and all members of the Class for
damages sustained as a result of defendants' wrongdoing;
3. Awarding plaintiff and members of the Class the
costs and disbursements of this suit, including reasonable
attorneys', accountants' and experts' fees; and
4. Awarding such other and further relief as the Court
may deem just and proper.
Jury Demand
Plaintiff hereby demands a trial by jury.
Dated: New York, New York
January 7, 1998
KAUFMAN MALCHMAN KIRBY & SQUIRE, LLP
_________________________________
Jeffrey H. Squire, Esq. (JS 8910)
Ira M. Press, Esq. (IP 5313)
919 Third Avenue, 11th Floor
New York, New York 10022
(212) 371-6600
and
LAW OFFICES OF LIONEL Z. GLANCY
Lionel Z. Glancy, Esq.
Peter A. Binkow, Esq.
Michael Goldberg, Esq.
1801 Avenue of the Stars #308
Los Angeles, California 90067
(310) 201-9150
Attorneys for Plaintiff and the Class
G:\FILES\C1\FILES\GTINTERA\COMP.D29/010798/2:58 pm
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